**The banking sector has mostly recovered from the 1999 crisis, although financial intermediation has been slow to pick up** . After a long period of shrinkage due to the crisis, banking sector size begun to recover in 2004 and standard financial performance indicators – solvency, profitability, efficiency and asset quality – have significantly improved (see Table below). The recovery can be attributed to a combination of factors, such as the resumption of economic growth, a slightly increasing net interest margin in spite of declining interest rates, the post-crisis recapitalization programs (particularly for public banks), as well as the exit and/or restructuring of a significant quantity of nonperforming assets. However, financial intermediation has not yet recovered – in particular, net loans and leases plummeted from 36 percent to 25 percent of GDP over 1998-2003 and have only started to increase again in the last two years. By contrast, security holdings (mostly sovereign) have more than doubled as a proportion of GDP over this period and now represent one-third of banking sector assets.

**-** **<u>Table 3: Financial Performance of Credit Institutions (1998 2005)</u>**

||**Dec-98**|**Dec-99**|**Dec-00**|**Dec-01**|**Dec-02**|**Dec-03**|**Dec-04**|**Dec-05**|
|---|---|---|---|---|---|---|---|---|
|**NOMINAL GROWTH RATES**|||||||||
|Net Loans & Leases||-5%|-9%|0%|5%|7%|21%|18%|
|Securities||29%|42%|29%|13%|16%|28%|18%|
|Deposits||8%|2%|9%|5%|8%|21%|17%|
|Total Assets||1%|0%|5%|6%|9%|18%|17%|
|**AS % OF GDP**|||||||||
|Net Loans & Leases|36%|32%|25%|23%|23%|22%|23%|25%|
|Securities|7%|8%|10%|12%|12%|13%|15%|16%|
|Deposits|33%|33%|29%|29%|28%|27%|30%|32%|
|Total Assets|57%|53%|46%|45%|44%|42%|45%|48%|
|**SOLVENCY**|||||||||
|Net Worth/Total Assets|10.6%|11.0%|11.3%|11.2%|11.0%|11.6%|12.1%|12.3%|
|Capital Adequacy Ratio||10.9%|13.2%|13.3%|12.5%|13.1%|13.8%|13.5%|
|**PROFITABILITY**|||||||||
|Return on Average Assets (ROAA)|-2.5%|-3.5%|-2.3%|0.1%|1.1%|1.9%|2.7%|2.7%|
|Return on Average Net Worth (ROAE)|-21.0%|-32.6%|-20.7%|1.1%|9.6%|17.1%|23.0%|22.1%|
|Net Interest Margin (Net Interest Income/Average Assets)|_4.1%_|3.0%|3.5%|3.1%|3.4%|3.9%|4.2%|4.1%|
|**EFFICIENCY**|||||||||
|Cost-Income Ratio (Operating Expenses/Gross Income)|71%|81%|80%|74%|71%|62%|54%|51%|
|Operating Expenses/Average Assets||6.4%|6.7%|6.4%|6.3%|6.1%|5.4%|4.9%|
|Labor Costs/Operating Expenses|51%|46%|42%|43%|43%|44%|46%|45%|
|Number of Bank Employees|76,478|69,766|59,908|56,758|55,658|54,474|55,678||
|**ASSET QUALITY**|||||||||
|Past Due Loans/Total Gross Loans|10.7%|13.6%|11.0%|9.7%|8.7%|6.8%|3.3%|2.6%|
|Non-Performing Loans/Total Gross Loans||16.3%|16.4%|15.4%|13.6%|10.5%|5.8%|4.4%|
|Loan Loss Provisions/Total Gross Loans|4.1%|5.0%|6.2%|7.5%|7.6%|6.7%|4.8%|4.3%|
|Loan Loss Provisions/Non-Performing Loans||31%|38%|49%|56%|64%|82%|97%|
|Gross Loan Composition|||||||||
|_Commercial_|_53%_|_55%_|_59%_|_58%_|_62%_|_63%_|_67%_|_65%_|
|_Consumer_|_18%_|_13%_|_14%_|_16%_|_16%_|_18%_|_20%_|_24%_|
|_Microcredit_|||||_1%_|_1%_|_1%_|_2%_|
|_Mortgages_|_29%_|_31%_|_27%_|_26%_|_22%_|_18%_|_11%_|_9%_|
|**MEMO ITEM**|||||||||
|Real GDP Growth|0.6%|-4.2%|2.9%|1.5%|1.9%|4.1%|4.1%|5.1%|
|Inflation Rate (end-period)|16.7%|9.2%|8.7%|7.6%|7.0%|6.5%|5.5%|5.0%|
|Nominal 90-day deposit rate (% p.a.)|34.1%|15.8%|13.4%|11.5%|7.7%|7.9%|7.7%||
|Exchange Rate vs. USD (end-period)|1,542|1,874|2,229|2,291|2,865|2,778|2,390|2,288|

_Source: Superintendencia Financiera, IMF, Asobancaria and own analysis. Note: Credit institutions include commercial and housing banks, CFs and CFCs, but exclude IOEs and financial cooperatives._

**It is unclear to what extent Colombia’s current financial system structure hinders performance, at least when compared with regional peers** . Some academic studies in the past have convincingly argued that Colombia’s financial system structure has contributed to high operational costs. As can be seen in the Table below, although Colombia has a proportionally smaller and ‘shallower’ – in terms of access – financial

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