Audit for Treasury and Investment Function

1. Audit for Treasury and Investment Function Certificate Course on Concurrent Audit of Banks organized by Internal Audit Standards Boards, ICAI Session By: CA. Sanjay Gupta, Delhi Sanjay Gupta FCA, DISA, CISA, CRISC

2. Disclaimers • These are my personal views and can not be construed to be the views of the ICAI, IASB of ICAI, Regional Councils of ICAI. • These views do not and shall not be considered as professional advice Sanjay Gupta FCA, DISA, CISA, CRISC

3. Session overview • Rules & Regulations governingTreasury Functions in Bank • Treasury infrastructure and its internal control • Cash and investment Management Function • Asset and Liability Management Function Sanjay Gupta FCA, DISA, CISA, CRISC

4. Rules & Regulations governingTreasury Functions in Bank • Meaning The treasury function of the bank manages the funding of the balance sheet, maintenance of the statutory reserve requirements and the foreign exchange resources of the Bank, in accordance with RBI guidelines, keeping in view its objective of liquidity management and maximizing income by trading in the financial markets. • Examples Derivatives, Swaps, Futures, Options, debt instrument, treasury bill, bonds, Commercial Papers Sanjay Gupta FCA, DISA, CISA, CRISC

5. Rules & Regulations governingTreasury Functions in Bank Sanjay Gupta FCA, DISA, CISA, CRISC

6. RBI Guidelines Guidelines for Derivatives- • increased the focus on 'SUITABILITY' and 'APPROPRIATENESS' of derivative products being offered by market-makers to customers(users) as also customer appropriateness. • The market-makers should carry out proper due diligence. • Before offering any derivative product to clients, banks should obtain Board resolution from the corporate. • Document how the pricing has been done and how periodic valuations will be done. • Ascertain whether users has the appropriate authority to enter into derivative transactions. Sanjay Gupta FCA, DISA, CISA, CRISC

7. FEDAI Guidelines for Merchant Quotes • Banks will make remittances or open letter of credit in favour of the overseas suppliers provided an advance remittance for the full value or an irrevocable letter of credit for the full value has been received/ opened in favour of the merchandising trader who is not a mere financial intermediary. • Back-to-back letter will be treated as separate transaction and commission as per Rule 3 II.C. shall be charged to the customer. • The banks are allowed to fix Forward Purchase Contract if so desired by the merchant for the difference period of receipt of the proceeds of the on-sale. Cont… Sanjay Gupta FCA, DISA, CISA, CRISC

8. Investment Policy • Banks are required to frame their investments policy and obtain the Board’s approval. The investment policy may be suitably framed / amended to include Primary Dealer (PD) activities also. Within the overall framework of the investment policy, the PD business undertaken by the bank will be limited to dealing, underwriting and market–making in Government Securities. Investments in Corporate/ PSUs/ FIs bonds, Commercial Papers, Certificate of Deposits, debt mutual funds and other fixed income securities will not be deemed to be part of PD business. Such policies should be implemented to ensure that the operations in securities are conducted in accordance with sound and acceptable business practices. Within the policy framework, banks may undertake primary dealers’ activities in Government Securities. Sanjay Gupta FCA, DISA, CISA, CRISC

9. Maintenance of Cash Reserve Ratio (CRR) At present, effective from the fortnight beginning February 09, 2013, the CRR is prescribed at 4.00 per cent of a bank's total of DTL. Incremental CRR- The SCBs are required to maintain an additional average daily balance, the amount of which shall not be less than the rate specified by the Reserve Bank in the notification published in the Gazette of India from time to time. Cont… Sanjay Gupta FCA, DISA, CISA, CRISC

10. Demand and Time Liability Demand Liabilities- Demand Liabilities of a bank are liabilities which are payable on demand. These includes- • Current Deposits, • Demand Liabilities Portion Of Savings Bank Deposits, • Margins Held Against Letters Of Credit/Guarantees, • Balances In Overdue Fixed Deposits, • Cash Certificates And Cumulative/Recurring Deposits, • Outstanding Telegraphic Transfers (Tts), • Mail Transfers (MTs), • Demand Drafts (DDs), • Unclaimed Deposits, • Credit Balances In The Cash Credit Account And, • Deposits Held As Security For Advances Which Are Payable On Demand. Cont… Sanjay Gupta FCA, DISA, CISA, CRISC

11. Demand and Time Liability Time Liabilities-Time Liabilities of a bank are those which are payable otherwise than on demand. These Includes – • Fixed Deposits, • Cash Certificates, • Cumulative And Recurring Deposits, • Time Liabilities Portion Of Savings Bank Deposits, • Staff Security Deposits, • Margin Held Against Letters Of Credit, If Not Payable On Demand, Deposits Held As Securities For Advances Which Are Not Payable On Demand And, • Gold Deposits. Sanjay Gupta FCA, DISA, CISA, CRISC

12. Other Demand and Time Liabilities Other Demand and Time Liabilities Includes- • Interest accrued on deposits, • Bills payable, • Unpaid dividends, • Suspense account balances representing amounts due to other banks or public, • Net credit balances in branch adjustment account, any amounts due to the banking system which are not in the nature of deposits or borrowing Sanjay Gupta FCA, DISA, CISA, CRISC

13. Assets with the Banking System Assets with the banking system include balances with banks in current account, balances with banks and notified financial institutions in other accounts, funds made available to banking system by way of loans or deposits repayable at call or short notice of a fortnight or less and loans other than money at call and short notice made available to the banking system. Any other amounts due from banking system which cannot be classified under any of the above items are also to be taken as assets with the banking system. Sanjay Gupta FCA, DISA, CISA, CRISC

14. Liabilities not to be included for DTL/NDTL computation The under-noted liabilities will not form part of liabilities for the purpose of CRR and SLR- • Paid up capital, reserves, any credit balance in the Profit & Loss Account of the bank, amount of any loan taken from the RBI and the amount of refinance taken from Exim Bank, NHB, NABARD, SIDBI; • Net income tax provision; • Amount received from DICGC towards claims and held by banks pending adjustments thereof ; • Amount received from ECGC by invoking the guarantee; • Amount received from insurance company on ad-hoc settlement of claims pending judgment of the Court; • Amount received from the Court Receiver; Cont… Sanjay Gupta FCA, DISA, CISA, CRISC

15. Liabilities not to be included for DTL/NDTL computation • The liabilities arising on account of utilization of limits under Bankers Acceptance Facility (BAF); • District Rural Development Agency (DRDA) subsidy of Rs.10,000/- kept in Subsidy Reserve Fund account in the name of Self Help Groups; • Subsidy released by NABARD under Investment Subsidy Scheme for Construction/ Renovation/Expansion of Rural Godowns ; • Net unrealized gain/loss arising from derivatives transaction under trading portfolio; • Income flows received in advance such as annual fees and other charges which are not refundable; • Bill rediscounted by a bank with eligible financial institutions as approved by RBI and; • Provision not being a specific liability arising from contracting additional liability and created from profit and loss account. Sanjay Gupta FCA, DISA, CISA, CRISC

16. Exempted Categories • Liabilities to the banking system in India as computed under Clause (d) of the explanation to Section 42(1) of the RBI Act, 1934; • Credit balances in ACU (US$) Accounts; • Demand and Time Liabilities in respect of their Offshore Banking Units (OBU); and • SCBs are not required to include inter-bank term deposits/term borrowing liabilities of original maturities of 15 days and above and up to one year in "Liabilities to the Banking System" (item 1 of Form A return). Similarly banks should exclude their inter-bank assets of term deposits and term lending of original maturity of 15 days and above and up to one year in "Assets with the Banking System" (item III of Form A return) for the purpose of maintenance of CRR. The interest accrued on these deposits is also exempted from reserve requirements. Sanjay Gupta FCA, DISA, CISA, CRISC

17. Maintenance of CRR on Daily Basis With a view to providing flexibility to banks in choosing an optimum strategy of holding reserves depending upon their intra fortnight cash flows, all SCBs are required to maintain minimum CRR balances up to 70 per cent of the average daily required reserves for a reporting fortnight on all days of the fortnight with effect from the fortnight beginning December 28, 2002. Further In view of the amendment carried out to RBI Act 1934, omitting sub-section (1B) of Section 42, the Reserve Bank does not pay any interest on the CRR balances maintained by SCBs with effect from the fortnight beginning March 31, 2007. Sanjay Gupta FCA, DISA, CISA, CRISC

18. Fortnightly Return in Form A (CRR) All SCBs are required to submit to Reserve Bank a provisional Return in Form 'A' within 7 days from the expiry of the relevant fortnight which is used for preparing press communiqué. The final Form 'A' Return is required to be submitted to RBI within 20 days from expiry of the relevant fortnight. Based on the recommendation of the Working Group on Money Supply Analytics and Methodology of Compilation. Sanjay Gupta FCA, DISA, CISA, CRISC

19. Penalties (i) In case of default in maintenance of CRR requirement on a daily basis which is presently 70 per cent of the total CRR requirement, penal interest will be recovered for that day at the rate of three per cent per annum above the Bank Rate on the amount by which the amount actually maintained falls short of the prescribed minimum on that day and if the shortfall continues on the next succeeding day/s, penal interest will be recovered at the rate of five per cent per annum above the Bank Rate. (ii) In cases of default in maintenance of CRR on average basis during a fortnight, penal interest will be recovered as envisaged in sub-section (3) of Section 42 of Reserve Bank of India Act, 1934. SCBs are required to furnish the particulars such as date, amount, percentage, reason for default in maintenance of requisite CRR and also action taken to avoid recurrence of such default. Sanjay Gupta FCA, DISA, CISA, CRISC

20. Maintenance of Statutory Liquidity Ratio (SLR) The Reserve Bank can prescribe the SLR for SCBs in specified assets. The value of such assets of a SCB shall not be less than such percentage not exceeding 40 per cent of its total DTL in India as on the last Friday of the second preceding fortnight as the Reserve Bank may, by notification in the Official Gazette, specify from time to time. SCBs can participate in the Marginal Standing Facility (MSF) scheme introduced by Reserve Bank Under this facility, the eligible entities may borrow up to two per cent of their respective NDTL outstanding at the end of the second preceding fortnight from April 17, 2012. Additionally, the eligible entities may also continue to access overnight funds under this facility against their excess SLR holdings. In the event, the banks’ SLR holding falls below the statutory requirement up to two per cent of their NDTL, banks will not have the obligation to seek a specific waiver for default in SLR compliance arising out of use of this facility in terms of notification issued under sub section (2A) of section 24 of the Banking Regulation Act, 1949. Cont… Sanjay Gupta FCA, DISA, CISA, CRISC

21. Maintenance of Statutory Liquidity Ratio (SLR) Reserve Bank has specified vide notification DBOD.No.Ret.32/12.02.001/2012-13 dated July 31, 2012 that w.e.f. the fortnight beginning August 11, 2012 every SCB shall continue to maintain in India assets as detailed below, the value of which shall not, at the close of business on any day, be less than 23 per cent on the total net demand and time liabilities as on the last Friday of the second preceding fortnight valued in accordance with the method of valuation specified by the Reserve Bank of India from time to time: 1. Cash or 2. Gold valued at a price not exceeding the current market price, or Cont… Sanjay Gupta FCA, DISA, CISA, CRISC

22. Maintenance of Statutory Liquidity Ratio (SLR) 3. Investment in the following instruments which will be referred to as "Statutory Liquidity Ratio (SLR) securities- • Dated securities issued up to May 06, 2011 as listed in the Annex to Notification DBOD.No.Ret.91/12.02.001/2010-11 dated May 09, 2011; • Treasury Bills of the Government of India; • Dated securities of the Government of India issued from time to time under the market borrowing programme and the Market Stabilization Scheme; • State Development Loans (SDLs) of the State Governments issued from time to time under the market borrowing programme; and • Any other instrument as may be notified by the Reserve Bank of India. Sanjay Gupta FCA, DISA, CISA, CRISC

23. Procedure for Computation of SLR The procedure to compute total NDTL for the purpose of SLR under Section 24 (2) (B) of Banking Regulation Act, 1949 is broadly similar to the procedure followed for CRR . SCBs are required to include inter-bank term deposits / term borrowing liabilities of all maturities in 'Liabilities to the Banking System'. Similarly, banks should include their inter-bank assets of term deposits and term lending of all maturities in 'Assets with the Banking System' for computation of NDTL for SLR purpose. Sanjay Gupta FCA, DISA, CISA, CRISC

24. Classification and Valuation of Approved Securities for SLR As regards classification and valuation of approved securities, banks may be guided by the instructions contained in our Master Circular (as updated from time to time) on Prudential Norms for classification, valuation and operation of investment portfolio by banks . Sanjay Gupta FCA, DISA, CISA, CRISC

25. Penalties If a banking company fails to maintain the required amount of SLR, it shall be liable to pay to RBI in respect of that default, the penal interest for that day at the rate of three per cent per annum above the Bank Rate on the shortfall and if the default continues on the next succeeding working day, the penal interest may be increased to a rate of five per cent per annum above the Bank Rate for the concerned days of default on the shortfall. Sanjay Gupta FCA, DISA, CISA, CRISC

26. Return in Form VIII (SLR) 1. Banks should submit to the Reserve Bank before 20th day of every month, a Return in Form VIII showing the amounts of SLR held on alternate Fridays during immediate preceding month with particulars of their DTL in India held on such Fridays or if any such Friday is a Public Holiday under the Negotiable Instruments Act, 1881, at the close of business on preceding working day. 2. Banks should also submit a statement as annexure to Form VIII Return giving daily position of (a) assets held for the purpose of compliance with SLR, (b) the excess cash balances maintained by them with RBI in the prescribed format, and, (c) the mode of valuation of securities. Sanjay Gupta FCA, DISA, CISA, CRISC

27. Temporary/Ad-hoc measures At present, banks obtain liquidity from the Reserve Bank under the Liquidity Adjustment Facility (LAF) against the collateral of eligible securities that are in excess of their prescribed statutory liquidity ratio (SLR). In addition, purely as a temporary measure, scheduled commercial banks may avail additional liquidity support under the LAF to the extent of up to 0.5 per cent of their net demand and time liabilities. Sanjay Gupta FCA, DISA, CISA, CRISC

28. Audit Approach and Procedures The Statutory Auditors should verify and certify that all items of outside liabilities, as per the bank’s books had been duly compiled by the bank and correctly reflected under DTL/NDTL in the fortnightly/monthly statutory returns submitted to Reserve Bank for the financial year. The report of the statutory auditors in relation to compliance with SLR requirements has to cover two aspects: (a) correctness of the compilation of DTL position; and (b) maintenance of liquid assets as specified in section 24 of the Act. Cont… Sanjay Gupta FCA, DISA, CISA, CRISC

29. Audit Approach and Procedures • The central auditor should acquaint himself with the circulars/ instructions of the RBI regarding composition of items of DTL. For this purpose, he may request the management to provide him a copy of the relevant circulars/instructions. He should keep these circulars/instructions in mind while examining compliance with the SLR requirements. • To comply with the requirements relating to statutory liquidity ratio, banks have evolved systems whereby all branches send their weekly trial balance as on Friday and these are consolidated at the head office. Cont… Sanjay Gupta FCA, DISA, CISA, CRISC

30. Audit Approach and Procedures • Based on this consolidation, the DTL position is determined for every reporting Friday. The central auditor should request the branch auditors to verify the correctness of the trial balances relevant to the dates selected by him. The central auditor should also request the branch auditors to verify the cash balance at the branch on the dates selected by him. It should be ensured that such request is communicated to the branch auditors well in advance of commencement of the audit so that they can draw up their audit programme accordingly. The auditor should examine the consolidations prepared by the bank relevant to the dates selected by him. He should test check the figures in the consolidations with the related returns received from the branches. He should also test check the arithmetical accuracy of the consolidations. Sanjay Gupta FCA, DISA, CISA, CRISC

31. Checking of Computation of DTL by Auditor Items Excluded from Liability- • Part amounts of recoveries from the borrowers in respect of debts considered bad and doubtful of recovery. (b) Amounts received in Indian currency against import bills and held in sundry deposits pending receipts of final rates. (c) Un-adjusted deposits/balances lying in link branches for agency business like dividend warrants, interest warrants, refund of application money, etc., in respect of shares/debentures to the extent of payment made by other branches but not adjusted by the link branches. (d) Margins held and kept in sundry deposits for funded facilities. Sanjay Gupta FCA, DISA, CISA, CRISC

32. Checking of Computation of DTL by Auditor Items Included from Liability- (a) Net credit balance in Branch Adjustment Accounts. (b) Interest on deposits as at the end of the first half year reversed in the beginning of the next half-year. The auditor should also, particularly, examine whether the balances in Branch Adjustment Accounts of foreign branches have been taken into account in arriving at the net balance in Branch Adjustment Accounts. Sanjay Gupta FCA, DISA, CISA, CRISC

33. Audit Approach and Procedures • The auditor should examine whether the consolidations prepared by the bank include the relevant information in respect of all the branches. It may be noted that provisions for expenses and liabilities are usually made at the year-end. Similarly, even though interest accrues on a daily basis, it is recorded in the books only at periodic intervals. These items, though liabilities of the bank, are not included in the computation of DTL. The central auditor should state this fact in his report. • While reporting on compliance with SLR requirements, the auditor should specify the number of unaudited branches and state that he has relied on the returns received from the unaudited branches in forming his opinion Sanjay Gupta FCA, DISA, CISA, CRISC

34. Notifications Regarding SLR & CRR Sanjay Gupta FCA, DISA, CISA, CRISC

35. Investment in Treasury Bills Treasury bills or T-bills, which are money market instruments, are short term debt instruments issued by the Government of India and are presently issued in three tenors, namely, 91 day, 182 day and 364 day. Treasury bills are zero coupon securities and pay no interest. They are issued at a discount and redeemed at the face value at maturity. For example, a 91 day Treasury bill of Rs.100/- (face value) may be issued at say Rs. 98.20, that is, at a discount of say, Rs.1.80 and would be redeemed at the face value of Rs.100/-. The return to the investors is the difference between the maturity value or the face value (that is Rs.100) and the issue price. The Reserve Bank of India conducts auctions usually every Wednesday to issue T-bills. Payments for the T-bills purchased are made on the following Friday. The 91 day T-bills are auctioned on every Wednesday. Cont… Sanjay Gupta FCA, DISA, CISA, CRISC

36. Investment in Treasury Bills The Treasury bills of 182 days and 364 days tenure are auctioned on alternate Wednesdays. T-bills of 364 days tenure are auctioned on the Wednesday preceding the reporting Friday while 182 T-bills are auctioned on the Wednesday prior to a non-reporting Fridays. The Reserve Bank releases an annual calendar of T-bill issuances for a financial year in the last week of March of the previous financial year. The Reserve Bank of India announces the issue details of T-bills through a press release every week. Sanjay Gupta FCA, DISA, CISA, CRISC

37. TYPES OF INVESTMENTS Balance Sheet Disclosure a) Government Securities b) Other Approved Securities c) Shares d) Debentures & Bonds e) Subsidiaries and JVs f) Others (CPs, MF Units, etc.) Sanjay Gupta FCA, DISA, CISA, CRISC

38. TYPES OF INVESTMENTS HTM – Held To Maturity AFS – Available For Sale HFT – Held For Trading Sanjay Gupta FCA, DISA, CISA, CRISC

39. HTM – Held To Maturity Should be within 25% of total investments excluding: 1. Investments in Subsidiaries and JVs 2. Re- capitalization Bonds issued by GoI 3. Long Term Bonds issued by Infrastructure Companies wherein the residual maturity is not less than 7 years Cont… Sanjay Gupta FCA, DISA, CISA, CRISC

40. HTM – Held To Maturity 25% ceiling can be exceeded w.e.f. 02.Sep.04 subject to following: 1. Excess consists of only SLR securities, upto 25% of DTL as on last Friday of second preceding fortnight. 2. No fresh non-SLR securities permitted to be included in HTM except few. Cont… Sanjay Gupta FCA, DISA, CISA, CRISC

41. HTM – Held To Maturity Accounting 1. Profit would be first accounted in Profit & Loss Account and then appropriated to Capital Reserve Account (net of taxes). 2. Loss would be accounted in P & L Account. Cont… Sanjay Gupta FCA, DISA, CISA, CRISC

42. HFT – Held For Trading Are those investments which bank expects to make a gain by movement of interest rates / market rates and are required to be sold within 90 days. Sanjay Gupta FCA, DISA, CISA, CRISC

43. AFS – Available For Sale Are those investments which neither HTM or HFT. Sanjay Gupta FCA, DISA, CISA, CRISC

44. HFT / AFS Accounting Profit / Loss would be accounted in Profit & Loss Account Sanjay Gupta FCA, DISA, CISA, CRISC

45. Shifting of category - HFT / AFS / HTM HTM to AFS / HFT • Approval of Board required • Normally be allowed only at the beginning of the year • No further shifting to/from allowed Sanjay Gupta FCA, DISA, CISA, CRISC

46. Shifting of category - HFT / AFS / HTM HTM to AFS / HFT Accounting • Transferred at Book Value (which would be net of amortization) • Immediately marked to market and provision for depreciation made on the same day • Thus, Book Value remains unchanged Sanjay Gupta FCA, DISA, CISA, CRISC

47. Shifting of category - HFT / AFS / HTM • Transferred at Book Value or Market Value which ever is lower (provision for depreciation would be used in case Market Value being lower than Book Value) Sanjay Gupta FCA, DISA, CISA, CRISC

48. Shifting of category - HFT / AFS / HTM AFS to HFT • Approval of Board required / ALCO / Investment Committee • In case of exigencies, CEO or Head of ALCO can also approve the same which should be later on ratified Sanjay Gupta FCA, DISA, CISA, CRISC

49. Shifting of category - HFT / AFS / HTM HFT to AFS • Generally not permitted • Permitted only in exception circumstances • Approval of Board / ALCO / Investment Committee required Sanjay Gupta FCA, DISA, CISA, CRISC

50. Shifting of category - HFT / AFS / HTM AFS to / from HFT Accounting • Transferred at Book Value along with corresponding depreciation provision • Book Value remains unchanged Sanjay Gupta FCA, DISA, CISA, CRISC