Reverse Repurchase Agreement

Published Jan 19, 2023

Definition of Reverse Repurchase Agreement

A reverse repurchase agreement, also known as a reverse repo or a sell/buyback, is a financial transaction in which one party sells a security to another party and agrees to repurchase it at a later date at a higher price. That means the buyer of the security pays the seller a certain amount of money upfront and agrees to buy it back at a higher price at a later date.

The reverse repo refers to the seller side of this deal, as opposed to the regular repurchase agreement (which describes the buyer side).

Example

To illustrate this, let’s look at an example. Assume bank A wants to borrow money from bank B. To do this, bank A can enter into a reverse repurchase agreement with bank B. In this case, the bank that wants to borrow money (i.e., bank A) sells a security to the other bank (i.e., bank B) and agrees to buy it back at a higher price at a later date. Bank B pays bank A a certain amount of money upfront and agrees to sell the security back at a higher price at a later date.

Why Reverse Repurchase Agreements Matter

Reverse repurchase agreements are an important tool for banks and other financial institutions to manage their liquidity. They are often used to raise short-term funds or to invest excess cash.

In addition to that, they are also used by central banks to influence the money supply in the economy. That means they can be used to increase or decrease the amount of money in circulation. Thus, reverse repurchase agreements are an important tool for central banks to manage the money supply and influence the economy.