What is Repo Rate and Reverse Repo? Meaning and Differences

The Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) last revised the key repo rate on February 8, 2023, increasing it by 25 basis points from 6.25% to 6.50%. This marked the fourth consecutive repo rate hike by the MPC since the tightening cycle commenced in May 2022. A whole loan repo is a form of repo where the transaction is collateralized by a loan or other form of obligation (e.g., mortgage receivables) rather than a security. Open has no end date which has been fixed at conclusion.Depending on the contract, the maturity is either set until the next business day and the repo matures unless one party renews it for a variable number of business days. Alternatively it has no maturity date – but one or both parties have the option to terminate the transaction within a pre-agreed time frame. After the completion of a reverse repo operation, the Desk publishes a summary of results that provides the total amount submitted, total amount accepted, and the award rate.

Both the repurchase and reverse repurchase portions of the contract are determined and agreed upon at the outset of the deal. A slight change in it can directly impact EMIs and rates of interest on various types of loans like Personal Loans, Car Loans, Business Loans, Home Loans, etc. The repo rate is an influential component that affects various segments of the economy. Lastly, in an RRP, although collateral is reverse repo rate definition in essence purchased, the collateral generally never changes physical location or actual ownership. If the seller defaults against the buyer, then the collateral would need to be physically transferred. To tackle this situation, RBI comes up with instrument of Variable Reverse Repo Rate where Rate of interest is not fixed by RBI but by the market through auction.

The Fed is considering the creation of a standing repo facility, a permanent offer to lend a certain amount of cash to repo borrowers every day. It would put an effective ceiling on the short-term interest rates; no bank would borrow at a higher rate than the one they could get from the Fed directly. A new facility would “likely provide substantial assurance of control over the federal funds rate,” Fed staff told officials, whereas temporary operations would offer less precise control over short-term rates. While reverse repos may not receive as much attention as other monetary policy tools, they play a vital role in the Federal Reserve’s efforts to maintain control over short-term interest rates and bank reserves.

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1. As per the latest news, the repo rate remained unchanged for the eleventh consecutive time since February 2023, as announced on 6th December 2024.
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3. When the Fed wants to temporarily absorb excess reserves from financial institutions or maintain a specific target for short-term interest rates, it initiates reverse repo transactions.
4. When the scheme was introduced, repo auctions were described for operations that absorbed liquidity from the system and reverse repo actions for operations that injected liquidity into the system.
5. When the Desk conducts RRP open market operations, it sells securities held in the System Open Market Account (SOMA) to eligible RRP counterparties, with an agreement to buy the assets back on the RRP’s specified maturity date.

As a result, when the Treasury receives payments, such as from corporate taxes, it is draining reserves from the banking system. The TGA has become more volatile since 2015, reflecting a decision by the Treasury to keep only enough cash to cover one week of outflows. When the government runs a budget deficit, it borrows by issuing Treasury securities. The additional debt leaves primary dealers—Wall Street middlemen who buy the securities from the government and sell them to investors—with increasing amounts of collateral to use in the repo market.

Additionally should the Desk conduct term RRP, the Treasury securities serving as collateral for any outstanding term RRP operations would not be available to serve as collateral for ON RRP operations. Legal title to the securities passes from the seller to the buyer and returns to the original owner at the completion of the contract. However, any government bonds, agency securities, mortgage-backed securities, corporate bonds, or even equities may be used in a repurchase agreement. Essentially, repos and reverse repos are two sides of the same coin—or rather, transaction—reflecting the role of each party. A repo is an agreement between parties where a buyer agrees to temporarily purchase a basket or group of securities for a specified period.

Reverse Repo: The Federal Reserve’s Lesser-Known Financial Tool

The rate charged by Reserve bank of India for this transaction is called the repo rate. Reverse repo operation is when RBI borrows money from banks by lending securities. The collateral used for repo and reverse repo operations are Government of India securities. Oil bonds have been also suggested to be included as collateral for liquidity adjustment facility. In LAF, money transaction are done via real-time gross settlement (RTGS), an online money transfer method).

How Reverse Repurchase Agreements (RRPs) Work

For the party selling the security and agreeing to repurchase it in the future, it is a repurchase agreement (RP). For the party buying the security and agreeing to sell in the future, it is a reverse repurchase agreement (RRP). The Desk conducts ON RRP operations at a pre-announced offering rate set by the FOMC. Treasury securities held in the System Open Market Account (SOMA) portfolio to settle ON RRP transactions. A wide range of counterparties—primary dealers, banks, money market mutual funds, and government sponsored enterprises—are eligible to participate in the ON RRP. Each counterparty can invest funds in the ON RRP up to the per-counterparty limit.

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1. Hence in October 2004, when the revised scheme of LAF was announced, the decision to follow the international usage of terms was adopted.
2. First and foremost is paying interest on excess reserves, which the Fed started doing in 2008.
3. A repurchase agreement is technically not a loan because it involves transferring ownership of the underlying assets, albeit temporarily.
4. It is the rate where the commercial banks in India park excess funds with the Reserve Bank of India, typically for a short period of time.
5. When RBI increases the repo rate, banks have to pay higher interest on their borrowings.
6. The RBI loans money to commercial banks in exchange for any government securities.
7. The difference between the sale price and the repurchase price, together with the length of time between the sale and purchase, implies a rate of interest paid by the investor on the transaction.

Until 2003, the Fed did not use the term “reverse repo”—which it believed implied that it was borrowing money (counter to its charter)—but used the term “matched sale” instead. In a due bill repo, the collateral pledged by the (cash) borrower is not actually delivered to the cash lender. Rather, it is placed in an internal account (“held in custody”) by the borrower, for the lender, throughout the duration of the trade. This has become less common as the repo market has grown, particularly owing to the creation of centralized counterparties. Due to the high risk to the cash lender, these are generally only transacted with large, financially stable institutions.

But the Fed didn’t know for sure the minimum level of reserves that were “ample,” and surveys over the past year suggested reserves wouldn’t grow scarce until they fell to less than $1.2 trillion. The Fed apparently miscalculated, in part based on banks’ responses to Fed surveys. Repurchase agreements, or repos, are a form of short-term borrowing used in the money markets, involving the purchase of securities with the agreement to sell them back at a specific date, usually for a higher price.

First things first: what exactly is the repo market?

In a repo, the investor/lender provides cash to a borrower, with the loan secured by the collateral of the borrower, typically bonds. In the event the borrower defaults, the investor/lender gets the collateral. Investors are typically financial entities such as money market mutual funds, while borrowers are non-depository financial institutions such as investment banks and hedge funds.

These financial instruments are also called collateralized loans, buy/sell back loans, and sell/buy back loans. The repo rate spiked in mid-September 2019, rising to as high as 10 percent intra-day and, even then, financial institutions with excess cash refused to lend. This spike was unusual because the repo rate typically trades in line with the Federal Reserve’s benchmark federal funds rate at which banks lend reserves to each other overnight. The Fed’s target for the fed funds rate at the time was between 2 percent and 2.25 percent; volatility in the repo market pushed the effective federal funds rate above its target range to 2.30 percent. Repurchase agreement (repo or RP) and reverse repo agreement (RRP) refer to the complementary sides of a transaction that involves the temporary purchase of assets with the agreement to sell them back at a slight premium in the future. For the original seller of the assets who agrees to buy them back in the future, the transaction is a repo.

Some observers have pointed to the LCR as leading to an increase in the demand for reserves. Holding a lot of reserves won’t push a bank over the threshold that triggers a higher surcharge; lending those reserves for Treasuries in the repo market could. An increase in the systemic score that pushes a bank into the next higher bucket would result in an increase in the capital surcharge of 50 basis points. So banks that are near the top of a bucket may be reluctant to jump into the repo market even when interest rates are attractive. The Fed has gone out of its way to say that this is not another round of quantitative easing (QE). Some in financial markets are skeptical, however, because QE eased monetary policy by expanding the balance sheet, and the new purchases have the same effect.