## _cr05287 - Annex 2 contains summaries of assessments under four standard and codes: the IOSCO Principles; the CPSS ## Source details **Canonical URL:** [_cr05287 - Annex 2 contains summaries of assessments under four standard and codes: the IOSCO Principles; the CPSS](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05287.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05287.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05287.pdf.json) --- ### Summary and overall stability assessment - Author: Rodolfo Maino. - FSAP purpose: assess stability of the financial system as a whole, not individual institutions; do not cover institution-specific risks such as asset quality, operational or legal risks, or fraud. - Overall judgment: - The Colombian financial system "appears reasonably sound and stable" following the 1999 crisis, aided by bank recapitalization and supervisory improvements. - Key remaining concerns: solvency and profitability challenges in commercial banks; low specific provisioning on higher risk loans; potential overstatement of bank capital due to overvaluation of foreclosed assets and underestimation of market risk; continued weakness in mortgage banks (BECHs). - Structural shifts and risk profile: - Replacement of private sector loans with government bonds in bank balance sheets has shifted exposures from credit risk to market risk / sovereign credit risk. - Legal and supervisory weaknesses: - Superintendency of Banks lacks sufficient autonomy and independence. - Legal framework fails to effectively protect bank supervisors or the Superintendent. - Regulatory forbearance persists, evidenced by low levels of provisioned nonperforming loans and sensitivity of solvency ratios to conservative asset evaluation criteria. - Two largest institutions remain under FOGAFIN control; most recapitalized banks have regained market access or are backed by prominent financial holding companies. - Main financial vulnerabilities: - Credit risk and interest rate risk are the principal vulnerabilities given exposure magnitudes, relative sensitivities, and volatility of risk factors. - Largest interest rate shock impact would come from a precipitous rise in the yield curve. - Foreign exchange risk appears limited; equity price risk primarily affects finance corporations. - Legal and fiscal impediments to credit: - Law 550 (introduced during 1999 crisis) protects debtors in restructuring procedures and impedes bank credit; revision recommended. - Distortionary taxation: financial transactions tax reduces payment system efficiency and encourages underground economy activity; 1.5 percentage point stamp tax on bank loans disincentivizes long-term lending. - Housing finance: - Mortgage lending has not recovered; housing financing relies largely on repatriation of foreign assets or informal markets. - Recommendation: develop a comprehensive housing finance strategy including restructuring tax subsidies for mortgage lending. - Implementation challenges for risk-based provisioning: - SBC pioneering risk-based loan-loss reserve work requires substantial human resources investment and redefinition of supervisory approaches. - Need for an SBC road map for full implementation, clear alternatives for banks not opting for internal models, and an explicit definition of consolidation scope precondition for risk-based supervision. - Pension system and capital markets: - 1993 pension reform increased pension fund assets and will produce growing annuity issuance by life insurers; intermediation costs must be reduced, and parameters of the pay-as-you-go pillar adjusted (increase retirement age and vesting periods, reduce accrual rates). - Private capital markets show low liquidity and insufficient depth; modernization of securities market regulatory framework is critical. - Corporate governance and accounting: - Adoption of corporate governance norms oriented to reward efficient management recommended. - Improve accounting and auditing practices to stabilize credit flows and reduce corporate sector vulnerability. ### FSAP Update — main recommendations (implementation horizons specified) - Strengthening bank regulation and supervision by the SBC: - Provide the SBC with more autonomy and regulatory power. (MT) - Have the SBC prioritize the SARC project. (ST) - Ensure that the SBC moves toward full implementation of consolidated supervision. (MT) - Have the SBC adapt its internal organization and resources to accomplish the above challenges. (ST) - Bringing to an end the crisis resolution-phase: - Government should devise a comprehensive plan to privatize Bancafe and Granahorrar. (ST) - Strengthening insurance regulation and supervision: - Improve bank regulation, supervisory practices, and market infrastructure to cope with annuity market development. (ST) - Strengthen risk-oriented solvency and provisioning regulation in the nonlife sector. (MT) - Strengthen the independence of the regulatory function of the supervisory agency. (MT) - Provide adequate resources for insurance and pension supervision. (ST) - Strengthening pension funds regulation and supervision: - Eliminate fragmentation and privileges in the pension system. (MT) - Revision of the parameters of the “pay-as-you-go” scheme to insure long-term sustainability. (ST) - Constitute a task force to address the problem of contributive evasion. (ST) - Shift from prescriptive to risk-based approaches to pension regulation and supervision. (MT) - Coordinate the programs of different supervision agencies. (ST) - Improve capital markets regulatory framework: - Strengthen the regulatory regime by implementing the new Securities Market Law. (ST) - Take measures to harmonize responsibilities, avoiding current regulatory and supervisory overlap. (ST) - Adopt international auditing and accounting standards. (MT) - Ensure that Securities Superintendency (SVC) has sufficient resources for supervision, enforcement, and securities settlement. (ST) - Promote local and international cooperation to share information. (ST) - Developing the payment systems: - Strengthen the supervisory framework for payment systems by BRC (Banco de la República de Colombia). (MT) - Eliminate the financial transactions tax. (ST) - Reducing corporate sector vulnerabilities: - Improve auditing standards and professional standards. (MT) - Improve the dissemination of corporate data information. (ST) - Enhance quality of analysts, insolvency experts, and appraisers. (MT) - Revise Law 550 on insolvency procedures. (ST) - ST = recommendations that can be implemented in less than two years. - MT = recommendations that may take more than two years to implement, due to required legal or constitutional reforms. ### Macroeconomic context and selected indicators - Historical performance and crisis legacy: - From 1996 to 2001, real GDP grew by only 1 percent on average and unemployment rose to 20 percent at end-2001. - Combined public sector deficit grew from 3 percent of GDP in 1996 to 5.5 percent in 1999 and stayed above 3 percent from 2000 to 2002. - Public sector debt rose from about 45 percent of GDP in 2000 to 56 percent of GDP in 2003. - Policy response since 2002: - Government measures: expenditure cuts, a one-time wealth tax, broader tax package, and structural fiscal reform including pension reform; medium-term target to increase primary surplus to 3 percent of GDP and reduce public debt below 45 percent of GDP by 2010. - Monetary policy: inflation targeting and a floating exchange rate. - Recent outcomes and projections (exact figures preserved): - GDP growth expected to remain at 4.0 percent in 2005. - Combined public sector deficit for 2004: 1.2 percent of GDP (down from 3.6 percent in 2002). - Primary surplus reached 3.0 percent of GDP in 2004 (from 0.4 percent in 2002). - Total public debt declined to 54.1 percent of GDP in 2004 from 60.2 percent in 2002. - Select table excerpts (exact values preserved): - Real GDP: 2.9 (2000), 1.5 (2001), 1.9 (2002), 3.8 (2003), 4.0 (2004 Rev.), 3.8 (2004 Prel.), 4.0 (2005 Proj.), 4.0 (2006 Proj.) - Consumer prices (average): 9.2 (2000), 8.0 (2001), 6.3 (2002), 7.1 (2003), 6.0 (2004 Rev.), 5.9 (2004 Prel.), 5.2 (2005 Proj.), 4.8 (2006 Proj.) - Public sector debt: 47.7 (2000), 51.8 (2001), 60.2 (2002), 56.6 (2003), 52.1 (2004 Rev.), 54.1 (2004 Prel.), 51.2 (2005 Proj.), 49.5 (2006 Proj.) - Current account (deficit -): 0.9 (2000), -1.4 (2001), -1.7 (2002), -1.5 (2003), -2.2 (2004 Rev.), -1.1 (2004 Prel.), -2.9 (2005 Proj.), -2.6 (2006 Proj.) - Net official reserves: 8,800 (2000), 9,982 (2001), 10,507 (2002), 10,524 (2003), 11,408 (2004 Rev.), 13,195 (2004 Prel.), 12,340 (2005 Proj.), 12,653 (2006 Proj.) - NFPS primary balance: 0.9 (2000), 1.3 (2001), 0.4 (2002), 1.7 (2003), 2.2 (2004 Rev.), 3.0 (2004 Prel.), 2.7 (2005 Proj.), 2.7 (2006 Proj.) - Credit to the private sector: -8.6 (2000), 1.7 (2001), 4.0 (2002), 9.2 (2003), 11.5 (2004 Rev.), 12.2 (2004 Prel.), 14.6 (2005 Proj.), 14.0 (2006 Proj.) ### Vulnerabilities, development opportunities, and supervisory priorities — Banking sector - Banking sector key findings: - Main exposures: credit risk and interest rate risk; limited foreign exchange risk; equity price exposure concentrated in finance corporations. - Total bank loans decreased around 30 percent in real terms between 1998 and 2003. - Mortgage loans declined close to 60 percent (real terms). - Risk-weighted capital adequacy ratio (CAR) for the system: 14 percent as of September 2004, versus less than 11 percent before the crisis. - All institutions had a CAR above the 9 percent minimum as of September 2004. - Classified loans (substandard, doubtful or loss): 7.9 percent as of September 2004, down from 16.3 percent at end-1998. - Ratio of loan loss provisions to classified loans: grew from 25 to 54 percent since 1999. - Return on average assets: annualized 2.7 percent as of September 2004, versus -3.5 percent in 1999. - Three-month liquidity gap: improved from -120 percent of liquid assets in July 1999 to under -30 percent of liquid assets as of June 2004. - Emerging concentration risks: exposures to long-term fixed-rate treasury securities increase vulnerability to sovereign credit deterioration or to increases in interest rates. - Estimated core operational income (excluding valuation gains on government securities) to gross income: 82 percent versus operating plus provisioning expenses to gross income of 63 percent (staff estimate). ### Prudential changes, liquidity and rollover risks - Prudential changes and implications: - Specific provisioning of higher risk loans still appears low relative to better provisioned systems. - Prudential rules on market risks may underestimate capital requirements, e.g., allowing some netting of UVR and peso-denominated positions. - From July 2005, institutions required to hold provisions in line with estimated expected credit losses of their commercial and industrial loans. - Banks may adopt a supervisory model for computing expected losses or seek validation of their own internal models. - Tightening of provisioning for loans and foreclosed assets by end-2005. - Prudential tightening may require some institutions to increase provisioning and capital; institutions most sensitive: BECHs, followed by finance corporations and public banks; private banks could also fall below regulatory minimum. - Liquidity and rollover risk: - Half of the banks have a negative one-month maturity gap. - Systemic and structural gap at three months exists. - In a systemic liquidity shock, banks could incur losses liquidating negotiable securities given size of exposures and market crowding. - Private banks vulnerable to withdrawal of uninsured deposits. - Uninsured savings and current account deposits (above Col$ 20 million) account for 67 percent of total deposits and represent close to 80 percent of the deposit base of private banks. ### Stress Tests — main results and procedural gaps - Stress test outcomes: - Primary vulnerabilities: credit risk and interest rate risk. - Credit risk sensitivity: - Regression shows NPLs most sensitive to GDP growth. - Given a shock to GDP of -3 percent (equal to about 1 standard deviation), past dues estimated to increase by 14 percent of total loans. - For the aggregate of credit institutions, CAR would fall from 13.7 to 8.6 percent under that shock. - Interest rate risk: - Greatest impact on capital from a very large steepening of the yield curve. - Aggregate CAR after a steepening of the curve would fall to 6.8 percent. - Tests include the entire banking book (not marked-to-market); total simulated impact on capital unlikely to materialize in short-term accounting terms. - Foreign exchange and equity price risk: - Foreign exchange risk appears limited; moderate equity market shock would not severely affect commercial banks but could impact finance corporations. - Institutional and procedural gaps: - Stress testing not systematically emphasized; institutions allocate about US$0.1 million on risk aggregation and stress testing versus US$1 million on credit risk (SARC). - SBC resources stretched; recommendation to create stress testing committee leveraging public sector expertise (central bank to supply macro scenarios; SBC to assess impacts). ### Bank regulation, supervision, and auditors - Progress since 1999: - Progress in Basel Core Principles implementation. - Legal revisions (Law 510 in 1999, Decree 1720 in 2001, Law 795 in 2003) raised minimum bank capital requirements for credit and market risk and provided legal background for early warning, prompt corrective actions, and consolidated supervision. - SBC issued regulations defining a new risk-based loan classification and provisioning system (SARC). - Remaining weaknesses: - On- and off-site supervision gaps; control of operational risks and internal control procedures weak. - Regulation of country risk: no progress. - Risk-based regulation and consolidated supervision remain key issues. - SBC lacks sufficient autonomy and independence; norms related to banking sector issued by the Ministry of Hacienda, not by the SBC. - Internal organization: supervisory conduct based on units following individual supervised entities; staff not necessarily well-trained in risk management; qualified staff may be insufficient should many banks migrate to internal models. - SBC should issue norms concerning the role, duties, and responsibilities of external auditors (revisores fiscales). - Lack of audit standards and lack of alignment with International Accounting Standards represent a serious departure from international best practices. - Requirements that the SBC validate bank financial statements generate confusion of roles between the SBC and auditors. - Inter-agency coordination and cross-border supervision: - Improve coordination among SBC, SVC, and SSC with rules for exchange of information, consultation, monitoring, and conflict resolution. - Harmonize regulation and supervisory practices for independent brokers and bank-related brokers. - Define a “lead supervisor” with clear responsibility for market, credit and liquidity risks, and stress tests. - SBC lacks capacity to adequately examine local banks’ relationships with foreign branches. ### Mortgage, public banks, privatization and housing finance - Recovery and recapitalization: - Mortgage and public banks largely recovered and were heavily recapitalized. - One mortgage bank has prepaid its recapitalization obligation to FOGAFIN; the other three are expected to repay on schedule. - Mortgage securitization conduit has brought six issues to market. - Central bank’s hedging facility redesigned to more directly cover mismatch risk at a more attractive price. - Public banks received Col$6.1 trillion in recapitalization lines during the crisis. - From the three remaining public institutions, one will remain public as a development bank, while the other two are being privatized. - Legal and policy risks in mortgages: - Law 546 of 1999 imposed rigidities in mortgage design (e.g., outlawing floating rate peso loans). - Government should develop a strategic housing policy and restructure tax subsidies for mortgage lending to target low-income households. - Privatization status and recommendations: - Bancafé, Banco Agrario, and Granahorrar together represent around 14 percent of total assets of the banking system (commercial banks and BECHs). - Bancafé privatization has failed to date; labor costs and labor liabilities were main reasons for failure of the February 2004 auction. - Granahorrar improved its financial position but timing of privatization unclear. - Recommended privatization strategy elements: - (1) Solve the union problem of Bancafé by agreement with employees, taking labor liabilities out of the bank, or liquidating it. - (2) Improve marketability of Granahorrar, either as an ongoing concern or by liquidating it. - (3) Clarify rules regarding the definition of market power to reduce uncertainty to prospective bidders. ### Nonbank financial institutions — pensions and insurance - Pension system challenges: - Since 1993, Colombia has a funded scheme administered by private managers and a public PAYG scheme administered by Instituto de Seguridad Social. - Shift to private scheme produced rapid growth in private pension funds and depleted reserves of the public PAYG scheme. - Long-term projections for the deficit of the public pillar are of concern; reforms needed: increase retirement age, increase vesting period, reduce accrual rate. - AFP industry and costs: - Six private companies manage the funded scheme; the larger two concentrated more than 50 percent of the funds administered in August 2004. - Net costs of administration represent almost 15 percent of contributions collected in August 2004. - AFP portfolios heavily concentrated in public bonds; diversification recommended. - Recommendation: thorough analysis of the cost structure and reforms in administrative procedures and supervision. - Evasion and supervision: - High rates of evasion affect both funded programs and the PAYG scheme. - Collection control is decentralized and ex-post. - Recommendation: form a joint task force to design and implement programs to control evasion using Registro Unico de Aportantes information. - Supervision should shift from compliance-oriented to risk-based and coordinate with peer agencies. - Insurance sector: - Development of a regulatory structure for annuities should receive immediate attention. - Premiums have shown healthy growth in real terms; life sector linkage with annuities could contribute to capital market development. - Insurance supervisors improved technical skills since 1999 FSAP, but staff numbers diminished dramatically and constraints on technical knowledge remain. - Areas needing update: solvency margin formula, rules for provisions, distribution oversight. - Current solvency margin may not reflect underlying company risk profiles in the nonlife sector. - Recommendations: enhance political independence of regulatory process; implement transparent processes for regulatory development; allow SBC greater budget flexibility on a fee recovery basis with associated industry consultation; develop supervisory linkages with foreign supervisors; anticipate resolution regulation changes to provide a full “tool kit.” ### Corporate sector vulnerabilities — financing, information, governance - Financing and performance: - Corporate financial conditions improved over the last four years; average profitability (median firm return on assets) returned to pre-crisis levels but earnings remain low and uneven. - Many firms still appear unable to meet debt service obligations. - Companies reduced exposure to external debt; reliance on bank credit declined in real terms in favor of retained earnings and supplier credit; equity mobilization virtually nonexistent. - Market sources report only large exporting or importing corporations use foreign exchange denominated debt. - Heterogeneous recovery: - Tradable sector outperforms nontradable sector; larger companies undertook complex restructuring and benefited from lower cost of finance. - Corporate financial information and governance: - Quality of corporate financial information is a high-priority weakness. - Required actions: converge toward international accounting standards; more stringent auditing practices; effective regulatory enforcement; training for financial analysts and insolvency appraisers. - Authorities have collected corporate accounting data in an accessible electronic format; additional improvements suggested (single dataset with listed and unlisted firms; strengthen dissemination). - Corporate ownership remains concentrated; pyramid structures and cross shareholdings frequent. - Institutional investors should disclose corporate governance and voting policies. ### Key banking system indicators (selected items preserved exactly) - Capital adequacy ratio (with market risk) 3/: n.a., 11.3, 13.2, 13.0, 12.6, 13.1, 14.0. - Regulatory Tier I capital to risk weighted assets: n.a., 8.0, 9.2, 9.3, 9.7, 10.5, 11.4. - Capital to assets: 10.6, 11.0, 11.3, 11.2, 11.0, 11.5, 11.9. - Nonperforming loans net of provisions to capital 4/: 27.2, 35.9, 15.6, 5.6, 1.1, -3.8, -10.5. - Nonperforming loans to total loans 4/5/: 9.1, 12.4, 10.6, 10.2, 9.2, 6.8, 3.6. - Classified loans 5/: n.a., 18.1, 18.7, 18.1, 16.0, 12.1, 7.9. - Specific provisions to classified loans and leases: n.a., 25.3, 27.7, 37.5, 43.0, 47.6, 54.0. - Sectoral distribution of loans to total loans 5/: - commercial: 53.0, 55.2, 58.7, 58.4, 61.9, 62.8, 65.8. - consumer: 17.9, 13.4, 14.0, 15.6, 15.6, 18.0, 19.1. - housing: 29.1, 31.4, 27.2, 26.0, 21.7, 18.1, 14.1. - Foreign currency loans to total loans: 11.9, 9.0, 8.1, 7.0, 7.4, 4.7, 5.2. - Return on average equity: ...,-32.6,-20.7,1.1,9.6,17.0,23.4. - Return on average assets: ...,-3.5,-2.3,0.1,1.1,1.9,2.7. - Interest margin to gross income: 41.0, 30.7, 38.1, 32.7, 35.5, 37.4, 39.5. - Noninterest expenses to gross income: 83.5, 95.4, 93.7, 85.6, 80.7, 69.8, 59.8. - Personnel expenses to noninterest income: 43.0, 38.6, 36.2, 37.3, 38.3, 38.4, 41.5. - Spread between reference lending and deposit rates: 9.7, 4.4, 6.6, 8.3, 7.4, 7.4, 7.3. - Liquid assets to total assets 6/: 10.0, 11.9, 12.9, 16.5, 19.7, 18.7, 18.0. - Liquid assets to short-term liabilities 7/: 17.3, 19.2, 20.4, 25.2, 30.2, 29.0, 28.1. - Customer deposits to total (noninterbank) loans: 93.8, 107.5, 122.3, 136.1, 136.1, 136.0, 126.2. - Foreign currency liabilities to total liabilities: 12.1, 9.4, 9.4, 9.1, 8.6, 7.0, 6.2. - Net open position in foreign exchange to capital: 5.1, -0.1, -1.4, 4.8, 7.8, 4.3, 4.8. - Notes: - 4/ Loans past-due 90 days or more (120 days or more in the case of mortgages). - 5/ Loan data includes leases as of 2004. - 6/ Liquid assets include cash, deposits, and securities held for trading. - 7/ Customer deposits used as proxy for short-term liabilities. - 1/ Excluding credit unions and public sector special institutions (IOE). - 2/ Data to Sept. 2004 except data on foreign currency loans and liabilities, which are to June 2004. Returns are annualized as necessary. - 3/ Market risks requirements, effective only as of 2001, are weighted 60% until 2003, 80% in 2003, and 100% thereafter. ### Implementation status of FSAP 2000 recommendations (selected items) - Status legend: FI=Fully Implemented; NI=Not Implemented; PI=Partially Implemented; PL=Pending Legislation. - Selected recommendations and status: - A. Systemic liquidity arrangements: - Enhance the scope for market determination of central bank intervention rates. FI - Establish an arrangement to swap bank holdings of bank assets against tradable government securities. NI - Establish contingency plans to deal with small credit institutions exposed to liquidity pressures. NI - B. Payment system risk management: - Further encourage the development of the RTGS system. FI - Introduce measures to limit settlement risk in the check clearing system. FI - C. Housing sector issues: - Limit debt relief to debtors that are current in their payments and announce no further relief. FI - Adjust the interest rate insurance scheme to limit market distortions and strengthen hedging incentives. (status not marked) - Develop a contingency plan to deal with savings and loan institutions. FI - D. Public bank restructuring: - Tighten management of public banks with assistance of international investment bankers and reputable professional administrators. PI - Consider the introduction of an ad-hoc monitoring committee. NI - Enhance the tradability of recapitalization bonds. FI - E. Private bank recapitalization plan: - Subject recapitalized banks to special inspection and monitoring program. FI - Introduce an explicit arrangement to recapitalize FOGAFIN in the event of losses. FI - F. Corporate debt restructuring: - Limit scope for abuses in classification of restructured debts. NI - G. Bank supervision: - Strengthen procedures to review banks’ loan classification and internal risk management. PI - Strengthen on-site inspection procedures and training of on-site inspectors. PI - Introduce additional capital requirements for market risk. FI - Consider prudential measures to strengthen resilience to macroeconomic shocks and limit amplitude of credit cycles. PI - H. Framework for bank resolution: - Introduce regulations to implement a system of prompt corrective actions. FI - Implement FOGAFIN’s draft organic statutes. FI - Review bankruptcy and tax legislation to encourage debt restructuring and facilitate asset recovery. NI - I. Capital market development (selected): - Develop a comprehensive development strategy for capital markets and financial intermediaries. PL - Take measures to encourage long-term investments by pension funds. PL - Provide greater protection to mutual fund investors. PL - Review role of foreign investors and capital controls in new economic environment. PL - Strengthen the government securities market. PL - Promote development of capital markets’ infrastructure and enhance market transparency. PL - Initiate in-depth study of corporate sector to enhance transparency and governance. NI - Undertake study to identify discrepancies between Colombian accounting standards and International Accounting Standards and take measures to correct them. PI ### Insolvency procedures and creditor rights - Reform history and assessment: - Framework extensively reformed in 1999 to accelerate Concordato proceedings. - Law 550 described as "excessively tilted against creditors and, more specifically, against financial creditors’ rights," with potentially harmful effects on bank lending and financial deepening. - Improved economic conditions provide an opportunity to revise aspects of the legal framework to reestablish balance. - Current project of reforms of all insolvency laws before Congress provides opportunity to incorporate international standards. - Enforcement and registry infrastructure: - Colombian legal system provides varied protections of creditor rights and advanced registration procedures. - Enforcement proceedings inefficient; severe backlog in saturated commercial courts. - Land and movable registries should be centralized and automated. - Individual proceedings require accelerated procedures for collection; reforms needed for individual actions for collection of monies. - Main sources of ineffectiveness: - Lax prerequisites for restructuring agreements leading to possible failure and liquidation. - Weaknesses related to: (i) shareholders’ right to sit among creditors with voting rights; and (ii) violation of priority rules of secured and unsecured creditors. - Delays in insolvency procedures: resolution of creditor claims may take up to two years, against the four months prescribed by law. - Institutional recommendations: - Role of Superintendent of Companies should be better adapted to adjudicator of rights. - Superintendent of Companies should be granted independence; if making final decisions in insolvency matters, should have same independence as members of the Judiciary. ### IOSCO / securities market modernization - Market structure and regulatory modernization: - Private capital markets characterized by low liquidity and insufficient depth. - Causes: scarce supply of investment securities by local corporations; deficiencies in clearance and settlement systems; investment restrictions; issuance costs; taxation; lack of fixed income hedging instruments. - Government debt market has developed substantially. - Modernization of regulatory framework is key to increase liquidity, stimulate investment, and promote economic growth. - Emphasis on protecting investor rights, promoting market efficiency, integrity, and preventing systemic risks. - Review of accounting and auditing standards needed; program to adopt international financial reporting standards for listed corporations needed. - SBC overhauled AML/CFT regulations and adapting supervisory practices. ### CPSS / payment and settlement systems - Legal foundations and operational recommendations: - Draft securities markets law in Congress would boost local market development and address weaknesses in legal framework for payment system; improves compliance with CPSS standards. - Draft covers legal validation of multilateral netting; protection against bankruptcy; settlement finality; protection of collateral arrangements; pledge; segregation of accounts; legal definition of repos; central counterparties; novation; extends legal basis for funds and foreign exchange settlement systems. - Draft does not address lack of legal basis for the BRC’s oversight function. - Check system reduced systemic importance; BRC should continue efforts to reduce check usage and broaden electronic payments. - BRC should seek clear legislative authority for oversight of clearance and settlement systems and disclose publicly its objectives and implementation strategies. - Principal risk elimination in systems operated/owned by the stock exchange through delivery-versus-payment settlement recommended; settlement guarantee system or loss-sharing arrangement recommended. - SVC’s responsibilities on oversight of securities settlement systems should be included in the draft securities market law; SVC should ensure sufficient resources. - BRC and SVC should lead a cooperative forum for improving payment and securities settlement systems. ### AML/CFT summary assessment - GAFISUD conducted mutual evaluation in October 2004; ROSC expected for IMF/World Bank proforma review around April 2005. - Findings: - Colombian authorities committed to combating money laundering; significant number of convictions. - AML legislation makes money laundering an autonomous offense and covers most serious predicate offenses, though should incorporate smuggling and piracy. - Colombian legislation provides for “extinción de dominio” facilitating forfeiture of illicit property separate from criminal procedures. - Colombia has not ratified the UN Convention for the Suppression of Financing of Terrorism; no specific legislation criminalizing financing of terrorism. - Institutional framework: - Financial intelligence unit (Unidad de Información y Análisis Financiero) is a leading authority with adequate powers and systems. - Regulatory and supervisory elements of AML/CFT mainly led by financial supervisory agencies, the BRC, and Direccción de Impuesto y Aduanas Nacionales. - SBC overhauled its AML/CFT regulations and adapting supervisory practices; governmental oversight of other sectors subject to AML obligations require additional efforts. *Source: IMF staff report (_cr05287); Annex 2 summaries of assessments under IOSCO Principles; CPSS Core Principles for Systemically Important Payment Systems; Principles and Guidelines for Effective Insolvency and Creditor Rights Systems; and AML/CFT assessment by Financial Action Task Force of South America, October 2004.* ### Annex 2 contains summaries of assessments under four standard and codes: the IOSCO Principles; the CPSS ### _cr05287 - Annex 2 contains summaries of assessments under four standard and codes: the IOSCO Principles; the CPSS ### Summary and overall stability assessment - Author: Rodolfo Maino. - FSAP purpose: assess stability of the financial system as a whole, not individual institutions; do not cover institution-specific risks such as asset quality, operational or legal risks, or fraud. - Overall judgment: - The Colombian financial system "appears reasonably sound and stable" following the 1999 crisis, aided by bank recapitalization and supervisory improvements. - Key remaining concerns: solvency and profitability challenges in commercial banks, low specific provisioning on higher risk loans, potential overstatement of bank capital due to overvaluation of foreclosed assets and underestimation of market risk, and continued weakness in mortgage banks (BECHs). - Structural shifts and risk profile: - Replacement of private sector loans with government bonds in bank balance sheets has shifted exposures from credit risk to market risk / sovereign credit risk. - Legal and supervisory weaknesses: - Superintendency of Banks lacks sufficient autonomy and independence. - Current legal framework fails to effectively protect bank supervisors or the Superintendent. - Regulatory forbearance persists, evidenced by low levels of provisioned nonperforming loans and sensitivity of solvency ratios to conservative asset evaluation criteria. - Two largest institutions remain under FOGAFIN control; most recapitalized banks have regained market access or are backed by prominent financial holding companies. - Main financial vulnerabilities: - Credit risk and interest rate risk are the principal vulnerabilities given exposure magnitudes, relative sensitivities, and volatility of risk factors. - The largest interest rate shock impact would come from a precipitous rise in the yield curve. - Foreign exchange risk appears limited; equity price risk primarily affects finance corporations. - Legal and fiscal impediments to credit: - Law 550 (introduced during 1999 crisis) protects debtors in restructuring procedures and impedes bank credit; revision recommended. - Distortionary taxation: financial transactions tax reduces payment system efficiency and encourages underground economy activity; 1.5 percentage point stamp tax on bank loans disincentivizes long-term lending. - Housing finance: - Mortgage lending has not recovered; housing financing relies largely on repatriation of foreign assets or informal markets. - Recommendation: develop a comprehensive housing finance strategy including restructuring tax subsidies for mortgage lending. - Implementation challenges for risk-based provisioning: - SBC (Superintendency of Banks) pioneering risk-based loan-loss reserve work requires substantial human resources investment and redefinition of supervisory approaches. - Need for an SBC road map for full implementation, clear alternatives for banks not opting for internal models, and an explicit definition of consolidation scope precondition for risk-based supervision. - Pension system and capital markets: - 1993 pension reform increased pension fund assets and will produce growing annuity issuance by life insurers; intermediation costs must be reduced, and parameters of the pay-as-you-go pillar adjusted (increase retirement age and vesting periods, reduce accrual rates). - Private capital markets show low liquidity and insufficient depth; modernization of securities market regulatory framework is critical. - Corporate governance and accounting: - Adoption of corporate governance norms oriented to reward efficient management recommended. - Improve accounting and auditing practices to stabilize credit flows and reduce corporate sector vulnerability. ### FSAP Update — main recommendations (implementation horizons specified) - Strengthening bank regulation and supervision by the SBC: - Provide the SBC with more autonomy and regulatory power. (MT) - Have the SBC prioritize the SARC project. (ST) - Ensure that the SBC moves toward full implementation of consolidated supervision. (MT) - Have the SBC adapt its internal organization and resources to accomplish the above challenges. (ST) - Bringing to an end the crisis resolution-phase: - Government should devise a comprehensive plan to privatize Bancafe and Granahorrar. (ST) - Strengthening insurance regulation and supervision: - Improve bank regulation, supervisory practices, and market infrastructure to cope with annuity market development. (ST) - Strengthen risk-oriented solvency and provisioning regulation in the nonlife sector. (MT) - Strengthen the independence of the regulatory function of the supervisory agency. (MT) - Provide adequate resources for insurance and pension supervision. (ST) - Strengthening pension funds regulation and supervision: - Eliminate fragmentation and privileges in the pension system. (MT) - Revision of the parameters of the “pay-as-you-go” scheme to insure long-term sustainability. (ST) - Constitute a task force to address the problem of contributive evasion. (ST) - Shift from prescriptive to risk-based approaches to pension regulation and supervision. (MT) - Coordinate the programs of different supervision agencies. (ST) - Improve capital markets regulatory framework: - Strengthen the regulatory regime by implementing the new Securities Market Law. (ST) - Take measures to harmonize responsibilities, avoiding current regulatory and supervisory overlap. (ST) - Adopt international auditing and accounting standards. (MT) - Ensure that Securities Superintendency (SVC) has sufficient resources for supervision, enforcement, and securities settlement. (ST) - Promote local and international cooperation to share information. (ST) - Developing the payment systems: - Strengthen the supervisory framework for payment systems by BRC (Banco de la República de Colombia). (MT) - Eliminate the financial transactions tax. (ST) - Reducing corporate sector vulnerabilities: - Improve auditing standards and professional standards. (MT) - Improve the dissemination of corporate data information. (ST) - Enhance quality of analysts, insolvency experts, and appraisers. (MT) - Revise Law 550 on insolvency procedures. (ST) - ST = recommendations that can be implemented in less than two years. - MT = recommendations that may take more than two years to implement, due to required legal or constitutional reforms. ### Macroeconomic context and selected indicators - Historical performance and crisis legacy: - From 1996 to 2001, real GDP grew by only 1 percent on average and unemployment rose to 20 percent at end-2001. - Combined public sector deficit grew from 3 percent of GDP in 1996 to 5.5 percent in 1999 and stayed above 3 percent from 2000 to 2002. - Public sector debt rose from about 45 percent of GDP in 2000 to 56 percent of GDP in 2003. - Policy response since 2002: - Government measures: expenditure cuts, a one-time wealth tax, broader tax package, and structural fiscal reform including pension reform; medium-term target to increase primary surplus to 3 percent of GDP and reduce public debt below 45 percent of GDP by 2010. - Monetary policy: inflation targeting and a floating exchange rate. - Recent outcomes and projections (exact figures preserved from Table 1): - GDP growth expected to remain at 4.0 percent in 2005. - Combined public sector deficit for 2004: 1.2 percent of GDP (down from 3.6 percent in 2002). - Primary surplus reached 3.0 percent of GDP in 2004 (from 0.4 percent in 2002). - Total public debt declined to 54.1 percent of GDP in 2004 from 60.2 percent in 2002. - Select table excerpts (exact values preserved): - Real GDP: 2.9 (2000), 1.5 (2001), 1.9 (2002), 3.8 (2003), 4.0 (2004 Rev.), 3.8 (2004 Prel.), 4.0 (2005 Proj.), 4.0 (2006 Proj.) - Consumer prices (average): 9.2 (2000), 8.0 (2001), 6.3 (2002), 7.1 (2003), 6.0 (2004 Rev.), 5.9 (2004 Prel.), 5.2 (2005 Proj.), 4.8 (2006 Proj.) - Public sector debt: 47.7 (2000), 51.8 (2001), 60.2 (2002), 56.6 (2003), 52.1 (2004 Rev.), 54.1 (2004 Prel.), 51.2 (2005 Proj.), 49.5 (2006 Proj.) - Current account (deficit -): 0.9 (2000), -1.4 (2001), -1.7 (2002), -1.5 (2003), -2.2 (2004 Rev.), -1.1 (2004 Prel.), -2.9 (2005 Proj.), -2.6 (2006 Proj.) - Net official reserves: 8,800 (2000), 9,982 (2001), 10,507 (2002), 10,524 (2003), 11,408 (2004 Rev.), 13,195 (2004 Prel.), 12,340 (2005 Proj.), 12,653 (2006 Proj.) - NFPS primary balance: 0.9 (2000), 1.3 (2001), 0.4 (2002), 1.7 (2003), 2.2 (2004 Rev.), 3.0 (2004 Prel.), 2.7 (2005 Proj.), 2.7 (2006 Proj.) - Credit to the private sector: -8.6 (2000), 1.7 (2001), 4.0 (2002), 9.2 (2003), 11.5 (2004 Rev.), 12.2 (2004 Prel.), 14.6 (2005 Proj.), 14.0 (2006 Proj.) ### Vulnerabilities, development opportunities, and supervisory priorities - Banking sector: - Main exposures: credit risk and interest rate risk; limited foreign exchange risk; equity price exposure concentrated in finance corporations. - Need to address potentially overstated capital due to asset valuation and market risk underestimation. - Mortgage banks (BECHs) remain weak despite diversification. - Nonbank financial institutions, pensions, and insurance: - Pension funds: high asset accumulation post-1993 reform; need to reduce intermediation costs and adjust pay-as-you-go parameters for sustainability. - Insurance sector: prepare for annuity market development with improved regulation and supervision. - Capital markets: - Low liquidity and depth; modernization of regulatory framework and adoption of international accounting and auditing standards recommended. - Payment systems: - Financial transactions tax impairs payment system efficiency; elimination recommended. - Legal framework and insolvency: - Revise Law 550 to facilitate reorganization procedures more favorable to financial intermediation. *Source: IMF staff report (_cr05287); Annex 2 summaries of assessments under IOSCO Principles; CPSS Core Principles for Systemically Important Payment Systems; Principles and Guidelines for Effective Insolvency and Creditor Rights Systems; and AML/CFT assessment by Financial Action Task Force of South America, October 2004. Canonical URL: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05287.pdf* ### 16. The favorable economic outlook has opened a window of opportunity for further ### 16. The favorable economic outlook has opened a window of opportunity for further ### III. VULNERABILITIES AND DEVELOPMENT OPPORTUNITIES IN THE FINANCIAL SECTOR — Overview - Favorable economic outlook creates opportunity for further financial sector reforms. - Key macro-financial vulnerabilities: - Rising international interest rates may significantly affect gains in fiscal consolidation and deteriorate financial institutions’ balance sheets. - Any relaxation of fiscal discipline may jeopardize business confidence and compromise long-term growth. - Steady increases in net pension costs will complicate expenditure management unless pension reform is adopted soon. - Tenuous security situation might affect investment prospects and long-term growth. - Weakening of the inflation targeting approach could compromise progress in reducing inflation. - Greater exchange rate flexibility has improved external sector performance and increased the financial sector’s ability to assess foreign exchange risks and to withstand shocks. ### A. Update of Banking Sector Developments — Key findings - Crisis and aftermath (1998–1999): - Financial soundness deteriorated abruptly during 1998–1999 as adverse macroeconomic factors ended a credit boom and coincided with poor credit management and weak supervision. - By mid-1998 declining activity, real depreciation, a spike in (already high) real interest rates, and falling asset prices increased nonperforming assets and reduced liquidity, profitability, and solvency of many institutions. - Policy response and structural changes: - From 1999 to 2001 authorities introduced a mortgage debtor relief program, incentives for corporate debt restructuring, and incentives for bank recapitalization. - Prudential regulations were tightened, including a general provisioning requirement of 1 percent of total loans and capital requirements for market risk. - Intense consolidation since the crisis enhanced market share for larger banks. - Portfolio and asset trends (1998–2003): - Total bank loans decreased around 30 percent in real terms between 1998 and 2003. - Mortgage loans declined close to 60 percent (real terms), reflecting write-offs, stricter provisioning, and private sector balance sheet restructuring. - Decline in mortgage lending led to greater exposure to commercial and consumer loans. - Financial system composition (selected figures from Table 2 and memorandum): - Financial System Total Assets: 110,761 (Dec-2000) and 138,416 (Dec-2003) (values appear in table as raw entries). - Values of GDP in current billion US$ were $78.5 in 2000; and $81.5 in 2003. (table memorandum) - Improvement in soundness indicators (to Sept. 2004): - Risk-weighted capital adequacy ratio (CAR) for the system: 14 percent as of September 2004, versus less than 11 percent before the crisis. - All institutions had a CAR above the 9 percent minimum. - Classified loans (substandard, doubtful or loss): 7.9 percent as of September 2004, down from 16.3 percent at end-1998. - Ratio of loan loss provisions to classified loans: grew from 25 to 54 percent since 1999. - Return on average assets: annualized 2.7 percent as of September 2004, versus -3.5 percent in 1999. - Three-month liquidity gap: improved from -120 percent of liquid assets in July 1999 to under -30 percent of liquid assets as of June 2004. - Emerging concentration risks: - Capital, earnings, and liquidity now more exposed to long-term fixed-rate treasury securities; banks vulnerable to sovereign credit deterioration or to an increase in interest rates. - Estimated core operational income (excluding valuation gains on government securities) to gross income: 82 percent versus operating plus provisioning expenses to gross income of 63 percent (staff estimate). ### A. Update — Prudential changes and implications - Concerns remain about underestimation of provisioning and capital requirements: - Specific provisioning of higher risk loans still appears low relative to better provisioned systems. - Prudential rules on market risks may underestimate capital requirements, e.g., allowing some netting of UVR (real value of mortgages) and peso-denominated positions. - Policy actions (planned/implemented): - Starting in July 2005, financial institutions required to hold provisions in line with estimated expected credit losses of their commercial and industrial loans. - Banks may adopt a supervisory model for computing expected losses or seek validation of their own internal models. - Calculation of market risk capital requirements has improved; some residual netting practices remain. - Tightening of provisioning for loans and foreclosed assets by end-2005. - Impact of prudential tightening: - Adjustments indicate prudence would require some institutions to increase provisioning and capital. - Institutions most sensitive: BECHs, followed by finance corporations and public banks. Private banks could also fall below regulatory minimum because of lower initial capital base. - These prudential requirements will maintain pressures on provisioning and capital levels and most likely limit further compression on interest rate spreads. ### A. Update — Liquidity and rollover risk - Rollover vulnerability: - Half of the banks have a negative one-month maturity gap (liabilities liquidating within one month exceed assets liquidating within one month). - Systemic and structural gap at three months exists. - In a systemic liquidity shock, banks could incur losses liquidating negotiable securities given size of exposures and market crowding. ### B. Stress Tests — Main results - Primary vulnerabilities: credit risk and interest rate risk. - Credit risk sensitivity: - Regression analysis shows NPLs most sensitive to GDP growth. - Given a shock to GDP of -3 percent (equal to about 1 standard deviation), past dues estimated to increase by 14 percent of total loans. - For the aggregate of credit institutions, CAR would fall from 13.7 to 8.6 percent under that shock. - Interest rate risk: - Greatest impact on capital from a very large steepening of the yield curve (joint effect of valuation losses and higher capital requirements). - Aggregate CAR after a steepening of the curve would fall to 6.8 percent. - Tests include the entire banking book (not marked-to-market); total simulated impact on capital unlikely to materialize in short-term accounting terms. - Foreign exchange and equity price risk: - Foreign exchange risk appears limited because most banks are long in U.S. dollars; indirect corporate-sector risk also appears limited. - Moderate equity market shock would not severely affect commercial banks but could impact finance corporations. - Liquidity stress: - Private banks vulnerable to withdrawal of uninsured deposits. - Uninsured savings and current account deposits (above Col$ 20 million) account for 67 percent of total deposits and represent close to 80 percent of the deposit base of private banks. ### B. Stress Tests — Institutional and procedural gaps - Need for systematic emphasis on stress testing: - Financial sector has high-quality technical capability, but recent resources devoted to SARC; little systematic attention to stress testing. - Survey: financial institutions allocating about US$0.1 million on risk aggregation and stress testing versus US$1 million on credit risk (SARC). - Capacity constraints at the Superintendency of Banks (SBC): - Resources stretched; recommendation to create stress testing committee leveraging public sector expertise (central bank to supply macro scenarios; SBC to assess impacts). ### C. Bank Regulation and Supervision Update — Progress and remaining weaknesses - Improvements since 1999 FSAP: - Progress in Basel Core Principles implementation. - Significant revisions of legal framework 1999–2003 (Law 510 in 1999, Decree 1720 in 2001, Law 795 in 2003) raised minimum bank capital requirements for credit and market risk and provided legal background for early warning, prompt corrective actions, and consolidated supervision. - SBC issued regulations defining a new risk-based loan classification and provisioning system (SARC). - Areas with modest or no progress: - On- and off-site supervision (SBC still working on draft project to introduce improvements). - Control of other material risks (operational, procedural) and banks’ internal control procedures. - Regulation of country risk: no progress. - Risk-based regulation and consolidated supervision remain key issues. - SBC autonomy and legal framework shortcomings: - SBC lacks sufficient autonomy and independence; legal framework fails to effectively protect supervisors or the Superintendent. - SBC subject to government-wide fiscal restraints though resources are provided by direct levies on banks and exceed SBC expenditures. - Profile, terms of appointment and removal of the Superintendent remain unclear since 1999 FSAP. - Norms related to banking sector issued by the Ministry of Hacienda, not by the SBC, creating de facto subordination and potential conflicts of interest. - Previous efforts to increase SBC autonomy through legal changes met congressional opposition. - Potential area of conflict: definition of nonzero risk weights on banks’ holdings of government debt for capital requirement purposes—in line with Basel II—where conflicting views may emerge. - Internal organization and capacity needs at SBC: - Supervisory conduct based on units following individual supervised entities, staff not necessarily well-trained in risk management. - Qualified staff may be insufficient should many banks migrate to internal models. - Risk-based supervision requires innovations in supervisory approach and organization. - Validation and supervision of databases, systems, models, methodologies and consistency of results are major challenges for the SBC. *Source: _cr05287 - 16. The favorable economic outlook has opened a window of opportunity for further* ### 31. The SBC should issue norms concerning the role, duties, and responsibilities of ### _cr05287 - 31. The SBC should issue norms concerning the role, duties, and responsibilities of ### Supervisory framework and external auditors - The SBC should issue norms concerning the role, duties, and responsibilities of external auditors (revisores fiscales). - Identified weaknesses: - Lack of audit standards and lack of alignment with International Accounting Standards represent a serious departure from international best practices for financial reporting and transparency. - Requirements that the SBC validate bank financial statements generate a confusion of roles and responsibilities between the SBC and the auditors that needs to be addressed. - Progress and remaining needs: - Since 1999, important progress has been made to facilitate consolidated supervision of financial conglomerates, but a comprehensive vision of how group risks may affect banks’ soundness needs to be defined. - Steps taken: establishment of capital adequacy rules; definition of limited accounting regulations and disclosure requirements; empowerment of SBC to access related company information. - Inter-agency coordination recommendations: - Improve coordination of efforts and information among the SBC, the Securities Superintendency (SVC), and the Superintendency of Companies (SSC). - Rules for cooperation should include specific requirements for exchange of information, consultation and assistance on policy, monitoring of markets and entities, and conflict resolution processes. - Harmonize regulation and supervisory practices for independent brokers and bank-related brokers to assure a level playing field. - Define a “lead supervisor” with clear responsibility and accountability concerning market, credit and liquidity risks, and stress tests. - Cross-border supervision gap: - The SBC lacks the capacity to adequately examine the relationship between local banks and their foreign branches; the degree and nature of local banks’ exposure to risk assumed by their overseas branches are not currently known by the SBC. ### Mortgage and public banks — status and policy actions - Recovery and recapitalization: - Mortgage and public banks, central to the 1999 crisis, have largely recovered and were heavily recapitalized through several schemes. - One mortgage bank has prepaid its recapitalization obligation to FOGAFIN, and the other three are expected to repay on schedule. - Mortgage securitization conduit has brought six issues to market. - The central bank’s hedging facility has been redesigned to more directly cover mismatch risk at a more attractive price. - Public banks received Col$6.1 trillion in recapitalization lines during the crisis. - Most resolved institutions have been liquidated or sold. From the three remaining public institutions, one will remain public as a development bank, while the other two are being privatized. - Legal and policy risks in mortgages: - Law 546 of 1999 imposed rigidities in mortgage design that negatively affected lower-income borrowers (e.g., outlawing floating rate peso loans). - Government should develop a strategic housing policy aimed at reducing the housing deficit as an alternative to the constitutional court’s interest rate ceilings. - Government should restructure tax subsidies for mortgage lending to eliminate benefits to wealthy households and directly benefit low-income households given constitutional court-imposed restrictions on Social Priority Housing lending. - Privatization and restructuring issues: - After the crisis, authorities adopted a successful plan to divest or liquidate public banks; recapitalization was complemented with disposal of unproductive assets. - Bancafé, Banco Agrario, and Granahorrar together represent around 14 percent of total assets of the banking system (commercial banks and BECHs). - Bancafé privatization has failed to date: labor costs and labor liabilities (strong union presence) were main reasons for failure of the February 2004 auction; market concentration limits discourage participation of large financial groups; procedures should be clarified. - Granahorrar improved its financial position but timing of privatization is unclear; lower franchise value, higher cost funding base, high exposure to mortgage loans, but does not have Bancafé’s labor liabilities. - Recommended privatization strategy elements: - (1) Solve the union problem of Bancafé by agreement with employees, taking labor liabilities out of the bank, or liquidating it. - (2) Improve marketability of Granahorrar, either as an ongoing concern valuable for prospective bidders or liquidating it. - (3) Clarify rules regarding the definition of market power to reduce uncertainty to prospective bidders. ### Nonbank financial institutions — pensions and insurance - Pension system structure and challenges: - Since 1993, Colombia has a funded scheme administered by private managers and a public “pay-as-you-go” (PAYG) scheme administered by Instituto de Seguridad Social. - Shift of contributors to the private scheme over a decade produced rapid growth in private pension funds and depleted reserves of the public PAYG scheme. - Long-term projections for the deficit of the public pillar are of concern; further reforms are needed, including increasing the retirement age and vesting period, as well as reducing the accrual rate to achieve long-term sustainability. - AFP industry structure and costs: - Six private companies (Pension Fund Firms or AFP) manage the funded scheme; the larger two concentrated more than 50 percent of the funds administered in August 2004. - Net costs of administration represent almost 15 percent of contributions collected in August 2004, a percentage above the average of other Latin American countries with similar schemes. - Need for a thorough analysis of the cost structure to identify main components, including regulatory amendments, reforms in administrative procedures, and improved supervision. - AFP portfolios heavily concentrated in public bonds and should be far more diversified. - Evasion of contributions and collection control: - High rates of evasion affect both funded programs and the PAYG scheme. - Collection control is decentralized and ex-post, based on beneficiary claims at retirement. - Recommendation: form a joint task force of agencies involved in collection to design and implement programs to control evasion based on Registro Unico de Aportantes information. - Supervision approach and capacity: - Supervision model should shift from compliance-oriented to a risk-based approach. - Both funded and PAYG schemes are supervised by Superintendencia Bancaria; centralized supervision may allow influence over PAYG but current resources are insufficient. - PAYG supervision should coordinate with peer agencies (Contraloría de la Nación, Contaduría General, Procuraduría de la Nación, and Superintendencia Bancaria) to reduce inefficiencies and duplication. - Insurance sector developments and needs: - Development of a complete regulatory structure for annuities should receive immediate attention. - Premiums have shown healthy growth in real terms; life sector linkage with annuities could contribute to capital markets development; nonlife sector likely to play a more limited role. - Insurance supervisors improved technical skills and updated procedures since the 1999 FSAP, but staff numbers diminished dramatically and constraints on technical knowledge, experience, and skills are a concern. - Recent law reflects international trends and good practices, but areas needing update include solvency margin formula, rules for provisions, and distribution oversight. - Analysis suggests current solvency margin does not reflect underlying company risk profiles in the nonlife sector. - Independence and technical capacity recommendations: - Concerns persist about independence of regulatory process; location of regulatory development in Hacienda runs contrary to full observance of international standards. - Administrative steps to enhance political independence recommended: (1) implement transparent processes for regulatory development; (2) allow SBC greater budget flexibility on a fee recovery basis with associated industry consultation. - Efforts to develop sector technical capacity should include sound regulation of change of control, supervisory linkages for exchange of information with foreign supervisors, and anticipatory changes to resolution regulations to provide a full “tool kit.” ### Corporate sector vulnerabilities — financing, information, and governance - Financing and performance: - Financial conditions of the corporate sector improved over the last four years due to sustained economic recovery and lower interest rates, but vulnerabilities remain. - Average profitability (return on assets of the median firm) has returned to pre-crisis levels but earnings remain low and unevenly distributed. - Many firms still appear unable to meet debt service obligations despite a restrained degree of leverage. - Companies reduced exposure to external debt, reliance on bank credit declined in real terms in favor of retained earnings and supplier credit, while equity mobilization was virtually nonexistent. - Market sources report only large exporting or importing corporations use foreign exchange denominated debt. - Heterogeneous recovery: - Recovery uneven across sectors: tradable sector outperforms nontradable sector; larger companies have undertaken complex restructuring, gaining efficiency and benefiting from lower cost of finance. - Corporate financial information weaknesses: - Quality of corporate financial information is a high-priority weakness. - Required actions: further convergence toward international accounting standards, more stringent auditing practices, effective regulatory enforcement. - Regulatory effort should be complemented by training programs for financial analysts and insolvency appraisers. - Authorities have collected corporate accounting data in an accessible electronic format; additional improvements suggested, such as creating a single dataset with information from listed and unlisted firms and strengthening dissemination/publicity of corporate sector information. - Corporate governance features: - Market liberalization has partially transformed business groups into more focused, professionally managed and transparent operations. - Nevertheless, corporate ownership remains concentrated, business groups with pyramid structures and cross shareholdings are frequent. - Institutional investors acting in a fiduciary capacity should disclose their overall corporate governance and voting policies, including procedures for deciding use of voting rights. ### Key banking system indicators (selected items preserved exactly as reported) - Capital adequacy ratio (with market risk) 3/: n.a., 11.3, 13.2, 13.0, 12.6, 13.1, 14.0 (years shown across table). - Regulatory Tier I capital to risk weighted assets: n.a., 8.0, 9.2, 9.3, 9.7, 10.5, 11.4 (as in table). - Capital to assets: 10.6, 11.0, 11.3, 11.2, 11.0, 11.5, 11.9. - Nonperforming loans net of provisions to capital 4/: 27.2, 35.9, 15.6, 5.6, 1.1, -3.8, -10.5. - Nonperforming loans to total loans 4/5/: 9.1, 12.4, 10.6, 10.2, 9.2, 6.8, 3.6. - Classified loans 5/: n.a., 18.1, 18.7, 18.1, 16.0, 12.1, 7.9. - Specific provisions to classified loans and leases: n.a., 25.3, 27.7, 37.5, 43.0, 47.6, 54.0. - Sectoral distribution of loans to total loans 5/: - commercial: 53.0, 55.2, 58.7, 58.4, 61.9, 62.8, 65.8. - consumer: 17.9, 13.4, 14.0, 15.6, 15.6, 18.0, 19.1. - housing: 29.1, 31.4, 27.2, 26.0, 21.7, 18.1, 14.1. - Foreign currency loans to total loans: 11.9, 9.0, 8.1, 7.0, 7.4, 4.7, 5.2. - Return on average equity: ...,-32.6,-20.7,1.1,9.6,17.0,23.4. - Return on average assets: ...,-3.5,-2.3,0.1,1.1,1.9,2.7. - Interest margin to gross income: 41.0, 30.7, 38.1, 32.7, 35.5, 37.4, 39.5. - Noninterest expenses to gross income: 83.5, 95.4, 93.7, 85.6, 80.7, 69.8, 59.8. - Personnel expenses to noninterest income: 43.0, 38.6, 36.2, 37.3, 38.3, 38.4, 41.5. - Spread between reference lending and deposit rates: 9.7, 4.4, 6.6, 8.3, 7.4, 7.4, 7.3. - Liquid assets to total assets 6/: 10.0, 11.9, 12.9, 16.5, 19.7, 18.7, 18.0. - Liquid assets to short-term liabilities 7/: 17.3, 19.2, 20.4, 25.2, 30.2, 29.0, 28.1. - Customer deposits to total (noninterbank) loans: 93.8, 107.5, 122.3, 136.1, 136.1, 136.0, 126.2. - Foreign currency liabilities to total liabilities: 12.1, 9.4, 9.4, 9.1, 8.6, 7.0, 6.2. - Net open position in foreign exchange to capital: 5.1, -0.1, -1.4, 4.8, 7.8, 4.3, 4.8. Notes accompanying table (preserved): - 4/ Loans past-due 90 days or more (120 days or more in the case of mortgages). - 5/ Loan data includes leases as of 2004. - 6/ Liquid assets include cash, deposits, and securities held for trading. - 7/ Customer deposits used as proxy for short-term liabilities. - 1/ Excluding credit unions and public sector special institutions (IOE). - 2/ Data to Sept. 2004 except data on foreign currency loans and liabilities, which are to June 2004. Returns are annualized as necessary. - 3/ Market risks requirements, effective only as of 2001, are weighted 60% until 2003, 80% in 2003, and 100% thereafter. ### Implementation status of FSAP 2000 recommendations (selected items) - Status legend: FI=Fully Implemented; NI=Not Implemented; PI=Partially Implemented; PL=Pending Legislation. - Selected recommendations and status: - A. Systemic liquidity arrangements: - Enhance the scope for market determination of central bank intervention rates. FI - Establish an arrangement to swap bank holdings of bank assets against tradable government securities. NI - Establish contingency plans to deal with small credit institutions exposed to liquidity pressures. NI - B. Payment system risk management: - Further encourage the development of the RTGS system. FI - Introduce measures to limit settlement risk in the check clearing system. FI - C. Housing sector issues: - Limit debt relief to debtors that are current in their payments and announce no further relief. FI - Adjust the interest rate insurance scheme to limit market distortions and strengthen hedging incentives. (status not marked) - Develop a contingency plan to deal with savings and loan institutions. FI - D. Public bank restructuring: - Tighten management of public banks with assistance of international investment bankers and reputable professional administrators. PI - Consider the introduction of an ad-hoc monitoring committee. NI - Enhance the tradability of recapitalization bonds. FI - E. Private bank recapitalization plan: - Subject recapitalized banks to special inspection and monitoring program. FI - Introduce an explicit arrangement to recapitalize FOGAFIN in the event of losses. FI - F. Corporate debt restructuring: - Limit scope for abuses in classification of restructured debts. NI - G. Bank supervision: - Strengthen procedures to review banks’ loan classification and internal risk management. PI - Strengthen on-site inspection procedures and training of on-site inspectors. PI - Introduce additional capital requirements for market risk. FI - Consider prudential measures to strengthen resilience to macroeconomic shocks and limit amplitude of credit cycles. PI - H. Framework for bank resolution: - Introduce regulations to implement a system of prompt corrective actions. FI - Implement FOGAFIN’s draft organic statutes. FI - Review bankruptcy and tax legislation to encourage debt restructuring and facilitate asset recovery. NI - I. Capital market development (selected): - Develop a comprehensive development strategy for capital markets and financial intermediaries. PL - Take measures to encourage long-term investments by pension funds. PL - Provide greater protection to mutual fund investors. PL - Review role of foreign investors and capital controls in new economic environment. PL - Strengthen the government securities market. PL - Promote development of capital markets’ infrastructure and enhance market transparency. PL - Initiate in-depth study of corporate sector to enhance transparency and governance. NI - Undertake study to identify discrepancies between Colombian accounting standards and International Accounting Standards and take measures to correct them. PI *Italic: Source: _cr05287 - 31. The SBC should issue norms concerning the role, duties, and responsibilities of* ### 56. The framework for insolvency procedures and the protection of creditor rights ### The framework for insolvency procedures and the protection of creditor rights ### Reform history and overall assessment - The framework for insolvency procedures and the protection of creditor rights was extensively reformed in 1999, in order to accelerate the very protracted Concordato proceedings under the previous law. - Law 550 on reorganization was introduced in an emergency context, and approved under pressure to protect distressed debtors’ interests. - Law 550 is described as "excessively tilted against creditors and, more specifically, against financial creditors’ rights," with a potentially harmful effect on bank lending and on the financial deepening of the Colombian economy. - Improved economic conditions provide an opportunity to revise some aspects of the legal framework in order to reestablish a balanced approach to insolvency procedures. - The current project of reforms of all insolvency laws before Congress, and the widespread movement toward reform of laws on individual actions, provide a clear opportunity to incorporate international standards into Colombian law. ### Enforcement of creditor rights and registry infrastructure - The Colombian legal system provides sophisticated and varied protections of creditor rights in individual proceedings and advanced procedures for their registration. - Enforcement proceedings for both unsecured and mortgage creditors are inefficient and have caused a severe backlog of cases in saturated commercial courts. - Land and movable registries should be centralized and automated. - Individual proceedings are plagued by the lack of appropriate accelerated procedures toward the collection of funds for both secured and unsecured creditors. - Individual actions for the collection of monies need to be reformed. ### Main sources of ineffectiveness in insolvency system - Two main sources of ineffectiveness stand out: - Laxity of prerequisites for restructuring agreements, which may eventually lead to the failure of the restructuring plan and to liquidation. - Weaknesses of the restructuring procedure are largely related to: - (i) the shareholders’ right to sit among the creditors with voting rights; and - (ii) the violation of the priority rules of secured and unsecured creditors. - Delays in insolvency procedures that do not allow companies to rapidly reorganize or to be liquidated. - Market practitioners have indicated that the resolution of the creditors claims may take up to two years, against the four months prescribed by the law. ### Institutional recommendations for adjudication and independence - Confidence in insolvency resolution procedures would increase were the role of Superintendent of Companies better adapted to its role of adjudicator of rights. - Given his jurisdictional functions the Superintendent of Companies should be granted independence. - If the Superintendent is to make final decisions in insolvency matters, he should be granted the same independence as members of the Judiciary. ### B. IOSCO Objectives and Principles of Securities Regulation — market structure and regulatory modernization - Private capital markets have developed somewhat but continue to be characterized by low liquidity and insufficient depth. - Causes cited include scarce supply of investment securities by local corporations, deficiencies in clearance and settlement systems, investment restrictions, issuance costs, taxation and the lack of fixed income hedging instruments. - Most resources are channeled through the banking sector; capital markets have still not become an alternative financing source for the private sector. - Secondary market liquidity lags behind comparable countries, especially in equity. - The government debt market has developed substantially. - The modernization of the regulatory framework for securities markets is key to increase liquidity, to stimulate investment and to promote economic growth. - The securities regulatory regime is under review and there are many substantial changes underway regarding suitable regulations, supervision capable of enforcing the regulations and the implementation of international standards. - Emphasis is on protecting investor’s rights, promoting market efficiency, integrity and trustworthiness among parties, and preventing systemic risks. - Authorities are working on important reforms to reinforce their supervision and watchdog capabilities. - Progress is being made to eliminate regulatory arbitrages and clarify roles and supervisor functions. - A review of accounting and auditing standards and procedures used in Colombia is needed. - A program to adopt international financial reporting standards for listed corporations is needed. - The SBC recently overhauled its AML/CFT regulations and is adapting its supervisory practices accordingly, while governmental oversight of other sectors subject to AML obligations require additional efforts. ### C. CPSS Core Principles for Systemically Important Payment Systems — legal foundations and operational recommendations - The draft of the securities markets law, currently in Congress, would provide a boost to local markets development. - The draft addresses most of the weaknesses identified in the legal framework for the payment system and improves compliance with CPSS standards. - It covers legal validation of multilateral netting, protection of the system against bankruptcy procedures, settlement finality, protection of collateral arrangements, pledge, segregation of accounts, the legal definition of repos, central counterparties, and novation. - It also extends this legal basis for funds and foreign exchange settlement systems. - However, it does not address the lack of legal basis for the BRC’s oversight function. - The check system has significantly reduced its “systemic importance” but the BRC should continue efforts to reduce the use of checks among intermediaries and broaden the use of electronic payments. - The high value of some of the checks settled and the fact that this instrument is sometimes used by financial intermediaries to settle payments confirm that additional efforts to encourage electronic payments are needed. - The BRC should seek clear legislative authority for the oversight of clearance and settlement systems to ensure development and operation of payment mechanisms that contribute to the integrity, efficiency and safety of all financial markets and the operation of monetary policy. - The BRC should disclose publicly its objectives relating to all significant payment system matters along with its implementation strategies. - The central bank should provide guidance to private sector organizations on governance, day-by-day management, diminishing of risks, and policies for transactions. - The BRC should continue to play an active role in leading payments system reform in the country. - Principal risk should be eliminated in systems operated or owned by the stock exchange through settlement of all operations on a delivery-versus-payment basis. - The supervisory function over settlement should be strengthened to ensure proper funds delivery. - Settlement of stocks should include a settlement guarantee system or some kind of loss-sharing arrangement. - Authorities and regulators must continue to encourage the use of electronic money transfers for settlement of the cash leg of securities transactions. - The SVC’s responsibilities on the oversight of the securities settlement systems should be included in the draft securities market law. - The SVC should ensure that sufficient resources are devoted to this function. - It is recommended that the BRC and the SVC play a leadership role in conforming to a cooperative forum for improving the payment and securities settlement system. ### D. Summary assessment of AML/CFT - In October 2004, GAFISUD conducted a mutual evaluation of Colombia to assess compliance with the FATF 40 plus 8 Special Recommendations on AML/CFT. - GAFISUD provided the mission with a copy of the evaluation report and a summary of key findings, and is currently drafting the ROSC. - The ROSC is expected to be sent for IMF/World Bank proforma review around April 2005. - The summary indicates: - Colombian authorities are deeply committed to combating money laundering and have achieved a significant number of convictions. - Colombian AML legislation makes money laundering an autonomous offense and covers most serious predicate offenses, although it should also incorporate smuggling and piracy among them. - With respect to confiscation of illicit property, Colombian legislation is among the few that provide for “extinción de dominio” (domain extinction) which facilitates the forfeiture of illicit property through a process separate from money laundering criminal procedures. - Colombia has not ratified the UN Convention for the Suppression of Financing of Terrorism, and there is no specific legislation that criminalizes the financing of terrorism. - The financial intelligence unit (Unidad de Información y Análisis Financiero) is one of the leading authorities in AML/CFT controls in Colombia with adequate powers and systems. - The regulatory and supervisory elements of AML/CFT are mainly led by the financial supervisory agencies, the BRC, and the revenue and customs (Direccción de Impuesto y Aduanas Nacionales) authorities. - The SBC recently overhauled its AML/CFT regulations and is adapting its supervisory practices accordingly, while governmental oversight of other sectors subject to AML obligations require additional efforts. *Source: _cr05287 - 56. The framework for insolvency procedures and the protection of creditor rights* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05287.pdf_