The adoption, by the Mexican financial groups that owned banks, of the GAAP and BCBS principles from 1994 and onwards, strengthened and made them attractive to foreign firms. Those changes are analyzed by comparing banking indicators and by comparing the international and the Mexican banking regulatory principles.
The internationalization of the Mexican financial system, in general, and of its banking sector in particular, is a relatively recent phenomenon, which came as an aftermath of the 1994-95 financial crisis. This was part of a reorganization strategy for the recovery of the financial system, justified as a measure to secure the public’s
551 See Mahmood Bagheri, Informational Intermediaries and the Emergence of the New Financial Regulation Paradigm, 24 (11) THE COMPANY LAWYER (2003).
deposits and recapitalization of the existing banks, many of which were in trouble. It was necessary in order to make possible the bailout of the banking sector.
Allowing foreign capital to invest in larger proportions in Mexican banks quickly changed the distribution of shares between Mexican and foreign capital. On December 1996 (right before the new regulation on foreign investment came into effect) only 7% of the total shares of Mexican banks were in hands of foreigners. Just three months later, by March 1997, 17% of shares were owned by foreigners.
As of June 2008, 19 of 32 Mexican private banks were controlled by foreign capital, including the most important private banks: Bancomer, BANAMEX, and (then) Banca Serfin. Chart 2 shows the Chronology of the first wave of acquisitions and mergers of private Mexican banks by foreign firms.
Chart 2
Chronology of Mergers and Acquisitions of Mexican Banks by Foreign Firms552
Date Foreign Bank Mexican Bank
May 30th, 1995 BBV Banco Mercantil Probursa
August 9th, 1996 BBV Banca Cremi and Banco Oriente March 18th, 1997 Santander Grupo Financiero Serfin
May 16th, 1997 Santander InverMexico and Banco Mexicano
August 27th, 197 Citibank Banca Confia
May 8th, 1997 Santander Grupo Financiero Serfin March 30th, 2000 Nova Scotia Bank Grupo Financiero Inverlat
June 29th, 2000 BBVA Grupo Financiero Bancomer May 17th, 2001 Citibank Grupo Financiero Banamex
December, 2002 HSBC Grupo Financiero Bital
At the same time (January 1997), new accounting principles were adopted, which modified some concepts such as loans and overdue accounts. Market to market value
552
analysis was introduced; and inflationary effects were taken into account in bank accountings. One of their aims is to provide clear and accurate information the markets. It is believed that GAAP rules contributed to accelerate the internationalization of bank management practices in Mexico, as they made it possible to compare Mexican banks against their international counterparts.
In this way the financial system was concentrated and capitalized between 1998 and 2003. The financial system reached systemic stability due to a reduction in competition among the banking institutions. The analysis on the intermediaries’ financial performance is done by implementing profit and banking operation indicators. Particularly, the profit analysis is made by means of financial margin estimation and the total interest, while the operational analysis is done based on administrative costs over assets ratio.
The bank loans to the private sector and the unpaid credits of Mexican banks decreased after the internationalization. This is relevant since the origins of the banking crisis of 1994-95 are related to inappropriate policies related to credit expansion and unsuitable accounting practices. Starting in 1998, housing commercial loans and delinquent loans were reduced.
Mexican banks have been ever since more risk adverse in the long run. Therefore, financial globalization brought, as benefits to the Mexican economy, greater systemic stability, higher profitability and efficiency for banks, and most likely better authorization practices and higher loan repayment rate.
In México, the regulation and risk management practices are differentiated according to the type of financial intermediation activity. The difference in Mexico assumes that the intermediaries carry on their activities in a very specialized approach so as to guarantee the stability and performance of the financial system performance, which justifies the existence of institutional practices and specialized regulation for banking intermediaries as well as for non banking intermediaries, in addition to the existent common practices for any other institutions. (See Chart 3).
Chart 3
REGULATION AND RISK MANAGEMENT IN MEXICO553
Institution type Risk Management Memoranda Issued by
Commercial banks 1423 CNVB
Development banks 1473 CNVB
Securities Brokers 10-247 CNVB
Insurance companies S-11.6 CNSF
Retirement funds 51-1 CONSAR
All 31 BANXICO guideline to operate in the derivatives market BANXICO
Bank management in Mexico adopted gradually and increasingly the definitions and development of international practices, especially after the 1994-1994 crisis. At the regulatory level, the globalization of the Mexican financial system started in 1994 with the implementation of BCBS (1988) recommendations, which imposed international standard to measure the solvency and performance of Mexican banks.
Internationally, the creation of new financial instruments and the risk position enlargement in the markets throughout the 1990s led to better risk management. Toward that end, BCBS rules were updated in November 2005. Although originally meant to be regional, BCBS’s recommendations have reached global dimensions in practice. Ever since, management practices and bank risk regulations have been influenced by Basel II, which is recognized by more than 130 countries, including Mexico, as well as by IMF and WB. The Mexican financial system had no trouble adopting Basel II, since its regulation has been very strict after the “Tequila Crisis.”
553
Chart 4
BASEL AGREEMENTS INSTRUMENTATION IN MEXICO
Date Basel Mexico Contents
July 1998
Capital Agreement
Capital measures and standards to acquire international convergence. July 1994 Rules on capitalization requirements (SHCP) Memorandum 2019/95 (BANXICO)
This regulation aim to assure a given "regulatory capital" which would face the banks duties regarding the economic crises.
Sept. 1995
The 31 requirements to participate in the derivative market are presented and it intend to minimize insolvency risks and the financial system liquidity.
June 1999
First document
First consultancy document. The new agreement consists in three core principles: minimum capital requirement, supervision process and effective market discipline implementation.
Nov. 1999
Memorandum 1423 (CNBV)
Prudential dispositions in terms of integral risk Management.
Jan. 2001
Second document
Second consultancy document. Internal methodologies are emphasized, into market disciple supervision. It is more flexible and induces to better risk management. Feb.
2001
Memorandum 1480 (CNBV)
Methodology used by commercial banks to evaluate the given loans. Oct. 2002 Third Quantitative Impact study (QIS)
Technical orientation on the quantitative impact study to estimate the impact of the new agreement in the given loans. Nov. 2002 Third document Memorandum 1506
(CNBV) Prudential dispositions for internal control.
April 2003
Third consultancy document. Reform recommendations regarding regulation and supervision of the financial system, emphasizing quality management and banking risk administration. June 2004 New Capital Agreement or Basel II
Important recommendations focused on measurement and control including financial risks (liquidity, interest rate, exchange rate) as well as operative risks. It is of remarkable importance the politics, processes and procedures evaluations for the risk management.
July 2004
Modifications C-1423 (CNBV)
Prudential dispositions in terms of integral risk Management Basic principles related to this management and mechanisms that allow activities that involve risk levels linked to the net capital and operative capacity. Derogation of the C-1423.
Ever since, Mexican regulation has aimed to reduce information asymmetry problems and improve risk management. Specially, information problems are confronted by implementing early warning systems and market discipline. The adoption of these systems aims to detect and prevent capitalization problems and banks’ insolvency. Market discipline changes seek the homologation of the information must be revealed and published by the banks to analyze their solvency and financial situation.
The Mexican directives on risks (CNBV 2004a and 2004b) are in agreement with BCBS’s principles. The purpose is to have time series to analyze the mentioned events via financial modelling. Regarding credit risk, the guidelines allow grading the portfolio by the types of credit it contains and also establishes methodologies to define risk estimations and the possibility to implement internal methodologies. This regulation became compulsory in Mexico in 2007.
In order to guarantee that banks are duly capitalized (which is necessary to protect the public that trusts their savings or investments to their hands), and to promote financial stability (which is also necessary to promote economic development), Mexican financial authorities and the ABM agreed to adopt the New Capital Agreement (NCA) stated by Basel II.
The aim of the BCBS is to elaborate a new agreement for the adequate capital ratio in the banks. In order to strengthened them and assure stability, by means of adopting of risk management practices more strict and precise. This effort was officially stated in the document entitled “International Measures and Capital Standards convergence, reviewed framework” which contains the principles and standards usually named as Basel II or NCA.
Among Basel II core purposes are the establishment of principles and standards, to reflect with precision and sensitivity the effects on the banks capital due to the risks that the intermediaries face. Such as: credit risk, market risk and operational risk.
The NCA has three core principles. Principle 1 is “Minimum Capital Requirement.” For credit risk, four aspects are considered: 1) Standard simplified focus; 2) Standard focus; 3) Basic internal qualification focus; and 4) Advanced internal qualification focus. For the operational risk, four focuses are also taken in account: 1) Basic indicator focus; 2) Standardized focus; 3) Alternative Standardized focus; and 4) Advanced Measurement focus.
Principle 2 is “Supervision process” and refers to a higher independency level and institutional autonomy. The supervisor may request the banks to maintain a capitalization level above the minimum. Principle 3 is “Effective use of market discipline” and encourages the implementation of best practices when information is revealed, so that the market and society have the tools to evaluate the banks’ financial condition.
Mexican financial authorities considered the following key points to implement Basel II: 1) All financial institution had to implement at least the Standard Focus when calculating credit risk of capital requirement. As for the operational risk, banks had to adopt the Basic Indicator Focus with the option of using the Standard method or the Alternative Standard method. Regarding market risk, banks may use the internal model to determine the risk value. 2) Communication channels with external financial entities were established, in order to coordinate the transitions to Basel II. 3) The following chronogram was considered to implement the NCA in Mexico, in order to operate synchronized with the best international standards and thus embrace a healthy and progressive development.
Chart 5
SUBJECT DATE
Principle 1: “Minimum Capital Requirement”
a. by credit risk
Standard focus January 2007
Basic internal qualification focus January 2007
Advanced internal qualification focus January 2008
b. by operational risk
Basic indicator focus January 2007
Standardized focus January 2007
Alternative Standardized focus January 2007
Principle 2: “Supervision process”
Adoption of Principle 2 January 2007
Principle 3: “Effective use of market discipline”
Adoption of principle 3 January 2007