Why Do Banks Use Repurchase Agreements

Under a pension contract, the Federal Reserve (Fed) buys U.S. Treasury bonds, U.S. agency securities or mortgage-backed securities from a primary trader who agrees to buy them back within one to seven days; an inverted deposit is the opposite. This is how the Fed describes these transactions from the perspective of the counterparty and not from its own point of view. First, Bear Stearns, then Lehman, could not sell enough deposits to pay these lenders. Soon, no one wanted to pay them anymore. It got to the point where Lehman didn`t even have enough money at his disposal to make pay slips. Before the crisis, these investment banks and hedge funds were completely unregulated. A pension contract (repo) is a short-term guaranteed credit: one party sells securities to another and agrees to buy them back at a higher price at a later price. The securities serve as collateral. The difference between the initial price of the securities and their redemption price is that of the interest paid on the loan called the pension rate. The main difference between a term and an open repo is between the sale and repurchase of the securities.

The Fed makes reverse deposits with primary traders and other banks, government-subsidized companies and money funds. It sells treasures and other securities to banks. This reduces the level of credit available to banks and thus increases interest rates. To determine the actual costs and benefits of a pension transaction, the buyer or seller who wishes to participate in the transaction must take into account three different calculations: Rests are popular because they are simple and safe. Financial institutions such as banks, securities dealers and hedge funds do not have large amounts of cash available. They prefer to put all their money into work. If they need money in a hurry, they can turn to the pension market. On the other hand, money funds have a lot of money. They are happy to lend money to the financial institution overnight for a small fee.

In a repo, the investor/lender provides cash to a borrower, the loan being secured by the borrower`s collateral, usually bonds. If the borrower becomes insolvent, the guarantee is granted to the investor/lender. Investors are generally financial enterprises such as money funds, while borrowers are non-intrusive financial institutions, such as investment banks and hedge funds. The investor/lender calculates an interest rate called “pension rate” $X the granting of loans and recovers a higher amount $Y. In addition, the investor/lender may demand guarantees that require a value greater than the amount he lends. This difference is the “haircut.” These concepts are illustrated in the diagram and in the equations section. If investors are at greater risk, they may charge higher pension interest rates and demand higher reductions. A third party may be involved to facilitate the transaction; In this case, the transaction is called a “tri-party deposit.” [3] Market participants often use pension and RRP transactions to purchase funds or use funds for short periods of time. However, transactions in which the central bank is not a party do not affect the total reserves of the banking system.

Under the pension agreement, the financial institution you sell cannot sell the securities to others unless you default on your promise to buy them back. This means that you must meet your obligation to repurchase. If not, it can damage your credibility. It can also mean a missed opportunity if security had gained in value after the economy. You can agree on the repurchase price at the time the contract is concluded so that you can manage your cash flow in order to have funds for the transaction. A potential cost of a pension purchase contract is that of marginal payments. You must do so if the security value decreases before you buy it back.

Bookmark permalink.

Lukket for kommentarer.