Using loan-level data from the Mexican credit registry, we evaluate how bank characteristics affect the transmission of domestic and foreign shocks to credit supply. We find that banks with higher capital, liquidity, profitability, long-term funding and deposit funding show a smaller response to shocks. By contrast, banks with high credit risk and foreign funding show a larger response. Second, foreign banks respond more sensitively to shocks compared to domestic banks. Finally, the credit supply to firms that are small, have higher credit risk and weak banking-relationships shows a larger response to shocks. The evolution of bank characteristics in Mexico, through the lens of these results, has strengthen the resilience of its financial system.

In this paper we document empirical evidence regarding the unintended consequences of financial regulatory changes on market liquidity of Mexican sovereign debt. We find mixed impacts: in the context of Basel 2.5, Basel III and the Liquidity Coverage Ratio, we find negative effects, while in the case of the Dodd-Frank Act and the Volcker Rule we find positive effects. The difference in results can be explained by the fact that some of the regulatory changes mainly imposed additional constraints on government debt holdings, while others were designed to enhance transparency and thus reduce uncertainty as well as information asymmetries. Moreover, our estimates suggest that the aggregate effect of the regulatory changes decreased the weekly turnover ratio of Mexican sovereign debt securities by 18 percent. Our results hold under different liquidity measures and different econometric specifications.

We examine the role of imposing tighter limits on interbank exposures in reducing contagion and aggregate losses. In our model contagion risk arises as a result of the individual idiosyncratic failure of each bank in the banking system. Following Guerrero-Gomez and Lopez-Gallo (2004), we use a sequential default algorithm that is useful for tracing the path of contagion from a trigger bank to other banks during several contagion rounds. We test different types of limits on inter-SIB (systematically important banks) exposures, SIB to non-SIB exposures, and non-SIB to all other banks; and we study three different assumptions about banks’ behavioural responses under a stricter regulatory lending regime. We also “stress test” all banks within the banking system and extend the analysis on the benefits of using tighter limits in a fragile banking system. Calibrating the model to Mexican banking sector data, this network model shows that tighter limits for inter-SIB exposures are a useful tool for reducing contagion risk. Moreover, we find that tighter limits may lead to an increase in contagion risk under specific allocation assumptions.