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 1

2 Market Share 1/ 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 Number of Institutions 2/ ’s 1940’s1945’s1950’s1990’s2000’s / On assets 2/ Additionally there are five 2nd-tier public financial institutions, created in the 1980’s and 1990’s, that still remain today

Loans and Deposits US$ Billions ROE, NPL/Total Loans % The economic slow down at the end of the 1990’s considerably deteriorated the financial system... 3 D-96D-01D-97D-98D-99D-00 Loans Deposits Return on equity Non performing loans / total D-96D-01D-97D-98D-99D-00

.. and publics banks were the most affected during the crisis Private Banks Public Banks 9% Minimum Required D-97D-98D-99D-00 Capital Adequacy Ratio % D-97D-98D-99 D-00 Non-Performing Loans / Total Loans % 4 D-97D-98D-99 D-00 Net Income 1/ 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 Recoveries D-03 Net cost D-03 Public Banks Mortgage Borrowers Private Banks Credit Unions Total Cost Financial Crisis Cost US$ Billions 1/, % 5 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” 6

History Current Situation Banco Agrario: a successful example? Lessons AGENDA 7

December 1995June 2004 Public Banks’ reduction %, Number 8 As a consecuence, public sector participation in the financial system has declined to 15% of total system assets Employees Branches Institutions Market Share 1/ 20%15% 1/ On assets

Their performance indicators have reached those of private banks Interest-earning assets / Interest-bearing liabilities Performance Indicators % D-01D-02D-03D-04 9 Efficiency ratio D-01D-02D-03D-04 % NPL’s D-01D-02D-03D-04 Interest-earning assets / interest-bearing liabilities D-01D-02D-03D-04 Efficiency ratio D-01D-02D-03D-04 % NPL’s D-01D-02D-03D-04 Private Banks Public Banks

Net income US$ millions However, their net income has increased substantially less than that of private banks Private Banks Public Banks D-01D D-03D times 3.3 times Net income Growth

History Current Situation Banco Agrario: a successful example? Lessons AGENDA 11

Asset Composition 2/ – Banco Agrario US$ 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 12 Net LoansInvest. Securities OtherTotal assetsDepositsOther Liabilities Shareholders’ Equity 1/ An Institution created in 1931 to promote credit to the agricultural sector 2/ 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 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 13 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 14 # of branches # of towns reached Banco Agrario Private Competitor Public Competitor Rural Branches 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 15 Net income US$ millions D-01D-02D-03D-04 D-00 ROA % D-01D-02D-03D-04 D-00 NPL’s % D-01D-02D-03D-04 D-00 Efficiency ratio % D-01D-02D-03D-04 D-00

Challenges – Banco Agrario However, its recent success can be threatened by vulnerable governance structure 16 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 17

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 18

THE ROLE OF PUBLIC BANKS IN COLOMBIA Washington, February 25th. of 2005 DEPOSIT INSURANCE AND BANK RESTRUCTURING AGENCY