Big interest rate changes expected next year

South Africa’s key benchmark interest rate, the Johannesburg Interbank Average Rate (JIBAR) is set to end in 2025 and be replaced by a new index, promising a significant improvement in the calculation of interest rates in the country. 

The South African Reserve Bank (SARB) recently announced the completion of the observation period for the South African Rand Overnight Index Average (ZARONIA). 

Director at BDO Zakhele Nyandeni said this is a big shift in South Africa’s financial landscape, transitioning from the Johannesburg Interbank Average Rate (JIBAR) to ZARONIA as the primary reference rate. 

Understanding and navigating this transition is crucial to ensure stability, integrity, and transparency in South Africa’s financial markets.

For years, JIBAR has been the key benchmark interest rate in South Africa, influencing the pricing and valuation of various financial products. 

JIBAR is calculated based on the rates at which banks are willing to lend unsecured funds to each other.  

Nyandeni said its reliability has been increasingly questioned because it is calculated based on expert judgment rather than actual transactions. 

This makes it vulnerable to manipulation and less reflective of true market conditions. A shift in global regulations has led to less unsecured interbank lending, which has made it harder to accurately calculate rates like JIBAR. 

ZARONIA, in comparison, doesn’t face this issue as it is calculated based on actual overnight transactions in the wholesale funds market, making it a more reliable reference rate. 

By reflecting the actual cost of borrowing on an overnight basis, ZARONIA offers a stable and transparent measure that aligns with international standards for risk-free rates. 

This means that going forward, ZARONIA will be the recommended alternative reference rate for ZAR-denominated financial contracts.

Implications for South Africans

ZARONIA is set to seriously impact the valuations of various assets. Thus, it will necessitate changes in the pricing of loans, derivatives, and other financial instruments. 

Financial models and valuation methodologies will have to be updated to incorporate the new reference rate.

This shift may alter pricing dynamics and change the price of financial products tied to JIBAR, creating disruptions for financial institutions, corporations and individuals with existing contracts. 

As a result, institutions or individuals could face liquidity issues and other challenges in managing their risk exposures, hedging strategies, and capital requirements.

Entities with existing JIBAR-linked contracts will need to review and potentially renegotiate terms to incorporate ZARONIA, Nyandeni explained. 

Financial institutions must also assess and upgrade their systems to accommodate ZARONIA. This includes updating valuation models, risk management frameworks, and reporting mechanisms. 

Under the new reference rate, institutions will also need to reevaluate risk exposures, hedging strategies, and capital requirements. 

The move to ZARONIA is also expected to enhance market transparency and reduce the risk of manipulation. 

To ensure a smooth transition, Nyandeni market participants must undertake several key actions –

• Collaborate with regulators, financial institutions, and industry bodies to develop comprehensive transition plans that address legal, operational, and technological aspects.
• Educate all involved stakeholders about ZARONIA and its implications. Clear communication strategies will help mitigate uncertainty and facilitate smoother adoption.
• Conduct rigorous testing of updated systems and processes to identify and resolve potential issues. Implementing robust operational controls will mitigate risks associated with the transition.

This shift promises to enhance market integrity and transparency, reduce manipulation risks, and foster greater confidence in financial instruments by adopting a more robust and reliable reference rate. 

With JIBAR coming to its expected end in 2025, financial institutions will have to begin their preparations as soon as possible to minimise any potential instability.