Statutory Branch Audit of Banks

1
Statutory Branch Audit of Banks

• Radhesh L. Bhat
• Partner

2
Topics covered......

1. General
2. Verification of Advances
3. Income Recognition Asset Classification norms
   of RBI
4. Long Form Audit Report (LFAR)

3
General
4
Knowledge of bank business (SA 310)

• Obtain a level of knowledge of bank business to
  enable to identify the events, transactions and
  practices that may have significant effect on the
  financial information
• Sources of Information
• Banks annual report to shareholders
• Internal financial management reports for current
  and previous periods including budget if any
• Previous year audit working papers
• Discussion with and Letters seeking Information
  from bank branch Manager
• Bank policy and procedures manual

5
Transactions in a Branch..

• Deposits account
• 1. Savings Account
• 2. Current Account
• 3. Fixed Deposit Account

6
Transactions in a Bank

• Loan accounts - Funded Non Funded
• Funded (INR/FC)
• 1. Term Loans
• 2. Cash Credits/Overdrafts (working capital
  Loans)
• 3.Bill Discounting
• Packing credit loans (working capital)

7
Transactions in a Bank

• Loan accounts Unfunded
• 1. Letter of Credit (L/C)
• 2. Bank Guarantees (BG)
• Total advance (exposure) includes funded
  unfunded

8
Transactions in a Bank

• Accounting

Cash
Clearing
Transfer
9
Letter seeking information

• Before actual commencement of audit a letter may
  be written to the management of bank asking for
  following information
• 1. Basic information about the bank/branch and
  its operations
• 2. Copies of last year statutory audit
  report/comments
• 3. Copy of concurrent/inspection/IS audit/revenue
  audit reports
• 4. Information of top n borrowers for each
  kinds of loans/deposits
• 5. Instructions issued by Head office for closing
  of accounts
• 6. Exception reports generated by the software

10
Other matters

• Internal control system in CBS environment
• Large volume of transactions
• Risk involved, including possibility of frauds
• Applicability of laws
• Audit Planning and Programme

11
What is CBS environment?
Mobile Banking
Branch
Central Server
Credit card
Back office
Net banking
ATM
12

• Questions ???

13

• Verification of Advances

14
Classification of Advances

• Three ways of classification of advances in
  balance sheet as schedule 9 of banking regulation
  act ,1949
• A) Classification by nature
• i)Bills purchased and discounted
• ii)Cash credits, overdrafts and loans repayable
  on demand
• iii)Term loans
• B) Classification by security
• i)Secured by tangible assets     

15
Classification of Advances

• ii) Covered by bank/ government guarantees
• iii) Unsecured
• C) Classification by location
• I. Advance in India      (i) Priority
  sector      (ii) Public sector      (iii)
  Banks      (iv) Others

16
Classification of Advances

• II. Advances outside India    (i) Due from
  banks    (ii) Due from others        (a) Bills
  purchased and discounted        (b) Syndicated
  loans        (c) Others

17
Audit Procedures

• 1.   Inspection
• 2.   Observation
• 3.   Inquiry confirmation
• 4.   Computation
• 5. Analytical Procedures
• S A 500 (Audit Evidence)

18
Inspection and observations

• Inspection consists of examining records,
  documents, or tangible assets, ledger accounts
• The auditor inspects in order to
• Ensure physical existence of assets that the bank
  holds
• Obtain the necessary understanding of the terms
  and conditions of agreements (including master
  agreements)
• - Consider their enforceability and
• - Assess the appropriateness of the
  accounting treatment they have been given.

19
Verification of Advances

1. General
2. Verification of Advances against Stock Debtors
3. Verification of advances against fixed
   deposits/NSC/Gold
4. Verification of advances immovable property
5. Verification of advances against bills purchased
   and discounted

20
Verification of loans and advances (General)

• Check the individual balance in each loan ledger
  with the loan schedules/lists
• Verify the head office sanction /renewal for
  advances sanction as per appropriate authorities
• See that margins are maintained in respect of
  secured advances
• Examine that the operation of each advance is
  reviewed at least once in a year
• Documentation

21
Verification of loans and advances - General
Audit process

• Compliance of procedures ( Application ,
  Sanctioning , Disbursement , Review and
  Monitoring)
• Quality of advance ( Health , Operation
  ,Security ,Risk and risk mitigation)
• Compliance with IRAC norms
• Identification of NPA
• Disagreements with branch giving rise to MOC
• Reporting of NPA to the relevant authority

22
Audit process

• Application
• Prescribed format
• Accompanying documents (constitution, Financials,
  approvals , Project report agreements etc.)
• KYC guidelines
• Processing
• Compliance with policies and guidelines
• Appraisal (technical feasibility, economic
  viability and assessment of credit worthiness)
• Documentation of appraisal
• Review by controlling authority

23
Audit process

• Sanctioning
• Sanctioning by appropriate authority
• Sanctioning beyond the delegated authority
• Terms of sanction
• - Details of security (primary collateral)
• -Repayment Terms

24
Audit process

• Documentation (SA 230)
• legal execution of all the necessary documents as
  per terms of sanction.
• deficiencies in documentation,
• non-registration of charges,
• non-obtaining of guarantees
• Marking of lien (loan against deposit)
• Legal scrutiny- legal title
• Valuation of security
• Safe custody of documents

25
Audit process

• Disbursement
• Compliance of sanction terms
• Reporting to sanctioning authority
• End use utilization
• Review /Monitoring
• Clear understanding of procedures of the bank
• Inspection of borrowing unit
• Obtaining balance confirmation / acknowledgement
  of debts),
• Review of account operations and reporting of
  deficiencies such as frequent/ unauthorised over
  drawing beyond limits to sanctioning
  authority .

26
Audit process

• Review/ monitoring
• Submission of the stock/book debt statements /
  other operational data and financial statements,
  its scrutiny and appropriate follow up
• Stock audit (particularly stock audit of all
  borrowers exceeding Rs.5 crores)
• Inspection / physical verification of securities
  charged to the bank. Valuation by approved
  valuers of security, once in 3 years, or a
  shorter duration if so required.
• Obtaining/ review of audited (under RBI
  guidelines /other statute) accounts of
  non-corporate entities with limits above Rs.10
  lakhs
• Inadequate insurance coverage , etc
• Initiating proceedings for recovery / recalling
  as per instructions of the appropriate authority

27
Drawing Power

• Terms of sanction
• Stock of inventory/ book debts
• Paid stock
• Realisable debtors (Sanction terms)
• Random verification/comparison of stock
  statements and DP entered in the system
• Comparison with Audited statements
• Periodic inspection by branch officials
• Stock audits
• Charging of penal interest exceedings
• Reporting of exceedings

28
Drawing power -Illustration
Particulars Amount (Rs.lacs)
Inventory as per the stock statement 75
Creditors for purchases 15
Paid stock 60
Margin as per sanction-25 15
DP against stocks (A) 45
Debtors 125
Debtors more than 90 days 15
Eligible debtors 110
Margin as per sanction- 30 33
DP against debtors (B) 77
29
Areas of concern

• Sanction beyond delegated authority - Reporting
• Health of borrower
• Year end sanction to existing borrowers or group
  concerns
• Circuitous transactions
• Restructuring of advances ( evergreening)
• Year end regularisations
• Devolvement non fund based advances
• Bullet repayments
• Advances to risky sectors

30
Export credit

• Pre shipment credit (financing production cycle)
• On the basis of individual order
• Liquidated out of export proceeds only and
  normally not out of rupee funds (except where the
  raw materials required for processing exceed FOB
  value of contract in which case advance has to be
  repaid within maximum 30 days of advance)
• Post shipment (financing of bills raised on
  oversees buyer)
• Concessional rate of interest
• Export proceeds normally to be received in 180
  days (Extended to 360 days by RBI)
• Concessional rate of interest

31
Operation of the account Critical audit
procedures

• No of occasions of balance exceeding drawing
  power
• Reason for excess drawing
• Whether excess drawings are reported to
  controlling authority
• Total summation less interest , balance
• Adverse observations (concurrent / stock/
  internal /other audits / RBI inspection )

32
Verification of advances against bills purchased
and discounted Specific points

• All the outstanding bills have been taken in the
  balance sheet
• The bills must be genuine trade bills
• Verify accompanying documents
• The bills are not overdue. If there are any
  overdue bills, the auditors should ascertain the
  reasons for the delay and the action taken by the
  bank

33
End use of Funds

• In cases of project financing, banks ensure end
  use of funds by, inter alia, obtaining
  certification from the Chartered Accountants
• In case any falsification of accounts on the part
  of the borrowers is observed by banks, Banks can
  lodge a formal complaint against the auditors of
  the borrowers, with Institute of Chartered
  Accountant of India (ICAI) if it is observed that
  the auditors were negligent or deficient in
  conducting the audit to enable the ICAI to
  examine and fix accountability of the auditors

34
Diversion of Funds

• Diversion of funds would be construed to include
  any one of the under-noted occurrences
• Utilisation of short-term working capital funds
  for long-term purposes
• Deploying borrowed funds for purposes /
  activities or creation of assets other than those
  for which the loan was sanctioned
• Transferring funds to the subsidiaries / group
  companies or other corporate entities by whatever
  modalities

35
Documentation

• Compiling of information required for annexure to
  the LFAR relating to furnishing details of
  large/irregular/ critical accounts
• List of large advances i.e. those in respect of
  which the outstanding amount is in excess of 5
  of the aggregate advances of the Branch or
  Rs.2.00 crores whichever is less duly certified
  by the Branch Manager

36

• Questions ???

37
Income Recognition Asset Classification norms
of RBI

• Known as
• Prudential Norms

38
Income Recognition

• Income from NPA is recognised on realisation.(
  not on accrual basis concept of uncertainty)
• On becoming NPA income recognised, but not
  actually realised is to be reversed
• Processing fee on sanction/renewal is recognised
  on accrual basis (still concept of uncertainty
  applies)
• BG commission/ income from bills discounting, etc
  are recognised over the period of the
  guarantee/tenure of the instrument

39
Appropriation of recovery in NPAs

• Interest realised on NPAs may be taken to income
  if they are not out of fresh/ additional credit
  facilities sanctioned.
• In the absence of a clear agreement, the banks
  has exercise the right of appropriation of
  recoveries and account the same in a uniform and
  consistent manner.
•  Interest Application
• Interest on NPA can be accounted by credit
  to Interest Suspense Account ( not to income
  account) or such other proforma accounts.

40
What is a Non Performing asset?

• Ceases to generate income (RBI Master Circular)
• 90 days over due norm
• Over due if not paid on due date fixed by Bank
• Out of order
• Continuously in excess of sanctioned limits /
  drawing power
• No credits continuously for 90 days (as on the
  date of balance sheet) or credits not sufficient
  to cover the interest debited during the same
  period

41
NPA various type of facilities
Facility Criteria
Term Loan Interest and or principal remain overdue for more than 90 days
Cash credit and over draft Account is out of order
Bills purchased or discounted Overdue and unpaid for more than 90 days
Securitisation The amount of liquidity facility remains outstanding for more than 90 days
Direct Agricultural Advances (as listed in master circular) Short duration crop(( crop season less than one year)- Instalment and or interest remain overdue for two crop seasons Long duration crop( crop season more than one year)- Instalment and or interest remain overdue for one crop seasons As determined by state level bankers committee for each state
42

• Questions ???

43
Categories of NPAs
Category Basis Remarks
Substandard Assets NPA upto 12 months Possibility of sustaining some loss, if deficiencies are not corrected
Doubtful Assets Substandard for a period exceeding 12 months Recovery, is questionable/ not probable
Loss Assets Where loss is identified by the bank / or the RBI inspection To be written off or fully provided
44
Questions ???

• radhesh_at_varmaandvarma.com

45
Guidelines for classification

• Loss Assets are written off 100
• Accounts with temporary deficiencies
• DP arrived at based on stock statements older
  than 3 months, would be irregular and will become
  NPA if not rectified for a continuous period of
  90 days even though the health of the account is
  satisfactory.
• Regular and ad hoc credit limits not reviewed/
  renewed within 180 days from the due date will be
  treated as NPA.

46
Guidelines for classification- issues

• Upgradation of loan accounts classified as NPAs
• Accounts regularised near about the balance sheet
  date
• Borrower-wise and not facility-wise
  classification.
• Project loans - 6 months crieteria

47
Projects under implementation
Particulars Standard NPA
Category I (Projects where financial closure had been achieved and formally documented) For not exceeding 2 years beyond the date of completion of the project, as originally envisaged at the time of initial financial closure For time over run beyond 2 Years
Category II (Projects sanctioned before 1997 with original project cost of Rs.100 crores or more where financial closure was not formally documented) for a period not exceeding 2years beyond the deemed date of completion of the project, as decided by the an independent Group constituted. For time over run beyond 2 Years
Category III (Projects sanctioned before 1997 with original project cost of less than Rs.100 crores where financial closure was not formally documented) for a period not exceeding 2 years beyond the date of completion of the project as originally envisaged at the time of sanction. For time over run beyond 2 Years
48
Special Type of advances

• Post-shipment Supplier's Credit  not treated as
  a NPA to the extent payment has been received
  under ECGC
• Central Government guaranteed advances vis a vis
  NPA
• Advances under consortium arrangements
• Advances against Term Deposits, NSCs, KVP/IVP,
  etc
• Loans with moratorium for payment of interest

49
Provisioning Norms
Category Provision
Loss assets written off or 100 percent provision.
Doubtful assets 100 percent of unsecured portion and in regard to the secured portion, 25 upto one year , 40 for one to three years and 100 for more than three years
Sub standard assets  15, unsecured advances require an additional provision of 10
Standard Assets 0.40 for loans not falling in specific sectors (refer para 5.5 of master circular)
50
Audit Reports
51
Various Reports/Certificates

• 1. AUDIT REPORT (and annexure to audit report,
  if any)
• 2. Tax Audit Report
• 3. Certificates
• 4. MOCs -Income recognition asset
  Classification
• 5. LFAR

52
Questions???

• radhesh_at_varmaandvarma.com

53

• LONG FORM AUDIT REPORT
• (LFAR)

54
LFAR Basics

• LFAR (a management report) is an additional
  reporting requirement.
• The main objective is to report on systemic
  deficiencies.
• Any serious adverse observation require
  qualification of the main report also.
• Discuss the contents of the report with the
  Branch head to avoid any factual errors.
• Matters required to be reported by the auditor in
  LFAR are illustrative not exhaustive

55
Approach to LFAR

• Read LFAR before commencement of audit
• Gather information along with the verification of
  advances, verification of income, etc.
• Link the results of the above to questions in
  LFAR
• Discussion with Branch Personnel and obtaining
  evidences

56
Cash and Bank Balances

• General level of Cash balance ,
• Cash balance retention limit ,
• Reporting of excess cash holding ,
• Adequacy of insurance cover for cash-on-hand
  and cash-in-transit
• Keeping cash in effective joint custody of two
  or more officials,
• Periodic verification of cash balance,

57
Bank balances and money at call or short notice

• Obtaining of bank balance confirmations as at
  the year-end
• Report on nature and extent of difference in
  reconciliation of bank balances
• Cash transactions remaining unresponded
• Revenue items requiring adjustment write-off
• Old outstanding balances remaining unexplained /
  unadjusted. Give details for
• outstanding between six months and one year and
• one year and above
• Report any item in reconciliation requiring
  special attention of the management

58
Investments

• Investments held on behalf of H.O/other offices
  and its physical verification
• If not available for verification any acceptable
  other evidence is produced.

59
Advances

• Examine
• all large advances (outstanding amount is in
  excess of 5 of the aggregate advance of the
  branch or Rs.2 crores, whichever is less).
• a test check of other advances.
• In respect of large advances , report all major
  adverse features, deficiencies, etc attach
  separate annexures.,
• In respect of other advances, generally comment
  upon the adverse features , deficiencies along
  with specific instances.

60
Advances

• Application/proposal/ Appraisal
• Sanctioning/Disbursement/Documentation
• Review /Monitoring/Supervision
• Recovery

61
Guarantees Letters of Credit

• Details of outstanding in respect of guarantees
  invoked and funded (in the prescribed format)
• Guarantees invoked and paid but not adjusted
  (Date of invocation, Name of the party ,Name of
  beneficiary, amount , date of recovery)
• Guarantees invoked but not paid (Date of
  invocation , Name of the party, Name of
  beneficiary ,amount ,date of recovery)
• Similarly for Letter of Credit

62
OTHER ASSETS

• STATIONERY AND STAMPS Observe the internal
  control system, verify and document
• Control over inventory-joint custody
• Control over ATM/PIN
• cases of missing/lost items of such stationery?

63
Suspense a/c sundry assets

• Obtain details of old outstanding entries and
  ascertain the reasons for delay in adjusting the
  entries
• Unadjusted debits (such as ATM entries ,
  fraudulent withdrawals, shortage of cash)
• Report nature and amounts of any unusual items
  observed on a test check

64
Liabilities

• Deposits
• Compliance with guidelines on conduct and
  operations of inoperative accounts. Report
  deviations
• Identify , investigate and report any unusual
  large movements (increase or decrease) in the
  aggregate deposits between the balance sheet
  date and the date of audit.
• Details of overdue/ matured term deposits at the
  end of the year

65
Liabilities

• Other Liabilities - Bills Payable, sundry
  deposits
• Obtain and report the details of (number of
  items and the aggregate amount of items pending
  for three years or more.
• Give details of old balances (Year, No of
  items, Amount, Remarks)
• Report the nature and the amounts of any
  unusual items or material withdrawals or debits

66
Contingent Liabilities

• Obtain a list of Major items of the contingent
  liabilities (other than constituents liabilities
  such as guarantees, letters of credit,
  acceptances, endorsements, etc.) not acknowledged
  by the branch.
• Discuss with the Branch in charge about any
  notice from Income Tax department, VAT
  department, etc.

67
Profit and Loss A/c

• System to compute discrepancies in interest /
  discount and interest on deposits and for
  timely adjustment thereof - Check a few cases
  manually
• Details of material excess/ short credit of
  interest observed on test checking of interest
  .
• Compliance with the income recognition norms
  prescribed by RBI
• Check unexpired interest on bills discounting.
• Analytical procedures

68
General Books Records

• In respect of Computerised branches
• Whether hard copies of accounts are printed
  regularly?
• The extent of computerization covered.
• Data security measures
• Regular back-ups of accounts
• Contingency and disaster recovery plans
• Offer suggestion for the improvement
• Reconciliation of control and Sub ledgers

69
General

• INTER BRANCH ACCOUNTS
• AUDIT/INSPECTION
• FRAUDS

70
Miscellaneous

• Window dressing?
• Where documents of title in relation to branch or
  other branches are available at the branch,
  whether same have been verified.
• Are there any other matter, which you as a
  branch auditor would like to bring to the notice
  of the management or the Central Statutory
  Auditors

71
Other areas

• ANNEXURE TO THE LFAR FOR FURNISHING DETAILS OF
  LARGE/IRREGULAR/CRITICAL ACCOUNTS
• SPECIALISED BRANCHES

72

• Questions ???

73
(No Transcript)