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What is meant by Repo Rate and Reverse Repo Rate.
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Answer Posted / shrikant.ramchandra.gadade
Meaning of epo Rate-A repo or more broadly, a repurchase
agreement, is normally a contract through which a seller of
securities promises to buy them back at a later date for a
mutually agreed price. Overnight repo, term repo, reverse
repo, purchase agreement, buyback, and leaseback are some
of the other related terms used in these kinds of
operations.
Financial instruments like treasury or government bills,
treasury/government or corporate bonds, and stocks/shares
are offered as securities in a repurchase agreement.
Typically, in this agreement, a prospective seller submits
the instruments for cash, with a promise to repurchase them
from the buyer at a specified time. The sum being repaid is
always greater than the sum received at the time of
agreement. The difference amount is termed as repo rate.
A repo differs marginally from a loan transaction. While
taking a loan, the debtor places the instruments under a
lien to the lender. Physical possession of the securities
lies with the lender during the tenancy of the loan. When
the loan is fully settled, the borrower gets back the
ownership of the securities. If the debtor fails to clear
the loan, the lender can dispose of the securities to
recover the dues. If the sale value of the securities is
lesser than the total loan amount, the creditor holds the
legal right to recover the balance amount from the debtor.
In the case of a repo, the cash provider can liquidate the
securities if the seller defaults in the repurchase of the
instruments. However, the repo buyer cannot recover the
full amount, if the sale value of the securities is lesser
than the cash lent originally. This can happen if the
instruments had depreciated in value during the repo
agreement period. On the other hand, if the securities had
appreciated during that period, the buyer stands to make a
fair profit. Thus, a repo transaction carries a definite
element of risk. Normally, repos are invariably
overcollateralized to reduce the amount of risk involved.
Daily market-to-market margining is also resorted to in
repo agreements.
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