CAN PUBLIC BANKS WORK (IN COLOMBIA)?

1. DEPOSIT INSURANCE AND BANK RESTRUCTURING AGENCY • CAN PUBLIC BANKS WORK (IN COLOMBIA)? Washington, February 25th. of 2005

2. AGENDA History Current Situation Banco Agrario: a successful example? Lessons 1

3. 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% Market Share1/ of public banks in Colombia %, number 1940’s 1945’s 1950’s 1990’s 2000’s 1935’s Number of Institutions2/ 3 5 5 8 13 5 1/ On assets 2/ Additionally there are five 2nd-tier public financial institutions, created in the 1980’s and 1990’s, that still remain today 2 Source: Special Report from “Contraloria General de la República de Colombia”, Superintendencia Bancaria, Analysis Fogafín

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

5. .. and publics banks were the most affected during the crisis Non-Performing Loans / Total Loans % Private Banks Public Banks Capital Adequacy Ratio % D-97 D-98 D-99 D-00 Net Income1/ US$ millions 9% Minimum Required D-97 D-98 D-99 D-00 D-97 D-98 D-99 D-00 4 1/ Cumulative D-97 to D-00

6. Althoughpublic banks accounted for only 18% of total assets in 1999, they represented 60% of the crisis cost Financial Crisis Cost US$ Billions1/, % 4% of 2002 GDP Public Banks Mortgage Borrowers Private Banks Credit Unions Total Cost Recoveries D-03 Net cost D-03 5 1/ Calculated with 2002 average exchange rate

7. The intensity with which the financial crisis affected the public banks revealed their weaknesses State-owned banks’ weaknesses • 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. Internal • 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”. External 6 Source: Fogafín, Special Report from “Contraloría General de la República de Colombia”

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

9. As a consecuence, public sector participation in the financial system has declined to 15% of total system assets Public Banks’ reduction %, Number December 1995 June 2004 Market Share1/ 20% 15% Institutions 13 5 Employees 23.283 10.511 Branches 1.593 1.105 8 1/ On assets

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

11. 918 515 286 187 129 106 81 -80 D-01 D-02 D-03 D-04 However, their net income has increased substantially less than that of private banks Public Banks Net income US$ millions Private Banks Net income Growth 7.0 times 3.3 times 10

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

13. 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 Asset Composition2/ – Banco Agrario US$ millions Relevant Data • The 5th. largest bank in the system • 709 branches • 4.102 employees • Almost 3 million deposit accounts • 83% of its total loans went to finance agricultural sector in 2004 Invest. Securities Net Loans Other Total assets Rediscount Deposits Other Liabilities Shareholders’ Equity 1/ An Institution created in 1931 to promote credit to the agricultural sector 2/ December 2004 12

14. 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 • 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 Law • 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 Charters • 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 Internal Policies 13

15. 709 368 236 Banco Agrario Private Competitor Public Competitor 687 124 153 Banco Agrario Private Competitor Public Competitor Banco Agrario has the largest network of banking agencies: 709 branches of which more than 71% are in rural areas Banking Agencies – Banco Agrario # of branches # of towns reached Rural Branches • 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 14

16. 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 Net income US$ millions ROA % D-01 D-02 D-03 D-04 D-00 D-01 D-02 D-03 D-04 D-00 NPL’s % Efficiency ratio % D-01 D-02 D-03 D-04 D-00 D-01 D-02 D-03 D-04 D-00 15

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

18. AGENDA History Current Situation Banco Agrario: a successful example? Lessons 17

19. 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

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