We're looking at our example banks balance sheet here, and we're specifically gonna focus on sale and repurchase agreements, which are commonly known as repos.

We can see these on the balance sheet in the liability section as securities sold under agreement to repurchase at fair value.

So let's look at the mechanics of how these work.

The first thing that happens is there's an effective sale.

One party, we're gonna call them, the borrower agrees to sell, and another party that we're gonna call the lender agrees to buy the assets.

And then at a later date, which could be the next day or any time later, the same two parties agree to reverse the transaction with the borrower agreeing to repurchase the assets they originally sold.

The borrower is selling assets and receiving cash, and then at a later date has to pay cash to buy back the assets at a slightly higher price, which reflects the interest element.

It's worth noting that price will be agreed in advance.

What we've effectively got here is a kind of collateralized borrowing.

The borrower is getting cash now and has to give up some assets effectively as collateral, and then has to pay cash out later.

Essentially repaying the loan to get their collateral back.

In this case, for the repos on the bank's balance sheet, they're going to be in the position of the borrower.

Let's say that the assets are sold for 12 initially, which creates an increase in cash of 12 and an increase in the repo liability of 12.

Then on the repurchase date, the bank pays slightly more, let's say 12.1 in cash and the repo liability gets cleared.

But because they paid out slightly more in cash than they initially received, they will need to record the difference as an interest expense in the income statement as they're effectively the borrower here.

And you can just see that here with the 0.1 impact on retained earnings.

If we take a look at reverse repurchase agreements, also known as reverse repos, these are actually exactly the same thing.

But instead of being on the borrowing side, you are on the lending side.

If you enter into a reverse repo, we'll still have the same mechanics for the transaction, but you'll end up with a line on the asset side of your balance sheet.

And you can see that here where the reverse repos are about $180 billion and referred to as securities purchased under agreements to resell.

And let's have a quick look at the mechanics of reverse repos here.

So again, we start with a sale, and we've also got a borrower and a lender, but our bank is on the lending side here rather than the borrowing side.

We start with the transfer out of cash from the lender and the receipts of collateral.

The second part of the repurchase agreement is that the assets need to be repurchased by the Borrower.

So what happens on the balance sheet of our bank from the reverse repo side, you can see that initially cash goes down by 12 and there's a reverse repo asset created.

And then on the second stage, when the repo clears or is re paid, then the reverse repo asset falls and the cash goes up by 12.1, which is slightly more than the initial cash paid out, and that difference is reflected as interest income in our income statement.

There's another form of financial asset, which is worth mentioning here, which is called securities loaned.

These are similar to repos in some regards, but there are some subtle differences.

Repos tend to be items which are collateralized by treasury bonds.

However, with securities loaned, the security involved can be either bonds or equities.

This may well be triggered by a client wishing to borrow a security to open a short position, but the cash received as collateral can also act as financing for the bank.

In addition, for the securities loaned, the bank may not only be receiving cash as collateral, they may actually be receiving other securities as well.

So a repo is generally entered into for funding, and our collateral is treasury bonds, and you're receiving cash if you are borrowing under the repo market for securities loaned, you are lending securities and you may be receiving cash, but you could also be receiving treasury bonds or equities.

So there are some subtle differences here, but repos tend to be entered into very much for cash funding, where securities loaned could be triggered by the need to borrow to open a short position by a client, and it could be both for treasury bonds or equities, whereas repos is typically just using treasury bonds as collateral.