A reverse repurchase agreement is a short-term deal in which one party lends cash and takes securities as collateral, with the borrower agreeing to buy those securities back on a set future date at a slightly higher price. The gap between the two prices is the interest the cash lender earns. It is the mirror image of a repurchase agreement, or “repo”: the same trade, viewed from the cash lender’s side of the table rather than the borrower’s.
These transactions are one of the safest ways large institutions park spare cash overnight or for a few weeks, and they form the backbone of the U.S. money markets.
How the Transaction Works
Every reverse repo has two legs. On the opening leg, the cash lender wires funds to the borrower and receives securities in return. On the closing leg, which happens on a pre-agreed date, the borrower buys those securities back at a slightly higher price. That price difference is the lender’s return, and the implied interest rate it represents is called the repo rate.1Federal Reserve Bank of Richmond. Repurchase and Reverse Repurchase Agreements
In U.S. markets, the repo rate uses an Actual/360 day-count convention. Interest accrues based on the actual number of calendar days the deal is outstanding, divided by a 360-day year. Lend $10 million overnight at a 4% repo rate and the interest works out to $10,000,000 × 0.04 × (1/360), or roughly $1,111 for the one night.
Although the paperwork records a sale followed by a repurchase, the economics are those of a secured loan. The sale-and-repurchase form matters for one practical reason: if the borrower defaults, the cash lender already owns the collateral outright and does not need to foreclose on a pledged asset.
Overnight, Term, and Open Agreements
Most reverse repos backed by Treasury securities settle overnight, with the closing leg happening the next business day. Term reverse repos run longer, with standard maturities of one, two, or three weeks and one, two, three, or six months. Open repos have no fixed end date and roll forward each day until either side terminates the agreement.1Federal Reserve Bank of Richmond. Repurchase and Reverse Repurchase Agreements
Haircuts and Margin
Cash lenders protect themselves by applying a haircut, meaning they pay out slightly less cash than the collateral’s market value. If the securities drop in price before the deal closes, there is still enough collateral to cover what was lent. In the tri-party repo market, Treasury collateral typically carries a haircut of about 2%.2Federal Reserve Board. Proportionate Margining for Repo Transactions
Bilateral Treasury repos often work differently. About 70% of Treasury transactions in the non-centrally cleared bilateral market carry no haircut at all, and some even have negative haircuts, where the cash lender pays more than the collateral’s face value. The reason is the deep trust between established counterparties and the near-zero credit risk of U.S. government debt.2Federal Reserve Board. Proportionate Margining for Repo Transactions
Riskier collateral demands a larger cushion. Corporate bonds and mortgage-backed securities typically require bigger haircuts than Treasuries because their prices move more and their credit quality is lower.
Tri-Party vs. Bilateral Structure
Reverse repos settle through one of two structures, and the difference matters more than it might look at first.
In a bilateral repo, the two counterparties handle everything themselves. They agree on specific securities down to the individual CUSIP, and each party’s custodian bank manages clearing and settlement. The cash lender takes full control of the collateral and can reuse it in other transactions. That flexibility comes with higher operational overhead and the risk of a settlement fail when the lender doesn’t return the securities on time.3Federal Reserve Bank of New York. Reference Guide to U.S. Repo and Securities Lending Markets
In a tri-party repo, a clearing bank sits between the two sides and acts as an agent. In the U.S., government securities clearing banks fill this role. The clearing bank handles settlement, custody, collateral valuation, and the optimization of which specific securities satisfy the collateral requirement. The cash lender agrees to accept any securities within a broad asset class, such as “U.S. Treasuries,” rather than naming specific issues. Collateral posted in a tri-party repo cannot be repledged outside the tri-party platform, which protects the borrower against settlement fails on the closing leg.3Federal Reserve Bank of New York. Reference Guide to U.S. Repo and Securities Lending Markets
Tri-party arrangements are generally cheaper and more efficient for large-scale participants because the clearing bank’s technology handles the operational work. Bilateral deals give the cash lender more control over collateral selection and reuse, which matters for firms running complex trading strategies.
What Collateral Gets Accepted
The security of a reverse repo depends almost entirely on the quality of the collateral. U.S. Treasury securities are the standard because they carry no credit risk and are extremely liquid. Agency debt issued by entities such as Fannie Mae and Freddie Mac is also widely accepted. Some deals use investment-grade corporate bonds or agency mortgage-backed securities, with larger haircuts to account for greater price volatility and credit exposure.
Government money market funds, which are major participants in the repo market, face strict rules under SEC regulations. A government money market fund must invest at least 99.5% of its total assets in cash, government securities, or repurchase agreements fully collateralized by government securities and cash.4eCFR. 17 CFR 270.2a-7 – Money Market Funds
Who’s on Each Side
Reverse repos bring together institutions with opposite short-term needs. On the cash-lending side, the biggest players are money market funds. They hold enormous pools of cash that need to earn a return while remaining immediately accessible. Banks, insurance companies, and large corporations with temporary surplus cash also lend through reverse repos.
On the borrowing side, the main participants are investment banks and securities dealers who need to finance their inventory of bonds and other securities. A dealer holding $5 billion in Treasuries doesn’t fund that position entirely with its own capital. It borrows most of the cash through repos, pledging the securities as collateral. That financing function is what keeps markets liquid, with cash flowing from institutions that have too much of it to institutions that need it, and high-quality securities moving the other way as insurance.
The Federal Reserve’s ON RRP Facility
The Federal Reserve operates its own Overnight Reverse Repurchase Agreement facility, known as the ON RRP, as a supplementary tool for controlling short-term interest rates. The Fed describes it as supporting the federal funds rate target range set by the Federal Open Market Committee.5Federal Reserve Board. Overnight Reverse Repurchase Agreement Operations
When the Fed conducts an ON RRP operation, it sells securities to an eligible counterparty and agrees to buy them back the next day at a slightly higher price. The counterparty’s cash sits on the Fed’s balance sheet overnight instead of circulating in the financial system.5Federal Reserve Board. Overnight Reverse Repurchase Agreement Operations
The facility’s main job is to put a floor under short-term rates. If the Fed offers a risk-free overnight rate to eligible counterparties, no rational money market fund will lend to a private counterparty at a rate below what the Fed is paying. That keeps short-term rates from falling below the FOMC’s target range even when the financial system is awash in cash. As of late March 2026, the ON RRP offering rate is 4.25%.6Federal Reserve Bank of New York. Reverse Repo Operations
Eligible counterparties include money market funds, government-sponsored enterprises such as the Federal Home Loan Banks, and primary dealers. Each counterparty faces a daily cap of $160 billion.7Federal Reserve Board. Money Market Fund Repo and the ON RRP Facility Commercial banks generally don’t use the ON RRP because they have access to a separate Fed tool, interest on reserve balances, that serves a similar purpose for them.5Federal Reserve Board. Overnight Reverse Repurchase Agreement Operations
How Reverse Repos Get Recorded
Even though a reverse repo is legally structured as a sale and repurchase, it is almost always recorded on the books as a secured borrowing rather than a true sale. Under FASB standards, both standard repos and transactions such as repurchase-to-maturity agreements must be accounted for as secured borrowings because the party in the repo retains exposure to the transferred securities throughout the term.8Financial Accounting Standards Board. Accounting Standards Update 2014-11 – Transfers and Servicing (Topic 860)
For the cash lender in a reverse repo, the cash paid out is recorded as a short-term investment, and the difference between the purchase price and the repurchase price is recognized as interest income over the life of the agreement.9National Association of Insurance Commissioners. Statutory Issue Paper No. 45 – Repurchase Agreements, Reverse Repurchase Agreements and Dollar Repurchase Agreements
For the borrower, the cash received is recorded as a liability, and the price differential is recognized as interest expense. The underlying securities stay on the borrower’s balance sheet because the economic exposure never truly transfers. The accounting reflects what the deal really is: a loan, dressed in sale paperwork.9National Association of Insurance Commissioners. Statutory Issue Paper No. 45 – Repurchase Agreements, Reverse Repurchase Agreements and Dollar Repurchase Agreements