When they have Treasury bills galore but not enough cash on hand, banks turn to the repo market

Obvious as it may seem, banks need cash. Cash is required for operations and to fund the bank’s positions. Counterintuitive as it may seem, banks don’t always have enough cash. When a bank is short of cash for operations, to fund their positions, or even to satisfy regulatory requirements for minimum amounts on reserve, they may turn to the repo market.

‘Repurchase agreements’

The repo market where banks play relies on somewhat mundane “repurchase agreements,” sometimes called “repos.” Repurchase agreements are a form of short-term borrowing, often used by entities that deal in government securities. In that scenario, a dealer sells the securities to investors, but for a very short period of time… even just overnight or for 48 hours. The dealer then buys them back the next day for slightly more money.

That “slightly more” is akin to the interest rate charged by the purchaser for loaning the dealer its money overnight. It’s a way for the dealers to generate short-term capital.

Now, let’s apply that to banks

As has been said, banks sometimes need cash at times when they’re bursting with other non-cash securities or Treasury bills. A Treasury bill is a short-term debt obligation (a year or less) backed by the Treasury Department, which sells them during auctions in $1,000 denominations. It’s the way the government raises funds or — to put it less generously — incurs debt.

Banks hold lots of Treasury bills, but need lots of cash. On the repo market, banks use repurchase agreements to temporarily sell their Treasury bills overnight or for 48 hours, with an agreement in advance to repurchase them for a little bit more. The bank with the Treasury bills acquires cash for short-term needs; the bank who acquires the Treasury bills earns a little something for giving up some of its excess cash for a short period.

Obvious as it may seem, banks need cash. Cash is required for operations and to fund the bank’s positions. Counterintuitive as it may seem, banks don’t always have enough cash.

Maybe you heard of a bit of pinch in the repo market recently?

In September 2019, there seemed to be a lot more banks with Treasury bills seeking short-term cash than there were banks with short-term cash to give up. Banks desperate to get cash could still get it, but based on basic supply and demand, the cost was increasing.

There were lots of reasons for the shortage of readily available short-term cash:

  • corporate tax bills had come due, and they were paid in cash
  • billions in Treasury bills had just been released and settled which meant an unusually high number ot Treasury bills at the same time that there was an unusually low amount of cash
  • banks that might have had money to lend were holding it to meet liquidity requirements imposed after the financial crisis

The ‘Fed’ to the rescue

The repo market became a more-stressful-than-usual place in September 2019 when there were more hopeful borrowers than willing lenders. To ease those stresses in the repo market, the Federal Reserve itself injected over $220 billion as of October 30, 2019.

The most nervous observers feel like they’ve seen this before. In 2007, spiking stresses in the repo market required cash injections by the Fed, too. What’s different this time? According to Paddy Hirsch, host of NPR’s “The Indicator” podcast: “…the issue then was that the collateral was bad, that the securities that they were giving up were these dodgy home loans and securities attached to that. But today the collateral is much better because it’s treasury securities.”

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