What Is a Retail Repurchase Agreement?

A retail repurchase agreement, also known as a “retail repo agreement,” offers investors an attractive alternative to traditional savings accounts. In this financial product, investors engage in a transaction with a bank, purchasing a share of a pool of securities, typically comprised of short-term U.S. government or agency debt lasting less than 90 days. At the end of the 90-day period, the bank repurchases the share from the investor at a premium.

Key Takeaways:

• A retail repurchase agreement functions similarly to money market accounts for saving purposes.
• Investors purchase assets from a bank for a period shorter than 90 days, with the bank repurchasing those assets at the term’s conclusion, providing a premium to the investor.

How Retail Repurchase Agreements Work

From the investor’s perspective, the profit from this transaction is akin to the interest earned in a traditional savings account. While retail repurchase agreements are like scaled-down versions of wholesale agreements between banks, they involve smaller denominations – usually $1,000 or less – and are completed within 90 days.

Retail repurchase agreements differ from wholesale ones in their size and handling of assets. In retail agreements, assets are sold and repurchased within 90 days by the bank, unlike in wholesale agreements where assets act as collateral and do not change hands. Common collateral in wholesale agreements includes U.S. Treasury securities, agency debt, corporate securities, or mortgage-backed securities.

The history of retail and wholesale repurchase markets traces back to the ’70s and ’80s, emerging as avenues for large financial institutions to raise short-term capital amid rising interest rates. Today, the repo market is critical for U.S. banks’ daily liquidity needs and is an integral part of the financial system.

In 1979, U.S. banking regulators exempted retail repurchase agreements from interest rate caps, prompting banks to offer them at premium rates. These agreements, competing with money market funds, are sold by banks and savings institutions without FDIC protection.

Real-World Example of a Retail Repurchase Agreement

Meet Michael, a loyal customer at XYZ Financial. Upon being offered a higher interest rate, Michael learns about converting his savings account to a retail repurchase agreement. Under this arrangement, he buys a portion of high-quality U.S. government debts, which the bank will repurchase from him with a premium within 90 days.

Before committing, Michael researches the risks associated with retail repurchase agreements. Though offering higher interest, they lack FDIC protection. In case of XYZ Financial’s bankruptcy, asserting claim to the assets might be challenging.

Should Michael opt against the transaction, he might consider a money market mutual fund as an alternative to retail repurchase agreements.