Economists and business leaders have welcomed the South African Reserve Bank’s (SARB) decision to cut the repo rate by a further 50 basis points (bps) to 3.75% on 21 May 2020. This has resulted in a reduction of the prime rate quoted by our commercial banks from 7.75 % to 7.25 %. This is the fourth reduction of the repo rate in 2020, bringing about a cumulative reduction of 275 bps, which is the lowest rate during our democratic era.

This decision was made to further manage the impact that COVID-19 continues to have on South Africa’s fragile economy. Central banks globally have similarly been aggressively slashing lending rates in an attempt to mitigate the crippling effects of the pandemic on their respective economies.

The effect of repo rate cuts on debt payments

Borrowers that have elected a fixed interest rate under their loan agreements would not necessarily benefit from the reduction in the repo rate. Borrowers that have elected variable interest rates linked to the prime rate will l benefit from this reduction.

The reduction in the variable interest rate creates savings on the interest that would have been payable. This may in turn create opportunities for borrowers to elect (if they have available cash flow) to repay their capital instalments sooner, whether on a pro rata basis or inverse order of maturity. These options must be carefully considered under the terms of the loan agreement entered into to ensure compliance with any conditions and restrictions that may apply to payments of interest and repayment of capital.

The relief provided by the repo rate cut is the reduction in the lending rate of banks which creates some breathing space for borrowers trying to manage reduced cash-flow and revenue in these trying times for purposes of servicing their debt obligations.

One area that we have seen decline is the property market; prices of properties have taken a sharp drop in these uncertain times. This being said, the opportunity created by the cut in the repo rate and the reduced borrowing rates is that businesses and consumers who are in a better cash flow position are able to take advantage of the better borrowing rates to make investment in, and purchase, property. This in itself will boost the property market and make the market more active and contribute to the economy. As a word of caution, again, the terms of any property finance agreements must be scrutinised to ensure that provisions are acceptable and that proposed new investors in the property market take into account all factors to ensure that they are able to repay the loans in future.

The SARB recognises that it needs to revitalise and assist the economy and borrowers and consumers will benefit as they will have reduced debt obligations. The rate cut has a knock-on effect on the prescribed rate of interest so that unpaid debts will carry a lower rate if no specified rate applies. It also affects the maximum lending rate under the National Credit Act.

While lender margin profitability may be decreased, the slash in rates may allow for more consistent and stable repayment of loans and ensure that lenders do not need to call defaults on loans prematurely.  Borrowers are cautioned to carefully review their facility agreements to assess how they are able to take advantage of the reduced interest rates. Our Banking and Finance team are available if you need assistance.