The Competition Commission is at an advanced stage of an investigation into a cartel involving South African retail banks. The inquiry concerns the prime interest rate used by these banks, which is uniformly set at the repo rate plus 3.5 percentage points.
Before proceeding, it is essential to establish a clear understanding of the arguments presented here by beginning with basic definitions. Interest, commonly known as the price of money, is more accurately described as the price of time. ‘Interest’ refers to the cost incurred for borrowing money, which is essentially a reward for delaying consumption. The ‘prime rate’ is the standard interest rate used by banks as a benchmark for pricing loans to consumers. It is typically set at a margin above the repo rate. The ‘repo rate’ is the interest rate at which the South African Reserve Bank lends money to commercial banks, currently used to influence economic activity and control inflation.
Time, in the sense that all human beings across the world prefer present consumption over future consumption as a starting point. We all desire to have things now rather than later. This preference is universal because if it were not true, humans would perpetually delay gratification, always waiting for a future payoff that would be greater than the present.
This preference for present goods forms the basis of interest. Since we all prefer to satisfy our wants now rather than in the future, there must be a reward for delaying satisfaction for any period. This reward typically comes in the form of having more of whatever you postponed consuming in the past. Beyond these mechanics, there exists a moral dimension to this trade-off: deferring consumption today may benefit future generations, introducing an element of intergenerational equity. Additionally, the opportunity cost associated with delaying consumption is not just a financial consideration but an ethical one, where the decision to wait implies a societal choice about resource allocation and current versus future welfare.
The market interest rate emerges when individuals who wish to delay consumption (savers) interact with those who prefer not to delay consumption (borrowers). The rate resulting from these interactions is known as the social rate of time preference, which represents the true interest rate.
Nowhere in this conception is there a central authority, such as the Reserve Bank, determining the interest rate for market participants. The existence of instruments like the repurchase rate and the prime rate is not a result of unfettered market operations but rather a consequence of state coercion through legislation in one form or another.
Monetary policy
For instance, the repurchase rate is influenced by the South African Reserve Bank Act, which outlines the powers of the Reserve Bank in monetary policy, including interest rate setting. Moreover, the Banks Act and its related regulations further establish frameworks within which the prime rate is benchmarked.
While this discussion primarily critiques coercive rate-setting, it’s crucial to acknowledge that not all state intervention aims to control prices. Legitimate safety regulations, such as those ensuring the solvency and stability of the banking sector, play a vital role in protecting consumers and maintaining economic stability. For instance, a regulation that criminalises the unjust practice of fractional reserve banking would be welcomed.
The prime interest rate argument is based on the distorted interest rate regime that exists not only in South Africa but globally. This should be the framework within which the disputes between the various parties involved are understood.
What is the prime rate? It is the interest rate that banks use as a benchmark to price loans for consumers. There is also the repurchase rate, or repo rate, which is the interest rate charged to banks when they borrow from the South African Reserve Bank (SARB). The prime rate is typically set as a margin above the repo rate and serves as the benchmark for pricing various types of consumer loans.
For example, in South Africa, the repo rate is 7%. Since the prime lending rate is a flat 3.5%, the benchmark for consumer loans is the sum of the repo rate and the prime rate, totalling 10.5%. This 10.5% rate then varies based on the borrower’s risk profile and the individual bank’s margins, resulting in interest rates on loans ranging from prime plus 7% (17.5% interest rate) to prime minus 1% (9.5% interest rate).
The repo rate distorts the true societal rate of time preference, as does the prime lending rate derived from it. Therefore, its removal, as suggested by the Reserve Bank governor, is a small but welcome step toward establishing a sound monetary regime. The removal should ideally see a market rate being favoured, but it would mean that another benchmark like the repo rate or the interbank overnight rate, would be used.
Prime rate
From a sound money perspective, the prime rate is problematic because, as admitted by the banks and the Governor, it is not determined by market operations – as any price should be. Instead, the prime lending rate results from an agreement or understanding initiated by the SARB in the early 2000s to set the prime rate benchmark at 350 basis points (3.5%).
According to previous interpretations of Section 4(1)(b) of the Competition Act by the Competition Commission this situation constitutes restricted coordination among competitors. This reasoning was applied in the Rand manipulation case currently being heard in the courts.
This specific section of the Competition law addresses offences per se; therefore, no justification of efficiency or other reasons can excuse such behaviour under the law. However, we must consider whether the collusion or cartel behaviour is spontaneous or a forced adaptation to state-sanctioned market conditions.
Beyond the fact that the prime rate was admittedly developed with the involvement of the SARB, free markets make cartels nearly impossible to sustain.
An agreement to maintain a certain price point means that businesses often cannot grow their market share and, consequently, their profitability. In the market, competitors will always undercut one another to gain a larger market share.
Cartels typically persist when they are enforced or protected by the state. This is the case here: banks use the prime rate because the monetary regime, as determined by the Reserve Bank, compels them to operate within the same cost structure. The responsibility for the prime lending rate lies with the central bank and the normalized, state-sanctioned injustices of practices such as fractional reserve banking.
The Competition Commission is therefore examining the symptoms of this coordination rather than its underlying cause. Coordination in the market generally indicates that participants face shared constraints, rather than implying any grand agreements, with exceptions notwithstanding.
Disconnected
The root cause of the problem is the central banking system, which creates money, artificially sets interest rates instead of allowing the market to determine them, and facilitates credit expansion that is disconnected from actual savings. This results in herd-like lending cycles, where banks price loans similarly, reflecting the artificial interest rate signals set by the central bank. These similar lending behaviours and pricing strategies among banks are not entirely due to collusion; rather, they represent a response to the distorted signals originating from the Reserve Bank.
Therefore, the Competition Commission is justified in investigating the prime lending rate, as it contributes to price rigidity due to the prevalence of a flat rate that has become the industry norm. This practice stifles competitive discovery because prices are artificially benchmarked against the prime rate, which conceals the true risks since it does not arise from genuine market operations.
One may diverge from the Commission by applying their reasoning from previous similar cases to explain why the prime lending rate is problematic. The Commission holds the view that coordinated benchmarks, such as the prime rate, reduce competition. However, this coordination occurs only because interest rates are not determined by the market but are instead set by a central authority, the SARB.
Therefore, the conclusion the Commission may reach (the inquiry report has not been released yet) could be to identify a better benchmark, such as using the overnight rate. However, this would not be a long-term solution, if any. The problem is that rates are not determined by market operations. Consequently, the solution must be to abandon any centralised rate (like the Repo Rate) as a benchmark and allow the market to set the interest rate.
The primary problem is that the SARB views its setting of interest rates as a one-way transmission of monetary policy. This approach is precisely the issue and should be discontinued. Interest rates should not be used as a policy tool; instead, they should reflect the scarcity of savings.
Until the current status quo of centralised interest rate setting and monetary policy is addressed and reformed, issues such as price rigidity and the suppression of competitive discovery will persist, even in the absence of a prime lending rate.
Therefore, the Commission should address the core issue: central banking. Until then, South Africans will continue down the road to serfdom, while those with vested interests in the current status quo laugh all the way to the bank.
[Image: Andre Taissin on Unsplash]
The views of the writer are not necessarily the views of the Daily Friend or the IRR.
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