Why the debate over prime does, and doesn’t matter

Prime is one of those numbers South Africans with debt watch like hawks – like the petrol price or the rand-dollar rate. The reference rate sits at the centre of mortgages, overdrafts and vehicle finance, serving as a benchmark for borrowers to see whether they are paying more or less than the market rate.  

It gives someone taking out a loan an idea of whether lenders see them as risky (prime plus x basis points), average (prime) or reliable (prime minus x basis points). When interest rates go up or down, whatever the customer’s rate is pegged at moves in tandem.  

There’s a far more jaundiced view of this rate, however: that prime serves as a handsome, baked-in margin for the country’s banks, before they even start assessing clients for risk. It is, after all, a full 3.5 percentage points above what financial services firms would pay if they had to take the unusual step of borrowing from the lender of last resort, the South African Reserve Bank (SARB).  

Set at 350 basis points (bps) since 2001, this number is now up for debate; at the same time, it is the grounds for a “cartel investigation” by the Competition Commission, which is at an advanced stage according to News24.  

But the Banking Association South Africa (Basa), the industry’s main lobby group, argues the debate is being misunderstood. It says the actual price of credit reflects a range of considerations, including a bank’s cost of funds, the borrower’s credit profile and the lender’s risk appetite.   

In Basa’s view, a single benchmark makes it easier for customers to compare pricing across banks, while the fixed repo-prime spread ensures that monetary policy decisions on interest rates transmit cleanly through the system.  

High spread, high profit?  

Radebe Sipamla, a portfolio manager at Mergence Investment Managers, agrees that prime is only the start of the pricing conversation – but says the benchmark debate can’t be separated from the shape of the banking market.   

South African banks, he says, enjoy high returns on equity (ROE), which measures how much profit a company generates for each rand invested by a shareholder. Local banks’ ROEs have averaged between 15% and 18% over the past decade – much higher than banks in the US or Europe, where ROEs are closer to 12%.  

Much of this is down to the historic dominance of the Big Four: Absa, FirstRand, Nedbank and Standard Bank.  

Newer entrants have helped introduce competition at the edges, he says, but the likes of Capitec, Investec, Discovery and TymeBank haven’t “really displaced the market shares of the incumbents”.   

Pricing advantage  

Economist Iraj Abedian, the founder and CEO of Pan-African Investment and Research Services, is in the camp that believes banks have an immediate pricing advantage from the 350bps gap, having raised questions about its magnitude more than 20 years ago in a conversation with the late SARB governor Tito Mboweni.   

His argument is that banks consider prime when lending money, but when they need money in the form of deposits, “they don’t have any respect for prime”.  

It’s important to understand how it got to this point.  

A semi-formal link between the SARB’s policy rate and bank lending rates has existed since the 1920s, helping to ensure that changes in the policy rate are passed on to bank clients.  

In the post-World War II period, the margin was smaller: a SARB study notes that minimum overdraft rates were set about 150bps above the policy rate under an agreement between the SARB and commercial banks.  

In February 1982, the SARB decided to abolish the “direct link” between its policy rate and the prime overdraft rate, allowing lenders to set their own rates “in response to market forces”. This meant that the conventional notion of prime as the “best” or lowest lending rate fell away, and, while still linked to the monetary policy rate, it became an informal shared market yardstick rather than a fixed price.  

But that informal arrangement hardened into what we have today, with the reference rate settling at a spread of 350bps in 2001, following a technical change in how the SARB implemented the repo rate.   

Attracting scrutiny   

By the late 2000s, the rate was attracting scrutiny. In 2009, the SARB governor met executives from the five largest banks and Basa, and a formal review was launched. The question wasn’t whether prime should exist, but whether the benchmark – and the uniform gap between repo and prime – was weakening competition or pushing up borrowing costs.  

The review’s conclusion was that the size of the repo-prime spread was “immaterial” to how banks price loans. Prime, it found, works mainly as a reference rate, making it easier for customers to compare offers and for banks to quote rates as “prime plus” or “prime minus”, depending on risk. A uniform spread, in that sense, was seen as helping consumers shop around, rather than preventing banks from competing.  

‘Inadvertently complicit’  

Sipamla says that the SARB’s recent revisit of the issue suggests it may be reassessing its historical distance from pricing debates. “The SARB was inadvertently complicit in allowing the incumbent banks to dominate discussions on pricing for credit as it adopted a largely referee-type hands-off approach to allow market forces to determine pricing.”   

In his view, the change in “rhetoric” stemming from the SARB “is [an] acknowledgement that market forces haven’t best served the interests of retail banking clients or SMMEs in setting competitive credit rates”.  

Izak Odendaal, the chief investment officer at Old Mutual’s multi-manager business, Symmetry, says the SARB’s review could boil down to one of two questions: whether South Africa still needs a single benchmark rate that all banks use as a reference point and, if it does, whether the fixed 350bps “is still appropriate” in a world of structurally lower interest rates.   

When the spread was set in 2001, the repo rate was far higher, meaning the benchmark gap was a smaller share of the headline policy rate. As interest rates have trended lower, the same 350bps now feels more material.  

For Basa, the most important point is that prime is a reference point – not the economics of lending. That’s why it believes a review of prime won’t automatically mean cheaper credit.  

Changing the benchmark may shift the starting point, but it doesn’t necessarily lower the “all-in” price of debt that borrowers are offered.  

‘Institutional privilege’  

Odendaal, in an interview with BDTV, argues this is where expectations can run ahead of reality. “For any typical borrower, your loan already reflects your own credit risk profile and the bank’s risk appetite, and, in that sense, changing prime or changing the spread is not going to make a huge difference.”   

The meaningful impact, he says, would be on existing borrowers whose loans are contractually linked to prime: if the spread were reduced, those rates would fall automatically. But that creates awkward questions about who benefits, and who pays – including what happens to bank margins.  

Abedian isn’t satisfied with this argument, especially given the low interest rates bank customers earn on their cash savings. Also, other industries don’t have benchmark prices from which they compete.  

“Somehow in this process, banks managed to separate themselves from the rest of the economy and create this institutionalised privilege,” he says, “which to my mind has no economic rationale.”  

Times have changed, especially now that the SARB is targeting inflation of 3%.   

“You’re creating a monopoly,” Abedian says, adding that during his discussion with Mboweni, he urged the governor to think about it. “We can’t just do things because our forefathers did. Otherwise, we would be in a horse and cart now.”  

Nonsense debate   

In 2001, the repo rate was 9.5% compared with 6.75% today. That means the effective difference between the repo and prime was 37%, compared with 52% now. The lower rates go, the more this old convention starts to feel like a structural tax on borrowers. Abedian’s conclusion is not to pull the plug overnight, because too many contracts and instruments are built around prime, but to phase out what he sees as a relic. Give the system 12-18 months, then step the spread down further over time.  

Renier Kriek, CEO of Sentinel Homes, thinks the debate collapses into nonsense the moment people believe the 350bps gap is “what banks earn”. Kriek’s core point is that banks are not funded by borrowing from the SARB because access to its facilities comes with scrutiny and penalties, designed for stress, not day-to-day lending.  

Banks fund themselves primarily through deposits and wholesale markets (other financial institutions), and their true costs are shaped by funding conditions, capital requirements, risk and competition.  

“Prime feels like a policy lever, but it isn’t one,” Kriek adds. Banks price loans from the “bottom up”: they assess the borrower, the term, the risk and the amount of capital they need to set aside as a buffer for bad debts. They also consider competition. Only after that do they translate the rate into prime-linked language because it is what customers recognise – and because it allows like-for-like comparison across lenders. That translation step may be annoying, but it is not the underlying economics of lending.  

Still competitive

Sipamla argues that the industry has shown it can compete below prime without sacrificing strong profitability. “Evidence of this is clear in how, in lower credit-risk segments, such as retail private banking or within products such as home loans, banks have been pricing credit at ‘prime minus’ post the global financial crisis, yet they’ve sustained high risk-adjusted margins.”  

He also points out that big-ticket lending already works on different benchmarks, with pricing that sits well below prime. Most corporate lending by the banks is already priced at benchmark rates that banks charge each other, and which are materially lower than the prime lending rate. “The banks have been able to sustain ROEs in the high double digits due to their holistic product offering to clients that includes non-interest revenue items such as advisory or structuring fees.”  

Kriek believes that return on assets (ROA), which measures how much profit a bank generates from its assets, is a better way to measure profit margins. In that aspect, the Big Four hover between 1% and 2%, while Capitec, which traditionally has been more focused on unsecured lending, is at about 6%.   

Lower hurdle rate  

Sipamla agrees that the lower inflation and interest rates go, the harder it becomes to defend a spread set by history rather than economics. Still, even if the SARB nudges the benchmark lower, it won’t automatically force banks to lend more cheaply in a meaningful way.  

“A shift to lower spreads versus prime will not have a direct impact on credit scoring as the same criteria for determining creditworthiness will likely remain in place.” Instead, he argues, the biggest driver of affordability may be structural rather than mechanical.  

“A lower cost of capital resulting from the new inflation target band set by the SARB will most likely have the greatest positive impact in spurring credit supply and improving credit affordability,” Sipamla believes.  

If policymakers sell this as a shortcut to cheaper mortgages, they may be setting borrowers up for disappointment. However, if they frame it honestly as a clean-up – a review of how prime is defined, communicated and used in contracts – it may reduce confusion, even if it doesn’t deliver immediate relief.  

If the answer is credibility and contract clarity, the outcome may be a long, careful transition that changes very little on a day-to-day basis. But if the answer is the cost of credit, the SARB will have to explain – plainly – why moving a reference rate does not automatically move the price of risk.  

Either way, prime is about to lose its aura. And, for people who cling to simple numbers for comfort, that may be the most disruptive change of all.  

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