If you have been reading business press over the last week or so you have surely seen that the Central Bank of Kenya has been mopping up money from the economy through repurchase agreements (repos). Over the last 5 trading sessions the CBK has mopped up Ksh 31.1 billion through these repos.

What does all this mean?

Before getting into the description and use of repurchase agreements we need to understand what liquidity is and how it affects the economy.

Liquidity may describe the ease with which an asset can be sold or bought or a business’ ability to meet its payment obligations. In our context liquidity refers to the amount of money commercial banks hold in their reserves to meet the depositor’s requirements of withdrawals on demand.

Excess liquidity therefore means that commercial banks are holding more cash reserves than they ideally should, above the usual requirement. This means that commercial banks are have more cash in holding than the CBK would desire.

With higher cash reserves comes higher money supply, banks have more money to lend to one another and to customers. The lending between banks is determined by the interbank rate, which if you have been following the news, has been falling over the last few days. We can hypothesize that since the banks have higher cash reserves they can lend it to one another at a lower rate as it is in plenty.

The CBK on the other hand sees this as an undesirable situation. Lower interbank rates mean that banks can borrow cheaper and lend cheaper increasing the supply of money within the money markets. An increase in money supply is one of the factors that lead to inflation.

Bingo!

The CBK is mopping up excess liquidity in the economy so as to curb inflation.