On March 9 there will be a fundamental change in the way interest rates are determined. It could result in your home loan and overdraft rates changing more often than in the past.
The Reserve Bank plans to introduce a new interest rate mechanism the repurchase or "repo" rate which will replace the present bank rate.
Up to now a reduction or an increase in the bank rate has signalled a corresponding change in the interest rate your bank will charge you on your overdraft or home loan.
The bank rate, set by the Reserve Bank, is the interest rate at which banks borrow money from the Reserve Bank. It is determined by a number of factors, including the level of demand for money, the inflation rate and the exchange rate. A low bank rate stimulates the economy, a high bank rate slows it down.
Certain weaknesses in the present system are the reason why the Reserve Bank is planning to change it. For example, the economy might be slowing down but the evidence on which the Reserve Bank acts is only available a few months later so a hike in the bank rate occurs too late to be fully effective.
Dr Ernie van der Merwe, a Reserve Bank economic adviser, says big banks have easy access to Reserve Bank funds at a fixed bank rate. This contributes to the rigidity of rates in the money market.
Kallie Hugo, chief dealer at the Reserve Bank, says under the new system banks will have to tender daily for the money that they need at the repurchase or repo rate.
Initially the Reserve Bank will set the repo rate, but once the system has settled down, it will set only the amount and the maturity date of the loan. Those banks which are prepared to borrow money from the Reserve Bank at the highest rate will be allocated the funds they need.
Borrowing from the Reserve Bank is not be the only option for commercial banks. They can also borrow from one another, known as the inter-bank market. For the smaller banks that do not have a clearing account with the Reserve Bank, inter-bank borrowing is the only option.
The banks will borrow money from whatever source offers the best interest rate. The level of demand for money will determine interest rates. Banks which have not been able to get money elsewhere will tender aggressively for the money offered by the Reserve Bank.
Through this tendering process, market forces will determine the repo rate, rather than it being set by the Reserve Bank only, says Hugo.
As a last resort, banks that have not been able to get funds from the tendering process or via the inter-bank market will be able to borrow money from the Reserve Bank at the marginal lending rate. This is a "penalty" rate, which will be set by the Reserve Bank at about two percent above the repo rate.