The banking system 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).
As at January 2018, the Mexican banking market is composed of 49 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
In the months to come, the house of representatives is expected to approve a bill to regulate fintech companies. This regulation may be beneficial to banking institutions, as it will enable the latter to partner with fintech companies to explore new markets and businesses. Various banking institutions, such as Scotiabank, BBVA Bancomer and Santander, are known to publicly support fintechs, aiming to do business with these technology companies in adapting banking products and services to a constantly evolving market.
In June 2016, the government published its National Policy on Financial Inclusion, the aim of which is that at least half the adult population of the country that currently has no access to financial services will become part of the formal financial system. The process of financial inclusion may be accelerated through fintechs, as they can provide access, by electronic means, to banking products that as yet are not offered in regions of the country where banking institutions are difficult to access. Mexico has been included by the World Bank as one of the 25 countries prioritised to achieve its Universal Financial Access by 2020 initiative.4 Although the financial sector has been making efforts to achieve financial inclusion, the telecommunications sector still needs to be further developed to grant virtual access, in those places where no physical access exists, to financial products and services.
The year 2018 will be affected by a number of factors, not only for the banking market, but for the financial position of Mexico as a whole. The negotiations on the North American Free Trade Agreement (NAFTA) are still ongoing. The discussions include amendments to financial services and several others, which may affect trade as it currently stands between Mexico, Canada and the United States. Furthermore, 2018 is a presidential election year in Mexico and the results of that election could also have an impact on Mexico’s financial position and, consequently, the banking market.
Interest rates increased significantly during 2017 and are expected to continue this trend during 2018 following in the footsteps of the US Federal Reserve and other monetary regulators worldwide.
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:
- directing monetary policy and controlling inflation;
- financing the federal government;
- minting coins and issuing bills; and
- regulating intermediation and financial services.
Banxico accomplishes these tasks in part by establishing the 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 those regulations. It regulates certain aspects of banks as they relate to payment systems and derivatives, among others.
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 the 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 authorisations, 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, which in the short term will also include fintechs, 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 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,5 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 the surveillance and regulation of banks, but from a consumer-protection standpoint. CONDUSEF is in charge of regulating the marketing and offering of services by financial institutions to the public at large. It also serves as a mediator of disputes between financial consumers and financial institutions.
Retail banking institutions must be incorporated as corporations under Mexican law,6 their by-laws must 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 ‘fully fledged retail banks’ or ‘niche retail banks’, depending on the activities that they intend to perform; hence, the minimum capital stock requirement varies according 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 of 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 Mexico and the country where the holding entity resides.
Affiliate banking institutions’ capital stock is composed of Series F and Series B shares. The former may be acquired only by the foreign bank or the specialised government agency as a deposit insurance institution (IPAB, which secures personal bank accounts up to a maximum of 400,000 investment units (UDIs)7), 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, may also be freely subscribed and have limited voting rights.
Finally, development banks are decentralised agencies of the federal government known as ‘national credit companies’, which 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, and offer 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
The SHCP is one of the main regulators in the banking system. Its main authorities are:
- the issuance of general rules;
- control of financial policies;
- budget control;
- administrative control; and
- granting authorisations for specific activities.
Regarding the 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, namely:
- maintaining the stability and supply of the currency;
- the control and prudential regulation of the financial system;
- acting as lender of last resort;
- modulation of the public debt; and
- coordination of the payment systems.
Additionally, with the SHCP, Banxico 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 include:
- operating with credit institutions as reserve bank and lender of last resort;
- granting loans to credit institutions and the federal government;
- determining the characteristics of lending, deposit and services activities by credit institutions as well as securities and derivatives transactions;
- setting limits on lending and deposit transactions to control the risk of banking institutions;
- requesting periodic reports and information regarding financial entities’ activities and results; and
- 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;
• ratings of credit portfolios;
• 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 and is considered the main prudential regulator.
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 (CEO) and lastly an audit committee that is directly accountable to the board of directors. The board of directors is composed of five to 15 members, who are elected by the shareholders, of which 25 per cent must be independent members and the majority must reside in Mexico. It shall hold meetings at least quarterly. These 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 for the shareholders’ meeting); it has all the necessary powers and authority to represent the bank and lead its business.
A statutory audit committee is also required, which shall be composed of 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:
- requesting monthly reports from the board of directors, including a financial situation statement and a results statement;
- examining the operations, documentation, registry and any other evidence to the extent necessary to oversee the operations; and
- 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 committee regarding accounting and information policies and the sufficiency and adequacy of certain criteria are included.
The CEO must be an individual who resides in Mexico for tax purposes, with a 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 that 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 for their aptitude and professional reputation. The committee 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 chairman. Mexican law also requires there to be a secretary, who may or may not be a member of the committee, and who will be entitled to keep all minutes and records. Meetings shall take place at least four times a year, and their resolutions will be validly adopted if approved by the majority, provided that the chairman, or his or her deputy, 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. The control system shall include:
- policies concerning the organisational structure of the bank;
- communication channels and information flow mechanisms;
- general operating policies;
- a business continuity plan; and
- 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 subcommittees, 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 compensation 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 539 million Mexican pesos) and for the smallest niche retail banks 36 million UDIs (currently around 215 million Mexican pesos). The regulatory minimum capitalisation index for Mexican banks is, as per Basel III, currently 10.5 per cent. Each of the 49 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 11.22 per cent; Bancomer BBVA, which is the biggest bank in Mexico, has reached 11.95 per cent; conversely, UBS has 562.4 per cent and Pagatodo, a local bank, has 439.03 per cent.8
Retail banks’ capital, as in most of the world, is divided into Tier 1 and Tier 2 capital, each with their particularities:
- Tier 1 capital, or basic capital, includes capital stock, capital reserves and not-distributed profits. It 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.
- Tier 2 capital, or supplementary capital, is the monies that finance the bank’s activities. It is composed of 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.
- Net capital: the addition of Tier 1 and Tier 2.
- 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. 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 basic capital 2, when the ratio of 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 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 specific general rules issued by the CNBV. The regulating groups are supervised by the same governmental agencies as regular retail banking institutions; holding companies of financial groups have a specific treatment which differs from their subsidiaries; and these groups may be composed of different types of financial entities, including non-bank financial institutions 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 may be classified into five groups, according to their capitalisation index:
- a level I: institutions whose capitalisation index is higher than 10.5 per cent;
- b level II: institutions that have a capitalisation index equal to or higher than 8 per cent;
- c level III: banks that have a capitalisation index equal to or higher than 7 per cent;
- d level IV: institutions with a capitalisation index equal to or higher than 4.5 per cent; and
- e level V: institutions with a capitalisation below 4.5 per cent.
Minimum measures have three levels:
- The first is triggered when a banking institution is downgraded to level II as per its capitalisation index. In that 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 with the regulator;
• partly restrict dividend payments, compensation and extraordinary bonus; and
• refrain from increasing financing to relevant related persons.
- 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.
- 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 groups:
- For 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;
• the institution 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.
- 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.
- 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 (1) downgrades of a banking institution’s index capitalisation level within one month, and not remedying it within one business day; (2) the institution putting itself in a situation that is cause for revocation of its banking authorisation; or (3) the institution defaulting on any of its primary payment obligations, and the banking stability committee of the federal government determining that this is the case.
If a management intervention is declared by the CNBV, the IPAB will (1) appoint a precautionary manager (with full authority as if that individual acted as sole director of the entity, substituting the board of directors and the shareholders’ meeting); (2) prepare a report regarding the status of the institution; and (3) engage in all activities and transactions required to safeguard the interests of the public at large.
For the fulfilment of his or her 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 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, or to a new banking institution created by the IPAB for that sole purpose; or, in the event that there are only liquid assets, the sale of those assets in favour of any capable third party.
In the event that 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, the internal corporate structure of entities, 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, currency exchange, securities transactions, 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. It is usually performed through three different types of negotiable instruments: banknotes, 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 banknotes 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 daily by Banxico to enable 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 this event, the persons or entities either selling or acquiring the shares must notify the CNBV within three business days of the date on which 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 the CNBV.
Prior authorisation is also required if a person or group of persons, whether or not they are current shareholders, intend to acquire 20 per cent or more, or to secure control of the entity. The requirements to secure this authorisation are broader, and are similar to those required for the incorporation of the institution: 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 also 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 the matter 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 the 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 the assignment is made to:
- other banks;
- trusts implemented by the federal government to promote the economy; or
- trusts that have as their main purpose the issuance of securities.
If the assignment or discount of the credit portfolio is intended for any other person, consent from the CNBV must be secured in advance.
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
Despite certain adverse events, such as the renegotiation of NAFTA and the value of the peso, which has been decreasing very slowly, Mexico’s growth reported an increase of 2.1 per cent in its gross domestic product (GDP), which exceeded the 1.8 per cent projections by Banxico. The International Monetary Fund has projected a growth of 2.3 per cent in Mexico’s GDP for 2018.
Banking institutions enjoyed record profits during 2017, but this year’s presidential elections and the results of the NAFTA negotiations will affect both growth and profits. Nevertheless, the stability of the Mexican banking system is expected to remain as it is, given that banks are overcapitalised, and banking operations should continue to grow, albeit at a lower rate than in previous years.
VIII OUTLOOK AND CONCLUSIONS
We expect that financial growth will continue to increase in Mexico, and reach a credit penetration of 40 per cent of GDP by the end of the decade.
Financial technology solutions continue to be developed. The new regulations and interest from banking institutions in fintechs will allow banks to partner with start-ups in developing solutions for financial inclusion. The financing of development banks continues to grow, maintaining default rates near to 4 per cent during the past year and increasing credit portfolios and financial collection.
Overall, however, growth in the Mexican banking sector is expected to be slower than in 2017.
1 Federico De Noriega Olea is a partner and Juan Enrique Lizardi Becerra is an attorney at Hogan Lovells BSTL, SC.
3 Statistics Bulletin for Retail Bankinf as of 31 December 2016, available at http://portafolioinfo.cnbv.gob.mx/Paginas/Contenidos.aspx?ID=40&Contenido=Boletines&Titulo=Banca%20M%C3%BAltiple.
4 World Bank Group, available at www.bancomundial.org/es/news/feature/2016/06/23/mexico-to-accelerate- path-to-financial-inclusion.
5 Known as the Circular Única de Bancos.
6 As sociedades anónimas.
7 As at 14 February 2018, 1 UDI is equivalent to 5.986216 Mexican pesos.
8 See footnote 3.