THE WORLD BANK GROUP COLOMBIA FINANCIAL SECTOR ASSESSMENT PROGRAM March 2022 TECHNICAL NOTE THE ROLE OF THE STATE IN THE PROVISION OF FINANCIAL SERVICES Prepared by This Technical Note was prepared in the context of a Finance, Competitiveness, and joint IMF-World Bank Financial Sector Assessment Innovation Global Practice, Program (FSAP) virtual mission in Colombia during WBG November, 2021 led by Zsofia Arvai, IMF and Raquel Letelier, World Bank, and overseen by the Monetary and Capital Markets Department, IMF, and the Finance, Competitiveness, and Innovation Global Practice, World Bank Group. The note contains the technical analysis and detailed information underpinning the FSAP assessment’s findings and recommendations. Further information on the FSAP program can be found at www.worldbank.org/fsap. Colombia CONTENTS GLOSSARY ...................................................................................................................................................................................... 3 Executive Summary ................................................................................................................................................................. 4 RECOMMENDATION TABLE .......................................................................................................................................................... 7 LANDSCAPE ............................................................................................................................................................................... 9 FUNCTIONAL ASSESSMENT...................................................................................................................................................14 Rationale for State Intervention ............................................................................................................................14 Recommendations ......................................................................................................................................................20 FINANCIAL AND ECONOMIC PERFORMANCE ......................................................................................................................22 SOFIs Financial Performance...................................................................................................................................22 Economic Performance of State Interventions ................................................................................................24 Recommendations ......................................................................................................................................................24 OPERATIONAL ENVIRONMENT .............................................................................................................................................25 Regulation and Supervision of SOFIs ..................................................................................................................25 Ownership Framework for SOFIs...........................................................................................................................26 Corporate Governance Regulation Applicable to SOFIs ..............................................................................29 SOFI corporate governance practices .................................................................................................................31 Competitive Neutrality Considerations ..............................................................................................................35 CONSIDERATIONS ON SPECIFIC INSTITUTIONS ...................................................................................................................38 BA and Finagro.............................................................................................................................................................38 Bancoldex .......................................................................................................................................................................41 FNG ...................................................................................................................................................................................42 Recommendations ......................................................................................................................................................42 Annex..........................................................................................................................................................................................46 2 Colombia GLOSSARY BA Banco Agrario BANREP Banco de la República BDC Business Development Bank of Canada CAF Corporación Andina de Fomento CEO Chief Executive Officer CNCA Comisión Nacional de Crédito Agropecuario COP Colombian Peso DFI Development Financial Institution DGPE Dirección General de Participaciones Estatales DNP Departamento Nacional de Planeación FAG Fondo Agropecuario de Garantías FDN Financiera de Desarrollo Nacional FNA Fondo Nacional del Ahorro FNG Fondo Nacional de Garantías GB Grupo Bicentenario GCF Green Climate Fund GMS General Meeting of Shareholders IDEA Instituto de Desarrollo de Antioquia IFC International Financial Corporation INFI Institutos Financieros de Fomento y Desarrollo Territorial IT Information Technology MHCP Ministerio de Hacienda y Crédito Público MSME Micro, Small and Medium Size Enterprises M&E Monitoring and Evaluation OECD Organization for Economic Cooperation and Development PCG Partial Credit Guarantee ROE Return on Equity SFC Superintendencia Financiera de Colombia SOFI State Owned Financial Institution TDA Título de Desarrollo Agropecuario VIS Viviendas de Interés Social 3 Colombia EXECUTIVE SUMMARY1 The State plays an important role in the provision of financial services in Colombia through state-owned financial institutions (SOFIs), interest rate controls, mandatory investment requirements and credit subsidies. State-owned financial institutions (SOFIs) hold about 12 percent of banking sector assets and about 8 percent of insurance sector assets. SOFIs are key actors in microcredit, agricultural and small business loans markets. The recently created Grupo Bicentenario (GB), a financial holding for SOFIs reporting to the Ministry of Finance (Ministerio de Hacienda y Crédito Público, MHCP), aspires to become the third largest financial group in Colombia. There are also fourteen small subnational development financial institutions (Institutos Financieros de Fomento y Desarrollo Territorial, INFIs), albeit the size of the sector is unknown as most INFIs do not disclose financials 2. All credit in Colombia is subject to interest rate controls, either ceilings under usury caps set relative to industry rates or regulated rates in socially sensitive sectors. Mandatory investments remunerated at below market rates are used to provide subsidized credit to the agricultural sector. The State also provides interest rate subsidies to private intermediaries lending to certain sectors and subsides agricultural insurance premiums. In the past, agricultural producers have received debt relief, undermining credit culture. SOFIs should play a more prominent role in supporting financial inclusion, green activities and fostering competition among private financial providers. Most SOFI interventions focus on improving credit terms for existing borrowers. Few public credit programs target first time borrowers or contain graduation provisions to ensure program beneficiaries transition to commercial financial products. Rebalancing resources from credit subsidies to business development programs should be considered, and coordination between SOFIs and technical assistance providers enhanced. While some SOFIs fully integrate sustainability factors into investment decision-making and project cycles, others fail to offer tailored products or products with characteristics well-suited to addressing climate impacts. As the SFC introduces new rules that mandates disclosure of sustainability risks confronting financial entities, including SOFIs, the pressure to introduce climate risk management practices and introduce new green products may increase. SOFIs should also support the development of financing platforms in which private intermediaries offer financial services to target segments including in partnership with Fintechs. Auctioning of SOFIs’ guarantee and liquidity facilities could ensure funds are allocated to intermediaries offering better conditions. SOFIs should also intensify efforts to support non-bank financial intermediaries to diversify the financial sector. 1 This Technical Note has been prepared by Eva Gutierrez, Lead Financial Economist, WBG. It includes contributions on corporate governance issues from Alexander Berg, Senior Financial Sector Specialist, WBG, and on green practices and products by Cindy Paladines, Financial Sector Specialist, WBG. Claudia Carlisle Meek and Ruben Barreto (Consultants, WBG) provided research assistance. 2 To date, under the Colombian regulatory framework, the SFC carries out control and surveillance over three INFIs that have been authorized to enter the special surveillance regime and thus can manage liquidity surpluses of subnational public entities. 4 Colombia SOFIs have traditionally complemented the private financial sector, although increased involvement in direct lending and leasing activities of credit SOFIs could raise competitive neutrality considerations, if they were to receive subsidies. State-owned banks have focused on rural areas, small agricultural producers, small business, or infrastructure projects often at subsidized rates. They also play a countercyclical role including during the COVID pandemic. Except for Banco Agrario (BA), which acts as a commercial bank, the other state-owned banks have traditionally provided liquidity to financial intermediaries and participated in syndicated loans. Banks abundant liquidity, a relatively underdeveloped non-bank credit provider sector, and difficulties in transferring subsidies to final borrowers, have prompted some SOFIs to develop direct lending and leasing products to segments previously attended through financial intermediaries to reduce rates to final borrowers. To maintain profitability, many SOFIs have diversified into commercial segments competing with private providers. As SOFIs venture into direct lending and commercial activities the potential effects of their activities on competitive neutrality should be carefully analyzed. Allocating subsidies through interest rate compensation mechanisms to all financial institutions, not only SOFIs, would help maintain a level playing field and increase the program implementation network. Commercial and developmental activities of SOFIs should be defined and pricing policies in both segments defined. SOFIs currently do not present financial stability risks albeit expansion of direct loans could negatively affect financial indicators. SOFIs in general present healthy financial indicators. SOFIs are adequately regulated and supervised by the SFC, following the same supervision methodology that applies to private entities. However, more depth in the on-site inspections of SOFIs granting direct credit would be appropriate to detect any potential loan evergreening. Regulation to apply the Financial Conglomerate law to GB should be promptly issued. All SOFIs can be liquidated by Presidential Decree which would support prompt resolution, and many have issued subordinated instruments that can be converted in equity. Credit institutions risk management systems are adequate for their current activities. New direct lending activities will consume more capital and could deteriorate asset quality and increase administrative costs. Improving product design, incorporating best practices, strengthening governance and continuing to improve risk management would support expansion of SOFI activities in a non- distortionary way. For example, Bancoldex should consider piloting a direct loan program targeting younger firms in combination with consulting services. Consideration should be given to scale up Fondo Nacional de Garantías (FNG) operations with private intermediaries, improving features such as payment at 90 days of loan delinquency and introduction of first loss portfolio guarantees. SOFIs should continue to improve risk management as they expand the range of products and counterparties to include fintechs and other new players and to deal with climate risks. In conjunction with recommendations on corporate governance later discussed, the ownership structure of BA should be reformed including minority private owners to reduce political influence. Full implementation of the Grupo Bicentenario (GB) should accelerate. The MHCP created the GB in 2019 to act as a holding company for state owned financial institutions. The GB is a new public 5 Colombia enterprise, legally governed by private law. The stated goals of the GB include the consolidation of shareholding, building synergies among members of the group, and adopting modern corporate governance practices. The initial consolidation of SOFI ownership is underway; eight SOFIs are now held by the GB. However, the GB does not yet appear to be fully autonomous from MHCP. . The MHCP should appoint permanent boards and managers to the GB, with strong financial expertise and ramp up operations (especially around board appointments to the SOFIs). The MHCP should also work to clarify the respective roles of MHCP and the GB. The creation of GB provides an opportunity to conduct and ambitious review of the SOFI rationale and operations to prepare a strategy to restructure the group to increase efficiency, avoid duplication and ensure alignment with policy objectives. The review should assess among others the following options (i) restructuring FINAGRO, limiting its role to the support of private financial intermediaries, ceasing its operations with BA, (ii) consolidating all retail lending operations (except for those of Caja Honor) in BA, and (iii) transferring administration of the Fondo Agropecuario de Garantías (FAG) to the FNG. The corporate governance framework for SOFIs appears to be generally in line with international good practice albeit many board members and managers are politically appointed. The corporate governance framework for private financial institution applies to the SOFIs. In addition, the MHCP has issued several norms for public enterprises and financial institutions. To date, GB has not issued any additional corporate governance policy of its own. SOFIs’ corporate governance arrangements follow many elements of good practice. However, for many of the SOFIs GB does not have control over the appointment of board members and many SOFI boards do not appoint their CEOs. The GB should appoint board members and the Board should appoint the Chief Executive Officer (CEO) of the institution. GB should develop its own corporate governance policy for SOFIs. The legal and regulatory framework for operation of INFIs should be reviewed to focus on developmental activities and gap-filling/market-making roles, reduce potential distortions and improve governance and disclosure. An in-depth review of INFI functions and performance should be conducted to inform reform efforts. The new legal framework should ensure that INFIs have a clearly formulated developmental mandate, enhance corporate governance, and introduce appropriate disclosure and accountability mechanisms. Additionally, activities undertaken by INFIs may be limited, for example in the retail area, to further ensure alignment of instruments with objectives. Consideration could be given to require a minimum rating for INFIs to be able to attract funding from public institutions. Interest rate controls and mandatory investment requirements should be reviewed to limit distortions and foster the entrance of non-bank credit intermediaries. Interest controls have well- documented negative effects on overall credit supply and financial inclusion. A study on the effects of interest rate ceilings in Colombia for the period 1996-2006 found results consistent with the literature. Pending results of rigorous studies on the effect of current usury and housing interest rate ceilings, which currently do not appear binding except for the credit card segment, consideration could be given to calculate different ceilings for banks and non-deposit taking credit providers. This would help develop an ecosystem of alternative credit providers which typically focus on riskier segments. The 6 Colombia current agricultural policy that provides heavily subsidized lending to small rural producers through a tax on deposits introduces significant distortions. Consideration should be given to progressively increase interest rate ceilings and returns on Títulos de Desarrollo Agropecuario (TDAs). During the transition, the amount invested in TDAs could be increased to ensure the flow of resources to the sector. Monitoring and evaluation (M&E) and disclosure of public credit support policies and programs and their costs should be substantially strengthened to assess value for money. Information on credit support programs and their subsidies should be systemically compiled, aggregated, and reported. Profitability of SOFIs excluding subsidies should be calculated and disclosed. A strategy for systematic and rigorous impact evaluation of public credit programs and policies should be designed and implemented. The GB should also formulate a strategy for the M&E function at the group level following international best practices that would facilitate aggregate monitoring and disclosing of SOFI activities. RECOMMENDATION TABLE Recommendation Responsible Time 3 authority Policies and programs to support access to finance Monitor and disclose aggregated amount of subsidized credit. MHCP, DNP ST Compile information on credit support programs in ARCO Platform. DNP ST Formulate and implement strategy to evaluate impact of credit support programs DNP ST and policies. Evaluate impact of credit ceilings and mandatory investments as well as options for DNP, BANREP ST modification. Ensure budgetary subsidies for direct credit support programs are available to all MHCP ST credit intermediaries and not exclusive to SOFIs. Adopt policies to increase the number of hectares covered with agricultural CNCA MT insurance and cease to provide debt relief programs. Clarify the respective roles and status of both DGPE and the Grupo Bicentenario Update CONPES 3851 in order to clarify the permanence of the role of the MHCP / MHCP ST DGPE and introduce the GB and its role and purpose. Clarify and move away from the practice for GB that was established in 2020 to MHCP and ST “maintain the representation of the sectors to which they were attached or linked”. GB Appoint permanent boards and managers to the GB, with strong commercial MHCP I banking and other financial expertise. Ensure at least one board member in each institution is entrusted with oversight of MHCP ST the integration of climate risk by the institution, with defined timelines and regular reporting to the board. Corporate working groups and action plans should detail how climate risks will inform management processes as well as financial and investment decision-making, project cycles, and reporting. 3 I-Immediate” is within one year; “ST-short-term” is 1–3 years; “MT-medium-term” is 3–5 years. 7 Colombia Recommendation Responsible Time 3 authority Develop key policies for Grupo Bicentenario Issue regulation explicitly stating that GB is subject to the Financial Conglomerate GB I Law Finalize and communicate the draft strategy for GB and include a mission for the GB I GB that moves beyond commercial goals. Review the rationale for the different interventions of the State in the financial GB ST sector including a focus of expanding the universe of borrowers, green activities and developing ecosystem of financial provider, to guide GB’s strategy. Evaluate restructuring options including merger of institutions and transfer of GB ST functions from one institution to another to increase efficiency. Define developmental and commercial activities of SOFIs in the group and GB ST guidelines for pricing of activities. Develop a transparent dividend policy. GB ST Develop a monitoring and performance evaluation framework. GB ST Convert all SOFIs in the GB portfolio to mixed economy companies, with legal GB MT reforms as necessary. Establish corporate governance policies Update SOFI statutes to give the GB full authority over appointments of board GB ST members and allow boards to appoint the CEO of each institution. Develop a corporate governance policy for the SOFIs. GB ST Benchmark the levels of SOFI board and management remuneration. GB ST Review and improve corporate governance codes and reports. GB MT Monitor and improve SOFI website disclosures, inclusive of climate risks (as GB MT mandated by the SFC of commercial entities). SOFI Reform Bring private investors into the capital structure of Banco Agrario. MHCP MT Review legal and regulatory framework for INFIs to improve developmental focus, MHCP ST/MT corporate governance and disclosure. Reform guarantee products to reduce moral hazard, increase efficiency in the use MHCP, CNCA, ST/MT of resources and ensure prompt payment of the guarantee. FINAGRO, FNG Develop a pilot program for first time SME borrowers. Bancoldex ST/MT Develop electronic factoring platform open to multiple financial intermediaries. Bancoldex ST/MT BANREP: Banco de la República; CNCA: Comisión Nacional de Crédito Agropecuario; DNP: Departamento Nacional de Planeación; FNG: Fondo Nacional de Garantías; GB: Grupo Bicentenario; MHCP: Ministerio de Hacienda y Crédito Público 8 Colombia LANDSCAPE 1. Several state-owned financial institutions (SOFIs) provide financial services in Colombia in banking, asset management, and insurance. 4 The largest SOFI, holding a third of total SOFI assets, is a commercial bank (Banco Agrario, BA) focused on the agricultural sector and provision of financial services in rural areas (Table 1). Eight development financial institutions (DFIs), holding 60 percent of SOFI assets, provide credit for specific purposes but do not collect retail deposits. The National Savings Fund (Fondo Nacional del Ahorro, FNA) administers workers contributions for unemployment benefits except for the military and policy which are administered by Caja Honor. The other credit DFIs rest raise fund from capital markets, institutional depositors, and have access to some special funds. 5 A public partial credit guarantee (PCG) fund (Fondo Nacional de Garantias, FNG) guarantees loans to micro small and medium size enterprises (MSMEs) as well as some housing loans. 2. A conglomerate grouping SOFIs currently forms the fourth largest financial holding in Colombia. While the market share of the institutions is relatively modest, they play an important role in some segments. The recently created Grupo Bicentenario (GB), a holding for SOFIs reporting to the Ministry of Finance (Ministerio de Hacienda y Crédito Público, MHCP), aspires to create efficiency and act as the third largest financial holding in Colombia once all the envisioned SOFIs are integrated in the group. SOFIs hold about 5 percent of total financial sector assets, 0.1 percent of asset managers assets, about 8 percent of insurance sector assets and 12 percent of banking sector assets. The BA holds 3.5 percent of total deposits. However, it plays a key role certain segment such as microcredit and credit to small rural producers. 3. Colombian SOFIs behave countercyclically. In the past five years, credit growth of SOFIs has been the reverse image of the commercial banks credit growth, pointing to a countercyclical role. During the pandemic, public credit institutions expanded their operations. The FNG played an especially important role in supporting credit growth during this period (Figure 1). 4 In addition, there are two deposit insurance institutions and a pension provider which administers the defined benefit pension scheme and the voluntary pension scheme for low-income individuals. These institutions are not reviewed in this note and data on their assets is not included. 5 See discussion on competitive neutrality. 9 Colombia Table 1: Colombian State-Owned Financial Institutions Total Assets Institution (USD bill.) Type of Institution Market Segment/Mandate Banco Agrario 8.2 Commercial Bank Agricultural sector and rural financial services Bancoldex 2.5 DFI EXIM and MSMEs FINAGRO 3.4 DFI Agricultural credit FINDETER 3.1 DFI Credit to municipalities for infrastructure projects FNA 2.6 DFI Housing credit, focus on lower income households FDN 1.4 DFI National infrastructure projects Icetex 0.002 DFI Student loans Infrastructure project structuring. No longer providing Enterritorio 0.2 DFI finance Caja Honor 1.8 DFI Housing loans and savings for the military and police FNG 1.0 DFI Partial Credit Guarantee Fund Fidu Agraria 0.02 Asset Manager Agriculture and rural development related funds Fidu Coldex 0.02 Asset Manager Public funds promoting trade an innovation Fidu Previsora 0.1 Asset Manager Social sectors funds (teachers) and special programs Previsora 0.7 Insurance Company Motor third party liability, civil liability and vehicles Positiva 1.4 Insurance Company Focus on occupational hazards and underserved segments Assets calculated using 1 Colombian Peso = 0.00026 USD. Data as of June 2021. Source: SFC 10 Colombia Figure 1: Colombian SOFIs SOFI assets account for less than five percent of total SOFIs operate mostly as credit providers financial sector assets 6.0% 5.5% Public insurance assets as proportion of total insurance 5.0% assets 4.5% 4.0% Public asset manager assets 3.5% as proportion of total asset manager assets 3.0% Public credit institutions assets as proportion of total SOFI Assets/ Total Financial Sector Assets banking sector assets SOFI Assets/ Total Financial Sector Assets (excl Pensions) 0% 5% 10% 15% Source: SFC. SOFI assets exclude FNG Source: SFC SOFI credit behaves countercyclically … with credit supported by public guarantees growing almost 60 percent during COVID pandemic 14 60 12 50 10 8 40 6 30 4 20 2 - 10 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 0 SOFI Credit Asset Growth Dec-18 Dec-19 Dec-20 Bank Credit Asset Growth Source: SFC Source: FNG. 4. There are also fourteen small subnational development banks (INFIs), albeit the size of the sector is unknown as most INFIs do not disclose their balance sheet. INFIs (Institutos Financieros de Fomento y Desarrollo Territorial) provide credit, equity investments and manage regional public sector assets. They cannot collect retail deposits, albeit there have been some instances of illegal activities in this regard. INFIs collect deposits and administer funds of/from public entities and borrow from domestic and international DFIs. Only three INFIs with an external rating of AA or higher (provided by a credit rating agency) are authorized by the financial regulator (Superintendencia Financiera de Colombia, SFC) to manage liquidity surplus from municipalities and are supervised by the SFC. However, they are not allowed to administer fiscal resources transferred to regional governments (cuentas maestras). Non-rated INFIs do not disclose their financial statements. It is estimated that the largest INFI (Instituto para el Desarrollo de Antioquia, IDEA) holds about 60 percent of sector assets, which would put the total sector assets at about 4 percent of total national SOFI 11 Colombia assets. While IDEA has an important lending portfolio (40 percent of its total assets) the other INFIs have far smaller lending activity, acting mainly as holders of public regional enterprises. 6 5. State owned banks (including DFIs) in Colombia while playing a significant role hold a smaller asset share than in other countries in Latin America. Credit to MSMEs supported by FNG guarantees is however among the largest in Latin America. Figure 2: State-owned financial institutions in Latin America Credit to SMEs covered by PCGs as share to total credit to SMEs State-owned bank assets as a share of total banking sector (2019) assets (2021) 35 31.9 30 25 22.6 20 15 10.9 10 6.6 5 2.2 1.9 1.5 0.2 0.1 0.0 0 México (3ColombiaChile (1) ArgentinaEl Salvad Ecuador Uruguay Peru (2) Brazil (2) Paraguay Source: National Supervisory Agencies Source: “Challenges of Public Credit Guarantees in Latin America During the Pandemic”, World Bank Research Working paper 9895. 6. In Colombia, as in other countries in the region, all credit is subject to interest rate controls. Interest rate controls include ceilings under usury caps (imposed on commercial, consumer and microcredit loans) and ceilings imposed in socially sensitive sectors (e.g., housing and agricultural loans). Usury ceilings are 1.5 times the weighted average of rates applied by all credit providers operating in the segment regardless of the type of license under which they operate (e.g., commercial banks, finance companies, etc.). Housing ceiling rates were introduced after the mortgage crisis of the late 1990s in Colombia and are calculated by the Central Bank (Banco del la República de Colombia, BANREP) on real terms to ensure they are lower than rates in other products 7 . The SFC collects information of bank rates for other products and BANREP calculates a rate that would provide banks a 10 percent return on equity (ROE) while covering administrative, credit and funding costs. Interest rate on agricultural loans is determined by the National Agricultural Commission (Comisión Nacional de Crédito Agropecuario, CNCA). While credit rates are fully liberalized for all types of credit in some 6 Among the other INFIs disclosing statements, Inficaldas has the largest share of loans in total assets (14 percent). 7 Housing loan ceilings rates in Colombia have constitutional rank. 12 Colombia Latin American countries (e.g., Mexico), it is not uncommon in the region that 100 percent of credit is subject to interest rate controls. Figure 3. Share of Credit Subject to Interest Rate Controls in Selected Countries Source: World Bank staff calculations based on data from national financial regulators. Notes: data as of the latest available information; for Brazil, we use the earmarked financing lines for rural credit, real estate, and microcredit, as proxy for credit subject to interest rate controls. 7. Mandatory investment requirements are used to provide credit to the agricultural sector and have been used as well during the pandemic. Banks are obliged to invest a percent of deposits in loans to agricultural producers (cartera sustitutiva) at the regulated rate or on securities (Títulos de Desarrollo Agropecuario, TDAs) remunerated at below market rates. FINAGRO, a wholesale agricultural development bank, lends funds from TDAs, mostly to the BA, to provide loans for small rural producers at regulated rates. To respond to the pandemic, the BANREP reduced monetary reserve requirements and banks were mandated to invest those resources on securities used to fund government expenditures (Títulos de Desarrollo de Solidaridad) remunerated at market rates. 8 8. The total amount of subsidized credit in Colombia for different purposes is not compiled or monitored. In addition to subsidized credit provided by SOFIs to a variety of sectors, the State subsidizes mortgage rates for social housing (viviendas de interés social, VIS) for 7 years. The Ministry of Housing designs the program and transfers budgetary resources to financial institutions that provide the loans. VIS mortgages account for about a third of total mortgage portfolio. It is difficult however to assess the relevance of subsidized credit in certain segments and on the credit market overall, as this information is not compiled, disclosed and monitored with a system wide perspective. 8 Mandatory investment on these securities is approximately set at three percent of current deposits and one percent of time deposits. The securities have annual maturity, but the Government decides every year whether to rollover them. Reserve requirements on deposits are deducted from all mandatory investments. 13 Colombia FUNCTIONAL ASSESSMENT Rationale for State Intervention 9. Colombian SOFIs have traditionally complemented the financial sector, focusing on underserved segments and countercyclical activities. State-owned banks have focused on serving rural areas and small agricultural producers, MSMEs, low-income housing or infrastructure projects, often at subsidized rates, and on providing countercyclical finance as for example during the COVID emergency (see Table 1 and Figure 1). Bancoldex mandate refers to support to exporters and the national industry but about two thirds of its outstanding portfolio is credit to MSMEs. Insurance companies such as Positiva traditionally focuses on occupational hazards and coverage of unattractive segments for the private sector (e.g., taxi drivers). Asset managers were created to administer public sector funds. For private asset managers, administration of these funds is complex due to public sector oversight requirements (e.g., from agency creating the fund, the Comptroller Office and the General Prosecutor Office). 10. SOFI interventions largely aim to improve credit conditions for firms and households that already have access to finance instead of on bringing new borrowers into formal credit. Among the largest SOFIs providing credit or guarantees to households and MSMEs (Bancoldex, FINAGRO, BA, FNG) only FNG includes in its mandate a reference to bringing new borrowers into formal credit. All of them however provide subsidized credit/guarantees in certain programs. FINDETER also provides subsidized loans. Maturity of loans by SOFIs can reach up to 20 years and short-term loans (less than one year maturity) are typically less than 15 percent of their portfolio. Long-term rediscount lines provided by SOFIs are attractive to banks who are reluctant to issue long- term bonds to avoid maturity mismatches in case of loan prompt repayment. 11. Colombian SOFIs implemented several temporary Government programs to alleviate the impact of the pandemic. Programs provided attractive conditions (grace periods, medium term maturity) and limited time windows (See Box 1). Many programs included subsidies to interest rates and fees financed with budgetary resources. Bancoldex and FINDETER were authorized to provide subsidized loans directly to final borrowers. SOFIs also introduced new technologies and solutions to make it easier for clients to request a loan and simplify processes. In addition to implementing COVID programs, SOFIs expanded their portfolio of traditional products. The performance of the loans is yet to be seen as many of them are just now exiting grace periods. 14 Colombia Box 1. Main COVID programs implemented by Colombian SOFIs Banco Agrario launched Avanza Colombia, a working capital credit program for individual entrepreneurs and firms. The program was implemented with the bank’s own resources albeit for some activities (e.g., sports) it received resources from government agencies. Loans were guaranteed by FNG, had a maturity of 3-5 years and grace period of 4-12 months. From April 2020 to Sept. 2021, the program disbursed COP 778 billion (about 5 percent of the total BA loan portfolio), with about 80 percent allocated to small business. About 4 percent of that portfolio had overdue payments at Sep. 2021. BA also originated loans using special covid rediscount facilities from Bancoldex and FINDETER. BA restructured COP 3.4 bill in loans in line with the SFC circulars. Those loans are now current or have been provisioned for. To increase outreach and efficiency, BA enabled its banking agents to process credit applications, being the first Colombian bank to do so. The bank also launched new web-based solutions for loan originations including through tablets in disperse rural areas. Bancoldex implemented the portfolio "Responde,” of subsidized loans implemented with the support of several institutions including public entities and chambers of commerce. Short-term credits were replaced with medium-term credits with average terms exceeding 2.5 years. About 2 percent of these loans are past- due. Bancoldex also provided subsidized direct loans (14 percent of its total COVID funds) for working capital (3 years) with one year grace periods. Loans were guaranteed by FNG and less and 0.5 percent are delinquent. In September 2021, it launched a direct loan line for 3-5 years loans with a 6-month grace period. About a fourth of the rediscount COVID lines disbursed less than 25 percent of allocated resources. Overall, it disbursed COP 2016 billion (11 percent of loan portfolio). The implementation of digital rediscount reduced from 72 hours to 24 hours the time of a transaction from its execution to its disbursement. FINDETER implemented 12 special COVID lines with long maturities and grace periods (e.g., up to 7 years maturity and 2-year grace period for working capital loans). Most lines were for working capital loans but some allowed debt substitution and investment. About 56 percent of funds were committed in direct loans to utility and transport companies affected by the pandemic and to municipalities for infrastructure investments at very favorable conditions (e.g., loans to utility companies carried zero interest rates). Disbursement of loans to public utility companies was lower than expected as citizens largely continued paying bills during the pandemic and due to the time limit to request the loan. Lines for transport companies (or the municipalities that own them) also went largely unused given limited indebtedness capacity of the companies and the fact many of them are owned by different municipalities served by the company which prevented agreement on requesting the loan. However, direct credit lines to municipalities disbursed quickly and had to be increased. Overall, only 5 lines disbursed more than 50 percent of the total allocated funds. FINAGRO implemented a COVID credit line subsidized by the Ministry of Agriculture to provide loans to small and medium size producers. Loans could be used for agricultural activities or to normalize existing non- subsidized credits for these activities. Rates applied to final borrowers from loans funded by this credit line were capped by the program to ensure the subsidy was passed to the final borrowers. About 80 percent of the available funds were disbursed. FNG launched the guarantee program Unidos por Colombia. The guarantees could cover independent workers, micro enterprises (formal or informal), working capital investment loans to MSMEs, large firms as well as loans on social interest housing (VIS) for young individuals (18-28 years). The guarantees covered up to 80 percent of the loan (up from the 50 percent coverage of the standard FNG guarantee) and the guarantee fee was subsidized (up to 70 percent). The program was quite successful and as of August 2021 accounted for 58 percent of total credits guaranteed by FNG, which in turn had increased by 70 percent since the launching of the program. Only 2.5 percent of the loans guaranteed by the program are past due more than 30 days (compared to 10 percent of loans guaranteed under other FNG facilities) as many of those loans have long grace periods. 15 Colombia 12. Colombian DFIs also provide a variety of non-financial services. DFIs focused on infrastructure provide technical assistance and consulting for project formulation and structuring. Bancoldex provides a variety of services to business including networking and business matching and training programs in cooperation with other institutions. It also operates the program Banca de las Oportunidades, that provides financial education and literacy services and technical assistance to financial intermediaries. 13. In Colombia, SOFIs have begun to support the climate agenda, albeit with substantial variation among institutions. The extent to which SOFIs are integrating climate risks in their corporate governance, financing decisions, and project cycles varies by institution. Some SOFIs, especially those focused on extending credit to agriculturalists, livestock-focused MSMEs, and/or infrastructure are expanding their product portfolio to include the extension of credit at preferential rates for households or businesses that are using climate-sensitive business practices or materials. For example, FDN counts the International Financial Corporation (IFC) as among its primary stakeholders, and sustainability principles have been integrated in all aspects of the organization, from corporate governance and strategy to risk management, project selection, and on-going monitoring and evaluation. FDN’s projects include financing a light-rail project in Medellín, to the purchase of 259 electric buses in Bogotá. Finally, some SOFIs that have market access have begun exploring the use of labelled bonds as a funding tool to take advantage of growing interest in labelled products among domestic and global investors. For instance, Bancoldex issued its first green bond in 2017. The US $67 million green bond was the country’s first to be listed on the Colombian Stock Exchange and was oversubscribed by a factor of 2.5. (See Table 2 for additional examples of climate-related strategies and products offered by selected SOFIs) 14. Asobancaria has played a supportive role in building the green capacity of SOFIs through the Green Protocol. 9 There is hope that the GB can further strengthen this platform approach by continuing to build institutional capacity related to green issues. BA, Bancoldex, FINAGRO, FINDETER, and FDN are signatories to the Asobancaria’s Green Protocol and its principles. 10 The Green Protocol began as an initiative of the Asobancaria in 2014 to support the integration of sustainability factors in the corporate governance of financial institutions and support the development of new financial activities and products targeted at green-oriented development and industry in the country. Through the Green Protocol and associated capacity building measures, Asobancaria has provided strategic support to its members in integrating best practice approaches for climate risk management and greening their business. Asobancaria has also taken on a helpful role in monitoring the impact of climate factors on member institutions. As the GB takes shape it can apply the lessons learned from the Asobancaria to strengthen the capacity of group members to identify, 9 https://www.asobancaria.com/protocolo-verde/ 10 The Banking and Financial Institutions Association of Colombia, Asobancaria, monitors the impact of sustainability factors on business practices among its membership, which includes many SOFIs. In 2019, Asobancaria noted that 43% of its members were engaged in active management of climate-related risks and 41% of members had identified full or partial investments in green projects. 10 This share is likely to have increased in recent years. 16 Colombia assess, and manage climate related risks, as well as integrate climate factors in credit evaluation processes and project cycles. Box 2. The Role of NDBs in addressing climate risks and opportunities National development banks (NDBs) can play a key role in stimulating ‘green’ investments in the low carbon economy. With more than half of Colombia’s land area under forest cover, and its bountiful biodiversity under threat from floods, drought, and other natural hazards, SOFIs can play an important role in seeding financing for important climate-related investments. NDBs have historically played an important role in greening economies by delivering financial solutions that internalize the externalities imposed by climate change. These activities contribute to making the pricing structure of green investments more attractive relative to ‘less green’ options. As the IADB argued in a recent report on NDBs and climate risk 1 , “recognizing climate-related risks and opportunities allows the NDB to make more informed decisions in asset allocation to protect their portfolio”. In addition, seizing climate related opportunities can enable NDBs to, “correct prevailing market failures in green investments”. Financial solutions can take many forms, but include green guarantees, equity and venture capital, first and second tier lending to MSMEs, businesses, and infrastructure. The financial profile of these instruments can also be crafted to better suit the profile required of green investments, including longer tenors, preferential fees and/or interest rates, flexible amortization schedules, etc. 1/ IADB, A Guidebook for National Development Banks on Climate Risk, 2021. https://publications.iadb.org/publications/english/document/A-Guidebook-for-National-Development-Banks-on- Climate-Risk.pdf 15. Some SOFI’s have benefitted from the support of global concessional funds to strengthen their climate risk management practices or to expand their product portfolio to include new green products and services. FINDETER is an accredited entity of the Green Climate Fund (GCF) and has received support to develop the Colombia Municipal Solid Waste Nationally Appropriate Mitigation Actions strategy 11 alongside the Ministry of Housing, Cities and Territory. The strategy aims to reduce methane and other greenhouse gas emissions by advancing policies and projects that contribute to sustainable integrated solid waste management. To receive accreditation, FINDETER had to demonstrate its capacity to manage resources in line with the GCF’s fiduciary standards. The GCF also assesses accredited entities’ ability to manage environmental and social risks that may arise at the project level. While the accreditation process is complex, the process can help other SOFIs in Colombia improve their governance processes related to climate change issues and enable further access to GCF’s concessional finance and technical assistance. Global funds such as the GCF can play a stronger role in helping to strengthen the capacity of SOFIs to on-lend to MSMEs and infrastructure in ways that will support Colombia’s strategic climate related goals. The World Bank is 11 17 Colombia working with SOFIs such as the FDN to improve their understanding of the global concessional funds that do exist and enable their access. Table 2. Climate policies and strategies of selected SOFIs Climate-related governance, strategy & risk Examples of climate products Institution management practices • ‘Credito Verde’ extends credit at preferential rates to small, medium, and large agriculturalists. • Due diligence practices strengthened by incorporating ESG factors in credit • Signatory to the Green Protocol evaluation process. • Reports integrating climate risk in Banagrario • Product examples include: Safeguards were portfolio management and in credit put in place to ensure credits to livestock analysis husbandry do not contribute to deforestation - immediate repayment would be required of farmers that go against these policies. • Due diligence strengthened by incorporating ESG factors in credit • Signatory to the Green Protocol evaluation process, particularly for MSMEs; • SARAS (Sistema de analísis de riesgos exclusion lists in draft form ambientales y sociales)/ESG risks • Product examples include: With IADB management system in place support, crowded-in local long-term (updated with the support of KfW, financing to fund the conversion of 180 Bancoldex IADB) diesel buses to hybrid models • Sustainable finance strategy • Bancoldex Capital provided equity capital to (including Colombia’s first green a fund, Progresa, that invested in Hybrytec, a bond) designer, retailer, and installer of • Sustainability Working Group with photovoltaic energy systems in remote Board-level representation areas. • Signatory to the Green Protocol • Preferential rates for renewable energy FINAGRO • Environmental management system in projects place • Signatory to the Green Protocol • Accredited entity of the GCF • Green waste management credits to FINDETER • Developed corporate ESG strategy, municipalities • Developed a SARAS/ ESG risk management system • Green and sustainable national infrastructure projects, in line with IFC’s Performance • Signatory to the Green Protocol Standards. • IFC is a stakeholder, and has FDN • Product examples include: financing light rail contributed to FDN’s sustainable risk in Medellín; metro extension in Bogotá; management policies and strategies electric buses to replace diesel-fuelled fleet 18 Colombia 16. Overall, there is a strong focus on crowding in private sector finance by operating through financial intermediaries and providing risk sharing facilities. Except for BA, which acts as a commercial bank, the largest DFIs (e.g., FINAGRO, FINDETER and Bancoldex) have traditionally operated through financial intermediaries providing them with liquidity facilities. FDN provides mostly direct loans but can only finance 25 percent of infrastructure projects, which forces the institution to catalyze large amounts of private finance. FNG and FINAGRO through the FAG provide PCGs that are available to all credit intermediaries (both public and private). 17. However, SOFIs are increasingly focusing on direct lending and commercial operations to cross-subsidize developmental interventions. Abundant liquidity in the banking sector, a relatively underdeveloped non-bank credit intermediation sector, and difficulties in transferring subsidies to final borrowers through wholesale operations have prompted some institutions (e.g., Bancoldex and FINDETER) to develop direct lending products. 12 As SOFIs transition to direct lending, a new set of skills is needed. Credit risk, operational risk and administrative costs (particularly in the case of retail programs) are likely to increase which could negatively impact financial indicators. SOFIs are also increasingly venturing into commercial sectors to support activities in underserved markets through cross subsidization. To maintain profitability while serving target market segments, many SOFIs have diversified their activities. For example, Positiva has developed commercial products such as life insurance (in addition to its focus on occupational hazard and underserved segments), while FNA loans to higher income households account for about half of its loan portfolio (albeit its focus is on lower income households), and public asset managers compete with private ones for the administration of collective investment schemes funds and business structuring. In the creation of GB, significant emphasis has been placed on the ability of the group to compete with other financial conglomerates given its size which will reinforce this trend (see discussion on competition neutrality). 18. The rationale for the operations of several INFIs appears weak, while lack of information on the activities of the sector hampers their assessment. INFIs can exploit their presence and knowledge of the territories to structure and fund municipal infrastructure and economic development projects. 13 However, given that many of the INFIs are very small, they play a minor gap- filling role focusing on administration of public enterprises, payroll loans for public sector workers, treasury loans to public administration, invoice discount, microcredit and other functions, which could be served by private institutions. Through Convenios for administration of monetary resources, INFIs can obtain cheap funding that allows them to compete with SOFIs offering direct loans, as well as private institutions. Public entities can register the resources placed in convenios as executed, albeit the actual expenditure of the funds will take place in a future fiscal year. Convenios can be subscribed 12 Bancoldex began providing direct credit in loan syndications, taking up to 50 percent of project risk and up to USD 30m per project. In 2019 it began venturing in direct retail operations as it absorbed ARCO, a leasing company. Currently, direct lending amounts to about 20 percent of the loan portfolio and it is envisioned to grow to 40 percent in 2026 through expansion of lending to SMEs through digital channels. FINDETER began providing subsidized direct loans to local municipalities, focusing on lower income ones. Its direct loans amount to about 10 percent of total loans. 13 For example, INFIs can fund housing projects in which the municipality provides the land and thus cannot be used as collateral for the developer. For example, IDEA has funded some of this type of projects under project finance structures. Inficaldas supported projects include agroparks, logistic and hydroelectric projects. 19 Colombia with private financial entities as well, but that would require open tender processes, thus public administrations prefer using INFIs. For some INFIs, Convenios represent up to 50 percent of their funding. Weak institutional practices and lack of efficient mechanisms for reporting and control of activities appear to be the main problems of the sector and had propitiated questionable practices of INFIs. 14 Overall, lack of disclosure makes comprehensive assessment of INFIs difficult. Recommendations 19. SOFIs should play a more prominent role in fostering inclusion by expanding the universe of borrowers. Except for a few programs, most of SOFI interventions focus on improving credit terms for borrowers who already have credit histories and could be served by private participants as opposed to bringing new borrowers into formal credit. MSME surveys indicate that while most firms that request a loan get it approved, most firms do not ask for it even if they need it. Informality and lack of financial capabilities are main factors behind MSME self-exclusion from credit markets. However, few public credit programs implemented by SOFIs target first time borrowers or contain graduation provisions to ensure program beneficiaries transition to commercial financial products. Consideration should be given to rebalancing resource allocation from credit subsidies to MSME technical assistance programs as well as to enhance coordination between SOFIs and technical assistance providers. 20. SOFIs should extend their integration of climate-related factors in corporate governance, strategy development, credit screening and selection, and on-going monitoring and evaluation, in line with SFC guidance. SOFI’s should continue to build internal capacity and understanding of climate risks and opportunities at all levels of the institution, with key targets and metrics publicly shared to enhance accountability. The SFCs recently issued key guidance to supervised entities to support climate-related financial risk management at the firm-level, and the SOFIs should adopt this guidance and support implementation of its key provisions. 15 This work could also be further supported and facilitated through the Grupo Bicentenario and existing platforms including the Asobancaria. Colombia’s significant green finance policy advancements, including the development of a green taxonomy, will help improve awareness of the activities and investments that will contribute to Colombia’s climate and environmental goals, including for SOFIs. In addition, the SFC’s adoption of the Sustainability Accounting Standards Board disclosure standards will apply to listed SOFIs, which will improve transparency but also enhance scrutiny surrounding what SOFIs are doing to address sustainability and climate-related issues with their balance sheets. 16 14 For example, see IDEA’s annual loan to the Antioquia Liquor Company while the company was part of the regional government budget (part of the Secretaría de Hacienda de la Gobernación). The loan was given to liquor distributors to buy the liquor improving the company sales. The loan was disbursed directly to the Secretaria de Hacienda and IDEA took the bottles as security. In 2019, that operation alone amounted to 17 percent of IDEA’s portfolio according to Fitch. The operation received public scrutiny in 2018. The Antioquia Liquor Company was transformed into a mixed economy company and IDEA no longer funds its distributors. 15 https://www.superfinanciera.gov.co/jsp/10088401 16 https://phrlegal.com/wp-content/uploads/2021/11/proynorma24-21-1.pdf 20 Colombia 21. SOFIs could also increase focus in fostering competition among private financial providers. Colombian SOFIs could support the development of financing platforms in which all private intermediaries could offer financial services to targeted segments, to foster competition and diminish reliance on subsidies. The current microcredit marketplace under development by Bancoldex is an example of such solutions that could also be applied to other products and segments such as factoring. Auctioning of SOFI resources in some programs (i.e., FAG guarantees) could be explored to ensure funds are allocated to intermediaries offering better conditions to final borrowers. SOFIs should intensify efforts to support non-bank credit providers including by providing technical assistance to them to ensure they qualify as SOFI borrowers with a view to diversify financial sector intermediation. 22. Interventions of SOFIs could be better coordinated to improve efficiency, avoid duplication and ensuring alignment with policy objectives. SOFIs are increasingly venturing in new market segments and products, but coordination could be improved to ensure the institution best positioned implements the new products. While Bancoldex is expanding its direct leasing product, agreement to commercialize it through the BA network could not be reached as BA could offer leasing at lower rates using its own funding. Thus, BA is currently developing its own leasing product. Bancoldex and BA direct loans to MSMEs and small rural producers are guaranteed respectively by FNG (partially owned by Bancoldex) and FINAGRO (through its credit guarantee scheme FAG) which could perhaps be better used by private intermediaries while public ones could assume and manage the risk directly. If found appropriate, part of the capital of FNG and FAG could be transferred as funds to these institutions to cover credit risks so that administration of such resources by the institution that originates the credit supports incentive alignment (see section on specific institutions). Bancoldex, FINDETER and FINAGRO offer products to municipalities or municipal enterprises. Grupo Bicentenario was created with the intention to exploit synergies and realize efficiencies, but the operationalization of the group has been delayed (see section on ownership framework for SOFIs). 23. The legal and regulatory framework for operation of INFIs should be reviewed for them to refocus on developmental activities and gap-filling/market-making roles, reduce potential distortions and improve their governance and disclosure. As a first step, an in-depth review of INFI functions and performance should be conducted to assess opportunities for INFIs to support economic development and evaluate their current performance. The insights of such assessment can serve as the basis for the legal and regulatory review. The new legal framework should ensure that INFIs have a clearly formulated developmental mandate and that their activities target underserved segments in which INFIs have a clear comparative advantage, not arising from regulatory arbitrage considerations, by introducing appropriate disclosure and accountability mechanisms. Additionally, activities undertaken by INFIs may be limited, for example in the retail area, to further ensure alignment of instruments with objectives. Consideration could be given to require a minimum rating for INFIs to be able to attract funds from or sign Convenios with public institutions. 17 Only those INFIs operating with their own equity and funding from national or foreign DFIs would be exempt from 17 If such minimum rating is set at AA, this would allow them to administer public sector liquidity surplus as well, which triggers oversight by the SFC. 21 Colombia rating requirements. This would not only improve incentives for effective risk management, but it would also automatically enhance disclosure of their operations. Amendments should be also introduced to ensure that human resource policies are conducive to hiring and retaining good caliber professionals through the political cycles. 24. Interest rate controls and mandatory investment requirements should be reviewed to limit distortions. Interest controls have well-documented negative effects on overall credit supply and financial inclusion as banks reallocate credit from riskier borrowers to larger firms and the state. 18 The negative effects are stronger the more binding is the interest rate ceiling on bank operations which is more likely to occur with fixed caps than with caps related to industry averages. A study on the effects of interest rate ceilings in Colombia for the period 1996-2006 found results consistent with the literature of the effects of this type of measure, with other policies such as the financial transactions tax, reserve requirements and mandatory investments also affecting financial depth negatively 19 . Currently market interest rates are well below interest rate ceilings, except for credit cards suggesting that usury ceilings and housing interest rates ceilings are not restrictive. Pending results of rigorous studies on the effect of current usury and housing interest rate ceilings, consideration could be given to calculate different ceilings for banks and non-deposit taking credit providers. This would help develop an ecosystem of alternative credit providers which typically charge higher rates than banks and focus on riskier segments as they face higher funding costs. The current agricultural policy that provides heavily subsidized lending to small rural producers through a tax on deposits introduces significant distortions. At the current rate, credit to small producers appears substantially rationed. Furthermore, mandatory investment requirements likely increased lending rates for all borrowers. Consideration should be given to progressively increase interest rate ceilings and returns on TDAs. During the transition, the amount invested in TDAs could be increased to ensure the flow of resources to the sector. 20 FINANCIAL AND ECONOMIC PERFORMANCE SOFIs Financial Performance 25. SOFIs report healthy financial soundness indicators. SOFIs in general are well capitalized (See Table 3). BA contributed to the capital of Grupo Bicentenario, resulting in a deterioration in the bank capitalization, partly reversed with the early adoption of Basel III in 2020. Institutions providing mostly wholesale lending have very low non-performing loan (NPLs). In the case of BA, asset quality indicators compare unfavorably with private banks given its focus in riskier segments such as small 18 https://openknowledge.worldbank.org/bitstream/handle/10986/34672/Interest-Rate-Repression-Around-the- World.pdf?sequence=1&isAllowed=y 19 https://www.repository.fedesarrollo.org.co/bitstream/handle/11445/1107/Co_Eco_Junio_2008_Estrada_Murcia_y_Pe nagos.pdf?sequence=4&isAllowed=y 20 Gutierrez, Eva; Reddy, Rekha. 2015. Expanding Opportunities for Rural Finance in Colombia. World Bank, Washington, DC. © World Bank. https://openknowledge.worldbank.org/handle/10986/23766 License: CC BY 3.0 IGO. 22 Colombia agricultural producers and rural areas. However, asset quality has improved with a declining NPL ratio of 6.8 percent in 2021 (from 7.7 in 2018), reflecting improved risk management. The bank has been recovering loans subject to forbearance measures during the pandemic and the share of restructured loans has declined, standing at 4.5 percent of total loans. NPLs are well provisioned in all SOFIs. All SOFIs reported profitability in the last five years. BA has the highest return on equity of any bank in Colombia as it has a low-cost funding base, large investment portfolio of public securities that provide an important source of income, and lower capital relative to assets. Furthermore, BA is only allowed to provide a service at below cost if a budgetary compensation is provided. 21 Table 3: SOFIs Selected Financial Soundness Indicators: Financial Soundness Solvency Provisioning Indicators, June 2021 ratio (%) NPLs (%) Ratio (%) ROE (%) Banco Agrario 15.67 6.84 155 32.8 Bancoldex 18.45 2.38 106 4.0 FINDETER 33.06 0.40 180 3.5 FDN 77.35 0.00 366,727% 4.2 FINAGRO 31.75 0.00 44,307 6.4 FNA 81.38 5.36 103 4.8 Caja Honor 11.82 0.01 16,718 2.3 Icetex N.A. N.A. N.A. 1.9 Enterritorio N.A. N.A. N.A. 2.2 Private Banks (total) 20.29 4.60 159 10.8 Source: SFC 26. INFIs supervised by the SFC are also well capitalized and profitable. For example, the capitalization ratio of IDEA exceeded 29 percent at end-2020 and return on assets stood at 1.8 percent. Given the nature of operations, the 20 largest creditors of IDEA concentrated 77.2 percent of the total loan portfolio. NPLs were relatively high at 8.2 percent but were fully provisioned for. All loans are collateralized, half of them with assets placed in a trust. 27. Information on the costs of state interventions in the financial sector is not systematically monitored and disclosed. Information received on the subsidies provided to SOFIs and interest rate support programs was not comprehensive. 22 The fact that SOFIs do not calculate and report profitability excluding subsidies and that no institution monitors and discloses the total amount of subsidized credit in Colombia makes it difficult to collect this information. Only one SOFI indicated it calculated its ROE excluding subsidies, as well as for the other SOFIs for comparative purposes, but this calculation is internal and not disclosed. 21 Article 235 of the Estatuto Orgánico del Sistema Financiero. 22 Subsidies either from budgetary resources or access to funding at below market rates from government loans or mandatory investments remunerated at below market rates. 23 Colombia Economic Performance of State Interventions 28. There is no systematic monitoring of State interventions or programs which prevent their rigorous evaluation. Furthermore, existing evaluations are not disclosed. There is no single source for aggregate and user-friendly information on public programs to support access to finance and their costs. Currently, the National Planning Department (Departamento Nacional de Planeación, DNP) does not formulate multi-annual plans to conduct a comprehensive evaluation of the economic impact of public credit programs on productivity, income and employment. No impact assessment of COVID programs is being undertaken beyond monitoring of disbursed amounts and number of beneficiaries. Some programs have been evaluated in the past, but without clear criteria for their selection, such as their size or direct relationship to priority policy objectives. Impact studies are not always published. 23 The MHCP is not aware of reviews of public credit programs. There has not been a review of the effects of interest rate caps since 2006. There is no evaluation of the impact of mandatory investment coefficients on interest rates and their impact on total credit, investment, and employment. Most SOFIs have a dedicated monitoring and evaluation (M&E) unit, typically monitoring performance indicators with a focus on outputs (e.g., amounts disbursed, number of clients served, etc.) but rarely looking at outcomes in terms of economic impact (e.g., jobs created, sales, productivity, etc.) or increased financial inclusion (e.g., number of new borrowers brought into formal credit, number of graduated borrowers, etc.). Few conduct evaluations of economic impact of their activities. Existing M&E units report to management instead of reporting directly to the Board. Recommendations 29. Monitoring of public credit support policies and programs, of SOFI activities and disclosure of costs should be substantially strengthened. To monitor the scope and costs of public policies and programs, information on credit support programs and on subsidies of any kind provided to SOFIs and private financial institutions to support credit activities should be systemically compiled and reported. The ARCO platform operated by the DNP that contains information on programs to foster competitiveness should include all finance programs. Profitability of SOFIs excluding subsidies should be calculated and disclosed to assess their performance and the extent to which they rely on budgetary and interest rate support to conduct operations. This transparency is essential to assess the cost-benefit of state interventions. In Brazil for example, calculation of the subsidies received by BNDES (a bank that always reported healthy profitability) through treasury loans at below market rates, triggered a discussion on the cost-benefit analysis of such interventions that propitiated policy reforms. While the cost of state interventions in Colombia is likely much smaller, clear accounting of the costs is important, particularly as debt accumulated during the pandemic constrains fiscal space. 30. A strategy for systematic and rigorous impact evaluation of public credit programs and policies should be designed and implemented. The strategy could be designed by the DNP in 23 In 2019, a study was conducted on the effect of Bancoldex interventions on small firms. The study found such interventions increased value added but it was not published. 24 Colombia collaboration with stakeholders and implemented by SOFIs and agencies responsible for the policies and programs in collaboration with academia. Consideration should also be given to disclosing the beneficiaries of subsidized public credit programs so that academics could use existing public databases (e.g., information on public listed companies, social security and tax administration) to independently evaluate the impact of such programs as done for example in Brazil. Grupo Bicentenario should also formulate a strategy for the M&E function at the group level following international best practices that would facilitate aggregate monitoring and disclosing of SOFI activities. A central M&E unit could also support the collection of available system wide information to monitor trends in non- beneficiary population to conduct means analysis as part of key performance indicators and expand them beyond outputs. Information on beneficiaries could also be collected from existing sources or beneficiary surveys integrated in the loan/program administrative process. OPERATIONAL ENVIRONMENT Regulation and Supervision of SOFIs 31. SOFIs in Colombia are constituted under different legal forms which has operational implications. Colombian SOFIs are either mixed economy companies (Sociedades de Economía Mixta) or industrial and commercial state-owned enterprises (Empresas Industriales y Comerciales del Estado). 24 The former can have both public and private capital and private company law applies to them (unless otherwise established in the law authorizing their creation) including in case of liquidation. If more than 90 percent of capital is public, public sector workers regime apply. The latter are governed by their own law and by-laws. They operate under private law, but labor is hired and fired under public sector workers regime. All SOFIs can be liquidated by Presidential Decree which would support prompt resolution, and many have issued subordinated instruments that can be converted into equity. The Draft Law on Payment Systems and Capital Markets (PL No. 413 of 2021) has a chapter on SOFIs that envisions changes in their legal form to transform them into mixed economy companies. However, in the case of FNA, the draft was amended during parliamentary discussions as it was considered to open the door for the privatization of the company. 32. SOFIs are supervised by the SFC, largely as private financial institutions, but with some differences arising from their state-owned nature. Supervision for Enterritorio and ICETEX is limited to monitoring their financial situation and those relative to the funding and provision of student loans respectively. 25 For the rest of SOFIs, regulation is similar to that of private institutions regarding capitalization, foreign exchange operations and concentration exposure. Banco Agrario adopted Basel III in 2020, while Bancoldex, Finedeter, FDN and FINAGRO operate under Basel II. SOFIs need to either comply with liquidity requirements or have models for the administration of liquidity risk approved by the SFC. SOFIs operating wholesale develop an internal methodology for the determination of loan 24 All SOFIs in Table 1 except for FNA, Enterritorio, Caja Honor and Icetex and mixed economy companies. 25 Currently the SFC's supervision on “Icetex” applies only to financial operations related to educational savings certificates (TAE, for its acronym in Spanish), under numeral 2 art. 277 EOSF. 25 Colombia reserves that is approved by the SFC. Members of the Board and management appointed by the President of the Republic do not need to be vetted by the SFC. The SFC actively supervises SOFIs requesting modification to models and assumptions used by SOFIs for the constitution of reserves. However, more depth in the on-site inspections of SOFIs granting direct credit would we appropriate to detect any potential loan evergreening. In addition, SOFIs are subject to the oversight of the Comptroller Office, in regard to the use of public funds, and the General Prosecutor Office. Ownership Framework for SOFIs 33. Colombia has been working for several years to reform its ownership framework for state owned enterprises and financial institutions. How SOFIs are owned and controlled is a crucial feature of their governance. International good practice recommends that SOFIs and other public enterprises be owned and controlled by a strong central Ministry, Agency, or holding company. Key successful factors for a strong owner include strong, commercially oriented and management; operational autonomy and independence; and high degree of accountability and transparency. In Colombia, reforms have been underway since 2015. The process began with the drafting of a state ownership policy in 2015 (published as CONPES 3851). The General Directorate of State Participations (Dirección General de Participaciones Estatales, DGPE) of the MHCP was created to act as a central ownership entity for public enterprises, in line with the Organization for Economic Cooperation and Development (OECD) Guidelines for the Governance of State-Owned Enterprises. 26 The OECD accession process was very important in encouraging the reform. DGPE was originally intended to be a temporary institution to move the process forward while a permanent body was created. However, it remains in place as the focus of the reform effort and is working to maximize the value of the portfolio, and act as a “a catalyst for a wide variety of public policies that are executed or channeled through these entities.” It has 15 staff and is working to implement international good practices. 34. As part of the on-going reforms, the MHCP created the GB in 2019 to act as a holding company for state owned financial institutions. The GB is a new public enterprise, legally governed by private law. The GB is 99.99+ percent owned by the MHCP and is supervised by DGPE. 27 Initial capital for the Group (in the amount of COP 700,000 mill., about USD 180 million) was divested from Banco Agrario’s capital. The capital was subsequently reduced by half. 35. The founding decree 28 and corporate bylaws establish the basic corporate governance arrangements for the GB. The key governance bodies of the GB are the General Meeting of 26 Colombia has a significant public enterprise sector. As of the end of 2019, the State had direct ownership in 105 public enterprises, of which 40 were majority owned. The companies generated COL 95 billion in revenue (about $25 million) and employed over 28,000 people. See DGPE annual reports on public enterprises. 27 A small number of shares are held by the Ministry of Agriculture and Corabastos SA, as a result of the transactions that provided the capital to create the GB. 28 Article 331 of Law 1955 of 2019 issued the 2018-2022 National Development Plan, "Pact for Colombia, Pact for Equity". The Plan granted powers to the President of the Republic to create an “entity of the Executive Branch of the national order responsible for the management of the public financial service that affects higher levels of efficiency. In accordance with this provision of the Law, Decree 2111 of 2019 created the legal entity “Grupo Bicentenario S.A.S.”. 26 Colombia Shareholders (GMS), the Board of Directors, and the President (Chief Executive Officer). The Board of Directors consists of seven members, elected by the GMS, with the President appointed by the Board. At least two of the members must be independent (although independence is not defined by the decree). The current Board was appointed in 2019 and is composed of five officials of the MHCP and will be in place until a Board is elected by the GMS. The first President was also temporarily appointed by decree in 2019, and later replaced by another temporary President by decree in 2021 (Decree 681 2021). The Board met four times in 2020. An organizational structure for GB has been drafted, including position descriptions, remuneration policy, and business processes. This structure also requires Board approval (as of mid-2021). In general, the provisional appointments to the board of GB, and the lack of approved strategy and policies, imply a lack of commitment to the project, and a lack of autonomy. A permanent board and President should be appointed to the GB, with strong commercial banking and other financial expertise. 36. The initial consolidation of ownership is underway. In September 2020, the first eight companies were added to the Group. Six more will be added in the future, as early as 2022. To add companies to the Group, the shareholding of each state-owned financial institution is first re- registered in the name of the MHCP, and then contributed by MHCP in kind to the capital of the Group. These transfers come with an important caveat – the financial institutions “will maintain in their corporate governance the representation of the sectors to which they were attached or linked”. 29 37. The stated goals of GB include the consolidation of shareholding and building synergies among members of the Group. • Consolidate shareholding in the SOFIs in the GB and restructure and rationalize the portfolio. The GB furthers the CONPES 3851 goal of ownership centralization, by bringing together all financial institutions under the MHCP and the GB, regardless of the past ownership stakes of the former line Ministries. GB can now restructure and rationalize the portfolio to improve their performance. • Increase coordination among the SOFIs to strengthen performance and delivery of services. The goal is to create “the third largest financial holding in Colombia”, a loose Group that works together for a common purpose, coordinates strategies, prevents “mutually contradictory objectives”, sets guidelines, improves communication, and provides shared services to Group members. A frequently mentioned benchmark is Colombia’s Grupo Aval. Past coordination among SOFIs was considered to be limited because companies reported to different Ministries. The new GB will “strengthen the generation of value for shareholders and all stakeholders” and “strengthen the ability to compete of companies with majority state participation”. 30 • Increasing scale and profitability by working through each other’s branch networks. One cited example was to build alliances between banks and insurance companies and exploit the large branch network of Banco Agrario. 29 MHCP Decree 492, March 2020 30 Grupo Bicentenario, Informe de Gestión, 2020. 27 Colombia • Implement modern corporate governance practices and improve transparency. This includes separating the ownership function over financial institutions from the regulatory and public policy functions of the Ministry. This is very much in line with the guidance of the OECD and good regulatory practice in general. • A less frequently mentioned goal is to “correct market failures” and “promote access to finance and social inclusion to the financial system.” 38. The GB is now working to restructure some of its holdings. The GB is now working to consolidate and reduce duplication in its holdings, including among the three asset managers and the two insurance companies. However, a much more comprehensive and ambitious review should be conducted (see discussion in the section on specific institutions). 39. A strategic plan which further defines the goals and rationale of the Group is under development. A working group consisting of staff from the MHCP and the GB Board and management has developed a draft strategy, but it does not yet appear to have been formally approved. 31 The strategy appears to be largely “commercial” in nature. Significant emphasis is placed the size of the Group. There are potentially some benefits of increasing competition in some areas of the financial sector – although this has not yet been formally explored. There is some mention of “gap filling” and financial inclusion goals. But there is less emphasis (in publicly available information) about establishing a clear mission and rationale for the SOFIs in the portfolio, including identifying / addressing market failures, filling gaps and improving access to finance. 40. There are opportunities for synergies, but there are limitations and risks as well. There is significant debate and discussion among stakeholders about the mission and role of the GB, and the opportunities for synergies and adding value. There are potential synergies for the institutions serving retail customers in underserved areas (e.g., providing insurance services through the BA branch network). But building a business on the basis of an existing branch network is “easier said than done”. For example, there are many examples of bancassurance-type strategies that have not been fully successful. In the current environment, when customers (including low-income customers) are increasingly accessing financial services through a variety of digital platforms, the branch network may have less value. For entities that do not serve retail customers and all the entities with specialized business models (including all the wholesale development banks), the ability of the different members of the holding to add value from each other’s networks may be more challenging. There are possibilities for adding value through shared services but there are risks as well. Many of the strategy documents and annual reports discuss the question of shared services and synergies at some length. Information technology (IT) is put forward as an area where there could potentially be major cost savings. In theory, common IT platforms, data centers, and networks could reduce costs to all of the members of the holding. However, potential risks are also high. The different business models of the SOFIs may different IT solutions. 31 This summary is based on the Group’s 2020 annual report. 28 Colombia Corporate Governance Regulation Applicable to SOFIs 41. The corporate governance framework for SOFIs is driven by law 489/98 on public administration, company law, the policies and preferences of the government (as shareholder), regulations of the SFC, and decisions of each board of directors. for the state-owned financial institutions are generally founded as mixed economy companies, as defined in law 489 of 1998. The corporate governance framework is further regulated by the Commercial Code, the SFC (as regulator), and by the MHCP (as owner). SFC regulation includes mandatory requirements for supervised entities (vigilados) including the SOFIs. The Country Code of Corporate Governance applies to SOFIs that are issuers of securities. 32 to apply the country code of corporate governance (2014). While the Financial Conglomerate Law applies to the GB, the SFC required to issue a regulation explicitly stating that a particular group is subject to that law and in the case of GB the regulation is still in drafting albeit is expected to be issued soon. In addition, the MHCP has issued several norms for public enterprises, which apply to SOFIs. To date, GB has not issued any additional corporate governance policy of its own. 42. Although a detailed assessment was not carried out for this technical note, the corporate governance legal and regulatory framework for supervised entities appears to be generally in line with international good practice. Under the Commercial Code, Colombian companies and financial institutions must establish a one-tier board and oversee the legal representative (chief executive officer, CEO). Boards can elect alternates (suplentes) whose profiles have to match the composition of the principal board. Under Law 964 of 2005 (Article 44), the boards of supervised financial institutions (including the relevant SOFIs) must have between 5 and 10 members, 25 percent of the members must be independent, and the legal representative cannot be the Chairman of the Board. According to the Estatuto Orgánico Financiero, at least 50 percent of board members should be non-executive directors. Board members and managers of supervised financial institutions must apply for the authorization of the SFC before becoming officers of the company. 43. The Country Code of Corporate Governance (Código País) is also applicable to SOFIs that issue securities. The Código País, updated in 2014, consists of 33 measures (Medidas) that cover the full range of international good practice in corporate governance. The Código País is designed to be applied on a “comply or explain”, i.e., companies are not required to comply with its requirements, but are required to disclose any non-compliance. 33 On an international comparative basis, it is an unusual feature of the regulatory framework that this type of “soft law” is applied to regulated financial institutions. On the one hand, the “comply or explain” approach provides an important element of proportionality to governance regulation. It also allows financial institutions to differentiate themselves to shareholders and other stakeholders. On the other hand, many important elements of the legal and regulatory framework are optional. The Board of Directors is responsible for adopting the Código País, while its implementation is a joint responsibility of the Board and the management. Relevant companies and financial institutions report on their corporate governance practices through 32 The Country Code (Codigo País) currently applies to Bancoldex, Finagro, Findeter, and Banco Agrario. 33 See next section for info on level of compliance. 29 Colombia the Encuesta (survey exercise) of the Código País, and the SFC makes these reports publicly available on the SFC website. 44. Supervised financial institutions must have independent audit committees and are encouraged to have risk committees. Supervised financial institutions are required by the SFC’s Basic Legal Circular (Circular Básica Jurídica) to have an audit committee, with 3 members and a majority of independent directors. The Código País encourages the establishment of a risk committee and other committees. SFC regulation and the Código País also establish the requirements for internal controls. Supervised entities are required to establish the core control functions of risk management, internal audit and compliance. The circulars lay the framework for internal control systems, defined as the set of policies, principles, standards, procedures and monitoring and evaluation mechanisms established by the board and senior management The Circular defines the responsibility of the boards, the audit committee, the CEO, the internal auditor, and the compliance director. Supervised entities are required to instill a sense of integrity throughout the organization, and to issue a code of conduct. The Board and senior management are expected to show commitment and leadership on internal controls and ethical values. Supervised entities should have a risk management unit. 45. In general, the corporate governance framework for SOFIs requires or encourages Boards to carry out the functions required by the international good practice. The Código País defines the role of the board by identifying its key functions and responsibilities. Boards are responsible for i) reviewing and approving corporate strategy, ii) monitoring management performance, iii) developing a risk policy and overseeing the development of a risk management function, iv) setting performance objectives and key performance indicators, and v) reviewing and approving major capital expenditures. The DGPE is also involved in the drafting and monitoring of each SOFI’s strategic plans. 46. In theory, SOFI Boards appoint the President/CEO – but there are many exceptions. In general, Law 489/98 gives the President of the Republic the power to appoint the President of each SOFI. However, the statutes that create the individual SOFIs appear to override Law 489/98. Measure No. 24 of the Código País recommends the establishment of a Nomination and Remuneration Committee, which will, among other functions, ”(…) propose the appointment and removal of the President of the company or person acting as well as their remuneration." As shown below, about half of the SOFIs surveyed report that, according to their individual statutes, the President of the Republic appoints the President (CEO) of the SOFI, who is treated as a “public servant”. This is problematic for the accountability of the CEO of each SOFI, and for the possible politicization of the position. 47. The Código País establishes a requirement for board evaluation. Measure 19.9 states that “every year, the Board of Directors assesses the effectiveness of its work as a collective body, that of its committees, and that of its members individually considered, including peer evaluation.” Every other year, the boards should use an external facilitator for the board evaluation process. 48. The revisor fiscal (sometimes translated as “statutory auditor”) is a traditional Colombian institution that carries out a number of different activities in addition to the auditing of financial statements. Financial institutions are required to appoint a revisor fiscal to 30 Colombia conduct an annual audit of their financial statements. The revisor fiscal is required to certify that the enterprise’s internal control system is effective, to safeguard the enterprise’s assets and ensure that all the institution’s obligations to various government agencies (including tax administration) have been met in a timely way. 34 49. DGPE has set some basic corporate governance policies for all public enterprises. DGPE has established a basic framework for board appointments. Decree 2032 of 2018 created a committee responsible for the nomination, election and performance evaluation of board members, composed of the Minister, the Secretary-General of the MHCP, and the Director of the DGPE. The DGPE acts as secretariat for the Committee. However, as shown below, many board appointments do not appear to be under the authority of the DGPE (or the GB) but remain in the hands of the traditional line ministries, or the President. The DGPE has also put in place corporate governance good practice guidelines for public enterprises (including SOFIs). This includes a “decalog” of 10 high-level good governance practices (see Annex Table A2). The recommended practices include reporting on corporate governance, establishing key policies (including for the appointment of management), requiring a formal evaluation of the internal control system, and giving the Board “responsibility for strategy” aligned with the vision of shareholders. The DGPE has also established policies for the characteristics of good board members, and for the appointment of the revisor fiscal (both presented in Annex Table A3). 50. However, the full adoption of international good practice is incomplete. While progress has been made, consolidation of shareholding under one owner and the creation of a performance monitoring and measurement system under the GB is not yet in place. GB (as the nominal owner of the SOFIs) does not appear to have adopted formal corporate governance policies of its own. In addition, the division of labor between the GB and the MHCP in setting of policies for the SOFIs can be clarified. The MHCP is responsible for setting policies for all public companies in its portfolio. But it is unclear if the Ministry’s policies (for example, the decalogue of corporate governance practices) or remuneration policies also apply to the SOFIs within the GB, or to the GB itself. The fact that the acting board and management of GB are staff seconded from the MHCP also blurs the distinction between the two. SOFI corporate governance practices 51. This section reviews the adoption of good corporate governance by SOFIs. It is based on several sources of information: i1) a review of individual SOFI corporate governance codes, summarized in Table 3 below, ii) a review of SOFI compliance with the decalogue of corporate governance good practices, compiled by the DGPE, iii) interviews with key institutions, and iv) reviews of SOFI websites. 35 34 More details in the FSAP Detailed Assessment Report: Basel Core Principles for Effective Banking Supervision. 35 Corporate governance codes for 12 SOFIs were provided. 31 Colombia 52. The survey confirms that SOFIs follow many elements of corporate governance good practice. In general, SOFIs follow the SFC’s mandatory requirements, as well as the “decalogue” of the MHCP. SOFIs also appear to apply many of the recommendations in the Código País (although adoption is not universal). The SOFIs surveyed follow independence requirements and have audit and risk committees in place (see Table 3 below). The MHCP decalogue compliance report presented in the Annex (Table A2) shows full compliance, except around the appointment of the President (CEO) (see below). 53. In practice, the boards of SOFIs appear to play a relatively central and strategic role. Interviews with the key banks suggests that most boards do appear to guide management in developing and ultimately approving corporate strategy. SOFI boards interviewed stated that their main role was to provide managerial oversight. All members of the Board of Directors must have skills that allow them to exercise an adequate performance of their functions. Among these are analytical and managerial skills, a strategic vision of the business, objectivity and ability to present their point of view and ability to evaluate senior management or management cadres. 54. SOFI boards are relatively small by international standards. According to the surveyed SOFI corporate governance codes as presented in Table 3, 8 SOFIs have five members, 2 SOFIs have 7 members, and 2 SOFIs (BA and FDN) have 9 members. This overall average size is like in the private sector. 36 But five-member boards could raise concerns for financial institutions, because they may not be large enough to accommodate the demands of the various committees of the boards. 55. Most SOFIs also appoint alternate directors. Under Colombian law, alternate directors can be appointed to the Board. They must have the same qualifications as other directors. Alternate directors raise some corporate governance concerns, as they may confuse the duties of individual directors to their banks (for example, it is not clear if the alternate director votes according to his own conscience, or on the instructions of the main director), and because they are expensive (they receive similar remuneration to the main directors). The Código País (Medida 15.1) supports these concerns and recommends that companies and financial institutions do not appoint alternates. The surveyed SOFI corporate governance codes indicate that five of the SOFIs surveyed do not have alternate directors, but 7 SOFIs do have at least some alternate directors. In general, SOFIs with more sophisticated governance arrangements (e.g., FDN) do not appoint alternates. 36 Corporate Governance ROSC for Colombia, World Bank, unpublished. 32 Colombia Table 4 – Key Elements of the Corporate Governance Framework for selected SOFIs Fiduprevisor Fiduagraria Banagrario Fiducoldex Segurexpo Enterirotio Bancoldex Findeter Previsor Finagro Icetex FDN Supervised by Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes SFC? Board of Directors Size 9 5 7 9 5 5 5 6 5 7 5 5 # executives 0 0 0 0 0 0 0 0 0 0 0 0 # independents 5 3 3 3 ? 2 2 0 3 0 2 1 Alternates? No Yes No No Yes Yes Yes Yes Yes No Yes Yes Independent No No No No No No No No No No No No chair? Management Appointed by ? No Yes No Yes Yes Yes No No Yes No No board? Audit committee Yes* Yes In place? Yes Yes * Yes Yes Yes Yes 3 Yes Yes Yes Size 3-5 3 3 ? 3 ? 4 3 3 Independents ? Maj ? >1 ? Maj >? >2 ? ? Risk committee Yes* ? In place Yes Yes * Yes Yes ? ? ? Yes Yes Yes Size ? 3 ? 3 ? ? >? ? Independence? ? No ? >1 ? ? ? ? Source: Corporate Governance Codes, SOFI websites. “?” indicates that information about the relevant item was not found in the Corporate Governance Policy of the respective SOFI. 56. According to the individual SOFI statutes, board composition is still based on the traditional relationships with line Ministries. SOFI board composition (as of end 2020) is presented in the Annex (Table A1). Current board composition reflects the impact of MHCP Decree 492 of March 2020, which resulted in the first transfers to the GB. That Decree states that the financial institutions “will maintain in their corporate governance the representation of the sectors to which they were attached or linked”. Board members are appointed through direct appointments by Ministries and other stakeholders, according to each SOFI’s statutes, as well as by the shareholder meeting (using the “quotiente electorale”, or cumulative voting system). Table A1 indicates that: • The traditional board structures have not changed “on paper”, as the line Ministries continue to have significant authority over Board appointments (especially appointments of Chairmen). 33 Colombia By statute, many directors (and most Board chairs) are either the relevant line Minister (or his or her appointee). The authorities argue that the government representatives assist in the implementation of sectoral public policies, established every 4 years through the National Development Plan. • The President of the Republic also has a significant formal role in Board appointment in many SOFIs. • Many of the boards are also “stakeholder boards” in the sense that many of the key (politically powerful) stakeholders are separately represented on the Board. For example, for the Board of Bancoldex, the exporters association is allowed to appoint one representative. Stakeholder board members have been criticized in other countries for acting in the interest of the group that appointed them, rather than in the interest of the SOFI. 57. However, MHCP has used the flexibility in the SOFI statutes to remove Ministers from the boards. The OECD assessment of corporate governance practices (carried out as part of OECD accession process) criticized the appointment of Ministers to the boards. Ministers on boards can politicize Board processes, and Ministers are often too busy to fully commit to their role as directors. In response, Ministers have been removed as chairs from the boards. For example, Table 5 below shows (in the first column) the statutory composition of the Board of Directors of Bancoldex, and (in the second column) its actual board members. The traditional Chairman (the Minister of Trade) has delegated his or her appointment to the Legal Advisor in the same Ministry. 58. The removal of Ministers from the boards was a positive step forward, but the new nominal shareholder (the GB) still has relatively little authority over Board appointments for most of the SOFIs. Only Findeter and FDN have “clean” board compositions (where all the members are appointed by the Shareholders Meeting). For Bancoldex, according to the Statute, only one of the 5 directors is appointed by the Shareholders Meeting (i.e., the GB). 59. Remuneration of the Board of Directors is established by MHCP Resolution. Remuneration for both Principal and Alternate members of the Board of Directors will be paid equally for their attendance at ordinary and extraordinary meetings and at the supporting Board Committees, in accordance with the remuneration scheme of Resolution No. 1290 of June 23, 2020. For example, for Bancoldex, the monthly fee is now set at 4 legal monthly minimum wages (4 SMMLV), or approximately USD 250, plus a similar amount for each committee meeting. In addition, the SOFIs assume expenses for accommodation and for training. 34 Colombia Table 5: Bancoldex –Statutory and Actual Board Composition Statutory Composition Actual Composition (Corporate Governance Code) (2020 Corporate Governance Report) The Minister of Trade, Industry and Tourism Legal Advisor to the Minister of Commerce, Industry and Tourism, delegated by the Minister of Commerce, Industry and Tourism. The Minister of Finance and Public Credit General Director of Public Credit and National Treasury, delegated by the Minister of Finance and Public Credit. The legal representative of the trust referred Appointed by the General Assembly of Shareholders. to in Article 283 of Decree 663 of 1993 A representative of the private sector (…) Representative of the private sector, appointed by the signed by the President of the Republic President of the Republic. A representative of the private (…) elected by Representative of the private sector, elected by the the associations of exporters exporters’ association. Source: Corporate Governance Code for Bancoldex (received from MHPC), and 2020 Corporate Governance Report for Bancoldex. 60. The Corporate Governance Codes indicate that in many SOFIs, the Board of Directors does not have appointment authority over the President (CEO). As shown in Table 4, according to statutes for 5 of the 12 surveyed SOFIs, the President (CEO) is appointed by the President of the Republic. For example, for ICETEX, “(…) the legal representation of ICETEX shall be in charge of a President, who shall be an agent of the President of the Republic, of his free appointment and removal, who shall take possession before him and shall have in charge of the administration of the entity”. In these cases, the President (CEO) is described as having the status of “public employee”. This violates the basic principle of the accountability of management to the Board of Directors, and greatly weakens the Board’s oversight role. 61. While SOFIs are already required to make significant disclosures about their governance, some improvements can be made. The Corporate Governance Policies produced by the SOFIs (and required by MCHP) are a welcome step. However, there is a high volume of required information, and it is currently presented in a somewhat fragmented way. Some pieces of information are currently not required – for example, it is not always clear who is the independent director, what is the definition of an independent director and who has appointed the legal representative. The Corporate Governance Policies (and reports) do not necessarily summarize the Board of Directors’ regulations and the Committee regulations, making it difficult to get a full picture of the governance of each institution. Competitive Neutrality Considerations 37 62. SOFIs in general have limited regulatory advantages and their impact on competitive neutrality appears to be limited so far. On the funding side, FNA and Caja Honor have a monopoly 37 See Technical Note on Competition in the Financial Sector for a more comprehensive discussion on competition issues. 35 Colombia in the administration of severance payments for public sector workers, FINAGRO receives resources from TDAs, FDN administers the resources of a public infrastructure fund (FONDES) and BAC has the monopoly on the administration of judicial deposits 38. Only the liabilities of FNA carry an explicit sovereign guarantee, while for other SOFIs, their liabilities can be guaranteed by the Government on a case-by-case basis (mostly in their operations with multilaterals such as the World Bank). However, the small size of FNA and BAC in the banking sector and their large share of operations in low-income housing and rural areas limit competition concerns. Most subsidized loans provided by SOFIs are either wholesale loans to financial intermediaries or, in the case of BAC, small rural producers loans which few private institutions are willing to serve at the current regulated rate. The fact that FDN can only fund 25 percent of projects and must crowd in private sector finance for the remaining 75 percent limits competitive neutrality concerns. 63. Market participants perceive SOFIs as complementary to the private sector as opposed to competitors. New direct lending activities of credit SOFIs could raise competitive neutrality considerations if they were to receive subsidies. Market participants value the focus of SOFIs in underserved segments and wholesale operations and, so far, do not perceive unfair competition from SOFIs. Wholesale institutions venturing into direct lending (i.e., Bancoldex and FINDETER) are deem unlikely to pose competitive threats to private participants given their higher funding costs, unless they operate with subsidies. Recommendations 64. Regulation subjecting GB to the Financial Conglomerate Law should be issued promptly. 65. Clarify the roles and status of both DGPE and the GB. Both DGPE and the GB exist in a kind of legal limbo, as DGPE is described as a temporary institution, and GB’s board and management have been appointed in an “acting” capacity. Accelerating formalization includes: • Updating CONPES 3851 in order to: i) clarify the permanence of the role of the MHCP/DGPE, ii) introduce the role and purpose of the GB (including basic references to improving access to finance and financial inclusion), and iii) establish a clear division of labor between the two. • Clarify and move away from the agreement that was established in 2020 to “maintain the representation of the sectors to which they were attached or linked”. • Appoint permanent boards and managers to the GB, with strong commercial banking and other financial expertise, and ramp up operations (especially around Board appointments). 66. Develop key policies for GB, including: • Prepare a strategy to restructure the portfolio of the GB in order to increase efficiency, avoid duplication and ensure alignment with policy objectives. 38 Judicial deposits collected by Banco Agrario are invested in government securities. Those deposits account for about a fourth of total bank assets. 36 Colombia • Update the mission/vision/rationale for the Grupo that moves beyond commercial goals and includes a mission of filling gaps in the delivery of financial services and building financial access and inclusion. • Prepare an analytical framework to develop a rationale for the different interventions of the State in the financial sector, to guide the Grupo’s strategy and the consolidation process. • Develop a transparent dividend policy. • Develop a monitoring and evaluation framework (including key performance indicators) for the individual institutions based on their strategies and missions. • Convert all SOFIs in the GB portfolio to mixed economy companies, with legal reforms as necessary. 67. Establish world-class corporate governance policies and practices, for both SOFIs and the GB, that build on current SFC and MHCP regulations (and current practices in many of the institutions). The GB should assume the authority implied by its mandate, and assume full authority over Board appointments and corporate governance policy for the SOFIs within its portfolio: • The GB should continue to update the statutes of the individual financial institutions, to give the GB full authority over Board appointments and remove any differences between the statutes and current practice. The new statutes should (as much as possible) remove references to reserving boards seats for other Ministries and move towards a model in which all Board members are appointed by the Shareholder Meetings. • The GB should adopt a formal board appointment policy (or clarify that it will follow the model already developed by the MHCP). The GB should consider engaging outside executive search firms or setting up nomination committees (comprised of individuals from outside of government, if needed) to strengthen the nomination process. • The statutes should allow the Boards of Directors of SOFIs to move towards a model (already in place in about half the SOFIs) that allows them to appoint the President (CEO) of each institution. • The GB should develop a Corporate Governance Policy, which goes beyond SFC regulations, and require the compliance with as many aspects of the Código País as possible. It should build on the Código País and include the medidas related to alternate directors, adoption of risk committees, and board evaluations. Where SOFIs are not able to comply, they should be required to provide detailed explanations as to why not. • The GB should benchmark the levels of remuneration in the private sector for management and Boards of Directors and ensure that the levels of remuneration are sufficient to attract the best applicants. • The GB should systematically review the Corporate Governance Codes and reports produced by the SOFIs and provide comments to improve their quality. The Codes should include key elements of Board and Committee regulations, and the Code of Ethics, in order to allow stakeholders to have a single document that fully describes governance practices. • The GB should periodically review the disclosure of non-financial information on SOFI websites, to ensure that content and quality matches what is required. 37 Colombia 68. As SOFIs venture into direct lending and commercial activities the potential effects of subsidies on competitive neutrality should be carefully analyzed and different options evaluated. For example, making budgetary subsidies available to both private and public institutions through interest rate compensation mechanisms would help maintain a level playing field and increase program execution through a larger network of implementing credit institutions. While higher funding costs of institutions without access to retail deposits limit the possibility of unfair competition in commercial segments, it would be appropriate to formally define what are the commercial and developmental activities of the institutions and formalize pricing policies in both segments. CONSIDERATIONS ON SPECIFIC INSTITUTIONS BA and Finagro 69. Banco Agrario is largely a development bank that operates under commercial bank license, intermediating FINAGRO resources for its developmental loans and providing financial services in rural areas 39. The bank social objective is to fund, principally but not exclusively, the agricultural sector. By law, less than 70 percent of its portfolio can be allocated to non-agricultural activities unless its Board of Directors approves otherwise. The bank provides a variety of products including consumer and corporate loans, public sector finance and microfinance as well as deposit and transactional products but the focus is clearly on agricultural production. At end June 2021, 43 percent of the total BA loans were granted to small rural producers, 27 percent to medium and large agricultural producers and agribusiness, and the rest was non-agricultural. Most of the agricultural loans are funded with FINAGRO loans (about 60 percent of total loan portfolio). 40 The bank has a small but growing consumer loan portfolio (8 percent of total loans) while housing loans are negligible. Commercial loans and microcredit accounted for 51 and 41 percent of the total loan portfolio respectively. Loans to public sector entities (municipalities and public sector companies) account for only one percent of the loan portfolio. The bank has the largest coverage network in Colombia, servicing 97 percent of towns with branches, ATMs and bank correspondents. It is also the only financial services provider in 445 municipalities in Colombia. Thanks to its vast network the bank won the tender for the disbursement of government programs in rural areas. Through Fiduagraria, BA provides rural customers access to investment funds and trust services. 41 The small rural producer loans (provided at regulated rates) and other developmental loans provided under special programs are funded with FINAGRO loans and guaranteed by FAG, ensuring the bank can at least cover costs 39 Banco Agrario and FINAGRO are part of the National System for Agricultural Credit (Sistema Nacional de Crédito Agropecuario), created to formulate the agricultural credit policy and administered by CNCA. 40 Banco Agrario serves large producers in conflict areas that private banks are unwilling to fund. Large producers and producers’ associations can get loans at subsidized rates under FINAGRO special credit lines for certain purposes such as energy efficiency, sustainable agriculture, investments to improve water management, or to implement projects in priority communities (eg. Afrocolombian communities). 41 Land titles can be placed in trust structures used to guarantee loans. 38 Colombia as mandated by law. For other products, the bank can offer competitive rates vis-a- vis other providers thanks to its low-cost funding base. In recent years, the bank has invested heavily in IT to improve transactional services which has allowed the bank to increase deposits. So far, the increase in deposits has mostly translated in an increase in investments. 42 Figure 4. Interest Rates in Selected Products Source: SFC. 70. Interest rate caps for small producers and lack of agricultural insurance limit private interest on lending to small rural producers, providing a role for BA. The small rural producer segment is risky due to income variability. Many small producers do not have commercialization arrangements and agricultural insurance is underdeveloped. Regulated interest rates are not high enough to cover credit costs (including capital cost) even using FAG guarantees, and thus private banks have not developed the necessary specialization to attend the sector even at the expense of increase their investments in TDAs 43. However, small producers close to urban areas and integrated in value chains (about 30 percent of total small rural producers) could be attractive for private banks. 71. FINAGRO is a wholesale development bank administering several policy funds, with BA as its main customer. FINAGRO provides rediscount loans using funding from TDAs to credit providers supervised by the SFC and credit cooperatives supervised by the Superintendencia de Entidades Solidarias. TDA rates are determined by the central bank while the rediscount rates (rate at which FINAGRO lends funds to intermediaries) and rate to final borrowers is determined by the CNCA. 42 Accordingly, the loan to deposit ratio declined from 96.6 percent at end 2019 to 84.3 percent in June 2021. 43 Loans to small producers granted at regulated rates by institutions reduce in 150 percent of the loan amount the TDA investment requirement to provide incentives to cater the segment. 39 Colombia In 2021 FINAGRO had a margin of 100-260 b.p. on that portfolio depending on the type of credit (e.g., for small or large producers) in these operations. TDAs are also used to fund loans under the special credit lines created by the Ministry of Agriculture. These lines are subsidized with budgetary resources and FINAGRO administers and transfer those subsidies to credit providers. FINAGRO administers the instruments for the management of agricultural risks according to the norms issued by the CNCA. These include the FAG and a fund that subsidizes agricultural insurance premiums (Fondo Nacional de Riesgos Agropecuarios, FNRA). Since 2019 FINAGRO also provides funding and technical assistance to unregulated microfinance institutions using the resources of the Rural Microfinance Fund. FINAGRO also administers debt relief programs created through special laws. Under these programs, FINAGRO purchases agricultural loans and restructured them providing long maturities and grace periods and lower (even zero) interest rates. Finally, FINAGRO also invest equity on agricultural projects through a fund of Funds.44 In June 2021, about 80 percent of FINAGRO loan portfolio was placed in BA (83 percent at end 2019) mostly in rediscount lines. About 90 percent FAG guarantees are extended to BA for its small rural portfolio. 72. The rural partial credit guarantee scheme is not financially sustainable. The FAG provides credit guarantees for agricultural loans (both commercial and subsidized rates) as well as to repo and forward operations in the agricultural stock exchange (Bolsa Mercantil de Colombia). The FAG is funded with its own capital, fee income and at least 25 percent of FINAGRO profits. Public agencies also can provide resources to subsidize fees. The FAG covers 50-80 percent of credit risk depending on the size of the producer, charging fees ranging from 1.5-3 percent of the guaranteed amount. In addition, BA often obtained additional guarantees from public agencies, which undermined rigor in the credit origination and monitoring process. In 2018 and 2019, the fund had to cover important credit losses which compromised the ability to continue issuing guarantees and had to receive additional funds from FINAGRO and the Ministry of Agriculture. The World Bank formulated a plan to improve the financial sustainability of the FAG, and several recommendations have been already adopted including (i) elimination of 100 percent coverage through multiple guarantees, (ii) modification of the base to calculate the fee (iii) introduction of incentives to intermediaries for effecting portfolio risk management, and (iv) improvements in FINAGRO system to administer and monitor risks. 45 Despite these improvements the FAG is still losing money. 73. While BA corporate governance framework is effective and compliant with banking system guidelines, the bank is not isolated from the risks of political interference in its operations. The problem is not unique to BA, but the fact that BA collects deposits from the public 44 The FONSA, the Rural Microcedit Fund, and the fund for equity investments are not part of the SNCA. A SNCA fund providing matching investments on agricultural investment loans funded with FINAGRO rediscount loans (Incentivo para la Capitalizacion Rural) is currently not operating as the Ministry of Agriculture is currently allocating resources to the special credit lines. 45 Informe de Evaluacion de Necesidades FAG, World Bank. 40 Colombia and grant loans in a politically sensitive sector involves higher risks. 46, 47 Appointments to the bank management have been at times the outcome of political negotiations among political parties. Political patronage has made difficult in the past to fire staff even when involved in malfeasance. 48 It also created a costly structure of advisors, many of whom lacked banking expertise. 74. Since 2019 the BA has undergone a reform process to address fraud and improve efficiency. A Presidential Decree (1341, 2019) modified the structure of the bank. Based on review of the NPLs, potential fraud patterns, and assessment of deficiencies in regional offices, new staff and management was hired in the regional offices following competitive procedures. A new manager for banking security, in charge of fraud identification was also selected. 49 Procurement processes were reviewed to make purchases more cost efficient and 213 high-paid positions were eliminated. The review discovered several instances of fraud that were communicated to the relevant authorities. 50 Cost savings through the use of IT channels, rationalization of the bank structure, fraud control and better monitoring of the portfolio have improved bank profitability (profits almost doubled in the last 3 years) and reduced NPLs (from 7.7 at end 2018 to 6.8 at June 2021). Bancoldex 75. Bancoldex is a business development bank mostly providing rediscount loans and direct credit with third party guarantees. Loans to financial intermediaries amount to over 60 percent of the institution portfolio. Rates to final intermediaries on Bancoldex rediscounted loans are determined by the intermediaries according to the borrower risk. However, during the pandemic Bancoldex ask intermediaries to lower rates to pass the subsidy to final borrowers (200-500 bp depending on firm size). On direct basis Bancoldex provides corporate credit and project finance to large corporates (2 percent of its portfolio) SME credit and leasing and invoice discount (about 20 percent of the portfolio). 51 Through the absorption of its subsidiary (ARCO), the bank aims to increase its retail lending and leasing SME operations. Bancoldex did expand its direct portfolio during the pandemic, largely using FNG guarantees with subsidized fee. As the elimination of the fee subsidy would make Bancoldex credit less attractive. Through its invoice discount platform as Bancoldex purchases invoices from vendors, insuring the risk of buyer with private credit insurance companies. Bancoldex funding 46 https://www.procuraduria.gov.co/portal/Procuraduria-confirmo-fallo-de-suspension-contra-expresidente-y-dos- exdirectivos-del-Banco-Agrario-por-prestamo-irregular-de-_120.000-millones-a-Navelena.news 47 https://www.procuraduria.gov.co/portal/Abren- investigacion_a_funcionarios_del_Banco_Agrario_por_presuntas_Irregularidades_en_el_manejo_del_mercado_de_libran zas.news 48 https://www.fiscalia.gov.co/colombia/seccionales/dos-exfuncionarias-de-banco-agrario-en-atlantico-aseguradas- por-supuestas-transacciones-irregulares/. 49 https://www.bancoagrario.gov.co/Noticias/Paginas/La-agenda-de-la-legalidad-contin%C3%BAa-en-el-Banco- Agrario.aspx 50 https://www.bancoagrario.gov.co/Noticias/Paginas/Banco-Agrario-instaur%C3%B3-nuevas-denuncias-por-fraude- bancario.aspx 51 Bancoldex also provides equity to firms through a fund of fund and guarantees on corporate bonds. 41 Colombia costs (the bank does not collect retail deposits), the lack of branches and the reliance on third party guarantees raise questions about the comparative advantage of Bancoldex in originating SME credit. 52 FNG 76. FNG provides pari-passu individual PCGs for MSME loans and VIS housing and has begun offering guarantees on crowdfunding portfolios and SME debt funds. FNG provides pari- passu guarantees on a loan-to-loan basis to accredited institutions automatically up to their allocated quota. Guarantee coverage was increased from 50 to 80 percent during the COVID emergency. Banks request the guarantee, but the borrower knows when the loan is guaranteed which may increase moral hazard. While the risk classification at origination of the loans insured by FAG is like the risk classification of un-guaranteed loans, the delinquency of FNG-guaranteed loans is higher. Most FNG guaranteed loans to MSMEs do not have other type of collateral besides personal guarantees.53 FNG has recently launched guarantee products to support the development of SME debt funds and guarantees on loans generated through crowdfunding platforms under a portfolio approach. It also provides guarantees on corporate bonds. 77. FNG has sophisticated risk pricing tools but operational procedures to pay the guarantee and recover loans are lengthy. Fees are calculated to ensure the financial sustainability of the scheme and differ by product and intermediary according to the expected loan losses. The losses are estimated with transition matrices that model the stochastic change process between loan payment behavior. The fees also incorporate components to cover administrative cost and the cost of capital. Only special government programs carry fee subsidies provided by budgetary resources. FNG targets a ROE equal to the inflation rate over a four-year period, but this objective was not achieved during the 2015-19 period. FNG guarantees pay 6 months after the loan is past-due. Guarantee payment only occurs after the lender has initiated a judicial process to recover the debt that can be initiated 120 days after the day is past-due. The process takes about 35 days in being approved and then FNG pays within 30 days of authorization. 54 FAG attempts to recover the loan first, and then sells the loans to third parties. On average, FNG recovers 10 percent of the guarantees paid in a two-year period. Recommendations 78. The creation of GB provides an opportunity to conduct and ambitious review of the SOFI operations with a view to prepare a strategy to restructure the group to increase efficiency, including through mergers and transfer of functions from one institution to another. Different proposals are under consideration, including merging of the fiduciaries and commercialization of their 52 Bancoldex funding structure is more suited to provision of long-term loans where the bank can offer extended grace periods. 53 VIS loans have the house as collateral as well, but it typically does not cover the value of the loan. 54 FAG has similar requirements, but process takes more time with banks receiving payment in 250-300 days. 42 Colombia activities through the BA network (as well as insurance activities. Other options to be analyzed and consider could include: • Restructuring FINAGRO limiting his role to the support of private financial intermediaries, ceasing its operations with BA. Segregation of the part of FINAGRO that operates with private intermediaries from that that operates with BA could be explored. Currently, FINAGRO profits from the operation of rediscount loans, mostly used by BA, and use those profits to subsidize FAG losses with also operates mostly with BA. The fact that FINAGRO products have large demand from BA reduces incentives to diversify the ecosystem of agricultural financial providers. On the other hand, the use of FAG guarantees diminish BA incentives to expand lending secured with movable guarantees and agricultural insurance and innovate in credit risk management. An alternative to explore would involve allocating directly TDA funds to BA (at least for the agricultural portfolio at regulated rates). Additionally, part of the capital currently in FAG could be transferred to BA whom from that point forward would administer the portfolio risk. An exception in the use of PCGs by BA could be considered for countercyclical considerations (e.g., in cases such as the COVID emergency). • Transfer the FAG administration to FNG. A single institution could realize savings and efficiency improvements administering the two guarantee funds. Also, procedures under both schemes could be harmonized. This would include documentation requirements, payment processes, risk-pricing and even policies regarding use of guarantees by other public financial institutions. 55 • Sell portfolios purchased by FINAGRO under debt relief programs to CISA and transfer any resource from the sale of those portfolios to FNRA. While FONSA and other debt relief programs provides relief in extreme events and allows affected borrowers to get new credits, it also creates moral hazard and undermines the payment culture. Programs to subsidize insurance premium are better suited to address sector losses. Furthermore, FINAGRO has set up a mechanism to recover the loan portfolio which is challenging and costly given its wholesale bank nature. FINAGRO could instead get authorization from the Ministry of Agriculture sell this portfolio to CISA (public sector enterprise under the MHCP created to purchase and administer portfolio of other public entities) or to private collector companies and transfer funds to FNRA to expand coverage of existing agricultural insurance programs. Currently there are 7 companies offering insurance, and 50 percent of resources are devoted to subsidizing small producers. More resources would allow to extend the coverage as currently less than half of total production is insured. • Transfer retail direct lending operations to BA. This would imply transferring operations from ICETEX, FNA and Bancoldex to provide all credit and leasing products leveraging its network and in the case of leasing provided by ARCO Bancoldex its lower funding costs. 55 For example, use of FNG by Bancoldex. 43 Colombia Only Caja Honor would continue providing direct lending. Transformation of Caja Honor into a cooperative could also be explored. 79. The ongoing reform initiatives in BA could be buttressed by changes in the ownership structure to limit political interference. The presence of private investors in the capital of FND has been key to limit political interference in that institution. The experience of BANRURAL in Guatemala, with producers and social associations becoming shareholders of the bank in the context of the peace process, provides an alternative but also successful blueprint for the ownership reform of the institution. Banco do Brasil is also a success story of how a public bank with substantial private capital participation (about 45 percent) can be profitable while maintaining social orientation. The bank plays an important role in the provision of rural financial services thanks to its network, including lending small agricultural producers not serviced by private banks. Banco do Brasil has adopted best sustainable lending practices and its share are listed in the dedicated segment on the New York Stock Exchange. Given BA’s rural and developmental nature, another suitable option could be to attract socially oriented investors which would help improving governance and bring know-how. 80. Bancoldex could develop a direct lending pilot program targeting viable riskier firms and auction their credit lines to institutions offering lower rates on portfolio basis as its funding and network structure appears better suited to a boutique operation positioned in the risk frontier than to a retail SME lending facility akin to a commercial bank. Given Bancoldex structural features, the Business Development Bank of Canada (BDC) can be relevant. BDC offers loans at higher rates than competitors to riskier firms, typically younger technologically savvy firms. These firms have incentives to graduate from BDC loans as soon as they have access to cheaper commercial credit. Consulting services are offered, for a fee, with the loan albeit the firm may decline them. Bancoldex could leverage its MSME training and consulting programs, and a recent pilot program implemented with the support of the Interamerican Development bank that generated three new credit analysis methodologies for early-stage companies to be used by financial intermediaries. With those building blocks, a pilot program could be launched and evaluated. 81. FINAGRO and Bancoldex should actively support fintech developments targeting underserved segments to create markets and increase their reach. Innovative fintech solutions are being implemented in many countries providing for example credit to taxi/uber drivers with repayment profile tailored to income data generated or creating a marketplace and logistic platform for small agricultural producers to sell directly. Wholesale credit SOFIs should have dedicated units to engage with the buoyant Colombian fintech industry to explore financial solutions and encourage the development of such solutions through the provision of credit lines and equity investments. Bancoldex should explore opening its invoice solution to more financial providers so competition among intermediaries would lower rates. 82. FAG product design could be reviewed in line with international best practices and explore new products to foster the use of movable guarantees. FNG could consider creating a SME portfolio guarantee product covering first losses, akin to its SME fund debt product. With the portfolio guarantees, borrowers do not know if the loan is guaranteed, which reduces moral hazard 44 Colombia on behalf of the borrower. First loss portfolio guarantees are more efficient as they allow to support more loans with same amount of capital. Auctioning guarantee resources also helps ensuring efficient use of the guarantee by lenders when fees are subsidized. Generous guarantees also reduce bank incentives to lend using movable assets. FAG could consider developing a guarantee that insures the value of movable assets if lenders cannot recover it at the time of liquidation. 56 FAG could also develop a guarantee on portfolios of SME invoices originated to SMEs. Reforms to make use of FNG capital more efficient should also be accompanied to reforms to make the product more attractive to borrowers by ensuring prompt payment of the guarantee. Consideration should also be given to entering into loan recovery agreements with lenders under success fee schemes. Experiences with Guarantee Auctions In the context of subsidized guarantees, is how to ensure that banks limit their use to those clients who truly require the guarantee and that subsidies are efficiently allocated. To optimize the use of the guarantee, some PCG schemes have introduced an auction mechanism. For example, the Chilean PCG fund (FOGAPE) holds auctions four to six times a year to allocate guarantees to the intermediaries that request the lowest coverage level for a certain volume of loans. Lenders can request up to 80 percent of coverage for long-term loans and up to 70 percent for short-term loans. No lender can get more than two thirds of the total volume of guarantees auctioned. Financial institutions that use less than 80 percent of the allotted guarantees are excluded from the next auction. In Mexico, NAFIN offers guarantees under a first-loss scheme, in which a bank can submit bids on coverage of up to 10 percent of the portfolio, depending on the type of borrower. NAFIN initially auctioned its guarantees fixing the coverage and allocating guarantees to the banks that offered the lowest interest rated for the borrowers. In 2014, they changed the auction to allocate to banks requesting the lowest coverage and capping the rates on the loans to final borrowers at the official 28- days interbank rate plus 700 basis points. The introduction of first-loss schemes and the auction reduced the average public sector coverage of all guaranteed loan portfolios to below 40 percent. 56 https://thedocs.worldbank.org/en/doc/362121537458541440- 0130022018/render/SecondLossPartialCreditGuarantee.pdf. 45 Colombia ANNEX Annex Table A1 – SOFI Board Composition (mid-2021) SOFI Board Composition (according to corporate governance code) Banagrario • The Minister of Agriculture and Rural Development or his delegate • The Minister of Finance and Public Credit or his delegate • The representative of the majority shareholder • The representative of the National Government • Five (5) independent members Bancoldex • The Minister of Trade, Industry and Tourism and the alternate indicated by him, in so far as the Nation - Ministry of Commerce, Industry and Tourism - has registered contributions in the capital of the company; • The Minister of Finance and Public Credit and the alternate indicated by him, to the extent that the Nation - Ministry of Finance and Public Credit - has registered contributions in the capital of the company; • The legal representative of the trust referred to in Article 283 of Decree 663 of 1993 ((note in practice this seat is appointed by the General Meeting) • A representative of the private sector, with his or her alternate, signed by the President of the Republic; • A representative of the private sector, with his respective alternate, elected by the associations of exporters that are registered as such in the Ministry of Commerce, Industry and Tourism. Enterritorio • The Director of the Departamento Nacional de Planeación (DNP) or one of its Deputy Directors-General in his capacity as delegate; • Three representatives of the President of the Republic; and • Three independent members appointed by the Director of the DNP. FDN • All members elected by the GSM. • The FDN Board of Directors is composed of nine (9) members elected by the General Shareholders' Meeting • Six members nominated by MHCP, of which at least three must be independent members. • IFC, CAF and SMBC each have the right to nominate one member Fiduagraria • Chairman of Board is President of Banco Agrario (appointment of President by BoD is not explicit) • All directors presumably appointed by General Assembly of Shareholders (not explicit in CG policy). • Independent directors not mentioned in CG policy. 46 Colombia SOFI Board Composition (according to corporate governance code) Fiducoldex • Board composition / appointment not explicit (presumably by General Assembly) • Independent directors not mentioned in CG policy. Fiduprevisora • The Minister of Finance and Public Credit or his delegate. • The President of La Previsora S.A., Insurance Company or his delegate. • A representative of the President of the Republic with his respective substitute. Finagro • The Minister of Agriculture and Rural Development or his delegate, as chairman. • President of Banco Agrario • Another representative of the State • One representative of the guilds of the agricultural sector, with his respective alternate, • One representative of the peasant associations, with his respective alternate, elected by them • The Director General of Planning of the Ministry of Agriculture and Rural Development, who shall have a voice but not a vote. Icetex • The Minister of National Education or the Deputy Delegate who presides. • A representative of the Council of Higher Education. • A representative of the National Accreditation Council. • A representative of Public Universities • A representative of private universities • A representative of the governors, appointed by the National Federation of Departments. • A representative of the mayors, appointed by the Colombian Federation of Municipalities. Findeter • Five members appointed by General Assembly and their alternates Previsora • Minister of Finance and Public Credit (as Chairman) or his delegate • Four members appointed by the General Assembly and their alternates. Segurexpo • Representative of Bancoldex (President of Bancoldex) • Representative of CESCE (Director of subsidiaries, CESCE) • Representative of Bancoldex (Legal Vice President, Bancoldex) • Representative of CESCE (Chief of control unit, CESCE) • Independent director Source: Individual SOFI Corporate Governance Codes 47 Colombia Annex Table A2 – SOFI Compliance with the MHCP Decalogue of Good Practices Banco Agrario Fiducoldex Bancóldex Previsora Findeter Positiva FDN FNG 1 Does the company have a Corporate Yes Yes Yes Yes Yes Yes Yes Yes Governance Code? 2 Does the company have transparency and contracting Yes Yes Yes Yes Yes Yes Yes Yes policies? 3 Does the company timely disclose relevant company information on its Yes Yes Yes Yes Yes Yes Yes Yes website? 4 Does the company have a regulation of the General Shareholders' Meeting where it includes topics such as its call, functions, majorities, Yes Yes Yes Yes Yes Yes Yes Yes development, preparation, exercise of its rights and presentation of information? 5 Does the company have a Board of Yes Yes Yes Yes Yes Yes Yes Yes Directors regulation? 6 Does the company have procedures for nomination, evaluation and No No No Yes Yes No Yes Yes removal of the manager and / or president of the entity? 7 Does the company submit to the board of directors a semi-annual report (by the head of internal Yes Yes Yes Yes Yes Yes Yes Yes control) giving an account of the evaluation of the internal control system and processes? 8 Does the company ensure adequate complaint mechanisms and Yes Yes Yes Yes Yes Yes Yes Yes procedures? 9 Is the board responsible for establishing the corporate strategy, Yes Yes Yes Yes Yes Yes Yes Yes which is aligned with the vision and objectives set by shareholders? 10 Does the board of directors have at least one (audit) committee charged Yes Yes Yes Yes Yes Yes Yes Yes with overseeing compliance with the internal audit program? % Degree of compliance (8 institutions) 90% 90% 90% 100 100 90% 100 100 % % % % Source: MHCP. No information was available from MHCP for FNA, ICETEX, Enterritorio or Finagro. 48 Colombia Annex Table A3 – Additional MHCP Principles and Guidelines Principles for the Composition of MHCP Boards of Directors 1. Boards of Directors must be interdisciplinary, made up of members with diverse profiles. 2. Ensure that boards have an appropriate succession and remuneration policies. 3. The roles and responsibilities of the chairman of the board must be clearly assigned, ensuring a minimum period for which he or she will exercise his or her function. 4. Boards of Directors must have a minimum of specialized board support committees 5. Members of Boards of Directors must have an imitation period of consecutive tenure and must seek the nomination of independent members. Guidelines for the selection of Revisor Fiscal Objective: Establish general criteria for the election of tax reviewer in companies considered majority and / or strategic by the DGPE and in Mass Public Transport Systems. Minimum criteria to be a candidate for Revisor Fiscal: 1. Be a legal entity with certified experience in the sector and with sufficient resources and personnel to fulfill its functions. 2. Demonstrate experience in multiple tax review contracts in companies with a level of assets equal to or higher than that of the company issuing the tender. 3. Demonstrate experience as a tax reviewer in multiple companies with majority public participation, independent of the sector and/or level of assets. 4. The contract will be for the period established in the Articles of Association, extendable up to one more period. The same revisor fiscal cannot exceed the maximum limit of 6 consecutive years in office; for Public Transport Systems the maximum limit is 4 consecutive years. In case of being appointed revisor fiscal for more than 2 continuous periods, the company must request the change of the work team. *Excluded from these minimum criteria are companies listed on the stock exchange and those that issue securities in international markets. 49