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Reverse Repo

A reverse repurchase agreement involves the purchase of securities with the promise to sell them at a higher price at a future date. For the buyer of the securities, it is a way to lend money and get paid with interest in the future. The securities serve as collateral for the loan. Conversely, for the seller of the securities, the reverse repo is a way to borrow money and pay back with interest later on.

Such agreement is a financial instrument which is often used to raise short-term capital. Government securities are often used as collateral for reverse repo agreements.

Central banks typically make use of reverse repo agreements to drain the reserves in the banking system before adding them back later on. For instance, the Fed uses a reverse repo to sell securities in exchange for US dollars in order to mop up the excess liquidity in the markets. In this case, reverse repos could serve as an alternative to tightening monetary policies such as raising interest rates or the reserve requirement.

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