Dear Mr Brits
Thank you for your response to my article on the prime lending rate. At Finweek we value feedback, even when people disagree with our articles. I would, however, like to say that I take exception to the fact that your letter was posted on the Banking Association’s website purporting to have been emailed to me when in fact the document was never sent.
It was only when I drew attention to this via Twitter that the letter was actually sent to me. I do, however, accept your apology for this oversight, as per your email on 30 July 2012. But back to the matter at hand – the: The mystery of the prime lending rate.
The explanation you provide in your letter has one failing that I have noticed in all the critiques my article has received from the banking community: a complete inability to explain how and why it was decided that the prime rate should be set a full 3.5 percentage points above the repurchase rate. Your letter claims that this 3.5 percentage point spread was “decided by the SARB in September 2001, and confirmed by the then Governor of the Reserve Bank Mr Tito Mboweni in 2009.”
Fine, but can you please explain how this 3.5 percentage point profit margin for banks was arrived at? As far as I can tell, there is absolutely no competitive, market-related process that’ is used to determine this 3.5 percentage point “spread”. Thus, in the absence of any explanation, one can only assume that it was arbitrarily decided by banking executives and the Reserve Bank Governor over a few single malts and some Cuban cigars.
If retailers or manufacturers got together and arbitrarily decided to institute a fixed profit margin on the sale of a particular article, good it would be branded collusion and they would be rightly sanctioned by the competition authorities. Why should banks be exempted from this?
I can already hear critics wailing that I am forgetting that the prime rate is in fact not a fixed reference point as banks sometimes shave a few percentage points off of the prime rate to throw the working serfs a bone. Of course, what they give with one hand they take away with the other by also adding a few percentage points to the prime rate in some cases.
The fact still remains that for any consumer seeking a loan, the prime lending rate is the reference point from which any rate negotiation begins. This grants banks a mandatory 3.5 percentage point “profit margin” without any market-related, competitive pricing process. It is merely assumed and hence blindly accepted, which effectively amounts to an obligatory 3.5 percentage point handicap for consumers even before a bank makes any effort to assess their individual creditworthiness.
I thus reiterate my original question: how was it decided that banks should automatically receive a 3.5 percentage point interest rate margin when extending loans to consumers? And why can the Reserve Bank, the Banking Association and the Finance Ministry give no meaningful explanation as to how this 3.5 percentage point gap was arrived at other than to say it was “decided” over a decade ago?
Your argument that the banks’ funding costs are not only determined by the Central Bank rate is true, but I fail to see how this justifies an arbitrary decision to fix the funding costs of consumers at 3.5 percentage points above the Central Bank rate – particularly when money market rates typically run at roughly 50-odd basis points above repo. The wheat price is not the sole determinant of bread producers’ costs, yet if they arbitrarily instituted a pre-determined, fixed profit margin on the sale of bread – and used the argument that they occasionally shaved off a few pennies for favoured customers – they would be dragged in front of the competition authorities. Why should banks be exempt from this scrutiny?
The only solution I can see would be for Government to pass legislation requiring banks to structure their interest rates on a “repo-plus” basis. This would allow for greater competition with loan rates decided on a case-by-case basis rather than a predetermined interest rate margin of 3.5 percentage points for which there exists no market-related explanation.