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«© 2006 International Monetary Fund October 2006 IMF Country Report No. 06/350 Mexico: Financial System Stability Assessment Update, including ...»

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© 2006 International Monetary Fund October 2006

IMF Country Report No. 06/350

Mexico: Financial System Stability Assessment Update,

including Summary Assessments on the Observance of Financial Sector Standards

and Codes on the following topics: The Basel Core Principles for Effective Banking

Supervision, and the IOSCO Objectives and Principles of Securities Regulation

The update to the Financial System Stability Assessment on Mexico was prepared by a staff team of the International Monetary Fund and the World Bank as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on August 4, 2006. The views expressed in this document are those of the staff team and do not necessarily reflect the views of the government of Mexico or the Executive Board of the IMF.

The policy of publication of staff reports and other documents by the IMF allows for the deletion of market-sensitive information.

To assist the IMF in evaluating the publication policy, reader comments are invited and may be sent by e-mail to publicationpolicy@imf.org.

Copies of this report are available to the public from International Monetary Fund ● Publication Services 700 19th Street, N.W. ● Washington, D.C. 20431 Telephone: (202) 623 7430 ● Telefax: (202) 623 7201 E-mail: publications@imf.org ● Internet: http://www.imf.org Price: $18.00 a copy International Monetary Fund Washington, D.C.

INTERNATIONAL MONETARY FUND

MEXICO Financial System Stability Assessment Update Prepared by the Monetary and Financial Systems and Western Hemisphere Departments Approved by Ulrich Baumgartner and Anoop Singh August 4, 2006 This report is based primarily on work undertaken during a visit to Mexico from February 22 to March 7, 2006, as part of the Financial Sector Assessment Program (FSAP) Update. The FSAP findings and recommendations were discussed with the authorities during the Article IV Consultation mission in May 2006. The FSAP team was co-led by Alfredo M. Leone (IMF) and Augusto de la Torre (World Bank), and comprised Jorge Cayazzo, Jorge Chan-Lau, Marco Espinosa-Vega, Jan Woltjer (all IMF);

Mario Guadamillas, Britt Gwinner, Gregorio Impavido, Emanuel Salinas, Constantinos Stephanou (all World Bank); Jonathan Katz (securities expert, formerly with the U.S. Securities and Exchange Commission);

Rudolph Zepeda (Directing Bank Examiner, U.S. Federal Reserve Bank of Atlanta); Ruth de Krivoy (former Governor of the Central Bank of Venezuela); and Solange Bernstein (Superintendent of Pension Funds Administrators of Chile). Pierre Papadacci and Sonia Echeverri (both IMF), and Martin Naranjo (World

Bank) assisted the mission. The main findings are:

• Helped by good macroeconomic policies, sound oversight, and a favorable external environment, the already sound Mexican financial system continues to increase its resilience. Although consumer and mortgage lending has been growing at a rapid pace, credit to the private sector remains low by some international comparisons.

• Most shortcomings identified during the 2001 FSAP have been addressed, but a number of supporting reforms are needed to boost efficiency in the financial system and to consolidate its stability.

• Key challenges for the authorities are: (a) entrenching stability by further strengthening prudential supervision and regulation, including by establishing full autonomy of the supervisory agencies, implementing full-fledged consolidated supervision of financial conglomerates, and enhancing monitoring of consumer and mortgage credit; (b) extending the reform and rationalization of development banks; and (c) continuing to promote wider and more efficient private sector access to finance including by fostering transparency and competition.

The main authors of this report are Alfredo M. Leone and Marco Espinosa-Vega, with contributions from other team members.

FSAPs are designed to assess the stability of the financial system as a whole and not that of individual institutions. They have been developed to help countries identify and remedy weaknesses in their financial sector structure, thereby enhancing their resilience to macroeconomic shocks and cross-border contagion.

FSAPs do not cover risks that are specific to individual institutions such as asset quality, operational or legal risks, or fraud.

-2

–  –  –

Glossary

Executive Summary

I. Macrofinancial and Institutional Setting

A. Macroeconomic Background

B. Macroeconomic Risks

II. Financial System Institutions and Markets

A. Credit Institutions

B. Housing Finance Markets

C. Development Banks

D. Derivatives Markets

E. Institutional Investors

III. Financial Sector Supervision and Regulation

A. Banking

B. Securities Markets

IV. Infrastructure

A. Payments

B. Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT)

C. Banking Safety Net Arrangements

AnnexObservance of Financial Sector Standards and Codes—Summary Assessments

Tables

1. Selected Economic Indicators, 1998–2006

2. Financial Soundness Indicators for Commercial Banks, 2000–06





3. Regional Comparison of Equivalent Fees Over Assets, 2005

4. Recommended Action Plan to Improve Compliance with the Basel Core Principles.........37

5. Recommended Action Plan to Improve Implementation of the IOSCO Objectives and Principles of Securities Regulation

6. Interest Rate, Exchange Rate, Credit Risk Sensitivity Tests, and Credit Risk “Tequila” Scenario, Effects on the Capital Adequacy Ratio

7. Interest Rate, Exchange Rate, Sovereign Risk, Credit Risk Sensitivity Analysis and “Peer” Scenario, Effects on the Capital Adequacy Ratio

8a. Market Risk Under a “Tequila” Scenario, Effects on the Capital Adequacy Ratio...........59 8b. Market Risk Under an “Oil Crisis” Scenario, Effects on the Capital Adequacy Ratio.....59 9a. Assumptions for Market Risk “Tequila” Scenario

9b. Assumptions for Market Risk “Oil Crisis” Scenario

10. Shocks on Premiums, Return and Loss Rate, and Scenarios, Effects on the Solvency Ratio

-3Figures

1. The Extension of the Domestic Yield Curve

2. Cross-Country Competitiveness Comparisons

3. Financial Sector Assets as of December 2005

4. Selected Financial Soundness Indicators for Commercial Banks

5. Total Financing to the Nonfinancial Private Sector

6. Implied Volatility in Mexican Peso–U.S. Dollar Options with Different Maturities........18

7. Average One-Month Forward Bid-Ask Spread in 2005

8. Number of New Annuitants

9. Asset/Liability Ratio for Commercial Banks

Boxes1. Key FSAP Update Recommendations

Appendixes I. Key Milestones in the Reform of the Financial Sector (2001-2006)

II. Detailed FSAP Update Recommendations

III. Stress Analysis for Commercial Banks, the Insurance Sector, and the Derivatives Exchange

IV. Payments and Securities Settlement Issues

-4

<

GLOSSARY

ACH Automatic clearing house AFOREs Private pension fund administrators AMAII Association of Independent Investment Advisors AMIB Asociación Mexicana de Intermediarios Bursátiles AML/CFT Anti-Money Laundering and Combating the Financing of Terrorism ASIGNA Stock exchange clearing fund BANSEFI Financial Services and National Savings Bank BCP Basel Core Principles for Effective Banking Supervision Bolsa Stock exchange BOM Bank of Mexico CAR Capital Adequacy Ratio CCP Central Clearing Counterparty CCV Central Counterparty for Equity Clearance and Settlement, a subsidiary of INDEVAL CECOBAN Banking Clearing Center CNBV National Banking and Securities Commission CNSF National Insurance and Sureties Commission COFEMER Federal Commission for Regulatory Improvement CONDUSEF Consumer Protection Agency CONSAR Pension Fund Commission CPSIPS Core Principles for Systemically Important Payment Systems CPSS Committee on Payment and Settlement Systems DA Development agency DB Development bank DRM Depósito de Regulación Monetaria EFT Electronic fund transfer FATF Financial Action Task Force FOVISSSTE Housing Fund of the Social Security Institute of Public Sector Workers FSAP Financial Sector Assessment Program FSC Financial Stability Committee IAS International Accounting Standards IMCP Mexican Institute of Public Accountants IMF International Monetary Fund IMSS Mexican Institute of Social Security INDEVAL Securities Depository INFONAVIT Institute of the Workers National Housing Fund IOSCO International Organization of Securities Commission IPAB Institute for the Protection of Bank Savings ISA International Standards on Audit LIC Law of Credit Institutions LMV Securities Markets Law LSM Mexican Corporation Law MBS Mortgage-backed securities MexDer Mexico’s Derivatives Market MOUs Memoranda of Understanding OTC Over-the-counter P&A Purchase (of assets) and Assumption (of deposit liabilities)

-5PCAs Prompt corrective actions POS Point of Sale RCV Pension account managed by AFOREs (Retiro, Cesantia y Vejez) SAPI Investment promotion vehicles aimed at facilitating the listing on the stock market of small- and medium-sized enterprises SENICREB Servicio Nacional de Información de Créditos Bancarios SHCP Secretariat of Finance and Public Credit SHF Federal Mortgage Society, a state-owned development bank SIAC System for Accountholders’ Service (Sistema de Atención a Cuentahabientes) SIDV Sistema Interactivo para el Depósito de Valores (SIDV), a securities settlement system SMEs Small- and medium-sized enterprises Sofoles Nondeposit-taking specialized credit institutions Solvency II EU Commission project aimed at reforming the EU solvency system for insurance companies SPEI A modern hybrid system (Sistema de Pagos Electrónicos Interbancarios) SPEUA Sistema de Pagos Electrónicos de Uso Ampliado SRO Self-regulatory organization TIIE Tasa de Interés Interbancaria de Equilibrio, benchmark in the interbank money market VaR Value at Risk

-6

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EXECUTIVE SUMMARY

The Mexican banking system is sound and has strengthened considerably in recent years. Overall, private banks are profitable and well-capitalized. In recent years, some development banks (DBs) have also reported adequate capital positions and positive results.

The system has benefited from the current economic recovery, which has boosted credit demand while contributing to a steady improvement in banks’ asset quality. Markets for derivatives (both over-the-counter (OTC) and exchange-traded) have grown significantly, allowing for better management of market risks.

The 2001 FSAP found that while sound macroeconomic policies and bank restructuring had contributed to a more resilient financial system, a number of shortcomings remained. In particular, insolvent banks could access the Bank of Mexico (BOM)’s liquidity support; there was no system of prompt corrective actions; the bank resolution framework was weak; there were serious deficiencies in the financial performance of development banks; housing finance required an overhaul; financial sector supervision required strengthening; and regulatory agencies lacked adequate autonomy.

Since then, the authorities have introduced a number of key reforms to consolidate

financial stability (Appendix I), including:

• Major improvements in compliance with the Basel Core Principles for Effective Banking Supervision (BCP) and the implementation of IOSCO Principles and Objectives of Securities Regulation. In particular, the legal and regulatory framework was strengthened, progress was made toward risk-based supervision, and the professionalism of the National Banking and Securities Commission (CNBV) was enhanced. Regarding securities regulation, the legal authority of the CNBV was expanded and transparency and market infrastructures were improved.

• Removal of the significant shortcomings in payment systems identified at the time of the 2001 FSAP. The uncollateralized BOM credit lines and guarantees were virtually eliminated, the legal basis for payments and clearing and settlement was substantially improved, and the oversight powers of the BOM were adequately clarified.

• Increased competition among the private managers of the defined-contribution pension funds. Policies aimed at loosening barriers to entry and facilitating migration to lower fee funds have made the market more contestable. Although still high, fees have decreased and expected replacement rates have increased.

• State-of-the-art regulation and supervision of the insurance industry. Regulation and supervision for the insurance industry have been significantly strengthened in line with the 2001 FSAP recommendations.

–  –  –

The Federal Mortgage Society (SHF), a specialized housing development bank, bridged the gap. Furthermore, an industry of private mortgage originators (Sofoles) has expanded rapidly. While still reliant on SHF’s funding, Sofoles have started tapping the market directly and mortgage-backed securities (MBS) are emerging.

Achieving the 2009 “sunset clause” for second-tier financing by SHF of housing lending is paramount for the development of private mortgage markets.

• Significant progress regarding the banking safety net. The prompt corrective actions (PCAs) in place meet international best practices, and the recent changes to the banking law to deal with insolvent commercial banks represent significant improvements. However, bylaws need to be amended as soon as possible to make the new resolution clauses fully implementable. There is also a need to establish a framework and operational guidelines for the resolution of financial groups.



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