Statutory audit of banks(overview) 2017

Statutory Audit of Bank Branches 2017(Overview)

“Thane “

Presentation By Mr. Nikhil.S. Gupta

Statutory Audit (Bank) 2017

1. Co-ordination with Branch Management Co-ordination between the Auditor and the branch management is essential for

an effective audit, timely completion with the highest audit quality.

It is advisable that immediately after accepting the appointment, the SBA should send a formal communication to the branch management/HO accepting his appointment and other declarations and undertakings so required.

Further, the SBA should also specify the books, records, and other information that he would require in the course of his audit. Such a communication would enable the branch management to keep the réquisit documents, information, etc., Read.

Friday, 31 March 2017


2.Reliance on / review of other reports The auditor should take into account the adverse comments, if any, on advances

appearing in the following: Previous audit reports. Latest internal inspection reports of bank officials. Reserve Bank’s latest inspection Report/Asset Quality Review/ Risk Based Supervision report. Concurrent /internal audit report. Report on verification of security. Any other internal reports specially related to particular accounts. Manager’s charge-handing-over report when incumbent is changed.



3.CLASSIFICATION OF ADVANCES



Classification of advances

Sector wise

Priority

Non priority

Security wise

Secured

Unsecured

Prudential norms

Standard

NPA



Sector wise classification

Priority• Agriculture• Education• Housing• Export credits• MSME• Social Infrastructure• Renewable energy• Others

Non Priority• Sectors other than priority are

covered under non priority sector



Security wise classification

Security Wise classification

Secured Unsecured



PRUDENTIAL NORMS CLASSIFICATION

Classification of advances as per

Prudential Norms

Standard Loans

Standard Regular

Special Mention

Account (SMA)

NPA Loans

Substandard Doubtful Loss



Sub classification of NPA accounts

NPA accounts

Sub standard accounts

Cash credit/ OD account

Technical reason

Financial reason

Term loans

Doubtful Loss



4. Type of Advances and Nature of Security

Fund Based and Non-Fund Based Credit Facilities

Fund based credit facilities are those where, upon sanction, there is an actual outflow of funds from the bank to the borrower, whereas non-fund based facilities are those, at the time of sanction which do not involve such outflow of the bank’s fund.

Typical examples of fund based facilities are term loan, cash credit and overdraft and that of non-fund based facilities are letters of credit, bank guarantees, letter of comfort, etc.. Non-fund based facility may turn into a fund based facility on due date / occurrence of the specified event like devolvement of bills under LC, invocation of Bank Guarantee, etc..



Cash Credit Cash credit facility is provided usually to entities(borrowers) engaged in manufacturing

and / or trading activities to enable them to meet the gap in their working capital requirements. This facility is repayable on demand. The cash credit facility is generally granted against the security of stocks of goods (net of trade creditors), standing crops, bills / book debts representing genuine sales(restricted to pre-defined age of such book debts).

Working Capital Demand Loan (WCDL) WCDL is granted for a fixed period on the expiry of which it has to be liquidated,

renewed or rolled over. Depending on the terms of sanction the repayment of WCDL can either be in the form of instalments spread over the tenure of the facility or bullet payment at the end of the tenure of the loan,. As the nomenclature suggests, WCDL is generally granted to meet the gap in working capital requirement

Term Loans Term loans are repayable in instalments spread over a period of time excluding the

moratorium period, if granted.



The moratorium period is assessed by the lender based on future cash flows and requirements of borrower.

The amount and periodicity of repayment is fixed at the time of sanction and is duly recorded in the loan documents

The interest rate for loans may be either on ‘fixed’ terms’ in which event the rate contracted originally holds good during the entire currency of the loan, or it may be on ‘variable’ terms; which means that the rate may undergo changes at unspecified periods on happening of certain events as outlined in the loan agreement

The term loans are generally extended for the following purposes: For setting up of plants, acquisition of fixed assets like land and building, plant and

machinery, furniture, vehicles, implements, houses, consumer durables, etc.. For meeting expenses on education / medical treatment of self/dependants. For meeting other personal expenses. For meeting deficit in the net working capital requirements as assessed by the bank.

(WCTL) For Marketing / Launching / Branding etc.



Overdrafts The overdraft facility may be either secured or clean (i.e., without security) and does

not generally carry a fix repayment schedule. The most common form of security for an overdraft arrangement is term deposit receipts. In such cases, care is taken to ensure that lien marking is done in the system and also on physical fixed deposit receipt (and not on fixed deposit advice). Overdrafts may also be granted against other securities like immovable properties, life insurance policies, shares, bonds, NSCs, Kisan Vikas Patra, Indira Vikas Patra, etc..



5. Early Warning signals for wrong doings in the loan accounts Default in payment to the banks/ sundry debtors and other statutory bodies,

etc.., Bouncing of the high value cheques. Raid by Income tax /sales tax/ central excise duty officials. Frequent change in the scope of the project to be undertaken by the borrower. Under insured or over insured inventory. Dispute on title of the collateral securities Costing of the project which is in wide variance with standard cost of Funds coming from other banks to liquidate the outstanding loan amount. Foreign bills remaining outstanding for a long time and tendency for bills to

remain overdue.



Request received from the borrower to postpone the inspection of the godown for filmy reasons.

Delay observed in payment of outstanding dues. Financing the unit far away from the branch. Claims not acknowledged as debt high. Frequent invocation of BGs and devolvement of LCs. Funding of the interest by sanctioning additional facilities. Same collateral charged to a number of lenders. Concealment of certain vital documents like master agreement, insurance coverage. Floating front / associate companies by investing borrowed money. Reduction in the stake of promoter / director. Resignation of the key personnel and frequent changes in the management. Substantial increase in unbilled revenue year after year. Large number of transactions with inter-connected companies and large outstanding

from such companies. Significant movements in inventory, disproportionately higher than the growth in

turnover.



Substantial related party transactions. Material discrepancies in the annual report. Significant inconsistencies within the annual report (between various sections). Poor disclosure of materially adverse information and no qualification by the Frequent request for general purpose loans. Movement of an account from one bank to another. Frequent ad hoc sanctions. Not routing of sales proceeds through bank. LC’s issued for local trade / related party transactions. High value RTGS payment to unrelated parties. Heavy cash withdrawal in loan accounts. Significant movements in receivables, disproportionately higher than the growth in turnover and/or increase in ageing of the receivables. Disproportionate increase in other current assets. Onerous clause in issue of BG/LC/standby letters of credit. In Merchanting trade, import leg not revealed to the bank.



Mortgage the transfer of an interest in specific immovable property for the purpose of securing

the payment of money advanced by way of loan, an existing or future debt, or the performance of an engagement which may give raise to a pecuniary liability

Pledge It involves bailment or delivery of goods by the borrower to the lending bank with the

intention of creating a charge thereon as security for the advance.Hypothecation It refers to the creation of an equitable charge (i.e., a charge created not by an express

enactment but by equity and reason), which is created in favour of the lending bank by execution of hypothecation agreement in respect of the moveable securities belonging to the borrower

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 asset under lien.

6. Mode of Creation of Security



Hypothecation

• Goods not in physical control of bank

• Creation of charge in favor of bank through execution of hypothecation deed

Pledge

• Security under physical possession of bank

• E.g. Pledge of FDR, Gold

Assignment

• Transfer of right of property in favor of the bank

• E.g. Assignment of LIC policy

Set off

• Statutory right of the Bank to adjust balance lying in any deposit account of the borrower with the loan balance.

Mortgage

• Involves mortgage of immovable property

7.Comparison of Mode of Creation of Security and Types of Mortgage



Type of Mortgages

Registered Mortgage

Equitable Mortgage

Mortgage deed executed in favour of the Bank and registered with the appropriate authority

Created by simple deposit of title deed by the mortgagor with clear intention to create the mortgage in favour of the Bank

Refer next slide for verification process of

equitable mortgage



Search on CERSAI site by the branch official to confirm non encumbrance. Snap shot of the search to be kept as part of the documents.

Complete search of property documents by the panel advocate for the prescribed period. Original search receipt to be kept as part of documents.

Unqualified Legal Opinion certifying the genuineness of title deed of the property and the right of the seller to sell the property Valuation of property by the approved valuer. Valuation report to be accompanied by the photograph of the property. In case of

properties above Rs. 50 crore, 2 independent valuation reports required as per RBI Guidelines. Site verification by the branch official. Creation of Equitable Mortgage on basis of complete chain of title deed as prescribed by the advocate Payment of stamp duty as per the applicable state laws. Laminated title deeds to be avoided Certified true copy of title deed on basis of which mortgage created to be obtained from the office of the Registering Authority

and compared with the originals Registration with CERSAI within 30 days

8.Verification of Mortgage



9.Types of Securities

Personal Security of Guarantor Fixed and Floating Charges Margin Goods Documents of Title to Goods Gold Ornaments and Bullion Life Insurance Policies Immovable Property Third Party Guarantees



10.Procedure for Sanction, Disbursement, Supervision and Renewal of AdvancesSanction All procedures from submission of Application form till submission of relevant documents

and KYC’s)Credit Appraisal The proposal is evaluated in the context of the directions of the RBI including prudential

exposure limits and the bank’s own credit policy and risk management guidelinesDisbursement

Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI)

The auditor needs to keep abreast the mandatory requirements related to registration of mortgages and compliance thereof by the lender bank, as applicable to the various forms of securities offered as security for the advances.



11.Stages of loan

Pre Sanction Documentation Post Sanction



12.Pre-sanction



Proper application and other relevant papers – ITR, Balance Sheet, License, Address Proof, Partnership Deed proprietorship proof, IEC Registration, SSI registration, Memorandum and Articles of Association

Due diligence for identification of the borrower including pre sanction visit Verification of KYC documents with the originals Direct third party verification of documents Generation of CIBIL reports, reference to RBI defaulters list, ECGC caution list Satisfactory status report from the existing bankers, Credit risk rating done Site verification and valuation of immovable properties by approved valuer and branch official Assessment of limit as per the guidelines, Loan granted within the discretionary power Compliance of Bank’s lending policy stipulations, Compliance of take over norms Issuance of sanction letter and their acceptance by borrowers and guarantor

Pre Sanction



13.Documentation



Acceptance of terms of sanction by the borrower and guarantor All required documents executed. Entry in document register made Vetting of documents by panel advocate Creation of Equitable Mortgage as per the guidelines Charge registration with ROC in case of company Properly filled and signed by the borrower and guarantor. Proper value of stamp or stamp

paper to be used. Date of stamp paper to be before the date of execution Stamp Paper to be in the name of the borrower or the Bank Execution of documents by the legally competent persons Documents to be alive. Limitation period normally 3 years which can be extended through

execution of fresh documents, obtaining balance confirmation or by making part payment in the account. Documents on the printed format of the Bank. No computer generated documents except through LAPS (Loan Application Processing System).Persons not legally competent to execute the documents: Minor, Insolvent, Insane, Person of unsound mind, Heavily drunk person

Documentation



14.POST SANCTION



All terms of sanction duly complied with Disbursement as per the terms of sanction. Prescribed margin obtained. Rate of interest correctly fed in system

Applicable charges recovered Overdrawing's in the account need based, properly reported, within discretionary

power, adjusted in time, Primary securities created and necessary bills held as proof of purchase. Submission of stock statement at prescribed interval, calculation of DP as per lending policy. Stock audit in applicable cases. Balance confirmation letter at periodic intervals. Monitoring of operations in account . Prompt action in case of early warning signals including low turnover, frequent excess, frequent returning of cheques, huge cash deposits and withdrawals, frequent LC devolvement. Submission of statements of financial performance (QIS etc.). Insurance of primary and collateral securities. Renewal of working capital limits on annual basis

POST SANCTION



15.Loan to Value (LTV) ratio

In order to prevent excessive leveraging, the LTV ratio in respect of housing loans should not exceed 80 per cent.

However, for small value housing loans, i.e., housing loans up to Rs. 20 lakh (which get categorized as priority sector advances), the LTV ratio should not exceed 90 per cent.

The Master Circular RBI/2015-16/46/DBR.No.DIR.BC.13/08.12.001/ 2015-16 dated July 1, 2015 on Housing Finance, lays down that the following LTV ratios have to be maintained by banks in respect of individual housing loans



Category of Loan LTV Ratio (%)(a) Individual Housing LoansUp to Rs. 20 Lakh 90Above Rs. 20 lakh & up to Rs. 75 lakh 80

Above Rs. 75 lakh75

The LTV ratio should not exceed the prescribed ceiling in all fresh cases of sanction. In case the LTV ratio is currently above the ceiling prescribed for any reasons, efforts

should be made to bring it within limits.In nutshell, auditor at branch may keep following in mind to plan comprehensive coverage of advances. Obtain top 10 exposure accounts Obtain the list of stressed accounts (SMA2) Obtain the list of restructured accounts Obtain the list of unsecured exposures above Rs. 1 Cr Early mortality cases



16.Criteria for Classification of Various Types of Credit Facilities (a) Term Loans: A term loan is treated as a non-performing asset (NPA) if

interest and/or instalment of principal remain overdue for a period of more than 90 days.

(b) Cash Credits and Overdrafts: A cash credit or overdraft account is treated as NPA if it remains out of order as indicated above.

(c) Bills Purchased and Discounted: Bills purchased and discounted are treated as NPA if they remain overdue and unpaid for a period of more than 90 days.



(d) Securitisation: The asset is to be treated as NPA if the amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitisation transaction undertaken in terms of guidelines on securitisation dated February 1, 2006.

(e) Agricultural Advances: 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 and, 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.

(f) Credit Card Accounts: credit card account will be treated as non performing asset if the minimum amount due, as mentioned in the statement, is not paid fully within 90 days from the payment due date mentioned in the statement as per Circular DBR.No.BP.BC.30/21.04.048/2015-16 dated July 16 2015. It is further suggested by RBI that banks should follow this uniform method of determining over-due status for credit card accounts while reporting to credit information companies (CIC) and for the purpose of levying of penal charges, viz., late payment charges, etc., if any



17.Cash credit Important areas to be considered while auditing for cash credits are: Verification of drawing power Insurance Monitoring of accounts



DP exceeds sanctioned limit

DP lower than sanctioned limit

Amount allowed to withdraw

Sanctioned limit

Drawing Power

18.Verification of drawing power



Paid Stocks Debtors MarginDrawing Power

Paid Stocks is Stocks less trade payables

Method of calculation differs from Bank to bank

and governed by loan policy of each bank

19.Calculation of drawing power



Stock statements to be in the Bank’s prescribed format Submission of Stock Statement at prescribed interval Stock statement as on last date of the month. Age wise classification of Sundry Debtors No DP on book debts against associate concerns if stipulated in sanction Quarterly certification of book debts by the Statutory Auditors of the borrower. Detail of Sundry Creditors provided Stocks purchased under LC to be shown separately Margin calculated correctly Correct entry in system. Penal interest flag for non submission is “ Y”

20.Important points for verification stock statement



Stocks should be fully insured for all risks including fire, earthquake, burglary, terrorism etc.

Stocks at all locations including stocks with processors need to be covered under insurance

Bank’s clause in insurance policy

Validity period to be alive

21.Insurance



22.Revenue leakage exercise



Reve

nue

Leak

age

Processing Fee

Interest

Service Charges

Processing Fee:Non charging of Processing feeNon Charging of Processing fee for broken periodNon Charging of Processing fee on non fund based limits

Service Charges:Non charging of commitment chargesNon Charging of annual lead bank charges



Interest:

Non Charging of interest in the accountReversal of penal interest for non renewal due to back dated history changeLoan against FDR- Increase in rate of interest of FDR without corresponding change in the rate of interest of the Loan accountNon charging of penal interest for non submission of stock statement, non renewal of accountNon charging for penal interest for non compliance of terms of sanction like failure to obtain external rating Continuation of charging concessional rate of interest/applicable charges after the lapse of sanction Non charging commercial rate of interest from the date of release in export limits where export has not taken placeCharging of rate of interest lower than applicable rate of interestContinuation of charging simple interest instead of compounded interest in case of education loans where repayment has started



23. Operating Framework for Identifying and Dealing with FraudsThere are certain areas wherein frauds had shown occurrence or increasing trend in banks. These areas include:- loans/ advances against hypothecation of stocks. housing loans cases. submission of forged documents including letters of credit. escalation of overall cost of the property to obtain higher loan amount. over valuation of mortgaged properties at the time of sanction. grant of loans against forged FDRs. over-invoicing of export bills resulting in concessional bank finance, exemptions

from various duties, etc.. frauds stemming from housekeeping deficiencies.



24. Common fraud risk factors in deposit taking, dealing and lending activities

Deposit Taking

• Camouflage of depositors by hiding their identity in connection with funds transfer or money laundering.

• Unrecorded deposits, theft of customer deposits particularly, from dormant accounts.

Dealing

• Delayed deal allocation represented by no time stamping of deals or alterations or overwriting on deals sheets.

• Exploiting weaknesses in matching procedures due to absence of proper guidelines

Lending

• Loans to fictitious borrowers, transactions with connected companies, kick backs and inducements, Selling recovered collateral at below market prices.

• Theft or misuse of collateral held as security.



25. Money laundering (Three steps)

It involves introducing money in the financial system by some means.Placement

It means carrying out transactions generally complex to camouflage the illegal source.Layering

It means acquiring wealth generated from the transactions of the illicit funds.Integration



26. Methods in which money laundering takes place Breaking up of cash into smaller amounts and depositing it in to the bank below

the monitored reporting thresholds.

Physically moving the cash into locations or jurisdictions and depositing it in off shore banks with lesser stringent enforcement laws and regulations.

Using business typically known to receive revenue in cash to be used to deposit criminally derived cash.

Trade based laundering – Over or Under Invoicing.



27.Window-dressing

There are several ways in which the deposits of a bank may be inflated for purposes of balance sheet presentation.

For example, some of the constituents may be allowed overdraft on or around the date of the balance sheet, the overdrawn amounts may be placed as deposits with the bank, and Borrowings and Deposits further advances may be given on the security of the deposit receipts, thus inflating deposits as well as advances.

The transactions may be reversed immediately after the close of the year. Where the auditor comes across transactions, which indicate the possibility of window-dressing, he may report the same in his long form audit report. In appropriate cases, the auditor should consider making a suitable qualification in his main audit report also.



28.Inter Office Transactions

Issue of remittance instruments like drafts/TTs/MTs on other branches. Payment of remittance instruments like drafts/TTs/MTs drawn by other branches. Payment to / receipts from other branches of the proceeds of instruments

received/sent for collection /realization/clearing. Payments made under LCs of other branches.

Cash sent to/received from other branches. Payment of instruments like gift cheques/ banker’s cheques/ interest warrants/

dividend warrants/repurchase warrants/refund warrants / travellers cheques, etc. which are paid by the branch on behalf of other branches which have received the amount for payment of these instruments from the customers concerned.



Wrong identification of the nature of transaction. Recording of particulars in incorrect fields. Wrong accounting of bank charges, commission, etc. Errors in writing the amounts. Incorrect branch code numbers Incorrect schedule numbers. Recording the same transaction twice. Difference between the closing and opening balances in successive daily statements. Squaring off the transaction by same amount without checking the transactions

29.Following are the most common types of error in inter branch transactions.



30.Service tax Liability of Banks

Full Reverse Charge i.e. 100% amount of Service Tax Services provided by recovery agent; Sponsorship Services; Arbitral Tribunal and

Legal Services; Services provided by Director; Import of Services; Services of Transport of Goods by a Goods Transport Agency; Services by way of supply of manpower for any purpose; Security Services; Services by way of renting of a motor vehicle designed to carry passengers after availing prescribed abatement [which is presently 60% of the total amount charged]; and

Services by Government or a Local Authority excluding Renting of Immovable Property Services, Services by Department of Posts by way of speed post, express parcel post, life insurance and agency services, Services in relation to an aircraft or a vessel and Services of transport of goods or passengers



Partial Reverse Charge: In respect of the following taxable services 50% amount of applicable Service Tax to be paid by Bank under Partial Reverse. The remaining 50% of the applicable Service Tax shall be charged by the Service Provider in his/its

invoice. Works Contract Services Services by way of Renting of a motor vehicle designed to carry passengers without

availing the prescribed abatement i.e. on gross amount charged.



31. Bank Audit in Computerised Environment Existing Installation of software's Purchases Password Controls Day Start-up Activities Transaction Controls Personnel Controls Day End Activities



32.Illustrative list of data for Compiling LFAR Branch closing instructions. Instructions of Controlling Authorities w.r.t. various issues. Organisation chart. Authorisation level and powers of branch officials. Previous years’ audit report / LFAR / Tax audit report, inspection report of the

branch, concurrent audit report and compliance thereon. Various policies (Credit, Investment, Recovery etc.) Cash retention limit. Demonetization issues particularly non-compliances of RBI’s directives. Insurance for cash / cash-in-transit. Bank confirmations / bank reconciliations.



In case of advances of more than Rs. 2 crores sanctioned limit and outstanding balance. (both funded and non-funded)

List of all advances party-wise and limit-wise. List of outstanding facility-wise. List of NPA’s and provisioning thereon. List of overdues / overdrawing's. Cases of sanctions not disbursed. Cases of overdue proposals for review/renewal Cases wherein stock/ book debt statements and other periodic operational data and financial statements etc. not received/ not received

timely. Stock audit reports/ unit inspection reports. List of borrowers wherein inspection/ physical verification of securities charged

to bank have been carried out by the branch. List of non-corporate entities enjoying limit more than Rs.10 lakh. Valuation reports of NPA accounts where outstanding is more than Rs.1 crore

and valuation has been done prior to three years.



Status of claims lodged with ECGC/DICGC/CGST. Details of cases of compromise / settlement and write off involving write off /

waivers in excess of Rs. 50 Lakhs. Report in desired format of advances of more than Rs. 2 crores. List of accounts downgraded/ upgraded.(with outstanding in excess of Rs. 1 Crore) Listing of expired guarantees. Details of outstanding amount of guarantees invoked and funded by the Branch Details of outstanding amount of letters of credit funded by the branch. Stock register/ Insurance register/ Stationery draw power register/Cheque book

issuance register/ Cash book/ Sanction register/ Custody register/ DD issued register/ Document register.

Break up of suspense accounts. List of sundry deposits/ bills payables/suspense accounts. List of provisions / prepaid expenses. List of contingent liabilities



List of frauds and follow-up action. List of security items as at 31st March. List of fixed assets. Year-wise break-up of matured deposits. Schedule of charges (for booking of Income). System audit report, conducted, if any. Financial statements of all the quarters of the year under audit. List of computer system (configuration-wise) and accounting system in operation. List of MIS reports / returns submitted to various authorities. Overdue locker rents / vacant lockers. Cash withdrawals / deposits of more than Rs.10 lakhs. ATM cards / pin cards not issued and lying in stock. Cheque books not issued and lying in stock. Status of PC anti-virus upgrades. Number of inoperative accounts and the process of allowing operations thereon. Number of accounts maintaining balances below prescribed minimum. Details of customers complaints. System generated statement for documents time barred by limitation.



Any questions?



Contact details

– Mr. Nikhil Gupta

– Email ID: [email protected]

– Mobile: +91 7208568515



Disclaimer

The views expressed in the following presentation should not be construed as the view of ICAI or my firm.

The views opined herein should not be considered as a professional advice

This presentation should not be reproduced in part or in whole, in any manner or form, without my written permission.

The failure of such may attract civil or criminal liabilities.



Thank you


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Statutory audit of banks(overview) 2017