Bangladesh Bank plans ECL system to strengthen banking risk management

Bangladesh Bank has taken the initiative to introduce the Expected Credit Loss (ECL) method to align the country's banking sector risk management and financial reporting standards with international practices.

Once implemented under International Financial Reporting Standard (IFRS) 9, the new method will bring major changes to banks' loan classification and provisioning system.

Under the framework, banks will have to set aside provisions for potential losses before a loan turns bad. The new system will come into effect from 2028. Bangladesh Bank issued a guideline in this regard today (8 March).

At present, banks in Bangladesh classify loans and maintain provisions based on an incurred loss model. But under IFRS 9, banks will be required to keep advance provisions based on forecasts of possible credit losses.

In assessing loan risk, banks will have to consider not only past data but also the current economic situation and future macroeconomic forecasts, such as GDP growth, interest rates and inflation.

A senior Bangladesh Bank official said, "Under the current system, provisions are made only after a loan becomes bad. But under the new method, banks will have to set aside provisions in advance by considering the potential risks of loans and the broader macroeconomic situation. As a result, if a loan turns non-performing, banks will not have to bear the entire provisioning pressure at once. This will also strengthen banks' capital management."

"Considering the current condition of the banking sector, banks will be given an additional five years from 2028 to adjust their capital. This will help keep potential capital pressure at a manageable level. If the new system reduces a bank's capital, there will also be an opportunity to gradually replenish it at a specified rate," he added.

According to the guideline, loans will be classified into three stages under IFRS 9.

In the first stage, provisions for performing loans will be determined on the basis of expected losses over the next 12 months.

In the second stage, if the credit risk of a loan increases significantly, banks will have to maintain provisions based on expected losses over the loan's entire lifetime.

In the third stage, for credit-impaired loans, provisions will have to be maintained based on expected losses over the full term of the loan.

Changes are also being introduced to the recognition of interest income. Under the new framework, interest income will be calculated based on the level of credit risk, allowing a more realistic reflection of banks' actual income and risk profile.

"In 2020, the Financial Reporting Council Bangladesh issued a notification to implement such standards. However, the Bangladesh Bank had not issued any comprehensive guideline on the matter until now," the official said.

"With the issuance of the new guideline, the path has been formally created for implementing the system. Several South Asian countries have already fully implemented this method," he added.