Prime interest rate: What is it, and do we need it?

You can also listen to this podcast on iono.fm here.

JIMMY MOYAHA: The South African Reserve Bank has put out a statement that was quoted by Bloomberg that they would potentially be rethinking how interest rates are priced, or how interest rates or the interest rate model in South Africa is arrived at.

We currently have a repo rate as well as a prime lending rate, and there is a 3.5% difference between those two numbers.

We could be doing away with this, but we don’t know when, we don’t know how, we don’t know why.

We’re going to be taking a look at this with a good friend of ours and the founder of Just One Lap, Simon Brown. He joins me on the line now to see if we can make sense of these developments.

Simon, always lovely having you on the show. A pleasant start to the New Year for you, I hope. This is a conversation that you and I have probably had at length on many an occasion … but this is a conversation that I suppose we’ve been hoping to hear from the South African Reserve Bank about. What have they said?

SIMON BROWN: Jimmy, evening. You’re 100% right. A conversation you and I have had many times; I think, an important conversation. To also be clear it’s a little bit of a nerdy one, but it really impacts any South African who has debt.

And what the Reserve Bank has said is that it, via the Monetary Policy Committee, every two months sets the repo rate [the repurchase rate; the rate at which it lends money to banks].

And from that the big banks take the repo rate, add 3.5% and create the ‘prime rate’.

Read: South Africa reviews prime rate used to price R6.2trn of credit

And when we buy a car or a house or use a credit card, they will link the debt we pay to that prime rate – [prime] plus half a percent [or] minus a quarter of a percent.

What the Reserve Bank is saying is ‘Hang on a second, why do we add 3.5%?’

Well, it turns out we add 3.5% because in the early part of this century the Reserve Bank said that was the margin above repo that banks could charge for prime.

What they are saying is, okay, so we told you to add 3.5%, but should that number be something else? That really is the debate. And of course we are talking about a lower number.

I think we should not get too excited. That number being a lower rate might not necessarily mean suddenly all our debt costs less. But it’s a conversation I think worth having.

JIMMY MOYAHA: Absolutely. And this is a conversation you and I have tried to get our heads around from the perspective of how this could work.

You touched on something quite important, saying even if we get a lower premium between the repo rate and the prime rate, it doesn’t necessarily mean it’ll translate to lower lending rates towards consumers, because the truth is that the banks can then still elect to have a higher lending rate for the consumer, even if they’re receiving a lower financing rate from their perspective.

Read:
Sarb cuts rates by 25 basis points
A calculated cut: Sarb eases interest rates

So how then does the conversation start to affect consumers when thinking whether or not this rate still benefits consumers in today’s day and age?

SIMON BROWN: Jimmy, you make a great point there, which I’ll touch on quickly.

The first part is that yes, banks are going to lend according to risk, and we can see our big banks all listed. We’ve got a sense the big four sort of have somewhere between a 0.5% to maybe 1.1% bad-debt ratio. They absolutely want to keep that [and not have it go higher]. And if prime was a different number, they wouldn’t necessarily give you an ultimately better rate.

I think what the discussion should be around why there is a mandated 3.5% premium to prime.

I’ll give you an example. If we go back just, what, to 2023, we were sitting at a prime rate of 11.25%, which would have made repo 8.75%. They were adding about a third onto it and taking a quarter of the profit.

But during the pandemic, when prime was 7%, repo was 3.5%. Half of it was going to the banks.

Now, I think that the fixed nature of it is where the debate should be. Should it be 3.5%? Should it be a fixed number?

If we look at the US, we’ve got the Federal Reserve and the FOMC [Federal Open Market Committee] and they set the short-term rate, which is effectively what our repo rate is.

Read: Fed cuts rates with three dissents, projects just one cut in 2026

But the mortgage rate, as they call it, in our case prime, the bond rate, is detached from it and done on pure risk metrics rather than sort of prescribed numbers, which means that over time that gap could narrow from 3.5% rather than as a one-off single step.

JIMMY MOYAHA: Simon, does this then complicate how we finance South Africans? If we start to have a clear detachment and we start to then say, okay, we’re going to still maintain whatever rates we have, or we’re going to reduce the premium from 3.5% down to 0.5% – and then banks can then decide from a risk perspective what they do, does that then leave South African consumers in a better-off position, or a worse-off position, or is it now potentially going to have pros and cons to it?

SIMON BROWN: There will always be pros and cons. I think probably better off overall and that’s because the banks [will] just say ‘We’re adding 3.5%’, and they’ll do it and we all just nod and say, okay, that’s apparently what you do.

But imagine if some bank wants to get competitive and, I don’t know, one of the banks says, you know what, we’re only going to add 3.4% or 3.2% or something like that, giving that flexibility.

Jimmy, we have a very, very strong banking system, In America the banks are going bankrupt all the time and falling over. I appreciate they have thousands of them and 300-plus million people. But our banking system is robust and [could] bring a careful sort of level of competition to it.

Listen/read: One ATM system for all banks? Reserve Bank proposal explained

We don’t want the Wild West, and we don’t want someone coming in and giving negative rates. That’s not what we’re looking for – [just] a little bit of flexibility. As the banks decide they want to perhaps lend more, they could drop their rate, or if they want to lend less, they could increase it relative to their assessed risk.

JIMMY MOYAHA: Speaking of that assessed risk side, before I let you go I want to get your thoughts on what then becomes the model or, I suppose, what then becomes, the concern from a banking perspective – if we are to perhaps adopt a new model, perhaps rethink how the current financing structures are in place, does that then mean from a banking perspective they might have profitability concerns?

Read: SA banks step up Africa drive amid fintech rivalry

For the longest time, the premium that’s been priced into the banks, along with how well-capitalised the banks are themselves, has meant that from a risk perspective they are relatively stable.

That’s a good thing when investors look at the stability of the financial sector locally.

SIMON BROWN: Absolutely. You make a great point about profitability of banks, which I appreciate is a touchy subject.

Our banks are very profitable.

But ultimately, if – put it this way, if the difference between the repo and the prime [rate] went from 3.5% to 2.5% tomorrow morning, our banks would make less money. It’s as simple as that, which is partly why it needs to be a process.

And I’m reminded, Jimmy, of when we had the ‘glide path’ for the telcos. They used to charge insane interconnect fees … and Icasa came in and said: Look, you can’t do this. We appreciate this is how you make your money. Let’s have a plan where we will, over a period of time, reduce this down.

I think this is very much what the Reserve Bank has done, saying let’s start thinking about having a conversation. What’s the story? How should we look at this? How can we do it in a, to be clichéd, responsible process?

And to be clear, we’ve just changed our inflation target last year and that got a little bit spicy for a while there, but otherwise it went smoothly and it’s only going to benefit South African consumers.

Read:
Lower inflation target set to reshape rand’s long-term path
South Africa inflation expectations eased with 3% target, Sarb says

And ultimately, removing a fixed number here and saying ‘Let’s give some latitude’, I think will benefit consumers in the long term.

JIMMY MOYAHA: The South African Reserve Bank is potentially rethinking how we have monies loaned to us as South Africans, and this could fundamentally reshape the financing structure of South Africa and the financial markets.

We’re going to keep an eye on this and see where this continues to develop and how it continues to unfold.

For now, we’ll leave this conversation on that note. Thanks so much to the founder of Just One Lap, a good friend of ours, Simon Brown, for joining us to look at this and see if we can make sense of it.

Follow Moneyweb’s in-depth finance and business news on WhatsApp here.