What is a Retail Repurchase Agreement
A retail repurchase agreement is an alternative to traditional savings deposit. Under a bank-issued retail repurchase agreement, an investor buys a pool of securities, usually U.S. government or agency debt, for a term of fewer than 90-days.
After the 90-day period, the bank repurchases that pool of securities at a premium. The extra income earned from the transaction is analogous to the interest an investor would gain from a traditional savings deposit. The pool of securities represents collateral that ensures future repayment.
BREAKING DOWN Retail Repurchase Agreement
A retail repurchase agreement is sold in small denominations of $1,000 or less. The assets are sold and then repurchased by the lending institution. In contrast, a wholesale repurchase agreement (Repo), are sold to large investors and institutions in denominations of $1 million or more. Here, the assets act as collateral and do not change hands. The most common underlying asset are U.S. Treasury securities, but collateral may include Federal Agency debt, mortgage-backed securities, and corporate securities.
The retail and wholesale repurchase markets developed in the 1970s and 1980s. They were a means for large securities firms and banks to raise short-term capital during an era of steadily rising interest rates. The repo market has grown to become an integral part of the U.S. financial system’s plumbing. It is a place where large financial institutions with significant holdings of government bonds can use those assets as collateral to meet their short-term financing needs.
The Growth and Risks of Repurchase Agreements
In 1979, U.S. banking regulators exempted retail repurchase agreements from interest-rate caps. In 1981 banks and savings and loan institutions began offering these investments to retail investors at premium rates. The retail repurchase agreements attempt to compete with money market mutual funds for depositors. By September of 1981, the total amount of retail repurchase agreements outstanding was $13.3 billion.
In 2017, The Securities Industry and Financial Markets Association (SIFMA) found that there is a $2.3 trillion national amount in repurchase agreements.
In this environment of quickly rising interest rates, retail repurchase agreements may be a convenient way for retail investors to earn higher returns on investments, which were still relatively liquid and safe. However, unlike traditional deposits, retail repurchase agreements are not protected by Federal Deposit Insurance Corporation (FDIC) insurance.
While secure government and other debt back the retail repurchase agreements, the investor's claim on that collateral is not always explicit. Investors in retail repurchase agreements should therefore always trust the soundness of the issuing financial institutions.
Retail Repurchase Agreements vs. Money Market Funds
A popular alternative to retail repurchase agreements is a money market fund. A money market fund is an investment whose objective is to earn interest for shareholders while maintaining a net asset value (NAV) of $1 per share. The makeup of a fund’s portfolio is short-term, or less than one year, securities representing high-quality, liquid debt and monetary instruments. Investors can purchase shares of money market funds through mutual funds, brokerage firms and banks.
Money market funds allow investors to invest in government securities, tax-exempt municipal securities, or corporate debt securities on a short-term basis. The total size of the money market fund industry has grown to more than $2.8 trillion in 2017, according to the Securities and Exchange Commission.