Solidifying regulations: Recent laws put the sector on track to meet international standards

When evaluating financial regulation in Colombia, it is easy to observe that the nation has learned well the lessons from past crises – namely the earlier financial crisis of 1982 and the mortgage crisis of 1998-99. As Óscar Cabrera Izquierdo, the president of BBVA Colombia, told OBG, “Since the last financial crisis, Colombia has developed two types of regulations. The first is very prudent, closely examining business processes and making it extremely difficult to generate a bubble like the recent ones in the US and Europe. The other is designed to mitigate the effects from elsewhere.”

INDEX CHANGES: In the wake of the mortgage crisis, for instance, maximum loan-to-value ratios were reduced from 100% to 70% to avoid a situation whereby over-indebted households face negative equity. One major contributing factor to the crisis was the fact that mortgage interest rates were indexed to the Unit of Constant Purchasing Power, a measure of inflation that included both consumer prices and mortgage interest. This meant that mortgage interest increases could become self-reinforcing, as was the case in the late 1990s when many borrowers could no longer meet repayments. After the crisis, a new index – the Real Value Unit – was created with mortgage interest rates stripped out. In addition, most new mortgages are now issued at fixed interest rates.

PRICKING THE BUBBLE: To prevent another credit bubble, the central bank decided in early 2012 to hike interest rates to slow the runaway growth in non-mortgage consumer credit that had been evident since early 2011. This sequence of monetary tightening had the desired effect, with consumer credit growth halving from nearly 30% in the first half of 2011 to reach a more modest 14.8% by January 2013. One result of past financial crises is popular distrust of the financial sector, manifested at times in the reluctance of companies and households to take on excessive debt.

While such caution may limit the scope for widespread financial distress, it also serves to undermine the proper functioning of the market economy, hampering financial intermediation and holding back economic development. Despite an acceleration in credit growth since the middle of the last decade, Colombia’s credit-to-GDP ratio remains well below that of other countries at a similar stage of development.

The authorities and banks themselves recognise the importance of consumer education and have begun engaging in extensive programmes to that end. The image and reputation of the financial sector has been improving in recent years, while consumer knowledge of the availability of financial services has been increasing. The impact of the recent problems at leading broker Interbolsa, which led to its closure, affecting retail investors in particular, shows how fragile the sector’s hard-won reputation for financial integrity is.

STRONG INSTITUTIONS: Colombia has a unified financial regulatory system, with the Financial Superintendence of Colombia (Superintendencia Financiera de Colombia, SFC) tasked with overseeing all aspects of the sector, including banking, capital markets, insurance, pension funds and brokers. Established in 2005, the SFC is organised into 10 functioning departments, although moves are under way to migrate to a “risk supervision model” whereby all activities will be analysed and regulated according to the level of risk they entail. It is envisaged that the structure of the SFC will be altered to accommodate this shift, better positioning it to adequately supervise the activities of Colombia’s complex financial conglomerates. Eventually, this should facilitate the full implementation of the second pillar of the Basel II supervisory framework.

At a strategic level, the Coordination Committee for Financial Regulation brings the SFC together with the other key financial authorities: the central bank, the Ministry of Finance and the Fund of Guarantees of Financial Institutions (Fondo de Garantias de Instituciones Financieras, FOGAFIN), which is tasked with guaranteeing customer deposits and restructuring financial entities in difficulty. Acting by consensus, the coordination committee meets several times a year to set the regulatory agenda, monitor progress towards strategic objectives and manage crises. However, according to María Inés Agudelo, the executive director of FOGAFIN, the recent closure of Interbolsa was not an example of the last of these methods. “Interbolsa was not insured by our deposit insurance so it is not an example of how our mechanisms work. The regulator decided to directly enter the situation to liquidate the institution so as to pay back creditors,” Agudelo told OBG.

NEW INITIATIVES: Since 2012 a number of regulatory innovations pertaining to the financial sector have been implemented, some of which are due to external exigencies and others to developments in Colombia. In light of concerns about the rising proportion of nonperforming loans (NPLs), particularly in the consumer credit sector, in June 2012 the SFC introduced a form of precautionary provisioning whereby credit institutions are obliged to increase the amount of provisions set aside against NPLs in the non-mortgage consumer segment where NPL growth accelerates.

In July 2012 the government enacted Law No. 1555, eliminating penalty charges for early repayments of loans. The aim of this law is to improve consumer protection and increase competition by making it easier for consumers to switch between banks. Preparations are also under way, albeit at an early stage, across the financial sector and among the authorities to ensure Colombia meets its January 2015 target for final migration to International Financial Reporting Standards.

NEW CAPITAL STANDARDS: Perhaps the most important regulatory changes relate to the implementation of Basel III. To better monitor and mitigate liquidity risk, Colombian banks must now report and respect a new 30-day liquidity ratio, in addition to the existing sevenday ratio. The definition of what can be counted towards meeting liquidity requirements has also been tightened. Although implementation of Basel II is incomplete as of now, migration to Basel III is under way and entails fundamental changes to solvency ratios and capital classification. The government issued Decree No. 1771 in August 2012, stipulating that the new capital requirements regime would come into effect in August 2013.

This will initially apply to all credit entities, but subsequent extension to all relevant sectors is anticipated.

The minimum capital adequacy ratio will remain at 9%, of which a minimum of 4.5% must be high-quality core Tier 1 equity. The solvency of the banking system has been somewhat complemented to date by the inclusion of goodwill as a form of capital.

Newly generated goodwill is to be discounted from calculations under the new regime, while existing goodwill is to be amortised over a 14-year period. Voluntary reserves will be recognised as part of Tier 2 capital up to a maximum of 10% of total regulatory capital, but deferred tax assets and pension liabilities are to be discounted. These changes will leave the banks well capitalised, although not as handsomely as before.

CONTROLLING INTEREST RATES: Colombia operates a number of legally enforced interest rate ceilings, differentiated by lending segment. Previously at fixed rates, these interest rate ceilings became variable from end-2011 and have since been drifting upwards. The maximum rate is calculated as being 50% higher than the weighted average of commercially available borrowing rates in a given market segment. In practice, average interest rates in each lending segments are below the legal ceiling and have become increasingly so since early 2011 given the rise in the so-called usury rates.

These increases have been the most dramatic in the microcredit segment, where the interest rate ceiling has increased from just below 35% in early 2010 to 53.45% by January 2013. A change was also phased in to allow more flexibility in the charging of higher rates on microloans; rates 7.5% above the usury rate are now permitted in some circumstances. During this time, the average microcredit lending rate available on the market remained relatively stable – at just above 30% – before declining marginally towards the end of 2012 to stand at 28.34% in January 2013, or 25% below the usury rate.

Meanwhile, in the consumer lending segment, the average market interest rate was around 18.6% in February 2013, while the maximum usury rate stood at 31.1%.