Financial Services in the Colombia–United States Free Trade Agreement
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specific macroeconomic conditions, some intermediaries without indexed deposits perceived disadvantages in the deposit market. Thus, the UPAC formula was gradually linked to certificate of deposit interest rates instead of CPI inflation. This scheme was sustainable as long as interest rates and inflation moved in the same direction. In the late 1990s, however, the inflation rate and house prices fell significantly, whereas interest rates rose abruptly, making the problems of the UPAC system more evident. The reforms in the 1990s. The 1998–99 foreign debt crisis in Latin America, the closing of international markets, and the effects these events had on growth highlighted the failure of the restrictions on the inflow of foreign investment as specified in the Andean Pact. The countries had to relax their policy in this area, attracting foreign investment as a mechanism for complementing the low level of domestic savings.6 The economic crisis turned out to be less severe in Colombia than in other countries in the region. Colombia’s efforts, taken during the crisis between 1982 and 1984, to make its policy more flexible to foreign investment proved important for the financial sector. In fact, the change in this policy allowed some foreign banks to receive additional capital from their headquarters, thereby reducing the fiscal cost that the government would eventually have had to bear for maintaining confidence in the system. Not until the beginning of the 1990s, however, did Colombia embark on significant financial liberalization. This effort was not an isolated measure, but rather part of a plan to make the economy as a whole more open and flexible. In fact, even though the financial sector reforms were a key part of the overall reform efforts, sensible changes affecting the labor market, the exchange rate and foreign investment, and the institutional policies of the central bank were introduced at the same time. Tariffs and barriers to foreign trade were significantly reduced as well. Changes in the structure and operation of the financial sector were a response to the growing recognition of the inefficiencies in financial intermediation. This recognition was, to a large extent, the result of the government’s high degree of financial repression. Limited competition existed between local entities—and between those entities and foreign providers (Hommes 1990; Ortega 1990). In 1991, the country adopted new regulations on the exchange rate and foreign investment that allowed greater flexibility in the movement of capital. The central bank abandoned its monopoly over international reserves and allowed banks to buy and sell foreign currency. Likewise, checking accounts could be established abroad, and the policy on