SEMINAR ON BANK BRANCH AUDIT

Organised by: W.I.R.C OF I.C.A.I SATURDAY 20TH MARCH 2010

AUDIT OF ADVANCES
&

PRUDENTIAL NORMS
VIPUL K. CHOKSI, FCA

Contents
a) Verification of Advances Types of Advances Evaluation of Internal Control. Extent of checking Major areas of consideration b) Income Recognition, Asset Classification and Provisioning Income. Identification of NPA. Provisioning norm for NPA. Important aspects of master circular. Restructuring & Agricultural Debt waiver. Income Recognition.
Vipul K. Choksi, FCA Choksi,

Types of Advances in Banks

FUNDED
Overdrafts/ Cash Credit Term Loans (Home Loans, Vehicle Loans, Mortgage Loans, etc) Working Capital Demand Loans Bills Purchased/ Discounted Packing Credit Foreign Currency loans

NON-FUNDED Guarantees Letter of Credit Letter of comfort Co-acceptance of Bills Buyers Credit

Vipul K. Choksi, FCA Choksi,

Evaluation of Internal Control

Existence of clearly laid down delegation of authority. Existence of clearly laid down eligibility criteria for loans. Existence of system of communicating the terms of sanction to the borrower. Existence of system of execution of documents before disbursement. Existence of system of post disbursement monitoring and reporting irregularity. Existence of system for implementation of IRAC Norms. Adequate control on changing of interest etc in CBS environment.

Vipul K. Choksi, FCA Choksi,

Extent of Checking
Extent would depend on assessment of EFFICACY of internal control Examine all large advances i.e. lower of
5% of Advances Rs.2.00 Crores

Verify advances which are adversely commented by/in Previous Audit report Internal/ Concurrent auditors Banks inspection report Report on verification of security
Vipul K. Choksi, FCA Choksi,

Extent of Checking
RBI inspection report Other report related to the particular advance Branches control returns to higher overdrawing , adhoc sanctions etc authorities concerning

Verify fresh advances granted during the year (if retail high volume then do sample basis) Accounts upgraded from NPA to standard For other than above advances to do on sample basis

Vipul K. Choksi, FCA Choksi,

Major Areas of Considerations

Credit Appraisal. Sanction / Disbursement. Documentation. Review / Monitoring / Supervision

Vipul K. Choksi, FCA Choksi,

Application & Appraisal

Prescribed Application Form from the borrower for fresh or renewal proposal KYC Compliance as Per RBI Requirements Evaluation of latest audited financial statements Review of Project Report Projected P&L, BS & Cash Flow Whether realistic Board Resolution for the availment of the facility obtained Latest Income Tax Records of Borrower and guarantor and their net worth statement.

Vipul K. Choksi, FCA Choksi,

Credit Appraisal
Whether Appraisal done by Competent person Confidential report and NOC from the existing banker CIBIL Report, Title clearance report & valuation report Nature of securities (prime/ collateral) offered and to confirm the adequacy of security cover Verify that important Financial ratios are satisfactory such as Debt Equity ratio Debt service Coverage ratio and other ratios Verify whether Exposure limit (including derivative instruments) is within the limits fixed by Bank- group wise, Industry wise & policy of Bank

Vipul K. Choksi, FCA Choksi,

Sanctioning/ Disbursement
Proposal has been routed through appropriate authorisation levels and recommendations are properly documented and noted Limits sanctioned are within the discretionary powers of the sanctioning authority In case where the sanctions are beyond the discretionary powers, the same has been reported to appropriate authorities and ratified within specified period Any change in the terms of sanction is ratified by appropriate authority

Vipul K. Choksi, FCA Choksi,

Sanctioning/ Disbursement
Pre disbursement unit inspection has been carried out & report held on record Acceptance of the borrower confirming the terms & conditions of sanction is obtained Compliance of terms of sanction.
Verify that Disbursement done only after compliance of all terms of Sanction terms and conditions

Vipul K. Choksi, FCA Choksi,

Documentation
All loan documents, as required by the sanction letter and loan policy have been executed (e g. DP Note, loan Agreement, Letter of guarantee, hypothecation Agreement, etc) Loan documents are properly executed and approved by legal expert, if required Fresh loan documents are obtained on change in limit, change in the constitution of the borrower Original agreement, share certificate, title deeds, title clearance certificate valuation report are held on record
Vipul K. Choksi, FCA Choksi,

Documentation
Charge on securities offered have been registered with registrar of companies/ appropriate authority Lien marking NOC of housing society Special Documentation for Consortium/ Multiple Banking advances
WHAT IF DOCUMENTS NOT AVAILABLE FOR VERIFICATION?

Vipul K. Choksi, FCA Choksi,

Monitoring / Supervision
Review/ Renewal of facilities carried out as per the policy of the bank Stock Inspection reports Regular QIS, Stock & Debtors statements are submitted and scrutinised Operation in party accounts critically review, specially at month end, quarter end Adequacy of Insurance

Vipul K. Choksi, FCA Choksi,

Monitoring/Supervision
Fund disbursement has been utilised towards the object for which limit was sanctioned i.e. Not diverted to group companies / associates or used to pay of existing overdues Periodic review of irregular/ overdue/ NPA accounts has been done at the appropriate level Penal interest to be charged if,
DP limits breached Statements not submitted

Vipul K. Choksi, FCA Choksi,

Drawing power Calculation (DP)

Based on Stocks, Debtors and Share value Critical review of stock/ Book Debts statement (Old debtors more than 90 days not to be considered) DP limits to be set as per latest statements if stock statements is older than 3 months account to be classified as irregular Verify banks guidelines for DP calculation specially for unpaid stocks Inventory & equity shares Valuation important in the current scenario Verify annual audit report of the borrower with the monthly stock statement for the last month of the year Verify Stock audit report for NPAs more than Rs.5.00 Crores

Vipul K. Choksi, FCA Choksi,

Frauds in Advances
Sanction without proper applications and credit appraisal Sanction made beyond discretionary power and nonreporting of the same to the appropriate authority Unauthorised release of securities Security valuation (Especially NPA account Eg Immovable Assets, patents, etc) Charging of same security to different Banks Diversion of funds Fraud risk relating to Controls Submission of fake transport documents/ godown receipts Discounting of accommodation bills/ issuance/ LC

Vipul K. Choksi, FCA Choksi,

IRAC Norms Objectives:

The classification of assets of banks has to be done on the basis of objective criteria, which would ensue a uniform and consistent application of the norms. The provisioning should be made on the basis of the classification of assets based on the period for which the asset has remained non-performing and the availability of security and the realisable value thereof.

Vipul K. Choksi, FCA Choksi,

RBI Circular Reference

Master Circular dated 1st July 2009 on IRAC Norms. Circular dated 31st August 2009 in respect of Agricultural debt waiver scheme. Circular dated 5th November, 2009 for provisioning on standard assets. Circular dated 1st December 2009 for provisioning coverage ratio.

Vipul K. Choksi, FCA Choksi,

Asset Type
hSTANDARD ASSET / PERFORMING ASSET
The account is not non-performing and does not carry more than the normal risk attached to the business.

hNON-PERFORMING ASSET (NPA)

The asset ceases to generate income for the bank. (Para 2 of the Master Circular)

Vipul K. Choksi, FCA Choksi,

Identification of NPA
Loans or Advance Interest and/or installment remains overdue for a period of more than 90 days in respect of a term loan. Bill remains overdue for a Discounted period of more than 90 days. Interest or installment remains overdue for two crop seasons for short duration crop, one crop season for long duration crop.

Bills Purchased and discounted Agricultural Advances

Vipul K. Choksi, FCA Choksi,

Identification of NPA ...

Derivative Transaction Overdue receivables representing positive mark to market value of a derivative contract remaining unpaid for a period of 90 days from specified due date. Any amount to be received remains overdue for a period of more than 90 days.
Vipul K. Choksi, FCA Choksi,

Others

Identification of NPA
hCash Credit / Overdrafts of Account remains out order

The account is treated as out of order if : Outstanding Balance remains continuously in excess of sanctioned limit/drawing power (for how many days?) or No credit continuously for 90 days as on the date of Balance Sheet or Credits in the account are not sufficient to cover interest debited during the same period. As per para 2.1.3, an account is classified as NPA only if interest due and charged during any quarter is not serviced fully within 90 days from the end of the quarter.
Vipul K. Choksi, FCA Choksi,

Classification Norms
hStandard Asset
The account is not non-performing.

hSub-Standard Asset
A sub standard Asset is one which has remained NPA for a period of less than or equal to 12 months.

hLoss Assets
These are accounts, identified by the bank or internal or external auditors or by RBI Inspectors as wholly irrecoverable but the amount for which has not been written off.

Vipul K. Choksi, FCA Choksi,

Classification Norms
h Doubtful Asset - Three Categories Category Doubtful - I Period up to One Year

Doubtful II One to Three Years Doubtful - III More than Three Years

Vipul K. Choksi, FCA Choksi,

Provisioning Norms
Standard Asset
Agricultural and SMEs Sectors Commercial Real Estate (CRE) Section Others .25% 1% .40%

Sub-standard Asset
10% of total outstanding 20% of total outstanding if loan is unsecured

Vipul K. Choksi, FCA Choksi,

Provisioning Norms
Doubtful Assets: Period Provision Up to 1 year 1to 3 years More than 3 years
(Secured + Unsecured) 20% + 100% 30% + 100% 100% + 100%

Loss Asset: 100% should be provided for

Vide circular dated December 2009, banks should have total provisioning coverage ratio of not less than 70%.

Vipul K. Choksi, FCA Choksi,

Provisioning for Country Risk

In respect of a country where its net funded exposure is 1% of its total exposure

Risk Category Insignificant Low Moderate High Very High Restricted

ECGC classification A1 A2 B1 B2 C1 C2

Provisioning requirement (%) 0.25 0.25 5 20 25 100

Off-Credit D 100 Lower provision in respect of short term exposure

Vipul K. Choksi, FCA Choksi,

Provisioning Norms
Provision Under Special circumstances
Advance under rehabilitation programme approved by BIFR / Institutions, Provision should be continued to be made on existing facilities. Additional facilities no provision for a period of one year. In case of advances guaranteed by CGTSI/ECGC, Provision should be made only for balance in excess of the amount guaranteed by these corporations.

Vipul K. Choksi, FCA Choksi,

Exceptions
Advances against term deposits, NSCs, IVPs, KVPs and Life Insurance Policies need not be treated as NPAs, till security cover is sufficient to cover outstanding balance (Para 4.2.11). Income to be recognised subject to availability of margin. Advance against gold ornaments / Government securities not exempt.
Vipul K. Choksi, FCA Choksi,

Exceptions (Contd):
Bank Finance with Moratorium [Para 4.2.12 (i)]. Housing or similar advances granted to staff members [Para 4.2.12 (ii)]. Central Government guaranteed advance to be classified as NPA only if Government repudiates the guarantee when invoked.

Vipul K. Choksi, FCA Choksi,

Classification
hClassification Qua Borrower (Para 4.2.7 of Master Circular)
All facilities granted to a borrower shall be treated as NPA & not only that facility which has become irregular. Obtain cross-branch confirmation for classification. Exception: Credit facility to Primary Agricultural Credit Society (PACS) and Farmers Service Societies (FSS) under on lending arrangement,(Para 4.2.10)

Vipul K. Choksi, FCA Choksi,

Classification
hConsortium Advances (Para 4.2.8 of Master Circular)
Member banks shall classify the accounts according to their own record of recovery. Bank needs to arrange to get their share of recovery or obtain an express consent from the Lead Bank.

Vipul K. Choksi, FCA Choksi,

Important Aspects
hClarifications vide Master Circular (Temporary deficiency) : (Para 4.2.4 of Master Circular)
Outstanding Balance in account based on the drawing power calculated from stock statements older than 3 months would be deemed as irregular & if such irregular drawing are permitted for a period of 90 days, account needs to be classified as NPA. Non-renewal/ Non-regularisation of regular/ adhoc limit within 180 days from the due date.

Vipul K. Choksi, FCA Choksi,

Important

Contd.

hStraightaway Classification (Para 4.2.9 of Master Circular)

Where realisable value of security is less than 50% of the value assessed, account to be straightaway classified as Doubtful Asset. Where realisable value of security is less than 10% of outstanding balance, account to be straightaway classified as Loss Asset. hValuation of Securities In respect of NPAs with the balance of Rs. 5.00 crores & above, bank needs to formulate policy for annual stock audit by external agencies & in respect of immovable properties, valuation to be carried out once in 3 years by approved valuer.
Vipul K. Choksi, FCA Choksi,

Important

Contd.

h Solitary Credit Entry (Para 4.2.6)

Care should be taken that a single entry in the account made at/near the balance sheet date extinguishing the overdue interest/principal is not the only criterion for classifying the asset as standard. h Regularisation of Account (Para 4.2.6) Account need not be classified as NPA if account has been regularised by the date of Balance sheet by payment of overdue through genuine sources & not by sanction of additional facility or transfer of funds between accounts. (Also ensure that a/c remains regular subsequently.) h Take out Finance (Para 4.2.16). h Post-shipment supplier credit (Para 4.2.17). h Export Project Finance (Para 4.2.18)
Vipul K. Choksi, FCA Choksi,

Income Recognition
h Income Recognition

For NPA accounts income should be recognised on realisation basis. When an account becomes non-performing, unrealised interest of the previous periods should be reversed or provided. h Adjustment of Recoveries - Priority Unrealised Expenses Unrealised Interest Amount of Principal Outstanding Clarification vide Master Circular - in the absence of clear agreement between the Bank and the Borrower, an appropriate policy to be followed in uniform and consistent manner. (Para 3.3.2)
Vipul K. Choksi, FCA Choksi,

Restructuring
hHarmonisation of all categories of debt restructuring (other than these restructured under natural calamity).
Restructuring divided in following four categories;
i. ii. iii. iv. Industrial Units. Industrial Units under CDR Mechanism SMEs All other advances.

Vipul K. Choksi, FCA Choksi,

Restructuring Contd.
Highlights Restructuring of accounts could take place in following stages
Before commencement of commercial production After commencement of commercial production / operation but before the asset has been classified as Sub Standard. After the commencement of commercial production / operation but after the asset has been classified as Sub Standard or doubtful.

Vipul K. Choksi, FCA Choksi,

Restructuring Contd.
Any category of advance can be rescheduled prospectively. Only viable account can be restructured. Otherwise it would be treated an attempt at even greening. Restructured account can be upgraded to standard category after observation of satisfactory performance during the specified period. specified period means period of one year from the date when the 1st payment of interest or installment falls due under the terms of restructuring. Provision against restructured advances as per existing provisioning norms. Provision for diminution in fair value of restructured advances.

Vipul K. Choksi, FCA Choksi,

Restructuring Contd.
The diminution in fair value to be recomputed on each balance sheet. Option of providing diminution @5% of the total exposure, in respect of restructured accounts where the dues are less than Rupees One Crore. Asset taken as security against sacrifice should be valued @ Rs.1/Valuation and provisioning issues for equity debt, instruments received on restructuring. Norms for conversion of unpaid interest into FITL debt/equity.

Vipul K. Choksi, FCA Choksi,

Restructuring Contd.
Standard advance should be reclassified as sub standard immediately except if following conditions are satisfied. i. Dues of the bank are fully secured by tangible security (except SSI borrower with outstanding upto Rs.25 lacs & infrastructure projects) ii. Unit becomes viable in 10 years, if it is engaged in infrastructure activities and in 7 years in case of other units.

Vipul K. Choksi, FCA Choksi,

Restructuring Contd.
iii. Repayment period including moratorium does not exceed 15 and 10 years for infrastructure and other projects, (exception housing loan RBI circular dated 3rd November 2008) iv. Promoters sacrifice and additional funds brought by them should be a minimum of 15% of banks sacrifice. v. Personal guarantee is offered by promoters. vi. The restructuring is not repeated restructuring The exception will not apply to consumer and personal advances, capital market and real estate exposure

Vipul K. Choksi, FCA Choksi,

Agricultural Debt Waiver Scheme

Prudential norms. Agricultural debt waiver and debt relief scheme 2008.
Amount eligible for waiver to be transferred to a separate account named Amount receivable from Government of India under Agricultural Debt Waiver Scheme 2008. Banks neither to claim nor recover from the farmer, interest in excess of the principal amount, penal interest, legal charges, miscellaneous charges etc for the assets which are NPA at the time of restructuring.

Vipul K. Choksi, FCA Choksi,

Agricultural

Contd.

The balance may be treated as performing asset provided adequate provision is made for loss in present value term. Assumptions for receipt of money from Government of India. a) 32% by 30th September 2008. b) 19% by 31st July 2009 c) 39% by July 2010 d) 10% by July 2011. (Since Government of India has decided to pay interest on balance installments, loss in PV term need not be provided).
Discount rate 9.56%.

Vipul K. Choksi, FCA Choksi,

Agricultural

Contd.

Provision required under the current norms of standard asset need not be provided. Provision already held in NPA account may be reckoned for meeting the required provision on PV basis. Prudential provision more than the amount of provision may be reversed in the proportion of 32%, 19%, 39% and 10% during the year ended, March 2009, 2010, 2011 and 2012 only after the installments for the relative year have been received. In case of rejection of claims normal prudential norms be applied Under the Scheme, in case of other farmers 75% of the amount should be released in three installments of 30th September 2008, 31st March 2009 and 30th June 2009.

Vipul K. Choksi, FCA Choksi,

Agricultural

Contd.

Vide circular dated June 25, 2009, there was a relaxation permitting farmers to pay the amount in single installment by 30th June 2009. Vide circular dated August 31, 2009, this date extended to 31st December 2009. Banks allowed to recover less than 75% of the amount provided they dont claim difference from Govt. Farmers relevant account may be treated as standard provided.
i) ii) Adequate provision is made by the bank for the loss in PV terms. The farmers have given undertaking to pay their share and pay them share of the settlement within one month of due date.

Fresh Agricultural loan be treated as standard.

Vipul K. Choksi, FCA Choksi,

Thank you!