# General Business Category > Business Finance Forum >  Prime vs repo interest rate

## Dave A

Tito Mboweni has questioned why the prime rate of banks follows the repo rate so closely. And now the DA raises the same question:



> There is no reason why bank lending rates should remain constant over time, the Democratic Alliance said in a statement on Wednesday.
> 
> "There is no reason why the 3.5 percent difference between the repo rate and the interest rate that banks charge consumers should remain constant over time, or across the entire banking sector," Dion George, the shadow finance minister said.
> full story from Business Report here


Given that funds from the Reserve Bank make up only a small portion of lending banks' funding, the point seems valid on the surface. But I have a horrid suspicion that once Tito and Dion have thought this through a bit they're going to be sorry they ever raised the subject, especially right now.

First of all the fact that prime tracks the repo means that when Tito decides to influence the economy through a repo rate change his influence extends directly into the economy. You'd think Tito would like that idea. He is certainly going to get hopping mad if he reduces the repo rate and the banks don't follow suit. If the banks don't take their cue from the Reserve Bank, the effect of Reserve Bank intervention can only get diminished.

And at this point I can hear a cheer from some quarters, but this tale isn't over yet.

The truth is that when it comes to *actual* lending rates provided by the banks, prime is only a reference point. Two years ago getting asset finance at below prime was a fairly regular occurence. Try to get a rate below prime now!

The market *is* affected by supply and demand, and right now funding for loans are in short supply. Tito & co might want rates to go down to stimulate the economy or ease debt burdens, but in the open market place the pressure is to bid up to get the money you want. If the prime rate floated off the repo right now it would probably head up, not down!

With a substantial chunk of existing loans' interest rates linked to the prime rate, I don't see this being in the interest of over-indebted consumers, especially right now.

Good luck with that meeting on Thursday, Tito. But if the gap between repo and prime widens, I'm not going to be thanking you.

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## I Robot

Address by Dr XP Guma, Deputy Governor, South African      Reserve Bank to the IPM Annual Business Conference in         association with NKR Nedbank Auditorium, Durban   

18 May 2009 

1. Introduction 

Mr Chairman, ladies and gentlemen, let me begin by thanking you for your invitation to me to participate in this meeting today: for me it is usually better to speak when asked than to ask to speak. 

The title of my talk today is well known to those who have an interest in and may be well versed in the precepts of that component of public policy which is known as "monetary policy": that is, the use of monetary instruments to influence macro-economic outcomes. This is so because it was the topic chosen for the Presidential address delivered at the Eightieth Annual Meeting of the American Economic Association on 29 December 19671: an association which remains one of the foremost scholarly associations of the economic(s) profession; and has been the scale upon which many nuggets of theoretical insight have been assayed. 

Theoretical elegance within the confines of the spaces occupied by trained economists is one thing: relevance to, and understanding by, a broader public whose lives are affected by the actions of Central Banks is another. My purpose today is to speak to the latter. 

2. The Friedman statement 

For my purpose today, the questions to which answers are required are, in the main, those to which the 1967 - address was directed, namely: 

i) What monetary policy cannot do?
ii) What monetary policy can do? 

A paraphrasing of Friedman would indicate that the course adopted by Central Banks in order to achieve a particular objective, cannot: 

(1) peg interest rates for more than very limited periods
(2) peg the rate of unemployment for more than very limited periods. 

These are, as stated in the address, only two of the limitations of monetary policy which can be drawn from the "infinite world of negation". To the list could be added many others: for example, easy finance for SMMEs, secure and guaranteed employment for all job seekers including graduates of tertiary institutions, full capacity utilisation for airline companies, unlimited connections for the cellular-less and infinite airtime for the connected2. 

But, monetary policy can: 

iii) prevent money itself from being a major source of economic disturbance
iv) provide a stable background for the economy, such policy being the primary responsibility of national central banks. 

Logically, therefore, if monetary policy is to provide a stable background for the economy, it must do so by deliberately employing its powers to that end.

More...

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## Dave A

It is a fairly heavy read, but it leads to this section:



> This is so because the transmission mechanism of monetary policy in contemporary, market-oriented economic systems is based on the assumptions that: 
> 
> 1) credit markets exist and operate efficiently
> 2) the policy rate of the central bank is the primary determinant of interest rates in the market for credit
> 3) there exist stable, rational and predictable relationships between money and credit, on the one hand; and a host of macro-economic variables on the other and
> 4) the demand for and supply of credit are brought into equilibrium, in part, by "the" interest rate.


Note carefully points 2 and 4.

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## Dave A

> Commercial banks are not necessarily passing on the benefits of lower interest rates to consumers, South African Reserve Bank governor Tito Mboweni said on Wednesday evening. 
> 
> He was speaking at the Sake24 Economist of the Year award ceremony in Kyalami, Johannesburg.
> 
> This is the third time this month that the Reserve Bank's governor has criticised local commercial banks.
> 
> "It appears that domestic banks are charging higher spreads relative to prime than was previously the case," he said.
> full report from M&G here


Really?  :Slap: 

Well, the market is not exactly awash in liquid capital for financing at the moment. And how is playing with the prime rate going to change that?
At least this way when the repo rate goes down, *all* the existing linked loans go down, thanks.

New business needs to negotiate its offset and it's going to be based on the current supply/demand situation.

I really don't understand what Tito is trying to achieve with this. Can anyone help me out?

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## Graeme

I am a shareholder in a S A bank and I would hate to see my investment harmed, but banks in South Africa are getting away with high interest rate spreads because they must be agreeing amongst themselves about the rates they give or charge and if that is so we are now talking about _collusion_.  SASOL, Tiger Brands, and others have been hammered for collusion - should banks be next?

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## wynn

Yes PLEEEEEEEEEZE!!!

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## Marq

> they must be agreeing amongst themselves about the rates


I've always said this must be the case. The numbers and timing are always somehow the same across the board. The problem is that any fines for collusion and fixing will not be returned to their clients (thats us) and they will just carry on as usual. 




> I really don't understand what Tito is trying to achieve with this. Can anyone help me out?


I dont think we will ever find out why he has a hair up his arse about a scenario thats been in place since central banking systems began. Probably been snubbed at the banking ball where they told him he was of no interest to them. :Wink:

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## Dave A

> The South African Reserve Bank (SARB) and South Africa's top five banking institutions will set up a committee to study lending rates, SARB Governor Tito Mboweni said on Friday. 
> 
> This follows a meeting between Mboweni and CEOs and one deputy CEO from the country's top banks on Thursday evening.
> 
> The sub-committee will be convened by Cas Coovadia of the Banking Association South Africa and senior Reserve Bank official Roelf du Plooy.
> full story from M&G here


As Marq would say, a plan to develop a plan...

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## Marq

This is the committee who will then choose a task team ....who will then make a plan to develop a plan.

Is this not going to be a committee to see how they can carry on price fixing while trying to fool the sheeple that it really is not as blatant as you think it is?

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## Dave A

I missed this bit in that last article -



> He (Tito Mboweni) contended that South Africa's banks were not necessarily passing on the benefits of repo rate cuts to consumers.


Hmm. Thinking about that....

SARB funding only makes up a small portion of the banks' reserves. How much money is he saving the banks when he drops the repo rate, and they drop their prime rate in like measure?

OK. I still don't get what he's on about.

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