when the fed banks repurchases securities from private banks it does so at a discounted rate known as the repo rate like prime rates repo rates are set by central banks 20 the repo rate system allows the fed to control the money supply by increasing or decreasing available funds 
an increase in repo rates means banks pay more for the money they borrow from the central bank this squeezes lenders profits and increases interest rates on loans made to the public this generally discourages people and businesses from taking out loans which can cut consumer spending business investment and the amount of money circulating in the economy this might be necessary if the central bank is attempting to tackle inflation a decrease in the repo rates has the opposite effect it makes borrowing cheaper resulting in more money being spent and swirling around the economy this can be helpful when central banks want to stimulate the economy to determine the costs and benefits of a repurchase agreement a buyer or seller makes three different calculations the cash paid for the initial security sale and paid for the repurchase will depend on the value and type of security in the repo in the case of a bond for instance both will derive from the clean price and the value of the accrued interest for the bond a crucial calculation for any repo agreement is the implied rate of interest if interest rates are unfavorable a repo agreement may not be the most efficient way to access short term cash a formula that can be used to calculate the real rate of interest is below interest rate future value present value 1 year number of days between consecutive legsonce the real interest rate has been calculated comparing the rate against other funding sources should reveal whether the repurchase agreement is a good deal generally as a secured form of lending repurchase agreements offer better terms than money market cash lending agreements from the perspective of a reverse repo participant the agreement can also produce extra income on excess cash reserves risks of reporepurchase agreements are low risk the most significant risk in a repo is that the seller may fail to repurchase the securities at the maturity date when this happens the security buyer may liquidate the security to recover the cash it paid 21this still constitutes a risk since the security value may decline after the initial sale and the buyer may have few options other than to hold onto the security which it never wanted for this purpose or sell it for a loss the borrower also faces some risk if the security value rises above the agreed upon terms the creditor may not return the security there are ways to mitigate these risks in repurchase agreements for instance many repos are over collateralized in these cases if the collateral falls in value a margin call will require the borrower to amend the securities offered if it seems likely that the security value may rise and the creditor may not sell it back to the borrower under collateralization can be used to mitigate this risk 17generally credit risk for repurchase agreements depends on many factors including the terms of the transaction the liquidity of the security and the needs of the counterparties involved the financial crisis and the repo marketafter the 2008 financial crisis investors focused on a particular type of repo known as repo 105 there was speculation that these repos played a part in lehman brothers attempts at hiding its declining financial health leading up to the crisis 22 during this time the repo market in the u s and abroad shrunk significantly though it has since recovered and continues to grow 19the crisis revealed problems with the repo market in general since then the federal reserve has stepped in to analyze and mitigate systemic risk the fed identified at least three areas of concern starting in late 2008 the fed and other regulators established new rules to address these and other concerns the new regulations increased pressure on banks to maintain their safest assets such as treasurys giving them incentives not to lend them through repos 23despite these and other regulatory changes over the last decade there are still systemic risks within the repo space the fed continues to worry that a default by a major repo dealer could inspire a fire sale among money funds which would then negatively affect the broader market the future of the repo space may involve continuing regulations that limit the actions of these transactors or it may involve a shift toward a centralized clearinghouse system for the time being though repurchase agreements remain an important means of facilitating short term borrowing 2recent changes in the repo marketthe results from the fed s post 2008 actions were significant up through late 2008 the estimated value of global securities lent this way was close to 4 trillion that figure hovered near 2 trillion for much of the next decade 12by the 2020s the fed was increasingly entering into repurchase or reverse repurchase agreements to offset temporary swings in bank reserves the major jump comes from 2021 to 2023 when there was a major boost in the estimated value of repos traded peaking at about 4 7 trillion in june 2023 before settling back to under 4 0 trillion by the end of that year 19until 2021 the fed was a relatively minor player in repos when a sudden jump in fed actions put it at the center of the market on rrp agreements grew from about 1 trillion in the spring of 2021 to 2 7 trillion in assets by december 2022 24 by 2023 the repo market was about three times larger than at the beginning of 2021 with the fed serving as the critical counterparty for most of these transactions the significant rise in repo volumes can be attributed to several prominent changes within the market and the broader economy the pandemic set off a rush for safe assets driven by the period s extensive economic uncertainties in july 2021 the federal open market committee fomc established the srf as a backstop in the money markets the srf was intended to smooth liquidity in the repo market further and provide a dependable source of cash in exchange for safe investments like government bonds it soon became a crucial part of how major financial institutions across the u s managed their short term liquidity needs 25 meant as a supplement it replaced much of the market under the srf eligible institutions could borrow money overnight from the federal reserve using securities such as treasury bonds as collateral the interest rate on these loans known as the repo rate is set by the fomc and is generally above the market rate ensuring the srf is used as a backstop rather than a primary funding source 25 concurrently the fed s increase in bond holdings a measure to improve market liquidity was part of its broader monetary policy to stabilize and support the economy however from mid 2022 through 2023 the fed wound down these holdings under a policy known as quantitative tightening marking a shift from its earlier expansionary monetary stance 2627 pulling back its efforts to support the economy by this time inflation was a critical worry the fed sought to decrease the size of its balance sheet reducing the fed s balance sheet mainly involves cuts in three crucial areas of federal reserve liabilities deposits of the u s treasury deposits of banks known as reserves and deposits of money market funds at the fed through the on rrp 24 the size of its part in the repo market would be easier to cut given that the fed has less control over the other two as the fed sought to decrease its balance sheet on rrp made the most sense to pull back although bank reserves were to play a vital role in future cuts to the fed s balance sheet scaling back the on rrp is generally regarded as less disruptive to the monetary system than cuts to bank reserves the combination of pandemic driven economic uncertainty the establishment of the srf increased bond holdings quantitative tightening and regulatory changes led to a significant increase in the federal reserve s involvement in repo transactions this resulted in the fed becoming a critical counterparty in the repo market with the market size tripling from the beginning of 2021 to 2023 changes in the on rrp should cause a move away from the fed as a primary counterparty toward the private sector as its overnight repo sales continue downward however the capacity of the private repo market to handle much higher volumes in the mid 2020s and beyond is in some doubt 2426 the fed s active participation has significantly increased the repo market s size and it s unknown if the private sector could adjust to step in for the fed s increased role in the repo market the signs are positive the first quarter of 2024 saw a return to may 2021 on rrp levels about 327 billion with the private market absorbing the lost liquidity from the fed 28 money market funds have been adjusting their strategies significant providers of cash to the repo market they have increased their private repo lending volumes especially above the on rrp rates that said the jury is still out if the private markets can make up for the massive place the fed filled in this area in the early 2020s who benefits in a repurchase agreement in theory all parties benefit the seller gets the cash injection it needs while the buyer gets to make money from lending capital who buys repurchase agreements the sellers of repo agreements can be banks hedge funds insurance companies money market mutual funds and any other entity in need of a short term infusion of cash on the other side of the trade the buyers are commercial banks central banks asset managers with temporary cash surpluses and so on 21