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Audit of Advances

Baroda Study Circle of WIRC of ICAI

Audit of Advances
Rajkot Branch - WIRC of ICAI
Dhinal Shah,CA

Structure of presentation 
       Introduction Types of Advances Audit Approach Major areas of consideration Some specific areas Key Points Disclosure requirement Areas to focus .. 3 4 . 5 .. 7 . 33 . 45 48 . 51

21 March 2010

Audit of Advances



Major Activity of BANK Largest ACCOUNT CAPTION in ASSETS Major Source of INCOME Most FOCUSED Audit Area Can SUBSTANTIALLY CHANGE the financial results Time consuming, AUDIT PLANNING is essential Master Circulars of RBI

21 March 2010

Audit of Advances


Types of Advances
Overdraft/Cash Credit  Term Loans (Home Loans, Vehicle Loans, Mortgage Loans)  Working Capital Demand Loans  Bills Purchased/Discounted/ Foreign Bills for Collection  Packing Credit  Foreign Currency loans


Guarantees Letter of Credit Letter of Comfort Co-acceptance of Bills

21 March 2010

Audit of Advances


Audit Approach 
Extent would depend on assessment of EFFICACY of internal control  Examine all large advances i.e. which are lower of following 2 Criteria  5% of Advances  Rs.2 crore  Verify all problematic accounts  Verify advances which are adversely commented by/in  Previous Audit report / LFAR  Internal/Concurrent auditors  Banks inspection report (including RBI Inspection)  Report on verification of security (Stock Audit, etc.)
21 March 2010 Audit of Advances 5

adhoc sanctions etc  Verify fresh advances granted during the year (if retail high volume then do sample basis)  Accounts upgraded from NPA to standard  For other then above advances to do on sample basis 21 March 2010 Audit of Advances 6 .Audit Approach     RBI inspection report Any other report related to the particular advance Managers charge handing over report Branches control returns to higher authorities concerning overdrawing .

       Existence of clearly laid down delegation of authority. Existence of system of communicating the terms of sanction to the borrower. Existence of system of post disbursement monitoring and reporting irregularity. Adequate control on changing of interest etc in CBS environment. Existence of clearly laid down eligibility criteria for loans. Existence of system for implementation of IRAC Norms. 21 March 2010 Audit of Advances 7 . Existence of system of execution of documents before disbursement.

Major Areas of Considerations Pre Sanction  Application  Credit Appraisal  Sanctioning/Disbursement  Documentation Post sanction      Review/Monitoring Asset classification Provisioning Norms Income Recognition Restructuring 21 March 2010 Audit of Advances 8 .

Application        Prescribed Application Form from the borrower for fresh on renewal proposal KYC Compliance as Per RBI Requirements Evaluation of latest audited financial statements Review of Project Report Projected P&L. BS & Cash Flow Board Resolution for the availment of the facility obtained Latest Financial Statements / Income Tax Records of Borrower and guarantor Various Registrations/Licenses/Permits 21 March 2010 Audit of Advances 9 .

Title clearance report & valuation report Nature of securities (prime/ collateral) offered and to confirm the adequacy of security cover  Verify that important Financial ratios are satisfactory such as  Debt Equity ratio  Debt service Coverage ratio and other ratios        21 March 2010 Audit of Advances 10 .Credit Appraisal Verify Appraisal Note of Bank is proper Whether Appraisal done by Competent person Review Projections whether realistic Net worth statement of the borrower and guarantor Confidential report and NOC from the existing banker CIBIL Report.

evaluation of financial statements.Credit Appraisal       Creditworthiness of borrower Verify whether Exposure limit (including derivative instruments) is within the limits fixed by Bank-group wise. capacity utilization Report of Dun & Bradstreet for Export finance or while opening Letter of Credit is obtained Whether the branch has a policy of maintaining Rejected Proposals Whether Branch is conducting credit rating of major advances accounts on periodic basis 21 March 2010 Audit of Advances 11 . sources and periodicity of repayments. Industry wise & policy of Bank Prospects of business.

the same has been reported to appropriate authorities and ratified within specified period Any change in the terms of sanction is ratifed by appropriate authority Pre disbursement unit inspection has been carried out & report held on record Adhoc limits (increase) given to borrower for temporary/ seasonal/ peak periods whether reported to controlling authorities and whether liquidated in time 21 March 2010 Audit of Advances 12 .Sanctioning/Disbursement       Proposal has been routed through appropriate authorisation levels and recommendations are properly documented and noted Limits sanctioned are within the discretionary powers of the sanctioning authority In case where the sanctions are beyond the discretionary powers.

but the sanction is silent. it is for the auditor to report the defect in the sanction as a violation of Loan policy. etc) Audit of Advances 13   21 March 2010 . not to consider creditors as a deduction. But where a specific mention is made in the sanction. Project. then the terms of sanction have to be adopted and the same has to be considered in drawing power calculation Verify Margin Money to be brought by borrower Verify end use of funds ( capex. Verify all Ad hoc sanction limits given Acceptance of the borrower confirming the terms & conditions of sanction is obtained Sanction letter/limit approval letter stating the terms and conditions is available If the Loan policy or Manual specifies the adjustment of creditors.Sanctioning/Disbursement      Verify that Disbursement done only after compliance of all terms & conditions of Sanction letter.

changes. title deeds. hypothecation Agreement. share certificate. DP Note. Audit of Advances 14 21 March 2010 . title clearance certificate valuation report are held on record In case of Third party borrowing against Branch Fixed Deposits. if required whether appropriately stamped Fresh loan documents are obtained on change in limit. loan Agreement. Letter of guarantee. change in the constitution of the borrower As per Sanction Letter and Bank Policy Original agreement. as required by the sanction letter and loan policy have been executed (eg. different inks etc. normal lending rate of interest should be applied as against concessional rate Documents should not be blank or incomplete & there should be no overwriting. etc) Loan documents are properly executed and approved by legal expert.Documentation        All loan documents.

Mortgage Registration) NOC of housing society Memorandum and Articles of Association or proof of constitution of the borrower Special Documentation for Consortium/ Multiple Banking advances Whether advances against lien of deposits have been properly granted by marking a lien on the deposit in accordance with the guidelines of the controlling authorities of the bank 21 March 2010 Audit of Advances 15 .Documentation       Original documents are kept in safe custody Charge on securities offered have been registered with registrar of companies/ appropriate authority (RTO.

balance exceeding limits . and any margin is to be introduced Adequacy of Insurance Audit of Advances 16   21 March 2010 . in order to know whether the borrower is over financed. quarter end ( turnover in account. transfers from / to accounts) In cases where borrower is availing Multiple banking Facility. whether the branch obtains outstanding position from each Bank and compares the limits availed with stocks held and DP applicable. cheques dishonored. Excessive Cash transactions.Review/Monitoring       Review/ Renewal of facilities carried out as per the policy of the bank Verify Follow up of accounts pending renewal LC issuance check for ever greening Security / Stock Inspection reports Regular QIS. dormancy of account. specially at month end. Stock & Debtors statements are submitted Operation in party accounts critically review.

e.Review/Monitoring    Fund disbursement has been utilised towards the object for which limit was sanctioned i. Not diverted to group companies/ associates or used to pay of existing overdues Periodic review of irregular/ overdue/ NPA accounts has been done at the appropriate level Penal interest to be charged if.  DP limits breached  Statements not submitted   Letter of Acknowledgement / Balance Confirmation Bills Discounted a) whether accommodation bills b) whether ECGC Cover taken? 21 March 2010 Audit of Advances 17 .

If stock statements is older than 3 months account to be classified as irregular  Verify banks guidelines for DP calculation specially for unpaid stocks  Verify Inventory & equity shares Valuation  Verify annual audit report of the borrower with the monthly stock statement for the last month of the year  Verify Stock audit report for NPA s more than Rs5 Crore 21 March 2010 Audit of Advances 18 .Review/Monitoring Drawing Power Calculation  Based on Stocks. Debtors and Share value  Critical review of stock/ Book Debts statement (Old debtors more than 180 days not to be considered)  DP limits to be set as per latest statements.

Immovable Assets.g. Patents)  Charging of same security to different Banks  Diversion of funds  Fraud risk relating to Controls  Submission of fake transport documents/ godown receipts  Discounting of accommodation bills/ issuance/ LC 21 March 2010 Audit of Advances 19 .Review/Monitoring Fraud in Advances  Sanction without proper application and/or credit appraisal  Sanction made beyond discretionary power and nonreporting of the same to the appropriate authority  Unauthorised release of securities  Security valuation (Especially NPA account e.

RBI Circular Reference     RBI Circular Reference Master Circular dated 1st July 2009 on IRAC Norms. Circular dated 1st December 2009 for provisioning coverage ratio. 21 March 2010 Audit of Advances 20 . Circular dated 31st August 2009 in respect of Agricultural debt waiver scheme. Circular dated 5th November. 2009 for provisioning on standard assets.

NON-PERFORMING ASSET (NPA) The asset ceases to generate income for the bank. (Para 2 of the Master Circular) 21 March 2010 Audit of Advances 21 .Asset Classification Asset Type STANDARD ASSET / PERFORMING ASSET The account is not non-performing and does not carry more than the normal risk attached to the business.

3 an account will be NPA only if interest due & charged during as quarter is not serviced fully within 90 days from end of quarter.Asset Classification A non performing asset (NPA) is a loan or an advance where:  Interest and/ or installment of principal remain overdue for a period of more than 90 days in respect of a term loan  The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted  If the Cash Credit/Overdrafts account remains Out of Order as described below if the outstanding balance remains continuously in excess of the sanctioned limit/ drawing power No credits in the account for 90 days as at period end.1. Stock statement more than 3 months old for a continuous period of 90 Days  Regular/ Adhoc limits are not revised within 180 days of due date/ Adhoc sanction date  Derivatives: Receivables on account of mark to Market Value remain overdue for more than 90 days 21 March 2010 Audit of Advances 22 . credits not enough to cover interest debited during the period As per para 2.

 NPA merely due to temporary deficiencies (guidelines in master circular dated 1st July 2009) (e. date of NPA. genuineness. provisioning/Value of security. etc  Identification of assets as NPAs should be done on an ongoing basis  Verify if account regularised with only few audits at period ended (source. additional audit etc. Renewal/Review pending for 180 days.g. Excess drawn on limits due to drawing power calculated on more than 3 month old stock statement)  Verify errors in classification.) 21 March 2010 Audit of Advances 23 . interest reversal  Verify audit trail for changes to critical dates e.Asset Classification  NPAs Borrower-wise and not Facility-wise.g.

Asset Classification        Make a Detailed Note on observation and facts especially where you are recommending a change of classification In respect of NPAs over Rs.5 Crore  Stock audit-Annually  Immovable properties-once in 3 years Do not go by BANKS circular (Interpretation mistakes could be there) Verify that Repayment is from genuine sources NPA accounts can be upgraded to performing after all overdues are adjusted or at least reduced to a period of less than 90 days Suit filled accounts to be classified as Doubtful unless there is strong justification against it In case of Consortium advance record of recovery of particular Bank only to be considered. Audit of Advances 24 21 March 2010 .

IVP and Life policy not to be treated as NPA provided adequate margins are available Note. NSC.KVP.Asset Classification  NPAs are categorized based on the period for which asset has remained nonperforming: Substandard Assets which has remained NPA for a period less than or equal to 12 months Doubtful Assets if it has remained in the substandard category for a period of 12 months Loss Assets identified by the bank or internal/ external auditors or the RBI inspection but the amount has not been written off wholly   Advances against Term deposits.Advances against Gold ornaments and government security and all other securities are not covered in the aforesaid exception Amount guaranteed under ECGC need not be treated as NPA Audit of Advances 25 21 March 2010 .

then NPA Erosion in value of security :Where erosion of security is to the extent 50% of outstanding NPAs--.loss Projects under implementation ± separate set of guidelines under Master Circular  21 March 2010 Audit of Advances 26 . if not done within 180 days.doubtful 90% of outstanding NPAs--.Asset Classification   Regular/ad-hoc limits need to be reviewed /regularised not later than 3 m from due date/ date of adhoc sanction.

Provisioning Norms     Higher provisioning is warranted if threats to recovery Verify secured and unsecured portion of advances Critically verify the value of security as on the balance sheet date For accounts classified as doubtful. verify  Primary and secondary security charged to the bank  Present value through approved valuer (once in 3 Years)  Inspection  In case of Foreign currency denominated Loan Revaluation gain from Foreign exchange fluctuation to be considered as provision against the asset 21 March 2010 Audit of Advances 27 .

Provisioning Norms Asset Classification Standard Assets Amount of Provision Required in (%) Advances to Agriculture & SME 0. Disclose PCR in Notes to Accounts 21 March 2010 Audit of Advances 28 .25% Advances to Commercial Real Estate 1% Other Advances 0.40% 10 % on total amount And additional 10 % on unsecured portion Secured Portion Unsecured Portion Sub-Standard Asset Doubtful Asset Upto 1 Year 1 to 3 Year More than 3 year Loss Asset 20 % 30 % 100 % 100 % 100 % 100 % 100 % Provisioning Coverage Ratio to be 70% by 30/09/2010.

RRB.No.BC. 2010) Circular dated December 01. dated March 04.61/03.Provisioning Norms    For Restructured Advances additional provision on Unsecured portion of WCTL.covered under Restructuring Provisioning Requirement for Standard Assets for RRB s for Commercial Real Estate (CRE) is Increased to 1% (RBI circular PCD.34/2009-10. 2009 for Provisioning coverage for Advances 21March 2010 Audit of Advances 29 .05.

25 0.25 5 20 25 100 100 Lower provision in respect of short term Exposure Verify data carefully 21 March 2010 Audit of Advances 30 .Provisioning for Country Risk Net funded country exposures 1% of total Exposures Risk Category Insignificant Low Moderate High Very High Restricted Off-Credit ECGC classification A1 A2 B1 B2 C1 C2 D Provisioning requirement (%) 0.

Income recognition     Banks should not book income by way of interest on NPA However. IVPs. interest on such advances should not be taken to income account unless the interest has been realised Verify whether Interest calculations are correct or not Sample basis and Check Systems also 21 March 2010 Audit of Advances 31 . provided adequate margin is available in the accounts If Government guaranteed advances become NPA. NSCs. KVPs (check for fraudulent documents) and Life policies may be taken to income account on the due date. interest on advances against TD.

bills purchased and discounted. should be reversed or provided for if the same is not realised Note: Earlier reversal was for the previous year only & now since last year says past periods 21 March 2010 Audit of Advances 32 . interest accrued and credited to income account in the past periods. becomes NPA as at the close of any year. including Government guaranteed.Income recognition  If any advance.

In case of advances guaranteed by CGTSI/ECGC.Specific Areas Provisioning Norms « Provision Under Special circumstances  Advance under rehabilitation programme approved by BIFR / Institutions. Provision should be continued to be made on existing facilities. Additional facilities no provision for a period of one year.   21 March 2010 Audit of Advances 33 . Provision should be made only for balance in excess of the amount guaranteed by these corporations.

Exception: Credit facility to Primary Agricultural Credit Society (PACS) and Farmers Service Societies (FSS) under on lending arrangement.10) 21 March 2010 Audit of Advances 34 .2.12 (ii)].  Central Government guaranteed advance to be classified as NPA only if Government repudiates the guarantee when invoked. (Para 4.2.2.Specific Areas Exceptions:  Bank Finance with Moratorium [Para4.  Housing or similar advances granted to staff members [Para 4.12 (i)].

Restructured Loans: Master Circular of 1/7/2009    Only loans with Viability and with reasonable certainty of repayment to be Restructured Standard loan to be classified as Sub-standard after Restructuring Certain exceptions in circular:Other than for Capital Market Exposure. 21 March 2010 Audit of Advances 35 . Personal / Consumer Loan/ Commercial Real Estate  Incentive for quick implementation of Restructuring within 90 / 120 days asset classification which existed at time of restructuring application.

classification not be downgraded if satisfactory performance during the specified period subject to:  dues being fully secured (other than SSI whose outstanding is less than 25 lakhs & Infrastructure projects having cash flows to repay advance through escrow mechanism  unit becomes viable in 7 years (10 years for infrastructure cases)  repayment in 10 years (15 years for Infrastructure cases)  promoter sacrifice and additional funding at least 15 % of Bank Sacrifice  personal Guarantee of promoters  Not a repeated restructuring  Reschedulement of recovery cannot upgrade the classification from the previous classification 21 March 2010 Audit of Advances 36 .Restructured Loans  Asset Classification benefits .

Restructured Loans   Upgrading to standard category only after satisfactory performance during the specified period Specified period-period of one year from the date when the 1st payment of interest or installment of principal falls due under the terms of restructuring Additional finance to be treated as standard Asset. However interest income to be recognised only on cash basis for Assets which were NPAs at time of restructuring 21 March 2010 Audit of Advances 37 . upto one year after date of first principal / interest payment under approved restructuring package.

Restructured Loans        Fees and commissions earned by the bank as a result of renegotiations or rescheduling of outstanding debts to be recognised on an accrual basis over re-negotiated period Restructuring not to be retrospective Asset classification norms applicable till restructuring is finalised Provision to be made for the diminution in the fair value of the advance Valuation and provisioning issues for equity. 2008) Audit of Advances 38 21 March 2010 . debt instruments received on restructuring Norms for conversion of unpaid interest into FITL/ Debt/ Equity Repeated restructuring is allowed only if the viable units are facing temporary cash flow problems (December 08.

100% 21 March 2010 Audit of Advances 39 .if account not eligible for upgradation.Restructured Loans Additional Provision   WCTL Loans restructured under circulars dated.27 August 2008. 8 December 2008 Unsecured portion of WCTL created by conversion of irregular portion of principal dues over drawing power should be as under:  Standard assets 20%  Sub-Standard assets 20% in the first year then increase by 20% every year till specified period  After specified period.Unsecured Portion.

Agriculture Loans  NPA Classification   The installment of principal or interest thereon remains overdue for two crop seasons for short duration crops The installment of principal or interest thereon remains overdue for one crop season for long duration crops Banks not to claim nor recover interest in excess of principal amount.etc for the Assets which are NPA at the time of restructuring Unapplied interest on NPA loans are neither to be claimed from the government nor from the farmer Eligible amount to be credited to the borrower account by 30 September 2008 Small and marginal farmers entire eligible amount shall be waived  Agriculture debt waiver scheme and debt relief scheme 2008     21 March 2010 Audit of Advances 40 . penal interest. miscellaneous charges .

31 March 09. 2010 Balance in account to be treated as Performing asset. provided adequate provision for the loss is made in PV terms If not received till 31/01/2010 it is a NPA from old date Audit of Advances 41 21 March 2010 .30 June 2009 which is extended to 31/12/2009 vide circular dated 31/8/2009) 25/6/2009 Circular resolution permitting farmers to pay the amount in single installment by 30/6/2009 Farmers share has to be received within 1 month of the pre-specified due dates if not then the account will be classified as NPA Separate account Receivable from government of India under Agriculture Debt waiver Scheme 2008 It may be assumed that governments contribution would be received by June 30.Agriculture Loans        Other farmers.OTS in which entire rebate of 25% provided entire amount is repaid of the eligible amount for which the last dates of 3 installments fixed are 30/9/2008 which was extended to 31 March 09.

Government Guaranteed Advances     In case of NPA income not to be recognised unless it is actually realised State government guaranteed advances have to be classified as NPA if remains overdue for more than 90 days Central government advances to be considered as NPA only if guarantee invoked and repudiated by the government If bank has not invoked Central Government guarantee for long it should to be reported in the LFAR 21 March 2010 Audit of Advances 42 .

all the advances required to finance the production cycle advance is given on the basis of individual order obtained which is to repaid out of export proceeds The post shipment credit relates to financing of bills raised on the overseas buyer upon shipment of goods pending Verify proceeds received from export as these accounts have concessional interest 21 March 2010 Audit of Advances 43 .Packing Credit    Pre-shipment credit .

LFAR      Study the LFAR thoroughly with respect to advance portion Prepare the LFAR note for advances along with the statutory audit Give specific instances of shortcomings/ weaknesses in the advances sections Annexure to LFAR for large/ critical/ irregular accounts Critical comments affecting accounts should be part of main audit report and Qualified 21 March 2010 Audit of Advances 44 .

5(n) of the Banking Regulations Act. overdrafts and loans repayable on demand Overdue installments in respect of term loan to be included term loan and not loans repayable on demand As per Sec.KEY POINTS      Credit card dues are shown under cash credits. secured advance means an advance for which the market value of security is not at any time less than the amount of such advance Refinance obtained from refinancing agencies represents borrowings of the bank Bills discounted/negotiated/purchased under LC where the payment to the beneficiary is not under reserve is to be treated as an exposure on LC issuing bank and not on borrower 21 March 2010 Audit of Advances 45 .

the facility should be treated as unsecured Advances made against unapproved securities can be classified as secured 21 March 2010 Audit of Advances 46 . that part only should be classified as secured and balance amount must be classified as unsecured All accepted bills must be classified as unsecured unless collaterally secured Extension of surplus security in other facilities should not be considered unless agreed at the time of sanction In case documents are incomplete and or not in force.KEY POINTS      If only a part of advance is covered by the value of security as at the balance sheet date.

should be considered as Standard asset.KEY POINTS Bills discounted/purchased which have been rediscounted with RBI/IDBI/SIDBI must be shown under contingent liabilities In case of fully computerized. the banks are required to adopt uniform accounting policy  Foreign Bills under LC: Classification in a NPA a/c  In NPA accounts involving. If any bank has obtained a clarification individually from RBI. in case of partial recoveries in NPA. some banks are of the view. Foreign Bills under LC as one of the facilities. the same may be brought to the notice of auditors for information  Fixed Assets as a second charge . that the balance outstanding under this facility not being an exposure to the borrowers but to other banks . outstanding balances of Bills under LC are also to be aggregated with other balances for the purpose of calculation of provision.calculation of security value is important    21 March 2010 Audit of Advances 47 . being money due from the other bank ?  in a NPA account. ensure that there are proper systems for borrower wise classification In absence of a clear agreement with the borrower.

Should these non funded liabilities be provided for and if so under what classification? If these non funded liabilities are not to be included as NPA under what circumstances are these to be excluded 21 March 2010 Audit of Advances 48 . are accounted as NPA.KEY POINTS Provision against future LC / guarantee devolvement-In an existing NPA  Some of the guarantees/LCs which were devolved. There are certain other LCs and guarantees remaining to be realized.

Disclosure Requirements A) i) Bills purchased and discounted ii) Cash Credits. Advances Outside India 21 March 2010 Audit of Advances 49 . Advances in India i) Priority sector ii) Public sector iii) Banks iv) Others II. overdrafts and loans repayable on demand iii) Term Loans B) i) Secured by tangible assets ii) Covered by bank/Government guarantees iii) Unsecured C) I.

3 to 5 years. Unsecured and other in A.Disclosure Requirements i) Due from banks ii) Due from Others iii) Bills purchased and discounted iv) Syndicated loans v) Others Amount receivable from government of India under Agricultural Debt waiver scheme.1 to 3 years. 3 to 6 months.2008 should be separately under the head Term Loans. 14 days to 28 days. more than 5 years Segmental Analysis: Based on Wholesale and Retail Audit of Advances 50    21 March 2010 . 29 days to 3 months. B and C respectively Maturity Analysis: 1day to 14 days.6 months to 1 year.

Areas to focus in 2010           Real Estate loans Capital Market Loan Agricultural Loans Restructured Loans Commodity Loans Infrastructure/ SEZ/ Engineering Project Diamond industry Textile Export oriented loans looking at the global and Indian scenario possibly will have to see all loans 21 March 2010 Audit of Advances 51 .

Questions??? 21 March 2010 Audit of Advances 52 .

21 March 2010 Audit of Advances 53 .