A huge mistake
SOUTH AFRICAN Reserve Bank Governor Tito Mboweni has been very upset about banks' extension of credit to households. He's made some threats of action he could take - other than raising interest rates - to address the problem. Is he serious and what are the implications?
Speaking after December's Monetary Policy Committee meeting, Mboweni threatened to "adjust" the cash reserve requirements of SA's commercial banks to discourage the offering of credit to customers who didn't need it. He said he'd discussed the "madness" of credit card issuance with the banks. "If this trend doesn't stop, I may be forced to resort to adjusting the reserve requirement," Mboweni said.
Banks are required to keep a certain percentage of the deposits they attract as a deposit with the central bank. Currently, 2,5% of all their deposits are placed at the Bank. Clearly, that money isn't available to lend to the public.
In a speech to the Pretoria Press Club in 2002, in which he discussed monetary policy tools, Mboweni described the use of cash reserve requirements. He concluded: "The central bank has really one instrument to fight inflation in monetary policy terms. That instrument is the repo rate ... The hundred-plus economists at the central bank are convinced that the repo rate is the only weapon we have in combating inflation."
So what has happened since 2002 to change Mboweni's mind? It could be that he thinks the number of interest rate increases can be limited by tightening up credit conditions through the reserve requirements. His aim would be to put a brake on the growth in credit without hitting the economy too hard with interest rate hikes.
Yet that may not necessarily work. The effect that higher reserve requirements would have would be to raise banks' cost of funding. To the extent that they are able to, they'd just pass that cost on to consumers in the form of higher interest rates.
However, one analyst says the banks wouldn't dare to raise their prime rates without the Bank raising the repo rate. "If the banks did that they'd give Mboweni a triple heart attack," he says.
Standard Bank economist Goolam Ballim says banks would weigh up the higher cost of funding against the returns on their lending. The outcome could still be profitable, which would work against Mboweni's aims. "But the move would introduce some friction, which would have a retarding effect on credit growth."
Ballim says the threat recognises that rapid credit growth isn't necessarily inflationary and should therefore not necessarily be combated through the use of interest rates. Rather, Mboweni is worried about the systemic risk that households are getting themselves into by excessive borrowing.
"The warning may suggest that interest rate policy won't be as hawkish as some people fear. He may want to use the reserve requirements as an alternative to interest rate hikes," says Ballim, who believes there's a good chance the repo rate won't rise again in February.
Nedbank economist Dennis Dykes says the message he got is that Mboweni is looking at different cash reserve requirements for different kinds of lending. Thus mortgages would have a lower requirement than overseas holidays.
The catch with that argument is that the cash requirements are levied on deposits and not credit. But the way around that would be to say that certain deposits were used to fund certain lending and would then attract an "appropriate" cash requirement.
Dykes is probably right, in that Mboweni earlier this year said the central bank was looking at a way to de-link the mortgage interest rate from the repo rate. The reason was because mortgage debt was regarded as "good" debt.
You can envisage Mboweni allowing a higher cost of funding to translate into higher interest rates for some borrowing, while the cost of funding for other forms of borrowing is kept lower. Obviously, that would be a huge mistake. All sorts of special pleading would result - with, for example, small businesses saying theirs is also "good debt" and medical students saying the same. There would be a proliferation of interest rates and monetary policy would be rendered ineffective.
Dykes says Mboweni may hope that a higher cost of funding would make banks more discriminatory about lending for unnecessary spending. But he adds that customers with "blanket" access to credit - access mortgage type finance - wouldn't be affected by any attempt to rein in "unnecessary" credit extension.
Dykes also adds that Government and the Bank are sending mixed messages: in terms of the Financial Services Charter there has to be more lending, but according to Mboweni there's too much of it.