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Statutory Bank Branch Audit - Technical and

Practical Aspects

Compiled byANKIT AGRAWAL

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Contents of Balance Sheet (Form A)• Schedule –1 Capital • Schedule –2 Reserve and surplus • Schedule –3 Deposits • Schedule –4 Borrowings • Schedule –5 Other Liabilities and provisions• Schedule –6 Cash and bank balance with RBI • Schedule –7 Balance with bank and money at call

and short notice • Schedule –8 Investments• Schedule –9 Advances • Schedule –10 Fixed Assets • Schedule –11 Other Assets• Schedule –12 Contingent Liability

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Contents of Profit and Loss Account(Form B)

• Schedule-13 Interest Earned • Schedule-14 Other income• Schedule-15 Interest expended Schedule• Schedule-16 Operating expenses

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Circulars Issued by RBI • Disclosure in balance sheets dated July 1, 2006• Prudential norms on Income recognition,asset classification and

provisioning relating to advances dated 1st July 6• Management of advances dated January 22, 2007• Loans and advances-statutory and other restrictions dated 1st July

2006• Guarantees and co-acceptances dated July 1,2006• Guidelines for securitisation of standard assets dated 1st Feb 2006• Prudential Norms on Capital Adequacy dated July 1,2006• Para-banking Activities dated July 1,2006• Exposure norms dated October 10 ,2006• Cash Reserve ratio and Statutory Reserve ratio dated October

11,2006• Provisioning Requirement for Standard Assets dated Feb 19, 2007

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Definition of Non Performing Assets as per Circular dated 01-07-06

An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank (Para 2.1.1)

A non-performing asset (NPA) is a loan or an advance where; i. interest and/ or instalment of principal remain overdue for a period

of more than 90 days in respect of a term loanii. the account remains ‘out of order’ in respect of an Overdraft/Cash

Credit (OD/CC) iii. the bill remains overdue for a period of more than 90 days in the

case of bills purchased and discountediv. a loan granted for short duration crops will be treated as NPA, if the

instalment of principal or interest thereon remains overdue for two crop seasons.

v. a loan granted for long duration crops will be treated as NPA, if the instalment of principal or interest thereon remains overdue for one crop season. (Para 2.1.2 )

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INCOME RECOGNITION on NPA• Income from non-performing assets (NPA) is not recognised on accrual

basis but is booked as income only when it is actually received (Para 3.1.1)

• The Accounting Standard 9 (AS 9) on `Revenue Recognition' issued by the Institute Of Chartered Accountants of India (ICAI) requires that the revenue that arises from the use by others of enterprise resources yielding interest should be recognized only when there is no significant uncertainty as to its measurability or collect ability.

• Interest on advances against term deposits, NSCs, IVPs, KVPs and Life policies may be taken to income account on the due date, provided adequate margin is available in the accounts (Para 3.1.2)

• Fees and commissions earned by the banks as a result of re-negotiations or rescheduling of outstanding debts should be recognised on an accrual basis over the period of time covered by the re-negotiated or rescheduled extension of credit (Para 3.1.3)

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Reversal of Income• If any advance becomes NPA as at the close of any

year, interest accrued and credited to income account in the corresponding previous year, should be reversed or provided for if the same is not realised.(Para 3.2.1)

• This will apply to Government guaranteed accounts also.

• Fees, commission and similar income that have accrued should cease to accrue in the current period and should be reversed or provided for with respect to past periods, if uncollected. (Para 3.2.2)

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Categories of NPAClassification is only for the purpose of computing the amount of provision that should be made with respect to bank advances and certainly not for the purpose of presentation of advances in the banks balance sheet

• Sub-standard Assets - which has remained NPA for a period less than or equal to 12 months (Para 4.1.1)

• Doubtful Assets - has remained in the sub-standard category for a period of 12 months (Para 4.1.2)

• Loss Assets - loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly. (Para 4.1.3)

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Provision on Standard Assets• The banks should make a general provision of a minimum of

0.40 percent on standard assets on global loan portfolio basis • Banks would continue to make provision at 0.25 per cent for

direct advances to agricultural and SME sectors in the standard category (as per circular issued by RBI on 8th of Nov 2005)

• A small scale industrial unit is an undertaking in which investment in plant and machinery does not exceed 1 crore except in certain specified items under hosiery,hand tools, drugs. Pharmaceuticals. Stationery items and sport goods where investment limit has been extended to Rs. 5 crore

• Units with investment in Plant and machinery in excess of SSI limit and upto Rs 10 crore may be treated as medium enterprise (circular dated 19/08/2005)

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Provision on Sub-standard Assets (Para 5.4)

• A general provision of 10 percent on total outstanding should be made

• The ‘unsecured exposures’ which are identified as ‘substandard’ would attract additional provision of 10 per cent.

• The provisioning requirement for unsecured ‘doubtful’ assets is 100 per cent.

• Unsecured exposure is defined as an exposure where the realisable value of the security, as assessed by the bank is not more than 10 percent

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Provision on Doubtful Assets (Para 5.3)• 100 percent of the extent to which the advance is not covered by the realisable value of

the security • In regard to the secured portion, provision may be made on, at the rates ranging from 20

percent to 100 percent of the secured portion depending upon the period for which the asset has remained doubtful

Period for which the advance has remained in ‘doubtful’ category

Provision requirement (%)

Up to one year 20

One to three years 30

  More than three years (i) outstanding stock of NPAs as on March 31, 2004   

(ii) advances classified as ‘doubtful more than three years’ on or after April 1, 2004

60 per cent with effect from March 31, 2005 75 per cent with effect from March 31, 2006 100 per cent with effect from March 31, 2007 100 percent with effect from March 31, 2005

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Provision on Loss assets

(Para 5.2)Loss assets should be written off. If Loss Assets are permitted to remain in the books for any reason, 100 percent of the outstanding should be provided for.

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Key RATIOS for Analysis

• Non-performing loans to total loans • Cash and liquid securities (for example, those

due within 30 days) to total assets• Interest income as a percentage of average

interest bearing assets • Non-interest expense as a percentage of

operating income • Capital adequacy ratios • Return on average total assets

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Analytical Procedures

• Analytical procedures consist of the analysis of significant ratios and trends including the resulting investigation of fluctuations and relationships that are inconsistent with other relevant information or deviate from predicted amounts.

• By using analytical procedures, the auditor may detect circumstances that call into question the appropriateness of the going concern assumption, such as undue concentration of risk in particular industries or geographic areas and potential exposure to interest rate, currency and maturity mismatches.

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Verification of Loans and Advances (General)

• Check the individual balance in each loan ledger with the trial balance book

• Verify the head office sanction /renewal for advances sanction as per appropriate authorities

• See that margins are maintained in respect of secured advances • Examine that the operation of each advance is reviewed at least

once in a year • Examine that advances represent amount due to the bank • All the necessary documents (e.g., agreements, demand

promissory notes, letters of hypothecation, etc.) should be executed by the parties before advances are made

• Advances are classified in such a way that information required in schedule 9 of Banking Regulation Act, 1949 can be gathered.

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Verification of Advances against

Goods• Examine the stock statements and ascertain that the loans availed

is with in the drawing power/limits sanctioned • Verify that letter of hypothecation has been executed in favour of

bank • Verify that charge is duly registered with ROC in case of loan on

hypothecation to limited company • Verify the fire insurance policy and ascertain that polices are alive

as at 31st March 2006 • Banks should have a system in place to ensure that the borrower

does not avail the advantage double financing on same stock, i.e., financing from bank for the portion of stock not paid to the creditors

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Verification of Advances against Fixed Deposits

• See that bank’s lien have been marked on deposit receipts as in their respective ledger folio

• See that no advance is granted against duplicate receipt without proper verification

• In case of advances against deposit receipts of other branches ,to verify the intimation to that branch to mark the lien and to see that the same has been acknowledged by other branch

• See that deposit receipts /pass books/ cash certificates have been duly discharged in favor of bank at the time of discharge

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Verification of Advances against Vehicle

• Verify the copies of registration certificate • See that vehicle has been comprehensively

insured and verify the banker’s clause in insurance policy

• Test check the original certificate and ascertain that endorsement is made in favor of bank

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Verification of Advances against Immovable Property • Go through the legal opinion of bank’s lawyer

about title of property to the borrower • Verify the latest tax receipts towards the payment

of property tax and verify the encumbrance certificate

• Verify the valuation reports for the fixed assets charged to bank

• Verify whether building has been properly insured and policy has been taken in the joint name of bank and the mortgagor

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Verification of Advances against Insurance Policy

• Scrutinise the insurance policy and ascertain the surrender value

• If surrender value is subject to payment of certain premium the amount of such premium has been deducted from the surrender value

• Verify the latest premium receipts • Verify whether policies have been duly assigned

by the insured in favour of bank and assignment is noted by insurance company

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Verification of Advances against Bills Purchased

and Discounted • All the outstanding bills have been taken in the balance

sheet • All the details, including the nature of the bills and

documents, are mentioned in the register and that the bills have been correctly classified

• The bills purchased or discounted from different parties are in accordance with the agreements with them and the total of outstanding bills of each party is not in excess of the sanctioned limit

• The bills are not overdue. If there are any overdue bills, the auditors should ascertain the reasons for the delay and the action taken by the bank

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Documentation • A certificate stating that the Branch did not hold any investments on behalf

of the Head Office (if there are no such investments held by the Branch • List of large advances i.e. those in respect of which the outstanding amount

is in excess of 5% of the aggregate advances of the Branch or Rs.2.00 crores whichever is less duly certified by the Branch Manager

• A copy of the letter from Head Office regarding Sanction limit of the Branch Manager;

• List of cases where the Branch has not obtained stock/book debts statements at the end of the year;

• List of cases where insurance copies are yet to be received at the end of the year

• A copy of the Head office instructions for identification of NPAs and classification of advances

• List of major items pending for reconciliation under Inter-Branch Accounts• List of all fraud cases reported to RBI as fraud upto March 31st

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Documentation (AAS-3)Following certificates should be obtained

from management:• Cash Retention Limit duly certified by the

Branch Manager • A photo copy each of the confirmation

certificates for Balances with RBI, SBI and other banks

• A copy of the reconciliation statement in respect of differences in such balances with RBI, SBI and other banksList of overdue or matured investments at the end of the year duly confirmed by the Branch Manager;

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Various Reports / Certificates1. Tax Audit Report

2. Position of Advances above certain amount3. PMRY Audit Certificate4. DICGC Certificate5. Verification on Friday Statements Certificate(Form X sec 27)6. Service Tax Certificate7. Income on Insurance Business8. Frauds9. Ghosh Committee Recommendations10. Jilani Committee Recommendations11. LFAR12. MOC-Classification13. MOC-Income Recognition14. Other reports15. AUDIT REPORT- U/S 30 OF The Banking Regulation Act,1949 r.w.s.228(3) of

the Companies Act,1956