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Vol. 3, No. 7 JULY 2008 EconomicLetter Insights from the F e d e ral R e s e r v e B an k o f Dallas Reaching Mexico’s Unbanked by Edward C. Skelton Banks and the A well-developed financial system works as both a powerful antidote to government have poverty and a gateway to prosperity. By improving economic efficiency, boosting mounted a major effort consumers’ purchasing power and helping citizens realize economic opportu- to extend financial nity, broader access to financial services helps raise living standards. Low-income services to those families that take advantage of financial services enjoy increased security and re- without them. duced costs—in both paying for goods and services and seeking to build wealth. Better access to credit helps small businesses fulfill their potential. In the United States, the benefits of financial services are largely taken for granted. More than 90 percent of U.S. households have bank accounts, according to the Federal Reserve’s Survey of Consumer Finances. Nevertheless, both the private and public sectors devote considerable time and resources to extending banking services to the relatively small number of households that lack them. The situation is very different south of the border. Less than 25 percent of Mexicans possess even the most basic financial convenience: a simple checking account.1 Those without access to financial services encounter higher costs for cashing checks, paying bills and starting businesses. Bringing the benefits of financial services to more people is an important goal in Mexico. To achieve it, financial institutions and the government have mounted major efforts aimed at the vast number of citizens outside the formal financial system. Recent signs point to success with using a variety of innovative channels to reach Mexico’s unbanked and underbanked. Interestingly, among the foremost is a strategy banned in the United States—a bank and retail operation under common ownership. Because money is a primary obstacle, the poor are more likely to be unbanked. Plight of the Unbanked Lack of access to financial services imposes significant costs on Mexico’s unbanked—both individuals and Chart 1 Financial System Participation Low Among Poorer Households Millions of households Percent 6 100 5 80 Financial system participation 4 60 3 40 2 20 1 0 <152 152 to 314 315 to 667 668 to 1,048 1,049 to 1,619 1,620 to 2,476 2,477 to 8,190 8,191 to 37,238 >37,238 Monthly household income (U.S. dollars) SOURCE: Sigma Mercados y Libro Mercadológico BIMSA, 2007. EconomicLetter 2 F ederal Re serve Bank of Dallas 0 small businesses. Cashing paychecks requires up to 10 percent of income.2 Paying bills in cash takes more time, carries risks to personal security and entails transportation costs. For startup entrepreneurs, relying on the informal financial system can boost costs by 15 percent.3 A large, unbanked population burdens the financial system itself. The Banco de México, the country’s central bank, reports that cash transactions cost the system up to five times more to process than checks, which are, in turn, more expensive than electronic payments.4 In lieu of formal financial services, unbanked households resort to such options as the proverbial cash under the mattress and community savings clubs. What people really want are deposit accounts, even those that don’t pay interest, the World Bank reports. What stops individuals and small businesses from establishing a banking relationship? In a recent World Bank survey, 70 percent of Mexico’s unbanked cited high fees and minimum balance requirements as the principal reasons for not accessing the formal financial system. Because money is a primary obstacle, the poor are more likely to be unbanked. If we define participation as the ownership of at least one financial product, Mexican households with lower monthly incomes have lower rates of participation in the formal system (Chart 1). Even small reductions in bank fees, balance requirements and other barriers might encourage many to open an account. An estimated 90 percent of Mexicans are homeowners, a high rate that suggests a capacity for saving among the unbanked despite low income levels. Possession of a deposit account could spur additional saving. Geography is another barrier to banking relationships. Private commercial banks have a presence in only 465 of the country’s 2,439 municipalities. A government-owned development bank and a number of small financial intermediaries cover an additional 525 municipalities, leaving 1,449 municipalities and their total population of almost 14 million with little if any access to formal financial services. Market Responses Mexico’s financial sector has changed considerably over the past 10 years as its institutional, technological and regulatory environments have in many respects become world class.5 This newly energized financial system is looking beyond its traditional customer base. Entrants to the banking sector, including retailers, are targeting the unbanked and underbanked. They’ve been joined by some large banks, both domestic and foreign. These developments are beginning to attract more households to the formal financial system. New-bank strategies. Fourteen new banks have been chartered since May 2006, adding to a base of 28 institutions. The new banks are pursuing widely divergent approaches. Five are focusing on private banking, trading and other high-end activities. The nine others are targeting the unbanked or underbanked—usually low- and middle-income customers with monthly incomes of US$200–$3,600. The growth in specialized banks should continue because they can now take advantage of a charter that enables them to target specific markets. The niche bank charter, introduced in 2007, is likely to be an attractive vehicle for market entry because it entails lower startup and regulatory compliance costs. The charter presents an especially appealing opportunity for unregulated finance companies, known by the acronym sofomes, which stands for Sociedades Financiera de Objeto Múltiple. Sofomes, a relatively new type of finance company, can’t accept deposits and aren’t subject to regulation by the national banking commission, Comisión Nacional Bancaria y de Valores (CNBV).6 Mexico has about 400 sofomes, with the majority focused on the agricultural industry. The remainder mostly offer credit to micro to medium-sized businesses. Some sofomes have indicated an interest in becoming niche banks, which would allow them to accept deposits. A direct source of funds would lower costs, but the institutions would be subject to regulation. Most of the new banks targeting the unbanked or underbanked work through an existing retail business or, in one case, a microfinance business. The strategy of targeting the low-income end of the market can be traced to the emergence of Banco Azteca, the first bank owned by a retailer. Retailers and the unbanked. Azteca was established in 2002 by Grupo Elektra, a retailer specializing in sales to low-income consumers. Before opening its bank, Grupo Elektra gained extensive lending experience by extending store credit to customers. With its new venture, the retailer can also offer basic banking products. Before obtaining a bank charter, Grupo Elektra extended credit through its financing subsidiary, which didn’t have access to deposits as a source of funds. Instead, the subsidiary obtained funding by securitizing accounts receivable, issuing debt or borrowing money. The banking business provides Grupo Elektra with a relatively lowcost source of funds, an additional business line and a potential source of profits. Retailer-owned banks offer basic financial products, such as small personal loans and a savings account with a debit card and minimum initial balance of 50 pesos—about $4.90.7 Moreover, retailer-owned banks tend to offer interest rates 1 to 2 percentage points higher than traditional banks. The retailers also offer an appealing client base because an estimated 80 percent of the customers of Mexico’s large retail stores have never had bank accounts.8 Combined with F ederal Reserve Bank of Dallas This newly energized financial system is looking beyond its traditional customer base. Entrants to the banking sector are targeting the unbanked and underbanked. the capacity to purchase relatively bigticket items, this suggests the need for financial services. For customers, bank credit adds flexibility because store credit was obviously limited to purchasing goods sold by Grupo Elektra. Deposit accounts provide an additional option for customers, and access to the formal financial sector can reduce households’ cost of making and receiving payments. The retailer-owned bank strategy seems to be paying off. In less than five years, Azteca has grown into Mexico’s eighth-largest bank by deposits and 10th largest by assets. The bank has exported its business model to six other Latin American countries.9 Retailers have advantages over traditional banks in attracting deposits from the unbanked. First, the unbanked frequent stores, have some 3 EconomicLetter Expanding geographic reach through a brick and mortar network is expensive, but banks have other options. level of allegiance to them and already use stores as their primary source of credit (Table 1). Second, retailers’ existing storefronts allow them to open bank branches quickly and cheaply. Banco Azteca’s branch network and number of accounts are on a par with many of Mexico’s largest banks (Table 2). In terms of asset size, though, Azteca is much smaller, reflecting its low average account balance. The ability to establish new branches quickly at low cost is important because a physical presence is a key driver of financial services use. Not surprisingly, states with a large number of bank branches report higher financial system participation, as measured by the number of demand deposit accounts per capita (Chart 2).10 The CNBV has imposed specific conditions on retailers in the commercial banking business. One of the most publicized cases involves U.S.-based Wal-Mart, whose especially detailed restrictions may be a bellwether. The conditions center on transparency and maintaining a clear separation between the retail entity and bank.11 This retailer-owned bank strategy—so popular in Mexico—is prohibited in the United States. Generally, U.S. retailers may lease space to a bank but not own one. Objections Table 1 Where Do the Unbanked Get Credit? Percent Department store Friend/relative Government Savings bank Finance company Savings and loan Credit union Nongovernmental organization Other 48.6 8.6 5.7 4.3 2.9 1.4 1.4 1.4 25.7 Table 2 Retailer-Owned Bank Attracts Small Accounts Number of branches Number of accounts Assets (millions of pesos) Deposits (millions of pesos) Azteca 1,121 6,254,981 53,183 44,956 Bancomer 1,862 12,579,085 741,276 466,224 Banamex 1,618 7,285,045 589,720 320,846 Bank Santander 983 9,694,405 427,598 236,210 HSBC-Bital 1,360 4,600,241 355,526 263,856 Banorte 1,062 6,182,950 273,049 182,351 NOTE: Data are as of March 31, 2008. SOURCE: Comisión Nacional Bancaria y de Valores. SOURCE: World Bank. EconomicLetter 4 to mixing banking and commerce in the United States include issues with deposit insurance and the concentration of economic power.12 Large-bank strategy. Large banks aren’t well positioned to serve the unbanked because their branch networks still reflect the historical focus on relatively high-income households. The ratio of bank branches to population tends to be higher in states with high per capita levels of economic activity, whereas the unbanked are more likely to live in low-income, sparsely populated areas (Chart 3). Expanding geographic reach through a brick and mortar network is expensive, but banks have other options. Some large banks have recognized the potential in forming a relationship with retailers and created joint ventures to launch sofomes that operate inside the stores. The new entities largely target store customers who have had little or no interaction with a bank by offering small loans without requiring a credit history. Because people in even the smallest towns and poorest pockets of big cities visit stores, the strategy should allow banks to reach customers missed by traditional branching. Larger banks find these joint ventures attractive. First, the sofomes aren’t subject to regulation by the CNBV, F ederal Re serve Bank of Dallas effectively lowering the cost of operations and compliance. Second, partnering with a retailer promises a way around low-income households’ perception of banks as intimidating, overly formal and inconvenient. By contrast, retailers are often viewed as sympathetic, familiar and customer-oriented. Banks could use the sofomes as stepping stones to providing households with full banking services. Microfinance lending. At yearend 2006, 44 microfinance institutions in Mexico reported data to the Inter-American Development Bank, up from 39 a year earlier.13 They included finance companies, a bank and nongovernmental organizations, such as those set up by the World Bank and the International Monetary Fund.14 These lenders offered business loans ranging from 100 to 30,000 pesos—or $9.78 to $2,933. Microloans averaged 4,500 pesos ($440), with monthly interest of 4.5 percent. Mexican microfinance lenders build extensive networks of small, sometimes home-based, branches. Over the past six years, private-sector microfinance institutions have funded more than 4.8 million loans. Still, a first quarter 2008 Banco de México study found that 70 percent of small businesses fulfilled their financing needs through trade credit—loans provided directly by the suppliers of goods and services. The growth potential in this sector continues to be significant. According to the International Finance Corp. (IFC), approximately 20 percent of Mexico’s businesses, and a mere 11 percent of microbusinesses, have accessed the formal financial system. The World Bank has found that small businesses gaining access to capital tend to generate large increases in profitability, with an estimated return of 20 to 33 percent on the funding received.15 Moreover, the more constrained access to capital had been, the greater the return once the obstacles were removed. Chart 2 Deposit Accounts More Common in States with Abundant Branches Demand deposit accounts per 1,000 people 1,200 900 600 300 0 0 5 10 15 20 Bank branches per 100,000 people NOTES: Each point represents one of the 31 states plus the Federal District. Census data are for 2005; bank data are as of March 31, 2008. SOURCES: Comisión Nacional Bancaria y de Valores; Instituto Nacional de Estadística y Geografía; author’s calculations. Chart 3 Bank Branches More Often Seen in High-Income States Branches per 100,000 people 20 15 10 5 0 0 5,000 10,000 15,000 20,000 Per capita gross state product (U.S. dollars) NOTES: Each point represents one of the 31 states plus the Federal District. Census and gross state product data are for 2005; bank data are as of March 31, 2008. SOURCES: Comisión Nacional Bancaria y de Valores; Instituto Nacional de Estadística y Geografía; author’s calculations. F ederal Reserve Bank of Dallas 5 EconomicLetter Mexico’s banks have become more aggressive in lending to micro to medium-sized businesses. For instance, Banco Compartamos, a finance company before obtaining a bank charter in 2006, offers working-capital loans to microbusinesses. Over the past five years, the institution has grown at a compound annual rate of 46 percent in terms of clients and 60 percent in loans outstanding. As of Dec. 31, 2007, Compartamos had more than 800,000 clients and 4.1 billion pesos ($401 million) in performing loans, spread over 252 locations in 29 of Mexico’s 32 states. Grupo Financiero Ixe, a holding company for a small bank that had focused on middle- and upper-income households and on corporations, is using a $70 million capital injection from the IFC—the World Bank’s private-sector arm—to enter the realm of microfinance. As a group, commercial bank lending to micro to medium-sized businesses is growing rapidly (Table 3).16 Last year, lending to microbusinesses alone more than tripled. As these tiny enterprises’ access to credit continues to improve, the overall Mexican economy should benefit. Government Responses Some studies have found that the prices banks in Mexico charge for financial services exceed international Table 3 Bank Credit Up Sharply (Millions of pesos) 2006 2007 Microbusinesses Small businesses Subtotal 3,070 23,385 26,455 10,296 35,646 45,942 Medium-sized businesses Total 12,544 38,999 16,513 62,455 SOURCE: Mexican Bankers’ Association. standards.17 Indeed, the Banco de México has criticized the cost of banking, focusing on what it considers a lack of competition in a system where the top six banks control about 85 percent of loans and deposits. For their part, banks cite excessive regulatory burden as an impediment to providing lower cost services, a contention backed by studies that find Mexico’s compliance costs higher than those in many other countries.18 The government has developed a variety of initiatives designed to address several of these issues. Increasing competition. While the recent surge in new banks is encouraging, regulators have taken additional measures to spur entry into the market. These include lowering capital requirements and streamlining the application process for niche charter banks. Making entry into the industry less expensive and easier should enhance competition. So should the improved availability and standardization of information that can help households shop for the best deal on financial services. The Banco de México posts fees, interest rates on deposits and the cost of credit on its website. In April 2007, Congress passed legislation that also improves transparency, promotes competition and increases consumer protection. Among other things, it requires financial institutions to provide clearer information about the cost of credit in terms of both fees and interest rates. The reform also requires that the banking industry develop basic, nofee deposit accounts for households lacking access to the formal financial system. In addition, the law prohibits fees charged for banking services from being high relative to a customer’s income, particularly for checking accounts linked to automatic payroll deposits and credit cards. Banks are prohibited from charging undisclosed fees. Lastly, service providers must notify the Banco de México at least 30 days before changing fees. EconomicLetter 6 F ederal Re serve Bank of Dallas Reducing regulatory burden. In addition to its consumer protections, the 2007 legislation clarified regulators’ role, gave banks more responsibility for policing themselves and eased restrictions on financial institutions, including allowing banks to outsource various operations and services. The new law also strengthened external auditors’ role. Previous reforms allowed banks to develop their own credit rating and provisioning methodologies. For example, a 2006 law standardized regulations across the different types of financial institutions. Regulators continue to work to harmonize accounting standards across financial institutions to achieve a consolidated, less burdensome supervisory approach. A public institution. Banco del Ahorro Nacional y Servicios Financieros (Bansefi) is a governmentowned development bank formed in 2001 with a mandate to expand households’ access to affordable, formal financial services. The institution both serves the unbanked directly and works with small institutions that target this group. Bansefi has approximately 5 million savings accounts and opens an average of 28,000 accounts a month. The bank offers no-fee, interest-bearing savings accounts with an initial deposit as low as 50 pesos, about $4.90. Bansefi’s 550 branches tend to be located in rural areas (Chart 4A). The positive correlation between a large urban population and the availability of a commercial bank branch highlights the development bank’s role as a rural provider of financial services and complement to commercial banks (Chart 4B). In addition to offering savings and deposit accounts directly to households, Bansefi operates as a second-tier bank for savings and credit entities. In this role, it provides support to over 600 privately or collectively held small financial intermediaries that serve the unbanked. The support includes training and technical assistance, access to Bansefi’s operational infrastructure and automation services, and the development of a broader range of financial products. Bansefi has developed a technological platform that offers small financial intermediaries access to common backoffice operations, thereby increasing economies of scale and efficiency. A large proportion of Mexico’s population remains unbanked, but recent trends suggest private and public sector efforts are helping the country make important strides toward reaping the benefits of greater financial system participation. Many new banks are targeting the unbanked, and their alliances with retailers give them leverage to achieve that goal. Large established banks, too, are undertaking new initiatives—again, often in partnership with retailers—to reach the unbanked. These efforts, combined with government programs reducing regulatory burden and promoting competition, offer the promise of bringing low-income consumers the benefits of access to the financial system. Skelton is a business economist in the Financial Industry Studies Department of the Federal Reserve Bank of Dallas. Chart 4 Bansefi Complements Commercial Banks A. Bansefi More Common in Rural Areas… Branches per 100,000 people 10 8 6 4 2 0 20 40 60 80 100 Population in cities (percent) NOTES: Each point represents one of the 31 states plus the Federal District. Census data are for 2005; bank data are as of year-end 2007. B. …While Commercial Banks Focus on Urbanized States Branches per 100,000 people 20 15 10 Notes 1 Estimates of the financial penetration rate in Mexico vary. The World Bank’s 2006 “Mexico: 5 Country-Level Savings Assessment” reports that other studies have found 15–25 percent of the urban population and 6 percent of the rural population had access to the financial system. World 0 20 40 60 80 100 Population in cities (percent) Bank estimates, which divide the number of people NOTES: Each point represents one of the 31 states plus the Federal District. Census data are for 2005; bank data are as of March 31, 2008. with banking accounts in Mexico by the population, SOURCES: Comisión Nacional Bancaria y de Valores; Instituto Nacional de Estadística y Geografía; author’s calculations. yield a financial penetration rate of 23.8 percent. 2 Data in this section are drawn from “The Urban Unbanked in Mexico and the United States,” well as many bill paying, money exchange and 4 by John P. Caskey, Clemente Ruíz Durán and check cashing services. In this article, informal in “The High Cost of Being Unbanked,” Tova Maria Solo, World Bank Policy Research institutions are generally those whose trans- AccessFinance, February 2005. Working Paper no. 3835, February 2006. actions are not captured directly by national 5 accounts data and do not pay taxes. Formal Slump,” by Robert V. Bubel and Edward vices include moneylenders, family members, financial institutions include commercial banks, C. Skelton, Federal Reserve Bank of Dallas and rotary savings and credit associations, as savings and loans, and finance companies. Southwest Economy, May/June 2005, and 3 In Mexico, informal providers of financial ser- F ederal Reserve Bank of Dallas Banco de México information, as reported See “Mexico Emerges from 10-Year Credit 7 EconomicLetter EconomicLetter “Financial Globalization: Manna or Menace? The 13 Case of Mexican Banking,” by Robert V. Bubel and America and the Caribbean: How Large Is the Edward C. Skelton, Federal Reserve Bank of Dallas Market?” by Sergio Navajas and Luis Tejerina, Southwest Economy, January/February 2002. Inter-American Development Bank, November 6 Before 2007, finance companies existed solely The 2005 data are from “Microfinance in Latin 2006. The 2006 data are from an April 2008 as sofoles, or Sociedades Financiera de Objeto update of this survey. Limitado. Sofoles not converting to a sofomes 14 charter continue to be regulated by the CNBV. of a broad range of financial services to low- 7 At the time this was written, the peso–dollar exchange rate was 10.23. 8 “Éxito de Azteca, Bancarizar a Estratos de Microfinance is often defined as the provision income households and their microenterprises. This definition has been liberally expanded in Mexico to include unbanked small- and medium- Ingresos Bajos,” by Alicia Salgado, El Financiero, sized enterprises. Unregulated microfinance Nov. 3, 2005. institutions in Mexico generally offer only credit 9 The countries are Brazil, Honduras, Peru, products to their customers. Guatemala, Panama and El Salvador. The retailer 15 already had operations in four of the six coun- Capital and Access to Finance in Mexico,” by tries and could use existing retail locations to Robert Cull, David McKenzie and Christopher offer banking services. In the other two coun- Woodruff, World Bank, Feb. 12, 2007. tries, Brazil and El Salvador, Elektra is entering 16 both the local retail and local banking market. Financiera defines business size by the number The Federal District has a ratio of deposit of permanent employees. The definitions are dif- 10 See “Experimental Evidence on Returns to In Mexico, development bank Nacional accounts to people greater than 1. This probably ferent for manufacturing, commerce and service reflects people who work and bank in the Federal industries. District but live in a suburb. 17 11 See Diario Oficial de la Federación, “Resolución For example, see “Banking Services for Everyone? Barriers to Bank Access and Use por la que se autoriza la organización y operación Around the World,” by Thorsten Beck, Asli de una institución de banca múltiple denominada Demirguc-Kunt and Maria Soledad Martinez Banco Wal-Mart de México Adelante, S.A.,” Peria, World Bank Policy Research Working Dec. 9, 2006. Although this resolution is more Paper no. 4079, December 2006. Of the 193 detailed than that for other retailers with banking banks in 53 countries covered by the study, subsidiaries, the requirements are similar. Mexican banks performed below the median 12 The separation of banking from commerce in on most measures of access and affordability, the U.S. has a long and complex history. The including those for fees on checking accounts, National Bank Act of 1863 prohibited national minimum balances for checking and savings banks from owning equity securities and enu- accounts, the number of documents needed to merated the activities in which these banks could open checking accounts, the cost of consumer engage. The Bank Holding Company Act of 1956 and small business credit, the days needed to prohibited banks from engaging in activities not process credit applications and ATM fees. closely related to banking. However, although 18 industrial loan companies, or ILCs, are similar to Report for Mexico finds that although financial banks, those meeting certain conditions may be system regulation is improving at an impres- owned by commercial entities. sive rate, the regulatory and supervisory system For more on ILCs, see “Industrial Loan Companies: A Growing Industry Sparks a is published monthly by the Federal Reserve Bank of Dallas. The views expressed are those of the authors and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System. Articles may be reprinted on the condition that the source is credited and a copy is provided to the Research Department of the Federal Reserve Bank of Dallas. Economic Letter is available free of charge by writing the Public Affairs Department, Federal Reserve Bank of Dallas, P.O. Box 655906, Dallas, TX 75265-5906; by fax at 214-922-5268; or by telephone at 214-922-5254. This publication is available on the Dallas Fed website, www.dallasfed.org. For example, the May 2007 IMF Country continues to be complex and compartmentalized, leading to high compliance costs. Richard W. Fisher President and Chief Executive Officer Helen E. Holcomb First Vice President and Chief Operating Officer Harvey Rosenblum Executive Vice President and Director of Research W. Michael Cox Senior Vice President and Chief Economist Robert D. Hankins Senior Vice President, Banking Supervision Executive Editor W. Michael Cox Editor Richard Alm Associate Editor Monica Reeves Graphic Designer Ellah Piña Public Policy Debate,” by Kenneth Spong and Eric Robbins, Federal Reserve Bank of Kansas City Economic Review, Fourth Quarter 2007. For insight into the debate about retailerowned banks, see “The Mixing of Banking and Commerce: A Conference Summary,” by Nisreen H. Darwish and Douglas D. Evanoff, Chicago Fed Letter, November 2007. Federal Reserve Bank of Dallas 2200 N. 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