Statutory Bank Branch Audit - Technical and Practical Aspects

1
Statutory Bank Branch Audit - Technical and
Practical Aspects

• CA. Rajkumar S. Adukia
• radukia_at_vsnl.com /rajkumarfca_at_gmail.com
• http//www.carajkumarradukia.com
• 093230 61049/098200 61049

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Agenda

1. General
2. Pre commencement of work
3. Understanding the banking business
4. Audit Planning
5. Audit procedures
6. Audit Reports

3
General
4
History of banks

• In 1920 Imperial bank was established
• The Reserve Bank of India was established as the
  Central bank of the country in 1935 under an act
  called  Reserve Bank of India Act,1934
• In 1955, the Imperial Bank of India was
  nationalised and was given the name "State Bank
  of India".
• On the suggestions of Narsimham Committee, the
  Banking Regulation Act was amended in 1993 and
  thus the gates for the new private sector banks
  were opened.

5
Types of banks

1. Nationalised banks
2. Co-operative banks
3. Private sector banks
4. Foreign banks
5. Regional rural banks

6
Special kinds of business undertaken by bank
branches

1. Foreign exchange business
2. NPA recovery business
3. Service branches dealing in Clearing house
   operations business
4. Corporate banking and Industrial finance business
5. Personal banking business
6. Housing finance business
7. SSI business
8. Agricultural finance business

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Pre-commencement Work
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Pre-commencement Work

• Beginning of audit cycle is from receipt of
  appointment letter
• Check the compliance u/s. 226 (3) with regard to
  qualifications and disqualifications of auditors
• (concurrent ,Internal,Revenue,
  Stock,System, Credit Risk or other Special Audits
  conducted in same previous year)
• Decision for Acceptance or Rejection of
  Assignment ( Cost Benefit analysis, other
  considerations e.g. time available, expertise
  available)
• Communication with Previous Auditor by
  Registered AD (clause 8 of First Schedule to the
  Chartered Accountants Act, 1949
• Finding Out Expected date of submission of
  reports

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Pre-commencement Work

• Finding out Scope of work
• Issue of Engagement Letter under AAS 26.
• Copy of all circulars of RBI applicable to
  branch have to be obtained and kept ready for
  reference
• Attending bank branch audit seminars could
  enhance the auditors knowledge on bank audits
• Banking terminology and schemes should be well
  understood
• A reading of Guidance note on audit of banks by
  ICAI would provide valuable guidance.
• It should be ensured that minimum fees is set as
  per RBI circular dated 17th March 2004

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Disqualifications

• It should be ensured before accepting the
  assignment that you do not come into following
  category of persons ( Section 226(3) of Companies
  Act 1956)
• Body Corporate
• An officer or employee of the Bank
• A person who is a partner, or who is in the
  employment, of an officer or employee of the Bank
  
• A person who is indebted to the Bank for an
  amount exceeding one thousand rupees, or who has
  given any guarantee or provided any security in
  connection with the indebtedness of any third
  person to the bank for an amount exceeding one
  thousand rupees
• person holding any security of that bank,
  Security means an instrument which carries
  voting rights.

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Understanding the Banking Business
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Knowledge of bank business

• The auditor needs to obtain a level of knowledge
  of bank business that will enable him to identify
  the events, transactions and practices that may
  have significant effect on the financial
  information
• Knowledge of bank business can be obtained from-
• 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

13
Knowledge of bank business

• Usage of knowledge of bank business
• To develop an overall audit plan
• To identify areas of special audit consideration
• To evaluate the reasonableness of accounting
  estimates and management representations
• To make judgments regarding the appropriateness
  of accounting policies and disclosures

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Letter seeking information

• Before actual commencement of audit a letter
  may be written to the management of bank asking
  for following information
• Organizational chart of bank and bank branch
• List of departments in the bank branch along with
  name of head of department.
• Authority and responsibility of each officer in
  the bank
• Special feature of each banking product
• Areas where work has been outsourced to outsiders

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Letter seeking information

1. Copies of last year annual accounts and current
   year quarterly/half yearly accounts
2. Information of top 10 borrowers for each kind of
   loan
3. Instructions issued by Head office for closing of
   accounts
4. Details of software used by bank
5. List of reports generated by the software
6. Accounting policy followed by the bank
7. Copy of day book

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Areas where special knowledge about the business
of Bank Branch is required

• Special Features of Banking Business
• Special audit considerations in bank branch
  audits
• Laws applicable to the banking business
• Internal controls in banks
• Additional Controls for Computerised Environment
• Accounting System
• Accounting standards applicable to bank
• Formats of Financial Statements ( as per schedule
  III section 29 of Banking Regulation Act ,1949)
• Important Circulars of RBI

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Peculiar features of banking business

• Custody of large volumes of monetary items,
  including cash and negotiable instruments, whose
  physical security has to be ensured
• Deals in a large volume and variety of
  transactions in terms of both number and value.
• Operate through a wide network of branches and
  departments, which are geographically dispersed
• The nature of business which makes it susceptible
  to Frauds by Customers.

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Special audit considerations in bank branch
audits

• Effect of the statutory and regulatory
  requirements
• The scale of banking operations and the resultant
  significant exposures
• Extensive dependence on IT to process
  transactions
• Continuing development of new services and
  banking practices
• Particular nature of risks associated with the
  transactions undertaken by banks

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Internal controls in bank branch

1. Work of one staff member is invariably supervised
   / checked by another staff member, irrespective
   of the nature of work
2. Banks have a system of job rotation among staff
3. The financial and administrative powers of each
   official / each position are fixed and
   communicated to all persons concerned
4. Branch managers have to send periodic
   confirmation to their controlling authority on
   compliance of the laid down systems and
   procedures.

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Internal controls in bank branch

• All branches of a bank have a unique code number
  which is circulated amongst all offices of the
  bank
• All books are to be balanced periodically.
  Balancing is to be confirmed by an official
• Particulars of lost security forms are
  immediately advised to controlling so that they
  can exercise caution
• Fraud prone items like currency, valuables,
  draft forms, term deposit receipts, travellers
  cheques and other such security forms are in the
  custody of at least two officials of the branch

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Additional Controls for Computerised Environment

1. The system maintains a record of all log-ins and
   log-outs
2. If the transaction is sought to be posted to a
   dormant (or inoperative) account, the processing
   is halted and can be proceeded with only with a
   supervisory password
3. The system checks whether the amount to be
   withdrawn is within the drawing power.
4. The system flashes a message if the balance in a
   lien account would fall below the lien amount
   after the processing of the transaction

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Additional Controls for Computerised Environment

• Access to the system is available only between
  stipulated hours and specified days only.
• Individual users can access only specified
  directories and files
• Exception situations such as limit excess,
  reactivating dormant accounts, etc. can be
  handled only with a valid supervisory level
  password.
• A user timeout is prescribed
• Once the end-of-the-day process is over, the
  ledgers cannot be opened without a supervisory
  level password

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Laws applicable to the banking business

1. Banking Regulation Act, 1949
2. Banking Companies (Acquisition and Transfer of
   Undertakings) Act, 1970
3. Banking Companies (Acquisition and Transfer of
   Undertakings) Act, 1980
4. State Bank of India Act, 1955
5. State Bank of India (Subsidiary Banks) Act, 1959
6. Regional Rural Banks Act, 1976
7. Companies Act, 1956
8. Co-operative Societies Act, 1912 or the relevant
   state Co-operative Societies Act.

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Laws applicable to the banking business

• Information Technology Act, 2000 
• Prevention of Money Laundering Act, 2002
• Credit Information Companies Regulation Act, 2005
• Securitisation and Reconstruction of Financial
  Assets and Enforcement of Security Interest Act,
  2002
• Banking Cash Transaction Tax (Chapter VII of
  Finance Act, 2005)
• Service Tax (Chapter V of Finance Act,1994)
• Income Tax Act ,1961
• Securities Transaction tax (Chapter VII of
  Finance (No 2) Act , 2004

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Laws applicable to the banking business

• Regulations relating to Foreign exchange
• FEMA 1999 Notifications ( Nos 1,3,5,8,23 and 26)
• Master circular issued by RBI on exports and good
  of services dated 1st Oct 2005
• Master circular issued by RBI on Rupee export
  credit and export credit in foreign currency
  dated 1st July 2005
• Foreign Trade Policy 2004-09
• FEDAI Guidelines
• Banks Internal Guidelines
• Four categories of Transactions are usually
  undertaken at a branch -
• Export related transactions
• Import related transactions
• Remittances (Inward/Outward)
• Treasury Operations (Dealing Room/Investments)
• The bank is required to take an undertaking under
  section 10(5) of FEMA, 1999 from the applicant to
  ascertain and satisfy itself about the purpose of
  transaction

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Application of other laws not barred

• As per the section 2 of Banking Regulation Act
  ,1949 the provisions of this Act shall be in
  addition to, and not, in derogation of the
  Companies Act, 1956 , and any other law for the
  time being in force
• The provisions of the other laws shall apply to
  all proceedings unless they are inconsistent with
  the Banking Regulation act,1949

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Accounts and balance-sheet

• Sub-section (1) of section 29 of the Banking
  Regulation Act, 1949 requires every banking
  company to prepare a balance sheet and a profit
  and loss account in the forms set out in the
  Third Schedule to the Act or as near thereto as
  the circumstances admit.
• Form A of the Third Schedule to the Banking
  Regulation Act, 1949, contains the form of
  Balance Sheet
• Form B contains the form of Profit and Loss
  account

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Contents of Balance sheet (Form A)

• Schedule 1 Capital
• Schedule 2 Reserve and surplus
• Schedule 3 Deposits
• Schedule 4 Borrowings
• Schedule 5 Other Liabilities and provisions
• Schedule 6 Cash and bank balance with RBI
• Schedule 7 Balance with bank and money at
  call and short notice
• Schedule 8 Investments
• Schedule 9 Advances
• Schedule 10 Fixed Assets
• Schedule 11 Other Assets
• Schedule 12 Contingent Liability

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Classification of Advances as per schedule 9

• 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     

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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

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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

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Some disclosure items in balance sheet

1. Capital Adequacy Ratio
2. Movements in NPAs
3. Movement of provisions held towards NPAs
4. Business (deposits plus advances) per employee
5. Maturity Patterns of deposits, borrowings, loans
   and advances
6. Exposures to real estate sector,Capital market
7. Disclosure of Penalties imposed by RBI
8. Details of Single Borrower/Group Borrower Limit
   exceeded by the bank

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Contents of Profit and Loss accounts (Form B)

• Schedule-13 Interest Earned
• Schedule-14 Other income
• Schedule-15 Interest expended Schedule
• Schedule-16 Operating expenses

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Types of accounting softwares

• Stand alone branch-level packages
• Multi-branch solutions
• Foreign branches
• Packages for specialized areas
• Packages for Service branch
• IT services like KYC
• Some of the softwares used by banks are Finacle
  (Infosys), Bancs (TCS), and Flex cube (I Flex)

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Possible Segments in bank business as per AS-17

• Business segments
• Treasury
• Other bank operations
• Residual operations
• Geographic Segments
• Domestic
• International

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Possible Related party in banks as per AS-18

• Parent
• Subsidiaries
• Associates/ Joint ventures
• Key management personnel
• Relatives of key management personnel

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Circulars issued by RBI

• Disclosure in balance sheets dated July 1, 2006
• Prudential norms on Income recognition,asset
  classification and provisioning relating to
  advances dated 1st July 6
• Management of advances dated January 22, 2007
• Loans and advances-statutory and other
  restrictions dated 1st July 2006
• Guarantees and co-acceptances dated July 1,2006
• Guidelines for securitisation of standard assets
  dated 1st Feb 2006
• Prudential Norms on Capital Adequacy dated July
  1,2006
• Para-banking Activities dated July 1,2006
• Exposure norms dated October 10 ,2006
• Cash Reserve ratio and Statutory Reserve ratio
  dated October 11,2006
• Provisioning Requirement for Standard Assets
  dated Feb 19, 2007

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Definition of Non performing assets as per
Circular dated 01-07-06

• An asset, including a leased asset, becomes
  non-performing when it ceases to generate income
  for the bank (Para 2.1.1)
• A non-performing asset (NPA) is a loan or an
  advance where
• interest and/ or instalment of principal remain
  overdue for a period of more than 90 days in
  respect of a term loan
• the account remains out of order in respect of
  an Overdraft/Cash Credit (OD/CC) 

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Definition of Non performing assets as per
Circular dated 01-07-06

• the bill remains overdue for a period of more
  than 90 days in the case of bills purchased and
  discounted
• a loan granted for short duration crops will be
  treated as NPA, if the instalment of principal or
  interest thereon remains overdue for two crop
  seasons.
• a loan granted for long duration crops will be
  treated as NPA, if the instalment of principal or
  interest thereon remains overdue for one crop
  season. (Para 2.1.2 )

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INCOME RECOGNITION on NPA

• Income from non-performing assets (NPA) is not
  recognised on accrual basis but is booked as
  income only when it is actually received (Para
  3.1.1)
• The Accounting Standard 9 (AS 9) on Revenue
  Recognition' issued by the Institute Of Chartered
  Accountants of India (ICAI) requires that the
  revenue that arises from the use by others of
  enterprise resources yielding interest should be
  recognized only when there is no significant
  uncertainty as to its measurability or collect
  ability.

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INCOME RECOGNITION on NPA

• Interest on advances against term deposits, NSCs,
  IVPs, KVPs and Life policies may be taken to
  income account on the due date, provided adequate
  margin is available in the accounts (Para 3.1.2)
• Fees and commissions earned by the banks as a
  result of re-negotiations or rescheduling of
  outstanding debts should be recognised on an
  accrual basis over the period of time covered by
  the re-negotiated or rescheduled extension of
  credit (Para 3.1.3)

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Reversal of income

• If any advance becomes NPA as at the close of any
  year, interest accrued and credited to income
  account in the corresponding previous year,
  should be reversed or provided for if the same is
  not realised.(Para 3.2.1)
• This will apply to Government guaranteed accounts
  also.
• Fees, commission and similar income that have
  accrued should cease to accrue in the current
  period and should be reversed or provided for
  with respect to past periods, if uncollected.
  (Para 3.2.2)

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Categories of NPA

• Classification is only for the purpose of
  computing the amount of provision that should be
  made with respect to bank advances and certainly
  not for the purpose of presentation of advances
  in the banks balance sheet

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Categories of NPA

• Sub-standard Assets - which has remained NPA for
  a period less than or equal to 12 months (Para
  4.1.1)
• Doubtful Assets - has remained in the
  sub-standard category for a period of 12 months
  (Para 4.1.2)
• Loss Assets - loss has been identified by the
  bank or internal or external auditors or the RBI
  inspection but the amount has not been written
  off wholly. (Para 4.1.3)

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Provisioning norms

• The primary responsibility for making adequate
  provisions for any diminution in the value of
  loan assets, investment or other assets is that
  of the bank managements and the statutory
  auditors. (Para 5.1.1)
• The assessment made by the inspecting officer of
  the RBI is furnished to the bank to assist the
  bank management and the statutory auditors in
  taking a decision in regard to making adequate
  and necessary provisions in terms of prudential
  guidelines.(Para 5.1.1)

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Provision on standard assets

• The banks should make a general provision of a
  minimum of 0.40 percent on standard assets on
  global loan portfolio basis
• Banks would continue to make provision at 0.25
  per cent for direct advances to agricultural and
  SME sectors in the standard category (as per
  circular issued by RBI on 8th of Nov 2005)
• A small scale industrial unit is an undertaking
  in which investment in plant and machinery does
  not exceed 1 crore except in certain specified
  items under hosiery,hand tools, drugs.
  Pharmaceuticals. Stationery items and sport goods
  where investment limit has been extended to Rs. 5
  crore
• Units with investment in Plant and machinery in
  excess of SSI limit and upto Rs 10 crore may be
  treated as medium enterprise (circular dated
  19/08/2005)

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Provision on sub standard assets (Para 5.4)

• A general provision of 10 percent on total
  outstanding should be made
• The unsecured exposures which are identified as
  substandard would attract additional provision
  of 10 per cent.
• The provisioning requirement for unsecured
  doubtful assets is 100 per cent.
• Unsecured exposure is defined as an exposure
  where the realisable value of the security, as
  assessed by the bank is not more than 10 percent

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Provision on Doubtful assets( Para 5.3)

• 100 percent of the extent to which the advance is
  not covered by the realisable value of the
  security
• In regard to the secured portion, provision may
  be made on, at the rates ranging from 20 percent
  to 100 percent of the secured portion depending
  upon the period for which the asset has remained
  doubtful

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Provision on Doubtful assets( Para 5.3) Contd
Period for which the advance has remained in doubtful category Provision requirement ()
Up to one year 20
One to three years 30
  More than three years (i) outstanding stock of NPAs as on March 31, 2004     (ii) advances classified as doubtful more than three years on or after April 1, 2004 60 per cent with effect from March 31, 2005 75 per cent with effect from March 31, 2006 100 per cent with effect from March 31, 2007 100 percent with effect from March 31, 2005
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Provision on Loss assets (Para 5.2)

• Loss assets should be written off. If loss assets
  are permitted to remain in the books for any
  reason, 100 percent of the outstanding should be
  provided for

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Audit Planning
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Importance of Audit Planning

• Well planned is half done
• One should know destination to plan well
• Good planning leads to effective reporting. Audit
  destination is report ( to express opinion on
  financial statements)
• Audit planning helps in controlling audit risks

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Considerations for overall audit Plan

1. The terms of his engagement and any statutory
   responsibilities
2. The nature and timing of reports or other
   communication
3. The applicable legal or statutory requirements
4. The accounting policy adopted by bank and changes
   in these polices
5. The identification of significant audit areas
6. The degree of reliance he expects to be placed on
   accounting systems and internal control

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Considerations for overall audit Plan

• The nature and timing of audit evidence obtained
• The work of internal auditors and extent of their
  involvement
• The involvement of expert
• The allocation of work to be undertaken between
  joint auditors and procedures for its control and
  review
• Establishing and coordinating staffing
  requirements

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Audit Programme

• An audit program can contain following columns
• Particulars
• Closing Balance
• Sample Size
• Criteria for selection of data in sample
• Date/ Months/ Period
• Action to be taken
• Person In charge

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Audit Procedures
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Audit Procedures

• 1.   Inspection
• 2.   Observation
• 3.   Inquiry confirmation
• 4.   Computation
• 5. Analytical Procedures
• Audit Documentation and Audit Evidence are
  outcome of Audit procedures AAS 3 and AAS 5

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Inspection and observations

• Inspection consists of examining records,
  documents, or tangible assets
• The auditor inspects in order to
• Be satisfied as to the physical existence of
  material negotiable assets that the bank holds
• Obtain the necessary understanding of the terms
  and conditions of agreements (including master
  agreements) that are significant individually or
  in the aggregate in order to
• - Consider their enforceability and
• - Assess the appropriateness of the accounting
  treatment they have been given.

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Inquiry and Confirmation

• The auditor inquires and confirms in order to
• Obtain evidence of the operation of internal
  controls
• Obtain evidence of the recognition by the banks
  customers and counter parties of amounts, terms
  and conditions of certain transactions
• Obtain information not directly available from
  the banks accounting records.

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Key ratios for analysis

• Non-performing loans to total loans
• Cash and liquid securities (for example, those
  due within 30 days) to total assets
• Interest income as a percentage of average
  interest bearing assets
• Non-interest expense as a percentage of operating
  income
• Capital adequacy ratios
• Return on average total assets

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Analytical procedures

• Analytical procedures consist of the analysis of
  significant ratios and trends including the
  resulting investigation of fluctuations and
  relationships that are inconsistent with other
  relevant information or deviate from predicted
  amounts
• By using analytical procedures, the auditor may
  detect circumstances that call into question the
  appropriateness of the going concern assumption,
  such as undue concentration of risk in particular
  industries or geographic areas and potential
  exposure to interest rate, currency and maturity
  mismatches.

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Verification of Advances

1. General
2. Verification of Advances against goods
3. Verification of advances against fixed deposits
4. Verification of advances vehicles
5. Verification of advances immovable property
6. Verification of advances against insurance policy
   
7. Verification of advances against shares
8. Verification of advances against bills purchased
   and discounted

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1. Verification of loans and advances (General)

• Check the individual balance in each loan ledger
  with the trial balance book
• 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

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Verification of loans and advances (General)

• Examine that advances represent amount due to the
  bank
• All the necessary documents (e.g., agreements,
  demand promissory notes, letters of
  hypothecation, etc.) should be executed by the
  parties before advances are made
• Advances are classified in such a way that
  information required in schedule 9 of Banking
  Regulation Act, 1949 can be gathered.

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2.Verification of advances against goods

• Examine the stock statements and ascertain that
  the loans availed is with in the drawing
  power/limits sanctioned
• Verify that letter of hypothecation has been
  executed in favour of bank
• Verify that charge is duly registered with ROC in
  case of loan on hypothecation to limited company
  
• Verify the fire insurance policy and ascertain
  that polices are alive as at 31st March 2006
• Banks should have a system in place to ensure
  that the borrower does not avail the advantage
  double financing on same stock, i.e., financing
  from bank for the portion of stock not paid to
  the creditors

66
3. Verification of advances against fixed
deposits

• See that banks lien have been marked on deposit
  receipts as in their respective ledger folio
• See that no advance is granted against duplicate
  receipt without proper verification
• In case of advances against deposit receipts of
  other branches ,to verify the intimation to that
  branch to mark the lien and to see that the same
  has been acknowledged by other branch
• See that deposit receipts /pass books/ cash
  certificates have been duly discharged in favor
  of bank at the time of discharge

67
4. Verification of advances against vehicle

• Verify the copies of registration certificate
• See that vehicle has been comprehensively insured
  and verify the bankers clause in insurance
  policy
• Test check the original certificate and ascertain
  that endorsement is made in favor of bank

68
5.Verification of advances against immovable
property

• Go through the legal opinion of banks lawyer
  about title of property to the borrower
• Verify the latest tax receipts towards the
  payment of property tax and verify the
  encumbrance certificate
• Verify the valuation reports for the fixed assets
  charged to bank
• Verify whether building has been properly insured
  and policy has been taken in the joint name of
  bank and the mortgagor

69
6.Verification of advances against insurance
policy

• Scrutinise the insurance policy and ascertain the
  surrender value
• If surrender value is subject to payment of
  certain premium the amount of such premium has
  been deducted from the surrender value
• Verify the latest premium receipts
• Verify whether policies have been duly assigned
  by the insured in favour of bank and assignment
  is noted by insurance company

70
7. Verification of advances against shares

• Loan against security of shares to individuals
  should not exceed Rs 10 lakh per individual
  borrower in case securities are in physical form
  and Rs 20 lakh if securities are held in demat
  form (Para 3.4.3 of Master circular exposure
  norms)
• A uniform margin of 50 shall be applied on all
  advances against shares ( Para 3.4.6 )
• Bankers lien should be noted in Demat account of
  the client
• If the person in whose name the securities are
  registered is other than the borrower, the bank
  satisfy itself that the person has a good title
  to the security. The bank also obtains a letter
  of renunciation from the person in whose name the
  securities are registered.

71
8.Verification of advances against bills
purchased and discounted

• All the outstanding bills have been taken in the
  balance sheet
• All the details, including the nature of the
  bills and documents, are mentioned in the
  register and that the bills have been correctly
  classified
• The bills purchased or discounted from different
  parties are in accordance with the agreements
  with them and the total of outstanding bills of
  each party is not in excess of the sanctioned
  limit
• 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

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Advances against working capital

• The assessment of working capital requirement of
  borrowers, other than SSI units, requiring fund
  based working capital limits upto Rs.1.00 crore
  and SSI units requiring fund based working
  capital limits upto to Rs.5.00 crore from the
  banking system may be made on the basis of their
  projected annual turn over (Para 2.1 of
  Management of advances)
• The working capital requirement is to be assessed
  at 25 of the projected turnover(including excise
  duty) to be shared between the borrower and the
  bank, viz. borrower contributing 5 of the
  turnover as net working capital (NWC) and bank
  providing finance at a minimum of 20 of the
  turnover.(Para 2.2)
• For example, in case, annual turnover of a
  borrower is projected at Rs. 60.00 lakh, the
  working capital requirement will be computed at
  Rs. 15.00 lakh (i.e. 25) of which Rs. 12 lakh
  (i.e. 20) may be provided by the banking system,
  while Rs. 3.00 lakh (i.e. 5 ) should be
  borrower's contribution towards margin money.
  (Para 2.6)

73
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
  (Para 6.8 of Management of advances )

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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 not in conformity with the
  terms of sanctions
• 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 corporates by whatever
  modalities
• Routing of funds through any bank other than the
  lender bank or members of consortium without
  prior permission of the lender
• Investment in other companies by way of acquiring
  equities / debt instruments without approval of
  lenders
• Short fall in deployment of funds vis-à-vis the
  amounts disbursed / drawn and the difference not
  being accounted for.
• (Para 6.3 of management of advances )

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Documentation

• A certificate stating that the Branch did not
  hold any investments on behalf of the Head Office
  (if there are no such investments held by the
  Branch
• 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
• A copy of the letter from Head Office regarding
  Sanction limit of the Branch Manager

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Documentation

• List of cases where the Branch has not obtained
  stock/book debts statements at the end of the
  year
• List of cases where insurance copies are yet to
  be received at the end of the year
• A copy of the Head office instructions for
  identification of NPAs and classification of
  advances
• List of major items pending for reconciliation
  under Inter-Branch Accounts
• List of all fraud cases reported to RBI as fraud
  upto March 31st

77
Documentation AAS 3

• Following certificates should be obtained from
  management
• Cash Retention Limit duly certified by the Branch
  Manager
• A photo copy each of the confirmation
  certificates for Balances with RBI, SBI and other
  banks
• A copy of the reconciliation statement in respect
  of differences in such balances with RBI, SBI and
  other banksList of overdue or matured
  investments at the end of the year duly confirmed
  by the Branch Manager

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Computer Assisted Audit Techniques (CAAT)

• CAAT are computer programs and data that the
  auditor uses as part of the audit procedures to
  process data of audit significance, contained in
  an entitys information systems
• CAAT may be used in performing various
  auditing procedures, including the following
• Tests of details of transactions and balances,
  for example, the use of audit software for
  recalculating interest or the extraction of
  invoices over a certain value from computer
  records

79
Computer Assisted Audit Techniques (CAAT)

• Analytical procedures, for example, identifying
  inconsistencies or significant fluctuations
• Tests of general controls, for example, testing
  the set-up or configuration of the operating
  system or access procedures to the program
  libraries or by using code comparison software to
  check that the version of the program in use is
  the version approved by management
• Sampling programs to extract data for audit
  testing
• Reperforming calculations performed by the
  entitys accounting systems.

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Audit Reports
81
Various Reports/Certificates

1. Tax Audit Report
2. Position of Advances above certain amount
3. PMRY Audit Certificate
4. DICGC Certificate
5. Verification on Friday Statements
   Certificate(Form X sec 27)
6. Service Tax Certificate
7. Income on Insurance Business
8. Frauds

82
Various Reports/Certificates(Contd.)

• Ghosh Committee Recommendations
• Jilani Committee Recommendations
• LFAR
• MOC-Classification
• MOC-Income Recognition
• Other reports
• AUDIT REPORT- U/S 30 OF The Banking Regulation
  Act,1949 r.w.s.228(3) of the Companies Act,1956

83
Special purpose certificates in banks

• Certificate for advances to infrastructure
  project and income generated thereon
• Certificate of reconciliation of securities by
  the bank
• Certificate of advances exceeding 10 crores
• Certificate pertaining to credit/deposit ratio
• Certificate of cash and bank balances

84
Plan for each Report separately

• Effective planning requires separate plan for
  each report
• Find out common data and interlinking in various
  reports
• (Jilani committee is on internal control
• Ghosh committee is on Fraud, EDP controls,
  internal Checks
• LFAR has many issues on internal control it is
  like audit programme and check list)

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LFAR

• Reserve bank of India (RBI) advised the current
  format of LFAR (LFAR) for the banks from their
  auditors vide circular number DBS.CO.PP.BC.11/11.0
  1.005/2001-2002 dated April 17, 2002
• This report is not substitution of the statutory
  report, neither a part of the said report. LFAR
  is actually a management Report.
• Matters required to be reported by the auditor in
  LFAR are illustrative not exhaustive
• The Statutory Branch Auditors should address LFAR
  to Chairman of Bank, Copy to Central Statutory
  Auditors (Para 1 of LFAR)
• At times though audit qualifications are included
  in the LFAR, they are not highlighted in the main
  Audit Report Every adverse comment would not
  result in Qualification in main audit report.
  Auditor has to use his professional judgment
  having regard to the facts and circumstances of
  each case. (Para 3 of LFAR Questionnaire)

86
Major Clauses in LFAR

• I Assets
• 1. Cash
• 2. Balance with RBI ,SBI and other banks
• 3. Money at call and short notice
• 4. Investments
• 5. Advances
• 6. Other Assets
• II Liabilities
• 1. Deposits
• 2. Other Liabilities
• 3. Contingent liabilities
• III Profit and Loss account

87
Major Clauses in LFAR

• IV General
• 1. Books and records
• 2. Reconciliation of Control and subsidiary
  records
• 3. Inter branch accounts
• 4. Audits/ Inspections
• 5. Frauds
• 6. Miscellaneous
• Questionnaires Applicable to Specialized Branches
• For Branches dealing in Foreign Exchange
  Transactions
• For Branches dealing in very large advances in
  excess of Rs. 100 crores
• For Branches dealing in Non Performing Assets
  such as Asset Recovery Management Branches.
• For Branches dealing in Clearing House
  Operations, normally referred to as Service
  Branches

88
Ghosh Committee

• High level Committee on fraud and malpractice in
  banks under chairmanship of Shri A. Ghosh ex
  deputy governor
• To enquire into various aspects of frauds and
  malpractices in bank
• To make recommendations to reduce such incidence.
  
• Committee submitted report in June,1992
• The report is divided into Groups A,B,C,D with A,
  B and D having 2 parts each, Group C having one
  part.
• Out of 97 Recommendations 27 required to be
  reported exclusively at Branch level, 43
  exclusively at RO/ZO/HO level and 27 at both
  levels

89
Four groups under Ghosh Committee

• Group A -Recommendations which have to be
  implemented by the banks immediately
• Group B- Recommendations requiring RBI approval
• Group C- Recommendations requiring approval of
  Government of India
• Group D Recommendations requiring further
  examination in consultation with IBA

90
Main objectives of Ghosh Committee

• Safety of assets
• Compliance with laid down policies and procedures
• Proper segregation of duties and responsibilities
  of staff
• Timely prevention and detection of frauds and
  malpractices

91
Jilani Committee

• Working group to review the internal control and
  inspection and audit system in banks under the
  chairmanship of Mr. Rashid Jilani. The committee
  submitted its report in July 1995
• Objective was to review the efficacy and
  adequacy of internal control and inspection and
  audit system in a bank with a view to
  strengthening the supervisory system and
  reliability of data
• The Implementation form is divided into 25
  points,10 of them are applicable on a Bank
  branch.

92
S No Recom no in WG report Nature of recommendation Implementation Status at Branch Implementation Status at RO\ZO Implementation Status at HO
13 39 Follow up on major/serious irregularities detected during Concurrent audit to be immediately taken up with HO. Time bound plan for rectification should be made. Fraudulent transactions to be reported to vigilance/ chief of inspection
14 41 Small and Medium sized Branches to rectify irregularities pointed out during inspection/audit within 4 months
93
S No Recom no in WG report Nature of recommendation Implementation Status at Branch Implementation Status at RO\ZO Implementation Status at HO
15 44 Auditors and inspector to get the majority of irregularities rectified during their stay at branches concerned and guide them with it.
16 45 Immediate action to be taken to plug gaps in serious irregularities\Revenue leakages which have surfaced due to loopholes in existing procedures
94
S No Recom no in WG report Nature of recommendation Implementation Status at Branch Implementation Status at RO\ZO Implementation Status at HO
19 53 Appropriate Control Measures should be devised and documented to prevent the computer system from attack of unscrupulous elements.
20 54 Various Tests to be carried out to ensure that EDP applications have resulted in consistent and reliable system for inputting, processing and generation of output of data
95
S No Recom no in WG report Nature of recommendation Implementation Status at Branch Implementation Status at RO\ZO Implementation Status at HO
22 59 Entire domain of EDP activities be brought under scrutiny of Inspection and Audit department.
23 61 For bringing about uniformity of software, a formal method of change be approved by the management.
96
S No Recom no in WG report Nature of recommendation Implementation Status at Branch Implementation Status at RO\ZO Implementation Status at HO
24 71 Completion of enquiries expeditiously and bringing to book delinquent staff so as to deter other from frauds. Internal vigilance machinery to be strengthened and reviewed by board every 6 months
25 74 Regular checking by inspectors and auditors to verify correctness of information regarding asset classification, Income recognition and provisioning.
97
Reporting under Banking Regulation act,1949

• As per section 30(3) of a banking regulation act
  ,1949 an auditor is required to state in his
  report of a banking company incorporated in India
  the following --
• (a) whether or not the information and
  explanations required by him have been found to
  be satisfactory
• (b) whether or not the transactions of the
  company which have come to his notice have been
  within the powers of the company

98
Reporting under banking regulation act ,1949

• (c) whether or not the returns received from
  branch officers of the company have been found
  adequate for the purposes of his audit (not
  applicable to bank branch)
• (d) whether the profit and loss account shows a
  true balance of profit or loss for the period
  covered by such account
• (e) any other matter, which he considers should
  be brought to the notice of the shareholders of
  the company

99
Non applicability of CARO, 2003

• Statement of companies (Auditors Report )
  order 2003 is not applicable to banking company
  as defined in clause (c) of section 5 of Banking
  regulation act.1949
• Banking company means any company, which
  transacts the business of banking in India
• Any company which is engaged in the manufacture
  of goods or carries on any trade and which
  accepts deposits of money from the public merely
  for the purpose of financing its business as such
  manufacturer or trader shall not be deemed to
  transact the business of banking

100
PEER REVIEW CONSIDERATIONS

• Compliance with technical standards
• Office system and procedure
• Quality of reporting
• Training of staff
• Quality Review Board ( Proposed Section 28A to 28
  D )
• All services will be covered

101

• THANK YOU