bank_branch_statutory_audit_2016_prh

Bank Branch Statutory AuditAdvances – Funded & Non Funded

Kolhapur - 16 March, 2016

C.A. Parag HangekarFCA, DISA(ICAI),CIA(USA)

PartnerBatliboi & Purohit

E-mail: [email protected]

mailto:[email protected]

C.A. Parag Hangekar

Agenda• Introduction• Types of advances • Nature of Securities• Fund Based Advances - Extent of verification• Reporting of verification• Stages of verification• Verification of Non Fund based advances• Borrowing Arrangements• Restriction on Advances• General Issues/ Risks• Memorandum of Changes (MOC)

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Some of the Laws applicable to Banks:

– The Banking Regulation Act, 1949– State Bank of India Act, 1955– State Bank of India (Subsidiary Banks) Act, 1959– The Companies Act, 2013 (registration of charges, resolutions, borrowing

powers etc.)– The Reserve Bank of India Act, 1934– Prevention of Money Laundering Act, 2002– Securitization & Reconstruction of Financial Assets & Enforcement of

Security Interest Act, 2002– The Foreign Exchange Management Act– The Income Tax Act, 1961 (Tax Audit)– Service Tax Rules– The Stamp Act of the States/ The Indian Stamp Act – Negotiable Instrument Act– Law of Limitation

C.A. Parag Hangekar 3

Statements/ Reports from System

• Facility wise/ party wise list of accounts o/s• Exception Reports – interest deviations etc.• List of accounts due for renewal• List of ad hoc advances granted • List of accounts with inadequate insurance/ expired insurance• O/s bills statements – overdue bills• Expired Guarantees • List of accounts overdrawn/ excess granted• CC/OD accounts month wise details of debit and credit

transactions / turnover.• NPA statements – EAS/ SMA – Very Important report• Stock statements not received


Advances

¾ Advances – Largest revenue earner –- Major Activity of Bank & Largest item in ASSETS- Major Source of INCOME & Most FOCUSED Audit Area

¾ More than 75% of the audit time is devoted on Advances – major RISK area.

¾ Can SUBSTANTIALLY CHANGE the financial results of the Branch/ Bank


Types of Advances

• Fund based : a) Demand/ Term Loanb) Cash Creditc) Overdraftsd) Export credit – Packing Credite) Bills purchased/ discounted

• Non Fund based: a) Guaranteesb) Co - acceptancesc) Letter of credit (LC)


Nature of securities

• Primary & Collateral Securities• Mode of creation of security

– Hypothecation– Pledge– Mortgage– Assignment

• Personal security of guarantor• Goods, Gold ornaments and bullions, life

insurance policies, documents of title to goods


Fund Based Advances

• Demand/ Term Loans –– Loans are repayable in installments over a

period of time.– TL are for acquisitions/creation of capital

assets which become the security of the loan.– Fixed repayment schedule and monthly

interest charged on reducing balance method.– Loans with repayment periods greater than 36

months usually are called Term Loans and of lesser period are known as Demand Loans.


Fund Based Advances (Contd)

– The end use of the funds disbursed are fixed and for a pre specified purpose and are supposed to be used for the same purpose.

– CA certificate is obtained towards the end use of funds

– The Bank directly pays the amounts to the suppliers of the borrower but in some instances lump sum payments are given to the borrower in their current accounts or CC accounts.



• Cash Credit:– This is a working capital facility granted to the

borrower against the primary security of stock and receivables to fill the gap in working capital requirements.

– It is normally renewed each year and is repayable on demand.

– Borrower is sanctioned a limit based on his eligibility and his actual monthly drawing power is calculated based on the hypothecated value of stock of goods, book debts after deducting the margins.



• Overdraft:– This limit may be either secured or clean and

does not generally carry a repayment schedule.– Overdrafts are generally given against FDR, Life

Insurance Policies, NSCs etc.– Several times the purpose of funds are not

questioned to the borrower, but now a days many Banks are sanctioning this advance only for business purposes and several are converting it into short term loans with specified repayment periods.



• Export Credit –– It is disbursed in the modes of Pre Shipment

& Post Shipment credit.– Pre Shipment is granted for the production of

the goods to be exported.– Post Shipment relates to the financing of the

Bills raised on the overseas buyer upon shipment of goods.



– Pre shipment credit has to be liquidated from the export proceeds only and cannot be adjusted out of rupee funds.

– Pre shipment credit can be granted at any branches but the export bills are handled only by authorized foreign dealer branches as foreign exchange is involved and there is reporting to RBI.

– Export proceeds have to be normally received within 180 days from the date of shipment. In genuine cases the Bank can extend the time limit as per the policy laid down or with the permission of RBI.



• Bills:– Funding against the bills is meant to finance the

actual sale transactions of the borrower.– It includes

• Purchase of Bills by the Bank if these are payable “On Demand”

• Discounting of Bills by the Bank if these are usance bills

• Advance against bills under collection from drawees.

• Auditors should verify the rebate on bills discounted and interest accrual.


Extent of verification• Large advances which constitute individually

more than 5% of the aggregate outstanding of that Branch or Rs. 2 crores, whichever is lower.

• Sampling will also depend on the existence of the internal control procedures and the reports given by the various auditors like the concurrent and stock auditors.

• If the NPA‟s are high or extensive problem is identified, samples selected should be more.


Reporting of verification

• Discrepancies noted in the advances have to be reported in 2 separate reports – one is the statutory audit report for “Major/Critical Discrepancies” and the other is a detailed report in the Long Form Audit Report.

• It is advisable that the auditors devise their format in which the queries can be noted down so that this helps them in compiling both the above reports simultaneously. It should be kept in mind that material discrepancies which don‟t need a MOC are to be detailed in the LFAR.


Stages of Verification

• Pre Sanction: Credit appraisal and sanction:–Documents required–Sanction letter –RBI stipulations (Prudential Norms

for Individuals and Group)


Credit Appraisal & Sanction

¾ Prescribed Application Form from the borrower forfresh or renewal proposal (deed, MOA/AOA)

• - original signed form maintained in the loan file¾ KYC Compliance as per RBI Requirements and the

internal guidelines of the Bank• - all the photocopies of the KYC documents of the

Firm/ Company along with the proprietor/ partners/directors obtained

¾ Project Report, Projected P&L, TEV study report,Balance Sheet & Cash Flow

• - ascertain the genuineness and authenticity of thereports, qualifications of the statutory auditors,reasonableness in the projections and the feasibility ofthe TEV report.



¾ Latest audited financial statements and unauditedprovisional financial data for the period after theBalance Sheet date.- effect of the auditors qualification on the financialsconsidered, latest data whether adverse or in line withprojections.

¾ Board Resolution for the availment of the facilityobtained

¾ SSI and other statutory registrations, NOC fromGovernment Departments, pollution boards etc.- certificates to be alive and all copies maintained on file

¾ In case of short review / technical review check theapplication from party- should not be suo moto by the branch



• Adhoc Limits / Temporary limits- application from the borrower- for genuine reasons- all the relevant supportings submitted by the borrower- corresponding changes made in the security and loan agreements- appropriate authority to sanction- given for a specified period and adjusted within the said time- should not be accommodation facility



¾ Fresh Loans & Renewals : Whether appraisedproperly?

¾ Verify Appraisal note of Bank is proper and done bycompetent person

¾ Proposal has been routed through appropriateauthorization levels.

¾ Recommendations are properly documented andnoted.

¾ Limits sanctioned - discretionary powers of thesanctioning authority within Delegated Powers.

¾ Whether adverse remarks of field officer are overruled by seniors?

¾ Sanctions are within the discretionary powersC.A. Parag Hangekar 21


¾ Any change in the terms of sanction is ratified byappropriate authority.

¾ Pre disbursements unit inspection report.¾ Proper assessment of Financial Viability of

proposal¾ Compliance with RBI Guidelines / Bank Guidelines¾ Nature of securities (primary/ collateral) offered and

to confirm the adequacy of security cover.¾ Credit Rating – Internal / External¾ Adverse comments by auditors, inspectors, etc.¾ Net worth statement of the borrowers¾ Review Projections whether realistic or not.



¾ Projections, Sources, repayment schedule.¾ Adequacy of security cover, credit worthiness of

borrower, Title clearance & Valuation of Securities.• - net worth statements of the borrowers duly certified

by CA• - valuation from 2 empanelled valuers and the

variations in the values• - legal vetting and opinion from the empanelled

advocate on the title and ownership¾ Exposure limit – Group/Industry wise• - individual borrowers 15% and 40% for group• - additional 5% and 10% respectively for

infrastructure projects• - sector specific limits determined by Banks



¾ Due Diligence Certificate[Multiple/Consortium]

¾ CIBIL Report – Adverse comments / Score¾ Confidential report & NOC from existing

banker.¾ Important Financial Ratios (DSCR, Current,

PL)¾ Interchangeability of Limits – Main / Sub

Limits¾ Interchangeability can be between two sub

limits within the same facility or two differentfacilities.



¾ Sanctioned Limits conveyed to borrower.¾ Sanction T & C to be accepted by the borrower.¾ Loan documents, as per the sanction letter and loan

policy have been executed.¾ Vetting by legal expert, if required.¾ Fresh loan documents are obtained on change in

limit, change in constitution of the borrower¾ Original documents, share certificate, title deeds, title

clearance certificate, valuation report are held onrecord

¾ Stamp Duty: As per the applicable Stamp Act.¾ Insurance: All securities charged to the Bank –

Insured adequately /Policy to have Bank Clause.C.A. Parag Hangekar 25


¾ Original documents are kept in safe custody.¾ Charge on securities offered have been

registered with registrar of companies /appropriate authority within stipulated time.

¾ Lien marking – FD, NOC & Lien confirmation¾ Special Documentation for Consortium/ Multiple

Banking advances¾ No Blank /Partly filled documents to be kept.


Disbursement• Post Sanction: Disbursement:

– Documents by the Bank– Stamping– Documents to be obtained from the borrower– Insurance– Special terms and conditions

¾ Client Master in CBS Properly recorded.

¾ Verify that Disbursement done only after compliance of all terms andconditions of Sanction.

¾ Verify all Ad hoc sanction limits given.

¾ Acceptance of the borrower confirming the terms & conditions of sanctionis obtained.

¾ Home Loans/term loans to be disbursed directly to the Builder /Owner/supplier.

¾ Post Disbursement Inspection.C.A. Parag Hangekar 27

Stages of Verification (Contd.)

• Monitoring - Review of Operations:– Scrutiny of the accounts in the system.– Verification of the stock and books debts

statement.– Drawing Power limits.– Accounts with other Banks.– Audit reports.– Direct reporting to RBI.


Review of Operations

¾ Review / Renewal of facilities carried out as per thepolicy of the bank.

¾ Verify Follow up of accounts pending renewal.¾ Stock Inspection reports.¾ Regular submission of stocks / book debts statements

and calculation of correct D.P.¾ Stock/debts statements and other periodic operational

data and financial statements etc received regularlyfrom borrowers and duly scrutinized.

¾ Important registers – Discretionary power, insurance,limitation, security verification.



¾ Scrutiny of Exceptional Transactions¾ End use of Funds ¾ Penal interest to be charged if, ¾ Credit Discipline - Timely adjustment of adhoc

limits / Servicing of Interest.¾ Monthly turnover to commensurate with Annual

Projection.¾ Credit Turnover in the account to match with

sales (stock statement)



¾ Consortium meetings: Read Minutes & exchangeof Information between the Banks

¾Management explanation of unusual items / largetransactions

¾Over limit - TOD¾ Any comment by inspectors/auditors¾ Insufficient security¾ Correct feeding of interest rates in the system¾ Scrutiny of QIS- Regularity in submission,

Achievement of performance vis-à-vis Projection,Reasons for Variance.


Drawing Power Calculation

¾ Based on Stocks, Debtors and Share value- Criticalreview of stock / Book Debts statements

¾ Stock & Debtors - sister/ associate concern ¾ DP limits to be set as per latest statements. If stock

statements is older than 3 months accounts to be classified as “irregular”

¾ Verify banks guidelines for DP calculation specially for unpaid stocks

¾ Inventory & equity shares valuation important in the current scenario

¾ Verify Stock audit report for NPA‟s more than Rs. 1.00 Crore


Stock statements

¾ Regularity in submission of statements.� Slow/non moving/ obsolete stock to be deducted

for D.P.� Unpaid Stock / Stock under Usance L/C to be

declared separately and deducted for D.P.calculation.

� Age of the book debts. Certification from a C.A.� Value of stock / Book Debts as on 31st March

¾ Physical Inspection of Securities…� Periodic Inspections of Stocks -

Deficiencies/Irregularities � Consortium Account - inspection reports

exchanged.C.A. Parag Hangekar 33

Term Loan

¾ End-use of funds, disbursement by way ofDD/PO/Cheques directly in favour of Suppliers

¾ Disbursement by way of reimbursement only ifpermitted by sanction and after meeting all sanctionterms.

¾ Disbursement strictly as per projectimplementation.

¾ Repayment schedule to be as per the sanction andverify record of repayment

¾ Stipulated installments/interests are being paid regularly



• Renewal/ Enhancement/ Reschedulement/ Balance Confirmation:– Limits are renewed at the end of each year, non

renewal can make the account a NPA.– Ad hoc limits to be renewed within 180 days from the

date of sanction.– Sufficient documents are required for any increase or

re-alignment in the limits.– Reschedulement is done by Banks when a particular

project gets delayed or there is a crisis faced by the borrower. It is permitted subject to the proper sanction and as per RBI rules.



• Physical inspection of securities & valuation– Physical inspection not usually possible due to

shortage of time and hence have to rely on the report of the stock auditor/concurrent auditor/internal inspection department etc.

– Obtaining stock auditors report is mandatory above a certain limit as prescribed by the Bank.

– RBI states mandatory stock audit in cases of NPA accounts where the O/s is Rs. 5 crores and above.

– Valuation to be done once in 3 years for all immovable properties



• Verification of the charges/income due on the advances– Following are some of the charges recoverable from the

borrowers on various advances as prescribed by the Bank, which the auditors should at least test check:

– Charges for processing of loan, stamping, insurance, valuation fees, stock auditors fees, legal fees, postage and courier etc.

– Interest levied : The auditor has to confirm that the rate as per the sanction is correctly updated in the client master in the system. Interest run reports can be generated from the system and verified. Also penal interest in case of over drawings, late submission of the stock statements and the QIS, non-renewal of the limits need to be checked, to ascertain the revenue leakage.


Non Fund Based Advances

• Guarantees– Financial, Performance & Deferred Payment guarantee– Financial guarantee is issued in lieu of deposit mainly

for tenders, bidding processes etc.– Performance guarantee is issued for guaranteeing

performance of any contractual obligations like delivery of machinery, goods etc.

– Deferred payment guarantee is issued to the equipment manufacturer on behalf of its client for payment. It could be for specific or multiple transactions.

– Upon invocation of the guarantee the facility becomes a Fund based and should be classified accordingly.


Non Fund Based Advances

• Co-acceptance of bills– Seller dispatches the goods and the bills

raised is co-accepted by the buyers banker.– Sellers banker discounts the bill– Auditors have to be cautious since such type

of arrangement is used by borrower to float accommodation bills.

– RBI has mandated that this facility should be extended to only those borrowers who enjoy other credit facilities from the Bank.


Non Fund Based Advances (Contd.)

• Letter of Credit (LC):– LC is a promise by a bank to honor the payments to

be made by its customer (the buyer/importer) to the seller/exporter. The LC amounts are debited to the cash credit account of the borrower and if there is no limit available then sometimes the same is debited to a separate account which becomes a devolved LC.

– Auditors should be careful in the accounts where there are frequent devolvement of LC.

– The interest calculation on the LC based on the tenure should be checked.

– Check for multiple CIF of borrowers in such cases.


Borrowing Arrangements

• Sole Banking – Borrower obtains credit from a single Bank.

• Multiple Banking – There is no formal arrangement between the lending Banks. Each Bank has its own set of loan documents, securities and mode of lending independent of other lending banks. The borrower has to deal with each of the banks separately.


Borrowing Arrangements

• Consortium Arrangement – Number of lending banks is more than one. The lending banks form a formal consortium. Main features:– Bank with the largest exposure is the lead bank– Common set of loan documents, which is obtained by

the lead bank on behalf of all the consortium member banks.

– Lead bank is responsible for overall monitoring.– The securities are shared by the member banks in an

agreed proportion based on their exposures.– Borrower maintains direct business relationship with

all the member banks of consortiumC.A. Parag Hangekar 42

Restriction on Advances

¾ Advances to Bank‟s Directors – Section 20(1) of BankingRegulation Act.

¾ Advances to Relatives of Bank‟s Directors – Not withoutprior approval of Board.

¾ Loans to companies for buy back of shares – notpermitted

¾ Loans to industries consuming O‟Zone depletingsubstances such as Foam, Refrigerators, AirConditioners, Aerosol Products, Solvents, FireExtinguishers etc.

¾ Loans against shares, debentures and bonds.¾ Restriction on payment of commission to staff members¾ Restrictions on offering incentives for loan products.


General Issues/ Risks

¾ Sanction without proper applications and credit appraisal

¾ Sanction made beyond discretionary power and non-reporting of the same to the appropriate authority

¾ Unauthorised release of securities

¾ Charging of same security to different Banks and for different facilities

¾ Diversion of funds - to other concerns

¾ Fraud risk relating to controls – Debits in income


General Issues/ Risks

¾ Accommodation of excess drawing to customers.¾ Frequent overdrawing beyond limits¾ Bouncing of cheques due to insufficient funds ¾ Frequent issue of stop payment instructions.¾ Cheques deposited and not honored.¾ TOD for major part of the month, adjusted at end¾ Non submission of FS in time – non renewal¾ Existence of overdue bills, devolved L\C etc…¾ Delay / Non Submission of Stock / Book debts

statement.¾ POTENTIAL NPA‟S(Early Alert/Special Mention)


Report & MOC

• Main Report should be a self contained document and should contain no reference of any point made in the LFAR¾ Audit Qualifications in the Main Report only and not in

LFAR• Report needs to be made out in the form and manner

prescribed, subject to the qualifications being incorporated in the report and duly quantified in the Memorandum of Changes (MOC). In case of NIL MOC mention NIL in the main Audit Report and don‟t write „subject to‟ which might create confusion to the CSA.

• For suggesting any changes �Quantify in MOC (qualification)- MOC – Auditors

prerogative and need not take confirmations from the branch manager

�Its an annexure to Main reportC.A. Parag Hangekar 46

Memorandum of Changes (MOC)

• All the rectifications in the financial statements should be necessarily done through MOC only.

• MOC are mostly of 3 kinds – Having effect on the Balance Sheet - Advances - NPA

classification.– Having effect on the Profit & Loss account – increase or

decrease in the revenue.– Having effect on the various statements of the final accounts set.

• MOC is prepared by the auditor and it not mandatory that the Branch Manager should sign it. His signature only denotes concurrence.

• It is advisable that the auditors attach a brief note with the MOC towards the reasons for classifying NPA accounts for the benefit of the Central Statutory Auditors.


Exceptions / Clarifications

Solitary Credit Entry

9Care should be taken that a solitary or few credits inthe account made at/near the balance sheet dateextinguishing the overdue interest/principal is not theonly criteria for classifying the asset as standard.

9RBI has specially mentioned on window dressing andauditors have to be careful in analyzing such entriesto ascertain their authenticity.


Thank you

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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