Mexico banks could face credit risks from proposed outsourcing ban

The Mexican government's proposal to ban outsourcing, or the contracting of jobs by third-party companies, could reverberate through the banking system, analysts told S&P Global Market Intelligence.

The final months of 2020 saw Mexican President Andrés Manuel López Obrador rallying to pass a bill that would prohibit most forms of outsourcing. In special cases where employee outsourcing would be allowed, stricter approvals and higher penalties relating to compliance would be imposed, adding layers of administrative rigidity.

The proposed legislation, which will likely be debated in congress in the second half of the year, has become a fiercely debated topic due to its far-reaching labor implications, as well as for its likely impact on credit demand.

Outsourced workers in the country had reached 4.6 million in 2018, up from 1 million employees in 2003. While maintenance and warehouse jobs are the most frequently outsourced, skilled and permanent employment has also been increasingly subcontracted.

Opponents of the subcontracting model say that it has hampered collective bargaining, curtailed wage growth and adversely impacted workers' retirement benefits. AMLO has strongly vilified subcontracting, saying it is "used as a form of tax fraud" and has led to employees being "denied their job benefits."

The business sector, on the other hand, has strongly opposed the proposed outsourcing ban, citing its negative impact on investment inflows and the cost of doing business in the country given potentially higher labor costs.

"It is essentially adding an extra layer of red tape for businesses and firms to use these subcontracted workers, now that they have to get state approval for that," according to Nikhil Sanghani, an emerging markets economist at Capital Economics. "That is something that would make the labor market in Mexico even more inflexible and potentially add cost to businesses."

"It would be an additional headwind to businesses and employees at a time when Mexico's economy is already soft," Sanghani added.

In its latest quarterly report, Banco de México said that the lack of an agreement regarding outsourcing regulation was a downside risk to GDP growth, due to its need to allow "to both protect employment and workers’ rights, and to achieve an efficient and flexible labor allocation."

Impact on credit

Luis Niño de Rivera, the president of banking association ABM, warned that abolishing outsourcing in the country would have an "impact on credit" given the substantial loss in employment that the blanket proposal could entail.

According to Alfredo Calvo, a senior director at S&P Global Ratings' financial services ratings group for Latin America, the outsourcing bank's effect on credit would mostly stem from the payroll-backed loan segment.

Payroll-deductible loans have been an increasing presence in Mexico's credit segment in the past years, accounting for 6.0% of total bank and AMDEN — or Mexican Association of Payroll Lenders — loans at the end of 2020, according to a Fitch Ratings report.

Payroll-tied credit is availed by employees by taking out the loan through the bank holding their payroll accounts, with their salary used as collateral. These loans are usually associated with lower default rate given the automatic deduction process from employees' salary accounts on each payday.

However, a massive dismissal of employees through the outsourcing ban would have a negative impact on banks' asset quality given the growing importance of payroll loans in their books, Calvo said.

On the corporate segment, "there is a potential for disruption if the additional cost that businesses have to take on could mean that NPLs might rise, [especially] if they are already operating with high costs and weak revenues because [of a] pretty weak [economy]," Sanghani said. "There is [credit] risk from that and … from consumers as well," he noted.

However, Mexican lenders could rely on their bolstered positions in the past years to cushion against any potential shock from the bill. "[T]heir large and well-diversified business and loan portfolio could mitigate the potential impact of the outsourcing law," Calvo noted.

Keeping ties

After facing dissent from business chambers, AMLO signed an agreement with business leaders and unions in December 2020 that postponed congressional debates. Shortly after, however, the president doubled down on his comments about outsourcing, saying that subcontractors were undermining the Mexican job market.

"Market participants are in a good position [to maintain] a dialogue with the government," Calvo said. This is evidenced in the negotiation made by business leaders with the Mexican administration that led to the delay of the bill's discussion in Congress. Keeping an open communication between business leaders and the administration will be necesssary to arrive at a conclusion that is both favorable for both parties.

Meanwhile, BanCoppel SA Institución de Banca Múltiple Director General Julio Carranza Bolívar said that, given outsourcing's impact on the banking sector, there is a need for "searching together with the government, what are the best ways" for its mandate.

For Capital Economics' Sanghani, it is difficult to say whether the ban will go through or not. "... [O]ften, what we have seen is that AMLO talks a big game, but actually his actions can be less radical than his words," the economist noted. "It seems like he does not want to go all guns blazing with this outsourcing ban, that is why he postponed it and it seems like he is at least listening to business' concerns."

AMLO's government has backtracked on other controversial measures, such as the recent proposal for the central bank to absorb lenders' excess U.S. dollar holdings, a measure that analysts believed would have had an adverse impact on the monetary authority's autonomy.

"The government may come up with these slightly radical plans, but when push comes to shove, they might delay or end up watering them down," Sanghani pointed out.

This S&P Global Market Intelligence news article may contain information about credit ratings issued by S&P Global Ratings. Descriptions in this news article were not prepared by S&P Global Ratings.