Introduction:
In the earlier days, companies issued their shares and bonds as physical certificates. Buying and holding shares in physical format was a lengthy and burdensome process. Sometimes, people may buy fake share certificates, it’s like exchanging our services with fake currency bills.
To find the solution for such complications, the physical share and other security certificates are converted into electronic format; this process is called Dematerialization. A Demat account is used to store the securities such as shares, bonds, etc. in electronic or Dematerialized form. The converse of this process, electronic form to physical format, is called Rematerialization.
Nowadays, a Demat account is compulsory for anyone who wants to invest or trade shares and other securities in a stock market. It is also easier to trade using Demat account from anywhere, a person sitting at home can buy and sell shares. This increases the accessibility and safety of the securities.
A Demat account is similar to your savings account in the bank where you hold your savings and cash deposits. Instead of cash, you save shares and other securities in the Demat account. The securities such as Equity Shares, Mutual Funds, ETF Funds, Index Funds, Debt Funds, Government and Corporate Bonds, etc. could be bought and held in a Demat account.
In India, the Demat accounts and electronic trading started in 1996 after the introduction of the depository system by the Depository Act of 1996, under the regulation of SEBI.
Depositories:
A Depository is an institute with a huge collection of already verified shares held in electronic mode that offers efficient settlement of transactions made through Demat accounts. Nowadays, a 2-in-1 Demat Account and a Trading Account in the association of depository and depository participant like a stockbroker is provided to the client (investor or trader) .
National Securities Depository Limited(NSDL) and Central Depository Services Limited(CDSL) are two leading depositories in India. These depositories maintain all the Demat accounts. As of January 2023, there are around 11 crore or 110 million demat accounts in India.
Depository Participant:
Depositary Participant is an intermediary that connects the investor and the depository. These intermediaries carry out the actions in various securities at the depository on behalf of their clients (traders or investors). Commonly, any financial organizations like banks, stockbrokers, fund houses, non-banking financial companies, etc. could be depository participants. Every depository participant has a unique identification number registered with SEBI.
Advantages of Demat account:
- A simple way to hold securities that even an inexperienced user can do.
- Much safer than physical certificates because fake securities, delays, thefts, etc. are eliminated.
- Reduced paperwork makes it easier and appropriate for issuers (companies) for the transfer of securities. This process also reduces transaction cost.
- There is no need for the investor to acknowledge every change like a bank account, address, etc. to all the issuers of shares held in his/her Demat account; the depository participant takes care of that.
- The depository participant conducts the transfer of securities, and hence, there is no need for notifying the respective companies.
- The dividends, bonus or split issues of securities are credited directly into Demat accounts and linked Bank accounts.
- Only one Demat account is enough for holding both equity and debt instruments.
- Last, but not least, it gives the traders the freedom to participate in trading and investing from anywhere, even from home. A computer, laptop, or any other device with an internet connection and installed applications are enough to start trading.
Disadvantages:
- Dematerialized securities might cause uncontrolled trading of securities.
- The market regulator has to keep a strict vigilance on the trading in dematerialized securities since availability and accessibility of securities has increased exponentially.
- The need for the supervision of market participants is high since the participants such as stockbrokers and operators can manipulate the security prices in the stock markets.
- The agreements made during the initialization of Demat account and process of dematerialization is very long and elaborate, which a juvenile investor would find very difficult to understand.
- A Demat account with dormant shares could not be closed, therefore, the investor has to continue paying the charges such as maintenance fees, portfolio charges, etc. to the participant.
- The depositories can charge maintenance and other fees even on dormant accounts.
Caution:
There is a possibility of depository participants to involve in unscrupulous activities like pledging the shares belonging to the dormant Demat accounts of clients as collateral for securing the loans from Banks and other financial institutions. This is what happened with Karvy Stock Broking in 2019; this brokerage firm used ₹2300 crore worth shares from the Demat accounts of their 95000 clients for securing the loans from Banks and used the cash for their own financial investments.
Here is an article covering the Karvy Demat Scam
Summary:
So you need a Demat account to start investing in securities either equity(shares) or debt(bonds). A Demat account is like a bank account but holds securities instead of cash. Securities are converted from the physical form like certificates to electronic form; this process is known as Dematerialization. The Demat account is linked to a Depository that holds the bulk collection of electronic shares. The Demat account holder and Depository are connected through an intermediary, Depository Participant like a stockbroker.
Disclaimer:
I provide the information and my views on the website only to educate new investors, stock market enthusiasts, and the common public on equity or stock market investments. Please consult your financial adviser before making any investments in the stock market. In case of any queries, you can contact me via email ID or Contact Form.
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