Audit of Advances & NPA - Critical Aspects 01 May 2020bangaloreicai.org/assets/uploads/newsletters/779b... · Net NPA ratio 6.9 8 4.8 Particulars 2016-17 2017-18 2018-19 No. of banks

01 May 2020

Audit of Advances & NPA - Critical Aspects

01 May 2020

CA Gautam ShahKhimji Kunverji & Co LLP

CA Gautam Shah 1

Structure of Presentation

▪ Setting the Context

▪ COVID-19 Impact

▪ FY: 2020

▪ Banking Frauds

▪ Branch Audit - Advances

▪ Non-Performing Asset

▪ Case Study

01 May 2020 CA Gautam Shah 2

01 May 2020

Setting the Context

CA Gautam Shah 3

01 May 2020

Governed by Banking Regulation Act, 1949 (e.g. Presentation and disclosures(Schedule III))

Regulated by the Reserve Bank of India (e.g. Prudential norms etc. )

Key characteristics of a Bank are:

• Acceptance of deposits → commercial lending activity + treasury/investment activity

• Conduct of business and operations is either centralised at head officeand/or decentralised in branches;

• Significant dependence on technology due to very high volumes and highdegree of automation of operations

Key characteristics of a Bank

CA Gautam Shah 4

Reserve Bank of India

Scheduled Banks

Commercial Bank

Foreign Bank (46)

RRB

(53)

Public Sector Bank

(18)

Private Sector Bank *

(39)

Co-op Bank (77)

01 May 2020

*Includes Small Finance Banks and Payment Banks

Banking Facts

CA Gautam Shah 5

01 May 2020

Particulars 2016-17 2017-18 2018-19

No. of banks 27 21 18No. of offices 91,445 90,821 87,860Deposits* 80,76,800 82,62,322 84,86,215Advances* 55,57,200 56,97,350 59,26,286CRAR 12.1 11.7 12.2Net NPA ratio 6.9 8 4.8

Particulars 2016-17 2017-18 2018-19

No. of banks 21 21 22No. of offices 24,661 28,805 32,375Deposits* 25,64,800 30,13,688 37,70,013Advances* 22,19,500 26,62,753 33,27,328CRAR 15.5 16.4 16.1Net NPA ratio 2.2 2.4 2.0

Public Sector Bank (*Rs in Crore)

Private Bank (*Rs in Crore)

Source: RBI

Banking Facts

CA Gautam Shah 6

01 May 2020

April 01, 2017

State Bank of India’s Merger with its 5 associate banks as well as Bhartiya Mahila Bank

April 01, 2019

Bank of Baroda’s Merger with Vijaya Bank and Dena Bank

April 01, 2020

Merger of 10 PSU Banks into 4 large banks

PSBs – Mega Mergers in recent times

CA Gautam Shah 7

Merger of Banks – Bank’s Ranking

01 May 2020

SN Bank Names Business (Rs. in Trillion) Market share (%)

1 State Bank of India 52.05 22.5

2 Punjab National Bank + Oriental Bank of Commerce + United Bank of India

17.95 7.7

3 HDFC Bank 17.50 7.6

4 Bank of Baroda (Post merger) 16.13 7.0

5 Canara Bank + Syndicate Bank 15.20 6.6

6 Union Bank + Andhra Bank + Corporation Bank

14.59 6.3

7 ICICI Bank 12.72 5.5

8 Axis Bank 10.60 4.6

9 Bank of India 9.04 3.9

10 Indian Bank + Allahabad Bank 8.08 3.5

Note: Figures till March 2019

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01 May 2020

COVID-19 Impact

CA Gautam Shah 9


COVID-19 impact: Moody’s changes

outlook on Indian banks to negativeThe Indian banks’ asset quality will deteriorate, says theinvestors services agencyMoody’s Investors Service on Thursday changed the outlook forIndian banking system to negative from stable, as it expectsdeterioration in banks’ asset quality due to disruption ineconomic activity from the Coronavirus outbreak.It said Banks’ asset quality will deteriorate across thecorporate, small and medium enterprises and retail segments,leading to pressure on profitability and capital.

The Economic Times

Impact of COVID-19: Taking a toll on global banking systemDecreased productivity and lockdowns have already startedto take a toll on the financials of the corporate sector. Supplychain disruptions, manufacturing hindrances and crippledhealth systems need a hefty public fund/stimulus to continueoperations smoothly.Income from tourism, entertainment sectors among manyothers has already crippled the economic situation. Factorslike these are all adding up to strain the global economywhich might also have its repercussions in the year ahead.

Accenture Report

COVID-19 & Audit Approach

https://www.thehindu.com/topic/coronavirus/



Source: BDO Study April 2020


01 May 2020

▪ Challenges in Audit▪ Timelines for Audit▪ Financial Statement Close Process of the Branches▪ Cash Verification▪ Availability of Data & Documents – Use of IT Tools▪ Alternate Audit Procedures▪ Reporting – Audit Report or LFAR

▪ Impact of COVID-19 on borrower – Resulting Impairment▪ Tourism Industry▪ Airlines▪ Theaters ▪ Malls & Real Estate

▪ Controls may have jeopardized, needing more professional skepticism

CA Gautam Shah 12

01 May 2020

Banking Frauds

CA Gautam Shah 13

No. of Frauds cases reported by RBI regulated entities in the Banking sector

Frauds- Statistics

01 May 2020

Bank Group/Institution2017-18 2018-19

No. of CasesAmount Involved

No. of CasesAmount Involved

Public Sector Banks 2,885 38,260.87 3,766 64,509.90Private Sector Banks 1,975 2,478.52 2,090 5,515.10Foreign Banks 974 256.00 762 955.30Financial Institutions 12 164.70 28 553.40Total 5,916 41,167.00 6,801 71,542.90

(Rs. in crore)

Source: RBI

CA Gautam Shah 14

Frauds in Various Banking Operations Based on the Date of Reporting (At end-March)

Frauds- Statistics

01 May 2020

(Cases in number and amount in Rs. crore)

2016-17 2017-18 2018-19

No. Amt. No. Amt. No. Amt.

Advances 2,322 20,561 2,525 22,558 3,606 64,548

Card/Internet 1,372 42 2,059 110 1,866 71

Deposits 695 903 691 457 593 148

Cash 239 37 218 40 274 56

Others 153 77 138 242 197 244

Cheques/DD 235 40 207 34 189 34

Off- balance sheet 5 63 20 16,288 33 5,538

Clearing, etc accounts 27 6 37 6 24 209

Foreign exchange transactions 16 2,201 9 1,426 13 695

Non-resident accounts 11 3 6 5 3 0

Inter-branch accounts 1 1 6 1 3 0

Total 5,076 23,934 5,916 41,167 6,801 71,543

CA Gautam Shah 15

Top 10 list of Borrowers flagged as wilful default and reported by banks under CRILC reporting as on April 30 2019

(Rs. in Crore)

01 May 2020

SN Borrower Default Amount

1 GITANJALI GEMS LIMITED 5,044

2 REI AGRO LIMITED 4,197

3 WINSOME DIAMONDS AND JEWELLERY LIMITED

3,386

4 RUCHI SOYA INDUSTRIES LIMITED 3,225

5 ROTOMAC GLOBAL PRIVATE LIMITED 2,844

6 KINGFISHER AIRLINES LIMITED 2,488

7 KUDOS CHEMIE LIMITED 2,326

8 ZOOM DEVELOPERS PRIVATE LIMITED 2,024

9 DECCAN CHRONICLE HOLDINGS LIMITED 1,951

10 SIDDHI VINAYAK LOGISTIC LIMITED 1,349

TOTAL 28,834

Banking Facts – Wilful Default

CA Gautam Shah 16

▪ Scam amounting to Rs. 6,500 crore or over 70 % of all of the bank’sadvances. A scam of under-reporting of NPAs.

▪ Huge loan to the Housing Development and Infrastructure Ltd (HDIL) andits group entities. This fraud case is related to transfer of 70 per cent ofthe total credit facilities of the PMC bank to HDIL and its associatedcompanies which is against RBI lending norms.

▪ The bank had created around 21,049 new accounts by bogus names toconceal 44 loan accounts which had ideally become NPAs. The bank'ssoftware was also tampered to conceal these loan accounts.

▪ In 2018-19, the bank had reported a net profit of Rs. 99.69 crore in itsannual report. The bank showed 3.76 per cent (or Rs. 315 crore) ofadvances, (Rs. 8,383 crore) as gross non-performing assets (NPAs), whichwas good performance as compared to public-sector banks. However, it isnow clear that the bank presented false financial reports to hide the badloan mess and the alleged collusion with HDIL and other companies.

Recent Case – PMC Bank (Sept 2019)


▪ Action against the Auditor:

▪ Arrest by EOW for not raising the red-flags over suspicious entries inits books and exposure to HDIL;

▪ EOW has written to the ICAI to take disciplinary action

▪ Amendment to Banking Law:

▪ Reserve bank to have control over Co-operative banks;

▪ Move to ensure better professionalism and corporate governance;

▪ RBI can supersede management if co-operative bank fails;

▪ Will protect interest of depositor;

▪ Cooperative banks to be audited as per RBI Rule;

▪ Prior nod from RBI required for CEO appointment

Impact of PMC Bank:


▪ The group had a total external debt of Rs.94,216 Crore. Of the total debt,about Rs.57,000 Crore is from Public Sector Banks.

▪ In July 2018, IL&FS subsidiary IL&FS Transport had delayed Rs.450 Crore ofrepayment to SIDBI. This is where the IL&FS Crisis started.

▪ On 1st October, NCLT has allowed the Govt. of India to take control of thecompany and its matter. Govt. of India had sacked the IL&FS board.

▪ Investigation by SFIO ordered into the affairs of the IL&FS and filed its firstcharge sheet against the top officials and directors of IL&FS, its Auditorsand others in the IL&FS Financial Services (IFIN) fraud case.

▪ The entire banking system witnessed the biggest liquidity freeze in Indiadue to collapse of IL&FS. The liquidity shortage across banks and NBFCshas led to a situation where most NBFCs are now struggling for survival.

Recent Case: IL&FS (Sept 2018)


▪ Off-Balance Sheet Fraud

▪ Fake bank guarantee in excess of Rs.13,800 crore. They received creditfrom the overseas banks to fund their business/imports.

▪ In March 2018, the RBI scrapped banking instruments such as Letter ofUndertaking. The Government has also approved the Fugitive EconomicOffenders Bill to stop economic offenders from escaping Indian Law.

▪ The gems and jewellery sector continues to be hurt by constrained accessto bank finance

▪ PNB posted standalone loss of Rs 492.28 crore for the December quartercompared with a profit of Rs 246.51 crore in the same period last year.Raising the alarm, the provisions for the quarter jumped 73.25% y-o-y toRs. 4,445.36 crore from Rs. 2,565.77 crore.

Recent Case – PNB Scam & Gitanjali Group (Feb 2018)


▪ Interlinking various databases and information systems

▪ To improve the fraud risk management framework for banks:

• the master directions on frauds shall be revised

• workshops will be conducted on frauds

• fraud registry will be made more user-friendly; and

• fraud analytics will be improved

▪ Data on frauds are currently collected from payment systemoperators.

RBI Measures on Frauds:

01 May 2020

Source: RBI

CA Gautam Shah 21

01 May 2020

Bank Branch Audit

CA Gautam Shah 22

01 May 2020

Banking Structure

CA Gautam Shah 23

Bank Audit ProcessBranch’s financial statement gets consolidated to RO

RO to Zone

Zone to Bank’s Financial Statements

While auditing the bank’s financial statements, Statutory Central Auditor rely onthe Bank’s Branch Auditor’s report and same fact is also mentioned in the auditreport for the Bank as whole

SA 600 – Permits Auditor to rely on work of Component Auditors

Hence Branch Auditors is Responsible for Financial Statements, RBICompliances, NPAs, Restructured Advances of the Branch


Key Steps in Branch Audit

Deliverables of Bank Branch Auditors

1. Branch’s Balance Sheet

2. Branch’s Profit and Loss Account

3. Branch’s Audit Report

4. Branch’s LFAR

5. Branch’s Tax Audit

6. Returns as per closing instructions of Bank

7. Certificates as per closing instructions of the Bank


Key Steps in Branch Audit◼ Appointment Formalities – Engagement Letter with Bank Branch, NOC

◼ Read Circular issued by HO. It covers many important aspects

◼ Attend Meeting organised by HO. SCAs highlights imp aspects in Meeting

◼ Planning Meeting with Branch Manager

▪ Understand Operations of the Branch

▪ Meet all operations head and audit co-ordinator

▪ Ask for previous year financials, LFAR, CY Internal Audit Report, RBI audit report and any other audit conducted during the year

▪ Any major event or changes during the year

▪ Any NPA, Restructuring during the year – get brief about same

▪ Discussion on sanctioning and monitoring process

▪ Brief discussion on IT system and process

▪ Internal circulars from Controlling Authority


01 May 2020

Advances

CA Gautam Shah 27

Introduction

▪ Major Activity of BANK

▪ Largest ACCOUNT CAPTION in ASSETS

▪ Major Source of INCOME

▪ Most FOCUSED Audit Area – Requires knowledge of overall economy, industry etc..

▪ Can SUBSTANTIALLY CHANGE the financial results

▪ Time consuming, AUDIT PLANNING is essential

▪ Master Circulars of RBI


Banks Financials


Schedule 31-03-2020CAPITAL AND LIABILITIESCapital 1 11 00 00Reserves and surplus 2 33 00 00Deposits 3 357 50 00Borrowings 4 93 50 00Other liabilities and provisions 5 55 00 00

TOTAL 550 00 00ASSETS

Cash and balances with Reserve Bank of India 6 33 00 00Balances with banks and money at call and short notice 7 22 00 00Investments 8 137 50 00Advances 9 302 50 00Fixed assets 10 27 50 00Other assets 11 27 50 00

TOTAL 550 00 00

65%

17%

25%

55%

Advances- Bird’s eye view


Classification of Loan Assets - Bank Group-wise

01 May 2020

Bank Group

EndMarc

h

Standard Assets Sub-StandardAssets

Doubtful Assets Loss Assets

Amt. Percent

Amt. Percent

Amt. Percent

Amt. Percent

PSBs 2018 46,02,125 84.5 2,05,340 3.8 5,93,615 10.9 46,521 0.9

2019 50,86,874 87.8 1,37,377 2.4 5,06,492 8.7 66,239 1.1

PVBs 2018 24,50,552 96.0 27,203 1.1 69,978 2.7 5,243 0.2

2019 31,03,581 95.2 42,440 1.3 1,04,696 3.2 9,576 0.3

FBs 2018 3,49,475 96.2 3,831 1.1 8,364 2.3 1,635 0.5

2019 3,94,699 97.0 3,163 0.8 7,985 2.0 1,034 0.3

All SCBs

2018 74,02,152 88.1 2,36,374 2.8 6,71,957 8.0 53,398 0.6

2019 85,85,154 90.2 1,82,980 1.9 6,19,173 6.5 76,849 0.8

Percentages given above is a per cent to gross advances

Source: RBI

(Amount in Rs. Crore)

CA Gautam Shah 31

Audit Approach▪ Extent would depend on assessment of EFFICACY of internal control

▪ Examine all large advances i.e. which are lower of following Criteria ▪ 5% of Advances ▪ Rs.2 crore

▪ Verify all problematic accounts, potential NPAs

▪ Verify advances which are adversely commented by/in –• Previous Audit Report/ LFAR• Internal/ Concurrent Auditors• Banks Inspection Report (including RBI Inspection)• Report on Verification of Security (Stock Audit, etc.)• Accounts from SMA Reporting


Audit Approach

• Exchange Information report from Consortium/Multiple Bankers

• Any other report related to the particular advance

• Branch Manager’s charge handing over report

• Branches control returns to higher authorities concerning overdrawing , adhoc sanctions, Probable NPAs Report, etc

▪ Verify fresh advances granted during the year (if retail high volume then do sample basis)

▪ Verify compliance of Restructuring Norms and its asset classification

▪ Accounts upgraded from NPA to Standard – Full Recovery


▪ Existence of clearly laid down delegation of authority

▪ Existence of clearly laid down eligibility criteria for loans

▪ Existence of system of communicating the terms ofsanction to the borrower

▪ Existence of system of execution of documents beforedisbursement

▪ Existence of system of post disbursement monitoring andreporting irregularity

▪ Existence of system for implementation of IRAC Norms

▪ Adequate control on changing of interest rates, terms andconditions, etc. in CBS environment

Audit of Advances 3401 May 2020

Evaluation of Internal Control

CA Gautam Shah 34

Major Areas of Considerations

Pre Sanction

▪ Application▪ Credit Appraisal

▪ Sanctioning/Disbursement▪ Documentation

Post sanction

▪ Review/Monitoring▪ Asset classification▪ Provisioning Norms▪ Income Recognition

▪ Restructuring


Finacle MenusFinacle: Important Menus for Advances

ACLI

ACI

HACLI

AINTRPT

LTL

ACCBAL

CUSTBALP

ACLPCA


To view accounts ledger

Drawing Power, Sanction Limit

Interest Report

Verifying day end balances

Generate customer balance report as on date

Customer Account Ledger

List of Accounts under one SOL ID

To verify Advances details viz interest, terms of payment

Accounting of Advances:

01 May 2020

Date Particulars INR INR INR

02-02-2020 Cheque No-01530 - M/s Sundar Vora 20,000,000 - 20,000,000

03-02-2020 Cheque No-01580 - M/s Govind Prasad 10,000,000 30,000,000

25-02-2020 Transfer from M/s Retail Private Limited 10,000,000 20,000,000

28-02-2020 Int from 01-02-2020 to 28-02-2020 206,738 - 20,206,738

01-03-2020 Recovery of Interest from SB Account 2580 206,738 20,000,000

25-03-2020 Transfer to Current A/c- 2350 15,000,000 - 35,000,000

31-03-2020 Int from 01-03-2020 to 31-03-2020 346,789 - 35,346,789

04-04-2020 Transfer from Current A/c- 2350 15,000,000 20,346,789

CA Gautam Shah 37

Verification of Loan Documents:

01 May 2020

Documents Relevance - Why? Objective – What?

Credit Approval note and Sanction letter for Loan facility

• Terms and conditions attached to the loans;

• To evaluate the compliance with the credit policy and other regulatory/internal circulars

External Agency Reports (Legal Report/Valuer Report/CIBIL Report/CRILIC Report)

• Credit risk evaluation;• Security risk-title and

value;

• To evaluate the credit worthiness & compliance with internal parameters;

• To evaluate the security coverage (RBI/Internal parameters-LTV ratio)

Internal Inspection report

• Fraud risk & genuineness of borrower;

• To evaluate the Existence of Security charged with bank;

Post disbursement compliance

• Perfection of Security and registration of charge

• To verify the registration and creation of charge in favor of bank

CA Gautam Shah 38

01 May 2020

Detailed verification Process:SN Particulars Verification Process

1 Previous year Reports & Documents:• Previous Year LFAR &

Audit Report• Concurrent Audit /

Internal Auditor's report

• HO/RO Inspection Reports

• RBI Inspection Report• Special Audit

Scrutinise these reports and identify any accounts whichmay need special attention ( i.e. leads to credit weakness)- excess withdrawal,- frequent cheque return accounts,- irregular stock statements,- non-compliance to sanction terms (with respect tosecurity).

Accounts reflecting in these reports should form a part ofthe sample list for verification of advances.

2 Pre-Audit work ▪ Review of Closing Circular issued by Head Office▪ Study of Significant accounting policies of the Bank &

computer system▪ Study of Business mix of the Branch & determination

of the sample size and percentage of checking in eacharea

▪ Intimation in writing whether given to the Branch

CA Gautam Shah 39

01 May 2020


Manager regarding requirements for audit anddocuments to be kept ready for audit including for LFAR,Tax Audit Report and Certification.

3 SMA Reports Advances Monitoring Report generated at Branch levelwhich aims to identify the stress accounts. Scrutiniseeach account to know whether the same has slipped intoNPA or if not whether it has been kept standard byunusual transaction that cannot be termed as businesstransaction.

4 Sample Selection Top accounts on the basis of outstanding amount as onthe quarter end. At least few samples of each type offacility are covered under selected samples.

5 Sanction Letter The sanction letter states that the Bank is ready toproceed with the approval of a loan and includes thefollowing details:• Total loan amount to be sanctioned• Tenure for the loan repayment

CA Gautam Shah 40

01 May 2020


• Applicable interest rates – fixed or floating Rate ofInterest (ROI)

• Actual applied ROI• Base Rate for interest calculation• Applicable EMI or Pre-EMI amount• The validity period of the sanction letter• Terms and Conditions of the lenderThe sanction letter does not mean a legal approval of theloan. The validity of the sanction letter varies fromorganization to organization but usually valid from 30 daysto 60 days.

6 Loan documents as required by sanction letter

Auditor should verify whether:• All the particulars in the documents have been filled in.• All the particulars filled in are correct.• Signature and acceptance from the borrower has been

obtained including the sanction letter.• Branch official concerned have verified & authorized that

all the documents have been duly obtained.

CA Gautam Shah 41

01 May 2020


• Creation of charge – ROC site• Board resolutions – authorizing signatory• Borrower and Guarantors papers

7 Verification of Advances ▪ Scrutinise the operations of the ledger account of eachsample to check:

• transfer from/transfer to other accounts,• frequent cheque returns,• excessive withdrawal,• turnover in account is disproportionate to sale in

business,• transfer of funds to group concern,• regularity of payment,• utilisation of amount (CC/OD facility), DP computation• penal interest in case of default

▪ Look into the group companies, directors, etc andfacilities provided to such related parties. Any potentialNPA case in the group could affect the status of other

CA Gautam Shah 42

01 May 2020


companies in that group. One can refer the followingwebsites for the purpose:✓ Watchout Investor: for all news related to the industry in

which the borrower seeks loan✓ Tofler: to obtain knowledge about the related parties of

the borrower and various other information

▪ To ensure utilisation of loan funds by the borrower,obtain End use certificate provided by a CharteredAccountant (if prescribed in sanction terms) andcompare the same with the disclosure in the financialstatements - cash flow statements & CARO report (enduse clause) of the borrower.

▪ Adverse comments in audit report of the borrowingcompany should be correlated with the terms of thesanction of loan.

CA Gautam Shah 43

01 May 2020


▪ Check other documentations like project report, auditedFS, cash flows etc to understand the business of theborrower. Obtain knowledge of that industry to identifypotential risks and also assesement of impact of changein Government Rules & Regulations.

CA Gautam Shah 44

Key Check Points

▪ Review of limits increased and decreased during the period

▪ Understand the inherent weakness of the borrower depending on the sector it belongs and the current situation in the economy (E.g. COVID 19)

▪ Monitor the Projections made by the borrower vis a vis actuals presented in audited financial Statements

▪ Check the status of the Project for which the loan is funded


▪ Review the end use certificate considering the purpose ofloan. Don’t just check the receipt and non receipt of the same.

▪ Review the Changes in internal Rating of the borrower andunderstand the reason for the change.

▪ Read the communications sent by the bank to themanagement or vice versa.

▪ Review the Stock statements in a manner to understand themovement of both the stock and debtors and not merely thetimely collection of it by the bank.

▪ For advances in the nature of credit card, understand the typeof transaction made as end use of funds is very important insuch products.

Key Check Points


▪ Ensure the borrower is legally compliant with any applicable Lawsand Regulations.

▪ Change in any terms of the loan should be evaluated consideringthe possibility of Restructured Account.

▪ Review the minutes internal meetings and understand if anyborrower was discussed for any matter and consider it for yoursample testing.

▪ Read the credit appraisal note properly and monitor the rating▪ Map the Deposits with the advances, borrower-wise▪ Check if there is no window dressing done by the bank by inflating

the advances and deposits by availing the unutilized sanction limit▪ Read, observe, ask questions and learn to make well informed

judgments

Key Check Points


Challenges for AuditorsInformation System

Lack of visible evidenceRisk of undetected system errors and bugsHidden Frauds in SystemRetrieving information and assessing implementation of computer related process

Application

Compliances with KYC Norms

Loan sanctioned to a Company which in turn provides finance toindividual farmers without ensuring compliance with KYCrequirements. Auditor should verify KYC documents on test basis


Challenges for AuditorsDocumentation

Consortium Banking: Original Document

In Case of consortium advances, original documents like Consortiumloan agreements, Security Valuation report, etc. are kept by leadbankers

Auditor should ensure copy of all the original documents should bekept by member banks

System of Centralised storage/documentation

Some of the Banks have system of maintaining documents atcentralised location

Auditor should ensure to visit that location and verify thatdocuments or get them at the branch


Challenges for AuditorsDocumentation

Execution of documents in local languageSome banks execute documents in local language and are not available in English language

Auditor should insist for translation or confirmation of validity of such documents by an expert


01 May 2020

Non Performing Assets

CA Gautam Shah 51

01 May 2020

Banking Facts - NPAsSource – CARE research reportNon Performing Assets

Year NPAs in Public Sector Banks31-03-2016 5,40,00031-03-2017 6,84,70031-03-2018 8,95,60131-03-2019 7,39,541

(Rs in Crore)

Source: RBI

Public Sector Banks Particulars 31.03.17 31.03.18 31.03.19 30.06.19 30.09.19Gross NPA Ratio 10.61 13.81 11.25 11.80 11.60

Private Banks Particulars 31.03.17 31.03.18 31.03.19 30.06.19 30.09.19Gross NPA Ratio 4.05 4.61 5.20 5.30 5.40

CA Gautam Shah 52

01 May 2020

Particulars Amount Fresh/new NPAs during 2015-16 3,81,000Fresh/new NPAs during 2016-17 3,27,500Fresh/new NPAs during 2017-18 4,88,200Fresh/new NPAs during 2018-19 2,16,763Fresh bad loans in the last 4 years 14,13,463

Banking Facts – NPAs (PSBs)(Rs in Crore)

Year Operating profit NPA provisions Net profit

PSB’s2018-19 1,49,820 2,16,454 (66,634)H1' FY 2019-20 84,035 80,815 3,223

PVB’s

2018-19 1,28,524 1,00,904 27,623

H1' FY 2019-20 73,923 58,123 15,800

(Rs in Crore)

CA Gautam Shah 53


Bank NPA Divergence in FY19

01 May 2020

BankGross NPAs

Reported by banks Assessed by RBI Divergence

SBI 172,750 184,682 11,932

Bank of Baroda 69,924 75,174 5,250

Yes Bank 7,883 11,160 3,277

Punjab National Bank 78,473 81,090 2,617

Central Bank of India 32,356 34,921 2,565

UCO Bank 29,888 31,106 1,218

Bank of India 60,661 61,778 1,117

Union Bank of India 48,729 49,318 589

Indian Bank 13,353 13,537 184

Allahabad Bank 28,705 28,772 67

Lakshmi Vilas Bank 3,359 3,416 57

(Rs. In crore)

CA Gautam Shah 55

Bank NPA Divergence in FY19

01 May 2020

Bank

NPA provisions

Reported by banks Assessed by RBI Divergence

SBI 106,856 118,892 12,036

Bank of Baroda 46,001 50,091 4,090

Yes Bank 3,398 4,376 978

Punjab National Bank 48,151 50,242 2,091

Central Bank of India 19,934 20,722 788

UCO Bank 18,994 20,384 1,390

Bank of India 39,392 40,838 1,446

Union Bank of India 28,397 29,984 1,588

Indian Bank 6,132 7,136 1,004

Allahabad Bank 21,261 21,714 453

Lakshmi Vilas Bank 1,786 1,897 111

(Rs. In crore)

CA Gautam Shah 56

▪ In instances of faliure of multiple restructurings, the banks had failed toback date the NPA

▪ Upgradation was observed even in absence of satisfactory performanceduring the specified period

▪ Accounts were not downgraded when conditions for eligibility ofrestructuring benefit were not met

▪ Accounts were upgraded despite partial recovery of overdues

▪ The latest position of Drawing Power (DP) as intimated by the lead bankwas not updated in the system, resulting in non-recognition of thedowngradation

▪ Evergreening of accounts by sanction of additional loans were observed

▪ Latest valuation of security was not obtained or erosion in the value ofsecurity was not recognised

▪ Shortfall in provisioning was observed as the valuation of investmentexposure was not in line with extant guidelines

Reasons for Divergence in Asset Classification

01 May 2020

Source: RBI

CA Gautam Shah 57

▪ RBI may not approve de-barred Auditors undertaking Statutory Audit inCommercial Banks for a specific period;

▪ Lapses in carrying out audit assignments resulting in misstatement ofbank’s FS;

▪ Wrong certification given by Auditors with respect to list of certification asadvised by RBI to the banks;

▪ Wrong information in LFAR;

▪ Issues relating to misconduct by Auditors in respect to Bank AuditAssignment;

▪ Cautionary advice to the audit firm in case of lapses not material innature;

Consequences for Divergence


Asset Classification (Cont..d)

▪ NPAs – Borrower-wise and not Facility-wise (To consider all exposure of a borrower including derivatives)

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

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

▪ Identification of assets as NPAs should be done on an ongoing basis

▪ Verify if account regularised with only few audits at period ended (source, genuineness, additional audit etc.)


Asset Classification (Cont..d)

▪ Make a Detailed note on observation and facts especially where youare recommending a change of classification

▪ In respect of NPAs over Rs.5 Crore, independent valuation▪ Stock audit-Annually

▪ Immovable properties-once in 3 years

▪ Verify that Repayment is from genuine sources

▪ NPA accounts can be upgraded to performing if all the arrears andprincipal and not only critical overdues are paid by the borrower

▪ Suit filled accounts to be classified as Doubtful unless there is strongjustification against it

▪ In case of Consortium advance record of recovery of particular Bankonly to be considered.


LC Devolvement and BG Invocation

Amount to be added to principal facility i.e. CC account and need to review asper IRAC Norms

LC Devolvement – Rs.20 Cr on 20 Feb 2020

CC Account – DP Rs.120 Cr

CC Balance

From 01 Jan 2020 to 28 Feb 2020 – Above DP i.e. Rs.125 Cr

From 01 Mar 2020 to 31 Mar 2020 – Below DP but above Rs.110 Cr

→ LC Devolvement not o/s more than 90 days – Not NPA

→ CC, not over drawn for more than 90 days – Not NAP

→ To Add LC devolvement to CC, Combine balance over drawn for more than90 days - NPA

Asset Classification


Frauds committed by Borrowers/ Erosion in value of security : Where erosion of security is to the extent

▪ 50% of value as assessed by the bank at the time of lastinspection – Doubtful

▪ 90% of outstanding NPAs – Loss

Doubtful advances guaranteed under ECGC – No provision to bemade for guaranteed amount

Example:

Total o/s – Rs.5 Cr, Security – Rs.1.50 Cr, ECGC – 50%

Provision : 5 Cr – 1.50 Cr = 3.50 Cr @ 50% = Rs.1.75 Cr plus 40% ofsecured portion i.e. Rs.0.60 Cr

Hence total provision Rs.2.35 Cr

Asset Classification


Provisioning Norms

▪ Higher provisioning is warranted if threats to recovery

▪ Verify secured and unsecured portion of advances

▪ Critically verify the value of security as on the balance sheet date

▪ For accounts classified as doubtful, verify

▪ Primary and secondary security charged to the bank

▪ Present value through approved valuer (once in 3 Years)

▪ Inspection

▪ In case of Foreign currency denominated Loan Revaluation gain from Foreign exchange fluctuation to be considered as provision against the asset


Project Loans▪ Project Loans means any term loans which has been extended

for the purpose of setting up of an economic venture

▪ For all projects financed by the FIs/ banks after May 28, 2002,the ‘Date of Completion’ and the ‘Date of Commencement ofCommercial Operations’ (DCCO), of the project should beclearly spelt out at the time of financial closure of the projectand the same should be formally documented

▪ A loan for an infrastructure (infra) project will be classified asNPA if it fails to commence commercial operations within twoyears from the original DCCO, even if it is regular as per recordof recovery

▪ A loan for a non-infrastructure (non-infra) project will beclassified as NPA if it fails to commence commercial operationswithin one year from the original DCCO, even if is regular asper record of recovery


▪ Identifying accounts as NPA where inherent weaknesses, solitarycredit are observed (Para 4.2.6 of RBI Master Circular on IRAC)

▪ Identifying erosion in security of NPAs and resultants acceleratedprovisioning

▪ Verifying unsecured loans with sanction limit upto 1 crore

▪ Difficulties in verifying and identifying NPAs specially for theAgricultural Loans and Kisan Credit Card (KCC) Scheme Loans

▪ Identifying quick mortality cases

▪ Ensuring genuine transactions in cash credit account

Challenges for Auditors


▪ Correctness of Stock and Debtors statements

▪ Correctness of data input e.g. security valuation, interest rate, penalinterest charges, inspection details, etc.

▪ Divergence of fund and End use of funds

▪ Running Packing Credit Account:▪ Disbursed amount should be paid within due date as per LOI or

purchase order▪ System appropriates the funds as per FIFO basis rather than

adjusting against actual Bill receipt▪ Hence, System does not capture the old o/s bills and account

never becomes NPA▪ System uses the same logic as that for CC accounts which is

incorrect(E.g. Amount received towards bill o/s for < 180 days getsappropriated towards bill o/s > 180 days)

Challenges for Auditors


▪ Asset Shortage is the shortfall in the value of security asagainst net outstanding balance, which requires additionalprovision as per extant norms.

▪ Additional Provision can be because of Ageing or AssetShortage

▪ Manual calculation of Asset shortage can be a challenge

▪ Non updation/ Wrong updation of security value in the system

▪ Other Discrepancies

- Non availability of Lenders’ latest dues: consortium/multiplebanking

- Status of unpaid statutory dues not ascertained

- Latest status required for registration of charges with authorities

- Older Valuation Reports/ Stock Statements

Challenges for Auditors- Asset Shortage


◼‘A’ takes TOD in Cash Credit (CC) account from Branch and transfers the amount to the Current (CA) account of ‘B’

◼ ‘B’ transfers the amount to the ‘CC’

account of ‘C’ (no other transactions)

◼ ‘C’ serves its interest

(no other transactions) and

transfers the amount to CA

account of ‘A’ which in turn

transfers to its(‘A’) CC account

68CA Gautam Shah

Circuitous Transactions

01 May 2020

A

BC

69CA Gautam Shah01 May 2020

CASHCIRCUITOUS TRANSACTIONS

“A” takes TOD from “Branch”

“A” withdraws cash from respective Branch

‘Teller A’

“B” deposits the same amount into it’s A/c to avoid being an “NPA”

‘Teller A/B’

A & B are Related Parties

Circuitous Transactions

Case StudiesM/s K.C. & Co. has two facilities with XYZ Bank Ltd. CC/OD facility of INR5 cr. and General Business Purpose Term Loan of INR 10 cr. (disbursed tothe extent of INR 8 cr.). As on February 2020, the CC/OD facility is out oforder and will be classified this account as NPA as on March 31, 2020.During the month of March-2020, M/s K.C. & Co. requested foradditional disbursement of the loan to the extent of INR 2cr.

On 28th March 2020 the firm repaid the overdue amount in the CC/ODfacility and the account is regular as on 31st March 2020. During thecourse of statutory audit, the auditor raised an objection stating that theaccount has been regularised by sanctioning an additional facility to theborrower and this account should be classified as NPA as on 31st March2020.


Case StudiesM/s XYZ & Co. (Mr. X & Mr. Y only partners of the firm are brothers) hasfollowing facility with ABC Bank Ltd. Term Loans- INR 5 Cr, CC/OD facility-INR 3 cr. Both the partners are also having housing loan with the bank.The cumulative o/s of such loans are INR 2 cr. The CC/OD facility of thefirm has been classified as out of order due to continuously overdrawnfor more than 90 days. There is no other business activity carried out bythe partners of the firm.

The statutory auditor is of the view that the housing loan of partners ofthe firms should be classified as NPA and the bank should make provisionon such loans as well. Whether the auditor is justified in classifying theseadvances as NPA?


Case StudiesDuring the year, PQR Pvt. Ltd. has been classified as NPA since the creditsin the account were not able to cover the interest debited in theaccounts. On verification of the account statement the auditor observedthat the bank has charged Rs.200,000 as Bank Guarantee commission inthe account, however the same has not been recovered by the bank bututilised through unutilised limit in the system.

The account is classified as Sub-Standard Account as on 31st March 2020.

The auditor insisted on reversal of such fees income, however the bank isof the view that the said commission have been realised throughunutilised limit in the CC account and hence should not be reversed.


◼ The company is engaged in the manufacture and sale of fabrics andgarments from its own production facilities.

◼ CDR was implemented in the account in September 2013 withreference date of April 2013.

◼ The conditions of CDR relating to perfection of security, pledge ofshares etc., were not met. Non-payment of principal/interest dueswithin 90 days was observed.

◼ Post CDR, there was conversion of FITL / WCTL into equity

◼ Subsequently S4A was implemented in the account in November2016. However, S4A implementation was not completed within thestipulated 180 days.

◼ Even after S4A the account has been facing stress.

◼ Whether the account needs to be downgraded? If yes, the date ofNPA?


Case Studies

◼ The Company is engaged in manufacturing. CC facilities were availedfor which the primary security was paripassu charge on currentassets (stock and book debts) and second paripassu charge onfactory land & building.

◼ The company did not submit stock statement after June 2018

◼ Primary security (stock and book debt) fully eroded and plants areshut since Aug 2018;

◼ The realisable value of the security was less than 50%

◼ What is the Asset Classification and provisioning?


Case Studies

◼ The corporate loan sanctioned to the company to address short termcash flow mismatches for two years in November 2016 was rolledover in December 2018 for four years on account of financial stressin the account.

◼ The bank’s appraisal note stated that “The company is facingdifficulty in generating adequate cash flow in view of stressedmarket condition.

◼ Expecting improvement from current year, the company requestedfor rollover of facility for further four years for smooth operations”.

◼ Opinion?


Case Studies

Questions???


Gautam ShahKhimji Kunverji & Co [email protected]