Back from the dead: once the bane of the economy, Mexico's banks show signs of domestic recovery and international assimilation.

It took nearly a decade, a US$105 billion government bailout and what some argue is a big chunk of Mexico's sovereignty, but the nation's banking sector has largely healed from the dismal years following the 1994-1995 peso crisis.

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Scars are still apparent, but after years of stagnant growth, the sector is once again "pretty healthy," said Jonathan Heath, a Mexico City-based economist with LatinSource, a network of economists in Latin America.

Consumer lending, on ice because of bad loans and flimsy bankruptcy laws, is now seeing solid growth. Though corporate lending and bank-issued mortgages are still lagging, some say that even in those areas, banks are starting to see a slight uptick. Margins among banks have improved and the sector--at an overwhelming cost to taxpayers--has emerged from crisis.

While the word "crisis" often appears in discourses on Latin America politics, finance and business, Mexico's banking sector was indeed in a huge funk in the late 1990s. After the December 1994 devaluation, interest rates skyrocketed above 90%. Many lenders who couldn't keep up with loan payments were forced to default. Banks took the hit; new lending came to a virtual halt. That, in turn, dampened consumer spending and capital investment.

REGAINING SOME MUSCLE

But consumer lending in Mexico is humming once again. Consumer credit card lending in 2003 grew about 33% in real terms, marking the fourth year of strong double-digit growth. Banks, which once enjoyed a healthy share of the mortgage market, have mostly lost out to small and agile mortgage lenders called sofoles. There is some speculation that as banks become more robust, they will acquire sofoles and once again become important players in the mortgage market.

Banks today are better capitalized than they were before. The perceived risk in the market has diminished so much that structured financing, a once popular finance option among Mexican banks, is no longer necessary, said Samuel Fox, senior director of international structured finance for Fitch Ratings. "Banks can get a better cost of funds elsewhere."

Structured finance in general is more costly because a client must pledge valuable assets toward the financing. Given Mexico's investment grade status, banks can access markets with greater ease and banks.' foreign owners, who tend to have deeper pockets than their prior Mexican owners, can effectively cover financing needs.

Could Mexico's banking sector be on the verge of a bubble? Akiko Kudo, a Latin America bank analyst at Fitch Ratings in New York, is doubtful. Kudo said the health of Mexican banks appears solid in part because they have refrained from corporate lending. Others agree that since their comeback, Mexican banks have been too conservatively managed to risk a burst bubble.

OWNERSHIP CHANGES

On their road to rehabilitation, Mexico's banks have undergone major changes in ownership. Vanished are the green and maroon logo colors of the nation's former banking giants Bancomer and Banamex; in are the blue hues of their big-footed multinational parents Spainish Banco Bilbao Vizcaya Argentaria (BBVA) and Citibank. British-owned HSBC, which last year delisted Bital after buying out the bank, is but the latest to slap its color scheme across Mexico's urban landscape.

But the change in color schemes is not the real difference within the sector. Banks' revenue formulas have also shifted, observers say. Previously, a key source of revenue for banks came from interest on loans. But now banks are ringing up quick and easy profits by charging extremely high service fees, said Alonso Cervera, a Mexico analyst at Credit Suisse First Boston, noting that "one bank charges 1,000 pesos per bounced check."

In February, BBVA announced it would raise its stake in BBVA-Bancomer from 60% to 100% for US$4.1 billion. Mexico's largest bank in terms of assets, BBVA-Bancomer will soon delist from the Mexican Stock Exchange, news that sent Bank of Mexico Gov. Guillermo Ortiz into a tizzy. He was quoted as saying that publicly traded financial institutions "have, by definition, a more transparent attitude."

Ortiz also said that delisting BBVA-Bancomer would remove one of the most liquid stocks from the Bolsa. Banamex, owned by Citibank, delisted in 2001.

Banorte, the largest remaining Mexican-owned bank is much smaller and less liquid, according to Urban Larson, a Latin America fund manager for Baring Asset Management. "The [banking] sector is now such a tiny part of the index that investors can more easily ignore it. Some have already switched to housing stocks, but they are not very liquid either," Larson said, adding that Ortiz is right. "We need more liquidity in the Bolsa."

GLOBALIZATION POSITIVES

But a key upside to internationalism is that the system as a whole is less risky and more sophisticated than before, analysts note. "Banks are more efficient and give better service," said Ignacio Cedillo Bravo, an analyst at Mexico City-based Bursametrica.

After the deregulation and privatization of the early 1990s, Mexican banks were badly mismanaged. Branch bank managers ruled their banks like fiefdoms. Collateral on loans was often sketchy at best: at the former Banco Inverlat, once controlled by a Mexican family and later acquired by Canada's Bank of Nova Scotia, bank employees were startled to see a warehouse of old black-and-white televisions used as collateral on a multi-million dollar loan. Even on the eve of the famous devaluation, commercial banks were aggressively promoting credit card giveaways.

STRICTER CREDIT AND ACCOUNTING

Larson thinks that foreign-owned banks in Mexico will be better shielded from colossal management sins of the past because banks have become much stricter about granting credit than they used to be.

"One of the fastest growing consumer credit products is a loan with automatic monthly reimbursement from the customer's salary," he said, adding that the product is only available to people working in the formal economy and whose employers pay them via direct deposit.

Tougher accounting standards have also helped make balance sheets more honest, Larson noted. Amid a national uproar over the mega-bailout, Mexican banks began adopting stiffer U.S. GAAP-like accounting rules in the late 1990s. "Mexican bank balance sheets are very credible as management is quite conservative," he said.

But with the nation's major banks now delisted, or about to be, balance sheets will fall under investors' radars. "There's less scrutiny for the banks now," said Cervera. "It's a bigger burden on authorities to inform the public about every bank."

Will national banking officials succeed in coercing banks to keep their reporting and balance sheets clean? "I hope that happens," Cervera said.

TRANSPARENCY REQUIRED

Ortiz publicly mentioned how a lack of transparency could hurt the banking sector. Finance Secretary Francisco Gil Diaz was later reported as saying banking regulators could address those concerns. Mexicans have paid a high cost for rehabilitating their financial sector. An amount equivalent to about 14% of the nation's 2002 gross domestic product went toward the bank bailout.

As has occurred globally, the consolidation of Mexico's financial sector has cost thousands of jobs. Moreover, some Mexicans worry about the financial sector's complete loss of sovereign control and question foreigners' will-ingness to contribute to Mexico's long-term economic and social health.

"I don't think foreign bankers will ever feel the social obligation to carry out transactions for the benefit of the country," said a Mexico City executive who spoke on condition of anonymity. "As long as service fees and commissions generate large profits, they won't feel the need to increase lending that could benefit Mexicans."

This article is reprinted with permission from knowledge@wharton, an online resource affiliated with the University of Pennsylvania's Wharton School of Business.

By knowledge@wharton