PRAS in banking stands for Purchase and Resale Agreements.
Purchase and Resale Agreements (PRAs) are financial instruments used primarily for short-term funding and liquidity management. They essentially involve the sale of a security with an agreement to repurchase it at a predetermined price and future date. It's a form of collateralized lending.
Here's a breakdown:
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The Transaction: One party (the seller/borrower) sells a security to another party (the buyer/lender) and simultaneously agrees to buy it back at a later date at a specified price.
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Purpose: PRAs allow institutions to borrow funds for a short period using their securities as collateral. This is often used for overnight or short-term financing needs.
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Function: From an economic standpoint, a PRA is functionally similar to a secured loan. The difference lies in the legal structure; it's technically a sale and repurchase rather than a loan.
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Example: A bank needs to raise funds overnight to meet its reserve requirements. It enters into a PRA, selling government bonds to another institution with an agreement to repurchase them the next day at a slightly higher price. The difference in price represents the interest paid for the overnight funding.
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Key Features:
- Repurchase Price: Predetermined at the outset of the agreement. It's higher than the initial sale price, reflecting the interest/fee for the funding.
- Maturity Date: Typically short-term, often overnight, but can extend to longer periods.
- Underlying Security: Usually high-quality, liquid assets like government bonds, but can include other securities.
- Risk Mitigation: The transaction is collateralized by the underlying security, reducing the lender's risk.
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Benefits:
- Liquidity Management: Helps institutions manage their short-term funding and liquidity needs.
- Short-Term Investments: Offers investors short-term investment opportunities with relatively low risk.
In summary, PRAs are a common tool in the banking industry for managing short-term funding requirements using securities as collateral. They are functionally equivalent to secured loans.
