A functioning private banking sector is crucial to the economic growth of states in transition. In this paper, Dempsey draws on his experience working in the central banks of Iraq, Jordan, and Lebanon, to highlight the financial, banking, and central banking reforms necessary to spur Libya’s economic growth. With nearly 85 percent of the working population employed in the public sector, Libya is desperately in need of a more vibrant private sector.

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The paper was launched at the Legatum Institute - details here.

INTRODUCTION

A functioning private banking sector is crucial to the economic growth of states in transition. States in the midst of radical change, even states which are engulfed in violent conflict, such as Iraq and Afghanistan, are capable of developing working banks and financial institutions. Such institutions can add an element of stability to an otherwise volatile situation. This paper examines the current situation of banking and finance in Libya, a country undergoing a constitutional crisis, and argues that even in the current climate reforms can take place.

The political background is far from simple; the Libyan legal system is in a state of flux. The General National Congress (GNC), Libya’s interim legislature, was elected in July 2012 and given an 18-month mandate to ensure that a constitution was drafted and to guide the country towards general elections. However, the GNC’s term expires in February 2014 and protracted political tensions and militia violence have delayed efforts to organize elections for a constitutional assembly, meaning that a new constitution will not be ready in time. At the time of writing, GNC spokesperson Omar Omeidan predicted an extension to the February deadline. This would leave Libya in a legal vacuum.

In the meantime, the GNC continues to delay decisions on infrastructure and investment, which has the effect of further weakening public trust in the GNC. The political isolation law—legislation designed to vet members of the old regime—has proved controversial in its implementation. Though intended as an improvement, in practice it deprives fragile transitional institutions of bureaucratic talent, and is used to play political games. Initial, piecemeal efforts to liberalize the Libyan economy have also faltered, creating greater risk and dissuading financiers from investing.

Recently, the Central Bank of Libya added to the uncertainty for financial institutions by declaring that all such institutions must become ‘sharia compliant’ by 2015. This decision will discourage investment and economic growth: few Libyan banks or agencies have the capacity to operate solely as Islamic institutions and will find it difficult to make the conversion by 2015.

Major lenders, such as the Sahara Bank, are now uncertain as to what will happen to their existing loans. This uncertainty further impedes confidence in the management of Libya’s financial sector.

Currently, state-owned banks dominate the financial landscape of Libya, although a series of partial privatisations occurred in 2007.1 These banks, though heavily capitalized, have ceased lending. Bank lending failure can be attributed to three factors:

  1. the lack of a Libyan land registry;
  2. the lack of a Libyan credit bureau;
  3. inadequate central bank regulation.

However, there are means by which the situation can be improved. Libya can learn from the experiences of other resource rich states emerging from centralised regimes. The experience of Iraq, for example, shows that political interference in banking regulation can thwart economic progress.3 Based on research in Libya as well as on the author’s own experience working in the Central Banks of Iraq, Jordan and Lebanon, this paper will recommend financial, banking, and central bank reforms

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The Transitions Forum is a series of projects dedicated to the challenges and possibilities of radical political and economic change.