Mexican Banks Facing a Relapse

Just as Mexico’s banks were beginning to recover this year from the self-inflicted wounds of the mid-1990s peso crisis, the spread of global economic ills has threatened to reinfect the nation’s still-feeble banking system.

Only this year did the banks, digging themselves out from under a deluge of unpayable loans, resume lending. Now lending has virtually stopped again as interest rates soared from about 20% to more than 40% in some cases--raising the specter of yet more loans going bad.

Most bankers and economists agree that reforms implemented in Mexico since 1995 sharply reduce the chances that the current turmoil will unleash a second full-scale financial crisis.

But they worry that the banking sector’s lethargic recovery will be further delayed, crimping what has been one of the developing world’s strongest growth rates.

Healthy banks able to provide financing for both consumers and producers are critical if the year-old surge in the domestic economy--it grew 7% last year and is projected to gain another 4% in 1998--is to withstand pressures from the global economic turmoil.

“The banking situation is dramatically better than it was, but to say it’s healthy or that enough progress has been made would be a bit Pollyannaish,” said Deborah L. Riner, chief economist for the American Chamber of Commerce in Mexico. “Banks are still seriously undercapitalized . . . and the sudden jump in interest rates clearly bears a price.”

Interest rates are a key central bank tool to control inflation and to keep the free-floating peso from dangerous volatility. Rates on government Treasury bills, called cetes, briefly soared to 50% in early September. While key rates have since come back down, people are jittery as worldwide instability persists. The 28-day cetes rate as of Friday stood at 31.5%--still a dozen points above rates a few months ago.

The turbulence comes as politicians finally appear near a deal on how to pay for the $55-billion bailout that prevented a total collapse of the banking system during the deep recession after the December 1994 peso devaluation.

That bailout program, known as Fobaproa, took over bad bank debts owed by borrowers, who were unable to make payments in the mid-1990s when interest rates and inflation skyrocketed and the economy fizzled.

Yet with the domestic economy now finally recovering, the concern is that the worldwide woes have pushed interest rates so high that the banks could find themselves coping with Fobaproa II--a new mountain of unpayable loans that would further weaken the banking sector.

One sign of worry is that bank shares have been among the hardest hit this year on the Mexican stock exchange. The three largest banks’ share prices all have fallen more than 67%, compared with the overall index decline of 44%.

Analysts do expect the latest scare to serve a purpose: encourage still-deeper financial reforms and accelerate the huge changes already taking place in the industry, including more mergers and more creative corporate financing methods.

In addition to paying for the bailout, the package of bills now before the Mexican Congress would allow still greater foreign participation in banking, create a U.S.-style ceiling on bank deposit insurance and give more independence to the National Banking and Securities Commission.

Mexico’s chastened banks have already taken strong medicine to improve their controls and productivity since the previous crisis. Foreign banks, which bought up major pieces of the banking industry following the 1995 troubles, also have injected much-needed expertise and capital.

The industry points to hard-won progress in recent years, such as cutting employees from 34 per branch to 20, and implementing better procedures for lending decisions.

But as Carlos Gomez y Gomez, president of the Mexican Bankers Assn., put it recently: “Let’s not fool ourselves: If interest rates stay so high, this will damage the Mexican economy.”

Last month, Gomez himself made what seems an unlikely suggestion for a banker: People should stop borrowing until things settle down.

The banking industry went through a wrenching transformation after the 1994-95 crisis as troubled banks were seized by the government, merged or bought out. Gomez y Gomez, who is also head of Spanish bank Santander’s Mexican operation, predicted further consolidation.

“What we see ahead in the financial sector is a situation similar to Canada’s, with a reduced number of banks [but which will] have national coverage and be well-supervised and much more competitive.”

John S. Donnelly, head of Chase Manhattan Bank in Mexico, said the recent problems will encourage the government to take steps to speed up mergers. “We may end up with five major banks. And I do think this [interest rate] spike has firmly convinced the Mexican government that it has to take measures to improve the capitalization of the banks. The spike just makes everyone realize the fragility was [already] there.”

Susana Ornelas, banking analyst for Deutsche Morgan Grenfell, said she expects real loan growth in 1999 to slow to 2% to 3%, way down from the projected 7%.

“The recovery will still be slower than we had expected, and past-due loan ratios will not fall as quickly as we had foreseen even a few months ago.”

Yet she added that the risk of a major financial crisis is lower than in 1995 for several reasons.

“People are not as indebted as in 1995, and interest rates still are not as high. . . . Plus, about 25% of loan portfolios are in dollars, and these are mainly for export-oriented companies. Finally, a lot of these loans, including small loans like mortgages, are still receiving discounts and other help from the government.”

“I do think there’s potential for continued improvement,” Ornelas said. “At least I don’t foresee significant deterioration like that in 1995 and ’96.”

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Economic Recovery Threatened

Mexican interest rates are sky-high...threatening economic recovery.