Sunday, March 29, 2009

Mexican banking and upper bound rates

In recent weeks a debate developed at congress. Mexican banks have a foreign nature since most of them are owned by transnational corporations.

Attention to their policies about active rates was drawn when it came to light that these institutions are still profitable. Official agencies such as the National Banking Comission (CNBV) declared that profits were to be explained by charges on depositors, other than interest rates, for example, those made cause of transactions, commonly known as commissions.

Furthermore, it was made public that rates are considerably higher in Mexico than in banks' home- countries.

These facts caused outrage in a number of political sectors. Even though banks argue that high rates can be supported on an income and risk assessment, comissions can not.

There is one more argument that add weakness to the risk argument of above, Mexican bank market is an oligopoly.

This is why Congressmen are inolved in a series of reforms addressing high rates and comissions. However popular, the first problem -interest rates- is far more complicated to solve. It involves a series of reforms of the market structure since an apparent colusion is taking place.

Comissions on the other hand, are only an instrument for voracious rent-seeking. It is common knowlege, for example that if one holds 1k pesos in a bank account for a year, the balance will end up well below 1k pesos, since a comission of no use would have charged.

The latter is a clear example of a pervasive rent-seeking scheme, which in turn provides with no incentives to lend to a risky project. Moreover, high interest rates with long terms became an appealing mechanism to dilute consumption credit risk.

Put together all these features and you will have a poor banking system. Possible solutions rely on legislation, certainly not for high interest rates, but for the high level and number of comissions. A fix yearly schedule for these charges should be decided by either the Central Bank or the CNBV. In order to address the number and level of comissions a feasible solution should be to increase savings mobility across banks. This only measure will end up reducing both the number and the level of comissions -I. Llamosas thought this too.

Another possible measure can force the recipient bank to pay for the comission charged for changing one's savings account from a bank to another. An optimal rule would include a zero comission in changing banks for a depositor.

The case for an upper bound in interest rates is more complicated. Assume there is a maximum rate i*. Every economist knows that the interest rate is composed by at least three parts. First, it must measure the risk of re-payment. Second, it must provide inflation insurance. Third, it includes an extra positive profit for the bank.

Assume this third part is zero -like a competitive market should observe. Now, there are at least two kinds of agents with high inherent risk, the lower income citizens and the risky projects undertaken. Both would need to pay an interest that would probably be higher than i*. So, none of this agents will be a subject with credit worthiness. The latter may force this agents on to the black market of credit, known for it's ruthlessness.

Assume that i* is set too low, then this latter case holds. Assume i* is set too high, then we have the current situation, and there are no incentives for banks to lend at a competitive rate since a possible solution (a collusive one) is to set rates at i*.

Although profitable in terms of votes for this summer's election, imposing an upper bound to interest rates charged on banking loans is not an option. Congress should focus on comissions and improving market mechanisms in order to guarantee competition.

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