By Miyelani Mkhabela

The primary mission of the South African Reserve Bank (SARB) is to protect the value of the rand in the interest of balanced and sustainable economic growth in South Africa, through a monetary policy targeting inflation of 1-3% and by enhancing financial stability, acting independently and without fear, favour, or prejudice.

The SARB has considered to replace the Prime Lending Rate (PLR) with the SARB Policy Rate (SPR), to better serve consumers experiencing high cost of living and debt service, reducing unsustainable lending practices by commercial banks, reducing economic vulnerabilities and currency risks and managing unethical banking practices that makes prime lending rates not consistent amongst commercial banks and other financial institutions.

The PLR has evolved into a rate that no longer stands for a base rate for pricing credit to bank clients. Its current role is administrative and detached from its original purpose, having become a fixed spread (currently 350 basis points) above the South African Reserve Bank (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. 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 PLR originated as an interest rate set by banks for their most creditworthy clients, known as ‘prime clients’. Traditionally, it represented the lowest interest rate that a bank could offer, with each bank setting its own rate independently. In South Africa during the mid-1970s, individual banks’ PLRs were typically 2.5– 3.5 percentage points above the policy rate set by the SARB. This link between PLRs and the policy rate was discontinued in 1982 and, consistent with the intended purpose of the PLR, banks became free to determine their own PLRs in response to market forces and subject only to the influence of broad official monetary policy and statutory ceilings.

The PLR was subsequently determined as a fixed spread of 350 basis points above the SPR. This spread was not a regulatory prescription, but an outcome of where the PLR was relative to the SPR at the time and the technical adjustments implemented by the SARB.

The approach to fix the spread between a reference rate and the interest rate set by the monetary authority (the SARB) has several benefits, especially in the context of retail lending:

• It sets up a link that ensures future changes in the policy rate are transmitted to clients.
• It cuts the administrative burden and risk of renegotiating interest rates embedded in a contract by enabling adjustments in customer lending rates resulting from changes in the reference rate.
• It increases transparency and enables customers to easily compare lending rates, which would be difficult if each lender used their own PLR.

The decision to fix the PLR at 350 basis points in 2001 was further reinforced in 2009, with a joint SARB/Banking Association South Africa (BASA) committee (henceforth, the ‘technical committee’) recommending that there should be a single PLR with a fixed spread to the SPR. Essentially, the committee concluded that the spread between the PLR and the SPR was largely immaterial for setting actual lending rates, as the PLR served as a reference rate for pricing loans rather than as a determinant thereof.

Several other aspects are instructive to note, remaining relevant for consideration in this proposal:

The committee noted that the role of the PLR had changed from being the lowest or best lending rate to being a reference rate to which banks linked floating interest rates on loans and advances.

The report of the committee noted that the fixed spread between the PLR and the SPR was not a guaranteed interest margin for lenders, although this misconception still persists in public discourse.

The practice where banks each quoted their own PLRs, which represented the interest charged to their ‘prime clients’, was not ideal. The committee was concerned that this practice would result in multiple PLRs and complicate monetary policy transmission as well as the ability of consumers to compare interest rates across different institutions.

The SARB must create interventions to limit commercial banks to charge the SPR plus margin of above 500 basis points, as that is harmful to individual and business consumers, and unfair commercial lending practices.

The committee concluded that there was good reason to consider alternatives to the PLR setup and made three recommendations. The committee recommended that the SPR be considered as a replacement for the PLR. The committee noted that South Africa could, in practice, revert to the old arrangement where banks quoted their own individual PLRs that were a true reflection of their ‘base’ for setting lending rates. The committee considered an alternative where the SARB prescribed a narrower spread between the PLR and the SPR.

In the end, the committee assessed that replacing the PLR with the SPR was the most viable alternative, but it would require careful implementation. The transition of the PLR to SPR need risk mitigation for legal complications and market disruptions.

Using the SPR has several benefits to commercial banks clients as 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. It poses minimal transition complexities and can be a soft landing for both individual and business consumers, given that the spread between the PLR and the SPR has been fixed since 2001.

Technically, changing the reference rate for pricing should not result in changes in lending rates and banks’ profitability. From a consumer’s perspective, using the SPR as the reference rate against which lending rates are quoted means that consumers would be quoted spreads that are positive and large compared to spreads quoted against the PLR, even though the actual lending rate is the same, all else being equal. This potential for misperception highlights the need for a well-designed communication strategy to accompany the transition. Over time, however, replacing the PLR with the SPR would improve transparency and public understanding of how monetary policy affects borrowing costs.

Over the long term, using the SPR directly would simplify the lending rate structure and eliminate misconceptions about the role of the PLR and its spread to the SPR. Consumers could better understand the SARB’s influence on lending rates, enabling them to make more informed financial decisions.

Estimates suggest that there are more than 12 million contracts that currently reference the PLR. The estimated value of these contracts is more than R3.2 trillion, of which retail mortgages and consumer loans are the largest, accounting for 37% of the total exposure.

• The SABB must set and standardise the benchmark for a SPR plus margin.
• The SARB must set and standardise the transmission mechanism with a margin that doesn’t exceed 500 basis points.
• The SARB must have strict measures for liquidity management.
• The SARB Must proceed in replacing the PLR with the SPR with a consumer friendly margin limit, increasing commercial lending transparency.
• The SARB must better manage the existing credit facility contracts to automatically transition to SPR and curbed margin.
• The SARB need an integrated communication and public relations in consulting with all stakeholders.
• The SARB need to monitor the actual margin and have penalties for commercial banks that will exceed SPR plus 500 margin, regardless of the risk profile.
• The SARB need to monitor the commercial banks to treat South African citizens equally.
• SARB must monitor SPR plus margins charged to micro, small and medium enterprises to reduce the injustices experienced by entrepreneurs as that discourages inventiveness.
• SARB must collaborate with commercial banks for an affirmative fixed SPR without a commercial margin to boost economic activity and job creation.
• The SARB must give commercial banks conditions to remove margin above the prime lending rate in all historical transactions and reconcile compliance at SARB and banks level.

Managing the transition from the PLR to an SPR- based lending framework would require a careful and methodical approach, especially given the extensive use of the PLR in contracts. Many mortgages, personal loans and credit agreements are currently tied to the PLR, and an abrupt replacement could risk legal and operational complexities. A well-planned transition is therefore essential to mitigate these potential challenges and maintain consumer confidence.

Miyelani Mkhabela is a CEO and Chief Economist at Antswisa Capital Partners.