The monetary policy transmission theory taught at universities is that when a central bank cuts its benchmark lending rate, commercial banks will follow its lead and reduce the lending rate they charge consumers.
The reality, however, in South Africa is that due to commercial banks becoming more risk-averse given the slow economic growth and the numerous retrenchment announcements, this theoretical transmission mechanism has broken down, so that instead of welcoming lower overdraft rates, consumers are seeing higher average overdraft rates.
Although most commercial banks say they cut the rates they charge their customers soon after the South African Reserve Bank (SARB) cuts the repo rate, the reality is that it can take some time to adjust all the rates that are linked to the repo rate.
The 25 basis point cut by the SARB in July last year has failed to reach consumers, as the average overdraft rate reported to the SARB by the commercial banks rose to 10.6% in December, from 10.45% in August.
In 2018, when the SARB cut the rate by 25 basis points in March, there was a delayed reaction to the cut, and the full 25 basis points cut was never fully passed on. In March, the overdraft rate dipped by only 5 basis points from February. There was a further 13 basis points cut in April. The reality is that despite two 25 basis points cuts in the repo rate, the December 2019 average overdraft of 10.6% is higher than it was in January 2017, when the average overdraft rate was 10.47% and the repo rate was 7%.
Intellidex’s head of capital markets research, Peter Attard Montalto, said the increase in the average overdraft rate reflected the rise in risk aversion among commercial banks. He also did not expect the 25 basis points cut in the repo rate by the SARB in January this year to be fully passed on to consumers.
“This was as new risk metrics came in for clients on this kind of lending. I would expect average overdraft rates to drop, but maybe not by the full amount,” he said.
Credit demand
Economic theory says that if the price of a good or service increases, then, all other things being equal, the demand for that good or service will decrease. This is reflected in the January 2020 credit demand data from the SARB, as total domestic credit growth plunged to a year-on-year (y/y) rise of only 4.38% after growing by 9.69% y/y in August last year.
The Nedbank Group Economic Unit said the credit growth outlook for this year remained subdued.
“Growth in household demand for credit will be contained by job insecurity, high unemployment, slow income growth and relatively high existing debt burdens. Corporate demand is likely to remain volatile and weak, hurt by fragile business confidence in the face of weak growth prospects and difficult operating conditions. The figures reflect persistent weakness in economic activity. Growth outlook is still subdued and will not pose significant demand pressures on prices. Given these factors, one would expect the SARB to ease rates further,” the unit said.
In 2017, the margin between the average overdraft rate and the repo rate was 33.6 basis points, but this widened to 36 basis points in 2018, and last year it increased further to 39.5 basis points. Although a basis point is only a hundredth of 1% (0.01%), when dealing with trillions of rand, that tiny percent represents a significant amount of money. In December last year, banks lent out just over R3.5trillion, so one basis point was the equivalent of some R350million.
The impact on consumers is even more severe if we look at the real overdraft rate, which is the nominal rate minus the consumer inflation rate. In January 2017, the inflation rate was 6.6% y/y, giving a real overdraft rate of 3.87%. Inflation has eased in subsequent months, and in December last year it was 4% y/y, which meant that the real average overdraft rate increased to 6.6%.
Wage increases
Compounding the rise in the real overdraft rate is the fact that, for the majority of wage earners, wage increases last year did not keep pace with inflation. Last October, Finance Minister Tito Mboweni said in his Medium Term Budget Policy Statement that private sector employees were granted wage increases averaging only 2.1% y/y in the first half of 2019.
The lack of flow-through of the SARB’s repo rate cut and the below-inflation income increases are some of the reasons the ratio of household debt to income rose to 72.6% in the third quarter of last year, from 71.6% in the second quarter of 2018. It is also reflected in slowing real retail sales growth, which fell by 0.4% y/y in December from a 2.4% y/y increase in June. Real retail sales grew by only 1.2% y/y last year compared with a 2.2% increase in 2018 and a 3.5% jump in 2017.