A loan-level analysis of bank lending in Mexico

UAA

BIS Working Papers

No 802

 

A loan-level analysis of bank lending in Mexico

by Carlos Cantú, Roberto Lobato, Calixto López and Fabrizio López-Gallo

 

Monetary and Economic Department

July 2019

 

JEL classification: D22, D84, E31

Keywords: inflation expectations, firms' survey, new information.

This publication is available on the BIS website (www.bis.org).

 

© Bank for International Settlements 2019. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated.

ISSN 1020-0959 (print)

ISSN 1682-7678 (online)

 

A loan-level analysis of bank lending in Mexico

by Carlos Cantú, Roberto Lobato, Calixto López and Fabrizio López-Gallo

 

Abstract

We use loan-level data from the Mexican credit registry to study how bank-specific characteristics influence credit supply. We explore how these characteristics affect the transmission of monetary policy and their role in building banks’ resilience to external shocks. Then, we compare the response of the credit supply of foreign subsidiaries to that of domestic banks. Finally, we study the impact of other micro characteristics on the credit supply and their influence on the transmission of shocks. Our results highlight the importance of banks’ strong balance sheets and stable sources of funding for the provision of credit in Mexico. In general, these characteristics shelter banks from shocks.

JEL classification: D22, D84, E31

Keywords: inflation expectations, firms' survey, new information.

1. Introduction

There was a substantial change in the structure of the global financial sys­tem and the interactions of its players after the great financial crisis (GFC). This change affected how banks fund their operations, grant credit, the busi­ness lines they engage in, and their response to monetary policy and external shocks. There is a growing body of literature on whether structural breaks after the GFC have changed how bank-specific characteristics affect loan pro­vision. In Latin America, this area of research has taken advantage of the granularity provided by credit registry data. This paper seeks to contribute to the literature on the role of bank-specific characteristics on the supply of credit, and how these characteristics affect the relevant channels through which monetary policy and external shocks operate in the financial system. We focus on the Mexican banking system, which presents an interesting case given its high concentration and the participation of foreign subsidiaries of international banks.

Globalization prompted the internationalization of banks, which has af­fected financial systems in Latin America. Forty years ago the Mexican bank­ing sector comprised mainly local suppliers and specialized intermediaries, and foreign competition was limited. Then, after the expropriation of banks in 1982, the public sector took on the task of providing banking services and the industry became fully state-owned. Nowadays, this industry is populated by both foreign and domestic corporations, with a greater proportion of them be­ing foreign-owned. The defining changes in the banking sector were catalysed by the reforms implemented after the 1995 crisis and the signing of the North American Free Trade Agreement (NAFTA). These reforms accelerated the ex­pansion of international banking, leading to a consolidation of the banking system. In recent years, the Mexican banking sector has grown at a steady pace, with the seven largest banks owning 80 percent of the system assets and with subsidiaries of international banks holding a market share of 65 percent (Graph 1). More recently, the financial authorities have implemented a se­ries of reforms aimed at enhancing competition and financial stability in the industry. The evaluation of the role of bank characteristics on the supply of credit is relevant for the proper implementation of policies that aim to foster a stable financial system.

This paper has three aims. First, we study how banks’ balance sheet char­acteristics amplify or dampen the effects of domestic and external shocks on the supply of credit in Mexico (eg. do well-capitalised banks react more or less sensitively to monetary policy shocks?). Second, we evaluate if foreign subsidiaries react more or less sensitively to domestic and external shocks compared to domestic banks. As part of this analysis, we assess how the re­sponse depends on foreign subsidiaries’ balance sheet characteristics (eg. do well-capitalised foreign subsidiaries react more or less sensitively to mone­tary policy shocks compared to well-capitalised domestic banks?). Finally, we determine how other characteristics (loan, relationship, firm, and indus­try) weaken or strengthen the impact of domestic and external shocks on loan growth (eg. is the supply of credit to firms with stronger banking relationships more or less affected by monetary policy shocks?).

Our main results are the following. First, we show that banks with stronger balance sheets and with stable sources of funding supply more credit, whereas banks with higher risk indicators and a universal business model grant less credit. Second, in general, characteristics that foster loan growth shelter banks from shocks. By contrast, characteristics that are negatively related to loan growth amplify the effects of shocks. Third, compared to domestic banks, for­eign subsidiaries shrink their credit supply more actively when the economy is hit by shocks. However, in contrast to domestic banks, a universal business model and higher share of funding from foreign sources help subsidiaries react less sensitively to shocks. Fourth, there is a positive relationship between loan growth and high-quality creditors with strong relationships with banks. Addi­tionally, the loan supply to these creditors is less affected by shocks. Finally, low competition in the banking industry has a negative relationship with loan growth but helps shield the system against shocks.

The paper is structured in the following way. Section 2 contains a short lit­erature review. Section 3 presents an overview of the evolution of the Mexican banking system, highlighting the reforms that have shaped the industry. Sec­tion 4 describes the data used in the analysis. Section 5 explains the empirical strategy. Section 6 analyses the results and Section 7 concludes.

2. Literature Review

This paper contributes to the literature on the transmission channels of mon­etary policy and external shocks to the financial system. The bank-lending channel of transmission of monetary policy operates through banks’ liability side. A tightening in monetary policy reduces reserves from the banking sys­tem and banks reduce lending as there are fewer loanable funds (Bernanke and Blinder (1988)). Kashyap and Stein (2000) find that smaller and less liquid banks in the United States react more to changes in monetary policy. For the Mexican case, Bank of Mexico (2017) analyzes the effects of unexpected monetary policy shocks on the supply of credit using loan-level data. They find that banks with a higher level of liquidity reduce less their credit supply in response to an increase in the policy rate. Levin, Lopez and Lopez-Gallo (2017) study the impact of the implementation of loan-loss provisioning rules in Mexico. They find that this policy had a negative effect on credit and the effect was larger for credit denominated in local currency compared to foreign- currency loans.

Other studies focus on the effects of foreign policies on domestic lending. Buch and Goldberg (2017), find that effects of prudential spillovers sometimes spill over borders through bank lending. They show that balance sheet con­ditions and business models drive the amplitude and direction of spillovers to lending growth rates. We corroborate these results and show that banks with strong balance sheets reduce less their credit supply when faced by monetary policy or global external shocks. Particularly for Mexico, Levin et al (2017) assess the inward cross-border spillover effect of prudential policies and find that the increase in capital requirements in the United States had a significant impact on bank lending in Mexico.

Our second contribution is to the literature on how foreign subsidiaries respond differently to shocks compared to domestic banks. Within this lit­erature, Mexico is an interesting case of study given the strong presence of foreign subsidiaries (65% of the share of total banks’ assets in the system). CGFS (2018) studies the implications of regulatory changes on bank lending in Mexico and focuses on the change in behaviour of foreign subsidiaries after the implementation of Basel 2.5, Basel III and the liquidity coverage ratio, using credit registry data. Their results suggest that post Basel III, foreign subsidiaries decreased their credit growth rate more than domestic banks. We study the response of subsidiaries to domestic monetary policy shocks and find a similar result.

Other studies focus on how subsidiaries respond to foreign shocks. Morais et al (2015) use loan-level data to study how foreign monetary policy shocks affect lending by foreign banks in Mexico. They find that a softening of for­eign monetary policy increases the supply of credit of foreign banks to Mexican firms. Additionally, they show that the supply of credit increases dispropor­tionately more for borrowers with high ex-ante loan rates and high ex-post loan defaults, implying the existence of an international risk-taking channel of monetary policy. Also using loan-level data, Alcaraz et al (2018) assess how unconventional central bank intervention in Europe affect lending conditions in Mexico. They conclude that there are significant spillovers from headquarters to subsidiaries (and vice-versa) even with strict limits on internal transfers of capital and liquidity between entities. Our paper focuses on the effect of global shocks (risk, liquidity, economic policy uncertainty, and commodity prices) in­stead of foreign monetary policy shocks, but we find results consistent with the literature.

Our last contribution is to the literature on the benefits of relationship lending. Kysucky and Norden (2016) conduct a meta-analysis of 101 studies and find that long-lasting, exclusive, and synergy-creating bank relationships are associated with higher credit volume. They also find that the benefits are greater when bank competition is high and do not depend on the size of the firm.

3. Evolution of the Mexican Banking System

The Mexican banking system underwent an important transformation process the last 30 years. This transformation can be described as a process of consol­idation and openness to foreign investors. There are three main stages in the evolution of the Mexican banking system. The first occurred after a change in banking law allowed the creation of multibanks in 1975, which paved the way for the emergence of universal banks (Del Angel (2015)). The second stage initiated by the nationalisation of banks in 1982 and started the process of consolidation. Prior to the nationalisation there were 60 multipurpose banks in Mexico, their number was reduced to 18 by 1990 (Graph 1, left panel). A second effect of nationalisation was the development of the securities market in Mexico. (Del Angel et al (2005)). The government prohibited banks from offering other financial services other than banking; contributing to the devel­opment of other financial intermediaries such as brokerage firms (Del Angel et al (2017))). A third effect was a contraction in bank lending to the private sector as the government imposed many constraints on the banking sector. These restrictions included reserve requirements, interest rate ceilings on bank deposits and loans, and lending quotas on high priority economic sectors. The process of reprivatization of commercial banks started in 1989. Mexico re­gained entry to international capital market and bank credit to the private sector increased dramatically (Graph 1, right panel). However, the legal and regulatory environment was not the best-suited to incentivise efficient lending and minimize risks.

The last and most important stage in the transformation of the Mexican banking system occurred after the 1995 Mexican crisis. The Mexican gov­ernment implemented several policies to prevent the collapse of the banking system. These included restrictive monetary and credit policies, measures to improve liquidity and capitalisation, debtor relief efforts, and the transfer of non-performing loans into public debt (Herandez (2007). Additionally, a change in the terms of NAFTA allowed foreigners to invest in the banking sector and by 1998 all restrictions were lifted (Castellanos et al (2015)).

The reforms enacted after the 1995 crisis strengthen the stability of the banking sector and paved the way for the inclusion of Mexico into the global financial system. These reforms made it possible for banks to face the GFC with elevated levels of high quality capital and liquidity. After the crisis, the financial authorities in Mexico implemented all the standards and recommen­dations of financial regulation that the international organisms proposed in response to the crisis. More recently in 2013, the Mexican authorities put into effect a series of reforms aimed at ensuring bank stability, competition, and promoting financial inclusion and economic development.

The number of banks has continued to rise in the past years, with the greatest increase in domestic banks (from 15 in 2003 to 29 in 2017 (Graph 2, left panel)). Financial deepening, measured as the ratio of credit to the non-financial sector to GDP, has also increased. Credit to firms constitutes the largest share, followed by consumer credit (Graph 2, right panel). Bank credit accounts for about 58% of the total local non-financial private funding since the GFC. The next biggest funding source (21%) is the Mexican federal institute for workers’ housing (INFONAVIT), therefore banks’ role as lenders is the most relevant. The continued growth in credit does not pose an immi­nent threat to financial stability given the high level of capitalisation of banks and their low share of riskier loans. The capital adequacy ratio has remained above 10 percent for the past ten years (Graph 3, left panel). Additionally, Mexican banks have a higher level of capital relative to risk weighted assets and a higher proportion of Tier 1 capital relative to total capital compared to global banks (Banco de Mexico (2017)). Finally, the ratio of non-performing loans and write-off to gross loans has remained stable and below 3 percent (Graph 3, right panel).

Mexican banks rely heavily on demand and time deposits as their main sources of funding, which have been increasing as a share of total liabilities (Graph 3, left panel). After the GFC, banks proportionally reduced their op­erations with securities and derivatives and their market making activities. Instead, banks have increased their holdings of bonds, driven by higher is­suance of domestic government debt. Greater access to international capital markets has allowed banks to increase their liabilities in foreign currency. For­eign currency mismatches in banks’ balance sheets are not a concern since there are strict regulatory limits that prevent substantial imbalances (Graph 4, right panel). Given these limits, an increase in volatility of the nominal exchange rate has a limited negative impact on the financial results of banks. However, the increase in the share of derivative contracts in total liabilities indicates that banks have been increasing their hedge of foreign currency ex­posure.

Another consequence of the GFC was a change in banks’ business models in Mexico. The structure of a bank, and what it does, is driven by factors such as market forces and regulation, but most importantly by the bank’s manage­ment of its balance sheet. Hence, the bank’s business model can be broadly defined by its funding and liquidity strategies, and its sensitivity to funding investment opportunities. Following a methodology similar to the one applied in the Basel Committee on Banking Supervision (BCBS) we classify banks in Mexico into three categories: trading, universal and commercial banks.

The analysis uses thresholds based on balance sheet data to determine the categories. In broad terms, trading banks have a high share of trading asset securities on their balance sheet, whereas commercial banks have a low share of trading account securities and a substantial share of loans on their balance sheet. Universal banks cover the middle ground..

Graph 5 presents the transition banks’ business models in Mexico during the last decade. Before the GFC, Mexican banks started to diversify their operations. The number of universal banks increased by 4 and the number of trading banks by 3. However, the GFC had a negative effect on banks’ mar­ket making activities. Many global banks wound down or closed their trading desks in several locations around the world as a response to structural reforms. As a result, trading operations of global banks in Mexico were reduced. For example, Deutsche Bank and ING Bank closed their Mexican subsidiaries af­ter the crisis. These two banks were very active in local debt and derivative markets. The number of trading banks fell to 1 and there was a substantial increase in commercial banks (to 22 in 2013 from 8 in 2007). During the past four years, the Mexican banking system recovered and became more sophisti­cated. Banks are increasing their market making activities and new trading banks have opened for operation. The number of commercial banks is higher than the number of banks with other business models. However, universal banks dominate the system, as their share of total assets is greatest. The next section explores formally how these changes in the Mexican banking system and banks’ business models have influenced loan provision.

4. Data

In this study we use two data sets from Comision Nacional Bancaria y de Valores (CNBV), Mexico’s financial system regulatory and supervisory insti­tution. The first one is a credit registry (R04C report) of all the commercial loans from banks to firms between September 2009 and December 2017 in a quarterly basis. This report contains the current status of all loans given by commercial banks operating in Mexico to firms and individuals with commer­cial activity. Then, we construct a subsample that considers only firms that have multiple loans from more than one bank (MBR database). With this database we can disentangle credit supply shifts from credit demand shifts by introducing time-variant firm fixed effects in the regressions.. The com­plete data set has a total of 9, 207, 498 observations from 611,194 firms and 44 banks, while the MBR database consists of 3, 394, 771 observations from 113, 548 firms and 42 banks.

We obtain additional information on the characteristics of the loan and firm from the credit registry. We classify these characteristics into three categories:

  • Loan characteristic: dummy variable for large loans (credits at least greater than the 85 percentile), dummy variable for fixed rate loans, and time to maturity (in quarters).
  • Bank-firm relationship characteristics: dummy variable if the loan is a credit line, length of bank-firm relationship (in quarters), dummy variable if the loan includes collateral, number of banking relationships.
  • Firm characteristic: size of firm (three categories: small, medium and large depending on number of employees), credit score (numeric value where the highest number indicates a better credit score).

The second data set provides banks’ balance sheet information and indexes used by the regulatory institutions. This information is self-reported each month as part of mandatory filings by the CNBV and then made public. We classify bank-specific characteristics from this database into five categories:

  • Main indicators: size (log of total assets), liquidity coverage ratio and bank capital ratio (net capital to total assets).
  • Risk profile: share of non-performing loans to total loans and share of write-offs to total loans.
  • Revenue mix: diversification ratio (non-interest income to total in­come) and share of trading assets to total assets.
  • Funding composition: share of long-term funding, share of funding from foreign sources and share of demand deposits to total funding.
  • Profitability: efficiency (operating cost to total income).

The last variable we consider is the Herfindahl-Hirschman Index (HHI) measure of competition in the Mexican banking system. This measure was constructed using the share of each bank’s assets in the financial system.

Despite a negative skew in the distribution of credit in the MBR database (Graph 6, left panel), summary statistics of variables used in the analysis are similar across data sets (Table 1). This implies that the MBR database pro­vides an accurate representation of the complete data and that the results obtained from the MBR database will hold in the complete database. Still, for robustness, we run all regression with the complete database to confirm this assumption. Correlations in the subsample do not indicate problems with col­inearity (Table 2). There are no correlations bigger than 0.75 and the biggest is -0.71 between log(Total assets) and long term funding. The former is one the most correlated variables, which is natural given its importance.

In the second part of the paper we analyse how subsidiaries react differ­ently to shocks compared to domestic banks. For this analysis we focus on the MBR database. The sample of loans granted by subsidiaries consists of 1,839,695 observations from 97,697 firms and 13 banks, while for domestic banks consists of 931,800 observations from 70,016 firms and 29 banks. The distribution of loans granted by subsidiaries compared to the distribution of loans granted by domestic banks is similar (Graph 6, right panel). Addition­ally, there are no major differences between the BSCs descriptive statistics by type of bank (Table ??). However, there are some important differences be­tween the characteristics of a loan granted by subsidiaries compared to a loan granted by domestic banks. Domestic banks lend more to larger firms and grant larger loans. By contrast, subsidiaries take less risk by granting loans to high-quality firms, measured by the firm’s credit score. Using Kolmogorov- Smirnov, the characteristics that are more different in the distribution of loans granted by subsidiaries and loans granted by domestic banks are credit line, fixed rate, and maturity. First, subsidiaries grant a higher proportion of credit line loans, whereas domestic banks grant approximately the same proportion of credit lines and non-credit lines. Second, subsidiaries grant more loans with fixed rates while domestic banks grant more loans with variable rates (90% of loans). Finally, while more than half the loans granted by subsidiaries have long term maturities, almost all of the loans granted by domestic banks have short term maturities.

We consider five types of shocks in the analysis. First, we evaluate the response of credit to the quarterly change in Mexico’s monetary policy rate (Graph 7, panel 1). Our period of study includes both easing and tightening phases in monetary policy. Second, we study four types of external shocks: global financial risk, global liquidity, global economic policy uncertainty, and global commodity prices. These are defined by dummy variables that depend on percentile value thresholds of proxy variables that represent each shock (shaded areas in Graph 7). The global risk shock corresponds to a dummy variable that takes the value of one if the VIX index lies above its 75th per­centile (Graph 7, panel 2). The global liquidity shock corresponds to a dummy variable that takes the value of one if the BIS global liquidity indicator lies above its 75th percentile (Graph 7 panel 3). The global economic policy un­certainty shock corresponds to a dummy variable that takes the value of one if the Baker et al (2016) index is above its 80th percentile (Graph 7, panel 4). Finally, the global commodity price shock corresponds to a dummy variable that takes the value of one if the annual growth in commodity prices is below its 40th percentile (Graph 7, panel 5).

5. Empirical Strategy

The empirical analysis studies the determinants of the credit supply in Mexico and evaluates which characteristics amplify or dampen the effects of domestic and external shocks. The dependent variable in all specifications is the log- change in the total amount (sum of loans) owed by firm f to bank b at time t. In the baseline specification, the explanatory variables of interest are a vector of bank specific characteristics (BSC) Xbt-1. We include time-invariant bank fixed effects ab. and time-variant firm fixed effects Yft to control for demand shifts and identify properly changes in the credit supply. We estimate the following panel equation:

Image rxq

A drawback from the identification strategy is that it is necessary to re­strict the database to consider only firms with multiple banking relationships (MBR). In section 4 we showed that the distribution of loans between the MBR database and the complete database is similar. Still, for robustness, we estimate the effect of BSCs on loan growth with the complete database controlling for demand shifters:

Image ncqm

where Other ft are credit demand controls, MacrOi,t are macroeconomic con­trols, and aftb are time-invariant bank-firm fixed effects. We include loan, bank-firm relationship, firm, and industry characteristics in the vector of de­mand controls. Finally, we include quarter, state and sectorial dummies.

1.1. Transmission of domestic and global shocks

We extend the baseline specification to analyse the influence of a bank’s struc­ture on the effect of domestic and global shocks on loan growth. First, we focus on the role of BSCs on the transmission of shocks to credit supply:

Image s1ip

In equation 3 we evaluate the transmission of monetary policy through the bank-lending channel, where Ait-1 is the quarterly change in the policy

rate. Tightening or loosening the monetary policy stance changes the risk free rate and banks’ funding costs, which affects loan provision. In equation 3 we study how global shocks affect the credit supply. We characterise each of the four global shocks (high global financial uncertainty, high global liquidity, high economic policy uncertainty, low growth in commodity prices) with dummy variables (Di). We focus the analysis on the interaction term between BSCs and the shocks (в*).

Next, we differentiate the behaviour of foreign subsidiaries’ credit supply to that of domestic banks:

Image wd9x

We include a dummy variable (Fb) for banks that are foreign subsidiaries and explore whether they react differently to shocks (в2). Additionally, we analyse if there is a difference in the role of BSCs of subsidiaries in the trans­mission of shocks (вз).

Finally, we study how loan, bank-firm relationship, firm, and industry char­acteristics can strengthen or weaken the effect of shocks on credit supply:

Image wjyq

We study the role of different characteristics in the transmission of shocks (A*) and the direct effect of shocks on credit supply (8).

  1. Results

    1. Baseline results

Table 4 presents the results of the baseline specification (equation 1). We estimate a regression for each individual block of bank-specific characteristics (columns (1)-(5)). Then, we estimate a regression that includes all variables that were statistically significant in the results from their individual block (col­umn (6)). We follow the same strategy for all the equations in the empirical analysis.

Banks with strong balance sheets supply more credit in Mexico. First, within banks, those that are large and well-capitalised grant more credit, whereas those that have a higher share of non-performing loans and write­offs grant less credit. The estimated coefficient implies that a 1-percentage point increase in the bank capital ratio increases the growth in bank credit around 0.14 percentage points. This result is importance since one of the main objectives of post-crisis regulation has been to strengthen banks' capital position. One concern has been that higher capital requirements might re­strain loan growth, but this result shows that a larger capital base can reduce financing constraints for banks allowing them to grant more credit.

Second, we obtain a negative relationship between the growth of credit in Mexico and diversification of bank's activities and income sources. This implies that banks with a commercial business model (lower non-interest in­come to total income and lower trading assets as a share of total assets) grant more credit compared to universal business model banks. Finally, we find that banks with a higher share of long-term funding and lower share of funding from foreign sources grant more credit. These last results imply that the com­position of banks' liabilities in terms of source type and maturity affects the credit supply. Particularly, a higher share of stable sources of funding can foster banks’ loan growth.

For robustness, we obtain the estimates of the effect of BSCs on loan growth with the complete database, controlling for other loan demand shifters (equa­tion 2). We confirm that both the sign and significance of the coefficients remain the same with the exception of the coefficient of the LCR (Table 4, column (7)). We postpone the discussion on the influence of other micro char­acteristics on credit supply for a later section.

2. How do banks with different characteristics react to shocks?

Table 5 reports the coefficients of the interaction term between BSCs and the five shocks shocks (one domestic monetary policy shock and four external global shocks (equation 3 and equation 4)). For the monetary policy shock, the results are the following (Column (1)). First, strongly capitalised and highly liquid banks adjust less their credit supply when faced with a monetary policy shock. Second, banks with high risk indicators (non-performing loans and write-offs), high share of trading assets to total assets and high share of funding from foreign sources are more affected by monetary policy shocks. Finally, highly-profitable banks that rely more on deposits are less apt to re­duce their credit supply during a monetary tightening. Deposits, like demand and savings deposits, are largely inelastic and have historically insulated bank funding costs against economic shocks by smoothing borrowing costs (Berlin and Mester (1999)). All together, the results imply that BSCs that reduce banks’ constraints to raise funds from stable sources weaken the transmission channel of monetary policy. Our findings are consistent with the literature on the bank-lending channel (Altunbas et al (2012), Kishan and Opiela (2000), and Altunbas et al (2010)).

Next, we analyse how banks with different characteristics react to external shocks. First, we consider global risk (high VIX index (column (2))). Strongly capitalised and highly-liquid banks are less apt to reduce credit supply during periods of high global financial risk. These results are well documented in the literature (Kapan and Minoui (2013)) and stress the importance of liquidity and capital as buffers that mitigate the effects of risk shocks. Banks with a higher diversification ratio (non-interest income) are more affected by global risk shocks, while banks with a higher share of trading assets are less affected by these shocks. This implies that universal business model banks are more affected by high global risk, but a higher share of trading assets dampens the effect. Finally, as in the baseline, banks with a higher share of long-term fund­ing and lower share of funding from foreign sources react less sensitively to global risk shock.

The second shock corresponds to high global liquidity conditions (Column (3)). In the aftermath of the GFC, permissive credit conditions in advanced economies eased liquidity constraints in emerging markets (BIS (2011)). While liquidity shortages can have important implications for stability and growth, global liquidity excesses can contribute to the endogenous build-up of vulnera­bilities (Caruana (2014)). Highly-liquid banks with low risk indicators expand more their credit supply during high liquidity periods. By contrast, banks with a higher share of trading assets take less advantage of the easing in liquidity conditions and increase their credit supply to a lesser extent. Finally, banks that draw on stable sources of funding (higher share of deposits and long-term funding) are more apt to increase their credit supply when global liquidity is high. Together, these results imply that banks which supply more credit during high liquidity periods have characteristics that help them address any potential build-up of vulnerabilities (high liquidity, low risk, and stable sources funding).

The third shock corresponds to periods of high economic policy uncertainty (Column (3)). High economic uncertainty is associated with greater stock price volatility in international markets and reduced business investment in policy- sensitive sectors. Generously capitalised banks that rely more on deposits are less affected by economic policy uncertainty shocks. By contrast, banks with a higher diversification ratio and a greater share of funding from foreign sources are more affected by these shocks. Then, commercial business model banks with a deposit-based funding structure can sustain credit growth when faced by shocks that curtail investment opportunities.

The last shock corresponds to periods of low growth in global commodity prices (Column (4)). Commodity prices can affect bank lending through the credit supply channel driven by the nominal exchange rate and export rev­enues (Kohlscheen, Avalos and Schrimpf (2016) and Agarwal et al (2018)). Highly-liquid and profitable banks with stable sources of funding (long-term funding and deposits) react less sensitively to commodity price shocks. By contrast, banks with a universal business model, high risk indicators and high dependence on funding from foreign sources are more vulnerable against these shocks. Currency mismatches in banks’ balance sheets can further amplify the negative effect of commodity price shocks.

A common result in all specifications is that Mexican banks that draw on funding from foreign sources are more apt to reduce their credit supply when hit by shocks. In the aftermath of the GFC there has been a shift in the drivers of international bank lending (Avdjiev et al (2017)). International banks flows have become more responsive to the degree of commonality of financial cycles and the stance of policy in advanced economies. Then, banks that rely on funding from foreign sources are increasingly susceptible to changes in global financial and economic conditions. On the upside, regulation that prevents cur­rency mismatches in banks’ balance sheets and the increase in banks’ hedging against their foreign currency positions mitigates this vulnerability.

3. How do foreign subsidiaries respond differently to shocks?

There is a strong presence of foreign subsidiaries in Mexico. They are formally independent legal entities, but they follow the guidelines of the parent bank. Moreover, there is strict regulation and supervision that covers changes in risk exposures and limits on internal transfers of capital and liquidity between headquarters and subsidiaries. The number of subsidiaries increased after all restrictions on foreign investment in banks were lifted in 1998. In 2017, from a total of 48 banks operating in Mexico 19 are foreign subsidiaries and from the 7 largest banks 5 are subsidiaries. Additionally, foreign subsidiaries hold 65% of the share of total banks’ assets in the system. We find that foreign subsidiaries are more affected by shocks and that some BSCs influence differ­ently the transmission of shocks for subsidiaries than for domestic banks.

Table 6 reports the results of estimation that includes the foreign subsidiary dummy (equation 5 and equation 6). We find that the interaction term of the subsidiary dummy with each shock is negative and statistically significant. This implies that foreign subsidiaries’ credit supply reacts more sensitively to domestic monetary policy and external shocks. One explanation for this behaviour is that international banks usually assess risk across their whole institution. Then, a negative shock can have a greater effect on subsidiaries as headquarters adjusts their risk-taking globally (Alcaraz et al (2018)).

The results from the double interaction (shock*BSC) are consistent with those obtained in Table 5 and with the analysis presented in the previous sec­tion. There are two set of results from the coefficients of the triple interaction (shock*subsidiary*BSC). BSCs associated with strong bank balance sheets in­fluence the transmission of shocks in the same manner for subsidiaries as for domestic banks. In general, large, highly-liquid, strongly-capitalised domestic banks and subsidiaries with a higher share of long-term funding are more shel­tered against shocks. By contrast, domestic banks and subsidiaries with high risk indicators and high share of trading assets are more vulnerable against shocks.

Next, there are some bank characteristics that, while for domestic banks strengthen/weaken the transmission of shocks, they have the opposite effect for subsidiaries. First, in general, subsidiaries with a higher diversification ratio (universal business model) and that draw more on funding from foreign sources are less affected by shocks. These two characteristics were generally associated with higher vulnerabilities for domestic banks. A higher share of funding from foreign sources constitutes a greater risk for domestic banks as it can lead to currency mismatches in their balance sheets. By contrast, subsidiaries are allowed to receive contributions from their parent bank, which would lead to a higher share of funding from foreign sources. This extra line of credit can help subsidiaries when funding becomes scarce due to shocks. Second, in general, subsidiaries with a higher share of deposits are more affected by shocks while for domestic banks the result is the opposite. During periods of high stress foreign subsidiaries attract less domestic deposits and higher funding from foreign sources. The difference between the flow of funds compared to domestic banks is due to the ability of complex banks to reallocate liquidity across the different jurisdictions in which they operate (Cetorelli and Goldberg (2012)).

4. How do other micro characteristics affect the trans­mission of shocks?

The last part of our analysis takes advantage of the additional information contained in the credit registry to evaluate how other characteristics (loan, bank-firm relationship, firm and industry) influence the supply of credit in Mexico. For this analysis we use the complete database and control for a se­ries of demand shifters and seasonal/state/sector effects.

First, we corroborate that the effects of shocks on credit supply are consis­tent (Table 7). Monetary policy, global risk, economic policy uncertainty and commodity price shocks have a negative effect on the supply of credit, while global liquidity shocks have a positive effect. Then, we divide our findings on the effects of other characteristics into two sets. The first set corresponds to those characteristics that have a positive relationship with credit growth during normal times and when the economy is hit by shocks. The second set corresponds to those characteristics that have a positive/negative relationship with credit growth during normal times but the opposite relationship with credit growth when the economy is hit by shocks.

Within our first set, there is a positive relationship between credit growth and if the loan is a credit line and includes collateral. Moreover, credit growth is higher for firms with longer relationships with banks and higher credit scores. The positive relationships are maintained during shock periods. One addi­tional result during periods of stress is that credit growth for larger firms reacts less sensitively than for smaller firms.

Within our second set, there is a positive relationship between credit growth and if the loan is large, has a fixed rate, and long maturity. By contrast, dur­ing shock periods, there is generally a negative relationship between credit growth and these loan characteristics. One explanation is that banks become more risk adverse during stress periods and prefer to grant loans with safer characteristics. For example, Black and Rosen (2016) show that in response to a monetary tightening, banks reduce the average maturity of their loan supply, which effectively reduces the loan supply over time. Turning to bank- relationship characteristics, credit growth is negatively related to the number of banking relationships, but credit growth to firms with more banking rela­tionships is less affected during shock periods. Finally, there is an negative relationship between credit growth and less competition in the banking sector (higher Herfindahl index), but less competition shelters the banking industry from shocks. This last result is particularly relevant since the banking sector in Mexico is highly concentrated and not very competitive.

7. Conclusions

After the GFC, a renewed effort has been made to implement regulatory re­forms aimed at safeguarding financial stability and strengthening bank balance sheets. The aim is to make banks more resilient and to reduce the transmis­sion of negative shocks to the real economy via the credit channel. This paper explores the determinants of the credit supply in Mexico, taking advantage of the granularity provided by credit registry data.

First, we find that banks with stronger balance sheets (large and well- capitalised) and with stable sources of funding (higher long-term and lower funding from foreign sources) supply more credit. Additionally, banks with higher risk indicators (non-performing loans and write-offs) and with a uni­versal business model (those that rely on non-interest income and have a higher share of trading assets) grant less credit. Second, we show that the importance of bank characteristics in the transmission of shocks depends on the type of shock. In general, strong balance sheets, stable funding, and high profitability weaken the transmission of shocks. On the contrary, higher bank-risk indi­cators, a universal business model, and greater dependence on funding from foreign sources strengthen the transmission of shocks. Third, foreign sub­sidiaries in Mexico contract their credit supply more actively than domestic banks do when a shock hits the economy. In contrast to domestic banks, for­eign subsidiaries with a universal business model, a higher share of funding from foreign sources, and a lower share of deposits are more sheltered against shocks. Fourth, there is a positive relationship between loan growth and high- quality creditors with strong banking relationships. Additionally, the loan supply to these creditors is less affected by shocks. Finally, weak competition in the banking industry has a negative relationship with loan growth but helps shield the system against shocks.

 

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