investment and treasury
TRANSCRIPT
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BANK AUDIT
INVESTMENT AND TREASURY
Presented byCA C. V. SAJAN
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How to approach the audit Regulatory perspective takes in to account most of the
aspects as RBI has given detailed guidance on accounting ,
internal control , risk management and accountabilityissues. Therefore compliance of RBI circular is the prime
objective
Work allocation can be broadly in to (a)Asset
classification(b) valuation Verification of front office and
back office operation including account examination and
reconciliation (d) Examination of files , reports, board notes.
Getting acquainted with the system and software is the key
LFAR shall comprehensively cover observations on every
point RBI has prescribed as compliance including from
proprietary angle
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Regulatory concerns this year
Tendency to stack up investment in HTM on one side and
at the same time conducting sales from that portfolio in
violation of RBI circular spirit.
Exposure to capital marketdirect and indirect
correctness of data and system of data capturing
Exposure to NBFCs and using NBFC route for sensitivesector like Real estate
Compliance of guidelines in investing PTC and SCs issued
by SC /RC
Private placement of Debt in the name of Infra structurewithout adhering to rating, listing requirements and other
exposure to unlisted securities
Correctness of Valuation in view of rising yields and NPI
in unlisted categories
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Valuation
Valuation could be a laborious exercise
Master circular dt 1-7-09 , Paragraph 3.5 to 3.10.3 givedetailed yard sticks for measurement
Market value in the case of unlisted securities could be a
challenge.
Correctness of market quotes /YTM rate applied in
government securities need thorough examination
Zero coupon Bonds , deep discount Bonds etc need
special care Investment in SR/PTC issued by SC/ RCs need care as
lower of NBV of assets or redemption value is the norm
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Profit and loss aspects
No capitalization of broken period interest paid
/received. As such they are to the P/L account Income recognition on accrual basis only where there are
no arrears
Dividend recognition only after AGM approval by
investee companies , ie after establishing right to receive
Income on NPI not accrued as in advances
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Verification of settlement
The settlement of all outright secondary market
transactions in Government Securities will be doneon a standardized T+1 basis
Select appropriate samples and ensure that settlements
are done on T+1 basis
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Same day accounting for SLR purpose
All the transactions put through by a bank, either on
outright basis or ready forward basis and whetherthrough the mechanism of Subsidiary General Ledger
(SGL) Account or Bank Receipt (BR), should be
reflected on the same day in its investment account
and, accordingly, for SLR purpose whereverapplicable.
Based on sample testing, this aspect needs to be
verified
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Authenticity of BRs ( Bankers Receipt )
BR s are less prevalent now a days. Yet in case of
allotment in pipeline BRs are used For issue of BRs, the banks should adopt the format
prescribed by the Indian Banks' Association (IBA) andstrictly follow the guidelines prescribed by them in
this regard. The banks, subject to the above, could issue BRs
covering their own sale transactions only and shouldnot issue BRs on behalf of their constituents,
including brokers. Undertaking whether transactions through BRs were
there or not , to be collected and in case of any,verification on sample basis needed
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Instances of SGL form return by RBI
There are remote possibilities of SGL form returning by
RBI , for want of balance in sellers account This is a fraud prone area
Immediate information to RBI is necessary in such cases.
Ask for records that capture such instances and conclude
on instances, if any, during reporting period
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LFAR to carry comment on investments in shares/
debentures The observation to include whether the bank has
(i) Built up adequate expertise in equity research byestablishing a dedicated equity research department, aswarranted by their scale of operations;
(ii) Formulated a transparent policy and procedure forinvestment in shares, etc., with the approval of the
Board; and (iii) The decision in regard to direct investment in
shares, convertible bonds and debentures were takenby the Investment Committee set up by the bank'sBoard.
Opinions shall be formed from proprietary anglewhether the Investment Committee should be heldaccountable for the investments made by the bank.
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Ready forward transactions Repo transactions , and reverse repo transactions , are
liquidity management tools
Securities are not transferred, but only lien is marked. Banks shall show these transactions as sale and purchase
First leg of transaction is contracted at market rate Plusinterest accrued. On completion of second leg, net
difference between contracted prices and settlement ofinterest accrued becomes the interest expenses ( inrepo) . Security is accounted at original carrying value oncompletion of second leg.
Outstanding RF transactions on reporting date to reflectthe mark to market impact in buyers books.
Seller shall reverse the profit booked on repo and put inother liabilities. Similarly loss booked on repo if any bereversed to reflect in other assets.
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RBI Norms on ready forward transactions
Repo transactions may not be done with the custodian of
SGL and Both the constituents shall not have SGL account with
the same custodian
Central government securities ( including T Bills ) and
dated State government securities are only allowed Permitted for securities only in excess of SLR
All ready forward contracts shall be settled throughthe SGL Account / CSGL Account maintained with the
RBI, Mumbai, with the Clearing Corporation of IndiaLtd. (CCIL) acting as the central counter party for allsuch ready forward transactions.
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Reconciliation of SGL balance
SGL account with RBI has to be reconciled with
investment portfolio of the bank Instances of bouncing from SGL account of insufficient
balance of security in SGL account in case of sale of
securities be enquired in to for reporting purposes.
Similarly instances of bouncing from current accountwith RBI on account of purchase of securities also be
enquired into .
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Short sale of government securities
Banks may sell a government security already contracted for
purchase, provided:
1. The purchase contract is confirmed prior to the sale,
2. The purchase contract is guaranteed by CCIL or the security is
contracted for purchase from the Reserve Bank and,
3. The sale transaction will settle either in the same settlement cycle
as the preceding purchase contract, or in a subsequent settlement
cycle so that the delivery obligation under the sale contract is met
by the securities acquired under the purchase contract
For purchase of securities from RBI through Open Market
Operations (OMO), no sale transactions should be contracted priorto receiving the confirmation of the deal/advice of allotment from
the RBI.
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Investment in shares
Audit committee is required to monitor and keep
surveillance of investment in shares Monthly review of exposure to capital market be done ,
both for fund and non fund exposures . Board note may
be examined to ensure compliance of this.
The review shall cover adequacy of internal control andrisk management systems
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Engagement of Brokers
Inter bank security transactions are not allowed through
brokers Brokers are permitted for other deals , only for the
limited purpose of introducing the two parties.
Of the total transactions , individual broker can not
transact for more than 5% volume.
Records to explicitly carry details on broker engagement
and top management be informed (brokerwise) , about
the transactions , brokerage etc..
Auditor to examine on the overall involvement of brokers
and make an audit note appropriately for inclusion in
LFAR if required.
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Half yearly review reports
Make sure that half yearly review reports sent by the
Bank to RBI are examined Study the concurrent audit reports and reconcile with
reports to Board /RBI.
Make note of the points about system flaws or non
compliance of norms for inclusion in LFAR
Treasury concurrent audit reports are required to be
presented to CMD on monthly basis. Examine the report
and take cues there from.
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NON SLR INVESTMENTS
Include shares, Corporate debts, Units of MFs,Investment in VCF, Mortgaged backed securities, Asset
Backed securities, Bonds issued by SCs and RCs Investment grade credit rating and listing required for
corporate bonds .(Exception for infrastructure Bonds)
Ceiling for unlisted Non SLR investments up to 10% of
total Non SLR Investments plus additional 10% forspecified SC/ RC Bonds
All the procedures in credit appraisal and sanction , needto be followed in investment in Non SLR.
Private placement of debts with investment departmentis an area of Concern for RBI.
Auditors need to thoroughly examine all the exposures inthis category from the risk , reward and compliance
points, more particularly of borrower clients.
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Exposure to capital market
Verify the data capturing system for this purpose and
include observation in LFAR. Aggregate exposure limit in all forms (both FB and
NFB) is 40 per cent of its net worth as on March 31
of the previous year.
Within this overall ceiling, the banks direct
investment in shares, convertible bonds /
debentures, units of equity-oriented mutual funds
and all exposures to Venture Capital Funds (VCFs)[both registered and unregistered] should not exceed
20 per cent of its net worth.
Board can fix lower ceiling limits too. Check it out.
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Issues related to classification
Categorization in to HTM , AFS , HFT is required at the
time of transaction. Ensure compliance Further classification in to following six heads for
the purpose of presentation
a) Government securities,
b) Other approved securities,
c) Shares,
d) Debentures & Bonds,
e) Subsidiaries/ joint ventures and
f) Others (CP, Mutual Fund Units, etc.).
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HTM to include only the following
(a) SLR Securities upto 25 percent of their DTL as on
the last Friday of the second preceding fortnight. (b) Non-SLR securities included under HTM as on
September 2, 2004.
(c) Fresh re-capitalisation bonds received from the
Government of India towards their re-capitalisation
requirement and held in Investment portfolio.
(d) Fresh investment in the equity of subsidiaries and
joint ventures (e) RIDF/SIDBI deposits.
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Treatment of profit on HTM sale
Profit on sale is first credited to P/L, however, equal
amount is appropriated to capital reserve.
Ensure correctness of HTM profits to comment on the
appropriation
Loss on HTM sale is charged to P/L
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Can debentures/ Bonds be under HTM
Those issued prior to Sep 2, 2004 were allowed to be
included under HTM, provided they were part ofadvances granted to a company
Non SLR investments issued after Sep 2, 2004,are not
allowed to be included in HTM. Accordingly Debentures/Bonds are out of scope of HTM .
Consequently they are subject to mark to market
valuation and provisioning norms .
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Complication with HFT and AFS
While HFT is meant for short term trading , AFS becomes
the residual category Profit or loss on sale in both cases go to P/L
HFT must be liquidated in 90 days
Shifting HFT to AFS is permitted only in exceptional
situations (, like failure to sell in 90 days due to tight
liquidity in market), and that too subject to top
management approval .
Not selling with in 90 days for fear of loss requires
commenting.
Auditors to take a view on the HFT trade practices, efficacy
of buy-sell strategies and about the shifting of HFT to AFS
during the year
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Valuation HTM
No marking to market
Measure at cost. In case cost is more than redemptionvalue , excess is amortised over the residual life period.
In such cases the cost less amortization is the value.
Such a charge is allowed as reduction from interest
income from Investments
Where there are investments in JVs/ Subsidiaries ,
dimunition in value other than temporary be providedfor , investment wise
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Valuation AFS and HFT
Every item is Marked to market , taking all the items in a
classification together. In the case of foreign investments, marking to market under
five classifications is done, scrip wise
Further, the investment in a particular classification, both in
domestic and foreign securities, may be aggregated for thepurpose of arriving at net depreciation/appreciation of
investments under that category.
Net depreciation, if any, shall be provided for. Net
appreciation, if any, should be ignored
No offsetting of depreciation in one classification with
appreciation in another.
Book values of individual securities undergo, no change.
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Valuation Challenges
AFS/ HFT are valued at market rates for quoted items
For unquoted , different norms are prescribed rangingfrom cost basis for T bills , periodical YTM( announced
PDAI )basis for central govt securities to bench marked
YTM basis for others like State Govt securities, Other
approved securities etc.. Zero coupon Bonds and other Deep discount bounds
require special attention as Interest accrued shall be
reckoned as part of carrying value
Unquoted preference shares are based at YTM. Howeverthose issued as rehabilitation etc require special bench
marking . Care needed in testing valuation basis
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Unquoted Preference shares
a) The YTM not to be lower than that for a GOI loan
B) The mark-up for the unrated preference sharesshould appropriately reflect the credit risk borne by
the bank.
c) Investments in preference shares as part of the
project finance may be valued at par for a period of
two years after commencement of production or
five years after subscription whichever is earlier.
d) Where investment in preference shares is as partof rehabilitation, the YTM rate should not be lower
than 1.5% above the coupon rate/ YTM for GOI loan
of equivalent maturity.
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Preference shares - contd..
e) Where preference dividends are in arrears, no credit
should be taken for accrued dividends and the value
determined on YTM should be discounted by at least 15% ifarrears are for one year, and more if arrears are for more
than one year. The depreciation/provision requirement
arrived at in the above manner in respect of non-performing
shares where dividends are in arrears shall not be allowed tobe set-off against appreciation on other performing
preference shares.
f) The preference share should not be valued above its
redemption value. g) When a preference share has been traded on stock
exchange within 15 days prior to the valuation date, the
value should not be higher than the price at which the share
was traded.
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Derivatives
Verification of derivative transactions
Examine whether they are own account or clientaccount and correctness of disclosure
Issues of client complaints on sale of any derivative
products or any claims / litigation
correctness of marking to market
Completeness of disclosure on derivatives in Notes on
accounts
LFAR Note on derivative activities, loss /gain , nature ofexposures, hedging strategies, effectiveness , outstanding
etc..
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Other treasury operations
Verification of liquidity management,
Call money operations Interest calculation and
issue of CRR compliance certificates
Issue of other certificates including verification of SLR
etc..
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Thanks
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