Going straight to the topic, whether it is a repurchase or a reverse repurchase, its essence is a transaction, a transaction that requires an agreement to be signed. Repurchase and reverse repurchase are actually the same tool, and the reason why they are distinguished is because of the different angles. If you understand repurchase, you will naturally understand reverse repurchase.
Repurchase is a kind of overnight loan, of course, there are also longer-term ones. We can start from the fact that it has collateral.
repurchase
An example: If you think of a repurchase agreement as a loan, I (the person who borrowed the money) sell you securities today and promise to buy them back tomorrow. So it shouldn't be difficult to understand that the securities are transferred from me (the borrower) to you (the lender) and then returned to me (the borrower).
The flow of funds is just the opposite, first transferred from you (the party who obtained the securities) to me (the party who borrowed funds), and then returned to you the next day.
From this perspective, it is easy to understand why securities are called collateral. Because as long as I borrow funds, it means that you now hold my short-term U.S. debt, that is, I give you short-term U.S. debt, and you give me funds.
If I don't pay you back tomorrow, my short-term U.S. debt will be yours, and you can sell them and do whatever you want.
Therefore, the organizational form of the repurchase agreement is the sale of securities + repurchase. From this perspective, securities are collateral, which is a guarantee for loans. You don't need to rely on my credit or reputation, you have something real as a guarantee.
The converse is also true.
If you don't give me back my securities, I don't have to pay you back. If you sell these securities to others or you go bankrupt, I will take this loan for nothing until you find a way to get the same securities back to me.
And that's called a collateral default, and a default means a free overnight loan, and consecutive rollovers of that loan are free.
Therefore, for both parties, the repurchase agreement is collateralized, the funds are the collateral of the securities, and the securities are the collateral of the funds.
Buybacks from a Balance Sheet Perspective
For the term repo, there is no standardized set of wording usage among countries. In the U.S., the party “doing the repo” refers to the party that lent the funds; in London, the party “doing the repo” refers to the party that borrowed the funds. It looks confusing, but it doesn't matter, it will be clear at a glance on the balance sheet.
One thing to note is that almost all repo transactions will have a securities dealer playing one side, and keeping this in mind can help you make effective distinctions.
Next, we use examples to illustrate repurchase and reverse repurchase. Focus on securities dealers. Pension funds and banks play soy sauce.
Generally speaking, the representation form of the balance sheet in the chart is assets on the left and liabilities on the right.
1. Trader → pension fund
Repo loans are counted on the liability side of securities dealers. Why is it recorded on the liability side? Because the repo loan is a liability, which means you borrow money. I wrote in the QE article two days ago that the money you deposit in the bank is the bank's liability to you. The securities dealer got the money through the mortgage bond, and the money should naturally be recorded on the liability side.
Here is a little knowledge: if an account is recorded on the asset side of the balance sheet, then a bond is added; conversely, if an account is recorded on the liability side, then a fund is added. The reason is not explained here, just remember this result.
My point of view is to follow the money. Currency is better than securities, so by paying attention to the flow of funds, you can understand which end of the balance sheet the repurchase loan should be on.
The repurchase loan in the above picture is a part of the money (assets) allocated by the pension fund and lent to securities dealers. The securities dealer secured the money with the bond as collateral. Therefore, repurchase loans are a liability for securities dealers, and an asset for pension funds, which should be well understood.
The superannuation fund lends (lents) the money to earn some interest, and it's a secured loan, so it's a safe bet. In fact, for American banks or large institutions, cash has never been the best choice for these institutions, because their money comes from depositors and investors, and these institutions need to be responsible to them (giving interest or dividends), and Cash cannot make money in hand, so either lend out or buy financial products or assets.
So for the pension fund, instead of holding a lot of cash, it's better to hold these repo loans to securities dealers (lending money to dealers), so that they can still get interest. So pension funds are happy to do that.
2. Dealer→Bank
Sometimes, instead of borrowing money, securities dealers lend (finance out) and take securities as collateral. This is often called a "reverse repo" because it is the reverse of a repurchase. Meaning that money flows to the left (banks), while collateral flows to the right (dealers).
In fact to make sense of this whole picture, just remember that collateral or securities are always flowing to the right and money is always flowing to the left.
Therefore, the reverse repurchase is shown in this figure: the securities dealer lends funds to the bank, and the bank hands the securities as collateral to the securities dealer.
Why are banks doing this?
Banks hold securities as part of their assets, and one way to finance these securities holdings is to repurchase these securities overnight. In this way, banks do not need to have corresponding deposit accounts to finance these assets, and they can put The repo market acts as the liability to finance these assets.
When there were a lot of bonds issued, rating agencies like Moody's came into being to figure out which bonds were of good quality, or how much money should be raised against those bonds, and that's how the entire rating industry grew.
reverse repurchase
The "reverse repurchase" has been explained above, but its essence is actually repurchase, isn't it?
The relationship between a bank and a securities dealer is no different than that between a securities dealer and a pension fund, where the transactions use the same instruments but are called differently.
They are called differently because of the security dealer's point of view.
Repurchase is one thing, reverse repurchase is another; repurchase is a liability item, and reverse repurchase is an asset item.
From a securities dealer's perspective, they are very different; but once you step outside, they are the same tool.
the fed
When it comes to repurchase and reverse repurchase, the Fed can't get around it. Because the Federal Reserve sometimes regards itself as a bank to do reverse repurchase, you must not be misled at this time. Because the Fed means it's a liability, they're borrowing money from securities dealers.
And when the Fed lends funds (including all open market operations), it happens on the asset side of the Fed. The Fed calls these asset-side operations repurchases. At this time, they put themselves in a position similar to pension funds.
Therefore, for the Fed's repurchase and reverse repurchase, you need to remember it backwards. The reason is very stinky and long, knowing or not knowing has little effect, so just record the result directly.
When securities dealers do reverse repurchase, it is included in the asset item, and when the Fed does reverse repurchase, it is included in the liability item.
When a securities dealer does a repo, it is included in the liability item, and when the Fed does a repo, it is included in the asset item.
To distinguish between repurchase and reverse repurchase, you have to know who the parties to the transaction are, and follow the money to clear your mind.
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