Mexico’s Quiet Reform

Mexico’s having quite the year, and not just because El Tricolor qualified for the 2014 World Cup. Since taking office last December, President Enrique Peña Nieto, his Institutional Revolutionary Party and the opposition National Action Party have launched a massive economic reform push under their Pact for Mexico. They’ve taken on Telecom and Media monopolies, put the state-run Energy sector in their crosshairs and modernized the labor code, all in the name of opening up Mexico’s economy. And while these and other similar moves should provide tremendous economic benefit over time, another reform that has flown mostly under the radar has the potential to provide sizeable near-term benefits: a simple banking reform, just passed by Mexico’s Senate. With banks about to be able to lend more freely, Mexico—and the global economy—is about to get more fuel for growth.

Mexico is one of the most underbanked countries in the developing world. Commercial bank credit to the nonfinancial private sector is just about 15% of GDP—peanuts compared not only to developed economies like the United States (150%), but also Emerging Markets like Brazil and Chile (50% and 70%, respectively). Lending to small businesses and low-income families is especially limited. Why? Current laws and regulations make it tough for banks to enforce lending conditions. Collecting collateral on a loan gone bad is an arduous process. For example, it takes three years, on average, for commercial banks to repossess a house from a delinquent mortgage, compared to approximately four months in California (repossession laws vary among US states) and one month (following a court hearing) in the UK. This incentivizes banks to lend to only the safest, most credit-worthy businesses and individuals, which shuts out small and medium businesses (SMEs). For banks, the risk/return trade off of serving even slightly iffy borrowers doesn’t make sense.

SMEs have historically had a difficult time competing in a country dominated by huge state-run enterprises, and much of the Pact for Mexico aims to improve their plight. SMEs, which are far less bloated and prone to corruption than the state-run monopolies, could and should be the economy’s growth engine. Monopoly reform creates room for that to happen—SMEs have more opportunities and more room to compete. But they also need credit so they can invest and grow. If banks don’t lend, SMEs’ potential goes by the wayside—or businesses fund operations with credit cards, an extremely costly strategy.

The pending bank reform aims to fix this by strengthening banks’ abilities to recover on bad loans—essentially encouraging banks to lend by curbing the risks. The new system includes specialized courts and judges—important for an overworked and overextended judiciary—and enables development banks to register losses, which allows them to underwrite more SME lending. This should give banks confidence they won’t be hampered by a slow, ineffective judicial process, likely enabling them lend more freely—supply increases!

Unlike the proposed energy reforms, which may take years before we see an impact, the lending reforms could bring benefits in the near term. Barring unforeseen delays in implementing new laws—always a possibility—Mexico’s central bank governor Agustin Carstens said the reform could increase the potential GDP growth rate by half a percentage point over the next two to three years, a figure some consider conservative. When banks lend to more businesses, more capital flows through the real economy, fueling growth. When SMEs spend to expand their businesses they’ll likely invest in new equipment, technology, facilities and the like, giving Mexico’s economy a nice tailwind. US firms should get a small boost, too—Mexico is the US’s third-largest trading partner, accounting for 13.2% of total trade year to date (through September 30). The more Mexico and its businesses grow, the more we trade.

A Mexico with freer markets and a modernized banking system is likely a faster-growing Mexico—and a bigger contributor to global growth. With many investors still looking to the so-called BRICS as the biggest Emerging Markets and fretting a slowdown, a bigger Mexican contribution to global GDP likely catches a lot of folks off guard. That underappreciated input likely provides tailwinds globally, not just in Mexico.