Audit of Banks

18 Audit of Banks
18.1 – LEGAL AND REGULATORY FRAMEWORK

Acts governing (a) Banking Regulation Act, 1949;
Banking (b) Reserve Bank of India Act, 1934;
Operations (c) Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970;
(d) State Bank of India Act, 1955;
(e) Regional Rural Banks Act, 1976;
(f) Companies Act, 2013;
(g) Cooperative Societies Act, 1912 or the relevant State Cooperative Societies Acts;
(h) Information Technology Act, 2000;
(i) Prevention of Money Laundering Act, 2002;
(j) Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest
Act, 2002;
(k) Credit Information Companies Regulation Act, 2005; and
(l) Payment and Settlement systems Act, 2007
Audit of As per Sec. 30(1) of the Banking Regulation Act, the balance sheet and profit and loss account of
Accounts & a banking company should be audited by a person duly qualified under any law for the time
Appointment of being in force to be an auditor of companies.
Auditor Authority appointing the Auditors
• Auditor of a banking company is to be appointed at the AGM of the shareholders. Auditor of
a nationalised bank is to be appointed by the concerned bank acting through its Board of
Directors. In either case, approval of the RBI is required before the appointment is made.
• Auditors of the SBI are to be appointed by the CAG in consultation with the C.G.
• Auditors of regional rural banks are to be appointed by the concerned bank with the
approval of the C.G.
Scope of In addition to main audit report, SCAs are required to issue the following reports/certificates:
Assignment of 1. Report on adequacy and operating effectiveness of Internal Controls Over Financial
Statutory Reporting in case of banks which are registered as companies under the Companies Act in
Central Auditor terms of Section 143(3)(i) of the Companies Act, 2013.
(SCA) 2. Long Form Audit Report (LFAR).
3. Report on compliance with SLR requirements.
4. 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.
5. Certificate on reconciliation of securities by the bank (both on its own investment account
as well as PMS Banks' account).
6. Certificate on compliance by the bank in key areas of prudential and other guidelines
relating to such transactions issued by the RBI.
18.3
Audit of Banks Chapter 18
7. Report on whether the income recognition, asset classification and provisioning have
been made as per the guidelines issued by the RBI.
8. Report on whether any serious irregularity was noticed in the working of the bank which
requires immediate attention.
9. Certificate in respect of custody of unused Bank Receipt forms and their utilisation.
10. Authentication of capital adequacy ratio, including disclosure requirements and other
ratios reported in the notes on accounts.
11. Certificate in respect of DICGC claims.
12. 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.
13. Report on instances of adverse credit-deposit ratio in the rural areas.
14. Asset liability management.
15. Certificate on Corporate Governance in case of banks listed on Stock Exchange. In some
banks this certification may not be got done by the central auditors.
16. Certification on claim of various interest subsidies and interest subvention.
Contents of In the case of a nationalised bank, the auditor is required to make a report to the Central
Audit Report Government in which the auditor should state the following:
1. Whether, in the auditor’s opinion, the balance sheet is a full and fair balance sheet
containing all the necessary particulars and is properly drawn up so as to exhibit a true
and fair view of the affairs of the bank.
2. In case the auditor had called for any explanation or information, whether it has been
given and whether it is satisfactory.
3. Whether or not the transactions of the bank, which have come to the auditor’s notice, have
been within the powers of that bank.
4. Whether or not the returns received from the offices and branches of the bank have been
found adequate for the purpose of audit.
5. Whether the profit and loss account show a true balance of profit or loss for the period
covered by such account.
6. Any other matter which the auditor considers should be brought to the notice of the
Central Government.
Points to remember
(i) Reporting requirements under Companies Act, 2013 are not applicable in case of a
nationalised bank. However, in case of a banking company, following matters need
to be reported:
(a) Matters as stated u/s 143(3) of Companies Act, 2013;
(b) Adequacy and Operating Effectiveness of Internal Financial Controls u/s
143(3)(i) of the Companies Act, 2013.
(c) Other matters in accordance with rule 11 of the Companies (Audit and
Auditors) Rules, 2014.
(ii) Reporting requirements relating to the Companies (Auditor’s Report) Order, 2020
are not applicable to a nationalised bank or to a banking company.
18.4
Chapter 18 Audit of Banks
LFAR • Besides the audit report as per the statutory requirements discussed above, 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 long form audit report is to be given by statutory branch auditors as well as statutory
central auditors.
• The LFAR for branch auditors is in form of questionnaire where observations/comments
have to be provided on range of matters including cash, balance with banks, investments,
advances, deposits etc. These are submitted by the statutory branch auditors to statutory
central auditors.
• The consolidation is done at head office level and LFAR for bank is submitted by statutory
central auditors to management. The LFAR, on the bank, after due examination, should be
placed before the ACB of the bank indicating the action taken/proposed to be taken for
rectification of the irregularities, if any, mentioned therein; and a copy of the LFAR and the
relative agenda note, together with the Board's views or directions, is submitted to RBI
within 60 days of submission of LFAR by statutory auditors.
IMPORTANT QUESTIONS
Q. No. 1: What do you understand by Long Form Audit Report? [Nov. 08 (2 Marks)]
Q. No. 2: M/s GH & Associates have been appointed as Central Statutory Auditors of BNB Bank, a
nationalized bank, headquartered in New Delhi for the F.Y 2021-2022. Bank functions in
automated environment using “FLC Software”. While preparing audit report, one of the partners
highlighted that some matters covered by Companies Act, 2013 and the requirements of
Companies (Auditor's Report) Order, 2020 reporting. You are required to answer the following:
(i) To which authority auditors should submit their audit report?
(ii) List the matters covered under Companies Act, 2013 and
(iii) Reporting under Companies (Auditor's Report), Order, 2020.
[July 21 – New Syllabus (5 Marks)]
HINT: Refer the topic “Contents of Audit Report” (i) Central Government (ii) Reporting under Companies
Act, 2013 not required in case of nationalised bank. However, in case of banking company, various
reporting requirements u/s 143 of the Companies Act, 2013 will be applicable. (iii) Not Applicable.
18.2 – CONDUCTING A BANK AUDIT

Stages in Initial Initial Considerations include considerations of:
conducting a Considerations 1. Acceptance & Continuance
Bank Audit 2. Declaration of Indebtedness
Stage I
3. Internal Assignments in Banks by Statutory Auditors

4. Terms of Audit Engagements
5. Communication with Previous Auditor
6. Establish Engagement Team
Understanding Auditor is required to obtain understating of:
the business
Stage II
• Bank and its Environment including Internal Control

operations
• Bank’s Accounting Process
• Risk Management Process
18.5
Requirements of Risk Management System in a Bank
Involvement of • Risk Management policies should be approved
TCWG by TCWG.
• While approving the policies, TCWG should
ensure that 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 considers as
acceptable.
Identification, Risks that may significantly affect the
measurement achievement of bank’s goals and objectives should
& monitoring be identified, measured and monitored against
of risks pre-approved limits and criteria.
Control Banks must have appropriate controls to manage
activities its risks, including the following:
• effective segregation of duties,
• verification and approval of transactions,
• setting of limits, and
• reporting and approval of exception.
Monitoring Independent risk management unit should be set
activities up which regularly assess the risk management
models, methodologies and assumptions used to
measure and manage risk.
Reliable Banks must have a reliable information system
information that provide adequate financial, operational and
systems compliance information on a timely and
consistent basis to management and TCWG.
Risk Auditor is required to identify and assess following risk:
Assessment • Risks of Material Misstatements
Stage III
• Risk of Fraud including Money Laundering

• Specific Risks
• Risk Associated with Outsourcing of activities.
Execution Execution stage considers the following:
• Engagement Team Discussions
• Response to the Assessed Risks
Stage IV
• Establish the Overall Audit Strategy

• Audit Planning Memorandum
• Determining Audit Materiality
• Appropriateness of Going Concern
Stage
Reporting Main report and Other Reports/Certificates.

V
18.6
Need for Special audit considerations arise in the audit of banks because of:
Special Audit 1. the particular nature of risks associated with the financial transactions undertaken by banks;
Considerations 2. voluminous scale of banking operations and the resultant significant exposures which can
in audit of arise within short period of time;
Banks
3. extensive dependence on IT for process of transactions;
4. various statutory and regulatory requirements; and
5. the continuing development of new products and services and banking practices which may
not be matched by the concurrent development of accounting principles and auditing
practices.
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.
Special Information to Considering the importance of IT systems in preparation and presentation of
Considerations be shared by financial statements, it is imperative that bank should share detailed
in CIS Banks with information with auditors like:
environment Auditors 1. Overall IT policy, structure and environment of Bank’s IT system
2. Data processing and data interface under various systems
3. Data integrity and data security
4. Business Continuity plans and disaster control plans
5. Accounting manual and critical accounting entries, their processes and
involvement of IT systems
6. Controls over key aspects, use of various account heads, expense
booking, overdue identification etc.
7. Controls on recording of various e-banking and internet banking
products and channels
8. MIS reports being generated and their periodicity
9. Major exception reports and process of generation including embedded
logic
10. Process of generating various information related to various
disclosures in financial statements and involvement of IT systems
Review of IT • Overall review of IT environment and computerized accounting system
Environment has to be taken at head office level. The branch auditors generally do
not have access to IT policy and processes implemented by the bank.
• Hence, based upon guidance and information received from Statutory
central auditors, branch auditors need to ensure that data review and
analysis through CBS is carried out and tests of controls and
substantive checking of sample transactions is carried out at branch
level and results are shared with statutory central auditors.
Key security The key security control aspects that an auditor needs to consider when
control aspects undertaking audit in a computerised environment include the following:
that an auditor 1. Ensure that authorised, accurate and complete data is made available for
needs to processing.
consider 2. 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.
18.7
3. Ensure that the system prevents unauthorised amendments to the
programmes.
4. 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
appropriate.
5. 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.
6. 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.
7. 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.
8. Verify that the account master and balance cannot be
modified/amended/altered except by the authorised personnel.
9. Verify that all the general ledger accounts codes authorised by Head
Office are in existence in the system.
Risk based Risk-based Internal audit is conducted based upon the risk assessment of business and control
Internal Audit risks of branches. The risk assessment process includes:
(a) Identification of inherent business risks in various activities undertaken by branches
(Business risk).
(b) Assessment of effectiveness of control systems for monitoring inherent risks of business
activities of branch (Control risk).
(c) Making an assessment of level and direction of various risk areas and assess level and
direction of overall business risk and control risk.
(d) Drawing up of risk matrix taking into account factors viz. Risk of branch.
IMPORTANT QUESTIONS
Q. No. 3: Write short note on: Requirements of a Risk Management Process/System in a bank.
[Nov. 16 (4 Marks)]
Q. No. 4: Banks, because of certain characteristics, are distinguished from other commercial enterprises
and hence it needs special audit consideration. As an auditor of a bank, specify the various
peculiarities which may necessitate special audit consideration to be taken care by you.
[May 19 – New Syllabus (4 Marks)]
18.3 - INTERNAL CONTROL PROCEDURES IN BANK

General 1. The staff and officers of the bank should be shifted from one position to another frequently and
Controls without prior notice.
2. The work of one person should be checked by another person.
18.8
3. A responsible officer should be given possession of demand drafts, cheque books etc.
4. The signature book should be kept with a responsible officer.
5. The bank should take insurance policies against loss and employee's infidelity.
6. The management structure should be clearly drawn and rights and duties should be properly
understood.
Cash 1. Cash should be kept in joint custody of atleast two responsible officers.
2. Surprise checking should be conducted.
3. The cashier should not have access to customer's ledger accounts and the day book.
4. Payments should be made only after the vouchers have been passed by a proper officer.
5. Receipt and payment scrolls (memoranda books maintained by the cashier) should be
compared with the cash column of the day book by an independent person.
6. The limits on the payment powers of the teller should be laid out.
Clearings 1. Under the Cheque Truncation System (CTS) implemented by RBI, an electronic image of the
cheque is transmitted to the paying branch through the clearing house, along with relevant
information like data on the MICR band, date of presentation, presenting bank, etc. This
effectively eliminates the associated cost of movement of the physical cheques, reduces the
time required for their collection.
2. As per RBI guidelines, the branch is required to either call the customer or email him for any
cheque received for the amount of ₹ 5 lakh and above in respect of inward clearings. The
Auditor may verify the compliance on test check basis.
3. The Auditor is to check whether signature of the drawer of the cheque is being verified by the
staff or not as else there will be liability of the paying bank under all circumstances.
4. The unpaid cheques received in outward clearing should be either sent to the customers at
their recorded address or the customers be informed to collect the same from bank branch.
Bills for 1. All documents accompanying the bill should be received and entered in the register by a proper
Collection officer.
2. The accounts of the principals should be credited only after realisation of the bill.
3. It should be ensured that bills sent by one branch to another branch for collection are not
included twice in the amalgamated balance sheet.
Bills 1. At the time of purchase of the bills, an officer should verify that all documents of title are
Purchased properly assigned to the bank.
2. Sufficient margin should be kept while purchasing or discounting of a bill.
3. All irregular outstanding accounts should be periodically reported to the head office.
4. In case of purchase or discounting of a bill, proportionate income should be recognised between
the periods.
Loans and 1. Advances should be made only after evaluating creditworthiness of the borrowers and
advances obtaining sanction from the proper authorities of the bank.
2. All the loan documents like promissory notes, letters of hypothecation, guarantee letter, etc.
should be executed by the parties before advances are made.
3. While determining the loan amount to be sanctioned, sufficient margin should be kept against
securities taken so as to cover any decline in the value thereof and also to comply with RBI
directives.
18.9
4. Securities should be received and returned by responsible officer and should be kept in the
joint custody of atleast two responsible officers.
5. Securities requiring registration should be registered in the name of the bank.
6. In the case of physical possession of goods as security, the goods should be test checked at the
time of receipts. In respect of hypothecated goods not in possession of the bank, surprise
checks should be made.
7. Personal inquiries should be made so as to determine market value of goods.
8. For any increase/decrease in the value of securities, drawing power should be adjusted. All the
accounts should be kept within both the drawing power and the sanctioned limit at all times.
9. All irregular accounts should be brought to the notice of the H.O. regularly.
10. The operation in each advance should be reviewed at least once every year.
11. There should exist a proper system for post disbursement supervision and follow-up.
12. Classification of advances should be made as per RBI Guidelines.
13. Ensure that the funds disbursed should be utilized only for the purpose for which advances
has been granted.
Demand 1. The signatures on a DD should be checked by an officer with the Signature Book.
Drafts 2. All the DDs issued by a branch should be immediately confirmed by the advices to the paying
branch.
3. If the paying branch does not receive proper confirmation of any DD from the issuing branch
or does not receive credit in its account with that branch, it should take immediate steps to
ascertain the reasons.
Inter Branch 1. The accounts should be adjusted only on the basis of advices (and not on the strength of
Accounts entries found in the statement of account) received from other branches.
2. Prompt action should be taken preferably by central authority, if any entries (particularly
debit entries) are not responded to by any branch within a reasonable time.
Credit Card 1. There should be effective screening of applications with reasonably good credit assessments.
Operations 2. There should be strict control over storage and issue of cards.
3. There should be a system whereby a merchant confirms the status of unutilised limit of a
credit card holder from the bank before accepting the settlement in case the amount to be
settled exceeds a specified percentage of the total limit of the card holder.
4. There should be system of prompt reporting by the merchants of all settlements accepted by
them through credit cards.
5. Reimbursement to merchants should be made only after verification of the validity of
merchant’s acceptance of cards.
6. All the reimbursements should be immediately charged to the customer’s account.
7. There should be a system to ensure that statements are sent regularly and promptly to the
customer.
8. There should be a system of monitor and follow-up of customers’ payments.
9. Items overdue beyond a reasonable period should be identified and attended to carefully.
Credit should be stopped as early as possible, to avoid increased losses.
10. There should be a system of periodic review of credit card holders’ accounts. On this basis, the
limits of customers may be revised, if necessary. The review should also include determination
of doubtful amounts and the provisioning in respect thereof.
18.10
Q. No. 5: How will you evaluate the Internal Control system in the area of Credit Card operations of a Bank?
[Nov. 09 (5 Marks)]
Or
You have been appointed as an auditor of LCO Bank, a nationalized bank. LCO Bank also deals in
providing credit card facilities to its account holder. The bank is aware of the fact that there
should be strict control over storage and issue of credit cards. How will you evaluate the Internal
Control System in the area of Credit Card operations of a Bank?
[Nov. 19 – New Syllabus (4 Marks), MTP-Oct. 20]
Q. No. 6: While doing the audit of a nationalized bank, your audit assistant informed you that there are a
lot of irregularities in demand drafts. What guidance would be given to audit assistant?
[Nov. 13 (4 Marks)]
Q. No. 7: You are auditing a small bank branch with staff strength of the manager, cashier and three other
staff S1, S2 and S3. Among allocation of work for other areas, S1 who is a peon also opens all the
mail and forwards it to the concerned person. He does not have a signature book so as to check
the signatures on important communications. S2 has possession of all bank forms (e.g. Cheque
books, demand draft/pay order books, travellers’ cheques, foreign currency cards etc.). He
maintains a record meticulously which you have test checked also. However, no one among staff
regularly checks that. You are informed that being a small branch with shortage of manpower, it
is not possible to always check the work and records. Give your comments. [MTP-Nov. 21]
HINT: Contention of bank that being a small branch with shortage of manpower they are not able to
check the work and records on regular basis, is not tenable as such lapses in internal control pose risk of
fraud. The auditor should report the same in his report accordingly.
18.4 - VERIFICATION OF INVESTMENTS

Audit Internal Control • Examine the internal controls over investments so as to ensure whether
procedure for Evaluation and the same are in consonance with the guidelines of the RBI.
verification of Review of • Review the investment policy of the bank to ascertain that the policy
Investments Investment conforms, in all material respects, to the RBI’s guidelines as well as to any
Policy statutory provisions applicable to the bank.
Separation of • Examine whether the bank is maintaining separate accounts for the
Investment investments made by it on their own Investment Account, on PMS client’s
Functions 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.
Examination of • Examine the reconciliation of the investment account.
Reconciliation
Examination of • Ascertain whether the investments made by the bank are within its
Documents authority.
• Ensure that the transactions for the purchase/sale of investments are
supported by due authority and documentation.
Physical • Verify the investment scrips physically at the close of business on the date
Verification of the balance sheet.
18.11
• Verify investments held with public debt office of RBI, custodians and
depository with the statement of holdings as on date of balance sheet.
Independent balance confirmation requests can be made in accordance
with SA-505.
• 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 extended period, the auditor should obtain written explanation
from the management for the reasons thereof.
• 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 an undertaking from them that they hold the securities on behalf of
the bank.
Examination of 1. Examine whether the method of accounting followed by the bank in
Valuation respect of investments, including their year-end valuation, is appropriate.
2. Examine whether the investments have been properly classified into the
three categories at the time of acquisition based on such intention as
evidenced by the decision of the competent authority such as Board of
directors, Asset Liability Committee (ALCO) or Investment Committee.
3. Examine compliance by the bank with the guidelines of the RBI relating
to valuation of investments.
4. Verify that investments are classified as non-performing investments
(NPI) as per applicable RBI guidelines. (Non-performing investments are
those where interest/principal is in arrears and remains unpaid for more
than 90 days). In such cases, banks have not to reckon income on
securities and are required to make provisions for depreciation in value
of investment.
5. 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.
6. Verify whether adequate disclosure of any change in method of valuation
of investment is made.
7. Examine whether the profit or loss on sale of investments has been
computed and accounted for properly.
8. Verify that there is a proper system for recording and maintenance of
TDS certificates received by the bank
Dealings in Examine whether bank’s income from such activities has been recorded and
Securities on is fairly stated in the bank’s F.S.
Behalf of Others
Examination of • Examine that entire investment portfolio of bank is classified under three
classification categories i.e. HTM, HFT and AFS and shifting of securities is as per
and shifting regulatory norms and laid down policy.
• Examine whether the shifting of the investments from “Available for sale”
to “Held to maturity” is duly approved by the Board of Directors of the
bank.
18.12
Special Pursuant to RBI’s circulars, issued from time to time, banks require their central auditors to issue
purpose the following certificates regarding investments of the bank (in addition to their main audit
Certificates report and the LFAR):
Relating to 1. Certificate on reconciliation of securities by the bank (both on its own Investment Account as
Investments well as PMS client’s account). The reconciliation is to be presented in a given format.
2. Certificate on compliance by the bank in key areas of prudential and other guidelines relating
to such transactions issued by the RBI.
Income Performing Banks may book interest income from all performing investments on accrual
Recognition Investments basis provided interest rates on these instruments are pre-determined.
Norms - Income on NPI Income on NPI should be recognized on realisation.
Investments
Government • Income on securities of Corporate/PSU in respect of which the payment
Guarantee of interest and repayment have been guaranteed by the C. G./S.G. can be
accounted for on accrual basis.
• However, where the interest is not serviced regularly and is in arrears,
such income cannot be accounted for on accrual basis.
Dividends Income from Dividend on Shares of Corporate Bodies can be booked on
accrual basis, if the same has been declared by the Corporate Body in its
AGM and the Shareholder’s right to receive payment is established.
Units of MFs Income from units of Mutual Funds should be accounted for only on cash
basis.
IMPORTANT QUESTIONS
Q. No. 8: Your firm has been appointed as Central Statutory Auditors of a Nationalised Bank. The bank has
recognised on accrual basis income from dividends on securities and Units of Mutual Funds held
by it as at the end of financial year. The dividends on securities and Units of Mutual Funds were
declared after the end of financial year. Comment. [MTP-Oct. 18, RTP-Nov. 18]
HINT: Recognition of dividend income on securities may be recognized on accrual basis if the same has
been declared by the Corporate Body in its AGM and the Shareholder’s right to receive payment is
established. In the present case, dividends were declared after the end of financial year. Hence,
recognition of income from dividends on securities and units of mutual fund on accrual basis is not in
order.
Q. No. 9: ABN Bank was engaged in the business of providing Portfolio Management Services to its
customers, for which it took prior approval from RBI. Your firm has been appointed as the
statutory auditors of the Bank’s financial statements for the year 2021-22. Your senior has
instructed you to verify the transactions of Portfolio Management Services (PMS). While verifying
the transactions you noticed that the bank has not maintained separate record for PMS
transactions from the Bank’s own investments. As a statutory auditor what methodology will be
adopted by you for verification of PMS transactions? [RTP-Nov. 20, MTP-April 21]
HINT: Auditor should advise the bank to segregate the PMS transactions from its own investments and
provide the certificate of external auditor.
18.13
18.5 - VERIFICATION OF ADVANCES
(INCOME RECOGNITION AND ASSETS CLASSIFICATION NORMS – IRAC NORMS)
Audit Advances generally constitute the major part of the assets of the bank. There are substantial
Approach number of borrowers to whom variety of advances are granted. The audit of advances requires
the major attention from the auditors. The auditor is primarily concerned with obtaining
evidence about the following while carrying out audit of advances:
(1) Amounts included in the balance sheet in respect of advances are outstanding at the date of
balance sheet.
(2) Advances represent amounts due to the bank.
(3) Amounts due to the bank are appropriately supported by loan documents.
(4) There are no unrecorded advances.
(5) The stated basis of valuation of advances is appropriate and properly applied and
recoverability of advances is recognized in their valuation.
(6) Advances are disclosed, classified and described in accordance with recognized accounting
policies and practices and relevant statutory and regulatory requirements.
(7) Appropriate provisions towards advances are made as per RBI norms, accounting standards
and generally accepted accounting practices.
General Audit Evaluation of (a) Examine area of credit appraisal and verify whether laid down
Procedure Internal Control procedures regarding credit appraisals including loan applications,
preparation of proposals, obtaining satisfaction about creditworthiness
of borrowers are being followed;
(b) Examine advances are sanctioned according to delegated authority;
(c) Examine all necessary loan documents have been executed after sanction
but before disbursals are made to borrowers;
(d) Examine compliance with stipulated terms of sanction and end use of
funds more particularly in case of term loans;
(e) Examine existence, enforceability and valuation of securities. In respect
of securities requiring registration, examine this area also;
(f) Examine the validity of the recorded amounts;
(g) Review operations of the accounts and look for adverse features like
unauthorised over drawings beyond limits;
(h) Examine whether system laid down in bank for review/renewals of
advances is being followed;
(i) Review whether drawing power is being calculated properly on basis of
stock/book debt statements received from borrowers as stipulated in
respective sanction letters;
(j) Ensure compliance with Loan Policy of Bank as well as prudential norms
of RBI including appropriate asset classification and provisioning.
Substantive (1) Verify correctness of master data of loan accounts updated in CBS. Check
Audit parameters like instalments, EMI, rate of interest, tenure of loans etc.
Procedure (2) Verify that each customer of bank is tagged under single customer id in
respect of all its accounts including those in which credit facilities are
granted.
18.14
(3) Examine all large advances while other advances may be examined on a
sample basis.
(4) Examine accounts identified to be problem accounts but which have not
yet slipped into NPA category.
(5) Examine those accounts which have been adversely commented upon by
concurrent auditors/bank’s internal inspection/RBI inspection team.
(6) Examine list of restructured accounts to ensure that restructure is as per
RBI guidelines. Remember restructured account portfolio requires
additional provisioning.
(7) Examine quick/early mortality accounts. Any advance slippage to NPA
within 12 months of its sanction is called as quick/early mortality case.
(8) Verify completeness and accuracy of interest being charged.
(9) Carry out appropriate analytical procedures.
Examination of (i) Review periodic statements submitted by the borrowers indicating the
recoverability extent of compliance with terms and conditions.
(ii) Review latest financial statements of borrowers.
(iii) Review reports on inspection of security.
(iv) Review Auditors’ reports in the case of borrowers enjoying aggregate
credit limits of ₹ 10 lakh or above for working capital from the banking
system.
Audit Asset • Verify whether bank has a system of ongoing identification and
Procedure in Classification classification of advances through CBS without manual intervention and its
Special Cases accuracy in crystallising date of NPA.
• Examine the appropriateness of classification made by the branch,
particularly, to find out any threats to recovery.
• Examine whether the secured and the unsecured portions of advances
have been correctly segregated.
• Review and compare the date of NPA of loan accounts mentioned in
current year statements with that of previous year. Reasons for any change
should be ascertained.
Point to remember
• Where it appears that an account has inherent weakness and few credits
near the balance sheet tries to make it regular, the account should be
classified as NPA. If 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,
the auditor should carefully assess whether the repayment was out of
genuine sources or not.
• It is to be ensured 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 significant to determine the
classification and hence specific care be taken in this regard.
18.15
• In case of consortium advances, asset classification should be based on
the record of recovery of individual member banks and other aspects
having a impact on the recoverability of the advances.
Drawing Power • Ensure that the DP is calculated as per the BOD guidelines of the respective
(DP) bank and agreed upon by the concerned statutory auditors.
Calculation • Ensure that due consideration has been given to proper reporting of
sundry creditors for the purposes of calculating DP.
• Ensure that bank has conducted stock audit for all accounts having
exposure of more than stipulated limit. Review the report submitted by the
stock auditors and consider the comments made by the stock auditors on
valuation of security and calculation of drawing power.
• Special focus need to be given in examining the DP calculation in case of
working capital advances to companies engaged in construction business.
Accounts with • Banks should not classify an advance account as NPA merely due to the
temporary existence of some deficiencies which are temporary in nature such as non-
deficiencies availability of drawing power based on latest available stock statement,
balance outstanding exceeding the limit temporarily and non-renewal of
limits on the due date. However, stock statements relied upon by the banks
for determining drawing power should not be older than 3 months.
• The outstanding in the account based on drawing power calculated from
stock statements older than 3 months are considered as irregular. Ensure
adherence to these guidelines.
Limits not • As per RBI norms, accounts where regular/ad hoc limits are not reviewed
reviewed within 180 days from the due date/date of ad hoc sanction, need to be
classified as NPA.
• Auditors should ensure that the ad hoc sanctions are not done on
repetitive basis.
Asset • Ensure that asset classification is borrower wise and not facility wise.
classification to Therefore, it is to be ensured that all the facilities granted by a bank to
be borrower borrower will have to be treated as NPA and not particular facility which
wise and not has become irregular.
facility wise • Further, if debits arising out of devolvement of LC or invoked guarantees
are kept in separate account, the outstanding balance should be treated as
part of borrower’s principal account for purpose of application of
prudential norms on asset classification, income recognition and
provisioning.
Government • Credit facilities backed by guarantee of the Central Government though
Guaranteed overdue should be treated as NPA only when the government repudiates
Advances its guarantee when invoked. This exemption is only for the purpose of
asset classification and provisioning and not for the purpose of recognition
of income. Interest on such advances should not be taken to income
account unless it has been realized.
• Credit facilities backed by S.G. guarantee should be classified as NPA in
normal way.
18.16
Agricultural (a) To ensure that NPA norms have been applied in accordance with the crop
Advances/ season as determined by the State Level Bankers’ Committee in each State.
Loans (b) To ensure that NPA norms on basis of crop season are made applicable to
all direct agricultural advances listed in Master Circular on lending to
priority sector.
(c) To ensure that in respect of agricultural loans (other than priority sector),
identification of NPAs has been done on the same basis as non-agricultural
advances.
Points to remember
• Agricultural advances are classified as NPA if interest and/or Instalment
of principal is overdue for (a) two crop seasons, in case loans granted for
Short Duration crops, (b) one crop season, in case loans granted for Long
Duration crops (i.e. more than 1 year).
• Long duration crops mean the crops with crop season longer than one
year. Short Duration Crops means the crops, other than long duration
crops.
• Crop season means the period up to harvesting of the crops, as
determined by the State Level Bankers’ Committee in each State.
Provisioning (a) Check the latest RBI Master Circular in this regard.
towards (b) Check the provisions in detail with the statement of advances.
Standard Assets (c) Check the provisions bifurcation of standard advances under relevant
category for proper calculation of provision and certified at branches
level.
Points to remember
Provision for standard assets is also required to be made at variable rates in
respect of different sectors for the funded outstanding in accordance with RBI
norms as a matter of prudence.
Restructured • Restructuring is an act in which a lender, for economic or legal reasons
Advances relating to borrower’s financial difficulty, grants concessions to the
borrower. It may involve modification of terms of advances including
alteration of amount of instalments/alteration of repayment period/rate
of interest/sanction of additional credit facilities etc. to help in curing of
default.
• RBI has given revised guidelines for treatment of restructured accounts
by its circular. Auditor should verify compliance with the requirements of
the circular issued in this regard.
• Banks may restructure the accounts classified under standard, sub-
standard or doubtful categories. Banks cannot restructure accounts with
retrospective effect. Once the bank receives an application/proposal in
respect of an account for restructuring, it implies that the account is
intrinsically weak. Accordingly, 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.
• On restructuring, the account will be downgraded from Standard to
substandard. NPAs will remain in the same category.
18.17
Upgradation of • Examine all the accounts upgraded from NPA to standard category during
Account the year, to ensure that the upgrading of each account is strictly in terms of
RBI guidelines.
• There can be a possibility of incorrect upgradation of account on the basis
of partial recoveries made in the account and overdue portion might not
have wiped out completely.
• There can also be a possibility of recoveries being made in the account
after cut-off date and account being upgraded as on date of balance sheet.
Verification of General Auditor should examine the followings:
Provision for verification (1) Policy laid down by the BOD relating to procedures,
NPA points valuation and delegation of powers including non-
performing financial assets that may be purchased/
sold, norms for such purchase/sale, valuation procedure
and accounting policy.
(2) Only such NPA has been sold which has remained NPA
in the books of the bank for at least 2 years.
(3) Assets have been sold/ purchased “without recourse”
only i.e. the entire credit risk associated with the NPA
should be transferred to the purchasing bank.
(4) 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.
(5) NPA has been sold at cash basis only. Under no
circumstances, NPA can be sold to another bank at a
contingent price. The entire sale consideration has to be
received on upfront basis.
(6) Bank has not purchased an NPA which it had originally
sold.
Additional Auditor should ensure the following:
Points in case (1) On the sale of the NPA, the same has been removed from
of Sale of an the books of account of selling bank on transfer;
NPA (2) 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.
(3) 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.
Additional Auditor should verify the following:
Points in case (1) NPA purchased has been subjected to the provisioning
of purchase requirements appropriate to the classification status in
of an NPA the books of the purchasing bank.
18.18
(2) 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.
(3) For the purpose of capital adequacy, banks have
assigned 100% risk weights to the NPAs purchased
from other banks
Verification of • Inspect the policies and see whether they are assigned to the bank and
advances whether such assignment has been registered with the insurer.
against Life • Examine whether premium has been paid on the policies and whether
Insurance they are in force.
Policies
• Obtain Certificate regarding surrender value from the insurer.
• 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.
Verification of (a) Sanctioning: Auditor should examine the sanction letter and loan
advances documents to ascertain important terms and conditions.
against goods (b) Verification of Stock statements: To ascertain the quantity and value
of goods hypothecated.
(c) Inspection: Ascertain whether the premises of the borrowers are
periodically inspected by the bank officials to verify the quantity as per
the stock statements.
(d) Stock Audit: Review the stock audit report and identify whether the
report contains any adverse comments.
(e) Insurance: Ascertain whether the stock is appropriately insured and
policies are in favour of the bank.
(f) Documents of title: Inspect the documents of title to goods to ensure
that they are endorsed in favour of the bank.
IMPORTANT QUESTIONS
Q. No. 10: ABC Bank had sanctioned credit limits of ₹ 100 lakh to M/s. Volkart Ltd. on 1st Sep. 2020. The
renewal of limits was due on 1st Sep. 2021. While doing the statutory branch audit for the year
ended 31st March 2022, you find that the renewal has not been done even though 180 days are
over. The bank says that the renewal process has been initiated on time and most of the
document are received. The account is operated regularly and is in order; balance is maintained
within drawing power. It also shows a letter from Volkart stating that due to a sudden death of
their auditor, a new auditor had to be appointed. Procedure for appointment took some time and
the new auditor was doing the audit all over again. The limit was not renewed till 31.03.2022.
However, the audited financials are received on 10th April 2022 and the renewal letter was issued
immediately. Your assistant is insisting that the account must be classified as NPA since the limit
was not renewed as on 31.03.2022. What is your opinion?
HINT: Even if the sanction was issued after the balance sheet date, it relates to the position as on the
balance sheet date, hence asset need to be classified as a standard asset;
18.19
Q. No. 11: Your firm has been appointed as branch auditor of East West Bank Ltd. In carrying out
verification of advances, what are the primary evidences you will look into?
[May 18 – Old Syllabus (4 Marks)]
HINT: Refer the topic “General Audit Procedure”
Q. No. 12: Your firm has been appointed as auditors of a branch of a nationalised Bank. The bank is a
consortium member of Cash Credit Facilities of ₹ 50 crores to X Ltd. Bank's own share is ₹ 10
crores only. During the last two quarters against a debit of ₹ 1.75 crores towards interest, the
credits in X Ltd.'s account are to the tune of ₹ 1.25 crores only. Based on the certificate of lead
bank, the bank has classified the account of X Ltd. as performing. [RTP-Nov. 18]
HINT: Advance to be classified as NPA.
Q. No. 13: M/s. S Ltd. is a MSME unit. The company does multiple banking. The company is availing cash
credit limit from U Bank of ₹ 0.25 crores. The limit availed remained less than ₹ 5.00 crores
during all the days of F.Y. 2021-22. The company has not done any credit in cash credit account
during the year as it is operating current account in newly opened another bank branch adjoining
to company premises. The company is having sufficient security of stocks and debtors and DP of ₹
25.00 crores remains all over the year. The company is availing term loans from other bank
branches. Now the Bank Manager is insisting to route the sale proceeds through U Bank,
otherwise cash credit limit and term loan accounts with other banks will be treated as Non-
Performing Accounts. Now company seeks your opinion. [MTP-Aug. 18, RTP-Nov. 18]
HINT: Cash credit facility with U bank need to be classified as NPA as there are no credit in the account to
serve the interest charged in the account. Classification of term loan with other banks depends upon the
payment made to that bank.
Q. No. 14: Shy & Co. had been allotted the branch audit of a nationalized bank for the year ended 31st March,
2022. In the audit planning, the partner of Shy & Co. observed that the allotted branches are
predominantly based in rural areas and major portion of the advances were for agricultural
purpose. He needs your assistance in incorporating the criteria prescribed for determination of
NPA norms in respect of agricultural advance, in audit plan. [May 14 (5 Marks)]
HINT: Refer the topic “Verification of agricultural advances”
Q. No. 15: In course of audit of Good Samaritan Bank as at 31st March 2022 you observed the following: In a
particular account there was no recovery in the past 18 months. The bank has not applied the
NPA norms as well as income recognition norms to this particular account. When queried the
bank management replied that this account was guaranteed by the central government and hence
these norms were not applicable. The bank has not invoked the guarantee. Please respond.
Would your answer be different if the advance is guaranteed by a State Government?
[May 13 (5 Marks), MTP-April 18, MTP-April 19, March 21; RTP-Nov. 19, May 20]
HINT: Bank is correct to the extent of not applying the NPA norms for provisioning purpose. But this
exemption is not available in respect of income recognition norms.
The situation would be different if the advance is guaranteed by State Government because this
exception is not applicable for State Government Guaranteed advances, where advance is to be
considered NPA if it remains overdue for more than 90 days.
Q. No. 16: The bank’s advance portfolio comprised of significant loans against Life Insurance Policies. Write
suitable audit program to verify these advances. [May 13 (3 Marks), RTP-May 20; MTP-March 21]
Q. No. 17: During the bank audit AB & Co. a new Chartered Accountant firm, observed the sale/purchase of
NPAs. Please help them by narrating the aspects, relating to sale/purchase of NPAs, to be
considered. [May 15 (4 Marks)]
18.20
Or
In the course of audit of skip Bank Ltd., you found that the bank had sold certain of its non-
performing assets. Draft the points of audit check that are very relevant to this area of checking.
[May 18 – New Syllabus (4 Marks)]
Or
CA. K have been doing audit of branch of LUD Bank Ltd. The principal business of the branch is
lending advances to large corporates. Since last one year, many large accounts have become Non-
Performing Asset (NPA) as per guidelines. The Management of the Bank decided to sell one of the
NPA account and consequently one NPA namely DEF Ltd. amounting to ₹ 10.00 Crores was sold to
Asset Reconstruction Company. What audit points CA K should keep in mind while doing audit of
this transaction? [Jan. 21 – New Syllabus (5 Marks)]
Q. No. 18: M/s Sri & Co., Chartered Accountant have been allotted the branch audit of a nationalized bank
for the year ended 31st March, 2022. You are part of audit team and have been instructed by your
partner to verify the following areas:
(i) Fulfilment of the criteria prescribed for NPA norms for the advances given for agricultural
purposes.
(ii) Drawing power calculation from stock statements in respect of working capital accounts.
What may be your areas of concern as regards matters specified above?
[May 19 – Old Syllabus (5 Marks)]
Q. No. 19: In the course of statutory Branch audit of KS Bank Ltd., you observe that some borrower accounts
have been regularised before Balance sheet date by payment of overdue amount. Narrate the
audit procedures to be carried out with special focus on the Classification of advances and
Provisioning for Non-Performing Assets of the Branch. [Nov. 20 – New Syllabus (5 Marks)]
Q. No. 20: M/s Aadi & Co., Chartered Accountants, have been allotted the branch audit of a nationalized
bank for the year ended 31st March, 2021. You are part of audit team and have been instructed by
your partner to verify the following areas:
(i) Fulfilment of the criteria prescribed for NPA norms for government guaranteed advance.
(ii) Fulfilment of the criteria prescribed for NPA norms for the advances given for agricultural
purposes.
(iii) Drawing power calculation from stock statements in respect of working capital accounts.
(iv) Accounts where regular/ad hoc limits are not reviewed within 180 days from the due
date/date of ad hoc sanction.
What may be your areas of concern as regards matters specified above? [MTP-Oct. 21]
Q. No. 21: Gupta & Co. has been appointed as a statutory auditor of TCB Bank Ltd., a private sector bank,
registered with RBI. Mr. Kaival Gupta, the engagement partner, while performing the audit as per
the checklist, noted down the following points, which would be part of the audit queries, as
tabulated below:
Sr. No. Queries
1 Interest on State Government Guaranteed advance has been taken to income even
though such advance has remained overdue for more than 90 days.
2 There is an account for which an ad hoc limit has not been reviewed for 180 days
from the date of such ad hoc sanction and such account has been treated as a
performing asset in the books.
18.21
3 One of the NPAs was sold for a value higher than the net book value. Profit was not
recognized but the excess provision in respect of the same has been reversed.
4 In case of one of the accounts, an additional temporary limit has been sanctioned for
25% of the existing limit and for 120 days tenure.
5 On verification of outstanding forward exchange contracts, the ‘net position’ in
respect of one of the foreign currencies was not squared and was uncovered by a
substantial amount.
You are required to provide the reasons due to which such queries would have been raised by Mr.
Kaival and describe the actions that may be taken by the person responsible on behalf of TCB
Bank Ltd. for solving such queries. [RTP-Nov. 21]
HINT: (1) Interest income recognized on such advance would be reversed and would be taken to income
only when it is realized. (2) It’s treatment in the books would be changed from performing asset to a non-
performing asset from the date when such change in the treatment was required. (3) The entry for
reversal of the excess provision would be cancelled in the books and such excess provision would be
retained to meet the shortfall/loss that may arise because of the sale of other non-performing financial
assets. (4) The terms of additional temporary limit in case of such account would be revised to 20% of
the existing limit and for 90 days maximum tenure. (5) The net “position” of the branch in relation to
each foreign currency should be squared off and get covered by a substantial amount.
Q. No. 22: Your firm has been appointed as a statutory auditor of a nationalised bank which has multiple
banking accounts and consortium accounts of corporate borrowers and of which many accounts
are falling within the purview of CDR (Corporate Debt Restructuring) mechanism.
Enumerate the audit procedure to be carried out for assessing such borrowers' accounts.
[Dec. 21 – Old Syllabus (5 Marks)]
18.6 - VERIFICATION OF OTHER ASSETS

Cash (a) Carry out the physical verification of cash (including foreign currency, if any, cash at ATM
and cash at cash deposit machines) as close to the balance sheet date as possible.
(b) The cash balance as physically verified should be agreed with the balance shown in the
cash register/balance in CBS.
Balance with (a) Verify the ledger balances in each account with reference to the bank confirmation
RBI certificates and reconciliation statements as at the year-end.
(b) Review the reconciliation statements and give special attention to the below-mentioned
items appearing in the reconciliation statements:
• Cash transactions remaining unresponded;
• Revenue items requiring adjustments/write-offs; and
• Other credit and debit entries originated in the statement provided by RBI remaining
responded for more than 15 days.
Money at call (a) Verify whether there is a proper authorisation, general or specific, for lending of the
and Short money at call or short notice.
Notice (b) Examine whether the instructions or guidelines laid down by the head office or controlling
office of the branch in regard to such transactions are being complied with.
18.22
(c) Verify the call loans with the certificates of the borrowers and the call loan receipts held
by the bank.
(d) Check whether the aggregate balances of money at call and short notice as shown in the
relevant register agree with the control accounts as per the general ledger.
(e) Examine subsequent repayments received from borrowing banks to verify the amounts
shown under this head as at the year-end.
Inter-office It represents the balance of all inter-branch transactions of the bank. The same are to be
Adjustments disclosed “NET”. If the inter-office adjustment (Net) is a debit, it is to be shown under “other
(Branch Adj. assets” and if it is a credit, it is shown under “other Liabilities and Provisions”. These can be
Accounts) sub-divided into segments like DD paid, Inter-branch remittances, Head Office Account, etc.
The auditor should pay special attention to the following points:
(a) The origin and validity of old outstanding unmatched entries, particularly debit entries. The
auditor may also seek confirmation of transactions relating to outstanding.
(b) Whether there are any reversal entries indicating the possibilities of irregular payments or
frauds.
(c) Whether the balances include any items in the nature of cash-in-transit, which remain
pending for more than a reasonable period. This is because such items are not expected to
remain outstanding beyond a very small period during which they are in transit.
(d) Whether transactions, other than those relating to inter-branch transactions have been
included in inter-branch accounts.
(e) Any unusual items put through inter-branch accounts as well as old or large entries
outstanding in inter-branch accounts should be carefully looked into. The auditor may also
seek explanations from the management in this regard.
Non-banking (a) Ensure that the heading includes those immovable properties/tangible assets which the
assets acquired bank has acquired in satisfaction of debts due or its other claims and these are being held
in satisfaction with intention of being disposed off.
of claims (b) Verify terms of settlement with the party, order of the Court or the award of arbitration,
etc. forming the basis of acquisition of such assets.
(c) Ensure the ownership of the assets so acquired is legally vested in the bank. If there is any
dispute over the title of the property, the auditor should examine whether the recording of
the asset is appropriate or not.
(d) 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".
(e) Ensure that as at date of acquisition, the assets should be recorded at lower of net book
value of advance or net realisable value of asset acquired.
IMPORTANT QUESTIONS
Q. No. 23: While auditing the branch of a Bank you are required to examine inter branch adjustments. What
points require your special attention? [May 10 (6 Marks)]
18.23
18.7 – VERIFICATION OF CAPITAL AND LIABILITIES
Capital • Verify the opening balance of capital with reference to the audited balance sheet of the
previous year.
• In case of increase in capital during the year, examine the relevant documents supporting
the increase. For example, in case of an increase in the authorised capital, the auditor should
examine the special resolution of shareholders and the memorandum of association. In case
of an increase in subscribed and paid-up capital, the auditor should examine the
prospectus/other offer document, reports received from registrars to the issue, bank
statement, etc.
Capital The term ‘capital adequacy’ is used to describe the adequacy of capital resources of a bank in
Adequacy relation to the risks associated with its operations.
Stress Testing • RBI has required that all commercial banks (excluding RRBs) shall put
in place a Board approved ‘Stress Testing framework’ to suit their
individual requirements which would integrate into their risk
management systems.
• Stress tests are designed to understand whether a bank has enough
capital to survive plausible adverse economic conditions and to
maintain enough buffer to stay afloat under extreme scenarios.
BASEL III • Basel III norms relate to the Capital Adequacy requirement compliance
framework which the Bank has to achieve as contained in the BASEL III accord.
• 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.
• 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.
• The Basel III accord, aims at:
(a) improving the banking sector's ability to absorb shocks arising
from financial and economic stress, irrespective of reasons thereof;
(b) improving risk management and governance practices; and
(c) strengthening banks' transparency and disclosure standards.
Reserves and • Verify the opening balances of various reserves with reference to the audited balance sheet
Surplus of the previous year. Any additions to or deductions from reserves should be verified in the
usual manner, e.g., with reference to board resolution.
• In the case of statutory reserves and share premium, ensure compliance with legal
requirements.
• 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.
• Examine whether the appropriations from share premium account conform to the relevant
legal requirements.
18.24
Deposits Current and (1) Verify on a sample basis current account and saving accounts opened
saving accounts during the year for adherence to KYC norms.
(2) Verify the balances in individual accounts on a sample basis.
(3) Check the calculations of interest on a test check basis. Remember that
no interest is paid generally on current accounts by banks.
(4) Examine whether the procedure for obtaining balance confirmation
periodically has been followed consistently.
(5) Ensure that debit balances in current accounts are not netted out on the
liabilities side but are appropriately included under the head
‘advances’.
(6) Inoperative accounts (both current and saving) are a high-risk area of
frauds in banks. As per RBI guidelines, a savings/current account
should be treated as inoperative/dormant if there are no transactions
in the account for over a period of two years. Verify on a sample basis
some of inoperative accounts revived/closed during the year. Ensure
that inoperative accounts are revived only with proper authority.
Term deposits (1) Examine whether the deposit receipts and cash certificates are issued
serially and all of them are accounted for in the registers.
(2) Verify in case of bulk deposits (₹ 2 crore and above for scheduled
commercial banks presently), correct rate of interest has been offered.
(3) In case of closure of term deposit, test check whether required
foreclosure penalty has been deducted from applicable rate of interest
payable.
(4) Verify on sample basis some of recurring deposit accounts opened
during the year.
(5) Verify correctness of rate of interest on term deposits on sample basis.
Deposits (1) Verify some of FCNR accounts opened during the year on sample basis
designated in and ensure these conform to RBI directions.
foreign (2) Verify on sample basis permissible credits and debits in FCNR accounts
currencies as per RBI directions.
(3) In case of FCNR accounts, examine whether these have been converted
into Indian Rupees at rate notified in this behalf by head office.
(4) Examine whether any resultant increase or decrease has been taken to
the profit and loss account.
(5) Verify that interest on deposits has been paid on the basis of 360 days
in a year.
Bills payable (i) Evaluate the existence, effectiveness and continuity of internal controls over bills payable.
Such controls should usually include the following-
• Drafts, mail transfers, traveller’s cheques, etc. should be made out in standard
printed forms.
• Unused forms relating to drafts, traveller’s cheques, etc. should be kept under the
custody of a responsible officer.
• The bank should have a reliable private code known only to the responsible officers
of its branches, coding and decoding of the telegrams should be done only by such
officers.
18.25
• The signatures on a demand draft should be checked by an officer with the specimen
signature book.
• 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.
(ii) 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.
(iii) 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 be examined specially
in so far as large value items outstanding on the balance sheet date are concerned.
Contingent Disclosure The Third Schedule to the Banking Regulation Act, 1949, requires the
Liabilities Requirements disclosure of the following as a footnote to the balance sheet.
(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-
• In India.
• Outside India.
(v) Acceptances, endorsements and other obligations.
(vi) Other items for which the bank is contingently liable.
Audit Approach In respect of contingent liabilities, the auditor is primarily concerned with
seeking reasonable assurance that all contingent liabilities are identified
and properly valued. The auditor should obtain representation from
management that:
(1) all off-balance sheet transactions have been accounted in the books of
account as and when such transaction has taken place;
(2) all off balance sheet transactions have been entered into after
following due procedure laid down;
(3) all off balance sheet transactions are supported by the underlying
documents;
(4) all year end contingent liabilities have been disclosed;
(5) the disclosed contingent liabilities do not include any crystallised
liabilities which are of the nature of loss/expense and which,
therefore, require creation of a provision/adjustment in the financial
statements;
(6) the estimated amounts of financial effect of the contingent liabilities
are based on the best estimates in terms of AS 29, including
consideration of the possibility of any reimbursement;
(7) 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
18.26
consequent upon the invocation of the said guarantee(s) and that no
violation of Sec. 20 of the Banking Regulation Act, 1949 has arisen on
account of such guarantee; and
(8) 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
Verification (1) Ensure that there exists a system whereby the non-fund based
Aspects facilities or additional/ad hoc credit facilities to parties are extended
only to their regular constituents, etc.
(2) 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.
(3) Verify in case of LCs for import of goods, the payment to the overseas
suppliers is made based on shipping documents and after ensuring
that the said documents are in strict conformity with the terms of LCs.
(4) 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.
(5) Test the completeness of the recorded obligations.
(6) 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.
(7) Review whether comfort letters issued by the bank has been
considered for disclosure of contingent liabilities.
(8) Examine whether the bank has given any guarantees in respect of any
trade credit (buyer’s credit or seller’s credit) and the period of
guarantees is co-terminus with the period of credit reckoned from the
date of shipment.
(9) Verify whether bank has extended any non-fund facility or
additional/ad hoc credit facilities to other than its regular customers.
In such cases, auditor should ensure concurrence of existing bankers
of such borrowers and enquire regarding financial position of those
customers.
Claims against (a) The auditor should examine the relevant evidence, for example correspondence with
the bank not lawyers, claimants, workers/officers and workmen’s/officer’s unions.
acknowledged (b) The auditor should also review the minutes of the meeting of the Board of
as debt directors/committees of the Board, contracts, agreements and arrangements, list of
pending legal cases and correspondence relating to taxes, duties etc., to identify claims
against the bank.
(c) The auditor should ascertain from the management the status of claims outstanding as at
the end of previous year.
(d) A review of subsequent events would also provide evidence about completeness and
valuation of claims.
18.27
Liability on (a) Verify the outstanding forward exchange contracts with the statement of outstanding
account of forward exchange contracts generated from the bank’s computerised accounting system
outstanding or manual register maintained by the branch.
Forward (b) The auditor may physically verify the underlying documents including confirmations from
Exchange merchants to test the existence of such outstanding contracts.
contracts (c) The auditor may verify outstanding derivative contracts like options, interest rate swaps
etc. with reports generated in this regard.
Guarantees (a) Examine the adequacy of internal controls exercised over issuance of guarantees, for
example, whether guarantees are sanctioned by appropriate authority, whether adequate
margins are taken from customers before issuance of guarantees, etc.
(b) Examine the adequacy of controls exercised over unused guarantee forms, for example,
whether unused forms are kept under the custody of a responsible official, whether a
proper record of forms issued is being kept, whether stock of forms is periodically verified
and reconciled with the book records, etc.
(c) Examine whether the prescribed procedure of marking off the expired guarantees is being
followed or not.
(d) Examine the relevant guarantee registers with the list of outstanding guarantees to ensure
that all outstanding guarantees are included in the amount disclosed.
(e) Examine that expired guarantees are not included in this head.
(f) Verify guarantees with the copies of the letters of guarantee issued by the bank and with
the counter-guarantees received from the customers.
(g) Verify the securities held as margin.
(h) Ensure whether a provision is required in terms of the requirements of AS 29, "Provisions,
Contingent Liabilities and Contingent Assets”, in case any claim arises under these
guarantees.
Acceptances, (1) Evaluate the adequacy of internal controls over issuance of letters of credit and over
Endorsements custody of unused LC forms in the same manner as in the case of guarantees.
and Other (2) Verify the balance of letters of credit from the register maintained by the bank. The
Obligations 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.
(3) Examine whether the bank has incurred a potential financial obligation in respect of
letters of comfort and if such obligation has been cast, ensure the amount to be disclosed
under contingent liability.
IMPORTANT QUESTIONS
Q. No. 24: How do you examine claims against the Bank not acknowledged as debts? [May 10 (4 Marks)]
Q. No. 25: While doing the audit of a Nationalised bank branch, your audit assistant informed you that he
suspects some irregularities in Guarantees issued by the Bank. What should be your guidance in
the matter to check the same? [May 18 – Old Syllabus (4 Marks)]
Q. No. 26: INDO Bank appointed your firm of Chartered Accountants as a branch auditor for the financial
year 2021-22. Being head-in-charge of the assignment, while planning, you distributed the work
among your team members and assigned Mr. Pary for verification of bills payable. However, Mr.
Pary, being fresh to the bank audits, needs your guidance. Kindly guide. [MTP-Oct. 19]
18.28
Q. No. 27: While auditing APNA Bank, you observed that a lump sum amount has been disclosed as
contingent liability collectively. You are, therefore, requested by the management to guide them
about the disclosure requirement of Contingent Liabilities for Banks. Kindly guide. [RTP-Nov. 19]
18.8 – VERIFICATION OF IMPORTANT RATIOS

Statutory Central statutory auditors of the banks are required to verify the compliance of SLR on 12 odd
Liquidity dates in different months of a financial year not being Fridays.
Ratio (SLR) The resultant report is to be sent to the management of the bank and to the RBI. To verify
compliance with SLR requirements, the statutory auditor has to examine two aspects:
(a) Correctness of the figure of the Demand and Time Liabilities (DTL), and
(b) Maintenance of prescribed percentage of liquid assets.
Audit Approach 1. Obtain an understanding of the relevant circulars of the RBI so as to
and Procedure ascertain the items to be included in composition of DTL.
2. Request the branch auditors to verify the correctness of the trial balances
and examine the cash balance at the branch on the selected dates.
3. Examine, on a test basis, the consolidations regarding DTL position
prepared by the head office with reference to the related returns received
from branches. Ensure that the consolidations prepared by the bank
include the relevant information in respect of all the branches.
4. Examine the composition of items of DTL as per circulars/instructions of
RBI.
5. Ensure that the interest accrued but not accounted for in the books is
included in composition of DTL.
6. Specify number of unaudited branches and a statement that auditor has
relied on the returns received from the unaudited branches in forming his
opinion.
Items to be (a) Part recoveries from the borrowers in respect of debts considered bad
excluded in DTL and doubtful.
(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.
Items to be (a) Net credit balance in branch adjustment accounts including those relating
included in DTL to foreign branches.
(b) Interest on deposit as at the end of the first half year reversed in the
beginning of the next half-year.
(c) Borrowings from abroad needs to be considered as ‘liabilities to other’
and thus, needs to be considered at gross level.
Capital Meaning Measurement of adequacy of capital resources of bank in relation to risks
Adequacy associated with its operation.
Ratio Requirement • For Public Sector Bank: 9%
• For Private Sector Banks: 10%
18.29
Computation Capital Funds
×100
Risk Weighted Assets and Off B / S Items
Components of • Capital Funds are classified in two categories: Tier I and tier II
Capital Funds • Tier I Fund includes Paid Up capital, Statutory Reserves, Free Reserves as
reduced by equity investments in subsidiaries, intangible assets & current
b/f losses.
• Tier II Fund includes undisclosed reserves, general provision and loss
reserves, hybrid debt capital instruments and subordinated assets.
• Tier II Capital cannot exceed 100% of Tier I Capital.
IMPORTANT QUESTIONS
Q. No. 28: As statutory central auditors of a Nationalized bank, what special points are to be borne in mind
in the audit of compliance with "Statutory Liquidity Ratio" (SLR) requirements?
18.9 - CONCURRENT AUDIT SYSTEM

Meaning and • It is an examination which is contemporaneous with the occurrence of transactions.
Nature • It attempts to shorten the interval between a transaction and its examination by an
independent person not involved in its documentation.
• There is an emphasis in favour of substantive checking in key areas rather than test checking.
• It is considered as part of bank’s early-warning system to ensure timely detection of
irregularities.
Coverage of • The scope of work to be entrusted to concurrent auditors, coverage of business/branches,
Business etc. is left to the discretion of the head of internal audit of banks with the due prior approval
of the Audit Committee of the Board of Directors (ACB).
• Banks may, however, ensure that risk sensitive areas identified by them as per their specific
business models are covered under concurrent audit. The detailed scope of the concurrent
audit may be determined and approved by the ACB.
• The broad areas of coverage under concurrent audit shall be based on the identified risk of
the unit and must include random transaction testing of sufficiently large sample of such
transactions wherever required.
Types of Cash (1) Daily cash transactions with particular reference to any abnormal/ high
Activities to value receipts and payments.
be Covered (2) Proper accounting of inward and outward cash remittances.
(3) Proper accounting of currency chest transactions, its prompt reporting
to the RBI.
(4) Expenses incurred by cash payment involving sizeable amount.
Investments (1) Ensure that in respect of purchase or sale of securities the branch has
acted within its delegated power having regard to its Head Office
instructions.
(2) Ensure that the securities held in the books of the branch are physically
held by it.
(3) Ensure that the branch is complying with the RBI/head Office
guidelines regarding BRs, SGL forms, delivery of scrips, documentation
and accounting. Ensure that the sale or purchase transactions are done
at rates beneficial to the bank.
18.30
Deposits (1) Check the transactions about deposits received and repaid.
(2) Percentage check of interest paid on deposits may be made including
calculation of interest on large deposits.
(3) Check new accounts opened particularly current accounts. Operations
in new current/SB accounts may be verified in the initial periods to see
whether there are any unusual operations.
Advances (1) Ensure that loans and advances have been sanctioned properly in
accordance with delegated authority.
(2) Ensure that securities and documents have been received and properly
charged/registered.
(3) Ensure that post disbursement supervision and follow-up is proper,
such as receipt of stock statements, instalments, recovery/renewal of
sanction limits, etc.
(4) Verify whether there is any misutilisation of the loans and whether
there are instances indicative of diversion of funds.
(5) Check whether the letters of credit issued by the branch are within the
delegated power and ensure that they are for genuine trade
transactions.
(6) Check the bank guarantees issued, whether they have been properly
worded and recorded in the register of the bank. Whether they have
been promptly renewed on the due dates.
(7) Ensure proper follow-up of overdue bills of exchange.
(8) Verify whether the classification of advances has been done as per RBI
guidelines.
(9) Verify whether the claims to DICGC and ECGC is submitted in time.
(10) Verify that instances of exceeding delegated powers have been
promptly reported to controlling/Head Office by the branch and have
been confirmed or ratified at the required level.
Foreign (1) Check foreign bills negotiated under letters of credit.
Exchange (2) Check FCNR and other non-resident accounts whether the debits and
credits are permissible under rules.
(3) Check whether inward/outward remittance have been properly
accounted for.
(4) Examine extension and cancellation of forward contracts for purchase
and sale of foreign currency. Ensure that they are duly authorised and
necessary charges have been recovered.
(5) Ensure that balances in Nostro accounts in different foreign currencies
are within the limit as prescribed by the bank.
(6) Ensure that the overbought/oversold position maintained in different
currencies is reasonable, considering the foreign exchange operations.
(7) Ensure adherence to the guidelines issued by RBI/HO of the bank about
dealing room operations.
(8) Ensure verification/reconciliation of Nostro and Vostro account
transactions/balances.
18.31
House Keeping (1) Ensure that the maintenance and balancing of accounts, ledgers and
registers including clean cash is proper.
(2) Early reconciliation of entries outstanding in the inter-branch and
inter-bank accounts, Suspense Account, Sundry Deposits Account,
DDRR Account, Drafts Account, etc.
(3) Ensure timely adjustment of large value entries.
(4) Carry out a percentage check of calculations of interest, discount,
commission and exchange.
(5) Check whether debits in income account have been permitted by the
competent authorities.
(6) Check the transactions of staff accounts.
(7) Examine the day book to verify as to how the differences in clearing
have been adjusted.
(8) Detection & prevention of revenue leakages through close examination
of income and expenditure accounts.
(9) Verify cheques returned/bills returned register and look into reasons
for return of those instruments.
(10) Checking of inward and outward remittances (DDs, MTs & TTs)
Appointment • It is the discretion of individual banks to consider whether concurrent audit should be done
of Concurrent by bank’s own staff or external auditors.
Auditors and • If bank has engaged its own officials, they should be experienced, well trained and sufficiently
Accountability senior. The staff engaged on concurrent audit must be independent of the branch where
concurrent audit is to be conducted.
• Appointment of an external audit firm may be initially for one year and can be extended up to
three years, after which an auditor could be shifted to another branch subject to satisfactory
performance.
• If external firms are appointed and any serious acts of omissions or commissions are noticed
in their working their appointments may be cancelled and the fact may be reported to RBI &
ICAI.
Remuneration • Terms of appointment of the external firms of Chartered Accountants for the concurrent
of Concurrent audit and their remuneration may be fixed by banks at their discretion.
Auditor • Broad guidelines should be framed by Audit committee of the Board for these purposes.
Suitable packages should be fixed by each bank’s management in consultation with its Audit
Committee, keeping in view various factors such as coverage of areas, quality of work
expected, number of people required for the job, number of hours to be spent on the job, etc.
Reporting • There should be proper reporting of the findings of the concurrent auditors. For this purpose,
System each bank should prepare a structured format. The major deficiencies/aberrations noticed
during audit should be highlighted in a special note and given immediately to the bank’s
branch/controlling offices. A quarterly review containing key features brought out during the
concurrent audits should be placed before the Audit Committee of Board of Directors (ACB).
• There should be zone-wise reporting of the findings of the concurrent audit to ACB and an
annual appraisal/report of the audit system should be placed before the ACB.
• Before submission of the report the auditor should discuss the important issues on which
he/she wishes to report with the branch manager and concerned officers. This will enable
the auditor to take into consideration the opposite view point and clarify any doubts.
18.32
• Minor irregularities pointed out by the concurrent auditors are to be rectified in a timely
manner. Serious irregularities should be reported to the controlling offices/ Head Offices for
immediate action.
• Whenever fraudulent transactions are detected, they should immediately be reported to
Inspection & Audit Department (Head Office) as also the Chief Vigilance Officer as well as
Branch Managers concerned (unless the branch manager is involved).
• Follow-up action on the concurrent audit reports should be given high priority by the
controlling office/Inspection and Audit Department and rectification of the features done
without any loss of time.
IMPORTANT QUESTIONS
Q. No. 29: Explain the scope of concurrent audit of a bank with reference to Reserve Bank of India
guidelines.
Q. No. 30: As the concurrent auditor of Nagpur Main Branch of XYZ Bank Ltd. state the issues which have to
be considered in the audit of advances. [Nov. 08 (6 Marks)]
Or
ABC Chartered Accountants have been appointed as concurrent auditors for the branches of
Effective Bank Ltd. for the year 2021-22. You are part of the audit team for Agra branch of the
bank and have been instructed by your senior to verify the advances of the audit period. You are
required to guide your assistant about the areas to be taken care while doing verification during
the concurrent audit. [RTP-May 19]
Q. No. 31: As the concurrent auditor of Z Bank Ltd you are requested by its management to draft an internal
control policy in respect of loans and advances. What factors do you consider as important while
drafting such a policy? [May 12 (10 Marks)]
Q No. 32: You are the Concurrent Auditor of a Branch of Nationalized Bank which deals in foreign exchange
transactions. Give focus areas of your checking in this respect. [Nov. 18-New Syllabus (4 Marks)]
Or
You have been appointed as Concurrent Auditor of a nationalized bank branch. The main
business at the branch is dealing in foreign exchange. Suggest the main areas of coverage in
regard to foreign exchange transactions of the said branch under concurrent audit.
[Nov. 19 – Old Syllabus (5 Marks)]
Or
You have been appointed as Concurrent auditor of one of the branches of Coin Bank Ltd. This
branch is dealing mainly in foreign exchange. State the suggested audit procedures to be covered
by you to check the foreign exchange transactions of this branch while doing Concurrent audit.
[Dec. 21 – New Syllabus (5 Marks)]
18.33
Summary of Examination Weightage
Attempt Marks Topics Covered
May 2018 4 Verification of Sale of Non-Performing Assets
Nov. 2018 4 Verification of Foreign Exchange Transactions
May 2019* 4 Peculiarities which necessitate special audit considerations
Nov. 2019* 5 Evaluation of Internal Control System in Credit Card Operations
May 2020 - Exams cancelled due to Covid-19
Nov. 2020* 5 Audit procedures for examination of the Classification of advances and
Provisioning for Non-Performing assets
Jan. 2021* 5 Verification of Sale of Non-Performing Assets
July 2021* 5 Auditor’s report in case of a nationalised Bank
Dec. 2021 5 Verification of Foreign Exchange Transactions
*Only Descriptive Questions
18.34

Audit of Banks

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18 Audit of Banks

18.1 – LEGAL AND REGULATORY FRAMEWORK

18.2 – CONDUCTING A BANK AUDIT

3. Internal Assignments in Banks by Statutory Auditors

• Bank and its Environment including Internal Control

• Risk of Fraud including Money Laundering

• Establish the Overall Audit Strategy

Reporting Main report and Other Reports/Certificates.

18.3 - INTERNAL CONTROL PROCEDURES IN BANK

18.4 - VERIFICATION OF INVESTMENTS

18.6 - VERIFICATION OF OTHER ASSETS

18.8 – VERIFICATION OF IMPORTANT RATIOS

18.9 - CONCURRENT AUDIT SYSTEM

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