How Banorte is Taking Action Against COVID-19By Jan Hogewoning | Tue, 04/14/2020 - 14:36
Q: What impact are you expecting from the COVID-19 crisis and what is the worst-case scenario?
A: High volatility across financial assets is one impact, although it has not yet been as high as the 2007-2008 financial crisis. A second is the possibility that the number of nonperforming loans will rise. First, because of greater volatility in the financial markets and second, due to the lack of revenues and lingering fixed and variable costs, the quarantine is making it hard for SMEs to access liquidity. If the government does not implement a fiscal program for companies in the next few weeks, this will worsen greatly. Banorte has been fortunate because we have not increased our portfolio in SMEs significantly over the last two years after experiencing problems with a credit authorization system. Nonetheless, we will still feel an impact in this area.
The third impact is economic crisis. Regardless of the fiscal program, which will make it easier for everyone, the unemployment rate will go up, which will also impact nonperforming loans. Right now, unemployment is at 3.6 percent, but it could go as high as 5 or 6 percent.
Banks in Mexico are capitalized at an average of 15 percent, similar to 2008-09 financial crisis. However, this 15 percent is more solid today because the banking sector complies with Basel III and the liquidity requirement ratio. Banorte is capitalized at 30 percent. We have enough capital to face the crisis. It will be tough, no doubt, particularly with the current quarantine and the uncertainty regarding when things will go back to normal.
In the worst-case scenario, the quarantine would be extended to eight weeks or more. Our projections are for new cases to peak around April 20. I believe we will probably exit quarantine in the first half of May. This is the baseline scenario. A bad scenario would be to extend it for the whole month of May, and in the worst case, extend it through June. We would be aiming to cut expenses where it hurts less and become more restrictive regarding credit issuance. While in the past we would change the way we pay dividends, the CNBV (Mexican bank regulator) has advised financial institutions not to pay dividend, at least this year. Finally, the last resort would be layoffs.
Q: What steps has Banorte taken in light of the COVID-19 pandemic?
A: First, we are providing the same services. As the government identified banking as essential services, during phase 1, 100 percent of our branches remained open. Of course, they are manned with minimum personnel, who are following the correct sanitary and health procedures. We receive customers one by one, with stickers on the floors indicating where they can stand. Now that we are in phase 2, we are working to close about one third of our branches, choosing the ones that are too close to each other, following the regulator. On the operational side of the bank, 70 percent of our staff are working from home on a rotation basis, coming into the office every two weeks, which is the incubation period of the virus. Furthermore, they operate in different parts of the office than their previous shift. Our sanitation staff is working harder than before, rigorously sanitizing everything.
Our credit lines also remain open. This is a commitment from Banorte to help customers cope with the quarantine. We want to prevent liquidity issues from becoming a solvency problem, which is why we were the first bank to defer interest payments on all main loans, credit cards, mortgages and SME loans for four months. Every bank in Mexico has asked the authorities for a certain degree of flexibility regarding the regulatory framework.
Q: What actions are being taken by the Bank of Mexico (Banxico)?
A: Banxico cut interest rates by 50 basis points, and will likely cut them further. The bank’s next meeting is in May. In terms of nominal interest rates, Mexico ranks the highest among emerging markets. Banxico has not done as much as other central banks around the world during the crisis. In the past months, 67 banks have cut rates, in part to create controlled inflation. There is more space for Banxico to reduce rates. Many people believe the bank could do a lot more than just 50 or 100 basis points. Right now, rates are around 6.50 percent but they should be lowered to 3 percent. Unfortunately, Banxico will not be able to do that partially because of the exchange rate volatility. It is important to remember that the credit penetration rate in Mexico is one of the lowest among emerging markets. The main channel of transmission of monetary policy is not the aggregate demand channel via credit. The main channel of transmission is the exchange rate. They can lower the rates taking care that the exchange rate does not go through the roof.
In this context, Banxico has announced a series of measures to provide liquidity, in dollars and pesos. It has increased non-deliverable forward (NDFs) auctions. It is also auctioning US dollar credit, repayable in six months, providing liquidity in dollars. Fortunately, neither of these two mechanisms require use of foreign reserves, even though Mexico’s foreign reserves are very high. If you add the flexible credit line of the IMF, the central bank has US$285 billion dollars in foreign reserves. This is three times what the central bank had during the financial crisis of 2008-2009. Banxico is using the swap line that the US Federal Reserve extends. In other words, the dollars are coming from the US Fed, not Banxico. For pesos, to increase liquidity, the bank reduced the monetary deposit requirement. All banks that have an account at Banxico must have a certain amount deposited. They reduced this to provide some liquidity. They also did bond exchanges, and are now purchasing bonds at the long end of the curve and providing short-term bonds, to provide more liquidity.
Q: What impact have you felt from the rising dollar-peso exchange rate?
A: By law, we need to cover all our FX positions. In terms of our treasury, we do not have a problem. The loans we have issued in US dollars are covered with other measures. In our capital offering we have Tier 1 and Tier 2 bonds, both dollar-denominated.
From a macroeconomic perspective, there are two impacts. First, some companies do not have a natural supply in dollars. Sometimes they issue debt in US dollars, leading to a foreign currency mismatch. We do not see the problem going this far even though the exchange rate has shifted significantly. Even with our smaller clients, we have not observed this. In terms of inflation, in the past, for a 10 percent depreciation of the peso we had to add 100 basis points to the headline inflation over a three-month span. Things have changed significantly since 2004. Regardless of how the economy is doing, for the same percentage of depreciation we now have to add 25 basis points instead of 100 in a time span of six to nine months. The state of the economy does matter now. In a recession or deceleration, it is harder for companies to transfer higher costs to the customer. At the moment, our own forecast for the year is 3.6 percent inflation. We have not changed that, although we are planning a revision in early May. The economy is already facing a negative output cap and gasoline prices are low. At least this will compensate the impact of the shift in the exchange rate.
The equilibrium level for the exchange rate, for at least the next 14 months, is MX$22 to the dollar. The interest rate between the US and Mexico is carried. Carry trade, however, is no longer an important indicator due to high volatility. Today, we are facing COVID-19. Next, we will face the US election. Trump will not spare Mexico in his political attacks. USMCA may have already been practically approved but security and the wall will be a topic for sure. His comments will strengthen the dollar further. Its value will then probably depreciate after the election and the peso will benefit from that.
Q: What actions are being taken by the government?
A: The Ministry of Finance changed the calendar for bond issuance, now issuing them on a quarterly basis. They reduced the amount they will issue at the long end of the curve and increased the amount at the short end of the curve. This will have the same impact as with bond exchanges. We are expecting much more from the government. We value the fact that our president wants to maintain fiscal responsibility. However, in times of a health and an economic emergency, the most important thing is to reassign part of the budget to areas that need it.
The budget has many parts. The first part is government administration, which does not have much room for reallocation. The second is pensions, where you cannot do a lot either. Third, you have social programs, which have been elevated to constitutional level so they no longer provide much flexibility for reallocation. What is left is the budget for the main construction projects the president has promised. These include the Mayan Train and the Dos Bocas refinery. Those budgets should be reallocated to health, to buy more ventilators and to undertake other measures to support the health system. These funds should also be used to help companies. SMEs do not have enough cash to survive three or four weeks without revenue, let alone to pay their employees. The government will either have to direct funds to them or defer payment of taxes and increase deductibles on a temporary basis.
Q: Where does the country stand regarding emergency funds?
A: We have emergency funds. Unfortunately, the government had to use half of the biggest emergency fund last year: the Budgetary Income Stabilization Fund (FEIP). All the stabilization funds add up to approximately US$9.5 billion. This is far higher than in 2008, when it stood at approximately US$3.15 billion. However, because of the decline of GDP, non-oil fiscal revenues have also declined significantly. To comply not with the primary surplus but at least with the deficit target proposed by the budget, the government will have to use stabilization funds. I do not think this will be enough to help out companies and counter unemployment. Companies will have to fire their workers and some will close down. To revive them will be very hard if not impossible. I would qualify the central bank actions as timely, deep and showing commitment. With respect to the government, we are still waiting for more action.
Q: How probable are bank bailouts?
A: Rules and regulations in Mexico have been very restrictive since the Tequila financial crisis in 1995. This is why Mexico was also the first country to comply with Basel III rules for capital allocation and leverage. While bailouts are a possibility, we do not think we will see a bank bailout in this crisis. Smaller banks facing problems could be absorbed by larger banks. We also have Federal Deposit Insurance (IPAB), which did not exist before. It allows banks to cover around US$100,000 per account. Of course, if the account is in mutual bonds or stocks, you have a very different issue.
Q: What opportunities could arise from the crisis?
A: There are three types of opportunities. First, we were the first to defer payments for our customers for the next four months. This has an impact on our customers. It helps people notice that we support our clients. We were very transparent with our proposal, declaring we were not going to charge any late fees, commissions and nothing would show up in the credit bureau as credit-negative. This action can help attract new customers.
Second, since we are a financial group, not only a bank, we have other wings that continue to grow. Banorte is also an insurance company, a brokerage house, and we even have a fiscal warehouse, pension funds and mutual funds. We are open to acquiring or merging with other institutions or acquiring assets from other banks. Mexico has 52 banks. The major eight institutions have around 70 percent of the total banking assets. Having said this, smaller banks will be facing more trouble trying to refinance their operation. They could face issues with nonperforming loans and, as result, they could have trouble complying with their liquidity requirements. We could acquire these banks or buy assets, such as loans.
Third, even though we often state we are a technology-driven bank, having won awards for our applications, this situation is definitely pushing us to the edge in terms of technology use. Integrating and expanding our capabilities in this area will allow us to become even more efficient. While we normally would have progressed at a slower pace, this situation is speeding things up. Obviously, more home office and less use of office space will also be a more cost-efficient development.
Grupo Financiero Banorte is a Mexican banking and financial services holding company. It is one of the four largest commercial banks in Mexico by assets and loans and the largest retirement fund administrator
Apart from being Chief Economist and Head of Research at Grupo Financiero Banorte, Gabriel Casillas is also president of the National Commitee of Economic Studies, part of the Mexican Institute for Financial Executives (IMEF)