Colombia during the Crisis of the 1980s

Carlos Eduardo Hernándezi and Edwin López-Riveraii

PLEASE CITE AS:

Hernández, C. & López, E. (2023). Colombia during the Crisis of the 1980s. In: Hsu, Sara
(compilador). Encyclopedia of Financial Crises. Edward Elgar Publishing

ABSTRACT

The 1980s debt crisis brought havoc to most Latin American economies, with some countries
reducing their GDP by more than 10% in a year. A remarkable exception was Colombia, where the
economic crisis was very mild. The Colombian GDP did not fall in any year, there was no public debt
default or hyperinflation, and the total cost of bank bailouts was lower than 6% of GDP. Nevertheless, the
crisis of the 1980s in Colombia is a case study on the social costs of conflicts of interest and tunneling in
the banking sector.

ARTICLE

Unlike in other Latin American economies, the crisis of the 1980s was mild in Colombia. GDP
per capita only fell by 1.9% between 1981 and 1983. In fact, during the worst year of the crisis, real GDP
still grew by 0.9% (Table 1).

Table 1. Year with the lowest GDP growth during the crisis. Latin American Countries.

Country Year Annual GDP Growth

Colombia 1982 +0.9%
Argentina 1985 -5.2%
Ecuador 1983 -0.3%
 Brazil 1981 -4.3%
Chile 1982 -11%
Peru 1983 -10.4%
Venezuela 1980 -4.4%
Mexico 1983 -3.4%
Uruguay 1983 -10.3%
Paraguay 1983 -3%
Bolivia 1983 -4%
Panama 1983 -4.5%
Costa Rica 1982 -7.2%
Latin America and the Caribbean 1983 -2.5%
Source: World Bank (data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG)

The most crucial loser of the crisis was the financial sector: six banks, which accounted for 46%
of the assets of the banking system, became insolvent (Hernández, Caballero-Argáez and Tovar 2022).
One of the six banks was liquidated, whereas the other five banks were bailed out and confiscated by the
Colombian government (Caballero-Argáez and Urrutia 2006, 171). By the end of the crisis, most of the
banking system, as measured by assets, was controlled by the Colombian government (Hernández,
Caballero-Argáez and Tovar 2022).iii

Before the crisis, there was an economic boom distinguished by four features: (i) high export
iv
prices , (ii) strict regulation of exchange and interest rates, (iii) capital flow controls, and (iv) the
prohibition of foreign investment in the banking sector (Caballero-Argáez 1988, Garay 1998, Caballero-
Argáez and Urrutia 2006, Ocampo 2015, Perez-Reyna and Osorio-Rodriguez 2021, Hernández,
Caballero-Argáez and Tovar 2022). This prohibition on foreign investment, which had a nationalist
motivation, was in place since 1975 (Barajas, Steiner and Salazar 2000, Junguito 2019, Hernández,
Caballero-Argáez and Tovar 2022).

In this context of abundance and regulations, a group of Colombian banks perpetrated risky
credit practices: loan concentration on few debtors, loans to members of the board, and loans to
shareholders (Palacios 1985, Villegas 1990, 14). Some shareholders used the loans to play the stock
market (Palacios 1985, Villegas 1990, 14). These practices were standard among private banks whose
board membership was concentrated and had few foreigner members, immigrant members, or members
with experience in the real sector (Hernández, Caballero-Argáez and Tovar 2022).
 Furthermore, some banks opened subsidiaries overseas throughout the 1970s. These subsidiaries
were expected to raise funds in the international markets, exploit tax benefits from other countries, and
avoid the regulations on foreign exchange that were in place in Colombia (Caballero-Argáez 1988). In
addition, some subsidiaries used short-term loans from overseas to fund long-term loans in Colombia
(Caballero-Argáez 2019).

The expansion of the Colombian economy peaked in 1978 when GDP grew by 8.5%. Since then,
the Colombian economy slowed down, led by a collapse in international coffee prices: 63% in real terms
between 1977 and 1981 (Hernández, Caballero-Argáez and Tovar 2022). In 1981, the year before the
nadir of the crisis, annual GDP growth was 2.3%.

In response to the reduction in coffee prices, the current account balance moved from 2% of GDP
in 1977 to -6% of GDP in 1981 (Ocampo 2015, 69). Nevertheless, the real exchange rate did not
depreciate during this period (Ocampo 2015, 69). A possible explanation is that the reduction in exports
was compensated by an increase in external debt from both the private and public sectors (Ocampo 2015,
72). The external public debt doubled as the fiscal deficit of the public sector moved from a small surplus
in 1978 to a deficit of 5% of GDP in 1981 (Ocampo 2015, 68).

Borrowing overseas became increasingly expensive as international interest rates soared

throughout the late 1970s and early 1980s (Caballero-Argáez 2019). After Mexico defaulted on its
sovereign debt in August 1982, borrowing overseas became very difficult for Colombian debtors,
including the Colombian government (Caballero-Argáez 2019). Due to the reductions in capital inflows
and export revenues, foreign currency became scarce: foreign exchange reserves fell 69% from 1981 to
1984, while the current account deficit was contracting from 6% to 2% (Ocampo 2015, 69, 72). Overall,
1982 was the worst year of the crisis, with GDP growing 0.9%.

The crisis had a major impact on the banking sector. Nonperforming loans grew from 2% to 12%
of total loans during the crisis (Ocampo 2015, 101). Banks that had perpetrated risky credit practices
incurred great losses (Palacios 1985, Hernández, Caballero-Argáez and Tovar 2022). In addition, the
Panamanian subsidiary of a Colombian bank used deposits from the public to bail out mutual funds
managed by the business group that controlled the bank (Caballero-Argáez 1988). This subsidiary had
more considerable losses than the subsidiaries of other banks when multiple mutual funds went bankrupt,
international capital became expensive, and the Colombian peso depreciated throughout the early 1980s.

Raising capital for distressed banks during the crisis was hard: bank owners were on the brink of
insolvency, and equity financing was not profitable for other local investors (Palacios 1985). Furthermore,
regulation prevented foreign banks from equity financing or buying Colombian banks. Since bank
liquidations would have involved significant losses for depositors and further reductions in economic
activity, the banks were bailed out by the government (Palacios 1985, Anzola and Arias 2009, 73). The
legal framework that the government used for bailing out the banks was known as 'oficialización'. During
'oficialización,' the government injected capital in exchange for the property and control of the bank.
Former shareholders lost their stocks without compensation (Hernández, Caballero-Argáez and Tovar
2022).

The government funded the bailout operation by issuing debt and money. At the time, the central
bank was directed by a board appointed and controlled by the national government (Hernandez and
Jaramillo 2017). The fiscal deficit of the government was growing due to increased expenditures and
decreasing revenues, so the board authorized that part of the deficit be funded with money creation
(Junguito and Rincón 2004, Hernandez and Jaramillo 2017, Perez-Reyna and Osorio-Rodriguez 2021).v
Bailing out banks cost between 3 and 6% of GDP (Caballero-Argáez and Urrutia 2006, 120, Honohan and
Klingebiel 2003). This cost was much lower than in the Southern Cone of the Americas, where it was
close to 40% (Ocampo 2014).

The academic literature attributes Colombia’s solid performance during the crisis to two factors:
First, the net external debt of the government and private companies was low at the start of the crisis. For
example, Colombia accumulated foreign exchange reserves during the coffee export boom of the 1970s,
so the external debt net of foreign exchange reserves in 1979, at the start of the crisis, was very low
(Ocampo 2015, 71). Second, capital controls were in place before and during the crisis (Ocampo 2014,
Ocampo 2015, 71-73). In contrast to the Colombian case, the crisis in other countries of Latin America
was characterized by sudden stops and current-account reversals in countries with high levels of net
external debt and low capital controls (Ocampo 2014). Net capital flows in Latin America fell from 2% to
-6% of GDP during the crisis (Ocampo 2014).

The crisis induced regulatory changes that intended to attenuate future banking crises. Before the
crisis, regulation on conflicts of interest was lax (Gallon 1986). Furthermore, capital requirements for
banks did not consider loan quality (Ocampo 2015). In response to the crisis, the government and
congress took the following measures: First, they enacted new prudential regulations to prevent conflicts
of interests, financial statement manipulation, and excessive leverage (Palacios 1985, Ocampo 2015).
Second, they created a system of deposit insurance funded by money creation (Palacios 1985, Anzola and
Arias 2009, 64) Third, they created organizations and formal procedures for the intervention of banks in
distress (Hernández, Caballero-Argáez y Tovar 2022). Fourth, they eliminated restrictions on foreign
investment in the banking sector to facilitate funding, privatization, and competition in the banking sector
(Barajas, Steiner y Salazar 2000, Hernández, Caballero-Argáez y Tovar 2022). These regulatory changes,
with some variations, persist until 2022.vi

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ENDNOTES

i
Assistant Professor. School of Management, Universidad de los Andes,
[email protected]
ii
Associate Professor. School of Economics and Management, Universidad Jorge Tadeo Lozano,
[email protected]
iii
In turn, the share of banks on the assets of the financial sector was 74% in 1990 (Ocampo 2015)
iv
Frosts in Brazil almost tripled real coffee prices between 1975 and 1977. When the price of coffee
peaked in 1977, coffee accounted for 65% of exports (Caballero-Argáez 2019, Hernández, Caballero-
Argáez y Tovar 2022).
v
The fiscal déficit of the public sector, excluding financial institutions, was 7% of GDP in 1982 (Junguito
and Rincón 2004)
vi
After further reforms in the early 1990s, deposit insurance is not funded with money creation but with
government revenues and debt.