Fitch: Election, NAFTA Raise Mexico Bank/NBFI Uncertainties

Thursday, July 12, 2018

By Fitch Ratings

Monterrey/New York-10 July 2018: Uncertainties over potential economic policy changes after Mexico's general election and protracted North American Free Trade Agreement (NAFTA) re-negotiations could have a low to moderately negative effect on loan growth, asset quality and profitability for Mexican banks and non-bank financial institutions (NBFIs), Fitch Ratings says. However, bank and NBFI credit profiles have demonstrated resiliency thus far, and outlooks remain broadly stable under our base case.

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It remains highly uncertain if there will be any significant policy changes for financial institutions following Mexico's recent general election. President-elect López Obrador (pictured) has indicated that key economic anchors, including central bank autonomy and the flexible exchange rate and inflation-targeting monetary policy regimes, would remain in place.

Nonetheless, some campaign platform promises point to potential regulatory changes. Stated policy goals from López Obrador's "National Plan 2018-2024" include increasing financial inclusion and the authorization of new niche market participants to boost small- and medium-sized enterprise (SME) and primary-sector lending. Proposals also include consolidation and improvement of the country's development institutions, and modifying financial regulation and supervision for smaller banks and NBFIs.

The National Plan states that regulatory changes are not intended to relax the stability, integrity or efficiency of the financial system, anti-money laundering certifications or the protection of depositors. Capital requirements of banks are not expected to materially change, given Mexico's adoption of Basel III standards.

Economic uncertainty linked to protracted NAFTA re-negotiations could also add to challenges for the financial sector. Our base case remains for NAFTA to be resolved with limited effect on Mexican trade and key export sectors. However, the continuation of an elongated renegotiation process could affect investor and consumer confidence, potentially affecting loan demand, asset quality and profitability.

Fitch believes niche segments more often targeted by NBFIs could be more sensitive, as economic uncertainty and inflation have led to moderately weaker consumer and SME loan credit quality. On the other hand, overall asset quality of the banks continues to be reasonably strong, with non-performing loan ratios near historical lows.

NBFI ratings already tend to be lower than bank ratings, reflecting the riskier nature of their loan portfolios, less diversified business models and reliance on wholesale funding sources. Continued political and trade-related uncertainty would negatively affect smaller, less capitalized niche NBFIs players the most, particularly those that are more reliant on secured and/or short-term funding sources.

Fitch expects the banking system's loan growth to slow in 2018 to between 8% to 10% from the low-teens growth seen in recent years, due in part to economic uncertainty and tightened underwriting standards.

The effect of lower portfolio growth on profitability may be partially offset by rising domestic interest rates. Large banks continue to benefit from low-cost deposits, while medium-sized banks have been able to handle increased funding costs reasonably well. Larger NBFIs have been able to pass higher funding costs on to customers, while smaller NBFIs with lower pricing power have seen a reduction in spreads. Medium- and small-sized banks and NBFIs have managed to sustain reasonable access to funds for short-term growth. Lenders have been relatively active in local and international debt markets in preparation for pre- and post-election market uncertainty. Fitch considers this commensurate with our stable outlook on the financial system.