Retail Repurchase Agreement: What It is, How It Works, Example

What Is a Retail Repurchase Agreement?

A retail repurchase agreement, also known as a “retail repo agreement,” is a financial product that serves as an alternative to traditional savings accounts. When an investor enters into a retail repurchase agreement with a bank, that investor purchases a share of a pool of securities, usually consisting of U.S. government or agency debt with a term of fewer than 90 days. Once the 90-day period has expired, the bank repurchases that share from the investor at a premium.

How Retail Repurchase Agreements Work

From the investor’s perspective, this transaction's profit is analogous to the interest they would otherwise gain on a traditional savings account. This type of transaction is essentially a scaled-down version of the wholesale repurchase agreements entered into between banks, although these wholesale agreements typically take place in minimum denominations of $1 million and are often extended for short periods, such as overnight.

Unlike their wholesale counterparts, retail repurchase agreements are sold in small denominations of $1,000 or less. The assets contained in the pool are sold and then repurchased up to 90 days later by the bank. Aside from their size, another major difference between retail repurchase agreements and wholesale repurchase agreements is that the assets act as collateral for wholesale transactions and do not change hands. The most common assets used as collateral in wholesale repurchase agreements are U.S. Treasury securities, although other collateral may include agency debt, corporate securities, or even mortgage-backed securities (MBSs).

The history of the retail and wholesale repurchase markets dates back to the 1970s and 1980s when they arose as a way for large securities firms and banks to raise short-term capital. At that time, interest rates were steadily rising, making it difficult to raise capital in a timely manner through traditional means. Since then, the repo market has grown to become an integral part of the U.S. financial system and is essential for meeting the nation’s banks' daily liquidy.

In 1979, U.S. banking regulators exempted retail repurchase agreements from interest rate caps. This led banks and savings and loan institutions to begin offering retail repurchase agreements to their customers at premium rates. These new products were positioned to compete with so-called money market funds, which are often sold as mutual funds to depositors. Importantly, these retail repurchase agreements are not subject to Federal Deposit Insurance Corporation (FDIC) protection.

Real-World Example of a Retail Repurchase Agreement

Michael has been a regular customer at XYZ Financial for many years. During one of his visits to the bank, the teller informs him that he could earn a higher interest rate if he converts his savings account into a retail repurchase agreement. Under the terms of this agreement, Michael would purchase a share of a pool of assets, which the bank would then repurchase from him at a premium within 90 days. The teller explains to Michael that the assets in question are high-quality U.S. government debts.

Before making his decision, Michael researches retail repurchase agreements to better understand their potential risks. Michael confirms that although the proposed transaction would offer him higher interest than a traditional savings account, he would not be subject to the protection of the FDIC. Moreover, Michael learns that if XYZ Financial were to become bankrupt during the 90-day term, he may have difficulty establishing his specific claim to the agreement's underlying assets.

Suppose Michael does not wish to proceed with the proposed transaction. In that case, he might alternatively put his money into a money market mutual fund, which is a popular alternative to retail repurchase agreements.