The term REPO is an acronym for “repository”. It refers to a central storage location for data. Its origin is Latin, where repositorium means a vessel or a chamber. Banks borrow money from the RBI by selling excess government securities and then enter into a contractual agreement with the RBI to repurchase the equivalent at a later date. While the full form of REPO is a repository, it has many other uses.
A repurchase agreement, as the name implies, is an agreement in which one party sells a security to another. That person then buys it back from the seller at a pre-determined price. Typically, a repo agreement is a short-term transaction, but it can last up to two years. This type of arrangement allows banks to raise short-term capital by selling securities and pledging them as collateral.
Repo rates are important to everyone, from investors to the common man. They influence everything from interest rates on loans to the return on deposit accounts. In times of financial stress, people often take out loans from banks, paying interest on the money. A commercial bank may borrow money from the apex bank of a country, and in return, it borrows that money at a certain interest rate. The Central Bank of a nation adjusts the rate at which it lends money to commercial banks based on the Repo Rate.
The repurchase agreement involves unique terminology. The most common term is the “leg” of the repurchase transaction. The legs are the initial sale and the repurchase. The leg between the two transactions is called the “start leg” and the “close leg.” Both sides of the repo transaction use a legal term known as a repo. A repo transaction may involve two types of terms: an open repo, a term, and a closed repo.
A sell and buyback transaction does not require any special legal documentation. However, a repo requires a master agreement between the buyer and seller. This master agreement is called a global master repo agreement. Failure to sign a master repo agreement may diminish one’s legal standing to retrieve collateral. Hence, the parties to a repo transaction must sign the master agreement. There are many benefits to signing a master agreement:
A repurchase agreement is a short-term contract between two parties whereby the selling party sells the securities for a higher price and the buyer purchases them for a lower price. During a growing economy, Repo Rates are low and the RBI slashes them to increase the supply of money into the economy. On the other hand, high repo rates hinder economic growth and slow the economy. Hence, repurchase agreements are needed when the economy is facing financial difficulties.
Term and Overnight Repo are two types of Repo transactions. Overnight repo involves selling securities to the RBI and repurchasing them the next day. Term repo, on the other hand, includes a longer period of time. Its average tenure is seven days, while Term repo has a duration of fourteen to 28 days. Banks purchase these securities from the RBI when they need additional funds. So, these are the two basic types of repos.
