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b | Forensic audit of Non Performing Assets: navigating hidden threats
© 2019 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All
rights reserved
Table of
contents
Key issues 01
Preliminary analysis 02
Detailed analysis 04
Key recommendations 07
Appendix 1 -
Key legislative and regulatory provisions requiring
forensic audits 08
Appendix 2 -
What is a forensic engagement? What skills are required of its
practitioners? How is a forensic engagement different from a
financial statement audit engagement? 09
Appendix 3 -
Forensic engagements of NPAs 12
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1 | Forensic audit of Non Performing Assets: navigating hidden threats
Key issues
In May 2015, the Reserve Bank of
India (RBI) mandated the banks to
use forensic audit as a preventive
detect various types of frauds, this
document focusses on corporate
borrowal frauds and explores the
and investigative tool to detect following key issues:
frauds and deal with Red Flagged
1. Are the mandates for a forensic
Accounts (RFAs) of corporate
audit given in an independent and
borrowings over INR50 crore.1
objective manner? Do they have
After three years, the problem of
the right scope of work?
NPAs has still remained acute in the
case of large corporate loans. The 2. Is the system of selection of
introduction of beneficial ownership forensic auditors such that only
provisions in the Companies Act, individuals/firms really equipped
2013, Insolvency and Bankruptcy to conduct forensic audits in a
Code 2016 (e.g., section 29A), Bank’s professional manner get qualified
Know Your Client (KYC) and Anti- for taking up such engagements?
Money Laundering (AML) provisions,
3. Are forensic audit reports
etc., also require application of
proving useful as preventive
forensic audit methods to identify
and investigative tools, and
the actual beneficiaries of funds
for recovery of a bank’s assets
disbursed in the banking sector.2
which may have been diverted or
It is time to reflect how and if in siphoned off?
the last three years, banks have
4. Are forensic audit proving useful
effectively used forensic audit
for potential detailed investigation
to reduce NPA losses, recover
and prosecution by Law
assets and improve governance.
Enforcement Agencies (LEAs)?
Accordingly, this document covers
the various facets of forensic audits If answers to some of the above
for banks as a tool to manage questions are in the negative, then
their NPAs, both for preventive it has to be examined why forensic
and investigative purposes. While audits have failed and what remedial
forensic audits can be used to actions are called for.
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2
Preliminary analysis
Issue 1 – Scope deficiency and limitations in forensic audit mandates
The foremost issue is the lack of funds has not yet surfaced in such Fifthly, the scope of a forensic
awareness of the nature of frauds entities under the same promoters. audit cannot ideally be defined
and the relevant review period. The upfront, as in most cases the
Besides, there are several
scope of forensic audit in most upfront requirement is to first
other ways (some of which are
cases is limited only to the last two identify the possible red flags and
discussed later in this document)
to four years period during which get prima facie evidence to initiate
in which the scope of the forensic
fraudulent transactions were a detailed forensic audit. Hence,
audit and its efficacy may be
actually suspected. Experienced a forensic audit for NPAs can be
seriously impaired.
investigators know that in case of structured in two stages:
large value frauds the preparation Thirdly, certain inherent limitations
1. Preliminary investigative stage,
of frauds such as manipulation of of forensic audits vis-à-vis LEAs
initiated by the banks to get
financial statements commences may make less information
prima facie evidence of frauds
much earlier – sometimes three available to a forensic accountant
in the borrowal accounts. This
to four years before the fraudulent as compared to a government
can help enable the bank/s to
transaction is actually suspected. investigator. For instance, a
determine if the case is worthy
The evidence for the motive behind forensic accountant cannot
of reporting to the RBI and
the fraud normally lies in the period compel anybody to produce
LEAs as required by the RBI’s
of preparation. If that period is information, conduct searches,
Circular on fraud reporting.
not included in the scope of the acquire communication and
The standard (burden) of proof
forensic audit, the usefulness correspondences, acquire
during this stage should be
of the audit report is severely accounts and records of group/
low because of the limited
diminished. related parties, etc. Certain
information during this phase
limitations can be overcome by
The second area where the
incorporating a contractual clause 2. Detailed investigative stage,
scope is not properly defined is
that the accounts and records of initiated during investigations
by limiting forensic audit to the
the borrowing entity as well as its by LEAs after the fraud has
firm(s)/ companies where the
subsidiaries and related entities been reported under the
fraudulent transactions may have
over which it has control or to RBI Circular. This stage may
been actually suspected. In most
which it has advanced funds be have access to additional
large value fraud cases, a number
made available during forensic information, as the LEAs have
of group/related entities/persons
engagements. legal powers to call/obtain
acting in concert are also involved,
information and documents
some of which may be borrowers Fourthly, sometimes, banks
compared to the first stage,
of other banks in other multiple themselves also do not provide
which is based more on
banking arrangements. There is a all transactional information and/
voluntary (through contractual
need for all bankers to join hands or supporting documents. This
and statutory) co-operation.
in coordinating forensic audit on should be insisted upon in the inter
associated/related entities, even se contracts between consortium
if the immediate loss of bank banks.
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3 | Forensic audit of Non Performing Assets: navigating hidden threats
© 2019 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All
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4
Detailed analysis
While forensic engagements Forensic engagements deployed by shareholders to ensure
can be a very valuable tool by the banks in cases of corporate that credible, reliable forensic
for detection and prevention NPAs have banks, regulators (e.g., engagements be performed.
of financial crimes, the lack RBI, SEBI, etc.) and LEAs as its
Part 2 – Unavoidable limitations
of training and experience potential users. Therefore, it is
where resolution by banks and
by various practitioners who critical that the work performed
forensic accountants is not
perform forensic engagements, in forensic engagements
possible – these limitations arise
a lack of understanding of be independent, objective,
due to uncontrollable factors such
basic requirements by various detail-oriented, high-quality
as legal or statutory restrictions
stakeholders, and lack of with appropriate utilisation of
which are beyond the ability
co-operation by the bankers appropriate forensic methods
or legal powers of banks and
and borrowers have seriously and tools. In the last three years
forensic accountants to resolve.
threatened the quality and is that in practice, the forensic
However, it is experienced that a
reliability of forensic engagements. engagements in NPAs have
lot of banks and even regulators,
suffered from serious limitations
Many reports labelled as ‘forensic’ LEAs, etc. do not fully understand
and no conclusive results have
may have been prepared by these limitations and may have
been achieved in many instances.
practitioners without sufficient unreasonable expectations from
The limitations, which are
forensic experience in investigative forensic engagements.
imposed on forensic audits and
methods, tools, and techniques,
have diminished the quality and
structured or unstructured training,
reliability of forensic engagements,
or any on-the-job experience with
may be analysed in two parts:
another forensic accountant. The
quality of such forensic reports Part 1 – Avoidable limitations
vastly falls short of the high where resolution by banks
standards which courts or other and forensic accountants is
adjudicating bodies require. These possible – these limitations arise
factors not only significantly due to controllable factors and
affect the appropriate outcome significantly compromise the
and mislead the users of such quality of forensic engagements.
reports, but also significantly These limitations must be resolved
reduce the credibility, reliability
and reputation of forensic
engagements because the users
will lose faith in the ability of
forensic audits to detect frauds.
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5 | Forensic audit of Non Performing Assets: navigating hidden threats
1. The loan agreement does not contain a contractual 4. No access to electronic information with borrowers. For
clause that the business accounts of the borrowing example, various electronic data on servers and laptops
entity as well as its subsidiaries and related entities over of the borrower’s owners and staff are not accessible
which it has control will be made available for third party to the forensic accountant to determine if they contain
audit (including forensic engagements) evidence of any wrongdoing such as diversion or
siphoning off of funds;
2. No or limited access to accounts and records of the
borrowing entity and its related entities who may have 5. No access to all other possible evidence because
received funds from the borrowing entity (for example if of lack of legal powers of search, seizure, etc. Such
a loan is taken by a Special Purpose Vehicle (SPV) entity powers are available only to government agencies.
who has passed it on to a group entity, the records
of group entity are not accessible during the forensic
engagement)
3. Sometimes banks do not provide transactional
information in bank accounts or supporting documents
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7 | Forensic audit of Non Performing Assets: navigating hidden threats
Key recommendations
01 Two potential stages of forensic
engagements can be explored as explained
earlier:
a. Preliminary investigative stage, initiated by the
banks to identify prima facie evidence of frauds in
the borrowal accounts, and determine if the case
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8
Appendix 1
Key legislative and regulatory provisions
requiring forensic audits
RBI’s circular on Framework for dealing with loan frauds (extracts) dated 7 May 2015:
1.0 Objective of the framework: In the context of bank to report the RFA or Fraud status of the account
increasing incidence of frauds in general and in loan on the Central Repository of Information on Large
portfolios in particular, objective of this framework is (CRILC) platform so that other banks are alerted.
to direct the focus of banks on the aspects relating Thereafter, within 15 days, the bank which has red
to prevention, early detection, prompt reporting to flagged the account or detected the fraud would ask
the RBI (for system level aggregation, monitoring the consortium leader or the largest lender under
and dissemination) and the investigative agencies MBA to convene a meeting of the Joint Lender’s
(for instituting criminal proceedings against the Forum (JLF) to discuss the issue. The meeting of
fraudulent borrowers) and timely initiation of the the JLF so requisitioned must be convened within
staff accountability proceedings (for determining 15 days of such a request being received. In case
negligence or connivance, if any) while ensuring that there is a broad agreement, the account would be
the normal conduct of business of the banks and classified as a fraud; else based on the majority rule
their risk taking ability is not adversely impacted and of agreement amongst banks with at least 60 per
no new and onerous responsibilities are placed on cent share in the total lending, the account would
the banks. … The early detection of Fraud and the be red flagged by all the banks and subjected
necessary corrective action are important to reduce to a forensic audit commissioned or initiated
the quantum of loss which the continuance of the by the consortium leader or the largest lender
Fraud may entail under MBA. All banks, as part of the consortium
or multiple banking arrangement, would share the
3.1 At present the detection of frauds takes an
costs and provide the necessary support for such an
unusually long time. Banks tend to report an
investigation
account as fraud only when they exhaust the
chances of further recovery. … More importantly, it 5.4 The forensic audit must be completed within a
delays action against the unscrupulous borrowers maximum period of three months from the date of
by the law enforcement agencies which impact the the JLF meeting authorising the audit. Within 15 days
recoverability aspects to a great degree and also of the completion of the forensic audit, the JLF will
increases the loss arising out of the fraud reconvene and decide on the status of the account,
either by consensus or the majority rule as specified
5.1 RBI Master Circular DBS.CO.CFMC.
above. In case the decision is to classify the account
BC.No.1/23.04.001/2014-15 dated July 01, 2014 on
as a fraud, the RFA status would change to Fraud
Frauds - Classification and Reporting (Para 3.2.4)
in all banks and reported to RBI and on the CRILC
provides that all the banks which have financed
platform within a week of the said decision. Besides,
a borrower under Multiple Banking Arrangement
within 15 days of the RBI reporting, the
(MBA) should take co-ordinated action, based on a
bank commissioning/ initiating the
commonly agreed strategy, for legal / criminal actions
forensic audit would lodge a complaint
and the bank which classifies or declares a fraud
with the CBI on behalf of all banks in the
should report the same to CFMC, RBI within the
consortium/MBA.
deadlines specified in the Master Circular on Frauds -
Classification and Reporting cited above
5.3 The initial decision to classify any standard or NPA
account as RFA or ‘Fraud’ will be at the individual
bank level and it would be the responsibility of this
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© 2019 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All
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10
interpret relevant analyses information collected identify fraud patterns; and forensic
of information and the work performed, auditors are trained to provide
including the work and expert testimony to the trier of
e) the ability to document
information of others, fact. Experience shows that it
and explain business
may become subject to takes at least five to six years of full
information and the results
disclosure and be tendered time practice to learn the various
of the financial analyses for
as evidence, and concepts and nuances of a forensic
decision-making purposes,
accounting engagement.
and g) the ability to document
and present investigative Beyond the common professional
f) the ability to render relevant
findings and conclusions for accounting skills between both
and appropriate opinions
decision making purposes. the financial statement auditors
and conclusions based on
and forensic accountants,
the findings and results of 3. An investigative mindset
the two have vastly different
the work performed. requires a sceptical attitude
experience and skillsets. At the
in the identification, pursuit,
2. Investigative skills require the strategic level, the differences
analysis and evaluation of
following sub-components: include investigative skills and
information relevant to each
investigative mindsets, and at
a) an understanding of the engagement, contemplating
the operational level include the
context within which that it may be biased, false
knowledge of key legal concepts,
the engagement is to be and/or incomplete. This is
court procedures, evidence
conducted (for example, applicable in identifying and
handling, clear identification of
the tribunal process, laws, assessing relevant issues,
civil and criminal matters, a highly
regulations, contracts or assessing the plausibility of
sceptical attitude, appearing as a
policies relevant to the the underlying assumptions,
witness in adjudicating body, etc.
engagement) assessing substance over form,
The objectives of the two types of
b) the ability to identify, and developing hypotheses for
engagements also vary significantly
obtain, examine and assess the purpose of addressing the
– the former is geared to give
information relevant to the issues under investigation.
an opinion on overall financial
engagement Comparison of forensic statements based on materiality
c) the ability to analyse and accounting engagements whereas the latter is concerned
with only a line item or particular
compare various types and with financial statement
sources of information wrongdoing or violation, without
audit engagements consideration of the materiality of
d) an understanding of the Forensic accounting is a specialised the overall financial statements.
types of information that field within accountancy, and Overall, the scope of audit is broad
would assist in establishing its practitioners should possess and prima facie, but of the forensic
motivation, intent and bias special investigative skills engagement is narrow and deep.
e) an understanding of the and mindset, gained through
ways in which information experience in human psychology,
could be fabricated or laws (e.g., civil, criminal, and
concealed; understanding administrative) and a variety of
patterns and red flags forensic methods and tools.
Forensic engagements also use
f) an understanding that advanced data analytics tools to
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11 | Forensic audit of Non Performing Assets: navigating hidden threats
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The RBI’s circular puts an onus on bank functionaries From a strategic perspective, the frauds can be
for laxity in effective supervision over the operations in classified as Borrowal frauds and Non-borrowal frauds.
borrowal accounts rendering the advance difficult for The nature of manipulations can be broadly analysed
recovery and resulting in financial loss to the bank. into four main categories as set out below.
Facets of borrowal frauds which generally become subject matter of forensic engagements:
3. While there are many types of bank frauds where the forensic engagements may be
used to detect and prosecute, this paper focuses on large corporate borrowal frauds.
© 2019 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights
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KPMG in India contacts:
Nilaya Varma
Partner and Leader
Markets Enablement
T: +91 124 669 1000
E: nilaya@kpmg.com
Jagvinder Brar
Partner
Forensic Services
T: +91 124 307 9469
E: jsbrar@kpmg.com
Maneesha Garg
Partner and Co-Head
Forensic Services
T: +91 120 386 8501
E: maneesha@kpmg.com
Suveer Khanna
Partner
Forensic Services
T: +91 22 3090 2540
E: skhanna@kpmg.com
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