Financial Crises and Regulatory Responses

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This is the first of five articles in the Bank Resolution series:

1. Financial Crises and Regulatory Responses
2. A Special Insolvency Regime for Banks
3. Bank Capitalization and Early Warnings
4. Systemic Importance of Banks; Resolution Alternatives
5. Bank Resolution Techniques

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The 1994-1995 Mexican Crisis: The Bank Rescue

The Mexican financial crisis of 1994-1995 marked a pivotal moment in the country's economic history, triggering a series of regulatory reforms that would reshape its banking sector. This crisis, often referred to as the "Tequila Crisis," exposed significant vulnerabilities in Mexico's financial system and prompted decisive action from regulators to prevent a complete collapse of the banking sector.

At the heart of the initial response was what became known simply as "The Bank Rescue." This process, implemented within a relatively incomplete framework, saw regulators taking ad hoc measures consistent with international sound practices to recapitalize the banking system. While The Bank Rescue successfully prevented a deeper crisis that could have destroyed the entire financial system, it was not without controversy. The process was riddled with political turmoil, leaving scars that are yet to heal three decades later.

The 2004 Early Warnings Regulation

The 1994-1995 crisis served as a wake-up call, inspiring significant improvements to the regulators' toolkit for addressing financial distress in banks. The first major step in this direction came in 2004 with the incorporation of an "early warnings" system. This system was designed to allow regulators to detect banks in the process of financial deterioration and act accordingly. It required banks to regularly calculate their capitalization index, with regulators implementing certain measures based on each bank's level to prevent further deterioration.

The 2006 Bank Resolution Framework

Building on this foundation, Mexico adopted a comprehensive framework for bank resolution in 2006. This framework enabled regulators to implement modern bank resolution techniques for an orderly and expedient liquidation of a failed bank or for the healing of a systemically important bank. The 2006 framework had a four-fold stated purpose: protect savers' deposits, protect the stability of the payments system, prevent systemic risk, and minimize taxpayers' costs.

The 2008-2020 Global Crisis: Basel III

The global financial crisis of 2008-2010 further accelerated the evolution of Mexico's banking regulations. In response to this worldwide crisis, Mexico adopted a version of the Basel III rules, which set new global capital and liquidity standards for banks. This adoption came even before the full implementation of Basel II, underscoring Mexico's commitment to maintaining a robust and resilient banking sector.

The 2014 Overhaul: Modernization of the Resolution Framework

The culmination of these regulatory efforts came in 2014 with the passage of a new bill to overhaul the framework for bank insolvency. These 2014 reforms incorporated several key changes, including the concept of judicial liquidation for banks with negative shareholders' equity. It represented a significant step forward in aligning Mexico's bank resolution framework with international best practices.

Conclusions

The journey from the 1994-1995 crisis to the 2014 Reform illustrates the complex and iterative nature of financial regulation. It shows how regulators must constantly adapt to new challenges, learning from both domestic experiences and international trends.?

Throughout this period of regulatory evolution, we see a clear trend towards more proactive and comprehensive oversight of the banking sector. From the reactive measures of The Bank Rescue to the proactive early warning systems and the sophisticated resolution framework of the 2014 Reform, Mexican regulators demonstrated a commitment to learning from past crises and building a more resilient financial system.

The resulting framework, while not without its challenges, represents a significant improvement in Mexico's ability to prevent, detect, and manage banking crises, ultimately contributing to the stability and resilience of the country's financial system.

The complete version of the article from which this series was taken can be found here