SFC - Key Attributes of Effective Resolution Regimes for Financial Institutions

COLOMBIA

PILOT OF THE DRAFT ASSESSMENT METHODOLOGY

DETAILED ASSESSMENT OF OBSERVANCE

KEY ATTRIBUTES OF EFFECTIVE

RESOLUTION REGIMES FOR FINANCIAL

INSTITUTIONS

Financial Stability Board International Monetary Fund The World Bank

February 2016COLOMBIA

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CONTENTS

GLOSSARY __________________________________________________________________________________________ 3

EXECUTIVE SUMMARY ___________________________________________________________________________ 4

INTRODUCTION __________________________________________________________________________________ 8

A. Background _____________________________________________________________________________________ 8

B. Institutional Setting and Market Infrastructure __________________________________________________ 9

C. Review of Preconditions _______________________________________________________________________ 13

RECOMMENDED ACTIONS AND THE AUTHORITIES' RESPONSE ____________________________ 62

A. Action Plan ____________________________________________________________________________________ 62

B. Authorities Response __________________________________________________________________________ 68

TABLES

1. Detailed Assessment Report ___________________________________________________________________ 17

2. Recommended Actions ________________________________________________________________________ 65

BOX

1. Mixed Conglomerates—Implications for Bank Resolution _____________________________________ 12COLOMBIA

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Glossary AM Assessment methodology BR Colombian central bank ( Banco de la República) CCSBSO Central American Council of Banking Supervisors ( Consejo Centraoamericano de Supervisores Bancarios, de Seguros y de Otras Instituciones Financieras) CCSSF Financial Sector Coordinati on and Monitoring Committee (Comité de Coordinación y Seguimiento del Sistema Financiero ) DL Decree Law EC Essential Criteria EOSF Organic Statute of the Financial System (Estatuto Orgánico del Sistema Financiero) FMI Financial market infrastructure FOGACOOP Deposit insurance fund for cooperative institutions (Fondo de Garantías de Entidades Cooperativas )

DL Decree Law EC Essential Criteria EOSF Organic Statute of the Financial System (Estatuto Orgánico del Sistema Financiero) FMI Financial market infrastructure FOGACOOP Deposit insurance fund for cooperative institutions (Fondo de Garantías de Entidades Cooperativas ) FOGAFIN Deposit insurance fund for financial institutions (Fondo de Garantías de Instituciones Financieras ) FSAP Financial Sector Assessment Program FSB Financial Stability Board G-SIFI Global systemically important financial institution IMF International Monetary Fund ISDA International Swaps and Derivatives Association KA Key Attributes of Effective Resolu tion Regimes for Financial Institutions MHCP Ministry of Finance ( Ministerio de Hacienda y Crédito Público) MOU Memorandum of understanding OTC Over-the-counter financial contracts P&A Purchase and assumption SES Superintendency of the solidary economy (Superintendencia de la Economía Solidaria ) SFC Superintendency of financial institutions ( Superintendencia Financiera de Colombia) SIFI Systemically import ant financial institution SSoc Superintendency of corporations ( Superintendencia de Sociedades) URF Financial Regulation Agency ( Unidad de Regulación Financiera)COLOMBIA

4 INTERNATIONAL MONETARY FUND EXECUTIVE SUMMARY The Colombian authorities have strong powers to manage weak and failing financial institutions, and a track record of using them. While there have not been any failures of banks or institutions of systemic importance for many years, the failures of several non-bank financial institutions important in their subsectors, and many smaller institutions, have been managed effectively. While not without passing controversy, the authorities have been able to manage these events in an orderly and efficient way, without adverse consequences for financial stability, and without putting public funds at risk.

Colombia’s resolution regime, however, has shortcomings with respect to the standards set in the Key Attributes (KA). Important resolution powers are not available to the authorities, the regime does not emphasize minimizing the exposure of taxpayers to loss, and taking resolution

without putting public funds at risk.

Colombia’s resolution regime, however, has shortcomings with respect to the standards set in the Key Attributes (KA). Important resolution powers are not available to the authorities, the regime does not emphasize minimizing the exposure of taxpayers to loss, and taking resolution actions does not hinge on an assessment of non-viability. While weak, failing and insolvent financial institutions are subject to administrative powers that share features with those described in the KAs, and the authorities’ objectives to preserve financial stability are similar, the regime is premised on timely intervention to forestall triggering an official takeover of the firm, rather than resolution as considered in the KAs. There are no requirements for, and few tools enabling, the imposition of losses on the shareholders responsible for the institution’s failure, or the avoidance of taxpayer exposure to loss or unwarranted protection of unsecured and uninsured creditors. Rather, the Colombian regime seeks to minimize financial stability risks by avoiding failures of systemic financial firms where possible, firstly through shareholder action under threat of official takeover, but also through the use of public or deposit insurance funds. In this sense, while the Colombian framework has some of the features needed for orderly resolution, it falls short of the KAs’ other central objective of avoiding bail-outs of shareholders and unsecured and uninsured creditors.

Colombia has a large and diversified financial system compared with peer countries, with significant cross-border institutions and large mixed function conglomerates. The four largest banking groups are considered systemic, and account for over 70 percent of banking assets. Of these four groups, the top three are domestic and privately owned, while the fourth is foreignowned and, at the time of writing, part of a global systemically important institution (G-SIFI) following a multiple point of entry resolution strategy. Two other G-SIFIs have a smaller presence in Colombia, which is not the home jurisdiction of any G-SIFIs. The three largest domestically-owned banking groups are regionally systemic financial institutions in Central America, with subsidiaries that are materially important for the groups, and systemically important for the host jurisdictions.

Colombia, which is not the home jurisdiction of any G-SIFIs. The three largest domestically-owned banking groups are regionally systemic financial institutions in Central America, with subsidiaries that are materially important for the groups, and systemically important for the host jurisdictions. These large groups are part of mixed-function conglomerates, with significant financial interests besides banking (organized under separate controlling entities, including nonfinancial holding companies), and common ownership with large real sector operations across a wide range of economic activities.

This context informed the assessment of the KAs. While the absence of non-viability triggers for resolution or a focus on the protection of public and deposit insurance funds constitute differencesCOLOMBIA INTERNATIONAL MONETARY FUND 5 between the Colombian regime and the KAs that were reflected in the assessment, due weight was given to the authorities’ ability to ensure orderly outcomes in the economic and financial circumstances in which their resolution powers are exercised. The Colombian banking system is overwhelmingly deposit-funded, interconnectedness is assessed as low by the authorities, and there are no markets in many complex financial products. Some of the provisions of the KAs are less relevant in this context. A number of the essential criteria in the draft assessment methodology relating to KAs 8, 9 and 10 are relevant only with respect to G-SIFIs, and thus were not assessed (although some of the substantive points would appear equally relevant for regionally or domestically systemic institutions). Finally, the absence of some powers or provisions in the law, implied that other aspects of the KAs were not relevant or not applicable. As this pilot assessment was undertaken with a draft methodology that is subject to change, implying that grades would not be comparable, these were not given.

The scope and applicability of resolution powers, and the authority to apply them, are clear and extend to all banks and systemically important financial companies (KAs 1 and 2). The regime covers a broad spectrum of financial entities, including all systemically important banks, but does not extend to holding companies (either for the financial part or the overall conglomerate).

and extend to all banks and systemically important financial companies (KAs 1 and 2). The regime covers a broad spectrum of financial entities, including all systemically important banks, but does not extend to holding companies (either for the financial part or the overall conglomerate). While the scope of the powers and responsibilities of different agencies is defined, there is no clear lead authority for resolution of conglomerates including nonfinancial firms (notably holding companies). While this raises the potential that resolution could be impeded, the regulatory requirement to organize financial and nonfinancial activities separately within a group is a mitigating factor in the Colombian context. Resolution authority for financial firms is clearly delegated to the financial superintendency (SFC), while FOGAFIN has a consultative or specific operational roles in the execution of some resolution tools. The resolution authority is operationally and financially independent, and has shown capacity to make resolution decisions on a technical basis. Recent reforms established a fixed term of four years for superintendents, with early termination requiring public justification. Nonetheless, formal safeguards and protections of that independence could be strengthened further to ensure freedom from political or industry influence is maintained, especially if more complex situations were to arise.

While the SFC can apply a range of preventive measures and take control of a troubled firm, its ability to employ resolution powers by overriding shareholders’ consent is limited (KA3). The SFC can take control of the business and property of an institution upon a wide range of triggers, although these are not specifically based on the institution’s non-viability. The SFC can also apply preventive measures—such as an order to raise capital or to transfer assets and liabilities— aimed at rescuing an institution. These measures enable the SFC to exercise pressure on banks’ shareholders and management, since failure to comply with the SFC orders will lead to takeover and control. However, the SFC cannot transfer assets and liabilities to a private sector buyer or a bridge bank through directly binding powers that explicitly override shareholders’ consent (and allocate losses to shareholders and creditors) in the public interest. Transfer powers affect shareholders’

control. However, the SFC cannot transfer assets and liabilities to a private sector buyer or a bridge bank through directly binding powers that explicitly override shareholders’ consent (and allocate losses to shareholders and creditors) in the public interest. Transfer powers affect shareholders’ economic and governance rights, altering fundamental competences under corporate law, hence the need for an explicit override of shareholder consent. Under the current framework, it is unclear what would happen if shareholders did not consent to such intrusive orders, potentially leaving theCOLOMBIA 6 INTERNATIONAL MONETARY FUND authorities with few options beyond liquidation or nationalization. Introducing effective transfer powers (such as purchase and assumption and bridge bank) is a key reform that would give the authorities a powerful tool for preserving financial stability and confidence in resolution, while minimizing fiscal costs or outlays from the deposit insurance fund. Introducing an assessment of non-viability, based on clear criteria, as a trigger for resolution would enable timely action, minimizing disruption and economic losses. Finally, the legal framework should foresee speedier pay-out of insured deposits, within seven working days, to better ensure financial stability is preserved.

The legal framework does not include the stays and legal safeguards used in connection with resolution powers (KAs 4 and 5). Rights to terminate financial contracts early, triggered by takeover actions or other forms of intervention, cannot be stayed. However, it is not clear that powers to impose a temporary stay are immediately needed considering the resolution tools currently available. Similarly, the lack of effective transfer powers reduces the need for the legal safeguards that are appropriate where creditors of the same class are treated differently as a result of a partial transfer of assets and liabilities. If the framework is revised to allow transfer of selected assets and liabilities, a stay power would be highly desirable to support their effective use, and appropriate legal safeguards will be needed. Similarly, introducing safeguards to ensure that creditors are not left worse off in resolution than they would be in liquidation would become important once such powers have been adopted.

There are few constraints on the use of public funds in resolution (KA6). Resolution funding is

appropriate legal safeguards will be needed. Similarly, introducing safeguards to ensure that creditors are not left worse off in resolution than they would be in liquidation would become important once such powers have been adopted.

There are few constraints on the use of public funds in resolution (KA6). Resolution funding is provided through the deposit insurance reserve, which is privately funded by the industry ex ante, with possible recourse to borrowing, or public resources should the fund be depleted. The obstacles to the use of public funds in resolution are not onerous, and there are no provisions requiring that shareholders or unsecured and uninsured creditors absorb losses before resolution funding is provided, including through measures that would effectively bail-out these shareholders and creditors, protecting them from loss. There is no requirement or mechanism for the recovery of losses incurred in the provision of public funding from the industry.

The SFC can coordinate with other jurisdictions, and has agreed supervisory memoranda of understanding with home and host jurisdictions important for Colombia (KAs 7, 8 and 9). However, no cross-border cooperation or coordination mechanisms focused on resolution strategies exist. Although Colombia is a host jurisdiction for three G-SIFIs, the authorities have not been invited to participate in a crisis management group or enter into a cooperative arrangement. There are no provisions for the recognition of actions taken by foreign resolution authorities, or any specific provisions regarding support for such resolution measures. A foreign resolution action would lead to consideration of whether and what actions would be appropriate by the Colombian authorities. While there are no impediments to taking supportive actions, not all resolution measures are available (e.g. bail-in, transfer of assets to another firm or stays on termination rights in some financial contracts), and such measures taken by foreign authorities could not be given effect in Colombia. Nevertheless, given the current structure of the Colombian market, the limitedCOLOMBIA INTERNATIONAL MONETARY FUND 7 mechanisms available to support foreign resolution measures appear adequate to enable orderly implementation of foreign resolution actions in most circumstances.

Recovery and resolution planning are absent, and are a priority reform area (KAs 10, 11, and

INTERNATIONAL MONETARY FUND 7 mechanisms available to support foreign resolution measures appear adequate to enable orderly implementation of foreign resolution actions in most circumstances.

Recovery and resolution planning are absent, and are a priority reform area (KAs 10, 11, and 12). The SFC does not require recovery plans, prepare resolution plans or carry out resolvability assessments for systemically important banks; developing a work program managed by a small unit of specialized staff is a key area for progress. The importance to both home and host jurisdictions of the cross-border activities of the large Colombian financial groups implies a need to cooperate in developing resolution strategies, and internal cooperation with FOGAFIN is similarly important. The SFC currently lacks the power to require firms to change their business organization and legal structure in order to improve resolvability (although the draft law on conglomerates will allow the SFC to do this for supervisory purposes, which could help to achieve this aim). While the legal framework allows for access to information and information sharing (with adequate safeguards) with domestic and foreign authorities, management information systems have not been tested for their capacity to address the needs of recovery and resolution planning. Nevertheless, the legal framework provides authority to elicit information from firms, and to require the maintenance of information systems capable of producing the required information.COLOMBIA

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INTRODUCTION

A. Background

1. At the request of the Colombian authorities, the bank resolution regime was assessed against the Key Attributes of Effective Resolution Regimes for Financial Institutions (KAs). The assessment was conducted by staff of the Financial Stability Board (FSB), International Monetary Fund (IMF) and World Bank utilizing the draft KA Assessment Methodology (AM)1. The assessment reviewed the resolution regime as of October 2015, and was limited to the banking sector, considering only those elements of the AM that directly relate to bank resolution without assessing those addressing the resolution of insurance firms, investment firms and financial market infrastructures (FMIs).

2. As a draft methodology was used, the findings of the assessment should be viewed as

considering only those elements of the AM that directly relate to bank resolution without assessing those addressing the resolution of insurance firms, investment firms and financial market infrastructures (FMIs).

2. As a draft methodology was used, the findings of the assessment should be viewed as preliminary. A central goal of this assessment was to test the draft AM, and a future revision of the AM might yield different results with respect to the adherence of the Colombian bank resolution regime to the KAs. In this light, no ratings were assigned in this review. This assessment was the first one undertaken in a country that is not a member of the FSB, or home to a Global Systemically

Important Financial Institution (G-SIFI).

3. The authorities provided a detailed self-assessment in accordance with a template and questionnaire prepared by the assessment team, which was reviewed off-site. The comprehensive report with this assessment was coordinated by the Superintendency of Financial Institutions (SFC), with contributions from the deposit insurance fund (FOGAFIN), the central bank

(BR) and the Financial Regulation Agency (URF—an op erationally independent office of the Ministry of Finance (MHCP)). In addition, related laws, decrees and other relevant documentation were reviewed. The team benefitted from the findings of the Financial Sector Assessment Program (FSAP) undertaken in 2012/13. A mission then visited Bogotá from September 28 to October 13, 2015, to meet with the authorities and market participants. During the onsite visit meetings were held with SFC, FOGAFIN, BR and URF, and a closing meeting was held with the Minister of Finance, the Financial Superintendent, the Director of FOGAFIN, and BR. In addition, the mission met with representatives of the large domestically owned banks, foreign banks, law firms, the stock exchange and clearing house, and other market participants.

4. The authorities extended full cooperation to the assessment team. There were no substantive impediments to the completion of the assessors’ work. The cooperation, time dedicated, and frank and cordial discussions that the authorities offered the team is greatly appreciated.

and clearing house, and other market participants.

4. The authorities extended full cooperation to the assessment team. There were no substantive impediments to the completion of the assessors’ work. The cooperation, time dedicated, and frank and cordial discussions that the authorities offered the team is greatly appreciated.

1 The mission was led by Mr. Alvaro Piris (IMF, Monetary and Capital Markets Department), and comprised Ms. Ruth Walters and Mr. Vijay Tata (FSB Secretariat), and Messrs. Alessandro Gullo (IMF, Legal Department) and Jan Nolte (World Bank, Finance and Markets Global Practice).COLOMBIA

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B. Institutional Setting and Market Infrastructure Overview of the resolution regime

5. The Colombian legal framework does not include the full range of resolution powers and related attributes as specified in the KAs. Weak, failing and insolvent financial institutions are subject to administrative powers that share many features with resolution powers as described in the KAs. The objectives of the resolution authority are consistent with some of those described in the preamble to the KAs, namely the avoidance of “severe systemic disruption… while protecting vital economic functions.” However, the early intervention tools available (known as rescue tools— “institutos de salvamento”)—are focused on avoiding the need fo r “takeover and control” rather than the resolution of failing financial institutions when assessed as non-viable by the resolution authority, and there is no clear priority given to avoid exposing taxpayers to loss. The framework does not recognize resolution as a stand-alone legal proceeding, empowering the authorities to impose resolution measures (such as restructuring or winding down a firm’s operations) through a directly binding measure, without shareholder and creditors’ consent.2 The scope for shareholders to absorb losses is limited to liquidation, nationalization or capitalization with deposit insurance funds, and only to liquidation with respect to unsecured and uninsured creditors. In trying to preserve financial stability, the authorities have few options beyond actions to avoid takeover and control, including through use of public funds and without explicit powers to override shareholder consent,

and only to liquidation with respect to unsecured and uninsured creditors. In trying to preserve financial stability, the authorities have few options beyond actions to avoid takeover and control, including through use of public funds and without explicit powers to override shareholder consent, liquidation, and nationalization.

6. This context informs the assessment of the KAs. While the Colombian resolution regime goes well beyond subjecting failing banks to ordinary corporate insolvency proceedings, the motivation and feasibility of avoiding bail-outs of shareholders and unsecured and uninsured creditors that lie behind the KAs is absent. The approach taken by the assessors was to judge the regime’s adherence to each KA and essential criterion (EC) on its own merits, while the overall conclusions acknowledge that the current regime deviates from the intent and spirit that lies behind the KAs in important respects.

7. Colombia’s constitution gives primary responsibility for regulating and supervising the financial system to the President of the Republic. The MHCP has delegated powers of legislative initiative and regulation of the financial sector, the latter through the URF, while supervision is the competence of the SFC.

8. Responsibility for bank resolution is delegated to the SFC and FOGAFIN. The SFC is responsible for deciding when a bank should be resolved, working closely with FOGAFIN, that has specific functions in the execution of resolution. The SFC, an administratively and operationally

2 The authorities’ have noted their disagreement with this representation (see “The Authorities’ Response”, p. 68). Given the interference with shareholders’ economic and governance rights under ordinary corporate law, the assessors decided to leave the representation unchanged, considering that an explicit legal provision for overriding shareholder consent, applying generally to resolution actions, is necessary to support effective implementation of resolution and allocate losses to shareholders and creditors in the public interest in line with the KAs.COLOMBIA 10 INTERNATIONAL MONETARY FUND independent agency of the MHCP, is responsible for supervision of all financial institutions, including banks, insurance and securities firms, except a narrowly defined subset of cooperatives. The deposit

resolution and allocate losses to shareholders and creditors in the public interest in line with the KAs.COLOMBIA 10 INTERNATIONAL MONETARY FUND independent agency of the MHCP, is responsible for supervision of all financial institutions, including banks, insurance and securities firms, except a narrowly defined subset of cooperatives. The deposit insurance agency, FOGAFIN, has a separate board and mandate, also deriving its authority from the MHCP, and is subject to the oversight of the SFC. The SFC and FOGAFIN, along with the BR and MHCP play a key role in monitoring financial stability, with policy in this area coordinated through the Financial Sector Coordination and Monitoring Committee (CCSSF). The BR ranks financial firms by their systemic importance, for consideration by the CCSSF twice a year.

9. The specific resolution regime for cooperatives is not reviewed in this assessment.

Approximately 11,400 cooperatives that accept deposits (only from their members) are supervised by the Superintendency of the Solidary Economy (Superintendencia de la Economía Solidaria—SES). The SES has broadly similar supervisory and resolution powers as the SFC, and there is a separate deposit insurance fund (Fondo de Garantías de Entidades Cooperativas— FOGACOOP). These cooperatives are subject to limits on financial functions and funding sources, and must convert to financial cooperatives supervised by SFC when a size threshold is reached. Due to their small size— total assets are equal to under 5 percent of financial system assets—and the low exposure of the banking sector—loans to cooperatives account for about 0.5 percent of the total loan portfolio of credit institutions—these entities are not cons idered to be of systemic importance. Failing institutions have usually been managed through arranged mergers within the cooperative sector.

10. The financial system, SFC and FOGAFIN are governed by the body of law contained in the organic statute of the financial system (EOSF). This decree compiles the many laws governing the financial system and has the legal hierarchy of the underlying laws. It includes all the powers

10. The financial system, SFC and FOGAFIN are governed by the body of law contained in the organic statute of the financial system (EOSF). This decree compiles the many laws governing the financial system and has the legal hierarchy of the underlying laws. It includes all the powers available to the SFC and FOGAFIN in resolution. Financial regulation, including with respect to resolution powers, is expressed through Presidential decrees, and is compiled in Decree 2555 (2010), which is lower in the legal hierarchy than the EOSF.

11. The SFC has administrative powers to manage failing financial institutions. The law enables the SFC to intervene (“toma de posesión”, henceforth “takeover and control”) a bank if triggers are met, including a capital adequacy threshold, failure to comply with a rehabilitation plan addressing identified weaknesses and several other conditions including payments failure, breaches of regulations or supervisory orders, and unsafe and unsound management. Once takeover and control has been triggered, a strategy to enable recovery of the institution or initiate a liquidation is taken. The SFC may also take actions to prevent the triggers for takeover and control being reached, including changing management and requiring a rehabilitation plan, among others.

Overview of the financial system

12. Colombia’s financial system is relatively large and diversified in relation to other middle income countries. Total financial system assets are equivalent to close to 150 percent of GDP, with credit institutions (overwhelmingly banks) accounting for about 45 percent of the total. Of 57 credit institutions, 25 are banks (the others being financial corporations of various types and financial cooperatives, subject to limitations on their operations and the nature of their liabilities).

About 30 percent of financial system assets are held in trust structures, including investment fundsCOLOMBIA INTERNATIONAL MONETARY FUND 11 administered on behalf of third parties (including private wealth vehicles), public sector infrastructure investment funds, and collective investment vehicles such as mutual funds. The largest private trusts are part of financial groups that include banks. Pension funds account for a further

INTERNATIONAL MONETARY FUND 11 administered on behalf of third parties (including private wealth vehicles), public sector infrastru