Haircut - Financial definition
Concise definition of the term haircut
Haircut is a percentage that is subtracted from the market value of an asset which is being used as collateral in a transaction. The level of the haircut reflects the asset's riskiness. The riskier an asset is, the higher the applied haircut will be.
Comprehensive definition of the term haircut
Haircut is commonly used in many financial operations where collateral is being used, like for example securities lending.
Even if the lender of the cash receives securities as a guarantee, and margin calls are made periodically, he still has a risk the importance of which
will depend on the counterparty and the evolution of the collateral's market price.
The haircut is thus an additional way of reducing the risk of loss in the event of default by the counterparty.
The haircut is thus an additional way of reducing the risk of loss in the event of default by the counterparty.
A haircut of 5% would mean for example that, for collateral with a market value of 10 million euros, the borrower can receive a loan of 9.5 million euros.
As stated above, the percentage of the haircut is determined by both the counterparty's credit quality and the market risk of the collateral.
Thus, the haircut for a loan guaranteed by triple-A rated government bonds will be lower than for a loan collateralized by an equity portfolio.
It will also be different for a tier-one international bank and for a tiny regional bank.Thus, the haircut for a loan guaranteed by triple-A rated government bonds will be lower than for a loan collateralized by an equity portfolio.