The Impact of Short- Term Interest Rates on Bank Funding Costs

Azasakhe Nkcubeko Nomsobo,Roscoe Bertrum Van Wyk

doi:10.22610/jebs.v10i3.2323

Azasakhe Nkcubeko Nomsobo, Roscoe Bertrum Van Wyk

Open Access

https://doi.org/10.22610/jebs.v10i3.2323

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Abstract

This study examines the impact of short- term interest rates on bank funding costs in South Africa. Literature suggests that rising short- term interest rates may cause similar financial crises experienced in 2007/08 (Bonner & Eijffinger, 2013; Turner, 2013; SaraÃ§ & Karagoz, 2016). It is vital to study short- term interest rates and bank funding costs in order to achieve financial stability. The study uses quarterly time series data for the period 2000 to 2014. To estimate the regression, the study uses the Vector Autoregressive model (VAR) and the data is found stationary at first difference. The 3 months Johannesburg Interbank Agreed Rate (JIBAR) is used as a proxy for bank funding costs whilst the prime overdraft rate, 10 -year government bonds and capital ratio are used as proxies for short- term, long- term interest rates and bank capital, respectively. The results show a positive and significant long- term relationship between the variables. The results for prime overdraft rate, 10 -year government bonds and capital ratio conform to the apriori expectations. For GDP growth the results show a positive relationship which does not conform to apriori expectations. Using the variance decomposition, the study illustrates fluctuations in JIBAR was due to changes in its value and fluctuations in the prime rate are also due to JIBAR. The study presents policy options whereby regulatory efforts need to strengthen the capital buffers of banks to reduce bank funding costs and therefore reduce short- term interest rates imposed on borrowers.

Highlights

Banks are required to fund their business activities
After 10 years the results show that 73% of the volatility in Johannesburg Interbank Agreed Rate (JIBAR) was due to shocks resulting from the variable itself
The purpose of this study was to examine the impact of short term interest rates on bank funding costs in the context of South Africa

Summary

Introduction

Banks are required to fund their business activities. Funding is done by lending at interest rates that are higher than the cost of the money they lend. Bank funding costs is important for monetary policy stability as it affects the outlook for growth and inflation. This was not noticed during the recent financial crisis as the bank’s funding costs increased relative to risk-free interest rates and implied an upward pressure on lending rates. When the cost of credit is high, the overall economic activity will be negatively affected, this causes higher costs of servicing debt and increases the number of default payments. This will weigh down the bank’s profitability because the credit loses faced by the banks

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