Reverse Repo

A reverse repo, or reverse repurchase agreement, is a transaction in which one party buys securities and agrees to sell them back at a set price on a later date. The buyer is in effect lending cash against collateral, and the higher resale price is its interest. It is the mirror image of a repurchase agreement (repo): the same deal is a repo for the side that borrows cash and a reverse repo for the side that lends it.

The term matters most in central banking, where it names standing facilities and daily operations. In Pakistan, the State Bank of Pakistan's (SBP) overnight reverse repo facility is its lending window and the ceiling of the interest rate corridor, set 100 basis points above the policy rate. In the United States, the Federal Reserve's overnight reverse repo facility does the opposite: it absorbs cash from money market funds and dealers. The difference comes down to whose side of the trade the name describes.

Imagine lending a neighbour Rs 50,000 and taking their gold bangles as security, with a promise that they will buy the bangles back next week for Rs 50,100. You are the one handing over cash and holding the bangles. From your side, that is a reverse repo; from your neighbour's side, it is a repo.

If the neighbour fails to pay, you keep the bangles and sell them. Because the loan is secured this way, the fee is lower than for an unsecured loan. Banks and central banks use exactly the same idea, with government bonds in place of jewellery and millions in place of thousands.

The interest on a reverse repo is the gap between the purchase and resale prices. For an overnight or short deal it is usually worked out as:

• $P$ is the cash amount lent (the purchase price of the securities).
• $r$ is the annual reverse repo rate, as a decimal.
• $d$ is the number of days the deal runs.

Example: a bank lends Rs 1 billion overnight at 12.5%. The interest is $1{,}000{,}000{,}000 \times 0.125 \times 1 \div 365 \approx 342{,}466$, so the securities are resold for about Rs 1,000,342,466. The cash lender usually takes securities worth a little more than the cash, the difference being a haircut, so that a fall in their price does not leave it short. Some counting conventions use a 360-day year instead of 365.

When the SBP set up its corridor in August 2009, its old 3-day repo lending window, known historically as the discount rate, was converted into an overnight reverse repo facility and made the ceiling. A scheduled bank or primary dealer short of cash at the end of the day can sell eligible Market Treasury Bills (MTBs) or Pakistan Investment Bonds (PIBs) to the SBP and buy them back next day. The SBP is lending cash and holding securities, so from the SBP's side it is a reverse repo.

Since March 2020 the ceiling has been set 100 basis points above the policy rate, and the matching repo facility floor 100 basis points below it. In April 2026, for instance, an SBP circular set the overnight reverse repo at 12.5% and the repo at 10.5% around an 11.5% policy rate. Because a bank can always borrow at the ceiling, interbank overnight rates, such as the call money rate, rarely trade above it. Frequent use of the ceiling is a sign of tight liquidity and usually prompts injections through open market operations (OMOs), which are themselves reverse repo auctions from the SBP's side. Islamic banks use a parallel Shariah-compliant facility instead.

• United States. The Fed's overnight reverse repo facility (ON RRP) lets eligible money market funds, banks and dealers lend cash to the Fed against Treasury securities. Its offering rate is tied to the bottom of the federal funds rate target range, so it acts as a floor. Usage swelled to more than US$2 trillion in 2022 when the system was flooded with reserves after quantitative easing (QE), then fell sharply as the Fed shrank its balance sheet.
• India. The Reserve Bank of India's reverse repo rate was for many years the rate at which it absorbed surplus cash; since 2022 its standing deposit facility has taken over the floor role.

So a "reverse repo rate" can be a ceiling in Karachi and a floor in New York. The mechanics are identical; only the naming perspective differs.

Money market funds, corporate treasuries and banks use reverse repos to park cash safely for short periods, while dealers use them to borrow specific securities. The main risk is counterparty risk: if the borrower defaults, the lender must sell the collateral, which may have lost value. In stressed markets, haircuts widen and short-term interest rates in the money markets can jump, as happened in the US repo market in September 2019.

• Federal Reserve Bank of New York: Reverse repo operations
• State Bank of Pakistan