## _cr16361

## Source details

**Canonical URL:** [_cr16361](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16361.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16361.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16361.pdf.json)

---

### EXECUTIVE SUMMARY
- Mexico’s economic fundamentals are strong; medium-term outlook foresees steady growth underpinned by strong macroeconomic policies, broad reform initiatives, and relatively strong balance sheets.
- Key external risks: United States (U.S.) growth slowdown, lower oil prices, and volatility in global financial markets.
- Financial system resilience:
  - Solvency and liquidity stress tests of the banking system indicate it can withstand severe adverse macro-financial shocks despite large capital losses in some cases.
  - The insurance sector could endure a combination of interest rate, exchange rate, and equities market shocks.
  - Pension funds are exposed to market risk, but liquidity risks are lower.
  - Sensitivity analysis indicates large listed corporations could broadly cope with adverse exchange rate, earnings, and interest rate shocks.
- Prudential oversight progress and remaining governance gaps:
  - Significant progress in strengthening prudential oversight.
  - Important gaps persist in operational independence, budget autonomy, and legal protection of supervisors.
  - A fully functioning consolidated supervision framework is not yet in place.
- Financial sector safety net and resolution:
  - Banxico’s liquidity operating framework is robust; liquidity regulation and emergency liquidity provision upgraded since the last FSAP.
  - Deposit insurance broadly conforms to best international practice, with concerns: governance gaps, multiplicity of mandates, and small size of the ex-ante resolution fund.
  - Special bank resolution regime strengthened but requires extensions (e.g., coverage of financial holding companies (FHC)) and powers to improve resolvability.
  - No formal contingency plan for a systemic crisis and no system-wide crisis simulation process.
- Financial sector development challenges:
  - Access to finance and long-term financing remain limited; private sector credit to GDP about 30 percent.
  - Improvements to financial infrastructure (credit and collateral registry, insolvency enforcement) recommended.
  - Development banks (DBs) play an increasing role in financial inclusion; need to ensure sustainable involvement and avoid crowding out.

### KEY RECOMMENDATIONS (SELECTED)
- Institutional arrangements and governance
  - Integrate all prudential supervision into one Prudential Supervisor covering banks, securities, insurance firms, pension funds and other financial institutions. (Medium-Term)
  - Amend laws to clearly establish financial stability as the primary objective for the new supervisor and strengthen governance and budgetary independence of the supervisor and IPAB. (Medium-Term)
- Financial stability policy framework
  - Establish more clearly the status of the CESF as the preeminent voice regarding assessment of financial stability risks. (Short-Term)
- Financial sector oversight
  - Adopt a consolidated supervision framework and strengthen reporting on related party lending. (Short-Term)
  - Revise corporate governance of development banks. (Short-Term)
  - Enhance definitions of “common risk” and “related party” and review role of Banxico in capital requirement determinations. (Short- to Medium-Term)
- Deposit insurance, crisis management, and resolution
  - Transfer the legacy debt at IPAB to the sovereign balance sheet. (Medium-Term)
  - Adopt legislation removing bail-out options for shareholders and subordinated debt holders of systemic banks. (Medium-Term)
  - Develop formal contingency plans and simulation exercises for systemic crises. (Medium-Term)
- Development banks and inclusion
  - Revise DB strategies to include indicators of financial inclusion and private sector crowding-in, eliminating quantitative targets. (Short-Term)
- Pensions and SME finance
  - Increase contribution rates to fully funded pension schemes to ensure higher replacement rates. (Short-Term)
  - Create a credit registry to increase financial information available to lenders. (Medium-Term)

### MACRO-FINANCIAL CONTEXT
- Growth and inflation
  - Economy grew on average by 2.5 percent per year since the last FSAP in 2012.
  - Growth projected to average about 2.4 percent in 2016–20.
  - Core inflation close to the 3 percent target since 2011.
- External sector and buffers
  - Flexible Credit Line (FCL) arrangement renewed and extended to U.S. dollar 88 billion on May 27, 2016.
  - By end-August 2016, nonresidents held a third of all domestic government debt securities, and 60 percent of Mbonos (fixed rate bonds).
- Fiscal and monetary policy
  - Multi-year fiscal consolidation program: fiscal deficit declining by 0.5 percentage points of GDP per year to 2.5 percent of GDP in 2018.
  - Free-floating peso main shock absorber; since mid-2014 peso depreciated by close to 50 percent vis-à-vis the U.S. dollar.
- Reforms and balance sheets
  - Wide-ranging reforms launched in 2013–14 (financial sector, energy, telecommunications, anti-trust, labor, taxes, education).
  - Households’ debt about 15 percent of GDP; banking system holds large buffers.
- Key risks
  - U.S. slowdown, protectionism, lower oil prices, and increased global volatility could tighten financial conditions, raise non-performing loans and pressure the exchange rate.

### FINANCIAL SECTOR STRUCTURE AND SOUNDNESS
- Size and composition
  - Financial sector assets amounted to 90 percent of GDP in 2015; over half are commercial banking assets.
  - Development banks reached around 10 percent of financial sector assets by end-2015.
  - Nonbank sector accounts for 30 percent of financial sector assets.
  - Sofomes account for 1 percent of financial system assets.
  - The seven largest banks (G-7) account for about 80 percent of total bank assets; five of the G-7 are foreign subsidiaries accounting for about 65 percent of commercial banks’ assets.
- Commercial banks (end-2015)
  - Total capital adequacy ratio (CAR) stood at 15 percent.
  - Liquid assets about 35 percent of short-term liabilities.
  - All banks met minimum 60 percent LCR in September 2015; many exceed 100 percent requirement to apply from 2019.
  - Foreign currency loans 13 percent of total loans.
  - Net open position in FX to Tier 1 capital: -0.2 percent.
  - NPL ratio declined from 3.2 percent in 2013 to 2.6 percent in 2015.
  - Returns on equity averaged 17 percent over the last three years; lending-deposit spread around 10 percentage points.
- Development banks (end-2015)
  - CAR at 14.1 percent.
  - Liquid assets to liquid liabilities about 120 percent.
  - NPLs below 2 percent since 2010; provisions cover about 260 percent of NPLs.
- Nonbank sectors
  - Pension funds (SIEFOREs): investment limits set by CONSAR; projected replacement rates for funded scheme 28 to 34 percent versus 80–100 percent under IMSS and ISSSTE pay-as-you-go; transition rule generates an abrupt reduction in replacement rates of about 50 percent.
  - Mutual funds: assets grew from 5 percent of GDP in 2005 to 11 percent of GDP in 2015; concentrated in short-term sovereign and IPAB securities and exposed to redemption risks.
  - Insurance companies (2015): minimum capital guarantee coverage ratio ~1.9 times; technical reserve coverage ratio 1.1 times; return on equity 14 percent; liquid assets to current liabilities ratio 3.5.

### STRESS TESTS, RESILIENCE, AND INTERCONNECTEDNESS
- Stress test design and coverage
  - Banxico and CNBV conducted BU and TD stress tests covering at least 80 percent of commercial banks’ assets.
  - Two adverse macroeconomic scenario sets over 2016 Q1–2020 Q4: (i) V-shaped (resembles 2008–09); (ii) U-shaped (protracted recession).
  - Liquidity stress tests based on LCR framework (Basel III).
- Key stress test findings
  - Large commercial banks remained adequately capitalized in the BU ST; no large commercial bank failed the TD ST.
  - A protracted recession (U-shaped) more damaging than a V-shaped one; impacts partly offset by higher net interest margins and balance sheet rebalancing.
  - Static balance-sheet assumptions could reduce CARs by as much as 1¼ percentage points.
  - Adjusting risk-weights to reflect PD changes could reduce system CAR by as much as 6 percentage points and caused one G-7 bank’s CAR to fall to 7¼ percent in BU sensitivity analysis.
  - By end of fifth year of TD ST: five banks (20 percent of banking system assets) failed in U-shaped scenarios; two banks (7 percent of banking system assets) failed in V-shaped scenarios.
- Liquidity tests
  - Average LCR of G-7 banks stood at 208 percent by end-2015.
  - All G-7 banks had ample liquidity in domestic and foreign currency; some small banks faced FX liquidity needs.
  - In LCR 2010b test, banks below the 29 percent median ST LCR level represented 15 percent of system assets; a few small banks (~4 percent of total bank assets) had ST LCRs below 10 percent and 8 percent in LCR 2013 and LCR 2010b tests respectively.
- Interconnectedness and contagion
  - Interconnectedness risk appears manageable and affects mainly small firms.
  - Brokerage houses most affected but not systemic by size.
  - Direct exposures concentrated in securities holdings, FX transactions, deposits, loans, derivatives and repos.
  - Loss given default assumed equal to 100 percent of net uncollateralized exposure in contagion model.

### NON-BANK FINANCIAL INSTITUTIONS AND CORPORATE SECTOR STRESS
- Insurance companies
  - Portfolios diversified but sensitive to interest rate shocks; simultaneous shock scenario saw solvency ratios increase due to exchange rate gains offsetting valuation losses; isolating interest shock produced solvency declines with only two to four insurers facing shortfalls up to 3.7 percent of assets.
- Pension funds
  - Aggregate NAV could decline by 6 to 10 percent under simultaneous shocks (versus 16 percent during GFC); interest rate shocks largest contributor; pension funds less sensitive to liquidity risks; regulatory VaR adjustments and six-month regularization provide stability.
- Corporate sector
  - Largest 50 publicly listed corporations resilient to large shocks; sample market capitalization represented 34 percent of GDP and 30 percent of all corporate debt.
  - In worst-case no exchange rate hedging scenario: interest coverage ratio for six companies would fall below 1; their debts equal 6.6 percent of total corporate sector debt and about 1 percent of total bank loans; a default would raise gross corporate NPL ratio from 0.02 to 0.22 percentage point.

### SUPERVISION, GOVERNANCE, AND REGULATORY GAPS
- Progress since 2012 FSAP: adoption of risk-based framework, stricter limits on related party transactions, Basel III implementation (2013), special resolution regime for banks.
- Remaining gaps and governance issues
  - CNBV and IPAB lack operational independence, budget autonomy, and legal protection; board composition and appointment/dismissal processes lack fixed terms and safeguards.
  - CNBV Board: five out of 13 members directly appointed by SHCP and five indirectly under SHCP control; posts have no defined terms.
  - Budgetary constraints: CNBV budget approved by SHCP; salary freeze for over a decade causing high staff turnover and retention problems.
  - Legal gaps limit CNBV’s consolidated supervision powers and ability to assess groups and FHCs.
  - Securities market supervision: derivatives law for OTC not yet in place; CNBV staffing allocates less than 8 percent to securities market activities.
- Recommendations
  - Strengthen supervisory governance, prioritize safety and soundness, ensure independent boards with clear appointment/dismissal rules, and provide budgetary independence.
  - Integrate prudential supervision into a single Prudential Supervisor while strengthening independence protections.
  - Require IFRS adoption for banks and empower supervisor to require tax-deductible prudential provisions beyond IFRS 9 where warranted.

### PAYMENT SYSTEMS (SPEI) AND FINANCIAL MARKET INFRASTRUCTURES
- SPEI role and performance
  - Sistema de Pagos Electronicos Interbancario (SPEI) owned and operated by Banxico; central to payment and securities settlement; supports 15 payment types.
  - Payments volumes processed by SPEI grown by annual average rate of 32 percent over past five years.
  - In 2015, SPEI processed transactions equivalent to 10 times the country’s GDP.
- PFMI observance and improvements
  - SPEI largely observes the Principles for Financial Market Infrastructures (PFMI): well-founded legal basis, sound governance, comprehensive operational risk management, business continuity and information security aligned with commercial standards.
  - Areas for improvement: collateral haircut methodology under extreme conditions; establish participants’ formal consultation mechanism; articulate risk-based access requirements; procedures for suspension and orderly exit of participants.

### FINANCIAL STABILITY FRAMEWORK (CESF) AND MACROPRUDENTIAL ARRANGEMENTS
- CESF established by Presidential Decree in 2010 and law in 2014; includes SHCP, Banxico, and supervisors to identify risks and recommend policies.
- Shortcomings
  - CESF lacks powers to implement measures and relies on members; SHCP influence is strong with Minister chairing.
  - Macroprudential responsibilities and tool ownership not clearly assigned; instruments applied by various authorities based on mandates without a singular authority for execution.
- Recommendations
  - Assign CESF responsibility for monitoring and assessing systemic vulnerabilities and formulating macroprudential policy responses; enhance recommendation visibility and consider “comply or explain” approach; ensure decisions focused on financial stability and insulated from undue political considerations.

### DEPOSIT INSURANCE, IPAB FINDINGS, AND RECOMMENDATIONS
- Deposit insurance framework
  - Managed by IPAB; broadly conforms to best international practice as a loss minimizer with an ex ante fund and resolution authority.
  - Current coverage limit allows coverage of approximately 99 percent of depositors but only 55 percent of total deposits.
  - Current reserve level approximately 1 percent of insured liabilities (IPAB fund represents about 1 percent of insured deposits or 0.75 percent of all member banking liabilities).
  - By law 75 percent of IPAB’s premiums must go towards repayment of legacy debt (nominally MXN 800 billion).
- Governance and operational independence issues
  - Minister of SHCP chairs IPAB Board; no fixed term for Executive Director; quorum rules do not require independent members; salary and budget constraints limit independence.
  - IPAB has approximately 300 employees.
- Funding and resolution constraints
  - IPAB can issue government guaranteed debt up to 6 percent of its member institutions’ liabilities without formal executive approval.
  - No limit on IPAB’s contribution to recapitalization or restructuring of a systemic bank; funding priorities in systemic resolution not clearly defined.
  - Recommendation: transfer legacy debt to the government budget; cap IPAB’s contribution to systemic resolutions; devise workable resolution funding formula protecting deposit insurance fund.
- Operational preparedness
  - IPAB conducts simulation exercises annually since 2011 but has not prepared a system-wide contingency plan for systemic crises; IPAB lacks tested capability to reimburse a very large number of depositors in seven days.
  - Recommendation: complete system-wide contingency planning and simulation exercises; develop IPAB contingency plan for systemic institution failures.

### LEGAL, INSOLVENCY, AND CRISIS MANAGEMENT ISSUES
- Resolution and crisis management
  - 2014 reforms strengthened special bank resolution regime: clearer timeframes, clarified courts’ role, removal of resolution suspensions, expanded IPAB powers.
  - Enhancements needed: extend regime to FHCs; strengthen authorities’ power to require improvements to resolvability; enable purchase and assumption with third parties; develop systemic-determination guidelines; improve recovery plans quality and scope.
- Insolvency framework
  - 2014 Mercantile Law amendments: reduced influence of related parties in reorganization, procedural consolidation for large groups, debtor-initiated reorganization for imminent insolvency, first priority post-commencement financing.
  - Shortcomings: regime rarely used, enforcement of secured interests challenging, complexity discourages use, court-based enforcement remains the norm, judicial proceedings do not distinguish immovable vs movable collateral.
- Contingency planning
  - No formal system-wide contingency plan or system-wide simulation exercises; IPAB simulations exist but not system-wide.

### FINANCIAL SECTOR DEVELOPMENT, CAPITAL MARKETS, AND INCLUSION
- Depth and structure
  - Domestic capital markets: very liquid government bond market; shallow corporate debt and equity markets.
  - Equity markets amount to only 38 percent of GDP.
  - Mexico’s private sector credit to GDP ratio about 30 percent.
  - Only 29 percent of the poorest population have an account versus 50 percent average in Latin America.
- Market-deepening recommendations
  - Promote hybrid capital market instruments (private equity funds) for infrastructure financing.
  - Broaden debt instruments: infrastructure debt funds, covered bonds, standardized securitization bonds.
  - Use market and regulatory measures to increase corporate bond and equity market depth and liquidity.
- Development banks
  - DBs should focus on financial inclusion and crowding in private sector, ensure sustainable pricing, and graduate beneficiaries to private provision; consider coordination, service sharing, and mergers.

### SELECTED QUANTITATIVE INDICATORS (AS REPORTED)
- Financial sector assets: 90 percent of GDP (2015).
- Development banks: ~10 percent of financial sector assets (end-2015).
- Nonbank sector: 30 percent of financial sector assets.
- Sofomes: 1 percent of financial system assets.
- G-7 banks share of bank assets: ~80 percent.
- CAR (commercial banks, 2015): 15 percent.
- Foreign currency loans (2015): 13 percent of total loans.
- NPL ratio (2015): 2.6 percent.
- Returns on equity (last three years average): 17 percent.
- Households’ debt: about 15 percent of GDP (2015); Household Debt to GDP (June 2016): 16.0.
- Mutual funds AUM: 11 percent of GDP (2015).
- SPEI processed transactions equivalent to 10 times GDP (2015).
- Average LCR of G-7 banks (end-2015): 208 percent.
- Stress test horizon: five years (2016 Q1–2020 Q4).
- TD ST CAR failure threshold: 8 percent.
- IMF forecast selected series (IMF forecast, selected values):
  - IGAE (YoY growth rate) series (2016 Q1–2021 Q2): 2.53 2.48 2.26 2.33 2.50 2.57 2.64 2.69 2.75 2.80 2.83
  - Cete28 series: 3.41 3.75 4.00 4.25 4.50 4.75 5.00 5.25 5.25 5.50 6.00
  - Unemployment series: 4.05 4.05 4.05 4.05 3.90 3.90 3.90 3.90 3.83 3.83 3.83
  - Inflation series: 2.71 2.82 3.01 3.32 2.94 2.95 2.98 3.02 3.01 3.00 3.00
  - FX series (IMF forecast): 18.04 18.16 17.93 17.69 17.68 17.73 17.79 17.86 17.81 17.84 17.89
- U-shaped scenario selected series
  - IGAE (YoY) (2016 Q1–2018 Q4): 1.66 0.00 -1.18 -2.19 -2.64 -1.41 -0.87 -0.16 0.43 0.87 2.47
  - Exchange rate USD-MXN (2016 Q1–2018 Q4): 17.74 20.01 19.74 21.31 22.53 25.09 27.01 28.24 29.91 30.21 30.46
- V-shaped scenario selected series
  - IGAE (YoY) (2016 Q1–2018 Q4): 1.66 -3.24 -4.80 -5.69 -5.53 -0.39 2.42 4.55 3.95 3.05 3.07
  - Exchange rate USD-MXN (2016 Q1–2018 Q4): 17.74 20.63 22.81 24.09 26.04 26.04 26.49 27.78 28.53 28.37 28.37

*Source: IMF Financial Sector Assessment Program — Mexico (2016), document _cr16361.*

### 2016. More information on the FSAP may be found

### _cr16361 - 2016. More information on the FSAP may be found

### EXECUTIVE SUMMARY
- Mexico’s economic fundamentals are strong; medium-term outlook foresees steady growth underpinned by strong macroeconomic policies, broad reform initiatives, and relatively strong balance sheets.
- Key external risks: United States (U.S.) growth slowdown, lower oil prices, and volatility in global financial markets.
- Financial system resilience:
  - Solvency and liquidity stress tests of the banking system indicate it can withstand severe adverse macro-financial shocks despite large capital losses in some cases.
  - The insurance sector could endure a combination of interest rate, exchange rate, and equities market shocks.
  - Pension funds are exposed to market risk, but liquidity risks are lower.
  - Sensitivity analysis indicates large listed corporations could broadly cope with adverse exchange rate, earnings, and interest rate shocks.
- Prudential oversight progress and remaining governance gaps:
  - Significant progress in strengthening financial sector prudential oversight.
  - Important gaps persist in operational independence, budget autonomy, and legal protection.
  - A fully functioning consolidated supervision framework is not yet in place.
- Financial sector safety net:
  - Banxico’s liquidity operating framework is robust; liquidity regulation and emergency liquidity provision have been significantly upgraded since the last FSAP.
  - Deposit insurance broadly conforms to best international practice, but concerns include governance gaps, multiplicity of mandates, and small size of the ex-ante resolution fund.
- Resolution and crisis management:
  - Special bank resolution regime strengthened but requires enhancements (e.g., extend coverage to financial holding companies (FHC); ensure authorities’ power to require banks to improve their resolvability).
  - No formal contingency plan for dealing with a systemic crisis and no process for systemic crisis simulation exercises.
- Financial Stability Council (CESF):
  - Establishment was important; should be further developed to be the main forum for communicating stability assessments and assessing stability implications of policy instruments.
- Financial sector development challenges:
  - Access to finance and provision of long-term financing remain limited.
  - Credit to the private sector and households’ use of deposit accounts are low; new loan origination by commercial banks has remained sluggish; long-term financing is scarce.
  - Improvements to financial infrastructure could help (e.g., credit and collateral registry, insolvency enforcement).
- Development Banks (DBs):
  - Playing an increasingly important role in fostering financial inclusion.
  - Need to ensure sustainable involvement while avoiding market distortions and crowding out; use appropriate pricing policies and a process to graduate beneficiaries to private-sector provision.

### EXECUTIVE SUMMARY — KEY RECOMMENDATIONS (Table 1)
- Institutional Arrangements and Governance
  - Integrate all prudential supervision aimed at the safety and soundness of financial institutions, in one Prudential Supervisor, covering banks, securities, insurance firms, pension funds and other financial institutions. (Medium-Term)
  - Amend relevant laws to (a) clearly establish financial stability as the primary objective for the new supervisor, other objectives (e.g., development) are secondary and should be narrowly defined; and (b) strengthen the governance of the supervisor and IPAB (e.g., composition of governing boards and the appointment and dismissal of senior personnel) and ensure their supervisory and budgetary independence. (Medium-Term)
- Financial Stability Policy Framework
  - Establish more clearly the status of the CESF as the preeminent voice of its members regarding the assessment of financial stability risks. (Short-Term)
- Financial Sector Oversight
  - Adopt a consolidated supervision framework that corrects for legal gaps on the CNBV’s ability to perform consolidated supervision and strengthen the regulatory reporting framework for related party lending. (Short-Term)
  - Revise corporate governance of development banks in line with international best practices (board composition, mechanisms for election of CEOs). (Short-Term)
  - Enhance definitions of “common risk” and “related party”, including explicit definition of “economic dependency”, grouping loans collateralized by the same collateral, and explicit references to persons who exercise significant control. (Short-Term)
  - Review the role of Banxico in determining certain capital requirements; CNBV should assume sole responsibility for such functions. (Medium-Term)
  - Streamline regulation and supervision of “other financial institutions” to facilitate consolidation and integration. (Medium-Term)
- Deposits Insurance, Crisis Management, and Resolution
  - Transfer the legacy debt at IPAB to the sovereign balance sheet. (Medium-Term)
  - Adopt legislation removing bail out options for shareholders and subordinated debt holders of systemic banks. (Medium-Term)
  - Develop formal contingency plans and simulation exercises to deal with a systemic crisis. (Medium-Term)
- Development Banks
  - Revise strategy and objectives for development banks to include indicators of financial inclusion and private sector crowding-in, eliminating quantitative targets. (Short-Term)
- Pensions
  - Increase the contribution rates to fully funded pension schemes to ensure higher replacement rates and reduce fiscal risk. (Short-Term)
- Small and Medium-size Enterprise Finance
  - Create a credit registry to increase financial information available to lenders. (Medium-Term)

### BACKGROUND — A. Macro-financial Context
- Growth and inflation
  - Mexico’s economy grew, on average, by 2.5 percent per year since the last FSAP in 2012.
  - Growth is projected to average about 2.4 percent in 2016–20.
  - Core inflation close to the 3 percent target since 2011; headline inflation at target.
- External sector and buffers
  - Flexible Credit Line (FCL) arrangement renewed and extended to U.S. dollar 88 billion on May 27, 2016.
  - Level of FX reserves remains adequate according to standard measures.
  - By end-August 2016, nonresidents held a third of all domestic government debt securities, and 60 percent of Mbonos (fixed rate bonds).
- Fiscal and monetary policy
  - Multi-year fiscal consolidation program with the fiscal deficit (defined as public sector borrowing requirement) declining by 0.5 percentage points of gross domestic product (GDP) per year to 2.5 percent of GDP in 2018.
  - The free-floating peso is the main shock absorber; since mid-2014, the peso depreciated by close to 50 percent vis-à-vis the U.S. dollar.
- Reforms and balance sheets
  - Wide-ranging reform program launched in 2013–14 covering financial sector, energy, telecommunications, anti-trust, labor markets, taxes, and education.
  - Banking system holds large buffers; households’ debt is about 15 percent of GDP with significant positive net financial assets.
  - Debt maturity profile of large listed private corporations largely termed out; FX debt risks largely offset by natural and financial hedges.
  - Financial sector exposures to the housing market remain very limited.
- Key risks to the outlook
  - A U.S. growth slowdown would hurt Mexico through trade links and investor confidence, possibly leading to capital outflows.
  - A rise in protectionism in key export markets would have similar effects.
  - Lower growth would weaken bank and corporate balance sheets (rising non-performing loans; loss in value of fixed rate security holdings) and public finances (higher borrowing costs).
  - Increase in global financial market volatility could lead to capital outflows absent a deterioration in fundamentals.
  - Lower oil prices would weaken public finances and the current account balance.
  - All above shocks would tighten financial conditions and increase pressure on the exchange rate.

*Source: IMF Financial Sector Assessment Program — Mexico (2016).*

### 4.      Mexico’s financial sector is bank dominated and relatively small compared with other

### _cr16361 - 4.      Mexico’s financial sector is bank dominated and relatively small compared with other

### Financial sector structure
- Financial sector assets amounted to 90 percent of GDP in 2015, with over half being commercial banking assets.
- Development banks activities have grown rapidly since the 2014 reforms reaching around 10 percent of financial sector assets by end-2015.
- The nonbank sector accounts for 30 percent of financial sector assets (pension funds, mutual funds, and insurance companies).
- Other financial intermediaries—brokerage firms, regulated and unregulated non-deposit-taking financial institutions (sofomes), savings and credit institutions, and deposit warehouses—are small but important for microfinance and financial inclusion.
  - Sofomes account for only 1 percent of the financial system assets.
- The seven largest banks (G-7), all fully owned by financial groups, account for about 80 percent of total bank assets.
- Bank deposit concentration: the share of deposits by the largest depositors averages 14 percent of total deposits in G-7 banks, and is as high as 34 percent in one bank.
  - Large depositors are defined as depositors with more than MXN 200 million in deposit accounts or that represent 0.5 percent of a bank’s total liabilities.
- Five of the G-7 banks are foreign subsidiaries and account for about 65 percent of commercial banks’ assets.
- A memorandum of understanding (“Convenio de Responsabilidad”), included in the 2014 financial group law, assigns the holding (FHC) unlimited responsibility for the obligations of each group company and regulates financial transactions between parent and subsidiary, with substantive funding repatriation subjected to authorities’ approval and compliance with domestic regulations.

### Financial system soundness — banks and DBs
- Commercial banks (end-2015):
  - Total capital adequacy ratio (CAR) stood at 15 percent.
  - Liquid assets were about a third of total assets (around 35 percent of short-term liabilities).
  - In September 2015, all banks had met the minimum 60 percent liquidity coverage ratio (LCR) requirement, with a large number exceeding the 100 percent requirement that will apply from 2019 on.
  - Foreign currency loans accounted for only 13 percent of total loans in 2015.
  - Ratio of net open position in FX to Tier 1 capital was -0.2 percent.
  - NPL to total loans ratio declined from 3.2 percent in 2013 to 2.6 percent in 2015.
  - Returns on equity averaged 17 percent over the last three years; lending-deposit spread around 10 percentage points.
- Development banks (DBs) (by end-2015):
  - CAR at 14.1 percent.
  - Liquid assets to liquid liabilities ratio about 120 percent.
  - NPLs have remained below 2 percent since 2010.
  - Provisions cover about 260 percent of NPLs.

### Non-banking financial sector: strengths and challenges
- Pension funds (SIEFOREs):
  - Investment limits set by CONSAR; market and credit exposures well managed.
  - Projected replacement rates under the fully funded scheme appear insufficient.
  - The transition rule is to generate an abrupt reduction in the pension replacement rates of about 50 percent.
  - Initial calculations suggest expected replacement rates offered by the funded pension scheme range from 28 to 34 percent, but 80–100 percent under IMSS and ISSSTE pay-as-you-go scheme.
- Mutual funds:
  - Assets under management grew from 5 percent of GDP in 2005 to 11 percent of GDP in 2015.
  - Highly concentrated in short-term sovereign and IPAB securities and exposed to redemption risks.
  - Client redemptions during the 2008 GFC caused substantial withdrawals; subsequent net outflows observed (smaller than 2008).
  - “Circuit-breaker” mechanisms were adopted after the 2008 crisis to manage liquidity during stress.
- Insurance companies (2015):
  - Minimum capital guarantee coverage ratio (MCGCR) about 1.9 times.
  - Technical reserve coverage ratio stands at 1.1 times.
  - Return on equity is 14 percent.
  - Liquid assets to current liabilities ratio stands at 3.5.
  - New regulations require Solvency II-type risk-based capital and mark-to-market valuation of assets and liabilities.

### Household, corporate, and sovereign leverage
- Households:
  - Bank lending to households accounts for 37 percent of total loans.
  - 60 percent of household lending are non-revolving personal loans and credit cards; remaining are housing loans.
  - Credit card and non-revolving personal loans grew at a compounded annual rate of 15 percent over the last five years; housing loans grew at 12 percent compounded annual growth rate.
  - Household leverage rose from 13 percent of GDP in 2008 to 15 percent of GDP in 2015.
- Corporates:
  - Corporate leverage of the largest 50 traded companies has increased but is moderate at the aggregate level relative to other EMs.
  - Foreign currency debt accounts for about half of total debt for the largest 50 companies.
  - Foreign currency revenue accounts for about 30 percent of total revenue for the largest 50 companies on average.
  - Most companies use plain vanilla derivatives to hedge foreign currency bonds and project financing debts; some use short-term 6 to 12-month currency forwards.
  - Commodity-related corporations (e.g., mining, PEMEX suppliers) are vulnerable; bank exposure to the sector is 6 percent of total loans and gross sectoral NPL ratio is 0.1 percent.
- Sovereign debt holdings:
  - Nonresidents, pension funds, and mutual funds hold large shares of local currency sovereign debt.
  - Commercial banks’ holdings of government bonds are large relative to their balance sheet but less than 5 percent of the sovereign debt portfolio.
  - In the event of a sharp capital flow reversal, residents would have limited room to absorb significant amounts of debt securities.
  - Authorities’ tools in a tail event include discretionary foreign exchange interventions, targeted liquidity provision, and debt duration management.

### Challenges ahead and reform agenda
- Integration and market presence:
  - Mexico’s financial sector is rapidly integrating into the global financial system; the peso is the tenth most traded currency and the first among emerging markets.
  - Mexican sovereign instruments are included in major sovereign bond indexes (e.g., WGBI, JP Morgan’s Government bond EM index), encouraging nonresident participation in the peso-denominated sovereign debt market (surged after 2010).
- 2014 financial deepening reform objectives (four pillars):
  - (a) increase competition by inhibiting anti-competitive practices;
  - (b) encourage credit through development banks by strengthening their legal framework, objective and operating capacity;
  - (c) expand credit through private financial institutions by enabling more systematic evaluation of commercial bank credit and more efficient channeling towards productive activities;
  - (d) maintain a stable and solid financial system.
- Reform outcomes and measures:
  - Strengthened banking sector buffers and adopted a resolution and liquidation framework.
  - Gave a more proactive role to development banks in credit allocation and enhanced protection of financial service consumers.

### Financial sector resilience — stress testing and interconnectedness
- Stress test framework:
  - Banxico and CNBV conducted bottom up (BU) and top down (TD) stress tests covering at least 80 percent of commercial banks’ assets.
  - Tests used two adverse macroeconomic scenarios over a five-year horizon during 2016 Q–2020 Q4: (i) a V-shaped scenario resembling the 2008–09 crisis; (ii) a U-shaped protracted recession with a slower recovery.
  - Liquidity stress tests based on the LCR framework (Basel III).
  - Interconnectedness risk analysis focused on direct exposures between banks and nonbank financial institutions as the main contagion channel.
- Solvency test results:
  - Large commercial banks remained adequately capitalized in the BU ST (above the 8 percent minimum regulatory capital requirement applied to total capital).
  - No large commercial bank failed the TD ST.
  - A protracted recession (U-shaped) is more damaging than a V-shaped recession; impacts were partly offset by higher net interest rate margins and loan portfolio rebalancing consistent with scenario credit growth assumptions.

*INTERNATIONAL MONETARY FUND*

### 17.      Large commercial banks remained adequately capitalized in the BU ST, and no large

### _cr16361 - 17.      Large commercial banks remained adequately capitalized in the BU ST, and no large

### Capital Adequacy and Top-Down (TD) / Bottom-Up (BU) Stress Tests
- Large commercial banks remained adequately capitalized in the BU ST; no large commercial bank failed the TD ST, despite large capital losses in some cases.
- Higher probability of defaults (PDs) led to higher credit losses and associated loss reserves, reducing banks’ ability to generate earnings and affecting ROE and ROA negatively.
- The fall in earnings was offset by higher interest margins; initial high levels of CARs helped banks withstand shocks.
- The BU ST allowed dynamic rebalancing of balance sheets, reducing credit exposures and corresponding risk-weighted assets (RWAs), which helped support CARs.
- Keeping the balance sheet static (not allowing banks to reduce exposures) could reduce CARs by as much as 1¼ percentage points.
- Initially, the BU ST set risk weights (RW) for different asset classes constant. Adjusting RWs to reflect changes in PDs of banks’ loan portfolios could reduce the system CAR by as much as 6 percentage points and caused one of the G-7 banks to fail, with its CAR falling to a low of 7¼ percent.
- TD system-wide results were driven by the good performance of the G-7 banks; none of the G-7 banks failed the ST whether CAR calculations assumed fixed or PD-adjusted RWs.
- Small commercial banks suffered larger CAR declines in the TD STs. Although no bank failed in either scenario, some banks’ capital requirements to total capital declined by more than 30 percent at the end of the third year of the TD ST.
- By the end of the fifth year of the ST:
  - Five banks (20 percent of the banking system assets) failed in the U-shaped set of scenarios.
  - Two banks (7 percent of banking system assets) failed in the V-shaped set of scenarios.
- Five-year results are subject to high uncertainty and counterintuitive behavior of PDs in the TD ST scenarios beyond the three-year horizon.

### Liquidity Tests
- All G-7 banks enjoyed ample liquidity in domestic currency and foreign currency, but some small banks appeared to face foreign currency liquidity needs.
- The ST LCRs of the G-7 banks met (or exceeded) the regulatory threshold (Annex I, Table 3) even when applying the LCR 2010 test with a 10 percent run-off rate on stable deposits (instead of the standard 5 percent run-off rate).
- The banking system also performed well when inflows and outflows were consolidated across all significant currencies.
- A few small banks (about 4 percent of total bank assets) had ST LCRs that fell below 10 percent and 8 percent in the LCR 2013 and LCR 2010b tests respectively.
- In the LCR 2010b test, banks below the 29 percent median ST LCR level represented 15 percent of the system’s assets.
- The average liquidity coverage ratio (LCR) of G-7 banks stood at 208 percent by end-2015.
- HQLAs deposited abroad, ample domestic currency liquidity, and deep and liquid FX markets in Mexico would further expand buffers to meet FX-denominated obligations in case of stress.

### Interconnectedness Risk
- Interconnectedness risk appears manageable, affecting only small firms.
- The exercise encompassed a broad sample of firms and direct exposures (Annex I, subsection B).
- Brokerage houses appeared most affected though their size is relatively small and they are not considered sources of systemic risk.
- During 2015, banks and brokerage houses’ assets breaching regulatory minimum standards fluctuated from a low 4½ percent of their total assets to a high 8 percent of total assets.
- The affected banks were small, each holding on average about ½ percent of assets in the system.
- Reduction in interconnectedness risk (versus a record high of 20 percent of assets in 2008–09) is partly explained by banks’ lower exposures to foreign financial institutions in response to stricter regulatory limits on net open positions in foreign currency.

### Development Banks
- The three largest development banks could withstand adverse shocks.
- Under the two V- and U-shaped scenarios, the CNBV’s BU ST found their CARs remained above the 8 percent regulatory minimum total capital.
- One development bank would see its CAR fall below 10½ percent, the regulatory level prompting regulatory intervention.
- Authorities’ policy: in event of capital shortages, redistribute excess capital in development banks at the aggregate to ensure all individual banks comply with regulation (the burden-sharing mechanism has been used in the past).

### Non-Banking Financial Institutions: Insurance Companies and Pension Funds
- Insurance companies and pension funds could endure a number of large market shocks; they are heavily invested in debt instruments, equities, and foreign exchange securities.
- Sensitivity analyses covered the ten largest insurance companies (about 80 percent of total insurance assets) and 73 pension funds covering all assets under management.
- Analyses found these institutions and funds to be resilient to market shocks (single shocks on interest rate, exchange rate, and equity market, as well as combined shocks) albeit with pockets of vulnerability.
- Regulatory mechanisms in place should prevent forced selling during volatile market conditions.

Insurance companies
- Investment portfolios were well diversified and generally resilient to market risks, but sensitive to interest rate shocks.
- Under the simultaneous shock scenario, solvency ratios increased because revaluation losses in mark-to-market securities were largely offset by exchange rate gains from a peso depreciation.
- Isolating the interest shock, solvency ratios were projected to decline due to relatively large holdings of fixed income peso denominated securities.
- Even then, only two to four insurers were found to face shortfalls of up to 3.7 percent of assets; these shortfalls could be corrected by rebalancing the portfolio towards lower risk assets or re-insuring liabilities.

Pension funds
- Performance appeared aligned with risk tolerance, but aggregate net asset value (NAV) could decline to close to the 2007–08 crisis levels.
- If all shocks materialized simultaneously, aggregate NAV could decline by 6 to 10 percent, compared to the 16 percent decline during the GFC.
- Interest rate shocks caused the largest NAV decline; FX depreciation gains on FX-denominated assets offset part of the decline.
- Pension funds were found to be less sensitive to liquidity risks.
- Under current legislation, pension fund managers are not obliged to sell assets in volatile times; regulatory VaR confidence level adjusts automatically, and there is a six-month regularization period to restore compliance.
- Market-to-market losses are unrealized unless shocks are permanent and assets are sold.
- System improvements recommended include adopting a long-term strategic benchmark-based approach favoring stable long-term investment strategies.

### Corporate Sector
- The largest 50 publicly listed corporations displayed resilience to large shocks; spillovers to the banking sector appeared low.
- The sample’s market capitalization represented 34 percent of GDP and 30 percent of all corporate debt.
- Three alternative corporate hedging scenarios were considered: (i) “natural” hedging; (ii) “natural” and financial hedging; and (iii) no hedging.
- Shocks to the exchange rate and interest rate were severe. In a worst-case scenario of no exchange rate hedging:
  - Interest coverage ratio for six companies would fall below 1, implying possible difficulties servicing debt interest payments on time.
  - Their debts account for 6.6 percent of total corporate sector debt and about 1 percent of total bank loans.
  - A default would translate into a small increase in the gross corporate NPL ratio (from 0.02 to 0.22 percentage point).

### Micro- and Macro-Prudential Oversight: Progress and Gaps
- Significant progress since the 2012 FSAP in strengthening prudential oversight, but important gaps remain, including lack of progress in strengthening governance arrangements of supervisory agencies and IPAB.
- No progress on governance framework of supervisory agencies since last FSAP: CNBV and IPAB lack operational independence, budget autonomy, and legal protection, and are encumbered with multiple mandates.
- Specific governance issues:
  - CNBV Board members are ex-officio; five out of 13 CNBV Board members are directly appointed by the SHCP and five are indirectly under SHCP control. Posts have no defined terms; reasons for dismissal of board members or the president are not clearly specified.
  - CNBV lacks autonomy on its budget, which is approved by the SHCP and subject to federal fiscal measures. A salary freeze has been in place for well over a decade, resulting in unusually high staff turnover.
  - Legal protection framework for supervisors is limited and does not provide statutory immunity for lawful performance of duties.
  - Agencies’ focus on financial stability is diluted by multiple objectives including developmental and consumer protection responsibilities.
- Recommendations:
  - Strengthen supervisory governance to prioritize safety and soundness as the primary mandate; other mandates should be secondary and narrowly defined.
  - Governance boards should be composed of independent members with clear rules and processes for appointment and dismissal.
  - Supervisor should have capability to use tools needed to ensure stability: licensing, on-site inspections, off-site monitoring, sanctioning and enforcement.
  - Budgetary independence is important to plan budgets, allocate resources, and ensure staff adequacy and quality.
  - Consider integrating all prudential supervision into one Prudential Supervisor covering banks, securities, insurance firms, pension funds and other financial institutions to improve consolidated supervision and reduce regulatory arbitrage.
  - Any move to integrate should be accompanied by strengthening CNBV’s independence.

### Banking Supervision and Regulatory Gaps
- Since the last FSAP, significant improvements: adoption of risk-based framework, stricter limits on related party transactions, Basel III implementation in 2013, and adoption of a special resolution regime for banks.
- Remaining gaps:
  - Corporate governance rules for banks; definitions of large exposure, common risk and related parties; liquidity rules for development banks.
  - Role of Banxico in determining certain capital requirements should be reviewed; CNBV should assume sole responsibility for these functions.
  - Further improvements needed in risk-based supervision, including updating risk assessment and rating system.
  - Gaps in legal framework limit CNBV’s ability to perform effective consolidated supervision, hindering assessment of banks as part of holding companies.
  - If tail risks identified in stress test (RAM in Table 5) materialize, contagion effects throughout groups may not be detected early due to lagging inter-agency cooperation.
  - Accounting and auditing framework should be strengthened by requiring banks to adopt IFRS (in line with other listed companies) with accompanying powers for supervisor to ask for tax deductible prudential provisions beyond IFRS 9 (IAS 39) requirements.

### Securities Supervision and Capacity Constraints
- 2014 reforms introduced new securities regulations and supervisory powers to CNBV, except in derivative markets.
- Derivatives market regulation relies on general provisions encompassing SHCP, Banxico and CNBV; a law for OTC derivatives is not yet in place, which could impair CNBV enforcement.
- CNBV to formally start applying strengthened risk-based supervision in securities for intermediaries in 2017.
- Risk-based supervision work (with World Bank support) to cover: (i) an institutional report on surveillance activities; (ii) a risk matrix and risk-based supervision procedures; and (iii) grading to signal importance of findings.
- CNBV enhanced public disclosures (obligation to disclose administrative sanctions via its Webpage), but internal regulatory process, top priorities for 2016, and 2014–18 strategic plan and targets have not been formally shared with market participants.
- Staffing constraints could impair implementation of improvements and new instruments:
  - CNBV allocates less than 8 percent of its staff to securities markets’ activities.
  - Retention of qualified experienced staff, particularly at senior levels, is challenging due to wages frozen for over a decade.
  - Lack of oversight capacity is a major risk.

### Payment Systems: SPEI
- Assessment focused on Sistema de Pagos Electronicos Interbancario (SPEI).
- SPEI is central to Mexico’s payment and securities settlement infrastructure, processing large-value and retail payments and supporting 15 different types of payments.
- SPEI began operations in 2004 and is owned and operated by Banxico.
- Payments volumes processed by SPEI have been growing by an annual average rate of 32 percent over the past five years.
- In 2015, SPEI processed transactions for the equivalent of 10 times the country’s GDP.

*Source: IMF staff summary of the content unit provided.*

### 37.      SPEI largely observes the Principles for Financial Market Infrastructures (PFMI), but

### 37.      SPEI largely observes the Principles for Financial Market Infrastructures (PFMI), but

### SPEI and PFMI observance
- SPEI is supported by well-founded legal basis and sound governance arrangements.
- Comprehensive risk management approach with emphasis on operational risk management.
- Business continuity and information security policies aligned with internationally-accepted commercial standards.
- Areas for improvement:
  - Strengthen the collateral haircut methodology in extreme market conditions.
  - Enhance transparency by establishing participants’ formal consultation mechanism.
  - Articulate risk-based access requirements.
  - Establish specific procedures for facilitating the suspension and orderly exit of a participant that breaches, or no longer meet, these requirements.

### Financial Stability and Macroprudential Framework
- Mexico moving towards a system-wide approach to identification and mitigation of financial stability risks.
- Financial System Stability Council (CESF):
  - Established by Presidential Decree in 2010 and law in 2014.
  - Brings together the SHCP, Banxico, and other financial sector supervisors to identify and analyze potential risks and recommend policies, including macroprudential policies.
  - CESF does not have powers to implement measures; relies on its members.
  - SHCP, with the Minister chairing, has strong influence in proceedings.
- Shortcomings:
  - Macro-prudential policy framework does not clearly assign responsibility for identification and mitigation of potential systemic risks.
  - Macro-prudential instruments have been applied by various authorities based on legal mandates without a clearly assigned authority to prepare and execute macroprudential policy.
- Effectiveness of arrangements:
  - CESF strengthened coordination and collaboration on risk identification and assessment.
  - Less effective in policy formulation; public statements and press releases provide limited insight into deliberations and precise recommendations.
  - Overlap and multiplicity of communication channels (e.g., CESF Annual Report vs. Banxico Annual Financial System Report and SCHP Quarterly Reports) can affect clarity of the message.
- Recommendations to strengthen CESF:
  - Assign CESF responsibility for monitoring and assessing emerging systemic vulnerabilities and formulating macroprudential policy response, without necessarily controlling tools directly.
  - Enhance recommendations to tool-owning authorities, make recommendations public, and in some cases adopt a “comply or explain” approach.
  - Ensure decisions are taken purely on grounds that contribute towards ensuring financial stability and provide greater assurances against undue political considerations.

### Financial Sector Safety Nets and Crisis Management — Liquidity Framework
- Measures in place to reduce likelihood of liquidity stress and deal with it.
- Banxico:
  - Maintains extensive database of financial exposures and conducts monthly network analysis.
  - Assessed systemic liquidity risks across Banxico’s liquidity management; liquidity regulation applied to banks and emergency liquidity assistance; short-term money markets; mutual funds; government securities markets; and the foreign exchange market.
  - Liquidity operating framework in normal times supports efficient pricing and distribution of liquidity; banks have certainty about day-to-day liquidity and access to a collateralized overdraft for operational problems.
  - Collateral pressure could arise due to increasing demands on HQLA and high foreign ownership of government securities.
  - Recommendation: Banxico could consider broadening the collateral framework to mitigate increased financial risks through higher haircuts.
- Liquidity regulation and emergency liquidity provision upgrades:
  - (a) Mexico is implementing the LCR in line with the internationally agreed timetable. In 2016, the required compliance is 70 percent; all major banks and most banks are above 100 percent. It is expected that the LCR will eventually be applied in foreign currency but for the moment they remain subject to a stringent foreign currency liquidity metric. Banks must also provide annually, a Liquidity Contingency Plan to the CNBV, detailing the sources of funding and procedures for dealing with liquidity stress.
  - (b) Banxico’s contingent liquidity arrangements upgraded since last FSAP and include:
    - Standing Additional Ordinary Liquidity Facility: automatic once requested, provided against a broader range of collateral and can be rolled over on a daily basis.
    - Emergence Liquidity Assistance Facility (ELA): internal protocols established with no public commitment to provide ELA; assistance assessed and provided case-by-case to minimize moral hazard.

### Deposit Insurance
- Managed by IPAB; framework broadly conforms to best international practice.
- Coverage:
  - Current limit allows for coverage of approximately 99 percent of depositors but only 55 percent of total deposits in the system.
- IPAB capabilities and issues:
  - IPAB is also the resolution authority and cooperates closely with other safety net members.
  - 2014 Banking Act amendments gave IPAB greater powers to manage deposit insurance and resolution functions.
  - IPAB has authority to issue government guaranteed debt to the markets up to 6 percent of its member institutions’ liabilities without formal executive approval.
  - Effectiveness undermined by multiple mandates and limited resources.
  - Current reserve level for the deposit insurance fund approximately 1 percent of insured liabilities.
  - IPAB’s priorities in case of funding needs for resolution of a systemic bank or payment of insured depositors in a small or medium bank are not clearly defined.
- Recommendations:
  - Transfer legacy debt to the government’s budget.
  - Find a workable resolution funding formula that protects IPAB's deposit insurance fund from depletion by resolution funding for systemic banks.

### Resolution and Crisis Management Framework
- Improvements since last FSAP:
  - 2014 financial sector reform strengthened special bank resolution regime with clear and shorter timeframes, clarified role of courts, removed resolution action suspensions, and expanded IPAB’s powers.
- Remaining enhancements needed:
  - Extend the special resolution regime to cover the FHCs.
  - Strengthen authorities’ power to require banks to make changes to improve resolvability (e.g., issuance of loss-absorbing capacity tools).
  - Enable conduct of purchase and assumption transactions with third parties.
  - Develop guidelines for systemic determinations.
  - Clarify internal guidelines on timely entry into the resolution process to avoid delays.
  - Improve quality and scope of banks’ recovery plans.
  - Address lack of specific provisions for conglomerates on prevention, management, and resolution to avoid increased crisis costs.

### Contingency Plans and Insolvency Proceedings
- Contingency planning:
  - No formal contingency plan for systemic crisis.
  - No system-wide systemic simulation exercise to assess authorities’ ability to deal with a systemic crisis.
  - IPAB undertakes its own simulation exercises but regular system-wide crisis simulation exercises are absent.
  - Recommendation: Pursue systemic crisis contingency planning and simulation exercises as part of normal business practice.
- Insolvency framework:
  - 2014 amendments to the Mercantile Law (“Ley de Concursos Mercantiles”) introduced reforms: reduced influence of related parties in voting on reorganization plans; procedural consolidation of large corporate groups in insolvency; filing of reorganization by debtors in cases of imminent insolvency; and first priority post-commencement financing for distressed businesses.
  - Shortcomings:
    - Insolvency regime does not support preserving going-concern value and is rarely used.
    - Enforcement of secured interests remains a challenge.
    - Regime is complex and discourages use of insolvency proceedings; creditor committees and creditor meetings are virtually non-existent.
    - Court-based enforcement remains the norm despite addition of out-of-court enforcement remedies for security interests in deposit accounts.
    - Judicial proceedings still do not differentiate between immovable and movable collateral.

### Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT)
- Coexistence of a sophisticated financial sector and a large cash-based informal sector could pose significant implementation challenges.
- IMF will conduct an AML/CFT assessment of Mexico during February/March 2017.

### Financial Sector Development Priorities
- Access to finance and long-term financing remain primary challenges for a large segment of the economy.
- Key statistics and comparisons:
  - Mexico’s private sector credit to GDP ratio is just about 30 percent.
  - Only 29 percent of the poorest Mexican population have an account, compared to an average of 50 percent in Latin America.
- Financial inclusion and development bank (DB) role:
  - Efforts focus on enhancing DBs to expand credit and financial services, particularly to SMEs and public infrastructures, through first and second tier lending and guarantees and establishing quantitative credit targets.
  - Development bank involvement should be sustainable and avoid market distortions by:
    - Focusing on financial inclusion and crowding in the private sector.
    - Ensuring sustainability when pricing programs.
    - Gradually phasing-out support for beneficiaries who can be served by the private sector.
    - Exploring coordination opportunities, service sharing, and merging institutions.
- Financial infrastructure improvements:
  - Reforms introduced to credit information, insolvency framework, and enforcement of mobile guarantees.
  - Further actions needed to make the movable collateral registry fully operational and to test the new framework.
  - Creation of a credit registry would facilitate entrance of firms that exploit credit information.
- Infrastructure financing:
  - Regulatory framework and policies could be enhanced to mobilize resources and broaden investor base.
  - Recommendations: introduce more flexible instruments such as infrastructure debt funds; broaden investor base; emphasize guarantees by development banks instead of direct lending; promote off-loading of mature infrastructure assets of SOFIs.
- Pension system sustainability:
  - Current contribution rates for IMSS workers are significantly below OECD countries’ prevailing levels.
  - Recommendation: impose a sunset clause on accumulation of defined benefits, in line with OECD recommendations, to smooth replacement rate trajectory, reduce fiscal deficits from the transition generation, and provide funding for universal pension rights (pending Senate approval).
  - Annuity market: four players with two holding three quarters market share; new entrants would increase competition and sustainability.

*Source: _cr16361 - 37.      SPEI largely observes the Principles for Financial Market Infrastructures (PFMI), but*

### 60.      Domestic capital markets are unevenly developed with a very liquid government bond

### Domestic capital markets are unevenly developed with a very liquid government bond market but shallow corporate debt and equity markets

### Capital markets structure and functioning
- Government bond markets are deep and well-diversified in terms of range of instruments and maturities, providing liquidity in all relevant benchmarks.
- The strong presence of foreigners supported the yield curve lengthening and secondary market liquidity.
- Corporate equity and bond markets are small, expensive, and illiquid, and therefore not a reliable source of long-term financing.
- Equity markets amount to only 38 percent of GDP and are less dynamic than in peer countries; they are tilted towards large enterprises and family owned corporations.
- Development of hybrid capital market instruments via private equity funds could provide a promising venue for mature infrastructure investments.
- There is significant scope to broaden existing debt instruments to include infrastructure debt funds, covered bonds, and standardized securitization bonds to appeal to a larger range of private sector investors.

### Policy recommendations and market-deepening measures
- Promote the development of hybrid capital market instruments (for example, via private equity funds) to channel long-term financing into infrastructure.
- Broaden the menu of debt instruments to include:
  - infrastructure debt funds;
  - covered bonds;
  - standardized securitization bonds.
- Use market and regulatory measures to increase corporate bond and equity market depth and liquidity, thereby reducing cost of long-term private financing and crowding-in private investors.

### Stress testing framework, scenarios, and key modeling features
- Two main authorities conducted stress tests:
  - CNBV conducted Bottom-Up Stress Tests (BU ST) for the seven largest commercial banks.
  - Banxico conducted Top-Down Stress Tests (TD ST) for the largest twenty-one banks in the system.
- Failure criterion in the TD ST: a bank fails the test if its capital adequacy ratio (CAR) falls below 8 percent.
- Scenario design and horizon:
  - Scenarios covered the period 2016 Q1–2020 Q4 (generated using a VAR specification).
  - Stress test horizon: five years.
  - Two sets of simulated negative macroeconomic scenarios:
    - V-shaped scenario set (short-lived adverse conditions; rapid recovery; average severity resembled the 2008–09 financial crisis).
    - U-shaped scenario set (protracted recession; initial shocks less severe but recovery slower).
  - BU ST used two scenarios corresponding to the average scenario from the U-shaped and V-shaped sets.
  - TD ST used a probabilistic approach in which a bank’s CAR was calculated for each single scenario in the set.
- Variables included in scenarios:
  - Domestic: exchange rate, rate of the 28-day Cetes, Mexican stock index (IPC), domestic index of economic activity (IGAE), consumer price index (CPI), commercial bank credit, unemployment rate.
  - International: U.S. industrial production index, West Texas Intermediate oil price, U.S. three-month Treasury bill yield, U.S. 10-year Treasury bond yield, VIX, Dow Jones Industrial Average index.
- Modeling of risk parameters:
  - Probability of Default (PD) and Loss Given Default (LGD) were modeled as functions of macroeconomic and financial variables.
  - BU ST: latent factor function of scenario variables served as explanatory variable for bank- and loan-specific risk parameter models.
  - TD ST: ARIMA models (including own lagged values and scenario variables) generated PD projections by loan category; LGD linked to the level of PD using an explicit LGD model.
  - CAR adjustments: although fixed risk-weights were assumed, the CAR was adjusted to account for changes in assets’ PDs by multiplying the unadjusted CAR by the ratio of required capital computed with end-quarter bank-weighted PDs to required capital computed with end-December 2015 bank-weighted PDs (required capital calculated using the asymptotic single risk factor approach proposed by Basel).

### Selected quantitative facts and indicators (as reported)
- Equity markets amount to only 38 percent of GDP.
- Stress test scenario period: 2016 Q1–2020 Q4.
- Stress test horizon: five years.
- CAR failure threshold in TD ST: 8 percent.
- Table 2 headline indicators (selected):
  - GDP per capita (U.S. dollars, 2015): 9,452
  - Poverty headcount ratio (% of population, 2014) 1/: 46.2
  - Population (millions, 2015): 121.0
  - Life expectancy at birth (years, 2015): 74.9
  - Infant mortality rate (per thousand, 2015): 12.0
- Banking sector soundness indicators (selected):
  - Regulatory capital to risk-weighted assets (2015): 15.0
  - Regulatory Tier 1 capital to risk-weighted assets (2015): 13.3
  - Nonperforming loans to total gross loans (2015): 2.6
  - Return on assets (2015): 1.6
  - Household Debt to GDP (June 2016): 16.0

*Source: IMF staff report excerpt.*

### Annex Table 1. Banking Stress Test Matrix (continued)

### Annex Table 1. Banking Stress Test Matrix (continued)

### Tail shocks — Scenario analysis
- Scenario-based tests assess impacts on the entire portfolio including the loans and, if applicable, the trading book, in both the TD and BU exercises.
- TD ST uses a set of simulated adverse scenarios, and a set of simulated severely adverse scenarios; shocks are consistent with values observed in past stress episodes (e.g. 1994, 1998, and 2008).
- Each set of scenarios will comprise 2000 scenarios.
- Scenario generation:
  - The two sets of scenarios will be generated using the central bank VAR macro model used in its stress tests, upon specifying shocks to the baseline.
- Domestic macro-financial variables include:
  - the global economic activity indicator, inflation, unemployment, the 28-day Cetes rate, the exchange rate, and the domestic stock index.
- Foreign macro-financial variables include:
  - the USD short and long-term rates, U.S. industrial production, oil prices, the Dow-Jones index, and the VIX index.
- BU ST severe and severely adverse scenarios:
  - The severe and severely adverse scenarios in the BU ST will be set equal to the average scenario realization from the set of TD ST severe and severely adverse scenarios respectively.

### Tail shocks — Sensitivity analysis
- Sensitivity analyses conducted in the BU and TD exercises evaluate:
  - domestic shocks: direct effects of interest rate shocks;
  - interest rate shock on credit quality;
  - direct and indirect effects of exchange rate shocks;
  - a decline in oil prices;
  - a decline in the prices of sovereign securities;
  - an external credit-rating downgrade.

### Risks and Buffers
- Risks/factors assessed (how each element is derived, assumptions):
  - Credit risk on the banking book and trading book.
  - Market risk and sovereign losses: direct effects of interest rate shocks; direct effects of exchange rate shocks; shocks to sovereign yields.
  - Credit losses.
  - Losses from bonds and money market instruments (sovereign and other issuers) in the banking and trading books.
  - Funding costs.
  - Market risk, including FX risk.
- Behavioral adjustments:
  - Static balance sheet assumption.
  - Balance sheet growth conditional on economic scenarios.
  - No capital injections or changes in bank strategies.
  - No dividend payments by banks that remain adequately capitalized.

### Regulatory and Market-Based Standards and Parameters
- Regulatory standards referenced:
  - Basel III standards (revision as of January 2013). See Committee on Banking Supervision (2013), "Basel III: The LCR and liquidity monitoring tools,” Basel, January 2013.
  - Basel III standards (revision as of January 2013). See Committee on Banking Supervision (2013), "Basel III: The LCR and liquidity monitoring tools,” Basel, January 2013.

### Reporting Format for Results — Liquidity outputs
- Output presentation:
  - Liquidity gap by bank and by currency, aggregated.
  - Survival period in days by bank, number of banks that can still meet their obligations.
  - (Repeated items in source: Liquidity gap by bank and by currency, aggregated; Survival period in days by bank, number of banks that can still meet their obligations.)

### Banking Sector: Contagion Risk — Institutional perimeter and data
- Institutions included:
  - Commercial banks
  - Brokerage firms
  - Siefores
  - Mutual funds
  - Foreign financial intermediaries
- Market share:
  - > 80 percent of total banking sector assets.
- Data and baseline date:
  - Latest data: End December 2015.
  - Source: supervisory data.
  - Scope of consolidation: perimeter of individual banks.

### Channels of Risk Propagation — Methodology
- Methodology:
  - Network interbank model (Central Bank).

### Contagion tail shocks and outputs
- Size of the shock:
  - Pure contagion: default of institutions.
- Reporting format for results — Output presentation:
  - Number of undercapitalized and failed institutions, and their shares of assets in the system.
- Source of contagion analysis: IMF staff / Banxico.

### Annex Table 2 — Domestic Variables, Stress Scenario Projections (selected series)
- Provided quarterly series for Year 2016–2021 across scenarios (IMF forecast, U-shaped scenario, V-shaped scenario). Selected exact values from the table:
  - IMF forecast, IGAE (YoY growth rate) series (2016 Q1–2021 Q2): 2.53 2.48 2.26 2.33 2.50 2.57 2.64 2.69 2.75 2.80 2.83
  - IMF forecast, Cete28: 3.41 3.75 4.00 4.25 4.50 4.75 5.00 5.25 5.25 5.50 6.00
  - IMF forecast, Unemployment: 4.05 4.05 4.05 4.05 3.90 3.90 3.90 3.90 3.83 3.83 3.83
  - IMF forecast, Inflation: 2.71 2.82 3.01 3.32 2.94 2.95 2.98 3.02 3.01 3.00 3.00
  - IMF forecast, FX: 18.04 18.16 17.93 17.69 17.68 17.73 17.79 17.86 17.81 17.84 17.89
- U-shaped scenario, selected IGAE and FX values:
  - IGAE (YoY growth rate) series (2016 Q1–2018 Q4): 1.66 0.00 -1.18 -2.19 -2.64 -1.41 -0.87 -0.16 0.43 0.87 2.47
  - Exchange rate, USD-MXN series (2016 Q1–2018 Q4): 17.74 20.01 19.74 21.31 22.53 25.09 27.01 28.24 29.91 30.21 30.46
- V-shaped scenario, selected IGAE and FX values:
  - IGAE (YoY growth rate) series (2016 Q1–2018 Q4): 1.66 -3.24 -4.80 -5.69 -5.53 -0.39 2.42 4.55 3.95 3.05 3.07
  - Exchange rate, USD-MXN series (2016 Q1–2018 Q4): 17.74 20.63 22.81 24.09 26.04 26.04 26.49 27.78 28.53 28.37 28.37
- Source for table: Banco de Mexico and staff calculations.

### Annex Table 3 — Liquidity Stress Test Results (selected panel statistics)
- Source: Banxico.
- Panel A: Seven largest banks, Consolidated Across Currencies:
  - LCR 2013: 25th percentile 137, Median 148, Average 208, 75th percentile 276
  - LCR 2010a: 25th percentile 94, Median 115, Average 136, 75th percentile 163
  - LCR 2010b: 25th percentile 87, Median 105, Average 124, 75th percentile 150
- Panel A: Seven largest banks, By Currency:
  - LCR 2013 (Foreign Currency): 25th percentile 78, Median 150, Average 128, 75th percentile 155
  - LCR 2010b (Foreign Currency): 25th percentile 70, Median 1994, Average 1699, 75th percentile 97 (note: values reproduced exactly as in source table)
- Panel B: Banking system, Consolidated Across Currencies:
  - LCR 2013: 25th percentile 123, Median 180, Average 173, 75th percentile 354
  - LCR 2010a: 25th percentile 81, Median 109, Average 114, 75th percentile 212
  - LCR 2010b: 25th percentile 78, Median 107, Average 107, 75th percentile 204
- Panel B: Banking system, By Currency:
  - Foreign Currency (25th percentile 89, Median 662, Average 127, 75th percentile 157)
  - Domestic Currency (25th percentile 75, Median 916, Average 84, 75th percentile 112)
- (Values preserved verbatim from source table layout.)

### Annex Figure 1 — Domestic variables: historical and average stress scenario values
- Figure panels listed:
  - (a) Exchange Rate MXN per U.S. Dollar
  - (b) 28-day Cetes (In percent)
  - (c) IPC Index, Year on Year Percent Change
  - (d) Credit, Year-on-year Percent Change
  - (e) Inflation, year-on-year Percent Change
  - (f) Unemployment (In percent)
- Source: IMF staff.

### Interconnectedness Analysis — Methodology and results
- Sample and coverage:
  - Contagion model covered foreign financial intermediaries (119 firms) and international conglomerates (133 firms); domestic financial firms, including commercial banks (47 firms), development banks (6 firms), brokerage firms (33 firms), mutual funds (327 firms), pension fund managers (77 firms), insurers (56 firms), and other domestic financial intermediaries (125 firms).
- Bilateral direct exposures by asset class:
  - Direct exposures in the network were due to, in decreasing order of importance: securities holdings, foreign exchange transactions, deposits, loans, and derivative transactions, including repo operations.
- Model and assumptions:
  - Banxico used a contagion model similar to peer institutions and the IMF.
  - Based on bilateral exposures in securities, derivatives, and deposits and loans in both domestic and foreign currency.
  - The model captures losses triggered by the failure of an individual firm, which can trigger second-round effects.
  - Loss given default is assumed equal to 100 percent of the net uncollateralized exposure.
  - Simulation exercises assume failure of an individual firm to determine worst possible contagion chain (largest total losses).
- Dates analyzed:
  - end-June 2015, end-September 2015, and end-December 2015.

### Annex II — Implementation of the 2012 FSAP Recommendations (selected items)
- Short-term recommendations:
  - Increase budget autonomy for CNBV and CNSF; increase resources commensurate with new responsibilities (wider regulatory perimeter). — Not Implemented
  - Extend scope of CNBV regulatory and supervisory powers to financial and mixed-activity groups. — Partially Implemented
  - Fully implement Pillar 2 supervisory processes, including ICAAP and criteria to require buffers above regulatory minima. — Implemented
  - Tighten concentration limits (including applicable standards) and introduce capital charge for concentration risk under Pillar 2. — Implemented
  - Establish emergency contingency funding mechanism for IPAB, guaranteed by SHCP; transfer IPAB’s debt to the Federal Government. — Not implemented
  - Change pension fund investment guidelines and regulatory tools to encourage focus on long term returns, including using long-term benchmarks. — Not implemented
  - Improve legal framework for derivatives. — Not implemented
  - Establish program to address weak and not yet regulated cooperatives. — Implemented
  - Revisit the structure of commissions and ensure bank account contestability to promote access to finance. — Note Implemented
- Medium-term recommendations (selected):
  - Enhance independence and accountability of the CNBV and CNSF (including by revisiting supervisory architecture) and strengthen the legal protection of supervisors. — Not implemented
  - Strengthen powers and increase resources at CONDUSEF and study allocation of responsibilities with PROFECO. — Implemented
  - Increase replacement rates at retirement. — Not implemented
  - Promote greater competition for mutual fund providers by facilitating entry by independent operators. — Implemented
  - Promote regional integration of capital markets; prepare a medium-term strategy for capital market development. — Not implemented

### Annex III — Report on the Observance of Core Principles for Effective Deposit Insurance Systems (IPAB)
- High-level assessment:
  - The deposit insurance framework, managed by Instituto para la Protección al Ahorro Bancario—Deposit Insurer (IPAB), broadly conforms to best international practice.
  - IPAB is a loss minimizer deposit insurer, managing an ex ante fund; it is also the resolution authority and cooperates with other financial safety net members.
- Funding and reserve levels:
  - Current reserve level covers approximately 1 percent of insured deposits.
  - By law 75 percent of IPAB’s premiums must go towards repayment of the debt, which has grown in nominal terms to MXN 800 billion.
  - IPAB collects quotas from its 46 member institutions based on members’ liability operation; quotas are collected at the lowest rate authorized by its law (40 basis points).
  - Result: IPAB’s fund represents about 1 percent of insured deposits or 0.75 percent of all member banking liabilities.
- Mandates, constraints, and governance issues:
  - IPAB has multiple mandates: managing legacy assets, repaying legacy debt, insuring depositors, acting as resolution authority and source of resolution funding for systemic banks.
  - Constraint: 75 Percent of its premiums go to repayment of legacy debt, hindering growth of the fund and independent financial management.
  - There is no limit on the amount IPAB must contribute to recapitalization or restructuring of a systemic bank from its deposit insurance fund.
  - Board structure issues:
    - No requirement that the Governing Board convene only when all members are present or that a majority of those present be independent Board members.
    - No fixed term for the Executive Director; no protection from dismissal except for cause.
    - This raises potential lack of operational independence.
- Crisis preparedness:
  - IPAB has not prepared or tested a contingency plan for a systemic crisis or the failure of a systemic bank.
  - No regular system-wide crisis simulation exercises to test authorities’ cooperation and communication in crisis times.
- Operational strengths and recommendations:
  - Strengths: culture of cooperation with safety net players; strong performance in handling the Banco Bicentenario failure; ongoing planning for potential resolutions; openness and transparency.
  - Main area for improvement: find a solution to funding issues—address repayment of legacy debt and devise a workable resolution funding formula that protects the deposit insurance fund and IPAB’s primary mission of protecting insured depositors at small and medium banks.
- Legal and operational details:
  - Deposit insurance is compulsory for all deposit-taking commercial banks and those banks licensed to take deposits.
  - IPAB protects all retail depositors up to UDI 400,000 per depositor per member institution.
  - Foreign currency accounts are insured but are limited by law to certain businesses authorized by Banxico; personal foreign currency accounts exist.
  - IPAB is legally mandated to reimburse depositors within three months after a bank’s license is revoked.
  - IPAB’s Board composition: seven members, head of SHCP as Chair, four independent members, and representatives of CNBV and Banxico.
  - IPAB has approximately 300 employees.
- Methodology for assessment:
  - Evaluation used the Methodology for Compliance Assessment adopted in November 2014 by the International Association of Deposit Insurers; assessment addressed IPAB’s compliance as an insurer of deposits in commercial banks, based on review of laws, regulations, and practices.

*Source: IMF staff; Banco de Mexico; Banxico (as presented in the original IMF annex tables and text).*

### 15.      IPAB’s governance structure should be adjusted to provide it with greater operational

### 15.      IPAB’s governance structure should be adjusted to provide it with greater operational independence

### Governance and operational independence
- Findings:
  - The Minister of SHCP serves as Chairman of IPAB’s Board, which affects IPAB’s ability to operate as a truly independent entity.
  - There is no fixed term for IPAB’s Executive Director and no protection for removal except for cause.
  - The law does not require a quorum of the Board to include at least some of the independent Board members; a quorum of four members suffices provided that SHCP is in attendance.
  - IPAB is structured as a public entity decentralized from the federal public administration with its own budget and source of funds, but government guidelines established by SHCP limit its ability to set its own salary levels.
  - The requirement to use much of its income to service legacy debt potentially impacts operational independence.
  - External and internal audits are required, but there is no specific requirement that such audits assess the extent to which IPAB is meeting its mandate.
- Recommendations:
  - Reconsider the structure of IPAB’s Board to provide less of a governing role for SHCP and allow IPAB greater operational independence.
  - The Executive Director should have a fixed term of office with removal permitted only for cause.
  - Require Board quorum rules to ensure independent Board members are included for decisions affecting operational independence.

### Funding, legacy liabilities, and contribution limits
- Findings:
  - IPAB must use 75 percent of its premium income to repay debt from the 1994–95 financial crisis and manage assets inherited from the predecessor organization (Fobaproa).
  - IPAB’s insurance fund is and will remain underfunded until the issue of its legacy debt requirement is addressed.
  - IPAB has substantial borrowing authority, including an explicit government guarantee for its borrowings and the ability to arrange emergency financing up to 6 percent every three years of the total liabilities of its member institutions.
  - As of April 2016 the fund held MXN 26 billion.
- Recommendation:
  - Cap IPAB’s contribution from its deposit insurance fund to a resolution of a systemic bank to reduce the risk that the fund will never be sufficient to meet its primary mandate of paying depositors without prolonged borrowing and future industry repayments.

### Resolution tools and market constraints
- Findings:
  - The inability for potential acquirers to access relevant data before a bank’s license revocation makes the use of the purchase and assumption (P&A) tool very difficult.
  - The Mexican banking market has relatively few participants, raising confidentiality and competition approval considerations for P&A transactions.
  - IPAB has not fully assessed member institutions’ appetite and capacity for becoming paying agents, purchasing troubled assets, and completing whole bank P&A transactions.
- Recommendations:
  - Eliminate legal and operational obstacles that prevent potential acquirers from accessing necessary information prior to license revocation to facilitate P&A transactions.
  - Consider confidentiality mechanisms and competition authority processes to avoid undue delays in acquisitions.
  - IPAB should increase outreach to assess member institutions’ appetite and capacity for serving as paying agents, purchasing troubled assets, and conducting whole bank P&A transactions.

### Contingency planning, crisis management, and simulation exercises
- Findings:
  - IPAB has a compendium of procedures for bank resolution and has conducted annual simulation exercises since 2011.
  - All operating procedures are being updated to reflect the 2014 Banking Law.
  - Under Article 120 of the Banking Law, IPAB must include simulation exercises as part of resolution plans.
  - IPAB has not prepared a contingency plan for dealing with a systemic crisis or the failure of a systemic bank.
  - Four authorities interact in the bank recovery and resolution regime: SHCP, Banxico, CNBV and IPAB; all participate in the Financial Stability Council. CESF functions under “moral suasion.”
  - A communication policy exists at SHCP, but it is unclear whether it governs all communication activities in a crisis or has been discussed by financial authorities as a group.
- Recommendations:
  - Authorities should complete a system-wide contingency plan for crisis preparedness, particularly for a systemic crisis, with individual agency plans feeding into the overall plan.
  - IPAB should develop a contingency plan for the failure of a systemic institution and for a systemic crisis.
  - Conduct system-wide simulation exercises involving all safety-net players.

### Cross-border coordination and membership issues
- Findings:
  - Foreign banks in Mexico are required to be established as subsidiaries and are subject to Mexican banking laws.
  - IPAB has not entered into agreements with all relevant deposit insurers that would cover communication if a parent of a subsidiary bank in Mexico were to experience difficulties resulting in a deposit insurance payout in the home country.
  - All commercial banks become members of IPAB upon authorization; deposit-taking development banks with implicit government guarantees are not required to be members.
  - There are no procedures to allow for a period of continuation of coverage after a license revocation by CNBV.
- Recommendations:
  - Enter into agreements with relevant deposit insurers to coordinate communications in cross-border stress events involving parent and subsidiary banks.
  - Consult IPAB as part of the licensing process for new banks or conversions of non-bank institutions into banks.
  - Study whether and how deposit-taking development banks could be incorporated into the deposit insurance system.
  - Establish procedures to allow a fixed period of separate coverage for depositors after a bank merger to enable account restructuring and assurance of complete coverage.

### Coverage, premiums, and targets
- Findings:
  - Coverage is defined per person (natural or legal) per institution and denominated in Unidades de Inversion (UDIs).
  - The same level and scope of coverage applies equally to all members of IPAB; foreign currency deposits are insured but not widely used.
  - Funding comes from regular and special quotas collected from banks based on banking liabilities; rates can be no less than 4 per thousand and cannot exceed 8 per thousand of institutions’ total liability operations per year.
  - IPAB may arrange emergency financing from Banxico, development banks, commercial banks, multilateral institutions or capital markets, but there are no explicit, formal arrangements for contracting emergency financing although negotiations are underway.
  - IPAB has not formally adopted a target fund ratio for its deposit insurance fund.
- Recommendations:
  - IPAB should provide for separate coverage for a fixed period of time for depositors after a bank merger to allow depositors to restructure accounts and be assured of complete coverage.
  - Formally adopt target fund metrics and formalize arrangements for emergency financing.

*Source: IMF country report excerpt on IPAB governance, funding, and compliance with the Core Principles for Effective Deposit Insurance Systems.*

### 1.1 percent of insured deposits. IPAB’s law requires it to invest

### _cr16361 - 1.1 percent of insured deposits. IPAB’s law requires it to invest

### Funding, investments, and constraints
- IPAB’s law requires it to invest its funds in highly liquid government securities or deposits with Banxico.
- Current contribution level referenced: 1.1 percent of insured deposits.
- IPAB is required to repay debt from the 1994–95 financial crisis; this repayment requirement hampers its ability to reach a target level for its deposit insurance fund.
- IPAB has not formally adopted a target ratio for its deposit insurance fund, although it has completed an analysis of the issue.
- As a resolution authority, the lack of a limitation on IPAB’s contribution to a systemic resolution potentially puts at risk its ability to build a fund to pay insured depositors for a non-systemic small or medium bank following a recapitalization or restructuring of a systemic bank.
- Recommendation/findings:
  - IPAB as the deposit insurer should have control over the use of its funds.
  - IPAB should be limited in the amount it must contribute to a recapitalization or restructuring of a systemic bank.
  - IPAB’s contribution should be made only after shareholders’ interests are reduced to zero.

### Public awareness (Core Principle 10)
- IPAB’s law requires financial institutions to inform users of services of the types of operations covered by deposit insurance and in what amount.
- Banks cannot be required to publicize IPAB’s activities.
- Article 188 of the Banking Law sets requirements for IPAB announcing how depositors will be repaid after a bank failure.
- IPAB’s website states coverage is provided free of charge to bank customers.
- IPAB has objectives for its public awareness program but has not established a target level for public awareness.
- IPAB is subject to the General Guidelines for Social Communication Campaigns of Agencies and Instrumentalities of the Federal Public Administration.
- IPAB works with banks and other safety-net members to maintain consistency of information and promote public awareness.
- IPAB cannot impose penalties or require banks to correct or amend erroneous information they provide to CONDUSEF or clients about IPAB.
- There is no independent evaluation of the effectiveness of IPAB’s public awareness activities.
- Recommendation/findings:
  - IPAB should have the authority to require banks to correct or amend any erroneous information they provide on IPAB.
  - IPAB should undertake an assessment of the public’s awareness of the existence and coverage limits of deposit insurance offered by IPAB to inform its public awareness program.

### Legal protection (Core Principle 11)
- Articles 271 to 274 of the Banking Law provide legal protection to IPAB and individuals working for it for actions taken in good faith in the course of duty.
- IPAB has a trust fund for this purpose and the ability to provide an insurance policy for each public servant who wants one.
- IPAB has a code of ethics and conduct for employees.
- A law governing all public servants requires disclosure of potential conflicts of interest related to activities of the responsible public servant.

### Dealing with parties at fault in a bank failure (Core Principle 12)
- The Banking Law requires the liquidator to inform competent authorities of evidence of violations of certain provisions of the Banking Law.
- IPAB must review all of the bank’s information during liquidation and report evidence of wrongdoing to competent authorities.
- Appropriate institutions in the safety-net and the prosecutor’s office have powers of investigation concerning parties responsible for a bank failure.
- Relevant authorities (resolution authorities, liquidators, prosecutors, judiciary) have necessary powers to seek compensation for damages caused by those responsible for a bank failure.
- Restitution can be sought from criminal offenders.

### Early detection and timely intervention (Core Principle 13)
- Article 129 of the Banking Law sets quantitative criteria that trigger timely intervention; Article 128 sets other grounds for license revocation.
- There is no periodic review of the criteria for triggering corrective actions and/or revocation of a bank’s license.
- CNBV has broad powers to exercise prompt corrective action and intervene a bank.
- Between 8 percent total capital and 4.5 percent CET1, CNBV has significant discretion to allow a bank to continue operating under conditions or to revoke the license.
- CNBV informs IPAB when an institution’s capital ratio falls below 8 percent; IPAB may participate in special inspection visits to ascertain the bank’s financial situation.
- Operational independence and procedures for systemic determinations should be strengthened:
  - CNBV and IPAB have political appointees on their boards.
  - Their head does not have a fixed-term mandate and there are no dismissal criteria, which may put independence in question.

### Failure resolution (Core Principle 14)
- IPAB’s governance structure may prevent complete operational independence.
- IPAB has sufficient resources to exercise its resolution powers when considering its significant borrowing ability.
- The special resolution regime provides tools for resolution of banks of all sizes.
- Purchase and assumption (P&A) is untested because potential acquirers cannot access relevant data before license revocation.
- A bridge bank may be utilized as a “partial payment” systemic bank if the bank’s entire operation is not found systemic under Article 29 bis 6 of the Banking Law.
- Roles of authorities participating in a bank resolution are clearly defined in the Banking Law.
- IPAB lacks the power to write down or convert the bank’s debt to equity.
- IPAB is subject to the least cost rule for all non-systemic resolutions; the creditor hierarchy is set forth in the Banking Law—subrogated claims of IPAB are fourth in the hierarchy of claims.
- No discrimination against depositors based on nationality or residence.
- Only a claim for damages is allowed under Article 273 of the Banking Law for claims relating to resolution of financial institutions.
- There can no longer be actions filed to halt the resolution process.
- Article 188 provides IPAB up to five days after a bank enters liquidation to publish the bank’s resolution process.
- Findings on P&A and systemic resolution:
  - The Purchase and Assumption (P&A) tool is untested and impractical for most banks due to inability of acquirers to access data pre-license revocation without costly loss-sharing agreements.
  - The ability to use the bridge bank tool in resolving a systemic bank (rather than one deemed partially systemic) is not clear.
  - There is no assurance that shareholders and unsecured creditors of a systemic bank resolved under Open Bank Assistance mechanisms fully bear losses prior to use of deposit insurer, resolution authority or public funds.

### Reimbursing depositors (Core Principle 15)
- The law provides IPAB up to 90 days to reimburse depositors.
- Reimbursements could be done faster; example: Banco Bicentenario’s 200 depositors were reimbursed in two days.
- IPAB does not yet have the ability to reimburse a large number of depositors in seven days or less; planning for a paying agent bank to complete large reimbursements within seven days or less is ongoing.
- The law makes no provision for advance or partial payments of insured deposits.
- Insured institutions must have information on insured obligations as described in IPAB’s law and lending operations for IPAB to apply set-off as required by Article 175 of the Banking Law.
- IPAB has power to review bank records with on-site examinations at member institutions.
- The law provides IPAB the ability to use necessary human and technical resources to prepare for prompt reimbursement.
- IPAB makes regular use of simulation exercises for planning.
- IPAB conducted a review of the reimbursement process in the 2014 failure of Banco Bicentenario; the reimbursement process is audited by IPAB’s internal auditor.
- The setting-off of insured deposits against past due loans is part of the 2014 Banking Law (Arts. 124 and 175) but their calculation is cumbersome and recovery of past due loans is small.
- Finding summary:
  - The law provides up to 90 days to reimburse depositors; IPAB is not yet prepared to reimburse a very large number of depositors in less than 7 days.
  - The requirement to apply set-off against past due loans may complicate reducing the time required to reimburse depositors.

### Recoveries (Core Principle 16)
- Article 169 of the Banking Law clearly establishes IPAB’s role as the liquidator of a bank in resolution.
- The creditor hierarchy provides IPAB the same position as an insured depositor for recovery in liquidation.
- IPAB acts as the liquidator of the failed institution.
- The Banking Law establishes rules for asset recovery and provides IPAB flexibility in disposal practices (e.g., Banco Bicentenario).
- Article 207 sets rules as to eligible persons to buy assets from a failed bank.
- IPAB has established policies on how provisions of the law will be applied.

### Authorities’ response (selected points)
- Core Principle 2, Essential Criteria 1: The debt from FOBAPROA has never been public debt; it has always been IPAB’s debt.
- Core Principle 2, Essential Criteria 3: The issue of debt repayment is out of place under this CP which addresses Mandate and Powers.
- Core Principle 6, Essential Criteria 2: Notation that IPAB has not prepared a contingency plan for a systemic crisis or failure of a systemic bank seems outside scope of the EC.
- Core Principle 6, Essential Criteria 4: The EC addresses participation in contingency planning and crisis simulation exercises; IPAB would participate if held.
- Core Principle 6, Essential Criteria 5: Coordination of communication activities takes place with all authorities.
- Core Principle 6: Authorities believe IPAB is Compliant (not Largely Compliant) because IPAB does all it can and this CP addresses the deposit insurer’s role in contingency planning.
- Core Principle 8, Essential Criteria 2: Text inaccurately describes evolution of coverage level for deposits.
- Core Principle 8, Essential Criteria 9: Foreign currency deposits are insured.
- Core Principle 9, Essential Criteria 5: Repayment of funds from legacy debt is not paid to the government but is used to directly repay debt.
- Core Principle 9, Essential Criteria 9: Legacy debt is not government debt.
- Core Principle 9, Essential Criteria 10: Since the minimum level of premiums to be charged is 4 basis points the adoption of risk based premiums would never result in less income.
- Core Principle 12, Essential Criteria 1: Text missing.
- Core Principle 14, Essential Criteria 2: Bridge bank is allowed for bank that has not been given open bank assistance.

*International Monetary Fund — Excerpt from IPAB assessment (document _cr16361).*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16361.pdf_