Definition:
A haircut is the percentage by which the value of an asset is reduced when it is accepted as collateral. It acts as a safety buffer for lenders against potential declines in the asset's price. Generally, the riskier or more volatile the asset, the larger the haircut applied.
What is the meaning of a “haircut”?
A haircut in finance is the percentage by which the market value of an asset is reduced when determining its value for lending, collateral, margin, or risk-management purposes.
The idea is simple: an asset may be worth ₹100 today, but if its price falls tomorrow and the borrower defaults, the lender may not be able to recover the full ₹100 by selling it. To protect against this risk, the lender does not treat the asset at its full market value.
Suppose you own shares worth ₹100 lakh and want a loan against them. If the lender applies a 20% haircut, it will recognize only ₹80 lakh as collateral value. The remaining ₹20 lakh acts as a safety buffer against price declines, liquidity issues, and selling costs.
So, does the asset's value fall when a haircut is applied to it?
Nope.
The lender does not “take away” ₹20 lakh from you. The shares are still worth ₹100 lakh in the market. The haircut only determines how much value the lender is willing to recognize for risk purposes.
The size of the haircut depends on:
Price volatility: Assets whose prices move sharply can lose value quickly, so they receive higher haircuts.
Liquidity: Assets that are difficult to sell quickly receive higher haircuts.
Credit quality: Safer assets receive lower haircuts.
Market conditions: During crises, lenders often increase haircuts because uncertainty rises.
Meaning of haircut in debt restructuring
In debt restructuring, a haircut is the percentage of money that a lender, creditor, or bondholder agrees to give up when a borrower cannot repay the full amount owed.
In other words, the creditor accepts receiving less than the original debt.
Suppose a company borrowed ₹100 crore from a bank. The company runs into financial trouble and can realistically repay only ₹60 crore. Rather than forcing bankruptcy and potentially recovering even less, the bank may agree to accept ₹60 crore as full settlement.
The bank is giving up ₹40 crore.
So, here Haircut = Amount Forgiven ÷ Original Debt
Haircut = ₹40 crore ÷ ₹100 crore = 40%
So when news reports say, “Banks took a 70% haircut on the loan,” it means the banks recovered only 30% of the amount they were originally owed and wrote off the remaining 70%.
Definition:
A haircut is the percentage by which the value of an asset is reduced when it is accepted as collateral. It acts as a safety buffer for lenders against potential declines in the asset's price. Generally, the riskier or more volatile the asset, the larger the haircut applied.
What is the meaning of a “haircut”?
A haircut in finance is the percentage by which the market value of an asset is reduced when determining its value for lending, collateral, margin, or risk-management purposes.
The idea is simple: an asset may be worth ₹100 today, but if its price falls tomorrow and the borrower defaults, the lender may not be able to recover the full ₹100 by selling it. To protect against this risk, the lender does not treat the asset at its full market value.
Suppose you own shares worth ₹100 lakh and want a loan against them. If the lender applies a 20% haircut, it will recognize only ₹80 lakh as collateral value. The remaining ₹20 lakh acts as a safety buffer against price declines, liquidity issues, and selling costs.
So, does the asset's value fall when a haircut is applied to it?
Nope.
The lender does not “take away” ₹20 lakh from you. The shares are still worth ₹100 lakh in the market. The haircut only determines how much value the lender is willing to recognize for risk purposes.
The size of the haircut depends on:
Price volatility: Assets whose prices move sharply can lose value quickly, so they receive higher haircuts.
Liquidity: Assets that are difficult to sell quickly receive higher haircuts.
Credit quality: Safer assets receive lower haircuts.
Market conditions: During crises, lenders often increase haircuts because uncertainty rises.
Meaning of haircut in debt restructuring
In debt restructuring, a haircut is the percentage of money that a lender, creditor, or bondholder agrees to give up when a borrower cannot repay the full amount owed.
In other words, the creditor accepts receiving less than the original debt.
Suppose a company borrowed ₹100 crore from a bank. The company runs into financial trouble and can realistically repay only ₹60 crore. Rather than forcing bankruptcy and potentially recovering even less, the bank may agree to accept ₹60 crore as full settlement.
The bank is giving up ₹40 crore.
So, here Haircut = Amount Forgiven ÷ Original Debt
Haircut = ₹40 crore ÷ ₹100 crore = 40%
So when news reports say, “Banks took a 70% haircut on the loan,” it means the banks recovered only 30% of the amount they were originally owed and wrote off the remaining 70%.