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North American free trade agreement : issues on trade in financial services for Mexico

  • Vittas, Dimitri
  • Demirguc-Kunt, Asli
  • Musalem, Alberto

To maximize the efficiency gains from the North American Free Trade Agreement (NAFTA), the regulatory environment for Mexican banking, insurance, and securities markets should be further harmonized with those of the more advanced and efficient Canadian and U.S. markets. The authors argue that a prerequisite for NAFTA's success is to remove regulatory distortions and to eliminate opportunities for regulatory arbitrage. Moreover, eliminating or reducing disparities between the NAFTA countries'tax rates and ways of levying taxes would help prevent distortions, tax evasion, and tax avoidance. Complete harmonization may not be feasible or even desirable, given the way the three countries'financial systems have evolved and the differences between their industrial structures and stages of economic development. In banking, insurance, and securities markets, the main free trade issues are the convergence of authorization criteria and the removal of most of the obstacles to freedom of establishment. It is also important to harmonize guarantee schemes and to create well-defined Mexican schemes to protect small, unsophisticated investors rather than mismanaged institutions. The key to NAFTA's success in the financial sector will be effective prudential regulation and supervision - particularly because of the heavy financial pressures on the newly privatized banks and the financial groups that own them. Without effective supervision, the new owners of the banks may take excessive risks to recoup the substantial element of goodwill in the privatization price, before the protection from foreign competition and new entrants is phased out. An integrated market will presuppose greater cooperation and information exchange among the national regulatory authorities to ensure, for instance, that weak banks do not undermine credit standards and that weak insurers do not offer deceptively low-priced policies. In these areas, Mexico needs intensive training and cooperation with the Canadian and U.S. regulatory authorities. To increase the contestability of the financial markets and benefit from the transfer of financial technology, the Mexican financial system should be opened to foreign entry. But Mexico needs to modernize its financial institutions and the authors conclude that the proposed NAFTA should allow for a gradual approach to foreign entry. A reasonable transition period, extending up to the year 2000, will give Mexican institutions ample time to achieve the efficiency gains that motivated the quest for the agreement in the first place.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1153.

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Date of creation: 31 Jul 1993
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Handle: RePEc:wbk:wbrwps:1153
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  1. William F. Sharpe, 1977. "Bank Capital Adequacy, Deposit Insurance and Security Values, Part I," NBER Working Papers 0209, National Bureau of Economic Research, Inc.
  2. David H. Pyle, 1983. "Pricing deposit insurance: the effects of mismeasurement," Working Papers in Applied Economic Theory 83-05, Federal Reserve Bank of San Francisco.
  3. Barnes, Guillermo, 1992. "Lessons from bank privatization in Mexico," Policy Research Working Paper Series 1027, The World Bank.
  4. Sharpe, William F., 1978. "Bank Capital Adequacy, Deposit Insurance and Security Values," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 13(04), pages 701-718, November.
  5. Paul L. Joskow, 1973. "Cartels, Competition and Regulation in the Property-Liability Insurance Industry," Bell Journal of Economics, The RAND Corporation, vol. 4(2), pages 375-427, Autumn.
  6. Shaffer, Sherrill, 1993. "A Test of Competition in Canadian Banking," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(1), pages 49-61, February.
  7. Vittas, Dimitri, 1991. "Measuring commercial bank efficiency : use and misuse of bank operating ratios," Policy Research Working Paper Series 806, The World Bank.
  8. David H. Pyle., 1983. "Pricing Deposit Insurance: The Effects of Mismeasurement," Research Program in Finance Working Papers 142, University of California at Berkeley.
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