Mexican Banks Show Low Risk of Contagion From SVB

Silicon Valley Bank (SVB) and Signature Bank were the second and third largest bank failures in US history, respectively. Following these events, people started questioning the soundness of the global banking system, financial markets experienced a great deal of volatility, and regulators around the globe rushed to assure the public that the whole financial system remains robust. In view of all this, it might be appropriate to take a deep look at the foundations of the Mexican financial system, which, as of today, seem solid to this analyst.

Interest rate hikes, poor management and technological changes were some of the reasons behind the SVB crisis. Much of SVB’s deposit portfolio came from volatile and interest rate-sensitive sectors, such as technology, startups and venture capital. Hence, firms within these industries —- and SVB’s deposits — thrived in an environment of zero interest rates and excessive liquidity, but rapidly started to feel the pain when the Federal Reserve (Fed) started its — still ongoing — campaign to reign in the worst inflation in four decades, raising benchmark interest rates from 0-0.25% to 4.75-5.00% in just one year and reverting some of the quantitative easing of previous years. As the venture capital frenzy dried up, SVB’s clients tapped their bank accounts, desperate to cover their working capital needs.

Furthermore, most of SVB’s deposits were invested in held-to-maturity (HTM) securities. HTM securities (like long duration bonds) yield higher returns but are less liquid and their valuation is more sensitive to inflation and changes in interest rates than, say, available-for-sale securities (AFS). Hence, the value of some SVB assets collapsed as interest rates increased dramatically. This could have “only” remained as an unrealized loss, but SVB was forced to sell many of its HTM securities at a discount, to honor its customers’ withdrawals.

When the broad public got wind of all the above-mentioned issues and SVB announced its intentions to raise capital, deposit outflows deepened and a major bank run was inevitable, exacerbated by technological change: today, there’s no need to drag ourselves to the bank and wait in endless lines to carry out any transaction; all we have to do is reach our phones and type a few commands. Also, customers of other small and regional banks panicked and began to pull out their deposits, which led to the failure of Signature Bank.

Authorities may have some responsibility in this mess, since SVB’s poor management of interest rate and liquidity risk was evident, at least, since the end of 2022. But the actions adopted in the aftermath of the failure  of SVB and Signature Bank seem to be effective in avoiding a run on the whole financial system. Firstly, regulators issued a systemic-risk exemption to guarantee all the deposits on both banks. Secondly, the Fed created a facility to provide liquidity to banks in case they experienced a sudden increase in deposit outflows. Furthermore, the largest banks in the US system (Bank of America, Wells Fargo, Citigroup, JP Morgan and others) agreed to assist another troubled regional bank (First Republic), through a $30 billion deposit. Also, let’s not forget that the whole US banking system is relatively well capitalized, with the Tier 1 risk-based capital ratio standing at 13.6%, well above the 9.9% of 2008.

Moving on to the Mexican banks, the capital ratio for the whole system stands around 19%, above the 16% before the pandemic. Also, the most relevant asset of Mexican banks is their lending portfolio, which is 50% of total assets, while investment securities play a minor role, accounting for only 24% of total assets (57% in the case of SVB). This clearly demonstrates that Mexican banks run a much more traditional business model and that their management is more conservative than SVB and even other financial institutions in the US. On top of that, a bank run, although it is not impossible, can hardly materialize when customers are able to get a real risk-free interest rate of nearly 4% on their savings accounts.

Given the above-described nature of Mexican banks, interest rate and liquidity risks seem to be relatively manageable. But what about other risks, such as the effect of an economic downturn on the quality of the lending portfolio? That’s a fair question, considering that the lending portfolio accounts for half of total assets, as mentioned above, and economic growth is expected to moderate this year, as a result of persistently high levels of inflation and monetary policy tightening.

To answer this question, we should look at the delinquency ratio, which stood at 2.1% as of January (that is relatively low by historical standards), while bank lending showed a real annual growth of 3.1%. Furthermore, the Mexican economy has shown more resilience than expected. At the start of 2023, economic activity, measured by the Global Economic Activity Index (IGAE), accelerated to 0.6% m/m, its largest expansion in four months, and the unemployment rate marked a historical low of 2.9%.

All in all, Mexican banks have a more traditional business model than SVB and other US banks, hence liquidity and interest rate risks appear somewhat under control. Also, the economy seemed to be firmer at the start of the year, reducing the probability of a severe worsening of lending portfolio quality.