What are liquidity management and open market operations?

Liquidity Management in a Nutshell

Liquidity is basically talking about how much cash you have.

Liquidity management generally refers to either the availability of cash to trade a financial asset at its current price (maybe a stock or something like that) or the liquidity of large financial institutions-- whether or not a bank or some institution has the ability to meet its short-term liabilities with its liquid assets.

If it is over-leveraged, then it does not mean that it is not a successful concern, but that if it has to meet all its short-term debts immediately, then it will fail and go under. In this case, I think you're talking about banks.

Open Market Operations

These are the operations conducted by the Reserve Bank of India (RBI). They will either buy or sell securities from or to the market. They do this to monitor and manage the liquidity in the market.

  • When commercial banks purchase Government securities, they have less cash and cannot lend to the industries or other commercial sectors.
  • If RBI buys these securities then the commercial banks have more cash. Thus they are able to lend more money, and there is more cash in the economy.
  • Similarly, when there is an excess of cash in the economy, the RBI can sell these securities and reduce excess cash.
  • Thus the RBI can use OMO and other financial instruments to reach its monetary policy targets.

Why Is This Important?

While this doesn't seem to have any direct effect on us as traders in the market, it doesn't take a genius to see that open market operations and liquidity in the banks can directly affect the market.

If commercial banks have less liquidity, then they will stop lending, and commercial sectors will also stop investing as they will not have funds.