What Are Purchase and Resale Agreements?
Central banks conduct various types of sale and repurchase agreements (repo transactions) as part of the open market operations they use to implement monetary policy. These are typically undertaken with the intention to affect liquidity and therefore interest rates in the money market. A Purchase and Resale Agreement (PRA) is the specific name given to one of these operations when used by the Bank of Canada (BoC), with the intention to provide liquidity to the market.
Understanding Purchase and Resale Agreements (PRAs)
Special Purchase and Resale Agreements (SPRAs) are overnight operations, but term Purchase and Resale Agreements (PRAs) are for longer time periods. Term PRAs have typically only been used during periods of market stress, and are not currently in use.
Generally, in a repo transaction, two counterparties will enter into an agreement whereby one will sell securities to the other and simultaneously agree to repurchase them at a specified later date at a fixed price. The securities can therefore effectively be regarded as collateral for a cash loan. The securities involved are usually fixed-interest securities, and pricing is agreed in terms of interest rates. This agreed-upon interest rate is termed the repo rate. While many market participants engage in such transactions, when central banks do so it is usually only with certain banks in their domestic money markets, on a short-term basis, and undertaken with the aim of implementing monetary policy.
In a term PRA, the BoC will buy securities from a specified type of bank (namely, a primary dealer in Canadian government securities) with an agreement to sell them back to that bank after a specified term, which could range up to a year. This gives a temporary injection of cash (as the banks receive the payment for the securities) into the money market, helping improve their liquidity and place downward pressure on market interest rates.
History of Purchase and Resale Agreements
The BoC first used term PRAs from December 2007, after Canadian money markets had tightened in the midst of global funding problems following the onset of the 2007 financial crisis; a brief determination that the situation had calmed was reversed in March 2008 when funding pressures again manifested, leading to the collapse of Bear Sterns. The BoC allowed PRAs to mature in June and July, only for the Lehman's collapse and near-bankruptcy of AIG to again impact the money market in September 2008 and again see PRAs used to help ease conditions. The final PRA matured in 2010.