The banking system in Mexico is regulated by four main governmental agencies: the Bank of Mexico (Banxico) as the Mexican central bank, the Ministry of Finance and Public Credit (SHCP) as the ministry within the executive branch in charge of regulating financial institutions, the National Banking and Securities Commission (CNBV) as an agency that directly depends on the SHCP and the Financial Consumer Protection Commission (CONDUSEF).
Currently, the Mexican banking market is composed of 47 retail banking institutions, six development banks and 23 financial groups.2 The five largest retail banking institutions in the market – based on the amount of assets, resources collected from the public at large and participation in loan portfolios – are BBVA Bancomer, Santander, Citibanamex, Banorte and HSBC, respectively.3
As a consequence of the financial reforms issued by the executive branch in early 2014, gradual changes to the market, such as financial inclusion, the increase in credit penetration due to the ease of credit offers and secured transactions’ legal structures, have been made, thus improving banks’ confidence in lending with the assurance of a higher recovery rate in the event of foreclosure or execution. Notwithstanding the foregoing, some rating agencies, such as Moody’s and Standard & Poors, changed their perspective on the Mexican banking system from ‘stable’ to ‘negative’ given that credit portfolios have increased by banking institutions while the economic growth remains depressed, and the public debt increases.4 Inflation during 2015 was reduced 2.13 per cent; however, during 2016, inflation increased more than double the 2015 inflation rate, reaching 4.86 per cent based on Banxico’s annual average CPI general index.5 Inflation during 2017 will continue increasing, mainly due to the liberalisation of gas prices.
In June 2016, the government published its National Policy on Financial Inclusion, which expects that at least half of the adult population of the country that currently has no access to financial services will become part of the formal financial system in Mexico. According to the World Bank, Mexico represents around 2.6 per cent of the adult population that has no access to financial services; therefore, Mexico has been included as one of the 25 countries that the World Bank has prioritised to achieve its Universal Financial Access by 2020 initiative.6
The market in Mexico is expecting changes and considerable growth, with changes being driven by the emergence of new banking players such as Bank of China Mexico, as a subsidiary of Bank of China Limited, and Banco S3 México, an affiliate of Banco Santander, which market will be focused on financial institutions and institutional clients.
II THE REGULATORY REGIME APPLICABLE TO BANKS
Banxico is the central bank of the government, governed by the Bank of Mexico Law. The primary activities of Banxico consist of:
- a directing monetary policy and controlling inflation;
- b financing the federal government;
- c minting coins and issuing bills; and
- d regulating intermediation and financial services.
Banxico accomplishes these tasks in part by establishing required characteristics for financial transactions (e.g., mandatory rates, terms and interest).
Banxico issues general provisions and regulations that are applicable to financial institutions, issuers of securities, intermediaries and the public at large. Banxico also has the authority to sanction entities and individuals that do not comply with such regulations. It regulates certain aspects of banks as they relate to payment systems and derivatives, among other aspects.
The SHCP is a ministry of the Federal Public Administration. It evaluates, surveys, promotes and organises financial services rendered by banking and non-banking agents. Through its separate agencies, including the CNBV and the Insurance and Bonds National Commission, the SHCP evaluates and surveys banks, bonding and insurance companies, brokerage houses and all other entities within the financial system.
The SHCP has the authority to issue rules to develop provisions of the Credit Institutions Law (LIC), which is the main body of law governing banks and their transactions. One of the main functions of the SHCP is to issue money laundering rules.
The CNBV is in charge of granting licences, inspecting and surveying all financial activities, transactions and entities; it also acts as an enforcement body for those entities under its surveillance. All financial activities are mainly coordinated and regulated by the CNBV; as such, it can be considered the most important government agency for such matters.
Authorisations to undertake banking and other regulated financial activities in Mexico will commonly have to be filed with, inter alia, the SHCP, Banxico and the CNBV, but the authorisation is ultimately issued by the CNBV.
Besides the LIC as the main body of banking law, there are two additional regulations that are of importance for banking institutions: the general rules applicable to banks issued by the CNBV (known as the Circular Única de Bancos), and Circular 3/2012 issued by Banxico (provisions applicable to transactions of credit institutions and rural financial institutions).
CONDUSEF is another regulatory agency in charge of banks’ surveillance and regulation, but from a consumer-protection standpoint. CONDUSEF is in charge of regulating the marketing and offering of services by banks to the public at large. It also serves as a mediator of disputes between financial consumers and banks.
Retail banking institutions must be incorporated as corporations (sociedades anónimas) under Mexican law, their by-laws shall be approved beforehand by the CNBV and the authorisation for their incorporation must be published in the Federal Official Gazette. Mexican law provides the opportunity to incorporate ‘full-fledged retail banks’ or ‘niche retail banks’ depending on the activities that they intend to perform; hence, the minimum capital stock requirement varies with respect to the kind of bank.
The capital structure of banks also varies based on whether a foreign financial institution owns 51 per cent or more in the capital stock. A bank whose capital stock is owned by a foreign financial institution is called an ‘affiliate banking institution’. To form one of these entities, a bilateral international treaty must exist between the country where the holding entity resides and Mexico.
Affiliate banking institutions’ capital stock is composed of Series F and Series B shares: the former may only be acquired by the foreign bank or the specialised governmental agency as deposit insurance institution (IPAB, which secures personal bank accounts up to a maximum of 400,000 investment units (UDIs), where a UDI as of 9 March 2017 is equivalent to 5.700045 Mexican pesos) and shall not be lower than 51 per cent. Series B shares may be freely subscribed and grant limited voting rights.
The capital stock of retail banks that are not affiliate banking institutions is composed of Series O and Series L shares: Series O shares are common shares and may be freely subscribed, and Series L shares, which may represent up to 40 per cent of the issued shares, have limited voting rights and may also be freely subscribed.
Finally, development banks are decentralised agencies of the federal government known as ‘national credit companies’ that may perform credit operations in the same way as retail banks. However, their purpose is to render services for the development of specific segments of the national economy, promoting, for instance, foreign commerce or the development of public works. The 2014 reform made the rules applicable to development banks more flexible by removing obstacles that limit their functioning and including mechanisms that allow them to obtain the funds needed to fulfil their social objective. Likewise, development banks were granted certain powers in order for them, through the offering of financial services, to promote innovation, boost environmental sustainability and promote financial inclusion of micro, small and medium-sized enterprises and small rural producers.
III PRUDENTIAL REGULATION
i Relationship with the prudential regulator
- a the issuance of general rules;
- b control of financial policies;
- c budget control;
- d administrative control; and
- e granting authorisations for specific activities.
Regarding control of financial policies, the SHCP is entitled to plan, coordinate, evaluate and oversee the country’s banking system, including Banxico, retail banks, development banks, financial groups, and any other institution that performs credit and banking activities. This control over financial policies includes insurance, securities, surety bonds and credit ancillary activities.
Banxico’s main activities are those of a regular central bank:
- a maintaining the stability and supply of the currency;
- b control and prudential regulation of the financial system;
- c acting as lender of last resort;
- d modulation of the public debt; and
- e coordination of the payment systems.
Additionally, along with the SHCP, it has the authority to issue general rules. From all other authorities granted to Banxico, we highlight the strengthening and development of the financial system, which includes:
- a operating with credit institutions as reserve bank and lender of last resource;
- b granting loans to credit institutions and the federal government;
- c determining the characteristics of lending, deposit and services activities by credit institutions as well as securities and derivatives transactions;
- d setting limits on lending and deposit transactions to control the risk of banking institutions;
- e requesting periodic reports and information regarding financial entities’ activities and results; and
- f issuing an opinion regarding:
• any application for an authorisation to act as a retail banking institution;
• acquisitions of more than 5 per cent of ordinary shares from retail banking institutions, including subsidiary institutions from foreign entities;
• mergers or spin-offs of retail banks;
• the establishment of foreign financial entities’ subsidiaries as retail banks;
• financial entities’ capitalisation thresholds;
• credit portfolios’ ratings;
• support documentation for lending, services and deposit transactions; and
• the integration of reserve funds corresponding to credit ratings for prudential, solvency and stability purposes.
Banxico is also able to impose sanctions on financial entities and request the performance of audits and inspection visits to such entities.
The CNBV may be considered as the Mexican equivalent to the Financial Services Authority of the United Kingdom, and a mixture of the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the state banking commissions from the federal reserve banks and the Securities and Exchange Commission of the United States. The CNBV is the regulator in charge of oversight and the control body of the banking, financial and securities systems in Mexico.
ii Management of banks
Management of banks is entrusted to three main bodies. The first is the board of directors, followed by the chief executive officer and lastly an audit committee that directly depends from the board of directors. The board of directors is composed of five to 15 members at the election of the shareholders, of which 25 per cent must be independent members and the majority must reside in Mexico. It shall have at least quarterly meetings. Such meetings will be valid when 51 per cent of the members of the board are present; of those members, at least one must be an independent member. The members of the board must fulfil certain requirements regarding experience, reputation, ethics and knowledge.
The board of directors is the body in charge of performing and approving all actions required to fulfil the bank’s purpose (with the sole exception of those expressly reserved to the shareholders’ meeting); it has all powers and authority to represent the bank and lead its business.
A statutory audit committee is also required, which shall be composed by at least two statutory auditors: one appointed by the ordinary series of shares (Series O and Series F) and the other by the limited series of shares (Series L and Series B). This committee is in charge of:
- a requesting monthly reports from the board of directors, including a financial situation statement and a results statement;
- b examining the operations, documentation, registry and any other evidence to the extent necessary to oversee the operations; and
- c filing an annual report to the shareholders’ meeting regarding the truthfulness, sufficiency and rationale of the information delivered by the board to the shareholders’ meeting, in which the opinions of the members of this statutory audit committee regarding accounting and information policies and criterias’ sufficiency and adequacy are included.
The CEO must be an individual who resides in Mexico for tax purposes, with recognised moral reputation and at least five years’ experience in senior decision-making positions. The CNBV has the authority to remove any officer in the event he or she does not comply with these requirements or ceases to comply with them. The CEO is in charge of the elaboration and presentation of policies for the correct application and utilisation of the human and material resources of the entity, including the consideration of their efficient use, restrictions on misuse, oversight and control mechanisms.
The audit committee is the body entitled to follow up on the internal and external audit processes of the institution, as well as with the internal comptroller. It ensures that accounting and financial information is generated in accordance with the applicable requirements and accounting principles.
The members of this committee are selected based on their aptitude and professional reputation. It shall be composed of at least three and no more than five members, one of whom must be an independent member and shall act as chair. Mexican law requires the existence of a secretary of the committee, who may or may not be a member, and who will be entitled to keep all minutes and records. Meetings shall take place on a quarterly basis at least, and their resolutions will be validly adopted if approved by the majority, provided that the chair, or its alternate, attends the meeting. Employees and officers of banking institutions are not allowed to be part of this committee.
The committee’s main activities consist of proposing to the board an internal control system for the operations of the institution, and its supervision. Such control system shall include:
- a policies concerning the organisational structure of the bank;
- b communication channels and information flow mechanisms;
- c general operating policies;
- d a business continuity plan; and
- e control measures for the correct approval, processing and registration of the bank’s transactions.
In addition to the aforementioned managerial and vigilance bodies, banking institutions shall incorporate other types of sub-committees, such as a corporate banking credit committee, internal credit committee, risks committee, human resources and institutional development committee, and compensation committee.
Mexican banking law contemplates two types of compensations for officers and employees: ordinary and extraordinary. Ordinary compensation is salary, benefits and fixed remunerations, and extraordinary compensation covers all types of variable compensations based on results. The compensation committee is the body in charge of overseeing the compliance of these compensations with Mexican law by means of a compensation system that must be implemented and cover all policies and proceedings determined by the bank to comply with CNBV’s general rules with respect to risk management. Mexican laws and regulations do not limit the compensation of banking officers and employees.
iii Regulatory capital and liquidity
Regulatory capital for full retail banks is 90 million UDIs (currently this is around 513 million Mexican pesos) and for the smallest niche retail banks 36 million UDIs (currently this is around 205 million Mexican pesos). The regulatory minimum capitalisation index for Mexican banks is, as per Basel III, currently 8 per cent, and is expected to increase to 10.5 per cent in January 2019. Each of the 47 retail banking institutions in Mexico has a capitalisation index higher than the minimum required; thus all banks are qualified by the CNBV under the highest category. For example, HSBC, one of the retail banking institutions with a lower capitalisation index percentage, has 12.88 per cent; Bancomer BBVA, which is the biggest bank in Mexico, has reached 13.73 per cent; and others such as UBS have 451.99 per cent. Pagatodo, a local bank, has 667.52 per cent.7
In Mexico, retail banks’ capital is divided, as in most of the world, into Tier 1 and Tier 2 capital, each with their particularities:
- a Tier 1 capital, or basic capital, which includes capital stock, capital reserves and not-distributed profits, is divided into core Tier 1 capital or basic capital 1, which is paid capital plus earned capital and includes profits, reserves and valuations, and has a minimum capitalisation index at 4.5 per cent, and Tier 1 or basic capital 2, which is composed of regular capital stock plus capital increases that have not been formalised, plus all capitalisation instruments less subordinated debt, share investments, pending reserves and others.
- b Tier 2 capital or supplementary capital, which is the monies that finance the bank’s activities and is composed by capitalisation instruments that exceed the basic capital, such as preferred and convertible shares, subordinated debt, debt convertible into shares and a part of the reserves for non-recoverable credits.
- c Net capital: the addition of Tier 1 and Tier 2.
- d Capital supplements, the additional margin that each bank shall contribute to operate with a positive margin promoted by the regulators.
As a consequence of Basel III, Mexico has implemented requirements regarding capital instruments (subordinated debentures). The first requirement is that either the issuer or the controlling entity of the corporate group be listed in the Mexican Stock Exchange (Bolsa Mexicana de Valores). The second is that these instruments shall have one of the following features: convertibility of the principal amount of the subordinated debentures into equity or a reduction in the principal value of the debentures. The convertibility or reduction in the debentures value shall be triggered, regarding the instruments corresponding to the basic capital 2, when the ratio of the basic capital 1 reaches a value of 5.125 per cent with respect to the assets subject to the risk. For debentures subject to the supplementary capital, these shall be converted when they reach a value of 4.5 per cent of the basic capital 1 with respect to the assets subject to the risk. Hence, the banks may timely absorb any losses, improving solvency in difficult scenarios and before governmental intervention.
Financial groups are regulated under Mexican law by a specific law, the Law Regulating Financial Groups, and the specific general rules issued by the CNBV. These groups are supervised by the same governmental agencies as regular retail banking institutions; holding companies of financial groups have a specific treatment different from their subsidiaries; and such groups may be composed by different types of financial entities, including non-bank banks or even real estate managing corporations.
iv Recovery and resolution
Mexican law establishes two types of early warnings for banking institutions facing solvency or capital problems: minimum measures, and additional measures applied discretionally by the CNBV.
Banking institutions depending on their capitalisation index may be classified into five groups:
- a level I for institutions whose capitalisation index is higher than 10 per cent;
- b level II for those institutions that have a capitalisation index equal or higher than 8 per cent;
- c level III banks that have a capitalisation index equal or higher than 7 per cent;
- d level IV are institutions with a capitalisation index equal or higher than 4.5 per cent; and
- e level V for those institutions with a capitalisation below 4.5 per cent.
Minimum measures have three levels:
- a The first one is triggered when a banking institution is downgraded to level II as per its capitalisation index. In such event, the institution would have to:
• deliver a detailed evaluation report of the reasons for its financial situation;
• not engage in any transaction that may put its capitalisation index below the minimum requirement;
• file a capital conservation plan to the regulator;
• partly restrict dividend payments, compensation and extraordinary bonus; and
• refrain from increasing financing to relevant related persons.
- b At the second level, if downgraded further to level III, the bank would have to:
- • deliver a capital restoration plan;
- • suspend dividend payments;
- • suspend any repurchase programmes for its own shares;
- • defer interest and principal payment of subordinated debentures or convert them early into shares; and
- • suspend the payment of compensation and extraordinary bonus.
- c At the last level, when it reaches level IV or V, the entity will not be allowed to make new investments in non-financial assets, open branches or engage in any new activity distinct from its regular transactions.
Additional measures also have three different levels, based on the capitalisation index levels:
a At capitalisation level II:
• the banking institution must deliver a detailed report regarding the manner and terms under which it will manage the assets subject to total risks and the strategy to follow to strengthen its capitalisation index;
• for retail banking entities controlled by foreign financial institutions, the above-mentioned report must be delivered to the highest ranking officer of such area in the foreign financial institution;
• it must retain specialised external auditors for special audits; and
• it must minimise the effects of transactions entered into with entities of the same corporate group that carry a monetary benefit transfer.
b For level III, the banking institution must:
• not increase salaries or benefits to any employee (including officers);
• limit the execution of new transactions that may affect its capitalisation index; and
• not execute transactions with entities of the same corporate group.
c For levels IV and V, the banking institution must:
• substitute officers, members of the board, statutory auditors or external auditors;
• reduce its risk exposure; and
• modify policies regarding interest rates paid over deposits that are over the regular risk level assumed by the entity.
The law also contemplates a ‘management intervention’, which is triggered as a consequence of downgrades of a banking institution’s index capitalisation levels within one month, and not remedying it within one business day; the institution putting itself in a situation that is cause for revocation of its banking authorisation; or defaulting on any of its primary payment obligations, and the banking stability committee of the federal government determines so.
If a management intervention is declared by the CNBV, the IPAB will appoint a precautionary manager (with full authority as if such individual acted as sole director of the entity substituting the board of directors and the shareholders’ meeting); prepare a report regarding the status of the institution; and engage in all activities and transactions required to safeguard the interests of the public at large.
For the fulfilment of its duties, the precautionary manager may be assisted by a consultation committee appointed by the IPAB. This managerial intervention may only terminate if the bank has begun its dissolution, the IPAB sells all of the bank’s capital stock, or the irregular or illegal transactions have been corrected.
If, after the intervention made by the precautionary manager to the banking institution it is determined by the government’s banking stability committee that the institution’s recovery is unfeasible, the CNBV revokes the bank’s concession, and the IPAB will intervene as the institutional liquidator, starting by paying all the amounts corresponding to secured transactions, and followed by the transfer of the bank’s assets to a stable banking institution able to maintain them to preserve the continuity of the banking operations; a newly created banking institution by the IPAB for that sole purpose; or, in the event there are only liquid assets, to their sale in favour of any capable third party.
In the event the assets of the banking institution are not enough to pay its debt, a regulated mechanism to liquidate the defaulting institution’s capital stock to cover as much of its debt as possible shall apply. At this moment, the bank is formally declared bankrupt.
IV CONDUCT OF BUSINESS
The conduct of business of Mexican banking institutions is regulated by Banxico and CNBV general rules, mainly the general rules applicable to credit institutions issued by the CNBV and Circular 3/2012 issued by Banxico.
The CNBV rules are aimed at prudential regulation, capitalisation, reserves, evaluation, risk management, entities’ internal corporate structures, financial information, its disclosure, external auditors, regulatory reports, early warnings and corrective measures.
On the other hand, Circular 3/2012 regulates transactions, deposits, debt certificates, subordinated debentures, bankers’ acceptance, structured banking notes, credit transactions referenced to investment units or currency, banking cards (debit and credit), direct debiting, funds transfers, trusts, commissions, mandates, appraisals, ATMs, non-banking cards, securities transactions, currency exchange, precious metals and transactions with derivative instruments.
In the Mexican market, funding is normally made to small banks by development banks for the former to lower interest rates and compete with larger banks that have a sound capital structure and reserves and therefore do not require public funding.
Interbank funding is common in the Mexican banking market It is usually performed through three different types of negotiable instruments: bank notes, bankers’ acceptance and deposit certificates. These may be exchanged by direct or repurchase transactions. Banxico has established a formula that generates an average interbank funding rate, which is based on the amounts marketed by banking intuitions for bank notes on a given date, the interest rate, amounts marketed by banking intuitions for bankers’ acceptances on a given date, the interest rate, and amounts marketed by banking intuitions for deposit certificates on a given date and the interest rate. This rate is published by Banxico on a daily basis for the public to evaluate funding transactions between banks and brokerage houses.
VI CONTROL OF BANKS AND TRANSFERS OF BANKING BUSINESS
i Control regime
The LIC regulates any transfer of shares of a banking institution over 2 per cent; in such case, the persons or entities either selling or acquiring such shares must notify the CNBV within three business days following the date the transaction takes place.
If more than 5 per cent of a banking institution’s capital stock is intended to be acquired by a person or group of persons directly or indirectly, prior approval from the CNBV must be secured. To obtain this authorisation, the intended purchaser must comply with certain requirements and provide the information requested by such agency.
If a person or group of persons, whether or not current shareholders, intend to acquire 20 per cent or more, or secure control of such entity, prior authorisation is also required; the requirements to secure such authorisation are broader, similar to those required for the incorporation of the institution. These requirements are a complete set of information regarding the acquiring party and its shareholders, their information, good reputation and moral qualifications, a list of the intended new board members and high-ranking officers as well as their qualifications, a general operating plan for the bank, and a strategic programme for the organisation, management and internal controls of the institution. The CNBV may request any additional information.
If the requirements imposed by the CNBV for the acquisition of the shares are not complied with, the bank shall refrain from registering new shareholders as such, and report this situation to the CNBV within five business days.
ii Transfers of banking business
Mexican civil law states, as a general rule, that the assignment of credits or account receivables may be effective after notifying the debtor and registering such assignment with the Single Registry of Security Interests. For the assignment of debts, the debtor must secure consent from the creditor.
Nonetheless, the LIC provides a special rule that the assignment or discount of credit portfolios may be performed by banks without any restriction, provided that such assignment is made to:
- a Banxico;
- b other banks;
- c trusts implemented by the federal government to promote the economy; or
- d trusts that have as their main purpose the issuance of securities.
If the assignment or discount of the credit portfolio is intended to any other person, consent from the CNBV must be previously secured.
Hence, credit portfolios may be assigned without the customer’s consent provided that notice is given. Regarding the assignment of deposits, the customer’s consent is required as a general rule.
VII THE YEAR IN REVIEW
Economic growth in Mexico has been slow over the past months due to the oil price and the price ratio between Mexican pesos and dollars increasing to a historic maximum during 2016. The World Bank has projected an economic growth for the country of 1.8 per cent, which is lower than the economic growth during the past few years. Notwithstanding the economic growth of the county, the current index capitalisation in the banking market is higher than the Basel III requirements, meaning that the majority of banks currently operating in Mexico are soundly capitalised.8
An amendment to anti-money laundering provisions for financial institutions was published on 24 February 2017, which focuses anti-money laundering requirements and know-your-costumer formats based on the risk perspective of each costumer. Furthermore, an amendment to the Circular Única de Bancos regarding the calculation of capital requirements is currently being discussed and studied by the National Commission for Regulatory Improvements.
VIII OUTLOOK AND CONCLUSIONS
Financial growth decreased in Mexico last year. However, based on the publication of the National Policy on Financial Inclusion, as well as on the support of the World Bank to increase credit penetration among Mexico’s population, we expect that financial growth will continue to increase, and reach a credit penetration of 40 per cent of the gross domestic product by the end of the decade.
Financial technology solutions continue to be developed, such as mobile phone payment applications, mobile points of sale, electronic banking services, and more efficient credit granting procedures implemented through ATMs and web appliances, and banking usage is being pushed in parts of the country that have previously not benefitted from such attention. Development banks financing continues to grow, maintaining default rates near to 4 per cent over the past year and increasing credit portfolios and financial collection.
Overall, however, growth in the Mexican banking sector is expected to be slow during 2017.
1 Federico De Noriega Olea is a partner and Juan Enrique Lizardi Becerra is an attorney at Hogan Lovells BSTL, SC.
3 SHCP and CNBV capitalisation index amounts as of 31 December 2016, available at portafolioinfo.cnbv.gob.mx/PortafolioInformacion/BE_BM_201701.pdf.
4 Press note published by El Economista, a local newspaper, press note available at eleconomista.com.mx/sistema-financiero/2016/08/23/malas-noticias-moodys-sistema-bancario-mexicano.
6 World Bank Group, available at www.bancomundial.org/es/news/feature/2016/06/23/mexico-to-
7 See footnote 3.
8 See footnote 3.