Tunneling when Regulation is Lax: The Colombian Banking Crisis of the 1980s

Abstract

We study the resilience of banks to macroeconomic slowdowns in a context of lax microprudential regulations: Colombia during the 1980s. Multiple banks performed poorly during the crisis due to practices that tunneled resources from depositors to shareholders and board members. Such practices—related lending for company acquisitions, loan concentration, and accounting fraud—were enabled by power concentration within banks, lax regulation, and the expectation of bailouts. We provide evidence for this mechanism by comparing the local banks and business groups that failed during the crisis, the local banks and business groups that survived the crisis, and the former foreign banks—all of which survived the crisis. The regulatory changes during the crisis also support our proposed mechanism.

Keywords: Banking, Tunneling, Related Lending, Financial Crises, Foreign Banks, Debt Crisis

JEL Classification: N26, G21, G28, G30, G33