Audit of Banks
Audit of Banks
Audit of Banks
Banks occupy the pride of place in any financial system by virtue of the significant role they play in
spurring economic growth by undertaking maturity transformation and supporting the critical payment
systems. The specificity of banks, the volatility of financial markets, increased competition and
diversification, however, expose banks to risks and challenges. The protection of depositors’ interests
and ensuring financial stability are two of the major drivers for putting in place an effective system of
supervision of banks.
Credibility of an institution, particularly that of financial institution depends on its internal control and
supervision mechanism which can promptly detect irregularities, if any, and take corrective measures
and ensure non recurrence of irregularities. Business of banking is susceptible to frauds. It is therefore
necessary to have an internal control and supervision mechanism for ensuring that no one person is in a
position to violate procedures, rules, regulations, guidelines, do an unauthorized act detrimental to the
organization which remains undetected for an indefinite period or long time. Therefore, inspection and
audit plays crucial role in success of banking operations.
The balance sheet and the profit and loss account of a banking company have to be audited as
stipulated under Section 30 of the Banking Regulation Act, 1949. Every banking company’s account
needs to be verified and certified by the Statutory Auditors as per the provisions of legal frame work.
The powers, functions and duties of the auditors and other terms and conditions as applicable to
auditors under the provisions of the Companies Act are applicable to auditors of the banking companies
as well. The audit of banking companies books of accounts calls for additional details and certificates to
be provided by the auditors.
They include:
Whether or not;
The transaction of the company, as observed by the auditor were within the powers of the company;
Profit and loss account shows a true picture of the profit or loss for the period for which the books have
been audited and any other observations to be brought to the notice of the shareholders;
Special responsibility is cast on the bank auditor in certifying the bank’s balance sheet and profit and
loss account, since that reflects the sound financial position of the banking company. Apart from the
balance sheet audit, Reserve Bank of India is empowered by the provisions of the Banking Regulation
Act, 1949 to conduct/order a special audit of the accounts of any banking company. The special audit
may be conducted or ordered to be conducted, in the opinion of the Reserve Bank of India that the
special audit is necessary;
In the public interest and/or
The Reserve Bank of India’s directions can order the bank to appoint the same auditor or another
auditor to conduct the special audit. The special audit report should be submitted to the Reserve Bank
of India with a copy to the banking company. The cost of the audit is to be borne by the banking
company.
Regulatory framework
Regulatory framework under which banks has to perform their work are mentioned below:
Banking co. Acquisition and transfer of undertaking Act, 1970 (amended in 1980).
RBI and Indian Institute of Chartered Accountants of India (ICAI) together scrutinise and appoint an
auditor or audit firm for the audit of the bank after obtaining indebtedness declaration from a
respective firm or an auditor.
The audit firm or an auditor cannot assign with any other statutory audit in the year they are appointed
as a bank auditor. Before initialising the audit, the firm needs to establish the undertaking of
engagement terms describing the time period of audit term. However, as per ICAI Act, 1949 before
getting engaged the auditor need to communicate with the previous auditor of the bank in writing for
taking his consent.
After that, the new auditor will review the initial opening balance, and if he founds any material
misstatement or errors affecting financial statement, he can assert his point of view in his audit report
by way of qualified or adverse report.
Thereafter assessment of engagement risk is done, which is a difficult part of the audit procedure, and
then the engagement team gets established to manage the risks and complexities of bank operations.
Auditor then tries to understand the working environment and internal controls of the organisation for
deciding the basis of the audit.
Thereafter, banks accounting process, risk management process and risk identification are made along
with control and monetary activities considered by the management. At last, after reviewing all the
relevant elements, an auditor prepares an audit report defining his opinion regarding the financial
condition of the bank as well as if any loopholes found in following the mentioned regulations under Act
1. Concurrent Audit
Banks deals with a large number of transactions on a daily basis whose examination is also necessary on
a continuous basis for determining the accuracy of the financial statement. For conducting such audit an
external auditor is appointed by the bank known as a concurrent auditor who performs an audit of the
transaction on a monthly basis.
The main objective of conducting a concurrent audit is to ensure compliance with the internal systems,
procedures and the guidelines of the bank. Concurrent audit is always performed on a continuous basis
to examine whether proper guidelines are following by the banks or not such as proper documentation,
proper cash verification, NPA classification, etc.
2. Internal Audit
Along with the concurrent audit, banks also perform an internal audit for which they appoint an internal
auditor to make a regular check on the financial activities of the bank throughout the year.
One of the prominent sectors of internal audit is information system audit, which is becoming a
necessary part of a banking system with the rapid growth of computerised banking functions, and it is
important to keep an eye on such system on timely intervals to check their work ability.
Therefore, the auditor should also have a basic knowledge of banking software’s so that he may identify
the errors easily without any help of bank employee as they sometimes also try to distract the auditor
for overlapping their mistakes.
3. Statutory Audit
Statutory Audit itself comprises the word statute, which means regulation. Thus, it can be understood
easily that the statutory audit is a mandatory audit defined under the law or Banking Regulation Act,
1949. Under Statutory Audit ICAI and RBI altogether assigns the banks to an auditor who is generally a
practising chartered accountant and this auditor performs year-end audit in all branches assigned to
them by the ICAI from the end of March to first or second week of April.
Some of the important aspects which should be covered under statutory audit is cash verification, tax-
related issues, loan accounts verification. After that, an auditor prepares an audit report defining his
opinion on a financial statement for which he has been allotted a specific time under which he has to
perform an audit and submit his report.
Statutory Auditors cannot just depend on the accounts recognized by the system. The auditor
required to move extra distance just to recognize the hidden non-performing assets (NPA)
accounts in the bank audit. Before understanding this concept first, let’s understand what is a
non performing asset?
What is an NPA?
A non-performing asset (NPA) refers to the categorization of advances and loans that are in
arrears or in default. A loan is also referred to as arrears where the interest payments or
principal are missed or late. A loan is said to be in a default when the lender believes the loan
agreement to be broken and the debtor is unable to meet his obligations.
The classification of the assets is generally guided by the master circular of the Reserve Bank of
India[1] dated 1st July 2015 which pact with the ‘, Asset Classification, Prudential norms on
Income Recognition, and the Provisioning pertaining to Advances.’
• The installment and/or interest of primary remain unpaid for a time period of not less
than 90 days in respect to the term loan;
• The bank account stays out of order in the value of a Cash credit or an over draft facility;
• The bill stays unsettled for a time period of not less than 90 days in the matter of bills
discounted and purchased;
• The installment of interest or principal further remains unpaid for two crop seasons for
little duration crops;
• The installment of interest or principal further remains unpaid for one crop season for
lengthy duration crops; and
• The amount of liquidity capability stays exceptional for not less than 90 days, in respect
of a securitization deal commence in terms of strategy on securitization dated 1 st
February, 2006.
The foremost thing an auditor must perform is to go from beginning to end of the Internal Audit
reports. These reports will give an actual forthcoming of the functioning of the Branch. This will
also give a light idea of those loan accounts which are frequently irregular, chronic, overdrawn
and where terms and condition of authorization are not complied with. From the list of these
financial records and an exercise can be made to determine new Non performing Assets
accounts.
The accounts screening can provide a fair idea of correct categorization of the advances of a
Branch. The Interest’s payment by the end of each month may avoid a cash credit description
from being confidential as an NPA account, but if the credits in the account are not
proportionate with the limits authorized, then this may point toward diversion of funds, closure
of business or a substantial fall in the business activity of the entity of the borrower.
However, while opening the accounts related to loans in the computer system, if coding of such
housing loans is incorrectly done as the agriculture loan then the system can never recognize
such loans as NPAs.
Restructuring of accounts leads to NPA
The accounts restructuring system without obtaining submission from the borrower company
and also without performing additional loan documents and determining the future feasibility
of the business may lead to categorization of these accounts as Non Performing Assets.
Accounts where reformation is regularly done are also obligatory to be classified as NPAs.
The projects which are financed by banks, the ‘Date of Commencement’ or the ‘Date of
Completion’ and of Commercial Operations’ (DCCO), of the venture is clearly spelled out at the
moment of financial closure of the project and the same is officially recognized. This is also
documented in the evaluation note by the bank during the permit of the loan.
The auditors shall scrutinize the DCCO in respect of term loan accounts. Non attainment of
DCCO may lead to categorization of the account as NPA.
In case of amounts of cash credit, it is predetermined to submit a book and stock debts
statement quarterly/ monthly. These statements are obligatory to determine the accessibility
of primary security at all times. The drawing power is drawn based on the accessibility of these
securities.
A working capital borrowable account will become nonperforming assets if such uneven
drawings are allowed in the account for a nonstop period of 90 days even though the unit must
be working or the financial position of the borrower is satisfactory.
Similarly, in the case of accounts of home loans, which are over 10 years old and where there is
outstanding principal is still over 50% of the total loan amount authorized, such accounts must
be screened carefully.