Is it important to have a prime rate if banks can use their discretion about the risk you pose by offering a lending rate lower the prime rate?
There has been talk over the past few months of “phasing out the prime lending rate”, but most consumers do not know what that even means and what it will do to their cash flow.
We asked Therese Grobler, head of wealth management at Momentum Financial Planning, to explain.
“For over two decades the prime lending rate has dictated the cost of consumer finance in South Africa.
“Whether you were signing for a new car, a first home, or a personal loan, the conversation almost always revolves around ‘prime plus’ or ‘prime minus’. Yet very few consumers are ever encouraged to understand what those terms actually mean, or how interest rates are constructed.”
Speaking at Davos, South African Reserve Bank (Sarb) governor Lesetja Kganyago said the prime rate would potentially be phased out in line with the bank’s current reform drive. Grobler says while this might sound like technical jargon, it presents an important opportunity to improve how consumers understand the true cost of borrowing.
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What is the prime lending rate?
To understand the change, we have to look at the current “350 basis point” rule. In South Africa, there are currently two main rates. The repo rate is the interest rate at which the Sarb lends money to commercial banks (currently 6.75%). The prime rate is the benchmark rate banks use to lend to the public (currently 10.25%).
Since 2001, the gap between these two has been fixed at exactly 3.5% (350 basis points). If the Sarb increases the repo rate by 0.25%, prime automatically goes up by 0.25%. Grobler says while this system made rate changes easy to follow, it also meant that many borrowers focus on the outcome (their repayment) rather than understanding how that number is assembled.
Shift to a repo-plus model
The governor indicated that the bank would move toward a repo-plus model. Instead of using a middleman rate like prime, banks would price loans directly against the repo rate. For consumers, this shift is less about higher or lower rates and more about clarity.
ALSO READ: Reserve Bank keeps repo rate unchanged, warns of geopolitical risk
What are the potential benefits?
1. Clearer explanations of interest rates
Currently, the prime margin combines several factors into a single figure.
“Under a repo-plus model, banks may explain lending rates more explicitly, showing how the base rate, risk and service costs contribute to the final rate you pay. This can help consumers better understand why two people may pay different interest rates, even when borrowing similar amounts.”
2. Easier to compare offers
When pricing is expressed directly against the repo rate, it may become simpler for consumers to compare offers across banks.
“Instead of relying on familiar but abstract terms like ‘prime plus’, borrowers can focus on how much above the repo rate they are charged and why.”
3. Direct monetary policy impact
When the Sarb changes interest rates, it wants the effect to be felt immediately in the economy.
Moving to a repo-plus model simplifies this. It removes an unnecessary layer of signalling and gives the Sarb a tighter rein on the economy, making it easier for them to accelerate or decelerate consumer spending when necessary.
ALSO READ: Repo rate cut no help for consumers on brink of financial disaster
Will your debt get cheaper?
A change in the benchmark does not automatically mean a change in the cost of debt, Grobler says.
“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.