Federal Reserve Bank of Cleveland
Press Release

For Release: May 20, 1997
Contact: John Martin, 216/579-2847 or June Gates, 216/579-2048

Cost of Mexican Banking Reform May Be Higher Than Expected

Analysts have praised Mexican banking reform packages, but a recent Economic Commentary published by the Federal Reserve Bank of Cleveland maintains that some elements of the current reform efforts may provide only short term benefits and could ultimately boost the cost of resolving Mexico's debt problem.

The Commentary's author, economist William Osterberg, highlights aspects of current and previous banking reforms that might shield banks from the discipline of the market and compromise the country's monetary policy. It is widely believed, Osterberg notes, that the fragility of the Mexican banking system may have played a crucial role in the actions of the Mexican central bank during the 1994-95 peso crisis. He says there may be a continuing temptation to modify monetary policy for the sake of propping up banks. He adds that the central bank does further harm if it lends to commercial banks to fund projects that are not profitable enough. This lending may impede the development of banking skills and result in inflation when the creation of credit is not matched by an increase in output.

Osterberg says some features of Mexican banking reform have only short run value and could increase the prices at which Mexican banks attract funding or the likelihood that taxpayers will have to provide additional assistance. He maintains that reforms should encourage and aid banks in developing the skills necessary to evaluate the profitability of projects, and the riskiness of borrowers and outstanding loans.

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