Exposure Draft
Guidance Note on Audit of Banks
(2018 Edition)
(Last date for comments: January 13, 2018)
Issued by
Auditing and Assurance Standards Board
The Institute of Chartered Accountants of India
(Set up by an Act of Parliament)
New Delhi
Exposure Draft
Guidance Note on Audit of Banks
(2018 Edition)
Your comments on this Exposure Draft should reach us by January 13, 2018.
Comments are most helpful if they indicate the specific paragraph(s) to which
they relate, contain a clear rationale and, where applicable, provide a suggestion
for alternative wording. The comments should be sent to:
Secretary, Auditing and Assurance Standards Board
The Institute of Chartered Accountants of India
ICAI Bhawan, A-29, Sector-62,
NOIDA, Uttar Pradesh 201 309
Comments can also be e-mailed at: aasb@icai.in
Contents
Part I Knowledge of the Banking Industry ................................... ......................................... 1-2
Part II Risk Assessment and Internal Control ............................. ....................................... 3-76
Chapter 1: Initial Considerations........................... ........................................... .............................................. 4-15
Chapter 2: Risk Assessment and Internal Control ................................................ ............................................ 16-49
Chapter 3: Special Considerations in a CIS Environment ..................................... ............................................ 50-76
Part III Audit of Advances and NPAs ............................................ ................................... 77-220
Chapter 1: Advances - Agriculture ...................................................................... ............................................ 78-94
Chapter 2: Advances Other than Agriculture .................................................... .......................................... 95-157
Chapter 3: Scrutiny of Advance Accounts presented in Ind AS by Borrowers ....... .........................................158-164
Chapter 4: Asset Classification, Income Recognition and Provisioning ................ .........................................165-220
Part IV Items of Bank's Financial Statements and Auditing Aspects .......................... 221-356
Chapter 1: Cash, Balances with RBI and Other Banks, and Money at Call and Short Notice ..........................222-228
Chapter 2: Fixed Assets and Other Assets ......................................................... .........................................229-237
Chapter 3: Borrowings and Deposits .................................................................. .........................................238-248
Chapter 4: Capital, Reserves and Surplus ......................................................... .........................................249-255
Chapter 5: Other Liabilities and Provisions ......................................................... .........................................256-258
Chapter 6: Contingent Liabilities and Bills for Collection ...................................... .........................................259-265
Chapter 7: Treasury Operations Foreign Exchange and Derivative Transactions ........................................266-315
Chapter 8: Profit and Loss Account ..................................................................... .........................................316-330
Chapter 9: Disclosure Requirements in Financial Statements ............................... .........................................331-345
Chapter 10: Consolidation of Branch Accounts .................................................... .........................................346-349
Chapter 11: Consolidation of Financial Statements .............................................. .........................................350-352
Chapter 12: Inter-Office Transactions .................................................................. .........................................353-356
Part V Long Form Audit Reports .................................................. ................................. 357-407
Chapter 1: Long Form Audit Report in case of Bank Branches ............................ .........................................358-388
Chapter 2: Long Form Audit Report in case of Banks... ......................... ............ ........................... ............389-407
Part VI Special Aspects ................................................................. ................................. 408-453
Chapter 1: Basel III ............................................................................................ .........................................409-423
Chapter 2: Special Purpose Reports and Certificates .......................................... .........................................424-426
Chapter 3: Compliance with Implementation of Ghosh & Jilani Committee Recommendations ......................427-431
Chapter 4: Other Aspects......................................................... ............... ... .........................................432-443
Chapter 5: Other Aspects Service tax /Goods and Services Tax....................... .........................................444-453
Contents of Accompanying CD ....................................................... ................................. 454-612
I. Part I Knowledge of the Banking Industry .............................................................. 456-529
1. Banking in India ...................................................................................................................................457-477
2. Accounting and Auditing Framework .....................................................................................................478-491
3. Accounting Systems .............................................................................................................................492-519
4. Legal Framework ..................................................................................................................................520-529
II. Appendices .................................................................................................................. 530-575
I. Section 6 of the Banking Regulation Act 1949
II. The Third Schedule to the Banking Regulation Act, 1949
III. Illustrative Format of Report of the Auditor of a Nationalised Bank
IV. Illustrative Format of Report of the Auditor on the Standalone Financial Statements of a Banking Company
V. Illustrative Format of Report of the Branch Auditor of a Nationalised Bank
VI. Illustrative Format of Report of the Branch Auditor of a Banking Company
VII. Illustrative Format of Engagement Letter in case of a Nationalised Bank
VIII. Illustrative Format of Engagement Letter to be sent to the Appointing Authority of the Nationalised Bank by
Branch Auditor
IX. Illustrative Format of Engagement Letter to be sent to the Appointing Authority of the Banking Company
X. Illustrative Format of Engagement Letter to be sent to the Appointing Authority of the Banking Company
(Separate only for Internal Financial Control u/s 143(3)(i) of Companies Act, 2013)
XI. Illustrative Format of Written Representation Letter to be obtained from Branch Management
III. Illustrative Audit Documentation in case of Bank Branch Audit ............................. 576-579
IV. Illustrative Bank Branch Audit Programme for the year ended March 31, 2018 ..... 580-589
V. Illustrative Checklist for the Verification of the aspects of the Treasury/
Investments of the Bank in Statutory Audit .............................................................. 590-591
VI. List of Relevant Master Directions issued by RBI..................................................... 592-593
VII. List of Relevant Master Circulars issued by RBI....................................................... 594-595
VIII. List of Relevant General Circulars ............................................................................. 596-612
I
Knowledge of the Banking Industry
1.01 The banking industry is the backbone of any economy as it is essential for sustainable socio-economic
growth and financial statements in the economy. There are different types of banking institutions prevailing in India
which are as follows:
(a) Commercial Banks.
(b) Regional Rural Banks.
(c) Co-operative Banks.
(d) Development Banks (more commonly known as `Term-Lending Institutions').
(e) Payment Banks.
(f) Small Finance Banks.
1.02 All these banks have their unique features and perform various functions / activities subject to complying
with the RBI guidelines issued from time to time. Section 6 of the Banking Regulation Act, 1949, lists down the forms
of business in which banking companies may engage. The text of the Section 6 has been reproduced in Appendix I
of the Guidance Note (given in CD accompanying the Guidance Note).
1.03 Of these banks, commercial banks are the most wide spread banking institutions in India. Commercial
banks provide a number of products and services to general public and other segments of economy. Two of the main
functions of commercial banks are (1) accepting deposits and (2) granting advances. In addition to their main banking
activities, commercial banks also undertake certain eligible Para Banking activities which are governed by the RBI
guidelines on Para Banking activities.
1.04 The functioning of banking industry in India is regulated by the Reserve Bank of India (RBI) which acts as
the Central Bank of our country. RBI is responsible for development and supervision of the constituents of the Indian
financial system (which comprises banks and non-banking financial institutions) as well as for determining, in
conjunction with the Central Government, the monetary and credit policies keeping in with the need of the hour.
Important functions of RBI are issuance of currency; regulation of currency issue; acting as banker to the central and
state governments; and acting as banker to commercial and other types of banks including term-lending institutions.
Besides, RBI has also been entrusted with the responsibility of regulating the activities of commercial and other
banks. No bank can commence the business of banking or open new branches without obtaining licence from RBI.
The RBI also has the power to inspect any bank.
1.05 The provisions regarding the financial statements of banks are governed by the Banking Regulation Act,
1949. The Third schedule to the aforesaid Act, prescribes the forms of balance sheet and profit and loss account in
case of banks. Readers may refer Appendix II of the Guidance Note (given in CD accompanying the Guidance Note)
for text of third schedule to the Banking Regulation Act, 1949. Further, in case of banking companies, the
requirements of the Companies Act, 2013, relating to the balance sheet, profit and loss account and cash flow
statement of a company, in so far as they are not inconsistent with the Banking Regulation Act, 1949, also apply to
the financial statements, as the case may be, of a banking company. It may be noted that this provision does not
apply to nationalised banks, State Bank of India, its subsidiaries and regional rural banks.
1.06 The provisions regarding audit of Nationalised Banks are governed by the Banking Regulation Act, 1949
and the RBI Guidelines. The provisions regarding audit of Banking Companies are governed by the Banking
Regulation Act, 1949, RBI Guidelines and the provisions of the Companies Act, 2013. The illustrative formats of
auditor's report are given in Appendices III to VI of the Guidance Note (given in CD accompanying the Guidance
Note) as follows:
Appendix III - Illustrative Format of Report of the Auditor of a Nationalised Bank
Appendix IV - Illustrative Format of Report of the Auditor on the Standalone Financial Statements of a Banking
Company
Appendix V - Illustrative Format of Report of the Branch Auditor of a Nationalised Bank
Appendix VI - Illustrative Format of Report of the Branch Auditor of a Banking Company
1.07 The auditors (both central statutory auditors and branch auditors) should also ensure that their audit report
complies with the requirements of SA 700, "Forming an Opinion and Reporting on Financial Statements", SA 705,
"Modifications to the Opinion in the Independent Auditor's Report" and SA 706, "Emphasis of Matter Paragraphs and
Other Matter Paragraphs in the Independent Auditor's Report".
1.08 Besides the main audit report, the terms of appointment of auditors of public sector banks, private sector
banks and foreign banks (as well as their branches), require the auditors to also furnish a long form audit report
(LFAR). The matters to be dealt with by auditors in LFAR have been specified by the RBI.
1.09 For the reference and benefit of the members, Appendices VII to XI of the Guidance Note provide the
illustrative formats of Engagement Letter in case of a Nationalised Bank, Engagement Letter to be sent to the
Appointing Authority of the Nationalised Bank by Branch Auditor, Engagement Letter to be sent to the Appointing
Authority of the Banking Company, Engagement Letter to be sent to the Appointing Authority of the Banking
Company (Separate only for Internal Financial Control u/s 143(3)(i) of Companies Act, 2013) and Written
Representation Letter to be obtained from Branch Management.
Important Note
Readers may refer the CD accompanying the Guidance Note wherein the details of the following Chapters of "Part I -
Knowledge of the Banking Industry" have been given:
Chapter 1: Banking in India
Chapter 2: Accounting and Auditing Framework
Chapter 3: Accounting Systems
Chapter 4: Legal Framework
2
Part II
Risk Assessment and Internal Control
II-1
Initial Considerations
1.01 This Chapter discusses the matters to be considered by a proposed central auditor/branch auditor upon
receiving intimation of appointment. It also deals with aspects of planning and preliminary work to be undertaken by
the central/branch auditor before actually commencing the audit work.
Statutory Central Auditors
1.02 Most banks, especially those in public sector, appoint four or more (depending upon their size and Board
decision, as per RBI guidelines) firms of chartered accountants to act jointly as statutory central auditors (SCAs).
1.03 The appointment letter sent by banks in connection with the appointment of SCAs typically contains the
following:
Period of appointment.
Particulars of other central auditors.
Particulars of previous auditors.
Procedural requirements to be complied with in accepting the assignment, e.g., letter of acceptance (the letter
usually contains, inter alia, averment as to absence of disqualification for appointment, way in which the audit
has to be conducted and confirmation of present name, constitution and address of the auditor), declaration of
fidelity and secrecy, restriction on accepting other assignments from the bank, etc.
A statement of division of work and review and reporting responsibilities amongst joint auditors (Generally this is
decided at a later stage)
Scope of assignment which includes any special reports or certificates to be given by the SCAs in addition to the
main report. Presently, the SCAs have to furnish the following reports/certificates in addition to their main report:
a) Report on adequacy and operating effectiveness of Internal Controls over Financial Reporting in case of
banks which are registered as companies under the Companies Act in terms of Section 143(3)(i) of the
Companies Act, 2013 which is normally to be given as an Annexure to the main audit report as per the
Guidance Note on Audit of Internal Financial Controls over Financial Reporting issued by the ICAI.
b) Long form audit report.
c) Report on compliance with SLR requirements.
d) Report on whether the treasury operations of the bank have been conducted in accordance with the
instructions issued by the RBI from time to time.
e) Certificate on reconciliation of securities by the bank (both on its own investment account as well as PMS
Banks' account).
f) Certificate on compliance by the bank in key areas of prudential and other guidelines relating to such
transactions issued by the RBI.
g) Report on whether the income recognition, asset classification and provisioning have been made as per the
guidelines issued by the RBI from time to time.
h) Report on whether any serious irregularity was noticed in the working of the bank which requires immediate
attention.
i) Certificate in respect of custody of unused Bank Receipt forms and their utilisation.
Initial Considerations
j) Authentication of capital adequacy ratio, including disclosure requirements and other ratios reported in the
notes on accounts.
k) Certificate in respect of DICGC claims.
l) Report on status of the compliance by the bank with regard to the implementation of recommendations of
the Ghosh Committee relating to frauds and malpractices and of the recommendations of Jilani Committee
on internal control and inspection/credit system.
m) Report on instances of adverse credit-deposit ratio in the rural areas.
n) Asset liability management.
o) Certificate on Corporate Governance in case of banks listed on Stock Exchange.
p) Certification on claim of various interest subsidies and interest subvention.
Basis of computation of audit fee and scale of travel and related allowances and conveyance charges and other
expense reimbursement entitlements, if any.
Declaration of Indebtedness
1.04 The RBI has advised that the banks, before appointing their statutory central/circle/ branch auditors, should
obtain a declaration of indebtedness in proforma 'A' given in Annexure to the Notification No. RBI/2004/161 Ref
DBS.ARS No B.C. 09 /08.91.001/2003-04 dated April 20, 2004. In addition to this, the RBI has further advised the
banks that no credit facility (including guaranteeing any facilities availed of by third party) should be availed of by the
proprietor/any of the partners of the audit firm/members of his/their families or by firm/ company in which he/they are
partners/directors.
Other Considerations relating to Institute of Chartered Accountants of India(ICAI)/ Reserve Bank of
India (RBI).
In terms of the existing guidelines, an audit firm which takes up statutory central audit assignment in private
and foreign banks will not qualify to take up statutory audit in public sector banks during that particular year.
These revised guidelines will come into effect from the year 2012-13. In case a firm not appointed as SCA of
any PSB, such a firm can be appointed as SCA of four private sector banks and four foreign banks
simultaneously each year. As per RBI guidelines to private sector banks it has been decided that, an audit
firm, after completing its four year tenure in a particular private/foreign bank, will not be eligible for
appointment as SCA of the same bank for a period of six years.
With respect to PSBs and other Private banks which are listed on stock exchanges, there could a possibility
that the partner and/or his relatives are shareholders of such PSBs and other Private banks. Care should be
taken to dispose off the shares or take corrective action, as per the code of conduct of the ICAI, SEBI
regulations, Companies Act and the firm's internal policies, in such a scenario prior to acceptance of the
Statutory Audit.
Internal Assignments in Banks by Statutory Auditors
1.05 The RBI, vide its circular no. Ref.DBS.ARS.No. BC. 02/ 08.91.001/ 2008-09 dated December 31, 2008 on
"Internal assignments in banks by statutory auditors", decided that the audit firms should not undertake statutory
audit assignment while they are associated with internal assignments in the bank during the same year. In case the
firms are associated with internal assignment it should be ensured that they relinquish the internal assignment before
accepting the statutory audit assignment during the year.
1.06 As the central auditors for private banks are appointed every year by their shareholders in the Annual
General Meetings (AGM), each bank is required to obtain prior approval of the RBI in terms of the provisions of
Section 30(1A) of the Banking Regulation Act, 1949 before making appointment/re-appointment of the auditors.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Communication with Previous Auditor
1.07 As per Clause 8 of the Part I of the first schedule to the Chartered Accountants Act, 1949, a chartered
accountant in practice cannot accept position as auditor previously held by another chartered accountant without first
communicating with him in writing.
1.08 The objective of communicating with the previous auditor is that the proposed auditor may have an
opportunity to know the reasons for the change in order to be able to safeguard his interest, the legitimate interest of
the public, and the independence of the existing chartered accountant. When communicating with the previous
auditor, the incoming auditor should primarily find out whether there is any professional or other reason why he
should not accept the appointment.
1.09 A mere posting of letter under certificate of posting is not sufficient to establish communication with the
previous auditor unless there is some evidence to show that the letter has in fact reached the previous auditor. The
incoming auditor should, therefore, communicate with the previous auditor in such a manner as to retain in his hands
positive evidence of the delivery of the communication to the addressee. In the opinion of the Council of the Institute,
communication by a letter sent `Registered Acknowledgement Due' or by hand against a written acknowledgement
would in the normal course provide such evidence. Further it is seen, nowadays, that auditors communicate with
each other electronically by email and often soft copies are used, however it is always advisable to subsequently
procure the hard copies of the letters and proof of delivery and file the same in the audit files.
1.10 It is desirable that a member, on receiving communication from the auditor who has been appointed in his
place, should send a reply to him as soon as possible.
1.11 The RBI has advised the banks that in order to enable the proposed auditors to comply with the requirement
of communication with the previous auditor, they should mention the name and address of the previous auditor in the
appointment letter.
1.12 In case of joint auditors, each of the incoming auditors needs to communicate with each of the outgoing
auditors.
Some Important Standards on Auditing (SA) for the Initial Considerations
Terms of Audit Engagements
1.13 Standard on Auditing (SA) 210, "Agreeing the Terms of Audit Engagements" requires that for each period to
be audited, the auditor should agree on the terms of the audit engagement with the bank before beginning significant
portions of fieldwork. It is imperative that the terms of the engagement are documented, in order to prevent any
confusion as to the terms that have been agreed in relation to the audit and the respective responsibilities of the
management and the auditor, at the beginning of an audit relationship.
1.14 When establishing the terms of engagement, the auditor must agree on its understanding with the
management as to the objectives and scope of the audit engagement, the extent of management's responsibilities
and its own responsibilities. This minimises the risk of misunderstandings in future and there is no expectation gap
from both the parties.
1.15 The form and content of audit engagement letter may vary for one bank to another, but it would generally
include reference to following:
The objective of the audit of financial statements.
Management's responsibility for the financial statements.
Management's responsibility for selection and consistent application of appropriate accounting policies, including
implementation of the applicable accounting standards along with proper explanation relating to material
departures from those accounting standards.
Management's responsibility for assessment of the entity's ability to continue as a going concern.
6
Initial Considerations
Management's responsibility for making judgements and estimates that are reasonable and prudent so as to
give a true and fair view of the state of affairs of the bank at the end of the financial year and of the profit or loss
of the bank for that period.
Management's responsibility for the maintenance of adequate accounting records and internal controls for
safeguarding the assets of the company and for preventing and detecting fraud or other irregularities.
The scope of the audit, including reference to the applicable legislation, regulations, and the pronouncements of
the RBI and the ICAI.
The fact that having regard to the test nature of an audit, persuasive rather than conclusive nature of audit
evidence together with inherent limitations of any accounting and internal control system, there is an unavoidable
risk that even some material misstatements, resulting from fraud, and to a lesser extent error, if either exists,
may remain undetected.
Unrestricted access to whatever records, documentation and other information requested in connection with the
audit.
The fact that the audit process may be subjected to a peer review and/or quality review under the Chartered
Accountants Act, 1949.
1.16 The auditor may also include the following matters in the engagement letter:
Arrangements regarding the planning and performing the audit, including the fact that the audit will be carried out
in accordance with the auditing standards generally accepted in India. Further, it should be spelt out that the
audit would be performed to obtain reasonable assurance about whether the financial statements are free of
material misstatements. It should clearly be spelt out that the audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements including assessment of the accounting
principles used and significant estimates made by management, as well as evaluating the overall financial
statement presentation However, having regard to the nature of the audit and volume and complexity of
transactions, persuasive rather than conclusive nature of audit evidence, together with inherent limitations of any
accounting and internal control system, there is an unavoidable risk that even some material misstatements of
financial statements, resulting from fraud, and to a lesser extent error, if either exists, may remain undetected.
Expectation of receiving from management written confirmation concerning representations made in connection
with the audit.
Request for the bank to confirm the terms of the engagement by acknowledging receipt of the engagement
letter.
Description of any other letters or reports the auditor expects to issue to the bank.
Basis on which fees are computed and any billing arrangements.
A reference to any further agreements between the auditor and the client.
The auditor should require the bank management to identify and inform him about any adverse observations in
the implementation of the demonetisation scheme, the effect whereof may need to be considered by including a
paragraph in the engagement letter.1
1.17 The following are certain specific aspects which need to be kept in mind while issuing an engagement letter
in case of banks:
The use and source of specialised accounting principles, with particular reference to any requirements under the
law or regulations applicable to banks, e.g., the Banking Regulation Act, 1949, various RBI master circulars on
matters, such as, provision for NPAs, classification and valuation of investments, etc.
1
Refer Appendix VII of the Guidance Note for illustrative format of the engagement letter.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
The contents and form of the financial statements (including disclosures) and auditors' report as laid down in the
Banking Regulation Act, 1949 and various RBI circulars as well as the various special purpose reports required
from the auditor in addition to the report on the financial statements.
The nature of any special communication requirements or protocols that may exist between the auditor and the
regulators, e.g., communication directly by the auditor to the RBI in case of serious irregularities or material
frauds observed during the course of the audit.
1.18 An illustrative format of engagement letter in case of a Nationalised Bank is given in AppendixVII of this
Guidance Note. An illustrative format of engagement letter to be sent to the appointing authority of the Nationalised
Bank by Branch Auditor is given in Appendix VIII of the Guidance Note.
1.19 An illustrative format of engagement letter to be sent to the appointing authority of the Banking Company
(Where auditor's responsibility regarding reporting on Internal Financial Controls is contained within the same
Engagement Letter) is given in Appendix IX of this Guidance Note. An illustrative format of Engagement Letter to
be sent to the appointing authority of the Banking Company (Containing auditor's responsibility regarding reporting
on Internal Financial Controls only) is given in Appendix X of the Guidance Note.
Initial Engagements
1.20 Standard on Auditing (SA) 510, "Initial Audit Engagements-Opening Balances", deals with the auditor's
responsibility relating to opening balances when conducting initial audit engagement. Opening balances include
financial statement amounts as well as matters requiring disclosures. The sheer volume makes verification of
opening balances a challenge by itself where normal traditional techniques of verification are not in practice.
1.21 The auditor needs to perform the audit procedures as mentioned in SA 510 and if after performing those
procedures, the auditor concludes that the opening balances contain misstatements which materially affect the
financial statements for the current period and the effect of the same is not properly accounted for and adequately
disclosed, the auditor should express a qualified opinion or an adverse opinion, as appropriate.
Assessment of Engagement Risk
1.22 The assessment of engagement risk is a critical part of the audit process and should be done prior to the
acceptance of an audit engagement since it affects the decision of accepting the engagement and also in planning
decisions if the audit is accepted.
1.23 The process of assessing engagement risk consists of identifying risk factors and exercising professional
judgment to determine whether such factors, separately or in combination, are significant enough to require a special
response. Prior to accepting an engagement, the auditor should obtain a preliminary knowledge of the banking
industry and of the nature of ownership, management and operations of the bank to be audited.
1.24 For a prospective audit engagement, the auditor must assess engagement risk based on past experience in
the industry, the information obtained from predecessor auditors, inquiries of senior management, those charged with
governance, and other appropriate sources. For a continuing audit engagement, the auditor must assess
engagement risk based on his experience with the bank and additional audit procedures performed in the previous
audits.
1.25 For an audit engagement for which a higher engagement risk is assessed, the auditor should respond
appropriately in planning and performing the audit. The auditor then needs to determine whether the increased
engagement risk is pervasive to the audit engagement as a whole, as a result of one or more pervasive risks, or as a
result of one or more specific risks.
1.26 The auditor would ordinarily need to document the assessment of engagement risk, factors identified as
increasing engagement risk, and, if the additional information obtained during the engagement indicates a change in
engagement risk, the auditor would need to document its considerations as to whether the planning decisions remain
appropriate and the effect, if any, on the audit plan. A yearly assessment of engagement risk will ensure the firm's
8
Initial Considerations
continuing independence and ability to act and that the engagement risk is still within the firm's pre-determined
appetite for risk.
Planning
1.27 SA 300, "Planning an Audit of Financial Statements" requires that the auditor shall undertake the following
activities prior to starting an initial audit:
(a) Performing procedures required by SA 220, "Quality Control for an Audit of Financial Statements" regarding the
acceptance of the client relationship and the specific audit engagement; and
(b) Establish understanding of terms of engagement as per SA 210, "Agreeing the Terms of Audit Engagements"
1.28 Planning would involve establishing overall audit strategy to set the scope, nature, timing, extent of
resources required and direction of audit. The audit plan needs to be properly documented with respect to timing,
extent of checking, audit procedures to be followed at assertion level and should be flexible and updated or changed
as and when necessary. Further the audit plan should be communicated to the audit team. SA 220, "Quality Control
for an Audit of Financial Statements" establishes standards on the quality control, generally, and with regard to the
work delegated to assistants on an individual audit. Before starting initial audit engagement, perform procedures
required under SA 220 regarding client acceptance etc. Also ensure that a proper communication has been sent to
the predecessor auditor. The auditor should also keep in mind the requirements of SQC 1, "Quality Control for Firms
that Perform Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services
Engagements".
1.29 The below-mentioned procedures, as applicable to Head Office, may also be applicable in case of audit of a
Branch Office, modified to the extent relevant for the particular branch audit assignment.
Establish the Engagement Team
1.30 The selection of the engagement team is a key activity in the development and execution of an effective and
efficient audit plan. The assignment of qualified and experienced professionals is an important component of
managing engagement risk. The size and composition of the engagement team would depend on the size, time
available to complete the assignment, nature, and complexity of the bank's operations.
1.31 The audit engagement partner should be satisfied that the engagement team collectively has the
appropriate capabilities, competence, and time to perform the audit engagement. The audit engagement partner
should determine that the engagement team selected is appropriate for the audit engagement.
1.32 The audit engagement partner is also responsible for ensuring where additional technical assistance or
specialised knowledge is required as a result of the nature and characteristics of the audit engagement. This may
require the inclusion of one or more specialists, like, IT specialists, fair value specialists, etc. Other specialists with
appropriate competencies can also be used, including but not limited to those related to fraud, exploratory data
analysis, tax, industry, financial instruments and derivatives, legal, actuarial, post-employment benefits, etc.
Understanding the Bank and its Environment
1.33 It is the auditor's responsibility to identify and assess risk of material misstatement in financial statements
and assertion levels, through understanding, the entity, its environment and its internal control system. This would
help him in designing and implementing various audit procedures as response to such assessed risk areas and
reduce the risk to acceptable low levels.
1.34 Standard on Auditing (SA) 315, "Identifying and Assessing the Risks of Material Misstatement Through
Understanding the Entity and Its Environment" lays down that the auditor should obtain an understanding of the entity
and its environment, including its internal control, sufficient to identify and assess the risks of material misstatement
in the financial statements whether due to fraud or error, and sufficient to design and perform audit procedures.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
1.35 In performing audit of a bank, the auditor should have or obtain knowledge of the business sufficient to
enable him to identify and understand the events, transactions and practices that, in the auditor's judgment, may
have a significant effect on the financial statements or on the examination or comments in the audit report. Such
knowledge is used by the auditor in assessing inherent and control risks and in determining the nature, timing and
extent of audit procedures. Understanding the bank and its environment is a continuous and cumulative process of
gathering and assessing the information and relating the resulting knowledge to audit evidence and information at all
stages of the audit.
1.36 The auditor can obtain knowledge of the bank from a number of sources namely:
Discussion with management of the bank.
Discussion with internal/concurrent/other audit personnel regarding the nature, timing and extent of work done
by them and review of their audit reports, especially how issues raised are closed.
Discussion with peers (other auditors) and with legal and other advisors who have provided services to the bank
or within the industry.
Discussion with knowledgeable people outside the bank (for example, industry economists, industry regulators,
customers and suppliers).
RBI guidelines and other regulatory pronouncements.
Documents produced by the bank (for example, minutes of meetings, annual reports, etc.).
RBI inspection reports.
General reading and keeping abreast with the latest developments in the Industry and general economic
scenario.
In case of audit of foreign branches, knowledge of the local laws and trade practices of the geographical location
of bank would also be used.
1.37 Understanding the business and using this information appropriately assists the auditor in assessing risks
and identifying problems, planning and performing the audit effectively and efficiently, evaluating audit evidence, and
providing better services to the bank.
Review of Closing Instructions and Communication with Branch Auditors
1.38 It is a common practice that all public sector banks issue closing instructions to branches, based on which
branches prepare their balance sheet, profit and loss account and other returns necessary for preparation of the
financial statements of the bank as a whole. These instructions issued by the HO are called `accounts closing
instructions' and include the format of the financial statements and other relevant returns, significant accounting
policies to be followed, other instructions necessary for the conduct and completion of the audit, timelines of audit
completions and consolidations etc. Many a times, besides general instructions this may also include specific
directions on review and verification of certain information required by the SCA for their audit. Considering the
significance of these instructions, it is advisable that before these instructions are sent to branches, the SCA review
them to assess whether the instructions are sufficiently comprehensive, clear and adequate to facilitate the
compilation of branch financial statements and other relevant data accurately and expeditiously. The SCA should
particularly examine whether the instructions are in consonance with the accounting policies of the bank and are in
such compliant that stand the test of SA 600 Using the Work of Another Auditor, so that the SCA has the comfort
and confidence in the procedures adopted by the branch auditors by relying on the information and assurance
provided by them.
1.39 Further, in many cases, immediately after the appointment of branch auditors but before the
commencement of audit, the bank's management organizes a face to face meeting between the SCA and the branch
10
Initial Considerations
auditors, wherein the SCA issues specific instructions for the conduct of audit detailing the areas of concern that
require extra care and special notice by branch auditors.
Co-ordination with Bank Management
1.40 A proper and smooth co-ordination between the auditor and the bank management is essential for an
effective audit and timely completion of the assignment. In the past, many a times, the audit work has got delayed
due to non-availability of books, information, records, etc. To minimise the possibility of such an occurrence, it is
advisable that after accepting the appointment, the SCA should send a formal communication to the bank
management specifying the books, records, analyses and other information that the auditor would require in the
course of his audit. Such a communication would enable the bank management to keep the requisite documents,
information, etc., ready well in advance. Further it is also advisable to complete verification of certain non-financial
areas (like documentation, verification of sanction and post sanction terms, review, monitoring and supervision etc.)
before the year end so that the pressure of completion of audit post year end is minimal.
1.41 With the introduction of CBS, the auditor can also request for the data dump in a soft copy (depending upon
the confidentiality compliances) well in advance and can complete his analysis, testing, verification and sampling
sitting in the comfort of his own office without personal visits to the concerned department of the bank.
1.42 The bank's management can also be requested to have a training session for the engagement team on the
use of the CBS and the various reports that con be generated from it. This would help the engagement team to be
well prepared before starting the actual audit on the field.
Relationship among Joint Auditors
1.43 Public sector banks in India as well as some private sector banks appoint more than one firm as statutory
auditors. There is also a rotation policy in place. The joint auditors should mutually decide and divide the audit work
amongst themselves so as to ensure equitable distribution of work. This is usually done so in consultation with the
management. The division of work as well as the areas of work to be covered by all of them should be approved by
all, adequately documented and communicated to the management and in case of public sector banks,
communicated to RBI also. With all banks on CBS platform and with the level of automation, the division of work is
usually done based on various departments at the HO, like Treasury, central accounts, etc. or geographical areas.
However certain areas of work, owing to their nature or importance would often not be divided and would be covered
by all the joint auditors.
1.44 As per Standard on Auditing (SA) 299, "Responsibility of Joint Auditors", in respect of audit work divided,
each joint auditor is responsible only for the work allocated to him, whether or not he has prepared a separate report
on the work performed by him. On the other hand, all the joint auditors are jointly and severally responsible -
in respect of the audit work which is not divided among the joint auditors and is carried out by all of them;
in respect of decisions taken by all the joint auditors concerning the nature, timing or extent of the audit
procedures to be performed by any of the joint auditors. It may, however, be clarified that all the joint auditors are
responsible only in respect of the appropriateness of the decisions concerning the nature, timing or extent of the
audit procedures agreed upon among them; proper execution of these audit procedures is the separate and
specific responsibility of the joint auditor concerned;
in respect of matters which are brought to the notice of the joint auditors by any one of them and on which there
is an agreement among the joint auditors;
for examining that the financial statements of the entity comply with the disclosure requirements of the relevant
statute; and
for ensuring that the audit report complies with the requirements of the relevant statute.
1.45 It is the responsibility of each joint auditor to determine the nature, timing and extent of audit procedures to
be applied in relation to the area of work allocated to him. The issues such as appropriateness of using test checks or
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
sampling should be decided by each joint auditor in relation to his own area of work. This responsibility is not shared
by the other joint auditors. Thus, it is the separate and specific responsibility of each joint auditor to study and
evaluate the prevailing system of internal control relating to the work allocated to him. Similarly, the nature, timing
and extent of the enquiries to be made in the course of audit as well as the other audit procedures to be applied are
solely the responsibility of each joint auditor.
1.46 In the case of audit of large banks with several branches, including those required to be audited by branch
auditors, the branch audit reports/returns may be required to be scrutinised by different joint auditors in accordance
with the allocation of work. In such cases, it is the specific and separate responsibility of each joint auditor to review
the audit reports/returns of the branches allocated to him and to ensure that they are properly incorporated into the
accounts of the entity. In case of a Bank having foreign branches, the SCA should review the completeness and
accuracy of information obtained by the Bank from its foreign branches and the auditors of such branches.
1.47 There may be a situation, where foreign branches are located in jurisdictions, where the local law, does not
mandatorily require such branch to be audited. Bank managements may in such case, voluntarily get the branch
audited. The auditor should accordingly consider the status of the branch i.e., audited or unaudited while reporting on
the financial statements of the bank.
1.48 Generally, the joint auditors may arrive at an agreed report. However, where the joint auditors are in
disagreement with regard to any matters to be covered by the report, each one of them should express his own
opinion through a separate report. A joint auditor is not bound by the views of the majority of the joint auditors
regarding matters to be covered in the report and should express his opinion in a separate report in case of a
disagreement.
Statutory Branch Auditors
1.49 This section discusses the matters to be considered by a proposed statutory branch auditor (SBA) upon
receiving intimation of appointment and before commencing the actual audit engagement. It deals with aspects of
preliminary work to be undertaken by the branch auditor before actually commencing the audit work. The letter of
appointment sent by banks to branch auditors typically contains the following:
Appointment under the Banking Regulation Act, 1949, and the underlying duties and responsibilities of the SBA.
Particulars of branch(s) to be audited and of the region/zone to which the branch reports.
Particulars of statutory central auditors.
Particulars of previous auditors.
Guidelines for conducting audit of Branches, completion of audit, eligible audit fees and reimbursement of
expenses etc.
Procedural requirements to be complied with in accepting the assignment, e.g., letter of acceptance, declaration
of indebtedness, declaration of fidelity and secrecy, other undertaking by the firm/SBA, specimen signatures, etc.
Scope of work - Besides the statutory audit under the provisions of the Banking Regulation Act, 1949, SBA is
also required to verify certain other areas and issue various report and certificates like LFAR, Tax Audit Report,
certificates for cash verification on odd dates, Ghosh & Jilani reports etc.
Co-ordination with Branch Management
1.50 Now a days typically, SBA, are given limited time within which they have to undertake the audit of branches
allotted to them. Co-ordination between the auditor and the branch management is essential for an effective audit,
timely completion with the highest audit quality. NOC from the previous auditor should be obtained and kept on
record by SBA. It is advisable that immediately after accepting the appointment, the SBA should send a formal
communication to the branch management/HO accepting his appointment and other declarations and undertakings
so required. Further, the SBA should also specify the books, records, and other information that he would require in
12
Initial Considerations
the course of his audit. Such a communication would enable the branch management to keep the requisite
documents, information, etc., ready.
1.51 After the completion of the appointment formalities, the SBA should immediately visit the concerned
branches allotted, so as to get the feel of the business, nature and competences of the staff and understanding of the
flow of information and authority. Thereafter the SBA should draw up a detailed plan for the audit and it is advisable
to complete the entire non-financial verification (like documentation, sanctioning terms, review of the supervision and
monitoring terms, review of the concurrent/internal audit and inspection reports before the year-end. An illustrative
format of written representation letter to be obtained from the branch management is given in Appendix XI of this
Guidance Note.
Standard on Auditing (SA) 600, "Using the Work of Another Auditor"
1.52 The SBA's report on the financial statements examined by him is forwarded to the SCA with a copy to the
management of the bank. The SCA, in preparing his report on the financial statements of the bank as a whole, deals
with the branch audit reports in such manner as he considers necessary. In such a reporting arrangement, Standard
on Auditing (SA) 600, "Using the Work of Another Auditor" needs to be emphasized.
1.53 Nowadays with all banks operating on CBS platform and moving towards more centralization of functions at
HO adds to the dynamics of reporting. Considering the volume of transactions to be verified and the organizational
structure of bank, particularly in the case of public sector banks, SCA's reliance on work done by the SBA is of
utmost importance.
1.54 The SCA would be the Principal Auditor (PA), who is responsible for the reporting on the financial
information for the bank as a whole and the SBA would be the other auditor (OA) other than the PA, who is
responsible for reporting on financial information of the branch as a component. As per SA 600, the degree of
reliance, SCA would have on the SBA would depend upon many considerations, few of which are discussed as
follows:
(a) the materiality of the portion of the financial information which the SBA audits and its effect on the overall
financial position;
(b) the technical competence and knowledge of the SBA and the degree of confidence he provides to the SCA;
(c) the SCA's assessment of risk of material misstatements in the financial information of the components audited
by the other auditor; and
(d) the performance of additional procedures as set out in SA 600 regarding the components audited by other
auditor resulting in the principal auditor having significant participation in such audit.
1.55 The SCA should perform procedures to obtain sufficient appropriate audit evidence, that the work of the
SBA is adequate for the SCA's purposes in the context of the specific assignment. The SCA might discuss with the
SBA the audit procedures applied or review a written summary of the SBA's procedures and findings which may be in
the form of a completed questionnaire or check-list or an Audit Summary Memorandum. This is usually done via the
personal meeting between the SCA and all the SBA or via the bank's closing instruction (as discussed before). The
nature, timing and extent of procedures will depend on the circumstances of the engagement and the SCA's
knowledge of the professional competence of the SBA. The SCA may conclude that it is not necessary to apply
procedures such as those described in above paragraph because sufficient appropriate audit evidence has been
previously obtained that acceptable quality control policies and procedures are complied with in the conduct of SBA's
practice.
1.56 The SCA should consider the significant findings of the SBA. The SCA may consider it appropriate to
discuss with the SBA and the management of the component, the audit findings or other matters affecting the
financial information of the components. He may also decide that supplemental tests of the records or the financial
statements of the component are necessary. Such tests may, depending upon the circumstances, be performed by
the SCA or the SBA.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
1.57 In certain circumstances, the SBA may happen to be a person other than a professionally qualified auditor.
This may happen, for instance, where a component is situated in a foreign country and the applicable laws permit a
person other than a professionally qualified auditor to audit the financial statements of such component. In such
circumstances, the procedures outlined above assume added importance.
1.58 The SCA should document in his working papers the extent of reliance he has relied upon the work done by
other auditors with reasons therefor. The SCA should also document the procedures performed as prescribed by SA
600 and his conclusions reached. The SCA should document how he has dealt with a specified opinion (i.e. qualified,
adverse or disclaimer) of the SBA in framing his own report.
1.59 Further, it is also the responsibility of the SBA to inform or bring to the notice of the SCA any areas of
concern that have come to his knowledge in the context in which his work is to be used by the SCA. For example, by
bringing to the SCA's immediate attention any significant findings requiring to be dealt with at entity level, adhering to
the time-table for audit of the component, etc. He should ensure compliance with the relevant statutory requirements.
Similarly, the SCA should advise the SBA of any matters that come to his attention that he thinks may have an
important bearing on the SBA's work.
1.60 When the SCA has to base his opinion on the financial information of the entity as a whole relying upon the
statements and reports of the SBAs, his report should state clearly the division of responsibility for the financial
information of the entity by indicating the extent to which the financial information of components audited by the SBAs
have been included in the financial information of the entity, e.g., the number of divisions/branches/ subsidiaries or
other components audited by SBAs. The SCA would not be responsible in respect of the work entrusted to the SBAs,
except in circumstances which should have aroused his suspicion about the reliability of the work performed by the
SBAs.
Engagement and Quality Control Standards
1.61 The auditor/audit firm should establish a system of quality control designed to provide reasonable assurance
that the auditor/firm and its personnel comply with professional standards and regulatory and legal requirements, and
that reports issued by the firm or engagement partner(s) are appropriate in the circumstances and will survive the test
of any regulatory, legal or other action that may arise in future. This system of quality control should consist of
policies designed to achieve its objectives and the procedures necessary to implement and monitor compliance with
those policies. The nature of the policies and procedures developed by individual or firms to comply with SQC will
greatly depend on various factors such as the size, maturity, geographical location, type of work handled and other
operating characteristics.
1.62 The ICAI has issued various Engagement and Quality Control Standards applicable to an audit of financial
statements which are mandatorily to be followed by all practitioners. Understanding of the concepts in these
Engagement Standards would help the auditor in discharging his duties in a diligent way.
Special Audit Considerations in Foreign Banks
1.63 Audit of foreign banks operating in India, poses unique challenges compared to local banks in India. Foreign
banks have different operating models compared to local banks, and, to a limited extent, they also operate in a
different regulatory environment.
1.64 Foreign banks operate in India through branches and do not have a separate legal entity existence in India.
However, for all practical purposes, the RBI regulates their functioning in India, with regards to scale and nature of
business they undertake in India.
1.65 Auditors of foreign bank will have to modify their audit procedures so as to take care of the operational
structure and operations of these banks.
1.66 Some of the important elements related to foreign banks which may have a bearing on the audit plan and
procedure are listed below:-
Management structure.
14
Initial Considerations
More centralised operational functions.
High level of automation and IT functions - Core banking software are used globally.
Requirement for compliance with foreign legal and regulatory requirements.
Cross border flow and processing of data.
Complex treasury operations and cross border forex deals.
Highly structured and well documented operational processes.
Complex treasury transactions.
15
II-2
Risk Assessment and Internal Control
Characteristics of a bank
2.01 Banks have certain characteristics distinguishing them from most other commercial enterprises e.g.,
Custody of large volumes of monetary items, including cash and negotiable instruments, whose physical security
has to be ensured. This applies to storage and the transfer of monetary items making banks vulnerable to
misappropriation and fraud necessitating establishment of formal operating procedures, well-defined limits for
individual discretion and rigorous systems of internal control.
Engagement in a large volume and variety of transactions in terms of number and value which necessarily
requires complex accounting and internal control systems and widespread use of Information Technology (IT).
Operation through a wide network of geographically dispersed branches and departments necessitating a
greater decentralization of authority and dispersal of accounting and control functions, with consequent
challenges in maintaining uniform operating practices and accounting systems, particularly when the branch
network transcends national boundaries.
Assumption of significant commitments without actual outflow of funds. These items, called 'off-balance sheet'
items, may at times not involve accounting entries and the failure to record such items may be difficult to detect.
Engagement in transactions that are initiated at one location, recorded at a different location and managed at yet
another location.
Direct Initiation and completion of transactions by the customer without any intervention by the bank's
employees. For example, over the Internet or mobile or through automatic teller machines (ATMs).
Integration and linkages of national and international settlement systems could pose a systemic risk to the
countries in which they operate.
Regulatory requirements by governmental authorities often influence accounting and auditing practices in the
banking sector.
2.02 Special audit considerations arise in the audit of banks because of:
the particular nature of risks associated with the transactions undertaken;
the scale of banking operations and the resultant significant exposures which can arise within short period of
time;
the extensive dependence on IT to process transactions;
the effect of the statutory and regulatory requirements;
the continuing development of new products and services and banking practices which may require concurrent
development of accounting principles and auditing practices.Evolution of technology and providing services
through Net Banking and Mobiles has exposed banks to huge operational and financial risk.
The auditor should consider the effect of the above factors in designing his audit approach. It is imperative for SBAs
and SCAs to have detailed knowledge of the products offered by banks and risks associated with them, and
appropriately address them in their audit plan to the extent they give rise to the risk of material misstatements in the
financial statements.
In today's environment, the banks use different applications to carry out different transactions which may include data
flow from one application to other application; the auditor while designing his plans should also understand interface
controls between the various applications.
Risk Assessment and Internal Control
Identifying and Assessing the Risks of Material Misstatements
2.03 Standard on Auditing (SA) 315, "Identifying and Assessing the Risks of Material Misstatement Through
Understanding the Entity and Its Environment" requires the auditor to identify and assess the risks of material
misstatement at the financial statement level and the assertion level for classes of transactions, account balances,
and disclosures and paragraph 26 of SA 315 provides a basis for designing and performing further audit procedures.
SA 315 requires the auditor to put specific emphasis on the risks arising out of the fraud, changes in regulatory
environment, complex transactions, related party transactions, and abnormal business transactions.
Understanding the Bank and Its Environment including Internal Control
2.04 As per SA 315, the auditor's objective is to identify and assess the risks of material misstatement, whether
due to fraud or error, at the financial statement and assertion levels, through understanding the entity and its
environment, including the entity's internal control, thereby providing a basis for designing and implementing
responses to the assessed risks of material misstatement. This will help the auditor to reduce the risk of material
misstatement to an acceptably low level and enable them to issue audit report based on theaudit findings.
2.05 An understanding of the bank and its environment, including its internal control, enables the auditor:
to identify and assess risk;
to develop an audit plan so as to determine the operating effectiveness of the controls, and to address the
specific risks. Further, documentation of the auditor's understanding of the bank and its environment provides an
effective mechanism for accumulating and sharing knowledge and experience and briefing the same to all the
members of the engagement team, particularly in case of multi-location audit engagements.
to assist in issuing audit report on internal financial controls in terms of Section 143(1)(i) of the Companies Act,
2013, wherever applicable2.
2.06 The audit engagement partner should appropriately be involved so as to achieve its basic objective of
identifying and assessing the risks of material misstatement, whether due to fraud or error, at the financial statement
and assertion levels. The use of professional skepticism, and experience acquired during the course of other audits
play a vital role in this process.
2.07 In addition to the considerations mentioned in paragraph 11 of SA 315, when obtaining an understanding of
the bank and its environment, including its internal control, the auditor is required to:
Obtain an understanding of the bank's accounting process relevant to financial reporting.
Obtain an understanding of the bank's internal control relevant to the audit.
2.08 Management may prepare a variety of information so as to operate the business more effectively and
efficiently. The auditor may consider to use this information in identifying risks of material misstatements. Such
information may be internally generated (e.g., budgets and strategic plans, monthly financial and operating reports)
or externally generated (e.g., trade periodicals, analysts' reports on the banking industry or the bank).
2.09 While obtaining an understanding of the bank and its environment, including its internal control, the auditor
should consider whether the information obtained during the course of audit indicates risks of material misstatement
due to fraud. For this purpose, the following factors assume importance:
2
The ICAI has issued the Guidance Note on Audit of Internal Financial Controls over Financial Reporting in September 2015 in accordance
with Section 143(3)(i) of the Companies Act, 2013. This Section casts a new reporting requirement for statutory auditors of companies under
the Act, to state in their audit report whether the company has adequate internal financial controls system in place and to opine on the
operating effectiveness of such controls. Members should refer the Guidance Note for comprehensive details on the aforesaid reporting.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Understanding the bank's corporate governance structure, formation of various committees of board of directors
and determination of their specific functions, extent of audit coverage, etc. Provisions of clause 49 of the Listing
Agreement also need to be complied by the listed banks.
Obtaining and maintaining a record of the understanding of the products and services offered by the bank. The
auditor should be aware of the various deposit, loan and treasury products and services that are offered and
continue to be developed and modified by the bank in response to market conditions and guidelines issued by
the RBI from time to time. Similarly, the auditor should obtain an understanding of the nature of services
rendered through off balance sheet and other similar instruments; inherent risks arising as a result thereof; and
auditing, accounting and disclosure implications thereof.
Understanding the regulatory requirements of other regulatory authorities like SEBI, IRDA for other products like
depository participants, investment banking, insurance, mutual fund, etc. The same is important, as the bank
may face penal action in case of non-compliance with respective regulation.
The extent of use of service organisations needs to be evaluated, since it is the responsibility of the bank to
ensure compliance with the rules and regulations, as well as to ensure that the service organisations have
adequate internal controls. The auditor may ask for report under SA 402 "Audit Considerations Relating to An
Entity Using a Service Organisation."
2.10 The auditor may decide to visit the significant operating units of the bank, especially, in case of multi-
location bank. This would enhance the auditor's understanding, and would also assist in the assessment of
engagement risk, and identification of pervasive risks and specific risks. Such visits enable the auditor to interact with
the local management and acquire understanding of their significant policies, and other relevant factors affecting the
working of that particular operating unit.
2.11 In obtaining an understanding of the bank and its environment, the auditor, ordinarily, documents the
following:
pervasive risks and specific risks that have been identified;
needs, expectations, and concerns of senior management and those charged with governance; and other
relevant administrative matters.
Structure of overall internal control environment of a bank
2.12 The auditor should obtain an understanding of the control environment sufficient to assess management's
attitudes, awareness and actions regarding internal control and their importance in the entity. Such an understanding
would help to make a preliminary assessment of the adequacy of the accounting and internal control system as a
basis for the preparation of the financial statements, and of the likely nature, timing and extent of audit procedures.
2.13 The overall control environment of a bank generally includes a mix of the following:
I. Board of Directors or senior management and its Committees
2.14 The organisational structure of a bank assists it in managing its responsibility of oversight and control.
Banks usually have the following committees:
Executive Committee monitors the overall functioning of the bank and ensures compliance with laid down
policies and procedures. This committee usually consists of the Chief Executive Officer, Chief Operating Officer
and all business line heads.
Operations Committee reviews potential operational risks.
Asset Liability Committee - monitors the capital and liquidity profile, maturity mismatches, core gap analysis, etc.
of the bank.
Risk Committee entity-wide risk assessment and risk management by formulating appropriate strategies to
mitigate the identified risks.
18
Risk Assessment and Internal Control
2.15 Banks also have an Audit Committee, , Shareholder Grievance Committee, etc. Further, function specific
committees such as, the Investment Committee, Credit Committee, Information Technology Committee, CSR
Committee, etc. also exists, which report to the Board of Directors or the Executive Committee.
2.16 The Board of Directors or the Executive Committee of a bank is responsible for the strategic planning
process of the bank such as identifying goals and objectives, formulating the strategies to attain the objectives,
assessing performance of the bank against approved budgets. Thus, it sets the tone and operating style at the top
and weaves the entire control environment in the bank.
II. Internal Audit
2.17 The internal audit function constitutes a separate component of internal control with the objective of
determining whether other internal controls are well designed and properly operating. Banks generally have a well-
organised system of internal audit. The internal audit is usually carried out either by a separate department within the
bank or at times by independent firms of chartered accountants.
2.18 RBI has advised banks to adopt a framework for Risk-Based Internal Audit to ensure that the internal audit
is undertaken in the bank in a risk focused manner. This would also facilitate in adoption of the Risk-based
Supervision framework. Attention is invited to RBI circular DBS.CO.PP.BC.14 /11.01.005/ 2003-04, dated June 26,
2004 on "Risk Based Supervision Follow up of Risk Management Systems in Banks"
2.19 As per section 138 of Companies Act, 2013 and Rules thereunder, the following classes of companies shall
be required to appoint an internal auditor or a firm of internal auditors, who shall either be a chartered accountant or a
cost accountant, or such other professional as may be decided by the Board to conduct internal audit of the functions
and activities of the company:-
(a) every listed company;
(b) every unlisted public company having-
(i) paid up share capital of fifty crore rupees or more during the preceding financial year; or
(ii) turnover of two hundred crore rupees or more during the preceding financial year; or
(iii) outstanding loans or borrowings from banks or public financial institutions exceeding one hundred crore
rupees or more at any point of time during the preceding financial year; or
(iv) outstanding deposits of twenty five crore rupees or more at any point of time during the preceding financial
year; and
(c) every private company having-
(i) turnover of two hundred crore rupees or more during the preceding financial year; or
(ii) outstanding loans or borrowings from banks or public financial institutions exceeding one hundred crore
rupees or more at any point of time during the preceding financial year:
Provided that an existing company covered under any of the above criteria shall comply with the requirements of
section 138 and this rule within six months of commencement of such section.
Explanation- For the purposes of this rule
(i) the internal auditor may or may not be an employee of the company;
(ii) the term "Chartered Accountant shall mean "Chartered Accountant whether engaged in practice or not.
The audit committee of the company or the Board shall, in consultation with the internal auditor, formulate the scope,
functioning, periodicity and methodology for conducting the internal audit.
It should be noted that Internal Audit differs from Concurrent audit in certain ways. While Concurrent audit examines
transactions close to the occurrence to find errors so as rectify the same and understand the process gaps so that
the process gaps can be remediated so that the occurrence of errors will be eliminated. Though Concurrent audit has
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
also become risk based, the movement is from the transactional gap to the control. Internal audit is predominantly
risk and control based with focus on control assurance. For example, even if a design of a control is not in place,
internal audit will highlight the same even if there is no transactional error.
RBI has issued circulars on risk based internal audit of banks where the focus is clearly on prioritizing the audit work
based on the degree of the risk.
III. Revenue Audit
2.20 Revenue audit is usually conducted at branches and is aimed at identifying cases of leakage of revenue
due to wrong computation of interest, non-application of interest on time, application of incorrect rates of
interest/exchange/commission, non-application of penal interest, non-recovery or short-recovery of service charges
on guarantees and letters of credit, etc. This type of revenue audit is also known as `income and expenditure audit' or
`income leakage audit'.
IV. Branch Inspection
2.21 Such inspection is much broader in scope than revenue audit, and covers all important areas of functioning
of the branch, including efficacy of systems and procedures, compliance with head office directions, customer
service, maintenance of books and records, etc. Most banks have a fixed schedule of branch inspection. This is
typically in the nature of internal audit.
V. Head Office (HO) Inspection
2.22 The inspection at head office level is aimed at evaluating the functions being carried out at the head office
and covers, inter alia, investment and other treasury functions, functioning of the central stationery department, fixed
assets (if centralised), inter-branch reconciliation, etc.
HR is a key area of HO inspection with focus on employee engagement, training based on current and future job
roles and skill set gaps, employee selection and screening methods, employee attrition etc. Another key area is the
audit of the Risk Assessment process or the manner in which risks are identified and periodically reviewed by the
bank, controls are designed in response to mitigate the risks, ongoing review of efficacy of the controls to identify
residual risks and whether they are within the risk appetite of the Bank.
VI. Concurrent Audit
2.23 A system of concurrent audit at large and other selected branches has been in vogue in most of the banks
for quite long. Recognising the importance of concurrent audit in the banking sector, the RBI, vide its Circular No.
BC.182/16.13.100/93-94 dated October 11, 1993, addressed to all scheduled commercial banks (except regional
rural banks) formally advised such banks to institute an appropriate system of concurrent audit. The RBI also
specified the minimum extent of banking operations to be covered under concurrent audit within a defined time-
frame, and also suggested the areas to be covered by concurrent audit. Subsequently, vide its circular no. DOS No.
B.C. 16/08-91-021/96 dated August 14, 1996, the RBI has made certain refinements in the scope of concurrent audit.
On July 16, 2015, RBI issued circular no. DBS.CO.ARS. No. 2/08.91.021/2015-16 on Concurrent Audit System in
Commercial Banks - Revision of RBI's Guidelines, which includes guidelines on scope of concurrent audit, coverage
of business/branches, types of activities to be covered, appointment of auditors and accountability, facilities for
effective concurrent audit, remuneration and reporting system. A minimum coverage of concurrent audit is listed in
Annexure II forming part of the aforesaid Circular. This circular is available on the RBI's website rbi.org.in.
VII. Systems Audit
2.24 The bank carries out a systems audit periodically to assess the effectiveness of the hardware, software and
operations to identify any changes required therein based on the guidelines mentioned in the RBI, vide its circular no.
DBS.CO.OSMOS.BC/11/33.01.029/2003-04 dated April 30, 2004 on "Information System Audit - A review of Policies
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Risk Assessment and Internal Control
and Practices". Also refer to the guidelines relevant to Information System Audit in the circular no.
DBS.CO.ITC.BC.No.6/31.02.008/2010-11 dated April 29, 2011.
2.25 The SBA/SCA may interact with the Information Systems (IS) auditor to understand the scope and audit
plans of the systems audit. These audits should be preferably undertaken prior to the statutory audit so that the IS
audit reports are available to the SBAs/SCAs well in time, for examination and incorporating comments, if any, in the
audit reports.
2.26 The report of RBI's Working Group on Information Security, Electronic Banking, Technology Risk
Management and Cyber Frauds has recommended implementation of good level of controls in areas of IT
Governance, Information Security, IT Operations, IT Outsourcing, IS Audit, Cyber Fraud, Business Continuity
Planning, Customer Education and Legal Issues.
VIII. Vigilance Function in banks
2.27 All banks have a vigilance department, though it may be assigned different names in different banks. Its
functions include - to keep surveillance over the suspect staff/transactions, to look into cases of
frauds/misappropriation/ connivance, etc. leading to loss to the bank. In the case of large non-performing assets, the
department may be required to investigate and find out the reasons for the account becoming non-performing. The
nature of findings of the vigilance department is of relevance to the auditor, particularly in evaluating the efficacy of
internal controls.
IX. RBI Inspection
2.28 The RBI carries out inspection of Head Office functions and departments as well as branches under section
35 of the Banking Regulation Act, 1949, to examine compliance by the bank of various policies and norms about
credit and other functions laid down by the RBI from time to time. Besides, it also carries out inspection of currency
chest branches to review chest balances and other functions being performed by the branch as an agent of the RBI.
RBI inspections, however, are not in the nature of internal audit. RBI categories the issues noted in the course of the
inspection into various actionable on the part of the bank as major or minor.
Understand the Bank's Accounting Process
2.29 The accounting process produces financial and operational information for management's use and it also
contributes to the bank's internal control. Thus, understanding of the accounting process is necessary to identify and
assess the risks of material misstatement whether due to fraud or not, and to design and perform further audit
procedures. In obtaining an understanding of the accounting process, the auditor may seek to identify the significant
flow of the transactions and significant application systems that are relevant to the accounting process.
2.30 When obtaining an understanding of the accounting process, the auditors, ordinarily, focus only on such
processes that relate to the effectiveness and efficiency of operations and compliance with laws and regulations and
impact the financial statements or their audit procedures. While obtaining the understanding of the significant flow of
the transactions, the auditor should also obtain an understanding of the process of recording and processing of
journal entries, and should also make inquiries about inappropriate or unusual activity relating to the processing of
journal entries and other adjustments.
2.31 The auditors should also document their understanding of the accounting process, including the significant
flow of transactions, the relevant computer processing environments or any other relevant information. Such
documentation would ordinarily be either a narrative description, graphical representation (e.g., a flow chart), or a
combination of the two. The following factors should be kept in mind while obtaining the understanding of the
accounting process in case of banks:
The need to process high volumes of transactions accurately within a short time which is met through large scale
use of IT.
The need to use electronic funds transfer or other telecommunication systems to transfer large sums of money.
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The conduct of operations in many locations with a resultant geographic dispersion of transaction processing
and internal controls.
Structure of Internal Control Procedures in a Bank
2.32 The specific internal control procedures to be followed in an enterprise depend on the nature, volume and
complexities of its operations and the management's attitude towards control. As in the case of other enterprises, the
internal control procedures relevant to assertions made in the financial statements of bank generally fall under the
following categories:
I. Delegation of Powers
2.33 Banks have detailed policy on delegation of powers. The financial and administrative powers of each
committee/each official/each position are fixed and communicated to all persons concerned. This policy on
delegation of powers is approved either by Board of Directors or Executive Committee.
II. Authorisation of Transactions
2.34 Authorisation may be general (i.e., it may relate to all transactions that conform to prescribed conditions
referred to as routine transactions) or it may be specific with reference to a single transaction (non-routine
transactions and accounting estimates). It is necessary to establish procedures which provide assurance that
authorisations are issued by persons acting within the scope of their authority, and that the transactions conform fully
to the terms of the authorisations. The following procedures are usually established in banks for this purpose:
All financial decisions at any level are required to be reported to the next higher level for
confirmation/information. For example, in case of a money market transaction, if the dealer exceeds the pre-
defined limits such as a position limit or counterparty limit, then the transaction has to be vetted and confirmed
by the head dealer.
All transactions entered into the applications require authorization at different level based on authority to get
executed.
Any deviation from the laid down procedures requires confirmation from/intimation to higher authorities.
Branches have to send periodic confirmation to their controlling authority on compliance of the laid down
systems and procedures.
SBAs should specifically review the delegation of powers to note the authorization, approval, exception, waiver and
ratification powers of each bank official.
III. Segregation and Rotation of Duties
2.35 A fundamental feature of an effective internal control system is the segregation and rotation of duties in a
manner conducive to prevention and timely detection of occurrence of frauds and errors. Functions typically
segregated are authorisation of transactions; execution of transactions; physical custody of related assets;
maintenance of records and documents etc.
2.36 Banks usually adopt the following measures:
Work of one staff member is invariably supervised / checked by another staff member, irrespective of the nature
of work.
Banks have a system of rotation of job amongst staff members, which reduces the possibility of frauds and is
also useful in detection of frauds and errors. Most banks usually have a process of giving "block" leave to its staff
members wherein the employee stays away from work for at least a continuous period of 2 weeks.
RBI vide its circulars and notifications suggested banks to establish effective segregation in its functions, for
example, the master circular on prudential norms for classification, valuation and operation of investment portfolio by
banks, clearly advises banks to have functional separation of trading, settlement, monitoring and accounting
activities.
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Risk Assessment and Internal Control
IV. Maintenance of Adequate Records and Documents
2.37 Accounting controls should ensure that the transactions are recorded at correct amount and in the
accounting periods in which they are executed, and that they are classified in appropriate accounts. Moreover,
recording of transactions should be such as would facilitate maintaining the accountability for assets. The procedures
established in banks to achieve these objectives usually include the following:
All records are maintained in the prescribed books and registers only. This ensures that all requisite particulars
of a transaction are adequately recorded and also that the work of finalisation of accounts is facilitated. For
example, deal slips pertaining to purchase and sale of securities along with the respective counterparty
confirmations for the deals are filed together in the deal register.
All Bank branches have a unique code number which is circulated amongst all offices of the bank and is required
to be put on all important instruments.
All books are to be balanced periodically and it is to be confirmed by an official specifically assigned for the
same. For example, in case of purchase and sale of security transactions, the banks periodically reconcile the
security balance in the banks book vis-à-vis the balance in the custodian account (i.e., Subsidiary General
Ledger or Demat Account). It may be noted that the RBI vide its Master Circular DBR No. BP.
BC.6/21.04.141/2015-16 dated July 1, 2015, "Prudential Norms for Classification, Valuation and Operation of
Investment Portfolio by Banks" has also mandated that investment balances as per bank's book should be
reconciled at quarterly intervals with the balances in the Public Debt Office's books. If the number of transactions
warrant, such reconciliation should be undertaken more frequently, say on a monthly basis. This reconciliation
should be periodically checked by the Internal Auditors.
All inter-office transactions are to be reconciled at regular intervals.
V. Accountability for and Safeguarding of Assets
2.38 The accountability for assets starts at the time of their acquisition and continues till their disposal. The
accountability for assets is achieved by maintenance of records of assets and their periodic physical verification. To
safeguard the assets, it is also necessary that access to assets is limited to authorised personnel and covers direct
physical access and also indirect access through preparation or processing of documents that authorise the use or
disposal of assets. The following are some of the important controls implemented by banks in this regard:
Particulars of lost security forms which are immediately advised to branches to exercise caution.
Specimen signatures of all officers are captured and scanned in the system and available for view/access in all
branches which were earlier maintained in a book. The officials approving the payment of the instruments drawn
on their branches by other branches are required to confirm the signatures on the instruments with reference to
the specimen signatures. Likewise, the branches have on record the specimen signatures of the authorised
officials of approved correspondent banks also.
Instruments of fund remittances above a cut-off level are to be signed by more than one official.
Important financial messages, when transmitted electronically, are generally encrypted.
Negative lists like stop-payment cheques or stop payment instructions are kept, which may deal with the
particular kind of transaction. There may be a caution list for advances also.
Sensitive items like currency, valuables, draft forms, term deposit receipts, traveller's cheques and other such
security forms are in the custody of at least two officials of the branch. (However, in the case of very small
branches having only one official, single custody is also permitted.)
All assets of the bank/charged to the bank are physically verified at specified intervals.
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VI. System Configuration and Account Mapping
2.39 Information technology (IT) has played a major role in providing a competitive edge to banks in
differentiating themselves in the market place and to deliver their services more effectively at a lower cost.
VII. Independent Checks
2.40 Independent checks involve a periodic or regular review of functioning of the system by independent
persons to ascertain whether the control procedures are being performed properly. Banks have an elaborate system
of various forms of independent checks covering virtually every key aspect of their functioning.
Understanding the Risk Management Process
2.41 Management develops controls and uses performance indicators to aid in managing key business and
financial risks. An effective risk management system in a bank generally requires the following:
Oversight and involvement in the control process by Those Charged With Governance (TCWG): TCWG should
approve the documented risk management policies. The policies should be consistent with the bank's business
objectives and strategies, capital strength, management expertise, regulatory requirements and the types and
amounts of risk it regards as acceptable. TCWG are also responsible for laying down the risk appetite and
establishing a culture within the bank that emphasises commitment to internal controls and high ethical
standards. Management is responsible for implementing the strategies and policies set by those charged with
governance thereby ensuring that an adequate and effective system of internal control is established and
maintained.
Identification, measurement and monitoring of risks: Risks that could significantly impact the achievement of
bank's goals should be identified, measured and monitored against pre-approved limits and criteria in a
Documented Risk Register. This function is usually performed by the bank's Risk Committee or an independent
risk management unit, which is also responsible for validating and stress testing the pricing and valuation models
used by the front and back offices. Further, it also monitors risk management activities and evaluates the
effectiveness of risk management models, methodologies and assumptions used. The mid office, which is
responsible for identifying, measuring and reporting the risk associated with the transaction, within each function
usually reports to the Risk Committee or the independent risk management unit. Thus, in this manner the bank's
management monitors the overall risks faced by the bank.
Control activities: A bank should have appropriate controls to manage its risks, including effective segregation of
duties (particularly, between front and back offices), accurate measurement and reporting of positions,
verification and approval of transactions, reconciliation of positions and results, setting of limits, reporting and
approval of exceptions, physical security and contingency planning. The following are certain common questions
/steps, which have to be kept in mind whilst undertaking / performing control activities:
Nature of Questions Questions to be considered / answered
Who Who performs the control?
Does the above person have requisite knowledge and authority to perform
the control?
What What evidence is generated to demonstrate / prove that the control is
performed?
When When and with what frequency is the control performed?
Is the frequency enough to prevent, detect and correct Risk of Material
Misstatements?
Where Where is the evidence of performance of the control retained?
For how long is the evidence retained?
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Risk Assessment and Internal Control
Is the evidence accessible for / available for audit?
Why Why is the control being performed?
What type of errors are prevented or detected through the performance of
the control?
How How is the control performed?
What are the control activities?
Can these activities be bypassed?
Can the bypass, if any, be detected.
How are exceptions / deviations resolved on identification?
What is the time frame for resolving the exceptions / deviations?
2.42 RBI has directed banks vide its Master Direction No. RBI/FMRD/2016-17/31 FMRD Master Direction No.
1/2016-17 on `Risk Management and Inter-bank Dealings' dated July 5, 2016, the risk management framework and
reporting requirements with respect to certain categories of transactions such as, forward contracts and hedging
transactions entered into by the bank with residents, managing of assets and liabilities of the bank and hedging the
same, hedging of Tier I capital in case of foreign banks, etc.
2.43 For every bank in India, certain risk management limits such as, the Net Open Position (`NOP') Limit and
Aggregate Gap Limit (`AGL') are approved by the RBI after making an assessment of each bank's overall risk
appetite. Banks install checks in their daily processes to ensure that these limits are being adhered to at all times.
2.44 As part of regulatory reporting, banks are also required to report to the RBI a host of other risk management
limits such as, single and group borrower limits (these limits give an indication of concentration risk), credit exposure
for derivatives (this indicates the potential replacement cost of the derivative portfolio), capital market exposure of the
bank, country risk exposure and exposure to sensitive sectors such as, real estate, etc.
Monitoring activities: Risk management models, methodologies and assumptions used to measure and manage
risk should be regularly assessed and updated. This function may be conducted by the independent risk
management unit. Internal Auditor should test the risk management process periodically to check whether
management policies and procedures are complied with and whether the operational controls are effective. Both
the risk management unit and internal auditors should have a reporting line to those charged with governance
and management that is independent of those on whom they are reporting.
Reliable information systems: Banks require reliable information systems that provide adequate financial,
operational and compliance information on a timely and consistent basis. TCWG and management require risk
management information that is timely, accurate and easily understood and that enables them to assess the
changing nature of the bank's risk profile.
Engagement Team Discussions
2.45 The engagement team should hold discussions to gain better understanding of the bank and its
environment, including internal control, and also to assess the potential for material misstatements of the financial
statements. All these discussions should be appropriately documented for future reference. The discussion provides:
An opportunity for engagement team members, including the audit engagement partner, to share their insights
based on their knowledge of the bank and its environment.
An opportunity for engagement team members to exchange information about the bank's business risks.
An understanding amongst the engagement team members about effect of the results of the risk assessment
procedures on other aspects of the audit, including decisions about the nature, timing, and extent of further audit
procedures.
2.46 The discussion between the members of the engagement team and the audit engagement partner should
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
be done on the susceptibility of the bank's financial statements to material misstatements. These discussions are
ordinarily done at the planning stage of an audit. Specific emphasis should be provided to the susceptibility of the
bank's financial statements to material misstatement due to fraud, that enables the engagement team to consider an
appropriate response to fraud risks, including those related to engagement risk, pervasive risks, and specific risks. It
further enables the audit engagement partner to delegate the work to the experienced engagement team members,
and to determine the procedures to be followed when fraud is identified. Further, audit engagement partner may
review the need to involve specialists to address the issues relating to fraud.
2.47 The engagement team discussion ordinarily includes a discussion of the following matters:
Errors that may be more likely to occur;
Errors which have been identified in prior years;
Method by which fraud might be perpetrated by bank personnel or others within particular account balances
and/or disclosures;
Audit responses to Engagement Risk, Pervasive Risks, and Specific Risks;
Need to maintain professional skepticism throughout the audit engagement;
Need to alert for information or other conditions that indicates that a material misstatement may have occurred
(e.g., the bank's application of accounting policies in the given facts and circumstances).
2.48 On the matters relating to fraud, the engagement team discussion ordinarily includes the following:
An exchange of ideas among engagement team members about how and where they believe the bank's
financial statements may be susceptible to material misstatement due to fraud. Further, manner of involvement
of the management, those charged with governance and others within the entity should also be discussed.
Consideration of circumstances that might be indicative of fraud in the earnings of the bank; and the practices
that might be followed by the bank's management to manage earnings that could lead to fraudulent financial
reporting.
Consideration of the external/internal factors affecting the bank that may create an incentive or pressure on
management or others to commit fraud.
Consideration of management's involvement in overseeing the employees having access to cash or other assets
susceptible to misappropriation.
Consideration of unusual or unexplained changes in behaviour or lifestyle of management or employees that
may have come to the attention of the engagement team.
Consideration of the types of circumstances that, if encountered, might indicate the possibility of fraud.
Selection of audit procedures to respond to the susceptibility of the fraud.
Consideration of any allegations of fraud or suspected fraud that may have come to the auditor's attention.
Consideration of the risk of management override of controls.
2.49 Further, the audit engagement partner should also consider matters to be communicated to the members of
the Engagement Team not involved in the discussion. For multi-location audit engagements for which separate
engagement teams are performing work under the supervision of audit engagement partners in separate locations,
the auditor may hold multiple discussion that involve the members of the engagement team in each significant
location.
2.50 With respect to the engagement team discussions, the auditor may document the following matters:
discussion amongst the engagement team regarding the susceptibility of the material misstatement whether due
to fraud or not; and
significant decisions reached during the discussion amongst the engagement team regarding the susceptibility of
the material misstatement whether due to fraud or not.
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Risk Assessment and Internal Control
Establish the Overall Audit Strategy
2.51 Standard on Auditing (SA) 300, "Planning an Audit of Financial Statements'' states that the objective of the
auditor is to plan the audit so that it will be performed in an effective manner. For this purpose, the audit engagement
partner should:
establish overall audit strategy, prior to the commencement of an audit; and
involve key engagement team members and other appropriate specialists while establishing the overall audit
strategy depending on the characteristics of the audit engagement.
2.52 The overall audit strategy sets the scope, timing and direction of the audit as it guides the development of
detailed audit plan. The establishment of the overall audit strategy involves:
Identifying the characteristics of the audit engagement that define its scope, such as the financial reporting
framework used (Third Schedule to the Banking Regulation Act, 1949), additional reporting requirements at
various locations of the components of the bank prescribed by the RBI, etc.
Consider the various RBI Circulars, Master Circulars and Master Directions issued from time to time, as
applicable.
Consider the requirements of various Accounting Standards, Guidance Notes and Standards on Auditing, to the
extent applicable, to assess the nature and extent of audit procedures to be performed.
Ascertaining the reporting objectives of the audit engagement to plan the timing of the audit and the nature of the
communications required, such as deadlines for interim and final reporting, key dates for expected
communications with the management and with those charged with governance.
Considering the important factors that will determine the focus of the engagement team's efforts, such as
determination of appropriate audit materiality, preliminary identification of significant risks, preliminary
identification of material components and significant account balances and disclosures.
Consider the factors that, in the auditor's professional judgment, are significant in directing the engagement
team's efforts.
Consider the results of preliminary engagement activities and, where applicable, whether knowledge gained on
other engagements performed by the engagement partner for the bank is relevant.
Ascertain the nature, timing and extent of resources necessary to perform the engagement.
2.53 The auditor should document the overall audit strategy, including any significant changes thereto. The
documentation of the overall audit strategy records the key decisions considered necessary to properly plan the audit
and to communicate significant matters to the engagement team. For example, the auditor may summarise the
overall audit strategy in the form of a memorandum that contains key decisions regarding the overall scope, timing
and conduct of the audit. Ordinarily, following are documented as part of establishing the overall audit strategy:
Summarisation of significant matters relating to overall audit strategy.
Significant risks identified.
Other decisions considered necessary to properly plan the audit.
Develop the Audit Plan
2.54 SA 300, "Planning an Audit of Financial Statements" deals with the auditor's responsibility to plan an audit of
financial statements in an effective manner. It requires the involvement of all the key members of the engagement
team while planning an audit. Before starting the planning of an audit, the auditor must perform the procedures as
defined under SA 220, "Quality Control for an Audit of Financial Statements" for reviewing the ethical and
independence requirements. In addition to this, the auditor is also required to comply with the requirements of SA
210, "Agreeing the Terms of Audit Engagements".
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2.55 The auditor must establish overall audit strategy for developing an audit plan for the bank's financial
statements as a whole, and at the assertion level for classes of transactions, account balances, and disclosures. To
be efficient, the auditor must plan the audit by considering the inter-relationships amongst the various risk
assessment procedures, planned control-reliance strategy, planned substantive procedures, and at the assertion
level for classes of transactions, account balances, and disclosures so as to avoid unnecessary duplication of effort.
This can further be summarised by preparing an audit planning memorandum detailing the various activities to be
performed by an auditor while conducting an audit of a bank. The audit plan documents the nature, timing and extent
of the planned audit procedures.
2.56 Ordinarily, to develop the audit plan the auditor would need to gather detailed information about the bank
and its operating environment, which will enable to plan audit procedures for each significant account balances and
disclosures. The requisite detailed information may be obtained from the following:
Understanding of the bank, its environment and the bank's internal control;
Understanding the bank's accounting process;
Reading the minutes of various committees of the bank;
Reading the Annual Financial Inspection for the prior year(s);
Performing a preliminary analytical review;
Assessment of risk at the assertion level;
Planning a Control-Reliance Strategy;
Planning substantive procedures;
In case of identified misstatements, obtaining reasonable assurance from the substantive procedures;
Consideration of expectations and concerns of management, which could impact the timing of the audit
procedures. In some cases, management may request the auditor to perform audit procedures on specific areas
(e.g., controls) so as to provide assurance on the design, implementation, and operating effectiveness of those
specific areas;
Work performed by internal / concurrent auditors;
Statutory or other legal and regulatory requirements;
Using the work of an expert;
Specific assertion level risks for classes of transactions, account balances, disclosures and audit procedures
based on overall engagement risk;
Impact of multiple locations, subsidiaries and associates on audit procedures;
Consideration of the nature, timing, and extent of audit procedures required under SA 540, "Auditing Accounting
Estimates, Including Fair Value Accounting Estimates, and Related Disclosures" for fair value measurements
and disclosures; and
Consideration of appropriateness of going concern assumptions.
2.57 The auditor could use the information gathered above to develop an effective audit plan that will
appropriately respond to identified risks, and would also help in providing the necessary level of assurance.
2.58 When developing audit plan for an initial audit engagement, the auditor should consider the nature, timing,
and extent of audit procedures that will need to be performed on the opening balances, as well as their effect on the
current year's audit procedures. In this regard, the auditor is also required to perform the procedures as given in SA
510, "Initial Audit Engagements-Opening Balances".
2.59 In developing the audit plan, the auditor should ordinarily document the following:
The overall audit strategy;
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Risk Assessment and Internal Control
Any significant changes made during the audit engagement to the overall audit strategy or the audit plan, and
the reasons for such changes;
Decisions impacting the nature, timing, and extent of audit procedures; and
Audit plan, including any significant changes made during the audit engagement.
Audit Planning Memorandum
2.60 The auditor should summarise audit plan by preparing an audit planning memorandum in order to:
Describe the expected scope and extent of the audit procedures to be performed.
Highlight all significant issues and risks identified during planning and risk assessment activities, as well as
decisions of reliance on controls.
Provide evidence that they have planned the audit engagement appropriately and have responded to
engagement risk, pervasive risks, specific risks, and other matters affecting the audit engagement.
2.61 The audit planning memorandum should be approved by the audit engagement partner. It ordinarily
addresses the following matters:
Assessment of and planned responses to the engagement risk, pervasive risks or specific risk at the assertion
level for classes of transactions, account balances, and disclosures.
Assessment of the initial conclusions in respect to the independence and potential conflict of interest.
Other significant issues arising out of the planning activities, which may include the following:
o Identified fraud risk factors;
o Preliminary conclusions regarding the components of internal control;
o Audit materiality;
o IT environment of the bank and need to use the work of an expert; and
o Changes in the bank's environment such as, changes in accounting policies or accounting process of the
bank.
Determine Audit Materiality
2.62 SA 320, "Materiality in Planning and Performing an Audit" defines the materiality in the context of an audit. It
describes that financial reporting frameworks often discuss the concept of materiality in the context of the preparation
and presentation of financial statements. Although financial reporting frameworks may discuss materiality in different
terms, they generally explain that:
Misstatements, including omissions, are considered to be material if they, individually or in the aggregate, could
reasonably be expected to influence the economic decisions of users taken on the basis of the financial
statements;
Judgments about materiality are made in light of surrounding circumstances, and are affected by the size or
nature of a misstatement, or combination of both;
Judgments about matters material to users of the financial statements are based on a consideration of the
common financial information needs of users as a group. The possible effect of misstatements on specific
individual users, whose needs may vary widely, is not considered.
The determination of audit materiality is a matter of professional judgment and is affected by the auditor's
perception of the financial information needs of users of the financial statements.
2.63 SA 320 also defines performance materiality as the amount or amounts set by the auditor at less than
materiality for the financial statements as a whole to reduce to an appropriately low level the probability that the
aggregate of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
If applicable, performance materiality also refers to the amount or amounts set by the auditor at less than the
materiality level or levels for particular classes of transactions, account balances or disclosures.
2.64 When establishing the overall audit strategy, the auditor shall determine materiality for the financial
statements as a whole. If, in the specific circumstances of the bank, there is one or more particular classes of
transactions, account balances or disclosures for which misstatements of lesser amounts than the materiality for the
financial statements as a whole could reasonably be expected to influence the economic decisions of users taken on
the basis of the financial statements, the auditor shall also determine the materiality level or levels to be applied to
those particular classes of transactions, account balances or disclosures. The auditor shall determine performance
materiality for purposes of assessing the risks of material misstatement and determining the nature, timing and extent
of further audit procedures.
2.65 As per SA 450, "Evaluation of Misstatements Identified During the Audit", the auditor is required to
accumulate material misstatements identified during the audit, Further, it also requires an auditor to communicate on
a timely basis all misstatements accumulated during the audit with the appropriate level of management, unless
prohibited by law or regulation and also request management to correct those misstatements. If management refuses
to correct some or all of the misstatements communicated by the auditor, the auditor should obtain an understanding
of management's reasons for not making the corrections and should take that understanding into account when
evaluating whether the financial statements as a whole are free from material misstatement. The auditor is also
required to reassess materiality determined in accordance with SA 320 to confirm whether it remains appropriate in
the context of the entity's actual financial results. Further, he should also determine whether uncorrected
misstatements are material, individually or in aggregate. The auditor should, unless prohibited by law or regulation,
communicate with those charged with governance, uncorrected misstatements and the effect that they, individually or
in aggregate, may have on the opinion in the auditor's report. The auditor's communication should identify material
uncorrected misstatements individually. The auditor should request that uncorrected misstatements be corrected.
The auditor should request a written representation from management and, where appropriate, those charged with
governance whether they believe the effects of uncorrected misstatements are immaterial, individually and in
aggregate, to the financial statements as a whole. A summary of such items shall be included in or attached to the
written representation.
Consider Going Concern
2.66 In obtaining an understanding of the bank, the auditor should consider whether there are events and
conditions which may cast significant doubt on the bank's ability to continue as a going concern. The auditor needs to
consider events and conditions relating to the going concern assumption when performing risk assessment
procedures so as to make timely discussions with the management, review the management's plans, and resolution
of any identified going concern issues. Audit procedures, which may indicate that there could be a question about a
bank's ability to continue as a going concern for the foreseeable future as mentioned in paragraph A16 of SA 570,
Going Concern.
2.67 There are certain specific events or conditions, which the auditor should consider to assess the ability of the
bank to continue as a going concern:
Rapid increase in the volume of derivative business without necessary controls being put in place.
Decline in the projected profitability, if the bank is at or near its minimum level of regulatory capital.
Increasing level of non-performing assets.
Higher interest rates being paid on deposits and borrowing than the market rates.
Actions taken or threatened by regulators that may have an adverse effect on the ability of the bank to continue
as a going concern.
High concentration of exposure to certain borrowers or industries showing credit weakness.
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Risk Assessment and Internal Control
Low provision coverage ratio.
Operating Framework for Identifying and Dealing with Frauds
2.68 All banks have policy and operating framework in place for detection, reporting and monitoring of frauds as
also the surveillance/ oversight process in operation so as to prevent the perpetration of frauds. The RBI, , vide its
Circular No. DBS. CO.FrMC.BC.No.10/23.04.001/2010-11 dated 31st May 2011, had identified certain areas wherein
frauds had shown occurrence or increasing trend in banks. These areas include:-
loans/ advances against hypothecation of stocks.
housing loans cases.
submission of forged documents including letters of credit.
escalation of overall cost of the property to obtain higher loan amount.
over valuation of mortgaged properties at the time of sanction.
grant of loans against forged FDRs.
over-invoicing of export bills resulting in concessional bank finance, exemptions from various duties, etc.
frauds stemming from housekeeping deficiencies.
2.69 RBI has accordingly prescribed certain guidelines to be incorporated by the banks in their operating
framework for identifying and dealing with frauds. These guidelines have been detailed in the following paragraphs.
2.70 The operating framework for tracking frauds and dealing with them should be structured along the following
tracks:
(i) Detection and reporting of frauds.
(ii) Corrective action.
(iii) Preventive and punitive action.
(iv) Provisioning for Frauds.
(i) Detection and Reporting of Frauds
(a) The banks are required to have a set of prescribed procedures and criteria with which the events or
transactions having serious irregularities are analysed and assessed to establish occurrence of fraud.
(b) The banks may define a `fraud' based on the guidelines issued by RBI. While doing so, they may clearly
demarcate/ distinguish the occurrence of an event on account of negligence `in conduct of duty' from `collusion'
by the bank staff (with the borrowers and with an intention to cheat the bank).
(c) Care needs to be exercised while dealing with instances of `wilful default'. In this connection, a wilful default
would be deemed to have occurred if any of the following events is noted:
The unit has defaulted in meeting its payment / repayment obligations to the lender even when it has the
capacity to honour the said obligations.
The unit has defaulted in meeting its payment / repayment obligations to the lender and has not utilised
the finance from the lender for the specific purposes for which finance was availed of but has diverted the
funds for other purposes.
The unit has defaulted in meeting its payment / repayment obligations to the lender and has siphoned off
the funds so that the funds have not been utilised for the specific purpose for which finance was availed of,
nor are the funds available with the unit in the form of other assets.
The unit has defaulted in meeting its payment / repayment obligations to the lender and has also disposed
off or removed the movable fixed assets or immovable property given by him or it for the purpose of
securing a term loan without the knowledge of the bank / lender.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Further, the banks may also examine the `intent' to defraud, irrespective of whether or not actual loss
takes place. Keeping these key factors in mind, any action taken in collusion to derive undue/ unjust
benefit or advantage should be termed as fraud.
Accordingly, once a fraud is detected, a report must be prepared and submitted to the "Competent
Authority".
As a part of their overall policy and operating framework, the banks need to identify and designate the
Competent Authority to whom such reports should be submitted.
The fraud report should be a diagnostic assessment, clearly bringing out the causes of the fraud and
identify whether the fraud occurred due to `system failure' or `human failure'.
(ii) Corrective Action
2.71 An important corrective step in a fraud is recovery of the amount siphoned off through the fraud. A
structured scrutiny/ examination of events or transactions would lead to quick conclusion whether a fraud has
occurred and the bank's funds have been siphoned off. Therefore, this exercise is the first critical step towards
corrective action in the sense that it would lead to expeditious filing of police complaints, blocking/ freezing of
accounts and salvaging funds from the blocked/ frozen accounts in due course.
2.72 Once a set of transactions is explicitly identified as fraudulent, the mandate for seizing and taking
possession of related documents, issuance of suspension order/ order to proceed on leave to identified/ suspected
employees would be easier thereby preventing them from destroying/ manipulating evidences or obstruction of
investigations.
(iii) Preventive and Punitive Action
2.73 The preventive action as deemed necessary to address the `system failure' and/ or punitive action as
prescribed internally for `human failure' should be initiated immediately and completed expeditiously by the banks.
2.74 Generally, in the current system driven environment in banks, wherever transactions occur in breach of/
overriding "Controls", they get reflected in the "end of day exception reports". Accordingly, all such exception reports
should be perused by the designated officials and a post facto authorization for the transactions accorded.
2.75 In certain cases the process may not have got duly implemented reflecting the poor internal control
mechanisms. Therefore, banks should ensure that they bring in the needed refinement in this process and also
specify the levels/ authority to whom the exception reports will be invariably submitted and the manner in which the
authority will deal with the exception reports.
2.76 The entire gamut of the manner in which the exception reports are generated, transactions contained in the
reports are examined/ scrutinised, and the reports submitted to higher authorities for necessary authorizations for
breaches should be periodically subjected to review and oversight by the bank's management/ Board of Directors.
2.77 In addition to the above, banks have also been advised by RBI to take steps to put in place certain controls
and disincentives in their HR processes and internal inspection/ audit processes as part of their fraud risk
management framework. These include:
(a) For key and sensitive posts such as those in dealing rooms, treasury, relationship managers for high value
customers, heads of specialized branches, etc., selecting only such officers who satisfy the "Fit and Proper"
criteria. The appropriateness of such postings should be subjected to periodical review.
(b) Putting in place the "staff rotation" policy and policy for "mandatory leave" for staff. The internal auditors as also
the concurrent auditors must be specifically required to examine the implementation of these policies and point
out instances of breaches irrespective of apparent justifications for non-compliance, if any. The decisions taken /
transactions effected by officers and staff not rotated/ availing leave as per policy should be subjected to
comprehensive examination by the internal auditors/ inspectors including concurrent auditors. The findings
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Risk Assessment and Internal Control
thereon should be documented in a separate section of the audit/ inspection reports.
(c) Building up a database of officers/ staff identified as those having aptitude for investigation, data analysis,
forensic analysis, etc. and expose them to appropriate training in investigations and forensic audit. For
investigation of frauds, only such officers/ staff should be deployed through the "fraud investigation unit/ outfit".
(iv) Provisioning for Frauds
2.78 RBI has vide its circular RBI/2015-16/376 DBR.No.BP.BC.92/21.04.048/ 2015-16 dated 18th April, 2016,
decided to amend the provisioning norms in respect of all cases of fraud, as under:
a. Banks should normally provide for the entire amount due to the bank or for which the bank is liable (including in
case of deposit accounts), immediately upon a fraud being detected. While computing the provisioning
requirement, banks may adjust financial collateral eligible under Basel III Capital Regulations - Capital Charge
for Credit Risk (Standardised Approach), if any, available with them with regard to the accounts declared as
fraud account;
b. However, to smoothen the effect of such provisioning on quarterly profit and loss, banks have the option to
make the provisions over a period, not exceeding four quarters, commencing from the quarter in which the fraud
has been detected;
c. Where the bank chooses to provide for the fraud over two to four quarters and this results in the full provisioning
being made in more than one financial year, banks should debit 'other reserves' [i.e., reserves other than the
one created in terms of Section 17(2) of the Banking Regulation Act 1949] by the amount remaining un-
provided at the end of the financial year by credit to provisions. However, banks should proportionately reverse
the debits to `other reserves' and complete the provisioning by debiting profit and loss account, in the
subsequent quarters of the next financial year;
d. Banks shall make suitable disclosures with regard to number of frauds reported, amount involved in such
frauds, quantum of provision made during the year and quantum of unamortised provision debited from `other
reserves' as at the end of the year.
Assess the Risk of Fraud
2.79 As per SA 240, "The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements", the
auditor's objectives are to identify and assess the risks of material misstatement in the financial statements due to
fraud, to obtain sufficient appropriate audit evidence on those identified misstatements and to respond appropriately.
The attitude of professional skepticism should be maintained by the auditor so as to recognise the possibility of
misstatements due to fraud. When obtaining an understanding of the bank and its environment, the auditor should
make inquiries of management, internal auditors and others regarding the following:
Management's assessment of the risk that the financial statements may be materially misstated due to fraud,
including the nature, extent and frequency of such assessments as well as the controls in place to prevent and
detect fraud.
Management's process for identifying and responding to the risk of fraud in the bank, including any specific risks
of fraud that management has identified or that have been brought to its attention; or classes of transactions,
account balances, or disclosures for which a risk of fraud is likely to exist; and the internal control that
management has established to address these risks. The auditor could also obtain information from the
management regarding the various frauds which have occurred in the year under audit or previous years to
identify system lacunae which led to the lapse. The auditor could ascertain whether the necessary rectification/
remedial action has been taken to prevent similar frauds from happening again. The auditor could also ascertain
the necessary controls (preventive, detective or deterrent manual or automated) in place to ensure early
detection of frauds post occurrence.
Management's communication, if any, to those charged with governance regarding its processes for identifying
and responding to the risks of fraud in the bank.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Management's communication, if any, to regulatory authorities.
Management's communication, if any, to employees regarding its views on business practices and ethical
behaviour.
Actual, suspected, or alleged fraud that the bank is investigating.
Process the bank undertakes to respond to internal or external allegations of fraud affecting the bank.
Understanding how those charged with governance exercise oversight of management's processes for
identifying and responding to the risks of fraud in the bank, and the internal control that management has
established to address these risks. This also helps to corroborate management's responses to the inquiries
mentioned above.
2.80 The auditor could use the information gathered above to develop an effective audit plan that will
appropriately respond to identified risks, and would also help in providing the necessary level of assurance.
2.81 Some of the common fraud risk factors in deposit taking, dealing and lending activities areas are
summarised hereunder:
Deposit Taking Dealing Lending
Management and Camouflage of Off market / related party Loans to fictitious borrowers.
employee frauds depositors by hiding their deals whereby no Transactions with connected
identity in connection checks are carried out companies.
with funds transfer or on the prices at which Kick backs and
money laundering. deals are transacted or inducements.
Unrecorded deposits. there are unusual activity
Selling recovered collateral
Theft of customer levels with certain at below market prices.
deposits particularly, from counter-parties.
Bribes to obtain release of
dormant accounts. High level of business
security or to reduce the
with particular brokers, amount claimed.
including payment of
abnormal commission. Theft or misuse of collateral
held as security.
False deals represented
by unusual number of
cancelled deals or
unusually high number
of unsettled transactions.
Delayed deal allocations
represented by no time
stamping of deals or
alterations or overwriting
on deals sheets.
Exploiting weaknesses
in matching procedures
due to absence of proper
guidelines.
External Frauds Money Laundering. Fraudulent custodial Impersonation and false
Fraudulent instructions. sales. information on loan
Counterfeit currency. False information or applications.
documents regarding Fraudulent valuations.
counter-parties. Misappropriation of loan
funds by agents / customers
2.82 ICAI in February, 2016 issued the Revised Guidance Note on Reporting on Fraud under Section 143(12) of
the Companies Act, 2013. Part B of the Guidance Note paragraph 11 deals with Reporting to RBI in case of frauds
noted in audit of banks. Auditors of banking companies may also refer the Guidance Note for further clarity.
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Risk Assessment and Internal Control
2.83 The MCA issued the Companies (Amendment) Act, 2015 in May 2015 which, inter alia, amends section
143(12) of the Companies Act, 2013.The amended section 143(12) reads as follows:
"Notwithstanding anything contained in this section, if an auditor of a company in the course of the
performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or
amounts as may be prescribed, is being or has been committed in the company by its officers or employees,
the auditor shall report the matter to the Central Government within such time and in such manner as may
be prescribed:
Provided that in case of a fraud involving lesser than the specified amount, the auditor shall report the
matter to the audit committee constituted under section 177 or to the Board in other cases within such time
and in such manner as may be prescribed:
Provided further that the companies, whose auditors have reported frauds under this sub-section to the
audit committee or the Board but not reported to the Central Government, shall disclose the details about
such frauds in the Board's report in such manner as may be prescribed."
Further, the MCA through its notification dated 14 December 2015 has also amended Rule 13 of the Companies
(Audit and Auditors) Rules, 2014. The amended Rule 13 requires the reporting of a fraud as follows:
(1) If an auditor of a company, in the course of the performance of its duties as statutory auditor, has reason to
believe that an offence of fraud, which involves or is expected to involve individually an amount of rupees one crore
or above, is being or has been committed against the company by its officers or employees, the auditor shall report
the matter to the Central Government.
(2) The auditor shall report the matter to the Central Government as under:-
(a) the auditor shall report the matter to the Board or the Audit Committee, as the case may be, immediately but not
later than two days of his knowledge of the fraud, seeking their reply or observations within forty-five days;
(b) on receipt of such reply or observations, the auditor shall forward his report and the reply or observations of the
Board or the Audit Committee among with his comments (on such reply or observations of the Board or the
Audit Committee) to the Central Government with in fifteen days from the date of receipt of such reply or
observations;
(c) in case the auditor fails to get any reply or observations from the Board or the Audit Committee within the
stipulated period of forty-five days, he shall forward his report to the Central Government along with a note
containing the details of his report that was earlier forwarded to the Board or the Audit Committee for which he
has not received any reply or observations;
(d) the report shall be sent to the Secretary, Ministry of Corporate Affairs in sealed cover by Registered Post with
Acknowledgement Due or by Speed Post followed by an e-mail in confirmation of the same;
(e) The report shall be on the letter-head of the auditor containing postal address, e-mail address and contact
telephone number or mobile number and be signed by the auditor with their seal and shall indicate Membership
Number; and
(f) the report shall be in the form of a statement as specified in Form ADT-4.
(3) In case of a fraud involving lesser than the amount specified in sub- rule (I), the auditor shall report the matter to
Audit Committee constituted under section 177 or to the Board immediately but not later than two days of his
knowledge of the fraud and he shall report the matter specifying the following:-
a) Nature of Fraud with description;
b) Approximate amount involved; and
c) Parties involved.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
(4) The following details of each of the fraud reported to the Audit Committee or the Board under sub-rule (3) during
the year shall be disclosed in the Board's Report:-
a) Nature of Fraud with description;
b) Approximate Amount involved;
c) Parties involved, if remedial action not taken; and
d) Remedial action taken.
The auditor of a banking company would need to comply with provisions of section 143(12) and the related Rules
also.
2.84 RBI circular dated 7th May 2015 on framework for dealing with loan frauds has introduced the concept of a
Red Flag Account (RFA), i.e., an account where suspicion of fraudulent activity is thrown up by the presence of one
or more early warning signals (EWS).
2.85 Some Early Warning signals which should alert the bank officials about some wrongdoings in the loan
accounts which may turn out to be fraudulent include:
1) Default in payment to the banks/ sundry debtors and other statutory bodies, etc., bouncing of the high value
cheques.
2) Raid by Income tax /sales tax/ central excise duty officials.
3) Frequent change in the scope of the project to be undertaken by the borrower.
4) Under insured or over insured inventory.
5) Invoices devoid of TAN and other details.
6) Dispute on title of the collateral securities.
7) Costing of the project which is in wide variance with standard cost of installation of the project.
8) Funds coming from other banks to liquidate the outstanding loan amount.
9) Foreign bills remaining outstanding for a long time and tendency for bills to remain overdue.
10) Onerous clause in issue of BG/LC/standby letters of credit.
11) In Merchanting trade, import leg not revealed to the bank.
12) Request received from the borrower to postpone the inspection of the godown for flimsy reasons.
13) Delay observed in payment of outstanding dues.
14) Financing the unit far away from the branch.
15) Claims not acknowledged as debt high.
16) Frequent invocation of BGs and devolvement of LCs.
17) Funding of the interest by sanctioning additional facilities.
18) Same collateral charged to a number of lenders.
19) Concealment of certain vital documents like master agreement, insurance coverage.
20) Floating front / associate companies by investing borrowed money.
21) Reduction in the stake of promoter / director.
22) Resignation of the key personnel and frequent changes in the management.
23) Substantial increase in unbilled revenue year after year.
24) Large number of transactions with inter-connected companies and large outstanding from such companies.
25) Significant movements in inventory, disproportionately higher than the growth in turnover.
26) Significant movements in receivables, disproportionately higher than the growth in turnover and/or increase in
ageing of the receivables.
27) Disproportionate increase in other current assets.
28) Significant increase in working capital borrowing as percentage of turnover.
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Risk Assessment and Internal Control
29) Critical issues highlighted in the stock audit report.
30) Increase in Fixed Assets, without corresponding increase in turnover (when project is implemented).
31) Increase in borrowings, despite huge cash and cash equivalents in the borrower's balance sheet.
32) Liabilities appearing in ROC search report, not reported by the borrower in its annual report.
33) Substantial related party transactions.
34) Material discrepancies in the annual report.
35) Significant inconsistencies within the annual report (between various sections).
36) Poor disclosure of materially adverse information and no qualification by the statutory auditors.
37) Frequent change in accounting period and/or accounting policies.
38) Frequent request for general purpose loans.
39) Movement of an account from one bank to another.
40) Frequent ad hoc sanctions.
41) Not routing of sales proceeds through bank.
42) LC's issued for local trade / related party transactions.
43) High value RTGS payment to unrelated parties.
44) Heavy cash withdrawal in loan accounts.
45) Non submission of original bills.
2.86 Besides the above Red flags, auditor could also review
a) Cheque/bills discounting facility used for liquidation of funds without any physical collateral or just for deferment
of liability.
b) Repayment of third party loans despite bank's loan account irregular or out of order.
c) Maintenance of bank accounts with other bank without consent of lender bank.
d) Inordinate delay in conducting stock inspections by bank officials and/or stock auditors at the instance of the
borrower not to show its weakness and mis-utilisation of funds.
2.87 RBI in the Master Direction No. RBI/DBS/2016-17/28 DBS.CO.CFMC. BC.No.1/23.04.001/2016-17 on
"Frauds Classification and Reporting by commercial banks and select FIs" dated July 1, 2016 has stated that the
following acts constitute fraud:
Fraudulent removal of pledged stocks / disposal of hypothecated stocks without the knowledge of the bank /
inflating the value of stocks in the stock statements & drawing excess bank finance.
Diversion of funds, lack of interest or criminal neglect on the part of the borrowers partners etc., in adhering to
financial discipline and managerial failure with mala fide intent leading to the unit becoming sick and laxity in
effective supervision over the operations in borrowable accounts on the part of bank functionaries rendering the
advance difficult for recovery and resulting in financial loss to the bank.
The Master Direction states that banks should conduct an annual review of the frauds to consider-
a) Whether the systems in the bank are adequate to detect frauds, once they have taken place, within the
shortest possible time.
b) Whether frauds are examined from staff angle and, wherever necessary, the staff side action is taken
without undue delay.
c) Whether deterrent punishment is meted out, wherever warranted, to the persons found responsible without
undue delay.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
d) whether frauds have taken place because of laxity in following the systems and procedures or loopholes in
the system and, if so, whether effective action has been taken to ensure that the systems and procedures
are scrupulously followed by the staff concerned or the loopholes are plugged.
e) Whether frauds are reported to the local Police for investigation.
Diversion of Funds, inflating value of stocks, showing unpaid stocks as paid stocks, not providing for bad debts etc.,
are common practices by unscrupulous borrowers in Banks and frequently reported by Concurrent / Stock auditors in
Banks.
Auditors should take due cognizance of the same and banks could be asked to report the same as frauds on a case
to case basis after due consideration of the borrower's intent and the frequency of such instances, risk of default as a
result of such practices, materiality of the amount financed by the bank and outstanding, availability of collateral and
loan to value ratio or margin of safety.
Assess the Risk of Money Laundering
2.88 Due to the nature of their business, banks are ready for targeting those who are engaged in the money
laundering activities by which the proceeds of illegal acts are converted into proceeds from the legal acts. The RBI
has framed specific guidelines that deal with prevention of money laundering and "Know Your Customer (KYC)"
norms. The RBI has from time to time issued guidelines ("Know Your Customer Guidelines Anti Money Laundering
Standards"), requiring banks to establish policies, procedures and controls to deter and to recognise and report
money laundering activities. The RBI, vide its master direction no. RBI/DBR/2015-16/18 Master Direction
DBR.AML.BC.No.81/ 14.01.001/2015-16 dated December 08, 2016 on "Know Your Customer (KYC) Direction,
2016", have advised the banks to follow certain customer identification procedure for opening of accounts and
monitoring transactions of a suspicious nature for the purpose of reporting it to appropriate authority. These policies,
procedures and controls commonly extend to the following:
Customer acceptance policy, i.e., criteria for accepting the customers.
Customer identification procedure, i.e., procedures to be carried out while establishing a banking relationship;
carrying out a financial transaction or when the bank has a doubt about the authenticity/veracity or the adequacy
of the previously obtained customer identification data. A requirement to obtain customer identification (know
your client).
Monitoring of transactions Banks are advised to set key indicators for risk sensitive (e.g., high turnover
accounts or complex or unusual transactions accounts) accounts, taking note of the background of the customer,
such as the country of origin, sources of funds, the type of transactions involved and other risk factors. Banks
should also put in place a system of periodical review of risk categorisation of accounts and the need for
applying enhanced due diligence measures. Such review of risk categorisation of customers should be carried
out at a periodicity of not less than once in six months. In view of the risks involved in cash intensive businesses,
accounts of bullion dealers (including sub-dealers) and jewellers, the banks are also advised to categorise these
accounts as `high risk' requiring enhanced due diligence. Further, the banks are also required to subject these
'high risk accounts ' to intensified transaction monitoring. High risk associated with such accounts should be
taken into account by banks to identify suspicious transactions for filing Suspicious Transaction Reports (STRs)
to FIU-IND.
2.89 Further, banks should closely monitor the transactions in accounts of marketing firms (MLM Companies). In
cases where a large number of cheque books are sought by the company, there are multiple small deposits
(generally in cash) across the country in one bank account and where a large number of cheques are issued bearing
similar amounts/dates, the bank should carefully analyse such data and in case they find such unusual operations in
accounts, the matter should be immediately reported to Reserve Bank and other appropriate authorities such as
Financial Intelligence Unit India (FIU-Ind) under Department of Revenue, Ministry of Finance.
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Risk Assessment and Internal Control
2.90 Banks were advised to complete the process of risk categorization and compiling/updating profiles of all of
their existing customers in a time-bound manner latest by end-March 2013.
2.91 Such review of risk categorisation of customers has to be carried out at a periodicity of not less than once in
six months.
Closure of accounts - In case of non-application of proper KYC measures, banks may decide to close the
account of the particular customer after giving due notice to the customer.
Risk Management - The Board of Directors of the bank should ensure that an effective KYC programme is put in
place by establishing appropriate procedures and ensuring their effective implementation. It should cover proper
management oversight, systems and controls, segregation of duties, training and other related matters.
Responsibility should be explicitly allocated within the bank for ensuring that the bank's policies and procedures
are implemented effectively. Concurrent/ Internal Auditors should specifically check and verify the application of
KYC procedures at the branches and comment on the lapses observed in this regard. The compliance in this
regard should be put up before the Audit Committee of the Board on quarterly intervals.
Reporting to the authorities of suspicious transactions or of all transactions of a particular type, for example,
cash transactions over a certain amount.
2.92 The RBI master direction also advised the banks to pay special attention to any money laundering threats
that may arise from new or developing technologies including, internet banking that might favour anonymity, and take
measures, if needed, to prevent their use in money laundering schemes. Further, banks are required to report all
frauds to the RBI on a periodical basis. The auditors should review the same to get an idea of the nature and extent
of frauds. "Money mules"3 can be used to launder the proceeds of fraud schemes (e.g., phishing and identity theft) by
criminals who gain illegal access to deposit accounts by recruiting third parties to act as "money mules." In some
cases these third parties may be innocent while in others they may be having complicity with the criminals. In a
money mule transaction, an individual with a bank account is recruited to receive cheque deposits or wire transfers
and then transfer these funds to accounts held on behalf of another person or to other individuals, minus a certain
commission payment. Money mules may be recruited by a variety of methods, including spam e-mails,
advertisements on genuine recruitment web sites, social networking sites, instant messaging and advertisements in
newspapers. When caught, these money mules often have their bank accounts suspended, causing inconvenience
and potential financial loss, apart from facing likely legal action for being part of a fraud. Many a times the address
and contact details of such mules are found to be fake or not up to date, making it difficult for enforcement agencies
to locate the account holder. The operations of such mule accounts can be minimised if banks follow the guidelines
contained in the Master Directions on Know Your Customer (KYC). Banks are, therefore, required to strictly adhere to
the guidelines on KYC/AML/CFT issued from time to time and to those relating to periodical updation of customer
identification data after the account is opened and also to monitoring of transactions in order to protect themselves
and their customers from misuse by such fraudsters.
2.93 Money laundering involves three steps namely - Placement Layering -- Integration.
Placement involves introducing money in the financial system by some means.
Layering means carrying out transactions generally complex to camouflage the illegal source.
Integration means acquiring wealth generated from the transactions of the illicit funds.
2.94 Some methods in which money laundering takes place are as under -
3
The RBI, vide its circular no. DBOD.AML. BC. No. 65/14 .01.001/2010-11 dated December 7, 2010 provides guidance on Operation of bank
accounts & money mules.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Breaking up of cash into smaller amounts and depositing it in to the bank below the monitored reporting
thresholds.
Physically moving the cash into locations or jurisdictions and depositing it in off shore banks with lesser
stringent enforcement laws and regulations.
Using business typically known to receive revenue in cash to be used to deposit criminally derived cash.
Trade based laundering Over or Under Invoicing.
Shell companies operating in jurisdictions not requiring reporting of beneficial owner to earn tax favored profits.
Round Tripping wherein money is deposited in a controlled foreign corporation offshore preferably a tax haven
where minimal records are kept & then shipped back as FDI to earn tax favored profits through a shell
company.
Use of Casinos Chips are purchased with laundered cash and on winning, the buyer either gets back the
winnings in cheque or gets a receipt for the winnings.
Real estate Transactions seller agrees to understate the value of the property and collects the difference in
cash.
Bank capture Buying a controlling interest in a Bank in a jurisdiction with weak money laundering controls and
then move money through the bank without much scrutiny.
2.95 Banks use computer software in place whereby they generate alerts based on thresholds as per parameters
given in IBA guidance. The bank scans through these alerts and in case they find anything suspicious they have to
report the same to the Financial Intelligence Unit. This reporting varies from bank to bank as the definition of
"suspicious" is interpreted by various banks differently. Banks should have adequate documentation in place
justifying why a transaction was not reported as Suspicious when they had alerts of the same. Banks also need to
review these alerts from time to time. If a Suspicious Transaction Reports (STR) is reported in a Low risk account,
the classification in the account may need upgradation to a High risk profile account.
2.96 Statutory Central Auditors should review the process of closure of AML alerts. AML alerts are transactions
identified by AML application as exceptional. The same needs to be closed after getting explanation from customer
regarding genuineness of transactions. In many Banks the AML alerts are closed based on information provided by
Branch Managers, which he/she receives from customer. At Branch level the Statutory Branch Auditors may review
process of documenting explanations received from customer regarding AML alerts.
Statutory Central Auditors should review the process of modifications/deletion in parameters entered in AML
application for generation of alerts.
Assess Specific Risks
2.97 The auditors should identify and assess the risks of material misstatement at the financial statement level
which refers to risks that relate pervasively to the financial statements as a whole, and potentially affect many
assertions. Risk of material misstatement at the assertion level for specific class of transactions, account balances
and disclosures need to be considered because such consideration directly assists in determining the nature, timing
and extent of further audit procedures at the assertion level necessary to obtain sufficient appropriate audit evidence.
2.98 For this purpose, the auditor should perform the following:
Identify risks throughout the process of obtaining an understanding of the bank and its environment, including
applicable controls that relate to the risks, and by considering the account balances or disclosures in the
financial statements.
Ascertain account balances or disclosures wherein control lapses or errors have been identified in the past.
Pinpoint each risk to one or more assertions relating to the account balances or disclosures.
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Risk Assessment and Internal Control
Consider whether the risks are of a magnitude that could result in a material misstatement of the financial
statements.
Document the identified and assessed risks of material misstatement at the assertion level.
2.99 Although there is always a risk of misstatement for each significant account balance and disclosure, a
specific risk exists when the auditor recognises one or more factors that significantly increases the risk of material
misstatement. This assessment is based on the nature of the risk, the likelihood of the occurrence of the risk, and the
likely magnitude of any resulting misstatements.
2.100 The identification of specific risks, which arise on most audits, is a matter of professional judgment. The
factors influencing the identification of specific risks may include the following:
past misstatements strongly indicate about the likely occurrence of future misstatements;
the application systems are unreliable;
non-systematically processed transactions have a disproportionately higher likelihood of misstatement than
those routine transactions that are processed by reliable application systems;
absence of secondary review;
the incidence of misstatements is greater in transactions relating to accounting estimates and adjustments at or
near to the end of an accounting period (i.e., cut-offs and accruals); and
the incidence of misstatements associated with unusual or complex transactions.
The greater the likelihood that the risk could result in a material misstatement of the financial statements, the greater
the potential for that risk of material misstatement to be assessed as a specific risk.
2.101 The auditor's assessment of the risks of material misstatement at the assertion level is based on available
audit evidence which may change during the course of the audit as and when further audit evidence is obtained
indicating the change in the previously obtained audit evidence (e.g., when performing substantive procedures, the
auditor may detect misstatements in amounts or frequency greater than that of consistent with their risk assessment).
In these circumstances, the auditor needs to consider whether it is appropriate to revise the risk assessment
procedures and modify the further planned audit procedures accordingly. The auditor is required to document the
identified and assessed risks of material misstatement at the assertion level.
2.102 Most transactions involve more than one type of the risk identified, as mentioned in the Annexure-1 to this
Chapter. Furthermore, the individual risks set out above may be correlated with one another. For example, a bank's
credit exposure in a securities transaction may increase as a result of an increase in the market price of the securities
concerned. Similarly, non-payment or settlement failure can have consequences for a bank's liquidity position. The
auditor therefore considers these and other risk correlations when analysing the risks to which a bank is exposed.
Risk Associated with Outsourcing of Activities
2.103 Further, the modern day banks make extensive use of outsourcing as a means of both reducing costs as
well as making use of services of an expert not available internally. There are, however, a number of risks associated
with outsourcing of activities by banks and therefore, it is quintessential for the banks to effectively manage those
risks. RBI's circular no. DBOD.BP.40/ 21.04.158/2006-07 dated November 3, 2006 contains extensive guidelines on
managing the risks associated with the outsourcing of financial services by banks. The circular, however, also
mandates that banks which choose to outsource financial services should not outsource core management functions
including internal audit, compliance function and decision-making functions like, determining compliance with Know
Your Customer (`KYC') norms for opening deposit accounts, according sanction for loans (including retail loans) and
management of investment portfolio.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
2.104 In addition to understanding the external factors that could indicate increased risk, the natures of risks
arising from the bank's operations are also of significant importance. Factors that contribute significantly to
operational risk include the following:
(a) The need to process high volumes of transactions accurately within a short time through the large-scale use of
IT.
(b) The need to use electronic funds transfer (EFT) or other telecommunication system to transfer ownership of
large sums of money, with the resultant risk of exposure to loss arising from payments to incorrect parties
through fraud or error.
(c) The conduct of operations in many locations with a resultant geographic dispersion of transaction processing
and internal controls. As a result:
(i) there is a risk that the bank's worldwide exposure, customer-wise and product-wise may not be adequately
aggregated and monitored; and
(ii) control breakdowns may occur and remain undetected or uncorrected because of the physical separation
between management and those who handle the transactions.
(d) The need to monitor and manage significant exposures that can arise over short timeframes. The process of
clearing transactions / RTGS / NEFT may cause a significant build-up of receivables and payables during a day,
most of which are settled by the end of the day. This is ordinarily referred to as intra-day payment risk. These
exposures arise from transactions with customers and counterparties and may include interest rate, currency
and market risks.
(e) The handling of large volumes of monetary items, including cash, negotiable instruments and transferable
customer balances, with the resultant risk of loss arising from theft and fraud by employees or other parties.
(f) The inherent complexity and volatility of the environment in which banks operate, resulting in the risk of
inappropriate risk management strategies or accounting treatment, in relation to such matters as the
development of new products and services.
(g) Overseas operations are subject to the laws and regulations of the countries in which they are based as well as
those of the country in which the parent entity has its headquarters. This may result in the need to adhere to
differing requirements, thereby, leading to risk that operating procedures that comply with regulations in some
jurisdictions do not meet the requirements of others.
Response to the Assessed Risks
2.105 SA 330, "The Auditor's Responses to Assessed Risks" deals with the auditor's responsibility to design and
implement responses to the risks of material misstatement identified and assessed by the auditor in accordance with
SA 315. Further, it requires the auditor to design and implement overall responses to address the assessed risks of
material misstatement at the financial statement level. The auditor should design and perform further audit
procedures whose nature, timing and extent are based on and are responsive to the assessed risks of material
misstatement at the assertion level. In designing the further audit procedures to be performed, the auditor should:
(a) Consider the reasons for the assessment given to the risk of material misstatement at the assertion level for
each class of transactions, account balance, and disclosure, including:
(i) The likelihood of material misstatement due to the particular characteristics of the relevant class of
transactions, account balance, or disclosure (i.e., the inherent risk); and
(ii) Whether the risk assessment takes into account the relevant controls (i.e., the control risk), thereby
requiring the auditor to obtain audit evidence to determine whether the controls are operating effectively
(i.e., the auditor intends to rely on the operating effectiveness of controls in determining the nature, timing
and extent of substantive procedures); and
(b) Obtain more persuasive audit evidence the higher the auditor's assessment of risk.
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Risk Assessment and Internal Control
2.106 The auditor shall design and perform tests of controls and substantive procedures to obtain sufficient
appropriate audit evidence, as to the operating effectiveness of relevant controls, and to detect material
misstatements at the assertion level.
Risk Control Matrix (RCM)
2.107 The various risks, both at the financial statement level and at the process level which are assessed together
with the controls relevant against the same can be documented in the form of a RCM, which is a comprehensive
document which captures at one place, for each business cycle, the following information:
· The risks of material misstatement including the fraud risks and any other significant risks which must be
separately identified.
· The account balances affected against each of the risks identified above.
· The financial statement assertions which are addressed for each of the above risks and accounts balances.
· The controls which address each of the risks and assertions. A control may address more than one risk or
assertion as discussed earlier.
· The frequency of the control.
· Who is responsible for testing and reporting on the control and the document(s) which need to be prepared to
evidence the exercise of the control.
An illustrative format of the RCM is given hereunder:
RISK CONTROL MATRIX--------BUSINESS CYCLE#
Risk (what could go Account Balances Description of Control Control Type Manual / Automated
Wrong?) Affected Activity * Preventive / Detective control
* Should also cover / address the responsibilities, frequency, and documentary evidence. The frequency could
also be specified in separate column.
# The following are some of the common business cycles for which separate RCMs could be prepared,
depending upon the nature of the entity's business and the materiality of the particular process, which are
relevant from the point of view of ICFR:
· Financial Closing and Reporting
· Bill to collect (Revenue and Receivables)
· Procure to Pay (Purchase / Expenses and Accounts Payables)
· Payroll
· Treasury
· Cash and Bank
· Fixed assets and Depreciation
· Taxation
· Lending
· Borrowing
· Deposits (Separately for Term Deposits and Current and Savings Accounts)
· Derivatives and FX
· Third party products / cross selling products
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
An important element in the preparation of the RCM is to understand the interplay between the business cycles and
the related activities / processes and the account balances affecting the same, to the extent it impacts the financial
reporting. Finally, the RCM should also help to identify controls which are relevant and not relevant.
Preparation of a RCM is one of the documentation methods for the Internal Control Framework and would assist in
reporting on the operating effectiveness of Internal Financial Controls, wherever applicable. Further, whilst the
preparation of the same is recommended by the Management as a part of its assessment of the design and
operating effectiveness of the controls for Board Reporting, in terms of Section 134(5)(e) of the companies Act, 2013,
in case the same is not prepared the auditor can use the same for testing the operating effectiveness of Internal
Financial Controls over Financial Reporting. The requirement of IFCFR is applicable to the banks registered under
the Companies Act, 2013. As such the other banks such as public sector banks, RRBs do not have to legally adhere
to the requirements in the form mentioned in this paragraph. However, the banks may follow this voluntarily to help
them monitor the control environment effectively. The Management should put in place a system to periodically test
the effectiveness of the significant controls identified in the RCMs.
Value-at-risk (`VAR')
2.108 For a given portfolio, value-at-risk measures the potential future loss (in terms of market value) that, under
normal market conditions, will not be exceeded, with a defined confidence level in a defined period. The value-at-risk
for a total portfolio represents a measure of diversified market risk (aggregated using pre-determined correlations) in
that portfolio. Banks calculate value-at-risk for both internal and regulatory reporting using a 99% confidence level.
Stress Testing
2.109 Globally, banks are increasingly relying on statistical models to measure and manage the financial risks to
which they are exposed. These models are gaining credibility because they provide a framework for identifying,
analysing, measuring, communicating and managing these risks. Since models cannot incorporate all possible risk
outcomes and are generally not capable of capturing sudden and dramatic changes, banks supplement models with
`stress tests'. Internationally, stress testing has become an integral part of banks' risk management systems and is
used to evaluate the potential vulnerability to some unlikely but plausible events or movements in financial variables.
There are broadly two categories of stress tests used in banks, viz., sensitivity tests and scenario tests. These may
be used either separately or in conjunction with each other.
2.110 Banks usually use a wide range of quantitative tools and matrices to measure and monitor risks. Some of
the commonly used tools to measure and monitor market risk are Value at Risk (VAR) and Stress Testing.
2.111 RBI, vide its circular no. DBOD. No. BP. BC.101 / 21.04.103/ 2006-07 dated June 26, 2007 on "Guidelines
on Stress Testing" has required that all commercial banks (excluding RRBs and LABs) shall put in place a Board
approved `Stress Testing framework' to suit their individual requirements which would integrate into their risk
management systems. The circular further requires that the framework should satisfy certain essential requirements
as listed therein.
2.112 The circular also states that while traditionally stress tests are used in the context of managing market risks,
these may also be employed in the management of credit risks, operational risks and liquidity funding risk. Banks
should identify their major risks that should be subjected to stress tests.
2.113 Banks should stress the relevant parameters at least at three levels of increasing adversity minor,
medium, and major with reference to the normal situation and estimate the financial resources needed by it under
each of the circumstances to:
a) meet the risk as it arises and for mitigating the impact of manifestation of that risk;
b) meet the liabilities as they fall due; and
c) meet the minimum CRAR requirements. Banks may apply stress tests at varying frequencies dictated by their
respective business requirements, relevance and cost.
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Risk Assessment and Internal Control
2.114 The results of the various stress tests should be reviewed by the senior management and reported to the
Board. The circular emphasises that these results should be an essential ingredient of bank's risk management
systems.
2.115 The remedial actions that banks may consider necessary to activate when the various stress tolerance
levels are breached may include:
a) Reduction of risk limits;
b) Reduction of risks by enhancing collateral requirements, seeking higher level of risk mitigants, undertaking
securitisation, and hedging;
c) Amend pricing policies to reflect enhanced risks or previously unidentified risks;
d) Augmenting the capital levels to enhance the buffer to absorb shocks;
e) Enhancing sources of funds through credit lines, managing the liability structure, altering the liquid asset profile,
etc.
2.116 Stress tests should, as far as possible, be conducted on a bank-wide basis and should be adequately
tailored to capture country or market or portfolio specific factors. Stress tests undertaken on a bank-wide basis
enable the Board and senior management to assess the potential impact of the stress situations on the bank's
earnings and capital position, and enable them to develop or choose appropriate strategies for mitigating and
managing the impact of those situations. The framework also helps bank managements in understanding the bank's
risk profile and adjusting it in accordance with their risk appetite. The stress test results should be considered while
establishing and reviewing various policies and limits.
2.117 RBI requires the banks to put in place appropriate stress test policies and the relevant stress test framework
for the various risk factors by September 30, 2007 as also to ensure that their formal stress testing frameworks,
which are in accordance with these guidelines, are operational from March 31, 2008.
BASEL III framework
2.118 The Basel Committee on Banking Supervision (BCBS) and the Financial Stability Board (FSB) had
undertaken an extensive review of the regulatory framework in the wake of the sub-prime crisis. In the document
titled `Basel III: A global regulatory framework for more resilient banks and banking systems', released by the BCBS
in December 2010, it had inter alia proposed certain minimum set of criteria for inclusion of instruments in the new
definition of regulatory capital. The RBI issued a circular no. DBOD.No.BP.BC.98 /21.06.201/2011-12 dated May 2,
2012 on the subject "Guidelines on Implementation of Basel III Capital Regulations in India" and also Master Circular
No. DBR.No.BP.BC.1/21.06.201/2015-16 dated July 1, 2015 on "Basel lII Capital Regulations". Vide these circulars
the RBI has prescribed the final guidelines on Basel III capital regulations. The reader may refer to the chapter 1,
"Basel III" of Part VI of the Guidance Note for the detailed guidance on the New Capital Adequacy Framework, i.e.,
Basel III.
Demonetisation
2.119 Auditors could review closure of pending compliances of the issues raised by Concurrent/Internal/External
Auditors/Inspectors on demonetization process. Appropriate reporting could be done in the LFAR for the year
depending on the pending issues and its severity.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Annexure 1
Risks Associated with the Banking Activities
Risk is a function of probability or likelihood of occurrence and the significance of the impact. Risk implies
vulnerability and threat. The key is the impact as an event may have a very low probability of occurrence or even
remote probability but the impact could be disastrous. In such cases risks do not get identified or get due focus thus
diluting controls necessary for their mitigation. Another key factor is the speed at which risks permeate through the
entity once affected. Globalization of the economy has led to integration of world economies & increased the risks &
an event occurring anywhere in the world can have an impact on Banks in India.
Risks associated with banking activities can be broadly categorised as follows:
a) Concentration Risk: Banking risks increase with the degree of concentration of a bank's exposure to any one
customer, industry, geographic area or country. For example, a bank's loan portfolio may have large
concentrations of loans or commitments to particular industries, and some, such as real estate, shipping and
natural resources, may have highly specialized practices. Assessing the relevant risks relating to loans to entities
in those industries may require knowledge of these industries, including their business, operational and reporting
practices.
b) Country Risk: The risk of foreign customers and counterparties failing to settle their obligations because of
economic, political and social factors of the counterparty's home country and external to the customer or
counterparty.
c) Credit Risk: The risk that a customer or counterparty will not settle an obligation for full value, either when due
or at any time thereafter. Credit risk, particularly from commercial lending, may be considered the most important
risk in banking operations. Credit risk arises from lending to individuals, companies, banks and governments. It
also exists in assets other than loans, such as investments, balances due from other banks and in off-balance
sheet commitments. Credit risk also includes country risk, transfer risk, replacement risk and settlement risk.
d) Currency Risk: The risk of loss arising from future movements in the exchange rates applicable to foreign
currency assets, liabilities, rights and obligations.
e) Fiduciary Risk: The risk of loss arising from factors such as failure to maintain safe custody or negligence in the
management of assets on behalf of other parties.
f) Interest Rate Risk: The risk that a movement in interest rates would have an adverse effect on the value of
assets and liabilities or would affect interest cash flows.
g) Legal and Documentary Risk: The risk that contracts are documented incorrectly or are not legally enforceable
in the relevant jurisdiction in which the contracts are to be enforced or where the counterparties operate. This
can include the risk that assets will turn out to be worthless or liabilities will turn out to be greater than expected
because of inadequate or incorrect legal advice or documentation. In addition, existing laws may fail to resolve
legal issues involving a bank; a court case involving a particular bank may have wider implications for the
banking business and involve costs to it and many or all other banks; and laws affecting banks or other
commercial enterprises may change. Banks are particularly susceptible to legal risks when entering into new
types of transactions and when the legal right of the counterparty to enter into a transaction is not established.
h) Liquidity Risk: The risk of loss arising from the changes in the bank's ability to sell or dispose of an asset. The
risk of liquidity risk turning into a solvency risk needs to be monitored as risk can swiftly move across the entity.
i) Modelling Risk: The risk associated with the imperfections and subjectivity of valuation models used to
determine the values of assets or liabilities.
j) Operational Risk: The risk of direct or indirect loss resulting from inadequate or failed internal processes,
people and systems or from external events.
k) Price Risk: The risk of loss arising from adverse changes in market prices, including interest rates, foreign
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Risk Assessment and Internal Control
exchange rates, equity and commodity prices and from movements in the market prices of investments.
l) Regulatory Risk: The risk of loss arising from failure to comply with regulatory or legal requirements in the
relevant jurisdiction in which the bank operates. It also includes any loss that could arise from changes in
regulatory requirements. For example, money laundering risk is a Regulatory risk. (The circular -
DBS.CO.PP.BC.6/11.01.005/2006-07 dated April 20, 2007 on "Compliance Function in Banks" which lays down
detailed requirements in respect of compliance related aspects such as compliance risk, responsibility of the
Board of Directors, responsibility of the senior management, compliance policy, compliance structure,
compliance principles, process, procedures, compliance programme, etc. is relevant).
m) Replacement/Performance Risk: The risk of failure of a customer or counterparty to perform the terms of a
contract. This failure creates the need to replace the failed transaction with another counter party at the current
market price. This may result in a loss to the bank equivalent to the difference between the contract price and
the current market price.
n) Reputational Risk: The risk of losing business because of negative public opinion and consequential damage to
the bank's reputation arising from failure to properly manage some of the above risks, or from involvement in
improper or illegal activities by the bank or its senior management, such as money laundering or attempts to
cover up losses.
o) Settlement Risk: The risk that one side of a transaction will be settled without value being received from the
customer or counterparty. This will generally result in the loss to the bank of the full principal amount.
p) Solvency Risk: The risk of loss arising out of possibility of bank not having sufficient value of assets to meet its
obligations on the due date, whereas liquidity risk means the risk related to disposal of assets.
q) Transfer Risk: The risk of loss arising when a counterparty's obligation is not denominated in the counterparty's
home currency. The counterparty may be unable to obtain the currency of the obligation irrespective of the
counterparty's particular financial condition.
r) Volatility Risk: This is a type of market risk which specifically pertains to option positions. An increase in the
volatility of the price of the instrument underlying the option will generally result in an increase in the value of any
bought (long) option position. The opposite will apply for a decrease in volatility.
Following are examples of some events/ transactions that give rise to one or more of the abovementioned risks
(though they may not have a direct impact on the financial statements of a bank:
Cyber Risks - Use of Internet / Mobile Banking has changed the dimension of banking and with it resulted in
new risks Cyber risks or risks associated due to Identity Thefts, Hacking, Spam, Phishing / Vishing / Dos or
DDos attacks, e-mail spoofing, virus attacks, Use of malicious codes, compromise of digital signatures etc.,
resulting in loss or compromise of data is very common. Risks associated with usage of Debit & Credit Cards or
through ATM operations are also increasing.
Cyber criminals can commit a crime much faster than conventional fraudsters plus have the added advantage
of anonymity. The level of anonymity makes attempting and successfully conducting a cyber crime relatively
easier than conventional frauds. It also makes dealing with cyber criminals a daunting aspect.
Usage of Social Networking sites has exploded over the past few years especially amongst the youth. Personal
information is routinely exchanged on a real time basis on social networking sites. This is misused by people
purporting to be trusted members of the group while in eventuality they may be fraudsters. Confidential private
information exchanged over emails also can be easily tracked and misused.
Hacking or Cracking means illegal intrusion into the information on a computer system or network. The motive
could include greed, power, revenge, adventure, desire to access forbidden information, destructive mindset
and wanting to sell to earn revenue.
Phishing refers to the acquiring of sensitive information such as user names, passwords or credit card details
by masquerading as a trustworthy entity in an electronic communication. The word is an eulogy of the fishing
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
technique of using a bait to lure the victim. It directs users to enter details on a fake website whose look and feel
are almost identical to the legitimate one. It exploits the user's trust in not being able to identify the site being
visited or the program being used is not the real one.
Vishing and Smishing are phone scams similar to "phishing". Vishing is a telephone call claiming to be from a
legitimate company requesting your personal information to resolve an urgent financial matter Smishing is
accomplished through text messages on a cell phone by asking a person to call a particular number or click on
a link that could contain malicious code that could potentially steal information stored in that person's cell phone
without his/her knowledge.
Data theft is aided by use of hand held devices like flash drives, I-pods, digital cameras and the ability to
transmit large amounts of data quickly vide e-mail, web pages, USB drives, DVD storages & other hand held
devices.
E mail spoofing is sending an email to another person in such a way that it appears that the email was sent by
someone else. The mail appears to originate from one source but is actually sent from another source.
Denial of Service or DOS attacks floods the bandwidth of the victim's network or fills his email box with spam
mail depriving him of service that he is entitled to access or provide.
Dissemination of viruses by use of malicious software that attaches itself to other software. Some of the
common viruses are Virus worms, Trojan horse, Web jacking, Email bombing.
Impersonation: A crime in which an imposter obtains key pieces of personal information in order to
impersonate someone else. The imposter assumes the identity of that person to make transactions, purchases
or get loans or credits. This could also be done for illegal immigration, hiding from creditors or people who want
to be anonymous for personal reasons. The person whose identity is assumed suffers various consequences as
a result of being held responsible for the perpetrators actions.
Botnets - networks of compromised computers, controlled by remote attackers in order to perform such illicit
tasks as sending spam or attacking other computers.
Malvertising is a method whereby users download malicious code by simply clicking at some advertisement
on any website that is infected.
Cyber Extortion: refers to blackmailing the victim and extorting money to stop the DOS attacks or give back
the information stolen or discontinue vandalism etc.
Cyber Terrorism / Warfare: Refers to Distributed Denial of service attacks, hate websites and hate emails,
attacks on service network etc.
Computer Vandalism refers to damaging or destroying data rather than stealing or misusing it. Programs are
used which attach themselves to a file and then circulate.
PUPs (Potentially Unwanted Programs) are less harmful but annoying malware which installs unwanted
software in your system including search agents and toolbars.
Software piracy through either theft or illegal copying of genuine programs or by counterfeiting and distribution
of product intended to be passed as originals.
Misuse of Digital Signature: If the private key is not stored securely, it can be misused without the knowledge
of the owner of the Private key to issue unauthorized digital certificates for cyber espionage, malware diffusion
or sabotage.
Man in the Middle Attacks (MITM) refers to attacks where the attacker secretly relays or possibly alters the
communication between two parties who believe they are directly communicating with each other. The attacker
intercepts all messages between the two victims and injects new ones and in fact controls the entire
conversation.
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Risk Assessment and Internal Control
Credit Card Frauds involving Debit or Credit cards for obtaining goods without paying or obtaining
unauthorized funds from an account.
Use of fake identities, documentations or impersonation to obtain genuine cards.
Using a stolen or lost Credit card for illegal purchases before the holder notifies the issuing bank and the issuing
bank puts a block on the account.
Skimming is the theft of payment card information used in a legitimate manner by using basic methods like
photocopying receipts or advanced methods like using small electronic devices (skimmers) to swipe & store
hundreds of victim card numbers.
Tele Phishing is obtaining a list of individuals with their name & phone numbers luring victims into thinking that
they are speaking with a trusted organization while handing over sensitive information such as card details.
A Merchant at a POS(Point of Sale) terminal may allow a fraudster to get goods on a stolen credit card for
consideration. He may provide the details of customer cards to the fraudster for a consideration. He can
connive with the fraudster & allow him to substitute the imprinter to collect data which can then be used to
multiply cards.
The merchant may at times swipe the card for a nonexistent transaction & accommodate another by lending
him money from the value of the transaction he has received from the paying bank.
At times a card holder may himself declare the card as stolen or lost to the issuer. Soon after he himself uses
the card to its limits. The loss on the card post intimation is the loss of the banker / issuer & gains are made in
this manner.
Various credit cards are applied simultaneously at the same time by a fraudster with no previous default history
& with the intention to use the card to the fullest and not to repay. At times the fraudster may agree to a one
time settlement of the dues at a much lesser amount than what he owes.
Auditor has to review whether risks faced by the Branch are appropriately identified and assessed and whether
appropriate controls are put in place, implemented and monitored to reduce/mitigate risks to an acceptable
level. Testing of efficiency, effectiveness of controls and reporting to give an assurance thereon is a key audit
function.
49
II-3
Special Considerations
in a CIS Environment
3.01 As per SA 315, "Identifying and Assessing the Risks of Material Misstatement through Understanding the
Entity and Its Environment", the overall objective and scope of an audit does not change in a Computer
Information Systems (`CIS') environment. However, the use of a computer changes the processing, storage,
retrieval and communication of financial information and may affect the accounting and internal control systems
employed by the bank, accordingly, CIS environment may affect:
the procedures followed by the auditor in obtaining sufficient understanding of the accounting and internal
control system;
the auditor's evaluation of inherent risk and control risk through which the auditor assesses the audit risk;
and
the auditor's design and performance of tests of control and substantive procedures appropriate to meet
the audit objective.
3.02 The auditor should evaluate, inter alia, the following factors to determine the effect of CIS environment on
the audit:
the extent to which the CIS environment is used to record, compile and analyse accounting information;
the system of internal control in existence in the bank with regard to:
(i) flow of authorised, correct and complete data to the processing centre;
(ii) processing, analysis and reporting tasks undertaken; and
the impact of computer-based accounting system on the audit trail that could otherwise be expected to
exist in an entirely manual system.
3.03 In today's environment all banks have set up and implemented large scale computerisation projects, which
has resulted in changes in the processing and storage of information. Information generated by IT systems are also
used for decision making. The importance, extent of use and complexity of a bank's information systems affect the
organisation and procedures employed by the entity to achieve adequate internal control. Thus, while the overall
objective and scope of audit do not change simply because data is maintained on computers, the procedures
followed by the auditor in his study and evaluation of the accounting system and related internal controls and the
nature, timing and extent of his other audit procedures are affected in a CIS environment. The nature of audit
evidence and the techniques used to evaluate them have also undergone a significant change. Audit procedures are
now transformed from "Auditing around the computer" to "Auditing through the computer".
3.04 The control concerns arising from the use of IT by a bank are similar to those arising when IT is used by
other organisations. However, the matters that are of particular concern to the auditor of a bank include the
following:
The use of IT to calculate and record substantially, all of the interest income and interest expense, which
are ordinarily two of the most important elements in the determination of a bank's earnings.
The use of IT and telecommunications systems to determine the foreign exchange security and derivative
trading positions, and to calculate and record the gains and losses arising from them.
The extensive, and in some cases almost total, dependence on the records produced by IT because they
represent only readily accessible source of detailed up-to-date information on the bank's assets and liability
positions, such as, customer loan and deposit balances.
Special Considerations in a CIS Environment
The use of complex valuation models incorporated in the IT systems.
The models used to value assets and the data used by those models are often kept in spreadsheets
prepared by individuals on personal computers not linked to the bank's main IT systems and not subject to
the same controls as applications on those systems.
The use of different IT systems resulting in the risk of loss of audit trail and incompatibility of different
systems.
The use of multiple channels of delivery of services to a bank's customers such as ATM, EFT, internet
banking, card-based payment systems, etc.
The integrity of financial data moving through data interfaces between several systems.
Potential risk of management override of controls through privileged access to information systems.
Potential segregation of duty issues arising from access to multiple systems granted to users.
The extensive use of third party vendors (service organizations) to whom financial data processing
activities or management of IT infrastructure is outsourced.
3.05 Electronic Funds Transfer (`EFT') systems are used by banks both internally (for example, for transfers
between branches and between automated banking machines and the computerised files that record account
activity) and externally between the bank and other financial institutions (for example, through the SWIFT network)
and also between the bank and its customers through the internet or other electronic commerce media.
3.06 The auditor obtains an understanding of the core IT, EFT, telecommunication applications and the links
between those applications. The auditor relates this understanding to the major business processes or balance sheet
positions in order to identify the risk factors for the organisation and therefore, for the audit. In addition, it is important
to identify the extent of the use of self-developed applications or integrated systems, which will have a direct effect on
the audit approach. (Self-developed systems require the auditor to also focus more extensively on the program
change controls).
3.07 When auditing in a distributed IT environment, the auditor obtains an understanding of where the core IT
applications are located. If the bank's Wide Area Network (WAN) is dispersed over several countries, specific
legislative rules might apply to cross-border data processing, in such an environment, audit work on the access
control system, especially on access violations, is an important part of the audit. Further, if the system is hosted
outside India, Auditor can obtain report of service organization as per SAS70 or equivalent work/report from that
country.
3.08 RBI's circular No -DBOD.COMP.BC.No.130/ 07.03.23/ 2000-01 dated 14th June 2001 on Internet banking in
India Guidelines, states in Para II on Legal Issues as follows, "Considering the legal position prevalent, there is an
obligation on the part of banks not only to establish the identity but also to make enquiries about integrity and
reputation of the prospective customer. Therefore, even though request for opening account can be accepted over
Internet, accounts should be opened only after proper introduction and verification of the identity of the customer".
3.09 RBI has issued guidelines to scheduled commercial banks on cyber security framework vide its circular no
RBI/2015-16/418 DBS.CO/CSITE/BC.11/33.01.001/2015-16 dated June 2, 2016. As per this circular, banks are
required to report promptly (Within 2 to 6 hours) the cyber- attack incidents, in the format given in Annexure 3 of the
aforesaid circular.
Banks should immediately put in place a cyber-security policy elucidating the strategy containing an appropriate
approach to combat cyber threats given the level of complexity of business and acceptable levels of risk, duly
approved by their Board.
Confirmation in this regard should be communicated to Cyber Security and Information Technology Examination
(CSITE) Cell of Department of Banking Supervision, Reserve Bank of India, Central Office, World Trade Centre-I, 4th
Floor, Cuffe Parade, Mumbai - 400 005 at the earliest, and in any case not later than September 30, 2016.
A Cyber Crisis Management Plan (CCMP) should be immediately evolved and should be a part of the overall Board
approved strategy.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Categorisation of Banks based on level of Computerisation
3.10 Banks may be divided into three board categorises based on the level of computerisation:
Non-computerised banks
Partially Computerised banks
Fully computerised banks
The importance, extent of use and complexity of information systems of each bank may be different than the
others. For effectively using a risk-based audit approach, an auditor needs to evaluate the IT risks for a bank
before determining the nature, timing and extent of audit procedures.
3.11 Special care has to be taken while doing an audit in a fully computerised environment (where the Bank
uses Core Banking Solution-CBS).
Responsibility of Central Auditor vis-à-vis Branch Auditor in fully computerised bank
3.12 Banks, which have high level of computerisation and centralisation, equally have a high level of
decentralisation of processes and underlying activities, e.g., in case of advances, the credit processing and
accounting are centralised but at the same time there could be separate teams carrying out various parts of credit
processing and day-to-day monitoring at the central level; and each team is aware of the specific part of activity
only. The central auditor's biggest challenge is to first get acquainted with all the decentralised processes and
activities and then to co-ordinate with the relevant persons for the required information. Normally, the central
auditor uses the work of an expert for reviewing the computerisation processes and systems, especially in case of
core banking system. The findings and reservations, if any, of an expert should be communicated to the other joint
auditors. Similarly, the central auditor may consider necessary to communicate the findings and reservations, if
any, of an expert to branch auditors to review certain specific aspects at the branch level. This will not only aid in
enhancing the control review process of an audit but also enable the central auditor as well as the branch auditors
to formulate their audit methodology and sampling techniques.
3.13 It may also be noted that foreign banks in India are largely guided by global policies, processes and
systems (including IT systems) with some level of customisations to meet the local requirements. In some foreign
banks, even the IT systems (hubs, servers, etc.) and monitoring thereof (periodic system audit, etc.) are
centralised in other countries and no country-specific-process documentation and periodic validations are
prescribed by that foreign bank. Therefore, the local IT teams may at the time of an audit not be in a position to
explain the basic configuration of accounting systems and how the local requirements are in-built in the global
systems. In some other banks, the primary accounting records are maintained as per global reporting standards
and the local financial statements are extracted from those records. Further, the scope of internal auditors and
system auditors, etc., is decided on the global basis rather than on country basis. Such high level of globalisation
poses big challenge for the local auditors and they have to largely rely on the past consistent globally accepted
practices and then to base their audit opinion on explanations and representations coupled with test of controls
and substantive checking to the extent possible. These banks are also required to adhere to the guidelines of the
RBI with regard to computerisation and the checks and controls around it.
3.14 Generally, the branch auditors do not have access to the overall IT policy, processes, controls and
accounting procedures implemented by the bank. Moreover, the branch auditors confront following practical
issues at fully computerised branches:
Accounting manual, entries, calculations and framework is built in computerised accounting systems.
Critical IT and manual controls are centralised at HO level.
Limited access to periodical MIS and exception reports generated by the system.
Documentation of critical processes performed for accounting and book keeping (IT and Manual).
Access to primary records and entry level transactions.
Audit sampling.
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Special Considerations in a CIS Environment
Hard copies of transactions.
Independent IT Audit at branches, etc.
3.15 The overall review of IT environment and of the computerised accounting system has to be taken up at
central level. The management plays a more proactive role to ensure that the computerised accounting systems
are working properly and effectively. It is for the central auditor to review whether the management is performing
this role effectively. The roles and responsibilities of bank, the central auditor and the branch auditors can be
enumerated as under.
Role and responsibilities of the Bank
3.16 Considering the importance of IT systems in the preparation and presentation of financial statement, it is
imperative that the bank should share the detailed information about the following key aspects relating to IT
environment of the bank with the central auditor at regular intervals:
Overall IT Policy, structure and environment of the bank's IT system and changes/developments, if any,
thereto.
Data processing and data interface under various systems.
Data integrity and data security.
Business Continuity Plans and Disaster Recovery Plans.
Accounting manual and critical accounting entries (including month-end and year-end) and the processes
and involvement of IT systems.
Controls over key aspects, such as, account codes and mapping thereof, use of various account heads
including other assets and other liabilities, asset classification, income recognition, expense booking,
overdue identification, month-end and year-end procedures, valuation and re-valuation of various items of
the financial statements, KYC, ALM, etc.
Controls and recording of various e-banking and internet banking products.
Manual processing of key transactions.
MIS reports being generated and the periodicity thereof.
Hard copies being generated and the periodicity thereof.
Process of generating information related to various disclosures in the financial statements and the
involvement of the IT systems.
Major exception reports and the process of generation thereof along with logic embedded in generation of
such reports.
Major IT related issues (including frauds and failures) faced and resolved/unresolved during the year, such
as, data/system corruption, system break-down, etc., having bearing on the preparation and presentation of
financial statements.
Significant observations of internal auditors, concurrent auditors, system auditors, RBI inspection and
internal inspection, etc., related to computerised accounting and overall IT systems.
Customer complaints related to mistakes in transactions (interest application, balances, etc.).
In order to ensure that the technology deployed to operate the payment system/s authorised is/are being
operated in a safe, secure, sound and efficient manner and as per the process flow submitted by the bank
for which authorisation has been issued, banks are required to get a System audit done by a firm of
Chartered Accountants / Certified Information System Auditor. The scope of the System audit would include
evaluation of the hardware structure, operating systems and critical applications, security and controls in
place, including access controls on key applications, disaster recovery plans, training of personnel
managing systems and applications, documentation, etc. The system auditor is also required to comment
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
on the deviations, if any, in the processes followed from the process flow submitted to RBI while seeking
authorisation.4
Role and responsibilities of the central auditor
3.17 Based on the information received from the bank, the statutory central auditor would:
Need to review whether there is clear segregation of work to be undertaken at central level and branch
level under the bank's IT system for accounting of transactions.
Consider the need for sending a detailed note to the branch auditors explaining their roles and
responsibilities in the light of what is stated above.
Review whether access to primary and subsidiary records is provided and use of data analysis tools is
allowed at central and branch level.
Perform test of controls and substantive checking of sample transactions at the central level and if
required, share the results with the branch auditors.
Based on the work undertaken, identify key issues to be taken up with the Audit Committee and the Board
of the bank.
Consider whether the significant adverse observations in the periodic system audit reports need to be
shared with the branch auditors and also be considered while framing the opinion of true and fair view of
the financial statements of the bank.
Role and responsibilities of branch auditors
3.18 Based on the guidance and information received from the central auditor, the branch auditors need to
ensure that:
Their roles and responsibilities are clearly understood and implemented.
To the extent possible, data analysis tools are used for better and effective audit.
Test of controls and substantive checking of sample transactions is carried out at the branch level and,
where considered necessary, the results are shared with the statutory central auditors.
Significant observations having bearing on the true and fair view are reported to the statutory central
auditors.
Any other limitations on audit which are required to be reported to the central auditors are reported in a
timely manner.
Audit in a CIS environment
Assessment of Inherent and Control Risks
3.19 The nature of banking operations is such that the auditors may not be able to reduce audit risk to an
acceptably low level by the performance of substantive procedures alone. This is because of factors such as the
following:
The extensive use of IT and EFT systems, which means that much of the audit evidence is available only in
electronic form and is produced by the bank's own IT systems.
The high volume of transactions processed by banks, which makes reliance on substantive procedures
alone impracticable.
The geographic spread of banks' operations.
4
Refer RBI circular No. DPSS.AD.No./ 1206/02.27.005/2009-2010 dated 7th December, 2009 on "System Audit of the Payment
Systems operated under the PSS Act, 2007".
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Special Considerations in a CIS Environment
Complex trading transactions.
3.20 In most situations, the auditors' ability to reduce audit risk to an acceptably low level would be affected by
the internal control systems established by the management that allow the auditors to be able to assess the level of
inherent and control risks as less than high. The auditors obtain sufficient appropriate audit evidence to assess the
level of inherent and control risks.
3.21 The auditor's procedures would need to be adapted as the circumstances warrant and in respect of each
account, different procedures may be necessary. An illustrative checklist on audit considerations in a CIS
environment is given as Annexure A to this Chapter. Further, an illustrative checklist on Bank Audit in computerised
environment, which is divided in two parts, viz., Part I, Bank Audit in computerised environment and Part II, automatic
teller machines is given as Annexure B to this Chapter.
3.22 The principal objective of the auditor in undertaking an audit in a CIS environment is to evaluate the
effectiveness of controls. In simple words, controls are those policies and procedures which the organisation
implements to minimise the events and circumstances whose occurrence could result in a loss / misstatement. There
are mainly four types of controls.
A. Deterrent controls - Deterrent Controls are designed to deter people, internal as well as external, from doing
undesirable activities. For example, written policies including the punitive measures may deter people from doing
undesired activities.
B. Preventive Controls - Preventive Controls prevent the cause of exposure from occurring or at least minimise the
probability of unlawful event taking place. For example, security controls at various levels like hardware,
software, application software, database, network, etc.
C. Detective Controls - When a cause of exposure has occurred, detective controls report its existence in an effort
to arrest the damage further or minimise the extent of the damage. Thus, detective controls limit the losses if an
unlawful event has occurred.
D. Corrective Controls - Corrective Controls are designed to recover from a loss situation. For example, Business
Continuity Planning is a corrective control. Without corrective controls in place, the bank has risk of loss of
business and other losses due to its inability to recover essential IT based services, information and other
resources after the disaster has taken place.
3.23 The auditor should obtain a preliminary understanding of the IT environment and various controls put in
place by the management, including entity-level controls and then test and evaluate whether the controls are
operating effectively. The auditor should discuss the methodology adopted by the bank in implementing controls
and their monitoring with the Head of the IT department and the Head of the audit department. These discussions
will enable the auditor to get a view on the manner in which the bank has implemented controls. Based on these
discussions, the auditor could interact with the various officials of the bank to determine whether they are
sensitised to the control expectations of the management considering the technology deployed. If this sensitisation
level is low, the auditor may need to perform more extensive audit procedures.
Security Control Aspects
3.24 The key security control aspects that an auditor needs to address when undertaking audit in a
computerised bank include:
Ensure that authorised, accurate and complete data is made available for processing.
Ensure that in case of interruption due to power, mechanical or processing failures, the system restarts
without distorting the completion of the entries and records.
Ensure that the system prevents unauthorised amendments to the programmes.
Verify whether "access controls" assigned to the staff-working match with the responsibilities as per
manual. It is important for the auditor to ensure that access and authorisation rights given to employees are
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
appropriate.
Verify that segregation of duties is ensured while granting system access to users and that the user
activities are monitored by performing an activities log review.
Verify that changes made in the parameters or user levels are authenticated.
Verify that charges calculated manually for accounts when function is not regulated through parameters are
properly accounted for and authorised.
Verify that all modules in the software are implemented.
Verify that exceptional transaction reports are being authorised and verified on a daily basis by the
concerned officials. It is important for auditor to understand the nature of exception and its impact on
financials.
Verify that the account master and balance cannot be modified/amended/altered except by the authorised
personnel.
Verify that all the general ledger accounts codes authorised by Head Office are in existence in the system.
Verify that balance in general ledger tallies with the balance in subsidiary book.
Verify that important passwords like database administrator and branch manager's password are kept in
sealed cover with branch manager so that in case of emergency and the absence of any of them the
passwords could be used to run the system promptly.
Since back up is taken at centralised location, Central Auditor should:
o Check that the bank takes daily and monthly backups. The backup media should be duly labelled and
indexed properly and should be maintained under joint custody.
o Ideally, daily backup should be taken in 6 sets, one for each weekday and 12 sets for each month end.
Verify that backup register is maintained and updated.
Verify that the backup media is stored in fireproof cabinet secured with lock and key and also that the off-
site backups are preserved for the emergency.
Verify that the anti-virus software of latest version is installed in servers/PCs of branches to prevent data
corruption, and is being regularly updated for new viruses.
Verify that security patches are applied to systems as and when they are released by the vendors /
developers.
Verify that there are no unauthorised software installed / existent in the Servers / PCs
Verify that access to the computer room is restricted to authorised persons only.
Outsourcing of Financial Services by Banks
3.25 Outsourcing is a worldwide phenomenon, finding presence in every industry, including the banking industry.
With a view to ensure that the banks adequately address the risks associated with outsourcing of some of their
activities (especially financial services) by banks as also to bring such outsourced activities under the regulatory
purview and protect the interests of the customers, the RBI issued circulars no. DBOD.BP.40/21.04.158/2006-07
dated November 3, 2006 on "Managing the Risks and Code of Conduct in Outsourcing of Financial Services by
Banks" read with circular DBOD.No.BP.97/ 21.04.158/2008-09 dated December 11, 2008 and circular
DBS.CO.PPD.BC.5/ 11.01. 005/2008-09 dated April 22, 2009.
3.26 The circular defines "outsourcing" as "a bank's use of a third party (either an affiliated bank within a
corporate group or a bank that is external to the corporate group) to perform activities on a continuing basis that
would normally be undertaken by the bank itself, now or in the future". 'Continuing basis' would include agreements
for a limited period.
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Special Considerations in a CIS Environment
3.27 The said circular contains detailed requirements in respect of the various aspects related to outsourcing,
including:
Activities that should not be outsourced.
Material outsourcing.
Bank's role and regulatory and supervisory requirements.
Risk management practices for outsourced financial services.
Role of Board of Directors and senior management.
Evaluation of risks.
Evaluating the capability of the service provider.
Outsourcing agreement.
Confidentiality and security.
Responsibility of DSA/ DMA/ Recovery Agents.
Business continuity and management of disaster recovery plan.
Monitoring of outsourced activities.
Redressal of grievances related to outsourced services.
Reporting of transactions to Financial Intelligence Unit.
Off-shore outsourcing of financial services.
Self assessment/ proposed outsourcing arrangements.
3.28 Further, paragraph 5.9.3 of the circular envisages that regular audits either by the internal auditors or
external auditors of the bank should assess the adequacy of the risk management practices adopted in overseeing
and managing the outsourcing arrangement, the bank's compliance with its risk management framework and the
requirements of these guidelines. The auditor should accordingly undertake procedures necessary to meet these
requirements. The scope of the auditor's procedures would, however, be within the requirements of the SA 402,
"Audit Considerations relating to an Entity Using a Service Organisation".
3.29 As per another circular no RBI/2014-15/497 DBR.No.BP.BC.76/ 21.04.158/2014-15 dated March 11, 2015,
auditor needs to check that in certain cases, like outsourcing of cash management, which involve reconciliation of
transactions between the bank, the service provider and its sub-contractors reconciliation of transactions between the
bank and the service provider (and/ or its subcontractor), are carried out in a timely manner. An ageing analysis of
entries pending reconciliation with outsourced vendors was placed before the Audit Committee of the Board (ACB).
Auditor should also check the reason for old outstanding items therein.
Security and Risk Mitigation Measures for Electronic Payment Transactions
3.30 Electronic Payments effected through alternate products/channels are becoming popular among the
customers with more and more banks providing such facilities to their customers. One such initiative by RBI is
mandating additional factor of authentication for all Card Not Present (CNP) transactions. Banks have also to put in
place mechanisms and validation checks for facilitating on-line funds transfer, such as: (i) enrolling customer for
internet/mobile banking; (ii) addition of beneficiary by the customer; (iii) velocity checks on transactions, etc.
3.31 With cyber-attacks becoming more unpredictable and electronic payment systems becoming vulnerable to
new types of misuse, it is imperative that banks introduce certain minimum checks and balances to minimise the
impact of such attacks and to arrest/minimise the damage. Accordingly, banks are required by the RBI to put in place
security and risk control measures vide its circular DPSS (CO) PD No.1462/02.14.003/2012-13 dated February 28,
2013 and circular no RBI/2015-16/418 DBS.CO/CSITE/BC.11/33.01.001/2015-16 dated June 2, 2016.
Opening and Operation of Accounts and Settlement of Payments for Electronic Payment Transactions
Involving Intermediaries
3.32 The use of Electronic/Online Payment modes for payments to merchants for goods and services like bill
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
payments, online shopping etc., has been gaining popularity in the country. The increased facilitation by banks and
prepaid payment instrument issuers of the use of electronic modes by customers for payments to merchants
generally involves the use of intermediaries like aggregators and payment gateway service providers. Further,
Electronic Commerce and Mobile Commerce (e-commerce and m-commerce) service providers have also been
acting as intermediaries by providing platforms for facilitating such payments. In most existing arrangements
involving such intermediaries, the payments made by customers (for settlement of e-commerce/m-commerce/bill
payment transactions) are credited to the accounts of these intermediaries, before the funds are transferred to the
accounts of the merchants in final settlement of the obligations of the paying customers. Any delay in the transfer of
the funds by the intermediaries to the merchants account will not only entail risks to the customers and the merchants
but also impact the payment system. With a view to safeguard the interests of the customers and to ensure that the
payments made by them are duly accounted for by the intermediaries receiving such payments and remitted to the
accounts of the merchants who have supplied the goods and services without undue delay, RBI vide its circular no.
DPSS.CO.PD.No.1102 /02.14.08/ 2009-10 dated November 24, 2009 issued guidelines for opening and operation of
accounts and settlement of payments for electronic payment transactions involving intermediaries to ensure safe and
orderly conduct of such transactions. As per RBI Circular No BI/2010-11/339
DPSS.CO.OSD.No.1448/06.08.001/2010-2011 dated December 28, 2010, banks are required to obtain quarterly
certificate from the concurrent auditor on the operations of the intermediaries' accounts including all the
intermediaries accounts maintained with bank.
E Banking
3.33 E-banking may be defined as the automated delivery of new and traditional banking products and services
directly to customers through electronic, interactive communication channels. E-banking includes the systems that
enable financial institution customers, individuals or businesses, to access accounts, transact business, or obtain
information on financial products and services through a public or private network including internet. Customers
access e-banking services using an intelligent electronic device, such as, a personal computer (PC), personal digital
assistant (PDA), smart phones, automated teller machine (ATM), kiosk, etc.
Risks associated with E-banking
Transaction/ Operations Risk
3.34 Transaction/Operations risk arising from fraud, processing errors, system disruptions, or other unanticipated
events shows the bank's inability to deliver products or services. This risk exists in each product and service offered.
The level of transaction risk is affected by the structure of the bank's processing environment, including the types of
services offered and the complexity of the processes and supporting technology.
3.35 In most instances, e-banking activities will increase the complexity of the bank's activities and the quantity of
its transaction/operations risk, especially if the bank is offering innovative services that have not been standardised.
Since customers expect e-banking services to be available 24x7, banks should ensure their e-banking infrastructures
contain sufficient capacity and redundancy to ensure reliable service availability.
3.36 The auditor should examine whether in order to mitigate transaction/operations risk, the bank has put in
place effective policies, procedures, and controls to meet the new risk exposures introduced by e-banking. The basic
internal controls would include segregation of duties, dual controls, and reconciliations. Information security controls,
in particular, become more significant requiring additional processes, tools, expertise and testing.
Credit Risk
3.37 Generally, the bank's credit risk is not increased by the mere fact that a loan is originated through an e-
banking channel. However, the bank should ensure that additional precautions are in place when originating and
approving loans electronically including assuring management information systems effectiveness by preparing a
track of the performance of portfolios originated through e-banking channels. The following aspects of on-line loan
origination and approval tend to make risk management of the lending process more challenging:
Verifying the customer's ID for on-line credit applications and executing an enforceable contract;
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Special Considerations in a CIS Environment
Monitoring and controlling the growth, pricing, and on-going credit quality of loans originated through e-
banking channels;
Monitoring and oversight of third-parties operations doing business as agents or on behalf of the banks;
Valuing collateral and perfecting liens over a potentially wider geographic area; and
Collecting loans from individuals over a potentially wider geographic area.
If not properly managed, these aspects can significantly increase credit risk.
Compliance/ Legal Risk
3.38 Compliance and legal issues arise out of the rapid growth in usage of e-banking services and the
differences between the electronic and paper-based processes. E-banking is a new delivery channel where the laws
and rules governing the electronic delivery of certain financial products or services may be ambiguous or still
evolving. Specific regulatory and legal challenges include:
Uncertainty over the legal jurisdictions applicable to the transaction taking place through e-banking;
Delivery of credit and deposit related disclosures/notices as required by law or regulation;
Retention of required compliance documentation for on-line advertising, applications, statements,
disclosures, notices; and
Establishment of legally binding electronic agreements.
3.39 Banks offering e-banking services, both informational and transactional, assume a higher level of
compliance risk because of the changing nature of the technology, the speed at which errors can be replicated, and
the frequency of regulatory changes to address e-banking issues. The potential for violations is further heightened by
the need to ensure consistency between paper and electronic advertisements, disclosures and notices.
Reputational Risk
3.40 The rise of the sophisticated cyber crime has become one of the fastest growing security and reputational
risks to banks. The cyber crime landscape features malware exploits that can routinely evade traditional security
controls. The reactive attack and penetration approaches of the past may no longer be sufficient to deal effectively
with that level of ingenuity of cyber attacks and are being replaced with new forms of cyber intelligence capable of
enhancing traditional security programs. Adding a layer of complexity to the issue is the rise of social networking,
online communications, and online financial transactions. The bank has a significant role to play in identifying and
addressing this risk thereby safeguarding its reputation and instilling the confidence in its customers.
Mobile Banking
3.41 Mobile banking involves undertaking banking transactions using mobile phones by bank customers that
involve credit/debit to their accounts. It also covers accessing the bank accounts by customers for non-monetary
transactions like, balance enquiry, `stop payment' instruction of cheques, transactions enquiry, location of the nearest
ATM/branch, etc.
3.42 With a view to ensure that the banks adequately address the risks associated with mobile banking, the RBI
has issued Master Circular No. RBI/2016-17/17 DPSS.CO.PD.Mobile Banking No. 02/02.23.001/2016-17 dated July
1, 2016 on "Mobile Banking Transactions in India Operative Guidelines for Banks". The guidelines are applicable to
all scheduled commercial banks (including Regional Rural Banks), Urban Cooperative Banks, State Cooperative
Banks and District Central Cooperative Banks. A bank needs to obtain prior approvals of the RBI before
commencement of mobile banking services in India.
3.43 In carrying out an audit of mobile banking transactions, the auditor is primarily concerned about aspects
such as authentication procedures, understanding the information security framework, compliances with regulatory
requirements, etc.
Authentication procedures for mobile banking transactions - All transactions affecting an account including those
which lead to an account being debited or credited should be allowed only after authentication of the mobile
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
number and the MPIN associated with it. Further, the accounts allowed to be transacted through mobile banking
should be correctly linked with the mobile phones so as to safeguard against spoofing of the phone numbers. The
auditor needs to ensure that the bank has put in place a system of document based registration with relevant
details and with mandatory physical presence of the customers, before commencing mobile banking services.
Information Security framework- The auditor needs to ensure that the bank has proper infrastructure and
information security policy put in place since information security is of paramount importance and critical to the
business of mobile banking services and its underlying operations. Therefore, technology used for mobile banking
should be secure and should be able to ensure confidentiality, integrity, availability and authenticity. Proper level
of encryption should be implemented for communicating between the customer, mobile service provider and the
bank. The bank needs to ensure that proper security checks have been made to ascertain the security levels of
the service providers. The payment authorisation message from the user's mobile phone should be securely
encrypted and checked for tampering by the service provider or the bank. It should not be possible for any
interceptor to change the contents of the message. The statutory auditor should, accordingly, undertake
procedures necessary to evaluate the bank's compliance with these requirements.
Compliance with Regulatory Guidelines- Banks need to ensure that the guidelines on KYC norms, anti-money
laundering, risks and controls in computers and telecommunications, etc., issued by the RBI which apply to mobile
banking are also adhered to. The auditor also needs to examine whether the transaction limit, as stipulated by the
RBI, is adhered to and imposed on mobile banking transactions.
3.44 The dependence of banks on mobile banking service providers may place knowledge of bank systems
and customers in a public domain. Mobile banking system may also make the banks dependent on small firms
(i.e., mobile banking service providers) with high employee turnover. It is therefore imperative that sensitive
customer data, and security and integrity of transactions are protected. It is necessary that the mobile banking
servers at the bank's end or at the mobile banking service provider's end, if any, should be certified by an
accredited external agency. In addition, banks should conduct regular information security audits on the mobile
banking systems to ensure complete security.
3.45 Transactions up to Rs. 5000/- can be facilitated by banks without end-to-end encryption. The risk aspects
involved in such transactions may be addressed by the banks through adequate security measures. (Circular
DPSS.CO.No.2502/02.23.02/ 2010-11 dated May 4, 2011)
3.46 RBI Circular dated 4th December 2014 on Mobile Banking Transactions in India - Operative Guidelines for
Banks has felt the need for greater degree of standardization in procedures relating to on-boarding of customers for
mobile banking (new customers, existing account holders whose mobile numbers are available with the bank but not
registered for mobile banking, and existing account holders where mobile number is not available with the bank), as
also the subsequent processes for authentication, including accessible options for generation of MPIN by customers.
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Special Considerations in a CIS Environment
Annexure A
An Illustrative Checklist on Audit Considerations in CIS environment
While carrying out the audit in fully computerised environment, it is important to note that the primary audit objective
does not undergo change, it is only the approach and methodology that undergoes a change. For achieving the
primary objective in each of the aspects of the financial statements balance sheet, profit and loss account, financial
disclosures, notes to accounts, and special purpose certificates, the auditors must consider the following broad
suggestions-
Clearly identify and document the underlying audit objective and also the significant inherent risks
(accounting, compliance, etc.) involved in each of the area.
Gain an understanding of the IT system in use, flow of activities/processes, data interface, flow of
accounting entries, regular and exception reports generated on daily basis, critical manual processes and
controls.
Understand and document the processes involved and IT systems used for month end and year end
financial closures and data extractions.
Identify sample size and carry out test of controls and substantive checking.
Document process and results.
Form an opinion.
The following indicative checklist can be used (centralised and decentralised) while undertaking the audit in fully
computerised environment:
Sr. No. Particulars Yes/No/NA Comments
A Basic Approach and Methodology Centralised
i. Have you understood the overall IT Policy, IT organization
structure, IT Governance framework and control environment of
the bank and the relation thereof to the preparation and
presentation of financial statements?
ii. Have you obtained sufficient appropriate information about the
total IT systems in use and the area covered therein?
iii. Have you obtained flow charts of activities in relation to data entry,
recording, processing, storage and interface in each of the
systems? Obtain a list of unprocessed transactions as at the year
end.
iv. Have you gathered information about the critical IT and manual
controls in relation to data processing and data interface, in
general, and accounting and preparation and presentation of
financial statements in particular?
v. Have you reviewed the process documents for all the critical
processes having bearing on recording of transactions and
preparation and presentation of financial statements? In case the
processes are not documented, have you ensured that written
representation explaining the whole process has been taken on
record?
vi. Have you reviewed the work done by other agencies, such as,
internal auditors, concurrent auditors, internal inspectors and
system auditors in relation to IT processes and systems? Have
you documented significant observations, if any, made by any of
the above agencies?
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Sr. No. Particulars Yes/No/NA Comments
vii. Have you enquired about the major breakdowns/corruption in
system/data during the year having bearing on the preparation
and presentation of financial statements and how the same were
resolved? Obtain details of unresolved issues, if any, as at the
year end.
viii. Have you identified the samples for test of controls and
substantive checking? Have you documented the process of
sampling and the details of sample selected? Have you taken
screen shots of the relevant accounts/data used in sampling?
ix. Have you compared the outcome of testing with the financial
records? Are you satisfied with the results of test of controls and
substantive checking? If not, have you taken some more samples
for further testing?
x. If you are not satisfied with the results, has this been escalated to
concerned officials and those issues have been resolved.
xi. Are there any unresolved issues and have you noted the same for
final reporting?
xii. Have you documented the entire audit process and significant
observation at all stages?
xiii. Have you obtained written representations from the management
on all the required matters?
B System of accounting and record keeping Centralised
i. Have you understood the process of creating head of accounts?
Are there adequate controls on creating new heads of accounts
and closing unused heads of account? Obtain a list of accounts
heads created and closed during the year?
ii. Have you understood the nature and title of all the account heads
used in preparation and presentation of financial statements?
Obtain written note on basic purpose and usage of all head of
accounts and their mapping/linkage with main heads of financial
statements.
iii. Have you understood process of recording transactions in all the
heads of accounts including routing/intermediary accounts?
Obtain a list of all the routing accounts and purpose and usage
thereof? Review the balances held and the ageing of these
accounts as at the year end.
iv. Have you understood the concept of out of the book entries
passed at the year end for the purpose of financial closure and
subsequent accounting/reversal thereof? Obtain a list of common
OBE passed the year end. Have you reviewed the OBE passed at
year end and also subsequent accounting and reversal thereof till
the date of signing?
v. Have you ensured that the balances as the general ledger are
tallied with the balances as per the sub-systems used for
recording primary transactions? In case of significant differences,
ensure that the same are reported in the audit report as
qualification?
vi. In respect of financial information required for disclosures in the
notes to accounts and also for special purpose certificate, have
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Special Considerations in a CIS Environment
Sr. No. Particulars Yes/No/NA Comments
you understood the process of compiling information and the
underlying systems used? Obtain all the back up papers used for
generating such financial information.
C Certain specific aspects Decentralised
i. In case of deposits have you understood the process for
compliance with KYC? Please carry out test check of certain
cases and document the test results.
ii. In case of deposits have you understood various types of deposits
and carried out test check to ensure interest accrual, application,
year end provisions, TDS calculations, etc., are correct? (In view
of voluminous records/accounts, many a times, it is not possible to
compare the results of test of controls and substantive checking
for year end interest accrual with the books of account as
individual customer level data is not generated.) Please document
the process and test results.
iii. In case of advances have you understood various types of
facilities being offered, the process of monitoring the limits and
interest accrual and application (including year end provisions) in
accounts under various types of facilities? Special care needs to
be taken while monitoring the excesses/over-limits in case of
fungible/interchangeable limits. Special care also needs to be
taken for new age products being offered by various banks, such
as, Channel Financing, Business Banking, Small and Medium
Enterprises Financing, Gold Loans, etc. (In view of voluminous
records/accounts, many a times, it is not possible to compare the
results of test of controls and substantive checking for year end
interest accrual with the books of account as individual customer
level data is not generated.) Please document the process and
test results.
iv. In case of advances have you understood the process of
identifying non-performing assets (NPA) under various types of
facilities (cash credit, overdraft, term loan, packing credit, bill
purchase and discounting) and segments (wholesale and retail)?
Special care need to be taken while reviewing the overdue or DPD
(days past due) reports provided by the banks, as many banks
have filtration process before final reports are generated. (In case
private sector and foreign banks, the retail assets are categorised
under various products and monitored accordingly for asset
classification and security-wise classification. Even the NPA
norms (which are generally more stringent than RBI norms) and
security-wise classification is decided on product level basis and
applied accordingly.
v. Have you understood the process of identifying NPA borrower-
wise and not facility-wise? (In case of private sector banks and
foreign banks, due to voluminous data, such identification is either
not done or is done at a time lag and in some case, the customer
data in retail portfolio is not matched with wholesale portfolio for
this purpose. Further, special care need to be taken in case of
new age products as, in some banks, these facilities may not fall
within wholesale and retail portfolio for the purpose of monitoring.)
Please document the process and test results.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Sr. No. Particulars Yes/No/NA Comments
vi. In case of foreign currency assets and liabilities, have you
understood the process of revaluation (as per Accounting
Standard (AS) 11 /FEDAI guidelines) periodically and at the year
end, as the case may be? Please document the process and
results.
vii. In case of sundry assets and liabilities, have you understood the
usage, process of clearance of outstanding items, periodic ageing
and reporting and provisioning of old items? (In case of fully
computerised banks, some of these heads of account are used as
routing accounts and have specified frequency for periodic
clearance.) Please document the process and test results.
viii. In case of day to day operating expenses, have you understood
the process of accounting, payments, TDS calculation and year
end provisioning? (In case of private sector banks, the accounting
and payment of expenses is centralised and generally there is
substantial time gap between receipt of goods/services, receipt of
bill and accounting thereof. Special care need to be taken for
provision for expenses as at the year end. Further in case of
payments to staff, many banks do not provide access to staff
records due to confidentiality. In such cases, please ensure that
alternate audit approach is used to verify aggregate payments
instead of merely relying on representation by the management or
outsourced service provider.) Please document the process and
test results.
ix. In case of fixed assets have you understood the process of the
entire process of purchasing fixed assets and the capitalisation
and amortisation thereof? (Due to voluminous transactions and
internal processes involved in purchase of fixed assets, many
banks follow the practice of capitalising the assets (largely in case
of it assets) on the date of payment rather than date on which
asset is ready for use or date on which asset is put to use. Such
practices must be corrected.) Please document the process and
test results.
x. Have you understood the process of maturity-wise classification of
assets and liabilities of the bank? (In many banks it is not possible
to compare the results of test check carried out in this regard with
the actual classification, as it is in-built in the basic system and
moreover, the account level information is not readily available.)
Please document the process and test results.
xi. In case of data migration from one platform to another platform
have you verified that the same was error free and there are no
pending issues having bearing on the preparation and
presentation of financial statements with migration report?
xii. In case of errors spotted during the audit, have you enquired
about the primary reason/s and specific pattern/s, if any for the
errors? (In computerised accounting, due to automated data
processing, it is quite likely that there are some primary reasons
and some patterns behind the errors which, if not detected, could
lead to serial misstatement in the financial statements.) Please
document the process and test results.
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Special Considerations in a CIS Environment
Annexure B
I. Bank Audit in Computerised Environment
An Illustrative Checklist
This Annexure is divided in two parts, viz., Part I deals with Bank Audit in Computerised Environment while Part II
deals with Automatic Teller Machines. The checklists given therein does not form part of the Guidance Note and is
only illustrative in nature. Members are expected to exercise their professional judgement while making its use
depending upon facts and circumstances of each case.
Existing Installation
Auditors need to verify the system software and version being operated at the Branch. It is advised to obtain the
licensed copy of the software along with the documentation provided by the vendor and compare the same with the
software running in the live environment. To carry out verification, auditor may look into the following:
a) The software register to check whether all the software in use is entered and maintained desktop-wise.
b) Note the Name and Version of software currently in use.
c) It is the latest version of the software authorised by the Central Office of the Bank to be used.
d) Installation of the software is in accordance with the directions issued by the Central Office.
e) All the modules of the software are properly installed and are working. If any module is not in use presently,
reason has to be ascertained and documented.
f) Physical verification of the copies of the software, documentation and manuals was carried out by Internal /
Concurrent / Statutory Auditors.
g) The existence of Annual Maintenance Contract is in operation and was duly renewed on the expiry date.
Purchases
Computerisation is a constant process of development and improvement over the previous technology. In this
process Banks also upgrade their hardware's and software installed to improve efficiency and provide better service
to the customers. There has being a phase of such improvements, where branches operating on Automatic Ledger
Posting Machines (ALPM) were upgraded to semi-computerised branches and then to fully computerised branches.
The fully computerised branches are now in the process of being upgraded to fully networked branches. The phase
is almost over barring possibility few exceptions of ALPM branches, which are in the process of upgradation.
Auditors, in many branches might come across the purchases made for new softwares during the concerned
Financial Year. To achieve the desired level of satisfaction that the purchase process was in accordance with the
guidelines of the Central Office and installation was carried out under the supervision of the appropriate person
auditor may verify the following:
a) Software register is duly updated with new purchases.
b) Purchase Order was duly filed and purchase was properly authorised and software was obtained from
authorised vendor only.
c) The license of the software, warranty obtained and registration with the manufacturer is completed.
d) Installation was inspected and completed in the prescribed order.
e) Purchase was at reasonable value.
Logical Access Controls
To ascertain that assets are safeguarded and data integrity is maintained by the computer system, auditors may
verify the following:
a) Does security policy address specific capabilities of operating systems and require that the available security
features be implemented?
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
b) Is there a security officer appointed in writing?
c) Does the security officer ensure that available features have been implemented?
d) Is there a process in place for granting access levels?
e) Do users have only the minimum access level needed to do their job?
f) Are Users' access restricted to specific applications, menus within applications, files, and servers?
g) Is file maintenance a separate access privilege?
h) Is maintenance restricted to a minimum number of persons and is it properly approved and reviewed?
i) Is the password file encrypted?
j) Are methods in place to detect security violations?
k) Can security restrictions be overridden?
l) Are access levels periodically reviewed by the internal auditor?
m) Are procedures implemented to limit access to workstations after normal working hours?
n) Is modem access protected by a secure system, such as call back?
o) Are modem numbers changed periodically?
Password Controls
There are few fundamental problems in maintaining the integrity of the password, they are:
i. Users for their convenience write down the password, as they are hard to remember.
ii. Users to reduce the burden of remembering cumbersome passwords, opt for easy to use passwords, which are
also easy to guess.
iii. Users in routine do not change their passwords at regular intervals.
iv. Users fail to appreciate the importance of having password and consequences of its being compromised.
v. Passwords in Banks change hands very fast for the convenience of work.
vi. Certain Access Control Mechanism requires users to enter multiple passwords.
vii. Certain System Software does not store password in the encrypted form.
viii. Passwords are not changed / deleted on the transfer / retirement of the operator / officer in the Master Record
of the System Software.
ix. Passwords are transmitted in clear test form, especially in Wide Area Network (WAN).
Auditors are required to take extra caution in verifying the integrity of passwords in the branches. Following issues
should be looked into to establish the integrity:
a) Password Register for the updating with the changes.
b) Passwords secrecy is maintained by the following officers of the Bank:
i. Branch Manager
ii. System Administrator
iii. Users
iv. Authorised Persons
c) The critical passwords, for accepting sensitive jobs are known only to Branch Manager or System
Administrator. Sensitive jobs include:
i. To enter operating systems.
ii. To take back-ups.
iii. To monitor disk space.
iv. To create/edit Master Records.
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Special Considerations in a CIS Environment
d) The Operating System Password is kept under Dual Control of Branch Manager and System Administrator.
The password should be protected in a sealed cover and opened in the presence of at least two persons. It
should be changed at once on being opened.
Day Start-up Activities
Following areas require the attention of the auditor:
(a) Verify that day start-up Activities of a computer system is carried out either by the Branch Manager or System
Administrator. It should be properly documented and signed in the register maintained.
(b) Verify the time of commencement of day-start-up activities. It should not be carried out prior to the banking
hours.
(c) Verify that all the security checks are performed as per the prescribed guidelines from the Central Office of the
Bank.
(d) Verify that banking date is verified daily and check sum facility is used regularly.
Transaction Controls
Following are the areas the auditor may verify along with going through the manuals in relation to data base
management:
a. Date is authorised either by Branch Manager or System Administrator.
b. The control exists in the software to check that the entries pertaining to current date would be only accepted.
There should not be any provision to feed back dated or future dated entries.
c. In the case of non-usage of terminals, terminals are logged-off.
d. Register for recording of problems in the software and the suitable action taken.
e. For only physically present users of the computer system, the requisite terminal/user account is enabled, else
the account remains disabled.
f. Special batch reports are printed, checked, authenticated and duly filed.
Personnel Controls
To discourage misuse of funds and such practices, it is important to implement Personnel Controls. Auditor may
verify the following to establish that efficient and effective personnel management practices are followed:
a. The technical competence of the employees of the bank operating the computer system.
b. Whether adequate training was imparted to the employees in connection with the operations of the software,
presently being used in the bank.
c. The segregation of duties among the bank employees and the process of monitoring the performance of each
employee.
d. Authorization for amounts entered by the operators are clearly defined and documented.
e. Job rotation is carried out at regular intervals.
Day End Activities
Keeping in view, the serious effects on the system software, auditor may scrutinize the entries on and around the
various closing dates of the Bank. This verification can be conducted by going through the exceptional report or
Supplementary generated by the system software. Besides this, auditor should also verify that following activities are
carried out regularly and documented:
a. Day end activities are carried out by either the Branch Manager or System Administrator and are properly
documented.
b. Supplementary are checked and special users are deleted.
c. The following functions are completed at the day end:
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
i. Minimum balances calculated.
ii. Products calculated for Current Account (Debit balances)
iii. Mandatory reports generated.
iv. Fall back procedures activated.
v. Day end back up taken.
vi. Recording of entries in back-up register.
vii. Recording in Log Books.
viii. Filing of reports.
ix. Shutting down of complete computer system.
d. The data back-ups taken are in safe custody and properly documented.
e. Server Room is properly locked and the keys are kept only with authorised person.
f. The generation of following documents:
i. Access log
ii. Supplementary
iii. Audit Trail
iv. Transaction number is given for each transaction entered.
g. After the business hours of the bank computer operators perform the following functions:
i. Supplementary Report is printed either by Branch Manager or System Administrators and filed.
ii. Cash Denomination Report is printed and filed.
iii. Vouchers are tallied and signed either by Branch Manager or System Administrator.
Parameter/ Master File
Parameters/ Master are quantity constant but could vary for different cases. In banks, we come across various types
of accounts with different guidelines to operate them. In a Parameter/ Master File, all the relevant information related
to that particular account is feeded and stored. The information would relate to Rate of Interest to be applied, Penal
Interest to be charged, Commission Rates, Operation Limits in case of loans, Nature of operation of account, single /
jointly etc. This exercise is carried out at the first stage of implementation of computerisation of the Branch.
Thereafter, the system software behaves according to the Parameters enforced currently are as per latest circulars.
It is important to check that the Parameter/ Master File if accessible to the operators should only be in read-only
format, else it would invite undesirable modifications, which would lead to revenue leakage and misuse of funds.
Whenever any alterations are to be made in the Parameter/ Master File, printouts of the file prior to the changes and
after the changes should be taken and documented in safe custody of Branch Manager. Auditor should verify the
following:
a. Authorised personnel to mark all the Bank Holidays into the software in the beginning of the Financial Year.
b. Operation limits and authorisation levels are defined clearly for the operators and supervisors.
c. The parameters for Interest and Bank Charges are defined in accordance with the relevant rates and
guidelines. The file is updated as and when changes are announced.
d. Printouts of parameter file are taken out before and after changes are given effect and documented.
e. The safe custody of the printouts with Branch Manager and alterations are entered into "Parameter Register".
e-Banking/Internet Banking Procedures
1. Identify the bank's current and planned e-Banking activities and review the bank's public Internet Websites.
Consider whether the bank provides the following types of services:
a. Telephone banking.
b. Retail Internet banking services.
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Special Considerations in a CIS Environment
c. Corporate/ wholesale Internet banking services.
d. Internet services provider (ISP).
e. Brokerage services over the Internet.
f. Insurance service over the Internet.
g. Trust services over the Internet.
h. Account aggregation.
i. Electronic bill payment.
j. Other activities (e.g. Web portals, financial calculators, cross-marketing arrangements and alliances,
unique services, etc.).
2. Review prior audit reports related to e-Banking, including compliance, information technology, and other
examination areas that may be relevant.
3. Determine if material changes have been made to e-Banking products, services, or operations since the last
examination and if any significant changes are planned in the near future.
4. Determine if the bank operates the Web site(s), e-Banking system(s) or core data processing system(s)
internally and whether any activities are outsourced to a vendor. Identify the location of the following
operations:
a. Design and maintenance of the bank's public Web site or home page.
b. Computer/ server for the bank's public Web site.
c. Development and maintenance of the bank's electronic banking system(s).
d. Computer/ server for the bank's e-Banking system(s).
e. Customer service (e.g., call center) for electronic banking services.
f. Electronic bill payment processing or other ancillary services.
5. If the bank operates the e-Banking system or core data processing system in-house, review the topology
(schematic diagram) of the systems and networks, and determine whether there is a direct, on-line connection
between the bank's core processing systems and the electronic banking system.
6. If the bank operates the e-Banking system or core data processing system in-house, review the transaction
processing flows between the e-Banking system and the bank's core processing systems and identify key
control points. Determine whether information is exchanged in a real-time, batch (overnight), or hybrid
processing mode. In case the bank uses the services of any professional agency for any part of the work, the
auditor should apply the standards laid down in SA 402, "Audit Considerations Relating to an Entity Using a
Service Organisation".
7. Determine the adequacy of risk management for e-Banking activities given the level of risk to the institution;
following procedures are to be valuated:
a. Adequacy of policies and procedures governing e-Banking activities.
b. Adequacy of internal controls and security for e-Banking activities.
c. Adequacy of audit coverage for e-Banking activities.
d. Adequacy of monitoring and compliance efforts.
e. Adequacy of vendor and outsourcing management.
f. Adequacy of Board and management oversight.
8. Determine the impact of any deficiencies on the financial condition of the organization.
9. Determine the extent of supervisory attention needed to ensure that any weaknesses are addressed and that
associated risk is adequately managed.
Adequacy of Internal Controls:
1. Are updates and changes to the bank's public website(s) are made only by authorised staff and subject to dual
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
verification?
2. Are website information and links to other websites regularly verified and reviewed by the bank for:
a. Accuracy and functionality?
b. Potential reputational, compliance, and legal risk?
c. Appropriate disclaimers?
3. Do operating policies and procedures include:
a. Procedures for, and controls, over opening new customer accounts submitted via electronic channels to
verify potential customer identity and financial condition?
b. Procedures for administering access to the electronic banking system (e.g., customer passwords, PINs,
account numbers)?
c. Requirements for review of or controls over wire transfers or other large transfers initiated through the
electronic banking system for potentially suspicious activity?
d. Appropriate authorizations for electronic debits initiated against accounts at other institutions, if such
transfers are allowed?
e. Depending on the type of account, dollar limits on transactions over a given time period initiated through
the electronic banking service?
f. Reconcilement and accounting controls over transactions initiated through the electronic banking system,
including electronic bill payment processing?
4. Do written information security policies and procedures address electronic banking products and services?
5. Are business recovery procedures adequate? Consider whether the procedures address:
a. Events that could affect the availability of the electronic banking system, such as system outages, natural
disasters, or other disruptions?
b. Planned recovery times that are consistent with the degree of importance of the electronic banking
activities to the institution?
c. Has management established an incident response plan to handle potential system security breaches,
website disruptions, malicious tampering with the Web site or other problem situations?
6. Has the bank or service provider implemented a firewall to protect the bank's web site?
7. Are ongoing monitoring and maintenance arrangements for the firewall in place to ensure the firewall is
properly maintained and configured?
8. If the bank uses a turnkey e-Banking software package or outsources to a service provider:
a. Is bank staff familiar with key controls detailed by the vendor's security and operating manuals and
training materials?
b. Are workstations that interface with the service provider's system for administrative procedures or
transfer of files and data are kept in a secure location with appropriate password or other access control,
dual verification procedures, and other controls?
9. Does the bank's administration of access to the e-Banking system by bank staff and customers include:
a. Procedures to ensure that only appropriate staff is authorised to access e-Banking systems and data,
including access to any workstations connected to a remote system located at a service provider?
b. The length and composition of passwords and PINs?
c. Encryption of passwords and PINs in transit and storage?
d. The number of unsuccessful logon attempts before the password is suspended?
e. Procedures for resetting customer passwords and PINs?
f. Automatic logoff controls for user inactivity?
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Special Considerations in a CIS Environment
10. Have security vulnerability assessments and penetration tests of e-Banking systems been conducted and the
results reviewed by the bank?
11. Has the bank or its service provider established:
a. An intrusion detection system for e-Banking applications?
b. Procedures to detect changes in e-Banking files and software?
c. Measures to protect the e-Banking system from computer viruses?
d. Procedures for ensuring on an ongoing basis that e-Banking applications, operating systems, and related
security infrastructure incorporate "patches" and upgrades that are issued to address known security
vulnerabilities in these systems?
12. If e-mail is used to communicate with customers, are communications encrypted or does the bank advise
customers to not send confidential information via e-mail?
13. Are adequate summary-level reports made available to management to allow monitoring of:
a. Web-site usage?
b. Transaction volume?
c. System problem logs?
d. Exceptions?
e. Unreconciled transactions?
f. Other customer or operational issues?
14. Has management established adequate procedures for monitoring and addressing customer problems
regarding e-Banking products and services?
15. Does management accurately reports its primary public web-site address on the Report of Condition?
16. Have required Suspicious Activity Reports involving e-Banking, including any computer intrusions, been filed?
17. Is each significant vendor, service provider, consultant, or contractor relationship involved in development and
maintenance of the e-Banking services covered by a written, signed contract? Depending on the nature and
criticality of the services, do contracts specify:
a. Minimum service levels and remedies or penalties for non-performance?
b. Liability for failed, delayed, or erroneous transactions processed by the service provider and other
transactions where losses may be incurred (e.g. insufficient funds).
c. Contingency plans, recovery times in the event of a disruption, and responsibility for back-up of programs
and data.
d. Data ownership, data usage, and compliance with the bank's information security policies.
e. Access by the bank to the service provider's financial information and results of audits and security
reviews.
f. Insurance to be maintained by the service provider.
18. Has legal counsel reviewed and vetted the contracts to ensure they are legally enforceable and that they
reasonably protect the bank from risk?
19. Has the bank ensured that any service provider responsible for hosting or maintaining the bank's web-site has
implemented:
a. Controls to protect the bank's Web site from unauthorized alteration and malicious attacks?
b. Procedures to notify the bank in the event of such incidents?
c. Regular back-up of the bank's Web-site information?
20. Depending on the nature and criticality of the services, does the bank conduct initial and periodic due diligence
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
reviews of service providers, including:
a. Reviewing the service provider's standards, policies and procedures relating to internal controls, security,
and business contingency to ensure they meet the bank's minimum standards?
b. Monitoring performance relative to service level agreements and communicating any deficiencies to the
service provider and to bank management?
c. Reviewing reports provided by the service provider relating to response times, availability/ downtime,
exception reports, and capacity reports and communicating any concerns to bank management and the
vendor?
d. Periodically reviewing the financial condition of the service provider and determining whether back-up
arrangements are warranted as a result?
e. Conducting on-site audits of the service provider if appropriate based on the level of risk?
f. Ensure that the bank staff receives adequate training and documentation from the vendor or service
provider?
21. If the bank operates a turnkey e-banking software package:
a. Is software held under an escrow agreement?
b. Has the bank established procedures to ensure that relevant program files and documentation held under
the software escrow agreements are kept current and complete?
22. If a vendor maintains the bank's electronic banking system, does the bank monitor on-site or remote access of
the bank's systems by the vendor, through activity logs or other measures?
Evaluation of Operating System
1. Obtain or prepare logical and physical diagrams of the operating system and attached local and wide area
networks.
2. Document the operating system domain(s), identifying the Primary Domain Controller (PDC), Backup Domain
Controller, and any other operating system servers or significant operating system workstations participating in
the domain.
3. Using the information obtained in the prior steps, document the server and directory location of the significant
application programs and data within the network; document the flow of transactions between systems and
nodes in the network.
4. Using the Server Manager Utility, review all trusted domains assigned to the audit domain and include these
trusted domains within the audit scope.
5. Assess whether the trusted domains are under the same physical and administrative control and are logically
located within the same sub-network.
6. Determine that router filtering is being used to prevent external network nodes from spoofing the IP address of
a trusted domain.
User Security
Determine that the user log in identification and authentication process are properly configured and that users are
assigned to operating system groups which are consistent with their job requirements for system access.
1. Obtaining the documented security policies and procedures for the operating system server environment. Use
the User Manager utility to display the global log in accounts security parameters and review and assess the
following settings:
a. Forcibly disconnect remote users (forces users to log off the system after a predetermined limit of time).
b. Minimum password age in days
c. Maximum password age in days
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Special Considerations in a CIS Environment
d. Minimum password length
e. Password uniqueness (number of past passwords disallowed for future use)
f. Account lockout after `X' number of bad log in attempts
g. Account lockout--reset the bad log in count after `X' number of minutes
h. Accounting lockout duration--require administrator to unlock or automatically unlock after X number of
minutes.
i. User must log on to change password (may allow or restrict users with expired passwords from logging
on and changing the password themselves or requiring an administrator to change the password for
them)
2. Determine that the Administrator (super user) and Guest accounts have passwords assigned to them (by
attempting to log on without providing a password). Also ascertain that the Administrator account password is
well controlled and used/ known by only the system administrator and a backup person.
3. Using the User Manager utility, review the following account property settings active in each user's individual
profile, which may override the global account policy:
a. Full name (should be used to facilitate ID management).
b. Description (job, department, etc.).
c. Change password at next log in (should be used for new users' initial log in).
d. User cannot change password (forces administrator to manage the password; may be used for vendor
and other third-party accounts).
e. Password never expires (may be used to override the global restriction in the Accounts Policy).
f. Account disabled.
g. Account locked out.
h. Groups (cross-reference to group's audit procedures).
i. Profile (each user should have a home directory, path statement, and log in script).
j. Hours (log in time restrictions).
k. Log on to (restricts workstations from which the user may log in from).
l. Account (specifies local or global and may specify an expiration date).
4. Using the User Manager utility, review and assess User Rights assigned to groups and individual users.
5. Use the User Manager utility to view and assess membership in the sensitive built-in groups: Administrators,
Domain Administrators, and Account Operators. Assess the appropriateness of users assigned to these
groups.
6. Using the User manager utility, document user membership in groups used to grant access to resources with
audit significance (application program and data directories and files), cross-reference to review file system
security audit steps, and assess appropriateness of each user's membership in groups.
File System Security
To ensure that significant system and application program and data resources are protected from unauthorized
access and modifications.
1. Review the file system directory trees to ensure that only operating system file systems are used on servers
within the audit scope (since any other file system type, DOS or other, cannot be controlled by operating
system security with the exception of operating system share security).
2. Using the File Manager directory tree utility, list out the Security Permissions for all system directories and
significant application programs and directories; perform the following:
a. Determine that the owner of all operating system directories is the Administrator account.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
b. Determine that application program and data directories are owned by a restricted application owner
account of the operating system Administrator account .
c. Review and assess permissions assigned to groups and individual accounts, noting that Full Control (all
permissions) and Change (Read, Write, Execute, and Delete) permissions are restricted to authorized
users (cross-reference groups to earlier step, identifying users with the groups they belong to).
d. Determine that Change permissions and Take Ownership permissions are restricted to Administrative
accounts and groups.
e. Using the File Manager directory, identify all shared directories (directories made available to users of the
network). Review and assess share permissions assigned to these directories on a group or user basis.
Operating System Audit and Logging
To determine whether adequate detective controls have been configured and that the information generated by these
controls is being reviewed and followed upon:
1. Using the User Manager utility, review the Audit Policy options in effect for the domain (and server, if
applicable). Normally, all failure conditions should be audited.
2. Using the Event Viewer utility, review the audit log for suspicious events and follow up on these events with the
security administrator.
Operating System Services
To ensure that only necessary, secure services are active in the operating system environment:
1. From the control panel, click on the services option and review all active or dormant services. Identify the
purpose and necessity of each. Unnecessary services should be disabled.
2. Ensure that each service, logs on as on account other than the system account unless the service requires the
system account. Audit the permissions granted to each service account.
3. Determine that each service account has the advanced user right, called log on as a service.
Operating System Networking
To determine that the network and network services are protected against unauthorized access and use:
1. Identify all necessary Net BIOS services offered on each server. Access the propriety of each and if it is
running as a non-privileged service account, unless the service requires the system account.
2. Review router configurations for routers that connect the operating system network to external networks.
Ensure that the TCP/UDP ports 137, 138 and 139 are blocked or altered to restrict Net BIOS traffic coming into
and going out of the network.
3. Identify all active, native, and third-party TCP/IP network services active on the operating system server. Audit
the security of each service.
The Operating System Registry
To Review the security over system and program control parameters in the operating system registry:
1. Review the operating system directory and file permissions over system and program control parameters in the
operating system registry.
2. View the registry permission for the major system and program keys and sub keys to ensure the following:
a. The administrators' local group owns each key.
b. The owner group and system global group have full access permissions.
c. The global group called everyone, has restricted special access permissions.
74
Special Considerations in a CIS Environment
II. Automatic Teller Machines
More than two decades have elapsed since the introduction of ATMs by Banks in India. Initially, these were installed
by larger co-operative Banks and the new private sector Banks. Today, ATM service is offered by even small co-
operative Banks making such a service sin-qua-non of Banking in India. ATM houses one of the primary asset of the
Bank cash which has to be recognized by the auditor in his scope of work. While verification of cash in the ATM is
one aspect, the operational efficacy should be responsive to the policy of the Bank and the standard operating
procedures including the directives of the RBI.
Banking business deals with money and ATM is one part of its service. The auditor needs to view this service with
the same critical eye as any manual cash management. Following aspects of internal control in relation to ATMs may
be ascertained and evaluated by the auditor:
Pre-installation Stage
1. Board's sanction of ATM installation service.
2. ATM installation complies with the strategic Information Technology plan of the Bank.
3. Purchase of ATMs need to be driven through the same formality of a purchase of asset of the Bank like
flotation of tenders, etc.
4. Location of the ATMs both branch attached as well as independent locations should be finalized to achieve the
aim of Bank's investment in this service.
5. All requisite permissions and licenses should be obtained by the Bank including communication to the Reserve
Bank of India.
6. Environmental preparations should be made considering legal, security and operational issues. Environmental
policy should be also set in writing to permit standard environment with sufficient provision to permit
customization necessitated by location peculiarities.
7. The estate department of the Bank or an independent architect should certify to the Estate department about
the quality and appropriateness of translation of set policy at each of the ATM location.
8. Cash replenishment policy needs to be finalized before operating any of the ATMs. This can be a set policy or
a contingent policy determined by the number of ATM units set up by the Bank. Cash replenishment can either
be managed by the Bank itself or can be outsourced. With the Bank itself it can either be done by a Central or
Regional office or a nodal equivalent branch in which case, the ATM cash balance is reflected in the books of
this Branch. The various alternatives should be evaluated and selected.
9. If the cash management of ATMs is to be outsourced, similar procedure should be adopted by invitation of
either open tenders or inviting tenders.
10. Insurance of cash in ATMs should be negotiated with insurance companies and if the number of ATMs is
numerous, select insurance companies may be invited to bid.
11. Application software should be able to communicate with the ATM software and this delicate requirement
should be specifically mentioned in the agreement with the ATM vendor and application vendor since their co-
operation is essential at this stage.
12. ATM software, operation and reflection in the main application should be software tested either internally or
through a professional firm before operations commence.
13. Cash replenishment policy should be set ensuring the maximum limit set per ATM is not exceeded.
Operational stage
1. Is the security manual in place describing the security measures of replenishing cash in the ATMs?
2. Are all the staff involved in cash transfers screened thoroughly and their photos and prints taken? In case of a
contract, does the service vendor follow similar formalities? This should be periodically checked by the Bank
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
and this point needs to be have been specifically made in the agreement with him.
3. Is the process of allocation of ATM cards secure?
a. Are the Personal Identification Numbers (PIN) generated randomly?
b. Are the PIN cards printed in a manner that no staff is able to read them without tearing open the seal?
c. Are the cards and PIN numbers sent separately? Popular delivery mode is delivery of card only through a
courier agency. The PIN number is physically delivered through the branch. In case the PIN number is
also to be delivered, it should be given on a later date and that too through another courier agency.
d. The Courier agency should be under separate contract to fulfill the extra formality of identification
confirmation of the person accepting the card with the strict instruction to hand over the card only to the
person to whom the card is allotted.
e. Bin filling exercise should be done in the presence of at least two persons who should supervise each
other to ensure correct denominations are inserted in the correct bins.
f. User report if available on the `special service ATM card' should be obtained and filed for future
reference. This should ideally record the time and date of opening the ATM machine presumably to
replenish it. Along with this, the cash balance after replenishment should also be printed.
g. Cash shortages should be thoroughly investigated with full reference to the server report, compared with
the ATM's log available on site of ATM.
h. All cards should be changed after a period say 2 years to allot cards to only regular users thus
diminishing risk of the cards of non-users.
4. Whether surprise checks are carried out by the vendor or the Bank's departmental officer to ensure the amount
and time of currency replenished as reflected in the register is accurately recorded?
5. Whether schedules of currency replenishment are not static and are changed on each occasion randomly to
ensure that there is no definitive pattern?
6. Whether ATMs providing additional service like refilling phone cards or e-transfers etc. are system audited
periodically?
7. Whether the bank has a system to thoroughly report and investigate complaints regarding non-performance of
services?
8. Whether `Cash in ATM' and `Cash in transit' insurance is kept alive at all times?
76
Part III
Audit of Advances and NPAs
III-1
Advances-Agriculture
Introduction
1.01 Indian Agriculture has always been the backbone of Indian economy despite sustained progress in industrial
and service(s) sector. It still contributes around 18 % of the national income and provides employment opportunities
to around 50% of the population. Indian agriculture has been source of raw materials to many of our leading
industries like cotton, jute textile industries, sugar, flour mills, vanaspati, oil mills etc. Besides, many industries like
handloom weaving, rice-dehusking etc. depend indirectly on the agriculture. Rapid growth in agriculture is essential
not only for self-reliance but also to earn valuable foreign exchange.
1.02 The agriculture sector in India is pre-dominantly dependent on Monsoon rains which more often than not
tend to be of erratic nature. Hence, agricultural credit is considered as one of the most basic input for conducting all
agricultural development programmes. In India there is an immense need for proper agricultural credit as the
economic condition of Indian farmers generally is of subsistence. From the very beginning the prime source of
agricultural credit in India has been money lenders as many of the commercial banks were generally discouraged by
inherent characteristics of Indian agriculture like uncertain character of Indian agriculture, small amounts of individual
loans, inadequate security for loans, difficulty in recovery of loans from farmers and lack of business experience of
working with rural sector.
1.03 With a view to ensure wider spread of agricultural credit, the Government adopted the institutional credit
approach through various agencies like co-operatives, commercial banks, regional rural banks etc. to provide
adequate credit to farmers, at a cheaper rate of interest. The long term and short term credit needs of these
institutions are also being met by National Bank for Agricultural and Rural Development (NABARD). It is the evolution
of agricultural finance. It has the objective of promoting the health and the strength of the credit institutions which are
in the forefront of the delivery system namely, cooperatives, commercial banks and regional rural bank. It is, in brief,
an institution for the purpose of refinance; with the complementary work of directing, inspecting and supervising the
credit- flows for agricultural and rural development.
1.04 The evolution of institutional credit to agriculture could be broadly classified into four distinct phases
i. 1904-1969 (predominance of co-operatives and setting up of RBI);
ii. 1969-1975 [nationalization of commercial banks and setting up of Regional Rural Banks (RRBs)],
iii. 1975 - 1990 (setting up of NABARD) and;
iv. From 1991 onwards (financial sector reforms): The genesis of institutional involvement in the sphere of
agricultural credit could be traced back to the enactment of the Cooperative Societies Act in 1904. The
establishment of the RBI in 1935 reinforced the process of institutional development for agricultural credit.
Advances - Agriculture
District Central Co-op. Banks to be added after State Co-op. Banks in the following chart
1.05 Following measures were announced in Union Budget 2016-17 for Agriculture & Farmers' Welfare:
The target for agricultural credit in 2017-18 has been fixed at Rs. 10 lakh crore.
Special efforts will be made to ensure adequate ow of credit to the under serviced areas, the eastern states and
Jammu & Kashmir.
Support to NABARD for computerisation and integration of all 63,000 functional PACS with the Core Banking
System (CBS) of District Central Cooperative Banks (DCCBs). This will be done in 3 years at an estimated cost of
R1,900 crore, with financial participation from state governments.
The coverage of Pradhan Mantri Fasal Bima Yojana (PMFBY) will be increased from 30 per cent of cropped area
in 2016- 17 to 40 per cent in 2017-18 and 50 per cent in 2018-19.
Government will set up new mini labs in Krishi Vigyan Kendras (KVKs) and ensure 100 per cent coverage of all
648 KVKs in the country. In addition, 1,000 mini labs will be set up by qualified local entrepreneurs.
Enhancement in the corpus of Long Term Irrigation Fund (LTIF) with NABARD from Rs. 20,000 crore to Rs.
40,000 crore.
A dedicated Micro Irrigation Fund will be set up in NABARD with an initial corpus of Rs. 5,000 crore, to achieve
the goal `per drop more crop'.
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The coverage of National Agriculture Market (e-NAM) will be expanded from the current 250 markets to 585
APMCs. States will be urged to undertake market reforms and de-notify perishables from APMC.
A model law on contract farming would be prepared and circulated among the states for adoption.
A Dairy Processing and Infrastructure Development Fund will be set up in NABARD with a corpus of Rs. 8,000
crore over three years. The initial corpus will be Rs. 2,000 crore.
1.06 Government has increasingly begun to tap institutional finance from banks and other term lending
institutions for financing various developmental programmes in the State in view of the need to supplement plan
financing. Banks in the State have also played a pivotal role in this regard. However, credit should be utilized in
prudent manner to maximize returns and spread the benefit over wider sections of the population. Successful
implementation of socioeconomic developmental programmes calls for effective co-ordination between financial
agencies and government departments. It also helps in improvising efficiency of resource allocation & identifying
infrastructural gaps.
1.07 The State Level Bankers' Committee (`SLBC'), constituted by the Reserve Bank of India under the Lead
Bank Scheme periodically takes up the review performance and monitors progress under special schemes. At the
district level the District Consultative Committee with the Chief Executive Officer of Zilla Panchayat as chairperson
and representatives of financial institutions and Heads of Government departments at the district level as members'
monitors the implementation of government sponsored schemes & Service Area Credit Plans. At the block level,
Block Level Bankers' Committee chaired by Lead District Manager with bank managers and departmental heads of
government at block level as members periodically reviews the implementation of government sponsored schemes &
Service Area Credit Plans and sorts out problems encountered in the implementation of various programmes. In
order to select & prioritise the works for loan assistance from National Bank for Agriculture and Rural Development
(NABARD) under Rural Infrastructure Development Fund (RIDF) Scheme, launched in 1995-96, a Cabinet Sub-
Committee on RIDF has been constituted under the chairmanship of the Minister for Public Works. There is also a
High Power Committee chaired by the Additional Chief Secretary and Development Commissioner for reviewing the
implementation of RIDF projects. These policy measures have resulted in the increase in the share of institutional
credit of the rural households.
Role of Commercial Banks in providing agricultural credit
1.08 Commercial banks are guided by priority sector lending policy of providing credit to various deserving
sectors/sections including agriculture and allied activities.
1.09 Commercial banks entered the field of agricultural credit in a major way following their nationalisation in
1969. Growth in commercial bank credit to agriculture, which was lower than the growth in aggregate bank credit
during the 1990s, picked up sharply in the first half of the 2005s and largely coincided with the growth in aggregate
bank credit. There was a downturn in the growth in commercial bank credit to agriculture after 2005-06, when growth
in aggregate bank credit also slowed down. Previously commercial banks (CBs) were confined only to urban areas
serving mainly to trade, commerce and industry. Their role in rural credit was abysmally low i.e., 0.9 per cent in 1951-
52 and 0.7 per cent in 1961-61. The insignificant participation of CBs in rural lending was explained by the risky
nature of agriculture due to its heavy dependence on monsoon, unorganized nature and subsistence approach. In
the year 1990-91 share of commercial banks increased up to 54 percent. At present, they are the largest source of
institutional credit to agriculture.
Priority Sector Lending
1.10 With a view to regulate and encourage the flow of agricultural credit by all scheduled Commercial Banks, the
RBI from time to time, issues a number of guidelines /instructions/directives to banks on Priority Sector Lending.
1.11 Priority Sector Lending (PSL) programme has been an integral part of the banking policy in India. It is a
major public policy intervention through which credit is directed to the sectors of national priorities critical for both
employment and equity. The Priority Sector Lending (PSL) programme of India is one among the longest serving
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Advances - Agriculture
directed lending programmes in the world. This scheme is intended to give loans to the important sectors of the
economy (agriculture, small scale industries etc.) in such a way to ensure maximum credit flow to the last man in the
last village of the country through a strong banking network. The origin of the PSL programme can be traced back to
the Credit Policy for 1967-68, when public sector banks were advised to increase their involvement in financing of
certain sectors identified as priority sectors in line with the national economic policy. Priority sector lending in its
present form was introduced in 1980, when it was also made applicable to private sector banks and a sub-target was
stipulated for lending to the "weaker" sections of the society within the priority sector.
Meaning Priority Sector & Priority sector advances
1.12 Priority sector refers to those sectors of the economy which may not get timely and adequate credit in the
absence of this special dispensation. Priority sector advances are small value loans to farmers for agriculture and
allied activities, micro and small enterprises, poor people for housing, students for education and other low income
groups and weaker sections.
1.13 In terms of RBI Master Direction- RBI/ FIDD/ 2016-17/ 33 Master Direction FIDD.CO.Plan.1/04.09.01/2016-
17 "Master Direction- Priority Sector Lending- Targets and Classification" dated July 7, 2016 the categories under
priority sector are as follows:
(i) Agriculture
(ii) Micro, Small and Medium Enterprises
(iii) Export Credit
(iv) Education
(v) Housing
(vi) Social Infrastructure
(vii) Renewable Energy
(viii) Others
1.14 The targets and sub-targets for agriculture set under priority sector lending for all scheduled commercial
banks operating in India are furnished below for Domestic scheduled commercial banks and Foreign banks with 20
branches and above:
Agriculture 18 percent of Adjusted Net Bank Credit (ANBC) or Credit Equivalent Amount of Off-
Balance Sheet Exposure, whichever is higher.
Within the 18 percent target for agriculture, a target of 8 percent of ANBC or Credit
Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher is prescribed for
Small and Marginal Farmers.
Foreign banks with 20 branches and above have to achieve the Agriculture Target
within a maximum period of five years starting from April 1, 2013 and ending on March
31, 2018 as per the action plans submitted by them and approved by RBI. The sub-
target for Small and Marginal farmers would be made applicable post 2018 after a
review in 2017. ##
## Additionally, domestic banks are directed to ensure that the overall lending to non-corporate farmers does not fall
below the system-wide average of the last three years achievement. All efforts should be maintained to reach the
level of 13.5 percent direct lending to the beneficiaries who earlier constituted the direct agriculture sector. The
applicable system wide average figure for computing achievement under priority sector lending will be notified every
year. For FY 2015-16, the applicable system wide average figure is 11.70 percent.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Computation of Adjusted Net Bank Credit (ANBC)
1.15
Bank Credit in India [As prescribed in item No.VI of Form `A' under Section 42 (2) of the RBI I
Act, 1934].
Bills Rediscounted with RBI and other approved Financial Institutions II
Net Bank Credit (NBC)* III (I - II)
Bonds/debentures in Non-SLR categories under HTM category+ other investments eligible to IV
be treated as priority sector +Outstanding Deposits under RIDF and other eligible funds with
NABARD, NHB, SIDBI and MUDRA Ltd. on account of priority sector shortfall + outstanding
PSLCs
Eligible amount for exemptions on issuance of long-term bonds for infrastructure and V
affordable housing as per circular DBOD.BP.BC.No.25/08.12.014/2014-15 dated July 15,
2014.
Eligible advances extended in India against the incremental FCNR (B)/NRE deposits, VI
qualifying for exemption from CRR/SLR requirements.
ANBC III+IV-V-VI
* For the purpose of priority sector computation only. Banks should not deduct / net any amount like provisions,
accrued interest, etc. from NBC
A. The computation of priority sector targets/sub-targets achievement will be based on the ANBC or Credit
Equivalent Amount of Off-Balance Sheet Exposures, whichever is higher, as on the corresponding date of the
preceding year.
B. For the purpose of priority sector lending, ANBC denotes the outstanding Bank Credit in India [As prescribed in
item No.VI of Form `A' under Section 42 (2) of the RBI Act, 1934] minus bills rediscounted with RBI and other
approved Financial Institutions plus permitted non SLR bonds/debentures under Held to Maturity (HTM) category
plus other investments eligible to be treated as part of priority sector lending (e.g. investments in securitised
assets).
C. The outstanding deposits under RIDF and other funds with NABARD, NHB, SIDBI and MUDRA Ltd. in lieu of
non-achievement of priority sector lending targets/sub-targets will form part of ANBC.
D. Advances extended in India against the incremental FCNR (B)/NRE deposits, qualifying for exemption from
CRR/SLR requirements, as per the Reserve Bank's circulars DBOD.No.Ret.BC.36/12.01.001/2013-14 dated
August 14, 2013 read with DBOD.No.Ret.BC.93/12.01.001/2013-14 dated January 31, 2014 and DBOD mailbox
clarification issued on February 6, 2014 will be excluded from the ANBC for computation of priority sector lending
targets, till their repayment.
E. The eligible amount for exemption on account of issuance of long-term bonds for infrastructure and affordable
housing as per Reserve Bank's circular DBOD.BP.BC.No.25/08.12.014/2014-15 dated July 15, 2014 will also be
excluded from the ANBC for computation of priority sector lending targets.
F. For the purpose of calculation of Credit Equivalent Amount of Off-Balance Sheet Exposures, banks may be
guided by the Master Circular on Exposure Norms issued by the Department of Banking Regulation
Agriculture (Priority Sector)
1.16 Hitherto the agriculture advances were bifurcated into direct / indirect agriculture advances, however, in
terms of revised guidelines issued by Reserve Bank of India (RBI-2014-15/573
FIDD.CO.Plan.BC.54/04.09.01/2014-15 dated April 23, 2015), the present distinction has been dispensed with and
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Advances - Agriculture
the lending to agriculture sector has been defined to include (i) Farm Credit (which will include short-term crop
loans and medium/long-term credit to farmers) (ii) Agriculture Infrastructure and (iii) Ancillary Activities.
1.17 A list of eligible activities under the three sub-categories is indicated below:
(i) Farm Credit
A. Loans to individual farmers [including Self Help Groups (SHGs) or Joint Liability Groups (JLGs), i.e. groups of
individual farmers, provided banks maintain disaggregated data of such loans] and Proprietorship firms of
farmers, directly engaged in Agriculture and Allied Activities, viz., dairy, fishery, animal husbandry, poultry, bee-
keeping and sericulture. This will include:
a. Crop loans to farmers, which will include traditional/non-traditional plantations and horticulture, and, loans
for allied activities.
b. Medium and long-term loans to farmers for agriculture and allied activities (e.g. purchase of agricultural
implements and machinery, loans for irrigation and other developmental activities undertaken in the farm,
and developmental loans for allied activities.)
c. Loans to farmers for pre and post-harvest activities, viz., spraying, weeding, harvesting, sorting, grading and
transporting of their own farm produce.
d. Loans to farmers up to Rs. 50 lakh against pledge/hypothecation of agricultural produce (including
warehouse receipts) for a period not exceeding 12 months.
e. Loans to distressed farmers indebted to non-institutional lenders.
f. Loans to farmers under the Kisan Credit Card Scheme.
g. Loans to small and marginal farmers for purchase of land for agricultural purposes.
B. Loans to corporate farmers, farmers' producer organizations/companies of individual farmers, partnership firms
and co-operatives of farmers directly engaged in Agriculture and Allied Activities, viz., dairy, fishery, animal
husbandry, poultry, bee-keeping and sericulture up to an aggregate limit of Rs. 2 crore per borrower.
This will include:
a. Crop loans to farmers which will include traditional/non-traditional plantations and horticulture, and, loans for
allied activities.
b. Medium and long-term loans to farmers for agriculture and allied activities (e.g. purchase of agricultural
implements and machinery, loans for irrigation and other developmental activities undertaken in the farm,
and developmental loans for allied activities.)
c. Loans to farmers for pre and post-harvest activities, viz., spraying, weeding, harvesting, sorting, grading and
transporting of their own farm produce.
d. Loans up to Rs. 50 lakh against pledge/hypothecation of agricultural produce (including warehouse receipts)
for a period not exceeding 12 months.
(ii) Agriculture Infrastructure
a. Loans for construction of storage facilities (warehouses, market yards, godowns and silos) including cold storage
units/ cold storage chains designed to store agriculture produce/products, irrespective of their location.
b. Soil conservation and watershed development.
c. Plant tissue culture and agri-biotechnology, seed production, production of bio-pesticides, bio-fertilizer, and
vermi composting. For the above loans, an aggregate sanctioned limit of Rs. 100 crore per borrower from the
banking system, will apply.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
(iii) Ancillary activities
a. Loans up to Rs. 5 crore to co-operative societies of farmers for disposing of the produce of members.
b. Loans for setting up of Agriclinics and Agribusiness Centres.
c. Loans for Food and Agro-processing up to an aggregate sanctioned limit of Rs. 100 crore per borrower from the
banking system.
d. Loans to Custom Service Units managed by individuals, institutions or organizations who maintain a fleet of
tractors, bulldozers, well-boring equipment, threshers, combines, etc., and undertake farm work for farmers on
contract basis.
e. Bank loans to Primary Agricultural Credit Societies (PACS), Farmers' Service Societies (FSS) and Large-sized
Adivasi Multi-Purpose Societies (LAMPS) for on-lending to agriculture.
f. Loans sanctioned by banks to MFIs for on-lending to agriculture sector as per the conditions specified in
paragraph 19 of these Master Directions.
g. Outstanding deposits under RIDF and other eligible funds with NABARD on account of priority sector shortfall.
1.18 For the purpose of computation of achievement of the sub-target, Small & Marginal Farmers will include the
following:-
Farmers with landholding of up to 1 hectare (Marginal Farmers). Farmers with a landholding of more than 1
hectare and up to 2 hectares (Small Farmers).
Landless agricultural labourers, tenant farmers, oral lessees and share-croppers, whose share of
landholding is within the limits prescribed for small and marginal farmers.
Loans to Self Help Groups (SHGs) or Joint Liability Groups(JLGs), i.e. groups of individuals Small and
Marginal farmers directly engaged in Agriculture and Allied Activities, provided banks maintain
disaggregated data of such loans.
Loans to farmers' producer companies of individual farmers, and co-operatives of farmers directly engaged
in Agriculture and Allied Activities , where the membership of Small and Marginal Farmers is not less than
75 percent by number and whose land-holding share is also not less than 75 percent of the total land-
holding.
1.19 Kisan Credit Card (KCC)
a) In terms of RBI Cir. No. RPCD:F.S.D. BC No. 77/05/09/2011-12 dt. 11.05.2012 revised scheme for issue of
Kisan Credit card was introduced by RBI which was subsequently modified vide various circulars. Latest Master
cir. No. RBI/2017-18/4 FIDD:CO.FSD.BC. No. 71/05.05.10/2017-18 dt. 03.07.2017.
b) The scheme was simple and hassle free for both the farmers and bankers. The scheme was aimed at providing
adequate & timely credit support under single window to the farmers for their cultivation and other needs as
indicated below:
Short term credit limits
i. To meet the short term credit requirement for cultivation of crops
ii. Post harvest expenses
iii. Produce marketing loan
iv. Consumption requirement of farmer household
v. Working capital for maintenance of farm assets & activities allied to agriculture like dairy, inland fishery
etc.
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Advances - Agriculture
Long term Credit Limit: Investment credit requirement for agriculture & allied activities like pump sets,
sprayers, dairy animals etc
c) It may be noted that KCC is not a type of loan, but is a channel for granting either short term or long term
agricultural finance.
1.20 Interest Application
a) Unlike normal loans, the interest on agricultural advances is not charged at monthly rests but is charged
normally at half yearly or annual rests.
b) Compounding of Interest is generally not permitted in respect of an Agricultural advance, unless it turns out to be
a non-performing advance.
Examples of Interest application according to crop seasons and for other activities:
Crop Season Kharif Rabi Horticulture
Disbursement Period April 01 to Sept 30 Oct 01 to March 31
Interest Application Annual Annual Annual
Interest Application date 31st March 30th June 31st March
Compounding Annual Annual Annual
Due Date 31st March 30th June One year after first
disbursement every
year.
Compounding from date After 31st March After 30th June After end of year (to
be calculated from
date of first
disbursement every
year)
Penal Interest If overdue, after 31st If overdue, after 30th If overdue, from the
March June due date
Allied Activities
Dairy, Poultry Goat Rearing, Piggery
Repayment Quarterly Half Yearly / Yearly
Interest Application Quarterly Half Yearly / Yearly
Interest application date Quarter end Half Year end / Year end
Compounding Frequency Quarterly Half Yearly / Yearly
Compounding from date After Quarter end After Half Year end / Year end
Penal Interest If overdue, after Quarter If overdue after half year /year end.
end
Interest Subvention
1.21 Public / Private Sector Scheduled Commercial Banks (in respect of loans given by the rural and semi urban
branches) are eligible under the scheme. Interest subvention of 2% p.a. is allowed on their own funds used for short
term crop loans upto Rs.3.00 lakh per farmer. Short term credit made available at 7% p.a. to farmers is considered
for interest subvention.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
This is calculated on the crop loan amount from the date of its disbursement/ drawal up to the date of actual
repayment of the crop loan by the farmer or up to the due date of the loan fixed by the banks, whichever is earlier,
subject to a maximum period of one year.
From 2011-12, additional interest subvention of 3% to those farmers, who repay their short term crop loans promptly
and on or before the due date. Farmers, who promptly repay their crop loans as per the repayment schedule fixed by
the banks, extended loans at an effective interest rate of 4% p.a.
Interest subvention scheme to post harvest loans
1.22 Scheme extended to small & marginal farmers (having Kisan Credit Card) for a further period upto six
months, post-harvest, against negotiable warehouse receipt for keeping their produce in warehouses. To discourage
distress sale by farmers & to encourage them to store their produce in warehouses against warehouse receipts.
Auditors have to submit certificate of Interest Subvention alongwith annual accounts of the branch audited by them.
Non-achievement of priority sector targets
1.23 Scheduled Commercial Banks having any shortfall in lending to priority sector shall be allocated amounts for
contribution to the Rural Infrastructure Development Fund (RIDF) established with NABARD and other Funds with
NABARD/NHB/SIDBI/ MUDRA Ltd., as decided by the Reserve Bank from time to time. The achievement will be
arrived at the end of financial year based on the average of priority sector target /sub-target achievement as at the
end of each quarter.
While computing priority sector target achievement, shortfall / excess lending for each quarter will be monitored
separately. A simple average of all quarters will be arrived at and considered for computation of overall shortfall /
excess at the end of the year. The same method will be followed for calculating the achievement of priority sector
sub-targets. (Illustrative example given in Annex A of Master Directions Priority Sector lending Target and
Classification issued dated December 22, 2016)
The interest rates on banks' contribution to RIDF or any other Funds, tenure of deposits, etc. shall be fixed by
Reserve Bank of India from time to time.
The misclassifications reported by the Reserve Bank's Department of Banking Supervision would be adjusted/
reduced from the achievement of that year, to which the amount of declassification/ misclassification pertains, for
allocation to various funds in subsequent years.
Non-achievement of priority sector targets and sub-targets will be taken into account while granting regulatory
clearances/approvals for various purposes.
Agriculture Advances
1.24 The credit needs of cultivators fall into three broad categories:
i. Crop Loan or Short Term - mainly for financing current expenditure in connection with the raising of crops.
ii. Medium Term - for meeting outlay relating to the replacement and maintenance of assets and for capital
investment designed to increase the output from land. Such loans are generally repayable in 3 to 5 years. They
are sanctioned for purposes such as deepening of wells, sinking of new wells, installation of pump sets,
purchase of agricultural machinery or a pair of bullocks, etc.
iii. Long Term - for capital investments in agriculture such as sinking of new wells, construction of tube wells, land
levelling, bunding, terracing, purchase of tractors, power tillers and other costly machinery, electrical motors,
purchase of land, etc. Such loans are generally repayable over a period of 5 to 15 years and in exceptional
cases in 20 years.
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As per the extant RBI guidelines, "long duration" crops would be crops with crop season longer than one year and
crops, which are not "long duration" crops would be treated as "short duration" crops. The crop season for each crop,
which means the period up to harvesting of the crops raised, would be as determined by the State Level Bankers'
Committee in each State depending upon the duration of crops raised by an agriculturist.
State Level Banker's Committee (SLBC)
1.25 The Agriculture finance is supervised and monitor by State Level Banker's Committee (`SLBC') and its
decisions are implemented by all banking sector having branches in the state. Every state has its own SLBC and
guidelines have been issued to banks to develop agricultural finance.
The SLBC is an inter-institutional forum for co-ordination and joint implementation of development programmes and
policies by all the financial institutions operating in a state. Although SLBC is envisaged as a bankers' forum,
Government officials are also included. The Lead Bank designated as 'Convenor Bank'. The State Level Banker's
Committee meets once a quarter.
The SLBC of the respective state decides the crop season for each crop, which effectively means the period upto
harvesting of the crop raised and the banks of the respective state have to adhere with the crop season as decided
by the SLBC of that respective state. Hence, practically it may occur that same crop may have different harvesting
season in different states as decided by the respective SLBC of those states. In these cases the auditor needs to
verify whether the Banks have the requisite mechanism to map the crop season(s) vis-à-vis the crop season(s) as
defined by the SLBC of each state as any discrepancies may have a direct impact on identification of NPAs.
Examples: Harvesting Season as defined by SLBC in different states
A. SLBC Rajasthan
*As per RBI guidelines, the SLBC has to determine crop season for each crop so as to decide the NPA norms to be
followed in the State for asset classification under Agriculture Advance. Based on the sowing , harvesting period
prevailing in the State & looking to the crop pattern, Agro Climatic condition, the Crop season for Kharif & Rabi
season was proposed as under, which was unanimously approved by the house.
Kharif Crop - April Dec - Due date of repayment may be fixed 31st March
Rabi Crop - Oct April - Due date of repayment may be fixed 30th June
(*Excerpts from minutes of 108th meeting of SLBC Rajasthan held on 16.03.2011)
B. SLBC Gujarat
Short duration Mono cropping farmers:
PARTICULARS KHARIF SEASON RABI / SUMMER SEASON
Year of sanction of Loan 2004-05 2004-05
Month of sanction April 04 to June 04 October 04 to November 04
Season start June -July 04 November-December 04
Harvest Time October-November 04 February-March 05
Due date for Repayment 31.03.2005 30.06.2005
1st crop season June 05 to December 05 October 05 to March 06
2nd crop season June 06 to December 06 October 06 to March 07
Short duration Double cropping farmers:
PARTICULARS KHARIF SEASON RABI / SUMMER SEASON
Year of sanction of Loan 2004-05 2004-05
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Month of sanction April - June 04 October - November 04
Season start June -July 04 November-December 04
October-November 04 February-March 04
Due date for Repayment 31.03.2005 30.06.2005
1 st crop season October 04 - March 05 June 05 - December 05
2 nd crop season June 05 - December 05 October 05 - March 06
Two Crops seasons is considered as under:
If a farmer is growing Crops only in Kharif season and land remains fallow during the rest of the year, two crop
season will spread over two years. Similar is the case if crops are grown only in Rabi season by a farmer. In this
case, repayment date will be fixed once in a year.
If the farmer is growing Kharif as well as Rabi crops, two crop seasons will spread over one year period. There
will be two repayment dates during one year period.
(* Excerpts from MINUTES OF 119th STATE LEVEL BANKERS' COMMITTEE MEETING held on Dec 22, 2008 at
Dena bank)
Security for Crop Loan
1.26 An essential feature of the crop loan system is that a cultivator's eligibility for loan and its size are
determined not with reference to the value of the land or any other tangible security that he is in position to offer but
on the basis of the size of the land holding he cultivates and the crops he grows. The repayment of loans is expected
out of the sale proceeds of the crops raised. A distinction has to be drawn between:
i. loan to a cultivator and loan for agricultural production;
ii. Loans given without reference to outlays on the crops and repaying capacity generated thereby will fall in the
former category; whereas, crop loans fall in the latter category, as they are essentially need based and
production-oriented (and not security oriented).
While the security offered will not be the basis for a crop loan, it does not mean that the security aspect should be
completely done away with. Security is necessary to provide against the possibility of a loan becoming unrealisable.
Many Cooperative Societies Acts and Banks provide for a charge on the "standing crops as security" for advances
made for agricultural purposes. If the crops grown are really to constitute the security for advances, it is necessary to
ensure that the repayment of loan is made out of the sale proceeds of crops grown.
However, partly because of the ineffective linking of credit with marketing and partly because of inadequate and
inefficient supervision, the credit agency has little or no control over the sale of crops. Further, it is also difficult to
enforce the charge on crops in spite of the provision therefor in the Cooperative Societies Acts.
Mortgage of land would appear to be a sound security from the point of view of the lending agency. But insistence on
such security is likely to create difficulties to the borrowers.
Firstly, the procedure and formalities which an execution of mortgage involves are generally time consuming and
elaborate. Secondly, it may handicap a borrower in raising medium or long term loans for which mortgage of land is
normally insisted upon. Thirdly, a large number of cultivators would be deprived of loans because of their inability to
provide mortgage security e.g., tenants, oral lessees, etc.
NPA Norms for Agriculture Advances
1.27 NPA classification of Agricultural Loans is linked with:
i. Nature of crop
ii. Duration of crop / crop season
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Applying a single form for NPA & setting up the system parameters in CBS is difficult. System is required to be
configured to capture relevant SLBC guidelines for crop seasons & classification of crops and also implementation of
relaxations due to natural calamities.
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 and, 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. Depending upon the duration of
crops raised by an agriculturist, the above NPA norms would also be made applicable to agricultural term loans
availed of by him.
These NPA norms should be made applicable only to Farm Credit extended to agricultural activities as listed at
paragraph III (1) of the Circular on Priority Sector Lending Targets and Classification RBI/FIDD/2016-17 /33 Master
Direction FIDD.CO.Plan.1/04.09.01/2016-17 dated July 07, 2016. An extract of the list of these items is furnished in
the Annex 2 of the Master Circular Prudential Norms on Income Recognition, Asset Classification and
Provisioning pertaining to Advances.
In respect of agricultural loans, other than those specified in the Annex - 2 and term loans given to non-
agriculturists, identification of NPAs would be done on the same basis as non-agricultural advances, which, at
present, is the 90 days delinquency norm.
It is important to note that the duration of crops / crop season and the overdue period for NPA's would be
determined by the State Level Bankers' Committee (`SLBC') of each state as per the extant guidelines of RBI.
Further, based on the harvesting period as noted by the SLBC would be taken into consideration while
identification of accounts as NPA's.
Maharashtra SLBC
1.28 Based on the resolution and minutes of 71st steering committee meeting of SLBC held on Sep 6, 2004
following guidelines have been framed for identification of NPA's in respect of Farm credit (erstwhile Direct
Agricultural Advances) and come into effect from Sep 30, 2004.
It was decided that in Maharashtra State except sugarcane and banana, all other crops would be
reckoned as Short duration crops.
A. Short Duration Crops:
1. Kharif / Rabi crops: A loan granted for Kharif / Rabi crop will be treated as NPA if the instalment of
principal or interest thereon remains overdue for a period of 21 months from repayment due date.
2. Horticulture Crops: A loan granted for Horticultural crop will be treated as NPA if the instalment of
principal or interest thereon remains overdue for a period of 24 months from repayment due date.
B. Long Duration Crops:
1. Perennial Crop Sugarcane (Adsali): A loan granted for sugarcane (Adsali) will be treated as NPA if the
instalment of principal or interest remains overdue for a period of 18 months from repayment due date.
2. Perennial Crop Banana (Mrig Bahar): A loan granted for banana crop will be treated as NPA if the
instalment of principal or interest remains overdue for a period of 21 months from repayment due date.
3. Repayment due date means the date fixed at the time of sanction of loan for repayment of crop loan or
instalments/interest of term loan.
C. Agricultural term Loan:
Depending upon the duration of crops raised (i.e., short duration, long duration or both), by an agriculturalist,
respective overdue period as applicable to the crops mentioned above in (A) and (B) will be applicable for
identification of NPAs in agricultural term loans availed by the borrower.
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Type Short Duration Short Duration Long Duration Crop Horticulture (e.g.
Crop Loan - Kharif Crop Loan - Rabi Loan (e.g. Sugarcane Alphanso
with 18 month Mangoes) Cash
harvesting period) credit for recurring
expenses
Loan Disbursed April - Sept 13 Oct - Mar 13-14 June - July 13 July - Sept 13
Due Date 31-Mar-14 30-Jun-14 31-Mar-15 30-Jun-14
Overdue Date 1-Apr-14 1-Jul-14 1-Apr-15 1-Jul-14
Compounding 1-Apr-14 1-Jul-14 1-Apr-15 1-Jul-14
NPA turning date 31-Mar-16 30-Jun-16 31-Mar-17 30-Jun-16
Remark After two crop After two crop After one crop season. After two crop
season. First crop season. First crop First crop season will season. First crop
season will end at season will end at end at March 2015 and season will end at
March 2015 and June 2015 and other will end at March June 2015 and
other will end at other will end at 2017 other will end at
March 2016 June 2016 June 2016
Allied Activity (Instalment)
Dairy Goat Rearing Piggery Poultry
Type (equated quarterly (equated half yearly / (equated half yearly / (equated quarterly
installment with yearly installment yearly installment installment with
moratorium period, considering considering moratorium period,
first installment will moratorium period of moratorium period of first installment will
due on Sept 30, six months first six months first due on Sept 30,
2013) installment is due on installment is due on 2013)
June 30, 2014) June 30, 2014)
Loan Disbursed 1-Jun-13 1-Jul-13 1-Jul-13 1-Jun-13
Due Date 30-Sep-13 30-Jun-14 30-Jun-14 30-Sep-13
Overdue Date 1-Oct-13 1-Jul-14 1-Jul-14 1-Oct-13
Compounding 1-Oct-13 1-Jul-14 1-Jul-14 1-Oct-13
NPA turning date 31-Dec-13 30-Sep-14 30-Sep-14 31-Dec-13
Remark After 90 days After 90 days overdue After 90 days After 90 days
overdue overdue overdue
Investment Credit (Instalment)
Type Investment Credit - Minor Irrigation system to a farmer cultivating cotton
Loan Disbursed 1-Jun-13
Due Date 31-Mar-14
Overdue Date 1-Apr-14
Compounding 1-Apr-14
NPA turning date 31-Mar-16
Remark After two crop season. First crop season will end at March 2015 and
other will end at March 2016
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While identifying NPAs following points may be noted:
a. Term loan/s availed with crop loan/s: Where an agriculturist has availed loans both for short duration as well
as long duration crops along with Term loan/s, such term loan/s will be classified as NPA if either of the loans
for short duration or long duration crops is classified as NPA.
Example 1: An agriculturist avails following loans
i) Crop loan for kharif crop (a short duration crop) is availed on 1.6.2004 for which repayment due date
prescribed is 31.03.2005.
ii) Crop loan for Adsali sugarcane (a long duration crop) is availed on 1.7.2004 for which repayment due
date prescribed is 30.06.2006.
iii) A term loan for deepening of well is availed on 01.05.2004 for which first repayment instalment is due on
30.06.2006.
If crop loan for Kharif crop remains overdue up to 31.12.2006 (i.e. overdue for 21 months after repayment due
date of 31.03.2005) this crop loan along with the crop loan for sugarcane and term loan for deepening of well,
will be classified as NPA with effect from 31.12.2006
b. Term loan/s availed without crop loan: where an agriculturist has availed only Agricultural Term Loan without
availing any crop loan, details of crops grown (i.e. whether kharif / Rabi, horticulture, sugarcane or banana)
are required to be obtained, verified and recorded. Based on the duration of these crops, overdue period for
each crop as stated in (A) or (B) above will be identified and recorded. If the term loan remains overdue for
the period identified as above, the same will be classified as NPA.
Example 2: In the example 1 referred to above, if only term loan is availed without availing crop loan for kharif
crop & sugarcane, which are actually grown by the borrower, overdue period will be identified as 21 months
for kharif crop and 18 months for sugarcane crop as mentioned above paras. The term loan will become NPA
if its instalment of principal or interest remains overdue for 18 months from repayment due date i.e., from
30.06.2006 (overdue period applicable will be the lower of 18 or 21 months as applicable for crops grown by
the borrower). Thus the loan for deepening of well will become NPA on 31.12.2007.
RBI Clarification received by Maharashtra SLBC
1.29 Loan may be treated as NPA immediately on completion of two crop seasons / one crop season (as the
case may be, depending on the duration of the crops) after the repayment due date. Two crop seasons after the due
date should refer to only those two consecutive crop seasons in which the farmer usually undertakes crop production.
The crop season for each crop, means the period up to harvesting of the crops raised. The asset classification norms
assume that there is normal crop yield during the season for which credit is extended. Hence, immediately after
consecutive two harvest seasons (as per the cultivation pattern followed by the farmer borrower) from repayment due
date, the account is to be identified as NPA as per the revised guidelines. In case the yield is affected by natural
calamities as declared by the State Government, the loan accounts should be restructured / rescheduled.
Example of NPA identification
1.30 Example of NPA identification for various types of Crop loans is given in the Annexure (enclosed)
Some of the key points while auditing agriculture advances:
1.31 The audit approach for agriculture advances has to be on the similar lines as that of other advances. The
following is a summary of few Key aspects in the audit of Agricultural Advances:
a. Sanctioned amount of Agriculture Loans should be as per scale of finance applicable to the land under cultivation
and the crop being cultivated. Further, necessary securities should be obtained as per the guidelines framed by
the bank.
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b. Auditors should verify that the agricultural credit is extended only after obtaining `No dues/ No objection
certificates' from the existing credit agencies in the area of finance.
c. Disbursement of agricultural finance is required to be carried out in various `stages' based on the requirements
of farming activity. This needs to be ensured strictly. In some cases, the expenditure is incurred by farmer from
his/her own sources or from non institutional lenders and subsequently banks are requested to reimburse the
same. In such cases, auditors have to carefully verify the facts from the documents/evidences available on
record. Under all situations, auditors should verify that the bank holds documents evidencing the utilisation of
loans for agricultural activities.
d. For crop loans, primary security is normally the standing crops under cultivation, as such pre and post sanction
visits by the officers of bank, who are experts in Agriculture finance and adequate documentation of visit report is
a key control.
e. While verifying the security offered for agricultural loans, it is to be confirmed that the security is legally
enforceable. Standing crops and agricultural machinery and implements are secured by a hypothecation charge,
while the agricultural land is secured by a mortgage charge. Auditors have to ensure that amongst others, the
following has been duly taken on record by the banks:
Copy of the land revenue extracts.
Land Tax Assessment and payment receipt.
Copy of record with sub registrar (wherever applicable)
Original copies of the title deeds
Search of title deeds and Legal opinion from the advocate on the Bank's approved panel
Valuation of land from a valuer on the Bank's approved panel.
f. Loans granted to farmers against the security of NSC, KVP or Fixed Deposits of Banks, which has been utilised
for agricultural purposes, is allowed to be classified under the category of finance to agriculture. However,
auditors should carefully verify the loan documents and other supporting documents to ensure that non-
agricultural loans are not classified as Agricultural Finance.
g. Agricultural Advances are required to be serviced through realisation of sale proceeds to crop. Auditors should
be skeptical about the nature and timing credits coming in to service the agricultural loans and ensure that they
are from genuine sources.
Agricultural Advances Affected by Natural Calamities
1.32 Paragraph 4.2.13 of the Master Circular - Prudential norms on Income Recognition, Asset Classification
and Provisioning pertaining to Advances dated July 1, 2015 deals elaborately with the classification and income
recognition issues due to impairment caused by natural calamities. Banks may decide on their own relief
measures, viz., conversion of the short term production loan into a term loan or re-schedulement of the repayment
period and the sanctioning of fresh short-term loan, subject to the guidelines contained in RBI's latest Master
Circular on "Prudential Norms on Income Recognition, Asset Classification and Provisioning Pertaining to
Advances" dated July 1, 2015 and directions contained in RBI Master Direction
FIDD.No.FSD.BC.02/05.10.001/2016-17 dated July 1, 2016 on "Master Direction - Reserve Bank of India (Relief
Measures by Banks in Areas Affected by Natural Calamities) Directions, 2016". In such cases the NPA
classification would be governed by such rescheduled terms. Asset classification of remaining amount (if any), not
restructured, continue to be governed by original terms & conditions.
Additional finance granted due to natural calamities treated as a standard assets, and will be governed by the
terms & conditions of its sanction. Different dues from the borrower (e.g. current dues, dues which are not
restructured etc.) will be classified under different asset classification norms. This is accepted departure from the
basic principle of IRAC norms, i.e. NPA should be borrower-wise and not facility-wise.
In such cases of conversion or re-schedulement, the term loan as well as fresh short-term loan may be treated as
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current dues and need not be classified as NPA. The asset classification of these loans would thereafter be
governed by the revised terms & conditions and would be treated as NPA if interest and/or instalment of principal
remain overdue for two crop seasons for short duration crops and for one crop season for long duration crops. For
the purpose of these guidelines, "long duration" crops would be crops with crop season longer than one year and
crops, which are not 'long duration" would be treated as "short duration" crops.
Agricultural Debt Relief Schemes
1.33 Debt Relief schemes for agricultural sector (i.e. Crop Loan Waiver schemes) are under implementation in
the States of Uttar Pradesh, Punjab & Maharashtra. The salient features of the schemes are as under:
Scheme in Uttar Pradesh
1.34 Uttar Pradesh Government Crop Loan Redemption Scheme -2017 provides for the upliftment and
sustainable development of small and marginal farmers.
The government of Uttar Pradesh shall provide loan redemption of up to Rs. 1 lakh to individual small and marginal
farmers whose Crop loan was disbursed by Lending Institution as on or before 31 March 2016. For the purpose of
calculating the loan redemption amount, the outstanding (including the accrued interest) as on March 31, 2016 would
be reduced by the repayments/ credits received from the farmer during Financial Year (FY) 2016 -17 (after 31st
March 2016 till 31st March 2017) without taking into account the money withdrawn by the farmer or new sanctions
during FY 2016-17.
Criteria
1.35 The farmer taking the loan, bank branch (through which the loan has been granted) and the farmer's owned
land, all shall be in the state of Uttar Pradesh The total area of all the lands owned by the Small farmer would not
exceed 2 hectares and by the marginal farmers would not exceed 1 hectare The farmer whose crop loans were
restructured due to occurrence of natural calamities in accordance with the guidelines of the Reserve Bank of India
(RBI) will be covered under this scheme. Crop loans taken by farmers for cultivation on government-leased land, as
per the Revenue Records of government
Excluded loans
1.36 Crop loans availed by Self Help Groups (SHGs) and Joint Liability Groups (JLGs) Loans to farmers by
companies or corporate guaranteed even though disbursed by lending institutions, other institutions like Trusts,
Partnerships, Micro Finance Institutions (MFIs)/Urban Cooperative Banks (UCBs), Loans extended to sugar factories
for onward lending to member farmers Term loans given for any purposes, Loan or cash credit accounts given for
fisheries or any kind of activities allied to agriculture.
Any loan (including crop loan) taken by particular farmer against the same piece of land, for the same purpose but
from more than one bank would not be eligible for any redemption. However, if the farmer has availed the loan from
multiple banks for multiple crops against the security of different agricultural lands, the redemption would be given on
proportional basis, subject to a maximum aggregate of Rs. 1 lakh Cases where money withdrawn from the Kisan
Credit Card (KCC) account has been misutilized or not used for crop purposes, but deposited in any term/ recurring
deposit account.
NPAs
1.37 Crop loans of individual small and marginal farmers classified as NPAs by the lending institutions in line with
the RBI norms would form part of the loan redemption scheme for NPAs. In case of NPAs, loans prescribed under
the scheme, disbursed up to 31st March 2016, would be taken into consideration. Recovery charges while calculating
the outstanding balance for NPA accounts will not be part of the eligible amount. The redemption amount for NPA
loans would be up to Rs 1 lakh.
Scheme in Punjab
1.38 The crop loan waiver scheme, based on the recommendations of an expert group headed by eminent
economist Dr. T. Haque, will directly benefit nearly 10.25 lakh farmers across the state. The Chief Minister had in
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June 2017 announced waiver of the entire crop loans (upto Rs 2 lakhs) of all small and marginal farmers (upto 5
acres) and a relief of Rs.2 lakhs to the remaining marginal farmers irrespective of the amount of loan.
The scheme envisages that in case of marginal farmer (less than 2.5 acres) the entire eligible amount of those
farmers who have total outstanding crop loan liability upto Rs. 2 lakh shall be provided as debt relief and in case of
eligible amount of more than Rs.2 lakh, only Rs.2 lakh shall be provided as debt relief. In case of small famers (from
2.5 acres to less than 5 acres), the entire eligible amount of those farmers who have total outstanding crop loan
liability upto Rs.2 lakh, shall be provided as debt relief.
The debt waiver scheme would cover crop loan disbursed to farmers in the state by scheduled commercial banks,
cooperative credit institutions (including urban cooperative banks and regional rural banks, collectively called as the
'lending institutions'.
In the case of a farmer who has taken loans from two separate lending institutions, the first priority shall be given to
the Cooperative institutions and second to the Public Sector Banks and third to the Commercial Banks in that order.
The amount eligible for debt relief shall comprise of the outstanding liability under crop loan (principal and interest) as
on March 31, 2017. The interest outstanding from April 1, 2017 till date of notification shall be additional.
Scheme in Maharashtra
1.39 Crop loan waiver for scheme for farmers in Maharashtra State will waive loans up to Rs 1.5 lakhs
completely. The waiver scheme--'Chhatrapati Shivaji Maharaj Krushi Sanman Yojana' will benefit around 89 lakh
farmers in the state and will make around 40 lakh debt-free. "Those farmers who have paid back their loans regularly,
we will give 25 per cent loan return benefit to them.
The government will tie up with banks to cope with the financial burden which would be repaid in instalments over
four years. "The 7/12 land extracts of farmers having loans up to Rs 1.5 lakh will be cleared, thereby making around
40 lakh cultivators debt-free. Farmers, whose crop loan has been restructured from 2012 to 2016 and who are still
defaulters as on June 30, 2016, will get incentives up to 25 per cent of the crop loan or Rs 25,000, whichever is less.
For 6 per cent farmers, the government will bring in an OTS (one time settlement) scheme, under which those who
have debts of Rs 1.5 lakh, will get 25 per cent of the outstanding amount or Rs 1.5 lakh, whichever is less".
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III-2
Advances-Other than Agriculture
This Chapter is divided into following parts:
A. Introduction
B. Type of Advances and Nature of Security
C. Bank's Process
D. Regulatory Aspects
E. Accounting and Audit Process
A. Introduction
2.01 Lending constitutes a major activity of a bank besides the investment function. The core business of
banks is accepting deposits for onward lending. Advances, generally, constitute the largest item on the assets side
of the balance sheet of a bank and are major source of its income.
2.02 Audit of advances is one of the most important areas covered by auditors. It is necessary that auditors
should have adequate knowledge of the banking industry and the regulations governing the banks. Auditors must
be aware of the various functional areas of the bank/branches, its processes, procedures, systems and prevailing
internal controls.
2.03 Advances generally comprise of:
a) money lent by the bank to its customers including interest accrued and due;
b) debit balances in the account of the depositors;
c) Inter-Bank Participation Certificates.
2.04 Every bank has its credit policy approved by its board of directors. The credit policy is generally in line
with the applicable RBI guidelines, relevant acts and regulations. The auditors must acquaint themselves with the
credit policy of the bank and composition of its advances portfolio. Generally, this policy is regularly updated by
the bank. The auditor should obtain the latest policy of the bank. The bank's corporate office periodically send the
guidance/circular to their branches, the auditor should be aware about those circular/guidance during the course
of their branch audit.
B. Type of Advances and Nature of Security
Fund Based and Non-Fund Based Credit Facilities
2.05 Fund based credit facilities are those where, upon sanction, there is an actual outflow of funds from the
bank to the borrower, whereas non-fund based facilities are those, at the time of sanction which do not involve
such outflow of the bank's funds. Typical examples of fund based facilities are term loan, cash credit and overdraft
and that of non-fund based facilities are letters of credit, bank guarantees, letter of comfort, etc. Non-fund based
facility may turn into a fund based facility on due date / occurrence of the specified event like devolvement of bills
under LC, invocation of Bank Guarantee, etc.
Cash Credit
2.06 Cash credit facility is provided usually to entities (borrowers) engaged in manufacturing and / or trading
Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
activities to enable them to meet the gap in their working capital requirements. This facility is repayable on demand.
The cash credit facility is generally granted against the security of stocks of goods (net of trade creditors), standing
crops, bills / book debts representing genuine sales (restricted to pre-defined age of such book debts).
2.07 Cheque book is issued to the borrower for withdrawal of money against the limit sanctioned. The
withdrawals are permitted within the drawing power balance available against facility amount approved. This is a
revolving facility and is, generally, reviewed and renewed annually or on other intervals as per the policy of the bank.
The Bank based on the credit assessment of the borrower performs periodical review of the borrower.
2.08 The cash credit advances are generally on `floating' interest rate basis. The rate is reset periodically,
depending upon any changes in the bank's base rate (MCLR Marginal Cost of fund based Lending Rate) /
spread in relation to the class of borrower / risk perception about the borrower.
Working Capital Demand Loan (WCDL)
2.09 WCDL is granted for a fixed period on the expiry of which it has to be liquidated, renewed or rolled over.
Depending on the terms of sanction the repayment of WCDL can either be in the form of instalments spread over
the tenure of the facility or bullet payment at the end of the tenure of the loan,. As the nomenclature suggests,
WCDL is generally granted to meet the gap in working capital requirement. WCDL is considered as a part of
working capital facility at the time of renewal or roll over.
Term Loans
2.10 Term loans are repayable in instalments spread over a period of time excluding the moratorium period, if
granted. The moratorium period is assessed by the lender based on future cash flows and requirements of
borrower. However, if there is a default in compliance with terms and conditions by the borrower, the bank has the
right to demand repayment of the entire loan outstanding, before due date. In few cases, there are terms for
increase in interest rate of the borrower as stipulated in sanction terms and conditions. The amount, periodicity of
repayment, last draw down date and other terms and conditions are fixed at the time of sanction and duly
recorded in the loan documents. The amount and the periodicity may be uniform throughout the life of the loan, or
either or both of them may differ from instalment to instalment. Besides, repayment schedule may either be drawn
only for the principal amount in which case periodic interest has to be paid by the borrower separately as and
when due, or a schedule may be fixed with `equated monthly instalments' which also includes the amount of
interest likely to be applied to the account during its entire tenure at the rate of interest applicable at the time of
sanction/documentation/first disbursement. The disbursal may happen in one tranche or more than one tranches
as per the requirements of the borrower. Generally, the bank also open a current account of the borrower so he
can utilize the funds. The cheque books are issued for current account under this facility.
2.11 The interest rate for loans may be either on `fixed' terms' in which event the rate contracted originally
holds good during the entire currency of the loan, or it may be on `variable' terms; which means that the rate may
undergo changes at unspecified periods on happening of certain events as outlined in the loan agreement. This
aspect is a subject matter of negotiation between the bank and the borrower. Interest is charged on reducing
balance method.
2.12 The term loans are generally extended for the following purposes:
For setting up of plants, acquisition of fixed assets like land and building, plant and machinery, furniture,
vehicles, implements, houses, consumer durables, etc.
For meeting expenses on education/medical treatment of self/dependants.
For meeting other personal expenses.
For meeting deficit in the net working capital requirements as assessed by the bank.(WCTL)
For Marketing / Launching / Branding etc.
2.13 Banks may give general purpose loans also i.e. without stipulating any end-use of funds, on the strength
of a suitable collateral security (normally mortgage of immovable properties), or even without security based on
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the credit worthiness of the borrower. The bank policy provides guidance and documentation to be obtained for
end use of funds.
Foreign Currency Loans
2.14 Banks are authorised to lend in foreign currency. These loans are sanctioned as per the EXIM Policy and
guidelines issued by Reserve Bank of India from time to time. Foreign Currency Loans may be in nature of Term
loans or Working Capital loans. These loans may be issued independently or through conversion of rupee
term/working capital loan to foreign currency loan for a stipulated period as per the guidelines issued by RBI.
Overdrafts
2.15 The overdraft facility may be either secured or clean (i.e., without security) and does not generally carry a fix
repayment schedule. The most common form of security for an overdraft arrangement is term deposit receipts. In
such cases, care is taken to ensure that lien marking is done in the system and also on physical fixed deposit receipt
(and not on fixed deposit advice). Fixed deposits are generally for specific period and need to be renewed on the
maturity. The care should be taken to ensure that interest rate spread between overdraft and fixed deposit are
maintained. Also, the bank has updated lien mark on new fixed deposit. Overdrafts may also be granted against
other securities like immovable properties, life insurance policies, shares, bonds, NSCs, Kisan Vikas Patra, Indira
Vikas Patra, etc. The bank has to ensure that proper margin i.e. security value and loan amount has been kept while
sanctioning the overdraft.
Bills
2.16 The finance against bills is meant to finance the actual sale transactions. The finance against bills can be
in any of the below mentioned form:
Purchase of bills by the bank if these are payable `on demand'.
Discounting of bills by the bank if these are usance (or time) bills.
Advance against bills under collection from the drawees, whether sent for realisation through the bank or
sent directly by the drawer to the drawees.
2.17 A unique kind of facility under this head is advances against bills drawn on public sector undertakings /
government departments which do not accept bills. In such cases, pre-receipted challans are submitted by the
borrower to the bank as an evidence for availing finance there against (a pre-receipted challan establishes genuine
movement of goods and ensures that the funds of the bank are used for sanctioned purposes only). This facility is
commonly known in the banking sector as `government bills facility' or `supply bills facility'. It may also be mentioned
that the purchase / discounting of bills may be either under a letter of credit or without a letter of credit. In case of
dishonour of bills, banks have the right to recover the amount from the drawer with penalty, additional interest, etc.
2.18 Bills may be either `documentary', i.e., accompanied by the original documents of title to the goods, or
`clean', i.e., without the original documents of title to the goods. In the case of documentary bills, the bank
releases the documents of title to the drawee only against payment (in the case of demand bills purchased) or
against acceptance (in the case of usance bills discounted). On release of documents of title after acceptance of
usance bills, these also assume the nature of clean bills. The bills may be domestic (denominated in rupee for
domestic trade) or foreign (denominated in foreign currency for import/export).
2.19 The RBI has issued guidelines for regulation of discounting and rediscounting of bills (Ref. Master
Circular No. DBR.No.Dir.BC.10/13.03.00/ 2015-16, dated July 01, 2015, "Loans and Advances-Statutory and other
Restrictions".
Export
Export Credit
2.20 Exporters are granted facilities in the form of cash credit and bills only but, being of a special nature,
require a separate mention here. These facilities extended to exporters are in the form of `pre-shipment credit' and
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`post-shipment credit'. All type of advances sanctioned to finance the production cycle i.e. from procurement of
raw materials to bringing them to the port for despatch fall under `pre-shipment credit' category. It also includes
financing of working capital expenses towards rendering of services. The advance is given either on the basis of
individual order obtained, or the customer is sanctioned an export packing credit (EPC) limit and the advances are
disbursed on submission of individual orders; in the latter case, EPC becomes a running account. The exporter
usually adjusts the account by drawing bills of exchange on the foreign buyer, which are discounted by the bank
under the letter of credit and the proceeds collected from the foreign bank. The post-shipment credit relates to
financing of bills raised on the overseas buyer upon shipment of goods/ services. Another feature of export credit
is that the advance may be granted in Indian Rupees or a designated foreign currency. In the latter case, the loan
is disbursed in a foreign currency. The export credit is granted at concessional rates of interest. The pre-shipment
credit has to be liquidated out of the export proceeds only and cannot be adjusted out of rupee funds (except
where the raw materials required for processing exceed the FOB value of the contract, in which the excess
advance has to be repaid within a maximum of 30 days from the date of advance). The export proceeds have
normally to be received within 9 months from the date of shipment. The period can be extended in genuine cases,
with the approval of the bank (within the discretion available to it under the regulations in force at the relevant
time) or of the RBI, as permitted by the Exchange Control Manual and the operating instructions issued by the
Reserve Bank from time to time. The bills representing the export proceeds can be handled only by branches
permitted to act as authorised foreign exchange dealers as they involve handling transactions in a foreign
currency and reporting to Reserve Bank.
2.21 Pre-shipment credit granted in a foreign currency is called `Packing Credit in Foreign Currency' (PCFC)
advance and has to be repaid out of the export bills discounted under the Export Bills Rediscounting (EBR)
scheme or out of export proceeds. Each bank designates a few select branches to handle PCFC and EBR
transactions. The Rupee Export credit is also allowed to be shared between export order holders and
manufacturer of the goods to be exported. Similarly, bank may extend PCFC also to the manufacturer on the
basis of disclaimer from the export order holder through his bank. PCFC granted to the manufacturer can be
repaid by transfer of foreign currency from the export order holder by availing of PCFC or by discounting of bills. It
should be ensured that no double financing is involved in the transaction and total period of packing credit is
limited to the actual cycle of production of the exported goods. (Ref. Para 5.12 of the Master Circular No. DBR
No.DIR.BC.14/04.02.002/2015-16 dated July 1, 2015, "Rupee/Foreign Currency Export Credit & Customer Service
to Exporter"). PCFC may be made available to both the supplier of EOU/EPZ/SEZ unit and the receiver of EOU /
EPZ / SEZ unit and PCFC for supplier EOU / EPZ / SEZ unit will be for supply of raw material/components of
goods which will be further processed and finally exported by receiver EOU / EPZ / SEZ unit. The PCFC extended
to the supplier EOU/EPZ/SEZ unit will have to be liquidated by receipt of foreign exchange from the receiver
EOU/EPZ/SEZ unit, for which purpose, the receiver EOU/EPZ/SEZ unit may avail of PCFC. The stipulation
regarding liquidation of PCFC by payment in foreign exchange will be met in such cases not by negotiation of
export documents but by transfer of foreign exchange from the banker of the receiver EOU/EPZ/SEZ unit to the
banker of supplier EOU/EPZ/SEZ unit. Thus, there will not normally be any post-shipment credit in the transaction
from the supplier EOU/EPZ/ SEZ unit's point of view. In all such cases, it has to be ensured by banks that there is
no double financing for the same transaction. Needless to add, the PCFC to receiver EOU/EPZ/SEZ unit will be
liquidated by discounting of export bills or by receipt of export proceeds. (Ref Master Circular DBR
No.DIR.BC.14/04.02.002/2015-16 dated July 01, 2015, "Rupee/Foreign Currency Export Credit & Customer
Service to Exporter"). In this context, attention of the readers is also invited to RBI's Circular No.
DBOD.Dir.BC.NO.57/04.02.001/2013-14 on "Export Credit in Foreign Currency" dated September 25, 2013.
Import
Trade Credit Buyer's Credit
2.22 In Indian context, this facility is provided by overseas banks / foreign branches of Indian banks to the
importers of capital goods and raw material through Indian Banks to its customers (importers) towards payment of
imports in India. The overseas bank either (i) credits the amount of Buyer's credit in the NOSTRO account of the
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Indian bank and the Indian bank remits the funds to the overseas supplier of the importer for payment of import bill or
(ii) remits the funds to the overseas supplier of the importer for payment of import bill of the importer. The typical flow
of transaction of Buyer's Credit (with underlying import through LC transaction) is as follows:
1) The borrower imports goods from foreign supplier against Foreign Letter of Credit (FLC) drawn in favour of
foreign supplier;
2) The borrower either through its Indian bank or on its own approaches foreign bank (or overseas / foreign
branches / offices of Indian banks) for availing Buyer's Credit for payment to be made to the foreign supplier;
3) The borrower's bank arranges the credit and provides a quote with details like the tenure, rate of interest
applicable (including margin) and foreign currency conversion rate to the borrower.
4) The Letter of Comfort is issued by Indian bank to the foreign bank on approval of terms and conditions through
SWIFT message for the proposed Buyers Credit;
5) The foreign Bank remits funds to the NOSTRO Account of Indian bank which is handling import transaction, on
the strength of the Letter of Comfort (LoC)/ Letter of Undertaking (LoU) which is issued by the Indian bank in its
favour;
6) The Indian bank remits the funds to foreign supplier through its NOSTRO Accounts;
7) The Indian bank subsequently retires and reverses the Letter of Credit in its book and passes another entry for
creation of a non-fund based (contingent) liability of Letter of Comfort;
8) On the due date of Buyer's Credit, the Indian bank remits the funds (inclusive of interest) to the overseas bank
and recovers the similar amount from its customer;
9) With respect to liability towards Letter of Comfort, the Indian banks accounts for the same as a "Contingent
Liability".
The entries of the inward and outward remittances (specified in steps 4 and 5) are to be recorded in the books of
accounts (NOSTRO Mirror Account) of the Indian bank.
Following documents are required to be verified by the statutory auditors during review of Buyers' Credit Transaction
and its accounting treatment in the Indian Bank's books.
1) (Loan) Agreement, if any, entered between the Indian importer (borrower), overseas bank (lender), the Indian
bank (facilitator);
2) Underlying documents for import of capital goods or raw materials;
3) Maximum tenure of buyer's credit as per guidelines of RBI;
4) SWIFT messages originated by overseas bank specifying the terms of Buyer's Credit;
5) The calculation of contingent liability towards LoC/ LoU is inclusive of interest accrued on the Buyer's Credit as
on financial statement date;
6) Documentation / Agreement between overseas bank and Indian bank, and, any further confirmatory documents
exchanged between overseas bank and Indian bank;
7) Review of documents specifying right of recovery against borrower, in case if the borrower defaults in repayment
of Buyer's Credit;
8) Balance confirmations obtained from the overseas bank;
9) Charge created in records of RoC related to the security offered for Buyer's Credit vis-à-vis disclosure of Buyer's
Credit in the financials of borrowers as secured / unsecured loan;
10) Acknowledgement of debt, if any, obtained from the borrower;
11) The calculation of drawing power for working capital finance availed by the borrower is net of the Buyer's Credit;
12) Form 15CA / Form 15CB compliance made by the borrower.
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Nature of Security
2.23 A brief reference has been made in the preceding section to the types of securities commonly accepted
by banks for granting different kinds of credit facilities. In this section, the aspect will be examined in greater detail.
Primary and Collateral Securities
2.24 The term `primary security' refers to the security offered by the borrower for bank finance or the one
against which credit has been extended by the bank. Primary security is the principal security for an advance. A
collateral security is an additional security. Security can be in any form i.e. tangible or intangible asset, movable or
immovable asset.
Mode of Creation of Security
2.25 Depending on the nature of the item concerned, creation of security may take the form of a mortgage,
pledge, hypothecation, assignment, set-off, or lien.
Mortgage
2.26 Mortgage has been defined under section 58 of the Transfer of Property Act, 1882, as "the transfer of an
interest in specific immovable property for the purpose of securing the payment of money advanced by way of
loan, an existing or future debt, or the performance of an engagement which may give raise to a pecuniary
liability".
2.27 Mortgages are of several kinds but the most important are the Registered Mortgage and the Equitable
Mortgage. A Registered Mortgage can be affected by a registered instrument called the `Mortgage Deed' signed
by the mortgagor. It registers the property to the mortgagee as a security. Equitable mortgage, on the other hand,
is effected by a mere delivery of title deeds or other documents of title with intent to create security thereof. The
government mandate to register all types of mortgages with Central Registry of Securitisation Asset
Reconstruction and Security Interest of India (CERSAI) should be strictly followed by banks.
Pledge
2.28 A pledge is defined under section 172 of the Indian Contract Act, 1872, as "the bailment of goods as
security for payment of a debt or performance of a promise." A pledge thus involves bailment or delivery of goods
by the borrower to the lending bank with the intention of creating a charge thereon as security for the advance.
The legal ownership of the goods remains with the pledger while the lending banker gets certain defined interests
in the goods. The pledge of goods constitutes a specific (or fixed) charge. In a pledge, the bank has all the
liabilities and responsibilities of a bailee of goods. The bank may be held responsible for not carrying out their
obligations as bailee.
Hypothecation
2.29 The term `hypothecation' is not defined in law. In commercial parlance, the term refers to the creation of
an equitable charge (i.e., a charge created not by an express enactment but by equity and reason), which is
created in favour of the lending bank by execution of hypothecation agreement in respect of the moveable
securities belonging to the borrower. Neither ownership nor possession is transferred to the bank. However, the
borrower holds the physical possession of the goods as an agent/trustee of the bank. The borrower periodically
submits statements regarding quantity and value of hypothecated assets (stocks, debtors, etc.) to the lending
banker on the basis of which the drawing power of the borrower is fixed.
Assignment
2.30 Assignment represents a transfer of an existing or future debt, right or property belonging to a person in
favour of another person. Only actionable claims (i.e., claim to any debt other than a debt secured by a mortgage
of immovable property or by hypothecation or pledge of moveable property) such as book debts and life insurance
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policies are accepted by banks as security by way of assignment. An assignment gives the assignee absolute
right over the moneys/debts assigned to him. The transfer of debt, right or property is subject to all the liabilities
and equity to which the transferor was subject on the date of transfer. In other words, the assignee cannot get a
better title than that of the assignor.
Set-off
2.31 Set-off is a statutory right of a creditor to adjust, wholly or partly, the debit balance in the debtor's account
against any credit balance lying in another account of the debtor. A lending bank has the right of set-off in the
absence of an agreement, express or implied, to the contrary with the borrower. The right of set-off enables a
bank to combine two accounts (a deposit account and a loan account) of the same person provided both the
accounts are in the same name and in the same right (i.e., the capacity of the account holder in both the accounts
should be the same). For the purpose of set-off, all the branches of a bank are treated as one single entity. The
right of set-off can be exercised in respect of time-barred debts also.
Lien
2.32 Lien is creation of a legal charge with consent of the owner, which gives lender a legal right to seize and
dispose / liquidate the asset under lien.
Types of Securities
2.33 The characteristics of a good security from the viewpoint of the lending bank are marketability; easy
ascertainability of value, stability of value, clean title and transferability/transportability. The most common types of
securities accepted by banks are the following.
Personal Security of Guarantor
2.34 The personal security of guarantor comprises a guarantee by a third party for payment of loan
outstanding, in the event of default by the borrower. No charge is created on the guarantor's movable or
immovable assets.
Fixed and Floating Charges
2.35 A fixed charge (also called `specific charge') is a charge on some specific and ascertained assets. The
creator of the charge (i.e., the borrower) cannot deal with the asset without the specific consent of the holder of
the charge (i.e., the lender). A floating charge, on the other hand, is an equitable charge on the assets, present as
well as future. A floating charge attaches to assets whose condition varies from time to time in the ordinary
course of business (e.g., work-in-process). A floating charge crystallises (i.e., becomes a fixed charge) when
money becomes repayable and the holder of the charge (i.e., lender) takes necessary steps for the enforcement
of the security.
Margin
2.36 Margin on Loans is upfront payment by the borrower towards the purpose of the loan sanctioned. Banks
provide finance after keeping suitable margin, depending upon the risk perception of the bank. Margin is deducted
from the value of the assets to take care of any downward fluctuations in the market value of the assets.
Generally margin in prescribed in every sanction letter in terms of percentage of security value, as per credit policy
of bank. For certain types of loans such as advances against gold ornaments and jewellery, RBI has defined limits
on the loan to value
Stock Exchange Securities and Other Instruments
2.37 Stock exchange securities include shares, debentures and bonds which are traded on stock exchanges.
These securities are easily marketable; their market value is readily ascertainable; it is easy to ascertain the title of
the depositor; and they are easy to pledge. The banks have policy for shares against which they provide the loan
and periodically re-assess the eligible share as security for lending against the same. In addition to stock
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exchange securities, banks also make advances against such instruments as gilt-edged securities, National
Savings Certificates, Kisan Vikas Patras, Indira Vikas Patras, Gold Bonds, etc. It may be noted that the banks are
not allowed to provide loans to companies for buy back of shares / securities. Further, the banks are not allowed
to provide loans against security of its own shares.
2.38 These securities are usually in the possession of the bank. Wherever the shares are held as security by a
bank (whether as primary or as collateral security), banks are required to have them transferred in their own
names if the loan amount exceeds the ceiling prescribed by RBI. The ceiling is different for shares in
dematerialised form and those in physical form. In other cases, (i.e., where the loan amount does not exceed the
prescribed ceiling), banks accept the aforesaid securities subject to the following conditions:
(a) in the case of physical shares, if they are accompanied by blank transfer deeds duly signed by the person in
whose name they are registered; in case of shares held in dematerialised form, authorisation slips should be
obtained from the borrower and should be passed on to relevant depository participant who immediately
marks those shares as pledged or:
(b) if the bank holds a general power of attorney from the person in whose name they are registered.
2.39 If the person in whose name the securities are registered is other than the borrower, the bank has to
particularly satisfy itself that the person has a good title to the security. The bank also obtains a letter of
renunciation from the person in whose name the securities are registered.
2.40 In the case of advances against bearer securities (Kisan Vikas Patras/ Indira Vikas Patras), banks obtain
independent/direct confirmation of the genuineness of the certificates from issuing authorities. In the case of
bearer securities, only possession by the bank is sufficient.
2.41 In the case of government paper and inscribed stock, the banks should get them registered in their own
name while accepting them as security.
2.42 Before accepting shares as security, the lending bank has to ensure that the provisions of section 19 of
the Banking Regulation Act, 1949 are not contravened. This section prohibits a banking company from holding
shares in any company, whether as pledge, mortgagee or absolute owner, of an amount exceeding thirty per cent
of the paid up share capital of that company or thirty per cent of its own paid-up share capital and reserves,
whichever is less.
Goods
2.43 Goods constitute a significant proportion of the securities taken by banks. They are either the stock-in-
trade of its trading customers or the finished products of manufacturers. Raw materials, work-in-process, etc., are
also accepted as security. Banks should have a system in place to ensure that the borrower does not take
advantage of double financing on same stock, i.e., in respect of unpaid stocks and is financed against paid stocks.
2.44 Goods may be either hypothecated to, or pledged with, the bank. As mentioned earlier, in case of
hypothecation of goods, banks obtain periodic statements from the borrowers (generally, monthly), declaring the
quantity and value of the goods on the basis of which the drawing power of the borrowers is fixed. The officers of
the lending bank pay regular visits to godowns or factories of the borrowers to inspect them and to check the
correctness of records maintained by the borrowers on the basis of which, the periodic statements are prepared
by them. They also check the value of the goods in stock with reference to sale bills, market quotations, etc. In
case of large advances, the inventory is subject to inspection and verification (stock audit) by external agency at
stipulated intervals. The auditor may go through the same for determining existence and adequacy of security and
also to determine the irregularity in the account, if any.
2.45 Stock registers are maintained by the godown keepers of the lending bank in respect of goods pledged
with the bank. The godowns are regularly inspected by the inspectors and other officers of the bank. When goods
are brought into the godown, the godown keeper has to satisfy himself, by appropriate test checks, regarding the
quantity and quality of goods. Banks have to exercise care to ensure that frauds are not perpetrated against them
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by pledging packages not containing the specified goods and later on holding them responsible for the goods
supposed to have been pledged according to the documents.
2.46 The goods are insured against fire and other risks involved and the insurance policies are either in the
name of, or endorsed in favour of, the bank.
2.47 In case the borrower is a company, the bank has to ensure that charge on the goods hypothecated is
registered with the Registrar of Companies.
Documents of Title to Goods
2.48 A document of title to goods is a negotiable or quasi-negotiable instrument. According to section 2(4) of
the Sale of Goods Act, 1930, a document of title is any document used in the ordinary course of business as proof
of the possession or control of goods, or authorising or purporting to authorise, either by endorsement or by
delivery, the possessor of the document to transfer or receive the goods represented thereby. Documents of title
include:
Bill of lading
Railway receipt
Transporter's receipt
Dock warrant
Warehouse-keeper's certificate
Wharfinger's receipt
Warrant or order for delivery of goods
Before being pledged with the bank, these documents have to be appropriately endorsed in favour of the bank.
Gold Ornaments and Bullion
2.49 Gold ornaments are accepted by banks as security on the basis of assessor's certificate regarding the
content, purity and weight of gold and the value thereof. Valuation, however, keeps changing as a result of market
fluctuations. Loans are given only on the basis of gold content of ornaments, no regard being had to labour
charges. RBI has, vide its Master Circular No. DBR.No.Dir.BC.10/13.03.00/2015-16 on Loans and Advances-
Statutory and Other Restrictions dated July 1, 2015, directed banks to give preference to hallmarked jewellery for
granting advances. RBI has, vide its Circular No. DBOD.BP.BC.No.86/21.01.023/2013-14 on "Lending against
Gold Jewellery" dated January 20, 2014, issued guidance in respect of Advances against Gold Ornaments and
Jewellery for the purpose of Medical Expenses and Meeting Unforeseen Liabilities". In this context, attention of the
readers is also invited to RBI's Circular No. DBOD.No.BP.79/21.04.048/2013-14 on "Non-Agriculture Loans
against Gold Ornaments and Jewellery" dated December 30, 2013 containing guidelines on bullet repayment of
loans extended against pledge of gold ornaments and jewellery for other than agricultural purposes.
Life Insurance Policies
2.50 Life insurance policies have to be assigned in favour of the bank and such assignment has to be
registered with the insurer. The surrender value of the policies is taken as the basis of valuation.
Plantations
2.51 Advances are made to agriculturists such as tea gardeners to finance their growing crops. When the
produce is harvested, processed and sold, the money is repaid to the bank.
2.52 The basis of calculating the amount of the advance is the estimated crop of the season. This depends
upon the area under cultivation, expected yield, etc. Separate advances are made for each season's crop.
2.53 The crop to be produced is hypothecated to the bank. Generally, the fixed assets of the plantation are
also mortgaged with the bank as collateral security. Finance is taken from the bank to incur expenditure on the
crop. As such, the amount of the advance increases as the crop grows.
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Immovable Property
2.54 Before advancing money on mortgage of immovable property, the lending bank has to satisfy itself that
the borrower has a clear and unencumbered title to the property, and that the property is marketable and
adequately insured. For this purpose, banks also ascertain whether the property in question has already been
mortgaged to any other financial institution and if so, the details of the charges already created on the property. In
respect of advances to public companies against the mortgage of a block of assets, it is essential that the
provisions of section 180(1)(a) of the Companies Act, 2013 need to be kept in view.
Third Party Guarantees
2.55 Advances covered only by the personal guarantee of third parties (except banks and government) in
addition to the personal security of the borrower are not classified as `secured' advances and would be classified
as `unsecured' advances in the financial statements.
2.56 The guarantee bond executed by the guarantor in favour of the bank may be in bank's own prescribed
form or otherwise. Such bonds are generally executed by holding companies, overseas customers, overseas
principals, insurance companies, etc. A letter of continuity is also obtained from the guarantor.
Banker's General Lien
2.57 Besides the above securities, which are created by an agreement between the borrower and the bank, a
lending bank also has a general lien under the law. A lien represents the right of retaining the goods/securities
unless a debt due by a debtor is paid to the creditor (retainer), provided there is no agreement, express or implied,
to the contrary. A lien is a statutory right, which does not require any separate agreement. Under section 171 of
the Indian Contract Act, 1872, a banker may, in the absence of an agreement to the contrary, retain as security for
a general balance of account, any goods and securities bailed to him. This is called banker's general lien. Two
conditions necessary for creating such lien are:
(a) the securities must have been placed in his hands as a banker by his customers; and
(b) they are not specifically appropriated.
2.58 Examples of securities over which a banker has general lien are credit balance in any other account, bonds
and coupons deposited for collection, securities allowed to remain in the banker's hands after repayment of a secured
advance, etc. Examples of securities on which a banker does not have a general lien are securities deposited for safe
custody, money deposited or earmarked for a specific purpose, documents executed for a special purpose, etc. Lien is
applicable even in respect of the borrower's obligations as a surety. The banker's right of general lien over the security is
not barred by the law of limitation and can be exercised in the case of unenforceable or time-barred debts also.
2.59 The term `negative lien' is commonly used to refer to an undertaking given by the borrower to the bank
that borrower will not create any charge such as lien, pledge, hypothecation, or mortgage, over his immovable and
moveable properties and assets including uncalled capital without the prior permission of the bank. A negative
lien relates to goods, securities, etc., which are not in the possession of the bank. Negative lien does not require
registration with the Registrar of Companies or similar other authorities.
C. Bank's Process
Procedure for Sanction, Disbursement, Supervision and Renewal of Advances
2.60 Each bank has its own procedures for sanctioning, disbursal, supervision and renewal of advances.
Following is the common process across banks w.r.t. advances.
Sanction
2.61 Initiation of process of sanction of advance is receipt of a formal request from the applicant. The request
may be in the form of a standard format (Loan Application Form) of the bank or in the form of a letter in which case
the bank requests the intending borrower to furnish the standard format duly filled in. All applications are entered
in a Loan Applications Received Register (the exact nomenclature may vary from bank to bank). The required
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supporting documents are to be furnished along with the application. The Bank should ensure that the documents
are obtained from respective borrowers as per the Loan policy of the Bank.
Credit Appraisal
2.62 The proposal is evaluated in the context of the directions of the RBI including prudential exposure limits
and the bank's own credit policy and risk management guidelines. Besides, the proposal is appraised on the
following parameters to ensure technical feasibility, economical viability and commercial acceptability (the degree
of scrutiny depends largely on the amount of the advance):
Performance of the unit vis-a-vis other similar units.
Conduct of its accounts with the lenders.
Experience, competence and profile of the management of the unit.
Guarantees and collateral securities offered.
Trend and ratio analysis to see that the unit's growth is healthy, financials are sound, liquidity is comfortable
and the promoters have a reasonable stake in the unit.
Availability of inputs for production.
Market condition.
Technology in use.
Unit's capability to achieve the projected operating and performance levels and to service the debt.
Applicability of norms/benchmarks relating to scale of finance, e.g., Nayak Committee recommendations for
SSI units, scale of finance fixed by the bank for agricultural finance to be extended in the local area, etc.
CIBIL, RBI List of defaulter, Credit and confidential reports from other banks. These are to be checked from
respective websites.
Various disclosure/notices issued by the government/government authority such as with regard to shell
companies, defunct companies, directors of these type of companies, etc.
Latest Govt. policy about particular industry / Locational restriction, etc.
2.63 If the official concerned finds the proposal acceptable, a detailed appraisal note is submitted along with
necessary supporting documents with recommendations to the authority having powers to sanction it. Each official
who has been vested with powers to sanction advances has a monetary ceiling upto which he can sanction
advances to the specified kind of borrowers (like individuals, partnerships, companies, etc.) and/or for the
specified activities (like agriculture, industry, professional education, business, etc.) and / or for the type of facility
(term loan, overdraft, cash credit, etc.). Such powers are properly documented and circulated by the bank to all its
offices as Delegation of Powers. The officials at the branch can sanction only those advances, which fall within
their delegated powers. For advances, which require to be sanctioned by higher authorities, the branch has to
carry out the appraisal and send the proposal along with its recommendations to its controlling office for necessary
sanction. As and when the advance is sanctioned by the competent authority (which could be an official, a
committee of officials or the board of directors of the bank, depending on the amount involved), the fact of
sanction along with detailed terms and conditions of the sanction are communicated by the controlling office to the
branch. The bank generally records the sanction details in the system. In many cases, the system is updated for
pre-sanction, pre-disbursement documents for each loan. The document discrepancy report then acts as a check
for documents received and pending for monitoring purposes.
Disbursement
2.64 After the sanction of the advance, the branch communicates the terms and conditions of the sanction to
the applicant and obtains its consent for the arrangement. Thereafter, the documents as prescribed by the bank
are obtained, charges created and, the bank's charge over the unit's assets noted with the authorities concerned,
e.g., Registrar of Companies, Road Transport Authority, insurance company, land records authority, CERSAI, etc.
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In the case of an advance to a partnership firm, while the account is opened in the trade name of the firm, the
security documents are got executed from the partners in both their individual capacity (i.e., without mentioning
the name of the firm or affixing the stamp of the firm) and in their capacity as partners of the firm. This is to ensure
that the advance may be recovered from the assets of the firm as well as from the individual assets of the
partners.
2.65 After the above formalities have been completed, the advance is released in the following manner:
Term loans (granted generally for acquisition of fixed assets, etc.) are disbursed on the basis of quotations/
proforma invoices obtained by the borrower from the vendors and submitted to the bank either along with the
application or later. In case of large projects, the schedule and status of completion of projects have also to
be seen. Banks generally stipulate a stated percentage of the cost to be met by the borrower from his own
funds. Once the borrower provides his contribution to the bank, the branch debits the Term Loan account
with the balance amount and pays the amount to the vendor directly along with a letter stating the purpose of
the funds. The term loan may be released in one or more instalments. As and when the asset is received by
the borrower, the bank officials inspect it, record the particulars in their books, and obtain copies of the final
invoices for their record from the borrower.
There may be instances where, on business considerations, the borrower has already acquired the asset. In
such a case, he submits the documentary evidence to the branch and seeks reimbursement to the extent
permissible. The branch officials inspect the asset and verify books of account of the borrower and, if
satisfied, credit the eligible amount to the borrower's account (current / cash credit, as desired by the
borrower) by debiting his term loan account.
Cash credit advances are released on the basis of drawing power calculated as per the stock statements
(which may be book debts, stock-in-trade, trade creditors, advance received from customers, advance given
to trade creditors, Buyer's Credit, etc.) submitted by the borrower as per the periodicity laid down in the terms
of sanction. The branch officials verify the stock statements (in some cases, tangible securities like stock-in-
trade are also physically verified) and calculate the `drawing power' based on the security held by the
borrower and the margin prescribed in the sanction. In case of consortium accounts, the drawing power
calculation and allocation is made by the Lead Bank and is binding on the Member Banks (Circular No.
C&I/Circular/2014-15/689 dated 29 September 2014 issued by the Indian Banks Association). This `drawing
power' is noted in the system in respect of Cash Credit accounts and is a guide to the official concerned while
authorising debits to the account.
The procedures of many banks require the branch manager to periodically submit a certificate to the
controlling authority (i.e., regional or zonal office) that all disbursements during the relevant period have been
made only after completion of the necessary formalities.
Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI)
The auditor needs to keep abreast the mandatory requirements related to registration of mortgages and
compliance thereof by the lender bank, as applicable to the various forms of securities offered as security for
the advances.
Monitoring and Supervision
2.66 The following are the procedures usually adopted by banks for monitoring and supervision of advances
after disbursement:
Regular inspection of the borrower's assets and books. The main purposes of inspection are as follows:
o To ensure that the amounts disbursed have been utilised for purposes for which the advance was sought.
o To check that the borrower has not acquired / disposed of any asset without the consent / knowledge of
the bank, depending upon the terms of the advance. Acquisition of fixed assets from working capital
funds may amount to diversion of short-term funds which, from the viewpoint of the bankers, is not a sign
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of financial prudence.
o To cross-check the figures declared in the stock statements with the books maintained by the borrower
(including excise and other statutory records, as applicable) as well as to physically verify the stock items,
to the extent possible.
o To check that the unit has been working on projected levels particularly in the areas of sales and
production and the general working of the unit is satisfactory.
o To ensure that the borrower has not availed of finance against stocks for which it has itself not made the
payment.
o To ensure that the borrower has not availed of unauthorised finance from any other lender.
o To ensure that the borrower has not made any investment in, or advances to, its associates without the
bank's approval, if such approval is required as per the terms of the loan or otherwise diverted the funds.
o To check that there is a regular turnover of stocks and the unit does not carry any obsolete, unusable
stocks. Generally, banks place a limit on the age of stocks which are eligible for bank finance; the items
older than such limit are not financed. Similarly, in the case of book debts, debts outstanding beyond a
specified period are also not eligible for bank finance. However, the trade creditors irrespective of age are
required to be netted off against the stock to calculate the amount of `paid stock'
o To ensure that the borrower continues to be engaged in the activity for which the loan has been granted.
Periodic review of the progress in implementation of the project (to note whether project timelines given at the
time of processing loan are being adhered to. If there are delays, it may hamper the project completion and
may affect servicing of loan). Generally, in large and complex project, banks appoint lead engineer agency
who provides the status of the project on periodically basis.
Review of the conduct of the account.
Obtaining and scrutinising stock statements.
Obtaining other relevant financial data periodically and analysis of the data. Banks obtain information at
monthly / quarterly / half yearly / yearly intervals about on the levels of sales, production, profit, cash accruals,
break up of assets and liabilities, cash flows etc. The analysis covers the following points:
o Comparison of the data with the projections contained in the appraisal note to find out the deviations, the
reasons thereof, and the corrective action to be taken, wherever necessary.
o Comparison of the unit's performance, on an on-going basis, with other similar units.
o Ratio analysis based on the provisional data submitted by the unit to find out the liquidity and solvency
position and any diversion of short-term resources towards long term uses.
o Observing the credits to the account.
Whenever the above analysis indicates weaknesses in operations, or the need for additional documentation
or security, a dialogue is held with the borrower, with consequent follow-up.
RBI, vide its circular no. DBS.CO.PPD.BC.No. 5 /11.01.005/2010-11 dated January 14, 2011 on "End Use of Funds -
Monitoring", has advised to evaluate and strengthen the efficacy of the existing machinery in the banks for post-
sanction inspection by the bank officers, supervision and follow-up of advances. There needs to be a proper process
of stock audit of the borrowers. Effective monitoring of the end use of funds lent is of critical importance in
safeguarding a bank's interest. Further, this would also act as a deterrent for borrowers to misuse the credit
facilities sanctioned, and in the process, help build a healthy credit culture in the Indian banking system.
Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair recovery of lenders
Framework for revitalisation of distressed assets
2.67 The RBI has issued guidelines for classification of standard assets into three sub-categories, viz., SMA-0,
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SMA-1 and SMA2 in order to recognise the financial distress in any performing asset at an early stage, besides
regulatory compliances like forming of Joint Lender's Forum, reporting to CRICL, etc. for specified categories of
Special Mention Accounts (SMA). In case if the bank does not follow the said regulatory compliances, such
accounts are subjected to accelerated provisions. These provisions are elaborately given in Paragraphs 4.109 to
4.112 of Part III of the Guidance Note.
Renewal of Advances
2.68 Working capital advances are generally granted for one year at a time and require renewal if the borrower
wants to continue the facility beyond that period at the same level, reduced level or increased level, depending
upon the borrower's needs, its financial ratios, the bank's perception of risk and so on. Loans repayable over a
period of time in instalments are not renewed. However, some banks have a system of reviewing these loans
from time to time primarily with the objective of risk evaluation and interest rate resetting.
2.69 The procedure described above for sanction of advances is also followed, to the extent applicable, for
renewal of advances already granted to an applicant.
2.70 The RBI guidelines require banks to renew the advances within 6 months of the expiry of the limit. Hence
no working capital limit can remain without reviewed for more than 18 months. It should be ensured that the latest
audited balance sheet, various compliance proofs should be on bank's record. Further the various monitoring
reports such as inspections, stock audit and operations in the account should be taken cognisance of during
renewal.
2.71 Non-renewal sometimes may appear to be administrative delay but it may not be so. Hence stricter
compliances should be ensured.
Nature of Borrowing Arrangements
2.72 The following paragraphs explain the different ways in which a banking arrangement can be tied up by a
borrower.
Sole Banking
2.73 In this arrangement, the borrower obtains credit from a single bank. This is the simplest form of tie-up and is
operationally convenient for both the lender and the borrower. Most of the banking tie-ups in India are of this type
because the quantum of bank finance in an individual case is usually small. Depending on the nature and extent of
credit facility offered, the lending bank itself may stipulate that the borrower will not avail of finance from another
bank.
Consortium Arrangement
2.74 In this type of arrangement, the number of lending banks is more than one. The lending banks form a
formal consortium. Salient features of the arrangement are:
The consortium has a formal leader, called the `lead bank' (normally though not necessarily, the bank with
the largest exposure).
The consortium frames and adopts its rules within the RBI framework for conducting its business with the
borrower.
There is a common set of loan documents, which is obtained by the lead bank on behalf of other participating
banks also.
The lead bank is responsible for overall monitoring.
The member banks of the consortium have rights over the security in an agreed proportion.
The borrower maintains direct business relationship with all member banks of the consortium.
Minutes of the consortium meetings are circulated amongst the members.
Banks should exchange information about the conduct of the borrowers' accounts with other banks at least at
quarterly intervals.
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Multiple Banking
2.75 In this type of arrangement, there is no formal arrangement amongst the lending banks. Each of them has
its set of loan documents, securities and mode of lending, independent of other lending banks. The borrower has
to deal with each of the banks separately.
2.76 The RBI, vide its Circular No. DBOD No. BP. BC.46/ 08.12.001/2008-09 dated September 19, 2008 on
"Lending under Consortium Arrangement/Multiple Banking Arrangements", encourages the banks to strengthen their
information back-up about the borrowers enjoying credit facilities from multiple banks as under:
(i) At the time of granting fresh facilities, banks may obtain declaration from the borrowers about the credit
facilities already enjoyed by them from other banks, as prescribed in the RBI Circular No. DBOD.No.BP.BC.94
/08.12.001/2008-09 dated December 08, 2008 on "Lending under Consortium Arrangement/Multiple Banking
Arrangements". In the case of existing lenders, all the banks may seek a declaration from their existing
borrowers availing sanctioned limits of Rs.5.00 crores and above or wherever, it is in their knowledge that
their borrowers are availing credit facilities from other banks, and introduce a system of exchange of
information with other banks as indicated above.
(ii) Subsequently, banks should exchange information about the conduct of the borrowers' accounts with other
banks at least at quarterly intervals.
(iii) Obtain regular certification by a professional, preferably a Company Secretary, regarding compliance of
various statutory prescriptions that are in vogue, as per specimen given in the RBI Circular.
D. Regulatory Aspects
Guidelines of the Reserve Bank of India on Income Recognition, Asset Classification, Provisioning
and Other Related Matters
2.77 Detailed guidelines w.r.t. Income Recognition, Asset Classifications and provisioning requirements have
been presented at Chapter 4 of Part III of the Guidance Note.
Restrictions on Advances
2.78 The Master Circular no. RBI/2015-16/95 DBR.No.Dir.BC.10 /13.03.00/2015-16 dated July 1, 2015, on
"Loans and Advances - Statutory and other Restrictions" issued by the RBI contains detailed requirements and
guidelines in respect of statutory and other restrictions on loans and advances by banks.
Statutory Restrictions
Advances against Bank's own Shares
2.79 In terms of Section 20(1) of the Banking Regulation Act 1949, a bank cannot grant any loan or advance
against the security of its own shares.
Advances to Bank's Directors
2.80 Section 20(1) of the Banking Regulation Act, 1949 also lays down the restrictions on loans and advances to
the directors and the firms in which they hold substantial interest.
2.81 Banks are prohibited from entering into any commitment for granting any loans or advances to or on behalf
of any of its directors, or any firm in which any of its directors is interested as partner, manager, employee or
guarantor, or any company (not being a subsidiary of the banking company or a company registered under Section 8
of the Companies Act, 2013 or a Government company) of which, or the subsidiary or the holding company of which
any of the directors of the bank is a director, managing agent, manager, employee or guarantor or in which he holds
substantial interest, or any individual in respect of whom any of its directors is a partner or guarantor. There are
certain exemptions given in the aforesaid Master Circular in this regard.
2.82 For the above purpose, the term 'loans and advances' shall not include the following:
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(a) loans or advances against Government securities, life insurance policies or fixed deposit;
(b) loans or advances to the Agricultural Finance Corporation Ltd;
(c) such loans or advances as can be made by a banking company to any of its directors (who immediately prior to
becoming a director, was an employee of the banking company) in his capacity as an employee of that banking
company and on the same terms and conditions as would have been applicable to him as an employee of that
banking company, if he had not become a director of the banking company. The banking company includes
every bank to which the provisions of Section 20 of the Banking Regulation Act, 1949 apply;
(d) such loans or advances as are granted by the banking company to its Chairman and Chief Executive Officer,
who was not an employee of the banking company immediately prior to his appointment as Chairman/Managing
Director/CEO, for the purpose of purchasing a car, personal computer, furniture or constructing/ acquiring a
house for his personal use and festival advance, with the prior approval of the RBI and on such terms and
conditions as may be stipulated by it;
(e) such loans or advances as are granted by a banking company to its whole time director for the purpose of
purchasing furniture, car, Personal Computer or constructing/acquiring house for personal use, festival advance
with the prior approval of RBI and on such terms & conditions as may be stipulated by it;
(f) call loans made by banking companies to one another;
(g) facilities like bills purchased/discounted (whether documentary or clean and sight or usance and whether on
D/A basis or D/P basis), purchase of cheques, other non-fund based facilities like acceptance/co-acceptance of
bills, opening of L/Cs and issue of guarantees, purchase of debentures from third parties, etc.;
(h) line of credit/overdraft facility extended by settlement bankers to National Securities Clearing Corporation
Ltd.(NSCCL) / Clearing Corporation of India Ltd. (CCIL) to facilitate smooth settlement; and
(i) a credit limit granted under credit card facility provided by a bank to its directors to the extent the credit limit so
granted is determined by the bank by applying the same criteria as applied by it in the normal conduct of the
credit card business.
2.83 Purchase of or discount of bills from directors and their concerns, which is in the nature of clean
accommodation, is reckoned as `loans and advances' for the purpose of Section 20 of the Banking Regulation Act,
1949.
Restrictions on Power to Remit Debts
2.84 Section 20A of the Banking Regulation Act, 1949 stipulates that notwithstanding anything to the contrary
contained in Section 180 of the Companies Act, 2013, a banking company shall not, except with the prior approval of
the Reserve Bank, remit in whole or in part any debt due to it by -
any of its directors, or
any firm or company in which any of its directors is interested as director, partner, managing agent or
guarantor, or
any individual, if any of its directors is his partner or guarantor.
Any remission made in contravention of the provisions stated above shall be void and have no effect.
Restriction on Holding Shares in Companies
2.85 In terms of Section 19(2) of the Banking Regulation Act, 1949, banks should not hold shares in any
company except as provided in sub-section (1) whether as pledgee, mortgagee or absolute owner, of an amount
exceeding 30 percent of the paid-up share capital of that company or 30 percent of its own paid-up share capital and
reserves, whichever is less.
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2.86 Further, in terms of Section 19(3) of the Banking Regulation Act, 1949, the banks should not hold shares
whether as pledgee, mortgagee or absolute owner, in any company in the management of which any managing
director or manager of the bank is in any manner concerned or interested.
2.87 Accordingly, while granting loans and advances against shares, statutory provisions contained in Sections
19(2) and 19(3) should be strictly observed.
Restrictions on Credit to Companies for Buy-back of their Securities
2.88 In terms of Section 68 of the Companies Act, 2013, companies are permitted to purchase their own
shares or other specified securities out of their:
Free reserves, or
Securities premium account, or
Proceeds of any shares or other specified securities,
subject to compliance of various conditions specified in sub-section (2) of section 68 of Companies Act, 2013.
Therefore, banks should not provide loans to companies for buy-back of shares/securities.
Regulatory Restrictions
Granting Loans and Advances to relatives of Directors
2.89 Without prior approval of the Board or without the knowledge of the Board, no loans and advances should
be granted to relatives of bank's Chairman/Managing Director or other Directors, Directors (including
Chairman/Managing Director) of other banks and their relatives, Directors of Scheduled Co-operative Banks and
their relatives, Directors of Subsidiaries/Trustees of Mutual Funds/Venture Capital Funds set up by the financing
banks or other banks. However, banks may grant loan or advance to or on behalf of spouses of their Directors in
cases where the spouse has his/her own independent source of income arising out of his/her employment or
profession and the facility so granted is based on standard procedures and norms for assessing the
creditworthiness of the borrower. Such facility should be extended on commercial terms. Accordingly, the Banks
should not grant loans and advances without the approval of Board of Directors/Management Committee
aggregating Rupees twenty five lakhs and above to
a. directors (including the Chairman/Managing Director) of other banks;
b. any firm in which any of the directors of other banks is interested as a partner or guarantor;
c. any company in which any of the directors of other banks holds substantial interest or is interested as a director
or as a guarantor;
d. any relative other than spouse and minor/dependent children of their own Chairmen/Managing Directors or
other Directors;
e. any relative other than spouse and minor/dependent children of the Chairman/Managing Director or other
directors of other banks;
f. any firm in which any of the relatives other than spouse and minor/ dependent children as mentioned in (d) & (e)
above is interested as a partner or guarantor;
any company in which any of the relatives other than spouse and minor / dependent children as mentioned in (d) &
(e) above hold substantial interest or is interested as a director or as a guarantor.
Restrictions on Grant of Loans and Advances to Officers and the Relatives of Senior Officers of Banks
2.90 Loans and advances to officers of the bank - No officer or any Committee comprising, inter alia, an officer as
member, shall, while exercising powers of sanction of any credit facility, sanction any credit facility to his/her relative.
Such a facility shall ordinarily be sanctioned only by the next higher sanctioning authority. Credit facilities sanctioned
to senior officers of the financing bank should be reported to the Board. Loans and advances and award of contracts
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to relatives of senior officers of the bank or proposals for credit facilities to the relatives of senior officers of the bank
sanctioned by the appropriate authority should be reported to the Board. Further, when a credit facility is sanctioned
by an authority, other than the Board, to -
any firm in which any of the relatives of any senior officer of the financing bank holds substantial interest, or is
interested as a partner or guarantor; or
any company in which any of the relatives of any senior officer of the financing bank holds substantial interest,
or is interested as a director or as a guarantor, such transaction should also be reported to the Board.
Credit facility will not include loans and advances such as housing loans, car advances, consumption loans, etc.,
granted to an officer of the bank under any scheme applicable generally to bank employees.
Restrictions on Grant of Financial Assistance to Industries Producing / Consuming Ozone Depleting
Substances (ODS)
2.91 Banks should not extend finance for setting up of new units consuming/producing the Ozone Depleting
Substances (ODS). No financial assistance should be extended to small/medium scale units engaged in the
manufacture of the aerosol units using chlorofluorocarbons (CFC) and no refinance would be extended to any project
assisted in this sector.
Restriction on Advances against Sensitive Commodities under Selective Credit Control (SCC)
2.92 With a view to prevent speculative holding of essential commodities with the help of bank credit and the
resultant rise in their prices, in exercise of powers conferred by Section 21 & 35A of the Banking Regulation Act,
1949, the Reserve Bank of India, issues, from time to time, directives to all commercial banks, stipulating specific
restrictions on bank advances against specified sensitive commodities.
2.93 Commodities presently under the Selective Credit Control include:
a) food grains i.e. cereals and pulses,
b) selected major oil seeds indigenously grown, viz. groundnut, rapeseed / mustard, cottonseed, linseed and
castor seed, oils thereof, vanaspati and all imported oils and vegetable oils,
c) raw cotton and kapas,
d) sugar/ gur / khandsari,
e) Cotton textiles which include cotton yarn, man-made fibres and yarn and fabrics made out of man-made fibres
and partly out of cotton yarn and partly out of man-made fibres.
Restriction on payment of commission to staff members including officers
2.94 Section 10(1)(b)(ii) of Banking Regulation Act, 1934, stipulates that a banking company shall not employ
or continue the employment of any person whose remuneration or part of whose remuneration takes the form of
commission or a share in the profits of the company. Further, clause (b) of Section 10(1)(b)(ii) permits payment of
commission to any person who is employed only otherwise than as a regular staff. Therefore, banks should not
pay commission to staff members and officers for recovery of loans.
Restrictions on offering incentives on any banking products
2.95 Banks are also not permitted to offer any banking products, including online remittance schemes etc., with
prizes /lottery/free trips (in India and/or abroad), etc. or any other incentives having an element of chance, except
inexpensive gifts costing not more than Rs. 250/-, as such products involve non-transparency in the pricing
mechanism. Such products, if offered, by banks are considered as violation of the extant guidelines and the banks
concerned are liable for penal action.
Restrictions on Other Loans and Advances
Loans and Advances Against Shares, Debentures and Bonds
2.96 Banks are required to strictly observe regulatory restrictions on grant of loans and advances against
shares, debentures and bonds which are detailed in the July, 2015 Master Circular on Exposure Norms'. The
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restrictions, inter alia, on Loans and Advances Statutory and Other Restrictions loans and advances against
shares and debentures, are:
(a) No loans to be granted against partly paid shares.
(b) No loans to be granted to partnership/proprietorship concerns against the primary security of shares and
debentures.
2.97 RBI's Master Circular on "Loans and Advances - Statutory and Other Restrictions" contains guidelines for
granting Loan and Advances against Shares, Debentures and Bonds as follows:
Advances to individuals
2.98 Banks may grant advances against the security of shares, debentures or bonds to individuals subject to the
following conditions:
(i) Amount of advance: Loans against the security of shares, debentures and bonds should not exceed the limit
of Rs. 10 lakhs per individual if the securities are held in physical form and Rs. 20 lakhs per individual if the
securities are held in dematerialised form.
(ii) Margin: Banks should maintain a minimum margin of 50 percent of the market value of equity shares /
convertible debentures held in physical form. In the case of shares / convertible debentures held in
dematerialised form, a minimum margin of 25 percent should be maintained. These are minimum margin
stipulations and banks may stipulate higher margins for shares whether held in physical form or dematerialized
form. The margin requirements for advances against preference shares / nonconvertible debentures and bonds
may be determined by the banks themselves.
(iii) Lending policy: Each bank should formulate with the approval of their Board of Directors, a Loan Policy for
grant of advances to individuals against shares / debentures / bonds keeping in view the RBI guidelines. Banks
should obtain a declaration from the borrower indicating the extent of loans availed of by him from other banks
as input for credit evaluation. It would also be necessary to ensure that such accommodation from different
banks is not obtained against shares of a single company or a group of companies. As a prudential measure,
each bank may also consider laying down appropriate aggregate sub-limits of such advances.
Advances to Share and Stock Brokers/ Commodity Brokers
2.99
(i) Banks and their subsidiaries are not permitted to undertake financing of 'Badla' transactions. Banks can grant
advances only to share and stock brokers registered with SEBI and who comply with capital adequacy norms
prescribed by SEBI / Stock Exchanges. This could be towards their need based overdraft facilities / line of credit
against shares and debentures held by them as stock in trade. A careful assessment of need based
requirements for such finance should be made taking into account the financial position of the borrower,
operations on his own account and on behalf of clients, income earned, the average turnover period of stocks
and shares and the extent to which the broker's funds are required to be involved in his business operations.
Banks may also grant working capital facilities to such stock brokers to meet the cash flow gap between
delivery and payment for DVP transactions undertaken on behalf of institutional clients viz. FIs, Flls, mutual
funds and banks, the duration of such a facility will be short and would be based on an assessment of the
financing requirements keeping in view the cash flow gaps, the broker's funds required to be deployed for the
transaction and the overall financial position of the broker. The utilisation to be monitored on the basis of
individual transactions. Further, Banks may institute adequate safeguards and monitoring mechanisms. A
uniform margin of 50 per cent is required to be applied on all advances/ financing of IPOs/ issue of guarantees
on behalf of share and stockbrokers. A minimum cash margin of 25 per cent (within the margin of 50%) shall be
maintained in respect of guarantees issued by banks for capital market operations. The above minimum margin
will also apply to guarantees issued by banks on behalf of commodity brokers in favour of commodity
exchanges viz. National Commodity & Derivatives Exchange (NCDEX), Multi Commodity Exchange of India Ltd.
(MCX) and National Multi Commodity Exchange of India Ltd. (NMCEIL), in lieu of margin requirements as per
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the commodity exchange regulations. These margin requirements will also be applicable in respect of bank
finance to stock brokers by way of temporary overdrafts for DVP transactions. Banks may issue guarantees on
behalf of share and stock brokers/commodity brokers in favour of stock exchanges in lieu of security deposit to
the extent it is acceptable in the form of bank guarantee as laid down by stock exchanges. Banks may also
issue guarantees in lieu of margin requirements as per stock exchange regulations.
(ii) The requirement relating to transfer of shares in bank's name in respect of shares held in physical form
mentioned at Sl. No. (ix) of paragraph 2.3.1.14 of the aforesaid Circular would not apply in respect of advances
granted to share and stock brokers provided such shares are held as security for a period not exceeding nine
months. In the case of dematerialised shares, the depository system provides a facility for pledging and banks
may avail themselves of this facility and in such cases there will not be need to transfer the shares in the name
of the bank irrespective of the period of holding. The share and stock brokers are free to substitute the shares
pledged by them as and when necessary. In case of a default in the account, the bank should exercise the
option to get the shares transferred in its name.
Bank Finance for Market Makers
2.100 Banks may provide need based finance to meet the genuine credit requirements of approved Market
Makers. For this purpose, they should lay down appropriate norms for financing them including exposure limits,
method of valuation, etc. They should also follow the guidelines given below:
a) Market Makers approved by stock exchange would only be eligible for grant of advances by scheduled
commercial banks.
b) Market Making may be for equity as well as for debt securities including State and Central Government
securities.
c) A uniform margin of 50 per cent shall be applied on all advances / financing of IPOs / issue of guarantees on
behalf of market makers. A minimum cash margin of 25 per cent (within the margin of 50%) shall be maintained
in respect of guarantees issued by banks for capital market operations.
d) Banks may accept, as collateral for the advances to the Market Makers, scrips other than the scrips in which the
market making operations are undertaken.
e) Banks should ensure that advances provided for Market Making are not diverted for investment in shares other
than the scrip earmarked for Market Making purpose. For this purpose, a suitable follow-up and monitoring
mechanism must be evolved.
f) The ceiling of Rupees ten lakhs / Rupees twenty lakhs for advances against shares/debentures to individuals
will not be applicable in the case of Market Makers.
2.101 Each bank should lay down a detailed loan policy for granting advances to Stock Brokers and Market
Makers and also a policy for grant of guarantees on behalf of brokers which should include, interalia, the following:
Purpose and use of such advances / guarantees.
Pricing of such advances.
Control features that specifically recognise the unique characteristics and risks of such financing.
Method of valuation of collateral.
Frequency of valuation of shares and other securities taken as collateral.
Guidelines for transfer of shares in bank's name.
Maximum exposure for individual credits (within the RBI prescribed prudential Single Borrower Limit). The
Board may also consider laying down a limit on the aggregate exposure of the bank to this sector.
Approval process for identification of eligible securities against which loan can be provided
Periodic re-assessment of eligible security so that they continued to be allowed as eligible security
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Advances Other than Agriculture
The aggregate portfolio, its quality and performance should be reviewed and put up at least on a half-yearly basis to
the Board.
Advances to Individuals against shares to joint holders or third party beneficiaries
2.102 While granting advances against Shares held in joint names to joint holders or third party beneficiaries,
banks should ensure that no advances to other joint holders or third party beneficiaries is granted to circumvent the
above limits placed on loans/advances against shares and other securities.
Financing of Initial Public Offerings (IPOs)
2.103 Banks should ensure that no advances exceed the limit of Rs. 10 lakhs to any individual against security of
shares, convertible bonds, convertible debentures, units of equity oriented mutual funds and PSU bonds for
subscribing to IPOs. Further, the Bank should not extend any credit or financing to Corporates for investment in other
companies' IPOs and to NBFCs for further lending to individuals for IPOs.
Bank Finance to assist employees to buy shares of their own companies
2.104
(i) Banks may extend finance to employees for purchasing shares of their own companies under Employees Stock
Option Plan (ESOP)/ reserved by way of employees' quota under IPO to the extent of 90% of the purchase
price of the shares or Rs. 20.00 lakh, whichever is lower. Banks are not allowed to extend advances including
advances to their employees/ Employees' Trusts set up by them for the purpose of purchasing their own banks'
share under ESOPs/IPOs or from the secondary market irrespective of whether the advances are secured or
unsecured. Follow on Public Offers (FPOs) will also be included under IPO.
(ii) Banks should obtain declaration from the borrower indicating the details of the loan/advances availed against
shares and other securities specified above, from any other bank/s in order to ensure compliance with the
ceilings prescribed for the purpose.
Advances to other borrowers against shares / debentures / bonds
2.105
(i) The question of granting advances against Primary Security of shares and debenture including promoters'
shares to industrial, corporate or other borrowers should not normally arise except for secured loans granted
towards working capital or for other productive purposes other than NBFCs. In such cases, Banks should
accept shares only in dematerialised form. Banks may accept shares of promoters only in dematerialized form
wherever demat facility is available. The question of granting advances against Primary Security of shares and
debenture including promoters' shares to industrial, corporate or other borrowers should not normally arise
except for secured loans granted towards working capital or for other productive purposes other than NBFCs. In
such cases, Banks should accept shares only in dematerialised form. Banks may accept shares of promoters
only in dematerialised form wherever demat facility is available.
(ii) Banks may obtain collateral security of shares and debentures by way of margin for a temporary period of one
year from borrowers other than NBFCs who are in the course of setting up of new projects or expansion of
existing business or for the purpose of raising additional working capital required by units Banks have to satisfy
themselves regarding the capacity of the borrower to raise the required funds and to repay the advance within
the stipulated period.
Bank Loans for Financing Promoters Contribution
2.106 The promoters' contribution towards the equity capital of a company should come from their own resources
and the bank should not normally grant advances to take up shares of other companies. However, banks are
permitted to extend loans to corporate against the security of shares (as far as possible in dematerialised form) held
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by them to meet the promoters' contribution to the equity of new companies in anticipation of raising resources
subject to the following terms and conditions and as detailed in the loan policy of the bank, in addition to the general
guidelines given in para 2.3.1.14 of the Master Circular on Loans and Advances Statutory and Other restrictions
dated July 1, 2015.
i) The margin and period of repayment of the loans may be determined by the banks.
ii) Loans sanctioned to corporates against the security of shares (as far as possible, demat shares) for meeting
promoters' contribution to the equity of new companies in anticipation of raising resources, should be treated as
a bank's investments in shares which would thus come under the ceiling of 40 percent of the bank's net worth
as on March 31 of the previous year prescribed for the bank's total exposure including both fund based and
non-fund based to capital market in all forms. These loans will also be subject to individual/group of borrowers
exposure norms as well as the statutory limit on shareholding in companies, as detailed in the Master Circular
RBI/2015-16/70 DBR.No.Dir.BC.12/13.03.00/2015-16 dated July 1, 2015 on Exposure Norms.
iii) Banks may extend financial assistance to Indian companies for acquisition of equity in overseas joint ventures /
wholly owned subsidiaries or in other overseas companies, new or existing, as strategic investment, in terms of
a Board approved policy, duly incorporated in the loan policy of the banks. Such policy should include overall
limit on such financing, terms and conditions of eligibility of borrowers, security, margin, etc. The finance would
be subject to compliance with the statutory requirements under Section 19(2) of the Banking Regulation Act,
1949.
iv) The restriction on grant of bank advances for financing promoters' contribution towards equity capital would also
extend to bank finance to activities related to such acquisitions like payment of non-compete fee, etc. Further,
these restrictions would also be applicable to bank finance to such activities by overseas branches /
subsidiaries of Indian banks.
v) With the approval of the Board of Directors, the banks should formulate internal guidelines with appropriate
safeguards for this purpose.
vi) Under the refinance scheme of Export-Import Bank of India, the banks may sanction term loans on merits to
eligible Indian promoters for acquisition of equity in overseas joint ventures / wholly owned subsidiaries,
provided the term loans have been approved by the EXIM Bank for refinance
Advances against Units of Mutual Funds
2.107 While granting advances against Units of mutual funds, the banks should adhere to the following guidelines:
i) The Units should be listed in the Stock Exchanges or repurchase facility for the Units of mutual fund should be
available at the time of lending.
ii) The Units should have completed the minimum lock-in-period stipulated in the relevant scheme.
iii) The amount of advances should be linked to the Net Asset Value (NAV) / repurchase price or the market value,
whichever is less and not to the face value.
iv) Advance against units of mutual funds (except units of exclusively debt oriented funds) would attract the
quantum and margin requirements as applicable to advance against shares and debentures. However, the
quantum and margin requirement for loans/ advances to individuals against units of exclusively debt-oriented
mutual funds may be decided by individual banks themselves in accordance with their loan policy.
v) The advances should be purpose oriented, taking into account the credit requirement of the investor. Advances
should not be granted for subscribing to or boosting up the sales of another scheme of the mutual funds or for
the purchase of shares/ debentures/ bonds etc.
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Advances Other than Agriculture
[For exposure norms w.r.t. Advances against Mutual Funds, please refer to para 4.6 of the Master Circular on
Exposure Norms dated July 1, 2015.]
Margin Trading
2.108 Banks may extend finance to stockbrokers for margin trading. The Board of each bank should formulate
detailed guidelines for lending for margin trading, subject to the following parameters:
(a) The finance extended for margin trading should be within the overall ceiling of 40% of net worth prescribed for
exposure to capital market.
(b) A minimum margin of 50 per cent should be maintained on the funds lent for margin trading.
(c) The shares purchased with margin trading should be in dematerialised mode under pledge to the lending bank.
The bank should put in place an appropriate system for monitoring and maintaining the margin of 50% on an
ongoing basis.
(d) The Bank's Board should prescribe necessary safeguards to ensure that no "nexus" develops between inter-
connected stock broking entities/ stockbrokers and the bank in respect of margin trading. Margin trading should
be spread out by the bank among a reasonable number of stockbrokers and stock broking entities.
2.109 The Audit Committee of the Board should monitor periodically the bank's exposure by way of financing for
margin trading and ensure that the guidelines formulated by the bank's Board, subject to the above parameters, are
complied with. Banks should disclose the total finance extended for margin trading in the "Notes on Account" to their
Balance Sheet.
Financing for Acquisition of Equity in Overseas Companies
2.110 Banks may extend financial assistance to Indian companies for acquisition of equity in overseas joint
ventures / wholly owned subsidiaries or in other overseas companies, new or existing, as strategic investment, in
terms of a Board approved policy, duly incorporated in the loan policy of the banks. Such policy should include
overall limit on such financing, terms and conditions of eligibility of borrowers, security, margin, etc. While the Board
may frame its own guidelines and safeguards for such lending, such acquisition(s) should be beneficial to the
company and the country. The finance would be subject to compliance with the statutory requirements under Section
19(2) of the Banking Regulation Act, 1949.
Refinance Scheme of Export Import Bank of India
2.111 Under the refinance scheme of Export Import Bank of India (EXIM Bank), the banks may sanction term
loans on merits to eligible Indian promoters for acquisition of equity in overseas joint ventures / wholly owned
subsidiaries, provided that the term loans have been approved by the EXIM Bank for refinance.
Arbitrage Operations
2.112 Banks should not undertake arbitrage operations themselves or extend credit facilities directly or indirectly to
stockbrokers for arbitrage operations in Stock Exchanges. While banks are permitted to acquire shares from the
secondary market, they should ensure that no sale transaction is undertaken without actually holding the shares in
their investment accounts.
General guidelines applicable to advances against shares / debentures / bonds
2.113 Statutory provisions regarding the grant of advances against shares contained in Sections 19(2) and (3) and
20(1) (a) of the Banking Regulation Act 1949 should be strictly observed. Shares held in dematerialised form should
also be included for the purpose of determining the limits under Section 19(2) and 19(3) ibid.
2.114 While considering grant of advances against shares / debentures banks must follow the normal procedures
for the sanction, appraisal and post sanction follow-up.
2.115 Advances against the primary security of shares / debentures / bonds should be kept distinct and separate
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
and not combined with any other advance.
2.116 Banks should satisfy themselves about the marketability of the shares / debentures and the networth and
working of the company whose shares / debentures / bonds are offered as security.
2.117 Shares/ debentures/ bonds should be valued at prevailing market prices when they are lodged as security
for advances.
2.118 Banks should exercise particular care when advances are sought against large blocks of shares by a
borrower or a group of borrowers. It should be ensured that advances against shares are not used to enable the
borrower to acquire or retain a controlling interest in the company/ companies or to facilitate or retain inter-corporate
investments.
2.119 No advance against partly paid shares shall be granted.
2.120 No loans to be granted to partnership/ proprietorship concerns against the primary security of shares and
debentures.
2.121 Whenever the limit/limits of advances granted to a borrower exceeds Rupees ten lakhs, it should be
ensured that the said shares / debentures / bonds are transferred in the bank's name and that the bank has exclusive
and unconditional voting rights in respect of such shares. For this purpose the aggregate of limits against shares/
debentures/ bonds granted by a bank at all its offices to a single borrower should be taken into account. Where
securities are held in dematerialised form, the requirement relating to transfer of shares in bank's name will not apply
and banks may take their own decision in this regard.
2.122 Whenever the limit/limits of advances granted to a borrower exceeds Rupees ten lakhs, it should be
ensured that the said shares / debentures / bonds are transferred in the bank's name and that the bank has exclusive
and unconditional voting rights in respect of such shares. For this purpose the aggregate of limits against shares /
debentures / bonds granted by a bank at all its offices to a single borrower should be taken into account. Where
securities are held in dematerialised form, the requirement relating to transfer of shares in bank's name will not apply
and banks may take their own decision in this regard. Banks should, however, avail of the facility provided in the
depository system for pledging securities held in dematerialised form under which the securities pledged by the
borrower get blocked in favour of the lending bank. In case of default by the borrower and on the bank exercising the
option of invocation of pledge, the shares and debentures get transferred in the bank's name immediately.
2.123 Banks may take their own decision in regard to exercise of voting rights and may prescribe procedures for
this purpose.
2.124 Banks should ensure that the scrips lodged with them as security are not stolen / duplicate / fake / benami.
Any irregularities coming to their notice should be immediately reported to RBI.
2.125 Banks operating in India should not be a party to transactions such as making advances or issuing back-up
guarantees favouring other banks for extending credit to clients of Indian nationality / origin by some of their overseas
branches, to enable the borrowers to make investments in shares and debentures / bonds of Indian companies.
2.126 A uniform margin of 50% shall be applied on all advances against shares/financing of IPOs/issue of
Guarantees. A minimum cash margin of 25% (within margin of 50%) shall be maintained in respect of guarantees
issued by banks for capital market operations. These margin requirements will also be applicable in respect of bank
finance to stock brokers by way of temporary overdrafts for DVP transactions.
Advances against Fixed Deposit Receipts issued by Other Banks
2.127 There have been instances where fake term deposit receipts, purported to have been issued by some
banks, were used for obtaining advances from other banks. In the light of these happenings, RBI has advised the
banks to desist from sanctioning advances against FDRs, or other term deposits of other banks.
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Advances Other than Agriculture
Advances to Agents/Intermediaries Based on Consideration of Deposit Mobilisation
2.128 Banks should desist from being party to unethical practices of raising of resources through
agents/intermediaries to meet the credit needs of the existing/prospective borrowers or from granting loans to the
intermediaries, based on the consideration of deposit mobilisation, who may not require the funds for their genuine
business requirements.
Loans Against Certificate of Deposits (CDs)
2.129 Banks cannot grant loans against CDs. Furthermore, they are also not permitted to buy-back their own
CDs before maturity. However, these restrictions on lending and buy back in respect of CDs held by mutual funds
are relaxed. While granting such loans to the mutual funds, banks should keep in view the provisions of paragraph
44(2) of the SEBI (Mutual Funds) Regulations, 1996. Further, such finance if extended to equity-oriented mutual
funds, will form part of banks' capital market exposure, as hitherto.
Finance for and Loans/Advances against Indian Depository Receipts (IDRs)
2.130 Banks are not permitted to grant any loan / advance for subscription to Indian Depository Receipts (IDRs).
Further, no loans/ advances can be granted against security / collateral of IDRs issued in India.
Bank Finance to Non-Banking Financial Companies (NBFCs)
2.131 The RBI, vide its Master Circular No. DBR.BP.BC.No.5/21.04.172/ 2015-16 on Bank Finance to Non-
Banking Financial Companies (NBFCs) dated July 1, 2015 provides as follows:
2.132 The ceiling on bank credit linked to Net Owned Fund (NOF) of NBFCs has been withdrawn in respect of
all NBFCs which are statutorily registered with RBI and are engaged in principal business of asset financing, loan,
factoring and investment activities. Accordingly, banks may extend need based working capital facilities as well as
term loans to all NBFCs registered with RBI and engaged in infrastructure financing, equipment leasing, hire-
purchase, loan, factoring and investment activities.
2.133 In the light of the experience gained by NBFCs in financing second hand assets, banks may also extend
finance to NBFCs against second hand assets financed by them.
2.134 Banks may formulate suitable loan policy with the approval of their Boards of Directors within the
prudential guidelines and exposure norms prescribed by the Reserve Bank to extend various kinds of credit
facilities to NBFCs subject to the condition that the activities indicated in the Master Circular are not financed by
them.
2.135 In respect of NBFCs which do not require to be registered with RBI, viz.:
i) Insurance Companies registered under Section 3 of the Insurance Act, 1938;
ii) Nidhi Companies notified under Section 406 of the Companies Act, 2013;
iii) Chit Fund Companies carrying on Chit Fund business as their principal business as per Explanation to Clause
(vii) of Section 45-I(bb) of the Reserve Bank of India Act, 1934;
iv) Stock Broking Companies / Merchant Banking Companies registered under Section 12 of the Securities &
Exchange Board of India Act; and
v) Housing Finance Companies being regulated by the National Housing Bank (NHB) which have been
exempted from the requirement of registration by RBI], banks may take their credit decisions on the basis of
usual factors like the purpose of credit, nature and quality of underlying assets, repayment capacity of
borrowers as also risk perception, etc.
2.136 Banks are prohibited from providing credit for the following activities of NBFCs:
(i) Bills discounted/rediscounted by NBFCs, except for rediscounting of bills discounted by NBFCs arising from
the sale of
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(a) commercial vehicles (including light commercial vehicles), and
(b) two-wheeler and three-wheeler vehicles, subject to the following conditions:
the bills should have been drawn by the manufacturers on dealers only.
the bills should represent genuine sale transactions as may be ascertained from the
chassis/engine numbers.
before rediscounting the bills, banks should satisfy themselves about the bonafides and track
record of NBFCs which have discounted the bills.
(ii) Investments of NBFCs both of current and long term nature, in any company/entity by way of shares,
debentures, etc. However, Stock Broking Companies may be provided need-based credit against shares and
debentures held by them as stock-in-trade.
(iii) Unsecured loans/inter-corporate deposits by NBFCs to/in any company.
(iv) All types of loans/advances by NBFCs to their subsidiaries, group companies/entities.
(v) Finance to NBFCs for further lending to individuals for subscribing to Initial Public Offerings (IPOs) and for
purchase of shares from secondary market.
Bank Finance to Residuary Non-Banking Companies (RNBCs)
2.137 Residuary Non-Banking Companies (RNBCs) are also required to be mandatorily registered with RBI. In
respect of such companies registered with RBI, bank finance would be restricted to the extent of their Net Owned
Fund (NOF). The computation of NOF will be as per definition of NOF as given in the explanation to Section 45-IA
of the Reserve Bank of India Act, 1934.
Bridge loans / interim finance to NBFCs
2.138 Banks should not grant bridge loans of any nature, or interim finance against capital / debenture issues
and / or in the form of loans of a bridging nature pending raising of long-term funds from the market by way of
capital, deposits, etc. to all categories of Non-Banking Financial Companies, i.e., equipment leasing and hire-
purchase finance companies, loan and investment companies and also Residuary Non-Banking Companies
(RNBCs).
2.139 Banks should strictly follow these instructions and ensure that these are not circumvented in any manner
whatsoever by purport and / or intent by sanction of credit under a different nomenclature like unsecured
negotiable notes, floating rate interest bonds, etc., as also short-term loans, the repayment of which is proposed /
expected to be made out of funds to be or likely to be mobilised from external / other sources and not out of the
surplus generated by the use of the asset(s).
Advances against collateral security of shares to NBFCs
2.140 Shares and debentures cannot be accepted as collateral securities for secured loans granted to NBFCs
borrowers for any purpose.
Restriction on Guarantees for placement of funds with NBFCs
2.141 Banks should not execute guarantees covering inter-company deposits / loans thereby guaranteeing
refund of deposits / loans accepted by NBFCs / firms from other NBFCs / firms. The restriction would cover all
types of deposits / loans irrespective of their source, including deposits / loans received by NBFCs from trusts and
other institutions. Guarantees should not be issued for the purpose of indirectly enabling the placement of deposits
with NBFCs.
Bank Finance to Equipment Leasing Companies
2.142 Banks should not enter into lease agreements departmentally with equipment leasing companies as well
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Advances Other than Agriculture
as other Non-Banking Financial Companies engaged in equipment leasing.
Bank Finance to Factoring Companies
2.143 Banks are permitted to extend financial assistance to support the factoring business of Factoring
Companies which comply with the following criteria:
(a) The companies qualify as factoring companies and carry out their business under the provisions of the
Factoring Regulation Act, 2011 and Notifications issued by the Reserve Bank in this regard from time to time.
(b) They derive at least 75 per cent of their income from factoring activity.
(c) The receivables purchased / financed, irrespective of whether on 'with recourse' or 'without recourse' basis,
form at least 75 per cent of the assets of the Factoring Company.
(d) The assets / income referred to above would not include the assets / income relating to any bill discounting
facility extended by the Factoring Company.
(e) The financial assistance extended by the Factoring Companies is secured by hypothecation or assignment of
receivables in their favour.
(f) Banks offering factoring services may decide percentage of the invoice to be paid upfront based on their own
assessment of the credit worthiness of the assignor / buyer, due diligence carried out by them and other
commercial considerations.
(g) Factoring transactions on `with recourse' basis shall be eligible for priority sector classification by banks, which
are carrying out the business of factoring departmentally. The factoring transactions taking place through
TReDS shall also be eligible for classification under priority sector upon operationalization of the platform. For
detailed guidelines, refer RBI circular FIDD.CO.Plan.BC.10/04.09.01/2016-17 on "Priority Sector Lending
status for Factoring Transactions"
Restrictions regarding investments made by banks in securities/ instruments issued by NBFCs
2.144 Banks should not invest in Zero Coupon Bonds (ZCBs) issued by NBFCs unless the issuer NBFC builds up
sinking fund for all accrued interest and keeps it invested in liquid investments / securities (Government bonds).
2.145 Banks are permitted to invest in Non-Convertible Debentures (NCDs) with original or initial maturity up to
one year issued by NBFCs. However, while investing in such instruments banks should be guided by the extant
prudential guidelines in force, ensure that the issuer has disclosed the purpose for which the NCDs are being issued
in the disclosure document and such purposes are eligible for bank finance in terms of instructions given in the
preceding paragraphs.
Advances Against NR(E) and FCNR(B) Deposits
2.146 Grant of advance against NR(E) and FCNR(B) deposits would be subject to the guidelines issued under
Foreign Exchange Management Act, 1999.
Advances Against Bullion/Primary Gold
2.147 Banks are prohibited from granting any advance against bullion/ primary gold. However, specially minted
gold coins sold by banks are not treated as "bullion" or "primary gold" and hence the same is acceptable as
security upto 50 gms per customer. Such loans to be granted by the bank, may be covered under the policy
framed by the bank's Board, in terms of RBI circular DBOD.No. BC. 138/21.01.023/94 dated November 22, 1994.
Further, for cases wherein advances have been granted against the gold coins it should be ensure that the end
use of funds is for approved, non- speculative purposes. Banks are also required to desist from granting advances
to silver bullion dealers which are likely to be utilised for speculative purposes.
Loans for Acquisition of KVPs
2.148 The grant of loans for acquiring/investing in KVPs does not promote fresh savings and, rather,
channelises the existing savings in the form of bank deposits to small savings instruments and thereby defeats the
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very purpose of such schemes. Banks should therefore ensure that no loans are sanctioned for acquisition
of/investing in Small Savings Instruments including Kisan Vikas Patras.
Advances against Gold Ornaments & Jewellery
2.149 The RBI vide its Master Circular No. RBI/2015-16/95 DBR.No.Dir.BC.10/13.03.00/2015-16 dated July 1,
2015 provides that hallmarking of gold jewellery ensures the quality of gold used in the jewellery as to carat fineness
and purity. Hence, banks find granting of advances against the security of such hallmarked jewellery safer and
easier. Preferential treatment is given to loans against hallmarked jewellery which will also be in the long-term
interest of consumer, lenders and the industry. Based on gold purity and content the bank decides on the margin and
rates of interest.
Loan to Value Ratio for Loan against Gold Ornaments & Jewellery
2.150 The RBI vide its Master Circular No. RBI/2015-16/95 DBR.No.Dir.BC.10/13.03.00/2015-16 dated July 1,
2015 provides that loans (including bullet repayment loans) sanctioned by banks against pledge of gold ornaments
and jewellery for non-agricultural purposes should not exceed 75 per cent of the value of gold ornaments and
jewellery.
2.151 In order to standardize the valuation and make it more transparent to the borrower, gold ornaments and
jewellery accepted as security / collateral will have to be valued at the average of the closing price of 22 carat gold for
the preceding 30 days as quoted by the India Bullion and Jewellers Association Ltd. [Formerly known as the Bombay
Bullion Association Ltd. (BBA)]. If the gold is of purity less than 22 carats, the bank should translate the collateral into
22 carat and value the exact grams of the collateral. In other words, jewellery of lower purity of gold shall be valued
proportionately.
2.152 Loans extended against pledge of gold ornaments and jewellery for other than agricultural purposes, where
both interest and principal are due for payment at maturity of the loan will be subject to the following conditions:
(i) Banks, as per their Board approved policy, may decide upon the ceiling with regard to the quantum of loan that
may be granted against the pledge of gold jewellery and ornaments for non-agricultural end uses.
(ii) The period of the loan shall not exceed 12 months from the date of sanction.
(iii) Interest will be charged to the account at monthly rests and may be recognized on accrual basis provided the
account is classified as `standard' account. This will also apply to existing loans.
(iv) Such loans shall also be governed by other extant norms pertaining to income recognition, asset classification
and provisioning which shall be applicable once the principal and interest become overdue.
Gold (Metal) Loans
2.153 Presently, nominated banks can extend Gold (Metal) Loans to exporters of jewellery who are customers of
other scheduled commercial banks, by accepting stand-by letter of credit or bank guarantee issued by their bankers
in favour of the nominated banks subject to authorised banks' own norms for lending and other conditions stipulated
by RBI. Banks may also extend the facility to domestic jewellery manufacturers, subject to the conditions as specified
by RBI's Master Circular RBI/2015-16/95 DBR.No.Dir.BC.10/13.03.00/2015-16 dated July 1, 2015 on Loans and
Advances- Statutory and Other restrictions.
2.154 The nominated banks may continue to extend Gold (Metal) Loans to jewellery exporters subject to the
following conditions:
The exposure assumed by the nominated bank extending the Gold (Metal) Loan against the stand-by LC / BG
of another bank will be deemed as an exposure on the guaranteeing bank and attract appropriate risk weight as
per the extant guidelines.
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The transaction should be purely on back-to-back basis i.e. the nominated banks should extend Gold (Metal)
Loan directly to the customer of a non-nominated bank, against the stand-by LC / BG issued by the latter.
Gold (Metal) Loans should not involve any direct or indirect liability of the borrowing entity towards foreign
suppliers of gold.
The banks may calculate their exposure and compliance with prudential norms daily by converting into Rupee
the gold quantity by crossing London AM fixing for Gold / US Dollar rate with the rupee-dollar reference rate
announced by RBI.
2.155 Banks should recognise the overall risks in extending Gold (Metal) Loans as also in extending SBLC / BG.
Banks should lay down an appropriate risk management / lending policy in this regard and comply with the
recommendations of the Ghosh Committee and other internal requirements relating to acceptance of guarantees of
other banks to obviate the possibility of frauds in this area.
2.156 Nominated banks are not permitted to enter into any tie up arrangements for retailing of gold / gold coins
with any other entity including non-banking financial companies / co-operative banks / non-nominated banks.
Loans and advances to Micro and Small Enterprises (MSEs)
2.157 MSE units having working capital limits of up to Rs. 5 crore from the banking system are to be provided
working capital finance computed on the basis of 20 percent of their projected annual turnover. The banks should
adopt the simplified procedure in respect of all MSE units (new as well as existing).
Working Capital Finance to Information Technology and Software Industry
2.158 Following the recommendations of the "National Taskforce on Information Technology and Software
Development", Reserve Bank has framed guidelines for extending working capital to the said industry. Banks are,
however, free to modify the guidelines based on their own experience without reference to the Reserve Bank of
India to achieve the purpose of the guidelines in letter and spirit. The salient features of these guidelines are set
forth below:
(i) Banks may consider sanction of working capital limits based on the track record of the promoter's group
affiliation, composition of the management team and their work experience as well as the infrastructure.
(ii) In the case of the borrowers with working capital limits of up to Rs 2 crore, assessment may be made at 20
percent of the projected turnover. However, in other cases, the banks may consider assessment of MPBF on
the basis of the monthly cash budget system. For the borrowers enjoying working capital limits of Rs 10 crore
and above from the banking system, the guidelines regarding the loan system would be applicable.
(iii) Banks may obtain collateral security wherever available. First/ second charge on current assets, if available,
may be obtained.
(iv) The rate of interest as prescribed for general category of borrowers may be levied. Concessional rate of
interest as applicable to pre-shipment/post-shipment credit may be levied.
(v) Banks may evolve tailor-made follow up system for such advances. The banks could obtain quarterly
statements of cash flows to monitor the operations. In case the sanction was not made on the basis of the
cash budgets, they can devise a reporting system, as they deem fit.
Guidelines for bank finance for PSU disinvestments of Government of India
2.159 In terms of RBI circular DBOD No. Dir.BC .90/13.07.05/98 dated August 28, 1998, banks have been advised
that the promoters' contribution towards the equity capital of a company should come from their own resources and
the bank should not normally grant advances to take up shares of other companies. Banks were also advised to
ensure that advances against shares were not used to enable the borrower to acquire or retain a controlling interest
in the company/companies or to facilitate or retain inter-corporate investment. It is clarified that the aforesaid
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instructions of the 1998 circular would not apply in the case of bank finance to the successful bidders under the PSU
disinvestment programme of the Government, subject to the following:
· Banks' proposals for financing the successful bidders in the PSU disinvestment programme should be approved
by their Board of Directors.
· Bank finance should be for acquisition of shares of PSU under a disinvestment programme approved by
Government of India, including the secondary stage mandatory open offer, wherever applicable and not for
subsequent acquisition of the PSU shares. Bank finance should be made available only for prospective
disinvestments by Government of India.
· The companies, including the promoters, to which bank finance is to be extended, should have adequate net
worth and an excellent track record of servicing loans availed from the banking system.
· The amount of bank finance thus provided should be reasonable with reference to the banks' size, its net worth
and business and risk profile.
2.160 In case the advances against the PSU disinvestment is secured by the shares of the disinvested PSUs or
any other shares, banks should follow RBI's extant guidelines on capital market exposures on margin, ceiling on
overall exposure to the capital market, risk management and internal control systems, surveillance and monitoring by
the Audit Committee of the Board, valuation and disclosure, etc. In this regard, banks may be guided by the Master
Circular on Exposure Norms dated July 1, 2015.
Stipulation of lock-in period for shares
2.161 Banks may extend finance to the successful bidders even though the shares of the disinvested company
acquired/ to be acquired by the successful bidder are subjected to a lock-in period/ other such restrictions which
affect their liquidity, subject to fulfillment of following conditions:
(a) The documentation between the Government of India and the successful bidder should contain a specific
provision permitting the pledgee to liquidate the shares even during lock-in period that may be prescribed in
respect of such disinvestments, in case of shortfall in margin requirements or default by the borrower.
(b) If the documentation does not contain such a specific provision, the borrower (successful bidder) should obtain
waiver from the Government for disposal of shares acquired under PSU disinvestment programme during the
lock-in period.
2.162 As per the terms and conditions of the PSU disinvestments by the Government of India, the pledgee bank
will not be allowed to invoke the pledge during the first year of the lock-in period. During the second and third year of
the lock-in period, in case of inability of the borrower to restore the margin prescribed for the purpose by way of
additional security or non-performance of the payment obligations as per the repayment schedule agreed upon
between the bank and the borrower, the bank would have the right to invoke the pledge. The pledgee bank's right to
invoke the pledge during the second and third years of the lock-in period, would be subject to the terms and
conditions of the documentation between Government and the successful bidder, which might also cast certain
responsibilities on the pledge banks.
2.163 RBI has also clarified that the concerned bank must make a proper appraisal and exercise due caution
about creditworthiness of the borrower and the financial viability of the proposal. The bank must also satisfy itself that
the proposed documentation, relating to the disposal of shares pledged with the bank, are fully acceptable to the
bank and do not involve unacceptable risks on the part of the bank.
2.164 Further, in terms of IECD Circular No. 10/ 08.12.01/ 2000- 2001 dated 8 January 2001, banks are precluded
from financing investments of NBFCs in other companies and inter-corporate loans / deposits to/ in other companies.
However, the Special Purpose Vehicles (SPVs) which comply with the following conditions would not be treated as
investment companies and therefore would not be considered as NBFCs:
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a) They function as holding companies, special purpose vehicles, etc., with not less than 90 per cent of their total
assets as investment in securities held for the purpose of holding ownership stake,
b) They do not trade in these securities except for block sale,
c) They do not undertake any other financial activities, and
d) They do not hold/accept public deposits.
Financing Housing Projects
2.165 During the recent period, housing sector has emerged one of the biggest loan portfolios of banks. The
focus of the RBI, therefore, is to ensure orderly growth of this portfolio. The Master Circular
No.DBR.No.DIR.BC.13/ 08.12.001/2015-16 dated July 1, 2015 on Housing Finance provides guidance in respect
of the housing finance provided by the banks. Banks could deploy their funds under the housing finance allocation
in any of the three categories as per the norms provided in the Master Circular, i.e.
Direct Finance.
Indirect Finance.
Investment in Bonds of NHB/HUDCO, or combination thereof.
2.166 The Master Circular also contains a number of guidelines for this purpose, including conditions wherein a
bank cannot extend credit for housing purposes. These conditions are as follows:
(i) In case of lending to housing intermediary agencies, the banks are required to ensure that the former have
complied with the guidelines of the National Housing Board (NHB). In terms of the NHB guidelines, a
housing finance companies' total borrowings, whether by way of deposits, issue of debentures/ bonds,
loans and advances from banks or from financial institutions including any loans obtained from NHB, should
not exceed 16 times of their net owned funds. (i.e., paid up capital and free reserves less accumulated
balance of loss, deferred revenue expenditure and intangible assets.)
(ii) Banks are also not permitted to extend fund based or non fund based facilities to private builders for
acquisition of land even as part of a housing project.
(iii) Banks cannot grant finance for construction of buildings meant purely for Government/Semi-Government
offices, including Municipal and Panchayat offices. However, banks may grant loans for activities, which will
be refinanced by institutions like NABARD.
(iv) Projects undertaken by public sector entities which are not corporate bodies (i.e., public sector undertakings
which are not registered under Companies Act or which are not Corporations established under the relevant
statute) also cannot be financed by banks.
(v) In terms of the orders of the Delhi High Court, banks also can not grant loans in respect of:
Properties which fall in the category of unauthorised colonies unless and until they have been
regularised and development and other charges paid.
Properties which are meant for residential use but which the applicant intends to use for commercial
purposes and declares so while applying for the loan.
Loan to Value (LTV) ratio
2.167 In order to prevent excessive leveraging, the LTV ratio in respect of housing loans should not exceed 80
per cent. However, for small value housing loans, i.e., housing loans up to Rs. 20 lakh (which get categorized as
priority sector advances), the LTV ratio should not exceed 90 per cent. RBI vide their circular dated June 7, 2017
has changed LTV ratio for housing loans. The revised LTV ratio is applicable for all loan sanctioned post June 7,
2017.
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(a)
(b)
The LTV ratio should not exceed the prescribed ceiling in all fresh cases of sanction. In case the LTV ratio is
currently above the ceiling prescribed for any reasons, efforts should be made to bring it within limits.
Happy ending home loans
2.168 It has been observed that some banks have introduced certain incentive to home loans from regular
payment of EMI/dues. As per the feature, the borrower gets waiver of some EMI amount either at the end of the
loan or on some periodical basis. The auditor need to ensure that the bank has made sufficient provision in the
books for future waiver of EMI in the books.
Innovative Housing Loan Products Upfront Disbursal of Housing Loans
2.169 It has been observed that some banks have introduced certain innovative Housing Loan Schemes in
association with developers / builders, e.g. upfront disbursal of sanctioned individual housing loans to the builders
without linking the disbursals to various stages of construction of housing project, interest / EMI on the housing loan
availed of by the individual borrower being serviced by the builders during the construction period / specified period,
etc. This might include signing of tripartite agreements between the bank, the builder and the buyer of the housing
unit.
2.170 These loan products are popularly known by various names like 80:20, 75:25 Schemes.
2.171 Such housing loan products are likely to expose the banks as well as their home loan borrowers to
additional risks e.g. in case of disputes between individual borrowers and developers / builders, default / delayed
payment of interest / EMI by the developer / builder during the agreed period on behalf of the borrower, non-
completion of the project on time, etc. Further, any delayed payments by developers / builders on behalf of individual
borrowers to banks may lead to lower credit rating / scoring of such borrowers by credit information companies
(CICs) as information about servicing of loans gets passed on to the CICs on a regular basis. In cases where bank
loans are also disbursed upfront on behalf of their individual borrowers in a lump-sum to builders / developers without
any linkage to stages of construction, banks run disproportionately higher exposures with concomitant risks of
diversion of funds.
2.172 In view of the higher risks associated with such lump-sum disbursal of sanctioned housing loans and
customer suitability issues, banks are advised that disbursal of housing loans sanctioned to individuals should be
closely linked to the stages of construction of the housing project / houses and upfront disbursal should not be made
in cases of incomplete / under-construction / green field housing projects.
2.173 It is emphasized that banks while introducing any kind of product should take into account the customer
suitability and appropriateness issues and also ensure that the borrowers / customers are made fully aware of the
risks and liabilities under such products.
Retail loans
2.174 The banks generally provide other various retail advances namely:
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Home loans and loans against property
Vehicle loans
Personal loan
Consumer durable loans
Credit cards
2.175 Generally, loans are either sourced through direct selling agents or through bank's own branches. The bank
has a credit policy which defines process to be followed for sanction and disbursement of loan and the various
documents required.
2.176 Generally, the credit assessment process is not as detailed as followed in the corporate loans. The bank
generally collects following documents:
Completely filled Loan Application Form with customers signature
Income proof like Salary slip, Financial statement, Income tax returns, Bank statement
Photograph
Business continuity proof (e.g. Form D of Maharastra Shops and Est Act, Any other govt certificate for doing
business)
Residence proof
Identification proof
Contact Point Mobile No of applicants is mandatory
Age proof
PAN Card
2.177 The banks generally have a system in which various information collected are inputted. The system
generally automatically runs a credit filter report. The credit Filter report is based on pre-defined criteria as per the
credit policy like minimum income criteria, employment details, age, telephone etc. and the score are generated from
the system.
2.178 As a part of sanction process of the loan, the bank also runs CIBIL score and if CIBIL score is above
specific score than the bank considers for further sanction.
2.179 The bank also conducts field investigations on the proposed customer which generally involve residential
and office visits. Few banks also have the process of Fraud Containment Unit (FCU) Screening of selected sample of
file. At the FCU, the FCU officer screens through the genuineness and authenticity of the documents from the
perspective of any traces of a fraud.
2.180 Post the above verification by FCU, the bank also initiates the Positive Dedupe check for positive database,
wherein if the customer is existing customer of the bank, the system gets the popup of such links on his screen.
2.181 The credit officer initiates the negative dedupe check on the negative database through system, Negative
Dedupe check against the RBI defaulter list, Terrorist list and declined applications. Such list is uploaded in the
system by Central team of the bank. If the customer is traced under such negative listing then loan application is
rejected by the credit officer in the system.
2.182 Once, all the processes are completed and based on the results, the bank sanctions the loan.
Financing of Infrastructure Projects
2.183 The RBI has revised the definition of Infrastructure Lending vide Master Circular on Loans and Advances
Statutory and Other Restrictions dated July 1, 2015 read with Circular No. RBI/2012 13/297/DBOD.BP.BC.No
58/08.12.014/ 2012-13 dated 20/11/2012 on "Second Quarter Review of Monetary Policy 2012-13 - Definition of
`Infrastructure Lending". RBI has periodically added certain sectors as infrastructure lending from time to time.
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2.184 The revised definition of `infrastructure lending' will be effective from the date of this circular. The exposure
of banks to projects under sub-sectors which were included under the previous definition of infrastructure, but not
included under the revised definition, will continue to get the benefits under `infrastructure lending' for such exposures
till the completion of the projects. However, any fresh lending to those sub-sectors from the date of this circular will
not qualify as `infrastructure lending'.
2.185 The definition of Infrastructure Lending would include credit facility extended by Lenders (i.e., Banks &
Selected AIFIs) to a borrower for exposure in the various infrastructure sub-sectors as per paragraph 2.3.7.2 of
Master Circular on Loans and Advances- Statutory and Other Restrictions dated July1, 2015, read with Circular No.
DBOD.BP.BC.No.66/08.12.2014/2013-14 on "Financing of Infrastructure Definition of `Infrastructure Lending'"
dated November 25, 2013.
2.186 In view of the critical importance of the infrastructure sector and high priority being accorded for
development of various infrastructure services, Banks/FIs are free to finance technically feasible, financially viable
and bankable projects undertaken by both public sector and private sector undertakings subject to the following
conditions:
i. The amount sanctioned should be within the overall ceiling of the prudential exposure norms prescribed by RBI
for infrastructure financing.
ii. Banks/ FIs should have the requisite expertise for appraising technical feasibility, financial viability and
bankability of projects, with particular reference to the risk analysis and sensitivity analysis.
iii. In respect of projects undertaken by public sector units, such term loans should not be in lieu of or to substitute
budgetary resources envisaged for the project. The term loan could supplement the budgetary resources if such
supplementing was contemplated in the project design. Banks/FIs are, advised to follow the above instructions
scrupulously, even while making investment in bonds of sick State PSUs as part of the rehabilitation effort.
iv. Banks may also lend to SPVs in the private sector, registered under the Companies Act for directly undertaking
infrastructure projects which are financially viable and not for acting as mere financial intermediaries. Banks may
ensure that the bankruptcy or financial difficulties of the parent/ sponsor should not affect the financial health of
the SPV.
v. In few cases where the completion of the project gets delayed, the RBI vide its Master Circular No. RBI/2015-
16/95 DBR.No.Dir.BC. 2/21.04.048/2015-16 dated July 1, 2015 provides detailed guideline on the classification
and provision for project loans. The RBI vide its Circular No. RBI/2016-17/122 DBR.No.BP.BC.34
/21.04.132/2016-17 provides guideline for project companies where change of ownership are happen/happening
and date of commencement of commercial operation (`DCCO').
vi. The auditor should obtain the list of all outstanding project loans of the bank. The details should also include
information about original DCCO and revision of DCCO, if any. The auditor should verify that the revision of the
project DCCO is based on the technical and financial study and is approved by competent authority. The auditor
should also verify the revision in DCCO, and check whether the same is permissible under the extent RBI
guidelines. Auditor should apply professional judgement and skepticism while evaluating/ accessing and
concluding on compliance of the said guidelines for deferment of DCCO and retaining standard/standard
restructured classification. To verify compliance of the same, auditor shall obtain documentary evidences for
e.g.: legal documents for Court cases, Lead engineers report/ Review note/ consortium meeting minutes
specifying the event that is beyond promoter's control etc., as the case may be.
vii. RBI has issued clarification on their mail box on the assessment of project cost and revision in the project cost.
RBI mail box clarification also provides guidance on classification of loan in case revision of project cost is above
certain percentage of original project cost. The auditor should also ensure compliance with those clarification.
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2.187 Types of Financing by Banks
(i) In order to meet financial requirements of infrastructure projects, banks may extend credit facility by way of
working capital finance, term loan, project loan, subscription to bonds and debentures/ preference shares/
equity shares acquired as a part of the project finance package which is treated as "deemed advance" and any
other form of funded or non-funded facility.
(ii) Take-out Financing Banks may enter into take-out financing arrangement with IDFC/ other financial institutions
or avail of liquidity support from IDFC/ other FIs. Banks may also be guided by the instructions regarding take-
out finance contained in Circular No.DBOD.BP.BC.144/21.04.048/2000 dated February 29, 2000.
(iii) Inter-institutional Guarantees: Banks are permitted to issue guarantees favouring other lending institutions in
respect of infrastructure projects, provided the bank issuing the guarantee takes a funded share in the project at
least to the extent of 5 per cent of the project cost and undertakes normal credit appraisal, monitoring and
follow-up of the project.
(iv) Financing promoter's equity: In terms of Circular No.DBOD.Dir.BC.90/ 13.07.05/98 dated August 28, 1998,
Banks were advised that the promoters' contribution towards the equity capital of a company should come from
their own resources and the bank should not normally grant advances to take up shares of other companies. In
view of the importance attached to the infrastructure sector, it has been decided that, under certain
circumstances, an exception may be made to this policy for financing the acquisition of the promoters' shares in
an existing company, which is engaged in implementing or operating an infrastructure project in India. The
conditions, subject to which an exception may be made, are as follows:
The bank finance would be only for acquisition of shares of existing companies providing infrastructure
facilities. Further, acquisition of such shares should be in respect of companies where the existing foreign
promoters (and/ or domestic joint promoters) voluntarily propose to disinvest their majority shares in
compliance with SEBI guidelines, where applicable.
The companies to which loans are extended should, inter alia, have a satisfactory net worth.
The company financed and the promoters/ directors of such companies should not be a defaulter to banks/
FIs.
In order to ensure that the borrower has a substantial stake in the infrastructure company, bank finance
should be restricted to 50% of the finance required for acquiring the promoter's stake in the company being
acquired.
Finance extended should be against the security of the assets of the borrowing company or the assets of
the company acquired and not against the shares of that company or the company being acquired. The
shares of the Borrower Company / Company being acquired may be accepted as additional security and not
as primary security. The security charged to the banks should be marketable.
Banks should ensure maintenance of stipulated margins at all times.
The tenor of the bank loans may not be longer than seven years. However, the Boards of banks can make
an exception in specific cases, where necessary, for financial viability of the project.
This financing would be subject to compliance with the statutory requirements under Section 19(2) of the
Banking Regulation Act, 1949.
The banks financing acquisition of equity shares by promoters should be within the regulatory ceiling of 40
per cent of their net worth as on March 31 of the previous year for the aggregate exposure of the banks to
the capital markets in all forms (both fund based and non-fund based).
The proposal for bank finance should have the approval of the Board.
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Strategic Debt Restructuring scheme:
2.188 RBI in notifications DBR.BP.BC.No.101/21.04.132/2014-15 dated June 8, 2015 and DBOD.BP.BC.No.97/
21.04.132/2013-14 dated February 25, 2016 announced the strategic debt restructuring scheme. RBI has further
provided guidelines on the same vide its Circular No. RBI/2016-17/122 DBR.No.BP.BC.34/21.04.132/2016-17. The
scheme has been established based on the general principle of restructuring that the shareholders bear the first
loss rather than the debt holders and also to ensure more `skin in the game' of promoters. In many cases of
restructuring of accounts, borrower companies are not able to come out of stress due to operational/ managerial
inefficiencies despite substantial sacrifices made by the lending banks. In such cases, change of ownership could
be a preferred option. The Joint Lenders' Forum (`JLF') should actively consider such change in ownership under
the above Framework issued vide the circular DBOD.BP.BC.No.97/21.04.132/2013-14 dated February 26, 2014.
2.189 To ensure more stake of promoters in reviving stressed accounts and to initiate change of ownership in
accounts which fail to achieve the projected viability milestones, banks may, at their discretion, undertake a
`Strategic Debt Restructuring (`SDR') by converting loan dues to equity shares. Banks should consider using SDR
only in cases where change in ownership is likely to improve the economic value of the loan asset and the
prospects of recovery of their dues. The trigger for SDR must be non-achievement of viability milestones and /or
non-adherence to `critical conditions' linked to the option of invoking SDR, as stipulated in restructuring
agreement, and SDR cannot be triggered for any other reason.
2.190 For restructuring a borrower account under SDR, the banks are required to ensure the following:
i. If the borrower is not able to achieve the viability milestones and/or adhere to the critical conditions, the
JLF must immediately review the account and examine whether the account will be viable by effecting a
change in ownership. If found viable under such examination, the JLF may decide on whether to invoke
the SDR, so as to acquire majority shareholding in the company.
ii. Banks must include necessary covenants in all loan agreements, including restructuring, supported by
necessary approvals/authorisations (including special resolution by the shareholders) from the borrower
company, as required under extant laws/regulations, to enable invocation of SDR in applicable cases.
The auditor should ensure that these terms and conditions are included in all loan agreements.
iii. The decision on invoking the SDR by converting the whole or part of the loan into equity shares should be
taken by the JLF within 30 days from review of the account and should be approved by the majority of the
JLF members i.e. minimum of 60% of creditors by value and 50% of creditors by number. This date is
referred to as `Reference Date'. The attendance and votes of JLF members should be documented in the
minutes to JLF meeting. The auditor should ensure that the JLF has made the decision with requisite
majority.
iv. The conversion by lenders will be subject to member banks' respective total holdings in shares of the
company.
v. The banks should conform to the statutory limit in terms of Section 19(2) of Banking Regulation Act,
1949.
vi. The conversion package should be designed so that post the conversion, all lenders under the JLF must
collectively hold 51% or more of the equity shares issued by the company. The auditor should ensure that
the bank's share in the conversion package is appropriately computed.
vii. The JLF must approve the SDR conversion package.
viii. The conversion of debt into equity as approved under the SDR should be completed within an overall
timeline of 210 days from the date of the review of achievement of milestones/critical conditions. The
auditor should verify the compliance with timelines for implementation of SDR.
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ix. Banks must ensure compliance with the provisions of Section 6 of Banking Regulation Act and JLF
should closely monitor the performance of the company and consider appointing suitable professional
management to run the affairs of the company. The banks should not allow the current management to
continue without the representatives of banks on the Board of the company and without supervision by an
entity/person appointed by the banks.
2.191 Stand-Still clause:
The invocation of SDR will not be treated as restructuring for the purpose of asset classification and provisioning
norms. The existing asset classification of the account, as on the reference date, will continue for a period of 18
months from the reference date. The auditor should validate the asset classification of the borrower as on the
reference date. In case the SDR package is not implemented within 180 days from the `Reference date' or the
banks are unable to divest their stake to a `new promoter' within 18 months from the reference date, the loans will
be classified as per the conduct of the account as per the extant RBI guideline on IRAC, assuming the aforesaid
`stand-still' in asset classification had not been given.
2.192 Banks must prepare a bank's board approved policy towards invocation/release of personal guarantees
and this should be based on the principle of reasonable satisfaction of lenders' claims. This could include pledge
of the existing promoters' share in favour of the lenders. Personal guarantees should be released only after
transfer of ownership and/or management control to the new promoters.
2.193 JLF and lenders must divest their holdings in the equity of the company as soon as possible. On
divestment of banks' holding in favour of a `new promoter', the asset classification of the account may be
upgraded to `Standard'.
2.194 The banks must ensure that the `new promoter' is not be a person/entity/subsidiary/associate etc.
(domestic as well as overseas), from the existing promoter/promoter group. Banks must clearly establish that the
acquirer does not belong to the existing promoter group and must exercise necessary due diligence in this regard.
The banks should ensure that the new promoters acquire at least 26 per cent of the paid up equity capital of the
borrower company within the period of 18 months from `Reference date' and new promoters should take over the
management of the company. The auditors must ensure the new promoter is not a part of the existing promoter/
promoter group. The auditor should ensure that the bank has divested its share within the appropriate timelines.
2.195 The banks should continue to hold the amount of provision held in the account as on reference date.
Banks may reverse the provision held only when all the outstanding loan/facilities in the account perform
satisfactorily during the `specified period', i.e. principal and interest on all facilities in the account are serviced as
per terms of payment during that period. If satisfactory performance during the specified period is not evidenced,
the asset classification of the restructured account would be based on IRAC norms as per the repayment schedule
that existed as on the reference date.
2.196 Banks should make provisions such that, by the end of the 18 month period from the reference date, they
hold provision of at least 15 per cent of the residual loan. The provision should be made in equal instalments over
the four quarters. This provision shall be reversed only when all the outstanding loans/facilities in the account
perform satisfactorily during the `specified period' after transfer of ownership/management control to new
promoters.
2.197 At the time of divestment of their holdings to a `new promoter', banks may refinance the existing debt of
the company considering the changed risk profile of the company without treating the exercise as `restructuring'
subject to banks making provision for any diminution in fair value of the existing debt on account of the refinance.
2.198 Conversion Price:
Conversion of outstanding debt into equity instruments should be at a `Fair Value' which will not exceed the lowest
of the following, subject to the floor of `Face Value' (restriction under section 53 of the Companies Act, 2013):
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a) Market value (for listed companies): Average of the closing prices on a recognized stock exchange during
the ten trading days preceding the `reference date'
b) Break-up value: Book value per share to be calculated from the company's latest audited balance sheet
(without considering 'revaluation reserves', if any) adjusted for cash flows and financials post the earlier
restructuring; the balance sheet should not be more than a year old. In case the latest balance sheet is
not available this break-up value shall be Re.1.
2.199 The Fair value should be decided at a `reference date'. The auditor should verify the computation of
conversion price as per RBI guidelines. The pricing under SDR has been exempted from SEBI ICDR regulations,
2009. In case of listed companies, the acquiring lender on account of conversion of debt into equity under SDR is
also exempted from the obligation to make an open offer under regulation 3 and regulation 4 of the provisions of
the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
2.200 Banks must periodically value and provide for depreciation of these equity shares as per IRAC norms for
investment portfolio. Banks have the option of distributing the depreciation on equity shares acquired under SDR,
over a maximum of four calendar quarters from the date of conversion of debt into equity. The auditor should
verify the computation and spread of provision for depreciation.
Scheme for Sustainable Structuring of Stressed Assets
2.201 RBI vide circular RBI/2015-16/422 DBR.No.BP.BC. 103/21.04.132/2015-16 dated June 13, 2016, has
allowed to facilitate the resolution of large accounts under Scheme for Sustainable Structuring of Stressed Assets.
For being eligible under the scheme, the account should meet all the following conditions:
(i) The project has commenced commercial operations;
(ii) The aggregate exposure (including accrued interest) of all institutional lenders in the account is more
than Rs.500 crore (including Rupee loans, Foreign Currency loans/External Commercial Borrowings,);
(iii) The debt meets the test of sustainability as outlined in para 5 of the circular.
A debt level will be deemed sustainable if the Joint Lenders Forum (JLF)/Consortium of lenders/bank conclude
through independent techno-economic viability (TEV) that debt of that principal value amongst the current
funded/non-funded liabilities owed to institutional lenders can be serviced over the same tenor as that of the
existing facilities even if the future cash flows remain at their current level. For this scheme to apply, sustainable
debt should not be less than 50 percent of current funded liabilities. This is referred to as Part A in paragraph
below.
Sustainable Debt
2.202 The resolution plan may involve one of the following options with regard to the post-resolution ownership
of the borrowing entity:
(a) The current promoter continues to hold majority of the shares or shares required to have control;
(b) The current promoter has been replaced with a new promoter, in one of the following ways:
i. Through conversion of a part of the debt into equity under SDR mechanism which is thereafter sold
to a new promoter;
ii. In the manner contemplated as per Prudential Norms on Change in Ownership of Borrowing Entities
(Outside SDR Scheme);
(c) The lenders have acquired majority shareholding in the entity through conversion of debt into equity either
under SDR or otherwise and
i. allow the current management to continue or
ii. hand over management to another agency/professional under an operate and manage contract.
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Note: Where malfeasance on the part of the promoter has been established, through a forensic audit or otherwise,
this scheme shall not be applicable if there is no change in promoter or the management is vested in the
delinquent promoter.
2.203 In any of the circumstances mentioned above, the JLF/consortium/bank shall, after an independent TEV,
bifurcate the current dues of the borrower into Part A and Part B as described below;
(a) Determine the level of debt (including new funding required to be sanctioned within next six months and non-
funded credit facilities crystallising within next 6 months) that can be serviced (both interest and principal)
within the respective residual maturities of existing debt, from all sources, based on the cash flows available
from the current as well as immediately prospective (not more than six months) level of operations. For this
purpose, free cash flows (i.e., cash flow from operations minus committed capital expenditure) available for
servicing debt as per latest audited/reviewed financial statement will be considered. Where there is more than
one debt facility, the maturity profile of each facility shall be that which exists on the date of finalising this
resolution plan. For the purpose of determining the level of debt that can be serviced, the assessed free cash
flow shall be allocated to servicing each existing debt facility in the order in which its servicing falls due. The
level of debt so determined will be referred to as Part A in these guidelines.
(b) The difference between the aggregate current outstanding debt, from all sources, and Part A will be referred
to as Part B in these guidelines.
(c) The security position of lenders will, however, not be diluted and Part A portion of loan will continue to have at
least the same amount of security cover as was available prior to this resolution.
Assets classification and provisioning
2.204 (A) Where there is a change of promoter
In case a change of promoter takes place, i.e. a new promoter comes in, the asset classification and provisioning
requirement will be as per the `SDR' scheme or `outside SDR' scheme as applicable. RBI vide circular
No.RBI/2016-17/121 DBR.No.BP.BC.33/21.04.132/2016-17 dated November 10, 2016 have revised the assets
classification norms for loans under the Scheme for Sustainable Structuring of Stressed Assets, in cases where
there is no change of promoters.
2.205 In respect of an account that is classified as a non-performing asset as on the reference date, the Part B
instruments shall continue to be classified as non-performing investment and provided for as a non-performing
asset as per extant prudential norms, as long as such instruments remain in Part B. The sustainable portion (Part
A) may optionally be treated as `Standard' upon implementation of the resolution plan by all banks, subject to
provisions made upfront by the lenders being at least the higher of 50 percent of the amount held in part B or 25
percent of the aggregate outstanding (sum of Part A and part B). For this purpose, the provisions already held in
the account can be reckoned.
2.206 In all cases, lenders may upgrade Part B to standard category and reverse the associated enhanced
provisions after one year of satisfactory performance of Part A loans. In case of any pre-existing moratorium in the
account, this upgrade will be permitted one year after completion of the longest such moratorium, subject to
satisfactory performance of Part A debt during this period. However, in all cases, the required MTM provisions on
Part B instruments must be maintained at all times. The transition benefit available in terms of above para can
however be availed.
Flexible Structuring of Long Term Project Loans to Infrastructure and Core Industries (5/25)
2.207 Infrastructure and core industries projects are characterised by long gestation periods and large capital
investments. The long maturities of such project loans consist of the initial construction period and the economic
life of the asset /underlying concession period (usually 25-30 years). In order to ensure stress free repayment of
such long gestation loans, their repayment tenor should bear some correspondence to the period when cash flows
are generated by the asset. RBI allows banks to finance long-term projects in infrastructure sector and core
industries sector under circular DBOD.No.BP.BC.24/21.04.132/2014-15 provided:
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
a) Only term loans, in which the aggregate exposure of all institutional lenders exceeds Rs.500 crore, to
infrastructure projects and projects in core industries sector where will qualify for refinancing. The auditors
should ensure that the loans are for projects which pertain to the above classification of infrastructure projects
and core industries.
b) At the time of initial appraisal of such projects, banks must fix an amortisation schedule (Original Amortisation
Schedule) and ensure that the cash flows from such projects and all necessary financial and non-financial
parameters are robust even under stress scenarios. The auditors should verify the Original Amortisation
Schedule fixed by the bank.
c) The tenor of the Amortisation Schedule should not be more than:
i. 80% of the initial concession period in case of infrastructure projects under public private partnership
(PPP) model;
ii. or 80% of the initial economic life envisaged at the time of project appraisal for determining the user
charges / tariff in case of non-PPP infrastructure projects;
iii. or 80% of the initial economic life envisaged at the time of project appraisal by Lenders Independent
Engineer in the case of other core industries projects
The auditors should verify the initial economic period/ initial economic life envisaged and should
ensure that the amortisation schedule is in compliance of RBI guidelines.
d) The bank may sanction the loan for a medium term say 5 to 7 years to take care of initial construction period
and also cover the period at least up to the DCCO and revenue ramp up. The repayment at the end of this
period should be equal to present value to the remaining residual payments corresponding to the Original
Amortisation Schedule. The repayment could be structured as a bullet repayment, with the intent specified up
front that it will be refinanced. The auditors should verify the computation of repayment and the periodic
refinancing of debt
e) The repayment schedules of Initial Debt Facility must normally correspond to the Original Amortisation
Schedule, unless there is an extension of DCCO. The auditors should ensure compliance with IRAC norms
regarding extension of DCCO in such cases.
f) The Amortisation Schedule of a project loan can be modified once during the course of the loan (after DCCO)
based on the actual performance of the project in comparison to the assumptions made without being treated
as `restructuring' provided:
i. The loan is a standard loan as on the date of change of Amortisation Schedule;
ii. Net present value (`NPV') of the loan remains the same before and after the change in Amortisation
Schedule;
iii. The entire outstanding debt amortisation is scheduled within 85% of the intial concession period/
initial economic life of the project;
iv. The viability of the project must be reassessed by the bank and vetted by the Independent Evaluation
Committee;
The auditors should verify the revised amortisation schedule fixed, verify the computation of NPV,
ensure that the amortisation schedule is within 85% of the economic life of the project and ensure
that the viability of the project is reassessed. The auditor should verify the economic life calculated
based on the concession period or LIEs report and must understand the assumptions used for
computation of the same.
g) Banks can determine the pricing of the loans at each stage of sanction of the Initial Debt Facility or
Refinancing Debt Facility, commensurate with the risk at each phase of the loan, and such pricing should not
be below the Base Rate of the bank.
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Advances Other than Agriculture
h) The bank must have a Board approved policy for such financing.
Income recognition
2.208 Provisions and regulations on Income recognition have been elaborately discussed in Chapter 4 of part III of
Guidance Note.
Prudential Exposure Limits
Single and Group Borrower Limits5
2.209 With a view to achieve a better risk management and avoidance of concentration of credit risk, the RBI
from time to time, prescribes, limits on exposure of a bank to individual borrowers and groups of borrowers in
India. The Master Circular No. RBI/2015-16/70 DBR.No.Dir.BC.12/13.03.00/ 2015-16 dated July 1, 2015 on
"Exposure Norms", lays down the ceiling on credit exposure to individual/group borrowers in relation to bank's
capital fund as defined under capital adequacy standards (Tier-I and Tier-II Capital). The ceiling on exposure to
individual borrowers is 15 per cent of capital funds and 40 per cent in the case of a borrower group. However,
exposure to borrowers belonging to a group may exceed the exposure norms of the 40 per cent of the bank's
capital funds by an additional 10 per cent, provided the additional credit exposure is on account of extension of
credit for infrastructure projects. Exposure to single borrower may also exceed by 5 per cent, provided the
additional exposure is on account of infrastructure projects. Derivative Products such as Forward Rate
Agreements and Interest Rate Swaps are also captured for computing exposure by applying the conversion
factors to notional principal amounts. Banks should also include forward contracts in foreign exchange and other
derivative products like currency swaps, options, etc., at their replacement cost value in determining individual/
group borrower exposure. The Master Circular on Exposure Norms contains guidelines on calculation of the credit
exposure in derivative products.
2.210 In addition to the exposure limit as permitted above, banks may, in exceptional circumstances, with the
approval of their Boards, consider enhancement of the exposure to a borrower (single as well as group) upto a
further 5 per cent of capital funds..
2.211 With effect from May 29, 2008, the exposure limit in respect of single borrower has been raised to twenty
five per cent of the capital funds, only in respect of Oil Companies who have been issued Oil Bonds (which do not
have SLR status) by Government of India. In addition to this, banks may in exceptional circumstances, consider
enhancement of the exposure to the Oil Companies up to a further 5 per cent of capital funds.
2.212 Such exposures where the bank has exceeded the prudential exposure limit should be appropriately
disclosed in the "Notes to Accounts" to the Balance Sheet.
Disinvestment Programme of the Government of India
2.213 On account of banks' financing of acquisition of PSU shares under the Government of India
disinvestment programmes, if any bank, is likely to exceed the regulatory ceiling of single / group borrower limit,
RBI will consider relaxation on specific requests from banks in the single/group credit exposure norms on a case
by case basis, provided that the bank's total exposure to the borrower, net of its exposure due to acquisition of
PSU shares under the Government of India disinvestment programme, should be within the prudential
single/group borrower exposure ceiling prescribed by RBI.
Sector Specific Limit
2.214 Apart from limiting the exposures to an individual or a borrower group as indicated above, banks may
5
RBI vide its circular No. DBOD.No.BP.BC.96/21.06.102/2013-14 on Guidelines on Management of Intra-Group Transactions and Exposures
providing guidelines on Intra-Group Transactions and Exposures (ITEs) for banks. The guidelines contain quantitative limits on financial ITEs
and prudential measures for the non-financial ITEs to ensure that banks engage in ITEs in safe and sound manner in order to contain
concentration and contagion risks arising out of ITEs. These guidelines l become effective from October 1, 2014.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
also consider fixing internal limits for aggregate commitments to specific sectors, e.g. textiles, jute, tea, etc., so
that the exposures are evenly spread over various sectors. These limits could be fixed by the banks having regard
to the performance of different sectors and the risks perceived. The limits so fixed may be reviewed periodically
and revised, as necessary.
Lending to NBFCs
2.215 The exposure (both lending and investment, including off balance sheet exposures) of a bank to a single
NBFC / NBFC-AFC (Asset Financing Companies) should not exceed 10% / 15% respectively, of the bank's capital
funds as per its last audited balance sheet. Banks may, however, assume exposures on a single NBFC / NBFC-
AFC up to 15%/20% respectively, of their capital funds provided the exposure in excess of 10%/15% respectively,
is on account of funds on-lent by the NBFC / NBFC-AFC to the infrastructure sector. Exposure of a bank to
Infrastructure Finance Companies (IFCs) should not exceed 15% of its capital funds as per its last audited balance
sheet, with a provision to increase it to 20% if the same is on account of funds on-lent by the IFCs to the
infrastructure sector. Further, banks may also consider fixing internal limits for their aggregate exposure to all
NBFCs put together. Infusion of capital funds after the published balance sheet date may also be taken into
account for the purpose of computing exposure ceiling. Banks should obtain an external auditor's certificate on
completion of the augmentation of capital and submit the same to the Reserve Bank of India (Department of
Banking Supervision) before reckoning the additions to capital funds.
Bills Purchased/Discounted under Letter of Credit
2.216 In cases where the bills discounting/purchasing/negotiating bank and LC issuing bank are different
entities, bills purchased/ discounted/ negotiated under L/C (where payment to the beneficiary is not "under
reserve") is to be treated as an exposure on L/C issuing bank and not on borrower. In the case of negotiations
"under reserve", the exposure will be treated as an exposure on the borrower. However, in cases where the bills
discounting/purchasing/ negotiating bank and LC issuing bank are part of the same bank, i.e. where LC is issued
by the Head Office or branch of the same bank, then the exposure should be taken on the third party/borrower and
not on the LC issuing bank.
Unhedged Foreign Currency Exposure of Corporates
2.217 To ensure that each bank has a policy that explicitly recognises and takes account of risks arising out of
foreign exchange exposure of their clients, foreign currency loans above US $10 million, or such lower limits as may
be deemed appropriate vis-à-vis the banks' portfolios of such exposures, should be extended by banks only on the
basis of a well laid out policy of their Boards with regard to hedging of such foreign currency loans. Further, the policy
for hedging, to be framed by their Boards, may consider, as appropriate for convenience, excluding the following:
Where forex loans are extended to finance exports, banks may not insist on hedging but assure themselves
that such customers have uncovered receivables to cover the loan amount.
Where the forex loans are extended for meeting forex expenditure.
2.218 Banks may also consider stipulating a limit on unhedged position of corporates on the basis of bank's
Board approved policy. In this context, attention of the readers is also invited to RBI's Circular No.
DBOD.No.BP.BC.85/21.06.200/2013-14 on "Capital and Provisioning Requirements for Exposures to entities with
Unhedged Foreign Currency Exposure" dated January 15, 2014 and clarification DBOD.No.BP.BC.116/
21.06.200/2013-14 dated June 3, 2014 providing requirements for exposures to entities with unhedged foreign
currency exposure.
2.219 The auditor while carrying out the audit of the Unhedged Foreign Currency Exposure (UFCE), should
ensure that the Bank has:-
Obtained the UFCE information from all its branches (including foreign branches) in respect of large
borrowers.
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Advances Other than Agriculture
Obtained a certificate in respect of UFCE from entities on a quarterly basis on self-certification basis, and
which has preferably been internally audited by the entity concerned. However, at least on an annual basis,
UFCE information should be audited and certified by the statutory auditors of the entity for its authenticity.
Computed "Capital and Provisioning Requirements for Exposures to entities with UFCE" at least on a
quarterly basis, as per the applicable RBI guidelines.
Lending for Real Estate
2.220 Banks are required to frame comprehensive prudential norms relating to the ceiling on the total amount of
real estate loans, single/group exposure limits for such loans, margins, security, repayment schedule and availability
of supplementary finance and the policy should be approved by the banks' Boards. The disbursements in case of
these loans should be made only after the borrower has obtained requisite clearances from the government
authorities.
2.221 RBI has also required that the banks' Boards may also consider incorporation of aspects relating to
adherence to National Building Code (NBC) in their policies on exposure to real estate. The information regarding
the NBC can be accessed from the website of Bureau of Indian Standards (www.bis.org.in). Banks should also adopt
the National Disaster Management Authority (NDMA) guidelines and suitably incorporate them as part of their loan
policies, procedures and documentation.
Financing of Joint Ventures
2.222 Banks are allowed to extend credit/non-credit facilities (viz. letters of credit and guarantees) to Indian Joint
Ventures/Wholly-owned Subsidiaries abroad and step-down subsidiaries which are wholly owned by the overseas
subsidiaries of Indian Corporates. Banks are also permitted to provide at their discretion, buyer's credit/acceptance
finance to overseas parties for facilitating export of goods and services from India. The above exposure will, however,
be subject to a limit of 20 percent of banks' unimpaired capital funds (Tier I and Tier II capital)and would be subject to
the conditions laid down in this regard in the Master Circular on `Loans and Advances Statutory and Other
Restrictions' dated July 1, 2015.
Limits on Banks' Exposure to Capital Markets
Statutory limit on shareholding in companies
2.223 No banking company is permitted to hold shares in any company, whether as pledgee, mortgagee or
absolute owner, of an amount exceeding 30 percent of the paid-up share capital of that company or 30 percent of its
own paid-up share capital and reserves, whichever is less, except as provided in sub-section (1) of Section 19 of the
Banking Regulation Act, 1949. Shares held in demat form should also be included for the purpose of determining the
exposure limit. This is an aggregate holding limit for each company.
Regulatory Limit
A. Solo Basis
2.224 The aggregate exposure of a bank to the capital markets in all forms (both fund based and non-fund based)
should not exceed 40 per cent of its net worth as on March 31 of the previous year. Within this overall ceiling, the
bank's direct investment in shares, convertible bonds / debentures, units of equity-oriented mutual funds and all
exposures to Venture Capital Funds (VCFs) [both registered and unregistered] should not exceed 20 per cent of its
net worth.
B. Consolidated Basis
2.225 The aggregate exposure of a consolidated bank to capital markets (both fund based and non-fund based)
should not exceed 40 per cent of its consolidated net worth as on March 31 of the previous year. Within this overall
ceiling, the aggregate direct exposure by way of the consolidated bank's investment in shares, convertible
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
bonds/debentures, units of equity-oriented mutual funds and all exposures to Venture Capital Funds (VCFs) [both
registered and unregistered] should not exceed 20 per cent of its consolidated net worth6.
Sectoral Distribution
2.226 Advances are required to be classified, inter alia, into those in India and those outside India, with further
sub-classification under each category. One such sub-classification that merits discussion from an auditor's
perspective is advances in India to priority sectors.
2.227 Priority sector advances include:
Advances for agriculture and other allied activities However, RBI, vide its circular no. RPCD.CO.Plan.BC.
51 /04.09.01/2010-11 dated February 2, 2011 on "Classification of loans against gold jewellery" clarifies that
loans sanctioned to NBFCs for on-lending to individuals or other entities against gold jewellery, are not
eligible for classification under agriculture sector. Similarly, investments made by banks in securitised assets
originated by NBFCs, where the underlying assets are loans against gold jewellery, and
purchase/assignment of gold loan portfolio from NBFCs are also not eligible for classification under
agriculture sector.
RBI vide its master circular no FIDD.FID.BC.No.02/12.01.033/2015-16 dated July 1, 2015 has provided details on
SHG- Bank linkage Programme. In order to enable the banks to report their SHG lending without difficulty, it
was decided that the banks should report their lending to SHGs and/or to NGOs for on-lending to
SHGs/members of SHGs under the new segment, viz. 'Advances to SHGs' irrespective of the purposes for
which the members of SHGs have been disbursed loans. Lending to SHGs should be included by the banks as
part of their lending to the weaker sections (under priority section).
Advances to minority communities.
Advances to micro/small/medium scale enterprises7.
Advances to small road transport operators.
Advances to retail traders and small business enterprises.
Advances to professionals and self-employed.
Advances sanctioned to State sponsored organisations for scheduled castes/scheduled tribes.
Educational loans upto the prescribed limit RBI, vide its circular no. RPCD.SME & NFS.BC.No. 69/06.12.05
/2009-10 dated April 12, 2010 on "Collateral Free Loans - Educational Loan Scheme", clarified that banks
must not, mandatorily, obtain collateral security in the case of educational loans upto Rs. 4 lakh.
Housing loans upto prescribed limits8.
Funds provided to RRBs.
Micro credit9.
Any other priority sector advances, such as SEPUP (Self-Employment Programme for Urban Poor), PMRY
(Prime Minister's Rozgar Yojana), SEEUY (Self-Employment Scheme for Educated Unemployed Youth)
6
Attention of the readers is drawn to Master Circular of RBI, DBR.No.Dir.BC.12/13.03.00/2015-16 dated 1 July 2015, for components of capital
exposure, exclusions, method of computation of capital exposure for the purpose and Intra-day limits.
7
The RBI has issued a master circular no. FIDD.MSME & NFS. BC. No. 07/06.02.31/2015-16on "Lending to Micro, Small and Medium
Enterprises (MSME) Sector" dated July 1, 2015. Also refer to the circular no. RPCD.SME & NFS.BC.No.79/06.02.31/2009-10 dated May 6,
2010 on "Working Group to Review the Credit Guarantee Scheme for Micro and Small Enterprises (MSEs) Collateral free loans to MSEs".
8
Attention is also invited to circular no. DBOD.No.BP.BC. 69 /08.12.001/2010-11 dated December 23, 2010 on "Housing Loans by Commercial
Banks LTV Ratio, Risk Weight and Provisioning", circular no. RPCD.MSME & NFS.BC.No. 30 /06.11.01/ 2012-13 dated September 18,
2012 on "Scheme of 1% interest subvention on housing loans up to Rs. 15 lakh" and Master circular no. DBR. No.DIR.BC.13/08.12.001/2015-
16 dated July 1, 2015 on "Housing Finance".
9
The RBI has issued a master circular no. RPCD.MFFI.BC.No. 05/12.01.001/2010-11 dated July 1, 2010 on "Micro Credit".
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Advances Other than Agriculture
SGSY (Swarna jayanti Gram swaraj Swarojgar Yojana)10, SJSRY (Swarna jayanti Sahakari Rozgar Yojana).
2.228 Priority sector advances generally carry an interest rate, which is lower than the normal rate of interest on
lending to other sectors. These advances are also known as DRI advances, i.e., advances on which differential
rate of interest is applicable. Under the Reserve Bank of India's guidelines, a specified proportion of the total
advances of banks are to be made to priority sectors necessarily. Depending upon the nature and type of facilities
extended, the bank may get subsidy from the Government to fully or partly offset the shortfall in interest rate
and/or get indemnified for bad debts for the whole or a portion of such advances.
2.229 RBI has issued a guidelines for the targets and sub-targets set under priority sector lending for all
scheduled commercial banks operating in India. For detailed information on the guidelines, refer RBI circular
FIDD.CO.Plan.BC.54/04.09.01/2014-15 on "Priority Sector Lending Targets and Classification".
2.230 Government of India vide Notification dated February 04, 2016 has specified "Dealing in Priority Sector
Lending Certificates (PSLCs) in accordance with the Guidelines issued by Reserve Bank of India" as a form of
business under Section 6 (1)(o) of the Banking Regulation Act, 1949. The purpose of PSLCs is to enable banks to
achieve the priority sector lending target and sub-targets by purchase of these instruments in the event of shortfall
and at the same time incentivize the surplus banks; thereby enhancing lending to the categories under priority
sector. Refer RBI circular FIDD.CO.Plan.BC.23/04.09.01/2015-16 for detailed guidelines on PSLCs.
System of Base Rate and Interest Rate
2.231 The RBI vide its Circular No. DBR.No.Dir.BC.9/13.03.00/2015-16 dated April 1, 2015 and
DBR.No.Dir.BC.67/13.03.00/2015-16 dated December 17, 2015 on "Interest Rates on Advances" required the
banks to freely determine the lending rates on the advances as per their Board approved policy subject to the
guidelines contained in the circular. The Base Rate system is aimed at enhancing transparency in lending rates of
banks and enabling better assessment of transmission of monetary policy. Accordingly, the following is the
summary guidelines were issued by RBI for implementation by banks. For detailed guidelines, refer above
mentioned RBI circulars:
Banks were required to obtain the approval of their respective Boards for the Prime Lending Rate which was
the minimum rate charged by them for the credit limits of over Rs 2 lakhs. In case of loans up to Rupees two
lakh, it was decided to continue to protect these borrowers by prescribing the lending rates. With effect from
April 29, 1998, it was decided that interest on Credit limit of Rs. 2 lakh and below shall not exceed PLR which
was available to the best customer of the concerned bank. In order to enhance transparency in bank's pricing
of their loan products as also to ensure that the PLR truly reflects the actual cost, in year 2003, it was
decided to abolish the prescription of minimum lending rate for credit limits of over Rupees two lakh and
banks were given the freedom to fix the lending rates for such credit limits subject to Benchmark Prime
Lending Rate (BPLR) and spread guidelines. Banks were required to obtain the approval of their respective
Boards for the BPLR, which would be the reference rate for credit Iimits of over Rs. 2 lakh. Each bank's
BPLR had to be declared and be made uniformly applicable at all branches. BPLR continued to be the ceiling
rate of interest for advances upto Rs. 2 lakh.
Base Rate shall include all those elements of the lending rates that are common across all categories of
borrowers. There can be only one Base Rate for each bank. Banks may choose any benchmark to arrive at
the Base Rate that may be disclosed transparently.Banks are free to use any other methodology, as
considered appropriate, provided it is consistent and is made available for supervisory review/scrutiny, as
and when required.
Banks are required to review the Base Rate at least once in a quarter with the approval of the Board or the
10
Attention is the readers is drawn to master circular No. FIDD.CO.Plan.BC.04/04.09.01/2015-16dated July 1, 2015 on "Priority Sector Lending -
Special Programmes Swarna jayanti Gram Swarozgar Yojana (SGSY)" and Circular No. RPCD.GSSD .BC.No.30 /09.01.01/2010 -11 dated
December 15, 2010 on "Swarna jayanti Gram Swarozgar Yojana (SGSY) - Group Life Insurance Scheme". (Add circular related to NRLM as
well)
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Asset Liability Management Committees (ALCOs) as per the bank's practice. Banks are allowed to review
Base Rate methodology after three years from date of its finalizationwith the approval of their Board of
Directors/ ALCO.
All rupee loans sanctioned and credit limits renewed w.e.f. April 1, 2016 will be priced with reference to the
Marginal Cost of Funds based Lending Rate (MCLR) which will be the internal benchmark for such purposes.
Audit teams should verify whether new loans sanctioned and credit limits renewed post April 1, 2016 is under
the new MCLR regime.
The MCLR will comprise of Marginal cost of funds, Negative carry on account of CRR, Operating costs and
Tenor premium.
Spread
(i) Banks should have a Board approved policy delineating the components of spread charged to a customer. It
should be ensured that any price differentiation is consistent with bank's credit pricing policy.
(ii) Bank's internal pricing policy must spell out the rationale for, and range of, the spread in the case of a given
category of borrower, as also, the delegation of powers in respect of loan pricing. The rationale of the policy
should be available for supervisory review.
(iii) The spread charged to an existing borrower should not be increased except on account of deterioration in
the credit risk profile of the customer or change in the tenor premium. Any such decision regarding change in
spread on account of change in credit risk profile should be supported by a full-fledged risk profile review of
the customer. The change in tenor premium should not be borrower specific or loan class specific. In other
words, the change in tenor premium will be uniform for all types of loans for a given residual tenor.
(iv) The guidelines contained in sub-paragraph (iii) above are, however, not applicable to loans under
consortium/ multiple banking arrangements.
Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest (SRFAESI) Act, 2002
Securitisation of Standard Assets
2.232 After the enactment of the Securitization and Reconstruction of Financial Asset and Enforcement of
Security Interest Act, 2002, banks have got significant power to possess the securities of defaulting borrower.
Banks can now take possession of the assets from borrower and convert the same in Security Receipts. In the
process of securitisation, assets are sold to a bankruptcy remote special purpose vehicle (SPV) in return for an
immediate cash payment. The cash flow from the underlying pool of assets is used to service the securities issued
by the SPV. Securitisation thus follows a two-stage process. In the first stage, there is sale of single asset or
pooling and sale of pool of assets to a 'bankruptcy remote' special purpose vehicle (SPV) in return for an
immediate cash payment and in the second stage repackaging and selling the security interests representing
claims on incoming cash flows from the asset or pool of assets to third party investors by issuance of tradable debt
securities. Thus, the non-performing asset of the banker is taken out of the balance sheet of the bank and
converted into Security Receipts.
2.233 In order to further strengthen banks' ability to resolve their stressed assets effectively, RBI has issued
revised guideline to improved framework governing sale of such assets by banks to SCs/RCs/other banks/Non
Banking Financial Companies /Financial Institutions etc. In order to enhance transparency in the entire process of
sale of stressed assets, banks are required to do following:
Identification of stressed assets beyond a specified value, as may be determined by bank's policy, for
sale shall be top-down i.e., the head office/corporate office of the bank shall be actively involved in
identification of stressed assets, including assets which are classified as Special Mention. Account, to be
put on sale. Early identification will help in low vintage and better price realisation for banks;
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Advances Other than Agriculture
At least once in a year, preferably at the beginning of the year, banks shall, with the approval of their
Board, identify and list internally the specific financial assets identified for sale to other institutions,
including SCs/RCs;
At a minimum, all assets classified as `doubtful asset' above a threshold amount should be reviewed by
the board/board committee on periodic basis and a view, with documented rationale, is to be taken on
exit or otherwise. The assets identified for exit shall be listed for the purpose of sale as indicated above;
Prospective buyers need not be restricted to SCs/RCs. Banks may also offer the assets to other
banks/NBFCs/FIs, etc. who have the necessary capital and expertise in resolving stressed assets.
Participation of more buyers will result in better price discovery;
In order to attract a wide variety of buyers, the invitation for bids should preferably be publicly solicited so
as to enable participation of as many prospective buyers as possible. In such cases, it would be desirable
to use eauction platforms. An open auction process, apart from attracting a larger set of borrowers, is
expected to result in better price discovery.. Banks should lay down a Board approved policy in this
regard;
Banks must provide adequate time for due diligence by prospective buyers which may vary as per the
size of the assets, with a floor of two weeks;
Banks should have clear policies with regard to valuation of assets proposed to be sold. In particular it
must be clearly specified as to in which cases internal valuation would be accepted and where external
valuation would be needed. However, in case of exposures beyond Rs.50 crore, banks shall obtain two
external valuation reports;
The cost of valuation exercise shall be borne by the bank, to ensure that the bank's interests are
protected;
The discount rate used by banks in the valuation exercise shall be spelt out in the policy. This may be
either cost of equity or average cost of funds or opportunity cost or some other relevant rate, subject to a
floor of the contracted interest rate and penalty, if any.
2.234 In order to make sure that sale of stressed assets by banks actually result in `true sale' of assets and to
create a vibrant stressed assets market, it has been decided to progressively restrict banks' investment in SRs
backed by their own stressed assets.
i) With effect from April 1, 2017, where the investment by a bank in SRs backed by stressed assets sold by it,
under an asset securitisation, is more than 50 percent of SRs backed by its sold assets and issued under that
securitisation, the provisions held in respect of these SRs will be subject to a floor; this floor shall be
progressive provisioning as per extant asset classification and provisioning norms, notionally treating book
value of these SRs as the corresponding stressed loans, assuming these had remained, without recovery of
principal, on the bank's books. In effect, provisioning requirement on SRs will be higher of the:
a. provisioning rate required in terms of net asset value declared by the SCs/RCs; and
b. provisioning rate as applicable to the underlying loans, assuming that the loans notionally continued in
the books of the bank;
ii) With effect from April 1, 2018, the above threshold of 50 percent will stand reduced to 10 percent.
2.235 These Security Receipts are treated as non-SLR security (Investment) in the books of subscribing bank
as per RBI guidelines. In the absence of ready market for the Security Receipts, the subscribing bank needs to
value Security Receipts on the basis of Net Asset Value to be declared by Securitising Company on a quarterly
basis. Further, when a bank sells the non-performing assets to securitising company, if the sale value of assets is
less than the Net book Value, i.e., books value of advances less provisions, the shortfall needs to be debited to
Profit & Loss Account. However, in case the sale value being higher, excess provision cannot be reversed and is
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kept to meet the shortfall/ loss on account of other non-performing assets.
E. Accounting and AuditingAspects
Balance Sheet Disclosure
2.236 The Third Schedule to the Act requires classification of advances made by a bank from three different
angles, viz., nature of advance, nature and extent of security, and place of making advance (i.e. whether in India
or outside India). Accordingly, the advances are to be classified in Schedule 9 to the balance sheet as follows.
A. (i) Bills purchased and discounted
(ii) Cash Credits, 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. Advances in India
(i) Priority sectors
(ii) Public sector
(iii) Banks
(iv) Others
II. Advances outside India
(i) Due from banks
(ii) Due from others
(iii) Bills purchased and discounted
(iv) Syndicated loans
(v) Others
Classification Based on Nature of Advance (Section A)
2.237 Different classifications under section A will be as follows:
(a) In classification under section `A', all outstandings in India as well as outside India less provisions made,
will be classified under three heads.
(b) Outstandings in credit card operations should be shown as part of advances under the head `cash credits,
overdrafts and loans repayable on demand'.
(c) Term loans will be loans not repayable on demand and would include overdue instalments.
(d) All interest bearing loans and advances granted by the bank to its employees should be shown as part of
advances.
Classification Based on Nature and Extent of Security (Section B)
2.238 Different classifications under section B will be as follows:
(a) All advances or part of advances, which are secured11 by tangible assets, whether in India or outside India,
should be shown under the heading `secured by tangible assets'. Advances against book debts may be
included under the head `Secured by Tangible Assets', and presented in Schedule 9 (Advances) as follows:
11
A `secured advance', according to section 5(n) of the Banking Regulation Act, 1949 means an advance made on the security of assets the
market value of which is not at any time less than the amount of such advance.
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Advances Other than Agriculture
"B Secured by Tangible Assets" (includes advances against book debt)
(b) Advances in India and outside India to the extent they are covered by guarantees of Indian and foreign
governments and Indian and foreign banks and DICGC and ECGC are to be included under the head
`advances covered by bank/government guarantees'.
(c) Unsecured advances will include advances not classified under (i) & (ii) of section B.
Classification based on Place of Making Advances (Section C)
2.239 a) Advances to sectors, which are classified as priority sectors according to the instructions of the RBI, are
to be classified under the head `priority sectors'. Such advances should be excluded from, `Advances to
Public Sector'.
b) Advances to Central and State Governments and other government undertakings including government
companies and corporations which are, according to the statutes, to be treated as public sector companies,
are to be included in the category `Public Sector'.
c) All advances to the banking sector including co-operative banks will come under the head `Banks'.
d) All the remaining advances will be included under the residual head `Others'; typically this category will
include non-priority advances to the private, joint and co-operative sectors.
Audit Approach and Procedures
2.240 Advances generally constitute the major part of the assets of the bank. There are large number of borrowers
to whom variety of advances are granted. The audit of advances requires the major attention from the auditors.
2.241 In carrying out audit of advances, the auditor is primarily concerned with obtaining evidence about the
following:
a. Amounts included in balance sheet in respect of advances are outstanding at the date of the balance sheet.
b. Advances represent amount due to the bank.
c. Amounts due to the bank are appropriately supported by Loan documents and other documents as applicable
to the nature of advances.
d. There are no unrecorded advances.
e. The stated basis of valuation of advances is appropriate and properly applied, and that the recoverability of
advances is recognised in their valuation.
f. The advances are disclosed, classified and described in accordance with recognised accounting policies and
practices and relevant statutory and regulatory requirements.
g. Appropriate provisions towards advances have been made as per the RBI norms, Accounting Standards and
generally accepted accounting practices.
2.242 The auditor can obtain sufficient appropriate audit evidence about advances by study and evaluation of internal
controls relating to advances, and by:
examining the validity of the recorded amounts;
examining loan documentation;
reviewing the operation of the accounts;
examining the existence, enforceability and valuation of the security;
checking compliance with RBI norms including appropriate classification and provisioning; and
carrying out appropriate analytical procedures.
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2.243 In carrying out substantive procedures, the auditor should examine all large advances while other advances
may be examined on a sampling basis. The accounts identified to be problem accounts however need to be
examined in detail unless the amount involved is insignificant. The auditor can obtain the list of SMA 1 and SMA 2
borrowers from the bank and the same should also be considered for selection of problematic accounts. The extent
of sample checking would also depend on the auditor's assessment of efficacy of internal controls. What constitutes
a `large advance' would need to be determined in the context of volume of operations of the branch. As a general
rule, however, an advance may be considered to be a large advance if the year-end balance is in excess of Rs.2
crore or 5% of the aggregate year-end advances of the branch, whichever is less.
2.244 Advances which are sanctioned during the year or which are adversely commented by RBI inspection
team, concurrent auditors, bank's internal inspection, etc., should, generally, be included in audit sample. Besides
this new advances sanctioned during the year should be included on selective basis in the sample.
2.245 In nutshell, auditor at branch may keep following in mind to plan comprehensive coverage of advances.
1. Obtain top 10 exposure accounts: It may be advisable for a branch auditor to visit the branch and ask the list
of top 10 accounts/ exposures along with all the details such as status and security etc before starting of the
audit.
2. Obtain the list of stressed accounts (SMA 1 and SMA2): The banks monitors stressed accounts on daily
basis. The account that generally has overdue beyond 60 days or likely to slip to NPA at the quarter end is
termed as stressed account (some banks may use different terminology). It is advisable to obtain such list of
stressed accounts at least 15 days ahead of the closing date i.e. say stressed account list as on 15th March.
This will provide the auditor a ready list of such accounts. The auditor then can scrutinise (based on materiality)
to know whether the account has slipped or if not whether has been kept standard by unusual transaction that
cannot be termed as business transaction. The RBI through its circulars has time and again been emphasising
that stray credit at the quarter end need not qualify to keep account standard. We need to assess whether
account is inherently weak. If so the same may have to be downgraded. As regards the partial recovery in
overdue account (qualifying the criteria for classification of an account as NPA), such account cannot be
upgraded unless overdue portion is recovered in entirety. As regards subsequent credit (after the date of
balance sheet), the same will not improvise the classification of an advance.
3. Obtain the list of restructured accounts: As we are aware restructured account portfolio requires separate
additional provisioning. It is necessary to obtain the list of such accounts and ensure whether the restructure is
as per the RBI directives.
4. Obtain the list of CDR accounts: Please ensure the compliance with the RBI guidelines in respect of CDR
accounts.
5. Obtain the list of unsecured exposures above Rs. 1 Cr.: Unsecured exposure has significant impact on the
bank, if slips to NPA. Many a times such accounts are reviewed in the traditional manner. These require close
monitoring not only from the perspective of financial parameters of the prudential guidelines but also non-
financial parameters that give signals of the possible ill health. The banking industry (especially PSUs) has
faced severe damages on account non-identification of such non-financial parameters.
6. Early mortality cases: Any advance slippage to NPA within 12 months of its introduction is called early
mortality case. Early mortality cases invoke penalty to the sanctioning authorities. This will have to be checked
to understand the reason for such happening to avoid such cases in future and also to find out whether there
are any cases classified as performing on some untenable ground to push it beyond early mortality.
Evaluation of Internal Controls over Advances
2.246 The auditor should examine the efficacy of various internal controls over advances to determine the nature,
timing and extent of his substantive procedures. In general, the internal controls over advances should include, inter
alia, the following:
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The bank should make an advance only after satisfying itself as to the credit worthiness of the borrower by doing
KYC compliance, proper credit appraisal etc. and after obtaining sanction from the appropriate authorities of the
bank. The sanction for an advance should specify, among other things, the limit of borrowing, nature of security,
margin to be kept, interest, terms of repayment etc. It also needs to be ensured that the loans sanctioned are as
per the Loan Policy of the bank and adhere to the regulatory (RBI) norms unless a specific exemption is taken in
this regard.
All the necessary documents (e.g., agreements, demand promissory notes, letters of hypothecation, etc.) should
be executed by the parties before advances are made.
The compliance with the terms of sanction and end use of funds should be ensured.
Sufficient margin as specified in the sanction letter should be kept against securities taken so as to cover for any
decline in the value thereof. The availability of sufficient margin needs to be ensured at regular intervals.
If the securities taken are in the nature of shares, debentures, etc., the ownership of the same should be
transferred in the name of the bank and the effective control of such securities be retained as a part of
documentation.
All securities requiring registration should be registered in the name of the bank or otherwise accompanied by
documents sufficient to give title to the bank.
In the case of goods in the possession of the bank, contents of the packages should be test checked at the time
of receipt. The godowns should be frequently inspected by responsible officers of the branch concerned, in
addition to the inspectors of the bank.
Surprise checks should be made in respect of hypothecated goods not in the physical possession of the bank.
Drawing Power Register should be updated every month to record the value of securities hypothecated. These
entries should be checked by an officer.
The accounts should be kept within both the drawing power and the sanctioned limit.
All the accounts which exceed the sanctioned limit or drawing power or are otherwise irregular should be brought
to the notice of the controlling authority regularly.
The operation of each advance account should be reviewed at least once a year, and at more frequent intervals
in the case of large advances.
Computation of Drawing Power/Limits in respect of stocks hypothecated
2.247 In respect of credit facilities against hypothecation of stocks (inventories) being the primary security, the
Bank's system of appraisal for determining the maximum permissible finance to borrowers and fixing of limits, inter
alia, should generally take into consideration the level of sundry creditors (comprising `unpaid for' stocks). The
sanction is expected to be in tune with the appraisal so made. While sanctioning such credit facility, the bank is
expected to stipulate in the documents, that for computing the Drawing Power, the value of declared stocks is to be
considered only net of the stipulated margin; and that the declared stocks shall not cover the borrower's liability
outstanding by way of unpaid for stocks (whether in the form of sundry creditors for purchases or covered by LCs/
guarantees/ co-acceptances or Buyer's Credit availed for procurement of material). The Bank should also insist on
such information from borrowers. In case of consortium accounts, the drawing power calculation and allocation is
made by the Lead Bank and is binding on the Member Banks.
2.248 The Reserve Bank of India has been issuing guidelines on the treatment of unpaid stocks while arriving at
the drawing power available in the borrowal accounts. The thrust of the guidelines is avoidance of double financing
on the unpaid stocks, if such stocks are taken as eligible for computation of drawing power.
2.249 The matter having been re-examined by Reserve Bank of India, vide directive No. IECD.No.32/08.10.01/92-
93 dated 28th April, 1993 had advised as regards the treatment of unpaid stocks while arriving at the drawing power
available in the borrower accounts, wherein the thrust is avoidance of the double finance on the unpaid stock, if such
stocks are taken as eligible for computation of drawing power. Thus, it would be unrealistic to assume that the
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
composition of the stock items, the level of stock held and the portion of unpaid stock considered at the time of
appraisal would be static and should be presumed to be at the same level for subsequent period. For the said
reason, the drawing power needs to be recomputed based on variations, not only in composition and level of stock
but also in the unpaid portion of stocks before the stipulated margin is applied as per the sanction terms of a working
capital finance.
2.250 The auditor should review the policy of the bank in this regard for any inherent weakness in the credit
system, where the stringency in appraisal, is relaxed while sanctioning the advances, having consequential effect on
monitoring and supervision, and may have effect on the classification status of the Borrower, where the drawing
power falls short of the outstanding.
2.251 Banks usually consider credit facilities by way of Hypothecation of stocks and a charge on the sundry
debtors. The Drawing Power is required to be computed net of the stipulated margin, based on and applied to the
total eligible current assets comprising:
Net Value of Stock as stated above, and
Net Value of Debtors (i.e., eligible Trade Debtors Less Bills Discounted with Bank). The bank usually prescribes
the conditions as to what comprise eligible trade debtors, and stipulates the period for debts being considered as
current and good on which the margin is computed.
2.252 For the purposes of classification of advances, the computation of drawing power based on realistic value of
hypothecated stocks (net of unpaid for stocks, whether covered by Buyer's Credit, LCs/ Guarantees/ Co-acceptances
or otherwise) and margin as stipulated, is vital, particularly in cases of default, and in border-line cases where the
health status of borrowers may be in question, to gauge slippages.
2.253 Due care is required to be exercised by the auditor in case of
Documents retained in original at centralised offices where these are not available at the branches that are
advised of drawing power limits; and
consortium advances, where the bank, not being the leader, gets the related figures of drawing power from the
leader bank, without the related evidence of computation or appropriateness of the drawing power.
The auditor needs to look into this aspect to verify that there is no slippage of the account into NPA classification.
Long Form Audit Report
2.254 The auditor has to comment on various specific issues as mentioned in the Long Form Audit Report of the
bank. While evaluating the efficacy of internal controls over advances, the auditor should particularly examine those
aspects on which he is required to comment in his long form audit report. Thus, he should examine, inter alia,
whether the loan applications are complete and in prescribed form; procedural instructions regarding grant/
renewal/enhancement of facilities have been complied with; sanctions are within delegated authority and
disbursements are as per terms of the sanction; documentation is complete; and supervision is timely, effective and
as per prescribed guidelines. The auditor can gather the requisite evidence by examining relevant documents (such
as loan application forms, supporting documentation, sanctions, security documents, etc.) and by obtaining
information and explanations from the branch management in appropriate cases. The detailed directives / guidance
with regard to such issues are given in a separate Chapter on Long Form Audit Report. The auditors must familiarise
themselves with those issues and guidance relating to the same and should cover the same during the regular
course of audit of advances.
2.255 Observations relating to procedural significance should be mentioned in LFAR. Please note that the whole
bank LFAR gets finalised within 60 days of signing of financial statements. Hence during finalisation CSA
predominantly concentrates on main audit report submitted by the branch auditor. Any observation that requires to be
dealt with during finalisation may miss the attention of CSA if the same is mentioned in LFAR alone. Such
observations that need to be dealt with for finalisation of the banks financial statements should find place in main
audit report along with appropriate MOC, if required.
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Advances Other than Agriculture
Examining the Validity of Recorded Amounts
2.256 The auditor should ascertain the status of balancing of subsidiary ledgers relating to advances. The total of
balances in the subsidiary ledgers should agree with the control accounts in the General Ledger. The auditor should
also tally the total of the statement of advances with the balances as per general ledger/ subsidiary ledgers. He
should also cross-check the balances of the advances selected for examination as listed in the statement of
advances with the balances in the relevant advance accounts in the subsidiary ledgers. Banks often obtain balance
confirmation statements from borrowers periodically. Such statements have a dual advantage in preventing disputes
by the customer and extending the period of limitation by reference to the date of confirmation. Wherever available,
such confirmations may be seen.
2.257 These days most of the banks have their `advances' statements generated through the system. The auditor
should ensure that the fields which system copies from last year are the same and he should take extra care in
relation with the date of NPA and date of becoming doubtful asset as these facts have great bearing on the
provisioning. The auditor should obtain audit trail from the bank to verify whether there are any changes or not.
Examination of Loan Documents
2.258 As indicated earlier, the documents relating to advances would be affected by the legal status of the
borrower and the nature of security. Thus, where the borrower is a company, loan documents would include
certificate of incorporation, memorandum and articles of association, certificate of commencement of business (in the
case of public limited companies), resolution of board of directors, and special resolution of shareholders [in cases
covered by section 180 (1)(c) of the Companies Act, 2013, etc. Where the borrower is a partnership firm, loan
documents would include copy of partnership deed. Where the security is in the form of mortgage, apart from
mortgage deed (in the case of English Mortgage) or letter of intent to create mortgage (in the case of Equitable
Mortgage), the evidence of registration of the charge with the Registrar of Companies would also form part of loan
documentation if the borrower is a company. Each bank has its own set of rules regarding the documents to be
obtained from various types of borrowers and in respect of different kinds of securities. The formats of many of the
documents are also prescribed. The auditor should evaluate the adequacy of the loan documents in the context of
the rules framed by the bank in this regard.
Centralisation and location of original loan documents at Loan Processing Centres
2.259 Of late, there is an increasing propensity in banks to process the loans and advances, including appraisal,
sanction, documentation, initial disbursements, etc., at Loan Processing Centres/Offices (by whatever name called)
and to execute and physically hold all the documents at such locations, that may not be in very close proximity to the
branch, where the borrowal accounts are maintained/serviced. The Branch places reliance only on the Sanction
letters, on the presumption that all the required legal and documentation formalities are correct and complete at the
centralized location.
2.260 In the absence of the original documents (or even authenticated copies thereof) on an updated basis, the
auditor would need to request the management for the files identified for examination by him. The branch auditor
must be satisfied on the authenticity and terms of the sanction (in case the sanction letters are only computer
generated but not authenticated), the completeness of the records, duly updated, for all accounts where the sanction
was so conveyed; and further whether the number of accounts and amounts recorded at such centres tally with the
corresponding data at the branch. It needs to be confirmed as to whether there are any cheques held by such
centres that remain unbanked affecting the borrowal account balance. Reference must also be made to any adverse
observations in the related monitoring/supervisory report on the documentation aspects at the centralized location.
Review of Operation of Account
2.261 The auditor should review the operation of the advance accounts. In doing so, an intelligent scrutiny of the
operation of the account should be carried out to see that the limit is not generally exceeded; that the account is not
becoming stagnant; that the customer is not drawing against deposits which are not free from lien; that the account is
not window-dressed by running down overdrafts at the year end and again drawing further advances in the new year,
etc.
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2.262 The auditor should also examine whether there is a healthy turnover in the account. It should be seen that
the frequency and the amounts of credits in the account are commensurate with the sanctioned limit and the nature
and volume of business of the borrower. Any unusual items in the account should be carefully examined by the
auditor. If the auditor's review indicates any unhealthy trends, the account should be further examined. The auditor's
examination should also cover transactions in the post-balance sheet date period. Large transactions in major
accounts particularly as at the year-end may be looked into, to identify any irregularities in these accounts. A written
note/explanation may be obtained from the management as regards any major irregularities which may have a
bearing on his report.
2.263 The auditor may also review the following to assess the recoverability of advances:
(a) Periodic statements submitted by the borrowers indicating the extent of compliance with terms and conditions.
(b) Latest financial statements of borrowers.
(c) Reports on inspection of security.
(d) Auditors' reports in the case of borrowers enjoying aggregate credit limits of Rs. 10 lakh (or as approve by
BOD of bank) or above for working capital from the banking system.
2.264 The auditor should satisfy himself that interest is being charged on all performing accounts regularly. He
should compare the rate of interest with the agreement and the sanction and with the credit rating reports where the
rate of interest is linked to credit rating. In case the interest rate is to be revised based on the changes in
PLR/BPLR/Base Rate of the bank, it needs to be ensured that the rate of interest to be charged form the borrower is
suitably revised as and when there are changes in PLR/BPLR/Base Rate. Calculation of interest should be test-
checked. The auditor should examine that interest not received on any account, which is a non-performing asset as
per the guidelines of the RBI, has not been recognised as income. It may be noted that interest accrued but not due
on advances does not form part of advances.
2.265 The penal interest in case of delayed submission of stock statements, non-creation of security overdrawn
accounts etc., needs to be charged as per sanctioned terms and norms of the bank. The compliance of the same
should be checked in detail by the auditors.
2.266 In the case of advances covered by guarantees of DICGC/ECGC/CGTS, in case of default the auditor
should examine whether appropriate steps have been taken for lodging of claims for guarantees in accordance with
the applicable procedure. The claims declined by DICGC/ECGC/CGTS should not be considered as recoverable
while calculating the provisions against the respective advances.
2.267 In respect of consortium advances, the auditor should particularly examine
(a) compliance with the limits stipulated by the consortium in lending moneys to the borrower;
(b) the bank's monitoring of securities like stocks, etc., which are in its custody/charge; and
(c) follow-up with lead bank on pending issues.
2.268 Apart from the usual audit procedures applicable in respect of advances, the auditor should examine
whether the bank has correctly classified the inter-bank participation certificates. In the case of participations on risk-
sharing basis, the auditor should examine whether any loss has devolved on the bank as on the balance sheet date
and, if so, whether adequate provision in respect of such loss has been made.
Verification of Security against Advances
2.269 From the view point of security, advances are to be classified in the balance sheet in the following manner:
(a) Secured by tangible assets.
(b) Covered by bank/government guarantees.
(c) Unsecured.
2.270 An advance should be treated as secured to the extent of the value of the security on the reporting date. If
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only a part of the advance is covered by the value of the security as at the date of the balance sheet, that part only
should be classified as secured; the remaining amount should be classified as unsecured.
2.271 As mentioned earlier, the Reserve Bank has specified that advances against book debts may be included
under the head `secured by tangible assets'.
2.272 The following points are relevant for classifying the advances based on security.
(a) Government guarantees include guarantees of Central/State Governments and also advances guaranteed by
Central/State Government owned corporations and financial institutions like IDBI, IFCI, ICICI, State Financial
Corporations, State Industrial Development Corporations, ECGC, DICGC, CGTS, etc.
(b) Advances covered by bank guarantees also include advances guaranteed against any negotiable instrument,
the payment of which is guaranteed by a bank.
(c) Advances covered by bank/government guarantees should be included in unsecured advances to the extent
the outstanding in these advances exceed the amount of related guarantees.
(d) While classifying the advances as secured, the primary security should be applied first and for the residual
balance, if any, the value of collateral security should be taken into account. If the advance is still not fully
covered, then, to the extent of bank/government guarantees available, the advance should be classified as
`covered by bank/government guarantee'. The balance, if any, remaining after the above classification, should
be classified as `unsecured'.
(e) There may be situations where more than one facility is granted to a single borrower and a facility is secured,
apart from primary and collateral securities relating specifically to that facility, by the residual value of primary
security relating to any other credit facility (or facilities) granted to the borrower. In such a case, in the event of
shortfall in the value of primary security in such a credit facility, the residual value of primary security of the other
facility (or facilities, as the case may be) may be applied first to the shortfall and the value of collateral securities
should be applied next.
(f) In the case of common collateral security for advances granted to more than one borrower, if there is a
shortfall in value of primary security in any one or more of the borrowal accounts, the value of collateral
security may be applied proportionately to the shortfall in each borrowal account.
(g) Advances covered by ECGC/DICGC,CGTS guarantees should be treated as covered by guarantees to the
extent of guarantee cover available. The amount already received from DICGC/ECGC/CGTS and kept in
sundry creditors account pending adjustment should be deducted from advances.
(h) An account which is fully secured but the margin in which is lower than that stipulated by the bank should
nevertheless be treated as fully secured for the purposes of balance sheet presentation.
(i) All documentary bills under delivery-against-payment terms (i.e., covered by RR/Airway Bill/Bill of lading) for
which the documents are with the bank as on the balance sheet date should be classified as `secured'.
(j) Documentary bills under delivery-against-acceptance terms which remain unaccepted as at the close of 31st
March (i.e., for which the documents of title are with the bank on this date) should be classified as secured. All
accepted bills should be classified as `unsecured' unless collaterally secured.
(k) Cheques purchased including self-cheques (i.e., where the drawer and payee are one and the same) should
be treated as unsecured.
(l) Advances against supply bills, unless collaterally secured, should be classified as unsecured even if they have
been accepted by the drawees.
(m) `Security' means tangible security properly discharged to the bank and will not include intangible securities
like guarantees (including State government guarantees), comfort letters, etc. Moreover, the rights, licenses,
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
authorisations, etc., charged to the banks as collateral in respect of projects (including infrastructure projects)
financed by them, should not be reckoned as tangible security. (Ref Master Circular No. RBI/2015-
16/99DBR.BP.BC.No.23/21.04.018/2015-16 dated July 1 2015 on Disclosure in Financial Statements- Notes
to Accounts)
2.273 In examining whether an advance is secured and, if so, to what extent, the auditor is concerned with
determining
(a) whether the security is legally enforceable, i.e., whether the necessary legal formalities regarding
documentation, registration, etc., have been complied with;
(b) whether the security is in the effective control of the bank; and
(c) to what extent the value of the security, assessed realistically, covers the amount outstanding in the advance.
2.274 The auditor should examine the following aspects in respect of advances classified as `secured':
(a) Documents executed are complete and in force.
(b) Where documents have not been renewed, the limitation period has not expired.
(c) Evidence is available as to the market value of the security.
(d) Evidence is available that
i. hypothecated/pledged goods are the property of the borrowers and are not old/obsolete or otherwise
unsaleable;
ii. advances against book debts of borrowers are related to their current debts and not old/doubtful debts; and
iii. Stocks hypothecated/pledged are paid stocks owned by the borrower.
(e) In the case of companies, the charge is appropriately registered with the Registrar of Companies and a
certificate of registration of charge or other evidence of registration is held.
(f) Borrowers are regular in furnishing the requisite information regarding the value of security lodged with the
bank.
(g) In respect of the second charge being available in respect of certain assets, the amount of the lender(s)
enjoying the first charge on such asset be worked out and only the residuary value, if any, available for second
charge holders, be considered.
2.275 The following paragraphs deal with the different types of securities against advances generally accepted by
banks and the manner in which the auditor should verify them.
Stock Exchange Securities and Other Securities
2.276 The auditor should verify stock exchange securities and their market value in the same manner as in the
case of investments. The auditor should examine whether the securities have been registered or assigned in favour
of the bank, wherever required and verify the same with Demat Statement.
2.277 It sometimes happens that a quoted security may not have frequent transactions on the stock exchange and
the quotation included in the official quotations may be that of a very old transaction. In such a case, the auditor
should satisfy himself as to the market value by scrutiny of balance sheet, etc., of the company concerned,
particularly, if the amount of advance made against such security is large.
2.278 Banks do not generally make advances against partly paid securities. If, however, any such shares are
accepted by the bank as security and these are registered in the name of the bank, the auditor should examine
whether the issuing company has called up any amount on such securities and, if so, whether the amount has been
paid in time by the borrower/bank.
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Advances Other than Agriculture
Goods
2.279 In respect of hypothecated goods, the auditor should check the quantity and value of goods hypothecated
with reference to the statement received from the borrower. He should also examine the reasonableness of
valuation. Letter of hypothecation should also be examined by the auditor. If the value of the goods is higher than the
amount mentioned in the letter of hypothecation, the bank's security is only to the extent of the latter. Auditor should
also verify that the Bank has system of maintenance of proper register in this regard as also system of scrutiny of
stock/book debt statement furnished by the borrower.
2.280 The auditor should also check nature of goods hypothecated/pledged. If the goods are of perishable nature,
it will not have market value.
2.281 In case of goods/book debts, movable assets hypothecated , auditor should also examine whether the Bank
has system in place for periodical inspection of such goods/debts/assets and records of borrowers by its own officer
or by external agencies like firm of Chartered Accountants. Whether proper register is maintained in this regard and
timely action is taken whenever there is an adverse remark in the inspection report. Auditor should also check that
there is adequate insurance cover in respect of goods /assets hypothecated and there is a bankers' clause in the
policy.
2.282 In respect of goods pledged with the bank, the auditor should check the statement received from the
borrower regarding the quantity and value of goods pledged by him. He should test check the godown registers and
the valuation of the goods. If there is any outstanding delivery order against the goods as on the balance sheet date,
the same should be deducted from the total quantity in hand in ascertaining the value of the goods constituting the
security. The auditor may also examine the key movement register to verify the movement of goods inwards and/or
outwards.
2.283 Sometimes, goods are in the possession of third parties, such as clearing and forwarding agents,
transporters, brokers, warehouse-keepers, etc. If these parties have given an undertaking to the bank that they will
hand over the goods or sale proceeds thereof to the bank only, i.e., they have 'attorned' to the bank the advances
made against such goods should be considered as secured. In such cases, certificates should be obtained by the
bank from such third parties regarding quantities on hand on balance sheet date. The valuation of such goods
should be checked by the auditor. In case the borrower is a company, the auditor should examine the certificate of
registration of charge on the goods hypothecated with the Registrar of Companies. It may be mentioned that in case
of pledge of goods, registration of charge is not necessary.
Gold Ornaments and Bullion
2.284 The auditor may inspect and weigh (on a test basis) the ornaments on the closing date. He should also see
the assayer's certificate regarding the net gold content of the ornaments and their valuation. Valuation should also
be checked with reference to the current market price of gold. In context to the valuation, attention is also invited to
the valuation norms as given in the RBI circular no. DBOD.No.BP.BC.27/21.04.048/2014-15 on "Loans against Gold
Ornaments and Jewellery for Non-Agricultural End-uses" dated July 22, 2014.
2.285 In respect of gold and silver bars, the auditor should inspect the bars on a test basis and see that the mint
seals are intact. The weights mentioned on the bars may generally be accepted as correct.
Life Insurance Policies
2.286 The auditor should inspect the policies and see whether they are assigned to the bank and whether such
assignment has been registered with the insurer. The auditor should also examine whether premium has been paid
on the policies and whether they are in force. Certificate regarding surrender value obtained from the insurer should
be examined. The auditor should particularly see that if such surrender value is subject to payment of certain premia,
the amount of such premia has been deducted from the surrender value.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
2.287 It should be verified whether the policies are assignable in bank's favour. In certain types of policies, the
assignment to third party are restricted.
Bank's Own Deposit Certificates
2.288 The auditor should inspect such certificates and examine whether they have been properly discharged and
whether the lien of the bank is noted on the face of the certificates as well as in the relevant register of the bank and
also in CBS master data.
Hire-purchase Documents
2.289 These advances may be classified as secured against the hypothecation of goods. Where there is no
hypothecation, the advance will be classified as unsecured.
Plantations
2.290 These advances are classified as secured against the crop and/or the fixed assets (viz., mortgage of land)
of the plantation. The auditor should examine the agreement and the title deeds. Regarding the estimate of the
crop, he may examine the record of the garden for the last few years. He should also ascertain whether the crop is
properly insured against natural calamities and other disasters such as hail, etc.
2.291 Auditor should keep in mind that where moratorium is available for payment of interest in such plantation
projects, the payment of interests becomes due only after the moratorium or gestation period is over and in such a
case the account will become NPA in case interest is not recovered after the due date of such interest after
moratorium period, if specifically mentioned in the sanction letter.
Immovable Property
2.292 The auditor should inspect the title deed, the solicitor's/advocate's opinion taken by the bank in respect
thereof, and the mortgage deed. For valuation, he may rely upon the architect's or valuer's report (which should be
taken atleast once in three years) after carrying out appropriate audit procedures to satisfy himself about the
adequacy of the work of the architect/valuer for his purpose.12 He should also examine the insurance policies.
2.293 In some cases, banks make advances against immovable properties where the title deeds are not in the
name of the borrower. For example, an advance may be given against the security of a flat in a co-operative group
housing society, the title deeds of which may not be in the name of the borrower. In such cases, the auditor should
examine the evidence regarding the right or interest of the borrower in the property mortgaged, e.g., power of
attorney, share certificate of co-operative group housing society, `no objection certificate' from the society/lessor (in
the case of leasehold properties) for offering the property as security, etc.
2.294 In case the bank has accepted third party property as a security. The owner of the property should also
execute guarantee bond in bank's favour. The mortgage value in bank's favour should be equal/in excess of loan
amount covered by such mortgage.
Reliance on / review of other reports
2.295 The auditor should take into account the adverse comments, if any, on advances appearing in the following:
Previous audit reports.
Latest internal inspection reports of bank officials.
Reserve Bank's latest inspection Report/Asset Quality Review/ Risk Based Supervision report.
Concurrent /internal audit report.
12
Reference may be made in this regard to SA 620, "Using the Work of an Auditor's Expert".
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Advances Other than Agriculture
Report on verification of security.
Any other internal reports specially related to particular accounts.
Manager's charge-handing-over report when incumbent is changed.
The above reports should be reviewed in detail. The Statutory Central Auditors must review the Annual Financial
Inspection report of RBI relating to the bank and should check whether the variations in provisions, etc., reported by
RBI have been properly considered by the bank management.
Third Party Guarantees
2.296 The auditor should examine the guarantee bonds and the demand promissory notes in order to verify the
third party liability. Auditor should satisfy that the guarantee is in force as at the date of the balance sheet. In the
absence of a provision to the contrary, a guarantee terminates by revocation or upon death of the surety. The surety
is also discharged (unless there is a specific covenant to the contrary) if the creditor arranges with the principal
debtor for compromise, or agrees to give time or agrees not to sue him, without consulting the surety. If any variation
is made in the terms of the contract between the principal debtor and the creditor without the surety's consent, it
discharges the surety as to transactions subsequent to the variation. The guarantee forms used by banks normally
seek to ensure the continuing obligation of the guarantor in spite of these contingencies. If such clause is absent then
Auditor has to see the acknowledgement to debt from the borrower as well as guarantor is obtained by the Bank.
Verification of Bills Purchased and Discounted
2.297 The auditor should familiarise with the guidelines issued by RBI and the policies framed by the bank itself
regarding the discounting and rediscounting of bills. The auditor should ascertain that the policy framed by the bank
conforms to the requirements laid down by the RBI.
2.298 Bills purchased and discounted have to be shown separately in the balance sheet as a part of `advances'.
Further, under the head `advances outside India' in the balance sheet, bills purchased and discounted outside India
have to be shown separately. This category will include bills covering export of goods, bills discounted by foreign
branches of the bank and payable in their respective countries, etc.
2.299 Banks purchase or discount bills of exchange drawn or endorsed by their customers. The bank credits the
amount of the bill to its customer after deducting the discount. The total amount of such bills is shown as an asset in
the balance sheet.
2.300 In certain eligible cases, the bills purchased or discounted by the bank may be rediscounted by it with the
RBI IDBI/SIDBI. Such bills would not be included under advance but would constitute a contingent liability.
2.301 Bills purchased and discounted by the bank are generally drawn on outstation parties and are, therefore,
sent by the bank to its branches or agents for collection immediately after their receipt. They are generally not in the
possession of the bank on the closing date. The auditor therefore has to rely upon the Register of Bills Purchased
and Discounted and the party-wise Register of Bills maintained by the bank. The auditor should examine these
registers and satisfy himself that:
(a) all the outstanding bills have been taken in the balance sheet;
(b) all the details, including the nature of the bills and documents, are mentioned in the register and that the bills
have been correctly classified;
(c) 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; and
(d) 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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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
2.302 The auditor should examine whether registers of bills purchased and discounted are properly maintained
and the transactions are recorded therein correctly. He should examine whether the bills and the documents
accompanying the bills are properly endorsed and assigned in favour of the bank. In checking the bills, it should be
ensured that the bills are held along with the documents of title. In the case of documentary bills, it should be
examined whether that the related RRs/TRs are held along with the invoices/ hundies / bills and that these have not
been parted with. Wherever such RRs/TRs are not held on record, the fact should be duly considered by the auditor.
The auditor should also examine bills collected subsequent to the year-end to obtain assurance regarding
completeness and validity of the recorded bill amounts.
Other Aspects
2.303 Sometimes, a customer is sanctioned a cash credit limit at one branch but is authorised to utilise such
overall limit at a number of other branches also, for each of which a sub-limit is fixed. In such a case, the
determination of status of the account as NPA or otherwise should be determined at the limit-sanctioning branch with
reference to the overall sanctioned limit/drawing power, and not by each of the other branches where a sub-limit has
been fixed. The auditor of the limit-sanctioning branch should examine whether it receives particulars of all
transactions in the account at sub-limit branches and whether the status of the account has been determined by
considering the total position of operation of the account at all concerned branches. As far as sub-limit branches are
concerned, they should follow the classification adopted by the limit-sanctioning branch.
2.304 The auditor should examine that any advances made by a banking company otherwise than in the course of
banking business, such as, prepaid expenses, advance for purchase of assets, etc., is not included under the head
`advances' but is included under `other assets'.
2.305 The amounts of advances in India and those outside India are to be shown separately in the balance sheet.
This classification will depend upon where the advance was actually made and not where it has been utilised.
Generally speaking, figures of Indian branches will be shown as advances in India and figures of foreign branches as
advances outside India.
2.306 The auditor should examine whether any loan has been granted in violation of the statutory limitations
contained in section 20 of the Banking Regulations Act, 1949. If any such loan has been granted the report will have
to be drafted with suitable qualifications, as the transaction would be ultra vires.
2.307 It may also be examined whether the bank has a system of ensuring the end use of the funds granted as
compared with the purpose of sanction. The reports submitted by the inspectors/officers in this regard should be
reviewed to form opinion on the quality of the asset and also to consider reporting any matter in the LFAR.
2.308 Adverse features in a borrower's account are required to be reported in LFAR and hence during the course
of verification all material information should be noted and documented in appropriate format. Following is an
illustrative but not an exhaustive format:
1. Name of the Borrower.
2. Constitution.
3. Sanctioned limits as on Balance Sheet date.
4. Any change in limit during the year.
5. Terms of sanction.
6. Details of fulfilment of terms of sanction.
7. Details of Loan documents and observations on the same.
8. Balance outstanding as at balance sheet date.
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Advances Other than Agriculture
9. Classification as per bank.
10. Whether classification requires a change.
11. If so the reasons for the differing view and the impact of the same.
12. Whether necessary changes made in Memorandum of Changes.
13. Observations on the conduct of the account.
14. Deficiencies noted in the account.
15. Availability of security and adequacy of its insurance cover along with Bank's name.
16. Timely submission of stock statement and other statements.
17. Analysis of stock statements vis a vis financial statements.
Drawing Power Calculation
2.309 Working capital borrowal account, drawing power calculated from stock statement older than 3 months has
to be considered as "irregular" (overdue). If such "irregular" continues for 90 days, account has to be classified as
NPA, even though the account is otherwise operated regularly.
2.310 The stock statements, quarterly returns and other statements submitted by the borrower to the bank should
be scrutinised in detail.
2.311 The audited Annual Report submitted by the borrower should be scrutinised properly. The monthly stock
statement of the month for which the audited accounts are prepared and submitted should be compared and the
reasons for deviations, if any, should be ascertained.
2.312 It needs to be examined whether the drawing power is calculated as per the extant guidelines formulated by
the bank, which should also be in line with RBI guidelines/directives. Special consideration should be given to proper
reporting of sundry creditors for the purposes of calculating drawing power. As a general principle, and with the
objective of avoidance of double financing, the unpaid stocks should not be considered while computing the DP
available in the borrowal accounts.
2.313 The stock audit should be carried out by the bank for all accounts having funded exposure of more than
Rs.5 crores. Auditors can also advise for stock audit in other cases if the situation warrants the same. Branches
should obtain the stock audit reports from lead bank or any other member, as decided in consortium in the cases
where the Bank is not leader of the consortium of working capital. The report submitted by the stock auditors should
be reviewed during the course of the audit and special focus should be given to the comments made by the stock
auditors on valuation of security and calculation of drawing power.
2.314 The drawing power needs to be verified carefully in case of working capital advances to entities engaged in
construction business. The valuation of work in progress should be ensured in consistent and proper manner. It also
needs to be examined whether the mobilization advance being received by the contractors is reduced while
calculating drawing power. Further is respect of certain businesses such as diamond merchants and jewellers, the
auditor should exercise due caution while verifying realisable value of the inventory of precious metals, diamonds,
jewellery etc. The auditor may also consider obtaining assistance of an expert in case circumstances so warrant.
2.315 In case of consortium accounts, the drawing power calculation and allocation is made by the Lead Bank and
is binding on the Member Banks.
Lending under Consortium Arrangement / Multiple Banking Arrangements
2.316 In order to strengthen the information sharing system among banks in respect of the borrowers enjoying
credit facilities from multiple banks, the banks are required to obtain regular certification by a professional, preferably
a Company Secretary, Chartered Accountants or Cost Accountants regarding compliance of various statutory
prescriptions that are in vogue, as per specimen given in Annexure III (Part I and II), to the RBI Circular No.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
DBOD.No. BP.BC.110/08.12.001/2008-09 dated February 10, 2009. Annexure III is given in CD for reference.
2.317 The LFAR should include non-compliance of the RBI Circular, indicating the cases in which the reports have
not been obtained for review by the auditors.
2.318 Accounts under Consortium arrangements may, notwithstanding that these are classified as Standard, due
to servicing thereof in a Bank, may nonetheless be intrinsically weak or may even be NPA in other participating
bank(s), including on the basis of the certificate/report as aforesaid. The auditor should consider this aspect and
classify the account appropriately based on facts and circumstances, particularly based on any serious adverse
remarks/comments in the certificate issued pursuant to the RBI circular.
2.319 The auditor should check the compliance with RBI guidelines on unhedged foreign currency exposure. Self-
declaration from the client or Independent auditors' certificate of foreign currency exposure should be obtained by the
Bank. Such declaration/certificate can be cross checked with the computation of standard asset provisioning.
Retail Assets
2.320 The retail assets in various banks at present form a significant part of their portfolio. As there are large
numbers of accounts in these cases, the same poses a challenge for the auditors. The classification and provisioning
towards the same should, however, be done as in case of other assets.
2.321 There may be a large number of accounts under retail assets, which have been restructured/rescheduled
during respective years including repetitive rephasements. The process of the bank to report / record all such
reschedulement/restructuring needs to be reviewed and adequacy of the same should be checked. In case of
restructuring of consumer and personal advances, the same should immediately be treated as NPA. The accounts
are treated as restructured when the bank, for economic or legal reasons relating to borrower's financial difficulty,
grants to the borrower concessions that the bank would otherwise not consider. The HO of the bank should instruct
properly to branches in this regard.
Restructuring of cases
2.322 RBI has given guidelines for treatment of restructured accounts in part B of the Master Circular on
Prudential Norms on Income Recognition, Assets Classification and Provisioning Pertaining to Advances dated July
1, 2015. The provisions of this Circular has been discussed in Chapter 4. The auditor should verify compliance with
the requirements of the said circular.
Once the bank receives an application/proposal in respect of an account for restructuring, it implies that the account
is intrinsically weak. Thereby during the time the account remains pending for restructuring, the auditors need to take
a view whether provision needs to be made in respect of such accounts pending approval for restructuring.
Funding of Interest
2.323 In addition, the auditor should also consider the fact that during the course of restructuring/rescheduling in
any manner, the interest element, in addition to the principal may also be rescheduled by the bank. This
reschedulement of interest may be with or without sacrifice. In some cases future interest may also be funded apart
from the principal. In such cases, the auditor should examine whether the RBI's requirements with regard to
provisioning for sacrifice have been complied with by the bank. In case of interest sacrifice, the model prescribed by
RBI includes calculation and provisioning for sacrifice on future interest as well. The auditor should examine the
terms of funding of interest and if the same is in the nature of moratorium for payment of interest, then the interest
would become due only after the moratorium period is over. The funded interest cannot be recognised as income if
the account is treated as NPA.
Sacrifice of interest
2.324 In respect of sacrifice of interest, the auditor should examine whether:
(a) Interest sacrifice involved in the amount of interest has been provided for by debit to Profit & Loss account and
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Advances Other than Agriculture
held in a distinct account.
(b) Sacrifice is recomputed on each balance sheet date till satisfactory completion of all repayment obligations
and full repayment of the outstanding in the account, so as to capture the changes in the fair value on account
of changes in BPLR/ Base Rate, term premium and the credit category of the borrower and the consequent
shortfall in provision or reversal of the amount of excess provision has been held in the distinct account.
(c) In the event any security is taken against interest sacrifice, the same has been valued at Re.1/- till maturity of
the security. As per RBI norms, the interest sacrifice in all the restructured cases needs to be worked out
including for Working Capital Loans. In the case of working capital facilities, the diminution in the fair value of
the cash credit /overdraft component may be computed reckoning the higher of the outstanding amount or the
limit sanctioned as the principal amount and taking the tenor of the advance as one year. The term premium in
the discount factor would be as applicable for one year. The fair value of the term loan components (Working
Capital Term Loan and Funded Interest Term Loan) would be computed as per actual cash flows and taking
the term premium in the discount factor as applicable for the maturity of the respective term loan components
The process of identifying such interest sacrifice in case of working capital loans needs to be looked upon in
detail.
2.325 In case the bank has agreed to convert existing/future exposure to the borrower in to Funded Interest Term
Loan, such interest should be parked under sundry liabilities and should not be reckoned as income.
Other Aspects
2.326 Separate norms for classification have been prescribed for accounts covered under schemes for
`Restructuring / Rescheduling of Loans', `Corporate Debt Restructuring (CDR)' or `Small & Medium Enterprises
(SME)'. The auditors should go though the same to see whether these have been properly applied by the bank.
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III-3
Scrutiny of Advanced Accounts Presented
in Ind AS by Banks
Preamble
3.01 The Ministry of Corporate Affairs (MCA) on 6th April 2016, amended Schedule III to include general
instructions for preparation of financial statements of a company whose financial statements are required to comply
with Ind AS.
The amendment is applicable to following classes of companies from 1 April 2016
Companies listed/ being listed and Net worth is Rs. 500 crs. or more
Unlisted Companies whose Net worth is Rs. 500 crs. or more
Holding/ Subsidiary/ Joint Venture or associate of above
3.02 From 1 April 2017, the amendment will also be applicable to following classes of companies:
All other Companies listed/being listed
Unlisted Companies whose Net worth is Rs. 250 crs or more and less than Rs. 500 crs.
Holding/ Subsidiary/ Joint Venture or associate of above
3.03 The amendment divides Schedule III into two parts i.e. Division I and II. Division II covers the complete set
of Financial Statements under IndAS which include:
1. Balance Sheet
2. Statement of Profit and Loss divided in two parts as profit or Loss section and Other Comprehensive Income
3. Statement of changes in equity
4. Cash Flow Statement
5. Notes
3.04 Banks often refer to the Financial Statements of companies for credit decision regarding new lending,
review and credit monitoring in the form of end use of funds, ratio analysis etc. The Financial statements is thus
treated as Base Document for the prupose of Credit Appraisal, Review and monitoring. Since the accounting
treatment, disclosures and formats of Financial statements have changed due to compliance with Ind AS ,it is
important for Banks to understand the intricacies of this changing reporting structure.
3.05 Major Financial Impacts (List is illustrative)
1. Property, Plant & Equipment (IND AS 16)
Key Area Impact
For first time adoption three option of transition First two options will lead to changes in Debt equity ratio
are available-
In case of fair valuation, value adopted by the company
Scrutiny of Advanced Accounts Presented in Ind AS by Banks
a. Recomputation of cost as on vis-a-vis considered by the bank (for collateral security)
transition date since inception needs to be cross referenced
b. Fair Valuation of PPE as on transition It needs to be analysed whether fair value option has
date been availed and how it impacts the financial position
and future cash flows. t.
c. Carrying value of PPE as of transition
date as per Indian GAAP
Decommissioning, restoration and similar Such accounting treatment will have following impact :
liabilities
Increased depreciation
To be recognised as part of the cost of
Increase in interest cost due to unwinding of discounted
an item of PPE
liability
To be recognised as a liability in
Whenever such type of provision is done, the nature and impact
accordance with Ind AS 37.
of such provision should be analyzed. Detailed calculation should
be checked for analyzing the possible deviations.
2. Investment Property (IND AS 40)
Key Area Impact
IND AS 40 requires separate disclosure in Information about assets held for capital appreciation/rental
Balance sheet for assets which qualifies as purposes will be separately available
Investment property as follows:
Such readily available information will be useful in assessing the
Fair value of Investment Properties real net worth of the company. Also, details of method used to
calculate fair value will be useful in assessing the possible
Revenue generating and non revenue
deviations in value.
generating Investment properties with
details of income and direct operating This disclosure will give an idea of the income earning capacity.
expenses. This may also give indication about the fair value of the property.
Restrictions on realizability and This information about all encumbrances will help in analyzing the
contractual commitments practical usefulness of the property
3. Accounting for Government Grants and disclosure of Government Assistance (IND AS 20 )
Key Area Impact
Government grants are bifurcated in two It is pertinent to note that IND AS 20 does not recognize the
categories : concept of grant in the nature of promotors contribution. Thus,
concept of capital reserve has been done away with.
Grants related to assets and
Grants related to income
Recognition of grant as operating income will increase the
Para 24 states that Government grants related
EBITDA
to assets, including non-monetary grants at fair
value, shall be presented in the balance sheet
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
by setting up the grant as deferred income
Disclosure regarding unfulfilled conditions and This disclosure requirement allows the stakeholders to assess the
other contingencies attaching to government nature and impact of liabilities attaching the assistance received
assistance that has been recognized
4. Revenue (IND AS 18)
Key Area Impact
Para 9 states that revenue shall be measured at Grossing up of excise duty
the fair value of the consideration received or
This will have an impact while while comparing
receivable. As a result
information with earlier periods
Revenue is to be presented gross of
Reduction in revenue by large amounts where the
excise duty and
company operates customer loyalty programs/discount
Revenue is to be presented net of coupons/gift vouchers, etc.
incentives, quantity discounts, trade
discounts, volume rebates, etc.
Para 11 states that when the Whenever the sale is made at deferred credit terms, revenue will
be reduced and will be recognized as interest in other income.
arrangement effectively constitutes a financing
transaction, the fair value of the consideration is
determined by discounting all future receipts
using an imputed rate of interest
5. Inventories (IND AS 2)
Key Area Impact
Para 36 of IND AS 2 requires disclosure of the The stakeholders will be able to analyze the quantum of the non
amount of any write-down of inventories moving inventories. This can be utilized while calculating drawing
recognized as an expense in the period power
6. Events after the Reporting Period (IND AS 10)
Key Area Impact
Para 12 states that If an entity declares This change will have huge impact on the retained earnings of
dividends to holders of equity instruments (as many companies. Dividends recognized as liability will now be
defined in Ind AS 32, Financial Instruments: added back to reserves which will largely impact the debt equity
Presentation) after the reporting period, the ratio.
entity shall not recognise those dividends as a
liability at the end of the reporting period
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Scrutiny of Advanced Accounts Presented in Ind AS by Banks
7. Accounting Policies, Changes in Accounting Estimates and Errors (IND AS 8)
Key Area Impact
Para 32 states that changes in the useful lives Earlier, change in the method of depreciation was considered as a
of, or expected pattern of consumption of the change in accounting policy. However, IND AS 8 regards it as
future economic benefits embodied in, change in estimate.
depreciable assets are to be regarded as
This change implies that the changes in depreciation method will
changes in estimates
have to be accounted for prospectively as against the earlier
treatment of retrospective application.
Such change is very important since it will restrict the companies
from profit management by using changes in depreciation method
as a tool.
8. Financial Instruments (IND AS 109, IND AS 32)
Key Area Impact
Para 15 of IND AS 32 states that the issuer of a The definition of equity has wide impact on the various
financial instrument shall classify the instrument, instruments issued by the company. This standard gives
or its component parts, on initial recognition as a importance to substance over form. Thus, classification of an
financial liability, a financial asset or an equity instrument into equity or liability is very crucial.
instrument in accordance with the substance of
Such classifications might change the entire composition of the
the contractual arrangement and the definitions
balance sheet.
of a financial liability, a financial asset and an
equity instrument This might have significant impact on the debt-equity ratio of the
company as well as P&L.
Real estate and start ups will be most affected
Foreign currency convertible bonds (FCCB) Interest cost will be increased since in these cases the premium
to be paid while redemption is to be factored at the time of issue
of loan instrument itself.
Structured Instrument Impact on the interest cost to a large extent
Wherever instruments have been structured to provide for lower
interest rates at the beginning and higher interest rates towards
the end, such instruments will have to be fair valued w.r.t the
prevailing market interest rates and accounting will have to be
done accordingly.
Compound Financial instruments An instrument may contain an option to convert the debt
instrument into equity.
Para 28 of IND AS 32 states that the issuer of a
non-derivative financial instrument shall Here, since the instrument contain both the features of equity and
evaluate the terms of the financial instrument to debt, the amount needs to be bifurcated into equity and debt by
determine whether it contains both a liability and computing the fair value of the equity portion.
an equity component. Such components shall
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
be classified separately as financial liabilities,
financial assets or equity instruments in
accordance with paragraph 15
Classification of investments The strategic investments made by the company will be classified
as FVTOCI. The fluctuations in the fair value will not affect P&L
For equity instruments not held for trading the
but affect the reserves. The Bank can judge the group structure
standards provides two options FVTOCI and
and its performance.
FVTPL
All fluctuations in fair value will be accounted for in P&L. Careful
Investments held for trading will always be
study for the purpose of profitability is needed here by Banks.
classified as FVTPL
Loans extended with conversion option Such accounting treatment will ensure the real value of loans
extended in the balance sheet. Wherever the companies are loss
Such loans will always be classified as FVTPL
making, fair value of loans advanced to such companies will be a
since SPPI criteria is not met
crucial aspect
Fair valuation of startup companies Crucial Since FVTPL instruments will have direct impact on P&L
aspect Wherever the companies have invested in startups, fair valuation
of such investments will always be crucial. It would vary based on
the business performance.
Investments in mutual funds P&L volatility will increase due to the fair valuation of investments
on mutual funds.
It will be classified as FVTPL instrument since
SPPI criteria will not be met. Also, it will always
be held for trading
Classification of a liability/asset A financial liability/asset implies that the settlement will be either
in cash or by transfer of other financial liability/asset.
An entity needs to classify a liability as financial
or other liability as well as an asset as a Other liabilities/asset implies settlement in other than cash mostly
financial or other asset through delivery of services/goods.
The classification of liability/asset into financial This classification to a large extent provides insight about the
or other is very important since the provisions of liabilities in monetary and non monetary terms
IND AS 109 applies to only financial
Thus, the stakeholders might be able to approximate the cash
liabilities/asset.
flows of the company at a gross level.
Impact of expected credit loss model The companies needs to evaluate the increases in credit risks
associated with the financial assets and make loss allowance in
Para 5.5 of IND AS 109 requires impairment of
the books of accounts wherever required.
financial assets based expected credit loss
model. Two approaches have been specified : The stakeholders can enquire about the details of assessment
made by the company for evaluating the credit risks of the
General approach
financial assets.
Simplified approach
Similarly such enquiries can be made for other major financial
assets also.
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Scrutiny of Advanced Accounts Presented in Ind AS by Banks
9. Business Combinations (IND AS 103)
Key Area Impact
No concept of appointed date or effective date IND AS recognizes only the date when the control is obtained.
This implies that agreements entered into will form basis of
accounting.
Intangible assets needs to be carved out All kinds of intangible assets to be identified separately from
goodwill and accounted for in a business combination at fair
value. This will provide real information about what the company
is paying for. It will provide true value of goodwill after identifying
all other intangibles
Measurement at fair value - The acquirer shall This requirement ensures that the businesses are being acquired
measure the identifiable assets acquired and at real values. It will provide readily available data to stakeholders
the liabilities assumed at their acquisition-date about the true values of businesses being acquired.
fair values
10. Disclosure Impacts
a. Presentation of Financial Statements (IND AS 1)
Key Area Impact
Capital Management This is an important disclosure with regard to the capital
management policy of the company.
Para 134 states that an entity shall disclose
information that enables users of its financial This disclosure gives information about what are the
statements to evaluate the entity's objectives, objectives of the company w.r.t the capital
policies and processes for managing capital requirements/adequacy
It describes the policies adopted by the company to
achieve the objectives set by the company
Further, it also provides useful information about the
steps which the company takes to adhere to the policies.
The above information showcases the overall thought process of
the company i.e. the policies adopted to maximize shareholder
value, what kind of risks and how much risk the company is willing
to take, the need for raising capital,
b. Operating segment (IND AS 108)
Key Area Impact
New concept of Chief operating decision maker Major change in the disclosure requirements. Stakeholders will
(CODM) introduced get to know how the businesses are getting managed, the overall
decision making process and the allocation of resources of the
Operating segments to be disclosed based on
company
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
how CODM reviews the operating results
Apart from the segment disclosures, following
entity wide disclosures are mandatory :
Information of revenues against each product/service offered by
Information about products and the company is useful for analyzing the major stream
services
Information about exports and assets located outside India will
Information about geographical areas provide information about the major area of operation of the
company
Information about major customers
(revenue above 10%) This will provide information about the concentration of the source
of revenue of the company which enables to analyse the quantum
of risks associated
c. Financial Instruments (IND AS 107)
Key Area Impact
This standard requires a wide disclosures in Such disclosures enables the stakeholders to analyze what kind
relation to financial instruments. Some of them of risk the company is exposed to and the quantum of risk. This
are as under : will enable to ascertain the possible impact on the profitability of
the company.
Credit risk disclosure enables the user of financial statements to
Disclosures regarding nature and extent of risks
understand the effect of credit risk on the amount, timing and
arising from financial instruments (Para 31-39):
uncertainty of future cash flows
Credit risk
Liquidity risk disclosures enables the user of financial statements
Liquidity risk to understand the information such as maturity profile of the
Market risk financial liabilities which gives an idea about the requirement of
cash and it's sufficiency as well as information about policies to
manage liquidity needs
Sensitivity Analysis of market risks (Para 40-42) Such information enables the stakeholders to analyse the
exposure to each type of market risk and the possible volume of
Foreign currency risks
change that could affect the financial position of the company
Interest rate risks
Further, the disclosures regarding how company manages such
Other price risks risks also provides useful information regarding the mitigation plan
in case the risk materialize and also the sufficiency of such
management
All these disclosures regarding the risk exposure and
management gives vast information and enables the stakeholders
for internal credit rating purposes
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III-4
Asset Classification, Income Recognition
and Provisioning
Guidelines of the Reserve Bank of India on Income Recognition, Asset Classification,
Provisioning and Other Related Matters
4.01 In its report submitted in 1992, the Committee on Financial System set up by the RBI under the
Chairmanship of Mr. M. Narasimham made several recommendations concerning accounts of banks. The
Committee recommended that a policy of income recognition should be objective and based on record of recovery
rather than on any subjective considerations. Likewise, the classification of assets should be done on the basis of
objective criteria which would ensure a uniform and consistent application of norms. As regards provisioning, the
Committee recommended that provisions should be made on the basis of classification of assets under different
categories. Vide its Circular No. BP.BC.129/21.04.043-92 dated April 27, 1992, the Reserve Bank issued
guidelines to be followed by all scheduled commercial banks (excluding regional rural banks) for income
recognition, asset classification, provisioning and other related matters. These guidelines (commonly referred to
as `prudential guidelines' or `prudential norms') have since been modified in several respects through various
circulars of the Reserve Bank. The latest Master Circular No. RBI/2015-16/101DBR.No.BP.BC.2/21.04.048/2015-
16 was issued on July 1, 2015 on `Prudential Norms on Income Recognition, Asset Classification and Provisioning
Pertaining to Advances". The salient points of the guidelines as presently in force are discussed below:
Non-Performing Assets
4.02 Under the guidelines, income recognition, and provisioning in respect of a credit facility are based on its
status of classification as performing or non-performing. A credit facility becomes non-performing "when it ceases
to generate income for a bank". Detailed guidelines have been laid down for determining the status of different
kinds of credit facilities (term loans, cash credits and overdrafts, bills purchased and discounted, and other credit
facilities) as performing or non-performing. These are discussed below:
Criteria for Classification of Various Types of Credit Facilities
4.03 In line with the international best practices and to ensure greater transparency, the RBI has directed the
banks to adopt the `90 days' overdue' norm for identification of NPAs from the year ending March 31, 2004.
4.04 Banks have been charging interest at monthly rests, from April 1, 2002. However, the banks should
continue to classify an account as NPA only if the interest charged during any quarter is not serviced fully within
90 days from the end of the quarter.
4.05 An account should be treated as 'out of order' if the outstanding balance remains continuously in excess
of the sanctioned limit/drawing power. In cases where the outstanding balance in the principal operating account is
less than the sanctioned limit/drawing power, but there are no credits continuously for 90 days as on the date of
Balance Sheet or credits are not enough to cover the interest debited during the same period, these accounts
should also be treated as 'out of order'. Further, any amount due to the bank under any credit facility is `overdue'
if it is not paid on the due date fixed by the bank.
4.06 The following criteria are to be applied for determining the status of various types of credit facilities:
(a) Term Loans: A term loan is treated as a non-performing asset (NPA) if interest and/or instalment of
principal remain overdue for a period of more than 90 days.
Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
(b) Cash Credits and Overdrafts: A cash credit or overdraft account is treated as NPA if it remains out of order
as indicated above.
(c) Bills Purchased and Discounted: Bills purchased and discounted are treated as NPA if they remain overdue
and unpaid for a period of more than 90 days.
(d) Securitisation: The asset is to be treated as NPA if the amount of liquidity facility remains outstanding for more
than 90 days, in respect of a securitisation transaction undertaken in terms of guidelines on securitisation
dated February 1, 2006.
(e) Agricultural Advances: 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 and, 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.
(f) Credit Card Accounts: credit card account will be treated as non-performing asset if the minimum amount due,
as mentioned in the statement, is not paid fully within 90 days from the payment due date mentioned in the
statement as per Circular DBR.No.BP.BC.30/21.04.048/2015-16 dated July 16 2015. It is further suggested by
RBI that banks should follow this uniform method of determining over-due status for credit card accounts while
reporting to credit information companies (CIC) and for the purpose of levying of penal charges, viz., late
payment charges, etc., if any.
4.07 As per the guidelines, "long duration" crops would be crops with crop season longer than one year and
crops, which are not "long duration" crops would be treated as "short duration" crops. The crop season for each
crop, which means the period up to harvesting of the crops raised, would be as determined by the State Level
Bankers' Committee in each State. Depending upon the duration of crops raised by an agriculturist, the above
NPA norms would also be made applicable to agricultural term loans availed of by him.
4.08 The above norms should be made applicable to all direct agricultural advances as listed in the Master
Direction on Lending to Priority Sector-Target and Classification dated July 7, 2016. In respect of all other
agricultural loans, identification of NPAs would be done on the same basis as non-agricultural advances, which, at
present, is the 90 days delinquency norm. In this context, attention of the Readers is also invited to Guidelines on
Joint Lenders Forum and Corrective Action Plan providing the framework outlining a corrective action plan that will
incentivise early identification of problem cases, timely restructuring of accounts which are considered to be
viable, and taking prompt steps by banks for recovery or sale of unviable accounts.
Classification Norms relating to NPAs
Temporary Deficiencies
4.09 The classification of an asset as NPA should be based on the record of recovery. Bank should not
classify an advance account as NPA merely due to the existence of some deficiencies which are temporary in
nature such as non-availability of adequate drawing power based on the latest available stock statement, balance
outstanding exceeding the limit temporarily, non-submission of stock statements and non-renewal of the limits on
the due date, etc. In the matter of classification of accounts with temporary deficiencies, banks have to follow the
following guidelines:
(a) Banks should ensure that drawings in the working capital account are covered by the adequacy of the
current assets, since current assets are first appropriated in times of distress. Drawing Power is required to
be arrived at based on current stock statement. Proper computation of drawing power (as per Bank's policy)
is imperative as the advances are to be checked with reference thereto. The creditors (for Goods) should
be reduced from the stock and debtors within the stipulated period while calculating the drawing power.
However, considering the difficulties of large borrowers, stock statements relied upon by the banks for
determining drawing power should not be older than three months. In case of consortium accounts, the
drawing power calculation and allocation is made by the Lead Bank and is binding on the Member Banks
(circular no. No. C&I/Circular/2014-15/689 dated 29 September 2014 issued by the Indian Banks Association).
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Asset Classification, Income Recognition and Provisioning
(b) The outstanding in the account based on drawing power calculated from stock statements older than three
months is deemed as irregular.
(c) A working capital borrowing account will become NPA if such irregular drawings are permitted in the
account for a continuous period of 90 days even though the unit may be working or the borrower's financial
position is satisfactory.
(d) Regular and ad hoc credit limits need to be reviewed/ regularised not later than three months from the due
date/date of ad hoc sanction. In case of constraints such as non-availability of financial statements and
other data from the borrowers, the branch should furnish evidence to show that renewal/ review of credit
limits is already on and would be completed soon. In any case, delay beyond six months is not considered
desirable as a general discipline. Hence, an account where the regular/ adhoc credit limits have not been
reviewed/ renewed within 180 days from the due date/ date of adhoc sanction will be treated as NPA.
Regularisation Near About Balance Sheet
4.10 The asset classification of borrower accounts where a solitary or a few credits are recorded before the
balance sheet should be handled with care and without scope for subjectivity. Where the account indicates
inherent weakness on the basis of the data available, the account should be deemed as a NPA. In other genuine
cases, the banks must furnish satisfactory evidence about the manner of regularisation of the account to eliminate
doubts on their performing status.
Cheque bounce
4.11 In case the account is regularised by making payment through cheque, the Auditor should review the
actual realisation of cheques to assess the NPA classification. In case, the cheque is bounced, same should not
be considered as credit in the Advance account for assessing the NPA classification.
Subsequent Recoveries
4.12 There may be a case where account is NPA as at reporting date and there are subsequent recoveries in
advance account which results in one of the following:
a. Subsequent recovery of overdue amount
b. Subsequent recovery of full due amount as at the date of recovery
c. Subsequent recovery of full outstanding amount and account is closed
In case b & c above, it may happen that the account is classified as NPA as at reporting date and provision is
created against same which may get reversed in subsequent reporting period either due to upgradation of account
or closure of account. Currently since there is no specific guidance available from regulator on treatment of
subsequent recoveries on assessment of NPA accounts as on reporting date, the status of account as at reporting
date need to be considered,
Subsequent Adjusting Event
4.13 In case there is a recovery in account before reporting date which gets evident subsequently than same
can be considered as adjusting event as per para 8 of AS-4 for assessment of NPA account as on reporting date.
For example, say in case of a consortium loan account, there is a recovery by lead bank but it has not passed on
the share of recovery to the member banks. If there is an evidence of recovery by the lead bank then even if the
credit is not passed on to the member banks , then the same can be considered as adjusting event.
Para 8 of Accounting Standard 4, Contingencies and Events Occurring after the Balance Sheet Date.
Events which occur between the balance sheet date and the date on which the financial statements are
approved, may indicate the need for adjustments to assets and liabilities as at the balance sheet date or
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
may require disclosure.
Adjustments to assets and liabilities are required for events occurring after the balance sheet date that
provide additional information materially affecting the determination of the amounts relating to conditions
existing at the balance sheet date.
Asset Classification to be Borrower-wise not Facility-wise
4.14 All facilities granted to a borrower and investment made in securities issued by the borrower will have to
be treated as NPA/NPI and not the particular investment/facility once any or a part of the facility/investment has
become irregular.
4.15 In case debits arising out of devolvement of letters of credit or invoked guarantees are parked in a
separate account, the balance outstanding in that account also should be treated as a part of the borrower's
principal operating account for the purpose of application of prudential norms on income recognition, asset
classification and provisioning. The following provisions are given in the master circular in this regard:
(i) The bills discounted under LC favouring a borrower may not be classified as a Non-performing advance
(NPA), when any other facility granted to the borrower is classified as NPA. However, in case documents
under LC are not accepted on presentation or the payment under the LC is not made on the due date by the
LC issuing bank for any reason and the borrower does not immediately make good the amount disbursed as a
result of discounting of concerned bills, the outstanding bills discounted will immediately be classified as NPA
with effect from the date when the other facilities had been classified as NPA.
(ii) The overdue receivables representing positive mark-to-market value of a derivative contract will be treated as
a non-performing asset, if these remain unpaid for 90 days or more. In case the overdues arising from forward
contracts and plain vanilla swaps and options become NPAs, all other funded facilities granted to the client
shall also be classified as non-performing asset following the principle of borrower-wise classification as per
the existing asset classification norms. Accordingly, any amount, representing positive mark-to-market value
of the foreign exchange derivative contracts (other than forward contract and plain vanilla swaps and options)
that were entered into during the period April 2007 to June 2008, which has already crystallised or might
crystallise in future and is / becomes receivable from the client, should be parked in a separate account
maintained in the name of the client / counterparty. This amount, even if overdue for a period of 90 days or
more, will not make other funded facilities provided to the client, NPA on account of the principle of borrower-
wise asset classification, though such receivable overdue for 90 days or more shall itself be classified as
NPA, as per the extant IRAC norms. The classification of all other assets of such clients will, however,
continue to be governed by the extant IRAC norms.
(iii) If the client concerned is also a borrower of the bank enjoying a Cash Credit or Overdraft facility from the
bank, the receivables mentioned at item (ii) above may be debited to that account on due date and the impact
of its non-payment would be reflected in the cash credit / overdraft facility account. The principle of borrower-
wise asset classification would be applicable here also, as per extant norms.
(iv) In cases where the contract provides for settlement of the current mark-to-market value of a derivative
contract before its maturity, only the current credit exposure (not the potential future exposure) will be
classified as a non-performing asset after an overdue period of 90 days.
(v) As the overdue receivables mentioned above would represent unrealised income already booked by the bank
on accrual basis, after 90 days of overdue period, the amount already taken to 'Profit and Loss a/c' should be
reversed and held in a `Suspense Account- Crystalised Receivables' in the same manner as done in the case
of overdue advances.
(vi) Further, in cases where the derivative contracts provides for more settlements in future, the MTM value will
comprise of (a) crystallised receivables and (b) positive or negative MTM in respect of future receivables. If
the derivative contract is not terminated on the overdue receivable remaining unpaid for 90 days, in addition
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Asset Classification, Income Recognition and Provisioning
to reversing the crystallised receivable from Profit and Loss Account as stipulated in para above, the positive
MTM pertaining to future receivables may also be reversed from Profit and Loss Account to another account
styled as `Suspense Account Positive MTM'. The subsequent positive changes in the MTM value may be
credited to the `Suspense Account Positive MTM', not to P&L Account. The subsequent decline in MTM
value may be adjusted against the balance in `Suspense Account Positive MTM'. If the balance in this
account is not sufficient, the remaining amount may be debited to the P&L Account. On payment of the
overdues in cash, the balance in the `Suspense Account-Crystalised Receivables' may be transferred to the
`Profit and Loss Account', to the extent payment is received.
(vii) If the bank has other derivative exposures on the borrower, it follows that the MTMs of other derivative
exposures should also be dealt with / accounted for in the manner as described in para above, subsequent to
the crystalised/settlement amount in respect of a particular derivative transaction being treated as NPA.
(viii) Since the legal position regarding bilateral netting is not unambiguously clear, receivables and payables
from/to the same counterparty including that relating to a single derivative contract should not be netted.
(ix) Similarly, in case a fund-based credit facility extended to a borrower is classified as NPA, the MTMs of all the
derivative exposures should be treated in the manner discussed above.
4.16 The Auditor needs to ensure that each customer of the bank is tagged under one single Customer ID in
respect of all his/its accounts, including those in which credit facilities are granted, irrespective of their location , to
enable the bank, (subject to the relaxations/exceptions for the time being applicable to any account/facility), to
accord the same NPA classification status to the customer/borrower , based on the most adverse classification
determined for any of his/its account/ facility. The auditor should also review the facilities enjoyed by such
borrower's related or group entities. The NPA classification so made does not automatically extend to such related
or group entities, where the classification would have to be judged based on independently, i.e., at the entity level
and not at a group level.
Non Financial Parameters
4.17 Normally NPA assessment is done based on record of recovery of dues in advances account. However
there are many other non financial parameters which also should be consider while assessing classification of
NPA account
Inherent weakness in account
Achievement of DCCO
Failure to comply with key restructuring conditions
Erosion in value of security
All above aspects are dealt with in detail in the following paragraphs of this chapter
Advances to Primary Agricultural Credit Society (PACS) Farmers Service Society (FSS) ceded to
Commercial Banks
4.18 In case of advances granted under the on-lending system, however, only the particular credit facility
granted to PACSs or FSSs, which is in default for a period of two crop seasons in case of short duration crops and
one crop season in case of long duration crops, as the case may be, after it has become due will be classified as
NPA and not all the credit facilities sanctioned subject to such conditions as specified in the RBI's latest Master
Circular on Prudential Norms on Income Recognition, Asset Classification and provisioning pertaining to Advances
dated July 1, 2015. The other direct loans & advances, if any, granted by the bank to the member borrower of a
PACS/ FSS outside the on-lending arrangement will become NPA even if one of the credit facilities granted to the
same borrower becomes NPA.
Erosion in Value of Securities/ Frauds Committed by Borrowers
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
4.19 In respect of accounts where there are potential threats for recovery on account of erosion in the value of
security or non-availability of security (not to be misinterpreted for loan classified as "Unsecured loans" as
unsecured borrowers are dealt by separate provisioning parameters) and existence of other factors such as frauds
committed by borrowers, such accounts need not go through the stages of asset classification. In such cases, the
asset should be straightaway classified as doubtful or loss asset, as appropriate. Further,
(i) Erosion in the value of securities by more than 50% of the value assessed by the bank or accepted by RBI
inspection team at the time of last inspection, as the case may be, would be considered as "significant",
requiring the asset to be classified as doubtful straightaway and provided for adequately.
(ii) The realisable value of security as assessed by bank/approved valuers/RBI is less than 10% of the
outstanding in the borrower accounts, the existence of the security should be ignored and the asset should
be classified as loss asset. In such cases the asset should either be written off or fully provided for.
(iii) Provisioning norms in respect of all cases of fraud:
a. The entire amount due to the bank (irrespective of the quantum of security held against such assets), or
for which the bank is liable (including in case of deposit accounts), is to be provided for over a period
not exceeding four quarters commencing with the quarter in which the fraud has been detected;
However, where there has been delay, beyond the prescribed period, in reporting the fraud to the
b.
Reserve Bank, the entire provisioning is required to be made at once. In addition, Reserve Bank of
India may also initiate appropriate supervisory action where there has been a delay by the bank in
reporting a fraud, or provisioning there against.
c. Where the bank chooses to provide for the fraud over two to four quarters and this results in the full
provisioning being made in more than one financial year, banks should debit 'other reserves' [i.e.,
reserves other than the one created in terms of Section 17(2) of the Banking Regulation Act 1949] by
the amount remaining un-provided at the end of the financial year by credit to provisions. However,
banks should proportionately reverse the debits to `other reserves' and complete the provisioning by
debiting profit and loss account, in the subsequent quarters of the next financial year.
Government Guaranteed Advances
4.20 The credit facilities backed by guarantees of Central Government though overdue may be treated as NPA
only when the government repudiates its guarantee when invoked. This exemption from classification of Central
Government guaranteed advances as NPA is not for the purpose of recognition of income. In case of State
Government guaranteed loans, this exemption will not be available and such account will be NPA if interest /
principal / other dues remain overdue for more than 90 days.
Advances Under Consortium
4.21 Consortium advances should be based on the record of recovery of the respective individual member
banks and other aspects having a bearing on the recoverability of the advances. Where the remittances by the
borrower under consortium lending arrangements are pooled with one bank and/or where the bank receiving
remittances is not parting with the share of other member banks, the account should be treated as not serviced in
the books of the other member banks and therefore, an NPA.
The banks participating in the consortium, therefore, need to arrange to get their share of recovery
transferred from the lead bank or to get an express consent from the lead bank for the transfer of their share of
recovery, to ensure proper asset classification in their respective books.
Advances Against Term Deposits, NSCs, KVPs/ IVPs, etc.
4.22 Advances against Term Deposits, NSCs eligible for surrender, KVP/IVP and life policies need not be
treated as NPAs, provided adequate margin is available in the accounts. Advance against gold ornaments,
government securities and all other securities are not covered by this exemption and should be classified as NPA
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Asset Classification, Income Recognition and Provisioning
as per the extant IRAC norms.
Agricultural Advances Affected by Natural Calamities
4.23 Paragraph 4.2.13 of the Master Circular deals elaborately with the classification and income recognition
issues due to impairment caused by natural calamities. Banks may decide on their own relief measures, viz.,
conversion of the short term production loan into a term loan or reschedulement of the repayment period and the
sanctioning of fresh short-term loan, subject to the guidelines contained in RBI's latest Master Circular on
"Prudential Norms on Income Recognition, Asset Classification and Provisioning Pertaining to Advances" dated
July 1, 2015 and guidelines contained in RBI FIDD.No.FSD.BC.01/05.10.001/2015-16 dated July 1, 2015 on
"Guidelines for Relief Measures by Bank in Areas Affected by Natural Calamities". In such cases the NPA
classification would be governed by such rescheduled terms.
4.24 In such cases of conversion or re-schedulement, the term loan as well as fresh short-term loan may be
treated as current dues and need not be classified as NPA. The asset classification of these loans would
thereafter be governed by the revised terms & conditions and would be treated as NPA if interest and/or
instalment of principal remain overdue for two crop seasons for short duration crops and for one crop season for
long duration crops. For the purpose of these guidelines, "long duration" crops would be crops with crop season
longer than one year and crops, which are not 'long duration" would be treated as "short duration" crops.
4.25 While fixing the repayment schedule in case of rural housing advances granted to agriculturist under
Indira Awas Yojana and Golden Jubilee Rural Housing Finance Scheme, banks should ensure that the interest/
instalment payable on such advances are linked to crop cycles.
Advances Granted Under Rehabilitation Packages Approved by BIFR/Term Lending Institutions
4.26 In respect of advances under rehabilitation package approved by BIFR/term lending institutions, the
provision should continue to be made in respect of dues to the bank on the existing credit facilities as per their
classification as sub-standard or doubtful asset. This classification cannot be upgraded by the bank unless the
package of renegotiated terms has worked satisfactorily for a period of one year. As regards the additional
facilities sanctioned as per package finalised by BIFR and/or term lending institutions, the income recognition,
asset classification norms would apply after a period of one year from the date of disbursement.
Transactions Involving Transfer of Assets through Direct Assignment of Cash Flows and the Underlying
Securities
4.27 Originating Bank: The asset classification and provisioning rules in respect of the exposure representing the
Minimum Retention Requirement (MRR) of the Originator of the asset would be as under:
a) The originating bank may maintain a consolidated account of the amount representing MRR if the loans
transferred are retail loans. In such a case, the consolidated amount receivable in amortisation of the MRR and
its periodicity should be clearly established and the overdue status of the MRR should be determined with
reference to repayment of such amount. Alternatively, the originating bank may continue to maintain borrower-
wise accounts for the proportionate amounts retained in respect of those accounts. In such a case, the overdue
status of the individual loan accounts should be determined with reference to repayment received in each
account.
b) In the case of transfer of a pool of loans other than retail loans, the originator should maintain borrower-wise
accounts for the proportionate amounts retained in respect of each loan. In such a case, the overdue status of
the individual loan accounts should be determined with reference to repayment received in each account.
c) If the originating bank acts as a servicing agent of the assignee bank for the loans transferred, it would know the
overdue status of loans transferred which should form the basis of classification of the entire MRR/individual
loans representing MRR as NPA in the books of the originating bank, depending upon the method of accounting
followed as explained in para (a) and (b) above.
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4.28 Purchasing Bank: In purchase of pools of both retail and non-retail loans, income recognition, asset
classification and provisioning norms for the purchasing bank will be applicable based on individual obligors and not
based on portfolio. Banks should not apply the asset classification, income recognition and provisioning norms at
portfolio level, as such treatment is likely to weaken the credit supervision due to its inability to detect and address
weaknesses in individual accounts in a timely manner. If the purchasing bank is not maintaining the individual
obligor-wise accounts for the portfolio of loans purchased, it should have an alternative mechanism to ensure
application of prudential norms on individual obligor basis, especially the classification of the amounts corresponding
to the obligors which need to be treated as NPAs as per existing prudential norms. One such mechanism could be to
seek monthly statements containing account-wise details from the servicing agent to facilitate classification of the
portfolio into different asset classification categories. Such details should be certified by the authorized officials of the
servicing agent. Bank's concurrent auditors, internal auditors and statutory auditors should also conduct checks of
these portfolios with reference to the basic records maintained by the servicing agent. The servicing agreement
should provide for such verifications by the auditors of the purchasing bank. All relevant information and audit reports
should be available for verification by the Inspecting Officials of RBI during the Annual Financial Inspections of the
purchasing banks.
4.29 The above guidelines prescribed for Originating Bank and Purchasing Bank do not apply to:
(a) Transfer of loan accounts of borrowers by a bank to other bank/FIs/NBFCs and vice versa, at the
request/instance of borrower;
(b) Inter-bank participations;
(c) Trading in bonds;
(d) Sale of entire portfolio of assets consequent upon a decision to exit the line of business completely. Such a
decision should have the approval of Board of Directors of the bank;
(e) Consortium and syndication arrangements and arrangement under Corporate Debt Restructuring mechanism;
(f) Any other arrangement/transactions, specifically exempted by the Reserve Bank of India.
Post Shipment Supplier's Credit
4.30 In respect of post-shipment credit extended by the banks covering export of goods to countries for which the
ECGC's cover is available, EXIM Bank has introduced a guarantee-cum-refinance programme whereby, in the event
of default, EXIM Bank will pay the guaranteed amount to the bank within a period of 30 days from the day the bank
invokes the guarantee after the exporter has filed claim with ECGC.
Accordingly, where the credit extended by banks are guaranteed by EXIM Bank, the extent to which payment has
been received from EXIM bank on guarantee the advance may not be treated as NPA.
Takeout Finance
4.31 Takeout finance is the product emerging in the context of the funding of long-term infrastructure projects.
Under such an arrangement, the bank or financial institution financing infrastructure projects will have an
arrangement with any financial institution for transferring to the latter the outstanding in respect of such financing
in their books on a predetermined basis. In view of the time-lag involved in taking-over, the possibility of a default
in the meantime cannot be ruled out. The norms of asset classification will have to be followed by the concerned
bank/financial institution in whose books the account stands as balance sheet item as on the relevant date. If the
lending institution observes that the asset has turned NPA on the basis of the record of recovery, it should be
classified accordingly. The lending institution should not recognise income on accrual basis and account for the
same only when it is paid by the borrower/ taking over institution (if the arrangement so provides). The lending
institution should also make provisions against any asset turning into NPA pending its takeover by taking over
institution. As and when the asset is taken over by the taking over institution, the corresponding provisions could
be reversed. However, the taking over institution, on taking over such assets, should make provisions treating the
account as NPA from the actual date of it becoming NPA even though the account was not in its books as on that
date.
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Export Project Finance
4.32 Where the actual importer has paid the dues to the bank abroad and the proceeds have not been made
good to the bank granting finance due to any political reasons, such account need not be classified as NPA if the
bank is able to establish through documentary evidence that the importer has cleared the dues in full. The account
will, however, have to be considered as NPA if at the end of one year from the date the amount was deposited by
the importer in the bank abroad, the amount has not still been remitted to the bank.
Net Worth of Borrower/Guarantor or Availability of Security
4.33 Since income recognition is based on recoveries, net worth of borrower/guarantor should not be taken
into account for the purpose of treating an advance as NPA or otherwise, except to the extent provided in Para
4.2.9 of the Master Circular dated July 1, 2015. Likewise, the availability of security guarantee is not relevant for
determining whether or not an account is NPA.
Project Finance Under Moratorium Period
4.34 In the case of bank finance given for industrial projects or for agricultural plantations etc., where
moratorium is available for payment of interest, payment of interest becomes due after the moratorium or
gestation period is over, and not on the date of debit of interest. Therefore, such amounts of interest do not
become overdue and hence the accounts do not become NPA, with reference to the date of debit of interest. They
become overdue after due date for payment of interest as per the terms of sanction and consequently NPA norms
would apply to those advances from that due date.
Advances to Staff
4.35 Interest bearing staff advances as a banker should be included as part of advances portfolio of the bank.
In the case of housing loan or similar advances granted to staff members where interest is payable after recovery
of principal, interest need not be considered as overdue from first due date onwards. Such loans/advances should
be classified as NPA only when there is a default in repayment of instalment of principal or payment of interest on
the respective due dates. The staff advances by a bank as an employer and not as a banker are required to be
included under the sub-head `Others' under the schedule of Other Assets.
Partial Credit Enhancement to Corporate Bonds
4.36 In a waterfall mechanism, Credit Enhancement (CE) gets drawn only in a contingent situation of cash flow
shortfall for servicing a debt / bond etc., and not in the normal course of business. Hence, such an event is
indicative of financial distress of the project. Keeping this aspect in view, a drawn tranche of the contingent PCE
facility will be required to be repaid within 30 days from the date of its drawal (due date). The facility will be treated
as NPA if it remains outstanding for 90 days or more from the due date and provided for as per the usual asset
classification and provisioning norms. In that event, the bank's other facilities to the borrower will also be classified
as NPA as per extant guidelines.
NPA Management
4.37 The RBI has issued Master Circular dated July 1, 2015,on Prudential Norms on Income Recognition, Asset
Classification and provisioning pertaining to Advances. The Circular stresses the importance of effective mechanism
and granular data on NPA management in the banks and provides as follows:
Asset quality of banks is one of the most important indicators of their financial health. However, it has been
observed that existing MIS on the early warning systems of asset quality, needed improvement. Banks are,
therefore, advised that they should review their existing IT and MIS framework and put in place a robust MIS
mechanism for early detection of signs of distress at individual account level as well as at segment level (asset
class, industry, geographic, size, etc.). Such early warning signals should be used for putting in place an
effective preventive asset quality management framework, including a transparent restructuring mechanism for
viable accounts under distress within the prevailing regulatory framework, for preserving the economic value of
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those entities in all segments.
The banks' IT and MIS system should be robust and able to generate reliable and quality information with regard
to their asset quality for effective decision making. There should be no inconsistencies between information
furnished under regulatory/statutory reporting and the banks' own MIS reporting. Banks are also advised to have
system generated segment-wise information on non-performing assets and restructured assets which may
include data on the opening balances, additions, reductions, (upgradations, actual recoveries, write-offs etc.)
closing balances, provisions held, technical write-offs, etc.
Income Recognition
On Advances Granted
4.38 Banks recognise income (such as interest, fees and commission) on accrual basis, i.e., as it is earned. It is an
essential condition for accrual of income that it should not be unreasonable to expect its ultimate collection. In view of
the significant uncertainty regarding ultimate collection of income arising in respect of non-performing assets, the
guidelines require that banks should not recognise income on non-performing assets until it is actually realised. When a
credit facility is classified as non-performing for the first time, interest accrued and credited to the income account in the
corresponding previous year which has not been realised should be reversed or provided for. Further,
i. Interest income 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.
ii. 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.
iii. If Government guaranteed advances become NPA (subject to what is stated hereunder in respect of
Central Govt. guaranteed accounts), the interest on such advances should not be taken to income account
unless the interest has been realised.
Credit facilities backed by guarantee of the Central Government, though overdue, may be treated as NPA
only when the Government repudiates its guarantee when invoked. Thus, where the guarantee is not
invoked/repudiated, the related account cannot be classified as NPA and by implication, the advance is to
be treated as "Standard" for the purpose of provisioning. This exemption from classification of such Central
Government guaranteed advances as NPA is not for the purpose of recognition of income; and income is to
be recognized only based on realisations made.
Reversal of Income
4.39 If any advance, including bills purchased and discounted, becomes NPA as at the close of any year, the
entire interest accrued and credited to income account in the past periods, should be reversed or provided for if
the same is not realised. This will apply to Government guaranteed accounts also.
4.40 In respect of NPAs, 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.
4.41 Further, in case of banks which have wrongly recognised income in the past should reverse the interest if
it was recognised as income during the current year or make a provision for an equivalent amount if it was
recognised as income in the previous year(s).
On Leased Assets
4.42 The finance charge component of finance income (as defined in AS 19 Leases) on the leased asset
which has accrued and was credited to income account before the asset became non-performing, and remaining
unrealised, should be reversed or provided for in the current accounting period.
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On Take-out Finance
4.43 In the case of take-out finance, if based on record of recovery, the account is classified by the lending
bank as NPA, it should not recognise income unless realised from the borrower/taking-over institution (if the
arrangement so provides).
On Partial Recoveries in NPAs
4.44 In the absence of a clear agreement between the bank and the borrower for the purpose of appropriation
of recoveries in NPAs (i.e., towards principal or interest due), banks are required to adopt an accounting policy
and exercise the right of appropriation of recoveries in a uniform and consistent manner. The appropriate policy to
be followed is to recognise income as per AS 9 when certainty attaches to realisation and accordingly amount
reversed/derecognised or not recognised in the past should be accounted.
4.45 Interest partly/fully realised in NPAs can be taken to income. However, it should be ensured that the
credits towards interest in the relevant accounts are not out of fresh/additional credit facilities sanctioned to the
borrowers concerned.
Memorandum Account
4.46 On an account turning NPA, banks should reverse the interest already charged and not collected by
debiting Profit and Loss account, and stop further application of interest. However, banks may continue to record
such accrued interest in a Memorandum account in their books for control purposes. For the purpose of computing
Gross Advances, interest recorded in the Memorandum account should not be taken into account.
Classification of Advances
4.47 The guidelines require banks to classify their advances into four broad categories for the purpose of
provisioning as follows:
(a) Standard assets
A standard asset is one which does not disclose any problems and which does not carry more than normal risk
attached to the business. Such an asset is not a non-performing asset. However as per para 2.1 of Notification
dated February 26, 2014, RBI has directed the banks to classify the standard accounts according to their overdue
status under Special Monitoring Accounts popularly known as SMA. Under this
SMA Categories Basis of Classification
SMA-0 No overdue but sign of incipient stress (as per annexure to the Master Circular on
Prudential Norms on Income Recognition, Asset Classification and Provisioning
pertaining to Advances dated July 1, 2015
SMA-1 Overdue between 30 -60 days
SMA-2 Overdue between 60-90 days
Such classification also serves to be useful for bank officers monitoring as well as audit perspective to check the
transactions & methods of keeping these standard at the balance sheet date.
(b) Sub-standard assets
A sub-standard asset is one which has remained NPA for a period less than or equal to 12 months. Such an
asset will have well defined credit weaknesses that jeopardize the liquidation of the debt and are characterized by
the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected.
(c) Doubtful assets
An asset is classified as doubtful if it has remained in the sub-standard category for a period of 12 months. Such
an asset has all the inherent weaknesses as in a doubtful asset and an added characteristic that the weaknesses
make the collection or liquidation in full highly improbable or questionable.
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(d) Loss assets
A loss asset is one where loss has been identified by:
(a) the bank; or
(b) the internal or external auditors; or
(c) the RBI inspection.
but the amount has not been written off wholly. In other words, such an asset is considered uncollectible and of
such little value that its continuance as a bankable asset is not warranted although there may be some salvage or
recovery value.
It may be noted that the above classification is meant for the purpose of computing the amount of provision to be
made in respect of advances. The balance sheet presentation of advances is governed by the Third Schedule to
the Banking Regulation Act, 1949, which requires classification/presentation of advances altogether differently.
Guidelines on Restructuring of Advances by Banks
4.48 The RBI, vide its Master Circular No.DBR.No.BP.BC.2/21.04.048/2015-16 dated July 1, 2015 issued
prudential guidelines on restructuring of advances by banks. The Guidelines also contain the organisational
framework for restructuring of advances under consortium/ multiple banking/ syndication arrangements, i.e., the
CDR mechanism.
4.49 In line with the recommendation of the Working Group under the Chairmanship of Shri B. Mahapatra, to
review the existing prudential guidelines on restructuring of advances by banks/financial institutions, the extant
incentive for quick implementation of restructuring package and asset classification benefits (paragraphs 4.219 to
4.221 (available on restructuring on fulfilling the conditions will however be withdrawn for all restructurings effective
from April 1, 2015 with the exception of provisions related to changes in DCCO in respect of infrastructure as well as
non-infrastructure project loans. It implies that with effect from April 1, 2015, a standard account on restructuring (for
reasons other than change in Date of Commencement of Commercial Operations (DCCO)) would be immediately
classified as sub-standard on restructuring as also the non-performing assets, upon restructuring, would continue to
have the same asset classification as prior to restructuring and slip into further lower asset classification categories
as per the extant asset classification norms with reference to the pre-restructuring repayment schedule.
4.50 The guidelines issued by the Reserve Bank of India on restructuring of advances (other than those
restructured under a separate set of guidelines issued by the Rural Planning and Credit Department (RPCD) of the
RBI on restructuring of advances on account of natural calamities) are divided into the following four categories:
Guidelines on restructuring of advances extended to industrial units.
Industrial units under the Corporate Debt Restructuring (CDR) Mechanism.
Small and Medium Enterprises (SME).
All other advances.
In these four sets of guidelines on restructuring of advances, the differentiations were broadly made based on
whether a borrower is engaged in an industrial activity or a non-industrial activity. In addition, an elaborate
institutional mechanism was laid down for accounts restructured under CDR Mechanism. The major difference in the
prudential regulations was in the stipulation that subject to certain conditions, the accounts of borrowers engaged in
industrial activities (under CDR Mechanism, SME Debt Restructuring Mechanism and outside these mechanisms)
continued to be classified in the existing asset classification category upon restructuring. This benefit of retention of
asset classification on restructuring was not made available to the accounts of borrowers engaged in non-industrial
activities except to SME borrowers.
4.51 In the backdrop of extraordinary rise in restructured standard advances, these prudential norms were further
revised by taking into account the recommendations of the Working Group under the Chairmanship of Shri B.
Mahapatra, to review the existing prudential guidelines on restructuring of advances by banks/financial institutions.
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The details of the institutional / organizational framework for CDR Mechanism and SME Debt Restructuring
Mechanism are given in Annex - 4 to the RBI's Master Circular on "Prudential Norms on Income Recognition, Asset
Classification and Provisioning to Advances" dated July 1, 2015 to be read along with circular no. DBOD.BP.
BC.No.45/21.04.132/2014-15.
4.52 The CDR Mechanism (Annex - 4 of the Master circular) will also be available to the corporates engaged in
non-industrial activities, if they are otherwise eligible for restructuring as per the criteria laid down for this purpose.
Further, banks are also encouraged to strengthen the co-ordination among themselves in the matter of restructuring
of consortium / multiple banking accounts, which are not covered under the CDR Mechanism.
Key Concepts
4.53 Key concepts used in these guidelines are defined in Annex 5 to the RBI's Master Circular on "Prudential
Norms on Income Recognition, Asset Classification and Provisioning to Advances" dated July 1, 2015.
General Principles and Prudential Norms for Restructured Advances
4.54 The principles and prudential norms laid down in below given paragraphs are applicable to all advances
including the borrowers, who are eligible for special regulatory treatment for asset classification.
Eligibility criteria for restructuring of advances
4.55 Banks may restructure the accounts classified under 'standard', 'sub- standard' and 'doubtful' categories.
4.56 Banks cannot reschedule / restructure / renegotiate borrowal accounts with retrospective effect. While a
restructuring proposal is under consideration, the usual asset classification norms would continue to apply. The
process of re- classification of an asset should not stop merely because restructuring proposal is under
consideration. The asset classification status as on the date of approval of the restructured package by the
competent authority would be relevant to decide the asset classification status of the account after restructuring/
rescheduling/ renegotiation. In case there is undue delay in sanctioning a restructuring package and in the meantime
the asset classification status of the account undergoes deterioration, it would be a matter of supervisory concern.
4.57 Normally, restructuring cannot take place unless alteration / changes in the original loan agreement are
made with the formal consent / application of the debtor. However, the process of restructuring can be initiated by the
bank in deserving cases subject to customer agreeing to the terms and conditions.
4.58 No account will be taken up for restructuring by the banks unless the financial viability is established and
there is a reasonable certainty of repayment from the borrower, as per the terms of restructuring package. Any
restructuring done without looking into cash flows of the borrower and assessing the viability of the projects / activity
financed by banks would be treated as an attempt at ever greening a weak credit facility and would invite supervisory
concerns / action. Banks should accelerate the recovery measures in respect of such accounts. The viability should
be determined by the banks based on the acceptable viability benchmarks determined by them, which may be
applied on a case-by-case basis, depending on merits of each case.
4.59 Illustratively, the parameters may include
the Return on Capital Employed.
Debt Service Coverage Ratio.
Gap between the Internal Rate of Return.
Cost of Funds and
the amount of provision required in lieu of the diminution in the fair value of the restructured advance.
4.60 The viability should be determined by the banks based on the acceptable viability parameters and
benchmarks for each parameter determined by them. The benchmarks for the viability parameters adopted by the
CDR Mechanism are given in the Appendix to Part B of this Master Circular and individual banks may suitably
adopt them with appropriate adjustments, if any, for specific sectors while restructuring of accounts in non-CDR
cases.
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4.61 The borrowers indulging in frauds and malfeasance will continue to remain ineligible for restructuring.
4.62 Banks may review the reasons for classification of the borrowers as willful defaulters, especially in old cases
where the manner of classification of a borrower as a willful defaulter was not transparent, and satisfy itself that the
borrower is in a position to rectify the willful default. The restructuring of such cases may be done with Board's
approval, while for such accounts the restructuring under the CDR Mechanism may be carried out with the approval
of the Core Group only.
4.63 BIFR cases are not eligible for restructuring without their express approval. CDR Core Group in the case of
advances restructured under CDR Mechanism, the lead bank in the case of SME Debt Restructuring Mechanism and
the individual banks in other cases, may consider the proposals for restructuring in such cases, after ensuring that all
the formalities in seeking the approval from BIFR are completed before implementing the package.
Miscellaneous
4.64 The banks should decide on the issue regarding convertibility (into equity) option as a part of restructuring
exercise whereby the banks / financial institutions shall have the right to convert a portion of the restructured amount
into equity, keeping in view the statutory requirement under Section 19 of the Banking Regulation Act, 1949, (in the
case of banks) and relevant SEBI Regulations.
4.65 Conversion of debt into preference shares should be done only as a last resort and such conversion of debt
into equity/preference shares should, in any case, be restricted to a cap (say 10 per cent of the restructured debt).
Further, any conversion of debt into equity should be done only in the case of listed companies.
4.66 Acquisition of equity shares / convertible bonds / convertible debentures in companies by way of conversion
of debt / overdue interest can be done without seeking prior approval from RBI, even if by such acquisition the
prudential capital market exposure limit prescribed by the RBI is breached. However, this will be subject to reporting
of such holdings to RBI, Department of Banking Supervision (DBS), every month along with the regular Department
of Supervision by Banks (DSB) Return on Asset Quality. Nonetheless, banks will have to comply with the provisions
of Section 19(2) of the Banking Regulation Act, 1949.
4.67 Acquisition of non-SLR securities by way of conversion of debt is exempted from the mandatory rating
requirement and the prudential limit on investment in unlisted non-SLR securities, prescribed by the RBI, subject to
periodical reporting to the RBI in the aforesaid DSB return.
4.68 Banks may consider incorporating in the approved restructuring packages creditor's rights to accelerate
repayment and the borrower's right to pre pay. Further, all restructuring packages must incorporate `Right to
recompense' clause and it should be based on certain performance criteria of the borrower. In any case, minimum 75
per cent of the recompense amount should be recovered by the lenders and in cases where some facility under
restructuring has been extended below base rate, 100 per cent of the recompense amount should be recovered.
4.69 As stipulating personal guarantee will ensure promoters' "skin in the game" or commitment to the
restructuring package, promoters' personal guarantee should be obtained in all cases of restructuring and corporate
guarantee cannot be accepted as a substitute for personal guarantee. However, corporate guarantee can be
accepted in those cases where the promoters of a company are not individuals but other corporate bodies or where
the individual promoters cannot be clearly identified.
Disclosures
4.70 With effect from the financial year 2012-13, banks are required to disclose in their published annual Balance
Sheets, under 'Notes on Accounts' information relating to number of accounts and amount of advances
restructured, and the amount of diminution in the fair value of the restructured advances as per the format given in
Annex 6 to the RBI circular. The information would be required for advances restructured under CDR
Mechanism, SME Debt Restructuring Mechanism and other categories separately. Banks must disclose the total
amount outstanding in all the accounts / facilities of borrowers whose accounts have been restructured along with the
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restructured part or facility. This means even if only one of the facilities / accounts of a borrower has been
restructured, the bank should also disclose the entire outstanding amount pertaining to all the facilities / accounts of
that particular borrower. The disclosure format prescribed in Annex-6, inter-alia, includes the following:
i. details of accounts restructured on a cumulative basis excluding the standard restructured accounts which cease
to attract higher provision and risk weight (if applicable);
ii. provisions made on restructured accounts under various categories; and
iii. details of movement of restructured accounts.
This implies that once the higher provisions and risk weights (if applicable) on restructured advances (classified as
standard either ab initio or on upgradation from NPA category) revert to the normal level on account of satisfactory
performance during the prescribed period, such advances should no longer be required to be disclosed by banks as
restructured accounts in the "Notes on Accounts" in their Annual Balance Sheets. However, the provision for
diminution in the fair value of restructured accounts on such restructured accounts should continue to be maintained
by banks as per the existing instructions.
4.71 It has been reiterated that the basic objective of restructuring is to preserve economic value of units, not
ever greening of problem accounts. This can be achieved by banks and the borrowers only by careful assessment of
the viability, quick detection of weaknesses in accounts and a time-bound implementation of restructuring packages.
(Text of RBI Master circular on "Prudential Norms on Income Recognition, Asset Classification and Provisioning
pertains to Advances" for Annex 1 to 6 is given in CD.)
Guidelines on Joint Lenders Forum (JLF) and Corrective Action Plan (CAP)
4.72 These guidelines are applicable for lending under Consortium and Multiple Banking Arrangements (MBA)
[except instructions in paragraphs 4.73, 4.109, 4.116 and 4.117 below and in case of dissemination of Information,
which are applicable in all cases of lending], and should be read with prudential norms on `Restructuring of
Advances by banks' as contained in Part B of this Master Circular no. RBI/2015-16/101 DBR.No.BP.BC.2/
21.04.048/2015-16 dated July 1, 2015 issued prudential guidelines on restructuring of advances by banks.
Formation of Joint Lenders' Forum
4.73 Bank is required to classify the loan accounts into 3 categories as special mention accounts as given below:
1) SMA-0: Principal or interest payment not overdue for more than 30 days but account showing signs of incipient
stress as given in appendix to Part C of Master Circular no. RBI/2015-
16/101DBR.No.BP.BC.2/21.04.048/2015-16 dated July 1, 2015.
2) SMA-1: Principal or interest payment overdue between 31-60 days.
3) SMA-2: Principal or interest payment overdue between 61-90 days.
Banks are required to report credit information, including classification of an account as SMA to CRILC (Central
Repository of Information on Large Credits)on all their borrowers having aggregate fund-based and non-fund based
exposure of Rs.50 million and above. Except the exemption granted for Crop loans, interbank exposure and
exposure to NABARD, SIDBI, EXIM Bank and NHB from reporting as per Reserve Bank of India circular no.
DBOD.BP.BC.No.45/21.04.132/2014-15 dated October 21, 2014.
4.74 Reserve Bank of India vide circular no. DBOD.BP.BC.No.45/21.04.132/ 2014-15 dated October 21, 2014
clarified that bank must report Cash credit (CC) and Overdraft (OD) accounts, including overdraft arising out of
devolved LCs/Invoked guarantees to CRILC as SMA 2 when these are `out of order' for more than 60 days. Similarly,
bills purchased or discounted (other than those backed by LCs issued by banks) and derivative exposures with
receivables representing positive mark to market value remaining overdue for more than 60 days should be reported
to CRILC as SMA-2.
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4.75 Further, Banks should continue to report the credit information and SMA status to CRILC on loans including
loans extended by their overseas branches. However, formation of JLF will not be mandatory in cases of offshore
borrowers which do not have any presence in India, either by way of a subsidiary, parent or a group entity. Further,
the inclusion of offshore lenders as part of JLF shall not be mandatory. Formation of JLF will not be mandatory on
reporting of investment portfolio as SMA, except in cases of bonds/debentures acquired on private placement basis
or due to conversion of debt under restructuring of advances.
1) Banks should mandatorily form a committee to be called Joint Lenders' Forum (JLF) if the aggregate exposure
(AE) [fund based and non-fund based taken together] of lenders in that account is Rs 1000 million and above
and the account is reported by any of the lenders to CRILC as SMA-2.
2) Lenders also have the option of forming a JLF even when the AE in an account is less than Rs.1000 million
and/or when the account is reported as SMA-0 or SMA-1.
4.76 Existing Consortium Arrangement for consortium accounts will serve as JLF with the Consortium Leader as
convener, for accounts under Multiple Banking Arrangements (MBA), the lender with the highest AE will convene
JLF.
4.77 In case of a borrower's request for formation of JLF, the account should be reported as SMA-0 on such
request to CRILC and the lender should form the JLF immediately if the AE is Rs 1000 million and above. The
formation of JLF is optional for other cases of SMA-0 reporting.
4.78 All the lenders should formulate and sign an Agreement (which may be called JLF agreement) incorporating
the broad rules for the functioning of the JLF. The Indian Banks' Association (IBA) has prepared a Master JLF
agreement and operational guidelines for JLF which can be adopted by all lenders.
4.79 JLF formation and subsequent corrective actions will be mandatory in accounts having AE of Rs.1000
million and above, in other cases also the lenders will have to monitor the asset quality closely and take corrective
action for effective resolution as deemed appropriate.
Corrective Action Plan (CAP) by JLF
4.80 The options under Corrective Action Plan (CAP) by the JLF would generally include
a) Rectification: Obtaining a specific commitment from the borrower to regularise the account so that the account
comes out of SMA status or does not slip into the NPA category. Commitment supported by identifiable cash
flows without loss or sacrifice to existing lenders, additional funding through equity/strategic investors. These
measures without any changes to the terms and conditions of the loan.
b) Restructuring: At this stage, commitment from promoters for extending their personal guarantees along with
their net worth statement supported by copies of legal titles to assets may be obtained along with a declaration
that they would not undertake any transaction that would alienate assets without the permission of the JLF.
c) Recovery: Once the first two options at (a) and (b) above are seen as not feasible, due recovery process may
be resorted to. The JLF may decide the best recovery process to be followed, among the various legal and
other recovery options available, with a view to optimising the efforts and results.
4.81 The decisions agreed upon by a minimum of 75% of creditors by value and 60% of creditors by number in
the JLF would be considered as the basis for proceeding with the restructuring of the account, and will be binding on
all lenders under the terms of the ICA (Inter creditor agreement). However, if the JLF decides to proceed with
recovery, the minimum criteria for binding decision, if any, under any relevant laws/Acts would be applicable.
4.82 The JLF is required to arrive at an agreement on the option to be adopted for CAP within 45 days from (i)
the date of an account being reported as SMA-2 by one or more lender, or (ii) receipt of request from the borrower to
form a JLF, with substantiated grounds, if it senses imminent stress. The JLF should sign off the detailed final CAP
within the next 30 days from the date of arriving at such an agreement.
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4.83 If the JLF decides on option of rectification or restructuring given above, but the account fails to perform as
per the agreed terms under the option, the JLF should initiate recovery.
4.84 Joint Lenders' Forum Empowered Group (JLF EG)
A. Sometimes Boards of the banks find it difficult to approve the decisions taken by JLF as the JLFs do not have
senior level representations from the participating lenders. In this regard, it is clarified that, although RBI has not
explicitly prescribed the level of representation in its guidelines, banks are expected to depute sufficiently
empowered senior level officials for deliberations and decisions in the meetings of JLF.
B. Nevertheless, it has been decided that JLF will finalise the CAP and the same will be placed before an
Empowered Group (EG) of lenders, which will be tasked to approve the rectification/restructuring packages
under CAPs. The JLF-EG shall have the following composition:
i. A representative each of SBI and ICICI Bank as standing members;
ii.A representative each of the top three lenders to the borrower. If SBI or ICICI Bank is among the top three
lenders to the borrower, then a representative of the fourth largest or a representative each of the fourth
and the fifth largest lenders as the case may be;
iii. A representative each of the two largest banks in terms of advances who do not have any exposure to the
borrower; and
iv. The participation in the JLF-EG shall not be less than the rank of an Executive Director in a PSB or
equivalent.
The JLF convening bank will convene the JLF-EG and provide the secretarial support to it.
Restructuring under JLF
4.85 If the JLF decide to restructure as CAP, it can be referred to CDR cell or restructure the same independent
of CDR mechanism. For restructuring process refer Master Circular no. RBI/2015-
16/101DBR.No.BP.BC.2/21.04.048/2015-16 dated July 1, 2015 along with clarification issued by Reserve bank of
India circular no. DBOD.BP.BC.No.45/21.04.132/2014-15 dated October 21, 2014.
Restructuring of Doubtful accounts under JLF
4.86 In terms of paragraph 4.3.6 of the circular DBOD.BP.BC.No.97/ 21.04.132/2013-14 dated February 26,
2014, while generally no account classified as doubtful should be considered by the JLF for restructuring, in cases
where a small portion of debt is doubtful i.e. the account is standard/sub-standard in the books of at least 90% of
creditors (by value), the account may then be considered under JLF for restructuring.
4.87 In partial modification of the above, it has been decided that a JLF may decide on restructuring of an
account classified as `doubtful' in the books of one or more lenders similar to that of SMA2 and sub-standard assets,
if the account has been assessed as viable under the Technology Economic Viability (TEV) and the JLF-EG concurs
with the assessment and approves the proposal.
Strategic Debt Restructuring:
4.88 RBI circular DBOD.BP.BC.No.97/21.04.132/2013-14 dated February 26, 2014 on "Framework for
Revitalising Distressed Assets in the Economy Guidelines on Joint Lenders' Forum (JLF) and Corrective Action
Plan (CAP)", wherein change of management was envisaged as a part of restructuring of stressed assets. Paragraph
5.3 of the circular states that the general principle of restructuring should be that the shareholders bear the first loss
rather than the debt holders. With this principle in view and also to ensure more `skin in the game' of promoters,
JLF/Corporate Debt Restructuring Cell (CDR) may consider the following options when a loan is restructured:
Possibility of transferring equity of the company by promoters to the lenders to compensate for their sacrifices;
Promoters infusing more equity into their companies;
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Transfer of the promoters' holdings to a security trustee or an escrow arrangement till turnaround of company.
This will enable a change in management control, should lenders favour it.
4.89 It has been observed that in many cases of restructuring of accounts, borrower companies are not able to
come out of stress due to operational/ managerial inefficiencies despite substantial sacrifices made by the lending
banks. In such cases, change of ownership will be a preferred option. Further, under JLF and CDR mechanism, the
restructuring package should also stipulate the timeline during which certain viability milestones (e.g. improvement in
certain financial ratios after a period of time, say, 6 months or 1 year and so on) would be achieved. The JLF must
periodically review the account for achievement/non-achievement of milestones and should consider initiating
suitable measures including recovery measures as deemed appropriate. With a view to ensuring more stake of
promoters in reviving stressed accounts and provide banks with enhanced capabilities to initiate change of ownership
in accounts which fail to achieve the projected viability milestones, banks may, at their discretion, undertake
a `Strategic Debt Restructuring (SDR)' by converting loan dues to equity shares, which will have the following
features:
(i) At the time of initial restructuring, the JLF must incorporate, in the terms and conditions attached to the
restructured loan/s agreed with the borrower, an option to convert the entire loan (including unpaid interest), or
part thereof, into shares in the company in the event the borrower is not able to achieve the viability milestones
and/or adhere to `critical conditions' as stipulated in the restructuring package. This should be supported by
necessary approvals/authorisations (including special resolution by the shareholders) from the borrower
company, as required under extant laws/regulations, to enable the lenders to exercise the said option
effectively. Restructuring of loans without the said approvals/authorisations for SDR is not permitted. If the
borrower is not able to achieve the viability milestones and/or adhere to the `critical conditions' referred to
above, the JLF must immediately review the account and examine whether the account will be viable by
effecting a change in ownership. If found viable under such examination, the JLF may decide on whether to
invoke the SDR, i.e. convert the whole or part of the loan and interest outstanding into equity shares in the
borrower company, so as to acquire majority shareholding in the company;
(ii) Provisions of the SDR would also be applicable to the accounts which have been restructured before the date
of this circular provided that the necessary enabling clauses, as indicated in the above paragraph, are included
in the agreement between the banks and borrower;
(iii) The decision on invoking the SDR by converting the whole or part of the loan into equity shares should be taken
by the JLF as early as possible but within 30 days from the above review of the account. Such decision should
be well documented and approved by the majority of the JLF members (minimum of 75% of creditors by value
and 60% of creditors by number);
(iv) In order to achieve the change in ownership, the lenders under the JLF should collectively become the majority
shareholder by conversion of their dues from the borrower into equity. However the conversion by JLF lenders
of their outstanding debt (principal as well as unpaid interest) into equity instruments shall be subject to the
member banks' respective total holdings in shares of the company conforming to the statutory limit in terms of
Section 19(2) of Banking Regulation Act, 1949;
(v) Post the conversion, all lenders under the JLF must collectively hold 51% or more of the equity shares issued
by the company;
(vi) The share price for such conversion of debt into equity will be determined as per the method given in paragraph
44 of this circular;
(vii) Henceforth, banks should include necessary covenants in all loan agreements, including restructuring,
supported by necessary approvals/authorisations (including special resolution by the shareholders) from the
borrower company, as required under extant laws/regulations, to enable invocation of SDR in applicable cases;
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(viii) The JLF must approve the SDR conversion package within 90 days from the date of deciding to undertake
SDR;
(ix) The conversion of debt into equity as approved under the SDR should be completed within a period of 90 days
from the date of approval of the SDR package by the JLF. For accounts which have been referred by the JLF to
CDR Cell for restructuring in terms of paragraph 4.2 of circular DBOD.BP.BC.No.97/21.04.132/2013-14 dated
February 26, 2014 cited above, JLF may decide to undertake the SDR either directly or under the CDR Cell;
(x) The invocation of SDR will not be treated as restructuring for the purpose of asset classification and
provisioning norms;
(xi) On completion of conversion of debt to equity as approved under SDR, the existing asset classification of the
account, as on the reference date indicated at para 4.90(ii) below, will continue for a period of 18 months from
the reference date. Thereafter, the asset classification will be as per the extant IRAC norms, assuming the
aforesaid `stand-still' in asset classification had not been given. However, when banks' holding are divested to a
new promoter, the asset classification will be as per the para 4.89(xiii) below;
(xii) Banks should ensure compliance with the provisions of Section 6 of Banking Regulation Act and JLF should
closely monitor the performance of the company and consider appointing suitable professional management to
run the affairs of the company;
(xiii) JLF and lenders should divest their holdings in the equity of the company as soon as possible. On divestment of
banks' holding in favour of a `new promoter', the asset classification of the account may be upgraded to
`Standard'. However, the quantum of provision held by the bank against the said account as on the date of
divestment, which shall not be less than what was held as at the `reference date', shall not be reversed. At the
time of divestment of their holdings to a `new promoter', banks may refinance the existing debt of the company
considering the changed risk profile of the company without treating the exercise as `restructuring' subject to
banks making provision for any diminution in fair value of the existing debt on account of the refinance. Banks
may reverse the provision held against the said account only when all the outstanding loan/facilities in the
account perform satisfactorily during the `specified period' (as defined in the extant norms on restructuring of
advances), i.e. principal and interest on all facilities in the account are serviced as per terms of payment during
that period. In case, however, satisfactory performance during the specified period is not evidenced, the asset
classification of the restructured account would be governed by the extant IRAC norms as per the repayment
schedule that existed as on the reference date indicated at para 4.90(ii) below, assuming that `stand-still' /
above upgrade in asset classification had not been given. However, in cases where the bank exits the account
completely, i.e. no longer has any exposure to the borrower, the provision may be reversed/absorbed as on the
date of exit;
(xiv) The asset classification benefit provided at the above paragraph is subject to the following conditions:
a) The `new promoter' should not be a person/entity/subsidiary/associate etc. (domestic as well as overseas),
from the existing promoter/promoter group. Banks should clearly establish that the acquirer does not belong
to the existing promoter group; and
b) The new promoters should have acquired at least 51 per cent of the paid up equity capital of the borrower
company. If the new promoter is a non-resident, and in sectors where the ceiling on foreign investment is
less than 51 per cent, the new promoter should own at least 26 per cent of the paid up equity capital or up to
applicable foreign investment limit, whichever is higher, provided banks are satisfied that with this equity
stake the new non-resident promoter controls the management of the company.
c) Vide circular dated 10th November, 2016, it has been decided to modify paragraph (xiv)(b) of circular
DBR.BP.BC.No.101/21.04.132/2014-15 dated June 8, 2015 and paragraph 7 of circular DBR.BP.BC.No.82 /
21.04.132/2015-16 dated February 25, 2016 as under:
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"The new promoter should have acquired atleast 26 percent of the paid up equity capital of the borrower
company and shall be the single largest shareholder of the borrower company. Further, the new promoter
shall be in `control' of the borrower company as per the definition of `control' provided in the Companies Act
2013 / regulations issued by the Securities and Exchange Board of India / any other applicable regulations /
accounting standards as the case may be."
It is clarified that `stand-still' clause only applies to asset classification and banks shall not recognize income
on accrual basis if the interest is not serviced within 90 days from the due date.
Banks shall make disclosures on invocation of SDR in annual financial statements as per the format given.
4.90 The conversion price of the equity shall be determined as per the guidelines given below:
(i) Conversion of outstanding debt (principal as well as unpaid interest) into equity instruments should be at a `Fair
Value' which will not exceed the lowest of the following, subject to the floor of `Face Value' (restriction under
section 53 of the Companies Act, 2013):
a) Market value (for listed companies): Average of the closing prices of the instrument on a recognized stock
exchange during the ten trading days preceding the `reference date' indicated at (ii) below;
b) Break-up value: Book value per share to be calculated from the company's latest audited balance sheet
(without considering 'revaluation reserves', if any) adjusted for cash flows and financials post the earlier
restructuring; the balance sheet should not be more than a year old. In case the latest balance sheet is not
available this break-up value shall be Re.1.
(ii) The above Fair Value will be decided at a `reference date' which is the date of JLF's decision to undertake SDR.
4.91 The above pricing formula under Strategic Debt Restructuring Scheme has been exempted from the
Securities and Exchange Board of India (SEBI) (Issue of Capital and Disclosure Requirements) Regulations, 2009
subject to certain conditions, in terms of SEBI (Issue of Capital and Disclosure Requirements) (Second Amendment)
Regulations, 2015 notified vide the Gazette of India Extraordinary PartIIISection 4, published on May 5, 2015.
Further, in the case of listed companies, the acquiring lender on account of conversion of debt into equity under SDR
will also be exempted from the obligation to make an open offer under regulation 3 and regulation 4 of the provisions
of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011
in terms of SEBI (Substantial Acquisition of Shares and Takeovers) (Second Amendment) Regulations, 2015. This
has been notified vide the Gazette of India Extraordinary PartIIISection 4 published on May 05, 2015. Banks
should adhere to all the prescribed conditions by SEBI in this regard.
4.92 In addition to conversion of debt into equity under SDR, banks may also convert their debt into equity at the
time of restructuring of credit facilities under the extant restructuring guidelines. However, exemption from regulations
of SEBI, as detailed in paragraph 4.91 above, shall be subject to adhering to the guidelines stipulated in the above
paragraphs.
4.93 Acquisition of shares due to such conversion will be exempted from regulatory ceilings/restrictions on
Capital Market Exposures, investment in Para-Banking activities and intra-group exposure. However, this will require
reporting to RBI (reporting to DBS, CO every month along with the regular DSB Return on Asset Quality) and
disclosure by banks in the Notes to Accounts in Annual Financial Statements. Equity shares of entities acquired by
the banks under SDR shall be assigned a 150% risk weight for a period of 18 months from the `reference date'
indicated in paragraph 4.90(ii). After 18 months from the `reference date', these shares shall be assigned risk weights
as per the extant capital adequacy regulations.
4.94 Equity shares acquired and held by banks under the scheme shall be exempt from the requirement of
periodic mark-to-market (stipulated vide Prudential Norms for Classification, Valuation and Operation of Investment
Portfolio by Banks) for the 18 month period indicated at para 4.89(xi).
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4.95 Conversion of debt into equity in an enterprise by a bank may result in the bank holding more than 20% of
voting power, which will normally result in an investor-associate relationship under applicable accounting standards.
However, as the lender acquires such voting power in the borrower entity in satisfaction of its advances under the
SDR, and the rights exercised by the lenders are more protective in nature and not participative, such investment
may not be treated as investment in associate in terms of paragraph 10.2.3 of Annexure to circular
DBOD.No.BP.BC.89/21.04.018/2002-03 dated March 29, 2003 on `Guidelines on Compliance with Accounting
Standards (AS) by Banks'.
4.96 With reference to the provisions contained in circular DBR.BP.BC.No. 101/21.04.132/2014-15 dated June 8,
2015 on "Strategic Debt Restructuring", it is advised that in cases of failure of rectification or restructuring as a CAP
as decided by JLF in terms of paragraph 3 of circular DBOD.BP.BC.No.97/ 21.04.132/ 2013-14 dated February 26,
2014, JLF will have the option to initiate SDR to effect change of management of the borrower company subject to
compliance with the conditions as stated above.
Asset Classification Norms
4.97 While a restructuring proposal is under consideration by the JLF/CDR, the usual asset classification norm
would continue to apply. The process of re-classification of an asset should not stop merely because restructuring
proposal is under consideration by the JLF/CDR.
4.98 Incentive for quick implementation of a restructuring package, the special asset classification benefit on
restructuring of accounts as per extant instructions would be available for accounts undertaken for restructuring
under these guidelines, subject to adherence to the overall timeframe for approval of restructuring package detailed
in paragraphs 27.3 and 27.4 of Master Circular no. RBI/2015-16/101 DBR.No.BP.BC.2/21.04.048/2015-16 dated
July 1, 2015 to be read along with Reserve bank of India circular no. DBOD.BP.BC.No.45/ 21.04.132/ 2014-15 dated
October 21, 2014 and implementation of the approved package within 90 days from the date of approval. The asset
classification status as on the date of formation of JLF would be the relevant date to decide the asset classification
status of the account after implementation of the final restructuring package. As mentioned in paragraph 20.2.3 in
Part B of this Master Circular, the special asset classification benefit as above will however be withdrawn for all
restructurings with effect from April 1, 2015 with the exception of provisions related to changes in Date of
Commencement of Commercial Operations (DCCO) in respect of infrastructure and non-infrastructure project loans.
Audit Procedure for Accounts falling under CDR Programme
4.99 Following audit procedures are to be carried out to assess / gain an understanding about the borrower
account.
(a) Review the present classification of the account under IRAC norms adopted by the bank and corresponding
provision made in the books of accounts, if any. If the account is already treated as NPA in the books of the
bank, the same cannot be upgraded only because of the CDR package.
(b) Review the Debtor- Creditor Agreement (DCA) and Inter Creditor Agreement (ICA) with respect to availability of
such agreements and necessary provisions in the agreement for reference to CDR cell in case of necessity,
penal clauses, stand-still clause, to abide by the various elements of CDR system etc., (DCA may be entered into
at the time of original sanction of loan or at the time of reference to CDR).
(c) Auditor has to ascertain the terms of rehabilitation along with the sacrifices, if any, assumed in the
rehabilitation program to verify whether such sacrifices have been accounted in the books of accounts of the
lender. Ascertain whether any additional financing / conversion of loan into equity have been envisaged in the
rehabilitation / restructuring program.
4.100 There are two Categories of CDR system namely Category 1 CDR system and Category 2 CDR system.
Category 1 CDR system covers borrower accounts classified as `Standard' and `Sub-Standard' assets whereas
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Category 2 CDR system covers advances classified as `Doubtful' asset. Corporates classified as willful defaulter,
indulging in fraud or misfeasance even in a single bank will not be considered for CDR scheme. Auditor needs to
ascertain whether the borrower account falls under Category 1 CDR system or Category 2 CDR system or classified
as willful defaulter, fraud etc.,
4.101 Auditor should also ascertain whether account has been referred to BIFR, as such cases are not eligible for
restructuring under CDR system. Large value BIFR cases may be eligible for restructuring under CDR if specifically
recommended by CDR core group. Auditor has to verify the necessary approvals / recommendations by CDR core
group if auditor comes across any BIFR cases.
4.102 Auditor has to examine whether the accounts wherein recovery suits have been filed, the initiative to resolve
under CDR system is taken by at least by 75% of the creditors by value and 60% in number provided the account
meets the basic criteria for becoming eligible under CDR mechanism.
Treatment of accounts restructured under CDR program: Classification and Provisioning
4.103 The criteria for classification of accounts will be on the basis of record of recovery as per the existing
prudential norms. The asset classification will be as per the lender bank's record of recovery and will be bank
specific.
4.104 The auditor should examine whether the lender has applied the usual asset classification norms pending
outcome of the account with the CDR Cell. The asset classification status should be restored to the position, which
existed at the time of reference to the cell if the restructuring under the CDR system takes place.
4.105 The auditor should also verify whether that in case a standard asset has been restructured second or more
time, it has been downgraded to "substandard" asset.
4.106 The auditor should also verify whether the proper disclosure in the Notes to Accounts in respect of CDR of
SME undertaken by the bank during the year, as prescribed in the RBI's circular, has been made.
4.107 Guidelines on Scheme for Sustainable Structuring of Stressed Assets (S4A)
Resolution of large borrowal accounts which are facing severe financial difficulties may, inter-alia, require co-
ordinated deep financial restructuring which often involves a substantial write-down of debt and/or making large
provisions.
In order to ensure that adequate deep financial restructuring is done to give projects a chance of sustained
revival, the Reserve Bank, after due consultation with banks, has decided to facilitate the resolution of large
accounts, which satisfy the conditions set out in the following paragraphs.
Eligible Accounts
For being eligible under the scheme, the account (In respect of Securitisation Companies/ Reconstruction
Companies (SCs/RCs), only those accounts are eligible which, in addition to meeting the listed criteria, have
been acquired against consideration in cash only, i.e. not by issuing any Security Receipts) should meet all the
following conditions:
(i) The project has commenced commercial operations;
(ii) The aggregate exposure (including accrued interest) of all institutional lenders in the account is more than
Rs.500 crore (including Rupee loans, Foreign Currency loans/External Commercial Borrowings);
(iii) The debt meets the test of sustainability as outlined in Debt Sustainability below.
Debt Sustainability
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A debt level will be deemed sustainable if the Joint Lenders Forum (JLF)/Consortium of lenders/bank conclude
through independent techno-economic viability (TEV) that debt of that principal value amongst the current
funded/non-funded liabilities owed to institutional lenders can be serviced over the same tenor as that of the
existing facilities even if the future cash flows remain at their current level. For this scheme to apply, sustainable
debt should not be less than 50 percent of current funded liabilities. This is referred to as Part A in
paragraph 2 of Sustainable Debt below.
Sustainable Debt
1. The resolution plan may involve one of the following options with regard to the post-resolution ownership of
the borrowing entity:
(a) The current promoter continues to hold majority of the shares or shares required to have control;
(b) The current promoter has been replaced with a new promoter, in one of the following ways:
(i) Through conversion of a part of the debt into equity under SDR mechanism which is thereafter
sold to a new promoter;
(ii) In the manner contemplated as per Prudential Norms on Change in Ownership of Borrowing
Entities (Outside SDR Scheme);
(c) The lenders have acquired majority shareholding in the entity through conversion of debt into equity
either under SDR or otherwise and
(i) allow the current management to continue or
(ii) hand over management to another agency/professionals under an operate and manage contract.
Note: Where malfeasance on the part of the promoter has been established, through a forensic audit
or otherwise, this scheme shall not be applicable if there is no change in promoter or the management
is vested in the delinquent promoter.
2. In any of the circumstances mentioned above, the JLF/consortium/bank shall, after an independent TEV,
bifurcate the current dues of the borrower into Part A and Part B as described below;
(a) Determine the level of debt (including new funding required to be sanctioned within next six
months and non-funded credit facilities crystallising within next 6 months) that can be serviced (both
interest and principal) within the respective residual maturities of existing debt, from all sources, based
on the cash flows available from the current as well as immediately prospective (not more than six
months) level of operations. For this purpose, free cash flows (i.e., cash flow from operations minus
committed capital expenditure) available for servicing debt as per latest audited/reviewed financial
statement will be considered. Where there is more than one debt facility, the maturity profile of each
facility shall be that which exists on the date of finalising this resolution plan. For the purpose of
determining the level of debt that can be serviced, the assessed free cash flow shall be allocated to
servicing each existing debt facility in the order in which its servicing falls due. The level of debt so
determined will be referred to as Part A in these guidelines.
(b) The difference between the aggregate current outstanding debt, from all sources, and Part A will be
referred to as Part B in these guidelines.
(c) The security position of lenders will, however, not be diluted and Part A portion of loan will continue to
have at least the same amount of security cover as was available prior to this resolution.
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The Resolution Plan
The Resolution Plan shall have the following features:
(a) There shall be no fresh moratorium granted on interest or principal repayment for servicing of Part A.
(b) There shall not be any extension of the repayment schedule or reduction in the interest rate for
servicing of Part A, as compared to repayment schedule and interest rate prior to this resolution.
(c) Part B shall be converted into equity/redeemable cumulative optionally convertible preference
shares. However, in cases where the resolution plan does not involve change in promoter, banks may,
at their discretion, also convert a portion of Part B into optionally convertible debentures. All such
instruments will continue to be referred to as Part B instruments in this circular for ease of reference.
Valuation and marking to market
For the purpose of this scheme, the fair value for Part B instruments will be arrived at as per the following
methodologies:
(a) Equity - The equity shares in the bank's portfolio should be marked to market preferably on a daily
basis, but at least on a weekly basis. Equity shares for which current quotations are not available or
where the shares are not listed on the stock exchanges, should be valued at the lowest value arrived
using the following valuation methodologies:
o Break-up value (without considering 'revaluation reserves', if any) which is to be ascertained
from the company's latest audited balance sheet (which should not be more than one year prior
to the date of valuation). In case the latest audited balance sheet is not available the shares are to
be valued at Re.1 per company. The independent TEV will assist in ascertaining the break-up
value.
o Discounted cash flow method where the discount factor is the actual interest rate charged to
the borrower plus 3 per cent, subject to floor of 14 per cent. Further, cash flows ( cash flow
available from the current as well as immediately prospective (not more than six months) level of
operations) occurring within 85 per cent of the useful economic life of the project only shall be
reckoned.
(b) Redeemable cumulative optionally convertible preference shares/ optionally convertible debentures -
The valuation should be on discounted cash flow (DCF) basis. These will be valued with a discount rate
of a minimum mark up of 1.5 per cent over the weighted average actual interest rate charged to the
borrower for the various facilities. Where preference dividends are in arrears, no credit should be taken
for accrued dividends and the value determined as above on DCF basis should be discounted further
by at least 15 per cent if arrears are for one year, 25 per cent if arrears are for two years, so on and so
forth (i.e., with 10 percent increments).
Where the resolution plan does not involve a change in promoter or where existing promoter is allowed to
operate and manage the company as minority owner by lenders, the principle of proportionate loss sharing
by the promoters should be met. In such cases, lenders shall, therefore, require the existing promoters to
dilute their shareholdings, by way of conversion of debt into equity /sale of some portion of promoter's equity
to lenders, at least in the same proportion as that of part B to total dues to lenders. JLF/Consortium/bank
should also obtain promoters' personal guarantee in all such cases, for at least the amount of Part A.
The upside for the lenders will be primarily through equity/quasi equity, if the borrowing entity turns around.
The terms for exercise of option for the conversion of preference shares/debentures to equity shall be
clearly spelt out. The existing promoter or the new promoter, as the case may be, may have the right of first
refusal in case the lenders decide to sell the share, at a price beyond some predetermined price. The
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lenders may also include appropriate covenants to cover the use of cash flows arising beyond the projected
levels having regard to quasi-equity instruments held in Part B.
Other important principles for this scheme are the following:
(a) The JLF/Consortium/bank shall engage the services of credible professional agencies to conduct the
TEV and prepare the resolution plan. While engaging professional agencies, the JLF/Consortium/bank
shall ensure that the agency is reputed, truly independent/free from any conflict of interest, has proven
expertise and will be in a position to safeguard the interest of lenders while preserving the economic
value of the assets.
(b) The resolution plan shall be agreed upon by a minimum of 75 percent of lenders by value and 50
percent of lenders by number in the JLF/ consortium/ bank.
(c) At individual bank level, the bifurcation into Part A and part B shall be in the proportion of Part A to Part
B at the aggregate level.
Overseeing Committee
a) An Overseeing Committee (OC), comprising of eminent persons, will be constituted by IBA in consultation
with RBI. The members of OC cannot be changed without the prior approval of RBI.
b) The resolution plan shall be submitted by the JLF/consortium/bank to the OC.
c) The OC will review the processes involved in preparation of resolution plan, etc. for reasonableness and
adherence to the provisions of these guidelines, and opine on it.
d) The OC will be an advisory body.
Asset Classification and Provisioning
(A) Where there is a change of promoter
In case a change of promoter takes place, i.e. a new promoter comes in, the asset classification and
provisioning requirement will be as per the `SDR' scheme or `outside SDR' scheme as applicable.
(B) Where there is no change of promoters
(i) In view of the need to provide reasonable time to the overseeing committee to review the processes
involved in the resolution plan, the Asset classification as on the date of lenders' decision to resolve the
account under these guidelines (reference date) will continue for a period of 180 days from this date.
This standstill clause is permitted to enable JLF/consortium/bank to formulate the resolution plan,
submit the same to the overseeing committee formed under the guidelines and implement it.
Banks should normally submit the resolution plan to the overseeing committee within 90 days from the
reference date. It is expected that the overseeing committee would review the processes involved in
preparation of resolution plan, etc. for reasonableness and adherence to the provisions of these
guidelines, and convey its final opinion on it within a period of 45 days. Subsequently, banks shall
implement the resolution plan within the next 45 days. However, banks will have flexibility on the above
time lines, within the overall period of 180 days. If the resolution plan is not implemented within this
period, the asset classification will be as per the extant asset classification norms, assuming there was
no such `stand-still'. It is clarified that `stand-still' clause only applies to asset classification and banks
shall not recognize income on accrual basis if the interest is not serviced within 90 days from the due
date;
(ii) In respect of an account that is `Standard' as on the reference date, the entire outstanding (both Part A
and part B) may be treated as 'Standard' subject to provisions made upfront by the lenders being
at least the higher of 40 percent of the amount held in part B or 20 percent of the aggregate
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outstanding (sum of Part A and part B). For this purpose, the provisions already held in the account can
be reckoned. These provisions may be reversed one year after the date of implementing the resolution
plan or one year after completion of the longest pre-existing moratorium, whichever is later, subject to
satisfactory performance of Part A and Part B during this period.
(iii) In respect of an account that is classified as a non-performing asset as on the reference date, the Part
B instruments shall continue to be classified as non- performing investment and provided for as a non-
performing asset as per extant prudential norms, as long as such instruments remain in Part B. The
sustainable portion (Part A) may optionally be treated as `Standard' upon implementation of the
resolution plan by all banks, subject to provisions made upfront by the lenders being at least the
higher of 50 percent of the amount held in part B or 25 percent of the aggregate outstanding (sum of
Part A and part B). For this purpose, the provisions already held in the account can be reckoned.
(iv) In all cases, lenders may upgrade Part B to standard category and reverse the associated enhanced
provisions after one year of satisfactory performance of Part A loans. In case of any pre-existing
moratorium in the account, this upgrade will be permitted one year after completion of the longest such
moratorium, subject to satisfactory performance of Part A debt during this period. However, in
all cases, the required MTM provisions on Part B instruments must be maintained at all times. The
transition benefit available in terms of paragraph 9(B)(vi) can however be availed.
Banks shall make disclosures in their annual financial statements on application of the Scheme for
Sustainable Structuring of Financial Assets, as per the format in the Appendix. These disclosures shall
be made with respect to the accounts under the observation period specified at (iv) above.
Disclosures on the Scheme for Sustainable Structuring of Stressed Assets (S4A), as on (INR Crore)
No. of accounts Aggregate Amount outstanding Provision
where S4A has been amount Held
applied outstanding
In Part A In Part B
Classified as XXXXX XXXXX XXXXX XXXXX
Standard
Classified as XXXXX XXXXX XXXXX XXXXX
NPA
(v) Any provisioning requirement on account of difference between the book value of Part B instruments
and their fair value as indicated in para 7.2 ibid, in excess of the minimum requirements prescribed as
per the above para (ii) and (iii), shall be made within four quarters commencing with the quarter in
which the resolution plan is actually implemented in the lender's books, such that the MTM provision
held is not less than 25 percent of the required provision in the first quarter, not less than 50 percent in
the second quarter and so on. For this purpose, the provision already held in the account can be
reckoned.
(vi) If the provisions held by the bank in respect of an account prior to this resolution are more than the
cumulative provisioning requirement prescribed in the applicable sub-paragraphs above, the excess
can be reversed only after one year from the date of implementation of resolution plan (i.e. when it is
reflected in the books of the lender, hereinafter referred to as `date of restructuring'), subject to
satisfactory performance during this period.
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(vii) The resolution plan and control rights should be structured in such a way so that the promoters are not
in a position to sell the company/firm without the prior approval of lenders and without sharing the
upside, if any, with the lenders towards loss in Part B.
(viii) If Part A subsequently slips into NPA category, the account will be classified with slippage in category
with reference to the classification obtaining on the reference date and necessary provisions should be
made immediately.
(ix) Where a bank/NBFC/AIFI chooses to make the prescribed provisions/write downs over more than
one quarter and this results in the full provisioning/write down remaining to be made as on the close of
a financial year, banks/NBFCs/AIFIs should debit 'other reserves' [i.e., reserves other than the one
created in terms of Section 17(2) of the Banking Regulation Act 1949] by the amount remaining un-
provided/not written down at the end of the financial year, by credit to specific provisions. However,
bank/NBFC/AIFI should proportionately reverse the debits to `other reserves' and complete the
provisioning/write down by debiting profit and loss account, in the subsequent quarters of the next
financial year. Banks shall make suitable disclosures in Notes to Accounts with regard to the quantum
of provision made during the year under this scheme and the quantum of unamortised provisions
debited to `other reserves' as at the end of the year.
Mandatory Implementation
Once the resolution plan prepared/presented by the lenders is ratified by the OC, it will be binding on all lenders.
They will, however, have the option to exit as per the extant guidelines on Joint Lenders' Forum (JLF) and
Corrective Action Plan (CAP).
Timelines for Stressed Assets Resolution
4.108 RBI Circular DBR.BP.BC.No.67/21.04.048/2016-17 dated May 05, 2017 describes the timelines for
stressed assets resolution.
"Framework for Revitalising Distressed Assets in the Economy Guidelines on Joint Lenders' Forum (JLF) and
Corrective Action Plan (CAP)" aims at early identification of stressed assets and timely implementation of a
corrective action plan (CAP) to preserve the economic value of stressed assets. In order to ensure that the CAP
is finalised and formulated in an expeditious manner, the Framework specifies various timelines within which
lenders have to decide and implement the CAP. The Framework also contains disincentives, in the form of
asset classification and accelerated provisioning where lenders fail to adhere to the provisions of the
Framework. Despite this, delays have been observed in finalising and implementation of the CAP, leading to
delays in resolution of stressed assets in the banking system
CAP can also include resolution by way of Flexible Structuring of Project Loans, Change in Ownership under
Strategic Debt Restructuring, Scheme for Sustainable Structuring of Stressed Assets (S4A), etc.
Lenders must scrupulously adhere to the timelines prescribed in the Framework for finalising and implementing
the CAP. To facilitate timely decision making, it has been decided that, henceforth, the decisions agreed upon
by a minimum of 60 percent of creditors by value and 50 percent of creditors by number in the JLF would be
considered as the basis for deciding the CAP, and will be binding on all lenders, subject to the exit (by
substitution) option available in the Framework. Lenders shall ensure that their representatives in the JLF are
equipped with appropriate mandates, and that decisions taken at the JLF are implemented by the lenders within
the timelines.
It shall be noted that
(i) the stand of the participating banks while voting on the final proposal before the JLF shall be unambiguous
and unconditional;
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(ii) any bank which does not support the majority decision on the CAP may exit subject to substitution within
the stipulated time line, failing which it shall abide the decision of the JLF;
(iii) the bank shall implement the JLF decision without any additional conditionalities; and
(iv) the Boards shall empower their executives to implement the JLF decision without requiring further
approval from the Board.
Accelerated Provision Norms
4.109 In cases where banks fail to report SMA status of the accounts to CRILC or resort to methods with the intent
to conceal the actual status of the accounts or evergreen the account, banks will be subjected to accelerated
provisioning for these accounts and/or other supervisory actions as deemed appropriate by RBI. The current
provisioning requirement and the revised accelerated provisioning in respect of such non performing accounts are
provided in para 31.1 of Master Circular no. RBI/2015-16/101 DBR.No.BP.BC.2/ 21.04.048/ 2015-16 dated July 1,
2015.
4.110 Further, any of the lenders who have agreed to the restructuring decision under the CAP by JLF and is a
signatory to the ICA and DCA, but changes their stance later on, or delays/refuses to implement the package, will
also be subjected to accelerated provisioning requirement as indicated at para 31.1 of the aforementioned Master
Circular, on their exposure to this borrower i.e., if it is classified as an NPA. If the account is standard in those
lenders' books, the provisioning requirement would be 5%.
4.111 Presently, asset classification is based on record of recovery at individual banks and provisioning is based
on asset classification status at the level of each bank. However, if lead bank or the bank with second largest AE as
per Reserve bank of India circular no. DBOD.BP.BC.No.45/21.04.132/2014-15 dated October 21, 2014 fail to
convene the JLF or fail to agree upon a common CAP within the stipulated time frame, the account will be subjected
to accelerated provisioning as indicated at para 31.1 of the aforementioned Master Circular , if it is classified as an
NPA. If the account is standard in those lenders' books, the provisioning requirement would be 5%.
4.112 If an escrow maintaining bank under JLF/CDR mechanism does not appropriate proceeds of repayment by
the borrower among the lenders as per agreed terms resulting into down gradation of asset classification of the
account in books of other lenders, the account with the escrow maintaining bank will attract the asset classification
which is lowest among the lending member banks but will also be subjected to corresponding accelerated provision
instead of normal provision. Further, such accelerated provision will be applicable for a period of one year from the
effective date of provisioning or till rectification of the error, whichever is later.
Duration of application of extant penal provisions (5% in case of Standard account and accelerated
provision in case of NPAs)
4.113 Penal provisions are applicable under certain cases vide circular DBOD.BP.BC.No.97/21.04.132/ 2013-14
dated February 26, 2014. While the duration of such penal provision has been specified in case of an escrow account
maintaining bank which does not appropriate proceeds of repayment by the borrower among the lenders as per
agreed terms resulting into down gradation of asset classification of the account in books of other lenders, the
duration has not been prescribed in other cases. Banks are advised that the penal provisions in the other cases
under the Framework will be applicable for the following durations:
Sl. No. Reason for Penal Provision Duration
(i) Banks fail to report SMA status of the accounts to From the date of imposition of penal provision
CRILC or resort to methods with the intent to conceal as advised by RBI Inspection/Statutory Auditor
the actual status of the accounts or evergreen the till one year or rectification of defect, whichever
account. is later.
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(ii) Lenders who have agreed to the restructuring
decision under the CAP by JLF and are signatories to
the ICA and DCA, but change their stance later on, or
delay/refuse to implement the package.
(iii) Lenders fail to convene the JLF or fail to agree upon a
common CAP within the stipulated time frame.
(iv) Accelerated provision for existing loans/exposures of From the date of notification as wilful defaulter
banks to companies having director/s (other than in the list of wilful defaulters till the removal of
nominee directors of government/financial institutions the name from the list.
brought on board at the time of distress), whose
name/s appear more than once in the list of wilful
defaulters.
Disagreement on restructuring as CAP and Exit Option
4.114 In terms of para 10.3 of circular DBOD.BP.BC.No.45 / 21.04.132 / 2014-15 dated October 21, 2014 banks,
irrespective of whether they are within or outside the minimum 75 per cent and 60 per cent, can exercise the exit
option for providing additional finance only by way of arranging their share of additional finance to be provided by a
new or existing creditor.
4.115 It has been brought to notice that sometimes disagreement arises among lenders on deciding the CAP on
rectification or restructuring, resulting in delay in initiating timely corrective action. Although co-operation among
lenders for deciding a CAP by consensus is desirable for timely turn-around of a viable account, it is also important to
enable all lenders to have an independent view on the viability of account and consequent participation in rectification
or restructuring of accounts, without allowing them to free ride on efforts made by others. In view of this, it has been
decided that dissenting lenders who do not want to participate in the rectification or restructuring of the account as
CAP, which may or may not involve additional financing, will have an option to exit their exposure completely by
selling their exposure to a new or existing lender(s) within the prescribed timeline for implementation of the agreed
CAP. The exiting lender will not have the option to continue with their existing exposure and simultaneously not
agreeing for rectification or restructuring as CAP. The new lender to whom the exiting lender sells its stake may not
be required to commit any additional finance, if the agreed CAP involves additional finance. In such cases, if the new
lender chooses to not to participate in additional finance, the share of additional finance pertaining to the exiting
lender will be met by the existing lenders on a pro-rata basis.
Wilful Defaulter and Non-Cooperative Borrower
4.116 The provisioning in respect of existing loans/exposures of banks to companies having director/s (other than
nominee directors of government/financial institutions brought on board at the time of distress), whose name/s
appear more than once in the list of wilful defaulters, will be 5% in cases of standard accounts; if such account is
classified as NPA, it will attract accelerated provisioning as indicated at para 31.1 of Master Circular on Prudential
Norms. This is a prudential measure since the expected losses on exposures to such borrowers are likely to be
higher. It is reiterated that no additional facilities should be granted by any bank/FI to the listed wilful defaulters, in
terms of paragraph 2.5 (a) of Master Circular on Wilful Defaulters dated July 1, 2015.
4.117 With a view to discouraging borrowers/defaulters from being unreasonable and non-cooperative with
lenders in their bona fide resolution/recovery efforts, banks may classify such borrowers as non-cooperative
borrowers, after giving them due notice if satisfactory clarifications are not furnished. Banks will be required to report
classification of such borrowers to CRILC. Further, banks will be required to make higher/accelerated provisioning in
respect of new loans/exposures to such borrowers as also new loans/exposures to any other company promoted by
such promoters/ directors or to a company on whose board any of the promoter / directors of this non-cooperative
borrower is a director. The provisioning applicable in such cases will be at the rate of 5% if it is a standard account
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
and accelerated provisioning as per para 31.1 of Master Circular on Prudential Norms, if it is an NPA. Reporting of
non-cooperative borrower has to be read along with Reserve Bank of India circular no.
DBR.No.CID.BC.54/20.16.064/2014-15.
Upgradation of Loan Accounts Classified as NPAs
4.118 (i) If arrears of interest and principal are paid by the borrower in the case of loan accounts classified as
NPAs, the account should no longer be treated as non-performing and may be classified as `standard'
accounts. Upgradation is allowed only if the account reaches "no overdues" status. This should not be
misunderstood with "overdues brought within 90 days". Upgradation of a restructured/ rescheduled/CDR
accounts is governed by the restructuring / reschedulement/CDR norms as discussed later in the Chapter.
(ii) Auditor has to verify that any upgrading of accounts classified as `Sub-Standard' or `Doubtful' category wherein
restructuring / re phasement of principal or interest has taken place should be upgraded to the `Standard Asset'
category only after a period of one year after the date when first payment of interest or of principal, whichever is
earlier, falls due under the rescheduled terms, subject to satisfactory performance during the period. The total
amount becoming due during this period of one year should be recovered and there should be no overdues to
make it eligible for upgradation. If the amount which has become due during this one year period is on a lower
side vis a vis total amount outstanding, the other aspects of the account, viz financial performance, availability
of security, operations in account, etc., should be reviewed in detail and only if found satisfactory, the account
should be upgraded.
(iii) Recovery in an advance which was rescheduled cannot give the advance a better classification than the
previous one. NPA accounts can be upgraded to Performing Accounts, provided all overdue are adjusted or
atleast reduced to a period of less than 90 days.
(iv) Upgradation within the NPA category is not permitted i.e. a Doubtful account cannot be made Sub-standard
even if the overdue are reduced to less than 12 months.
Provisioning for Loans and Advances
4.119 The RBI's Master Circular of July 1, 2015 on Income Recognition, Asset Classification and Provisioning
Pertaining to Advances contains the principles to be followed by the bank in calculating the provisions required for
the NPAs in conformity with the prudential norms. The circular also requires the bank to take into consideration
aspects such as time lag between an account becoming an NPA, its recognition as such, realisation of security
and the erosion over time in the value of security charged to the bank, while calculating the required amount of
provision. The specific requirements of the Master Circular in respect of provisioning are as follows:
(a) Loss assets
4.120 The entire amount should be written off. If the assets are permitted to remain in the books for any reason,
100 percent of the outstanding should be provided for.
(b) Doubtful assets
4.121 The provisioning for doubtful assets under loans and advances is as under:
(i) Full provision to the extent of the unsecured portion should be made. In doing so, the realisable value of the
security available, to which the bank has a valid recourse, should be determined on a realistic basis. Auditor
should verify whether that the security is considered based on the latest information available with the bank.
DICGC/ECGC cover is also taken into account (this aspect is discussed in detail later in this Chapter).
(ii) In regard to the secured portion, provision may be made on the following basis, at the rates ranging from
25% to 100% of secured portion depending upon the period for which the asset has remained doubtful. In
case the advance covered by CGTSI guarantee becomes non-performing, no provision need be made
towards the guaranteed portion. The amount outstanding in excess of the guaranteed portion should be
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Asset Classification, Income Recognition and Provisioning
provided for as per the extant guidelines on provisioning for non-performing advances.
Period for which the advance has been considered as doubtful % of provision on secured portion
Upto 1 year 25
More than 1 year and upto 3 years 40
More than three years 100
Valuation of Security: With a view to bringing down divergence arising out of difference in assessment of the
value of security, in cases of NPAs with balance of Rs. 5 crore and above, stock audit at annual intervals by
external agencies appointed as per the guidelines approved by the Board is mandatory in order to enhance the
reliability on stock valuation. Collaterals, such as immovable properties charged in favour of the bank are required
to be got valued once in three years by valuers appointed as per the guidelines approved by the Board of
Directors.
(c) Sub-standard assets
4.122 A general provision of 15% on total outstanding should be made without making any allowance for
DICGC/ECGC cover and securities available. Unsecured exposures, which are identified, as sub-standard would
attract an additional provision of 10%. (i.e., total 25% of total outstanding). However, in view of certain safeguards
such as escrow accounts available in respect of infrastructure lending, infrastructure loan accounts which are
classified as sub-standard will attract a provisioning of 20 per cent instead of the aforesaid prescription of 25 per
cent. To avail of this benefit of lower provisioning, the banks should have in place an appropriate mechanism to
escrow the cash flows and also have a clear and legal first claim on these cash flows. Unsecured exposure' is
defined as an exposure (including all funded and non-funded exposures) where realisable value of the tangible
security properly charged to the bank, as assessed by bank/approved valuers/RBI inspectors, is not more than
10%, ab initio, of the outstanding exposure. `Security' means tangible security properly discharged to the bank and
will not include intangible securities like guarantees (including State government guarantees), comfort letters, etc.
4.123 In order to enhance transparency and ensure correct reflection of the unsecured advances in Schedule 9
of the banks' balance sheet, the following RBI requirements are applicable from the financial year 2009-10
onwards:
a) For determining the amount of unsecured advances for reflecting in schedule 9 of the published balance
sheet, the rights, licenses, authorisations, etc., charged to the banks as collateral in respect of projects
(including infrastructure projects) financed by them, should not be reckoned as tangible security. Hence such
advances shall be reckoned as unsecured.
b) However, banks may treat annuities under build-operate-transfer (BOT) model in respect of road / highway
projects and toll collection rights, where there are provisions to compensate the project sponsor if a certain
level of traffic is not achieved, as tangible securities subject to the condition that banks' right to receive
annuities and toll collection rights is legally enforceable and irrevocable.
c) It is noticed that most of the infrastructure projects, especially road/highway projects are user-charge based,
for which the Planning Commission has published Model Concession Agreements (MCAs). These have been
adopted by various Ministries and State Governments for their respective public-private partnership (PPP)
projects and they provide adequate comfort to the lenders regarding security of their debt. In view of the
above features, in case of PPP projects, the debts due to the lenders may be considered as secured to the
extent assured by the project authority in terms of the Concession Agreement, subject to the following
conditions
i) User charges / toll / tariff payments are kept in an escrow account where senior lenders have priority
over withdrawals by the concessionaire;
ii) There is sufficient risk mitigation, such as pre-determined increase in user charges or increase in
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concession period, in case project revenues are lower than anticipated;
iii) The lenders have a right of substitution in case of concessionaire default;
iv) The lenders have a right to trigger termination in case of default in debt service; and
v) Upon termination, the Project Authority has an obligation of (i) compulsory buy-out and (ii) repayment of
debt due in a pre-determined manner.
In all such cases, banks must satisfy themselves about the legal enforceability of the provisions of the
tripartite agreement and factor in their past experience with such contracts.
d) Banks should also disclose the total amount of advances for which intangible securities such as charge over
the rights, licenses, authority, etc., has been taken as also the estimated value of such intangible collateral.
The disclosure may be made under a separate head in "Notes to Accounts". This would differentiate such
loans from other entirely unsecured loans.
4.124 As per the existing instructions of RBI, in the Balance Sheet of the banks, the amounts comprising
Debtors (though not tangible assets), charged as security are grouped as secured by tangible assets and
disclosure is made with a remark in parenthesis in the Schedule 9, without any quantification of the advances
covered by security of Debtors. The amounts comprising the intangibles as per the RBI's Master Circular on
Income recognition and Asset Classification Norms will need to be culled out of the secured exposures and
quantified to be reflected as unsecured advances; which would also require corresponding reclassification of
advances for the earlier year. More importantly, in case of NPAs, the unsecured portion would attract a higher
provision, when segregated from the secured portion.
(d) Standard Assets
4.125 The bank is required to make a general provision for standard assets at the following rates for the funded
outstanding on global loan portfolio basis. The general provision towards standard assets as per Master Circular is
as follows:
a) Farm Credit to Agricultural and Small and Micro Enterprises (SMEs) sectors - 0.25%.
b) Advances to Commercial Real Estate (CRE) sector 1.00%.
c) Advances to Commercial Real Estate Residential Housing Sector (CRE - RH) at 0.75 per cent.
For this purpose, CRE-RH would consist of loans to builders/developers for residential housing projects
(except for captive consumption) under CRE segment. Such projects should ordinarily not include non-
residential commercial real estate. However, integrated housing projects comprising of some commercial
space (e.g. shopping complex, school, etc.) can also be classified under CRE-RH, provided that the
commercial area in the residential housing project does not exceed 10% of the total Floor Space Index (FSI)
of the project. In case the FSI of the commercial area in the predominantly residential housing complex
exceeds the ceiling of 10%, the project loans should be classified as CRE and not CRE-RH.
d) Housing loans extended at teaser rates 2.00%- The provisioning on these assets would revert to 0.40 per
cent after 1 year from the date on which the rates are reset at higher rates if the accounts remain `standard'.
e) Restructured accounts classified as standard advances will attract a higher provision (as prescribed from time
to time) in the first two years from the date of restructuring. In cases of moratorium on payment of
interest/principal after restructuring, such advances will attract the prescribed higher provision for the period
covering moratorium and two years thereafter.
Restructured accounts classified as non-performing advances, when upgraded to standard category will attract
a higher provision (as prescribed from time to time) in the first year from the date of upgradation.
As per para 17.4.1 of IRAC Norms, with effect from April 1, 2016 provision on new restructured standard accounts
would be made at 5 per cent. The phased manner plan for increase in the provision to 5 per cent was in existence
till March 31, 2016.
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Asset Classification, Income Recognition and Provisioning
All other loans and advances not included in (a), (b), (c), (d) and (e) above -0.40%.
4.126 It is clarified that the Medium Enterprises will attract 0.40% standard asset provisioning. The definition of the
terms Micro Enterprises, Small Enterprises, and Medium Enterprises shall be in terms of Master Circular on Lending
to Micro, Small & Medium Enterprises (MSME) Sector.
4.127 While the provisions on individual portfolios are required to be calculated at the rates applicable to them,
the excess or shortfall in the provisioning, vis-a-vis the position as on any previous date, should be determined on
an aggregate basis. If the provisions required to be held on an aggregate basis are less than the provisions held
as on November 15, 2008, the provisions rendered surplus should not be reversed to P&L account but should
continue to be maintained at the level, existed as on November 15, 2008. In case of shortfall determined on
aggregate basis, the balance should be provided for by debit to P&L account.
4.128 The provisions on standard assets should not be reckoned for arriving at net NPAs. The provisions
towards Standard Assets need not be netted from gross advances but included as 'Contingent Provisions against
Standard Assets' under 'Other Liabilities and Provisions - Others' in Schedule 5 of the balance sheet.
4.129 Banks shall make additional provision of 2% (in addition to country risk provision that is applicable to all
overseas exposures) against standard assets representing all exposures to the step-down subsidiaries of Indian
companies, to cover the additional risk arising from complexity in the structure, location of different intermediary
entities in different jurisdictions exposing the Indian company, and hence the bank, to greater political and
regulatory risk. All the step-down subsidiaries, including the intermediate ones, must be wholly owned subsidiary
of the immediate parent company or its entire shares shall be jointly held by the immediate parent company and
the Indian parent company and / or its wholly owned subsidiary. The immediate parent should, wholly or jointly
with Indian parent company and / or its wholly owned subsidiary, have control over the step-down subsidiary.
4.130 A high level of unhedged foreign currency exposures of the entities can increase the probability of default
in times of high currency volatility. Hence, banks are required to estimate the riskiness of unhedged position of
their borrowers as per the instructions contained in RBI circular DBOD.No.BP.BC.85/21.06.200/2013-14 dated
January 15, 2014 and circular DBOD.No.BP.BC.116/21.06.200/2013-14 dated June 3, 2014 and make
incremental provisions on their exposures to such entities:
Likely Loss / EBID (%) Incremental Provisioning Requirement on the total
credit exposures over and above extant standard
asset provisioning
Upto15 per cent 0
More than 15 per cent and upto 30 per cent 20bps
More than 30 per cent and upto 50 per cent 40bps
More than 50 per cent and upto 75 per cent 60bps
More than 75 per cent 80 bps
Provisioning requirements for derivative exposures
4.131 Credit exposures computed as per the current marked to market value of the contract, arising on account
of the interest rate & foreign exchange derivative transactions, and gold, shall also attract provisioning
requirement as applicable to the loan assets in the 'standard' category, of the concerned counterparties. All
conditions applicable for treatment of the provisions for standard assets would also apply to the aforesaid
provisions for derivative and gold exposures.
Provisioning Norms for Leased Assets
4.132
i) Substandard assets
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a) 15 percent of the sum of the net investment in the lease and the unrealised portion of finance income
net of finance charge component. The terms `net investment in the lease', `finance income' and `finance
charge' are as defined in `AS 19 Leases' issued by the ICAI.
b) Unsecured lease exposures which are identified as `substandard' would attract additional provision of
10 per cent, i.e., a total of 25 per cent.
ii) Doubtful and
iii) Loss assets
This is same as for Loan Assets.
Provisioning Coverage Ratio
4.133
i. Provisioning Coverage Ratio (PCR) is essentially the ratio of provisioning to gross non-performing assets and
indicates the extent of funds a bank has kept aside to cover loan losses.
ii. From a macro-prudential perspective, RBI had required that the banks should build up provisioning and capital
buffers in good times i.e. when the profits are good, which can be used for absorbing losses in a downturn. This
was aimed at enhancing the soundness of individual banks, as also the stability of the financial sector. It was,
therefore, decided that banks should augment their provisioning cushions consisting of specific provisions
against NPAs as well as floating provisions, and ensure that their total provisioning coverage ratio, including
floating provisions, is not less than 70 per cent. Accordingly, banks were advised to achieve this norm not later
than end-September 2010.
RBI has further advised the banks that:
a. the PCR of 70 percent may be with reference to the gross NPA position in banks as on September 30,
2010;
b. the surplus of the provision under PCR vis-a-vis as required as per prudential norms should be
segregated into an account styled as "countercyclical provisioning buffer", computation of which may be
undertaken as per the format given in Annex 3 to the RBI's Master Circular on "Prudential Norms on
Income Recognition, Asset Classification and Provisioning pertaining to Advances" dated July 1, 2015;
and
c. this buffer will be allowed to be used by banks for making specific provisions for NPAs during periods of
system wide downturn, with the prior approval of RBI. As a countercyclical measure, vide RBI circular
No. DBOD.No.BP. 95/21.04.048/2013-14 on "Utilisation of Floating Provisions/Counter Cyclical
Provisioning Buffer" dated February 7, 2014 banks were permitted to utilise upto 33 per cent of
countercyclical provisioning buffer / floating provisions held by them as on March 31, 2013, for making
specific provisions for non-performing assets, as per the policy approved by their Board of Directors
d. banks are required to build up `Dynamic Provisioning Account' during good times and utilize the same
during downturn. Under the proposed framework, banks are expected to either compute parameters
such as probability of default, loss given default, etc. for different asset classes to arrive at long term
average annual expected loss or use the standardized parameters prescribed by RBI towards
computation of Dynamic Provisioning requirement. Dynamic loan loss provisioning framework is
expected to be in place with improvement in the system. Meanwhile, banks should develop necessary
capabilities to compute their long term average annual expected loss for different asset classes, for
switching over to the dynamic provisioning framework.
iii. The PCR of the bank should be disclosed in the Notes to Accounts to the Balance Sheet.
Accounting and Provisioning Norms for Equipment Leasing Activity
4.134 While the accounting and provisioning norms discussed above shall also apply in respect of equipment
leasing activities the bank should follow the AS 19 on "Leases" issued by Institute of Chartered Accountant of
India (ICAI) in accounting for lease transactions.
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Provisioning for Certain Specific Types of Advances
4.135 The guidelines also deal with provisioning for certain specific types of advances as follows.
Advances Guaranteed by ECGC
4.136 In the case of advances guaranteed by ECGC, provision should be made only for the balance in excess
of the amount of such guarantee. Further, while arriving at the provision required to be made for doubtful assets,
realisable value of the securities should first be deducted from the outstanding balance in respect of the amount
guaranteed by these Corporations and then provision should be made. (For examples on calculation of the
provision, refer the Master Circular on Income Recognition, Asset Classification and Provisioning Pertaining to
Advances, dated July 1, 2015)
Advance covered by guarantees of Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE)
or Credit Risk Guarantee Fund Trust for Low Income Housing ( CRGFTLIH)
4.137 In case the advance covered by CGTMSE or CRGFTLIH guarantee becomes non-performing, no
provision need be made towards the guaranteed portion. The amount outstanding in excess of the guaranteed
portion should be provided for as per the extant guidelines on provisioning for non- performing advances.(For
illustrative examples of provisioning in case of advances covered by CGTSI guarantee, refer the paragraph 5.9.5
of the Master Circular No. on Prudential Norms on Income Recognition, Asset Classification and Provisioning
Pertaining to Advances, dated July 1, 2015.)
After statutory audit, RBI conducts annual financial inspection of banks. Auditors may go through the divergence
reported by RBI, if any, in terms of classification as well as provisioning and whether the same divergence has been
appropriately addressed /clarified, by Banks. Accordingly auditor would be well advised to consider these aspects
while take final view on classification /provisioning of such accounts.
Treatment of interest suspense account
4.138 Amounts held in Interest Suspense Account should not be reckoned as part of provisions. Amounts lying in
the Interest Suspense Account should be deducted from the relative advances and thereafter, provisioning as per the
norms, should be made on the balances after such deduction.
Disclosures
4.139 The information with respect to NPAs required to be disclosed under "Notes to Accounts" in the financial
statements of banks is discussed in the chapter "Disclosure Requirement in Financial Statements".
Provisioning Norms
Normal provisions
4.140 Banks will hold provision against these advances as per the existing provisioning norms.
Income Recognition
4.141 The banks may recognise income on accrual basis in respect of the three categories of projects under
implementation which are classified as 'standard'. RBI, however, prohibits banks from recognising income on accrual
basis in respect of the above three categories of projects under implementation which are classified as a
`substandard' asset. Banks may recognise income in such accounts only on realisation on cash basis.
Reserve for Exchange Rate Fluctuations Account (RERFA)
4.142 When exchange rate movements of Indian rupee turn adverse, the outstanding amount of foreign
currency denominated loans (where actual disbursement was made in Indian Rupee) which become overdue goes
up correspondingly, with its attendant implications of provisioning requirements. Such assets should not normally
be revalued. In case such assets need to be revalued as per requirement of accounting practices or for any other
requirement, the following procedure may be adopted:
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The loss on revaluation of assets has to be booked in the bank's Profit & Loss Account.
Besides the provisioning requirement as per Asset Classification, banks should treat the full amount of the
Revaluation Gain relating to the corresponding assets, if any, on account of Foreign Exchange Fluctuation as
provision against the particular assets.
Provisioning For Country Risk
4.143 Banks are required to make provisions, with effect from the year ending 31 March 2003, on the net
funded country exposures on a graded scale ranging from 0.25 to 100 percent according to the risk categories
mentioned below. To begin with, banks are required to make provisions as per the following schedule:
Risk Category ECGC Classification Provisioning requirement
(per cent)
Insignificant A1 0.25
Low A2 0.25
Moderate B1 5
High B2 20
Very high C1 25
Restricted C2 100
Off-credit D 100
4.144 Banks are required to make provision for country risk in respect of a country where its net funded exposure
is one per cent or more of its total assets. The provision for country risk shall be in addition to the provisions required
to be held according to the asset classification status of the asset. In the case of `loss assets' and `doubtful assets',
provision held, including provision held for country risk, may not exceed 100% of the outstanding. Banks may not
make any provision for `home country' exposures i.e. exposure to India. The exposures of foreign branches of Indian
banks to the host country should be included. Foreign banks shall compute the country exposures of their Indian
branches and shall hold appropriate provisions in their Indian books. However, their exposures to India will be
excluded. Banks may make a lower level of provisioning (say 25% of the requirement) in respect of short-term
exposures (i.e., exposures with contractual maturity of less than 180 days).
4.145 Provisioning norms for sale of financial assets to Securitisation Company (SC) / Reconstruction company
(RC)
(i) When a bank / FI sells its financial assets to SC/ RC, on transfer the same will be removed from its books.
(ii) If the sale of financial assets to SC/RC, is at a price below the net book value (NBV) (i.e., book value less
provisions held), the shortfall should be debited to the profit and loss account of that year. Banks can also
use countercyclical / floating provisions for meeting any shortfall on sale of NPAs i.e., when the sale is at a
price below the net book value (NBV).
However, for assets sold on or after February 26, 2014 and upto March 31, 2015, as an incentive for early
sale of NPAs, banks can spread over any shortfall, if the sale value is lower than the NBV, over a period of
two years. This facility of spreading over the shortfall will be subject to necessary disclosures in the Notes to
Account in Annual Financial Statements of the banks. The RBI vide Notification dated May 21, 2015 had
decided to extend this dispensation for assets sold on or after March 31, 2015 and up to March 31, 2016
Further RBI has vide notification DBR.No.BP.BC.102/21.04.048/2015-16 dated June 13, 2016 has decided to
extend the dispensation of amortising the shortfall up to March 31, 2017. However for the assets sold from
the period April 1, 2016 to March 31, 2017, banks will be allowed to amortise the shortfall over a period of
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only four quarter from the quarter in which the sale took place.
Further, where a bank chooses to make the necessary provisions over more than one quarter and this results in
the full provisioning remaining to be made as on the close of a financial year, banks should debit 'other
reserves' [i.e., reserves other than the one created in terms of Section 17(2) of the Banking Regulation Act
1949] by the amount remaining un-provided at the end of the financial year, by credit to specific provisions.
However, banks should proportionately reverse the debits to `other reserves' and complete the provisioning by
debiting profit and loss account, in the subsequent quarters of the next financial year.
Banks shall make suitable disclosures in Notes to Accounts with regard to the quantum of provision made
during the year to meet the shortfall in sale of NPAs to SCs/RCs and the quantum of unamortised provision
debited to `other reserves' as at the end of the year.
(iii) For assets sold on or after February 26, 2014, banks can reverse the excess provision on sale of NPAs, if
the sale value is for a value higher than the NBV, to its profit and loss account in the year the amounts are
received. However, banks can reverse excess provision arising out of sale of NPAs only when the cash
received (by way of initial consideration and / or redemption of SRs / PTCs) is higher than the net book value
(NBV) of the asset. Further, reversal of excess provision will be limited to the extent to which cash received
exceeds the NBV of the asset. With regard to assets sold before February 26, 2014, excess provision, on
account of sale value being higher than NBV, should not be reversed but should be utilized to meet the
shortfall/ loss on account of sale of other financial assets to SC/RC.
(iv) When banks/ FIs invest in the security receipts/ pass-through certificates issued by SC/RC in respect of the
financial assets sold by them to the SC/RC, the sale shall be recognised in books of the banks / FIs at the
lower of:
the redemption value of the security receipts/ pass-through certificates, and
the NBV of the financial asset.
The above investment should be carried in the books of the bank / FI at the price as determined above until its
sale or realization, and on such sale or realization, the loss or gain must be dealt with in the same manner as
at (ii) and (iii) above.
4.146 All instruments received by banks/FIs from SC/RC as sale consideration for financial assets sold to them
and also other instruments issued by SC/ RC in which banks/ FIs invest will be in the nature of non SLR securities.
Accordingly, the valuation, classification and other norms applicable to investment in non-SLR instruments
prescribed by RBI from time to time would be applicable to bank's/ FI's investment in debentures/ bonds/ security
receipts/PTCs issued by SC/ RC. However, if any of the above instruments issued by SC/RC is limited to the
actual realisation of the financial assets assigned to the instruments in the concerned scheme the bank/ FI shall
reckon the Net Asset Value (NAV), obtained from SC/RC from time to time, for valuation of such investments.
4.147 Banks'/ FIs' investments in debentures/ bonds/ security receipts/PTCs issued by a SC/RC will constitute
exposure on the SC/RC. As only a few SC/RC are being set up now, banks'/ FIs' exposure on SC/RC through
their investments in debentures/ bonds/security receipts/PTCs issued by the SC/ RC may go beyond their
prudential exposure ceiling. In view of the extra ordinary nature of event, banks/ FIs will be allowed, in the initial
years, to exceed prudential exposure ceiling on a case-to-case basis.
4.148 Banks/ FIs, which sell their financial assets to an SC/ RC, shall be required to make the disclosures in the
Notes on Accounts to their Balance sheets. For guidelines on the presentation of the disclosures, refer para 6.6 of
the master circular BR.No.BP.BC.2/21.04.048/2015-16 - Prudential norms on Income Recognition, Asset
Classification and Provisioning pertaining to Advances.
4.149 Prudential Guidelines on provisioning in case of Revitalising Stressed Assets in the Economy.
Pursuant to the RBI notification DBR.BP.BC.No.82/ 21.04.132 / 2015-16 dated February 25, 2016 on Review of
Prudential Guidelines- Revitalising Stressed Assets in the Economy, the classification of the advances and
provisioning thereon will be as follows:
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Category A-
In case the lender agreed to Corrective Action Plan (CAP) in the Joint Leander Forum (JLF) meeting and also
conveyed final approval to the CAP within the stipulated period.
Asset classification- As per the extant asset classification norms
Provisioning- As per the extant provisioning norms.
Category-B
In case the lender agreed to CAP as approved in the JLF meeting but conveyed final approval and signed off the
detailed final CAP after the stipulated period but within the prescribed implementation period.
Asset classification: Lowest asset classification of the borrower among all the JLF lenders.
Provisioning- A penal provisioning of 10 per cent in addition to provisioning applicable as per Lowest asset
classification of the borrower with any JLF lender, for one year from the date of sign off of CAP.
Category-C
In case the lender agreed to CAP, as approved, in the JLF meeting but failed to convey final approval and sign off
the detailed final CAP within prescribed implementation period.
Asset classification: Lowest asset classification of the borrower among all the JLF lenders.
Provisioning: A penal provisioning of 15 per cent in addition to provisioning applicable as per Lowest asset
classification of the borrower with any JLF lender, for one year from the date of sign off of CAP.
As the prescribed implementation period is over, the lender has to compulsorily abide by the terms of the
approved CAP.
4.150 RBI vide their circular dated 1 September 2016 has issued guidelines on Sale of Stressed Assets by
Banks. In terms of these guidelines, the Board of the bank need to lay down detailed policies and guidelines on
sale of stressed assets to SC/ RC which should, inter alia, cover the following aspects:
i. Financial assets to be sold.
ii. Norms and procedure for sale for such financial assets.
iii. Valuation procedure to be followed to ensure that the realisable value of financial assets is reasonably
estimated.
iv. Delegation of powers of various functionaries for taking decision on the sale of the financial assets; etc.
Auditors need to ensure that the Bank comply with the RBI Guidelines issued on 1 September vide circular
number RBI/2016-17/56 DBR.No.BP.BC.9/ 21.04.048/2016-17. In addition to the existing disclosure, Banks need
to comply with the disclosure requirement in this circular.
4.151 Disclosure Requirements
A. Details of financial assets sold to SC/RC: (Amounts in Rupees crore)
1. No. of accounts sold
2. Aggregate outstanding (net of provisions)
3. Aggregate consideration received
4. Additional consideration realized in respect of accounts transferred in earlier years
5. Aggregate gain / loss over net book value
B. Details of Book Value of investments in Security receipts (Amounts in Rupees crore)
1. Book Value of investments in Security receipts - Backed by NPA's sold by bank as underlying
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2. Book Value of investments in Security receipts Backed by NPA's sold by other banks / financial institutions/
non banking financial companies as underlying
3. Totals of above
Other Aspects
4.152 Certain other important aspects of the guidelines relating to provisioning are discussed below.
Floating Provisions
Principle for Creation and Utilisation of Floating Provisions by Banks
4.153 RBI mandates banks to hold floating provisions in respect of "Advances" as well as "Investments"
separately. The Master Circular of July 1, 2015 on Prudential Norms on Income Recognition, Asset Classification
and Provisioning Pertaining to Advances, requires the Board of Directors of banks to lay down a policy regarding
the level to which floating provisions can be created. The floating provisions should not be used for making
specific provisions as per the extant prudential guidelines in respect of nonperforming assets or for making
regulatory provisions for standard assets. The floating provisions can be used only for contingencies under
extraordinary circumstances for making specific provisions in impaired accounts after obtaining board's approval
and with prior permission of RBI. The boards of the banks should lay down an approved policy as to what
circumstances would be considered extraordinary.
4.154 It is clarified that the extra-ordinary circumstances refer to losses which do not arise in the normal course
of business and are exceptional and non-recurring in nature. These extra-ordinary circumstances could broadly
fall under three categories viz. General, Market and Credit. Under general category, there can be situations where
bank is put unexpectedly to loss due to events such as civil unrest or collapse of currency in a country. Natural
calamities and pandemics may also be included in the general category. Market category would include events
such as a general melt down in the markets, which affects the entire financial system. Among the credit category,
only exceptional credit losses would be considered as an extra-ordinary circumstance.
4.155 Floating provisions cannot be reversed by credit to the profit and loss account. They can only be utilised
for making specific provisions in extraordinary circumstances as mentioned above. Until such utilisation, these
provisions can be netted off from gross NPAs to arrive at disclosure of net NPAs. Alternatively, they can be treated
as part of Tier II capital within the overall ceiling of 1.25 % of total risk weighted assets.
4.156 Banks should make comprehensive disclosures on floating provisions in the "notes on accounts" to the
balance sheet on (a) opening balance in the floating provisions account, (b) the quantum of floating provisions
made in the accounting year, (c) purpose and amount of draw down made during the accounting year, and (d)
closing balance in the floating provisions account.
Additional Provisions for NPAs at higher than prescribed rates
4.157 A bank may voluntarily make specific provisions for advances at rates which are higher than the rates
prescribed under existing regulations, to provide for estimated actual loss in collectible amount, provided such
higher rates are approved by the Board of Directors and consistently adopted from year to year. Such additional
provisions are not to be considered as floating provisions. The additional provisions for NPAs, like the minimum
regulatory provision on NPAs, may be netted off from gross NPAs to arrive at the net NPAs.
Loss Assets
4.158 Every bank should have board approved policy for classification of advance account as Loss Asset. The
Auditor should review the policy and ensure that all important criteria for classification of account as Loss Asset is
covered in policy.
Further, the Bank should consistently apply policy to all advance accounts and in case of any deviation same also
need to be approved by board. The auditor should ensure compliance with policy of classification of account as Loss
Asset.
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Write-off of NPAs
4.159 The banks should either make full provision as per the guidelines or write off the advances and claim the
tax benefits as are applicable, by evolving appropriate methodology in consultation with their auditors/tax
consultants. Recoveries made in such accounts should be offered for tax purposes as per the rules. Banks may
write-off advances at Head Office level, even though the advances are still outstanding in the branch books. At the
branch level, provision requirement as per classification norms shall be made and in respect of loss assets 100%
provision shall be made.
Guidelines on Sale/Purchase of NPAs
4.160 The Master Circular on Advances require the Board of Directors of the banks to lay down policy in respect of
the aspects relating to sale/ purchase of NPAs, including:
(a) Non-performing financial assets that may be purchased/ sold;
(b) Norms and procedure for purchase/ sale of such financial assets;
(c) Valuation procedure to be followed to ensure that the economic value of financial assets is reasonably
estimated based on the estimated cash flows arising out of repayments and recovery prospects;
(d) Delegation of powers of various functionaries for taking decision on the purchase/ sale of the financial assets
etc.; and
(e) Accounting policy.
4.161 RBI also casts a responsibility on the Board to satisfy itself that the bank has adequate skills to purchase
non-performing financial assets and deal with them in an efficient manner which will result in value addition to the
bank.
4.162 Banks should, while selling NPAs, work out the net present value of the estimated cash flows associated
with the realisable value of the available securities net of the cost of realisation. The sale price should generally not
be lower than the net present value so arrived.
4.163 The estimated cash flows are normally expected to be realised within a period of three years and at least
10% of the estimated cash flows should be realised in the first year and at least 5% in each half year thereafter,
subject to full recovery within three years.
4.164 A bank may purchase/sell nonperforming financial assets from/to other banks only on `without recourse'
basis, i.e., the entire credit risk associated with the nonperforming financial assets should be transferred to the
purchasing bank. Selling bank shall ensure that the effect of the sale of the financial assets should be such that the
asset is taken off the books of the bank and after the sale there should not be any known liability devolving on the
selling bank.
4.165 Banks should ensure that subsequent to sale of the non-performing financial assets to other banks. They do
not have any involvement with reference to assets sold and do not assume operational, legal or any other type of
risks relating to the financial assets sold. Consequently, the specific financial asset should not enjoy the support of
credit enhancements / liquidity facilities in any form or manner.
4.166 Under no circumstances can a sale to other banks be made at a contingent price whereby in the event of
shortfall in the realisation by the purchasing banks, the selling banks would have to bear a part of the shortfall.
4.167 Further, NPAs can be sold to other banks only on cash basis. The entire sale consideration should be
received upfront and the asset can be taken out of the books of the selling bank only on receipt of the entire sale
consideration.
4.168 A non-performing financial asset should be held by the purchasing bank in its books at least for a period of
15 months before it is sold to other banks. Banks should not sell such assets back to the bank, which had sold the
NPFA.
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Asset Classification, Income Recognition and Provisioning
4.169 Banks are also permitted to sell/buy homogeneous pool within retail non-performing financial assets, on a
portfolio basis provided each of the non-performing financial assets of the pool has remained as non-performing
financial asset for at least 2 years in the books of the selling bank. The pool of assets would be treated as a single
asset in the books of the purchasing bank.
4.170 The selling bank should pursue the staff accountability aspects as per the existing instructions in respect of
the non-performing assets sold to other banks.
4.171 Prudential norms for banks for the purchase/sale transactions issued by RBI, from time to time, should be
adhered to.
4.172 As per the Master Circular on Prudential Norms on Advances dated July 1, 2015, if the sale is in respect of
Standard Asset and the sale consideration is higher than the book value, the excess provisions may be credited to
Profit and Loss Account. Excess provisions which arise on sale of NPAs can be admitted as Tier II capital subject to
the overall ceiling of 1.25% of total Risk Weighted Assets. Accordingly, these excess provisions that arise on sale of
NPAs would be eligible for Tier II status.
Asset Classification Norms
4.173 The asset classification norms for sale/purchase of NPAs are as follows:
(i) The non-performing financial asset purchased, may be classified as `standard' in the books of the purchasing
bank for a period of 90 days from the date of purchase. Thereafter, the asset classification status of the
financial asset purchased, shall be determined by the record of recovery in the books of the purchasing bank
with reference to cash flows estimated while purchasing the asset which should be in compliance with
requirements as discussed in preceding paragraphs.
(ii) The asset classification status of an existing exposure (other than purchased financial asset) to the same
obligor in the books of the purchasing bank will continue to be governed by the record of recovery of that
exposure and hence may be different.
(iii) Where the purchase/sale does not satisfy any of the prudential requirements prescribed in these guidelines
the asset classification status of the financial asset in the books of the purchasing bank at the time of purchase
shall be the same as in the books of the selling bank. Thereafter, the asset classification status will continue to
be determined with reference to the date of NPA in the selling bank.
(iv) Any restructure/reschedule/rephrase of the repayment schedule or the estimated cash flow of the non-
performing financial asset by the purchasing bank shall render the account as a non-performing asset.
Provisioning Norms
Books of Selling Bank
4.174 The provisioning norms for books of selling bank are as under:
(i) When a bank sells its nonperforming financial assets to other banks, the same will be removed from its books
on transfer.
(ii) If the sale is at a price below the net book value (NBV) (i.e., book value less provisions held), the shortfall
should be debited to the profit and loss account of that year.
(iii) If the sale is for a value higher than the NBV, the excess provision shall not be reversed but will be utilised to
meet the shortfall/ loss on account of sale of other non-performing financial assets.
Books of Purchasing Bank
4.175 The provisioning norms for books of purchasing bank are as under:
The asset shall attract provisioning requirement appropriate to its asset classification status in the books of the
purchasing bank.
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Accounting of Recoveries
4.176 Any recovery in respect of a non-performing asset purchased from other banks should first be adjusted
against its acquisition cost. Recoveries in excess of the acquisition cost can be recognised as profit.
Capital Adequacy
4.177 For the purpose of capital adequacy, banks should assign 100% risk weights to the non-performing financial
assets purchased from other banks. In case the nonperforming asset purchased is an investment, then it would
attract capital charge for market risks also.
Exposure Norms
4.178 The purchasing bank will reckon exposure on the obligor of the specific financial asset. Hence these banks
should ensure compliance with the prudential credit exposure ceilings (both single and group) after reckoning the
exposures to the obligors arising on account of the purchase.
Disclosure Requirements
4.179 Banks which purchase nonperforming financial assets from other banks shall be required to make the
following disclosures in the Notes on Accounts to their Balance sheets:
A. Details of nonperforming financial assets purchased: (Amounts in Rupees crore)
1. (a) No. of accounts purchased during the year
(b) Aggregate outstanding
2. (a) Of these, number of accounts restructured during the year
(b) Aggregate outstanding
B. Details of nonperforming financial assets sold: (Amounts in Rupees crore)
1. No. of accounts sold
2. Aggregate outstanding
3. Aggregate consideration received
4. Additional consideration realized in respect of accounts transferred in earlier years
5. Aggregate gain / loss over net book value
C. Details of Book Value of investments in Security receipts (Amounts in Rupees crore)
1. Book Value of investments in Security receipts - Backed by NPA's sold by bank as underlying
2. Book Value of investments in Security receipts Backed by NPA's sold by other banks / financial institutions/
non banking financial companies as underlying
3. Totals of above
The purchasing bank shall furnish all relevant reports to RBI, Credit Information Company which has obtained
Certificate of Registration from RBI and of which the bank is a member etc. in respect of the nonperforming financial
assets purchased by it.
Auditor's Report in case of Bank Borrowers
4.180 The RBI vide its circular no. DBOD.No. CAS(COD)BC.146/27-77 dated December 22, 1977 had
prescribed that all borrowers having credit limit of Rs.10 lakh and above from the banking system should get their
annual accounts audited by chartered accountants. Further the RBI vide its circular
DBOD.No.BP.BC.33/21.04.018/2002-03 dated October 21, 2002 has authorised the Board of Directors of banks to
fix a suitable cut off limit with reference to the borrowing entity's overall exposure on the banking system, over
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Asset Classification, Income Recognition and Provisioning
which audit of accounts of borrower by chartered accountants would be mandatory.
Sale/ Purchase of NPAs
4.181 In case of a sale/ purchase of NPAs by the bank, the auditor should examine the policy laid down by the
Board of Directors in this regard relating to procedures, valuation and delegation of powers.
4.182 The auditor should also examine that:
(i) only such NPA has been sold which has remained NPA in the books of the bank for at least 2 years.
(ii) the assets have been sold/ purchased "without recourse' only.
(iii) subsequent to the sale of the NPA, the bank does not assume any legal, operational or any other type of risk
relating to the sold NPAs.
(iv) the NPA has been sold at cash basis only.
(v) the bank has not purchased an NPA which it had originally sold.
4.183 In case of sale of an NPA, the auditor should also examine that:
(i) on the sale of the NPA, the same has been removed from the books of the account.
(ii) the short fall in the net book value (NBV) has been charged to the profit and loss account.
(iii) where the sale is for a value higher than the NBV, no profit is recognised and the excess provision has not
been reversed but retained to meet the shortfall/ loss on account of sale of other non-performing financial
assets.
4.184 Similarly, in case of purchase of NPAs, the auditor should verify that:
(i) the NPA purchased has been subjected to the provisioning requirements appropriate to the classification status
in the books of the selling bank.
(ii) any recovery in respect of an NPA purchased from other banks is first adjusted against its acquisition cost and
only the recovered amount in excess of the acquisition cost has been recognised as profit.
(iii) for the purpose of capital adequacy, banks has assigned 100% risk weights to the NPAs purchased from other
banks.
Verification of Provision for Non-performing assets
4.185 An important aspect of audit of advances relates to their classification and provisioning. This implies that a
proper provision should be made in respect of advances where the recovery is doubtful. As mentioned earlier, the
Reserve Bank has prescribed objective norms for determining the quantum of provisions required in respect of
advances. The auditors must familiarise himself fully with the norms prescribed by RBI in this regard. However, these
norms should be construed as laying down the minimum provisioning requirements and wherever a higher provision is
warranted in the context of the threats to recovery, such higher provision should be made. Provisions of section 15 of
the Banking Regulation Act, 1949, which applies to banking companies, nationalised banks, State Bank of India, its
subsidiaries, and regional rural banks, the bank concerned should make adequate provision for bad debts to the
satisfaction of its auditor before paying any dividends on its shares.
4.186 The accounting entry for provision in respect of debts that are doubtful of recovery is usually made at the
head office level and is not recorded in the books at the branch level. The amount of provision to be made at the
head office level is based largely on the classification of various advances into standard, sub-standard, doubtful and
loss categories. The auditor should carefully examine whether the classification made by the branch is appropriate. In
doing so, he should particularly examine the classification of advances where there are threats to recovery. The
auditor should also examine whether the secured and the unsecured portions of advances have been segregated
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correctly and provisions have been calculated properly.
4.187 As per the Reserve Bank guidelines, if an account has been regularised before the balance sheet date by
payment of overdue amount through genuine sources, the account need not be treated as NPA. Where, subsequent
to repayment by the borrower (which makes the account regular), the branch has provided further funds to the
borrower (including by way of subscription to its debentures or in other accounts of the borrower), the auditor should
carefully assess whether the repayment was out of genuine sources or not. Where the account indicates inherent
weakness on the basis of the data available, the account should be deemed as a NPA. In other genuine cases, the
banks must furnish satisfactory evidence to the satisfaction of Statutory Auditors about the manner of regularisation
of the account to eliminate doubts on their performing status.
4.188 It is to be examined whether that the classification is made as per the position as on date and hence
classification of all standard accounts be reviewed as on balance sheet date. The date of NPA is of significant
importance to determine the classification and hence specific care be taken in this regard. The regularisation and / or
closure of account subsequent to the date of balance sheet will not have any impact on improvisation of the
classification of advance as on the date of NPA.
Projects under Implementation
4.189 For all projects financed by the FIs/ banks after 28th May 2002, the date of completion of the project should
be clearly spelt out at the time of financial closure of the project
Project Loans
4.190 There are occasions when the completion of projects is delayed for legal and other extraneous reasons like
delays in Government approvals etc. All these factors, which are beyond the control of the promoters, may lead to
delay in project implementation and involve restructuring/reschedulement of loans by banks. Accordingly, the
following asset classification norms would apply to the project loans before commencement of commercial
operations. These guidelines will, however, not be applicable to restructuring of Advances classified as Commercial
Real Estate exposures; Advances classified as Capital Market exposure; and Consumer and Personal Advances
which will continue to be dealt with in terms of the extant provisions.
4.191 For this purpose, all project loans have been divided into the following two categories:
a. Project Loans for infrastructure sector.
b. Project Loans for non-infrastructure sector.
'Project Loan' would mean any term loan which has been extended for the purpose of setting up of an economic
venture. Banks must fix a Date of Commencement of Commercial Operations (DCCO) for all project loans at the time
of sanction of the loan / financial closure (in the case of multiple banking or consortium arrangements).
Project Loans for Infrastructure Sector
4.192(i) A loan for an infrastructure project will be classified as NPA during any time before commencement of
commercial operations as per record of recovery (90 days overdue), unless it is restructured and becomes
eligible for classification as 'standard asset' in terms of paras (iii) to (v) below.
(ii) A loan for an infrastructure project will be classified as NPA if it fails to commence commercial operations within
two years from the original DCCO, even if it is regular as per record of recovery, unless it is restructured and
becomes eligible for classification as 'standard asset' in terms of paras (iii) to (v) below.
(iii) If a project loan classified as 'standard asset' is restructured any time during the period up to two years from the
original date of commencement of commercial operations (DCCO), in accordance with the provisions of Part B
of this Master Circular, it can be retained as a standard asset if the fresh DCCO is fixed within the following
limits, and further provided the account continues to be serviced as per the restructured terms.
(a) Infrastructure Projects involving court cases
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Up to another 2 years (beyond the existing extended period of 2 years i.e. total extension of 4 years), in
case the reason for extension of date of commencement of production is arbitration proceedings or a court
case.
(b) Infrastructure Projects delayed for other reasons beyond the control of promoters
Up to another 1 year (beyond the existing extended period of 2 years i.e. total extension of 3 years), in
other than court cases.
(iv) It is re-iterated that the dispensation is subject to adherence to the provisions regarding restructuring of
accounts as contained in the Master Circular which would inter alia require that the application for restructuring
should be received before the expiry of period of two years from the original DCCO and when the account is still
standard as per record of recovery.
The other conditions applicable would be:
a. In cases where there is moratorium for payment of interest, banks should not book income on accrual
basis beyond two years from the original DCCO, considering the high risk involved in such restructured
accounts.
b. Banks should maintain provisions on such accounts as long as these are classified as standard assets as
under:
Particulars Provisioning Requirement
If the revised DCCO is within two years from the original 0.40 per cent
DCCO prescribed at the time of financial closure
If the DCCO is extended beyond two years and upto four Project loans restructured with effect from June 1, 2013:
years or three years from the original DCCO, as the case
5.00 per cent From the date of such restructuring till
may be, depending upon the reasons for such delay
the revised DCCO or 2 years from the date of
restructuring, whichever is later
Stock of project loans classified as restructured as on
June 1, 2013:
3.50 per cent - with effect from March 31, 2014
(spread over the four quarters of 2013-14)
4.25 per cent - with effect from March 31, 2015
(spread over the four quarters of 2014-15)
5.00 per cent - - with effect from March 31, 2016
(spread over the four quarters of 2015-16)
The above provisions will be applicable from the date of
restructuring till the revised DCCO or 2 years from the
date of restructuring, whichever is later.
(v) For the purpose of these guidelines, mere extension of DCCO would not be considered as restructuring, if the
revised DCCO falls within the period of two years from the original DCCO. In such cases the consequential shift
in repayment period by equal or shorter duration (including the start date and end date of revised repayment
schedule) than the extension of DCCO would also not be considered as restructuring provided all other terms
and conditions of the loan remain unchanged.
(vi) In case of infrastructure projects under implementation, where Appointed Date (as defined in the concession
agreement) is shifted due to the inability of the Concession Authority to comply with the requisite conditions,
change in date of commencement of commercial operations (DCCO) need not be treated as `restructuring',
subject to following conditions:
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a. The project is an infrastructure project under public private partnership model awarded by a public
authority;
b. The loan disbursement is yet to begin;
c. The revised date of commencement of commercial operations is documented by way of a supplementary
agreement between the borrower and lender; and
d. Project viability has been reassessed and sanction from appropriate authority has been obtained at the
time of supplementary agreement.
4.193 Change in Ownership
i. In order to facilitate revival of the projects stalled primarily due to inadequacies of the current promoters, if a
change in ownership takes place any time during the periods quoted in paragraphs 4.2.15.3 of the circular or
before the original DCCO, banks may permit extension of the DCCO of the project up to two years in addition to
the periods quoted at paragraph 4.2.15.3 of the circular as the case may be, without any change in asset
classification of the account subject to the conditions stipulated in the following paragraphs. Banks may also
consequentially shift/extend repayment schedule, if required, by an equal or shorter duration.
ii. In cases where change in ownership and extension of DCCO (as indicated in paragraph 4.2.15.5 (i) of the
circular) takes place before the original DCCO, and if the project fails to commence commercial operations by
the extended DCCO, the project will be eligible for further extension of DCCO in terms of guidelines quoted at
paragraph 4.2.15.3 of the circular. Similarly, where change in ownership and extension of DCCO takes place
during the period quoted in paragraph 4.2.15.3 (i) of the circular, the account may still be restructured by
extension of DCCO in terms of guidelines quoted at paragraph 4.2.15.3 (ii) of the circular, without classifying the
account as non-performing asset.
iii. The provisions of paragraphs 4.2.15.4 (i) and 4.2.15.4 (ii) of the circular are subject to the following conditions:
a. Banks should establish that implementation of the project is stalled/affected primarily due to inadequacies of
the current promoters/management and with a change in ownership there is a very high probability of
commencement of commercial operations by the project within the extended period;
b. The project in consideration should be taken-over/acquired by a new promoter/promoter group with
sufficient expertise in the field of operation. If the acquisition is being carried out by a special purpose
vehicle (domestic or overseas), the bank should be able to clearly demonstrate that the acquiring entity is
part of a new promoter group with sufficient expertise in the field of operation;
c. The new promoters should own at least 51 per cent of the paid up equity capital of stake in the acquired
project. If the new promoter is a non-resident, and in sectors where the ceiling on foreign investment is less
than 51 per cent, the new promoter should own atleast 26 per cent of the paid up equity capital or up to
applicable foreign investment limit, whichever is higher, provided banks are satisfied that with this equity
stake the new non-resident promoter controls the management of the project;
d. Viability of the project should be established to the satisfaction of the banks;
e. Intra-group business restructuring/mergers/acquisitions and/or takeover/acquisition of the project by other
entities/subsidiaries/ associates etc. (domestic as well as overseas), belonging to the existing
promoter/promoter group will not qualify for this facility. The banks should clearly establish that the acquirer
does not belong to the existing promoter group;
f. Asset classification of the account as on the `reference date' would continue during the extended period. For
this purpose, the `reference date' would be the date of execution of preliminary binding agreement between
the parties to the transaction, provided that the acquisition/takeover of ownership as per the provisions of
law/regulations governing such acquisition/takeover is completed within a period of 90 days from the date of
execution of preliminary binding agreement. During the intervening period, the usual asset classification
norms would continue to apply. If the change in ownership is not completed within 90 days from the
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preliminary binding agreement, the `reference date' would be the effective date of acquisition/takeover as
per the provisions of law/regulations governing such acquisition/takeover;
g. The new owners/promoters are expected to demonstrate their commitment by bringing in substantial portion
of additional monies required to complete the project within the extended time period. As such, treatment of
financing of cost overruns for the project shall be subject to the guidelines prescribed in paragraph 13 of the
circular. Financing of cost overrun beyond the ceiling prescribed in paragraph 13 of the circular would be
treated as an event of restructuring even if the extension of DCCO is within the limits prescribed above;
h. While considering the extension of DCCO (up to an additional period of 2 years) for the benefits envisaged
hereinabove, banks shall make sure that the repayment schedule does not extend beyond 85 per cent of
the economic life/concession period of the project; and
i. This facility would be available to a project only once and will not be available during subsequent change in
ownership, if any.
iv. Loans covered under this guideline would attract provisioning as per the extant provisioning norms depending
upon their asset classification status.
Project Loans for Non-Infrastructure Sector
4.194(i) A loan for a non-infrastructure project will be classified as NPA during any time before commencement of
commercial operations as per record of recovery (90 days overdue), unless it is restructured and becomes
eligible for classification as 'standard asset' in terms of paras (iii) to (iv) below.
(ii) A loan for a non-infrastructure project will be classified as NPA if it fails to commence commercial operations
within one year from the original DCCO, even if is regular as per record of recovery, unless it is restructured and
becomes eligible for classification as 'standard asset' in terms of paras (iii) to (iv) below.
(iii) In case of non-infrastructure projects, if the delay in commencement of commercial operations extends beyond
the period of one year from the date of completion as determined at the time of financial closure, banks can
prescribe a fresh DCCO, and retain the "standard" classification by undertaking restructuring of accounts in
accordance with the provisions contained in this Master Circular, provided the fresh DCCO does not extend
beyond a period of two years from the original DCCO. This would among others also imply that the restructuring
application is received before the expiry of one year from the original DCCO, and when the account is still
"standard" as per the record of recovery.
The other conditions applicable would be:
a. In cases where there is moratorium for payment of interest, banks should not book income on accrual
basis beyond one year from the original DCCO, considering the high risk involved in such restructured
accounts.
b. Banks should maintain provisions on such accounts as long as these are classified as standard assets as
under:
Particulars Provisioning Requirement
If the revised DCCO is within one year from the original 0.40 per cent
DCCO prescribed at the time of financial closure
If the DCCO is extended beyond one year and upto two Project loans restructured with effect from June 1, 2013:
years from the original DCCO prescribed at the time of
5.00 per cent From the date of restructuring for 2 years
financial closure
Stock of Project loans classified as restructured before
June 01, 2013:
3.50 per cent - with effect from March 31, 2014
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(spread over the four quarters of 2013-14)
4.25 per cent - with effect from March 31, 2015
(spread over the four quarters of 2014-15)
5.00 per cent - with effect from March 31, 2016
(spread over the four quarters of 2015-16)
The above provisions will be applicable from the date of
restructuring for 2 years.
(iv) For this purpose, mere extension of DCCO would not be considered as restructuring, if the revised DCCO falls
within the period of two years from the original DCCO. In such cases the consequential shift in repayment
period by equal or shorter duration (including the start date and end date of revised repayment schedule) than
the extension of DCCO would also not be considered as restructuring provided all other terms and conditions of
the loan remain unchanged.
Other Issues
4.195(i) All other aspects of restructuring of project loans before commencement of commercial operations would be
governed by the provisions of Part B of Master Circular on Prudential norms on Income Recognition, Asset
Classification and Provisioning Pertaining to Advances. Restructuring of project loans after commencement of
commercial operations will also be governed by these instructions.
(ii) Any change in the repayment schedule of a project loan caused due to an increase in the project outlay on
account of increase in scope and size of the project, would not be treated as restructuring if:
(a) The increase in scope and size of the project takes place before commencement of commercial
operations of the existing project.
(b) The rise in cost excluding any cost-overrun in respect of the original project is 25% or more of the original
outlay.
(c) The bank re-assesses the viability of the project before approving the enhancement of scope and fixing a
fresh DCCP.
(d) On re-rating, (if already rated) the new rating is not below the previous rating by more than one notch.
(iii) Project loans for Commercial Real Estate
CRE projects mere extension of DCCO would not be considered as restructuring, if the revised DCCO falls
within the period of one year from the original DCCO and there is no change in other terms and conditions
except possible shift of the repayment schedule and servicing of the loan by equal or shorter duration compared
to the period by which DCCO has been extended. However, the asset classification benefit would not be
available to CRE projects if they are restructured.
(iv) Multiple revisions of the DCCO and consequential shift in repayment schedule for equal or shorter duration
(including the start date and end date of revised repayment schedule) will be treated as a single event of
restructuring provided that the revised DCCO is fixed within the respective time limits stipulated at paragraphs
4.2.15.3 (iii) and 4.2.15.4 (iii) of the Master Circular No. RBI/2015-16/101DBR.No.BP.BC.2/21.04.048/2015-16
on Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances,
dated July 1, 2015 and all other terms and conditions of the loan remained unchanged.
(v) Banks, if deemed fit, may extend DCCO beyond the respective time limits stipulated at paragraphs 4.2.15.3 (iii)
and 4.2.15.4 (iii) of the Master Circular No. RBI/2015-16/101 DBR.No.BP.BC.2/21.04.048/2015-16 on
Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances, dated
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July 1, 2015; however, in that case, banks will not be able to retain the `standard' asset classification status of
such loan accounts.
(vi) In all the above cases of restructuring where regulatory forbearance has been extended, the Boards of banks
should satisfy themselves about the viability of the project and the restructuring plan.
4.196(i) The RBI vide its Circular No. RBI/2014-15/182 DBOB. No.BP.BC.33/21.04.048/2014-15 dated August 14,
2014 on "Prudential Norms on Income Recognition, Assets Classification and Provisioning Pertaining to
Advances Project under Implementation" mentions that banks have represented to RBI that in respect of
funding of cost overruns, which may arise on account of extension of DCCO within the above (i.e.; two years
and one year for infrastructure and non-infrastructure projects from original DCCO date with other terms and
conditions remain unchanged), time limits may be allowed without treating the loans as restructured.
(ii) In cases where banks have specifically sanctioned a `standby facility' at the time of initial financial closure to
fund cost overruns, they may fund cost overruns as per the agreed terms and conditions.
(iii) In cases Where the initial financial closure does not envisage such financing of cost overruns, based on the
representations from banks, it has been decided to allow banks to fund cost overruns, which may arise on
account of extension of DCCO within the time limits quoted at paragraph (i) above, without treating the loans as
`restructured asset' subject to the following conditions:
(a) Banks may fund additional `Interest during Construction', which may arise on account of delay in
completion of a project;
(b) Other cost overruns (excluding Interest during Construction) up to a maximum of 10% of the original
project cost
(c) Debt Equity Ratio as agreed at the time of initial financial closure should remain unchanged subsequent to
funding cost overruns or improve in favour of the lenders and the revised Debt Service Coverage Ratio
should be acceptable to the lenders
(d) Disbursement of funds for cost overruns should start only after the Sponsors/Promoters bring in their
share of funding of the cost overruns; and
(e) All other terms and conditions of the loan should remain unchanged or enhanced in favour of the lenders.
Flexible structuring of Long Term Project Loans to Infrastructure and Core Industries
4.197 (i) In view of the challenges faced by Banks, the RBI has clarified in its circular no.
DBOD.No.BP.BC.24/21.04.132/2014-15 on Flexible Structuring of Long Term Project Loans to Infrastructure
and Core Industries dated July 15, 2014, that it has no objection to banks' to fix longer amortisation period for
loans to projects in infrastructure and core industries sectors, say 25 years, based on the economic life or
concession period of the project, with periodic refinancing, say every 5 years. For details refer to the circular.
(ii) The RBI has further clarified in its circular no. DBOD.No.BP.BC.24/ 21.04.132/2014-15 Flexible Structuring of
Long Term Project Loans to Infrastructure and Core Industries dated December 15, 2014 that the flexible
structuring of existing loans will be allowed in addition to new loans as per the norms given in the circular.
(iii) For detailed guidelines on the Flexible structuring of Long Term Project Loans, refer para 10 and 11 of the
master circular DBR.No.BP.BC.2/21.04.048/2015-16 - Master Circular - Prudential norms on Income
Recognition, Asset Classification and Provisioning pertaining to Advances.
Income recognition
4.198(i) Banks may recognise income on accrual basis in respect of the projects under implementation, which are
classified as `standard'.
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(ii) Banks should not recognise income on accrual basis in respect of the projects under implementation which are
classified as a `substandard' asset. Banks may recognise income in such accounts only on realisation on cash
basis. Consequently, banks which have wrongly recognised income in the past should reverse the interest if it
was recognised as income during the current year or make a provision for an equivalent amount if it was
recognised as income in the previous year(s). As regards the regulatory treatment of `funded interest'
recognised as income and `conversion into equity, debentures or any other instrument' banks should adopt the
following:
a) Funded Interest: Income recognition in respect of the NPAs, regardless of whether these are or are not
subjected to restructuring/ rescheduling/ renegotiation of terms of the loan agreement, should be done
strictly on cash basis, only on realisation and not if the amount of interest overdue has been funded. If,
however, the amount of funded interest is recognised as income, a provision for an equal amount should
also be made simultaneously. In other words, any funding of interest in respect of NPAs, if recognised as
income, should be fully provided for.
b) Conversion into equity, debentures or any other instrument: The amount outstanding converted into other
instruments would normally comprise principal and the interest components. If the amount of interest dues
is converted into equity or any other instrument, and income is recognised in consequence, full provision
should be made for the amount of income so recognised to offset the effect of such income recognition.
Such provision would be in addition to the amount of provision that may be necessary for the depreciation
in the value of the equity or other instruments, as per the investment valuation norms. However, if the
conversion of interest is into equity which is quoted, interest income can be recognised at market value of
equity, as on the date of conversion, not exceeding the amount of interest converted to equity. Such equity
must thereafter be classified in the "available for sale" category and valued at lower of cost or market
value. In case of conversion of principal and /or interest in respect of NPAs into debentures, such
debentures should be treated as NPA, ab initio, in the same asset classification as was applicable to loan
just before conversion and provision made as per norms. This norm would also apply to zero coupon
bonds or other instruments which seek to defer the liability of the issuer. On such debentures, income
should be recognised only on realization basis. The income in respect of unrealised interest which is
converted into debentures or any other fixed maturity instrument should be recognized only on redemption
of such instrument. Subject to the above, the equity shares or other instruments arising from conversion of
the principal amount of loan would also be subject to the usual prudential valuation norms as applicable to
such instruments.
Provisioning norms on restructured advances
Normal provisions
4.199(i) Banks will hold provision against the restructured advances as per the extant provisioning norms.
(ii) Restructured accounts classified as standard advances will attract a higher provision (as prescribed from time to
time) in the first two years from the date of restructuring. In cases of moratorium on payment of interest/principal
after restructuring, such advances will attract the prescribed higher provision for the period covering moratorium
and two years thereafter.
(iii) Restructured accounts classified as non-performing advances, when upgraded to standard category will attract a
higher provision (as prescribed from time to time) in the first year from the date of upgradation.
(iv) The above-mentioned higher provision on restructured standard advances (2.75 per cent as prescribed vide
circular dated November 26, 2012) would increase to 5 per cent in respect of new restructured standard
accounts (flow) with effect from June 1, 2013 and increase in a phased manner for the stock of restructured
standard accounts as on May 31, 2013 as under :
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3.50 per cent - with effect from March 31, 2014. (spread over the four quarters of 2013-14)
4.25 per cent - with effect from March 31, 2015. (spread over the four quarters of 2014-15)
5.00 per cent - - with effect from March 31, 2016.(spread over the four quarters of 2015-16)
Provision for diminution in the fair value of restructured advances-
4.200(i) Reduction in the rate of interest and/or reschedulement of the repayment of principal amount, as part of the
restructuring, will result in diminution in the fair value of the advance. Such diminution in value is an economic
loss for the bank and will have impact on the bank's market value of equity. It is, therefore, necessary for banks
to measure such diminution in the fair value of the advance and make provisions for it by debit to Profit & Loss
Account. Such provision should be held in addition to the provisions as per existing provisioning norms and in
an account distinct from that for normal provisions.
For this purpose, the erosion in the fair value of the advance should be computed as the difference between the
fair value of the loan before and after restructuring. Fair value of the loan before restructuring will be computed
as the present value of cash flows representing the interest at the existing rate charged on the advance before
restructuring and the principal, discounted at a rate equal to the bank's BPLR or Base Rate13 (whichever is
applicable to the borrower) as on the date of restructuring plus the appropriate term premium and credit risk
premium for the borrower category on the date of restructuring. Fair value of the loan after restructuring will be
computed as the present value of cash flows representing the interest at the rate charged on the advance on
restructuring and the principal, discounted at a rate equal to the bank's BPLR or base rate (whichever is
applicable to the borrower) as on the date of restructuring plus the appropriate term premium and credit risk
premium for the borrower category on the date of restructuring.
The above formula moderates the swing in the diminution of present value of loans with the interest rate cycle
and will have to be followed consistently by banks in future. Further, it is reiterated that the provisions required
as above arise due to the action of the banks resulting in change in contractual terms of the loan upon
restructuring which are in the nature of financial concessions. These provisions are distinct from the provisions
which are linked to the asset classification of the account classified as NPA and reflect the impairment due to
deterioration in the credit quality of the loan. Thus, the two types of the provisions are not substitute for each
other.
ii) There could be divergences in the calculation of diminution of fair value of accounts by banks. For example,
divergences could occur if banks do not appropriately factor in the term premium on account of elongation of
repayment period on restructuring. In such a case the term premium used while calculating the present value of
cash flows after restructuring would be higher than the term premium used while calculating the present value
of cash flows before restructuring.
Further, the amount of principal converted into debt/equity instruments on restructuring would need to be held
under AFS and valued as per usual valuation norms. Since these instruments are getting marked to market, the
erosion in fair value gets captured on such valuation. Therefore, for the purpose of arriving at the erosion in the
fair value, the NPV calculation of the portion of principal not converted into debt/equity has to be carried out
separately. However, the total sacrifice involved for the bank would be NPV of the above portion plus valuation
loss on account of conversion into debt/equity instruments.
Auditor should therefore verify that Bank has correctly captured diminution in fair value of restructured accounts
as it will have a bearing not only on the provisioning required to be made by them but also on the amount of
sacrifice required from the promoters
13
This change has been introduced as a result of the introduction of Base Rate System w.e.f. July 1, 2010 vide circular
DBOD.No.Dir.BC.88/13.03.00/2009-10 dated April 9, 2010 on `Guidelines on the Base Rate'.
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Auditors should also verify that there is no any effort on the part of banks to artificially reduce the net present
value of cash flows by resorting to any sort of financial engineering. Auditor should also verify that there is a
proper mechanism in place of checks and balances to ensure accurate calculation of erosion in the fair value of
restructured accounts.
4.201 In the case of working capital facilities, the diminution in the fair value of the cash credit / overdraft
component may be computed as indicated in para 4.197(i) above, reckoning the higher of the outstanding amount or
the limit sanctioned as the principal amount and taking the tenor of the advance as one year. The term premium in
the discount factor would be as applicable for one year. The fair value of the term loan components (Working Capital
Term Loan and Funded Interest Term Loan) would be computed as per actual cash flows and taking the term
premium in the discount factor as applicable for the maturity of the respective term loan components.
4.202 In the event any security is taken in lieu of the diminution in the fair value of the advance, it should be valued
at Re.1/- till maturity of the security. This will ensure that the effect of charging off the economic sacrifice to the Profit
& Loss account is not negated.
4.203 The diminution in the fair value may be re-computed on each balance sheet date till satisfactory completion
of all repayment obligations and full repayment of the outstanding in the account, so as to capture the changes in the
fair value on account of changes in BPLR or base rate (whichever is applicable to the borrower), term premium and
the credit category of the borrower. Consequently, banks may provide for the shortfall in provision or reverse the
amount of excess provision held in the distinct account.
4.204 If due to lack of expertise / appropriate infrastructure, a bank finds it difficult to ensure computation of
diminution in the fair value of advances, as an alternative to the methodology prescribed above for computing the
amount of diminution in the fair value, the banks has the option of notionally computing the amount of diminution in
the fair value and providing therefor, at five percent of the total exposure, in respect of all restructured accounts
where the total dues to bank(s) are less than rupees one crore.
4.205 The total provisions required against an account (normal provisions plus provisions in lieu of diminution in
the fair value of the advance) are capped at 100% of the outstanding debt amount.
Risk-Weights
4.206 The RBI circular also provides that:
a. Restructured housing loans should be risk weighted with an additional risk weight of 25 percentage points.
b. With a view to reflecting a higher element of inherent risk which may be latent in entities whose obligations have
been subjected to restructuring / rescheduling either by banks on their own or along with other bankers /
creditors, the unrated standard / performing claims on corporates should be assigned a higher risk weight of
125% until satisfactory performance under the revised payment schedule has been established for one year
from the date when the first payment of interest / principal falls due under the revised schedule.
c. For details on risk weights, Master Circular RBI/2015-16/58 DBR.No.BP.BC.1/21.06.201/2015-16 dated July 1,
2015 on `Basel III Capital Regulations' may be referred.
Prudential Norms for Conversion of Principal into Debt / Equity
Asset classification norms
4.207 A part of the outstanding, principal amount can be converted into debt or equity instruments as part of
restructuring. The debt / equity instruments so created will be classified in the same asset classification category in
which the restructured advance has been classified. Further movement in the asset classification of these
instruments would also be determined based on the subsequent asset classification of the restructured advance.
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Asset Classification, Income Recognition and Provisioning
Income recognition norms
Standard Accounts
4.208 In the case of restructured accounts classified as 'standard', the income, if any, generated by these
instruments may be recognised on accrual basis.
Non- Performing Accounts
4.209 In the case of restructured accounts classified as non-performing assets, the income, if any, generated by
these instruments may be recognised only on cash basis.
Valuation and provisioning norms
4.210 These instruments should be held under AFS and valued as per usual valuation norms. Equity classified as
standard asset should be valued either at market value, if quoted, or at break-up value, if not quoted (without
considering the revaluation reserve, if any) which is to be ascertained from the company's latest balance sheet. In
case the latest balance sheet is not available, the shares are to be valued at Re. 1. Equity instrument classified as
NPA should be valued at market value, if quoted, and in case where equity is not quoted, it should be valued at Re.
1. Depreciation on these instruments should not be offset against the appreciation in any other securities held under
the AFS category.
Prudential Norms for Conversion of Unpaid Interest into 'Funded Interest Term Loan' (FITL), Debt or
Equity Instruments
Asset classification norms
4.211 The FITL / debt or equity instrument created by conversion of unpaid interest will be classified in the same
asset classification category in which the restructured advance has been classified. Further movement in the asset
classification of FITL / debt or equity instruments would also be determined based on the subsequent asset
classification of the restructured advance.
Income recognition norms
4.212 The income, if any, generated by these instruments may be recognised on accrual basis, if these
instruments are classified as 'standard', and on cash basis in the cases where these have been classified as a non-
performing asset.
4.213 The unrealised income represented by FITL / Debt or equity instrument should have a corresponding credit
in an account styled as "Sundry Liabilities Account (Interest Capitalization)".
4.214 In the case of conversion of unrealised interest income into equity, which is quoted, interest income can be
recognized after the account is upgraded to standard category at market value of equity, on the date of such
upgradation, not exceeding the amount of interest converted into equity.
4.215 Only on repayment in case of FITL or sale / redemption proceeds of the debt / equity instruments, the
amount received will be recognized in the P&L Account, while simultaneously reducing the balance in the "Sundry
Liabilities Account (Interest Capitalisation)".
Valuation & Provisioning norms
4.216 Valuation and provisioning norms would be as per para 4.210 above. The depreciation, if any, on valuation
may be charged to the Sundry Liabilities (Interest Capitalisation) Account.
Special Regulatory Treatment for Asset Classification
4.217 The special regulatory treatment for asset classification, in modification to the provisions in this regard
stipulated in para 18 of the Master Circular No. RBI/2015-16/101 DBR.No.BP.BC.2/21.04.048/2015-16 on
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances, dated July 1,
2015, will be available to the borrowers engaged in important business activities, subject to compliance with certain
conditions as enumerated in para 20.2 of the above mentioned master circular. Such treatment is not extended to the
following categories of advances:
i. Consumer and personal advances;
ii. Advances classified as Capital market exposures;
iii. Advances classified as commercial real estate exposures.
The asset classification of these three categories accounts as well as that of other accounts which do not comply with
the conditions enumerated in para 20.2 of the aforesaid Master Circular, are governed by the prudential norms in this
regard described in para 17 of the Master Circular.
Elements of special regulatory framework
4.218 The special regulatory treatment has the following two components:
(i) Incentive for quick implementation of the restructuring package.
(ii) Retention of the asset classification of the restructured account in the pre-restructuring asset classification
category.
Incentive for quick implementation of the restructuring package
4.219 During the pendency of the application for restructuring of the advance with the bank, the usual asset
classification norms would continue to apply. The process of reclassification of an asset should not stop merely
because the application is under consideration. However, as an incentive for quick implementation of the package, if
the approved package is implemented by the bank as per the following time schedule, the asset classification status
may be restored to the position which existed when the reference was made to the CDR Cell in respect of cases
covered under the CDR Mechanism or when the restructuring application was received by the bank in non-CDR
cases:
(i) Within 120 days from the date of approval under the CDR Mechanism.
(ii) Within 120 days from the date of receipt of application by the bank in cases other than those restructured under
the CDR Mechanism.
Asset classification benefits
4.220 Subject to the compliance with the undernoted conditions in addition to the adherence to the prudential
framework laid down in para 17 of the Master Circular DBR.No.BP.BC.2/21.04.048/2015-16 on Prudential norms on
Income Recognition, Asset Classification and Provisioning pertaining to Advances dated July 1, 2015:
(i) In modification to para 17.2.1 of aforesaid Master Circular, an existing 'standard asset' will not be downgraded to
the sub-standard category upon restructuring.
(ii) In modification to para 17.2.2 of aforesaid Master Circular, during the specified period, the asset classification of
the sub-standard / doubtful accounts will not deteriorate upon restructuring, if satisfactory performance is
demonstrated during the specified period.
4.221 However, these benefits will be available subject to compliance with the following conditions:
i) The dues to the bank are 'fully secured' as defined in Annex 5 of the Master Circular on Prudential Norms on
Income Recognition, Asset Classification and Provisioning pertaining to Advances dated July 1, 2015. The
condition of being fully secured by tangible security will not be applicable in the following cases:
(a) MSE borrowers, where the outstanding is up to Rs. 25 lakh.
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Asset Classification, Income Recognition and Provisioning
(b) Infrastructure projects, provided the cash flows generated from these projects are adequate for repayment
of the advance, the financing bank(s) have in place an appropriate mechanism to escrow the cash flows,
and also have a clear and legal first claim on these cash flows.
ii) The unit becomes viable in 8 years, if it is engaged in infrastructure activities, and in 5 years in the case of other
units.
iii) The repayment period of the restructured advance including the moratorium, if any, does not exceed 15 years in
the case of infrastructure advances and 10 years in the case of other advances. The aforesaid ceiling of 10
years would not be applicable for restructured home loans; in these cases the Board of Directors of the banks
should prescribe the maximum period for restructured advance keeping in view the safety and soundness of the
advances.
iv) Promoters' sacrifice and additional funds brought by them should be a minimum of 20 per cent of banks'
sacrifice or 2 per cent of the restructured debt, whichever is higher. This stipulation is the minimum and banks
may decide on a higher sacrifice by promoters depending on the riskiness of the project and promoters' ability to
bring in higher sacrifice amount. Further, such higher sacrifice may invariably be insisted upon in larger
accounts, especially CDR accounts. The promoters' sacrifice should invariably be brought upfront while
extending the restructuring benefits to the borrowers. The term 'bank's sacrifice' means the amount of 'erosion in
the fair value of the advance'; or "total sacrifice", to be computed as per the methodology enumerated in para
4.197(i) and (ii) above.
(Prior to May 30, 2013, if banks were convinced that the promoters face genuine difficulty in bringing their share
of the sacrifice immediately and need some extension of time to fulfill their commitments, the promoters could be
allowed to bring in 50% of their sacrifice, i.e. 50% of 15%, upfront and the balance within a period of one year.
However, in such cases, if the promoters fail to bring in their balance share of sacrifice within the extended time
limit of one year, the asset classification benefits derived by banks will cease to accrue and the banks will have
to revert to classifying such accounts as per the asset classification norms as given in para 17.2 of aforesaid
Master Circular.
v) Promoter's contribution need not necessarily be brought in cash and can be brought in the form of de-rating of
equity, conversion of unsecured loan brought by the promoter into equity and interest free loans.
vi) The restructuring under consideration is not a 'repeated restructuring' as defined in para (v) of Annex - 5 of the
Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to
Advances dated July 1, 2015.
4.222 As per para 20.2.3 of the Master Circular dated July 1, 2015 the extant incentive for quick implementation of
restructuring package and asset classification benefits (paragraphs 4.219 to 4.221 (available on restructuring on
fulfilling the conditions will however be withdrawn for all restructurings effective from April 1, 2015 with the exception
of provisions related to changes in DCCO in respect of infrastructure as well as non-infrastructure project loans. It
implies that with effect from April 1, 2015, a standard account on restructuring (for reasons other than change in
DCCO and) would be immediately classified as sub-standard on restructuring as also the non-performing assets,
upon restructuring, would continue to have the same asset classification as prior to restructuring and slip into further
lower asset classification categories as per the extant asset classification norms with reference to the pre-
restructuring repayment schedule.
4.223 Accelerated Provisioning
In cases where banks fail to report SMA status to the accounts to CRILIC or resort to methods with the intent to
conceal the actual status of the accounts or evergreen the accounts, banks will be subjected to accelerated
provisioning for these accounts as under:
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Asset Period as NPA Current Provisioning Revised accelerated
Classification provisioning (%)
Sub Standard Upto 6 months 15 15 (no change)
(Secured) 6 months to 1 year 15 25
Sub Standard Upto 6 months 25(other than infrastructure 25
(unsecured ab initio) loans)
20 (infrastructure loans)
Same as above
6 months to 1 year 40
Doubtful I 2nd year 25(secured portion) 40
100 (unsecured portion)
100
Doubtful II 3rd & 4th year 40 (secured portion) 100 for both secured and
100 (unsecured portion) unsecured portion
Doubtful III 5year onwards 100 100
4.224 The accelerated provisioning requirement as above is not only for non reporting or delayed reporting or
wrong reporting of SMA status bit also for delay/refusal in implementation of package already agreed by lender under
CAP by JLF.
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Part IV
Items of Bank's Financial Statements
and Auditing Aspects
IV-1
Cash, Balances with RBI and Other Banks,
and Money at Call and Short Notice
1.01 Cash, Balances with RBI and Other Banks, and Money at Call and Short Notice constitutes one of the
important items of balance sheet of a bank. Of these items, only a few select branches in each bank handle the
transactions relating to money at call and short notice.
Balance Sheet Disclosure
1.02 The Third Schedule to the Banking Regulation Act, 1949, requires the following disclosures to be made in
the Schedule 6 & Schedule 7 of balance sheet regarding cash, balances with RBI, balances with other banks, and
money at call and short notice.
Cash and Balances with Reserve Bank of India-Schedule 6
I. Cash in hand (including foreign currency notes)
II. Balance with Reserve Bank of India
(i) in Current Account
(ii) in Other Accounts
Balances with Banks and Money at Call and Short Notice- Schedule 7
I. In India
(i) Balances with other banks
(a) in Current Accounts
(b) in Other Deposit Accounts
(ii) Money at call and short notice
(a) with banks
(b) with other institutions
II. Outside India
(i) in Current Accounts
(ii) in Other Deposit Accounts
(iii) Money at call and short notice
Balances with Reserve Bank of India, Balances with Other Banks
1.03 Banks maintain accounts with RBI and other Banks for Banking Operations however only select branches
maintain account with RBI. The branches also maintain accounts with other banks for banking operations.
Money at Call and Short Notice
1.04 Money at call and short notice represents short-term investment of surplus funds in the money market.
Money lent for one day is money at `call' or `call money' means deals in overnight funds, while money lent for a
period of more than one day and up to fourteen days is money at `short notice'. The lender bank does not get any
security for money lent at call or short notice. The participants of call and notice money market are scheduled
commercial banks (excluding RRBs), co-operative banks (other than land development banks) and primary dealers
(PDs), both as borrowers and lenders. Non-bank institutions (other than PDs) are not permitted to participate in
call/notice money market. Scheduled commercial banks usually borrow from this market to meet the requirements
Cash, Balances with RBI and Other Banks, and Money at Call and Short Notice
relating to cash reserve ratio or statutory liquidity ratio. The decisions to borrow from, or lend in, the market are taken
usually at the head office level and communicated to select branches for effecting the borrowing/lending.
1.05 RBI vide its Master Direction no. RBI/FMRD/2016-17/32 FMRD. Master Direction No. 2/2016-17 dated July
7, 2016 on "Money Market Instruments: Call/ Notice Money Market, Commercial Paper, Certificates of Deposit and
Non-Convertible Debentures (original maturity up to one year)" provides the detailed guidelines on the prudential
limits in respect of both outstanding and lending transactions in call/notice money market for scheduled commercial
banks, co-operative banks and PDs. The eligible participants are free to decide the interest rates in call/notice
money market. Computation of interest payable would be based on the methodology given in handbook of market
practices brought out by the Fixed Income Money Market and Derivates Association of India (FIMMDA) and the
eligible participants may adopt the documentation suggested by FIMMDA from time to time. The Call/Notice Money
transactions can be executed either on NDS-Call, a screenbased, negotiated, quote-driven electronic trading
system managed by the Clearing Corporation of India (CCIL), or over the counter (OTC) through bilateral
communication. NDS-Call (a screen based, negotiated, quote-driven system), do not require separate reporting,
however, it is mandatory that all OTC deals should be reported within 15 minutes on NDS-Call reporting platform
irrespective of the size of the deal.
Audit Approach and Procedures
Cash
1.06 The auditor should carry out verification of the balance of cash on hand. As far as possible, the auditor
should visit the branch at the close of business on the last working day of the year or before the commencement
of business on the next day for carrying out the physical verification of cash. If, for any reason, the auditor is
unable to do so, he should carry out the physical verification of cash as close to the balance sheet date as
possible. . In few Banks, the branch deposits a large portion of its cash balance with the RBI or the State Bank of
India or any other bank on the closing day, in such cases, the auditor must request the branch to provide sufficient
appropriate evidence for the same.
1.07 Care should be taken to ensure that if cash is kept separately in different departments or at different
locations (e.g., at extension counters), all the balances are verified by the auditor simultaneously. The auditor
should also ensure that there is no movement of cash till the such cash are physically verified.
1.08 The auditor should evaluate the effectiveness of the system of internal controls in branch regarding daily
verification of cash, maintenance of cash balance registers and vault register, custody of cash, custody of vault
keys, daily cash holding and retention limit of the branch, etc. The auditor should examine/inquire whether there is
a global (insurance) policy taken for safety of cash from theft or burglary and such policy is effective as on
reporting date. This would be relevant for a bank as a whole and there would not be any insurance policy available
at the branch level, however the branch auditor should seek a Xerox copy of the same from the Head office. The
Central Statutory Auditor should also make an analysis of the quantum of cash holding and whether the insurance
cover is adequate. This will also be important from the perspective of reporting in Long Form Audit Report (LFAR)
under (I) Assets-Cash.
1.09 For physically verifying the cash-on-hand, the auditor may proceed as below:
(a) Physically verify the cash-on-hand available at the branch. The extent of verification would depend upon
the auditor's assessment of the efficacy of internal control system including adherence to cash retention
limits fixed by the head office, mode of custody of cash (whether single or joint), and frequency of cash
verification by branch officials and/or by internal or concurrent auditors. Normally, in a bank, 100 notes of
each denomination and thereafter 10 packets of 100 notes each are bundled together. Wherever sample
checking is conducted, it is advisable that number of bundles of 100's is fully counted. Besides, the
number of notes in samples of bundles of old notes of different denominations may also be checked, the
sample size for larger denomination notes being higher than that in the case of smaller denomination
notes. The number of notes in a small sample of bundle of new notes of larger denominations (say, Rs.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
100 or more) may also be counted. In any event, care should be taken to ensure that all bundles
produced for audit verification are properly sealed. Loose/soiled notes should be counted in full. Coins
may be counted, or weighed and converted into monetary value as per RBI guidelines. The process and
unprocessed notes should be separately kept and the denomination of the same should be separately
mentioned in the cash balance register.
(b) Obtain a certificate from the bank indicating denomination-wise cash balance as on the date of
verification.
1.10 Notes/coins in sealed packets may be accepted based on a written representation from the branch
management and cross-checked with subsequent entries in the books of account.
1.11 The cash balance as physically verified should be agreed with the balance shown in the cash book and
the books of account. When the physical verification of cash is carried out by the auditor before or after the date of
the balance sheet, the auditor should perform the additional audit procedure to reconcile the results of verification
with the cash balance as at the balance sheet date.
1.12 Foreign currency notes should also be verified at the time of physical verification of cash. The auditor
should also ensure that these notes are converted at the market rate prevailing on the closing day as notified by
the Foreign Exchange Dealers' Association of India (FEDAI) in accordance with the accounting policy followed by
the bank.
1.13 Special care needs to be exercised in cases where the branch operates currency chest and/or Small Coin
Deposits. In respect of currency chest operations, the branch merely acts as an agent of the RBI to facilitate the
distribution of bank notes and rupee coins. The balance in currency chest at any point of time is the property of the
RBI and not of the bank. Therefore, while the auditor may not physically count the balance in currency chest on
closing day, but should take sufficient safeguards to ensure that currency chest balance is not mixed up in the
cash balances produced for physical verification. Also, it should be recognised that the bank may be contingently
liable for any shortfall in the currency chest balance. Accordingly, the branch auditor should pay special attention
to the system of operation of currency chest transactions, recording of such transactions, method and frequency of
counting of cash, and reconciliation with the link office. The auditor should perform compliance tests to evaluate
the effectiveness of the system of operation of currency chest. The auditor should also examine whether the
system is such that the transactions relating to deposits into and withdrawals from, currency chest are recorded
appropriately. In case the relevant transactions are required to be communicated to a link office of the bank (which
maintains the account of RBI) for the purpose of reporting the same to the RBI, the auditor should evaluate the
effectiveness of the system of reporting in terms of timeliness and accuracy.
1.14 In terms of the Master Direction No RBI/DCM/2017-18/59Master Direction DCM(CC) No.G -
2/03.35.01/2017-18 dated October 12, 2017 on "Levy of Penal Interest for Delayed Reporting/Wrong
Reporting/Non-Reporting of Currency Chest Transactions and Inclusion of Ineligible Amounts in Currency Chest
Balances" the banks are required to report the minimum amount of deposit into/withdrawal from currency chest of
Rs.1,00,000/- and thereafter, in multiples of Rs. 50,000/-. Further, the banks are obliged to follow the instructions
regarding timely reporting of Currency Chest Transactions by the banks for branches to which Currency chests are
attached; and non-compliance of the RBI instructions invite Levy of Penal Interest for delayed reporting/wrong
reporting/non-reporting of Currency Chest transactions and penal measures for cases involving
shortages/inclusion of counterfeit bank notes in chest balances/ chest remittances.
1.15 All currency chest transactions (deposits into /withdrawals from currency chest) at the respective branch,
must be reported through ICCOMS on the same day by 9 PM [by uploading data through the Secured Website
(SWS)] to the link office to which the branch is attached for this purpose. Each Link office must, in turn, report to
the RBI Issue Office concerned, latest by 11 PM on the same day, the consolidated net position for all the linked
branches; except in certain exceptional circumstances, like during strike period and on account of genuine
difficulties faced by chests especially in hilly/remote areas and other chests affected by natural calamities, etc.,
where the default may be acceptable to the RBI, at its discretion. However, in case of wrong reporting
representations for waiver will not be considered.
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Cash, Balances with RBI and Other Banks, and Money at Call and Short Notice
1.16 The said directions cover:
a. Levy of penal interest for delays.
b. Wrong reporting and levy of penal interest.
c. Maximum penal interest to be charged.
d. Penal interest for inclusion of ineligible amounts in the currency chest balances.
e. Rate of penal interest (to be levied at the rate of 2% over the prevailing Bank Rate for the period of
delayed reporting/wrong reporting/non-reporting /inclusion of ineligible amounts in chest balances).
f. Levy of penal interest in respect of currency chests at treasuries.
1.17 The operation of currency chests attached to the various branches of the bank, affects the balances in
accounts of RBI maintained by the bank at the designated branches; and it is imperative that the transactions on
value date basis are recorded (as it affects the cash balance and that with RBI, on the day of the cash withdrawal
from or deposit into the currency chest). Designated branches that maintain the RBI account should pass the
entries the day of the transaction for currency chest attached to it; and as the Link Office for other branches
operating Currency chests, based on inward communication from such other branches linked to it.
1.18 Due to any delays in communication by such branches to the Link Office, the amount required to be
debited or credited to RBI Account, remains in a nominal account (Inter branch Adjustments) and affects the RBI
account balance in the books of the Link Office. On line communication system should remedy this to ensure
recording of entries at the designated Link Office, simultaneously as they take place at all currency chest
branches.
1.19 The auditor should examine whether the account of the RBI at the designated branch maintaining the RBI
Account has incorporated all the currency chest transactions on a value date basis as at the year end. He should
also enquire as to whether the Bank has received any communication from RBI regarding any defaults in the
operation of the currency chests, that may have penal consequences and whether during the year, any penalties
have been levied on this account.
1.20 RBI Master Circular No. RBI/2017-18/3DCM(NE) No.G - 1/08.07.18/2017-18 dated July 03, 2017 on
"Facility for Exchange of Notes and Coins" requires that all designated bank branches should display at their branch
premises, at a prominent place, a board indicating the availability of note exchange facility with the legend,
"Soiled/Mutilated notes are Accepted And Exchanged Here". Banks should ensure that all their designated branches
provide facilities for exchange of notes and coins. The branches should ensure that the note exchange facility is not
cornered by private money changers / professional dealers in defective notes. The auditor should also inquire about
the service charges levied by the bank on Exchange of soiled notes as per RBI Notification No. RBI/2016-17/15 DCM
(NE) No.120/08.07.18/2016-17 dated July 14, 2016 to identify the revenue leakage in the bank.
1.21 The auditor should verify that the banks have not stapled the notes. Some banks in spite of RBI's
instructions continue to follow the practice of stapling of note packets. This practice, apart from damaging notes,
reduces the life span of notes and renders it difficult for customers to open note packets easily. Banks should do
away with stapling of any note packets and instead secure them with paper bands. Further, RBI has issued, Master
Circular No. RBI/2017-18/26 DCM (FNVD) G 4/16.01.05/2017-18dated July 20, 2017on "Detection and Impounding
of Counterfeit Notes" which provides operational guidance on detection and impounding of Counterfeit notes. The
Government of India has framed Investigation of High Quality Counterfeit Indian Currency Offences Rules, 2013
under Unlawful Activities (Prevention) Act (UAPA), 1967. The Third Schedule of the Act defines High Quality
Counterfeit Indian Currency Note. Activity of production, smuggling distribution and circulation of High Quality
Counterfeit Notes has been brought under the ambit of UAPA, 1967.
1.22 Increasingly banks are entering into an agreement with third party vendors for management of their ATM
operations. These vendors collect amount from banks and are responsible for loading amount in the ATM. They are
also responsible for collecting (deposited by customers) amount from ATM and depositing with bank. The auditor
should verify an agreement entered with these vendors. The auditors should also understand the process of
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
providing, collecting and reconciliation etc. with these vendors and test controls in the process.
At each period end, the auditor should send independent balance confirmation to these vendors about balance held
by them and should verify reconciliation statements.
1.23 Also in respect of ATM operations, banks are centralizing the process of monitoring ATM balance. This
division monitors balance as per the books and balance as per ATM machine (commonly termed as Switch balance)
and their reconciliation and ensuring timely adjustment of reconciling entries. The auditor should understand the
process of monitoring of balance, reconciliation etc. and based on the risk assessment should understand controls in
the process and strategy of testing these controls.
1.24 Where ATMs are operated by bank themselves, auditor should verify the cash at ATMs also and tally the
same with books of accounts. At each reporting period end, the auditor should obtain the reconciliation statement
and should verify the reconciliation statement.
Balance With RBI
1.25 In a bank, only a few select branches are designated to have accounts (Deposit/Current) with the RBI,
the main account generally being with the Treasury Branch. The procedures of confirmation/reconciliation are no
different as compared to accounts and balances with other banks and need to be followed except the
confirmations.
1.26 It is relevant to point out that, amongst others, currency chest operations involve entries in the accounts
maintained with RBI. Where currency chest is attached to the branch maintaining RBI account, all deposits into and
withdrawals from the currency chest trigger a debit /credit to the account maintained at the Branch itself. Other
branches of the bank having currency chests but not maintaining the RBI Account would be linked to such Branch
and would be required to transmit information forthwith for all deposits into/withdrawal from the attached currency
chest through Inter branch mechanism. The effect of such entries is required to be considered in the RBI account on
a value date basis.
1.27 The auditor of the Branch maintaining the RBI account should follow direct confirmation procedures of the
balances in the RBI account and examine the reconciliation to ensure that all transactions originating in the account
statement of the RBI are duly responded on value date basis.
1.28 The auditor should enquire into the reasons /justification for the following items appearing in the
reconciliation statements:
(i) cash transactions remaining unresponded;
(ii) revenue items requiring adjustments/write-offs; and
(iii) old outstanding balances remaining unexplained/ unadjusted for significant period.
Balance With Banks (Other than Reserve Bank of India)
1.29 The auditor should also apply the procedures described in paragraphs above in examining the balances
with banks other than RBI. While reviewing the reconciliation statements, the auditor should pay particular
attention to the following:
(a) Examine that no debit for charges or credit for interest is outstanding and all the items which ought to
have been taken to books of accounts for the year have been considered. This should be particularly
observed when the bills collected, etc., are credited with net amount and entries for commission, etc., are
not made separately in the statement of account.
(b) Examine that no cheque sent or received in clearing is outstanding. As per the practice prevalent among
banks, any cheques returned unpaid are accounted for on the same day on which they were sent in
clearing or on the following day.
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Cash, Balances with RBI and Other Banks, and Money at Call and Short Notice
(c) Examine that all bills or outstanding cheques sent for collection and outstanding as on the closing date
have been credited subsequently.
1.30 The auditor should also examine the large transactions in inter-bank accounts, particularly towards the
year-end, to ensure that no transactions have been put through for window-dressing.
1.31 In respect of balances in deposit accounts, original deposit receipts should be examined in addition to
confirmation certificates obtained from banks in respect of outstanding deposits. Balances in deposit accounts are
usually (though not necessarily) in round figures. Where such balances are in odd figures, the auditor should
enquire whether the account concerned is actually of the nature of a deposit account. The auditor should also
ensure that interest on such deposits have been recorded on time proportion basis and interest have been
recorded till the closing day.
1.32 The balances with banks outside India should also be verified in the manner described above. These
balances should be converted into the Indian currency at the exchange rates prevailing on the balance sheet date.
1.33 Increasingly banks are automating the process of reconciliation with other banks. In case of system
process, the auditor should understand the system, system controls and manual controls. The auditor should also
assess the system access control and program change controls of the reconciliation system. (Also refer chapter 3,
Special Considerations in a CIS Environment of Part II).
Money at Call and Short Notice
1.34 The auditor needs to enquire whether the bank has an approved risk policy of lending money at call or
short notice and the same has been adhered before lending money at call or short notice. This would be more
relevant at the Head Office rather than at the branch level.
1.35 The auditor should examine whether there is a proper authorisation, general or specific, for lending of the
money at call or short notice. Compliance with the instructions or guidelines laid down in this behalf by the head
office or controlling office of the branch, including the limits on lending in inter-bank call money market, should
also be examined.
1.36 Call loans should be verified with the certificates of the borrowers and the call loan receipts held by the
bank. The auditor should examine whether the aggregate balances comprising this item as shown in the relevant
register/account tally with the control accounts as per the general ledger. The auditor should also examine
subsequent repayments received from borrowing banks to verify the amounts shown under this head as at the
year-end. It may be noted that call loans made by a bank cannot be netted-off against call loans received.
1.37 Like deposits with banks, money at call and short notice are also usually (though not necessarily) in
round figures. Any odd balances should, therefore, put the auditor to enquiry.
1.38 The auditor should also verify that borrowing or lending for more than 14 days are not classified under
this head, but are classified as `deposits' or `advances', depending on the nature of lending and the parties to
whom the moneys have been lent.
1.39 The auditor needs to verify monies at call to banks, whether they are fresh or roll over of the old
transactions and ascertain whether any provision or write off is required.
1.40 It may be noted that as per the directions of the RBI, banks cannot pay any brokerage on deposit and call
loans, except to the extent specified in paragraph 8(e) of the RBI circular dated July 22, 1971.
1.41 The auditor should examine whether interest has been properly accrued and accounted for on year-end
outstanding balances of money at call and short notice by confirming the same from the opposite party.
1.42 Auditor's Role:
The auditor should familiarize himself with the various circulars/ notifications/ instructions issued by Government and
RBI in connection with the demonetization scheme of Government of India.
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The auditor should assess based on the observations of the concurrent auditor/ special auditor/ other auditor/
inspectors, etc., whether the bank has laid down a proper system to ensure compliance of the aforesaid
requirements.
In case of any material non-compliance observed, the auditor should exercise professional judgement in
determining the manner of reporting of such non-compliance.
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IV-2
Fixed Assets and Other Assets
Fixed Assets
2.01 Fixed assets comprise premises and other fixed assets such as furniture and fixtures, motor vehicles, office
equipment, computers, other intangible assets such as application software and other computer software, etc.
2.02 In the case of most banks, fixed assets can be purchased by the head office, regional/zonal offices and
branches up to the monetary ceiling specified (though purchase of land and buildings is usually centralised) for
themselves as also for offices within their control. However, banks generally prefer to centralise the function of
obtaining insurance and obtain a comprehensive policy for assets at numerous locations (to avail the benefit of
rebate on bulk business). Fixed assets, particularly furniture and fixture, consumer durables, etc. are provided by
banks to the staff and the account for the same is maintained at the office where the employee is posted. For
disposal of fixed assets, powers are delegated to various levels in the bank.
2.03 As far as maintenance of records relating to fixed assets is concerned, practices vary among banks. In
some banks, the offices acquiring the fixed assets have to maintain proper records including the provision of
depreciation thereon whereas in case of some banks, the same is being done at Head Office. In such a case, the
acquisitions, disposals, etc. are advised by the branch/other office concerned to the head office through the inter-
branch accounting mechanism. A variant of this practice involves the recording of depreciation by branches and
other offices based on the advice received from the head office. In recent times, some of the banks have installed
Fixed Asset Management Software and the information relating to purchase, sale of fixed assets and depreciation
thereon (in some cases) is accounted for with the help of such a software. This is usually done at a centralized HO
level and reports are generated at branches and/or regional/zonal offices. In some cases, passing of entries of
certain types of IT assets, like computers, printers, ATMs etc., are centralized at the HO. However, physical records
need to be updated at branches. Also branches need to update records/inform HO in case there has been physical
movement of assets from one branch/location to another including in case of transfers at staff quarters or disposal. At
the branch level, an auditor needs to conduct a physical verification of all assets particularly those acquired during
the year and match the same with fixed asset management system (manual or electronic). Discrepancies, noticed if
any, on such verification should have been properly dealt with in the books.
Balance Sheet Disclosure
2.04 The Third Schedule to the Banking Regulation Act, 1949 requires fixed assets to be classified into two
categories in the balance sheet, viz., Premises and Other Fixed Assets. Though not specifically mentioned under the
Banking Regulation Act, 1949, the assets taken on lease and intangible assets should be shown separately for
proper classification and disclosure and also to comply with the requirements of the Accounting Standards (ASs)
issued by the Institute of Chartered Accountants of India (ICAI).
2.05 As per the Notes and Instructions for compilation of balance sheet, issued by the RBI, premises wholly or
partly owned by the banking company for the purpose of business including residential premises should be shown
under the head, `Premises'. Furniture and fixtures, motor vehicles, office equipments, computers and all other fixed
assets except premises should be shown under the head `Other Fixed Assets'.
2.06 The original cost of fixed assets as on 31st March of the preceding year, additions thereto and deductions
therefrom during the year, and total depreciation written off to date are to be disclosed in the financial statements.
The Notes and Instructions for Compilation of Balance Sheet, issued by the RBI, require that where sums have been
written-off on reduction of capital or revaluation of assets, every balance sheet after the first balance sheet
subsequent to the reduction or revaluation should show the revised figures for a period of five years with the date and
amount of revision made.
Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
2.07 No rates of depreciation on fixed assets have been prescribed by the Banking Regulation Act, 1949. The
provisions of the Schedule II to the Companies Act, 2013, should, therefore, be kept in mind in this respect especially
in so far as the banking companies are concerned. Disclosure is mandatory in respect of the method adopted to
compute the revalued amounts, the nature of the indices used, the year of any appraisal made and whether an
external valuer was involved in case the assets are stated at revalued amounts. Banking Regulation Act, 1949
requires that the auditor should examine whether the rates of depreciation are appropriate in the context of the
expected useful lives of the respective fixed assets. Depreciation rates must be reconfirmed with the Accounting
policy of the bank. In respect of computers and data processing equipments, RBI has directed that depreciation
should be provided over three year period. With respect to fixed assets held at foreign offices/branches, depreciation
policy should be consistent with that followed by the bank as a whole and to the extent not contradictory with the local
laws and regulations. Further, as per note 4 of Schedule II of the Companies Act, 2013, useful life specified in Part C
of the Schedule is for whole of the asset. Where cost of a part of the asset is significant to total cost of the asset and
useful life of that part is different from the useful life of the remaining asset, useful life of that significant part shall be
determined separately, in other words component accounting with respect to fixed assets would be mandatory
effective from financial year 2015-16 onwards.
2.08 An immovable property acquired by the bank in satisfaction of debts due should be included under the head
'fixed assets', if it is held by the bank for its own use.
2.09 The Third Schedule to the Banking Regulation Act, 1949, does not specifically deal with disclosure of land.
Land is generally shown under the heading `premises'.
Other Assets
2.10 The following items broadly are to be disclosed under the head 'Other Assets':
Inter-office adjustments (net) Stationery and stamps
Interest accrued Non-banking assets acquired in satisfaction of
claims
Tax paid in advance/tax deducted at source
Others
2.11 As per RBI Circular no. DBOD.BP.BC.24/21.04.048 of March 30, 1999, credit card outstanding is not to be
included under `Other Assets'. Instead, they have to be shown as part of advances.
2.12 As per RBI circular DBOD.BP.BC.83/21.01.002/2000-01 of February 28, 2001, all loans and advances given
to staff, which are non-interest bearing should be included in item 'Others' under 'Other Assets' and should not be
reflected as `Advances'.
Audit Approach and Procedures
Fixed Assets
2.13 In carrying out the audit of fixed assets, the auditor is concerned, primarily, with obtaining evidence about
their ownership, existence and valuation. For this purpose, the auditor should review the system of internal
controls relating to fixed assets, particularly the following:
Control over expenditures incurred on fixed assets acquired or self constructed;
Accountability and utilisation controls; and
Information controls for ensuring availability of reliable information about fixed assets.
2.14 The branch auditor should ascertain whether the accounts in respect of fixed assets are maintained at the
branch or centrally. Similarly, the auditor should ascertain the location of documents of title or other documents
evidencing ownership of various items of fixed assets. The procedures described in the following paragraphs
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would be relevant only to the extent the accounts and documents of title, etc., relating to fixed assets are
maintained at the branch. Where the acquisition, disposal, etc., of fixed assets take place at branches / other
offices, but accounting of fixed assets is done at the head office, the branch auditor should examine whether
acquisitions, disposals, etc. effected at the branch during the year have been properly communicated to the head
office. In cases where, for any reason acquisition of fixed asset is shown in suspense account then the branch
cannot classify the asset in the Balance Sheet under this head unless the asset is put to use or ready for use, as
the case may be, and all internal formalities are completed. A long standing suspense entry of this type should be
properly dealt with by the auditor and may need to be escalated to the statutory central auditors if the amount
involved is material.
Premises
2.15 The auditor should verify the opening balance of premises with reference to schedule of fixed assets,
ledger or fixed assets register. Acquisition of new premises should be verified with reference to authorisation, title
deeds, record of payment, etc. Self-constructed fixed assets should be verified with reference to authorisation
from appropriate authority and documents such as, contractors' bills, work order records, record of payments and
completion certificate. The auditor should also examine whether the balances as per the fixed assets register
reconcile with those as per the ledger and the final statements.
2.16 In the case of leasehold premises, capitalisation and amortisation of lease premium, if any, should be
examined. Any improvements to leasehold premises should be amortised over their balance residual life. It would
be appropriate to segregate the cost/value of the land from the building/superstructures to ensure that
depreciation/amortisation is appropriately considered in case of leasehold premises.
2.17 In case the title deeds are held at the head office or some other location, the branch auditor should obtain
a written representation to this effect from the branch management and should bring this fact to the notice of the
Statutory Central Auditor through a suitable mention in his report. This fact should also be brought in the Long
Form Audit Report (LFAR).
2.18 Where premises are under construction, it should be seen that they are shown under a separate heading,
e.g., `premises under construction'. Advances to contractors may be shown as a separate item under the head
`fixed assets' or under the head `other assets'. It should be verified that where the branch has obtained the licence
to commence business and is ready for use then the same is not shown as "premises under construction". In such
cases even if all the bills/ documents from the contractors/suppliers are not received, at the year end, an estimate
of the expenditure thereon should be made and capitalised on a provisional basis.
2.19 Where the premises (or any other fixed assets) are re-valued, the auditor should examine the
appropriateness of the basis of revaluation. The auditor should also examine whether the treatment of resultant
revaluation surplus or deficit is in accordance with Accounting Standard (AS) 10, "Accounting for Fixed Assets".
The auditor should also check the impairment, if any, by applying the principles laid down in Accounting Standard
(AS) 28, "Impairment of Assets".
2.20 The auditor should specifically keep in mind the provisions of section 9 of the Banking Regulation Act, 1949,
which prohibit a banking company from holding any immovable property, howsoever acquired (i.e., whether acquired
by way of satisfaction of claims or otherwise), for a period exceeding seven years from the date of acquisition, except
such as is required for its own use. The auditor should specifically examine that no immovable properties other than
those required for the own use of the bank have been included in fixed assets (own use would cover use by
employees of the bank, e.g., residential premises provided to employees). The branch auditor should also obtain a
written representation to the above effect from the branch management.
Other Fixed Assets
2.21 The procedures discussed above regarding premises also apply, to the extent relevant, to verification of
other fixed assets. In respect of moveable fixed assets, the auditor should pay particular attention to the system of
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recording the movements as well as other controls over such fixed assets, e.g., their physical verification at
periodic intervals by the branch management and/or by inspection/internal/concurrent audit team. The auditor
should also examine whether discrepancies have been properly dealt in the books of account and adequate
provision in respect of any damaged assets has been made. as per the physical verification of Fixed assets
reports available on record.
2.22 In recent years, banks have incurred substantial expenditure on computer hardware and software.
Computer hardware qualifies the definition of a `fixed asset' as given in AS 10, "Accounting for Fixed Assets".
Computer software that is essential for the functioning of the hardware (e.g., operating system) can be considered
an integral part of the related hardware. The expenditure incurred on acquisition and installation of the hardware
(as also on any systems software considered to be an integral part of the related hardware) should be capitalised
in accordance with the principles laid down in AS 10, "Accounting for Fixed Assets", and depreciated over the
remaining useful life of the hardware. Hardware and software are susceptible to faster rate of technical
obsolescence; hence the auditor must take into consideration this fact while verifying the provision for depreciation
on these assets. The same, however, should not be depreciated for a period of more than three years.
2.23 Application software is not an integral part of the related hardware and is treated as an intangible asset.
Accordingly, the same should be accounted for as per Accounting Standard (AS 26), "Intangible Assets". The
treatment of expenditure on applications software, whether acquired from outside or developed in-house, would
also be similar. However, in estimating the useful life of applications software, the rapid pace of changes in
software as also the need for periodic modification/ upgradation of software to cater to changes in nature of
transactions, information needs etc. need special consideration. As far as expenditure during the stage of in-
house development of software is concerned, the same needs to be accounted for in accordance with AS 26,
"Intangible Assets", according to which expenditure incurred during the research phase should not be capitalised
as part of cost of intangibles. While capitalising the development phase expenditure, due consideration should be
given to Paragraph 44 of the said Standard. Further, due care should be taken in verifying the date of
capitalization and date on which asset was put to use/ ready for intended use, particularly in case of
implementation of application software and system. While conducting the audit of intangible assets, the auditor
should also consider the guidelines given by RBI by way of Circular No.DBOD.No.BP.BC.82/21.04.018/2003-04,
dated April 30, 2004.
In case of Banking Companies, the auditor needs to verify that the requirements of Schedule II to the Companies
Act, 2013 are also complied with including identification of components wherever applicable. Banks may acquire
software at considerable expenditure. The system of recording this expenditure as part of the fixed assets (so that
it may be depreciated) or to defer expenditure (for amortisation over its useful life) may be reviewed. The Bank's
Accounting Policy in this regard must be enquired into, and a note kept on record. Non provision for this intangible
will not attract the provisions of Section 15 of the Banking Regulation Act, as per a notification specifically issued
by the Govt. of India.
At times, though depreciation has been fully provided on certain types of assets, however, they continue to be in
use. In such cases the auditor should verify that the bank's policy in this regard has been followed.
2.24 Many a times, fixed assets like furniture, office equipments, etc., are transferred from one branch to
another. The auditor should examine whether accumulated depreciation in respect of such assets is also
transferred. It may be noted that the consolidated accounts of the bank would not be affected by such transfers. In
recent times, the fixed asset management softwares are in use. The auditor has to examine the reasonableness of
the internal controls with respect to recording such inter branch transfer of assets
2.25 It should be examined whether fixed assets have been properly classified. Fixed assets of similar nature
only should be grouped together. For example, items like safe deposit vaults should not be clubbed together with
the office equipments or the theft alarm system of the bank.
2.26 In respect of fixed assets sold during the year, a copy of the sale deed, if any, and receipt of the sale
value should be examined by the auditor. In such a case, it should also be seen that the original cost and
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accumulated depreciation on the assets sold have been correctly adjusted. Profit earned or loss incurred on such
sales should also be checked.
In case of sale/disposal/scrapping of fixed assets, the auditor should examine whether there is an adequate
control system in place and the same has been adhered to. The auditor should also ensure that proper accounting
for the same has been done.
2.27 The auditor should examine whether any expenditure incurred on a fixed asset after it has been brought
to its working condition for its intended use, has been dealt with properly. According to AS 10, "Accounting for
Fixed Assets", such expenditure should be added to the book value of the fixed asset concerned only if it
increases the future benefits from the asset beyond its previously assessed standard of performance.
2.28 The auditor at head office level should examine if the consolidated fixed assets schedule matches in all
respect and all the transfers' ins/outs, are tallied. A broad check on the depreciation amount vis-a-vis the gross
block of assets must be reviewed with special emphasis on the computer hardware/software.
Leased Assets
2.29 RBI's Circular No. DBOD No.FSC.BC.70/24.01.001/99 dated July 17, 1999 deals with accounting and
provisioning norms to be followed by banks undertaking leasing activity. The auditor, in respect of leased assets,
should also have regard to the requirements of AS 19, "Leases". Assets given on Lease need to be separately
shown in same manner as other assets.
Impairment of Assets
2.30 AS 28, Impairment of Assets prescribes the procedures that an enterprise should apply to ensure that its
assets are carried at not more than their recoverable amount. An asset is treated as carried at more than its
recoverable amount if its carrying amount exceeds the amount to be recovered through use or sale of the asset. If
this is the case, the asset is described as impaired and this Standard requires the enterprise to recognise an
impairment loss. This Standard also prescribes when an enterprise should reverse an impairment loss and it
prescribes certain disclosures for impaired assets. This Standard requires that an enterprise should assess at each
balance sheet date whether there is any indication that an asset may be impaired. The impairment loss, if
recognised, shall be debited in the profit and loss account provided no revaluation reserve exists at that date in
relation to the asset, and if it exists, the loss should first be debited to revaluation reserve. After debiting the
revaluation reserve, if still there is impairment loss then the same should be debited to profit and loss account. RBI's
circular on compliance with Accounting Standards, issued in April 2004 states as follows in respect of AS 28:
The Standard would not apply to investments, inventories and financial assets such as loans and advances
and may generally be applicable to banks in so far as it relates to fixed assets.
Banks may also take into account the following specific factors while complying with the Standard:
Paragraphs 7 and 8 of the Standard have clearly listed the triggers which may indicate impairment of the
value assets. Hence, banks may be guided by these in determining the circumstances when the Standard
is applicable to banks and how frequently the assets covered by the Standard need to be reviewed to
measure impairment.
In addition to the assets of banks which are specifically identified above, viz., financial assets,
inventories, investment, loans and advances etc to which the Standard does not apply, the Standard
would apply to financial lease assets and non-banking assets acquired in settlement of claims only when
the indications of impairment of the entity are evident.
Other Assets
2.31 The branch auditor may carry out the audit of various items appearing under the head `Other Assets' in
the following manner.
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Inter-Office Adjustments
2.32 Inter Office Adjustments/Inter Branch Account is dealt separately in Chapter 12 of Part IV on "Inter-office
Transactions".
Interest Accrued
2.33 The main components of this item are interest accrued but not due on investments and advances and
interest due but not collected on investments. As banks normally debit the borrower's account with interest due on
the borrowers repayment cycle date, there would usually be an amount of interest accrued but not due on
advances on balance sheet date. On the other hand, interest on government securities, debentures, bonds, etc.,
which accrues from day to day should be calculated and brought into account, in so far as it has accrued on the
date of the balance sheet. The auditor should examine whether the interest has been accrued on the entire loans
and advances portfolio of the bank. Special consideration should be given to the overdue bills purchased/discounted.
Several times the interest accrued on such advances is manually computed by the Branch and the auditors should
check the workings thoroughly so as to avoid any income leakages. As far as possible, the detailed break up of the
loan portfolio and the interest accrual should be obtained and the same should agree with the general ledger
balance. This would ensure completeness of the interest accrual of Advances. The auditor should also examine the
interest accrued on advances by re-computing it on a test check basis by referring to the loan parameters like
frequency of payment of interest amount, rate of interest, period elapsed till the date of balance sheet, etc., from
the loan agreements. This would ensure the completeness of the interest accrual on advances. In the current
banking scenario the interest accrual setup is automated system driven for most banks and the auditor should
verify the in built logic and controls of the system.
2.34 The auditor should examine whether that only such interest as can be realised in the ordinary course of
business should be shown under this head. This is based on the principle, recognised in AS 9 that revenue cannot
be recognised if there is a significant uncertainty about its collectability; as also with instructions given by RBI to
the effect that interest be not recorded as income in respect of Non Performing assets. Interest accrued in the
current year in respect of accounts identified as NPAs must be reversed to Income and derecognised and cannot
be the subject matter of a provision.. Dividends recognised as income but not received may be included in the
residuary sub-head of `Others'. Dividends and interest on investments would be recognised in the books of the
branch only if it is handling the work relating to investments or receipt of income on investments.
Tax Paid in Advance/Tax Deducted at Source
2.35 Generally, this item is dealt with at the head office only and would, therefore, not appear in the balance
sheet of a branch, except that tax deducted at source on fixed deposits and other products/services if handled at
the branch level. The procedures to be followed by the branch auditor for verification of tax deducted at source by
the branch would be similar to those in an audit of other types of entities. The branch auditor needs to examine
whether the certificates for such tax deducted at source is collected by the branch and the original copy is sent to
the Head Office along with the transfer of such Tax Deducted at Source (TDS) amount to Head Office on periodic
basis as defined.
2.36 At Head Office, the availability of all the TDS Certificates, submission of the same with Income Tax
Department/claim of the same in Income Tax returns filed should be checked to verify the justification of the claim
towards such certificates. The auditor should also verify the online tax credit from the Income Tax website with the
TDS/advance tax recoded in the books and ask for a reconciliation of the same. Income recognized in the books
could also be cross verified by this analysis. If there is any TDS, the auditor needs to enquire as to the income to
which it pertains so that the bank claims it in its assessments. If it is on account of payments that cannot be
explained, this needs a provision.
Stationery and Stamps
2.37 Internal controls over stationery of security items (like term deposit receipts, drafts, pay orders, cheque
books, traveller's cheques, gift cheques, etc.) assume special significance in the case of banks as their loss or
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misuse could eventually lead to misappropriation of the most valuable physical asset of a bank, viz., cash. The
branch auditor should study and evaluate the existence, effectiveness and continuity of internal controls over
these items in the normal course of his audit. It may be noted that the branch auditor is required to specifically
comment on the adequacy of the relevant internal controls in his LFAR.
2.38 As per RBI instructions, The item "Stationery and Stamps" should include only exceptional items of
expenditure on stationery like, bulk purchase of security paper, loose leaf or other ledgers, etc., which are shown
as quasi-asset to be written off over a period of time. The valuation of such items is suggested to be at cost
without any element of escalation/appreciation. In other words, the normal expenditure on stationery may be
treated as an expense in the profit and loss account, while unusually heavy expenditure may be treated as an
asset to be written off based on issue/consumption. At the branch level, the expenditure on latter category may
not appear since a considerable part of the stationery is supplied to branches by the head office.
2.39 The auditor should physically verify the stationery and stamps on hand as at the year-end, especially
stationery of security items. Any shortage should be inquired into as it could expose the bank to a potential loss
from misuse. The auditor should examine whether the cost of stationery and stamps consumed during the year
has been properly charged to the profit and loss account for the year in the context of the accounting
policy/instructions from the head office regarding treatment of cost of stationery and stamps.
Non-Banking Assets Acquired in Satisfaction of Claims
2.40 Under this heading, will be included, those immovable properties/tangible assets, which the bank has acquired
in satisfaction of debts due or its other claims and are being held with the intention of being disposed of.
2.41 While examining this item, the auditor should specifically keep in mind the provisions of section 9 of the
Banking Regulation Act, 1949, which prohibit a banking company from holding any immovable property, however
acquired (i.e. whether acquired by way of satisfaction of claims or otherwise), except such as is required for its own
use, for any period exceeding seven years from the date of acquisition thereof. During this period, the bank may deal
or trade in any such property for the purpose of facilitating the disposal thereof. The RBI has the power to extend the
aforesaid period in a particular case up to another five years.
2.42 Except when held for its own use, AS 10, "Accounting for Fixed Assets", would not be applicable on those
fixed assets which are held with the bank in satisfaction of claim. At the date of acquisition, the assets should be
recorded at amount lower of the net book value of the advance or net realisable value of asset acquired. At each
balance sheet date, net realisable value of such assets may be re-assessed and necessary adjustments may be
made.
2.43 The auditor should verify such assets with reference to the relevant documentary evidence, e.g., terms of
settlement with the party, order of the Court or the award of arbitration, etc. The auditor should verify that the
ownership of the property is legally vested in the bank's name. If there is any dispute or other claim about the
property, the auditor should examine whether the recording of the asset is appropriate or not. In case the dispute
arises subsequently, the auditor should examine whether a provision for liability or disclosure of a contingent liability
is appropriate, keeping in view the requirements of AS 29 "Provisions, Contingent Liabilities and Contingent Assets".
Others
2.44 This is the residual heading, which will include items not specifically covered under other sub-heads, e.g.,
claims which have not been received, debit items representing additions to assets or reductions in liabilities which
have not been adjusted for technical reasons or want of particulars, etc., receivables on account of government
business, prepaid expenses, Accrued income other than interest (e.g., dividend declared but not received) may
also be included under this head. The audit procedures relating to some of the major items included under this
head are discussed below.
Non-Interest Bearing Staff Advances
2.45 The auditor should examine non-interest bearing staff advances with reference to the relevant
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documentation and the bank's policy in this regard. The availability, enforceability and valuation of security, if any,
should also be examined. It needs to be examined whether the same relates to employees on the roll of the bank
on the date of the preparation of financial statements.
Banks grant unsecured advances to staff like festival/drought relief/housing advances etc. due to the employer-
employee relationship where normally lien is marked on the terminal benefits of the employee; but advances
against FDRs and other securities etc. are also given. While distinction needs to be made between advances
given by the bank as an "employer" and as "banker", the RBI's latest applicable circular needs to be kept in view
as regards disclosure requirement of advances in the latter category i.e. as banker.
Security Deposits
2.46 Security deposits with various authorities (e.g., on account of telephone, electricity, etc.,) and with others
(e.g., deposits in respect of premises taken on rent) should be examined with reference to documents containing
relevant terms and conditions, and receipts obtained from the parties concerned. The auditor should verify that the
deposits have not become due as per the terms and conditions. If it is so, then the recoverability of the same
needs to be looked into in detail and appropriate provision should be suggested against the amount where
recovery is in doubt.
2.47 The auditor, based on the materiality, should send independent balance confirmation for security deposit
at period end and should document the reason in the case of any differences. Verification of all security deposits
given during the year should be conducted and that of older deposits can be done on a test check basis.
Suspense Account
2.48 'Suspense' account is another item included under 'other assets'. Ideally, where accounts are maintained
properly and on a timely basis, the suspense account may not arise. However, in a practical situation, suspense
account is often used to temporarily record certain items such as the following:
(i) amounts temporarily recorded under this head till determination of the precise nature thereof or pending
transfer thereof to the appropriate head of account;
(ii) debit balances arising from payment of interest warrants/ dividend warrants pending reconciliation of
amounts deposited by the company concerned with the bank and the payment made by various branches
on this account;
(iii) amounts of losses on account of frauds awaiting adjustment.
RBI has also suggested a quick audit of entries in Suspense Account and the status thereof to be reported in
terms of its circulars dated 6.7.95/18.8.95 and reference may also to be made to the old RBI Circular
DBOD.BP.BC.4/21.04.018/2003-04 dated 19.7.03.
2.49 The auditor should pay special attention to any unusual items in suspense account since these are prone
to fraud risk. The auditor should obtain the management policy for provision/write off for old outstanding items. He
should obtain from the management, details of old outstanding entries/age-wise balances along with narrations in
suspense account. The auditor should also verify the reasons for such delay in adjusting the entries. Where the
outstanding balances comprised in suspense account require a provision/write-off, the auditor should examine
whether the necessary provision has been made/written off. All items of more than 6 months in suspense accounts
need special attention of the auditor. The auditor has to certify that all the suspense account entries through a
separate certificate in the annual closing sets.
Prepaid Expenses
2.50 The auditor should verify prepaid expenses in the same manner as in the case of other entities. The
auditor should examine whether the basis of allocation of expenditure to different periods is reasonable. The
auditor should particularly examine whether the allocation of discounting and rediscounting charges paid by the
bank to different accounting periods is in consonance with the accounting policy followed for the bank as a whole.
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Fixed Assets and Other Assets
Miscellaneous Debit Balances on Government Account
2.51 Miscellaneous debit balances on government account in respect of pension, public provident funds,
compulsory deposit scheme payments, etc., for which the branch obtains reimbursement from the government
through a designated branch, are also included under the head 'others'. In many cases, the accounting for this is
outside the core banking solution and needs the special attention of the auditor. The auditor should review the
ageing statements pertaining to these items. He should particularly examine the recoverability of old outstanding
items. The auditor should also examine whether claims for reimbursement have been lodged by the branch in
accordance with the relevant guidelines, terms and conditions. The net balances of the amount recoverable at the
Head Office level should also be taken along with the age-wise analysis of the same. In case of old outstanding
balances without any confirmation or proper justification of the same, should be provided for /written off as the
case may be in the accounts.
2.52 The residual item of "Others" in "Other Assets" generally constitutes a significant amount in the Balance
Sheet of the bank. The Head Office auditors should obtain the head wise details of the same along with the
previous year figures. The age-wise details of the major outstanding should also be obtained. Further, the major
variance as compared to the previous year figures should also be enquired into and reasons for the same should
be recorded and reviewed. In case any amount seems doubtful of recovery, appropriate provisions against the
same should be made.
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IV-3
Borrowings and Deposits
Borrowings
3.01 Borrowings usually take place only at head office of the bank. In case of exception there is a borrowing at
few designated branches authorised in this behalf by the head office or other controlling authority either generally
or specifically in respect of a particular borrowing. As such, this item generally does not figure in the balance
sheets of most branches of the bank.
Balance Sheet Disclosure
3.02 Borrowings of a bank are required to be shown in balance sheet as follows.
I. Borrowings in India
(i) Reserve Bank of India
(ii) Other Banks
(iii) Other Institutions and Agencies
II. Borrowings outside India
RBI vide its circular no. DBOD.BP.BC No.81/ 21.01.002/2009-10 dated March 30, 2010 on "Classification in the
Balance Sheet - Capital Instruments" advised that the following classification may be adopted in the balance sheet
from the financial year ending March 31, 2010:
Under Schedule 1 Capital
1) Perpetual Non-Cumulative preference shares (PNCPS)
Under Schedule 4 Borrowings
1. Innovative Perpetual Debt Instruments (IPDI).
2. Hybrid debt capital instruments issued as bonds/debentures.
3. Perpetual Cumulative Preference Shares (PCPS).
4. Redeemable Non-Cumulative Preference Shares (RNCPS).
5. Redeemable Cumulative Preference Shares (RCPS).
6. Subordinated Debt.
3.03 The total amount of secured borrowings included under the above heads is to be shown by way of a note
to the relevant schedule (Schedule 4). Secured borrowings for this purpose include borrowings/refinance in India
as well as outside India. It may be noted that the inter-office transactions are not borrowings and therefore, should
not be presented as such.
3.04 RBI, Export-Import Bank of India (EXIM Bank), National Bank for Agriculture and Rural Development
(NABARD) and Small Industries Development Bank of India (SIDBI) are the major agencies providing refinance to
banks, generally for loans extended to specified sectors. Borrowings from Reserve Bank of India include refinance
obtained by the bank from the RBI. Similarly, borrowings from other banks include refinance obtained by the bank
from commercial banks, co-operative banks, etc. Refinance obtained by the bank from EXIM Bank, NABARD,
SIDBI and other similar institutions and agencies is to be included under `borrowings from other institutions and
agencies'. This head will also include the bank's liability against participation certificates on non-risk sharing basis
issued by it to participating banks.
Borrowings and Deposits
3.05 Credit balances, if arising, in NOSTRO represent Deposits repayable on demand as also VOSTRO
Accounts which are akin to Current account balances and do not constitute borrowings unless an
overdraft/borrowing facility is obtained and evidenced on record.
3.06 `Borrowings outside India' include borrowings of Indian branches abroad as well as borrowings of foreign
branches. Funds raised by foreign branches by way of certificates of deposit, notes, bonds, etc. have to be
classified as `deposits' or as `borrowings' depending upon documentation. The `Notes and Instructions for
Compilation' of balance sheet and profit and loss account, issued by the RBI, clarify that since refinance obtained
by a bank from the RBI and various institutions is to be shown under the head `borrowings', the related advances
should be shown on the assets side at the gross amount.
3.07 Money at call or short notice taken by the bank is also shown under this head. RBI through its "Master
Circular no. RBI/2015-16/55 FMRD.DIRD. 01 /14.01.001/2015-16 on "Call-Notice Money Market Operations" dated
July 1, 2015 has set down the prudential limit for transactions in call/notice money market. In terms of the said
circular, on a fortnightly average basis, the borrowings should not exceed 100 percent of the capital funds (i.e.,
sum of Tier I and Tier II capital) of latest audited balance sheet. However, banks are allowed to borrow a
maximum of 125 percent of their capital funds on any day, during a fortnight.
Certificates of deposits are to be treated (at the discounted value at the year-end), as deposits and not as
Borrowings.
Inter Bank Liabilities (IBL)
3.08 Liability side management has its own merits from the point of view of financial stability. Controlling the
concentration risk on the liability side of banks is, therefore, as important as controlling the concentration risk on
asset side. More particularly, uncontrolled IBL may have systemic implications, even if, the individual counterparty
banks are within the allocated exposure.
3.09 Further, uncontrolled liability of a larger bank may also have a domino effect. In view of this, it has
become important to put in place a comprehensive framework of liability management so that banks are aware of
the risks inherent in following a business model based on large amount of IBL and the systemic risks such a
model may entail. In order to reduce the extent of concentration on the liability side of the banks, the following
guidelines have been prescribed by the RBI (applicable from April 1, 2007) vide its circular no. DBOD.BP.BC.66/
21.01.002/2006-07 of March 6, 2007.
(a) The IBL of a bank should not exceed 200% of its net worth as on 31st March of the previous year.
However, individual banks may, with the approval of their Boards of Directors, fix a lower limit for their inter-
bank liabilities, keeping in view their business model.
(b) The banks whose CRAR is at least 25% more than the minimum CRAR as on March 31, of the previous
year, are allowed to have a higher limit up to 300% of the net worth for IBL.
(c) The limit prescribed above will include only fund based IBL within India (including inter-bank liabilities in
foreign currency to banks operating within India). In other words, the IBL outside India are excluded.
(d) The above limits will not include collateralised borrowings under CBLO and refinance from NABARD, SIDBI
etc.
(e) The existing limit on the call money borrowings prescribed by RBI will operate as a sub-limit within the
above limits.
(f) Banks having high concentration of wholesale deposits should be aware of potential risk associated with
such deposits and may frame suitable policies to contain the liquidity risk arising out of excessive
dependence on such deposits.
Deposits
3.10 Deposits represent the most important source of funds for a bank. Deposits are received from a large
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number of constituents, generally in small amounts.
Balance Sheet Disclosure
3.11 Deposits are required to be classified in the balance sheet under the following heads.
A. I. Demand Deposits
(i) From Banks
(ii) From Others
II. Savings Bank Deposits
III. Term Deposits
(i) From Banks
(ii) From Others
B. I. Deposits of branches in India
II. Deposits of branches outside India
Types of Deposits
3.12 Deposits accepted by banks are primarily of two types those repayable on demand (demand deposits)
and those repayable after a fixed term (term deposits), though in this case also, the deposits may be repaid
prematurely at the request of the depositor.
Demand Deposits
3.13 Current accounts are the most common form of demand deposits of banks. Though savings bank
deposits are also, in substance in the nature of demand deposits, the Third Schedule to the Banking Regulation
Act, 1949, does not consider them demand deposits. This may, perhaps, be due to the fact that withdrawals from
savings bank accounts in excess of the limits prescribed by the bank can be made only with prior notice to the
bank.
3.14 Current accounts can be opened in the names of individuals, associations of persons, corporate bodies,
trusts, societies, etc., i.e., for all kinds of customers. The operations on current accounts opened in joint names
may be joint, single, by either holder or by surviving holder, depending on the mode of operation chosen by the
account holders. The salient features of this type of accounts are:
There is no restriction on the quantum of funds withdrawn by the account holder at any one time.
There is no restriction on the number of transactions in the account during any period of time.
No interest is payable on this deposit except where it may be specifically permitted by the bank / RBI.
Savings Bank Deposits
3.15 Savings accounts are generally in the names of individuals either singly or jointly, and sometimes, in
the names of institutions which are specifically approved by the RBI for maintaining savings bank accounts with
banks. In terms of RBI's guidelines, no bank can open a savings bank account for government departments,
municipal corporations, municipal committees, any political party, or any trade, business or professional concern,
whether such concern is a proprietary or a partnership firm or a company or an association. As in the case of
current accounts, savings bank accounts can also be opened in joint names.
3.16 The salient features of this type of accounts are:
Banks place restrictions on the maintenance of minimum balance (separate for cheque book and without
cheque book), amount of funds that can be withdrawn by the account holder at any point to time. Beyond this
cut-off level, banks require the depositors to give notice of a specified period for withdrawal of the amount.
Banks also place restrictions on the number of withdrawals from the account during a stated period of time,
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usually one year. For the number of withdrawals beyond this number, banks have the right to levy service
charges. The intention behind putting this restriction is to ensure that the savings bank accounts (on which the
account holder is entitled to payment of interest) are used to promote genuine savings and are not used as
substitutes for current accounts (on which the account holder usually does not get interest).
Interest is payable as per the RBI guidelines in force. In the past, interest was paid annually but now, banks
pay interest at quarterly / half-yearly intervals on daily outstanding balances. Depending on the practice
adopted by each bank provision for the balance period up to the year-end may made at branches/Head
Office.
Interest on savings bank accounts is required to be calculated on a daily product basis in terms of Para 3.2.1
of the RBI Master Circular DBR.No.Dir.BC. 7/13.03.00/2015-16 dated 1-7-2015; and the banks have been
given freedom to fix the rate of interest on savings accounts.
3.17 In the case of both current and savings bank accounts, if there are no operations on the account by the
account holder during a prescribed period (such period may vary from bank to bank), such accounts are identified
as `dormant' or `inoperative' accounts and may be transferred to a separate ledger. Further, transactions in these
accounts are allowed only with authority of the official designated by the bank for this purpose. Removing of
"Specimen signature" cards from active cards can be one of the controls.
Term Deposits
3.18 Term deposits (known by different nomenclature in different banks) are repayable after a specified period
of time. The minimum period of these deposits, at present, is 7 days. The salient features of this kind of deposits
are given below:
Interest is payable at periodic intervals to the depositors or as per their instructions.
In case a depositor so desires, the periodic interest can be reinvested in fresh term deposits. Such schemes
are generally called `reinvestment plans'. In this case, the interest payable is compounded at the specified
intervals and the resultant maturity value is indicated on the deposit receipt at the time of issuing the receipt.
The head offices of banks issue maturity value charts for the guidance of their branches from time to time.
3.19 Recurring deposit accounts are an important variant of term deposit. In a recurring deposit, a specified
sum is deposited at regular intervals, generally once a month, for a pre-determined period. On the expiry of this
period, the maturity proceeds, which are known at the time of opening the account, are repaid to the depositors or
as per their instructions. No recurring deposit is accepted under FCNR(B) Scheme. Some of the banks are offering
fixed / flexible recurring deposit accounts in recent times where the customer chooses amount of deposit each
time based on their convenience.
3.20 Cash certificates and certificates of deposit (CD), in demat form or otherwise, are two other variants of
term deposits. Cash certificates are issued at discounted value, e.g., a certificate with face value of Rs. 100 and
term of 5 years may be issued at, say, Rs. 49. The certificates of deposit are short-term negotiable money market
instruments and are issued in only dematerialised form or as a Usance Promissory Note. However, according to
the Depositories Act, 1996, investors have the option to seek certificate in physical form. Further, issuance of CDs
will attract stamp duty. In this regard, the RBI has issued Master Circular No. RBI/2015-16/57 FMRD.DIRD. 03
/14.01.003/2015-16 on "Guidelines for Issue of Certificates of Deposit" dated July 1, 2015. CDs may be issued at
a discount on face value. The rate of interest thereon is negotiable with the depositor and may vary on a daily
basis. The maturity period of CDs issued by banks should not be less than 7 days and not more than one year.
Banks are allowed to issue CDs on floating rate basis provided the methodology of compiling the floating rate is
objective, transparent and market-based. The issuing bank/FI is free to determine the discount / coupon rate. The
interest rate on floating rate CDs would have to be reset periodically in accordance with a pre-determined formula
that indicates the spread over a transparent benchmark. CDs can be issued in Demat or in physical form, and in
the latter case must be issued on security paper stationery, in denomination of Rs. 1 lac(for a single subscriber) or
in multiple of Rs 1 lac and without the benefits of repatriation if issued to NRI. Other than for NRIs these are
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transferrable by endorsement and delivery.
There is no grace period for repayment of CDs. If maturity date happens to be on holiday it should be paid on the
immediately preceding working day. Banks may, therefore, so fix the period of deposit that the maturity date does
not coincide with a holiday to avoid loss of discount / interest rate. All OTC trades in CDs shall be reported within
15 minutes of the trade on the FIMMDA reporting platform.
3.21 In respect of term deposits, banks issue Deposit Receipts. These receipts are not negotiable, and
therefore, deposits cannot be transferred without the consent of the bank. Certificates of deposits are, however,
transferable. CDs held in physical form are transferable by endorsement and delivery. CDs in dematerialised form
can be transferred as per the procedure applicable to other demat securities. There is no lock-in period for CDs.
Banks / FIs cannot grant loans against CDs. Furthermore, premature buyback is not permitted and no loans can
be taken against CDs However, the Reserve Bank may relax these restrictions for temporary periods through a
separate notification.
3.22 Banks should include the amount of CDs in the fortnightly return under Section 42 of the Reserve Bank of
India Act, 1934 and also separately indicate the amount so included by way of a footnote in the return. Further,
banks / FIs should report the data on issuance of CDs on the web-based module under the Online Returns Filing
System (ORFS) within 10 days from the end of the fortnight to which it pertains.
3.23 Banks normally allow repayment of the deposits before the due date; however, the rate of interest paid to
the depositor in case of premature repayment is lower than the rate contracted initially. Auditor has to verify the
scheme of fixed deposits thoroughly. If a depositor does not take repayment on the date of expiry, the interest
ceases to run from the date, though the bank continues to be a debtor of the depositor. A matured deposit can be
renewed by the depositor for a further period. Where a deposit is renewed some time after its maturity, banks
generally allow interest from the date of maturity rather than from the date of renewal. In other words, the renewal
is given a retrospective effect. In case the deposit is matured and not renewed by the customer, the interest same
as saving bank rate is provided on the same as per RBI Guidelines.
Pro-rated expenditure by way of discounts up to the year end on each certificate must be accrued / adjusted and
included under the head "Other Liabilities", as the terms of issue warrant that the proceeds be paid only on
maturity.
3.24 Rate of interest payable on fixed deposits as well as other deposits depends on current economic
conditions, decided by banks from time to time Interest rates are regulated by an Inter-Bank Agreement which is
revised from time to time. The rate of interest on certificates of deposits is negotiable with the depositor, especially
in the case of bulk/wholesale deposits.
3.25 Following are important issues in respect of different category of accounts which auditor must consider:
(a) FCNR Accounts
Maintenance of position viz. details of deposits tallying the position with reference to branches
periodically.
System of reporting to the position maintenance office by the branches including "C" category branch.
Applicability of notional rate.
Revaluation is done every reporting Friday for CRR purposes.
Provisions/payment of interest on a regular basis to reflect the due liability.
Is it debited to the proper Head of accounts?
Random check of interest as interest is charged every month based on LIBOR.
How the payment is effected-expeditiously?
On payment whether the liability is reversed.
Method of reconciliation of Nostro account with FCNR (B).
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Borrowings and Deposits
It should not be revalued and taken to profit and loss.
Many banks have a separate Nostro account for FCNR (B) balances converted on a notional basis.
Further, RBI, vide its Master Circular No. RBI/2015-16/40 DBR.No.Dir.BC.8/13.03.00/2015-16 dated July 1, 2015
on "Interest rates on deposits held in FCNR (B) Accounts", provides guidance on the interest rates on deposits
held in FCNR(B) accounts. The Circular further prohibit banks to:
i. accept or renew a deposit over five years;
ii. discriminate in the matter of rate of interest paid on the deposits, between one deposit and another
accepted on the same date and for the same maturity, whether such deposits are accepted at the same
office or at different offices of the bank, except on the size group basis. The permission to offer varying
rates of interest based on size of the deposits will be subject to the following conditions:
a. Banks should, at their discretion, decide the currency-wise minimum quantum on which differential
rates of interest may be offered. For term deposits below the prescribed quantum with the same
maturity, the same rate should apply.
b. The differential rates of interest so offered should be subject to the overall ceiling prescribed.
c. Interest rates paid by the bank should be as per the schedule and not subject to negotiation between
the depositor and the bank.
iii. pay brokerage, commission or incentives on deposits mobilized under FCNR(B) Scheme in any form to any
individual, firm, company, association, institution or any other person.
iv. employ/ engage any individual, firm, company, association, institution or any other person for collection of
deposit or for selling any other deposit linked products on payment of remuneration or fees or commission
in any form or manner.
v. accept interest-free deposit or pay compensation indirectly.
(b) Resident Foreign Currency Accounts
Exporters having good track record to open foreign currency account with banks.
RBI will permit.
Unit located in SEZ may hold an account in Foreign Currency.
Diamond Dollar Accounts may be opened with permission from RBI to transact business in Foreign
Currency.
The returning Indians can have their foreign currency accounts to be covered into RFC same feature as
of FCNR.
(c) EEFC account
Non-interest bearing No credit facilities against the security of the balances.
100% of inward remittance for Status Holder Exports, professional service rendered in personal capacity.
100% of EOU, STP and EHTP 50% for other payments received from a unit DTA for goods supplied to
SEZ.
(d) Non-resident Bank Accounts
Name of such accounts and type of arrangement.
Funding of these accounts bonafide transactions freely convertible balance.
System of monitoring overseas bank not to take a speculative view on rupees.
Forward purchase/sale of foreign currencies against rupee for funding is prohibited offer two ways
quote is also prohibited.
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Temporary overdrawals to overseas branch/ correspondent not to exceed Rs. 500.00 lakh in aggregate in
all overseas branch/correspondent in the books of the bank.
Purpose is essential.
Period not to exceed 5 days.
Statement to be sent to Forex Market Division of RBI.
Further, RBI, vide its Master Circular No. RBI/2015-16/39 DBR.No.Dir.BC.7/13.03.00/2015-16 dated July 1, 2015
on "Interest Rates on Rupee Deposits held in Domestic, Ordinary Non-Resident (NRO) and Non-Resident
(External) (NRE) Accounts" provides guidance on the interest rates on rupee deposits held in Domestic, Ordinary
Non-Resident (NRO) and Non-Resident (External) (NRE) Accounts.
Further, paragraph 3.16 of aforesaid Master Circular also provides the guidelines with respect to the conversion of
a term deposit, a deposit in the form of daily deposit or a recurring deposit for reinvestment in term deposit and
states that a bank, on a request from the depositor, should allow conversion of a term deposit, a deposit in the
form of daily deposit or recurring deposit, to enable the depositor to immediately reinvest the amount lying in the
aforesaid deposits with the same bank in another term deposit. On a review and in order to facilitate better asset-
liability management (ALM), with effect from April 20, 2010, banks are permitted to formulate their own policies
towards conversion of deposits.
(e) Rupee Accounts (Exchange House)
Accounts opening require approval from RBI.
Trade transaction per transaction upto Rs.2.00 lakh is permitted.
Reconciliation issues and concurrent auditor overseas report.
Debits/claims outstanding as the branches pending receipt of the credit.
Method of value dating the transactions and overdraft arisen thereon.
Collection of overdue interest for such over drawn balances.
Unclaimed Deposits/ Inoperative Accounts
3.26 As per RBI Circular no. DBOD No. Leg.BC.34/ 09.07.005/2008-09 dated August 22, 2008 on "Unclaimed
Deposits/inoperative accounts in Banks", a bank is required to make an annual review of accounts in which there
are no operations (other than crediting of periodic interest or debiting of service charges) for more than one year.
A savings as well as current account should be treated as inoperative/ dormant if there are no transactions in the
account for over a period of two years. In case any reply is given by the account holder giving the reasons for not
operating the account, banks should continue classifying the same as an operative account for one more year
within which period the account holder may be requested to operate the account. However, in case the account
holder still does not operate the same during the extended period, banks should classify the same as inoperative
account after the expiry of the extended period. If a Fixed Deposit Receipt matures and proceeds are unpaid, the
amount left unclaimed with the bank will attract savings bank rate of interest. In terms of Foreign Exchange
Management (Crystallization of Inoperative Foreign Currency Deposits) Regulations, 2014 and vide Notification No.
FEMA 10A/2014-RB dated March 21, 2014 , issued under Foreign Exchange Management Act (FEMA), 1999
relating to inoperative foreign currency deposits, directions have been issued under Sections 10(4) and 11(1) of
FEMA; and as per Clause 2.7 of the RBI Master Circular DBOD.No.Dir.BC.14/13.03.00/2014-15 dated 1-7-2014,
inoperative deposits having a fixed term and those with no fixed term maturity, after the expiry of a three month
notice upon completion of three years, will get crystallized into Rupees.
Depositor Education and Awareness Fund (DEAF) Scheme 2014
3.27 Reserve Bank of India vide its circular no. DBOD. DEAF Cell. BC. No. 101/ 30.01.002/2013-14 dated
March 21, 2014 namely "The Depositor Education and Awareness Fund Scheme, 2014 - Section 26A of Banking
Regulation Act, 1949" has laid down certain guidelines with respect to the said fund.
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3.28 Under the provisions of Section 26A of the Banking Regulation Act, 1949 the amount to the credit of any
account in India with any bank which has not been operated upon for a period of ten years or any deposit or any
amount remaining unclaimed for more than ten years shall be credited to the Fund, within a period of three months
from the expiry of the said period of ten years. The Fund shall be utilised for promotion of depositors' interest and for
such other purposes which may be necessary for the promotion of depositors' interests as specified by RBI from time
to time. The depositor would, however, be entitled to claim from the bank the deposit or any other unclaimed amount
or operate the account after the expiry of ten years, even after such amount has been transferred to the Fund. The
bank would be liable to pay the amount to the depositor/claimant and claim refund of such amount from the Fund.
3.29 All such unclaimed liabilities (where amount due has been transferred to DEAF) may be reflected as
"Contingent Liability Others, items for which the bank is contingently liable" under Schedule 12 of the annual
financial statements. Banks are also required to disclose the amounts transferred to DEAF under the notes to
accounts.
Accounting
3.30 Banks may account the CDs at issue price under the Head "CDs issued" and show the same under
"Deposits". Accounting entries towards discount will be same as in case of `Cash Certificate'. Banks should
maintain a register of CDs issued with complete particulars.
3.31 The Bank will maintain "CD Redemption Account" represented by specific ISIN.
Combinations of Demand and Term Deposits
3.32 Although the above are the basic types of deposits, these days, most of the banks are also offering
combinations of two or more of them. These blended products are known by different names in different banks.
Procedural Aspects
3.33 Some banks use a single application form for opening various types of accounts, viz., Savings, Current
and Term Deposits while some others adopt the system whereby, for each type of account, a different type of form
is used. The form essentially provides for particulars of the account holder(s), mode of operation on the account,
term of the deposit (if applicable), signatures of the account holder(s), photograph of the account holder(s) etc. In
the case of partnership firms, a copy of the partnership deed and in the case of companies, copies of the
memorandum and articles of association, certificate of incorporation and resolution passed by the board for
opening the account/making the deposit are obtained. Particulars of all new accounts opened are recorded in a
register.
Know Your Customer Requirements (KYC)
3.34 Reserve Bank of India vide its master circular no. RBI/2015-16/42 DBR.AML.BC.No.15/14.01.001/2015-16
dated July 1, 2015 on "Know Your Customer (KYC) norms/Anti-Money Laundering (AML) standards/Combating
Financing of Terrorism (CFT)/Obligation of banks and financial institutions under PMLA, 2002" has laid down
certain guidelines to prevent banks from being used, intentionally or unintentionally, by criminal elements for
money laundering or terrorist financing activities. The guidelines prescribed in this circular, popularly known as
KYC guidelines, also enable banks to know/understand their customers and their financial dealings better which in
turn help them manage their risks prudently.
These guidelines contain detailed requirements for banks in respect of customer acceptance policy, customer
identification procedures, monitoring of transactions and risk management.
Audit Approach and Procedures
Borrowings
3.35 Where borrowings are shown by branch:
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Auditor must ensure that the borrowings/refinance
i) is separately disclosed as required by law
ii) balance confirmation certificates are obtained in evidence of borrowings from each lender; and
iii) the nature and extent of security is determined and disclosed
3.36 The auditor should understand process of new borrowing, repayment of borrowing and test controls
around these processes.
3.37 Borrowings from RBI, other banks/financial institutions, etc., should be verified by the auditor with
reference to confirmation certificates and other supporting documents such as, application form, sanction letter,
agreements, interest rate, security, correspondence, etc. Audit evidence in the form of external confirmations
received directly by the auditor from appropriate confirming parties / lenders may assist the auditor in obtaining
audit evidence that the auditor requires to respond to significant risks of material misstatement. The auditor is
required to comply with the requirements of Standard on Auditing (SA) 505, "External Confirmations" which
contains guidance on designing and performing external confirmation procedures to obtain relevant and reliable
audit evidence.
3.38 The auditor should also examine whether a clear distinction has been made between `rediscount' and
`refinance' for disclosure of the amount under the above head since rediscount does not figure under this head.
3.39 The auditor should examine whether borrowings of money at call and short notice are properly
authorised. The rate of interest paid/payable on, as well as duration of such borrowings should also be examined
by the auditor.
3.40 The auditor should similarly examine the relevant correspondence or other documents to verify whether
the branch has been authorised by the head office to borrow/retain other borrowings and that the terms on which
borrowings have been made are in accordance with the authorisation.
3.41 The auditor should examine whether the amount shown in the branch accounts is properly classified
based on security or otherwise.
3.42 In case of borrowing through bonds and debentures, generally banks appoint the registrar for
maintenance of records of borrowing such as bond holders etc. The auditor can obtain the balance confirmation
from registrar of the bonds including other parameters of borrowing at each period end.
Deposits
3.43 In carrying out audit of deposits and liabilities, the auditor is primarily concerned with obtaining
reasonable assurance that all known liabilities are recorded and stated at appropriate amounts.
The auditor may verify various types of deposits in the following manner.
Current Accounts
3.44 The auditor should verify the balances in individual accounts on a test check basis and should also
examine whether the balances as per subsidiary ledgers tally with the related control accounts in the General
Ledger. In case of any differences, the auditor should examine the reconciliation prepared by the branch in this
regard.
3.45 Some banks have a procedure for obtaining confirmation of balances periodically. The auditor should
examine whether the procedure laid down in this behalf has been followed consistently throughout the year. He
should also examine, on a test check basis, the confirmations received.
3.46 The auditor should examine whether the debit balances in current accounts are not netted out on the
liabilities side but are appropriately included under the head `Advances'.
3.47 Inoperative accounts are a high risk area of frauds in banks. While examining current accounts, the
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auditor should specifically cover in his sample some of the inoperative accounts revived / closed during the year.
The auditor should also ascertain whether inoperative accounts are `revived' only with proper authority. For this
purpose, the auditor should identify cases where there has been a significant reduction in balances compared to
the previous year and examine the authorisation for withdrawals. Ratio analysis and comparatives can be used to
select / identify such variation.
Savings Bank Deposits
3.48 The auditor should verify the balances in individual accounts on a test check basis and should also
examine whether the balances as per subsidiary ledgers tally with the related control accounts in the General
Ledger. In case of any differences, the auditor should examine the reconciliation prepared by the branch in this
regard.
3.49 The auditor should also check the calculation of interest on a test check basis. In case of branch under
Core Banking Solution (CBS) the product sheet for calculation of interest on saving bank accounts can be
obtained in selected sample and auditor can verify the calculation. In case of manual branches the calculation can
be verified as per the work sheets.
3.50 As in the case of current accounts, the auditor should pay special attention to inoperative savings bank
accounts.
Term Deposits
3.51 While evaluating the internal controls over term deposits, the auditor should specifically examine whether
the deposit receipts and cash certificates are issued serially and all of them are accounted for in the registers. The
auditor should also satisfy himself that there is a proper control over the unused forms of deposit receipts and
cash certificates to prevent their misuse.
3.52 As stated earlier, the rate of interest on Certificates of Deposits (CDs) is negotiable with the depositor.
This area is quite sensitive. The auditor should bear this fact in mind while examining the efficacy of prescribed
internal controls with regard to rates of interest on CDs.
3.53 The auditor should verify the deposits with reference to the relevant registers. The auditor should also
examine, on a test check basis, the registers with the counter-foils of the receipts issued and with the discharged
receipts returned to the bank. The reconciliation of subsidiary records for various types of term deposits with the
related control accounts in the General Ledger should be examined. The auditor should also examine whether
provision has been made for interest accrued on the deposits up to the date of the balance sheet. Auditor should
also examine whether the proper provision for interest payable on deposits is made.
3.54 In some cases, banks employ some persons as `collectors' to collect the deposits from depositors, e.g., in
case of recurring deposits. In such cases, the auditor should specifically examine the efficacy of the internal
control procedures for reconciling the records of the bank with those of the collectors.
3.55 Term deposits from banks are usually (though not necessarily) in round figures. Any odd balances in term
deposits should therefore be selected by the auditor for verification on a sample basis.
3.56 If a Fixed Deposit Receipt matures and proceeds are unpaid, the amount left unclaimed with the bank will
attract savings bank rate of interest (Para 3.4 of Master Circular for Re. deposits).
Deposits Designated in Foreign Currencies
3.57 In the case of deposits designated in a foreign currency, e.g., foreign currency non-resident deposits, the
auditor should examine whether they have been converted into Indian rupees at the rate notified in this behalf by
the head office. The auditor should also examine whether any resultant increase or decrease has been taken to
the profit and loss account. It may also be seen that interest on deposits has been paid on the basis of 360 days in
a year
i) For deposits up to one year, at the applicable rate without any compounding effect.
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ii) In respect of deposits for more than 1 year, the interest on FCNR (B) deposits should be calculated at intervals
of 180 days each and thereafter for remaining actual number of days, till normal maturity.
Further, in case of conversion of FCNR (B) deposits into NRE deposits or vice versa before maturity has been
subjected to the provisions relating to premature withdrawal.
Interest Accrued But Not Due
3.58 The auditor should examine that interest accrued but not due on deposits is not included under the
relevant deposits but is shown under the head `other liabilities and provisions'.
Overall Reconciliation
3.59 The procedures of banks usually provide for periodic correlation of outstanding deposits with the cost
of deposits. The auditor should ascertain from the management whether such an exercise has been carried out
and if so, he should review the same. The auditor should examine that interest accrued but not due has also
been considered for this purpose.
Inoperative Accounts
3.60 Internal controls over Inoperative accounts, is imperative. A response to the letter addressed to the Branch
will assist the Auditor to take a view on the system of dealing with Inoperative Accounts. Attention needs to be
sharply focused on debits/withdrawals to ascertain whether these are unauthorised. In testing the debits, attention
should be specially paid to large and repetitive debits out of otherwise dormant accounts.
Centralisation of these needs to be encouraged and such a recommendation needs to be made through the LFAR.
While scrutinising deposit ledgers, it is appropriate to ensure whether there are any stagnant/ inoperative accounts,
which remain to be transferred. Computer generated exception reports will also reveal the status of the Inoperative
accounts.
Window-dressing
3.61 There are several ways in which the deposits of a bank may be inflated for purposes of balance sheet
presentation. For example, some of the constituents may be allowed overdraft on or around the date of the
balance sheet, the overdrawn amounts may be placed as deposits with the bank, and further advances may be
given on the security of the deposit receipts, thus inflating deposits as well as advances. The transactions may be
reversed immediately after the close of the year. Where the auditor comes across transactions, which indicate the
possibility of window-dressing, he may report the same in his long form audit report. In appropriate cases, the
auditor should consider making a suitable qualification in his main audit report also.
Unauthorised Deposits, particularly, during the period that deposits of demonetized currency notes were allowed,
comprise the bank's liability and can be treated as Deposits, pending completion of any enquiry/investigation, with
the safeguards the bank may take to avoid any wrongful claim thereon. The auditor may consider reporting the same
in the LFAR by way of information.
Know Your Customers Norms
3.62 RBI has issued instructions to all banks to implement without fail certain procedural norms on KYC.
Failure would attract levy of penalty and if penalty has been levied the same is to be disclosed in the notes to
accounts. In view of the nature of the directive the audit procedure may be suitably adopted to enquire the system
of implementation and review of other reports in respect of this area. The auditor should examine that there exists
proper procedure in place to ensure that framework relating to `Know Your Customer' and Anti-Money Laundering
measures is formulated and put in place by the bank.
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IV-4
Capital, Reserves and Surplus
Capital
4.01 The following particulars have to be given in respect of share capital in the balance sheet.
(a) For Banks Incorporated in India
Authorised Capital (shares of Rs.__ each)
Issued Capital (shares of Rs.__ each)
Subscribed Capital (shares of Rs.__ each)
Called-up Capital (shares of Rs.__ each)
Less: Calls unpaid
Add: Forfeited shares
(In case of Nationalised Banks capital owned by Central Government as on the date of balance sheet including
contribution from Government, if any, for participating in World Bank Projects should be shown separately.)
(b) For Banks Incorporated Outside India
(i) Capital (the amount brought in by banks by way of start-up capital as prescribed by RBI should be
shown under this head).
(ii) Amount of deposit kept with the RBI under section 11(2) of the Banking Regulation Act, 1949.
RBI vide its circular no. DBOD.BP.BC No.81/ 21.01.002/2009-10 dated March 30, 2010 on "Classification in the
Balance Sheet - Capital Instruments" advised that under the Schedule 1- Capital, Perpetual Non-Cumulative
Preference Share (PNCPS) should be sub classified in the balance sheet from the financial year ending March 31,
2010.
4.02 If circumstances permit, items which can be combined may be shown under one head, for instance, `Issued
and Subscribed Capital'.
4.03 In case of banking companies incorporated outside India, the amount of deposit kept with the RBI under
section 11(2) of the Act has to be shown under this head; the amount, however, should not be extended to the outer
column.
4.04 The RBI's Master Circular no. RBI/2015-16/99 DBR.BP.BC No.23/21.04.018/2015-16 dated July 1, 2015 on
"Disclosure in Financial Statements Notes to Accounts" lays down the certain aspects to be disclosed in respect of
capital for the current as well as the previous year.
Capital Adequacy Measures in India
4.05 In India, the statutes governing various types of banks lay down the minimum capital requirements for them.
Besides, there are also requirements for maintenance of statutory reserves. Considering the variations in minimum
capital requirements applicable to different types of banks and taking into account the approach adopted by Basel
Committee, the Reserve Bank prescribed, in year 1992, a uniform methodology for determining the capital adequacy
of scheduled commercial banks (other than regional rural banks). The Master Circular No. RBI/2015-16/85
DBR.No.BP.BC.4./21.06.001/2015-16 dated July 1, 2015 on "Prudential Guidelines on Capital Adequacy and Market
Discipline - New Capital Adequacy Framework (NCAF)" provides the guidelines to be followed by banks for capital
adequacy. As per RBI circular RBI/2016-17/321 DBR.No.BP.BC.74/21.06.009/2016-17 dated June 13, 2017
Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Prudential Guidelines on Capital Adequacy and Market Discipline- New Capital Adequacy Framework (NCAF) -
Eligible Credit Rating Agencies INFOMERICS Valuation and Rating Pvt Ltd. (INFOMERICS) - The long term and
short term ratings issued by these domestic credit rating agencies have been mapped to the appropriate risk weights
applicable as per the Standardised Approach under the Basel II Framework. Some of the important aspects of the
circular are covered below.
4.06 The basic approach of capital adequacy framework is that a bank should have sufficient capital to provide a
stable resource to absorb any losses arising from the risks in its business. Capital is divided into tiers according to
the characteristics/qualities of each qualifying instrument. For supervisory purposes capital is split into two
categories: Tier I and Tier II, representing different instruments' quality as capital.
Tier I capital consists mainly of share capital and disclosed reserves and it is a bank's highest quality capital
because it is fully available to cover losses.
AS per RBI circular RBI/2016-17/222, DBR.BP.BC.No.50/21.06.201/2016-17 dated Feb 2, 2017, Additional Tier 1
capital, the change in coupon discretion needs to be considered.
Tier II capital consists of certain reserves and certain types of subordinated debt. The loss absorption capacity
of Tier II capital is lower than that of Tier I capital.
When returns of the investors of the capital issues are counter guaranteed by the bank, such investments will not be
considered as Tier I/II regulatory capital for the purpose of capital adequacy.
4.07 The 2015 Master Circular on Prudential Norms on Capital Adequacy and Market Discipline New Capital
Adequacy Framework (NCAF) also covers the concept of `Capital Adequacy Requirement for Credit Default Swap
(CDS) Positions in the Banking Book'. Readers may refer to the Circular for detailed guidelines in this regard.
Components of Capital
4.08 The Master Circular on Capital Adequacy discusses the Capital Funds in two categories capital funds for
Indian banks and capital funds of foreign banks operating in India.
Undisclosed Reserves
4.09 They can be included in capital, if they represent accumulations of post-tax profits and are not encumbered
by any known liability and should not be routinely used for absorbing normal loss or operating losses.
Re-valuation Reserves
4.10 It would be prudent to consider re-valuation reserves at a discount of 55 percent while determining their
value for inclusion in Tier II capital. Such reserves will have to be reflected on the face of the Balance Sheet as re-
valuation reserves.
4.11 However, as per RBI's circular no. RBI/2015-16/331 DBR.No.BP.BC.83/ 21.06.201/ 2015-16 dated 01st
March, 2016 revaluation reserves arising out of change in the carrying amount of a bank's property consequent upon
its revaluation may, at the discretion of banks, be reckoned as Common Equity Tier 1 (CET1) capital at a discount of
55%, instead of as Tier 2 capital under extant regulations, subject to meeting the following conditions:
bank is able to sell the property readily at its own will and there is no legal impediment in selling the property;
the revaluation reserves are shown under Schedule 2: Reserves & Surplus in the Balance Sheet of the bank;
revaluations are realistic, in accordance with Indian Accounting Standards;
valuations are obtained, from two independent valuers, at least once in every 3 years; where the value of the
property has been substantially impaired by any event, these are to be immediately revalued and appropriately
factored into capital adequacy computations;
the external auditors of the bank have not expressed a qualified opinion on the revaluation of the property;
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Capital, Reserves and Surplus
the instructions on valuation of properties and other specific requirements as mentioned in the RBI's circular no.
RBI No.2006-2007/224 DBOD.BP.BC No. 50 / 21.04.018/ 2006-07 dated 4th January, 2007 on `Valuation of
Properties - Empanelment of Valuers' are strictly adhered to.
Foreign Currency Translation Reserve (FCTR)
4.12 As stated in RBI's circular no. RBI/2015-16/331 DBR.No.BP.BC.83/21.06.201/2015-16 dated 01st March,
2016, Banks may, at their discretion, reckon foreign currency translation reserve arising due to translation of financial
statements of their foreign operations in terms of Accounting Standard (AS) 11 as CET1 capital at a discount of 25%
subject to meeting the following conditions:
the FCTR are shown under Schedule 2: Reserves & Surplus in the Balance Sheet of the bank;
the external auditors of the bank have not expressed a qualified opinion on the FCTR.
4.13 Deferred Tax Asset (DTA) As per RBI's circular no. RBI/2015-16/331 DBR.No.BP.BC.83/
21.06.201/2015-16 dated 01st March, 2016:
(i) Deferred tax assets (DTAs) associated with accumulated losses and other such assets should be deducted
in full from CET1 capital.
(ii) DTAs which relate to timing differences (other than those related to accumulated losses) may, instead of full
deduction from CET1 capital, be recognised in the CET1 capital up to 10% of a bank's CET1 capital, at the
discretion of banks [after the application of all regulatory adjustments].
(iii) The amount of DTAs which are to be deducted from CET1 capital may be netted with associated deferred
tax liabilities (DTLs) provided that:
· both the DTAs and DTLs relate to taxes levied by the same taxation authority and offsetting is
permitted by the relevant taxation authority;
· the DTLs permitted to be netted against DTAs must exclude amounts that have been netted against
the deduction of goodwill, intangibles and defined benefit pension assets; and
· the DTLs must be allocated on a pro rata basis between DTAs subject to deduction from CET1 capital
as at (i) and (ii) above.
General Provisions and Loss Reserves
4.14 Such reserves can be included in Tier II capital if they are not attributable to the actual diminution in value or
identifiable potential loss in any specific asset and are available to meet unexpected losses. Adequate care must be
taken to see that sufficient provisions have been made to meet all known losses and foreseeable potential losses
before considering general provisions and loss reserves to be part of Tier II capital. General provisions/loss reserves
will be admitted up to a maximum of 1.25 percent of total risk weighted assets. `Floating Provisions' held by the
banks, which is general in nature and not made against any identified assets, may be treated as a part of Tier II
capital within the overall ceiling of 1.25 percent of total risk weighted assets. Excess provisions which arise on sale of
NPAs would be eligible Tier II capital subject to the overall ceiling of 1.25% of total Risk Weighted Assets.
Hybrid Debt Capital Instruments
4.15 Those instruments which have close similarities to equity, in particular when they are able to support
losses on an ongoing basis without triggering liquidation, they may be included in Tier II capital. At present
following instruments have been recognised and placed under this category.
i. Perpetual Cumulative Preference Shares (PCPS)/ Redeemable Non-Cumulative Preference Shares
(RNCPS)/ Redeemable Cumulative Preference shares (RCPS) as part of upper Tier II capital.
ii. Debt capital instruments eligible for inclusion as Upper Tier II capital.
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The guidelines governing the instruments at (i) and (ii) above, indicating the minimum regulatory requirements
are furnished in Annexure 4 and Annexure 3 respectively to the Master Circular on Prudential Guidelines on
Capital Adequacy and Market Discipline- New Capital Adequacy Framework (NCAF).
4.16 As per RBI's circular no. RBI/2015-16/428 DBR.BP.BC.No.105/ 21.06.001/ 2015-16 dated 23rd June, 2016,
the extant instructions have been reviewed and it has been decided that banks need not submit a copy of the offer
document with respect to any debt/capital raised as above, to Reserve Bank of India. Banks shall however, report to
the Principal Chief General Manager, Department of Banking Regulation, Reserve Bank of India, Mumbai, the details
of the debt raised as per the format prescribed in this circular duly certified by the compliance officer of the bank. The
compliance with the Basel III Capital regulations will continue to be examined by RBI's Department of Banking
Supervision, in course of the supervisory evaluation.
4.17 Banks shall however, continue to obtain and keep on their records a certificate from statutory auditors and
an external legal opinion in terms of Annex 16 of the Master Circular on Basel III Capital Regulations dated 01st July,
2015.
Subordinated Debt
4.18 Banks can raise, with the approval of their Boards, rupee-subordinated debt as Tier II capital, subject
to the terms and conditions given in the Annexure 5 to the Master Circular on Prudential Guidelines on Capital
Adequacy and Market Discipline- New Capital Adequacy Framework (NCAF).
Investment Reserve Account
4.19 In the event of provisions created on account of depreciation in the `Available for Sale' or `Held for
Trading' categories being found to be in excess of the required amount in any year, the excess should be
credited to the Profit & Loss account and an equivalent amount (net of taxes, if any and net of transfer to
Statutory Reserves as applicable to such excess provision) should be appropriated to an Investment Reserve
Account in Schedule 2 "Reserves & Surplus" under the head "Revenue and other Reserves" and would be
eligible for inclusion under Tier II within the overall ceiling of 1.25 per cent of total Risk Weighted Assets
prescribed for General Provisions/ Loss Reserves.
4.20 Banks are allowed to include the `General Provisions on Standard Assets' and `Provisions held for
Country Exposures' in Tier II capital. However, the provisions on `standard assets' together with other `general
provisions/ loss reserves' and `provisions held for country exposures' will be admitted as Tier II capital up to a
maximum of 1.25 per cent of the total risk-weighted assets.
Reserves and Surplus
Balance Sheet Disclosure
4.21 The following are required to be disclosed in the balance sheet under the head `Reserves and Surplus'.
I. Statutory Reserves
II. Capital Reserves
III. Share Premium
IV. Revenue and Other Reserves including Investment Reserve Account
(In respect of items IIV above, opening balance, additions during the year and deductions during the
year are to be shown separately in respect of each item)
V. Balance in Profit and Loss Account
Statutory Reserves
4.22 Under sub-section (1) of section 17 of the Banking Regulation Act, 1949 every banking company
incorporated in India has to transfer 20% of its profits to its reserve fund each year before declaring dividends.
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Capital, Reserves and Surplus
The transfer to reserve as above and any other reserve created in pursuance of any section of the Act has also
to be disclosed under the aforesaid head. Section 17(2) of Act provides that where a banking company
appropriates any sum or sums from the reserve fund or the share premium account, it shall, within twenty-one
days from the date of such appropriation, report the fact to the RBI, explaining the circumstances relating to
such appropriation.
4.23 All scheduled commercial banks, including foreign banks operating in India, (except RRBs/LABs) have
been instructed to transfer not less than 25% of the `net profit' (before appropriations) to the Reserve Fund with
effect from the year ending 31st March, 2001. Such transfer to reserves may be made "after adjustment /
provision towards bonus to staff".
Capital Reserves
4.24 The expression `capital reserves' does not include any amount regarded as free for distribution through
the profit and loss account. According to the Notes and Instructions for Compilation of Balance Sheet, issued by
the RBI, surplus on re-valuation or sale of fixed assets is to be treated as capital reserve. As per RBI master
circular No DBR No BP.BC.6 /21.04.141/2015-16 dated July 1, 2015 - Profit on sale of investments in this category
should be first taken to the Profit & Loss Account, and thereafter be appropriated to the `Capital Reserve Account'. It is clarified
that the amount so appropriated would be net of taxes and amount required to be transferred to Statutory Reserves. Loss on
sale will be recognised in the Profit & Loss Account.
Securities Premium Account
4.25 According to sub-section (1) of section 52 of the Companies Act, 2013, where a company issues
shares at a premium, the amount of premium should be transferred to a separate account to be called `the
securities premium account'. The provisions of this Act regarding reduction of capital also apply to securities
premium account. However, as per sub-section (2) of section 52 of Companies Act, 2013, the securities
premium may be applied for the following purposes:
(a) issuing fully paid bonus securities;
(b) writing off the preliminary expenses;
(c) writing off the expenses of, or the commission paid or discount allowed on, any issue of securities or
debentures; or
(d) providing for the premium payable on the redemption of any redeemable preference securities or
debentures; or
(e) for the purchases of its own shares or other securities under section 68 of Companies Act, 2013.
As per sub-section (3) of section 52, the security premium account may be applied by such company, as may
be prescribed and whose financial statement comply with the accounting standards prescribed for such class of
companies under section 13314 of Companies Act, 2013.
(a) in paying up unissued equity shares of the company to be issued to members of the company as fully
paid bonus shares; or
(b) in writing off the expenses of or the commission paid or discount allowed on any issue of equity shares of
the company; or
(c) for the purchases of its own shares or other securities under section 68.
4.26 A banking company has to report to the RBI any appropriations made from the securities premium
14
The MCA vide its General Circular No. 15/2013 dated 13th September 2013 has clarified that to facilitate proper administration of the notified
sections of the Companies Act 2013, in respect of the Section 133, "Till the Standards of Accounting or any addendum thereto are prescribed
by Central Government in consultation and recommendation of the National Financial Reporting Authority, the existing Accounting Standards,
notified under the Companies Act, 1956 shall continue to apply."
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
account. Such an appropriation can be only for the purposes described above or in accordance with the
provisions governing reduction of share capital by a company.
Revenue and Other Reserves
4.27 According to the Notes and Instructions for Compilation of Balance Sheet and Profit and Loss Account,
issued by the RBI, the expression `Revenue Reserve' shall mean any reserve other than capital reserve.
4.28 All reserves, other than those separately classified (viz., statutory reserves, capital reserves and share
premium) will be shown under this head. The expression `reserve' shall not include any amount written off or
retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of
providing for any known liability. In terms of RBI guidelines, the `Investment Reserve Account' representing
write back of excess provision on investments has to be treated as revenue reserve.
Balance of Profit
4.29 This item includes balance of profit after appropriations. According to the Notes and Instructions for
compilation of balance sheet and profit and loss account, issued by the RBI, in case of loss, the balance may be
shown as a deduction. Though it is not mentioned whether the loss is to be deducted from the aggregate of `reserves'
or from `revenue and other reserves' only, it is obvious on a consideration of legal requirements and sound
accounting principles that the loss should be deducted only from revenue reserves.
4.30 Further, as prescribed by RBI's circular no. DBOD.BP.BC.31/21.04.018/ 2006-07 dated September 20,
2006, the banks need to obtain prior approval of the Reserve Bank of India before any appropriation is made from the
statutory reserve or any other reserve.
4.31 The said circular also requires that:
(i) All expenses including provisions and write offs recognised in a period, whether mandatory or
prudential, should be reflected in the Profit and Loss Account for the period as an `above the line' item
(i.e., before arriving at the net profit);
(ii) Wherever draw down from reserves takes place with the prior approval of Reserve Bank, it should be
effected only "below the line", (i.e., after arriving at the profit/loss for the period); and
(iii) Suitable disclosures should be made of such draw down of reserves in the `Notes on Accounts' to the
Balance Sheet.
Audit Approach and Procedures
Capital
4.32 The auditor should verify the opening balance of capital with reference to the audited balance sheet of
the previous year. In case there has been an increase in capital during the year, the auditor should examine the
relevant documents supporting the increase. For example, in case of an increase in the authorised capital of a
banking company, the auditor should examine the special resolution of shareholders and the memorandum of
association. An increase in subscribed and paid-up capital of a banking company, on the other hand, should be
verified with reference to prospectus/other offer document, reports received from registrars to the issue, bank
statement, etc. Compliance with section 14 of the Banking Regulation Act, 1949, should also be examined. In
case of increase in capital of a nationalised bank through fresh contributions by the government, the auditor
should examine correspondence/government notification or order, bank statement, etc.
4.33 In the case of newly formed banking companies/places of business established in India for the first
time by a banking company incorporated outside India, the auditor should also examine compliance with the
provisions of sections 11 and 12 of the Banking Regulation Act, 1949.
4.34 The auditor should also check the compliance with capital adequacy requirements for banks.
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Capital, Reserves and Surplus
4.35 The auditor should verify the compliance with the RBI reporting and other requirements issued from
time to time.
4.36 In case there has been an increase in Share Capital during the year/period under audit, the auditor
should verify the effect of such increase on the disclosures in respect of Earnings per Share (EPS) as well as
the percentage of promoter holding.
4.37 In case issuance of new share capital by bank, the auditor should examine the compliance with section
13 of the Banking Regulation Act, 1949 in respect of restriction on commission, brokerage, discount etc. on sale
of shares.
Reserves and Surplus
4.38 The auditor should verify the opening balances of various reserves with reference to the audited
balance sheet of the previous year. Additions to or deductions from reserves should also be verified in the usual
manner, e.g., with reference to board resolution. In the case of statutory reserves and securities premium,
compliance with legal requirements should also be examined. Thus, the auditor should specifically examine
whether the requirements of the governing legislation regarding transfer of the prescribed percentage of profits
to reserve fund have been complied with. In case the bank has been granted exemption from such transfer, the
auditor should examine the relevant documents granting such exemption. Similarly, auditor should examine
whether the appropriations from securities premium account conform to the relevant legal requirements.
4.39 Where the local laws or regulations governing overseas branches require creation of certain reserves,
the auditor should examine compliance with the relevant requirements concerning the quantum and manner of
disclosure of such reserves. The auditor should also ascertain that whenever necessary to secure compliance
with the local laws of the respective foreign countries, separate identity of such reserves has been maintained
in the balance sheet of the bank as a whole. The auditor should also ascertain that all provisions regarding
eligibility criteria and quantum of dividend have been fulfilled in respect of dividend paid by the bank, if any,
during the year.
4.40 The auditor should examine the nature of various accounts included under this head to examine that
only accounts in the nature of reserves are included. The auditor should verify whether the utilisations of
reserves are in accordance with regulatory and statutory requirements and whether the reporting requirements
have been complied with in terms of the requirements of Banking Regulation Act, 1949 and the Guidelines of
the RBI, issued from time to time.
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IV-5
Other Liabilities and Provisions
Balance Sheet Disclosure
5.01 The Third Schedule to the Banking Regulation Act, 1949, requires disclosure of the following items under
the head `Other Liabilities and Provisions':
(a) Bills payable (c) Interest accrued
(b) Inter-office adjustments (net) (d) Others (including provisions)
Bills Payable
5.02 Bills payable represent instruments issued by the branch against moneys received from customers, which
are to be paid to the customer or as per his order (usually at a different branch). These include demand drafts,
telegraphic transfers, mail transfers, traveller's cheques, pay-orders, banker's cheques and similar instruments
issued by the bank but not presented for payment till the balance sheet date.
Inter-office Adjustments
5.03 The balance in inter-office adjustments account, if in credit, is to be shown under this head. Chapter 12 of
Part IV of the Guidance Note provides the detailed guidelines on the aspects of Inter-office Transactions.
Interest Accrued
5.04 Interest due and payable and interest accrued but not due on deposits and borrowings are to be shown
under this head. The interest accrued in accordance with the terms of the various types of deposits and
borrowings are considered under this head. Such interest is not to be clubbed with the figures of deposits and
borrowings shown under the head `Deposits and Borrowings'.
Others (Including Provisions)
5.05 According to the Notes and Instructions for compilation of balance sheet and profit and loss account,
issued by the RBI, the following items are to be included under this head:
(a) Net provision for income tax and other taxes like interest tax, less advance payment and tax deducted at
source.
(b) Surplus in bad and doubtful debts provision account (such surplus is in the nature of a reserve).
(c) Surplus in provisions for depreciation in securities (such surplus is in the nature of a reserve).
(d) Contingency funds, which are actually in the nature of reserves but are not disclosed as such.
(e) Proposed dividend/transfer to Government.
(f) Other liabilities, which are not disclosed under any of the major heads such as unclaimed dividend,
provisions and funds kept for specific purposes, unexpired discount, outstanding charges like rent,
conveyance, etc. and tax deduction by bank payable on or before the due date.
(g) Certain types of deposits like staff security deposits, margin deposits, etc., which are repayable only subject
to compliance with certain conditions. (The interest on such deposits would also be included under this
head).
(h) Blocked Account arising from transfer of credit entries in inter-branch accounts outstanding for more than five
years.
5.06 Besides the above items, the following are other important items usually included under this head:
(a) Collections in respect of suit-filed accounts. These are not adjusted against advances till final settlement.
(However, for the purpose of provisioning against non-performing advances, such credit balances are taken
Other Liabilities and Provisions
into account for ascertaining net outstanding).
(b) Collection of income-tax on behalf of the Government.
(c) Collection from DICGC. These are carried till final realisation/write-off of the concerned advance account.
(d) Provisions for frauds. These are ultimately adjusted by way of a write-off.
(e) Insurance claims received in respect of frauds. These are retained separately till final write-off in respect of
fraud.
(f) Provision for gratuity, pension and other staff benefits.
(g) Provision for bank's share in the expenses of the Banking Services Recruitment Board.
(h) Provision for audit fees.
(i) Unamortized interest income on the bills purchased/ discounted.
5.07 It may be noted that many of the items to be disclosed under this head are accounted for at the head
office level and would not therefore form part of balance sheet of a branch.
Audit Approach and Procedures
5.08 The auditor may verify the various items under the head `other liabilities and provisions' in the following
manner.
Bills Payable
5.09 The auditor should evaluate the existence, effectiveness and continuity of internal controls over bills
payable. Such controls should usually include the following:
(a) Drafts, mail transfers, traveller's cheques, etc., should be made out in standard printed forms.
(b) Unused forms relating to drafts, traveller's cheques, etc., should be kept under the custody of a responsible
officer.
(c) The bank should have a reliable private code known only to the responsible officers of its branches coding
and decoding of the telegrams15 should be done only by such officers.
(d) The signatures on a demand draft should be checked by an officer with the specimen signature book.
(e) All the telegraphic transfers and demand drafts issued by a branch should be immediately confirmed by
advices to the branches concerned. On payment of these instruments, the paying branch should send a debit
advice to the originating branch.
(f) If the paying branch does not receive proper confirmation of any telegraphic transfers or demand draft from
the issuing branch, it should take immediate steps to ascertain the reasons.
(g) In case an instrument prepared on a security paper, e.g., draft, has to be cancelled (say, due to error in
preparation), it should be examined whether the manner of cancellation is such that the instrument cannot be
misused. (For example, in the case of drafts, banks generally cut the distinctive serial number printed on the
form and paste it in the book in which drafts issued are entered.) Cases of frequent cancellation and re-
issuance of drafts, pay orders, etc., should be carefully looked into by a responsible official.
5.10 Based on auditor's evaluation of the efficacy of the relevant internal controls, the auditor should examine
an appropriate sample of outstanding items comprised in bills payable accounts with the relevant registers.
Reasons for old outstanding debits in respect of drafts or other similar instruments paid without advice should be
ascertained. Correspondence with other branches after the year-end (e.g., responding advices received from
other branches, advices received from other branches in respect of drafts issued by the branch and paid by the
other branches without advice) should also be examined specially in so far as large value items outstanding on the
balance sheet date are concerned.
15
Telegrams has been discontinued since 15th July, 2013 and this is now just for academic purposes.
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Others (Including Provisions)
5.11 It may be noted that the figure of advances and investments in the balance sheet of a bank excludes
provisions in respect thereof made to the satisfaction of auditors. The issue of determining the adequacy of
provision for doubtful advances is discussed in detail under Assets Classification, Income Recognition and
Provisioning chapter of this Guidance Note. The auditor should examine other provisions and other items of
liabilities in the same manner as in the case of other entities. Specifically, in case of tax deducted by the bank and
payable to the government authorities before the due date, this function may be centralized or de-centralized.
While verifying this, the auditor must check whether tax has been correctly deducted from payments as per the
provisions of the Income Tax Act, 1961 and paid on or before the due date as specified under the Act or Rules
therefor. Many a times in case of branch audit, reporting has to be done before the due date of paying tax
deducted at source for the month of March. In such cases the auditor should report delays observed till the date of
his verification and clearly bring out the fact that he has not verified the payment of tax, due date of which would
be after the date of the audit report.
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IV-6
Contingent Liabilities
and Bills for Collection
Balance Sheet Disclosure
6.01 The Third Schedule to the Banking Regulation Act, 1949, requires the disclosure of the following as a
footnote to the balance sheet.
(a) Contingent Liabilities
I. Claims against the bank not acknowledged as debts
II. Liability for partly paid investments
III. Liability on account of outstanding forward exchange contracts.
IV. Guarantees given on behalf of constituents
(a) In India
(b) Outside India
V. Acceptances, endorsements and other obligations
VI. Other items for which the bank is contingently liable
(b) Bills for Collection
Contingent Liabilities
6.02 The term `contingent liabilities' can take two forms. On the one hand, a contingent liability refers to
possible obligations arising from past transactions or other events or conditions, the existence of which will be
confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within
the control of the enterprise. On the other hand, a contingent liability may also take form of a present obligation
that arises from past events or transactions but is not recognised due to the fact that either it is not probable
that an outflow of resources embodying economic benefits will be required to settle the obligation, or a reliable
estimate of the amount of obligation cannot be made. Thus, contingent liabilities may or may not crystallise into
actual liabilities. If they do become actual liabilities, they give rise to a loss or an expense. The uncertainty as to
whether there will be any obligation differentiates a contingent liability from a liability that has crystallised.
Contingent liabilities should also be distinguished from those contingencies which are likely to result in an
obligation on the entity (i.e., the obligation is not merely possible but probable) and which, therefore, require
creation of a provision in the financial statements (Members may refer to Accounting Standard (AS) 29,
"Provisions, Contingent Liabilities and Contingent Assets")
Letter of Credit, Bank Guarantees and Letters of Comfort
6.03 The concepts of Letters of Credit, Bank Guarantees and Letters of Comfort have been discussed in the
Chapter "Advances-Other than Agriculture" of the Guidance Note.
Liability on Partly Paid Investments
6.04 If the bank holds any partly paid shares, debentures, etc., the auditor should examine whether the
uncalled amounts thereof are shown as contingent liability in the balance sheet.
Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Liability on Account of Outstanding Forward Exchange Contracts
6.05 All branches which undertake foreign exchange business (i.e., those which are authorised foreign
exchange dealers) usually enter into forward exchange contracts. The amount of forward exchange contracts,
which are outstanding on the balance sheet date, is to be shown under this head.
Guarantees Given on Behalf of Constituents
6.06 The amount of all guarantees outstanding on the balance sheet is to be shown under the above head
after deducting therefrom any cash margin.
Acceptances, Endorsements and Other Obligations
6.07 This item includes the following balances:
(a) letters of credit opened by the bank on behalf of its customers; and
(b) Bills drawn by the bank's customers and accepted or endorsed by the bank (to provide security to the
payees).
6.08 The total of all outstanding letters of credit as reduced by the cash margin and after deducting the
payments made for the bills negotiated under them should be included in the balance sheet. In case of
revolving credit, the maximum permissible limit of letters of credit that may remain outstanding at any point of
time as reduced by the cash margin should be shown. If the transactions against which the letter of credit was
opened have been completed and the liability has been marked off in the books of the bank, no amount should
be shown as contingent liability on this account.
Other Acceptances and Endorsements
6.09 Sometimes, a customer of the bank may issue a usance bill payable to his creditor and drawn on the bank.
The bank, on accepting such a bill, becomes liable to pay it on maturity. In turn, it has to recover this amount from its
customer.
6.10 The total of all outstanding acceptances and endorsements at the end of the year, as reduced by the cash
margin, should be disclosed as contingent liability.
Other Items for Which the Bank is Contingently Liable
6.11 Under this head are to be included such items as arrears of cumulative dividends, bills re-discounted,
commitments under underwriting contracts, estimated amounts of contracts remaining to be executed on capital
account, disputed tax liabilities, credit enhancement in respect of securitised loans to which the assignee or the
special purpose vehicle has recourse, etc.
6.12 Underwriting involves an agreement by the bank to subscribe for the shares or debentures which remain
unsubscribed in a public issue, in consideration of commission.
6.13 Rediscounting is generally done with the RBI, Industrial Development Bank of India or other financial
institutions or, in the case of foreign bills, with foreign banks. If the drawer dishonours the bill, the re-discounting bank
has a right to proceed against the bank as an endorser of the bill.
6.14 Tax demands, which has been disputed are in the nature of contingent liability and should be disclosed.
Where an application for rectification of mistake has been made by the entity, the amount should be regarded as
disputed. Where the demand notice/intimation for the payment of tax is for a certain amount and the dispute relates
to only a part and not the whole of the amount, only such amount should be treated as disputed. A disputed tax
liability may require a provision or suitable disclosure as per provisions of Accounting Standard (AS) 29, "Provisions,
Contingent Liabilities and Contingent Assets".
6.15 Disputed tax liabilities in respect of income-tax and similar central taxes would not form part of balance
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sheet of a branch as these items are dealt with at the head office level.
6.16 The liability involved in cases lodged against Bank in various courts including consumer dispute redressal
forums, Banking Ombudsman as per Reserve Bank of India and any other Authority are in the nature of contingent
liability and should be disclosed.
Bills for Collection
6.17 Bills held by a bank for collection on behalf of its customers are to be shown as a footnote to the balance
sheet.
6.18 These bills are generally hundies or bills of exchange accompanied by documents of title to goods.
Frequently, no bills of exchange are actually drawn; the bank is asked to present invoices and documents of title with
instructions to collect the amount thereof from the party in whose name the invoice has been made. The documents
of title enclosed with the bills for collection are usually not assigned to the bank.
6.19 A bank may get bills for collection from -
(a) its customers, drawn on outstation parties; or
(b) its other branches or other outstation banks or parties, drawn on local parties.
6.20 On receipt of the bills drawn on outstation parties, the bank forwards them to its branch or other
correspondent at the place where they are to be collected. Such bills are called Outward Bills for Collection.
6.21 Bills received by the bank from its outstation branches and agents, etc. for collections are called Inward Bills
for Collection.
6.22 It may be noted that if a bill is received by one branch of the bank from a customer and sent by it to another
branch of the bank for collection, the same bill will be shown as an Outward Bill at the first branch and as an Inward
Bill at the other branch. In the consolidated balance sheet of the bank, however, all such bills should be shown only
once. Therefore, Inward Bills for Collection are excluded from the balance sheet of each branch.
Co-acceptance of Bills
6.23 In its Master Circular No. RBI/2015-16/76 DBR. No. Dir. BC.11/13.03.00/2015-16 dated July 1, 2015 on
"Guarantees and Co-acceptances", the RBI had reiterated the need for the banks to be cautious while co-
accepting bills of their customers and discounting the same so as to avoid loss to banks arising on account of
frauds perpetrated in the guise of bills. The circular requires the banks, inter alia, not to extend their co-
acceptances to house bills/ accommodation bills drawn by group concerns on one another. In its circular the
RBI had also listed a number of safeguards to be undertaken by banks while co-accepting bills.
Audit Approach and Procedures
Contingent Liabilities
6.24 In respect of contingent liabilities, the auditor is primarily concerned with seeking reasonable assurance
that all contingent liabilities are identified and properly valued. To this end, the auditor should, generally follow the
audit procedures given below:
(a) The auditor should verify whether there exists a system whereby the non-fund based facilities to parties are
extended only to their regular constituents, etc.
(b) Ascertain whether there are adequate internal controls to ensure that transactions giving rise to contingent
liabilities are executed only by persons authorised to do so and in accordance with the laid down
procedures.
(c) The auditor should also examine whether in case of LCs for import of goods, as required by the
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abovementioned Master Circular on guarantees and co-acceptances, the payment to the overseas suppliers
is made on the basis of shipping documents and after ensuring that the said documents are in strict
conformity with the terms of LCs.
(d) Ascertain whether the accounting system of the bank provides for maintenance of adequate records in
respect of such obligations and whether the internal controls ensure that contingent liabilities are properly
identified and recorded.
(e) Performs substantive audit tests to establish the completeness of the recorded obligations. Such tests
include confirmation procedures as well as examination of relevant records in appropriate cases.
(f) Review the reasonableness of the year-end amount of contingent liabilities in the light of previous
experience and knowledge of the current year's activities.
(g) Review whether comfort letters issued by the bank has been considered for disclosure of contingent
liabilities.
(h) Obtain representation from the management that:
(i) all contingent liabilities have been disclosed;
(ii) the disclosed contingent liabilities do not include any contingencies which are likely to result in a loss/
expense and which, therefore, require creation of a provision in the financial statements;
(iii) the estimated amounts of financial effect of the contingent liabilities are based on the best estimates
in terms of Accounting Standard 29, including any possibility of any reimbursement;
(iv) in case of guarantees issued on behalf of the bank's directors, the bank has taken appropriate steps
to ensure that adequate and effective arrangements have been made so that the commitments would
be met out of the party's own resources and that the bank will not be called upon to grant any loan or
advances to meet the liability consequent upon the invocation of the said guarantee(s) and that no
violation of section 20 of the Banking Regulation Act, 1949 has arisen on account of such guarantee;
and
(v) Such contingent liabilities which have not been disclosed on account of the fact that the possibility of
their outcome is remote include the management's justification for reaching such a decision in
respect of those contingent liabilities.
(i) The auditor should also examine whether the bank has given any guarantees in respect of any trade credit
(buyer's credit or seller's credit)16. The period of guarantees is co-terminus with the period of credit reckoned
from the date of shipment.
(j) Verify whether the bank has extended any non-fund facility or additional/ad hoc credit facilities to persons
other than its regular customers. In such cases, auditor should examine the existence of concurrence of
existing bankers of such borrowers and enquire regarding financial position of those customers.
6.25 The specific procedures to be employed by the auditor to verify various items of contingent liabilities are
discussed in the following paragraphs. It may be noted that many of the items discussed in the following
paragraphs, may be designated in foreign currencies.
Claims Against the Bank Not Acknowledged as Debts
6.26 The auditor should examine the relevant evidence, e.g., correspondence with lawyers/others, claimants,
workers/officers, and workmen's/officers' unions. The auditor should also review the minutes of meetings of board
of directors/committees of board of directors, contracts, agreements and arrangements, list of pending legal
cases, and correspondence relating to taxes, and duties, etc., to identify claims against the bank. The auditor
should ascertain from the management the status of claims outstanding as at the end of the year. A review of
subsequent events would also provide evidence about completeness and valuation of claims. Based on the
16
In terms of the Circular No. A.P. (Dir. Series) 60 dated January 31, 2004, any trade credit extended for a period of three years and above
comes under the category of external commercial borrowings.
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circumstances of each case, the auditor should verify whether the item would remain a claim against the bank not
acknowledged as debt or it would be a liability requiring provisioning. The auditor should use professional
judgement to determine as to which claims can be construed as a contingent liability.
Liability on Account of Outstanding Forward Exchange Contracts
6.27 The auditor may verify the outstanding forward exchange contracts with the register maintained by the
branch and with the broker's advice notes. In particular, the net "position" of the branch in relation to each foreign
currency should be examined to see that the position is generally squared and not uncovered by a substantial
amount. The net "position" as reported in the financial statements may be verified with reference to the foreign
exchange position report prepared by the back office.
Guarantees Given on Behalf of Constituents
6.28 The auditor should ascertain whether there are adequate internal controls over issuance of guarantees,
e.g., whether guarantees are issued under proper sanctions, whether adherence to limits sanctioned for
guarantees is ensured, whether margins are taken from customers before issuance of guarantees as per the
prescribed procedures, etc.
6.29 The auditor should ascertain whether there are adequate controls over unused guarantee forms, e.g.,
whether these are kept under the custody of a responsible official, whether a proper record is kept of forms issued,
whether stock of forms are periodically verified and reconciled with the book records, etc.
6.30 The auditor should examine the guarantee register to seek evidence whether the prescribed procedure of
marking off the expired guarantees is being followed or not.
6.31 The auditor should check the relevant guarantee registers with the list of outstanding guarantees to
obtain assurance that all outstanding guarantees are included in the amount disclosed in this behalf. The auditor
should also examine that expired guarantees are not included in this head. He should verify guarantees with the
copies of the letters of guarantee issued by the bank and with the counter-guarantees received from the
customers. He should also verify the securities held as margin. If a claim has arisen, the auditor should consider
whether a provision is required in terms of the requirements of AS 29, "Provisions, Contingent Liabilities and
Contingent Assets".
6.32 The auditor should obtain a written confirmation from the management that all obligations in respect of
guarantees have been duly recorded and that there are no guarantees issued upto the year-end which are yet to
be recorded. Many a times it is observed that in certain cases, old and expired bank guarantees are not cancelled
from the records. This would result in excess capital adequacy provisioning for the bank. Also, it should be
confirmed that the margins are recorded at their proper value including the interest accrued. The auditor should
verify the Bank Guarantee register for the purpose.
Acceptances, Endorsements and Other Obligations
6.33 The auditor should evaluate the adequacy of internal controls over issuance of letters of credit and over
custody of unused LC forms in the same manner as in the case of guarantees.
6.34 The auditor should verify the balance of letters of credit from the register maintained by the bank. The
register indicates the amount of the letters of credits and payments made under them. The auditor may examine
the guarantees of the customers and copies of the letters of credit issued. The security obtained for issuing letters
of credit should also be verified.
Other Acceptances and Endorsements
6.35 The auditor should study the arrangements made by the bank with its customers. He should test check
the amounts of the bills with the register maintained by the bank for such bills. The auditor should also examine
whether such bills are marked off in the register on payment at the time of maturity.
6.36 In respect of letters of comfort, the auditor should examine whether the bank has incurred a potential
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financial obligation under such a letter. If a comfort letter does not cast any such obligation on the bank, no
disclosure under contingent liability is required on this account.
Common Procedures
6.37 The auditor should obtain a written confirmation from the management that all obligations assumed by
way of acceptances, endorsements and letters of credit have been duly recorded and there are no such
obligations assumed upto the year-end, which are yet to be recorded.
6.38 The auditor should ascertain whether a contingent obligation assumed by a bank either by way of
acceptance, endorsement etc., has resulted in an actual obligation owing to any act or default on the part of its
constituent. In such a case, a provision would have to be made in the accounts for the bank's obligation. The
amount of the provision should be determined taking into account the probable recovery from the customer.
Other Items for Which the Bank is Contingently Liable
6.39 The auditor should examine whether commitments under all outstanding underwriting contracts have
been disclosed as contingent liabilities. For this purpose, the auditor should examine the terms and conditions of
the relevant contracts.
6.40 Rediscounting is generally done with the RBI, Industrial Development Bank of India or other financial
institutions or, in the case of foreign bills, with foreign banks. If the drawer dishonours the bill, the rediscounting
bank has a right to proceed against the bank as an endorser of the bill. The auditor may check this item from the
register of bills rediscounted maintained by the branch. He should satisfy himself that all the bills are properly
marked off on payment at the time of maturity.
6.41 In respect of disputed tax demands, the auditor should examine whether there is a positive evidence or
action on the part of the bank to show that it has not accepted the demand for payment of tax or duty. Where an
application for rectification of mistake has been made by the entity, the amount should be regarded as disputed.
Where the demand notice/intimation for the payment of tax is for a certain amount and the dispute relates to only a
part and not the whole of the amount, only such amount should be treated as disputed. A disputed tax liability may
require a provision or suitable disclosure as per provisions of AS 29, "Provisions, Contingent Liabilities and
Contingent Assets". In determining whether a provision is required, the auditor should, among other procedures,
make appropriate inquiries of management, review minutes of the meetings of the board of directors and
correspondence with the entity's lawyers, and obtain appropriate management representations.
6.42 Disputed tax liabilities in respect of income-tax and similar central taxes would not form part of balance
sheet of a branch as these items are dealt with at the head office level. However, the principles enunciated above
should be followed in dealing with taxes and duties (such as, local taxes) dealt with at the branch level.
6.43 The auditor should also look into the manner of disclosure of interest rate swaps and other derivative
transactions in the financial statements of the bank.
6.44 The auditor should check whether any liability involved in cases lodged against Bank.
6.45 The auditor as in the case of other entities may verify other items under this head.
Bills for Collection
6.46 The auditor should examine whether the bills drawn on other branches of the bank are not included in
bills for collection.
6.47 Inward bills are generally available with the bank on the closing day and the auditor may inspect them at
that time. The bank dispatches outward bills for collection soon after they are received. They are, therefore, not
likely to be in hand at the date of the balance sheet. The auditor may verify them with reference to the register
maintained for outward bills for collection.
6.48 The auditor should also examine collections made subsequent to the date of the balance sheet to obtain
further evidence about the existence and completeness of bills for collection.
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6.49 In regard to bills for collection, the auditor should also examine the procedure for crediting the party on
whose behalf the bill has been collected. The procedure is usually such that the customer's account is credited
only after the bill has actually been collected from the drawee either by the bank itself or through its agents, etc.
This procedure is in consonance with the nature of obligations of the bank in respect of bills for collection.
6.50 The commission of the branch becomes due only when the bill has been collected. The auditor should,
accordingly, examine that there exists adequate internal control system that debits the customer's account with
the amount of bank's commission as soon as a bill collected is credited to the customer's account. The auditor
should also examine that no income has been accrued in the accounts in respect of bills outstanding on the
balance sheet date.
Co-acceptance of Bills
6.51 The auditor should examine whether the bank has instituted an adequate internal control system to
comply with the safeguards as set out by the RBI's Master Circular No. RBI/2015-16/76 DBR. No. Dir.
BC.11/13.03.00/2015-16 dated July 1, 2015 on "Guarantees and Co-acceptances" to ascertain whether such
system, inter alia, captures all such items, appropriately records the same and also determines all the material items
forming contingent liabilities, whether any item needs a provision in the books.
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IV - 7
Treasury Operations-
Foreign Exchange and Derivative Transactions
This Chapter has four sections as follows:
Section A: Overview of Treasury Operations in a Bank
Section B: Investments
Section C: Forex and Derivatives
Section D: Compliance with CRR and SLR Requirements
Section A: Overview of Treasury Operations in a Bank
7.01 Treasury operations is one of the most important function of a bank, responsible for the processing of all
financial market transactions and usually much more, including a crucial role in managing risk. Treasury comprises
two main components Investments (comprising transactions related to domestic investments and money market
operations) and Forex & Derivatives.
Core functions of Treasury Operations in Bank
7.02 The core areas of treasury operations in a bank can be functionally divided into the following broad
compartments as mentioned below:
Front Office Operations (Dealing room operations);
Middle Office Operations (Market Risk Department / Product Control Group); and
Back Office Operations (Deal Confirmation and Settlement).
7.03 Increasing regulation and compliance requirements and the need for risk management have made `treasury
front and back office efficiency' as one of the most critical factors in ensuring the well-being of any bank today. This is
certain to continue as the operations of treasury becomes more onerous while financial products become
increasingly complex, despite streamlining of processing systems.
Front office Operations
7.04 The front office operations consist of dealing room operations wherein the dealers transacts deals with the
various approved counterparties. Deals are transacted by dealers on various anonymous order matching platforms
such as NDS-OM, CROMS, NDS-CALL, FX-CLEAR, FX-SWAP, and over communication platform such as Reuters',
Bloomberg, telephonic conversation with counter party or through empanelled brokers.
7.05 The dealers are primarily responsible to check for counterparty exposure limits, eligibility, and other
requirements of the Bank before initiating any deal with the counterparty. Dealers must ensure that all risk/credit
limits are available before transacting a deal. Also, the deal must not contravene the current regulations regarding
dealing in INR with overseas banks/counterparties. All counterparties are required to execute the International
Swaps and Derivatives Association (`ISDA') agreement as well as pass a board resolution allowing it to enter into
derivative contract. As soon as the deal is struck with counterparty, the deal details are noted in a dealers' deal pad
and thereafter captured in front office system of the Bank which gets queued in for authorization by back office.
Treasury Operations
Middle office Operations
7.06 Middle office is responsible for online risk measurement, monitoring and management reporting. The other
functions of Mid-Office are:
Limit setting and monitoring exposures in relation to limits;
Assessing likely impact of market movements based on internal assessments and external /Internal research;
Evolving hedging strategies for assets and liabilities;
Interacting with the bank's Risk Management Department on liquidity and market risk;
Monitoring open currency positions;
Calculating and reporting VAR;
Stress testing and back testing of investment and trading portfolios;
Risk-return analysis; and
Marking open positions to market to assess unrealized gain and losses.
Back office Operations
7.07 The mainstream role of the back office is in direct support of the dealing room or front office. Traditionally,
this included the input of deal details in the settlement system, checking of deal input details, verification by
confirmation from counterparty, settlement, checking existence of a valid and enforceable International Swap Dealers
Association (`ISDA') agreement and reconciliation of positions and nostro accounts. However, with the advent of
online front office systems and, more importantly, online tradingplatforms, the input of deals has progressively
moved to the dealing room as mentioned above.
7.08 An important development in the back office has been the advent of straight-through processing (STP), also
called `hands-off' processing. This has been made possible through enhancement of computer system to real time
online input in the trading platform, which in turn has meant that the back office can authorise/confirm deals pending
for authorisation in the trading platform. In practice this is done automatically by matching incoming data from
counterparties and thereby focussing on investigating exceptions. With the introduction of online trading systems, the
deal is `confirmed' as it is done, allowing the back office to concentrate principally on handling exceptions, settlement
and monitoring and risk control. This is a completely different approach than the earliler system of input and checking
of written paper-based deals that represented only a dealer's version of what the deal was before external verification
could even commence.
7.09 One of the basic tenets for a treasury area in a bank is the strict segregation and allocation of duties
between the front, middle and back office, the latter controlling confirmations, settlement and accounting of
transactions. These are even more important in an era of straight-through processing where the checks are fewer
and must essentially be independent. However, while this is straight forward for the processing functions, the
independent monitoring and management of complex trading risks can be much more problematical, requiring the
ability and market knowledge to understand how the trades and hedges in the dealer's book are structured.
Input and completion
7.10 The first core function for the back office is to extract the details of the deal either through the input system
or by accessing the online platform and authorise/confirm the same after verifying the deal details with the external
evidence i.e. incoming data from counterparty, Reuters'/Bloomberg's conversation, broker notes. Deals input through
front-end data capture or agreed on one of the proprietary trading systems are subjected to numerous system checks
to ensure that the transaction details is technically correct. Some deals will require settlement instructions to be
added, but for straightforward foreign exchange and derivative deals done with other banks and large corporates,
standard settlement instructions (SSIs) may have already been added as per the agreement. This could also be true
for derivatives transactions in the larger treasuries. However, these types of transactions generally need more
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checking and manual intervention because of the wide variety of their use. Bank normally releases its own
confirmation to the counterparty, particularly for over the counter (`OTC') deals.
Counterparty confirmation
7.11 The second core function for the back office is to verify the deal from the counterparty as soon as possible
after the transaction has been done. For bank-to-bank trading, the verification can take the form of a confirmation of a
deal done through Reuters conversation or trading systems, or a broker's confirmation if the deal has been done
through a broker. Telephone confirmations are also sought for immediate authorisation. Further, the banks have
entered into bilateral agreement with counterparty banks who are members of CCIL; whereby exchange of
confirmations for Forex Interbank deals (matched on CCIL) have been discontinued.
7.12 Deals done with customers (non-banks) will normally be confirmed by e-mail, with instructions swapped on
the telephone, depending on the arrangements. Increasingly, however, corporate customers are using automatic
confirmation-matching services. It is essential that the deal is confirmed independently of the trader before any kind
of value is given or payment is made.
F-TRAC (FIMMDA Trade Reporting and Confirmation) System
7.13 It is to be noted that all entities regulated by RBI, IRDA and PFRDA have to mandatorily report secondary
market Corporate Bond trades on F-TRAC. Other entities regulated by SEBI or any other regulators have been
mandated to report OTC secondary market Corporate Bond on F-TRAC, or any other SEBI authorised reporting
platform. All entities have to report CP's & CD's only on F-TRAC.
Settlement
7.14 The third core function in the processing chain is that of settlement. This can take the form of a clean
currency payment/receipt at the bank's accounts or through the medium of CCIL. The CCIL settlement process is a
multilateral netting system for Inter bank transactions that will net the member's payment and receipts in a currency,
even if they are due to or due from him from different counter parties and settles the net position in both legs of the
transaction.
Reconciliation
7.15 Operations areas are typically involved in a number of reconciliation processes, including the reconciliation
of dealers' overnight positions, NOSTRO accounts and brokerage payments. This can also mean reconciling
positions for margin calls in futures trading or reconciling custody accounts to the underlying securities in securities
trading. However, the basic reconciliation function is to agree or reconcile the entries that have passed over an
account with correspondent bank against those that have been passed internally in the books of the bank to a
NOSTRO account. After reconciliation, the unmatched items in both accounts then represent those that have not
been responded to in either the books of the bank or its correspondent and should therefore requires to be
investigated.
Section B: Investments
Disclosure Requirements
7.16 Investments of banks should be disclosed as per following 6 classifications:
(i) Governments Securities;
(ii) Other Approved Securities;
(iii) Shares (both equity as well as preference);
(iv) Debentures and Bonds;
(v) Subsidiaries/ Joint Ventures/ Associates;
(vi) Other investments, such as, Commercial Papers, Certificate of Deposits, Security Receipts (SR), Pass
Through Certificates (PTC), Units of Mutual Funds, Venture Capital Funds, Real Estate Funds, Real
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Estate Investment Trust (REITs), Infrastructure Investment Trust (InvITs) etc.
However, banks are not permitted to make investments in immovable properties for earning rentals, though it can
gainfully deploy any business premises, which is not being used for the business. Thus, banks will not have
immovable properties as part of their investment portfolio. (Section 6 of Banking Regulation Act, 1949)
Important Terms
7.17 The following are some of the terms, which are commonly used in relation to investments of banks.
Approved Securities
7.18 Section 5(a) of the Banking Regulation Act, 1949 defines `approved securities' to mean securities in
which a trustee may invest money under clauses (a) to (d) and (f) of section 20 of the Indian Trusts Act, 1882.
Approved securities comprise primarily the securities issued or guaranteed by the Central or State Government, or
any other security expressly authorised by the Central Government by notification in the official gazette.
Subsidiary General Ledger (SGL)
7.19 This is a ledger maintained by the Public Debt Office (PDO) of RBI in which accounts of different banks
are maintained regarding their holding of Government securities. The transactions through SGL Accounts should
be in compliance of Master Circular on Prudential Norms for Classification, Valuation and Operation of
Investment Portfolio by Bank dated July 1, 2015.
Repo and Reverse Repo Transaction
7.20 Repo and Reverse Repo is a one of the mechanisms of lending and borrowing, wherein Repo means
borrowing of money (against placing of Government security as collateral) and Reverse Repo means lending of
money (against receipt of Government security as collateral) at a transaction value equivalent to the market rate of
the security as on the date on which the transaction is made, at an agreed rate of interest and tenure. The
underlying security though transferred from one beneficiary to other counterparty, the risk/rewards related to such
underlying security remains with the lender of the security.
7.21 RBI has banks allowed to undertake repo in corporate debt securities and issued `Repo in Corporate
Debt Securities (Reserve Bank) Directions, 2015' on 3rd February 2015.
RBI vide its circular no. RBI/2015-2016/403 FMRD.DIRD. 10 /14.03.002/2015-16 dated 19th May, 2016 on
"Repo/Reverse Repo Transactions with RBI" (effective from 3rd October 2016) has decided to: (a) align the
accounting norms to be followed by market participants for repo/reverse repo transactions under LAF and the
Marginal Standing Facility (MSF) of RBI with the accounting guidelines prescribed for market repo transactions.
Accordingly, all repo/ reverse transactions are required to be accounted as lending and borrowing transactions
with effect from 3rd October 2016.
Banks shall classify the balances in Repo A/c under Schedule 4 (Borrowing). Similarly, the balances in Reverse
Repo A/c shall be classified under Schedule 7 (Balances with banks and money at call and short notice). The
balances in Repo interest expenditure A/c and Reverse Repo interest income A/c shall be classified under
Schedule 15 (Interest expended) and under Schedule 13 (Interest earned) respectively.
RBI vide notification RBI/2016-2017/156 FMOD.MAOG No. 117/01.01.001/2016-17 dated November 25, 2016 has
decided that the Oil Bonds issued by GOI will qualify as eligible securities for Repos, Reverse Repos and MSF, on
E-Kuber system.
In terms of RBI notification no. RBI/2016-17/49 FMRD.DIRD.6/14.03.002/2016-17 dated August 25, 2016, repo
transactions are now allowed between the permitted entities, namely, (a) SGL A/c holders; (b) A SGL A/c holder
and its own gilt account holder (GAH); (c) A SGL A/c holder and a GAH under another custodian; (d) GAHs under
the same custodian; and (e) GAHs under two different custodians, subject to the conditions as specified in the
said notification.
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Short Sale
7.22 Short Sales is defined as sale of securities which one does not own, i.e., selling of a security without
possessing stock of such securities. A bank can also undertake `notional short sale' wherein it can sell a security
short from HFT even though the stock of said security is held under HFT / AFS / HTM category. Thus, short sales
include actual as well as `notional' short sale. A short sale can be undertaken by the bank subject to certain
conditions as stipulated by RBI and within specified limits. Securities which are sold short are invariably required
to be delivered on the settlement. A bank may meet the delivery obligation for a security sold short, by utilising the
securities acquired under `reverse repo' mechanism (except under RBI's Liquidity Adjustment Facility). However,
as announced in paragraph 13 of the Statement on Developmental and Regulatory Policies, of the fourth Bi-monthly
Monetary Policy Statement for 2017-18 dated October 04, 2017, it has now been decided that market participants
undertaking `notional' short sale need not compulsorily borrow securities in the repo market. While the short selling
entity may ordinarily borrow securities from the repo market, in exceptional situations of market stress (e.g. short
squeeze), it may deliver securities from its own HTM/AFS/HFT portfolios. If securities are delivered out of its own
portfolio, it must be accounted for appropriately and reflect the transactions as internal borrowing. All `notional' short
sales must be closed by an outright purchase in the market. It may be ensured that the securities so borrowed are
brought back to the same portfolio, without any change in book value. The short selling entity must adhere to the
extant regulations and accounting norms governing sale or valuation of securities in its portfolios. The bank may
frame a Board approved policy for this purpose. Even though reverse repos can be rolled over, short sale position
needs to be covered within a maximum period of three months including day of trade.
STRIPS
7.23 STRIPS stand for Separate Trading of Registered Interest and Principal Securities. Stripping is a process of
converting periodic coupon payments of an existing Government Security into tradable zero-coupon securities, which
will usually trade in the market at a discount and are redeemed at face value. For instance, stripping a five-year
Government Security would yield 10 coupon securities (representing the coupons), maturing on the respective
coupon dates and one principal security representing the principal amount, maturing on the redemption date of the
five-year security. Reconstitution is the reverse process of stripping, where, the Coupon STRIPS and Principal
STRIPS are reassembled into the original Government Security. Detailed guidelines outlining the process of
stripping/reconstitution and other operational procedures regarding transactions in STRIPS are given in Master
Circular on Prudential Norms for Classification, Valuation and Operation of Investment Portfolio by Bank dated July 1,
2015. When Issued Securities
7.24 `When, as and if issued' (commonly known as `when-issued' (WI)) security refers to a security that has
been authorized for issuance but not yet actually issued. `WI' trading takes place between the time a new issue is
announced and the time it is actually issued. All 'when issued' transactions are on an 'if' basis, to be settled if and
when the actual security is issued.
The NDS-OM members have been permitted to transact on `When Issued' basis in Central Government dated
securities, subject to the guidelines of RBI.
Certificate of Deposit (CD)
7.25 It is a negotiable money market instrument and issued in dematerialized form or as a Usance Promissory
Note against funds deposit at a bank or eligible Financial Institution for a specified time period. CDs can be issued
by a bank with a maturity period which is not less than 7 days and not more than one year, from the date of issue
and should have a minimum deposit size from a single subscriber not less than Rs. 1 lakh. CDs may be issued at
a discount to face value or at a fixed / floating coupon rate.
7.26 Banks have to maintain appropriate reserve requirements, i.e., CRR and SLR, on the issue price of the
CDs. There is no lock-in period for the CDs. Though, NRIs may also subscribe to CDs (but only on non-repatriable
basis), such CDs cannot be endorsed to another NRI in the secondary market.
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Banks/FIs may account the issue price under the Head "CDs issued" and show it under deposits. Accounting
entries towards discount will be made as in the case of "Cash Certificates".
Commercial Paper (CP)
7.27 It is an unsecured money market instrument issued in the form of a promissory note by Corporates, PDs,
FIs subject to compliance with the guidelines issued by RBI vide Master Direction on Money Market Instrument:
Call/Notice Money Market, Commercial Paper, Certificate of Deposit and Non Convertible Debentures dated July
7, 2016. The tenure of CP should not be less than 7 days and not more than one year, from the date of issue.
7.28 Options (Call/Put) are not permitted on CP. Also, underwriting or co-acceptance to the issue of CP is not
allowed. The minimum credit rating shall be `A3' as per rating symbol and definition prescribed by SEBI, which
should be ensured by the issuers.
Non-Convertible Debentures (NCDs)
7.29 It is a debt instrument issued by a corporate (including NBFCs) with original or initial maturity up to one
year and issued by way of private placement, in denominations with a minimum of Rs. 5 lakhs (face value) and in
multiples of Rs. 1 lakh, subject to the eligibility criteria as specified by RBI.
7.30 An eligible corporate intending to issue NCDs shall obtain credit rating for issuance of the NCDs from one
of the rating agencies registered with SEBI or other credit rating agencies as may be specified by RBI. NCDs shall
not be issued for maturities of less than 90 days from the date of issue and the exercise date of option (put/call), if
any, attached to the NCDs shall not fall within the period of 90 days from the date of issue. The tenor of the NCDs
shall not exceed the validity period of the credit rating of the instrument i.e. minimum `A2' as per rating symbol and
definition prescribed by SEBI.
REITs & InvITs
7.31 Infrastructure Investment Trust (InvITs) and Real Estate Investment Trusts (REIT) are like mutual funds,
which enables investment by individual/institutional investors in income earning assets to receive periodic return
consisting of return of principal as well as income.
Reserve Bank of India vide RBI/2016-17/280 DBR. No. FSD. BC. 62/24.01.040/2016-17 April 18, 2017 has allowed
banks to participate in Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) within the
overall ceiling of 20 per cent of their net worth permitted for direct investments in shares, convertible bonds/
debentures, units of equity-oriented mutual funds and exposures to Venture Capital Funds (VCFs) [both registered
and unregistered]. Before making investments, Banks are required to put in place a Board approved policy on
exposures to REITs/ InvITs which should lay down an internal limit on such investments within the overall exposure
limits in respect of the real estate sector and infrastructure sector. Banks are not permitted to invest more than 10 per
cent of the unit capital of a REIT/ InvIT. Banks need to ensure adherence to the prudential guidelines issued by RBI
from time to time on Equity investments by Banks, Classification and Valuation of Investment Portfolio, Basel III
Capital requirements for Commercial Real Estate Exposures and Large Exposure Framework, as applicable.
Legal Requirements
7.32 For the purposes of section 24 of the Banking Regulation Act, 1949, the valuation of securities is to be
done with reference to the cost price, market price, carrying cost or face value, or a combination of these methods,
as may be specified by the RBI from time to time.
7.33 Section 19 of the Act places restrictions on overall holding of investments by banks in the shares of
companies (except in the shares of subsidiary company. As per Section 19(2) of the Act, no banking company
shall hold shares in any company, whether as pledgee, mortgagee or absolute owner, of an amount exceeding
thirty per cent of the paid-up share capital of that company or thirty percent of its own paid up share capital and
reserves, whichever is less.
7.34 It should be observed that the limit of thirty per cent, as specified in section 19 of the Act, applies to all
shares whether held as investments or as pledgee or mortgagee. Securities pledged by borrowers against
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advances are, therefore, to be taken into account. Securities held for safe custody are, however, not to be taken
into account.
7.35 Under section 15(2) of the Act, it is necessary that before distributing dividends, a banking company
provides for depreciation in the value of its investments in shares, debentures or bonds (other than the
investments in approved securities) to the satisfaction of its statutory auditors. Investments in approved securities
are exempted from this requirement provided such depreciation has not actually been capitalised or otherwise
accounted for as a loss. In this regard, it may be noted that the RBI guidelines require banks to provide for
depreciation in the value of certain approved securities also. Depreciation in respect of such approved securities
accounted for, as a loss by the bank would not therefore be covered by the exemption granted under the section.
7.36 In case of banking companies, section 187 of the Companies Act, 2013 is also relevant. This section
provides that all investments made by a company on its own behalf shall be made and held by it in its own name,
except in the following cases:
(a) Shares in a subsidiary may be held in the name(s) of the company's nominee(s) to the extent necessary to
ensure the minimum number of members as required by law.
(b) Investments may be deposited with the bankers of the company for collection of dividend or interest.
(c) Investments may be deposited with, or transferred to, or held in the name of, the State Bank of India or a
scheduled bank to facilitate transfer thereof, subject to the conditions laid down in this behalf.
(d) Investments may be deposited with, or transferred to, any person by way of security for repayment of a loan
or performance of an obligation undertaken by the company.
(e) Investments in the form of securities may be held in the name of a depository.
7.37 In respect of investments not held in the company's own name as per the exceptions made under section
187 of the Companies Act, 2013, a register has to be maintained by the company, as per format prescribed from
time to time
7.38 Section 186 of the Companies Act, 2013, which imposes certain restrictions on the purchase of securities
in other companies, does not apply to a banking company.
7.39 The provisions of section 179 of the Companies Act, 2013, also need to be noted. This section provides
that normally, the power to invest the funds of a company shall be exercised by its board of directors only by
means of resolutions passed at meetings of the Board. The section, however, permits the Board, by means of a
resolution passed at a meeting, to delegate this function to a committee of directors, managing director, manager
or any other principal officer of the company or, in the case of a branch office, to a principal officer of the branch
office provided that such a resolution for delegation specifies the amount up to which the investments may be
made and the nature of the investments.
Balance Sheet Presentation
7.40 The Third Schedule to the Banking Regulation Act, 1949, requires the disclosure of investments in the
balance sheet as follows:
I. Investments in India in
(i) Government securities
(ii) Other Approved Securities
(iii) Shares
(iv) Debentures and Bonds
(v) Subsidiaries and/or Joint Ventures
(vi) Others (to be specified)
II. Investments outside India in
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(i) Government securities (including local authorities)
(ii) Subsidiaries and/or Joint Ventures Abroad
(iii) Other Investments (to be specified)
7.41 In addition to other disclosures regarding investments, the Notes and Instructions for Compilation of
Balance Sheet, also require the following information to be disclosed in the balance sheet:
(a) gross value of investments in India and outside India;
(b) aggregate of provisions for depreciation, separately on investments in India and outside India; and
(c) net value of investments in India and outside India.
(d) movement of provisions held towards depreciation on investments including opening balance by adding
provisions made during the year and after deducting write-off/ write-back of excess provisions during the
year.
7.42 The gross value of investments and provisions need not, however, be shown against each of the
categories specified in the Schedule. The break-up of net value of investments in India and outside India (gross
value of investments less provision) under each of the specified category need only be shown.
7.43 For disclosures relating to investments in notes on accounts, please refer Chapter 9 of Part IV of the
Guidance Note.
Guidelines of the RBI regarding transactions in Securities
7.44 The Reserve Bank of India has issued the Master Circular dated July 1, 2015 on "Prudential Norms for
Classification, Valuation and Operation of Investment Portfolio by Banks", consolidating instructions/guidelines
issued to banks on matters regarding prudential norms for classification, valuation and operation of Investment
portfolio of banks. It may be noted that the Reserve Bank of India has not issued consolidated master circular after
issuing the above said circular. The amendments are being issued through various Notifications and Circulars and
accordingly auditors are advised to refer various circulars and notifications related to treasury operations issued
after 1st July, 2015.
Classification of Investments
7.45 Banks are required to classify their entire investments portfolio (including SLR securities and non-SLR
securities) into three categories: held-to-maturity, available-for-sale and held-for-trading.
(i) Held-to-maturity (HTM)
This category would comprise securities acquired by the bank with the intention to hold them up to maturity.
(ii) Held-for-trading (HFT)
The investments classified under HFT would be those from which the bank expects to make a gain by the
movement in interest rates/market rates. These securities are to be sold within 90 days.
(iii) Available-for-sale (AFS)
This category will comprise securities, which do not qualify for being categorised in either of the above categories,
i.e., those that are acquired neither for trading purpose nor for being held till maturity.
7.46 Banks should decide the category of the investment at the time of acquisition and the decision should be
recorded on the investment proposal/deal slip.
7.47 Investments under HTM category should not normally exceed 25% of the total investments of the bank,
except as specified in the Master Circular, wherein the limit of 25% can be exceeded.
The Banks may hold the following securities under HTM:
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(a) SLR Securities upto prescribed percentage of their DTL as on the last Friday of the second preceding
fortnight (updated vide RBI notification RBI/2017-18/70 DBR.No.Ret.BC.90/12.02.001/2017-18 dated
October 4, 2017), which is as follows:
Period Prescribed percentage of DTL
07 January 2017 to 25 June 2017 20.50%
24 June 2017 to 13 October 2017 20.00%
14 October 2017 onwards 19.50%
(b) Non-SLR securities included under HTM as on September 02, 2004.
(c) Fresh re-capitalisation bonds received from the Government of India towards their re-capitalisation
requirement and held in Investment portfolio, excluding re-capitalisation bonds of other bank acquired for
investment purpose.
(d) Fresh investment in the equity of subsidiaries and joint ventures.
(e) RIDF/SIDBI/RHDF deposits.
(f) Investment in long-term bonds (with a minimum residual maturity of seven years) issued by companies
engaged in infrastructure activities.
7.48 The banks will have the freedom to decide on the extent of holdings under HFT and AFS. This will be
decided by them after considering various aspects such as basis of intent, trading strategies, risk management
capabilities, tax planning, manpower skills, capital position.
7.49 RBI vide its circular dated 16th July 2015 decided that for accounting periods commencing on or after
April 1, 2015, deposits placed with NABARD/ SIDBI/ NHB on account of shortfall in priority sector targets should
be included under Schedule 11- `Other Assets' under the subhead `Others' of the Balance Sheet instead of
disclosing under Schedule 8 "Investments".
Exposure Limits
7.50 The RBI, vide its Master Circular dated July 1, 2015 on "Exposure Norms" provides requirements in
respect of exposure limits for banks. Further, the Reserve Bank of India vide Notification No. RBI/2016-17/167
DBR.No.BP. BC.43/21.01.003/2016-17 December 01, 2016 has issued guidelines on Large Exposure Framework
(LEF). These guidelines shall come into effect with effect from April 1, 2019.
As per guidelines banks cannot participate in the equity of financial services ventures including stock exchanges,
depositories, etc., without obtaining the prior specific approval of the Reserve Bank of India, notwithstanding the
fact that such investments may be within the ceiling prescribed under Section 19(2) of the Banking Regulation Act.
RBI has (vide its Circular no. DBR.No.FSD.BC.37/24.01.001/2015-16 dated September, 2015) permitted banks
which have CRAR of 10 per cent or more and have also made net profit as of March 31 of the previous year that
they need not approach RBI for prior approval for equity investments in cases where after such investment, the
holding of the bank remains less than 10 per cent of the investee company's paid up capital, and the holding of the
bank, along with its subsidiaries or joint ventures or entities continues to remain less than 20 per cent of the
investee company's paid up capital. Financial Services Companies have been defined in Annex I to the Master
Circular DBR.No.FSD.BC.19/ 24.01.001/2015-16 dated July 1, 2015. The investment will continue to be subject to
prudential limits as mentioned in Para 3.1 (a) and (c) of Master Circular DBR.No.FSD.BC.19/24.01.001/2015-16
on `Para-banking Activities' dated July 1, 2015.
The auditor needs to check compliance with above mentioned circulars, while auditing equity investments in
financial services company by the bank.
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Audit Approach and Procedures
7.51 The auditor's primary objective in audit of investments is to satisfy themselves as to their existence and
valuation. Examination of compliance with statutory and regulatory requirements is also an important objective in
audit of investments in as much as non-compliance may have a direct and material impact on the financial
statements. The latter aspect assumes special significance in the case of banks where investment transactions
have to be carried out within the numerous parameters laid down by the relevant legislation and directions of the
RBI. The auditors should keep this in view while designing their audit procedures relating to investments. The
Reserve Bank of India has started issuing Master Directions on all regulatory matters beginning January 2016.
Internal Control Evaluation and Review of Investment Policy
7.52 The auditors should familiarise themselves with the instructions/ directions issued by the RBI regarding
transactions in investment securities. The Banks should frame Internal Investment Policy Guidelines and obtain the
Board's approval. The investment policy may be suitably framed / amended to include Primary Dealer (PD) activities
also. Further, the Reserve Bank of India has issued Master Directions on Operational Guidelines for Primary Dealers
dated July 1, 2016, which should be complied by Banks. The auditor should review the investment policy of the
bank to ascertain that the policy conforms, in all material respects, to the RBI's guidelines as well as to any
statutory provisions applicable to the bank..
7.53 The Banks' management should ensure that there are adequate internal control and audit procedures for
ensuring proper compliance in regard to the conduct of the investment portfolio. The banks should institute a regular
system of monitoring compliance with the prudential and other guidelines issued by the Reserve Bank of India. While
examining the internal controls over investments the auditor should particularly examine whether the same are in
consonance with the guidelines of the RBI a gist of which has also been included in the Master Circular on
Prudential Norms for Classification, Valuation and Operation of Investment Portfolio by Bank dated July 1, 2015.
They should also judge their efficacy. By efficacy, it is meant that not only the auditor would check the operating
effectiveness of various internal controls but also at the first place check and evaluate the design of such internal
controls.
7.54 Any deficiencies noted from the audit procedures should be reported by the auditor to the Management/
Those charged with Governance in accordance with SA 265 "Communicating Deficiencies in Internal Control to
Those Charged with Governance and Management".
7.55 Some of the typical audit procedures would include:
perusing the investment policy and preparing brief note on key points of compliances.
examing whether the Investment policy has been periodically reviewed by the Management.
verify whether investment policy lays down clear parameters for stop loss limits or there exits any separate
stop loss policy.
perusing the minutes of board/board appointed committee for approval of investment policy and obtain the
list of modification made in the policy compared to earlier approved policy.
examining whether the investments made by the bank are in accordance with the laid down investment policy
and are also in compliance with the RBI guidelines w.r.t. exposure norms.
verification of valuation of investments as per the method and frequency as defined by RBI.
perusing reports on concurrent audit of treasury transactions, system audit report, if any and follow-up action
taken by the management thereon.
perusing the half yearly review of portfolio by the Board of Directors of the bank and also reviewing annual
inspection report of the RBI carried out under Section 35 of the Banking Regulation Act, 1949.
Verification of voice recording mechanism and to ensure user ids of dealers left / transferred/ on leave is
deactivated / suspended on timely basis.
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Process Review, Walk through and Control Testing
7.56 For the purpose of identifying significant processes, the auditor may identify significant accounts and
processes linked to significant accounts. They may carry out detailed understanding of process from inception of
transaction to its final accounting. The banks normally have documented standard operating procedures (SOPs),
hence auditor can peruse SOPs for understanding and documenting significant processes. During the process
understanding, auditors may identify various control points in the process like reconciliation, maker checker,
segregation of duties, etc. The auditors may carry out walk through of few transactions for validating process
understanding and existence of indentified controls. Identified controls needs to be further segregated to manual
controls and IT controls for testing of those controls for sample transactions. This sample needs to be selected
randomly from total population of transactions as per the methodology.
7.57 In today's scenario, most of the treasury functions of banks are performed in an automated environment
(for example, trade booking, settlement and accounting). In such a situation, it becomes imperative for the auditors
to test the general information technology controls and system application controls around the functioning of the
systems involved and also the interfaces between various systems.
7.58 Some of the typical audit procedures include:
Identification of specific application controls based on process understanding and walkthroughs.
Perusal of IT application controls and document whether controls are effective and reliance can be placed on
same.
Perusal of IT system audit report, Internal Control Guidance report and action taken thereon.
Based on out come of IT control testing, further audit strategy need to be formulated.
Substantive Audit Procedures
7.59 Considering that the investments comprise a substantial portion of a bank's balance sheet, a combination
of test of operating effectiveness of controls and substantive audit procedures (including substantive analytical
procedures) would be necessarily carried out by the auditor to conclude effectively on the completeness,
recognition and measurement, accuracy and existence of the banks' investments, related income/ expenses and
associated balances.
Examination of Reconciliation
7.60 The auditor should examine the reconciliation of the investment balances as per the financial statements
with that of the balances with the custodians (PDO or a depository for investments held in dematerialised form),
account statements of mutual fund, physically verify the securities on hand, obtain independent confirmations from
custodians, counter-party banks for BRs on hand, to examine the control and reconciliation of BRs issued by the
bank. In addition to examining the period end reconciliations, the auditor needs to examine such reconciliations at
other interim intervals, to ensure that the process is followed throughout the audit period. Needless to add, the
actual control and reconciliations etc., are to be carried out by the bank's management; however, the auditor
needs to examine the same.
7.61 Some typical audit procedures would include:
perusing the process, frequency of reconciliation and controls over same.
perusing the reconciliation (period end as well as interim) and examining whether proper impact has been given
for reconciling items.
obtaining direct balance confirmations.
Inspection of Documents
7.62 The auditor should ascertain whether the investments made by the bank are within its authority. In this
regard, the auditor should examine whether the legal requirements governing the bank, relating to investments,
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have been complied with and the investments made by the bank are not ultra vires the bank. Apart from the
above, the auditor should also ascertain that any other covenants or conditions which restrict qualify or abridge
the right of ownership and/or disposal of investments, have been complied with by the bank.
7.63 The auditor should satisfy himself that the transactions for the purchase/sale of investments are
supported by approval of due authority and documentation. The acquisition/disposal of investments should be
verified with reference to the broker's contract note, bill of costs, receipts and other similar evidence. The auditors
may also check whether brokers note is dated and time stamped or not. The auditors should also check the
segregation of duties within the bank staff in terms of executing trades, settlement and monitoring of such trades,
and accounting of the same (generally termed as front office, middle office and back office functions' segregation).
7.64 Some typical audit procedures would include:
checking compliance with all applicable legal requirements.
checking approval and all supporting documents for purchase and sale of investments.
checking segregation of duties.
ensure that the inherent risk of management overriding controls is mitigated.
Examination of Existence of Investments
7.65 The auditor may advise the bank to list out investments held in physical form separately from those held
in dematerialised form with the PDO or with a depository. Banks are permitted to make fresh investments and hold
bonds and debentures, privately placed or otherwise, and equity instruments only in dematerialised form.
7.66 The auditor should verify the investments held with PDO, custodians and the depository, at the close of
business on the date of the balance sheet with the statement of holdings. The auditor should circulate and
maintain control over independent investments' balance confirmation requests to the custodian and other
constituents (for example, RBI for SGL and CSGL balances) in accordance with SA 505, "External Confirmations"
issued by ICAI. Furthermore, an auditor should design sufficient alternative audit procedures in situations where
the independent confirmations are not received back (after reasonable follow up procedures) before the auditor
signs off on the bank's financial statements. These alternative procedures should also be designed in such a way
that independent data points are used for corroborating investment balances. (e.g.: the auditor gets the bank
personnel download the investment statement in his own presence e.g. from E-Kuber for Government Securities,
DP's website for Shares and Bonds etc.)
7.67 The auditor should peruse banks process of periodic physical verification of investments and satisfy
himself with adequacy of process and controls. Based on assessment of physical verification process of bank, the
auditor may verify the investment scrips physically at the close of business on the date of the balance sheet. In
exceptional cases, where physical verification of investment scrips on the balance sheet date is not possible, the
auditor may carry out the physical verification on a date as near to the balance sheet date as possible. In such a
case, they should take into consideration any adjustments for subsequent transactions of purchase, sale, etc. In
the current environment, where the banks generally have their investment securities in dematerialised form, the
importance of independent audit confirmation requests multiplies. Auditors may also check feasibility of converting
physical shares in dematerialised form. If feasible, auditors may suggest banks to convert physical shares into
dematerialised form.
7.68 Investments are normally dealt with at the head office and not at the branches. However, sometimes, for
realisation of interest etc., and other similar purposes, some of the investment scrips may be held at branch
offices. In such cases, the auditor needs to examine the records maintained at the head office to record details of
scrips held at other locations and request the respective branch auditors to physically verify such scrips as a part
of their audit. The auditor needs to obtain a written confirmation to this effect from the branch auditors. The branch
auditors should also be requested to report whether adequate records are maintained by the branch for the
securities held by it on behalf of the head office.
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7.69 The auditor may specifically request the branch auditors to examine and report any cases of non-receipt
of income against investments for a long period or of scrips being held without being redeemed long after the
redemption date, as these situations might be indicative of the scrips being forged or otherwise unrealisable.
7.70 In case the investment scrips are held at an unaudited branch, the auditor should request the
management to obtain the scrips at the head office for his examination.
Cut-off Procedures
7.71 In terms of testing completeness of investments balances at the reporting date, the auditor should
carefully devise cut-off procedures. This should be designed after understanding the bank's procedures for
ensuring the appropriate period of accounting for investments. As mentioned in the master circular above, the
banks should follow `Settlement Date' accounting for recording transactions in Government securities. In respect
of transactions other than in Government securities, the bank should follow the accounting policy consistently
either `Trade Date' or `Settlement Date' accounting.
7.72 Some typical audit procedures would include:
Obtaining list of transactions executed on period end date and examining whether the same is correctly
recorded and accounted.
Checking first few sample transactions of subsequent period and ascertaining whether the same pertains to
current reporting period.
Checking control over transaction numbering by the system and ascertaining whether the transaction with
last number for period end is recorded in current period and next transaction is recorded in subsequent
period.
7.73 In respect of BRs issued by other banks and on hand with the bank at the year-end, the auditor should
examine confirmations of counterparty banks about such BRs. Where any BRs have been outstanding for an
unduly long period, the auditor should obtain written explanation from the management for the reasons thereof.
This procedure may not, however, be necessary where scrips are received from counterparty banks before the
completion of the audit.
7.74 The auditor should examine the reconciliation of BRs issued by the bank. He should also examine
whether the securities represented by BRs issued by the bank and outstanding at the year-end have been
excluded from investments disclosed in the balance sheet.
Examination of classification and shifting
7.75 The auditor should examine whether the shifting of the investments to/from HTM category is carried out
only once during a financial year and at the beginning of the financial year unless otherwise stipulated by RBI
under special dispensation. Such shifting is required to be duly approved by the Board of Directors of the bank. As
regards the shifting of investments from AFS to HFT, the auditor should verify the same as having been duly
approved by the Board of Directors / ALCO / Investment Committee. In case of exigencies, the shifting from AFS
to HFT may be done with the approval of the Chief Executive of the Bank/ Head of ALCO, but should be ratified by
the Board of Directors later. Shifting of investments from HFT to AFS is generally not allowed. However, it will be
permitted only under exceptional circumstances like not being able to sell the security within 90 days due to tight
liquidity conditions, or extreme volatility, or market becoming unidirectional. Such transfer is permitted only with
the approval of the Board of Directors/ ALCO/ Investment Committee.
7.76 Transfer of scrips from AFS / HFT category to HTM category should be made at the lower of book value
or market value. In other words, in cases where the market value is higher than the book value at the time of
transfer, the appreciation should be ignored and the security should be transferred at the book value. In cases
where the market value is less than the book value, the provision against depreciation held against this security
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(including the additional provision, if any, required based on valuation done on the date of transfer) should be
adjusted to reduce the book value to the market value and the security should be transferred at the market value.
7.77 In the case of transfer of securities from HTM to AFS / HFT category,
a. If the security was originally placed under the HTM category at a discount, it may be transferred to AFS / HFT
category at the acquisition price / book value. (It may be noted that as per existing instructions banks are not
allowed to accrue the discount on the securities held under HTM category and, therefore, such securities would
continue to be held at the acquisition cost till maturity). After transfer, these securities should be immediately re-
valued and resultant depreciation, if any, may be provided.
b. If the security was originally placed in the HTM category at a premium, it may be transferred to the AFS / HFT
category at the amortised cost. After transfer, these securities should be immediately re-valued and resultant
depreciation, if any, may be provided.
7.78 It is to be noted that in case if the bank is following `Weighted Average Method', the cost of acquisition of
the security is required to be considered redundant and instead book value (which would be weighted average
value) needs to be considered for the purpose of above mentioned both clauses.
7.79 If the value of sale or transfer (excluding one-time shifting and additional shifting explicitly permitted by
RBI), exceeds 5% of the book value of HTM investments as at the beginning of the year, the bank should disclose
market value of the investments under HTM category along with disclosure of excess of book value over market
value for which provision is not made.
7.80 The audit procedures in this regard would include:
obtaining list of shifting of investments during the reporting period.
checking compliance with RBI guidelines and existence of proper approvals for same.
checking proper recording/ accounting of book value and depreciation on date of shifting.
Examination of Accounting and Valuation
7.81 Investments in securities now-a-days constitute a substantial part of total assets of many banks. Method
of valuation of investments followed by a bank may, therefore, have a significant effect on its balance sheet and
profit and loss account. The auditor should examine whether the method of accounting followed by the bank in
respect of investments, including their year-end valuation, is appropriate, consistent and in conformity to RBI
guidelines as laid down in the Master Circular.
7.82 The auditor should examine the appropriateness of accounting policies followed by the bank. In case any
of the accounting policies are not appropriate, the auditor should consider the effect of adoption of such policy on
the financial statements and, consequently, on his audit report. In this regard, it may be noted that Accounting
Standard (AS) 13, "Accounting for Investments", does not apply to banks.
7.83 According to RBI guidelines, in respect of shares which are unquoted or for which current quotations are
not available, the market value has to be determined on the basis of break-up value (excluding Revaluation
Reserves, if any) as per the latest balance sheet of the company (which should not be more than one year prior to
the date of valuation). In case the latest balance sheet is not available the shares are to be valued at Re.1 per
company. This might create a problem in the case of new companies whose first annual reports are not yet
available. It appears that in such a situation, it would be appropriate to value the shares at cost except where the
evidence available indicates the deterioration in the value.
7.84 RBI guidelines require that individual scrip in the available-for-sale (`AFS') category should be marked to
market at quarterly or more frequent intervals. It is further required that net depreciation in respect of each of the
categories in which investments are presented in the balance sheet should be provided for and net appreciation
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should be ignored. As regards the scrips in Held for Trading (HFT) category, the same should be marked to
market at monthly or at more frequent intervals in the similar manner, except in the following cases:
i) Equity shares should be marked to market preferably on daily basis, but at least on a weekly basis;
ii) Banks which undertake short sale transactions, the entire HFT portfolio including the short position
should be marked to market on daily basis.
The book value of the individual script would not undergo any change after mark to market exercise is conducted
at the balance sheet date.
7.85 It is pertinent to note that though intra-category netting off of depreciation and appreciation is permitted,
the same (netting off) is not permitted inter-category. The provision for depreciation would be made on an
aggregate basis for HFT and AFS category separately without changing the book value of individual scrips.
7.86 As regards the investments in HTM category, the same need not be marked to market except in case
wherein the diminution in the value is other than temporary in nature or impairment of the investments due to
specified circumstances. As regards the other HTM securities, if the acquisition cost / book value is more than
face value, the premium should be amortised over the period of residual maturity period using constant yield
method or straight line method.
7.87 In determining the market value of debt securities under HFT and AFS categories, interest accrued up to the
balance sheet date should be reduced from the market price, if the market price includes the accrued interest, to
avoid its double counting of interest - first as accrued interest and secondly as a part of market value.
7.88 The auditor should examine the process of valuation followed by the Bank and perform checks to examine
that the market rates taken by the bank for valuation of investment securities are in accordance with the RBI
guidelines. The auditor should also examine the accounting entries passed for marked to market depreciation, to
ascertain, whether RBI guidelines pertaining to inter-category netting off are followed. Further, the auditor should
include investment from each class of investment in its sampling technique in accordance with SA 530 "Audit
Sampling "so as to ensure that the valuation policy of all classes of investments gets validated. Audit sampling can
be applied using an either statistical or non-statistical sampling approach which is a matter of auditor's judgment.
Particular focus should be on investments which involve management judgment or are not simple rule based
valuations (preference shares and pass through certificates). While the auditor checks the valuation of investment
securities across products in line with RBI prescribed methodology, they should also carefully focus on assessing the
appropriateness of inputs used in various valuation models / formulae. This would include a check of:
Use of appropriate cash flows (for instruments such as PTCs)
Use of appropriate risk free rates (depending on maturity of instrument)
Use of appropriate risk spreads
Use of appropriate `ratings' for bonds
Receipt of dividend (for preference shares)
Validity of various inputs like call/put option date, redemption premium, staggered redemption, etc
Arithmetical accuracy of a valuation (using `re-performance' technique)
7.89 In case of banks which have automated means of valuing the investments (for example, system computes
values), the auditor should also check system controls and if deemed necessary, consider involving an expert to
check the integrity of system logic (to avoid, `garbage in garbage out' kind of output).
7.90 In case the bank does not have automated means of valuation of investments (for example, valuation is
computed over excel spreadsheets), the auditor should check end user computing controls over such spreadsheet
usage. This would include a check of access controls over such files, change management controls, etc. This would
help auditor conclude that the files for valuation of investments are not manipulated. This can also be classified as an
anti-fraud control.
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7.91 The auditor should examine whether the profit or loss on sale of investments has been computed
properly. The carrying amount of investments disposed off should be determined consistently on similar basis. In
case of HTM investments, Net Profit on sale of investments in this category should be first taken to the Profit & Loss
Account, and thereafter be appropriated to the `Capital Reserve Account' net of taxes and Net Loss will be
recognised in the Profit & Loss Account.
7.92 The classification of investments into held-to-maturity, held-for-trading and available-for-sale categories is
based on the intention with which the respective investments have been acquired by the bank. The auditor should
examine whether the investments have been properly classified into the three categories at the time of acquisition
based on such intention as evidenced by dealers' pad or equivalent, along with reference to the decision of the
competent authority such as Board of directors, ALCO or Investment Committee.
7.93 Equity, debentures and other financial instruments acquired by way of conversion of outstanding principal
and / or interest should be classified in the AFS category, and valued in accordance with the extant instructions on
valuation of banks' investment portfolio. Equity classified as standard asset should be valued either at market
value, if quoted, or at break-up value, if not quoted (without considering the revaluation reserve, if any) which is to
be ascertained from the company's latest balance sheet. In case the latest balance sheet is not available, the
shares are to be valued at Re.1. Equity instrument classified as NPA should be valued at market value, if quoted,
and in case where equity is not quoted, it should be valued at Re.1. Depreciation on the instruments acquired by
way of conversion, whether classified as standard or NPA, should not be offset against the appreciation in any
other securities held under the AFS category.
7.94 As per RBI guidelines, investments classified under held-for-trading category should be sold within 90
days of their acquisition, failing which they should be shifted to the available-for-sale-category. The auditor should
accordingly ascertain that no investments purchased more than 89 days before the balance sheet date have been
classified under this category.
7.95 In respect of debt securities, interest accrued upto the balance sheet date is usually recognised as
income in the profit and loss account. One of the essential conditions for accrual of income is that it should not be
unreasonable to expect ultimate collection thereof.
7.96 A change in the method of valuation of investments constitutes a change in accounting policy and
adequate disclosure regarding the fact of the change along with its financial effect should be made in the balance
sheet. If the valuation of Investment is outsourced to an agency, certain audit procedures would need to be
applied at such processing agency also.
7.97 Some of the typical audit procedures would include:
obtaining list of investment as at reporting period from Bank and ascertaining completeness of the same by
reconciliation process as highlighted above.
checking the carrying amount of investments and ensuring that same is calculated on consistent basis. This
is normally calculated by system, hence need to check IT controls and calculation on sample basis for
ensuring accuracy.
In case quotes are available, checking source of capturing market price/ fair value as at reporting date.
In case quotes are not available, checking calculation for fair value as at reporting date to ensure compliance
with RBI guidelines.
checking calculation of Marked to Market Gain/ loss and accounting for same in compliance with RBI
guidelines.
Chart of basis of Marked to Market procedure based on type of investments (Unquoted)
Type of Investment Basis of Valuation
Unquoted Central Government Securities Prices / YTM rates put out by PDAI / FIMMDA
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Type of Investment Basis of Valuation
Treasury Bills Carrying Cost (acquisition cost plus discount accrued)
State Government Securities By YTM method by marking it up by 25 basis point above Central
Government Securities' Yield as put in by PDAI / FIMMDA
Other Approved Securities By YTM method by marking it up by 25 basis point above Central
Government Securities' Yield as put in by PDAI / FIMMDA
Debentures / Bonds Valued with appropriate mark-up (which would be graded based on
rating assigned to the security, and subjected to minimum of 50
basis point) over Central Government Securities' Yield as put in by
PDAI / FIMMDA
Bonds issued by State Distribution Same as above except that the mark-up would be 50, 75 and 100
Companies (DISCOM) under Financial basis point, when the liability is with the respective state
Restructuring Plan government, guaranteed by respective state government or not
guaranteed by state government, respectively
Zero Coupon Bonds (ZCBs) Present Value (PV) to Face Value (FV) of ZCBs to be calculated by
using `Zero Coupon Yield Curve (ZCYC)' with appropriate mark up
as per zero coupon spread put out by FIMMDA
Preference Shares Valued with appropriate mark-up (which would be graded based on
rating assigned to the security) over Central Government Securities'
Yield as put in by PDAI / FIMMDA, subjected to an upper cap of
redemption value of preference shares
Equity Shares Valued at break-up value without considering `revaluation reserves',
if any
Units of Mutual Funds Latest Re-purchase price or NAV and if NAV is not available, at cost
Commercial Papers Carrying Cost (acquisition cost plus discount accrued)
Investments in RRBs Carrying Cost (i.e., at book value)
Securities issued by Securitisation Company Lower of redemption Value or Net Book Value (NBV)
(SC) / Reconstruction Company (RC)
Venture Capital Funds (VCFs) For first three years, VCFs may be classified under HTM and
subsequently under AFS and valued for Units / Equity / Bonds as
per specified norms
Note: If the debentures/bonds/preference shares are quoted and are transacted within 15 days prior to the valuation
date, the valuation adopted as per above mentioned method, should not be higher than the said transaction rate. For
further additional elaborate guidance, FIMMDA guidelines in this regard may be referred to.
Non-Performing Investments (NPI)
7.98 In respect of securities included in any of the three categories where interest/ principal is in arrears, banks
should not reckon income on the securities and should also make appropriate provisions for the depreciation in the
value of the investment. The banks should not set-off the depreciation requirement in respect of these non-
performing securities against the appreciation in respect of other performing securities.
7.99 An NPI, similar to a non performing advance (NPA), is one where:
(i) Interest/ installment (including maturity proceeds) is due and remains unpaid for more than 90 days.
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(ii) The above would apply mutatis-mutandis to preference shares where the fixed dividend is not paid. If the
dividend on preference shares (cumulative or non-cumulative) is not declared/paid in any year it would be
treated as due/unpaid in arrears and the date of balance sheet of the issuer for that particular year would be
reckoned as due date for the purpose of asset classification.
(iii) In the case of equity shares, in the event the investment in the shares of any company is valued at Re.1 per
company on account of the non availability of the latest balance sheet in accordance with the instructions
contained in paragraph 3.7.5 of the RBI Master Circular on Prudential Norms for Classification, Valuation and
Operation of Investment Portfolio by Banks dated July 1, 2015, those equity shares would also be reckoned as
NPI.
(iv) If any credit facility availed by the issuer is NPA in the books of the bank, investment in any of the securities,
including preference shares issued by the same issuer would also be treated as NPI and vice versa. However, if
only the preference shares are classified as NPI, the investment in any of the other performing securities issued
by the same issuer may not be classified as NPI and any performing credit facilities granted to that borrower
need not be treated as NPA. The Auditor should review the mechanism adopted by the Bank for classifying the
investments as NPI where the credit facility has been classified as NPA and vice versa and test the
effectiveness of the mechanism followed particularly the timeliness of such classification.
(v) The investments in debentures / bonds, which are deemed to be in the nature of advance would also be
subjected to NPI norms as applicable to investments.
(vi) In case of conversion of principal and / or interest into equity, debentures, bonds, etc., such instruments should
be treated as NPA ab initio in the same asset classification category as the loan if the loan's classification is
substandard or doubtful on implementation of the restructuring package and provision should be made as per
the norms. Further movement in the asset classification of these instruments would also be determined based
on the subsequent asset classification of the restructured advance.
Classification of State Government guaranteed investments as NPI
7.100 With effect from the year ending March 31, 2006, investment in State Government guaranteed securities,
including those in the nature of `deemed advance', attract prudential norms for identification of NPI and
provisioning, when interest/installment of principal (including maturity proceeds) or any other amount due to the
bank remains unpaid for more than 90 days.
7.101 The prudential treatment for Central Government Guaranteed bonds has to be identical to Central
Government guaranteed advances. Hence, bank's investments in bonds guaranteed by Central Government need
not be classified as NPI until the Central Government has repudiated the guarantee when invoked. However, this
exemption from classification as NPI is not for the purpose of recognition of income.
7.102 The audit procedures would include:
Identifying Non Performing Investments based on RBI guidelines as defined above. In case advances given
to a party is classified as NPA, investment in securities issued by same party also needs to be classified as
NPI and vice-versa except in case of preference shares, wherein if a preference share is classified as NPI,
the performing securities and performing credit facilities granted to the said party need not be treated as NPI
/ NPA.
Ascertaining whether the bank has made appropriate provision for the depreciation in the value of the NPI.
Ensuring that the banks have not off-set the depreciation on NPI against the appreciation in respect of other
performing securities.
Obtaining separate list of investments as a result of conversion of interest/ principal. These investments need
to be classified as NPI ab initio, if the loan's classification is NPA on implementation of the restructuring
package.
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Special Aspects
7.103 The auditor should pay special attention to ascertaining whether the investments have been purchased or
sold cum-dividend/ex-dividend, cum-interest/ex-interest, cum-right/ex-right, or cum-bonus/ex-bonus. They should
check whether appropriate adjustments in this regard have been made in the cost/sales value of securities
purchased or sold.
7.104 In the case of a right issue, the offer letter should be examined. The auditor should check control over
recording, exercising, renouncing of rights and also valuation of rights yet to be exercised. Where the rights have
been renounced or otherwise disposed off or not exercised, the auditor should examine that same have been duly
accounted for. Similarly, the auditor should examine the relevant documents in the case of detachable warrants.
They should also examine that these have been properly accounted for.
7.105 As regards bonus shares, the intimation to the bank regarding such issue should be examined with a
view to ascertaining the receipt and recording of the requisite number of shares in the records maintained by the
bank in this regard.
Investment Fluctuation Reserve (IFR), Market Risk & Investment Reserve Account
(IRA)
7.106 The RBI's Master Circular specifies the following guidelines with respect to IFR and IRA:
Investment Fluctuation Reserve
(i) Banks were advised to build reserves towards investment fluctuation, of a minimum 5% of the investment
portfolio within 5 years period.
(ii) To ensure smooth transition to Basel II norms, banks have been advised to build adequate reserve towards
capital charge for market risks in a phased manner over a two year period as follows:
(a) In respect of securities included in the HFT category, open gold position limit, open foreign exchange
position limit, trading positions in derivatives and derivatives entered into for hedging trading book
exposures by March 31, 2005; and
(b) In respect of securities included in the AFS category by March 31, 2006.
(iii) As advised by RBI in October, 2005, Banks maintaining capital of at least 9 per cent of the risk weighted
assets for both credit risk and market risks for both HFT (of items - open gold position limit, open foreign
exchange position limit, trading positions in derivatives and derivatives entered into for hedging trading book
exposures) and AFS category as on March 31, 2006 may treat the entire balance of IFR as Tier I capital,
may transfer the balance in the IFR `below the line' in the Profit & Loss Appropriation account to statutory
reserve, general reserve or balance of Profit and Loss Account.
Investment Reserve Account
(iv) Provisions created for depreciation on investments in the AFS and HFT categories if found excessive should
be credited to the Profit & Loss Account and equivalent amount (net of taxes, if any and net of transfer to
Statutory Reserve as applicable to such excess provision) should be appropriated to an Investment Reserve
Account in Schedule 2 "Reserves and Surplus" under the head "Revenue and Other Reserves" and would
be eligible for inclusion under Tier II within the overall ceiling of 1.25% of total risk weighted assets
prescribed for general provisions/ Loss Reserves.
(v) The Investment Reserve Account can be utilised in the manner prescribed in the Master Circular.
(vi) The amounts debited to the Profit & Loss Account for provision should be debited under the head
"Expenditure - Provisions & Contingencies". The amount transferred from the Investment Reserve Account to
the Profit & Loss Account should be shown as "below the line" item in the Profit and Loss Appropriation
Account after determining the profit for the year. Provision towards any erosion in the value of an asset is an
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item of charge on the profit and loss account and hence should appear in that account before arriving at the
profit for the accounting period. Adoption of the following would not only be adoption of a wrong accounting
principle but would, also result in a wrong statement of the profit for the accounting period:
(a) the provision is allowed to be adjusted directly against an item of reserve without being shown in the
profit and loss account, or
(b) a bank is allowed to draw down from the Investment Reserve Account before arriving at the profit for
the accounting period (i.e., above the line), or
(c) a bank is allowed to make provisions for depreciation on investment as a below the line item, after
arriving at the profit for the period,
Hence none of the above options are permissible.
(vii) The withdrawal from the Investment Reserve Account cannot be used for dividend declaration. Dividends
should be payable only out of current year's profit. However, the balance in the Investment Reserve
Account transferred `below the line' in the Profit and Loss Appropriation Account to Statutory Reserve,
General Reserve or balance of Profit & Loss Account would be eligible to be reckoned as Tier I capital.
7.107 The auditor should also examine whether the bank, as required by the RBI, is maintaining separate
accounts for the investments made by it on its own Investment Account, on PMS clients' account, and on behalf of
other constituents (including brokers). As per the RBI guidelines, banks are required to get their investments under
PMS separately audited by external auditors. The auditor should review the report of such external auditors, if
available, and check whether the discrepancies pointed out in the report have been adequately dealt with. The
auditor should also verify that PMS transactions are carried out through a separate SGL account, and that there is no
switching between the bank's own investment account and PMS clients' account except in accordance with the
guidelines laid down by the RBI in this regard.
7.108 Investments should not normally be held by any other person (as laid down in the City Equitable Fire
Insurance Co. case). If any investments are so held, proper enquiry should be made to ensure that there is some
justification for it, e.g., shares may be held by brokers for the purpose of transfer or splitting-up etc. Shares may
also be lodged with the companies concerned for transfer etc. When investments are held by any other person on
behalf of the bank, the auditor should obtain a certificate from him. The certificate should state the reason for
holding the investment (e.g., in safe custody or as security). The receipt originally issued by such person while
taking delivery of the investment is not adequate for audit purposes. In the case of inscribed stock also, a
certificate should be obtained which should certify the holding of the bank as at the date of the balance sheet.
7.109 Where securities lodged for transfer have not been received back within a reasonable period, or where
share certificates, etc., have not been received within a reasonable period of the lodging of the allotment advice,
the auditor should examine whether adequate follow-up action has been taken. He may, in appropriate cases, also
enquire from the issuers, or their registrars, about the reasons for the delay. In cases where the issuer/registrar
has refused to register the transfer of securities in the name of the bank, the auditor should examine the validity of
the title of the bank over such securities.
7.110 If certain securities are held in the names of nominees, the auditor should examine whether there are proper
transfer deeds signed by the holders and also an undertaking from them that they hold the securities on behalf of the
bank. The auditor may also check compliance with Section 89 of the Companies Act, 2013 - Declaration in respect of
beneficial interest in any share.
7.111 While examining the investment portfolio, the auditor should pay special attention to securities whose
maturity dates have already expired. It is possible that income on such investments may also not have been
received. In case the amount of such investments or the income accrued thereon is material, the auditor should seek
an explanation from the management on this aspect. They should also consider whether the income accrued
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requires reversal as also whether any provision for loss in respect of such investments is required. Similarly, where
income on any security is long overdue, the auditor should consider whether provision is required in respect of such
income accrued earlier.
7.112 The auditor should check whether the overdue amount in respect of matured investment is disclosed as
Investment or other assets. Since the investments had already matured, the overdue amount should be disclosed as
Other Assets and not Investments.
Income from investments
7.113 The auditor should examine whether income from investments is properly accounted for. This aspect
assumes special importance in cases where the bank has opted for receipt of income through the electronic/on
line medium.
7.114 Some of the typical audit procedures would include:
Re-computation of amortisation of premium / discount on investment securities.
Re-performance of profit / loss on sale of investments keeping into consideration the method of allocating cost
to securities (FIFO or weighted average).
Assessing the dividend recognition policy of bank considering revenue recognition principles of Accounting
Standard 9, Revenue Recognition.
Re-computation of interest income on investments and checking the treatment of broken period interest,
including ensuring proper cut-offs at reporting period ends.
Checking of proper recognition of investment valuation loss as at reporting date
Checking of interest accrual in respect of interest-bearing investment outstanding at reporting date.
7.115 Considering that banks have large investment portfolio, use of substantive analytical procedures may be
a useful audit technique for the auditor to conclude income associated with investment balances is free from
material misstatement. One of such techniques may include `yield analysis' for the disaggregated investment
portfolio of the bank.
7.116 There may be cases where the certificates of tax deduction at source (TDS) received along with the
dividend/interest on investments are found missing. This increases the incidence of tax on the bank. The auditor
should see that there is a proper system for recording and maintenance of TDS certificates received by the bank.
The auditor may also review Form 26AS to ensure that the proper credit will be made available to the bank.
7.117 A part of the outstanding principal amount can be converted into debt or equity instruments as part of
restructuring. In the case of restructured accounts classified as 'standard', the income, if any, generated by these
instruments may be recognised on accrual basis. In the case of restructured accounts classified as non-performing
assets, the income, if any, generated by these instruments may be recognised only on cash basis. Auditor should
verify that recognition of assets on conversion / restructuring does not exceed the amount restructured.
Special-purpose Certificates Relating to Investments
7.118 It may be noted that pursuant to RBI's circulars, issued from time to time, banks require their central
statutory auditors to issue the following certificates regarding investments of the bank (in addition to their main
audit report and the long form audit report).
(i) Certificate on reconciliation of securities by the bank (both on its own Investment Account as well as PMS
clients' account). The reconciliation is to be presented in a given format.
(ii) Certificate on compliance by the bank in key areas of prudential and other guidelines relating to such
transactions issued by the Reserve Bank of India.
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The auditor may consider relying on the work done during the course of audit for the purposes of such certificates.
As per the Master circular, the certificate should reach the Regional Office of the DBS, RBI, under whose
jurisdiction the bank's head office is located within one month from the close of the accounting year, and thus for
banks whose accounts have not been audited by the stated period may issue the certificate based on the
unaudited books of account.
Dealings in Securities on Behalf of Others
7.119 Apart from making investments on its account, a bank may also deal in securities on behalf of its
customers only with the prior approval from RBI. These activities of banks are in the nature of trust or fiduciary
activities. The accounting implications of the trust activities of banks may be noted.
7.120 Banks commonly act as trustees and in other fiduciary capacities that result in holding or placing of
assets on behalf of individuals, trusts, retirement benefit plans and other institutions. Provided the trustee or
similar relationship is legally supported, these assets are not assets of the bank and, therefore, are not included in
its balance sheet. If the bank is engaged in significant trust activities, disclosure of that fact and indication of the
extent of those activities is made in its financial statements because of the potential liability if it fails in its fiduciary
duties. For this purpose, trust activities do not encompass safe custody functions.
7.121 The auditor should examine whether bank's income from such activities has been recorded and is fairly
stated in the bank's financial statements. The auditor also needs to consider whether the bank has any material
undisclosed liability from a breach of its fiduciary duties, including the safekeeping of assets.
The auditor also needs to give certificate for reconciliation of securities held by the bank as custodian.
The text of Illustrative Checklist for the Verification of the aspects of the Treasury/Investments of the Bank in
Statutory Audit is given in CD.
Section C: Forex and Derivatives
Overview of Forex and Derivative Operations in a Bank
7.122 Banks transact in various treasury instruments with an objective of hedging their risks and also to generate
trading profits. Apart from regular proprietary business, the treasury operations of a bank aim to continue to focus on
enhancing returns from customer relationships that have been built, and successfully capitalise on this to rapidly
increase income from foreign exchange and derivative transactions from customers, as also to assist them in
covering and hedging their foreign currency and derivative positions.
7.123 The foreign exchange market encompasses transactions in which funds of one currency are sold for funds
in another currency. These transactions take the form of contracts calling for the parties in the contract to deliver to
each other on a fixed date a specified sum in a given currency. The exchange, the delivery of one currency on receipt
of another, can take place at the time the contract is negotiated or at some future date, as stated in the contract.
7.124 Foreign exchange transactions, to be distinguished from transactions in foreign currencies, consist of
contracts in which each party is committed to deliver one currency while, at the same time, receive another. Until the
time of delivery, when settlement is to be made on the contract, the contract represents a future commitment of the
Bank's resources. Thus, the maturity of a contract culminates in the realisation of the transaction envisaged in the
contract, at which time the counterparties are given value for the currencies the contract says they are to receive.
7.125 In foreign exchange contracts, the value date is the date on which the contract matures, that is the date on
which settlement is to be made. For loans and borrowings, including those in the money markets, on the other hand,
the value date is that date on which the borrower receives constructive use of the funds loaned, while the maturity
date is that future date on which it will repay the funds it has borrowed.
Derivatives
7.126 In India, different derivatives instruments are permitted and regulated by various regulators, like Reserve
Bank of India (RBI), Securities and Exchange Board of India (SEBI). Broadly, RBI is empowered to regulate the
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interest rate derivatives, foreign currency derivatives and credit derivatives. For regulatory purposes, derivatives have
been defined in the Reserve Bank of India Act, vide circular No. DBOD. No. BP.BC. 86/21.04.157/2006-07 dated 20
April 2007 as follows:
7.127 "Derivative" means an instrument, to be settled at a future date, whose value is derived from change in
interest rate, foreign exchange rate, credit rating or credit index, price of securities (also called "underlying"), or a
combination of more than one of them and includes interest rate swaps, forward rate agreements, foreign currency
swaps, foreign currency-rupee swaps, foreign currency options, foreign currency-rupee options or such other
instruments as may be specified by the RBI from time to time.
Products offered in Forex and Derivative business
7.128 There are various types of foreign exchange and derivative contracts offered in normal course of banking
business including inter-alia Cash, Tom & Spot, Foreign exchange forward, Swap, Currency Swap, Credit Default
Swap, Currency Option, Forward rate Agreement, Interest rate swap, Interest rate futures, Interest rate cap & floor,
Currency futures, Interest Rate Options. The following circulars are relevant and give guidance on these products:-
DBOD.No.BP.BC. 44/21.04.157/2011-12 dated 2 November 2011 modifying the 20 April 2007 circular
DBOD.BP.BC.No. 61/21.06.203/2011-12 of 30th November 2011 regarding credit default swaps
IDMC.MSRD.4801/06.01.03 dated June 3, 2003 on Exchange-Traded Interest Rate Derivatives
IDMD.PDRD.No. 1056/03.64.00/2009-10 dated September 1, 2009 on Guidelines on Exchange Traded
Interest Rate Derivatives
RBI/2010-11/147 A.P. (DIR Series) Circular No. 05 dated July 30, 2010 on "Guidelines on trading of
Currency Options on Recognised Stock / New Exchanges
DBOD.No.BP.BC.51 / 21.06.101 / 2010-11 dated October 28, 2010 on Introduction of Exchange Traded
Currency Options Permitting Banks to Participate in Currency Options on Recognized Stock / New
Exchanges
RBI/2016-17/199 FMRD.DIRD.12/14.01.011/2016-17, December 29, 2016 on Introduction of Interest Rate
Options in India, detailed directions of which are given in Notification No. FMRD-DIRD.11/2016 dated
December 28, 2016.
Derivatives Markets
7.129 There are two distinct groups of derivative contracts:
Over-the-counter (OTC) derivatives: Contracts that are traded directly between two eligible parties, with or
without the use of an intermediary and without going through an exchange.
Exchange-traded derivatives: Derivative products that are traded on an exchange.
Participants
7.130 Participants of this market can broadly be classified into following two functional categories:
User: A user participates in the derivatives market to manage an underlying risk.
Market-maker: A market-maker provides bid and offer prices to users and other market-makers. A market-
maker need not have an underlying risk.
At least one party to a derivative transaction is required to be a market-maker.
Purpose
7.131 Users can undertake derivative transactions to hedge an existing identified risk on an ongoing basis during
the life of the derivative transaction or for transformation of risk exposure, as specifically permitted by RBI. Market-
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makers can undertake derivative transactions to act as counterparties in derivative transactions with users and
also amongst themselves. The major objectives/purpose for undertaking derivative transactions has been
explained below:
Objectives/Purpose Reasons
Use of derivatives by the Bank to manage its balance sheet exposures.
Balance Sheet Management The Bank will use derivatives as a means for managing the interest rate,
liquidity and foreign exchange risks arising from its banking operations.
Offering derivative products to existing and new clients as an additional
product from the Bank.
Client servicing
The Bank will offer derivative products to enhance product offerings to its
existing clients as well as to build new client relations.
The Bank will undertake derivative transactions to earn trading profits.
Proprietary Trading The Bank's treasury may take view-based transactions as well as offer two-
way quotes on derivatives within the limits prescribed by this policy.
Broad Principles for Undertaking Derivative Transactions
7.132 The major requirements for undertaking any derivative transaction include:
In addition to generic derivative products, market-makers may also offer structured derivative products to
users as long as they do not contain any derivative instrument as underlying and have been specifically
permitted by RBI in its Master Direction No. 1/2016-17 dated July 5, 2016 on `Risk Management and Inter-
Bank Dealings' and guidelines contained in RBI's Circular DBOD.No.BP.BC.86/21.04.157/2006-07 dated 20
April 2007 on Comprehensive Guidelines on Derivatives and further amendments issued vide circulars
DBOD.No.BP.BC. 27 / 21.04.157/2011-12 dated 2 August 2011 and DBOD.BP.BC.44/21.04.157/2011-12
dated 2 November 2011 (`the Comprehensive Guidelines on derivatives')
a. The following derivative instruments used to hedge an existing interest rate and forex exposure, on a
standalone basis, may be treated as generic derivative products:
o Forex Forward Contracts
o Forward Rate Agreements
o Interest rate caps and floors (plain vanilla only)
o Plain Vanilla Options (call option and put option)
o Interest Rate Swaps
o Currency Swaps including Cross-Currency Swaps
o Exchange traded Currency Futures
o Exchange traded currency options
o Interest Rate Options.
b. The following derivative products may be treated as structured derivative products:
o Instruments which are combination of either cash instrument and one or more generic derivative
products
o Instruments which are combination of two or more generic derivative products
Market-makers should be in a position to arrive at the fair value of all derivative instruments, including
structured products on the basis of the approach specified in the Comprehensive Guidelines on derivatives.
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7.133 It may be ensured that structured products do not contain any derivative, which is not allowed on a
standalone basis. Further,
All permitted derivative transactions, including roll over, restructuring and novation can be contracted only at
prevailing market rates.
All risks arising from derivatives exposures should be analysed and documented, both at transaction level and
portfolio level.
The management of derivatives activities should be an integral part of the overall risk management policy and
mechanism. It is desirable that the board of directors and senior management understand the risks inherent in
the derivatives activities being undertaken.
Market-makers should have a `Suitability and Appropriateness Policy' vis-à-vis users in respect of the products
offered, on the lines indicated in the guidelines given in the Circular.
Market-makers may, where they consider necessary, maintain cash margin/liquid collateral in respect of
derivative transactions undertaken by users on mark-to-market basis.
Risk Management and Corporate Governance Aspects
7.134 The Comprehensive Guidelines on derivatives also sets out the basic principles of a prudent system to
control the risks in derivatives activities. These include:
(a) appropriate oversight by the board of directors and senior management;
(b) adequate risk management process that integrates prudent risk limits, sound measurement procedures and
information systems, continuous risk monitoring and frequent management reporting; and
(c) comprehensive internal controls and audit procedures.
Suitability and Appropriateness
7.135 While undertaking derivative transactions with or selling structured derivative products to a user, a
market-maker should:
(a) document how the pricing has been done and how periodic valuations will be done. In the case of structured
products, this document should contain a dissection of the product into its generic components to
demonstrate its permissibility, on the one hand, and to explain its price and periodic valuation principles, on
the other. The following information may be shared with the user:
(i) Description of the transaction.
(ii) Building blocks of the transaction.
(iii) Rationale along with appropriate risk disclosures.
(iv) Sensitivity analysis identifying the various market parameters that affect the product.
(v) Scenario Analysis encompassing both the possible upside as well as the downsides.
(b) analyse the expected impact of the proposed derivatives transaction on the user.
(c) Before offering any derivative product to a client, obtain Board resolution from the corporate which contains
the details specified in the Comprehensive Guidelines on derivatives.
(d) identify whether the proposed transaction is consistent with the user's policies and procedures with respect
to derivatives transactions, as they are known to the market-maker.
(e) ensure that the terms of the contract are clear and assess whether the user is capable of understanding the
terms of the contract and of fulfilling its obligations under the contract.
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(f) inform the customer of its opinion, where the market-maker considers that a proposed derivatives transaction
is inappropriate for a customer. If the customer nonetheless wishes to proceed, the market-maker should
document its analysis and its discussions with the customer in its files to lessen the chances of litigation in
case the transaction proves unprofitable to the customer. The approval for such transactions should be
escalated to next higher level of authority at the market-maker as also for the user.
(g) ensure the terms of the contract are properly documented, disclosing the inherent risks in the proposed
transaction to the customer in the form of a Risk Disclosure Statement which should include a detailed
scenario analysis (both positive and negative) and payouts in quantitative terms under different combination
of underlying market variables such as interest rates and currency rates, etc., assumptions made for the
scenario analysis and obtaining a written acknowledgement from the counterparty for having read and
understood the Risk Disclosure Statement.
(h) guard against the possibility of misunderstandings all significant communications between the market-maker
and user should be in writing/email or recorded in meeting notes.
(i) ensure to undertake transactions at prevailing market rates and to avoid transactions that could result in
acceleration/deferment of gains or losses.
(j) should establish internal procedures for handling customer disputes and complaints. They should be
investigated thoroughly and handled fairly and promptly. Senior management and the Compliance
Department/Officer should be informed of all customer disputes and complaints at a regular interval.
It may also be noted that the responsibility of `Customer Appropriateness and Suitability' review is on the market-
maker.
Documentation
7.136 The comprehensive guidelines on derivatives circular require the market participants to ensure that
documentation requirements in respect of derivative contracts are complete in all respects.
Identification and Management of Risk
7.137 Market-makers should identify the various types of risk to which they are exposed in their derivatives
activities. The main types of risk are:
credit risk
market risk
liquidity risk
interest risk
operational risk
legal risk
The RBI circular requires that all significant risks should be measured and integrated into an entity-wide risk
management system.
Risk limits
7.138 Risk limits serve as a means to control exposures to the various risks associated with derivative activities.
Limits should be integrated across all activities and measured against aggregate risks. Limits should be
compatible with the nature of the entity's strategies, risk measurement systems, and the board's risk tolerance. To
ensure consistency between limits and business strategies, the board should annually approve limits as part of the
overall budget process.
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Independent Risk control
7.139 There should be a mechanism within each entity for independently monitoring and controlling the various
risks in derivatives. The inter-relationship between the different types of risks needs to be taken into account.
Operational Controls
7.140 The nature of the controls in place to manage operational risk must be commensurate with the scale and
complexity of the derivatives activity being undertaken. The operational controls could in addition to segregation
of duties, cover aspects such as:
trade entry and transaction documentation
confirmation of trades
settlement and disbursement
reconciliations
revaluation
exception reports
accounting treatment
audit trail
Prudential Norms Relating to Derivatives
7.141 The prudential norms relating to derivatives minimum capital adequacy requirement, credit exposure
norms, ALM etc. will be as prescribed by RBI from time to time. Attention of the reader may be drawn on RBI's
Circular No. DBOD.No.BP.BC.48 / 21.06.001/2010-11 dated October 1, 2010 and
DBOD.No.BP.BC.31/21.04.157/2008-09 dated August 8, 2008, DBOD.No. BP.BC.57/21.04.157/200809 dated
October, 13 2008, DBOD.No.BP.BC. 28/21.04.157/2011-12 dated August 11, 2011 and DBOD.No.BP.BC.31
/21.04.157/2012-13 dated July 23, 2012 on "Prudential Norms for Off-Balance Sheet Exposures of Banks" and
RBI's Master Circular No. RBI/2015-16/70/DBR.No.Dir.BC.12/13.03.00/2015-16 dated July 1, 2015 on "Exposure
Norms".
Asset Classification of Derivatives
7.142 RBI vide its Circular No. DBOD.No.BP.BC.57/ 21.04.157/2008-09 dated October 13, 2008 on "Prudential
Norms for Off-Balance Sheet Exposures of Banks" and Circular No. RBI/2015-16/101
DBR.No.BP.BC.2/21.04.048/2015-16 dated July 1, 2015 on "Prudential Norms on Income Recognition, Asset
Classification and Provisioning pertaining to Advances" advised the banks including foreign branches of Indian banks
as under:
i. The overdue receivables representing positive mark-to-market value of a derivative contract will be treated
as a non-performing asset, if these remain unpaid for a period of 90 days from the specified due date for
payment.
ii. In case the overdues arising from forward contracts and plain vanilla swaps and options become NPAs, all
other funded facilities granted to the client shall also be classified as non-performing asset following the
principle of borrower-wise classification as per the existing asset classification norms.
iii. However, any amount, representing positive mark-to-market value of the foreign exchange derivative
contracts (other than forward contract and plain vanilla swaps and options) that were entered into during the
period April 2007 to June 2008, which has already crystallised or might crystallise in future and is / becomes
receivable from the client, should be parked in a separate account maintained in the name of the client
/counterparty. This amount, even if overdue for a period of 90 days or more, will not make other funded
facilities provided to the client, NPA on account of the principle of borrower-wise asset classification, though
such receivable overdue for 90 days or more shall itself be classified as NPA, as per the extant IRAC norms.
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The classification of all other assets of such clients will, however, continue to be governed by the extant
IRAC norms
iv. If the client concerned is also a borrower of the bank enjoying a Cash Credit or Overdraft facility from the
bank, the receivables mentioned at item (i) above may be debited to that account on due date and the impact
of its non-payment would be reflected in the cash credit/overdraft facility account. The principle of borrower-
wise asset classification would be applicable here also, as per extant norms.
v. In cases where the contract provides for settlement of the current mark-to market value of a derivative
contract before its maturity, only the current credit exposure (not the potential future exposure) will be
classified as a non-performing asset after an overdue period of 90 days.
vi. As the overdue receivables mentioned above would represent unrealised income already booked by the
bank on accrual basis, after 90 days of overdue period, the amount already taken to 'Profit and Loss a/c'
should be reversed.
7.143 RBI vide its Circular No. DBOD.No.BP.BC.48 / 21.06.001/2010-11 dated October 1, 2010 on "Prudential
Norms for Off-Balance Sheet Exposures of Banks - Bilateral netting of counterparty credit exposures" has decided
that since the legal position regarding bilateral netting is not unambiguously clear, bilateral netting of mark-to-market
(MTM) values arising on account of such derivative contracts cannot be permitted. Accordingly, banks should count
their gross positive MTM value of such contracts for the purposes of capital adequacy as well as for exposure norms.
7.144 RBI vide its Circular No. RBI/2015-16/101 DBR.No.BP.BC.2/21.04.048/ 2015-16 dated July 1, 2015 on
"Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances" advised
banks that credit exposures computed as per the current marked to market value of the contract, arising on account
of the interest rate & foreign exchange derivative transactions, credit default swaps, shall also attract provisioning
requirement as applicable to the loan assets in the 'standard' category, of the concerned counterparties. All
conditions applicable for treatment of the provisions for standard assets would also apply to the aforesaid provisions
for derivative exposures.
7.145 RBI vide its circular no. DBOD.BP.BC.28/21.04.157/2011-12 dated August 11, 2011 has further clarified
that:
In cases where the derivative contracts provides for more settlements in future, the MTM value will comprise of
(a) crystallised receivables and (b) positive or negative MTM in respect of future receivables.
If the derivative contract is not terminated on the overdue receivable remaining unpaid for 90 days, in addition to
reversing the crystallised receivable from Profit and Loss Account as stipulated in para 1 of aforementioned
circular, the positive MTM pertaining to future receivables may also be reversed from Profit and Loss Account to
another account styled as `Suspense Account Positive MTM'. The subsequent positive changes in the MTM
value may be credited to the `Suspense Account Positive MTM', not to P&L Account.
The subsequent decline in MTM value may be adjusted against the balance in `Suspense Account Positive
MTM'. If the balance in this account is not sufficient, the remaining amount may be debited to the P&L Account.
On payment of the overdues in cash, the balance in the `Suspense Account-Crystalised Receivables' may be
transferred to the `Profit and Loss Account', to the extent payment is received.
If the bank has other derivative exposures on the borrower, it follows that the MTMs of other derivative
exposures should also be dealt with / accounted for in the manner as described above, subsequent to the
crystalised/settlement amount in respect of a particular derivative transaction being treated as NPA.
Since the legal position regarding bilateral netting is not unambiguously clear, receivables and payables from/to
the same counterparty including that relating to a single derivative contract should not be netted.
Similarly, in case a fund-based credit facility extended to a borrower is classified as NPA, the MTMs of all the
derivative exposures should be treated in the manner discussed above.
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These guidelines are applicable to both outstanding derivatives contracts and the derivatives transactions
undertaken from the date of the circular.
Re-structuring of derivative contracts
7.146 In cases where a derivative contract is restructured, the mark-to-market value of the contract on the date
of restructuring should be cash settled. For this purpose, any change in any of the parameters of the original
contract would be treated as a restructuring. RBI vide NotificationRBI/2016-17/45 DBR.No.BP. BC.7/21.04.157/
2016-17 dated August 25, 2016 has clarified that cash settlement is required of the change in mark-to-market value
of the restructured derivative contract. Banks are permitted to restructure derivative contract at prevalent market
rates, and not on the basis of off-market rates.
Provisions in case of foreign branches and subsidiaries of the Indian Banks
7.147 The RBI vide its circular No. DBOD.No.BP.BC.89 /21.04.141/2008-09 dated December 1, 2008 on
"Operations of foreign branches and subsidiaries of the Indian banks Compliance with
statutory/regulatory/administrative prohibitions/ restrictions" provides that transactions by the foreign branches /
foreign subsidiaries, in financial products which are not available in the Indian market and on which no specific
prohibition has been currently placed by the RBI, no prior approval of the RBI would be required for the purpose
provided these are merely plain-vanilla financial products. Banks should, however, ensure that their foreign
branches / subsidiaries, dealing with such products in foreign jurisdictions, have adequate knowledge,
understanding, and risk management capability for handling such products. Such products should also be
appropriately captured and reported in the extant off-site returns furnished to the RBI. These products would also
attract the prudential norms such as capital adequacy, credit exposure, periodical valuation, and all other
applicable norms. In case the current RBI norms do not specify prudential treatment of such financial products, it
would be incumbent upon the banks to seek specific RBI guidance in the matter. RBI vide Notification NO./2013-
14/588 DBOD.No.BP. BC.111/21.04.157/2013-14 May 12, 2014 permitted that if foreign branches / subsidiaries of
Indian banks propose to offer structured financial and derivative products that are not specifically permitted by the
Reserve Bank in the domestic market, they may do so only at the established financial centers outside India like New
York, London, Singapore, Hong Kong, Frankfurt, Dubai, etc. subject to compliance with the conditions stipulated
therein.
Risk management
7.148 This is a function that can sit well in the middle office provided it is properly staffed by officers who
understand fully the business and risks involved which usually means ex-market practitioners. It can range from
agreeing overnight cash positions for the trading room through to full-risk modeling associated with derivatives
trading and hedging. In between can come monitoring of counterparty, country, dealer and market-related limits that
have been set and approved in other areas of the bank such as the credit department.
Risk Identification Process
Price or Rate Risk
Foreign Exchange Rate Movement Risk
7.149 Foreign exchange rate movement risk arises from net exchange position in a currency. If the position is
long or overbought and there is depreciation in the currency, a loss occurs. On the other hand, if an appreciation
occurs while the dealer is holding a long net position, there will be a profit from such change in exchange rates. The
opposite will occur if the net positions were short or oversold in that currency. Price risk of this kind also exists on
execution of a swap. This is also known as the 'tail', which arises because in a swap the effects of two foreign
currency amounts, inflow and outflow, are different on account of present valuing all cash flows.
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US$/INR FX Forwards Risk
7.150 Forward points (premia/discount) in the Indian markets are not entirely a function of interest rate differentials
but a function of demand and supply of forward currency. As a result, normally banks treat traded forward points (up
to 1-year) as a market factor, and use this to compute the implied INR rate (MIFOR) up to the 1-year segment.
Beyond 1-year, forward points are computed from the INR currency swap/ MIFOR quotes and US$ swap curve.
Timing Risk
7.151 As per market practice, FX contracts with timing discretion (Option Period Forwards or OPFs) versus INR
are typically for a period of one week to a maximum of one month. The customer has the discretion to pick up the
contract on any day of the window period. In case the customer is buying the foreign currency (`FCY'), the swap
points/contract rate is fixed based on the last date of the period in case the FCY is at a premium against the INR or
the first date in case the FCY is at a discount. Hence, unless the swap points change from premium to discount or
vice versa after entering into the contract, the counterparty would not benefit by taking delivery before last date in
case of premium or after first date in case of discount. In the unlikely event of this happening and if the bank has not
hedged the contract similarly with another contract with discretion period, an adverse impact on Profit and Loss
Account could arise. In such a case, the market counterparty could pick up the contract early while the hedge
contract would still be outstanding and the gap would have to be covered again at incremental cost.
Credit Risk
7.152 Credit risk is the risk that the counterparty to a financial transaction - here a foreign exchange contract - may
become unable to perform its obligation. The extent of risk depends on whether the other party's inability to pay is
established before the value date or is on the same value date of the foreign exchange contract.
Pre-Settlement Likely Exposure
7.153 Trading (or pre-settlement) exposure occurs when a counterparty defaults on its contractual obligation before
the settlement date and the bank has to defend the position in the market with another counterparty at the then
prevailing rate. The bank is exposed to possible adverse price fluctuations between the contract price and the market
price on the date of default or final liquidation.
Settlement Risk
7.154 This occurs when items of agreed upon original equal value are not simultaneously exchanged between
counter parties; and/or when Bank's funds are released without knowledge that counter value items have been
received by the bank. Typically, the duration is overnight/over weekend, or in some cases even longer i.e., until bank
receives the confirmation of receipt of funds. The risk is that bank delivers but does not receive delivery. In this
situation 100% of the principal amount is at risk.
Market risk
7.155 Market risk is the risk of loss due to adverse changes in the market value (the price) of an instrument or
portfolio of instruments. Such exposure occurs with respect to derivative instruments when changes occur in market
factors such as underlying interest rates, exchange rates, equity prices, and commodity prices or in the volatility of
these factors.
Liquidity Risk
7.156 Liquidity risk refers to the ease with which a foreign exchange spots position or gap can be liquidated. The
approved spot DV01 limit factors in the liquidity risk associated with the product. Tenor wise DV01 limits in the case
of US$INR gaps factor in the liquidity in the forward markets. Institutions involved in derivatives activity face two
types of liquidity risk: market liquidity risk and funding liquidity risk.
Market Liquidity Risk
7.157 Market liquidity risk is the risk that an institution may not be able to exit or offset positions quickly, and in
sufficient quantities, at a reasonable price. This inability may be due to inadequate market depth in certain products
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(e.g. exotic derivatives, long-dated options), market disruption, or inability of the bank to access the market (e.g.
credit down-grading of the institution or of a major counterparty).
Funding Liquidity Risk
7.158 Funding liquidity risk is the potential inability of the institution to meet funding requirements, because of cash
flow mismatches, at a reasonable cost. Such funding requirements may arise from cash flow mismatches in swap
books, exercise of options, and the implementation of dynamic hedging strategies.
Sovereign Risk or Cross Border Risk
7.159 This is the risk that the Government of a particular country may interfere with a payment due to the Bank
from a client resident in that country and preclude the client from converting and/or transferring the funds. In such
cases, bank's obligor may be economically sound and capable of repaying its obligation, but its country's
Government may place an embargo on remittances for political/economic reasons.
Operations Risk
7.160 This can occur if an error in processing results in a loss and/or excess over prescribed risk/regulatory limits.
Legal risk
7.161 Legal risk is the risk of loss arising from contracts, which are not legally enforceable (e.g. the counterparty
does not have the power or authority to enter into a particular type of derivatives transaction) or documented
correctly.
Regulatory risk
7.162 Regulatory risk is the risk of loss arising from failure to comply with regulatory or legal requirements.
Reputation risk
7.163 Reputation risk is the risk of loss arising from adverse public opinion and damage to reputation.
Risk Management Limits and Monitoring
7.164 All banks, managements should have a risk management policy, laying down clear guidelines for concluding
the transactions and institutionalise the arrangements for a periodical review of operations and annual audit of
transactions to verify compliance with the regulations.
Overnight Net Exchange Position Limit/Factor Sensitivity Limits for Spot FX
7.165 NOOPL may be fixed by the boards of the respective banks and communicated to the Reserve Bank
immediately. However, such limits should not exceed 25 percent of the total capital (Tier I and Tier II capital) of a
bank, refer RBI Master Directions Risk Management and Inter Bank Dealings dated July 5, 2016.. This limits the
maximum allowable excess of assets plus exchange bought contracts over liabilities plus exchange sold contracts
("overbought" position) and the reverse ("oversold" position) that may be carried overnight in foreign currencies.
Daylight Limit
7.166 As mentioned for NOOPL these refer to the maximum net positions that can be taken during the trading day
in each currency. In case of large intra-day flows and positions, it is expected that the desk will keep the risk
department informed about the same.
Value at Risk (`VAR') limits
7.167 Spot VAR measures the change in the economic value of a currency position due to a standard deviation
adverse change in the spot rates for that currency. The standard deviation for each currency is a measure of the
volatility of movements of the spot exchange rate versus the US$. The Spot VAR along with VAR of other products
should be within the VAR limit as stipulated in the Bank's risk guidelines.
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7.168 The spot VAR of each currency is computed using the individual currency's volatility and the Factor
Sensitivity (DV01) as well as the covariance between currencies. The volatility factors and the covariance coefficients
are as per the risk guidelines of the Bank.
Gap DV01 and VAR limits
7.169 The Gap DV01 for USDINR FX forwards is monitored on MIFOR & LIBOR curve. Gap DV01 is computed as
the effect of 1 basis point change in the MIFOR/ LIBOR for the tenor on the P&L. The Gap VAR is computed using
volatilities for each tenor of the MIFOR/ LIBOR curve and the correlation between them.
7.170 The Banks are also required to compute VAR on a daily basis as per the RBI model on the overall bank
gap. The bank has to maintain a separate VAR limit for derivative transactions as mentioned in the RBI Circular No.
MPD.BC.187/07.01.279 dated July 7, 1999.
7.171 As of the last reporting Friday of every month, treasury operations has to prepare the GAP report in
prescribed format as given by the RBI for the overall gap position of the Bank.
Aggregate Contract Limit
7.172 This limits the gross outstanding spot and future exchange contracts, both bought and sold. It is computed
by adding the US$ equivalents of the sum total of all outstanding contracts across all currencies. It restrains overall
trading volume and its monitoring provides an indication of any unusual activity.
Options Limit
7.173 These are specifically designed to control the risks of the options. Options limit may include Delta, Gamma,
Vega, Theta and Rho limits. Delta is a measure of the amount an option price would be expected to change for a
unit change in the price of the underlying instrument. Gamma is a measure of the amount delta would be expected
to change in response to a unit change in the price of the underlying instrument. Vega is a measure of the amount
an option's price would be expected to change in response to a unit change in the price of volatility of the underlying
instrument. Theta is a measure of the amount of an option's price would be expected to change in response to
changes in options time to expiration. Rho is a measure of the amount an option's price would be expected to
change in response to changes in interest rates.
Stop Loss Limit
7.174 Stop loss limits can be based on market prices or the losses reflected by those prices. If market prices reach
a level where losses on that position equal or are greater than some predetermined limit then the position is closed
out.
Management Action Trigger (MAT)
7.175 MAT represents the management's tolerance for accepting the market risk related losses on a daily and
cumulative month-to-date basis especially on the trading portfolio.
The P&L for spot trading are monitored as part of the Spot MAT limit while the P&L forwards trading is monitored within
the Interest rate products MAT.
Limit Exceptions
7.176 A limit exception is a trade or position specific authorization to exceed a limit for a defined period of time. All
limit exceptions must be approved in advance of establishing a position that would exceed a limit.
7.177 Normally Market Risk Management is responsible for maintaining all documentation of the excess including
the agreed upon corrective action and the resolution date and is responsible for the ongoing monitoring of the excess
to ensure the corrective action is carried out.
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Accounting for Forex and Derivative Transactions
7.178 Accounting is generally handled by the back office which acts as an intermediary between the treasury
business unit and the finance department to ensure that the accounting of treasury products is accurate and correct.
7.179 Attention of the readers is invited to paragraphs 36 to 39 of Accounting Standard 11, whereby a forward
exchange contract or another financial instrument that is in substance a forward exchange contract in entered into,
which is not intended for trading or speculation purposes, to establish the amount of the reporting currency required
or available at the settlement date of a transaction, the premium or discount arising at the inception of such a forward
exchange contract should be amortized as expense or income over the life of the contract. Exchange differences on
such a contract should be recognized in the statement of profit and loss in the reporting period in which the exchange
rates change.
7.180 Any profit or loss arising on cancellation or renewal of such a forward exchange contract should be
recognized as income or as expense for the period. Such contracts should not be marked to market.
7.181 It also enables treasury operations staff to understand the accounting that is peculiar to treasury, such as
the `trading account' and `base currency' concepts. This is vital as most of the accounting is `hidden' by being
automatically systems generated as a result of deal input of various types. Indeed, this problem is self-perpetuating
as the more complex the deals become the more likely a bank will be to automate to prevent errors.
Documentation
7.182 This can range from simple customer mandates through to full legal documentation with both banks and
customers. The bank's legal department is responsible for legal agreements depending on what types of business is
being conducted and, crucially, whether the counterparties intend to net payments at settlement. Organizationally,
this area can be viewed in a similar way to the accounting function. If documentation forms part of the back office
then the business will be more understood by management and better controlled as a result. The Comprehensive
Guidelines on derivatives also requires the market participants to ensure that documentation requirements in
respect of derivative contracts are complete in all respects.
Rate Reasonability
7.183 The bank's risk department will perform the rate reasonability process as per the Price Verification Policy of
the bank and for any transaction that falls outside the band specified, the same should be enquired into for reasons.
Position and P&L Reconciliation
7.184 This is one of the most important controls on deals position which is carried out by the bank's risk
department / back office. The trader's net currency-wise exchange position as per front office system should be
matched on a daily basis by risk department / back office with the back office systems position. The position
exceptions should be communicated to the front office and a resolution is arrived at.
Regulatory Reporting requirements
7.185 Derivatives are governed by the Foreign Exchange Management (Foreign Exchange Derivative Contracts)
Regulations, 2000. Derivatives are allowed only under the provisions of these regulations and amendments since, or
with the prior permission of the Reserve Bank of India. The reporting requirements under RBI Master Direction No.
1/2016-17 dated July 5, 2016 on `Risk Management and Inter-Bank Dealings' and RBI Circular No. DBOD. No.
BP.BC.86/21.04.157/2006-07 dated April 20, 2007 on "Comprehensive Guidelines on Derivatives" should be
adhering to.
7.186 Following are some of the reports to be submitted to RBI:
i) Daily statements of Foreign Exchange Turnover in Form FTD and Gaps, Position and Cash Balances in Form
GPB.
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ii) Statement of Nostro / Vostro Account balances on a monthly basis.
iii) Consolidated data on cross currency derivative transactions undertaken by residents.
iv) Details of exposures in foreign exchange as at the end of every quarter as per those details of exposures of all
corporate clients who meet the prescribed criteria have to be included in the report. The AD banks should
submit this report based on bank's books and not based on corporate returns.
v) Details of option transactions (FCY-INR) undertaken on a weekly basis.
vi) Total outstanding foreign currency borrowings under all categories as on the last Friday of every month.
vii) Monthly report (as on the last Friday of every month) on the limits granted and utilized by their constituents
under the facility of booking forward contracts on past performance basis.
viii) Statement in form BAL giving details of their holdings of all foreign currencies on fortnightly basis through
Online Returns Filing System (ORFS).
ix) A monthly statement, in respect of cover taken by FIIs, indicating the name of the FII / fund, the eligible
amount of cover, the actual cover taken, etc.
x) List (in triplicate) of all bank's offices/branches, which are maintaining Rupee accounts of non-resident banks
as at the end of December every year.
xi) Quarterly report on the forward contracts booked and cancelled by SMEs and Resident Individuals.
xii) Consolidated data on the transactions undertaken by non-residents under the scheme.
xiii) Doubtful transactions involving frequent cancellation of hedge transactions and / or the underlying trade
transactions by non-residents under the scheme.
7.187 Another significant feature of the foreign exchange business of banks in India is the requirement of
reporting of transactions, at specified intervals, by the branches to the Reserve Bank of India by means of `R'
returns, as enumerated in the Exchange Control Manual. Those branches which handle foreign exchange
transactions and are under obligation to report them directly to Reserve Bank are called the `Authorised Dealers'
(ADalso called `position maintaining branches'). The ADs can be nominated only with the approval of the
Reserve Bank of India and each AD would have a unique Code Number, which must be mentioned in all reports to
the Reserve Bank. In addition to these ADs, individual banks may also, subject to report to the Reserve Bank,
nominate some other branches to handle the specified type of foreign exchange business but these branches will
have to route their transactions through an AD only (such branches are often called `reporting branches').
7.188 Moreover, ADs have to provide forms A2 for all interbank cross-currency deals done with overseas banks
maturing during a fortnight to the RBI through the R-Return which is submitted on a fortnightly basis.
7.189 ADs also have to submit a report (MAP/ SIR) in the format as prescribed by the RBI. This is required to be
prepared for 4 major currencies (i.e. US$, GBP, YEN and CHF). MAP will be prepared for the last reporting Friday of
each month.
7.190 As required by RBI circular FMD.MSRG.No.67/02.05.002/2011-12 dated March 9, 2012, all inter-bank OTC
foreign exchange derivatives are required to be reported on a platform to be developed by the Clearing Corporation
of India (CCIL). All/selective trades in OTC foreign exchange and interest rate derivatives between the CategoryI
Authorised Dealer Banks/market makers (banks/PDs) and their clients are required to be reported on the CCIL
platform subject to a mutually agreed upon confidentiality protocol.
7.191 As per RBI circular FMD.MSRG.No.72/02.05.002/2012-13 dated October 12, 2012, it is decided with effect
from November 5, 2012 that following derivative products need to be reported to CCIL by the banks:
FCY(excluding USD)-INR forwards
FCY(excluding USD)-INR FX swaps
FCY-FCY forwards
FCY-FCY FX Swaps
FCY-FCY options
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Valuation of foreign exchange forwards and derivative products
7.192 Valuation of derivatives, particularly long-tenor derivative products, many of which could be proprietary
products of banks, may be difficult to value, as they may be illiquid instruments.
7.193 As part of its normal day to day operations and for managing its interest rate and foreign exchange risk, a
bank or financial institution may deal with a number of financial instruments. Depending on the type of financial
instrument and the purpose for which it was entered into, it is necessary to value the deals periodically. Some of the
financial instruments in which banks and financial institutions transact are complex in nature.
7.194 The valuation models used for these financial instruments are sophisticated and involve complex algorithms.
Generally, inputs into these models are sourced from market available data points. Given the enormous "leverage"
provided by various derivative financial instruments and the track record of significant losses reported in the industry,
the valuation of these instruments will generally have a high inherent risk.
7.195 The valuation of derivatives should be based on marked to market (MTM) and on net present value (NPV)
basis.
Guidance for Arriving at Fair / Market Value
7.196 As a general rule, for an instrument that is actively traded on a recognized public exchange, the price
quoted by the exchange where the instrument is traded is used as an appropriate valuation price to arrive at the fair
value of the instrument.
7.197 In case of instruments that are actively traded over the counter, the quoted bid price for long positions and
quoted offer price for short positions is used as an appropriate indicative valuation price. These may be obtained
through relevant market makers or brokers.
7.198 In case of thinly traded instruments/non-traded OTC derivatives, various techniques are used to determine
the best estimate of a market price. This synthetic market price may be derived through use of market data (such as
interest/ exchange rates) in appropriate models/systems designed for this purpose.
7.199 In case of the following instruments, fair value can be arrived at using the market data as mentioned there
against:
FX spot / forwards Prices as published by Foreign Exchange Dealers Association of India (`FEDAI'). With
effect from 31 December 2014, these are further required to be adjusted for arriving net
present value.
Exchange traded
Prices quoted on the relevant exchange
interest rate futures
Commodity futures Prices quoted on the relevant exchange
OTC derivatives:
Options Black Scholes Merton Method.
Swaps / Forward Rate Discounted cash flows using the applicable Interest Curves (ROI can be taken from
Agreements FIMMDA / NSE / Reuters' site based on the nature and currency of the product.
7.200 The valuation of derivatives is based on exchange rate and the swap rate prevailing on the valuation date.
Various banks use different in-house/ vendor developed model for valuation of their derivative products. However,
the general benchmarks used for valuation are OIS/MIBOR, MIFOR, MITOR, LIBOR and INBMK as per the end of
the day quotes appearing on the Bloomberg or Reuters page.
7.201 In case of hedge swaps, the income/ expense is accounted for on an accrual basis except the swap
designated with an asset or liability that is marked to market or lower of cost or market value in the financial
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statements. In that case, the swap should be marked to market with the resulting gain or loss recorded as an
adjustment to the market value of designated asset or liability. Whereas, the trading swaps are marked to market as
per the instructions contained in the RBI circular NO. MPD. BC. 187/07.01.279/1999-2000 dated July 7, 1999.
7.202 The market to market gain/ loss on forward financial derivatives contract is derived from the difference
between the agreed-upon contract price of an underlying item and the current market price (or market price expected
to prevail) of that item, times the notional amount, approximately discounted. The notional amounts - sometimes
described as the nominal amount - is the amount underlying a financial derivatives contract that is necessary for
calculating payments or receipts on the contract. This amount may or may not be exchanged.
7.203 In the specific case of a swap contract, the market value is derived from the difference between the
expected gross receipts and gross payments, appropriately discounted; that is, its net present value.
7.204 The market value for a forward contract can therefore be calculated using available information market
and contract prices for the underlying item, time to maturity of the contract, the notional value, and market interest
rates. From the viewpoint of the counter parties, the value of a forward contract may become negative (liability) or
positive (asset) and may change both in magnitude and direction over time, depending on the movement in the
market price for the underlying item. Forward contract settled on a daily basis, such as those traded on organized
exchanges - and known as futures - have a market value, but because of daily settlement it is likely to be zero value
at each end-period.
7.205 The price of an option depends on the potential price volatility of the price of the underlying item, the time to
maturity, interest rates, and the difference between the contract price and the market price of the underlying item.
7.206 For traded options, whether they are traded on an exchange or not, the valuation should be based on the
observable price. At inception the market value of a non-traded option is the amount of the premium paid or received.
Subsequently, non-traded options can be valued with the use of mathematical models, such as the Black-Scholes
formulae, that take account of the factors mentioned above that determine option prices. In the absence of a pricing
model, the price reported for accounting or regulatory purposes might be used. Unlike forwards, options cannot
switch from negative to positive value, or vice versa, but they remain an asset for the owner and a liability for the
writer of the option.
7.207 It may be mentioned that counter party wise netting is only allowed where specific legally enforceable
bilateral netting arrangement such as International Swaps and Derivative Association (ISDA) master agreement, etc.,
exists.
Examples for the Calculation of Market or Fair Values of Derivative Contracts
7.208 The following examples indicate how to calculate the market or fair value of various derivative contracts.
7.209 For a forward, a contract to purchase USD against EUR at a forward rate of say, 1.00 when initiated has a
positive market value if the EUR/ USD forward rate at net present value at the time of reporting for the same
settlement date is lower than 1.00. It has a negative market value if the forward rate at net present value at the time
of reporting is higher than 1.00, and it has a zero market value if the forward rate at the time of reporting is equal to
1.00.
7.210 For swaps, which involve multiple (and sometimes two-way) payments, the market or fair value is the net
present value of the payments to be exchanged between the counter parties between the reporting date and the
contracts maturity, where the discount factor to be applied would normally reflect the market interest rate for the
period of the contract's remaining maturity. Thus, a fixed/floating swap which at the interest rates prevailing at the
reporting date involves net annual receipts by the reporter of say, 2% of the notional principal amount for the next
three years has a positive marked to market (or replacement) value equal to the sum of three net payments (each 2%
of the notional amount), discounted by the market interest rate prevailing at the reporting date. If the contract is not in
the reporter's favour (i.e., the reporter would have to make net annual payments), the contract has a negative net
present value.
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7.211 Unlike forwards or swaps, OTC options have a market or fair value at initiation which is equal to the
premium paid to the writer of the option.
7.212 Throughout their life, option contracts can only have a positive market or fair value for the buyer and a
negative market or fair value for the seller. If a quoted market price is available for a contract, the market value to be
reported for that contract is the product of the number of trading units of the contract multiplied by that market price. If
a quoted market price is not available, the market or fair value of an outstanding option contract at the time of
reporting can be determined on the basis of secondary market prices for options with the same strike prices and
remaining maturities as the options being valued, or by using option pricing models.
7.213 In an option pricing model, current quotes of forward prices for the underlying (spot prices for American
options) and the implied volatility and market interest rate relevant to the option's maturity would normally be used to
calculate the market values. Options sold and purchased with the same counter party should not be netted against
each other, nor should offsetting bought and sold options on the same underlying. RBI vide its Circular on DBOD.
No.BP.BC.76/21.04.157/2013-14 dated December 09, 2013 has issued operational Guidelines on "Novation of OTC
Derivative Contracts"
Audit Approach
7.214 While innovative products and ways of trading create new possibilities for earnings for the bank, they also
introduce novel and sometimes unfamiliar risks that must be identified and managed. Failure to do so can result
losses entailing financial and reputational consequences that linger long after the loss has been recognized in
financial statements. Hence, auditor should assess controls as part of audit work.
7.215 It is imperative that an auditor obtains a complete overview of the treasury operations of a bank before the
commencement of the statutory audit. After conducting appropriate risk assessment of the treasury processes, the
audit program needs to be designed in a manner that it dovetails into not just the control assessments of the treasury
process but there is an assurance that the figures appearing in the financial statements as well as the disclosures are
true and reflect fairly the affairs of the bank treasury.
Audit Programming and Procedures
7.216 In framing the audit program, an auditor needs to take into consideration their findings of the adequacy of
controls within the processes as explained in this Guidance Note. Reserve Bank of India prescribes concurrent audit
/internal audit for a 100% verification of treasury transactions. Hence, the selection of samples can be influenced by
the nature, extent and timings of concurrent/internal audit function including the compliance mechanism of the Bank.
Further, RBI requires compliance reports on derivatives separately to be prepared by the Bank as per RBI Guidelines
on Derivatives vide circular no. DBOD.No.BP.BC.44/21.04.157/ 2011-12 dated November 2, 2011 which the auditor
should take into consideration.
7.217 The following are illustrative audit procedures/ approach that may form part of the audit program.
Product Program and Policy
7.218 The auditor should obtain the approved product policy and procedures of the Bank relating to foreign
exchange and derivative business and review them for adequacy and coverage and check whether the policy is
commensurate with the nature of operations and adequately covers all the activities of the Bank.
Further, in accordance with the Comprehensive Guidelines on derivatives, the auditor should obtain and verify full
particulars of the model used for valuation and the documented algorithms used by the Bank.
Customer/User Suitability and Appropriateness Policy
7.219 The auditor should obtain approved `Customer/User Suitability and Appropriateness Policy' and verify that
such policy is in line with the Comprehensive Guidelines on derivatives and is approved by the Board.
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Auditor should also verify the process followed by the bank for classification of customer into different
grades/classification.
Credit limits
7.220 For the selected samples, the auditor should check whether appropriate credit limits are in place for foreign
exchange and derivative transactions. Additionally, the auditor should:
Check whether the name of the counterparty is in the approved counterparty list for the purpose of treasury
transactions.
Check whether the credit limits are set for different customers and they are adhered to in a consistent manner
and for any limit breaches, appropriate sanctions / ratifications are in place.
Check whether the counterparty exposure limit reports for all brokers, lenders, etc., are generated and
monitored on a regular basis.
Check dealer limits- Maximum amount a dealer can transact without seeking higher-level approval and
sanctions/ratifications for any breaches.
Check product limits- Maximum exposure the entity should have in a particular instrument or product.
Check sector limits Maximum investment in a particular sector (for example, exposures to companies
incorporated with limited liability in India).
For the selected samples, confirm and review signed and authorized ISDA agreement, signed and authorized
collateral agreement, credit risk assessment of the customer and confirm, whether credit positions are within
established limits for each customer.
Check whether the above limits are entered into the software system being used by the Branch for conducting
the said transactions.
Deal Initiation and Recording
7.221 For the selected samples, the auditor should check whether deals carried out by the front office are
appropriately recorded in the deal slips and whether the same is correctly entered in the front office deal recording
system.
For the selected samples check whether the deal ticket is complete and accurate with respect to all transaction
details like counterparty name, contract rate, notional amount, transaction date / maturity date, value date /
settlement agent and buy / sell date.
Check whether deal tickets are generated automatically by front office systems, or trader should use
sequentially numbered deal tickets.
Check whether the dealers use dedicated calling lines and all the telephone lines are linked to a voice recording
machine.
Verify the adherence to the voice recording mechanism
Verify whether user IDs of dealers left / transferred/ on leave is deactivated / suspended on timely basis.
Verify whether, the Use of Mobile Phones is restricted in the Dealing Room and mechanism for ensuring
adherence thereto
Verify the recordings for few of the selected samples to ascertain that the recording machine is working in order.
Deal Authorisation
7.222 Following audit procedures may be followed by an auditor while checking the procedures for deal
authoritisation.
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Check whether proper authorization levels are set for treasury operations and observe and verify whether the
prescribed procedure is followed.
For the selected samples, check whether deals entered in front office system are authorised by the back office
team after verifying the deal details with external evidences like Reuters' conversation, telephonic conversation
with customers' back office, etc.
Examine the selected deals from the front office and establish that they are confirmed by the back office
operations.
Check that all sampled deals are authorised at the proper levels of authority against the deal slip.
Check whether alterations and cancellations on deal slips are duly authorised.
Segregation of Duties
7.223 For this, the audit procedure may include:
Checking and ascertaining that segregation of duties is in place. Under no circumstances staff involved in
initiating deals should be involved in checking or receiving deal related documents.
Verify whether there is any overlapping of duties
Verifying that there is clear segregation, functionally and physically, between the front office, back office and
middle office in respect of derivative transactions.
Checking that there is segregation between functions of authorisation, execution and recording of transactions.
In cases where management override has taken place, ascertain that satisfactory reasons for doing so were
recorded and produced for audit verification.
Checking whether treasury personnel have availed minimum leave during the financial year.
Counterparty confirmations
7.224 For this, the auditor would inter alia:
Understand the process of sending and tracking the confirmations including follow up procedures
Understand the process of MIS reporting to the senior management in respect of the non-receipt of
counterparty confirmations.
Verify that confirmations from Bank to counterparty are sent within a reasonable time and there exists a
mechanism for follow-ups for pending counterparty confirmations.
Determine the status of any missing / pending confirmations (currently in the Confirmation Tracking List) and
assess whether there are any provisioning concerns on the trades
Check whether the format of the counterparty confirmation is as approved by the Local Legal Counsel of the
Bank from time to time.
Verify controls implemented by banks to ensure completeness of all deal confirmations.
Inquire of any exception report or other mechanism of tracking missing confirmations.
Customer Complaints
7.225 As per the Comprehensive Guidelines on Derivatives, while undertaking derivative transactions with or
selling structured derivative products to a user, a market-maker should establish internal procedures for handling
customer disputes and complaints. They should be investigated thoroughly and handled fairly and promptly. Senior
management and the Compliance Department/Officer should be informed of all customer disputes and complaints at
a regular interval. For this, the auditor should verify controls over recording and handling of customer disputes and
complaints and ensure the Bank's adherence to RBI requirements.
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Underlying document
7.226 The audit procedures for this aspect include:
Understand the process and policy of the Bank in respect of the underlying documents.
The auditor should ensure that the bank should obtain the original documents from the client and or certified
document by the person who is authorised to do the derivative deal. The auditor should check the details in
client master page by checking the board resolution.
The auditor should ascertain whether the Bank has a mechanism whereby, if the documents are not submitted
by the customer within 15 days, the contract gets cancelled, and the exchange gain, if any, is not passed on to
the customer. The primary responsibility for ensuring this remains with the Bank and the auditors should verify
controls around the same.
The auditor should ensure that the Bank has a mechanism to ensure that if the underlying is not provided three
times a year; then the client will have to produce upfront underlying and the 15 days grace will not be allowed to
the client.
For the selected samples, review and check the underlying documents duly received by the bank.
In cases, where the underlying documents with regard to the forex transactions are maintained at branches,
then, the auditor may obtain confirmation from such branches about existence of the underlying documents and
review sudden spurt in foreign exchange transactions of any branch in a particular month/period, if any, and test
adherence to the RBI guidelines relating to merchant transactions
Accounting of transaction in the general ledger
7.227 The audit procedures for this aspect include:
Checking whether there is a direct hands-off between front end system and the accounting system for passing
accounting entries in the general ledger.
Checking whether correct accounting entries are recorded in the general ledger and the back office regularly
reviews the accounting entries passed in the general ledger.
Checking whether the treasury department generates a daily P&L (desk-wise) and same has been reviewed
and compared to the general ledger to identify any mismatches.
Understand the accounting scheme for the various products. Further, inquire about the routine and non
routine accounting entries with the bank,
For the selected samples, verify the accounting entries passed
Position Reconciliation
7.228 The audit procedures include:
Checking whether daily position reconciliations are performed between front office deal positions and back
office deal positions by the treasury back office and position differences if any are appropriately enquired into.
Checking whether the Bank maintains customer wise, currency wise and deal wise positions on a daily basis in-
order to monitor customer limit breaches and sectoral limit breaches.
Checking whether the inter branch reconciliations between the Treasury Branch and the Authorised Branches
are carried out on a periodic basis and there are no old and long outstanding items uncleared.
Deal Settlements
7.229 The audit procedures include:
Checking whether there exists effective mechanism for settlement of deals on due date and whether deals due
for settlement are generated on a daily basis by back office.
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Examining whether customer intimations are sent across as soon as the deal is settled and the respective
customer accounts are debited / credited.
Examining whether the Settlement desk ensures proper settlement of funds through CCIL/RTGS/SWIFT
networks. Any deal rejected by CCIL should be examined and settlement through any other means should be
taken up only after thoroughly examining the deal/deal confirmation as in most of the cases the rejection is on
account of improper deal entry.
Examining whether deal is settled / cancelled in case no confirmation is received from customers till expiry
dates.
Realised profit / loss on derivative transactions
7.230 The audit procedures include:
Recalculating the profit or loss for sample trades selected and agree to the general ledger.
Test the general and IT application controls for automated computation of profit or loss.
Vouch to cash settlement in the case of realized gains and losses.
Rate Scan
7.231 The audit procedures for this would include:
Checking whether for the selected deals, the rates taken are the prevailing rates in the market at the time of
striking the deal.
Checking whether in outright deals the back office checks the rate scans for the veracity of the rate at which the
dealer has struck the deal. Any deviation should be enquired into Compliance with Accounting Standard (AS)
11.
Margins held with exchanges / margins held under Credit Support Annex (`CSA')
7.232 The forward contracts in banks are now a days increasingly being collateralized using Customer Support
Annex (CSA) margins which form part of the ISDA agreement. The audit procedures for this would include:
Sending independent third party confirmations to confirm the balances held as at the reporting date
Agreeing the balances to underlying supporting such as margin statements.
Assessment of controls
7.233 The audit procedure may include verifying and assessing controls including:
Existence of comprehensive treasury policy and operating procedures manual (SOP).
Review of the policies and procedures document and assess comprehensiveness of the same.
Determining whether the above document addresses, in granular detail, the framework within which the
treasury business and operations have to be conducted.
Inquiring on the procedures the bank has when there is a change over or new appointment to a `review' role
within the treasury function.
Understanding the level of detail in which the process of, i.e., handover of responsibilities operates.
Inquiring whether there has been any change in responsibilities in the current period and in case there are
changes, verifying whether there is an appropriate training mechanism and whether signoffs have been
regularized after the new superior has taken over the responsibilities.
On a test check basis, verifying whether the review process and controls were working effectively during the
transition period.
Obtaining and reviewing on test check basis, the daily Profit and Loss prepared for MIS purpose and assessing
the granularity and exhaustiveness of the same;
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Assessing whether such Profit and Loss is granular enough to provide desk wise, product wise and various
price component wise Profit and Loss.
Assessing whether gross position reviews are undertaken and also whether such Profit and Loss are prepared
and reviewed at a gross trade level.
Reviewing the Bank's policy on valuation. On a test check basis, verifying whether the material valuation
adjustments are reviewed, authorized and are appropriate.
Verifying whether these valuation adjustments are disclosed / visible in the reconciliation.
Assessing whether there is an independent `Valuation Control' team.
Checking whether dealers have access to adjust or modify trade values.
Checking whether the reconciliations are prepared on a timely basis and the un-reconciled items are
independently inquired by the back office.
Reviewing the ageing and quantum of the un-reconciled items and inquire for the high value and long
outstanding reconciling items.
Assessing whether the escalations are done in a timely manner for the large / unusual / recurring reconciliation
items.
Market Risk System
Reviewing the key market risk reports generated and verifying that these reports are in sync with risk attributes
of the products being traded and convey the risk positions appropriately.
Cancelled / amended / late (C/A/L) booking of futures trades into the Front Office risk system
Reviewing the policy of the bank as regards the cancelled / amended / late booked trades and whether there is
a clear policy describing the Front office supervisor's responsibility in respect of reviewing and signing off on
these instances
Reviewing whether these instances are reported to the senior management as per the policy and are ratified.
Verifying whether the system is capable to capture the C/A/L and obtaining a complete inventory of these
instances.
Reviewing the frequency of such instances during the period and verifying on a test check basis whether there
is a justification of such cancellations / amendments / delays.
Checking the process relating to late trades how does these get captured in risk reporting's (if there is a time
cut off when such reports are generated).
Fictitious trades with deferred settlement dates and/or at off-market prices and subsequent amendments
Reviewing the controls over cancellation of trades before reaching settlement dates and check whether these
are ratified by the authorized personnel with appropriate justifications.
Reviewing the "Rate scan" process performed by mid-office and whether the exceptions noted in the rate scan
are inquired.
Reviewing the Day 1 Profit or Loss assessment process and verify whether the Day-1 Profit or Loss is
sufficiently assessed and explained.
Verifying whether the change in pricing / other criterion is approved and confirmed with the counterparty.
Breaches of the Net Delta Limits
Verifying whether the breaches to the delta limits set by the Bank are monitored on a frequent basis and
whether the breaches (if any) are ratified by the authorized personnel and the reason is recorded for such
breaches.
Failure to identify and escalate risk issues
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Verifying whether a process is in place to educate employees about escalation mechanism to report any events
that represent a risk to the institution and is embedded in the code of conduct. This may include directly
reporting the incidences to the highest authorities on a no name basis, hotline numbers etc.
Quality of supervision
Assessing and determining the nature of comments and queries that are posed by the reviewer on any
reconciliation breaks, long unexplained balances, exceptional trades, follow up on responses, etc.
Determining and assessing whether the review function is not a mere sign off and it is conducted with
appropriate supervisory intent.
Temporary discontinuance of a process or control
Verifying that the controls identified and tested have been operational throughout the period and where there
has been a temporary discontinuance (for any reason) verify whether there were alternative controls.
Rewards and recognition policy not in sync with ideal `risk and control' culture
Reviewing the remuneration policy and independently assess how and to what degree it addresses matters
relating to risk and compliance with control policies as part of the employee remuneration for treasury staff
members.
Outsourced/Hubbed process
Reviewing the Service Level Agreements (SLAs) and agreements with such agencies and verify the robustness
of the controls that reside in house in the bank to review and understand the work undertaken at outsourced /
hub locations.
Reviewing and verifying the documentary evidence of the communication the bank has with these agencies on
a regular basis. The forward contracts in banks are now a days increasingly being collateralized and using
Customer Support Annex (CSA) margins, which form part of the ISDA agreement. The auditor should devise
audit procedures required to be performed for verification of these margin balances as per the underlying
agreements.
NOSTRO and VOSTRO Accounts
7.234 A fundamental feature of foreign exchange transactions is that the useful possession of any currency can
be had only in the country in which it is a legal tender or countries in which it is circulated. (e.g., US Dollar is
widely circulated in Russia, CIS countries). Therefore, in order to be able to put through foreign exchange
transactions, banks normally maintain stocks of foreign currencies in the form of bank accounts (usually current
accounts) with their overseas branches/correspondents. Such a foreign currency account maintained by a bank at
an overseas centre is usually designated by it as `NOSTRO Account' (i.e. "Our account with you"). Thus, banks in
India may maintain a pound-sterling account with its London office/correspondent; such account would be called
by it as NOSTRO Account. Conversely, if a foreign bank is to deal in a local currency of another country, it would
maintain a `VOSTRO Account' (i.e. `your account with us') with the local bank, e.g. a bank in England may
maintain a `VOSTRO Account' in Indian Rupee with a correspondent bank in India. A VOSTRO account is in
substance no different from any other account in the local currency.
NOSTRO / VOSTRO Reconciliation
7.235 In respect of old unreconciled entries in NOSTRO Accounts, the RBI vide its Circular DBOD
No.BP.BC.67/21.04.048/99 dated July 1, 1999 has allowed, as a one time measure, a netting off procedure.
7.236 The auditor may consider the following aspects in respect of NOSTRO reconciliation:
Whether a system of periodical reconciliation is in place.
Whether the reconciliation process followed ensures matching of each item and not for overall matching of total
amount
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Whether logs are generated for any change made in entry and whether maker checker is implemented for
authorising changes made in entry, if any, for reconciliation
Whether confirmations from the foreign banks are obtained on a periodic basis. This may be either through
physical confirmations, swift messages, emails, etc.
whether Information to the controlling office is sent on a timely basis.
whether long outstanding are taken up and reconciled.
random check of the method of reconciliation.
Debits outstanding both in the mirror account and in the Nostro accounts are to be verified and recommend for
provision wherever necessary.
Set off the credit against debits only at the permission of the head office for long outstanding entries.
7.237 RBI's circular no. DBOD.BP.BC.16/21.04.018/2001-02 of August 24, 2001 has also clarified that the
balances carried in "Sundry Debtors/ Unclaimed Deposits Accounts" under NOSTRO Accounts, represent
unreconciled entries which may be large in a few cases and hence susceptible to frauds. Accordingly, the banks
should transfer the following balances in the "Sundry Debtors/ Unclaimed Deposits Accounts" appearing in the
books of the bank as on September 30, 2001 to distinct "Blocked Accounts" and shown under "Other Liabilities
and Provisions" (item no. iv of Schedule 5) in the balance sheet:
(i) the net credit balance arising out of the netting of entries pertaining to the period prior to April, 1996; and
(ii) credit entries originated on or after April 1, 1996 and remaining unreconciled in NOSTRO/ mirror accounts for
more than three years.
Further, the balances in the Blocked Accounts will be reckoned for the purposes of maintenance of CRR/ SLR.
7.238 Any adjustment from the Blocked Accounts should be permitted with the authorisation of the two officials,
one of whom should be from outside the branch concerned, preferably from the Controlling branch/ head office if
the amount exceeds Rs. one lakh.
7.239 The audit considerations for this aspect include:
Examining whether currency wise NOSTRO reconciliation is performed on a day-to-day basis and check for
long outstanding items.
Checking whether there exists a policy of following up for outstanding reconciliation items with the
counterparties or with the respective banks.
Outstanding debit items over 90 days attract provisioning under RBI provisioning norms.
Examining whether the statement of account is sent to the Vostro account holder and periodic confirmation is
obtained and discrepancies, if any, is properly dealt in the books of accounts
Evaluation of Internal Audit/Concurrent Audit
7.240 The audit considerations for this aspect include:
Examining whether treasury transactions are separately subjected to concurrent audit by internal auditors /
external auditors and monthly reports containing their findings are submitted to the management for corrective
action.
Obtaining the monthly concurrent audit reports of the treasury operations and check whether deficiencies if any,
mentioned in the report are rectified or noted for corrective action by the management.
In internal audit reports, examining whether major control weaknesses are highlighted and a management
action plan to remedy the weaknesses are agreed with a timeframe.
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Management should periodically monitor newly implemented systems and controls to ensure they are working
appropriately. Failure of management to implement recommendations within an agreed timeframe should be reported
to the Audit Committee.
Risk Management
7.241 The audit considerations for this aspect include:
Checking whether the bank has adequate risk management process, sound risk measurement procedures,
sound information systems, continuous risk monitoring and frequent management reporting for treasury
operations.
Examining whether the mid-office monitors the exchange and gap positions for cut loss limits, overnight limits,
daylight limit, liquidity, counterparty exposure limit and aggregate gap limit fixed in the banks trading policy/
guidelines.
Reviewing the adequacy and effectiveness of the overall risk management system, including compliance with
policies, and procedures.
Investigating unusual occurrences such as significant breaches of limits, unauthorized trades and unreconciled
valuation or accounting differences.
Inquiring whether there is a `New Product Approval' process prior to undertaking transactions in new or
structured derivative products and verifying whether the `New Product Paper' for all new derivative products is
approved and signed-off by the Chief Compliance Officer of the bank.
Obtaining the `Risk Management Policy' of the bank and verifying whether risk management pertaining to
derivative transactions is an integral part of the policy.
Verify whether the Policy is updated on a periodic basis in line with the dynamic market and regulatory changes.
Verifying that the `Risk Management Policy' for derivative transactions has been approved by the Board.
Verifying that the policy inter alia covers the following aspects:
(i). Defines the approved derivative products and the authorized derivative activities;
(ii). Details requirements for the evaluation and approval of new products or activities;
(iii). Ensures appropriate structure and staffing for the key risk control functions, including internal audit;
(iv). Establishes management responsibilities;
(v). Identifies the various types of risks faced by the bank and establishes a clear and comprehensive set
of limits to control these;
(vi). Establishes risk measurement methodologies which are consistent with the nature and scale of the
derivative activities;
(vii). Requires stress testing of risk positions;
(viii). Details the type and frequency of reports for monitoring risks which are submitted to the Board (or
committees of the Board);
(ix). Typical risks and commonly used risk limits in respect of derivative transactions.
Information Technology (`IT') Controls
7.242 The audit considerations for this aspect include:
Obtain IT related information from the bank for treasury operations and review, as appropriate, minutes of any
committees responsible for overseeing and coordinating IT resources and activities to determine user
involvement and organizational priorities.
Review organizational charts, job descriptions, and training programs to ascertain that the bank has a sufficient
number of technology personnel and that these personnel have the expertise the bank requires.
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Review MIS reports for significant IT systems and activities to ascertain that risk identification, measurement,
control, and monitoring are commensurate with the complexity of the bank's technology and operating
environment.
Evaluate the separation of duties and responsibilities in the operation and data processing of treasury functions.
Evaluate the adequacy of input/output controls and reconcilement procedures for batch capture and image
capture systems.
Review controls and audit trails over master file change requests (such as address changes, due dates,
commission / interest rates, and service charge indicator) and also consider individuals authorized to make
changes and potential conflicting job responsibilities and documentation/audit trail of authorized changes and
procedures used to verify the accuracy of master file changes.
Assess adequacy of controls over changes to systems, programs, data files, and PC-based applications and
consider procedures for implementing program updates, releases, and changes.
Check if controls are in place to restrict and monitor use of data-altering utilities and adequate process
management to select system and program security settings (i.e., whether the settings were made based on
using sound technical advice or were simply default settings).
Check whether controls are established to prevent unauthorized changes to system and programs security
settings.
Evaluate the effectiveness of password administration for employee and customer passwords considering the
complexity of the processing environment and type of information accessed and consider confidentiality of
passwords - (whether only known to the employee/customer), procedures to reset passwords to ensure
confidentiality is maintained, frequency of required changes in passwords, password design (number and type
of characters), security of passwords while stored in computer files, during transmission, and on printed activity
logs and reports.
Determine whether the bank has removed/reset default profiles and passwords from new systems and
equipment and determine whether access to system administrator level is adequately controlled.
Check whether the data hands off process from one product processor to another or to any other system is
conducted under a secure environment and without or with least but controlled manual intervention.
Valuation of FX contracts and Derivatives
7.243 The audit procedures for valuation of FX contracts and Derivatives include:
For spot and tom contracts checking whether correct FEDAI rates are used by the Bank for marking them to
market. In case of automatic feed of FEDAI rates, verifying whether the rates are correctly uploaded into the
system. At the end of the reporting period, sight the process and verify the process of downloading rates from
external source and the process of uploading of rates in the system by the middle/back office for all FX
contracts and derivatives.
Process of computation of net present value of rates.
Re-performing and checking on a sample basis the accuracy of the MTM gain / loss booked by the bank on the
outstanding forex contract.
7.244 In case of valuations of swaps, options and other derivative products most of the banks have proprietary
valuation models developed by them or standard valuation software installed. In case of proprietary valuation
models, a model validation coupled with checking of input parameters would provide reasonable comfort on
valuations. In case of standard valuation models, auditors can resort to checking of input parameters along with
limited re-performance of derivative valuations. In such cases the auditor should also check system controls and if
deemed necessary, consider involving an expert to check the integrity of system logic. Further, the auditor can select
certain samples as per the methodology or depending upon the nature, timing and extent for getting it re valued
from the valuation expert. Auditor should also obtain the understanding of rate upload process and verify the timing of
rates upload in the system for valuation of derivative contracts. Auditors should carry out the valuation of the samples
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selected in a spreadsheet and compare the end results with the valuation as provided by the software system.
Sometimes the software systems are not capable of valuing certain treasury products such as partly redeemable
perpetual bonds, Security Receipts etc., for which the Branch has to value such products manually and the auditor
should gain sufficient knowledge to understand and confirm their valuation.
Section D: Compliance with CRR and SLR requirements
7.245 Due to the very nature of their operations, banks need to maintain sufficient liquid assets in the normal
course of their business. The failure of a bank to meet its liabilities to depositors, as and when called upon to do
so, undermines the confidence of the depositors not in the particular bank alone but in the entire banking system.
Recognising the need to safeguard the interests of depositors by ensuring that banks do not over-extend their
resources and thereby to maintain the confidence of the public in the banking system, Section 24(2A) of the
Banking Regulation Act, 1949 requires that a scheduled bank shall maintain in India, in addition to the average
daily balance which it is, or may be, required to maintain under Section 42 of the RBI Act, 1934, and every other
banking company, in addition to the cash reserve which it is required to maintain under section 18 of the Banking
Regulation Act, 1949, assets the value of which shall not be less than such percentage not exceeding forty per
cent of the total of its demand and time liabilities in India as on the last Friday of the second preceding fortnight in
such form and manner as the RBI may by notification in the official gazette, specify from time to time. This is
referred to as `Statutory Liquidity Ratio' (SLR). The Friday with reference to which the amount of liquid assets has
to be maintained during a fortnight is determined is commonly, referred to as the `reporting Friday'. The prescribed
percentage of liquid assets has to be maintained as at the close of business on every day. It may be noted that the
statutory liquidity ratio is to be maintained with reference to the bank as a whole, and not for individual branches.
7.246 The RBI vide its Master circular No. RBI/2015-16/98 DBR.No.Ret.BC.24/12.01.001/2015-16 on "Cash
Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)" dated July 1, 2015, has specified that consequent upon
amendment to the Section 24 of the Banking Regulation Act, 1949 through the Banking Regulation (Amendment)
Act, 2007 replacing the Regulation (Amendment) Ordinance, 2007, effective January 23, 2007, the Reserve Bank
can prescribe the Statutory Liquidity Ratio (SLR) for Scheduled Commercial Banks in specified assets. The value of
such assets of a SCB shall not be less than such percentage not exceeding 40 per cent of its total demand and time
liabilities in India as on the last Friday of the second preceding fortnight as the Reserve Bank may, by notification in
the Official Gazette, specify from time to time.
7.247 Further, Reserve Bank has specified vide notification RBI/2016-17/83 DBR.No.Ret.BC.15/12.02.001/2016-
17 dated October 13, 2016 that every Scheduled Commercial Bank shall continue to maintain in India assets as
detailed below, the value of which shall not, at the close of business on any day, be less than 20.75 per cent from
October 1, 2016 and 20.50 per cent from January 7, 2017, on the total net demand and time liabilities (NDTL) as on
the last Friday of the second preceding fortnight valued in accordance with the method of valuation specified by the
Reserve Bank of India from time to time:
(a) Cash or
(b) Gold as defined in Section 5(g) of Banking Regulation Act, 1949 valued at a price not exceeding the current
market price, or
(c) unencumbered investment in the following instruments which will be referred to as "Statutory Liquidity Ratio
(SLR) securities":
(i) Dated securities of the Government of India issued from time to time under the market borrowing
programme and the Market Stabilization Scheme;
(ii) Treasury Bills of the Government of India;
(iii) State Development Loans (SDLs) of the State Governments issued from time to time under the market
borrowing programme; and
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(d) the deposit and unencumbered approved securities required, under sub-section (2) of section 11 of the Banking
Regulation Act, 1949 (10 of 1949), to be made with the Reserve Bank by a banking company incorporated
outside India;
(e) any balance maintained by a scheduled bank with the Reserve Bank in excess of the balance required to be
maintained by it under section 42 of the Reserve Bank of India Act,1934 (2 of 1934);
7.248 Provided that the instruments referred to in items (1) to (3) above that have been acquired under reverse
repo with Reserve Bank of India, shall not be included as SLR securities for the purpose of maintenance of SLR
assets up to October 2, 2016. From October 3, 2016 such securities acquired from Reserve Bank shall be
considered as eligible assets for SLR maintenance.
7.249 However, in term of Master Circular on Prudential Norms for Classification, Valuation and Operation of
Investment Portfolio by Banks dated July 1, 2015, the regulatory treatment of market repo transactions in
Government securities will continue as hitherto, i.e., the funds borrowed under repo will continue to be exempt from
CRR/SLR computation and the security acquired under reverse repo shall continue to be eligible for SLR.
In respect of repo transactions in corporate debt securities, the amount borrowed by a bank through repo shall be
reckoned as part of its DTL and the same shall attract CRR/SLR.
Encumbered SLR securities are not to be included for the purpose of computing percentage specified herein above,
to the extent of outstanding liabilities against the same.
7.250 If a banking company fails to maintain the required amount of SLR, it shall be liable to pay to RBI in
respect of that default, the penal interest for that day at the rate of three per cent per annum above the bank rate
on the shortfall and if the default continues on the next succeeding working day, the penal interest may be
increased to a rate of five per cent per annum above the bank rate for the concerned days of default on the
shortfall.
7.251 As section 24 of the Banking Regulation Act, 1949 is also applicable to nationalised banks, State Bank of
India and its subsidiaries, and regional rural banks too have to comply with the above requirements.
7.252 According to Section 24(3) of the Banking Regulation Act, 1949, for the purpose of ensuring compliance
with this section, every banking company is required to furnish to the RBI, in the prescribed form and manner, a
monthly return showing particulars of its assets maintained in accordance with this section and its demand and
time liabilities in India at the close of the business on each alternate Friday during the month. In case any such
Friday is a public holiday, the computation of SLR is to be done at the close of business on the preceding working
day. The return in form VIII is to be furnished within 20 days after the end of the month to which it relates. The
banks should also submit a statement as annexure to the form VIII giving daily position of
(a) value of securities held for the purpose of compliance with SLR and
(b) the excess cash balances maintained by them with RBI in the prescribed format.
As per Circular RBI/2016-17/302 Ref: DBR.CO.No.Ret.BC/66/12.07.144/2016-17 May 11, 2017, the reporting of
SLR has been moved from PCRPCD to XBRL (Extensible Business Reporting Language) platform from April 2017
onwards.
7.253 The RBI, vide its circulars DBOD No.761-A/08/07/003/93 dated February 8, 1993 and 829/08.07.003/93
dated February 20, 1993, has asked the banks to advise their statutory central auditors to verify the compliance of
statutory liquidity ratio on twelve odd dates in different months not being Fridays. The said compliance report by
the auditors is to be submitted separately to the top management of the bank and to the RBI.
7.254 The statutory auditor should verify and certify that all items of outside liabilities, as per the bank's books
had been duly compiled by the bank and currently reflected under demand and time liabilities (DTL) and net
demand and time liabilities (NDTL) in the fortnightly/monthly statutory returns submitted to the RBI for the financial
year.
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Computation of CRR
7.255 The RBI introduced the system of lag of one fortnight in maintenance of stipulated CRR by banks w.e.f.
November 06, 1999 to improve cash management by banks. Further, the daily minimum CRR maintenance
requirement has been reduced to 90 percent effective from the fortnight beginning from April 16, 2016.
Computation of SLR
7.256 Refer Master circular No. DBR.No.Ret.BC.24/12.01.001/2015-16 on "Cash Reserve Ratio (CRR) and
Statutory Liquidity Ratio (SLR)" dated July 1, 2015, for guidance on computation of SLR. Further, RBI notification
RBI/2016-17/83 DBR.No.Ret.BC.15/12.02.001/2016-17 dated October 13, 2016 has been issued in this regard.
Audit Approach and Procedures
7.257 The report of the statutory auditors in relation to compliance with SLR requirements has to cover two
aspects:
(a) correctness of the compilation of DTL position; and
(b) maintenance of liquid assets as specified in section 24 of the Act.
7.258 The statutory central auditor should acquaint himself with the circulars/ instructions of the RBI regarding
composition of items of DTL. For this purpose, he may request the management to provide him a copy of the
relevant circulars/instructions. He should keep these circulars/instructions in mind while examining compliance
with the SLR requirements.
7.259 To comply with the requirements relating to statutory liquidity ratio, banks have evolved system of
consolidating trial balances of all branches and head office to compile consolidated trial balance of bank as a
whole at its head office. Based on this consolidation, the DTL position is determined for every reporting Friday.
The statutory central auditor should request the branch auditors to verify the correctness of the trial balances
relevant to the dates selected by him. The statutory central auditor should also request the branch auditors to
verify the cash balance at the branch on the dates selected by him. It should be ensured that such request is
communicated to the branch auditors well in advance of commencement of the audit so that they can draw up
their audit programme accordingly.
7.260 Most of the liquid assets for the purpose of compliance with the SLR requirements comprise of approved
securities, which are usually dealt with at the head office and a few large branches. The auditors should test check
the relevant records maintained by the bank in respect of investments to verify the amount of approved securities
held by the bank on the dates selected by him. The auditor should ascertain the valuation basis applicable at the
relevant time and examine whether the valuation of securities done by the bank is in accordance with the
guidelines prescribed by the RBI.
7.261 The auditor should examine the consolidations prepared by the bank relevant to the dates selected by
him. He should test check the figures in the consolidations with the related returns received from the branches. He
should also test check the arithmetical accuracy of the consolidations.
7.262 While examining the computation of DTL, the auditor may specifically examine whether the following
items have been excluded from liabilities:
(a) Part amounts of recoveries from the borrowers in respect of debts considered bad and doubtful of recovery.
(b) Amounts received in Indian currency against import bills and held in sundry deposits pending receipts of final
rates.
(c) Un-adjusted deposits/balances lying in link branches for agency business like dividend warrants, interest
warrants, refund of application money, etc., in respect of shares/debentures to the extent of payment made
by other branches but not adjusted by the link branches.
(d) Margins held and kept in sundry deposits for funded facilities.
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7.263 Similarly, the auditor may specifically examine whether the following items have been included in
liabilities:
(a) Net credit balance in Branch Adjustment Accounts. The credit entries in branch adjustment account which
are outstanding for more than 5 years are required to be considered at gross;
(b) Interest on deposits as at the end of the first half year if reversed in the beginning of the next half-year.
(c) Borrowings from abroad by banks in India needs to be considered as `liabilities to other' and thus, needs to
be considered at gross level unlike `liabilities towards banking system in India', which are permitted to be
netted off against `assets towards banking system in India'. Thus, the adverse balances in Nostro Mirror
Account needs to be considered as `Liabilities to other'
(d) The reconciliation of Nostro accounts (with Nostro Mirror Accounts) needs to be scrutinized carefully to
analyze and ascertain if any inwards remittances are received on behalf of the customers / constituents of
the bank and have remained unaccounted and / or any other debit (inward) entries have remained
unaccounted and are pertaining to any liabilities for the bank.
7.264 The auditor should also, particularly, examine whether the balances in Branch Adjustment Accounts of
foreign branches have been taken into account in arriving at the net balance in Branch Adjustment Accounts.
7.265 The auditor should examine whether the consolidations prepared by the bank include the relevant
information in respect of all the branches.
7.266 It may be noted that provisions for expenses and liabilities are usually made at the year-end. Similarly,
even though interest accrues on a daily basis, it is recorded in the books only at periodic intervals. Thus, such
interest accrued but not accounted for in books should be included in the computation of DTL.
7.267 As stated in preceding paragraphs, a considerable part of the information required by the central auditor
for reporting on compliance with the SLR requirements will flow from the branches. It is suggested that the
relevant information pertaining to the branches within a region may be consolidated at the regional level. The
auditor of the region concerned should verify the same in the manner described in the above paragraphs and
report on the same. The consolidated statement should also be counter-signed by the regional manager. The
auditor at the central level should apply the audit procedures listed in the above paragraphs to the overall
consolidation prepared for the bank as a whole. Where such a procedure is followed, the central auditor should
adequately describe the same in his report.
7.268 While reporting on compliance with SLR requirements, the auditor should specify the number of
unaudited branches and state that he has relied on the returns received from the unaudited branches in forming
his opinion. Necessary audit procedures should be developed based on introduction of Automated Data Flow
(ADF) for CRR & SLR reporting.
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IV-8
Profit and Loss Account
8.01 Subsection (1) of section 29 of the Banking Regulation Act, 1949, requires the preparation of Profit and
Loss Account in Form B of Third Schedule to the Act or as near thereto as the circumstances admit. This subsection
is applicable to Banking Companies, Nationalised Banks, State Bank of India and its Subsidiaries, and Regional
Rural Banks.
Disclosures
8.02 The Profit and Loss Account as set out in Form B has four broad heads:
Income
Expenditure
Profit/ Loss
Appropriations
The information to be provided under each of the above heads is also specified in the Schedule. It would be pertinent
to note that knowledge of the Bank's accounting policies is of utmost importance before verifying the items within the
profit and loss account. The auditor must make enquiries with the management to ascertain whether there have been
any changes in the accounting policies and also review the closing circulars issued by the controlling authorities of
the Bank.
Applicability of AS 5 and Materiality
8.03 Accounting Standards are intended to apply only to items that are material. Since materiality is not
objectively defined, RBI, vide its Circular No. DBOD.No.BP. BC. 89 /21.04.018/2002-03 dated March 29, 2003 on
"Guidelines on compliance with Accounting Standards (AS) by banks", has advised that all banks should ensure
compliance with the provisions of accounting standards in respect of any item of prior period income or expenditure,
which exceeds one per cent of total income/ total expenditure of the bank if the income or expenditure is reckoned on
gross basis or one per cent of the net profit before taxes or net losses as the case may be if the income is reckoned
on net of costs.
8.04 Since the format of the profit and loss accounts of banks prescribed in Form B under Third Schedule to the
Banking Regulation Act, 1949 does not specifically provide for disclosure of the impact of prior period items on the
current year's profit and loss, such disclosures, wherever warranted, may be made in the Notes on Accounts to the
balance sheet of banks.
Interest Earned
8.05 The following items are included under this head:
(a) Interest/Discount on Advances/Bills: This includes interest and discount on all types of loans and advances
like cash credit, overdrafts, demand loans, term loans, export loans, domestic and foreign bills purchased and
discounted (including those rediscounted), overdue and penal interest and interest subsidy, if any, relating to
such advances/bills. The amount to be included under this head is net of the share of participating banks
under interbank participation schemes on risksharing basis. In modern day banking, the entries for interest
income on advances are automatically generated through a batch process in the CBS system. The auditor
must consider the internal controls over modification in interest rates in the CBS system and verify whether
these have been appropriately accounted for in the accounts
(b) Interest Income on Investments: This includes all income derived from Government securities, bonds and
Profit and Loss Account
debentures of corporates and other investments by way of interest and dividend, except income earned by
way of dividends, etc., from subsidiaries and joint ventures abroad/in India. Broken period interest paid on
securities purchased and amortisation of premium on SLR investments is net off from the interest income on
investments.
(c) Interest on Balances with RBI and Other Interbank Funds: This includes interest on balances with Reserve
Bank and other banks, call loans, money market placements, etc.
(d) Others: This includes any other interest/discount income not included in the above heads. Interest on
advances given by the bank to staff member in its capacity as employer rather than as banker should be
included under this head.
Income from Investments
8.06 Interest and dividend on investments is usually accounted for at the head office. Such interest and dividend,
therefore, may not appear in the profit and loss account of a branch. The related audit procedures described below
would be relevant only in cases where interest/ dividend on investments is recorded at the branch under audit.
Similarly, since only a few designated branches maintain accounts with RBI or are authorised to lend money at call
and short notice, this item would appear in the profit and loss accounts of such branches only.
Profit on Sale of Investments: Investments are dealt in the course of banking activity and hence the net profit
or loss on sale of investments is taken to profit and loss account. As investments are dealt with at the head
office level, this item will not appear in the profit and loss account of a branch.
Profit/Loss on Revaluation of Investments: In terms of guidelines issued by RBI, investments are to be valued
at periodical intervals and depreciation or appreciation in valuation should be recognized under this head. As
investments are dealt with at the head office level, this item will not appear in the profit and loss account of a
branch. The net profit or loss on account of the revaluation of investments held by the bank is reported under
this head.
Other Income
8.07 The following items are included under this head:
(i) Commission, Exchange and Brokerage: This item comprises of the following:
(a) Commission on bills for collection.
(b) Commission/exchange on remittances and transfers, e.g. demand drafts, NEFT, RTGS, etc.
(c) Commission on letters of credit and guarantees, letter of comforts.
(d) Loan processing, arranger and syndication fees.
(e) Mobile banking fees.
(f) Credit/Debit card fee income including annual fee income, merchant acquiring income, interchange fees,
etc.
(g) Rent from letting out of lockers.17
(h) Commission on Government business.
(i) Commission on other permitted agency business including consultancy and other services.
(j) Brokerage on securities.
(k) Fee on insurance referral.
(l) Commission on referral of mutual fund clients.
(m) Service/transaction banking charges including charges levied for transaction at other branches.
(n) Income from rendering other services like custodian, demat, investment advisory, cash management and
17
As per the Notes and Instructions for compilation of the profit and loss account, issued by the Reserve Bank, this item should come under
this head. There is, however, a contrary view in some quarters that locker rent should be included in miscellaneous income. The latter view
seems more plausible.
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other fee based services.
(ii) Profit on sale of Land, Buildings and Other Assets: This item includes profit (net of any loss) on sale of land,
buildings, furniture, motor vehicles, gold, silver, etc.
(iii) Profit on exchange transactions: This includes revaluation gains/losses on forward exchange contracts and
other derivative contracts, premium income/expenses on options, etc.
(iv) Income earned by way of dividends, etc., from subsidiaries and joint ventures abroad/in India.
(v) Miscellaneous income.
Profit/Loss on Revaluation of Fixed Assets
8.08 According to the Notes and Instructions for compilation of profit and loss account, issued by the RBI, the
net profit/loss on revaluation of the aforesaid assets may also be shown under this item. In this regard, the
requirements of AS 10, Accounting for Fixed Assets, relating to revaluation of fixed assets assume significance.
According to the Accounting Standard, when a fixed asset is revalued in financial statements, the entire class of
assets should be revalued, or the selection of assets for revaluation should be made on a systematic basis. It is
also provided that an increase in net book value arising on revaluation of fixed assets should be credited directly
to owners' interests under the head of revaluation reserve. However, if such increase is related to and not greater
than a decrease arising on revaluation which was previously recorded as a charge to the profit and loss account, it
may be credited to the profit and loss account. On the other hand, any decrease in net book value arising on
revaluation of fixed assets should be charged directly to the profit and loss account except that to the extent that
such a decrease is related to an increase which was previously recorded as a credit to revaluation reserve and
which has not been subsequently reversed or utilised, it may be charged directly to revaluation reserve account.
8.09 From the above, it can be seen that as per AS 10, surplus on revaluation of a fixed asset cannot be
credited to the profit and loss account except to the extent that such surplus represents a reversal of a related
previous revaluation decrease that was charged to the profit and loss account.
Profit on Exchange Transactions
8.10 This item includes profit (net of loss) on dealings in foreign exchange. All income earned by way of foreign
exchange commission and charges on foreign exchange transactions except interest are to be included under this
head. As foreign exchange transactions take place only at a few select branches of a bank, this item may not appear
in the profit and loss accounts of all branches. The audit procedures in this regard would include:
a) Checking that the year-end outstanding entries are translated/restated at appropriate rates of exchange as
communicated by the Controlling- authority, for recording profit/ loss on exchange transactions. After the
introduction of CBS, this has become a systems driven adjustment. The auditor should understand the
process of foreign exchange rate upload in the system for revaluation of forward contracts and derivative
contracts. Each bank has a process to daily upload of day's foreign exchange rate and curves etc. in the
system at the specific time. The auditor should verify independently rates on sample basis which are
uploaded in the system. The auditor should verify the internal controls in place for such centralized system
upload including whether the same are done under appropriate authority. The auditor should also obtain the
audit trail from the system to understand whether subsequent modification in system has been made and
reason for the same.
b) Obtaining the revaluation report of outstanding forward exchange contracts and other derivative contracts as
on the reporting date and agreeing the currency-wise notional amounts of the forward exchange contracts
and other derivative contracts with the foreign currency general ledger to ascertain completeness of
revaluation report. Further, on a sample basis, recompute the valuation of the forward exchange contracts
and other derivative contracts using a valuation tool.
c) Obtaining the bank's risk policy to understand the bank's process of classification of hedge, assessment of
hedge effectiveness and accrual of hedge cost. The auditor should obtain the report of hedge transaction
outstanding on reporting date and hedge effectiveness.
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d) Testing large transactions and check whether these are recorded in compliance with the directions of the
controlling authority.
e) Scrutinising transactions recorded in the postbalance sheet period to ascertain that no material items have
been ignored up to the year end.
f) Enquiring and obtaining explanations regarding unusual large transactions/entries involving huge gains/
losses for the year and the same needs to be documented in the work paper.
Income Earned by Way of Dividends, etc. from Subsidiaries and Joint Ventures abroad/in India
8.11 It may be noted that any income derived from the investment portfolio by way of interest and dividend is not
to be included under this head but under the subhead 'income on investments' under the head `interest earned'. As
investments are usually dealt with at the head office level, this item may not appear in the profit and loss account of a
branch.
Miscellaneous Income
8.12 This head generally includes following items of income:
(a) rental income from bank's properties;
(b) security charges;
(c) insurance charges recoverable from customers;
(d) Other income from carrying out other services like selling of gold coins etc.
The auditor can ascertain whether any premises or part thereof is let out, and, if, so, whether rent recoveries are
recorded upto the year-end at the rates as applicable. The auditor may verify various items of miscellaneous
income in the same manner as in the case of other entities.
8.13 The Notes and Instructions for compilation of profit and loss account, issued by the Reserve Bank, require that
in case any item under this head exceeds one per cent of the total income, particulars thereof may be given in the notes.
Expenses
8.14 Expenditure is to be shown under three broad heads: interest expended; operating expenses; and
provisions and contingencies.
Interest Expended
8.15 The following items are included under this head:
(a) Interest on Deposits: This includes interest paid/ payable on all types of deposits including deposits from
banks and other institutions. Usually, the rates of term deposits of banks are amended from time to time by
the ALCO or the Board. The auditor must verify the system in place to give effect to these changes in the
CBS system of the Bank.
(b) Interest on Reserve Bank of India/ InterBank Borrowings: This includes interest/ discount on all borrowings
and refinance from the RBI and other banks.
(c) Others: This includes discount/ interest on all borrowings/ refinance from financial institutions. All other
payments like interest on participation certificates, penal interest paid, etc. may also be included here.
(d) Auditor should verify the interest reset on premature withdrawals of deposits and interest charged on loan
overdraft against the same. Appropriate charge of penalty as per each bank's policy should also be verified.
8.16 RBI, vide its circular no. DBOD.Dir.BC.42/13.03.00/2011-12 dated October 25, 2011 (as amended by
RBI's Circular No. DBOD.Dir.BC.75/13.03.00/2011-12 dated January 25, 2012), has deregulated the savings bank
deposit interest rate. In other words, the banks are now free to determine their savings bank deposit interest rate.
The auditor should verify that prior approval of the Board/Asset Liability Management Committee (if powers are
delegated by the Board) has been obtained by a bank while fixing interest rates on such deposits.
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8.17 Further, vide its Circular No. DBOD.Dir.BC.64/13.03.00/2011-12 dated December 16, 2011; RBI has
also deregulated the interest rates on Non Resident (External) Rupee Deposits and Ordinary Non-Resident
(NRO) Accounts as follows:
Banks are free to determine their interest rates on both savings deposits and term deposits of maturity of one
year and above under Non-Resident (External) Rupee (NRE) Deposit accounts and savings deposits under
Ordinary Non-Resident (NRO) Accounts. However, interest rates offered by banks on NRE and NRO deposits
cannot be higher than those offered by them on comparable domestic rupee deposits.
Prior approval of the Board/Asset Liability Management Committee (if powers are delegated by the Board)
needs to be obtained by a bank while fixing interest rates on such deposits. At any point of time, individual
banks need to offer uniform rates at all their branches.
The revised deposit rates apply only to fresh deposits and on renewal of maturing deposits.
Banks also need to closely monitor their external liability arising on account of such deregulation and ensure
asset-liability compatibility from systemic risk point of view.
8.18 Attention is also drawn to RBI Master circular no. DBR.No.Dir.BC.8/13.03.00/2015-16 dated 1st July 2015, by
which RBI has consolidated instructions pertaining to FCNR(B) deposits by Banks. Specific consideration should
be given to the ceiling on interest rates, 360 days to a year basis for interest payment, rounding off of interest etc.
Recurring Deposits should not be accepted under the FCNR (B) Scheme. The interest on FCNR (B) deposits should
be calculated and paid at intervals of 180 days each and thereafter for the remaining actual number of days.
However, the depositor will have the option to receive the interest on maturity with compounding effect.
Auditor should verify concurrent or internal audit reports for revenue leakages detected but not rectified till date.
Appropriate entries if necessary could be passed.
Operating Expenses
8.19 The following items are included under this head:
(i) Payments to and Provisions for Employees: This item includes salaries and wages of staff, allowances, bonus,
other staff benefits like provident fund, pension, gratuity, leave fare concession, staff welfare, medical allowance
to staff, etc. It may be noted that provision for terminal benefits like pension and gratuity is usually made only at
the head office level. Salaries and allowances payable to the bank's staff and officers are usually governed by
agreement with the employee unions or awards of a judicial tribunal.
(ii) Rent, Taxes and Lighting: This item includes rent paid by the bank on buildings, municipal and other taxes,
electricity charges and other similar charges and levies. Auditor should specifically review cases where rental
increases are in dispute & unpaid. Necessary provisions / disclosures should be appropriately made. It may be
noted that income-tax and interest on tax are not to be included under this head. Similarly, house rent
allowance and other similar payments to staff would not appear under this head.
(iii) Printing and Stationery: This item includes books and forms and stationery used by the bank and other
printing charges except those incurred by way of publicity expenditure. While some stationery may have
been purchased by the branch, other stationery (security paper like draft forms, cheque books) would have
been received by the branch from the head office. Auditor should specifically note the bank policy in this
regard whether the same is expensed out on purchase or on usage. In any case any unusable or outdated
stationery should be expensed out. If any Stationery is shown as an asset, necessary physical verifications
should be done.
(iv) Advertisement and Publicity: This item includes expenditure incurred by the bank for advertisement and
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publicity, including printing charges of publicity material. Auditor should specifically review such agreements
to find out commitments made for such expenses in future periods.
(v) Depreciation on Bank's Property: This item includes depreciation on bank's own property, motor cars and
other vehicles, furniture, electrical fittings, vaults, lifts, leasehold properties, non-banking assets, etc.
Depending on the procedure followed in the bank, provision for depreciation may be either centralised at the
head office level through fixed asset management software or decentralized and manual at branches and
other offices. Auditor should specifically review the useful life at the year end and provide for additional
depreciation in case there is any downward revision in the useful life. Auditor should ensure that fixed assets
are accounted on date asset is put to use. Necessary accounting of the asset to be done & depreciation
calculated from this date. Generally, banks account for fixed assets on date of final payment irrespective of
the asset being put to use much earlier.
Auditor should note the process for verifying assets booked by branch but allotted to employees & located at
Bank residential premises allotted to these employees.
(vi) Directors' Fees, Allowances and Expenses: Expenditure incurred in this regard is recorded under this head.
This item is dealt with at the head office level and would not therefore be relevant at the branch level.
(vii) Auditors' Fees and Expenses: Remuneration payable to Statutory Auditors and Branch auditors and
expenses in connection with audit like reimbursements are recorded under this head. This item is usually
dealt with at the head office level and would not therefore be relevant at the branch level.
(viii) Law Charges: All legal expenses and reimbursement of expenses incurred in connection with legal services
are to be included here. Auditor should specifically review the Legal agreements to note future commitments
for payables. Expenses paid to advocates recovered from Borrowers by direct debit to that account should be
specifically noted for consistency in accounting.
(ix) Postage, Telegrams, Telephones, etc.: This item includes all postal charges like stamps, telegrams,
telephones, teleprinters, etc. Issuance of Telegrams has been discontinued since 15th July 2013 and this head
is now just for academic purposes.
(x) Repairs and Maintenance: This item includes repairs to bank's property, their maintenance charges, etc.
Amortization of such expenses should be specifically noted.
(xi) Insurance: This item is usually dealt with at the head office level and may not therefore be relevant at the
branch level. This includes Premium paid to DICGC, Insurance of Cash on Hand, in ATM & in transit and also
Insurance of Fixed Assets, Employee Fidelity Insurance, Fraud Covers, Coverage for Cyber Risks. Auditor
should specifically ensure that all risks are insured adequately. Decision not to insure specific risks / assets
should be approved at appropriate Management levels & Auditor should obtain the relevant documents for
record.
(xii) Direct Marketing Expenses: These are the expenses incurred majorly for sourcing of retails loans/credit cards
and collection of retail overdue loans. RBI circular RBI/2006/167/DBOD.NO.BP.40/21.04.158/2006-07 dated
3rd November 2006 clearly states that activities of internal audit, compliance function and decision making
functions like compliance with KYC norms for opening deposit accounts, according sanction for loans
(including retail loans) and management of retail loans cannot be outsourced.
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(xiii) Other Expenditure: This item includes all expenses other than those included in any of the other heads, like,
license fees, donations18, subscriptions to papers, periodicals, entertainment expenses, travel expenses, etc.
The Notes and Instructions for compilation of profit and loss account, issued by the Reserve Bank, require that
in case any particular item under this head exceeds one per cent of the total income, particulars thereof may be
given in the notes.
Some banks follow the policy of providing for the promotional points earned by the customers on the use of
Debit/Credit cards. These provisions could be shown under this head.
Expenses should be accounted on accrual and not on cash basis. Necessary payment vouchers of April month
could be verified for the same. Necessary confirmations or representations for the same could be obtained.
Provisions and Contingencies
8.20 This item represents the aggregate of the provisions made in respect of the following:
(a) Non-performing assets
(b) Taxation
(c) Diminution in the value of investments
(d) Provisions for contingencies
Provisioning norms for NPA of nationalised banks are given in RBI/2015-16/101 DBR.No.BP.BC.2/21.04.048/2015-
16 dated 1st July, 2015. Interest reversal in case of advances which have become NPA to be specifically checked.
The most important item included in this head is the provision in respect of nonperforming assets. The other
provisions are usually made at the head office level.
Deferred Tax Liability on Special Reserve created under Section 36(1)(viii) of the Income Tax Act,
1961
8.21 RBI vide its Circular No. DBOD.No.BP.BC.77/21.04.018/2013-14 on "Deferred Tax Liability on Special
Reserve created under Section 36(1)(viii) of the Income Tax Act, 1961" dated December 20, 2013 advised banks, as
a matter of prudence, DTL should be created on Special Reserve.
8.22 For this purpose, banks may take the following course of action:
a) If the expenditure due to the creation of DTL on Special Reserve as at March 31, 2013 has not been fully
charged to the Profit and Loss account, banks may adjust the same directly from Reserves. The amount so
adjusted may be appropriately disclosed in the Notes to Accounts of the financial statements for the financial
year 2013-14.
b) DTL for amounts transferred to Special Reserve from the year ending March 31, 2014 onwards should be
charged to the Profit and Loss Account of that year.
In view of the requirement to create DTL on Special Reserve, banks may reckon the entire Special Reserve for the
18
The Reserve Bank of India, from time to time, prescribes the limits up to which banks can make donations. As per the Reserve Bank of
India's circular no. DBOD. No. Dir. BC. 50/ 13.01.01/ 200506 dated December 21, 2005, the policy relating to donations given by banks to
various entities may be formulated by the Board of Directors of the banks. While formulating any such policy, the circular requires the directors
to take into account inter alia, the following principles:
(i) profit making banks, during a financial year, may make donations upto one percent of the published profits for the previous years.
This limit of one percent would include contributions made by the bank to any fund created for specific purposes such as
encouraging research and development. However, donations/ subscriptions to the Prime Minister's National Relief Fund and to
professional bodies related to banking industry, such as the Indian Banks Association, Indian Institute of Banking etc., is excluded
from such limit of one percent.
(ii) loss making banks can make donations upto Rs. 5 lakhs in a financial year including donations to the Prime Minister's National
Relief Fund and other professional organisations listed in (i) above.
The circular has clarified that the unutilised portion of one percent cannot be carried forward to the next year. The Circular also outlines the
procedure for making contribution to the Prime Minister's National Relief Fund.
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purpose of computing Tier-I Capital. Reference in this regard is also drawn to the Announcement "Manner of
Reporting by the Auditors In Respect of RBI's Circular on Deferred Tax Liability on Special Reserve created under
Section 36(1) (viii) of the Income Tax Act, 1961" dated April 30, 2014 issued by the Auditing and Assurance
Standard Board of the Institute of Chartered Accountants of India.
Appropriations
8.23 Under this head, the net profit/ loss for the year as well as profit/ loss brought forward have to be shown.
The appropriations of the aggregate thereof are to be shown under the following heads:
(a) Transfer to Statutory Reserves.
(b) Transfer to Capital Reserves.
(c) Transfer to Investment Fluctuation Reserve.
(d) Transfer to Debenture Redemption Reserve.
(e) Transfer to Other Reserves.
(f) Transfer to Government/ Proposed Dividend.
(g) Transfer to Tax on Dividend.
8.24 The appropriations of profits are decided at the head office level. This item would not therefore appear in the
profit and loss account at the branch level. The central statutory auditor should therefore verify compliance with the
statutory requirement regarding transfers to reserve accounts and the other appropriation as applicable will have to
be taken into consideration while verifying these. According to RBI circular RBI/2006-07/132 DBOD.BP.BC No. 31 /
21.04.018/ 2006-07 dated 20th September 2006 all expenses including provisions and write-offs recognized in a
period, whether mandatory or prudential, should be reflected in the profit and loss account for the period as an `above
the line' item (i.e. before arriving at the net profit).
Audit Approach and Procedures
Income
8.25 In carrying out an audit of income, the auditor is primarily concerned with obtaining reasonable assurance
that the recorded income arose from transactions, which took place during the relevant period and pertain to the
bank, that there is no unrecorded income, and that income is recorded in proper amounts and is allocated to the
proper period. In view of the mandatory requirement of recognition of income, the recognition of revenue will have to
be subjected to examination vis-à-vis the guidelines. Vide circular DBOD.No.BP. BC. 89 /21.04.018/2002-03 dated
29th March 2003, RBI has advised that in respect of any income which exceeds one percent of the total income of the
bank if the income is reckoned on a gross basis or one percent of the net profit before taxes if the income is reckoned
net of costs, should be considered on accrual as per AS-9. If any item of income is not considered to be material as
per the above norms, it may be recognised when received and the auditors need not qualify the statements in that
situation. As per AS-9 Revenue Recognition, revenue arising from the use by others of enterprise resources yielding
interest, royalties and dividends should only be recognised when no significant uncertainty as to measurability or
collectability exists. If revenue recognition is postponed, as per AS-1 on Disclosure of Accounting Policies, an
enterprise should also disclose the circumstances in which the revenue recognition has been postponed pending the
resolution of significant uncertainties.
8.26 Since the entire accounting in banks is done on the CBS, the auditor should plan the audit procedure
based on controls testing. If he is not satisfied with the controls in place for accounting and recording of items
of income and expenses correctly he should resort to more of substantive checking of documents and records.
In case auditor decides to adopt the control reliance strategy, the auditor should perform test of controls which
mitigate the risk of what could go wrong.
Interest Income
8.27 As a measure of control and also to ensure that the legal remedies against defaulting borrowers are
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not adversely affected, banks commonly follow the procedure of recording interest on non-performing advances
in a separate account styled as 'Interest Suspense' or other similar account. Amounts lying in Interest
Suspense Account do not represent income of the bank and have also to be deducted from the relevant
advances. The auditor should also check whether, in terms of the income recognition guidelines issued by the
RBI, the bank has either reversed or made provision in respect of interest accrued and credited to income
account, in respect of an advance (including bills purchased and discounted) that becomes NPA as at the close
of any year. Income in case of NPA account should be recognised only on realisation on cash basis as per
RBI/2015-16/101DBR.No.BP.BC.2/21.04.048/ 2015-16 dated 01/07/2015. These norms are also applicable to
Government Guaranteed Advances.
8.28 In case of accounts under Corporate Debt Restructuring (CDR) scheme, the auditor should see
whether the income on projects under implementation which have been classified as standard has been
accounted for on accrual basis pursuant to the RBI's income recognition norms. Banks are not permitted to
recognize income on accrual basis from projects under implementation which have been classified as `sub
standard' asset. Bank may recognize income in such accounts only on realisation on cash basis. Income in
respect of Funded Interest and where loans are converted into equity, debentures or any other instrument is to
be recognized on the same basis as in the case of restructuring and re-scheduling of loans.
8.29 The said norms also require that the banks should not recognise income from those projects under
implementation which have been classified as sub-standard and it should be recognised only on cash basis.
The auditor should also, accordingly, see whether any interest on such projects which has been recognised as
income in the past is either reversed or a provision for an equivalent amount is made in the accounts.
8.30 The auditor may assess the overall reasonableness of the figure of interest earned by working out the
ratio of interest earned on different types of assets to the average quantum of the respective assets during the
year. The auditor should obtain an in-depth understanding as to how the bank's management monitor their
business, analyse its credit portfolio and the interest income thereon.
8.31 For example, the auditor may obtain from the bank an analysis of sector-wise and segment-wise
deployment of credit, including the lending rates of advances in various sectors and figures of advances
outstanding at the end of each month/quarter. From such information, the auditor may work out a weighted
average lending rate. This analysis can be done for corporate and retail loan portfolio separately. In case of
retail loans, the portfolio can be further bifurcated into home loans, auto loans, personal loans, jewel loans, etc.
Further, the auditor should understand the process of computation of the average balance and re-compute the
average balance on sample basis.
8.32 The auditor should set the expectation for the movement in yield based on the discussion and inquiries
made with the management; rate movement observed in the industry, etc., and should obtain explanations for
major variances in the yield on month on month basis or quarterly basis.
8.33 To ascertain completeness of interest income in the analysis, the auditor should obtain general ledger
break-up for the interest income earned during the respective months/quarter and examine whether the aggregation
of the same agrees with the interest income considered for the yield analysis. The auditor should analyze
monthly/quarterly yields and document the reasons for the variances as per the expectation set. The auditor may
also compare the average yield on advances with the corresponding figures for the previous years and analyse
any material differences. The auditor may also compare the reported market yield in percentage terms with
market rates, RBI rates, advertised rates and rates across various products of the bank. Interest Income includes
interest accrued but not due on investments.
8.34 The auditor should, on a test check basis, verify the rates of interest as per terms of sanction in the
CBS as well as the calculation of interest through product rate sheets generated by CBS to satisfy himself that
(a) Interest has been charged on all the performing accounts upto the date of the balance sheet;
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(b) Interest rates charged are in accordance with the bank's internal regulations, directives of the RBI and
agreements with the respective borrowers. The scrutiny of interest rates charged is particularly
important in the case of advances made on floating interest rate basis;
(c) Discount on bills outstanding on the date of the balance sheet has been properly apportioned between
the current year and the following year;
(d) Interest on interbranch balances has been provided at the rates prescribed by the head office; and
(e) Any interest subsidy received (or receivable) from RBI in respect of advances made at concessional rates of
interest is correctly computed.
8.35 The auditor should also understand the process of accrual of interest income on credit card portfolio.
Credit card account will be treated as an NPA if the minimum amount due as stated in statement is not fully paid
within 90 days from the date of last statement The auditor should understand the assumption taken for accrual of
interest income such as revolving portfolio, standard assets etc. and independently assess the reasonableness of
these assumptions.
8.36 The auditor should also satisfy himself that interest on nonperforming assets has not been
recognised unless realised.
8.37 As per AS 9, " Revenue Recognition", dividends should be recognised when the right to receive
payment is established, i.e. dividend has been declared by the corporate body at its Annual General Meeting
and the owner's right to receive payment is established. The auditor should test certain samples of the dividend
income booked during the period by obtaining the counterfoils of dividend warrants and the amount credited in the
bank account.
8.38 In the case of bill discounting, interest income is received in advance hence, the auditor should examine
whether the interest income for the period has been accounted for properly and the balance is treated as other
liabilities. In CBS, the interest on bill discounted is system driven and the auditor should verify the in-built logic of
the system. For the sample cases, the auditor should verify the interest income on bill discounted by obtaining the
underlying documents like purchase order, letter of credit, etc.
8.39 The auditor should also understand the process of increase or decrease in base rate and process of
updating in the system. The auditor should also ascertain compliance with RBI guideline in respect of increase in
tenor of retail loan due to increase in base rate. The auditor should also verify on sample basis to whether the
increase/decrease in base rate are effected in the system on the effective date.
8.40 Interest income includes interest accrued but not due on assets. However, as banks normally debit the
borrower's account with interest due on the month end, at balance sheet date there would not usually be any
amount of interest accrued but not due on advances on balance sheet date. Auditor should verify the same.
8.41 The auditor should examine the completeness of accrual of the interest by obtaining a detailed break-up of
the loan portfolio (scheme wise or segment wise) and the interest accrual on the same. The aggregation of loan
portfolio should be agreed to the general ledger.
8.42 The auditor should examine whether interest has been accrued on the entire investment and money market
lending portfolio by obtaining the detailed break-up of the investment and money market lending portfolio along with
the interest accrued thereon and agree the same with the general ledger. The auditor should re-compute the
interest accrual on sample basis considering parameters like frequency of payment of interest amount, rate of
interest, period elapsed till the date of balance sheet, etc., from the term sheet, deal ticket, agreements, etc.
8.43 The auditor should obtain the list of the dividend income booked during the period and agree the total with
the general ledger. Income on NPI should be realised on cash basis only.
Income on Investments has been explained in detail in Chapter 7 of the Part IV of the Guidance Note.
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8.44 In determining the extent of sample checking, the auditor should take into account, inter alia, the results of the
analytical procedures and the reports, if any, on income and expenditure/ revenue audit as well as other internal and
RBI inspection reports. The auditor's assessment of the effectiveness of concurrent audit would also affect the extent of
his detailed checking of interest earned. In determining the extent of sample checking, the auditor may place greater
emphasis on examining interest on large advances.
Commission Income
8.45 Auditor may check the items of commission, exchange and brokerage on a test check basis. Such
examination can be done for commission earned on bills sent for collection, commission on letters of credit,
guarantees and letter of comforts. The auditor should examine whether the commission on nonfunded business
(e.g., letters of credit, guarantees and bills for collection) has been properly apportioned between the current year
and the following year.
8.46 The auditor should obtain details of loans sanctioned and disbursed during the period as well as verify the
policy of the bank for booking the processing fee income on such loans. For corporate loans, the processing fee
income for the material loans sanctioned and disbursed should be re-computed and verified on test check basis by
obtaining the loan agreements, sanction letter, etc. Further, for loans sanctioned but not disbursed wherein the
processing fee income has been booked on accrual basis, the auditor should verify the subsequent receipt of the
same and enquire for subsequent reversals. For retail loans, the auditor should perform analytical procedures for
computing the processing fee percentage for different ticket size loans.
8.47 The auditor should obtain an understanding of the various types of fee income earned on credit cards and
debit cards. Further, the auditor should obtain the rate matrix for various fees charged to the customer. On a sample
basis, the auditor should verify whether the fees charged and accounted is as per the rate matrix. Interchange fees is
earned from service providers namely Visa, Master card, Amex proportionate to the transactions entered by the
customer. On a sample basis, the auditor should verify whether the interchange fees have been received and
accounted as per the agreement. Merchant acquiring income is earned on the transactions entered by the customers
of other banks on the bank's terminal. The auditor should perform analytical procedures for such income and obtain
the explanation for the variances, if any.
8.48 The auditor should understand how management monitors non-funded business and use their analysis for
analytical procedures. The auditor should understand the relation with fee income with the business. For example,
month on month /quarter loan processing fees with sanction value to arrive at average processing fees on
monthly/quarterly basis. The auditor should analyse monthly/quarterly fee percentage and document the reasons for
the variances as per the expectation set. Similarly auditor can perform analysis of other fee income by doing
monthly/quarterly guarantee fees with average monthly/quarterly guarantee amount, interchange credit card fees vis
a vis inter charge transactions etc.
8.49 The auditor may also compare the average fee income with the corresponding figures for the previous
years and analyse any material differences.
8.50 The auditor should also check whether any fees or commission earned by the banks as a result of
renegotiations or rescheduling of outstanding debts has, in terms of the income recognition guidelines issued
by the RBI, have been recognised on an accrual basis over the period of time covered by the renegotiated or
rescheduled extension of credit.
8.51 According to the guidelines for income recognition, asset classification, etc., issued by the RBI, if
interest income from assets in respect of a borrower becomes subject to non-accrual, fees, commission and
similar income with respect to same borrower that have been accrued should cease to accrue for the current
period and should be reversed or provided for with respect to past periods, if uncollected. The auditor should
examine whether the bank has accordingly made suitable adjustments for derecognition/ reversal of
uncollected commission, etc.
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Profit and Loss Account
8.52 Fee on insurance referral is fast emerging as a major source of income for banks. In terms of the RBI
Master Circular No. DBR.No.FSD.BC 19/24.01.001/2015-16 dated July 1, 2015 on "Para Banking Activities",
banks are permitted to undertake insurance business as agents of insurance companies on fee basis or referral
arrangement without any risk participation subject to the conditions prescribed under the Master Circular. The
auditor should carefully examine the agreement entered into by the bank and the concerned insurance
company to see the basis for calculation of the said fee, time when the referral fees becomes due to the bank.
Normally, as an industry practice, such agency arrangements also contain clauses known as "claw back" of
agency fee, whereby if the client referred to the insurance company by the bank fails to pay the insurance
premium for a stipulated amount of time, the agency fees paid or due to the bank becomes recoverable from
the bank or is frozen. Such clauses have a direct impact on the recognition of income from the agency fees in
terms of Accounting Standard 9, Revenue Recognition and may, therefore, require creation of a corresponding
provision in the accounts. There has been no new Master Direction issued by RBI in 2016 dealing with Para
Banking Activities.
8.53 Profit on Sale of Investments: As per Circular DBOD/BP.BC.34/ 21//04.19/2010-11 dated 6 August, 2010,
investments are dealt in the course of banking activity and hence the profit or losses in sale of investments are taken
to Profit & Loss account. The auditor should obtain the investment policy of the bank and understand whether the
bank is using FIFO method or weighted average cost method for computing the profit/loss on sale of investments. As
investments are usually dealt with at the head office level, this item may not appear in the profit and loss account of a
branch.
Valuation of investment
Held to maturity - investment classified under HTM category need not be marked to market and will be carried at
acquisition cost, unless it is more than the face value, in which case the premium should be amortized over the
period remaining to maturity.
AFS - the individual scrip in the category will be marked at quarterly or at more frequent intervals.
8.54 Profit/ Loss on Revaluation of Investments: In terms of guidelines issued by RBI, investments are to be
valued at periodical intervals and depreciation or appreciation in valuation is to be recognised under this head. As
investments are usually dealt with at the head office level, this item may not appear in the profit and loss account of a
branch.
8.55 Profit on sale of Land, Buildings and Other Assets: This item includes profit (net of any loss) on sale of land,
buildings, furniture, motor vehicles, gold, silver, etc.
8.56 The auditor can check authority for disposal of:
fixed assets, if any, sold during the year under audit; and
non-banking assets acquired in satisfaction of claims.
The auditor should also vouch transactions in evidence of profit/ loss recorded by the Branch in respect of assets, as
aforesaid.
Profit/ Loss on Revaluation of Fixed Assets
8.57 The auditor should satisfy himself about the appropriateness and proper application of the basis of
revaluation of fixed assets adopted by the bank. Where revaluation is based on an appraisal/report/certificate
by approved valuers, the auditor should examine the appraisals to the extent possible and satisfy him about
their adequacy for audit purposes.
8.58 The revaluation of fixed assets can be done on the basis of appraisals by competent valuers such as
engineers or architects, or on the basis of indexation of historical cost, or with reference to current prices. The
auditor should satisfy himself about the appropriateness and proper application of the basis of valuation
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adopted by the bank. Where revaluation is based on an appraisal by valuers, the auditor should examine the
appraisals to the extent possible and satisfy himself about their adequacy for audit purposes.
8.59 The auditor should also examine that the bank has complied with the provisions of AS 28, Impairment of
Assets. In terms of paragraph 58 of AS 28, an impairment loss should be immediately recognised as an expense in
the Profit and Loss Account, unless the asset is carried at revalued amount in accordance with AS 10. In such a
case, any impairment loss of a revalued asset should be treated as a revaluation decrease under AS 10.
8.60 The Notes and Instructions for compilation of profit and loss account, issued by the Reserve Bank, require that
in case any item under this head exceeds one per cent of the total income, particulars thereof may be given in the notes.
Interest on Deposits
8.61 The auditor may assess the overall reasonableness of the amount of interest expense in accordance
with Master Direction DBR. Dir. No.84/13.03.00/2015-16 "Reserve Bank of India (Interest Rate on Deposits)
Directions, 2016" by analysing ratios of interest paid on different types of deposits and borrowings to the
average quantum of the respective liabilities during the year. For example, the auditor may obtain from the bank
an analysis of various types of deposits outstanding at the end of each quarter. From such information, the
auditor may work out a weighted average interest rate. The auditor may then compare this rate with the actual
average rate of interest paid on the relevant deposits as per the annual accounts and enquire into the
difference, if material. The auditor may also compare the average rate of interest paid on the relevant deposits
with the corresponding figures for the previous years and analyse any material differences. The auditor should
obtain general ledger break-up for the interest expense incurred on deposits (savings and term deposits) and
borrowing each month/quarter. The auditor should analyse month on month (or quarter) cost analysis and
document the reasons for the variances as per the benchmark stated. He should examine whether the interest
expense considered in the cost analysis agrees with the general ledger. The auditor should understand the
process of computation of the average balance and re-compute the same on sample basis.
8.62 The auditor should, on a test check basis, verify the calculation of interest. He should satisfy himself
that:
(a) Interest has been provided on all deposits and borrowings upto the date of the balance sheet; and verify
whether there is any excess or short credit of material amount.
(b) Interest rates are in accordance with the bank's internal regulations, of the RBI directives, and agreements
with the respective depositors;
(c) In case of Fixed Deposits it should be examined whether the Interest Rate in the accounting system are in
accordance with the Interest Rate mentioned in the Fixed Deposit Receipt/Certificate.
(d) Interest on Savings Account should be checked on a test check basis in accordance with the rules framed
by the bank in this behalf.
(e) Discount on bills outstanding on the date of the balance sheet has been properly apportioned between the
current year and the following year;
(f) Payment of brokerage is properly authorised; and
(g) Interest on interbranch balances has been provided at the rates prescribed by the head office.
(h) Interest on overdue/ matured term deposits should be estimated and provided for.
8.63 The auditor should ascertain whether there are any changes in interest rate on saving deposits and term
deposits during the period. The auditor should obtain the interest rate card for various types of term deposits and
analyse the interest cost for the period. The auditor should examine the completeness that there has been interest
accrued on the entire borrowing portfolio by obtaining the detailed break up the money market borrowing portfolio
and the interest accrued and the same should agree with the GL code wise break up. The auditor should re-compute
the interest accrual on sample basis i.e., by referring to the parameters like frequency of payment of interest
amount, rate of interest, period elapsed till the date of balance sheet, etc from the term sheet, deal ticket,
agreements, etc.
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Profit and Loss Account
Expenditure
Operating Expenses
8.64 Generally the audit procedures followed by auditors in any entity are to be followed.
Payments to and Provisions for Employees
8.65 The auditor should ascertain the procedure followed by the bank in this regard while verifying this item. The
auditor should obtain the human resource policy and identify the benefits available to employees. Auditor should
understand the compensation structure and process of payment of salary, benefits like employee stock options, car
assistance, leave encashment, asset assistance, etc. to the various grades of employees. He should obtain the
standard compensation structure for each grade of employee. In case, where payment is made on production of
evidence or incurrence by employee, auditor should ascertain whether provision for the same has been made in the
books.
8.66 The auditor should perform an overall analytical review for the payments and provisions for employees by
month on month grade-wise analysis of the employees cost and number of employee in that grade to identify per
employee cost month on month and enquire about the variances, if any. The auditor should examine whether all the
benefits for all the employees have been appropriately accounted for.
8.67 The auditor should also check the calculation of salaries and allowances, etc. on a test check basis
with reference to appointment/awards/offer letters. He may also assess the reasonableness of expenditure on
salaries, allowances, etc. by working out their ratio to total operating expenses and comparing it with the
corresponding figures for previous years.
8.68 Auditor should also obtain an understanding of the provision for payment of bonus and other incentive and
ascertain adequacy of the amount recorded by the bank. Further, the auditor should verify whether the bank has
made adequate provisions for employee benefits and has complied with the recognition, measurement and
disclosure requirements of AS 15.
Rent, Taxes and Lighting
8.69 The auditor may check the following on a test check basis:
Rent paid and verify whether adjustments have been made for the full year on account of rent at the rates as
applicable and as per agreement in force.
Rent does not include House Rent Allowance to employees.
Whether municipal rates/ taxes are duly paid/ adjusted for the year under audit.
Enquire whether any disputed liability exists on this account upto the year-end.
Further, the auditor should obtain the listing of the premises which have been obtained on lease. If the lease
agreements have escalation clause, lease equalization should be done in accordance with AS-19 unless the
terms and conditions of the lease indicate otherwise.
In addition, the auditor should perform month on month rent analysis and verify major variance in the average
rent per month per branch.
Printing and Stationery
8.70 The auditor should verify this item with reference to documents evidencing purchase/debit note
received.
Advertisement and Publicity
8.71 Expenditure incurred by the bank for advertisement and publicity, including printing charges of publicity
material is verified with the documents.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Depreciation on Bank's Property
8.72 The auditor should ascertain the procedure followed by the bank while verifying this item.
8.73 This item includes depreciation on bank's own property, motor cars and other vehicles, furniture, electrical
fittings, vaults, lifts, leasehold properties, nonbanking assets, etc. Depending on the procedure followed in the bank,
provision for depreciation may either be centralised at the head office level or decentralised.
8.74 The auditor should check head office instructions as regards adjustments of depreciation on the fixed
assets of the Branch.
8.75 The auditor should also check whether depreciation on fixed assets has been adjusted at the rates and
in the manner required by head office.
8.76 The auditor may also report unadjusted depreciation on assets acquired but not capitalised.
8.77 The auditor should re-compute the depreciation for the period, perform depreciation rationalisation and
agree the amount with the general ledger.
8.78 The auditor may also verify and obtain explanation for the unadjusted depreciation on assets acquired but
not capitalised.
Provisions and Contingencies
8.79 The auditor should ascertain compliance with the various regulatory requirements for provisioning as
contained in the various circulars.
8.80 Obtain an understanding as to how the Bank computes provision on standard assets and non-performing
assets. It will primarily include the basis of the classification of loans and receivables into standard, sub-standard,
doubtful, loss and non-performing assets. For verification of provision on standard assets, the auditor should verify
the loan classification on a sample basis. The auditor should obtain the detailed break up of standard loans, non-
performing loans and agree the outstanding balance with the general ledger. The auditor should examine whether by
performing re-computation the provisions in respect of standard loans, NPA and NPI comply with the regulatory
requirements.
8.81 The auditor should obtain the tax provision computation from the bank's management and verify the nature
of items debited and credited to profit and loss account to ascertain that the same are appropriately considered in the
tax provision computation. The auditor should re-compute the provision for tax by applying the applicable tax rate
after considering the allowances and disallowances as per Income Tax Act, 1961. The other provisions for
expenditure should be examined vis a vis the circumstances warranting the provisioning and the adequacy of the
same by discussing and obtaining the explanations from the bank's management.
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IV-9
Disclosure Requirements in Financial
Statements
9.01 Sub-sections (1) and (2) of section 29 of the Banking Regulation Act, 1949 deal with form and content
of financial statements of a banking company. Sub-section (1) of section 29 requires every banking company to
prepare a balance sheet and a profit and loss account in the forms set out in the Third Schedule to the Banking
Regulations Act, 1949 (hereinafter referred to as `the Act'). Form A of the Third Schedule to the Act contains the
form of balance sheet and Form B contains the form of profit and loss account.
9.02 The disclosure requirements for disclosure in the financial statements can be broadly classified in the
following four categories:
(i) Prescribed by Reserve Bank of India.
(ii) Prescribed by Accounting Standards and other pronouncements.
(iii) Requirement emanating from Statues.
(iv) Requirement emanating from Listing Agreement.
9.03 Disclosures Prescribed by RBI: In addition to the disclosures to be made in the balance sheet and
profit and loss account in pursuance of the requirements of the Third Schedule to the Act, the RBI has, vide its
Master Circular no. DBR.BP.BC No. 23/21.04.018/2015-/16 dated July 1, 2015 on "Disclosure in Financial
Statements - Notes to Accounts", prescribed disclosures to be made in the Notes to Accounts in respect of
certain significant aspects of the items of financial statements of banks. The Banks should, at a minimum,
disclose the items listed in the circular in the `Notes to Accounts'. However, banks should also make more
comprehensive disclosures than the minimum required under the circular if they become significant and aid in
the understanding of the financial position and performance of the bank. The disclosure listed is intended only
to supplement, and not to replace, other disclosure requirements under relevant legislation or accounting and
financial reporting standards. Where relevant, a bank should comply with such other disclosure requirements as
applicable.
9.04 Disclosures Required Under Accounting Standards: The disclosure requirements under the various
notified Accounting Standards, prescribed under section 133 of the Companies Act, 2013 read with Rule 7 of
the Companies (Accounts) Rules, 2014 and various applicable pronouncements of the ICAI.
9.05 Requirements of Statutes: The requirements of the Companies Act, 2013 relating to the balance sheet
and profit and loss account of a company, in so far as they are not inconsistent with the Banking Regulation
Act, 1949 also apply to the balance sheet or profit and loss account of a banking company [sub-section (3) of
section 29 of the Act]. It may be noted that this provision applies only to those banks, which have been
incorporated as companies.
9.06 Requirement of Listing Agreement: Banks listed on a stock exchange have to also comply with the
requirements of the Listing Agreement as amended from time to time.
Disclosure of Summary of the Significant Accounting Policies
9.07 Banks should disclose the accounting policies regarding key areas of operations at one place, i.e., under
Schedule 17, along with notes to accounts in their financial statements. This may include disclosure, such as, Basis
Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
of Accounting, Transactions involving foreign exchange, Investments classification, valuation, etc, Derivative
Transactions, Advances and Provisions thereon, Fixed Assets and Depreciation, Revenue Recognition (including
strategic Debt Restructuring), Employee Benefits, Provision for Taxation, etc.
9.08 The Form A and B of the Third Schedule contains 16 schedules, which is to be uniformly used by all
the banks. In addition to the 16 detailed prescribed schedules, banks are required to furnish the `Summary of
Significant Accounting Policies' and `Notes to Accounts' under Schedule 17 and Schedule 18 respectively, to
maintain uniformity. This Chapter deals with disclosure requirements in Notes to Accounts as laid down in the
respective RBI circular. The disclosures requirement contained in the Master Circular are minimum disclosure
requirements. The banks may consider disclosing significant additional information for enhancing the
understanding of the users of the financial statements.
9.09 The previous year's comparatives should also be disclosed along with the disclosures for the current
year.
Audit Approach
9.10 The auditor's primary objective in audit of disclosures made in the notes to accounts is to satisfy that
such disclosures are free from material misstatement. Examination of compliance with statutory, regulatory and
accounting standard's requirements is also an important objective in as much as non-compliance may have a
direct and material impact in understanding the financial statements. The auditor should keep this in view while
designing audit procedures relating to disclosures. The auditor could have a checklist of all the prescribed
disclosure requirements which should include a column of the manner in which the data is extracted by the bank
and the manner of auditor's verification of the same. This will ensure completeness and accuracy of the various
disclosures. Care needs to be taken that the qualitative disclosures emanate from various policies, procedures
and practices of the bank and represent the manner in which the bank conducts its activities referred to in the
disclosures. The auditor needs to be satisfied that the quantitative disclosures originate from the books of account
and other related records. The auditor should be satisfied with regard to the procedure of the bank to extract the
relevant information. In case the process of extraction is automated the auditor can focus on the concerned
systems controls too. In case the process is manual then more rigorous verification is necessary. Some of the
disclosures could emanate from software and management information systems that are not seamlessly linked to
the core banking software or any accounting software. In such cases the auditor should obtain audit evidence as
to the robustness of the process followed by the bank to arrive at the data / information that is eventually disclosed
in the financial statements.
9.11 The following paragraphs list the various requirements of disclosures. The audit approach for verification
of these disclosures is detailed in the respective chapters of this Guidance Note.
Disclosures Prescribed by RBI19
9.12 Banks are also required to comply with the Accounting Standard 1 on "Disclosure of Accounting Policies"
issued by the Institute of Chartered Accountants of India (ICAI). In addition to the 16 detailed prescribed
schedules to the balance sheet, banks are required to furnish the information as discussed in the following
paragraphs in the "Notes to Accounts":
9.13 Capital20
(i) The Capital to Risk-weighted Assets Ratio (CRAR) as assessed by the Bank on the basis of the guidelines
issued by the RBI for implementation of the Capital Adequacy Framework should be computed and disclosed
in Notes to accounts.
19
The RBI vide its Master Circular No. DBR.BP.BC No.23 /21.04.018/2015-16 dated July 1, 2015 on "Disclosure in Financial Statements -
Notes to Accounts" prescribes the disclosures to be made by the banks in the notes to accounts.
20
For the format of disclosures please refer to the relevant paragraphs of "Master Circular-Disclosure in Financial Statements-Notes to
Accounts".
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Disclosure Requirements in Financial Statements
(ii) CRAR should be computed on over all basis (i.e. Total Capital) and also for Tier I and Tier II capital.
(iii) Amount of equity capital raised
(iv) Amount of Additional Tier 1 capital raised; of which
a. Perpetual Non cumulative Preference Shares (PNCPS)
b. Perpetual Debt Instrument (PDI)
(v) Amount of Tier 2 capital raised; of which
a. Debt capital instrument
b. Preference Share Capital Instrument: [Perpetual Cumulative Preference Shares (PCPC)/Redeemable
Non-Cumulative Preference Shares (RNCPS)/ Redeemable Cumulative Preference Shares (RCPS)]
(vi) For nationalized banks percentage of the shareholding of the Government of India should also be disclosed.
9.14 Investments
(i) The details of investments and the movement of provisions held towards depreciation of investments of the
bank should be stated under following heads:
(a) gross value of investments in India and outside India;
(b) aggregate of provisions for depreciation, separately on investments in India and outside India;
(c) net value of investments in India and outside India; and
(d) Movement of provision held towards depreciation on investment stating opening balance, provisions
made during the year, appropriation/transfer, if any, from Investment Fluctuation reserve, write- off/
write back of excess provisions and closing balance.
(ii) The gross value of investments and provisions need not, however, be shown against each of the categories
specified in the Schedule. The break-up of net value of investments in India and outside India (gross value
of investments less provision) under each of the specified category need only be shown.
Repo Transactions
9.15 The details of Securities sold under repo and Securities purchased under reverse repo for Government and
Corporate debt securities during the year should be disclosed stating minimum and maximum outstanding balance daily
average outstanding balance of securities and Outstanding as on March 31.
9.16 Non-SLR Investment Portfolio
(i) The composition of issuer of Non SLR investments should be disclosed in notes to account categorizing the
issuer into PSUs, FIs, Banks, Private Corporates, Subsidiaries/Joint Ventures and Others.
(ii) The Grand total of the issuer wise details of Non-SLR investment should tally with the total of Investments
included under the following categories in Schedule 8 to the balance sheet:
a. Shares
b. Debentures & Bonds
c. Subsidiaries/joint ventures
d. Others
(iii) The investments held with each category of issuer should be classified into extent of private placement,
below investment grade security, unrated securities and unlisted securities. Amounts reported under the
above classification may not be mutually exclusive.
(iv) Provision held towards depreciation of investments should be shown separately.
(v) The movement in gross non-performing Non-SLR investments (i.e. securities other than government and
other approved securities) should also be disclosed separately along with total provision thereof.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Sale and transfers to/from HTM Category
9.17 If the value of sales and transfers of securities to / from HTM category exceeds 5 per cent of the book
value of investments held in HTM category at the beginning of the year, the bank should disclose the market value
of the investments held in the HTM category and indicate the excess of book value over market value for which
provision is not made. This disclosure is required to be made in `Notes to Accounts' in the bank's audited Annual
Financial Statements. The 5 per cent threshold referred to above will exclude the one - time transfer of securities
to / from HTM category with the approval of Board of Directors permitted to be undertaken by banks at the
beginning of the accounting year and sales to the Reserve Bank of India under pre-announced OMO auctions.
9.18 Derivatives
(i) Forward Rate Agreement/ Interest Rate Swap: Following details are required to be disclosed with respect to
Forward Rate Agreement/Interest Rate Swap:
a) Notional principal of swap agreements,
b) Losses which would be incurred if counterparties failed to fulfill their obligations under the
agreements,
c) Collateral required by the bank upon entering into swaps,
d) Concentration of credit risk arising from the swaps (for e.g. exposures to particular industries or
swaps with highly geared companies) and,
e) Fair value of the swap book.
(ii) Nature and terms of the swaps including information on credit and market risk and the accounting policies
adopted for recording the swaps should be disclosed.
(iii) Examples of concentration could be exposures to particular industries or swaps with highly geared
companies.
(iv) If the swaps are linked to specific assets, liabilities, or commitments, the fair value would be the estimated
amount that the bank would receive or pay to terminate the swap agreements as on the balance sheet date.
For a trading swap the fair value would be its mark to market value.
(v) Exchange Traded Interest Rate Derivatives: With respect to Exchange Traded Interest Rate Derivatives
instrument-wise disclosure of Notional principal amount of Exchange Traded Interest Rate Derivatives
undertaken during the year, derivatives outstanding as on March 31, derivatives outstanding and not "highly
effective" should be disclosed. Mark-to-market value of exchange traded interest rate derivatives
outstanding and not "highly effective instrument-wise should also be disclosed.
9.19 Disclosures on risk exposure in derivatives
(i) Qualitative Disclosure: Banks should discuss their risk management policies pertaining to derivatives with
particular reference to the extent to which derivatives are used, the associated risks and business
purposes served. The discussion shall also include:
a) the structure and organisation for management of risk in derivatives trading,
b) the scope and nature of risk measurement, risk reporting and risk monitoring systems,
c) policies for hedging and/or mitigating risk and strategies and processes for monitoring the
continuing effectiveness of hedges/mitigants, and
d) accounting policy for recording hedge and non-hedge transactions; recognition of income,
premiums and discounts; valuation of outstanding contracts; provisioning, collateral and credit risk
mitigation.
(ii) Quantitative Disclosure: Quantitative disclosure with regard to currency and interest rate derivatives
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Disclosure Requirements in Financial Statements
should be disclosed in notes to accounts stating:
a) The notional principal amount of derivatives both for hedging and trading.
b) Mark to market position separately for positive and negative marked to market position.
c) Credit Exposure.
d) Likely impact of one percentage change in interest rate on hedging and trading derivatives and
maximum and minimum change in interest rate observed during the year.
9.20 Asset Quality
(i) Non-performing assets: Banks are required to disclose Net NPA as percentage to net advances and the
details of movement of gross NPAs, net NPAs and provisions during the year.
(ii) Following details are to be disclosed in respect of Loan Assets subjected to restructuring:
i. details of accounts restructured on a cumulative basis excluding the standard restructured accounts
which cease to attract higher provision and risk weight (if applicable);
ii. provisions made on restructured accounts under various categories; and
iii. details of movement of restructured accounts.
Above details are classified under different categories as under:
i. Type of restructuring- Under CDR Mechanism, Under SME Debt Restructuring Mechanism and Others
ii. Asset Classification of restructured accounts- Standard, Sub-standard, Doubtful and Loss assets
iii. Movement under each of the above disclosing No. of borrowers, Amount outstanding and Provision
thereon
These details are to be disclosed in a tabular format as given in the Master Circular on Disclosure in
Financial Statements - Notes of Accounts dated July 1, 2015.
Bank should also disclose investment in equity shares under strategic Debt Restructuring
Banks must disclose the total amount outstanding in all the accounts/ facilities of borrowers whose accounts
have been restructured along with the restructured part or facility. This means even if only one of the facilities/
accounts of a borrower have been restructured, the bank should also disclose the entire outstanding amount
pertaining to all the facilities/ accounts of that particular borrower.
(iii) Financial assets transferred during the year to securitisation company (SC)/reconstruction company (RC) -
With regards to financial assets transferred by the bank to securitisation/reconstruction company the bank is
required to disclose the number of accounts transferred, aggregate value (net of provisions) of accounts sold
to SC/RC, aggregate consideration and additional consideration realized in respect of accounts transferred in
earlier years. Aggregate gain/loss over net book value is also required to be computed and disclosed.
To enhance transparency additional disclosure for investment in Security Receipts (SRs) is required
Particulars SRs issued within SRs issued more than SRs issued more
past 5 years 5 years ago but within than 8 years ago
past 8 years
(i) Book value of SRs
backed by NPAs sold by the bank
as underlying
Provision held against (i)
(ii) Book value of SRs
backed by NPAs sold by other
banks/ financial institutions/ non-
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banking financial companies as
underlying
Provision held against (ii)
Total (i + ii)
Disclosures on the Scheme for Sustainable Structuring of Stressed Assets (S4A), as on March 31 (INR Crore)
No. of accounts Amount outstanding
Aggregate amount
where S4A has been Provision Held
outstanding In Part A In Part B
applied
Classified as Standard
Classified as NPA
Additional disclosures are required to be made in respect of Flexible Structuring of existing loans, Accounts
still under the stand-still period under SDR scheme, Change in Ownership outside SDR scheme, Change in
Ownership of projects under Implementation, as per format in the Appendix to RBI Circular RBI/2016-17/122
DBR. No. BP.BC.34/21.04.132/2017-17 dated November 10, 2016.
(iv) Details of non-performing financial assets purchased/sold - Banks which purchase/ sold non-performing
financial assets from/to other banks shall be required to make the following disclosures in the Notes on
Accounts to their Balance sheets:
A.Details of non-performing financial assets purchased:
(a) No. of accounts purchased during the year
(b) Aggregate outstanding
Of these, number of accounts restructured during the year
Aggregate outstanding
B. Details of non-performing financial assets sold:
(a) No. of accounts sold during the year
(b) Aggregate outstanding
(c) Aggregate consideration received
(v) Provisions on Standard Asset: Provisions made towards Standard Assets should be disclosed separately in
notes to account. It may be noted that the amount need not be netted of from gross advances but shown
separately as 'Provisions against Standard Assets', under 'Other Liabilities and Provisions - Others' in
Schedule No. 5 of the balance sheet.
9.21 Business Ratios: RBI has prescribed following ratios to be computed by the bank to be disclosed in the
notes forming part of the balance sheet:
(i) Interest Income as a percentage to Working Funds- Working funds is to be reckoned as average of total
assets (excluding accumulated losses, if any) as reported to RBI in Form X under Section 27 of the Banking
Regulation Act, 1949, during the 12 months of the financial year.
(ii) Non-interest income as a percentage to Working Funds- Non-interest income is to be reckoned as income
reported under Schedule 14.
(iii) Operating Profit as a percentage to Working Funds- Operating Profit is to be reckoned as profit before
making provisions, i.e., Total income as per Schedule 13 and Schedule 14 less Total expenditure as per
Schedule 15 and Schedule 16.
(iv) Return on Assets (it should be with reference to average working funds i.e., total of assets excluding
accumulated losses, if any): The return is to be reckoned as the net profit for the year after making all the
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Disclosure Requirements in Financial Statements
provisions.
(v) Business (Deposits plus advances) per employee (inter- bank deposits may be excluded): This ratio may be
computed based on the average business and average no. of employees during the year.
(vi) Profit per employee: This ratio may be computed based on the average no. of employees during the year.
9.22 Asset Liability Management: Banks are required to disclose the maturity pattern of Deposits, Advances,
Investments, Borrowings, Foreign Currency assets, Foreign Currency liabilities as on balance sheet date. The
maturity pattern needs to be disclosed in following time buckets-
(i) Day 1
(ii) 2 to 7 days
(iii) 8 to 14 days
(iv) 15 to 28 days
(v) 29 days to 3 months
(vi) Over 3 months & upto 6 months
(vii) Over 6 months & upto 1 year
(viii) Over 1 year & up to 3 years
(ix) Over 3 years & upto 5 years
(x) Over 5 years
The maturity pattern of demand deposits and demand loans (including in foreign currency) is to be based on
empirical study carried by the bank. Based on such study, such deposits and loans should be classified under
different buckets. Auditor will also have to verify the accuracy of the maturity pattern generated by the system at
Branch level and also at controlling office level to ensure the accuracy of disclosure made under this paragraph.
9.23 Exposures: The Reserve Bank of India, vide its Master Circular DBR.No.Dir.BC. 12/13.03.00/2015-16 of
July 1, 2015 on "Exposure Norms" provides requirements in respect of exposure limits for banks. Under the
master circular on Disclosure in Financial Statements the RBI has prescribed the details which need to be
disclosed with respect to Banks exposure to real estate sector and capital market:
(A) Exposure to Real Estate Sector- Banks are required to disclose direct and indirect exposure to real estate
sector in the below mentioned format
a) Direct exposure
(i) Residential Mortgages: Includes lending fully secured by mortgages on residential property
that is or will be occupied by the borrower or that is rented; (Individual housing loans eligible
for inclusion in priority sector advances may be shown separately)
(ii) Commercial Real Estate- Both fund and non-fund based lending secured by mortgages of
commercial real estate (office buildings, retail space, multi-purpose commercial premises,
multi-family residential buildings, multi-tenanted commercial premises, industrial or warehouse
space, hotels, land acquisition, development and construction, etc.).
(iii) Investments in Mortgage Backed Securities (MBS) and other securitised exposures-
a. Residential,
b. Commercial Real Estate.
b) Indirect Exposure: Fund based and non-fund based exposures on National Housing Bank (NHB) and
Housing Finance Companies (HFCs).
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(B) Exposure to Capital Market- Banks are required to disclose the total exposure to capital market under the
following heads:
a. direct investment in equity shares, convertible bonds, convertible debentures and units of equity-
oriented mutual funds the corpus of which is not exclusively invested in corporate debt;
b. advances against shares/bonds/debentures or other securities or on clean basis to individuals for
investment in shares (including IPOs/ESOPs), convertible bonds, convertible debentures, and units
of equity-oriented mutual funds;
c. advances for any other purposes where shares or convertible bonds or convertible debentures or
units of equity oriented mutual funds are taken as primary security;
d. advances for any other purposes to the extent secured by the collateral security of shares or
convertible bonds or convertible debentures or units of equity oriented mutual funds i.e. where the
primary security other than shares/convertible bonds/convertible debentures/units of equity oriented
mutual funds does not fully cover the advances;
e. secured and unsecured advances to stockbrokers and guarantees issued on behalf of stockbrokers
and market makers;
f. loans sanctioned to corporates against the security of shares / bonds/ debentures or other securities
or on clean basis for meeting promoter's contribution to the equity of new companies in anticipation
of raising resources;
g. bridge loans to companies against expected equity flows/issues;
h. underwriting commitments taken up by the banks in respect of primary issue of shares or convertible
bonds or convertible debentures or units of equity oriented mutual funds. However, RBI, vide its
Master Circular No. DBR.No.Dir.BC. 12/13.03.00/2015-16 dated July 1, 2015 on "Exposure Norms"
has clarified that with effect from April 16, 2008, banks may exclude their own underwriting
commitments, as also the underwriting commitments of their subsidiaries, through the book running
process for the purpose of arriving at the capital market exposure of the solo bank as well as the
consolidated bank.
i. financing to stockbrokers for margin trading;
j. all exposures to Venture Capital Funds (both registered and unregistered).
The exposure is to be reckoned with reference to higher of outstanding and sanctioned limit. Exposure to the
sensitive sector would include lending which is primarily secured against such sensitive sector.
9.24 Risk category-wise country-wise exposure: As per the extant RBI guidelines, the country wise net
exposure of the Bank and the provision held thereof is categorized into various risk categories listed below:
(i) Insignificant
(ii) Low
(iii) Moderate
(iv) High
(v) Very High
(vi) Restricted
(vii) Off-credit
(viii) Total
9.25 Till the banks move over to own internal rating systems, they may use the seven category classification
followed by Export Credit Guarantee Corporation of India Ltd. (ECGC) for the purpose of classification and making
provisions for country risk exposures. ECGC shall provide to banks, on request, quarterly updates of their country
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Disclosure Requirements in Financial Statements
classifications and shall also inform all banks in case of any sudden major changes in country classification in the
interim period.
9.26 Details of Single Borrower Limit (SGL), Group Borrower Limit (GBL) exceeded by the bank: The bank
should make appropriate disclosure in respect of cases where it had exceeded the prudential exposure limits
during the year. The sanctioned limit or entire outstanding, whichever is high, shall be reckoned for arriving at
exposure limit and for disclosure purpose. The same needs to be verified from the minutes of Board meeting of
the bank. If there is no such disclosure, auditor may take representation from bank in this regard.
9.27 Following disclosure need to be made:
i. The number and amount of exposures in excess of the prudential exposure limit during the year.
ii. Credit exposure as percentage to capital funds and as a percentage to total assets, in respect of:
the largest single borrower.
the largest borrower group.
the 20 largest single borrower.
the 20 largest borrower group.
iii. Credit exposure to the five largest industrial sectors (if applicable) as percentage to total loan assets.
iv. Total amount of advances for which intangible securities such as charge over the rights, licenses, authority,
etc. have been taken as also the estimated value of such intangible collateral. The disclosure shall be made
under a separate head to differentiate such loans from other entirely unsecured loans.
v. Factoring exposures.
vi. Exposures where the Bank had exceeded the Prudential Exposure Limits during the year.
9.28 Unsecured Advances - To ensure correct reflection of the unsecured advances in Schedule 9 of the
banks' balance sheet, the banks are required to follow the norms as under:
For determining the amount of unsecured advances for reflecting in Schedule 9 of the published balance
sheet, the rights, licenses, authorizations, etc., charged to the banks as collateral in respect of projects
(including infrastructure projects) financed by them, should not be reckoned as tangible security. Hence such
advances shall be reckoned as unsecured.
Banks should also disclose the total amount of advances for which intangible securities such as charge over
the rights, licenses, authority, etc. has been taken as also the estimated value of such intangible collateral.
The disclosure may be made under a separate head in "Notes to Accounts". This would differentiate such
loans from other entirely unsecured loans.
9.29 Disclosure of Penalties imposed by RBI: At present, Reserve Bank is empowered to impose penalties on
a commercial bank under the provision of Section 46(4) of the Banking Regulation Act, 1949, for contraventions of
any of the provisions of the Act or non-compliance with any other requirements of the Banking Regulation Act,
1949; order, rule or condition specified by Reserve Bank under the Act. The penalty also is required to be
disclosed in the "Notes on Accounts" to the Balance Sheet.
9.30 Provisions and Contingencies: To facilitate easy reading of the financial statements and to make the
information on all Provisions and Contingencies available at one place, banks are required to disclose in the
`Notes to Accounts' the following information:
(i) Provisions for depreciation on Investment.
(ii) Provision towards NPA.
(iii) Provision towards Standard Asset.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
(iv) Provision made towards Income tax.
(v) Other Provision and Contingencies (with details).
9.31 Floating Provisions- Banks are required to make comprehensive disclosures on the movement of floating
provisions in the "notes to accounts" to the balance sheet as follows:
Opening balance in the floating provisions account.
The quantum of floating provisions made in the accounting year.
Amount of draw down made during the accounting year.
Closing balance in the floating provisions account.
For draw down of provision during the year, purpose of draw down is required to be mentioned.
9.32 Draw Down from Reserves: Suitable disclosures should be made regarding any draw down of reserves.
9.33 Disclosure of complaints- Banks are also required to disclose the following brief details along with their
financial results:
(i) Customer Complaints
(a) No. of complaints pending at the beginning of the year.
(b) No. of complaints received during the year.
(c) No. of complaints redressed during the year.
(d) No. of complaints pending at the end of the year.
(ii) Awards passed by the Banking Ombudsman
(a) No. of unimplemented Awards at the beginning of the year.
(b) No. of Awards passed by the Banking Ombudsmen during the year.
(c) No. of Awards implemented during the year.
(d) No. of unimplemented Awards at the end of the year.
9.34 Disclosure of Letter of Comforts (LOCs) issued by banks- The banks are required to disclose full
particulars of all the Letter of Comforts (LoCs) issued by them during the year, including their assessed financial
impact, as also their assessed cumulative financial obligations under the LoCs issued by them in the past and
outstanding at the end of current year. Auditor would be required to verify the accuracy of system generated data
in respect of this disclosure and verify that disclosure is correctly made.
9.35 Provisioning Coverage Ratio (PCR) - The PCR (ratio of provisioning to gross non-performing assets)
should be disclosed in the Notes to Accounts to the Balance Sheet.
9.36 Bancassurance Business - The details of fees / brokerage earned in respect of insurance broking, agency
and bancassurance business undertaken by bank is required to be disclosed in the `Notes to Accounts' to the
Balance Sheet.
9.37 Concentration of Deposits - Total Deposits of twenty largest depositors and Percentage of Deposits of
twenty largest depositors to Total Deposits of the bank should be disclosed by the bank in the notes to accounts.
9.38 Concentration of Advances - Total Advances of twenty largest borrowers and Percentage of Advances to
twenty largest borrowers to Total Advances of the bank should be disclosed by the bank in the notes to accounts.
Advances should be computed as per definition of Credit Exposure including derivatives furnished in the Master
Circular on Exposure Norms.
9.39 Concentration of Exposures - Total Exposure to twenty largest borrowers/customers and Percentage of
Exposures to twenty largest borrowers/customers to Total Exposure of the bank on borrowers/customers should
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Disclosure Requirements in Financial Statements
be disclosed by the bank in the notes to accounts. Exposures should be computed based on credit and investment
exposure as prescribed in the Master Circular on Exposure Norms.
9.40 Concentration of NPAs - Total Exposure to top four NPA accounts should be disclosed by the bank in the
notes to accounts.
9.41 Sector-wise NPAs Percentage of NPAs to Total Advances in the sectors, such as, Agriculture & allied
activities, Industry (Micro & small, Medium and Large), Services, Personal Loans, should be disclosed by the bank
in the notes to accounts.
9.42 Movement of NPAs Movement in NPAs during the year including opening balance, additions during the
year, less upgradations, recoveries (excluding recoveries made from upgraded accounts) and write off during the
year, should be disclosed by the bank in the notes to accounts.
9.43 Overseas Total Assets, Total NPAs and Total Revenue should be disclosed by the bank in the notes to
accounts.
9.44 Off-balance Sheet SPVs sponsored (which are required to be consolidated as per accounting norms)
both domestic and overseas should be disclosed by the bank in the notes to accounts.
9.45 Unamortized Pension and Gratuity Liabilities: Appropriate disclosures of the accounting policy followed in
regard to amortization of pension and gratuity expenditure may be made in the Notes to Accounts to the financial
statements.
9.46 Disclosures on Remuneration: Private sector banks and foreign banks (to the extent applicable) are
advised to disclose remuneration as specified in the Master Circular on "Disclosures in Financial Statements-
Notes to Accounts".
9.47 Disclosures relating to Securitisation: The Notes to Accounts of the originating banks should indicate the
outstanding amount of securitized assets as per books of the SPV sponsored by the bank and total amount of
exposures retained by the bank as on the date of balance sheet to comply with the Minimum Retention
Requirement (MRR). These figures should be based on the information duly certified by the SPV's auditors
obtained by the originating bank from the SPV.
9.48 Credit Default Swaps: Banks using a proprietary model for pricing CDS, shall disclose both the proprietary
model price and the standard model price in terms of extant guidelines in the Notes to the Accounts and should also
include an explanation of the rationale behind using a particular model over another.
9.49 Intra Group Exposure
With the developments of financial markets in India, banks have increasingly expanded their presence in permitted
financial activities through entities that are owned by them fully or partly. As a result, banks' exposure to the group
entities has increased and may rise further going forward. In order to ensure transparency in their dealings with group
entities, banks should make the following disclosures for the current year with comparatives for the previous year: (a)
Total amount of intra group exposures (b) Total amount of top 20 intra group exposures (c) Percentage of intra group
exposures to total exposure of the bank on borrowers / customers (d) Details of breach of limits on intra group
exposures and regulatory action thereon, if any.
The details may be verified by the auditor from investment details of Bank and other relevant information available
with Bank.
9.50 Transfer to Depositor Education and Awareness Fund (DEAF):
Unclaimed liabilities where amount due has been transferred to DEAF is required to be reflected as `Contingent
Liability - Others, items for which the bank is contingently liable' under Schedule 12 of the annual financial
statements. Banks are also required to disclose the amounts transferred to DEAF under `Notes to Accounts' as per
the format given below.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
(Amount in Rs. crore)
Particulars Current Year Previous Year
Opening balance of amounts transferred to DEAF
Add: Amounts Transferred to DEAF during the year
Less: Amounts reimbursed by DEAF towards claim
Closing balance of amounts transferred to DEAF
9.51 Unhedged Foreign Currency Exposure:
Banks are required to disclose-
i. their policy on managing credit risk arising out of unhedged foreign currency risk of the Borrowers.
ii. Incremental provision and additional capital held by the Bank for unhedged foreign currency exposure of their
borrowers.
Auditor needs to understand the policy of the bank for unhedged foreign currency exposure and verify that it is
appropriately disclosed. As also incremental provision and additional capital held.
9.52 Liquidity Coverage Ratio (LCR)
i. Banks are required to disclose information on their Liquidity Coverage Ratio (LCR) in their annual financial
statements under `Notes to Accounts', for which the LCR related information needs to be disclosed in the elaborate
format as given in the Master Circular.
LCR is a ratio of two factors, viz, the stock of High Quality Liquid Assets and the Net Cash Outflows over the next 30
calendar days.
The LCR requirement would be binding on banks from January 1, 2015; with a view to provide a transition time for
banks, the requirement would be minimum 60% for the calendar year 2015 i.e. with effect from January 1, 2015, and
rise in equal steps to reach the minimum required level of 100% on January 1, 2019, as per the time-line given
below:
January 01, 2017 January 01, 2018 January 01, 2019
Minimum LCR 80% 90% 100%
ii. Besides above, the Banks are also required to provide qualitative discussion around the LCR to facilitate
understanding of the data provided, for example:
(a) the main drivers of their LCR results and the evolution of the contribution of inputs to the LCR's calculation over
time;
(b) intra period changes as well as changes over time;
(c) the composition of HQLA;
(d) concentration of funding sources;
(e) derivative exposures and potential collateral calls;
(f) currency mismatch in the LCR;
(g) a description of the degree of centralisation of liquidity management and interaction between the group's units;
and
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Disclosure Requirements in Financial Statements
(h) other inflows and outflows in the LCR calculation that are not captured in the LCR common template but which
the institution considers to be relevant for its liquidity profile.
iii. The relevant RBI circular reference no. DBOD.BP.BC.No.120 / 21.04.098/2013-14 dated June 9, 2014 can
be referred for further details.
Fraud Reporting
9.53 As per RBI circular DBR.No.BP.BC.92/21.04.048/2015-16 dated April 01, 2016 on Provisions pertaining to
Frauds, Bank should make suitable disclosure regarding
i. No. of Fraud reported;
ii. Amount involved in such frauds;
iii. Quantum of Provisions during the year;
iv. Quantum of unamortized Provision debited to other reserves
Disclosures prescribed by Accounting Standards
9.54 This Guidance Note deals with only those disclosure requirements where RBI has issued guidelines in
respect of disclosure as per Accounting Standards.
1. As the format of the profit and loss account of banks prescribed in Form B under Third Schedule to the
Banking Regulation Act 1949 does not specifically provide for disclosure of the impact of prior period items on the
current year's profit and loss, such disclosures, wherever warranted, may be made in the Notes on Accounts of
banks. (AS-5, "Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies")
2. Disclosure with regards to the circumstances in which revenue recognition has been postponed pending
the resolution of significant uncertainties. (AS-9, "Revenue Recognition")
3. Banks may follow the disclosure requirements prescribed under AS 15 (revised), `Employees Benefits'
issued by ICAI.
4. While complying with AS-17, "Segment Reporting", banks are required to adopt the following:
i) The business segment should ordinarily be considered as the primary reporting format and geographical
segment would be the secondary reporting format.
ii) Reported business segments should be `Treasury', `Corporate/Wholesale Banking', `Retail Banking' and
`Other banking operations'.
iii) `Domestic' and `International' segments will be the geographic segments for disclosure.
iv) Banks may adopt their own methods, on a reasonable and consistent basis, for allocation of expenditure
among the segments.
For the formats relating to the segment reporting disclosures, readers may refer to the above Master Circular.
5. Related Parties: Related parties for a bank are its parent, subsidiary(ies), associates/joint ventures, Key
Management Personnel (KMP) and relatives of KMP. KMP are the whole time directors for an Indian bank and the
chief executive officer for a foreign bank having branches in India Banks need to report related party relationships
and transactions between a reporting enterprise and its related parties. No disclosure is required in respect of related
parties, which are "State-controlled Enterprises" as per paragraph 9 of Accounting Standard (AS) 18. Further, in
terms of paragraph 5 of AS 18, transactions in the nature of Banker-customer relationship are not required to be
disclosed in respect of Key Management Personnel and relatives of Key Management Personnel. Further, where
there is only one entity in any category of related party, banks need not disclose any details pertaining to that related
party other than the relationship with that related party. RBI has modified illustrative disclosure format recommended
by the ICAI to suit banks. (AS-18, "Related Party Disclosures").
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
6. As regards disclosures in the `Notes on Accounts' to the Consolidated Financial Statements (AS-21,
"Consolidated Financial Statements"), banks may follow the general clarifications issued by Institute of Chartered
Accountants of India from time to time. A parent company, presenting the CFS, should consolidate the financial
statements of all subsidiaries - domestic as well as foreign, except those specifically permitted to be excluded
under the AS-21. The reasons for not consolidating a subsidiary in CFS should be disclosed in the CFS. The
responsibility of determining whether a particular entity should be included or not for consolidation would be that of
the Management of the parent entity. In case, its Statutory Auditors are of the opinion that an entity, which ought
to have been consolidated, has been omitted, they should incorporate their comments in this regard in the
"Auditors Report".
7. Adoption of AS 22, "Accounting for Taxes on Income", may give rise to creation of either a deferred tax
asset (DTA) or a deferred tax liability (DTL) in the books of accounts of banks. This would give rise to certain
issues, which have a bearing on the computation of capital adequacy ratio and banks' ability to declare dividends.
In this regard RBI has clarified as under:
(i) DTL created by debit to opening balance of Revenue Reserves on the first day of application of the
Accounting Standards 22 or to Profit and Loss account for the current year should be included under item
(vi) `others (including provisions)' of Schedule 5 - `Other Liabilities and Provisions' in the balance sheet. The
balance in DTL account will not be eligible for inclusion in Tier I or Tier II capital for capital adequacy
purpose as it is not an eligible item of capital.
(ii) DTA created by credit to opening balance of Revenue Reserves on the first day of application of Accounting
Standards 22 or to Profit and Loss account for the current year should be included under item (vi) `others' of
Schedule 11 `Other Assets' in the balance sheet.
(iii) The DTA computed as under should be deducted from Tier I capital:
DTA associated with accumulated losses; and
The DTA (excluding DTA associated with accumulated losses), net of DTL. Where DTL is in excess
of the DTA (excluding DTA associated with accumulated losses), the excess shall neither be
adjusted against item (i) nor added to Tier I capital.
8. A bank may acquire more than 20% of voting power in the borrower entity in satisfaction of its advances and
it may be able to demonstrate that it does not have the power to exercise significant influence since the rights
exercised by it are protective in nature and not participative. In such a circumstance, such investment may not be
treated as investment in associate under AS 23, "Accounting for Investments in Associates in Consolidated Financial
Statements". Hence the test should not be merely the proportion of investment but the intention to acquire the power
to exercise significant influence.
9. Merger/ closure of branches of banks by transferring the assets/ liabilities to the other branches of the
same bank may not be deemed as a discontinuing operation and hence AS 24, "Discontinuing Operations", will
not be applicable to merger / closure of branches of banks by transferring the assets/ liabilities to the other
branches of the same bank. Disclosures would be required under the Standard only when:
(i) discontinuing of the operation has resulted in shedding of liability and realization of the assets by the bank
or decision to discontinue an operation which will have the above effect has been finalized by the bank and
(ii) the discontinued operation is substantial in its entirety.
10. With regards to Accounting Standard (AS) 25, "Interim Financial Reporting", the half yearly review
prescribed by RBI for public sector banks, in consultation with SEBI, vide circular DBS. ARS. No. BC 13/
08.91.001/ 2000-01 dated 17th May 2001 is extended to all banks (both listed and unlisted) with a view to ensure
uniformity in disclosures. Banks may also refer to circulars DBS.ARS.No.BC.4/08.91.001/2001-02 dated October
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Disclosure Requirements in Financial Statements
25, 2001 and DBS.ARS.No.BC.17/08.91.001/2002-03 dated June 5, 2003 and adopt the format prescribed by the
RBI for the purpose.
11. Other Accounting Standards - Banks are required to comply with the disclosure norms stipulated under
the various Accounting Standards issued by the Institute of Chartered Accountants of India.
9.55 Other Disclosures:
Disclosure as required under Micro, Small and Medium Enterprises Development Act, 2006 (MSMED).
The disclosure requirements in Section 22 requires any buyer, whose annual accounts audited under any law for
the time being in force, to furnish the following additional information in his annual statement of accounts.
9.56 The following details relating to Micro, Small and Medium Enterprises shall be disclosed in the notes:-
1. The principal amount and the interest due thereon (to be shown separately) remaining unpaid to any supplier
at the end of each accounting year;
2. The amount of interest paid by the buyer in terms of section 16 of the Micro, Small and Medium Enterprises
Development Act, 2006, along with the amount of the payment made to the supplier beyond the appointed
day during each accounting year;
3. The amount of interest due and payable for the period of delay in making payment (which have been paid but
beyond the appointed day during the year) but without adding the interest specified under the Micro, Small
and Medium Enterprises Development Act, 2006;
4. The amount of interest accrued and remaining unpaid at the end of each accounting year; and
5. The amount of further interest remaining due and payable even in the succeeding years, until such date when
the interest dues above are actually paid to the small enterprise, for the purpose of disallowance of a
deductible expenditure under section 23 of the Micro, Small and Medium Enterprises Development Act, 2006.
Corporate Social Responsibility (CSR)
9.57 As per Section 135 of the Companies Act, 2013 a CSR committee has been formed by the Company. The
funds are utilized throughout the year on the activities which are specified in Schedule VII of the aforesaid Act.
Gross Amount required to be spent by the company during the year XX crores.
The areas of CSR activities and contributions made thereto are as follows
Particulars In cash Yet to be paid in Cash Total
Amount spent during the year on
1) Construction/ Acquisition of any
assets
2) For purposes other than (1) above:
(Specify)
For detail guidance, refer "Guidance Note on Accounting for Expenditure on Corporate Social Responsibility
Activities", issued by ICAI in May, 2015.
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IV-10
Consolidation of Branch Accounts
10.01 Consolidation of branch accounts (audited and unaudited) is one of the important and sensitive aspect of
the financial statements of a bank. Preparation of the consolidated financial statements of the bank as a whole (after
consolidation of accounts of branches) is the responsibility of the bank's management. RBI vide its Circular No
DBOD.No.BP.BC.72/21.04.018/2001-02 dated February 25, 2003 has issued guidelines to banks on consolidated
accounting and other quantitative methods. The following documents are consolidated:
Balance Sheets
Profit and Loss Accounts
LFAR (Long Form Audit Report)
Ghosh Committee compliance checklists
Jilani Committee compliance checklists
Tax Audit reports
Other various reports like, Assets classification, fixed assets, bills payable, sundries, credit subventions, etc
10.02 Process of consolidation
The consolidation process starts from the Branch level and the accounts of branches get consolidated at the
respective regional office and all regional offices get consolidated at respective Zonal office and all zonal offices get
consolidated at Head Office. The procedures regarding consolidation of accounts vary from bank to bank, in some
banks mostly in a private sector the entire consolidation work gets done at the head office.
Bank managements generally follow the below mentioned process for the purpose of consolidation:
Step 1
Back up of the Financial Statements as on 31st March
At the year-end i.e., 31st March, the bank takes the backup of financial data and keeps the same on different
software. This data is given for audit purpose to the statutory auditor.
Step 2
Consolidation of Branch Accounts
Effect of Memorandum of Changes (MOC)
There are two types of financial statements, Pre-MOC, i.e., the original data and Post-MOC, i.e., after giving the
effect of accounting entries suggested by the central statutory auditor (which is known as MOC). The MOC are not
fed in the live data but are recorded on a different software (e.g., ROSS, ADF) at all levels like Branches, Region,
zone and Head office. All MOC suggested at branches get consolidated and recorded at regions and MOC of regions
get consolidated at the concerned Zone and MOC of the Zones get consolidated at Head Office.
In this way, the effect of MOC at all levels of bank gets recorded in the parallel software e.g. ROSS, ADF. For making
any changes in the financial statement there has to be an MOC approved by the statutory auditor. Therefore, there
will be an MOC for difference between Pre-MOC financial statements and Post-MOC financial statements.
Accounting of MOC effect in live data
After the financial statements get approved and signed with all changes the MOCs gets accounted in live data. For
example, the financial statements for the financial year 2016-17 gets approved and signed on 30th April, 2017, then
on that day or on any other day with value date of 30th April, 2017, all MOCs will be accounted in the live data. So
from that day a particular account will be shown as NPA if the same had been made NPA by way of MOC during the
audit.
Step 3:
Regional office
Process:
1. Branches depending on the limits prescribed can be either audited branches or unaudited branches.
2. At the branch level the audited financial statements as well as unaudited financial statements signed by Bank
manager is uploaded in the system and consolidated data is generated at regional office level.
3. Regional office accounts gets consolidated and also adjustments if any are made at regional level. The Regional
Office is a cost centre and the auditor has to certify the financial statements of the Regional Office in addition to
the consolidation of the Branches under the relevant Regional Office.
Audit Approach:
1. Statutory Central Auditor (SCA) for a Region must verify the completeness of the data uploaded by the branches
into the system.
2. SCA on sample basis must also verify the completeness of the data.
3. SCA Should obtain reasonable assurance and sufficient appropriate audit evidence of the adjustments made if
any at the regional office level.
4. SCA should also check the arithmetic accuracy of the number of financial statements to be uploaded at regional
office level.
5. SCA may communicate to the SBAs, the requirements regarding process of consolidation for the current year,
about the significant observations from the previous year's audit, quarterly reviews and additional precautions,
modifications in Audit Program required considering the recent RBI Circulars. This communication can be
circulated along with the closing instructions to SBAs.
6. SCA should ensure on sample basis if all the documents as required by the respective banks have been taken at
each level of consolidation i.e. appropriate flow of data along with the required documents.
Zonal Office and Head Office
Process:
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
At zonal level all the regional office data is consolidated and further adjustments if any is made. Bank as a whole then
consolidates all the zones ensuring the accuracy of the data uploaded at each stage of hierarchy. Similar to the
Regional office, the Zone also is a cost center and has its own financials which need to be certified by the auditor.
Mainly the expenses comprise of salaries, advertising and promotions etc.
Audit Approach - Zonal Office Auditor:
1. Statutory Central Auditor (SCA) for a Zone must verify the accuracy of the data uploaded by the Regional office
into the system.
2. SCA on sample basis must also verify the completeness of the data
3. SCA should obtain reasonable assurance and sufficient appropriate audit evidence of the adjustments made if
any at the Zonal office level.
4. SCA should also check the arithmetic accuracy of the number of financial statements to be verified at Zonal office
level.
Audit Approach to be followed by Bank consolidating Auditor:
1. The consolidating Auditor must ensure the completeness as well as accuracy of the data at the bank as a whole.
2. Auditor should obtain reasonable assurance and sufficient appropriate audit evidence of the adjustments made if
any at the Bank level.
10.03 The Statutory Central Auditor should also examine the following key additional aspects;
a. Reversal of interest on inter-branch balances and other similar items.
b. Cancellation of transfers of assets among branches.
c. Review of observation made by the branch auditor in audit report and LFAR.
d. Review of the various audited and unaudited returns.
e. Effect of Memorandum of Changes (MOC).
Review of MOCs so as to ascertain whether there are systemic issues or deficiencies which need to be addressed by
the management.
IT Controls
10.04 There is a significant and voluminous data involved during this whole process of consolidation.
Consolidation being a system oriented process, auditor must verify if the IT controls of the bank are effective.
Consolidation of Overseas Branches
10.05 While consolidating the overseas branches the auditor should examine the following aspects;
a. The various reports of the overseas branches would be received in the local currencies of the reporting
countries which need to be converted into the Indian currency.
b. The effect of reinstatement of assets and liability which is given in Accounting standard 11 (The Effects of
Changes in Foreign Exchange Rates). RBI has also issued a circular for compliance of the AS 10.
DBOD.BP.BC.No.76/21.04.018/2005-06) dated April 5, 2006.
c. Foreign exchange gain and loss.
d. As per AS 11 (revised 2003), the method used to translate the financial statements of a foreign operation
depends on the way in which it is financed and operates in relation to the reporting enterprise. For this purpose,
foreign operations are classified as either "integral foreign operations" or "non-integral foreign operations".
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e. In terms of its circular no DBOD.BP.BC.76/ 21.04.018/2004-05 dated March 15, 2005, the RBI has prescribed
that with the issuance of the said circular, there should normally be no need for any statutory auditor for
qualifying financial statements of a bank for non-compliance with Accounting Standard 11 (revised 2003).
Whenever specific difference in opinion arises among the auditors, the statutory central auditors would take a
final view. Continuing difference, if any, could be sorted out in prior consultation with RBI, if necessary.
f. The auditor may also review the compliance with the applicable local laws and regulations of the concerned
country by the overseas branches.
g. As advised by ICAI, statutory auditor has to give the total number and amount of debits/ credits arising pursuant
to the Memorandum of changes submitted by them in their audit reports under the "Other Matters Paragraph".
The auditor should furnish the statement of Adjustments for non-uniform accounting policies
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IV-11
Consolidation of Financial Statements
11.01 The Reserve Bank of India, in its requirement of disclosures in Financial Statements has included AS 21:
Consolidated Financial Statements (CFS) that includes consolidated Balance Sheet, consolidated Profit and Loss
Account & notes, explanatory material that form an integral part thereof and also consolidated cash flow statements.
11.02 Consolidated Financial Statements are presented for a group of entities under the control of a parent. A
parent is an entity that has one or more subsidiaries. For the purpose of CFS it may be noted that if a parent does not
have subsidiary but has investment in associates and joint ventures, it will be required to prepare CFS. However, for
the purpose of quarterly reporting under SEBI guidelines, CFS will not be necessary if the parent does not have
subsidiary but has investments in associates and joint ventures. For the purpose of this guidance a parent would
mean a Consolidating Bank.
Responsibility of a Bank
11.03 The responsibility for preparation and presentation of CFS is that of the Bank. This responsibility, inter alia,
includes:
1. Identifying components including financial information.
2. Identifying reportable segments.
3. Identifying related party transactions.
11.04 Responsibility of the Statutory Central Auditor
It is necessary for the auditor to take into consideration the accounting standards relevant for the purpose of CFS.
They are AS 21: Consolidated Financial Statements, AS 23: Accounting for Investments in Associates and AS 27:
Financial Reporting of Interests in Joint Ventures. Further, careful consideration should be given by the auditor of
CFS to Other Matters, Emphasis of Matter, Modified Opinion in the report issued by the component auditors.
In addition to the Accounting Standards, it is pertinent for an auditor to consider the relevant accounting and auditing
Guidance Notes.
When the parent's auditor decides that to make reference to the auditor's report of the other auditors in the auditor's
report on CFS, the latter should disclose clearly the magnitude of the portion of the financial statements audited by
the other auditor(s). This may be done by stating the rupee amounts or percentages of total assets and total revenue
of subsidiary (ies) included in CFS not audited by the parent's auditor. However, reference in the report of the auditor
of CFS to the fact that part of the audit of the group was made by other auditor(s) is not to be construed as a
modification of the opinion. The auditor should also consider implications on reporting if some of the components are
unaudited21.
Generally, while conducting audit of a bank, SCA has a practice of issuing general instructions for the SBAs to
facilitate easy consolidation of branch accounts. It would be appropriate to have a similar approach with respect to
auditors of components, if the component auditors are different from the group auditor. This is especially important in
21
Attention in this regard is drawn to the Announcement on "Manner of Disclosure in the Auditor's Report of the Fact of Inclusion of Unaudited
Financial Statements/ Information of Component/s in the Financial Statements Audited by the Principal Auditor(s)" issued by ICAI in February,
2014.
Consolidation of Financial Statements
case of "the other financial information" which is necessary for the purpose of consolidation and preparation of notes.
It is advisable to make sufficient arrangements for co-ordination and efforts at the planning stage.
Audit of CFS
11.05 Audit of CFS needs to be planned properly with regards to following aspects:
1. Accounting policies of Bank and its various components. It is very much probable that the policies of the
components may differ from each other depending upon the respective business lines.
2. Auditor should obtain list of all the subsidiaries, associates and joint ventures of Bank, whether to be included
under CFS or not. Any entity that has been kept outside CFS should be carefully examined for its exclusion with
respect to the relevant statute. At this stage it is important to note that the ownership of the voting rights does
not necessarily qualify for the purpose of CFS. It would be necessary to understand the concept of the control of
the enterprise. If the auditor establishes that the bank exercises control over the entity in spite of minor
shareholding by virtue of control over the composition of board of directors/governing body, such enterprise
would qualify for CFS. There would be many other ways to exercise the control. To verify the same it is
advisable that the auditor verifies the board minutes, shareholder agreements entered into by the bank with the
other entities, the various business agreements such as technology and knowhow supply, or enforcement of
statue as the case may be. The auditor would need to exercise professional judgment to determine the control
in such cases.
3. The auditor should identify the changes in the shareholding that might have taken place since the last audit.
4. Following transactions require attention for current period consolidation adjustment:
a) Intra group interest/management fees paid and received.
b) Unrealized intra group profits on assets acquired within the components.
c) Intra group indebtedness.
d) Adjustments relating to harmonizing different accounting policies within the group.
e) Adjustments made for the effects of the significant transaction or event that occur between the date of
financial statement of the bank and one or more of the components, if they follow different financial
reporting dates.
f) Determination of movement of equity attributable to minority since the date of subsidiary.
g) In case of step acquisition, appropriate adjustments need to be carefully audited.
h) Further due care be taken in respect of impairment of goodwill in addition to review of net worth and
profit reconciliation to ensure completeness of consolidation exercise.
5. As far as possible the formats of the financial statements and cash flows used for the purpose of bank's
individual financial reporting should be used for the CFS.
6. The auditor should examine that the financial statements used in the consolidation are drawn up as of the same
reporting date. If that is not possible, AS 21 allows adoption of six month old balance sheet of subsidiaries and
prescribes that adjustments shall be made for the effects of significant transactions or other events that have
occurred during the intervening period. In case that the balance sheet dates of parent and subsidiaries are
different, inter-group netting shall be done as on the balance sheet date of the parent entity. In the cases where
the balance sheet date coincides with that of the bank, the bank shall publish its CFS without waiting for the
audit of their subsidiaries by the Comptroller and Auditor General. However, the bank shall ensure completion
of statutory audit of the accounts of such subsidiaries before consolidation with the parent's accounts.
7. The SCAs should examine that the CFS is prepared using uniform accounting policies for like transactions and
other events in similar circumstances. If it is not practicable to do so, that fact shall be disclosed together with
the proportions of the items in the consolidated financial statements to which the different accounting policies
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
have been applied. For the purpose of preparing the CFS using uniform accounting policies, the banks shall rely
on a Statement of Adjustments for non-uniform accounting policies, furnished by the Statutory Auditors of the
subsidiaries.
8. In cases where different entities in a group are governed by different accounting norms laid down by the
concerned regulator for different businesses, the bank shall use for consolidation purposes the rules and
regulatory requirements applicable to the banks in respect of like transactions and other events in similar
circumstances. In situations where regulatory norms have not been prescribed by RBI, the norms as applicable
according to the accounting standards may be followed.
9. For the purpose of valuation, the investments in associates (other than those specifically excluded under AS 23)
shall be accounted for under the "Equity Method" of accounting in accordance with AS 23 which shall be
examined by the auditor.
10. The valuation of investments in subsidiaries which are not consolidated and associates which are excluded
under AS 23, shall be as per the relevant valuation norms issued by the Reserve Bank of India. The valuation of
investments in joint ventures shall be accounted for under the `proportionate consolidation' method as per AS
27. The banks may take into account the provisions of the accounting standards relating to the exclusion of
subsidiaries, associates or joint ventures from consolidation under specific circumstances shall be examined by
the auditor.
Management Representations
11.06 SA 580, "Written Representations" requires the auditor to obtain written representations from management
and where appropriate those charged with governance. Such representations would include:
a) Completeness of components included in the CFS.
b) Identification of reportable segments for segmental reporting.
c) Identification of related parties and related party transactions for reporting.
d) Appropriateness and completeness of consolidation adjustments, including the elimination of intra-group
transitions.
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IV-12
Inter Office Transactions
12.01 Inter-office transactions mostly take place at branches. The balances can be debit balance or credit
balances in Balance Sheet of the branches. Branches have number of transactions amounting to large sums with the
other branches and controlling office, hence it becomes very important to monitor the same. It is the responsibility of
the bank to reconcile their transactions on a daily basis and keep a track on un-reconciled transactions.
12.02 Followings are the major transactions which occur between branches and Head office.
a. Issue of remittance instruments like drafts/TTs/MTs on other branches.
b. Payment of remittance instruments like drafts/TTs/MTs drawn by other branches.
c. Payment to / receipts from other branches of the proceeds of instruments received/sent for collection
/realization/clearing.
d. Payments made under LCs of other branches.
e. Cash sent to/received from other branches.
f. Payment of instruments like gift cheques/ banker's cheques/ interest warrants/ dividend warrants/repurchase
warrants/refund warrants / travelers cheques, etc. which are paid by the branch on behalf of other branches
which have received the amount for payment of these instruments from the customers concerned.
g. Head office interest receivable and payable by the branches.
h. Profit/loss transferred by the branch to head office.
i. Government receipts and payments handled by the branch either as the nodal branch or as an agent of the
nodal branch.
j. Operations by the authorised branches on the bank's NOSTRO accounts.
k. Foreign exchange transactions entered into by the branch for which it has to deal with the nodal forex
department of the bank for exchange of rupees with foreign currency.
l. Deposits into and withdrawal of money, by branches into currency chest maintained by another branch.
m. Gold Banking Transactions at the branch on behalf of nodal branches.
n. Transactions through NEFT, RTGS, NACH, UPI,etc..
o. ATM transactions of the customer either at ATM linked with other branches or with merchant establishments.
p. Internet based transactions other than inter-account transfers with the same branch.
q. Credit card related transactions of the customers.
r. Nostro Accounts of Indian Branches maintained with Overseas Branches of the bank.
s. Capital Funds with the Overseas Branches.
t. Head Office balances with the overseas branches including subordinated debt lent to the overseas branches.
u. Service Tax transactions advises to Nodal branches where Service Tax remittance is made where Service Tax
is remitted on behalf of other branches within their fold.
Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
12.03 Following are the most common types of errors observed in inter branch transactions.
Wrong identification of the nature of transaction.
Recording of particulars in incorrect fields.
Wrong accounting of bank charges, commission, etc.
Errors in writing the amounts.
Incorrect branch code numbers
Incorrect schedule numbers.
Recording the same transaction twice.
Difference between the closing and opening balances in successive daily statements.
Squaring off the transaction by same amount without checking the transactions.
12.04 Banks generally have a separate department to deal with the process of reconciliation of inter branch
transactions. Following is the generally followed reconciliation process.
Each branch submits the transaction statement (can be also generated through CBS System) in the prescribed
format. RBI had advised the banks (vide its circular dated April 28, 1993) to segregate inter-branch transactions
relating to demand drafts from other inter-branch transactions. Further, vide its circular no. DBS.CO.SMC.BC
No. 28/22.09.001 dated 20th August, 1998, RBI has directed the banks to introduce the system of segregating
DD/TT/MT transactions, with reconciliation at weekly intervals and close monitoring of large amounts.
On receipt of the statement, reconciliation department scrutinizes the data like opening balance, account heads
etc. and rectify the same for any error in data.
After rectifying the error, the same are fed into the system.
As and when the other branch settles the funds transfer transaction in its books (by way of payment of
draft/traveller's cheques, etc. or by acting on the advices received under the inter-branch account mechanism),
it advises the details of these transactions like the netting reference number, account currency, foreign currency
amount, local currency amount, event, reporting branch code no., date of transaction at the reporting branch,
type of transaction, draft no., etc., to the reconciliation department.
Some of the transactions do not reconcile due to incorrect data entry or non-accounting of transactions by other
branch, which might indicate fraud if debit transaction in one branch does not have corresponding credit effect
in other branch.
The total number of inter-branch transactions makes their reconciliation a tedious task. Lack of reconciliation
causes this account to be susceptible to frauds. Recognizing this, RBI has taken a number of measures to
achieve an expeditious reconciliation of these transactions by the banks concerned. Non-reconciliation results
in a 'fraud risk factor' as defined in SA 240, "The Auditor's Responsibilities Relating to Fraud in an Audit of
Financial Statements". This Standard further provides that in such situation, auditor needs to modify his audit
procedures to reduce the effect of the constituents of fraud risk.
In all inter-office transactions, one branch originates a transaction (called the `reporting branch' or the
`originating branch') and the other branch (called the `responding branch') settles the transactions at its end.
12.05 Many Banks have the concept of `Service Branches' for such inter branch transactions. These Service
Branches exclusively provide the following services:
a. They act as agents for the other branches of the bank for collection of instruments drawn on local branches of
other banks (Clearing).
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Inter Office Transactions
b. To centralise the payment of drafts drawn by other outside branches.
12.06 Audit Approach
Inter branch account has been very sensitive area and can prove to be problematic or prone to errors and frauds.
The Auditor should review the system of operation for such sensitive account. Several times it has been observed
that there are old entries in such accounts due to migration issues. The auditor should check thoroughly the details of
such entries with their ageing and also the improvement in settlement of the entries on a periodic basis by the Bank
and its reporting to the audit committee. Such old entries have been noticed between the Treasury Branch and other
Branches/ Head Office.
Every bank has its own procedures and methodology for inter branch transactions hence it is very important for
the auditor to understand the procedure followed by the bank for recording inter-branch transactions. The
procedure followed by the bank for maintaining inter-branch transactions should be as per the RBI
requirements.
RBI has directed banks to introduce the system of segregating DD/TT/MT transactions, with reconciliation at
weekly intervals and close monitoring of large amounts vide its circular no. DBS.CO.SMC.BC No. 28/22.09.001
dated 20th August, 1998.
Bank has to provide 100% provision against the net debit balance arising out of the un-reconciled entries
outstanding for more than 6 month in the inter-branch account, from the year ending March 31st, 2004 vide its
circular no. DBOD No. BP.BC. 73 /21.04.018/2002-03 dated 26th February, 2003.
As per RBI Circular from 1st April 1999, Bank should maintain category wise/Head wise accounts of various
types of transactions under inter branch accounts and the netting off the transactions should be done on
category wise, hence the net debit in one category is not to be set-off against net credit in another category.
Banks have been advised by RBI to segregate the credit entries outstanding for more than five years in inter-
branch accounts and transfer them to a separate Blocked Account which should be shown in the balance sheet
under the head `Other liabilities and provisionsOthers' (Schedule 5). While arriving at the net amount of inter-
branch transactions for inclusion in the balance sheet, the aggregate amount of Blocked Account should be
excluded and only the amount representing the remaining credit entries should be netted against debit entries.
Banks have been advised that any adjustment from the Blocked Account should be permitted only with the
authorisation of two officials, one of whom should be from outside the branch concerned, preferably from the
controlling/head office if the amount exceeds Rs.1 lakh
There are some transactions like dividend warrant, interest warrant, refund order etc. which required special
attention because in the recent past number of transactions has been reported by the bank in these groups. In
these transactions the funds are deposited at one branch and payments take place at many branches. Hence to
prevent the frauds the outstanding balances of these accounts should be checked with professional skepticism.
Auditor should review all material transactions accounted in inter-branch account just before the year end and
where required, request the bank management to rectify the same by accounting in the correct account head.
The auditor should cautiously review all material transactions outstanding in inter branch account even if it is
outstanding for more than 6 month for which 100% provision is made.
The auditor should check all adjustments in the account and ensure that the adjustments are done properly and
supported by adequate documentary evidence as to its validity. Also verify that the reversal entries are made
under proper authority and after due explanation and evidence.
The account should be adjusted only on the basis of advices and not on the strength of entries found in the
statement of account received from other branches.
Prompt action should be taken preferably by central authority, if any entries particularly debit entries are not
responded to any branch within a reasonable time.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
The auditor should report on the year end status of inter branch accounts indicating the dates upto which all or
any segments of accounts have been reconciled. The auditor should also indicate the number and amount of
outstanding entries in the inter branch accounts, giving the relevant information separately for debit and credit
entries. The auditor can obtain the relevant information primarily from branch audit reports.
Normally Inter-branch accounts are reconciled at HO and unreconciled entries are sent to originating branches
for their response. Branch auditor is expected to check whether such responses are sent promptly.
Branches must ensure to respond the entries in Inter Branch Transaction System (IBTS) at their earliest. Items
of revenue nature such as travelling expenses bills, and any other expense/income item should not be allowed to
float in Inter Branch Transaction System (IBTS) for a longer period.
Nostro Accounts at branch - Branches should also prepare reconciliation statement (REC) relating to those
accounts for each of the Foreign Offices or Foreign Correspondents, as the case may be for examination by
SBAs.
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Part V
Long Form Audit Reports
V-1
Long Form Audit Report
in Case of Bank Branches
1.01 In the case of branches, the auditors have to answer a detailed questionnaire formulated by the RBI.
Such a report is usually termed as Long Form Audit Report (LFAR).
1.02 In the year 1985, RBI advised the Public Sector Banks to obtain LFAR from the auditors. The LFAR is not a
substitute for the Branch statutory report and is not deemed to be a part of the said report. The operations and audits
of a bank are mainly based on the effective internal controls and this report serves the purpose of bringing to the
notice of the Management the lacunae, shortcomings and failures in respect of compliance or adherence to the
internal control measures adopted by the Banks. The main report is to be submitted as per the requirements of the
Banking Regulations Act, 1949. LFAR is a separate report to be submitted to the Management, in the format
prescribed by the RBI. The latest format of LFAR has been revised in the year 2003 and was made effective from
31st March, 2003. RBI vide its Circular No. RBI/2014-15/626 DBS.CO.ARS.BC 8/08.91.001/2014-15 dated June 4,
2015 provides that the branches below the cut-off point, which are subject to concurrent audit by chartered
accountants, shall submit their LFARs and other certifications audited by the concurrent auditors. They shall submit
their LFAR only to the Chairman of the bank. The banks in turn will consolidate / compile all such LFARs submitted
by the Concurrent Auditors and submit to Statutory Central Auditor as an internal document of the bank.
1.03 LFAR is a questionnaire, which asks specific questions for which replies should be specific. Auditor
should give specific comments and should refrain from answering issues for which replies were never sought
unless relevant. The replies so prepared would reveal some facts which may be required to be considered by
the Management for improving the working of the bank. It is advisable to discuss the contents of the LFAR with
the branch head and get his responses before finalising the same. The object is to ensure correct presentation
so as to state facts which have been verified during the course of audit.
1.04 It should be noted that specific disclosure, such as, in respect of extent of checking, manner of sample
selection, limitations of documents verified, representations received, etc., should be made in the LFAR. The
reliance placed on the computer system, which the auditor has not tested in depth for its reliability, should be
clearly brought out in the LFAR. The auditor should also seek written representation from the Management
regarding any changes in CIS (Computer Information System) that have taken place during the year. In the
preparation of the LFAR, the auditor should call for and consider the previous reports to ascertain whether in
respect of the accounts for the year under audit, there are any matters, which deserve the attention of the
Management, particularly about adverse comments of a material nature in which remedial action was
warranted.
1.05 The main report is a self-contained document and should not make any reference to the LFAR.
However, matters in the main report may be elaborated in the LFAR. Where any of the comments made by the
auditor in the LFAR is adverse, he should consider whether a qualification in the main report is necessary.
Situations where relevant instances are giving rise to reservation / adverse remarks should be given along with
reasons. It should not, however, be assumed that every adverse comment in the LFAR would necessarily result
in a qualification in the main report. In deciding whether a qualification in the main report is necessary, the
auditor should use his judgement in the facts and circumstances of each case. It should be noted here that
mere comment in LFAR may not be sufficient without corresponding comment in the main audit report, should it
be a matter of qualification. LFAR is finalised 60 days after the financial statements are signed. Hence mere
comment in LFAR in lieu of comment in main report will not be considered to be appropriate reporting.
Long Form Audit Report in Case of Bank Branches
1.06 In designing his audit program the auditor should take into consideration the requirement of the LFAR
questionnaire and should, accordingly, plan his audit work so as to cover the areas mentioned in the LFAR
simultaneously. This would enable the auditor to appreciate and consider the effect of various matters to be
reported in his LFAR and his main audit report. As far as possible both the report should be submitted
simultaneously. LFAR should not be finalised after the main audit report is signed but should be completed
simultaneously in the case of a branch. However, the submission of the main report should not be delayed
merely because the LFAR is pending for completion.
1.07 LFAR in respect of bank branches is prepared in such a manner so as to enable the expeditious
completion and submission of the LFAR by the statutory auditors. It would also be desirable that the branch
auditor familiarise themselves with the questionnaire applicable to the statutory auditors. In response to a
question, the statutory auditor should consider comments made by the branch auditors in their LFAR with
respect to such question. He should use his judgement to determine whether comments / observations made in
the branch LFAR is material enough to be incorporated in his own report.
1.08 Some of the matters dealt with in the LFAR need compilation of detailed information / statements. It
should be recognised that the responsibility for such compilation is that of the bank / branch concerned.
1.09 In the LFAR, replies are given only to questions enumerated in the LFAR. The LFAR is only indicative
in nature and additional areas like, KYC compliance / Demat accounts / Lockers / Security arrangements / Risk
based audits / Service Tax/ ATM's / TDS, Mobile Banking/internet Banking/ RTGS/NEFT transactions etc.,
1.10 Some important areas to be noted while preparing LFAR are as follows:
(a) The auditor should be aware of the limits fixed or of various Instructions given by the Controlling Authorities of
the bank with respect to various aspects covered in the LFAR.
(b) The auditor should note that in certain questions he has to specifically give an opinion.
(c) In certain questions replies are to be given specifically based on the cases examined / test checks done.
(d) In certain cases he has to study the system presently in operation in the bank so as to give his reply.
(e) In certain questions he has to specifically give suggestions, especially, regarding improvement in
computerised information system and minimising possibility of frauds.
(f) LFAR should not be treated as mere information provider mechanism. Cases are found where LFAR merely
lists observations without any conclusion thereon. It may not be construed to be audit reporting without proper
opinion on the same.
An illustrative list of data which is to be collected by the Auditor from the Branch for the purpose of
compiling LFAR
Branch closing instructions.
Instructions of Controlling Authorities w.r.t. various issues.
Organisation chart.
Authorisation level and powers of branch officials.
Previous years' audit report / LFAR / Tax audit report, inspection report of the branch, concurrent audit
report and compliance thereon.
Various policies (Credit, Investment, Recovery etc.)
Cash retention limit.
Insurance for cash / cash-in-transit.
Bank confirmations / bank reconciliations.
In case of advances of more than Rs. 2 crores sanctioned limit and outstanding balance. (both funded and
non-funded)
List of all advances party-wise and limit-wise.
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List of outstanding facility-wise.
List of NPA's and provisioning thereon.
List of overdues / overdrawings.
Cases of sanctions not disbursed.
Cases of overdue proposals for review/renewal.
Cases wherein stock/ book debt statements and other periodic operational data and financial statements
etc. not received/ not received timely.
Stock audit reports/ unit inspection reports.
List of borrowers wherein inspection/ physical verification of securities charged to bank have been carried
out by the branch.
List of non-corporate entities enjoying limit more than Rs.10 lakh.
Valuation reports of NPA accounts where outstanding is more than Rs.1 crore and valuation has been done
prior to three years.
Status of claims lodged with ECGC/DICGC/CGST.
Details of cases of compromise / settlement and write off involving write off / waivers in excess of Rs. 50
Lakhs.
Report in desired format of advances of more than Rs. 2 crores.
List of accounts downgraded/ upgraded.(with outstanding in excess of Rs. 1 Crore)
Listing of expired guarantees.
Details of outstanding amount of guarantees invoked and funded by the Branch
Details of outstanding amount of letters of credit funded by the branch.
Stock register/ Insurance register/ Stationery draw power register/ Cheque book issuance register/ Cash
book/ Sanction register/ Custody register/ DD issued register/ Document register.
Break up of suspense accounts.
List of sundry deposits/ bills payables/suspense accounts.
List of provisions / prepaid expenses.
List of contingent liabilities.
List of frauds and follow-up action.
List of security items as at 31st March.
List of fixed assets.
Year-wise break-up of matured deposits.
Schedule of charges (for booking of Income).
System audit report, conducted, if any.
Financial statements of all the quarters of the year under audit.
List of computer system (configuration-wise) and accounting system in operation.
List of MIS reports / returns submitted to various authorities.
Overdue locker rents / vacant lockers.
Cash withdrawals / deposits of more than Rs.10 lakhs.
ATM cards / pin cards not issued and lying in stock.
Cheque books not issued and lying in stock.
Status of PC anti-virus upgrades.
Number of inoperative accounts and the process of allowing operations thereon.
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Long Form Audit Report in Case of Bank Branches
Number of accounts maintaining balances below prescribed minimum.
Details of customers complaints.
System generated statement for documents time barred by limitation.
1.11 Management Representation Letter should be demanded for matters as considered appropriate by the
auditor, and which may include matters as enumerated below:
a) Use of fixed assets.
b) Effective operation of the internal control system throughout the year.
c) Maintenance of effective joint custody of cash at all times during the year.
d) Proper recording of all customer complaints.
e) Notice and reporting of frauds during the year.
f) Adherence to branch timings.
g) Non-sharing of passwords.
h) Nil window dressing of accounts.
i) Genuineness of credits, if any, in NPA accounts at the year end.
j) Physical verification of assets.
k) Amounts outstanding for substantial period in Suspense Account, Nominal Accounts, Bills Payable, Sundry
Deposits, etc.
l) Matters, that can not be adequately supported by any evidence, such as cash retention limit, insurance cover
for cash-in-transit and cash-in-transit, rotation of duties, etc.
1.12 SA 580, "Written Representations" requires an auditor to seek written representations from the auditee,
which in the case of branch audit will be furnished by the branch Management (generally the branch head).
1.13 As per Paragraph 18 of SA 580 when one or more requested written representations are not provided, the
auditor needs to discuss the matter with the Management, re-evaluate the integrity or Management and evaluate the
effect that this may have on the reliability of representations (oral or written) and audit evidence in general and take
appropriate actions, including the possible effect on the opinion in the auditor's report in accordance with SA 705.
Long Form Audit Report of Bank Branches
1.14 The clauses in the LFAR questionnaire to be dealt with by the branch auditors are discussed in the
following paragraphs. The key word used in these paragraphs is `Controlling Authority'. The auditor should refer
the relevant circulars issued by the relevant Controlling Authority, as in the case of a branch any authority
which is in a position to control its affairs can be called as a Controlling Authority, e.g., head office/zonal office
or regional office.
1.15 It should be noted that replies are sought specifically in conjunction with the relevant bank instructions.
A branch may be observing a system of control which may be perfectly in order but if the same is contrary to
the instructions of the Controlling Authority on the same then it has to be specifically stated as a violation in the
report.
I. Assets
Cash
(a) Does the branch generally carry cash balances, which vary significantly from the limits fixed by the
Controlling Authorities of the bank?
A letter received from controlling office to be perused to ascertain the cash retention limit allotted to the
branch (including foreign currencies).
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The limits as above to be verified with the daily closing cash balance (including foreign currency) of the
Branch.
Any exceptions may be reported as under:
i. We have been informed that Controlling Office had fixed Cash Retention Limit of Rs. --------.
ii. During the year under audit the cash balance was in excess of Retention Limit on many / few
occasion. The instances are as under:-
Date Balance in Rs.
The above data can be obtained from system generated report.
(b) Does the branch hold adequate insurance cover for cash-on-hand and cash-in- transit?
Generally, the Branch cash balance has been covered under the Bankers' Indemnity Policy.
A copy of the policy to be obtained from Branch. In case the insurance is taken by Head Office /
Controlling Office, a copy of policy or any correspondence from Head Office / Controlling Office in this
regard to be perused.
(c) Is cash maintained in effective joint custody of two or more officials, as per the instructions of the
Controlling Authorities of the bank?
Obtain the instructions in this regard and peruse the compliance thereof.
Generally, the Cash is held in the Joint Custody of Cashier and Officer of the Branch.
Specify the name and designation of the concerned persons.
(d) Has the cash balances at the branch been checked at periodic intervals as per the procedure prescribed
by the Controlling Authorities of the bank?
Obtain the copy of the procedure prescribed by the Controlling Authorities and examine the compliance
thereof. In addition, ascertain, whether the branch is under Concurrent Audit. Generally, the Concurrent
Auditors do the Cash verification every month.
In addition to above, officials who are not dealing with cash are also doing verification on monthly basis.
Balances with Reserve Bank of India, State Bank of India and Other Banks
(a) Were balance confirmation certificates obtained in respect of outstanding balances as at the year-end
and whether the aforesaid balances have been reconciled? If not, the nature and extent of differences
should be reported.
Balance confirmation certificates obtained in respect of outstanding balances as at the end of every
month.
Obtain the Bank Reconciliation Statement.
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Long Form Audit Report in Case of Bank Branches
If the reconciliation is not carried out or carried out incorrectly the same to be reported.
If any difference is observed, then report the amount, nature of difference and period since lying in the
reconciliation statement
(b) Your observations on the reconciliation statements may be reported in the following manner:
(i) Cash transactions remaining unresponded (give details)
Give full details.
(ii) Revenue items requiring adjustments/ write-off (give details)
Give full details.
(iii) Old outstanding balances remaining unexplained/ unadjusted. Give details for:
Outstanding between six months and one year; (including Receivable or payable)
One year and above (including Receivable or payable)
(c) In case any item deserves special attention of the Management, the same may be reported.
Give full details.
Money at Call and Short Notice
Has the Branch kept money-at-call and short notice during the year? If so, whether instructions/ guidelines, if any,
lay down by the Controlling Authorities of the bank have been complied with?
Generally, this is looked after by Treasury Department, hence, such types of transactions generally do not
appear in Branch Books.
However, confirm that no such transactions are appearing in the Branch Trial Balance.
If there are transactions, obtain the instructions / guidelines laid down by the Controlling Authorities and
examine the compliance thereof.
Investments
Generally, this is looked after by Treasury Department, hence, such types of transactions do not appear in
Branch Books.
However, confirm that no Investments are appearing in the Branch Trial Balance.
If Investments are appearing in the Trial Balance physical verification should be conducted and reported
accordingly. Also verify investment balance confirmation of counter party (Investee) with balance appearing in
Branch Books.
(A) For Branches in India
a) Are there any investments held by branches on behalf of Head Office/ other offices of the bank? If so,
whether these have been made available for physical verification or evidences have been produced with
regard to the same where these are not in possession of the branch?
If Investments are held on behalf of Head Office / Other Offices above procedure should be followed.
b) Whether any amounts received as income on such investments have been reported to the Head Office?
Confirm from the Branch Trial balance whether any such income is received. If yes, ascertain whether
the instructions in this regard of the head office / controlling office is complied with..
c) In respect of investments held by branches on behalf of Head Office/ other offices of the bank whether
any income is accrued / received and recognised as income of the branch contrary to the instructions of
the Controlling Authorities of the bank?
Confirm from the Branch Trial balance whether any such income is received. If yes, ascertain whether
the instructions in this regard of the head office / controlling office are complied with.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
d) Whether there are any matured or overdue investments, which have not been encashed? If so, give
details?
This can be ascertained from physical verification of Investment statement.
e) Whether the guidelines of the Reserve Bank of India regarding Transactions in Securities have been
complied with.
Refer guidelines of Reserve Bank of India together with Head Office instruction.
f) Whether the guidelines of the Reserve Bank of India regarding valuation of Investments have been
complied with.
Refer guidelines of Reserve Bank of India together with Head Office instruction (Valuation Policy of the
Bank).
(B) For Branches outside India
The audit of Branches outside India is not allotted to Indian Chartered Accountants Firms; hence not
applicable.
a) In respect of purchase and sale of investments, has the branch acted within its delegated authority,
having regard to the instructions/ guidelines in this behalf issued by the Controlling Authorities of the
bank?
b) Have the investments held by the branch whether on its own account or on behalf of the Head Office/
other branches been made available for physical verification? Where the investments are not in the
possession of the branch, whether evidences with regard to their physical verification have been
produced?
c) Is the mode of valuation of investments in accordance with the RBI guidelines or the norms prescribed by
the relevant regulatory authority of the country in which the branch is located, whichever are more
stringent?
d) Whether there are any matured or overdue investments, which have not been encashed? If so, give
details?
Advances
(a) Credit Appraisal
In your opinion, has the branch generally complied with the procedures/ instructions of the Controlling
Authorities of the bank regarding loan applications, preparation of proposals for grant/ renewal of
advances, enhancement of limits, etc., including adequate appraisal documentation in respect thereof.
Refer circular issued by Head Office regarding Credit Appraisal.
Enquire whether specific facility wise loan application form is prescribed by the Bank.
Confirm that the instructions are followed by the Branch while accepting the loan application form.
Refer circular issued by Head Office regarding preparation of proposals for grant / renewal of
advances, enhancement of limits, etc., including adequate appraisal documentation in respect thereof.
While reporting under this clause, auditor should consider the "Early mortality cases" in the branch
The auditor would also need to consider whether:
The branch is adhering to various guidelines issued by RBI regarding lending against own shares,
lending to directors or their relatives.
In respect of lending under consortium / multiple banking arrangement, the branch is obtaining
declaration from the borrowers about the credit facilities already enjoyed by them from other banks in
the format prescribed in circulars DBOD.No.BP.BC.46/08.12.001/2008-09 dated September 19, 2008
and DBOD.No.BP.BC.94/08.12.001/2008-09 dated December 08, 2008.
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Long Form Audit Report in Case of Bank Branches
Bank is exchanging / sharing information of the credit facilities sanctioned to the borrowers with other
lending bankers.
The branch is practicing due diligence to assess the credit worthiness of the borrowers and not relying
on margin and security as a substitute for due diligence.
The branch is adhering to the prudential exposure limits prescribed by RBI and Head Office.
Latest IT returns of Borrowers / Guarantors have been obtained.
Latest CIBIL or other Credit Information Company report has been obtained and verified.
(b) Sanctioning/ Disbursement
(i) In the cases examined by you, have you come across instances of credit facilities having been
sanctioned beyond the delegated authority or limit fixed for the branch? Are such cases promptly reported
to higher authorities?
Confirm sanctioning / disbursement discretionary power regarding advances.
Report the cases where credit facilities having been sanctioned beyond the delegated authority or limit
fixed for the branch
Whether such type of cases promptly reported to higher authorities.
Such type of cases may be reported in the following format.
Generally, cases are seen in the branch where the limits of existing borrowers are allowed to be
overdrawn for a period beyond permissible time. Such cases should be reported.
exceeding the delegated
Sanction date/ Authority
Balance outstanding on
ratification from Higher
Name of the borrower
Amount sanctioned
Date of sanction /
Account Number
Type of facility
Sanction limit
31.03.20XX
Authority
authority
Sr. No.
(ii) In the cases examined by you, have you come across instances where advances have been disbursed without
complying with the terms and conditions of the sanction? If so, give details of such cases.
Obtain original Title deed, Execution of Documents. Vetting of documents by legal dept./ legal resource.
Report the cases where advances have been disbursed without complying with the terms and
conditions of the sanction letter.
Main aspects to be covered are:
- Registration of charges search report.
- Resolutions guarantees mortgage creation.
- Legal opinion valuation encumbrance certificate insurance.
- Lien on deposits margins for BG and LC and loan on deposits.
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Report the cases along with the deviations.
(c) Documentation
(i) In the cases examined by you, have you come across instances of credit facilities released by the branch
without execution of all the necessary documents? If so, give details of such cases.
Report the cases where credit facilities released by the branch without execution of all the necessary
documents. Physical verification of documents is critical. This is one of the important function of the
branch audit and the reason why branch audit exists.
The exact nature of irregularity / document not obtained may be provided in the following format.
Verify Custody of Documents Whether document movement register tracking changes is maintained
Scanning of important documents.
Nature of irregularity
Balance outstanding
Account Number
/ documents not
Sanction date /
Type of facility
Sanction limit
Name of the
31.03.20XX
Authority
borrower
obtained
Sr. No.
on
(ii) In respect of advances examined by you, have you come across cases of deficiencies in documentation,
non-registration of charges, non-obtaining of guarantees, etc.? If so, give details of such cases.
Report cases of deficiencies in documentation, non-registration of charges, non-obtaining of
guarantees, etc.
Make sure that the documents are adequately stamped and also that they are executed within six
months of purchasing the stamp paper.
The instances should be reported in the following format.
Account Number
Sanction date /
Type of facility
Sanction limit
Name of the
outstanding
irregularity
& a/c no.
Authority
Nature of
borrower
Balance
Sr. No.
Time barred documents list to be furnished as under
Sr. Name Account Outstanding Sanction limit / Date of document
No. of the borrower Number balance Authority
The time barred accounts statement can be generated through system.
When the document became time barred, no legal action can be initiated against the borrower.
(iii) Whether advances against lien of deposits have been properly granted by marking a lien on the deposit
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Long Form Audit Report in Case of Bank Branches
in accordance with the guidelines of the Controlling Authorities of the bank.
Refer the guidelines issued by Head Office in this regard.
Report the cases, where the deposits / NSCs, paper securities etc., are matured, however not adjusted
against the respective advances.
Instances should be given in the following format.
Sr. Name of the Account Sanction Outstanding Date of document Particulars of
No. borrower Number limit / balance Security
Authority
(d) Review/Monitoring/ Supervision
(i) Is the procedure laid down by the Controlling Authorities of the bank, for periodic review of advances
including periodic balance confirmation/ acknowledgement of debts, followed by the branch?
Provide analysis of the accounts overdue for review/ renewal
o between 6 months and 1 year, and
o over 1 year
Refer the guidelines issued by Head Office in this regard.
Date / month in which accounts were due for review and the date / month on which the review was
done may be obtained.
It may be noted that there would be cases that are seen performing at the balance sheet date but
evidently stressed. Comments on such account with respect to branch efforts on monitoring and
information availability on same should be commented upon.
In view of changes in the reporting requirements in CARO for corporate borrowers, it is necessary for
branch auditor to carefully go through the annual reports to ensure that there no adverse comments in
the balance sheet of a borrower that affects reporting at the branch level.
Date / Month of review can be verified from the sanction documents / terms
Instances should be given in the following format.
Sr. Name of the Type of Facility & Balance Review overdue Ageing
No. Borrower Account Number outstanding as on since
31.03.20XX
(ii) Are the stock / book debt statements and other periodic operational data and financial statements, etc.,
received regularly from the borrowers and duly scrutinised? Is suitable action taken on the basis of such
scrutiny in appropriate cases?
Borrower wise / month wise record showing receipt of security statement be confirmed..
Confirm the working of drawing power based thereon.
Confirm whether these statements are obtained on time.
Compare movement shown in book debt & creditors with debit/credits in the Bank.
Further, in respect of consortium advance, the drawing power should be determined by the lead bank and
circulated to the other member banks (circular no. No. C&I/Circular/2014-15/689 dated 29 September 2014
issued by the Indian Banks Association).
(iii) Whether there exists a system of obtaining reports on stock audits periodically? If so, whether the branch
has complied with such system?
Refer the guidelines issued by Head Office in this regard and confirm the compliance thereof.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Examine the compliances obtained, action taken in cases wherein deficiencies are reported by the
stock auditors.
Obtaining written reverts from the Borrower..
Whether adverse issues in stock audit reports are duly factored in review / renewal notes.
Compare with annual accounts for divergences and obtain satisfactory explanations
(iv) Indicate the cases of advances to non-corporate entities with limits beyond Rs.10 lakhs where the branch
has not obtained the accounts of borrowers, duly audited under the RBI guidelines with regard to
compulsory audit or under any other statute.
Obtain list of non corporate borrowers enjoying facilities in excess of Rs.10.00 lakhs and report where
audited statements are not on record.
A list of such cases is to be given in the following format.
Sr. Name of the Borrower Account Number Sanction Date of last audit completed
No. Limit
(v) Has the inspection or physical verification of securities charged to the Bank been carried out by the
branch as per the procedure laid down by the Controlling Authorities of the bank?
Refer the guidelines issued by Head Office in this regard.
A list of such cases is to be given in the following format.
Reporting deviations if any reasons for the deviations
Sr. Name of the Account Sanction Last date of inspection or physical
No. Borrower Number Limit verification
(vi) In respect of advances examined by you, have you come across cases of deficiencies in value of
securities and inspection thereof or any other adverse features such as frequent/unauthorised
overdrawing beyond limits, inadequate insurance coverage, etc.?
Note down the remarks regarding deficiencies in value of securities and inspection report submitted by
the concerned officer.
Confirm whether Insurance is in favour of Bank.
The cases where frequent / unauthorized over drawings beyond limits are granted is to be given in the
following format.
Check whether Insurance covers risks the mortgaged securities are subject to Check adequacy of
Insured value and location wise -
Sr. Name of the Account Sanction Balance Drawing Irregularity
No. Borrower number Limit Outstanding power
For cases, wherein insurance details are not available is to be given in the following format.
Sr. Name of Account Sanction Value of Security
No. the Borrower Number Limit
For cases, wherein there is inadequate insurance may be given in the following format.
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Long Form Audit Report in Case of Bank Branches
Sr. Name of the Account Sanction Value of Insured Inadequate
No. Borrower Number Limit Security for Rs. Insurance
(vii) In respect of leasing finance activities, has the branch complied with the guidelines issued by the
Controlling Authorities of the bank relating to security creation, asset inspection, insurance, etc? Has the
branch complied with the accounting norms prescribed by the Controlling Authorities of the bank relating
to such leasing activities?
Refer the guidelines issued by Head Office in this regard.
(viii) Are credit card dues recovered promptly?
Refer the guidelines issued by Head Office in this regard.
Whether the branch maintains debit balances in the card dues customers.
Confirm, whether such debit balances are included in advances classification statements.
(ix) Has the branch identified and classified advances into standard/sub-standard/ doubtful/ loss assets in
line with the norms prescribed by the Reserve Bank of India.
Refer the guidelines issued by Reserve Bank of India together with Head Office in this regard.
Wherever, such guidelines are not followed Memorandum of Changes be given with reason.
The branch auditor shall also verify compliance with the guidelines issued by Head Office with regard to
identification and classification of loan accounts into special mention accounts and incremental
provisioning requirement on account of unhedged foreign current exposures in line with the norms
prescribed by the Reserve Bank of India
(x) Where the auditor disagrees with the branch classification of advances into standard / sub-standard /
doubtful / loss assets, the details of such advances with reasons should be given. Also indicate
whether suitable changes have been incorporated / suggested in the Memorandum of Changes.
Refer the guidelines issued by Reserve Bank of India together with Head Office in this regard.
Wherever, such guidelines are not followed Memorandum of Changes be given with reason.
(xi) Have you come across cases where the relevant Controlling Authority of the bank has authorised legal
action for recovery of advances or recalling of advances but no such action was taken by the branch? If
so, give details of such cases.
Refer the guidelines issued by Head Office in this regard.
Wherever, such guidelines are not followed such cases be reported in the following format.
Sr. Name of the Account Sanction Instructions to Present
No. Borrower Number Limit take legal action Status
on
(xii) Have all non-performing advances been promptly reported to the relevant Controlling Authority of the bank?
Also state whether any rehabilitation programme in respect of such advances has been undertaken, and if so,
the status of such programme.
Refer the guidelines issued by Head Office in this regard.
Wherever, such guidelines are not followed such cases be reported
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Sr. Name of the Account Sanction Rehabilitation Present
No. Borrower Number Limit programme Status
sanctioned
(xiii) Have appropriate claims for DICGC/CGSTE and Export Credit Guarantee/ Insurance and subsidies, if
any, been duly lodged and settled? The status of pending claims giving year wise break-up of number
and amounts involved should be given in the following format:
DICGC not applicable, as most of the Banks have opted out of DICG.
Report here the claims if any outstanding on account of ECGC/CGST.
Report the cases not accepted / rejected by ECGC/CGST.
Particulars Number Amount (Rs.)
Claims as at the beginning of the year
(Give year-wise details)
Further claims lodged during the year
____ _______
Total A ____ _______
Amounts representing:
(a) Claims accepted/ settled (give
year-wise details)
(b) Claims rejected (give year-wise
details)
____ _______
Total B ____ _______
Balance as at the year-end (give year-
wise details) ____ _______
A-B
=== ======
(xiv) In respect of non-performing assets, has the branch obtained valuation reports from approved valuers for
the fixed assets charged to the bank, once in three years, unless the circumstances warrant a shorter
duration?
Refer the guidelines issued by Head Office in this regard.
Wherever, such guidelines are not followed such cases be reported in the following format.
Whether valuation is done on a consistent basis at fair Market value, Realizable value, Distress
value Whether Fall in Market value has been factored in the valuation -
Outstanding
Name of the
Report date
Valuation
Borrower
Sanction
Account
Security
Security
Value of
Balance
Number
Sr. No.
Latest
Limit
(xv) In the cases examined by you has the branch complied with the Recovery Policy prescribed by the
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Long Form Audit Report in Case of Bank Branches
Controlling Authorities of the bank with respect to compromise/ settlement and write-off cases? Details of
the cases of compromise/ settlement and write-off cases involving write-offs/ waivers in excess of Rs.50
lakhs may be given.
Refer the guidelines issued by Head Office in this regard.
Wherever, such guidelines are not followed such cases be reported in the following format.
Account Number
Settlement Amt.
Compromised /
Outstanding
Name of the
Recovery
Recovery
Borrower
Sanction
Effected
Balance
effected
Sr. No.
To be
Limit
(e) Guarantees and Letters of Credit
Normally handled at Corporate or Head Office.
However, inquire whether such type of cases are handled at Branch and reply accordingly.
(i) Details of outstanding amounts of guarantees invoked and funded by the branch at the end of the year
may be obtained from the Management and reported in the following format:
(a) Guarantees invoked, paid but not adjusted:
Sr. Date of Name of Name of Amount Date of Remarks
No. invocation the party beneficiary Recovery
(b) Guarantees invoked but not paid:
Sr. No. Date of Name of Name of Amount Date of Remarks
invocation the party beneficiary Recovery
(ii) Details of the outstanding amounts of letters of credit and co-acceptances funded by the Branch at the
end of the year may be obtained from the Management and reported in the following format:
Sr. Date of Name Nature (LC/ co- Amount Date of Remarks
No. funding of the acceptance, etc.) Recovery
party
Other Assets
(a) Stationery and Stamps
(i) Does the system of the Bank ensure adequate internal control over issue and custody of stationery
comprising security items (Term Deposit Receipts, Drafts, Pay Orders, Cheque Books, Traveller's
Cheques, Gift Cheques, etc.)? Whether the system is being followed by the branch?
The Head Office instructions to be seen and confirm whether internal control is in existence.
Carry out the physical verification of security items including stamps.
Whether lost security items are reported to Controlling Authority.
Note down the accounting treatment given to Stationery items as every Bank is having different policy
in this regard.
Comment on the usage of security items during the year and the stock of such items vis a vis usage.
Report lacunas observed in the system at the branch as this is a fraud prone area.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
(ii) Have you come across cases of missing/ lost items of such stationery?
Deficiencies in controls that lead to the missing stationery to be stated.
Sr. Description of Consecutive Date of Missing
No the security item No. of the item Loss Reported on
(b) Suspense Accounts/ Sundry Assets
(i) Does the system of the Bank ensure expeditious clearance of items debited to Suspense Account? Details
of old outstanding entries may be obtained from the branch and the reasons for delay in adjusting the
entries may be ascertained. Does your scrutiny of the accounts under various sub-heads reveal balances,
which in your opinion are not recoverable and would require a provision/ write-off? If so, give details in the
following format:
Year Amount (Rs.) Remarks
Refer the guidelines issued by Head Office in this regard.
Whether, such guidelines are followed strictly.
The Debit entries in your opinion not recoverable should be reported for making adequate provision.
Age wise analysis report through the system may be referred for the same.
Reasons for such debits to be clarified.
(ii) Does your test check indicate any unusual items in these accounts? If so, report their nature and the
amounts involved.
Information to be given in the following format
In case of long outstanding entries over a period of one year the details to be seen with regard to its
nature and possibility of recovery in case of debit items, if you feel that items are not recoverable
necessary provision to be suggested in Memorandum of Changes (MOC)
Sr. No. Particulars of Outstanding balance as Whether provision is necessary,
debit entry on 31.03.20XX reasons
there of
Follow the above said procedure in this regard.
II. Liabilities
Deposits
(i) Have the Controlling Authorities of the bank laid down any guidelines with respect to conduct and
operations of Inoperative Accounts? In the cases examined by you, have you come across instances
where the guidelines laid down in this regard have not been followed? If yes, give details thereof.
Refer the guidelines issued by Head Office in this regard.
Whether, such guidelines are followed strictly.
Wherever the guidelines are not followed report the same along with full details.
Whether system identifies the inoperative accounts and converts the status of such accounts to
inactive.
Whether branches are transferring inoperative accounts and shown under a separate DEAF Deposits
accounts in the branch General Ledger.
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Long Form Audit Report in Case of Bank Branches
Whether unclaimed liabilities (whether amount due has been transferred to DEAF) is reflected as
Contingent Liability.
Note down the procedure for making such inoperative account, operative.
(ii) After the balance sheet date and till the date of audit, whether there have been any unusual large
movements (whether increase or decrease) in the aggregate deposits held at the year-end? If so, obtain
the clarifications from the Management and give your comments thereon.
Compare the aggregate deposits as on 15th March, 20XX, 31st March, 20XX and last day of audit.
Ascertain the reason for large variation other than due to application of interest / provision as on 31st
March, 20XX
Ensure there is no evergreening
(iii) Are there any overdue/ matured term deposits at the end of the year? If so, amounts thereof should be
indicated.
Refer the guidelines issued by Head Office in this regard.
Whether, such guidelines are followed strictly.
Whether interest is provided on matured deposit as per RBI guidelines.
Follow up done with customers to renew such accounts
Other Liabilities
Bills Payable, Sundry Deposits, etc.
(i) The number of items and the aggregate amount of old outstanding items pending for three years or more
may be obtained from the branch and reported under appropriate heads. Does the scrutiny of the accounts
under various sub-heads reveal old balances? If so, give details in the following format:
Year No. of items Amount (Rs.) Remarks
Refer the guidelines issued by Head Office in this regard.
Whether, such guidelines are followed strictly.
Obtain the listing of bills payable together with the due date
(ii) Does your test check indicate any unusual items or material withdrawals or debits in these accounts? If
so, report their nature and the amounts involved.
Refer the exceptional transaction report generated through system.
Movement in such accounts may be compared and reason may be analysed.
Contingent Liabilities
List of major items of the contingent liabilities (other than constituents' liabilities such as guarantees, letters of
credit, acceptances, endorsements, etc.) not acknowledged by the branch?
List of claims against the branch together with the status of claim may be obtained.
List of contingent liability to be verified and the same to be compared with last year's list.
The items not appearing in the current year's list may be enquired with reasons thereof.
Whether any provisioning is warranted against these Contingent Liabilities.
III. Profit and Loss Account
(a) Whether the branch has a system to compute discrepancies in interest / discount and for timely
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
adjustment thereof in accordance with the guidelines laid down in this regard by the Controlling
Authorities of the bank? Has the test checking of interest revealed excess / short credit of a material
amount? If so, give details thereof.
Refer concurrent audit / internal inspection audit / income & expenditure audit reports.
Test check interest / discount calculations. Whether changes in interest rates are correctly captured.
Generate Exceptional Transactions report and verify interest is applied to all applicable accounts
Generally, interest application is a system-generated entry; hence test check may be applied for
confirming interest calculations.
Wherever excess / short credit of material amount is noticed, such cases may be reported in the
following format.
Test check cases of premature withdrawals for re-computing interest wrt revised tenor.
Sr.No A/c No Interest calculated Interest calculated by us Difference
by the system
(b) Has the branch complied with the Income Recognition norms prescribed by the RBI?
Refer RBI Master circular on IRAC norms together with other circulars issued by RBI on IRAC norms
from time to time.
Ensure asset classification is being done through system and no manual intervention is in place.
In case, the income recognition in NPA accounts is done manually and is not automated, then the
auditor should also verify the system and process being followed by the branch to ascertain whether
their exist a systematic manner of recognition of income and should also test whether the same
complies with the Accounting Policy of the Bank relating to appropriation of recoveries
Confirm whether IRAC norms are followed strictly through system.
(c) Whether the branch has a system to compute discrepancies in interest on deposits and for timely
adjustment of such discrepancies in accordance with the guidelines laid down in this regard by the
Controlling Authorities of the bank? Has the test check of interest on deposits revealed any excess/ short
debit of material amount? If so, give details thereof.
Refer the guidelines issued by Head Office/RBI in this regard.
Whether, such guidelines are followed strictly.
Check the correctness of interest rates fed in the system with the sanction terms on test check basis.
Also, updation of base rates in the system, in case of changes may be verified.
Generally, interest application is a system-generated entry; hence test check may be applied for
confirming interest calculations.
Wherever excess / short credit of material amount is noticed, such cases may be reported in the
following format.
Sr. No A/c No Interest calculated by the Interest calculated by (Short) / Excess Interest calculated
system us by the system
(d) Does the bank have a system of estimating and providing interest accrued on overdue / matured term
deposits?
Refer the guidelines issued by Head Office in this regard.
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Whether, such guidelines are followed strictly.
In most of the Banks such exercise is carried out at Head Office through system.
(e) Are there any divergent trends in major items of income and expenditure, which are not satisfactorily
explained by the branch? If so, the same may be reported upon. For this purpose, an appropriate
statement may be obtained from the branch Management explaining the divergent trends in major items
of income and expenditure.
The divergent trends can be identified by way of comparison analysis on the basis of previous quarters
/ half year / previous year figures, keeping in mind the changes in business volumes and business mix.
Compare the aggregate figures as on 15th March, 20XX, 31st March, 20XX and last day of audit. Also
compare some of the transfers on the last two days of the year end and identify whether there are any
transfers of undrawn portion from the loan accounts to current account or deposit account.
IV. General
Books and Records
(a) In case any books of account are maintained manually, does general scrutiny thereof indicate whether
they have been properly maintained, with balances duly inked out and authenticated by the authorised
signatories?
Now a days CBS is followed hence question of maintaining manual books of accounts does not arise.
Balancing is also done through system.
Balancing report may be generated to confirm that no difference is appearing in the balancing report.
Exception Reports can be generated from the system to verify whether there are differences. If there
are differences, the same should be reconciled / rectified by branch.
(b) In respect of computerised branches:
Whether hard copies of accounts are printed regularly?
Refer the guidelines issued by Head Office. On the basis of instructions, documents to be stored in
hard copies and the periodicity of printing may be identified.
Indicate the extent of computerisation and the areas of operation covered through manual
intervention.
Are the access and data security measures and other internal controls adequate?
Refer the guidelines issued by Head Office Awareness of Branch officials with Security guidelines -
Password Policy, Anti viruses on systems, Access to pen drives etc. may be checked as a part of
access and data security controls
Whether regular back-ups of accounts and off-site storage are maintained as per the guidelines of
the Controlling Authorities of the bank?
Refer the guidelines issued by Head Office for compliance Whether backups are periodically tested.
Whether adequate contingency and disaster recovery plans are in place for loss/ encryption of data?
Refer the guidelines issued by Head Office & compliance thereof. Note if any fire drills or any other
evacuation drills are conducted Whether any Fire Safety Audits are conducted -
Do you have any suggestions for the improvement in the system with regard to computerised
operations of the branch?
Reconciliation of Control and Subsidiary Records
Enquire at branch the system of reconciliation followed.
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Whether any long outstanding debit entries are appearing in the reconciliation statement.
o If answer is positive, same should be reported.
Have the figures, as at the year-end, in the control and subsidiary records been reconciled? If not, the last date
upto which such figures have been reconciled should be given under the respective heads, preferably in the
following format:
Account Date General Ledger Subsidiary Last Date on
Balance (Rs.) Balance (Rs.) which
balanced
Inter-Branch Accounts
Check for any entries not responded -
Now a day's CBS is implemented hence question of reconciliation of Inter Branch Accounts does not
arise at Branch.
(i) Does the branch forward on a daily basis to a designated cell/ Head Office, a statement of debit/ credit
transactions in relation to other branches?
(ii) Does a check of the balance in the Head Office Account as shown in the said statement during and as at
the year-end reveal that the same is in agreement with the Head Office Account in the general ledger?
(iii) Are there any outstanding debits in the Head Office Account in respect of inter-branch transactions?
(iv) Does the branch expeditiously comply with/ respond to the communications from the designated cell/
Head Office as regards unmatched transactions? As at the year-end are there any unresponded/
uncomplied queries or communications? If so, give details?
(v) Have you come across items of double responses in the Head Office Account? If so, give details.
(vi) Are there any old/ large outstanding transaction/ entries at debits as at year-end which remain
unexplained in the accounts relatable to inter-branch adjustments?
Audits/Inspections
(i) Is the branch covered by concurrent audit or any other audit/ inspection during the year?
(ii) In framing your audit report, have you considered the major adverse comments arising out of the latest
reports of the previous auditors, concurrent auditors, stock auditors or internal auditors, or in the special
audit report or in the inspection report of the Reserve Bank of India? State the various adverse features
persisting in the branch, though brought out in these audit/ inspection reports.
Obtain a list of audit which the Branch was subjected to during the previous year.
The scope of each audit may be reviewed to identify adequate coverage of branch activities.
Obtain all the reports and peruse the reports for any adverse remarks.
Whether branch has been addressing all issues noted promptly whether there are any repeat issues
Whether the Gap or Process failure that lead to the transactional error reported is addressed -
Frauds
Furnish particulars of frauds discovered during the year under audit at the branch, together with your suggestions,
if any, to minimise the possibilities of their occurrence
Enquire about any fraud reported to Controlling Authority/vigilance dept. Head Office during the
financial year.
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The auditor should also examine whether:
the branch is having an effective credit monitoring for its Advances portfolio
the branch has an adequate system in place to identify Early Warning Signals(EWS) of incipient
sickness / fraudulent activities in respect of loans. Some of the Early Warning signals which should
alert the bank officials about some wrongdoings in the loan accounts which may turn out to be
fraudulent:
Default in payment to the banks/ sundry debtors and other statutory bodies, etc., bouncing of the
high value cheques.
Raid by Income tax /sales tax/ central excise department.
Frequent change in the scope of the project to be undertaken by the borrower.
Under insured or over insured inventory.
Invoices devoid of TAN and other details.
Dispute on title of the collateral securities.
Costing of the project which is in wide variance with standard cost of installation of the project.
Funds coming from other banks to liquidate the outstanding loan amount.
Foreign bills remaining outstanding for a long time and tendency for bills to remain overdue.
Onerous clause in issue of BG/LC/standby letters of credit.
In merchanting trade, import leg not revealed to the bank.
Request received from the borrower to postpone the inspection of the godown for flimsy reasons.
Delay observed in payment of outstanding dues.
Financing the unit far away from the branch.
Claims not acknowledged as debt high.
Frequent invocation of BGs and devolvement of LCs.
Funding of the interest by sanctioning additional facilities.
Same collateral charged to a number of lenders.
Concealment of certain vital documents like master agreement, insurance coverage.
Floating front/ associate companies by investing borrowed money.
Reduction in the stake of promoter/ director.
Resignation of the key personnel and frequent changes in the Management.
Substantial increase in unbilled revenue year after year.
Large number of transactions with inter-connected companies and large outstanding from such
companies.
Significant movements in inventory, disproportionately higher than the growth in turnover.
Significant movements in receivables, disproportionately higher than the growth in turnover and/or
increase in ageing of the receivables.
Disproportionate increase in other current assets.
Significant increase in working capital borrowing as percentage of turnover.
Critical issues highlighted in the stock audit report.
Increase in Fixed Assets, without corresponding increase in turnover (when project is
implemented).
Increase in borrowings, despite huge cash and cash equivalents in the borrower's balance sheet.
Liabilities appearing in ROC search report, not reported by the borrower in its annual report.
Substantial related party transactions.
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Material discrepancies in the annual report.
Significant inconsistencies within the annual report (between various sections).
Poor disclosure of materially adverse information and no qualification by the statutory auditors.
Frequent change in accounting period and/or accounting policies.
Frequent request for general purpose loans.
Movement of an account from one bank to another.
Frequent ad hoc sanctions.
Not routing of sales proceeds through bank.
LCs issued for local trade / related party transactions.
High value RTGS payment to unrelated parties.
Heavy cash withdrawal in loan accounts.
Non submission of original bills.
whether there is a system to identify these EWS and take appropriate remedial action.
whether an Anti-fraud policy is in place and communicated to all.
whether Anti-fraud trainings are organized? Whether any fraud risk scenarios are identified and any
fraud control measures mapped to such risks.
Miscellaneous
(i) Does the examination of the accounts indicate possible window dressing?
Compare the aggregate figures as on15th March, 20XX, 31st March, 20XX and last day of audit.
(ii) Does the branch maintains records of all the fixed assets acquired and held by it irrespective of whether
the values thereof or depreciation thereon have been centralised? Where documents of title in relation to
branch or other branches are available at the branch, whether the same have been verified.
Refer the guidelines issued by Head Office in this regard.
Whether, such guidelines are followed strictly.
(iii) Are there any other matters, which you as a branch auditor would like to bring to the notice of the
Management or the Central Statutory Auditors?
Instances are given as under
System related issues
Issues relating to Statutory Payments and Accrual of Statutory Liabilities
Short / Excess Provisioning in NPA Accounts / Non Provisioning for SMA2 Accounts
Compliance with the requirements of RBI and Head Office instructions for Unhedged Foreign Currency
Exposure
ATM related issues
Whether AMC's terms are followed strictly
Security related issues.
Issues which may impact other Branches and not just the branch under audit -
.
For XYZ and Co.
Chartered Accountants
Firm's Registration Number
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Long Form Audit Report in Case of Bank Branches
Signature
(Name of the Member Signing the Audit Report)
(Designation)
Membership Number
Place of Signature:
Date:
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Questionnaire Applicable to Specialised Branches
For Branches dealing in Foreign Exchange Transactions
1.16 It should be noted that certain branches do not deal in foreign exchange transactions but foreign
currency accounts are maintained there and all records of account opening documentation are held at these
branches. In such cases, checking and reporting should be done of the account opening documentation and
commented upon in this section of LFAR.
1. Are there any material adverse features pointed out in the reports of concurrent auditors, internal auditors
and/ or the Reserve Bank of India's inspection report which continue to persist in relation to NRE/ NRO/
NRNR/ FCNR-B/ EEFC/ RFC and other similar deposit accounts If so, furnish the particulars of such
adverse features.
1.17 The auditor should make a written request to the branch Management for furnishing him the latest
available reports of the statutory auditors and of the concurrent auditor or stock auditor or internal auditors, as
also of the RBI where inspection or special audit has taken place for the branch. The auditor should scrutinise
the contents of such reports in relation to NRE/ NRO/ NRNR/ FCNR-B/ EEFC/ RFC and other similar deposit
accounts and take a note of relevant major adverse comments. In case adverse features are observed to
persist at the branch or where no remedial action has been initiated or taken by the branch Management, he
should report the same.
2. Whether the Branch has followed the instructions and guidelines of the Controlling Authorities of the bank
with regard to the following in relation to the foreign exchange and, if not, state the irregularities.
(a) deposits
(b) advances
(c) export bills
(d) bills for collection
(e) any other area
1.18 The auditor also has to make himself familiar with the relevant aspects of the Exchange Control
Manual and its compliance. The auditor should verify whether the instruction and guidelines of the Controlling
Authorities of the bank in relation to the foreign exchange have been followed by the branch in respect of these
areas. If any irregularity is observed the same should be reported with details. Auditor to verify proper filing of
BEF & XOS returns -
3. Obtain a list of all NOSTRO Accounts maintained/ operated by the Branch from the branch Management.
1.19 The auditor should obtain a list of all NOSTRO Accounts for the purpose of verification from the branch
Management.
(a) Are the NOSTRO Accounts regularly operated?
1.20 The auditor should verify whether the NOSTRO Accounts are being regularly operated. If not give the
list of NOSTRO Accounts with balances outstanding, which are not operated regularly, the date of last
transaction, etc. The auditor should specifically comment on overdrafts in NOSTRO accounts, if any.
(b) Are periodic balance confirmations obtained from all concerned overseas branches/ correspondents?
1.21 The auditor should verify whether the balance confirmation from all concerned overseas branches/
correspondents have been obtained on a periodic basis. He should report the names of the bank and the period
wise outstanding balances, which remain unconfirmed.
(c) Are these accounts duly reconciled periodically? Your observations on the reconciliation may be reported.
1.22 While examining the transaction in foreign exchange, the auditor should also pay attention to
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reconciliation of NOSTRO Accounts with the respective minor account. The amount in the NOSTRO account is
stock of foreign currency in the form of bank accounts with the overseas branches and correspondents. Un-
reconciled NOSTRO Accounts, on an examination, may reveal unauthorised payments from the foreign
currency account, unauthorised withdrawals, and unauthorised debit to minor account. The auditor should also
evaluate the internal control with regard to inward/ outward messages. The inward/outward messages should
be properly authenticated and discrepancies noticed should be properly dealt with in the books of accounts. In
case balance confirmation certificate have been received but the same have not been reconciled, the auditor
should report, in respect of each bank, the balances as per books maintained by the branch and the balance as
per the relevant balances confirmation certificate, stating in either case whether the balance is debit or credit.
Whether the branch is following HO guidelines for reporting requirements under Foreign Account Tax
Compliance Act (FATCA) and Common Reporting Standards (CRS).
4. Does the Branch follow the prescribed procedures in relation to maintenance of Vostro Accounts?
1.23 The auditor should verify whether prescribed procedure in relation to inter-bank confirmation in the
Vostro account is followed or not. In case balance confirmation certificate have been received but the same
have not been reconciled, or where confirmation has not been received the same should be reported, in respect
of each Vostro Account. The RBI has also issued the Master Directions FED Master Direction No.2 /2015-16
dated January 01, 2016 (updated on April 28, 2016) on "Opening and Maintenance of Rupee/Foreign Currency
Vostro Accounts of Non-resident Exchange Houses".
For branches dealing in very large advances, such as, Corporate Banking Branches and Industrial Finance
Branches or branches with advances in excess of Rs. 100 crores
1. In respect of borrowers with outstanding of Rs. 2 crores and above, the information in the enclosed format
should be obtained from the Branch Management. Comments of the Branch Auditor on advances with
significant adverse features and which might need the attention of the Management/Central Statutory
Auditors should be appended to the Long Form Audit Report.
1.24 The branch auditor should obtain details and other information, in respect of all advances, which are in
excess of Rs. 2 crores, which would be relevant to complete the enclosed format from branch manager.
1.25 Any advances account with significant adverse features like, non-operative for quite a long time,
renewed without adequate credit appraisal, fresh advances granted without obtaining necessary approval, etc.,
on which branch auditor has commented and which is of such a nature that central statutory auditor is required
to consider it for qualifying and/or disclosing in main report, should be attached as an annexure to LFAR. In
cases where limits are allocated to any branch, by a Main branch, the exchange of information between
branches has to be verified -
2. What, in your opinion, are the major shortcomings in credit appraisal, monitoring, etc.?
1.26 Major shortcomings in credit appraisal will have to be disclosed in the LFAR which could either be
stated on the face of the report or could be reference to an annexure. Examples of major shortcomings in credit
appraisal are stated below:
Loan application not on record at Branch.
The appraisal form was not filled up correctly and thereby the appraisal and assessment was not done
properly.
Loan application is not in the form prescribed by Head Office.
The Bank did not receive certain necessary documents and annexures required with the application form.
Basic documents such as Memorandum and Articles of Association, Partnership deed, etc., which are
pre-requisite to determine the status of the borrower have not been obtained.
Certain adverse features of the borrower not incorporated in the appraisal note forwarded to the
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Management.
Industry/ group exposure and past experience of the Bank is not dealt in the appraisal note sent to the
Management for sanction.
The level for inventory/ book-debts/ creditors for finding out the working capital is not properly assessed.
Techno-economic feasibility report, which is required to know the technical aspects of the borrower's
business, is not obtained from Technical Cell.
Credit report on principal borrowers and confidential report from their banks are not insisted from the
borrowers.
The opinion reports of the associate and/or sister concerns of the borrower are not scrutinised/ called for/
not updated/ not satisfactory.
The procedure/ instructions of Head Office regarding preparation of proposals for grant or proposals for
renewal of advances or proposals for enhancement of limits, etc., are not followed.
No exposure limits are fixed for forward contract for foreign exchange sales/ purchase transactions.
No adequate security obtained/ charge created.
The director/borrower's names do not appear in RBI/CIBIL defaulters list.
3. List the accounts (with outstanding in excess of Rs.1 crore), which have either been downgraded or
upgraded with regard to their classification as Non Performing Asset or Standard Asset during the year and
the reasons therefore.
1.27 For advance accounts where outstanding balance is in excess of Rs. 1 crore and which have been re-
classified from non-performing asset to standard asset or vice-a-versa, the list will have to be attached to the
report specifying the reasons with brief explanations for such re-classification.
For branches dealing in recovery of Non Performing Assets such as Asset Recovery Management Branches
1. In respect of every advance account in excess of Rs. 2 crores, the information in the enclosed format should
be obtained from the Branch Management. Comments of the Branch Auditor on advances with significant
adverse features and which might need the attention of the Management/Central Statutory Auditors should
be appended to the Long Form Audit Report.
1.28 The Branch auditor should obtain details and other information, in respect of all advances, which are in
excess of Rs. 2 crores, which would be relevant to complete the format (given in the Annexure) obtained from
branch Management.
1.29 Any advances account with significant adverse features like, non-operative for quite a long time,
renewed without adequate credit appraisal, fresh advances granted without obtaining necessary approval, etc.,
on which branch auditor has commented and which is of such a nature that attention of central statutory auditor
requires to consider it for qualifying and/ or disclosing in main report, should be attached as an annexure to
LFAR.
2. List the accounts (with outstanding in excess of Rs. 2 crores), which have been upgraded from Non
Performing to Standard Assets during the year and the reasons therefor.
1.30 For advance accounts where outstanding balance are in excess of Rs. 2 crores which have been
reclassified from Non Performing Assets to Standard Assets, the list will have to be attached to the report
specifying the reasons with brief explanations for such re-classification.
3. Whether the Branch has a system of updating periodically, the information relating to the valuation of security
charged to the bank?
1.31 The branch auditor should enquire as to the existence of the system, if any, pertaining to the valuation of
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Long Form Audit Report in Case of Bank Branches
security charged to the bank. If the system is in existence, the auditor should examine whether the system
periodically updates the information pertaining to the value of such security and takes necessary steps for
increase/diminution in the value of such security.
4. Age-wise analysis of the recovery, suits-filed and pending may be furnished.
1.32 Age-wise analysis of the recovery suits filed and pending should be given along with the current status
of each recovery suit.
5. Is the Branch prompt in ensuring execution of decrees obtained for recovery from the defaulting borrowers?
Also list the time-barred decrees, if any and reasons therefor.
1.33 In case decrees have been obtained for recovery from the defaulting borrowers, the auditor should
check whether the branch is prompt in execution of decrees like, drawings from the account and payment from
these accounts have been stopped. If not, the same should be reported. The list should be given in the case of
time barred decrees with the reasons therefor.
6. List the recoveries and their appropriation against the interest and the principal and the accounts settled/
written off/ closed during the year.
1.34 A list will have to be annexed which will specify the non-performing advances recovered and the
amounts adjusted towards interest and principal. A list of the accounts settled, written closed, if any, will also
have to be attached. The auditor should satisfy himself whether the recoveries appropriated against interest are
in accordance with the RBI guidelines and normal accounting principles.
7. List the new borrower accounts transferred to the Branch during the year. Have all the relevant documents and
records relating to these borrower accounts been transferred to the Branch? Has the Branch obtained confirmation
that all the accounts of the borrower (including non-fund based exposures and deposits pending adjustment/ margin
deposits) been transferred to the Branch?
1.35 A list of new borrower accounts transferred to the branch from the other branches during the year should be
annexed. The auditor should verify whether the documents and records relating to the transferred accounts have
been obtained like, letter from the transferor branch, detail of the accounts, etc. The branch should also obtain a
confirmation that all the accounts of the borrower (including non-fund based exposures and deposits pending
adjustment/ margin deposits) have been transferred to the branch. In case any adverse features have been observed
in such transfer, the same should be reported.
For branches dealing in Clearing House Operations, normally referred to as Service Branches
1. Does the branch have a system of periodic review of the outstanding entries in clearing adjustments
accounts? In your view has the system generally been complied with?
1.36 The auditor should verify whether the branch is having system of periodic review of the outstanding
entries in clearing adjustments accounts. On a test check, auditor should verify whether the system, generally,
has been complied with.
2. Whether review of the clearing adjustments accounts (inwards/ outwards) reveals any old/ large/ unusual
outstanding entries, which remain unexplained? Give year-wise break-up of outstanding in number and
value:
1.37 If the review of clearing adjustments accounts (inwards/outwards) reveals any old/large/unusual
outstanding entries, which remain unexplained, the auditor should report the same. Year-wise break up should
be given of outstanding clearing in number and value in the following format.
Inward Clearing
Number Value
Normal Clearings
High Value Clearings
Inter-Branch Clearings
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
National Clearings
Returned/ Dishonored Clearings
Outward Clearing
Number Value
Normal Clearings
High Value Clearings
Inter-Branch Clearings
National Clearings
Returned/ Dishonored Clearings
3. Has the Branch strictly followed the guidelines of the Controlling Authority of the bank with respect to
operations related to clearing transactions? Comment on the systems and procedures followed by the
Branch in this regard.
1.38 Auditor should verify whether the guidelines of the Controlling Authority of the bank with respect to
operations related to clearing transactions has been strictly followed. In case the same has not been followed,
the auditor should report the same. The auditor should report on the system and procedures followed by the
branch in this regard.
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Annexure
LFAR (For Large/ Irregular/ Critical Advance Accounts)
(To be obtained from the branch Management by the Branch Auditors of branches dealing in large advances/
asset recovery branches)
1. Name of the Borrower
2. Address
3. Constitution
4. Nature of business/ activity
5. Other units in the same group
6. Total exposure of the branch to the Group+
Fund Based (Rs. in lakhs)
Non-Fund Based (Rs. in lakhs)
7. Name of Proprietor/ Partners/ Directors
8. Name of the Chief Executive, if any
9. Asset Classification by the Branch
(a) during the current year
(b) during the previous year
10. Asset Classification by the Branch Auditor
(a) during the current year
(b) during the previous year
11. Are there any adverse features pointed out in relation to asset classification by the Reserve Bank of
India Inspection or any other audit.
12. Date on which the asset was first Classified as NPA (where applicable)
Facilities sanctioned:
Date of Nature of Limit Prime Collateral Margin % Balance outstanding at the
Sanc-tion facilities (Rs. in Security Security year-end
Lakhs) Current Previous
Year Year
Provision made: Rs.________ lakhs
13. Whether the advance is a consortium advance or an advance made on multiple-bank basis.
14. If Consortium,-
(a) names of participating banks with their respective shares
(b) name of the Lead Bank in Consortium
15. If on multiple banking basis, names of other banks and evidence thereof.
16. Has the Branch classified the advance under the Credit Rating norms in accordance with the
guidelines of the Controlling Authorities of the Bank.
17. (a) Details of verification of primary security and evidence thereof;
(b) Details of valuation and evidence thereof
Date verified Nature of Security Value Valued by
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Insured for Rs. _______ lakhs (expiring on ________)
18. (a) Details of verification of collateral security and evidence thereof
(b) Details of valuation and evidence thereof
Date verified Nature of Security Value Valued by
Insured for Rs. _______ lakhs (expiring on ________)
19. Give details of the Guarantee in respect of the advance
(a) Central Government Guarantee;
(b) State Government Guarantee;
(c) Bank Guarantee or Financial Institution Guarantee;
(d) Other Guarantee
Provide the date and value of the Guarantee in respect of the above.
20. Compliance with the terms and conditions of the sanction
Terms and Conditions Compliance
(i) Primary Security
a) Charge on primary security
b) Mortgage of fixed assets
c) Registration of charges with Registrar of Companies
d) Insurance with date of validity of Policy
(ii) Collateral Security
a) Charge on collateral security
b) Mortgage of fixed assets
c) Registration of charges with Registrar of Companies
d) Insurance with date of validity of policy
(iii) Guarantees - Existence and execution of valid guarantees
(iv) Asset coverage to the branch based upon the arrangement (i.e., consortium
or multiple-bank basis)
(v) Others:
a) Submission of Stock Statements/ Quarterly Information Statements and
other Information Statements
b) Last inspection of the unit by the Branch officials: Give the date and
details of errors/ omissions noticed
c) In case of consortium advances, whether copies of documents
executed by the company favouring the consortium are available.
d) Any other area of non compliance with the terms and conditions of
sanction
21. Key financial indicators for the last two years and projections for the current year (Rs. in lakhs)
Indicators Audited Audited Estimates for year
year ended 31st year ended 31st ended 31st March ___
March___ March___
Turnover
Increase in turnover % over previous
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Long Form Audit Report in Case of Bank Branches
year
Profit before depreciation, interest and
tax
Less: Interest
Net Cash Profit before tax
Less: Depreciation
Less: Tax
Net Profit after Depreciation and Tax
Net Profit to Turnover Ratio
Capital (Paid-up)
Reserves
Net Worth
Turnover to Capital Employed Ratio
(The term "Capital Employed" means the
sum of Net Worth and Long Term
Liabilities)
Current Ratio
Stock Turnover Ratio
Total Outstanding Liabilities/Total Net
Worth Ratio
In case of listed companies, Market
Value of Shares
(a) High;
(b) Low; and
(c) Closing
Earnings Per Share
Whether the accounts were audited? If
yes, upto what date; and are there any
audit qualifications
22. Observations on the operations in the account:
Excess over drawing Excess over limit
power
1. No. of occasions on which the Balance exceeded the
drawing power/ sanctioned limit (give details)
Reasons for excess drawings, if any
Whether excess drawings were reported to the Controlling
Authority and approved
Debit Summation Credit Summation
(Rs. in Lakhs) (Rs. in Lakhs)
2. Total summation in the account during the year
Less: Interest
Balance
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
23. Adverse observations in other audit reports/ Inspection Reports/ Concurrent Auditor's Report/ Internal
Audit Report/ Stock Audit Report/ Special Audit Report or Reserve Bank of India Inspection with regard
to:
(i) Documentation; (ii) Operations;
(iii) Security/Guarantee; and (iv) Others.
24. Branch Manager's overview of the account and its operation.
25. (a) In case the borrower has been identified/ classified as Non-performing Asset during the year,
whether any unrealised income including income accrued in the previous year has been
accounted as income, contrary to the Income Recognition Norms.
(b) Whether any action has been initiated towards recovery in respect of accounts identified/
classified as Non-performing Assets.
Date: Signature and Seal of Branch-in-Charge
388
V-2
Long Form Audit
Report in Case of Banks
2.01 The statutory auditors should address their LFAR to the Chairman of the bank concerned and also a copy
thereof should be forwarded to the designated office of the RBI. Many of the matters to be dealt with by the
statutory auditors in their LFARs are, normally, based on the LFARs received from the branch auditors. In dealing
with such matters, the statutory auditors are expected to make their observations on the basis of review of branch
auditors' LFARs.
2.02 Where any of the comments made by the auditor in his LFAR is adverse, he should consider whether a
qualification in his main report is necessary. It should not, however, be assumed that every adverse comment in
the LFAR would necessarily result in a qualification in the main audit report. In deciding whether a qualification in
the main report is necessary, the auditor should use his professional judgement having regard to the facts and
circumstances of each case.
2.03 Where the auditors have any reservation or adverse remarks with regard to any of the matters to be dealt
with in their LFARs, they should give the reasons for the same.
2.04 The matters to be dealt with by the statutory auditors in their LFARs are discussed in the following
paragraphs.
I. Advances
2.05 Lending activities constitute an important part of a bank's operations. The statutory auditors are expected
to offer their comments on various aspects of lending activities in their LFARs. The format of LFAR requires the
statutory auditors to offer their comments on the following aspects:
a. Credit policy e. Review / Monitoring / Supervision
b. Credit appraisal f. Recovery Policy in respect of Bad
c. Sanctioning / Disbursement / Doubtful Debts/NPAs
d. Documentation g. Large advances
2.06 The statutory auditors are expected to offer their comments on the adequacy and effectiveness of the
internal control systems relating to the above aspects of credit administration. In order to form an opinion on these
matters, the statutory auditors would also need to consider the branch auditors' LFARs. In cases where sanctions
are accorded otherwise than at the branch level (i.e., by higher / Controlling Authorities), the auditors should carry
out, on a selective basis, an examination of the specified matters at the head office and / or other controlling
offices of the bank.
2.07 Every bank usually has a written manual of instructions which describes in detail the procedures to be
followed for executing various types of transactions and also lays down limits on delegated powers in respect of
various operations of the bank. The auditor should examine such manual of instructions and report his views as to
the adequacy of the relevant instructions in the LFAR. Further every bank will have its own limits above which the
instances of observations be attached to LFAR comments. It would be prerogative of the auditors to revise these
limits in consultation with the Management.
2.08 Further, as per the "Master Circular Loans and Advances Statutory and Other Restrictions" dated July
Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
1, 2015, DBR.No.Dir.BC.10/13.03.00/2015-16 dated July 1, 2015 issued by the RBI, all banks are required to
frame "Fair Practices Code for Lenders" based on the Guidelines contained in this Master Circular. The Fair
Practices Code Covers areas, such as, applications for loans and their processing, loan appraisal and terms /
conditions, disbursement of loans including changes in terms and conditions, post disbursement supervision,
general aspects, etc. Further, RBI vide its circular no. DBOD. Leg. BC. 61 /09.07.005/2010-11 dated November
12, 2010 on "Guidelines on Fair Practices Code for Lenders Disclosing all information relating to processing fees
/ charges" requires the banks to disclose 'all in cost' inclusive of all such charges involved in processing / sanction
of loan application in a transparent manner to enable the customer to compare the rates / charges with other
sources of finance. It should also be ensured that such charges / fees are non-discriminatory.
Credit Policy
2.09 In respect of loan policy, the auditor is expected to give his observations on
Existence of Loan Policy specifying the prudential exposure norms, industry-wise exposures, regular
updation of the policy, system of monitoring and adherence thereto.
2.10 Each bank has its own policy for sanctioning, disbursing, supervising and renewing loans. The policy
usually includes the terms and conditions for granting loans, limits upto which loans may be disbursed to individual
clients, industry wise exposure, i.e., different exposure limits for different industries, etc. The policy should
specifically include the prudential norms given by the RBI. The auditor should report whether the policy is in
existence and the same is regularly updated depending on the guidelines issued by the RBI. The Master Circular
on "Loans and Advances Statutory and other Restrictions", DBR.No.Dir.BC.10/13.03.00/2015-16 dated July 1,
2015, provides a framework of the rules / regulations / instructions issued to Banks on statutory and other
restrictions on loans and advances. The Master Directions on "Lending to Micro, Small & Medium Enterprises
(MSME) Sector" FIDD.MSME & NFS.3/06.02.31/2016-17 dated July 21, 2016, contains guidelines / instructions /
directives issued by the RBI to banks in regard to matters relating to lending to Micro, Small & Medium Enterprises
sector. The auditor should also enquire whether there is any system followed by the bank for regularly monitoring
the policy laid down by the bank.
Credit Appraisal
2.11 In respect of credit appraisal, the auditor is expected to give his observations on
Existence of a well-laid system of appraisal of loans / credit proposals, including adequacy of information
for appraising the creditworthiness of the applicant, and adherence thereto.
2.12 Credit appraisals require a detailed analysis of the borrower's or, counterparties financial position and
debt-servicing ability, a thorough understanding of their background and the purpose of the credit and an
evaluation of the collateral pledged, if any. The auditor should review the system of credit appraisal followed by
the bank. He should examine whether the system facilitates a proper evaluation of the credit risk. In order to
facilitate collection and analysis of all the relevant data for evaluating creditworthiness of a prospective borrower,
banks generally use standardised loan application forms. The factors considered in evaluating loan applications
normally include the purpose of loan, prospects of the business, the sources and period of repayment (in case of
term loans), the borrower's stake and security, etc. Further, information in the form of financial statements, costing
analyses, market information, External Rating, tax status, project reports (in case of new projects), etc., is also
usually obtained from prospective borrowers and analysed.
2.13 The auditor should also satisfy himself that the system of credit appraisal is actually in force. For this
purpose, he should review the relevant observations of the bank's branch auditors contained in their LFARs.
Where the auditor has serious reservations about the quality of credit appraisal, he may also give his observations
in this regard.
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Long Form Audit Report in Case of Banks
Sanctioning/Disbursement
2.14 In respect of sanctioning / disbursement of advances, the auditor is expected to comment on
Delegation of powers / authority at various levels; adherence to authorised limits; whether limits are
disbursed after complying with the terms and conditions of sanction.
2.15 The auditor should familiarise himself with the system of sanctioning and disbursement of advances. He
should also familiarise himself with the relevant directives of RBI. Normally, the system in a bank provides for
limits on the sanctioning powers of authorities at various levels. The auditor should examine the documents
prescribing such limits, e.g., operation manual, circulars from head office, etc. Where the branch auditors' reports
indicate cases of credit facilities sanctioned beyond the aforesaid limits, the auditor should draw attention to this
fact in his LFAR. The auditor should also examine the branch auditors' report to ascertain whether such cases
have been promptly reported to higher authorities as per the procedure laid down in this regard. If not, he should
report the fact, giving illustrations of non-compliance with the laid down procedure in his LFAR.
2.16 The auditor should also review the sanctions made at different levels. For this purpose, the auditor should
randomly select a sample of sanctions made at various levels and review whether the procedure laid down for the
concerned level has been followed. Where the auditor has serious reservations about any of the aspects thereof,
he should give his observations in this regard in his LFAR. Where the branch auditors' reports indicate cases
where limits have been disbursed without complying with the terms and conditions of the relevant sanctions or
cases of frequent overdrawing beyond sanctioned limits, the auditor should state this fact in his LFAR, giving
illustrations.
Documentation
2.17 The auditor is expected to comment on the following aspects of documentation in respect of advances:
System of ensuring that documents are executed as per the terms of sanction.
Nature of documentation defects observed during audit and suggestions to avoid such defects.
System of documentation in respect of joint/consortium advances.
Renewal of documents.
2.18 Generally, the system of a bank prescribes the specific documents to be executed in respect of various
types of credit facilities, including special documentation required in cases of consortium advances, advances to
companies, statutory corporations and government undertakings, etc. It may be noted that in case of consortium
advances, original documents are held by the lead bank, however, copies of such documents are available with
each of the participating banks. Banks also usually have a system of renewal of documents and of periodically
obtaining confirmation of balances to ensure that the documents do not become time-barred.
2.19 The auditor should review the system of obtaining the loan documents, including renewal thereof. He
should examine whether the system provides for obtaining all such loan documents which are required to protect
the interests of the bank.
2.20 Where the branch auditors' reports indicate cases of credit facilities accorded without proper
documentation, the auditor should state this fact in his report, giving illustrations.
2.21 The auditor is also required to comment on the nature of documentation defects observed during the
audit and to make suggestions to avoid such defects. The auditor can obtain the relevant information substantially
from the branch audit reports and from records maintained at the head office / regional or zonal offices of the
bank.
Review/ Monitoring/ Supervision
2.22 In respect of review, monitoring and supervision of advances, the auditor is required to comment on the
following aspects:
Periodic balance confirmation / acknowledgement of debts.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Receiving regular information, Stock / Book Debt statements, Balance Sheet, etc.
Receiving audited accounts in case of borrowers with limits beyond Rs.10 lakhs.
System of scrutiny of the above information and follow-up by the bank.
System of periodic physical verification or inspection of stocks, equipment and machineries and other
securities.
System and periodicity of stock audits.
Inspection reports and their follow-up.
Norms and awarding of Credit Rating.
Review / renewal of advances including enhancement of limits.
Monitoring and follow-up of overdues arising out of other businesses such as leasing, hire purchase,
credit cards, etc.
Overall monitoring of advances through maturity/ aging analyses; Industry-wise exposures and
adherence to the Loan Policy.
System of monitoring of off-balance sheet exposures including periodic reviews of:
(a) claims against the bank not acknowledged as debts
(b) letters of credit
(c) guarantees
(d) ready forward transactions
(e) co-acceptances
(f) swaps, etc.
The auditor should examine whether the internal credit rating system has linkage with pricing of advances
with various products.
System of monitoring of unhedged foreign currency exposure and adequacy of provisioning thereof.
System of classification, monitoring, reporting and provisioning, if required of loan accounts in 3 categories
as special mention accounts.
2.23 Generally, banks have a system of periodic review of each advance. The primary purpose of such a
review is to ensure that the assumptions on the basis of which the loan had been sanctioned continues to hold
good; the loan is used for the purpose for which it was sanctioned and in case of deviation in respect of any
aspect of the sanction, approval of appropriate authority has been obtained; the project has been implemented as
per the approved lines; there are no unexplained overruns in cost of the project; the borrowing unit is functioning
properly; the stipulated instalments/interest are being paid regularly and promptly and, in case of default or delay
in payment, the reasons are looked into; the terms and conditions of the loan, particularly restrictive covenants,
are being duly complied with; the required margins have been maintained in the account at all times; the
properties mortgaged/hypothecated/ pledged are maintained in good order by the borrower and adequately
insured, etc. The auditor should examine whether the system of periodic review is functioning effectively. He
should review the LFARs given by the branch auditors to identify any weaknesses in the design of the system and
in its implementation.
2.24 The auditor should examine whether there is an effective system of obtaining confirmations /
acknowledgement of debts periodically. For this purpose, the auditors should also review the branch audit reports.
2.25 The RBI has issued a circular (dated April 12, 1985) advising all scheduled banks to ensure that non-
corporate borrowers enjoying aggregate working capital limit of Rs.10 lakhs or more from the banking system get
their accounts audited by chartered accountants in the prescribed manner. The auditor is expected to report on
compliance with this requirement in case of sanction or renewal of limits, primarily on the basis of a review of
branch audit reports. The auditor should report the number of branches and the total number of accounts in
respect of which audited accounts have not been placed on record.
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Long Form Audit Report in Case of Banks
2.26 The auditor is also expected to comment on the effectiveness of system of physical verification or
inspection of stocks, machineries and such other securities which have been charged to the bank. The auditor's
comments will be based primarily on a review of branch audit reports.
2.27 In 1985, the RBI advised banks to introduce a comprehensive and uniform Health Code System
indicating the quality or health of individual advances. At present the health code system is not in operation.
2.28 However, in the wake of the introduction of guidelines for income recognition, assets classification and
provisioning vide RBI's Circular No. DBOD.BP.BC.129/ 21.04.043-92 dated April 27, 1992, the RBI reviewed the
need to continue to require the classification of advances as per the Health Code System. Based on the review,
the RBI made the continuance of the Health Code System discretionary for banks. In case a bank uses this tool,
auditors may peruse the information from an audit perspective.
2.29 The auditor should examine whether the bank has continued to classify the advances as per the Health
Code System. If so, the auditor should familiarise himself with the procedure followed by the bank for classifying
advances as per the Health Code System. Any defects or inadequacies in the procedure should be dealt with in
the report along with recommendations/ suggestions for improvement or for remedial action to be taken on the
existing procedure by the Management. The auditor should also review whether the classification of advances as
per the Health Code System has been made on the basis of a realistic assessment. Where, in the opinion of the
auditor, the classification should have been different from that made by the bank, he should report the same.
2.30 Where the bank has discontinued the Health Code System the auditor should state this fact.
2.31 The auditor may review the statistical and analytical reports on advances which are often placed for
information before the Board of Directors or submitted to the RBI. Based on this data, the Board assesses the
bank's exposure to various industries. The auditor is expected to comment on the effectiveness of such reporting
system in vogue in the bank.
2.32 Generally, banks have a system of periodic review of credit rating awarded to various clients. The
purpose is to review whether the rating which had been awarded to a particular client continues to hold good as
per the norms or whether a review of the credit rating was required. The auditor should examine whether the
system of periodic review is functioning effectively as per the norms fixed by the bank. He should review the
LFARs given by the branch auditors to identify whether the norms for credit rating are being followed consistently.
Where the branch auditors have pointed out any weaknesses in the review / monitoring / supervision of such
norms, the auditor should, if the weaknesses are material, comment and find out the impact.
2.33 Apart from conducting the normal banking business, banks also undertakes other activities like, leasing,
hire purchase, etc. The auditor should examine whether the bank has a system for monitoring the overdue arising
out of this business. The auditor should also examine whether for the purpose of overdue, regular follow-up is
done with the customers from which the funds are due.
Recovery Policy in Respect of Bad/Doubtful Debts/ NPAs
2.34 The auditor is expected to report on the following aspects of the recovery period:
Existence of a recovery policy; regular updation thereof; monitoring and adherence thereto; compliance
with the RBI guidelines.
System of monitoring of recovery from credit card dues in respect of credit cards issued.
Effectiveness of the system for compiling data relating to the bad and doubtful debts and the provision in
respect thereof.
System for identification, quantification and adequacy of provision (including that at foreign branches).
System for suspension of charging of interest and adherence thereto.
Ascertaining the realisable value of securities (including valuation of fixed assets) and the possible
realisation from guarantors including DICGCI/ ECGC/CGST.
Assessment of the efficacy of rehabilitation programmes.
Method of appropriation of recoveries against principal, interest, etc.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
System of compromise/ settlement. Review such cases and cases of recovery of over Rs.1.00 crore and
also the cases wherein limit of sacrifices laid down in the Recovery Policy is exceeded. Compliance with
RBI guidelines.
Provision/write-offs under proper authority.
Recovery procedures including those relating to suit filed and decreed accounts
System of identifying and reporting of willful defaulters.
2.35 The Bank should have a policy for recovery of the bad and doubtful debts and NPAs. The auditor should
examine whether the policy framed complies with the RBI guidelines and also that the same policy is followed by
the branches. The policy should be regularly monitored and updated keeping in view the RBI guidelines where the
bank gives credit to its customers by way of credit card also, the auditor should examine whether proper
procedure is adopted to recover the credit card dues. The RBI has issued a Master Circular on "Credit Card, Debit
card and Rupee Denominated Cobranded Prepaid Card Operations of banks" (RBI/2015-16/31 DBR.No.FSD.BC.
18/ 24.01.009/ 2015-16) dated July 1, 2015. The circular provides general guidelines to banks on their credit card
operations, and the systems and control expected of them in managing their credit card business.
2.36 The RBI has issued detailed guidelines for income recognition, asset classification, provisioning and other
related matters vide Master Circular on "Prudential Norms on Income Recognition, Asset Classification and
Provisioning pertaining to Advances" (DBR.No.BP.BC.2/21.04.048/2015-16) dated July 1, 2015. Under the
guidelines, the quantum of provision as also the charging of interest is dependent upon the classification of
advances into performing or non-performing. The non-performing advances are required to be further classified
into sub-standard, doubtful and loss assets. The auditor should satisfy himself that there exists a system of
ensuring correct classification of advances as per the RBI guidelines. For this purpose, the auditor should review
the adequacy and appropriateness of the instructions issued to the branches.
2.37 According to the aforesaid guidelines, income from Non-performing Advances (NPAs) is not recognised
on accrual basis but is booked as income only when it is actually received. However, 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. As a measure of control and also to ensure that the legal remedies
against defaulting borrowers are not adversely affected, banks normally follow the procedure of recording interest
on non-performing advances in a separate account styled as `Interest Suspense' or maintaining only a record of
such interest in proforma accounts. It may be noted that the amounts held in Interest Suspense Account (or other
similar account) cannot be reckoned as part of provision in respect of non-performing advances. Amounts lying in
Interest Suspense Account are to be deducted from the relevant advances, and provisions (as required by the RBI
norms) are to be made on the balances after such deduction.
2.38 The auditor should enquire into the procedure followed by the bank for recording interest on non-
performing advances. Any departures from the laid down procedure which comes to the auditor's attention should
be reported. The auditor should also comment on the increase/ decrease during the year in the aggregate balance
held in Interest Suspense Account.
2.39 Realisable value of securities is relevant in determining provisioning against doubtful debts. Therefore,
the auditor should examine whether there is a system of having realistic estimates of the value of security
available, such as immovable properties, plant and machinery and stocks. The availability of security or net worth
of borrower/guarantor should not be taken into account for the purpose of treating an advance as NPA or
otherwise, as income recognition is based on record of recovery.
2.40 Every bank usually has a procedure for the write-off of bad debts, including the limits on authority to deal
with/approve such write-offs. These limits are normally sanctioned by the Board of Directors or other similar
authority. The auditor should examine the relevant procedure as also whether the provisions/write-off confirm to
the laid down procedures.
2.41 At times, the Management may opt for one-time settlement or an out-of-court settlement with the
defaulting borrowers on agreed stipulations as to down payment and installment over a period. The auditor should
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Long Form Audit Report in Case of Banks
verify the authority for write-off, if any, arising out of such settlement and the system for proper accounting thereof.
2.42 As regards advances to sick units which are under rehabilitation programmes, the auditor should examine
whether the bank has adhered to the broad parameters for grant of relief / concessions as per the RBI guidelines.
The auditor should examine the efficacy of rehabilitation programs by comparing the actual performance with the
estimates contained in the rehabilitation programme. On the basis of such assessment, the auditor should examine
whether any further provision is required in respect of the units concerned. In this regard, it may be pointed out that
the Guidelines require that provision should continue to be made in respect of the dues to a bank in respect of
existing credit facilities sanctioned to a unit under rehabilitation, as per their classification as sub-standard or doubtful
asset. As regards the additional facilities sanctioned as per package finalised by BIFR and/or term lending
institutions, provision on additional facilities sanctioned need not be made for a period of one year from the date of
disbursement. Further, in respect of additional credit facilities granted to SSI units which are identified as sick and
where rehabilitation packages/ nursing programs have been drawn by the bank themselves or under consortium
arrangements, no provision need to be made for a period of one year.
2.43 The auditor is also expected to comment on the efficacy of the procedure for recovery of bad/doubtful
advances, including that relating to suit-filed and decreed accounts. The auditor can get the relevant information from
the branch audit reports and from the records maintained at head office/regional or zonal offices. The auditor should
particularly review the efficacy of procedure for recovery in cases where decrees have been obtained in favour of the
bank. Where there are significant doubts about the execution of the decrees, the auditor should take this fact into
account in determining the adequacy of the provision.
Large Advances
2.44 In respect of large advances, the auditor's responsibility is as under:
Comments on adverse features considered significant and which need Management's attention.
2.45 In the normal course of audit, the auditor would obtain from the Management a list of problem accounts and
discuss the same to determine whether any such account is doubtful of recovery. On the basis of information and
explanations provided by the Management, the auditor may be satisfied that certain problem accounts need not be
considered doubtful of recovery and, therefore, not be provided for beyond the provision required under the
guidelines for provisioning issued by the RBI. In respect of such major accounts, the auditor should give relevant
details in the LFAR. The details to be given in respect of each such account should include the name of the borrower,
the amount outstanding and a brief history and statement of facts. It would be desirable for the auditor to obtain the
relevant explanations from the Management in writing.
2.46 As regards adverse features in large accounts, the auditor can obtain relevant information substantially
from the branch LFARs and from records maintained at the head office/regional or zonal offices. Banks usually
have a system of reporting to the Board on large accounts (e.g., accounts where the borrowings are of Rs 2 crores
or 5% of aggregate year-end advances of the branch whichever is lower) where the adverse features have been
observed, including accounts which require a review or close monitoring to ensure that they do not become sub-
standard or doubtful at a later stage. Unhealthy features in such accounts include frequent over-drawing beyond
sanctioned limits, non-furnishing of data relating to security, defaults in furnishing of the information relating to the
security charged to the bank, non- registration of charge in the case of companies, default in the matter of various
stipulations for borrowings (for example, keeping the security uninsured, accumulation of old/obsolete stocks,
etc.), non-renewal of documents, defaults in complying with the repayment schedules, frequent returning of bills in
bill-discounting facility, and non-observance of the covenants between the bank and the borrower which may have
a significant impact on the realisability of the advance or which may cause detriment to the security charged. The
auditor should review the relevant reports submitted to the Board, where available.
2.47 The auditor should indicate the name of the branch, the name of the borrower, the balance as at the year-
end and the general nature of adverse features noticed during the year. In case the adverse features have been
persistent over a period of time and adverse comments have been made by the previous auditor(s) on these
accounts, the same should also be reported.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
2.48 In case the auditor notices a trend of the adverse observations then he may suitably report them in a
summarised manner. In case this adverse trend is of a significant nature the auditor will need to consider the
same while reporting on the effectiveness of internal financial controls, if such reporting is applicable to the bank.
II. Liquidity and Funds Management
Investments
2.49 The auditor is expected to comment on the following aspects of investments:
Existence of investment policy and adherence thereto; compliance with RBI guidelines.
System of purchase and sale of investments; delegation of powers; reporting system; segregation of back
office function, etc.
Controls over investments, including periodic verification/ reconciliation of investments with book records.
Valuation mode; changes in mode of valuation compared to previous year; shortfall and provision thereof.
Investments held at foreign branches; valuation mode; regulatory reserve requirements; liquidity.
Composition of investment portfolio as per RBI guidelines and the depreciation and diminution in the
value of investments, if any, not provided for.
System relating to unquoted investments in the portfolio and the liquidity of such investments.
System relating to SGL/BRs; control over SGL/BRs outstanding at the year end and their subsequent
clearance.
System and periodicity of concurrent and internal audit/ inspection of investment activities; follow up on
such reports.
System of recording and accounting of income from investments
System of monitoring of income accrued and due but not received.
System of monitoring matured investments and their timely encashment.
Average yield on investments.
System related to Repos
2.50 The auditor is required to comment whether there exists any investment policy in accordance with RBI
guidelines and whether the same has been properly implemented. For that purpose, the auditor should not only
familiarise himself with the investment policy of the bank, including broad investment objectives, authorities
competent to make investments, procedure to be followed to put through deals, procedure to be followed for
obtaining sanction of the appropriate authority, prescribed exposure limits and the system of reporting but also
report whether the same is in existence in accordance with the RBI Guidelines and whether the same is being
properly implemented. The RBI has issued detailed guidelines concerning investment portfolio of banks (Master
Circular on "Prudential Norms for Classification, Valuation and Operation of Investment portfolio by Banks" DBR
No BP.BC.6 /21.04.141/2015-16 dated July 1, 2015). These guidelines include instructions in respect of ready
forward or buy-back deals, transactions in government securities for which Subsidiary General Ledger (SGL)
facility is available, issue of bank receipts (BRs) and related records, internal control system for buying and selling
securities, dealings through brokers and uniform accounting for Repo/Non-Repo transactions. The RBI has also
issued detailed guidelines in respect of accounting of investments, including their classification under permanent
and current categories. The auditor should familiarise himself with these guidelines and examine whether the bank
has complied with them.
2.51 The auditor should examine the efficacy of various controls over investments, including the functional
separation of various operations, custody of investment scrips, periodic physical verification of investments and
reconciliation with book records. Any shortcomings in the prescribed system or non-compliance with the
prescribed system should be reported.
2.52 The auditor should enquire into the mode of valuation of investments and ascertain whether the mode of
valuation followed during the year is same as that followed in the previous year. The auditor's reporting requirements
include: (a) the mode of valuation of year-end investments, and (b) any change in the mode of valuation of
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Long Form Audit Report in Case of Banks
investments as compared to that of the previous year.
2.53 The auditor should ascertain the method followed for recording of the shortfall (depreciation) in the value
of investments which is arrived at by comparing the market value of Investments with their book value as at the
year end. If bank has not provided for depreciation on investments then the auditor should state the fact.
2.54 While reporting on the shortfall in value as at the year-end, the auditor may give the relevant information
separately in respect of various kinds of investments (e.g., government securities, other approved securities, etc.).
The manner of arriving at the shortfall in the value of securities should be indicated particularly in the case of non-
traded or unquoted securities. Further, the auditor should also verify entries made in "Investment Reserve
Account" and proper utilisation of the same, if any.
2.55 The auditor should carefully scrutinize the entire investment portfolio keeping in mind the RBI guidelines
and comment whether investment portfolio is as per the RBI guidelines. The auditor should also verify that the
accounting methodology for Repo/ Reverse Repo transactions is appropriate and uniform throughout the year. For
this purpose, the auditor should thoroughly familarise himself with the RBI guidelines. A brief discussion of RBI
guidelines is already given in earlier chapters.
2.56 In case of unquoted investments, reporting requirements of the auditor include:
Whether appropriate system is followed for valuation of the unquoted investment in the portfolio. The
basis of valuation is different depending on the type of investment.
Whether the unquoted investments are liquid in nature, i.e., they are easily saleable in the open market.
This depends on the trend of the sale price, net-worth of the enterprise, the market condition, etc.
2.57 Amongst internal audit of various areas and departments, internal audit of investment activities is one of
the important requirements. While not only the scope and frequency of various types of internal audits in different
banks varies, their form also varies, one of which is concurrent audit. Concurrent audit is to be regarded as bank's
early-warning system to ensure timely detection of irregularities and lapses which helps in preventing fraudulent
transactions. It also refers to examination of the transactions by an independent person not involved in its
documentation. The emphasis is in favour of substantive checking in key areas rather than test checking.
2.58 Auditor is expected to report whether the bank has a proper system of conducting concurrent and internal
audit of investment activities either through its own staff or external auditors. The option to consider bank's own
staff or external auditors is at the discretion of the individual banks. The auditor is expected to comment on the
system in existence. The auditor should also enquire whether the bank has appropriate system for carrying out the
inspection of investment activities on a regular basis. The auditor should report whether the bank has undertaken
a follow up of the report and implemented relevant suggestions.
2.59 Income from investments includes all income derived from the investment portfolio by way of interest and
dividend etc., from subsidiaries and joint ventures abroad / in India. The bank should have an appropriate system
of recording income so that all the incomes which arose from the transaction which took place during the relevant
period and pertain to the bank are actually recorded. The auditor should report whether there are no unrecorded
incomes and that income is recorded in proper amounts and that it is allocated to the proper period.
2.60 The auditor should report whether there is a proper system for monitoring income accrued and due but
not received and whether appropriate steps have been taken by the bank to recover the same.
2.61 The bank should have a system of keeping a track of investments which would mature in the near future
so that its encashment can be done as soon as they mature. The auditor is required to report whether investments
are encashed on time. The auditor should also report whether the bank has a system of monitoring the matured
investment, i.e, the matured investments and depending on the requirement for funds, reinvestment of the same.
The funds should be reinvested taking into consideration the risk-return analysis.
2.62 In case of investments held at foreign branches, the auditor should satisfy himself for existence of such
investments. The auditor should examine that such investments are as per the rules and regulations set out by the
bank and the RBI. Valuation policy of such investment should be on same line as of investments held in India.
Such investment should be critically examined from the point of view of their liquidity.
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2.63 Auditor should find out average yield on investments made by the bank. Such yield should be compared
with the previous year as well as with industry norms. In case of investment where average yield is not adequate,
such investment should be scrutinized for their continuity.
SLR/CRR Requirements-System of Ensuring Compliance
2.64 The auditor is expected to comment on the following aspects of the system for ensuring compliance with
the SLR/CRR requirements:
System of compiling weekly DTL position from branches.
Records maintained for the above purpose
2.65 Section 24 of the Banking Regulation Act, 1949, requires that every scheduled commercial bank shall
maintain, in India, in cash, gold or unencumbered approved securities, an amount, the value of which shall not, at the
close of business on any day, be less than 20.75 per cent from October 1, 2016 and 20.50 per cent from January 7,
2017, on the total net demand and time liabilities (NDTL) as on the last Friday of the second preceding fortnight
valued in accordance with the method of valuation specified by the Reserve Bank of India from time to time.. This is
referred to as 'statutory liquidity ratio' (SLR). Section 18 of the Act requires that every banking company, not being a
scheduled bank, shall maintain in India by way of cash reserve with itself, or by way of balance in a current account
with the RBI, or by way of net balance in current accounts, or in one or more of the aforesaid ways, a sum equivalent
to at least 4.00 per cent of the total of its demand and time liabilities in India as on the last Friday of the second
preceding fortnight. Every scheduled bank is similarly required, by virtue of the provisions of section 42(1) of the
Reserve Bank of India Act, 1934, to maintain with the RBI an average daily balance the amount of which shall not be
less than 4.00 per cent of the total of its demand and time liabilities in India. The said rate may, however, be
increased by the RBI by notification up to 20% of the total of demand and time liabilities in India. Consequent upon
the amendment to sub-section (1) of Section 42 of the RBI Act, 1934, effective from June 22, 2006, the RBI having
regard to the needs of securing monetary stability in the country, can prescribe the Cash Reserve Ratio (CRR) for
Scheduled Commercial Banks without any floor rate or ceiling rate. The RBI, from time to time, reviews the evolving
liquidity situation and accordingly decides the rate of CRR required to be maintained by Scheduled Commercial
Banks. In terms of RBI circular dated November 26, 2016 on Requirement for maintaining additional CRR, Banks,
effective from the fortnight beginning November 26, 2016, are required to maintain with an incremental CRR of 100
per cent on the increase in NDTL between September 16, 2016 and November 11, 2016.
2.66 These requirements seek to ensure that banking institutions maintain adequate liquid assets in an
unencumbered form so as to safeguard the interests of depositors.
2.67 To comply with these requirements, banks have evolved systems whereby all branches send their weekly
trial balance as on every Friday and these are consolidated at the head office. Based on this consolidation, the
total demand and time liabilities (DTL) is determined for every alternate Friday (normally called `the reporting
Friday'). Banks have to maintain cash or other eligible assets on the basis of the DTL position during the following
fortnight.
2.68 The auditor should examine the system for compilation of DTL position, including verification of returns
and their consolidation by the bank. The auditor should request the Management to provide him a compilation of
all the circulars / instructions of the RBI regarding composition of items of DTL. He should review their compliance
by the bank. Any weaknesses in the system of compilation of DTL and its reporting to the RBI in the prescribed
form should be reported by the auditor, along with the suggestions, if any, to overcome such weaknesses.
2.69 The auditor may examine compliance with SLR/CRR requirements with reference to the eligible assets
maintained by the bank.
2.70 It may be noted that the RBI, vide its Master Circular No. RBI/2015-16/98 DBR. No. Ret.
BC.24/12.01.001/2015-16 dated July 1, 2015 on "Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)"
requires that the statutory auditors should verify and certify that all items of outside liabilities, as per the bank's
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books had been duly compiled by the bank and correctly reflected under DTL/NDTL in the fortnightly/monthly
statutory returns submitted to RBI for the financial year.
Cash
2.71 The auditor is required to comment on cash operations as under:
System of monitoring of cash at branches; and Management of cash through currency chest operations.
Insurance cover (including insurance for cash in transit).
System and procedure for physical custody of cash.
2.72 The cash is normally maintained under joint custody of the branch manager and the cashier. The main
key to the safe is with the branch manager while the second and the third keys are with the accountant and/ or
cashier. Each branch should maintain the records showing the details of keys and key-holders. Further, the bank
should have a system of verifying whether the instructions of the bank in this regard have been complied with
consistently throughout the year.
2.73 In the normal course, cash balances are expected to be verified on a daily basis and recorded in the cash
book under the signature of the branch manager and another authorised signatory, since cash is under dual charge
at the branch level. The auditor should ensure whether the bank has a system for verifying the same. The system
should include general scrutiny of the cash book to ascertain whether it is in accordance with the instructions given
by the bank, physical verification of cash and agreeing the same with the books maintained, with due authentication
of such balances by the authorised signatories. For this purpose, the auditor should review the LFARs of the
branches.
2.74 The auditor should ensure whether the bank has the system of checking the cash balance at the
branches at periodic intervals by the authorised officials of the bank.
2.75 The auditor is also supposed to comment whether the system relating to Management of the cash
through currency chest operations is appropriate. The currency chest operations are those where the bank holds
cash as an agent of RBI. The auditor should report whether the bank has a system of regularly monitoring the
currency chest operations. The balances in the chest should be periodically verified by the bank officials.
2.76 The auditor should examine and report on the adequacy of the insurance cover for cash with reference to
the cash balance generally carried by the bank. He should also examine whether the insurance policy is in force.
The auditor should ensure and comment whether the bank has obtained a global insurance policy in respect of
cash at all the branches. The auditor is also supposed to report whether the insurance obtained includes the
insurance for cash-in-transit.
2.77 The auditor should ensure about the system followed for the physical custody of cash. The system may
include as to maintenance of cash will be in joint custody of which two or more officials, verification of the cash
balance on daily basis and tallying the same with the books maintained, etc. The system should also include the
names of the person who will have the custody of the keys. The auditor should properly examine the system and
procedure and report whether the same is appropriate or there are any loopholes.
Call Money Operations
2.78 The auditor is required to make comments on system relating to call money operations as under:
System related to inter-bank call money.
2.79 The auditor should verify that aspects relating to call money operations, viz., prudential limits in respect of
outstanding borrowing and lending transactions, reporting requirement, documentation, etc., are adhered to in
accordance with the guidelines of RBI Master Directions on "Master Direction on Money Market Instruments:
Call/Notice Money Market, Commercial Paper, Certificates of Deposit and Non-Convertible Debentures (original
maturity up to one year)" dated July 7, 2016 (FMRD. Master Direction No. 2/2016-17. Any changes made to the rules
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and regulation during the year should be scrutinised. Auditor should check that all the above changes are promptly
and correctly conveyed to all the branches and whether any branch LFAR contains any negative remarks for the
above system.
Asset Liability Management
2.80 Regarding asset liability Management, the auditor is expected to make comment on the following
aspects:
Existence of Policy on Asset Liability Management and monitoring thereof; compliance with the RBI
guidelines.
Functioning of Asset-Liability Management Committee
2.81 RBI has issued guidelines on ALM system vide circular no BP.BC.8/21.04.098/99 dated February 10,
1999 advising banks to give adequate attention to put in place an effective ALM system. Bank should set up an
internal Asset-Liability Committee, headed by CEO/CMD or ED. The Management Committee or any specific
Committee of the Board should oversee the implementation of the system and review its functioning periodically.
The auditor should ensure whether the bank has a policy on Asset-Liability Management and whether the same
complies with the RBI guidelines. As per the RBI guidelines the ALM process rests on three pillars:
ALM Information Systems
Management Information Systems
Information availability, accuracy, adequacy and expediency
ALM Organisation
Structure and responsibilities
Level of top Management involvement
ALM Process
Risk parameters Risk Management
Risk identification Risk policies and
Risk measurement tolerance level
The auditor should also report whether the ALM policy is regularly monitored.
2.82 As per the circular No.BP.BC.8/21.04.098/99 dated February 10, 1999 Asset Liability Management
Committee consists of the bank's senior Management including CEO. This committee should be responsible for
ensuring adherence to the limits set by the Board as well as deciding the business strategy of the bank (on the asset-
liability sides) in line with the bank's budget and decided risks, Management objectives. As per the circular, each
bank is supposed to decide on the role of its Asset Liability Committee, its responsibility as also the decisions to be
taken by it. The auditor should ensure and report whether the committee is functioning as per the decisions formed
by the bank. The functioning of the committee should be useful and helpful to the Bank.
Structural liquidity at periodical intervals.
2.83 The final guidelines issued in circular no BP.BC.8/21.04.098/99 dated February 10, 1999 suggest the bank to
prepare Statements of Structural Liquidity by placing all cash inflows and outflows in the maturity ladder according to
expected timing of cash flows. As a measure of liquidity banks are required to monitor their cumulative mismatches
across all time buckets in their Statement of Structural Liquidity by establishing internal prudential limits with the
approval of the Board/ Management Committee. As per the guidelines, the mismatches (negative gap) during the time
buckets of 1-14 days and 15-28 days in the normal course, are not to exceed 20% of the cash outflows in the respective
time buckets. The RBI has issued "Guidelines on Asset-Liability Management (ALM) system amendments" (DBOD.
No. BP.BC. 38/21.04.098/2007-08) dated October 24, 2007 wherein the time buckets for preparation of Statement of
Structural Liquidity has been revised. The banks are required to adopt a more granular approach to measurement of
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liquidity risk by splitting the first time bucket in to three time buckets viz., next day, 2-7 days and 8-14 days. Accordingly,
format of Statement of Structural Liquidity has been revised and also guidance for slotting the future cash flows of banks
in the revised time buckets has also been suitably modified. However, the frequency of supervisory reporting of the
Structural Liquidity position shall be fortnightly, with effect from the fortnight beginning April 1, 2008. In this regard, RBI,
vide its circular on "Guidelines on Asset Liability Management (ALM) System (DBOD.No.BP.BC.68/21.04.098/2007-08
dated April 9, 2008), has advised banks to submit the Statement of Structural Liquidity as on the first and third
Wednesday of every month to RBI. The auditor is required to report whether the bank is preparing the Statement on
Structural Liquidity at the prescribed periodical intervals.
III. Internal Control
2.84 The auditor is expected to comment on the following aspects of internal control:
Written guidelines/instructions/manual for accounting aspects.
Balancing of Books/Reconciliation of control and subsidiary records
Inter-branch Reconciliation
Branch Inspections
Concurrent Audit
Dealing Room Operations
RBI Inspection
Frauds/Vigilance
Suspense Accounts, Sundry Deposits, etc.
Written Guidelines/Instructions/Manual for Accounting Aspects
2.85 Generally, every bank has a written guidelines/manual/ instructions, which describes in detail, the procedures
to be followed for executing various types of transactions. The manual normally also includes guidelines for accounting
of various types of transactions. The auditor should examine whether there exists a written manual or other compilation
in relation to various accounting aspects in the bank. The auditor should also examine whether there is a system of
updating the manual or other compilation periodically. He should particularly enquire whether the directions/ instructions
of the RBI relating to accounting aspects are incorporated in the manual promptly. The auditor should also examine the
system of communicating any changes in the manual to the branches.
Balancing of Books/Reconciliation of control and subsidiary records
2.86 These are:
System of monitoring the position of balancing of books/ reconciliation of control and subsidiary records.
Follow-up action.
2.87 The auditor's comments would cover the head office/regional or zonal offices as well as the branches. The
auditor can get the requisite information in respect of branches substantially from the LFARs pertaining to branches. The
auditor is also expected to comment on the balancing of the books of account, e.g., whether the primary books of
account have been tallied and the general ledger balanced. The auditor should examine the position relating to
balancing of books which form the basis of the financial statements. The status as at the year-end relating to books not
balanced should be clearly indicated by stating the relevant particulars and indicating the extent to which these remain
to be balanced.
2.88 The auditor should state the number of branches in respect of which the control and subsidiary records
have not been reconciled. Where such records have been reconciled after the year-end, the auditor should
exercise his judgment as to whether such cases need to be reported.
2.89 In so far as the head office is concerned, the auditor should give his observations on the unreconciled
balances between the control and subsidiary records. It is suggested that, in respect of the relevant heads of
account, the report should show the amount appearing in the general ledger, the aggregate amount appearing in
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the subsidiary records, and the difference between the two. The observations of the auditor would cover non-
balancing of subsidiary records at the head office and persistent defaults observed in reconciliation of control and
subsidiary records.
2.90 The auditor should critically examine the system for reporting the status of balancing/reconciliation by
branches and offer his comments and suggestions, if any.
Inter-branch Reconciliation
2.91 These are:
Comments on the system/ procedure and records maintained.
Test check for any unusual entries put through inter-branch/ head office accounts.
Position of outstanding entries; system for locating long outstanding items of high value.
Steps taken or proposed to be taken for bringing the reconciliation up-to-date.
Compliance with the RBI guidelines with respect to provisioning for old outstanding entries.
2.92 Inter-branch accounts are normally reconciled by each bank at the central level. While practices with
various banks may differ, the inter-branch accounts are normally sub-divided into segments or specific areas, e.g.,
'Drafts paid/ payable', 'inter-branch remittances', 'H.O. A/c', etc. The auditor should report on the year-end status
of inter-branch accounts indicating the dates up to which all or any segments of the accounts have been
reconciled. The auditor should also indicate the number and amount of outstanding entries in the inter-branch
accounts, giving the relevant information separately for debit and credit entries. The auditor can obtain the
relevant information primarily from branch audit reports. Where, in the course of audit, the auditor comes across
any unusual items in inter-branch/head office accounts, he should report the details of such items, indicating the
nature and the amounts involved. The auditor should examine the procedure for identifying the high-value items
remaining outstanding in inter-branch reconciliation. He should review the steps taken or proposed to be taken by
the Management for clearing the outstanding entries in inter-branch accounts, particularly the high-value items. If
he has any specific suggestions for expeditious reconciliation of inter-branch accounts including any
improvements in the systems to achieve this objective, the same may be incorporated in the report. In the new
CBS environment the branch reconciliation is done of IT department at H.O. in most of the banks.
2.93 Considering the extent of arrears in inter-branch accounts, the RBI, vide its circular no. DBOD No.
BP.BC. 73 /21.04.018/2002-03 dated February 26, 2003 has advised banks to arrive at the category-wise position
of unreconciled entries outstanding in the inter-branch accounts for more than six months as on March 31, 2004
and make provision equivalent to 100 percent of the aggregate net debit under all categories. While doing so, it
may be ensured that:
(i) The credit balance in the Blocked Account created in terms of instructions contained in circular DBOD No.
BP.BC.73/21.04.018/98 dated July 27, 1998 is also taken into account; and
(ii) The net debit in one category is not set-off against net credit in another category.
Branch Inspections
2.94 These are:
System of branch inspections: frequency; scope/ coverage of inspection/ internal audit, concurrent audit
or revenue audit; reporting.
System of follow-up of these reports; position of compliance.
2.95 The auditor should acquaint himself with the scheme of various internal inspections existing in the bank,
viz., internal audit, concurrent audit, revenue audit, etc. He should consider whether the frequency and coverage
of various types of audit are adequate having regard to the size of the bank. He should also examine the system
of follow-up and compliance with reports of various auditors.
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Dealing Room Operations
2.96 The auditor should obtain and comment on the observations forming part of the System Audit Report of
Dealing Room required to be conducted in terms of RBI guidelines
RBI Inspection
2.97 The auditor should obtain and comment on the observations forming part of Annual Financial Inspection
u/s 35 of the Banking Regulation Act, 1949 conducted by RBI.
Frauds/Vigilance
2.98 These are:
Observations on major frauds discovered during the year under audit.
System of follow-up of frauds/ vigilance cases. (Reported to RBI in FMR1.)
2.99 The auditor is expected to give his observations on major frauds discovered during the year under audit.
He is also expected to comment on the efficacy of the system of follow-up on vigilance reports.
2.100 Banks normally maintain a record, usually in separate register, of the frauds that have taken place at any
branch or other office which have been brought to the notice of the head office/Controlling Authority of the bank. A
brief history of each of the frauds discovered is also available to the statutory auditor, through reports by the
Management to the Board of directors as also to the RBI. The RBI has issued Master Directions on "Frauds-
Classification and Reporting" (RBI/DBS/2016-17/28 DBS.CO.CFMC.BC.No.1/23.04.001/2016 -17) dated July 1,
2016. The directions / circulars require the banks to report to RBI complete information about frauds and the
follow-up action taken thereon.
2.101 The auditor should look into the cases of major frauds which have been discovered and recorded
including those which have been reported after the year-end. He should report on major frauds discovered and
recorded by the bank. He should also examine the quarterly and annual review of frauds done by the bank and
ascertain the number of frauds where final action has been taken by the banks and cases disposed of.
2.102 In case the auditor observes weaknesses in the internal control system which have resulted in frauds, or
where the modus operandi is common, he may give his suggestions for overcoming such weaknesses by taking
preventive steps to reduce/minimise incidence of frauds.
Suspense Accounts, Sundry Deposits etc.
2.103 These are:
System for clearance of items debited/credited to these accounts.
2.104 The auditor should look into the procedure of the bank to determine whether entries raised in nominal
heads of account including `Suspense Accounts' and 'Sundry Deposits' or `Sundries Account' are cleared
expeditiously.
2.105 In the course of audit, the auditor would have examined large items and also old outstanding entries
included in the year-end balances in such accounts. It is possible that whereas a debit entry has been raised to
`Suspense Account', the corresponding credit may be lying in 'Sundry Deposits'; or other similar account and an
exercise may not have been carried out by the bank to adjust these transactions on matching, after proper scrutiny
thereof. In his report, the auditor should bring out large and old outstanding entries which deserve the attention of
the Management for expeditious clearance. He may also make his suggestions to the Management for expeditious
clearance of these entries by adjustment thereof after making a thorough scrutiny of the transitions. The auditor
may also point out any adjustments of large outstanding in these accounts which have not been specifically
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explained to him in the course of his audit, for example, for want of relevant documents/evidence or vouchers,
etc., and where he is not satisfied with the nature of adjustments made.
2.106 Where, in the course of audit, the auditor comes across any unusual items in `Suspense' or `Sundry
Deposits Account', he should report the details of such items, indicating the nature and the amounts involved. The
relevant information will be available to the auditor primarily from the branch audit reports.
IV. Capital Adequacy
2.107 The auditors are required to:
Enclose a copy of the capital adequacy certificate.
The auditors should bring out their observations on the systems and processes being followed by the
Bank for compilation of capital adequacy returns as well as on the efficacy of the internal control system
over the computation of the Risk Weighted Assets.
V. Automation and Computerisation
2.108 Computerisation results in changes in the processing and storage of information and affects the
organisation and procedures employed by the entity to achieve adequate internal control. The auditor should
ensure whether there exists any policy for computerisation and automation. The auditor is also required to
comment whether any progress has been made during the period under review. Progress may be in the nature of
conversion of partially computerised bank into fully computerised, or increasing the level of computerisation and
thereby making the work simpler.
2.109 Pursuant to circular DBS.CO.PP.BC.11/11.01.005/2001-2002 dated 17 April 2002, `Long Form Audit
Report to the Management by Central Statutory Auditors of Banks', the Central Statutory Auditors should address
their Long Form Audit Report to the Chairman of the Bank concerned and a copy thereof should be forwarded to
the designated office of the Reserve Bank of India. Some of the key aspects as regards to automation and
computerisation which should be covered are as follows. Regarding computerisation, the auditors are required to
comment on the following aspects:
Existence of Computerisation and Automation Policy; progress made during the year under review.
Critical areas of operations not covered by automation.
Number of branches covered by computerisation and the extent of computerisation.
Procedures for back-ups, off-site storage, contingency and disaster recovery and adherence thereto.
Existence of Systems/ EDP audit; coverage of such audit.
Electronic Banking; existence of systems and procedures; monitoring; regular updation of technology;
method of review and audit of procedures.
Suggestions, if any, with regard to computerisation and automation.
2.110 The central statutory auditor may in addition to performing specific work to comment on the above points
may also review the adequacy and appropriateness of the Information Security Policy and report any
shortcomings or suggestions for improvement in the computerisation and automation in the LFAR based on the
discussions with the Management and IT personnel and leveraging on the work performed whilst undertaking audit
procedures. The auditor may also report in his LFAR whether the approved Information Technology Security
Policy is in place and communicated to all the branches for implementation.
2.111 The auditor is also required to comment whether the critical areas are covered by automation and the
application used therein together with the fact as to whether the systems are developed in-house or acquired from
external vendors. Generally, critical areas like treasury and loans are supported by sub-systems which are
interfaced to the General Ledger. The auditor needs to make sure that there is a formal process of reconciliation of
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these sub- systems with the GL on a periodical basis. Further, the relevant application and access controls as
prevalent to the CBS should also be followed for these sub-systems.
2.112 The auditor should also report the number of branches covered by computerisation and the extent of
computerisation. The extent of computerisation may include inquiring whether the branch is fully or partially
computerised. For this purpose auditor will have to go through the LFARs of the branches. In case of private
sector banks and foreign branches, the central statutory auditor may inquire and verify about the level of branch
automation when he conducts branch visits.
2.113 The bank should have a documented procedure for off-site backup. The auditor should enquire about the
adequacy of the procedures followed for the recovery of data in case of contingency and disaster including details of
the data backup policies for its systems and data, disaster recovery plans, periodicity of backups and details of offsite
locations.
2.114 The auditor should report whether the bank has the system of conducting Systems audits periodically to
assess the effectiveness of the software, hardware and operations to identify any changes required therein. The
auditor also needs to review these reports to assess the impact of IT issues, if any, on the audit of the bank and
his scope of work.
Reconciliation of Control and Subsidiary Records
2.115 Have the figures, as at the year end, in the control and subsidiary records been reconciled? If not, the last
date upto which such figures have been reconciled should be given under the respective heads, preferably in the
following format:
Account Date General Ledger Subsidiary Last Date on which
Balance (Rs.) Balance (Rs.) balanced
VI. Profitability
2.116 The auditor is required to comment on the profitability aspects as under:
Analysis of variation in major items of income and expenditure compared to previous year.
Important ratios such as ROA, ROE etc; comparison and analysis in relation to previous year.
Policy relating to general provisions/ reserves.
2.117 The auditor is expected to present an analysis of variations in major items of income and expenditure
compared to previous year, along with important ratios. This information is normally compiled by banks as per the
requirements of the RBI. Wherever feasible, the auditor may also comment on the extent of income generated
through non-traditional and specialized activities, such as, merchant banking, consumer banking, etc., as also on
any unusual items of income and expenditure which may have had a significant impact on the profit/loss for the
year.
2.118 The effects of any changes in accounting policies on the profit/loss for the year should be reported by the
auditor.
VII. Systems and Controls
2.119 The auditor is required to comment on systems and controls as under:
Existence of systems and procedures for concurrent and internal audits, inspections, EDP audit of computer
systems/software, etc.; monitoring and follow - up on such reports;
2.120 Internal audit is an important constituent of the system of internal control in banks. Banks should
generally have well organised system of internal audit. The internal audit is carried out either by separate
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departments within the bank or by firms of chartered accountants. The scope and frequency as also the form of
various types of internal audits in different banks varies, and one of which is concurrent audit.
2.121 A system of concurrent audit at large and other selected branches has been in vogue in most banks for
quite long. Recognising the importance the concurrent audit in the banking sector, the RBI, vide its circular no
BC.182/16.13.108/93-94 dated October 11,1993 addressed to all scheduled commercial banks (except regional
rural banks) formally advised such banks to institute an appropriate system of concurrent audit. It may be also
noted that the RBI vide its circular no DOS. NO.8.C.16/08-91-021/96 dated August 14, 1996 has incorporated new
guidelines for concurrent audit system in commercial banks. The system includes scope of concurrent audit,
coverage of business/branches, types of activities covered, appointment of auditors, facilities for effective
concurrent audit, remuneration and the reporting systems. Concurrent audit is regarded as bank's early-warning
system to ensure timely detection of irregularities and lapses which helps in preventing fraudulent transactions. It
also refers to examination of the transactions by an independent person not involved in its documentation. The
emphasis is in favour of substantive checking in key areas rather than test checking.
2.122 The auditor should enquire whether the bank has a system of conducting concurrent and internal audit,
inspections of various departments inside the bank, etc. either through its own staff or external auditors. The
option to consider bank's own staff or external auditors to undertake audit is at the discretion of the individual
banks. The auditor is required to comment on the system in existence. The auditor should report whether the
follow-up of the reports of internal and concurrent audits, etc. is carried out and relevant suggestions implemented
timely.
2.123 Auditor should report whether there is a system of conducting Risk based audits Auditor should
comment on the system in place for closure of audit issue and to ensure that there are no repeat observations or
there is a significant reduction in repeat audit issues. Auditor should examine whether there is a mechanism to
remedy the underlying process gap by conducting Root- Cause analysis by testing the Control Process.
Existence of Management Information System; method of compilation and accuracy of information.
Reliability of regulatory reporting under the Off Site Surveillance System of the RBI.
2.124 The Management of banks requires database information for taking policy decisions as well as for taking
other corrective measures. Banks operate their business through network of their branches spread over a vast
geographical area. Thus, auditor should check that an effective Management information system exists which
generates timely, accurate, reliable, relevant and complete information.
VIII. Other Matters
2.125 Besides the above matters, the auditor is also expected to comment on the following:
Comments on accounting policies, if any, including comments on changes in accounting policies made
during the period.
Policies and systems for monitoring activities such as underwriting, derivatives, etc.
Adequacy of provisions made for statutory liabilities such as Income Tax, Interest Tax, Gratuity, Pension,
Provident Fund, etc.
Adequacy of provisions made for off-balance sheet exposures and other claims against the bank.
Any major observations on branch returns and process of their consolidation in final statement of
accounts.
Balances with other banks - observations on outstanding items in reconciliation statements.
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Long Form Audit Report in Case of Banks
Procedure for revaluation of NOSTRO accounts and outstanding forward exchange contracts.
Observations on the working of subsidiaries of the bank:
(a) reporting system to the holding bank and
(b) major losses of the subsidiary, if any.
Any other matter, which the auditor considers should be brought to the notice of the Management.
2.126 The Long Form Audit Report (LFAR) issued by the RBI clarifies that the matters required to be reported
by the auditor therein are illustrative and not exhaustive. Therefore, if it is felt that if there is any other important
matter which deserves to be included in the LFAR the statutory auditor may do so. The LFAR format was drafted
in 2003. There have been significant changes in the banking Industry ever since. As a result certain additional
areas which have not been considered in any of the above paragraphs can also be considered. The following is an
illustrative list of few such matters:
Corporate Governance Legal departments (Details relating to suit filed
Borrowings and decreed accounts)
Premises Merchant banking activity
Stationery department Inter Office adjustments
Jilani and Ghosh Committee Compliances Planning department
Implementation of recommendation of Mitra Raj Bhasha
Committee Voluntary retirement scheme
Service Tax Demat accounts and Loan against Shares
Fringe Benefit Tax Legal Compliance Certificate
Stress Testing
2.127 The auditor should examine whether the Income Tax liability is computed as per the provisions of the
Income Tax Act, 1961. Apart from that the auditor should review the appellate orders received during the year and
consider the need for any additional provision/ reversal. If there is no requirement to retain a provision, it can be
reversed.
2.128 Provisions for certain employee costs, such as, bonus, ex-gratia in lieu of bonus, and gratuity, pension
and other retirement benefits are usually made at the head office level. The auditor should examine whether the
liability for bonus is provided for in accordance with the Payment of Bonus Act, 1965 and/or agreement with the
employees or an award of a competent authority.
2.129 The auditor should examine whether provisions in respect of termination benefits; retirement benefits
such as gratuity, pension, post-employment life insurance and post-employment medical care; and other long term
employee benefits like, long-service leave, bonuses, deferred compensation, etc., are made in accordance with
the requirements of Accounting Standard (AS) 15, "Employee Benefits". The auditor should examine the adequacy
of the provisions made with reference of such documentary evidence as reports of actuaries or certificates from
the LIC, as appropriate under the facts and circumstances of the case.
2.130 Auditor should reassess all off-balance sheet exposures and other claims against the bank for its
contingency and chances of accrual. Auditor can go through the relevant files, papers and documents related to
legal case.
407
Part VI
Special Aspects
VI-1
Basel III
Introduction
1.01 Basel capital adequacy norms are meant for the protection of depositors and shareholders by prescriptive
rules for measuring capital adequacy, thereby evolving methods of determining regulatory capital and ensuring
efficient use of capital.
1.02 Basel III accord strengthens the regulation, supervision and risk management of the banking sector. It is
global regulatory standard on capital adequacy of banks, stress testing as well as market liquidity risk.
1.03 The Basel III accord, aims at:
a. improving the banking sector's ability to absorb shocks arising from financial and economic stress, whatever
may be the source;
b. improving risk management and governance practices; and
c. strengthening banks' transparency and disclosure standards.
1.04 Basel II has been fully implemented in all commercial banks (except RRBs and LABs) in India by March 31,
2009. In this regard, the RBI has also issued a Master Circular no. DBR.No.BP.BC.4/21.06.001/2015-16 dated July
1, 2015 on "Prudential Guidelines on Capital Adequacy and Market Discipline - New Capital Adequacy Framework
(NCAF)".
1.05 The major changes made in Basel III over Basel II are as under:
(a) Quality of Capital: One of the key elements of Basel III is the introduction of much stricter definition of capital,
which means the higher loss-absorption capacity, which in turn would lead to banks becoming stronger with
enhanced capacity to withstand periods of stress.
(b) Capital Conservation Buffer: Beginning 31st March, 2016, Banks are required to hold capital conservation
buffer of 0.625%, which will gradually increase to 2.5% by 31st March, 2019. This is to ensure that banks
maintain a cushion of capital that can be used to absorb losses during periods of financial and economic stress.
(c) Counter cyclical Buffer: The counter cyclical buffer ensures increased capital requirements in good times and
decrease the same during bad times.
(d) Minimum Common Equity and Tier 1 Capital Requirement: The minimum requirement for common equity,
the highest form of loss-absorbing capital, has been increased to 5.50% of RWA. The Minimum Tier 1 capital
has been increased to 7%, which means that Additional Tier I (AT 1) capital can be maximum of 1.50% of
RWA. Though, the minimum total capital (Tier I plus Tier II) requirement remains at 9%, which means that the
Tier 2 capital can be admitted maximum of 2% of RWA. With the requirement of gradually maintaining 2.5% of
RWA as Capital Conservation Buffer in the form of CET 1, the minimum total capital requirement shall increase
to 11.50% of RWA by 31st March, 2019.
(e) Leverage Ratio: Analysis of 2008 financial crisis indicates that value of assets went down much more than
what was perceived based on their risk rating, which lead to stipulation of Leverage Ratio. Therefore, under
Basel III, a simple, transparent, non-risk based leverage ratio has been introduced. A Leverage Ratio is the
relative amount of capital to total assets (not risk-weighted). The Basel Committee used the revised framework
for testing a minimum Tier 1 Leverage Ratio of 3% during the parallel run period up to January 1, 2017. The
final calibration, and any further adjustments to the definition, will be completed by 2017, with a view to
Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
migrating to a Pillar 1 treatment on January 1, 2018. Currently Indian Banking System is operating at a leverage
ratio of more than 4.5%. The final minimum leverage ratio will be stipulated taking into consideration the final
rules prescribed by the Basel Committee by end of 2017.
(f) Liquidity Ratios: Under Basel III, a framework for liquidity risk management has been set up. Liquidity
Coverage Ratio (LCR) has become operational since 1st January, 2015.
1.06 Basel III capital regulation has been implemented from April 1, 2013 in India in phases and it will be fully
implemented as on March 31, 2019. In view of the gradual phase-in of regulatory adjustments to the Common Equity
component of Tier 1 capital under Basel III, certain specific prescriptions of Basel II capital adequacy framework (e.g.
rules relating to deductions from regulatory capital, risk weighting of investments in other financial entities etc.) will
continue to apply till March 31, 2018 on the remainder of regulatory adjustments not treated in terms of Basel III
rules. In this regard, the RBI has also issued a Master Circular no. DBR.No.BP.BC.1/21.06.201/2015-16 dated July 1,
2015 on "Basel III Capital Regulations".
Guidelines on BASEL III Capital Regulations
1.07 The RBI had issued a circular no. DBOD.No.BP.BC.98 /21.06.201/2011-12 dated May 2, 2012 on the
subject "Guidelines on Implementation of Basel III Capital Regulations in India". Vide this circular, the RBI has
prescribed the final guidelines on Basel III capital regulations. RBI issued a master circular no.
DBR.No.BP.BC.1/21.06.201/ 2015-16 dated July 1, 2015 on Basel III Capital Regulations. Following are main
features of these guidelines:
These guidelines became effective from April 1, 2013 in a phased manner. The Basel III capital ratios will be
fully implemented as on March 31, 2019.
The capital requirements for the implementation of Basel III guidelines may be lower during the initial periods
and higher during the later years. While undertaking the capital planning exercise, banks should keep this in
view.
Liquidity Coverage Ratio has been introduced in a phased manner starting with a minimum requirement of 60%
from January 01, 2015 and reaching minimum 100% on January 01, 2019.
The banks are required to disclose capital ratios under Basel III from quarter ending June 30, 2013.
Components of Capital
1.08 Total regulatory capital will consist of the sum of the following categories:
(i) Tier 1 Capital (going-concern capital)
(a) Common Equity Tier 1
(b) Additional Tier 1
(ii) Tier 2 Capital (gone-concern capital)
Limits and Minima
Regulatory Capital As % to
RWAs
(i) Minimum Common Equity Tier 1 Ratio 5.5
(ii) Capital Conservation Buffer (comprised of Common Equity) 2.5
(iii) Minimum Common Equity Tier 1 Ratio plus Capital 8.0
Conservation Buffer [(i)+(ii)]
(iv) Additional Tier 1 Capital 1.5
(v) Minimum Tier 1 Capital Ratio [(i) +(iv)] 7.0
(vi) Tier 2 Capital 2.0
(vii) Minimum Total Capital Ratio (MTC) [(v)+(vi)] 9.0
(viii) Minimum Total Capital Ratio plus Capital Conservation 11.5
Buffer [(vii)+(ii)]
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Basel III
Capital What Constitutes Tier 1 and Tier 2 a Representative Sample
1.09 The Master Circular on Basel III Capital Regulations discusses the capital funds in two categories
capital funds for Indian banks and capital funds of foreign banks operating in India. The following table shows
the components of the capital funds for Indian vis a vis foreign banks operating in India:
Indian Banks Foreign Banks operating in India
Tier I Capital
Common Equity Tier I Paid up equity capital (ordinary shares)22 Interest free funds from Head Office23
(CET 1) Share premium on issue of common shares
Statutory reserves Statutory reserves kept in Indian books
Capital reserves representing surplus Capital reserves representing surplus arising out
arising out of sale proceeds of assets of sale of assets in India held in a separate
account and which is not eligible for repatriation
so long as the bank functions in India
Other disclosed free reserves, if any Remittable surplus retained in Indian books
which is not repatriable so long as the bank
functions in India
Revaluation reserves with discount of 55% Revaluation reserves with discount of 55% (till
(with effect from 1st March 2015), subject to 29th February 2016), subject to meeting
meeting conditions prescribed in RBI conditions prescribed in RBI circular dated 1st
circular dated 1st March 2016 March 2016
Foreign currency translation reserve arising Foreign currency translation reserve arising due to
due to translation of financial statements of translation of financial statements of their foreign
their foreign operations in terms of operations in terms of Accounting Standard (AS)
Accounting Standard (AS) 11 at a discount 11 at a discount of 25%, subject to meeting
of 25%, subject to meeting conditions conditions prescribed in RBI circular dated 1st
prescribed in RBI circular dated 1st March March 2016
2016
Balance in Profit & Loss Account at the end
of the previous financial year
Profits of current financial year on a
quarterly basis provided the incremental
provisions made for NPA at the end of any
of the four quarters of the previous financial
year have not deviated more than 25%
from the average of the four quarters with
certain adjustments given in the Master
Circular
Interest free funds remitted from abroad for the
purpose of acquisition of property and held in a
separate account in Indian books provided they
are non-repatriable and have the ability to absorb
losses regardless of their source
Less: Regulatory adjustments / deductions Less: Regulatory adjustments / deductions
applied in the calculation of Common applied in the calculation of Common Equity Tier
Equity Tier 1 capital 1 capital
22
Refer Annexure 1 to Master Circular on Basel III Capital Regulations for criteria.
23
Refer Annexure 2 to Master Circular on Basel III Capital Regulations for criteria.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Additional Tier I (AT 1) Perpetual non-cumulative preference Head office borrowings in foreign currency by
shares24 foreign banks operating in India as per criteria25
Share premium on instruments included in
AT 1 capital
Debt Capital instruments including
Perpetual Debt instruments26
Any other instrument notified by RBI from Any other instrument notified by RBI from time to
time to time time
Less: Regulatory adjustments / deductions Less: Regulatory adjustments / deductions
applied in the calculation of Additional Tier applied in the calculation of Additional Tier 1
1 capital capital
Tier II Capital Revaluation reserves with discount of 55% Revaluation reserves with discount of 55% (till
(till 29th February 2016) 29th February 2016)
General provisions and loss reserves General provisions and loss reserves
Debt Capital instruments27 Head Office (HO) borrowings in foreign currency
received as part of Tier 2 debt capital
Perpetual Cumulative Preference Shares Perpetual Cumulative Preference Shares
(PCPS)/ Redeemable Non- Cumulative (PCPS)/ Redeemable Non- Cumulative
Preference Shares (RNCPS) /Redeemable Preference Shares (RNCPS)/ Redeemable
cumulative preference shares(RCPS)28 cumulative preference shares (RCPS) 29
Premium on instruments included in Tier 2
Less: Regulatory adjustments / deductions Less: Regulatory adjustments / deductions
applied in the calculation of Tier 2 capital applied in the calculation of Tier 2 capital
1.10 In case of foreign banks operating in India, RBI's Master Circular on Capital Adequacy also lays down
certain additional provisions in respect of capital to be followed by such banks.
1.11 Capital instruments which no longer qualify as AT 1 capital or Tier 2 capital (e.g. IPDI and Tier 2 debt
instruments with step-ups) will be phased out beginning January 1, 2013. Fixing the base at the nominal amount of
such instruments outstanding on January 1, 2013, their recognition will be capped at 90% from January 1, 2013, with
the cap reducing by 10% in each subsequent year. This cap will be applied to Additional Tier 1 and Tier 2 capital
instruments separately and refers to the total amount of instruments outstanding which no longer meet the relevant
entry criteria. The following chart graphically depicts the provisions relating to such instruments:
24
Refer Annexure 3 to Master Circular on Basel III Capital Regulations for criteria.
25
Refer Annexure 4 to Master Circular on Basel III Capital Regulations for criteria.
26
Refer Annexure 4 to Master Circular on Basel III Capital Regulations for criteria.
27
Refer Annexure 5 to Master Circular on Basel III Capital Regulations for criteria.
28
Refer Annexure 6 to Master Circular on Basel III Capital Regulations for criteria.
29
Refer Annexure 6 to Master Circular on Basel III Capital Regulations for criteria.
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Basel III
TRANSITIONAL ARRANGEMENTS FOR NON-EQUITY REGULATORY CAPITAL INSTRUMENTS
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Deductions from CET I, AT I and Tier II
1.12 The deductions from CET I, AT I and Tier II are tabulated below:
Item Extent of Deduction
(in %)
CET I AT 1 Tier II
Intangible assets including Goodwill 100 ---
Losses in the current period 100 ---
Losses brought forward from previous periods 100 ---
Deferred tax asset associated with accumulated losses 100 ----
Cash Flow hedge reserve 100 ---
Shortfall of provisions to expected losses 100 ---
Gains on sale related to securitisation transactions 100 ---
Cumulative Gains and losses due to changes in own credit risk on 100 ---
fair valued liabilities
Defined benefit pension fund liabilities and un-amortised 100 -
employees' benefits
Investments in own shares (if not already netted off paid-up 100 ---
capital on reported balance sheet) including indirect investments
DTAs which relate to timing differences (other than those related Excess of 10% of ----
to accumulated losses) CET- 1
DTAs on timing difference along with limited recognition of Excess of 15% of
significant investments in the common shares of unconsolidated CET- 1
financial (i.e. banking, financial and insurance) entities taken
together
Equity investments in insurance subsidiaries 100
Investments in equity instruments of other subsidiaries and capital 100
of other Banks, insurance companies etc. which is more than 10%
of Bank's CET1
Equity investments in non-financial subsidiaries 100
Intra group transactions beyond permissible limits 100
Reciprocal cross investments in capital of other banks in the same Full Full Full
component of capital
Securitization exposure 50 50
Investment in financial subsidiaries and associates which is 50 50
above 30 per cent in the paid up equity of entity and not
consolidated for the capital adequacy purposes
Shortfall in the regulatory capital requirements in the de- 50 50
consolidated entity
Such amount of investment in the following which is in excess of 50 50
10% of investing bank's capital funds:
· Equity shares;
· Perpetual Non- Cumulative Preference Shares;
· Innovative Perpetual Debt Instruments;
· Upper Tier II Bonds;
· Upper Tier II Preference Shares;
· Subordinated debt instruments; and
· Any other instrument approved as in the nature of capital.
Investments made by a banking subsidiary/associate in the 50 50
414
Basel III
equity or non-equity regulatory-capital instruments issued by its
parent bank
If net overseas placements with Head Office/other overseas 100 ---
branches/other group entities exceed 10% of the bank's
minimum CRAR requirement, the amount in excess of this limit
would be deducted from Tier I capital
Capital to Risk-weighted Assets Ratio (CRAR)
1.13 The RBI requires banks to maintain a minimum CRAR of 9 per cent on an ongoing basis. The Master
Circular on Capital Adequacy contains detailed guidelines on calculation of risk weighted assets and off-balance
sheet items and CRAR.
1.14 The CRAR is computed as follows:
Eligible Total Capital funds × 100
------------------------------------------------------------
Credit Risk RWA + Market Risk RWA + Operational Risk RWA
1.15 The minimum CRAR is required to be maintained at consolidated level also as per Basel III guidelines.
The requirements mentioned above relates to standalone Bank only. For the requirement for the consolidated
capital, the readers may refer the Master Circular on Basel III Capital Regulations.
Board Oversight
1.16 The board of directors and senior management of each subsidiary/overseas branch should be responsible
for conducting their own assessment of the subsidiary's/overseas branch's operational risks and controls and
ensuring the subsidiary/overseas branch is adequately capitalised in respect of those risks.
Disclosure (Pillar 3)
1.17 Pillar 3 aims primarily at disclosure of a bank's risk profile and capital adequacy. It is recognised that the
Pillar 3 disclosure framework does not conflict with requirements under accounting standards, which are broader in
scope. The banks in India have to follow Pillar 3 disclosure over and above the RBI master circular on "Disclosure in
Financial Statements - Notes to Accounts". Information would be regarded as material if its omission or misstatement
could change or influence the assessment or decision of a user relying on that information. Pillar 3 disclosures will be
required to be made by the individual banks on a standalone basis when they are not the top consolidated entity in
the bank.
Role of auditors of banks
1.18 Based on RBI appointment letter, the external auditors of the bank are required to provide a certification on
the capital adequacy ratio computation. The auditor needs to understand more comprehensively the approach and
mechanism adopted by the bank, and accordingly certify the computation. Considering the intricacies involved in the
computation itself further supplemented by enhanced judgement factor, it would be prudent for the certifying auditor
to obtain an adequate understanding of the Basel III norms as prescribed by RBI and also deploy more senior
members of its staff to audit the capital adequacy computations.
1.19 Further, some banks may also avail services of their external auditors to review the quality of internal
controls and systems, and assess the scope and adequacy of the internal audit function.
1.20 In the concept of Basel III, the capital computation is primarily aimed from central/head office perspective.
Basel III is not only about capital adequacy but is also about creating a robust risk management structure. Hence,
apart from the capital adequacy computation, the auditors should verify the robustness of the risk management
structure embedded in the bank, across its branches. This risk management spreads across all the types of risk, i.e.,
credit risk, market risk and operational risk. Hence, the auditors also play a critical role in ensuring that the bank has
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
adopted a consistent practice and as part of their attest function report on its appropriateness of risk management
practice as well on the RWA.
Role of branch auditors
1.21 In case of credit risk management, the underlying computation for Basel III is based on credit ratings, which
may be driven centrally and passed onto branches such that branches follow head office instructions in its entirety.
This way the bank branch auditors check only the computation process and test check the source rather than getting
into the credit rating process. The branch auditors can assess any issues relating to completeness and correctness
of the data, which is used to compute the underlying risks emanating from credit market and operational risk. It is
finally the pyramid approach whereby all the data from branches will get consolidated at head office. The statutory
central auditors may choose to test check certain source data and also verify the basis considered at the head office.
1.22 It will not be practical to expect the branch to comprehensively understand the Basel III requirements in its
entirety. The bank branch auditor should assess the sufficiency of the instructions provided to the branch by the head
office and its adherence at the branch level. Any errors at bank branch level can have a cascading effect at the head
office, especially when a large number of branches are involved.
1.23 The statutory central auditors should primarily look into the computation of components of various capital as
part of their attest function. As regards the overall capital adequacy computation, particularly with respect to RWAs,
while the granular data may have been audited by the Branch Statutory Auditors, the Statutory Central Auditors,
apart from verifying the consolidation of data emanating from branches/regions/zones/circles etc. should perform the
test of reasonableness as well as completeness. As per requirements set by the RBI, the Statutory Central Auditors
are required to certify the capital adequacy computation. The statutory central auditors may review the work done by
internal auditors, as may be stipulated by the management or the regulators. The Basel Accord does provide specific
areas where internal auditors play a role.
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Basel III
Annexure 1
Illustrative Audit Checklist for Capital Adequacy
The checklist is only illustrative in nature. Members are expected to exercise their professional judgment while
using the checklist depending upon facts and circumstances of each case.
Audit Procedures
CET 1, AT 1 and Tier II
1. Tally the balances in the various elements of Capital from the trial
balance/ groupings/ draft financial statements
2. Check whether various instruments comply with the guidelines as
laid down in the Master Circular by referring to the Terms of Offer
and whether the same are approved by the Board or other
appropriate committee
3. Check whether appropriate discounting has been applied in the case
of instruments issued
4. In case of foreign banks, examine whether the undertaking has been
obtained that the bank would not remit abroad the funds received
and shown as Capital Reserve or Remittable Surplus
5. Examine whether various limits upto which individual elements are
to be included in CET1, AT1 and Tier II capital as laid down in the
Master Circular are adhered to.
6. Verify various deductions with the balances in the audited accounts
and check the same for limits and eligibility (e.g. securitisation
exposure) as laid down in the Master Circular.
7. Verify the correctness of progressive discount based on the
remaining maturity of instruments eligible for AT1 and Tier II
Capital Charge on Credit Risk
The capital charge for credit risk is the sum total of the capital charge to
be maintained in respect of the following:
On balance sheet items
Off balance sheet items
Failed transactions
NPAs
Securitisation transactions
duly adjusted for haircuts based on the nature of the collateral.
Risk Weights On Balance Sheet Items
The risk weights for all on balance sheet items need to be determined
based on the credit ratings assigned by the rating agencies chosen by
the RBI.
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
1. Reconcile the balances of various advances and other operating
receivables where there is a credit risk and which are considered for
calculation with the following schedules in the financial statements to
ensure completeness:
Schedule 6 Cash and balances with Reserve Bank of India
Schedule 7- Balances with Banks and Money at Call and Short
Notice
Schedule 9- Advances
Schedule 11(vi) Other Assets Others
2. Review and document the process of compilation and mapping of
the various items on balance sheet based on the categories and
their risk weights together with the appropriate ratings and / or other
conditions, as applicable.
3. For a sample of transactions verify the ratings with the letters issued
by the rating agencies and accordingly check the correctness of the
risk weights assigned.
4. In cases where the risk weights are dependent on the fulfilment of
certain conditions (other than ratings) verify the compliance
therewith based on the appropriate documentary evidence. (e.g.
claims on banks, regulatory retail portfolio, claims against residential
property etc.)
5. Verify the validity of guarantees issued by Central or State
Government. Verify whether the bank has properly classified claims
on State Government and claims guaranteed by State Government
due to difference risk weight.
6. Verify the correctness of claims on CGTSI and ECGC
7. Verify the classification of loans restructured loans/ NPAs/ NBFC/
CRE/ CRE-RH etc.
8. Verify LTV ratio on a test check basis in respect of housing loans
Risk Weights Off Balance Sheet Items
The risk weight for all off balance sheet credit exposures is generally
calculated as a two step process as under, separately for market and
non-market related exposures:
The notional amount is converted into a credit equivalent amount by
multiplying the amount by the specified credit conversion factor (for
non market transactions) or by applying the current exposure
method (for market related transactions).
The resulting credit equivalent amount is multiplied by the risk
weight applicable to the counterparty or the purpose for which
finance is extended or the type of asset, whichever is higher.
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Basel III
Where the exposure is secured by eligible collateral or guarantee, the
credit risk mitigation guidelines may be applied.
1. Reconcile the balances of the various off balance sheet exposures
which are considered for calculation with the financial statements,
especially the schedule of contingent liabilities.
2. Review and document the process of compilation and mapping of
the various off balance sheet item based on the nature of the
instruments.
3. For a sample of non-market transactions, check the calculations of
the credit equivalent amount with specified credit conversion factor
based on the nature of the instrument. Check the necessary
documentation to confirm the nature of the instrument.
4. For a sample of market related transactions, check the necessary
documentation to confirm the nature of the contract and accordingly
check the calculations for the current credit exposure and the
potential future exposure.
5. Verify the classification of Financial and Performance Guarantee by
perusing the sample guarantee issued by the branches
6. Verify whether bills accepted under Letter of Credit is assigned
100% risk weight as CCF
7. Verify whether the bank has proper control for accounting Buyer's
credit/ Letter of Comfort
8. Verify the correctness of undrawn exposures
Capital Charge Failed Transactions
1. Review and document the procedures for tracking and monitoring
the credit risk exposure arising from unsettled transactions, both on
Delivery Versus Payment (DVP) and non DVP basis.
2. For a sample of DVP transactions, examine whether the settlement
has taken place on a timely basis. In case of delays, check the
calculation of the capital charge by multiplying the positive current
exposure by the prescribed factor depending upon the number of
days delayed.
3. For a sample of non-DVP transactions, examine whether the
settlement has taken place as per the contracted maturity. In case of
delays, ascertain whether any payment made is considered as a
loan and the appropriate risk weight is considered. In case of
settlement beyond five days ascertain whether the full amount is
deducted from the capital.
Risk weights NPAs
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Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
1. Review and document the procedures for identifying the unsecured
portion of NPAs separately for qualifying residential mortgages and
others.
2. For a sample of residential mortgages which are NPAs, examine
whether they meet with the qualifying criteria with regard to the LTV
ratio and other factors and accordingly check the assignment of the
risk weight for the unsecured portion depending upon the level of
provisioning.
3. For a sample of NPAs other than residential mortgages check the
assignment of the risk weight based on the level of provisioning.
4. In respect of 3 above for identifying the secured portion examine
whether only eligible collateral are considered and the same are
properly documented and the bank has a clear and marketable title
to realise the same.
5. Verify whether bucketing in difference risk weight in respect of NPAs
based on NPA provision is carried out by the system and verify the
correctness of classification on a test check basis
Capital Charge Securitisation transactions
Banks are required to hold regulatory capital after adjusting the
prescribed deductions eligible against all securitisation exposures
including those arising from provision of credit mitigants, investment in
asset backed securities, retention of subordinated tranche and
extension of liquidity facility or credit enhancement.
Examine whether the securitisation transactions fulfil the requirements as
prescribed in Master Circular on "Prudential Guidelines on Capital
Adequacy and Market Discipline - New Capital Adequacy Framework"
(extract of the `Revision to the Guidelines on Securitisation
Transactions', issued vide circular DBOD.No.BP.BC.103/ 21.04.177/
2011-12 dated May 07, 2012 on 'Revision to the Guidelines on
Securitisation Transactions') to be eligible for deduction from capital.
1. Based on the above, for a sample of transactions / deals examine
whether the prescribed deduction from both CET 1, AT I and Tier II
capital has been correctly done based on the rating and the level of
provisions. Review the necessary documentation in support of the
same.
2. Based on the above ascertain whether the appropriate risk weights
have been assigned.
Collateral Risk Management and Credit Risk Mitigation
The objective of collateral risk management is to ensure that only the
eligible collateral are considered for netting off which are adjusted for
volatility depending upon the nature of the capital and further subjected
to various types of hair cuts for different categories of mismatches like
currency and tenor mismatches.
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Basel III
1. Review and document the process for collateral risk management as
appropriate and relevant including but not limited to:
Ageing reports
Confirmation procedures.
Control of documents
Compliance with covenants
Audit of collateral by independent agencies
2. Examine whether the bank has complete legal rights to enforce the
security including specific lien and is subject to hair cuts for residual
tenor mismatch and currency mismatch. Check the necessary
documentation in respect thereof.
Capital Charge for Market Risk
Capital charge for market risk involves computation of the capital charge
on interest rate related instruments and equities in the trading book and
foreign exchange risk, including gold and other precious metals.
Accordingly, the following would be covered:
Securities under the HFT and AFS category
Open gold and FX position limits
Trading position in derivatives
Derivatives entered into for hedging trading book exposures
Interest Rate General Market Risk
The capital requirement for general market risk is the sum of the
following four components:
(i) Net short (only derivatives) or long position in the trading book
(ii) Small proportion of matched position for each time band (vertical
disallowance)
(iii) A larger proportion of the matched positions across different time
bands (horizontal disallowance)
(iv) Net change for positions in options where applicable
1. Reconcile the balances considered for calculation of the general
interest rate risks trading book positions with the figures reported in
the financial statements.
2. Review and document the process for computation of the price
sensitivity (modified duration) for each instrument and test check the
calculations for a sample of instruments.
3. Review the process of capturing the above data into different time
bands based on the maturity and accordingly apply the prescribed
change in yield and check the calculations for the resulting capital
charge and the consequential vertical and horizontal disallowances
421
Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Interest Rate Specific Risk
The specific interest rate capital charge for different types of debt
securities / issuers is prescribed separately for the following categories:
Central, State and Foreign government bonds under HFT and AFS
category
Banks bonds under HFT and AFS category
Corporate bonds and securitised debt under HFT and AFS category
1. Reconcile the balances of government securities under AFS and HFT
considered for computation of specific interest rate capital charge
with the financial statements.
2. Review and document the process of compilation of data in respect
of various types of government securities under AFS and HFT based
on the type of investment and the residual maturity.
3. For a sample of transactions in respect of the above, verify the
allocation percentage of the specific risk capital based on the type of
investment and residual maturity based on the verification of the
relevant documentation.
4. Reconcile the balances of bonds issued by banks under AFS and
HFT considered for computation of specific interest rate capital
charge with the financial statements.
5. Review and document the process of compilation of data in respect of
various types of bonds issued by banks held as investments under
AFS and HFT based on the following parameters:
Level of capital adequacy
Nature of the bank (scheduled or non scheduled)
Residual maturity
6. For a sample of transactions in respect of the above, verify the
allocation percentage of the specific risk capital based on the various
parameters based on the verification of the relevant documentation.
7. Reconcile the balances of corporate bonds and securitised debt
under AFS and HFT considered for computation of specific interest
rate capital charge with the financial statements.
8. Review and document the process of compilation of data in respect
of corporate bonds and securitised debt instruments held as
investments under AFS and HFT based on the following parameters:
Rating assigned
Nature of the investment
Residual maturity
9. For a sample of transactions in respect of the above, verify the
422
Basel III
allocation percentage of the specific risk capital based on the various
parameters based on the verification of the relevant documentation.
Equity General and Specific Market Risk
A uniform percentage of 9% is currently attracted for the gross equity
position for both specific and general risks
Foreign Exchange and Gold
These currently attract a risk weight of 100% which is in addition to the
capital charge for credit risk for on and off balance sheet items
1. Check the computation of the net open position in each currency as a
summation of the following:
Net spot position
Net forward position
Guarantees and similar instruments
Net future expenses / incomes not yet accrued but fully hedged
2. Based on the calculations of the market risk for each of the above
check the computation of the aggregate capital charge of market
risks
Interest rate risk
a) General market risk
Net position
Horizontal disallowance
Vertical disallowance
b) Specific market risk
Specific and general market equity risk Foreign Exchange and gold
Capital Charge for Operational Risk
Currently banks are required to maintain capital charge for operational
risk at 15% of the average gross income for the last three financial
years
1. Obtain the computation of the gross total income and verify the same
from the respective years audited financial statements.
2. Examine whether the various deductions from the net profit are
appropriately considered.
For computing the gross income for determining the capital to be held against operational risk, there is a
clarification that the same should be considered based on the average of the last three financial years.
However, there is no clarity as to whether this includes the current financial year though the better practice
would be to consider the average of the preceding three years.
423
VI-2
Special Purpose
Reports and Certificates
Reporting of Frauds
2.01 The Reserve Bank of India vide its Master Direction No: DBS.CO.CFMC.BC.No.1/23.04.001/2016-17
Dated July 01, 2016 on "Frauds- Classification and Reporting", issued guidelines for classification of frauds and
reporting of frauds to RBI, Central Office as well as the concerned regional office of the Department of Banking
Supervision / Financial Conglomerate Monitoring Division (FCMD) at Central Office under whose jurisdiction the
bank's Head Office/branch is situated. The reporting requirements for various categories of frauds based on
financial exposure are specified in Para 3 of the Master Directions.
Audit Approach
2.02 The SBAs may verify the contents of certificates to be issued at branch level. All the Returns submitted by
branch to various higher authorities of the respective bank and also to various authorities of the regulators as per the
Master Directions dated 01.07.2016 shall be verified. Branch Auditors should ensure the correctness of financial
implication caused due to such frauds and confirm that the adequate provision for the same has been effected.
2.03 SCAs of the bank may verify the compilation of all such reports received from SBAs regarding the frauds
and check whether adequate provision for the same is effected at Head Office. SCAs should also verify the returns
submitted by the bank to regulators regarding such frauds during the year under audit.
2.04 SCAs may verify the methodology used by the bank in reporting of such frauds from branches to regional /
zonal / circle offices and to head office. SCAs shall verify the existence of internal control mechanism in place to
ensure completeness and correctness of such reporting and classification of frauds in the bank.
2.05 SCAs may also check the reporting and classifications of frauds at the Head Office level, where the cases
other than those reported through reports SBAs are considered.
2.06 SCAs may also check that the Board of Directors and Audit Committee of bank are being regularly updated
with reporting and classification on frauds throughout the year under audit.
Other Reports or Certificates
2.07 In addition to their audit reports, the SBAs and SCAs may also be required by their terms of engagement
or statutory or regulatory requirements to issue other reports or certificates. For example, presently, the branch
auditors are required to issue reports/certificates on the following matters besides their main audit report:
Long Form Audit Report for Branch. (Discussed in Part V of the Guidance Note)
Report on whether the income recognition, asset classification and provisioning have been made as per the
guidelines issued by the RBI from time to time.
Report on audit of DICGC items, wherein auditors have to specifically verify and certify the correctness of the
data in various returns and the insurance premiums paid to DICGC.
Report on status of the compliance by the bank with regard to the implementation of recommendations of the
Ghosh Committee relating to frauds and malpractices and of the recommendations of the Jilani Committee on
internal control and inspection/credit system.
Certificate for Prime Minister Rozgar Yojna for Unemployed Youth.
Special Purpose Reports and Certificates
Certificate of cash and bank balances.
Certificate relating to MOC entries of the previous years being accounted for.
Certificate relating to credit/ deposit ratio.
Certification of technology up gradation fund scheme (TUFS) non SSI textile centre.
Certification for advances to infrastructure project and income generated thereon.
Statement of accounts Re-structured/ Re-scheduled/ Re-negotiated related to CDR and non-CDR accounts.
Certificate of advances exceeding Rs.10 Crores.
Certificate regarding Special Deposit Scheme, 1975.
Certificate regarding Compulsory Deposit (Income-tax Payers) Scheme, 1974.
Certificate relating to recoveries in claim paid accounts under Small Loans Guarantee Scheme 1971/Small
Loans (SSI) Guarantee Scheme, 1981.
Certification of Borrowal Companies by Chartered Accountants/Company Secretaries (as per RBI circular on
"Lending under Consortium Arrangements/ Multiple banking Arrangements" dated December 08, 2008.
Certificate on Capital Adequacy
Certificate for Gold Stocks held for Sale of Gold/Metal Gold Loans.
Certificate for Gold Coins Held.
Certificate for Gold Deposit Scheme.
Certificate for IRAC Status of Credit Exposure in respect of Non-Performing Investments.
Certificates for IRAC Status of Credit Exposure in respect of borrowers having exposure with foreign offices.
Certificate for agricultural interest subvention claim @2% for residual period of repayment of the loans disbursed
during FY.
Certificate for agricultural interest subvention claim @2% for disbursements made during FY.
Certificate for additional interest subvention (Incentive @3%) for prompt repayment for short term production
loans disbursed during FY.Certain other certificates as may be prescribed by the concerned bank in their
respective closing instructions or appointment letters.
Certificate on Unhedged Foreign Currency Exposure in case of Borrowal having exposure of 1 crore or more.
Certificate on exposure to sensitive sectors .i.e. exposure to Capital Market, Infrastructure & Real Estate
Sector.
2.08 Besides this, SCAs are required to give following certificates/reports:
Certificate on Corporate Governance.
Report on whether the treasury operations of the bank have been conducted in accordance with the
instructions issued by the RBI from time to time.
Certificate on reconciliation of securities by the bank. (Both on its own investment account as well as PMS
clients' account).
Certificate on compliance by the bank in key areas of prudential and other guidelines relating to such
transactions issued by the RBI.
Certificate in respect of custody of unused BR forms and their utilisation. (as such banks do not use BR forms
any more. Further it is difficult to certify unused forms as they are not available for verification. This certificate
should be strictly based on and against the management representation. The auditor is advised to bring out
this fact clearly in the certificate.)
Various ratios and statements in the "Notes on Accounts".
425
Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
Report on instances of adverse credit- deposit ratio in the rural areas.
Certification on correctness of computation of DTL / NDTL
Report on compliance with CRR and SLR requirements.
Certification in respect of subsidy claimed by the bank under the PMRY Scheme during the financial year.
Certificate on compliance by bank on recommendations of:
Ghosh Committee, regarding frauds and malpractices in banks.
Jilani Committee, regarding internal control system in banks.
Dr. N. L. Mitra Committee, regarding maintenance of legal compliance certificate for credit sanction and
other transactions of Rs. 1 crore and above.
In line with the Master Directions on frauds, the SCAs to ensure that all the branches have complied with the
reporting as required by the said circular and respective SBA certificates are being received. A separate
Report should be given on any matter susceptible to be a fraud or a fraudulent activity or any foul play in any
transaction. In cases where the amount of fraud brought to the notice during audit and has remained to be
reported, the auditors are advised to report such instances directly to the CGM, Central office of Department
of Banking Supervision, RBI, Mumbai.
Certain other certificates as may be prescribed by the concerned bank in their respective closing instructions
or appointment letters.
2.09 While issuing a special purpose report or certificate, the auditors should bear in mind the
recommendations made in the Guidance Note on Reports or Certificates for Special Purposes (Revised 2016)
issued by the Institute of Chartered Accountants of India (ICAI).
426
V-3
Compliance with Implementation of Ghosh &
Jilani Committee Recommendations
3.01 The RBI in its efforts towards ensuring a strong, efficient and resilient banking system in the country, vide
its Circular No. DBS.Co.PPP.BC.No.39/ ND-01.005/99-2000 dated November 1, 1996, issued instructions relating
to frauds and malpractice in banks. The Circular was issued for the implementation of the 44th report of the
Committee on Government Assurances Ghosh and Jilani Committees' Recommendations.
Implementation of the Ghosh Committee Recommendations
3.02 The RBI set up a High Level Committee on Frauds and Malpractices in Banks under the Chairmanship of
Shri A. Ghosh, the then Dy. Governor, to enquire into various aspects of frauds and malpractices in banks with a
view to make recommendation to reduce such incidence. The Committee submitted its Report in June, 1992. The
recommendations contained in the report are related to frauds and malpractices in banks.
3.03 The RBI has divided all the recommendations into four groups as under:
(i) Group-A: Recommendations, which have to be implemented by the banks immediately.
(ii) Group-B: Recommendations requiring RBI's approval.
(iii) Group-C: Recommendations requiring approval of Government of India.
(iv) Group-D: Recommendations requiring further examination in consultation with IBA.
3.04 The RBI has summarised each of these recommendations for the purpose of reporting of their
implementation by the banks, in a `yes' or `no' format. The RBI has also categorised these recommendations into
(i) applicable to branches (ii) applicable to Controlling Offices like, Regional and Zonal Offices (some banks may
have some other name for controlling offices), (iii) applicable to Head Office and (iv) applicable to Treasury
Operations.
3.05 The report of the Ghosh Committee deals, mainly with the issues related to day-to-day administrative
functions that take place in a bank. The main objective behind the recommendations contained in the Ghosh
Committee Report is to ensure that there exists a proper system in banks to ensure the safety of assets,
compliance with the laid down policies and procedures, accuracy and completeness of the accounting and other
records, proper segregation of duties and responsibilities of the staff and also timely prevention and detection of
frauds and malpractices.
Implementation of Jilani Committee Recommendations
3.06 The RBI had set up a "Working Group to Review the Internal Control and Inspection and Audit System in
Banks" under the Chairmanship of Mr. Rashid Jilani. The Working Group was constituted in February, 1995 to
review the efficiency and adequacy of internal control and inspection and audit system in banks with a view to
strengthening the supervision system, both on-site and off-site, and ensuring reliability of data.
3.07 The 44th Report of the Committee on Government Assurances expressed concern that despite reporting
of the compliance with recommendations of the Jilani Committee, by the controlling office/branches, the same
might have not been implemented. Accordingly, RBI laid down the following procedure to ensure the
implementation of recommendations:
Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
A format containing 25 questions was issued to indicate the answer as either "Implemented" or "Not
Implemented".
Information received from all branches and ROs/ZOs to be consolidated at Head Office level and submission
of consolidated statement to RBI.
Implementation of recommendations to be verified during concurrent audit/inspection of branches/controlling
offices and comment on the same to be included in their report.
3.08 The report of the Jilani Committee contains twenty five recommendations which can broadly be divided
into three categories, (i) dealing with the EDP environment in the banks,(ii) dealing with the inspection/internal
audit system in the bank and (iii) deal with other miscellaneous aspects of functioning of a bank. The RBI has
summarised each of these recommendations for the purpose of reporting of their implementation by the banks, in
a `Implemented' or `not implemented' format. Some of the recommendations of Jilani Committee are to be
implemented by the banks at the branch office level, whereas some others are applicable to the
regional/zonal/head office level. However, some recommendations find applicability at all levels.
Responsibility of the Management
3.09 The RBI, vide its subsequent Circular dated June 28, 2002, issued to the banks has required the
concurrent auditors and inspectors of the bank branches/controlling offices to verify and comment in their reports
as to the status of implementation of the recommendations of the Ghosh and the Jilani Committees in the banks.
3.10 In terms of the letters issued to the banks regarding appointment of the statutory central auditors by the
RBI, the auditors are also required to verify and comment upon the compliance by the bank in regard to the status
of the implementation of the recommendations of the Ghosh and the Jilani Committees.
3.11 From the above it is clear that the implementation of the recommendations of the Ghosh and the Jilani
Committees is the responsibility of the management of the banks. The responsibility of the statutory auditors is to
verify and report on the status of implementation of these recommendations, thus far and no further. The results of
the verification carried out by the statutory auditor and his comments thereon would be given in a separate report.
3.12 RBI through its Master Circular No. DBR. No. Dir. BC.11/13.03.00 /2015-16 dated July 1, 2015 on
"Guarantees and Co-acceptances" has required that Banks should implement the following recommendations
made by the Ghosh Committee:
(i) In order to prevent unaccounted issue of guarantees, as well as fake guarantees, as suggested by IBA, bank
guarantees should be issued in serially numbered security forms.
(ii) Banks should, while forwarding guarantees, caution the beneficiaries that they should, in their own interest,
verify the genuineness of the guarantee with the issuing bank.
3.13 RBI through its Master Circular "Loans and Advances Statutory and Other Restrictions"
(DBR.No.Dir.BC.10/13.03.00/2015-16) dated July 1, 2015 requires that banks should ensure compliance with the
recommendations of the Ghosh Committee and other internal requirements relating to issue of guarantees to
obviate the possibility of frauds in the areas of issuance of Bank Guarantees in favour of Financial Institutions,
credit facilities extending to bank against the guarantees issued by other banks/FIs and advancement of Gold
(Metal) Loans.
3.14 In this regard, it may be noted that the RBI has also issued Master Directions on Frauds Classification
and Reporting by commercial banks and select FIs (RBI/DBS/2016-17/28 DBS.CO.CFMC.BC.No.1/23.04.001/2016-
17 dated July 1, 2016). These directions deal with Classification of Frauds, Reporting of Frauds to RBI, Quarterly
Returns, Reports to the Board, Fraud Monitoring Returns, etc. and the auditor should verify the compliance of the
same.
3.15 The RBI has issued a Master Circular on "Willful Defaulters" (DBR.No.CID.BC.22/20.16.003/2015-16
dated July 01, 2015) which also specifies the role of auditors including recommendations about action to be taken
428
Compliance with Implementation of Ghosh & Jilani Committee
against negligent / deficient auditors wherein falsification of accounts on the part of borrower is observed. Further,
it specifies that to monitor end-use of funds, if the lenders desire a specific certification from the borrowers'
auditors regarding diversion / siphoning of funds by the borrower, the lender should award a separate mandate to
the auditors for the purpose. In addition to this, banks are advised that with a view to ensuring proper end-use of
funds and preventing diversion/siphoning of funds by the borrowers, lenders could consider engaging their own
auditors for such specific certification purpose without relying on certification given by borrower's auditors.
However, this cannot substitute bank's basic minimum own diligence in the
3.16 In order to ensure that directors are correctly identified and in no case, persons whose names appear to
be similar to the names of directors appearing in the list of willful defaulters appearing in the list of willful
defaulters, are wrongfully denied credit facilities on such grounds, bank/FI have been advised to include the
Director Identification Number (DIN) as one of the fields in the data submitted by them to RBI/CIC.
3.17 In terms of Para 2.9 of Master Circular on Willful Defaulters as stated above, Banks / FIs have already
been advised to submit the list of suit-filed accounts and non-suit filed accounts of willful defaulters of Rs. 25 lakh
and above on a monthly or more frequent basis to all the four Credit Information Companies. This would enable
such information to be available to the banks / FIs on a near real time basis.
3.18 In terms of RBI Circular RBI / 2015-16 / 383 Ref.DBS.CO.PPD.BC. No. 10/11.01.005/2015-16 dated April
28, 2016, implementation status of Jilani committee recommendations are not required to be submitted to Audit
Committee of the Board of Directors (ACB). However, banks are advised to ensure that:
i) Compliance to these recommendations are complete and sustained,
ii) These recommendations are appropriately factored in the internal inspection/audit processes of banks and
duly documented in their manual/ instructions, etc.
3.19 Further, in terms of RBI Circular RBI / 2016-17 / 284 Ref. DBS.CO.PPD.BC.No.9/11.01.005/2016-17
dated April 20, 2017, compliance to the Ghosh Committee recommendation also need not be reported to Audit
Committee of the Board of Directors (ACB). However, banks are advised to ensure that:
i) Compliance to these recommendations are complete and sustained,
ii) These recommendations are appropriately factored in the internal inspection/audit processes of banks and
duly documented in their manual/ instructions, etc.
Audit Procedures
3.20 The RBI has prescribed separate formats to be filled in by the banks for reporting on compliance with/
implementation of the recommendations of the Ghosh and Jilani Committees. The responsibility of the statutory
auditors is to certify the status of compliance with/ implementation of the recommendations of the Ghosh and Jilani
Committees. Accordingly, the following procedures may be adopted by the statutory auditors of branches as well
as the central statutory auditors for certifying the compliance/ implementation status of the Ghosh and Jilani
Committees recommendations.
In case of the branch, the SBA shall enquire from the management of the branch whether it has prepared the
prescribed report on the implementation status of the recommendations of the Ghosh and Jilani Committees.
If yes, then whether the same has been forwarded to the Head Office for necessary action. If no, then the
auditor should obtain necessary representation from the management as to why the report has not been
prepared and/ or submitted and should appropriately qualify his report.
In case of the Head Office, the SCA shall obtain a confirmation from the management whether it has received
the report on the implementation status of the recommendations of the Ghosh and Jilani Committees from all
the branches, regional/ zonal offices, etc. and also whether it has prepared the status report as applicable to
the Head Office level. The SCA shall obtain a list of the branches, regional/ zonal offices which have not
submitted the prescribed report. Such a list would help the SCA to have a broad idea as to the extent of
implementation of the recommendations by the bank as a whole.
429
Exposure Draft of Guidance Note on Audit of Banks (Revised 2018)
The SCA should obtain and review a copy of the implementation status report(s) so prepared and submitted.
Such a review would help the auditors identify areas which are susceptible to fraud/ malpractices. The results
of such a review may also require the auditor to re-consider the nature, timing and extent of the procedures
adopted by him for carrying out the audit as well as his audit findings.
In case of Branch audit, where the concerned branch has been subjected to a concurrent audit, then the
report of the concurrent auditor on the status of implementation of the recommendations of the Ghosh and
Jilani Committees should also be obtained. In case, the branch is not subject to a concurrent audit, the SBA
should enquire whether it had been subjected to any inspection either by the in-house inspection department
or by the inspectors of the RBI. The auditor should review the comments, if any, of the concurrent auditor or
such inspectors on the said implementation status report.
The SCA may also request the management to provide a list of branches which had been subject to a
concurrent audit/ inspection by the in-house inspection department or the inspectors from the RBI. He may, if
considered necessary, select some such branches and review the comments of the concurrent auditors/
inspectors on the status of implementation of the recommendations. This would help to identify any common
cause of concern among the bank branches.
Where the status report, as prepared by the management indicates that any of the recommendations have not
been implemented, the auditor should request the concerned management to give a written representation as
to why the particular recommendation(s) has/have not been implemented.
The auditor may also consider it necessary to carry out test checks to ensure whether the recommendations
which have been said to have been implemented in the status report have indeed been implemented by the
management.
3.21 In case, auditors examination reveals that any of the recommendations indicated as having been
implemented have in fact not been implemented by the management, or where there is a failure to comply with
any of the recommendations of the two Committees, would not only indicate a weakness in the internal control
system in the bank but also raise doubts as to the integrity of the management. The auditor may, accordingly, also
need to re-consider the nature, timing and extent of other audit procedures as also the truth and accuracy of any
other management re-presentations obtained by the auditor.
Certificate of the Statutory Auditor on the Status of Compliance
3.22 Based on the work done, the auditor should assess whether any information obtained during the
verification indicates that any of the recommendations of the Ghosh and Jilani Committees have not been
implemented, either in full or in part. The auditor may consider expressing either disclaimer or appropriate
comments in respect of certain clauses such as Item Nos. 1.1 and 1.11 of Part II of Group A of Ghosh Committee.
3.23 The above-mentioned Certificate should describe the scope of the verification undertaken to enable the
readers to understand the nature of work performed and make it clear that a full fledged investigation had not
been undertaken. The Certificate of the auditor should also draw attention to the following facts:
That the responsibility for the implementation of the recommendations of the Ghosh and the Jilani
Committees is solely that of the management of the bank.
That the auditor has also considered the reports of all or certain, as the case may be, concurrent
auditors/inspectors of the bank branches on the status of implementation of the recommendations of the
Ghosh and Jilani Committees at the branch office and controlling offices.
That the verification was limited primarily to enquiries and obtaining confirmations from the management and
other appropriate persons.
That the auditor has carried out test checks to assess the status of implementation of the recommendations of
the Ghosh and Jilani Committees.
3.24 The Annexure A to this Chapter provides an illustrative format of the auditor's certificate w.r.t. compliance
with/ implementation of the recommendations of the Ghosh and Jilani Committees.
430
Compliance with Implementation of Ghosh & Jilani Committee
Annexure A
Illustrative Format of Certificate w.r.t. Compliance/ Implementation Status of the
Recommendations of the Ghosh and Jilani Committees
We have examined the attached Format of compliance/ implementation by _____________ (name of bank/ bank
branch) with the recommendations of the Ghosh Committee relating to Frauds and Malpractices in Banks and
Format of Progress in Implementation of Jilani Committee recommendations, as prepared by the management.
The responsibility for compliance with/ implementation of the recommendations of the Ghosh and the Jilani
Committees is that of the management of the ___________ (name of the bank/ bank branch). Our responsibility is
to examine the report on the status of compliance therewith as contained in the attached Formats, as prepared by
the management, thus far and no further.
We have not carried out an investigation into the status of compliance by/ implementation of the management with
the recommendations of the Ghosh and Jilani Committees. Our examination is limited to inquiries and obtaining
confirmations from the management and other appropriate persons and test checks of the attached status of
recommendations.
Based on our above examination, subject to the matter highlighted below, we certify that to the best of our
knowledge and belief and according to the information and explanation given to us and as shown by the records
examined by us, the attached Formats of compliance with the recommendations of the Ghosh and Jilani
Committees, as prepared by the management is correct.
1. ...........................
2. ............................
Date: For and on behalf of
Chartered Accountants
Place:
(Firm Registration No.)
......................................
(Name and Designation)
(Membership Number)
431
V-4
Other Aspects
Head Office
4.01 Apart from examination of consolidation of branch returns, verification of capital and reserves, and
verification of investments and provisioning in respect thereof, the central auditors also usually deal with the
following items:
provision for non-performing assets;
depreciation on assets like, premises, etc. where the recording of the relevant fixed assets is centralised at
the head office;
provisions for certain employee costs, such as, bonus/ex-gratia in lieu of bonus, gratuity, leave encashment,
pension and other retirement benefits;
provision for taxation;
provision for audit fee;
provisions to meet any other specific liabilities or contingencies the amount of which is material, for example,
provision for revision in pay-scales of employees, provision for foreign exchange fluctuations, etc; and
Dividends.
Provisioning for Non-performing Assets
4.02 The prudential norms issued by the RBI prescribe the percentage of provision to be made in respect of
advances classified under different categories, viz., standard, sub-standard, doubtful and loss assets. In this
context, the RBI has issued "Master Circular Prudential Norms on Income Recognition, Asset Classification and
Provisioning pertaining to Advances" (DBOD.No.BP.BC.2/21.04.048/2015-16) dated July 1, 2015. The primary
responsibility for making adequate provisions for any diminution in the value of loan assets, investment or other
assets is that of the bank management and the statutory auditors. The assessment made by the inspecting officer
of the RBI is furnished to the bank to assist the bank management and the statutory auditors in taking a decision
in regard to making adequate and necessary provisions in terms of prudential guidelines. It may be emphasised
that the percentages prescribed by the RBI reflect the minimum proportion of an advance that a bank ought to
provide for to comply with the guidelines. A bank can, at its discretion, make a higher provision than that required
under the prudential guidelines. Further, the bank needs to ensure that the bank complies with the PCR (Provision
Coverage Ratio) as prescribed by RBI.
4.03 As per RBI Circular RBI/2016-17/283 DBR.BP.BC.No.63/21.04.018/2016-17 dated April 18, 2017 issued
under the provisions of Section 35A of the Banking Regulation Act, 1949, Banks are required to make disclosures
as per Annexure to the said circular, wherever either (a) the additional provisioning requirements assessed by RBI
exceed 15 percent of the published net profits after tax for the reference period or (b) the additional Gross NPAs
identified by RBI exceed 15 percent of the published incremental Gross NPAs1 for the reference period, or both. The
disclosures, as above, shall be made in the Notes to Accounts in the ensuing Annual Financial Statements published
immediately following communication of such divergence by RBI to the bank. The disclosures in the Notes to
Accounts to the Annual Financial Statements may be included under the sub-head Asset Quality (Non-Performing
Assets) as referred to in paragraph 3.4 of Master Circular - Disclosure in Financial Statements - Notes to Accounts
Ref. DBR.BP.BC No.23 /21.04.018/2015-16 dated July 1, 2015. RBI has further stated that any contravention / non-
compliance of the above instructions shall attract penalties under the Act. While the requirement is to make
disclosures in the annual financial statements, auditors of listed banks may consider including such disclosures in the
quarterly financial results in the quarter in which the RBI inspection report is received.
Other Aspects
4.04 It has also been mentioned earlier that provisions in respect of non-performing assets are usually not
made at the branch level but at the head office level. The amount of provision (or minimum amount) to be made at
the head office level is based on classification of assets into standard, sub-standard, doubtful and loss assets.
Branch returns contain analysis of the advances into these categories. The central auditor examines prima facie
the correctness of the classification as a part of his examination of consolidation of branch returns. The branch
auditors' reports may also point out cases where in their opinion, there are threats to recovery that warrant a
higher amount of provision than that arrived at on the basis of the percentages specified by the RBI.
4.05 The auditor should examine whether the provision made by the management at the head office level
meets the minimum provisioning requirements prescribed by the RBI and also takes into account the threats to
recovery in specific cases. With regard to the latter, the auditor should ensure that the provision made by the
management is not less than that recommended by the respective branch auditors unless, based on the
information and explanations, which were not available to the branch auditors, he holds a contrary view, or unless
he otherwise believes that the branch auditors' objections have been met or are not of such nature and
significance as to warrant a provision in the overall context of the bank as a whole.
4.06 The Third Schedule to the Banking Regulation Act, 1949 lays down the requirements of disclosure
concerning advances. Accordingly, advances are required to be classified under various heads (Notes and
Instructions for Compilation' of Balance Sheet and Profit and Loss Account, issued by the RBI require that
provisions made to the satisfaction of the auditors should be excluded from advances under each head). The
concern of the auditor is with the overall adequacy of provisions in respect of each of the heads under which
advances are required to be shown in the balance sheet of a bank. Thus, for example, the auditor has to examine
the adequacy of the overall provisions recommended by the bank separately in respect of (a) bills purchased and
discounted, (b) cash credits, overdrafts and loans repayable on demand, and (c) term loans. Similarly, the auditor
should examine the overall adequacy of the provisions recommended under each of the other heads of advances
in the balance sheet. If, in his opinion, the overall provision recommended by the bank in respect of any of the
heads is inadequate, `the auditor should consider if his report needs to be modified with reference to the
requirements of Standard on Auditing (SA) 705 (Revised), Modifications to the Opinion in the Independent
Auditor's Report'.
4.07 The RBI has specified that advances against book debts may be included under the head `secured by
tangible assets'.
Recognition of Certain Expenses
4.08 Certain expenses, such as the following, are usually recognised at the head office level (or at zonal or
regional level):
(a) Directors' fees, allowances and expenses;
(b) Insurance;
(c) Auditors' fees and expenses; and
(d) Service tax, GST, etc.
Directors' Fees, Allowances and Expenses
4.09 This item includes sitting fees and all other items of expenditure incurred in relation to directors. The
daily allowance, hotel charges, conveyance charges, etc., though in the nature of reimbursement of expenses
incurred, may be included under this head. Similar expenses of local Committee members may also be included
under this head. Under the Companies Act, 2013 a director may receive remuneration by way of a fee for each
meeting of the Board or a Committee attended by him. Local Committees are appointed by banks as advisory
bodies in respect of the areas allotted to them. Their members are also paid fees or allowances.
4.10 The auditor may check the sitting fees and allowances with reference to the articles of the banking
company, agreements, minutes of the Board and Local Committees, etc. It may be noted that in the case of
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nationalised banks, the fees and the basis of reimbursement of travelling expenses are fixed by the Central
Government in consultation with the RBI. Copies of the relevant orders may be examined in this behalf.
Insurance
4.11 This item includes insurance charges on bank's property. It also includes insurance premium paid to
DICGC, etc., to the extent they are not recovered from the parties concerned.
4.12 Banks submit a Return on Total Insurable Deposits to RBI on a periodic basis. Insurance premium is
payable on such deposits. The auditor should check the basis of computation of insurable deposits and the
insurance premium paid on same.
4.13 The DICGC guarantee fees payable by banks are based on the outstanding amount of priority sector
advances covered by DICGC as on 31st March every year. The auditor should check the basis of
payment/provision for such guarantee fees.
Auditors' Fees and Expenses
4.14 This item includes the fees paid to the statutory auditors and auditors for professional services rendered
and all expenses for performing their duties, even though they may be in the nature of reimbursement of
expenses. If external auditors have been appointed by banks themselves for internal inspections and audits and
other services, the expenses incurred in that context including fees incurred for such assignments may not be
included under this head but shown under 'other expenditure'.
Provision for Depreciation
4.15 As mentioned earlier, practices differ amongst banks with regard to accounting for fixed assets and
provision for depreciation thereon. In case these accounting aspects in respect of all or certain categories of fixed
assets are centralised at the head office level, the central auditor should examine the same. The procedures to be
followed by the auditor in this respect would be similar to those discussed in Chapter 2 of Part IV on "Fixed Assets
and Other Assets" at the branch level, except that the central auditor may request the respective branch auditors
to examine the evidence of physical existence of fixed assets that, as per the records, are located at the branch or
have been provided to employees for use (such as residential premises).
Provisions for Certain Employee Costs
4.16 Provisions for certain employee costs such as bonus/ex-gratia in lieu of bonus, and gratuity, leave
encashment, pension and other retirement benefits are usually made at the head office level.
4.17 The auditor should examine whether the liability for bonus is provided for in accordance with the Payment
of Bonus Act, 1965 and/or agreement with the employees or award of competent authority.
4.18 The auditor should examine whether provisions in respect of employee benefits are made in accordance
with the requirements of Accounting Standard (AS) 15, "Employee Benefits". The auditor should particularly
examine whether provision for leave encashment has been made by the bank. As per AS 15, employee benefits
include all forms of consideration given by an enterprise in exchange for services rendered by employees. It
includes short-term employee benefits such as wages, salaries and social security contributions and non-
monetary benefits, post-employment benefits, other long-term employee benefits and termination benefits. The
auditor should examine the adequacy of the provisions made with reference to such documentary evidence such
as reports of actuaries or certificates from the Life Insurance Companies, as appropriate under the facts and
circumstances of the case.
4.19 In the case of employee benefits, the Master Circular on "Disclosure in Financial Statements Notes to
Accounts" (DBR.BP.BC No. 23 /21.04.018/2015-16) dated July 1, 2015 issued by the RBI with reference to
Accounting Standard 15, specifies that Banks may follow the disclosure requirements prescribed under AS 15
(revised), `Employees Benefits' issued by ICAI.
Provision for Taxation
4.20 Provision for taxation relates to income-tax, (including corporate dividend tax). The auditor must ensure
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compliance with AS 22, "Accounting for Taxes on Income".
Income-tax
4.21 Some of the items which have an effect on the liability of a bank for income-tax and therefore, need to be
specifically considered by the auditor are discussed in the following paragraphs.
The Statutory Auditor should consider impact of Income Computation and Disclosure Standards (ICDS) issued
vide notification dated 31 March 2015 by CBDT while calculation provision of Tax. The notification requires income
computation and disclosure standards to be followed by all assessees, following the mercantile system of accounting,
for the purposes of computation of income chargeable to income-tax under the head "Profit and gains of business or
profession" or "Income from other sources".
ICDS No. Name
I Accounting Policies
II Valuation of Inventories
III Construction Contracts
IV Revenue Recognition
V Tangible Fixed Assets
VI Effects of Changes in Foreign Exchange Rates
VII Government Grants
VIII Securities
IX Borrowing Costs
X Provisions, Contingent Liabilities & Contingent Assets
The notification came into force with effect from 1st day of April, 2016, and accordingly applies to the assessment
year 2017-18 and subsequent assessment years.
Bad Debts and Provision for Bad and Doubtful Debts
4.22 Section 36(1)(vii) of the Income-tax Act, 1961 deals with the allowability of bad debts and section
36(1)(viia) deals with the allowability of provision for bad and doubtful debts. According to section 36(1)(vii), bad
debts written off are admissible deduction subject to the conditions prescribed under section 36(2), i.e.,
(i) no such deduction shall be allowed unless such debt or part thereof has been taken into account in computing
the income of the assessee of the previous year in which the amount of such debt or part thereof is written off or
of an earlier previous year, or represents money lent in the ordinary course of the business of banking or
money-lending which is carried on by the assessee;
(ii) if the amount ultimately recovered on any such debt or part of debt is less than the difference between the debt
or part and the amount so deducted, the deficiency shall be deductible in the previous year in which the ultimate
recovery is made;
(iii) any such debt or part of debt may be deducted if it has already been written off as irrecoverable in the accounts
of an earlier previous year, but the Assessing Officer had not allowed it to be deducted on the ground that it had
not been established to have become a bad debt in that year;
(iv) where any such debt or part of debt is written off as irrecoverable in the accounts of the previous year and the
Assessing Officer is satisfied that such debt or part became a bad debt in any earlier previous year nor falling
beyond a period of four previous years immediately preceding the previous year in which such debt or part is
written off, the provisions of sub-section (6) of section 155 shall apply;
(v) where such debt or part of debt relates to advances made by an assessee to which clause (viia) of sub-section
(1) applies, no such deduction shall be allowed unless the assessee has debited the amount of such debt or
part of debt in that previous year to the provision for bad and doubtful debts account made under that clause.
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4.23 The said deduction is limited to the amount by which the bad debts exceed the credit balance in the
provision for bad and doubtful debts account made under section 36(1)(viia). According to section 36(1)(viia), a
specified percentage of the total income and a specified percentage of the aggregate average advances made by
the rural branches of the bank, both computed in the prescribed manner, is allowable as a deduction in respect of
provision for bad and doubtful debts made by banks other than foreign banks.
4.24 A scheduled bank/non-scheduled bank has the option to claim a further deduction for an amount not
exceeding the income derived from redemption of securities in accordance with a scheme framed by the Central
Government. This is in addition to the deduction specified in paragraphs above with respect to section 36(i)(viia).
However, for the purpose of claiming this deduction, it is necessary that such income should be disclosed in the
return of income under the head `Profit and gains of business or profession".
4.25 Section 36(1)(vii) requires the amount of any bad debt or part thereof to be written off as irrecoverable in
the accounts of the assessee for the previous year. It is sufficient compliance of the section if the write off is done
at Head Office level.
Special Reserve
4.26 Deduction in respect of a special reserve created and maintained by a banking company
(a) Section 36(1)(viii) provides deduction in respect of any special reserve created and maintained by a specified
entity, which includes a banking company.
(b) The quantum of deduction, however, should not exceed 20% of the profits derived from eligible business
computed under the head "Profits and Gains of Business or Profession" (before making any deduction under
this clause) carried to such reserve account.
(c) The eligible business, in case of a banking company, means the business of providing long-term finance for
(i) industrial or agricultural development or development of infrastructure facility in India; or
(ii) development of housing in India.
(d) However, where the aggregate amount carried to such reserve account exceeds twice the amount of paid up
share capital and general reserve, no deduction shall be allowed in respect of such excess.
(e) The Reserve Bank of India has issued circular No.: DBOD. No.BP.BC.77/21.04.018/2013-14 dated December
20, 2013 for creation of deferred tax liability on special reserves created under section 36(1)(viii) and entire
Special Reserves may be reckoned for the purpose computation of Tier-I Capital.
Interest on Non-Performing Accounts (NPAs)
4.27 According to section 43D, read with Rule 6EA of the Income-tax Rules, 1962, the income of a scheduled
bank by way of interest in relation to such categories of bad or doubtful debts as may be prescribed having regard
to the guidelines issued by the RBI in relation to such debts, shall be chargeable to tax only in the previous year in
which it is credited to the Profit and Loss Account or in the year of actual receipt, whichever is earlier.
Transactions with Foreign Banks/Foreign branches of Indian banks
4.28 The applicability of any Double Taxation Avoidance Agreement is to be taken into account for the
purpose of computation of tax in respect of transactions with foreign banks or foreign branches of Indian banks.
4.29 Similarly the applicability of Transfer Pricing Regulations is to be taken into account for the purpose of
computation of tax in respect of international transactions with Associated Enterprises covered under section 92E
of the Income-tax Act, 1961. Reference may also be made to the "Guidance Note on Report on International
Transactions under section 92E of the Income-tax Act, 1961 (Transfer Pricing)" issued by ICAI.
4.30 In respect of any provision for bad and doubtful debts made by a foreign bank, an amount not exceeding
5% of the total income (computed before making any deduction under Chapter VI-A) is allowable as deduction.
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Corporate Dividend Tax
4.31 A holding company receiving dividend from its subsidiary company can reduce the same from dividends
declared, distributed or paid by it. For this purpose, a holding company is one which holds more than 50% of the
nominal value of equity shares of the subsidiary.
4.32 There are certain conditions to be fulfilled to avail this benefit. They are -
the subsidiary company should have actually paid the dividend distribution tax;
the holding company should be a domestic company; and
It should not be a subsidiary of any other company.
4.33 It may be noted that the matching principle does not apply, i.e., dividend received from the subsidiary
company during the year can be reduced from the dividend distributed by the holding company during the same
year, irrespective of the period to which the dividends relate to. Even if the dividend received and dividend
distributed relate to different periods, the same can be adjusted and tax can be paid by the holding company on
the net figure. However, the dividend shall not be taken into account for reduction more than once.
4.34 According to the "Guidance Note on Accounting for Corporate Dividend Tax", issued by the Institute of
Chartered Accountants of India (ICAI), the liability for such tax should be recognised in the accounts of the same
financial year as appropriation of profit and not as a charge against profit in which the dividend concerned is
recognised.
Tax Refunds/Demands
4.35 Where an assessment order is received during the year, the auditor should examine the assessment
order and if any interest is determined on the amount of refund, the same should be considered as income. In
case where the assessment results in fresh demand, the auditor should consider the need for additional
provisioning. Where an assessment order is received during the course of audit, the auditor should examine the
same and consider its impact, if any, on the accounts under audit.
4.36 It is not prudent to recognise interest on possible refund which is not determined by any order from tax
authorities.
Pending Proceedings
4.37 The auditor should review the appellate orders received during the year and consider the need for any
additional provision/reversal.
Method of Accounting
4.38 Many banks account for commission, exchange, brokerage, interest on bills, locker rent and other fees as income
upon realisation. Section 145 of the Income-tax Act, 1961 provides, inter alia, that income chargeable under the head "Profits
and Gains of Business and Profession" shall be computed in accordance with either cash or mercantile system of accounting
regularly employed by the assessee. Auditors of banks to whom the Companies Act applies are required to follow accrual
basis of accounting. Further, accrual being a fundamental accounting assumption, the auditor would need to consider
modification/ reference to/ in the auditors report wherever cash basis of accounting is followed.
Reversal of Earlier Year's Provision
4.39 It is possible that subsequent judicial pronouncements/ appellate orders may make the provisions of
earlier years excessive.
4.40 As per Accounting Standard (AS) 29, "Provisions, Contingent liabilities and Contingent Assets", a
provision should be recognised only when (a) an enterprise has a present obligation as a result of a past event, (b)
it is possible that an outflow of resources embodying economic benefits will be required to settle the obligation,
and (c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no
provision should be recognised.
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4.41 Only in rare cases, e.g., a law suit, it may not be clear whether an enterprise has a present obligation. In
such a case, an enterprise determines whether a present obligation exists at the balance sheet date by taking into
account all available evidence. On the basis of such evidence, if it is more likely than not that a present obligation
exists at the balance sheet date a provision is recognised (if other recognition criteria are also met). However,
where it is more likely that no obligation exists at the balance sheet date, a contingent liability is disclosed unless
the possibility of an outflow of resources embodying economic benefits is remote.
4.42 On the above considerations, if there is no requirement to retain a provision, it can be reversed and the
amount of liability is included in contingent liability. A suitable note on the following lines is recommended:
(a) Provision for Income Tax is arrived at after due consideration of decisions of the Appellate authorities and
advice of counsels; and
(b) No provision is made for the disputed demands of Income tax keeping in view the judicial pronouncements
and/or legal counsels' opinion.
Items Requiring Special Consideration
Tax Implications of Valuation of Investments
4.43 The RBI has issued various circulars on valuation of investments, according to which the difference
between the market value/value as per yield to maturity method (YTM) will have to be provided in the books of
accounts for certain types of investments. The various judicial decisions on the allowability of depreciation in
valuation of investments, including implication of ICDS VIII, should be considered while provisioning.
Notional Gain/Loss on Foreign Exchange Translations
4.44 Banks are required to translate their foreign exchange balances / obligations in foreign currency as per
FEDAI Guidelines. The following decisions may be considered along with the by the auditor while recognising
gains or loss for tax purposes:
The Madras High Court in the case of Indian Overseas Bank Vs. Commissioner of Income-tax (1990) 183 ITR
200 has held that notional profits on translation of foreign exchange forward contracts is not taxable.
The Madras High Court in the case of Commissioner of Income-tax Vs. Indian Overseas Bank (1985) 151 ITR
446 has held that notional loss on translations of foreign exchange contracts is not tax deductible.
Broken Period Interest
4.45 The RBI, vide its Master Circular No. DBR No.BP. BC. 6/ 21.04.141 / 2015-16 on, "Prudential Norms for
Classification, Valuation and Operation of Investment Portfolio by Banks" dated July 1, 2015, advised that banks
should not capitalise the Broken Period Interest paid to seller as part of cost, but treat it as an item of expenditure
under P&L Account in respect of investments in Government and other approved securities. It is to be noted that
the above accounting treatment does not take into account the tax implications and, hence, the banks should
comply with the requirements of Income Tax Authorities in the manner prescribed by them.
4.46 However, a number of judicial decisions support the view that the interest is allowable as a business
deduction consequent to deletion of sections 18 to 21 of the Income tax Act, 1961.Honourable Bombay High Court
in case of American Express International Banking vs. CIT [2002] 258 ITR 601 (Bom) supports this view. The said
judgement has been followed in case of CIT vs. Citi Bank N.A. [2003] 264 ITR 18 (Bom), CIT vs. Nedungadi Bank
Ltd [2003] 264 ITR 545 (Ker) and by Honourable Bombay High Court in case of Union Bank of India in judgement
dated October 9, 2002 in I.T.R. No.28 of 1998. The Special Leave Petition (SLP) filed by the Department against
the judgement in case Union Bank of India has been dismissed by the Supreme Court. [Refer 268 ITR (St) 216]
Disallowance of expenditure incurred in earning income which is exempt from tax
4.47 Section 14A has been inserted by the Finance Act, 2001, with retrospective effect from 1-4-1962, to
provide that no deduction shall be allowed in respect of expenditure incurred by an assessee in relation to income
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which does not form part of the total income under the Income-tax Act, 1961. This principle will have application in
the matter of exempted income earned by banks also, e.g., income from tax-free securities and dividend from
shares of domestic companies.
4.48 Section 14A(2) empowers the Assessing Officer to determine the amount of expenditure incurred in
relation to such income which does not form part of the total income in accordance with such method as may be
prescribed. The method for determining expenditure in relation to exempt income is to be prescribed by the CBDT
for the purpose of disallowance of such expenditure under section 14A. Such method should be adopted by the
Assessing Officer if he is not satisfied with the correctness of the claim of the assessee, having regard to the
accounts of the assessee. Further, the Assessing Officer is empowered to adopt such method, where an assessee
claims that no expenditure has been incurred by him in relation to income which does not form part of total income
[section 14A(3)].
4.49 The CBDT has, vide Notification No.45/2008 dated 24.3.2008, inserted a new Rule 8D which lays down
the method for determining amount of expenditure in relation to income not includible in total income.
4.50 If the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied
with
(a) the correctness of the claim of expenditure by the assessee; or
(b) the claim made by the assessee that no expenditure has been incurred in relation to exempt income for
such previous year,
he shall determine the amount of expenditure in relation to such income in the manner provided hereunder -
4.51 The expenditure in relation to income not forming part of total income shall be the aggregate of the
following:
(i) the amount of expenditure directly relating to income which does not form part of total income;
(ii) in a case where the assessee has incurred expenditure by way of interest during the previous year which is
not directly attributable to any particular income or receipt, an amount computed in accordance with the
following formula, namely :
B
A×
C
Where,
A= amount of expenditure by way of interest other than the amount of interest included in clause (i)
incurred during the previous year;
B= the average of value of investment, income from which does not or shall not form part of the total
income, as appearing in the balance sheet of the assessee, on the first day and the last day of the
previous year;
C= the average of total assets as appearing in the balance sheet of the assessee, on the first day and
the last day of the previous year;
(iii) an amount equal to one-half per cent of the average of the value of investment, income from which does not
or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day
and the last day of the previous year.
4.52 'Total assets' means total assets as appearing in the balance sheet excluding the increase on account of
revaluation of assets but including the decrease on account of revaluation of assets.
4.53 The various judicial decisions on disallowance of expenses U/s.14A should be considered while making a
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provision for Income-tax. Reference may also be made to the "Guidance Note on Tax Audit under Section 44AB of
the Income-tax Act, 1961" issued by ICAI for detailed discussion.
Share Issue Expenses
4.54 The Supreme Court in the case of Brooke Bond India Ltd. Vs. Commissioner of Income-tax, 224 ITR 798,
has held that expenditure incurred on issue of shares is a capital expenditure for the purpose of taxation.
4.55 However, the expenditure incurred by a banking company on account of stamp duty and registration fees
for the issue of bonus shares is allowable as revenue expenditure as held by the Supreme Court in CIT v. General
Insurance Corporation (2006) 286 ITR 232.
4.56 Preliminary expenses are allowed as deduction under section 35D over a period of 5 successive years
starting from the year of commencement of business, i.e., one-fifth of the expenditure is allowed as deduction in
each year. Such preliminary expenses include the following:
(a) Expenditure in connection with:
(i) Preparation of feasibility report;
(ii) Preparation of project report;
(iii) conducting market survey or any other survey necessary for the business of the assessee;
(iv) engineering services relating to the business of the assessee:
Provided that the work in connection with the preparation of the feasibility report or the project report or the
conducting of market survey or of any other survey or the engineering services referred to in this clause is carried out
by the assessee himself or by a concern which is for the time being approved in this behalf by the Board;
(b) legal charges for drafting any agreement between the assessee and any other person for any purpose
relating to the setting up or conduct of the business of the assessee;
(c) Where the assessee is a company, also expenditure:
(i) by way of legal charges for drafting the Memorandum and Articles of Association of the company;
(ii) On printing of the Memorandum and Articles of Association;
(iii) by way of fees for registering the company under the provisions of the Companies Act, 2013;
(iv) in connection with the issue, for public subscription, of shares in or debentures of the company,
being underwriting commission, brokerage and charges for drafting, typing, printing and
advertisement of the prospectus;
(d) Such other items of expenditure (not being expenditure eligible for any allowance or deduction under any
other provision of this Act) as may be prescribed.
Where the aggregate amount of the expenditure referred to above exceeds an amount calculated at five per cent:
(a) of the cost of the project; or
(b) where the assessee is an Indian company, at the option of the company, of the capital employed in the
business of the company,
The excess shall be ignored for the purpose of computing the deduction allowable for the preliminary expanses.
4.57 Such preliminary expenses incurred before commencement of business is allowed as deduction to
companies in both the manufacturing and service sector. However, so far, such expenses incurred after
commencement of business for extension of an industrial undertaking or for setting up a new industrial unit were
allowed only for the companies in the manufacturing sector. This benefit has now been extended to the companies
in the service sector as well. Consequently, the banking sector would also be benefited. This amendment has
been effected by the Finance Act, 2008.
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Depreciation
4.58 Generally, in respect of buildings, pending registration of documents of title, a note is given mentioning
this fact. The Supreme Court has held in the case of Mysore Minerals Ltd., (1999) 106 Taxman 166, that "anyone
in possession of property in his own title exercising such dominion over the property as would enable others being
excluded therefrom and having the right to use and occupy the property and/or to enjoy its usufruct in his own right
would be the owner of the building though a formal deed of title may not have been executed and registered as
contemplated by the Transfer of Property Act 1882, Registration Act, etc." The judgement clarifies that an
assessee will be entitled to depreciation under section 32 of the Income tax Act, 1961 even where documents of
title are pending registration.
4.59 The Courts have held in the case of Syndicate Bank Vs. Commissioner of Income tax (1988) 172 ITR 561
and in the case of Commissioner of Income-tax Vs. Central Bank of India Ltd. (1976) 103 ITR 196 that lockers
(including, air - conditioners in locker rooms) are plant and machinery.
4.60 Where banks enter into sale and lease back transactions, according to Explanation 4A to Section 43(1),
the written down value (as per the provisions of the Income Tax Act, 1961) of the original seller will be the cost to
the bank for the purpose of depreciation.
Carry forward of unabsorbed business loss and depreciation on amalgamation of a banking company with
a banking institution
4.61 With a view to provide for carry forward and set-off of accumulated loss and unabsorbed depreciation
allowance of a banking company against the profits of a banking institution under a scheme of amalgamation
sanctioned by the Central Government, section 72AA has been inserted in the Income-tax Act, 1961. This section
provides that where a banking company has been amalgamated with a banking institution under a scheme
sanctioned and brought into force by the Central Government under sub-section (7) of section 45 of the Banking
Regulation Act, 1949, the accumulated loss and unabsorbed depreciation of the amalgamating banking company
shall be deemed to be the loss or the allowance for depreciation of the banking institution for the previous year in
which the scheme of amalgamation is brought into force. It is to be noted that all the provisions contained in the
Income-tax Act, 1961, relating to set-off and carry forward of loss and unabsorbed depreciation will apply
accordingly in such a case.
4.62 The Explanation to this section defines the expressions "accumulated loss", "banking company, "banking
institution" and "unabsorbed depreciation", for the purposes of this section as follows
(i) "accumulated loss" means so much of the loss of the amalgamating banking company under the head
"Profits and gains of business or profession" (not being a loss sustained in a speculation business) which
such amalgamating banking company, would have been entitled to carry forward and set-off under the
provisions of section 72 if the amalgamation had not taken place;
(ii) "banking company" shall have the same meaning assigned to it in clause (c) of section 5 of the Banking
Regulation Act, 1949;
(iii) "banking institution" shall have the same meaning assigned to it in sub-section (15) of section 45 of the
Banking Regulation Act, 1949;
(iv) "unabsorbed depreciation" means so much of the allowance for depreciation of the amalgamating banking
company which remains to be allowed and which would have been allowed to such banking company if
amalgamation had not taken place.
4.63 Any transfer of a capital asset by a banking company to a banking institution in a scheme of
amalgamation of such banking company with such banking institution sanctioned and brought into force by the
Central Government under sub-section (7) of section 45 of the Banking Regulation Act, 1949 shall not be regarded
as a transfer for the purposes of capital gains.
4.64 The cost of acquisition of the capital asset transferred to the banking institution, under the scheme of
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amalgamation of a banking company with the banking institution, shall be deemed to be the cost for which the
banking company acquired it.
FATCA /CRS
4.65 Foreign Account Tax Compliance Act (known in short as FATCA) is a legislation to counter tax evasion in
the United States of America (USA) FATCA was introduced by US Dept of Treasury (Treasury) and US Internal
Revenue Service (IRS) to encourage better tax compliance by preventing US persons from using banks and other
financial organisations to avoid US taxation on their income and assets.
4.66 As on 13th July 2015, 112 countries have agreed to comply with FATCA agreements (67 signed IGAs, 45
IGAs agreed in substance). As on 4th June 2015, 61 countries are signatories of Multilateral Competent Authority
Agreement (MCAA) committed to reciprocal tax information exchange.
4.67 India and the USA have signed the reciprocal version of model 1 IGA for FATCA on 9th July 2015.
4.68 India signed the OECD's CRS (Common Reporting Standards) on 3rd June 2015.
4.69 The IGA has 2 models India has signed Model 1 IGA wherein banks will have to report information to the
prescribed authority who in turn will submit information to the IRS.
4.70 In Model 1 IGA, the Foreign Financial Institution (FFI) has to report all FATCA related information to their
governmental agencies, which would then report the FATCA related information to the IRS. Some Model 1 IGAs are
reciprocal, requiring the US to provide certain information about residents of the Model 1 country to the Model 1
country in exchange for the information that country provides to the USA. An FFI covered by a Model 1 IGA will not
need to sign an FFI agreement but needs to register on the IRS's FATCA Registration Portal or file Form 8957.
4.71 Like FATCA, Common Reporting Standard (CRS) is a reciprocal exchange of information on financial
accounts on an automatic basis with other countries/ non-sovereign territories so as to combat the menace of
offshore tax evasion and avoidance and stashing of unaccounted money abroad.
4.72 India would be obligated to get its financial institutions to share financial account information of
accountholders who are tax residents in any of these countries. Likewise, India would also get similar information
through financial institutions of such treaty countries.
4.73 CBDT has notified Rule 114H for Due Diligence Requirement under FATCA, major requirements for the
Bank as under:
All the concerned financial institutions should register on the related e-filling portal of Income Tax Department as
Reporting Financial Institution by submitting the requisite details. Thereafter, the reports can be submitted online by
using the digital signature of the `Designated Director' by either uploading the Form 61B or `NIL' report.
4.74 As per RBI Circular RBI/2015-16/165 DBR.AML.BC.No.36 /14.01.001/2015-16, dated August 28, 2015, for
the new accounts opened after September 1, 2015, the due diligence procedures specified in Rule 114H (4) and
114H (6) would be applicable.
4.75 All the FIs have to submit reports online using the digital signature of the designated director by either
uploading Form 61B or Nil Report by September 10, 2015. The first reporting will be with respect to calendar year
2014 if an account has been identified as US reportable account consequent to completion of due- diligence
procedures as laid down in Rule 114H. Therefore, the reasons for the Nil report should be captured as under:
a. For pre-existing accounts:
Option 1: Due diligence procedure not completed
Option 2: Due diligence procedure completed but no reportable US account identified
b. For new accounts:
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Other Aspects
Option 1: Alternative procedure invoked
Option 2: Due diligence procedure as applicable to new accounts completed but no reportable US account identified
4.76 All the regulated entities should take action appropriately for the implementation of due diligence and
reporting requirements as laid down in the Rules and ensure compliance in a manner that lends itself to credible
auditability including audit of the IT system which should be suitably upgraded to not only maintain the information
required under the Rules but also to record and store the due diligence procedures. In due course, the detailed
guidelines for carrying out audit of IT system for ascertaining the degree and level of compliance with due diligence
procedures as laid down in the Rules will be issued.
4.77 Statutory Auditor should verify whether the Bank has put a process in place for complying with guidelines
under FATCA/CRS and submitted reports as required by FATCA.
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VI-5
Other Aspects - Service Tax/ Goods and
Services Tax
Brief History of Applicability of Service Tax on Banks
(A) Position under Positive List of Taxation
5.01 Some of the banking services have been brought under the Service Tax net. Banks need to ensure that
all unpaid service tax liability is adequately provided. It is worth highlighting here that, Service Tax was introduced
in India on 01.07.1994. However, Banking and Other Financial Services had been brought within the ambit of
Service Tax w.e.f. 16.07.2001. Services mentioned in clause (a) of section 65 (12) of the Finance Act, 1994 are
taxable, if provided by:
(a) Banking company and financial institution including NBFCs from July 16, 2001; or
(b) Any other body corporate from August 16, 2002; or
(c) Any other commercial concern from September 10, 2004.
5.02 Services mentioned in clause (b) of section 65 (12) of the Finance Act, 1994 are taxable, if provided by:
(a) Banking companies, financial institutions including NBFCs and other body corporates from July 1, 2003; or
(b) Commercial Concerns from September 10, 2004.
5.03 With effect from May 16,2008, section 65(12) has been amended to levy service tax on foreign exchange
broking and purchase or sale of foreign currency, including money changing, provided by a foreign exchange
broker or an authorised dealer in foreign exchange or an authorised money changer also.
(B) Position under Negative List of Services which is applicable w.e.f. July 1, 2012
5.04 After the introduction of Negative List i.e. with effect from July 1, 2012, Service Tax is applicable on
all services provided by banks except followings:
Services by the Reserve Bank of India;
Services by way of--
(i) extending deposits, loans or advances in so far as the consideration is represented by way of interest or
discount;
(ii) inter se sale or purchase of foreign currency amongst banks or authorised dealers of foreign exchange or
amongst banks and such dealers.
5.05 In addition, Banks are also required to pay service tax under reverse charge mechanism in following
cases:
a) Full Reverse Charge i.e. 100% amount of Service Tax
Services provided by recovery agent;
Sponsorship Services;
Arbitral Tribunal and Legal Services;
Services provided by Director;
Import of Services;
Other Aspects-Service Tax/ Goods and Services Tax
Services of Transport of Goods by a Goods Transport Agency;
Services by way of supply of manpower for any purpose;
Security Services;
Services by way of renting of a motor vehicle designed to carry passengers after availing prescribed
abatement and
Services by Government or a Local Authority excluding Renting of Immovable Property Services,
Services by Department of Posts by way of speed post, express parcel post, life insurance and agency
services, Services in relation to an aircraft or a vessel and Services of transport of goods or passengers
b) Partial Reverse Charge:
In respect of the following taxable services 50% amount of applicable Service Tax is to be paid by Bank under
Partial Reverse Charge. The remaining 50% of the applicable Service Tax shall be charged by the Service
Provider in his invoice.
Works Contract Services
Services by way of Renting of a motor vehicle designed to carry passengers without availing the
prescribed abatement i.e. on gross amount charged.
Point of Taxation for Service Tax payable under reverse charge is when, payment is made to service provider.
Where the payment is not made within a period of three months from the date of invoice, the point of taxation shall
be the date immediately following the said period of three months.
5.06 Rate of Service Tax on Banking & Other Financial Services during different periods
Period Service Tax EC SHEC SBC KKC Tota
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