BY LATIN AMERICA ADVISOR
Inter-American Dialogue

Mexico's government recently unveiled a financial reform bill that aims to increase lending rates in order to drive up economic growth, among other changes. The government claims the bill would simplify the bankruptcy process, introduce competition among banks and encourage the country's development bank to boost lending. Does the bill address the right areas of Mexico's financial system? What are the most significant changes that would occur under the reforms, and how will financial and other companies be affected? What will the reforms mean for the Mexican economy?

Nicolás Mariscal, member of the Advisor board and chairman of Grupo Marhnos in Mexico City: The Mexican financial system is strong; it has liquidity and capital but is small in relation to GDP. The financial reform bill addresses the right challenges to propel the growth of the financial sector and to promote a more competitive and productive economy. It is a comprehensive financial reform aimed at improving the Mexican financial system and reinforcing the protection of creditors' rights. At the same time, it would improve protection and options for the commercial banks through national development banking. The bill also promotes the expansion of other credit institutions, which are more effective, including the Sofoles. It will improve the legal framework for other instruments such as Structured Equity Securities, or CKDs, that are reinforcing private investment to develop important infrastructure projects like hospitals, or other instruments in the stock market such as the FIBRAS and referenced certificates. It will boost lending with better rates, but unfortunately it might not be fully reflected in the economy as it should, because one of the main problems is the large informal sector. The businesses that belong to the informal sector are not eligible for credits because they do not have the required legal documents. Therefore, the reform will help lead to more competitive banking and a more productive economy, but at the same time, efforts to reduce informality need prompt action.

Tapen Sinha, professor of risk management at the Instituto Tecnológico Autónomo de México and professor at the University of Nottingham Business School: Mexico has had a good run in the international arena lately. Part of the reason has been Brazil's recent lackluster performance. Another reason has been the success of 'Pact for Mexico.' A few weeks ago, Fitch Ratings upgraded its Mexico rating to BBB+. There are signs that Standard & Poor's and Moody's will follow suit. Mexico's rating is based on macroeconomic fundamentals and commitment to pass structural reform that the pact is undertaking. The latest proposal of the pact has been banking reform, which Mexico sorely needs. Less than 25 percent of Mexico's GDP is from the lending business; Brazil has twice that amount. Total credit given to small- and medium-sized companies has been less than 15 percent of the total credit even though these companies generate 75 percent of employment. Banks, however, have not suffered from such stingy behavior. If anything, they are amply rewarded. Spanish banks BBVA and Santander have 20 percent return on equity, whereas Citigroup-owned Banamex had 10 percent. It may seem paradoxical that banks are so profitable. They make money by charging people for anything and everything. The cost of certifying a check is $10 or more. All service charges are five to 10 times higher than in the United States. Yet, thanks to free-trade agreements, most banks in Mexico are foreign owned. They have yet to show 'best practices' in Mexico. The government, with the support of the opposition, is trying to force a change in behavior of the banks. If it succeeds, the GDP could grow at 6 percent rate in the medium term instead of half the current rate.

Alejandro Garcia, senior director for Latin America Financial Institutions at Fitch Ratings: Broadly speaking, the proposed reform is effectively addressing the most important challenges toward further expanding financial intermediation. The still-high operating costs and credit losses in selected sectors are key drivers of both low banking penetration and high interest rates in certain products, especially in retail lending. Improving the overall rule of law in financial activities, particularly in executing and foreclosing guarantees, should gradually have a positive effect on overall lending costs and, therefore, should also improve the availability and affordability of financial products. However, the positive effects for banks are most likely to be achieved over the medium term, when the lending and overall legal framework has been effectively and materially improved. There are other structural factors constraining financial intermediation, such as the population's unequal income distribution and high level of labor informality. Nonetheless, other non-bank intermediaries could see improvements over a relatively short timeframe, in the event that development banks effectively increase the availability of funds. Development banks and other government agencies are the main funding source for several lenders in sectors such as mortgage, consumer, small and medium-sized enterprises (SMEs) and agribusiness lending. These non-bank intermediaries are key players in certain regions and/or economic sectors. Therefore, if the availability of funding effectively increases, their relative contribution to total lending could grow over the near term. Improving the functioning of credit bureaus is also critical. Ample and detailed information on good borrowers should be widely available to ensure that they have easy access to better borrowing terms.

David Olivares, vice president and senior credit officer for Latin American bank ratings at Moody's Investors Service: The reform is credit positive for Mexican banks because it creates specialized courts that will streamline the bankruptcy process and facilitate enforcement of collaterals and guarantees, which has been a major barrier to more active lending, especially for loans to SMEs, which is a segment that offers banks great loan-growth potential. The reform also proposes a centralized credit bureau that will improve the quality of loan origination by allowing banks to cross-reference borrower information and better estimate expected credit losses. Mexico's two existing privately owned credit bureaus do not readily share information and do not include information from unregulated financial companies such as non-bank financial institutions or pawn shops, which are major sources of financing for low-income consumers, another source of growth potential for banks. The reform also includes partnerships between government-owned development banks and private institutions that promote specific sectors, and do not crowd out commercial banks' SME financing. The reform will also allow Mexican bank regulators to periodically evaluate bank lending and limit banks' proprietary trading if the regulator considers its lending volume too low. All in all, the reform aims at boosting bank lending in the country. With loans to GDP at less than 30 percent, Mexico's financial intermediation is modest and lags other Latin American countries, including Chile, Brazil and Colombia. The reforms require the amendment of at least 34 different laws, and will therefore take some time before they are enacted. But if enacted, they will ensure economic growth by providing broader access to credit.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor