Master Circular on Audit System issued by Government

We are aware that every year, on 1st July, the Reserve Bank of India comes out with Master Circulars on various subjects which consolidate all the instructions on the subject issued throughout the year. 102 such Master Circulars have been issued by the RBI on 2nd July, 2012 of which 67 are directly related to Banks and 35 are indirectly related to Banks. Master Circular no. UBD. CO.BPD.(PCB).MC.No.9 /12.05.001/ 2012-2013 is on Inspection & Audit Systems in Primary (Urban) Co-operative Banks.

However, this time, on 26th Sept., 2012, a new Master Circular no. F. No. 7/124/2012-BOA has been issued, not by the RBI but by the Govt. of India, Ministry of Finance giving guidelines / instructions to Public Sector Banks on Audit Systems in order to have these guidelines / instructions at one place for ready reference. What prompted the Govt. to step into the shoes of the RBI is not known. May be to avert any clash between two Regulators like the RBI & the ICAI?

Of late, there has been lot of talk doing the rounds that the Statutory Audit of Branches of Public Sector Banks, which has been a major source of revenue for many a Chartered Accountant Firms for many a years, may be abandoned. There has also been lot of talk about the quality of the Statutory Audits & Concurrent Audits being conducted by the Chartered Accountants. It is felt that there is multiplicity of various audits being conducted in Banks which consume lot of attention eating away productive time without commensurate results. It is also felt that there is need to revamp the Audit System as it has not kept pace with the technological advances that have taken place over the years.

On Statutory Audit front, major Banks like State Bank of India have been vocal on the issue of efficacy of the Statutory Audit of branches in the Core Banking Environment where all the data pertaining to all the branches of a Bank is available at the Central Data Center. They also point out that this is unnecessary cost that the PSBs have to incur while their peers in private sector like ICICI & HDFC don’t have to incur this cost. ICAI, on its’ part to protect the interest of its’ members, has been repeatedly pointing out that the total quantum of fees paid by PSBs to Statutory Auditors is just Rs. 400-500 crores annually as compared to the total Advances by these Banks of more than Rs. 35,00,000 crore of which more than 70% advances are covered by Statutory Branch Audits. It is pointed out that absence of independent statutory audit would invite greater frauds & malpractices. ICAI has voiced apprehensions regarding maintaining Auditors’ Independence in an important sector like Banking where huge public money is at stake, if the appointment of Auditors is left to the managements of the Banks. It has, in fact, advised the Govt. to place appointment of Auditors of Private Sector Banks also in the hands of RBI. While the controversy is raging, SBI has already abandoned the Tax Audit of branches which again has been a good source of revenue for the Chartered Accountants. As regards Concurrent Audit of branches, there have been concerns that in spite of regular audits being conducted by CA Firms, frauds & revenue leakages could not be contained / detected. On the other hand, it is also appreciated that the remuneration being paid to the CA Firms for conducting Concurrent Audits is quite poor and is not in keeping with the skill set required and the quantum of time to be spent in an era of ever increasing cost of skilled manpower. It is also appreciated that the system of appointing Concurrent Auditors is arbitrary and there is a casual approach of the Banks in this regard. It is pointed out by many Chartered Accountants that the Concurrent Audits are being cornered mainly by influential CA Firms having contacts / approach at the Head Offices of the Banks. All said, there has been lot of controversy on the subject.

In this background, the Govt. had appointed a Committee under the Chairmanship of Mr. Basant Seth, ex CMD of Syndicate Bank to address the issues. The Committee has submitted its’ Report to the Govt. outlining the urgent need to address some of the areas of concerns outlined above. It has submitted that there is urgent need to streamline the Internal Audit System, to make Concurrent Audits more effective by making them Risk based and to enhance the role of Information System Audit considering the fact that major frauds are now IT related. It is submitted by the Committee that the Statutory Audits have become routine and are not effective in the CBS era. Based on the Report, the Govt. has issued the Circular outlining guiding principles in respect of Internal, Concurrent and Branch Statutory Audits and has directed the Chairmen of PSBs to implement the Guidelines immediately, by suitably adapting them to their particular organization. The Circular, while listing out General Guiding Principles in respect of various audits being conducted in PSBs, also lists out separate Guiding Principles in respect of Risk Based Internal Audit, Information Systems Audits & Concurrent Audit.

While stressing the need to streamline the number of audits by strengthening the Internal Audit & Concurrent Audit, the Circular expects that this would not only lead to improvement in the quality of audits and reduction in the overall cost of audits to the Banks but would also lead to phasing out the existing Branch Statutory Audit System. Though the objective of streamlining the Audit System is laudable, phasing out the Branch Statutory Audit as an objective may not be appreciable. It would have been better if steps had been suggested to improve and strengthen the Branch Statutory Audit System & making it performance based so that the cost of it is not felt by the Banks.

The Circular advises the Banks:

1. To form Audit Committee of Executives of General Managers at Central Level and Zonal Audit Committees at lower levels.

2. Such Audit Committees to work under the guidance of Audit Committee of the Board & to meet regularly, at least 6 times a year and minutes of their meetings to be put up before the ACB. High Risk Audit Reports and Critical Findings should be directly put up before the ACB.

3. The Banks should switch over to software based audit process.

4. The Audit & Inspection Dept. should be strengthened & should be adequately manned. For attracting better talent in the Audit Dept., HR Policies should be adequately modified.

5. Off-site Monitoring Cell to be set up in the Audit Department which should review the MIS on critical items on daily basis & apprise Top Management of serious irregularities, if any, immediately.

6. Banks to devise & implement suitable training programs for all the auditors, whether internal or concurrent.

7. Auditors to sign an undertaking containing the Do's & Don'ts.

Looking at the general guiding principles certain points become quite clear:

1. The Government is concerned about the multiplicity of audits conducted in banks which consumes huge amount of time and attention of the functionaries.

2. Although 70% of business of banks is covered by concurrent audit, it has not proved to be effective in containing frauds and irregularities. It is proposed to strengthen Concurrent Audit System by making it risk focused. It is also proposed to give training to concurrent auditors.

3. It is proposed to strengthen Audit and Inspection Department which is so far has been neglected function. It is proposed to appoint Chartered Accountants, Cost Accountants, CISAs, professionals having experience in banking functions. To attract talent, it is proposed to modify HR policy of banks. The important point here is government sees much larger role for Chartered Accountants in various banking functions, more particularly in Audit and Inspection Department which shows that huge untapped job opportunities are available in this sector for Chartered Accountants.

The Circular has also laid out certain guiding principles in respect of Risk Based Internal Audit (RBIA), Information System Audit (ISA) and Concurrent Audit. As regards Risk Based Internal Audit, the Circular seeks to fix the periodicity of audits for high risk branches at 9-12 months, 12-15 months for medium risk branches and 15-18 months for low risk branches. It also advises that the Risk Based Internal Audit (RBIA) compliance should be done within 90 days of submission of the report and should not be delayed more than 120 days.

While advising the banks to make Information Systems Audit ( ISA ) an integral part of Internal Audit, it expects the Information Systems Audit to be carried out on a continuous basis, more particularly in critical areas. For the purpose, separate ISA teams are to be formed with persons having IT experience and CISA qualified professionals. ( I think the Institute will have to represent for modification to include DISA qualified professionals also in the Circular ). Because of the issuance of this Circular, huge opportunity has become available for CISA qualified professionals in the Banking Sector. As regards Concurrent Audit, the Circular seeks to enhance the role of Concurrent Auditors, more particularly in the high risk areas like SME, mid corporate, large corporate, Portfolio Management, Forex etc. Further it seeks to streamline the process of appointment of Concurrent Auditors. To obtain quality services, the Circular advises the banks to enhance the fees payable for concurrent audit suitably. But at the same time seeks to make the audit performance based with inclusion of deterrent provisions in the Letter of Appointment for delayed submission of reports and unsatisfactory performance. Performance Review of Concurrent Auditors on annual basis would now become mandatory. The role of Concurrent Auditors is sought to be enhanced by transferring many of the functions of Statutory Branch Auditors to Concurrent Auditors including annual certifications.

Going by the contents of the Circular, the Statutory Branch Audit is likely to be phased out over a period of next 2 years. Concurrent Auditors are now to be appointed from out of RBI Panel as per gradation of auditors and size of the branches to be audited. Obviously consolidation of small and medium sized firms remains the only option for the professionals in the SMP segment if such important work opportunities are not be missed.

Many of the contents of the Circular are not new and many Banks incorporate some of the conditions in the Letter of Appointment issued to Concurrent Auditors already. However, coming directly from the Finance Ministry, the Circular assumes significance and material changes may be expected in the days to come in the way audit of Banks is handled. There is lot of hue and cry about losing the lucrative Statutory Audit revenue . However, since the Circular is already issued, there is huge task on hand for the ICAI to get the Circular modified and to negate some of the contents of the Circular. It will have to lobby hard with the Govt. for any modifications to safeguard the interest of small firms. Ultimately, since change is inevitable, we will have to be ready for the same.

By,

CA GOKUL B. RATHI

FCA, DISA, CISA, Dip. In IFRS / Valuation