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In a repurchase agreement (repo), a party (usually a financial institution or a government organization) agrees to sell assets (often government bonds) to another party and then to buy those securities back at a later period, typically within one day to several weeks.
Repos are used to get short-term borrowing for a variety of reasons, including managing cash flow, paying regulatory requirements, financing inventory or investment operations, or financing inventory.
Repos are a cost-effective approach to getting short-term capital because the party selling the assets (the borrower) pays interest on the amount borrowed and the interest rate is often lower than that of other types of borrowing. Interest is earned by the party purchasing the assets (the lender), and the securities themselves act as collateral for the transaction.
Repo transactions are often carried out by specialist market participants known as "repo dealers," who serve as a middleman between the lending and borrowing parties. Banks, money market funds, and other financial organizations are participants in the vast and highly liquid repos market.
Repos can be used to manage the risks of short-term investments and to give the financial markets more liquidity. But, under certain conditions, such as when a large number of repo mature at once and cause a sudden shortfall of liquidity in the market, they can also pose hazards to the stability of the market.
To reduce possible dangers, regulators have created a number of rules and regulations and constantly monitor the repo market. The Dodd-Frank Act of 2010 for instance, enhanced reporting and transparency requirements for repo and other securities lending transactions and set additional obligations for repo dealers.
