15 Key Pointers for Auditors while auditing Bank Advances
The banking sector in the last 20 years has gone through an extensive shift maturing from direct customer interaction to virtual banking. Technology has boosted the banking sector to new levels. Banks have long abandoned the conservative and traditional system of banking and adopted progressive function such as merchant banking and underwriting, retail banking, etc. Even though banks have grown at a swift pace, various obstacles have also hindered its growth. One of the major problem faced by banks, are the growing Non Performing Assets (NPA’s).
What exactly are NPA’s?
According to RBI’s Master Circular on ‘Prudential Norms on Income recognition, Asset Classification and Provisioning pertaining to the Advances Portfolio’ –
- An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank.
- A NPA is defined as a credit facility in respect of which the interest and/ or instalment of principal has remained ‘past due’ for a specified period of time.
- Let us understand what is this “specified period of time” and what classifies as an NPA
|Facility||NPA Classification Criteria|
|Term Loan||interest and/ or instalment of principal remain overdue for a period of more than 90 days|
|Overdraft/Cash Credit||account remains ‘out of order’ for a period of more than 90 days|
|Bills Purchased and Discounted||bill remains overdue for a period of more than 90 days|
|Advance granted for agricultural purposes||interest and/or instalment of principal remains overdue for two harvest seasons but for a period not exceeding two and half years|
|Other Accounts||any amount to be received remains overdue for a period of more than 90 days|
India’s is currently facing an NPA nightmare where there is an ever increasing NPA due to lack of transparency and poor appraisal process. Auditors can also aid in detecting early NPA’s by proper scrutiny of advances. Audit of advances forms a major portion of work of the auditor. Auditor needs to be more perspective and sceptical while auditing advances as loans and advances are basically the survival unit of the bank.
Here are 15 points an Auditor can follow while conducting an audit of advances:
- Assessment of internal controls – IT controls, maker checker controls, if significant changes are to be made in the branches, whether the authority rests with the branch or HO, adequate control on changing of interest rates, terms and conditions in the system of the bank etc is extremely important while auditing advances. By understanding the control level in the branch one can perceive an initial risk which will help in formulating audit procedures.
- Ask branch to share the SMA (Special Mention Account) report to understand the potential NPA’s. It is important to verify these cases as there might be hidden NPA’s here.
- Refer the Concurrent Audit Reports, Previous Audit Reports, the Long Form Audit Report – LFAR, Internal Audit Report to find out any adverse comments.Verify if the bank has addressed any pending or negative issues addressed in the prior audit reports.
For Instance, Bank had to recover outstanding interest from a Mr A which was outstanding for 35 days. Now according to RBI, if any principal or interest payment or any other amount is wholly or partly overdue between 31 to 60 days, then the same is to be classified as SMA 1. The bank, however, had not classified Mr A as SMA 1 as according to the bank Mr A had a temporary emergency and the amount will be recovered in 5 days. If the same has been mentioned in the prior audit reports, verify whether proper recovery is made and Mr A is classified properly as per RBI norms,
4. Obtain a list and verify fresh advances sanctioned and/or disbursed during the year. If the list of fresh advances is large and it is impracticable to verify the whole lot, then sample checking can be done. However, one must remember to include large advances in this sample
5. Understand the bank policy for sanction and disbursement. This will give an idea of the appraisal process, documentation to be maintained, classification process etc.
6. Verify the Application form, Sanction Note and the Credit Appraisal process. Ensure whether the same is complete and all the T&C of the Credit Approval Notes and Sanction Letter are followed.
7. Verify external reports which are available on public domain such as Watchout, CIBIL, Tofler etc to find out information of the borrower and his borrowing/outstanding history.
8. Verify security created either in the form of a pledge or hypothecation. Ensure that the security is adequate and the same is actually present with the bank.
9. Verify end use of funds. Basically, loans are given for a particular purpose. Verify whether the amount disbursed by the bank is utilised for that purpose only.
10. Ensure the balance in the borrower’s account should not be allowed to exceed the drawing limit and if the same is done find out the reasons and procedure followed by the bank for the same.
11. If any advance has been upgraded from NPA to Standard, then ensure that there is full recovery (no amount should be overdue).
12. Ensure continuous review and monitoring of loans sanctioned is being done to find out if the advance is facing any risk.
13. Scrutinise the operations of the ledger to verify:-
i. Frequent returns
ii. Excessive withdrawals
iii. Regularity of payments
iv. Penal interest in case of default
14. The auditor is also to verify the classification of advances. Ensure that the same is done according to the Master Circular – Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances.
15. Ensure bank has made adequate provisioning as per Master Circular – Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances.
Here’s hoping that these pointers will aid you while auditing advances.