Cenbank moves to enhance banks’ shock-absorbing capacity

Highlights

• New standard to enhance credit-loss provisioning
• To boost transparency and confidence in banks' financial reporting
• It will align with global financial reporting norms
• Cenbank moves to enhance banks' shock-absorbing capacity

The Bangladesh Bank is set to enhance loan provisioning and shock-absorbing capacity in the banking sector by implementing a new provisioning system aligned with international best practices.

The central bank today (23 January) issued a circular stating that by 2027, banks will follow the International Financial Reporting Standard 9 (IFRS 9) method for loan provisioning under which banks will follow an Expected Credit Loss methodology-based provisioning system.

At present, banks are following a rule-based loan classification and provisioning system.

Bankers say the new standard will enhance credit-loss provisioning, transparency and confidence in banks' financial reporting. It will also align with global financial reporting norms, they say.

Bangladesh Bank Assistant Spokesperson Mohammad Shahriar Siddiqui told TBS, "Currently, we use rule-based provisioning when a loan defaults. According to this system, if a loan is regular, 1% provisioning is required against it. However, when it becomes classified, provisioning is done in stages ranging from 25% to 100%."

When transitioned to international best practices by 2027, the probability of default for a loan will be measured in advance, he said.

"This is a dynamic process. As a result, the strength of banks will increase, their shock-absorbing capacity will improve, and provisioning will no longer put additional pressure on bank capital," explained Shahriar.

Under the current system, if a loan is suddenly classified, the provisioning requirement increases significantly, he said. "As a result, banks often fail to meet the requirement and have to seek provision deferrals from the central bank."

Regarding the central bank's move, the managing director of a private bank told this newspaper, "It is a positive step that the central bank will implement loan provisioning following international practices. However, this will lead to an increase in both provisioning requirements and the volume of classified loans."

He further said, "Currently, banks are facing a liquidity crisis. If classified loans increase while implementing international practices, it could create challenges in conducting transactions with foreign banks."

Several South Asian countries, including India, Pakistan, and Sri Lanka, have partially implemented IFRS 9, while countries such as Australia, Canada, member states of the European Union, Japan, New Zealand, Singapore, the United Kingdom and the United States have fully implemented it.

A central bank official said, "The roadmap we have outlined for IFRS-9 requires banks to make their boards aware of it by March. They will prepare themselves and develop their capacity. 

"The central bank will also work on capacity building. After that, we will issue guidelines, conduct trial runs, move to parallel runs, and eventually replace the existing systems."

Now as per the Bangladesh bank master circular on loan classification and provision, if all types of loans are standard, the bank will maintain a 1% provision on the loan outstanding. If the loan is classified as SMA, a 5% provision will be made against the loan outstanding. 

Additionally, if the loan is sub-standard, a 20% provision will be required. If it is classified as doubtful, a 50% provision will be made, and if it is classified as bad/loss, a 100% provision will be made.

All types of loans will be classified as non-performing after three months of being overdue – instead of the current six months – effective from April 2025, as the central bank aligns the rule with international best practices under Basel III.