Financial services, a large and important component of the service sector, included private financial institutions that facilitated business and individual loans, as well as public institutions that directed funds to socially desirable activities that might not meet the credit requirements of private banks. The government played a major role in the financial sector because of the unwillingness of banks to make long-term loan commitments to riskier programs, such as coal development, and because of the necessity for periodic public intervention to stabilize financial markets. Although the banking system grew in the 1960s and 1970s and was considered relatively modern, it entered a period of deep crisis in 1982, which forced the government to redefine the basic structure of the private financial system.

One problem was the banking sector's concentration of ownership in the hands of a few large conglomerates. This reduced competition and made lending a precariously balanced game in which funds were shuttled among the larger institutions.

The economic downturn of the early 1980s also threatened the profitability of banking. Colombian financial institutions came under increasing pressure as the 1981 recession induced retrenchment of the manufacturing sector. This, in turn, caused a sharp rise in loan defaults. Real interest rates at the time averaged 10 to 12 percent, which exacerbated the payment problems of indebted companies. The number of loans considered unlikely to be collected as a percentage of the lending portfolio increased from 5.6 percent in 1982 to 11.3 percent in 1984. Foreign interests in Colombian banks also began to withdraw capital rather than deposit it, which further drained reserves necessary to meet regulatory requirements. Subsequent bank failures and nationalizations resulted in a decline in public confidence and led to massive government intervention.

In an effort to increase liquidity, the government reduced reserve requirements for certain types of deposits and shifted public funds into the financial system. In 1985 the government created the Financial Institutions Guarantee Fund (Fondo de Garantías de Instituciones Financieras) as the authority responsible for intervening in or recapitalizing, if necessary, financial institutions on the brink of bankruptcy. Despite these efforts, the government was forced to nationalize banks as they approached insolvency. Eighty percent of the Colombian financial industry had come under government control through this mean by the mid-1980s.

Notwithstanding increased government supervision, a large infusion of public capital, and improved economic conditions, the remaining private financial institutions continued to flounder in the late 1980s. Because of high inflation and unstable real interest rates, most depositors placed their money in readily accessible accounts such as checking accounts or short-term certificates of deposit. This constrained lending strategies, because larger portions of loan portfolios now had to be constructed with short-term arrangements in mind. Much of the longterm credit for mortgages and business investment had to be secured through the central bank or any one of the many government-operated development funds.

By 1988 the financial sector's problems appeared to go beyond a difficulty with short-term liquidity. Ownership remained highly concentrated, and inflation continued to increase the cost of transactions. An inadequate capital base, gross management inefficiencies, and high operating costs were other persistent problems. Loan defaults also occurred at alarming rates. To compensate, the government provided credit directly through public financial institutions financed with public funds or by forced investment from businesses and pension funds. These financial entities included the Institute of Industrial Development (Instituto de Fomento Industrial--IFI), the Land Credit Institute, and the Agrarian Bank; they served the long-term credit needs of industry, urban housing, agriculture, and other special interest groups.

Despite continuing doubts about the soundness of Colombia's banks, there were some signs that the financial sector was becoming more stable in 1988. Market interest rates began to fall, and the government used forced investment less frequently to attract lending funds. In addition, financial authorities planned to strengthen both the financial sector and the stock market by selling shares of the expropriated banks to small and medium-sized investors.

In 1988 the government announced plans to reprivatize the banking sector, beginning with the sale of the Bank of Bogotá (Banco de Bogotá). The government authorized the central bank to extend credits to the public that could be used to purchase shares of the expropriated bank. Restrictions were placed on the sale of the bank to avoid the ownership and management problems that had contributed to the institution's failure. Specifically, none of the previous owners were permitted to purchase bank shares, and no individual or family could acquire more than 3 percent or 10 percent, respectively, of any one bank. Authorities hoped that these measures would lead to other bank sales and return stability to a sector that was vital to the development of the national economy.

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Source: U.S. Library of Congress