So you’re down to your last couple of cents for the month.
The banks don’t want to lend you a dime because you owe them too much. Your family also wants to know nothing about your problems. You’ve cashed in your last investment.
So what’s a person to do when he or she needs cash urgently?
Well, if you haven’t noticed yet, there’s a new kid on the block – the Micro lender… And if you thought banks were expensive, try! Believe me when I say that only desperate people want to lend money from them.
So what do the banks do when they’re in a tight spot?
Well, they believe in ‘go big or go home’. No micro lenders for them. They approach a macro lender by the name of ‘The South African Reserve Bank’.
You see, when you and I lend money from a bank, it’s usually at ‘prime’ or ‘prime plus a couple of percentage points’. When banks lend money from the Reserve bank, it’s at the repurchase or repo rate.
What the bank does is temporary sell its financial assets to the reserve bank in exchange for the cash they need. As part of the deal banks must agree to repurchase their assets within a time period specified in the agreement.
It goes without saying that if the repo rate goes up; the prime lending rate goes up.
Because the bank is just like any other business – they like to maintain their profit margins.
It goes without saying that when interest rates go up, our appetite for buying on credit goes down.
And voila…There you have it!
If the Reserve Bank wants to limit spending, they simply increase the repo rate.
Why would the Reserve Bank want to limit spending?
Remember, with lots of freely available and cheap cash, consumers and producers tend to go on spending sprees. With all this cash chasing limited resources, it causes the cost of these limited resources to soar.
Think about it like this…
Peter wants to sell his VW golf so he advertises it in the junk mail. Ten desperate people respond to his ad begging to throw money at him. What does Peter do? He raises price until all but one is left. Why does he do this? Because he wants to make as much profit as possible!
Soaring prices we all know leads to inflation, and of course, when inflation skyrockets it hits everyone’s pockets hard. Less money in your pocket means higher wage demands, and so the Reserve Bank tries to keep inflation in check by making the lending of money (credit) expensive.
Let’s face it; it’s difficult to buy Peters Golf when your bank doesn’t want to lend you cheap money!
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Until next time.
The InsuranceFundi Team