Colombia: Selected Issues

Abstract

Colombia: Selected Issues

Colombian Corporate Vulnerabilities and Macrofinancial Implications1

Nonfinancial corporate debt and leverage have increased in recent years, supported by easy access to capital markets, abundant global liquidity, and low interest rates. While some sectors look somewhat more strained than others (oil, gas and airlines) debt-servicing capacity has also improved with recent economic growth. Various static shocks on earnings and FX depreciation for corporates do not impact significantly the soundness of the banking system and overall macrofinancial stability but lead to lower credit growth and would impact GDP. Further enhancement in the quality and coverage of nonfinancial corporate data together with improvements in the quality of bank capital would help improve macrofinancial outcomes as Colombia navigates and lower oil prices and higher FX volatility.

A. Corporate Sector Performance and Macrofinancial Implications

1. The performance of the corporate sector can have a sizeable macroeconomic and financial stability (macrofinancial) impact. The Colombian corporate sector debt represent around 45 percent of GDP while the amount of loans outstanding for the private corporate sector stand at 52 percent of total credit issued by Colombian financial intermediaries (banks and nonbanks). Depending on how well the overall corporate sector (non-financial and financial) performs it can have either vicious or virtuous macrofinancial loops and/or feedback loops with different degrees of amplification through the financial system and different dynamics across different economic sectors (Figure 1).

Figure 1.
Figure 1.

Corporate Macrofinancial Loops

Citation: IMF Staff Country Reports 2016, 134; 10.5089/9781484367520.002.A002

2. Macroeconomic shocks influence the corporate sector, which in turn affect macrofinancial stability (Table 1). Macroeconomic shocks impacts the corporate sector and which in turn feedback to macroeconomic variables amplified by financial intermediaries’ balance sheets. Typical macrofinancial links for Colombia in this juncture are detailed below (Table 1).

Table 1.

Macrofinancial Impacts of Events and Shocks Transmitted by Corporate Sector

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Source: IMF staff calculations.

3. The prospect of a growth slowdown for Colombia could have adverse implications for the corporate sector and consequently negative implications for macrofinancial stability (Table 1). Lower domestic growth would result in lower demand for corporate products and lower earnings. For some corporates this may mean reducing their output which may entail lower demand for employment and need for investment. This could in turn result in lower national output, income and expenditure. From a financial stability perspective lower growth scenarios would be adverse as bank income would not grow as rapidly. Corporate revenue would grow less in lower growth scenarios resulting in lower corporate deposits at banks and less likelihood of corporates taking out credit or loans for new investment. This would result in both lower returns for banks from their corporate portfolios and lower potential of deposit growth. Greater uncertainty over investment and employment could further restrict bank revenue and increase risks and produce potential for losses on bank portfolios.

B. Colombian Corporate Debt: Stylized Facts3

4. Colombian nonfinancial sector corporate debt has grown but remains moderate by international standards and is mostly domestic. As of June 2015 the debt of private sector corporates rose to around COP 183 billion pesos, which represents about 52 percent of credit institutions total loan portfolio (banks, nonbanks, microcredit balances). Total private sector corporate debt (domestic and foreign, loans and securities) in 2015 was 44.5 percent of GDP (COP 344.5 billion) up 2.2 percentage points since 2014. This reflected higher borrowing from financial institutions both at home and abroad. From 2000 to 2015, the principal sources of funding of the private corporate sector were loans with financial institutions both at home and abroad (Figure 2). The least used sources were bonds issued abroad and from foreign credit providers. However, since 2003 there continues to be a substitution of loans with foreign financial institutions by loans with domestic financial institutions. This suggests a strengthening of domestic macrofinancial linkages of Colombian private corporate sector debt.

Figure 2.
Figure 2.

Colombian Non-Financial Corporate Debt by Instrument and Currency

Citation: IMF Staff Country Reports 2016, 134; 10.5089/9781484367520.002.A002

Sources: Financial Superintendency, Superintendency of Corporates, Banco de la República.a / Only includes information from companies that report financial statements to the Superintendency of Corporates.b / Internal commercial financial leasing operations is assumed. This item is composed of loans denominated in local currency and foreign currency portfolios of commercial and microcredit.c / Includes financial leasing operations.d / The balance of bonds issued abroad is underestimated because it does not include exposures to oversees subsidiaries.

5. Colombian nonfinancial corporate debt continues to be peso-dominated though U.S. dollar denominated debt has grown reflecting depreciation effects rather than increased U.S. dollar funding by firms. Since 2004 Colombian private sector corporates have tended to issue debt in pesos (70 percent of total debt equivalent to 31.2 of GDP in 2015 (Figure 2). Since 2013 U.S. dollar indebtedness as a percent of GDP has risen by 3.6 percentage points driven in the main by the devaluation of the Colombian peso over the period against the U.S. dollar (3.4 percentage points out of 3.6) rather than by the increase in funding (0.2 percentage points of GDP).

6. Maintaining supervisory surveillance of corporate data and risk management practices would be desirable, especially with respect to determining impact of FX shocks. Given the importance of peso depreciation regarding private sector corporate foreign debt the central bank is able to access information on reported FX-denominated debt obligations (domestic bank or foreign) and is able to use a daily forwards database to create a mismatch indicator for natural hedges against external trade data. Corporate balance sheet information given that it is annual and available with a roughly 5-month lag can be difficult to reconcile with other databases held by authorities, often resulting in a considerable loss of information. Continued supervisory oversight of effectiveness of corporate hedges to mitigate FX risks from shocks will be important.

C. Colombian Corporate Debt Metrics4

7. Nonfinancial corporate debt has increased in recent years. The evidence from the previous section made clear that Colombian corporate debt has grown in recent years and has been dominated by domestic peso dominated bank loans rather than US dollar securities issuance. This switching to peso-dominated debt (due to depreciation of COP) goes somewhat against the grain of corporate debt in other emerging market economies wherein total corporate foreign exchange exposures (in volume and price terms) have grown due to easier access given low US policy rates, easier global liquidity from unprecedented QE and capital inflows (GFSR, October 2015). However the global commodity (lower oil) price shock, significant depreciation of COP and prospects for slower domestic growth are making the Colombian nonfinancial corporate somewhat more vulnerable to distress and default (Figure 3). Nevertheless, the impact on banks’ own default frequencies is very mild and is at much lower levels.

Figure 3.
Figure 3.

Probability of Default for Colombian Corporates and Banks

Citation: IMF Staff Country Reports 2016, 134; 10.5089/9781484367520.002.A002

Source: Moody’s KMV and CreditEdge.1/ The Expected Default Frequency (EDF) is the probability that a company will default within a given time horizon, typically one year, where default means the failure to make a scheduled debt payment.

8. While equity grew at a faster pace compared to debt for most companies, gross corporate leverage has increased and, after accounting for cash holdings, net leverage has increased further (Figure 4). For large firms, the ratio of total debt to total equity has increased somewhat since 2008. For medium-sized firms, gross leverage has increased more significantly. Sectors with relatively high gross leverage ratios compared to 2008 are Airlines, Gas Utilities and Oil and Gas. Additionally, accounting for cash holdings, net leverage—defined as total debt minus cash, divided by total equity—increased by about 10 percentage points between 2008 and 2014.

Figure 4.
Figure 4.

Corporate Debt and Earnings

Citation: IMF Staff Country Reports 2016, 134; 10.5089/9781484367520.002.A002

Sources: S&P Capital IQ data, IMF Staff calculations.

9. While Colombian corporate debt and leverage has increased somewhat, debt servicing capacity has also improved due to much faster earnings growth. Higher earnings have strengthened corporate debt servicing capacity, which remains strong for most firms. Earnings grew at a faster pace compared to interest expense from 2008 to 2014 (Figure 4). This has lead to an increase in the interest coverage ratio (ICR), and the median ICR across firms remains strong and sufficient to cover debt interest payments5. While most firms’ median ICR had been increasing, some sectors that have relatively high leverage (such as Airlines and Utilities) suffer from low ICRs unlike Oil and Gas. These sectors remain sensitive to global commodity prices (oil and gas) and domestic and global growth conditions.

10. Debt at Risk measures (ICR<2) for large fragile Colombian corporates have fallen over the period 2008-2014 reflecting robust domestic growth (Figure 5b). Colombian corporate solvency for fragile firms within our sample of large firms has improved over the 2008–14 period having benefitted from robust growth for this period. This evidence is in contrast to a much larger data set utilized by BanRep in its latest financial stability report, which has shown Debt at Risk (DAR) at relatively flat levels of around 25–30 percent.6 This is also in line with broader information for other emerging market economies presented in the IMF GFSR (October 2015). The evidence of much lower DAR numbers for our small 100 large corporates sample reflects probably a degree of sample specificities, which includes the firms that have had stronger balance sheets. While data for 2015 was not available allowing earnings growth (10 percent) due to economic growth in 2015 and accounting for further depreciation (30 percent) in 2015 would have seen DAR even for this large corporate sample increase from 5 to 12 percent. For large firms, the Debt/EBITDA ratio has almost doubled from 2008 to 2014, and reflects an increase in leverage, rather than a decrease in overall profitability. Sectors experiencing the most year-on-year growth are Airlines, Utilities, and Oil and Gas. More specifically, the Airlines and Utilities sectors’ ratios surpass the commonly suggested level of four. However, ratios higher than four or five typically signal that a firm is less likely to be able to take on additional debt required to grow the business but not necessarily indicative of a risk of distress or default.

Figure 5.
Figure 5.

Corporate Leverage and Earnings

Citation: IMF Staff Country Reports 2016, 134; 10.5089/9781484367520.002.A002

Sources: S&P Capital IQ and IMF staff calculations.

11. Debt distributions indicate a growing mass of both highly indebted firms and firms with very little debt. Debt-to-equity and debt-earnings has grown over time since 2008 albeit from lower levels for these larger corporates. The distribution further reveal that the debt/equity ratios show a marked bi-modality in 2014 indicating a growing hump of highly indebted firms and firms which have little debt (Figure 5). In 2008 the proportion of firms with high debt/equity was much less evident. These Colombian nonfinancial corporate debt dynamics have been driven by a sectoral story influenced by both domestic and global factors IMF GFSR (October 2015) that suggested that some economic sectors have had better debt dynamics than other sectors.

12. Across all firms there has been an improvement in debt servicing capacity. In particular there has been a growing mass of firms with ICR>3 in 2014 compared to 2008 (Figure 5). While this does suggest improved earnings growth, debt servicing capacity is likely to have suffered in 2015, with the FX depreciation and slow growth and continue to deteriorate in 2016.

D. Corporate Financial Soundness Index7

13. Individual metrics such as debt-to-equity and DAR can monitor and evaluate the credit-worthiness and prospects for corporate distress (default, liquidation, rating downgrades) but they have limitations. Individual metrics may not be able to fully reflect all necessary characteristics, which reflect corporate fragility and/or soundness. At the very least, individual metrics may not be able to fully bring together concerns over corporate debt, leverage, profitability, operating performance, and liquidity and the interactions between them. Such cross interdependencies between individual metrics would not be accounted for. Recent work by Banco de La Republica (BdR) has shown consistency between the composite indicator and credit risk indicators. In this sense a composite indicator would provide a more thorough assessment of corporate sector strengths and vulnerabilities.

14. BdR has constructed a very useful composite indicator for the period 2000-14. This composite indicator brings together 34 metrics grouped into five categories—activity, leverage, profitability, liquidity and size using principal component analysis to identify private corporate sector vulnerability. The construction of such a corporate sector financial soundness index (FSI) is a useful tool for monitoring financial stability concerns. The corporate FSI according to BdR is not constructed at the aggregate level as the methodology does not allow for inter-temporal comparisons. However, the corporate FSI can be constructed at the firm and industry level.

15. Considerable variation exists in the corporate FSI for Colombia by industry for 2014 (Figure 6). As of 2014 latest figures, the FSI calculated by industry shows a strong performance of firms (positive index) for accommodation and food service. Industries that depicted a weaker balance sheet and operating performance were financial intermediation (Agriculture and fishing, mining, manufacturing, real estate activities. and in past), transport and storage and electricity, gas and water supplies. With commodity price shocks and depreciation having continued in 2015 and the possibility of weker growth going into 2016 against also a weaker global economic growth increased uncertainty in financial markets this overall sectoral weakness suggest diminishing balance sheet scope to absorb macrofinancial spillovers from these shocks.

Figure 6.
Figure 6.

Colombian Corporate Financial Soundness Indicators

Citation: IMF Staff Country Reports 2016, 134; 10.5089/9781484367520.002.A002

Source: Banco de La Republica

16. For financial stability purposes the study related firms’ credit worthiness to banks and other creditor’s balance sheets. One would assume that high and positive levels of the corporate FSI would correlate with a low credit risk perception from its creditors, while low and negative levels of the corporate FSI would be related to higher perceptions of credit risk as long as comparisons are done in the same year. For Colombia ex ante credit risk can be measured by a quality index (QI) which is the ratio of risk loans (that firms find difficult to repay or loans they have defaulted on) and total gross loans. As expected (Figure 7) firms with a positive FSI have consistently lower QI (better credit worthiness) than those with a negative FSI this holds true for all years (particularly from 2000–13). This relationship is much less marked in the latest period of 2014 where credit worthiness as indicated by QI of strong and weak firms is now more similar (Figure 7), though at low levels. The QI measure has declined for both sets of firms since 2009. This decline was much less for stronger as opposed to weaker firms. This evidence suggests that as the economy starts to slow credit deterioration could be much greater for weaker as opposed to stronger firms in part due to their limited ability to absorb losses due to weaker balance sheets.

Figure 7.
Figure 7.

Corporate Credit Quality and Distributions

Citation: IMF Staff Country Reports 2016, 134; 10.5089/9781484367520.002.A002

Source: Banco de La Republica.

17. FSI empirical distributions can be constructed for both defaulting and non-defaulting firms the evidence finds the distribution of non-defaulting firms are more symmetric (just as likely to be strong or weak) (Figure 7).8 As one would expect firms that are defaulting are skewed to being weak (negative FSI). For 2014 the median (50th percentile) for defaulting was lower (-0.33) than non-defaulting firms (-0.09) this suggests firms with positive FSI are on average less prone to default on their obligations. The results for earlier distributions from 2000–13 (not produced here) show the same pattern of findings.

E. Stress/Sensitivity Tests

18. This section presents a variety of static stress/sensitivity tests. The test are one-period what-if impacts on key financial sector variables such as bank’s solvency (capital) and liquidity from a deterioration in Colombian private sector corporate balance sheets. We present evidence of staff’s stress tests and summaries of key stress tests undertaken by the BdR Financial Stability Department.

19. The stress tests undertaken here and by the BdR in their latest Financial Stability Report differ considerably both in aggregation (top-down and bottom-up), scope and data. There is no a priori reason that the output of the stress tests should be similar across the two exercises given the very different basis of the tests and shocks. However both exercises together provide a wider more comprehensive array of information on potential deterioration in nonfinancial sector corporate balance sheets and impacts on the financial sector than each of the exercises on their own as they cover a wider set of shocks under a wider set of assumptions than each set of tests on their own.

Staff Sensitivity/Stress Tests

20. In order to gauge the resilience of Colombian corporations to a combination of earnings and exchange rate shocks, we conducted a stress test analysis on a sample of firms, based on available balance sheet information and data provided by the authorities on 10 banks9. The shocks were derived from the following “severe but plausible” assumptions:

  • A 20 percent decline in earnings, similar to the median changes in firms’ EBIT across major EM countries during the Global Financial Crisis (GFC) of 2008.

  • Currency depreciation against the U.S. dollar of 70 percent, similar to trends observed around the GFC.

  • Corporate EBIT exposure to foreign currency of 60 percent assumed mainly through increased expenses from imports.

21. We also took into account financial hedges that could mitigate corporate exposure to exchange rate risk. Financial hedges were derived based on a simple assumption that 10 percent of EBIT exposure is hedged through derivatives. This takes into consideration the availability and effectiveness of hedges.10

22. Under these assumptions we then evaluated the Debt-at-Risk (DAR) measure under stressed assumptions, and derived new Non-performing Loans (NPLs). The new NPLs were derived from data on banks provided by the authorities, as well as on the following assumptions:

  • A 2.00x Interest Coverage Ratio (ICR) threshold for DAR, matching the non-stressed DAR and following industry conventions for ICR.

  • Corporate Loans as 65 percent of Total Loans, derived as the weighted average of the same data in the banking sample.

  • Probability of Default (PD) of 25 percent, which we based on World Bank recovery data for Latin America.11

  • Loss Given Default (LGD) of 60 percent, based on Banco de Bogota’s annual report estimates, which we then applied to the entire sample as a proxy.

Banking Sector Impacts

23. Corporate lending is a sizeable part of the total bank loans for our bank sample, but banks do have adequate buffers to absorb earnings and depreciation shocks. Lending to corporations account for around 65 percent (weighted average) of the 10 banks from our bank data sample. This is skewed in particular by the much larger proportion of corporate loans that form part of the larger balance sheets of domestic and systemically important Colombian banks. Total gross nonperforming loans (NPLs) for the entire Colombian banking system reached 2.83 percent in 2015 rising from very low levels. Total regulatory capital remains well above the minimum requirement of 9 percent at bank and system level. For the banks in our sample, median regulatory capital was around 14.3 percent and NPLs of 2.5 percent. In addition, Colombia also imposes a forward-looking expected loss provisioning approach on banks including a countercyclical provisioning requirement that delivers additional loss absorbency. Countercyclical provisions amounted to around 13–28 percent of total provisions depending on the bank in our sample. The following findings were observed:

  • Under the earnings shock – no Colombian bank in our sample falls below the regulatory minimum of 9 percent though all banks suffer a decline in their regulatory capital (Figure 8). Total median capital for all 10 Colombian banks falls to 13.6 percent (from 14.5 percent pre-shock)12.

  • Under the currency depreciation shock (including Corporate EBIT exposure to foreign currency of 60 percent) – no Colombian bank in our sample falls below the regulatory minimum of 9 percent though all banks suffer a decline in their regulatory capital (Figure 8). Total median capital for all 10 Colombian banks falls to 12.5 percent (from 14.5 percent pre-shock).

  • Under the earnings and currency shocks jointly – only two Colombian banks in our sample falls just below the regulatory minimum of 9 percent though all banks suffer a decline in their regulatory capital (Figure 8). Total median capital for all 10 Colombian banks falls to 11.4 percent (from 14.5 percent pre-shock). Indeed BdR static stress test also indicated that one bank falls below the regulatory minimum (Table 2)13.

  • Accounting for additional loss-absorbency buffers – Colombian banks are required to hold robust forward-looking provisions. The rules enable the accumulation of countercyclical specific and general provisions that add to their loss absorbency. Adding in their net-income and these provisions no Colombian banks fall below the regulatory minimum of 9 percent (Figure 8). Total median capital for all 10 Colombian banks rises from 11.4 percent to 13.1 percent. The SFC has also indicated that risk-weighted assets (RWA) are higher than other Latin American (LA) peers. In Colombia RWA represent 80 percent of total assets, while the average in the LA region is approximately 70 percent.

Figure 8.
Figure 8.

Corporate Stress Test Impacts on Bank and System Solvency

Citation: IMF Staff Country Reports 2016, 134; 10.5089/9781484367520.002.A002

Sources: Staff calculations, S&P Capital IQ, SFC.
Table 2.

Banco de La Republica Static Stress Tests

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Source: Banco de La Republica (2015).

24. While the impacts of static adverse earnings and currency depreciation shocks are manageable for the Colombian banking system it is useful to strike a cautionary note to these findings. First, we have assumed that legacy capital (held before August 23, 2012) held by some large Colombian banks as goodwill or intangibles acts as fully-loss absorbing capital similar to equity capital14. Under Basel III rules goodwill and intangibles are deducted from bank capital and as previous work in Karpowicz and Norat (2015a) has shown once legacy goodwill is removed capital levels and buffers for Colombian banks are lower and would be lower after stress test shocks. Even though since 2013 Colombian bank capital has been improved further transitioning to the Basel III capital definition by replacing legacy goodwill and intangibles and sequencing the moves to fully implement Pillar 2, systemic and countercyclical capital would add further loss absorbency and resilience to the Colombian banking system from corporate vulnerabilities. According to SFC’s exercises, the deduction of intangibles registered before August 2012 would reduce the total capital ratio by 0.7 percent and all credit institutions will continue fulfilling the minimum capital ratios. Regarding Pillar 2 it should be noted that the Decree 2392 of 2015 empowered the SFC to require additional capital levels based on the result of self-assessments of capital adequacy that institutions should perform and on the supervision process. Moreover, recently the SFC issued instructions about the stress test framework that institutions must follow which will be very useful in their self-assessment of capital adequacy. Secondly, as was outlined by the BdR (2015) liquidity stress tests, credit and market risk shocks impacting on Colombian corporates could affect Colombian banks funding and liquidity resilience through other financial entities (Table 2).

25. Recent work by rating agencies has shown that focusing on standardized higher-quality capital measures (tangible common equity to risk-weighted assets) across Latin American banks stress shocks indicated greatest vulnerability to Brazilian and Colombian bank solvency.15,16 Under such standardized measures that exclude goodwill Colombian bank capital tends to be at lower starting positions than many of the Latin American peers (Karpowicz and Norat (2015)). Under a severe stress scenario the Colombian banking system is the second worst performer (low-levels of post stress solvency) after Brazil. The Colombian banking system is disadvantaged under the low standardized measure of capital (low starting points) relatively higher credit costs (loan loss provisions over gross loans), limited efficiency (high cost-to-income) but still high earnings generation capacity. Post the severe stress test a sharp rise in past due loans and contraction in profitability would be particularly damaging to Colombian bank solvency. Notwithstanding the rating agency adjustments and stress tests, it is worth highlighting that the additional loss absorbency is built into credit institutions buffers through robust provisioning which incorporate countercyclical provisions (CIC), higher risk weights and forward-looking risk-based supervision, which has been upgraded in recent years. A study made by the SFC showed that if loans’ risk weights are changed by the reported average in LA, deducting all intangibles assets from CET1 and switching the CIC (0.8 percent of RWA) for the Basel III countercyclical capital buffer then the capital ratio might improve by 3.6 percent.

26. The authorities are intensifying their surveillance of the financial sector by enhancing their stress testing capabilities. The authorities continue to make great strides in stress testing, linking real sector (corporate and household) vulnerabilities with financial sector solvency concerns into liquidity impacts and contagion assessments. Advanced model development using DSGE and network models allied to more straight-forward balance sheet assessments, including more focused specific (thematic) liquidity and contagion stress testing will enable interconnected and systemic risks to be accommodated and identifying weaknesses in financial institutions business models and plans. The Fund is continuing to provide Technical Assistance (TA) on stress testing developments on such high-priority work.

F. Impacts, Spillovers and Feedbacks to Real Sector

27. The nonfinancial corporate debt and leverage metrics presented earlier have shown that corporate balance sheets have started to become more strained especially in some sectors. This could have adverse impacts on banks but stress tests indicate resilience to these shocks. Nonfinancial corporate sector distress, whether in the form of greater balance sheet stretch with worsening debt metrics or through outright default and corporate bankruptcies can lead to firms retrenching investment and deposits from the financial sector to meet obligations and maintain stronger cash flows. While corporate sector distress in the form of lower earnings, losses from depreciation shocks are also likely to lead to higher NPLs at credit institutions (banks and nonbanks) which can lower bank and nonbank capital and curtail credit supply as credit institutions seek to maintain capital levels and buffers.

Impacts of Corporate Stress on Investment and GDP

28. As leverage increases this increases credit risk on the corporate which faces higher borrowing costs (higher spreads) lowering borrowing and investment. Colombian corporate increase in debt and leverage could lower investment between 0.33–0.5 percentage points of the capital stock using estimates derived by Li, Magud and Valencia (2015) (Table 3). The authors also report an elasticity of real GDP growth to investment rate—measured in percent of a firms capital stock of about 0.1 across emerging markets. In this context a reduction of investment rate between 0.33–0.5 would lower real GDP between 0.033–0.05.

Table 3.

Stress scenarios and Impact on Corporate Investment Rates and GDP 1/

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Source: IMF staff calculations.

Li, Magud Valencia (2015) coefficients estimated in a panel of 17,000 firms in 38 emerging market countries, including Colombia. The study relates investment rates defined as capital expenditure divided by the capital stock—to net leverage, defined as total debt minus cash stocks divided by total equity.

Bank Capital and Credit Growth and GDP Impacts

29. The relationship between bank capital and credit supply is not clear-cut and both theoretical and empirical studies have shown both a positive and negative relationship between bank capital and credit growth, Martynova (2015) (Annex A). Some papers have focused on observed capital ratios and have found a positive relationship between bank capital and lending. Berrospide and Edge (2010), Carlson et al. (2013) among others use bank-level data to estimate the impact of capital on lending and found small positive effects on credit dynamics; more detailed quantitative results on the impact of bank capital fluctuations on lending is provided below (Table 4). Note that this heterogeneity could come from non-linear effects between capital and lending. Repullo and Suarez (2013) show banks under any regulatory regimes will hold positive capital buffers in order to preserve their future lending capacity.

Table 4.

Bank Capital and Quantitative Impact on Loan and Credit Growth

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Source: Gabone and Lame (2014) and IMF Staff calculations.

30. The earnings and depreciation shocks studied before adversely impact NPLs and bank capital by around 1.48 percentage points and this may reduce bank credit (loan) growth by 0.09-4.44 percentage points17 Utilizing the quantitative impact assessment from above (Table 4) we can see there is a wide variation in terms of impact on credit growth from bank capital. Previous studies have found that the impact can be greater in recessions relative to normal times reflecting the upper limit of 4.44 percentage points. A midpoint (between 0.09–4.44ppt) assessment of the impact of a reduction in bank capital would impact credit growth by 1.19 percentage points.

31. A reduction on average of 1.19 percentage points in Colombian bank credit growth due to a combined earnings and depreciation shock would have a marginal impact on real GDP. Calomiris and Mason (2003) have found have elasticities between real GDP and bank credit growth ranging from 0-0.4 percentage points. With a 1.19 average reduction in bank credit growth in Colombia real GDP based on such empirical estimates could decline anywhere in the region of 0-0.48 percentage points. Adding the investment impact on GDP could add at maximum 0.05 percentage points to this figure to give a value of 0.53.

32. There is reason to believe a 0.53 percentage point GDP impact could be an underestimate but the final impact would still be small. First, the earnings and depreciation shocks could be larger. Second, the credit growth reduction is assumed in our stress test exercise to arise from banks only. However taking account of solvency impacts for other credit institutions would imply larger credit growth and real GDP impacts. Third, the corporate earnings and depreciation shocks impact have been determined through a single round of macrofinancial linkages (corporate shocks impact financial sector that affect GDP), considering second round effects could have larger overall GDP impact. Finally, the stress tests undertaken take account of single or combined static shocks for earnings and depreciation. If these were to occur in a dynamic setting together with an adverse macroeconomic scenario then impact on bank and nonbank capital, credit growth and real GDP would be larger over a longer period.

G. Conclusions

33. It has been evident from a variety of individual and composite debt, leverage, balance sheet and income statement metrics that domestic macrofinancial linkages for Colombian nonfinancial corporate sector has been growing between 2003–15. The analysis presented here makes clear the importance of increased and enhanced macrofinancial surveillance of the nonfinancial corporate sector. Authorities could:

  • Increase the quality and coverage of Colombian nonfinancial corporate data tracked by the Corporate Superintendency. Increasing timeliness and removing data gaps would further enhance the calculation of individual and composite data metrics. In part some of this may be addressed by the move to IFRS accounts by firms.

  • Increase the supervisory capacity of the Corporate Superintendency to investigate nonfinancial corporate sector data and determine their macrofinancial implications especially on other sectoral balance sheets of the economy (government, financial, external, and households). This work should be undertaken with other stakeholders such as the BdR, and Financial Superintendency to further enhance the quality of nonfinancial corporate sector analysis within the Financial Stability Report.

  • The BdR should regularly update their work on the corporate financial soundness index (FSI) to help link data from individual corporates to a composite nonfinancial corporate vulnerability indicator at both firm and industry level. A more detailed and granular industrial breakdown of the FSI could also be helpful especially if adjusted small-sample problems in calculating the index for a particular sub-sector are overcome.

34. Static stress tests undertaken have clearly shown that credit institutions particularly banks are able to absorb adverse nonfinancial corporate sector losses without compromising individual or bank system solvency. This provides some confidence that current adverse macrofinancial impacts are likely to be contained from growing nonfinancial corporate vulnerability. This indicates that:

  • A strong and flexible macroeconomic policy framework that has constrained public debt and enabled flexible policy levers (exchange rate) to work has sustained a positive robust growth profile in recent years. This has helped to support nonfinancial corporate earnings and debt servicing capacity.

  • Colombian authorities’ progress in improving the effectiveness of the regulatory and supervisory framework for Colombia has resulted in greater loss absorbency within the financial sector, higher risk awareness through maintenance of existing higher risk weights and improved the forward looking risk based framework for financial institutions Karpowicz and Norat (2015b). This helps the financial sector to absorb nonfinancial corporate losses.

35. Notwithstanding the positive evidence from stress tests there is a need to avoid complacency:

  • There would be falls in bank credit growth of 4.44 percentage points and growth of 0.53 percentage points which would have further adverse macrofinancial impacts.

  • Bank capital should be increased early if called for from risk-based supervision. Colombian authorities’ introduction of regulations allowing Basel III compliant hybrid bonds in 2015 (Decree 2392, December 2015) is helpful18. However the raising of equity capital through issuance or through organic growth of capital by reducing banks dividend payout would add higher quality loss absorbency (Karpowicz and Norat 2015a). The Financial Superintendency has powers to further limit dividend payout for Colombian banks which would increase organic growth of capital (they have higher payouts than Latin American peers).

  • In the context of lower growth for longer and the potential for larger changes in nonfinancial corporate earnings, depreciation shocks and global uncertainty—bank solvency could be much lower. Moreover, the funding linkages between collective investment funds and banks in the Colombian financial system implies the potential for solvency concerns to transform into liquidity problems and raise contagion worries. The resulting vicious nonfinancial corporate macrofinancial loop (Figure 1) would be very damaging. There is a need for continued flexible and coordinated policy action, which addresses multiple areas of economic and financial imbalances in the economy. Specifically timely and robust policy actions that strengthen the real, fiscal, external and financial sector would strengthen nonfinancial sector corporate balance sheets that would reinforce a virtuous macrofinancial stability loop (Figure 1).

Annex I. Bank Capital and Credit Growth Study Summary

1. Determining the size and sign of the impact of bank capital to credit growth using various statistical regression or panel estimations does not yield a uniform message. Some studies suggest a strong positive impact, others a negative impact and other studies no relationship at all.

2. The positive relationship between bank capital and credit growth was most strongly evident during the recent financial crisis, banks with strong balance sheets were better able to maintain their lending. The study by Albertazzi and Marchetti (2010) uses Italian data in 2007–09 and finds evidence of a contraction of credit supply associated with low bank capitalization. Kapan and Minoiu (2013) employ a sample of more than 800 banks from 55 countries during 2006–10. They show that bank capital played a cushioning role: better capitalized banks (with lower leverage ratio) that were exposed to the financial market shocks decreased their supply of loans less than other banks. In conclusion, all studies referred to above suggest that higher capital makes the provision of credit more stable and robust even in economic downturns. More capital also allows banks to better withstand financial and real shocks. Bank capital increases the capacity to raise non-insured debt and thus banks’ ability to limit the effect of a drop in deposits on lending (Ashcraft, 2001). Indeed, using data for Italian banks in 1992–2001, Gambacorta and Mistrulli (2004) show that well-capitalized banks can better absorb temporary financial difficulties on the part of their borrowers and preserve long-term lending relationships.

3. However, studies that focus on banks in advanced economies during the 2008 crisis alone often come to different conclusions. Using OECD data Huang and Ratnovski (2009) find no relationship between pre-crisis bank capital and performance during the crisis. For their sample of European banks, Camara et al. (2010) report that well-capitalized banks took more risk before the 2008 crisis. Using a sample of 36 major global banks, the IMF’s GFSR (2009) finds that banks that received government support during the crisis had statistically higher capital metrics before the crisis. To sum up, empirical evidence fails to provide a definitive answer on whether higher capital will always and everywhere enhance financial stability. However in this paper we side with the view that higher capital will increase banks’ resilience, support credit to productive sectors of the economy and will reduce losses in a crisis period.

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1

Prepared by Mohamed Afzal Norat and David Jutrsa (MCM). We would like to thank Jorge Roldos, Daniel Rodríguez-Delgado, Maria Angelica Arbelaez, Esteban Gomez and Juliana Lagos for useful comments.

2

The terms –/+ refer to negative and positive impact on key macroeconomic variables (profits, output, investment, trade balance and growth) due to impact on corporates. For example, higher corporate distress would have a negative impact on Colombian corporate profitability, output, investment and growth. The impact on exports and import substitution could be positive. Overall the impact could be uncertain.

3

For further details, see Financial Stability Report, Banco de La Republica, September 2015.

4

The following section utilizes data from private vendors and corporate databases the latest 2015 data for the whole sample of firms is not available at this time. As Colombian corporate nonfinancial corporate switch to reporting on an IFRS basis, the timeliness and quality of corporate data is expected to improve.

5

ICR is computed as EBIT divided by interest expense; EBIT is earnings before interest, and taxes.

6

Evidence for DAR for a much broader smaller-sized set of fragile firms undertaken by Banco de la Republica in its latest Financial Stability Report indicate much higher levels of DAR (around 30 percent). Our much smaller sample of the larger firms are not comparable as earnings and debt dynamics differ considerably across different sized firms. For the sample of firms analyzed by BanRep, the fraction of fragile firms has been relatively flat around 30–35 percent even under shocks.

7

Our thanks are due to Esteban Gomez and his team at the Financial Stability department of the Banco de La Republica for the data, construction and calculation of the FSI metrics, validation tests and distributions for defaulting and non-defaulting firms. The data on firms used to construct these metrics account for around 48 percent of the commercial loan portfolio—they are a key set of debtors in the Colombian financial system. The work in this section is based on Lemus-Esquivel et al (2015). Again, in line with 2015 corporate data unavailability until June 2016, the composite metric was not available for 2015.

8

Defaulting firms are those defined as those moving from higher ratings (A or B) to lower ratings which could be defined as distress ratings (C, D, or E) during a given year. More details are provided in Lemus-Esquivel et. al. (2015).

9

Data was provided by the Financial Superintendency of Colombia for the following banks: Bancolombia, Banco de Bogota, Banco Davivienda, BBVA Colombia, Banco de Occidente, Banco Corpbanca, Banco GNB Sudameris, Banco Colpatria, Banco Popular, and Citibank Colombia. We would like to express our gratitude to Juliana Lagos and her staff for their excellent interaction and communication with the IMF team regarding this information.

10

It is not always the case that corporates are able to hedge their FX exposure due to very specific nature of risks their exposure involves (in terms of maturity, size, currency and cost). Even if such exposures can be hedged the hedge could be less than effective due to knock-out thresholds depending on the amount of depreciation (i.e. effective if depreciation is below 30 percent only) and mismatches in maturity of FX derivative instruments (of shorter term) used to hedge compared to longer maturity of the corporate exposure. Moreover, this could also entail additional rollover and liquidity risks as the FX derivatives contract expire while market and credit risks (from margin, collateral re-setting) would exist prior to maturity of the contracts. Surveys of the effectiveness of hedges from derivatives would have to be undertaken for nonfinancial and financial corporate by the Corporate and Financial Superintendencies. Further work by supervisors would help to address the strength of mitigating actions that nonfinancial and financial corporations can take against financial shocks (especially FX shocks).

11

Higher recent PDs have also been recently observed in Latin America from evidence presented: Caceres, C., and F. Rodrigues Bastos (2016) and International Monetary Fund (2016) and Duan et al (2015).

12

However if earnings were to decline to 40 percent (2 banks become close to regulatory minimum of 9 percent) while total median capital would be lower at around 12.1 percent. If earnings were to collapse to around 60 percent declines 2 banks would be below the regulatory minimum and one other bank close to the 9 percent threshold while total median capital for the banks would be around 11.2 percent.

13

While the focus on this paper is on static stress tests the BdR has undertaken dynamic stress tests in the Financial Stability Report, September 2015 in which the deterioration of the corporate portfolio is taken into account.

14

SFC regulations since 23 August 2012 have made clear that all intangibles whenever it was registered are to be deducted by credit institutions from capital and do not act as fully-loss absorbing capital.

16

Tangible common equity is a standardized definition of capital used by Moody’s in its stress tests to ensure comparability across its rating universe of 900 banks in 80 banking systems. It differs from regulatory capital measures of capital such as common equity tier 1 (CET1).

17

This includes all earnings and FX shocks as well as offsetting impact on loss-absorbency and capital from running down provisions and net income.

18

The regulatory decree strengthened the criteria for debt instruments to be recognized as capital Tier 1 and Tier 2.

Colombia: Selected Issues
Author: International Monetary Fund. Western Hemisphere Dept.