This paper discusses the Financial System Stability Assessment of Mexico. The Mexican banking system is profitable, liquid, well capitalized, and stress tests suggest that it is able to withstand severe shocks. The strength of capital buffers has persuaded the authorities to introduce Basel III capital requirements in 2012, well ahead of other countries. The institutional set-up for macrofinancial oversight and systemic crisis management has been strengthened with the establishment of the Financial System Stability Council.


This paper discusses the Financial System Stability Assessment of Mexico. The Mexican banking system is profitable, liquid, well capitalized, and stress tests suggest that it is able to withstand severe shocks. The strength of capital buffers has persuaded the authorities to introduce Basel III capital requirements in 2012, well ahead of other countries. The institutional set-up for macrofinancial oversight and systemic crisis management has been strengthened with the establishment of the Financial System Stability Council.

I. Introduction

A. Macroeconomic Outlook

1. Mexico’s strong economic policies underpinned the recovery following the global financial crisis. Mexico was hit hard by the global crisis; growth fell sharply in 2009 and financial markets came under severe pressure. However, strong fundamentals (including substantially strengthened balance sheets) and a skillful policy response (Box 1) helped maintain stability and supported a strong rebound in economic activity. This was assisted by an effective macroeconomic policy framework—the inflation target regime ensured price stability, the flexible exchange rate worked as a key shock absorber limiting capital flow volatility, and fiscal policy was guided by a balanced budget rule (Table 3).

Table 3.

Mexico: Selected Economic and Social Indicators, 2007–2012

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Sources: World Bank Development Indicators, CONEVAL, National Institute of Statistics and Geography; Bank of Mexico; Secretariat of Finance and Public Credit; and IMF staff estimates.

Estimated, the figures of population for 2001-2009 are under revision by INEGI and CONAPO.

Federal Government plus Social Security and State-owned Companies, excl. nonrecurrent revenue and net lending of development banks.

Authorities definition. The break in the series in 2009 is due to definitional and accounting changes of PIDIREGAS.

Estimated as as the difference between the augmented fiscal balance, as reported by SHCP, and public investment, as reported in the

Debt service on gross external debt of the federal government, development banks and nonfinanical public enterprises (adjusted for Pidiregas).

In percent of short-term debt by residual maturity. Historical data include all prepayments.


Real GDP in percent of 2005 GDP

(in percent of 2005 GDP)

Citation: IMF Staff Country Reports 2012, 065; 10.5089/9781475502756.002.A001

2. Growth has remained resilient this year, and is expected to moderate. Exports—especially of manufactured goods to the U.S.—have been an important contributor to Mexico’s recovery after the crisis. Domestic demand has been aided by a growing payroll, recovering credit growth, and the strong balance sheets of banks, corporates, and households. The exchange rate depreciated as investors covered currency exposures in the context of the global financial turmoil (divestment from short-term sovereign paper was rather modest and investors have maintained their positions in long-term paper). The inflation outturn has been better than expected, and inflation expectations are well anchored.

Policy Response to the Global Crisis

The authorities pursued countercyclical policies to ameliorate the impact of the global financial crisis, including on capital inflows. In 2009, the fiscal stimulus amounted to about 3 percent of GDP, while the central bank reduced its policy rate by 375 basis points. The flexible exchange rate regime buffered the impact of the crisis and helped a strong export resurgence, which spearheaded the recovery. With the recovery underway, the authorities started fiscal consolidation in 2010, while monetary policy remained accommodative.

The authorities acted to ensure the proper functioning of key markets. The central bank’s main actions included: (i) selling dollars to support the orderly function of the foreign exchange market given an extraordinary demand for foreign exchange; (ii) establishing a new liquidity facility for short-term liquidity needs which accepts a broader set of instruments as collateral and at a lower cost; and (iii) providing foreign exchange credit as the market for dollar funding dried-up, supported by a swap line with the U.S. Federal Reserve. Moreover, the authorities opened a flexible credit line with the IMF, fostering confidence in the authorities’ program, and the Ministry of Finance reduced domestic financing pressures through smaller debt issuances, purchases of less liquid public sector bonds, and interest rate swaps with financial institutions.

3. The main macroeconomic risks for Mexico’s financial system are linked to U.S. and European developments. The strong real sector linkages with the U.S. economy reflect the high integration in the manufacturing sector, as well as high remittances and tourism revenue. Although direct trade and investment linkages with Europe are modest, further turmoil in Europe could increase global investor risk aversion and emerging market risk premia. In addition, since Spanish bank subsidiaries account for about one-third of banking system assets, liquidity pressures faced by their parents could lead the subsidiaries to deleverage, impacting overall credit growth and economic activity in Mexico.

B. Financial Sector Structure

4. Financial intermediation and credit to the private sector in Mexico are among the lowest in Latin America and well below other emerging markets of comparable income (Figure 1). Consequently, a challenge for the Mexican authorities and for private sector stakeholders is to promote the growth of the financial system that supports financial stability as well as economic growth and national development.

Figure 1.
Figure 1.

Bank Claims on the Private Sector, 2010

(In percent of GDP)

Citation: IMF Staff Country Reports 2012, 065; 10.5089/9781475502756.002.A001

5. Mexico’s financial system is small and relatively concentrated, with the three largest banks accounting for 55 percent of bank assets. As of June 2011, 42 commercial banks had more than half the assets of the financial system (Table 4). The second largest group of financial intermediaries (in terms of assets) is the 14 pension fund managers (AFORES), which manage 86 pension funds (SIEFORES).1 The 43 mutual fund management companies manage 549 funds. The government has nine development banks and public sector funds, in addition to two large public mortgage entities—the Institute of the National Housing Fund for the Workers (INFONAVIT) and the Housing Fund of the Social Security Institute of Public Sector Workers (FOVISSTE). The rest of the system is dispersed and small.

Table 4.

Mexico: Financial Sector Structure

(Authorized financial institutions as of October 2011)

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Source: Bank of Mexico, CNBV, SHCP, Condusef, and AMFE 1.

Commercial bank total assets include those of regulated sofomes, which are consolidated with the respective bank.

Includes development banks and developmental trusts (FIRA, Financiera Rural, and FOVI) and three public mortgage entities.

6. Seven large financial groups anchored by a commercial bank include multiple nonbank financial intermediaries (Table 5). These groups control or manage about 73 percent of all financial assets. These close interconnections pose systemic risk, undermine competition, and create conflicts of interest, depending on whether profit is maximized at the level of the group or of individual financial entities. In this environment, transparency of intra-group transactions and exposures, as well as strong consumer protection, are essential for stability and market development.2

Table 5.

Mexico: Conglomeration in Mexico’s Financial System

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Sources: CNBV and CNSF.

Assets under management.

Ixe and Banorte merged in 2011.

7. The banking system is dominated by seven large banks, with 82 percent of bank assets; five of these are foreign-owned subsidiaries of major international banks. The remaining 34 banks represent a very heterogeneous group focused on corporate and consumer lending as well as niche banking, creating a two-tiered industrial organization. Larger banks compete for “blue chip” companies that could fund themselves abroad, and in the credit card and mortgage markets.

II. Banking System Stability Analysis

A. Commercial Banks

8. The Mexican banking system appears to be sound, profitable, and well capitalized (Table 6). The system-wide risk-weighted capital asset ratio stood at 16.5 percent as of June 2011, and capital is of high quality—14.3 percentage points is Tier 1. Profitability declined sharply in 2008–2009, but remained satisfactory as loan quality improved, provisions and writeoffs fell, and credit growth picked up (Figure 2). Liquid assets represent more than 40 percent of total assets. Commercial bank loans to sub-national governments and public enterprises, and holdings of government securities represent about a quarter of total bank assets.

Table 6.

Mexico: Financial Soundness Indicators

(In percent)

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Source: FSI.

As of June 2011.

Figure 2.
Figure 2.

Mexico: Lending in Mexico by Borrower Type and Total Loan Growth 1/

Citation: IMF Staff Country Reports 2012, 065; 10.5089/9781475502756.002.A001

Source: Comisión Nacional Bancaria y de Valores (CNBV)1/ Left-hand scale: lending in billions of Mexican pesos; right-hand scale: loan growth in percent.

9. Since the 2006 FSAP Update, Mexico has experienced four different episodes of financial system strain. The first was the post-Lehman turmoil, which led to high volatility in the Mexican foreign exchange market, forcing BoM to intervene; the closing of the capital markets for some issuers; the drying up of liquidity in the secondary debt markets; and the major losses experienced by large nonfinancial corporations in the over-the-counter (OTC) derivatives market. The second was a bursting of the credit card and personal loans bubble—the result of lax underwriting standards in some banks. The rapid expansion of credit card loans in 2005–06 resulted in a steep increase in nonperforming loans and significant write-offs when unemployment increased in 2009. The third was the distress experienced by the non-deposit-taking, unregulated housing finance institutions (Sofoles/Sofomes), which led to illiquidity and insolvency. The latest was the rapid increase—from a low base—in bank lending to states and municipalities. Some smaller banks took on very high exposures previously viewed as virtually risk-free; these loans suffered major restructuring, impacting liquidity and capital.

10. These episodes have encouraged better risk management and more disclosure. The CNBV modified the methodology for calculating provisions on both the credit and mortgage portfolios, and bank loans to states and municipalities. For the latter, it moved from a system based on ratings by rating agencies to an expected-loss method based on borrowers’ past repayment record and other creditworthiness indicators (debt level over eligible fiscal transfers, debt service to revenues, debt structure, and fiscal position).

11. With the deterioration in the international economic outlook, external vulnerabilities have become more prominent. In particular, potential distress in foreign parent banks, further EU-driven deterioration in international financial markets, and a U.S. growth slowdown are emerging threats. Capital flow reversal is a more general concern, given the high dependence on non-resident investment, in the context of rising risk aversion. On the domestic front, credit risk is the most important vulnerability identified in the banking system. While there are significant differences across banks, most are heavily exposed to their largest borrowers—especially smaller banks (Figure 3). In part, this reflects the high concentration prevalent in the Mexican economy. Nevertheless, the expected impact of these threats is limited.3 The use of derivatives for additional leverage and reducing return volatility poses risks for pension funds.

Figure 3.
Figure 3.

Mexico: Loan Portfolio Concentration4

(Borrowers (in order of size) versus bank capital)

Citation: IMF Staff Country Reports 2012, 065; 10.5089/9781475502756.002.A001

12. Interest rates have declined as a result of the 375 basis point cut in the policy rate implemented in response to the global crisis. Lending rates have generally fallen more among the largest banks, which likely reflect competition for large corporates. Consumer loan rates declined less than rates for corporates and government, reflecting a higher risk assessment following the steep increase in nonperforming loans—particularly on credit cards—after the 2008–2009 crisis. The net effect has been that the risk-adjusted financial margin declined, contributing to lower bank profitability.

B. Stress Testing

13. Stress tests were undertaken by CNBV, BoM, and the FSAP team. The approaches and stress scenarios differ, but the tests covered credit, market, liquidity, and contagion risks.5 All three exercises found that the banking system has adequate capital to withstand severe shocks.

14. The FSAP team performed stress tests to assess exposures under a pessimistic macroeconomic baseline and two adverse scenarios.6 The 10 largest banks’ quarterly pre-tax profit sensitivities to macroeconomic factors are modeled using publicly available information (Box 2). The methodology also analyzes the importance of bank-specific shocks and dividend policy assumptions for sustaining capital adequacy through a prolonged stress period. The profitability and capital adequacy of the Mexican banking system appear adequate to maintain the system through a prolonged period of stress. Even when banks are subjected to large idiosyncratic shocks each quarter, banking system profitability still remains sufficiently high that only three banks would post declining CAR ratios in scenario 2 when they retain all earnings—consistent with the 2008-2009 crisis episode (encompassing the bursting of credit card bubble and the sharp decline in output) when system-wide RoE declined from about 24 percent in 2005-2007 to 14 percent in 2008–2010 (Table 6).

Stress Tests

The FSAP mission estimated individual top-down stress test models for the 10 largest Mexican banks accounting for 84 percent of the Mexican banking system. Bank profits are modeled using publicly available macroeconomic data from the IMF WEO and IFS, and bank-specific data provided by the CNBV. Individual bank quarterly profits are explained by macroeconomic variables. Bank models are estimated on a common set of factors, but each bank’s sensitivities vary to accommodate individual bank exposure profiles. The model is estimated on pooled time series cross-section data in a regression with fixed effects and bank-specific factor interactions. The macroeconomic factors account for 23 percent of the overall sample variation in bank profit and loss rates. Bank-specific model residuals are used to parameterize bank-specific shocks in the stress test exercise.

The stress test included a WEO baseline scenario and two adverse slow-growth scenarios for 2012–2013. Given strong links to the United States, adverse Scenario 1 captures the effect of a slower but still positive growth path for the U.S. economy. Adverse Scenario 2 assumes a U.S. recession. Figure 1 plots GDP growth scenario assumptions and the paths for the remaining macroeconomic factors are summarized in Table 1.

Figure 1.
Figure 1.

Stress Test GDP Growth Scenario

Citation: IMF Staff Country Reports 2012, 065; 10.5089/9781475502756.002.A001

Large capital buffers and high profit margins enable Mexican banks to weather severe stresses without violating their regulatory minimum capital level. Even assuming normal profit distribution patterns, all banks maintained regulatory minimum capital levels under adverse Scenario 2, including the addition of a large bank-specific loss each quarter equal to one-half the ninetieth percentile loss of each bank’s factor model residual distribution. Only four banks experience a deterioration in their CAR (Figure 2), implying stress-related losses greater than profit distribution. For most banks, the ability to increase capital by retaining profits provides an additional and significant level of protection beyond their initial capital buffers.

Figure 2.
Figure 2.

CARs under Scenario 2 with Large Bank Specific Losses (2011Q2=100 percent)

Citation: IMF Staff Country Reports 2012, 065; 10.5089/9781475502756.002.A001

Table 1.

Stress Scenario Assumptions

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15. The CNBV stress test uses bank estimates of balance sheet and income statements under a two-year supervisory stress scenario. The stress scenarios were designed jointly by the IMF, the CNBV, and the SHCP. The baseline scenario (Table 7) follows June 2011 WEO projections; the adverse scenario mimics the effects of near-recession in Europe and recession in the United States.7 The CNBV provided banks with expected loss estimates for seven broad credit classes linking the probabilities of default of seven credit risk categories to macroeconomic factors. Banks made additional assumptions about credit growth, earnings retention, net interest margins and other important operational aspects and estimated the impact for their CAR over the stress period. These results were checked for consistency by CNBV, and then subjected to a CNBV model that estimates unexpected losses for each bank.8 The CNBV also uses econometric methods to assess systemic risk and contagion.

Table 7.

Mexico: CNBV Macroeconomic Scenarios, 2011–2013

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16. CNBV stress tests for the 10 largest banks suggest that the Mexican banking system would remain highly solvent with capital adequacy ratios well above 10 percent—consistent with the FSAP team’s stress test results (Table 8). The CNBV adjusts banks’ capital and reported CARs for hypothetical unexpected stress scenario losses and finds that some bank CARs fall significantly, but still leaving the system adequately capitalized. The CNBV analyzed each bank’s market risk exposures using a value-at-risk and stressed value-at-risk measure.9, 10 The CNBV assessed liquidity risk using the Basel III liquidity coverage ratio (LCR) and found most banks have more than adequate liquidity, but a few banks have LCRs below 100 percent. Liquidity risk concerns for the banking system as a whole are muted in view of the significant liquidity requirements in the form of monetary regulation deposits (DRM), exceeding 13 percent of customer deposits; also, foreign banks do not rely on parent bank or wholesale funding. The zero risk rating of government securities holdings was not stress tested.

Table 8.

Mexico: Stress Test Results, 2011–2013

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Source: CNBV, staff estimates.Note: Category I CAR>=10; Category II 8=<CAR<10; Category III 7<=CAR<8; Category IV 4<=CAR<7.

11 banks were considered here.

17. BoM’s stress test assumptions and results are published in its September 2011 Financial System Report. These involved stress scenarios that considered both macro-market shocks, similar to those described above but including a contagion phase, and a credit stress scenario. BoM measures contagion based on the idiosyncratic failure of single financial institution among all banks, brokerage firms, mutual funds, pension funds, and selected foreign institutions.11 BoM’s estimates suggest that contagion risk represents only a minor risk, which reflects the relatively limited role of interbank markets and the likely importance of wholesale funding from intra-group institutional investors. A more involved exercise considered contagion using a common shock to underlying macroeconomic variables that creates the potential for multiple institution failures and greater contagion risk.12 However, even in this case, the effect was modest, with losses rising from about 8.2 percent of system capital without contagion to around 13 percent.13

18. The BoM credit risk stress test triples bank portfolio default probabilities over 18 months, reduces bank interest income by 80 percent from pre-stress levels and shocks recovery rates to half of their historical averages. This exercise causes the system average CAR to fall by nearly 7 percentage points but still remain above the regulatory minimum.


19. Assessments of financial sector standards and codes found that despite good progress since the 2006 FSAP Update, there remains scope for further improvements.14 Overall, assessors considered banking, insurance, and securities regulation and supervision, as well as payment systems oversight, to be of high quality, notwithstanding the opportunities for improvement identified. Table 9 provides an overview of main financial sector legal reforms undertaken since 2006. There are a number of overarching themes that affect several supervisory agencies:

  • The CNBV and the CNSF should have more independence and budget autonomy to allow them to pursue their objectives, while increasing their accountability. There is neither a defined appointment period for, nor well-specified causes for dismissal of, senior management; make key staffing decisions, or set/modify the budget, even if fees collected from supervised institutions exceed its budget. High CNBV staff turnover related to below-market salaries has been a particular concern for maintaining the quality of supervision and institutional continuity.15 A widening regulatory perimeter for CNBV—AML/CFT supervision over a large number of foreign exchange houses and prudential supervision over small deposit-taking institutions—adds urgency to establishing budget autonomy. Increased independence should go hand in hand with enhanced accountability, including by publishing annual reports. With 10 out of 13 CNBV Board members under its control, the SHCP influence over Board composition appears excessive.

  • Legal protection of supervisors needs to be strengthened. Management, Board members, and staff are not accorded statutory legal immunity for the bona fide discharge of official functions that could hinder enforcement; former employees should also be covered. Legal protection is especially important in a civil code legal environment when implementing risk-based supervision, where the main challenge is to shift the responsibilities for identifying, measuring, controlling and monitoring risks to the Boards of supervised institutions, which requires prompt reaction by the supervisor to newly emerging risk. Hence, the CNBV has to strike a delicate balance between rules and discretion: on the one hand it has an interest in codifying the circumstances in which discretion will be exercised to minimize challenges to its authority; on the other, it needs the flexibility to deal promptly with novel situations using qualitative judgments than carry greater legal risk—rather than quantitative, compliance-based indicators.

  • Concentration and conglomeration risk should be reflected more prominently in the regulatory and supervisory framework. The presence of financial and mixed activity groups as well as concentrated loan portfolios create the potential for conflicts of interest in supervised entities and for hidden risks—including contagion—not fully addressed by existing regulations. Consolidated supervision should be strengthened by giving supervisors powers to regulate both financial and mixed-activity groups; prudential regulation—especially risk limits—and risk governance and management standards should be extended to the group level.

  • The sanctions regime should be strengthened; in particular, fines should be dissuasive and enforcement actions should be disclosed promptly.16 Other nonmonetary sanctions foreseen in the law could also be used more actively. Legal restrictions on disclosing enforcement proceedings before all rights of appeal have been exhausted and on reaching settlements interfere with the effectiveness of the sanctions regime, and should be removed.17

Table 9.

Mexico: Main Financial Sector Legal Reforms 2006–2011

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A. Banking Supervision

20. The CNBVs organization, regulations, and prudential supervision have been significantly overhauled since the 2006 FSAP Update. The CNBV’s staff is professional and has outstanding information systems at its disposal with high quality and granularity of data that form the basis for building robust analytical tools and models. Its regulatory framework is comprehensive and relies on well-developed supervisory methodologies and processes. Home-host cooperation is well developed.18 A new vice-presidency handles anti-money laundering and the combating financing of terrorism (AML/CFT) work; new departments have been created, new risk areas/functions have been added, and work is ongoing to develop analytical and statistical tools to fully implement Basel II and to deploy more sophisticated approaches to analyze risks in the banking system. Once in place, this should provide specific risk metrics and clearer criteria to differentiate each bank according to their risks.

21. CNBV has been reasonably effective in delivering supervision; however, implementing Basel II’s supervisory review (Pillar 2) would complement already strong capital buffers to reach a fully risk-based regulatory system. Currently: (i) the responsibilities of the Boards of Directors are not explicitly linked to the levels of risk and capital; (ii) portfolio concentration risk limits are unclear—exemptions are widespread; and (iii) the overall rating assigned to a supervised institution is not used effectively to require remediation. Adopting Pillar 2 would introduce a supervisory review process and associated standards providing the authority, methodologies, and criteria to require banks to increase capital (including to offset loan concentration, liquidity, interest and operational risks); it would also explicitly relate the outcomes of the supervisory review process with banks’ mandatory internal capital adequacy assessment process (ICAAP), to determine future capital needs and how these can be met. Additional measures to strengthen supervision are to: (i) create a quality assurance function to increase consistency and standardize supervision practices, documented in updated supervision manuals; (ii) introduce a formal supervisory cycle to cover all significant supervisory areas—this can also be used for resource planning; and (iii) standardize criteria and procedures, including metrics used internally for risk assessment and onsite inspections, to provide benchmarks against which business practices can be judged.

22. Weaknesses in the licensing regime should be addressed. The CNBV has taken over the licensing functions from the SHCP, but ultimate beneficial owners (UBO) are not necessarily clearly identified, parallel banks allowed to operate, and BoM holds veto power over granting licenses, even if it is represented on the CNBV’s Board. To address these shortcomings, the FSAP team recommends that the authorities: (i) adopt additional criteria for approval of applicants and tracking their sources of funds, and use the licensing process on an ongoing basis to clarify the identity of the final UBO—this concept should also be explicitly defined in law; (ii) introduce stringent operating criteria on parallel banking and mixed-activity groups (which bypass consolidated supervision), and use licensing powers to mandate changes in the by-laws of unregulated mixed-activity parent companies; and (iii) require banks, through regulation or by using licensing powers, to notify the CNBV of major changes planned in business activities, changes in structure, and adverse developments and breaches in regulations.

23. Liquidity and operational risk monitoring need strengthening. A new liquidity risk regulation should include the following elements: (i) banks must explicitly link credit risk and liquidity risk, monitor core liquidity risk indicators and limits, and must use forward looking liquidity risk metrics; and (ii) residual maturities and liquidity forecasts should be reported. Operational risk is currently monitored indirectly through supervision of banks’ internal controls and risk management systems. However, there is a clear regulatory regime and progress in terms of methodologies; implementation is slated for 2012 and will include a database to be used for measuring operational risk and allowing additional capital charges under Pillar 2.

B. Securities

24. Priorities in strengthening securities supervision include clarifying the derivatives legal framework, and strengthening enforcement powers and reporting standards. The CNBV’s responsibilities, powers, and jurisdiction with respect to derivatives are unclear, owing to the lack of specific legislation in this area; this raises concerns about the potential for overlaps with other agencies and the possibility of conflict in supervisory approaches. This gap in legislative coverage and authority should be filled promptly, either by development and passage of dedicated derivatives legislation or by extensive additions to the capital markets law—a timely effort in light of the G-20’s drive to boost supervision of derivatives markets.

25. Additional powers and tightened reporting standards would make achievement of the CNBV’s regulatory objectives more assured. These include the power to be more transparent about enforcement matters, to settle disciplinary matters without a hearing, to order restatements of financial statements by public issuers, to order restitution to compensate defrauded investors, to inspect any regulated entity without giving prior notice—even when no breach of the law is suspected—and to intervene in the sales and redemption process at mutual funds in appropriate circumstances. Although the reporting requirements are comprehensive and timely, the delivery time for public companies’ audited statements is long, the delay for capital adequacy reporting by market intermediaries should be shortened, and a notification requirement instated in case capital declines below required levels.

26. Further steps that would improve securities supervision include the following: (i) improve coordination with other authorities to ensure that similar investor protection rules apply to similar securities and insurance products; (ii) enhance CNBV transparency by making consolidated versions of rules more easily accessible on its website, and by expanding disclosure regarding its activities to enhance accountability and assist the industry in understanding the CNBV’s expectations; (iii) enhance market transparency by ensuring routine disclosure of full information on the risks posed by leverage to less sophisticated investors; (iv) increase transparency about issuers by ensuring shareholder meeting materials are posted online, with a longer notice period, and by reducing the threshold for reporting changes to insider ownership positions to no more than 2 percent from the current 5 percent; (v) complete the project to develop a comprehensive regulatory regime for conflicts of interest and conduct of business across all financial institutions regulated by the CNBV; (vi) invest more in examination programs in new areas, such as the new asset management program, and (vii) conduct periodic reviews of the continuous disclosure documents provided by public issuers to ensure appropriate standards continue to be met.

C. Insurance

27. A comprehensive legal and institutional framework supports the regulation and supervision of the insurance sector. This legal framework is about to be overhauled once the new insurance law is approved by parliament. The long preparation process of this new insurance law allowed the authorities to gain consensus among the different stakeholders. Its promulgation will result in improved compliance with the IAIS core principles, as described in the detailed assessment. Issuing and implementing secondary regulations will further boost compliance. However, as noted above, lack of independence and budget autonomy of the CNSF are concerns.

28. There is an important mismatch between the duration of the assets and the liabilities that need to be monitored. The mismatch of 5 years and 12 years in domestic and foreign currency, respectively, as revealed by the reported data, could be explained by the investment strategy of the industry waiting for the right moment to invest in a low interest rate environment. However, a mismatch in the order of 15 years in the indexed currency, mainly reflecting the lack of long-term government indexed paper, appears to be a source of vulnerability that needs close attention and monitoring.

29. The assessment of the IAIS principles gives rise to a number of recommendations: (i) establish an implementation plan for the adoption of the Solvency II regime targeted to the Mexican circumstances; (ii) introduce, once the new solvency regime is in place, an enhanced and more intrusive inspection system that is adequately resourced; (iii) step up the requirements for maximizing the value of assets of companies under liquidation and enhance the efficiency of the process as proposed in the new insurance law to improve winding-up proceedings for insurers; (iv) provide guidance on the accounting for reinsurance recoveries, as well as on the assets backing up catastrophic reserves that could require investments abroad; and (v) revisit the arbitration mechanism to encourage its use.

D. Payment Systems

30. The legal and regulatory framework for payment systems is sound, complete, and underpinned by a comprehensive payment systems law, but there are still gaps. The following recommendations apply: (i) for the payment system SPEI, BoM should integrate its business continuity plans with that of participants to establish a comprehensive system-wide business continuity plan; (ii) for the CLS, access by more Mexican financial institutions for foreign exchange settlement would decrease systemic risk and increase system efficiency; (iii) BoM and the CNBV should consider establishing formal oversight arrangements on payment and settlement system at the technical level, building on existing cooperation; and (iv) to prepare for the approaching adoption of the CPSS-IOSCO Principles for Financial Market Infrastructures, authorities should consider reviewing the coverage of central counterparties (CCPs) and other systemically important payment systems, issues related to crisis management and their link to bank resolution issues, and the legal protection for formalized arrangements for over-the-counter (OTC) derivatives clearing.

E. Supervisory Architecture

31. The longstanding lack of independence and budget autonomy of supervisors could be addressed by rationalizing Mexicos supervisory architecture. The present structure could be improved by: (i) reducing overlapping functions between the BoM and the CNBV in areas such as derivatives, capital and liquidity norms, and licensing; (ii) separating prudential from market-conduct roles to provide more space for capital market development; (iii) keeping up with an ever more integrated financial sector to focus in on industry conflict of interest issues and improve coordination; (iv) achieving better alignment between BoM and the CNBV during emergency liquidity support situations; and (v) minimizing the risk of other coordination and information failures between central bank and prudential authorities that would delay crisis response. Moreover, maintaining the status quo would risk deterioration in institutional strength and the further loss of high-quality, experienced staff.

32. Options—not necessarily mutually exclusive—could include: (i) integrating the prudential functions of the CNBV with BoM, and keeping the conduct of business functions separate, in a “twin peaks” model; (ii) consolidating the CNBV, CNSF, and CONSAR into an integrated financial supervision agency, to keep pace with the integration of the supervised industry; (iii) changing the administrative status of the supervisory agencies within the government structure, converting them from de-concentrated entities under the SHCP to decentralized agencies, increasing their budgetary autonomy and independence. Greater independence should go hand-in-hand with greater accountability.

IV. Liquidity Management And Financial Safety NET Arrangements

A. Liquidity Management

33. The cost of monetary policy is borne entirely by the central bank, and its balance sheet dynamics must be monitored. The central bank is responsible for the interest payments on the treasury securities issued for monetary policy purposes and on the short-term liquidity absorption deposits. With growing foreign reserves, financial results became increasingly dependent on the path of the exchange rate and on the differential between local and international interest rates. Moreover, there are no provisions in the central bank law regarding government coverage of central bank losses. BoM should ensure that a forward-looking monitoring of its balance sheet is in place to identify potential problems and allow proactive remedial measures.

34. A number of measures would help monetary policy transmission and banks’ liquidity management. Transferring IPAB’s debt to the Federal Government, as recommended below, would reduce floating-rate instruments to almost a half of their current outstanding amount. Banks’ liquidity management can be improved by: (i) changing the time of its first short-term daily intervention closer to the opening time of the interbank market, which would reduce uncertainty about the amount of liquidity available for the day; and (ii) settling the auctions of Bondes LD in T+1, instead of T+0, in order to prevent the results of the auction interfering with banks’ individual liquidity positions for the day.

B. Emergency Liquidity Facilities

35. BoM should consider disclosing the broad conditions for emergency lending, and consulting the CEF. BoM can provide liquidity to banks in two ways—a standing liquidity facility (SLF) introduced in 2008 and whose access requirements and conditions are public, and emergency liquidity assistance (ELA) for which BoM has developed policies, internal procedures, and standard contracts that have not made public on concerns of moral hazard. There is no formal consultation with the CNBV in assessing a bank’s solvency in response to a request for liquidity support. Also, BoM does not consult with CEF on the potential systemic impact of rejecting an ELA request by a bank that does not comply with BoM’s internal policy requirement.

C. Bank Resolution

36. The legal and institutional arrangements underpinning the financial safety net have undergone major changes since the Tequila crisis in 1995, and are broadly adequate. They include: (i) the introduction of a deposit insurance scheme with explicit and limited coverage in 1999; (ii) the introduction of, an early warning system in 2004 that triggers prompt corrective actions by the CNBV; (iii) legal changes in the bank resolution framework in 2006 that clarified the causes for revoking a bank’s license, set deadlines and specific responsibilities for each agency, added resolution options in line with international good practices, and introduced a distinction between systemic and nonsystemic banks (to be determined by the CEF); and (iv) transferred the authority for granting and revoking bank licenses (and issuing prudential regulations) in 2008 from the SHCP to the CNBV.

37. Currently, the authorities are drafting a major overhaul of the bank resolution framework for which they could consider the following:19 (i) strengthen the PCA framework by including liquidity indicators that are not considered PCA triggers, to enhance supervisors’ ability to act earlier to prevent the further deterioration of the institution; (ii) reduce the time delays involved in intervening in a troubled bank to avoid putting its orderly and timely resolution at risk; (iii) prevent delays in bank resolution through the appeals process—although this is in the law, it has not yet been tested in court; (iv) adopt implementing procedures for the use of trust funds to fully operationalize the purchase of assets and liabilities (P&A) bank resolution method; (v) adopt a streamlined administrative process for the liquidation of the residual balance sheet of a failed bank, instead of the current administrative and judicial process to reduce the time and increase the recovery value of a bank’s assets; and (vi) include the possibility of partial transfer of liabilities under a bank resolution process.

38. A recently conducted crisis simulation exercise led by the World Bank identified areas for improvement. The framework for injecting liquidity in systemic situations should be reviewed. It would also be desirable to establish an objective methodology for assessing the potential systemic consequences of bank liquidation, and to review the protocols to implement more oversight “in-situ” at the first signs of problems in banks. To overcome IPAB’s limited financial resources to meet its obligations, the “automaticity” of IPAB’s exceptional financing options should be reviewed, including the contingency lines of credit that BoM may provide at its discretion. To dispel concerns about the reliability of this arrangement, there is a need to establish a robust mechanism (e.g., explicit SCHP’s guarantees) to effectively protect BoM’s balance sheet for such operations. Finally, it would be appropriate to develop an external communications strategy for crisis situations identifying the entity that will be responsible for issuing public statements.

D. Deposit Insurance System

39. IPAB’s legacy debt service prevents a more rapid accumulation of funds; transferring this debt to SHCP would increase the credibility of the guarantee fund. Only 25 percent of collected premiums, net of operating expenses, are accumulated in a guarantee fund, undermining IPAB’s financial capacity to protect small depositors. The authorities are planning the transfer of IPAB’s debt to the Federal Government with a gradual reduction of the percentage of the deposit insurance premiums (currently 75 percent) earmarked to service that debt.

40. The deposit insurance system has a high coverage but few ex-ante resources and dependence on ex-post financing—reducing the coverage should be considered. The coverage limit is about US$137,000 per person and per institution, fully covering the obligations of 99.9 percent of all deposit accounts and 55 percent of total deposits; this coverage is the highest in Latin America both in nominal and per capita terms (Figure 4). At the same time, the ex-ante fund contains less than 1 percent of the amount of insured deposits, which would raise concerns about IPAB’s financial capacity to meet its obligations if a number of medium-sized banks were to fail. The minimum annual insurance premium is relatively high at 0.4 percent on total liabilities (with a ceiling of 0.8 percent); additionally, IPAB can issue debt up to 6 percent of the total liabilities of the system over three years; however, it is not clear how this would work in practice. The authorities should carefully consider the proper timing for the implementation of such a reduction in coverage.

Figure 4.
Figure 4.

Mexico: Deposit Insurance Coverage in Selected Countries, 2009

Citation: IMF Staff Country Reports 2012, 065; 10.5089/9781475502756.002.A001

Source: Bolzico, J., Gozzi, E., and Rossini F., 2010. “Financial Safety Net in American Countries—A Comparative Analysis” based on data of Superintendencias de Bancos and Central Banks data of January 2010.

V. Mexico And The International Reform Agenda

A. Basel III Implementation

41. Mexican authorities are committed to adopting key Basel III capital requirements by 2012, and banks are ready. According to the CNBV simulations, using June 2011 data, the impact of the adoption of the new requirements will be negligible for the banking system as a whole, with CARs decreasing from 16.5 percent to 16.1 percent (versus 8 percent in Basel III—10.5 percent, including the conservation buffer). At the time of the mission, not all elements had been simulated to estimate their effect—for example, the expected loss provisions for loans to corporates and small and medium enterprises have not been calculated. Simulations show that some banks—including a few large ones—appear close to the minimum requirements; it would be advisable to complete the simulation of the full impact of the new rules before their planned adoption.20

42. However, there are no plans yet to introduce the Basel III macroprudential or liquidity requirements. This applies to countercyclical capital buffers and capital surcharges for large banks, bail-in or contingent capital schemes, and internal models for counterparty credit risk. Consideration is being given to allow the recognition of subordinated debt as tier 1 capital, if it meets the criteria for loss absorption (through convertibility) and if the bank floats at least 15 percent of capital on the stock exchange (with the objective of increasing market discipline and to help develop the domestic equity market). Although an early introduction of Basel III liquidity requirements might be desirable from a prudential perspective, given existing maturity mismatches, the authorities plan to adopt Basel III liquidity requirements according to the agreed international timeframe, since some smaller banks might have difficulty complying with the net stable funding ratio. The new liquidity requirements would reduce threats to the stability of the banking system and allow banks easier access to capital markets. Therefore, the authorities may wish to create incentives to accelerate adoption of the new rules and conduct stress tests on banks’ liquidity to detect potential vulnerabilities.

43. The application of G-SIFI surcharges and other elements of Basel III may pose additional challenges for Mexico.21 Basel III’s higher risk weights for counterparty credit risk in trading books could lead to a reduction of liquidity in the debt and OTC derivative markets of emerging market economies, as banks will have less incentive to act as market makers. Staff and authorities agree that the calibration of sovereign risk charges are an additional challenge: banks can choose to apply a zero capital charge to domestic currency sovereign debt, or apply their own internal models and treat foreign subsidiaries’ holdings of domestic debt as foreign debt; in the end, parent bank risk models and home-country regulations may influence portfolio allocation decisions of their Mexican subsidiaries impacting local government securities markets. Similarly, capital surcharges applied by home country supervisors on for G-SIFI parent banks will affect capital allocation in the group, including subsidiaries.

B. Macroprudential Policy Framework and Instruments

44. The authorities should build on the recently created Financial Sector Stability Council (FSSC) to further strengthen the macroprudential framework. The Council strengthens coordination among agencies, analyzes emerging risks on a regular basis, and puts forward recommendations to address these risks (for example, on the how to address the growing risk of credit to states and municipalities); working groups focus on identification and measurement of systemic risk and the tools to offset this, data collection and availability of information to financial markets, financial system vulnerabilities, and bankruptcies. The following measures could be considered: (i) introduce a “comply or explain” approach to FSSC recommendations; (ii) improve mechanisms for sharing the analysis needed to assess risks; (iii) sharpen the differentiation between BoM and FSSC reports, with the latter focusing less on macroeconomic risks and more on identification of emerging financial system risks enhancing “market intelligence” (iv) monitor systemically the regulatory perimeter (both domestically and abroad); (v) communicate emerging risks to the public and industry, including by publishing recommendations and decisions; and (vi) analyze the effectiveness of a wide range of macroprudential instruments to counter systemic risk (including caps on loan-to-value, debt-to-income, credit growth; limits on maturity mismatches, time-varying or dynamic provisioning, and restrictions on profit distributions).

C. Cross-Border Coordination and Resolution

45. Internationally agreed principles should guide potential conflicts of interest between home and Mexican supervisors with respect to locally systemically important subsidiaries of G-SIFIs—a common feature in other emerging economies as well. Regulators are concerned first and foremost with domestic financial stability and depositor protection, and do not necessarily take into account the point of view of foreign jurisdictions. Foreign subsidiaries are incorporated under local laws, and the authorities see them technically and legally as standalone entities, even if they are supervised on a consolidated basis by a home supervisor. In extreme stress, conflicts of interest between host- and home-country authorities, as well as between local and foreign management, could arise. In case the resolution of a global bank were to be necessary, these tensions could be amplified by the lack of supranational laws and courts, as well as by the absence of effective cross-border resolution frameworks (including ex-ante agreed loss-absorption mechanisms).

46. Resolution of a G-SIFI should be based on cooperation and information sharing between host and home supervisors. Authorities and staff agree that coordination—in the form of a Memoranda of Understanding (MoU)—and the smooth functioning of supervisory and crisis management colleges are essential for ensuring a resolution process that balances the interest of host and home jurisdictions—assessors determined, including on the basis of contacts with selected home supervisors, that current cooperation arrangements with relevant foreign supervisors are excellent. However, access to supervisory colleges is not automatic and there is no agreed definition of systemic banks in host jurisdictions. Access to recovery and resolution plans (“living wills”) should be open to all stakeholders of a G-SIFI to converge on an optimal solution. Additionally, it is helpful to carry out cross-border crisis simulation exercises and have a reciprocal knowledge of legal and regulatory frameworks of parent and subsidiaries.

D. OTC Derivatives

47. As derivatives play an important role in Mexico’s financial system, it needs to closely monitor progress in international OTC derivatives reform and pursue agreements to establish robust CCP practices. With respect to the G-20 2009 decision to clear standardized derivatives through central counterparties by end-2012, Mexican authorities are concerned about an uneven implementation of the international reform of OTC derivatives and discrimination among jurisdictions. Moreover, the cross-border legal aspects could result in concentration of operations in just a few markets, as participants could be forced to operate in central clearing counterparties directly regulated and approved by foreign authorities. Thus, the scope of mutual recognition regimes for trade repositories and clearing houses should be carefully assessed to produce fair reciprocal treatment.

VI. Developmental Issues

48. Significant progress has been made in the area of public debt management; further improvements—particularly in information gathering and disclosure—are possible. Maturities have lengthened; the domestic/foreign and fixed/variable rate composition of government debt also improved markedly; the investor base has become more diversified; syndicated collocations of long-term fixed-rate and inflation-linked bonds are accelerating the establishment of market benchmarks and allow the inclusion of such bonds in the World Government Bond Index (WGBI). More information can be made available on ownership categories, and classification should also be based on risk positions (as opposed to legal ownership—this distinction is important for repos). The market for fixed-rate bonds could be further deepened by adjusting maturity dates. The persistent spread of around 40 basis points between the TPFB and the 28-day TIIE—both interbank funding rates—should be reduced by standardizing the treatment of IPAB premiums.

49. In contrast to the deep and liquid public debt market, corporate debt and equity markets are characterized by few issuers. Institutional investors, such as pension funds and mutual funds, hold most of their assets in fixed-income securities, mostly government bonds. As a result, financial savings are not being channeled into long-term productive investments. The relative importance of the capital markets agenda as a development tool should be elevated with a comprehensive medium-term strategy. Specific steps include: (i) reforming the mutual fund industry to foster competition; (ii) increasing controls on related-party transactions; (iii) creating a hybrid regime within the public offering framework to increase supply of securities and allow institutional investors to invest in specialized instruments; (iv) setting up a comprehensive program to encourage new issuers, including bringing large economic sectors, such as energy and banking, to the public equity market;22 (v) introducing a legal framework for derivatives; and (vi) increasing regional stock market integration.

50. Pension contribution rates for private employees should be set to achieve reasonable replacement rates at retirement, and the regulatory approach should focus on long-term investment performance. The latter would avoid excessive wasteful competition between funds driven by narrow focus on short-term returns. The use of derivative instruments for leverage rather than hedging should be carefully monitored. The private annuity system is overregulated and does not leave room for effective competition due to restrictions on pricing and technical parameters; its regulatory framework could be improved by a better selection of the reference interest rate and changes in investment regulation and contract policies.

51. The fragile private-sector housing finance funding and origination model was dealt a devastating blow by the global crisis. Many nonbank housing lenders and developers were pushed out of the market, leaving housing finance almost exclusively in the hands of government agencies (84 percent of mortgage originations) and commercial banks. Although overall lending volume has returned to pre-crisis levels, the lack of long-term funding has become an obstacle to balanced growth in mortgage lending; securitization is no longer an option as a funding instrument for private lending, as institutional investors shy away from these securities, despite healthy risk premiums and strong credit enhancements. Policy interventions should place a priority on ensuring a more level playing field between agencies and the private sector, reviving the private securitization market by restoring investors’ confidence and economic price formation, and developing a comprehensive strategy to support lending to the unaffiliated population.

52. Financial inclusion has increased significantly, but large segments of the population still have no access to financial services. The authorities have issued enabling regulations in a number of areas that permit a broad range of new business models for financial services. Most of these schemes are still in their infancy; it remains to be seen whether these new channels will become commercially viable. BoM should review its policies on retail commissions, as allowing free price setting for some services could increase provision of services.

53. A large number of cooperatives that will be transferred to CNBV supervision do not meet the regulatory prerequisites, and would need to be closed. However, there is no procedure in place yet to handle the closure of these institutions, and a process is needed for ensuring that customer accounts are protected or migrated to other institutions.

54. Progress has been made in credit reporting, with two bureaus expanding their coverage. However, the current credit information market is still incomplete and fragmented, resulting in behaviors that affect the competition in both the credit information market and the credit market itself. Improved standardization of information and the integration of players and products are needed, as well as strengthening oversight of credit reporting and reviewing governance structures of the credit bureaus, so as to eliminate possible conflicts of interest and ensure better sharing of information. The scope of data could also be expanded to include government programs, court judgments, fraud alerts, and property registries.

55. Legal and institutional weaknesses continue to hamper financial development, despite progress in this area. These include relatively weak property rights, a complex and unreliable insolvency and creditors’ rights framework, an inefficient and corrupt judicial system, and insufficient transparency in financial information, among others. These factors increase bank risks and raise the loss-given default, increasing bank spreads and restricting access, especially to small and medium enterprises.

Annex I. Basel Core Principles—Summary Assessment

A. Introduction and Methodology

1. An assessment of the Basel Core Principles for Effective Banking Supervision (BCP)

was conducted as part of the FSAP in September 2011. The assessment was performed by Joaquín Gutiérrez García from the IMF and Pierre-Laurent Chatain of the World Bank. It reflects the banking supervision practices of Mexico as of end-July 2011. Assessors conducted the evaluation in accordance with the guidelines set out in the Core Principles Methodology issued by the Basel Committee in October 2006 and assessed compliance against both essential and additional criteria.

B. Macroeconomic Background

2. Banking supervision is performed against the backdrop of a sound macroeconomic policy framework that has limited the fallout from the crisis. After a steep fall in output in 2009, owing to its close trade and financial linkages with the United States, Mexico experienced a broad-based recovery, with a resurgence of manufacturing exports as well as renewed strength of consumption. The authorities employed a wide range of countercyclical policies, with the central bank loosening monetary policy while the government applied a careful fiscal stimulus (3 percent of GDP). Other policies included foreign-exchange interventions (the first since September 1998) to promote and orderly functioning of FX markets by reducing volatility and restoring liquidity to FX markets, the use of an FX swap agreement with the U.S. Federal Reserve, and an FCL from the IMF to backstop net international reserves, and an additional liquidity facility allowing a broader range of eligible collateral for emergency liquidity support. In response to the surge in capital flows to emerging markets, the exchange rate appreciated by about 10 percent, significantly less than some other emerging markets in light of the slow U.S. recovery. The record of sound macroeconomic policies is reflected in low inflation—below 4 percent per annum—and sound balance sheets: net public sector debt stands at around 32 percent of GDP in 2011, and household borrowing is about 20 percent of disposable income. As a result, Mexico is investment grade, bolstering its resilience to further shocks.

3. The policy response also relied on macro- and micro-prudential instruments. Related-party lending for banks was tightened (to 25 percent of Tier 1 capital), which—given the large presence of foreign banks in Mexico—sought to gradually reduce the risk that foreign-owned banks would drain liquidity from domestic subsidiaries and add to the credit contraction. Second, forward-looking loan-loss provisioning was introduced on the consumer, mortgage, and states and municipalities portfolios (it is pending for credit to non-financial firms). There was a tightening of corporate disclosure on derivative positions following large losses by the corporate sector. Additionally, the regulatory perimeter is being expanded to cover mortgage providers that faced significant liquidity problems and losses.

4. Despite significant structural reforms, Mexico’s growth has remained low and the financial system shallow. Between 1985 and 2008, the annual average growth in per capita GDP amounted to 1.1 percent. During the last decade, Mexico has faced much stronger competition in international markets of manufacturing products. In addition, low growth is partly attributed to poorly functioning credit markets, a high degree of informality in the economy, and significant market distortions related to lack of competition.23 Mexico also scores high on corruption indices, mainly due to problems at the subnational level, and the legal system is not considered efficient. Measures of financial depth pinpoint to low financial intermediation, with credit to GDP well below peer emerging market economies, at about 20 percent of GDP at end-2010. Mexico’s dependence on oil exports has been in steady decline, although the share of oil revenues in the budget has not come down as rapidly as production due to the increase in international oil prices.

5. Main risk factors for the Mexican financial system are linked to global developments. A slowdown of the U.S. industrial production would have an adverse effect on domestic economic activity and, in turn, on the demand for credit and the quality of loan portfolios. Also, adverse developments in the oil market could result in a contraction of public expenditures due to lower international oil prices, although Mexico has actively hedged its oil exports. Progress has been made in extending the maturity and duration of government domestic debt; this should continue to reduce sensitivity to liquidity shocks in the current context of elevated volatility in global financial markets. Moreover, Mexico may also be affected by a global increase in risk aversion associated with financial distress, as well as spillovers from the European crisis, given the large presence of Spanish banks—operating as stand-alone subsidiaries, not branches—in the financial system.

C. Institutional and Market Structure—Overview

6. Mexican law assigns responsibility for the licensing and supervision of banks to the CNBV, which is also the securities regulator. Assessors observed some overlapping mandates with other authorities such as the BoM, which also has roles in bank licensing, capital and liquidity prudential regulation, and derivatives. The SHCP authorizes financial groups and has dominant presence on the governing Boards of the other agencies, except BoM, which is independent.

7. CNBV uses a mix of on-site and off-site supervision to evaluate the condition of banks. Banks’ off-site and on-site supervision duties are split between two vice presidencies; each vice president has approximately the same number of departments (“Direcciones Generales de Supervision”) and more or less the same number of examiners (130). Since the 2006 FSAP, the CNBV carried out 143 on-site examinations in 43 banks. In the last three years (2008-2010), the CNBV carried out 87 on-site examinations. The CNBV has a coherent process in place for planning and executing on-site and off-site activities, and new manuals have been issued to ensure that these are conducted in a thorough and consistent basis. The CNBV also makes active use of information provided in prudential returns. In addition, the CNBV has established different channels of communication with all levels of bank management.

8. Mexico’s financial system is small and concentrated, with seven banks accounting for more than 80 percent of the system’s assets. Financial intermediation and credit to the private sector are among the lowest in Latin America and well below other emerging markets of comparable income. At end-September 2011, there were 41 banks (bancos multiples), commonly divided into the following sub-groups: (i) 7 large banks, of which 5 are subsidiaries of foreign banks; (ii) 10 banks focused on consumer lending; (iii) 13 corporate banks; and (iv) 11 other investment banks.

9. There are 25 financial groups in which a holding manages several financial entities, usually including one bank. The largest are involved in virtually all financial business (banking, insurance, asset and fund management, brokerage, and pension fund administration). This may raise conglomeration issues (i.e., large banks with insurance company, pension fund, brokerage house, etc.) that, in spite of existing regulations, might lead to product bundling with nontransparent cross-subsidies, deterring entry and competition.24 More importantly, several banks are members of broader mixed-activity groups that conglomerate banking to commercial activities and still need to be regulated and supervised to mitigate association risks.

10. The banking system appears to be sound and profitable, and it has been strengthened considerably in recent years. The financial sector was not seriously affected by the crisis. Private banks appear to be well capitalized, with a system-wide risk-weighted capital asset ratio of 16.5 percent as of June 2011, with Tier I capital of 14.3 percent. Profitability declined sharply in 2008-2009, but has recovered more recently with the improvement in loan quality, a pickup in credit growth, and rapid declines in provisions and write-offs. Bank credit to the private sector has been pro-cyclical, but liquidity seems adequate. The loan-to-deposit ratio is moderate, and banks keep about one-third of their total assets invested in government securities.

11. Legal and institutional weaknesses continue to hamper financial development, despite progress in this area. These include relatively weak property rights, a complex and unreliable insolvency and creditors’ rights framework, an inefficient and corrupt judicial system, and insufficient transparency in financial information, among others. These factors increase bank risks and raise the loss-given default, increasing bank spreads and restricting access, especially to small and medium enterprises. Mexico has passed key reforms, including a Unified Registry for Movable Collateral, and reforms of the Law on Bankruptcy and the Commercial Code. In addition, improvements in credit bureaus and risk modeling have allowed banks, vendors, and other suppliers to better assess credit risks. However, costs of realizing collateral remain high and long.

D. Main Findings

12. Banking supervision in Mexico has been effective and has contributed to reducing the impact on the financial sector of the global financial crisis. The CNBV has achieved a fundamental step forward in implementing a complete Pillar I capital adequacy regime consistently with the Basel Committee standards. Capital ratios have been kept robust above regulatory minimum, supported in a rigorously applied forward-looking loan provisioning regime. The CNBV has successfully supervised adherence to the above two crucial regimes and developed robust means to quantify and monitor key risk measures.

13. Since the last FSAP Update in 2006, the CNBV has made steady progress in advancing a profound internal reorganization. Its supervisory culture is now much more risk-focused. Its internal organization visualizes supervision on institutional, group and by risk dimensions. Systemic supervision is being set up. Progress is also noticeable in the practices applied by the CNBV. The professionalism and quality of its management, and of the staff dedicated to supervision, are outstanding. It has put in place rich off-site systems for supervision and it is implementing changes toward a risk-based approach. However, crucial challenges remain ahead to preserve and to project forward what has already been achieved.

14. Important institutional issues outside the control of senior management in the CNBV threat the sustainability of the above achievements. The autonomy and the resources of the CNBV remain limited. The CNBV is still an agent of the Executive. Most of its key decisions belong to its Board. The Board’s activism to support the agency should provide more leadership required for a modern supervisory agency. The lack of autonomy in funding its activities and in providing reasonable competitive salaries is eroding the key element of supervision: its people. The turn-over of its staff is very high. Head-count seems excessive, but management cannot flexibly restructure it to its needs and use better its decreasing resources. There is also a proliferation of small institutions to supervise and an ever-increasing universe of compliance requirements that overload the CNBV.

15. The legal protection of supervisors needs to be strengthened. Management, Board members, and staff are not accorded statutory legal immunity for the bona fide discharge of official functions, hindering enforcement; former employees should also be covered. Legal protection takes on added importance in the context of implementing risk-based supervision in a civil code legal environment, where the main challenge is to shift the responsibilities for identifying, measuring, controlling and monitoring risks to the Boards of supervised institutions, which requires prompt reaction by the supervisor to new accumulations of risk. Hence, CNBV has to strike a delicate balance between rules and discretion: on the one hand it has an interest in codifying the circumstances in which discretion will be exercised to minimize challenges to its authority; on the other, it needs the flexibility to deal promptly with novel situations using qualitative judgments than carry greater legal risk—rather than quantitative, compliance-based indicators. Amendments to the legal framework will be needed to add these provisions.

16. Pillar 2 of the capital adequacy regime remains to be adopted, including publication of CNBV’s supervisory review process and associated standards. The strategic decision to adopt Basel II and a more risk-based approach to supervision makes critical the resolution of the issues discussed on autonomy and resources. Until now, the CNBV has focused on implementing the quantification of Pillar 1 risks and has advanced several internal elements of its supervisory review process under Pillar 2. However, several supervisory practices and associated standards deserve attention to complete Pillar 2.

17. Further actions are recommended to strengthen a robust regime for “downward” consolidated supervision of banking groups. There are 25 financial groups regulated by the SHCP being supervised by the CNBV. Asymmetries in the regulations across the financial sector have been evaluated and need now to be mitigated. The CNBV should be given powers to regulate all financial groups where banks are significant members. Prudential regulation, especially risk limits, and risk governance and management standards should be extended to the level of the holding company in regulated groups. More importantly, mixed-activity groups that perform banking and other financial activities together with commercial activities have to be regulated, providing effective powers to the CNBV to assess and resolve risks to banking and other financial activities from inter-group transactions. These actions will complete current consolidated supervision practices, reinforcing the CNBV’s authority to practice “upward group” consolidated supervision.

18. The assessment found other areas where the regulatory and supervisory framework should be further improved. AML supervision has been substantially strengthened. However, challenges remain and key decisions need to be made to bring Mexico to higher levels of compliance with international standards. Enforcement should become more focused in responding to substantive issues rather than reacting solely to breaches of compliance. Moreover, whilst operational risk is well regulated, its supervision is yet not fully operational, and needs to be performed more systematically at both macro and solo level, including systematic development of risk indicators.

19. Like for other risks, the assessors believe that there is a general need to provide further guidance to the industry regarding how the CNBV expects the institutions to implement in practice the mandated prudential standards. This, a clear communication of the supervisory process and on how the CNBV intends to escalate its response to changing risk profiles will complete its journey to an approach that judiciously combines elements of compliance, safety and soundness, and risk-based consolidated supervision.

20. The following summarizes the main findings of the detailed assessment of compliance with the BCP.

Objectives, independence, powers, transparency and cooperation

  • Objectives, Autonomy, Powers and Resources (CP1)

    • The legal framework clearly provides the objectives and powers for CNBV. The legislation also provides the authority to cooperate with foreign supervisors. The legislation grants CNBV broad powers to perform its functions. Information exchange agreements have been signed with a number of countries and home-country supervisors are given access to their institutions.

    • There are concerns, however, particularly with regards to autonomy and independence. There is not an appropriate provision in the law to provide adequate legal protection to the CNBV and its staff for actions taken and/or omissions made in good faith while still in active service. With respect to CNBV’s resources, assessors are not confident that there is a full understanding by CNBV’s Board of the complexities, incremental development, and demanding work load and resources needed to adopt a fully fledged Basel II risk-based approach to regulation and supervision.

  • Licensing and structure (CPs 2-5)

    • The term “bank” is defined in the law, as are the permissible activities. In practice however, several non-authorized financial entities are operating in the country and are illegally collecting deposits. It is difficult to evaluate the magnitude of the problem. The CNBV published a list of 14 entities that were collecting deposits from the public without proper authorization and outside the supervisory umbrella of CNBV. Another 39 entities had been identified earlier. Some of these are clearly misleading their customers by improperly using the name “bank”, e.g., Institute de Banca y Ahorro, Interbanc, Capitalbank, Inverban SA. The authorities have issued warnings not to carry out transactions with these entities; according to CNBV, several initiatives are under review to sanction these entities and their owners and managers.

    • The minimum requirements for establishing a financial institution in Mexico are clearly stated in the Banking Law (LIC). The new licensing regime has been conceived to provide CNBV with a full range of licensing, regulating and supervisory powers. However, the fact that a license requires binding favorable opinion of BoM may hinder CNBV discretionary power. The mechanisms for fit-and-proper tests are well processed but additional criteria regarding the origin of capital or a clear definition of the Ultimate Beneficiary Owner (UBO) would be desirable.

    • There is a legislative requirement and a well-defined process for reviewing and approving transfer of “controlling” ownership of a bank. Assessors could not find an obligation requiring banks to notify the supervisor as soon as they become aware of any material information which may negatively affect the suitability of a major shareholder.

    • CNBV has the power to review major acquisitions or investments by a bank, including the establishment of cross-border operations, and confirming that corporate affiliations or structures do not expose the bank to undue risks or hinder effective supervision.

  • Prudential Regulations and Requirements (CP 6-18)

    • The capital adequacy regime for banking in Mexico is in transition toward full implementation of the regime endorsed by the BCBS under its Basel II framework. The CNBV is also considering the adoption of some components of the Basel III framework, as well as to fully implement the Pillar 2 of the former Basel II regime. In addition, the CNBV has put in place mechanisms to entice institutions to operate with higher capital than the Basel minimum requirements. Authorities are advised to implement fully the Pillar 2 approach and the use of stress testing to set capital buffers. Inquiring institutions to operate an internal capital adequacy assessment process (ICAAP) would also be desirable.

    • Regarding risk management processes, further actions were found necessary in several areas. In particular, authorities are advised to communicate explicit standards for directors to implement the internal capital adequacy assessment process (ICAAP) governing forward looking capital planning. A change in the law to require consistent risk management standards at group level is also recommended.

    • Credit risks (CP8) are correctly identified and supervised. Some actions are suggested to enhance the effectiveness of implementation. Assessors are of the opinion that the regulatory framework for granting and administering credit activities and for classifying loan quality and provisioning for loan losses is sound and very complete.

    • Limits on large exposures and on connected lending are in place and considered adequate. They can be further reinforced, including mitigating concentration risks, by implementing several actions like, for example, amending the LIC to require observance of lending limits on a fully consolidated basis at holding company level and extend requirements to unregulated mixed-activity holdings.

    • On oversight of country risks, the CNBV believes that country and transfer risks are not significant risks to which the local institutions are exposed. Accordingly, these risks have not been explicitly conceptualized yet in the general provisions of the regulation governing risks and risk management with the same depth as other financial risks. There are not specific requirements set by CNBV regulation regarding the manner in which information, risk management and control system are expected to capture and to report country and transfer risks.

    • Market risks’ supervision is properly carried out. The CNBV determines periodically the suitability of market risk management processes and applicable policies through annual onsite reviews of the institutions’ activities and the examination of the annual reports of the risk management and internal audit units. With regards to liquidity risks, the country is preparing a major overhaul of the liquidity standards in order to implement the proposals of the BCBS under the Basel III regime. The CNBV has organized a quantitative impact study to evaluate the implications and details of the new liquidity regulations. Subject to the final phase-in period granted for implementation, the new liquidity regulations are expected to be adopted during the last quarter of 2011.

    • On operational risks (CP 15), despite a clear regulatory regime and progress made in terms of methodologies, supervision of these risks is still in a transitional phase. As of today, operational risks are approached indirectly through the supervision of internal controls and risk management. CNBV’s objective is to have operational risks’ oversight fully integrated into its supervisory process by 2012.

    • Internal control and audit have been an important focus for CNBV. The LIC provides a comprehensive regulatory framework for internal controls as well as for internal auditing. The CNBV has also spent a lot of energy and resources to formalize processes and methodologies to better oversee internal control functions in banks. Nevertheless, some improvements could be considered like, for example, the conduct of a full cycle of inspections across the industry on internal controls. The development of some metrics to better evaluate and monitor the intensity of banks’ audit efforts would also be useful.

    • Many challenges are still ahead for supervising AML/CFT and key decisions will have to be made to bring Mexico to a higher level of compliance in terms of preventing abuse of financial services. The legal and regulatory AML framework for banks is adequate and new regulations have recently been issued in relation to other financial institutions. The supervisory mandate of CNBV is clearly defined and CNBV enjoys full power to inspect banks’ premises and access all confidential information. Excellent cooperation has also been developed with both national and international counterparts. Further, several initiatives are underway to reinforce off-site surveillance, in particular through new reporting and risk assessment and rating tools. Nevertheless, the CNBV authorities will have to increase significantly human resources in the AML area and enforce AML regulations more effectively by using a broader range of sanctions in a more systematic way.

  • Methods of Ongoing Supervision (CPs19-21)

    • The quality of on-going supervision is good and CNBV has made great efforts to increase the effectiveness of its oversight. However, the supervisory approach needs to be further improved, particularly in relation to consolidated supervision. Along the same lines, it is particularly recommended to design a supervisory cycle along which all significant activities and central control functions should be inspected in full scope. A legal provision requiring banks to notify the CNBV of major changes planned in business activities, changes in structure, adverse developments and breaches in regulations is needed. Also, there is no particular mechanism that allows CNBV to evaluate risk accumulation at system level. Indeed, due to the fact that CNBV has not fully implemented Basel II, supervisory techniques do not allow staff to have an overview of the risks. It would be useful to speed up the migration toward Basel II so that CNBV can gain a more horizontal view of problems across the industry.

    • The architecture for on-site and off-site supervision has changed significantly since the 2006 FSAP. As part of this process, the distribution of portfolio of banks and other related FIs among the different units has been modified. Supervisory techniques have been improved through the creation of new tools for both on-site and off-site purposes. A dedicated Vice Presidency has been created to lead all AML/CFT functions, including training of other CNBV staff. Better coordination with other financial supervisors has also been developed. This reform, however, is in a transition phase. Several projects are still on-going. New manuals and methodologies have not been completely finalized (e.g., for operational risks) or are in a testing phase (e.g., for AML/CFT). Further progress is also needed to fully incorporate operational risks as well as reputational risks.

    • CNBV receives a fairly comprehensive set of information on banks and other nonbank financial institutions. The CNBV has developed a sophisticated system for collecting, reviewing and analyzing prudential reports and statistical returns from banks. The technological platform designed for regulatory reporting allows proper management of information comparable across institutions and sectors, and facilitates the analysis and development of aggregated statistical information.

  • Accounting and Disclosure (CP 22)

    • According to Mexico’s regulations, banks have to maintain adequate records drawn up in accordance with accounting policies and practices. As for external auditors, Mexico should strengthen enforcement mechanisms when CNBV believes that the external auditors do not have the requisite expertise, independence, or fail to follow professional standards. It is also desirable to set stronger rule for rotation of auditors. Lastly, Mexico is advised to complete in a reasonable timeframe convergence with IFRS.

  • Corrective and Remedial Powers of Supervisors (CP 23)

    • The corrective tools in Mexico are consonant with international best practices but its implementation is not as effective as it should be. Since the last FSAP, major improvements have been made to equip the country with a framework that permits timely corrective actions against banks. Remedial measures range from informal instructions directing a particular response by management, to the severe action of intervention and, if needed, liquidation (through the suspension of the institution’s license). Nevertheless, the CNBV has a long established tradition of forbearance. Fieldwork showed that the CNBV has been rather reluctant to resort to harsh penalties as a means to achieving better market discipline. Enforce decisions more effectively, define clear and well articulated criteria to support sanctions and improve the way sanctions are published are the most important reforms to be engaged.

    • Mexico’s financial sector safety net has been substantially upgraded since the last FSAP, but there are some areas for further improvement—legal reforms are currently being prepared. Improvements include a more streamlined bank resolution process, clarification of the causes for license revocation, and introduction of a distinction between systemic and nonsystemic banks.

  • Consolidated and Cross-Border Banking (CPs 24-25)

    • In the area of consolidated supervision, improvements are needed to fully meet international standards. In particular, authorities may wish to amend the law provide full powers to the CNBV for regulating financial groups, in addition to its current supervisory function. Moreover, CNBV should be equipped with the power to fully capture other forms of financial conglomeration, such as mixed-activity and horizontal groups. On the international cooperation front, Mexico has made considerable efforts to establish effective mechanisms for cross-Border supervision. An intensive policy has been pursued to consolidate home-host supervision through the signing of multiple MOUs and the participation in supervisor colleges, among others.

Annex Table 10.

Summary of Compliance with the Basel Core Principles

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Annex Table 11.

Recommended Action Plan to Improve Compliance of the Basel Core Principles

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E. Authorities’ Response

21. Mexican financial authorities agreed, in general, with the conclusions, observations and recommendations of the assessment regarding the implementation of Basel Core Principles in the Mexican financial sector. Financial authorities do not consider that their respective mandates overlap under an appropriate understanding of the Mexican legal system that clearly defines the respective powers granted to such authorities, and the close coordination maintained in practice by such authorities. Most of the written comments provided by the authorities on the preliminary draft were included in the final report. Authorities consider that the exercise represented a good opportunity to discuss both strengths and weaknesses on the banking system, as well as to draw attention to main issues that should be addressed in the future.

22. The authorities found the assessment both comprehensive and useful. Also, they believe that assessors’ advice and proposals will become part of their agenda for the upcoming years, and that the assessment rightly identifies opportunities for improvement. The report identifies the main concerns that the authorities currently have. Regarding the comments on CNBV independence, authorities acknowledge that improvements to corporate governance, in particular achieving a more balanced Board composition are desirable, but would like to note that the current arrangement has so far worked adequately since the Ministry of Finance has relied on technical considerations when deciding on matters of regulation and supervision. Also, they want to mention that there is not enough evidence to affirm that the current salary levels at CNBV are inadequate to attract high-caliber staff; what is a cause for concern is that they have been frozen in the last several years. If this trend is not reversed soon, the human capital of the institution will be severely impaired. Authorities are concerned that there is a risk that when implementing legal changes to grant CNBV more autonomy, an adverse outcome can occur that results in the institution being subject to political interference by Congress. However, authorities agree that providing a fixed term for the President of CNBV (with well-specified reasons for removal), and to allow CNBV to keep the fees collected is desirable.

23. In addition, they agree that it is necessary to review, improve, standardize, fully document and formalize supervisory procedures at the CNBV and will move forward to address these issues, although they consider that lack of standardization and formalization does not reflect in any way the quality of ongoing supervision of banks. Also, the authorities agree that high concentration of loan portfolios might raise concerns, although they consider that this should not be seen as a problem unique to the banking institutions and credit markets, but that should be considered as a reflection of a feature of the Mexican economy as a whole. Authorities share the assessors’ point of view regarding that some enhancements should be made to CNBV’s powers in some matters like the ability to take some discretionary decisions, to impose fines and to publish information on legal proceedings, but it should be noted that some of these powers might not be easily included in CNBV’s regulation due to the characteristics of the Mexican legal framework, considering the civil code and the law of judicial appeals and injunctions (amparos). On the other hand, they acknowledge that there are several opportunities to enhance consolidated supervision in Mexico, but will stress that to do so it is necessary to issue a Law to regulate and supervise financial conglomerates as well as economic conglomerates that contain a banking institution.

24. Regarding the adoption of Basel III in Mexico, they agree that one main challenge faced by CNBV is the full and thorough implementation of Pillar II. Nevertheless, it should be noted that significant progress has been made on current regulation on Pillar I -Mexico will be one of the early adopters-- and that important steps have been taken to complete implementation of all three pillars, although there are still several issues to address that are already part of the authorities’ agenda for the upcoming year.

25. With respect to the possible overlap between different authorities, while the law sets forth similar goals for the BoM and the CNBV (inter alia, to maintain and promote the sound development of the financial system) it grants each of such authorities different and distinctive powers to achieve such objectives. As an example, the CNBV is in charge of issuing prudential regulations and the BoM is responsible for defining the characteristics of transactions that banks can carry out. Furthermore, in respect of derivatives negotiated by banks, the BoM has the legal power to issue technical and operational regulations applicable to such transactions. In any case, both authorities have observed a coordination agreement between them to avoid any duplication in the regulations or in requesting information from financial institutions. The authorities hold frequent consultations and discussions with respect to regulations applicable to issues that may be covered by both authorities within their respective areas of competence. Moreover, with respect to the supervision carried out by each authority, coordination agreements ensure that any actions taken in connection therewith by one authority supplements the work carried out by the other. Concerning the participation of the central bank in the licensing of banks, authorities do not consider that the favorable opinion from such authority that is needed to grant a bank license could impinge on the process carried out by the CNBV. This is because the analysis carried out by the BoM for the opinion it needs to provide to the CNBV reinforces the analysis that the CNBV conducts. Such participation by the central bank also contributes to an appropriate and deeper fit and proper analysis that needs to be conducted with respect of any new financial institution. In any case, the role that the central bank may perform as lender of last resort lays down an appropriate basis for the intervention of the BoM in the bank licensing process.

Annex II. Iosco CORE Principles—Summary Assessment

A. Introduction and Methodology

1. The assessment was conducted during the IMF/World Bank Financial Sector Assessment Program (FSAP) mission to Mexico during the period September 7-21, 2011, by Tanis MacLaren, an external technical expert employed for this purpose by the IMF. The assessment was carried out using the 2003 IOSCO Methodology for Assessing Implementation of the IOSCO Principles (the Assessment Methodology). The assessment was based on information available as of September 2011.

B. Institutional and Market Structure—Overview

2. The Comisión Nacional Bancaria y de Valores (CNBV or the Commission) is a supervisory authority with broad authority to regulate certain aspects of the capital markets in operation in Mexico. The CNBV has regulatory authority over a broad range of securities market participants, including securities firms, self-regulatory organizations, securities exchanges, market infrastructure providers (central counterparties and securities depositories), external auditors, public issuers, rating agencies, price vendors, and collective investment schemes. The CNBV also is responsible for the supervision of banks, development banks and agencies, cooperatives, credit unions and other deposit-taking institutions. The CNBV reports to the SHCP.

3. The Comisión Nacional para la Protectión y Defensa de los Usuarios de Servicios Financieros (CONDUSEF) is the consumer protection agency in the jurisdiction. Its responsibilities include promoting financial education, setting certain consumer protection requirements, and receiving and responding consumer complaints about financial services firms. CONDUSEF lacks the resources and powers to function effectively as a consumer protection authority. It has no power to order a financial services provider to compensate an investor for losses or to arbitrate a dispute. The weakness of this agency is of concern as gaps in the consumer protection regime may negatively affect investors and undermine confidence in the system as a whole.

4. The regulator’s responsibilities, powers, and authority with respect to the securities market are established by statute. The CNBV was created as a regulator under the Ley de la Comisión Nacional Bancaria y de Valores (LCNBV). The LCNBV gives the Commission the authority to administer, enforce, and give effect to the provisions of the laws related to financial services in the jurisdiction. In the securities markets, the two key laws are the Ley del Mercado de Valores (Securities Market Law-LMV), which was effective as of the end of 2005, and Ley de Sociedades de Inversion (Investment Companies Law-LSI), which dates from 2001. These laws are supplemented with detailed secondary legislation in specific areas, including the Securities Firms Rules, Issuers Rules and Sociedade de Inversion (SI) Rules.

5. The Commission’s responsibilities, powers, and authority with respect to the derivatives market rely on a combination of the general authority granted to SHCP, the central bank and the Commission to regulate financial markets and their participants in Mexico. These provisions do not refer to derivatives specifically. The responsibilities and authority for regulation is split in practice among the CNBV, the SHCP, and BoM. All three entities have the authority to issue secondary legislation/rules for this market, which creates opportunities for duplication, overlap, and conflict in the provisions that govern.

6. There is one stock exchange (Bolsa Mexicana de Valores—BMV) and one derivatives exchange (MexDer) operating in Mexico under permissions granted by the Federal Government. Public offerings of securities in the jurisdiction must be listed on the BMV. Trading in equities or listed derivatives is required to take place on the exchanges. Trading in some fixed-income instruments and most derivatives takes place over the counter, often through electronic facilities operated by authorized inter-dealer brokers. The BMV, MexDer, the central securities depository (INDEVAL), and the central counterparties (CCV and Asigna) are all part of the BMV Group, a public company self-listed on the BMV. The BMV is a member of the World Federation of Exchanges.

7. The BMV has a very low number of listings and the liquidity of these is limited for all but the very largest companies in the domestic market. There are only 154 listed domestic companies and ETFs. There has been virtually no growth in the number of listings over the past five years, while market capitalization has increased 30 percent and trading volumes were up 131 percent (to US$453 million and US$79,986 million, respectively). Trading is concentrated in the largest issuers, with the five most active issues making up 68 percent of total traded value in 2011.25 Only about 30-40 domestic stocks are considered liquid.26

8. The growth in the BMV for listings has been in foreign equities (and some ETFs) that may be listed on the BMV for trading. These instruments are listed on the Sistema International de Cotizaciones (SIC). These securities have not been publicly offered in Mexico; are not listed in the Registro National de Valores (National registry of securities-RNV); and are listed on foreign securities markets recognized by the CNBV or whose issuers have otherwise been approved for listing by the CNBV. The CNBV has recognized several foreign stock markets viewed as having comparable standards, such as disclosure rules. These exchanges include NASDAQ, the New York Stock Exchange, the London Stock Exchange, the TSX Group, Inc., and the Deutsche Börse AG. Only qualified investors (institutions and high net worth individuals) may purchase securities listed on the SIC. Trades executed through the SIC settle through INDEVAL and are subject to the same operational rules and regulations as other trades executed on the Exchange. The number of listings has increased by more than 200 percent over the last five years (from 205 to 649), with the largest growth in exchange traded funds (ETFs), up 471 percent (from 55 to 314). As for the domestic market, the trading on the SIC is highly concentrated in the five most active listings, with these ETFs making up 58 percent of the total traded value in 2011.27

9. Much of the activity on the BMV comes from program trading orders that are placed to take advantage of price asymmetries between markets. According to the BMV, up to 90 percent of total orders in the cash market represent program trading orders. Most are cancelled before the trade is completed. The ratio of orders to trades is about 20 to one. The BMV has added significant systems capacity in recent years to handle the volume of orders. Its trading rules and the related CNBV Securities Firms Rules have recently undergone significant changes to modernize the rules regarding trading, to permit direct market access to institutional through member brokers, and to facilitate cross trading.

10. Growth of listings and trading on MexDer has been mixed. The market has experienced growth in the number of listed options (up 450 percent—from 980 to 5,468) and options trading volumes (up 36 percent) over the past five years, while the number of listed futures and trading volume has declined (11 percent and 85 percent, respectively). The values of exchange-traded instruments show a similar pattern: options trading values are up 83 percent and futures are down 85 percent. The overall decline on the futures side is largely because of a decline in listing and trading interest rate related instruments. MexDer officials indicated virtually all trading on the exchange represents trades by institutional investors or proprietary trading by the members.

11. As with the stock and derivatives markets, the growth in the collective investment scheme (SI) market has been slow. The number of SIs has grown only marginally over the past five years (9 percent). Assets under management have grown much faster to US$102 billion—up almost 60 percent over the same period. Most of the growth, both in the number of funds and in assets under management, is in equity funds, chiefly owing to their greater flexibility. Debt funds may only invest in debt instruments, while equity funds only have to have 20 percent invested in equities. In fact, most equity funds are operated as balanced funds, with a varying percentage of the funds invested in both types of securities. In the two years since the crisis, SIs have seen increased flows of funds that various market participants said reflected the fact that investors in SIs lost less money during the crisis than those who invested directly into the markets.

12. The Mexican system makes limited use of self-regulatory organizations (SROs) in carrying out the oversight of market participants. The exchanges and central counterparties are SROs automatically under the LMV. There are two other SROs—the Asociacion Mexicana de Asesores Independientes de Inversiones (AMAII), a voluntary association of independent investment advisors and the Asociacion Mexicana de Intermediarios Bursatiles (AMIB), an association to which securities brokers and SI operators and distributors must belong. These two associations operate more as trade associations than SROs. The regulatory functions the SROs carry out vary by SRO and run from virtually none for AMAII and AMIB to MexDer that conducts regular examinations of its members.

13. There are a relatively small number of authorized market intermediaries operating in Mexico and the numbers are static. There are 41 commercial banks, 6 development banks, 35 securities firms, 41 mutual fund operators, and 5 mutual fund distributors28 as of the end of 2010.

14. The number of staff at the CNBV has declined and turnover at the senior level is high. Staff salaries have been frozen for almost a decade, resulting in a decline in compensation of about 40 percent on a real basis, while at the same time demands on Commission staff have increased. Salary levels are now well below comparable positions in the private sector. This has had a predictably negative effect on attracting and retaining experienced and skilled staff. As a result, many experienced staff, particularly at senior levels, has left the CNBV for the private sector. This loss in expertise and institutional memory is an important problem that needs to be addressed before it hampers the CNBV’s effectiveness in carrying out its mandate.

C. Preconditions for Effective Securities Regulation

15. The preconditions for effective supervision (a stable macroeconomic environment, sound legal and accounting framework, and effectiveness of procedures for the efficient resolution of problems in the securities market) appear to be in place in the jurisdiction. As in many jurisdictions, the bankruptcy of market intermediaries is governed by the same legislation that governs any other corporate bankruptcy and it operates very slowly. While client assets held at the central depository are protected, it is not clear how the default procedures of the central counterparties would work in the event of a brokerage firm or large financial conglomerate bankruptcy.

D. Main Findings

16. Principles 1-5, principles relating to the regulator: The CNBV has clear statutory authority over and responsibility for the securities markets. Its authority with respect to derivatives markets is less clear-cut and needs to be rectified by the passage of express legislation. The operational independence of the agency is compromised by a lack of resources, the fact that 75 percent of the Board of Governors are appointed by the SHCP and may be dismissed without cause at any time, and the lack of statutory immunity for the Commission, its Board and staff members. Persons affected by decisions of the Commission are afforded a full range of protections, including the right to be heard, to written reasons and to rights of appeal. The laws should be amended to permit the conduct of surprise inspections of any regulated entity and to provide additional powers for the Commission with respect to enforcement matters, including enhanced transparency and the ability to settle matters. The staff is very professional and is subject to detailed conduct rules. Market participants uniformly praised the quality and openness of the CNBV staff.

17. Principles 6-7, principles relating to self-regulation: The Mexican system makes limited use of self-regulatory organizations (SROs) in carrying out the oversight of market participants. The regulatory functions the SROs carry out vary by SRO and run from virtually none to full rule-making and conducting regular examinations of its members. In all cases, the CNBV retains full authority to oversee SRO members. There is an appropriate SRO supervision program in place that varies by the nature of the SRO in question. The exchanges and central counterparties are subject to regular on-site inspections and their rules are subject to prior review and approval. MexDer has a compliance officer who is in charge of the surveillance of its members.

18. Principles 8-10, Principles relating to enforcement of securities regulation: The Commission has broad inspection, investigation and surveillance powers, but lacks the power to conduct inspections of regulated entities without notice. It has powers to investigate and take action against anyone who breaches the laws it administers. If there is evidence of possible illegal conduct, investigation inspections may be conducted with same day notice. The Commission carries on active inspection and enforcement programs. Both on-site and off-site reviews are performed of regulated entities. Market surveillance is performed at the exchanges and at the CNBV in parallel. There are some gaps in enforcement powers that should be filled and the sanctions available across the laws administered by the Commission should be brought into alignment. Fine levels should be reviewed to ensure they are consistent and high enough to be effective deterrents. The provision restricting disclosure of investigations and enforcement actions should be revised to permit fuller and earlier transparency.

19. Principles 11-13, Principles for cooperation in regulation: The Commission has the ability and capacity to share information and cooperate with regulators, both domestically and internationally, subject to the general requirement that there be an MOU in place. It can share confidential information with any other country through an MOU. It is a signatory to the IOSCO Multilateral MOU and to many bilateral MOUs with it counterparts in key jurisdictions, such as the United States, Brazil, Canada, United Kingdom, Argentina, Peru, El Salvador, Venezuela, Panama, as well as Spain, Germany, the Netherlands, and various other European countries.

20. Principles 14-16, Principles for issuers: Extensive requirements are in place for offering and disclosure documents. Public offering of securities (debt, equity or collective investment schemes) are required to be listed on the BMV and are subject to the exchange’s listing standards, in addition to the requirements set out in the LMV and the Issuers Rules. Both the BMV and the CNBV conduct reviews of the prospectus of the issuer. Continuous disclosure documents are made public through the facilities of the exchange and the Commission. Investors are treated equitably with respect to voting, access to information and the ability to participate in any takeover bid. Full information must be provided for any takeover bid. Information is publicly available regarding shareholdings of directors, officers and other insiders of the corporation. Accounting and auditing standards are in place and auditors are subject to oversight by the CNBV and detailed independence standards apply. By the beginning of 2012, public issuers will have to prepare their financial statements using International Financial Reporting Standards (IFRS) and be audited using International Standards of Audit (ISA). The publication of annual audited financial statements could be more timely and the access to information about shareholder meetings should be enhanced by requiring electronic publication of the materials.

21. Principles 17-20, Principles for collective investment schemes: The framework for regulation of SIs is largely compliant with the Principles. All SIs and their operators and distributors are subject to authorization and reporting requirements. All funds offered to the public must be registered with the CNBV, which process includes the review of a detailed prospectus. Funds must be established as corporations, with assets segregated from those of the operator and distributor. All SIs and their operators and distributors are subject to both off-site and on-site supervision. Any asset of an SI that may be held at a central depository must be so held. The central depository for securities is independent. The fund’s securities and its assets are subject to valuation by third party service providers (valuation companies and price vendors) that are required to be independent of the fund and its operator. Continuous disclosure of information and prices is provided through the fund or its distributor’s website. In addition, prices must be reported daily through the BMV’s system. The CNBV has the authority to suspend new placements, but no authority to order a fund to suspend or resume redemptions.

22. Principles 21-24, Principles for market intermediaries: A framework is in place for licensing and to apply on-going requirements for market intermediaries. Applicants are subject to detailed reviews before being authorized. There are initial and ongoing risk-based capital requirements that are based on a simplified version of Basel II and that address market, credit and operational risk. Liquidity is subject to separate testing but no specific capital requirements apply. Requirements regarding capital calculations and prompt (early) reporting of deficiencies by market intermediaries should be more rigorous. Market intermediaries are required to have extensive systems of risk management and internal controls in place. Client assets must be held in segregated accounts at central depositories. Intermediaries are required to know their clients and make suitable recommendations for those clients. The rules regarding conflicts of interest need improvement. There is no plan in place to address the failure of a broker; however, the law gives the CNBV broad powers to take action against a failing firm and require it to reduce its business, raise capital and give notice to its clients.

23. Principles 25-30, Principles for the secondary markets: Exchanges are subject to authorization by the SHCP with the advice of the CNBV (and BoM with respect to derivatives). Alternative trading systems for listed instruments are not permitted. The MexDer and central counterparties are subject to minimum capital requirements set by the authorities via MexDer’s Mandatory Rules. The SHCP may set capital requirements for the stock exchange, but has not done so. Market surveillance is performed at the exchanges and the CNBV in parallel. The CNBV has a comprehensive oversight system for exchange supervision that includes on-site examinations and off-site reviews of rules and other matters. The Commission may suspend a stock exchange and the SHCP has the authority to revoke the authorization of any exchange. There is both pre-trade and post-trade transparency of prices of shares in real time, but not for fixed income securities. The rules against market abusive transactions are extensive and there are mechanisms in place to detect improper conduct. Trades on both BMV and MexDer are cleared and settled through central counterparties that have detailed and transparent provisions designed to protect the markets against a default by any participant.

Annex Table 12.

Summary Implementation of the IOSCO Principles

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Authorities’ response to the assessment (CNBV)

24. Mexican financial authorities agreed, in general, with the conclusions, observations and recommendations of the assessment regarding the implementation of IOSCO Principles in the Mexican financial sector. Most of the written comments provided by these authorities on the preliminary draft were included in the final report. Authorities consider that the exercise represented a good opportunity to discuss both strengths and weaknesses on securities markets, as well as to draw attention to main issues that should be addressed in the future. Authorities believe that the evaluation of the principles is fair and objective.

25. The authorities found the IOSCO report both comprehensive and useful. Also, they believe that assessors’ advice and proposals will become part of their agenda for the upcoming years, and that the assessment identifies improvements that should be implemented in order to enhance the performance and development of securities markets. The report properly addresses main concerns, which are shared by authorities. On this behalf, they agree that two relevant weakness of Mexican securities market are its reduced number of listings and its low level of liquidity and, as a consequence, they welcome advice on how to move forward. Also, they agree that high concentration of portfolios might raise concerns, although they consider that this should not be seen as a problem unique to the securities market, but that should be considered as a characteristic of Mexican economy as a whole. Authorities also share the assessors’ point of view regarding that some enhancement should be made to CNBV’s powers to publish information regarding investigations and sanctions, in order to improve transparency and strengthen market discipline.

While they acknowledge that Mexico lacks a Law to regulate the domestic derivatives market, they believe that most of the recommendations suggested in the report might be implemented through secondary regulation, due to the fact that the SHCP, Banxico, and CNBV have broad powers to do so.

26. Regarding the assessment on Principle 14 (There should be full, timely and accurate disclosure of financial results and other information that is material to investors’ decisions) they believe that Mexico complies with most of the standards of this principle. In fact, compliance with this particular principle is similar to that observed in the most developed markets. Therefore, authorities are of the opinion that this principle should be assessed as Broadly Implemented (BI).

ANNEX III. Iais Core Principles—Summary Assessment

A. Introduction and Methodology

1. This is a full assessment of the insurance regulatory and supervisory system in Mexico. It was produced in the course of a joint IMF, World Bank mission in Mexico during September 8–21, 2011 under the Financial Sector Assessment Program (FSAP), and carried out by Rodolfo Wehrhahn (MCM). This assessment update was conducted with regard to the circumstances in place and the practices employed on September 21, 2011. A new insurance law is expected to be submitted to congress in September 2011. The long process in preparing this new Insurance Law (LISF) gaining consensus of the different stakeholders will certainly result in an improvement in compliance with the core principles, and those improvements have been referenced in the assessment. However, these improvements are referenced when appropriate, the lack of the corresponding secondary regulation and implementation prevented the assessor to take LISF in full consideration for this assessment.

2. The update assessment was carried out using the International Association of Insurance Supervisors (IAIS) core principles. The industry analysis focuses on both life and nonlife insurance companies and excludes the surety business that is also supervised by the CNSF. When relevant for the insurance sector, the pension fund industry is mentioned, but a formal assessment of the sector is outside the scope of this work. Sources of information included meetings with senior officials and staff from SHCP, CNSF, the consumer protection agency (Comisión Nacional para la protección y defensa de los usuarios de servicios financieros, CONDUSEF), as well as with market participants, trade associations and professional bodies. The assessor had access to a complete self assessment on the Insurance Core Principles (ICPs) and a detailed response produced by the SHCP and CNSF to a questionnaire. Official versions of the General Law of Insurance Institutions and Mutual Insurance Societies (LGISMS) and the insurance contract law (LSCS), as well as the relevant Articles in the CNSF bylaws and Internal Ordinances (Circular Única de Seguros, SSLO) were also available to the assessor.

B. Main Findings

3. A comprehensive legal and institutional framework supports the regulation and supervision of the insurance sector. Insurance business regulation and supervision are carried out by several entities. The SHCP is in charge of setting the insurance policy and introducing primary regulation, always with strong input from the CNSF that issues the secondary legislation and supervision. CONDUSEF is entrusted with consumer protection in the financial sector.

4. The authorities constantly update the legal and supervisory framework to align it with international best practice. A major overhaul of the insurance law is in the final stage to be presented to congress. The new proposed law will incorporate the recent international developments toward a risk sensitive solvency regime and an intrusive and continuous supervision. Further, a single Rules Book has been developed to harmonize and allow a comprehensive overview of the supervision in one source.

5. The level of compliance with the IAIS principles and the CNSF reputation and credibility are high. With only 2 partially observed and 9 largely observed principles out of the 28, Mexico shows a high level of compliance in a post-crisis environment. Transparent processes and an open dialogue with the industry have created the positive reputation of the agency. The powers allocated to the CNSF have been used according to the procedures with very low level of forbearance. Regular on-site inspections are strongly supported by a detailed off-site analysis. Data is collected at sufficient granularity and used continuously and effectively for supervisory and market analysis work. The group supervision needs to further develop, but the low complexity and limited number of groups in the insurance sector does not appear to make this a priority.

6. Significant steps have been taken in preparation for achieving further increased observance of the IAIS principles. The promulgation of the proposed LISF is strongly recommended to significantly increase compliance with the IAIS core principles. Principles 6, 9, 10, 15, 16, and 27 will be observed, should LISF be passed in its proposed form and properly implemented. The full allocation of the currently collected supervisory fees would allow continued well functioning of supervision, including the planned regulatory changes to the solvency regime.

7. The fiscal budgetary constraints are putting pressure on the functioning of the supervisory authority. As a result of the last years’ wage freeze, it has created a level of salaries in the CNSF that, when compared with the industry, is resulting in a drain of talent and hindering the ability to acquire needed expertise. The future performance of the CNSF is compromised.

8. Continuity of the CNSF needs to be strengthened. The lack of a procedure to appoint the Chairman of the agency creates uncertainty, which could impact on the operational independence of the CNSF. The appointment mechanisms of the Chairman and key members need to be established and the reasons for removal need to be publicly disclosed when exercised.

9. Consumer protection and financial literacy need to be further developed. The efforts initiated by CONDUSEF are all in the right direction and create a better understanding of insurance products and consumer rights. However, the impact has been limited as indicated by the broadly similar number of reconciliations over the last years and a lack of arbitration activity. The fines and preventive actions observed in the market have limited dissuasive power and need to be enhanced.

Conditions for Effective Insurance Supervision (ICP 1)

10. The conditions for effective supervision are largely met, considering current development of the insurance sector. The legal and judicial system is still struggling to gain full acceptance by the market and public in general. CONDUSEF’s conciliation/ arbitration to deal with disputed claims is a step in the right direction, creating a greater acceptance of the insurance contracts by consumers. The accounting, actuarial, and auditing standards are publicly available on the relevant professional organization’s website and they are in line with international standards. Mexican accounting standards are partly more conservative than the IFRS would like, allowing the catastrophic reserve to be a liability and recognizing the valuation of real estate. After several years of macroeconomic and financial stability, the amount of financial instruments has increased dramatically. However, further development is required to cover the demand for investment products. In particular, the inflation index and U.S. dollar-nominated instrument lag in duration with respect to the market demand. The laws and regulations are permanently updated to cope with relevant changes in the financial sector. The SSLO is a welcome document that brings all secondary legislation into one single document.

The Supervisory System (ICP 2 to ICP 5)

11. The CNSF has a broad range of powers to discharge its responsibility, but more are needed to increase its effectiveness. The powers include the ability to issue secondary legislation aimed to preserve the solvency, liquidity, and financial stability of the insurance institutions and mutual societies. To perform on-site inspections, impose administrative sanctions to enforce regulation to the institutions and persons under its inspection and surveillance. Additional powers to increase the effectiveness of supervision are required and will be incorporated in the new insurance law. Some of these functions are: issue prudential regulations that aim at preserving the solvency, liquidity, and financial stability of insurance companies and mutual insurance societies; and intervene in liquidation procedures of the insurance companies and mutual societies. The current lack of powers to effectively intervene in liquidation procedures could create a weakness in the protection of policyholders’ rights; in particular in the absence of a guarantee fund.

12. The appointment and removal of the CNSF President or Board members is not dictated by law, and, together with the absence of a term of office, it limit the independence of the CNSF. Further, the absence of a mandate to disclose the dismissal reasons of the president or a member of the CNSF Board adds to the vulnerability of the independence of the CNSF. The CNSF has demonstrated technical autonomy, but from legal and budgetary perspectives it is dependent on the executive power. The CNSF is subject to the expenditure restrictions that are applied to all entities of the Federal Government. Therefore, the supervisory authority does not have full discretion on resource allocation in accordance with its mandate, objectives, and the perceived risks.

The Supervised Entities (ICP 6 to ICP 10)

13. The requirements to be licensed are numerous, detailed, and transparent, and operating without a license is considered a criminal offense. Cases of enforcement have been reported in the past. Entities that could create complex supervisory structures or increase the risk of conflicts of interest, like mutual insurers, security brokers, credit organizations, pension administrators, etc., are ruled out as stockholders.

14. Since 2002, insurance legislation does not allow companies to offer both life and nonlife insurance; however, due to grandfathering rules, currently 33 insurers accounting for 58 percent of the market still operate as composite insurers. There are no appropriate measures to guarantee a segregated treatment of the risks, in particular in a winding-up situation. This could create a source of additional risk for consumers.

15. The Board is required to appoint the mandatory compliance officer for the supervised entity. The compliance officer has the responsibility to supervise the compliance with all internal and external applicable regulatory frameworks. While the law requires that the compliance officer is provided with sufficient resources to fulfill the responsibility, practice shown that a stronger entity is required for this internal surveillance position. This weakness is addressed in the new law and it replaces the Compliance Officer with an Audit Committee in Article 72 of the LISF project. The LISF states that institutions must have an Audit Committee that will be responsible for monitoring the adherence to the internal regulations set by the Board of Directors and the compliance with the applicable laws and administrative provisions.

Ongoing Supervision (ICP 11 to ICP17)

16. Current insurance and surety legislation does not grant powers to the authorities to force portfolio transfers. Thus, the supervisory and regulatory agencies do not have the power to arrange for a compulsory transfer of the obligations under the policies from a failing insurer to another willing insurer. However, it can facilitate the transfer where appropriate and where there is a willing transferee.

17. Current regulation does not explicitly protect an insurer from the effects of the financial difficulties affecting the financial group to which it belongs. However, the regulation has various preventive provisions that can be used to protect insurance and surety companies that belong to a group from the financial difficulties in other parts of the group, such as the prohibition to participate, directly or through a third person, in the authorized stockholders equity of insurance of surety companies, credit institutions, insurance mutual societies, brokerage firms, auxiliary credit organizations, mutual fund managers, savings and credit institutions, managing companies of pension funds, and savings and credit institutions. These provisions are helpful, but cannot cover all the different group structures.

18. There are clear provisions for the exit and winding up of insurers in Mexico. Policyholders have preference in a wind-up over other creditors. A protection fund exists only for pensions. The Resolution is initiated by either the license revocation followed by the corresponding administrative winding up of the entity or the filing of commercial bankruptcy. However, there are no requirements with respect to the maximization of the value of the liquidated assets or on the efficiency of the process. This could create the perception that the proceedings of the assets under liquidation were not optimized, or at least that there was no process for that.

19. Financial groups are subject to supervision and regulation. The supervision of financial institutions belonging to the same group is carried out by the corresponding agency: the CNBV, CNSF or CONSAR; the SHCF is required to nominate the leading supervisory agency for the financial group. The assigned leading supervisory agency is then granted with oversight powers that, under current legislation, are limited to the requirement of information. There are however few requirements on the group-wide governance and comprehensive risk management, and there is no group capital concept. Further, the CNSF has no direct jurisdiction to supervise unregulated holding companies and needs to operate indirectly through the regulated entities, thus, adding complexity to their supervision and monitoring activities of groups.

Prudential Requirements (ICP 18 to ICP 23)

20. Current Mexican solvency regime is sound and has a sufficient level of risk sensitivity to properly assess the level of capital required. In addition, the new law will introduce a new solvency regime that incorporates stochastic models and a calibration very close to Solvency II regime.

Markets and Consumers (ICP 24 to ICP 27)

21. Insufficiently detailed guidelines that pertain to the offering, sales operations, and financial services of the insurance and surety institutions seeking to protect the public have been issued. Given the low insurance penetration and insurance culture in Mexico, requirements for more clarity and transparency in the contracts aiming to protect insurance consumers is needed. The CNSF, together with CONDUSEF, should continue and increase their efforts in this area.


22. The AML-CFT requirements applicable to insurers are broadly in line with the FATF recommendations. In December 2008, GAFISUD issued Mexico’s levels of compliance with the international standard with the FATF 40 Recommendations plus nine Special Recommendations and a follow up document was published in December 2009. While the level of compliance is high, there are specific areas that need improvement.

With respect to Recommendation 5 on customer due diligence (CDD), some aspects remain to be implemented:

  • No distinction is made in all cases between CDD requirements for business relationships and all types of occasional transactions, including a direct requirement for aggregating linked occasional transactions.

  • There are inadequate provisions in the regulations with respect to CDD requirements when there are indications and/or certainty of false, erased, or altered identification documents.

  • There is no direct explicit requirement for financial institutions (FIs) to ascertain/request that applicants for business state whether they are acting on behalf of others.

  • There is no general requirement for obtaining information on the purpose and nature of business relationships.

With respect to Recommendation 13 on reporting of suspicious transactions, the obligation to report attempted transactions is not explicitly established in regulations and is not consistently implemented by financial institutions.

Annex Table 13.

Mexico: Summary of Observance of the Insurance Core Principles

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