Resilient market: Efforts to strengthen the system continue at home, while local players look to expand abroad

Largely shielded from the ill effects of the global financial crisis, Colombian banks have gone from strong to stronger. The sector is among the most stable and profitable in the region. Building on the solid domestic financial performances that have been seen in recent years, domestic institutions are increasingly looking towards regional expansion even as leading global banks are retrenching. At the same time, some international banking groups, particularly those from the Latin American region, are seeking footholds in the country. Accessing finance is often a struggle for firms and households alike, particularly smaller businesses and low-income families with little collateral. A third of the country’s adults still do not make use of any form of financial product, suggesting room for significant organic sector growth in the years to come. As Óscar Cabrera Izquierdo, the president of BBVA Colombia told OBG, “Colombia’s banking has an extremely bright future, particularly because the limitations of the banking system are so clearly defined, as in the case of underdeveloped infrastructure. It has yet to really come of age.”

REGULATION: Colombia has learned the lessons from its 1998-99 mortgage crisis. The banking sector is now characterised by strong supervision and relatively conservative lending policies. The country’s financial institutions are supervised by the Financial Superintendence of Colombia (Superintendencia Financiera de Colombia, SFC). Backed by a strong legal system, the SFC has effective operational independence and a broad regulatory remit that stretches across the whole financial sector. In addition to working towards the implementation of Basel II and Basel III requirements, Colombia is also in the process of full convergence to International Financial Reporting Standards by January 2015. Amid concerns of rapidly growing credit in early 2012, particularly in the consumer sector, the Banco de la República, the state-run central bank, engaged in a series of interest rate hikes. Having had the desired effect of restraining credit growth, the central bank reversed course in mid-2012, embarking on a rate-cutting cycle amid slowing economic growth and falling inflation. The main policy rate stood at 3.25% in March 2013, near record lows. The authorities also introduced counter-cyclical macroprudential policies, increasing the requirements for provisions against potential losses on consumer loans, for instance, where the rate of growth of nonperforming loans (NPLs) is accelerating.

FINANCIAL DEEPENING: Social structure, regulatory conservatism and a cultural aversion to excessive indebtedness following past financial crises have combined to make Colombia’s financial system relatively shallow by Latin American and wider emerging market standards. The legacy of the 1998-99 mortgage crisis was a half-decade of declining credit depth. Credit had fallen to 19.63% of GDP by 2003 before recovering, reaching the still comparatively low level of 37.75% of GDP by end-2012, which was up from 34.97% the previous year.

Since 2005, total assets in the financial system have expanded steadily from 89.32% of GDP to reach 136.04% of GDP by end-2012. Assets jumped from 119.83% of GDP during 2012 alone on the back of strong credit growth and a particularly impressive investment performance. Total investments across the financial system increased to 65.59% of GDP by end-2012, up from 56.43% a year earlier.

MARKET SIZE & STRUCTURE: What the Colombian financial sector may lack in size, it makes up for in terms of sophistication, boasting a wide variety of financial intermediaries. The mortgage crisis of the late 1990s gave rise to a degree of consolidation, particularly over the 2005-07 period. In 2001 there were 84 credit entities, of which 27 were banks. By 2007 this had fallen to 60, of which 16 were banks. After this time, there were a number of new market entrants, foreign and domestic. By the close of 2012 Colombia boasted 67 regulated credit entities, of which 23 were designated as banks.

LEADING BANKING GROUPS: Three large financial conglomerates dominate the banking landscape in Colombia: Grupo Aval, which owns Banco de Bogotá, Banco de Occidente, Banco Popular, Banco AV Villas as well as leading pension fund manager, Porvenir; Grupo Empresarial Antioqueño, major shareholder of Bancolombia, the top-ranked bank by assets; and Grupo Empresarial Bolívar, which owns Davivienda, ranked third by assets. Together, these three groups control 57.2% of the country’s banking assets.

FOREIGN PLAYERS: Although the banking sector is dominated by large, domestic conglomerates, there are few restrictions on foreign entrants and several leading global banks are represented in the sector. “Conditions are ripe for any investor to enter the country and indeed this is happening. Brazil’s BTG Pactual, Canada’s Scotiabank, Chile’s Corpbanca and Peru’s Banco de Crédito, to name a few, are already taking part in the Colombian financial market,” Carlos Raúl Yepes Jiménez, the president of Bancolombia, told OBG. “New foreign players have considerable scope for growth in the areas such as capital markets and mobile banking, for example.”

Recent years have seen a resurgence in foreign interest in the banking sector as well as a number of new entrants. Of the 16 banks operating in 2007, six were majority foreign-owned. By 2012, that was true of 10 of the 23 market players. In that year two new banks entered the market: Opportunity International, a Christian, non-profit-microfinance institution, opened a full service bank to serve people living in extreme poverty in Bogotá, while Brazilian bank Itaú BBA opened a subsidiary to engage in corporate lending and proprietary trading.

Foreign banks accounted for 24% of banking assets and 24% of bank loans at end-2012, ranking the country a little ahead of Brazil but significantly behind regional leaders Mexico, Peru and Chile in terms of foreign participation in the sector. In terms of lending portfolio quality and provisioning, foreign banks are almost identical to their domestic counterparts, but their solvency ratios generally tend to be several percentage points lower on average.

Indeed, the structure of the market makes it difficult for foreign entrants to compete successfully to earn a sizeable share of the market. “One of the greatest challenges facing foreign banks in Colombia is simply breaking into the arena against such wellestablished local players,” BBVA’s Cabrera told OBG. “Foreign banks have assumed the role of financiers. That is to say, they are not playing an industrial role but rather that of the financier.”

Despite these challenges, Spanish-headquartered BBVA has become the leading foreign bank, controlling 9% of assets and making it the fourth-largest bank in the country. Banco Santander, another Spanish player that held 3% of total banking assets, sold a 95% stake to Chilean CorpBanca for $1.155bn in 2012. Both BBVA Colombia and CorpBanca are subsidiaries that fund themselves primarily through Colombian retail deposits.

SOLID PERFORMANCE: With a return on assets (ROA) of 1.97% across all credit entities in 2012, albeit down from 2.1% in 2011, Colombia remains the leader of the pack in Latin America. Return on equity (ROE) of 13.56% also saw Colombia well placed among regional peers, although this measure was also down from 14.95% in 2011. These profitability indicators have, moreover, remained relatively stable since 2007, having turned negative in the early years of the century due to fallout from the mortgage crisis. With total profits at credit entities growing 4.83% to reach COP7.36trn ($4.42bn), 2012 proved to be the most profitable of the last 15 years.

Strong credit growth, rewarding investments and a wide, stable net interest margin of 7.5% are among the most important drivers of this above-par financial performance. Over the course of 2012, the sector’s aggregate gross financial margin increased by 17.75% to COP28.59trn ($17.15bn). Having contributed some 30% of that gross financial margin around the turn of the century, the net interest margin was contributing 60% of the total by year-end 2012. It is notable that Colombian banks have become more efficient over the past decade. Total administrative costs over total assets have fallen from just under 6.5% in early 2003 to reach 3.9% by January 2013. The cost-to-income efficiency ratio of the banking sector as a whole improved from 48.42% in 2011 to 46.29% in 2012, although this rate is still rather high when compared regionally.

That such robust profit generation comes despite banks’ middling efficiency, caps on lending rates, the presence of a financial transactions tax and compulsory, interest-free lending to the Agricultural Financing Fund, a state-sponsored fund aimed at rural and agricultural development – suggests that there is scope for improvements to profit margins.

RESILIENCE: Colombian credit entities are well capitalised with an aggregate capital adequacy ratio (CAR) of 16.01% at year-end 2012, significantly higher than the minimum required level of 9%. Capital adequacy has, moreover, improved year-on-year ( yo-y) since 2008, gradually rising from 13.58%. This continues a trend that was set in motion in the wake of the 1998-99 mortgage crisis, after which the banks suffered significant loan losses, necessitating a lengthy period of balance sheet repair. The 2012 increase came about as the 19.89% jump in capital outstripped the 11.6% rise in risk-weighted assets.

Colombian capital adequacy compares well with the CARs of its regional peers. This CAR currently flatters the sector given that it includes goodwill. Even if goodwill were excluded, the sector as a whole would still be capitalised at a significantly higher level than the minimum 9%. The government decreed in August 2012 that an even more robust capital regime would come into effect in August 2013. The minimum CAR will remain at 9%, but half of this must be Tier 1 equity, while newly generated goodwill is to be excluded from the calculations.

STAYING SELECTIVE: The IMF recently carried out a range of stress tests and found that all but three of the banks would remain above the minimum 9% capital threshold even in the event of a shock to GDP growth twice the magnitude experienced after the collapse of Lehman Brothers in 2008. Colombian banks have tended to be selective in allocating credit, generally concentrating on firms and households with sound balance sheets, thus reducing the rate of NPLs. However, this has given rise to a high degree of concentration in the banks’ lending portfolios, representing one of the most significant potential risks to systemic stability. For example, a full 90% of commercial loans are accounted for by only 7% of borrowers across the sector.

SHIFTING ASSET ALLOCATION: Some 43% of total assets in the financial system, or COP372.8trn ($223.7bn), are held by credit entities, whose assets increased by 16.1% in 2011, moderating to 11.72% growth in 2012. From 2000 to 2006, the credit entities’ investment portfolios grew at a faster rate than their loan portfolios, as loans were written down and credit growth was limited in the wake of the mortgage crisis. Subsequently, as credit growth recovered, there has been a moderate rebalancing in favour of loan portfolios. However, a strong performance by domestic capital markets during 2012 has seen acceleration in the growth of investment portfolios, which grew by 10.67% over the course of the year, as credit growth has slowed somewhat. At end-2012 63.48% of credit entities’ assets were accounted for by loan portfolios, with investments making up a further 19.46%. Some 60% of those investment portfolios consist of sovereign bonds, a proportion that has remained relatively steady over the past decade.

Having peaked at nearly 30% y-o-y in the first half of 2011, credit growth had slowed to a more modest 12.9% by January 2013. This aggregate masks a wide divergence in growth rates in different lending segments, although all followed a similar pattern of declining growth over the course of 2012.

However, commercial credit was growing at a real annual rate of only 10.8% in the year to the end of January 2013, contributing more than half of all credit growth in the economy due to its overwhelming size. The consumer, microcredit and mortgage lending segments remained relatively dynamic, with real annual growth rates of 14.8%, 18% and 20.8%, respectively. Consumer credit accounted for a little less than a third of total extra credit in the year to January 2013, but despite their relatively higher growth rates, the microcredit and mortgage segments contributed only 3.9% and 12.4%, respectively, of all extra credit in the economy over the same period, due to their relatively lower bases.

NPLS & PROVISIONS: Standing at 2.79% at endJanuary 2013, the rate of NPLs was relatively low by historical standards, but their rate of growth was a source of some concern. Credit growth had moderated to 12.9% by January 2013, but NPLs were rising at an annual rate of 27.6%. While this rate of increase in NPLs was still significantly lower than the rate above 80% that was achieved in early 1999 at the height of the mortgage crisis and above the 40% that was seen in early 2008 on the eve of the global financial crisis, authorities were monitoring it closely. Increased provisions against potential losses were mandated in certain lending segments. At 5.03% and 4.7%, NPLs were higher than average in the microcredit and consumer segments, but stood at 1.83% and 2.35% in the commercial and mortgagelending segments, respectively, at the end of January 2013. Growth in NPLs was accelerating for all lending segments, and reached 28%, 28.2% and 52.7% in the commercial, consumer and microcredit segments, respectively, in January 2013.

By end-2012, provisions against potential loan losses had reached COP11.43trn ($6.86bn), against NPLs in the amount of COP7.04trn ($4.22bn), indicating a coverage ratio of 162%. This figure masks a divergence in the coverage ratio between the commercial (200.9%) and consumer (137.3%) lending segments. The distribution of NPLs has also changed dramatically since 2004, albeit largely in line with changes in the underlying composition of lending portfolios. Whereas more than 60% of NPLs had related to mortgage loans in 2004 with only 10% accounted for by consumer credit, this position reversed itself within three to four years. By end-2012 48.27% of NPLs were in non-mortgage consumer credit, 40.07% were in commercial credit, less than 10% was in mortgage lending and a small but growing proportion was in microcredits.

MORTGAGE LENDING: The composition of credit entities’ loan portfolios has changed somewhat since the mortgage crisis. Mortgage lending, which had reached nearly 30% of all outstanding credit by the turn of the century, declined dramatically and now accounts for roughly 10% of all credit. The mortgage lending segment is further sub-segmented in two: loans that attract a subsidy so as to ensure that national housing policy objectives are met – categorised as Social Interest Housing, (Vivienda de Interés Social, VIS) – which accounted for 37% of the total by year-end 2012 – and the remainder. Given the maximum loan-to-value ratio of 70% mandated by the government in the aftermath of the mortgage crisis, a 30% down payment on a home is often beyond the reach of those on very low incomes. For a typical VIS mortgage, the bank would lend 65% of the value, the consumer would provide a 15% down payment and a government subsidy would make up the remaining 20%. Given that they are more responsive to market signals, non-VIS loan growth tends to be more volatile. In early 2011, for instance, real annual mortgage lending growth peaked at 25%, but this hides the fact that the respective peaks for VIS and non-VIS loans were roughly 15% and 40%.

DEFAULTS & DEBT: In the wake of the mortgage crisis, NPLs in the mortgage segment peaked at over 20% in 2002-03 before declining dramatically towards their long-term average of less than 5%. NPLs in the mortgage segment greatly outstripped provisions until the gap narrowed significantly in 2005, and the latter has broadly tracked the former since. There is some concern about the possibility of an incipient house price bubble, particularly in Bogotá where land that can be built upon is relatively scarce. In general, Colombian households do not carry a heavy debt burden. Gross household debt (consisting of consumer and mortgage debt) accounted for 12.9% of GDP by end-2012 and was expected to rise to 13.8% by end-2013, while debt service costs accounted for only 15% of citizens’ salaries on average.

COMMERCIAL CREDIT: With the share of mortgage lending having declined, micro-lending, and commercial and consumer lending have taken up the slack. Commercial credit is the largest lending segment in Colombia, accounting for almost 60% of the total outstanding at the end of 2012. This was up from just over 50% at the turn of the century, but it has declined moderately in recent years as consumer lending has taken off. As a percentage of GDP, commercial credit has doubled over the past decade from around 10% in the early years of the century to 19.9% by the end of February 2012. It is expected to rise to 20.8% of GDP by the same time in 2014.

As one would expect, this has led to increasing indebtedness among Colombian firms, although not to levels that are historically high or a source for immediate concern. Businesses had liabilities amounting to nearly 48% of assets at the peak of the country’s last financial crisis in 1999. This had fallen below 37% by 2004 before resuming a slow, steady march to its current level just above 42% on the back of strong credit growth to this segment. A little less than a fifth of firms’ liabilities and 7.9% of companies’ assets are accounted for by financial obligations. NPLs are traditionally lowest in the commercial lending segment and were running near historic lows at 1.83% in January 2013.

CONSUMER CREDIT: Credit growth has been particularly strong in the consumer segment in recent years, giving rise to fears that the debt burden could become unsustainable. With the onset of the mortgage crisis in the late 1990s, non-mortgage consumer credit also took a hit, and it would be several years before it returned to positive growth. However, from 2003 onwards lending to this segment accelerated, growth peaking at more than 30% in 2007. The subsequent onset of the global financial crisis took its toll, with consumer credit growth almost coming to a standstill in 2009, before re-accelerating in 2010 and 2011, and then moderating through 2012 as tighter monetary policy had the desired effect.

This pattern was continued, albeit with a lag, by NPLs. The y-o-y growth of consumer credit NPLs peaked in 2008 at more than 60% before declining dramatically, turning negative in 2010 and the beginning of 2011. However, following the strong consumer borrowing during the period, it was not long before NPLs were again on the rise, growing by upwards of 20% through 2012, even as lending growth slowed. Historically, provisions against NPLs in this segment tracked but did not exceed NPL levels. This changed in 2010 as the SFC pushed banks to adopt a more conservative provisioning policy for their consumer credit portfolios that would be sufficient to cover any deterioration in credit quality.

The distribution of consumer credit sub-segments has remained relatively stable over the past four years, with the exception of a shift in the balance between libranza loans (in which a worker with a credit from a third party is authorised to withhold a portion of wages from his or her employer, which is transferred to the bank) and libre inversión loans (a loan that is designed to serve multiple purposes). By the end of 2012 their shares of the consumer credit portfolio stood at 33% and 24%, respectively, a reversal in their positions of the four previous years. Overall, the consumer segment accounted for 29% of all lending in Colombia and 72% of all borrowers.

Recent years have seen an influx of retailers providing credit cards. Chilean retailer Falabella and the ubiquitous Colombian retailer Éxito have been key players behind this phenomenon. While this segment has been identified as an important growth opportunity, the authorities have been monitoring developments closely for fear of an unsustainable rise in consumer debt. They require, for instance, that all such credit cards be provided by, or in partnership with, a Colombian financial institution.

MOBILE BANKING: Unlike banking services, the mobile phone market in Colombia is characterised by high penetration, suggesting that there may be scope for mobile banking to significantly broaden access to financial services. This market segment is still in its infancy, but Banco Davivienda has already built a commanding presence while Bancolombia launched a new mobile banking service in early 2013.

MICROCREDIT: From a relatively low base, microlending has increasingly become a feature of Colombia’s financial landscape over the past 10 years. At the end of 2012, total microcredit outstanding was at COP7.13trn ($4.28bn), 68% of which was accounted for by loans equating to less than 25 times the legal monthly minimum wage, and the remainder relating to loans of up to 120 times the legal monthly minimum wage. Although the latter is the smaller sub-segment, it has been growing faster, with real annual growth rates upwards of 40% through 2011, before moderating towards 20% by end-2012.

During the first half of 2012, as monetary policy tightened, real annual credit growth in the microcredit segment as a whole dropped from more than 30% to less than 20%, and it remained relatively steady through year-end. However, rather worryingly, growth in NPLs began to accelerate towards the end of 2012, with total microcredit NPLs threatening to outpace total provisions. Overall, microcredit NPLs have remained relatively stable, at less than 10% of the total portfolio over the past decade.

FUNDING: Historically, customer deposits have been the primary source of funding for lending institutions, and these provided some 70% of funding by the end of 2012. At 15.49% in 2012, growth in customer deposits at Colombian credit entities was relatively robust and in line with credit growth. The distribution of deposits by type has remained relatively constant since the turn of the century, with demand deposits accounting for the largest proportion at the end of 2012, accounting for 46.19% of the total after having grown by 12.56% over the course of the year. Fixed-term deposits were next, accounting for 34.07%, with current accounts making up a further 16.54% and other forms of deposits at 3.06%. Leading Colombian banks have recently sought to capitalise on record-low interest rates and strong appetite for Colombian assets to raise debt on international markets. In the first three quarters of 2012, they sold $3.55bn worth of bonds – more than was raised from 1999 to 2011 combined. Although this represents a cheap form of funding in the current environment, it also increases the banks’ exposure to currency and refinancing risks.

INVESTMENT DESTINATION: A combination of strong domestic economic growth, loose monetary policies in the leading developed economies and attractive opportunities to profit from extracting natural resources have helped make Colombia an attractive destination for inward investment. In turn, these capital flows have caused the currency to rise in value, undermining national competitiveness. It is expected that looser monetary policy, combined with increased intervention by the central bank in the currency market, will serve to counteract this appreciation in the near term. Indeed, risks of a sudden reversal in capital flows are limited by the fact that only a fifth of capital inflows are accounted for by portfolio investments, the vast bulk coming from foreign direct investments, which reached a record $16.7bn in 2012.

To guard against a currency mismatch between assets and liabilities, financial entities will be looking to hedge their currency exposure and keep a minimum level of 5% of liquid assets in dollars at all times. The authorities’ caution on such foreign exchange risks is an example of their having learned from past financial crises, in Colombia and other countries, where overexposure to dollar-denominated liabilities has exacerbated underlying financial sector weaknesses in times of crisis.

FIGHTING MONEY LAUNDERING: Colombians are justifiably proud of their rigorous system for combating money laundering and the financing of terrorism. A dedicated unit within the Ministry of Finance tasked with investigating all suspect transactions, imposed a total of 52 anti-money laundering sanctions between January 2006 and March 2013.

OUTLOOK: Colombian banks are resilient and subject to stringent regulation. The authorities are now taking steps to further strengthen the integrity of the system. They have developed a comprehensive model to combat money laundering and the financing of terrorism, a model that could be applied elsewhere in the region and beyond. New innovations in mobile banking and the regional expansion by Colombian banks will likely bring new regulatory challenges, but none that should prove beyond the capabilities of the authorities.