Libya's civil war devastated its economy and banking system. But the revolution has created conditions for strong growth of an industry which made little headway under Gaddafi - Islamic finance.

Announcing the country's liberation to a cheering crowd in Benghazi last week, the head of the new government made few concrete pledges of economic policy. But one of them was to promote Islamic finance, which prohibits the lending of money for interest and other practices violating religious principles.

"We as a Muslim nation have taken Islamic sharia as the source of legislation, therefore any law that contradicts the principles of Islam is legally nullified," said National Transitional Council chief Mustafa Abdel Jalil. "We are working to establish Islamic banks that are far from interest."

He added, "There is a righteous intention to purify all of the financial laws. Perhaps in the future, all financial interest will be cancelled in accordance with Islamic law."

A blanket ban on conventional banking in Libya remains unlikely, bankers and financial experts say. The council wants to develop ties with the Western nations which aided it in the civil war and has pledged to respect their business interests.

Ultimately, the council may not have the authority to make permanent decisions about the shape of the country's financial system; these may only be made after parliamentary elections, which could be a year or more away under rules drawn up by the revolutionary forces.

"I don't see Libya departing in a massive way from the international financial system," said Sheikh Muddassir Siddiqui, sharia scholar and partner at law firm SNR Denton in Dubai.

"There is no need to reinvent the wheel. My own feeling is that they will continue for a period of time with existing laws and not upset existing contracts or treaties."

Still, experts say Libya is fertile ground for Islamic finance to take root -- partly because of the underdeveloped state of the financial system under Gaddafi.

Seventeen banks operated in Gaddafi's Libya but the system was dominated by four banks that were either state-owned or majority held by Libya's central bank. Western banks' presence mostly amounted to a handful of representative offices.

Most ordinary Libyans did not use credit cards and their banking services were largely limited to basic cash deposits and withdrawals -- making it easier for Gaddafi to keep control over the economy and society.

While Gaddafi publicly denounced the payment of interest, he did not support the development of Islamic banking in the country, analysts said. Financing for projects was largely conducted through the government or one its banking entities on a cash or bartership basis, said Ibrahim Zahaf, chief executive of Islamic finance consultancy Amanie North Africa.

"This is a society that hates credit, hates anything interest-bearing and has generally run on a cash culture," he said.

That gives Islamic finance a chance to be in on the ground floor as Libya builds a modern banking system, instead of developing as an adjunct to a sophisticated conventional banking industry as it has in most countries.

"There is going to be a process of starting from scratch, what we call the year zero syndrome," said David Butter, Middle East regional director at Economist Intelligence Unit in London.

"We'll definitely see growth in Islamic banking because there is a strong Islamist element to Libyan society and politics. But I think a parallel system with conventional finance is more likely."

Before Gaddafi's ouster there were initial steps towards establishing Islamic finance in Libya. The central bank allowed sharia-compliant branches to open, but these met tacit political opposition from within the regime. For example, Qatar Islamic Bank applied for a foreign banking licence last year but lost out to Italy's Unicredit SpA , a conventional institution in which Libya held a 7.5 percent stake.

Qatar's strong support of the Libyan rebels looks likely to aid QIB's cause going forward. Meanwhile, other Islamic institutions are keen on exploring opportunities in the country. One is Bahrain's Al Baraka Bank , which applied to open a representative office in Libya before the uprising.

"Under the new government, we hope that we can process our expansion (in Libya) a little bit faster. We are going for a full retail bank there. We hope that it can be done next year," Al Baraka's chief executive Adnan Ahmed Yousif told Reuters.

Standard Chartered , which bid unsuccessfully for a foreign bank licence in Libya last year, is also interested in the country. With its Islamic arm Standard Chartered Saadiq, it could potentially enter the conventional or Islamic banking markets there, or both.

"Once it stabilises we'll probably go. Libya long-term could be an attractive market, but in the short term we need to see how civil society and governance turns out. Until law, order and peace is restored, we would not want to put our staff in harm's way," said V. Shankar, Standard Chartered's chief executive for the Middle East, Africa, the Americas and Europe.

Creating a legal framework for Islamic finance in Libya could take longer than developing a conventional banking system, because of the need to consult scholars and choose between competing sharia-compliant practices.

Globally, many Islamic financial institutions look towards guidelines set by the Bahrain-based Accounting and Auditing Organization for Islamic Financial Insitutions in structuring deals and practices. But countries' interpretations of the guidelines vary, from Saudi Arabia's relatively strict approach to Malaysia's liberal stance.

It is still unclear which model Libya will adopt. The Malaysian one is generally considered more sophisticated and fully developed, and could make sense for Libya if it wanted to promote ties with Asian markets such as Malaysia and Indonesia.

The Saudi model could make sense because of geographical proximity to the Gulf, and if Libya wanted access to Saudi Arabia's huge pool of funds seeking sharia-compliant investments.

But the desire to attract foreign funds may not be a major factor in Libyan thinking, because the country is already expected to have plenty of money in the form of tens of billions of dollars placed abroad by the Gaddafi regime.

Amanie's Zahaf said there would be scope to start small in Libya, with local banks supplying the market with sharia-compliant services over the next two or three years. His own consulting firm plans to reopen the Tripoli office which it established just before the uprising.

"We have been approached for advice by some regulators in Libya and some big families but not on an official level yet," he said. "We are extremely positive about playing a role in developing Islamic finance in the region. Libya is our first intention on the radar," he added.-Reuters