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

The resilience of firms to industry-wide shocks has positive externalities in industries with systemic risk, such as banking. 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 and links with political power among local banks. In contrast, foreign-owned banks performed relatively well during the crisis due to three factors: (i) foreign-owned banks imported governance institutions and lending procedures from their headquarters, (ii) foreign-owned banks were not part of local business groups with concentrated ownership, and (iii) foreign-owned banks were ex-ante less likely to receive a bailout from the government. These factors continued to be relevant into the 1980s, even though the Colombian government had forced foreign banks to become minority stakeholders of their subsidiaries in 1975.