The money market is a key component of the financial system as it provides an avenue for the central bank and market participants to manage the demand and supply of short-term funds in any economy.

The money market is divided into two segments:

Borrowing and Lending segment – With or Without collateral

This segment includes money market tools or instruments such as Call Money, Notice Money, Term Money, Market Repo, TREPs, and Corporate Bond Repo. In this segment, market participants lend or borrow funds with securities as collateral or without collateral.

Asset Market – Purchase and Sale of securities

Governments and companies raise funds through the issuance of securities in the asset markets segment such as Cash Management Bills, Treasury Bills, Commercial papers, and Certificates of deposit.

The borrowing and lending segment of money markets becomes a crucial segment for the Reserve Bank of India to assess and manage the systemic liquidity and also serves as a tool for the transmission of its monetary policy.

While the uncollaterlised call money segment remains the bellwether for systemic liquidity, the repo market is a vital cog for financial institutions to secure funding and the development of both money and capital markets.

What exactly is a Market Repo?

A repo is a sale and repurchase agreement and is also known as a ready-forward contract. Repo refers to borrowing funds via the sale of securities with an agreement to repurchase the same at a future date with the interest for the borrowings incorporated in the repurchase price.

The seller of the security receives funds while the buyer of the security receives collateral for the funds he has lent. The underlying security is typically government securities or highly liquid corporate securities.

A reverse repo is the opposite of a transaction which is essentially a collateralised lending of funds. Each repo/reverse repo transaction has two parts. The repo period is the time between two parts.

The collateral in a case of a repo transaction is not pledged but sold to the buyer, the legal title of the securities given as collateral passes from the seller to the buyer for a term of the repo. As there is a legal title transfer, the buyer of the repo can use the collateral for purposes such as short cover positions or entering another repo transaction. The Reserve Bank of India regulates the repo market in India and allows the re-repo of securities acquired under reverse repo with certain restrictions and permits only government securities, treasury bills, and state development loans.

The repo market can be placed for a tenor of overnight to 1-year. Overnight repos have a single-day maturity, while term repos have fixed maturity longer than one-day and open repos allow both lender and borrower an option to terminate the repo each day.

A minimum market order value of a repo is ₹10 million and in multiples thereafter.

Major participants are scheduled commercial banks, primary dealers, mutual funds, non-banking finance companies, financial institutions, insurance companies, corporates, pension funds, payments banks, and small finance banks, among others.

Repo transactions against government securities are traded and reported on the Clearcorp Repo Order Matching System electronic platform of the clearcorp dealing system. These are settled by the Clearing Corporation of India Ltd along with government securities.

For corporate bond repos, the clearing and settlement are done through clearing houses of the recognised stock exchange and are reported on the F-TRAC platform.

Benefits of Repo Market

One of the key advantages of a repo transaction is that it protects against credit risk as both parties temporarily exchange cash and securities with a legal agreement in place and the economic ownership of the collateral still vests with the lender of the securities.

As collateral security is involved in the repo market, the cost is lower compared to uncollaterlised money market instruments.

A deep and liquid repo market helps the central bank to manage systemic liquidity in the economy. The liquidity also improves underlying security in the repo or reverse repo transaction.

Another benefit of this market is that it helps market participants to take a short and long position in the securities market enabling the establishment of interest rate hedge.

The repo market is used by traders for funding their positions and taking a position in the market to execute their views on the interest rate.

Repo Market Trends in India

Repo has been used as a market tool in India for a long time The Securities Contract (Regulation) Act of 1956 made it possible for repo trading to start in India. Until 1987, banks and other organisations like public sector institutions and corporations were free to use repo to buy back corporate securities and bonds issued by public sector undertakings. But this was stopped by the Reserve Bank of India in April 1987, and units of the Unit Trust of India could not be used in repo transactions after that.

Repo was also abused on a large scale, which led the Reserve Bank of India to ban it between banks and non-banking entities. This market segment received furtherblow due to the securities irregularities of 1992.

Before 2010, the legal nature of repo in India was mostly the securities sold under repo were bought and sold outright. This was changed with the Reserve Bank of India (Amendment) Act of 2006 defining "repo" and "reverse repo" as "an instrument for borrowing (lending) funds by selling (buying) securities with an agreement to repurchase (sell) the securities on a mutually agreed future date at an agreed price that includes interest for the funds borrowed".

The repo market was largely an over-the-counter market till the introduction of the clearcorp repo order matching system was launched for anonymous order matching on January 27, 2009, to facilitate transactions in market repos of government securities.

Currently, the order matching system facilitates two kinds of repos Basket Repo and Special Repo.

For basket repo a lender is assured of delivery of liquid security amongst the cluster of securities forming a specific basket and special repo is a more conventional repo where the lending of funds happens against a specific security.

As per the latest data published by the Clearing Corporation of India, the daily average value of market repo for the current financial year up to January 2023 stood at ₹1.21 trillion, significantly higher than the daily average value of ₹213.08 billion in the financial year 2009-10.

Since 2010, the Indian repo market has been showing signs of maturity with electronic trading, trade reporting, clearing through a central counterparty, and proactive risk management practices introduced by the regulators from time to time.

Sources: Reserve Bank of India, Clearing Corporation of India Ltd.