Prime Rate to Go – How It Will Affect You

Retail lending rates in South Africa, which include the interest rates you pay on credit cards, personal loans, vehicle finance and home loans, are governed by the repurchase (repo) rate, which is adjusted periodically by the South African Reserve Bank (SARB). But the relationship is not a direct one. There is a further rate between the lender and the consumer: the prime lending rate.

The prime rate has traditionally been the rate banks offer their lowest-risk customers, even going below prime if the customer is a highly favoured one.

At present, when applying for a vehicle loan or a home loan, for example, if you have earned the bank’s favour (by having a healthy bank balance and by paying off other debt without hiccups), it may offer you a rate of “prime minus 1%”. If, on the other hand, you are higher-risk (perhaps without any assets to speak of or lacking a solid credit record), the best rate the bank may offer you could be “prime plus 1%”.

Historically, through an agreement between the SARB and the major banks, the prime rate has been 3.5 percentage points above the repo rate. Currently, the repo rate (the rate at which banks can borrow from the SARB) is 6.75%. The prime rate, on which banks base their rates to their customers, is: 6.75% + 3.5% = 10.25%. If your bank offers you “prime + 1%” on your loan, you’ll be paying 11.25%.

The SARB is now intent on abolishing the prime rate, leaving the repo rate (or SARB policy rate, as referred to below) the sole reference rate between lenders and consumers. 

Last week, the SARB published a consultation paper, “Cessation of the prime lending rate”.  In its introductory paragraphs, the paper states: “The prime lending rate (PLR) has evolved into a rate that no longer represents a base rate for pricing credit to bank clients. 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 PLR has enabled the comparability of lending rates and better monetary policy transmission, it has also 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 prefers that the use of the PLR as a reference rate ceases. Instead, the PLR should be replaced with the SPR. 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. 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.”

Will the move favour consumers?

Although banks’ lending criteria and pricing are unlikely to be affected, the change in reference point may be beneficial to consumers in other ways, according to Stephan Potgieter, CEO of bond originator BetterBond.

“While this reform will not automatically reduce the cost of borrowing, it will change the way interest rates are communicated, by making the pricing structure more direct and easier to understand. It also sends a strong message about the country’s commitment to financial efficiency and transparency,” Potgieter says.

He says that, without the prime rate as a reference rate, banks will need to be more explicit about the margin they charge above the repo rate. “Instead of quoting ‘prime minus 1%’, they could offer ‘repo plus 2.5%’, for example. This will make it easier for consumers to compare offers across banks.”

Potgieter says another benefit will be felt when the SARB adjusts the repo rate. “Under the new approach, the impact on home loan repayments will be immediate and direct, without the need for an additional recalculation using the prime lending rate. If the Monetary Policy Committee announces a repo rate cut to 6.25%, for example, that becomes the new base rate as soon as it takes effect.”