An Overview of Interest Rates in South Africa

You have probably heard of the repo rate, the prime rate, SAFEX overnight, SABOR, treasury bills, government bonds, NCDs, JIBAR, swaps and FRAs. In case it gets a little fuzzy as to how they all inter-relate I thought I should jot down a few notes.

There are two free websites that contain interest rate data that is useful to corporates. The first is the South African Reserve Bank (SARB) current market rates page. The second is the fixed income rates page on the Rand Merchant Bank (RMB) website. The combination of these two websites provides a fairly comprehensive overview of the interest rate market in South Africa. The SARB publishes the date related to their rate data - so beware it is not live market data. The RMB rates are delayed by 15 minutes. 

Let’s start with the repo rate. The Governor of the South African Reserve Bank meets with his Monetary Policy Committee to set the repo rate and this then sets off a ripple effect whereby all interest rates are adjusted. The meeting dates are published on the SARB website. The current repo rate is 3.75%. At the end of each working day the banks tally up their net cash position taking into account all the deposits, loans, withdrawals, etc for the day. They are either short or long cash. They can borrow money from the SARB at the repo rate plus 100 basis points, so currently that would work out to 4.75%, or deposit excess cash with the SARB at repo less 200 basis points, which works out to 1.75%. These rates are commercially unfavourable to banks as certain corporate deposits are priced at c3.5% and if they place these funds on deposit at the SARB the bank earns 1.75% resulting in a negative carry of 1.75%. Instead the banks set off with each other at the repo rate at the end of each day and try to avoid borrowing or depositing money at the SARB. The repo rate is thus the ultimate rate at which banks can borrow from and lend to each other.

Per the SARB website, “Banks’ cost of funding is not determined only by the level of the repo rate, but by market forces and conditions in the money market. Banks’ total cost of funding is determined by their rand-denominated deposit rates, the cost of foreign funding and the cost of capital. The repo rate should, therefore, not be seen as a proxy for the average funding cost of banks.” The SARB website further states that, “ In practice, the funding costs of banks are derived from the money-market yield curve, and the repo rate has an indirect effect on banks’ lending rates via the yield curve.” 

Every day banks publish a set of money market rates at which they will buy and sell Negotiable Certificates of Deposit. The rates are published on their Bloomberg and Refinitiv (formerly Reuters) screens. Here is a sample of three banks submissions from 25 May 2020.

If you deposit money with Bank A and buy a 3 month NCD they will pay you 4.000% interest (the “sell” column). You commit your money to Bank A for 3 months. With an NCD the bank gives you a digital certificate that is administered by STRATE which can be traded. If you change your mind and want your money back the bank will buy back the NCD at an interest rate of 4.150% so you lose 15 basis points. 

Banks must post buy and sell NCD rates for which they are willing to trade between ZAR 20m and ZAR 100m. These rates are sampled and the mid of the buy and sell NCD rates for the mid-50% of banks is used to determine the daily Johannesburg Interbank Average Rates (JIBAR). To avoid any manipulation as happened with Libor there are numerous controls and checks upon checks. The full procedure is documented on the SARB website.

The JSE is the calculation agent and publishes the JIBAR rates every day at 10am. The rates for 25 May 2020 are as follows:

If you are observant, you may ask about the overnight rate for on demand funds. The two main overnight benchmark rates are the SAFEX Overnight Rate (also called the Rand Overnight Deposit Interest Rate or “RODI”) and the South African Benchmark Overnight Rate (SABOR).

The rates are from the previous working day - Friday 22 May 2020 - and are as follows:

The SAFEX Overnight Rate is the rate that the JSE pays on margin and default fund contributions. The JSE places the funds on deposit at high credit quality local commercial banks with not more than 30% being invested at a single institution. Margin holders are paid interest at the SAFEX Overnight Rate which is the weighted average rate received from the banks. 

To calculate the SABOR, each bank has to submit the interest rates they paid to their top 20 clients for overnight non-repo linked deposits. The top 20 clients can be banks or non-banks. This accounts for 95% of the weighting and the remaining 5% is the implicit interest rate in FX swaps. The SARB calculates and publishes the SABOR rate every day for the previous working day.

RMB shows the SAFEX Overnight Rate on the JIBAR page as the JIBAR overnight rate. Technically it is not a JIBAR rate. Presumably RMB figured it is the most convenient page to display the SAFEX Overnight Rate. The SABOR rate can be found on the SARB website.

In the technical literature there is a call for an Overnight Index Swap (OIS) rate in South Africa as there is in international markets (SONIA, EONIA/ESTER, SOFR, TONAR, SARON). It is preferable to use an OIS rate as the reference rate for commercial loans and derivatives such as swaps and FRAs as it is a (relatively) risk free tradeable point in time (overnight) rate. Overnight credit risk to major institutions is deemed insignificant and hence a swap curve bootstrapped from instruments that reference an overnight benchmark rate is considered the best proxy for a default-free interest rate curve. By contrast, 3 month JIBAR is the yield for a series of daily interest rates over a three month period and it contains bank risk. Benchmark rates are a complex topic. There is a move internationally from voluntary submissions by banks of their offer rates (ie old LIBOR) to the mandatory reporting of volume-weighted average prices based on actual transactions. There are pros and cons as to which trades are included in the calculation of the rate - secured or unsecured, only inter-bank, or inter-bank and other significant market players. The wider the net the greater the liquidity and the smaller the chance of manipulation, but it may be at the cost of introducing credit risk and non-wholesale margin. The SARB is consulting with the industry on the migration to an IOSCO compliant OIS type reference rate in South Africa.  

Per the SARB website, “Banks’ lending rates are determined by three main factors: their cost of funding, the credit risk profile of the client and the degree of risk appetite of the bank itself, which includes not only appetite for credit risk but also for liquidity and interest rate risk. Banks use their funding cost as a basis for determining the interest rate charged on a loan, by adding a risk premium that reflects the credit risk profile of a client and the bank’s risk appetite at a particular time. The credit risk profile of a client depends on various factors, such as the creditworthiness of the client (ability to repay), the term of a loan, the type of loan, the extent of collateral provided, concentration risk and the mix of products offered to the client.”

The prime rate is set at 350 basis points above the repo rate. Currently the rate is 7.25%. Banks quote many of their floating lending rates to clients, particularly retail clients, relative to prime. This does not imply that they price their loans off prime. As discussed earlier, lending rates are determined by a combination of factors. Once an appropriate lending rate for a client is determined, the bank offers this rate expressed at a link to prime. Banks are free to price their loans above or below the prime rate. ZAR denominated loans for large corporates are typically linked to 3 month JIBAR.

An interest rate swap is a contract in which a stream of future interest payments is exchanged for another based on a specified principal amount. Interest rate swaps usually involve the exchange of a fixed interest rate for a floating rate. The South African market evolved into a 3-month fixed versus floating convention for swaps because of the historic dominance of the 3-month maturity. 

There are set dates for the determination of the floating rate for JSE listed interest rate futures. The quarterly resets happen on the 3rd Wednesday in March, June, September and December. As swaps are “Over The Counter” (not listed) the reset dates are flexible and determined by when the contract is executed - the quarterly reset happens every 3 months from the date the swap was initiated.

The RMB website reflects the following swap rates:

The rate quoted is for the fixed leg. The current 3 month (floating) JIBAR rate is 4.06%. The swap market reflects that the quarterly resets of the 3 month JIBAR for the next (1) year are equivalent to a fixed rate of 3.90%. Clearly the market expects that JIBAR will drop below 3.90% in the coming year so that a fixed rate of 3.90% is equivalent to the 3 month JIBAR over the next 4 quarter ends. Stated slightly differently, as the current 3 month JIBAR rate is above 3.90% investors must expect it will drop below 3.90% for a portion of the year so a fixed rate of 3.90% is equivalent to the series of 4 quarter end floating rates.

The fixed rate for the 2 year swap is 4.17% so the market presumes the 3 month JIBAR rate will start to rise in the second year. As the market expects the 3 month JIBAR rate to dip below 3.9% in the first year it must expect the rate to rise quite sharply in the second year so that a fixed rate of 4.17% is equivalent to the series of 8 quarterly floating rates.

The year 1 swap provided information about a series of 4 points and the year 2 swap provides information about 8 points. If you remove the effect of the first 4 points you are left with the effect of the last 4 points. Mathematically it is possible to build a continuous curve of interest rate points that fits the market of where the swaps of different terms are trading. This is known as the swap curve.    

The 10 year swap rate of 7.17% is particularly startling. If you were paying the fixed rate, then you would pay (7.17% - 4.06%) x notional this quarter, then maybe (7.17% - 3.85%) x notional next quarter and then maybe (7.17% - 3.89%) x notional in the 3rd quarter until eventually 3 month JIBAR goes above 7.17% in the later years and the counterparty starts to pay you. A 10 yr swap comprises a stream of (4 quarters x 10 years) 40 quarterly 3 month JIBAR rates which the market implies are equivalent to a fixed rate of 7.17%. If the 3 month JIBAR rates are in the 4% region in the early years then they need to be in the 8% - 10% region in the later years so the stream of interest payments based on the floating 3 month JIBAR rate is equivalent to the fixed rate. It is scary to think that the market expects interest rates to rise this high in South Africa. Underlying this is the assumption that inflation in South Africa will also increase substantially. This is also reflected in the 10 year bond yields. The outlook in the UK, for example, is different and their 10 year swaps are trading in the range of 0.5%.

If you would like to convert your floating rate loan into a fixed rate loan then the swap curve is used to calculate the fixed rate that is equivalent to the future series of variable rates. From the rates in the swap table it should be intuitive that the longer the loan the higher the fixed rate will be.  

A Forward Rate Agreement (FRA) is an agreement where the parties agree to pay or receive the differential between a rate that will be determined at an agreed date in the future relative to a reference rate. A notional amount is used to calculate the rate differential but it is not exchanged. Here are the FRA rates per the RMB website on the 25 May 2020.

A 1x4 FRA means that the prevailing (4-1) 3 month JIBAR rate in 1 month’s time will be compared to the reference rate of 3.81%. If the 3 month JIBAR rate is say 3.91% in 1 month from today then one party will pay the other party 0.1% x the notional amount. The reverse would apply if the rate was 3.71%. A 4x7 FRA means the (4-7) 3 month JIBAR rate in 4 months will be compared to 4.32%. If it is higher than 4.32% then one party will benefit. If it is lower then the other party will benefit.

The FRA curve helps explain why the 1 year swap rate is 3.90% and the current 3-month JIBAR rate is 4.06%. The market expects the 3 month JIBAR rate will be 3.81% one month from now, 3.85% 3 months from now, etc. Beware though, you cannot use an arithmetic average to derive the swap curve as the calculation needs to involve the time value of money.

The SARB website reflects the following interest rates for the borrowings by the South African government on 25 May 2020. Treasury bills have a maturity that is less than a year and bonds have a maturity at issue that is greater than a year. (The interest rates are technically yields that are influenced by the price of the bonds. The intention of this article, however, is not to be overly technical.) 

Older corporate finance textbooks view government debt as risk free. The theory was that governments could always levy higher taxes to meet their debt repayments so there was no risk. Government treasury bills and bonds were used to construct the risk free yield curve. We know this is not the case in practice. The South African government is borrowing for 3 months at 4.19% and the average 3 month NCD of the 3 banks is 3.98% (ie the equivalent borrowing rate for the banks is 21 basis points less than the SA government). Banks were also considered risk free until the 2008 crises when Lehman Brothers went bankrupt. Risk free yield curves are now constructed from FRAs and swaps as notionals are not exchanged and the changes in market values are margined on a daily basis thus eliminating most of the credit risk. The SA government is borrowing for a term of 10 years at 9.72% yet a 10yr swap is 7.17%. This gives you an indication of the risk premium that investors want for long term South African government debt.

So all very interesting (,or maybe not..,) but what does this mean for corporates ? The market expects rates to decrease further and then start rising in 15 - 18 months. Good news for the next 15 months if you have debt, not good news if you are looking for yield on your cash investments. If you can tie up your surplus cash for a longer term then you will get better rates. The swap curve gives you a sense of the fixed rates you would get if you switched your debt from floating with prime or JIBAR to a fixed rate. Remember with corporate debt you are not swapping 3 month JIBAR for a fixed interest rate, you are swapping 3 month JIBAR plus a margin (of for example 1.5%) for a fixed interest rate so you need to take this into account when using the swap curve as a guide to get a sense of the fixed rates you could potentially get from a bank.

The point of this article, however, was not to do the analysis for you but rather “to teach you to fish” so that you can understand the interest rate market and do your own analysis as it applies to your business. All the corporate banks have teams that specialise in risk solutions and they are always willing to run the numbers for your specific circumstances. They also send out generic newsletters which you can subscribe to. I suggest you use these resources to validate your analysis.

As the SARB eloquently explains, banks raise money at different rates and lend money at different rates (it is not as simple as borrow at repo and lend at prime !). For the purpose of this point, permit the simplicity and assume the bank raised funds at 3.5% and lent those funds out at 7.5%. As you know there are different teams and divisions within a bank. There is the money market desk that raises money, there are retail bank accounts where customers deposit their salaries, there is the home loan division, the vehicle finance division, etc, etc. Should the team that raised the deposits at 3.5% be rewarded for the 4.0% margin or should it be the team that made the loan at 7.5% ? In practice, the bank treasury sets an internal rate - let’s say 5.5% and then the margin is split between the two teams. The bank treasury needs to provide an internal rate for different terms, for example the 5yr rate may be 8%. The point of my story is that teams within banks often do not see the whole picture - their behaviour is influenced by the customer rate they are earning relative to the internal treasury rate (which determines their personal margin which in turn affects their bonus). The treasury can use the internal treasury curve to sweeten the margin for particular products such as deposits when the bank needs cash or loans if the bank has excess cash. You should be alert to this when negotiating with a bank.

In conclusion, the Monetary Policy Committee sets the repo rate which influences all the interest rates in the South African market. Banks raise money in the money market in large part through NCDs. The banks publish tradeable NCD rates which are used to determine the mid JIBAR rate. The 3 month JIBAR rate is the primary reference rate used for many corporate loans, interest rate futures, swaps and FRAs. Swaps can be used to switch variable / floating rate loans to fixed rate loans. Bank lending is commonly linked to the prime rate which is set 3.5% above the repo rate. By analysing the swap curve you obtain an understanding of the market view of interest rates into the future.