1 José Julián Sidaoui Banco de México Washington, June 2003 Critical issues in Financial Stability: Preventing and Confronting Bank Insolvency The Mexican Banking Crisis of 1994

2 Contents I. The 1994 crisis II. Institutional framework and restructuring process III. Aftermath and Lessons

3 Predetermined exchange rate Speculative foreign capital inflows Real exchange rate appreciation Current account deficit Increase of domestic expenditure in non-tradable goods Asset price bubble Weak financial regulation and supervision Expansion of loanable funds Private sector credit boom Interest rate inflexibility The 1994 crisis Lack of transparency

4 Exchange Rate & Interest Rates The 1994 crisis Inflation (Annual rate) GDP Growth (Annual rate) Growth of Consumption & Investment (Annual rate) /01/199403/03/199403/05/199403/07/199403/09/199403/11/199403/01/199503/03/199503/05/199503/07/199503/09/ /11/ /01/199603/03/199603/05/199603/07/199603/09/199603/11/ day Cetes (lhs axis) Exchange Rate (rhs axis)

5 The 1994 crisis Real interest rates rose to unprecedented levels Economic activity plunged Unemployment increased Debt burden increased Credit portfolio deteriorated Funding rates increased Insufficient Capital Exchange rate depreciation Peso value of foreign currency denominated debt increased Debt amortization accelerated

6 Contents I. The 1994 crisis II. Institutional framework and restructuring process III. Aftermath and Lessons

7 Actions to confront a banking crisis depend on the restrictions imposed by each country’s institutional framework. Lack of political consensus Nationalization ruled out Weak legal framework for bank resolutions Universal deposit insurance Institutional framework

8 Programs adopted responded to specific needs. NeedsPrograms Restructuring process Difficulties in refinancing foreign liabilities Capital Shortage Ease debtor’s burden Dollar Liquidity Facility Temporary Capitalization Program Permanent Capitalization Measures Elimination of limits for FDI on the financial sector. Direct Support to Debtors Increase transparency and encourage market surveillance Adoption of international accounting standards and capitalization and provisioning rules. Limits to deposit insurance coverage. Creation of risk management units and new corporate governance rules

9 Contents I. The 1994 crisis II. Institutional framework and restructuring process III. Aftermath and Lessons

10 Aftermath A bank run was prevented and the payment system did not suffer any disruption. Liquidation of troubled banks and banks ’ mergers resulted in a more concentrated financial system. Of 33 banks that existed before the onset of the crisis, 23 survived. 15 changed hands (10 sold by Government and 5 by shareholders). Only 8 banks remained under the control of the same shareholders. 83% of Mexican banks’ assets are nowadays under foreign ownership Liquidated Sold by the Government Sold by shareholders New Banks Number of banks No changes in control

11 Firms’ and households’ net debtor (-) position with the domestic financial system decreased substantially Aftermath Stocks as percentage of GDP */ Includes funds transfered to FOBAPROA-IPAB and Udis trust funds. Stocks as percentage of GDP Financing of commercial banks to the private sector diminished.

Preventing insolvency - Sound macroeconomic environment - Strong prudential supervision and regulation - Transparency 2.- Dealing with insolvency - Strong legal framework - Bankruptcy law - Legal protection of supervisors 3.- What should have been done differently Lessons