If you hold shares in your Demat account and wish to utilize their value without selling them, it is essential to understand the concept of Collateral Amount in a Demat account. Many people mistake the collateral amount for the account balance, whereas the two are distinct. In this article, we will explain in simple terms how collateral works, where it is used, its benefits, and the key points to consider when utilizing it.
What Is Collateral Amount In Demat Account?
What is the collateral amount in a Demat account? It refers to the margin value you receive upon pledging eligible shares, ETFs, mutual funds, or other approved securities. This amount is not credited to your bank account as cash; instead, it appears as a trading margin. It can be utilized for MTF, Futures & Options (F&O), or other margin trades, subject to the broker’s policy and applicable exchange regulations.
How does it work?
When you pledge your eligible shares for margin, they are not sold, and you retain ownership of them. Once the pledge is complete, the broker assigns a collateral value calculated after deducting a haircut which can be used for MTF, Futures & Options (F&O), or other permitted margin trades.
Example: Suppose you hold eligible shares worth ₹2 lakh in your Demat account and suddenly require additional margin for trading. Instead of selling the shares, you can pledge them for margin. The broker then provides you with collateral value against these shares in accordance with established rules which you can use for permitted trades. This allows you to retain your investments without needing to sell them.
Why Do Brokers Ask For Collateral?
Brokers request collateral to safely provide trading margins to investors. This allows investors to access additional trading facilities without selling their existing investments, while also keeping the broker’s risk under control.
- To provide trading margin: If an investor wishes to engage in additional trading, the broker provides margin by accepting eligible shares or other approved securities as collateral. This eliminates the need for the investor to inject fresh funds every time.
- To mitigate broker risk: When a broker extends margin to an investor, the collateral serves as security. In the event of a sudden market downturn or if the investor fails to maintain the required margin, the collateral helps mitigate the broker’s risk.
- To facilitate Margin Trading Facility (MTF): Under MTF, the broker provides funds for purchases on behalf of the investor. Consequently, the broker requires collateral to ensure there is adequate security backing the funds provided.
- To meet margin requirements for Futures & Options (F&O): In Futures & Options (F&O) trading, maintaining the margin prescribed by the exchange is mandatory. Eligible collateral can help cover a portion of this margin, although cash margin may also be required in certain cases.
- To comply with SEBI and exchange regulations: SEBI and stock exchanges have established clear regulations regarding margins and risk management. In accordance with these rules, brokers accept only eligible securities as collateral and provide margin after applying the prescribed ‘haircut’ to them.
How Does Collateral Work In A Demat Account?
The process of creating collateral in a Demat account is completed in a few simple steps.
Step 1: Select Eligible Shares
First, your Demat account must hold shares or other securities that are included in the broker’s and exchange’s collateral list. Collateral benefits are available only on eligible securities.
Step 2: Pledge for Margin
Next, submit a margin pledge request for those shares via your trading app or the broker’s platform. Once approved, the shares remain in your name but are marked as collateral.
Step 3: Haircut Application
After the pledge is processed, the broker applies a specific ‘haircut’ to each security. This determines the value used for collateral purposes.
Step 4: Collateral Value Realized
The value remaining after the haircut is applied appears as ‘Collateral Value’ in your trading account. Note that this amount is not cash.
Step 5: Utilize the Margin
You can now use the available collateral value for MTF, Futures & Options (F&O), or other permitted margin trades, subject to the broker’s policies.
Read Also: MTF Pledge Explained
Collateral Amount Explained With A Real Example
Suppose you hold eligible shares worth ₹2,00,000 in your Demat account and pledge them for margin. If a 20% haircut applies to those shares, the collateral value would be calculated as follows.
| Description | Amount |
|---|---|
| Total value of eligible shares | ₹2,00,000 |
| Haircut | 20% (₹40,000) |
| Available Collateral Value | ₹1,60,000 |
| Trading Margin | ₹1,60,000 |
Calculation:
- ₹2,00,000 × 20% = ₹40,000 (Haircut)
- ₹2,00,000 − ₹40,000 = ₹1,60,000 (Collateral Value)
What Is Haircut In Collateral?
When accepting collateral, a broker does not provide a margin based on the full market value of your shares. This reduction is known as a “haircut,” and it is determined based on risk.
What does “haircut” mean?
A haircut is the percentage that a broker or exchange deducts from a security’s market value to determine its collateral value. Its purpose is to mitigate the risk associated with sudden market fluctuations.
Why does the haircut vary for different shares?
Not all shares share the same level of risk and liquidity. Shares prone to high price volatility may attract a higher haircut, whereas relatively stable and highly liquid shares typically have a lower haircut.
How does a haircut affect collateral value?
The higher the haircut, the lower the collateral value you receive. This means that two shares with the same market value could yield different available margins if they are subject to different haircuts.
| Share Value | Haircut | Collateral Value |
|---|---|---|
| ₹1,00,000 | 10% | ₹90,000 |
| ₹1,00,000 | 25% | ₹75,000 |
Which Securities Can Be Used As Collateral?
Only those securities are valid as collateral that are included in the eligible collateral lists of SEBI, stock exchanges, and the broker.
| Security | Availability as collateral |
|---|---|
| Eligible Equity Shares | Available on most eligible shares |
| Exchange Traded Funds (ETFs) | Available on many eligible ETFs |
| Mutual Fund Units | Available on select eligible schemes. |
| Government Securities (G-Secs, T-Bills) | widely available |
| Sovereign Gold Bonds (SGBs) | Available through some brokers |
| Corporate Bonds / Debt Securities | Available on eligible bonds |
| Gold ETFs | Available through several brokers |
| Unlisted Shares | Not valid as collateral |
| Non-Eligible or Restricted Shares | Not valid as collateral |
Difference Between Cash Margin And Collateral Margin
The purpose of Cash Margin and Collateral Margin is to provide margin for trading, but the mechanism for each is different.
| Base | Cash Margin | Collateral Margin |
|---|---|---|
| Source of margin | Cash deposited into the bank account | Pledged Eligible Securities |
| Requirement for cash | The full amount has to be deposited in cash. | You can get margin even without depositing additional cash. |
| Haircut | Not applicable | come into force |
| Impact of Market Value | The cash value remains stable. | The collateral may also change if the value of the securities changes. |
| Use | Useful for all types of margins. | For trades permitted by the broker and in accordance with the rules |
| Better for whom? | New investors and low-risk takers | Active traders who invest for the long term |
Where Can You Use Collateral Amount?
Collateral cannot be used universally; its utilization is determined by the broker’s policies and applicable exchange regulations regarding specific trading facilities.
- Futures Trading: Collateral can be used to meet a portion of the margin requirement in futures trading.
- Options Selling: Options selling requires margin; eligible collateral can help increase the available margin.
- Margin Trading Facility (MTF): Under MTF, collateral can be utilized to gain additional buying power.
- Intraday Trading: Some brokers offer collateral margin facilities for intraday trading as well, subject to their policies.
- Portfolio Funding: The value of long-term investments can be utilized as trading margin without having to sell the holdings.
Benefits Of Using Collateral In Demat Account
Investors can derive several practical benefits from the effective use of collateral.
- No need to sell investments: Collateral allows you to utilize the value of your eligible shares without selling them. This ensures your long-term investment remains intact.
- Better utilization of capital: Instead of deploying additional cash, you can use the value of your existing portfolio as margin. This leads to more efficient capital utilization.
- Access to additional trading margin: Having collateral available provides access to extra margin when needed, thereby increasing your buying power for trading.
- Continued receipt of corporate benefits: Pledging shares does not alter their ownership. Consequently, you continue to receive corporate benefits such as dividends, bonus shares, and rights issues where applicable.
- Investments remain active: Your portfolio remains invested even after being pledged as collateral. This means your investment stays intact while its value is simultaneously utilized for margin purposes.
Read Also: Joint Demat Account: Meaning, Features, Benefits, and Steps
Risks Of Using Collateral
Using collateral can be beneficial, but it also entails certain risks.
- Market Decline: If the value of pledged securities falls, their collateral value may also decrease.
- Increase in Haircut: Haircut rates may change based on market conditions or regulations, potentially reducing the available margin.
- Margin Shortfall: If the available margin falls below the required level, the broker may ask you to deposit additional margin.
- Forced Square-Off: If the margin requirement is not met on time, the broker may square off your open positions to mitigate risk.
- Interest on MTF: If you use the Margin Trading Facility (MTF), you may be required to pay interest charges on the funds provided by the broker.
Conclusion
Once you understand the concept of collateral amount in a Demat account, it becomes clear that you can utilize the value of your investments without actually selling them. If collateral is used prudently and in accordance with the rules, it can prove to be a useful option for effective capital management in trading.
Frequently Asked Questions (FAQs)
What is collateral amount in a Demat account?
It is the trading margin received in exchange for pledged securities.
Is the collateral amount real cash?
No, it is not cash but trading margin.
Can I withdraw the collateral amount?
No, it cannot be withdrawn.
Do pledged shares remain in my Demat account?
Yes, the shares remain in your Demat account.
Can all shares be used as collateral?
No, only eligible shares can be used.
