The Margin of Financial Intermediation in Colombia

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After several decades of financial repression with some partial attempts at liberalization, Colombian policymakers set out to complete the liberalization process in the early nineties, reducing financial taxation, freeing interest rates, facilitating entry/exit, and eliminating capital account restrictions. As this was expected to increase efficiency and competitiveness of financial intermediation, an implicit objective was to reduce interest rate spreads, historically high by international standards. We estimate a profit maximization model using panel data on 22 Colombian banks with monthly observations during 1992-96 to analyze the determinants of the spread between loan and deposit rates. Both state and private banks are examined. A continuous decline in spreads was explained primarily by a reduction in financial taxation since no significant gains in competition or efficiency occurred. Finally, bivariate tests suggested that banks exert their market power on the loan side where competition from other types of financial institutions has not been as great.