PROCAPTE

In 1982, Mexico experienced a crisis and nationalized its banking sector in response. The sector was reprivatized a decade later (World Bank 1995). That same year, the country signed the North American Free Trade Agreement (NAFTA) together with the US and Canada, which entered into force in the beginning of 1994. In this period, foreign capital inflows increased substantially, primarily driven by demand for Mexican government bonds, both peso-denominated Cetes and dollar-denominated Tesobonos. The debt of Mexican banks to foreign banks increased from $8 billion in 1991 to $16.5 billion in 1994 (Graf 1999).

The year 1994 was full of political turmoil. The uprising of the Zapatista Army of National Liberation (EZLN) in the southern state of Chiapas dragged on for months. Four months prior to Mexico’s presidential election, Luis Donaldo Colosio, candidate of the long-ruling PRI, was assassinated. Assassinations of other high-level politicians and the kidnapping of renowned businessmen brought a lot of uncertainty about the stability of the country. Fears of a government default siphoned capital from the country. International reserves fell from approximately $29 billion in February 1994 to $6 billion in December 1994 (Whitt 1996).

On December 1, 1994, the PRI replacement candidate Ernesto Zedillo took office. The Mexican peso had kept a crawling peg exchange rate policy to the US dollar that allowed the peso to fluctuate at most $0.004 per day. However, on December 20, 1994, the government widened the band of acceptable price change and the peso depreciated by 15%. Two days later, Mexico let the peso float freely, resulting in a major depreciation (see Figure 1).

Figure 1: Mexican peso depreciation

Source: FRED 2020.

Initially, financial markets were rattled, as the Mexican government seemed slow to respond, waiting until January 3, 1995, to announce a limited economic program known as the Agreement of Unity to Overcome the Economic Emergency (Acuerdo de Unidad para Superar la Emergencia Económica). The program committed the government to austerity, in hopes that the exercise would allow Mexico to access an International Monetary Fund (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. This 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 Mexican authorities in charge of overseeing the banking sector were the Bank of Mexico, the Ministry of Finance (SHCP), the National Banking and Securities Commission (CNBV)^FNIn May 1995, the National Banking Commission (CNB) and the National Securities Commission (CNV) were merged to become the CNBV. The CNBV is a dependency of the Ministry of Finance. Its President was appointed by the Minister of Finance. and the Bank Fund for Savings Protection (FOBAPROA). FOBAPROA served as a mechanism for “preventive support” to commercial banks and to protect savings. It was the government agency responsible for dealing with bank insolvencies (Graf 1999). It played the roles of bank restructuring, deposit insurance, and in some cases, lender of last resort (World Bank 1995). FOBAPROA went beyond simple deposit insurance. It provided a blanket guarantee of all unsubordinated liabilities of the commercial banks. FOBAPROA had broad powers to extend credit to banks to permit them to meet their obligations to depositors and other liability holders (World Bank 1995; 1998).

FOBAPROA was financed by monthly contributions from banks based on their liabilities. The Bank of Mexico was authorized to extend loans to FOBAPROA. FOBAPROA could also borrow from the Ministry of Finance (World Bank 1995).

The Bank of Mexico administered the daily operations of FOBAPROA. Meanwhile, FOBAPROA’s policy decisions were made by its nine-member Technical Committee. Four were from the Ministry of Finance, one being the Minister. Three were from the Bank of Mexico, one being the Governor. And two were from the CNBV, one being the President. The chairman of the Technical Committee was from the Ministry of Finance and had the deciding vote (Mackey 1999, 20; World Bank 1995). The CNBV had been the only agency with complete access to bank information. It was mainly the CNBV, with assistance from FOBAPROA’s staff, that prepared the technical documents that set the foundation for many of the Technical Committee’s decisions. 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).

Some of FOBAPROA’s objectives, as outlined by the Ministry of Finance included: limiting the risk of bank runs and preserving financial stability; protecting depositors and bank creditors; supporting the liquidity and solvency of institutions; minimizing fiscal costs by allocating them over time; and attracting foreign banks (Mackey 1999; Graf 1999).

During the first months of 1995, Mexican banking authorities, to mitigate the negative impacts of the peso crisis, put forward a number of measures that included provisions of liquidity, exhaustive inspections of banks that resulted in increased provisions, and a Temporary Recapitalization Program (PROCAPTE) for banks (World Bank 1995). The depreciation of the peso increased the peso value of loans denominated in foreign currency. The capital-asset ratio of the banking system fell from 9.3% by year-end 1994 to less than 8% two months later, and the ratio for half of the commercial banks dropped below the 8% minimum (Graf 1999). Banks with US dollar liabilities had to set aside an increasing amount of capital to cover potential losses from the currency devaluation. Meanwhile, higher interest rates increased the number of loan defaults by businesses and consumers across Mexico (Bloomberg 1995a). Eduardo Fernandez, President of the CNBV at the time, said that as a consequence of the devaluation and the abrupt increase in interest rates, the whole Mexican banking system was bankrupt and their equity was negative, including Banamex and Bancomer, two of the largest banks with approximately 50% of the whole market, and 35% of their assets in mortgages.

On February 22, 1995, the CNBV required all banks to increase provisions to the higher of: (a) 4% of the loan portfolio; or (b) 60% of nonperforming loans (NPLs); or (c) provisions required from quarterly loan classifications under previous rules (World Bank 1998). This arose from a concern that loan classification and provisioning had become difficult for banks to handle in the face of a widespread economic downturn. Under the new formula, all banks were required to increase provisions, and several fell short of meeting the required 8% capitalization (Karaoglan and Lubrano 1995; Mackey 1999). In early March 1995, the average reserves for NPLs were about 47.5% (WSJ 1995).

Bank stocks collapsed after the December 20 devaluation. The market capitalization of the whole financial system fell from $26.8 billion to $7.24 billion by early March 1995. Banks found it unfeasible to issue new equity, and the prospects of finding foreign equity partners for the more distressed banks seemed even more unlikely (FT 1995).

The Bank of Mexico was essential to the design and implementation of the Temporary Capitalization Program (PROCAPTE), introduced on February 24, 1995, in a circular the Bank of Mexico sent to all Mexican commercial banks (Mackey 1999). PROCAPTE was designed to temporarily recapitalize banks that, due to the economic situation, were unable to recapitalize themselves. Additionally, it aimed to signal to the financial markets that the government was prepared to support the banking system. PROCAPTE was not intended to provide new, permanent capital, as was the case with other government programs later introduced (Mackey 1999; see YPFS case by Leon Hoyos and Nye 2021 on FOBAPROA’s broad-based asset purchases). FOBAPROA acted as the administrator of PROCAPTE (World Bank 1995; Mackey 1999).

Earlier in February 1995, the Mexican government had amended the Law of Credit Institutions to allow for recapitalizations of commercial banks. All commercial banks were eligible to apply for PROCAPTE, and participation was voluntary (Mackey 1999). However, if a bank whose capital was below the regulatory minimum of 8% of risk-weighted assets chose not to participate, it risked losing its banking charter (World Bank 1995).

Funding for PROCAPTE came from the Bank of Mexico. In March 1995, the World Bank and the Inter-American Development Bank provided a $3.25 billion loan to the Mexican government, $2.25 billion of which was earmarked for support to the banking system, particularly to avoid bank insolvencies and help with accounting, public reporting standards, and regular inspections (DJ 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 fell below 2% of risk-weighted assets or if its capitalization ratio deteriorated at a rate exceeding 25% of the rate of deterioration of the rest of the PROCAPTE banks. 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 at an account at the Bank of Mexico for the duration of the recapitalization (see Figure 2). The Bank of Mexico paid the same rate of interest as the rate on the debentures. The size of the issue was sufficient to raise the capital level above 9% for the six banks that participated (Karaoglan and Lubrano 1995; World Bank 1995). Participating 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). If a bank remained in trouble, the government could take over the bank (WSJ 1995). If the bank’s capital ratio fell below 8.5%, FOBAPROA would acquire more subordinated debentures to reach the 9%. If a bank's capitalization ratio increased to more than 9%, the bank could redeem, partially or fully, the subordinated debentures held by FOBAPROA before their conversion (Karaoglan and Lubrano 1995).

On March 31, 1995, six banks participated in PROCAPTE, including Serfin, Inverlat, and Bital—the third-, fourth-, and fifth-largest banks in Mexico. All six banks failed to meet the government’s 8% capital requirement and risked losing their banking charters if they did not participate (Bloomberg 1995a; see Figure 3).

Figure 3:  PROCAPTE recapitalizations on March 31, 1995

Sources: Author’s compilation, based on: LAD 1995b; Bloomberg 1995b; Bloomberg 1995c; Graf 1999, table 4; Cypher 1996; Reuters 1996; World Bank 1995.

The combined equity of the six banks totaled MXN 10.2 billion at the end of 1994 (22.8% of the system’s total equity) and decreased by about MXN 3 billion by the end of February 1995^FNExchange rate on March 31, 1995, was MXN 6.82 = $1 (FRED 2020).. The banks’ average capitalization ratio fell from 8.1% to 5.8% in this period. PROCAPTE’s MXN 6.5 billion in issues increased the banks’ average capitalization ratio to 9.6% (Karaoglan and Lubrano 1995; World Bank 1995). Banks that did not seek PROCAPTE in the first round of recapitalizations were not excluded from applying in subsequent years (MXBU 1995).

Analysts expected a greater number of banks to participate in PROCAPTE. According to the CNBV, the banks that did not sell convertible bonds met reserve and capital requirements (Bloomberg 1995b). It is unclear from the research whether receiving new capital from shareholders was a precondition to participating in the program.

By the fall of 1995, only three banks remained in PROCAPTE, two of which were recapitalized through FOBAPROA's purchase of their loan portfolio and the other through an intervention (Karaoglan and Lubrano 1995). By June 1996, PROCAPTE holdings decreased to MXN 2.9 billion, with only two banks participating. By the end of 1996, this number rose to MXN 11.9 billion when one of the banks needed additional support. By June 1997, both banks had liquidated their debts. Of the six banks that participated in PROCAPTE, only two remained under control of their original shareholders; three were eventually taken over by the authorities, and the other was taken over by another bank (Graf 1999; OECD 1998). Overall, PROCAPTE concluded within a year, as participating banks secured private capitalizations or were part of other interventions (World Bank 1998).

In June 1995, Serfin left PROCAPTE after the bank repurchased MXN 3.2 billion of its mandatorily convertible subordinated debentures and raised MXN 2.17 billion in new capital (Reuters 1995a). A top Serfin official estimated that the bank’s capitalization level would surpass 9% once the operation was completed. He said that PROCAPTE gave the bank a capitalization ratio of more than 10% (Reuters 1995b). In June 1996, Confia also terminated its participation in PROCAPTE (Bloomberg 1997).

All PROCAPTE recapitalizations were repaid, except for the capital injected to Inverlat of MXN 1.4 billion, plus accrued interest of MXN 700 million. This was converted into equity shares of the bank. However, the value of these shares was zero, the balance was written off, and FOBAPROA recognized the losses (Mackey 1999).

Following the PROCAPTE recapitalization, the Mexican banking system began to attract foreign capital. Canada’s Scotiabank managed the operations of lnverlat with an option to acquire majority ownership in 2000. Citibank acquired Confia. All these transactions were facilitated by additional government support, most of it in the form of FOBAPROA’s purchases of troubled loans. Serfin, Mexico's third-largest bank, operated under an agreement in which HSBC acquired a 20% stake in the bank and played an active role in its management. Bital was largely controlled by a foreign financial institution. About 20% of the system’s assets were controlled by foreign financial institutions; including Serfin, the number would reach 30% (World Bank 1998).