Did you know that the stocks and bonds you own can be used as collateral for a loan? The process of using stocks or bonds as collateral for a loan is known as buyback. With this mechanism, you can use the repo to earn additional money without selling your assets.

Here is the full description.

What is a stock repurchase (Repo)?

A repurchase agreement (repo) is a lending transaction using stocks or bonds as collateral in which the borrower must buy back shares or bonds within a specified period of time and at a specified price.

Simply put, a buyback transaction is the same as when you apply for a bank loan with collateral in the form of a home or a motor vehicle. But this time the collateral is a security.

So if you don’t pay off the loan also known as Buy back your stocks and bonds within a specified period of time. Lenders have the right to sell securities to other people.

Because the prices of stocks and bonds in the secondary market fluctuate. Thus, collateral in the form of stocks and bonds is only 50% and 70% of all borrowed assets.

For example, you borrow Rp. 100,000,000 from the bank by doubling the number of shares you own. Securities will only be worth Rp 50,000,000 in the eyes of the bank. Therefore, you must have other assets to use as collateral.

This repurchase agreement (repo) can be executed by the parties. since the company Pension Fund Management Institute securities company to the central bank Although shares are used as collateral in accordance with OJK Regulation No. 40 /POJK.03/2017, it is unclear whether retail investors can use this mechanism to obtain bank loans.

Using the repurchase agreement

1. Get more money fast

As we all know, it takes at least 2 business days for the stock to be sold and funded into the account. Often times this is not fast enough for companies looking to get additional capital. Not to mention the factor that the cost of ordering in the market. Bank transfer fees, profit or not, etc.

One way companies can do this is through a repurchase. Companies can contact the securities companies they use and request them to borrow money with the shares they have as collateral, so companies don’t have to think about costs, profitability and everything else to get. new capital fast

2. Buyback is a tool of monetary policy.

One of the parties actively involved in repo transactions is the Central Bank, also known as Bank Indonesia. Bank Indonesia cooperates with other parties such as commercial banks or securities companies to use. repurchase agreement It is a tool for controlling the supply of currency (money supply), so the inflation and interest rates of a country can be controlled.

3. Repo is a short-term investment tool.

For institutions such as banks or securities companies A buyback is a safe bet for short-term excess liquidity. Because at least they can sell securities used as collateral if the borrower, whether it is an investor. securities company or other banks are unable to pay the debt

Type of repurchase agreement

1. Third party repos

The first and most widely used type are third-party repos. As the name implies, a third-party repo or three party repo be kind repurchase agreement which uses a third party service to connect the borrower or the existing shareholder (the seller) and the lender (buyer).

This third party’s duty is to keep stocks or bonds used as collateral. Ensuring that the seller receives the loan and delivers the securities used as collateral. Ensuring that the lender (buyer) submits loans and receives repayments.

However, this third party is not obligated to be the matchmaker or the party that unites the Seller and the Buyer. The seller must find an institution that is willing to lend money freely and vice versa.

Several global institutions are offering this tripartite buyback service, such as JP Morgan Chase, Clearsteram, Euroclear, while in Indonesia, PT Kliring Penjaminan Efek Indonesia (KPEI) has already launched this service.

2. Special delivery repo

The second type is specific delivery repos This type is relatively rarely used because it requires sellers (sellers, borrowers) and buyers (buyers, lenders) to submit securities used as collateral at a predetermined location and time.

3. Incarcerated

Custody holding is the third type of buyback. In this category, sellers can receive borrowed money without handing collateral to the buyer (buyer). They put the securities in an account with a bank or securities company. (custody account) instead

This type of repo is rarely performed due to the high risk. especially for buyers This risk arises especially if the seller is unable to pay off the loan along with the interest. but because the securities are in the seller’s account Therefore, buyers cannot collect or sell securities.

In some cases, securities lending transactions for short sale including one type repurchase agreement Up-to-date. In this transaction Traders borrow stocks or other securities from securities companies for later sale.

The trader must return the securities and interest to the securities company in a timely manner. If the price of the securities in the market decreases upon maturity Traders benefit from having to pay less and vice versa.

repurchase risk

The main risk of repurchase contracts aka repo is default risk (default risk). This risk arises if the borrower fails to repay the debt by the specified due date. In order for the lender (buyer) to sell the securities used as collateral.

While this may seem like a win-win solution, sometimes the price of a stock or bond used as a collateral decreases when it is sold. Buyers do the following:

  1. Over-collateralized pseudonym, the value of the security used as collateral must be higher than the amount borrowed. For example, you borrowed Rp. 100,000,000, so the value of the stock you secured at least Rp. 150,000,000.
  2. Ask the seller (seller) to change the securities used as collateral. Either by adding other assets or by other means.

Another potential risk in a repurchase transaction is when the buyer is reluctant to sell or return the secured securities. This may be because the market price of these securities has increased.

basically One of the main ways to deal with repo risk is to write the transaction contract in a way that prevents loss to one or both parties.

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