12. Audit of Banks Flashcards
Types of Banks
There are different types of banking institutions prevailing in India which are as follows:
- Commercial banks:
Commercial banks are the most widespread banking institutions in India, that provide a number of products and services to the general public and other segments of the economy.
Two of its main functions are:
a) accepting deposits and
b) granting advances. - Regional Rural Banks:
Regional Rural Banks known as RRBS are the banks that have been set up in rural areas in different states of the country to cater to the basic banking and financial needs of the rural communities. - Co-operative Banks:
Co-operative Banks function like Commercial Banks only but are set up on the basis of Cooperative Principles and registered under the Cooperative Societies Act of the respective state or the Multistate Cooperative Societies Act and usually cater to the needs of the agricultural and rural sectors. - Payments Banks:
Payments Banks are a new type of banks which have been recently introduced by RBI.
They are allowed to accept restricted deposits but they cannot issue loans and credit cards.
However, customers can open Current & Savings accounts and also avail the facility of ATM cum Debit cards, Internet-banking & Mobile banking.
Examples are:- Airtel Payments Bank, India Post Payments Bank, Paytm Payments Bank , etc. - Development Banks:
Development Banks had been conceptualized to provide funds for infrastructural facilities important for the economic growth of the country. Examples are:- Industrial Development Bank of India (|DBI), etc. - Small Finance Banks:
Small Finance Banks have been set up by RBI to make available basic financial and banking facilities to the unserved and unorganised sectors like small marginal farmers, small & micro business units, etc.
Responsibilities and functions of RBI.
The functioning of the banking industry in India is regulated by the Reserve Bank of India (RBI) which acts as the Central Bank of our country.
RBI is responsible for :
i) development and supervision of the constituents of the Indian financial system (which comprises banks and non-banking financial institutions)
ii) determining, in conjunction with the Central Government, the monetary and credit policies keeping in with the need of the hour.
iii) regulating the activities of commercial and other banks.
Important functions of RBl are:
i) issuance of currency;
ii) regulation of currency issue;
iii) acting as banker to the central and state governments; and
iv) acting as a banker to commercial and other types of banks including term lending institutions. Besides, RBI has also been entrusted with the responsibility of regulating the activities of commercial and other banks.
No bank can commence the business of banking or open new branches without obtaining a license from RBI.
The RBl also has the power to inspect any bank.
Peculiarities involved in banking operations.
Peculiarities involved in banking operations:
i) Huge volumes and complexity of transactions;
ii) Wide geographical spread of banks’ network;
iii) Large range of products and services offered;
iv) Extensive use of technology:
v) Strict vigilance by the banking regulator etc.
Engagement team discussions in the audit of banks.
All personnel performing an engagement, including any experts contracted by the firm in connection with that engagement are known to be the “Engagement Team”.
The engagement team should hold discussions to gain better understanding of the bank and its environment, including internal control, and also to assess the potential for material misstatements of the financial statements.
All these discussions should be appropriately documented for future reference.
These discussions are ordinarily done at the planning stage of an audit.
The engagement team discussion ordinarily includes a discussion of the following matters:
a) Errors that may be more likely to occur;
b) Errors which have been identified in prior years;
c) Method by which fraud might be perpetrated by bank personnel or others within particular account balances and/or disclosures;
d) Audit responses to Engagement Risk, Pervasive Risks, and Specific Risks;
e) Need to maintain professional skepticism throughout the audit engagement;
f) Need to alert for information or other conditions that indicate that a material misstatement may have occurred.
Appointment of the auditor of banks.
As per the provisions of the relevant enactments:
i) The auditor of a banking company is to be appointed at the annual general meeting of the shareholders,
ii) The 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 of India is required before the appointment is made.)
iii) The auditors of regional rural banks are to be appointed by the bank concerned with the approval of the Central Government.
Remuneration of the auditor of banks.
a) The remuneration of the auditor of a banking company is to be fixed in accordance with the provisions of Section 142 of the Companies Act, 2013 (i.e., by the company in general meeting or in such manner as the company in general meeting may determine).
b) The remuneration of auditors of nationalised banks and State Bank of India is to be fixed by the Reserve Bank of India in consultation with the Central Government.
Auditor’s report in case of a nationalised bank.
In the case of a nationalised bank, the auditor is required to make a report to the Central Government in which he has to state the following:
a) whether, in his opinion, the financial statements present a true and fair view of the affairs of the bank and
in case he had called for any explanation or information, whether it has been given and whether it is satisfactory;
b) whether or not the transactions of the bank, which have come to his notice, have been made within the powers of that bank;
c) whether or not the returns received from the offices and branches of the bank have been found adequate for the purpose of his audit; and
d) any other matter which he considers should be brought to the notice of the Central Government.
The report of auditors of State Bank of India is also to be made to the Central Government and is almost identical to the auditor’s report in the case of a nationalised bank.
Format of audit report of banks.
a) The auditors, central as well as branch, should also ensure that the audit report issued by them complies with the requirements of Standards on Auditing relating to Audit Report.
b) The auditor should ensure that not only information relating to the number of unaudited branches is given but quantification of advances, deposits, interest income and interest expense for such unaudited branches has also been disclosed in the audit report.
c) It may be noted that, in addition to the aforesaid, the auditor of a banking company is also required to state in his report the matters covered by Section 143 of the Companies Act, 2013.
However, it is pertinent to mention that the reporting requirements relating to the Companies (Auditor’s Report) Order, 2020 is not applicable to a banking company, as defined in clause (c) of Section 5 of the Banking Regulation Act, 1949.
Types of advances issued by banks.
Following are the two types of advances:
i) Funded loans
Funded loans are those loans where there is an actual transfer of funds from the bank to the borrower.
Examples of funded loans are Term loans, Cash credits, Overdrafts, Demand Loans, Bills Discounted and Purchased, Participation on Risk Sharing basis, Interest-bearing Staff Loans.
ii) Non-funded facilities
Non-funded facilities are those which do not involve such transfer.
Examples of non-funded loans are Letters of credit, Bank guarantees, etc.
Nature of security for bank finance.
A) Primary security:
Primary security refers to the security offered by the borrower for bank finance or the one against which credit has been extended by the bank.
This security is the principal security for an advance.
B) Collateral security:
Collateral security is an additional security.
Security can be in any form i.e. tangible or intangible asset, movable or immovable asset.
Any two modes of creation of security.
Depending on the nature of the item concerned, creation of security may take the form of-
i) Mortgage:
Mortgages are of several kinds but the most important are the Registered Mortgage and the Equitable Mortgage.
a) Registered Mortgage can be affected by a registered instrument called the ‘Mortgage Deed’ signed by the mortgagor.
It registers the property to the mortgagee as a security.
b)Equitable mortgage, on the other hand, is affected by a mere delivery of title deeds or other documents of title with intent to create security thereof.
ii) Pledge:
A pledge involves bailment or delivery of goods by the borrower to the lending bank with the intention of creating a charge thereon as security for the advance.
The legal ownership of the goods remains with the pledger while the lending banker gets certain defined interests in the goods.
Importance of implementation of KYC norms by a bank from the perspective of an auditor of a bank.
As per SA 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”, the auditor’s objective is to-
- identify and assess the risks of material misstatement in the financial statements due to fraud,
-to obtain sufficient appropriate audit evidence on those identified misstatements and
-to respond appropriately.
The attitude of professional skepticism should be maintained by the auditor so as to recognise the possibility of misstatements due to fraud.
The RBI has framed specific guidelines that deal with prevention of money laundering and “Know Your Customer (KYC)” norms.
The RBI has from time to time issued guidelines (“Know Your Customer Guidelines Anti Money Laundering Standards”), requiring banks to establish policies, procedures and controls to deter and to recognise and report money laundering activities.
What is a Non-performing Asset?
An asset becomes NPA when it ceases to generate income for the Bank.
A non-performing asset (NPA) is a loan or an advance where -:
i) interest and/ or installment of principal remain overdue for a period of more than 90 days in respect of a term loan;
ii) the account remains ‘out of order’ in respect of an Overdraft/Cash Credit (OD/ CC);
iii) the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted.
Account of a borrower availing cash credit facility from branch of a bank has become “Out or order.” Discuss the term “Out of order”.
An account should be treated as ‘out of order’ if:
i) The outstanding balance remains continuously in excess of the sanctioned limit/drawing power; or
ii) In cases where the outstanding balance in the principal operating account is less than the sanctioned limit/drawing power, but there are no credits continuously for 90 days as on the date of Balance Sheet ; or
iii) Credits are there but are not enough to cover the interest debited during the same period, these accounts should be treated as ‘out of order’.
Classification as NPA - Govt. guaranteed advances.
Central Govt. guaranteed Advances, where the guarantee is not invoked/ repudiated would be classified as Standard Assets, but regarded as NPA for Income Recognition purpose.
The situation would be different if the advance is guaranteed by the State Government, where advance is to be considered NPA if it remains overdue for more than 90 days for both Provisioning and Income recognition purposes.
