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Libya: Banking Sector Reform and Supervision

Core Content

This report outlines the challenges and reform priorities for the banking sector in Libya, focusing on strengthening financial stability, promoting credit growth, and aligning with international standards. It is prepared by the International Monetary Fund (IMF) as part of a periodic consultation with the country, and it is based on the 2012 Basel Committee for Banking Supervision (BCBS) sound principles for effective supervision. The analysis is conducted as of May 5, 2023, and includes recommendations for legal, governance, and operational improvements.

Main Challenges

• Underdeveloped Banking Sector: The banking sector in Libya is still rudimentary, with only 20 banks operating, and total assets around LYD 143 billion. Loans and credit facilities make up less than 15% of total banking assets, and credit to GDP remains low at 12% in 2022.
• Concentration of Ownership: The Central Bank of Libya (CBL) owns two of the largest four banks, which account for approximately 70% of sector assets and 80% of total credit. This creates a conflict of interest between regulatory and shareholder roles.
• Islamic Finance Development: Interest payments have been banned since 2013, and banks are still struggling to fully convert to an Islamic financial system. This has hindered credit growth and led to a reliance on fee income, including foreign currency transactions.
• Parallel Exchange Rate Market: The CBL's capital flow measures (CFMs) and macroprudential measures (MPMs) have led to the existence of a parallel foreign exchange market. Despite the relaxation of CFMs/MPMs, the parallel market persists due to sector inefficiencies and limited availability of foreign currency notes.
• Central Bank Split: The split of the CBL between Tripoli and the East has created liquidity imbalances and increased financial risks. The Eastern branch cannot access US$ or LYD notes, leading to a closed system that exacerbates the situation.
• Inefficient Legal System: The legal framework in Libya is weak, with slow enforcement, lengthy court proceedings, and high levels of non-compliance. This undermines the ability of banks to effectively manage credit risk and collateral.

Key Reforms and Recommendations

A. Banking Sector Reforms

• Strengthen Financial Stability Mandate: The banking law should include a clear financial stability mandate and governance structure that involves key authorities like the Ministry of Finance and the Ministry of Economy.
• Revisit Interest Rate Prohibition: The authorities should either allow for the coexistence of conventional and Islamic banks or develop a comprehensive roadmap for full conversion to Islamic finance. An exit plan for non-compliant banks should be established.
• Develop Islamic Finance Expertise: Banks need to build human capital in Islamic finance, including training staff and establishing Sharia-compliant governance structures. A Sharia board should be involved in product approval, but banks must also take responsibility for product development.
• Implement Macroprudential Framework: A macroprudential framework is necessary to promote financial stability and support monetary policy. This includes identifying tools to limit systemic risk and improve credit supply.
• Ease CFMs/MPMs Gradually: As conditions permit, the CBL should gradually relax capital flow and macroprudential measures to eliminate the parallel exchange rate market and support credit growth.
• Develop Legal and Administrative Procedures: Improving tax administration, credit registries, and collateral registries is essential for financial inclusion and efficient resource allocation. The legal system must be reformed to protect ownership rights and enforce contracts.

B. Governance and Legal Frameworks

• Enhance CBL Governance: The CBL's governance framework should be strengthened to ensure transparency and accountability. A clear separation between ownership and supervision is needed, with safeguards against conflicts of interest.
• Introduce Fit and Proper Regime: A fit and proper regime should be implemented to improve governance and compliance culture in banks. This includes regulatory interviews, exit interviews, and protections against unfair dismissal.
• Regulate Fintech and Innovative Services: The existing banking law should be updated to cover modern financial services such as payment services, crowdfunding, and digital assets. This would ensure a broader regulatory framework and consumer protection.
• Improve Internal and External Reporting: Banks should be required to develop comprehensive internal and external reporting systems to support management and supervision. This includes periodic reporting and transparency in financial statements.

C. Prudential and Operational Requirements

• Recapitalization Needs: Many banks are undercapitalized due to poor asset impairment recognition and provisioning. The CBL should encourage banks to conduct asset quality reviews and develop recapitalization plans.
• Strengthen Credit Underwriting: Banks should adopt clear credit risk appetite, underwriting criteria, and exposure limits. This would help reduce credit losses and improve credit supply.
• Improve Liquidity Management: The CBL should introduce liquidity instruments tailored to Islamic banks and align with Basel III standards. This would help manage liquidity risk and support future credit growth.
• Enhance AML/CFT Supervision: The CBL should strengthen AML/CFT supervision, increase FIU resources, and align with FATF recommendations. This includes improving screening and investigation software and automating back-office functions.

Conclusion

The report emphasizes the need for a comprehensive approach to banking sector reform in Libya, focusing on improving financial stability, enhancing credit growth, and aligning with international standards. It highlights the importance of legal and governance reforms, the development of Islamic finance products, and the need for a robust macroprudential framework. The CBL is encouraged to take a gradual and consultative approach to reforms, ensuring transparency, accountability, and the protection of public and private interests.