CAN PUBLIC BANKS WORK (IN COLOMBIA)?

Washington, February 25th. of 2005

DEPOSIT INSURANCE AND BANK RESTRUCTURING AGENCY

History

Current Situation

Banco Agrario: a successful example?

Lessons

AGENDA

2

3

Market Share1/ of public banks in Colombia%, number

At the beginning of the 1930’s public banks in Colombia had more than 30% of the assets of the system, today they only have 15%

Source: Special Report from “Contraloria General de la República de Colombia”, Superintendencia Bancaria, Analysis Fogafín

15,119,6

41,4

32,8

22,7

28,9

Number of Institutions2/ 513

1935’s 1940’s 1945’s 1950’s 1990’s 2000’s

8553

1/ On assets2/ Additionally there are five 2nd-tier public financial institutions, created in the 1980’s and 1990’s, that still remain today

Loans and DepositsUS$ Billions

ROE, NPL/Total Loans%

The economic slow down at the end of the 1990’s considerably deteriorated the financial system ...

4

15

20

25

30

35

40

45

-40

-30

-20

-10

0

10

20

D-96 D-01D-97 D-98 D-99 D-00

Loans

Deposits

Return on equity

Non performing loans / total

D-96 D-01D-97 D-98 D-99 D-00

.. and publics banks were the most affected during the crisis

Private Banks

Public Banks

0%

3%

6%

9%

12%

15%

18%

9% Minimum Required

D-97 D-98 D-99 D-00

Capital Adequacy Ratio%

0%

5%

10%

15%

20%

25%

30%

D-97 D-98 D-99 D-00

Non-Performing Loans / Total Loans %

5

-3.500

-2.500

-1.500

-500

500

D-97 D-98 D-99 D-00

Net Income1/

US$ millions

1/ Cumulative D-97 to D-00

Although public banks accounted for only 18% of total assets in 1999, they represented 60% of the crisis cost

3,0

2,8

3,4

1,40,6

5,70,4

Recoveries D-03

Net cost D-03

Public Banks

Mortgage Borrowers

Private Banks

Credit Unions

Total Cost

Financial Crisis Cost US$ Billions1/, %

6

4% of 2002 GDP

1/ Calculated with 2002 average exchange rate

State-owned banks’ weaknesses

Internal

• Poor accounting standards.

• Inadequate technological, operational and risk assessment

systems.

• High administrative and personnel costs.

• Lack of qualification of managers and board members.

• Political pressures over managers and board members.

• Lack of control by owner.

The intensity with which the financial crisis affected the public banks revealed their weaknesses

External

• Lack of an official strategy for credit allocation through public

banks.

• Supervisory flaws: Regulatory forbearance.

• Independent Auditors’ flaws.

• Poor information systems that limited market control.

• Persistent debt restructuring programs that deteriorated

“payment culture”.

Source: Fogafín, Special Report from “Contraloría General de la República de Colombia” 7

History

Current Situation

Banco Agrario: a successful example?

Lessons

AGENDA

8

December 1995 June 2004

Public Banks’ reduction%, Number

9

As a consecuence, public sector participation in the financial system has declined to 15% of total system assets

Employees

Branches

Institutions

1.593 1.105

23.283 10.511

13 5

Market Share1/ 20% 15%

1/ On assets

Their performance indicators have reached those of private banks

108115 121

101

Interest-earning assets / Interest-bearing liabilities

Performance Indicators%

D-01 D-02 D-03 D-04

10

65 6959

110Efficiency ratio

D-01 D-02 D-03 D-04

12 11

4

15% NPL’s

D-01 D-02 D-03 D-04

116 119 123116

Interest-earning assets / interest-bearing liabilities

D-01 D-02 D-03 D-04

8171 64

86

Efficiency ratio

D-01 D-02 D-03 D-04

8 63

9

% NPL’s

D-01 D-02 D-03 D-04

Private Banks

Public Banks

Net incomeUS$ millions

However, their net income has increased substantially less than that of private banks

Private Banks

Public Banks

D-01 D-02

81

286

106187

D-03 D-04

918

515

-80

129

11

7.0 times

3.3 times

Net income Growth

History

Current Situation

Banco Agrario: a successful example?

Lessons

AGENDA

12

Asset Composition2/ – Banco AgrarioUS$ millions

Banco Agrario was created with the performing assets and total deposits of Caja Agraria 1/. By government policy, this will be the only first-tier state-owned bank in Colombia

13

1.469

1.497

648195 2.340 540

160169

Net LoansInvest. Securities

Other Total assets Deposits Other Liabilities

Shareholders’ Equity

1/ An Institution created in 1931 to promote credit to the agricultural sector2/ December 2004

Relevant Data

•709 branches

•Almost 3 million deposit accounts

•83% of its total loans went to finance agricultural sector in 2004

•The 5th. largest bank in the system

•4.102 employees

Rediscount

This bank was created in 1999 with a clear mandate of providing credit to the agricultural sector and with a well defined set of operational parameters

14

Law

Charters

Internal Policies

•Provides clear focus to the bank’s objectives and activities

•Establishes that the social activities performed by the bank should be quantified and covered by the central government’s budget

•Subject to the same regulatory requirements as private banks

•Establish that at least 70% of its loan portafolio should be directed towards agricultural activities

•Limited credit exposure to individual clients (5% vs. 10% of shareholders’ equity)

•Fogafin (owner of 95% of the bank’s shares) is a member of the board of directors and acts as an “active” owner, establishing specific goals and monitoring its performance

•Credit risk is partially insured by the Agricultural Guarantee Fund (FAG)

•To diversify risk, 90% of the allocated loans are of less than US$5.000

•Branch managers do not have credit approval authority.

•Personnel chosen by external firms to prevent political appointees

•Loans given to associative agricultural projects are assessed by an external advisor

•A modern technology platform is being implemented to control operational risks

Banking Agencies – Banco Agrario

Banco Agrario has the largest network of banking agencies: 709 branches of which more than 71% are in rural areas

15

# of branches # of towns reached

Banco Agrario

Private Competitor

Public Competitor

687

124 153

Rural Branches

709

368236

Banco Agrario

Private Competitor

Public Competitor

•Has the largest branch network

•This network covers almost 60% of the total towns in Colombia

•Provides financial services throughout the country to communities with poor to no alternatives

• Is the largest provider of agricultural loans

• Is a key part of the payments system – cash distribution nation wide, government salaries and government subsidies

Banco Agrario

Its earnings recovered rapidly, the return on its assets (before taxes) is at a satisfactory 4.4%, and its NPL’s and Efficiency ratios have decreased

Performance Indicators – Banco Agrario

16

64

33 37 42

6

Net incomeUS$ millions

D-01 D-02 D-03 D-04D-00

4,43,2 3,7 3,6

0,7

ROA%

D-01 D-02 D-03 D-04D-00

4,1

9,16,2 4,8

11,5

NPL’s%

D-01 D-02 D-03 D-04D-00

5372 61 65

90

Efficiency ratio%

D-01 D-02 D-03 D-04D-00

Challenges – Banco Agrario

However, its recent success can be threatened by vulnerable governance structure

17

Reinforce its corporate governance

-Appointment of board members

-Election of president

Make sure that the bank will always have an “active” owner

Limit growth to prevent large losses in case of adverse circumstances

History

Current Situation

Banco Agrario: a successful example?

Lessons

AGENDA

18

LESSONS

The experience with 1st-tier public banks in Colombia has been plagued by government failures.

• The current policy is to limit participation to a single public bank.

• Other needs to be addressed by 2nd-tier banks and guarantee schemes (housing, micro credit, and agricultural loans)

However, poor performance need not to lead to closing shop. There may be room for public banks with clear and specific goals

Avoid having large public-commercial banks that lose goal and sense of purpose easily

Governance structures are key

• Clear mandate

• Ownership - a specific government agency should act as owner as a counter balance to political goals

• No political appointments - independent managers transparent hiring policies

• Equal supervision - subject to same regulatory standards as private sector

• Balance sheet protection - legal protection of its balance sheet and availability of complementary instruments: long term funds, credit guarantees

19

THE ROLE OF PUBLIC BANKS IN COLOMBIA

Washington, February 25th. of 2005

DEPOSIT INSURANCE AND BANK RESTRUCTURING AGENCY