audit of advances

Prepared by CA Mahesh K Madkholkar

Audit of Bank Advances

Index

04/07/23CA Mahesh K Madkholkar2

Introduction Advances – Funded and Non FundedClassification of AdvancesEvaluation of Internal ControlsProvisioning NormsAudit ProceduresLoan DocumentsReviewing Operation of accountsVerification of Securities against AdvancesRestructuring and Upgradation of AssetsResources

Introduction


The third schedule to the Banking Regulation Act, 1949 requires classification of advances made by Bank from three different angels :

Nature of AdvancesNature and extent of securityPlace of Making the advances ( In India or Outside)

Advances – Funded and Non Funded


Funded FacilitiesTerm LoansCash CreditBill Purchase/ DiscountingPre-shipment and post-shipment finance

Non Funded FacilitiesLetter of CreditGuarantees Underwritings Other Commitments

Classification of Advances


An asset, including a leased asset, becomes non performing when it ceases to generate income for the bank.

A non-performing asset (NPA) is a loan or an advance where;

interest and/ or installment of principal remain overdue for a period of more than 90 days in respect of a term loan

the account remains ‘out of order’ in respect of an Overdraft/Cash Credit (OD/CC)

Banks should, classify an account as NPA only if the interest due and charged during any quarter is not serviced fully within 90 days from the end of the quarter.

Out of Order Accounts

Classification of Advances


Standard Asset

Sub Standard Asset

Doubtful Asset

Remained NPA for 12 months or less

Remained sub-standard for 12 months or less

Evaluation of Internal Controls

04/07/23CA Mahesh K Madkholkar

Creditworthiness of the borrowersExecution of Loan DocumentsMargin SufficiencyCut- off point for high value accountsJoint Custody of SecurityTitle over the SecuritiesInspection after regular IntervalsSurprise ChecksModifications to DP BookRegularization of Accounts

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Guidelines for Classification


Take into account the degree of well-defined credit weaknesses and the extent of dependence on collateral security for realization of dues

Establish appropriate internal systems to eliminate the tendency to delay or postpone the identification of NPAs, especially in respect of high value accounts.

Responsibility and validation levels for ensuring proper asset classification may be fixed by the banks.

Asset Classification to be borrower-wise and not facility-wise


It is difficult to envisage a situation when only one facility to a borrower/one investment in any of the securities issued by the borrower becomes a problem credit/investment and not others.

All the facilities granted by a bank to a borrower and investment in all the securities issued by the borrower will have to be treated as NPA and not the particular facility/investment or part thereof which has become irregular

Accounts not to be considered as NPAs


Accounts regularized near about the Balance Sheet Date

Temporary DeficienciesNon availability of adequate DP Non submission of Stock StatementNon renewal of Limits on due date

Irregular Accounts

Upgraded or restructured accounts

Provisioning Norms


Classification of Asset

Type Provision (%)

Standard Asset Agricultural & SME 0.25 %

Commercial Real Estate

1.00%

Other Standard Asset

0.40%

Sub Standard Asset

Secured 10.0%

Unsecured 20.0%

Infrastructure Loan Accounts

15.0%

Doubtful Asset Unsecured 100%

Secured- upto 1 year

20.0%

Secured- 1 to 3 years

30.0%

Secured- 3 years & above

100%

Loss Asset ---- 100%

Audit Procedures


Evidence is to be obtained for

Amounts included in the balance sheet in respect of advances are outstanding at the date of the balance sheet.

Advances represent amount due to the Bank

There are no unrecorded advances

The stated basis of valuation of advances is appropriate and properly applied and that the recoverability of advances is recognized in their valuation.

The advances are disclosed, classified and described in accordance with recognized accounting policies and practices & relevant statutory and regulatory requirements.

Loan Documents


Documents depend uponLegal status of the BorrowerNature of Security

Documents includeCertificate of IncorporationMoA and AoA/ Partnership DeedResolution of Board of DirectorsResolution of ShareholdersMortgage Deeds ( Equitable/ English

Mortgage), etc

Review of Operation of Account


Whether limit is generally exceeded?

Whether the customer is not drawing against deposits which are not free from lien?

Whether account is not window-dressed?

Whether there is healthy turnover?

Review of Operation of Account


Review the following to assess the recoverability of advances

Periodic Statements submitted by borrowers indicating extent of complianceLatest Financial Statements of BorrowersReports of Inspection of SecurityAuditors’ reportsClaims Lodged for guarantees under DICGC/ ECGC covers

Verification of Security against advances


Legal enforceability of the security

Effective control of the Bank

Amount of Outstanding Loan Covered

Types of Securities provided


Stock Exchange SecuritiesGoods ( Pledge)Documents of Title to Goods (Hypothecation)Gold Ornaments/ BullionLIC policiesBank’s own Deposit CertificatesHire- Purchase DocumentsPlantationsImmovable PropertyECGC Covers

Restructuring of Loans


The stages at which the restructuring / rescheduling / renegotiation of the terms of loan agreement could take place, can be identified as under:

Before commencement of commercial production

After commencement of commercial production but before the asset has been classified as sub standard,

After commencement of commercial production and after the asset has been classified as sub standard

Treatment of RestructuredStandard Accounts


At any of the foregoing first two stagesA rescheduling of the installments of principal

alone would not cause a standard asset to be classified in the sub standard category provided the loan/credit facility is fully secured

A rescheduling of interest element would not cause an asset to be downgraded to sub standard category subject to the condition that the amount of sacrifice, if any, in the element of interest, measured in present value terms, is either written off or provision is made to the extent of the sacrifice involved

Treatment of restructured Sub-standard accounts


A rescheduling of the installments of principal alone, would render a sub-standard asset eligible to be continued in the sub-standard category for the specified period, provided the loan/credit facility is fully secured

A rescheduling of interest element would render a sub-standard asset eligible to be continued to be classified in sub standard category for the specified period subject to the condition that the amount of sacrifice, if any, in the element of interest, measured in present value terms, is either written off or provision is made to the extent of the sacrifice involved

Upgradation of restructured accounts


Sub Standard Asset

Standard Asset

One Year after the date on which first payment falls due

Provision can also be reversed after one year

Resources


DBOD.No.BP.BC.21 /21.04.048/2010-11 “ Master Circular -Prudential Norms on

Income Recognition, Asset Classification and Provisioning

pertaining to Advances” notified by RBI

Thank You!!!
