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"Dealers typically use repo to fund both their cash Treasury positions and their lending to clients through Treasury reverse repos. Thus, the ability and willingness to engage in repo, which increases the size of dealers’ balance sheets, will affect their willingness to take on additional inventories and provide lending through reverse repos"

extract from below report (Footnote 14, PDF page 43, internal page number 37)

https://www.federalreserve.gov/publications/files/financial-stability-report-20201109.pdf

From the above, it seems banks raise cash through repos (get cash in exchange for some collateral) to finance treasury holdings and lend the cash clients against treasury securities. I am trying to understand how banks then use the funds raised with repos and got lost:

step 1: banks get cash in exchange for collateral

step 2: then with this cash they either buy US treasuries (This means they borrow against some collateral(potentially UST) and then buy UST?) or lend this cash to clients against US treasuries (This means they borrow against UST and then lend against UST at a higher rate?)

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    $\begingroup$ Step 2: Dealer wants to buy a Treasury for their inventory, they use some of their own money but the rest of the money comes from putting up the bond as collateral in a repo (this is similar to buying stock on margin). Five minutes later a client calls, they have an emergency need for cash, they are willing to put up a Treasury bond for collateral, desire to get cash from us (client does a repo and we do a reverse repo). $\endgroup$
    – nbbo2
    Commented Feb 27, 2021 at 16:23
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    $\begingroup$ ok so we can say that banks use repo to finance their UST inventory to support their market making activity. $\endgroup$
    – Student
    Commented Feb 27, 2021 at 16:33
  • $\begingroup$ with regard to the reverse repos, is it correct to say that banks lend cash that has previously been borrowed against UST meaning they first borrow against UST and then lend against UST at a higher rate (gain from spread) or not? thanks $\endgroup$
    – Student
    Commented Feb 27, 2021 at 16:35
  • $\begingroup$ I do not think there is a spread, but I have never worked at a Primary Dealer. Someone else can answer that. $\endgroup$
    – nbbo2
    Commented Feb 27, 2021 at 16:36
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    $\begingroup$ Yes there is a spread. Typically a bank might borrow money in a repo at say Fed funds minus 5bp and lend it out in a reverse repo at say Fed Funds +5bp. In this case the spread would be 10bp. The actual numbers vary according to supply and demand. $\endgroup$
    – dm63
    Commented Feb 28, 2021 at 0:01

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First of all, banks play it both ways. Some banks (JPM especially) are cash-rich and will use their cash (pay depositors 0.00 %) to pick up revenue in the repo markets.

Other banks will use the cash from repo to fund other types of repos. For example, in their prime services business they might be able to do a securted loan to clients for LIBOR +50.

Banks can also take their morgtage notes and repo those and play the roll down. They get the higher rate of the mortgage and then pay the lower rates of the overnight repo market. This is a great trade until 2008 comes along and overnight cash dissapears.

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