Banks to make provisions for potential bad loans from 2028

Banks will have to keep provisions for potential losses before loans turn bad, from January 2028, according to a directive given by Bangladesh Bank (BB), which aims to enable lenders to detect the risk of credit deterioration in advance and enhance transparency in financial reporting.

To identify potential loan losses, banks will be required to classify loans based on a global standard -- the International Financial Reporting Standard 9 (IFRS 9). It specifies how an entity should classify and measure financial assets, financial liabilities and some contracts to buy or sell non-financial items.

In a circular yesterday, BB introduced guidelines for the loan loss framework based on IFRS 9.

Under the guidelines, banks will be required to apply the IFRS 9-based Expected Credit Loss (ECL) model to funded and non-funded credit facilities from January 1, 2028. The system will later be extended to other financial instruments from January 1, 2029.

Under the new framework, loans will be classified into three stages based on changes in credit risk: performing loans (Stage 1), loans with a significant increase in risk (Stage 2), and credit-impaired loans (Stage 3).

Provisions will be calculated based on either 12-month or lifetime expected credit losses, depending on the stage. A provision against loans is an expense set aside by banks from their earnings to cover anticipated losses from unpaid or defaulted loans.

The new rules will also extend provisioning requirements to off-balance-sheet exposures such as loan commitments, bank guarantees and unused credit lines, enabling banks to assess risks more comprehensively.

Currently, banks follow a rule-based loan classification and provisioning system, which relies on the “incurred-loss” approach -- where provisions are typically made after loans show clear signs of deterioration.

The IFRS 9 framework will shift the system to a forward-looking model, requiring banks to estimate potential credit losses in advance rather than waiting for borrowers to default.

Lenders will also have to account for macroeconomic indicators such as economic growth, inflation and interest rate trends when assessing credit risk.

Banks will need to upgrade their data infrastructure and risk-modelling systems to implement the framework, while the central bank will provide regulatory guidance and supervisory support to ensure a smooth transition, central bank officials said.

Industry insiders said that the successful implementation of IFRS 9 would make the banking sector more resilient and attractive to foreign investors by strengthening international confidence.