Repurchase Agreement (Repo)
A repurchase agreement, or repo, is a short-term loan structured as a sale: one party sells securities for cash and agrees to buy them back later at a slightly higher price. The securities are the collateral and the price difference is the interest.
Also called: repo · repos · repo market · reverse repo · reverse repurchase agreement · sale and repurchase agreement
Most repos are overnight and most use government bonds. The cash lender, for whom the trade is a reverse repo, holds the securities until the cash comes back, and can sell them if it does not. The lender usually advances a little less than the securities are worth; that margin is the haircut.
Repo is the main way dealers, hedge funds and other institutions finance their securities holdings, and one of the main places where money market funds, corporate treasuries and central banks place cash safely. Central banks use repo and reverse repo operations to steer short-term interest rates. The market turns over trillions of dollars a day.
It is also where modern runs occur. A borrower that depends on rolling its repo every morning is in trouble the day lenders decline to renew or demand larger haircuts, which is what happened to several firms in 2008. See shadow banking. Treasuries holding large balances, stablecoin issuers among them, use reverse repo as a secured alternative to leaving cash on deposit at a bank.
In practice
Whether a repo fully protects the cash lender depends on the legal agreement, the quality of the collateral and who holds it. Tri-party and cleared repo reduce, but do not eliminate, those risks.
Example
A fund sells US$10 million of Treasury bills to a dealer today for US$9.9 million and agrees to buy them back tomorrow for US$9.9014 million. It has borrowed overnight at about 5 percent a year, with a 1 percent haircut.
Commonly confused with
| Term | How it differs |
|---|---|
| FX swap | A repo exchanges cash for securities and back. An FX swap exchanges one currency for another and back. Both are secured short-term funding. |
See also
- HaircutA haircut is the percentage by which a lender discounts the market value of collateral when deciding how much to lend against it. A 2 percent haircut means US$100 of securities supports a loan of US$98.
- Shadow BankingShadow banking is credit intermediation carried out by institutions and markets outside the regular banking system: money market funds, finance companies, hedge funds, securitisation vehicles and repo markets doing what banks do without bank licences, deposit insurance or central bank backing.
- Money Market FundA money market fund (MMF) is an investment fund that holds short-term, high-quality debt such as Treasury bills, repo and commercial paper, and aims to keep a stable value while offering daily access. Investors use it like a deposit, but it is not one.
- FX SwapAn FX swap is a contract in which two parties exchange two currencies today and agree to reverse the exchange on a set future date at a rate fixed now. In economic terms it is a loan of one currency secured by another.
- Bank RunA bank run is a rush by depositors or other short-term creditors to withdraw their money from an institution because they fear it will fail. Because no bank holds enough liquid assets to repay everyone at once, the rush itself can cause the failure.
- Maturity TransformationMaturity transformation is the practice of funding long-term, illiquid assets with short-term liabilities that can be withdrawn or must be renewed quickly. It is the core economic function of banking and the source of its fragility.