Bank Audit-an over view of LFAR and Restricted Advances.

CA. T R CHANDRASEKARAN

trc@camcr.in

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.

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 responsibilities 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 (CBS) where transactions of the branch are processed only at the processing centers. 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 (2011-12)

Reserve Bank of India issued numerous circulars on Income Recognition, asset Classification and on provisions since April, 1992. Many of these circulars are now outdated, consolidating all the earlier circulars issued by them, RBI is issuing a master circular every year in the month of July. The circulars issued for the year 2011-12 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. RBI No.2011-2012/39 DBOD.No.BP.BC.12 /21.04.048/2011-12 dt.01/07/11 Master Circular -Prudential Norms on Income Recognition Asset Classification and provisioning pertaining to advances

2. RBI MASTER CIRCULAR NO. DBOD. No. Dir.BC-6/13.03.00/2011-12 DT. 1ST JULY 2011 Loans and Advances - Statutory and Other Restrictions

C.  Branch Long Form Audit Report (LFAR)

The objective of LFAR To

-report on the qualitative aspects of the various systems and procedures in all areas of banking like Credit Management ,House Keeping, Regulatory compliance, Statutory requirement etc.,

- help the management and the regulatory authorities to identify the strength and weakness of the systems and procedures prevalent in the bank.

·      -helps the subsequent auditor to understand the functioning and shortcomings of the branch

LFAR is not a question and answer format and usage of "yes' and “no" to be avoided. If the space provided is not adequate separate sheets has to be used. LFAR calls for a very proactive, positive and constructive approach from the auditors and in order to ensure a quality report, the branch auditors should study the various audit reports of the branch during the year like inspection report, previous statutory report, previous LFAR, RBI inspection reported audit report etc., The comments in the LFAR should not be vague but should be specific. General terms like "limits not renewed in a few cases”, “in a few ceases it was observed" "some balances did not tally"

Format for Branch LFAR is different from the Banks LFAR and Branch auditors have to be familiar with that also, so that Branch auditors can furnish feedback to the Statutory Central Auditors in order to enable them to incorporate such remarks in the banks LFAR. For doing this the branch auditor should be familiar with the points covered in the Bank's LFAR also

All details required for finalising the branch LFAR has to be collected before leaving the branch as the auditor is not entitled to claim separate TA and HA.

The main audit report and the LFAR are intended for a different purpose. Hence all the adverse comments affecting the P/L a/c and Balance sheet must be mentioned in the main report and qualified and should find a place in the LFAR also.

Regarding the audit of 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) 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 Outstanding as on the Closing date

(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 Go down 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' go downs.

 (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 lodgment, 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 , Last stock statement received, up to what date, 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, Value Rs., amount Outstanding as on the closing date, whether considered Secured / Unsecured  

(c) The Insurance Cover on the Stocks were inadequate in the following cases

Party, Amount of cover Rs. Value of stocks held Rs.

 The Insurance Cover for burglary has not been made in the following cases

 Name of the Party, facility, Nature of goods.

 (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 has not moved Rs. Value

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, margin not maintained 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.

Prior 2008 -- --

2008-2009 -- --

2009-2010 -- --

2010-2011 -- --

2011-2012 -- --

 Individual A/cs Sub Total as per columns provided

 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. even though 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. Please note deposit loans and jewel loans are NOT exempted from NPA norms.

(c) The Deposit Receipt has 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 Rs. Deposit details.

 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 account wise in L.A. Other accounts have to be reported group wise and year wise as explained in (a) above. Statutory auditors shall also report the accounts which have discrepancy as explained in (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 , amount 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 securities taken  

Party, Value of the Policy not taken, not renewed after

Consumer Credit Installment Loan

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

Party, Balance outstanding as at the Closing date, Number of installment paid up to the Closing date, Due date for last installment Payable,

Agricultural Short Term Production Loan

The following advances are long - overdue

Party, Date of Advance, Amount of Repayment Outstanding, due on

Agricultural Medium Term Loan

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

Party, Outstanding as at the closing date, Number of installment up to

The Closing date, Due date of last installment Payable.

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

(b) Latest surrender value certificate has not been obtained and produced to us in respect

of the following advances:

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

 (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 installment was long overdue in the following cases:

Party Amount outstanding Last installment Paid.

(c) The name of the bank has not been painted / name board has not been fixed on the machinery taken which is 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 Advance, Date of Advance, Date of default, outstanding Amount.

(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 Advance, Amount  Outstanding ,Interest debited

during the year

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

Party,  Nature of advance, Date of advance, Amount, Amount received Interest debited outstanding during the year accrued on loans

 (d) 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 Advance, Interest for the period,  Amount

 (e) 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 purchase, Party, Amount, Due on, Place at which drawn

Bills returned unpaid

The following bills returned unpaid remained unadjusted for a long period

Party, Date of purchase, Date of return, Amount,  Remarks*

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

1. There is a need for revision of the LFAR format considering the present-day system driven banking ,Due the fact that LFAR does not deal with the following matters which are  more important from the branch auditors  point of view

2. problems  arising out of CBS, malfunctioning of mobile, e’debit, internet banking

3. functioning of Cheque Truncation Scheme, RTGS, SWIFT payments, ATM long pending items etc.,

Conclusion

Inorder to have the LFAR more as an effective audit tool the LFAR should be revisited /Consider and/or to include the following aspects.
 

1)   Size of the Report to be cut to maximum 25 pages.

2)   Report to cover only

      Statutory violations

      Regulatory violations

      Business ethics violations

      Corporate governance violations

3)   Long Form Report Prescribed for Bank and Branches to be merged  as one report  so as to reflect all points at one place

4) LFAR to include comments about the Risk Based super vision.

5) LFAR to include about Basel II implementation and its progress.

6) No major violations affecting true and fair to be mentioned only in LFAR

7) Legal status to be accorded to LFAR as against its present Regulatory compliance

8) Foreign branches to adopt the LFAR format applicable at the respective Regulatory Authority

9) More coverage to be applied for integrated Treasury Management and its effective usage and also information system and its security.

10) AFI Report of RBI and LFAR can be merged and made as one so that RBI inspection can avoided or outsourced over a period of time

THE SALIENT FEATURES OF RBI MASTER CIRCULAR ON LOANS & ADVANCES –

STATUTORY & OTHER RESTRICTIONS

01. Advances against bank's own shares:

A bank cannot grant any loans and advances on the security of its own shares.( Section 20(1) of

the Banking Regulation Act, 1949)

02. Advances to bank's Directors :

B.R Act (Section 20(1)) also lays down the restrictions on loans and advances to the directors

and the firms in which they hold substantial interest.

Banks are prohibited from entering into any commitment for granting any loans or advances to or

on behalf of any of its directors, or any company/firm in which any of its directors is interested as partner,   manager, employee or guarantor.

 03.Restrictions on Power to Remit Debts

A banking company shall not, except with the prior approval of the Reserve Bank, remit in whole

or in part any debt due to it by any of its directors or any firm or company in which the directors

are having interest or partner or guarantor. ( S 20A of BR Act)

04. Restrictions on Holding Shares in Companies

04.a. Banks should not hold shares in any company except as provided in sub-section (1) whether as

pledgee, mortgagee or absolute owner, of an amount exceeding 30 percent of the paid-up share

capital of that company or 30 percent of its own paid-up share capital and reserves, whichever is

less. (Section 19(2) of the Act)

04.b. The banks should not hold shares whether as pledgee, mortgagee or absolute owner, in any

company in the management of which any managing director or manager of the bank is in any

manner concerned or interested. (Section 19(3))

05. Restrictions on Credit to Companies for Buy-back of their Securities

Banks shall not provide loans to companies for buy-back of their shares/ securities.

06. Regulatory Restrictions :Granting loans and advances to relatives of Directors

• Without prior approval of the Board or without the knowledge of the Board, no loans and advances aggregating to Rs. 25 Lakhs and above should be granted to relatives of the bank's

Chairman/Managing Director or other Directors or other bank’s Directors (including Chairman/Managing Director) and their relatives, including lending to directors and their relatives on reciprocal basis. Term relative is explained in RBI Master Circular dt. July 1, 2011.

• Loans & advances of less than Rs.25 Lakhs to these borrowers can be sanctioned at appropriate level as per delegation with suitable reporting to the Board.

06. b. The term ‘loans and advances’ will not include loans or advances against

• Government securities

• Life insurance policies

• Fixed or other deposits

• Stocks and shares

• Temporary overdrafts for small amounts, i.e. upto Rs. 25,000/-

• Casual purchase of cheques up to Rs. 5,000 at a time

• Housing loans, car advances, etc. granted to an employee of the bank

06.e. The guidelines are applicable while granting loans/ advances or awarding contracts to directors of scheduled co-operative banks or their relatives and to directors of Subsidiaries/trustees of mutual

funds/venture capital funds set up by them as also other banks.

07. Restrictions on Grant of Loans & Advances to Officers and Relatives of Senior Officers of

Banks

• Statutory regulations and/or the rules and conditions of service applicable to officers or employees of public sector banks indicate, to a certain extent, the precautions to be observed while sanctioning credit facilities to such officers and employees and their relatives.

• No officer or any Committee comprising, inter alia, an officer as member shall sanction any

credit facility to his/her relative but only by the next higher sanctioning authority. Credit facilities

sanctioned to senior officers shall be reported to the Board.

• Credit facilities to the relatives of senior officers of the bank sanctioned by the appropriate

authority should be reported to the Board.

08. Restrictions on Grant of Financial Assistance to Industries Producing / Consuming Ozone

Depleting Substances (ODS)

Banks should not extend finance for setting up of new units consuming/producing the Ozone

Producing Substances (ODS) as under:-

Sector Type of substance

Foam products Chlorofluorocarbon - 11 (CFC - 11)

Refrigerators and Air-conditioners CFC – 12

Aerosol products Mixtures of CFC - 11 and CFC – 12

Solvents in cleaning applications CFC - 113 Carbon Tetrachloride, Methyl Chloroform

Fire extinguishers Halons - 1211, 1301, 2402

No financial assistance should be extended to small/medium scale units engaged in the manufacture of the aerosol units using CFC and no refinance would be extended to any project assisted in this sector. (FI/12/96-97 2nd Feb 1996-IDBI)

09. Restrictions on Advances against Sensitive Commodities

under Selective Credit Control (SCC)

• RBI, ( Section 21 & 35A of the Act), issues, from time to time, directives to all commercial banks, stipulating specific restrictions on bank advances against specified sensitive commodities

viz. food grains i.e. cereals and pulses, oil seeds indigenously grown viz. groundnut,rapeseed/mustard, cottonseed, linseed and castorseed, oils thereof, vanaspati and all imported oils

and vegetable oils, raw cotton and kapas, sugar/gur/khandsari, cotton textiles which include

cotton yarn, man-made fibres and yarn and fabrics made out of man-made fibres and partly out

of cotton yarn and partly out of man-made fibres.

• Presently, the following commodities are covered under stipulations of Selective Credit Control:

a) Buffer stock of sugar with Sugar Mills

b) Unreleased stocks of sugar with Sugar Mills representing • levy sugar, and • free sale sugar.

• Banks are free to fix prudential margins on advances against these sensitive commodities. Banks

have the freedom to fix lending rates for the commodities coming within the purview of Selective

Credit Control, at or above Base Rate.

• The underlying objective of Selective Credit Control is to ensure that banks do not allow the

customers dealing in Selective Credit Control commodities any credit facilities which would

directly or indirectly defeat the purpose of the directives.

10. Restriction on payment of commission to staff members including officers

Banks should not pay commission to staff members and officers for recovery of loans.

11. Restrictions on offering incentives on any banking products

Banks should not offer any banking products, including online remittance schemes etc., with prizes /lottery/free trips (in India and/or abroad), etc. or any other incentives having an element of chance, except inexpensive gifts costing not more than Rs. 250/-.

12. Restrictions on other loans and advances

Loans and Advances against Shares, Debentures and Bonds

13. a. Advances to individuals

Banks may grant advances against the security of shares, debentures or bonds to individuals subject to the following conditions:

• Purpose of the Loan: Loan against shares, debentures and bonds may be granted to individuals to meet contingencies and personal needs or for subscribing to new or rights issues of shares /

debentures / bonds or for purchase in the secondary market, against the security of shares /debentures / bonds held by the individual.

• Amount of advance : The limit per individual should not exceed Rs. 10 lakhs and Rs. 20 lakhs if the securities are held in physical and dematerialized form respectively.

• Margin : A minimum margin of 50% of the market value of equity shares / convertible debentures held in physical form and 25% of the market value in case held in dematerialized form. These are minimum margin stipulations and banks may stipulate higher margins for shares whether held in physical form or dematerialised form.

• (iv) Lending policy: Each bank should formulate with the approval of their Board of Directors a Loan Policy for grant of advances to individuals against shares / debentures / bonds keeping in view the RBI guidelines.

13. b. Advances to Share and Stock Brokers/ Commodity Brokers

• Banks and their subsidiaries should not undertake financing of 'Badla' transactions.

• Share and stock brokers/commodity brokers may be provided need based overdraft facilities / line of credit against shares and debentures held by them as stock-in-trade

• The ceiling of Rs. 10 lakhs / Rs. 20 lakhs is not applicable for finance to these types of borrowers.

• Banks may grant short term working capital facilities to stock brokers registered with SEBI and who have complied with capital adequacy norms prescribed by SEBI / Stock exchanges to meet the cash flow gap between delivery and payment for DVP transactions undertaken on behalf of

institutional clients viz. FIs, Flls, mutual funds and banks.

• A uniform margin of 50 per cent shall be applied on all advances / financing of IPOs / issue of guarantees on behalf of share and stockbrokers. A minimum cash margin of 25 per cent (within the margin of 50%) shall be maintained in respect of guarantees issued by banks for capital market operations.

• Banks may issue guarantees in favour of stock exchanges in lieu of security deposit to the extent it is acceptable and may also issue guarantees in lieu of margin requirements as per stock exchange regulations.

• The transfer of shares in bank's name in respect of shares held in physical form shall not apply provided such shares are held as security for a period not exceeding nine months.

• Banks shall grant advances only to share and stock brokers registered with SEBI and who comply with capital adequacy norms prescribed by SEBI / Stock Exchanges.

14. Advances against Fixed Deposit Receipts (FDRs) Issued by Other Banks

• The banks should desist from sanctioning advances against FDRs, or other term deposits of other banks.

15. Advances to Agents/Intermediaries based on Consideration of Deposit Mobilization

• Banks should desist from entertaining advances to existing/prospective borrowers, agents/ intermediaries based on the consideration of deposit mobilization,

16. Loans against Certificate of Deposits (CDs)

• Banks should not grant loans against CDs nor permitted to buy back their own CDs before maturity save lending and buy back of CDs held by mutual funds till further notice. Such finance if extended to equity-oriented mutual funds will form part of banks’ capital market exposure, as hitherto.

17. Finance for and Loans/Advances against Indian Depository Receipts (IDRs)

• No bank should grant any loan / advance for subscription to Indian Depository Receipts (IDRs) and should not grant any loan / advance against security / collateral of IDRs issued in India.

 18. Financing promoter's equity

Notwithstanding the general guidelines that the bank should not normally grant advances to take up shares of other companies, considering the importance attached to the infrastructure sector, it has been decided to consider financing the acquisition of the promoter's shares in an existing

company which is engaged in implementing or operating an infrastructure project in India subject to :-

• The bank finance would be only for acquisition of shares of existing companies providing

infrastructure facilities. Further acquisition of such shares should be in respect of companies

where the existing foreign promoters (and/ or domestic joint promoters) voluntarily propose to

disinvest their majority shares in compliance with SEBI guidelines, where applicable.

• The companies to which loans are extended should, inter alia, have a satisfactory net worth.

• The company financed and the promoters/ directors of such companies should not be a defaulter to banks/ FIs.

• Bank finance should be restricted to 50% of the finance required for acquiring the promoter's

stake in the company being acquired.

• Finance extended should be against the security of the assets of the borrowing company or the

Assets of the company acquired and not against the shares of that company or the company being

acquired, but the shares may be accepted as additional security and not as primary security. The

security charged to the banks should be marketable.

• Banks should ensure maintenance of stipulated margins at all times.

• The tenor of the bank loans may not normally be longer than seven years.

• This financing would be subject to compliance with the statutory requirements of the B.R. Act,

1949 (Sec. 19(2)).

• The banks financing acquisition of equity shares by promoters should be within the regulatory

ceiling of 40 per cent of their net worth as on March 31 of the previous year for the aggregate

exposure of the banks to the capital markets in all forms (both fund based and non-fund based).

• The proposal for bank finance should have the approval of the Board.

19. Advances against Bullion/Primary gold

• Banks should not grant any advance against bullion/ Primary gold except specially minted gold coins sold by banks and desist from granting advances to the silver bullion dealers which are likely to be utilized for speculative purposes.

19.Loans for acquisition of Kisan Vikas Patras (KVPs)

• Banks should ensure that no loans are sanctioned for acquisition of /investing in Small SavingsInstruments including Kisan Vikas Patras

20. Bridge Loans against receivables from Government

• Banks should not extend bridge loans against amounts receivable from Central/State

Governments by way of subsidies, refunds, reimbursements, capital contributions, etc. with the

exception that Banks may continue to finance subsidy receivable under the normal Retention

Price Scheme (RPS) for periods upto 60 days in case of fertilizer industry and Banks may

continue to grant finance against receivables from Government by exporters (viz. Duty DrawBack and IPRS) to the extent covered by the existing instructions.

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