This Selected Issues paper analyzes the global crisis and potential growth in Mexico. The paper uses two methodologies to assess to what extent the global crisis is likely to weigh on Mexico’s growth potential. The first approach is sectoral, examining the historical relationship between financial stress and growth in manufacturing industries. The second approach uses a growth-accounting framework to take a closer look at likely developments in the factors that drive potential growth. The paper also examines spending patterns and risks of expenditures volatility from unanticipated shocks in macroeconomic variables under two alternative fiscal rules.

Abstract

This Selected Issues paper analyzes the global crisis and potential growth in Mexico. The paper uses two methodologies to assess to what extent the global crisis is likely to weigh on Mexico’s growth potential. The first approach is sectoral, examining the historical relationship between financial stress and growth in manufacturing industries. The second approach uses a growth-accounting framework to take a closer look at likely developments in the factors that drive potential growth. The paper also examines spending patterns and risks of expenditures volatility from unanticipated shocks in macroeconomic variables under two alternative fiscal rules.

IV. Expanding the Regulatory Perimeter: the Case of Sofoles and Sofomes1

A. Introduction

A key lesson of the recent global financial crisis is the importance of expanding the regulatory perimeter of financial supervision. As unregulated financial institutions may have close linkages with regulated ones, the regulation and supervision of non-bank, non-traditional financial firm’s remains one of the priorities for the supervisory authorities.

2. In Mexico, Sofoles and Sofomes have grown in their importance as financial intermediaries, pointing to the need to broaden the regulatory perimeter. The Sociedades Financieras de Objeto Limitado(Sofoles) started operating in 1993, with 21 entities recognized by the authorities. Since 2006, when the authorities decided to foster financial intermediation by liberalizing financial activities through creating the Sofomes (Sociedad Financiera de Objeto Multiple) the number of institutions has increased substantially (see below).23

B. Size and Linkages with the Banking System

3. Of the entire universe of Sofoles and Sofomes, the Comisión Nacional Bancaria y de Valores (CNBV) supervises the largest institutions and those with equity links to banks. Published financial information on Sofoles and Sofomes is limited—public information is available for only 25 of the regulated institutions. According to CNBV, as of June 2009, the 25 regulated Sofoles for which financial information is publically available accounted for about 2 percent of reported assets of the financial system,4 or about just over US$10 billion.5

4. The bulk of the portfolio of Sofoles in the CNBV data comprised primarily mortgage loans and commercial loans. Mortgage loans account for about 47 percent of the portfolio of the system, and commercial loans 34 percent. However, the participation of consumer loans has increased importantly in the last few years. While in 2006 consumer loans accounted for about 4 percent of the portfolio, by end June 2009 they had risen to 18 percent (see Graph 1). All the data have been obtained from various CNBV Statistical Bulletins for Sofoles.

Graph 1.
Graph 1.

Portfolio Composition (percent)

Citation: IMF Staff Country Reports 2010, 070; 10.5089/9781451981834.002.A004

5. The Sofoles have linkages to the rest of the financial system through credit lines from commercial and public banks, and liabilities traded in the Mexican stock exchange (See Box 1). As of June 2009, about 79 percent of funding came from banks loans, and 11 percent from other liabilities—mainly bonds traded in the stock exchange—accounting for 111 billion and 15 billion pesos respectively (see Graph 2).6

Graph 2.
Graph 2.

Sofoles/Sofomes: Sources of Funding (percentage)

Citation: IMF Staff Country Reports 2010, 070; 10.5089/9781451981834.002.A004

Housing Finance, Sofoles, and the Public Sector

Historically, the government has participated actively in providing housing finance, especially for low income borrowers. The government established the Instituto del Fondo Nacional de la Vivienda para los Trabajadores(INFONAVIT) and Fondo de la Vivienda del Instituto de Seguridad y Servicios Sociales de los Trabajadores del Estado(FOVISSSTE) in 1972 and 1973, respectively, to channel mandatory pension contributions into home mortgages. It set up Fondo de Operación y Financiamiento Bancario a la Vivienda(FOVI) in 1963 and the Sociedad Hipotecaria Federal(SHF) in 2002 to promote housing finance, while creating the Sociedades Financieras de Objeto Limitado(Sofoles), an entirely new class of mortgage lenders, in 1993. It introduced home mortgage interest rate deductibility and direct subsidies for home acquisition, improvement, and rental for low income individuals. A new law in 2004 provided for a discontinuation of SHF’s direct lending to the Sofoles by 2009, and of the government’s direct backing of SHF liabilities a few years thereafter. However, SHF’s role was expanded to provide mortgage insurance (MI), support issuance of mortgage-backed securities (RMBS) by Sofoles, and give liquidity and credit enhancement for RMBS.

As a result, the public sector has thus far played a leading role in housing finance in Mexico. As of end-2008 mortgages provided by INFONAVIT and FOVISSSTE represented nearly 80 percent of the outstanding stock of mortgage loans, and the mortgages provided by Sofoles accounted for about 8 percent of the outstanding stock. The public sector also has a considerable involvement in housing finance through SHF’s provision of mortgage insurance, purchases of RMBS, and as a market-maker for RMBS.

External and domestic factors have weakened the financial soundness of Sofomes and Sofoles. The global financial crisis has led to a significant drop in wholesale funding for all borrowers, including Sofoles, many of which depended on borrowing from the commercial paper market, in particular during the 2004-08 period. This, compounded by relatively loose lending standards in some cases, rising NPLs, accounting concerns, and the inability of some Sofoles to repay or renew their short-term commercial paper, has led a few Sofoles to experience severe liquidity and even solvency problems. The authorities have responded quickly to resolve the situation in troubled institutions which are now under resolution.

6. The importance of banks loans in the funding of Sofoles has increased in the last few years. The proportion of banks loans in the funding of Sofoles has increased with the introduction in 2008 of the authorities’ program to support the financial markets in the context of the global financial crisis (see Box 2). While in December 2006, banks loans represented about 70 percent of funding, by end-June 2009 the participation of banks loans in the funding of Sofoles had increased to about 80 percent.

Measures to Support Housing Financing Intermediaries7

The 2008 authorities’ plan to support housing finance intermediaries envisaged more than 40 billion pesos of SHF resources to foster and refinance mortgage loans. In addition, SHF was authorized to:

  • Establish guarantees for the issuance of debt of non-bank financial institutions to finance their liabilities for up to 22 billion pesos.

  • Use up to 20 billion pesos to offer lines to non-bank financial institutions to finance their liabilities.

  • Use up to 20 billion pesos to offer medium-term credit lines to finance mortgage loans.

  • Buy and sell mortgage-backed securities to guarantee the liquidity of the markets.

C. Financial Soundness

7. The financial soundness of the Sofoles has deteriorated in the last two years. In the context of the global financial crisis, pressures on the Mexican financial system have increased. However, the financial soundness of the Sofoles has come under greater pressure than for the core commercial banking system. As the real estate market and commercial activity have declined—main markets for Sofoles—nonperforming loans have more than tripled in the last two years reaching almost 9 percent of the portfolio as of end-June 2009. At the same time, provisions cover less than half the portfolio at risk, and profitability and capitalization have declined significantly.8

Table 1.

Mexico: Financial Soundness Indicators, 2005 - 2009

(percent)

article image
Source: C NB V.Note s:

As of June 2009.

Ratio Capital/Assets

8. The higher risk nature of the portfolio of Sofoles and Sofomes raises some concerns and it will be important to increase information on the sector. For the institutions for which public information is available, the high risk nature of their portfolio could further erode their thin capital base. In this regard, further information about the size of the sector, its overall financial soundness, and specific linkages to the rest of the financial system would be useful and is among the initiatives being undertaken by the authorities.

D. Policy Implications

9. The Sofoles/Sofomes system assets and linkages to the rest of the financial system have grown substantially in the last years. Therefore, after putting in place reforms—such as the creation of Sofomes in 2006—to liberalize the credit activity in Mexico, the authorities now intend to expand the regulatory perimeter of financial supervision to the non-bank financial subsystems that could represent some degree of material risk.

10. Various modalities are being considered for expanding the regulatory perimeter. Until now, all Sofoles and only those Sofomes which have equity linkages with other credit institutions (mainly banks) are regulated. According to a draft law presented at the Mexican Senate, a Sofom will also be regulated if:9

  • It has equity linkages with “entidades de ahorro y credito popular”(another type of non-bank financial institutions).

  • It funds its credit operations in the capital markets by issuing debt above a threshold of 400 million UDIS.10

11. Regulation and supervision of the system is to be stepped-up. Besides expanding the regulatory perimeter to all the Sofoles/Sofomes that represent material risks, the authorities intend to strengthen the procedures for applying for authorization, the background check of persons who intend to open a Sofom, and the sanctions and attributions of the CNBV for regulating the system.

12. Besides these considerations, additional measures to strengthen the supervisory framework could include:

  • Establishing minimum information reporting requirements for Sofoles/Sofomes (e.g., providing financial statements, financial soundness indicators, at least quarterly.

  • To make the supervisory regime manageable, establishing “subsidiary” supervision for the universe of Sofoles/Sofomes that are deemed non-systemic and so remain “unregulated” (for example, reporting financial information to the industry association).

References

  • Banxico, “Report on the Financial System,July 2009.

  • Banxico, “Inflation Report July-September 2008.

  • Secretaria de Hacienda y Crédito Público, “Challenges and Opportunities of the Sofom in Mexico,July 2009.

  • Comisión Nacional Bancaria y de Valores, “Boletín Estadístico Sociedades Financieras de Objeto Limitado,” various issues.

1

Prepared by Jose Giancarlo Gasha.

2

The original institutions Sofoles are financial institutions that extend credit and financing to specific sectors of the economy. Sofomes are financial institutions that, besides extending credit and financing, are allowed to perform leasing and factoring, and can operate in different sectors of the economy. These non-deposit taking institutions were created to primarily operate with costumers who did not have access to the banking system.

3

The main consideration for the creation of Sofomes were to: (i) creating a financial vehicle that, under a sole denomination, could engage in lending, leasing and factoring; (ii) giving the access to judicial process and fiscal benefits of the regulated system to the unregulated one; (iii) promoting basic surveillance of the system via the financial conditions requested by the providers of funds; and (iv) avoiding regulatory arbitrage between “unregulated” financial institutions, and their connected counterparts.

4

The denominator comprises only the main credit/deposit taking institutions: commercial banks, public banks, and Sofoles/Sofomes.

5

However the total number of institutions operating is reportedly higher such that the sectors’ overall balance sheet is likely larger.

6

According to Banxico’s July 2009 “Report on the Financial System”, in recent years banks have been allowed to separate their credit card business and create subsidiary Sofomes, which obtain the bulk of their funding from the parent bank. According to the Law of Credit Institutions the funding of a parent bank to other institution belonging to the same financial group is exempt from operational limits (i.e., “unlimited” funding). This arrangement allows banks to benefit from differences in the tax treatment of provisions: while banks can only deduct provisions for up to 2.5 percent of the portfolio, Sofomes are not subject to this limit. These regulatory differences may have had an impact in the increased activity of the sector. Importantly however, the supervision of the institutions is performed on a consolidated basis.

7

See Banxico’s “Inflation Report June-September 2008”.

8

The financial indicators presented belong to the 25 institutions for which CNBV reports information publicly.

9

A draft law in the Senate proposes amendments to the legal framework of Sofoles and Sofomes to expand the regulatory perimeter and strengthen the supervisory regime.

10

According to SHCP presentation “Challenges and Opportunities of the Sofom in Mexico” of July 2009, the rationale of this criterion would be to protect investors that do not have adequate risk management tools.

Mexico: Selected Issues Paper
Author: International Monetary Fund