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Statutory Bank Branch Audit - Technical and Practical Aspects

Statutory Bank Branch Audit - Technical and Practical Aspects

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Statutory Bank Branch Audit - Technical and Practical Aspects

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  1. Statutory Bank Branch Audit- Technicaland Practical Aspects CA. Rajkumar S. Adukia radukia@vsnl.com /rajkumarfca@gmail.com http://www.carajkumarradukia.com 093230 61049/098200 61049

  2. Agenda • General • Pre commencement of work • Understanding the banking business • Audit Planning • Audit procedures • Audit Reports Rajkumar S.Adukia

  3. General Rajkumar S.Adukia

  4. History of banks • In 1920 Imperial bank was established • The Reserve Bank of India was established as the Central bank of the country in 1935 under an act called  Reserve Bank of India Act,1934 • In 1955, the Imperial Bank of India was nationalised and was given the name "State Bank of India". • On the suggestions of Narsimham Committee, the Banking Regulation Act was amended in 1993 and thus the gates for the new private sector banks were opened. Rajkumar S.Adukia

  5. Types of banks • Nationalised banks • Co-operative banks • Private sector banks • Foreign banks • Regional rural banks Rajkumar S.Adukia

  6. Special kinds of business undertaken by bank branches • Foreign exchange business • NPA recovery business • Service branches dealing in Clearing house operations business • Corporate banking and Industrial finance business • Personal banking business • Housing finance business • SSI business • Agricultural finance business Rajkumar S.Adukia

  7. Pre-commencement Work Rajkumar S.Adukia

  8. Pre-commencement Work • Beginning of audit cycle is from receipt of appointment letter • Check the compliance u/s. 226 (3) with regard to qualifications and disqualifications of auditors (concurrent ,Internal,Revenue, Stock,System, Credit Risk or other Special Audits conducted in same previous year) • Decision for Acceptance or Rejection of Assignment ( Cost Benefit analysis, other considerations e.g. time available, expertise available) • Communication with Previous Auditor by Registered AD (clause 8 of First Schedule to the Chartered Accountants Act, 1949 • Finding Out Expected date of submission of reports Rajkumar S.Adukia

  9. Pre-commencement Work • Finding out Scope of work • Issue of Engagement Letter under AAS 26. • Copy of all circulars of RBI applicable to branch have to be obtained and kept ready for reference • Attending bank branch audit seminars could enhance the auditor’s knowledge on bank audits • Banking terminology and schemes should be well understood • A reading of Guidance note on audit of banks by ICAI would provide valuable guidance. • It should be ensured that minimum fees is set as per RBI circular dated 17th March 2004 Rajkumar S.Adukia

  10. Disqualifications It should be ensured before accepting the assignment that you do not come into following category of persons ( Section 226(3) of Companies Act 1956) • Body Corporate • An officer or employee of the Bank • A person who is a partner, or who is in the employment, of an officer or employee of the Bank • A person who is indebted to the Bank for an amount exceeding one thousand rupees, or who has given any guarantee or provided any security in connection with the indebtedness of any third person to the bank for an amount exceeding one thousand rupees • person holding any security of that bank, Security means an instrument which carries voting rights. Rajkumar S.Adukia

  11. Understanding the Banking Business Rajkumar S.Adukia

  12. Knowledge of bank business • The auditor needs to obtain a level of knowledge of bank business that will enable him to identify the events, transactions and practices that may have significant effect on the financial information • Knowledge of bank business can be obtained from- • Bank’s annual report to shareholders • Internal financial management reports for current and previous periods including budget if any • Previous year audit working papers • Discussion with and Letters seeking Information from bank branch Manager • Bank policy and procedures manual Rajkumar S.Adukia

  13. Knowledge of bank business Usage of knowledge of bank business • To develop an overall audit plan • To identify areas of special audit consideration • To evaluate the reasonableness of accounting estimates and management representations • To make judgments regarding the appropriateness of accounting policies and disclosures Rajkumar S.Adukia

  14. Letter seeking information Before actual commencement of audit a letter may be written to the management of bank asking for following information • Organizational chart of bank and bank branch • List of departments in the bank branch along with name of head of department. • Authority and responsibility of each officer in the bank • Special feature of each banking product • Areas where work has been outsourced to outsiders Rajkumar S.Adukia

  15. Letter seeking information • Copies of last year annual accounts and current year quarterly/half yearly accounts • Information of top 10 borrowers for each kind of loan • Instructions issued by Head office for closing of accounts • Details of software used by bank • List of reports generated by the software • Accounting policy followed by the bank • Copy of day book Rajkumar S.Adukia

  16. Areas where special knowledge about the business of Bank Branch is required • Special Features of Banking Business • Special audit considerations in bank branch audits • Laws applicable to the banking business • Internal controls in banks • Additional Controls for Computerised Environment • Accounting System • Accounting standards applicable to bank • Formats of Financial Statements ( as per schedule III section 29 of Banking Regulation Act ,1949) • Important Circulars of RBI Rajkumar S.Adukia

  17. Peculiar features of banking business • Custody of large volumes of monetary items, including cash and negotiable instruments, whose physical security has to be ensured • Deals in a large volume and variety of transactions in terms of both number and value. • Operate through a wide network of branches and departments, which are geographically dispersed • The nature of business which makes it susceptible to Frauds by Customers. Rajkumar S.Adukia

  18. Special audit considerations in bank branch audits • Effect of the statutory and regulatory requirements • The scale of banking operations and the resultant significant exposures • Extensive dependence on IT to process transactions • Continuing development of new services and banking practices • Particular nature of risks associated with the transactions undertaken by banks Rajkumar S.Adukia

  19. Internal controls in bank branch • Work of one staff member is invariably supervised / checked by another staff member, irrespective of the nature of work • Banks have a system of job rotation among staff • The financial and administrative powers of each official / each position are fixed and communicated to all persons concerned • Branch managers have to send periodic confirmation to their controlling authority on compliance of the laid down systems and procedures. Rajkumar S.Adukia

  20. Internal controls in bank branch • All branches of a bank have a unique code number which is circulated amongst all offices of the bank • All books are to be balanced periodically. Balancing is to be confirmed by an official • Particulars of lost security forms are immediately advised to controlling so that they can exercise caution • Fraud prone items like currency, valuables, draft forms, term deposit receipts, traveller’s cheques and other such security forms are in the custody of at least two officials of the branch Rajkumar S.Adukia

  21. Additional Controls for Computerised Environment • The system maintains a record of all log-ins and log-outs • If the transaction is sought to be posted to a dormant (or inoperative) account, the processing is halted and can be proceeded with only with a supervisory password • The system checks whether the amount to be withdrawn is within the drawing power. • The system flashes a message if the balance in a lien account would fall below the lien amount after the processing of the transaction Rajkumar S.Adukia

  22. Additional Controls for Computerised Environment • Access to the system is available only between stipulated hours and specified days only. • Individual users can access only specified directories and files • Exception situations such as limit excess, reactivating dormant accounts, etc. can be handled only with a valid supervisory level password. • A user timeout is prescribed • Once the end-of-the-day process is over, the ledgers cannot be opened without a supervisory level password Rajkumar S.Adukia

  23. Laws applicable to the banking business • Banking Regulation Act, 1949 • Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 • Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 • State Bank of India Act, 1955 • State Bank of India (Subsidiary Banks) Act, 1959 • Regional Rural Banks Act, 1976 • Companies Act, 1956 • Co-operative Societies Act, 1912 or the relevant state Co-operative Societies Act. Rajkumar S.Adukia

  24. Laws applicable to the banking business • Information Technology Act, 2000  • Prevention of Money Laundering Act, 2002 • Credit Information Companies Regulation Act, 2005 • Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 • Banking Cash Transaction Tax (Chapter VII of Finance Act, 2005) • Service Tax (Chapter V of Finance Act,1994) • Income Tax Act ,1961 • Securities Transaction tax (Chapter VII of Finance (No 2) Act , 2004 Rajkumar S.Adukia

  25. Laws applicable to the banking business Regulations relating to Foreign exchange • FEMA 1999 Notifications ( Nos 1,3,5,8,23 and 26) • Master circular issued by RBI on exports and good of services dated 1st Oct 2005 • Master circular issued by RBI on Rupee export credit and export credit in foreign currency dated 1st July 2005 • Foreign Trade Policy 2004-09 • FEDAI Guidelines • Bank’s Internal Guidelines Four categories of Transactions are usually undertaken at a branch - • Export related transactions • Import related transactions • Remittances (Inward/Outward) • Treasury Operations (Dealing Room/Investments) The bank is required to take an undertaking under section 10(5) of FEMA, 1999 from the applicant to ascertain and satisfy itself about the purpose of transaction Rajkumar S.Adukia

  26. Application of other laws not barred • As per the section 2 of Banking Regulation Act ,1949 the provisions of this Act shall be in addition to, and not, in derogation of the Companies Act, 1956 , and any other law for the time being in force • The provisions of the other laws shall apply to all proceedings unless they are inconsistent with the Banking Regulation act,1949 Rajkumar S.Adukia

  27. Accounts and balance-sheet • Sub-section (1) of section 29 of the Banking Regulation Act, 1949 requires every banking company to prepare a balance sheet and a profit and loss account in the forms set out in the Third Schedule to the Act or as near thereto as the circumstances admit. • Form A of the Third Schedule to the Banking Regulation Act, 1949, contains the form of Balance Sheet • Form B contains the form of Profit and Loss account Rajkumar S.Adukia

  28. Contents of Balance sheet (Form A) • Schedule –1 Capital • Schedule –2 Reserve and surplus • Schedule –3 Deposits • Schedule –4 Borrowings • Schedule –5 Other Liabilities and provisions • Schedule –6 Cash and bank balance with RBI • Schedule –7 Balance with bank and money at call and short notice • Schedule –8 Investments • Schedule –9 Advances • Schedule –10 Fixed Assets • Schedule –11 Other Assets • Schedule –12 Contingent Liability Rajkumar S.Adukia

  29. Classification of Advances as per schedule 9 Three ways of classification of advances in balance sheet as schedule 9 of banking regulation act ,1949 A)Classification by nature i)Bills purchased and discounted ii)Cash credits, overdrafts and loans repayable on demand iii)Term loans B) Classification by security i)Secured by tangible assets Rajkumar S.Adukia

  30. Classification of Advances ii)Covered by bank/ government guarantees iii) Unsecured C) Classification by location I. Advance in India      (i) Priority sector      (ii) Public sector      (iii) Banks      (iv) Others Rajkumar S.Adukia

  31. Classification of Advances II. Advances outside India    (i) Due from banks    (ii) Due from others        (a) Bills purchased and discounted        (b) Syndicated loans        (c) Others Rajkumar S.Adukia

  32. Some disclosure items in balance sheet • Capital Adequacy Ratio • Movements in NPAs • Movement of provisions held towards NPAs • Business (deposits plus advances) per employee • Maturity Patterns of deposits, borrowings, loans and advances • Exposures to real estate sector,Capital market • Disclosure of Penalties imposed by RBI • Details of Single Borrower/Group Borrower Limit exceeded by the bank Rajkumar S.Adukia

  33. Contents of Profit and Loss accounts (Form B) • Schedule-13 Interest Earned • Schedule-14 Other income • Schedule-15 Interest expended Schedule • Schedule-16 Operating expenses Rajkumar S.Adukia

  34. Types of accounting softwares • Stand alone branch-level packages • Multi-branch solutions • Foreign branches • Packages for specialized areas • Packages for Service branch • IT services like KYC Some of the softwares used by banks are Finacle (Infosys), Bancs (TCS), and Flex cube (I Flex) Rajkumar S.Adukia

  35. Possible Segments in bank business as per AS-17 Business segments • Treasury • Other bank operations • Residual operations Geographic Segments • Domestic • International Rajkumar S.Adukia

  36. Possible Related party in banks as per AS-18 • Parent • Subsidiaries • Associates/ Joint ventures • Key management personnel • Relatives of key management personnel Rajkumar S.Adukia

  37. Circulars issued by RBI • Disclosure in balance sheets dated July 1, 2006 • Prudential norms on Income recognition,asset classification and provisioning relating to advances dated 1st July 6 • Management of advances dated January 22, 2007 • Loans and advances-statutory and other restrictions dated 1st July 2006 • Guarantees and co-acceptances dated July 1,2006 • Guidelines for securitisation of standard assets dated 1st Feb 2006 • Prudential Norms on Capital Adequacy dated July 1,2006 • Para-banking Activities dated July 1,2006 • Exposure norms dated October 10 ,2006 • Cash Reserve ratio and Statutory Reserve ratio dated October 11,2006 • Provisioning Requirement for Standard Assets dated Feb 19, 2007 Rajkumar S.Adukia

  38. Definition of Non performing assets as per Circular dated 01-07-06 An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank (Para 2.1.1) A non-performing asset (NPA) is a loan or an advance where; • interest and/ or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan • the account remains ‘out of order’ in respect of an Overdraft/Cash Credit (OD/CC)  Rajkumar S.Adukia

  39. Definition of Non performing assets as per Circular dated 01-07-06 • the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted • 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. • 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. (Para 2.1.2 ) Rajkumar S.Adukia

  40. INCOME RECOGNITION on NPA • Income from non-performing assets (NPA) is not recognised on accrual basis but is booked as income only when it is actually received (Para 3.1.1) • The Accounting Standard 9 (AS 9) on `Revenue Recognition' issued by the Institute Of Chartered Accountants of India (ICAI) requires that the revenue that arises from the use by others of enterprise resources yielding interest should be recognized only when there is no significant uncertainty as to its measurability or collect ability. Rajkumar S.Adukia

  41. INCOME RECOGNITION on NPA • 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 (Para 3.1.2) • 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 (Para 3.1.3) Rajkumar S.Adukia

  42. Reversal of income • If any advance 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.(Para 3.2.1) • This will apply to Government guaranteed accounts also. • 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. (Para 3.2.2) Rajkumar S.Adukia

  43. Categories of NPA • Classification is only for the purpose of computing the amount of provision that should be made with respect to bank advances and certainly not for the purpose of presentation of advances in the banks balance sheet Rajkumar S.Adukia

  44. Categories of NPA • Sub-standard Assets - which has remained NPA for a period less than or equal to 12 months (Para 4.1.1) • Doubtful Assets - has remained in the sub-standard category for a period of 12 months (Para 4.1.2) • Loss Assets - 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. (Para 4.1.3) Rajkumar S.Adukia

  45. Provisioning norms • The primary responsibility for making adequate provisions for any diminution in the value of loan assets, investment or other assets is that of the bank managements and the statutory auditors. (Para 5.1.1) • The assessment made by the inspecting officer of the RBI is furnished to the bank to assist the bank management and the statutory auditors in taking a decision in regard to making adequate and necessary provisions in terms of prudential guidelines.(Para 5.1.1) Rajkumar S.Adukia

  46. Provision on standard assets • The banks should make a general provision of a minimum of 0.40 percent on standard assets on global loan portfolio basis • Banks would continue to make provision at 0.25 per cent for direct advances to agricultural and SME sectors in the standard category (as per circular issued by RBI on 8th of Nov 2005) • A small scale industrial unit is an undertaking in which investment in plant and machinery does not exceed 1 crore except in certain specified items under hosiery,hand tools, drugs. Pharmaceuticals. Stationery items and sport goods where investment limit has been extended to Rs. 5 crore • Units with investment in Plant and machinery in excess of SSI limit and upto Rs 10 crore may be treated as medium enterprise (circular dated 19/08/2005) Rajkumar S.Adukia

  47. Provision on sub standard assets (Para 5.4) • A general provision of 10 percent on total outstanding should be made • The ‘unsecured exposures’ which are identified as ‘substandard’ would attract additional provision of 10 per cent. • 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 is not more than 10 percent Rajkumar S.Adukia

  48. Provision on Doubtful assets( Para 5.3) • 100 percent of the extent to which the advance is not covered by the realisable value of the security • In regard to the secured portion, provision may be made on, 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 Rajkumar S.Adukia

  49. Provision on Doubtful assets( Para 5.3) Contd Rajkumar S.Adukia

  50. Provision on Loss assets (Para 5.2) • Loss assets should be written off. If loss assets are permitted to remain in the books for any reason, 100 percent of the outstanding should be provided for Rajkumar S.Adukia