Audit of Advances- Certain Key Questions &

Issues

CA.Vivek Krishna Govind

PRESENTATION STRUCTUREQUALITY OF APPRAISALHEALTH OF ACCOUNTSGREENING OF ACCOUNTSDRAWING POWERAGRICULTURAL ADVANCESPRE/POST SHIPMENT ADVANCESRESTRUCTURED ADVANCESPROJECTS UNDER IMPLEMENTATIONCONCERNS & CONTROLISSUES RELATING TO ADVANCES

INTRODUCTION

As per the Master Circular: “The policy of income recognition should be

objective and based on record of recovery than on any subjective considerations”

As per the Master Circular:“An asset becomes non-performing when it ceases to generate income for the bank”

Quality of Appraisal

Identification of risksQuick mortality indicates bad appraisalRestructuring (repeated or otherwise )Effective use of CIBILEnhancement of facilities to unhealthy accountsDiversification and Sector Risk cannot be compromised against long term relationship

No proper credit appraisal – Risky sector, deficiencies ignored

Real estate sector was under considerable stress.The Company was known to be under considerable stress at the time of appraisal.The proposal had serious viability concerns.The proposal to finance two projects, whereas the borrower has several projects, all at various stages of construction.The company had availed various housing loans from three branches in the names of directors and their relatives. These loans were availed for raising margin for the construction activities of the two projects proposed to be financed by the bank. This is a serious violation of RBI guidelines. The credit appraisal note states various discrepancies such as the track record of the company not being satisfactory,delays in execution of project, discrepancies in the financials,etc. Inspite of the same, the loan facility was sanctioned.

DEFICIENCIES IN APPRAISAL - INSTANCES

No proper credit appraisal – CIBIL reports, Discrepancies in documentation

CIBIL Report indicating serious adverse comments not seen verified before disbursement of loan.The disbursement made without ensuring the identity of the borrowers. There are apparent mismatch in the age of the borrower vis-à-vis their photographs obtained. The identity/signature of the borrowers are not properly authenticated/witnessed. The compliance of KYC norms were not satisfactory.There was also mismatch with the reported land holdings of each farmer and produce reported to be sold by them. The same quantity is documented as sold by each farmer irrespective of his reported area of land holding.

DEFICIENCIES IN APPRAISAL - INSTANCES

HealthField Input and market information-CIBILOperation

PerformanceDPDevolvement, Cheque returns and exceedings

Stress testingIdentification of stress pointsAction plan

Greening will only postpone the inevitable

Year-end RegularisationABC Limited enjoys OD and TL facility. Party consistently remits the interest at the end of each quarter only to regularize the account. These credits were immediately withdrawn by overdrawing the CC limit after the quarter end.There is no operation in the account except for servicing of CC/TL interest/instalments.

Audit proceduresThe financial health of the borrower was ascertained. Subsequent operations were reviewed. Year end regularisation through isolated transactions and subsequent withdrawal was not accepted.

HEALTH MONITORING - Instances

Year-end RegularisationThe statement of account shows credits and immediate debits and virtually no operational transactions.The borrower services the interest only after repeated persuasion and reminders.

Audit proceduresThe financial health of the borrower was ascertained. Credits in the account which are immediately withdrawn by exceeding the limit were not accepted as genuine transactions.

HEALTH MONITORING - Instances

XY Oils Ltd • It was learnt that the party faces a possible substantial loss which may

relate to trading in commodity futures by the promoters.AB Private Limited

The debtors as at year end was found to be Rs.1900 L (of which debts outstanding for more than 6 months amounted to Rs.1000 L) against the sales of Rs. 2500 Lacs, indicating high liquidity crunch of the business. There exists a dispute among the directors leading to the inability of the company to dispose of the property offered as collateral securityFrequent devolvement of LCs and continuous substantial excess over the limit.

Audit ProceduresFile and Financial Statements Review. Review of Media reports about Company

HEALTH MONITORING - Instances

Greening of bad accountsFew or isolated transactionsBorderline accounts involving serious health concernsCheque purchasesSubsequent regularization Isolated cash transactions for regularizationCircuitous transactionsAd hoc facilities

Cheque purchase, routed through sister concernThe Cash Credit account has been brought within the Limit on the last day of the quarter, by transfer from the current account of a sister concern. To enable this a cheque was purchased in the current account of of the sister concern.This cheque was subsequently dishonoured .Method of verificationAnalysis of source of credit transactions in the account.

GREENING OF BAD ACCOUNTS

Cheque purchases for Account regularizationThe OD account was regularized at the end of the quarter through cheque purchases, which were not presented for a number of days. Method of verificationAnalysis of source of credit transactions in the account.

GREENING OF BAD ACCOUNTS

Isolated cash transactions for regularizationTerm Loan seen serviced through cash, which was brought in by overdrawing the OD/CC account.

Method of verificationAnalysis of source of credit transactions in the account. When the source of credit is cash, the cash teller account of the day was verified. It was noticed that there was a corresponding credit in the cash teller, which was by overdrawing another account of the borrower.

GREENING OF BAD ACCOUNTS

Loans to associate concerns to regularize bad accounts, routed through multiple branchesOn scrutiny of the current accounts it was noticed that the major credits in the account were from the current accounts of sister concerns, maintained in another Branch of the same bank. These credits in turn came from current account of another associate concern. On scrutiny of the account of the said sister concern, it was noticed that the funds credited was out of the fresh general purpose Term Loan sanctioned to the associate concern. Method of verificationAnalysis of source of credits. Here multiple branches and multiple borrowers were involved. But the underlying source of all the credits were traced to a fresh facility granted to the associate concern.

GREENING OF BAD ACCOUNTS

RTGS transfers vide another bankFacilities of borrower seen closed and on the same day fresh credit facilities were granted, by routing the proceeds through RTGS vide another Bank.

Method of verificationReview of file and analysis of source of credits. RTGS transfers are usually seen as a genuine source of credit. However, it has to be ascertained whether fresh facility has been granted to the borrower.

GREENING OF BAD ACCOUNTS

Ad-Hoc facilitiesAd-hoc credit limits were seen granted to the borrowers at the period end, which were renewed as ad-hoc limits after the period end, instead of sanctioning regular limits.

Method of verificationReview of file and software to ascertain the date of extension of facilities and reasons for non sanctioning of regular limits.

GREENING OF BAD ACCOUNTS

Importance of drawing powerSanction terms (Bank Vs Consortium)DP is an indicator of Cash support needed for regular operationsExceedings indicate :

Diversion larger working capital gap

Correct assessment of DP -Submission of Inventory / debtors statement is not a routine procedure but a monitoring controlDifferences between Particulars furnished to bank and the audited accounts is a serious discrepancy Furnishing / accepting inaccurate DP is an act bordering on fraud

Importance of drawing powerMonitoring is a key requirement

Impact of creditors- Unpaid stockInspectionComparison with level of operations in the accountAgeing of stock and debtorsStock auditEffective use of concurrent audit

Bank’s share in Drawing Power in case of a consortium advance was wrongly taken.

Method of verification:Review of Correspondence from lead bank.

DISCREPANCIES IN COMPUTATION OF Drawing Power

Particulars Drawing power (in crores)

Total Drawing Power 22

Bank’s share in Drawing Power (45%)

9.9

Drawing Power computed by the bank (54%)

12

Debtors aged more than 90/120 days considered for computation of Drawing Power

Method of verification:Review of Book Debts Statements furnished with the Financial Statements.

DISCREPANCIES IN COMPUTATION OF Drawing Power

Particulars Drawing power (in crores)

Books Debts(less than 180 days) as per Financials

123

Books Debts as per Statement furnished by borrower

185

Instances where creditors are not deducted from stock to arrive at Paid Stock/ Comparison with Financial Statements1). As per the DP Statement, there is no amount of sundry creditors considered, whereas as per the latest audited balance sheet of the company, the amount of sundry creditors is around Rs 1.5 crores. 2). Drawing Power is being computed without considering correct amount of sundry creditors. The value of creditors as per the stock statements furnished by the company shows a low figure as compared to the general position of creditors vis-à-vis levels usually maintained by the company as is evident from the Audited financial statements of the company. Method of verification:Review of Financial Statements of the Company.

DISCREPANCIES IN COMPUTATION OF Drawing Power

The balance in the account as on 31.03.2011 is Rs 95 lakhs whereas, as per the audited Balance sheet of borrower the value of stock was only Rs 27.00 Lakhs.The security for the above OD/CC is hypothecation of stock of medicines and consumables. However as per the stock inspection conducted by branch and the value of stock, was shown as Rs 1.08 crores which appeared to be excessive.

DISCREPANCIES IN COMPUTATION OF Drawing Power

DISCREPANCIES IN COMPUTATION OF Drawing Power

Value as per BS-31.03.10 (in crores)

Value as per Stock Statement-31.03.10

Construction Materials

17.64 21.89

Building Materials 17.56 22.23

Construction WIP 50.94 70.12

Total 86.13 114.24

Sundry Debtors 89.87 93.44

Sundry Creditors 97.21 29.53

Consortium Advances- Bank to determine DP based on its own sanction terms and not as per DP allocated by them.

The working capital requirement limit of Rs 20 crores for 2010-11, was reviewed , based on the appraisal by the Lead Bank, who had arrived at the total MPBF of Rs 250 crores.The appraisal note that the projected NWC of Rs 120.54 crores as on 31.3.2011 is subject to infusion of Rs 380 crores of PE Funds, otherwise the projected NWC would be negative at (Rs 179.46 crores.) It is further noted in the note that the level of sundry Creditors is estimated at Rs 291.15 crores for 31.3.11 subject to the above infusion of PE funds of Rs 380 crores ,otherwise the level would be Rs 591.15 crores.The CMA data given by the company as on 31.03.11 has shown negative net working capital (NWC) of Rs.229crores.Method of verification:Level of DP as per MPBF method to be reassessed by the Bank periodically.

DISCREPANCIES IN COMPUTATION OF Drawing Power

Consortium Advances- Bank to determine DP based on its own sanction terms and not as per DP allocated by them.

As per the visit report of lead Bank as on 28/12/2010 stock of marble block which constitute more than 70% of the total value of stock has been moving slowly. More than 50% of debtors are of 6 months and above. DP is being permitted for debtor up to 90 days as per sanction terms. As per stock & audit report as on 31/1/201,1 66.43% of debtors exceed 180 days and only 12.33% is below 90 days. As per sanction terms margin for stock 25% and 50% on book debts. DP allocated and adopted at Rs.460 lacs as advised by the lead bankMethod of verification:Level of DP as per MPBF method to be reassessed by the Bank periodically.

DISCREPANCIES IN COMPUTATION OF Drawing Power

Agricultural advances

Sector riskAgricultural advances are monitored on the basis of technical requirements of NPARegular operation only will indicate the proper utilizationExplanation of borrower credibility/relationship is only of supplementary importanceResponsibility of field officers

Irregular operations in account and Diversion of fundsIn various cases, Agricultural proceeds and operations are not seen routed through the account.Utilized similar to a Term Loan facility. The borrowers were not remitting amounts in the account depending on the crop produce. Amounts are seen remitted at the period end only to regularize the account.The loans were not used for the purpose for which they were granted. Proper inspection was not seen carried out.Loans granted for purchase of land wrongly classified as Agricultural advance.

AGRICULTURAL ADVANCES

Pre/ post shipment advances

Operation through current account , allowing exceedings in current account Genuineness of export to be ensuredUtilization of PCL for regularization of exceedings / interest at end of the period. Recording valid reasoning for extensionContinuous monitoring for :

Delay in realizationBills drawn on associates

Fresh Packing Credit Facilities disbursed 1. ABC Textile Ltd. The borrower has serviced the dues for the two quarters in the year 2010-11 through disbursement of Packing Credit facilities. Some of the facilities are seen granted at the period end to service the instalments

2. XYZ Pvt Ltd Account regularized through fresh PCL's. PCL's seen overdue beyond 365 days

PRE-SHIPMENT AND POST SHIPMENT ADVANCES

Fresh Packing Credit Facilities disbursed Various PCL's seen disbursed during the quarter for regularization of Temporary OD.The interest and installments of the loans are serviced from the Current accountsOn scrutiny of the above Current Account ,the major credits to this account were observed to be from disbursement of Packing Credit loan. Except for such credits ,the account was overdrawn on most of the days during the quarter. Many transfers are made to the other current which manages to have credit balance throughout the quarter because of the above mentioned transfers and Packing Credit loan disbursements. And from this current account the above mentioned loans are periodically serviced ensuring that no default is made on such loan repayments.

PRE-SHIPMENT AND POST SHIPMENT ADVANCES

Restructured advances

Genuine appraisalViabilityReasonableness of terms of restructuring

Greening of bad accounts by restructuringSpecial portfolio

Moratorium is only for rehabilitation and not for monitoring of performance and compliance

Stress points to be monitored on an ongoing basis

Restructuring without proper consideration of health of borrower

The account was restructured with effect from 1st October 2011. The Bank had restructured the facilities on 31st March 2011 and implemented , vide the letter from the Sanctioning authority on the same date.6 PCLs totaling to Rs 9.55 crores was extended to 360 days.Three export bills drawn on its subsidiary company discounted on 23-06-2011 was extended up to 360 days.On 07.03.2012, one buyers credit amounting to Rs 651 lakhs was devolved.During quarter ended 31st December 2011, the CC limit was regularized by crediting an Inland Documentary Bill Purchased (IDBP) of Rs 108.65 lakhs (Rs 27.96 lakhs and Rs 80.69 lakhs each). The account was within the limit for only a single day during the December quarter.The same bills were dishonored in the subsequent quarter.

RESTRUCTURED ADVANCES

Projects under implementation

Importance of Commercial Operation Date(CoD)Assessment of progress of implementationStress testing

Project costing Means of finance Diversion ( borderline on fraud) End use

Timely extension in genuine instances

Extension of CODCommercial Operation Date(CoD) originally envisaged in the proposal was March 2009, subsequently extended to 30.09.2009 with a moratorium period of 6 months from 30.9.2009 for repayment, with repayment starting from 1/4/2010. This modification in the terms after disbursal of the loan amounted to a restructuring. Though the COD date was fixed as 30.09.2009, the Sales as per the Financials for the year ended 31.3.2010 is Nil. Though the company had informed the bank that they had commenced production in March 2010, ie. within 6 months from the COD, the audited financials of the company reveal that the company has not commenced production and hence no profit and loss account was drawn up for the period ended 31.3.2010. No follow up/inspection or information from field about stress.

COMMERCIAL OPERATION DATE

Unfunded LimitsIn terms of R B I Master Circular

– Discounting/Rediscounting of bills by bank’,the banks should open purchase/discount/negotiate bills under L Cs only in respect of genuine commercial and trade transactions of their borrower constituents who have been sanctioned regular credit facilities by the banks. Banks should not extend fund- based (including bills financing) or non-fund based facilities to non-constituent borrower or / and non-constituent member of a consortium / multiple banking arrangement. Bank is to ensure that the RBI guidelines in this context are not deviated.

Cases are noticed where only non-funded facilities have been granted to the borrowers

COMMERCIAL OPERATION DATE(DCCO)

ConcernsLarge frauds in the recent pastGreening of unhealthy accounts and lack of proper appraisal/follow up pre/ post sanctionHousing Loans

Builder risk assessmentMultiple lendingPremature disbursements

Retail vehicle loansAccommodation

Cheque purchaseDPNon compliance of terms of sanction

ConcernsBranch-Dependence on one or two key borrowers-Compromises and accommodationDisputes within the borrower entityPersisting audit commentsInsufficient operationsContinuous exceedings , Cheque returns and devolvementsFrequent roll-overs/extension of export credit

ConcernsBullet Loans-

High Riskcontinuous monitoring during the period, and not on expiry

Credit supervision- Identify stress at the earliest opportunity and take timely action / report to controlling authority

Significant Audit qualifications / adverse featuresField inputInspectionsDP

Concerns on trust

Complete transparency of information Prima facie unacceptable explanationsExplanations and justifications should be factual and true and should hold good over a periodJustifying end use without verificationProlonged absence of field visits , stock audit and prima facie variation in security valuation Technical regularizations

Control-Effective use of Technology

Exception reports Probable or Potential non performancePerformance of Restructured AdvancesRisky exposuresCODSector wise assessmentHealth-Accounts with inadequate level of TurnoverUpdation of DP/ Valuation of security

Control-Suggestions to be given in branch audit report

Improve quality of appraisalObtain CIBIL before disbursementDo not compromise on sanction terms before disbursementBalance between Growth and RiskEarly identification and monitoring of stress ABC classification

Control-Suggestions to be given in branch audit report

Emphasis on recovery Constant monitoring of

Insufficient operationsDisputes within the borrower entityPersisting audit commentsContinuous exceedings , Cheque returns and devolvement'sFrequent roll-overs/extension of export credit

ISSUES RELATING TO ADVANCES

SYSTEM FOR APPRAISAL OF CREDIT PROPOSALS NOT STRICTLY ADHERED TO.ADEQUATE INFORMATION IN RESPECT OF THE BORROWERS' STANDING, INTEGRITY, EXPERIENCE AND CAPABILITIES NOT OBTAINEDAT TIMES DUE CARE NOT TAKEN TO ENSURE WHETHER THE PURPOSE OF LOAN IS GENUINE

ISSUESBORROWERS ENJOY CREDIT FACILITIES WITH CERTAIN SPECIFIC BRANCHES OF THE BANK BUT OPERATING ACCOUNTS WITH OTHER BRANCHES WITHOUT THE KNOWLEDGE OF CONCERNED BRANCHES REFLECTING LACK OF PROPER CO-ORDINATION AND CONTROLIN CERTAIN CASES DISBURSEMENTS MADE PRIOR TO SANCTION OF LIMITS/ HIGHER LIMITS BY HIGHER AUTHORITIES

ISSUES

DISBURSEMENTS NOT DONE STRICTLY IN ACCORDANCE WITH THE SANCTIONDOCUMENTS FOUND TO BE INCOMPLETEADVANCES RELEASED BEFORE THE EXECUTION OF RELEVANT DOCUMENTSDOCUMENTS NOT RENEWED WITHIN SPECIFIED TIME

ISSUES

PERIODIC BALANCE CONFIRMATION/ ACKNOWLEDGEMENT OF DEBTS NOT OBTAINEDSUBMISSION OF AUDITED FINANCIAL STATEMENTS BY BORROWERS WITH LIMITS BEYOND Rs 10 LAKH NOT ENSUREDSECURITIES AVAILABLE INADEQUATE TO COVER THE OUTSTANDING BALANCES

ISSUESSTOCK STATEMENTS NOT RECEIVED IN MANY CASESWHEREVER RECEIVED, THEY ARE NOT ALWAYS VERIFIED BY CONDUCTING INSPECTIONSRENEWAL OF FACILITIES NOT DONE ON DUE DATESLATEST VALUATION FOR MOVABLE AND IMMOVABLE SECURITIES NOT OBTAINED

ISSUES

CLAIMS NOT FILED IN TIME WITH ECGC IN MANY CASESWHEREVER FILED, EFFECTIVE FOLLOW UP FOR RECOVERY OF SUCH CLAIMS NOT DONE

ISSUES

PRE/ POST SANCTION INSPECTIONS NOT UNDERTAKENCERTIFICATE OF REGISTRATION OF CHARGES FROM THE REGISTRAR OF COMPANIES NOT HELD ON RECORDEXCESS DRAWINGS BEYOND POWERS ALLOWEDPENAL INTEREST NOT BEEN CHARGED FOR DELAYED REPAYMENTS

ISSUES

PRESCRIBED MARGINS NOT MAINTAINEDDISCOUNTING OF BILLS IN RESPECT OF PARTIES WHOSE BILLS GOT RETURNED UNPAID EARLIER OR PAYMENT WHEREOF NOT FORTHCOMINGADEQUACY/CONTINUITY OF INSURANCE POLICIES NOT ENSURED

ISSUESMANY CASES WHERE BORROWERS HAVE GIVEN FIXED DEPOSITS AS SECURITY/MARGIN THAT HAVE MATURED BUT NO STEPS TAKEN TO RENEW THEMIN SOME CASES AD-HOC LIMITS SANCTIONED TO REGULARISE THE DEBIT BALANCES IN BORROWAL ACCOUNTS WHICH ARE IN EXCESS OF THE SANCTIONED LIMITS OF THE BORROWER

ISSUES

WHERE SUB-LIMITS TRANSFERRED FROM ONE BRANCH TO ANOTHER, INFORMATION ON THE FOLLOWING NOT AVAILABLE AT THE BRANCH WHERE THE MAIN ACCOUNT IS MAINTAINED :

• ABOUT THE OPERATION IN THE ACCOUNT• WHETHER THE ACCOUNT IS OVERDRAWN OR IN

ORDER

ISSUES

• WHETHER THE INTEREST IS SERVICED OR NOT• WHETHER ANY L/Cs WERE ISSUED AND

WHETHER ANY DEVOLVEMENTS UNDER L/Cs OUTSTANDING AND

• WHETHER ANY BILL PURCHASED/ DISCOUNTED IS OVERDUE

ISSUES

MAIN BRANCH NOT ADVISING ABOUT THE CLASSIFICATION OF THE ASSET TO THE BRANCH WHERE SUB-LIMITS ARE TRANSFERRED AND VICE A VERSAPROPER MONITORING OF ACCOUNTS NOT DONE TO PREVENT SLIPPAGE OF ACCOUNTS TO NPA CATEGORYNPA DATE NOT CORRECTLY DETERMINED

THANK YOU

Vivek Krishna GovindPartner,Varma & VarmaChartered Accountants