Understanding the degree to which changes in the policy rate are passed through to bank lending and deposit rates is central to the conduct of monetary policy.
The SARB has raised its policy rate by 475 basis points since November 2021. This has taken the prime lending rate to 11.75% currently. SARB’s estimate of the weighted average rate on all bank lending has only risen by around 350 basis points as at the end of June 2023 (compared with 475 points of tightening). Average lending rates have been slow to adjust. At the end of March 2023, weighted lending rates had risen by only 280 basis points (compared with 425 basis points of tightening at that time). Mortgage rates have adjusted fully, with average flexible household mortgage rates are 460 basis points higher than in November 2021. Other lending rates, such as household credit card or corporate overdraft rates have increased by over 400 basis points since SARB began tightening. For borrowers, higher lending rates imply tighter financial conditions, with households and firms having to spend more to service their debts. However, this data suggest that the full extent of monetary policy tightening has not yet passed through to borrowing costs in the economy.
A striking feature of banking in South Africa is the ‘stickiness’ of deposit rates for transactional accounts. The chart shows that household checking deposits rates have only risen by about 220 basis points, while corporate deposit rates are up by almost 285 basis points, on average. As we argued here, slow, and incomplete pass-through of policy changes to deposit rates is likely to have distributional consequences, as poorer individuals may hold proportionately larger balances in cheque accounts than wealthier individuals.
Another implication of the relative stickiness of deposit rates has been that bank funding costs did not match policy rate cuts following the onset of the COVID pandemic, which meant that financial conditions did not loosen as much as the lower policy rate would otherwise have implied. We showed in this paper that even though monetary policy pass-through to lending rates has been effective since the global financial crisis of 2008/9, the pass-through to deposit rates has been much lower. Despite policy easing following the onset of the pandemic, higher bank funding spreads limited pass-through of monetary easing to the real economy. Itis hard, unfortunately, to accurately assess the implications of the SARB’s tightening without updated measures of bank funding costs for South Africa.
Central banks typically assume full and symmetric monetary policy pass-through in their models. This evidence implies that monetary policy assessments need to consider the possibility of incomplete pass-through and incorporate factors such as funding spreads in evaluation of the appropriate policy stance.
SARB’s updated QPM model now includes a measure of bank lending conditions to its cost of credit channel that affects aggregate demand. This brings the model a bit more in line with best practice, recognising the importance of time-varying lending spreads in affecting policy transmission. That said, it might have been better to separately account for bank funding spreads and lending spreads, instead of proxying these as the difference between bank lending rates and the prime rate. This matters in the context of heightened sovereign risk, as bank funding costs are a channel through which fiscal risk can transmit to the economy and affect pass-through of interest rate changes to loan and deposit rates.
Footnotes
Lending rates can be set above or below the prime rate, depending on client risk profiles and market conditions. Despite the fixed prime rate spread with respect to the repo rate, bank average mortgage lending margins to the policy rate do not necessarily adjust one-for-one with the repo rate as the composition of the loan book changes over time and the terms on which new loans are extended may differ from the terms on existing loans. In practice, the spread of average mortgage rates over
the repo rate has been volatile since the global financial crisis.
The chart above presents changes in selected deposit and lending rates, not estimates of policy pass-through. As we show in this paper, modelling of the pass-through needs to control for bank funding costs and other operational and market-related factors that affect bank pricing decisions, such as margins and the extent of product-specific competition, operational costs and market- and lending risks.
It is worth elaborating on historical developments in funding costs in South Africa. South African banks are highly dependent on deposits as a form of bank funding, and importantly they provide relatively cheap funding. South African bank funding spreads rose dramatically with the onset of the COVID-19 pandemic. This is in sharp contrast to the experience of advanced economies such as Australia, where bank funding costs fell on the back of policy easing by the central bank. This is because the relative cost of raising deposit funding compared to money market reference rates rose sharply, given the dominance of deposits as a source of bank funding for banks in South Africa. In Australia, by comparison, the spread between deposit rates and reference rates has tended to be much lower than in South Africa, on average. Interestingly, Australian funding spreads on deposits have risen sharply since late 2022 , which the measure plotted on for Australia does not incorporate. Unfortunately, aggregate funding costs estimates are not published by the RBA, but their estimates the level of overall funding costs does appear to have a similar profile and level to the sub-component plotted below.
Although it is mostly market structure and market conditions that drive the components of funding costs, we argued in a previous paper that Basel 3 regulations served to increase banks’ funding costs in South Africa by increasing the duration of banks’ funding liabilities and the relative cost of deposit funding. This has implications for monetary policy by raising borrowing costs and affecting interest rate pass-through. The impact of these regulations on funding costs also has implications for financial stability policy because it affects financial conditions and the sensitivity of bank balance sheets to sovereign creditworthiness. Unfortunately, we cannot update the comparison below without updated funding cost estimates.
Early indications are that pass-through to credit extension have been also been weak recently. This likely reflects weaker credit demand and the offsetting impact of increases in market risk and liquidity.
