In the back pages of The FT you will see lots of different interest rate terms. Always confused me what all these terms and rates actually meant.
A term that is oftern reported in the press and media is the Repo Rate. When a bank or financial institution is short on funds they are able to borrow money from the central bank, eg The Bank of England. The repo rate is the rate at which banks or financial institutions borrow short term money. The repo rate is also referred to as the repurchase rate. A repo rate can be described as an interest rate on loans from the central bank. If the Bank of England desires to make it more costly for high street banks to borrow money then it will increase the repo rate, if they want to make it cheaper for money to be borrowed then the central bank reduces the repo rate.
Repo stands for “repurchase”. A good explanation is below, that I took from Wiki.
” A Repurchase agreement, also known as a Repo, or Sale and Repurchase Agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price will be greater than the original sale price, the difference effectively representing interest, sometimes called the repo rate. The party who originally buys the securities effectively acts as a lender. The original seller is effectively acting as a borrower, using their security as collateral for a secured cash loan at a fixed rate of interest. ”
To put it simply, the security that is the subject of the agreement to sell now and buy back later remains the asset of the bank. The bank, on the other hand, gets money which can be added to its cash reserve. The “fixed rate of interest” being charged in this transaction is the Repo Rate.
To summarise this, the bank enters into an agreement with the central bank, based on which it gets a security on loan from the central bank. It then promptly sells that security in the open market, raises cash and adds that to its cash reserves.Thus we see that Repo Rate are the means by which the central bank lends cash reserves to banks. When the central bank lends cash to a bank by accepting a government security as collateral (Repo), it is essentially augmenting the bank’s cash reserves.
In September of 2008, when the financial crisis was at its peak, after Lehman Brothers failed, European banks we running out of US Dollar$, infact that was a major problem at RBS, it was running out of US Dollar$ fortunately, UK HM Government came to the rescue, we saw a co-ordinated approach for the global central banks and use of the Repo Rate, when the US Federal Reserve lent US$ Dollars to the Bank of England, than then in turn lent those dollar$ to the UK banks, all via the Repo process