The prime lending rate has been set 350 basis points above the repo rate since 2001.
The South African Reserve Bank (Sarb) has tabled its proposal to remove the prime lending rate, the main reference commercial banks use to price loans. The country’s central bank wants commercial banks to price loans directly in line with its repurchase (repo) rate.
This change is made with consumers in mind; however, it will not change loan repayments, but it is expected to make loan costs clearer.
The prime lending rate has been set 350 basis points above the repo rate since 2001.
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Prime lending rate has changed over the year
The central bank on Monday released a statement outlining the reasons it wants the prime lending rate removed.
“The prime lending rate has evolved into a rate that no longer represents a base rate for pricing credit to bank clients,” said the Sarb. “Its current role is largely administrative and detached from its original purpose, having become a fixed spread (currently 350 basis points) above the Sarb policy rate (SPR) since 2001.
“While the simplicity of the prime lending rate has enabled the comparability of lending rates and better monetary policy transmission, it has also led to widespread misconceptions about its function.”
Perception of the prime lending rate
The central bank explained that people still think the prime lending rate is the main rate that determines loan interest, and also believe that the additional fixed percentage banks add on makes banks earn higher profits, which is not true.
In reality, banks set loan interest based on how much it costs them to borrow, how much risk they are willing to take, how risky they think they are, and how risky they think the borrower is.
The above perception is one of the reasons the Sarb seeks to remove the prime lending rate.
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Sarb added that replacing the prime lending rate with the repo rate will help people understand how their loans are structured.
“This approach would enhance transparency, create a clearer link between monetary policy decisions and lending rates, and make it easier for consumers to understand how banks price their loans,” said the Sarb.
“Actual loan pricing would remain unchanged, banks would continue to set lending rates based on risk and funding considerations, quoting them as a margin above the SPR (Sarb Policy Rate/Repo Rate) rather than the PLR (prime lending rate).”
Transition to using the repo rate
Sarb said the transition of replacing the prime lending rate with the repo rate must be carefully managed due to the extensive use of prime lending rate-linked contracts in retail and commercial lending.
“It is envisaged that the transition process will entail incorporating robust fallback language in new contracts and establishing safe harbour provisions to facilitate the migration of legacy contracts.
“Lessons from the recent Johannesburg Interbank Average Rate (Jibar) benchmark transition will inform the strategies needed for an orderly transition. While stakeholder engagement and public consultation commence now, the transition is only expected to start after the official cessation of Jibar in order to avoid overlaps.”
Will your debt get cheaper?
Therese Grobler, head of wealth management at Momentum Financial Planning, said a change in the benchmark does not automatically mean a change in the cost of debt.
“The economics of lending have not changed. Banks still have to consider individual credit risk, funding costs and operational expenses. What does change is how these elements are communicated to borrowers.
“If the prime rate is phased out, existing loans are unlikely to change overnight. Monthly repayments will generally remain the same, but borrowers may begin to see interest rates explained in a way that is more transparent and easier to understand.”
This shift encourages consumers to ask the right questions about how their interest rates are calculated, the factors that influence the margin they are charged and how their credit behaviour affects the rate they get.
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