Document of The World Bank

FOR OFFICIAL USE ONLY

Report No: 28928

IMPLEMENTATION COMPLETION REPORT(TF-22479 SCL-41960)

ON A

LOAN

IN THE AMOUNT OF US$ 15 MILLION

TO THE REPUBLIC OF

COLOMBIA

FOR A

FINANCIAL MARKETS DEVELOPMENT TECHNICAL ASSISTANCEPROJECT

June 20, 2004

Colombia and Mexico Country Management UnitFinance, Private Sector and Infrastructure DepartmentLatin America and the Caribbean Region

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

(Exchange Rate Effective May 31, 2004)

Currency Unit = Colombian Peso

Col. Peso 2,766.5 = US$ 1.00US$ 1.00 = Col. Peso 0.00036

FISCAL YEAR

January 1 to December 31

ABBREVIATIONS AND ACRONYMS

AML/CTF Anti-money laundering / Countering of terrorist financingBANCAFE Banco Cafetero (Bank serving the Coffee Grower’s Region)BECH Bancos Especializados en Crédito Hipotecario (Mortgage Banks)BR Banco de la República (Central Bank of Colombia)CAMEL Capital/Assets/Management/Earnings/Liquidity Bank Rating SystemCAV Corporación de Ahorro y Vivienda (Savings & Loan Banks)CONPES Consejo Nacional de Política Económica y Social (Economic Policy Council)DANE Departamento Administrativo Nacional de Estadística (Statistics Agency)DGCP Dirección General de Crédito Público (Public Debt Office of MoF)DGRF Direccion General de Regulación Financiera (Financial Regulation Department of MoF)DGSS Direccion General De Seguridad Social (Social Security Department in the MoF)DTF Depósitos a Término Fijo (Interest rate on time deposits)DTN Dirección del Tesoro Nacional (National Treasury in Ministry of Finance)FINDETER Financiera de Desarrollo Territorial (Municipal Financing Bank)FIs Financial Institutions (supervised by the Banking Superintendency)FOGAFIN Fondo de Garantías de Instituciones Financieras (Deposit Insurance Agency)FONPET Government Public Pension Reserve for Decentralized Departments/TerritoriesFRECH Fondo de Reserva para la Estabilización de la Cartera HipotecariaFSAP Financial Sector Assessment ProgramMBS Mortgage Backed SecuritiesMoF Ministry of FinanceP-FSAL I First Programmatic Financial Sector Adjustment LoanPCU Project Coordinating Unit within the MoF, the Implementing AgencyRP/REPO Repurchase Market / Repurchase OperationSARC Sistema de Administración Riesgos de Crédito (Credit Risk Mgmt. System)SB Superintendencia Bancaria (Superintendency of Banks)SES Superintendencia de Economia Solidaria (Superintendency of Cooperatives)SHD Secretaria de Hacienda Distrital (Treasury Department of the Capital District of Bogota)SIC Superintendencia de Industria y Comercio (Superintendency of Industry and Commerce)SS Superintendencia de Sociedades (Superintendency of Corporations)

SV Superintendencia de Valores (Securities Superintendency)TES Treasury Bills/NotesUIAF Unidad de Inteligencia y Análisis Financiero (Financial Intelligence Unit)UPAC Unidad de Poder Adquisitivo Constante (Mortgage Price Index)UVR Unidad de Valor Real (Index based on real value of mortgages)VAR Value at RiskVIS Vivienda de Interés Social (Social Priority Housing)

Vice President: David de FerrantiCountry Director Isabel GuerreroSector Manager John Pollner (Acting)

Task Team Leader/Task Manager: John Pollner

COLOMBIAFINANCIAL MARKETS DEVELOPMENT T.A. PROJECT

CONTENTS

Page No.1. Project Data 12. Principal Performance Ratings 13. Assessment of Development Objective and Design, and of Quality at Entry 24. Achievement of Objective and Outputs 105. Major Factors Affecting Implementation and Outcome 236. Sustainability 247. Bank and Borrower Performance 248. Lessons Learned 269. Partner Comments 2710. Additional Information 29Annex 1. Key Performance Indicators/Log Frame Matrix 31Annex 2. Project Costs and Financing 33Annex 3. Economic Costs and Benefits 37Annex 4. Bank Inputs 38Annex 5. Ratings for Achievement of Objectives/Outputs of Components 40Annex 6. Ratings of Bank and Borrower Performance 41Annex 7. List of Supporting Documents 42

Project ID: P006884 Project Name: CO FINANCIAL MARKETS DEVELOPMENT

Team Leader: John Daniel Pollner TL Unit: LCSFFICR Type: Core ICR Report Date: June 28, 2004

1. Project DataName: CO FINANCIAL MARKETS DEVELOPMENT L/C/TF Number: TF-22479; SCL-41960

Country/Department: COLOMBIA Region: Latin America and the Caribbean Region

Sector/subsector: Central government administration (55%); Compulsory pension and unemployment insurance (25%); Capital markets (20%)

Theme: Standards and financial reporting (P); Regulation and competition policy (P); Other financial and private sector development (P); Other accountability/anti-corruption (S); Legal institutions for a market economy (S)

KEY DATES Original Revised/ActualPCD: 11/22/1993 Effective: 06/30/1996 11/21/1997

Appraisal: 11/15/1996 MTR: 12/31/1999 02/08/2000Approval: 06/20/1997 Closing: 02/28/2002 12/31/2003

Borrower/Implementing Agency: GOVERNMENT OF COLOMBIA/MINISTRY OF FINANCEOther Partners: Superintendencies of Banks, Securities, Companies, Cooperatives, Industry;

FOGAFIN; Pensions Directorate; AML Unit; Public Credit Directorate; Financial Regulation Directorate; Capital City Gov't.

STAFF Current At AppraisalVice President: David de Ferranti Javed BurkiCountry Director: Isabel M. Guerrero Paul IsenmanSector Manager: John Pollner Krishna ChallaTeam Leader at ICR: John Pollner Andres D. JaimeICR Primary Author: J. Pollner; M. Lasaga

2. Principal Performance Ratings

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible)

Outcome: S

Sustainability: L

Institutional Development Impact: SU

Bank Performance: S

Borrower Performance: S

QAG (if available) ICRQuality at Entry: S S

Project at Risk at Any Time: No

3. Assessment of Development Objective and Design, and of Quality at Entry

3.1 Original Objective:The overall objective of the Project as stated in the MOP and in the Loan Agreement was to

support the Government’s efforts to foster more effective financial intermediation of resources, as well as more efficient operation of markets, as a key ingredient for sustained economic growth.

Most of the policy reform initiatives in the financial sector prior to this Project had focused on the financial intermediation system, which had traditionally been the major source of financing and the area where most urgent issues were concentrated due to the banking crisis of the mid-eighties and the subsequent nationalization of many financial institutions. These initiatives included the liberalization of interest rates, phasing out of credit subsidies and forced investments, reduction of segmentation in the financial system, reduction in the role of public financial institutions, greater autonomy for the Central Bank and improvements in banking supervision.

While policy reforms in financial intermediation during the late 1980s and the 1990s were instrumental in stabilizing the financial system, the capital markets remained small and rudimentary. A number of structural, institutional, and environmental factors conspired against the development of capital market activities. The shallowness of the capital markets was a deterrent to the growth of domestic industry which had to rely on more costly shorter-term financing for longer term investments.

In an effort to address the obstacles to the development of the capital markets, the Government appointed a high level commission in 1995 to make recommendations on capital markets initiatives. The recommendations of the Commission, which were based on analytical work carried out by capital markets specialists with the assistance of the Bank, were instrumental in guiding Government policy for capital markets development.

a/ 1/

The Financial Markets Development Project was thus designed to support the design and subsequent implementation of these initiatives.

In order to achieve the stated objectives, the project components were organized according to six specific objectives:

I. Developing the Financial Markets into a More Efficient Intermediation Channel

• Improve the functioning of the market by upgrading the pricing, trading, custody, clearing and settlement systems.• Enhance the liquidity of the public sector debt securities market through the development of the primary and secondary markets.• Promote greater participation in the financial markets by institutional investors.

II. Strengthening Policy Formulation, Regulation, and Supervision Capacity in the Financial Sector

• Harmonize and refine the regulatory framework of the financial system.• Strengthen the institutional capacity for supervision in the financial markets through provision of training for Superintendency of Banks (SB) and of Securities (SV) personnel. • Strengthen the policy formulation capacity at the Vice Ministry of Finance.• Creation of a new regulatory framework for the cooperative sector.

a/ All footnotes are listed as endnotes in Annex 7: List of Supporting Documents.

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III. Increasing the Supply of Securities and the Availability of other Financial Instruments

• Review changes required in the Borrower’s laws to facilitate the issuance of securities in the marketplace. • Provide training on financial instruments and markets to regulators, potential issuers and investors.• Promote new instruments such as securitization, venture capital funds, and derivatives markets.

IV. Consolidating the Reform of the Social Security System

• Implement the transfer of pension liabilities from the decentralized public sector entities to the new system.• Institutional strengthening of the pension Delegatura (Supervision Department within SB).• Institutional strengthening of the Institute of Social Security.• Continue to implement the general pension system reform.

V. The Development of a System of Financial Intelligence to Control Corrupt and Fraudulent Practices

• Structure the Unit for Financial Intelligence (UIAF) as an initial step leading to the establishment of the intelligence system.• Implementation of the system of financial intelligence in the SB, SV and the Superintendency of Companies (SS).• Expansion of the system of financial intelligence to additional sectors of the economy.

VI. Development of Competition Enhancement and Anti-Trust Policy Capacity

• Develop competition and anti-trust policy capacity.

The Capital Markets at the time of Project Design. Even though Colombia had the benefit of relatively low and stable inflation rates compared to other countries in Latin America, the capital market in Colombia had languished since the 1960s. During 1986-1993, average market capitalization of the Colombian markets was only 7 percent of GDP, comparable to Argentina, Indonesia and Nigeria, but well below the newly industrialized countries like Hong Kong, Malaysia, Singapore and Chile with similar ratios greater than 100 percent. Concentration indices for the Colombian stock market, measured as the share of the ten largest stocks in market capitalization, were among the highest in the world. During 1986-1993, the ten largest publicly issued stocks represented 74 percent of market capitalization, compared to 14-19 percent in the U.S. and Japan. The capital market was highly illiquid as demonstrated by the ratio of market transactions to GDP of only 5.2 percent, of which equity transactions were only 2.1 percent. One of the key constraints to the growth of the capital markets had been the paucity of supply of securities.

Risks to the Project. The Project’s Technical Annex identified three potential risks: i) institutional capacity for implementation; ii) maintenance of a sector-wide vision of achievement of objectives; and iii) political commitment to reforms. The institutional capacity at the Ministry of Finance, the Technical Vice-Ministry and the Project Coordination Unit (PUC) which had already managed earlier TA projects from the Bank and the Inter American Development Bank was considered strong. A Technical Committee was also created by the Borrower to supervise project implementation. While these arrangements were useful to provide overall guidance or sector-wide vision to a multifaceted project, the Bank should have

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given closer consideration to institutional limitations within existing as well as newly established beneficiary agencies. Project implementation challenged the capacity of some beneficiary agencies to manage operational activities involving complex procurement procedures prescribed by the Borrower’s as well as the Bank’s international practices.

The risk of political commitment was appropriately flagged at the time of Project preparation. Some sub-components called for regulatory reforms, either through the application of existing legislation or through the development of new legal reforms. The initiatives to increase the supply of securities, to promote development of a liquid public debt market, to create a new regulatory framework for the cooperatives sector, to enforce anti-money laundering practices, and to promote institutional investors all required legal reforms, for which political commitment was a basic ingredient. Perhaps additional analysis of the political environment in the context of these reforms would have been helpful. While the Project document referred to positive experiences with previous legislative modernization initiatives, a more forward looking political assessment may have been useful in the design of some of the sub-components such as the review of capital market norms. Additional details as to what types of legal reforms were expected to be addressed such as the issuance of regulations or the submission to Congress of new legislative projects would have been helpful in order to better gauge implementation risks.

One of the implementation risks not addressed by the appraisal was financial risk. As explained in the section on implementation / outcome, the economic / financial crisis of 1998-1999 resulted in fiscal austerity measures that curtailed budget allocations for Project activities that had already been approved for Bank funding. Because of the characteristics of the budgetary process in Colombia, any line item in the budget of the beneficiary entities is subject to cancellation as part of any general expenditure reduction directives issued by MoF, even if those items are to be funded directly by the Bank and not by general budget resources. For that reason explicit analysis of this risk and contingency plans of action in terms of alternative implementation strategies should have been explicitly considered.

3.2 Revised Objective:

The Project objectives remained unchanged. While additional beneficiary units were added, their activies were in conformance with the stated project objectives and adaptation to the then existent economic environment.

3.3 Original Components:

Overall Design of the Project

Project design evolved through several stages during an unusually long preparation period of more than five years, 1992-1997. After initial design in 1994, the Project was put on hold, then re-started in 1996, and finally presented to the Board in May 1997 as a different project than first proposed. The initial concept design had been a combination of a financial sector and a capital markets project consisting of policy reforms, technical assistance and a financing component to jumpstart capital market activities

3. The

goal first proposed in the Initial Executive Project Summary was to support the development of more robust capital markets and to thus reverse the decline of securities in the financing of private sector investments. The three components of policy reforms, financing, and technical assistance that had been envisioned in the original design addressed various impediments to capital markets development. The Bank wanted to adopt a two-pronged strategy of strengthening the institutional capacity of the financial markets while simultaneously providing financing to support the development of new financial instruments. The financial component would support the development of the securities market through a backstop facility to

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extend maturities of newly issued securities or other financing schemes designed to increase underwriting activity

4

. The Initial Executive Project Summary (February 1992) also contemplated the potential benefits to the capital markets from the introduction of securitization of assets, which later became one of the most dynamic innovations in the Colombian financial system. The technical assistance (TA) component in this hybrid operation was expected to assist the authorities (i) to review the existing regulatory framework and design a more adequate one; (ii) to design and implement efficient approval, supervision, and monitoring systems for newly issued securities; and (iii) to improve the market trading, clearing, settlement and payment systems.

By April 1994, the Bank had reached the decision to design two separate operations. The Final Executive Project Summary had thus narrowed the original scope to a Financial Markets TA Project and a separate loan or guarantee (backstop) facility to encourage the issuance of new longer-term financial instruments

5

. It was also assumed that a subsequent Social Security Reform project would provide the bulk of Bank support for pension reform. Bank staff also recommended a flexible design for the TA project that could be adjusted according to evolving market needs. The TA project qualified for streamlined processing and was thus subject to a single RVP review after appraisal, which was approved on April 29, 1994. In retrospect, given the changes, additional reviews might have been more optimal given the interim processing delays.

The FEPS for the TA had emphasized the capital markets components in terms of upgrading of securities markets regulations, policy formulation for capital markets, and promotion of new financial instruments. In addition, the project contained a Social Security reform component to address the needs of the growing private pension funds; and another component dealing with competition policy and anti-trust enforcement capabilities.

A Japanese Grant in 1994 for the amount of US$980,000 was utilized to fund studies and advisory services to assist with the preparation of the project

6

. However, during the second half of 1994 preparation of the TA project was unexpectedly put on hold as a change in government brought new appointments to the Vice-Ministry of Finance with a different view on the need for the project. With the approval of the Grant, the Government did not have the sense of urgency to proceed with the TA project since the Grant was already providing financial support for technical assistance activities. At the same time, Colombia’s successful venture into the international capital markets had noticeably eased the country’s international liquidity position at that time, thus reducing its need for Bank funding. The favorable terms obtained on new money raised in the international financial markets by the Government at that time also cast doubt on the need for a capital markets backstop-style financing operation as envisioned in the FEPS. Fortunately, the Japanese grant, which was originally intended to assist in the preparation of a broader financial and capital markets loan, continued to support research and consulting work that eventually proved essential in finalizing the design of the TA project.

Between the time of the FEPS and when the project was re-started in 1996, project design benefited from extensive work of the Capital Markets Mission in October 1994, which was financed by the Japanese Grant. While the principal conclusions of the Capital Markets Mission echoed the Bank’s earlier analysis in the Financial Sector Review (1993), the Mission report contained more concrete recommendations for improving the functioning of the capital markets that were incorporated into the final design of the TA project. The studies confirmed that capital market regulations needed to be upgraded in order to promote the issuance of securities, and that alternative mechanisms to introduce new financial instruments needed to be explored

7

.

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In its final form, the Project became quite ambitious. The main objective of the Project, to foster more effective financial intermediation of resources, covered a very broad spectrum of activities. The project thus incorporated a wide range of technical activities addressing issues of financial intermediation, institution building of regulatory agencies, social security reform, and capital markets development. Some of the specific objectives by themselves would have been justified as stand alone projects to improve the performance of the capital markets. The project involved 11 beneficiary entities (Department of Financial Regulation, Department of Public Credit, Department of Social Security, the Financial Intelligence Unit, all at the Ministry of Finance, FOGAFIN, the Superintendencies of Banking, Cooperatives, Corporations, Industry & Commerce, Securities, and the Treasury Department of the Capital District of Bogotá). The design of six specific objectives spread across the 11 beneficiary entities resulted in numerous project activities that put a heavy load on the borrower’s PCU implementation and the Bank’s supervision capacities.

The social security reform component, which had originally been considered as a separate operation, was merged into the TA project. By the time the project reached its final design, the reform of the Social Security system and the development of the private pension funds were already entering the fourth year, thus diminishing the need for Bank support of reforms in that sector though the work on quantifying and managing the outstanding public pension liabilities remained critical.

Project monitoring indicators were supposed to gauge the impact of project output on improved financial intermediation. Quantitative indicators such as market capitalization, volume of trading activity and growth of government securities were established as parameters for market performance. However, these indicators were very broad, making it difficult to isolate the specific TA contributions, when in most instances the outcomes would not be measurable until after a sufficiently long period of time to allow for adequate institutional development. A more appropriate approach would have been to specify narrower “micro-level” indicators such as the volume of repo operations, placements of securitized assets, and the publishing of market pricing information.

One year after the project was made effective on October 21, 1997, Colombia entered a period of severe economic and financial turbulence, posing another challenge to a Project that had already been subjected to numerous transformations during its design. Colombia's vulnerability to external shocks had intensified as a result of increased domestic violence and uncertainty regarding the future path of the internal conflict; a worsening of market sentiment towards Latin America; problems in Venezuela, the second largest market for Colombia's non-traditional exports; and an uncertain outlook for the US economy, Colombia's main trading partner. After decades of consistently solid growth and prudent economic management, Colombia entered its worst recession in over sixty years during 1998-1999. GDP declined 4.2 percent in 1999. This downturn in turn set off a financial sector crisis. The fiscal deficit surged due to the decline in economic activity and to government measures to stabilize the financial system through the assumption of failed banks’ liabilities. Excluding the one-time effects of the privatizations, the public sector deficit had risen from 0.3 percent of GDP in 1993 to 4.1 percent in 1999 (see Economic Indicators Table 1 in the Annex).

As a result of the economic / financial blowout the Government had to focus its priorities once again on the stabilization of financial intermediaries with less attention to issues of capital markets development. Nevertheless, the capital markets initiatives supported by the project were still considered to be highly relevant in terms of the Government’s medium-term strategy to support the capital markets. By providing technical assistance to financial sector regulatory agencies, the Bank’s TA loan also played a useful role during this particularly difficult period in Colombia. In response to Government concerns about the health of the financial sector, the Bank appropriately amended the Project Agreement in October 2000

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to include the deposit insurance agency (FOGAFIN) and the Superintendency of Companies (SS) as beneficiary agencies and to support their efforts to re-establish financial stability.

Design of the Principal Components of the Project:

I. Design of the Component to Develop the Financial Markets into a More Efficient Intermediation Channel

This component was designed to address the need to enhance trading information, clearing, and settlement systems as well as new trading instruments; to promote the market for public sector debt securities; and to assist institutional investors reach a bigger market presence. The principal activities in this component were supported by recommendations made by the Capital Markets Mission study. According to the Technical Annex, the bulk of the resources under this component, US$1,237,000 (6.2 percent of project costs) was to be channeled to the SV and to the Financial Regulation Unit at MoF (DGRF), with important participation by the Department of Public Sector Debt (DGCP). The upgrading of market trading information and the development of the public sector debt securities market were highly relevant factors for the efficiency of capital markets. At the same time, the sub-component to promote more trading in repos was an important linkage from the capital to the money market which helped to improve liquidity in the financial system.

II. Design of the Component to Strengthen Policy Formulation, Regulation, and Supervision Capacity in the Financial Sector

This component focused on the institutional strengthening of the principal regulatory and policy making agencies in the financial sector, including a sub-component aimed at harmonizing market regulations across regulatory entities. The activities under this component received the largest amount of project resources, or 22 percent of the total. The DGRF and the Superintendency of Cooperatives (SES) were relatively new organizations in need of institutional support. The SB and SV sub-components were also highly relevant in view of their pivotal role in the orderly development of the financial markets.

III. Design of the Component to Increase the Supply of Securities and the Availability of other Financial Instruments

According to the recommendations of the Capital Markets Mission, increasing the supply of securities was one of the key strategies for market development. Appropriately, most of the resources in this component were earmarked for the SV. With respect to the review and analysis of legal changes that would encourage firms to raise funds in the capital markets, greater focus may have been achieved if this component had adopted some of the specific recommendations made by the Capital Markets Mission. The promotion of new financial instruments was a worthwhile initiative, although some consideration may have been given to the existing timeline of the Colombian capital markets, in the sense that venture capital funds and derivates were not yet ready for take off. On the other hand, during the early design phase of this project, the Bank picked up on the great potential for securitization of assets, which was strongly endorsed by the Capital Markets Mission. This was truly an innovative and highly promising instrument for which this Project went on to become one of the principal sponsors of securitization of residential mortgages.

IV. Design of the Component to Consolidate the Reform of the Social Security System

At the time of the FEPS this component was envisioned as a support of the Government’s pension reforms instituted in 1993 with the creation of the private pension system. The initial design of this

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component included regulatory initiatives to assist in the development of the then newly created pension management companies, AFPs. By the time Project design had been re-started in 1996 and its approval in 1997, the initial phase of Social Security reform had been completed. The initial strategy in 1993 had in fact been to design a separate Bank operation in support of Social Security reforms and the development of the new pension system. In view of the successful start of the new pension reforms, it was subsequently decided to append this component to the Project and to focus on the estimation of the Government’s pension liabilities that had accrued to workers affiliated with the old Social Security system.

The Bank’s rationale for including this component was that successful development of capital markets in emerging market economies hinged on the growth of the pension system. The creation of private sector pension funds has generated substantial demand for securities, thus boosting market capitalization. It was felt that Colombia would follow a similar path, and that any activity in this area would be considered relevant for the Project’s objectives. While this analysis was valid, from a design perspective, this component added to the complexity of implementation.

V. Design of the Component to Develop a System of Financial Intelligence to Control Corrupt and Fraudulent Practices

After the design of the project was re-started in 1996, this component became an important condition for Board presentation. The goal was to put in place effective mechanisms to detect illegal practices in the financial system, and in particular money laundering. The system architecture consisted of an elaborate information network to compile intelligence based on market transactions within the financial system. The focal point of the system was the Unidad de Informacion y Análisis Financiero (UIAF), which was to be established by law as one of the conditions for effectiveness.

VI. Design of the Component to Develop Competition Enhancement and Anti-Trust Policy Capacity

As a result of a major restructuring within the Superintendency of Industry and Commerce (SIC) in 1992, the Government had created a Delegatura for the promotion of competition. The new entity presented both manpower and infrastructure deficiencies. Bank staff saw this as an opportunity to enhance the institutional framework of the SIC. This was supported by the Financial Sector Review (1993) which had concluded that there was market concentration in the financial system. On the other hand, it is not apparent how the improvement in the capacity of the SIC to support competition and pursue anti-trust policies would benefit the effectiveness of financial intermediation of resources. The finding by the Financial Sector Review regarding the existence of market concentration in the financial system by itself was not sufficient to conclude that there were restrictions to market entry. In fact, it has been demonstrated that small financial intermediaries can operate profitably in a market where a few large institutions dominate in terms of total system deposits.

3.4 Revised Components:

The severity of the economic / financial crisis during 1998-1999 and the Government’s need to focus on immediate challenges to the financial system heightened Project risks. In short, capital markets could not develop in a crisis environment. New institutional development needs were created as regulatory agencies raced to put in place new mechanisms to steer financial institutions back to a path of sustainable growth. While the crisis posed new challenges to the Project, it did not alter the relevance of the overall objective of fostering more effective financial intermediation of resources, in fact, the Project acted as a remedial instrument during this rough period. The component to strengthen regulation and supervision proved very helpful in dealing with financial sector problems, and the support of the new SES was

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instrumental in helping the agency gear up to manage an area that was particularly vulnerable to financial risks.

The crisis environment was ably managed by the Government while juggling the commitments under the Project, some of which were supportive of the stabilization efforts. Nevertheless, the Government approached the Bank to request the addition of two sub-components under the regulation and supervision component and another under the public sector debt securities sub-component. The Project was thus duly amended on October 6, 2000 to include the participation of FOGAFIN and the Superintendency of Corporations (SS) in support of supervision, and of the Department of Finance of the Capital District (Bogotá) as part of a debt issuance program. Support for FOGAFIN was related to its efforts to resolve insolvent financial institutions, and in the case of SS, their participation dealt with the Economic Emergency Law of 1999 that had assigned certain responsibilities to that agency in the restructuring of debtor firms with significant financial problems. By circumventing a formal bankruptcy proceeding, the measure to involve SS as a mediator in corporate restructurings was expected to provide some relief to the banks from asset quality problems to the extent that these firms had borrowed from the banks and the restructuring program allowed them to regain their financial health. Even though the crisis environment justified the inclusion of these new beneficiary entities in the Project, it did increase the implementation burden in an already crowded field of participants. For this reason, the design of a less complex more focused project from the start would have resulted in greater flexibility to add new sub-components during implementation as circumstances required.

3.5 Quality at Entry:

Quality at entry is judged to be satisfactory. Overall Project design was relevant in terms of the government’s development objectives and the need to support the financial and capital markets. The Bank’s Country Assistance Strategy (Report P6070, discussed by the Board on December 16, 1993) considered the issues addressed by the project as critical to the success of the overall economic reform program that Colombia had embarked upon. But considering the complexity of its design, the Project concept is deemed marginally satisfactory. On the other hand, the Implementing Agency’s technical capacity and established track record in successfully managing similar projects was considered a decisive factor in proceeding with the Project. As explained in an earlier section, sector work was extensive; first, in the form of the Bank’s Financial Sector Review (1993), and second, through the report issued by the Capital Markets Mission (1996).

Entry assessment by the Quality Assurance Group rated the project satisfactory. Project design, institutional capacity, implementation, risk, and sustainability were all rated satisfactory. Bank inputs and processes were rated marginal due to a low efficiency factor: a long time for preparation (5.5 years) and elevated costs; and to weakness in terms of peer review process. As explained earlier, Project preparation was interrupted during a two year period, thus explaining the appearance of a long gestation period. On the other hand, more reviews of the final design of the Project may have raised appropriate concerns about the complexity of the Project. In the final analysis, this TA Project could have been designed as separate independent operations as had originally been proposed, although this would have required Government demand as well, something which was not clearly evident; and would have required splitting up the project, something which would likely not have received endorsement by Bank management given other competing interests in the lending program.

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4. Achievement of Objective and Outputs

4.1 Outcome/achievement of objective:

The outcome of this Project is considered very satisfactory in terms of its contribution to the overall objective of fostering more effective financial intermediation of resources and a more efficient operation of the markets. This rating is based on the contribution of the Project to the Borrower’s skills in enhancing market efficiencies, in strengthening supervisory skills, in measuring the public sector’s pension liabilities, and in introducing new financial instruments. The combined effect of these initiatives is consistent with a positive impact on the overall objective.

If the outcome of this Project is measured against the initial monitoring indicators, then the impact would be considered marginal. As explained in the previous section, the quantitative indicators of Project outcome in this case were too broad and ambitious. It would be very difficult to trace the specific contributions of this Project to overall market capitalization, volume of trading activity, and growth of institutional investors from a myriad of macro-economic and political factors. At the same time, the onslaught of the 1998-1999 economic / financial crisis made these indicators somewhat irrelevant. The successful outcome of the Project is thus attributed to the development of institutional capacity mainly at DGRF, SB, DGSS, SS, UIAF, and FOGAFIN, which has provided the market skills to achieve more effective financial intermediation, and to the growth of certain types of market activities such as securitization of mortgages and repo transactions in the money market. Using a more realistic standard the Project is considered as successful.

Government budget restrictions did have an adverse impact on the Project. Government-imposed austerity measures to reign-in the fiscal deficit arising from the recession as well as the fiscal costs associated with the bail-out of the banks, led to a request by the Borrower for partial cancellation of Project funding. Since all Project activities were undertaken by agencies of the Government, the individual expenditure items associated with each activity of the Project had to be presented for approval as part of the national budget each year and subject to the same scrutiny as all other items in the budget. Government budget restrictions in turn were applied to all line items in the budget, regardless of their financing arrangements. Thus the purchase of computer equipment financed by a Bank loan would be subject to the same budgetary restrictions as any other expenditure item that was normally financed out of general budgetary resources. The initial request for partial cancellation of US$5.5 million was made in September 2001, including a request for extension of the closing date to 2003. In September 2003, the Borrower requested an additional cancellation of US$1.26 million. After deducting the canceled amounts, net disbursements under the Bank loan amounted to US$8.2 million, or 55 percent of the original Loan. Notwithstanding these cutbacks, the satisfactory evaluation in this ICR already takes into account the shortfall in project funding and recognizes the successful outcome based on the smaller disbursed amounts. This successful outcome shows that a simpler more focused Project would have been more effective. The Government’s strong commitment to the policy reforms supported by this Project, as evidenced by its decision to fund the affected activities from other sources, also supports the positive outcome.

At the same time, this Project was implemented during a period in which the Bank approved a structural reform loan in the financial sector, the FSAL (1999). The successful outcome of this loan, based on the corresponding ICR, is in some way linked to the institutional development contributions of this Project, since the reforms supported by the adjustment loan dealt with some of the components of this Project.

Overall, the contributions made by the project in improving the operations of the financial markets

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in Colombia were strategically very relevant and responded to the priorities and changing economic and market conditions of Colombia. The sector impact of the project, given these conditions, was broad and substantial.

The outcome of the six specific Project objectives is outlined below.

(i) Outcome of the Component to Develop Financial markets into a more efficient intermediation channel

The outcome of this component is considered satisfactory in terms of the upgrading of market pricing information and the enhancement of the public sector debt securities. By introducing greater transparency in market clearing transactions and increasing market liquidity for fixed income securities, these initiatives have improved market efficiencies. The principal outcomes of this component included:

Implementation of an institutional mechanism for daily on-line reporting of market transactions which has enhanced the availability of credible pricing information in the fixed income securities market and improved market transparency in a sector which has begun setting the basis for the growth of the capital markets.

Development and implementation of new regulations for the primary and secondary markets for public sector debt securities – coupled with the institutional systems, this has increased market liquidity and strengthened the intermediation of this market by defining the roles and accountabilities of market makers (e.g.: selected qualified banks) and involving a larger number of players with checks and balances, in this market.

The upgrading of the public debt management function at the Treasury Department of the Municipal Capital District of Bogotá has contributed to more sophisticated debt management strategies by entities outside of the central government with consequent payoffs in terms of greater market interest in their issuance of securities. This has lead to greater diversification of funding sources and lower cost of debt, while initiating growth in a municipal bond market based on budget/fiscal performance of cities rather than on a sovereign guarantee.

(ii) Outcome of the Component to Strengthen Regulation and Supervision Capacity in the Financial Sector

The outcome of the Regulation and Supervision component is considered satisfactory. Selective initiatives in this component included:

The development of the DGRF (Directorate General of Financial Regulation) within the Ministry of Finance (MoF) was instrumental in consolidating the Financial Regulation making function within MoF and strengthening the Government’s regulatory capacity as it should exist, i.e., a separate policy body from the supervisory function housed in the financial sector Superintendencies, and to ensure structural change consistent with the broader macroeconomic program of the Government.

The SB’s development of analytical banking models and training of supervisory staff , the SV’s training on different securities market instruments and acquisition of hardware and software for better monitoring the market, and SS’s development of analytical tools used in corporate restructurings combined with staff training at all three agencies, contributed to

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enhanced supervisory capacities including new regulatory frameworks and supporting technology tools to maintain improved oversight and early warning of sectoral developments, so as to prevent future weaknesses or insolvencies in the financial system which might have systemic effects including cross-contamination with the corporate sector.

By supporting the initial institutional development of the Superintendency of Cooperatives (SES) the Project helped to buttress the regulatory and supervisory capacity in an overlooked area of the financial system with widespread reach to the underserved population. In particular, while this sector did not constitute a large share of the financial system in terms of assets or deposits, it does cover a significant number of client/customers whose deposits need to be protected following the 1998 crisis, to avoid social and political disruption.

The impact on Project outcome was limited by the less aggressive contributions from the Securities Superindentency (SV) in the institutional development front. As mentioned earlier, SV slowed down implementation and these delays compromised subsequent disbursements after ensuing government budget cutbacks crystallized.

(iii) Outcome of the Component to Increase the Supply of Securities and Availability of other Financial Instruments

The outcome of the component to increase the supply of securities is considered highly satisfactory. Two key initiatives were supported by this Project: the drafting of a new Securities Law, which had not been considered as a possibility at the time of Project design, and to development of the securitization of housing loans, which created an important new financial instrument with a strong market potential. With respect to the regulatory environment, the original goal had been to upgrade regulations affecting transactions in the securities markets; so the drafting of a new law went beyond the initial expectations and served a very useful purpose in consolidating key capital market reforms within a consistent framework. The principal outcomes in this component were:

As a result of review and analysis of laws affecting the capital markets by DGRF and SV, new regulations were issued, and more importantly, the three stock exchanges in Colombia were merged into a single national exchange. Following that, a new Securities Law was drafted, which has been revised and is expected to be presented to Congress shortly. The changes introduced in the new version of the Securities Law will encourage and facilitate the issuance of securities in the market by reducing costly paperwork and fees, requiring minimum professional standards for operating a securities business, and implementing new corporate governance norms in the industry. The emergence of a larger capital market will eventually provide a parallel source of funding (besides only banks) for investment and growth in diversified industries wishing to reduce their cost of funding.

The development of securitization of housing loans has been a major innovation in the Colombian financial system promoting the development of the capital markets and the supply of funds for new investment. The wide acceptance of this instrument in the market is a tribute to the vision of investment bankers who recognized its potential, to Government regulatory initiatives, in part supported by this Project, and to the good risk management practices of financial intermediaries. This market has helped banks diversify their otherwise concentrated credit portfolios while allowing institutional investors such as pension funds invest in more varied securities with acceptable risk ratings.

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The current version of the proposed Securities Law does not include the reorganization of the regulatory agencies so as to expedite its approval by Congress. The issues of how many regulators are needed and the relationship between the different agencies has been left as a pending issue for a second generation reform.

(iv) Outcome of the Component to Consolidate the Reform of the Social Security System

The outcome of the Social Security and pension component was satisfactory. Strong Government commitment to reforms in this sector was instrumental in a very successful implementation. The activities supported by this Project were follow up reforms, since the private pension system had already moved along the learning curve by the time this loan was approved in 1997. The principal outcomes in this component were:

The development of a methodology to measure pension liabilities under the old defined-benefits Social Security system based on regularly updated work histories of affiliates, served to establish the value and size of the Government’s pension liability. This initiative supported by the Project represents a key information pillar in the new defined-contribution public / private pension system that enabled the government to regulate the parameters of the public system and its benefits, and encourage more active participation by affiliates to support the provision of pension services by the private sector while reducing State liabilities.

Institutional strengthening of the new Social Security Department in MoF and the new Directorate of Pensions in the SB was instrumental in providing the institutional capacity to, respectively, monitor and regulate the growing liabilities in the decentralized public pension sector (e.g.: municipalities and Departments) and enforce controls to reduce them, and to monitor the potential investment, liquidity and maturity risks in the fast emerging private pension system. These aspects are contributing to the sustainable provision of long term welfare to the retired and to be retired population.

While this component was very successful in terms of implementation, the impact on outcome is only indirect, in the sense that by having normalized its financial obligations under the old Social Security system the Government will facilitate the growth of the pension funds, albeit under a long term transition program.

(v) Outcome of the Component to Develop a System of Financial Intelligence to Detect Corrupt and Fraudulent Practices

The outcome of the component to develop a system of financial intelligence is considered satisfactory. This component contributed to the following successful outcome:

The creation of the UIAF with a sophisticated intelligence gathering mechanism and a national mapping system linked to suspicious transaction cross-links, has centralized Government surveillance of illegal activities through the financial system – such as money laundering, and thus provided a more effective institutional arrangement to successfully enforce the laws. An effective financial intelligence system has helped to identify irregular financial transactions and refer them to the Attorney General’s Office for criminal investigation, many such activities detected having been conducted on behalf of the drug trade and insurgency financing. This outcome has incrementally provided more confidence in

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certain sectors in the financial system so that legitimate investors can be assured of long term financial solvency and ethics of financial institutions.

While the sustainability of this outcome is likely, its continued improvement could become vulnerable to budgetary shortfalls given the ever increasing electronic information processing and equipment upgrades needed, and given the magnitude of the task that remains to be completed. While Colombia’s UIAF is one of the most advanced in the developing world, continued government commitment and donor support will be required to maintain this effort. This situation needs to be monitored.

(vi) Outcome of the Component to Develop Competition Enhancement and Anti-Trust Policy Capacity

The outcome of the component to develop competition and anti-trust policies is considered marginally satisfactory. While the implementation of this component was satisfactory, it is unclear that the outcome of this component will have a palpable impact on the effective financial intermediation of resources

8. This component contributed to the following outcome:

Improved institutional capacity through the restructuring of the SIC enabled this entity to more effectively comply with the following responsibilities: i) the development of anti-monopoly competition policies; ii) the review of pending mergers and acquisitions; and iii) the resolution of a backlog of cases involving anti-competitive practices. The latter occurred mostly in the real sector where price fixing and monopolistic industry behavior was investigated although it did not significantly affect financial sector activity.

4.2 Outputs by components:

Despite the implementation challenges arising from the complex design of the Project and the fallout from the economic / financial crisis, continuity of Bank supervision and the technical capacity of the Implementing Agency as well as most of the beneficiary entities kept the Project on a productive track up to the closing date. The Project was managed by three Task Managers; the first was responsible for the design of the Project, the second took on project supervision in its first year, and the third assumed management of the Project throughout the larger part of the implementation period. Government officials interviewed for this evaluation, both at the Implementing Agency and the beneficiary entities were appreciative of the fact that they dealt with the same Task Manager during most of the implementation of this complex project. In the case of relatively new Government entities supported by the Project, their lack of familiarity with Bank procurement policies resulted in implementation delays. Project supervision in this regard helped to keep the process rolling; although with outstretched resources due to the large number of sub-components. At the same time, the Borrower’s strong commitment to the reforms that were supported by this Project, as well as their technical capacity for implementation, were instrumental in achieving their committed tasks. Perhaps in another setting this Project would have encountered more protracted implementation barriers.

One of the initiatives undertaken by Bank staff during implementation was to re-focus the project into narrower areas of output in order to reduce the overly-complex structure of Project activities. This reformulation did not affect the objectives or the content of the individual components, but rather grouped them into more manageable clusters. The re-focus of the project outputs were arranged according to the

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following categories9

:

1. Development and implementation of various financial sector legislative projects including the design of the new Securities Law, the legislative approval and issuance of the necessary regulations pertaining to the new Law governing the Financial System, development and approval of the new Housing and Housing Finance Law which corrected some of the past issues related to mortgage rate indexing and authorized mortgage securitization, a new Social Security Law capping benefits and making adjustments to contributions, and the corporate sector law governing procedures, auditing and negotiation of out of court corporate debt restructurings.

2. Implementation of an integrated system for monitoring banking sector risks at the individual institutional level. This was developed as a CAMEL based rating system by the SB and was implemented in two phases: The first phase covered a credit risk system used for evaluating and classifying the portfolio quality of supervised banks. The second phase implemented a market risk system used to quantify potential loss exposure from market risks such as interest rates, maturity mismatches and currency exposure. All these modules were implemented in an automated computerized platform which received data ;

3. Implementation of a new bank resolution process by FOGAFIN which involved the development of regulations and procedures for permitting the bank restructuring/deposit insurance agency to resolve insolvent banks through the progressive dismounting of its assets and liabilities with an orderly transfer of viable parts of its balance sheet to healthy acquiring banks. This assisted in reducing the cost of bank failure resolution by avoiding outright liquidation and its implied immediate indemnification of all insured depositors;

4. The Corporation/Companies Superintendency (SS) developed a more effective mechanism to track and monitor via computerized records those companies participating in the corporate restructuring program administered by the SS and resolution reached on debt restructurings with creditors;

5. The quantification and reconciliation of the Government’s public pension liabilities was done, and from this exercise was implemented a statutory financial reserve fund established as the FONPET which received both central government and decentralized government contributions to cover the respective obligations to public employees. At the same time, policy options were developed to increase the flexibility of the investment regime and the reference portfolio for private pension funds, so as to augment their long term returns and attract more affiliates to the privately funded system;

6. The regulatory framework as well as the institutional modality and transactional operating procedures needed to activate the securitization of mortgage portfolios, was established, including for securitization of other types of assets.

The above activities helped to consolidate the remaining objectives under the Project. The revised sub-components were consistent with the original six specific objectives. As it turned out, they represented some of the more successful elements of the Project. Nevertheless, it would have been helpful to have documented the rationale for the changes and to have established a more explicit linkage between the reformulated output and the original components.

In another evaluation, the Quality Assurance Group rated the Project supervision as satisfactory10

. However, the report made several recommendations for further improvement, mainly that more quantitative indicators should have been used to gauge implementation progress, that loan proceeds could have been

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used more productively if the SV had not held up the disbursement process, that supervision should have monitored the evolution of specific components more closely; and that the re-focus of Project activities should have been formalized as an addendum or amendment. As discussed in the earlier section on design, the original quantitative indicators for this Project were much too broad and unrealistic in terms of the project’s leverage for achieving them, so that more specific and practical “micro” indicators would have been preferred. In this regard, perhaps some of these alternative quantitative indicators could have been identified at the time that Project activities were reformulated and simplified, though this was done to some extent with the specification of major expected project outcomes and outputs as documented in the mission Aide Memoires.

While fiscal problems caused by the economic / financial crisis was the main factor behind the partial cancellation of the Project, there were also implementation delays by beneficiary agencies due to insufficient planning, slow internal budgetary processes, and a lack of familiarity with procurement procedures. The SV, which had been assigned the biggest component of Project resources was in fact the weakest in implementation, and thus delayed disbursements. One of the stumbling blocks was SV’s lack of expertise in budget planning. Originally SV had been assigned about 17.5 percent of total Project costs. In the end, the agency only utilized 18.0 percent of its original project allocation, or 4.7 percent of total actual Project costs. This compares to total Project expenditures relative to originally budgeted amounts of 59 percent due to the public sector budget cutbacks and the subsequent cancellation of funding. More attention to institutional capacity in procurement matters at SV during Project preparation would have helped to design a more realistic implementation plan.

The principal outputs of the Project by component are summarized below.

I. Implementation / Output of the Component to Develop Financial markets into a more efficient intermediation channel

The actions undertaken in this component were led by the public debt management unit at MoF (DGCP), the General Directorate for Financial Regulation (DGRF), the Treasury Department of the Capital District Government (Bogotá) (SHD); and the Superintendency of Securities (SV). Some of the key outputs were:

• Upgraded actuarial, analytical and software tools used in the management of public sector debt and planning for its issuance schedule. (DGCP).• Definition of and implementation of strategies for raising debt in the international financial markets and in developing relationships with investment banks (DGCP).• The General Directorate for Financial Regulation of the Technical-Vice Ministry of MoF developed several economic models addressing developments and cycles in the financial system and its linkages with the performance of the rest of the economy.• The Stock Exchanges (Bolsas) were integrated and the unified exchange notably improved the reporting of market information, particularly the publishing of a daily price vector for all traded securities.• A regulatory and operational framework was developed for the repurchase (repo) market including the implementation of a Master-Repo agreement which contributed to significant growth in short term market transactions backed by collateral.• Within the Treasury Department of the Capital District Government of Bogotá (SHD) a methodology was developed including training, to evaluate and manage financial risks and asset / liability matching. Under this component, a risk management unit was established within the Office that developed investment and debt management policies. The new entity successfully implemented a comprehensive risk

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management process, which has significantly enhanced the debt profile of the Capital District and initiated the issuance market for municipal securities not backed by any sovereign guarantee. The development of financial risk management methodologies and sound risk practices has enhanced portfolio management of the treasury and debt departments.• Given the diversity of mutual fund instruments in Colombia’s capital markets, regulatory norms governing the supervision of mutual funds and harmonized capital requirements were issued. In addition, disclosure requirements and fact sheets indicating market and credit risk parameters have been implemented. A similar initiative is in progress with respect to the classification of pension funds.

In addition to the projects described above, the SV was active in disseminating information to investors, notably through its own website. In order to implement some of these initiatives Project funds were utilized to purchase computers and software.

The Project supported ongoing work in the development of the local market for fixed income government securities. The promotion of the public securities market benefited from the contribution of several consultants financed through the Project. Technical support was provided for the development of a Dutch auction mechanism based on the analysis of market characteristics. The market enhancement included the identification of market-makers as well as a secondary tier of market participants comprised of securities dealers and financial intermediaries. In 1999, the DGCP consolidated the regulatory framework for market-makers. Analytical work on the estimation of a zero coupon yield curve benefited from Project technical input. The construction of a yield curve has contributed to longer-term financing of the public sector, improved management of maturities, credibility of a government debt issuance strategy, and to greater market transparency especially in the valuation of private sector fixed income securities. The data points of the yield curve are reported on a daily basis by the stock exchange – the current time horizon goes up to ten years on a daily frequency.

The upgrading of the debt management unit at SHD represented a cultural shift in terms of the focus on cost optimization with explicit risk factors. The reorganization of the debt management unit included new functions including the creation of a debt management committee charged with implementing the newly established asset / liability policies. A portfolio model was developed to identify target parameters in terms of duration and foreign exchange exposure of liabilities as well as optimum strategies for the investment of funds. Credibility gained through this new risk management approach has enabled SHD to issue longer maturity debt instruments and has contributed to greater liquidity in the secondary market for these securities.

II. Implementation / Output of the Component to Strengthen Regulation and Supervision Capacity in the Financial Sector

This component involved a number of beneficiary entities including: DGRF, SB, SV, SS, SES, and FOGAFIN. Initially, it was assigned the largest share of resources under the Project. Implementation delays in this component were associated principally with the overall restrictions in the fiscal accounts which equally affected loan resources assigned within the national budget as well as counterpart resources. The principal outputs included:

• Technical consulting support in the drafting of law to reform the financial system including increased capital requirements and new authorized methods for bank resolution and/or restructuring, and associated regulations (DGRF).• Development of an advanced computerized credit and market risk system with CAMEL rating

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categories for use in banking supervision and assessment of bank weaknesses, and strengthened banking supervision through applying bank rating methodologies during on-site inspections and off site analysis (SB).• Development of a case-management methodology for the SS to respond on a timely basis to firms seeking to restructure debts as a result of financial problems, training in creditor/debtor negotiation and compromise-seeking methods, and implementation of an audit process to monitor restructuring recovery plans of companies having completed negotiations with creditors (SS).• Strengthening of the supervision of corporations through the upgrade of technology (computers and software) to analyze company financials and project emerging trends and debt sustainability. Information is received electronically from subject companies. The Superintendency of Corporations developed a financial database and risk rating matrix for registered companies that will assist in monitoring potential financial weakness through the establishment of a quantitative index of financial performance (SS). • Balance sheet valuations performed on the following banks: Superior, Selfin, Union Colombiana, Colpatria, Interbanco, Coltefinanciera and Credito through the hiring of expert consulting firms, in this case the firm McKinsey & Co. was utilized (FOGAFIN).• Provided training to FOGAFIN staff on comparative systems for designing and operating deposit insurance schemes (FOGAFIN).• Provided consultancy and equipment support to establish the new Superintendency of Cooperatives and establish a database of cooperatives subject to financial supervision as well as the development of prudential norms to regulate this sector. A comprehensive census of cooperatives was conducted nationwide in order to compile financial and legal information as well as operational statistics. Consultant support was utilized to implement a strategy to close and liquidate over 900 cooperatives which did not meet the financial viability criteria.(SES)

As a newly created entity within MoF, the DGRF made significant contributions to the drafting of regulations and new legislation through research and legal work supported by the Project. DGRF actively participated not only in the Financial System Law, but also in the drafting of the Housing Finance Law as well as in the Law for Corporate Debt Restructuring. Project funds supported the hiring of consultants which resulted in the identification of numerous regulations to support the implementation of these laws. This analysis included the evaluation of the new indexation scheme for residential mortgages imposed by a ruling of the Constitutional Court. DGRF was also involved in the drafting of the new Securities Law for which the Project also supplied expert consultants with strong knowledge of international best practices.

The issue of harmonization of regulatory norms across markets did not gain attention until the past couple of years, with policy reforms supported by a new Programmatic Financial Sector Loan (2003). The creation of a securities valuation committee in 2002, with participation from MoF, SB, and SV, was influential in defining uniform standards for securities valuation.

SB’s supervisory capacity benefited from numerous Project financed activities. One of the international consultants assisted in the design of a standard bank examination manual following the implementation of the credit risk and CAMEL rating methodologies. An initial attempt at implementing a policy for consolidated supervision consisted of a study of financial groups in Colombia and the development of a database representing forty financial holdings. Without the Project resources, SB would have been behind in terms of supervisory standards since a number of the activities supported by the Project could not have been financed through normal budgetary appropriations.

The development of a financial data base and performance indexes by the SS for the corporate sector, has enhanced the monitoring capacity of that Superintendency. A system was designed to

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accumulate financial information regularly provided by registered corporations to create solvency indicators. The development of this methodology was financed by the Project. Based on numerous ratios and other financial indicators the model generates an overall quantitative index of financial performance for approximately 7,400 medium to large firms which could have an impact on the banking system if their debts defaulted.

The Project provided much needed funding for the establishment of the Cooperatives SES which had been created by Law 454 of June 1998. The principal contributions consisted of funds to develop the administrative structure of SES, to support the development of a census of cooperatives which identified 6,484 existent entities. Several research projects were financed to perform analysis of the sector and its financial viability. Funds were also used to purchase supplies and equipment. Bank support was instrumental in this area, although in view of the magnitude of the task and the resource needs of SES in supervising so many cooperatives the Bank and the Government might have considered a bigger allocation to this sub-component of the Project.

III. Implementation / Output of the Component to Increase the Supply of Securities and Availability of other Financial Instruments

The goal of this component was to facilitate the issuance of securities in the market and to introduce new market instruments to enhance the investment menu available to investors. The extensive work done to upgrade and simplify the regulations dealing with the registration of new securities led to the conclusion that a more productive approach was to draft a new Securities Law to set forth a more enabling framework. However, the first version of the proposed legislation contained several controversial features that undermined its passage through Congress. The obstacles could have been surmounted if a wider representation of stakeholders had been consulted during the drafting stage. In the meantime, the Government has modified the proposed Law to resolve the initial objections and expects to resubmit it to the Congress by end 2004. Due to divided views on the subject, the new version of the Securities Law still leaves open a future question regarding the role and possible integration of the principal regulatory agencies (SB, and SV) in the supervision of the capital markets. This issue has been postponed to a future revision to the Securities Law, once the Government is able to achieve a consensus regarding the role of the regulatory agencies. This underscores the complexity of making changes to the legal framework and the need for greater focus on the political process in designing effective policy reforms. International experts differ on the best approach to regulating the capital markets, thus it is crucial to have a good appreciation of the political environment and its receptivity to revising existing laws in order to reach a successful outcome. Reforms cannot be solely dictated only by what is considered international best practice, particularly when country specific environments can differ in both the legal and operating framework.

One of the most important innovations in the financial system of Colombia has been the securitization of mortgage loans. The development of this instrument benefited from work undertaken by the Project. One of the pivotal factors was the vision developed by market participants relative to the strong potential for securitization as well as the balanced incentives provided by the Government. The Project supported the development of the technical tools and analytical models used in the design of the securitization business.

On the other hand, little interest materialized in the development of the derivatives market and venture capital funds, even though these were highlighted as significant capital markets initiatives in the Project description. One lesson from this experience is that the introduction of new financial instruments needs to be market-driven. In the case of securitization, there was a large pool of residential mortgages held by banks which in turn were looking to shift some of this risk out of their portfolios, thus making

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residential mortgages a natural candidate for securitization. In the case of derivatives such as futures and options, there was insufficient market interest due to a lack of incentives to use such instruments to reduce risk given existing bank regulations requiring reserves against such risks, to insufficient market liquidity in the underlying instruments, and to competing instruments such as the UVR indexed bonds which already provided a useful tool for the management and pricing of interest rate risk. The experience of this Project shows that the introduction of new financial instruments should be based on the operating market business environment and “gap” areas in risk management, rather than an idealized analysis of what a modernized market structure should look like.

The principal outputs in this component included:

• Preparation of a full draft of a new Securities Law which included innovative features such as harmonizing the mutual/investment funds industry, consistent guidelines for valuation of securities, corporate governance norms for management, auditors, Board members and employees of companies, rationalized procedures for the issuance of securities on the market, and qualification standards for industry professionals or new entrants. (DGRF, SV)• The issuance of regulations for the structure, valuation and trading of mortgage-backed securities developed under the project, based on the new legal framework established under the Housing Finance Law (SV).• Supervision procedures established to monitor the operation and risk management of new private securitization firms authorized in the Colombian housing and asset backed market financial markets (SV).• Promotion and development of the interest rate and currency swap and hedge markets and listing of such instruments on the stock exchange. Although, as discussed above, these instruments were not utilized as expected, the regulatory and operating framework for them was established.

The Project laid the foundation on which a successful securitization business was built. Titulizadora Colombiana, the first Colombian Securitization firm, was established in 2001 and has already issued four mortgage-backed securities in the market. Most of the investors have been financial intermediaries, thus providing them with a marketable asset as a substitute for a residential mortgage portfolio which was otherwise not a tradable instrument.

IV. Implementation / Output of the Component to Consolidate Social Security / Pension Reform

At the time of the first round of Social Security reforms and prior to project initiation, the public sector pension system was segmented, splintered across the states and municipalities, as well as the Institute of Social Security, and the special public sector pension funds. This Project component was designed to establish a centralized registry of workers with updated employment histories in order to calculate the Government’s total public pension liabilities, and thus plan on a funding strategy to ensure solvency in financing the future cumulative benefits of each affiliate. The Directorate for Social Security within MoF (DGSS), established under the Project, was well focused in terms of this task and implementation was thus relatively smooth. This component fully utilized its initial budgeted allocation (103 percent of the initial budgeted amount). Since implementation of the DGSS sub-component was up and running from the initial period of the Project, and funds were committed early on, it was not affected by the subsequent budget cutbacks.

The principal outputs in this component included:

• Compilation of a computerized historical data base of employment records for employees in

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territorial entities and national agencies for the purpose of calculating their accumulated and future pension benefits (DGSS).• Development of specialized software for installation in each participating agency in the central and decentralized government sectors.Software programs were PASIVOCOL for the compilation of information and PASIVONAL for the processing of data relating to individual labor/employment histories (DGSS). • Developed a Single/Unique Registry system (the RUA)for public pension funds affiliates so as to track the accumulation of benefits and payments thereof, without duplicating records or compensating individuals erroneously. This system was also used to track payments made on behalf of affiliates health and insurance benefits (DGSS).• Quantified the estimate of the Government’s pension liability, covering both the pension liability of the central government and the liability on behalf of decentralized (municipalities, Departments) government jurisdictions and specialized public pension funds. The estimated central government actuarial liability calculated, represented over 150 percent of GDP.• Created the FONPET, a Government established pension reserve fund, particularly to fund the decentralized government sector pension liabilities and to centralize these under a common institution. This also permitted the central government to demand contributions from the decentralized jurisdictions to cover their accumulated pension liabilities and build up an adequate FONPET reserve (DGSS).

The compilation of employment histories and estimation of the Government’s pension liability was a major undertaking which taxed the full resources of the DGSS. The employment history survey involved 3,351 government entities comprised of municipalities, departmental governments (similar to provinces), and other decentralized entities. DGSS developed questionnaires and associated software that was distributed to all the agencies. Consultants were contracted to develop the actuarial methodology to calculate the pension liabilities and train operators in the field. The first estimate completed revealed that many entities did not have reserves to cover these commitments, and in fact those liabilities were much higher than originally expected, roughly about 167 percent of GDP. In response, the Government created the Fondo Nacional de Pensiones de entidades Territoriales (FONPET: National Pension Fund for State Entities). Each entity is now responsible for updating their database in order to re-calculate the pension liabilities. Future monitoring of this sub-component is recommended in order to confirm full participation by all entities as well as to make certain that regular updates of system information are made on a timely basis.

V. lmplementation / Output of the Component to Develop a System of Financial Intelligence to Detect Corrupt and Fraudulent Practices

Progress in achieving this component was a condition for Project approval. For this reason, funding for this component was released during the early stages of the Project and thus avoided the subsequent fiscal restrictions. Nevertheless, access to financial support from other bilateral agencies resulted in marginal utilization of the Bank’s resources, with only 18.5 percent utilization of budgeted funds. As a result of Project support the following activities were realized:

• Support for the establishment, initial staffing, technical support, and organization of the money laundering unit within MoF. Funds were used in the building up of the Unit’s capacity including the purchase of computers and other equipment. (UIAF)• Support for the development of highly sophisticated software used to geographically map locations of enterprises across the nation including specialized algorithms to determine whether money flows could

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be considered suspicious given the industry base and revenue prospects of industries in particular sectors and sub-regions. The software was also linked to identification matching with respect to suspicious deposits or cash transactions with financial institutions across the country.• Support for the development of systems and software to allow financial institutions via the supervisory agencies, to electronically submit reports on suspicious cash or other transactions to the Unit, allowing it to correlate any such transactions with enterprises being investigated.

The UIAF has evolved rapidly and has established an information network to compile reports of questionable financial transactions and constitutes one of the most advanced Offices of its kind both in the region and globally in the developing world. All financial sector regulatory agencies are linked to the system and are required to make periodic reports. One potential weakness of the system is that the UIAF does not have enforcement powers, thus it must rely on the cooperation of the participating entities which so far (in the case of the banking superintendency) have fully supported the mandate of the Unit. Due to the sheer volume of transaction reports which are being processed, the unit is nearing its computing capacity, and thus should consider obtaining additional funding to upgrade its IT system. The unit currently has a staff of 26 persons, of which 5 are analysts and two IT technicians. Because of these resource limitations, it does not appear that the unit will have the capacity to develop the information systems for the incorporation of other sectors of the economy into the intelligence network as originally anticipated. UIAF is planning to expand its surveillance to the lottery businesses and casinos, jewelers, accountants, and lawyers; however, it has not been empowered with enforcement faculties and thus a regulatory framework to handle this will need to be established. At the same time, UIAF will also need to develop artificial intelligence systems to increase its capacity to handle the additional volume in transaction reports.

VI. lmplementation / Output of the Component to Develop Competition and Anti-Trust Policy Capacity

The Superintendency of Industry and Commerce (SIC) received funding from the Project to upgrade its IT system, to improve the regulatory framework established by the Competition Law, to participate in the FTAA negotiations and to provide technical capacity in the investigation of anti-trust and unfair competition cases. The principal outputs were:

• Consulting support to improve monitoring, processing and resolution of the investigative case load relating to anti-competitive practices, and to finance research work dealing with market structure and industry monopoly issues. (SIC)• Provided financial resources to support participation of SIC in the FTAA negotiations.(SIC)• Financed acquisition of equipment and software to track companies or enterprises under investigation for monopoly or anti-competition practices, and software to track the progress in the investigative case load and eventual settlement agreements.

The resources from the Project allowed the SIC to upgrade their case handling capacity. Consultants were hired to assist with the development of procedural guidelines for analysis of competitive practices. SIC was also able to update their information system and to develop new data bases to monitor market activities.

4.3 Net Present Value/Economic rate of return:

The project was a technical assistance operation supporting policy reforms and thus did not have a quantifiable economic result.

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4.4 Financial rate of return:

As above, the project’s outcome represented a “public good” and thus an immediate monetary benefit or rate of return was not applicable.

4.5 Institutional development impact:

The institutional development impact of the Project is deemed to be substantial based on the output of the six major components / specific Project objectives. The purpose of this Project was to build up institutional capacity and thus improve the enabling environment for the financial system – with special emphasis on the capital markets. The components of the Project focused on different aspect of institutional support such as enhancing the efficiency of the securities markets, strengthening existing regulations and supervision practices, improving the market’s information infrastructure, and reinforcing newly created regulatory and policy making entities in the financial sector.

While the overall thrust of the Project was on institutional reinforcement, the complexity of the Project and the number of beneficiary entities stretched the available resources during implementation. The areas of greater impact were the DGRF unit in MoF, which expanded its policy analysis capacity, the DGSS, also in MoF, which was able to compile a comprehensive data base to estimate the Government’s pension liability; through SV and DGRF, the development of securitization of mortgage loans, a notable market innovation; the establishment of the UIAF unit to monitor illegal financial transactions; the reinforcement of supervisory activities by SB; the strengthening of corporate financial monitoring by the SS; and while passage of the law is still pending, the drafting of a new Securities Market Law. The contribution of the Project to these sub-components was highly satisfactory, particularly with respect to their impact on market efficiencies. Of course the outcome from the new Securities Market Law hinges on final approval in Congress.

More emphasis in supporting some of the other components would have been helpful; however, the complex structure of the Project, combined with the Government’s decision to partially cancel funds, hindered outcome in those areas. The institutional development impact on SV was marginal. This was reflected in the limited use of resources. More up front attention to SV’s organizational structure, capacities and limitations would have resulted in a more realistic assessment of its institutional development needs in relation to project management. The Superintendency of Cooperatives (SES) benefited from support of the Project, yet the amount of resources allocated to this new agency relative to the magnitude of the task of monitoring thousands of financial cooperatives was unrealistic. Even though the funds channeled to SES were applied efficiently, within the overall scope of improving the performance of this agency, the use of much greater resources could have been contemplated. But once again, the complexity of the Project in view of the number of participating entities would have conspired against the efficient use of those additional resources.

5. Major Factors Affecting Implementation and Outcome

5.1 Factors outside the control of government or implementing agency:

The economic / financial crisis of 1998-1999 was one of the principal factors affecting Project implementation. Under the circumstances, there was a possibility that the Project would have been cancelled altogether in view of the Government’s concerns regarding the stabilization of the financial system. Fortunately, strong Government commitment to the reforms of the financial system was instrumental in the decision to continue with the Project although after some downsizing due to fiscal budget constraints.

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5.2 Factors generally subject to government control:

As mentioned above, the strong Government commitment to the reforms of the financial sector proved a decisive factor in the successful outcome of the Project. The high technical and organizational capabilities of key staff enabled implementation to proceed despite budget and economic hurdles. Of course, the fiscal austerity measures imposed as a result of the economic / financial crisis led to partial cancellation of Project funds.

5.3 Factors generally subject to implementing agency control:

The MoF was strongly committed to the Project’s objectives. The Project Coordinating Unit (PCU) had been in operation since 1996 as part of an earlier IDB project. The PCU complied with the onerous burden of preparing semi-annual Project Implementation Plans (PIAs), which was subsequently changed to an annual basis. However, the relatively high turnover of UC directors, four during the Project, did contribute to implementation delays, and potentially, lack of political power to avoid some of the project budget cuts experienced.

5.4 Costs and financing:

Not applicable.

6. Sustainability

6.1 Rationale for sustainability rating:

The sustainability of this Project is judged to be likely. The strong commitment by the Government to the reforms supported by the Project is expected to support further institutional development in the regulatory framework as well as in the functioning of the markets. The work done on improving the regulatory environment of the capital markets is expected to culminate with the approval by Congress of the Securities Law. Further work is needed in strengthening the institutional capacity of the beneficiary entities, particularly the SV, the SES, and the UIAF (mostly financial resources).

Rationale: The sustainability rating is given due to Colombia’s strong institutional capacity and highly trained professionals in the civil service. In addition, the new regulatory and supervisory models developed within the project, were absorbed, applied and disseminated within the beneficiary institutions. Project technical inputs were thus applied to work processes and internalized, versus being mere advisory consulting studies. The activities were also integrated with counterpart budgetary work program, which, although more limited in the latter years, helped to incorporate project outputs as part of institutional corporate targets.

6.2 Transition arrangement to regular operations:

Not applicable.

7. Bank and Borrower Performance

Bank7.1 Lending:

Bank performance in lending preparation and design is rated satisfactory. Project preparation,

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however, took an unusually long period of time, in large part due to changing Government signals, during which changes in market conditions affected the relevance of some of the Project components. By trying to consolidate several operations into one, the design of the Project became very complex. In terms of appraisal, inadequate assessment of the implementation capacity at the SV, the principal beneficiary of Project funds, subsequently resulted in implementation delays.

7.2 Supervision:

Bank performance during Project supervision is rated satisfactory. Based on interviews for this report, the Borrower was appreciative of the follow-up to implementation issues shown by supervision Missions. The fact that one Task Manager had responsibility of the Project during the full length of implementation was considered a positive factor by the Borrower. Supervision missions included experts in areas of interest to the beneficiary agencies. The Task Manager also took the initiative to refocus the Project activities in order to facilitate implementation; although a more formal approach to this adjustment in terms of documentation would have been helpful.

7.3 Overall Bank performance:

Overall Bank performance is deemed to be satisfactory.

Borrower7.4 Preparation:

Borrower performance during preparation is deemed marginally satisfactory in terms of Project design. As explained above, the complexity of the Project, political/personnel changes, and delays in completing key studies and diagnostics, impacted adversely on the process, even though some benefits did accrue towards the relevance of the final project design. Perhaps a more realistic approach in terms of initial strategy and implementation capacity of the Borrower would have sent useful signals to the Bank during preparation.

7.5 Government implementation performance:

Government implementation performance was satisfactory. As stated earlier in this report, the successful outcome of this Project is attributed in large part to the strong commitment by the Government to the reforms which were eventually defined and supported by the Project.

7.6 Implementing Agency:

The performance of the implementing agency, the Ministry of Finance, was satisfactory. The PCU was in regular contact with the beneficiary entities, this helped to identify ongoing implementation issues. The semi-annual and then annual progress reports prepared by the PCU contained an impressive amount of information; although this detracted somewhat from their ability to promote strategic direction to beneficiary entities. PCU effectiveness was modestly compromised by the turnover of project coordinators. Nevertheless, the regular ongoing staff provided continuity.

7.7 Overall Borrower performance:

After consideration of the above-mentioned factors and of the outcome of the Project, the overall performance of the Borrower is rated as satisfactory.

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8. Lessons Learned

The principal lessons derived from the outcome of the First Loan include the following:

v Strong Government commitment to the reforms supported by a TA Project is a decisive factor in its success. In view of the long drawn out preparation period, which ended with a hodgepodge of components that had earlier been envisioned as separate operations, changes in Government, and a subsequent economic / financial crisis, this Project would have encountered serious problems in another context, but for the strong commitment of the Government and its high technical capacity, the outcome was successful.

v TA project components are more relevant when supported by extensive economic sector work. The Bank’s Financial Sector Review (1993) followed by the Capital Markets Mission (1994-1996) report, funded by the Japanese Grant, provided valuable input during the design of the Project components.

v Design of a project has to be determined by the needs of the borrower. During the design phase the Bank was insistent on structuring a capital markets project involving the use of a backstop facility to support the issuance of longer maturities; however, the Government was never convinced of its relevance. Bank efforts to promote the backstop facility added to the delays in project preparation.

v Project design needs to be focused and with a limited number of components. The design of the TA Project was too complex in terms of the number of beneficiary entities and the number of sub-components. It is much better to design a sequence of TA operations with a logical buildup of activities than to structure a very broad project which taxes the Bank’s supervision capacity and the Borrower’s implementation capacity. Some entities that required additional support in order to meet their Project commitments such as SV and SES were not dealt with adequately.

v Project design has to be flexible particularly when there is a relatively long implementation period. In the case of the TA Project the initial Project matrix contained a very detailed listing of all activities with their respective costs. Such a rigid design of a project that is to run for several years is unrealistic in view of the state of flux in the economy and within each of the beneficiary agencies, particularly when there is a change in Government or the administration of a particular entity. It is not realistic to tie down all project components from the start, rather some flexibility is needed in terms of individual activities within a project component.

v Project design should be accomplished within a reasonably short period of time. In the case of this Project, design took over five years, given a two year pause. Nevertheless, many ideas and players took part in the evolution of the final Project structure which may have contributed to its extensive coverage.

v The longer the period of preparation, the more scrutiny should be applied by the internal review of the final project design. After the TA Project was re-started, the Bank should have applied a more rigorous test to the adequacy and relevancy of design, particularly in terms of the Borrower capacity. A simpler but successful project can have a much better outcome than an ambitious but complex one.

v Successful financial market innovations are market driven. The introduction of new financial instruments is a spontaneous creative response on the part of intermediaries to an existing market need; thus, attempts to artificially create a market instrument are not sustainable. The development of securitization of mortgage loans has been a major success; while the development of derivatives and

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options trading has lacked a critical mass for fruition. The design of these initiatives should be based on actual market data that supports the critical mass test for its feasibility.

v Project risk assessment needs to explicitly address Government budgetary policies as they relate to approval of Project-related expenditures. Project appraisal should include sensitivity analysis and contingency planning regarding any unexpected budget shortfall experienced by the borrower and alternative restructuring of project activities. The economic / financial crisis in 1998-1999 resulted in the implementation of fiscal austerity by the Government. Colombian budgetary practices apply any rollbacks in expenditures to all items in the national budget, including Project expenditure items, even though those items had already been earmarked for Bank financing and their cancellation resulted in the loss of those financial resources.

v When a beneficiary entity represents a significant share of project financing, staff should carefully evaluate implementation capacity. In the case of SV, lack of experience with Bank procurement and budgeting procedures undermined its use of Project resources and consequently delayed total disbursements.

v Complex institution building TA projects require post-closing follow up to check on the sustainability of the initiatives undertaken by the project and to assess the medium- to long-term effectiveness. Technical assistance, particularly institution building, is not a one time support activity. Monitoring of Project outcomes sometimes involves future follow-up to confirm sustainability of newly implemented practices. In the case of the Social Security component a lump sum of financial resources were applied to the establishment of a comprehensive compilation of employment histories and resulting pension liabilities; however, the credibility of this analysis hinges on continued full participation by all affected entities. Likewise, in the case of SES, the cooperatives superintendency, the Project provided funding to help jump-start the agency; nevertheless, institutional development at this agency was only at a nascent stage. In both instances the Bank should device a more formal monitoring process to evaluate the sustainability of its Projects. A project’s implementation should not end at the time of closing.

9. Partner Comments

(a) Borrower/implementing agency:

Ministerio de Hacienda y Crédito PúblicoRepública de Colombia

Bogotá D.C.,

SeñorJohn PollnerLíder Especialista del Sector FinancieroBanco Mundial

Asunto: Proyecto Desarrollo de los Mercados Financieros y de Capitales - BIRF 4196-CO

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Apreciado Señor Pollner:

En nombre del Gobierno Colombiano quiero expresarle mis agradecimientos por el apoyo permanente del Banco Mundial durante todo el desarrollo del proyecto “Desarrollo del Sector Financiero y del Mercado de Capitales”.

Sin lugar a dudas, este proyecto le permitió al Gobierno, a través del Ministerio de Hacienda y Crédito Público y de las demás entidades involucradas en el mismo, adelantar acciones orientadas al fortalecimiento de la regulación prudencial y la supervisión, tanto en el ámbito del mercado de capitales como en el del mercado intermediado, y establecer políticas que propicien estabilidad, claridad y nuevos instrumentos de apoyo en la actividad financiero, aseguradora, bursátil y cooperativa.

Muchas de estas acciones surgieron de las recomendaciones hechas por la Misión del Mercado de Capitales y, posteriormente, por la necesidad del Gobierno Nacional de reactivar los diversos sectores de la economía y en particular el sector financiero, ante las dificultades que a partir de 1998 evidenciaron muchas entidades y usuarios de dicho sector, lo que incluso llevó a declarar la emergencia económica. Esta coyuntura exigió esfuerzos adicionales del Gobierno con miras a recuperar y fortalecer el sector financiero y lograr la estabilidad y crecimiento económico.

El manejo de la crisis llevó al Gobierno a introducir arreglos normativos necesarios para modernizar algunos aspectos de la legislación, flexibilizar riguideces de la normatividad, corregir debilidades evidenciadas en el proceso de reacomodamiento del sector financiero, introducir mecanismos de protección a los usuarios del sistema e instrumentos para proteger la confianza del público y adecuar algunas normas a estándares internacionales y a los pronunciamiento de la rama jurisdiccional. Estos ajustes fueron recogidos en las recientes reformas financieras que el Gobierno puso a consideración del Congreso y que hoy son Leyes, dotando al sistema financiero de un nuevo marco legal y posibilitando su mayor desarrollo en condiciones de transparencia y equidad.

Hoy, podemos decir que la crisis fue superada y las cifras de desempeño del sector financiero lo corroboran. Como resultado de las mejores condiciones económicas, los establecimientos de crédito presentaron al cierre de diciembre de 2003, utilidades por COP $1.805 mil millones; el crédito neto del sistema aumentó en 6.89%; la exposición al riesgo del sector financiero se reduce porque la cartera vencida bruta disminuyó en el 17.84%; y, la solvencia de los establecimientos de crédito se sitúo en el 14.5%, por encima del mínimo requerido por las normas de regulación prudencial.

Por otro lado, la estabilidad de los mercados financieros contribuyó a que durante el año 2003 la economía colombiana presentara una dinámica caracterizada por la aceleración en el ritmo de crecimiento económico. La tasa de crecimiento económico de 3.74% registrada para éste año, así lo confirma. Este proceso, en lo que va corrido el año 2004, ha continuado no solo para los distintos agregados económicos sino para el sector financiero y las entidades que lo integran.

Igualmente, el proyecto posibilitó adelantar reformas en sectores estratégicos de la economía, como es el sistema de seguridad social, con el fin de evitar crisis fiscales futuras y generar confianza en el sistema. Otro sector que se vio beneficiado con el proyecto fue el sector empresarial a través del desarrollo de acciones en materia de supervisión de sociedades y del desarrollo de instrumentos en materia procedimental. Por su parte, el proyecto permitió que el Gobierno adelantara una estrategia de manejo y emisión de deuda pública del Estado así como una estrategia financiera para el Distrito Capital.

Queremos anotar, además, que el proyecto permitió la implementación del modelo institucional de la Unidad Administrativa Especial de Información y Análisis Financiero, UIAF, y de los sistemas de captación e identificación de información de dicha Unidad. Así mismo, la creación, implementación y fortalecimiento del modelo Institucional de la Superintendencia de la Economía Solidaria.

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Este trabajo conjunto con entidades externas al Ministerio de Hacienda y Crédito Público permitió, el fortalecimiento institucional y la consolidación de las entidades beneficiarias del proyecto, las cuales desarrollaron e implementaron proyectos de gran impacto económico y fiscal.

Por último, queremos anotar que el Gobierno sigue comprometido con las reformas del sector financiero y del mercado de capitales que permitan poner a tono con estándares internacionales nuestra normatividad y proteger adecuadamente a todos los intervinientes del sistema financiero, sin perder de vista la realidad del país. Por ello, el Gobierno tiene nuevos retos los cuales requieren, para su desarrollo, de un trabajo cuidadoso y coordinado entre las distintas entidades del Gobierno y del apoyo de la banca multilateral.

El Gobierno agradece el permanente acompañamiento por parte del Banco y está a disposición de los equipos técnicos del mismo para definir conjuntamente programas futuros de crédito y asistencia técnica en la medida en que se consoliden los ajustes y se requieran nuevas acciones para el mercado intermediado y desintermediado.

Cordial saludo,

María Inés AgudeloViceministro Técnica

(b) Cofinanciers:

(c) Other partners (NGOs/private sector):

10. Additional Information

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Colombia: Selected Economic Indicators 1995 1996 1997 1998 1999 2000 2001

GDP growth (%) 5.2 2.1 3.4 0.6 -4.2 2.9 1.4 Inflation (%): Average 20.9 20.8 18.5 18.7 10.9 9.2 7.9 year-end 19.5 21.6 17.7 16.7 9.2 8.8 7.6

Interest Rates: DTF 32.34 31.14 24.13 32.58 21.33 12.15 12.44 Lending rate 42.77 41.99 34.22 42.21 30.41 26.37 20.72

Exchange Rate (pesos / US$) Average 912.8 1036.5 1141.1 1427.0 1758.6 2087.4 2299.8 250 (% chg) 13.6 10.1 25.1 23.2 18.7 10.2 year-end 987.6 1005.3 1293.6 1542.1 1873.8 2229.2 2291.2 2864.8 (% chg) 1.8 28.7 19.2 21.5 19.0 2.8

Public Sector Deficit (% of GDP) with privatizations -0.06 -0.86 0.45 -3.14 -3.74 -3.76 -4.24 excl. privatization -0.31 -1.7 -2.81 -3.67 -4.08 -4.19 -4.34

Balance of Payments (millions of US$): Current Account (4,528) (4,642) (5,751) (4,858) 671 626 (1,251) (1,639)

Financial Account: FDI (net) 712 2,784 4,753 2,033 1,392 1,973 2,493 1,171 Loans (net) 1,565 2,595 1,517 97 (1,075) (1,354) (4) (1,347) Other (net) 2,282 1,304 318 1,184 (873) (634) (99) Net Financial Acct. 4,560 6,683 6,587 3,314 (555) (15) 2,390 1,295

Errors & Omissions (30) (321) (559) 154 (430) 259 78 482

Overall Balance 2 1,721 277 (1,390) (315) 870 1,217 o/w: chg. in reserves 2 1,721 277 (1,390) (315) 870 1,217

Crrnt Acct (% of GDP) -4.9 -4.8 -5.4 -4.9 0.8 0.7 -1.5

Sources: Central Bank, Finance Ministry, and the National Statistical Institute

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Annex 1. Key Performance Indicators/Log Frame Matrix

Outcome Indicators:

Indicator Initially Projected Actual/Latest Estimate

1994 : 23% 1997 : 21% 2000 : 12% 2002 : 14%

1999 : 10.9%Solvency / Capital Adequacy Ratio 2000 : 12.1% of the Banking System 10% 2001 : 9.8%

2002 : 10.0% 2003 : 11.0%

Yearly volume of pension liabilities 200% 150% of GDP

2000: 1342001: 1682002: 1352003: 236

1999 : 10,455 2000 : 13,206

Value of Private Pension Fund Assets NA 2001 : 15,604 (Pesos billions) 2002 : 18,279

2003 : 21,113 4/2004 : 21,317

Yearly average of equity market capitalization / GDP

NA

Yearly number of cases of anti-competitive practices investigated by SIC

150

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Output Indicators:

1995 2000 2001(Pesos mn.)Stocks 1,536 2,897 1,769CDTs 14,295 11,587 16,614Corporate Bonds 2,174 6,025 4,483Central Bank 1,260 0 0TES 1,655 35,110 48,275Other 4,860 6,469 10,752TOTAL 25,780 62,088 81,894

Stocks 6 4.7 2.2CDTs 55.4 18.7 20.3Corporate Bonds 8.4 9.7 5.5Central Bank 4.9 0 0TES (treasury sec.) 6.4 56.5 58.9Other 18.9 10.4 13.1 TOTAL 100 100 100

Colombia: Value of Securities Traded

(percent)

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Annex 2. Project Costs and Financing

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Project Costs by Components (Loan plus Counterpart - in US$ million)

Project Component Appraisal Revised after Cancellations

Actuals (Est.) Percentage of Revised

I. Developing Financial Markets

1,237,000 667,980 876,529 131%

A. Improving the functioning of the markets

575,000 91,702

B. Developing the market for public securities

487,000 690,184

C. Promote participation of institutional investors

175,000 94,643

II. Strengthening Regulation and Supervision Capacity

4,380,000 4,599,000 4,360,027 95%

A. Harmonization/refinement of the regulatory framework

440,000 1,937,131

B. Strengthening institutional capacity- market supervision

2,075,000 1,595,558

C. Creation of Cooperatives Superintendency

1,865,000 827,338

III. Increasing the Supply of Securities in the Market.

2,606,000 521,200 203,285 39%

A. Increasing securities supply 715,000 45,167B. Introducing & promoting new instruments

1,891,000 158,118

IV. Consolidating Social Security Reforms

4,371,000 2,877,283 3,238,752 113%

A. Implementing transfer of pension liabilities

3,370,000 1,327,499

B. Institutional strengthening of Delegatura of pensions (SB)

218,000 177,270

C. Institutional strengthening of Social Security Institute

250,000

D. Continue implementation and regulation of Law 100

533,000 1,733,983

V. Development of a system for Control of Money Laundering

2,680,000 536,000 414,805 77%

A. Establishment of the system of financial intelligence

850,000 351,516

B. Implementation of the new System in three priority sectors

500,000 63,289

C. Expand other sub-sectors 1,330,000VI. Development of Competition and Anti-trust policy capacity

1,880,000 827,200 626,187 76%

VII. Project Management A. Project Admin. & Mgmt. 816,000 652,800 556,678 85% B. Contingencies 2,030,000Other (incorporated ex post) 1,465,410

Total Project Costs 20,000,000 10,681,463 11,741,673 110%

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Project Financing by Source of Funding and Beneficiary (US$ mn.)

Beneficiary Initial EstimateTotal Project Costs Bank Gov't. Total %

PCU 816,000 44,790 168,700 213,490 26%DGCP 290,993 629,551 121,744 751,295 258%DGRF & MOF 2,856,475 1,229,458 762,935 1,992,393 70%DGSS 3,201,500 2,283,779 1,024,228 3,308,007 103%SB 962,032 1,269,840 379,574 1,649,414 171%SV 3,476,478 385,513 250,907 636,420 18%SS NA 417,514 246,820 664,334 NASES 1,678,500 688,125 146,327 834,452 50%SIC 1,692,000 351,104 313,527 664,631 39%SHD NA 97,576 38,262 135,838 NAFOGAFIN NA 460,462 22,670 483,132 NAUIAF 2,211,500 358,798 49,469 408,267 18%Contingency 2,814,522 TOTAL 20,000,000 8,216,510 3,525,163 11,741,673 59%

Actual

Project Costs by Procurement Arrangements (Appraisal Estimate) (US$ million equivalent)

Expenditure Category ICBProcurement

NCB Method

1

Other2 N.B.F. Total Cost

1. Works 0.00 0.00 0.00 0.00 0.00(0.00) (0.00) (0.00) (0.00) (0.00)

2. Goods 1.20 0.40 0.50 0.00 2.10(0.90) (0.30) (0.50) (0.00) (1.70)

3. Services 0.00 0.00 14.80 0.00 14.80(0.00) (0.00) (11.00) (0.00) (11.00)

4. Miscellaneous 0.00 0.00 3.10 0.00 3.10(0.00) (0.00) (2.30) (0.00) (2.30)

5. Miscellaneous 0.00(0.00)

0.00(0.00)

0.00(0.00)

0.00(0.00)

0.00(0.00)

6. Miscellaneous 0.00(0.00)

0.00(0.00)

0.00(0.00)

0.00(0.00)

0.00(0.00)

Total 1.20 0.40 18.40 0.00 20.00(0.90) (0.30) (13.80) (0.00) (15.00)

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Project Costs by Procurement Arrangements (Actual/Latest Estimate) (US$ million equivalent)

Expenditure Category ICBProcurement

NCB Method

1

Other2 N.B.F. Total Cost

1. Works 0.00 0.00 0.00 0.00 0.00(0.00) (0.00) (0.00) (0.00) (0.00)

2. Goods 0.87 0.00 0.00 0.00 0.87(0.80) (0.00) (0.00) (0.00) (0.80)

3. Services 1.04 2.46 4.92 8.42(0.84) (1.92) (3.84) (0.00) (6.60)

4. Miscellaneous 0.00 0.00 0.98 0.00 0.98(0.00) (0.00) (0.82) (0.00) (0.82)

5. Miscellaneous 0.00(0.00)

0.00(0.00)

0.00(0.00)

1.47(0.00)

1.47(0.00)

6. Miscellaneous 0.00(0.00)

0.00(0.00)

0.00(0.00)

0.00(0.00)

0.00(0.00)

Total 1.91 2.46 5.90 1.47 11.74(1.64) (1.92) (4.66) (0.00) (8.22)

Services = Consulting Services; Miscellaneous (line 4) = Training.

1/ Figures in parenthesis are the amounts to be financed by the Bank Loan. All costs include contingencies.2/ Shortlisting / shopping - individual consultancies.

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Annex 3. Economic Costs and Benefits

Not Applicable.

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Annex 4. Bank Inputs

(a) Missions:Stage of Project Cycle Performance Rating No. of Persons and Specialty

(e.g. 2 Economists, 1 FMS, etc.)Month/Year Count Specialty

ImplementationProgress

DevelopmentObjective

Identification/Preparation4/1994 2 TASK MANAGER (1),

CAPITAL MARKETS SPECIALIST (1)

11/1995 3 TM (1), BANKING CONSULTANT (1), CAPITAL MARKETS SPEC. (1)

8/1996 4 TM (1), FINANCIAL SPECIALIST (1), PROCUREMENT SPECIALIST (1), BANK SUPERVISION SPEC. (1)

Appraisal/Negotiation5/1997 5 TM (1), LEGAL (1),

FINANCIAL SPEC. (1), DISB. OFFICER (1), PROCUREMENT SPEC. (1)

Supervision06/19/1998 2 TASK MANAGER (1);

CONSULTANT (1)S S

04/17/1999 1 FINANCIAL SECTOR (1) S S2/10/2000 4 TASK MANAGER (1),

BANKING (1), FINANCIAL SECTOR (1), OPERATIONS (1)

S S

06/10/2000 2 FINANCIAL SECTOR / TM (1); FINANCIAL SECTOR (1)

S S

08/10/2000 1 TM / FINANCIAL SECTOR (1) S S04/06/2001 2 TM / FINANCIAL SECTOR (1);

FINANCIAL SECTOR (1)S S

01/25/2002 2 TM/LEAD FINANCIAL SPEC (1), BANKING SPEC (1)

S S

12/10/2003 FINANCIAL SECTOR (1); CAPITAL MARKETS (1)

ICR

05/02/2003 1 TM / FINANCIAL SECTOR (1) S S12/15/2003 TM / FINANCIAL SECTOR

(1); BANKING CONSULTANT (1)

S S

(b) Staff:

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Stage of Project Cycle Actual/Latest EstimateNo. Staff weeks US$ ('000)

Identification/Preparation 45.3 124.0Appraisal/Negotiation 45.2 88.6Supervision 72.6 188.0ICR 4.5 19.2Total 167.6 419.8

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Annex 5. Ratings for Achievement of Objectives/Outputs of Components(H=High, SU=Substantial, M=Modest, N=Negligible, NA=Not Applicable)

RatingMacro policies H SU M N NASector Policies H SU M N NAPhysical H SU M N NAFinancial H SU M N NAInstitutional Development H SU M N NAEnvironmental H SU M N NA

SocialPoverty Reduction H SU M N NAGender H SU M N NAOther (Please specify) H SU M N NA

Private sector development H SU M N NAPublic sector management H SU M N NAOther (Please specify) H SU M N NA

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Annex 6. Ratings of Bank and Borrower Performance

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HU=Highly Unsatisfactory)

6.1 Bank performance Rating

Lending HS S U HUSupervision HS S U HUOverall HS S U HU

6.2 Borrower performance Rating

Preparation HS S U HUGovernment implementation performance HS S U HUImplementation agency performance HS S U HUOverall HS S U HU

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Annex 7. List of Supporting Documents

Endnotes listed in this document:

1/ See Misión de Estudios del Mercado de Capitales: Informe Final, Ministerio de Hacienda – Banco Mundial – Fedesarrollo, Bogota, Colombia, May 1996.

2/ See Technical Annex: Colombia: Financial Markets Development Project, Report No. T-7135-CO, May 28, 1997.

3/ Financial Sector and Capital Markets Project Preparation Mission, BTO – Report, May 10, 1993.

4/ Similar capital markets backstop facility project was implemented in Argentina: Capital Markets Development Project (1992), Loan 3709.

5/ Colombia – FEPS Financial Markets Technical Assistance Project, by K. Challa, April 18, 1994.

6/ Japanese Grant approved May 6, 1994 -- The Grant provided resources for studies in the following areas: enhancement of the securities market regulatory framework; information disclosure and dissemination; strengthening surveillance / monitoring capacities of regulatory authorities; promotion and enlargement of financial markets; and social security reform.

7/ This report is based on information provided by the initial Task Manager who was interviewed for this evaluation as well as on available documentation. However, a number of relevant Project preparation documents covering the period from 1994 through approval in May 1997 were missing from the Project files.

8/ See comments in the previous section on Project design regarding this issue.

9/ Described in Ayuda Memoria, Mision de Supervision, April 6, 2001.

10/ Quality of Supervision Assessment (QSA5), October 8, 2002.

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