Overview

In finance, a haircut is the difference between the current market value of an asset and the value ascribed to that asset for purposes of calculating regulatory capital or loan collateral. The amount of the haircut reflects the perceived risk of the asset falling in value in an immediate cash sale or liquidation. The larger the risk or volatility of the asset price, the larger the haircut.

For example, United States Treasury bills, which are relatively safe and highly liquid assets, have little or no haircut, whereas more volatile or less marketable assets might have haircuts as high as 50%.

Lower haircuts allow for more leverage. Haircut plays an important role in many kinds of trades, such as repurchase agreements (referred to in debt-instrument finance as "repo" but not to be confused with the concept of repossession denoted by that term in consumer finance) and reverse repurchase agreements ("reverse repo" in debt-instrument finance).

SEC net capital rule

"Haircut" since has been extended to a number of other financial contexts, whenever it is desirable to show that some securities (typically debt securities) are being valued for some purpose at a discount.

ECB use of haircuts

The European Central Bank applies a haircut to all securities offered as collateral. The size of the haircut depends on the riskiness and liquidity of the security offered as collateral.

LTCM and haircut fees

The hedge fund Long Term Capital Management (LTCM) saw spectacular losses that led to its dissolution in 1998. It had previously been able to trade with little collateral on positions that were considered safe by its lenders.

As used for exchange-traded products

When used in the context of exchange traded products such as stocks, options, or futures, haircut is used interchangeably with the term margin. It is the amount of capital required by a broker to maintain the positions currently in a trading account. If haircut exceeds the account's capital, the broker can either require additional capital (e.g., margin call), or liquidate positions until the haircut no longer exceeds available capital.