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Type of banksType of banks
Commercial Banks. Co-operative Banks. Development Banks (more commonly
known as ‘Term-Lending Institutions’). Regional Rural Banks. Payment Banks. Small Finance Banks.
Commercial Banks. Co-operative Banks. Development Banks (more commonly
known as ‘Term-Lending Institutions’). Regional Rural Banks. Payment Banks. Small Finance Banks.
Regulatory FrameworkRegulatory Framework Banking Regulation Act, 1949. Companies Act, 2013. State Bank of India Act, 1955. State Bank of India (Subsidiary Banks) Act 1959. Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970. Regional Rural Banks Act, 1976. Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980. Information Technology Act, 2000. Prevention of Money Laundering Act,
2002. Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002. Credit Information Companies Regulation Act, 2005. Payment and Settlement Systems Act, 2007. Besides, the above enactments, the provisions of the Reserve Bank of India
Act, 1934,
Banking Regulation Act, 1949. Companies Act, 2013. State Bank of India Act, 1955. State Bank of India (Subsidiary Banks) Act 1959. Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970. Regional Rural Banks Act, 1976. Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980. Information Technology Act, 2000. Prevention of Money Laundering Act,
2002. Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002. Credit Information Companies Regulation Act, 2005. Payment and Settlement Systems Act, 2007. Besides, the above enactments, the provisions of the Reserve Bank of India
Act, 1934,
Peculiarities involved:Peculiarities involved:
Huge volumes and complexity oftransactions,Wide geographical spread of banks’
network, Large range of products and services
offered, Extensive use of technology, Strict vigilance by the banking regulator
etc.
Huge volumes and complexity oftransactions,Wide geographical spread of banks’
network, Large range of products and services
offered, Extensive use of technology, Strict vigilance by the banking regulator
etc.
Types of Audit Reports to be issuedTypes of Audit Reports to be issued
Statutory Audit Report as per SA700/705/706 LFAR (Long Form Audit Report) as per
requirements of RBI circular Tax Audit Report, as per Income tax Act,
1961
Statutory Audit Report as per SA700/705/706 LFAR (Long Form Audit Report) as per
requirements of RBI circular Tax Audit Report, as per Income tax Act,
1961
BANK AUDIT APPROACHBANK AUDIT APPROACHWho What When Where Why How
Whoperforms thecontrol?
Whatevidence isgenerated todemonstrate/prove thatthecontrol isperformed?
When andwith whatfrequency isthe controlperformed?
Where isthe evidenceofperformanceof thecontrolretained?
Why is thecontrolbeingperformed?
How is thecontrolperformed?What arethe controlactivities?
Whatevidence isgenerated todemonstrate/prove thatthecontrol isperformed?
Does theaboveperson haverequisiteknowledgeandauthorityto performthe control?
Is thefrequencyenough toprevent,detect andcorrect RiskofMaterialMisstatements?
Is theevidenceaccessiblefor /available foraudit?
What typeof errors areprevented ordetectedthrough theperformanceof thecontrol?
How areexceptions /deviationsresolved onidentification?What is thetime framefor resolvingtheexceptions /deviations?
The policy of income recognition should beobjective and based on record of recovery ratherthan on any subjective considerations.
Income from non-performing assets (NPA) is notrecognised on accrual basis but is booked asincome only when it is actually received.
Form and content of financial statements: Everybanking company needs to comply with the disclosurerequirements under the various Accounting Standards,as specified under section 133 of the Companies Act,2013, in so far as they apply to banking companies orthe Accounting Standards issued by the ICAI.
INCOME RECOGNITION POLICYINCOME RECOGNITION POLICY
The policy of income recognition should beobjective and based on record of recovery ratherthan on any subjective considerations.
Income from non-performing assets (NPA) is notrecognised on accrual basis but is booked asincome only when it is actually received.
Form and content of financial statements: Everybanking company needs to comply with the disclosurerequirements under the various Accounting Standards,as specified under section 133 of the Companies Act,2013, in so far as they apply to banking companies orthe Accounting Standards issued by the ICAI.
APPOINTMENTOF AUDITOR
at the AGMBankingCo.
NationalisedBank
SBISubsidiaries ofSBI- By SBI
by the C&AG of Indiain consultation withthe CG
approval ofthe RBI
by the bank concernedacting through its BoD.
Others
RRB by the bank concerned withthe approval of the CG
Remuneration ofAuditor
Co. in AGM
RBI with CGNationalisedBank & SBI
AUDITOR’S REPORTAUDITOR’S REPORT In the case of a nationalised bank, the auditor is required to make a
report to the CG in which he has to state the following:
whether, in his opinion, the BS exhibits a true and fair view of theaffairs of the bank, and in case he had called for any explanation,whether it has been given and whether it is satisfactory;
whether or not the transactions of the bank, have been within thepowers of that bank;
whether or not the returns received from the offices and branches ofthe bank have been found adequate for the purpose of his audit;
whether the P&L account shows a true balance for the periodcovered by such account; and
any other matter which he considers should be brought to the noticeof the Central Government
In the case of a nationalised bank, the auditor is required to make areport to the CG in which he has to state the following:
whether, in his opinion, the BS exhibits a true and fair view of theaffairs of the bank, and in case he had called for any explanation,whether it has been given and whether it is satisfactory;
whether or not the transactions of the bank, have been within thepowers of that bank;
whether or not the returns received from the offices and branches ofthe bank have been found adequate for the purpose of his audit;
whether the P&L account shows a true balance for the periodcovered by such account; and
any other matter which he considers should be brought to the noticeof the Central Government
Format of ReportFormat of Report Besides the audit report as discussed in previous
chapter, the terms of appointment of auditors ofpublic sector banks, private sector banks and foreignbanks (as well as their branches), require the auditorsto also furnish a long form audit report (LFAR).
The LFAR is to be submitted before 30th June everyyear.
Besides the audit report as discussed in previouschapter, the terms of appointment of auditors ofpublic sector banks, private sector banks and foreignbanks (as well as their branches), require the auditorsto also furnish a long form audit report (LFAR).
The LFAR is to be submitted before 30th June everyyear.
CONDUCTING AN AUDITCONDUCTING AN AUDIT 1. Initial consideration by the statutory auditor
◦ Declaration of Indebtedness: The RBI has advised that the banks, beforeappointing their auditors, should obtain a declaration of indebtedness.
◦ Internal Assignments in Banks by Statutory Auditors: The RBI decided that theaudit firms should not undertake statutory audit assignment while they areassociated with internal assignments in the bank during the same year.
◦ Planning: Standard on Auditing (SA) 300, “Planning an Audit of FinancialStatements” requires that the auditor shall undertake the planning activities.
◦ Communication with Previous Auditor: Obtain NOC
◦ Terms of Audit Engagements: SA 210, “Terms of Audit Engagements” requiresthat for each period to be audited, the auditor should agree on the terms of theaudit engagement with the bank
◦ Initial Engagements: The auditor needs to perform the audit procedures asmentioned in SA 510 “Initial Audit Engagements-Opening Balances”
◦ Assessment of Engagement Risk
◦ Establish the Engagement Team
◦ Understanding the Bank and its Environment: SA 315 “Identifying andAssessing the Risks of Material Misstatement Through Understanding theEntity and Its Environment”
1. Initial consideration by the statutory auditor
◦ Declaration of Indebtedness: The RBI has advised that the banks, beforeappointing their auditors, should obtain a declaration of indebtedness.
◦ Internal Assignments in Banks by Statutory Auditors: The RBI decided that theaudit firms should not undertake statutory audit assignment while they areassociated with internal assignments in the bank during the same year.
◦ Planning: Standard on Auditing (SA) 300, “Planning an Audit of FinancialStatements” requires that the auditor shall undertake the planning activities.
◦ Communication with Previous Auditor: Obtain NOC
◦ Terms of Audit Engagements: SA 210, “Terms of Audit Engagements” requiresthat for each period to be audited, the auditor should agree on the terms of theaudit engagement with the bank
◦ Initial Engagements: The auditor needs to perform the audit procedures asmentioned in SA 510 “Initial Audit Engagements-Opening Balances”
◦ Assessment of Engagement Risk
◦ Establish the Engagement Team
◦ Understanding the Bank and its Environment: SA 315 “Identifying andAssessing the Risks of Material Misstatement Through Understanding theEntity and Its Environment”
2. Identifying and Assessing the Risks of MaterialMisstatements.
3. Understanding the Bank and Its Environment includingInternal Control
4. Understand the Bank’s Accounting Process 5. Understanding the Risk Management Process
6. Engagement Team Discussions
7. Establish the Overall Audit Strategy
8. Develop the Audit Plan
9. Audit Planning Memorandum
10. Determine Audit Materiality
11. Consider Going Concern
12. Assess the Risk of Fraud
13. Assess Specific Risks
14. Risk Associated with Outsourcing of Activities
15. Response to the Assessed Risks
2. Identifying and Assessing the Risks of MaterialMisstatements.
3. Understanding the Bank and Its Environment includingInternal Control
4. Understand the Bank’s Accounting Process 5. Understanding the Risk Management Process
6. Engagement Team Discussions
7. Establish the Overall Audit Strategy
8. Develop the Audit Plan
9. Audit Planning Memorandum
10. Determine Audit Materiality
11. Consider Going Concern
12. Assess the Risk of Fraud
13. Assess Specific Risks
14. Risk Associated with Outsourcing of Activities
15. Response to the Assessed Risks
16. Stress Testing: RBI has required that all commercial banks shallput in place a Board approved ‘Stress Testing framework’ to suit theirindividual requirements which would integrate into their riskmanagement systems.
17. BASEL III framework: The Basel Committee on BankingSupervision (BCBS) and the Financial Stability Board (FSB) hasundertaken an extensive review of the regulatory framework. In thedocument titled ‘Basel III: A global regulatory framework proposedcertain minimum set of criteria for inclusion of instruments in the newdefinition of regulatory capital.
18. Reliance on / review of other reports: The auditor should take intoaccount the adverse comments, if any, on advances appearing in thefollowing-
◦ Previous audit reports.
◦ Latest internal inspection reports of bank officials.
◦ Reserve Bank’s latest inspection report.◦ Concurrent / Internal audit report.
16. Stress Testing: RBI has required that all commercial banks shallput in place a Board approved ‘Stress Testing framework’ to suit theirindividual requirements which would integrate into their riskmanagement systems.
17. BASEL III framework: The Basel Committee on BankingSupervision (BCBS) and the Financial Stability Board (FSB) hasundertaken an extensive review of the regulatory framework. In thedocument titled ‘Basel III: A global regulatory framework proposedcertain minimum set of criteria for inclusion of instruments in the newdefinition of regulatory capital.
18. Reliance on / review of other reports: The auditor should take intoaccount the adverse comments, if any, on advances appearing in thefollowing-
◦ Previous audit reports.
◦ Latest internal inspection reports of bank officials.
◦ Reserve Bank’s latest inspection report.◦ Concurrent / Internal audit report.
ADVANCESADVANCES Advances comprises of funded amounts by way
of :
◦ Term loans
◦ Cash credits, Overdrafts, Demand Loans
◦ Bills Discounted and Purchased
◦ Adverse balances in Deposit Accounts
◦ Participation on Risk Sharing basis
◦ Interest bearing Staff Loans
Advances comprises of funded amounts by wayof :
◦ Term loans
◦ Cash credits, Overdrafts, Demand Loans
◦ Bills Discounted and Purchased
◦ Adverse balances in Deposit Accounts
◦ Participation on Risk Sharing basis
◦ Interest bearing Staff Loans
CLASSIFICATION OF ADVANCESCLASSIFICATION OF ADVANCES Sector wise:
Security wise
Prudential Norms
Classification of Advances as per RBI norms
Priority
NPAsStandard
UnsecuredSecured
Non-Priority Sector wise:
Security wise
Prudential Norms
Classification of Advances as per RBI norms
Loss
Sub-standard
Doubtful
SMA- SpecialMentionAccounts
Standard Regular
Standard Loans NPA Loans
(Asset Classification would beborrower wise and not facility wise.)
Nature of SecurityNature of Security Primary security: It refers to the security offered by the
borrower for bank finance or the one against whichcredit has been extended by the bank. This security isthe principal security for an advance.
Collateral security: It is an additional security. Securitycan be in any form i.e. tangible or intangible asset,movable or immovable asset.
Primary security: It refers to the security offered by theborrower for bank finance or the one against whichcredit has been extended by the bank. This security isthe principal security for an advance.
Collateral security: It is an additional security. Securitycan be in any form i.e. tangible or intangible asset,movable or immovable asset.
Mode of Creation of SecurityMode of Creation of SecurityDepending on the nature of the item concerned, creation of security may take the form of a
mortgage, pledge, hypothecation, assignment, set-off, or lien.
Mortgage: Mortgage are of several kinds but the most important are the RegisteredMortgage and the Equitable Mortgage.
◦ A Registered Mortgage can be affected by a registered instrument called the ‘MortgageDeed’ signed by the mortgagor. It registers the property to the mortgagee as a security.
◦ Equitable mortgage, on the other hand, is effected by a mere delivery of title deeds orother documents of title with intent to create security thereof.
Pledge: A pledge thus involves bailment or delivery of goods by the borrower to thelending bank with the intention of creating a charge thereon as security for the advance.The legal ownership of the goods remains with the pledger while the lending banker getscertain defined interests in the goods. The pledge of goods constitutes a specific (or fixed)charge.
Hypothecation: The hypothecation is the creation of an equitable charge (i.e., a chargecreated not by an express enactment but by equity and reason), which is created in favourof the lending bank by execution of hypothecation agreement in respect of the moveablesecurities belonging to the borrower.
Neither ownership nor possession is transferred to the bank. However, the borrower holdsthe physical possession of the goods as an agent/trustee of the bank. The borrowerperiodically submits statements regarding quantity and value of hypothecated assets(stocks, debtors, etc.) to the lending banker on the basis of which the drawing power of theborrower is fixed.
Depending on the nature of the item concerned, creation of security may take the form of amortgage, pledge, hypothecation, assignment, set-off, or lien.
Mortgage: Mortgage are of several kinds but the most important are the RegisteredMortgage and the Equitable Mortgage.
◦ A Registered Mortgage can be affected by a registered instrument called the ‘MortgageDeed’ signed by the mortgagor. It registers the property to the mortgagee as a security.
◦ Equitable mortgage, on the other hand, is effected by a mere delivery of title deeds orother documents of title with intent to create security thereof.
Pledge: A pledge thus involves bailment or delivery of goods by the borrower to thelending bank with the intention of creating a charge thereon as security for the advance.The legal ownership of the goods remains with the pledger while the lending banker getscertain defined interests in the goods. The pledge of goods constitutes a specific (or fixed)charge.
Hypothecation: The hypothecation is the creation of an equitable charge (i.e., a chargecreated not by an express enactment but by equity and reason), which is created in favourof the lending bank by execution of hypothecation agreement in respect of the moveablesecurities belonging to the borrower.
Neither ownership nor possession is transferred to the bank. However, the borrower holdsthe physical possession of the goods as an agent/trustee of the bank. The borrowerperiodically submits statements regarding quantity and value of hypothecated assets(stocks, debtors, etc.) to the lending banker on the basis of which the drawing power of theborrower is fixed.
Assignment: Assignment represents a transfer of an existing or futuredebt, right or property belonging to a person in favour of anotherperson. Only actionable claims (i.e., claim to any debt other than a debtsecured by a mortgage of immovable property or by hypothecation orpledge of moveable property) such as book debts and life insurancepolicies are accepted by banks as security by way of assignment. Anassignment gives the assignee absolute right over the moneys/debtsassigned to him.
Set-off : Set-off is a statutory right of a creditor to adjust, wholly orpartly, the debit balance in the debtor’s account against any creditbalance lying in another account of the debtor. The right of set-offenables a bank to combine two accounts (a deposit account and a loanaccount) of the same person provided both the accounts are in the samename and in the same right (i.e., the capacity of the account holder inboth the accounts should be the same).
For the purpose of set-off , all the branches of a bank are treated as onesingle entity. The right of set-off can be exercised in respect of time-barred debts also.
Lien: Lien is creation of a legal charge with consent of the owner,which gives lender a legal right to seize and dispose / liquidate the assetunder lien.
Assignment: Assignment represents a transfer of an existing or futuredebt, right or property belonging to a person in favour of anotherperson. Only actionable claims (i.e., claim to any debt other than a debtsecured by a mortgage of immovable property or by hypothecation orpledge of moveable property) such as book debts and life insurancepolicies are accepted by banks as security by way of assignment. Anassignment gives the assignee absolute right over the moneys/debtsassigned to him.
Set-off : Set-off is a statutory right of a creditor to adjust, wholly orpartly, the debit balance in the debtor’s account against any creditbalance lying in another account of the debtor. The right of set-offenables a bank to combine two accounts (a deposit account and a loanaccount) of the same person provided both the accounts are in the samename and in the same right (i.e., the capacity of the account holder inboth the accounts should be the same).
For the purpose of set-off , all the branches of a bank are treated as onesingle entity. The right of set-off can be exercised in respect of time-barred debts also.
Lien: Lien is creation of a legal charge with consent of the owner,which gives lender a legal right to seize and dispose / liquidate the assetunder lien.
Prudential norms on Income Recognition, AssetPrudential norms on Income Recognition, AssetClassification and Provisioning pertaining to AdvancesClassification and Provisioning pertaining to Advances Non-performing Assets: An asset becomes NPA when it ceases to generate
income for the Bank.
A non-performing 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 account remains ‘out of order’ in respect of an Overdraft/Cash Credit◦ the bill remains overdue for a period of more than 90 days in the case of bills
purchased and discounted
Out of Order: An account should be treated as ‘out of order’ if the outstandingbalance remains continuously in excess of the sanctioned limit/drawing power.In cases where the outstanding balance in the principal operating account is lessthan the sanctioned limit/drawing power, but there are no credits continuouslyfor 90 days as on the date of BS or credits are not enough to cover the interestdebited during the same period, these accounts should be treated as ‘out oforder’.
Overdue: Any amount due to the bank under any credit facility is ‘overdue’ if itis not paid on the due date fixed by the bank.
Non-performing Assets: An asset becomes NPA when it ceases to generateincome for the Bank.
A non-performing 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 account remains ‘out of order’ in respect of an Overdraft/Cash Credit◦ the bill remains overdue for a period of more than 90 days in the case of bills
purchased and discounted
Out of Order: An account should be treated as ‘out of order’ if the outstandingbalance remains continuously in excess of the sanctioned limit/drawing power.In cases where the outstanding balance in the principal operating account is lessthan the sanctioned limit/drawing power, but there are no credits continuouslyfor 90 days as on the date of BS or credits are not enough to cover the interestdebited during the same period, these accounts should be treated as ‘out oforder’.
Overdue: Any amount due to the bank under any credit facility is ‘overdue’ if itis not paid on the due date fixed by the bank.
Accounts regularized near about the Balance Sheet Date:The asset classification of borrower accounts where a solitary ora few credits are recorded before the balance sheet should behandled with care and without scope for subjectivity.
Where the account indicates inherent weakness on the basis of thedata available, the account should be deemed as a NPA.
Advances under Consortium: Consortium advances should bebased on the record of recovery of the respective individualmember banks and other aspects having a bearing on therecoverability of the advances.
Drawing Power Allocation in case of Cash Credit Account:The Lead Bank would be responsible for computing the drawingpower of the borrower and allocate the same to member banks
Accounts regularized near about the Balance Sheet Date:The asset classification of borrower accounts where a solitary ora few credits are recorded before the balance sheet should behandled with care and without scope for subjectivity.
Where the account indicates inherent weakness on the basis of thedata available, the account should be deemed as a NPA.
Advances under Consortium: Consortium advances should bebased on the record of recovery of the respective individualmember banks and other aspects having a bearing on therecoverability of the advances.
Drawing Power Allocation in case of Cash Credit Account:The Lead Bank would be responsible for computing the drawingpower of the borrower and allocate the same to member banks
Accounts where there is erosion in the value ofAccounts where there is erosion in the value ofsecurity / frauds committed by borrowerssecurity / frauds committed by borrowers
Not prudent to follow stages of asset classification. It should bestraight-away classified as doubtful or loss asset as appropriate.
◦ Erosion in the value of security can be reckoned as significantwhen the realisable value of the security is less than 50 per centof the value assessed by the bank or accepted by RBI at the timeof last inspection, as the case may be.
◦ If the realisable value of the security, as assessed by the bank/approved valuers/ RBI is less than 10 per cent of the outstandingin the borrower accounts, the existence of security should beignored and the asset should be straight-away classified as lossasset.
Advances against Term Deposits, NSCs eligible for surrender,KVP/IVP and life policies need not be treated as NPAs, providedadequate margin is available in the accounts.
Not prudent to follow stages of asset classification. It should bestraight-away classified as doubtful or loss asset as appropriate.
◦ Erosion in the value of security can be reckoned as significantwhen the realisable value of the security is less than 50 per centof the value assessed by the bank or accepted by RBI at the timeof last inspection, as the case may be.
◦ If the realisable value of the security, as assessed by the bank/approved valuers/ RBI is less than 10 per cent of the outstandingin the borrower accounts, the existence of security should beignored and the asset should be straight-away classified as lossasset.
Advances against Term Deposits, NSCs eligible for surrender,KVP/IVP and life policies need not be treated as NPAs, providedadequate margin is available in the accounts.
Advances to StaffAdvances to Staff
Interest bearing staff advances as a banker should be included aspart of advances portfolio of the bank.
In the case of housing loan or similar advances granted to staffmembers where interest is payable after recovery of principal,interest need not be considered as overdue from the first quarteronwards.
Such loans/advances should be classified as NPA only when there isa default in repayment of installment of principal or payment ofinterest on the respective due dates.
The staff advances by a bank as an employer and not as a banker arerequired to be included under the sub-head ‘Others’ under theschedule of Other Assets.
Interest bearing staff advances as a banker should be included aspart of advances portfolio of the bank.
In the case of housing loan or similar advances granted to staffmembers where interest is payable after recovery of principal,interest need not be considered as overdue from the first quarteronwards.
Such loans/advances should be classified as NPA only when there isa default in repayment of installment of principal or payment ofinterest on the respective due dates.
The staff advances by a bank as an employer and not as a banker arerequired to be included under the sub-head ‘Others’ under theschedule of Other Assets.
Agricultural AdvancesAgricultural Advances As per the guidelines, Agricultural Advances are of two types,
(1) Agricultural Advances for “long duration” crops and(2) Agricultural Advances for “short duration” crops
The “long duration” crops would be crops with crop season longer thanone year and crops, which are not “long duration” crops would be treatedas “short duration” crops.
The crop season for each crop, which means the period up to harvesting ofthe crops raised, would be as determined by the State Level Bankers’Committee in each State.
The following NPA norms would apply to agricultural advances (includingCrop Term Loans):
A loan granted for short duration crops will be treated as NPA, if theinstallment of principal or interest thereon remains overdue for two cropseasons and,
A loan granted for long duration crops will be treated as NPA, if theinstallment of principal or interest thereon remains overdue for one cropseason.
As per the guidelines, Agricultural Advances are of two types,
(1) Agricultural Advances for “long duration” crops and(2) Agricultural Advances for “short duration” crops
The “long duration” crops would be crops with crop season longer thanone year and crops, which are not “long duration” crops would be treatedas “short duration” crops.
The crop season for each crop, which means the period up to harvesting ofthe crops raised, would be as determined by the State Level Bankers’Committee in each State.
The following NPA norms would apply to agricultural advances (includingCrop Term Loans):
A loan granted for short duration crops will be treated as NPA, if theinstallment of principal or interest thereon remains overdue for two cropseasons and,
A loan granted for long duration crops will be treated as NPA, if theinstallment of principal or interest thereon remains overdue for one cropseason.
COMPUTATION OF DRAWING POWERCOMPUTATION OF DRAWING POWER
Banks should ensure that drawings in the working capital accountare covered by the adequacy of the current assets.
Drawing power is required to be arrived at based on current stockstatement.
Stock statements relied upon by the banks for determining drawingpower should not be older than three months otherwise the DP isdeemed as irregular.
It needs to be ensured that the drawing power is calculated as perthe extant guidelines formulated by the BOD of the respective bankand agreed upon by the concerned statutory auditors.
The stock audit should be carried out by the bank for all accountshaving funded exposure of more than ` 5 crores.
Branches should obtain the stock audit reports from lead bank in thecases where the Bank is not leader of the consortium of workingcapital.
Banks should ensure that drawings in the working capital accountare covered by the adequacy of the current assets.
Drawing power is required to be arrived at based on current stockstatement.
Stock statements relied upon by the banks for determining drawingpower should not be older than three months otherwise the DP isdeemed as irregular.
It needs to be ensured that the drawing power is calculated as perthe extant guidelines formulated by the BOD of the respective bankand agreed upon by the concerned statutory auditors.
The stock audit should be carried out by the bank for all accountshaving funded exposure of more than ` 5 crores.
Branches should obtain the stock audit reports from lead bank in thecases where the Bank is not leader of the consortium of workingcapital.
AUDIT OF ADVANCESAUDIT OF ADVANCES
In carrying out audit of advances, the auditor is primarily concerned withobtaining evidence about the following:
◦ Amounts included in balance sheet in respect of advances areoutstanding at the date of the balance sheet.
◦ Amounts due to the bank are appropriately supported by Loandocuments and other documents as applicable to the nature of advances.
◦ There are no unrecorded advances.
◦ The stated basis of valuation of advances is appropriate and properlyapplied and that the recoverability of advances is recognised in theirvaluation.
◦ The advances are disclosed, classified and described in accordance withrecognised accounting policies and practices and relevant statutory andregulatory requirements.
◦ Appropriate provisions towards advances have been made as per theRBI norms, Accounting Standards and generally accepted accountingpractices.
In carrying out audit of advances, the auditor is primarily concerned withobtaining evidence about the following:
◦ Amounts included in balance sheet in respect of advances areoutstanding at the date of the balance sheet.
◦ Amounts due to the bank are appropriately supported by Loandocuments and other documents as applicable to the nature of advances.
◦ There are no unrecorded advances.
◦ The stated basis of valuation of advances is appropriate and properlyapplied and that the recoverability of advances is recognised in theirvaluation.
◦ The advances are disclosed, classified and described in accordance withrecognised accounting policies and practices and relevant statutory andregulatory requirements.
◦ Appropriate provisions towards advances have been made as per theRBI norms, Accounting Standards and generally accepted accountingpractices.
The auditor can obtain sufficient appropriate audit evidence aboutadvances by study and evaluation of internal controls relating toadvances, and by:
examining the validity of the recorded amounts;
examining loan documentation;
reviewing the operation of the accounts;
examining the existence, enforceability and valuation of thesecurity;
checking compliance with RBI norms including appropriateclassification and provisioning; and
carrying out appropriate analytical procedures.
In carrying out his substantive procedures, the auditor shouldexamine all large advances while other advances may be examinedon a sampling basis.
Advances which are sanctioned during the year or which areadversely commented by RBI inspection team, concurrent auditors,bank’s internal inspection, etc. should generally be included in theauditor’s review.
The auditor can obtain sufficient appropriate audit evidence aboutadvances by study and evaluation of internal controls relating toadvances, and by:
examining the validity of the recorded amounts;
examining loan documentation;
reviewing the operation of the accounts;
examining the existence, enforceability and valuation of thesecurity;
checking compliance with RBI norms including appropriateclassification and provisioning; and
carrying out appropriate analytical procedures.
In carrying out his substantive procedures, the auditor shouldexamine all large advances while other advances may be examinedon a sampling basis.
Advances which are sanctioned during the year or which areadversely commented by RBI inspection team, concurrent auditors,bank’s internal inspection, etc. should generally be included in theauditor’s review.
Evaluation of Internal Controls over Advances: The auditor shouldexamine the efficacy of various internal controls over advances todetermine the nature, timing and extent of his substantive procedures. Ingeneral, the internal controls over advances should include, inter alia, thefollowing:
The bank should make an advance only after satisfying itself as to thecredit worthiness of the borrower and after obtaining sanction from theappropriate authorities of the bank.
All the necessary documents (e.g., agreements, demand promissory notes,letters of hypothecation, etc.) should be executed by the parties beforeadvances are made.
The compliance with the terms of sanction and end use of funds should beensured.
Sufficient margin as specified in the sanction letter should be kept againstsecurities taken so as to cover for any decline in the value thereof.
If the securities taken are in the nature of shares, debentures, etc., theownership of the same should be transferred in the name of the bank andthe effective control of such securities be retained as a part ofdocumentation.
Evaluation of Internal Controls over Advances: The auditor shouldexamine the efficacy of various internal controls over advances todetermine the nature, timing and extent of his substantive procedures. Ingeneral, the internal controls over advances should include, inter alia, thefollowing:
The bank should make an advance only after satisfying itself as to thecredit worthiness of the borrower and after obtaining sanction from theappropriate authorities of the bank.
All the necessary documents (e.g., agreements, demand promissory notes,letters of hypothecation, etc.) should be executed by the parties beforeadvances are made.
The compliance with the terms of sanction and end use of funds should beensured.
Sufficient margin as specified in the sanction letter should be kept againstsecurities taken so as to cover for any decline in the value thereof.
If the securities taken are in the nature of shares, debentures, etc., theownership of the same should be transferred in the name of the bank andthe effective control of such securities be retained as a part ofdocumentation.
Drawing Power Register should be updated every month torecord the value of securities hypothecated. These entriesshould be checked by an officer.
The accounts should be kept within both the drawing powerand the sanctioned limit.
All the accounts which exceed the sanctioned limit ordrawing power or are otherwise irregular should be broughtto the notice of the controlling authority regularly.
The operation of each advance account should be reviewed atleast once a year, and at more frequent intervals in the case oflarge advances.
Drawing Power Register should be updated every month torecord the value of securities hypothecated. These entriesshould be checked by an officer.
The accounts should be kept within both the drawing powerand the sanctioned limit.
All the accounts which exceed the sanctioned limit ordrawing power or are otherwise irregular should be broughtto the notice of the controlling authority regularly.
The operation of each advance account should be reviewed atleast once a year, and at more frequent intervals in the case oflarge advances.
AUDIT OF REVENUE ITEMSAUDIT OF REVENUE ITEMS Audit Approach and Procedures
Banks recognise income (such as interest, fees and commission) onaccrual basis, i.e., as it is earned. It is an essential condition for accrualof income that it should not be unreasonable to expect its ultimatecollection.
In view of the significant uncertainty regarding ultimate collection ofincome arising in respect of NPA, the guidelines require that banksshould not recognize income on non-performing assets until it is actuallyrealised.
When a credit facility is classified as non-performing for the first time,interest accrued and credited to the income account in the correspondingprevious year which has not been realized should be reversed orprovided for. This will apply to Government guaranteed accounts also.
Audit Approach and Procedures
Banks recognise income (such as interest, fees and commission) onaccrual basis, i.e., as it is earned. It is an essential condition for accrualof income that it should not be unreasonable to expect its ultimatecollection.
In view of the significant uncertainty regarding ultimate collection ofincome arising in respect of NPA, the guidelines require that banksshould not recognize income on non-performing assets until it is actuallyrealised.
When a credit facility is classified as non-performing for the first time,interest accrued and credited to the income account in the correspondingprevious year which has not been realized should be reversed orprovided for. This will apply to Government guaranteed accounts also.
Interest on advances against Term Deposits, NSCs, KVPs and Lifepolicies may be taken to income account on the due date, providedadequate margin is available in the accounts.
In the case of bills for collection, the auditor should also examine theprocedure for crediting the party on whose behalf the bill has beencollected. The procedure is usually such that the customer’s account iscredited only after the bill has actually been collected from the draweeeither by the bank itself or through its agents, etc.
Fees and commissions earned by the banks as a result of re-negotiationsor rescheduling of outstanding debts should be recognised on an accrualbasis over the period of time covered by the re-negotiated or rescheduledextension of credit. Test checks the Interest earned by the banks forsample items.
Test check the Fees and commissions earned by the banks made forcommission on Bills for collection; Letters of credit; Bank Guarantees.
Interest on advances against Term Deposits, NSCs, KVPs and Lifepolicies may be taken to income account on the due date, providedadequate margin is available in the accounts.
In the case of bills for collection, the auditor should also examine theprocedure for crediting the party on whose behalf the bill has beencollected. The procedure is usually such that the customer’s account iscredited only after the bill has actually been collected from the draweeeither by the bank itself or through its agents, etc.
Fees and commissions earned by the banks as a result of re-negotiationsor rescheduling of outstanding debts should be recognised on an accrualbasis over the period of time covered by the re-negotiated or rescheduledextension of credit. Test checks the Interest earned by the banks forsample items.
Test check the Fees and commissions earned by the banks made forcommission on Bills for collection; Letters of credit; Bank Guarantees.
Reversal of IncomeReversal of Income
If any advance, including bills purchased and discounted, becomesNPA as at the close of any year, the entire interest accrued and creditedto income account in the past periods, should be reversed or providedfor if the same is not realised. This will apply to Governmentguaranteed accounts also.
In respect of NPAs, fees, commission and similar income that haveaccrued should cease to accrue in the current period and should bereversed or provided for with respect to past periods, if uncollected.
Further, in case of banks which have wrongly recognised income in thepast should reverse the interest if it was recognised as income duringthe current year or make a provision for an equivalent amount if it wasrecognized as income in the previous year(s).
Furthermore, the auditor should enquire if there are any large debits inthe Interest Income account that have not been explained. It should beenquired is there are any communications from borrowers pointing outdifferences in Interest charge, and whether action as justified has beentaken in this regard.
If any advance, including bills purchased and discounted, becomesNPA as at the close of any year, the entire interest accrued and creditedto income account in the past periods, should be reversed or providedfor if the same is not realised. This will apply to Governmentguaranteed accounts also.
In respect of NPAs, fees, commission and similar income that haveaccrued should cease to accrue in the current period and should bereversed or provided for with respect to past periods, if uncollected.
Further, in case of banks which have wrongly recognised income in thepast should reverse the interest if it was recognised as income duringthe current year or make a provision for an equivalent amount if it wasrecognized as income in the previous year(s).
Furthermore, the auditor should enquire if there are any large debits inthe Interest Income account that have not been explained. It should beenquired is there are any communications from borrowers pointing outdifferences in Interest charge, and whether action as justified has beentaken in this regard.
On Leased Assets: The finance charge component of finance income (as definedin AS 19 – Leases) on the leased asset which has accrued and was credited toincome account before the asset became non-performing, and remainingunrealised, should be reversed or provided for in the current accounting period.
On Take-out Finance: In the case of take-out finance, if based on record ofrecovery, the account is classified by the lending bank as NPA, it should notrecognize income unless realised from the borrower/taking-over institution (if thearrangement so provides).
On Partial Recoveries in NPAs:
In the absence of a clear agreement between the bank and the borrower for thepurpose of appropriation of recoveries in NPAs (i.e., towards principal or interestdue), banks are required to adopt an accounting policy and exercise the right ofappropriation of recoveries in a uniform and consistent manner. The appropriatepolicy to be followed is to recognise income as per AS 9 when certainty attachesto realisation and accordingly amount reversed/derecognised or not recognised inthe past should be accounted.
Interest partly/fully realised in NPAs can be taken to income. However, it shouldbe ensured that the credits towards interest in the relevant accounts are not out offresh/additional credit facilities sanctioned to the borrowers concerned.
On Leased Assets: The finance charge component of finance income (as definedin AS 19 – Leases) on the leased asset which has accrued and was credited toincome account before the asset became non-performing, and remainingunrealised, should be reversed or provided for in the current accounting period.
On Take-out Finance: In the case of take-out finance, if based on record ofrecovery, the account is classified by the lending bank as NPA, it should notrecognize income unless realised from the borrower/taking-over institution (if thearrangement so provides).
On Partial Recoveries in NPAs:
In the absence of a clear agreement between the bank and the borrower for thepurpose of appropriation of recoveries in NPAs (i.e., towards principal or interestdue), banks are required to adopt an accounting policy and exercise the right ofappropriation of recoveries in a uniform and consistent manner. The appropriatepolicy to be followed is to recognise income as per AS 9 when certainty attachesto realisation and accordingly amount reversed/derecognised or not recognised inthe past should be accounted.
Interest partly/fully realised in NPAs can be taken to income. However, it shouldbe ensured that the credits towards interest in the relevant accounts are not out offresh/additional credit facilities sanctioned to the borrowers concerned.
EXPENSESEXPENSES
Expenditure is to be shown under threebroad heads (1) Interest expended; (2) Operating expenses; and (3) Provisions and contingencies.
Expenditure is to be shown under threebroad heads (1) Interest expended; (2) Operating expenses; and (3) Provisions and contingencies.
Audit Approach and ProceduresAudit Approach and Procedures In carrying out an audit of Interest expended, the auditor is primarily
concerned with assessing the overall reasonableness of the amount byanalysing ratios
The auditor should obtain from the bank an analysis of various types ofdeposits outstanding at the end of each quarter. From such information,the auditor may work out a weighted average interest rate.
The auditor should also compare the average rate of interest paid onthe relevant deposits with the corresponding figures for the previousyears and analyse any material differences. The auditor should obtaingeneral ledger break-up for the interest expense incurred on deposits(savings and term deposits) and borrowing each month/quarter.
In carrying out an audit of Interest expended, the auditor is primarilyconcerned with assessing the overall reasonableness of the amount byanalysing ratios
The auditor should obtain from the bank an analysis of various types ofdeposits outstanding at the end of each quarter. From such information,the auditor may work out a weighted average interest rate.
The auditor should also compare the average rate of interest paid onthe relevant deposits with the corresponding figures for the previousyears and analyse any material differences. The auditor should obtaingeneral ledger break-up for the interest expense incurred on deposits(savings and term deposits) and borrowing each month/quarter.
The auditor should, on a test check basis, verify the calculation ofinterest and satisfy himself that:
◦ Interest has been provided on all deposits upto the date of thebalance sheet; and verify whether there is any excess or shortcredit of material amount.
◦ whether there are any changes in interest rate on saving depositsand term deposits during the period.
◦ Interest rates are in accordance with the bank’s internalregulations, of the RBI directives, and agreements with therespective depositors;
◦ In case of Fixed Deposits it should be examined whether theInterest Rate in the accounting system are in accordance with theInterest Rate mentioned in the Fixed Deposit Receipt/Certificate.
◦ Interest on Savings Account should be checked on a test checkbasis in accordance with the rules framed by the bank in thisbehalf.
◦ Interest on inter–branch balances has been provided at the ratesprescribed by the head office.
◦ Interest on overdue/ matured term deposits should be estimatedand provided for.
The auditor should, on a test check basis, verify the calculation ofinterest and satisfy himself that:
◦ Interest has been provided on all deposits upto the date of thebalance sheet; and verify whether there is any excess or shortcredit of material amount.
◦ whether there are any changes in interest rate on saving depositsand term deposits during the period.
◦ Interest rates are in accordance with the bank’s internalregulations, of the RBI directives, and agreements with therespective depositors;
◦ In case of Fixed Deposits it should be examined whether theInterest Rate in the accounting system are in accordance with theInterest Rate mentioned in the Fixed Deposit Receipt/Certificate.
◦ Interest on Savings Account should be checked on a test checkbasis in accordance with the rules framed by the bank in thisbehalf.
◦ Interest on inter–branch balances has been provided at the ratesprescribed by the head office.
◦ Interest on overdue/ matured term deposits should be estimatedand provided for.
For audit of Operating Expenses
The auditor should study and evaluate the system of internalcontrol relating to expenses, including authorisationprocedures in order to determine the nature, timing and extentof his other audit procedures.
The auditor should examine whether there are any DivergentTrends in respect of major items of Expenditure. The auditorshould perform an overall analytical review for the paymentsand provisions by month on month basis.
The auditor should also check the calculation whereverrequired and also assess the reasonableness of expenditure byworking out their ratio to total operating expenses andcomparing it with the corresponding figures for previousyears.
For audit of Operating Expenses
The auditor should study and evaluate the system of internalcontrol relating to expenses, including authorisationprocedures in order to determine the nature, timing and extentof his other audit procedures.
The auditor should examine whether there are any DivergentTrends in respect of major items of Expenditure. The auditorshould perform an overall analytical review for the paymentsand provisions by month on month basis.
The auditor should also check the calculation whereverrequired and also assess the reasonableness of expenditure byworking out their ratio to total operating expenses andcomparing it with the corresponding figures for previousyears.
For audit of Provisions and Contingencies The auditor should ascertain compliance with the various
regulatory requirements for provisioning as contained in thevarious circulars.
Obtain an understanding as to how the Bank computesprovision on standard assets and non-performing assets. Itwill primarily include the basis of the classification of loansand receivables into standard, sub-standard, doubtful, lossand non-performing assets.
For verification of provision on standard assets, we shouldverify the loan classification on a sample basis.
The auditor should obtain the tax provision computation fromthe bank’s management and verify the nature of items debitedand credited to profit and loss account to ascertain that thesame are appropriately considered in the tax provisioncomputation
For audit of Provisions and Contingencies The auditor should ascertain compliance with the various
regulatory requirements for provisioning as contained in thevarious circulars.
Obtain an understanding as to how the Bank computesprovision on standard assets and non-performing assets. Itwill primarily include the basis of the classification of loansand receivables into standard, sub-standard, doubtful, lossand non-performing assets.
For verification of provision on standard assets, we shouldverify the loan classification on a sample basis.
The auditor should obtain the tax provision computation fromthe bank’s management and verify the nature of items debitedand credited to profit and loss account to ascertain that thesame are appropriately considered in the tax provisioncomputation
