Bank Branch Audit--the Brass-tacks

I am writing this not to educate members, especially the rookie ones, about bank audit, but to clear things up in my own head. Writing down your thoughts helps you straighten out your thinking, clear up the cobwebs and make the concepts that were hitherto only clear to you crystal clear.

Godspeed to those who’ve been allotted bank audits. Commiserations to those who haven’t

had Lady Luck smile their way this time around.

The Guidance Note on bank audits the ICAI has brought out runs into 631 pages. I do not know of anyone who has read it—Read as in reading from cover to cover, like one read Khushwant Singh’s Delhi. But if you can find time to skim through it off and on, it would pay you. It is nicely written and explains the concepts in a simple language. Although it is no substitute for practical experience of actually having worked in a bank branch, reading the Guidance Note particularly on matters that you aren’t clear on, might save you a blush or two. The bank managers would instantly know where we stand in terms of our knowledge of banking. It’s very important that we pretend to have knowledge even if we don’t have it. The kind of information you ask for, the way you ask a question, your general approach and demeanor would matter an awful lot in how effective you are as a bank branch auditor.

The one great challenge in bank audit is--you guessed it--TIME! We have hardly got 4-5 days to complete the audit in. There is no time to prepare. The particular branch you’ve been allotted may have a certain kind of advances that you haven’t had much experience dealing with. You have no choice but to hit the ground running and improvise as you go along.

Since the audit fee is calculated with reference to the amount of advances the branch has, nearly all of us tend to become too obsessed with advances and focus all our attention on it. Once we have detected a few NPAs, our chests puff out triumphantly. NPA is the branch manager’s bugbear and the auditor’s hobbyhorse. How effective we have been in conducting the bank branch audit is often measured by how many accounts we have got turned into NPAs. While the thrust of a statutory branch audit certainly is to make sure no non-performing asset is camouflaged as a performing one, it’s high time we got off that horse and got down to looking at other aspects of the branch audit as well.

I shall begin with deposits.

Savings/Current Accounts:

Not everyone is entitled to open savings account. Mostly it’s the individuals and HUFs who can open saving accounts. Institutions such as municipal corporations/committees, political parties, trade associations, panchayats and clubs can’t open savings accounts. Registered societies, not-for-profit companies and a co-operative society financed by the bank can open saving accounts.

If you encounter a customer in the non-eligible category operating a savings account, have the account designated as a current account and the interest credited in that account reversed.

Make sure the KYC norms are complied with. Not anyone can just walk in and have an account with a bank. He might well be a Pakistani spy! Banks can’t be used as conduits to funnel money used to finance terrorism. So examine a few of the documents relating to the savings/current accounts opened during the year. The documents should clearly establish the antecedents of the account holder. Somebody already running an account with the bank should witness it.

The debit balances in the current as well as savings account are shown as “Advances” and not netted off with the credit balances. Interest on savings account is credited to the accounts twice a year. The second occasion generally does not coincide with the end of the year. So the branch will have created provision for interest on the savings account for a month or two on 31^st March. If it’s for one month, it will approximately be 1/12^th of the total interest expense on saving fund accounts appearing in the Profit and Loss account.

Of course, there is hardly anyone of us who hasn’t heard of the classic method of window-dressing that many branches engage in: Debit Advance, Credit Deposit.

Look out for a sudden spurt in advances/deposits at the year-end. The branch might well have done it at the behest of the borrowers/depositors themselves at the fag-end of the year. That does not let them off the hook, especially if the entry has been reversed on 01^st/2^nd April.

Fixed Deposit Receipts:

An FDR having matured but not encashed should cease to earn interest at the rate contracted at the time of opening of the term deposit. It is no longer a term deposit. It should not earn interest more than the rate applicable on savings deposits viz. 4%. But many banks have a practice of renewing the FDRs with retrospective effect so that the customer does not lose out on the interest. But if the diktat of the RBI is to be followed to the letter, this can’t be done. Unless the customer comes forward on the appointed day viz. the date of maturity of the FDR and gets it renewed, the deposit should cease to be a term deposit and should earn interest only at the savings rate.

Perform an analytical procedure: Calculate the Cost of Deposits (COD). Based upon the maturity pattern of the FDRs, we can know the average rate of interest on term deposits. That rate can be applied to the outstanding amount in the FDR account and compared with the figure of interest expense on term deposits.

Let’s talk about Advances now:

CC/Hypothecation Limits:

You would hardly have a client who doesn’t have a CC limit with a bank. A perfect Cash Credit account would have credit summations equal to the amount of sales projected in the CMA data submitted to the bank at the time of sanction. That will be approximately 4 to 5 times the amount of limit sanctioned. Since we do not live in a perfect world, a number of CC accounts you would encounter in the branch would be more like term loans. The party would serve the interest by having just enough credits in the account every month to cover up the interest debited. Technically, this account isn’t an NPA. But what we can do is raise an object that this account is actually a term loan disguised as a CC limit. Many unscrupulous businessmen do this: Instead of being saddled with the liability to pay off the instalment of a term loan every month/quarter, they would rather go in for a CC limit. With the connivance of obliging branch managers, many accounts that ought to have sanctioned as term loans are being operated as CC limits in thousands of bank branches across the country.

If the exposure in a CC account is more than Rs 5 crore, the bank gets the borrower subjected to an annual stock/book debts audit. The actual stocks might be quite different from what is reflected in the stock statements submitted by the borrower every month/quarter. But as stock auditors, we oblige the parties all the time. Still it’s worthwhile to go through the stock audit reports and note any adverse comments the CA might have put in there in the fine print.

The correct calculation of DP (Drawing Power) in a CC account is very important. The margins against CC (Stocks) are generally different from the margins against CC (Book Debts). And stocks should be only the paid stocks i.e. minus the creditors. The borrower can’t go in for double financing: Till the time you haven’t paid your creditors, you are not entitled to have those credit purchases financed by bank.

There might be situations where the DP for stocks works out to be a negative figure—the creditors might be more than the value of stocks. Should you net this negative figure off with the DP calculated with reference to the book debts? Depends upon the terms of sanction. Generally, the branches would ignore the negative figure and calculate the DP on book debts only.

The CC limits fall due for renewal after a year. A renewal delayed beyond a period of 180 days would result in the account being declared an NPA, in terms of the RBI Master Circular dated 01^st July 2013.

Besides, the CC limits, your branch might have many other types of advances. An exporter might be enjoying Packing Credit (PC) limits with the branch. PC limits are working capital loans granted at a concessional rate of interest against confirmed export orders. Money is transferred to the PC limit out of the CC limit. The borrower would like to have his PC account reflect the maximum amount sanctioned for it. PC is granted for a specified time period. It can be as long as 180 days. Since the PC is granted against export orders, it can be extinguished through post-shipment proceeds only. You can’t just liquidate your PC by transferring money back to it through your CC account! It has to be only through realization of export proceeds by the due date that a particular PC that has fallen due gets squared up. A delay beyond that would invite penal interest.

Most exporters go for post-shipment finance also. The post-shipment finance is done by way of bill discounting. The borrower draws a bill of exchange on the bank of his foreign customer. The branch you are auditing is the payee of the bill. The borrower subsequently discounts this bill with the branch and gets his PC liquidated through the post-shipment bill discounting. The bill of exchange will be backed up by an irrevocable letter of credit and a bill of lading.

To cover up for losses that would accrue to it if the foreign bank were to go under, the bank also obtains an ECGC (Export Credit Guarantee Corporation) cover before it grants the post-shipment credit. The ECGC premium is generally debited to the account of the borrower, although some banks waive it. The rate of interest the branch charges on the post-shipment bills discounted with it depends upon the country and the credit rating of the bank that has issued the LC. Discounting of Bills of exchange backed up by LCs of banks in countries like Ukraine, Bangladesh and some Middle East countries would understandably cost more than discounting of bills of customers located in the UK or the USA.

The branch does not bear the burden of concessional rate of interest on Packing Credit. It puts up a claim before the RBI to get reimbursement of the interest income it has lost in granting the PC. So the branch’s profits would be impacted to the extent they’ve made an error in calculating the interest subvention claim. Have the interest subvention claim checked thoroughly. The likelihood of an MOC being raised in that area is very high.

Educational Loans:

Banks don’t, rather can’t, insist on collateral in case of educational loans up to Rs 4 lacs. But if your branch does have educational loans in its portfolio, the average size of the loan is likely to be much higher than this figure. In cases of educational loans granted to study abroad, it is guaranteed that you will have a few cases where the “students” actually wanted to go abroad for working there. Since he didn’t have the necessary skills to obtain a work visa from the embassy, a well-wisher in Australia suggested him to apply for an educational visa instead. The embassy would easily grant it to him because the university in their country is wooing Indian students to shore up their dwindling revenues. After the initial disbursement, the account will lie dormant. The “student” doesn’t need the balance amount anymore. He’s already abandoned his studies and has begun working and remitting dollars to Daddyji in India. By the time the moratorium period runs out, he would have enough saved up to pay off his “education” loan.

All the parties involved—the bank, the borrower, the embassy granting the visa, the concurrent auditor--know what’s going on. They all turn a blind eye to it. You as a statutory auditor might have to do the same thing!

Ensure that except for books and hostel accommodation, the disbursement is released directly to the university.

Housing Loans:

Another area in retail financing prone to misuse is the housing loan. Make sure the municipality-approved MAP is invariably on record in case of construction of the house. You may also have to undertake a visit to the site of the house. You will unfailingly have cases where the borrower has set up a shop or an office in a part of the house.

Many banks have begun appointing CA firms as customer point verification agencies. The CPVAs verify and certify the genuineness of the ITRs of borrowers, their balance sheets, Form 16 and also conduct a field investigation ascertaining the creditworthiness of the applicant seeking to obtain a housing loan from the bank.

The amount of housing loan to be granted to the borrower will be determined by their monthly paying capacity and the value of the house.

The chain of title deeds would be on record along with the legal opinion by the advocate on the bank’s panel. I haven’t come across one, but I have heard of cases of people obtaining home loans from more than one bank on the strength of the same registered deed. I don’t see how’s that possible unless at least half a dozen people who have sold their souls to the devil have come together to pull this off. The NEC (Non-encumbrance Certificate) issued by the sub-registrar is an evidence that the property is free from any prior charges. The advocate issues his legal opinion only after obtaining the NEC. The branch would have a marketable title to the mortgaged property on the basis of the NEC and the legal opinion.

The property would also be got evaluated from the bank’s empanelled valuer.

Make sure the draft made out to the borrower has actually been handed over to her before the close of the year. To jack up the figure of advances on 31^st March, some branches would have the draft made out on the last day. This is a kind of window-dressing. If the borrower had still not collected it from the branch by the time you arrive at the branch in April, you can point that out in the LFAR.

Just like the COD, we must also do the YOA (Yield on Advances). Find out the average rate of interest and multiply it with the outstanding advances. If the figure showing up in your calculator is wide off the mark the figure of interest income on advances appearing in the Profit and Loss account, put off your plan to visit that ancient temple in the city that the manager is so hell-bent on taking you to!

General:

Some of us have neither got the time nor the patience to drop a letter to the previous auditor in terms of clause 8 of the Second Schedule. But what you can’t afford to overlook is the previous auditors’ statutory branch audit report! Comb through it. Also have on your table the concurrent audit report, the revenue audit report, if any conducted during the year, the bank’s internal inspection report and the RBI Inspectors’ report. The general comments we are called upon to make in the LFAR regarding credit appraisal, end-use of funds, compliance with KYC norms, documentation—take care that none of what you say is at odds with what’s stated in the concurrent auditor’s report.

I recently heard someone devise an acronym as a memory aid for what to look for in a borrower’s account: SODA. Security, Operation, Documentation, Amount. The advance should be backed up by sufficient amount of Security. It should be Operated in a manner it was meant to be. There should be no deficiency in Documentation. And the Amount—the amount outstanding in the loan account should be within what’s permissible in terms of the sanction and the drawing power.

This is the age of the internet. Establishing the creditworthiness of a potential borrower is just a few clicks of the mouse away. All the banks have to do is log into the CIBIL (Credit Information Bureau (India) Ltd) website. The borrowers can run but not hide. So make sure the CIBIL report is on record for each and every credit facility extended during the year under audit.

There is another wonderful website: www.cersai.org.in. This is an acronym for Central Registry of Securitization Asset Reconstruction and Security Interest. The idea behind setting up this website was to prevent crooked people to have the same property mortgaged to more than one bank and avail multiple loans. For every file you examine, look for a satisfactory CERSAI report. 

The banks now have three wonderful tools in their hands to prevent fraud and detect errors: CIBIL, CERSAI and CHARTERED ACCOUNTANTS.

All the best!

Thanks and Regards,

Sanjeev Bedi, FCA.