Phasing out prime rate doesn’t mean lower loan repayments, but more transparency, says Sarb

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. The central bank on Monday released a statementoutlining the reasonsit wants the prime lending rate removed. “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.” 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. Sarb added that replacing the prime lending rate with the repo rate will help people understand how their loans are structured.