The Financial System and Access to Credit in Mexico Micro and SME

1. The Financial System and Access to Credit in Mexico Micro and SME March 2013

2. Index

3. CreditGrowth, Micro Enterprises Number of clientsby Enterprise size* • Banks pay now more attention to Micro Enterprises. • From July 2009, the number of Micro clients increased by 36.4%. Clients Large Small Medium Micro */ Size of the Enterprise defined by number of employees and annual income.

4. CreditGrowth, Micro Enterprises Creditamountby Enterprise size* mmdp • The amount granted to Micro Enterprises has doubled from July 2009 to January 2013. • Greater number of clients • Greater amount granted Large Small Medium Micro */ Size of the Enterprise definedbynumber of employees and annualincome.

5. CreditGrowth, SME´s Amounts of Creditby Enterprise Size* mmdp • In July 2009, the segment of SME´s represented 48% of the amount of Commercial Loans. • In January 2013, the segment of SME´S represents 51.1%. • This means that smaller companies have increased their access to banking credit. SME Large SMECredits up to 100 mdp LargeCreditslargerthan 100 mdp */ Size of the Enterprise definedbynumber of employees and annualincome.

6. CreditGrowth, InterestRates The interest rates charged to Commercial Loans have decreased in all segments. However, interest rates charged to Micro Enterprises are volatile. It is considered that size is proportional to credit risk, and therefore interest rates charged to smaller enterprises are higher, even by 300 bp. InterestRateby Enterprise Size Vs. BankingFundingRate (TIIE) InterestRateby Enterprise Size % % Micro Small Medium Large

8. Empiric Evidence The CNBV performed two surveys and economical studies: • Survey to Micro and SME´S: the objective was to identify the sources and conditions of access to credit, use of the resources and factors for productivity. • Survey to Banks: the objective was to study the credit allocation strategies to Micro and SME´s, and analyze some factors that incentive or refrain credit.

9. Micro and SME´s Survey • National Survey of Competition, Credit Sources and the use of Financial Services by Enterprises (ENAFIN). • The objective of the Survey was to identify the reasons that slow down or refrain credit to enterprises in banks. • ENAFIN is a survey to no financial enterprises, with more than five employees, established in locations with 50,000 inhabitants or more. The sample contains 986 enterprises. The results are representative at a national level, by enterprise size. • Performed by the Interamerican Development Bank and the CNBV in 2009.

10. Micro and SME´s Survey • Six out of 10 enterprises are family businesses, 8 are owned by a man and 9 are registered to pay taxes. • The most used source is Suppliers, (55%). Credit from financial intermediaries represent the third source of finance for enterprises (43%). • The destination of the credit in most cases is working capital. • Revolving credit is the most used product.

11. Micro and SME´s Survey Most enterprises do not give guarantee for the credit, only 3 out of 10 do. Should the enterprise provide guarantee, they would pay a lower interest rate.

12. Micro and SME´s Survey Lowerinterestrates are associatedwithlowerrisk. Riskindicators: lack of payment, guarantee in thecredit. */ Size of the Enterprise defined by number of employees and annual income.

13. Micro and SME´s Survey • Only two out of ten enterprises ask for a long term traditional credit during 2005-2009, and only one out of ten obtained it. Long TermCredit This trend is also true for larger enterprises. */ Size of the Enterprise defined by number of employees and annual income.

14. Banks Survey Performed by CNBV and CEPAL (ComisiónEconómicaparaAmérica Latina y el Caribe) in 2011. • The objective of the survey was to analyze the target market of the banks, their business model and to find those factors limiting the offer of credit. • The sample contained 15 banks, which participate in the “SME Committee” of the Banks Association. These banks have 97% of the portfolio of credit for enterprises of 25 million pesos or less. • Additionally, personnel of NacionalFinanciera were interviewed, to complement the information obtained about guarantees of credits to micro and SME´s and the market function.

15. Banks Survey, business model Three identified business plans: • Large Banks: Attract as many clients as possible, through their branchs net or specialized executives. • Banks with an interest in Micro and SME´s: Niche or regional banks use “relationship lending” to attract clients. • Banks with no interest in Micro and SME´s: Banks that offer credit to Micro and SME´s only to serve their current clients.

16. Banks Survey, Target Market • Banks confirmed their interest to offer and compete for “complete solutions” for Micro and SME´s, with packages that include credit, deposits and means of payment. As much as 73% of interviewed banks offer more than 5 different products to their clients. • As much as 73% of interviewed banks have a specialized area to Micro and SME´s and a specialized strategy for the sector. • The functions of planning of targets and products, potential clients, origination and follow up of credit, collection in the first 30 days, are concentrated in this specialized area. • Banks usually have a specialized sales force inside the branches • As much as 83% of interviewed banks offer specialized and extensive (more than 80 hours a year) training for this areas. • Turn over of high level executives is 7 years. Average turn over for medium level executives is 4 years. In lower levels the turn over is 2 years. Análisis propio con base en entrevistas con los Bancos.

17. Banks Survey, Potential limitations for credit

18. Index

19. SOFOMES • “Multiple Object Financial Societies” (SOFOMES) is a new specialized vehicle for lending purposes. • They were intended to represent more competition for banks, diversifying the credit offer. • They are only regulated and supervised by CNBV in case the SOFOM is related to a bank. • SOFOMES were conceived as entities which have to compete for funding in the markets and, based on well informed participants, only those which effectively create value and perform better that the rest would prevail. • The most succesful SOFOMES are looking to transform to a niche bank or to another regulated financial entity.

20. SOFOMES SOFOMES lead to additional failures that affect the whole SME’s credit market, such as: • Do not report credit performance to the credit bureau; • Do not have clear incentives to adopt sound prudential practices. To complete credit records and enhance the credit score as an effective decision tool, SOFOMES should be forced to timely report credit performance from their borrowers to the credit bureau. On the other hand, there is not clear evidence (yet) that the cost of lending to SME’s decreased because of competition, since SOFOMES were created.

21. Transparency as a way to efficiency • In 2007 the Law of Transparency and Ordering of Financial Services (LTOSF) was issued. • Users of those services should compare net interest rates and contracts, between similar credit products offered by banks and other entities. • SOFOMES and non financial entities which are professional lenders are subject of this Law. • Despite Mexican financial authorities actively promote transparency and competition, people are not used yet to compare before acquiring the service.

22. SME’screditmarket Banks have to face the following challenges regarding SME financing: • Lack of timely financial reporting; • Inaccurate information to build expected loss credit ratings and pricing models; • Other credit activities could be more profitable of efficient in use of capital; • SME’s are adverse to demand credit. • Collecting the collaterals could be difficult in the short term.

23. Index

24. Conclusions • Six out of ten enterprises finance from suppliers, five with internal resources, four with financial intermediaries and two with friends or family • The smaller the enterprise, the bigger the chance to not have a traditional credit. • In the last five years, only two out of ten enterprises ask for a long term traditional credit and only one out of ten obtained it. • The smaller the credit risk, the smaller the credit rate. • Seven out of ten enterprises do not give any type or guarantee for their credit. • When they do give a guarantee they obtain smaller interest rates. • The smallest enterprises are more likely to be behind in their payments and pay larger interest rates

25. Conclusions • The principal obstacles to offer finance to micro and SME´s are: • Lack of legal protection for lenders: legal system is complex, slow and expensive. • Macroeconomic Factors: strong impact during crisis. • Cultural and regulatory factors: informality is the most important identified problem. • Banks face the largest problems to serve new enterprises (less than 2 years), informal and micro enterprises, as well as entrepreneurs. • This type of enterprises face obstacles derived from information asymmetries, transaction costs and lack of guarantees. • No evidence found that the origin of capital (national vs. foreign) or historical factors of the banks would obstacle the credit allocation. • Depending on the business model, banks seek to offer greater quantity of services to their clients.

26. Conclusions • Capital cost for SOFOMES is lower than for banks, giving them a competitive advantage. • In some cases they face difficulties to funding and therefore their growth is limited and subject to the economic cycle. • There is no evidence that they represent a real competition for banks, making the interest rates to decrease. • The fact that SOFOMES do not report to the credit bureau limits financial inclusion. • It is not clear that a regulatory burden would help them to have better practices.

27. Conclusions Credit to Micro and SME´s in Mexico is growing and in the right path, but there is still work to do.