Bangladesh Bank Tightens Oversight on Loan Classification and Provisioning

In a significant move to strengthen the financial sector, Bangladesh Bank has issued a new directive requiring all scheduled banks to reclassify their loans and maintain higher provisions by the end of the current quarter. The central bank’s latest circular, released on Wednesday, aims to address rising non-performing loans (NPLs) and align with international best practices under the Basel III framework.

The directive mandates that banks classify loans based on the number of days overdue, with stricter criteria for substandard, doubtful, and bad loans. For example, a loan overdue for more than 90 days will now be automatically classified as substandard, down from the previous 180-day threshold. This change is expected to increase the reported NPL ratio across the banking sector, which currently stands at around 8.5%, but could rise to over 12% after reclassification, according to industry analysts.

Banks have been given until March 31 to complete the reclassification and adjust their provisioning levels accordingly. For general provisions, banks must set aside 1% of unclassified loans, while substandard loans require 20%, doubtful loans 50%, and bad loans 100%. The central bank has warned that failure to comply will result in penalties, including restrictions on dividend distribution and new lending.

The move comes amid growing concerns over asset quality in Bangladesh’s banking sector, which has been plagued by political interference, weak governance, and a backlog of defaulted loans. In recent months, several state-owned banks have reported capital shortfalls, prompting the government to inject billions of taka to shore up their balance sheets. Private banks, while generally healthier, have also faced pressure from rising defaults in the garment and real estate sectors.

Economists have welcomed the directive, calling it a necessary step to restore confidence in the banking system. Dr. Zahid Hussain, a former lead economist at the World Bank’s Dhaka office, noted that ‘transparency in loan classification is the first step toward addressing the NPL problem. Without accurate data, it is impossible to assess the true health of banks or implement effective reforms.’ However, some bankers have expressed concern about the short-term impact on profitability, as higher provisions will eat into earnings.

To ease the transition, Bangladesh Bank has allowed banks to spread the additional provisioning requirement over two quarters, but only for loans that are reclassified as substandard or below. Additionally, banks can use their general reserves to cover part of the shortfall, subject to central bank approval.

The directive also includes measures to improve loan recovery. Banks are now required to form special asset management units to handle NPLs and report progress monthly. The central bank has also set up a dedicated monitoring cell to track compliance.

On the international front, the move aligns with global trends, as regulators in India, Pakistan, and other emerging economies have recently tightened NPL norms. The International Monetary Fund, in its latest Article IV consultation with Bangladesh, had urged the authorities to accelerate cleanup of bank balance sheets and strengthen supervision.

While the immediate effect may be a spike in reported NPLs, the long-term goal is to create a healthier banking environment that can support Bangladesh’s ambitious growth targets. As the country aims to become a middle-income nation by 2031, a robust financial system is critical to channel savings into productive investments.

Industry observers will be watching closely to see how banks respond, particularly state-owned lenders that have the highest NPL ratios. The central bank has signaled that it will not hesitate to take corrective actions, including replacing management, if banks fail to meet the new standards. For now, the message is clear: transparency and discipline are no longer optional in Bangladesh’s banking sector.