OREANDA-NEWS. The Mexican Financial System is comprised of both banks and non-bank financial institutions (NBFIs), the latter normally of much smaller size, and more concentrated business profiles, according to Fitch Ratings. Over the past few years, some of the medium and large sized NBFIs have been pursuing their conversion to a bank in order to improve their funding profile, looking for a stable and cheaper source, such as customer deposits.

Nonetheless, the recently converted entities have faced high conversion costs, especially heftier regulatory requirements related to corporate governance strengthening, more advanced technologies and higher credit costs. In addition, the ability of these banks to gain a material share of customer deposits has been relatively limited, with deposits growing only moderately and gradually, in most cases.

In the past five years, the Mexican regulator has approved 13 new banking licenses, two of which were previously subject to certain regulatory frameworks, but only nine are currently operating. Historically, results for those converted banks that were previously non-regulated entities have been mixed, although in most cases their performance has been weak, while it took them longer than expected to reach breakeven. Newly converted banks reported average ROA and impairments during the period 2011-2015 of -2.3% and 4.5%, respectively, levels that compare well below the average of the Mexican banking system (1.7% and 2.5%).

Their results are still pressured by weak efficiency ratios (cost to income of 173.9%, average during the same period) due to high operational expenses mainly related to personnel and corporate governance structure, such as the creation of committees and mandatory areas or roles. Another big impact in costs comes from their migration to a core banking system, which results in constant investment due to regular adjustments according to their banking activities, especially when preparing to collect deposits.

Finally, one important change when converting from a non-regulated entity to a bank that impact results is the adoption of new rules to calculate reserves for impaired loans. In a non-regulated environment, these entities use different methodologies for loan loss provisioning, but usually their policies are weaker compared to those required by the Mexican regulator, resulting in big impacts when adopting the more stringent regulatory model. The hit taken with the creation of reserves upon migrating to banks was, on average from 2011-2015, 169.6% of the operating profit (Banking system: 46.5% during the same period).

In some cases, the converted entities had suffered higher than projected losses that had been compensated with subsequent capital injections in order to sustain the operation.

However, there have been some exceptions of successful transitions of NBFI's to banks. Fitch believes the success of such entities is highly influenced by their consolidated model in specific niches. Being leaders in their respective line of business proved to be a competitive advantage that they have maintained through the conversion process. Also, those entities were somehow prepared in terms of corporate governance practices and adopted stricter provisioning practices prior to converting into a bank. Fitch believes that in the case of the Foreign Exchange banks, their successful conversion has also been partially aided by their previous regulated figure. In most of these cases, the converted banks have stayed true to their core business helping them in the transition.