A New Model for Market-Based Regulation of Subnational Borrowing: The Mexican Approach

26 Pages Posted: 20 Apr 2016

See all articles by Marcelo M. Giugale

Marcelo M. Giugale

World Bank; Georgetown University

Adam Korobow

affiliation not provided to SSRN

Steven B. Webb

World Bank - Economic Development Institute

Date Written: November 1999

Abstract

To bring fiscal discipline to state and municipal governments, Mexico's federal government has established a two-pillar framework that explicitly renounces federal bail-outs and establishes a Basel-consistent link between the capital-risk weighting of bank loans to subnational governments and the borrower`s credit rating. Whether the framework succeeds will depend partly on market assessments of the government's commitment to enforce bank capital rules and refrain from bailing out defaulting subnational governments.

Faced with weak subnational finances that pose a risk to macroeconomic stability, Mexico's federal government in April 2000 established an innovative incentive framework to bring fiscal discipline to state and municipal governments.

That framework is based on two pillars: an explicit renunciation of federal bail-outs and a Basel-consistent link between the capital-risk weighting of bank loans to subnational governments and the borrower`s credit rating.

In theory, this new regulatory arrangement should reduce moral hazard among banks and their state and municipal clients; differentiate interest rates on the basis of the borrowers' creditworthiness; and elicit a strong demand for institutional development at the subnational level.

But its success will depend on three factors critical to implementation: · Whether markets find the federal commitment not to bail out defaulting subnational governments credible. · Whether subnational governments have access to financing other than bank loans. · How well bank capital rules are enforced.

This paper - a product of the Mexico - Country Department and Poverty Reduction and Economic Management Sector Unit, Latin America and the Caribbean Region - is part of a larger effort in the region to understand the subnational underpinnings of sustainable, national economic framework. The authors may be contacted at mgiugale@worldbank.org, akorobow@worldbank.org, or swebb@worldbank.org

Suggested Citation

Giugale, Marcelo M. and Korobow, Adam and Webb, Steven Benjamin, A New Model for Market-Based Regulation of Subnational Borrowing: The Mexican Approach (November 1999). World Bank Policy Research Working Paper No. 2370, Available at SSRN: https://ssrn.com/abstract=630754

Marcelo M. Giugale (Contact Author)

World Bank ( email )

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Georgetown University ( email )

Washington, DC 20057
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Adam Korobow

affiliation not provided to SSRN

Steven Benjamin Webb

World Bank - Economic Development Institute ( email )

1818 H Street
Washington, DC 20433
United States