How financial intermediaries keep the economy moving

Ximena Torres

A country's financial system is like the circulatory system of the economy; both allow resources to flow and sustain development. A group of key players are involved in this process: financial intermediation institutions, which act as a bridge between those with surplus resources and those who need them. "They connect savers and borrowers," explained Corina Tovar Ureña, Deputy Manager of Regulation at the General Directorate of Financial System Affairs of the Bank of Mexico (Banxico).

Tovar was at ITESO as one of the speakers for the Bank of Mexico Chair, an economic and financial education program designed to familiarize students and faculty with the functions of the central bank. The specialist led the session on "Stability of the Financial System," focusing her explanations on Banxico's regulatory role over financial institutions.

To understand the issue, the specialist explained that bank accounts function like drawers. When a person decides to deposit their money, the funds don't remain static; instead, the financial institution lends them out or channels them to productive sectors that demand capital. "If it's businesses, they obtain resources to produce; if it's governments, to meet the needs of the people; if it's individuals, to obtain a mortgage, car loan, or even a credit card," Tovar exemplified.

The circulation of resources within the financial system creates a virtuous circle, because the surpluses of some allow the projects of others to be activated, so that, with greater intermediation, there is greater economic growth.

All of this takes place under the agreement that savers can access their money whenever they want, regardless of whether the companies, governments, or individuals who owe them are current on their loan payments. The Bank of Mexico ensures that financial institutions make the most prudent decisions to provide security for their clients and, consequently, encourage them to continue saving or borrowing money.

Prudential regulation from the Bank of Mexico

In Mexico, there are 54 commercial banks, and their assets represent 43.51 percent of the Gross Domestic Product (GDP), according to data presented by Tovar. Seven of these institutions, including BBVA, Santander, Banorte, and Banamex, hold 70.6 percent of the banking sector's assets.
The function of these companies is similar to that of financial institutions or popular savings banks grouped in Savings and Loan Cooperative Societies (Socap) and in Popular Financial Societies (Sofipo): they provide indirect financing in exchange for managing the risks of each operation.

This is what makes them different from brokerage firms, another type of intermediary company through which a person can buy stocks, bonds, and currencies on a stock exchange. The disadvantage of this direct financing method is that if a company goes bankrupt, no one is responsible for returning investors' money.

Conversely, if banks, savings and loan cooperatives (Socaps), and other financial institutions (Sofipos) face unpaid debt, “they must have a mechanism in place to hold reserves and meet their obligations to us as depositors, so they can return our money,” the speaker explained. The Bank of Mexico, through the Financial System Stability Council, the Bank of Mexico Law, and other regulatory instruments, is responsible for establishing the minimum requirements for this to happen.

Banxico's intention is to encourage banks to make the most prudent decisions to avoid various types of risk, especially systemic risks, which can cause problems throughout the Mexican financial ecosystem. Regulation is closely linked to supervision and is procyclical, meaning it always comes in response to market behavior.

If the opposite were true, and regulations were one step ahead of reality, it could stifle innovation. As Corina Tovar explained, the central bank aims to ensure that intermediary institutions continue to fulfill their role of mobilizing people's savings, diversifying and managing risk, reducing transaction costs, and evaluating projects with greater confidence for investment.

"Banks are natural risk-takers; they have incentives to do so because they'll earn more if they do. We tell them they can do it, but for every peso they take on risk, they have to put up a proportional amount of capital. [...] The minimum required is 10.5% regulatory capital; when they fall below that, alerts are triggered, and the authorities tell them they need to curb their growth," Tovar said, explaining his work.

This and other mechanisms are based on the regulation established by the Basel Committee on Banking Supervision, the main global regulatory body that has allowed the financial systems of each country to operate under the same principles.

During her presentation at ITESO, Tovar acknowledged that some finance students in the audience might wonder why they should be interested in regulatory issues, given that this is primarily a topic for lawyers. In response, the specialist said, "As finance professionals, we provide the analyses that enable the development of regulations."

Considering the lecture as a learning opportunity, the speaker invited the university community to the following sessions to be held at ITESO, which are scheduled for October 23 and 30 and will deal with payment systems in Mexico and the evolution and prospects of the central bank.