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V Financial Liberalization and Reform in Mexico

Author(s):
Claudio Loser, and Eliot Kalter
Published Date:
February 1992
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Sharmini Coorey

Until the late 1980s, despite a period of gradual transformation and liberalization, the financial system in Mexico was characterized by interest rate restrictions, domestic credit controls, high reserve requirements, fragmented financial markets, and other elements causing inefficiencies in the intermediation between borrowers and lenders. Capital markets were not well developed and firms often had to turn to informal markets for their long-term financing needs. The lack of an established bond market and the existence of an informal credit market impeded the conduct of monetary policy by restricting the scope for open market operations and limiting the ability of the Bank of Mexico to monitor overall credit market conditions.

In late 1988, the Government substantially accelerated the process of financial reform in the context of its overall economic program. The objectives were to enhance efficiency through greater reliance on market forces, to promote the growth and deepening of financial markets, and to improve the effectiveness of monetary policy. In addition, recognizing the increasing globalization of capital markets, the Government sought to improve the capitalization and integration of Mexican financial institutions with a view to preparing them to be competitive internationally. The approach was based on the two complementary processes of liberalization and institutional reform. Key measures included the liberalization of interest rates, the elimination of direct controls on credit, the re-privatization of the commercial banks, and the promotion of a universal banking system.1

This section reviews the program of financial liberalization and reform undertaken by Mexico since the late 1980s and the issues that have arisen in this regard. The first part outlines some important reforms that preceded this liberalization as well as financial market conditions before 1988, while the second reviews liberalization measures undertaken since the end of 1988. The privatization of the commercial banks is discussed in the third part and the impact of the liberalization on financial aggregates and interest rates is analyzed in the fourth part. The conclusion identifies some factors that have contributed to the success so far of Mexico’s financial liberalization and areas in which the reforms could be taken further.

Background and Developments, 1974–88

The foundation for the financial liberalization that took place after late 1988 was laid by institutional reforms undertaken since the mid-1970s, the most significant of which were the move from specialized banking to full-service banking, the modernization of the securities market, and the formation of a domestic public debt market. By the early 1970s, restrictions on the scope of the financial services credit institutions could offer had led to a proliferation of banks specializing in different types of services: commercial banks, mortgage banks, and financieras, which mostly financed trade and commerce. In 1974, the Government sanctioned the merger of these separate institutions into full-service banks that could benefit from economies of scale and the diversification of risk. In 1975, the Securities Market Law was enacted modernizing the structure of the securities market, institutionalizing brokerage houses, and substantially strengthening the regulatory role of the National Securities Commission (CNV).2 Mexican treasury bills (CETES) were created in 1978 to provide the Government with a tradable instrument to issue domestic debt and to conduct open market operations. Within a short period, the yield on these instruments became the most representative quotation in the money market.

Until the mid-1970s, the banking sector had been highly regulated, and featured ceilings on deposit rates and requirements to channel credit to a specified range of activities within given limits on lending interest rates. This system became unmanageable in 1974 when deposit rates had to be increased sharply to reflect the acceleration of inflation. In response, a weighted average deposit rate (CPP) was introduced to provide a more flexible basis for determining loan rates; subsequently, loan rate restrictions were gradually removed. Deposit rates, however, remained regulated, and banks continued to be required to allocate credit to certain sectors, including the Government. While these policies favored borrowers with access to bank credit, they also discouraged financial savings in formal markets and hindered the intermediation function of the formal banking sector. For much of the 1980s, reserve requirements of over 50 percent and required lending to the public sector crowded out credit to the private sector. In addition, monetary control was based mainly on quantitative credit controls rather than on market mechanisms, such as open market operations.

The commercial banks were nationalized in September 1982 at the height of Mexico’s debt crisis. The years from 1982 to 1988 were a period of financial disinter-mediation. The high implicit tax that reserve requirements and credit controls imposed on banks increased the cost of intermediation to such an extent that a parallel informal market for credit developed rapidly, particularly in 1987–88 when inflation picked up. By the end of this period, the growth and expansion of intermediaries outside the control of monetary authorities had eroded considerably the competitiveness of the commercial banks and weakened the effectiveness of monetary policy.

Liberalization and Reform, 1989–91

Faced with disintermediation in financial markets and in the context of a new adjustment program the authorities, in late 1988, embarked on a major reform of the financial system. This section reviews the major deregulation measures undertaken, including the legislative groundwork that was laid to privatize commercial banks and to foster the development of universal banking.

Interest Rate Deregulation and Changes in Reserve Requirement System

In November 1988, the Government eliminated quantitative restrictions on the issuance of bankers’ acceptances.3 Banks were allowed to invest freely from these resources, subject to the restriction of maintaining a liquidity ratio of 30 percent in the form of certain government debt instruments (CETES and BONDES) and interest-bearing deposits at the Bank of Mexico.4

In April 1989, the Government introduced several major reforms to allow banks to carry out their intermediation function more efficiently:

  • (1) controls on interest rates and maturities on all traditional bank instruments and deposits were eliminated;
  • (2) the reserve requirements on bank deposits were replaced by a 30 percent liquidity ratio similar to that applicable to bankers’ acceptances.5 Government paper held to satisfy the liquidity ratio would earn market interest rates and would be fully tradable;
  • (3) restrictions on bank lending to the private sector were removed; and
  • (4) mandatory lending at below-market interest rates to the public sector by commercial banks was discontinued.

In addition, banks were given a greater degree of managerial flexibility and the autonomy of bank boards was expanded. The role of providing preferential credit was limited to the development banks and trust funds; Nafinsa, the largest of such institutions, ceased its commercial banking activities in early 1989.

While deposit and lending rates previously had been set to ensure the profitability of the nationalized banks, these reforms allowed banks to set their own terms on deposit and credit operations, and increased the competitiveness of the formal banking sector. The decision to finance the public sector from the sale of bonds in the open market rather than through mandatory subsidized lending from commercial banks helped reduce distortions in interest rates and enhanced the effectiveness of open market operations. Although the abolition of forced lending schemes and the lowering of reserve requirements strengthened the liquidity of the banking system and freed a considerable amount of resources for the private sector, the 30 percent liquidity ratio still appeared higher than what banks would have determined voluntarily. The requirement to hold government paper had a negative impact on the yields of these instruments and constituted an implicit tax on the financial system.

In August 1991, in response to a rapid increase in foreign short-term borrowing by commercial banks, the authorities imposed liquidity coefficients on foreign currency deposits of up to 50 percent (depending on deposit maturities).6 At the same time, the public sector was reducing its domestic debt sharply, aided by revenue from privatization and a reduction in nominal and real interest rates. In these circumstances, faced with a strong growth in the demand for private credit, commercial banks encountered increasing problems trying to fulfill their liquidity requirements. As a result, Cetes rates fell to about 16 percent while deposit rates rose sharply to between 50–60 percent at the end of August. In September, the authorities acted to reduce the liquidity coefficient on domestic currency deposits from 30 percent to 25 percent applicable to the total stock of deposits outstanding at the end of August 1991 and to eliminate the liquidity ratio for deposits in excess of that level.7 This move to a zero marginal requirement was expected to reduce the spread between interest rates and channel additional resources.

Changes in Structure of Government Debt

An important aspect of the financial system in Mexico in recent years has been the rapid growth and diversification of the market for government debt. The development of this market aided the process of liberalization by providing the public sector with an alternative to forced lending from the banking system. It also has expanded the range of financial assets available to private investors; over 90 percent of the volume of trading in the Mexican securities market (Bolsa de Valores) is accounted for by public debt instruments.8

During the early and mid-1980s, Cetes, which yield market-determined interest rates, constituted 80–90 percent of domestic public debt (excluding Bonos de la Deuda Publica which are bonds held exclusively by the Bank of Mexico). Starting in 1988, the Government began to change the composition of its domestic debt in order to lengthen the maturity structure and increase the variety of options offered to the public. The share of the shorter-term Cetes in domestic public debt was gradually lowered while the share of the longer-term Bondes, which had been introduced in late 1987, was increased. In addition to Petrobonos (three-year bonds with a capital gain or loss linked to the price of oil), in 1986 the Government introduced indexed instruments in the form of Pagafes (28- to 364-day dollar-denominated treasury bills payable in pesos at a fixed interest rate), and in 1989 Ajustabonos (three- to five-year bonds with returns indexed to the consumer price index) and Tesobonos (one- to three-month bonds with returns indexed to the free exchange rate).

Institutional Reforms

In December 1989, in order to further the process of liberalization and strengthen banks and other financial institutions involved in credit and stock market operations, Congress approved additional wide-ranging institutional reforms.9 The measures were intended to increase competition and reduce market segmentation by expanding the scope of permissible activities for different types of financial institutions and by allowing a greater degree of integration in the provision of financial services. In addition, the reforms eliminated government regulation of insurance premiums and policies, deregulated and simplified the operations of mutual fund societies, strengthened the supervision and regulation of bank and nonbank financial institutions, and relaxed restrictions against the participation of foreign investors in the capital of some non-bank financial institutions.

In 1990, the Government launched two major interrelated initiatives to allow the privatization of commercial banks and to establish the framework for the formation of financial groups (the latter were envisaged as the main organizational structure of financial markets). On May 2, 1990, a bill was submitted to Congress to amend Articles 28 and 123 of the Constitution, permitting full private ownership of the commercial banks.10

The new Credit Institutions Law, enacted in July 1990, allows commercial banks to be majority owned and controlled by the private sector (with private foreign ownership restricted to 30 percent of capital), regulates banking, and establishes the terms under which the state exercises supervision and control over the banking system. The provisions regarding bank regulation are intended to limit the concentration of credit risk in the banking sector, to ensure the separation of interests between banking and other activities, and to avoid conflicts of interest in the management of banks.11

The Law Regulating Financial Groups regulates and permits the formation, under a common structure, of groups of companies performing different financial functions. It thus ends the traditional separation of banking from other types of financial activities, and in particular, allows banks and brokerage houses to come under the control of a single holding company. In order to limit the concentration of risk, ensure the adequacy of capital, and prevent the pyramiding of the capital base, the legislation restricts the participation of more than one kind of intermediary within a single financial group, exempts members of a group (but not the holding company) from liabilities stemming from losses of any other member, and prohibits members from investing in each other’s or the holding company’s stock.

The new law was the result of close cooperation between government officials and private sector financial experts; it was based on the recognition that the expansion of services offered by Mexican intermediaries was rapidly making the distinction between traditional banking and other financial activities more and more tenuous. According to the authorities, the legislation “opens the possibility of establishing financial holding companies, which would be the hub for the shaping of a universal banking system providing all financial services by a financial group.”12

Privatizing Commercial Banks

A gradual process of consolidation since the nationalization of the commercial banks had reduced the number of institutions from 60 in 1982 to 18 by 1988. Except for the chief executive officers, the management of these banks remained for the most part unchanged after nationalization. At the time of the privatization, 15 banks had up to 34 percent of shares held by the private sector and traded in the stock market, while 3 were fully owned by the Government.

The experience of commercial banks during the period of nationalization varied considerably. Money market activities and the market for government debt were important sources of profits for most banks, which at the same time also had profitable subsidiaries in areas such as foreign exchange dealing, investment banking, and leasing. These profits mostly were reinvested in new technology and product expansion.13 Following deregulation in early 1989, competition between banks and the privately owned brokerage houses intensified significantly, particularly in the management of money market and other relatively liquid funds.

The guidelines for the divestiture of the banks were established in the presidential decree of September 5, 1990. According to government statements, “the privatization process does not only seek to obtain a fair price for the banks, but also to shape a more efficient and competitive financial system and to foster sound financial practices. A diversified participation in the capital stock of banks is deemed desirable. The formation of a controlling group with a distinct identity which is accountable to the authorities is considered necessary. This controlling group should be balanced by a broad number of minority interests.”14

Controlling 51 percent blocks of shares are sold by auction to groups of individuals with Mexican citizenship who pass through an approval process (discussed below); the remaining 49 percent is floated in secondary offerings to institutional investors, companies, funds, and foreign investors subject to certain ceilings. In July 1991, the Mexican Government restructured some $1.2 billion of interbank credit lines belonging to the six largest Mexican banks.15 The restructuring enhanced the market value of these banks and facilitated their privatization by reducing the outstanding value of such debts by about 30 percent on average. By mid-1992, all the commercial banks were privatized, selling at considerably higher prices than initially expected by government officials.

The process of privatization raised a number of challenges. In order to retain public confidence, the Government has taken precautions to ensure the transparency of the process of privatization and its consistency with general principles followed in other divestitures. A Committee for the Divestiture of Commercial Banks was established to oversee the registration and approval of potential bidders, the valuation of the institutions, and the sale of the Federal Government’s equity.16 The approval process was designed to be open while ensuring that interested parties are able to accept the responsibilities involved.

Upon registering, groups or financial holding companies submitted a business plan, including the possible incorporation of the bank into the financial group, the areas of market concentration, and plans for capitalization. Approval by the Committee was required for these groups to participate in public auctions of controlling shares. In evaluating an application, the Committee took into consideration the overall strength and expertise of the partners, as well as their ability to commit fresh capital, since the growing lending market, technological developments, and the higher capital adequacy requirements demand substantial additional investments from the holding company. Approval was granted only to groups seeking to acquire the entire package that is being auctioned. The Committee was required to inform the public periodically regarding the progress at each stage of the privatization process.

The actual bids were received from approved parties after the Committee published the notice for the auction, which also specifies the conditions of payment. The auction was carried out under a closed bid system, and the bid price is the most important element at this stage of the process. After analyzing the offers, the Committee proposed the decisions necessary to implement the divestiture to an Intersecretarial Expenditure-Finance Commission.

Another issue that had to be addressed in the privatization process is the valuation of the banks. Under the procedures, each bank established the book value of its assets and liabilities based on the standards set by the Committee for Bank Divestiture; this valuation is verified by external consultants hired by the National Banking Commission. The economic valuation is determined by the Committee, which takes into consideration pertinent elements not included in the book value, such as the value of intangible assets and the bank’s potential for generating profits.

The order in which the banks are sold off is also an important issue, since, once sold, they are likely to put competitive pressure on those banks remaining under state ownership. The Government addressed this problem by first setting up an orderly procedure (discussed above) and then proceeding with the divestitures quite quickly. Some two thirds of total commercial banking assets, including the two largest banks, were sold within the first 12 months of the process. In addition, several small regional banks were sold first, allowing the Government to streamline the process before selling the larger banks.

A distinctive feature of financial liberalization in Mexico has been its emphasis on horizontal integration in the form of financial groups. Since the end of 1989, the private sector has been active in forming financial groups, including gaining access to a large amount of capital to purchase the banks. The private financial sector is likely to undergo a further restructuring as the newly formed financial groups strive to achieve integration within each group with a view to eliminating duplication and reducing costs.17 The regional distribution capabilities of these groups are likely to be an important determinant of their relative success. Moreover, competition may intensify in the future in light of recent indications that the Government may authorize new banking licenses (possibly to foreign banks). While a new supervisory and regulatory structure has been put in place, it is too early to assess how well this system will perform in the new, more competitive environment and how it will deal with marginal financial institutions that remain or become insolvent.

Effects of Financial Liberalization

The 1989–91 period when most of the significant financial reforms took place coincided with the implementation of a successful economic adjustment program. It is, therefore, difficult to distinguish between the effects of financial liberalization and those of the economic adjustment program on the gradual return of private sector confidence. Moreover, some of the important financial reforms have been introduced only recently and it is too early to evaluate their effects. Subject to these caveats, this section analyzes some quantitative evidence on the effects of deregulation and liberalization on financial variables.

As noted earlier, the deregulation of interest rates and the lifting of credit ceilings in early 1989 allowed banks to compete effectively in financial markets and encouraged private savings in financial assets. At the same time, beginning in the first quarter of 1989, the behavior of financial savings underwent a marked turnaround. Chart 6 shows that the ratio of broad money (M2) to GDP, which had declined from 1982 to 1988, rose markedly from the first quarter of 1989 to the second quarter of 1991.18 The relationship between currency and GDP remained relatively stable throughout the entire period, indicating that the expansion of bank deposits was mainly responsible for the growth in monetary aggregates after 1988. The ratio of money and bonds (M4) to GDP, which had been relatively flat in 1982–88 (except for a brief period in 1986–87), also increased strongly during the 1989–91 period.

Chart 6.Behavior of Financial Aggregates

Source: Bank of Mexico.

Further evidence of the contrast in financial intermediation between the periods 1982–88 and 1989–91 is provided in Chart 7. Following a sharp dip during the debt crisis in 1982–83, the growth rate of M2 in real terms remained consistently negative from mid-1985 to late 1988. The intensification of financial disintermediation is evident in the sharp fall in the ratio of M2 to currency in 1987–88. The ratio of M1 to currency remained relatively stable throughout this period as disintermediation was strongest in certain instruments, such as bankers’ acceptances. The financial reintermediation that occurred after 1988 is evident in the sustained pickup in the real rates of growth of the monetary aggregates. As shown in Table 8, in contrast to the declines in real terms observed in 1982–88, M2 grew at an average annual rate of almost 14 percent in real terms and M4 grew at an average annual rate of about 19 percent in real terms during the period from the begining of 1989 to the second quarter of 1991. This expansion coincided with an increase in the ratio of M2 to currency reflecting the relatively stronger growth of short-term bank deposits.

Chart 7.Indicators of Financial Aggregates

Source: Bank of Mexico.

Table 8.Real Growth of Financial Aggregates

(Average annual growth rates in percent)1

1982:IV–1985:111985:111–I988:IV1989:1–1991:11
M4-5.7-1.319.2
M2-7.7-8.513.8
Currency-12.4-4.110.9

Quarterly averages of 12-month changes.

Quarterly averages of 12-month changes.

The effects of the financial liberalization are also evident in the behavior of the money multiplier.19 The replacement of the high reserve requirement with a lower liquidity ratio and the removal of credit restrictions in early 1989 raised the money multiplier and permitted a greater supply response as the demand for Mexican financial assets rose with the return of confidence. Chart 8 illustrates the marked increase in the money multiplier, particularly for M2, after the first quarter of 1989.

Chart 8.Indicators of Bank Reserves

Source: Bank of Mexico.

1 Ratio of M1 or M2 to the monetary base, which is defined as currency plus bank deposits at the Bank of Mexico.

2 Bank holding of Cetes relative to total Cetes outstanding.

3 Bank holdings of Bondes relative to total BONDES outstanding.

4 Bank holdings of Cetes and Bondes relative to M2.

5 Bank holdings of Cetes and Bondes relative to M4.

In some contexts, interest rate deregulation has led to sharply higher real interest rates. In the case of Mexico, real interest rates remained mostly negative during the period of financial disintermediation, particularly in 1986–87 (Chart 9).20 They appear to have risen sharply to high levels before the financial liberalization, and then to have increased again immediately after interest rate deregulation in early 1989, before reaching a peak in the middle of that year.21 Thereafter they declined steadily from 36 percent in mid-1989 to about 6 percent by mid-1991 as financial intermediation improved and the economic adjustment program gained credibility. Hence, there is little evidence that financial liberalization increased real interest rates, other than temporarily.

Chart 9.Real Interest Rates

(In percent)

Source: Bank of Mexico.

Another aspect of financial developments in Mexico has been the evolution of the market for domestic public debt and the declining significance of monetary assets in relation to other financial assets. Chart 10 shows the sharp, but gradual, decline of the monetary aggregate M2 as a share of M4 from over 90 percent before 1982 to between 50 percent and 60 percent after 1989. The bottom panel illustrates the change in the composition of public debt, particularly since 1988. The share of Cetes as a proportion of the total value of outstanding government bonds declined from 88 percent in December 1987 to 47 percent in June 1991, while the share of the longer-term Bondes increased from 1 percent to 31 percent during the same period. The average maturity of public domestic debt increased from under four months in 1988 to almost one year in June 1991. The chart also shows the increasing significance of Ajustabonos; the returns of which are linked to the consumer price index; although introduced only in July 1989, they constituted 18 percent of public debt by June 1991.

Chart 10.Domestic Public Debt

Source: Bank of Mexico.

Conclusion

A salient feature of the financial liberalization in Mexico has been the implementation of a clearly defined strategy in gradual, well-ordered stages. The deregulation of interest rates and the liberalization of direct controls preceded the privatization of the banks by almost two years, affording banks an opportunity to adapt to the more competitive environment and increase their market value. Nonbank financial institutions were first allowed to form financial groups on a limited basis before the more general relaxation of restrictions against universal banking. In addition, the legislation permitting the formation of financial groups was in place in advance of the privatization of the commercial banks, enabling the domestic financial sector to put together the necessary capital and expertise. Moreover, the liberalization was comprehensive and placed the domestic financial system on a competitive basis.

Another important feature of the Mexican financial liberalization is that it took place in the context of a successful adjustment effort. The 1989–91 period when most of the important financial reforms took place was also a period of tight government budgets and strict financial discipline. The mutually reinforcing effects of these policies and the financial liberalization are likely to have contributed to the reintermediation in financial markets, the return of flight capital, and the gradual and marked decline in real interest rates.

As noted above, a great deal of the institutional foundation that made the post-1988 financial liberalization effective had been laid gradually over about a 15-year period. At the time of the liberalization, Mexico had a fairly active stock market, an array of private nonbank financial institutions and a significant government securities market. Moreover, except for some limited periods, the balance of payments had been relatively free of capital controls. These factors formed an adequate institutional context in which further liberalization and reform could take place.

Although the Government has actively promoted the integration of financial services, it has restricted the formation of links based on ownership and control between financial institutions and industrial concerns. The nationalization of the banks in 1982 broke up the traditional industrial-financial groups that had developed around the banks since World War II. An important consideration underlying financial reform, including the privatization of the commercial banks, has been the need to preserve the independence and objectivity of credit decisions and to limit the concentration of banking risk in specific industries. The separation of ownership and control between banks and financial groups on the one hand, and industrial and commercial concerns on the other, has been a basic characteristic of financial reform in Mexico.

While Mexico has made significant gains in liberalizing its financial markets, the reforms can be taken further in some areas. Foreign participation in Mexican financial markets is heavily restricted. Apart from one or two minor exceptions, foreign banks, insurance companies, brokerage houses, and other financial concerns are not permitted to operate in Mexico; foreign investors can own only nonvoting shares in Mexican financial institutions and that participation is limited to 30 percent of total stock. The authorities have indicated that an objective of financial liberalization is to allow Mexican financial institutions to be competitive internationally, and the opening up of trade in financial services is an issue that is being examined in the context of the Uruguay Round, as well as in the ongoing discussions on the free trade agreement with the United States and Canada.

Appendix I Legislation Introduced in 1990

The Credit Institutions Act

The new Credit Institutions Law, which abrogated the Law Regulating the Public Service of Banking and Credit, was enacted in July 1990. Under the terms of this act, the following apply.

(1) While development banks remained national credit institutions under public administration, commercial banks were transformed once again into business corporations from the July 1990 effective date. The incorporation of a new bank now requires an “authorization” from the Government rather than a “concession.”

(2) Commercial banks may now be majority-owned and controlled by the private sector. Up to 30 percent of the stock of a bank may be held by foreign investors with the exception of foreign governments and government-owned entities. Corporate rights of foreigners would be similar to those of national investors. Any one individual may own up to a maximum of 5 percent of the equity of a bank; this maximum may be increased to 10 percent with the prior authorization of the Government. Institutional investors may hold up to 15 percent of bank shares; financial holding companies are exempted from this maximum.

(3) Provisions are made to limit the concentration of credit risk and stock investments by banks and to ensure the separation of interests between banking and other activities. Lending to managers or partners of a bank is restricted.

(4) To ensure the professional management of banks, the National Banking Commission must authorize the appointment of a bank’s chief executive officer, members of its Board of Directors, statutory auditors, and other senior executives. The Commission is authorized to remove or suspend these officers in certain circumstances. The Board of Directors will be elected by shareholders and its composition will correspond to the type of share issued by the bank.

(5) The functions of the Fund for the Protection of Savings will be expanded. In addition to its traditional preventive role, it would provide “express and direct protection to depositors.”22

The Act Regulating Financial Groups

According to this new law, the following applies.

(1) Groups can now be formed with a wider range of institutions. There would be two different types of groups: those headed by a holding company and those headed by a bank or brokerage firm. The creation of a financial group requires the prior authorization of the Government. Groups headed by a holding company would offer the widest range of services and could comprise the holding company and at least three other financial institutions including banks, brokerage houses, insurance and bonding companies, investment companies, and auxiliary credit organizations.23 Groups headed by a commercial bank may acquire, with government authorization, controlling interests in financial institutions other than brokerage houses and insurance or bonding companies. Similarly, groups headed by a brokerage house may not hold an interest in commercial banks or insurance or bonding companies.

(2) With the purpose of diversifying the activities of these groups, two or more intermediaries of the same kind would not be permitted to form part of a group, except for investment or insurance companies, provided that they engage in different risks or activities.

(3) The holding company would be fully responsible for liabilities and losses of any of the financial entities of the group, while each of the entities would not be held responsible for the holding company’s losses nor for those of any other member of the group. According to the Mexican authorities, this provision “retains one of the main advantages of specialized financial intermediation, while providing for the benefits of a system of integrated financial services.”24

(4) Apart from some limited exceptions, the holding company may not contract any direct or contingent liabilities nor pledge its assets. Financial group members cannot invest in the holding company’s or in the other members’ capital stock. The purpose of this measure is to avoid the pyramiding of the capital base and to ensure the adequacy of capital requirements for the operations undertaken.

The Securities Market Act

This law, which had been originally introduced in 1975, was amended to (1) permit the formation of financial groups headed by brokerage firms, and (2) allow foreign investment of up to 30 percent of capital in brokerage houses and to set a limit of 10 percent on individual shareholdings.

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1Universal banking is a system that permits banks to accept deposits as well as engage in securities market activities. In Mexico, universal banking signifies the horizontal integration of financial institutions, such as commercial banks, brokerage houses, and insurance companies, subject to certain restrictions on cross ownership; commercial banks are permitted to invest in equities.
2Individual brokers were given strong incentives to incorporate through the offer of specific operating advantages. The Law has been updated several times since, including in 1978 to establish INDEVAL, a centralized depository institution, which features a computerized settlement and custodial system.
3At the time, there was a 100 percent reserve requirement against bankers’ acceptances issued beyond an authorized limit.
4Cetes are treasury bills with a maturity of mostly 28 or 90 days, while BONDES are government bonds with a maturity of one to two years; both kinds of bonds are denominated in pesos.
5At the time, banks were required to channel at least 50 percent of these deposits to the public sector (inclusive of reserve requirements).
6This ratio could be satisfied by holding U.S. Treasury bills or other specified high quality foreign currency instruments.
7However, banks were required to keep all reserves held in excess of the 30 percent liquidity ratio as of August 1991. Government debt instruments corresponding to these excess reserves and to the new 25 percent liquidity ratio were to be held until maturity when they would be exchanged for interest-bearing three- or ten-year bonds (respectively) at the Bank of Mexico. These new bonds would be negotiable only with the Bank of Mexico or with other commercial banks.
8Although, on average, stocks accounted for only about 1.5 percent of the total trading in the Bolsa from 1988–90, the Mexican stock market is the largest in Latin America in terms of capitalization.
9The reforms included amendments to five laws governing financial institutions.
10Article 28 of the Constitution establishes certain areas of activity as the exclusive functions of the state; during the debt crisis in 1982, this Article was amended to include banking. Since 1987, up to 34 percent of bank stock could be held by the private sector.
11A more detailed description of these reforms is given in the Appendix to this section.
12Bank of Mexico (1991), p. 90.
13Mexico’s commercial banks remained outside the public sector budget and were allowed to retain and reinvest their profits.
14Bank of Mexico (1991), p. 93.
15These debts, which had been rolled over since 1982, arose from short-term deposits made by foreign banks before the nationalization of the Mexican banks. The restructuring involved an auction that exchanged some of the credit lines for negotiable ten-year floating rate government bonds that could be redeemed at par for equity in Mexican banks.
16The Committee is chaired by the Under Secretary of Finance and Public Credit and is composed of the representatives of the Secretariat of Finance and Public Credit, the Bank of Mexico, the National Banking Commission, the National Securities Commission, and the Divestiture Unit, as well as individuals recognized for their expertise in the field.
17For example, banks, as well as brokerage houses, manage their own money market funds, while banks also invest in fixed income funds and equity funds; portfolio management activities of insurance companies also duplicate some of these activities. In addition, while the loan portfolios of banks are generally thought to be free of major problems, the weaker, particularly medium-sized, banks may not survive the more competitive environment following privatization.
18M1 = currency held by public + checking accounts;M2 = M1 + other short-term bank deposits and bankers’ acceptances;M4 = M2 + long-term bank deposits and government bonds held by public.
19The money multiplier is measured as the ratio of the monetary base to M2 or M1; the monetary base is defined as currency held by the public and the deposits of the banking system with the Bank of Mexico.
20Real interest rates are estimated on an ex post basis as one plus the nominal yield on one-month treasury bills divided by one plus the actual one-month rate of increase of the consumer price index. This assumes that the expected rate of inflation over the month can be approximated by the actual rate of inflation during the previous month.
21Measured real interest rates appear to have increased in the first half of 1988 mostly because there was a sharp deceleration of inflation during this period (see Chart 10). To the extent that the turnaround in inflation was largely unanticipated and expectations took some time to adjust, the measured real rate is likely to overstate the true real rate in 1988.
22Bank of Mexico (1991), p. 89. All banks contribute a premium to this fund; although there is no formal deposit insurance in Mexico, this fund provides some safety net in emergencies.
23Auxiliary credit organizations encompass credit unions, warehouse companies, leasing firms, financial factoring firms, and exchange houses.
* An earlier version of this section was published as part of “Mexico’s External Debt and the Return to Voluntary Capital Market Financing,” IMF Working Paper, WP/91/83 (Washington: International Monetary Fund, 1991).

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