The South African Reserve Bank’s (SARB’s) plan to eliminate the prime interest rate in South Africa could have the opposite effect of what it intends.
The SARB this week published a discussion paper clarifying its position on the prime rate and its intention to remove it from the country’s financial lexicon.
The prime lending rate is most often associated with lending in South Africa, which has been set at 350 basis points above the repo rate since 2001.
It is currently set at 10.25%, against the repo rate of 6.75%.
However, while most interest rates tied to loans are typically described in relation to prime (ie, prime-plus x% or prime-minus x%), it is not a policy rate.
That is to say, it is not a regulation; it is a convention or a benchmark, and only one reference point that lenders take into account when pricing loans.
Lenders typically price loans relative to prime, with premiums or discounts depending on the cost of funding, risk appetite, and the creditworthiness of clients.
Talk of dropping the prime rate has led to misconceptions, mostly among borrowers, that this will somehow make future lending, or their existing loans, cheaper.
According to Kruthum chair, Dr Stuart Theobald, this is not the case, and presents a very real challenge that the SARB will face with this move.
Ultimately, it won’t make much of a difference, he said, but the optics will be difficult to manage.
One of the biggest hurdles the SARB will face with the move is dispelling the misconception that the prime rate reflects banks’ profit-taking.
With a 350bp premium on the repo rate, many consumers see the difference as pure profit for banks, when in fact it is not.
“People believe, wrongly, that eliminating this spread would lower consumer debt costs. Banks set lending rates based on funding costs, risk appetite and client risk profiles. The prime rate is merely a convenient reference point, not a determinant of bank profitability,” Thebald said.
In taking on this misconception, the Reserve Bank might make things worse.
Plan for clarity could backfire
The central bank ultimately wants to abolish the prime rate concept entirely and replace the ‘repo rate’ terminology with the ‘SARB policy rate’ (SPR).
This means a home loan, car loan, or overdraft would be specified as “SPR plus x%” rather than “prime plus/minus x%”.
Of course, with lending conditions unchanged, the ultimate rate might reflect “SPR plus 4.5%” rather than “prime plus 1%”, giving consumers the impression that bank profit margins are even higher.
“Those who believe the 350bps spread is pure bank profit will transfer that belief to whatever new spread emerges,” Theobald said.
“If anything, seeing ‘SPR plus 4.5%’ may reinforce the perception that banks are charging excessive margins, now with even more visibly large numbers.”
The Krutham chair added that other problems might emerge, such as lenders moving towards other ‘creative ways’ of framing lending rates.
“Non-bank lenders, over which the Reserve Bank has limited jurisdiction, could market products using whatever reference points make their rates appear most attractive,” he said.
“The result could be a fragmented market that makes comparison shopping harder, not easier — the opposite of the intended transparency gain.”
This amounts to a change in terminology that has to be reflected in at least 12-million contracts worth R3.2 trillion, without solving some of its biggest problems.
“I’m left wondering whether this elaborate transition…solves any real problem or creates new ones while the old misconceptions persist,” Theobald said.
The discussion paper launches a consultation process with input due by March 20.
