Introduction

A repurchase agreement (repo) is a short-term transaction in which one party sells securities, typically government bonds, to another party while agreeing to repurchase them later at a slightly higher price. Economically, this functions like a secured loan, with the price difference being the repo rate. In India, repos are an essential mechanism for the banks and RBI to manage liquidity and keep the financial system moving.

How Repurchase Agreements Work

Ask yourself, as a bank, if you need money right now. A repurchase agreement with the Reserve Bank of India or any other lender would mean selling government securities and being able to use this money immediately. Then, the repurchase agreement models would include buying back the securities the next day at a higher price, which is not a problem. For example, the RBI's repo rate, approximately 6.5% as of 2025, dictates this price. Alternatively, a reverse repurchase agreement has you buying securities, and in return, you promise to sell them back; effectively, the same as lending money. The RBI conducts reverse repos to soak up excess cash on banks' behalf; they are also an essential tool for the RBI in its Liquidity Adjustment Facility (LAF) for managing money supply, especially in uncertain times such as the post-2020 recovery period.

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Benefits of Repurchase Agreements

So, why should you care about the repurchase agreement market? For banks, repo agreements are a way to earn rapid liquidity without permanently selling an asset, providing an opportunity for neatly managed operations. For you as an investor, these interests enable you to earn some return on excess cash in a low-risk way, since the interest earned on the repurchase agreement usually exceeds a regular savings account and potentially offers government bonds as security. For the economy, the RBI is actively managing inflation through its ability to conduct repurchase agreements. An increasing repo rate leads to a slowing in borrowing, which should mean prices cool. Conversely, a lower repo rate creates cheaper loans, which increases your investment in debt funds or lowers the EMIs on your house loan. All parties consider government securities and the transactions to provide safety.

Example of a repurchase agreement

Let's look at an example of a repurchase agreement. Suppose you're a bank manager needing Rs. 50 crores overnight. You would enter into a repo agreement with the RBI, which requires you to sell government bonds (Rs. 50 crores notional value) with an implicit agreement to repurchase them after 24 hours for Rs. 50.04 crore; the additional Rs. 4 lakhs would represent the repo rate interest. This repurchase transaction provides you with a way to immediately finance your cash needs while maintaining your long-term funding asset. Moreover, due to repo liquidity provision, it is possible to provide liquidity during the 2020 economic downturn. The RBI provided repo transactions on a much broader scale to banks so they could on-lend to businesses you will invest in or indirectly through mutual funds, ultimately facilitating market conditions' stabilisation.

The Repurchase Agreement Market in India

The repurchase agreement (repos or repo market) market in India is significant, and daily volumes typically exceed Rs. 2 lakh crores on some days, with deeper liquidity in the given market through financial institutions via a clearing platform such as Clearing Corporation of India (CCIL). Regarding market participants, the main entities are banks, primary dealers, and mutual funds, which regularly trade repos with the RBI/regulator. Recent regulatory changes, such as for tri-party repos, provide greater access to the repo market, potentially allowing you to indirectly participate as an investor in India through a money market fund. The repo market represents an essential source of financing for financial institutions to finance valuable collateral with the long-term intention of funding via repos. In an environment of stress, the repo market can mitigate risk and achieve stable funding for financial intermediaries.

Risks to Watch Out For

Though the benefits of repurchase agreements are clear, they do inject risks. The primary risk is counterparty risk. You must sell the collateral if a repo seller does not repurchase it as agreed. If the value of that collateral depreciates due to the market situation, you are left with a loss. The longer the repo period, the higher the risk because the values of securities can change with interest rate changes. In India, though, systemic risks are associated with all this liquidity due to global risks. In addition, the RBI has instituted some safeguards like over-collateralization (or "haircuts") to reduce this risk. Lastly, rising repo rates that won't affect repo transactions are reflected in loan borrowing and investment costs, if that is indirectly aligned to repo costs.

Conclusion

Being knowledgeable about repurchase agreements gives you power in your decision-making. Whether managing cash daily or an investor building a portfolio, repurchase agreements affect the market you are participating in. Motilal Oswal is here to help you with all these tools and develop a strategy to meet your desired goals around repurchase agreements. Be an informed money manager and use repurchase agreements to supplement your needs.