What Is a Repurchase Agreement (Repo)? How It Works

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A repurchase agreement (repo) is a contract in which one party sells securities to another and agrees to buy them back on a later date at a set, slightly higher price. Legally the deal is a sale followed by a repurchase. Economically it works as a short-term loan secured by collateral. The seller receives cash and pays interest. The buyer lends cash and holds the securities as protection. The interest is the gap between the sale price and the repurchase price, and expressed as an annual rate it is called the repo rate.

Repos are among the main ways banks, securities dealers, money market funds and central banks move cash for periods from one night to several months. Government bonds, U.S. Treasury securities above all, are the usual collateral, so the repo market connects the bond market to the daily funding of the financial system.

What Is a Repurchase Agreement?

A repurchase agreement has two linked transactions agreed at the same moment. On the start date, the borrower sells securities to the lender for cash. On the end date, it buys the same or equivalent securities back at a price fixed at the start. Because both prices are set at the outset, the lender earns the agreed interest, not the bond’s price change.

The structure is chosen for a specific reason. Because title to the collateral passes to the lender, a lender facing a defaulting borrower already owns the securities and can sell them to recover its cash. In the United States, qualifying repos also fall under “safe harbor” provisions of the Bankruptcy Code. Those provisions exempt them from the automatic stay that normally freezes a creditor’s claims when a borrower files for bankruptcy. A lender in an ordinary secured loan can be stuck waiting for the court. A repo lender can usually close out the trade and liquidate the collateral promptly. That legal certainty is a large part of why repo rates sit close to risk-free rates.

Even though repos are documented as purchases and sales, accounting and tax rules generally treat them as financing when the seller is committed to repurchase. The seller keeps the securities on its balance sheet and records a liability for the cash received. The buyer records a receivable rather than an investment in the bond. Exceptions to that treatment have mattered historically, as the Lehman Brothers case below shows.

Repos are money market instruments: short-dated, secured and interest-bearing. They are documented under master agreements that set out default rights, margin procedures and close-out mechanics. In the U.S. the standard form is SIFMA’s Master Repurchase Agreement. Cross-border and European repos are commonly documented under the Global Master Repurchase Agreement.

How a Repurchase Agreement Works

The near leg and the far leg

Every repo has two “legs.”

• The near leg (also called the start leg or opening leg) is the initial sale. The borrower delivers securities and the lender delivers cash.
• The far leg (also called the close leg or closing leg) is the repurchase. The lender returns the securities and the borrower pays the repurchase price, which equals the original cash plus interest.

The time between the legs is the term or tenor. For an overnight repo the far leg settles the next business day.

Haircuts and initial margin

Lenders rarely advance the full market value of the collateral. The difference is the haircut:

Haircut = (Collateral market value − Cash lent) ÷ Collateral market value

The same buffer can be quoted the other way round as initial margin, the ratio of collateral value to cash lent. A 2% haircut corresponds to an initial margin of about 102.04% (1 ÷ 0.98). The two quotes describe the same buffer but are not interchangeable numbers, so documents state which convention applies.

The haircut protects the lender if the borrower defaults and the collateral has to be sold at a lower price. Its size depends on how volatile and how liquid the collateral is, how long the term is, and how creditworthy the borrower is. Short-dated Treasury bills normally attract smaller haircuts than long-dated bonds. Corporate bonds and equities attract larger ones. Some repos between strong counterparties using Treasuries carry no haircut at all.

Variation margin during the term

Collateral is usually marked to market daily. If its value falls enough that the buffer erodes, the lender can issue a margin call, and the borrower posts more securities or returns some cash. If the collateral rises in value, the borrower can ask for securities back, because it is now overcollateralized and exposed to the lender. This two-way margining limits the exposure either party can build up before the far leg.

Who keeps the coupon?

Title passes to the buyer, but the economic exposure to the bond stays with the seller, which has committed to buy it back at a fixed price. If the bond pays a coupon during the term, the buyer passes an equivalent amount (a “manufactured payment”) to the seller. The seller therefore keeps the bond’s income and price risk, and the buyer earns only the repo interest. This is why a dealer can finance a bond position through repo and still profit or lose on the bond itself.

General collateral and specific collateral

Repos are also split by how much the lender cares about which securities it receives:

• General collateral (GC) repo: the lender accepts any security from an agreed basket, such as any Treasury security. The trade is driven by the cash. GC rates track overall short-term funding conditions.
• Specific collateral repo: the lender wants one particular security, often because it needs that bond to deliver against a short sale. When many participants want the same issue, it goes “special,” and the repo rate on that bond falls below the GC rate. The cash lender accepts a lower return in exchange for obtaining the bond it needs.

The distinction explains why two overnight Treasury repos on the same day can carry different rates: one prices cash, the other prices a scarce security.

Calculating the Repo Rate

To evaluate a repo, each side works out the cash paid in the near leg (the sale price), the cash paid in the far leg (the repurchase price) and the implied interest rate connecting them. For bond collateral, both amounts start from the bond’s dirty price (clean price plus accrued coupon), less any haircut.

The implied repo rate is:

Repo rate = (Repurchase price ÷ Sale price − 1) × (Day-count year ÷ Days in the term)

Rearranged, the far-leg amount is:

Repurchase price = Sale price × [1 + Repo rate × (Days in the term ÷ Day-count year)]

U.S. dollar repos conventionally use an actual/360 basis, so the day-count year is 360. Sterling markets generally use 365. Using the wrong basis shifts the computed rate by about 1.4% of its value, which can matter when comparing a repo with another funding source quoted on a different basis.

The rate is simple interest over the term, not compounded. A borrower rolling an overnight repo every day for a month pays interest on each night’s balance separately, and the total depends on each night’s rate. A borrower in a 30-day term repo locks one rate for the whole month.

Once a borrower has the implied rate, it compares that rate with alternatives such as unsecured borrowing, a credit line or selling the securities outright. Secured funding against high-quality collateral usually costs less than unsecured money market borrowing by the same institution, because the lender’s loss in a default is limited by the collateral. For the lender, the same rate is the return on cash that might otherwise sit idle or earn less in an unsecured deposit.

Example of a Repurchase Agreement

The following figures are hypothetical, not market quotes or any firm’s terms.

Overnight repo

A securities dealer owns Treasury notes with a market value of $10,000,000, including accrued interest. It needs overnight cash and agrees a repo with a money market fund on these terms:

• Haircut: 2%
• Repo rate: 5.00% annualized, actual/360
• Term: 1 day

Near leg. The fund lends 98% of the collateral value:

$10,000,000 × (1 − 0.02) = $9,800,000

The dealer delivers the notes, and the fund delivers $9,800,000.

Interest for one night:

$9,800,000 × 0.05 × (1 ÷ 360) = $1,361.11

Far leg. The next day the dealer pays:

$9,800,000 + $1,361.11 = $9,801,361.11

and receives its notes back.

Checking the implied rate:

($9,801,361.11 ÷ $9,800,000 − 1) × (360 ÷ 1) = 0.000138889 × 360 = 5.00%

Interest is calculated on the cash lent, not on the collateral’s market value. The dealer pays interest on $9.8 million even though it delivered $10 million of notes.

The same trade as a 30-day term repo

If the parties fix the term at 30 days at the same hypothetical 5.00% rate:

$9,800,000 × 0.05 × (30 ÷ 360) = $40,833.33

The repurchase price is $9,840,833.33, payable on day 30. In an overnight repo rolled daily, the dealer would face a new rate each morning and the risk that the lender declines to roll.

A margin call during the term

Suppose that on day 10 of the term repo, interest rates rise and the notes fall to $9,900,000. To restore the 2% haircut on the $9,800,000 loan, the fund needs collateral worth:

$9,800,000 ÷ 0.98 = $10,000,000

The shortfall is $10,000,000 − $9,900,000 = $100,000 of collateral. The dealer either delivers about $100,000 of additional eligible securities or repays enough cash to bring the loan back into line with the reduced collateral. This simplified calculation ignores accrued repo interest and any margin thresholds or minimum transfer amounts in the master agreement, which in practice affect whether and when a call is made.

What each side gets

The dealer funds a $10 million bond position with $200,000 of its own money (the haircut) and $9.8 million of borrowed cash, and it keeps the coupon income and price exposure on the notes. The fund earns a return on its cash and, if the dealer fails, holds Treasuries worth more than its loan on the day the deal was struck. This is how dealers finance inventory with leverage, and why the haircut sets that leverage: a 2% haircut supports up to roughly 50 times leverage on the position, while a 10% haircut supports about 10 times.

Repo vs. Reverse Repo

A repo and a reverse repo are the same transaction seen from opposite sides.

A reverse repo is not always about investing cash. A trader who has sold a Treasury short can enter a reverse repo to borrow the bond: it lends cash, receives the bond, delivers it to the buyer, and later buys it back in the market to return it in the far leg. If the bond is special, the trader may accept a below-market rate on its cash to obtain it.

The Federal Reserve’s naming is reversed

Fed operations are named from the counterparty’s point of view, which confuses many readers:

• In a Fed repo operation, the Fed buys securities from a dealer or bank and lends cash. The counterparty is doing a repo. Reserves in the banking system increase.
• In a Fed reverse repo operation, the Fed sells securities and borrows cash, usually from money market funds and other eligible institutions. The counterparty is doing a reverse repo. Cash is drained from the private market for the term.

Overnight, Term and Open Repos

Repos are classified by how the maturity is set.

Overnight repos mature the next business day. They make up a large share of activity because many borrowers, dealers in particular, fund securities inventory day by day, and many lenders, such as money market funds, want cash available quickly.

Term repos have a fixed maturity longer than one day, from a few days to several months. The rate is fixed for the whole term, and interest is paid at maturity with the repurchase price. Parties use term repos when they know how long the funding or investment is needed, or when the borrower wants to lock in its funding cost and avoid daily rollover.

Open repos (also called on-demand repos) have no set maturity. The trade rolls over automatically each day until either party gives notice, typically before an agreed daily cutoff. The rate is reset periodically by agreement, and interest is often settled monthly rather than at each roll. Because the rate follows market conditions, an open repo behaves much like a string of overnight repos with less paperwork.

The choice between them shifts risk between the parties. An overnight borrower bears rollover risk: if lenders pull back, it must find new funding the next morning or sell assets. A term borrower bears less rollover risk but pays the term rate even if overnight rates fall. A term lender’s cash is committed for the period. If it may need that cash early, it either keeps to shorter terms or negotiates early termination rights.

Why the Tenor Matters

A longer tenor gives more time for things to go wrong before the far leg:

• Collateral value can move further. Daily margining handles ordinary moves, but a large one-day jump in yields can still push collateral below the cash owed before the next margin call is met. Over a longer term there are more days on which such a jump can occur.
• The borrower’s credit can deteriorate. A dealer that is sound today may face trouble in three months. Lenders that worry about this cut the term they will offer, so the borrower has to roll more often.

As with bond maturities, term repo rates reflect the expected path of overnight rates over the term plus compensation for the added risk. Haircuts on longer-term repos are also frequently set higher than on overnight trades against the same collateral.

Types of Repurchase Agreements by Settlement Structure

How the collateral moves and who holds it gives rise to several structures.

Bilateral repo

In a bilateral repo, the two parties deal directly and settle on a delivery-versus-payment basis: securities move to the lender’s custody account at the same time cash moves to the borrower. Each side manages its own collateral valuation and margin. Bilateral repo suits specific-collateral trades, because the lender wants a particular bond delivered to it, and trades between dealers and sophisticated counterparties such as hedge funds. In the U.S., part of the bilateral Treasury repo market is cleared centrally through the Fixed Income Clearing Corporation, which steps between the two parties and becomes the counterparty to each.

Tri-party repo

In a tri-party repo, a clearing bank or other agent sits between the borrower and the lender. The agent does not find counterparties or broker deals. Once the two sides have agreed terms, the agent:

• holds the collateral in accounts on its own books,
• checks that the collateral meets the lender’s eligibility criteria (for example, Treasuries only, or investment-grade corporate bonds within set limits),
• values it daily and applies the agreed haircuts,
• moves cash and securities between the parties at the start and end of the trade, and
• substitutes collateral when the borrower needs specific securities back.

Tri-party repo lets cash lenders such as money market funds lend against pools of securities without building their own collateral operations. In the U.S., Bank of New York Mellon is the tri-party clearing bank, after JPMorgan Chase exited the business in the late 2010s. Outside the U.S., securities settlement organizations such as Euroclear and Clearstream provide tri-party services.

The U.S. tri-party market was reformed after 2008. The clearing banks had “unwound” maturing trades each morning and resettled new ones in the late afternoon, extending very large amounts of intraday credit to dealers every day. Regulators saw that dependence as a source of systemic risk, and the settlement process was redesigned to cut that intraday credit sharply.

Held-in-custody repo

In a held-in-custody (HIC) repo, the borrower receives cash but the collateral never leaves its control. It places the securities in a segregated custodial account for the lender instead of delivering them. This saves the cost of moving collateral, but it exposes the lender to the risk that the borrower pledges the same securities twice or becomes insolvent before the lender can take control of them. Because of that weaker protection, HIC repos are relatively uncommon and usually command a higher rate than delivered repo.

Specialized delivery repo

A specialized delivery repo is built around delivery of particular securities rather than a general pool, often less liquid instruments such as corporate or municipal bonds, and may involve additional guarantees. It is a niche structure rather than a mainstream funding tool.

Sell/buy-back

A sell/buy-back has the same economic result as a repo but is documented as two separate trades, an outright spot sale and a forward repurchase, instead of one agreement. Older sell/buy-backs often lacked the margining and close-out terms of a master repo agreement. They are now commonly documented under the same master agreements. Coupon treatment also differs: rather than passing a manufactured payment back during the term, the coupon is usually folded into the forward repurchase price.

What Securities Are Used as Collateral?

Lenders want collateral that holds its value predictably, can be valued accurately and can be sold quickly if the borrower defaults. In practice that means:

• U.S. Treasury securities (bills, notes and bonds), the core of the U.S. market.
• Agency debt and agency mortgage-backed securities issued or guaranteed by government-sponsored enterprises or government agencies.
• Other government bonds in non-U.S. markets, such as German, French or U.K. government debt.
• Corporate bonds, municipal bonds and asset-backed securities, usually with larger haircuts and concentration limits.
• Equities, accepted in some markets and tri-party programs with substantial haircuts.

“U.S. government repurchase agreements,” a line often seen in money market fund holdings reports, refers to repos collateralized by Treasury or agency securities. Under the SEC’s Rule 2a-7, a government money market fund must invest at least 99.5% of its total assets in cash, government securities, and repurchase agreements fully collateralized by cash or government securities. That rule is why government funds are among the largest cash lenders in the Treasury repo market.

Who Uses Repurchase Agreements and Why

Cash borrowers (repo sellers) include:

• Securities dealers and investment banks, which finance their inventories of bonds overnight. Market making in government bonds depends on this financing.
• Commercial banks, which use repo to manage day-to-day liquidity and reserves.
• Hedge funds and other leveraged investors, which fund bond positions with borrowed cash. One example is relative-value trades between Treasury cash bonds and futures.
• Insurers, pension funds and other asset managers, which sometimes raise cash against bond holdings instead of selling them.

Cash lenders (reverse repo buyers) include:

• Money market funds, which need short, secure places to invest large cash balances.
• Commercial banks and central banks with surplus cash.
• Corporate treasurers, securities lenders reinvesting cash collateral, and other institutions with temporary cash surpluses.
• Short sellers and dealers that need particular securities to deliver.

Individuals rarely trade repos directly. The market is wholesale, with trade sizes and documentation suited to institutions. Retail investors gain indirect exposure mainly through money market funds that hold repos, and the interest those funds earn reaches shareholders as part of the fund’s income.

Repos and Monetary Policy

Central banks use repos because they can add or remove cash from the financial system quickly, for a set period, against safe collateral, and without permanently changing their securities holdings.

The Fed’s standing facilities

The Federal Reserve sets a target range for the federal funds rate and uses two standing repo tools to keep money market rates within it:

• Overnight Reverse Repurchase Agreement Facility (ON RRP). Eligible counterparties, money market funds especially, can lend cash to the Fed overnight against Treasury collateral at a rate the Fed sets. Because they can always earn that rate from the Fed, they have little reason to lend to private borrowers for less, so the ON RRP rate acts as a floor for overnight rates. The Fed began testing the facility in 2013 and formally adopted it as a policy tool in 2015.
• Standing Repo Facility (SRF). Established by the Federal Open Market Committee in July 2021, the SRF lets eligible banks and primary dealers borrow cash from the Fed overnight against Treasury and agency collateral at a minimum rate set at the top of the target range. It is a backstop, not an everyday funding source, and limits how far repo rates can rise when private cash is scarce, as happened in September 2019.

Beyond the standing facilities, the Fed can run repo or reverse repo operations at its discretion to adjust reserves for a few days or weeks.

When the policy rate itself is called the “repo rate”

In some countries the central bank’s main policy rate is literally named the repo rate. The Reserve Bank of India’s repo rate, for example, is the rate at which it lends to banks against government securities, and changes in it feed through to banks’ funding costs and from there to loan and deposit rates.

In the U.S., market repo rates are set by supply and demand among private participants. The Fed influences them through its target range and facility rates but does not set each trade’s rate. Benchmarks summarize where the market trades. The most important is the Secured Overnight Financing Rate (SOFR), published by the New York Fed since 2018 and based on overnight Treasury repo transactions. SOFR replaced U.S. dollar LIBOR as the main reference rate for many loans and derivatives, so conditions in the repo market now feed directly into the floating rates many borrowers pay.

Risks and Limitations of Repurchase Agreements

Repos against high-quality collateral are designed to be low-risk, not riskless. The main risks:

Counterparty default plus collateral loss. If the borrower fails to repurchase, the lender sells the collateral. If its value has fallen by more than the haircut, or if selling it in a stressed market drives the price down, the lender loses the difference and then has a claim against a bankrupt firm. A lender that wanted a cash investment can end up holding a bond it never meant to own and taking a loss to exit.

Exposure for the borrower. The risk also runs the other way. If the collateral’s value rises well above the cash borrowed and the lender defaults, the borrower may not get its securities back and is left with a claim for the excess value. Haircuts work against the borrower here: the bigger the haircut, the more it stands to lose. Two-way margining reduces this exposure.

Wrong-way risk. Losses are worst when the borrower’s default and a drop in collateral value happen together, for instance when a dealer specializing in one type of bond fails just as that market sells off.

Rollover and run risk. Borrowers that depend on overnight repo need lenders to renew every day. In a panic, lenders can raise haircuts, accept only top-quality collateral or stop lending altogether. A firm that relied on repo for funding can lose access within days. This is a run on secured funding, and it played a central role in 2008.

Fire-sale and systemic risk. If a large dealer defaults, many lenders may try to sell the same collateral at once. Falling prices then hurt other holders of those securities and trigger more margin calls. Regulators have flagged the possibility that a major dealer default could force money funds into such sales.

Operational and legal risk. Failed deliveries, valuation errors, disputes over margin calls, and uncertainty about whether a structure (a held-in-custody repo, for instance) will be honored in insolvency all add risk.

Leverage. Because small haircuts allow large positions, repo can amplify a borrower’s gains and losses. The short-term financing often funds positions held much longer, a maturity mismatch that becomes dangerous when funding dries up.

Repos in Financial Crises

2008 and the run on repo

Before the 2008 financial crisis, investment banks financed large holdings of mortgage-related and other securities in the repo market, much of it overnight. As the value of mortgage securities became uncertain, lenders raised haircuts on that collateral or refused it, so firms needed far more of their own capital to hold the same assets or had to sell them into a falling market. Bear Stearns lost its repo funding in March 2008, and the strains spread across the dealer system. The repo market contracted sharply, though activity later grew well past its pre-crisis size.

Lehman Brothers and Repo 105

The 2010 report of the examiner in Lehman Brothers’ bankruptcy described how the firm had used transactions it called “Repo 105” (and “Repo 108” for equities). The name reflected collateral worth about 105% of the cash received. Lehman booked these transactions as sales rather than financings, which removed tens of billions of dollars of assets from its balance sheet around quarter-ends and made its leverage look lower than it was. Shortly after each reporting date, the assets came back. The episode showed how the boundary between a sale and a secured loan can be exploited, and it led to tighter accounting standards and disclosure requirements for repo-style transactions.

Post-crisis reforms

Regulators identified three weak points in the U.S. tri-party market:

1. Reliance on the intraday credit that the clearing banks extended to dealers.
2. The lack of workable plans for liquidating collateral in an orderly way if a large dealer defaulted.
3. Weak risk-management practices among participants.

The tri-party settlement redesign addressed the first. Broader post-crisis capital and liquidity rules, including leverage ratio requirements, made balance sheet space more expensive for banks. These rules made banks safer but also made them less willing to intermediate low-margin repo trades in large volume, a constraint that appeared at moments of stress.

September 2019

In mid-September 2019, overnight repo rates spiked well above the Fed’s target range for a few days. A corporate tax payment date and a large Treasury settlement drained cash from the system just as banks’ reserves had fallen and their willingness to lend in repo was limited by internal and regulatory liquidity requirements. The Fed responded by injecting cash through repo operations and later expanding its balance sheet. The episode led directly to the creation of the Standing Repo Facility in 2021 as a permanent backstop.

The pandemic and the growth of the ON RRP

In March 2020, the scramble for cash at the start of the COVID-19 pandemic disrupted even the Treasury market, and the Fed again used large repo operations to supply liquidity. Its asset purchases then filled the system with cash, much of it in money market funds that had more to invest than private repo borrowers could absorb at attractive rates. They turned to the ON RRP, where usage grew from about $1 trillion in the spring of 2021 to roughly $2.7 trillion by December 2022.

When the Fed began shrinking its balance sheet in 2022 under quantitative tightening, money market funds shifted cash into Treasury bills and private repo lending, and ON RRP usage fell steeply over 2023 and 2024. Whether private dealers can absorb very large repo volumes in stressed conditions without Fed support is still debated, which is part of why proposals for broader central clearing of Treasury repo have advanced.

Repo vs. Similar Terms

Several products and everyday terms are easy to confuse with a repurchase agreement.

FAQs

The Bottom Line

Repos matter most to banks, dealers, money market funds and central banks, which use them to move cash from overnight to several months against collateral such as Treasuries. Individuals rarely trade them and gain exposure mainly through money market funds. Repos against high-quality collateral are designed to be low-risk, yet haircuts and margining cannot fully remove default, collateral and rollover risk.