Prudential regulationi Relationship with the prudential regulator
The CNBV may be considered as the Mexican equivalent to the Financial Services Authority of the United Kingdom, and a mixture of the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the state banking commissions from the federal reserve banks and the Securities and Exchange Commission of the United States. The CNBV is the regulator in charge of oversight, and the control body of the banking, financial and securities systems in Mexico, and is considered the main prudential regulator.
The SHCP is also one of the main regulators in the banking system. Its main responsibilities are:
- the issuance of general rules;
- control of financial policies;
- budget control;
- administrative control; and
- granting authorisations for specific activities.
Regarding the control of financial policies, the SHCP is entitled to plan, coordinate, evaluate and oversee the country's banking system, including Banxico, retail banks, development banks, financial groups and any other institution that performs credit and banking activities. This control over financial policies includes insurance, securities, surety bonds and credit ancillary activities.
Banxico's main activities are those of a regular central bank, namely:
- maintaining the stability and supply of the currency;
- the control and prudential regulation of the financial system;
- acting as lender of last resort;
- modulation of the public debt; and
- coordination of the payment systems.
Additionally, with the CNBV and the SHCP, Banxico has the authority to issue general rules. Among all the authorities granted to Banxico, we highlight the strengthening and development of the financial system, which include:
- operating with credit institutions as reserve bank and lender of last resort;
- granting loans to credit institutions and the federal government;
- determining the characteristics of lending, deposit and services activities by credit institutions as well as securities and derivatives transactions;
- setting limits on lending and deposit transactions to control the risk of banking institutions;
- requesting periodic reports and information regarding financial entities' activities and results; and
- issuing an opinion regarding:
- any application for an authorisation to act as a retail banking institution;
- acquisitions of more than 5 per cent of ordinary shares from retail banking institutions, including subsidiary institutions from foreign entities;
- mergers or spin-offs of retail banks;
- the establishment of foreign financial entities' subsidiaries as retail banks;
- financial entities' capitalisation thresholds;
- ratings of credit portfolios;
- support documentation for lending, services and deposit transactions; and
- the integration of reserve funds corresponding to credit ratings for prudential, solvency and stability purposes.
Banxico is also able to impose sanctions on financial entities and request the performance of audits and inspection visits to such entities.ii Management of banks
Management of banks is entrusted to three main bodies. The first is the board of directors, followed by the chief executive officer (CEO) and, lastly, an audit committee that is directly accountable to the board of directors. The board of directors is composed of five to 15 members, who are elected by the shareholders, of which 25 per cent must be independent members and the majority must reside in Mexico. It shall hold meetings at least quarterly. These will be valid when 51 per cent of the members of the board are present: of those members, at least one must be an independent member. The members of the board must fulfil certain requirements regarding experience, reputation, ethics and knowledge.
The board of directors is the body in charge of performing and approving all actions required to fulfil the bank's purpose (with the sole exception of those expressly reserved for the shareholders' meeting); it has all the necessary powers and authority to represent the bank and lead its business.
A statutory audit committee is also required, which shall be composed of at least two statutory auditors, one appointed by the ordinary series of shares (Series O and Series F) and the other by the limited series of shares (Series L and Series B). This committee is in charge of:
- requesting monthly reports from the board of directors, including a financial situation statement and a results statement;
- examining the operations, documentation, registry and any other evidence to the extent necessary to oversee the operations; and
- filing an annual report to the shareholders' meeting regarding the truthfulness, sufficiency and rationale of the information delivered by the board to the shareholders' meeting, in which the opinions of the members of this committee regarding accounting and information policies and the sufficiency and adequacy of certain criteria are included.
The CEO must be an individual who resides in Mexico for tax purposes, with a recognised moral reputation and at least five years' experience in senior decision-making positions. The CNBV has the authority to remove any officer in the event that he or she does not comply with these requirements or ceases to comply with them. The CEO is in charge of the elaboration and presentation of policies for the correct application and utilisation of the human and material resources of the entity, including the consideration of their efficient use, restrictions on misuse, oversight and control mechanisms.
The audit committee is the body entitled to follow up on the internal and external audit processes of the institution, as well as with the internal comptroller. It ensures that accounting and financial information is generated in accordance with the applicable requirements and accounting principles.
The members of this committee are selected for their aptitude and professional reputation. The committee shall be composed of at least three and no more than five members, one of whom must be an independent member and shall act as chair. Mexican law also requires there to be a secretary, who may or may not be a member of the committee, and who will be entitled to keep all minutes and records. Meetings shall take place at least four times a year, and their resolutions will be validly adopted if approved by the majority, provided that the chair, or his or her deputy, attends the meeting. Employees and officers of banking institutions are not allowed to be part of this committee.
The committee's main activities consist of proposing to the board of directors an internal control system for the operations of the institution, and its supervision. The control system shall include:
- policies concerning the organisational structure of the bank;
- communication channels and information flow mechanisms;
- general operating policies;
- a business continuity plan; and
- control measures for the correct approval, processing and registration of the bank's transactions.
In addition to the aforementioned management and surveillance bodies, banking institutions shall incorporate other types of subcommittees, such as a corporate banking credit committee, internal credit committee, risks committee, human resources and institutional development committee, and compensation committee.
Mexican banking law contemplates two types of compensation for officers and employees: ordinary and extraordinary. Ordinary compensation is salary, benefits and fixed remunerations, and extraordinary compensation covers all types of variable compensations based on results. The compensation committee is the body in charge of overseeing the compliance of these compensations with Mexican law by means of a compensation system that must be implemented and cover all policies and proceedings determined by the bank to comply with the CNBV's general rules with respect to risk management. Mexican laws and regulations do not limit the compensation of banking officers and employees.iii Regulatory capital and liquidity
Regulatory capital for fully fledged retail banks is 90 million investment units (UDIs)8 (currently, this is around 645 million Mexican pesos) and, for the smallest niche retail banks, 36 million UDIs (currently around 258 million Mexican pesos). The regulatory minimum capitalisation index for Mexican banks is, as per Basel III, currently 8 per cent. Each of the 50 retail banking institutions in Mexico has a higher capitalisation index than the minimum required; thus, all banks are qualified by the CNBV under the highest category, with the overall capitalisation index for the Mexican banking system being 19.37 per cent.9 For example, as at December 2021, HSBC, one of the retail banking institutions with a lower capitalisation index percentage, had a capitalisation index of 13.68 per cent; and BBVA México, which is the biggest bank in Mexico, reached a capitalisation index of 19.07 per cent. Conversely, the capitalisation indexes of BNP Paribas México, Deutsche Bank, Mizuho Bank and Pagatodo, a local bank, were 130.10, 244.42, 104.30 and 245.03 per cent, respectively.10
Retail banks' capital, as in most of the world, is divided into Tier 1 and Tier 2 capital, each with their particularities:
- Tier 1 capital, or basic capital, includes capital stock, capital reserves and undistributed profits. It is divided into core Tier 1 capital or basic capital 1, which is paid capital plus earned capital and includes profits, reserves and valuations, and has a minimum capitalisation index of 4.5 per cent; and Tier 1 or basic capital 2, which is composed of regular capital stock plus capital increases that have not been formalised, plus all capitalisation instruments less subordinated debt, share investments, pending reserves and others, and has a minimum capitalisation index of 6 per cent;
- Tier 2 capital, or supplementary capital, finances the bank's activities. It is composed of capitalisation instruments that exceed the basic capital, such as preferred and convertible shares, subordinated debt, debt convertible into shares and a part of the reserves for non-recoverable credits;
- net capital: the sum of Tier 1 and Tier 2; and
- capital supplements, the additional margin that each bank shall contribute to operate with a positive margin promoted by the regulators.
As a consequence of Basel III, Mexico has implemented requirements regarding capital instruments (subordinated debentures). The first requirement is that either the issuer or the controlling entity of the corporate group be listed in the Mexican Stock Exchange. The second is that these instruments shall have one of the following features: convertibility of the principal amount of the subordinated debentures into equity or a reduction in the principal value of the debentures. The convertibility or reduction in the debentures value shall be triggered, regarding the instruments corresponding to basic capital 2, when the ratio of basic capital 1 reaches a value of 6 per cent with respect to the assets subject to the risk. For debentures subject to the supplementary capital, these shall be converted when they reach a value of 4.5 per cent of basic capital 1 with respect to the assets subject to the risk. Hence, the banks may timely absorb any losses, improving solvency in difficult scenarios and before governmental intervention.
Financial groups are regulated under Mexican law by a specific law, the Law Regulating Financial Groups, and specific general rules issued by the CNBV. The regulating groups are supervised by the same governmental agencies as regular retail banking institutions; holding companies of financial groups have a specific treatment that differs from their subsidiaries; and these groups may be composed of different types of financial entities, including non-bank financial institutions or even real estate managing corporations.iv Recovery and resolution
Mexican law establishes two types of early warnings for banking institutions facing solvency or capital problems: minimum measures and additional measures applied discretionally by the CNBV.
Banking institutions may be classified into five groups, according to their capitalisation index:
- Level I: institutions whose capitalisation index is higher than 10.5 per cent;
- Level II: institutions that have a capitalisation index equal to or higher than 8 per cent;
- Level III: banks that have a capitalisation index equal to or higher than 7 per cent;
- Level IV: institutions with a capitalisation index equal to or higher than 4.5 per cent; and
- Level V: institutions with a capitalisation below 4.5 per cent.
Minimum measures have three levels:
- the first level is triggered when a banking institution is downgraded to Level II as per its capitalisation index. In that event, the institution would have to:
- deliver a detailed evaluation report of the reasons for its financial situation;
- not engage in any transaction that may put its capitalisation index below the minimum requirement;
- file a capital conservation plan with the regulator;
- partly restrict dividend payments, compensation and extraordinary bonus; and
- refrain from increasing financing to relevant related persons;
- at the second level, if downgraded further to Level III, the bank would have to:
- deliver a capital restoration plan;
- suspend dividend payments;
- suspend any repurchase programmes for its own shares;
- defer interest and principal payment of subordinated debentures or convert them early into shares; and
- suspend the payment of compensation and extraordinary bonus; and
- at the third and last level, when it reaches Level IV or V, the entity will not be allowed to make new investments in non-financial assets, open branches or engage in any new activity distinct from its regular transactions.
Additional measures also have three different levels, based on the capitalisation index groups:
- for capitalisation Level II:
- the banking institution must deliver a detailed report regarding the manner and terms under which it will manage the assets subject to total risks and the strategy to follow to strengthen its capitalisation index;
- for retail banking entities controlled by foreign financial institutions, the above-mentioned report must be delivered to the highest-ranking officer of such area in the foreign financial institution;
- the institution must retain specialised external auditors for special audits; and
- it must minimise the effects of transactions entered into with entities of the same corporate group that carry a monetary benefit transfer; and
- for Level III, the banking institution must:
- not increase salaries or benefits to any employee (including officers);
- limit the execution of new transactions that may affect its capitalisation index; and
- not execute transactions with entities of the same corporate group; and
- for Levels IV and V, the banking institution must:
- substitute officers, members of the board, statutory auditors or external auditors;
- reduce its risk exposure; and
- modify policies regarding interest rates paid over deposits that are over the regular risk level assumed by the entity.
The law also contemplates a management intervention, which is triggered as a consequence of:
- downgrades of a banking institution's index capitalisation level within one month, and not remedying it within one business day;
- the institution putting itself in a situation that is cause for revocation of its banking authorisation; or
- the institution defaulting on any of its primary payment obligations, and the banking stability committee of the federal government determining that this is the case.
If a management intervention is declared, the CNBV and the Institute for the Protection of Bank Savings (IPAB) will:
- appoint a precautionary manager (with full authority as if that individual acted as sole director of the entity, substituting the board of directors and the shareholders' meeting);
- prepare a report regarding the status of the institution; and
- engage in all activities and transactions required to safeguard the interests of the public at large.
For the fulfilment of his or her duties, the precautionary manager may be assisted by a consultation committee appointed by the IPAB. This managerial intervention may only terminate if the bank has begun its dissolution, the IPAB sells all the bank's capital stock, or the irregular or illegal transactions have been corrected.
If, after the intervention made by the precautionary manager to the banking institution, it is determined by the government's banking stability committee that the institution's recovery is unfeasible, the CNBV will revoke the bank's concession and the IPAB will intervene as the institutional liquidator, starting by paying all the amounts corresponding to secured transactions, and followed by the transfer of the bank's assets to a stable banking institution able to maintain them to preserve the continuity of the banking operations, or to a new banking institution created by the IPAB for that sole purpose; or, in the event that there are only liquid assets, the sale of those assets in favour of any capable third party.
In the event that the assets of the banking institution are not enough to pay its debt, a regulated mechanism to liquidate the defaulting institution's capital stock to cover as much of its debt as possible shall apply. At this moment, the bank is formally declared bankrupt.