Audit of Advances-1

8/6/2019 Audit of Advances-1

1/53

Audit of Advances

Baroda Study Circle of WIRC of ICAI

Audit of AdvancesRajkot Branch - WIRC of ICAI

Dhinal Shah,CA


2/53

Structure of presentation

Introduction.. 3

Types of Advances 4

Audit Approach . 5

Major areas of consideration.. 7

Some specific areas. 33 Key Points . 45

Disclosure requirement 48

Areas to focus. 51

21 March 2010 2Audit of Advances


3/53

Introduction

Major Activity ofBANK Largest ACCOUNT CAPTION in ASSETS

Major Source ofINCOME

Most FOCUSED Audit Area

Can SUBSTANTIALLY CHANGE the financial results Time consuming, AUDIT PLANNING is essential

Master Circulars of RBI



4/53

Funded Overdraft/Cash Credit

Term Loans (Home Loans,

Vehicle Loans, Mortgage Loans)

Working Capital Demand Loans

Bills Purchased/Discounted/Foreign Bills for Collection

Packing Credit

Foreign Currency loans

Types of Advances

Non-funded Guarantees

Letter ofCredit

Letter ofComfort

Co-acceptance of Bills



5/53

Audit Approach

Extent would depend on assessment ofEFFICACY of internalcontrol

Examine all large advances i.e. which are lower of following2 Criteria

5% of Advances

Rs.2 crore

Verify all problematic accounts

Verify advances which are adversely commented by/in

Previous Audit report / LFAR

Internal/Concurrent auditors

Banks inspection report (including RBI Inspection)

Report on verification of security (Stock Audit, etc.)



6/53

Audit Approach

RBI inspection report

Any other report related to the particular advance

Managers charge handing over report

Branches control returns to higher authorities concerningoverdrawing , adhoc sanctions etc

Verify fresh advances granted during the year (if retail highvolume then do sample basis)

Accounts upgraded from NPA to standard

For other then above advances to do on sample basis



7/53

Existence of clearly laid down delegation of authority.

Existence of clearly laid down eligibility criteria for loans.

Existence of system of communicating the terms of sanction to the borrower.

Existence of system of execution of documents before disbursement.

Ex

istence of system of post disbursement monitoring and reporting irregularity. Existence of system for implementation of IRAC Norms.

Adequate control on changing of interest etc in CBS environment.

21 March 2010 Audit of Advances 7


8/53

Major Areas of Considerations

Pre Sanction

Application Credit Appraisal

Sanctioning/Disbursement

Documentation

Post sanction Review/Monitoring

Asset classification

Provisioning Norms

Income Recognition

Restructuring



9/53

Application

Prescribed Application Form from the borrower for freshon renewal proposal

KYCCompliance as Per RBI Requirements

Evaluation of latest audited financial statements

Review of Project Report Projected P&

L, BS &

Cash Flow

Board Resolution for the availment of the facility obtained

Latest Financial Statements / Income Tax Records ofBorrower and guarantor

Various Registrations/Licenses/Permits



10/53

Credit Appraisal

Verify Appraisal Note of Bank is proper

Whether Appraisal done by Competent person

Review Projections whether realistic

Net worth statement of the borrower and guarantor

Confidential report and NOC from the existing banker

CIBIL Report, Title clearance report & valuation report Nature of securities (prime/ collateral) offered and to

confirm the adequacy of security cover

Verify that important Financial ratios are satisfactory suchas

Debt Equity ratio

Debt service Coverage ratio and other ratios



11/53

Credit Appraisal

Creditworthiness of borrower

Verify whether Exposure limit (including derivative instruments) is within thelimits fixed by Bank-group wise, Industry wise & policy of Bank

Prospects of business, sources and periodicity of repayments, evaluation offinancial statements, capacity utilization

Report of Dun & Bradstreet for Export finance or while opening Letter of

Credit is obtained Whether the branch has a policy of maintaining Rejected Proposals

Whether Branch is conducting credit rating of major advances accounts onperiodic basis



12/53


Proposal has been routed through appropriate authorisationlevels and recommendations are properly documented andnoted

Limits sanctioned are within the discretionary powers of thesanctioning authority

In case where the sanctions are beyond the discretionary

powers, the same has been reported to appropriate authoritiesand ratified within specified period

Any change in the terms of sanction is ratifed by appropriateauthority

Pre disbursement unit inspection has been carried out & reportheld on record

Adhoc limits (increase) given to borrower for temporary/seasonal/ peak periods whether reported to controllingauthorities and whether liquidated in time



13/53


Verify that Disbursement done only after compliance of all terms &conditions of Sanction letter.

Verify all Ad hoc sanction limits given

Acceptance of the borrower confirming the terms & conditions ofsanction is obtained

Sanction letter/limit approval letter stating the terms andconditions is available

If the Loan policy or Manual specifies the adjustment of creditors,but the sanction is silent, it is for the auditor to report the defect inthe sanction as a violation ofLoan policy. But where a specificmention is made in the sanction, not to consider creditors as a

deduction, then the terms of sanction have to be adopted and thesame has to be considered in drawing power calculation

Verify Margin Money to be brought by borrower

Verify end use of funds ( capex, Project, etc)



14/53

Documentation

All loan documents, as required by the sanction letter and loanpolicy have been executed (eg. DP Note, loan Agreement, Letterof guarantee, hypothecation Agreement, etc)

Loan documents are properly executed and approved by legalexpert, if required whether appropriately stamped

Fresh loan documents are obtained on change in limit, change inthe constitution of the borrower

As per Sanction Letter and Bank Policy

Original agreement, share certificate, title deeds, title clearancecertificate valuation report are held on record

In case of Thirdparty borrowing against Branch Fixed Deposits,normal lending rate of interest should be applied as againstconcessional rate

Documents should not be blank or incomplete & there should beno overwriting, changes, different inks etc.



15/53

Documentation

Original documents are kept in safe custody

Charge on securities offered have been registered with registrarof companies/ appropriate authority (RTO, MortgageRegistration)

NOC of housing society

Memorandum and Articles of Association or proof of constitutionof the borrower

Special Documentation for Consortium/ Multiple Bankingadvances

Whether advances against lien of deposits have been properly

granted by marking a lien on the deposit in accordance with theguidelines of the controlling authorities of the bank



16/53

Review/ Renewal of facilities carried out as per the policy of the

bank Verify Follow up of accounts pending renewal

LC issuance check for ever greening

Security / Stock Inspection reports

Regular QIS, Stock & Debtors statements are submitted

Operation in party accounts critically review, specially at monthend, quarter end ( turnover in account, cheques dishonored,Excessive Cash transactions, dormancy of account, balanceexceeding limits , transfers from / to accounts)

In cases where borrower is availing Multiple banking Facility,

whether the branch obtains outstanding position from each Bankand compares the limits availed with stocks held and DP applicable,in order to know whether the borrower is over financed, and anymargin is to be introduced

Adequacy of Insurance

Review/Monitoring



17/53

Fund disbursement has been utilised towards the object forwhich limit was sanctioned i.e. Not diverted to groupcompanies/ associates or used to pay of existing overdues

Periodic review of irregular/ overdue/ NPA accounts hasbeen done at the appropriate level

Penal interest to be charged if,

DP limits breached

Statements not submitted

Letter of Acknowledgement / Balance Confirmation

Bills Discounted a) whether accommodation bills b)whether ECGCCover taken?


Review/Monitoring


18/53

Drawing Power Calculation

Based on Stocks, Debtors and Share value

Critical review of stock/ Book Debts statement (Old debtorsmore than 180 days not to be considered)

DP limits to be set as per latest statements. If stock statementsis older than 3 months account to be classified as irregular

Verify banks guidelines for DP calculation specially for unpaidstocks

Verify Inventory & equity shares Valuation

Verify annual audit report of the borrower with the monthlystock statement for the last month of the year

Verify Stock audit report for NPAs more than Rs5 Crore


Review/Monitoring


19/53

Review/Monitoring

Fraud in Advances

Sanction without proper application and/or credit appraisal

Sanction made beyond discretionary power and non-reporting of the same to the appropriate authority

Unauthorised release of securities

Security valuation (Especially NPA account e.g. ImmovableAssets, Patents)

Charging of same security to different Banks

Diversion of funds

Fraud risk relating to Controls Submission of fake transport documents/ godown receipts

Discounting of accommodation bills/ issuance/ LC



20/53

RBI CircularReference

Master Circular dated 1st July 2009 on IRAC Norms.

Circular dated 31st August 2009 in respect of Agricultural debt waiverscheme.

Circular dated 5th November, 2009 for provisioning on standard

assets. Circular dated 1st December 2009 for provisioning coverage ratio.

RBI Circular Reference



21/53

STANDARD ASSET / PERFORMING ASSET

The account is not non-performing and does not carry morethan the normal risk attached to the business.

NON-PERFORMING ASSET (NPA)

The asset ceases to generate income for the bank. (Para 2 ofthe Master Circular)

Asset Classification


Asset Type


22/53

Asset ClassificationA nonperforming asset (NPA) is a loan or an advance where:

Interest and/ or installment of principal remain overdue for a period of morethan 90 days in respect of a term loan

The bill remains overdue for a period of more than 90 days in the case of billspurchased and discounted

If the Cash Credit/Overdrafts account remains Out ofOrder as described below

if the outstanding balance remains continuously in excess of the sanctionedlimit/ drawing power

No credits in the account for 90 days as at period end.

credits not enough to cover interest debited during the period

As per para 2.1.3 an account will be NPA only if interest due & chargedduring as quarter is not serviced fully within 90 days from end of quarter.

Stock statement more than 3 months old for a continuous period of 90 Days

Regular/ Adhoc limits are not revised within 180 days of due date/ Adhocsanction date

Derivatives: Receivables on account of mark to Market Value remain overduefor more than 90 days



23/53


NPAs Borrower-wise and not Facility-wise.

NPA merely due to temporary deficiencies (guidelines in mastercircular dated 1st July 2009) (e.g. Renewal/Review pending for 180days, Excess drawn on limits due to drawing power calculated onmore than 3 month old stock statement)

Verify errors in classification, provisioning/Value of security,interest reversal

Verify audit trail for changes to critical dates e.g. date of NPA, etc

Identification of assets as NPAs should be done on an ongoingbasis

Verify if account regularised with only few audits at period ended

(source, genuineness, additional audit etc.)



24/53


Make a Detailed Note on observation and facts especially where

you are recommending a change of classification In respect of NPAs over Rs.5 Crore

Stock audit-Annually

Immovable properties-once in 3 years

Do not go by BANKS circular (Interpretation mistakes could bethere)

Verify that Repayment is from genuine sources

NPA accounts can be upgraded to performing after all overduesare adjusted or at least reduced to a period of less than 90 days

Suit filled accounts to be classified as Doubtful unless there isstrong justification against it

In case ofConsortium advance record of recovery of particularBank only to be considered.



25/53

NPAs are categorized based on the period for which asset has remainednonperforming:

Advances against Term deposits, NSC,KVP,IVP and Life policy not to be

treated as NPA provided adequate margins are availableNote- Advances against Gold ornaments and government security andall other securities are not covered in the aforesaid exception

Amount guaranteed under ECGC need not be treated as NPA

Substandard Assets which has remained NPA for a period less than orequal to 12 months

Doubtful Assets if it has remained in the substandard category fora period of 12 months

Loss Assets identified by the bank or internal/ externalauditors or the RBI inspection but the amount hasnot been written off wholly




26/53

Regular/ad-hoc limits need to be reviewed /regularised not later than 3m from due date/ date of adhoc sanction. if not done within 180 days,then NPA

Erosion in value of security :Where erosion of security is to the extent

50% of outstanding NPAs--- doubtful

90% of outstanding NPAs--- loss

Projects under implementation separate set of guidelines underMaster Circular




27/53

Provisioning Norms

Higher provisioning is warranted if threats to recovery

Verify secured and unsecured portion of advances

Critically verify the value of security as on the balance sheetdate

For accounts classified as doubtful, verify

Primary and secondary security charged to the bank

Present value through approved valuer (once in 3 Years)

Inspection

In case of Foreign currency denominated Loan Revaluation

gain from Foreign exchange fluctuation to be considered asprovision against the asset



28/53

Provisioning Norms

Asset Classification Amount of Provision Required in (%)

Standard Assets Advances to Agriculture & SME 0.25%

Advances to Commercial Real Estate 1%

Other Advances 0.40%

Sub-Standard Asset 10 % on total amount

And additional 10 % on unsecured portionDoubtful Asset

Upto 1 Year

1 to 3 Year

More than 3 year

Loss Asset 100 %

Secured Portion Unsecured Portion

20 % 100 %

30 % 100 %

100 % 100 %


Provisioning Coverage Ratio to be 70% by 30/09/2010. Disclose PCR in Notes to

Accounts


29/53

Provisioning Norms

For Restructured Advances additional provision on Unsecuredportion of WCTL- covered under Restructuring

Provisioning Requirement for Standard Assets for RRBs forCommercial Real Estate (CRE) is Increased to 1% (RBI circularPCD.RRB.No.BC.61/03.05.34/2009-10, dated March 04, 2010)

Circular dated December 01, 2009 for Provisioning coverage forAdvances

21March 2010 29Audit of Advances


30/53

Provisioning for Country Risk

Net funded country exposures 1% of total Exposures

Lower provision in respect of short term Exposure

Verify data carefully

Risk Category ECGC classification Provisioning requirement(%)

Insignificant A1 0.25

Low A2 0.25

Moderate B1 5

High B2 20

Very High C1 25

RestrictedC

2 100Off-Credit D 100



31/53

Income recognition

Banks should not book income by way of interest on NPA

However, interest on advances against TD, NSCs, IVPs, KVPs(check for fraudulent documents) and Life policies may be takento income account on the due date, provided adequate marginis available in the accounts

IfGovernment guaranteed advances become NPA, interest onsuch advances should not be taken to income account unless theinterest has been realised

Verify whether Interest calculations are correct or not Samplebasis and Check Systems also



32/53

Income recognition

If any advance, including Government guaranteed, billspurchased and discounted, becomes NPA as at the close of anyyear, interest accrued and credited to income account in thepast periods, should be reversed or provided for if the same isnot realised

Note:E

arlier reversal was for the previous year only & now sincelast year says past periods



33/53

Provisioning Norms Provision Under Special circumstances

Advance under rehabilitation programme approved by BIFR / Institutions,Provision should be continued to be made on existing facilities.

Additional facilities no provision for a period of one year.

In case of advances guaranteed by CGTSI/ECGC, Provision should be madeonly for balance in excess of the amount guaranteed by thesecorporations.

Specific Areas



34/53

Bank Finance with Moratorium [Para4.2.12 (i)].

Housing or similar advances granted to staff members [Para4.2.12 (ii)].

Central Government guaranteed advance to be classified as NPAonly if Government repudiates the guarantee when invoked.

Exception: Credit facility to Primary Agricultural Credit Society(PACS) and Farmers Service Societies (FSS) under on lending

arrangement, (Para 4.2.10)

Specific Areas

21 March 2010 Audit of Advances

Exceptions:


35/53

Restructured Loans: Master Circular of 1/7/2009

Only loans with Viability and with reasonable certainty ofrepayment to be Restructured

Standard loan to be classified as Sub-standard afterRestructuring

Certain exceptions in circular:Other than for Capital MarketExposure, Personal / Consumer Loan/ Commercial RealEstate

Incentive for quick implementation of Restructuring within 90 /120 days asset classification which existed at time ofrestructuring application.



36/53

Asset

Classification benefits - classification not be downgraded ifsatisfactory performance during the specified period subject to:

dues being fully secured (other than SSI whose outstanding isless than 25 lakhs & Infrastructure projects having cash flows torepay advance through escrow mechanism

unit becomes viable in 7 years (10 years for infrastructure cases)

repayment in 10 years (15 years for Infrastructure cases)

promoter sacrifice and additional funding at least 15 % of BankSacrifice

personal Guarantee of promoters Not a repeated restructuring

Reschedulement of recovery cannot upgrade the classificationfrom the previous classification


Restructured Loans


37/53

Upgrading to standard category only after satisfactoryperformance during the specified period

Specified period-period of one year from the date whenthe 1st payment of interest or installment of principal fallsdue under the terms of restructuring

Additional finance to be treated as standard Asset, uptoone year after date of first principal / interest paymentunder approved restructuring package. However interestincome to be recognised only on cash basis for Assetswhich were NPAs at time of restructuring


Restructured Loans


38/53

Fees and commissions earned by the bank as a result of re-negotiations or rescheduling of outstanding debts to berecognised on an accrual basis over re-negotiated period

Restructuring not to be retrospective

Asset classification norms applicable till restructuring isfinalised

Provision to be made for the diminution in the fair value ofthe advance

Valuation and provisioning issues for equity, debtinstruments received on restructuring

Norms for conversion of unpaid interest into FITL/ Debt/

Equity Repeated restructuring is allowed only if the viable units

are facing temporary cash flow problems (December 08,2008)


Restructured Loans


39/53

Restructured Loans

Additional Provision

WCTLLoans restructured under circulars dated- 27 August 2008,8 December 2008

Unsecured portion of WCTL created by conversion of irregularportion of principal dues over drawing power should be as

under: Standard assets 20%

Sub-Standard assets 20% in the first year then increase by20% every year till specified period

After specified period- if account not eligible forupgradation- Unsecured Portion- 100%



40/53

Agriculture Loans

NPA Classification

The installment of principal or interest thereon remains overdue fortwo crop seasons for short duration crops

The installment of principal or interest thereon remains overdue forone crop season for long duration crops

Agriculture debt waiver scheme and debt relief scheme 2008

Banks not to claim nor recover interest in excess of principal amount,penal interest, miscellaneous charges ,etc for the Assets which areNPA at the time of restructuring

Unapplied interest on NPA loans are neither to be claimed from thegovernment nor from the farmer

Eligible amount to be credited to the borrower account by 30

September 2008 Small and marginal farmers entire eligible amount shall be waived



41/53

Other farmers- OTS in which entire rebate of 25% provided entireamount is repaid of the eligible amount for which the last dates of 3installments fixed are 30/9/2008 which was extended to 31 March 09;31 March 09,30 June 2009 which is extended to 31/12/2009 videcircular dated 31/8/2009)

25/6/2009 Circular resolution permitting farmers to pay the amount insingle installment by 30/6/2009

Farmers share has to be received within 1 month of the pre-specifieddue dates if not then the account will be classified as NPA

Separate account Receivable from government of India underAgriculture Debt waiver Scheme 2008

It may be assumed that governments contribution would be receivedby June 30, 2010

Balance in account to be treated as Performing asset, providedadequate provision for the loss is made in PV terms

If not received till 31/01/2010 it is a NPA from old date


Agriculture Loans


42/53

GovernmentGuaranteed Advances

In case of NPA income not to be recognised unless it is actuallyrealised

State government guaranteed advances have to be classified asNPA if remains overdue for more than 90 days

Central government advances to be considered as NPA only if

guarantee invoked and repudiated by the government If bank has not invoked Central Government guarantee for long it

should to be reported in the LFAR



43/53

Packing Credit

Pre-shipment credit - all the advances required to finance theproduction cycle advance is given on the basis of individualorder obtained which is to repaid out of export proceeds

The post shipment credit relates to financing of bills raised onthe overseas buyer upon shipment of goods pending

Verify proceeds received from export as these accounts haveconcessional interest



44/53

LFAR

Study the LFAR thoroughly with respect to advance portion

Prepare the LFAR note for advances along with the statutoryaudit

Give specific instances of shortcomings/ weaknesses in theadvances sections

Annexure to LFAR for large/ critical/ irregular accounts Critical comments affecting accounts should be part of main

audit report and Qualified



45/53

KEYPOINTS

Credit card dues are shown under cash credits, overdrafts andloans repayable on demand

Overdue installments in respect of term loan to be included termloan and not loans repayable on demand

As per Sec. 5(n) of the Banking Regulations Act, secured advancemeans an advance for which the market value of security is notat any time less than the amount of such advance

Refinance obtained from refinancing agencies representsborrowings of the bank

Bills discounted/negotiated/purchased under LC where thepayment to the beneficiary is not under reserve is to betreated as an exposure on LC issuing bank and not on borrower



46/53

KEYPOINTS

If only a part of advance is covered by the value of security as atthe balance sheet date, that part only should be classified assecured and balance amount must be classified as unsecured

All accepted bills must be classified as unsecured unlesscollaterally secured

Extension of surplus security in other facilities should not beconsidered unless agreed at the time of sanction

In case documents are incomplete and or not in force, the facilityshould be treated as unsecured

Advances made against unapproved securities can be classified

as secured



47/53

KEYPOINTS

Bills discounted/purchased which have been rediscounted withRBI/IDBI/SIDBI must be shown under contingent liabilities

In case of fully computerized, ensure that there are proper systems forborrower wise classification

In absence of a clear agreement with the borrower, in case of partialrecoveries in NPA, the banks are required to adopt uniform accounting policy

Foreign Bills under LC: Classification in a NPA a/c In NPA accounts involving, Foreign Bills under LC as one of the facilities,

some banks are of the view, that the balance outstanding under thisfacility not being an exposure to the borrowers but to other banks,should be considered as Standard asset, being money due from theother bank ?

in a NPA account, outstanding balances of Bills under LC are also to beaggregated with other balances for the purpose of calculation ofprovision. If any bank has obtained a clarification individually from RBI,the same may be brought to the notice of auditors for information

Fixed Assets as a second charge - calculation of security value is important



48/53


Provision against future LC / guaranteedevolvement-In an existing NPA

Some of the guarantees/LCs which were

devolved, are accounted as NPA. There are

certain other LCs and guarantees remaining to

be realized. Should these non funded liabilitiesbe provided for and if so under what

classification? If these non funded liabilities are

not to be included as NPA under what

circumstances are these to be excluded

KEY POINTS


49/53

Disclosure Requirements

A) i) Bills purchased and discounted

ii) Cash Credits, overdrafts and loans repayable on demand

iii) Term Loans

B) i) Secured by tangible assets

ii) Covered by bank/Government guarantees

iii) Unsecured

C) I. Advances in India

i) Priority sector

ii) Public sector

iii) Banks

iv) Others

II. Advances Outside India



50/53

Disclosure Requirements

i) Due from banks

ii) Due from Others

iii) Bills purchased and discounted

iv) Syndicated loans

v) Others

Amount receivable from government of India underAgricultural Debt waiver scheme,2008 should be separatelyunder the head Term Loans, Unsecured and other in A, B and Crespectively

Maturity Analysis: 1day to 14 days, 14 days to 28 days, 29 daysto 3 months, 3 to 6 months,6 months to 1 year,1 to 3 years, 3to 5 years, more than 5 years

Segmental Analysis: Based on Wholesale and Retail



51/53

Areas to focus in 2010

Real Estate loans

Capital Market Loan

Agricultural Loans

Restructured Loans

Commodity Loans

Infrastructure/ SEZ/ Engineering Project Diamond industry

Textile

Export oriented loans

looking at the global and Indian scenario possibly will have to seeall loans



52/53

Questions???



53/53
