A repurchase agreement (repo) in which a non-bank counterparty borrows cash from the bank counterparty. It is reverse to the original situation (ordinary repo) where the bank counterparty borrows cash against collateral securities (securities posted as collateral against the repo loan). By nature, a reverse repo is a short-term agreement to buy securities at a specific price and sell them back at a slightly higher price. Typically, repos and reverse repos are short-term borrowing and lending arrangements, for overnight intervals.

Reverse repos are used by central banks as a mechanism to affect money supply: a central bank can increase the money supply, by reverse repos, via open market operations. In this sense, a reverse repo is a monetary policy instrument that helps regulators control the money supply in a country. An increase in the reverse repo rate will negatively impact the money supply and vice-versa, other factors held constant.

A reverse repo trade takes place using the reverse repo rate– that is, the rate at which the central bank borrows money from market players, such as commercial banks within its jurisdiction. An increase in this rate means that the central bank is increasing the incentives for commercial banks to invest their surplus funds with the central bank, thereby decreasing the money supply in the market. On the other hand, a decreasing rate implies that these banks get lower incentives to deposit their funds with the central bank, thereby increasing the money supply in the market.