# What Is a Reverse Repurchase Agreement (RRP)? How It Works, With Example

![Reverse Repurchase Agreement](https://www.investopedia.com/thmb/rfxYlZY2-TCA9OWmlrRPL9zw4K4=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/TermDefinitions_reversepurchaseagreement-9900cc299b4e4741b5b3846243e32a9a.jpg)

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## What Is a Reverse Repurchase Agreement (RRP)?

A reverse repurchase agreement (RRP), commonly referred to as a reverse repo, represents a transaction where the seller agrees to repurchase securities at a higher price on a specific future date. Functioning as a collateralized loan, it is the seller's perspective within a [repurchase agreement (RP)](https://www.investopedia.com/terms/r/repurchaseagreement.asp), essentially reflecting their role in obtaining short-term capital while managing cash flow challenges.  

### Key Takeaways

*   A reverse repurchase agreement (RRP) or reverse repo involves selling securities with an agreement to repurchase them at a higher price at a future date, essentially functioning as a collateralized loan.
*   Reverse repos are typically used by banks and financial institutions to manage short-term liquidity needs or cash flow issues, where the difference between the sale and repurchase price serves as interest.
*   The Federal Reserve employs reverse repos to manage liquidity in the financial system, selling securities to temporarily absorb excess cash from the market.
*   Unlike buy/sell back agreements, RRPs consolidate all transaction stages within a single contract, ensuring both parties uphold the agreement's terms.
*   In RRPs, while the buyer temporarily holds the collateral, control and ownership do not typically transfer unless default occurs.

## Understanding the Mechanics of Reverse Repurchase Agreements

Repos are classified as a money market instrument, and they are usually used to [raise short-term capital](https://www.investopedia.com/terms/s/short-term-gain.asp). Reverse repurchase agreements (RRPs, or reverse repos) are the seller's end of a repurchase agreement. These [financial instruments](https://www.investopedia.com/terms/f/financialinstrument.asp) are also called collateralized loans, buy/sell back loans, and sell/buy back loans.

Reverse repos are commonly used by businesses like lending institutions or investors to access short-term capital when facing [cash flow](https://www.investopedia.com/terms/c/cashflow.asp) issues. Essentially, the borrower sells assets like [business](https://www.investopedia.com/terms/b/business-asset.asp) equipment or company shares. Then, at a set future time, the lender sells the asset back for a higher price.

The higher buyback price is the [interest](https://www.investopedia.com/terms/i/interest.asp) the buyer earns for loaning money to the seller. The buyer holds the asset as collateral against the risk of seller [default](https://www.investopedia.com/terms/d/defaultrisk.asp). Short-term RRPs pose less [collateral](https://www.investopedia.com/terms/c/collateral.asp) risk than long-term RRPs, as long-term assets may [depreciate](https://www.investopedia.com/terms/d/depreciation.asp), increasing risk.

In a macro example of RRPs, the [Federal Reserve Bank](https://www.investopedia.com/federal-reserve-4689790) uses repos and RRPs to provide stability in lending markets through [open market operations (OMOs)](https://www.investopedia.com/terms/o/openmarketoperations.asp). The RRP transaction is used less often than a repo by the Fed, as a repo puts money into the banking system when it is short, whereas an RRP borrows money from the system when there is too much [liquidity](https://www.investopedia.com/terms/l/liquidity.asp). The Fed conducts RRPs to maintain long-term [monetary policy](https://www.investopedia.com/terms/m/monetarypolicy.asp) and control capital liquidity levels in the market.

### Key Insights into Collateral Management in RRPs

Part of the business of repos and RRPs is growing, with third-party collateral management operators providing services to develop RRPs to provide quick funding to businesses in need. Since quality collateral can be hard to find, businesses use their assets through tri-party RRPs to fund expansion, offering investment opportunities. This industry is known as collateral management optimization and efficiency.

## Comparing Reverse Repos with Buy/Sell Back Agreements

An RRP differs from buy or sell backs in a simple way. Buy or sell back agreements legally document each transaction separately, providing clear separation in each transaction. This way, each transaction is independent and enforceable on its own. In RRPs, each phase of the agreement is documented in the same contract, ensuring all phases are enforceable.

Lastly, in an RRP, although collateral is in essence purchased, the collateral generally never changes physical location or actual ownership. If the seller [defaults](https://www.investopedia.com/terms/d/default2.asp), the collateral must be physically transferred to the buyer.

> **Fast Fact**
>
> Repos and reverse repos are two sides of the same coin, reflecting the role of each party in the transaction. Repo refers to the buyer side of a repurchase agreement, while reverse repo refers to the seller side.

## Practical Example of a Reverse Repo Agreement

For example, Bank ABC has excess cash [reserves](https://www.investopedia.com/terms/b/bank-reserve.asp) and wants to use some of it. Meanwhile, Bank XYZ needs a temporary cash boost due to a reserve shortfall. Bank XYZ may enter a reverse repo agreement with Bank ABC, agreeing to sell securities for the other bank to hold overnight before buying them back at a slightly higher price. From the perspective of Bank ABC, which buys the securities and agrees to sell them back at a premium the next day, the transaction is a repurchase agreement.  

## How Does a Reverse Repurchase Agreement Work?

In a reverse repurchase agreement (RRP, or reverse repo), a party sells securities to a counterparty with the stipulation that it will buy them back at a slightly higher price. The agreement functions much like a collateralized loan. The original seller (engaging in a reverse repurchase agreement) receives an infusion of cash, while the original buyer (engaging in a repurchase \[repo\] agreement) essentially provides a loan and earns interest from the higher resale price. Generally, collateral assets don't physically change hands during the transaction.

## What Is the Benefit of a Reverse Repo?

In a reverse repo, a party in need of cash reserves temporarily sells a business asset, equipment, or even shares in another company, with the stipulation that it will buy the assets back at a premium. Like other types of lenders, the buyer of the assets in a repo agreement earns money for providing a cash boost to the seller, and the underlying collateral reduces the risk of the transaction.

## How Does the Federal Reserve Use Reverse Repos?

When the Federal Reserve uses a reverse repo, the [central bank](https://www.investopedia.com/terms/c/centralbank.asp) initially sells securities and agrees to buy them back later. In these cases, the Fed borrows money from the market, which it may do when there is too much liquidity in the system.

Regular repurchase agreements (repos), in which the Fed plays the role of the lender by buying securities and then selling them back, are a more common central bank measure to inject additional reserve balances into the banking system. The Fed is not the only central bank to use this liquidity-maintaining method. The Reserve Bank of India also uses repos and reverse repos as they work to stabilize the economy through the [liquidity adjustment facility](https://www.investopedia.com/terms/l/liquidity_adjustment_facility.asp).

## The Bottom Line

A reverse repurchase agreement (RRP), or reverse repo, refers to the seller side of a repurchase agreement (repo). The party executing the reverse repo sells assets to the other party while agreeing to buy them back later at a slightly higher price. From a practical perspective, a reverse repo agreement is akin to taking out a short-term loan, with the [underlying assets serving as collateral](https://www.investopedia.com/terms/g/gcf.asp).  

> **Article Sources**
>
> 1.  Brookings Institution. “[What Is the Repo Market, and Why Does It Matter?](https://www.brookings.edu/blog/up-front/2020/01/28/what-is-the-repo-market-and-why-does-it-matter/)”
>     
> 2.  Congressional Research Service. “[Repurchase Agreements (Repos): A Primer](https://crsreports.congress.gov/product/pdf/IF/IF11383),” Page 1.
>     
> 3.  Federal Reserve Bank of New York. “[FAQs: Reverse Repurchase Agreement Operations](https://www.newyorkfed.org/markets/rrp_faq.html).”
>     
> 4.  PwC Viewpoint. “[U.S. Transfers of Financial Assets Guide: 5.5 Repurchase Agreements](https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/transfers_and_servic/transfers_and_servic_US/chapter_5_accounting_US/55_repurchase_agreem_US.html).”
>     
> 5.  Federal Reserve System. “[Policy Tools: Overnight Reverse Repurchase Agreement Facility](https://www.federalreserve.gov/monetarypolicy/overnight-reverse-repurchase-agreements.htm).”
>     
> 6.  Federal Reserve Bank of New York. “[Repo and Reverse Repo Agreements](https://www.newyorkfed.org/markets/domestic-market-operations/monetary-policy-implementation/repo-reverse-repo-agreements).”