Haircut

A haircut is a percentage reduction applied to the market value of collateral to account for price volatility, liquidity risk, and potential losses during liquidation. Haircuts are widely used in secured lending, derivatives margining, and repo transactions to protect the lender or clearinghouse.

For example, if oil futures are posted as collateral, a clearinghouse may apply a haircut to reflect the risk that prices could fall before the collateral is liquidated. More volatile or less liquid assets typically receive higher haircuts. In energy markets, haircuts are adjusted based on market conditions, stress scenarios, and historical volatility.

Haircuts play a critical role in systemic risk management. By requiring excess collateral, they reduce counterparty risk and help ensure market stability during periods of stress. However, rising haircuts can also tighten liquidity, forcing market participants to post additional collateral or unwind positions, potentially amplifying market moves.