## _cr07171

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### I. Introduction — state ownership and DB role
- State ownership defined as the Sistema Financiero de Fomento including all development banks and trust funds (fiedeicomisos) under Secretaría de Hacienda y Crédito Público (SHCP).
- Development banks (DBs) and fideicomisos provided about 20-25 percent per cent of the total credit of the banking system during the last five years.
- Government ownership influences key sectors: rural, cooperative, public works, housing.
- 2001 joint World Bank-IMF FSAP identified problems: unclear mandates, overlapping activities with commercial banks, quasi-fiscal activities outside the budget process, pervasive losses (all except one DB loss-making), inefficiency (high costs, excessive staff, weak internal controls), and non-transparent, poorly targeted fiscal subsidies.
- Post-2001 FSAP: authorities initiated legal reforms and tighter monitoring addressing some problems.

### II. Theoretical framework and key evaluation questions
- Analytical stance: pro-market activism — limited, short-run government role in market-friendly ways while institutions develop.
- Four key assessment questions:
  - (i) Do DBs aim at mitigating a well-defined problem of access to finance?
  - (ii) How is the access problem incorporated into the legal mandate and is the mandate defined in a static or dynamic manner?
  - (iii) Are the institutional form, functions, and instruments consistent with a market-friendly mandate?
  - (iv) How is compliance with the mandate being measured and is the mandate achieved in a sound and sustainable way?
- Access failures arise from adverse selection, moral hazard, transaction costs, coordination and first-mover dilemmas.
- Mandates should be dynamic (transition-path oriented) rather than static.
- Pro-market activism design principles:
  - Be highly selective; work with markets.
  - Subsidies must be nonmarket disruptive (upfront), transparent (financed through the budget), and organized to avoid duplication and misuse.
  - Prevent political capture.
  - Align short-term with long-term incentives (Development Agency (DA) concept).

### Box 1 — Development Agency (DA) characteristics (summary)
- Explicit mandate; effectiveness measured by mandate objectives maximization at least cost and consistent with market development.
- Funded directly from government through the budget; publicly accountable for public monies and guarantees.
- Do not take public deposits, do not issue debt to the public, and are not part of the payment system.
- Use instruments such as partial guarantees, structured finance, pooling of infrastructure costs.
- Finance technical assistance directly or promote technical-assistance markets.

### Box 2 — The Sisyphus Syndrome (mandate-activity contradictions)
- Contradiction #1: DBs serving high risk/low yield clients → low profits or losses.
- Contradiction #2: To offset losses, DBs expand into commercial activities or need recapitalization.
- Contradiction #3: Governments apply commercial-bank regulation/supervision, clashing with PPP objectives.
- Contradiction #4: DBs abandon PPP or operational efficiency, creating confusing incentives.

### III. Evolution of DBs in Mexico (2000-2005) — advances and challenges
- General assessment: significant but uneven changes in institutional setting, instruments, transparency of subsidies, and performance behavior from 2000-2005.
- Some institutions transformed toward DA-like structures (example: Financiera Rural).
- Risk-adjusted capital ratios diminished since 2000 partly due to stricter regulation but stabilized around 15 percent for the whole sistema financiero de fomento compared to 14.5 percent for commercial banks in 2005.
- Profitability: system reversed to positive net results in all institutions except Bancomext in 2005, compared to negative net results for all institutions except Banjercito, Fira and Fovi in 2000.
- Challenges remain despite leadership in market-friendly instruments by some DBs.

Box 3 — Snapshot (exact points)
- System consolidation: from 20 institutions in 2000 (Banco Nacional de Comercio Exterior –Bancomext–, Banco Nacional de Crédito Rural –Banrural– together with its 12 affiliated banks–, Banco Nacional de Obras y Servicios Públicos –Banobras–, Nacional Financiera –Nafin–, Banco Nacional del Ejercito, Fuerza Aérea y Armada –Banjercito–, Fondo de Operación y Financiamiento Bancario a la Vivienda –Fovi– and Patronato de Ahorro Nacional –Pahnal–) to nine in 2005 with the liquidation of Banrural and its 12 affiliated banks and the establishment of Financiera Rural, Sociedad Hipotecaria Federal –SHF–, that absorbed Fovi portfolio and Banco del Ahorro Nacional y Servicios Financieros –Bansefi–, that absorbed Pahnal.
- Total assets reduced 8.9 percent mainly due to the drop of the financial agent portfolio (now off balance sheet).
- Share of second tier operations in the own portfolio (without financial agent portfolio) increased to 57 percent in real terms.
- Following changes in risk-adjusted capital ratio calculation, it stabilized around 15 percent for whole system (sistema financiero de fomento) compared to 14.5 percent for commercial banks in 2005; dispersion ranges from around 30 percent for Banobras y Banjercito to around 11.5 percent for Nafin.
- Profitability reversal: positive net results in all institutions except Bancomext (promotional activity and SANEAMIENTO) in 2005, compared to negative net results for all institutions except Banjercito, Fira and Fovi in 2000.

### Do DBs aim at mitigating well-defined access problems? — institution-specific progress
- Greatest progress: Financiera Rural, Fira, Bansefi, SHF and Nafin (partially) in identifying access problems.
  - Financiera Rural and Fira: rural access problems.
  - SHF: housing finance market development.
  - Nafin: SME access problems (modern management).
- Least progress: Bancomext and Banobras — perceived to expand lending to preserve real value of capital, competing with private institutions.
- Banjercito: serves military personnel; not a broad access problem.
- Rationale for interventions: information production and processing are public-good–type activities; cost pooling and technical assistance increase bankability. Financiera Rural, Fira, Bansefi, SHF and Nafin undertake these activities extensively.

### IV. Rural finance, Banrural liquidation, and Financiera Rural
- Banrural nonperforming to total loans ratio rose from 12.8 in December 1999 to 57.7 in December 2003 compared to an average of 3.6 percent for development banks in December 2003.
- Footnote: "These increase in NPLs does not necessarily reflect an actual deterioration of the loan portfolio; it mainly reflects efforts by the CNBV to make Banrural financial statements more transparent and accurate."
- Presence of Banrural created moral hazard and an "unwillingness to pay" distortion in the rural finance market.
- Liquidation of Banrural (now under liquidation by the Servicio de Administracción y Enajenación de Bienes –SAE–) and creation of Financiera Rural as a DA eliminated the unwillingness-to-pay distortion.
- Ratio of nonperforming to total loans has been under 3 percent since Financiera Rural establishment in 2003.
- Fira attempted to attract private institutions to rural finance with innovative instruments but with an important subsidy in pricing that "still remains today."
- Policy implication: "Fira will need to adjust the pricing of its instruments becoming closer to the market under this new context."

### V. Long-term financing, banking structure, and export promotion
- Structural mitigants:
  - Strong presence of foreign commercial banks internationalized the Mexican financial system and facilitated access to long-term finance.
  - Development of capital markets and investment ratings for some Mexican states mitigated long-term financing problems.
- Residual gaps:
  - Many SMEs and some States and municipalities still do not have access to long-term financing.
- Export promotion:
  - Bancomext lost cost-of-funds advantage for trade finance and maintained export promotion funded through its own earnings.
  - Recommendation: export promotion activity "should be funded directly through the budget and be well coordinated with other efforts (e.g., Ministry of Trade and the Diplomatic core)."
- Banjercito: services a professional group; no special systemic problem identified.

### VI. Legal mandates — incorporation and character (static vs dynamic)
- 2002 modification of the Credit Institutions Law (Ley de Instituciones de Crédito, LIC), Article 31 (DOF 24-06-2002): DBs' main objective is access to finance of legal persons and individuals and to provide technical assistance and training; they "need to preserve and maintain their capital in a sustainable way by means of efficiently, safely and transparently channeling resources."
- Mandate character:
  - Narrow, dynamic mandates: Financiera Rural, Fira, Bansefi, SHF.
  - Broader, less-defined, static mandates: Nafin, Banobras, Bancomext.
- Illustrative Organic Law mandates (selected Art. citations and DOF dates preserved in text):
  - Financiera Rural — Law DOF December 26th, 2002 (last modification DOF 01-08-2005). Art. 2: "Development financial sector related to agricultural, forestry, fishing and other activities related to the rural sector. Principle of Capital Preservation included"
  - Nacional Financiera (Nafin) — Law DOF December 26th, 1986 (last modification DOF 01-08-2005). Art. 2: "Promote savings and investments and channel financial and technical resources to industrial development and, in general, to national and regional economic development"
  - Sociedad Hipotecaria Federal (SHF) — Law DOF October 11th, 2001 (last modification DOF 01-08-2005). Art. 2: "Promote primary and secondary housing finance markets through guarantees to housing construction, acquisition and improvement, preferably in the social interest housing. Also, to increase the production capacity and technological development of the housing sector."
  - Banco del Ahorro Nacional y Servicios Financieros (Bansefi) — Law DOF June 1st, 2001 (last modification DOF 01-08-2005). Art. 3: "Promote savings, financing and investment in the cooperative sector offering instruments and financial services to channel the technical and financial support to develop a saving behavior and a healthy sector."
  - Banco Nacional de Comercio Exterior (Bancomext) — Law DOF January 20th, 1986 (last modification DOF 01-08-2005). Art. 2 and Art. 3: "Provide the service of a public bank under the objectives and priorities of the Nacional Development Plan ..., Finance and promote foreign trade."
  - Banco Nacional de Obras y Servicios Públicos (Banobras) — Law DOF January 20th, 1986 (last modification DOF 01-08-2005). Art. 2 and Art. 3: "Provide the service of a public bank under the objectives and priorities of the Nacional Development Plan ..., Finance and refinance public or private infrastructure investment projects and support the institutional strengthening of the Federal, State and Municipal governments ..."
  - Banco Nacional del Ejercito, Fuerza Aerea y Armada (Banjercito) — Law DOF January 13th, 1986 (last modification DOF 24-06-2002). Art. 2 and Art. 3: public bank functions in line with the Nacional Development Plan; "Financial support to the army members."
- Dynamic mandates in practice:
  - Financiera Rural and FIRA: prohibited from issuing deposits or any other form of liabilities; fund lending out of endowments and loan collections; FIRA exclusively second-tier lending.
  - BANSEFI (created 2001): mandate to promote popular savings and spearhead cooperative development of the Popular Savings and Credit sector (over 400 Cajas Populares); efforts underway to sell BANSEFI to the Cajas.
  - SHF will cease second-tier lending as of 2009.
  - Market-based lending by Financiera Rural is attracting banks back to the rural sector.
- Static mandates and managerial variation:
  - NAFIN, BANCOMEXT, and BANOBRAS constrained by static mandates; NAFIN repositioned (e.g., internet-based market for SME receivables); BANCOMEXT returned to first-tier lending since 1998; BANOBRAS losing cost-of-lending advantage and left with weakest subsovereigns.

### VII. Institutional form, instruments, subsidies, and governance
- Institutional form and instruments:
  - Financiera Rural, Fira, Bansefi and SHF have adopted an institutional form similar to a DA.
  - Nafin, Bancomext and Banobras maintained existing institutional settings.
  - Financiera Rural, Fira, Bansefi, SHF and Nafin are introducing incentive-compatible instruments, though pricing in some cases remains far from market conditions.
  - Movement from first-tier to second-tier lending increased intermediaries (banks, sofoles, nonbank entities).
- Subsidies and budget financing (transparency trends):
  - Subsidies increasingly financed through initial endowments of "DA type" institutions:
    - Financiera Rural endowment: US$1,720 million
    - Bansefi endowment: US$145 million
  - Liquidation of failed institutions now takes place through SAE versus past portfolio transfers (example: Banrural liquidation: US$3,000 million).
- Governance improvements introduced in 2002:
  - Greater independence of the Board (two independent Board members and "B" share comisarios).
  - Higher accountability of Board and General Manager (Director General).
  - Improvements in disclosure through annual operational and financial plans.
  - Creation of the Risk Management Committee and the Human Resources Committee.

### VIII. Innovation in instruments and market practices
- Innovations:
  - More guarantees with lower coverage.
  - Structured finance products.
  - Cooperation in financial infrastructure.
  - Direct provision and creation of technical assistance markets.
- Institutional practices:
  - Financiera Rural and Fira: matching grants to hire technical assistance.
  - Financiera Rural lends at market prices; Fira lends at market prices to large farmers but to the poorest farmers at subsidized interest rates.
  - Fira offers partial guarantees at subsidized prices and is phasing out the subsidy element.
  - Fira conducts investment bank–like structured finance operations and offers swaps at market prices.
  - Bansefi administers a one-off government investment subsidy to finance TA for CNBV licensing and initial setup of a common network (L@ Red de la Gente).
  - Nafin created an internet-based market for SME receivables (reverse factoring) in 2001.
- Selected instrument designs (examples):
  - Structured Finance for Working Capital (Fira): risk sharing among producers, suppliers, Ocean Garden, and FIRA with FIRA covering second losses.
  - Structured Finance for Inventory Financing (Fira): Cargill selects/monitors warehouses; margin calls; FIRA provides credit guarantees and charges a fee; Cargill guarantees purchase of most repossessed inventories.
  - Bansefi: technical assistance, training, technological platform, and common services network (L@ Red de la Gente).
  - Nafin: internet-based reverse factoring linking large buyers with suppliers; banks take buyers' credit risk (factoring without recourse).
  - Cooperation to create a venture capital fund: tax and Securities Market Law changes and creation of Sociedad Anónima Promotora de Inversión (SAPI).

### Implicit subsidy evidence (Figure 1 annual points)
- Guarantee average prices / implicit subsidy:
  - 1999: 4.02%
  - 2000: 4.10%
  - 2001: 4.09%
  - 2002: 4.17%
  - 2003: 4.35%
  - 2004: 4.64%
  - 2005: 4.93%

### IX. Measurement of mandate performance and evaluation issues
- Current state:
  - No DB in Mexico has developed a performance evaluation system compatible with DA functions.
  - Performance still measured by volumes of credit; traditionally evaluated by credit growth, absence of losses and outreach.
- Measurement challenges:
  - Defining opportunity cost of capital.
  - Measuring and managing risks.
  - Measuring impact on beneficiaries and real sector performance.
  - Lack of consistent information about subsidies and guarantees complicates measurement.
  - Broad mandates and dispersed subsidy information complicate measurement.
  - Mandate indicators generally not incorporated into institutional decision making (except Fira efforts).
- Positive comparability:
  - Level playing field in regulation and supervision: risk‑adjusted capital ratios: 15 percent for DBs versus 14.3 percent for commercial banks in 2005.
  - All DBs except Bancomext have positive net results (reversal from 2001 when all institutions except Banjercito, Fira and Fovi were making losses).

### X. Advances to be consolidated
- Maintain:
  - Dynamic mandate definition focused on specific access problems.
  - Transparency via DA-type institutional changes and subsidies financed through the budget.
  - Corporate governance improvements with better accountability and disclosure.
  - Level playing field with commercial banks in regulation and supervision.
  - Principle of capital preservation.
  - Process of market incentive-compatible instruments innovation.

### XI. Shorter-term reform priorities and policy recommendations
- Rationalize numerous financial subsidy and guarantee programs to avoid ill-targeting, duplications, and “double-dipping.”
- Continue government plan to establish a “subsidies bureau.”
- Make impact assessment of lending, guarantee, and subsidy programs part of program design and evaluation (requires construction of panel and cohort data).
- Identify and correct efficiency losses due to duplication of functions and infrastructures across DBs.
- Continue efforts in each DB to fully separate subsidies from finance, move to market-based pricing while ensuring remaining subsidies are well‑designed, well‑targeted, and funded directly from the budget.

### XII. Longer-term structural recommendations and institutional consolidation
- Subject to clear objectives and mandates:
  - A DA oriented towards SMEs should replace Nafin and Bancomext, with Bancomext’s export promotion functions transparently financed by the government’s budget.
  - As Fira moves to full market pricing, consider consolidating Fira and Financiera Rural into a single, rural‑oriented DA.
  - Consider transforming Banobras into a DA oriented towards capacity building in state and local governments.
- Bansefi and the Cajas sector:
  - Bansefi is becoming a Caja de Cajas, offering centralized, second-tier services to licensed Cajas.
  - Authorities plan to transfer Bansefi to the Popular Credit and Savings Sector (PCSS) through a “socialization” process; ensure Cajas sector is well qualified before transfer.
  - Initial deadline was June 2005 for Cajas to meet CNBV authorization standards; at FSAP Update mission only a few Cajas qualified.

### XIII. Bansefi socialization process — ownership, allocation and transformation rules
- Ownership and participation limits:
  - Sale of at least 51 percent and up to 100 percent of the shares to the SCIs; acquisition voluntary.
  - Federations and Popular Credit and Savings Entities authorized or in process: up to100 percent, each Federation/shareholding trust limited to a maximum of 10 percent.
  - Foreign popular credit and savings entities and multilateral organizations: temporary investment up to 49 percent.
  - Employees of Bansefi: up to10 percent.
  - Mexican Federal Government: temporary investment up to 49percent.
- Initial allocation limits for sale:
  - 60 percent to the Mexican SCIs.
  - 30 percent to Foreign Investors.
  - 10 percent to Bansefi’s employees (conditional).
- Sale process and pricing:
  - Bidders submit irrevocable offers with a cash deposit for 50 percent of the price as surety bond.
  - Purchase price determined in accordance with Bansefi’s book value.
  - Initial participants to pay 50 percent of the excess of the difference of a fixed percentage to be defined and the real IRR of the initial investment (when applicable).
- Transformation into a multiple banking institution:
  - Transformation ordered when purchase offers for at least 51 percent of shares are received.
  - Bansefi to become a stock corporation and multiple banking institution and adjust operations within six months under supervision of SHCP, CNBV and Bank of Mexico.
- Corporate governance:
  - Proposed corporate charter to align with commercial bank regulation and incorporate additional corporate governance measures and minority shareholder protections.

### XIV. Subsidy and financing programs to entrepreneurs, productive projects, small business, and intermediaries (select entries from Table 5)
- Ministry of Economy — Fund to Support the Micro, Small and Medium Enterprise (PYME Fund): temporary support to programs and projects of micro, small and medium enterprise. Promote the access to finance on micro, small and medium enterprise.
- Ministry of Economy — National Financing Program of the Micro-entrepreneurs: subsidy and financing for establishment and consolidation of national micro financing.
- Secretariat of Economy — National Fund to Support Enterprise in Solidarity (FONAES): subsidies to prompt productive work and business of rural population, peasants and indigenous and entrepreneurs of low income in rural areas.
- Sagarpa — Support Program to Access the Rural Financial System (PAASFJR): support producers to access credit resources.
- FIRA — Credit Program by Administration (PROCREA): facilitate formal financing of businessmen through Agent PROCREA.
- FINRURAL — Entidades Dispersoras Program Phase I: give credits to entidades dispersoras of credit and/or intermediaries directed to the rural sector not contemplated in LOFR nor regulated by CNBV.
- NAFIN — Comprehensive Program for the Micro-Enterprise: financing, qualification and technical assistance to the smallest economic units.
- BANSEFI — Consolidation of the Institutions of the Saving and Popular Credit Sector: subsidy to technical assistance to societies of saving and popular credit (SACPS).
- Sedesol — Program of Productive Options: multiple components offering support to poor population to generate productive options and consolidate producers.
- CONAZA — Program of Scientific Entailment and Transference of Technology: subsidies for investigation projects to promote sustainable development in arid and semi-arid zones.
- FONART — Granting of credit: credits to support cycle of production of popular traditional local crafts.

*Source: IMF staff annex, “Mandate Definition in the Organic Laws,” analysis of development banks and fideicomisos in Mexico, 2000-2005.*

### 1. Mandate Definition in the Organic Laws.............................................................................10

### 1. Mandate Definition in the Organic Laws

### I. Introduction — state ownership and DB role
- State ownership in financial intermediation in Mexico is defined here as the Sistema Financiero de Fomento including all development banks and trust funds (fiedeicomisos) under the aegis of Secretaría de Hacienda y Crédito Público (SHCP).
- About 20-25 percent per cent of the total credit of the banking system was provided by development banks (DBs) and funds (fideicomisos) during the last five years.
- Government ownership influences key sectors: rural, cooperative, public works, housing.
- The 2001 joint World Bank-IMF FSAP identified problems: unclear mandates, overlapping activities with commercial banks, quasi-fiscal activities outside the budget process, pervasive losses (all except one DB loss-making), inefficiency (high costs, excessive staff, weak internal controls), and non-transparent, poorly targeted fiscal subsidies.
- Post-2001 FSAP: authorities initiated legal reforms and tighter monitoring addressing some problems.

### II. Theoretical framework and key evaluation questions
- Analytical stance: pro-market activism — a middle ground recognizing a limited, short-run government role in market-friendly ways while institutions develop.
- Four key assessment questions for DBs:
  - (i) Do DBs aim at mitigating a well-defined problem of access to finance?
  - (ii) How is the access problem incorporated into the legal mandate and is the mandate defined in a static or dynamic manner?
  - (iii) Are the institutional form, functions, and instruments consistent with a market-friendly mandate?
  - (iv) How is compliance with the mandate being measured and is the mandate achieved in a sound and sustainable way?
- Access problems stem from principal-agent problems (adverse selection, moral hazard) and transaction costs; coordination and first-mover dilemmas can exacerbate access failures.
- Mandates should be dynamic (transition-path oriented) rather than static, recognizing legacy interventions and the objective of moving toward long-run market solutions.
- Pro-market activism design principles:
  - Be highly selective; interventions must work with markets, not against them.
  - Subsidies must be nonmarket disruptive (upfront), transparent (financed through the budget), and organized to avoid duplication and misuse.
  - Prevent political capture to preserve temporary and market-compatible interventions.
  - Institutional settings should align short-term with long-term incentives; the Development Agency (DA) concept is proposed as an aligning structure (Box 1).

### Box 1 — Concept of a Development Agency (DA) (characteristics summarized)
- Explicitly defined mandate; effectiveness measured by mandate objectives maximization at least cost and consistent with market development.
- Funded directly from government through the budget; publicly accountable for public monies and guarantees.
- Do not take public deposits, do not issue debt to the public, and are not part of the payment system.
- Use instruments such as partial guarantees, structured finance, pooling of infrastructure costs to mitigate asymmetric information, moral hazard, and transaction-cost problems.
- Finance technical assistance directly or promote technical-assistance markets to increase bankability.

### Box 2 — The Sisyphus Syndrome (mandate-activity contradictions)
- A. DBs are created for a public policy purpose (PPP) to serve high risk/low yield clients → leads to low profits or losses. (Contradiction #1)
- B. To offset losses, DBs expand into commercial-bank activities or require government recapitalization → creates Contradiction #2 (mandate vs. activities).
- C. Governments tighten administrative controls or apply commercial-bank regulation/supervision → Contradiction #3 (PPP vs. commercial evaluation standards).
- D. Results: DBs abandon PPP or disregard operational efficiency → Contradiction #4 (confusing incentives and reactions).

### III. Evolution of DBs in Mexico (2000-2005) — advances and challenges
- General assessment: significant but uneven changes in institutional setting, instruments, transparency of subsidies, and performance behavior from 2000-2005.
- Some institutions transformed toward DA-like structures (example: Financiera Rural created as a strictu sensu DA).
- Risk-adjusted capital ratios diminished since 2000 partly due to stricter regulation (risk assessment and provisioning) but stabilized around 15 percent for the whole sistema financiero de fomento compared to 14.5 percent for commercial banks in 2005.
- Profitability: system reversed to positive net results in all institutions except Bancomext in 2005, compared to negative net results for all institutions except Banjercito, Fira and Fovi in 2000.
- Challenges remain despite leadership in market-friendly instruments by some DBs.

Box 3 — Snapshot of Development Banks Evolution in 2000-2005 (exact points)
- System consolidation: from 20 institutions in 2000 (Banco Nacional de Comercio Exterior –Bancomext–, Banco Nacional de Crédito Rural –Banrural– together with its 12 affiliated banks–, Banco Nacional de Obras y Servicios Públicos –Banobras–, Nacional Financiera –Nafin–, Banco Nacional del Ejercito, Fuerza Aérea y Armada –Banjercito–, Fondo de Operación y Financiamiento Bancario a la Vivienda –Fovi– and Patronato de Ahorro Nacional –Pahnal–) to nine in 2005 with the liquidation of Banrural and its 12 affiliated banks and the establishment of Financiera Rural, Sociedad Hipotecaria Federal –SHF–, that absorbed Fovi portfolio and Banco del Ahorro Nacional y Servicios Financieros –Bansefi–, that absorbed Pahnal.
- Total assets reduced 8.9 percent mainly due to the drop of the financial agent portfolio (now off balance sheet).
- Share of second tier operations in the own portfolio (without financial agent portfolio) increased to 57 percent in real terms.
- Following changes in risk-adjusted capital ratio calculation, it stabilized around 15 percent for whole system (sistema financiero de fomento) compared to 14.5 percent for commercial banks in 2005; dispersion ranges from around 30 percent for Banobras y Banjercito to around 11.5 percent for Nafin.
- Profitability reversal: positive net results in all institutions except Bancomext (promotional activity and SANEAMIENTO) in 2005, compared to negative net results for all institutions except Banjercito, Fira and Fovi in 2000.

### Do DBs aim at mitigating well-defined access problems? — institution-specific progress
- Financiera Rural, Fira, Bansefi, SHF and Nafin (partially) made the greatest progress in identifying the access problems they aim to address:
  - Financiera Rural and Fira: addressing well-defined rural access problems.
  - SHF: focused on market development and access issues in housing finance.
  - Nafin (modern management): improved identification of SME access problems.
- Bancomext and Banobras: least progress in defining access problems; perceived to expand lending to preserve real value of capital, competing with private institutions.
- Banjercito: does not address a broad access problem; functions as a cooperative bank for military personnel and families.
- Rationale for pro-market activism interventions:
  - Information production and processing are public-good–type activities (non-rival, costly to exclude); private investors may under-invest in screening or new credit technologies due to free-rider and spillover issues.
  - Cost pooling (e.g., Bansefi for the cooperative sector) and activities like technical assistance, investment in information technologies, and education increase bankability and have positive spillovers; Financiera Rural, Fira, Bansefi, SHF and Nafin undertake these activities extensively.

*Source: IMF staff annex, “Mandate Definition in the Organic Laws,” analysis of development banks and fideicomisos in Mexico, 2000-2005.*

### 13.      In the case of rural finance, the presence of Banrural created a moral hazard

### _cr07171 - 13.      In the case of rural finance, the presence of Banrural created a moral hazard

### Rural finance: Banrural, liquidation, and Financiera Rural
- Banrural ratio of nonperforming to total loans rose from 12.8 in December 1999 to 57.7 in December 2003 compared to an average of 3.6 percent for development banks in December 2003.
- Footnote clarification: "These increase in NPLs does not necessarily reflect an actual deterioration of the loan portfolio; it mainly reflects efforts by the CNBV to make Banrural financial statements more transparent and accurate."
- The presence of Banrural created a moral hazard and an "unwillingness to pay" distortion in the rural finance market (in addition to potential capacity-to-pay problems).
- Liquidation of Banrural (now under liquidation by the Servicio de Administracción y Enajenación de Bienes –SAE–) and creation of Financiera Rural as a DA eliminated the unwillingness-to-pay distortion.
- The ratio of nonperforming to total loans has been under 3 percent since Financiera Rural establishment in 2003.
- Fira attempted to attract private institutions to participate in rural finance with innovative instruments (described in Box 2 of the Annex IX of the FSAP 2001) but with an important subsidy in the pricing that "still remains today."
- Policy implication: "Fira will need to adjust the pricing of its instruments becoming closer to the market under this new context."

### Long-term financing, banking structure, and export promotion
- Structural mitigants to long-term financing problems:
  - Strong presence of foreign commercial banks has internationalized the Mexican financial system and facilitated access to long-term finance in international markets.
  - Development of capital markets in Mexico and investment ratings for some Mexican states has mitigated long-term financing problems.
- Residual access gaps:
  - Many SMEs and some States and municipalities still do not have access to long-term financing.
- Export promotion and other specialized activities:
  - Bancomext has lost its competitive edge in cost of funds for trade finance with financial system internationalization and development, and has maintained an export promotion function funded through its own earnings.
  - Recommendation: export promotion activity "should be funded directly through the budget and be well coordinated with other efforts (e.g., Ministry of Trade and the Diplomatic core)."
  - Banjercito attends needs of a professional group and "does not present a particular problem different to the one that other professional groups may have."

### Legal mandate: incorporation and character (static vs dynamic)
- 2002 modification of the Credit Institutions Law (Ley de Instituciones de Crédito, LIC):
  - Article 31 of the LIC (changed in DOF 24-06-2002) states that development banks have as main objective access to finance of legal persons and individuals in addition to providing adequate technical assistance and training as indicated in their respective organic laws.
  - In developing such objectives they "need to preserve and maintain their capital in a sustainable way by means of efficiently, safely and transparently channeling resources."
- Mandate character across institutions:
  - Narrow, dynamic mandates (obliging redefinition upon achievement of objectives): Financiera Rural, Fira, Bansefi, SHF.
  - Broader, less well-defined, static mandates: Nafin, Banobras, Bancomext.
- Illustrative institutional mandates (as stated in Organic Laws):
  - Financiera Rural — Law DOF December 26th, 2002 (last modification DOF 01-08-2005). Art. 2: "Development financial sector related to agricultural, forestry, fishing and other activities related to the rural sector. Principle of Capital Preservation included"
  - Nacional Financiera (Nafin) — Law DOF December 26th, 1986 (last modification DOF 01-08-2005). Art. 2: "Promote savings and investments and channel financial and technical resources to industrial development and, in general, to national and regional economic development"
  - Sociedad Hipotecaria Federal (SHF) — Law DOF October 11th, 2001 (last modification DOF 01-08-2005). Art. 2: "Promote primary and secondary housing finance markets through guarantees to housing construction, acquisition and improvement, preferably in the social interest housing. Also, to increase the production capacity and technological development of the housing sector."
  - Banco del Ahorro Nacional y Servicios Financieros (Bansefi) — Law DOF June 1st, 2001 (last modification DOF 01-08-2005). Art. 3: "Promote savings, financing and investment in the cooperative sector offering instruments and financial services to channel the technical and financial support to develop a saving behavior and a healthy sector."
  - Banco Nacional de Comercio Exterior (Bancomext) — Law DOF January 20th, 1986 (last modification DOF 01-08-2005). Art. 2 and Art. 3: "Provide the service of a public bank under the objectives and priorities of the Nacional Development Plan ..., Finance and promote foreign trade."
  - Banco Nacional de Obras y Servicios Públicos (Banobras) — Law DOF January 20th, 1986 (last modification DOF 01-08-2005). Art. 2 and Art. 3: "Provide the service of a public bank under the objectives and priorities of the Nacional Development Plan ..., Finance and refinance public or private infrastructure investment projects and support the institutional strengthening of the Federal, State and Municipal governments ..."
  - Banco Nacional del Ejercito, Fuerza Aerea y Armada (Banjercito) — Law DOF January 13th, 1986 (last modification DOF 24-06-2002). Art. 2 and Art. 3: public bank functions in line with the Nacional Development Plan; "Financial support to the army members."
- Examples of dynamic mandates in practice:
  - Financiera Rural and FIRA: prohibited from issuing deposits or any other form of liabilities; fund lending out of endowments and loan collections; FIRA exclusively second-tier lending.
  - BANSEFI (created 2001): mandate to promote popular savings and spearhead cooperative development of the Popular Savings and Credit sector (over 400 Cajas Populares); efforts underway to sell BANSEFI to the Cajas.
  - SHF will cease second-tier lending as of 2009.
  - Market-based lending by Financiera Rural is attracting banks back to the rural sector.
- Examples of static mandates and managerial variation:
  - NAFIN, BANCOMEXT, and BANOBRAS constrained by static mandates in Organic Laws; initial niches eroded by market developments.
  - NAFIN has repositioned and developed new instruments (e.g., an internet-based market for SME receivables).
  - BANCOMEXT has gradually returned to first-tier lending since 1998.
  - BANOBRAS losing traditional cost-of-lending advantage and being left with the weakest subsovereigns as the most creditworthy state and local governments access private markets.

### Institutional form, instruments, subsidies, and governance
- Institutional form and instruments:
  - Financiera Rural, Fira, Bansefi and SHF have adopted an institutional form similar to a DA.
  - Nafin, Bancomext and Banobras have maintained their institutional setting.
  - Financiera Rural, Fira, Bansefi, SHF and Nafin are introducing incentive-compatible instruments, though pricing in some cases remains far from market conditions.
  - Movement from first-tier to second-tier lending increased the number and range of financial intermediaries (e.g., banks, sofoles and nonbank entities operating with Fira, SHF and Financiera Rural).
- Subsidies and budget financing (transparency trends):
  - Subsidies increasingly financed through initial endowments of "DA type" institutions:
    - Financiera Rural endowment: US$1,720 million
    - Bansefi endowment: US$145 million
  - Liquidation of failed institutions now takes place through SAE versus past portfolio transfers to Fideliq, for example Banrural liquidation: US$3,000 million.
- Governance improvements introduced in 2002 (areas of improvement):
  - Greater independence of the Board through the introduction of two independent Board members and "B" share comisarios.
  - Higher accountability of Board and General Manager (Director General).
  - Improvements in disclosure through annual submission of operational and financial plans.
  - Creation of the Risk Management Committee and the Human Resources Committee.

*Source: _cr07171 - 13.      In the case of rural finance, the presence of Banrural created a moral hazard*

### 26.      Innovation is taking place through the introduction of incentive-compatible

### _cr07171 - 26.      Innovation is taking place through the introduction of incentive-compatible

### Innovation in instruments and market practices
- Innovations introduced:
  - More guarantees with lower coverage.
  - Structured finance products.
  - Cooperation in financial infrastructure.
  - Direct provision and creation of technical assistance markets.
- Institutional examples and practices:
  - Financiera Rural and Fira promote capacity building via matching grants used by recipients to hire technical assistance.
  - Financiera Rural lends at market prices; Fira lends at market prices to large farmers but to the poorest farmers at subsidized interest rates.
  - Fira offers partial guarantees at subsidized prices and is implementing a program to phase out the subsidy element therein.
  - Fira has engaged in investment bank–like activities: coordinating large structured finance operations by aligning incentives and distributing risks among participants, and offering interest rate and currency swaps, all at market prices.
  - Bansefi administers a one-off government investment subsidy to finance TA to raise governance, transparency, and management capacity to standards required for licensing by the CNBV; this subsidy is also used to finance the initial setup of a common network and infrastructure to capture economies of scale for the Caja sector.
  - Nafin created an internet-based market for SME receivables (reverse factoring) that has become an example of innovative practices in the region.

### Selected instrument designs (Table 4)
- Structured Finance for Working Capital Financing (Fira):
  - Participants: Ocean Garden (large shrimp distributor), shrimp producers, shrimp feed suppliers, and private banks.
  - Mechanism: Ocean Garden signs supply agreements, advances working capital; credit rights transferred to a trust fund and sold to banks (SPV bankruptcy remote).
  - Incentive alignment and risk sharing:
    - Producer and feed suppliers provide guarantees for specific loans covering initial credit losses up to a certain level.
    - Ocean Garden provides a general guarantee covering initial credit losses up to a certain level.
    - FIRA provides a guarantee that covers second losses.
- Structured Finance for Inventory Financing (Fira):
  - Participants: FIRA, Cargill, private banks, sugar mills.
  - Mechanisms to address collateral issues:
    - Cargill selects and monitors warehouses.
    - Margin calls keep a constant loan-to-value ratio.
    - Loans extended through repos.
  - Risk sharing:
    - FIRA provides credit guarantees covering a large share of total loan value and charges a fee for the guarantee.
    - Cargill guarantees purchase of most repossessed inventories limiting FIRA’s exposure.
- Development of common financial infrastructure (Bansefi):
  - Activities: Technical Assistance; Training; Technological Platform; Common services network L@ Red de la Gente.
  - Benefits: Broadens client base (economies of scale), allows differentiated products (economies of scope), access to national payments system (network economies).
- Creation of a factoring market (Nafin):
  - Internet-based reverse factoring system (2001) linking large creditworthy buyers with their suppliers; banks take credit risk of buyers (factoring without recourse).
  - Reduces information problems, lowers transaction costs, creates credit history for suppliers, and fosters competition among financial institutions.
- Cooperation to create a venture capital fund (Nafin, Bancomext, Banobras, Focir, others):
  - Tax and Securities Market Law changes to facilitate trust fund transparency and creation of Sociedad Anónima Promotora de Inversión (SAPI).
  - Managed by Corporación Mexicana de Inversiones with a Board of four shareholders and four independent members.

### Implicit subsidy evidence (Figure 1)
- Guarantee average prices / implicit subsidy (annual points in figure):
  - 1999: 4.02%
  - 2000: 4.10%
  - 2001: 4.09%
  - 2002: 4.17%
  - 2003: 4.35%
  - 2004: 4.64%
  - 2005: 4.93%

### Measurement of mandate performance and evaluation issues
- Current state:
  - No DB in Mexico has succeeded in developing a performance evaluation system compatible with Development Agency (DA) functions.
  - Performance is still measured in terms of volumes of credit.
  - DBs have traditionally been evaluated by credit growth, absence of losses and outreach of the targeted population.
- Key measurement challenges:
  - Defining opportunity cost of capital.
  - Measuring and managing risks.
  - Measuring impact on beneficiaries and real sector performance.
  - Lack of consistent information about subsidies and guarantees complicates mandate measurement.
  - Broad mandates and dispersed information across multiple subsidy programs complicate measurement.
  - Mandate indicators are generally not incorporated into institutions’ decision making (except some efforts by Fira).
- Positive comparability:
  - Level playing field in regulation and supervision between DBs and commercial banks (risk‑adjusted capital ratios: 15 percent for DBs versus 14.3 percent for commercial banks in 2005).
  - Today, all DBs except Bancomext have positive net results, reverting the situation of 2001 when all institutions except Banjercito, Fira and Fovi were making losses.

### Advances to be consolidated
- Important advances to maintain:
  - Dynamic mandate definition with a focus on the specific access problem to be solved.
  - Transparency through changes in institutional setting (DA) and subsidies financed through budget.
  - Corporate governance improvements with better accountability and disclosure.
  - Level playing field with commercial banks in terms of regulation and supervision.
  - Principle of capital preservation.
  - Process of market incentive-compatible instruments innovation.

### Shorter-term reform priorities and policy recommendations
- Rationalize numerous financial subsidy and guarantee programs to avoid ill-targeting, duplications, and “double-dipping.”
- Continue the government plan to establish a “subsidies bureau.”
- Make impact assessment of lending, guarantee, and subsidy programs part of program design and evaluation (requires construction of panel and cohort data).
- Identify and correct efficiency losses due to duplication of functions and infrastructures across DBs.
- Continue efforts in each DB to fully separate subsidies from finance, moving to market-based pricing while ensuring remaining subsidies are well‑designed, well‑targeted, and funded directly from the budget.

### Longer-term structural recommendations and institutional consolidation
- Subject to clear objectives and mandates:
  - A DA oriented towards SMEs should replace Nafin and Bancomext, with the latter’s export promotion functions transparently financed by the government’s budget.
  - As Fira moves to full market pricing, consider consolidating Fira and Financiera Rural into a single, rural‑oriented DA.
  - Consider transforming Banobras into a DA oriented towards capacity building in state and local governments.
- Bansefi and the Cajas sector:
  - Bansefi is becoming a Caja de Cajas, offering centralized, second-tier services to licensed Cajas.
  - Authorities plan to transfer Bansefi to the Popular Credit and Savings Sector (PCSS) through a “socialization” process; important that the Cajas sector be well qualified before transfer.
  - Initial deadline was June 2005 for Cajas to meet CNBV authorization standards; at the time of the FSAP Update mission only a few Cajas qualified.

### Bansefi socialization process (Box 5) — ownership, allocation and transformation rules
- Ownership and participation limits:
  - Sale of at least 51 percent and up to 100 percent of the shares to the SCIs; acquisition voluntary.
  - Federations and Popular Credit and Savings Entities authorized or in process: up to100 percent, each Federation/shareholding trust limited to a maximum of 10 percent.
  - Foreign popular credit and savings entities and multilateral organizations: temporary investment up to 49 percent.
  - Employees of Bansefi: up to10 percent.
  - Mexican Federal Government: temporary investment up to 49percent.
- Initial allocation limits for sale:
  - 60 percent to the Mexican SCIs.
  - 30 percent to Foreign Investors.
  - 10 percent to Bansefi’s employees (conditional).
- Sale process and pricing:
  - Bidders submit irrevocable offers with a cash deposit for 50 percent of the price as surety bond.
  - Purchase price determined in accordance with Bansefi’s book value.
  - Initial participants to pay 50 percent of the excess of the difference of a fixed percentage to be defined and the real IRR of the initial investment (when applicable).
- Transformation into a multiple banking institution:
  - Transformation ordered when purchase offers for at least 51 percent of shares are received.
  - Bansefi to become a stock corporation and multiple banking institution and adjust operations to the applicable framework within six months under supervision of SHCP, CNBV and Bank of Mexico.
- Corporate governance:
  - Proposed corporate charter to be aligned with commercial bank regulation and to incorporate additional corporate governance measures and minority shareholder protections.

*Source: _cr07171 - 26.      Innovation is taking place through the introduction of incentive-compatible*

### 33.      Finally, as the DB system evolves towards a DA model, there will be a growing

### 33.      Finally, as the DB system evolves towards a DA model, there will be a growing

### Measuring and evaluating DB performance
- The current criteria—of measuring performance in terms of the volume of loan disbursements—is bound to become increasingly less relevant.
- The new criteria should focus on the impact of DA market-friendly interventions.
- As such interventions will increasingly involve nonlending instruments, their impact should be assessed in terms of their catalytic role in fostering a sustainable broadening of access to financial markets for underserved sectors.

### Table 5. Subsidy and Financing Programs to Enterpreneurs, Productive Projects, Small Business, and Intermediaries of “Popular”Banking — Agency / Program / Objectives
- Ministry of Economy — Fund to Support the Micro, Small and  Medium Enterprise (PYME Fund)
  - To give temporary support to programs and projects of micro, small and medium enterprise. Promote the access to finance on micro, small and medium enterprise.
- Ministry of Economy — National Financing Program of the Micro-entrepreneurs.
  - To give subsidy and financing for the establishment and consolidation for the sector of national micro financing.
- The Secretariat of Economy (Seconomía) — National Fund to Support Enterprise in Solidarity (FONAES)
  - Offering subsidies to prompt the productive work and business of the rural population, peasants and indigenous and entrepreneurs of low income of the rural areas, by means of support  to the formation of productive capital, business skills and the build up of financial intermediaries.
- The Secretariat of Economy (Seconomía) — Fund for Micro Financing of Rural Women (FOMMUR)
  - Channeling micro credits to rural women, with business vocation, willing to prompt productive and profitable projects with associative capacity.
- SRA — Women Program in the Agrarian Sector. (PROMUSAG)
  - Offering subsidies to productive projects to women of the agrarian sector.
- SRA — Fund for the Support to Productive Projects (FAPPA).
  - Offering subsidies and support to productive projects of the agrarian subjects and group of peasants that inhabit in agrarian areas.
- Sagarpa — Support Program to Access the Rural Financial System (PAASFJR )
  - Support the producers of the rural sector to access the credit resources to help them develop his activities and contribute to the development of an efficient rural system.
- Sagarpa — Support Program to the Rural Investment Projects (PAPIR)
  - Grant subsidies to promote the investment in capital good of the rural population to execute productive projects of proper technology application, productive re-conversion, collection, conditioning and transformation.
- Sagarpa — Regional Projects for Technical Aid to the Rural Micro-financing (PATMIR)
  - Offering subsidies to financial intermediaries not bankers to facilitate access to financial services to the inhabitants of marginalized rural regions.
- Sagarpa — Rural Development Programs Sub-program of Development (PRODESCA)
  - Developing the capacities of the rural population eligible to identify areas of opportunities, formulate, execute and consolidate projects that can improve their productive, commercial, organizational and business processes.
- Sagarpa — Strengthening Sub-programs of Rural Businesses and Organizations (PROFEMOR)
  - Incorporating to the Unit of Rural Production (UPR) and priority groups in an organized way to the appropriation of the added value in both senses of the productive academy, promoting synergies among the organizations, economic networks and the rural financial services, such as fortifying the processes of participation and self-management, that enable them to have a greater power of communication and positioning of their enterprises and organization.
- Sagarpa — Support Programs to the Social Organizations of Agribusiness and Fishing grounds (PROSAP)
  - Offering subsidies to the social and economic organizations of the rural sector to formulate and execute productive projects.
- STPS — Productive Investment Projects (PIP)
  - Offering subsidies by means of delivery of machinery, equipment and tools to unemployed people and sub-employed interested in developing a productive project.
- FIRA — Credit Program by Administration. (PROCREA)
  - Facilitating the formal financing of businessmen with a credit requirement of small amount, through a private intermediary called Agent PROCREA.
- FIRA — Comprehensive Technical Service (SATI)
  - Support credit operations to producers with an annual net income of 3,000 times lower than the minimum daily salary in the area, by means of professional advice in productive, administrative, financial and organizational aspects.
- FIRA — System of Stimuli to the Bank (SIEBAN)
  - Compensating the commercial banking by giving access to formal credit to low income producers in need of small credits.
- FIRA — System of Stimulus to the Credit Unions (SIESUC)
  - Consolidate and increase the operations between the Credit Unions, the Bank and the FIRA.
- FIRA — Service of Guarantees
  - Facilitating the access of producers and businessmen to the credit of the Private Bank complementing the own guarantee of the business.
- FINRURAL — Entidades Dispersoras Program Phase I
  - To give credits to entidades dispersoras of credit and/or financial intermediaries directed to the rural sector that were not contemplated in the LOFR, nor regulated by the CNBV
- FINRURAL — Program to reduce transaction costs.
  - Offering subsidies to the intermediaries to reduce the transaction cost of their clients.
- FINRURAL — Comprehensive Program of Formation, Qualification and Consulting for Producers and Rural Intermediaries.
  - Offering subsidies to the development of qualifications and consulting for producers and rural intermediaries.
- NAFIN — Comprehensive Program for the Micro-Enterprise.
  - Providing financing, qualification and technical assistance to the smallest economic units of the country.
- BANSEFI — Consolidation of the Institutions of the Saving and Popular Credit Sector.
  - Offering subsidy to the technical assistance to the society of saving and popular credit (SACPS) and to the personnel of the federations that group SACPS interested in receiving the supports to complying with the legal framework.
- BANSEFI — Qualification for the Personnel of Federations and SACP's.
  - Subsides to form human resources required by the  SACP's and federations to comply with the Law and the regulations.
- BANSEFI — Strengthening Program to the Saving and Popular Credit and Rural Microfinance. Technological Component.
  - To design, establish and operate an information system to support the saving and popular credit intermediaries in the generation and information dissemination, for own use and to comply with the regulation.
- BANSEFI — FOMIN. Component of Remittances of the Red of the People (La Red de la Gente)
  - To develop the connectivity between the systems in SACP's and BANSEFI, with the purpose to operate The Network of the People (La Red de la Gente), conformed by financial intermediaries that offer a variety of services with high quality and reduce costs to the societies and the end users, with national cover.
- Sedesol — Program of Productive Options:
  - (a) Support to the Word, (b) Productive Credit for Women,  (c) Granting support and enterprise formation, (d) Saving with you, (e) Productive Integration, (f) Local Development Agents
  - Offering support to the poor population from a strategy that could generate productive options, contribute to the consolidation of producers, favoring the formation of agencies of local development, and contribute to the formation of a system of social financing.
- Sedesol — Civic Initiative 3x1
  - Supporting the civil initiatives to make specific projects that involve improving de quality of life of 10 inhabitants through assembly of resource of the federation, states, municipalities of the same group of citizens organized, mainly the ones living abroad.
- Nacional Comisión on the Arid Zones (CONAZA) — Program of Scientific Entailment and Transference of Technology
  - Offering subsidies for investigation projects to promote sustainable development and the improvement of the quality of the rural inhabitants living in extreme poverty in the arid and semi- arid zones of the country.
- National Fund for the Promotion of the Local Crafts (FONART) — Granting of credit
  - Offering credits for the support of the cycle of production of the popular traditional local crafts

*Fuente: Oficina de Políticas Publicas, Encuesta a dependencias y entidades del Gobierno Federal sobre Transferencias, Financiamientos y Apoyos a Emprendedores, Proyectos Productivos, Micronegocios e intermediarios Financieros, Presidencia de la Republica, México, Marzo de 2004.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr07171.pdf_