Upon mild liver injury, new hepatocytes originate from preexisting hepatocytes. However, if hepatocyte proliferation is impaired, a manifestation of severe liver injury, biliary epithelial cells (BECs) contribute to new hepatocytes through BEC dedifferentiation into liver progenitor cells (LPCs), also termed oval cells or hepatoblast‐like cells (HB‐LCs), and subsequent differentiation into hepatocytes. Despite the identification of several factors regulating BEC dedifferentiation and activation, little is known about factors involved in the regulation of LPC differentiation into hepatocytes during liver regeneration. Using a zebrafish model of near‐complete hepatocyte ablation, we show that bone morphogenetic protein (Bmp) signaling is required for BEC conversion to hepatocytes, particularly for LPC differentiation into hepatocytes. We found that severe liver injury led to the up‐regulation of genes involved in Bmp signaling, including smad5, tbx2b, and id2a, in the liver. Bmp suppression did not block BEC dedifferentiation into HB‐LCs; however, the differentiation of HB‐LCs into hepatocytes was impaired due to the maintenance of HB‐LCs in an undifferentiated state. Later Bmp suppression did not affect HB‐LC differentiation but increased BEC number through proliferation. Notably, smad5, tbx2b, and id2a mutants exhibited similar liver regeneration defects as those observed in Bmp‐suppressed livers. Moreover, BMP2 addition promoted the differentiation of a murine LPC line into hepatocytes in vitro. Conclusions: Bmp signaling regulates BEC‐driven liver regeneration through smad5, tbx2b, and id2a: it regulates HB‐LC differentiation into hepatocytes through tbx2b and BEC proliferation through id2a; our findings provide insights into promoting innate liver regeneration as a novel therapy. (Hepatology 2017;66:1616–1630).