The role private full service banks, known in Mexico as “instituciones de banca múltiple” constitute an essential element in the economy. Their intermediation helps channel funds deposited by the saving public to sectors that can invest and generate production or that need then for consumption. Therefore, full service banks have been internationally cataloged as special corporations, subject to state authorization, regulation, and supervision.
The primary reasons behind regulation and supervision of banking activities are, among others, asymmetry of information, management of the public’s money by full service banks, strengthening of systems of payment, prevention of illegal operations, and establishment of mechanisms to promote financial culture. Thus, financial regulation must first seek to provide the elements that build security and transparency in full service banks, the banking system as a whole, and – mainly – the depositors.
With this goal in mind, and with the enactment – in late 2004 – of the permanent coverage regime, it was considered especially important to make changes in the laws governing full service banks that experience problems that can undermine their financial stability. It is clear that the existence of an established guarantee heightens the importance of the authorities’ acting opportunely when risk situations arise, to avoid massive withdrawal of funds from banks spurred by their perceived instability, and establish a procedure that allows for efficient and orderly liquidation.
In this sense, it was important to observe international experience, which teaches us that when full service banks experience problems of solvency and are in a process of deterioration, the financial authorities should order prompt corrective actions on a scale suited to the magnitude of their deterioration. Also, if they are incapable of solving their financial problems in a reasonable time, the authorities should take the measures necessary to ensure an orderly withdrawal from the financial market, making sure to preserve the value of their assets and seeking to minimize the impact on the user public, always ensuring the greatest possible protection for the interests of the depositors and, in general, the country’s system of payments. In such cases, it is common for the financial authorities to have the authority to take over the management of the affected institution, in order to define and implement a resolution method.
The comprehensive scheme for treating full service banks that present financial problems involves three successive stages. As shown in the following diagram, at present the Mexican legal system incorporates the first of them, relating to the system of early corrective action, and the second, relating to the resolution process in full service banks.
As we can see, the capital ratio (CR) serves as a catalyst for each stage of the aforementioned scheme; in other words it constitutes the decisive variable for the authorities to succeed in resolution of full service banks, providing the greatest possible protection for depositors, and even the banks’ other creditors. The reason the CR was considered the key indicator in the process is that it faithfully reflects a bank’s solidity by providing a measurable variable which, if calculated accurately and consistently, is recognized as a reflection of the bank’s solvency.
1. System of prompt corrective actions
In an effort to strengthen the legal framework governing credit institutions, to protect the interests of the saving public and the Mexican system of payments, in April 2004 the Mexican congress passed several amendments to the Law of Credit Institutions, establishing a series of rules that offer credit institutions a clearer legal framework in the areas of prudential regulation, supervision and oversight, and corporate governance.
The primary objective of the reforms, which were published in the Official Gazette of the Federation on June 16, 2004, was to give the financial authorities a regime that allows them to opportunely detect any disruption in the indices that reflect banks’ financial stability, and ensures their ability to take prompt preventive action. To this end, the regime known as "prompt corrective action" was incorporated in the Law of Credit Institutions, allowing the authority responsible for supervising the banking system – the National Banking and Securities Commission (Spanish acronym CNBV) – to classify full service banks in five categories, based on their level of compliance with the capitalization requirements established by law. Also, the law established a series of measures that the CNBV must impose on banks depending on their capital ratio or CR, without prejudice to the CNBV’s authority to impose additional measures by means of its general rules, which were issued December 3, 2004.
As shown in the diagram, the threshold to require full service banks to implement early corrective measures is when their CR falls below 10 percent, in other words when they are in category II, whereas when a bank is in the last category – category V – with an CR below 4 percent, the authorities will be obliged to resolve the bank.
2. Process of resolving full service banks
Although the aforementioned reforms represented a significant advance in strengthening protection of the interests of the saving public and creditors of full service banks in general, and also considering that, starting December 31, 2004, under the regime established for obligations guaranteed by the Institute for the Protection of Banking Savings, the value of the guarantee was restricted to the equivalent of four hundred thousand investment units per natural or legal person, it was imperative to make changes in laws applicable to full service banks that experienced problems that could affect their financial stability, in order to provide a timely and effective mechanism for their resolution.
Thus, on July 6, 2006, the Official Gazette of the Federation published a decree amending various provisions of the Law of Credit Institutions, the Law to Regulate Financial Groups and the Law of Banking Savings Protection, incorporating a regime that allows the financial authorities to act opportunely when full service banks experience problems that affect their financial stability and solvency, in order to prevent massive withdrawal of funds from banks spurred by their perceived instability, and establishing a procedure that allows for efficient and orderly liquidation.
The process of resolving a full service bank formally begins when its CR is 8 percent or less; however, when the CR is 8 percent or less and 4 percent or more, the bank is given an opportunity to continue to operate under the "Conditional Operation regime", subject to its meeting certain requisites. If a full service bank’s CR falls below 4 percent, the bank will automatically enter a bank resolution process, based on the law’s predefined methods.
3. Bankruptcy process - (in progress)
When a bank presents negative capital it is essential that it have effective rules that provide the greatest possible protection for the interests of its creditors. The legal framework in place, specifically the Law of Bankruptcies, establishes the steps to take in case of insolvency of a full service bank; however, although they constitute exceptions to the general regime applicable to bankruptcy, they have not provided the most efficient means of addressing all the problems bankruptcy entails for a bank and are insufficient for achieving effective resolution.
Consequently, lawmakers are currently working to propose certain amendments to existing laws that can create a regulatory framework that allows for more efficient and expeditious recovery of a full service bank’s assets, respecting due legal process at all times.
Under this proposal, as shown in the diagram, when a full service bank’s assets are insufficient to cover its liabilities, the bank will enter bankruptcy proceedings. The proposal’s primary objectives are as follows:
- Design a regulatory framework that conforms to the bank resolution scheme mentioned in the preceding section.
- Establish a bankruptcy process that prioritizes payment and transfer of operations depositors maintain in the bank.
- Provide for a complete, orderly, and expeditious process, safeguarding the rights of bank creditors and the general public.
- Establish legal certainty in the bankruptcy process, through the involvement of the judiciary, thereby guaranteeing the rights of depositors and creditors in general.
- Establish mechanisms that improve the chances of recovering assets, for the benefit of depositors and creditors in general.
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