Libyan Banks’ Credit & Collateral: Is this a crisis – how worried should I be?

By Julio Alonso

Confronting challenges like asset recognition and provisioning inadequacies, the Libyan banks are at a critical moment, exacerbated by the 2021 devaluation of the Libyan Dinar – with another official rate devaluation in sight. This situation has led to breaches of exposure limits, emphasizing the lack of mandatory asset quality reviews and regular credit assessments.

So how bad is this and what does it mean for you?

What is a Collateral?

A collateral is a crucial mechanism in the lending process, serving as a security measure for lenders. It is an item of value—such as a home in the case of a mortgage—that a lender can seize if a borrower fails to repay a loan according to agreed terms. This ensures that the lender can recover the lent amount by selling the collateral if necessary, acting as a guarantee for loan repayment.

Both central and commercial banks require collateral for loans to mitigate loss risks, impacting reputation and financial stability.

In Libya, the Central Bank mandates high capital adequacy ratios, with risk-weighted banking assets averaging at 16% in 2022—a robust figure that enhances protection but also compresses bank profitability and narrows margins, reducing risk-taking.

So, with everything seeming solid, where exactly is the problem?

Libyan Banks: Actual vs. Stated Collateral Valuation

Libya was ranked 186th out of 190 countries in the World Bank’s 2020 Doing Business report for the Getting Credit indicator, scoring zero in legal rights, credit information, and credit bureau coverage. Despite efforts by the Central Bank of Libya, including Circular 9/2022 that mandates Basel II and III compliance to manage systemic liquidity, and legal risks, challenges persist in credit analysis and oversight due to: poor risk governance, limited analytical tools and expertise, and insufficient human resource capacity in Libya’s financial sector.

The situation is exacerbated by underdeveloped collateral laws, inadequate safeguarding of secured creditors’ rights amidst insolvency, inefficient land registries affecting property ownership clarity, and a lack of competent valuation bodies. Coupled with a fragile judicial system, these factors lead to significant information asymmetries supporting the following claim: there exists a substantial gap between the book and market values of collaterals held by financial institutions.

Does the Collateral Book/Market Mismatch Matter?

While “yes” is the simple answer, understanding collateral’s composition and ownership is crucial to assess its impact on Libya’s economy and financial sector.

Despite over 20 banks operating in the nation, the sector shows significant concentration: the top five banks possess more than 77% of assets, control 88% of the lending market, and hold nearly 80% of deposits. This concentration, alongside the Central Bank of Libya’s solvency and its ownership of the four largest banks, virtually negates the risk of a systemic collapse due to collateral value issues.

Libyan banks currently have provisions of 3.85 billion Libyan dinars for non-performing loans, against loans and facilities valued at 25.35 billion dinars. Given that 30% of these loans are to the public sector, which carries minimal default risk, the provisions account for 22% of the genuinely risky loans—the private sector ones. This prompts the question: why precisely a 22%?

This provisioning rate is based on the latest detailed review of bank portfolio quality from 2010, where 20% of loans were flagged as non-performing. However, this figure is certainly low, as:

1. Legal restrictions prevent banks from writing off overdue loans without court approval.
2. There has been a massive increase in non-performing loans ratios since 2010, especially within state-owned banks.
3. More than 80% of the loans issued by various Libyan banks are non-performing.

However, despite the significant mismatch between the collateral book and market values, the Libyan banking system is not at risk of collapse; this is mainly because 63% of bank assets are deposits at the Central Bank, and overall loans and facilities represent only 17% of the banks’ assets. Thus, even in the most catastrophic scenario, the percentage impacted remains very low. Nonetheless, considering the conditions outlined above, banks must promptly reassess their capital positions.

An Incoming Banking Recapitalisation?

From all the above, we can conclude that Libyan banks need a recapitalisation to accurately reflect their financial situation, support credit growth, reduce information asymmetries, and improve the overall financial system. Considering various recapitalization strategies, such as mergers, acquisitions, capital injections, and the critical step of reclassifying non-performing loans to defaulted status, is essential.

Yet, the likelihood of a swift recapitalisation is very low. Its deep political implications, intertwined with the ownership of non-performing loans, and the need for judicial consent create substantial obstacles. Consequently, while strategies like bank mergers and capital infusions may be implemented, a genuine reflection of financial positions in Libyan banks is unlikely to materialize soon.

Libyan Credit Growth Does Not Need a Recapitalisation

Despite initial assumptions that increasing credit supply by shifting banking exposures from the central bank to the private sector might be hindered without addressing the previously mentioned challenges and avoiding a collateral trap, the situation unfolds differently. The Central Bank is actively moving towards centralizing banking loans through the establishment of a credit information centre.

This centralization of decision-making will enable the reintroduction of more credit into the Libyan market, thereby fostering national development through credit expansion. Meanwhile, the value of non-performing loans held by banks is being eroded by inflation, easing the impact of these loans on the financial and political system. Whilst significantly reducing politically motivated lending, fraud, and enhancing the overall market efficiency as well as availability of credit.

Is this a crisis – how worried should I be?

No, there’s no cause for alarm. Even in the most pessimistic scenarios concerning the mismatch between the book and market values of collateral, the Libyan banking system remains resilient against collapse. Despite liquidity issues and restricted deposit access are set to persist, improvements in IT governance and bank control are facilitating potential mergers, acquisitions, and capital injections.

All in all, given the effective leadership at the Central Bank, the banking system is not only secure but also on the verge of an unprecedented credit expansion, presenting a positive outlook for the future.