Changing the rules: Structural reform should go a long way towards tackling low credit penetration

One of the most important structural reforms for Mexico’s banking sector is wide-ranging financial reform. Presented to Congress in May 2013, approved in November 2013 and promulgated in January 2014, the reform includes various bodies in the financial sector, such as banks, stock exchange intermediaries, investors, insurance companies, saving and loan unions, and politicians.

The reforms addressed 34 pieces of legislation and different entities of the federal government and the central bank, Banco de México, will be responsible for implementing them. The National Banking and Securities Commission will be in charge of enforcing most of the new rules as the regulator of banks and capital markets, but other agencies, like the Secretariat of Finance and Public Credit, the National Commission for the Protection and Defence of Users of Financial Services (Comisión Nacional para la Defensa de los Usuarios de Servicios Financieros, CONDUSEF), and the Institute for the Protection of Bank Savings, will also take part in the process.

New Goals

The main objective of the financial reform is to increase the volume of credit in relation to GDP and to reduce the cost of loans. Mexico’s ratio of credit to GDP (18.5% in 2013) is low compared to more developed economies and its Latin American counterparts. The aim is to reach a ratio of domestic credit to the private sector of 40% in 2018, according to the guidelines in the national programme for the financing of development.

The financial reform has four pillars that aim to address the problem of low volume and the high cost of credit. The first pillar is fostering credit through development banks, while the other three aim to make commercial banks lend more and at lower rates. The second pillar involves increasing competition in the financial sector, the third focuses on the need to boost credit from private institutions and the fourth is aimed at strengthening the soundness of the financial sector. The target of the pillars and the main objective of the reform illustrate that it is less a reform of the financial sector and more about lending. Most of the measures are designed to increase the volume of credit and do not affect in significant ways other activities of the financial sector, such as capital markets or insurance.

This opinion is widely shared by other participants in the sector. As Gabriel Casillas, the director-general of economic analysis of Banorte, told OBG, “Financial reform is more associated with the tightening of financial regulations as happened after the financial instabilities in the US markets in 2007 and 2008, so I believe it would be better to call it a credit reform. Its main objective is to stimulate banks to provide more and cheaper credit.”

Opening New Doors

Regarding the first pillar, in December 2013 the credit portfolio of the six Mexican development banks stood at MXN567.8bn ($44.12bn), or 3.5% of GDP. To foster increased use of credit, there were changes made that aimed to give more regulatory and financial flexibility so that banks are able to extend credit to sectors and people that have limited access to traditional banking products. The increase in credit from development banks will have to be directed to families and small companies, as well as areas prioritised under national development. Development banks will also have to strengthen the process of financial inclusion. New regulations stipulate, for example, that development banks must take an approach that take gender into consideration by offering specific products that aim to improve equality between men and women. As public federal entities designed to work as instruments for economic policies, such a goal would face fewer obstacles than in the case of private banks.

Affordable Credit

The second pillar aims to promote more competition in the financial sector to increase the volume and reduce the cost of credit. In December 2013, the country’s seven largest banks were responsible for around 80% of the volume of credit. A committee of financial institutions will be created at CONDUSEF to make it easier for consumers to compare prices and conditions of different products before choosing a financial institution to work with or transferring their existing accounts to others offering better options. The committee will also provide information regarding sanctions imposed on financial institutions.

Facilitating Competition

Another measure intended to protect consumers is the prohibition of the practice of tie-in sales. Even before the approval of the new set of financial reforms in June 2013, the Federal Committee for Economic Competition (Comisión Federal de Competencia Económica, COFECE) was created and made responsible for evaluating competitive conditions in different markets. The COFECE will be responsible for drawing up a report on the system’s internal competitiveness and it will be allowed to make recommendations to the financial authorities and to take measures to curb uncompetitive practices.

According to Mario Maciel, director-general of CI Bank, the financial reform is a good first step to reducing concentration in the banking sector. “It might take a long time until we see a real impact in terms of lower concentration as the top five banks remain strong and well capitalised, but we are confident that new rules in the field of execution of guarantees and legal certainty will act as a catalyst for higher flow of credit from smaller banks,” he told OBG.

However, for Marcos Martínez Gavica, executive president of Santander, even with the reforms, a reduction in the concentration of credit in larger banks seems unlikely and even among top banks, a change in position would be difficult. And for Javier Foncerrada Izquierdo, the CEO of Grupo Financiero Inbursa, although concentration is high and credit penetration is low compared to other countries, he said competition is high among the top banks. In this sense, he stated, concentration should not be confused with limited competition.

New Avenues

The third pillar is considered by many people in the sector to be the most important part of the reform. The changes included under the third goal aim to reduce the risks of granting loans by financial institutions through a revision of the legal environment. Specifically, it involves a change in enforcing the guarantees given by the borrowers to make it simpler for banks to claim proffered collateral in the case of loan default.

For Foncerrada, any improvements in the process of recovering collateral may be a window of opportunity for banks to reach customers not previously considered creditworthy. Martínez also believes there is a strong possibility that a better regime for enforcing guarantees will help to increase lending. He added, however, that the change does not address the fundamental issue explaining the low level of credit: informality. Casillas told OBG that although the reform does not address the issue of informality, the changes in recovering collateral will make banks more likely to lend more and at a lower cost. He cites the example of Brazil, where similar changes were made regarding collateral and, as a result, it doubled its credit-to-GDP ratio in less than 10 years to around 50% in 2014. According to Casillas, after the implementation of the reform, Mexico could reach a 40% credit-to-GDP ratio in a decade.

Ensuring A Stable Foundation

In regard to strengthening the soundness of the financial sector as a whole, the fourth pillar includes new requirements for minimum reserve ratios and the quality of capital. The legal process in cases of bankruptcy or insolvency of companies has also been simplified, guaranteeing the protection of consumers’ savings in any such case. Information sharing and cooperation mechanisms among financial authorities will also be strengthened. Although the overall soundness of the Mexican banking system is proven, these measures are still seen as important in ensuring that expected growth in credit does not introduce new vulnerabilities into the system.

Héctor Chávez, the director-general of Santander brokerage house, warned that while promising, it may be too early to call the reforms a “game-changer”. He told OBG, “The measures affect the supply side of credit and it may not take effect so fast. At first, banks could wait and see how the new rules work before being more active on lending.”

Chávez acknowledged there will be more pressure on existing players but called it a fine-tuning process, in which banks cannot be forced to lend. In this sense, for Maria Tapia, senior investment officer at the Inter-American Bank of Development, financial reforms are an important initiative since the government needs banks to lend and provide the necessary credit to spur economic growth. However, it is still only an invitation to lend, so it will be necessary to watch the behaviour of banks after the measures come into force, to see if improving the supply conditions will prove to be an effective measure.