Colombia: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
01 Mar 1999
eISBN:
9781451808735
Language:
English
Keywords:
ISCR; CR; Colombia; inflation uncertainty; potential GDP; customs; asset ratio; Banco de la Republica; commercial finance; mortgage institution; asset quality; Loans; Financial sector; Mortgages; Nonperforming loans; Capital adequacy requirements; Global
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This Selected Issues paper and Statistical Appendix analyzes economic developments in Colombia during 1996–99. Output growth slowed sharply in 1996 and early 1997, but subsequently rebounded owing to stronger exports, a temporary boom in world coffee prices, and an easing of credit policy. Despite efforts at addressing the fiscal imbalances, the nonfinancial public sector deficit widened further to more than 4 percent of GDP in 1997. Monetary policy during 1996 and most of 1997 was geared toward stimulating domestic demand.

Abstract

This Selected Issues paper and Statistical Appendix analyzes economic developments in Colombia during 1996–99. Output growth slowed sharply in 1996 and early 1997, but subsequently rebounded owing to stronger exports, a temporary boom in world coffee prices, and an easing of credit policy. Despite efforts at addressing the fiscal imbalances, the nonfinancial public sector deficit widened further to more than 4 percent of GDP in 1997. Monetary policy during 1996 and most of 1997 was geared toward stimulating domestic demand.

III. Financial Sector Issues14

29. A broad-based reform of the financial system was implemented in the early 1990s, which achieved important progress in increasing efficiency, enhancing competition, and strengthening the regulatory framework. This chapter describes and assesses the key elements and effects of the reform, discusses recent trends in the health of the financial sector with particular attention to the heightened vulnerabilities stemming from the recent deterioration in the macroeconomic situation and downturn in worldwide market sentiment, and presents the main challenges to be addressed in the period ahead.

A. Overall Financial System Structure

30. The Colombian financial system presents a complex tapestry of institutions and regulations, which is largely the result of a broad-based reform implemented in the early 1990s aimed at enhancing competition and increasing efficiency. The financial sector reforms were part of a broader reform program that also included measures designed to liberalize the trade system, rationalize public sector operations, increase labor market flexibility, and strengthen central bank autonomy. In the financial sector, the reforms included the liberalization of interest rates, and reduced financial taxation through an easing of credit subsidies, forced investment requirements, and simplification of reserve requirements. The reforms also included a partial move toward a universal banking system through a reduction in financial sector segmentation among the four major groups of deposit-taking institutions (commercial banks, finance corporations, savings and mortgage institutions, and commercial finance companies) (Box 1).

Financial Sector Reform

The Colombian financial system weakened considerably in the 1980s. Banks were hurt by a contraction in foreign investment in the context of Latin America’s economic crisis of the 1980s, a weakened domestic economy, and insider trading. In addition, through off-shore branches, the Colombian banks lent to other Latin American countries, and suffered from their neighbors’ subsequent difficulties. As a result, the central bank and the deposit insurance agency (Fondo de Garantía de Instituciones Financieras) had to assist a number of banks, and intervened in and nationalized four banks.

Framework legislation for reform of the financial sector was contained in Law 45 of 1990 (adopted as part of the constitutional reform of that year), whose objectives were to reduce the specialization of financial institutions and foster greater competition among the four major groups (commercial banks, finance corporations, commercial finance companies, and savings and mortgage institutions). To achieve these objectives, the law:

  • allowed free entry into the industry (including full foreign ownership of financial institutions), subject to minimum capital requirements and suitability of ownership and management. Conversion from one type of institution to another was also eased;

  • streamlined regulations on mergers, acquisitions, and liquidation of financial institutions;

  • allowed financial intermediaries to expand through the creation of subsidiaries.

As a complement to this framework, new modalities for financial, brokerage, and insurance activities were contained in Law 35 of 1993 which, inter alia, reduced restrictions that limited the operations of various financial intermediaries. The most important of these reforms was that which concerned the leasing companies. Law 35 established that leasing companies must be converted into deposit-taking commercial finance companies or else be liquidated, while existing commercial finance companies were allowed to engage in leasing. Other principal features of this reform allowed (i) shares of commercial finance companies to be held by all credit institutions; (ii) savings and mortgage institutions to invest in other financial entities and extend consumer loans without mortgages, or mortgage loans to activities other than housing; and (iii) commercial finance companies and savings and mortgage institutions to engage in all types of foreign exchange operations.

31. Several steps to improve supervision were implemented, aimed at the upgrading of Colombia’s banking practices to international standards. In particular, the ability of the superintendency of banks to monitor requirements on monetary reserves, forced investments, capital, minimum net worth, and provisioning for nonperforming assets, as well as profit distribution and lending concentration was strengthened. Minimum capital requirements were established, capital/asset ratios based on Basle standards were introduced, and provisioning requirements were strengthened (Box 2).

Strengthening Supervision and Regulation

The main steps taken to strengthen supervision and regulation were the following:

  • Minimum capital requirements were established in 1991, which are adjusted annually in line with consumer price inflation.

  • In June 1994, capital adequacy requirements in line with Basle standards were adopted. The minimum capital to risk-weighted assets ratio currently stands at 9 percent (this level was increased from 8.3 percent in 1995), a requirement which must be met at the individual entity level, even if supervision is done on a consolidated basis for financial holdings. Calculation of risk-weighted assets by financial institutions is based on five different categories taking into account the borrower’s repayment ability, the repayment status of the loan, and the value and perceived quality of underlying collateral.

  • Provisioning requirements were tightened in 1995, with institutions being required to reserve past due loans in a shorter time frame.

  • Since 1995, regulations require the foreign currency position of financial institutions to be no greater than 20 percent of core capital; negative net foreign currency positions are not allowed; since 1996, institutions are authorized to borrow in foreign currency and lend these funds in local currency, up to 10 percent of their core capital.

32. These reforms contributed to a number of significant changes in the structure of the Colombia’s financial system during the first half of the 1990s. First, there was a large increase in foreign participation, which rose from 5 percent of total banking equity in 1990 to 25 percent by 1994 and an estimated 27 percent in 1997. During the first half of the 1990s most of the increased foreign interest was from other Latin American countries, but beginning in 1996 Spanish banks were at the forefront of foreign investment in the Colombian financial sector, with the Banco Bilbao Vizcaya (BBV) buying a controlling stake in the Banco Ganadero, the country’s largest bank, and the Banco Santander buying the Banco Comercial Antioqueño, the sixth largest. Second, the interpretation of Law 45 of 1990—that financial institution licensing should be quasi-automatic—and the decision to allow commercial finance companies specializing in leasing to accept deposits, led to a sizable increase in the number of deposit-taking institutions from 90 in 1990 to 130 by March 1997 (Table 1). The proliferation in number was especially marked for nonbank financial institutions, owing to the relatively low minimum capital requirements.

Table 1.

Colombia: Structure of the Financial System

article image
Sources: Banking Superintendency; and World Bank, “Colombia: Financial Reform” (1993).

33. The viability of the large number of institutions during the first half of the 1990s was aided by a rapid increase in intermediation, as annual growth in bank deposits and bank-issued securities (noncash broad money) averaged 15 percent in real terms during 1992-95 (Figure 1). However, problems stemming from the significant rise in the number of deposit-taking institutions began to be manifested in 1996, in the context of a sharp slowdown in broad money growth and a weakening in private sector credit in response to a downturn in economic activity.

Figure 1.
Figure 1.

Colombia: Selected Financial Indicators

Citation: IMF Staff Country Reports 1999, 006; 10.5089/9781451808735.002.A003

Sources: Banco de la Republica; and Fund staff estimates.1/ Defined as M3 plus bonds issued by financial institutions less currency in circulation.2/ Defined as the difference between the average rate charged on loans and the average rate paid on three-month time deposits during the last week of each month.

34. The effects of the downturn were exacerbated by the entrance into the financial system of strong competitors from abroad. This contributed to an erosion in intermediation margins, with the average spread between lending and deposit rates declining from nearly 9 percent at the start of 1997 to 6¼ percent by end-year. The fall in spreads was particularly marked for the savings and mortgage institutions owing to aggressive competition from commercial banks (particularly the Spanish-owned institutions) in the mortgage area (Box 3).

Interest Rate Spreads

The Colombian financial system has traditionally been characterized by large intermediation margins. To a considerable extent, this has been attributable to a large degree of financial taxation imposed by high reserve requirements, which averaged nearly 27 percent during 1992-94, before declining to 10.6 percent in 1996 and 8.6 percent in 1997. When adjusted for reserve requirements, the “effective” spread between lending and deposit rates during 1993-97 is considerably lower—about 4½ percent compared with 8¼ percent on an unadjusted basis. In addition to high reserve requirements, a comprehensive study by Barajas, et al. (1998)15 which examined the behavior of interest rate spreads using panel data for a large cross-section of Colombian banks found that the principle determinants of intermediation margins were (i) high operating costs (ii) the existence of significant market power notwithstanding the greater opening of the financial system to both domestic and foreign competition; and (iii) credit risk associated with a large ratio of nonperforming loans of state banks, and a more prudent behavior toward risk by private banks. State-owned banks were found to have considerably higher spreads than private banks owing to larger operational costs and poorer loan quality.

35. The most acute manifestation of the deterioration in the macroeconomic situation was experienced by commercial finance and leasing companies, in line with the particularly rapid growth in number during the early 1990s, and the procyclicality of their main lending activities. Moreover, leasing companies were adversely affected by the 1995 tax reform, which reduced incentives for leasing.

36. As a result, a second round of structural changes in the industry occurred beginning in early 1997 that was characterized by a consolidation movement which mainly centered on (though was not limited to) commercial finance companies, and leasing companies—in line with the relative severity of the difficulties facing these groups. In the event, the number of deposit-taking institutions declined from 139 at end-1996 to 126 at end-1997 as a result of nine mergers, three interventions, and one voluntary liquidation. In addition, there were 20 acquisitions in the industry, in most cases involving the takeover of relatively small institutions by larger ones, or by financial groups.

37. This restructuring increased concentration of the financial system: 70 percent of total financial system assets were held by the largest 15 percent of all entities at end-1997, all of which were banks, savings and mortgage institutions, and finance corporations. Four domestic financial conglomerates owned 21 banks out of a total of 32. The average volume of assets per institution remains small, compared with the rest of Latin America, with the largest Colombian bank ranking only forty-fifth in size in Latin America in 1996. As financial integration and competition from foreign banks increase, this situation could be disadvantageous to the international competitiveness of the system.

38. A key issue currently under debate in Colombia is the extent to which the system should further evolve toward one that is characterized by universal banking, i.e. where legal barriers to specialization are absent. This issue is of particular importance to the finance corporations—institutions that were created at the end of the 1950s in order to increase the availability of medium- and long-term financing for corporations and to contribute to local capital market development. The financial liberalization of the early 1990s generated a number of problems for the finance corporations. On the assets side, these institutions have confronted limited flexibility in their lending operations, as at least 80 percent of their paid capital and reserves is required to be held in the form of investments, half of which in equities or convertible bonds through the primary market. In addition, 50 percent of the total portfolio of investments and credits is required to be of long-term (greater than one year) maturity. These restrictions have posed significant constraints as virtually all corporate financing in Colombia takes the form of borrowing from banks or retained earnings.16 On the liabilities side, the deregulation process increased competition among financial institutions so that the finance corporations have increasingly been required to finance long-term investments with short-term volatile funds.

39. In addition to these balance sheet restrictions, the finance corporations have faced considerable competition from abroad in their lending activities in the context of the capital market liberalization initiated in the early 1990s, and large interest rate differentials between peso and foreign interest rates that prevailed from mid-1994 through end-1996 which made foreign financing relatively cheap for their mainly corporate clients (Figure 2). As a result of these factors, the interest rate spread for finance corporations has declined to levels significantly below the levels in the rest of the financial system, which has contributed to a significant decline in profitability in recent years.

Figure 2.
Figure 2.

Colombia: Interest Rate Differential on Peso-Denominated Borrowing

(In percentage points)

Citation: IMF Staff Country Reports 1999, 006; 10.5089/9781451808735.002.A003

Sources: Banco de la Republica; and Fund staff estimates.1/ Defined as the average lending rate for finance corporations less the U.S. prime rate. After Jan. 1994, assumes a monthly depreciation equal to the preannounced slope of the exchange rate band.

40. This environment has resulted in considerable change in the structure of this group, with some institutions having abandoned their intermediation activities in recent years to specialize in investment banking services, and others having merged with other entities, in some cases commercial banks. Further consolidation in the industry is likely in the absence of a new wave of reform defining whether the system should evolve toward one where all deposit-taking institutions face the same regulatory constraints, or where incentives are created which promote the further development of finance corporations as investment banks.

B. Developments in Financial Sector Lending and Deposits

41. Financial innovation, capital market liberalization, a decline in the heavy tax burden on banking activities (including through reserve requirements), and a rising government deficit have contributed to a number of changes in the structure of financial sector balance sheets since the early 1990s, including accelerated intermediation, a sharp increase in the level of real financial sector credit, and a greater share of domestic bank credit absorbed by the public sector.

42. Notwithstanding the imposition in 1993 of a nonremunerated deposit requirement on most foreign borrowing, positive interest rate differentials with foreign markets, new oil discoveries, and increased investor confidence attracted large capital inflows during the first half of the 1990s, which contributed to a real appreciation of the peso, a significant increase in international reserves, and sizable growth in monetary aggregates. This facilitated a rapid increase in domestic credit to the private sector during 1993-95 (Figure 3). Although the surge in credit was provided by all segments of the financial market, particularly strong growth occurred for the consumer (especially in the areas of automobile loans and credit card lending) and mortgage sectors. Private sector credit growth subsequently declined in response to a significant weakening in economic activity, but then accelerated in the second half of 1997 owing partly to expectations of exchange rate depreciation which prompted a shift by borrowers from foreign currency to peso-denominated credit.

Figure 3.
Figure 3.

Colombia: Financial System Credit

(Annual percentage change in real terms)

Citation: IMF Staff Country Reports 1999, 006; 10.5089/9781451808735.002.A003

Sources: Banco de la Republica; and Fund staff estimates.

43. Despite the rapid increase in domestic credit during the first half of the 1990s, Colombia remains underbanked relative to other emerging market countries (with an overall loan penetration ratio of about 40 percent of GDP at end-1997), pointing to significant growth potential in the industry. Loans as a share of total financial system assets are slightly higher at 65 percent, and about 10 percent is invested in securities—predominantly government fixed-income instruments. In 1997, there was a large increase in the share of central government bonds in total assets associated with both the higher public sector deficit and a shift in financing strategy to greater domestic financing.

44. Financial system claims on government entities grew considerably during 1993-97, reflecting the rise in borrowing requirements of these entities associated with their deteriorating budget balance (Table 2).17 As a result, the share of the private sector in total financial sector assets has been little changed at 85 percent since 1993, while that of municipalities grew from 2¼ percent in 1993 to 8½ percent by end-1997. The especially rapid growth in lending to the territorial governments arose from a sharp increase in their creditworthiness, stemming from the decentralization process initiated under the 1991 constitution which greatly increased their revenues. By early 1998, there was growing anecdotal evidence that a number of these entities faced considerable difficulties in servicing this debt, although the size of nonperforming loans for this group was still fairly small (at 2 percent of total loans in March 1998).

Table 2.

Colombia. Financial Sector Claims on the Nonfinancial Sector, 1994-97 1/

article image
Sources: Banco de la Republica; and Fund staff estimates.

Valued at constant exchange rates.

Departments and municipalities.

C. Bank Soundness and Profitability

45. The health of the banking system deteriorated beginning in late 1995 owing mainly to a sizable increase in the fiscal deficit which placed upward pressure on interest rates, and a sharp slowdown in economic growth. This deterioration accelerated in the first half of 1998, in response to political uncertainty, and contagion effects from the Asian crisis which resulted in a weakening in the terms of trade and large downward pressures on the exchange rate. To contain these pressures, the central bank tightened monetary policy which contributed to a significant increase in interest rates.

46. A key manifestation of the weakened health of the financial system was in a deterioration of asset quality, as the ratio of nonperforming loans to total loans rose from 5.8 percent at end-1995 to 8.2 percent in June 1998 (Figure 4); about 40 percent of the stock of nonperforming loans in May 1998 was classified as “doubtful” or “irrecoverable.”18 There was a particularly marked deterioration in the asset quality of the savings and mortgage institutions (accounting for about 20 percent of financial system assets) during this period, reflecting the slowdown in construction, coupled with a large increase in residential mortgage defaults. Although asset quality as of June 1998 was considerably better than during Colombia’s banking crisis of the early 1980s (when the total nonperforming loan ratio rose to over 20 percent), the full effect on asset quality of the rise in interest rates was likely not yet seen as nonperforming loans only show up on bank balance sheets with a lag.

Figure 4.
Figure 4.

Colombia: Nonperforming Loans as Share of Total Loans

(In percent)

Citation: IMF Staff Country Reports 1999, 006; 10.5089/9781451808735.002.A003

Source: Banco de la Republica.

47. The deterioration in asset quality contributed to a marked weakening in profits during 1997 and the first half of 1998 (Table 3), with profits as a share of assets falling from 1½ percent in 1996 to zero in June 1998. Profits during 1998 were also adversely affected by losses on entities fixed-income securities portfolios owing to the rise in interest rates and decline in stock market prices, given the requirement to mark-to-market portfolios monthly. Although the fall in profits was broad based, the finance corporations experienced particularly large declines owing to the concentration of negotiable securities in their portfolios. Profits were also especially weak for the savings and mortgage institutions, reflecting the particularly marked deterioration in asset quality (noted above), as well as a maturity mismatch between assets and liabilities given their tendency to attract deposits of short-term maturities and lend at long term.

Table 3.

Colombia: Financial System Profit Accounts, 1996-98

article image
Sources: Banking Superintendency; and Fund staff estimates.

48. Despite the deterioration in these key indicators of financial system health, the ability of Colombian financial entities to withstand adverse shocks has been bolstered by a number of factors. First, the significant increase in solvency levels since the early 1990s has greatly bolstered the ability to weather a deterioration in asset quality. Colombian financial institutions have tended to adopt a very cautious approach to risk management, holding general reserves well in excess of the level required to achieve the minimum mandated 9 percent risk-weighted capital adequacy ratio (CAR) (Table 4).19 Second, the small size of entities’ loan books in their overall asset portfolios makes the financial system better able to withstand the impact of deteriorations in loan quality in the face of higher interest rates. Third, the existence of capital controls reduces the ability of foreign investors to build up substantial short positions on the currency. Fourth, the importance of foreign direct investment flows in total capital inflows has increased steadily since the early 1990s and early indications are that such flows have been relatively resilient to downward shifts in market sentiment.

Table 4.

Colombia: Financial System Risk-Weighted Capital Adequacy Ratios, 1992-98

article image
Sources: Banking Superintendency; and Fund staff estimates.

49. Important strides in strengthening regulation and improving supervision of the financial system were made in the first half of the 1990s. However, there are a number of important challenges which remain to be addressed in this area. First, the current operating environment is characterized by group and cross holding structures with no clear definition or disclosure of holding by economic group, and the existence of bank investments in related parties. With the majority of commercial banks in the hands of four large domestic financial conglomerates (noted above), such an operating environment runs the risk of generating difficulties in the financial system arising from conflicts of interest, interlocking relations, and financial agglomeration. Second, the current regulatory framework (as defined in the organic law of the financial system), is not designed around a clear mechanism under which specific corrective actions are triggered in response to undercapitalization of the financial institutions concerned. Specifically, the mechanism for enforcing the capital adequacy requirement is not defined in the law—rather, the regulatory authorities have discretionary power to implement the mechanism. In addition, provisions governing recapitalization procedures are ambiguous, in terms of rules governing any required recapitalization. In the absence of clearly defined automatic mechanisms for capital increases when a financial institution’s capital falls below the minimum required level, there is a danger that undercapitalized institutions could stay on the market indefinitely with all the attendant implications. Third, the functions and operational methods of FOGAFIN (the deposit insurance scheme) are not explicitly stated in the law, thus exposing the system to potential pressures to be overly generous in the event of a bank failure. Fourth, despite steps to bolster supervision, the staffing for effective supervision remains inadequate, and the true solvency of many institutions, particularly the smaller ones, may be overstated. Fifth, the provisioning norms could be strengthened further, particularly in light of the recent pressures on asset quality.20

D. Conclusions

50. This chapter examined trends in the financial sector in recent years, against the background of a broad-based reform implemented in the early 1990s which achieved important strides in increasing efficiency, enhancing competition, and strengthening the regulatory framework. Notwithstanding these achievements, the financial sector is currently facing difficult times owing to increased foreign competition, a weakening of the macroeconomic environment, and heightened exposure to risk stemming from increased penetration into riskier consumer markets. A likely consequence of these factors will be further consolidation in the industry. In light of the increased vulnerabilities, it would be important to address the aspects of the supervisory and prudential regulatory framework that could entail risks for the soundness of the financial system in order to prevent these vulnerabilities from resulting in systemic problems.

14

Prepared by Reva Krieger.

15

See Barajas, et al., “Interest Spreads in Banking: Costs, Financial Taxation, Market Power, and Loan Quality in the Colombian Case 1974-96,” IMF Working Paper, 1998.

16

According to a survey of manufacturing companies, 60 percent of these firms’ financing was through borrowing from the financial system, and 30 percent from retained earnings. Only 10 percent was raised through the sale of shares. (See, Colombian Ministry of Finance, World Bank, and FEDESARROLLO, “Misión de Estudios del Mercado de Capitales: Informe Final,” May 1996)

17

Part of the increase in assets against the central government during 1997 reflects a valuation adjustment arising from the increase in government security prices.

18

These are loans for which payments of either interest or principal are greater than three months overdue in the case of consumer loans, four months overdue in the case of commercial loans, and six months overdue in the case of mortgage loans.

19

The CAR of nearly half of all financial entities was greater than 13 percent, for about one-third of the entities the CAR was between 10 and 13 percent, and for the remainder it was between 9 and 10 percent.

20

Under the current norms, principal on nonperforming loans secured by real collateral (usually real estate) is exempted from provisioning for the initial 12 months; provisioning is only required for the delinquent interest. As a result, specific provisions as a share of total loans remained nearly constant at 2.2 percent during the two-year period through June 1998, despite the significant rise in nonperforming loans.

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Cover IMF Staff Country Reports
Colombia: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Volume/Issue:
Volume 1999: Issue 006
Publisher:
International Monetary Fund
ISBN:
9781451808735
ISSN:
1934-7685
Pages:
133
DOI:
https://doi.org/10.5089/9781451808735.002
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    Colombia: Selected Financial Indicators

  • View in gallery

    Colombia: Interest Rate Differential on Peso-Denominated Borrowing

    (In percentage points)

  • View in gallery

    Colombia: Financial System Credit

    (Annual percentage change in real terms)

  • View in gallery

    Colombia: Nonperforming Loans as Share of Total Loans

    (In percent)

Colombia: Selected Financial Indicators

Colombia: Interest Rate Differential on Peso-Denominated Borrowing

(In percentage points)

Colombia: Financial System Credit

(Annual percentage change in real terms)

Colombia: Nonperforming Loans as Share of Total Loans

(In percent)