Audit of a Bank Branch in India

Bank Branch Audit-Quick Review of Master Circulars of RBI--LFAR--Tax Audit.
T. R. Chandrasekaran.
Bank audit has become almost a seasonal audit as far as branch auditors are concerned.Despite the fact that the listed banks are supposed to conduct quarterly audit/limited review as per the listing arrangements or RBI guidelines,the involvement of branch auditors are not utilised fully by the banks.Branch auditors' job role is limited to conduct the branch audit invariably during the last week of March or first week of April of a year. Branch auditors have to face several problems during this period namely, shortage of audit assistants due to CA examinations,unavailability of rail /bus/air tickets, branches are not geared up to prepare themselves for facing the audit procedures.
Fortunately the suspense prevailed over the question of power to have appointment has taken several twists and turn and temporarily solved at present for the year 2006--2007,and the list of branch auditors will be sent by RBI to the various banks for appointment.Almost all banks unanimously follow as far as branch audit is concerned one uniform system that is predetermined date for completion of the audit as well as placing the annual audited accounts to their Boards. In this context a quick review of the audit procedures to be adopted by the branch auditors without offending the RBI instructions and the responsiblities of the auditors are discussed below.
A. General Guide lines for Branch audit.
Certain amount of planning is necessary before the commencement of the audit which includes :-
1) ensuring the availability of audit staff for quick completion;2)conversant with the latest circulars issued by RBI and respective banks; 3) Accounting Standards issued by the ICAI as applicable to banks ;4) collecting the information relating to the business size of the branches to be audited in order to ascertain the manpower requirements and the number of days required to complete the audit ;5) knowing the location of the branches,availability of transport and tickets,nearby hotels,timings of the branches etc.,6) audit team should include persons who have the knowledge of the use of computers and the various computer operating systems.
System of keeping books and the nomenclature used by banks are not identical among banks.Moreover all banks are now under Core Banking Solutions system where transactions of the branch are processed only at the processing centres. In such branches the statements required for the purpose of audit are auto generated and require special knowledge for verifying the same.In the case of banks since there is a good system of internal control and audit ,hence the auditor need not spend much of his time on verification of deposit items and interest calculations,random test audit may be resorted to. However more vigil and verification is required in-respect of credit related disbursement made by the bank.similarly, unadjusted suspense accounts both debit and credit entries requires greater scrutiny from the point of true and fair view concept. In carrying out audit and verification, the auditor should keep in mind the concept of 'materiality' and items which do not materially affect the overall presentation of the financial statements may be ignored.
B. Master Circulars of RBI(2006-07)
Reserve Bank of India issued numerous cieculars on Income Recognition,asset Classification and on provisions since april,1992. Many of these ciculars are now outdated.However, consolidating all the earlier circulars issued by them, RBI is issuing a master cicular every year.The circulars issued for the year 2006-07 Which are more relevant for the purpose of branch audit are listed here.These circulars can be downloaded from the RBI's official website www.rbi.org.in

1. DBOD No. BP.BC 13/21.01.002 / 2006-07 of dt: 01.07.2006 - Master Circular - Prudential Norms on Capital Adequacy
2. DBS No. FrMc. BC No. 6/23.04.001 / 2006-07 dt : 25.07.2006 - Master Circular - Frauds -Classification and Reporting.
3. DBOD.No. BP. BC.14/21.04.141 / 2006-07 dt : 01.07.2006 - Master Circular - Prudential Norms for classification, valuation and operations of investment Portfolio by Banks.
4. DBOD No. BP.BC 15/21.04.048/2006-07 dt: 01.07.2006 - Master Circular - Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to the Advances.
5. DBOD No. BP.BC.21/21.04.048/2006-07 dt. 12.07.2006 – Annual Policy Statement for the year 2006-07 – Additional Provisioning Requirement for Standard Assets.
6. DBOD No.BP.BC.53/21.04.048/2006-2007 dt.31 01 2007 – Third Quarter Review of the Annual Statement on Monetary Policy for the year 2006 – 07. Provisioning requirement for Standard Assets and Risk Weights for Capital Adequacy.
certain basic details about the classiffication of advances and provisioning norms are given below.

Non-performing assets
An asset, including a leased asset, becomes non-performing when it ceases
to generate income for the bank.
A non-performing asset (NPA) is a loan or an advance where;
i) interest and/ or instalment of principal remain overdue for a period of more
than 90 days in respect of a term loan,
ii) the account remains ‘out of order’ as mentioned below in
respect of an Overdraft/Cash Credit (OD/CC),
iii) the bill remains overdue for a period of more than 90 days in the case of
bills purchased and discounted,
(iv) the instalment of principal or interest thereon remains overdue for two crop
seasons for short duration crops,
(v) the instalment of principal or interest thereon remains overdue for one crop
season for long duration crops.
Banks should, classify an account as NPA only if the interest charged during
any quarter is not serviced fully within 90 days from the end of the quarter.
'Out of Order' status
An account should be treated as 'out of order' if the outstanding balance remains
continuously in excess of the sanctioned limit/drawing power. In cases where the
outstanding balance in the principal operating account is less than the sanctioned
limit/drawing power, but there are no credits continuously for 90 days as on the
date of Balance Sheet or credits are not enough to cover the interest debited during
the same period, these accounts should be treated as 'out of order'.
‘Overdue’
Any amount due to the bank under any credit facility is ‘overdue’ if it is not paid on
the due date fixed by the bank.

INCOME RECOGNITION

Income recognition - Policy
The policy of income recognition has to be objective and based on the record
of recovery. Internationally income from non-performing assets (NPA) is not
recognised on accrual basis but is booked as income only when it is actually
received. Therefore, the banks should not charge and take to income account
interest on any NPA.
However, interest on advances against term deposits, NSCs, IVPs, KVPs and
Life policies may be taken to income account on the due date, provided adequate
margin is available in the accounts.
Fees and commissions earned by the banks as a result of re-negotiations or
rescheduling of outstanding debts should be recognised on an accrual basis over the
period of time covered by the re-negotiated or rescheduled extension of credit.
If Government guaranteed advances become NPA, the interest on such
advances should not be taken to income account unless the interest has been
realised.
Reversal of income
If any advance, including bills purchased and discounted, becomes NPA as at
the close of any year, interest accrued and credited to income account in the
corresponding previous year, should be reversed or provided for if the same is not
realised. This will apply to Government guaranteed accounts also.
In respect of NPAs, fees, commission and similar income that have accrued
should cease to accrue in the current period and should be reversed or provided for
with respect to past periods, if uncollected.
ASSET CLASSIFICATION
Categories of NPAs

Banks are required to classify non-performing assets further into the following three
categories based on the period for which the asset has remained non-performing
and the realisability of the dues:
a) Sub-standard Assets
b) Doubtful Assets
c) Loss Assets

Sub-standard Assets

With effect from 31 March 2005, a sub-standard asset would be one, which has
remained NPA for a period less than or equal to 12 months. In such cases, the
current net worth of the borrower/ guarantor or the current market value of the
security charged is not enough to ensure recovery of the dues to the banks in full. In
other words, such an asset will have well defined credit weaknesses that jeopardise
the liquidation of the debt and are characterised by the distinct possibility that the
banks will sustain some loss, if deficiencies are not corrected.

Doubtful Assets

With effect from March 31, 2005, an asset would be classified as doubtful if it
has remained in the sub-standard category for a period of 12 months.
A loan classified as doubtful has all the weaknesses inherent in assets that were
classified as sub-standard, with the added characteristic that the weaknesses make
collection or liquidation in full, – on the basis of currently known facts, conditions and
values – highly questionable and improbable.

Loss Assets

A loss asset is one where loss has been identified by the bank or internal or external
auditors or the RBI inspection but the amount has not been written off wholly. In
other words, such an asset is considered uncollectible and of such little value that its
continuance as a bankable asset is not warranted although there may be some
salvage or recovery value

Provisioning on NPAs

Sub - standard assets:

A general provision of 10 percent on total outstanding should be made without making any allowance for ECGC guarantee cover and securities available. The 'unsecured exposures' which are identified as 'substandard' would attract additional provision of 10 per cent, i.e., a total of 20 per cent on the outstanding balance. The provisioning requirement for unsecured 'doubtful' assets is 100 per cent. Unsecured exposure is defined as an exposure where the realisable value of the security, as assessed by the bank / approved valuers / Reserve Bank's inspecting officers, is not more than 10 percent, abinitio, of the outstanding exposure. 'Exposure' shall include all funded and non-funded exposures (including underwriting and similar commitments). 'Security' will mean tangible security property discharged to the bank and will not include intangible securities like guarantees, comfort letters etc.

Doubtful assets:

i)100 per cent of the extent to which the advance is not covered by the realisable value of the security to which the bank has a valid recourse and the realisable value is estimated on a realistic basis.
ii) In regard to the secured portion, provision may be made on the following basis, at the rates ranging from 20 percent to 100 percent of the secured portion depending upon the period for which the asset has remained doubtful:
Period for which the advance has
remained in `doubtful' category

Provision requirement(%)
Up to one year
20
One to three years
30
More than three years
100

Loss assets

Loss assets have to provided 100% whether written off or not.

State Government guaranteed exposures - Reserve Bank of India has recently revised the requirements of invocation of State Government guarantee for asset classification and provisions norms for these exposures. As per the revised guidelines,For the year ending March 31, 2005, a State Government guaranteed advance shall be classified as substandard or doubtful or loss, if interest and / or principal or any other amount due to the bank (even without invocation of the Statement Government Guarantee) remains overdue for more than 180 days and attract appropriate provisioning norms.

With effect from the year ending March 31, 2006, a State Government guarantee advance shall be classified as substandard or doubtful or loss, if interest and / or principal or any other amount due to the bank (even without invocation of the State Government Guarantee) remains overdue for more than 90 days and attract appropriate provisioning norms.

Central Govt. guranteed accounts
Advances Guranreed by the Central Govt. may be treated as performing assets until the gurantee is invoked and repudiated. This exemption from classification of Govrnment guarented advances as NPA is not for the purpose of recognition of income.

Agricultural Advances

For Agricultural direct advances (a) a loan granted for short duration crops will be treated as NPA, if the instalment of principal or interest thereon remains overdue for two crop seasons. (b) a loan granted for long duration crops will be treated as NPA, if the instalment of principal or interest thereon remains overdue for one crop season. For agricultural advances various guide lines were issued by RPCD and DBOD of RBI with respect to restructuring and additional fecilities to such direct advances affected by natural calamities.


RBI vide their Cicular DBOD. NO. BP.BC.21/21.04.048/2006 dt.12/07/07 haIncreased provision on certain type of Advances.
s issued fresh guide lines for making additional provisioning in respect of certain advances.
In terms of the above circular, the general provisioning requirement on standard
advances in specific sectors, i.e., personal loans, loans and advances qualifying as
capital market exposures, residential housing loans beyond Rs.20 lakh and commercial
real estate loans has been increased from 0.40 per cent to 1.0 per cent, for the
funded outstanding on portfolio basis.
3. In order to ensure that the above additional general provisioning on standard
advances in specific sectors are made in a smooth and non-disruptive manner, it has
now been decided to permit banks to phase in the additional provisioning requirement
over the financial year 2006-07 as under:
(a) 0.55% for the quarter ended June 2006;
(b) 0.70% for the half-year ending September 2006;
(c) 0.85% for the quarter ending December 2006; and
(d) 1% for the year ending March 2007


C. Tax Audit Report


Tax Audit Report to be given by the auditors in the case bank/branches of the bank are same as that is appilcable to any corporate assessee.
Form 3 CA and form 3 CD prescribed under the Income Tax rules are applicable.

Certain particulars in Form 3 CD can not be filled up at the branch level which can be filled up only at the Head Office level.In such cases Branch auditor
has to indicate in the Form 3 CD such details have to be filled up at H.O. level.Examples of such detials are Bonus paid,contribution to PF, Gratutity,etc.,
Section 269SS is not applicable to banks ,but section 269T is applicable

The following points in the Form 3 CD has got greater impact on thebanks and the auditors have to bestow more attention to the same while finalising Tax Audit Report

i)Particulars of each repayment of loan or deposit in an account exceeding the limit specified in section 269T made during the previous year
Name, address and permanent account number (if available with the assessee) of the payee,
Amount of repayment,
Maximum amount outstanding in the account at any time during the previous year,
Whether the repayment was made otherwise than by account payee cheque or account payee bank draft


ii)(a) Whether the assessee has complied with the provisions of Chapter XVII-B regarding deduction of tax at source and regarding the payment thereof to the credit of the Central Government. [Yes/No]
(b) If the provisions of Chapter XVII-B have not been complied
with,
please give the following details*, namely:-
Amount
(i) Tax deductible and not deducted at all
(ii) shortfall on account of lesser deduction
than required to be deducted
(iii) tax deducted late
(iv) tax deducted but not paid to the credit
of the Central Government
*Please give the details of cases covered in (i) to (iv) above.

For the assessment year 2007-08 onwards certain additional details regarding Fringe Benefit Tax(Section 115WC read with 115WB of the I T Act) has to be certified by Tax Auditor in the Form 3CD and should include payments made to employees for super annuation,entertainment ,sales promotion expenses, conference charges,conveyance,medical aid,tour expenses,hotel boarding and lodging expences,repair and maintenance including fuel expences and depreciation of of vehicles,use of telephones,guest house expences,gift and complimetary items,scholerships,
use of health and other clubs. etc,.

D. Long Form Audit Report(LFAR)
LFAR is not a question and answer format and usage of "yes' and"no" to be avioded.If the space provided is not adequate seperate sheets has to be used.
Format for Branch LFAR is different from the Banks LFAR and Branch auditors have to be familier with that also,sothat Branch auditors can furnish feedback to the
Statutory Cental Auditors inorder to enble them to incorporate such remarks in the banks LFAR.All details required for finalising the branch LFAR has to be collected before leaving
the branch as the auditor is not entitiled to claim seperate TA and HA.Regading the advances collection of the following details would be much helpful to the Branch Auditor to complete his LFAR.
ADVANCES
In respect of advances, reports in the following formats may be given:
(a) Demand Promissory Notes which matured during the year were not renewed till the date of completion of our audit in the following cases :
Name of party
Nature of Advance
Date of DPN
Amount
Rs.
Outstanding as on the Closing date
Rs.





(b) Documents executed in the following cases were incomplete
Party
Nature of Advance
Limit Sanctioned
Balance Outstanding
Remarks
Mention here about the defects in documents like omission to get signature of partner co-obligants, omission of particulars of goods hypothecated etc.

KCC
(a) If the Stock / Bin cards maintained at the Godown were incomplete / not written up at the time of our visit details may be given
(b) The name board in token of the goods having been pledged to the bank was not exhibited in the following parties' godowns.
(c) The branch does not keep the original or certified copy of invoices in respect of goods pledged, to verify the value of the goods pledged. State whether considered as secured or unsecured.
(d) The following goods pledged were not moved for considerable time (Depending upon type of goods)
Party
Date of lodgement
Description of materials
Value Rs.
OCC
(a) The stock statements from the following parties were not received as at the closing date.
Party
Outstanding as on the closing date
Rs.
Last stock statement received upto
Whether to consider the accounts as secured / unsecured

(b) No stock records are maintained at the Shop / Godown / Factory of the following parties to verify stock shown in the statement:
Party
Nature of Goods
ValueRs.
Outstanding as on the closing dateRs.
Whether considered Secured / Unsecured





(c) The Insurance Cover on the Stocks were inadequate in the following cases
Party
Amount of coverRs.
Value of stocks heldRs.




The Insurance Cover for burglary has not been made in the following cases
Name of the Party
(e) The charge in favour of the Bank has not been created and registered with the Register of Companies till the date of audit in respect of advances to the following companies.
(f) The name board of the bank in token of the goods having been hypothecated to the bank has not been exhibited in the shop / godown / factory of the following parties.
(g) The following items of stocks have not moved for considerable time
Party Date from which it Value
has not moved Rs.
Loan against own deposits
(a) In the Loan Analysis statements relating to Loan Against Deposits, each borrowal account will not be written individually by branches. However, the borrowal accounts which have discrepancies like imperfect documentation, non-compliance of RBI directives on Loan against Deposits, balance outstanding in the Loan account exceeds the deposits and unpaid interest etc., should be written individually. Total number of accounts and balance outstanding should be written with year-wise break-up as per format given below in L.A. statement.
Example
Year
No.of A/cs.
Balance Outstanding



Rs.
P.

Prior 2003

--
--

2003-2004

--
--

2004-2005

--
--

2005-2006

--
--

2006-2007

--
--
Individual A/cs

Sub Total


as per columns provided for in printout
1. _____________________________
2.______________________________
3.______________________________
___________________
Total ___________________
However, OD and TOD account against Deposits should be written individually as in the case of other borrowal accounts in LA statements with full particulars as per columns provided for in LA printout without any omission and the balances under Loan against Deposits, OD, TOD as per LA statements should individually tally with respective figures as per G.L.
(b) Statutory auditors shall scrutinize individual accounts even in Loan against Deposits with documents, securities, etc. eventhough not written individually in LA and ensure correctness of information given by branches. The discrepancies noticed during the course of audit shall be reported in Audit Report for follow up.
The Deposit Receipt have not been discharged in favour of the Bank in the following cases.
Party Amount outstanding
Rs.

(d) The RD / RP pass books have not been deposited with the branch in the following cases.
Party Amount outstanding
Rs.
(e) The lien on FD / RD / RP others has not been noted in the branch books in the following cases:
Name Type of Loan Balance outstanding
against Rs.
...............................................................................................................................................................

Jewel Loan

(a) In case of Jewel Loans also, the accounts which have discrepancies like advances against spurious gold, fraud, etc., alone should be reported by branches accountwise in L.A. Other accounts have to be reported groupwise and yearwise as explained in 5(a) above. Statutory auditors shall also report the accounts which have discrepancy as explained in 5 (b)

(b) The certificate for value of the jewel was not produced in the following cases.

Date of Name of the Balance outstanding
Advance borrower Rs.
.......................................................................................................................................................................



Staff Housing Loan / Home Loans

(a) The title deeds have not been deposited with the branch in the following cases. Mention whether considered
secured / unsecured in the accounts.

(b) Legal opinion relating to title to the property / encumbrance certificates were not produced to us in the following cases : (Indicate how it is dealt with in the accounts)

(c) Insurance Policy has not been taken / renewed in respect of properties offered as security in the following cases:


Party Value of the Policy not taken /
Property not renewed after



Consumer Credit Instalment Loan

We give below a list of instances where the instalments have not been paid regularly and the accounts are long overdue.

Party
Balance outstanding as at the Closing date
Number of instalments upto the Closing date
Due date for last instalment


Payable
Rs.
paid
Rs.



Agricultural Short Term Production Loan

The following advances are long - overdue

Party Date of Advance Amount of Repayment Outstanding due on

Rs.

Agricultural Medium Term Loan

Schedule of repayment has not been adhered to in the following cases:


Party Outstanding as at Number of instalments upto Due date of
the Closing date the Closing date last InstalmentPayable Paid .
Rs.


Policy Loans

(a) Assignments of the policy in favour of the bank has not been made in respect of the
following Advances:

Party Amount outstanding Remarks of
as at the closing date the Auditors
Rs.

(b) Latest surrender value certificate has not been obtained and produced to us in respect
of the following advances:


Party Outstanding Date of latest Remarks of
as at the Closing date Surrender Value the Auditors
Rs. Certificate

(c) The age has not been admitted in the policies in respect of advances to the following parties:



Medium Term Loans

(a) The following advances were made to acquire machineries but the invoices for purchase
of machineries were not made available to us / the machineries were not acquired
till the date of completion of our audit. Please state how dealt with in the accounts.

(b) The instalments were long overdue in the following cases:

Party Amount outstanding Last Instalment Rs. Paid



(c) The name of the bank has not been painted / name board has not been fixed on the
machinery as a token of the asset being hypothecated to the bank in the following cases.

(d) (i) The Insurance policy covering the machinery was not taken / not produced to us in the following cases:

(ii) The Insurance policy covering the machinery has not been renewed in the following cases :


Other Advances

(a) The following advances were long over-due as on the closing date :

Party Nature of Date of Date by Amount
Advance Advance which due outstanding
Rs.

(Report also TOD's not brought to credit within the stipulated time)

(b) The following accounts were inoperative except the debits for interest (increase in
working capital Accounts)

Party Nature of Amount Interest debited
Advance Outstanding during the year
Rs., Rs.

(c) The repayments in the following cases were negligible compared to the amount of
advances..

Party Nature of Date of Amount Amount received
Advance Advance outstanding during the year
Rs. Rs.

Interest accrued on loans

(a) The interest for the period mentioned in the following cases were wrongly debited in the loan account instead of interest accrued account. Please state whether rectified at the time of audit.

Party Nature of Interest for Amount
Advance the period Rs.

(b) The interest remained uncollected in the following cases while the loan account has
been settled in full.


Bills Purchased

The following bills were long over-due as on the closing date

DA Bills : (since adjusted items may be omitted)
Bill No. Date of Party Amount Due on Place at which
Purchase Rs. drawn
Bills returned unpaid

The following bills returned unpaid remained unadjusted for a long period
Party Date of Date of Amount Remarks*
Purchase return Rs.


* Mention here the reason for not debiting the party's account or where the goods are held and reason for non-payment.

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