Big changes to interest rates coming soon to South Africa

South Africa is poised for significant changes in its financial markets as it transitions from the Johannesburg Interbank Average Rate (JIBAR) to the South African Rand Overnight Index Average (ZARONIA) by 2026.

JIBAR has long served as a benchmark for short-term interest rates, determining the pricing of financial instruments such as loans, bonds, and derivatives.

However, its reliability has come under scrutiny in recent years due to its reliance on estimates rather than actual transactions, making it vulnerable to manipulation.

The decline in unsecured interbank lending-the market JIBAR is based on-has further diminished its relevance, as submissions for the rate are often based on expert judgment rather than real market activity.

This has sparked concerns similar to those seen in the 2012 London Interbank Offer Rate (LIBOR) scandal, where banks were found to have colluded to manipulate short-term rates for financial gain.

In response, the South African Reserve Bank (SARB) initiated a review of JIBAR in 2018, leading to the decision to phase it out.

ZARONIA is set to replace JIBAR as a more accurate and transparent benchmark, calculated based on actual overnight transactions between banks.

This shift aligns with global trends toward using risk-free rates that better reflect real market conditions, providing a more reliable measure of short-term borrowing costs.

Impact

ZARONIA's introduction marks a major improvement, as it eliminates the subjectivity of JIBAR and offers a stable, data-driven rate that reflects the true cost of overnight borrowing.

The PA and FSCA said the transition to ZARONIA is expected to have widespread effects across South Africa's financial system.

Nearly all financial contracts tied to JIBAR will be impacted, necessitating adjustments to loans, derivatives, and other products.

BDO director Zakhele Nyandeni said financial institutions will face challenges in upgrading their systems, valuation models, and risk management frameworks to accommodate the new benchmark.

Moreover, existing contracts linked to JIBAR will need to be renegotiated to incorporate ZARONIA, a complex and potentially disruptive process, he added.

Adding to this already significant transition, South Africa's economy may soon experience a short-term shift in interest rates.

Economists are increasingly expecting the South African Reserve Bank's Monetary Policy Committee (MPC) to cut interest rates at its upcoming November 2024 meeting.

A reduction of 25 to 50 basis points is anticipated, following a period where inflation has fallen below the midpoint of SARB's target range, aided by stabilising food prices, a stronger rand, and falling oil prices.

Such a cut would be the second rate reduction since November 2021 and could provide much-needed relief to borrowers.

However, while the SARB has room to cut rates, external risks loom.

Geopolitical tensions, particularly in the Middle East, could drive oil prices higher, potentially reigniting inflationary pressures.

In such a case, the central bank might be forced to reverse any cuts, underscoring the delicate balancing act the SARB faces.

Nevertheless, a rate cut would signal a more accommodative monetary policy stance, helping to support economic growth.

The convergence of these two developments-the transition to ZARONIA and the potential rate cut-highlights a transformative period for South Africa's financial sector.

The end of JIBAR and the implementation of a new, transparent benchmark will reshape interest rate calculations and influence the pricing of financial products for years to come.

Meanwhile, the prospect of lower interest rates in the short term may provide some immediate relief to consumers and businesses amid an otherwise challenging economic environment.