Participants in Repo Market in India
Repo Market is a tool to manage liquidity in financial institutions. In this article, we will see the Repo Market in India and participants in repo market.
Repo is used in India as an instrument for monetary policy by institutionalising daily Liquidity Adjustment Facility (LAF). It allows banks and Primary Dealers to manage their liquidity needs.
What is Repo?
- Repo (Repurchase Option) is a formal agreement between two counter-parties where one party sells securities to another party with the explicit intention of buying back the securities at a later date. The Repo can be called a Sell-Buy transaction. The seller of the securities agrees to buy back the securities from the buyer at a predetermined time and rate. The rate at which the seller agrees to buy back the securities will include the interest rate charged by the buyer for agreeing to buy the securities from the seller.
- The reason a seller wants to sell and buy back securities and paying interest on the transaction is that the seller requires funds. The seller of securities can be called as the Repo borrower as he receives funds for selling the securities. The buyer of the securities is the Repo lender as he pays for the securities purchased.
- The Repo rate is the rate of interest charged by the buyer of the securities to the seller of securities. For more details regarding Repo Rate, Refer the earlier article – What is Repo Rate?
- A Repo transaction has two legs. The first leg is the sale of securities by the Repo borrower to the Repo lender. The second leg is the purchase of securities by the Repo borrower from the Repo lender.
Types of Repos based on Maturity
There are basically four types of repos based on its maturity period.
- Overnight Repo : It refers to repos with a single-day maturity. Indian Repo market is predominantly an overnight repo market.
- Term Repo : It refers to repos that have a fixed maturity longer than one day. If the period is fixed and agreed in advance, it is a term repo, where either party may call for the repo to be terminated at any time, though it may require one or two days’ notice.
- Open Maturity Repo : These are the transactions where both parties have the option to terminate the repo each day. In an open repo there is no such fixed maturity period and the interest rate would change from day to day depending on the money market conditions. In such cases, the lender agrees to provide money for an indefinite period and the agreement can be terminated on any day. The open maturity structure permits entities in the repo transaction to continuously roll over overnight repos.
- Flexible Repo : Under flexible repos the lender places funds, but they are withdrawn by the borrower as per his requirements over an agreed period.
Participants in Repo Market
1. RBI – Banks can borrow or lend to RBI at fixed Repo or reverse repo Rate existing at that time. This fixed rate is also called LAF or Liquidity Adjustment Facility Repo Rate. This rate is the policy rate set by RBI and reviewed every quarter.
2. Commercial Banks & Primary Dealers – All commercial banks can participate in this market from both lending and borrowing side among themselves or with other participants. Repo Rate here can be market driven though it is mostly near LAF rate set by RBI.
3. Mutual Funds, Housing Finance Companies and Insurance companies can only enter into Reverse Repo transactions i.e. can only lend money. But these participants cannot borrow money in the market.
Inclusion of Non-banks Entities as participants in the repo market would have the following advantages :
- It will enhance liquidity in respect of Government securities held encouraging them to enlarge their holdings voluntarily which would be very much welcomed in the context of the Government’s market borrowing programme of higher amounts, in future.
- Nonbanks, when are allowed to operate two way instead of the existing one way by taking part in reverse repos only, would help the market to narrow the spreads between repo and reverse repo rates making efficient allocation of liquidity possible.
- It would give rise to varying maturities as far as repo transactions are concerned as the market participants would go in for periods of their choice thus giving rise to the development of a term money market through price discovery.