Repo, Reverse Repo and TREPS Products - Article

Introduction

Bank treasuries frequently face temporary liquidity surpluses and shortages.

A bank requiring funds can borrow unsecured money through instruments such as Call Money. Alternatively, it can obtain funds against eligible securities through a repo transaction.

This gives the basic distinction:

Call Money → unsecured borrowing

Repo → secured/collateralised borrowing against securities

From the other side of the same transaction, the party providing funds and receiving securities undertakes a Reverse Repo.

Modern money markets also use Tri-Party Repo, where an independent third party performs important collateral and settlement-related functions. In India, the institutional arrangement is commonly known as TREPS.

The current IIBF CAIIB BFM syllabus includes Money Market Products under Module C – Treasury Products.

Market repos continue to be governed by the Repurchase Transactions (Repo) (Reserve Bank) Directions, 2018, as amended from time to time. RBI's current investment directions continue to refer banks to this framework for repo and reverse-repo transactions.

Learning Objectives

After studying this topic, you should be able to:

• explain the basic structure of a repo transaction;

• distinguish repo from reverse repo;

• understand the two legs of a repo;

• explain how repo interest arises;

• distinguish secured repo from unsecured money-market borrowing;

• understand the purpose of collateral and haircut;

• explain the role of a Tri-Party Repo Agent;

• understand how TREPS operates in India; and

• distinguish market repo from RBI monetary-policy repo operations.

What Is a Repo?

Repo is short for repurchase agreement.

In economic terms, it is a collateralised borrowing transaction.

The borrower:

1. sells eligible securities to the lender in the first leg; and

2. simultaneously agrees to repurchase those securities on a future date at an agreed price.

The difference between the first-leg and second-leg consideration represents the interest on the funds borrowed.

RBI describes repo as borrowing funds by selling securities with an agreement to repurchase them on an agreed future date at an agreed price that includes interest for the funds borrowed.

Simple Economic Meaning

Ignore the legal sale-and-repurchase structure for a moment.

Economically:

Borrower needs cash → provides securities → receives cash → later repays cash plus repo interest → receives securities back

Therefore, repo is widely used by treasury for short-term funding and liquidity management.

The Two Legs of a Repo

Every repo has two connected transactions.

First Leg

The borrower:

• delivers securities; and

• receives funds.

The lender:

• provides funds; and

• receives securities.

Second Leg

At maturity:

• the borrower repays the agreed amount including repo interest; and

• the securities return to the borrower.

The transaction can therefore be represented as:

First Leg: Securities → Lender | Cash → Borrower

Second Leg: Cash + Repo Interest → Lender | Securities → Borrower

RBI accounting guidance recognises the economic substance as collateralised borrowing and lending even though securities move between the parties during the transaction.

What Is Reverse Repo?

A Reverse Repo is the same transaction viewed from the lender's side.

The lender:

1. purchases securities in the first leg while providing funds; and

2. agrees to sell those securities back on the future date.

RBI defines reverse repo as lending funds by purchasing securities with an agreement to resell them on an agreed future date at a price including interest for the funds lent.

This is one of the most frequently confused concepts in treasury.

Repo vs Reverse Repo

Do not think of Repo and Reverse Repo as two completely unrelated products.

They describe opposite perspectives of the same underlying transaction.

Repo Rate

The repo rate in a market repo represents the return or borrowing cost on the repo transaction, expressed as an annual interest rate.

For the borrower:

Repo interest = cost of borrowing

For the lender:

Repo interest = income from lending

RBI describes the repo rate as the return earned on a repo transaction expressed as an annual interest rate.

The market repo rate can be influenced by:

• demand and supply of short-term funds;

• general market liquidity;

• tenor;

• collateral characteristics;

• monetary conditions; and

• prevailing money-market rates.

Repo Is a Secured Money-Market Product

A repo differs fundamentally from Call, Notice, and Term Money because collateral is involved.

Unsecured Borrowing

In Call Money:

Cash provided → no specific security pledged

The lender primarily relies on the creditworthiness of the borrower.

Secured Repo

In repo:

Cash provided ↔ eligible securities

The securities provide protection to the lender if the borrower fails to fulfil its obligation.

Therefore:

Repo = collateralised

Call/Notice/Term Money = unsecured

Collateral in Repo

The security underlying the transaction acts as collateral from an economic perspective.

Eligible securities depend on the applicable RBI framework and the relevant market arrangement.

Government securities are important collateral in the Indian repo market.

RBI's framework also permits market repo in eligible corporate debt securities subject to prescribed conditions.

For TREPS, CCIL periodically publishes the securities eligible for collateral and the applicable haircuts. Current CCIL collateral information includes Government securities, Treasury Bills, and eligible State Development Loans under prescribed conditions.

What Is a Haircut?

Collateral may not always be given full value for borrowing purposes.

A haircut is a reduction applied to the market value of collateral when determining how much funding can be obtained against it.

For example, conceptually:

If securities are worth ₹100 but a haircut is applied, borrowing capacity will be based on an amount lower than ₹100.

The purpose is to create a protective margin against possible changes in collateral value.

A larger haircut means:

less borrowing against the same market value of securities.

The applicable haircut can vary with factors such as:

• security type;

• maturity;

• liquidity;

• price volatility; and

• risk-management rules of the relevant clearing or trading arrangement.

Why Treasury Uses Repo

1. Short-Term Liquidity

A bank may have good-quality securities but temporarily need cash.

Instead of permanently selling those securities, treasury can use them in a repo to obtain funds.

2. Temporary Deployment of Surplus Funds

A treasury with surplus funds may undertake the reverse side of a repo and earn interest while receiving securities as collateral.

3. Funding Against Securities

Repo converts securities held by treasury into a source of liquidity without requiring an outright economic disposal of the portfolio.

4. Liquidity Management

Repo allows treasury to match temporary funding shortages with suitable secured borrowing.

5. Securities-Market Activity

Repos support Government securities and other eligible debt markets by improving the ability of participants to finance securities positions.

Practical Example

Bank A owns eligible Government securities.

It requires ₹500 crore for a short period because of a temporary liquidity mismatch.

Instead of making an outright sale of the securities, Bank A enters into a repo with Bank B.

First Leg

Bank A:

• transfers the agreed securities; and

• receives ₹500 crore.

Bank B:

• gives ₹500 crore; and

• receives the securities.

Second Leg

On the agreed future date:

• Bank A pays ₹500 crore plus repo interest;

• Bank B returns the securities.

For Bank A:

Repo = borrowing

For Bank B:

Reverse Repo = lending

This single example explains both concepts.

Outright Sale vs Repo

A repo should not be confused with a normal sale of securities.

The agreement to reverse the transaction is the defining feature of a repo.

What Is Tri-Party Repo?

A conventional bilateral repo principally involves:

• borrower; and

• lender.

A Tri-Party Repo introduces a third entity called the Tri-Party Repo Agent.

RBI defines tri-party repo as a repo in which a third entity acts as an intermediary and facilitates services such as:

• collateral selection;

• payment and settlement;

• custody; and

• collateral management during the transaction.

Therefore:

Borrower + Lender + Tri-Party Agent = Tri-Party Repo

The third party helps reduce the operational burden of individually managing collateral and settlement.

What Is TREPS?

TREPS refers to the Indian Tri-Party Repo arrangement used for borrowing and lending of funds against collateral.

CCIL states that TREPS facilitates borrowing and lending under the tri-party repo arrangement.

In the current structure:

• Clearcorp Dealing Systems (India) Ltd. provides the TREPS dealing system;

• the system operates as an anonymous order-matching platform; and

• CCIL acts as Central Counterparty as well as Tri-Party Repo Agent for trades from the system.

The TREPS arrangement replaced the earlier market mechanism commonly known as CBLO.

Role of the Tri-Party Agent

The Tri-Party Agent performs important operational functions between borrower and lender.

These may include:

Collateral Selection

Eligible securities are identified according to prescribed criteria.

Collateral Valuation

Collateral is valued using the applicable framework.

Haircut Application

Appropriate haircuts are applied to determine borrowing capacity.

Collateral Management

Collateral continues to be monitored during the transaction.

Settlement Support

The agent facilitates the movement and settlement of cash and securities.

Custody and Administration

The tri-party arrangement reduces the need for borrower and lender to perform every collateral-management function bilaterally.

Participants in TREPS

CCIL states that repo-eligible entities may participate in Tri-Party Repo subject to the applicable framework and membership requirements.

Participant categories currently include entities such as:

• public-sector banks;

• private-sector banks;

• foreign banks;

• co-operative banks;

• Primary Dealers;

• financial institutions;

• mutual funds;

• insurance companies;

• NBFCs;

• corporates;

• provident and pension funds;

• Payment Banks; and

• Small Finance Banks.

Eligibility remains subject to the applicable regulatory and CCIL requirements.

This makes the TREPS market broader in participation than the traditional unsecured Call Money market.

Bilateral Repo vs TREPS

Repo and Reverse Repo Accounting Concept

Although securities are transferred legally during repo, banking accounting focuses on the economic substance.

RBI's accounting guidance treats the arrangement as collateralised:

• borrowing for the repo seller; and

• lending for the reverse-repo buyer.

The repo seller continues to reflect its economic interest in the security according to the applicable accounting framework.

For CAIIB, the key concept is:

Do not interpret repo merely as an ordinary purchase and sale of securities.

Its economic purpose is funding.

Repo vs RBI Policy Repo

The term repo can create confusion because it is used in two contexts.

Market Repo

This article mainly discusses a treasury product in which eligible market participants borrow and lend funds against securities.

RBI Monetary-Policy Repo

RBI also uses repo operations as part of its monetary and liquidity-management framework.

Here, RBI is the counterparty.

The policy repo rate should therefore not automatically be treated as the rate applicable to every market repo transaction.

RBI itself distinguishes repo/reverse-repo transactions with RBI from market repo transactions.

Repo vs Call Money vs TREPS

This table captures the most important conceptual distinction.

Risks in Repo Transactions

Repo is secured, but secured does not mean risk-free.

Collateral Risk

The market value of collateral may fall.

Haircuts and margin mechanisms help manage this risk.

Counterparty Risk

A party may fail to perform its obligation.

Collateral and clearing arrangements reduce but do not necessarily eliminate all forms of risk.

Liquidity Risk

Collateral that appears valuable may become difficult to sell during stressed market conditions.

Operational Risk

Errors may occur in:

• trade capture;

• settlement;

• collateral allocation;

• valuation; or

• margin processing.

Market Risk

Changes in security prices and interest rates affect collateral values and funding economics.

CAIIB Exam Focus

Repo means secured borrowing.

The borrower sells securities and agrees to repurchase them.

Reverse Repo means secured lending from the other party's perspective.

Repo and Reverse Repo are two sides of the same transaction.

A repo has two legs.

First leg provides funding; second leg reverses the securities transaction and includes repo interest.

Repo differs from Call Money because Repo is collateralised.

An outright securities sale does not contain an automatic repurchase agreement.

Haircut reduces the collateral value considered for funding purposes.

Tri-Party Repo introduces a third-party agent.

TREPS is India's institutional tri-party repo arrangement.

CCIL acts as Central Counterparty and Tri-Party Repo Agent for TREPS trades, while Clearcorp provides the dealing platform.

TREPS is not unsecured borrowing.

Collateral remains central to the transaction.

Market repo should not be confused with RBI's monetary-policy repo operation.

Common Exam Traps

Trap 1: Repo Means Lending of Funds

From the repo seller's perspective, incorrect.

Repo represents borrowing.

The corresponding lending side is Reverse Repo.

Trap 2: Repo and Reverse Repo Are Separate Unrelated Transactions

Incorrect.

They are the borrower and lender perspectives of the same transaction.

Trap 3: Repo Is an Unsecured Money-Market Product

Incorrect.

Repo is collateralised.

Trap 4: Call Money and Overnight Repo Are the Same Because Both Can Be Overnight

Incorrect.

Call Money is unsecured.

Repo involves securities as collateral.

Trap 5: The Security Is Permanently Sold in Repo

Incorrect.

A repurchase commitment is agreed at the outset.

This distinguishes repo from an outright sale.

Trap 6: Repo Interest Is a Coupon on the Security

Incorrect.

The security may have its own coupon, but repo interest is the cost of borrowing funds under the repo transaction.

Trap 7: TREPS Means Unsecured Lending Through CCIL

Incorrect.

TREPS is a tri-party repo, so collateral is fundamental to the arrangement.

Trap 8: Tri-Party Means Three Borrowers or Lenders

Incorrect.

The third party is the Tri-Party Agent, which performs collateral and settlement-related functions.

Trap 9: Haircut Is Interest Charged on a Repo

Incorrect.

Haircut relates to the value recognised for collateral. Repo interest represents the funding cost.

Trap 10: Secured Repo Has No Risk

Incorrect.

Collateral reduces credit exposure, but market, collateral, liquidity, operational and counterparty risks can still exist.

Trap 11: Every Repo Uses the RBI Policy Repo Rate

Incorrect.

Market repo rates are determined in the relevant market. The RBI policy repo rate belongs to the monetary-policy framework.

Trap 12: Reverse Repo Always Means RBI Absorbing Liquidity

Incomplete and potentially misleading.

In treasury terminology, reverse repo is fundamentally the lender's side of a repo transaction. RBI monetary operations are a specific regulatory context.

Memory Technique

Remember:

Repo = Receive money

The repo party receives funds against securities.

Reverse Repo = Release money

The reverse-repo party releases/lends funds and receives securities.

For TREPS, remember:

T = Third party

R = Repo

E = Eligible collateral

P = Professional collateral management

S = Settlement

The central CAIIB idea is:

Call = unsecured cash

Repo = secured cash

TREPS = secured cash + tri-party collateral management