Colombia - Financial Sector Adjustment Loan Project

Report No. PID7856 Project Name Colombia-Financial Sector Adjustment Loan Region Latin America and the Caribbean Sector Finance Program Objective Category Economic Adjustment Project ID COPA63643 Borrower Republic of Colombia Implementing Agencies Ministry of Finance, Central Bank, Superintendency of Banks, FOGAFIN (deposit insurance and bank resolution agency) Date PID Revised May 10, 1999 Project Appraisal Date March 6, 1999 Project Board Date September 1999 Background The Colombian banking system has historically developed under the specialized banking model, with functions divided between commercial banks, financial corporations , trade finance companies, savings and loans associations, and a cooperatives sector. Following a significant turmoil in the mid-1980's that led to closing and restructuring of some major financial institutions, the sector has benefited from considerable improvements in the prudential regulations, strengthened supervision, and positive rates of economic growth. .A Banking Law approved in 1990 laid the basis for longer term improvements, incorporating significant liberalization of the operations of the different types of financial institutions, decreasing credit subsidies and forced investment requirements, reducing financial system segmentation, and thus increasing competition. Benefiting from these improvements, by the mid- 1990s, the financial system had largely recuperated its solvency and stability. There has, however, been a considerable deterioration of the situation over the last 12 months. The round of turbulence and volatility in international capital flows which affected most emerging economies in 1998 following the financial crises in East Asia and Russia, including the resulting withdrawal of international commercial lending from Latin America, and the austerity measures Colombia has taken to counteract these, have notably weakened the system. Most importantly, interest rates rose and stayed at extraordinary levels of 15-25% in real terms over much of the last 12-month period, stretching the payment capacity of even the healthiest companies and individual borrowers in the economy. Damage inflicted by a major earthquake in the coffee growing region in early 1999 further strained Colombia's economy and parts of the financial system The overall impact on some parts of the system, such as the cooperatives, institutions engaged in housing and construction finance, and the smaller trade and financial institutions has been particularly severe. Reflecting this, reported arrears in the loan portfolio of the total banking system have grown sharply over the last year. Against this background, it is now  imperative for Colombia to further strengthen its monitoring and supervision of the banking system, and put in place a modern deposit insurance and problem bank resolution mechanism as a basis to overcome the structural fragilities identified in the system and facilitate a healthy longer term development of the financial sector. Project Description A $500 million FSAL is proposed to support a comprehensive program of financial sector reform being coordinated by the Government of Colombia. The loan is expected to be presented to the Board in FY00, and is proposed to be disbursed in two tranches. Disbursement of the proceeds would take place on the basis of an agreed "negative list". Among the main program objectives are: (i) to support required changes in financial sector legislation and regulations to facilitate strengthening of bank supervision and deposit insurance and promote timely, fair and efficient resolution of banks facing financial solvency problems; (ii) institutional strengthening of the bank supervision agency and FOGAFIN, the entity responsible for deposit insurance and bank resolution; (iii) restructuring recapitalization, privatization and, if necessary, liquidation of state owned and "officialized" banks currently under public sector management; (iv) help effective implementation of emergency measures to address the immediate impact on the financial system stemming from macro-economic, international market and related problems. The Inter-American Development Bank (IDB) and Corporation Andine de Fomento (CAF) are also expected to provide complementary financing to support the financial sector reform program. Environment and Resettlement Aspects No environmental or resettlement issues are raised by the proposed financial sector reform program. Contact Information: Krishna Challa Task Manager (202) 473-0133 The InfoShop The World Bank 1818 H Street, N.W. Washington D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 Note: This is information on an evolving project. Certain activities and/or components may not be included in the final project. Processed by the InfoShop week ending June 18, 1999. - 2 -