Commercial banks might widen lending margins to offset risks from diverging interest rates with South Africa, negating monetary easing benefits.
Eswatini's central bank may not achieve cheaper loans for businesses and households despite lowering interest rates, according to an International Monetary Fund (IMF) study. Commercial banks could increase their lending margins to protect profitability, especially when Eswatini's discount rate falls below South Africa's policy rate. This divergence creates risks for banks, prompting them to adjust rates on new loans to cover funding costs and market conditions.
The IMF report, "Monetary Policy Transmission Through Banking: Evidence from Eswatini," suggests that banks have discretion over margins for new loans, unlike existing variable-rate loans which adjust quickly to changes in the central bank's discount rate. This mechanism, where the Prime Lending Rate is set at 3.5 percentage points above the discount rate, has been in place since September 2003. However, banks can still influence overall borrowing costs by adjusting margins on new lending.
This situation is partly due to Eswatini's membership in the Common Monetary Area, which pegs the Lilangeni to the South African Rand and links domestic financial conditions to those in South Africa. Persistent interest rate differences can also encourage large companies to seek better returns or financing in South Africa, potentially weakening the intended stimulus of lower domestic rates and impacting economic activity.
Why it mattersInvestors may face higher borrowing costs and reduced investment opportunities if banks increase lending margins despite lower central bank rates.
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