Libya Tribune

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.

PART ONE

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.

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.

_____________________