Since President Enrique Pena Nieto took office last December, Mexico has embarked on a flurry of structural reforms in areas as varied as telecommunications, education, taxes and the country’s national oil industry.
Yet the one reform likely to have the most immediate positive economic effect has gone relatively unheralded: bank lending reform, which the Mexican Senate is about to approve. Although moves to open the oil industry represent a revolutionary shift, their impact on increased production might not be felt for years. Likewise, higher taxes on firms and individuals resulting from Mexico’s much-needed fiscal overhaul might well slow the Mexican economy in the short run. But by making it easier to extend credit to small and medium enterprises and low-income families, Pena Nieto’s lending reforms could boost the economy as early as next year.
Mexico’s commercial bank credit to the nonfinancial private sector is about 15 percent of gross domestic product. This is way below not only developed economies’ standards (in the U.S., for example, the ratio is more than 150 percent), but also emerging markets’ credit ratios. By comparison, the credit penetration rate is almost 25 percent in Peru, slightly above 40 percent in Colombia, close to 50 percent in Brazil and more than 70 percent in Chile.
Part of the reason for Mexico’s relative backwardness could be historical: The nationalization of the banking system in 1982 and Mexico’s banking crisis in 1994 could be factors. Yet a better explanation lies in two characteristics of the Mexican economy. First, a large number of workers and firms work under the regulatory table in the informal sector; second, under existing laws and regulations, banks face big hurdles in trying to recover collateral, and thus have had less incentive to make loans. It takes three years, on average, for commercial banks to repossess a house from a delinquent mortgage loan -- and that process can stretch as long as 10 years. Banks want to lend more to SMEs and low-income families that either operate in the informal sector or are high-risk potential clients, but the high probability of default and the low chance of repossession of collateral make them risky propositions.
Pena Nieto’s bank lending reform bill doesn’t address the informality issue. However, the reform does tackle collateral-recovery processes. First, the bill improves the processes by creating a system of specialized courts and judges, as well as making it easier to grant security for loans. Second, by enabling development banks such as Nacional Financiera SNC to register some losses (as long as those do not threaten a bank’s core capital), it frees them to significantly increase the amount and number of guarantees for commercial banks to lend to SMEs.
Brazil did something similar back in 2006 with its “alienacao fiduciaria” reform, in which it strengthened the banks’ ability to enforce contracts with their clients. This reform -- in addition to higher growth rates -- enabled the Brazilian economy to increase its credit penetration ratio to the current 45 percent from 18 percent. In this context, using quite conservative assumptions for Mexico -- such as GDP annual growth rates of 2.5 percent to 3 percent -- the credit-to-GDP ratio could easily reach 20 percent in five years and as high as 40 percent by 2025.
Even though the causal flow generally goes from economic growth to credit demand growth, plenty of research supports the idea that in countries such as Mexico with a high degree of credit rationing, causality could actually go from credit growth to economic growth, at least until the economy achieves its “natural” credit penetration ratio. In Mexico’s case, that should be about 40 percent. That calculation takes into account the global wave of financial regulation and Mexico’s particularly restrictive financial framework, which allowed the country to be the first to adopt minimum capital requirement standards under the Basel III rules back in January.
So how will this reform affect Mexico’s economic growth? I would put it as high as 0.75 percentage point on long-term potential GDP. In other words, the bank lending reform bill could raise the potential GDP growth rate to 3.75 percent, from a projected 3 percent. (My estimate is more bullish than that of the central bank of Mexico, which foresees an impact of 0.5 percentage point.) Moreover, Mexico could start to experience around 0.2 percentage point of additional growth as soon as next year.
The key to achieving these results will be speedy implementation. Secondary laws will have to be changed to reduce legal barriers to collateral recovery. Creating the new specialized courts and judges will be especially challenging, given the weakness of Mexico’s underfunded judiciary. And the actual, as opposed to the stated, willingness of generally conservative banking regulators to tolerate losses on the part of the development banks remains to be seen.
Even so, bank lending reform will help to ease foreign investors’ concerns about the looming negative impact of tax reform on the economy next year, which -- after all is said and done, including new taxes on soda and junk food -- could amount to 0.1 percent of GDP. Bank lending reform was not part of Pena Nieto’s original reform schedule in his presidential campaign. Together with the hoopla surrounding energy reform, that might explain the muted media attention. But keep your eyes on the lending window: By increasing access to banking services, this “stealth reform” has the potential to increase the productivity of small and medium enterprises and help workers to smooth their consumption patterns, changing Mexico’s patterns of social mobility and income distribution for the better.
(Gabriel Casillas is the chief economist and head of research of Grupo Financiero Banorte. The opinions expressed are his own.)
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