CONCURRENT AUDIT CERTIFICATE COURSE

1. CONCURRENT AUDIT CERTIFICATE COURSE LOANS AND ADVANCES BY CA Gokul B. Rathi

2. Importance of Advances - • Lending constitutes major activity of the bank • Advances generally constitute the largest item of assets • Major source of income • RBI closely regulates the lending activity of banks • Advances constitutes one of the major areas of verification for auditors

3. Types of Credit Facilities-

4. Term Loan Accounts – • Housing Loans / Property Loans :– • No foreclosure charges or pre payment penalties can be levied by banks in respect of Home Loans with Floating Interest Rates. • Moratorium can be granted, at the option of the borrower, till the completion of the construction or 18 months from the date of first disbursement, whichever is earlier. • No finance can be given against plot of land unless building plan is sanctioned. • Vehicle Loans :- • Loans against FD / IVP / KVP / LIC Policies • Gold Loans

5. CC/OD Limits – • Limit based accounts mainly given for Business purposes. ( mostly to meet the Working Capital Gap ). • A/c having continuous operations. The Borrower utilizes the limit as & when required & is charged for the amount utilized. • No Fixed EMI or monthly repayment for this advance. • Borrower expected to route all his business turnover through this account only, except otherwise permitted. • Credits in the account should be sufficient enough to at least cover the Interest debited monthly.

6. CC/OD Accounts :- • The Bank fixes the Drawing Power periodically (mostly monthly) for the a/c based on the stock / book debt statement submitted by the borrower. • Bank to review the operations in the account periodically (mostly quarterly) • For larger limit accounts, quarterly QIS Statements to be submitted by the borrower to the Bank. • They are subject to regular inspection as also yearly Stock Audit, if limit of Rs. 5 Crore & above.

7. Drawing Power – • It is common term associated mainly with CC / OD accounts. • DP is fixed by the Branch each month based on the Stock Statement /Debtors & Creditors Statements submitted by the borrower. • DP signifies the amount of the limit sanctioned up to which the borrower can withdraw from the CC account, i.e., • The Auditor has to verify whether DP has been properly calculated & fed into the System . • Whether stock statement submitted at quarter end is verified and certified by CA as stipulated in case of large limits ?

8. Drawing Power – • Drawing Power = Stock at Cost or Market Price whichever is lower + Sundry Debtors less than 90 days ( or as stipulated in sanction letter ) Less ( Sundry Creditors for stock & Expenses + Advances received against Orders ) Less Margin ( 25% or 30% as stipulated ) • Whether obsolete /non moving stock has been identified and classified separately. Such stock is to be valued at discounted price. • Whether stock against Packing Credit is segregated and valued separately. If not, the amount of Packing Credit is to be reduced for the purpose of arriving at the DP. • Whether any TOD granted beyond allowable DP ? If yes, whether ratification from higher authorities obtained. ? • Whether Penal Interest of 2% is being charged for amount drawn beyond DP ?

9. Temporary Overdraft (TOD) – • In case of business exigency, Branch Manager can sanction TOD or Temporary Overdraft to the borrower, over and above the Limit sanctioned, for a shorter period of 30-90 days. • Bank charges additional interest for the amount sanctioned as TOD. If the TOD is not repaid within stipulated period, penal interest is charged. • For limits sanctioned by the higher authorities, ratification from higher authorities for the TOD needs to be obtained. • If TOD is overdue beyond 90 days, the account would become NPA. • Proper documents need to be obtained for the TOD limit granted. Appropriate additional security needs to be taken if security already obtained for Principal Limits is not sufficient. • Processing fees and documentation charges need to be recovered.

10. Unsecured/Other Advances – • Unsecured Loans – Includes clean overdrafts, loans against personal security, clean bills or hundys purchased or discounted, cheques purchased and drawals allowed against cheques sent for collection. However, following shall not be considered as Unsecured Advances – • Advances backed by guarantee of Central Govt., State Govt., DICGC, FIs, Banks, etc. • Advances against supply bills drawn on Central / State Govt. or State Govt. Undertakings which are accompanied by receipted challans or duly authorized Inspection Notes, • Advances against trust receipts,( In an arrangement involving a trust receipt, the bank remains the owner of the merchandise, but the buyer is allowed to hold the merchandise in trust for the bank, for manufacturing or sales purposes.) • Advances against D/A Bills ( whether under L/C or not ) with usance not exceeding 90 days

11. Other Advances – • Advances against inland D/A Bills drawn under letter of credit • Advances against supply bills drawn on private parties of repute and receipted challans of Public Ltd. Cos. & parties of repute and not outstanding for more than 90 days • Advances against book debts outstanding for not more than 90 days • Advances against Cheques issued by Govt., public corporation & local self govt. • Advances in the form of Packing Credit for exports • Demand Drafts purchased • Advances against legal assignment of contract money due or to become due

12. Finance to Builders/Developers – • No fund based/non fund based facilities can be granted to builders/contractors for acquisition of Land. • If Land is accepted as collateral, valuation of such land has to be on current market price only and as per discounted value of property after development. • If any advance is granted to builders/developers against a Housing Project, the builder is required to enter into “Tri-party” agreement with the Buyer of flat & Bank. He has to repay proportionate amount of loan to get the flat released so that the customer may be able to mortgage the flat with his bank for housing loan. • The builder/developer is required to disclose prominently the fact of loans obtained against the Housing Project on any signboards of the Project as also on all the literature relating to the project.

13. Bills Discounting – • While verifying the Bills Purchased / Discounted /Negotiated under L/Cs or otherwise :- • The auditor to verify whether the bills represent genuine trade transactions, • Bills of Exchange are not drawn “without recourse” or Letter of Credits are not issued with the legend “without recourse” • Accommodation bills are not discounted • Proper record of all the bills discounted is maintained at the branch. • Bills issued by service companies are not discounted unless they are supported by proof of actual services rendered. • Bills discounted are not appearing as Debtors in the Book Debt Statement submitted to the bank for calculating Drawing Power, • Bills discounted by NBFCs are not rediscounted unless they relate to sale of commercial vehicles or 2/3 wheelers.

14. Bank Guarantees - • Guarantees should normally not be issued for a period beyond 10 years. • Guarantees may be (1) Finance Guarantees & (2) Performance Guarantees. Definition of the two terms are likely to be different in different banks. • Auditor to ensure that proper appraisal of the request for Bank Guarantee Limit has been done by the branch as in case of any other credit facility & adequate security has been obtained before sanctioning any B/G Limit to the borrower. Appropriate margin is obtained as per sanction terms when issuing a guarantee under sanctioned limit.

15. Bank Guarantees - • In case no limit is sanctioned to the borrower, 100% security is obtained, preferably cash security (FDR ) while issuing the B/G. • B/G forms should have been serially numbered and guarantee above a certain threshold should have been signed by 2 signatories of the bank. • To ensure that appropriate B/G commission has been collected apart from B/G issuing charges. Commission should also be charged for grace period for claim, if any. • Once due date of guarantee is over, sufficient notice, at least of 30 days, is issued to the beneficiary before reversing the liability of the Bank in it’s books. However, the security should not be released until the original guarantee bond is returned to the branch.

16. Letter of Credit – • Letter of Credit should be issued on security forms only. • L/C facility should normally be sanctioned to the customers enjoying other credit facilities with the bank, and only after obtaining appropriate security. • If L/Cs are opened for purchase of capital goods, the bank must ensure that the borrower has made arrangement of long term funds for meeting the liability under the L/C. • In no case working capital funds be allowed to be utilized to make payments under the L/C for Capital Goods. • Before opening the L/C for purchase of raw materials, the branch should ensure the borrower has made arrangements for retiring the L/C on due date from out of own funds or existing working capital facilities. • If L/Cs are opened for purchase of raw materials on D/A basis, the credit on the relative purchase is reduced for the purpose of working out the Drawing Power.

17. Co-acceptance of Bills :- • To ensure that co-acceptance facility is given to only those customers enjoying other credit facilities with the bank. • Only genuine trade bills should be co-accepted and it is to be ensured that the borrower has received the stock represented by the bills. • To ensure that goods represented by the bills are not over valued. • No accommodation bills should ever be co-accepted. • Proper record of bills co-accepted must be maintained by the branches and appropriate charges are collected from the borrowers for bills co-accepted. • Proper periodical returns of bills co-accepted are filed with controlling authorities.

18. End use of Funds - • End use of funds can be verified by way of :- • Meaningful scrutiny of quarterly progress reports /operating statements / balance sheets of borrowers • Regular inspection of borrowers’ assets charged to lenders as security. • Periodic scrutiny of borrowers’ books of accounts and no – lien accounts maintained with other banks • Periodic visits to the assisted units • System of periodic stock audits, in case of working capital finance • System of comprehensive Credit Audit or Credit Appraisal of large borrowers

19. Diversion of Funds – • Diversion would be construed to include any one of the following occurrences :- • Diversion of short term funds for long term purposes in violation of terms of sanction • Deploying borrowed funds for purposes/activities or creation of assets other than those for which the funds are sanctioned • Transferring funds to subsidiaries / group companies or other corporates by whatever modalities • Routing of funds through any other bank other than the lender bank or member of consortium without prior permission of the lender, • Investment in other companies by way of acquiring equities/debt instruments without approval of lenders. • Shortfall in deployment of funds vis-à-vis the amounts disbursed / drawn & the difference not being accounted for.

20. Audit Procedure – • Procedure of verification would be either “ONSITE” or “OFF SITE” –

21. Audit Procedure -

22. Before commencement of Audit – • Following documents to be verified - • BOOKS OF INSTRUCTIONS - Rules regarding Operations & Functioning • MANUAL OF DOCUMENTATION - Advances & Deposits. • LOAN POLICY - Objectives & Stipulations for each financial year. • MANAGER’S DISCRETIONARY LENDING POWERS • INTEREST RATES AND OTHER SERVICE CHARGES - Revenue Aspect. • CIRCULARS - Amendments & Highlights.

23. Scope of Audit/Verification – • Application : KYC Norms • Appraisal • Pre-sanction • Documentation • Disbursement • Post –sanction Unit inspection • Review & Renewal, etc.,

24. Application : KYC Norms - • Loan Application given by Applicant duly filled in with all required details. • KYC of the Borrower depending upon the status of the borrower – Ex.

25. CREDIT APPRAISAL – • Appraisal of Proposal : • Purpose of the Loan • Business of the applicant • Existing unit – its functioning • Financial viability – Assessment of Repayment capacity • All Primary and Collateral Securities • Compliance of RBI Guidelines : - • Due Diligence Certificate / Report • CIBIL and RBI Defaulters List. • Whether applicant is a “relative” of any Director or Senior Officer of the Bank. • Evaluation of Maximum Permissible Bank Finance (MPBF) • Appraisal made by authority as per Delegated Financial Powers (DFP). • Valuation of Prime and Collateral Securities.

26. CREDIT APPRAISAL – Issues • Loan Application not on record at Branch or not in the form prescribed by Head Office. • The Application Form was not filled up correctly and thereby the Appraisal and Assessment was not done properly. • The Bank did not receive certain necessary documents and Annexures required with the Application Form, e.g. Basic KYC documents • Certain adverse features of the borrower not incorporated in the appraisal note forwarded to the management. • The required licenses, permits, approvals to carry out the activity for which the financial assistance is sought for, are not obtained. • Prescribed margin not maintained for primary and collateral securities • Credit report, NOC, No dues certificate etc are not obtained, wherever applicable.

27. CREDIT APPRAISAL – Issues • The Branch has not obtained copies of competitive quotations/estimates in respect of finance for acquisition of fixed assets/plant and machinery / vehicles etc. • The past financial statements including audited statements wherever applicable and estimated/projected financial statements are not obtained, verified and analyzed. • Verify the Manager’s Discretionary Powers to ascertain whether the amount of advance falls under his/her Lending powers. If not whether ratification from HIGHER AUTHORITIES is obtained. • All terms and conditions of sanction order by the branch/RO/HO are properly complied with. CA Certificate is obtained wherever necessary, e.g. in case of fresh Capital infusion, non withdrawal of unsecured loans, etc. & is on record. • Classification of advances is done correctly, e.g. Priority/non-Priority.

28. CREDIT APPRAISAL – Issues • Industry / group exposure and past experience of the Bank is not dealt in the appraisal note sent to the management for sanction. • Techno-economic feasibility report, which is required to know the technical aspects of the borrower’s business, is not obtained from Technical Cell. • Credit Report on Principal borrowers and confidential reports from their banks are not insisted from the borrowers. • The opinion reports of the associate and/or sister concerns of the borrower are not scrutinized / called for / not updated / not satisfactory. • Appraisal note, internal credit rating, etc. are not prepared and filed. Independent Credit Rating, e.g. from CRISIL, CARE, ICRA, etc. is not obtained in case of large advances or is not on record.

29. Pre-sanction……………………Sanction In this stage, Branch performs following functions – • Preliminary Inspection of the Business unit or Securities offered by the Borrower. • Inspecting the Titles of the securities offered particularly immovable properties. • Preparing Visit Reports after such inspection stating reasons for either recommending to “SANCTION OR REJECT “ the request for credit facilities. • Auditor to peruse the Inspection/Visit Reports so as to ascertain any adverse features observed during the Inspection and how the same have been dealt with in the Appraisal Note.

30. DOCUMENTATION • Documentation deals with preparation of various documents and execution thereof before the Disbursement of the Loan sanctioned. • The various documents to be obtained would be enlisted in the Manual of Documentation. • The Complete set of all documents signed by the Borrower and Guarantors before the Officials should be kept securely in a separate file. • Such Documentation in respect of Advances above threshold limit needs to be verified by Panel Lawyer and Certificate thereof to be kept on record. • Loan application register is maintained and disbursal details are recorded.

31. DOCUMENTATION – Issues • The details of security against which the advance was sanctioned was not available / was not on record. • Mortgage for the property given as security is not created. • Mortgage for the property given as security created, but is inadequate as compared to terms of sanction. • Second charge, as required, on assets is not created in favour of the Bank. NOC from Bank having First Charge not obtained. • Documents of second charge on assets is not on record. • Documents pertaining to registration of charges with ROC, CERSAI or any other concerned authority are not on record. • Original Title Documents of properties mortgaged under Equitable Mortgage not obtained / not on record.

32. DOCUMENTATION - Issues • Authority Letter / Power of Attorney of the Bank to collect the original documents from the Sub – Registrar not on record. • Inter-se Agreement pertaining to Consortium Advances not yet executed / not available with Bank. • Documents signed by persons not duly authorized to sign or who have signed in other capacity accepted by the Bank. • Guarantee Bonds not on record, not renewed, not assigned. Further, Net Worth of Guarantors not available. • Signatures of the executants were not on all the pages of the documents. • Some of the documents on record were blank, without signatures of Branch Manager, witnesses or guarantors, etc. • Copies evidencing creation of Bank’s charge in the record of concerned Govt. Authorities, e. g. on 7/12 extract in case of Land. • Stamping of documents not as per the amended Stamps Act.

33. DOCUMENTATION - Issues • Revival letters in respect of documents to be reviewed not received from the borrowers . Acknowledgement of Debt not on record. • Documents have become mutilated, soiled, time barred or not obtained. • Report by the field officer/agency appointed to verify the credentials of the borrower not on record. • Charge on main and / or collateral securities not created in terms of sanction letter. • Chain documents for securities offered such as sale deed / lease deed / title deed / agreement of sale not available on record. • TDR are not discharged or renewed. Lien not noted in system. • Assignment not done in case of LIC Policies / NSCs.

34. DOCUMENTATION - Issues • “Nil Encumbrance Certificate/s” or “No Dues Certificate/s” or “No Lien Letters” not obtained for the mortgage/s. • Advances for Vehicle Loans - Registration Certificate, Transfer Forms, vehicle inspection report, etc. not obtained. • Completion Certificate, Possession Letter, Share Certificates in Societies etc. not on record for housing loans. • Documents are not duly attested/signed by concerned officials. • The agreements for hypothecation do not contain details of goods hypothecated. • Copy of bills / receipts, on the basis of which amount was disbursed not found on record. For example Vehicle Loans, Plat & Machinery.

35. DOCUMENTATION - Issues • Control Returns not sent to HO. The branch has not taken any action for non compliance of terms of sanction. • No documents executed for enhancement of limit. Application for TOD not on record. • ECGC cover not obtained in case of Export Finance. • In case of takeover of loans from other banks, their confidential status report on borrower not obtained. • Common seal not affixed on Letter of Comfort in case of companies. • Confirmed orders for export credit not found on record for facilities sanctioned.

36. DISBURSEMENT • To verify the compliance of all terms & conditions of sanction. • After all the Compliance enlisted above have been done, Loanamount is disbursed to the borrower. In case of pending compliances, undertaking is obtained from the borrower for it’s early compliance. • Disbursement of the loan should not be done directly to the account of the borrower or DD/Payslip should not be handed over to the borrower, e. g. Disbursement of Vehicle Loan/Housing Loan should be made directly to the Dealer of the Vehicle / Builder. • Whether all securities are received by the Branch. • Whether charge has been registered on the Securities as per Terms of Sanction. • Legal Report for title of securities. • Valuation Report of Securities. • Credit facility should be released after execution of all required documents.

37. DISBURSEMENT -Issues • Credit facility disbursed beyond the delegated authority or limit of the branch. • Certain proposals were sanctioned pending approval of higher authorities wherever required. • Ad-hoc limits were granted for which sanctions were pending since long. • Facilities were disbursed before completion of documentation or without following sanction terms. • Facilities were disbursed without any sanction. • Sanction letter is not on record. Sanction Terms not accepted by the borrower. • CIBIL Report not obtained & not scrutinized.

38. DISBURSEMENT –Issues • Guarantor as mentioned in the sanction letter not obtained. • Required promoters stake not invested before disbursement of loan. • Disbursement made without proper appraisal. • Charge not created on securities before disbursement as required by sanction letter /renewal letter. • Sanction terms were not complied with or were not recorded. • Disbursement made without proper sanction. • Term Loan disbursed by crediting cash credit or saving account of the borrower.

39. Post Disbursement Verification of Advances:- • Utilisation of Limit, Adequate Turnover, Submission of Periodical Stock/Debtor statements, Unit inspection, Audited financial statements after year end (in case of business accounts). • Whether position of each loan account is assessed at the end of the year & the borrower is informed of any irregularity in their a/cs. • In case of Overdues, if any, pending for longer period of time, notices for recovery are issued. • Examine the frequency of UNIT INSPECTION done by the branch & highlight any serious irregularities observed (Auditor to accompany br. officials for unit inspection of larger advances)

40. Post Disbursement Verification of Advances :- • Verify & comment on the recovery efforts done by the Branch in case of NPA accounts & Potential NPA accounts (SMA A/cs ), suit filed accounts, provisionally w/off accounts. • Examine periodically Insurance details of each loan & report on overdue policies or inadequate insurances. • Verify & report on the accounts that are due for Review / Renewal. • Check whether Acknowledgement of Debt (AOD) / Revival Letter (RL) has been obtained for all loans that are more than 36 months old. (Exception: Gold Loan & Loan against bank deposits). • Assessment of Quick Mortality cases.

41. Review/Renewal - • Procedure for Review / Renewal of Borrowal Accounts. • Proper procedure for Renewal – Analysis of Financial Statements - Any adverse features. • Reconciliation and Analysis of Audited Accounts of Borrower with QIS Reports and Projections. • Short Review should be avoided and regular Review/Renewal within specified periodicity. • Periodic Balance Confirmation of Debt. • Any adverse comments in the Stock Audit Report & how it is dealt.

42. Monitoring & Supervision – • Periodic Inspection / Physical Verification of Securities. • Recovery in accordance with Compromise Agreement. • Restructuring of Accounts. • Compliance of Prudential Norms for Income Recognition. • Suit filed cases – follow up. • NPA Reporting and Valuation of Securities thereof. • Irregularities in Accounts – Reclassification. • Recovery in W/off accounts.

43. Monitoring & Supervision – Issues • The account is frequently or continuously overdrawn and the branches have not taken sufficient steps to get the accounts regularized promptly. • The balance outstanding exceeds the drawing power frequently. • The stock, book-debts statements not received regularly/promptly. • The financial statements/audited statements/MIS/QIS/other operational data /AOD, etc., not received as stipulated. • The stock, book-debts statements, etc., not scrutinized and no suitable action is taken for deficiencies. • Non – moving stock is not deducted to arrive at the drawing power.

44. Monitoring & Supervision – Issues • The age –wise break–up of debtors is not found on record& the borrowers are allowed to draw money on entire outstanding debt. • Serious discrepancies observed in stock as per the stock statements at year end & stock figures in the annual audited financial statements. • No penal interest has been charged for delay in submission of various statements as per the terms of sanction depending upon the type of loan/ credit availed by the borrower. • End – use of funds not ensured/ not known. Funds utilized for purpose other than for which granted. • The valuation report in respect of tangible security from government approved valuer have not been obtained, or is more than 2 years old.

45. REVIEW / MONITORING / SUPERVISION – Issues • Application of wrong rate of interest, processing charges, commission, other charges, etc. resulting in income leakage/ excess booking of interest/charges by the Bank. • Insurance cover for stock / property is inadequate / not on record / not renewed / not endorsed in favour of the Bank. • Inspection / physical verification of security charged not being carried out. • The projections submitted by the borrower stay far beyond the actual performance. Further, no explanation for the same is taken from the borrower. • Major sale proceeds of the borrower not routed through the Bank. • Packing Credit is outstanding & Export Proceeds are credited toC/C.

46. REVIEW / MONITORING / SUPERVISION – Issues • Confirmation as to genuineness of export transactions not obtained from Bank’s foreign offices / correspondents / customs department. • Import credit bill of entry evidencing import of goods not on record. • Documents are not obtained for bills discounted under Letter of Credit. • Guarantees, Opinion Reports, Financial statements, IT assessment orders, etc. of guarantors are not on record. • Though government guaranteed accounts are irregular since long, the issue of invocation of guarantee is not considered.

47. REVIEW / MONITORING / SUPERVISION – Issues • Signboard of the bank is not displayed in godown where pledged / hypothecated stock is stored. • Valuation of stock is done on selling price rather than on cost or market price whichever is lower. • Limit not fully utilized by the borrower. Commitment charge not levied for the limit not utilized by the borrower. • TDR/STDR, which is matured, is neither renewed nor credited to loan a/c for which it is under lien. • No audit conducted for borrower having limit more than Rs. 10 Lacs. • The party is dealing with other bank for which permission is not obtained.

48. REVIEW / MONITORING / SUPERVISION – Issues • Regular meetings not held with other consortium members to review the performance of borrowers and to assess the current state of affairs. • Individual members of the consortium are not advised about the quarterly operating limits / D. P. allocated to each one of them. • Minutes of the consortium meetings not found on record. • Inspection report from the consortium members not obtained. Stock Audit Reports not obtained. • The capital of the borrower has eroded / net worth is negative / decreasing. Close monitoring not being done.

49. REVIEW / MONITORING / SUPERVISION – Issues • The account was overdue for repayment and / or no credit was received from the borrower for a long time. • The borrower is absconding or deceased and legal formalities are incomplete or there is willful default from the borrower. • Subsidy claim process was incomplete or subsidy was yet to be received and needs follow – up. • Security disposed of/ Entity closed by borrower and no action taken by the branch. • Irregularities not informed to controlling office / not contained in returns filed to controlling office. • Renewal proposals of advances not received on time and in many cases the limits are not renewed.

50. REVIEW / MONITORING / SUPERVISION - Issues • For Small Government Sponsored loan accounts, security cover could not be ascertained since neither any record is available nor physical verification conducted by the branch. • Joint inspection with auditors not arranged. • Heavy cash withdrawal for which consent of Guarantors is not taken. • Security obtained is inadequate/ lower as compared to amount of outstanding/ no collateral security. • Letter of subordination of deposits not taken. Pledge confirmation for shares not obtained from depository. • Secured and unsecured portion not segregated properly in advance return of the branch.