A repurchase agreement ('repo') is simultaneously a collateralised loan and a temporary sale of securities. The seller sells securities to the buyer with a contractual agreement to repurchase them at a defined price on a defined future date. The difference between the sale price and the repurchase price represents the interest on the implied loan.
Why repo exists
Repo solves two problems at once. A firm that holds government bonds but needs short-term cash can repo those bonds out — selling them temporarily and receiving cash, then buying them back later. A firm that wants to earn a return on excess cash but wants security can reverse repo — buying bonds temporarily and holding them as collateral. Both sides get what they need.
Banks use repo to finance their inventory of bonds. Hedge funds use repo to borrow cash against their holdings, effectively using leverage. Central banks conduct repo as a primary monetary policy tool.
General collateral and specials
Not all repos are created equal. General collateral (GC) repo accepts a broad basket of eligible bonds as collateral, and GC repo rates track closely to the central bank's policy rate. 'Special' repo involves a specific bond that is in high demand — perhaps because it is heavily shorted or needed for delivery into a futures contract. Special bonds trade at lower repo rates: the borrower is willing to accept less interest in return for obtaining that specific bond.
Securities lending
Securities lending is a close cousin of repo: the owner of a security temporarily transfers it to a borrower (who may need it for delivery or short selling), receiving cash or other securities as collateral and earning a lending fee. Pension funds and asset managers are large lenders through custodian-run securities lending programmes.
The full mechanics — how GC and special rates are determined, how securities lending programmes work operationally, and how repo is used by different market participants as a funding and positioning tool — are covered in depth in Market Mechanics — the complete plain-English guide to how a bank's markets business works.