What is a Demat Account and Why You Need One?

Wondering what is a Demat account? Well! it's short for Dematerialized Account and it allows investors to hold shares and other securities in an electronic format. This account is a mandatory requirement to invest in the Indian stock market. When investors buy and sell shares they are debited/credited from their Demat account.

Legal Framework of Demat Accounts

The Indian government introduced the concept of Demat accounts through the Depositories Act of 1996. The act aimed to simplify the process of trading shares electronically and to solve problems such as handling paperwork, delays, and forgery.

Following the Depositories Act, two main depositories were established, the National Securities Depository Limited (NSDL) in 1996 and the Central Depository Services Limited (CDSL) in 1998. The purpose of these depositories is to hold securities in electronic form and facilitate transactions.

Types of Demat Account

There are mainly three types of Demat accounts. Each account caters to different categories of investors:

1. Regular Demat Account

It's the standard form of Demat account for individuals living in India. Indian residents can hold shares and other securities in electronic form using this account.

2. Repatriable Demat Account

A Repatriable Demat Account is for non-resident Indians (NRIs). It enables them to invest in the Indian stock market and gives them the option to transfer their investment returns abroad. This account must be linked to a repatriable NRE (Non-Resident External) bank account. NRIs can transfer up to one million US dollars annually.

3. Non-Repatriable Demat Account

A non-repatriable demat account also caters to non-residential Indians. However, the primary difference between repatriable and non-repatriable accounts is that the holder of this account cannot transfer funds abroad. It is linked to a Non-Resident Ordinary account, and the funds remain in Indian banks.

Difference Between a Demat & Trading Account

A Demat account is like a bank account for your securities. It holds all the shares, bonds, government securities, mutual funds, and exchange-traded funds that you own in an electronic form. Whereas a trading account is for actively buying and selling shares and securities in the stock market. It acts as an intermediary that facilitates the trading.

So a trading account is essential for executing trades in the stock market. Without a trading account, it is not possible to buy or sell securities. Likewise, a Demat account is essential for having an electronic record of the holdings.

These two accounts link to each other so when investors purchase shares they are automatically credited to the Demat account. Conversely, when they sell shares, they are debited. There is also a settlement cycle that is typically T+2 working days, where T is the trading day. So it's only after the settlement period, that the system debits or credits shares from the Demat account.

Benefits of Demat Account

The following are some of the benefits of Demat accounts.

1. Demat accounts eliminate risks such as loss, theft, or damage. Securities in electronic form are much safer and easier to maintain.
2. Handling of securities is more convenient and efficient. Transactions execute faster than physically trading shares.
3. The account significantly reduces various costs of electronic holdings including stamp duty and handling charges.
4. Investors can easily track and manage their portfolios online through a single account.
5. The account facilitates faster settlement cycles leading to quicker execution of buying and selling of securities.

Drawbacks of Demat Account

There are also some drawbacks to having this account.

• There are certain fees to operate the account including the account opening fees, annual maintenance fees, custodian charges, and transaction fees.
• Typically, the account opening process is quite complicated, especially for new investors.
• Investors do not physically hold the shares, which can make it difficult to verify assets in case of disputes.
• The account requires intermediaries to process transactions, which leads to additional fees.

How To Open a Demat Account

Various financial institutions including banks such as HDFC bank and brokerage firms like Zerodha offer Demat accounts. To open an account, investors may visit the branch or apply online. Indian residents must meet certain eligibility criteria. The applicant must be a resident individual and provide one of the identity documents such as a PAN card, Aaadhar card, or passport. Other required documents include proof of a bank account and recent passport-size photographs.

For derivative trading, applicants may also need to provide income proof which is a salary slip or income tax returns. Following RBI and FEMA guidelines, non-resident Indians are required to submit a valid passport copy or PIO/OCI card.

Final Words

Hopefully, now you understand what a Demat account is and how it works. If you are just starting your trading journey,  make sure to explore the top brokers in India to open an account.