How Nafta Has Affected the Financial Service Industries in the United States, Canada, and Mexico

The North American Free Trade Agreement (NAFTA) was enacted in November of 1993 with aims to facilitate the free flow of goods, services and labor between the United States, Canada and Mexico. The ratification of NAFTA created the world's largest free market with roughly 390 million consumers and an estimated total output of $8.6 trillion. Clearly, this trade alliance has had a major influence on the financial service industries of the participating nations and will continue to do so in the future. However, the financial service provisions of NAFTA will have sufficiently greater implications for Mexico than either the United States or Canada. This is in part because Mexico is embarking upon a greater shift towards openness in its financial service industries. The fact that the financial markets of Canada and the United States have been highly integrated prior to NAFTA implies that they will not benefit as much from transactions within their own markets. What's more, Canada's trade with Mexico is 1 percent of its trade with the United States. However, the principal gains from financial integration of this sort have largely to do with the more efficient allocation of capital across international boundaries and the more efficient provision of domestic financial services to consumers.

The primary gains to the United States from the NAFTA financial services agreement will be predominantly seen in the long run. The access to a market that includes 90 million people and has been served by a financial and banking sector that has been relatively inefficient and illiquid will prove to be a major advantage to the United States. Although the market access to Mexico's financial industry has been gradual, U.S. banks, insurers and financial companies have free and fair access to Mexico. Further, in contrast to Canada, the United States has had strong historical ties with Mexico and this familiarity is expected to provide an advantage to the United States in Mexico. In the years to come, further growth of business for U.S. banks and financial institutions because of NAFTA can be expected.

A key impact of the financial services sector is that U.S. banks and financial institutions will be forced to improve their competitiveness. The McFadden Act (1927) and the Glass-Steagall Act (1933) limited branch-based banks and restricted services offered by financial institutions calling for the separation of commercial banks and investment banking. These had left U.S. banks relatively less competitive in the world market. Since the Gramm-Leach-Bliley Act (1999) amended the Glass-Steagall Act, many financial institutions have made steps towards offering a full range of financial services and greatly increased their market share.

Overall, the U.S. advantage from NAFTA is its virtually unlimited access to the Mexican market, which has been an incentive for the United States to restructure its domestic banking system. In the long run, NAFTA will help develop U.S. banking to compete not only in the NAFTA area but in other world markets as well. Another benefit of NAFTA will be increased

opportunities for U.S. and Canadian financial service companies (via the joint venture route), which will necessitate foreign companies to overcome cultural and language barriers. A wide variety of U.S. firms with existing investments in Mexico will be able to acquire previously prohibited majority ownership, including 100 percent ownership, in their investments. New U.S. entrants in many Mexican markets may start their own wholly-owned firms in Mexico

The greatest effect that the NAFTA financial service agreement has had on Canada is the liberalization of their financial sector. Many banks and financial institutions have been increasing in size through mergers and acquisitions. In 2001, the Royal Bank of Canada acquired Centura Banks and its 240 branches in the United States. They also purchased U.S. investment banks Dain Rauscher and Tucker Anthony Sutro for a combined $2 billion. Most recently, the Royal bank bought Barclay's and its $2.9 billion of private banking assets in the U.S. and Mexico. The Bank of Montreal is also buying U.S. assets. This financial services company recently acquired CFBdirect and Morgan Stanley's online-only accounts and placed them under its HarrisDirect brand.

Canada's major financial institutions are also getting involved in the Mexican market. The Bank of Montreal owns 16 percent of Mexico's largest bank, Grupo Financiero Bancomer, and Scotia bank owns 8 percent of Grupo Inverlat as well as maintains effective managing control.

Canadian banks also have a slight advantage over U.S. banks because of their long history of interstate branching and their experience with universal banking. These have just been recently allowed in the U.S. by the passing of the Gramm-Leach-Bliley Act.

The reduction of Mexican barriers will provide new markets and opportunities for the Canadian financial sector that they previously did not have access to. Canadian firms will be able to participate in sectors that were previously restricted. This essentially means access to Mexican banks, stock markets and investments that have limitless potential.

The financial sector in Mexico compared to the United States and Canada was, and is, very small and not very diversified. This makes this market extremely attractive to the foreign banks given its huge growth potential. An additional important financial service for the United States and Canada is the investment fund market, which is virtually non-existent in Mexico. The Mexican stock market is also sure to benefit from NAFTA. The "Bolsa" as it is called, is considered a young, inefficient and small stock market that holds much promise for U.S. and Canadian investors.

The Mexican banking industry has been widely opened up to external competition. Mexico is the largest economy in the world where such an

overwhelming majority of commercial bank assets (almost 80 percent) are controlled by foreign financial institutions. Since the establishment of NAFTA, the Mexican government, in conjunction with its banking sector, has concentrated on stabilization, modernization and a drive toward international comparable standards and objectives. They have implemented and maintained strict monetary and fiscal discipline. Mexico has successfully hit inflation targets in recent years and was as low as 3 percent in 2003 compared to 52 percent in 1995. The result has led to a much improved and strengthened financial system.

Financial institutions have moved quickly to implement new risk management policies and processes for credit administration. Asset liability management policies have been improved to better assess value of risk and mitigate liquidity and interest