audit of advances-1
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Audit of Advances
Baroda Study Circle of WIRC of ICAI
Audit of AdvancesRajkot Branch - WIRC of ICAI
Dhinal Shah,CA
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Structure of presentation
Introduction.. 3
Types of Advances 4
Audit Approach . 5
Major areas of consideration.. 7
Some specific areas. 33 Key Points . 45
Disclosure requirement 48
Areas to focus. 51
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Introduction
Major Activity ofBANK Largest ACCOUNT CAPTION in ASSETS
Major Source ofINCOME
Most FOCUSED Audit Area
Can SUBSTANTIALLY CHANGE the financial results Time consuming, AUDIT PLANNING is essential
Master Circulars of RBI
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Funded Overdraft/Cash Credit
Term Loans (Home Loans,
Vehicle Loans, Mortgage Loans)
Working Capital Demand Loans
Bills Purchased/Discounted/Foreign Bills for Collection
Packing Credit
Foreign Currency loans
Types of Advances
Non-funded Guarantees
Letter ofCredit
Letter ofComfort
Co-acceptance of Bills
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Audit Approach
Extent would depend on assessment ofEFFICACY of internalcontrol
Examine all large advances i.e. which are lower of following2 Criteria
5% of Advances
Rs.2 crore
Verify all problematic accounts
Verify advances which are adversely commented by/in
Previous Audit report / LFAR
Internal/Concurrent auditors
Banks inspection report (including RBI Inspection)
Report on verification of security (Stock Audit, etc.)
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Audit Approach
RBI inspection report
Any other report related to the particular advance
Managers charge handing over report
Branches control returns to higher authorities concerningoverdrawing , adhoc sanctions etc
Verify fresh advances granted during the year (if retail highvolume then do sample basis)
Accounts upgraded from NPA to standard
For other then above advances to do on sample basis
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Existence of clearly laid down delegation of authority.
Existence of clearly laid down eligibility criteria for loans.
Existence of system of communicating the terms of sanction to the borrower.
Existence of system of execution of documents before disbursement.
Ex
istence of system of post disbursement monitoring and reporting irregularity. Existence of system for implementation of IRAC Norms.
Adequate control on changing of interest etc in CBS environment.
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Major Areas of Considerations
Pre Sanction
Application Credit Appraisal
Sanctioning/Disbursement
Documentation
Post sanction Review/Monitoring
Asset classification
Provisioning Norms
Income Recognition
Restructuring
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Application
Prescribed Application Form from the borrower for freshon renewal proposal
KYCCompliance as Per RBI Requirements
Evaluation of latest audited financial statements
Review of Project Report Projected P&
L, BS &
Cash Flow
Board Resolution for the availment of the facility obtained
Latest Financial Statements / Income Tax Records ofBorrower and guarantor
Various Registrations/Licenses/Permits
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Credit Appraisal
Verify Appraisal Note of Bank is proper
Whether Appraisal done by Competent person
Review Projections whether realistic
Net worth statement of the borrower and guarantor
Confidential report and NOC from the existing banker
CIBIL Report, Title clearance report & valuation report Nature of securities (prime/ collateral) offered and to
confirm the adequacy of security cover
Verify that important Financial ratios are satisfactory suchas
Debt Equity ratio
Debt service Coverage ratio and other ratios
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Credit Appraisal
Creditworthiness of borrower
Verify whether Exposure limit (including derivative instruments) is within thelimits fixed by Bank-group wise, Industry wise & policy of Bank
Prospects of business, sources and periodicity of repayments, evaluation offinancial statements, capacity utilization
Report of Dun & Bradstreet for Export finance or while opening Letter of
Credit is obtained Whether the branch has a policy of maintaining Rejected Proposals
Whether Branch is conducting credit rating of major advances accounts onperiodic basis
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Sanctioning/Disbursement
Proposal has been routed through appropriate authorisationlevels and recommendations are properly documented andnoted
Limits sanctioned are within the discretionary powers of thesanctioning authority
In case where the sanctions are beyond the discretionary
powers, the same has been reported to appropriate authoritiesand ratified within specified period
Any change in the terms of sanction is ratifed by appropriateauthority
Pre disbursement unit inspection has been carried out & reportheld on record
Adhoc limits (increase) given to borrower for temporary/seasonal/ peak periods whether reported to controllingauthorities and whether liquidated in time
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Sanctioning/Disbursement
Verify that Disbursement done only after compliance of all terms &conditions of Sanction letter.
Verify all Ad hoc sanction limits given
Acceptance of the borrower confirming the terms & conditions ofsanction is obtained
Sanction letter/limit approval letter stating the terms andconditions is available
If the Loan policy or Manual specifies the adjustment of creditors,but the sanction is silent, it is for the auditor to report the defect inthe sanction as a violation ofLoan policy. But where a specificmention is made in the sanction, not to consider creditors as a
deduction, then the terms of sanction have to be adopted and thesame has to be considered in drawing power calculation
Verify Margin Money to be brought by borrower
Verify end use of funds ( capex, Project, etc)
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Documentation
All loan documents, as required by the sanction letter and loanpolicy have been executed (eg. DP Note, loan Agreement, Letterof guarantee, hypothecation Agreement, etc)
Loan documents are properly executed and approved by legalexpert, if required whether appropriately stamped
Fresh loan documents are obtained on change in limit, change inthe constitution of the borrower
As per Sanction Letter and Bank Policy
Original agreement, share certificate, title deeds, title clearancecertificate valuation report are held on record
In case of Thirdparty borrowing against Branch Fixed Deposits,normal lending rate of interest should be applied as againstconcessional rate
Documents should not be blank or incomplete & there should beno overwriting, changes, different inks etc.
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Documentation
Original documents are kept in safe custody
Charge on securities offered have been registered with registrarof companies/ appropriate authority (RTO, MortgageRegistration)
NOC of housing society
Memorandum and Articles of Association or proof of constitutionof the borrower
Special Documentation for Consortium/ Multiple Bankingadvances
Whether advances against lien of deposits have been properly
granted by marking a lien on the deposit in accordance with theguidelines of the controlling authorities of the bank
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Review/ Renewal of facilities carried out as per the policy of the
bank Verify Follow up of accounts pending renewal
LC issuance check for ever greening
Security / Stock Inspection reports
Regular QIS, Stock & Debtors statements are submitted
Operation in party accounts critically review, specially at monthend, quarter end ( turnover in account, cheques dishonored,Excessive Cash transactions, dormancy of account, balanceexceeding limits , transfers from / to accounts)
In cases where borrower is availing Multiple banking Facility,
whether the branch obtains outstanding position from each Bankand compares the limits availed with stocks held and DP applicable,in order to know whether the borrower is over financed, and anymargin is to be introduced
Adequacy of Insurance
Review/Monitoring
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Fund disbursement has been utilised towards the object forwhich limit was sanctioned i.e. Not diverted to groupcompanies/ associates or used to pay of existing overdues
Periodic review of irregular/ overdue/ NPA accounts hasbeen done at the appropriate level
Penal interest to be charged if,
DP limits breached
Statements not submitted
Letter of Acknowledgement / Balance Confirmation
Bills Discounted a) whether accommodation bills b)whether ECGCCover taken?
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Review/Monitoring
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Drawing Power Calculation
Based on Stocks, Debtors and Share value
Critical review of stock/ Book Debts statement (Old debtorsmore than 180 days not to be considered)
DP limits to be set as per latest statements. If stock statementsis older than 3 months account to be classified as irregular
Verify banks guidelines for DP calculation specially for unpaidstocks
Verify Inventory & equity shares Valuation
Verify annual audit report of the borrower with the monthlystock statement for the last month of the year
Verify Stock audit report for NPAs more than Rs5 Crore
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Review/Monitoring
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Review/Monitoring
Fraud in Advances
Sanction without proper application and/or credit appraisal
Sanction made beyond discretionary power and non-reporting of the same to the appropriate authority
Unauthorised release of securities
Security valuation (Especially NPA account e.g. ImmovableAssets, Patents)
Charging of same security to different Banks
Diversion of funds
Fraud risk relating to Controls Submission of fake transport documents/ godown receipts
Discounting of accommodation bills/ issuance/ LC
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RBI CircularReference
Master Circular dated 1st July 2009 on IRAC Norms.
Circular dated 31st August 2009 in respect of Agricultural debt waiverscheme.
Circular dated 5th November, 2009 for provisioning on standard
assets. Circular dated 1st December 2009 for provisioning coverage ratio.
RBI Circular Reference
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STANDARD ASSET / PERFORMING ASSET
The account is not non-performing and does not carry morethan the normal risk attached to the business.
NON-PERFORMING ASSET (NPA)
The asset ceases to generate income for the bank. (Para 2 ofthe Master Circular)
Asset Classification
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Asset Type
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Asset ClassificationA nonperforming asset (NPA) is a loan or an advance where:
Interest and/ or installment of principal remain overdue for a period of morethan 90 days in respect of a term loan
The bill remains overdue for a period of more than 90 days in the case of billspurchased and discounted
If the Cash Credit/Overdrafts account remains Out ofOrder as described below
if the outstanding balance remains continuously in excess of the sanctionedlimit/ drawing power
No credits in the account for 90 days as at period end.
credits not enough to cover interest debited during the period
As per para 2.1.3 an account will be NPA only if interest due & chargedduring as quarter is not serviced fully within 90 days from end of quarter.
Stock statement more than 3 months old for a continuous period of 90 Days
Regular/ Adhoc limits are not revised within 180 days of due date/ Adhocsanction date
Derivatives: Receivables on account of mark to Market Value remain overduefor more than 90 days
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Asset Classification
NPAs Borrower-wise and not Facility-wise.
NPA merely due to temporary deficiencies (guidelines in mastercircular dated 1st July 2009) (e.g. Renewal/Review pending for 180days, Excess drawn on limits due to drawing power calculated onmore than 3 month old stock statement)
Verify errors in classification, provisioning/Value of security,interest reversal
Verify audit trail for changes to critical dates e.g. date of NPA, etc
Identification of assets as NPAs should be done on an ongoingbasis
Verify if account regularised with only few audits at period ended
(source, genuineness, additional audit etc.)
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Asset Classification
Make a Detailed Note on observation and facts especially where
you are recommending a change of classification In respect of NPAs over Rs.5 Crore
Stock audit-Annually
Immovable properties-once in 3 years
Do not go by BANKS circular (Interpretation mistakes could bethere)
Verify that Repayment is from genuine sources
NPA accounts can be upgraded to performing after all overduesare adjusted or at least reduced to a period of less than 90 days
Suit filled accounts to be classified as Doubtful unless there isstrong justification against it
In case ofConsortium advance record of recovery of particularBank only to be considered.
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NPAs are categorized based on the period for which asset has remainednonperforming:
Advances against Term deposits, NSC,KVP,IVP and Life policy not to be
treated as NPA provided adequate margins are availableNote- Advances against Gold ornaments and government security andall other securities are not covered in the aforesaid exception
Amount guaranteed under ECGC need not be treated as NPA
Substandard Assets which has remained NPA for a period less than orequal to 12 months
Doubtful Assets if it has remained in the substandard category fora period of 12 months
Loss Assets identified by the bank or internal/ externalauditors or the RBI inspection but the amount hasnot been written off wholly
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Asset Classification
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Regular/ad-hoc limits need to be reviewed /regularised not later than 3m from due date/ date of adhoc sanction. if not done within 180 days,then NPA
Erosion in value of security :Where erosion of security is to the extent
50% of outstanding NPAs--- doubtful
90% of outstanding NPAs--- loss
Projects under implementation separate set of guidelines underMaster Circular
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Asset Classification
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Provisioning Norms
Higher provisioning is warranted if threats to recovery
Verify secured and unsecured portion of advances
Critically verify the value of security as on the balance sheetdate
For accounts classified as doubtful, verify
Primary and secondary security charged to the bank
Present value through approved valuer (once in 3 Years)
Inspection
In case of Foreign currency denominated Loan Revaluation
gain from Foreign exchange fluctuation to be considered asprovision against the asset
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Provisioning Norms
Asset Classification Amount of Provision Required in (%)
Standard Assets Advances to Agriculture & SME 0.25%
Advances to Commercial Real Estate 1%
Other Advances 0.40%
Sub-Standard Asset 10 % on total amount
And additional 10 % on unsecured portionDoubtful Asset
Upto 1 Year
1 to 3 Year
More than 3 year
Loss Asset 100 %
Secured Portion Unsecured Portion
20 % 100 %
30 % 100 %
100 % 100 %
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Provisioning Coverage Ratio to be 70% by 30/09/2010. Disclose PCR in Notes to
Accounts
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Provisioning Norms
For Restructured Advances additional provision on Unsecuredportion of WCTL- covered under Restructuring
Provisioning Requirement for Standard Assets for RRBs forCommercial Real Estate (CRE) is Increased to 1% (RBI circularPCD.RRB.No.BC.61/03.05.34/2009-10, dated March 04, 2010)
Circular dated December 01, 2009 for Provisioning coverage forAdvances
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Provisioning for Country Risk
Net funded country exposures 1% of total Exposures
Lower provision in respect of short term Exposure
Verify data carefully
Risk Category ECGC classification Provisioning requirement(%)
Insignificant A1 0.25
Low A2 0.25
Moderate B1 5
High B2 20
Very High C1 25
RestrictedC
2 100Off-Credit D 100
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Income recognition
Banks should not book income by way of interest on NPA
However, interest on advances against TD, NSCs, IVPs, KVPs(check for fraudulent documents) and Life policies may be takento income account on the due date, provided adequate marginis available in the accounts
IfGovernment guaranteed advances become NPA, interest onsuch advances should not be taken to income account unless theinterest has been realised
Verify whether Interest calculations are correct or not Samplebasis and Check Systems also
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Income recognition
If any advance, including Government guaranteed, billspurchased and discounted, becomes NPA as at the close of anyyear, interest accrued and credited to income account in thepast periods, should be reversed or provided for if the same isnot realised
Note:E
arlier reversal was for the previous year only & now sincelast year says past periods
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Provisioning Norms Provision Under Special circumstances
Advance under rehabilitation programme approved by BIFR / Institutions,Provision should be continued to be made on existing facilities.
Additional facilities no provision for a period of one year.
In case of advances guaranteed by CGTSI/ECGC, Provision should be madeonly for balance in excess of the amount guaranteed by thesecorporations.
Specific Areas
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Bank Finance with Moratorium [Para4.2.12 (i)].
Housing or similar advances granted to staff members [Para4.2.12 (ii)].
Central Government guaranteed advance to be classified as NPAonly if Government repudiates the guarantee when invoked.
Exception: Credit facility to Primary Agricultural Credit Society(PACS) and Farmers Service Societies (FSS) under on lending
arrangement, (Para 4.2.10)
Specific Areas
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Exceptions:
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Restructured Loans: Master Circular of 1/7/2009
Only loans with Viability and with reasonable certainty ofrepayment to be Restructured
Standard loan to be classified as Sub-standard afterRestructuring
Certain exceptions in circular:Other than for Capital MarketExposure, Personal / Consumer Loan/ Commercial RealEstate
Incentive for quick implementation of Restructuring within 90 /120 days asset classification which existed at time ofrestructuring application.
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Asset
Classification benefits - classification not be downgraded ifsatisfactory performance during the specified period subject to:
dues being fully secured (other than SSI whose outstanding isless than 25 lakhs & Infrastructure projects having cash flows torepay advance through escrow mechanism
unit becomes viable in 7 years (10 years for infrastructure cases)
repayment in 10 years (15 years for Infrastructure cases)
promoter sacrifice and additional funding at least 15 % of BankSacrifice
personal Guarantee of promoters Not a repeated restructuring
Reschedulement of recovery cannot upgrade the classificationfrom the previous classification
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Restructured Loans
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Upgrading to standard category only after satisfactoryperformance during the specified period
Specified period-period of one year from the date whenthe 1st payment of interest or installment of principal fallsdue under the terms of restructuring
Additional finance to be treated as standard Asset, uptoone year after date of first principal / interest paymentunder approved restructuring package. However interestincome to be recognised only on cash basis for Assetswhich were NPAs at time of restructuring
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Restructured Loans
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Fees and commissions earned by the bank as a result of re-negotiations or rescheduling of outstanding debts to berecognised on an accrual basis over re-negotiated period
Restructuring not to be retrospective
Asset classification norms applicable till restructuring isfinalised
Provision to be made for the diminution in the fair value ofthe advance
Valuation and provisioning issues for equity, debtinstruments received on restructuring
Norms for conversion of unpaid interest into FITL/ Debt/
Equity Repeated restructuring is allowed only if the viable units
are facing temporary cash flow problems (December 08,2008)
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Restructured Loans
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Restructured Loans
Additional Provision
WCTLLoans restructured under circulars dated- 27 August 2008,8 December 2008
Unsecured portion of WCTL created by conversion of irregularportion of principal dues over drawing power should be as
under: Standard assets 20%
Sub-Standard assets 20% in the first year then increase by20% every year till specified period
After specified period- if account not eligible forupgradation- Unsecured Portion- 100%
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Agriculture Loans
NPA Classification
The installment of principal or interest thereon remains overdue fortwo crop seasons for short duration crops
The installment of principal or interest thereon remains overdue forone crop season for long duration crops
Agriculture debt waiver scheme and debt relief scheme 2008
Banks not to claim nor recover interest in excess of principal amount,penal interest, miscellaneous charges ,etc for the Assets which areNPA at the time of restructuring
Unapplied interest on NPA loans are neither to be claimed from thegovernment nor from the farmer
Eligible amount to be credited to the borrower account by 30
September 2008 Small and marginal farmers entire eligible amount shall be waived
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Other farmers- OTS in which entire rebate of 25% provided entireamount is repaid of the eligible amount for which the last dates of 3installments fixed are 30/9/2008 which was extended to 31 March 09;31 March 09,30 June 2009 which is extended to 31/12/2009 videcircular dated 31/8/2009)
25/6/2009 Circular resolution permitting farmers to pay the amount insingle installment by 30/6/2009
Farmers share has to be received within 1 month of the pre-specifieddue dates if not then the account will be classified as NPA
Separate account Receivable from government of India underAgriculture Debt waiver Scheme 2008
It may be assumed that governments contribution would be receivedby June 30, 2010
Balance in account to be treated as Performing asset, providedadequate provision for the loss is made in PV terms
If not received till 31/01/2010 it is a NPA from old date
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Agriculture Loans
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GovernmentGuaranteed Advances
In case of NPA income not to be recognised unless it is actuallyrealised
State government guaranteed advances have to be classified asNPA if remains overdue for more than 90 days
Central government advances to be considered as NPA only if
guarantee invoked and repudiated by the government If bank has not invoked Central Government guarantee for long it
should to be reported in the LFAR
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Packing Credit
Pre-shipment credit - all the advances required to finance theproduction cycle advance is given on the basis of individualorder obtained which is to repaid out of export proceeds
The post shipment credit relates to financing of bills raised onthe overseas buyer upon shipment of goods pending
Verify proceeds received from export as these accounts haveconcessional interest
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LFAR
Study the LFAR thoroughly with respect to advance portion
Prepare the LFAR note for advances along with the statutoryaudit
Give specific instances of shortcomings/ weaknesses in theadvances sections
Annexure to LFAR for large/ critical/ irregular accounts Critical comments affecting accounts should be part of main
audit report and Qualified
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KEYPOINTS
Credit card dues are shown under cash credits, overdrafts andloans repayable on demand
Overdue installments in respect of term loan to be included termloan and not loans repayable on demand
As per Sec. 5(n) of the Banking Regulations Act, secured advancemeans an advance for which the market value of security is notat any time less than the amount of such advance
Refinance obtained from refinancing agencies representsborrowings of the bank
Bills discounted/negotiated/purchased under LC where thepayment to the beneficiary is not under reserve is to betreated as an exposure on LC issuing bank and not on borrower
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KEYPOINTS
If only a part of advance is covered by the value of security as atthe balance sheet date, that part only should be classified assecured and balance amount must be classified as unsecured
All accepted bills must be classified as unsecured unlesscollaterally secured
Extension of surplus security in other facilities should not beconsidered unless agreed at the time of sanction
In case documents are incomplete and or not in force, the facilityshould be treated as unsecured
Advances made against unapproved securities can be classified
as secured
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KEYPOINTS
Bills discounted/purchased which have been rediscounted withRBI/IDBI/SIDBI must be shown under contingent liabilities
In case of fully computerized, ensure that there are proper systems forborrower wise classification
In absence of a clear agreement with the borrower, in case of partialrecoveries in NPA, the banks are required to adopt uniform accounting policy
Foreign Bills under LC: Classification in a NPA a/c In NPA accounts involving, Foreign Bills under LC as one of the facilities,
some banks are of the view, that the balance outstanding under thisfacility not being an exposure to the borrowers but to other banks,should be considered as Standard asset, being money due from theother bank ?
in a NPA account, outstanding balances of Bills under LC are also to beaggregated with other balances for the purpose of calculation ofprovision. If any bank has obtained a clarification individually from RBI,the same may be brought to the notice of auditors for information
Fixed Assets as a second charge - calculation of security value is important
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Provision against future LC / guaranteedevolvement-In an existing NPA
Some of the guarantees/LCs which were
devolved, are accounted as NPA. There are
certain other LCs and guarantees remaining to
be realized. Should these non funded liabilitiesbe provided for and if so under what
classification? If these non funded liabilities are
not to be included as NPA under what
circumstances are these to be excluded
KEY POINTS
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Disclosure Requirements
A) i) Bills purchased and discounted
ii) Cash Credits, overdrafts and loans repayable on demand
iii) Term Loans
B) i) Secured by tangible assets
ii) Covered by bank/Government guarantees
iii) Unsecured
C) I. Advances in India
i) Priority sector
ii) Public sector
iii) Banks
iv) Others
II. Advances Outside India
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Disclosure Requirements
i) Due from banks
ii) Due from Others
iii) Bills purchased and discounted
iv) Syndicated loans
v) Others
Amount receivable from government of India underAgricultural Debt waiver scheme,2008 should be separatelyunder the head Term Loans, Unsecured and other in A, B and Crespectively
Maturity Analysis: 1day to 14 days, 14 days to 28 days, 29 daysto 3 months, 3 to 6 months,6 months to 1 year,1 to 3 years, 3to 5 years, more than 5 years
Segmental Analysis: Based on Wholesale and Retail
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Areas to focus in 2010
Real Estate loans
Capital Market Loan
Agricultural Loans
Restructured Loans
Commodity Loans
Infrastructure/ SEZ/ Engineering Project Diamond industry
Textile
Export oriented loans
looking at the global and Indian scenario possibly will have to seeall loans
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Questions???
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