## 1. Banking System Flows

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### A. Banking sector structure, performance, and recent policy shifts
- Banking sector size and composition:
  - Libya has 20 banks with total assets of around LYD 143 billion.
  - Loans and credit facilities are less than 15 percent of total banking sector assets.
  - Around 60 percent of banking sector assets are balances at the Central Bank of Libya (CBL).
  - Credit to GDP is 12 percent in 2022.
- Concentration and ownership:
  - The CBL owns two of the largest four banks (Al Jumhuriya, National Commercial Bank, Al Wahda, and Sahara).
  - These four public banks make up approximately 70 percent of banking sector assets and 80 percent of total credit.
- Interest prohibition and revenue adjustments:
  - Interest payments were outlawed in 2013, disrupting conventional banking and contributing to banks’ slow conversion to Islamic finance.
  - Banks increased fee income, including fees on foreign currency transactions, which contributed to persistence of the parallel foreign exchange market.
- Regulatory and liquidity rules:
  - CBL regulation number 11/2022 requires banks to calculate capital adequacy using the Basel II capital accord and maintain a ratio above 12.5 percent.
  - CBL regulation 2/2023 and 14/2022 introduce Basel III net stable funding ratio and the liquidity coverage ratio.
  - A dedicated CBL unit was created to oversee implementation.
- Foreign currency, CFMs/MPMs, and exchange rate developments:
  - The CBL approves foreign currency letters of credit (LCs) and conducts AML/CFT checks; it acts as clearer of US$ for Libyan banks.
  - The 2015 oil price crash led the CBL to introduce capital flow measures (CFMs) and macroprudential measures (MPMs), including annual limits on foreign currency for personal use, CBL approval for import letters of credit and limits on foreign currency prepaid cards.
  - A transaction tax on foreign exchange was introduced in 2018; the LYD was devalued in 2021.
  - The official exchange rate (US$/LYD 1.44) and the parallel market (US$/LYD 9) narrowed to only 6 percent.
  - The CBL decision to allow banks to lend up to 70 percent of the value of LCs supported credit growth in 2021 and 2022.
- Dual CBL operations and liquidity pressures:
  - Since 2014 the Eastern branch of the CBL operated independently and provided monetary financing to the administration in the East.
  - Only the CBL in Tripoli can provide US$ and is legally allowed to print currency notes; banks’ use of Tripoli balances for FX and notes pressures western liquidity while eastern settlement balances remain high.
  - As part of unification, the CBL has transferred around LYD 29 billion of balances in the Eastern branch to banks’ settlement accounts in Tripoli.
  - The Eastern branch engaged in LYD 8 billion of new monetary financing for the GNS and development projects in the East; further monetary financing should be avoided as it endangers financial stability.
- Operational and market frictions:
  - The parallel market persists due to banking sector inefficiencies, scarce foreign currency physical notes, and remaining CFMs/MPMs.

### B. Preconditions for effective banking supervision — gaps and priority reforms
- BCBS prerequisites and applicable areas:
  - Relevant prerequisites include sound macroeconomic policy, financial stability, crisis management and resolution frameworks, developed public infrastructure, and effective market discipline.
- Legal and governance deficiencies:
  - Article 5 of the 2012 banking law does not clearly include a financial stability mandate or governance structure; the law should be amended to include a clear, formal financial stability mandate and a governance structure that brings together the Ministry of Finance, the Ministry of Economy, and the CBL.
  - The CBL board has met only once since 2014 (in 2021, when it took the decision to devalue the LYD); reestablishing an effective board would strengthen governance and public confidence.
- Interest prohibition and Islamic finance transition options:
  - The 2013 prohibition of charging interest was introduced abruptly and without adequate preparation, further disrupting credit intermediation.
  - Options recommended:
    - Revisit the prohibition to allow both conventional and Islamic banks to coexist; or
    - Establish a road map for banks to fully embrace Islamic finance and develop Sharia-compliant lending products, including an exit plan for banks unable to convert.
  - The CBL should ensure banks establish effective sharia governance structures and develop human capital in Islamic finance to support credit growth.
- Macroprudential/monetary policy interface and CFMs/MPMs:
  - A macroprudential framework is required to promote financial stability and support monetary policy; most macroprudential tools are micro measures that can also influence aggregate credit supply.
  - The CBL has strengthened micro-prudential regulations (credit, capital, liquidity ratios), but further work is needed on implementation, CBL supervision capacity, and developing the macroprudential framework.
  - The CBL should continue to ease CFMs/MPMs as conditions permit to eliminate the parallel market and support credit growth.
- Crisis management and resolution:
  - Crisis management, recovery, and resolution regimes should be developed in the medium term to contain spillovers from bank failures, reduce moral hazard, and avoid public bailouts; CBL ownership of major banks reduces short-term urgency but these frameworks are essential for private-sector-led development.
- Public infrastructure and legal/administrative reforms:
  - Accounting and audit professions face informational and verification challenges; public financial statements are delayed or absent, limiting market discipline.
  - Tax administration is weak with high non-compliance, widespread tax exemptions, and manual processes that reduce data usability for banks.
  - The credit registry is infrequently updated and not always used by banks; CBL circular 4/2023 reaffirms the process to update and use credit registry information but it has not yet been implemented — further automation is recommended.
  - No collateral registries: property records were largely destroyed during the Ghaddafi regime and conflict, rendering immovable assets ineffective as collateral.
  - The rule of law is weak: court proceedings are lengthy and enforcement is slow; strengthening legal protection of ownership rights and contract enforcement is fundamental to support credit expansion.

### C. Principles for effective supervision — regulatory, governance, and supervisory measures
- CBL governance and alternative arrangements:
  - Enhance the CBL’s governance framework; when the board cannot be convened, decisions outside the governance structure should be necessity-based, clearly identified, and transparently disclosed.
  - Introduce alternative governance arrangements (e.g., internal consultative committees) to provide scrutiny when full board governance is impractical.
- Regulatory perimeter and consultative rulemaking:
  - Expand the regulatory perimeter to include innovative financial services (Fintech) such as payment services, crowdfunding, digital assets, and E-money; regulate the activity regardless of the provider.
  - Require the CBL to publicly consult with stakeholders (banks, finance companies, consumer groups, academia) before issuing regulations to minimize unintended consequences and allow for transition periods.
- Legal drafting and use of regulations:
  - Move some detailed requirements from the banking law into regulations to allow easier modification as practices evolve (examples: fit and proper regime, criteria for auditors and collateral valuers, who can petition for inspection, corporate governance specifics).
- Corporate governance and fit-and-proper regime:
  - Implement a fit and proper regime to identify key control functions, set minimum candidate criteria, and specify the CBL’s approval and review process.
  - CBL regulation number 6/22 is a significant step; recommended refinements include:
    - Requiring candidates to pass regulatory interviews.
    - Requiring exit interviews for departing officers.
    - Affording protection from unfair dismissal when acting in good faith.
    - Granting the CBL power to sanction authorized individuals for misconduct, including imposing bans on holding office at regulated financial institutions.

### Fit-and-proper regime for controllers and CBL ownership safeguards
- Fit and proper for controllers:
  - CBL approval should be required for legal or natural persons seeking to hold a controlling interest in a regulated financial institution.
  - A fit and proper controllers’ regime is a prerequisite for public banks’ divestment and is likely to:
    - ensure new owners promote good governance,
    - hold management accountable,
    - effectively monitor performance,
    - ensure criminal groups do not control financial institutions and engage in money laundering activities.
- CBL ownership and temporary safeguards:
  - Until the CBL can relinquish ownership of banks, it should establish internal safeguards to limit conflicts of interest between ownership and supervision.
  - Possible measures:
    - Assess a public bank’s board from two separate perspectives—investor (focus: maximizing return and shareholder wealth) and supervisor (focus: risk appetite and governance).
    - Strict internal separation within the CBL between functions overseeing investments and banking supervision.
    - Establish and observe guidelines on appointing and dismissing banks’ board members.

### Strengthening bank governance, reporting, and committee structures
- Minimum committee structure recommended for every bank:
  - An executive committee comprising senior executives.
  - Committees for credit risk (CRCO), assets and liabilities management (ALCO), operational risk (OPCO), compliance and legal risk.
- Issues and committee requirements:
  - CBL regulation 10/2022 requires banks to establish an ALCO, but the specified functions and mandate are described as too broad and ALCO membership includes the chairman of the board, which may blur the line between daily risk management and board oversight.
  - Committees should have clear and manageable terms of reference, a set of periodic reporting requirements, and a mechanism to track implementation of decisions.
- Internal and external reporting, financial statements:
  - Develop comprehensive internal management information to enable board and management to track strategy implementation, performance, and risk exposure.
  - CBL should periodically review information received by management for coverage, quality, and usefulness for decision making.
  - Data reporting to the CBL should be in a format that is easy to aggregate and analyze to assist risk assessment at individual banks and system-wide.
  - Replace the requirement for the general assembly to approve financial statements with board approval to avoid publication delays.
  - Banks should be required to publish unaudited interim statements.
- Modern bank reporting system and phased rollout:
  - CBL has set up a task force to automate and modernize bank reporting; progress on module design and system development has been made.
  - Adopt a gradual roll-out that prioritizes critical modules (example critical modules: capital, liquidity, and credit) and consult widely with CBL data users and bank representatives.

### Capital, asset quality, recapitalization, and Pillar II
- Capital adequacy and exposures:
  - Banking sector shows a Basel I capital adequacy ratio of around 16 percent at face value, but this reflects deficiencies in asset impairment recognition and provisioning.
  - Over 60 percent of banks’ assets are exposures to the CBL with no capital requirements.
  - If banks shift exposures from the CBL (zero risk weighted) to private sector borrowers (positive risk weights), new assets will consume capital quickly.
  - The 2021 devaluation of the LYD increased the LYD value of foreign currency‑denominated exposures and caused some banks to breach large exposure limits.
- Non-performing loans (NPLs) and provisioning:
  - Since 2011, NPLs have been estimated at around 20 percent of total loans and cannot be accurately measured due to conflict and political instability; true NPLs are likely much higher.
  - Banks are likely under‑provisioned and capital adequacy is likely overstated.
  - CBL actions recommended:
    - Request banks undertake an asset quality review against set NPL criteria.
    - Establish actual capital position.
    - Develop recapitalization plans (options include bank mergers, profit retention, and capital infusion).
- Basel II pillar II and capital add-ons:
  - CBL issued circular 9/2022 in October 2022, giving banks three months to implement guidance on Basel II pillar II.
  - Requires banks to conduct an Internal Capital Adequacy Assessment Process (ICAAP) and submit results for regulatory review.
  - As part of ICAAP supervisory review and evaluation process (SREP), CBL should apply a capital add-on to banks with risks not fully reflected in Basel pillar I capital (examples: concentration and liquidity risks).
  - Pillar II capital add-on can be used to influence bank behavior and risk taking (examples: underinvestment in technology, weak governance, deficiency in AML and CFT controls).

### Credit underwriting, information sharing, and liquidity management
- Credit underwriting and rating:
  - Require banks to adopt a credit risk appetite, clear underwriting criteria, exposure limits, and necessary controls.
  - Banks should periodically assess credit quality, identify signs of delinquency, and assign credit ratings commensurate with likelihood of default.
  - Supervisors should evaluate rating methodology and implementation and take corrective measures.
- Reporting and information sharing:
  - Banks should report loan portfolios rated under standardized criteria to the CBL and credit information center.
  - Granular reporting of large credit exposures helps identify concentration risk and assign appropriate Basel II pillar II capital add-ons.
  - Improved credit information and stress testing enable vulnerability identification.
- Liquidity management:
  - After abolishing interest rates in 2013, CBL did not introduce Islamic instruments and the interbank market did not develop.
  - Banks have no avenue to place excess liquidity; funds remain in CBL settlement accounts.
  - Recommendations:
    - Introduce liquidity management instruments tailored to Islamic banks.
    - Issue liquidity regulation in line with BCBS Basel III to limit banks’ liquidity and funding risk.
    - Set minimum criteria for sound liquidity risk management at banks.
  - Importance:
    - Critical when credit growth picks up and banks view excess liquidity at CBL as a cost.
    - Increases CBL’s ability to conduct monetary policy.

### Operational risk, technology adoption, and AML/CFT
- Operational risk and mitigation:
  - Libya’s environment (fragile security, inefficient legal system, weak rule of law) gives rise to operational risks including AML/CFT, fraud, physical damage to branches and ATMs.
  - Internet and mobile banking can reduce need to protect physical assets and increase security and traceability.
  - AML/CFT screening and investigation software, and automation of back‑office functions, can reduce AML/CFT risk and human errors.
  - CBL should introduce comprehensive operational risk requirements, possibly including specific system and user functionality requirements.
- AML/CFT supervision and FIU capacity:
  - The very low number—113 in 2022—of suspicious activity reports (SARs) to the Financial Intelligence Unit (FIU) indicates weak AML/CFT controls at banks.
  - Backlog of SARs implies inadequate FIU resources and systems to investigate and resolve suspicious transactions.
  - Recommendations:
    - CBL should ensure full implementation of AML/CFT regulations and address control failures at banks.
    - FIU should update systems and processes and increase resources to handle existing SAR filings and an expected rise in filings as banks improve controls.
- Domestic and international cooperation:
  - FIU has 12 memorandums of understanding with domestic authorities and 7 with international counterparts.
  - Domestic exchange of information and coordination across law enforcement, customs, and FIU are vital for effective investigations and prosecution.
  - International cooperation with other FIUs increases confidence in Libya’s financial system and deters money laundering syndicates.
  - Formal communication channels should be established to handle higher SAR volumes and more complex investigations.

### Conclusions and prioritized recommendations (priority labels preserved)
- Success of financial sector reforms depends on political and social stability and addressing gaps in BCBS prerequisites and principles, including central bank unification.
- Selected prioritized recommendations:
  - Structural
    - Unification of the CBL — High.
    - Banks’ disclosure — High.
    - Property registry — High.
  - Macroprudential Framework
    - Macroprudential framework — Medium.
    - Gradual easing of CFMs/MPMs — Medium.
    - Frameworks for crisis management, recovery, and resolution — Low.
  - Banking Law
    - Establish a financial stability committee (FSC) — High.
    - Islamic finance only or conventional and Islamic dual system — High.
    - Requirement to consult on new regulations — High.
    - Expand financial services coverage — Medium.
    - Streamline and reduce complexity — Low.
  - Governance
    - CBL - Establish alternative temporary governance arrangement — High.
    - CBL - Public ownership of banks — High (apply strict separation between ownership and supervision until divestment).
    - Divestment of CBL ownership — Medium.
    - Fit and proper — High (apply to controllers; CBL approval and sanction powers; include interviews).
    - Bank reporting system — High (gradual roll out aligned with new regulations).
    - Governance review and supervision — Medium.
  - Credit
    - Islamic products — High.
    - Credit underwriting — High.
    - Credit information center improvements — Medium.
  - Liquidity
    - Islamic liquidity management tools — High.
    - Liquidity management at banks — Medium.
    - Liquidity quantitative requirements (Basel III LCR and NSFR) — Medium.
  - Capital and Asset quality
    - Recapitalization of banks — High.
    - Past due and NPLs identification, reporting and provisioning — High.
    - Pillar II capital add-on — Medium.
  - Operational risk
    - Improve technology adoption in the banking sector — Medium.
  - AML/CFT
    - Enhance AML/CFT supervision — High.
    - FIU automation and resources — High.
    - Strengthen domestic and international cooperation — High.

### Annex I. Select BCBS Sound Principles (high-level supervisory principles)
- Supervisory responsibilities, powers, and independence:
  - Principle 1 – Responsibilities, objectives and powers.
  - Principle 2 – Independence, accountability, resourcing and legal protection for supervisors.
  - Principle 5 – Licensing criteria.
  - Principle 11 – Corrective and sanctioning powers of supervisors.
- Permissible activities and licensing:
  - Principle 4 – Permissible activities.
- Reporting, problem assets, and provisioning:
  - Principle 10 – Supervisory reporting.
  - Principle 18 – Problem assets, provisions, and reserves.
- Capital, credit risk, liquidity, and operational risk:
  - Principle 16 – Capital adequacy.
  - Principle 17 – Credit risk.
  - Principle 24 – Liquidity risk.
  - Principle 25 – Operational risk.
- Internal control, audit, and abuse prevention:
  - Principle 26 – Internal control and audit.
  - Principle 29 – Abuse of financial services.

*Source: LIBYA — BANKING SECTOR REFORM: A ROADMAP (May 5, 2023)*

### 1. Banking System Flows ________________________________________________________________ 6

### 1. Banking System Flows

### A. Banking sector challenges — structure, performance, and recent policy shifts
- Libya has 20 banks with total assets of around LYD 143 billion.
- Loans and credit facilities are less than 15 percent of total banking sector assets.
- Around 60 percent of banking sector assets are balances at the Central Bank of Libya (CBL).
- Credit to GDP is 12 percent in 2022.
- Concentration:
  - The CBL owns two of the largest four banks (Al Jumhuriya, National Commercial Bank, Al Wahda, and Sahara).
  - These four public banks make up approximately 70 percent of banking sector assets and 80 percent of total credit.
- Interest payments were outlawed in 2013, disrupting conventional banking and contributing to banks’ slow conversion to Islamic finance.
- To offset lost interest income, banks increased fee income, including fees on foreign currency transactions, which contributed to persistence of the parallel foreign exchange market.
- Recent regulatory developments and liquidity rules:
  - The CBL issued regulation number 11/2022 requiring banks to calculate capital adequacy using the Basel II capital accord and maintain a ratio above 12.5 percent.
  - The CBL issued regulation 2/2023 and 14/2022 to introduce Basel III net stable funding ratio and the liquidity coverage ratio.
  - A dedicated CBL unit was created to oversee implementation.
- Foreign currency and AML/CFT controls:
  - The CBL approves foreign currency letters of credit (LCs) and conducts AML/CFT checks; it acts as clearer of US$ for Libyan banks.
  - The 2015 oil price crash led the CBL to introduce capital flow measures (CFMs) and macroprudential measures (MPMs), including annual limits on foreign currency for personal use, CBL approval for import letters of credit and limits on foreign currency prepaid cards.
- Exchange rate developments and effects on credit:
  - A transaction tax on foreign exchange was introduced in 2018; the LYD was devalued in 2021.
  - The official exchange rate (US$/LYD 1.44) and the parallel market (US$/LYD 9) narrowed to only 6 percent.
  - The CBL decision to allow banks to lend up to 70 percent of the value of LCs supported credit growth in 2021 and 2022.
- Dual CBL operations and liquidity pressures:
  - Since 2014 the Eastern branch of the CBL operated independently and provided monetary financing to the administration in the East.
  - Only the CBL in Tripoli can provide US$ and is legally allowed to print currency notes; banks’ use of Tripoli balances for FX and notes pressures western liquidity while eastern settlement balances remain high.
  - As part of unification, the CBL has transferred around LYD 29 billion of balances in the Eastern branch to banks’ settlement accounts in Tripoli.
  - The Eastern branch engaged in LYD 8 billion of new monetary financing for the GNS and development projects in the East; further monetary financing should be avoided as it endangers financial stability.
- Operational and market frictions:
  - The parallel market persists due to banking sector inefficiencies, scarce foreign currency physical notes, and remaining CFMs/MPMs.

### B. Preconditions for effective banking supervision — gaps and priority reforms
- Regulatory and governance prerequisites (BCBS framework referenced):
  - The BCBS sets six prerequisites and twenty-nine principles for effective banking supervision; applicable prerequisites include sound macroeconomic policy, financial stability, crisis management and resolution frameworks, developed public infrastructure, and effective market discipline.
- Key legal and governance deficiencies:
  - The banking law (Article 5 of the 2012 banking law) does not clearly include a financial stability mandate or governance structure; the law should be amended to include a clear, formal financial stability mandate and a governance structure that brings together the Ministry of Finance, the Ministry of Economy, and the CBL.
  - The CBL board has met only once since 2014 (in 2021, when it took the decision to devalue the LYD); reestablishing an effective board would strengthen governance and public confidence.
- Interest prohibition and Islamic finance transition:
  - The 2013 prohibition of charging interest was introduced abruptly and without adequate preparation, further disrupting credit intermediation.
  - Options recommended:
    - Revisit the prohibition to allow both conventional and Islamic banks to coexist; or
    - Establish a road map for banks to fully embrace Islamic finance and develop Sharia-compliant lending products, including an exit plan for banks unable to convert.
  - The CBL should ensure banks establish effective sharia governance structures and develop human capital in Islamic finance to support credit growth.
- Macroprudential and monetary policy interface:
  - A macroprudential framework is required to promote financial stability and support monetary policy; most macroprudential tools are micro measures that can also influence aggregate credit supply.
  - The CBL has strengthened micro-prudential regulations (credit, capital, liquidity ratios), but further work is needed on implementation, CBL supervision capacity, and developing the macroprudential framework.
  - The CBL should continue to ease CFMs/MPMs as conditions permit to eliminate the parallel market and support credit growth.
- Crisis management, recovery, and resolution:
  - Crisis management, recovery, and resolution regimes should be developed in the medium term to contain spillovers from bank failures, reduce moral hazard, and avoid public bailouts; CBL ownership of major banks reduces short-term urgency but these frameworks are essential for private-sector-led development.
- Public infrastructure and legal/administrative reforms:
  - Accounting and audit professions face informational and verification challenges; public financial statements are delayed or absent, limiting market discipline.
  - Tax administration is weak with high non-compliance, widespread tax exemptions, and manual processes that reduce data usability for banks.
  - The credit registry is infrequently updated and not always used by banks; CBL circular 4/2023 reaffirms the process to update and use credit registry information but it has not yet been implemented — further automation is recommended.
  - No collateral registries: property records were largely destroyed during the Ghaddafi regime and conflict, rendering immovable assets ineffective as collateral.
  - The rule of law is weak: court proceedings are lengthy and enforcement is slow; strengthening legal protection of ownership rights and contract enforcement is fundamental to support credit expansion.

### C. Principles for effective supervision — regulatory, governance, and supervisory measures
- CBL governance and legal powers:
  - The CBL’s governance framework should be enhanced; when the board cannot be convened, decisions outside the governance structure should be necessity-based, clearly identified, and transparently disclosed.
  - Introduce alternative governance arrangements (e.g., internal consultative committees) to provide scrutiny when full board governance is impractical.
- Scope and coverage of regulation:
  - The regulatory perimeter should be expanded to include innovative financial services (Fintech) such as payment services, crowdfunding, digital assets, and E-money; regulate the activity regardless of the provider (e.g., deposit-taking, providing and arranging credit, issuing stored value, money remittance).
- Consultative rulemaking:
  - Banking laws should require the CBL to publicly consult with stakeholders (banks, finance companies, consumer groups, academia) before issuing regulations to minimize unintended consequences, allow for transition periods, and facilitate implementation.
- Legal drafting and use of regulations:
  - Some requirements currently in the banking law (fit and proper regime, criteria for auditors and collateral valuers, who can petition for inspection, corporate governance specifics) are better suited for regulations to allow easier modification as practices evolve.
- Corporate governance and fit-and-proper regime:
  - A fit and proper regime is needed to strengthen governance and compliance culture by identifying key control functions, setting minimum candidate criteria, and specifying the CBL’s approval and review process.
  - CBL regulation number 6/22 is a significant step, but refinements are recommended, including:
    - Requiring candidates to pass regulatory interviews.
    - Requiring exit interviews for departing officers.
    - Affording protection from unfair dismissal when acting in good faith.
    - Granting the CBL power to sanction authorized individuals for misconduct, including imposing bans on holding office at regulated financial institutions.

*Source: LIBYA — BANKING SECTOR REFORM: A ROADMAP (May 5, 2023)*

### 22.      A fit and proper regime should also apply to banks’ controllers. CBL approval should

### 1lbyea2023002 - 22.      A fit and proper regime should also apply to banks’ controllers. CBL approval should

### Fit and proper regime for controllers
- CBL approval should be required for legal or natural persons seeking to hold a controlling interest in a regulated financial institution.
- A fit and proper controllers’ regime is a prerequisite for public banks’ divestment and is likely to:
  - ensure new owners promote good governance,
  - hold management accountable,
  - effectively monitor performance,
  - ensure criminal groups do not control financial institutions and engage in money laundering activities.

### CBL ownership and temporary safeguards
- Until the CBL can relinquish ownership of banks, it should establish internal safeguards to limit conflicts of interest between ownership and supervision.
- Possible measures:
  - Assess a public bank’s board from two separate perspectives—investor (focus: maximizing return and shareholder wealth) and supervisor (focus: risk appetite and governance).
  - Strict internal separation within the CBL between functions overseeing investments and banking supervision.
  - Establish and observe guidelines on appointing and dismissing banks’ board members.

### Strengthening bank governance and management committees
- Minimum committee structure recommended for every bank:
  - An executive committee comprising senior executives.
  - Committees for credit risk (CRCO), assets and liabilities management (ALCO), operational risk (OPCO), compliance and legal risk.
- Rationale and issues:
  - Comprehensive management committee structure facilitates implementation of board strategy, creates accountability, and reduces corruption.
  - CBL regulation 10/2022 requires banks to establish an ALCO, but:
    - The specified functions and mandate are described as too broad.
    - ALCO membership includes the chairman of the board, which may blur the line between daily risk management and board oversight.
- Requirements for committees:
  - Clear and manageable terms of reference.
  - A set of periodic reporting requirements.
  - A mechanism to track implementation of decisions.

### Internal and external reporting, financial statements
- Develop comprehensive internal management information to enable board and management to track strategy implementation, performance, and risk exposure.
- CBL should periodically review information received by management for coverage, quality, and usefulness for decision making.
- Data reporting to the CBL should be in a format that is easy to aggregate and analyze to assist risk assessment at individual banks and system-wide.
- Recommendation on financial statements publication:
  - The requirement for the general assembly to approve financial statements delays publication and should be replaced with board approval.
  - Banks should be required to publish unaudited interim statements.

### Modern bank reporting system and phased rollout
- CBL has set up a task force to automate and modernize bank reporting; progress on module design and system development has been made.
- To limit administrative burden and ensure necessary data collection:
  - The task force should consult widely with CBL data users and bank representatives.
  - Adopt a gradual roll-out that prioritizes critical modules (example critical modules: capital, liquidity, and credit).
  - Phased development of analytic capabilities and fine-tuning of existing modules before adding new ones.

### Capital, asset quality, and recapitalization needs
- Capital adequacy and exposures:
  - Banking sector shows a Basel I capital adequacy ratio of around 16 percent at face value, but this reflects deficiencies in asset impairment recognition and provisioning.
  - Over 60 percent of banks’ assets are exposures to the CBL with no capital requirements.
  - If banks shift exposures from the CBL (zero risk weighted) to private sector borrowers (positive risk weights), new assets will consume capital quickly.
  - The 2021 devaluation of the LYD increased the LYD value of foreign currency‑denominated exposures and caused some banks to breach large exposure limits.
- Non-performing loans (NPLs):
  - Since 2011, NPLs have been estimated at around 20 percent of total loans and cannot be accurately measured due to conflict and political instability; true NPLs are likely much higher.
  - Banks are likely under‑provisioned and capital adequacy is likely overstated.
  - CBL actions recommended:
    - Request banks undertake an asset quality review against set NPL criteria.
    - Establish actual capital position.
    - Develop recapitalization plans (options include bank mergers, profit retention, and capital infusion).
  - Accurate balance sheets are imperative to support credit growth and facilitate eventual divestment of CBL interests.

### Use of Basel II pillar II and capital add‑ons
- CBL issued circular 9/2022 in October 2022, giving banks three months to implement guidance on Basel II pillar II.
  - Requires banks to conduct an Internal Capital Adequacy Assessment Process (ICAAP) and submit results for regulatory review.
- As part of ICAAP supervisory review and evaluation process (SREP), CBL should apply a capital add-on to banks with risks not fully reflected in Basel pillar I capital (examples: concentration and liquidity risks).
- Pillar II capital add-on can be used to influence bank behavior and risk taking (examples: underinvestment in technology, weak governance, deficiency in AML and CFT controls).

### Credit underwriting, rating, and information sharing
- Strengthen credit underwriting framework:
  - Require banks to adopt a credit risk appetite, clear underwriting criteria, exposure limits, and necessary controls.
  - Use capital add-ons under Basel II pillar II where underwriting standards are deficient.
- Asset credit quality assessment:
  - Banks should periodically assess credit quality, identify signs of delinquency, and assign credit ratings commensurate with likelihood of default.
  - Supervisors should evaluate rating methodology and implementation and take corrective measures.
- Reporting and information sharing:
  - Banks should report loan portfolios rated under standardized criteria to the CBL and credit information center.
  - Granular reporting of large credit exposures helps identify concentration risk and assign appropriate Basel II pillar II capital add-ons.
  - Improved credit information and stress testing enable vulnerability identification.

### Liquidity management
- Issues:
  - After abolishing interest rates in 2013, CBL did not introduce Islamic instruments and the interbank market did not develop.
  - Banks have no avenue to place excess liquidity; funds remain in CBL settlement accounts.
- Recommendations:
  - Introduce liquidity management instruments tailored to Islamic banks.
  - Issue liquidity regulation in line with BCBS Basel III to limit banks’ liquidity and funding risk.
  - Set minimum criteria for sound liquidity risk management at banks.
  - Importance:
    - Critical when credit growth picks up and banks view excess liquidity at CBL as a cost.
    - Increases CBL’s ability to conduct monetary policy.

### Operational risk, technology, and AML/CFT
- Operational risk environment and mitigation:
  - Libya’s difficult environment (fragile security, inefficient legal system, weak rule of law) gives rise to operational risks including AML/CFT, fraud, physical damage to branches and ATMs.
  - Internet and mobile banking can reduce need to protect physical assets and increase security and traceability.
  - AML/CFT screening and investigation software, and automation of back‑office functions, can reduce AML/CFT risk and human errors.
  - CBL should introduce comprehensive operational risk requirements, possibly including specific system and user functionality requirements.
- AML/CFT supervision and FIU resources:
  - The very low number—113 in 2022—of suspicious activity reports (SARs) to the Financial Intelligence Unit (FIU) indicates weak AML/CFT controls at banks.
  - Backlog of SARs implies inadequate FIU resources and systems to investigate and resolve suspicious transactions.
  - Recommendations:
    - CBL should ensure full implementation of AML/CFT regulations and address control failures at banks.
    - FIU should update systems and processes and increase resources to handle existing SAR filings and an expected rise in filings as banks improve controls.
- Domestic and international cooperation:
  - FIU has 12 memorandums of understanding with domestic authorities and 7 with international counterparts.
  - Domestic exchange of information and coordination across law enforcement, customs, and FIU are vital for effective investigations and prosecution.
  - International cooperation with other FIUs increases confidence in Libya’s financial system and deters money laundering syndicates.
  - Formal communication channels should be established to handle higher SAR volumes and more complex investigations.

### Conclusions and prioritized recommendations (high/medium/low)
- Success of financial sector reforms depends on political and social stability and addressing gaps in BCBS prerequisites and principles, including central bank unification.
- Selected prioritized recommendations (priority label preserved as in source):
  - Structural
    - Unification of the CBL — High.
    - Banks’ disclosure — High.
    - Property registry — High.
  - Macroprudential Framework
    - Macroprudential framework — Medium.
    - Gradual easing of CFMs/MPMs — Medium.
    - Frameworks for crisis management, recovery, and resolution — Low.
  - Banking Law
    - Establish a financial stability committee (FSC) — High.
    - Islamic finance only or conventional and Islamic dual system — High.
    - Requirement to consult on new regulations — High.
    - Expand financial services coverage — Medium.
    - Streamline and reduce complexity — Low.
  - Governance
    - CBL - Establish alternative temporary governance arrangement — High.
    - CBL - Public ownership of banks — High (apply strict separation between ownership and supervision until divestment).
    - Divestment of CBL ownership — Medium.
    - Fit and proper — High (apply to controllers; CBL approval and sanction powers; include interviews).
    - Bank reporting system — High (gradual roll out aligned with new regulations).
    - Governance review and supervision — Medium.
  - Credit
    - Islamic products — High.
    - Credit underwriting — High.
    - Credit information center improvements — Medium.
  - Liquidity
    - Islamic liquidity management tools — High.
    - Liquidity management at banks — Medium.
    - Liquidity quantitative requirements (Basel III LCR and NSFR) — Medium.
  - Capital and Asset quality
    - Recapitalization of banks — High.
    - Past due and NPLs identification, reporting and provisioning — High.
    - Pillar II capital add-on — Medium.
  - Operational risk
    - Improve technology adoption in the banking sector — Medium.
  - AML/CFT
    - Enhance AML/CFT supervision — High.
    - FIU automation and resources — High.
    - Strengthen domestic and international cooperation — High.

*Source: IMF country report content (LIBYA).*

### Annex I. Select BCBS Sound Principals

### Annex I. Select BCBS Sound Principals

### Supervisory responsibilities, powers, and independence
- Principle 1 – Responsibilities, objectives and powers: An effective system of banking supervision has clear responsibilities and objectives for each authority involved in the supervision of banks and banking groups. A suitable legal framework for banking supervision is in place to provide each responsible authority with the necessary legal powers to authorize banks, conduct ongoing supervision, address compliance with laws and undertake timely corrective actions to address safety and soundness concerns.
- Principle 2 – Independence, accountability, resourcing and legal protection for supervisors: The supervisor possesses operational independence, transparent processes, sound governance, budgetary processes that do not undermine autonomy and adequate resources and is accountable for the discharge of its duties and use of its resources. The legal framework for banking supervision includes legal protection for the supervisor.
- Principle 5 – Licensing criteria: The licensing authority has the power to set criteria and reject applications for establishments that do not meet the criteria. At a minimum, the licensing process consists of an assessment of the ownership structure and governance (including the fitness and propriety of Board members and senior management) of the bank and its wider group, and its strategic and operating plan, internal controls, risk management and projected financial condition (including capital base). Where the proposed owner or parent organisation is a foreign bank, the prior consent of its home supervisor is obtained.
- Principle 11 – Corrective and sanctioning powers of supervisors: The supervisor acts at an early stage to address unsafe and unsound practices or activities that could pose risks to banks or to the banking system. The supervisor has at its disposal an adequate range of supervisory tools to bring about timely corrective actions. This includes the ability to revoke the banking license or to recommend its revocation.

### Permissible activities and licensing
- Principle 4 – Permissible activities: The permissible activities of institutions that are licensed and subject to supervision as banks are clearly defined and the use of the word “bank” in names is controlled.

### Reporting, problem assets, and provisioning
- Principle 10 – Supervisory reporting: The supervisor collects, reviews and analyses prudential reports and statistical returns from banks on both a solo and a consolidated basis, and independently verifies these reports through either on-site examinations or use of external experts.
- Principle 18 – Problem assets, provisions, and reserves: The supervisor determines that banks have adequate policies and processes for the early identification and management of problem assets, and the maintenance of adequate provisions and reserves.

### Capital, credit risk, liquidity, and operational risk
- Principle 16 – Capital adequacy: The supervisor sets prudent and appropriate capital adequacy requirements for banks that reflect the risks undertaken by, and presented by, a bank in the context of the markets and macroeconomic conditions in which it operates. The supervisor defines the components of capital, bearing in mind their ability to absorb losses. At least for internationally active banks, capital requirements are not less than the applicable Basel standards.
- Principle 17 – Credit risk: The supervisor determines that banks have an adequate credit risk management process that takes into account their risk appetite, risk profile and market and macroeconomic conditions. This includes prudent policies and processes to identify, measure, evaluate, monitor, report and control or mitigate credit risk (including counterparty credit risk) on a timely basis. The full credit 12 Core Principles for Effective Banking Supervision lifecycle is covered including credit underwriting, credit evaluation, and the ongoing management of the bank’s loan and investment portfolios.
- Principle 24 – Liquidity risk: The supervisor sets prudent and appropriate liquidity requirements for banks that reflect the liquidity needs of the bank. The supervisor determines that banks have a strategy that enables prudent management of liquidity risk and compliance with liquidity requirements. The strategy takes into account the bank’s risk profile as well as market and macroeconomic conditions and includes prudent policies and processes, consistent with the bank’s risk appetite, to identify, measure, evaluate, monitor, report and control or mitigate liquidity risk over an appropriate set of time horizons. At least for internationally active banks, liquidity requirements are not lower than the applicable Basel standards.
- Principle 25 – Operational risk: The supervisor determines that banks have an adequate operational risk management framework that takes into account their risk appetite, risk profile and market and macroeconomic conditions. This includes prudent policies and processes to identify, assess, evaluate, monitor, report and control or mitigate operational risk on a timely basis.

### Internal control, audit, and abuse prevention
- Principle 26 – Internal control and audit: The supervisor determines that banks have adequate internal control frameworks to establish and maintain a properly controlled operating environment for the conduct of their business taking into account their risk profile. These include clear arrangements for delegating authority and responsibility; separation of the functions that involve committing the bank, paying away its funds, and accounting for its assets and liabilities; reconciliation of these processes; safeguarding the bank’s assets; and appropriate independent internal audit and compliance functions to test adherence to these controls as well as applicable laws and regulations.
- Principle 29 – Abuse of financial services: The supervisor determines that banks have adequate policies and processes, including strict customer due diligence rules to promote high ethical and professional standards in the financial sector and prevent the bank from being used, intentionally or unintentionally, for criminal activities.

*Annex I. Select BCBS Sound Principals*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1lbyea2023002.pdf_