Monday, April 12, 2010

No reason to change 3.5% margin for Prime interest over the Repo rate

South Africa's 4 big banks conventionally set their Prime Interest Rate to be 3.5% higher than the SA Reserve Bank's Repo Rate. Over the past year questions have been posed as to whether this understanding between banks could be seen as collusion and whether this fixed 3.5% margin should be more competitive.

Source: Business Day

"THERE are no compelling reasons to change from the current fixed spread of 350 basis points between the repo and prime rates, a report compiled jointly by the Reserve Bank and the Banking Association of SA has concluded.

It follows, therefore, that there should be a single prime rate for all banks, they said after looking at the role of the prime rate and the prime repurchase rate spread in the banking system. They undertook the study after a meeting last year on the spread between the rates, which was attended by then Bank governor Tito Mboweni , executives of SA’s five large banks and the association.

The report also suggested that the “prime overdraft rate” should only be referred to as the “prime rate”, with a clear understanding that its role had changed from an actual “lowest” or “best” lending rate to that of a reference rate to which banks linked floating interest rates on loans and advances.

The report concluded that the size of the spread between the repo rate and prime was immaterial to the setting of lending rates, as prime was primarily used as a reference rate or benchmark for pricing loans.

Although it could cause short- term problems and disruption with existing agreements, any change in the spread, or a change in the benchmark rate, would not change the methodology for establishing actual bank lending rates, the report said,

“A uniform spread helps to create a competitive environment for banks, which enables customers to choose between products and negotiate interest rates based on their credit profile,” it stated.

Finally, it was suggested that because lending rates differed significantly from prime at times, the Bank should closely monitor trends in banks’ actual lending and deposit rates. This would ensure a better assessment of the market forces that drove the pricing of loans, and the extent to which these forces offset or reinforced the monetary policy stance of the Bank. I-Net Bridge"