US embassy cable - 04BOGOTA9241

UNCLAS SECTION 01 OF 02 BOGOTA 009241 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, ELAB, PGOV, CO 
SUBJECT: COLOMBIAN BANKING REGULATIONS STABILIZE SECTOR 
 
 
1.  (U) SUMMARY. Colombia's banking regulators aided 
struggling banks through the banking crisis of the late 
nineties and have continued this work by strengthening banks 
against risk.  Colombia has implemented internal regulation 
to ensure against another banking crisis while also 
implementing Basel I standards (and beginning to implement 
Basel II) and by moving toward a standardized system to 
predict possible losses (SARC).  These regulations have 
advanced and strengthened the Colombian banking sector enough 
that Colombian industry experts are confident that past 
crises will not be repeated. END SUMMARY. 
 
2.   (U) Colombia's financial sector is at last emerging from 
the 1998 crisis.  Colombian bank regulators attributed the 
bank failures of the late 1990s to improperly controlled 
credit risk. The Senior Economist from Superbancaria, 
Carolina Baron, expounded upon this by saying that the 
banking crisis was triggered by skyrocketing interest rates 
(due to the Asian and Russian crises) for emerging markets. 
Individuals and companies simply could not pay the interest 
on their loans, which led to high rates of default.  This was 
clearly evident in the mortgage sector as individuals 
struggled to pay interest on mortgages.  Baron said this 
created a crisis of confidence in the banking sector. 
Industry experts reported that in Q2 1999, a deep fiscal gap 
(the fiscal deficit was 5.2 percent of GDP in 1999 compared 
with 2.8 percent for 2003) sparked a currency crisis (the 
peso devauled 20 percent).  This further weakened investor 
confidence.  Non-performing loans rose from 8 percent of 
total loans in 1998 to 14 percent in 1999.  The GOC took 
action to protect depositors and through direct intervention 
rescued many of these banks, but the bailout cost a total of 
4.3 percent of Colombia's GDP over a period of three years, 
from 1998 to 2000. 
 
HISTORY - FOGAFIN 
 
3.   (U) Founded in 1985 after a banking crisis, the Fondo de 
Garantas de Instituciones Financieras's (FOGAFIN) goal is to 
increase confidence in the Colombian financial system by 
insuring individual deposits and by working with banks 
through failures and restructuring, along the lines of the 
U.S. Federal Deposit Insurance Company.  FOGAFIN insured 
deposits beginning in the mid eighties and continued its work 
by restructuring banks throughout the financial crisis of the 
late nineties; however, it has not effectively achieved its 
goal of increasing investor confidence.  Part of the blame 
lies in the fact that FOGAFIN does not have the name 
recognition among the Colombian population to effectively 
build confidence in banking deposits.  Additionally, FOGAFIN 
insures less than USD 8,000 per individual account and takes 
3 to 4 months to pay in the event of a failure. 
 
4.    (U) FOGAFIN's work to restructure banks has been more 
successful.  By purchasing a private sector asset management 
company specializing in mortgage loan collection, Central de 
Inversiones (CISA), FOGAFIN worked to stabilize the Colombian 
banking system against future crises.  CISA recapitalized 
private and state owned financial institutions and dismantled 
bankrupt institutions.  FOGAFIN and CISA have taken on 
non-performing assets from multiple banks in order to help 
stabilize the industry.  Industry experts told Econoff that 
CISA did not use public funds to save private investors. 
Instead, FOGAFIN issued bonds to capitalize CISA, and then 
used those funds to purchase non-performing loans and 
real-estate properties.  CISA worked to collect or write-off 
non-performing loans.  In addition, once regulators increased 
the capital requirements for these banks, FOGAFIN offered 
loans to banks.  This joint effort by FOGAFIN and CISA 
stabilized banks and saved Colombia from even greater crisis. 
 
 
 
SUPERBANCARIA 
 
5.    (U) The banking superintendency, Superbancaria, is the 
regulatory arm of the banking industry.  It works closely 
with FOGAFIN to offer greater access to credit for struggling 
banks, but its main mission since 1923 has been to guarantee 
the solvency and stability of the financial system in 
Colombia.  The superintendency is currently working with 
banks to implement risk classification on a test basis and to 
assist with loan provisioning).  Superbancaria plays an 
important role in monitoring weak mortgage institutions and 
recently began monitoring market and institutional risk.  In 
December 2003, the Colombian Congress received a draft budget 
from the Uribe administration requesting full budgetary 
autonomy for Superbancaria, which should allow for more 
effective monitoring across the financial sector.  Law 795 of 
January 2003 increased independence of the financial 
institution's decision making; strengthened the code of 
conduct for administrators at institutions; and gave the 
banking superintendency greater regulatory and supervisory 
powers. 
 
 
POST CRISIS REGULATION 
 
6.    (U) Regulators believe the implementation of Basel I 
regulations, the implementation of a System of Credit Risk 
Administration (SARC) and the beginning steps to put the 
banking sector in line with the Basel II accord and 
international accounting standards will reduce credit and 
market risk and increase confidence. 
 
7.    (U) GOC regulators see all regulations as moving toward 
SARC and cited two specific examples that they felt would 
help implement SARC and would greatly strengthen the 
Colombian banking sector.  The SARC is a statistical model to 
determine future losses from credit portfolios which can help 
to evaluate risk.  Currently, banks hold a lot of government 
securities, increasing market risk.  With a capital cushion 
that is continually evaluated by bank regulators, banks and 
the government are able to reduce this exposure to market 
risk. The first step to move toward SARC was in 2000 when the 
GOC instituted regulations establishing early warning signals 
to indicate when a bank is nearing financial trouble, when 
liquidity is compromised and when capital goes below a 
certain level.  Regulators see these warnings signs as an 
important step to reduce market risk and give the government 
time to react early when stability is compromised. 
 
8.  (U) 2002 regulations created a system in which banks must 
evaluate the market value of their assets and electronically 
send that information to Superbancaria. This system is 
similar to the CAMEL ratings system, which was developed by 
the US Federal Reserve (FED) to monitor and evaluate risk. 
Much like with CAMEL ratings, Colombian banking regulators 
classify risk as credit, market, liquidity, operational and 
money laundering risk. While the FED evaluates banks by 
on-site examinations, Superbancaria receives this information 
electronically.  While the lack of off-site evaluations 
increases the risk that banks might send false information, 
industry experts note that banks would face sanctions and a 
possible revocation of their charter for false information. 
In 2003 as part of SARC, banks were required to complete the 
third phase of internal loan loss classification and reserve 
methodologies based on expected loss. 
 
9.  (U)  Regulators emphasized that these steps toward a more 
closely monitored banking system will aid against market and 
credit risk; however, there were laws passed after the 
banking crisis that regulators saw as harmful or incomplete. 
First, a 2001 ruling by the constitutional court requires 
mortgage loans to be no more than fifty percent of the price 
of the house. This law has negatively impacted poorer 
families because it is now more difficult to get a housing 
loan; individuals must pay up front fifty percent of the cost 
of their mortgage. Second, the GOC passed regulation in 2000 
for derivatives, which outlined how to calculate market 
value.  Regulators mentioned that they believe the GOC should 
push for greater reforms in the area. 
 
10.   (U) COMMENT. Colombians are gaining confidence in their 
banking system since the crisis of the late nineties. Experts 
are generally confident in their banking system and those in 
the banking sector believe the new regulations have raised 
the system to international standards.  While regulations 
have improved and the banking sector has grown, many analysts 
are still concerned about the market risk inherent in holding 
a large amount of government denominated debt. END COMMENT. 
DRUCKER