AUDIT OF BANKING COMPANIES

INTRODUCTION:

Every banking company has to obtain the previous approval of The Reserve Bank before
appointing or Re-appointing and removing any auditors.

Reserve Bank of India(RBI) is empowered to direct the auditor of a banking company to

audit account of a banking company in relation to any transaction or class of transactions
specified in the order. In the case of State Bank of India, the auditors are appointed by the
Reserve Bank of India.

By the amendment of 1968, Section 1A and section 1B of Section 30 inserted in the Banking
Regulation Act.

IMPORTANCE OF AUDIT IN BANKING:

 Auditing helps maintain the trust of depositors and shareholders in the banking
system.
 It ensures that financial statement present a true and fair view of the bank’s financial
position.
 Auditors helps identifying mitigate financial risks, safeguarding the interests of
stakeholders.

Audit (Section 30) -

(1) The balance-sheet and profit and loss account prepared in accordance with section 29
shall be audited by a person duly qualified under any law for the time being in force to be an
auditor of companies.
 (1A) Notwithstanding anything contained in any law for the time being in force or in any
contract to the contrary, every banking shall, before appointing re-appointing or removing
any auditor or auditors, obtain the previous approval of the Reserve Bank.

(1B) Without prejudice to anything contained in the Companies Act, 1956 (1 of 1956), or
any other law for the time being in force, where the Reserve Bank is of opinion that it is
necessary in the public interest or in the interest of the banking company or its depositors so
to do, it may at any time by order direct that a special audit of the banking company’s
accounts, for any such transaction or class of transactions or for such period or periods as
may be specified in the order, shall be conducted and may by the same or a different order
either appoint a person duly qualified under any law for the time being in force to be an
auditor of companies or direct the auditor of the banking company himself to conduct such
special audit] and the auditor shall comply with such directions and make a report of such
audit to the Reserve Bank and forward a copy thereof to the company.

(1C) The expenses of, or incidental to the special audit specified in the order made by the
Reserve Bank shall be borne by the banking company.

(2) The auditor shall have the powers of, exercise the functions vested in, and discharge the
duties and be subject to the liabilities and penalties imposed on, auditors of companies by
section 227 of the Companies Act, 1956 (1 of 1956), and auditors, if any, appointed by the
law establishing, constituting or forming the banking company concerned.

(3) In addition to the matters which under the aforesaid Act the auditor is required to state in
his report, he shall, in the case of a banking company incorporated in India, state in his report,
—

(a) whether or not the information and explanation required by him have been found to
be satisfactory;

(b) whether or not the transactions of the company which have come to his notice have
been within the powers of the company;
 (c) whether or not the returns received from branch offices of the company have been
found adequate for the purposes of his audit;

(d) whether the profit and loss account shows a true balance of profit or loss for the
period covered by such account;

(e) any other matter which he considers should be brought to the notice of the
shareholders of the company.

Key Audit Areas:

1. Loan Portfolio: Assessing the quality of the loans, provisioning, and adequacy of loan
loss reserves.
2. Capital Adequacy: Ensuring compliance with regulatory capital requirement.
3. Liquidity management: Evaluating the bank ability to meet short term obligation.
4. Compliance: Verifying adhere to the regulatory requirement and internal policies.
5. Internal control: assessing the effectiveness of internal control system in preventing
and detecting error and fraud.

Relevant Case Laws -

M.Hanumaiah Vs. Reserve Bank of India (2008) 1SSC 770

In this case, Supreme Court held that on receipt of a requisition in writing from the Reserve
Bank of India(RBI), the Registrar co-operative societies is statutorily bound to issue the order
of supersession of the committee of management of the Co-operative Bank. At that stage, the
affected Bank / its managing committee has no right of hearing or to raise any objection.

CHALLENGES IN BANKING AUDIT:

1. Complexity: Banking operation involve intricate financial products and transaction.

2. Regulatory Changes: keeping up with evolving regulatory requirement poses
challenges for auditors.
 3. Fraud risk: Banks are susceptible to fraud, requiring robust risk assessment and
detection procedure.
4. IT System: Reliance on complex IT systems increases the risk of cybersecurity threats
and data breaches.

Types of Bank Audits

There are many types of bank audits: risk-based internal audit, statutory audit and tax audit,
stock audit, credit audit, RBI inspection system audit, forensic audit, concurrent audit, snap
audit, and foreign exchange.

Risk-based internal audits provide reasonable assurance to top management and the Board
about the effectiveness and adequacy of the risk management and control framework in the
institutions’ operations

A statutory audit is carried out by chartered accountants instructed by a statute or law to

ensure that the books of accounts presented to different regulators and the public are fair

RBI inspection of bank branches empowers the Reserve Bank of India to supervise and
inspect commercial banks

Credit audit can bring out the spaces in the processing and sanctioning loans and monitoring
loan accounts and wrong documentation

According to the bank’s stock audit policy, the bank’s external auditors shall inspect assets
charged to the bank once or twice a year as desired by the bank

A forensic audit examines a company’s financial records to derive evidence from them and
use it in a court of legal proceedings

The forensic auditor’s report can help prosecute the parties involved in embezzlement, fraud,
or other financial misappropriations

There are many more different types of audits than the ones mentioned above. The banking
audit unveils the violation of rules or regulations of different financial institutions and
failures in compliance with the institution’s policies. Bank auditors look for the primary set of
issues to develop profiting proposals. Their discoveries are then documented and noted on a
file by the bank.

Statutory Audit of Banks

A statutory audit of banks is a type of banking that ensures that the financial statements and
books of account conferred to the regulators and the public are fair and precise. Statutory
auditors must ensure that the audit reports are compliant with the requirements mentioned in
the following standards.

The standard of auditing 700 involves forming an opinion on financial statements, the
standard of auditing 705, which includes modifications to the opinion in the self-reliant
auditor’s report and the standard of auditing 706 that emphasises the matter paragraphs and
further matter paragraphs in the unconventional auditor’s report.

Statutory auditors are usually given a time frame within which they have to audit the bank’s
branches allocated. An auditor should accept the appointment immediately and send a formal
intimation to the branch manager about the information necessary to conduct and complete an
audit. The assigned auditor should ensure that their report qualifies for advances, interest
expenses, deposits, etc. The essential elements to verify in a statutory audit of a bank are tax-
related objects, verification of cash procedures and loan accounts.

Process of Audit

The audit of banking involves various stages to complete the procedure successfully.

Legal Framework: Audits of banking companies are governed by a combination of banking

laws, regulatory guidelines, and auditing standards. In many jurisdictions, banking laws
mandate that banks undergo regular audits conducted by independent auditing firms.

Scope of Audit: The scope of the audit encompasses various aspects such as financial
statements, internal controls, risk management practices, compliance with regulatory
requirements, and adherence to accounting standards. Auditors assess the accuracy and
completeness of financial records and evaluate the effectiveness of internal controls in
mitigating risks.

Regulatory Compliance: Auditors ensure that banking companies comply with relevant
laws and regulations, including banking regulations, anti-money laundering (AML) laws,
know your customer (KYC) requirements, consumer protection laws, and data privacy
regulations. Non-compliance with these regulations can result in severe penalties and
reputational damage.

Risk Assessment: Auditors conduct risk assessments to identify potential risks that may
impact the financial health and stability of the banking company. This includes credit risk,
liquidity risk, operational risk, and compliance risk. Auditors assess the adequacy of risk
management practices and recommend improvements where necessary.

Fraud Detection: Auditors are responsible for detecting and preventing fraud within banking
companies. This involves assessing the effectiveness of fraud prevention measures,
conducting fraud risk assessments, and investigating any suspicious activities or irregularities
identified during the audit process.

Reporting: Upon completion of the audit, auditors issue an audit report detailing their
findings, conclusions, and recommendations. The audit report provides stakeholders,
including shareholders, regulators, and the board of directors, with assurance regarding the
reliability of the banking company's financial statements and the effectiveness of its internal
controls.

1. Eligibility, qualification & Disqualifications

Balance sheet and Profit and loss account of a banking company should be audited by
a person duly qualified under any law for the time being in force to be an auditor of
companies.

Section 141 of Companies Act, 2013 prescribes the auditor eligibility, qualification
and disqualifications.

2. Appointment

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 bank concerned acting

through its Board of Directors.

In either case, approval of the Reserve Bank is required before the appointment is
made.
The auditors of the State Bank of India are to be appointed by the CAG in
consultation with the Central Government.

The auditors of regional rural banks are to be appointed by the bank concerned with
the approval of the Central Government.

3. Remuneration

Remuneration of auditor of a banking company is to be fixed in accordance with the

provisions of section 142 of the Companies Act, 2013.

Remuneration of auditors of nationalised banks and State Bank of India is to be fixed

by the RBI in consultation with the Central Government.

4. Powers

Auditor of a banking company or of a nationalised bank, SBI or a regional rural bank

has the same powers as those of a company auditor in the matter of access to the
books, accounts, documents and vouchers.

Conclusion

The banking audit uncovers the breaching of laws and regulations of the financial institutions
and their negligence in following the bank’s policies. Bank auditors focus on the cause of
issues and make favourable recommendations for the institution. They document their
findings and keep them on the file of the bank.

Bank audits are essential to ensure that the bank’s practices are good. The bank audits can be
stress alleviating for the bank managers. Many audit software solutions can help the bank
smooth out the stay compliant for an easy audit process. The aim of an audit of a banking
company is rooted in compliance and can help the financial institution grow.