How Does a Demat Account Work?

Overview

Demat or dematerialised accounts were first introduced in India in 1996 by the National Stock Exchange (NSE). Since then it has revolutionized and transformed securities trading in the country and have made it faster, more secure, efficient and convenient.

Without demat accounts, trading and investing in securities would have not achieved the size, scale and speed that it has reached today. In the current age, we cannot imagine stock and derivatives trading without demat accounts. Indian investors today understand the importance of opening a demat account and it is proven by the fact that there were close to 3.5 crore demat accounts in India in 2018. In the same year, Indian investors opened 40 lakh demat accounts, the highest in a decade.

The popularity of demat accounts show that Indian investors are gradually moving from traditional investment instruments such as gold, real estate and fixed deposits to equities and derivatives. But what is a demat account and how it works?

What is a Demat Account?

A demat or dematerialization account is a system which allows the account holder or investor to store and trade stocks, bonds, ETFs, mutual funds and other securities in electronic form. Earlier stocks and securities were solely available and exchanged as physical certificates which made transactions and storage cumbersome and insecure. However, with the introduction of demat accounts, it reduced the time required for clearing, eliminated fraud cases, attracted more investors and traders, lowered brokerage rates and increased trading volume exponentially, especially in the equity market.

Today, it is mandatory to have a demat account if you want to invest or trade in equities, bonds, ETFs and other securities. The Securities and Exchange Board of India (SEBI) requires every company listed on the stock, derivatives and commodities exchanges to make available their securities in electronic form or demat form.

Benefits of Demat Account

A demat account allows investors and traders to perform electronic trading of stocks, bonds, mutual funds, exchange traded funds, futures, options and commodities. It has several benefits over physical trading of securities, including:

  • Faster and easy discovery of price of any security
  • No risk of losing or damaging physical certificates in storage or transportation
  • Enables technical and fundamental analysis of securities
  • Ensures faster clearing and settlement of transactions by clearing houses
  • Eliminates the risk of forged and fake share certificates
  • Reduced cost of transactions
  • No paperwork required for transfer of securities
  • Updating change of address is fast and easy as the change occurs simultaneously with the DP and the companies from where you buy the securities

How a Demat Account Works?

A demat account works similar to a savings bank account. While in a savings account, you can store cash in electronic form with a bank, in a demat account, you can store securities with a depository participant (DP) affiliated to the NSDL. The demat account allows you to hold shares and securities of various companies electronically. When you buy shares or securities, those are credited to your demat account and debited when you sell them.

We hope that now you have a better understanding of what is a demat account and how it works, and its benefits. Let’s get into some technical details now.

Participants in the Demat Account Opening Process

Demat accounts were made mandatory for trading in securities when the Depositories Act was passed in 1996. In the same year the National Securities Depository Limited (NSDL) came into existence as the largest repository of electronic securities in the country. After 3 years, in 1999, the Central Depository Services Ltd. (CDSL) was formed.

NSDL and CDSL are the two depositories in India formed under the Company Act, 1956 and registered by the SEBI. These two depositories have the authority to enrol agents known as depository participants (DPs) to provide demat services to Indian investors.

There are 3 key players in the demat account opening process. First, is your bank; second is the DP; and third is the main depository.

  • Bank – It is mandatory for you to link your savings bank account with the demat account as the money is used from your bank account to buy the securities. Once the securities are bought, they are then credited to your demat account. When you sell them using a trading account, it is deducted or debited from your demat account.
  • Depository participant (DP) – You need to approach a DP before opening a demat account. A depository participant can be a non-banking financial institution, a bank or a broker that has been authorised by the NSDL or CSDL to handle demat accounts on their behalf.
  • Depository – Depositories such as the NSDL and CSDL are responsible for maintaining the demat accounts and are key to the demat account opening process. While the DP has the authority to make transactions and update your demat account and acts as an intermediary between the depository and you (demat account owner), the depository holds the demat account in your behalf.

Dependencies with Trading and Savings Accounts

Demat, trading and savings accounts are different in how they function but they work together to provide you maximum benefits. These three types of accounts must be interlinked before you invest or trade in debt or equity assets.

A savings bank account is the first thing that you need to have to open a demat account. Once you buy the securities which are funded from your bank account, it’s credited to your demat account that holds these securities for you. However, if you want to sell and buy these securities frequently as a trader, you also need a trading account. Nowadays, most brokers provide a trading account along with a demat account so you don’t have to worry about first opening a demat account, and then getting a trading account. Once you have a 2-in-1 demat and trading account, you can link both of them to your savings bank account and start trading in equities, commodities, derivatives, mutual funds and currencies.

How to Choose the Best Demat Account?

Before opening a demat account, you must know how to evaluate the features and benefits of an ideal demat account. If you are looking for the best demat account in India, here are a few pointers to help you move in the right direction.

Things to Consider Choosing Best Demat Account

Simple Demat Account Opening Process

Simplicity is definitely a virtue when opening a demat account. SEBI provides a detailed process for opening a demat account but a lot rests on your broker to further simplify that process. Since demat accounts uses a digital method the entire demat account opening process should be carried out online.

Your depository participant (DP) should provide an e-KYC process that can be undertaken online by only using your Aadhar data. While the entire verification and documentation process is done through the internet, the DP should also be able to perform self-identification through online video mode. Also, check how soon you can start trading after opening a demat account – the sooner the better. Some DPs allow you to trade within an hour while some may ask you to wait for a few days. Ensure that your broker provides a fast, easy and transparent account opening process.

Low Demat Account Charges

Today, most DPs, banks and financial institutions do not charge customers for opening a demat account. However, there are operational costs associated with a demat account that you need to take into consideration.

For instance, you will have to incur the following charges to maintain a demat account:

  • Annual maintenance charge (AMC)
  • Transaction fees charged every time securities are debited from your demat account
  • Charges on rejection of Debit Instruction Slip (DIS)

Opt for demat accounts with zero AMC and reasonable charges. If you are a first time investor, you can also take advantage of attractive offers carried out by brokers, banks and financial institutions. If you want to just test the waters and are fine with limited privileges, you can open a Basic Services Demat Account (BSDA) that only provides the bare essentials at reduced costs.

Easy to Access and Operate

Investing and trading should be a seamless process with your demat, trading and savings bank account. It is essential that linking between the demat, trading and bank account is hassle free and easy for smooth transactions. Therefore, it is best to go for a 2-in-1 Demat and Trading account that provides seamless integration with your savings bank account.

When you are trading in shares, a minor delay can lead to losses, therefore fast and easy integration is vital. Also, ensure that your DP provides a mobile app that allows you to track, update and transact on the go. Another point to check is the online and mobile interface of the demat and trading account provided by your broker or DP. The interface should be responsive, easy to understand and bug-free.

Investing Insights and Data Analysis

Whether you are first-time or a seasoned investor, data analytics is vital to your investment success. Today, DPs have moved over plain vanilla demat accounts and have upgraded themselves to provide an array of financial insights and data analytic services to clients.

To take advantage of these value-added but crucial services, choose a DP that provides you these services with reasonable charges. You should enquire whether they provide timely alerts, direct call-to-action requests, demat inflow and outflow analytics, real-time valuation, portfolio performance analysis, etc.

Before you open a demat account, be careful to learn about all these factors and maximize your returns and protect your investments. A demat account and trading account is as essential as a bank account today to take advantage of India’s thriving financial markets. Don’t lose on this opportunity and open a demat account today to kick-start your investment journey.

With IIFL and Demat Trading account, you get access to the industry’s best trading platform and regular personalised portfolio analysis. IIFL is one of the few brokers which provide demat services of both NSDL and CDSL. Client investing with IIFL can use proprietary TT EXE, TT web (desktop) and IIFL markets app for transactions. For HNI clients, we provide dedicated experienced RMs to help in execution and advice.

Open Demat Account at IIFL