Mexican banks have weathered the Covid-19 pandemic crisis well, but inflation and an uncertain operating environment remain the biggest challenges for the sector. The lenders entered the pandemic with good credit fundamentals, while liquidity and capitalisation metrics remained solid.
“We are seeing a very resilient banking system with performance continuing to improve. Mexican banks are very prudential in times of stress and also very focused on less riskier clients, such as large-cap companies, local governments or high-income individuals,” says Alfredo Calvo, senior director at S&P Global Ratings.
For these reasons, lenders did not experience a material deterioration of asset quality during the pandemic. “The non-performing loan (NPL) ratio of Mexican banks peaked at 2.7% during the pandemic, and the parameter is stabilising at 2.6%, with NPLs fully covered by reserves,” says Mr Calvo.
The Mexican banking system has had historically good levels of loan loss reserves that solely cover non-performing assets, which in conjunction with robust capital adequacy ratios give them good loss absorption capacity.
“Common equity Tier 1, the most stringent capital ratio parameter, has been around 16% in the past few years, which is very high. This was due to lower credit demand and recommendations from the local regulator to reduce dividends during the pandemic,” says Alejandro Tapia, senior director at Fitch Ratings.
Common equity Tier 1, the most stringent capital ratio parameter, has been around 16% in the past few years, which is very high
Banks are also continuing to recover profitability for two reasons: their focus on consumer lending, which is more profitable, and their low cost of funding thanks to their strong reliance on deposits. “We estimate that deposits from retail customers represent about 50% of total deposits in the system,” says S&P’s Mr Calvo. This is positive in terms of cost and diversification of funding.
A strong regulatory environment
A solid capitalisation, together with other best practices and a strong regulatory environment, is partly a legacy of the ‘Tequila crisis’ of 1994, ignited by a sudden, severe devaluation of the Mexican peso. Following the crisis, Mexico opened its banking sector to foreign competition and foreign-owned banks currently control around 80% of the sector. “Foreign banks helped recapitalise the banking sector but also brought technology, better management standards and better risk management. This has helped the system manage the 2008 crisis,” says Alejandro Valenzuela, CEO of domestic lender Banco Azteca.
Mexican banks also implemented new regulatory rules consistent with IFRS9 accounting standards. After being deferred in 2021, the implementation of the new rules came into effect in January this year.
The new standards include the implementation of an expected credit loss framework for the recognition of impairment, among others. The impact of these accounting changes on Mexican commercial banks is low since the lenders previously followed an expected losses approach in all of their loan portfolios, according to Fitch Ratings.
Rising interest rates
While the banking sector is structurally solid, global macroeconomic challenges such as higher energy and food prices, inflation, higher interest rate and weaker economic growth linger. All these might affect earnings growth prospects and put pressure on asset quality and profitability. Weaker employment dynamics will have an impact on credit expansion. In light of these headwinds, the International Monetary Fund (IMF) has cut its 2022 economic growth forecast for Mexico to just 2% from 2.8% in January.
To curb inflation, the Banco de México (Banxico) increased its benchmark interest rate in June by a record 75 basis points. to 7.75%. “We estimate inflation to keep climbing towards 8.1% by year-end; we expect Banxico to continue hiking interest rates, anticipating the reference rate at 10% by December 2022,” says Marcos Ramirez, CEO of Grupo Financiero Banorte.
“Banxico has been tightening interest rates for the past year and it is difficult for everyone to give a good assessment about how monetary policy will react given the level of uncertainty still going through the whole world economy, the war in Ukraine, the dislocation of the supply chains worldwide and the aftermath of the Covid-19 pandemic,” says Banco Azteca’s Mr Valenzuela.
Lenders are coming up with different strategies to face the situation. “Inflation will especially impact the lower income segments that we serve. But for individual clients, we are maintaining the same rates for consumer loans and credit cards for at least the next 12 months,” says Carlos López-Moctezuma, CEO of BanCoppel and corporate director of financial services at Grupo Coppel.
Higher interest rates are usually positively correlated to banks’ profitability. However, Mexican banks may not fully benefit from this situation. “It is going to be difficult for banks to transfer higher interest rates to borrowers in order to avoid significant deterioration on asset quality,” S&P’s Mr Calvo explained.
Banks might need to increase provisions again because of these economic challenges. However, analysts do not expect a relevant damage on banks’ net income as happened in 2020 as a result of the pandemic.
Financial inclusion
Aside from current headwinds, Mexico has to deal with long-term challenges. The country lags behind others in terms of financial inclusion and credit penetration. In 2018, only around 47% of the population held a bank account in Mexico, much less than regional peers such as Costa Rica (68%) and Chile (74%), according to the Organisation for Economic Co-operation and Development (OECD).
Access to financial services is significantly unequal across income levels, gender, between rural and urban areas, and across states. Expanding access to finance would enable households and firms to access credit and increase investments.
“There was a discussion about financial inclusion already in the late 1980s, when I was working in government,” Mr Valenzuela recalls.
Part of this is due to the size of the informal economy that makes it difficult to prove people’s income and loans recovery. Informal workers accounted for 55.9% of the country’s workforce in 2021, according to the state’s statistics agency INEGI.
“In Mexico it is more difficult to identify clients correctly and we cannot follow them through, which makes credit assessment more complex,” says Mr Valenzuela.
The use of cash and informal credit is still widespread, especially in rural areas, where financial infrastructure is underdeveloped. The diffusion of digital financial services is slowly advancing but remains low, hampered by a low level of financial literacy and a digital divide.
“The banking system has to do a lot more because it continues to focus on large-cap companies or local governments, and it could be very active on serving small and mid-size businesses or individuals from low-income segments,” says Fitch’s Mr Tapia.
Although small and medium-sized enterprises (SMEs) provide more than 90% of Mexico’s private sector employment, only 3% have access to formal credit, according to the World Bank.
The size of domestic bank credit to the private sector is also low, at around 31.4% of gross domestic product (GDP) in Mexico in 2021, which is less than in Brazil (38%), Colombia (45%), Costa Rica (55%) and Chile (100%), according to the OECD.
“When you calculate loan to GDP, Mexico is almost as low as Argentina, with all its financial troubles,” says Felipe Carvallo, senior credit officer at Moody’s. All lending by commercial banks in Mexico is around 20%, and it only gets to 40% if one includes the development banks, he adds.
“Being a popular bank, our business model is focused on generating financial inclusion,” says Banco Azteca’s Mr Valenzuela. "So, we are one of the very few banks in Mexico that provide important amount of loans in small quantities, which also implies higher transaction, monitoring and follow-up costs.”
The banking system is working with the government to increase banking penetration.
Mexico is still a cash-based economy. “The way to transform it is with a convincing approach from our regulators. The population needs to be incentivised to adopt cashless mechanisms,” says Mr Ramirez.
“Mexico’s positive experience with the creation of bank accounts for the beneficiaries of government transfers could be further extended,” says Jorge Arce, president and CEO of HSBC Mexico.
Remittances are tied to the financial inclusion topic as well. “Every year around $50bn in remittances are sent to Mexico from the US. While part of this money goes to support families, it is also an alternative way to save for many Mexicans working in the US who for several reasons don’t have a bank account there,” explains Emilio Romano, Mexico country head at Bank of America.
“Enabling digital and card payments across public transports will also support financial inclusion. It is a good way to encourage people using electronic payments because it is a recurrent service. We are working with authorities on this front,” says Mr López-Moctezuma at BanCoppel.
Meanwhile, the government is planning to open around 2700 branches of state-owned social services bank, Banco del Bienestar. The branches will provide banking services to recipients of financial support from the government, while allowing marginalised communities to access financial services.
Digital banking
Digital banking can play a pivotal role as enabler of financial inclusion by making products and services more accessible. In this case, Mexico is behind countries like Brazil which, due its hyperinflation period in the 1990s, has been at the forefront of innovation in this space.
The Covid-19 pandemic and associated lockdowns have, however, been an accelerator of digital banking in Mexico. “During the pandemic we saw digital clients grow by threefold,” HSBC’s Mr Arce says.
Digitalisation is opening new opportunities for banks to reach new customers and help get more people into the banking system. Digital tools allow them to understand the cash flows of potential customers and assess their credit risk.
Banks are also working on alliances with fintech companies. In 2020, Banorte established a joint venture with Rappi, a Colombian on-demand delivery company, through which it has developed digital card RappiCard. “As of January 2021, 600,000 credit cards had already been issued,” says Mr Ramirez.
“There is still space for fintechs to find niches within the banking system because the banks continue to be small compared to the GDP. Fintechs could find innovative ways of minimising credit costs or of identifying the best individuals and SMEs to lend to,” says Mr Carvallo.
“We have been investing around 13% of our annual total income in our technological transformation. We have four major technologic bridges: the use of cloud, artificial intelligence, biometrics for identity and identification and data. All aiming [to improve] the personalisation of services,” says Banorte’s Mr Ramirez.
Compared to assets, credit costs and operating costs are higher in Mexico than other large banking systems in Latin America, according to Mr Carvallo at Moody’s. Lenders have been investing a lot in digitalisation to address operating efficiency. He says: “But it has been difficult. You can clearly see this looking at bank branches. Not only did we not see a decrease in the number of branches, but we have seen increases in some cases. And this is because customers demand physical presence.
“Absorbing high operating costs represents one of the difficulties that we mentioned for the potential buyer of Citibanamex, Citigroup's Mexican unit, because those are very important for maintaining low funding costs,” he explains.
Citigroup announced the intention to exit its Citibanamex consumer banking business in Mexico at the beginning of the year. A deal is not expected to be reached until January 2023. Banorte, Spain’s Banco Santander and Inbursa all have reportedly shown interest in the company, which had around $75bn in assets at the end of 2021.
Digital payments
Mexico is quite advanced with regards to its payment systems thanks to the Interbank Electronic Payment System (Spei), which is used only for money exchanges in Mexican pesos, and the Interbank Dollar Payment System (Spid), which is for US dollars. Both were implemented by Banxico and allow real-time transfers between accounts of different banks.
“Spei and Spid are world-class real-time payment systems, in many ways they work better than systems available in the US. It is possible to perform transfers between any two Mexican-based accounts in a matter of seconds,” says Mr Romano.
In 2019, the Bank of Mexico launched an electronic payment platform, known as Cobro Digital (CoDi), to allow users to make payments through their smartphone or from the internet. CoDi has not lived up to its expected growth as awareness is still lacking among the general population. The platform currently has 14 million users, out of a total population of 126 million. In comparison, PIX in Brazil, launched in November 2020, has 110 million users, out of a total population of 211 million.
“Banxico is now working on a new version of CoDi, which will be much more similar to PIX in Brazil or to Unified Payments Interface in India. But we need more efforts to really penetrate small mom and pop stores. The only way to do it is understanding what their needs are,” says Mr López-Moctezuma.
