PROCAPTE

On January 3, 1995, the Mexican government announced a limited economic program. The program, known as the Agreement of Unity to Overcome the Economic Emergency (Acuerdo de Unidad para Superar la Emergencia Económica) committed the government to austerity, in hopes that the exercise would allow Mexico to access an IMF Stand-By Arrangement and reassure foreign investors (GAO 1996). Two months later, on March 3, 1995, the government announced a revised and much broader financial package that contained specific measures to strengthen the financial system. It included fiscal and monetary adjustments, programs to deal with troubled banks, and an increase in the social safety net. Mexico received financial support through a $52 billion loan package from the international financial community, of which the US Treasury Department contributed $20 billion, the International Monetary Fund $17.8 billion, and the Bank for International Settlements $10 billion, with the rest coming from other bilateral and multilateral sources (World Bank 1995).

The first program introduced to recapitalize the banks was the Temporary Capitalization Program (PROCAPTE) in February 1995. PROCAPTE was intended to be a temporary program and was followed by further government measures such as the Capitalization and Loan Purchase of Bank Portfolio Program (CLPP) (World Bank 1995; see YPFS case by Leon Hoyos and Nye 2021 on FOBAPROA's broad-based asset purchases).

In February 1995, the Mexican Congress amended the Law of Credit Institutions to remove legal restrictions for injecting capital into banks. The subordinated debentures were issued in accordance with Article 4 of the Law of Credit Institutions (Mackey 1999).

The Temporary Capitalization Program (PROCAPTE) was announced through a Bank of Mexico circular of February 24, 1995, sent to commercial banking institutions and entered into effect on March 31, 1995 (World Bank 1995).

FOBAPROA acted as the administrator of PROCAPTE (World Bank 1995, 50–51, 97; Mackey 1999). The Bank of Mexico managed PROCAPTE separately from other programs (World Bank 1995).

FOBAPROA was established in 1990^FFOBAPROA is regulated by Article 122 of the Credit Institutions Law (Ley de Instituciones de Crédito), which became effective on July 18, 1990 and governs commercial and development banks (World Bank 1995). as a trust (fideicomiso) managed by the Bank of Mexico. It served as a preventive support mechanism for commercial banks, as well as for savings protection. FOBAPROA was the government agency in charge of bank insolvencies (Graf 1999; World Bank 1995). It also played the roles of bank restructuring, deposit insurance, and in some cases, lender of last resort (World Bank 1995). FOBAPROA offered more than simple deposit insurance. It provided a blanket guarantee of all unsubordinated liabilities of the commercial banks (World Bank 1998). FOBAPROA had broad authority to provide credit to banks to help them fulfill their obligations to depositors and other liability holders (World Bank 1995).

The Bank of Mexico managed the day-to-day operations of FOBAPROA. Meanwhile, FOBAPROA’s policy decisions were made by its nine-member Technical Committee: four from the Ministry of Finance, one being the Minister; three from the Bank of Mexico, one being the Governor; and two from the CNBV, one being the President (World Bank 1995). The chairman of the Technical Committee was from the Ministry of Finance and held the deciding vote (Mackey 1999). Although the CNBV contributed only two members to the Committee, it was mainly the CNBV, with the support of FOBAPROA staff, that prepared the technical documents that set the foundation for the decisions of the Technical Committee. The Bank of Mexico acted as the trustee of FOBAPROA, responsible for carrying out the Technical Committee’s resolutions and signed all agreements involving FOBAPROA’s financial assistance (Mackey 1999).

FOBAPROA had the right to request a review performed by the CNBV or an external auditor of the accounting records of a participant bank while the bank participated in the program or for six months after its participation. Conversion rates could be adjusted based on the results these reviews (World Bank 1995).

Eduardo Fernandez, former President of the CNBV, said that during the crisis, a tripartite committee not recognized in law operated permanently as an organ of decision and execution. It was integrated by the Ministry of Finance and Public Credit, the Bank of Mexico (including FOBAPROA), and the National Banking and Securities Commission (CNBV) in which the CNBV served as the coordinator of this ad-hoc committee and matters were resolved in a very dynamic way.

On March 31, 1995, six banks were recapitalized, including Serfin, Inverlat, and Bital—the third-, fourth-, and fifth-largest banks in Mexico. The overall amount was $950 million. The size of the issue for each bank was sufficient to raise the capital level of each to 9% (World Bank 1995). The banks’ average capitalization ratio increased from 5.8% to 9.6% (Karaoglan and Lubrano 1995; World Bank 1995).

PROCAPTE was funded by the Bank of Mexico (World Bank 1995). The central bank offset the monetary impact of the program by requiring banks to deposit compensating reserves with the central bank (OECD, 1995).

PROCAPTE was created principally through a loan of $3.25 billion provided by the Inter-American Development Bank and the World Bank. Of that, $2.25 billion went directly to support the banking system, and $1 billion was directed toward helping banks support government social programs. The two international institutions, together with Mexican authorities, agreed to strengthen accounting and public reporting standards and conduct regular audits of their accounts to ensure the solvency of Mexican banking system (DJ 1995).

Eduardo Fernandez, former President of the CNBV, said that funding for PROCAPTE was never required from the loan made available by the World Bank and the Inter-American Development Bank.

Participation in PROCAPTE was voluntary and open to all Mexican commercial banks. However, banks whose capital fell below 8% of risk-weighted assets faced mandatory recapitalization by FOBAPROA or the loss of their banking charter if they did not participate.

Banks seeking PROCAPTE assistance were required to submit a letter signed by the bank’s general manager during the last week of the month prior to receiving the recapitalization, with the obligation of later providing the financial details required by FOBAPROA and also the stockholder’s approval of corresponding agreements. The agreements for the issuance of the convertible debentures included recognizing any losses suffered before the conversion date. Shareholders of undercapitalized banks were required to submit a recapitalization plan within one month. If they did not, PROCAPTE would impose a recapitalization (World Bank 1995).

Through PROCAPTE, banks issued subordinated debentures to FOBAPROA in accordance with Article 4 of the Law of Credit Institutions. These were convertible into equity shares (common stock) with voting rights after five years. FOBAPROA could convert the debentures earlier if the bank’s capital fell below 2% of risk-weighted assets or if its capitalization ratio deteriorated at a rate exceeding the rate of deterioration of the rest of the PROCAPTE banks by more than 25% (World Bank 1995). After five years, any unpaid amounts would be converted to ordinary capital and sold by the government. PROCAPTE aimed to support banks rather than shareholders and did not intend to handle insolvencies (OECD 1995).

FOBAPROA bought the subordinated debentures with cash. However, banks had to deposit and maintain the cash proceeds in an account at the Bank of Mexico for the duration of the recapitalization (see Figure 2). The Bank of Mexico paid interest on the accounts at the same rate as the rate on the debentures. As a result, the debt was essentially costless to participating banks. The size of the issues were such that bank capital levels floated above 9% (World Bank 1995).

Banks participating in PROCAPTE had to maintain a capital ratio of at least 9% of net capital to risk-weighted assets (World Bank 1995). Banks were allowed to count the debentures to fulfill regulatory capital requirements (World Bank 1998). This requirement could be decreased to 8.5% if this decrease was the result of the establishment of preventive reserves. If a bank remained in trouble, the government could take over the bank. If the capital ratio fell below 8.5%, FOBAPROA would acquire more subordinated debentures to reach the 9%. If a bank’s capitalization ratio increased above 9%, the bank could redeem, partially or fully, the subordinated debentures held by FOBAPROA before their conversion (Karaoglan and Lubrano 1995). The administrators of PROCAPTE reserved the right, in the event that market conditions improved, to demand that the bank recapitalize itself by purchasing all or part of the subordinate debentures upon one year’s notice (World Bank 1995).

The issuer could acquire all or part of the debentures in the same proportion that it raised its capitalization level. The capitalization needed to support any growth had to come from the bank's own resources, such as profits and surplus, or from subordinated debentures not convertible into stock (World Bank 1995).

Banks were not allowed issue dividends, additional capital debt, or additional mandatorily convertible subordinated debentures until they repaid FOBAPROA or unless these were issued aligned with PROCAPTE (Mackey 1999; World Bank 1995).

Conversion terms

FOBAPROA set the following formula for converting the subordinated debentures into equity. The institution would deliver the amount of shares resulting from the application of the following formula:

NA=OS/[(CC-OS)/A]

Where:

NA = Number of shares acquired as a result of the conversion.

CC = The accounting capital on the last day of the month preceding the conversion date, or the arithmetic average of the accounting capital on the last day of the three months preceding that date, whichever was less. The CNBV and an external auditor had to approve the statistics.

OS = Amount of the debentures issued for PROCAPTE added with their yields.

A = Number of shares in circulation on the conversion date. If a bank had issued other mandatory convertible debentures, the amount obtained by applying the conversion formula agreed would be added to the number of shares.

PROCAPTE was designed such that, under normal circumstances, FOBAPROA would not convert the debentures. But if FOBAPROA did exercise its right of conversion, it would dispose of the shares as soon as possible (World Bank 1995).

PROCAPTE banks were subject to tighter supervision from the CNBV. Institutions suspended dividend payments and limited new loans (World Bank 1995).

To exit PROCAPTE, banks had to inject new capital before the five-year term of the mandatorily convertible debentures expired. Some banks were able to do so with additional government support via the Capitalization and Loan Purchase of Bank Portfolio program (CLPP). Other banks failed to raise capital and were taken over by FOBAPROA, with the CNBV intervening in some cases (Mackey 1999).

FOBAPROA could convert the debentures earlier if the bank’s capital fell below 2% of risk-weighted assets or if its capitalization ratio deteriorated at a rate exceeding the rate of deterioration of the rest of the PROCAPTE banks by more than 25%. When FOBAPROA reached the status of majority shareholder of a bank, it would dilute or replace completely the previous shareholders and restructure the bank. To minimize this transitory situation, FOBAPROA would establish principles and programs for the resolution, restructuring, and sale of those banks. FOBAPROA followed several objectives in this process: to reduce systemic risk; to ensure safety and soundness of banks and saving institutions, and not shareholders; to promote public confidence; to minimize restructuring costs; to prevent interventions by acting in a timely fashion; and to minimize public-sector participation (World Bank 1995).

PROCAPTE was designed such that, under normal circumstances, FOBAPROA would not convert the debentures. But if FOBAPROA did exercise its right of conversion, it would dispose of the shares as soon as possible (World Bank 1995).

If a bank’s capital adequacy ratio fell below zero, FOBAPROA would convert the subordinated debentures and replace the bank’s management. FOBAPROA would become the owner of the bank through the write-off of the previous capital and the subscription of a new capital issue. FOBAPROA then would put in place a program to recapitalize or rehabilitate, close, liquidate, sell, or merge the banks under its control (World Bank 1995).

This was based upon the World Bank’s advice that retaining the same management and ownership during a recapitalization “is likely to be unfair and perverse, because it would provide incentives for bad management; and ineffective, since the same problems are likely to recur” (World Bank 1995).

At the request of Mexican authorities, the Mexican Congress modified bank ownership laws to allow foreign financial institutions to control domestic banks that were in trouble. This accelerated the opening of Mexico's banking system to foreign participation (World Bank 1998).