Prepared & Presented By CA.Vishakh M

Practical Issues in Audit of Advances

(NPA)

1

ADVANCES Money lent by the bank to its customers and interest accrued and

due thereon (including guarantees invoked/Letters of credit

devolved on Bank)

Debit balances in deposit accounts

Amount of participation on risk-sharing basis under inter-bank

Participation schemes in capacity as a participating bank (net)

Amount receivable from Government of India under the

Agricultural Debt Waiver Scheme 2008.

2

TYPES OF ADVANCES

FUND BASED

For financing Fixed Assets

and Capital Expenditure

Term Loans

Long Term

Short Term

Demand Loans

For Working Capital

Overdraft

Cash Credit

Export Credit

Bills

NON FUND LIMITS

Bank Guarantees

Letter of Credit

Comfort Letters

3

COMMON NOMENCLATURES Corporate Personal Foreign

Currency /

Export /

Import

Priority Sector

and MSME

Term loans

- TLs

Housing Loans

Term Loans

-FCTLs

Agricultural

Loans

- AGTLs

Working Capital

Demand Loans

-WCDLs

Gold Loans Foreign Currency

Bills

Educational Loans

Cash Credits

-CCs

Personal Loans

- PLs

- Credit Card

Letter of Credit

-LCs

SME Advances

Ad hoc Sanctions

Overdraft

-ODs

-TODs

Vehicle Loans Pre / Post

Shipment Finance

-PCLs

Funded Interest

Term Loans

-FITLs 4

NON PERFORMING ASSETS (NPA)

The Reserve Bank of India sets guidelines for various aspects

regarding recognition and treatment of non performing assets.

“An asset including a leased asset, becomes non performing when

it ceases to generate income for the bank.”

Master Circular on “Prudential Norms on Income

Recognition, Asset Classification and Provisioning

Pertaining to Advances”

Ref:DBOD.No.BP.BC.1/21.04.048/2013-14 issued on July 1,

2013

5

Criteria for Classification as NPA Type of Advance Criterion

Term loan Interest and /or instalment of principal

remain overdue for a period of more than 90

days

Overdraft

Cash Credit

The account remains ‘out of order’

Bills The bill remains overdue for a period of

more than 90 days

Agricultural crops advance

Short duration

The instalment of principal or interest

thereon remains overdue for two crop

seasons

Agricultural crops advance

Long duration

The instalment of principal or interest

thereon remains overdue for one crop season

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Continued.. Type of Advance Criterion

Liquidity Facility under Securitisation

transaction

The amount of facility remains outstanding

for more than 90 days

Derivative Transactions The positive mark to market value unpaid

for 90 days from the specified due date

Interest Payments Interest charged during the quarter is not

paid in full for a period 90 days from the

end of quarter

Working Capital Loans Drawing power arrived on the basis of stock

and debtors statement which is more than 3

months old and drawings are permitted for a

continuous period of 90 days

Regular / Ad hoc limits Not reviewed / renewed within 180 days

from the due date / date of ad hoc sanction

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Continued.. Erosion in the value of security:

Extent of erosion Classification

50% of Outstanding NPA – Doubtful

90% of Outstanding NPA – Loss

Projects under implementation:

Date of commencement of

commercial operation (DCCO) Separate RBI norms

Date of Completion

Overdrawn Account:

No or insufficient credits to cover interest debited during 90 days of account being overdrawn

8

Explanations Out of Order:

Overdue:

Any amount due to the bank under any credit facility is

‘overdue’ if not paid on the due date fixed by the Bank

Balance outstanding criterion

Continuously is in excess of sanction

/drawing power

Straightaway ‘out of order’

Under principal amount is less than

sanctioned limit / drawing power

There are no credits continuously for

90 days as on balance sheet date or

Credits are insufficient to cover the

interest debited during that period

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Continued…

Accounts not classified as NPA

Loans and advances against

bank’s own deposits

National Savings Certificates eligible for surrender

Indira Vikas Patra

Kisan Vikas Patra

Life Insurance Policies

Where stipulated margin is maintained and lien is marked on security

Advances guaranteed by Central Government

Unless such guarantee is repudiated by CG when invoked

Asset Classification is Borrower-wise and not facility-wise

10

AUDIT

Policy and Guidelines Audit program

RBI Guidelines

Master Circular

Other Circulars

Credit Policy

Recovery Policy

Interest Rate and Charges Circulars – Bank (Income)

Instructions along with Year end returns

Audit Programme

Checklist

Returns

Advances

Confirmations

Others

Guidance Note on Audit of Banks

Documentation

11

Audit of Advances

Audit papers Bank documents

Borrower-wise + facility list

Document Limits

Sanction terms

Legal Compliance

Borrower acceptance

Correspondences

Adverse findings

Correctness of Income, Classification and Provisioning

Documents

Review and Renewals

Borrower- wise list containing borrowers on monetary limits

Below Rs.10 Lakhs

Rs.10 Lakhs to Rs.2 Crores

Above Rs.2 Crores

Borrower – wise + Facility wise exposure Checklist containing

Names, Limits, Sanction, Group, History,etc.

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Contineud…

Audit papers Bank documents Documents Review

Loan Application

Credit Appraisal

Loan Documentation

Demand Note

Loan Application (Bank)

Charge Documents

Vetting

Site Visit Reports

Project Financials / details

RoC

Borrowing Authority / approval

IT Reports / Returns

Audit reports

Land / Building / security records

Sanction Letter

Previous year Audit Report

Monthly Concurrent Audit Report

IT Audit Reports Technical

RBI Risk Based Audit Report

Quarterly Review Reports

Banks Potential NPA lists

Monitoring Reports

Correspondences with RBI - Replies

LFAR

Audit Report

Other Notices

Borrowers

13

Practical Approach

14

Understand the Audit Programme

Read and understand Audit instructions contained in RBI

Master / other circulars, Guidance Note by ICAI, Year end

circular of Bank, Policy of the Audit firm

Obtain Trial balance and Other Forms containing asset list

and classification

Mark areas of business in the Branch, assessing various types

of advances, composition and nomenclatures

Identify major advances, parties and industry segment

Contineud…

15

Obtain Borrower-wise cover notes containing summary

details of group / company and facilities enjoyed

Select connected advances and group borrowings

simultaneously

Document / jot down borrower-wise critical issues observed

in earlier report review

Ask for Account statements, simultaneous files, interest rate

and classification history in advance

Commence review borrower-wise+size of advances

Appraisal

16

Understand the Credit appraisal policy of the bank relevant to each type of facility/ borrower

Ensure that

Credit appraisal notes are in latest format

Information fed into credit appraisal notes are correct and from genuine verified sources

Credit appraisal notes are prepared by adequate authority and under strict guidelines of the bank.

Necessary documents with corroborating evidences are submitted by borrowers Latest Financials, IT Report / Returns, Management details, Industry and

Commerce, Associates, Borrowal history, Worth / wealth report etc.

Sanctions

17

Complete sanction letter to be on record.

Ensure that

Sanctions are within the delegated powers

Clear and unambiguous terms of sanction mentioned in letter

Sanctions are in their entirety communicated to borrowers and their unqualified acceptance is on record

Sanctions are properly recorded, reported and disclosed in Bank records and forwarded to concerned authorities.

Sanction letter is dated and held on face of documents

Reviews and renewals are to clearly be in alignment and in reference with original sanction

Disbursements

18

End use of funds is a primary evidence of genuine advances

Review all Invoices backing purchase of Capital assets, stamped documents, wiring/cheque /DD instructions and payee details.

Corroborate with Freight receipts/Excise records/tax records

Post disbursement inspection reports

Ensure margin requirements and borrower’s capital infusion

Ensure infrastructure works are completed before Working capital disbursements

All disbursements are related to business activity covered under the facility of the borrower

Documentation

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Documents for legally establishing the borrowers liability towards the bank.

Documents establishing bankers lien / right over the pledged / mortgaged / collaterised asset of the borrower

Ensure that

Documents are complete in all respects

Stamped adequately

Registered with concerned authority and confirmation / acknowledgments obtained and are on record

Duly vetted

Documents are kept safely and handled with confidentiality

Produced on demand to auditors

Account Masters in System

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End to End conversion of sanction details and terms in system (software)

Ensure that following are correctly keyed in and cross verified

Date of sanction and limits

Repayment Schedule

Stock and Debtors details for drawing power calculation

Borrower-wise grouping

Interest rate, borrower category for charges, review changes

Classification / Criterion for classification of advance and NPA status and date

Term Loans

21

Review documentation / periodical inspection of assets/insurance and Valuation of security

Review account balance by

Credit and debit summations

Regularity of Payments/credits

Interest rate changes and history

Intra group transfers via current accounts

Payee details for large disbursements

Ensure correct classification applying NPA norms

Arrive at year end figure and cross match with borrowers financials

Most importantly

review quarter end and beginning transactions

Effect of earlier comments by auditors / RBI / Monitoring Divisions

Working Capital Loans

22

Review continuous updating of documentation

Observe and estimate working capital needs by assessing

borrower’s

Industry/segment/place of business/customer line

Annual Turnover/seasonal turnover/credit period

Stock Audit Report

Ensure NPA norms and provisions are applied

Ensure drawing power calculations are correct and verified

Ensure account is regular in alignment with other facilities

enjoyed by the borrower

Bills

23

Ensure Bills are kept under borrower-wise and nature of bill wise registers

Ensure Bills are genuine trade transactions by corroborating with contract notes, purchase orders, LCs, freight bills, railway/loading receipts.

Ensure Bill finance are under sub limits mentioned in sanction letter

Payment history and system of follow up for collection

Banks cover note for Bills documentation and approval is duly filled and valid in respect of date, amount, serial number and classification

Export / Import Finance

24

Generally observe the borrower to be a valued customer of

the bank with good trade and borrowing history

Pre Shipment Credit / Packing credit:

Export orders / letter of credit to be attached for order based credit

Export permissions and projections to be obtained for running accounts

Ensure documentation of pledge / hypothecation of goods

Ensure valuation reports and ownership documents are in place along

with godown receipts

Ensure documentation of Insurance / ECGC covers

Confirm eligibility for interest subvention

Check for closure of credit from export proceeds

Ensure process is completed within 180 days in general

Ensure asset classification is correct

Continued…

25

Post Shipment Credit:

Usually in the nature of advances against bill for collection Ensure grouped accordingly as

Negotiation Bills under Letter of credit

Discounting of bills

Advance against receivables / drawback

Ensure adequate documentation is maintained with regards to sanction, ad hoc limit, date of collection and postage/ payer details

Proof of Export is on record

Forward contracts in connections are also to be verified

Ensure adequate control over screening of bills before purchase / discount, genuineness, procedural compliance with regards to proceeds application

Non Fund Limits

26

Letter of credit:

Ensure that

LCs are issued within the sanctioned limits and terms

Necessary approvals are obtained on the cover note for credit

approval Beneficiary details, FEMA compliance, Tax

compliance, RBI Guidelines

Recorded in the books of the bank adequately

Bills and LCs cross match

Adequate control is kept of tracing and monitoring LCs

borrower –wise and due dates are strictly adhered and

carried forward

Performance of borrower is satisfactory

Continued…

27

Bank guarantee:

Issued only as per sanction terms

Issued after upfront charges are collected

Ensure that

Guarantees are duly signed and printed on adequate stamp papers

and contains correct information and declaimer regarding

limitations

All outstanding Guarantees are duly recorded and reflected in

banks books and register

Repeated extensions are carefully verified

Invoked guarantees are paid duly and entries are correctly passed

Procedure for reversal of expired guarantees to be reviewed and

quarterly movement to be traced

Some Practical Issues

28

Advance against hypothecation of assets but assets not under

control of borrower – No value of security

Repayment Schedule made in ignorance of TDS compliance

for rental receipts – Non recovery / differential recovery

Advances emanating from one genre:

Education Loans belonging to one Institute students

Incomplete applications / documents / correspondence

Incomplete records / Mutilated records

Situations where pages are missing in Audit / Stock Audit

reports

Continued…

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End Use:

Borrower attaching invoices of second hand machinery

Change of purpose of commercial buildings effecting key

assumptions in project report

Repeated irregularity and restructure of agricultural advance –

Non site visits and plan evaluation

Management frauds

Industry slowdown / Regulatory changes / Compliance hit

Accounts – Pushing NPA Limits

3 Important Tips

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1. Read, observe, ask questions and learn to make well

informed judgments

2. Take one report / return / file at a time and trace the

balance / information up to final document / return /

total balance

3. Have correct record of each work done on files / returns

with regards to source, reference and impact.

THANK YOU

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References and sources: Guidance note on Audit of Banks by ICAI

RBI website – Circulars

Leaf from work of CA.Rajkumar.S.Adukia

CA.N.Ramesh and CA . H. Anil Kumar

(internal use only)