If ratified, the North American Free Trade Agreement would bring significant benefits to the three countries party to it. And the financial services component is a genuine breakthrough.

For more than 50 years, Mexico was one of the most restricted financial markets in the Western Hemisphere. Non-Mexican financial service firms were basically prohibited from establishing a presence.

A notable exception is Citibank, which has operated continuously in Mexico since 1929. The trade agreement would open the door for other U.S. and Canadian banks to serve the Mexican market at precisely the time when its economy has begun a rapid expansion.

Phased-In Access

The agreement provides a framework to facilitate trade in services, including financial trade in services, within North America.

It expands on the earlier initiatives in the Canada-U.S. Free Trade Agreement and on the efforts of the so-called Uruguay Round of multilateral trade in services and to create internationally agreed upon rules for such trade.

The agreement would give U.S. and Canadian banks phased-in access to the Mexican market with certain limitations on the structure and form of their operations, so it is important to understand precisely what the pact would accomplish.

U.S. banks would be able to enter the market either de novo or by purchasing an existing bank. Mexico has placed only its largest banks off-limits.

The agreement calls for a transition period running from 1994 to 2000. During that time, U.S. and Canadian banks would be able to grow in aggregate market capitalization from 8% to 15% of the capitalization of the Mexican banking system. Each individual bank's market share would be capped at 1.5% throughout this period.

The capitalization of the Mexican banking system as of June 1992 was about $8 billion.

This means U.S. and Canadian banks would be permitted to grow from an initial aggregate maximum capitalization of roughly $640 million, while each individual bank's capitalization would be able to grow from an initial limit of roughly $120 million as the capitalization of the banking system grows.

Comparable transition limitations would apply to other financial services, such as insurance, securities, and finance companies.

Ending the Limits

After 2000, all the caps would be removed. Mexico, however, could impose an optional one-time, three-year moratorium on any further U.S. or Canadian bank expansion, should those banks attain 25% of the Mexican market during the years 2000 to 2004.

Even if Mexico imposed the moratorium, there would be no permanent caps on banking after the year 2007.

The transition period with a market share cap is a good compromise. It addresses the desires of U.S. banks to establish a meaningful presence in the Mexican market, as well as the legitimate interest of Mexican officials in having their recently privatized banking industry remain largely under local control for the near future.

Subsidiaries Needed

The agreement would require that U.S. banks form subsidiaries to do business in either country. Although U.S. banks would prefer to have the right to operate through branches, the subsidiary structure does not appear to be an onerous burden.

Indeed, under the agreement a U.S. bank's Mexican subsidiary could function as a financial holding company, able to separately operate a bank, a securities firm, and an insurance firm as well as leasing and factoring businesses.

The net result is that subsidiaries of U.S. banks would be able to engage in more lines of business in Mexico than the parent bank can in the United States.

Moreover, the parties have agreed to negotiate direct branching when U.S. law has been liberalized to allow interstate branching.

The agreement provides for full national treatment for U.S. banks; our banks would be able to operate in Mexico under the same rules and prudential standards as domestic banks.

National treatment is more the exception than the rule among developing countries, which makes the trade agreement all the more significant.

With regard to legal lending limits, U.S. trade negotiators had sought a commitment that U.S. banks could lend up to 100% of the paid-in capital of their Mexican subsidiaries to individual customers.

In the end, the United States was unable get this provision included in the agreement. U.S. banks are hopeful that over time Mexico would agree to an increase in the lending limit.

Mexico will continue to allow its citizens to purchase financial services across border, from providers in the U.S. and Canada. Existing restrictions on cross-border solicitation, however, were not removed.

Mexico has agreed to a "standstill" in that no further prohibitions on solicitation, other than those already in place, would be imposed. U.S. banks would like to have seen an end to cross-border solicitation restrictions, but the standstill is a reasonable compromise for now.

The services component is but one part of the agreement relevant to U.S. banks.

Repatriating Profits

Indeed, it is in the "Investment" chapter that some of the most significant breakthroughs were made.

U.S. investors would gain the right to repatriate profits and obtain hard currency for all payments associated with an investment, and U.S. investors could go to international arbitration to seek monetary damages or restitution for any violation of these rights.

Most investments by U.S. services firms would be covered, including wholly or partly owned business enterprises, minority equity shares, real estate, and other tangible and intangible property.

The bottom line is that this trade agreement represents a genuine opportunity for U.S. banks positioned to offer services to the rapidly growing Mexican market.

Ideally, a "free trade" agreement for financial services would provide unrestricted freedom for banks and other financial services providers to offer-services in foreign markets through branches, subsidiaries, or cross-border sales.

Big Step Forward

Although the agreement falls short of this ideal, it is a big step forward. As the most comprehensive trade agreement affecting financial services that the United States has yet negotiated, it establishes many useful precedents.

It should serve as a model for other bilateral and multilateral trade agreements such as those contemplated under the Enterprise for the Americas Initiative as well as the General Agreement on Tariffs and Trade.

Consequently, the agreement represents significant progress for U.S. banks interested in broadening trade in financial services, not only within North America, but ultimately globally.

The U.S. Congress should move quickly to ratify the agreement.

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