The Bangladesh Bank has decided to adopt a forward-looking approach to provisioning for loan losses, requiring banks to set aside money for potential losses before loans become overdue or default.
Under this new system, banks will estimate possible losses over the entire life of a loan. The change, aligned with international financial reporting standards, will take effect in 2027.
The central bank issued a circular in this regard outlining road map on the matter.
The move aims to improve risk management and financial reporting transparency in the banking sector.
Currently, banks in Bangladesh follow a rule-based system for loan classification and provisioning, which categorises loans as unclassified, substandard, doubtful or bad, based on overdue periods, BB officials said.
Provisions are then set aside accordingly, using the traditional incurred-loss model. This model recognises credit losses only after clear evidence of impairment, often delaying recognition until significant damage has already occurred, they said.
The new system, called expected credit loss (ECL) model, will require banks to estimate potential credit losses over the lifetime of a loan or financial instrument, they added.
Unlike the incurred-loss model, the ECL model incorporates forward-looking information, including macroeconomic factors like GDP growth, inflation and sector-specific risks, to assess credit risks more proactively, they clarified.
The officials believed that the transition to the ECL model would strengthen the sector鈥檚 resilience by identifying risks earlier and enabling more accurate loss recognition.
This shift will help banks better absorb financial shocks and improve overall financial stability.
However, implementing the ECL model will involve significant adjustments, including upgrading IT systems, adopting advanced risk management practices and investing in workforce training.
The central bank鈥檚 roadmap instructed banks to prepare by reviewing internal systems, updating accounting practices and building institutional capacity.
An 鈥業FRS 9 Implementation Team,鈥� led by the managing director or chief executive officer of each bank, will oversee compliance, manage historical credit data and liaise with the central bank during the implementation process, it said.
Banks are also required to automate and enhance IT systems to support the new model, it said.
While higher provisioning requirements under the ECL model may impact short-term profitability, the long-term benefits are expected to outweigh the initial costs, bankers said.
They anticipated challenges, including significant expenses for system upgrades and data quality improvements.
Additionally, the shift from a rule-based to a principles-based approach will require cultural and operational changes across the sector.