The South African Reserve Bank wants the prime lending rate to go the way of the dodo, with the repo rate used in its place. (Photo: Waldo Swiegers / Bloomberg via Getty Images) The South African Reserve Bank (Sarb) has just published a consultation paper that sets out the case for abolishing the prime lending rate (PLR) and replacing it with the Sarb’s policy rate, which is commonly called the repo rate.
And when the Sarb wants to make a major policy change — as it did with the lowering of its inflation target — this is the path it follows: presenting the case in a robust and transparent manner that leads to the desired result.
The PLR is 350 basis points above the repo rate — they are 10.25% and 6.75%, respectively — and the paper argues its role is now largely administrative and has “led to widespread misconceptions about its function”.
“Many still perceive the PLR as the base rate for loan pricing and believe the fixed spread contributes to excessive bank profits, despite lending rates being determined by banks’ funding costs, risk appetites and client risk profiles.”
Consequently, the Sarb wants the PLR to go the way of the dodo, with the repo used in its place.
“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,” the paper maintains.
“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 rather than the PLR.”
This is crucial — your bond rate or the cost of your credit card payments is not about to suddenly fall when the repo is adopted. All of the usual factors, notably your risk profile, will still be at play.
But the enhanced transparency could conceivably lead to lower rates in some cases, as the reform would mean that banks have to disclose the spread they charge above the repo.
“The spread would be set to the added risk premium as negotiated between the counterparties involved in the transaction. The additional spread to the SPR would therefore capture information about the additional cost of credit above where the central bank sets its policy rate,” the paper says.
Public consultation
Stakeholder engagements and public consultation on this issue are now being launched.
“The transition from referencing the PLR to referencing the SPR, however, must be carefully managed due to the extensive use of PLR-linked contracts in retail and commercial lending,” the paper notes.
“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.”
The paper pointedly says that the 350-basis-point spread was not meant to be the baseline, though that is, in large part, the perception.
“Bank lending rates are typically determined by several factors, including the cost of funding, the client’s risk profile and the institution’s risk appetite. The intended use of the PLR as a reference rate is that only once an appropriate lending rate for a particular client has been determined should a bank link that lending rate to prime,” it says.
“The PLR is an administrative reference rate which, for all intents and purposes, has become redundant. One of the critical shortfalls is that the PLR is no longer an accurate representation of the economic realities of the interest it seeks to measure.”
Benefits
And using the repo rate — or SPR — has a number of benefits, the paper argues. These include:
- It is easy to understand, which is a desirable attribute for retail markets.
- It retains the direct link between lending rates and monetary policy.
- It creates transparency about the premium that banks charge their clients above the SPR. Such a premium should largely reflect funding conditions, the borrower’s risk profile and the lender’s risk appetite.
The paper says it is estimated that 12 million contracts with a value of R3.2-trillion currently reference the prime rate.
“Given the Sarb’s preferred alternative reference rate for the PLR, PLR-linked contracts would need to incorporate fallback language to facilitate the adoption of the SPR as the primary basis for a replacement rate,” the paper says.
That presumably means that the lawyers will be cashing in.
The bottom line is that the prime rate is on its way out and a new era of enhanced transparency in lending looks set to dawn. DM