Current Legal Issues Affecting Central Banks, Volume IV.

Chapter 9 The Implications of NAFTA for Central Banks

Robert Effros
Published Date:
April 1997
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The topic to be discussed in this chapter is the legal issues arising for central banks under Chapter Fourteen of the North American Free Trade Agreement (NAFTA).1 The discussion is a brief primer for lawyers engaged in financial services negotiations or advising on the regulation of financial services, particularly banking services, where NAFTA is applicable. This discussion may be viewed in light of the recent initiatives by the United States to seek further liberalization of financial services in Asia, Latin America, and other emerging markets of the world. It is intended to promote consideration of NAFTA, rather than to serve as a comprehensive explanation of NAFTA provisions. Those interested in the particulars of NAFTA should refer to the agreement itself or to the U.S. Government’s summary of NAFTA, which is included as part of the implementing legislation.2

The discussion below is divided into three sections. The first section considers how the NAFTA legal regime governs banking services and banking regulations. The second section briefly examines how NAFTA might promote integration in the financial sectors of NAFTA countries. The third section briefly discusses the balance of payments implications of NAFTA, particularly through its interface with the International Monetary Fund’s Articles of Agreement. Finally, the chapter discusses some matters of interest for central bank lawyers.

NAFTA Rules Governing Banking


NAFTA covers two types of activities in financial services: investment in financial services and cross-border trade in financial services. Generally speaking, the rules governing financial services investment are more developed in NAFTA than those governing cross-border financial services, so making this distinction is important.

Investment in financial services is defined under NAFTA as investment in a “financial institution.”3 The term “financial institution” is defined as a company that offers financial services and is regulated as a financial institution under the laws of the country in which it is located.4 The investment rules under NAFTA govern both the actual making of an investment in a financial institution and the treatment by a NAFTA government of a financial institution that is owned or controlled by nationals or companies from another NAFTA country. Cross-border financial services, in contrast, are defined under NAFTA as the provision of financial services by a person located in the territory of one NAFTA country to a person located in another NAFTA country.5

It is interesting to note that the NAFTA rules governing banking services are similar to the rules governing financial services under the General Agreement on Trade in Services (GATS),6 even though NAFTA’s entry into force predates the entry into force of the GATS. This is because Canada and the United States were among the more active delegations in negotiating the GATS provisions from 1986 until 1991.7 By the time that the NAFTA negotiations formally began in June 1991, the GATS rules were relatively settled, thus accounting for the similarity in policy goals and drafting of the two sets of provisions. One should be aware of these similarities when interpreting or applying either of the two agreements.

There are five basic obligations in NAFTA that govern financial services, as well as three supplementary rules and a number of general exceptions. This section will analyze each of these sets of provisions in turn, in order to survey the basic issues that a central bank lawyer might confront under NAFTA. In addition to honoring these provisions, each country may lodge “reservations” and invoke exceptions to the five basic obligations. These reservations and exceptions allow the member country to continue to enforce laws that are contrary to the legal rules on either a permanent or transitional basis. Transitional rules allow a country to conform over time its domestic laws that are contrary to the basic obligations.

Basic Rules Governing Financial Services

The five basic rules of NAFTA that govern financial services are rules affecting

  • national treatment;8
  • cross-border trade in services;9
  • most-favored-nation treatment;10
  • new financial services and data processing;11 and
  • senior management and boards of directors.12

National Treatment

National treatment under NAFTA, like that in the GATS, looks at the treatment that a government provides a foreign firm and asks whether it is “no less favorable” than that provided by the government to a similarly situated domestic firm.13 If it is less favorable, a reservation or exception must cover that treatment; if no reservation or exception applies, the discriminatory treatment will be considered to be a violation of NAFTA. Violations of NAFTA’s basic rules can result in the sanctioning of a government under the NAFTA dispute settlement procedure commenced by one member government against another member government.

The national treatment obligation is a cornerstone of the agreement, and much debate will likely focus on the addition of language in the obligation requiring “equal competitive opportunities” to be accorded to foreign persons.14 As a legal matter, this language comprises the concept of de facto national treatment, as opposed to the more technical concept of de jure national treatment. Under de facto national treatment, seemingly similar treatment of foreign and domestic firms will not be acceptable if in fact the result is a more burdensome treatment of the foreign firms.

Cross-Border Trade

The cross-border trade obligation under NAFTA is complex.15 There are two components of this rule: the first covers cross-border financial services that are provided on a solicited or fully serviced basis, and the second governs unsolicited transactions. Unsolicited transactions are sometimes considered to be transactions that are initiated by the purchaser of the service rather than the provider. In practice, it will be very difficult to distinguish between unsolicited and solicited transactions once they have been undertaken; it may thus be easier to distinguish between the two types of transactions by focusing on the degree of publicity, marketing, and servicing on the part of the nonresident financial service provider to determine whether a transaction is solicited or not.

Restrictions on solicited cross-border transactions under NAFTA are subject to a “standstill” commitment. Under the standstill obligation, further liberalization of solicited transactions need not occur under NAFTA, but no NAFTA government may become more restrictive than it was when NAFTA entered into force. Thus, under NAFTA, Mexico, Canada, and the United States must continue to permit cross-border loans denominated in foreign currency, provided that none of the exceptions or reservations permissible under NAFTA come into play.

For unsolicited cross-border transactions, in contrast, NAFTA requires each NAFTA government to permit persons located in its territory to purchase such financial services. Thus, a consumer in a NAFTA country is free under NAFTA to seek out, either electronically or physically, financial services for delivery. As it is extremely difficult for any economy in today’s world to prevent its citizens from going abroad and purchasing financial services on an unsolicited basis, this obligation is of questionable value.

Most-Favored-Nation Treatment

The third general obligation under NAFTA is the most-favored-nation obligation.16 This provision is fairly straightforward, requiring each NAFTA government to provide no less favorable treatment to persons of another NAFTA country than is provided to persons of any other NAFTA or non-NAFTA country. Honoring this obligation will ensure that future treatment exceeding NAFTA standards is always accorded to NAFTA firms. The provision is not, however, intended to prevent NAFTA countries from offering better treatment to non-NAFTA countries, based on regulatory cooperation or recognition arrangements or harmonization. Thus, bank regulators of a NAFTA country can provide better treatment to a non-NAFTA country than another NAFTA country if regulations provide an extra degree of regulatory safety to non-NAFTA firms.

New Financial Services and Data Processing

The fourth general obligation under NAFTA is the new financial services and data processing obligation.17 This obligation seeks to protect certain competitive advantages that Canadian and particularly U.S. financial services providers have as active international players utilizing innovation and central data processing facilities.

The first paragraph of the article describing this obligation18 permits a firm from one NAFTA country to offer through its office in another NAFTA country (the host country) any financial service that is permitted in the NAFTA territory if that service is not already offered in the host country. For example, J.P. Morgan, a U.S. bank, received authorization toward the end of 1994 to begin operating a subsidiary office in Mexico during 1995. Unless one of the exceptions under NAFTA applies, J.P. Morgan, a leader in currency derivatives, would be entitled to invoke the new financial services obligation to allow it to offer U.S. dollar-hedging derivatives in Mexico, even if Mexico did not permit such derivatives to be offered by domestic institutions.

The second paragraph of the article describing the new financial services obligation concerns data processing.19 This provision allows, for example, offices of a NAFTA firm located in a host country to transmit data back to its home country for processing. An important issue to consider under this provision is whether bank secrecy laws would be affected by this obligation. Presumably, a host country would be permitted to require that the data be encoded or protected in another form.

Senior Management and Boards of Directors

The fifth basic rule in the NAFTA financial services provisions is the senior management and board of directors obligation.20 There are two parts to this obligation. First, no NAFTA country can impose more than a simple majority requirement of citizenship for the boards of directors of its financial institutions.21 For example, although the United States can require that a portion of an 11-member board of a Mexican bank established in the United States be U.S. citizens, it may not require more than 6 members to be citizens. Second, the imposition of a nationality requirement for senior management is prohibited.22 A nationality requirement, however, does not include residency.

Supplementary Rules

In addition to the five basic rules, three supplementary rules under NAFTA apply to financial services. These rules, which cannot be subject to reservations, are transparency,23 free transfers,24 and the rule against expropriation.25


The transparency obligation requires the regulators of a NAFTA country to provide “to the extent practicable” advance notice of regulations imposed in the financial sector.26 In addition, each NAFTA government must process a “completed application” within 120 days of receipt.27 This provision’s liberalizing effects may be minimized owing to the flexibility that regulators will have to claim that an application is not completed or that advance notice is not practicable.

Free Transfers

The second supplementary rule is the free investment transfers obligation. This obligation, incorporated by reference into Chapter Fourteen of NAFTA, basically requires a country to permit inbound and outbound transfers of currency in support of financial investment.28 Recapitalization of investment, repatriation of dividends or liquidations, and currency transfers to facilitate any business of a foreign-owned financial institution in the host country would all qualify as investment transfers.

Rule Against Expropriation

The third supplementary rule is the rule against expropriation.29 This rule, similar to the free transfers rule incorporated by reference from the investment chapter of NAFTA, is important because it resolves an important North American jurisprudential debate. Earlier this century, the Mexican Government expropriated the properties of a number of U.S. and other countries’ oil companies. In the expropriation cases and controversies that transpired in connection with these cases under international law, the Mexican Government asserted two particular arguments that, if accepted, would have the effect of minimizing its liability for the expropriations.

The first argument is the so-called Calvo Doctrine, which prohibited a foreign corporation from seeking the assistance of its home government in a dispute over the investor’s rights with the host government. The second argument concerned the valuation of an expropriated investment. The Mexican government argued that the true valuation of expropriated property was the fixed asset value of the property, rather than the going-concern value of the enterprise (including projected revenue streams from a particular investment or from the granting of drilling rights).

NAFTA resolves these two investment debates either directly or indirectly. With respect to the Calvo Doctrine, NAFTA permits an investor to involve a host NAFTA government in an international dispute settlement procedure for violations of either the expropriation or free transfers article.30 Alternatively, a NAFTA government can commence a formal proceeding under NAFTA against a host government accused of expropriation. The valuation debate is resolved by NAFTA because the expropriation article requires that an investment subject to expropriation by a NAFTA government be compensated for by that government, taking into account the going-concern value of the investment.31

Reservations and Exceptions


Reservations under NAFTA are specifically listed derogations by individual countries from any of the five basic obligations of NAFTA.32 Reservations, which, for example, can be lodged for laws that are of particular political importance to a country, must be negotiated on a case-by-case basis. Reservations can be lodged against only the five basic rules of NAFTA—and not against the supplementary rules of Chapter Fourteen.


NAFTA also permits a country to invoke exceptions from its Chapter Fourteen provisions.33 Exceptions (as opposed to reservations) are drafted so that any country can invoke them. Similar to the GATS, there are two important exceptions: an exception for reasonable prudential financial regulation;34 and an exception for the implementation of nondiscriminatory monetary policy.35 The NAFTA exceptions are, however, drafted a bit tighter than the GATS exceptions.

The first prudential exception states that no provision of Chapter Eleven (the general investment chapter), Chapter Twelve (the general cross-border services provision), Chapter Thirteen (governing monopolies), or Chapter Fourteen (on financial services) shall be construed to prevent the application of “reasonable” measures taken for prudential reasons.36 One of the interesting questions presented by the drafting of this exception is how the word “reasonable” should be applied by dispute settlement panels. For instance, a panel might decide whether a measure is “reasonable” by reviewing the possible policies behind the measure and the actual effects of the regulation. A balancing test might be used, as was done in a number of panel rulings regarding exceptions for trade in goods disputes under the General Agreement on Tariffs and Trade, whereby the trade-limiting effects of a measure would be balanced against the interests of trade liberalization. Alternatively, a measure might be judged as to its reasonability according only to the stated purposes of the measure. In any case, the choice of the word “reasonable” will likely be the subject of debate in panel proceedings and have some effect on the overall value of NAFTA as a liberalizing instrument in financial services.

The second major exception under Chapter Fourteen of NAFTA is for nondiscriminatory monetary policy. Nothing in Chapters Eleven through Fourteen shall be construed to prevent a country from applying nondiscriminatory monetary policy and exchange rate measures.37 Here, too, interpretive issues are present. Assume that a country has a strong foreign presence in its market, with most of the foreign banks engaged in profitable trade finance business. Assume further that the country’s central bank restricts trade finance loans by all banks, in possible contravention of the cross-border trade and national treatment provisions of NAFTA. In such a case, it could be argued that the central bank could not rely on the monetary policy exception because of the disparate impact of the measure upon foreign banks.

In addition to the above two exceptions, there are two minor exceptions to Chapter Fourteen. The first exception allows restrictions on free transfers for affiliate transactions that are prudential in nature.38 Although this provision is arguably redundant in view of the broader prudential exception discussed above, the negotiators felt that the risk of a challenge to prudential affiliate transaction restrictions was serious enough to justify explicit mention.

The final exception allows discrimination against foreigners involved in the privatization of government monopolies in social security services.39 This political exception was made because the Canadian Government has a number of monopolies in the social security system that may be privatized; the assets of these monopolies, it was felt by the negotiators, should reasonably be limited to domestic ownership at the initial privatization.

Dispute Settlement

A variety of NAFTA provisions come into play for settling disputes concerning Chapter Fourteen.40 A financial services dispute can be litigated under NAFTA in two basic ways: the state-to-state dispute settlement procedures (governed by Chapters Fourteen and Twenty), and the investor-state dispute settlement procedures (governed by Article 1415 and Chapter Eleven). In this way, NAFTA differs significantly from the GATS because under the latter agreement only the state-to-state procedures are possible.41

State-to-State Dispute Settlement

Under the state-to-state dispute settlement procedures of NAFTA, any of the basic or supplementary rules governing financial services can be litigated between countries. Each dispute will likely be decided by members of a panel selected from two standing groups of experts: a financial services roster and a roster of general experts.42 Rules governing the appropriate mix of general and financial experts essentially ensure that finance experts will be involved in important financial services questions.43 This would be especially important when the prudential carve-out is invoked.

The state-to-state procedure is designed to promote a settlement of the dispute prior to a formal ruling of the panel. Once a NAFTA government feels that its nationals have been wronged under NAFTA, that government (the petitioner) can commence a long series of diplomatic and legal maneuvers to bring the host government (the respondent) to an international panel, which could ultimately issue a ruling against the respondent. The process begins with a consultation by the NAFTA governments over the issue.44 Although not formally required by the text, it is likely that the consultation would be conducted by the Financial Services Committee set up under NAFTA, comprising officials from the finance ministries of all three NAFTA countries.

If these informal consultations do not resolve the issue, a formal consultation phase can be invoked to continue the process.45 This consultation occurs between both financial and trade authorities of the countries involved. If those formal consultations do not result in a satisfactory resolution within a specified time period, a dispute settlement proceeding can be commenced by either party.46 After the panel has been selected, the litigants prepare briefs, and oral arguments are held. After the briefings and oral arguments, the dispute settlement panel issues a preliminary finding to both parties, either of which can then file an additional brief. Further oral arguments may also be held. After this second round of briefs, the dispute settlement panel issues a final ruling. Various minimum time limits are set forth in the NAFTA dispute settlement procedures, but these may be exceeded with agreement of the parties.

The final ruling of a state-to-state dispute settlement panel is not itself legally binding under NAFTA. This ruling may be accepted or ignored by the NAFTA parties as they see fit. If, however, the respondent is found to be in violation of NAFTA and chooses to continue the wrongful actions, the petitioner may retaliate by withdrawing benefits under NAFTA (that is, by derogating from NAFTA in a proportional manner in order to convince the respondent to conform with the agreement).47 This retaliation, however, can occur only within the financial services sector when financial services disputes are involved. In other words, while violations in the financial services sector under the GATS can be remedied by retaliation in other sectors (and vice versa), this option is not possible under NAFTA.

Investor-State Dispute Settlement

The investor-state dispute settlement procedures under Chapter Fourteen are generally available only for violations of the free transfers or expropriation provisions.48 The obvious benefit of this procedure is that an investor need not wait for its government to commence a state-to-state procedure before obtaining redress under NAFTA. Under the investor-state procedure, only monetary damages may be obtained from the offending NAFTA country. In addition, if the respondent country in such an action invokes the prudential carve-out, a state-to-state panel can be convened to decide whether the defense is justified.

Prospects for Future Integration and Liberalization

With the basic rules and functioning of NAFTA in mind, it may be appropriate to make a few points on the nature of the economic integration promoted by NAFTA.

NAFTA is very different from the European Union (EU) agreements on financial services. Under the EU’s directives, partial harmonization results when each country adopts the minimum standards of regulation legislated by the EU. By each country’s adoption of such standards, all countries in the EU can depend upon home country regulation for many aspects of financial regulation, providing in some circumstances a greater range of action for the branches of such institutions in the host country than the competing institutions that have been organized there.

Although NAFTA has no such direct regulatory harmonization, it sets the stage for future integration by enunciating principles throughout Chapter Fourteen that will serve as the basis for future negotiation. For example, in Canada and Mexico, banks, securities firms, and insurance companies can affiliate with each other through holding company or subsidiary structures.49 In the United States, however, the Glass-Steagall Act, the Bank Holding Company Act, and related laws prevent banks from fully affiliating with securities firms and insurance companies.50 Under NAFTA, nothing changes in this area.

Article 1403 of NAFTA, however, sets out the principle that each country must work to eliminate differences in financial structure in order to permit financial services providers to offer the full range of financial services. For future proceedings under NAFTA, including enlargement negotiations and annual meetings of the Financial Services Committee set up to administer Chapter Fourteen, the United States will continue to face pressure to reform its laws so as more fully to integrate banking and other financial services and thus ease the ability of Canadian and Mexican financial institutions to operate in the United States.

U.S. interstate banking restrictions are treated similarly under NAFTA. Here, too, Article 1403 of NAFTA articulates a principle, namely, that each country should permit banks to establish branches throughout their markets. The Mexican and Canadian financial systems permit interstate branches throughout their territories, while the United States traditionally did not permit banks to establish branches across states.51 NAFTA added an extra incentive to the United States to liberalize. Although Mexico and Canada do not now permit foreign banks to expand into their markets across international borders, the two countries have agreed under NAFTA to negotiate the liberalization of foreign bank branching legislation, as the United States has also adopted inter-state branching legislation.52 In this way, NAFTA sets the agenda for future liberalization and integration by tying the reaping of benefits in Mexico and Canada to the implementation of reform in the United States. While integration is thus not directly promoted by NAFTA, it is indirectly promoted through the conditions for future liberalization that are enunciated in the text.

Other provisions in NAFTA similary promote liberalization. Cross-border financial services are to be negotiated again by the NAFTA parties in six years.53 Also, the high capitalization levels for securities firms in Mexico must be addressed by the Mexican Government through a formal report.54 In each case, future discussions between the NAFTA parties are intended to lead to political pressure to liberalize.

NAFTA’s most important move toward liberalization is its program for opening the Mexican financial market, already well under way.55 Before NAFTA, the Mexican economy was essentially closed to meaningful foreign investment in the financial services sector, as a foreign financial services firm was basically limited to a 30 percent portfolio interest in domestic Mexican banks or securities firms. In insurance and in leasing and factoring, the maximum amount of foreign investment permissible was 49 percent.

NAFTA changed this closed situation by allowing NAFTA-incorporated firms with substantial business operations in the United States or Canada to invest in the Mexican financial system through wholly owned subsidiaries, subject to market share limitations. The market share caps are administered by the Mexican Government through a rationing system, under which the Mexican Government will award a certain amount of authorized capital levels to each foreign bank subsidiary and restrict further licenses or growth when these levels have been met.56

The NAFTA transition provisions are important to non-NAFTA governmental authorities because the U.S. Government intends to uphold these provisions as an acceptable way to achieve liberalization. In addition, the presence of U.S. financial firms in the Mexican market will further link the two economies through the increased domestic business that these U.S. institutions will be permitted to conduct. (No Canadian banks initially applied to open a subsidiary, although, as of the date of this publication, several significant Canadian investments in large Mexican financial institutions had been made or announced.)

Balance of Payments Implications

NAFTA sets out a general exception from its obligations when serious balance of payments difficulties threaten or occur in a NAFTA country’s economy.57 The Articles of Agreement of the International Monetary Fund (the IMF Agreement) circumscribe the ability of member countries to “impose restrictions on the making of payments and transfers for current international transactions”58 but, subject to the language of these Articles, generally allow countries to impose restrictions on capital account transactions.59

NAFTA limits, albeit somewhat unevenly, the ability of NAFTA governments to impose restrictions on current and capital account transactions.60 Restrictions imposed on transfers must be consistent with Article VIII, Section 3 of the IMF Agreement.61 In the latter case, if the restrictions are imposed on international capital transactions, they must be consistent with Article VI of the IMF Agreement.62 NAFTA further requires that restrictions imposed when a country is experiencing serious balance of payments difficulties shall avoid unnecessary damage to the economic interests of other NAFTA countries, must not be more burdensome than necessary, must be phased out as the situation improves, and must be applied on a national treatment or most-favored-nation treatment basis, whichever is better.63 In addition, such restrictions, if on the current account, must be submitted to the IMF for review.64 Restrictions must be consistent with the IMF Agreement65 and lead to consultations with the IMF and the implementation of economic policies consistent therewith.66 In the case of restrictions on transfers other than cross-border trade in financial services, such restrictions may not take the form of tariff surcharges or quotas.67

Lessons for Central Banks

There are several important lessons that central banks (particularly those in emerging markets) can draw from Chapter Fourteen of NAFTA. The first and most important lesson is that of policy emphasis: the U.S. Government has placed financial services on the trade policy agenda and may be expected to expend resources and political capital to open markets in the sector. The complexity and sweeping scope of Chapter Fourteen provides the framework for action. Central banks should participate in financial services negotiations, such as the negotiations already under way under the GATS, the negotiations involving Asian countries under the auspices of the Asia-Pacific Economic Cooperation (APEC) forum,68 and the negotiations in Latin America connected with the expansion of the Mercado Común del Sur69 and NAFTA. If central banks ignore these important trends, they will put trade ministries and finance ministries “in the driver’s seat” for financial services negotiations, possibly to the detriment of good policy or regulation.

The second lesson is that NAFTA and the GATS are similar. Central banks should follow developments of these two separate bodies of law with interest to ascertain the degree of scrutiny with which regulations governing international financial services will be reviewed. A country that is not a party to NAFTA may nevertheless be affected by NAFTA actions if the GATS jurisprudence uses NAFTA for precedent.

The third lesson is that financial services negotiation can at times be used to overcome domestic constituencies opposed to financial reform. For example, the Mexican banking system has for many years been highly concentrated, with the three largest banks controlling approximately 70 percent of the banking assets. One of the ways to promote competition in the banking sector is to authorize nonbank financial intermediaries to borrow money on the capital markets and make loans with these funds. Such authority did not exist in Mexico during the time of the NAFTA negotiations. The United States urged Mexico to create such a license as a step taken under the agreement. The Mexican Government agreed, thereby achieving a measure of liberalization that might not have occurred absent foreign negotiating interest. Other countries might consider this example when confronting structural problems in their economies while conducting financial services negotiations.

Above all, it is important to recognize that there is no great mystery to financial services in general, or the NAFTA financial services provisions in particular. While the language may appear complex and the trading interests promoted under the agreement may at times appear to take precedence over regulatory interests, in reality countries are unlikely to commence dispute settlement proceedings except to contest the most suspect regulatory measures. Nevertheless, central bankers should study NAFTA as an important new source of law governing financial services regulation.



Changed Circumstances

The most important NAFTA-related development concerns the unfortunate events that have befallen Mexico in recent months. In early 1995, the Mexican banking and monetary systems were in the midst of a severe liquidity and confidence crisis. Had it not been for the rescue package arranged by the U.S. Department of the Treasury, the International Monetary Fund, the World Bank, and a number of other public and private sector lenders, a large portion of Mexico’s mature dollar debt would have gone unpaid.

Following a drastic devaluation of the peso, large amounts of short-term dollar investment fled Mexico for other markets. Some of Mexico’s largest banks were taken over by Mexico’s banking authorities. The lack of confidence in public sector and banking debt caused the rates of interest on that debt to exceed 50 percent. While inflation was estimated at approximately 30 percent a year, some merchants and consumers had to pay rates in excess of 100 percent a year for their loans. As a consequence, commercial and consumer default and insolvency threatened.

Meanwhile, the loan loss reserves required by Mexico’s National Banking Commission (monies segregated from bank capital and returned earnings, and placed in a special account to cover the eventuality of losses) were increased. This reserve requirement places considerable pressure on the banks’ ability to meet both liquidity and capital adequacy requirements: as banks struggle to satisfy their reserve requirements by reducing their net capital, compliance with capital adequacy requirements becomes difficult. In addition, Mexican authorities have begun implementing a program of monetary austerity, which has restricted the supply of lending capital to Mexico’s banks, merchants, and consumers.

The severe scarcity of dollars that preceded the austerity measures had already pressured Mexican banking regulators to relax Mexico’s exceptions to NAFTA’s national treatment principle.1 These exceptions were intended to usher in competitive foreign financial services gradually over two decades. The sharp devaluation of the peso, the ensuing massive flight of dollars, and the policy of monetary austerity accentuated Mexico’s need for foreign lending capital. Accordingly, almost from the time that it was put into effect, the 30 percent limitation of foreign stock ownership of financial institutions imposed by NAFTA2 was bypassed by an authorization enabling foreign financial institutions to set up wholly owned subsidiary holding companies.3 Similarly, Mexico’s authorities may be considering the elimination of NAFTA limits on the total market share serviced by foreign banks. If this market share limitation were eliminated, some Mexican banks might easily be acquired or taken over by foreign banks as a result of the present low value of their stock. These acquisitions or takeovers, however, would be strongly opposed by Mexican controlling stockholders, who fear losing not only their control but also most of their investment. The opening of Mexico’s financial markets to foreign competition, therefore, is far from being as uneventful, gradual, or evolutionary a process as contemplated by NAFTA.

A Time for Realistic Evaluation

Arguably, this crisis merely precipitated the inevitable. When the Mexican bank nationalization decree was set aside, the newly privatized banks were not acquired in open and public bidding. Also, the high prices paid for the privatized banks did not reflect the true value of their assets. In exchange for being selected as buyers by Mexico’s authorities, the buyers paid higher prices than those that could have been obtained in an open market. In addition, they paid either cash or its equivalent. Consequently, the privatized banks started operations with insufficient working capital and with fewer dollars than were needed to repay the continuously mounting dollar debt or to collateralize loans that needed to be supported by dollar-denominated assets. Despite the sharp surge of short-term dollar investments in Mexico during the term of the previous Administration, the dollar debt of the privatized banks did not improve. Consequently, even if the present devaluation had not taken place, Mexican banks would not have been in a position to compete with their NAFTA rivals in financing the acquisition of dollar-denominated raw materials, inventory, equipment, or services.

There is a degree of unreality concerning the financing of cross-border trade obligations in NAFTA’s rules on “solicited” and “unsolicited” cross-border trade obligations. While in practice it is difficult to distinguish between unsolicited and solicited transactions, solicited transactions are subject under NAFTA restrictions to a “standstill” commitment: no further liberalization of solicited transactions need occur under NAFTA, but no NAFTA government may become more restrictive than it was when NAFTA entered into force. Considering Mexico’s dependency on dollars to finance its industrial, commercial, and tourist endeavors and the scarcity of dollars in its banking system, the NAFTA exceptions and reservations restricting the flow of institutional dollar loans4 seem to amount to a protectionist luxury that the nation can ill afford.

The inescapable reality is that for NAFTA to succeed the liberalization of both solicited and unsolicited cross-border transactions must occur. Otherwise, the absence or the high cost of credit with which to acquire raw materials, equipment, inventory, and services will continue to drive small- and medium-sized Mexican businesses into bankruptcy. The survival of much of this vital segment of Mexico’s economy is at stake. Similarly, the inability of Canadian and U.S. industrial investors to finance their investments in Mexico by carrying with them their home country lines of credit may continue to prevent significant investments from being made in Mexico. The modernization of Mexico’s Secured Transactions Law and its harmonization with Canadian and U.S. law and practice are absolutely necessary for the health, safety, and soundness of the country’s banking industry and investment picture.

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