| By Robert V. Bubel and Edward C. Skelton Federal Reserve Bank of Dallas |
Since the Tequila Crisis of 1994-95, one of Mexico´s most persistent and striking economic contradictions has been a recovery in economic growth coupled with stagnation in bank lending. This contradiction has fueled increasing concerns about bottlenecks within Mexico´s production chains and about what some analysts view as expansion rates below potential.
Lending typically declines in the wake of a financial shock, and Mexico´s Tequila Crisis was no exception. Mexico´s currency lost half its value in just a few months. The interbank interest rate rose some 60 percentage points, to over 90 percent, and remained above 20 percent until late 1999. Mexican banks needed most of their resources to resolve problem assets, leaving little room for new lending.
Even worse, credit extended by Mexico´s banks continued to fall long after the national economy had recovered. Compared with other countries in similar circumstances, Mexico´s stagnation in lending has been unusually severe and long-lasting. [1]
However, Mexican banks report that business loans began to grow substantially in fourth quarter 2004 and that healthy growth rates continued through the first quarter of this year, signaling a possible reversal of the credit slump of the past 10 years. We address the credit slump´s possible causes, its implications and what the nascent loan upturn seems to be telling us.
Globalization and Bank Credit
A vibrant banking system that growing businesses can turn to for credit facilitates firms´ entry into previously segmented markets, enhancing competition. The availability of finance promotes economic freedom by enabling entrepreneurs to leverage resources in pursuit of business opportunities. [2] Similar considerations apply to consumer credit, which can help individuals tap future income for present critical needs, such as housing and education.
Three years ago, in this same publication, we advocated financial globalization, using Mexico´s banks as a case study.
[3] We concluded that the growing prominence of foreign firms in the Mexican banking system (Chart 1) was not cause for alarm, but would promote world-class banking practices, enhance financial competition and result in greater financial stability. This was not to say Mexico´s banking system was in particular need of foreign involvement, but rather represented our view that international competition can promote economic and financial rigor in any country. Our analysis contrasted sharply with globalization´s detractors, who broadly claim foreign influences and international linkages are harmful.
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Today, many of the benefits we claimed would result from the international openness of Mexico´s banking system have been realized, but business lending has been slow to resume. In particular, evidence suggests that certain small- and mid-sized Mexican businesses have lacked adequate financing, resulting in bottlenecks in the production of key goods and services and holding Mexico´s economic competitiveness below its potential. [4]
It is in this context that the recent upsurge in business lending takes on particular importance. Consumer lending has been growing rapidly for many years now, but business lending was relatively restrained before the fourth quarter of last year, when real year-over-year growth reached 15 percent (Chart 2). Through the first quarter of 2005, aggregate business loans continued to grow strongly at a rate of 17 percent.
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Crisis and the Beginning of Reform
A few years prior to the Tequila Crisis, Mexico privatized its commercial banks after a decade of government ownership. During that decade, the banks had channeled most lending to the federal government. As a result, credit and market risk assessment were minimal.
Once privatized, the banks took steps to generate high returns and justify the steep auction prices at which they had been bought. The result was high-risk lending to the private sector. Incomplete legal enforcement of financial contracts, an underdeveloped system of supervision and regulation, an implied unlimited government guarantee of bank liabilities and the banks´ own inexperience in assessing the risks associated with lending to the private sector aggravated the problem. Bank lending expanded at an average annual rate of 25 percent from 1989 through 1994, resulting in a quadrupling of bank credit as a percent of GDP.
Bank credit to the private sector serves a vital economic role when properly extended, but this undisciplined explosion in lending gave rise to imbalances. At the end of 1994, Mexican banks´ risky loans became more precarious with the collapse of the peso and subsequent jumps in inflation and interest rates. The Tequila Crisis devastated the ability, and in some cases the willingness, of borrowers to repay their debt. The banks´ financial condition deteriorated severely.
Government programs to support the banking system took on a variety of forms. The government initiated programs to improve bank balance sheets by easing debtor burden. Discounts on loan balances and future payments were offered. Their cost was shared by the government and the banks. For the most part, the general public regarded these programs with indifference.
In contrast, the government´s forbearance policy for the banks themselves was wildly unpopular. The public viewed it as a taxpayer bailout of bank shareholders. Under the Loan Purchase and Recapitalization Program, the government gave the banks good bonds in exchange for bad loans. Suspicions were widespread that many of the loans were granted or defaulted upon fraudulently or had been extended to insiders. These bonds helped prevent failure, but their high volume and nonnegotiable nature constrained liquidity (Chart 3). At the hardest hit banks, shareholder value was substantially reduced or even eliminated.
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The crisis´ effect on the banks led many to question their privatization. There is much evidence that the source of bank problems was not privatization itself, but the lack of regulatory, risk management and legal infrastructure. Whatever its liabilities, the Tequila Crisis highlighted these problems and motivated change.
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Notes 1. "NAFTA and Mexico´s Less-Than-Stellar Performance," by Aaron Tornell, Frank Westermann and Lorenza Martinez, National Bureau of Economic Research, Working Paper No. 10289, February 2004. 2. "Financial Markets and Economic Freedom," [PDF] by Luigi Zingales, in The Legacy of Milton and Rose Friedman´s Free to Choose, Federal Reserve Bank of Dallas, 2004, pp. 175-89. 3. "Financial Globalization: Manna or Menace? The Case of Mexican Banking," by Robert Bubel and Edward Skelton, Federal Reserve Bank of Dallas Southwest Economy, January/February 2002. 4. Tornell, Westermann and Martinez (2004). |
About the Authors
Bubel and Skelton are international financial analysts in the Financial Industry Studies Department of the Federal Reserve Bank of Dallas.
About Southwest Economy
Southwest Economy is published six times annually by the Federal Reserve Bank of Dallas. The views expressed are those of the authors and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System.
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