A ‘repo’ is a form of secured short-term lending, usually between banks. A repo, or to give it its full title a ‘sale and repurchase agreement’, is a two-part transaction whereby one party agrees to sell securities to another and at the same time commits to buy back identical securities on a specified date at a specified price. The buyer of the securities provides cash to the seller at a predefined rate, the ‘repo interest rate’. On the second date the transaction is effectively unwound, with the original seller getting the securities back and the cash provider getting the cash back together with the agreed interest. In effect, a repo is a short-term secured loan – the securities acting as collateral.
In Figure 6.1, Bank A is said to have executed a repo, whereas Bank B has executed a ‘reverse repo’. Sometimes banks prefer, instead of going directly to another bank, to go via a third party when arranging a repo. Such arrangements are called tri-party repos (Figure 6.2). The tri-party repo agent takes a commission from both parties for arranging the trade.
There are basically two types of repos, ‘classic’ and ‘sell/buy-back’. In addition, ‘stock borrowing and lending’, which functions in a similar way, is often carried out by the same department in the bank and as a result is often grouped with it. These types are described later in the chapter.
As with many financial innovations the European financial markets have tended to follow those in America. This was certainly true ...