Audit of Advances other than Agriculture Advances

a. Ledger Review and Interest Verification:

Review of ledger for various facilities of large borrower samples selected should be done to get idea on operations of account. Generally, interest application, penal interest etc., would be done by system. However, it is advisable to check for few samples whether amount of interest is correct.

b. Overdrawing, LC Devolvement, and Year-End Window Dressing:

Check if there are frequent delays in payment of dues of loans or overdrawing in case of CC/OD accounts. Apart from this, devolvement of LCs, regularisation in account around critical dates such as dates for consideration as NPA, etc., are some examples, which may require detailed review of the account operations. Auditor may check the latest audited financial statements of the borrower, qualifications of borrowers’ statutory auditors if any, transactions with related parties etc., Here one should also check if the account is regularised at end of the financial year by showing cheque deposited under bank reconciliation and subsequently reversed in the following year indicating possible evergreening.

c. Stock & Receivables Discrepancies vs Audited Accounts and Drawing Power (DP):

Inquire into significant differences observed between the amounts of stock and receivables as per statement submitted by the borrowers and the amounts stated in audited financial statements. This aspect is overlooked many times by branch. Borrowers having financial difficulties may submit statements with inflated numbers and tend to show receivables beyond permissible period, under different category and within permissible time limit. In the event such discrepancy is noticed, auditor may ask branch management to immediately seek clarification and apply the correct value of stock and receivable for calculation of Drawing Power (DP). Correct application may result the account becoming overdue beyond 90 days and turn NPA.

Since the DP is manually fed in the System, based on such stock statements with higher value, System may not identify the account as overdue and it would result in incorrect classification. In most cases, this is the reason for non-identification of NPA by system and hence auditor should be careful in reviewing such accounts.

d. Stock & Receivable Audit and Inspections:

In case of large advances, annual stock audit and inspection would normally be one of the sanction conditions. We need to check if the stock and receivable audit has been conducted as per the terms and if there are any significant observations or remarks by the auditor, which may impact the operations of account or may indicate inherent weaknesses. Also, auditor should check if the branch has obtained necessary explanations and responses on stock audit reports, from the borrowers and considered necessary remarks while computing DP.

e. Bill Discounting and Interest Received in Advance:

In case of bill discounting, most Banks have policy of recognising interest over period of the bills. Such interest collected in advance is kept under other liabilities in balance sheet of the branch. Bill wise break up of the same may be taken and mapped with the interest on balance period of outstanding bills discounted. In case if difference is noticed, auditor may ask explanation from the branch and insist for passing necessary entry through profit & loss account to match the actual interest that ought to be kept under “interest received in advance” at the year end.

a. Classification on Restructuring:

The auditor may obtain a list of all the accounts restructured during the financial year. Upon restructuring, the accounts classified as ‘standard’ should be immediately downgraded as non-performing assets (NPAs), i.e., ‘sub-standard’ to begin with. The non-performing assets, upon restructuring, would continue to have the same asset classification as prior to restructuring. Accordingly, the provision requirements on NPA are also required to be complied with.

b. Conditions for Upgrading Accounts Which Are Restructured:

Standard accounts classified as NPA and NPA accounts retained in the same category on restructuring by the lenders may be upgraded only when satisfactory performance is demonstrated in all the outstanding loans/facilities of the borrower during the period from the date of implementation of resolution plan (RP) up to the date by which at least 10 percent of the outstanding principal debt as per the RP and interest capitalisation sanctioned as part of the restructuring, if any, is repaid. Provided that account cannot be upgraded before one year from the commencement of the first payment of interest or principal (whichever is later) on the credit facility with longest period of moratorium under the terms of RP.

c. Income Recognition:

Income recognition norms for restructured advances are the same as normal advances and are applied based on the respective classification of account except that unrealised income represented by FITL / Debt or Equity instrument, can only be recognised in the profit and loss account as under:

1. FITL/debt instruments: only upon receipt of the loan or sale/redemption, as the case may be;
2. Unquoted equity/ quoted equity (where advance is classified as NPA): only on sale;
3. Quoted equity (where Advance is classified as standard): market value of the equity as on the date of upgradation, not exceeding the amount of unrealised income converted to such equity. Subsequent changes to value of the equity should be dealt with as per the extant Prudential Norms on Investment Portfolio of Banks.

There are many other aspects related to stressed assets and for detailed guidance, one may refer to RBI notification on Prudential Framework for Resolution of Stressed Assets (DBR.No.BP.BC.45/21.04.048/2018-19) dated June 7, 2019.

a. Understanding Bank’s Software:

Most banks in India are on Core Banking Solution (CBS). Finacle is one such software used by many banks. Manual intervention is reduced to a large extent due to implementation of CBS and hence it has become essential for an Auditor to have a working knowledge of Finacle or other CBS software in order to conduct Bank Audit.

b. Exception Reports:

Auditor may request branch management for a list of exception reports that are generated by system. A few important reports related to advances are, excess drawing permitted over sanctioned limit through TOD, changes done in master data of borrowers, Interest rate changes etc.

c. Analytical Procedures:

Variance analysis of important ledgers related to advances, including interest earned and commission charged for comparable previous period many time throw up major exceptions which help auditor to find discrepancies. SA 520 also requires an auditor to perform analytical procedures.

d. Concurrent Audit Report Observations:

Branch auditor should obtain the concurrent/internal audit reports and check their comments on advances and verify the accounts where negative observations or accounts with irregularities have been commented upon. Also, if the discrepancies noticed have been resolved or satisfactorily answered. This will help also since concurrent/internal audit may have some observation on areas which the Branch Auditor has not covered in his sample.

e. Fraud Reporting:

Check with Branch if they generate the suspicious transaction report (STR) or they get the same from the HO or Risk Management department for providing response to the suspicious transactions and how they dealt with closure of the same. It is also important nowadays to check the effective implementation of staff rotation policy.

f. Classification of Advances:

One should also check other information related to classification of advances such as Priority/non-priority sector, Secured/Unsecured etc., as this information would eventually be compiled and published by the Bank by way of notes. This information is also essential for the Bank to ensure compliance with certain regulatory requirements such as priority sector advances etc.

g. Crystallisation of Overdue Export Bills:

When a foreign bill is discounted by the branch and not paid on due date, the AD bank as per policy formulated by it, needs to crystallise the foreign currency liability of the concerned bill. The bill will be crystalised by selling the liability amount in foreign currency at the prevailing TT selling rate or at the original bill buying rate, whichever is higher and convert the exporter’s liability in Rupee terms. Auditor needs to check if interest for the overdue period shall be recovered on the date of crystallisation at the appropriate rate and thereafter till the date of recovery of the crystallised amount.

h. Capital Adequacy:

There are various formats for reporting to the head office for the purpose of compilation of Risk Weighted Assets (RWA) for computation of capital adequacy. Information contained in these reports is mainly generated from the advance portfolio of the branch. Auditor can check the working/supporting documents from where the information in RWA working sheet is compiled and rating of the borrower and category of advance are two important points to verify.

i. Interest Subvention:

Auditor needs to check if the interest subvention benefits have been appropriately passed on to borrowers as per the notification of RBI. Extensions if any, granted for the packing credits/LCs in case of delayed exports/inward remittances and if the same are within the permissible time limit of RBI as subvention may not be available beyond normal permissible period.

j. LFAR Reporting:

This is a vast topic in itself and one may refer to the relevant RBI circulars as well as Guidance Note of ICAI on Bank audits. A couple of important points related to LFAR reporting of advances:

• Common irregularities observed such as non-submission of stock statements, frequency of LC devolvement, frequent overdrawing permitted, adequacy of insurance coverage, Stock audit not done, errors in DP calculations etc.,
• Obtain detailed annexure to LFAR from branch management and review the same for advances with outstanding balance of ₹ 2 crores and above- (applicable for Branches dealing in Large Advances/Asset Recovery Branches).