At a Glance
- The repo market allows banks, broker dealers and hedge funds to borrow cheaply
- On average, about $2-4 trillion in repos are traded each day
At the onset of the coronavirus crisis, the Federal Reserve relied on repurchase agreements, or repos, as a large part of its early intervention. At their peak in March, there were around $500 billion in repos outstanding. Repos are an important part of the financial system, but are often misunderstood.
A repo is a short-term secured loan. A party sells securities to another and agrees to repurchase those securities later at a higher price. The securities serve as collateral. The difference between the securities’ initial price and their repurchase price is the interest paid on the loan, known as the repo rate. On average, $2 to $4 trillion in repurchase agreements are traded each day.
The repo market is important for at least two reasons:
First, the repo market allows financial institutions that own lots of securities such as banks broker dealers and hedge funds to borrow cheaply, and allows parties with lots of spare cash to earn a small return on that cash without much risk, because securities, often U.S. Treasury securities, serve as collateral.
Second, the Federal Reserve uses repos and reverse repos to conduct monetary policy. When the Fed buys securities from a seller who agrees to repurchase them, it is injecting reserves into the financial system. On the other hand, when the Fed sells securities with an agreement to repurchase, it is draining reserves from the system.
The repo market is the fuel which keeps the financial system moving on a daily basis. Any disruptions or interruptions can make it difficult for all the capital markets.
Watch more of Jack Bouroudjian’s discussion on repos in this week’s episode above.