This Selected Issues paper assesses the potential financial vulnerabilities of the corporate sector in Mexico. It provides an overview of salient features of the Mexican corporate sector. The paper also presents the formal stress tests that estimate the potential effects of some macroeconomic and financial shocks, such as a sharp depreciation of the exchange rate, a sustained increase in interest rates, a slowdown in demand, and a prolonged international market closure on the corporate sector.

Abstract

This Selected Issues paper assesses the potential financial vulnerabilities of the corporate sector in Mexico. It provides an overview of salient features of the Mexican corporate sector. The paper also presents the formal stress tests that estimate the potential effects of some macroeconomic and financial shocks, such as a sharp depreciation of the exchange rate, a sustained increase in interest rates, a slowdown in demand, and a prolonged international market closure on the corporate sector.

II. Private Sector Financing in Mexico1

A. Introduction

1. Despite the banking sector’s substantial consolidation and strengthening of the last seven years,2,3 bank credit to the private sector has declined consistently in real terms since the Tequila crisis. On one hand, this resulted from banks’ efforts to strengthen their balance sheets and gradually eliminate the burden of nonperforming and restructured loans. On the other hand, demand for credit has also declined as enterprises restructured and strengthened their own balance sheets to reduce leverage. In addition, the weak functioning of the judicial system has limited creditors’ ability to collect even on collateralized loans, which further discouraged credit provision. Notwithstanding the dearth of bank lending, the economy was able to grow at a rapid pace between 1997 and 2000, with the private sector relying on alternative sources of financing (namely suppliers’ credits, foreign funds, and nonbank lending, as well as on internally generated funds such as retained earnings).

2. This paper reviews recent developments in credit to the private sector and the increasing role of institutional investors. It assesses whether prospects for private sector financing are likely to differ from the recent historical pattern and concludes that conditions are now favorable for a resumption of bank credit, as well as for the development of domestic capital markets. The recent sizable issuance of corporate bonds indicates that going forward the domestic debt market is likely to play a significant role. However, some areas are identified where further progress would be desirable to increase the funds available for private sector development.

3. The rest of the paper is organized as follows. Section B reviews the evolution of credit to the private sector in the last seven years and describes the main providers of credit. Section C examines firms’ financing sources. Section D reviews credit to households. Section E looks at recent regulatory changes that could affect private sector credit and Section F concludes by assessing prospects for a resumption of credit to the private sector.

B. Evolution of Credit to the Private Sector in Mexico

4. Overall credit to the private sector declined from 62 percent of GDP in 1994 to 31 percent at end–2001 (Table 1). Until the Tequila crisis, banks had been the main source of credit to the private sector in Mexico. Since then, bank credit has declined considerably in real terms, while nonbank and foreign financing have kept pace with real GDP growth and have increased significantly their share in private credit (Figure 1). Nonbank institutions have had strong growth in the last few years and are becoming important providers of credit to the private sector, at the same time fostering the development of domestic capital markets. The nonbank providers of credit are: non–deposit taking financial intermediaries with a limited objective (SOFOLES); mutual funds; pension funds (SIEFORES); insurance companies; credit unions; and other institutions, such as leasing and factoring firms, savings and loans cooperatives, brokerage houses and development trust funds.

Table 1.

Mexico: Evolution of Credit to the Private Sector 1994–2002

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Sources: Bank of Mexico; National Institute of Statistics and Geography (INEGI); and Fund staff calculations.

Includes credit to enterprises and to individuals with commercial activity

Includes investment in private sector securities and loans.

Includes leasing companies, factoring, savings and loans, development funds, stock brokers, reinsurance companies and “almacenes de deposito.”

Mutual funds were created in 1950 but its role in prividing credit to the private sector had been negligible until recently. Information before 2000 is not available in the same format.

Figure 1.
Figure 1.

Mexico: Composition of Credit to the Private Sector

Citation: IMF Staff Country Reports 2002, 238; 10.5089/9781451825619.002.A002

5. Bank credit fell from 45 to 14 percent of GDP between 1994 and 2001 and bank commercial loans from 35 to 9.6 percent of GDP (see Table 1). The sharp decline in bank credit was largely associated with banks’ need to strengthen their balance sheets and absorb the losses associated with debt restructuring, as well as a decline in the demand for credit from the private sector. In addition, the large demand for resources from the public sector and the perception of a dearth of creditworthy private clients has made it easier and more cost effective for banks to concentrate on a few clients (the government and large corporations) than to take on additional credit risk via broad–based lending.4 This trend was accentuated to some extent by the recent consolidation of the banking system (via mergers and purchases of domestic banks by foreign banks) which gave way to a further slowdown in credit growth while the banks adjust to their new corporate structure.5 However, with increasing competition, and lower, more stable interest rates, banks are increasingly pressured to resume broad–based lending.

6. Except for a brief period in 1998 and the slow recovery in 2000–01, nonrestructured loans to the private sector (which better reflect credit trends) have also declined since the crisis, but the magnitudes of the decline are smaller (Figure 2).6 The recovery observed in 2000–01 was largely due to commercial loans and the strong growth of consumer credit. In fact, consumer credit has registered strong growth since 1998 (over 12 percent on average in real terms), but it represents only a small share of total credit. In June 2002, commercial loans were down 6.9 percent in real terms from a year earlier. The recovery in credit in 1998 was accompanied by rapid economic growth, but this growth was halted after the Russia crisis in August of that year. Consumer credit recovered quickly after that, while the other forms of credit only rebounded in 2000 as economic activity gained momentum. Interestingly, the two sectors of the economy that have led growth in recent years have been those with access to credit—the export sector and, more recently, private consumption.

Figure 2.
Figure 2.

Mexico: Bank Credit to the Private Sector–Nonrestructured Loans

(Real growth rates)

Citation: IMF Staff Country Reports 2002, 238; 10.5089/9781451825619.002.A002

7. Nonbank credit to the private sector, on the other hand, registered strong growth since 1997. Although pension funds, mutual funds, investment houses (Sociedades Financieras de Objeto Limitado or SOFOLES7), and insurance companies accounted for only 12 percent of total credit to the private sector at end–2001, these institutional investors are rapidly acquiring a prominent role in financing the corporate sector. During the last seven quarters to June 2002, the performing loan portfolio of the SOFOLES registered annual growth rates of over 25 percent in real terms. The total loan portfolio of SOFOLES amounted to 10 percent of the total loan portfolio of banks.

8. Funds under management of local institutional investors have grown very briskly in the last few years: pension funds grew 52 percent in 2001 alone, and mutual funds rose even more (Table 2). The combined stock of funds of domestic institutional investors amounted to US$74 billion at the end of 2001.8 Furthermore, some Mex$40 billion (0.66 percent of GDP) enter the pension funds each year as new contributions, which in addition to a return on their total portfolio of about Mex$20 billion (0.3 percent of GDP), provides a total annual increase of Mex$60 billion (1 percent of GDP). The growth of mutual funds was spurred by the decline in interest rates, as investors searched for more lucrative opportunities and banks encouraged their clients to shift their funds from bank deposits to their own mutual funds.

Table 2.

Mexico: Domestic Institutional Investors 2000–01 Total Assets and Composition of Investment Portfolio

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Sources: CNBV, CONSAR, CNSF, and staff calculations.

9. The growing importance of domestic institutional investors increases the potential investor base of long maturity paper, providing a source of long–term funds for enterprises, thus far unavailable in Mexico. Typically, mutual funds invest in medium–term securities, while insurance companies and pension funds demand long–term bonds: these results from the maturity structure of their liabilities. The increasing role of institutional investors should help foster the development of the domestic financial markets, improve the transparency of these markets, and encourage better corporate governance of the issuers.9

10. With the decline in interest rates since 2001 and the emergence of a market for long–term instruments, conditions are favorable for a recovery in credit growth. The decline in interest rates has also led to a decline in the interest margin of banks which should gradually spur banks to seek higher returns by increasing credit to the private sector. The decline in rates has also increased the demand for credit from corporations. The combination of these factors plus the continued efforts by the authorities to improve the legal framework are likely to facilitate the recovery of credit growth once the economy recovers.

Domestic Capital Markets

  • The local corporate bond market has developed rapidly in the last year, owing to the sharp decline in domestic interest rates, the growing appetite of domestic institutional investors for corporate paper, and the success of a new instrument, called certiflcados bursatiles. The stock of corporate bonds has increased by about 40 percent from December 2000 to May 2002 even though it is still very small at about 2½ percent of GDP.

uA02bx1fig1

Corporate Bond Markets

Citation: IMF Staff Country Reports 2002, 238; 10.5089/9781451825619.002.A002

  • The stock of certificados bursatiles, which were introduced with the approval of the new capital markets law in 2001 and were first issued in August of 2001, has risen quickly to reach Mex$33 billion, equivalent to US$3.6 billion, at end May 2002. The characteristics of these issues have varied: tenor has been between 3 and 10 years, some two thirds were issued at variable rates (with either the rate on THE or CETES as the reference rate), but even some of the 10–year bonds were at fixed rates, a novelty for the Mexican market.

  • Only 15 entities accounted for this issuance, and 3 of them accounted for 63 percent of the total issuance. The main issuers in this market have been blue chip companies, which are AAA–rated on the local scale. The advantages of this new instrument are: the flexibility of design of the instrument by allowing the establishment of an issuance program (the corporation obtains approval for the total amount to be issued in bonds in the program but can choose to make the issues in different tranches to take advantage of market opportunities); the ease of issuance as there is no need to have permission from the shareholders’ assembly once the program is approved; and lower costs of issuance.

  • So far, there is no secondary market for these corporate bonds, as they are mainly in the hands of buy–and–hold domestic institutional investors and they cannot be repoed. However, the banks that issue them are guaranteeing some liquidity.

  • The local equity market, la Bolsa Mexicana de Valores (BMV), has not been an important source of financing in recent years, mainly because since the Russian crisis emerging market equities has been a shrinking asset class and domestic institutional investors do not yet play an important role on the BMV. The BMV had a capitalization of US$129 million dollars at the end of May, equivalent to 20 percent of GDP: this is very low not only compared to advanced economies, but also to other emerging market countries. In addition, the free float is much smaller than the market capitalization, as most companies continue to have a control shareholder. Foreigners play a very important role, as they hold almost half of market capitalization and account for over two thirds of the free float and trading. Even though the MSCI, the benchmark index for most foreign equity investors, has recently undergone a rebalancing that hurt Mexico, the lack of good opportunities in the rest of the region has meant that they have not reduced exposure to Mexico and maintain a relatively large overweight. The rest is held by domestic institutional investors, mainly mutual funds and private pension funds.

Retail investors appear to play a negligible role in this market, although the recent introduction of an exchange traded fund that tracks the IPC, the main stock exchange index, is likely to encourage retail investor participation in this market, together with the sizable decline in interest rates. The anticipated participation of SIEFORES in the near future will likely stimulate more activity in the equity market. These changes, together with important changes in corporate governance (see Chapter 1), and improvements in technology and costs in the BMV have created a more favorable environment for equity issuance. However, neither the authorities nor private market participants expect a very rapid increase in equity issuance in the near term.

11. Only a restricted group of Mexican companies have access to international capital markets. Since 1995, over 40 Mexican companies have issued bonds in international markets, and less than 10 since the Russian crisis, as the risk appetite for these issues has diminished greatly. While a handful of companies (less than 10) enjoy an investment grade rating that allows them to appeal to a broader investor base—including high–grade investors—the rest have a credit rating below investment grade and hence their market access remains linked to emerging markets’ performance.

12. Financing of firms through the equity markets also suffered as a consequence of the 1994–95 crisis. The lack of an adequate regulatory framework to inspire confidence in the aftermath of the crisis, as well as the dismal performance of equity markets in emerging economies, depressed the demand for traded equities and their valuations, and consequently inhibited the supply of new stocks. Between 1994 and 2001, market capitalization in the Mexican Stock Exchange (BMV) declined from 45 percent of GDP to 20 percent. The number of companies registered in the BMV is very small (less than 200) and ownership of these firms is highly concentrated. The latter implies that liquidity in the equity market is low, as only a small fraction of the stocks are traded: this is so also because most of the largest Mexican companies’ stocks trade in New York.

C. Private Firms’ Financing Sources

13. The Bank of Mexico (BOM) carries out a quarterly survey on firms’ financing sources that provides information on the financing of a broad set of companies, about 600 of them. Although this survey covers only financing sources external to the firm, staff estimates suggest that internal financing sources—that is reinvested earnings—cover a sizable part of firms’ financing needs. For example, for publicly traded companies, accumulated profits and reserves account for over 60 percent of capital and about 30 percent of capital and total liabilities.10 These percentages are likely to be higher for the universe of companies, given that the smaller the company, the less the access to financing sources external to the firm. The high share of internal financing in total firms’ financing can help explain why the Mexican economy has been able to have a good growth performance in the second half of the 1990s, despite declining credit to the private sector.

14. The most important source of firms’ financing is suppliers’ credits. For over 50 percent of the firms, suppliers’ credit is the main source of external financing and this share has been steadily increasing over time (see Table 3).11 For 20 percent of the firms, credit from commercial domestic banks is the main source of fund and its share has been on a declining trend since the inception of the survey in 1998. The reasons provided in the survey for not using bank financing are high interest rates, reluctance of banks to provide credit, and an uncertain economic environment (Table 4).

Table 3.

Mexico: Firms’ Financing Sources 1/

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Source: Bank of Mexico.

The annual data are averages of quarterly data.

The data for 2002 refer to the first quarter.

Table 4.

Mexico: Firms’ Reasons for Not Using Bank Credit1/

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Source: Bank of Mexico.

The annual data are averages of quarterly data.

The data for 2002 refer to the first quarter.

15. The third source of financing comes from enterprises of the same group mentioned by about 12 percent of the firms. Other sources identified separately are foreign banks with about 5 percent of the firms, development banks with about 2–3 percent, and parent companies with a share of about 3 percent. Bond issuance does not appear separately in the BOM survey but is included in the category “other,” suggesting that this source of funding has been only marginal, so far. Further, outside equity does not enter the survey at all, but as noted above has been a negligible financing source in recent years.

16. The financing structure differs considerably according to the size of the firm (Table 5). The shares of domestic and foreign bank financing, as well as “other liabilities” increase with the size of the firm, at the expense of suppliers’ credit which declines with the size of the firm. However, only AAA firms (with 1997 sales larger than Mex$5,000 million) have a share of domestic bank financing that is significantly above that of other firms (averaging about a third of total). For these firms, domestic bank credit represents the largest source of financing, while for all other categories suppliers’ credit remains the main one. Another peculiarity of AAA firms is that the share of “other liabilities” has been increasing rapidly, reaching 10 percent in the first quarter of 2002, while the average for all enterprises is below 2 percent. The latter is mainly due to the rapid development of the corporate bond market in the last nine months (see Box 1)12. Finally, foreign banks finance mainly large and AAA firms. The high concentration in the Mexican banking system and the high level of foreign ownership could exacerbate the tendency to provide credit mostly to large firms, as studies show that these characteristics of the banking system are associated with more credit to large firms and less to small firms.13

Table 5.

Mexico: Firms’ Financing Sources by Firm Size 1/2/

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Source: Bank of Mexico.

The annual data are averages of quarterly data.

Small firms are those with 1997 sales of up of Mex$100 million; medium firms had sales of Mex$101–500 million; large firms had sales of between Mex$501–5000 million; and AAA firms had sales above Mex$500 million.

The data for 2002 refer to the first quarter.

17. Some differences exist in the financing pattern of firms based on whether they are exporters or not (Table 6). Exporters typically use less suppliers’ credits and more foreign bank financing. Also, they tend to have more funding from their parent company, but less from other firms of the same group.

Table 6.

Mexico: Firms’ Financing Sources by Firm Type 1/

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Source: Bank of Mexico

The annual data are averages of quarterly data.

The data for 2002 refer to the first quarter.

18. Not only is domestic bank financing small in Mexico, but also it is mainly short–term and hence is being used mostly as working capital (over 60 percent), while only less than 17 percent was used to finance investment in the last three years (Table 7). As suppliers’ credit is of very short–term maturity,14 it appears that firms have to rely on foreign or development banks’ financing or on funds from the group or internal financing sources to finance investment expenditure, which requires long–term credit.

Table 7.

Mexico: Firms’ Uses of Bank Credit 1/

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Source: Bank of Mexico.

The annual data are averages of quarterly data.

The data for 2002 refer to the first quarter.

D. Credit to Households

19. Direct credit to households is very limited. The stock of bank loans for housing declined from 7 percent of GDP in 1994 to 3 percent of GDP in 2001 and consumer lending, despite its solid growth in the last few years, was less than 2 percent of GDP at end–2001, only half its 1994 level in terms of GDP (Table 8).15 In recent years, SOFOLES have filled part of the void left by commercial banks and have become a fast growing source of lending to households. SOFOLES’ assets (1.5 percent of GDP) are accounted for almost entirely (94 percent) by loans for housing and automobile purchases. Consumer loans from banks are mostly in the form of credit cards.16

Table 8.

Mexico: Credit to Households, 2001

(In percent of GDP)

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Source: Bank of Mexico

20. The authorities have been promoting a restructuring of the credit market for housing which should result in a resumption of credit growth in this segment of the market in the near future. The strategy seeks to refocus the government’s participation in the sector shifting from providing credit to the provision of loan guarantees through the newly created Sociedad Hipotecaria Federal (SHF) and by strengthening the credit programs of FOVISSSTE and INFONAVIT, particularly for low income households.17 In addition, the SHF is in charge of promoting the development of the market for mortgage-backed securities.

E. Recent Regulatory Reforms

21. The authorities believe that in order to support broad–based economic growth, credit to the private sector needs to recover and that access of small- and medium–sized enterprises to credit market’s needs to improve. For this purpose, they adopted a strategy to promote the resumption of credit growth whose objectives are to: promote domestic savings; strengthen the legal framework; foster the financial consolidation of the financial sector; deepen the development of domestic capital markets; and restructure the development banks.

22. The main reforms approved since January 2000 include:

  • approval of the People’s Savings and Credit Law (Ley de Ahorroy Crédito Popular) and the creation of the National Savings and Financial Services Bank (BANSEFI), which contribute to the development of the financial sector for low–income people in a secure and transparent environment;

  • approval of the Securities Markets Law in 2001 which includes changes to the legal framework for securities markets to improve transparency and corporate governance of traded companies and of stock brokers, enhance minority shareholders’ rights, regulate conditions under which public offerings are mandatory, and the creation of the certificados bursatiles as an instrument to help develop the long–term debt market (see Chapter 1);

  • approval of the new Investment Fund Law, which introduces a new approach to the regulation of such funds by establishing new rules regarding corporate governance of these institutions and widening the asset classes in which they can invest;

  • creation of a Federal Housing Institution (Sociedad Hipotecaria Federal), which will provide credit and loan guarantees to promote the resumption of housing lending and the development of a market for mortgage–backed securities;

  • overhaul of development banks which improves accountability and corporate governance, including through the regular publication of their financial statements and supervision by the Comisión National Bancaria y de Valores (CNBV), ensuring the preservation of their capital, improving their credit culture and strengthening their ability to provide technical assistance to their clients;

  • reforms of the Credit Institutions Law, which incorporates best corporate international practices that provide, inter alia, for better transparency, corporate governance, and the inclusion of independent board members and an auditing committee. Introduction of a legal framework that facilitates banks to provide products and services with broader scope and enforces controls on credits to related parties. Strengthening of supervision coupled with a reduction of its costs by introducing prompt corrective actions to provide better protection to bank depositors and delegating a greater supervisory responsibility to external auditors;

  • strengthening of bank regulation and supervision by enhancing the mandate of the CNBV improves corporate governance of commercial banks, promotes competition, and brings capital requirements closer to international standards. New rules on classification of the loan portfolio, overall risk management, and internal controls have been implemented;

  • reforms to the Pension System Law, approved by the House but not yet by the Senate which would allow workers not affiliated to the Mexican Institute of Social Security to have an account in a public pension fund (AFORE): this will result in increased retirement savings. The reform includes the widening of the assets in which pension funds can invest (see below);

  • amendments to banks’ capitalization requirements, which are in accordance with international standards with the aim of reactivating credit for housing;

  • approval of a law that regulates the operation of credit information institutions, strengthening the rights of individuals to access and correct their credit information;

  • approval of a new bankruptcy law (Ley de Concursos Mercantiles) which provides incentives for voluntary arrangements between creditors and debtors seeking to preserve the value of the company and to expedite the resolution of the problems that led the company to face payments problems;

  • other reforms to promote the development of institutional investors in an environment of higher accountability and transparency, and an improvement of the regulation of insurance companies, credit unions, and foreign exchange houses.

23. As mentioned above, recent changes to the investment requirements for pension funds and the decline in interest rates has led them to invest more in private securities. In fact, these changes were aimed at widening the choice of assets in which pension funds can invest. While before a maximum of 35 percent of the pension funds’ portfolio could be invested in securities issued by private entities, this limit has been eliminated. Instead, the present limits are set in terms of credit rating of the issuer, rather than whether the issuer is private or public. Now, pension funds can invest up to 100 percent of their portfolio in AAA–rated securities (on the local scale), up to 35 percent in AA–rated, and up to 5 percent in A–rated ones. However, concentration limits have been tightened. While before there was a 10 percent limit on any single issuer, now the limits are 5 percent of the portfolio for a single AAA–rated issuer, 3 percent for a AA–rated, and 1 percent for a A–rated issuer.18

24. Although restrictions on pension funds’ investments have been eased, they remain constrained to invest in securities issued only by Mexican entities, have at least 51 percent of their portfolio in securities with inflation protection, and cannot invest in equities.19 These restrictions have made pension funds captive investors in the local fixed income market. However, to ease these restrictions, mitigate the country risk, and allow pension funds to obtain a satisfactory return on their investments, further changes are afoot. Some amendments to the law on pension funds have been submitted to congress and have already been approved by the lower house. One of the main changes of these amendments is to allow pension funds to invest in securities issued by non–residents.20 If approved, these changes will likely lead to some funds being invested in foreign securities issued, but it is likely that pension funds will continue to have a home bias even after they are allowed to diversify their investments abroad. Consequently, they should increasingly play an important role in the financing of the private corporate sector. Furthermore, Comisión Nacional del Sistema de Ahorro para el Retiro (CONSAR), the regulatory body of pension funds which has the authority to decide on the instruments in which pension funds can invest, could also allow pension funds to invest in equities in the future.21

25. Finally, the government submitted to congress a reform proposal that would expedite creditors’ ability to recover the guarantees used as collateral in loan contracts. The proposal would allow the use of commercial trust funds to provide a loan guaranteed by the collateral provided by the debtor. If the client defaults on its obligations, the bank would be able to liquidate the trust fund and take possession of the guarantees without the need for a judicial order or the signature of the debtor. At present, the relatively weak functioning of the judicial system makes the process of recovering the collateral a long and expensive one. In addition, recourse to the legal system has given debtors the possibility of using dilatory practices which prevent creditors from foreclosing on debtors’ assets. This not only increases the risks to banks and consequently the lending rates, but it has also added to the disincentives to lend to the private sector altogether, especially to the lesser known clients (small– and medium–sized companies). The government anticipates that this legislative proposal would provide an added boost to the resumption of credit by providing commercial banks with greater legal certainty about their ability to collect the guarantees.22

F. Prospects for Credit Growth

26. The authorities’ efforts to improve the legal framework of the financial system are likely to pay off in the near future by facilitating a resumption of credit growth. The consolidation of the banking system, the relatively high levels of capital and loan provisioning, plus a satisfactory level of liquidity, will likely permit a recovery in credit growth as the economy rebounds. In addition, the recent decline in interest spreads, as well as the competition from the bond market, will begin to affect banks’ profitability and thus will force them to look for alternative sources of income, making them more willing to take on more credit risk in order to improve the bottom line. However, large corporations are still likely to be the big winners of this resumption of credit, at least in the initial stage, as they are the ones who have been able to maintain relations with banks.

27. However, at a later stage, it is likely that the top–rated companies will increase their borrowing abroad—since they are better placed to access international capital markets—and this will open up the domestic capital markets to lower–rated firms. Nevertheless, the credit rating limits which domestic institutional investors are subject to, as well as the desire of issuers and intermediaries to retain this as a high grade market in order to avoid the bad experiences of the early 1990s, will likely limit the credit quality of the issuers in the bond market. In line with the global tendency of banks to become service providers more than direct providers of credit, Mexican banks are likely to continue to encourage their customers to access the bond market directly, and hence it is likely that domestic capital markets may become as important as direct bank credit in the medium term.

28. Banks will likely resume direct lending by increasing credit to the best rated companies first, slowly moving down the credit curve. In a medium–term equilibrium, the largest corporates will continue to have access both to international as well as domestic credit markets while somewhat smaller companies, but still A–rated, will mostly borrow from domestic capital markets. Lower–rated companies or non–rated smaller companies are expected to borrow directly from domestic banks. Nonetheless, in the near future, development banks are likely to play an important role in providing credit access to small–and medium–size corporations.

29. Even though it is likely that equity issuance will resume over the medium term, neither the government nor private market participants expect a very rapid increase in issuance in the near future. The global tendency towards the concentration in a few very large equity markets will probably mean that the largest companies will be quoted in New York, while the BMV will become mainly a market for medium and small firms.

30. Despite the positive outlook for a resumption in credit growth and in general more sources of financing for private firms, there are some policy actions that the authorities could take to further this process. In particular, fiscal consolidation should continue apace to reduce the public sector’s absorption of domestic savings and release resources for private investment. The net borrowing requirements of the public sector have been equivalent on average, to 60 percent of domestic financial savings over the last seven years. Since demand for credit from the private sector was depressed during this period, the large absorption of loanable funds by the public sector was possible in an environment of declining interest rates. Nonetheless, moving forward, in order to allow broad–based credit growth without exerting excessive pressures on interest rates, the public sector will need to reduce its demand for domestic savings as the economy recovers.

31. Another area where progress is needed is the development of the credit infrastructure. Both banks and clients are not used to operating in the credit market and will need to be trained. Banks will need to strengthen their credit risk assessment capabilities, as they have done very little lending to clients other than the government and large corporations in recent years. A similar argument needs to be made for domestic institutional investors which need to increase their ability to analyze credit risk and not rely merely on credit ratings or on the safety of government securities. A credit culture on the part of enterprises also needs to be fostered—especially among smaller firms and microenterprises.

1

Prepared by Juan Pablo Cordoba (WHD) and Laura Papi (ICM).

2

Following the banking crisis of 1994-95, the government implemented various bank restructuring and debtor support programs that helped reestablish the solvency of the banking system and avoided losses to depositors. The Mexican banking system is currently considered to be well-capitalized and profitability has resumed.

3

The FSAP for Mexico found that the banking system does not pose systemic risks and currently all banks except one comply with the 2003 risk-weighted capital requirements.

4

Restructured loans absorb fresh bank funds because in some of these programs the government issued zero-coupon bonds which accrue income to the banks but do not provide liquid funds and, in other programs, banks have to write-off a portion of the asset on an annual basis as part of the loss-sharing agreements with the government.

5

It has also been reported that when two banks merge the lines of credit to borrowers by the new institution are not necessarily equivalent to the individual lines that each bank had with that borrower which may result in a credit squeeze.

6

Nonrestructured bank loans to the private sector are a better indicator of banking sector credit activity because it excludes all credits associated to restructuring programs. The latter include restructurings via UDIs trust funds (trust funds in which debts were restructured and redenominated in inflation indexed instruments), discounts on payments absorbed by both the government and banks, or exchanged for bonds issued by the bank deposit insurance agency (Institute para la Protection al Ahorro Bancario, IPAB) or its predecessor, FOBAPROA.

7

SOFOLES are nondeposit taking financial instutions that fund themselves via loans provided by commercial banks, the Federal Housing Institution (Sociedad Hipotecaria Federal, SHF) and commercial paper placements.

8

In addition, some private companies have their own pension funds: however, data on these are not available.

9

The development of a market for long-term fixed-rate securities has been promoted by the federal government: the government now issues fixed-rate securities on a regular basis (3-and 5-year bonds since 2000, 10-year bonds since 2001 and a 7-year bonds that was introduced in 2002). Institutional investor participation in this market has been strong and the existing government benchmark issues have facilitated the recent emergence of corporate issuers.

10

Although these figures refer to stocks, they can provide an indication of the importance of reinvested earnings in overall firms’ financing.

11

It should be noted that the BOM survey reports the percentage of firms who use a specific source of credit but the answers are not weighted by the amount of the credit provided. Therefore, the results should not be understood as indicating that a given source of credit is more important on the basis of the amount of the financing provided to the firms but only in terms of the number firms that have access to that form of credit.

12

However, this rapid increase in “other” financing needs to be interpreted with caution because the sample of AAA companies is very small (under 30 companies). Large swings in this category can be due to just one or two additional firms issuing in the local bond market.

13

Publicly available information provides the composition of credit to the private sector by sectors of economic activity but not by size of companies. The BOM is currently working with the CNBV and the banks to improve the survey of credit data provided by banks.

14

The BOM survey contains also data on firms that provide financing to other enterprises. Over three quarters of firms report that they provide some form of credit to other firms. The share of credit to their clients amount to almost 80 percent, and to their suppliers and enterprises of the same group about 10 percent each.

15

Consumer credit here excludes credit to households provided by non-financial institutions such as wholesale stores which at end-2001 was equivalent to 1.2 percent of GDP. This source of financing has grown nine-fold in real terms since 1994.

16

In addition to SOFOLES and bank loans, there are consumer loans granted directly by commercial establishments and retail stares. The total amount of registered consumer loans though these providers of credit was about 0.3 percent of GDP at end-2001.

17

FOVISSSTE and INFONAVIT are specialized public agencies which administer an earmarked contribution from public and private sector workers, and whose purpose is to provide credit for low income housing. Commercial banks borrow from these agencies at competitive rates and in turn provide housing lending to workers affiliated to them. If the credit is in good standing throughout the life of the loan, FOVISSSTE and INFONAVIT provide a discount of up to 20 percent of the value of the loan.

18

This is because SIEFORES’ funds have grown significantly and hence the previous limit would have entailed a very large amount of paper of an individual issuer.

19

Pension funds are restricted to having a maximum of 10 percent of their portfolio in foreign currency securities, which must be issued by Mexican entities. While previously, only UMS dollar bonds were allowed, recently the choice has been extended to issues of any Mexican issuer with investment grade rating on the global scale either in U.S. dollars, euros, or yen.

20

The changes to this law would allow SIEFORES to invest up to 20 percent of their portfolio in securities issued by non-resident entities, while at present they cannot invest in these assets. This limit would be introduced gradually and it would be 10 percent the first year.

21

The CONSAR together with the BOM have also recently introduced a regulation that allows pension funds to use simple derivatives to mitigate their risks.

22

The government anticipates that the trust funds will be used not only for commercial loans but also for housing loans and thus provide a boost to this market as well. Nonetheless, demand for this mechanism for housing loans may not be as high as the authorities anticipate because it does not provide the same level of legal protection that homeowners are used to under traditional mortgage-backed loans.

Mexico: Selected Issues
Author: International Monetary Fund