33 to lend to riskier clients and to not perform their monitoring function in respect to borrowers. Second, the fact that these insurance funds do not explicitly indicate what size of investor or depositor is covered may reduce incentives for the private monitoring of the financial intermediary or brokerage firm by large investors or depositors.' 98. A final area where a more explicit definition of rights and obligations may be needed is in the process for resolving bank failures. No well defined set of regulations and law govern the process for bank re-organization and liquidation. It would appear that an actual liquidation would have to fall under the auspices of a receiver under Mexico's bankruptcy law that is in need of modernization. The process is not legally defined to be "extra-judicial" as is the case in many countries. Moreover, the processes used and the degree to which the Central Bank and the Ministry of Finance ensure that equity holders take losses need to be made more explicit. In the absence of such reforms, disincentives can actually be created for different bank claimants (e.g. bondholders. equity holders and depositors) to avert financial problems by pressuring management.-99. Such findings would tend to heighten the need for a revision to valuation and capital regulations and a strengthening of external supervision in order to offset these free-rider and moral hazard problems. This would be aside from some changes in current design of the Funds to more explicitly define the nature of the Government liability. The NAFTA provisions as argued in section III. C. will act to hasten implementation of these reforms.

# A.3. Policies to Increase Liquidity of Domestic Securities Markets

100. Asset price volatility and systemic risk could rise under increased financial integration unless the liquidity of domestic securities markets is improved. This lack of liquidity could become more important given the duration mismatches that some financial institutions are starting to take regarding domestic interest rates. To improve liquidity of domestic securities markets requires actions to increase both the demand and supply of "private" securities in Mexico. In addition, it will require certain actions that will permit well capitalized intermediaries to make a market in such securities or to use them as collateral in repurchase agreements.

101. To increase the supply of securities offered more effort needs to be focused on the reasons why firms of all sizes have not gone to the capital markets more directly through initial public offerings. Many firms have favored financing through retained earnings or commercial bank finance vs. issuance of commercial paper (see Garber and Weisbrod (1991)). However, these trends appear to be changing as commercial paper offerings by both non-financial companies and financial groups increased by 50 percent in real terms in 1993. Moreover, data available from the Mexican Securities Exchange Commission (CNV) suggests that as many as 1000 new small and medium size firms may become eligible to list on Mexico's new second-tier stock exchange. However, in this latter case only six small to medium sized firms have listed on See Levine (I1993) or Glaessner and Mas (1992) that also makes this point. See Glaessner and Mas (1992) for Latin American experience and examples of how the banking law and regulations can be designed to create incentives for quick resolution of financial crises, through more effective private and government monitoring of financial intermediaries.