Libya’s banks struggle to escape Gaddafi’s shadow

Two men scuttle into an alleyway in the souk, holding between them what looks like a bin sack full of money. “Around 300,000 dinars maybe,” says Kalil, casting a professional eye over the couple. “Keep your eyes open and you’ll see millions flying around in here. This is Libya’s Wall Street.” If the souk is Libya’s Wall Street then Kalil is one of its hotshot traders. Relaxing outside one of Tripoli’s old town cafés, he cuts a dapper figure with slick, gelled hair, a navy suit jacket and an open smile. He operates out of one of the souk’s many gold shops, changing currencies and sending cash overseas.

According to Kalil, business is booming. “On a good day, when China and Dubai are open, I’ll personally transfer around 300,000 dinars ($230,000) and the whole souk probably transfers around 20 million dinars ($16 million),” he says. It’s not known exactly how much money passes through this illicit payment system but Kalil’s numbers might not be far off, according to the CEO of Libya’s largest privately controlled lender, Aman Bank’s Rashid Daoudi. He says “billions” are transferred though the informal system every year.

These unregulated services are so popular because lingering regulations from the Gaddafi-era mean sending large sums of money overseas through official channels is impossible for many businesses. For those who can, the process is cumbersome and expensive.

“More financial transactions take place outside Libya’s official banking system than within it,” another exasperated banker grumbles. “The gold shops make millions exploiting the inefficiencies in Libya’s financial system. If the country were run properly, they’d be out of the job.”

‘Rudimentary and shallow’

For many of Libya’s bankers, the thriving unregulated market in currencies has become a source of frustration and a symbol of everything that is wrong with the country’s banking system.

It’s now more than two years since the revolution and so far reforms have been slow to emerge and are uncoordinated. The system remains very much as Muammar Gaddafi left it: riddled with inefficiencies, hindered by poorly thought-out regulation, and technology that lags far behind the rest of the world.

“Essentially, when it comes to banking, we’re still waiting for the revolution,” says Adel Dajani, a director at Aman Bank. “Almost all of the regulations are still the same, the structure is still the same and a lot of people in the sector still have the same old Gaddafi mentality.”

In March, the IMF described financial intermediation in Libya as “rudimentary and shallow even by the modest standards of the Middle East and North Africa”. It says reforms to the banking system are urgently needed to help provide jobs and create inclusive growth.

The Economist Intelligence Unit predicts Libya will be the world’s third-fastest growing economy in 2013, expanding by 12.2%. However, as things stand, only a small fraction of the population benefits from the country’s breakneck growth. Poverty is widespread and, according to the IMF, youth unemployment was running at 25% to 30% at the end of 2010.

Creating large-scale reform in a system where the old ways are so entrenched is no easy task. Since the revolution, the environment for banks has become worse rather than better, with additional pressures from the precarious security situation and hastily drawn-up revolutionary legislation.

Privatization problems

“When it comes to reform, the central bank really is the crux,” says Daoudi. “It has a majority stake in all of Libya’s biggest banks, controlling 85% of the country’s banking assets.”

Daoudi says if these commercial banks are privatized, it will force the banks themselves to reform, responding to market pressures, and it would also free up resources at the central bank allowing it to focus on better regulation and monetary policy.

The Central Bank of Libya and Libya’s General National Congress have indicated they are in favour of continuing privatizations but it’s likely progress in this area will be a long way off, if it happens at all.

Motasim Elalem is a corporate finance advisory partner at the Libyan consultancy Rashad and a former US Federal Reserve bank regulator. He says part of the Gaddafi-era hangover is a bad habit of senior government officials carving out empires within Libya’s bureaucracy: centralizing power and increasing their own clout, rather than acting in the interest of the country.

“If you are the central bank, are you really going to give up the $40 billion in assets under your control?” he asks. “You’re not going to do that. The trouble is the people in the top tiers of Libya’s government institutions are looking out for themselves and their power.”

Recent bad experiences in the sector make the problem of privatizing state-controlled lenders even trickier. Before the revolution, Gaddafi initiated a wave of reforms and privatizations with a number of foreign banks entering into partnerships with Libyan lenders, but the tie-ups have been plagued with setbacks.

A prime example is BNP Paribas’s partnership with Sahara Bank. In 2007, BNP bought a 19% share in Sahara, one of Libya’s largest banks. At the time it was thought to be a shrewd move. Sahara would get much-needed access to technology and expertise, and BNP would gain access to the Libyan market, which seemed to be opening up and burgeoning with promise. However, this partnership proved to be problematic. Relations were difficult between the Libyan employees and the imported management, who came to Libya with unfamiliar ideas and salaries that were much larger than those of the locals.

BNP ended up pulling out its management team when revolution erupted in 2011 and the security situation deteriorated. Now, two years later, the executives have still not been replaced and there is no timeframe for the bank’s return to Libya.

BNP declined to comment on its Libyan joint venture, but according to Sahara there were problems from beginning.

“There was a culture clash,” says Omar Mohamed Saoud, the man filling the leadership gap at the top of Sahara Bank as head of the interim administrative committee. “It was related to BNP’s people, their thinking, their view of the partnership and their view of our clients.

“Before the partnership, if someone was known by the bank, we would deal with them on a trust basis. For example, if someone was from a well-known family, then the paperwork could just be an extra. When the BNP management came in we had to work according to their risk-management style, and this upset a lot of clients and caused a lot of problems.”

Keeping Libya’s banks Libyan

The disharmony in these partnerships, and especially at Sahara, has made a big impression on Libya’s banking sector, stirring up nationalist sentiment and giving ammunition to those who are against opening up the banking sector to more outside institutions.

“BNP’s partnership with Sahara was a very bad experience,” says Ahmed Rajab, general manager of Libya’s largest lender Gumhouria Bank. “They came in and appointed people who lacked proper experience of the local market over Libyans who had spent their whole lives at the company. They didn’t understand the mentality here and it made a very bad impression on local staff.” Many of Libya’s senior banking executives now believe allowing more access to foreign banks would cause more problems than it would solve.

Waha Bank general manager Hadi Ali Idris advocates secondments and in-house training as an alternative way of bringing employees up to speed and familiarizing them with up-to-date technology. He also says privatization of Libya’s state-controlled banks can be achieved without involving foreign firms, by selling publicly tradable shares rather than forming partnerships.

However, others involved in the financial sector, such as Rashad’s Elalem, say these moves on their own won’t be enough to bring about the radical transformation the sector needs.

“The Libyan economy cannot progress or compete with the rest of the world unless we’re forced to, and that won’t come about unless the playing field is levelled,” he says. “We’ve tried protecting and nurturing our businesses and that hasn’t worked.”

Unfortunately for those who share Elalem’s views, the protectionist sentiment is prevailing at a legislative level and on July 5, 2012, the National Transitional Council limited foreign ownership of a Libyan company to 49% in a law known locally as the oligarchs’ decree, due to it favouring those Libyans who became wealthy under the old regime.

Making interest illegal

Moves to introduce Islamic banking have further complicated the issue of bringing Libya’s banks in line with the rest of the world.

On January 6, 2013, the General National Congress went a step further than most lenders expected: passing a law that not only introduced Islamic banking but banned interest on financial transactions. The move is popular with Libya’s Muslim majority but for the nation’s lenders the law is problematic, giving them just two years to become fully Shariah compliant.

Gumhouria’s Rajab is one of many top banking executives who is worried about the changeover. “We have $1.4 billion in interest-baring loans on our books,” he says. “How will we find an alternative for this money? This law was drafted without any proper study of how the banking sector is going to be affected.”

Aman Bank is also planning to lobby against the new law, which it says will further isolate Libya’s economy at a time when it needs to become more integrated with the outside world.

“Libya should be able to benefit from both conventional banking and Islamic banking,” says Aman Bank’s Daoudi. “Infrastructure projects here need international banking, syndications, financing and we should not deprive them of options.”

The IMF agrees with Daoudi that the new legislation could damage the economy. It has warned that the ban on interest-based transactions could constrain “private sector efforts to invest and create employment” if proper foundations for Islamic finance aren’t in place.

Elsewhere, the law has been welcomed as a positive for the private sector. Ahmed El Faghi, general manager of Tripoli Chamber of Commerce, says the new legislation will unleash pent-up demand for loans to small and medium-sized businesses. “Many businesses are waiting for the changeover to Islamic banking and when the new law comes in we’re expecting a lot more loans to be taken out.”

Some banks could benefit more than others from the shift. Waha Bank is one of the lenders welcoming the move. “The recent changes have taken some banks by surprise,” says Ali Idris. “We’re the only bank that’s got a business plan for the next three years. Islamic banking can satisfy all of Libya’s needs and we’re ready to comply.”

‘Scientifically bankrupt’

The Gaddafi hangover isn’t just limited to regulation. Behind closed doors many bankers say billions in non-performing loans are yet to be provided for, with one banker even labelling the state-controlled banks “scientifically bankrupt”.

While the whispers about toxic fallout from years of overenthusiastic lending to loss-making state-controlled companies sound dramatic, the actual impact on the banking sector might end up being minimal.

“There are big losses that are yet to be quantified,” says Lotfi Baccouche, a senior partner at Parker Fitzgerald, a consultancy that specializes in risk and regulatory transformation. “These are a result of lending practices under the previous regime and assets destroyed during the revolution. Fortunately, due to oil revenues that have rebounded faster than expected, Libya does have the funds to bailout these banks.”

However, it remains to be seen how, when and if the losses will be dealt with. “An immediate drive to clear up the bank balance sheets is not advisable as it would cause disruption at an already turbulent time,” he says. “Closing banks would also be a bad idea as it would cost jobs at a time when unemployment is already high.”

Getting rid of old laws

Overhauling Libya’s broader legal system could see credit to the private sector increase, and property law is one key area that needs to be looked at, according to Sahara and Aman. At the moment, if a homeowner defaults on a loan, it’s almost impossible to seize their property due to Gaddafi-era legislation that gives occupiers unusually strong rights. To further complicate matters, tens of thousands of properties were confiscated by the Gaddafi regime, meaning multiple parties often lay claim to the same building.

These factors mean banks are reluctant to take property as collateral and it has led to the IMF labelling legal disputes over property ownership a potential source of instability for the financial sector.

Because of flaws such as this in Libya’s legislative framework, Aman Bank stayed out of retail finance altogether under Gaddafi. Now as the possibility of reform looms, it is tentatively making plans to start lending, but says it won’t commit itself until it sees commitment from regulators and lawmakers.

“The challenge is to create a retail banking system which will help the Libyan economy,” says Aman’s Daoudi. “This cannot be done unless the government gets rid of the old laws and introduces new laws that will protect banks and businesses.”

Whether or not the old laws will be changed any time soon is uncertain. The shape of Libya’s banking system is still a product of the political system and, aside from its new Islamic direction, the defining feature of Libyan politics at the moment is its instability.

Since the revolution, the turnover of politicians and government officials has been high, with dozens being barred from office by the country’s integrity commission and others standing down due to threats from militant groups.

Even more disruption could be in the pipeline due to a new law designed to exclude those with close connections to Gaddafi from powerful positions.

All this change means the outlook for Libya’s much-needed banking overhaul is constantly shifting, but according to Rashad’s Elalem, the surprises – when they come – won’t necessarily be negative.

“In spite of everything, I feel very optimistic,” he says, smiling. “Ahead of the anniversary of the revolution, many people predicted there would be violence and even another uprising but in the end it turned out to be a week-long party.

“That’s the trouble with Libya – just when you expect the worst, it turns around and completely exceeds your expectations.”