IMF Policy Paper: Mexico - Financial System Stability Assessment
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International Monetary Fund. Monetary and Capital Markets Department
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Publication Date:
22 Nov 2016
eISBN:
9781475556384
Language:
English
Keywords:
ISCR; CR; banking sector; coverage ratio; development bank; foreign currency; resolution regime; plain vanilla; liquidity arrangement; market shock; Mexican peso; government bond bond market; liquidity contingency plan; assistance facility
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This paper discusses the findings and recommendations made in the Financial System Stability Assessment for Mexico. Mexico’s economic fundamentals are strong. The medium-term outlook for the Mexican economy foresees steady growth underpinned by strong macroeconomic policies, broad reform initiatives, and relatively strong balance sheets. Key risks are external and include a U.S. growth slowdown, lower oil prices, and volatility in global financial markets. The financial system is broadly resilient, notwithstanding some weaknesses under certain adverse shocks. The solvency and liquidity stress tests of the banking system indicate that it can withstand severe adverse macro-financial shocks despite large capital losses in some cases.

Abstract

This paper discusses the findings and recommendations made in the Financial System Stability Assessment for Mexico. Mexico’s economic fundamentals are strong. The medium-term outlook for the Mexican economy foresees steady growth underpinned by strong macroeconomic policies, broad reform initiatives, and relatively strong balance sheets. Key risks are external and include a U.S. growth slowdown, lower oil prices, and volatility in global financial markets. The financial system is broadly resilient, notwithstanding some weaknesses under certain adverse shocks. The solvency and liquidity stress tests of the banking system indicate that it can withstand severe adverse macro-financial shocks despite large capital losses in some cases.

Background

A. Macro-financial Context

1. Economic fundamentals are strong, with a stable outlook for growth and inflation over the medium-term (Table 2). Mexico’s economy grew, on average, by 2.5 percent per year since the last FSAP in 20121,supported by both external and domestic demand. Growth is projected to average about 2.4 percent in 2016–20, with higher external demand and structural reforms compensating the likely negative impact of tightening U.S. monetary conditions. Credit expansion to the private sector is strong, albeit from a small base, and has been broadly consistent with progress in financial deepening (see the 2016 Article IV Staff Report). The credible monetary policy framework has kept inflation subdued, with core inflation close to the 3 percent target since 2011 and headline inflation at target. Inflation is expected to remain low as pass-through from the peso depreciation is limited. The external sector position remains broadly consistent with medium-term fundamentals. The level of foreign exchange (FX) reserves remains adequate according to standard measures. The Flexible Credit Line (FCL) arrangement, renewed and extended to U.S. dollar 88 billion on May 27, 2016, provides additional insurance against tail risks (Figure 1).

Figure 1.
Figure 1.

Reserves and Nonresident Portfolio Liabilities

(In US$ billion)

Citation: IMF Staff Country Reports 2016, 361; 10.5089/9781475556384.002.A001

Sources: Banxico, and IMF staff estimates.
Table 2.

Selected Economic, Financial, and Social Indicator

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

CONEVAL uses a multi-dimensional approach to measuring poverty based on a “social deprivation index,” which takes into account the level of income; education; access to health services; to social security; to food; and quality, size, and access to basic services in the dwelling.

Percent of population enrolled in primary school regardless of age as a share of the population of official primary education age.

Contribution to growth. Excludes statistical discrepancy.

2016 based on data available through February 2016.

2016 based on data available through May 2016.

2016 based on data available through March 2016.

Includes public sector deposits.

Data exclude state and local governments and include state-owned enterprises and public development banks.

2. Economic stability has been underpinned by strong macroeconomic policy frameworks, broad reform initiatives, and relatively strong balance sheets:

  • (a) Mexico has maintained a prudent fiscal stance, and is currently implementing a multi-year fiscal consolidation program, with the fiscal deficit (defined as public sector borrowing requirement) declining by 0.5 percentage points of gross domestic product (GDP) per year to 2.5 percent of GDP in 2018. The free-floating peso is the main shock absorber. Since mid-2014, the peso depreciated by close to 50 percent vis-à-vis the U.S. dollar driven by the decline in oil prices and spillovers from negative shocks in other large emerging markets. Furthermore, Mexico has maintained its open capital and current accounts, and its market-friendly and transparent regulations for foreign investment. By end-August 2016,

  • (b) A wide-ranging reform program was launched in 2013–14 covering the financial sector (Table 3), energy, telecommunications, anti-trust, labor markets, taxes, and education. The program aims at boosting potential growth, enhancing competition, reducing labor market frictions, encouraging investment, and strengthening the financial sector over the medium-term. Implementation is ongoing and full gains are still to unfold.

Table 3.

2013—14 Financial Sector Reform—Selected Key Measures

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Source: Banxico and IMF Staff.

  • (c) Banks and nonfinancial sector balance sheets remain relatively resilient. On average, the banking system holds large buffers and households’ debt is low (about 15 percent of GDP) with significant positive net financial assets. The debt maturity profile of large listed private corporations has largely been termed out, with FX debt risks largely offset by natural and financial hedges. Financial sector exposures to the housing market remain very limited.

3. The risks to Mexico’s economic outlook are mostly external: a U.S. growth slowdown, a rise in trade protectionism, global financial market volatility, and lower oil prices. A negative U.S. growth shock would hurt Mexico’s growth through strong trade links and a deterioration of investor confidence, possibly leading to capital outflows. A similar scenario would occur if there is a rise in protectionism in key export markets. Lower growth would weaken (a) bank and corporate balance sheets through rising non-performing loans and a loss in value of financial institutions’ fixed rate security holdings; and (b) public finances, through higher borrowing costs. An increase in global financial market volatility could also lead to capital outflows, fueled by a loss in investor confidence even in the absence of a deterioration of Mexico’s economic fundamentals. Lower oil prices would mainly affect Mexico by weakening its public finances and the current account balance. All these shocks would lead to a tightening of financial conditions and increasing the pressure on the exchange rate.

B. Financial Sector Context

4. Mexico’s financial sector is bank dominated and relatively small compared with other emerging market (EM) peers (Figure 2).

Figure 2.
Figure 2.

Mexico’s Financial System

Citation: IMF Staff Country Reports 2016, 361; 10.5089/9781475556384.002.A001

  • Financial sector assets amounted to 90 percent of GDP in 2015, with over half being commercial banking assets. Development banks activities have grown rapidly since the 2014 reforms reaching around 10 percent of financial sector assets by end-2015.

  • The nonbank sector remains underdeveloped, but has been growing at a faster pace than banks in recent years. Pension funds, mutual funds, and insurance companies account for 30 percent of financial sector assets. Other financial intermediaries—brokerage firms, regulated and unregulated non-deposit-taking financial institutions (sofomes),2 savings and credit institutions, and deposit warehouses operating mostly in rural areas—are small but play an important role in microfinance and financial inclusion.

5. The commercial banking sector is highly concentrated. Despite the wide and diverse range of financial intermediaries, the industry remains concentrated around conglomerate structures—which usually include a bank, a pension fund, a brokerage company, an insurance company, and a mutual fund. The seven largest banks (known as G-7), all fully owned by financial groups, account for about 80 percent of total bank assets. Bank deposit concentration is also high, with the share of deposits by the largest depositors averaging 14 percent of total deposits in G-7 banks, and as high as 34 percent in one bank.3

6. The sector has large foreign presence, but most activity remains local. Five of the G-7 banks are foreign subsidiaries of large global financial groups and account for about 65 percent of commercial banks’ assets. Banks, including foreign subsidiaries, keep the bulk of operations in Mexico, with funding depending on domestic savings and uses directed mostly towards domestic lending and government securities. A memorandum of understanding (MoU), known as the “Convenio de Responsabilidad,” and included in the 2014 financial group law assigns the holding (FHC) unlimited responsibility for the obligations of each group company, and the assumption of losses. This law also regulates financial transactions between the parent and the subsidiary, with substantive funding repatriation subjected to the authorities’ approval and compliance with domestic regulations.

Financial System Soundness

7. Commercial banks appear to be sound and profitable (Figure 3 and Table 4a).

Figure 3.
Figure 3.

Mexico’s Commercial Banks Performance

Citation: IMF Staff Country Reports 2016, 361; 10.5089/9781475556384.002.A001

Table 4a.

Financial Soundness Indicators 1/

(In percent)

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Sources: Banco de Mexico, CNBV

End of period, unless otherwise noted.

  • At the end of 2015, total capital adequacy ratio (CAR) stood at 15 percent and liquid assets was about a third of total assets (around 35 percent of short-term liabilities).4 In September 2015, all banks had met the minimum 60 percent liquidity coverage ratio (LCR) requirement, with a large number exceeding the 100 percent requirement that will apply from 2019 on.

  • FX risk exposures associated with foreign currency lending are low; foreign currency loans account for only 13 percent of total loans in 2015, and the ratio of net open position in FX to Tier 1 capital is negligible (-0.2 percent).5

  • The NPL to total loans ratio declined steadily from 3.2 percent in 2013 (a peak due to the large homebuilders’ defaults) to 2.6 percent in 2015.

  • Returns on equity averaged 17 percent over the last three years, with the spread between lending and deposit rates remaining high and stable, at around 10 percentage points.

8. DBs are well-capitalized and liquid. The CAR is high at 14.1 percent and the liquid assets to liquid liabilities ratio stood at about 120 percent by end-2015. DBs’ NPLs have remained below 2 percent since 2010 and provisions cover about 260 percent of NPLs.

9. The non-banking financial sector appears to be robust, but small and confronted with important challenges. In particular,

  • (a) The pension fund sector’s market and credit exposures are well managed but the scheme seems to be underfunded. Pension funds (SIEFOREs) are required to meet investment limits consistent with the risk tolerance levels assigned by CONSAR, the supervisory authority. However, the projected replacement rates under the fully funded scheme appear to be insufficient and the transition rule in place is to generate an abrupt reduction in the pension replacement rates of about 50 percent.6 Initial calculations suggest that the expected replacement rates offered by the funded pension scheme range from 28 to 34 percent, but 80–100 percent under the Mexican Institute of Social Security’s (IMSS) and Institute for Social Services and Security for State Workers (ISSSTE) pay-as-you-go scheme.

  • (b) Mutual funds are highly concentrated in short-term sovereign and IPAB securities and are exposed to redemption risks. Assets under management have grown significantly in the last decade, from 5 percent of GDP in 2005 to 11 percent of GDP in 2015 (Figure 4). Client redemptions during the 2008 GFC had led to substantial withdrawals. Since then, other episodes of net outflows have been observed although smaller in size compared to 2008. The “circuit-breaker” mechanisms adopted by the authorities after the 2008 crisis to manage liquidity during periods of stress should make the system more resilient.

Figure 4.
Figure 4.

Mutual Funds and Assets under Management

(In billions of pesos)

Citation: IMF Staff Country Reports 2016, 361; 10.5089/9781475556384.002.A001

Source: CNBV.

  • (c) The insurance sector is well-capitalized and liquid (Figure 5, Table 4b). Insurance companies’ minimum capital guarantee coverage ratio (MCGCR) is at about 1.9 times in 2015; a technical reserve coverage ratio stands at 1.1 times; and the return on equity is 14 percent. The sector’s liquid assets to current liabilities ratio stands at 3.5. Mexico introduced new regulations requiring the implementation of Solvency II-type risk-based capital and mark-to-market valuation of assets and liabilities.

Figure 5.
Figure 5.

Insurance Solvency Ratio 1/

Citation: IMF Staff Country Reports 2016, 361; 10.5089/9781475556384.002.A001

1/Sum of assets backing the minimum capital guarantee by the minimum capital guarantee requirement.Source: CNSF.
Table 4b.

Insurance Sector Soundness Indicators

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Source: CNSF.

Household, Corporate, and Sovereign Leverage

10. Household leverage is relatively low compared to other EM peers, but consumer loans are rising. Bank lending to household accounts for 37 percent of total loans, and 60 percent of these are non-revolving personal loans and credit cards. The remaining are housing loans. In the last five years, credit card and non-revolving personal loans have grown at a compounded annual rate of 15 percent, slightly higher compared to housing loans (12 percent compounded annual growth rate). The rapid growth in consumer loans could risk higher NPLs, especially in times of economic weakness. A mitigating factor is that household leverage remains low relative to other EMs, and has risen only slightly from 13 percent of GDP in 2008 to 15 percent of GDP in 2015.

11. The largest publicly-traded corporations appear to be sound despite higher leverage and high FX debt (Figure 6). While corporate leverage of the largest 50 traded companies has increased in recent years and its well-above 2008–09 levels, it is moderate at the aggregate level relative to other EMs. Interest coverage ratios also remained adequate, and the maturity profile of debts has largely been termed out as corporations took advantage of easy access to global capital markets to refinance their debts, typically at fixed rates. Most companies appear to have adequate cash buffers. Foreign currency debt accounts for about half of their total debt but, currently, some of these risks are minimized by “natural” hedges from foreign currency revenues and derivatives. On average, foreign currency revenue accounts for about 30 percent of total revenue for the largest 50 companies. Most companies use plain vanilla derivatives to hedge their foreign currency bonds and project financing debts close to their maturity. Some companies also hedge part of their mismatches in FX inflows and outflows through short term 6 to 12-month currency forwards.

Figure 6.
Figure 6.

Mexico’s Corporate Sector

Citation: IMF Staff Country Reports 2016, 361; 10.5089/9781475556384.002.A001

12. Nonetheless, commodity-related corporations are vulnerable. The mining sector is susceptible to declines in commodity prices and global demand, and PEMEX suppliers are coping with PEMEX delayed debt payments. Commercial banks’ exposure to this sector remains small (i.e., 6 percent of total loans) and their gross sectoral NPL ratio is very low at 0.1 percent.

13. Nonresidents hold large shares of local currency sovereign debt. Commercial banks’ holdings of government bonds are large relative to their balance sheet but small as a share of the sovereign debt portfolio (less than 5 percent). Larger holders of Mexican sovereign debt are nonresidents, pension funds, and mutual funds. In the event of a sharp capital flow reversal, residents would have little room to absorb significant amounts of debt securities. Banks have been reducing their market-making activities, especially those that are part of international groups and subjected to strict home-country regulation. Pension funds follow long-term strategies, and would likely only make limited use of the opportunity to pick up securities cheaply. Mutual funds are mostly in the money markets. They could play a larger role, if investors were to switch toward more debt funds, but given the conservative profile of most mutual fund investors, it seems unlikely.7

14. The development of Mexico’s financial sector can bring significant gains but also more risks and challenges. Mexico’s economy has been benefiting from the strengthening of the sector and, with the support of sound economic management and strong fundamentals, further gains are expected. However, the globalization and the deepening of the financial sector will give rise to new and more complex risk exposures that could undermine the soundness of the financial system, with adverse economic impact:

  • Mexico’s financial sector is rapidly integrating into the global financial system, and at a faster pace than many of its EM peers (especially in Latin America). The Mexican peso is the tenth most traded currency in the world and the first among emerging markets, and it is a benchmark for large EM currencies. Mexican sovereign instruments are trading in major sovereign bond indexes including the World Government Bonds Index (WGBI) and the JP Morgan’s Government bond EM index. Inclusion in major indexes has encouraged nonresidents large participation in the peso-denominated sovereign debt market (see ¶13), which surged after 2010. Mexican securities are also actively trading offshore.

  • The financial deepening reform agenda is ambitious. A comprehensive financial reform plan was approved in January 2014 with the objective of increasing the financial sector's contribution to economic growth and access to finance (Table 3). The reform relied on four main pillars: (a) increase competition in the financial sector by inhibiting anti-competitive practices; (b) encourage credit through development banks by strengthening their legal framework, objective and operating capacity; (c) expand credit through private financial institutions by enabling a more systematic evaluation of commercial bank credit and a more efficient channeling towards productive activities; and (d) maintain a stable and solid financial system. Apart from strengthening the banking sector buffers and adopting a resolution and liquidation framework, the reform gave a more proactive role to development banks in credit allocation and enhanced the protection of financial service consumers.

Financial Sector Resilience

A. Banks

15. The resilience of Mexico’s banking sector was assessed using solvency and liquidity stress tests (ST) and interconnectedness risk analysis. Banxico and the CNBV, in close coordination with the FSAP team, conducted bottom up (BU) and top down (TD) stress tests covering at least 80 percent of the commercial banks’ assets and used two sets of simulated adverse macroeconomic scenarios designed in line with Mexico’s key risks and transmission channels (Annex I, Table 3) over a five-year horizon during 2016 Q–2020 Q4 (Annex I subsection A and Annex I, Tables 1 and 2).

  • The BU solvency exercises assumed (i) a V-shaped scenario where the economy recovered rapidly from the initial shocks and that resembled the 2008–09 financial crisis; and (ii) a U-shaped protracted recession with a less severe initial shock than the V-shaped scenario set but with a slower recovery. The TD solvency STs used Banxico’s probabilistic approach, in which a bank’s CAR is calculated for each single scenario in the set.

  • The liquidity STs were based on the LCR framework introduced under Basel III in 2010 and revised in 2013.

  • Interconnectedness risk focused on how shocks arising from the failure of one firm propagated through the financial system. Direct exposures between banks and other nonbank financial institutions (NBFIs) constituted the main contagion channel.

Solvency Tests

16. Overall, Mexico’s banking sector seems to be resilient. Large commercial banks remained adequately capitalized in the BU ST (i.e., above the 8 percent minimum regulatory capital requirement applied to total capital) and no large commercial bank failed the TD ST. A protracted recession was more damaging to the banking system than a V-shaped recession, with the impact of the shocks partly offset by higher net interest rate margins (from higher interest rates) and a rebalancing of the loan portfolio consistent with the credit growth assumptions envisaged in the scenarios (Annex I, Table 2).

17. Large commercial banks remained adequately capitalized in the BU ST, and no large commercial bank failed the TD ST, despite large capital losses in some cases. Higher probability of defaults (PDs) led to higher credit losses and associated loss reserves, reducing the banks’ ability to generate earnings and affecting ROE and ROA negatively. The fall in earnings, however, was offset by higher interest margins, and the initial high levels of CARs helped banks withstand the shocks. Moreover, the BU ST allowed banks to rebalance their balance sheet dynamically, reducing their credit exposures in response to negative shocks and the corresponding risk-weighted assets (RWAs), which helped supporting CARs. Keeping the balance sheet static by not allowing banks to reduce exposures could reduce CARs by as much as 1¼ percentage points. Initially, the BU ST set the risk weights (RW) for different asset classes constant. Adjusting RWs to reflect changes in the PDs of the banks’ loan portfolios could reduce the system CAR by as much as 6 percentage points and caused one of the G-7 banks to fail, with its CAR failing to a low of 7¼ percent. The TD systemwide results were driven by the good performance of the G-7 banks, none of which failed the ST regardless of whether the CAR calculations assumed fixed or PD-adjusted RWs.

18. However, small commercial banks suffered larger CAR declines in the TD STs. 8

Although no bank failed in either scenario, some banks’ capital requirements to total capital declined by more than 30 percent at the end of the third year of the TD ST. By the end of the fifth year of the ST, five banks (20 percent of the banking system assets) failed in the U-shaped set of scenarios; and two banks (7 percent of banking system assets) failed in the V-shaped set of scenarios. The five-year results are subject to high uncertainty, and counterintuitive behavior of PDs in the TD ST scenarios beyond the three-year horizon (Figure 7).

Figure 7.
Figure 7.

System-Wide Capital Adequacy Ratio Distribution Across Scenarios in Top-Down Stress Test

(In percent)

Citation: IMF Staff Country Reports 2016, 361; 10.5089/9781475556384.002.A001

Source: Banxico and staff calculations.

Liquidity Tests

19. All G-7 banks enjoyed ample liquidity in domestic currency and foreign currency, but some small banks appeared to face foreign currency liquidity needs.9 The ST LCRs of the G-7 banks met (or exceeded) the regulatory threshold (Annex I, Table 3) even if applying the LCR 2010 test with a 10 percent run-off rate on stable deposits (instead of the standard 5 percent run off rate applied on the 2010 LCR tests). The banking system also performed well when inflows and outflows were consolidated across all significant currencies. Potential liquidity problems appeared, however, when the LCRs were calculated for foreign currency holdings. A few small banks (about 4 percent of total bank assets) ST LCRs fell below 10 percent and 8 percent in the LCR 2013 and LCR 2010b tests respectively. In the latter test, the banks below the 29 percent median ST LCR level represented 15 percent of the system’s assets. HQLAs deposited abroad, ample domestic currency liquidity, and deep and liquid FX markets in Mexico would further expand the buffers banks could use to meet FXdenominated obligations in case of stress.

Interconnectedness Risk

20. Interconnectedness risk appears to be manageable, as it affects only small firms. The exercise encompassed a broad sample of firms and direct exposures (Annex I, subsection B). Brokerage houses appeared to be the most affected even though their size is relatively small and are not considered to be sources of systemic risk. During 2015, banks and brokerage houses’ assets breaching the regulatory minimum standards fluctuated from a low 4½ percent of their total assets to a high 8 percent of total assets. The affected banks were small, each holding on average about ½ percent of assets in the system. The reduction in interconnectedness risk, which affected a record high of 20 percent of assets in the system during 2008–09, is partly explained by banks’ lower exposures to foreign financial institutions in response to stricter regulatory limits on net open positions in foreign currency.

B. Development Banks

21. The three largest development banks could also withstand adverse shocks. Under the two V-and U-shaped scenarios, the CNBV’s BU ST found their CARs remained above the 8 percent regulatory minimum total capital. One of the banks, however, would see its CAR fall below 10½ percent, the regulatory level prompting regulatory intervention. In the event of capital shortages, however, the authorities’ policy is to redistribute the excess capital in developments banks at the aggregate to ensure all individual banks comply with the regulation.10 This burden-sharing mechanism was used in the past to recapitalize a troubled bank.

C. Non-Banking Financial Institutions

22. Insurance companies and pension funds could endure a number of large market shocks. They are heavily invested in debt instruments, equities, and foreign exchange securities. Shocks emanating from macroeconomic weaknesses and external volatility will affect insurance solvency requirements and pensions’ investment limits, and could potentially spill over to the domestic capital market. The sensitivity analyses conducted jointly with the authorities covered the ten largest insurance companies with about 80 percent of the total insurance assets, and 73 pension funds covering all assets under management. The analyses found these institutions and funds to be resilient to the market shocks (single shocks on interest rate, exchange rate, and equity market, as well as combined shocks) albeit with certain pockets of vulnerability. Regulatory mechanisms in place should prevent forced selling during volatile market conditions that could further exacerbate market disruptions and add pressures.

23. Insurance investment portfolios were found to be well diversified, generally resilient to market risks, but sensitive to interest rate shocks. Under the simultaneous shock scenario, solvency ratios increased because revaluation losses in mark-to-market securities were largely offset by exchange rate gains from a peso depreciation. When isolating the interest shock, solvency ratios were projected to decline due to the relatively large holdings of fixed income peso denominated securities. But even in that case, only two to four insurers were found to face shortfalls of up to 3.7 percent of assets, which could be corrected by rebalancing the portfolio towards lower risk assets or re-insuring liabilities.

24. Pension funds’ performance appeared to be aligned with risk tolerance, but their net asset value (NAV) could decline to close to the 2007–08 crisis levels. If all shocks were to materialize simultaneously, the sensitivity analysis found that the aggregate NAV could decline by 6 to 10 percent, compared to the 16 percent decline during the GFC. Interest rate shocks caused the largest NAV decline, with the FX depreciation gains on FX-denominated assets offsetting the decline. In addition, pension funds were found to be less sensitive to liquidity risks. Under current legislation, pension fund managers are not obliged to sell assets in volatile times. The confidence level of the regulatory value-at-risk (VaR) limits adjusts automatically, and there is a six-month regularization period to restore compliance. Moreover, market-to-market losses are unrealized unless shocks are permanent and assets are sold. Nevertheless, the system has room for improvements, including adopting a long-term strategic benchmark-based approach that favors stable long-term investment strategies.

D. Corporate Sector

25. The largest 50 publicly listed corporations also displayed resilience to large shocks, and spillovers to the banking sector appeared to be low. The sample’s market capitalization represented 34 percent of GDP and 30 percent of all corporate debt.11 The exercise considered three alternative scenarios on how companies dealt with debt risks in their balance sheets: (i) “natural” hedging; (ii) “natural” and financial hedging; and (iii) no hedging. Shocks to the exchange rate and interest rate were severe. In a worst case scenario of no exchange rate hedging, interest coverage ratio for six companies would fall below 1, implying some possible difficulties for these companies to serve their debt interest payments on time. Their debts, however, account for only 6.6 percent of total corporate sector debt and about 1 percent of total bank loans; a default would only translate into a small increase in the gross corporate NPL ratio (from 0.02 to 0.22 percentage point).

Micro- And Macro-Prudential Oversight

26. Significant progress has been achieved since the 2012 FSAP in strengthening financial sector prudential oversight but a number of important gaps remain, including lack of progress in strengthening the governance arrangements of the supervisory agencies and IPAB.

A. Financial Sector Oversight and Regulations

Governance and Institutional Arrangements

27. There has been no progress on the governance framework of the supervisory agencies since the last FSAP. The CNBV’s and IPAB continue to lack operational independence, budget autonomy, and legal protection, and are encumbered with multiple mandates. In particular:

(a) The CNBV Board members are ex-officio, with five out of 13 CNBV Board members being directly appointed by the SHCP and other five members being indirectly under SHCP’s control. The posts have no defined terms, and the reasons for the dismissal of board members or the president are not clearly specified.

(b) The CNBV lacks autonomy on its own budget, which is approved by the SHCP and subject to fiscal measures adopted by the federal government. A salary freeze has been in place for well over a decade resulting in unusually high staff turnover raising concerns regarding quality of supervision and institutional continuity.

(c) The legal protection framework for supervisors is limited at present and does not provide statutory immunity to the supervisors for the lawful performance of their duties.

(d) The agencies focus on financial stability has been diluted by multiple objectives including, inter alia, developmental and consumer protection responsibilities.

28. The supervisory framework governance needs to be strengthened significantly to support Mexico’s financial sector standing domestically and globally and to effectively mitigate new emerging risks. Safety and soundness of the supervised institutions should be the primary mandate for the supervisor; other mandates should remain secondary and narrowly defined. Governance boards need to be composed of independent members with clear rules and process for the appointment and dismissal of senior personnel. The supervisor should have the capability to use the tools needed to ensure the stability of the financial system by exercising its judgment and powers, including with respect to licensing, on-site inspections and off-site monitoring, sanctioning and enforcement. Finally, budgetary independence allows the supervisor to plan its budget and to allocate resources according to its established priorities under its mandate, and to take the necessary measures to ensure the adequacy and quality of its staff.

29. Consideration should be given to integrating all financial supervisory functions into one agency. All prudential supervision, aimed at the safety and soundness of financial institutions, should be integrated in one Prudential Supervisor, covering banks, securities, insurance firms, pension funds and other financial institutions.12 In the context of Mexico’s rapidly evolving and increasingly complex financial sector and the dominant role played by large and diversified financial conglomerates, an integrated supervisor would be more effective in ensuring the soundness of the financial system and mitigating current and new risks. While some costs would be entailed in merging agencies, an integrated supervisor would be able to pool in the expertise needed to supervise a rapidly evolving and more complex financial system, carry out effective consolidated supervision as barriers to information sharing and cooperation from different line supervisors come down, and limit regulatory arbitrage. An integrated and more independent supervisor should also have more clout in implementing its policies and be able to make better contribution to the financial stability assessment and macroprudential policy setting within the CESF.

Banking

30. Since the last FSAP, Mexico’s banking sector supervision and regulatory framework has significantly improved. Measures include: adoption of a risk-based framework approach to supervision, the strengthening of financial groups’ legal framework with more restrictive limits to related party transactions, the implementation of the Basel III framework in 2013, and the adoption of a special resolution regime for banks.

31. Despite the progress, there is scope for further improvements. Regulatory gaps need to be addressed with respect to corporate governance rules for banks; the definitions of large exposure, common risk and related parties; and liquidity rules for development banks. The role of Banxico in determining certain capital requirements should be reviewed and the CNBV should assume the sole responsibility for these functions.13 Additional improvements in the risk-based supervision are needed, including updating the risk assessment and rating system. Gaps in the legal framework continue to limit the CNBV’s ability to perform effective consolidated supervision, which hinders supervisors’ assessment of the true situation of the bank as part of the holding company. If the tail risks identified in the stress test (RAM in Table 5) were to materialize, there is a risk that contagion effects throughout the group may not be detected early in the process as inter-agency cooperation to establish procedures to systematically monitor banking groups is lagging. Finally, the accounting and auditing framework for banks should be strengthened by requiring banks to adopt IFRS, in line with all other listed companies, with accompanying powers for the supervisor to be able to ask for tax deductible prudential provisions beyond IFRS 9 (IAS 39) requirements.

Table 5.

Risk Assessment Matrix

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Source: IMF staff.

Securities Supervision and Capacity Constraints

32. The 2014 reforms introduced new securities regulations and supervisory powers to the CNBV, except in the derivative markets. The new Law clearly defines the CNBV’s responsibilities and regulatory and supervisory enforceable oversight powers over a broad range of entities but with an important exception: derivatives. The derivatives market regulation relies on general provisions encompassing the SHCP, Banxico and CNBV. Furthermore, a law for OTC derivatives is not yet in place, which could impair the enforcement by the CNBV of current regulations in this area. The CNBV is to formally start applying strengthened risk-based supervision in the securities area for intermediaries in 2017.

33. A strengthened risk-based supervision on securities for intermediaries is to be in place in 2017. Risk methodologies and procedures were revised with the support of the World Bank, and work is to cover: (i)an institutional report on surveillance activities; (ii) a risk matrix and risk-based supervision procedures; and (iii) grading to signal the importance of the findings.

34. The CNBV has enhanced disclosures to the public, but it is not enough. Under the new legislation, the CNBV is obligated to disclose publicly, via its Webpage, the imposition of administrative sanctions. But, the CNBV’s internal regulatory process setting out its responsibilities, powers and priorities has not been formally shared with market participants, who also are not aware with the CNBV´s top regulatory priorities for 2016 or its 2014–18 strategic plan and targets.14

35. While the framework has been significantly enhanced, staffing constraints could impair implementation of these new improvements, including of new instruments. The CNBV allocates less than 8 percent of its staff to securities markets’ activities. Retention of qualified experienced staff, particularly at senior levels, challenging, with wages remaining frozen for over a decade. The lack of oversight capacity constitutes a major risk also in this area.

Payment Systems

36. The assessment of the payments systems focused on Sistema de Pagos Electronicos Interbancario (SPEI). The system is a central part of Mexico’s payment and securities settlement infrastructure, processing large-value and retail payments alike, and currently supports 15 different types of payments. SPEI was began operations in 2004 and is owned and operated by Banxico. Payments volumes processed by SPEI have been growing by an annual average rate of 32 percent over the past five years, and in 2015, SPEI processed transactions for the equivalent of 10 times the country’s GDP.

37. SPEI largely observes the Principles for Financial Market Infrastructures (PFMI), but could benefit from few enhancements. SPEI is supported by well-founded legal basis and sound governance arrangements. It has developed a comprehensive risk management approach with an emphasis on operational risk management. Business continuity and information security policies are shaped according to internationally-accepted commercial standards. There are, however, areas that can be improved. These include, inter alia, strengthening of the collateral haircut methodology in extreme market conditions, enhancing transparency by establishing participants’ formal consultation mechanism, articulating the risk-based access requirements and establishing specific procedures for facilitating the suspension and orderly exit of a participant that breaches, or no longer meet, these requirements.

B. Financial Stability and Macroprudential Framework

38. Mexico has been moving towards a system-wide approach to the identification and mitigation of financial stability risks. The Financial System Stability Council (CESF), established by Presidential Decree in 2010 and law in 2014, brought together the SHCP, Banxico, and other financial sector supervisors, to identify and analyze potential risks to the financial system, and recommend policies, including macroprudential policies, to mitigate them. The CESF does not itself have powers to implement measures or take actions; instead, it relies on its members, whose mandates all contribute towards the overarching objective of financial stability, and that are, in general, technically sound and well equipped to assess major systemic risks. The SHCP, with the Minister chairing the meetings, has strong influence in the proceedings.

39. Nonetheless, the macro-prudential policy framework does not clearly assign the responsibility for the identification and mitigation of potential systemic risks. Macro-prudential instruments have been applied in the course of time by various authorities based on their respective legal mandates, but there is no clearly assigned authority to prepare and execute macroprudential policy in the pursuit of overall financial stability.15

Effectiveness of Arrangements

40. The CESF has helped strengthen coordination and collaboration in the identification and assessment of potential risks to financial stability, but has been less effective in policy formulation. The arrangement has provided a dedicated platform for such exchanges, with the published Annual Report and Quarterly Press Releases being the result of collaboration on risk analyses to the Mexican financial system. But it is less clear how effective the CESF has been in formulating recommendations that have resulted in improved financial stability policy. The public statements and press releases provide limited insight in the deliberations within the CESF and precise recommendations.

41. Multiplicity of communication channels can affect the clarity of the message. There is considerable overlap between the CESF Annual Report and reports published by its members. This is particularly the case with the overall risk outlook in the Annual Financial System Report published by Banxico, and the Quarterly Reports on Public Finances issued by SCHP.

Strengthening the Macroprudential Framework

42. The CESF as the overarching platform to further financial stability should be strengthened further, with greater assurances that the recommendations will not be subject to undue political considerations. The CESF is a strong manifestation of the collective commitment to financial stability by the Mexican authorities. This role can be reinforced by assigning to the CESF the responsibility not only for monitoring and assessing emerging systemic vulnerabilities, but also for formulating the appropriate macroprudential policy response. Such an arrangement need not necessarily entail direct control by the CESF over macroprudential tools, but could take the form of enhanced recommendations to the authority who “owns” the tool in question. The forcefulness of recommendations could be strengthened by making them public and in some cases by adopting a “comply or explain” approach.

43. Increased responsibility for the CESF should be accompanied by greater assurances that the recommendations will not be subject to undue political considerations. In order to help build confidence, it is essential that decisions are taken purely on grounds that contribute towards ensuring financial stability. Even in the absence of political interference, it is important to avoid the perception that the arrangements might be prone to such influence.

Financial Sector Safety Nets And Crisis Management

A. Safety Nets

Liquidity Framework

44. Measures are in place to help reduce the likelihood of liquidity stress across the financial system and deal with it should it arise. Banxico has an extensive database of financial exposures and conducts network analysis on a monthly basis. Systemic liquidity risks in Mexico’s well-regulated, bank-centered, and active financial markets were assessed across a number of areas: Banxico’s liquidity management; liquidity regulation applied to banks and emergency liquidity assistance; short-term money markets; mutual funds; government securities markets; and the foreign exchange market.

45. Banxico’s liquidity operating framework in normal times fully supports the efficient pricing and distribution of liquidity. Banks have certainty about day-to-day liquidity conditions and have access to a collateralized overdraft in the event of operational problems. However, collateral pressure could arise in light of increasing demands on HQLA, combined with the high foreign ownership of government securities. The Banxico could consider broadening the collateral framework to mitigate increased financial risks through higher haircuts.

46. Liquidity regulation and the provision of emergency liquidity has been significantly upgraded since the last FSAP.

(a) Mexico is implementing the LCR in line with the international agreed timetable. In 2016, the required compliance is 70 percent; all major banks and most banks are above 100 percent. It is expected that the LCR will eventually be applied in foreign currency but for the moment they remain subject to a stringent foreign currency liquidity metric. Banks must also provide annually, a Liquidity Contingency Plan to the CNBV, detailing the sources of funding and procedures for dealing with liquidity stress.

(b) Banxico’ s contingent liquidity arrangements have been upgraded since the last FSAP. The arrangements include: (i) the Standing Additional Ordinary Liquidity Facility, which, once requested, the facility is automatic and provided against a broader range of collateral and can be rolled over on a daily basis; and (ii) the Emergence Liquidity Assistance Facility (ELA). For the latter, internal protocols have been established with no public commitment to provide ELA, thereby minimizing moral hazard, and such assistance will be assessed and provided on a case-by-case basis.

Deposit Insurance

47. The deposit insurance framework, managed by IPAB, broadly conforms to best international practice. The current limit allows for coverage of approximately 99 percent of depositors but only 55 percent of total deposits in the system. IPAB is also the resolution authority and has close cooperation with other members of the financial safety net. In 2014 the Banking Act was amended to provide IPAB with greater powers to manage both its deposit insurance and resolution functions. IPAB has authority to issue government guaranteed debt to the markets up to 6 percent of its member institutions’ liabilities without formal executive approval.

48. IPAB is a strong institution, but its effectiveness is undermined by multiple mandates and limited resources. It has a culture of cooperation with other safety net players, strong performance in the recent handling of a small bank failure, ongoing planning for potential financial institution resolutions, and openness and transparency in its operations and reporting. However, IPAB has been tasked with managing legacy assets, repaying legacy debt, insuring depositors, acting as the resolution authority, and injecting resolution funding to banks deemed systemic. In addition, the current reserve level for the deposit insurance fund is small by international standards at approximately 1 percent of insured liabilities. At present, operating under multiplicity of objectives, IPAB’s priorities in case of funding needs for the resolution of a systemic bank or the payment of insured depositors in a small or medium bank, are not clearly defined. Actions should be taken to transfer the legacy debt to the government’s budget, and to find a workable resolution funding formula that protects IPAB's deposit insurance fund from depletion by resolution funding for systemic banks.

B. Resolution and Crisis Management Framework and Resolution Regime

49. Mexico’s bank resolution regime has significantly improved since the last FSAP. The 2014 financial sector reform strengthened the special bank resolution regime by incorporating clear and shorter timeframes for resolution action, clarifying the role of courts and removing resolution actions suspensions, and expanding IPAB’s powers, among other measures.

50. However, the system still requires important enhancements in a number of areas. These include: extending the special resolution regime to cover the FHCs, strengthening the authorities’ power to require banks to make changes to improve their resolvability (e.g., the issuance of loss-absorbing capacity tools), and conduct purchase and assumptions transactions with third parties, developing guidelines for systemic determinations, clarifying internal guidelines on the timely entry into resolution process to avoid delays, improving the quality and scope of banks’ recovery plans. The lack of specific provisions for conglomerates on prevention, management, and resolution, could significantly increase the costs of a crisis.

Contingency Plans for Systemic Crisis

51. There is no formal contingency plan for dealing with a systemic crisis, nor a systemic simulation exercise to assess the authorities’ ability to deal with a systemic crisis. IPAB undertakes its own simulation exercises but there have been no regular system-wide crisis simulation exercises testing the effectiveness of the authorities' cooperation and their ability to coordinate and communicate effectively in times of crisis. A systemic crisis contingency planning and simulation exercise agenda should be pursued as part of normal business practice.

Insolvency Proceedings and Creditor Rights

52. The financial reform has brought major changes in the Mexican insolvency framework. The Mexican insolvency model is federal in nature, both in its application and Courts jurisdiction. The 2014 amendments to the Mercantile Law (“Ley de Concursos Mercantiles”) introduced many reforms, in line with past recommendations. These included: the reduced influence of related parties in the voting process in a reorganization plan; a procedural consolidation of large corporate groups in insolvency; a filing by reorganization by debtors in cases of imminent insolvency; and first priority post-commencement financing for distressed businesses.

53. However, the insolvency regime does not support preserving going-concern value and is rarely used, and the enforcement of secured interests remains a challenge. The regime continues to be quite complex and discourages the use of insolvency proceedings, and the use of creditor committees and creditor meetings is virtually non-existent. Although the 2014 reform added out of court enforcement remedies for security interests in deposit accounts, court-based enforcement is still the norm, and judicial proceedings still do not differentiate between immovable and movable collateral.

Anti-Money Laundering And Combating The Financing Of Terrorism

54. The coexistence of a sophisticated financial sector and a large cash-based informal sector could potentially pose significant challenges in the implementation of the AML/CFT. The IMF will conduct an AML/CFT assessment of Mexico during February/March 2017.

Financial Sector Development Priorities

55. Access to finance and long term financing remain primary challenges for a large segment of the economy. Despite its income and level of development, Mexico’s private sector credit to GDP ratio is just about 30 percent, and is one of the countries in Latin America and peer emerging markets (e.g., Russia, Turkey, South Africa) with the lowest number of adults holding an account at a financial institution, obtaining credit, and owing debit cards (Findex 2014). Furthermore, financial services’ provision is concentrated in urban areas, with only 29 percent of the poorest Mexican population having an account, compared to an average of 50 percent in Latin America. The authorities’ efforts at closing the gap have focused on enhancing the role of DBs to expand credit and financial services, in particular to SMEs and public infrastructures, through first and second tier lending and guarantees and establishing quantitative credit targets.16

56. The important role that development banks may have in fostering financial inclusion and deepening, needs to be done on a sustainable basis, generating the right incentives. To ensure effectiveness, sustainability, and to avoid creating market distortions, authorities may implement relevant changes to the current policy, focusing on financial inclusion, crowding in private sector, ensuring sustainability when pricing programs, and gradually phasing-out from those beneficiaries that can already be served by the private sector. Finally, opportunities to increase coordination by sharing services and merging institutions should be explored.

57. Further improvements to financial infrastructure would foster access, leveraging the impact of development banks. The financial reform introduced important reforms to the financial infrastructure framework, notably related to credit information, insolvency framework and enforcement of mobile guarantees. Further actions to make the movable collateral registry fully operational and to test the new framework are needed. The creation of a credit registry would further facilitate entrance of firms that exploit credit information.

58. The regulatory framework and policies for infrastructure financing could be further enhanced to facilitate mobilization of resources and broaden the investors’ base. While very positive progress has been made, further efforts are needed. This process would benefit from introducing more flexible instruments such as infrastructure debt funds, broaden the investor base, emphasizing the use of guarantees provided by development banks instead of direct lending, and promoting the off-loading of mature infrastructure assets of SOFIs.

59. Steps are needed to ensure the sustainability and competitiveness of the pension system. In particular, current contribution rates for IMSS workers are significantly below OECD countries’ prevailing levels. A sunset clause should be put on the accumulation of defined benefits, in line with OECD recommendations. These reforms would smooth the replacement rate trajectory, reduce fiscal deficits from the transition generation, and provide funding for universal pension rights, a measure pending the Senate’s approval. The annuity market is formed by four players, two of which hold three quarters market share. New entrants would make this market more competitive and sustainable.

60. Domestic capital markets are unevenly developed with a very liquid government bond market but shallow corporate debt and equity markets. Government bond markets are deep and well-diversified in terms of range of instruments and maturities, providing liquidity in all relevant benchmarks. The strong presence of foreigners supported the yield curve lengthening and secondary market liquidity. However, corporate equity and bond markets are still not a reliable source of long-term financing as they are small, expensive and illiquid. For instance, equity markets amount to only 38 percent of GDP, are less dynamic than in peer countries, and are tilted towards large enterprises and family owned corporations. The development of hybrid capital markets instruments, via private equity funds, could provide a promising venue for much needed mature infrastructure investments. There is significant scope to broaden existing debt instruments to include infrastructure debt funds, covered bonds, and standardized securitization bonds to appeal to a larger range of private sector investors.

Annex I. Bank Stress Tests and Interconnectedness

A. Solvency Stress Test Methodology

1. The CNBV’s conducted the BU ST for the seven largest commercial banks. The CNBV specified the risk parameters (PD and LGD) taking into account the banks’ portfolio characteristics for eleven asset classes, The banks projected net income, credit losses, loss reserves, and changes in their credit portfolio under the stress scenarios.

2. The Banxico conducted the TD ST for the largest twenty-one banks in the system. The Banxico projected the risk parameters, net income, credit losses, loss reserves and changes to the credit portfolio for each bank considering three asset classes. A bank fails the test if its capital adequacy ratio (CAR) falls below 8 percent.

3. The macroeconomic scenarios included both domestic and international economic and financial variables. Consistent with the TD STs conducted by Banxico on a regular basis, the domestic variables in the scenarios included the exchange rate, the rate of the 28-day Cetes (Mexican Federal Treasury Certificates), the Mexican stock index (IPC), the domestic index of economic activity (IGAE), the consumer price index (CPI), commercial bank credit, and the unemployment rate.

The set of international variables included the U.S. industrial production index, the West Texas Intermediate oil price, the U.S. three-month Treasury bill yield, the U.S. 10-year Treasury bond yield, the VIX, and the Dow Jones Industrial Average index. Only the domestic variables served as inputs in the satellite models. The horizon of the ST scenarios was five years. Interest rates and margins have remained low in Mexico.

A02ufig01

Average Funding Costs

Citation: IMF Staff Country Reports 2016, 361; 10.5089/9781475556384.002.A001

Source: IMF staff.

4. The STs used two sets of simulated negative macroeconomic scenarios. The scenarios, generated using a VAR specification, covered the period 2016 Q1–2020 Q4. The first set of scenarios. The first set of scenarios corresponded to short-lived adverse conditions, e.g., the V-shaped scenario set, where the economy recovered rapidly from the initial shocks. The average severity of this set of scenarios resembled the 2008–09 financial crisis. The second set of scenarios corresponded to a protracted recession, e.g. the U-shaped scenario set. In these scenarios, the initial shocks were less severe than in the V-shaped scenario set but the recovery was slower. The BU ST used only two scenarios, each corresponding to the average scenario from the U-shaped and V-shaped sets of scenarios. In contrast, the TD ST used the probabilistic approach proposed by Banxico, in which a bank’s CAR was calculated for each single scenario in the set of scenarios.

A02ufig02

Economic Activity Index

(Year-on-year percentage change)

Citation: IMF Staff Country Reports 2016, 361; 10.5089/9781475556384.002.A001

Source: Banxico and IMF staff.

5. Risk parameters, i.e., PD and LGD, were modeled as functions of the macroeconomic and financial variables. In the BU ST, a latent factor function of the scenario variables served as the explanatory variable in the models used to estimate bank-specific (including for development banks), loan-specific risk parameters. In the TD ST, ARIMA models including own lagged values and scenario variables generated the ST PD projections for each loan category. In the TD ST, the LGD was linked to the level of the PD using an explicit LGD model. In both the TD and BU STs, the flows in and out of the loan book and credit provisions, and capital projections follow standard formulas.

6. Although the STs assumed fixed risk-weights, the CAR was adjusted to account for changes in the assets’ PDs. The unadjusted CAR was multiplied by the ratio of the required capital for a unit exposure, calculated using the bank-weighted PD at end-December 2015, to the required capital calculated using the bank-weighted PD at the end of the quarter. The required capital was calculated using the asymptotic single risk factor approach proposed by Basel.

Annex Table 1.

Banking Stress Test Matrix

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Source: IMF staff.
Annex Table 2.

Domestic Variables, Stress Scenario Projections

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Source: Banco de Mexico and staff calculations.
Annex Table 3.

Liquidity Stress Test Results

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Source: Banxico.
Annex Figure 1.
Annex Figure 1.

Domestic Variables, Historical, and Average Stress Scenario Values

Citation: IMF Staff Country Reports 2016, 361; 10.5089/9781475556384.002.A001

B. Interconnectedness Analysis: Methodology and Results

7. The analysis of interconnectedness risk encompassed a broad sample of firms and used bilateral direct disaggregated by asset classes. The contagion model covered foreign financial intermediaries (119 firms) and international conglomerates (133 firms); domestic financial firms, including commercial banks (47 firms), development banks (6 firms), brokerage firms (33 firms), mutual funds (327 firms), pension fund managers (77 firms), insurers (56 firms), and other domestic financial intermediaries (125 firms). Direct exposures in the network were due to, in decreasing order of importance, to securities holdings, foreign exchange transactions, deposits, loans, and derivative transactions, including repo operations.

8. Banxico conducted the exercise using its contagion model which is similar to models used in peer institutions and the IMF. Based on bilateral exposures in securities, derivatives, and deposits and loans in both domestic and foreign currency, the model captures losses experienced by financial firms triggered by the failure of an individual firm to meet its obligations, which in turn can trigger second round effects. The loss given default is assumed equal to 100 percent of the net uncollateralized exposure. Simulation exercises, which assume the failure of an individual firm, serve to determine the worst possible contagion chain, i.e. the one that generates the largest impact on the system in terms of total losses. The analysis was conducted for three different dates: end-June 2015, end-September 2015, and end-December 2015, with the results reported below.

Annex Table 4.

Interconnectedness Risk

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Source: Banxico.

Annex II. Implementation of the 2012 Financial Stability Assessment Program Recommendations

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Annex III. Report on the Observance of Core Principles for Effective Deposit Insurance Systems

1. The deposit insurance framework, managed by Instituto para la Proteccion al Ahorro Bancario—Deposit Insurer (IPAB), broadly conforms to best international practice. IPAB is a loss minimizer deposit insurer, managing an ex ante fund. IPAB collects quotas from its 46 member institutions based on members' liability operation1 so that even non-deposit taking members (those licensed to take deposits but not yet accepting them) are required to pay a quota to the fund. IPAB is also the resolution authority and closely cooperates with other members of the financial safety net. In 2014 the Banking Law was amended to provide IPAB with greater powers to manage both its deposit insurance and resolution functions.

2. But the current reserve level for the deposit insurance fund is small by international standards. It covers approximately 1 percent of insured deposits. IPAB, as the successor to the deposit insurance vehicle used during the 1994-1995 banking crisis (Fobaproa), has been responsible for disposing of problem assets inherited from Fobaproa2 as well as repaying the debt incurred in managing that crisis. And by law 75 percent of IPAB's premiums must go towards repayment of the debt, which has grown in nominal terms to MXN 800 billion. This ongoing obligation continue to severely hinder IPAB's ability not only to grow its fund but also to independently manage its finances. Furthermore, there is no limit on the amount it must contribute to a recapitalization or restructuring of a systemic bank from its deposit insurance fund.

3. Also, the structure of IPAB's Board of Directors presents the potential for a lack of operational independence. There is no requirement that IPAB's Governing Board convene only when all its members are present or a majority of those present are independent Board members. There is no fixed term for the Executive Director of IPAB and no protection from dismissal except for cause. This board structure is not consistent with true operational independence.

4. IPAB has not participated in any contingency planning for system-wide crisis. IPAB does undertake its own simulation exercises but it has not prepared or tested a contingency plan for a systemic crisis or the failure of a systemic bank. There are no regular system-wide crisis simulation exercises held to test the effectiveness of the authorities' cooperation and their ability to communicate effectively in times of crisis.

5. IPAB has multiple mandates but has not been provided with a means to achieve the needed funding to meet its mandates. IPAB has been tasked with managing legacy assets, repaying legacy debt, insuring depositors and acting as the resolution authority and source of resolution funding for banks deemed systemic. However, it is constrained by the requirement that 75 Percent of its premiums go to repayment of the debt from the financial crisis more than twenty years in the past. Careful consideration should be given as to how best to manage these not-entirely-consistent mandates by addressing the repayment of legacy debt and finding a workable resolution funding formula that protects IPAB's deposit insurance fund, which supports its primary mission of protecting insured depositors at small and medium banks, from depletion by resolution funding for systemic banks.

6. Overall, IPAB is a strong institution. It has a culture of cooperation with other safety net players, strong performance in its recent handling of a small bank failure, ongoing planning for potential financial institution resolutions, and openness and transparency in its operations and reporting. However, there are several areas for improvement, most importantly the need for a solution to its various funding issues.

C. Methodology Used for the Assessment

7. The evaluation of the compliance with the Core Principles for Effective Deposit Insurance Systems was conducted on IPAB utilizing the Methodology for Compliance Assessment adopted in November 2014 by the International Association of Deposit Insurers.

The Assessment addressed IPAB's compliance with the Core Principles with respect to its operations as an insurer of deposits in commercial banks. The assessment was based on a review of relevant laws, regulations and regulatory and supervisory practices related to the banking sector and the operations of IPAB. IPAB is an independent deposit insurance agency which is a decentralized agency of the federal public administration under the SHCP.

8. There has been one recent experience with the failure of a small bank, Banco Bicentenario. The assessment considered the experience of IPAB in managing that failure and reimbursing the small number of insured depositors at the institution. The Technical Note on Bank Resolution and Crisis Preparedness addressed a wider range of issues related to the authorities' preparation and ability to handle financial sector crises generally.

D. Findings

9. The deposit insurance framework in Mexico for commercial banks, managed by IPAB, broadly conforms to best international practice. IPAB was established in 1999 under the Law for the Protection of Bank Savings (IPAB Act). Prior to IPAB's establishment there was blanket coverage of deposits in place and its establishment began the transition to a limited scheme for deposit insurance coverage (from 1999 to 2005). IPAB has 46 member institutions, with the seven largest commercial banks holding about 80 percent of the system's assets.

10. IPAB is funded by annual quotas collected from member banks based on their banking operations. IPAB collects quotas (an assessment based on bank liabilities) from its member banks at the lowest rate authorized by its law (40 basis points) and is required to devote 75 percent of its income on the repayment of debt resulting from the 1994-1995 financial crisis. As a result, it has

accumulated a relatively small deposit insurance fund representing about 1 percent of insured deposits or 0.75 percent of all member banking liabilities.

11. IPAB's Board is composed of seven members, with the head of SHCP acting as Chair.

There are four independent members of the Board as well as representatives of CNBV and Banxico. IPAB has approximately 300 employees.

12. Deposit insurance is compulsory for all deposit-taking commercial banks and those banks licensed to take deposits. IPAB protects all retail depositors, including corporate depositors, small businesses and individuals, up to the maximum of UDI 400,000 per depositor per member institution. Foreign currency accounts are insured but are not widely used in Mexico as such accounts are limited by law to only certain businesses authorized by Banxico; there are personal accounts held in foreign currency. IPAB is legally mandated to reimburse depositors within three months after a bank's license is revoked.

13. IPAB is the resolution authority. It is in charge of implementing resolution once CNBV has revoked the license and in cases deemed systemic by CEB when the license is not revoked.

It also has a significant role in the funding of resolution of systemic banks. IPAB's claim in the creditor hierarchy in liquidation is superior to claims by uninsured depositors.

14. IPAB has a number of strengths, including a culture of cooperation with other safety net players, strong performance in its handling of the Banco Bicentenario failure, planning for potential financial institution resolutions and openness and transparency in its operations and reporting. However, there are several areas for improvement, most importantly the need to address the required repayment from current quota collections of legacy debt arising from the more than 20-year-old financial crisis.

15. IPAB's governance structure should be adjusted to provide it with greater operational independence. The presence of the Minister of SHCP as Chairman of IPAB's Board, along with the absence of a fixed term for its Executive Director and no protection for his removal except for cause, impacts IPAB's ability to operate as a truly independent entity. The absence of a requirement that a quorum of the Board must include at least some of the independent Board members further erodes its operational independence.

16. IPAB's contribution to the amount it must contribute from its deposit insurance fund to a resolution of a systemic bank should be capped. Given its numerous mandates, IPAB's insurance fund is and will remain underfunded until the issue of its legacy debt requirement is addressed. By failing to limit what it must contribute to a systemic resolution, even given its substantial borrowing authority, there is a possibility that IPAB's fund will never be sufficient to meet its primary mandate of paying depositors without relying on a cycle of borrowing and future industry repayments that could stretch over many years.

17. IPAB should be able to use resolution tools other than liquidation by eliminating obstacles. The inability for potential acquirers to access relevant data before the bank's licens revocation make the use of the purchase and assumption very difficult. Given that the Mexican banking market has relatively few participants careful consideration needs to be given to how best to assure confidentiality if a troubled bank is identified as a candidate for a P&A transaction. The role of the competition authorities would also have to be considered to be certain that any necessary approvals for an acquisition would not be unduly delayed. IPAB should also do greater outreach to assess member institutions' appetite and capacity for becoming paying agents, purchasing troubled assets and completing whole bank purchase and assumption transactions.

IPAB Summary Compliance with the Core Principles for Effective Deposit Insurance Systems

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E. Authorities' Response

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1

Growth dipped in 2013 to 1.3 percent reflecting a weak external demand and a decline in construction caused by the new housing policy that led to the restructuring and downsizing of the largest home builders. nonresidents held a third of all domestic government debt securities, and 60 percent of Mbonos (fixed rate bonds).

2

These are financial institutions that perform operations such as leasing and factoring. A sofome cannot raise funds from public deposits. Sofomes account for only 1 percent of the financial system assets.

3

Large depositors are defined as depositors with more than MXN 200 million in deposit accounts or that represent 0.5 percent of a bank’s total liabilities.

4

Mexico’s minimum capital requirement for each tier of capital is: 4.5 percent of common equity tier 1 capital (CET1); 6 percent of Tier 1, and 8 percent of total capital. Systemic banks are required to hold a supplemental capital of 2.5 percent of their risk weighted assets (conservation buffer). Since May 2016, systemic banks are required to build a capital surcharge ranging from 0.6 percent to 1.5 percent of their risk weighted assets over a four-year period.

5

Banking sector exposures in foreign currency is limited by prudential regulations, including caps on net FX open positions (at 15 percent of Tier 1 capital) and liquidity requirements that limit currency mismatches.

6

Private employees who began working before mid-1997 and most public employees who enrolled prior to mid-2007 are grandfathered and may draw a pension under the previous defined benefit rule.

7

In a tail event of disorderly pressures in domestic securities markets and capital flows reversal, the authorities have a number of tools to prevent disorderly market conditions, including discretionary foreign exchange interventions, targeted liquidity provision, and debt duration management.

8

BU STs were not performed on the small banks.

9

The average liquidity coverage ratio (LCR) of G-7 banks stood at 208 percent by end-2015.

10

The authorities also indicated that even if one or more development banks were to face capital shortages, as long as there was excess capital at the aggregate level for the development banking sector, the capital could be redistributed among the banks facing capital shortages to ensure all firms were adequately capitalized.

11

The exercise focused on the largest publicly-listed corporations. It is estimated that 68 percent of the labor force works in small and medium enterprises (SMEs) but they create less than 40 percent of Mexican value added (OECD 2013 data). Data limitations prevented the extension of the analysis to the SME sector

12

Conduct supervision, aimed at consumer protection and integrity of markets, is performed by a separate Conduct Supervisor (CONDUSEF). It promotes financial transparency and education to help users make informed decisions on profits, costs, and risks of products and services provided by the Mexican financial system. The consolidation of the supervisory agencies together with the existing separate Conduct Supervisor would result in a twin-peak arrangement.

13

This recommendation should be implemented in line with the strengthening of the CNBV’s independence.

14

The CNBV’s 2016 five priorities are: (i) open architecture fund distribution; (ii) a second stock exchange; (iii) secondary rules applicable to brokerage houses; (iv) stock exchange rules; and (v) new rules applicable to central counterparties. The 2014–18 internal strategic plan has three strategic lines: (i) strengthening the processes at the CNBV by optimizing the supervision and enforcement; (ii) implementing the financial reform by issuing the regulation and to adapt the functions and structure of the CNBV to implement the financial reform; and (iii) procuring the solidness and development of the financial system in line with best international practices.

15

On October 2012, for instance, Banxico required banks to request its authorization to transfer assets abroad or conduct other operations between banks and relevant related parties if exceeding 25 percent of basic capital. In 2009–10 CONSAR increased the limits to the VaR for pension funds’ portfolios during periods of high volatility.

16

These targets may have generated perverse incentives by competing directly with the private sector through lower interest rates and reducing incentives for DBs to exit from lending operations.

1

Article 22 of IPAB’s law provides that the ordinary fees paid by member institutions may not be less than four thousand times over the amount of the banking operations of the institutions. Banking operations are defined in Article 46 of the Banking Law.

2

This aspect of its inherited obligations has largely been completed, with just two assets remaining for disposal.

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Cover IMF Staff Country Reports
Mexico: Financial System Stability Assessment
Author:
International Monetary Fund. Monetary and Capital Markets Department
Volume/Issue:
Volume 2016: Issue 361
Publisher:
International Monetary Fund
ISBN:
9781475556384
ISSN:
1934-7685
Pages:
58
DOI:
https://doi.org/10.5089/9781475556384.002
Figure 1.

Reserves and Nonresident Portfolio Liabilities

(In US$ billion)
Figure 2.

Mexico’s Financial System
Figure 3.

Mexico’s Commercial Banks Performance
Figure 4.

Mutual Funds and Assets under Management

(In billions of pesos)
Figure 5.

Insurance Solvency Ratio 1/
Figure 6.

Mexico’s Corporate Sector
Figure 7.

System-Wide Capital Adequacy Ratio Distribution Across Scenarios in Top-Down Stress Test

(In percent)

Average Funding Costs

Economic Activity Index

(Year-on-year percentage change)
Annex Figure 1.

Domestic Variables, Historical, and Average Stress Scenario Values