One of the objectives of the financial reform is the reactivation of the financial market to make it grow. Starting with the diagnosis that there is a low level of financing to the private sector in Mexico – it is the country where there is the least amount of lending, despite having one of the most solid robust financial systems in the world.
The solution proposed by the reform is to grant more and cheaper credit, that is, to expand credit.
While the authority is right in that the financing to the private sector is low, several questions arise as to why it is low and how it should grow. The objective of this paper is to review the second question and propose a reasonable dynamic of credit growth in Mexico.
Credit is a double-edged sword. Used properly and responsibly, it can boost economic growth. When used recklessly and in excess, the result can be a financial crisis due to excessive borrowing by households and businesses. The financial reform has positive aspects, since it addresses an important issue. However, it is important to be careful with credit expansion, given the national and international experience. Reinhart and Rogoff, in their book This Time is Different, warn about the risks of excessive financial expansion:
“When a financial boom is based on debt, the result will almost always be a false positive image of public policy, of the ability of a financial institution to generate huge profits or of the standard of living in a country. Most of these booms end badly. Of course, the debt instruments occupy a pivotal place in any economy, ancient or modern, but to strike a balance between risk and opportunities of debt will always be a great challenge.”
Figure 1 shows that the total financing to the private sector is low compared to the average in different regions of the world. It is striking that even the Middle East and North Africa have a greater average financing penetration than in Mexico.
Figure 1
Total financing to the private sector in Mexico, 2003-2013
(Percentage of the GNP)
In Mexico, the low level of credit in relation to the GDP may be due to a number of structural factors of the Mexican economy. Although it is a relevant question, it is not the purpose of this text to research it.
The data shows that credit is growing in Mexico, as shown in Figure 2. Although there was a slight adverse effect because of the international financial crisis of 2008, the indicator shows a clear upward trend. This reveals that the financial system has not been inactive, so acceleration will occur, but in a responsible manner.
Figure 2
Total financing to the private sector in Mexico, 2003-2013
(Percentage of the GDP)
Figure 2 shows a clear upward trend from 2006 to 2013, with an improvement of nearly eleven percentage points of the GDP, from 19.66% to 30.60%. However, it has not been enough to reach the levels of other nations and therefore it is a big challenge for Mexico.
Financing for families and businesses, well used, can help the economic growth. However, irresponsible expansion causes problems for the economy because of over-indebtedness and generates risks for the macroeconomic and financial stability.
Reinhart and Rogoff (2009) explain that excessive debt, either by governments, banks, businesses or households, increases vulnerability in the face of a crisis of confidence, especially when the debt is short term. In addition, they document with ample evidence the banking crises. It is interesting that the outcome of these crises has equally affected, for many years, rich, developing and poor countries.
Figure 3
Total financing to the private sector, Thailand, Indonesia and South Korea in the Asian crisis
(Percentage of GDP)
Figure 3 shows the fast growth rate of credit just before the great Asian crisis of 1997-1998. From the graph, it is clear that it may not be long before we see another crisis in the area, if we analyze how credit has grown since 2002. Will economic history repeat itself? Only time will tell.
In an analysis of the balance of savings and financing in Mexico, the Foundation for Financial Studies (FUNDEF, acronym in Spanish) states that in 2013, the Mexican private sector banking system financed 73.65% of the projects from the private sector, individuals and companies, well above the development bank, which granted only 6.68% of the loans. Therefore, it is the private banks that financed investment projects in the private sector. This funding, together with the retained earnings, are the two main sources used by companies for new investment projects.
Credit expansion in Mexico has been responsible and it grew on average 2.8 times the country’s GDP between 2006 and 2013. It should continue having a responsible expansion of between two and three times the GDP to avoid repeating past mistakes. For example, one of the factors that triggered the 1994 crisis was the expansion of irresponsible credit.?
References
Levine, Ross. 1997. “Financial Development and Economic Growth: Views and Agenda”, Journal of Economic Literature, vol. 35(2), pp. 688-726.
Rajan, R. y Ramcharan, Rodney. 2011. “Land and Credit: A Study of the Political Economy of Banking in the United States in the Early 20th Century,” Journal of Finance, vol. 66(6), pp. 1895-1931
Reinhart, C. y Rogoff, Kenneth. 2009. This Time Is Different: Eight Centuries of Financial Folly. Princeton University Press.
Reinhart, C. y Rogoff, Kenneth. 2009. “From Financial Crash to Debt Crisis”, NBER Working Papers 15795, National Bureau of Economic Research, Inc.
Sánchez J. y Zamarripa, Guillermo. 2015. “La situación del crédito en México: Perspectivas y recomendaciones”. Status report, FUNDEF.
Financing in Mexico
One of the objectives of the financial reform is the reactivation of the financial market to make it grow. Starting with the diagnosis that there is a low level of financing to the private sector in Mexico – it is the country where there is the least amount of lending, despite having one of the most solid robust financial systems in the world.
The solution proposed by the reform is to grant more and cheaper credit, that is, to expand credit.
While the authority is right in that the financing to the private sector is low, several questions arise as to why it is low and how it should grow. The objective of this paper is to review the second question and propose a reasonable dynamic of credit growth in Mexico.
Credit is a double-edged sword. Used properly and responsibly, it can boost economic growth. When used recklessly and in excess, the result can be a financial crisis due to excessive borrowing by households and businesses. The financial reform has positive aspects, since it addresses an important issue. However, it is important to be careful with credit expansion, given the national and international experience. Reinhart and Rogoff, in their book This Time is Different, warn about the risks of excessive financial expansion:
Figure 1 shows that the total financing to the private sector is low compared to the average in different regions of the world. It is striking that even the Middle East and North Africa have a greater average financing penetration than in Mexico.
Figure 1
Total financing to the private sector in Mexico, 2003-2013
(Percentage of the GNP)
In Mexico, the low level of credit in relation to the GDP may be due to a number of structural factors of the Mexican economy. Although it is a relevant question, it is not the purpose of this text to research it.
The data shows that credit is growing in Mexico, as shown in Figure 2. Although there was a slight adverse effect because of the international financial crisis of 2008, the indicator shows a clear upward trend. This reveals that the financial system has not been inactive, so acceleration will occur, but in a responsible manner.
Figure 2
Total financing to the private sector in Mexico, 2003-2013
(Percentage of the GDP)
Figure 2 shows a clear upward trend from 2006 to 2013, with an improvement of nearly eleven percentage points of the GDP, from 19.66% to 30.60%. However, it has not been enough to reach the levels of other nations and therefore it is a big challenge for Mexico.
Financing for families and businesses, well used, can help the economic growth. However, irresponsible expansion causes problems for the economy because of over-indebtedness and generates risks for the macroeconomic and financial stability.
Reinhart and Rogoff (2009) explain that excessive debt, either by governments, banks, businesses or households, increases vulnerability in the face of a crisis of confidence, especially when the debt is short term. In addition, they document with ample evidence the banking crises. It is interesting that the outcome of these crises has equally affected, for many years, rich, developing and poor countries.
Figure 3
Total financing to the private sector, Thailand, Indonesia and South Korea in the Asian crisis
(Percentage of GDP)
Figure 3 shows the fast growth rate of credit just before the great Asian crisis of 1997-1998. From the graph, it is clear that it may not be long before we see another crisis in the area, if we analyze how credit has grown since 2002. Will economic history repeat itself? Only time will tell.
In an analysis of the balance of savings and financing in Mexico, the Foundation for Financial Studies (FUNDEF, acronym in Spanish) states that in 2013, the Mexican private sector banking system financed 73.65% of the projects from the private sector, individuals and companies, well above the development bank, which granted only 6.68% of the loans. Therefore, it is the private banks that financed investment projects in the private sector. This funding, together with the retained earnings, are the two main sources used by companies for new investment projects.
Credit expansion in Mexico has been responsible and it grew on average 2.8 times the country’s GDP between 2006 and 2013. It should continue having a responsible expansion of between two and three times the GDP to avoid repeating past mistakes. For example, one of the factors that triggered the 1994 crisis was the expansion of irresponsible credit.?
References