The Chartered Accountant Journal • Bank Audit • March 2021

LFAR for Bank Branch

CA. Sandeep D. Welling

The author is a member of the Institute.

Email: eboard@icai.in

Citation: (2021) 69 CAJ 1125–1138

Pages 101–114 • Journal Page Nos. 1125–1138

Executive Overview & Context

LFAR format has been revised and a notification is issued by RBI dated September 5, 2020. There is no doubt the old format was long overdue as it contained the questions from pre-CBS era. During our audit for the financial statements as on March 31, 2021 it is necessary that we read and assimilate the questions carefully. The questions are formed in a manner where we may have to be careful in selection of the samples, ensuring that the questions in the LFAR are addressed with reference to the selected accounts. Read on…

Hitherto, the accounts selected for the purpose was forming part of our documentations and working papers. However, now LFAR expects us to list the accounts selected, which increase our responsibility manifold as the answers to the question in LFAR are expected with reference to the selection.

This article makes an attempt to address the nuances of LFAR. It must be remembered that where any of the comments made by the auditors in their LFAR is adverse, auditor should consider whether a qualification in their main report is necessary. It should not, however, be assumed that every adverse comment in the LFAR would necessarily result in a qualification in the main report. In deciding whether a qualification in the main report is necessary, the auditors should use their professional judgment in the facts and circumstances of each case. Where the auditors have any reservation or adverse remarks with regard to any of the matters to be dealt with in their Long Form Audit Reports, they may give the reasons for the same. Also, where relevant, instances of situations giving rise to their reservations or adverse remarks may also be given.

I. ASSETS

1. Cash

a) Does the system ensure that cash maintained is in effective joint custody of two or more officials, as per the instructions of the controlling authorities of the bank?
b) Have the cash balances at the branch/ATMs been checked at periodic intervals as per the procedure prescribed by the controlling authorities of the bank?
c.1) Does the branch generally maintain /carry cash balances, which vary significantly from the limits fixed by the controlling authorities of the bank?
c.2) Does the figure of the balance in the branch books in respect of cash with its ATM(s) tally with the amounts of balances with the respective ATMs, based on the year end scrolls generated by the ATMs? If there is any difference, same should be reported.
d) Whether the insurance cover available with the branch adequately meets the requirement to cover the cash-in hand and cash-in transit?

2. Balances with Reserve Bank of India, State Bank of India and Other Banks (For branches with Treasury Operations)

a) Were balance confirmation certificates obtained in respect of outstanding balances as at the year-end and whether the aforesaid balances have been reconciled? The nature and extent of differences should be reported.
b) Observations on the reconciliation statements may be reported in the following manner:
- i) Cash transactions remaining unresponded (give details)
- ii) Revenue items requiring adjustments/write-off (give details)
- iii) Other Credit and debit entries originated in the statements provided by RBI/other banks, remaining unresponded for more than 15 days
- iv) Where the branch maintains an account with the Reserve Bank of India, the following additional matter may be reported: Entries originated prior to, but communicated/recorded after, the year end in relation to currency chest operations at the branch/other link branches, involving deposits into/ withdrawals from the currency chest attached to such branches (Give details)
c) In case any matter deserves special attention of the management, the same may be reported.

3. Money at Call and Short Notice

a) Has the Branch kept money-at-call and short notice during the year?
b) Has the year end balance been duly confirmed and reconciled?
c) Has interest accrued upto the year end been properly recorded?
d) Whether instructions/guidelines, if any, laid down by the controlling authorities of the bank have been complied with?

4. Investments (For Branches outside India)

a) In respect of purchase and sale of investments, has the branch acted within its delegated authority, having regard to the instructions/ guidelines in this behalf issued by the controlling authorities of the bank?
b) Have the investments held by the branch whether on its own account or on behalf of the Head Office/other branches been made available for physical verification? Where the investments are not in the possession of the branch, whether evidences with regard to their physical verification have been produced?
c) Is the mode of valuation of investments in accordance with the RBI guidelines or the norms prescribed by the relevant regulatory authority of the country in which the branch is located whichever are more stringent?
d) Whether there are any matured or overdue investments which have not been encashed and / or has not been serviced? If so, give details?

5. Advances

General Instructions & Thresholds

(i) The answers to the following questions may be based on the auditor’s examination of all large advances. For this purpose, large advances are those in respect of which the outstanding amount is in excess of 10% of outstanding aggregate balance of fund based and non-fund based advances of the branch or Rs. 10 crores, whichever is less.

Care: For all accounts above the threshold, the transaction audit/account specific details to be seen and commented, whereas below the threshold, the process needs to be checked and commented upon. Comments of the branch auditor on advances with significant adverse features, which might need the attention of the management / Statutory Central Auditors, should be appended to the LFAR.

(iii) The critical comments based on the review of the above and other test check should be given in respective paragraphs as given in LFAR given below.

a) List of Accounts Examined for Audit

Account No.	Account Name	Balance as at year end – Funded	Balance as at year end – Non-funded	Total
XXXXXX	–	–	–	–
XXXXXX	–	–	–	–
Total		A	B	C = A + B
Total Outstanding of the Branch		X	Y	Z = X + Y
Percentage examined		A as % of X	B as % of Y	C as % of Z

You may observe that the LFAR expects us to attach an annexure giving details of the accounts selected during the course of our audit. It may be remembered that the questions at various places have specific purpose. Therefore, one simple selection will not help giving answers to all the questions. It is suggested that for each section and in some cases few questions in the section, list of accounts chosen for audit may be listed separately. However, for the purpose of overall percentage of coverage as envisaged above, common accounts, if any, may have to be merged.

b) Credit Appraisal

(i) In your opinion, has the branch generally complied with the procedures/instructions of the controlling authorities of the bank regarding loan applications, preparation of proposals for grant/ renewal of advances, enhancement of limits, etc., including adequate appraisal documentation in respect thereof. What, in your opinion, are the major shortcomings in credit appraisal, etc.
(ii) Have you come across cases of quick mortality in accounts, where the advance became Non-performing within a period of 12 months from the date of first sanction? Details of such accounts may be provided in following manner: Account No., Account Name, Balance as at year end.
(iii) Whether in borrowal accounts the applicable interest rate is correctly fed into the system?
(iv) Whether the interest rate is reviewed periodically as per the guidelines applicable to floating rate loans linked to MCLR / EBLR (External Benchmark Lending Rate)?
(v) Have you come across cases of frequent renewal / rollover of short-term loans? If yes, give the details of such accounts.
(vi) Whether correct and valid credit rating, if available, of the credit facilities of bank’s borrowers from RBI accredited Credit Rating Agencies has been fed into the system?
Guidance: The credit rating is essential for all exposures above 5 Cr. This determines the risk weight for the purpose of CRAR calculations. Non availability of credit rating would attract higher risk. In case the rating is not available, auditor should find out the earlier rating. Further banks many times confuse between Govt. Corporations and Government undertaking. Unless there is specific sanction term for not taking rating (only in case of Govt. undertaking, others have to be rated) valid rating certificate should be verified.

c) Sanctioning/Disbursement

(i) In the cases examined by you, have you come across instances of: (a) credit facilities having been sanctioned beyond the delegated authority or limit fixed for the branch? (b) Are such cases promptly reported to higher authorities?
(ii) Whether advances have been disbursed without complying with the terms and conditions of the sanction? If so, give details of such cases.
(iii) Did the bank provide loans to companies for buy-back of shares/securities?
Guidance: It is suggested that the management representation to this clause should be obtained as it is difficult for an auditor to find out unless specifically mentioned (which is very unlikely).

d) Documentation

(i) In the cases examined by you, have you come across instances of credit facilities released by the branch without execution of all the necessary documents? If so, give details of such cases.
(ii) Deficiencies in documentation, including non-registration of charges, non-obtaining of guarantees, etc.? If so, give details of such cases.
(iii) Advances against lien of deposits have been granted without marking a lien on the Bank’s deposit receipts and the related accounts in accordance with the guidelines of the controlling authorities of the bank.

e) Review / Monitoring / Supervision

(i) Periodic review of advances, balance confirmation/acknowledgement of debts; analysis of accounts overdue for review/renewal: a) between 3 to 6 months, and b) over 6 months; major shortcomings in monitoring.
(ii) Regular receipt and scrutiny of stock/book debt statements; proper computation of Drawing Power (DP); latest audited financial statements obtained for reviewed/renewed accounts.
(iii) System of periodic stock audit reports; branch compliance; details of cases where stock audit was required but not conducted, or where conducted but no action was taken on adverse features.
(iv) Advances to non-corporate entities with limits beyond threshold where audited accounts are not obtained.
(v) Due Diligence Report under consortium and multiple banking as per RBI requirements. If branch is not lead bank, copy obtained from lead bank.
(vi) Inspection and physical verification of securities charged; substantial deterioration in value of security compared to earlier valuation report.
(vii) Deficiencies in securities, frequent/unauthorized overdrawings, inadequate insurance coverage.
(viii) Red Flagged Accounts (RFA) compliance and policy deviations.
(ix) Comments on adverse features considered significant in top 5 standard large advances.
(x) Leasing finance activities compliance with security creation, inspection, insurance, and accounting norms.
Guidance: RBI Master circular on Lending to NBFCs (DBOD/IECS.No.7/08.12.01/2004-2005) and Exposure Norms caps must be verified. Categorization errors impact exposure disclosures and risk parameters.

f) Asset Classification, Provisioning of Advances and Resolution of Stressed Assets

(i) a–d) Automated identification and classification without manual intervention; compliance with RBI norms; SMA-0, SMA-1, SMA-2 classification tracking; auditor disagreements and incorporation in Memorandum of Changes (MOC).
(i) e) List of accounts (outstanding > Rs. 10.00 crore) downgraded or upgraded during the year with reasons (upgrades need rigorous checks).
(i) f) Compliance with RBI income recognition and provisioning guidelines (forms part of audit opinion).
(ii) a–g) Restructured/rephased accounts reporting; board approved resolution stance; accounts with exposure of Rs. 2,000 cr and above in the banking system; prompt CRILC reporting; accounts in SMA for 180 days continuously.
(iii) Upgradations in non-performing advances in line with RBI norms; auditor disagreements.
(iv) Authorized legal action or recalling of advances not initiated by branch.
(v) IBC process mandated but not initiated, or initiated by creditors; adequacy of provisions.
(vi) Credit guarantee claims (ECGC and others) lodged, settled, rejected with detailed table and provisioning impact.

Particulars	Number	Amount
Claim at the beginning of the year	–	–
Further claim lodged during the year	–	–
Total A	–	–
(i) Claims accepted/settled	–	–
(ii) Claims rejected	–	–
Total B	–	–
Balance as at year end (A–B)	–	–

(vii) Valuation reports from approved valuers for mortgaged immovables once in three years in NPAs.
(viii) Recovery policy compliance in compromise/settlements and write-offs exceeding Rs. 50.00 lakhs.
(ix) Age-wise analysis of decrees obtained and pending execution.
(x) Proper appropriation of recoveries between principal and interest.
(xi) Verification of documents held at Centralized Processing Centers (CPCs) on test check basis.
(xii) Major deficiencies in credit review, monitoring and supervision.

g) Non-Fund Based Facilities

(i) Details of LCs devolved or guarantees invoked during the year (Invocation Date, Party Name, Beneficiary Name, Amount, Recovery Date).
(ii) Details of LCs devolved or guarantees invoked but not paid (Invocation Date, Party Name, Beneficiary Name, Amount, Reason for non-payment).
(iii) Instances where interchangeability between fund based and non-fund based facilities was allowed subsequent to devolvement of LC / invocation of BG.

6. Other Assets – Suspense Accounts / Sundry Assets

(a)(i) Expeditious clearance of suspense items; details of entries outstanding > 90 days; ascertainment of unrecoverable balances requiring provision/write-off.
(a)(ii) Unusual items, material amounts, intangible items like unprovided losses / pending investigations.

II. LIABILITIES

1. Deposits

(a) System of identification of dormant / inoperative accounts and internal controls with regard to operations; reporting of deviations.
(b) Unusual large movements (increase or decrease) in aggregate deposits between balance sheet date and date of audit.
(c) Automatic renewal of FCNR(B) deposits; satisfaction of ‘non-resident status’ of depositor and dispatch of receipts/soft copies.
(d) Compliance with minimum balance regulations and levy of charges in savings accounts.
Guidance: RBI mandated certification for penalty levied for non-maintenance of minimum balance (DBR.No.Leg.BC.21/09.07.006/2015-16 dated July 1, 2015). Although branches state that calculations are automated, auditor must take at least 5 samples to test fairness and policy compliance.

2. Other Liabilities (Bills Payable, Sundry Deposits, etc.)

a) Number of items and aggregate amount of old outstanding items pending for 1 year or more (reported year-wise: Year, Number of Items, Amounts, Remarks).
b) Unusual items or material withdrawals/debits in these accounts.

3. Contingent Liabilities

List of major items of contingent liabilities (other than constituent’s liabilities such as guarantees, letters of credit, acceptances, endorsements, etc.) not acknowledged by the Branch.

III. PROFIT AND LOSS ACCOUNT

a) Test checking of interest/discount/commission/fees revealed excess/short credit of a material amount.
b) Compliance with RBI Income Recognition norms regarding charging of interest on NPAs.
c) Test check of interest on deposits revealing excess/short debit of material amount.
d) System of estimating and providing accrued interest on overdue/matured/unpaid/unclaimed term deposits including deceased depositors.
e) Divergent trends in major items of income and expenditure compared to previous year without satisfactory explanation.

IV. GENERAL

1. Gold / Bullion / Security Items

a) Effective joint custody of gold/bullion by two or more officials.
b) Adequate records for receipt, issues, and balances; periodic physical verification discrepancies.
c) Adequate internal controls over custody and issue of security items (Term Deposit Receipts, Drafts, Pay Orders, Cheque Books, Traveler’s Cheques, Gift Cheques, etc.); reporting missing/lost items.

2. Books and Records & Information Systems

a) Standalone software or manual systems not integrated with the Core Banking Solution (CBS).
b) i) Information Systems (IS) Audit adverse features pending compliance.
b) ii–iii) Regular generation, verification, and expeditious compliance of daily exception reports.
b) iv) Procedures and audit trail for manual intervention in system-generated data.
b) v) Data integrity for MIS at Head Office / Corporate Office level without back-ended adjustments.

3. Inter-Branch Accounts

Expeditious compliance with designated cell / Head Office on unmatched transactions; reporting un-responded queries beyond 7 days.

4. Frauds

(i) Frauds detected/classified without RBI reporting confirmation on record.
(ii) Suspected/likely fraud cases reported to higher office and status of investigation.
(iii) Potential risk areas for fraud (falsification, related party diversion, fake invoices/stock statements/bills, current accounts outside consortium, round tripping).
(iv) Effective working of Early Warning Signals (EWS) Framework and Red Flagged Accounts (RFA).

5. KYC / AML Guidelines

Adequacy of systems to ensure adherence to KYC/AML guidelines; test checks of accounts and verification of Cash Transaction Reports (CTR) and Suspicious Transaction Reports (STR).

6. Management Information System (MIS)

Data integrity for MIS at corporate office level and supervisory reporting; non-adherence to password protection policy and maker-checker principle.

7. Miscellaneous

Consideration of previous year’s Branch Audit Report / LFAR, internal/snap/concurrent audits, credit audit, stock audit, RBI inspection, revenue audit, and IS audit reports; matters to be brought to notice of SCAs.

Aspects to be Taken Care of During Checking of Profit & Loss Account

1. Application of Interest on Deposits

Interest on Term Deposits / Cumulative Deposits: Generally calculated centrally. No branch action necessary.
Overdue Term Deposits: System auto-renews during day-end, but manual branch intervention is often required in legacy data migration or system snags.
Interest with Treasury Branch: Done at Category A branches for Foreign Currency borrowings or settlement accounts.
Current Deposits: Provided only on Individual/Proprietary Current Accounts of deceased persons at SB interest rates from date of death.
Savings Bank Deposits: General savings interest at quarterly rest provided at Central Office, but specific schemes require branch verification.

2. Interest on Advances

General Advances (EMI & Non-EMI): Charged centrally, but branch must verify actual application since branch has operational control.
Interest on Bills Discounted (Advance Interest): Total collected credited to ‘Rebate on Bills Discounted’ and only monthly portion transferred to Income. Outstanding balance must match bill-wise rebate summary.

3. Interest on Overdue Export Bills

Export bills overdue < 90 days categorized as Standard Advances: calculate accrual interest up to 31st March, credit to ‘Income Account – Interest on Foreign Bills Purchased’ and debit ‘Suspense Account – Interest Accrued on Advances’ (reversed next working day in April).

4. Interest Paid on Borrowings (Refinance)

Refinance availed from IDBI / SIDBI / NABARD / EXIM Bank / NHB: ascertain interest payable up to 31st March, debit ‘Expenditure Account – Interest Paid on Borrowings – Refinance availed from IDBI/SIDBI etc.’ and credit ‘Bills Payable – Others – Int. payable on NABARD/SIDBI/Bank Refinance’ (reversed in April).

5. Other P&L Provisions & Expenses

Prepaid & Other Expenses: Common grey area; either pass Memorandum of Changes (MOC) or book entries as on date.
Bank Charges with Other Banks: Charges up to 31st March in reconciliation must be responded by debiting Expenditure.
Depreciation: Strict compliance with the revised Standard on Property, Plant and Equipment (PPE).

Annexure on Fraud: Skepticism, Lapses, and Early Warning Signals

In terms of extant RBI guidelines, auditors are required to report any suspicious/fraudulent activities that come to attention during audit. Statutory Auditors must display a greater degree of professional skepticism and independence in assessing asset classification, especially in large-value accounts. In an RBI study of 20 large value fraud cases, except in one case where external auditors pointed out non-compliance with sanction terms, in no other case were frauds detected through internal or external audit processes!

Administrative Lapses that May Lead to Fraud:

Opening current accounts outside consortium without NOC, facilitating diversion of funds.
Deficiency in EWS/RFA implementation: non-adoption of RBI list, non-integration with monitoring software, failure to conclude investigation within 6 months, and inconclusive forensic audits due to borrower non-cooperation.
Sale of accounts to Asset Reconstruction Companies (ARCs) just before fraud recognition.
Slow progress in investigation and prosecution of fraudsters.
Delayed recognition: advances-related frauds often season for 3 to 4 years as NPAs before being recognized as fraud.
Time lag between first bank and last bank in consortium reporting fraud (ideally should be within 6 months).
Complicity of bank officials and third parties with borrowers.
Reluctance to convene lenders’ meetings and delay in reporting to CRILC.

Transactions Demanding Extra Skepticism:

Liberal cash flow projections at proposal stage
Security perfection issues and over-valuation
Gold plating of projects
Deviation from credit and internal policies
Lack of continuous monitoring of cash flows
Diversion of funds

Key Early Warning Signals (EWS) to Watch:

Critical issues highlighted in stock audit reports
Poor disclosure of materially adverse information
Frequent changes in project scope
Liabilities appearing in ROC search reports but omitted from annual reports
Failure to route sales through consortium member banks
LCs issued for related parties without underlying trade transactions
Raids by Income Tax / Sales Tax / Central Excise officials
Significant reduction in promoter shareholding or high pledging of promoter shares

“Finally, it may be concluded, the responsibility as SBA was always like this. The only difference now is the part our working papers is becoming the reporting requirement.”