Global Financial Crisis and Bank Productivity in Mexico

Mexican Banking Sector Background

In the last decades the Mexican banking system has undergone several transformations. Private banks were nationalized in 1982 and in the period 1991-92 the banking system was privatized. In 1994 the North America Free Trade Agreement (NAFTA) was in force. From 1994 onwards banking investment was opened to foreign capital. Several restrictions were imposed under NAFTA covenants for overseas participation in the banking sector. While such limitations were supposed to last until 2000, they in fact were lifted during the Mexican financial crises that took place in 1995. After the crisis, foreign investment became predominant in the Mexican banking sector. Nowadays, the Mexican financial system includes 42 private banks, most of them foreign.

The financial liberalization process encompassed several reforms in order to enhance efficiency as well as to increase productivity in the financial system. Although 1989 is established as the year of the beginning of financial liberalization, in fact, since 1979 the Bank of Mexico introduced an auction system to determine the interest rate that would be paid to commercial banks for deposits they hold in the central bank. The financial liberalization process led to market based mechanism instead of a system based on quantitative credit controls and interest rate regulation. In 1989 the Mexican financial system underwent several legal reforms. It is important to stand out the admissibility of foreign investment participation in Mexican financial institutions´ equity.

Financial liberalization took place at a moment when Mexican banks conditions were not the best. The banking system was suffering from a growth crisis as well a low degree of capitalization. Thus, making them vulnerable to the greater risk that liberalization involved.

During the financial liberalization period, not only growth of the banking system was furthered, but also the interest margin improved. In addition, a decrease on market concentration was observed. Despite the risk levels went up, operational expenditures efficiency improved. However, as there was a sharp increase in interest expenditures, bank capitalization deteriorated.

The process of banking privatization occurs from June 1991 to July 1992. Nine banks were privatized during the first year, and another nine, in the second year. The control recovery of banks by their shareholders modified their attitude on risk taking. Under control of government commercial banks tended to be relatively conservative. Nevertheless, more aggressive levels of credit risk were observed on the new conditions.

Bank privatization increased interest margin, as well as profitability. Likewise, bank capitalization improved, and greater operational efficiency was achieved. Although interest expenditures declined in comparison to interest income, higher level of credit risk showed up. At the same time, a decrease in asset growth was experienced.

In 1994, once NAFTA became in force, a diagnosis of the Mexican financial system was carried out. As a result, national intermediaries were found to be at a relative disadvantage with regard to foreign counterparts. Domestic institutions showed lower levels of productivity and a greater market concentration.