What is Dematerialization?
Introduction to Dematerialization
Dematerialization is all about converting your physical shares and securities into
digital or electronic form. The idea is to simplify the entire process of buying,
selling, transferring and holding shares and also about making it cost-effective
and foolproof. In order to understand the importance of dematerialization, one needs
to grasp the benefits of dematerialization and the
benefits of a demat account. Let us focus on what is a demat account and
what is dematerialization at the outset
Demat account is an account where you hold shares and other securities in custody.
A demat account is somewhat like a bank account, the only difference being that
in a bank account you hold funds and in a demat account you hold shares and other
securities. Dematerialization, on the other hand, is a process. It is the process
of converting your physical shares into dematerialized shares and holding it in
an electronic form instead of physical certificates.
Dematerialization and the drawbacks of the physical shares model
Before the concept of demat was first introduced by SEBI in 1997, shares were held
in the form of share certificates. It was quite cumbersome. One had to safely keep
the share certificates in custody and ensure that it does not get lost or mutilated.
When the shares were purchased through a broker, the broker would give you the share
certificates in the name of the seller with the transfer form attached to it. The
buyer would have to send the certificates along with the transfer form to the company’s
registrar to get new certificates printed with their names. The entire process would
take more than a month and involved a lot of risks. Certificates could get lost
in transit, they could get misplaced or they could get mutilated. Quite often, the
transfer form got rejected because the signature in the transfer form did not match
with the signature in the company’s records. It is to overcome all these problems
that dematerialization was introduced in 1997.
Demat; trading account and banking are linked in a seamless loop
Your trading activity is a combination of your purchases and your sale. However,
trading is not just about trades but also payments and custody of shares. This is
how it works. When you buy shares in the trading account, the account has to be
pre-funded or you have to pay from your bank account by T+1. Then on T+2 day the
shares get credited to your demat account. When you sell shares, then the demat
account gets debited on T+1 day to the extent of shares sold and the net amount
(after costs) gets credited to your bank account on T+2 day. That is how the relationship
Rapid progress in dematerialization due to inherent advantages
Currently, more than 99% of all shares available in India are already dematerialized
and 100% of the settlement in the exchanges on a daily basis take place in demat
mode only. It has made the process of buying, selling and transferring shares easier,
quicker, safer and virtually seamless if you have an online trading and demat account.
Three facets of dematerialization
What we talk of demat, there are three facets we need to understand to get a complete
360o perspective of the demat process…
- First step is the dematerialization of physical shares. This is the first phase
when the physical shares held are sent to the DP for dematerialization along with
the demat request form (DRF). In case the certificates are not in your name, then
you can send the share certificates to the DP along with a transfer-cum-demat form.
- The second facet is the trading and settlement in demat form. That is the model
that exchanges follow today. All trades are executed and settled in demat form only.
You buy in demat, sell in demat and the trades get aggregated and settled by the
exchange in demat form. This also has important implications for IPO allotments
since they are done directly in demat form as credits to your demat account. When
you buy shares in the trading account, these shares get credited in demat mode into
your trading account on T+2 day. Similarly, when you sell shares in demat mode,
then the shares get debited to your demat account on T+1 day.
- The third facet of dematerialization is handling the corporate actions and data
updates to your demat account. Bonuses and splits are automatically credited to
your demat account based on the number of shares held by you on the record date.
In case of dividends, the data on ownership on record date is downloaded to the
registrar and the dividends are automatically credited to the mandated bank account.
The demat account is also used to centrally make changes to the customer’s details
like address, mobile phone, bank mandate and signature
Dematerialization is the process of converting your physical shares into an electronic
form as well as trading and settling trades in demat form. It is one of the key
pillars of modern capital markets.