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CrisisGroup.org: Of Tanks and Banks: Stopping a Dangerous Escalation in Libya

Posted by: Berhane.Habtemariam59@web.de

Date: Monday, 20 May 2019

 
Rotten euro banknotes, ruined when sewage water flooded the safe of the local branch of the Central Bank in downtown Benghazi, are stored in the coffers of the newly built offices of the Central Bank of Libya, Benghazi branch, November 2017. CRISISGROUP/Claudia Gazzini
 

An under-reported banking crisis threatens to exacerbate deadly fighting in Tripoli, ignite a protracted resource war and deepen the country’s east-west divide. A way out requires agreeing to a ceasefire in Tripoli and ending the four-year split between the Central Bank’s rival branches.

 

What’s new? A neglected banking crisis in Libya is coming to a head just as forces under Field Marshal Khalifa Haftar are trying to capture Tripoli. A protracted conflict will hinder efforts to reunify the divided banking system, fuelling prospects of a financial implosion and economic war alongside the military one.

Why did it happen? The looming crisis is a direct consequence of a four-year split between the Central Bank in Tripoli and its eastern branch, dating from the broader political divide that emerged in 2014. Haftar’s desire to seize control of the Central Bank and state assets possibly contributed to the timing of his offensive.

Why does it matter? Should the Central Bank freeze the operations of two key commercial banks because of falling reserves, the move could destabilise the east-based government and interrupt funding for Haftar-led forces. This would deepen the political divide between competing authorities in east and west and produce severe economic blowback throughout the country.

What should be done? In addition to a ceasefire, Libya’s warring sides should, at a minimum, reach agreement on standardising commercial banking operations in the east and work toward the Central Bank’s reunification. Libya’s foreign partners should offer expert advice and prioritise resolving the financial crisis in negotiations.

Executive Summary

As forces loyal to east-based military commander Khalifa Haftar battle armed groups in western Libya nominally loyal to the Tripoli-based government, a neglected and possibly explosive banking crisis could further destabilise the country. In April, the Tripoli-based Central Bank of Libya started enforcing restrictions on several eastern state-owned commercial banks, which together cover 30 per cent of Libya’s commercial banking needs. Such restrictions loomed prior to Haftar’s offensive, which may partly have been inspired by a spiralling banking feud rooted in Libya’s 2014 political split. If the Central Bank further tightens restrictive measures, this would compromise the east-based government’s ability to pay employees and Haftar’s forces. This in turn could prompt Haftar to cut oil exports from areas he controls and ignite an economic war. Averting such a crisis requires a settlement between the Central Bank in Tripoli and its eastern branch in Benghazi, operating autonomously since 2014, on how to account for commercial bank transactions. Libya’s international partners should work toward that goal.

The battle for Tripoli has already caused at least 300 deaths and displaced tens of thousands in a month of fighting. Haftar’s Libyan National Army’s (LNA) offensive, which began in early April, so far has foundered on the capital’s periphery in the face of fierce resistance from armed groups aligned with the UN-backed Government of National Accord. Both sides project confidence that they will prevail with military and financial support from their respective foreign sponsors. They have also rejected mediation by external neutral parties such as the UN. All signs point to a prolonged, highly destructive, stalemate.

Against the backdrop of ongoing fighting, the authorities in Tripoli evince little appetite for responding to the imminent banking crisis. They know they have the advantage of exclusive access to state funds accruing from oil sales, and that a concession from their side would save the very banks that have helped bankroll the military forces now besieging them. The Tripoli authorities may indeed be tempted to let the banking crisis come to a head, or even take additional measures such as interrupting salary payments to east-based civil servants currently on Tripoli’s payroll, in order to halt funding streams to the east, thereby hamstringing the LNA’s ability to carry on the fight.

Such a strategy could make military sense, but it would also compound Libya’s lingering economic crisis by orders of magnitude, with grave social, economic and political repercussions for the entire country. The commercial banks’ growing troubles could cause mass panic, aggravate an existing liquidity crisis and impede service delivery as key state companies and private firms, which hold accounts with these banks, may no longer be able to process payments or issue letters of credit to import the essential goods on which Libya is highly dependent.

A financial squeeze in the east could also reignite fighting over Libya’s sole source of revenue: its oil. In the short term, Haftar could ask his wealthy regional backers – mainly the United Arab Emirates (UAE) and Saudi Arabia – to bankroll his war effort, but as the battle wears on, the east-based government could decide to shut down the country’s oil fields and export terminals, most of which are under LNA control. This would deepen the de facto split between east and west, including the rift in the banking sector, and possibly become a prelude to partition. All these developments would vastly complicate efforts to reach a political settlement to the Libyan conflict overall.

To prevent such a catastrophic scenario, Libya’s competing military coalitions in the east and west should urgently agree to a ceasefire and then promptly launch negotiations between the Central Bank’s rival governors to settle the dispute over how to account for financial transactions in the east. Outside actors should press the parties to embark on this course of action and offer expert advice. The U.S. in particular should use its historical leverage over Libya’s financial and oil sectors and its newly declared sympathy for Haftar to usher the parties toward a financial settlement. This is an essential step that should support simultaneous political and military-to-military negotiations over reunifying governing institutions, including reconsolidating the Central Bank and appointing new bank governor.

Ultimately, only the reunification of Libya’s rival governments and state institutions, including its financial ones, can bring the stability that its citizens crave. Reunification by military means on which Haftar and his backers appear to be betting is likely to backfire. The promise of a financial settlement might make the difference Libyan parties need to agree to a ceasefire and put political negotiations back on track.

Tripoli/Benghazi/Brussels, 20 May 2019

I. Introduction: The Making of a Banking Crisis

In 2014, Libya suffered a political crisis that split the country into two rival parliaments and governments: the Interim Government headed by Prime Minister Abdullah al-Thinni in the east, which enjoyed international recognition until December 2015; and a Tripoli-based government. Subsequently, in the December 2015 UN-brokered Skhirat agreement, Libyan negotiators established a Government of National Accord in Tripoli, with a Presidency Council headed by Faiez Serraj, to which the UN Security Council extended international recognition. Nevertheless, the Thinni government continued to operate in the east, backing the Libyan National Army (LNA) forces of Field Marshal Khalifa Haftar.

The 2014 political crisis also triggered a rift in the Central Bank between Governor Siddiq Elkebir in Tripoli and his deputy, Ali al-Hibri, who proceeded to operate the bank’s Benghazi branch autonomously.

The rift in the Central Bank prompted a dispute between Libya’s two power centres, Tripoli and Benghazi, over how state revenues (mainly from oil sales) are allocated. Three related developments escalated this disagreement. The first was the Central Bank’s 2014 decision to disconnect the Benghazi branch from its automated electronic payment system, which prompted the latter to resort to a parallel manual accounting system.

The Central Bank has declared it does not recognise the Benghazi branch’s parallel accounting system, but the parliament based in the eastern city of Tobruk has said it does, and east-based authorities consider transactions conducted through it as valid under Libyan law.

The second was the east-based government’s decision to authorise the Benghazi branch to expand the bank’s monetary base (by printing cash and putting into circulation money funded through bonds and treasury bills not backed by actual capital) without the Central Bank’s approval in order to pay public-sector salaries and make other payments in areas under their control, including for the LNA.

Such payments have amounted to approximately nine billion dinars ($6.4 billion) a year since 2015. To make these payments, the east-based government has used commercial banks that have their headquarters and most of their branches in the east, from where they can cater to the east-based government’s newly recruited employees and security forces. Three banks in particular – the state-owned National Commercial Bank and the Wahda Bank, and the small private Commerce and Development Bank – process the bulk of these payments, which together account for 30 per cent of Libya’s commercial banking needs. As a result of such operations, these banks have accumulated reserves and credits with the Central Bank’s Benghazi branch, which the Central Bank in Tripoli does not recognise.
 
Haftar’s ongoing attempt to capture the capital by force is providing Tripoli-based authorities with a justification to let the financial crisis unfold.

The third development was the October 2018 introduction by the Tripoli government of financial measures that liberalised the purchase of foreign currency throughout the country at a new, higher rate.

This drained these three above-mentioned banks’ reserves with the Central Bank, which debited their accounts in local currency. Cumulatively, these three developments are dipping the east-based commercial banks into an acute crisis as their deposited reserves with the Central Bank have dropped close to the minimum required by law – 20 per cent of their total deposits. If they were to go below it – as appears imminent or may have happened already – the Central Bank could impose restrictions on them, mainly on foreign currency purchases, that would limit their ability to make payments; or it could even let their reserves completely run out, at which point the banks by default would be unable to operate.

In late April, Central Bank officials in Tripoli imposed limitations and special control mechanisms on foreign currency transactions on the Wahda Bank and Commerce and Development Bank, as well as two smaller banks.

The Central Bank claimed the measures constituted due diligence to prevent fraudulent transactions, but representatives of one of the targeted banks and the officials of the Central Bank’s Benghazi branch argue they are retaliatory measures singling out eastern banks, specifically those whose reserves with the Central Bank in Tripoli are drying up.

The restrictions already imposed, and additional ones expected to follow, including on other banks such as the National Commercial Bank, would block these banks from bankrolling the east-based authorities, and also affect their operations in the rest of the country.

The gathering banking crisis has yet to garner much public attention, but some officials in the Central Bank, its eastern branch and the three affected commercial banks first sounded the alarm in March.

Given the timing of Haftar’s advance on Tripoli, which kicked off in early April, it is quite possible that financial pressures helped motivate his decision to launch the offensive: he may have bet on a quick march into the capital to gain control of the central government and reconsolidate the Central Bank under his control. Such an outcome would have forced the Central Bank to accept all the liabilities of its eastern branch (which has openly supported the offensive) and given Haftar continued access to state funds. It also would have satisfied some of Haftar’s foreign backers, who accuse the Central Bank in Tripoli of bankrolling militias and Islamist groups they oppose.

If Haftar’s offensive fails, however, he may have little choice but to call on his foreign backers to bankroll public finances in the east. In the meantime, Haftar’s ongoing attempt to capture the capital by force is providing Tripoli-based authorities with a justification to let the financial crisis unfold and possibly even take additional steps to curb all domestic funding streams to those attacking Tripoli.

This report is based on scores of interviews with Libyan banking and government officials based in eastern and western Libya in the first quarter of 2019. It also builds on Crisis Group’s research into the financial aspects of the Libyan political crisis, ongoing since 2014.

II. From Political to Financial Rift

A. Divided Banks

The origin of the financial crisis lies in the September 2014 decision by the House of Representatives (HoR), which had installed itself in Tobruk in August after contested general elections two months earlier, to appoint the Central Bank’s former deputy governor, Ali al-Hibri, as interim governor, replacing Siddiq Elkebir. In reality, Hibri became the head of the Central Bank’s branch in Benghazi, now operating autonomously, while Elkebir remained in office in Tripoli.

Consequently, the competing governments in east and west began operating separate – and conflicting – monetary and fiscal policies.

The Central Bank retaliated in October 2014, disconnecting its eastern branch from its automated clearing system (Real-Time Gross Settlement, or RTGS), which all Libyan commercial banks use to manage their accounts with the Central Bank. Prior to 2014, the Central Bank had three operating branches – in Tripoli, Benghazi and Sebha; of these, Tripoli and Benghazi were linked to the RTGS. This meant that the two branches could process and clear both government and private payments to ministries, companies and individual account holders with commercial banks.

The Central Bank took this step to prevent east-based authorities from accessing government accounts and funds (both reserves and oil revenues).

The Tripoli-based parliament (General National Congress, GNC, elected in 2012) viewed the newly elected HoR as illegitimate. The decision to cut Benghazi off from the RTGS predates the November 2014 ruling of the Tripoli-based Supreme Court, in effect declaring the June 2014 HoR election unconstitutional; this subsequently gave the Central Bank cover to treat the HoR-backed government in the east as illegitimate and consider all HoR decisions related to banking, including its requests for budget disbursements, null and void.

The Central Bank’s decision was especially aimed at preventing the disbursement of funds to Haftar’s incipient LNA, which the HoR backed but the Tripoli authorities deemed illegal. However, the Central Bank kept on its payroll all public-sector employees hired before the 2014 political crisis, including many in the east, and kept commercial banks, including those in the east, connected to the RTGS system.

The suspension of the Benghazi branch from the Central Bank's automated clearing system continues until this day, giving rise to parallel yet overlapping financial systems in eastern and western Libya.

Despite being deprived of state financing and access to oil revenues, which accrued solely to the coffers of the internationally-recognised Central Bank in Tripoli, authorities in the east continued to operate with the HoR’s support and found other ways to fund themselves. Initially, they were able to obtain loans from Libyan commercial banks, and later, in 2015, bonds (or Treasury bills) underwritten by the Interim Government’s ministry of finance and the Central Bank’s eastern branch.

East-based authorities offset some of this debt by printing and putting into circulation ten billion dinars ($7 billion) worth of banknotes throughout 2015-2018 independently from the Central Bank in Tripoli.

The funding stream to the east-based authorities continued even after the 2016 installation of the Government of National Accord (GNA) in Tripoli, which the UN Security Council, but not the HoR, recognised. The suspension of the Benghazi branch from the Central Bank's automated clearing system continues until this day, giving rise to parallel yet overlapping financial systems in eastern and western Libya (see Appendix B).

B. Parallel Financial Systems

The aforementioned bonds and Treasury bills written out between 2015 and 2018 created an east-based public debt, not authorised by the Central Bank in Tripoli, amounting to 35 billion dinars ($25 billion), or almost nine billion dinars ($6 billion) a year.

The east-based government uses approximately 65 per cent of its funds to finance its operations, including the salaries of employees it hired after the 2014 political crisis (who are not included in the Tripoli budget) as well as employees hired before the crisis but cut off from the Tripoli payment system for technical and political reasons after 2014. It uses another 30 per cent to cover the LNA’s operational costs and salaries (most of which are not covered by the Tripoli budget).

The Central Bank’s Benghazi branch calculates the breakdown of its civilian versus military expenditures between 2015 and 2018 as follows:

Figure 1: Interim government (based in eastern Libya) expenditure 2015-2018 (in millions LYD) Source: Central Bank of Libya, Benghazi branch, March 2019 (unpublished source; the full breakdown of the figures is available in Appendix C of this report).

Throughout this same period, the Tripoli-based government’s budget averaged 36 billion dinars (slightly over $25 billion) a year. Oil revenues are the Tripoli government’s main source of income, but due to a shortfall in hydrocarbon production and exports, Tripoli has also faced a budget deficit, which has oscillated, averaging fifteen billion dinars ($10 billion) a year. In early 2019, the Central Bank indicated that the Tripoli government’s total cumulative outstanding debt to it was 62 billion dinars ($44 billion).

The breakdown of the Tripoli government’s expenditures, which shows that over half of its disbursements go toward salary payments, is as follows:

Figure 2: Expenditure of the Tripoli-based government 2015-2018 (in millions LYD) Source: Central Bank of Libya Economic Bulletin, 4th quarter 2018, Table 29 (the full breakdown of the figures is available in Appendix D of this report).

The Tripoli government’s budget covers most public-sector employees, including many civil servants and some LNA and other security officers in eastern Libya who were already on the public payroll prior to the 2014 crisis.

The government makes its salary payments by issuing electronic checks via the RTGS, which it processes through commercial banks across Libya. These payments, like all other transactions through electronic payment systems, including wire transfers, are first transferred from the Tripoli government’s main account to the deposit accounts that commercial banks keep with the Central Bank.

This is not the case for the east-based government’s expenditures after 2014. The Central Bank’s Benghazi branch, acting autonomously, writes out manual checks to government offices or companies, but they are cleared by commercial banks where customers have their accounts and pass through escrow (parallel) accounts that do not communicate with the automated electronic clearing system used in Tripoli. The result is a parallel system to account for commercial bank credits and debits with the Central Bank’s eastern branch. All Libyan commercial banks with branches in the east therefore operate two parallel systems: RTGS for “legal” transactions sanctioned by the Central Bank in Tripoli, and a manual one for other transactions (which Tripoli considers “rogue” operations) with the eastern branch. According to Siddiq Elkebir, the Central Bank governor, referring to the December 2015 Libyan Political Agreement that brought to power the Government of National Accord, “All of this [the bonds underwritten by the eastern authorities] is illegal, because it was not envisaged in the Skhirat agreement”; moreover, he said, the Central Bank does not recognise the manual clearing procedure adopted in the east.

Bank managers say that according to Libyan banking law they cannot refuse to process the manually issued checks from the Central Bank’s eastern branch or from commercial banks.

Ali al-Hibri, the eastern branch’s governor, agrees.

All commercial banks, including Libya’s largest bank, Jumhuriya Bank, headquartered in western Libya, have had to keep manual accounts with the Central Bank’s eastern branch. However, two banks in particular – the state-owned National Commercial Wahda Banks – and a third, smaller private bank, the Commerce and Development Bank, have processed the bulk of the east-based government’s payments by virtue of being headquartered in the east and having the greatest number of branches and clients in that region. This explains why these banks in particular are affected by the dual payment clearing system they must operate with the Central Bank and its eastern branch: using RTGS in Tripoli and manual in the east.

The processing of the east-based government’s payments and other commercial transactions has resulted over time in an accumulation of growing financial obligations by the Central Bank’s eastern branch to these commercial banks.

The key consequence of this is that these commercial banks have amassed reserves and deposits with the Central Bank’s eastern branch, while simultaneously carrying out other transactions through the Central Bank in Tripoli, where their reserves and deposits dwindled over time.

As a result of this dual payment clearing system, commercial banks maintained their primary deposit reserves with the Central Bank in Tripoli and carried out many transactions with it, while also doing business with the Central Bank’s eastern branch and accumulating other reserves (credit) with the latter. These two sets of commercial bank credits and deposits appear to be very similar, with one critical difference: the government in Tripoli and, by extension, international institutions, recognise the Central Bank’s reserves but not the eastern branch’s. This means that they also do not recognise the credits commercial banks have accumulated in the east. In practice, the Tripoli government has no oversight of the eastern branch’s reserves, and those funds reflect the eastern government asserting its authority to sell Treasury bills and print currency without Tripoli’s permission. Over time, commercial banks accumulated 21 billion dinars ($15 billion) worth of credit with the eastern branch, 65 per cent of it belonging to the three aforementioned banks.

Table 1 shows the latter’s accounts in detail as these stood in August 2018.

Table 1: Commercial bank deposits with Central Bank in Tripoli and its eastern branch in million LYD (as of 31 August 2018) and required (legal) deposits with CBL Tripoli in million LYD (as of 31 December 2018) Source: Central Bank of Libya, Benghazi branch, March 2019 (unpublished)

The unusual dual clearing system reflects the complex side effects of Libya’s political crisis. But from a financial point of view it was not an immediate problem as long as the commercial banks were able to maintain the legally required minimum deposits (20 per cent of each bank’s total deposits) with the Central Bank, which they did (Table 1, required deposits table). In fact, even as these banks accumulated reserves with the Central Bank’s eastern branch, their deposits with the Central Bank itself remained relatively stable between 2015 and 2018, staying above the 20 per cent threshold. This suggests that the dual clearing system could have continued without affecting the commercial banks’ overall operations.

III. Toward Climax: The September 2018 Financial Measures

The discrepancy in the commercial banks’ accounts with the two branches of the Central Bank worsened when the Tripoli government adopted an economic reform package it referred to as “financial measures” in September 2018 in an effort to liberalise access to letters of credit (which the Central Bank had capped since 2014), reduce black market transactions and improve liquidity in the banks.

The main component of these measures was the imposition of a hefty 183 per cent service fee on top of the official exchange rate for all foreign currency purchases involving commercial and personal transactions. While the official exchange rate remained at 1.39 dinar to the dollar, the imposition of the fee in effect created a second official exchange rate of 3.90 dinars to the dollar. This measure came into effect in October 2018 when the Central Bank started authorising letters of credit requests.

The east-based authorities initially applauded the financial measures adopted by Tripoli, because they had long called for a more open system to award letters of credit and for devaluing the dinar to reduce the black market exchange rate, which had reached seven dinars to the dollar.

Prior to these reforms, most Libyans and small traders could only access foreign currency through the black market; for the east-based government it was the sole means to access foreign currency, since the Central Bank’s eastern branch did not hold any.

When eastern banks started sounding the alarm bells in early 2019, the Tripoli authorities did not pursue any preventive measure, and refused even to acknowledge the problem publicly.

However, these measures, but especially the new fee, accelerated the problems derived from the dual settlement system and triggered an unanticipated backlash: they put an immediate strain on commercial banks’ accounts with the Central Bank, the country’s only repository of foreign currency. Even an east-based bank has to draw on its reserves with the Central Bank to acquire foreign currency. Commercial banks were affected to different degrees, but the National Commercial Bank and the Wahda Bank were hit hardest because of the volume of their transactions. In Hibri’s words: “Had [Tripoli] kept the previous exchange rate for the purchase of foreign currency, the problem would have taken three years to surface. But with the financial measures introduced in October, the depletion of commercial banks’ reserves in Tripoli accelerated”.

The extra cost for letters of credit purchased between October and December 2018 caused a sudden reduction in these banks’ deposits (up to 50 per cent for some banks, according to the Central Bank’s Benghazi branch) placing them below or very close to the required minimum.

Normally, when commercial banks’ reserves go below the required minimum, the Central Bank can decide in the first instance to restrict their transactions, for example limiting foreign currency trading or reducing to a minimum the amount of funds that can be transferred; if funds are depleted completely, it could suspend all of the banks’ operations. Should the Central Bank decide to help prevent a commercial bank from going bust, however, it could lend it funds to increase its reserves (similar to a bail-out), or reduce the required minimum deposits. When eastern banks started sounding the alarm bells in early 2019, the Tripoli authorities did not pursue any preventive measure, and refused even to acknowledge the problem publicly. Instead, it allowed the commercial banks’ reserves to drop further.

The drain on reserves continued after January 2019, when the banks processed other authorised foreign currency transactions, whether letters of credit or family allowances and money allocated for personal use.

Exact figures for these transactions’ total costs are not available but are likely considerable. The Wahda Bank alone stated that it has received $500 million (almost 700 million dinars) worth of requests from its clients for family allowances. Because of these and other transactions, the bank’s deposits with the Central Bank have declined further compared to the estimated figures at the end of 2018; as of mid-March 2019, they stood between one to two billion dinars, while its reserves with the Central Bank’s eastern branch increased to between five and six billion dinars in the same period.

The National Commercial Bank’s reserves with the Central Bank also dipped, but by how much is contested: according to the Central Bank’s Benghazi branch, they stood between two to three billion dinars in March 2019, while its reserves with the Benghazi branch remained high, approximately nine billion dinars. For their part, National Commercial Bank managers in Tripoli claim that its reserves with the Central Bank were just over four billion dinars.

Despite the discrepancy, these figures suggest that the two banks are coming dangerously close to the legally required minimum, which could prompt the Central Bank to take action against them, likely in the form of limitations on foreign currency transactions or restrictions on wire transfers.

Central Bank and government officials in Tripoli either minimise the problem with the commercial banks and their reserves, or deny that there is one. Yet, Central Bank-published data reflect the fact that there has been a sudden dive in the total volume of commercial banks’ reserves in Tripoli since the implementation of the financial measures in 2018. In the three months between October and December 2018, commercial banks’ total actual deposits with the Central Bank dropped by over 10 per cent from 101 billion dinars in September to 93 billion dinars at year end (as seen in Table 2).

Table 2: Total commercial bank deposits (in millions LYD) Source: Central Bank of Libya Economic Bulletin, 4th quarter 2018, Classification of Commercial Banks’ Deposits, Table 8.

The drop in dinar deposits is linked to an increase in the purchase of foreign currency and the transfer of funds abroad. (For every U.S. dollar a commercial bank purchases from the Central Bank, the latter debits the bank’s accounts the equivalent in Libyan dinars based on the exchange rate set by the Central Bank.) This is not limited to banks in the east: banks in western Libya are also purchasing high volumes of foreign currency to cover imports of consumer goods and relocate capital abroad. But the eastern banks are affected more because a higher proportion of their reserve deposits is held in the Central Bank’s Benghazi branch, which Tripoli does not recognise.

Data for the first three months of 2019 are not yet publicly available but, when and if released they are likely to show a further drop in overall reserve deposits with the Central Bank. With the start of Ramadan in early May, the demand for letters of credit increased because people shop more during the festivities, putting a further strain on commercial banks’ accounts with the Central Bank. In mid-March 2019, Marai al-Barasi, chairman of the Wahda Bank, began to ring the alarm bells:

We will face a real problem very soon. The demand for foreign currency is high and our reserves with the Central Bank are low. In about one month, the problem will become more apparent, and we will reach a point where we will not be able to cover any further requests [for allowances and letters of credit]. The depletion of our deposits in Tripoli might even affect salary payments. And what happens then, I really don’t know.

IV. Staving Off an All-out Banking Crisis

Sharply restricting the two commercial banks’ foreign currency transactions could have grave repercussions. How the crisis will unfold is unclear, in part because no specialist has seriously looked into the problems affecting these banks, much less tried to tackle them.

Yet a consensus is emerging among the few who follow the looming banking crisis that it could worsen Libya’s already severe liquidity problems, again raise the black market foreign exchange rate and in turn spur inflation. Service delivery is likely to be affected as well, because many state-owned companies (such as the electricity company or the east-based AGOCO oil company) and private companies that have accounts with these banks might be unable to process imports, including of spare parts, or fulfil payments of service contracts for the maintenance of their infrastructure. Such a development would affect the entire banking sector, especially if there is a rush on banks across the country. An open question is whether this will also affect salary payments for government employees.

Speaking in mid-March, just weeks before Haftar-led forces launched their offensive on Tripoli, Hibri painted an apocalyptic picture of what might happen: “A state of panic is possible. There could even be a second revolution here”, he said, referring to a possible uprising against Tripoli. He also warned that “if no solution is found for these banks, the LNA is likely to react”, suggesting that this could lead to another showdown at Libya’s oil terminals and oil fields or even accelerate an LNA advance toward Tripoli.

An official working with the Central Bank’s governor in Tripoli acknowledged that citizens might panic if the commercial banks’ operations were restricted.
 
A cut in the east’s funding streams would most likely force eastern authorities to seek external funding to bankroll the public sector.

If the banks fail, the political and military implications would be equally grave, as this would dramatically reduce the eastern government’s funding stream and by extension the LNA’s. This could add to the confrontational narrative against the authorities in Tripoli, with Haftar supporters accusing it not only of funding Islamist armed groups but of intentionally bankrupting the east-based government, the LNA and private companies – actions they say would retroactively justify the assault on the capital.

In the short term, a cut in the east’s funding streams would most likely force eastern authorities to seek external funding to bankroll the public sector. The most probable financiers would be Saudi Arabia and the United Arab Emirates (UAE). Riyadh appears to have already lent some financial support to the LNA to kick-start the offensive on Tripoli, but not for LNA or eastern government personnel salaries or operational costs, which the east-based government continues to pay.

But if the commercial banks that have helped bankroll the eastern government were to face restrictions as expected, the eastern authorities might call on their external backers to cover all public-sector expenditures. Alternatively, they could opt to print more cash to increase the money supply, though this would accelerate inflationary pressures. But these are short-term solutions that would do little to address the banking crisis, nor reconcile the dual payment clearance system. Local commercial banks would still be prevented from processing international payment orders as long as their reserves with the Central Bank remained under the legal threshold.

The LNA’s siege on Tripoli has also hardened positions in the capital, where officials increasingly are talking about taking all possible measures to curb the LNA’s financial resources, including by removing LNA military officers from the Tripoli payroll and even stopping paying the salaries of civil sector employees in the east. Speaking in late April, the interior minister in Tripoli said: “We have the database of all public-sector employees, and we can suspend salary payments to all those based in the east. And we should. Let them understand the consequence of their actions”.

The immediate impact of such punitive measures would be to increase the east-based government’s disbursement requirements well beyond the current level of its expenditures – approximately $6 billion a year.

In the long term, if the deep military and political rift continues without a major shift on the ground, the east-based government may place its bets on seeking access to Libya’s oil revenues and connecting the east-based banks, including the Central Bank’s Benghazi branch, to the international banking system. Whether it can do so is questionable, as both oil trading and access to Swift, the international wire transfer system used across the world, are highly dependent on U.S. approval. Over the years, Washington has repeatedly reaffirmed the principle that Libya’s financial institutions should remain undivided and that its government should be reunified. U.S. officials never legitimised the eastern government or the Central Bank’s Benghazi branch; the U.S. Treasury only has maintained contact with the Tripoli-based Central Bank governor.

In many respects, the U.S.’s firm stance on this matter has ensured that Libya’s oil revenues would solely accrue to the Central Bank in Tripoli, and thus to the UN-backed government, over the past years. But with U.S. President Donald Trump signalling his support for Haftar in mid-April, thus aligning the U.S.’s position with that Saudi Arabia, the UAE and Egypt, a change of policy vis-à-vis Libya’s finances and oil sector has become conceivable.

 

Before the LNA’s offensive, two controversial approaches were floated to resolve the banking crisis. The first, strongly backed by the east-based government, would be to persuade the Central Bank to recognise the credit commercial banks have accrued with its eastern branch.

This means that the Central Bank would absorb all or part of the east-based government’s debts (approximately 35 billion dinars) and possibly also reconnect the Central Bank’s eastern branch to the automated payment settlement system. Such a proposal would face fierce resistance in Tripoli. The Central Bank’s governor, Siddiq Elkebir, is on record as stating: “No way! No amount of screaming will get it done”, referring to both recognising the east-based government’s debt and reconnecting the Benghazi branch to the Central Bank’s clearing system.

Elkebir is refusing to do so because he neither trusts the sources of funds in the east nor the accuracy with which they are being reported, given the Central Bank’s lack of oversight over the manual accounting system. The launch of the assault on Tripoli can only have hardened his position.

Yet without immediate steps to rectify the situation, the commercial banks are bound to fail.

Another alternative – extreme, and only vaguely mooted – approach would be to have the banks “face the consequences of their actions”: let them fail.

This remains a conjecture for now but could quickly turn into de facto policy if the Central Bank continues not to take action and the LNA military offensive continues, openly supported by the Central Bank’s Benghazi branch.

But all the parties concerned are aware that this could trigger serious social unrest and precipitate a profound economic crisis with political and even military repercussions for almost everyone, including in western Libya.

Prior to the offensive, the east-based government proposed a third, middle-ground solution. It consists of changing how to account for foreign currency transactions. Rather than debiting the commercial banks’ reserves with the Central Bank for these transactions’ entire cost at the 3.90 dinars to the dollar exchange rate, they propose splitting this into two separate portions: one equivalent to the official 1.4 dinar to the dollar rate, to be debited to the commercial banks’ reserves with the Central Bank; and the other, with the fee added, to be debited to the credit these banks have accrued with the Central Bank’s eastern branch.

They argue that when the Tripoli authorities imposed the additional fee, they intended to use revenues accrued from it to cover the 63 billion dinar government debt with the Central Bank. Now, they say, the Government of National Accord should use these funds to cover the eastern debt as well in order to slow the rate at which the commercial banks’ reserves with the Central Bank are depleting, while also drawing down on the reserves these banks have accrued with the Central Bank’s eastern branch.

So far the authorities in Tripoli have ignored such proposals. To the contrary, on 20 March 2019 (before the offensive), the Tripoli government decided to use fifteen billion dinars ($11 billion) generated from foreign currency fees to cover one third of its 2019 budget.

The same day it also ordered that another five billion dinars ($3.5 billion) generated from foreign currency fees be used to pay back a portion of its accumulated debt with the Central Bank, and yet another five billion dinars ($3.5 billion) to finance future development projects that the Tripoli-based Presidency Council will oversee. There has been no mention of allocations for eastern debt repayment. Since the start of the military offensive in early April, the Central Bank has allocated a gargantuan two billion dinars ($1.4 billion) to support the war effort of Tripoli government-allied forces.

Although informed of the risks and implications of the problems affecting the commercial banks even prior to Haftar’s march on Tripoli, neither the Central Bank governor nor his advisers have offered a concrete proposal on how to prevent a full-fledged banking crisis. International actors who track Libya’s economic woes have remained either largely oblivious to this specific problem or were unable to persuade the Central Bank and finance ministry in Tripoli to address it.

Yet without immediate steps to rectify the situation, the commercial banks are bound to fail and the dispute over the allocation of oil revenues will come back with a vengeance, prolonging the war.

With a decisive victory by either side unlikely, outside actors, especially the warring sides’ respective foreign backers, should persuade the two rival governments to accept a ceasefire in place and kick-start negotiations to settle their financial dispute as an immediate priority. Currently there is strong opposition to this inside Libya: both sides view the fighting around Tripoli as an existential fight and have refused to even consider a cessation of hostilities or external mediation. The LNA is adamant it wants to seize the capital and place the state’s financial institutions under its control. Likewise, Tripoli-aligned forces say they are determined to push the LNA back to eastern Libya and undermine the east’s financial standing. These positions point to a possible protracted, expensive stalemate that could precipitate further external involvement and continued violence on multiple fronts across the country.

The two sides are taking a serious risk. Letting the crisis – the LNA’s military offensive and the Central Bank’s punitive measures – unfold in the current circumstances could redound negatively to both of them: it could devastate urban areas and severely harm the economy, increase liquidity problems, send prices skyrocketing and give a boost to black market trading. The prime beneficiaries would be military actors and black market traders, while hardest hit will be ordinary Libyans across the country. In the long term, it could give way to a much broader financial and resource war.

Without a nudge from Washington, authorities in Tripoli are unlikely voluntarily negotiate a financial compromise.

Foreign capitals and the UN should press the parties toward a ceasefire. To this end, Haftar’s backers in the Gulf should make it clear they do not intend to bankroll the east-based government if its accounts run dry, as appears possible, let alone give further financial support to the offensive. This could provide the necessary incentive for the LNA to halt its assault on Tripoli and agree to negotiate. Similarly, European capitals and regional backers of the Tripoli coalition need to pressure Serraj to agree to a ceasefire.

At the same time, the U.S. should exercise its leverage over the Central Bank in Tripoli, with which it has a preferential relation, to persuade it to resolve the banking problems affecting eastern Libya. Without a nudge from Washington, authorities in Tripoli are unlikely voluntarily negotiate a financial compromise. This would require Washington to return to a more even-handed approach to the Libyan conflict: rather than signalling military support for Haftar and (ambivalent) political recognition of Serraj, the Trump administration, with technical advice from the U.S. Treasury, should use its political capital and financial leverage to press the two sides toward a settlement of the banking crisis. The UN and international financial institutions such as the World Bank and the International Monetary Fund (IMF) should also offer expert advice.

Clearly, such a financial negotiation cannot happen in isolation; it will have to go hand in hand with political and military talks aimed at bridging the rifts across the country. But the offer of a financial track would increase the chances of persuading the parties to accept a ceasefire. Moreover, any future negotiations risk being pro forma if there is no attempt to also redress the financial imbalances that are a key driver of both the political and military conflict in Libya. To this end, several steps should be taken:

  • The rival governors of the Central Bank and its Benghazi branch should reaffirm their commitment to an external audit of the Bank, as they had promised to the UN special envoy in August 2018. The UN should urgently work to overcome technical delays that have held up this process.
     
  • In the meantime, the UN should convene a technical meeting of the rival governors, officials from the parallel finance ministries and Libyan financial experts. The goal would be for them to sketch out technical solutions to both the banking crisis and the host of problems that have accumulated since the 2014 split of the Central Bank, including how to standardise commercial banking operations in the east. This meeting should take place in the presence of specialists from the World Bank, the IMF and the U.S. Treasury, and possibly also of other European or regional financial institutions with relevant expertise. The UN should consider seeking the technical guidance of a senior and respected former Central Bank governor to help lead this process.
     
  • Those negotiating a solution to the Libyan crisis also should establish a new procedure to select a consensual Central Bank governor to overcome the deadlock in the process envisioned in the Libyan Political Agreement. This point should be covered by any future political talks.

V. Conclusion

Finding a solution to Libya’s looming banking crisis is necessary and urgent. Today’s predicament is the product of the 2014 political crisis and the increasingly polarised relations between west and east that flowed from it, which have soured and deepened since then. It is also the direct consequence of policy decisions that further entrenched political, military and financial divides. The Central Bank’s 2014 decision to cut off its Benghazi branch from the automated payment settlement system was aimed at preventing authorities in eastern Libya from tapping into the country’s financial assets. Tripoli achieved its objective, but in doing so it triggered a profound split inside the Central Bank and unleashed a powerful sense of disenfranchisement in the east. It also prompted Tripoli’s rivals to find other means through which to bankroll themselves and to expand their claims of sovereignty. This polarised the political scene further, deepened the military rift between east and west, exacerbated Libya’s economic crisis and contributed to the current war in the capital.

Similarly, attempts to address liquidity problems and the black market’s distortionary effects prompted the 2018 financial measures, especially the imposition of a hefty fee on foreign exchange transactions. This financially sensible move had unintended and unanticipated consequences: the rapid depletion of reserve deposits that banks headquartered in eastern Libya hold with the Central Bank in Tripoli.

The primary victims of the banking crisis would be account holders, but also the broader economy.

Remedial steps are both possible and necessary. But this would require that the warring parties, with the active support of international partners, agree to a ceasefire. This in turn would make negotiations on a financial settlement possible. Yet a ceasefire is less likely if, alongside necessary political and military talks, foreign stakeholders in the Libyan crisis fail to propose and pledge support for a solution to the financial crisis.

Failing to address the banking crisis would not only likely prolong the war; it also would have severe repercussions for Libya as a whole. The primary victims of the banking crisis would be account holders, meaning ordinary citizens, but also the broader economy, which had started to emerge slowly from a six-year downturn only earlier this year. Moreover, the warring parties’ foreign supporters might find that they would be asked to bankroll their proxies, especially in the east, allowing the fight to drag on without a decisive winner. This, of course, would have disastrous implications for Libya’s ability to finally extricate itself from its post-2011 upheaval.

Tripoli/Benghazi/Brussels, 20 May 2019

 

Appendix A: Map of Libya

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Appendix B: Financial Flow Chart

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Appendix C: Interim (Eastern) Government Expenditure 2015-2018 (in millions LYD)

Source: Central Bank of Libya, Benghazi branch, March 2019 (unpublished).

Appendix D: Tripoli Government Actual Revenue and Expenditure 2014-2018 (in millions LYD)

Data from CBL Economic Bulletin 4Q 2018, pg 61
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Embassy Media - Interview with Mr. Haileab Tesfay