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AUDIT OF ADVANCES

IN
BANK BRANCHES

Presentation By:

CA KAUSHIK C PATEL
Manubhai & Co.

INDEX
 Background
 Balance sheet disclosure
 Reporting requirement under LFAR
 Commonly used terms
 Operational aspects
 Income Recognition, Asset Classification, Provisioning

and Other Related Matters


 Prudential Guidelines on Restructuring of Advances
by Banks
 Audit Approach and Procedures

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BACKGROUND
PRELIMINARY :
 Lending constitutes major activity of the bank
 Advances generally constitute the largest item of the assets
 Major source of income
 RBI closely regulates the lending activity of banks
 Advances constitutes one of the major areas of verification

for the auditors


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BACKGROUND
CHALLENGES IN AUDIT OF ADVANCES:
 Specialized Branches
 System of Base rate
 Lending to Infrastructure Project
 Core Banking Solution (CBS) Computer generated statements
 Increase in default in repayment and restructuring
 Inadequate competent staff
 Doubtful integrity of staff and borrower
 Time Constraints to complete Audit
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BACKGROUND
 AREAS OF CONCERN

System generated statements


 All accounts not covered in auto NPA system
 System classifies PA to NPA and NPA to PA wrongly
 Interest charging on NPA accounts
 Reversal of interest not done properly where accounts down graded
 Apply wrong % of provision on NPA

 Temporary deficiencies
 Accounts regularize near balance sheet
 Assets classification when delay in approval of restructuring package
 Income recognition in case of FITL
 Accounts reported in special watch list report
 Computation of Drawing Power.
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BACKGROUND
FRAUD- A MAJOR AREA OF CONCERN
By Bank
 Sanction without proper documents and/or without approval of appropriate

authority
 Improper valuation of securities especially in NPA accounts
 Window dressing particularly at the year end Inflating figure of deposits

and advances
 Allowing withdrawals / disbursement in excess of available limit
 Wrong classification of advances
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BACKGROUND
FRAUD- A MAJOR AREA OF CONCERN
Against Bank
 Availing facility on the basis of forged documents / Unrealistic projections
 Offering securities in favour of more than one bank
 Diversion of funds
 Fake Purchase bills / Transport documents
 Discounting of Accommodation Bills
 Inflating value of stock / book debts

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BALANCE SHEET DISCLOSURE

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Balance sheet disclosure


Legal Requirement
 The Third Schedule to the Banking Regulation Act,

1949 requires classification of advances from three


different angles viz. nature of advance, nature and
extent of security and place of making advance (i.e. in
India or outside India)
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Balance sheet disclosure


A. Classification based on Nature of advance



Bills Purchased and Discounted


Cash Credit, Overdraft and Loans Repayable on
Demand
Term Loans

B. Classification based On Nature and extent of


securities



Advance Secured by Tangible Assets


Covered by bank / Government guarantee, DICGC
and ECGC
Unsecured
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Balance sheet disclosure


C. Place of making advance


Advances In India:
 Priority Sectors
 Public Sectors
 Banks
 Others
Advance Outside India:
 Due from Banks
 Due from Others
 Bills Purchased and discounted
 Syndicated Loans
 Others
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REPORTING REQUIREMENT UNDER LFAR

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LFAR
Credit Appraisal
Commenting on compliance with the procedures/instructions of the
controlling authorities of the Bank regarding loan applications, preparation
of proposals for grant/renewal of advances, enhancement of limits, etc.

Sanctioning/Disbursement
 Commenting on sanction beyond delegated authority or limit fixed for

the branch.
 Disbursement without complying with the terms and conditions of the
sanction.

Documentation
 Credit facilities released without execution of all the necessary

documents.
 Deficiencies in documentation, non-registration of charges, nonobtaining of guarantees, etc.
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LFAR
Review/Monitoring/Supervision
 Following up procedure laid down by the controlling authorities of the

Bank, for periodic review of advances including periodic balance


confirmation / acknowledgement of debts.
 Receipt of stock/book debt statements and other periodic operational
data and financial statements etc.
 Obtaining Audit Report in cases of advances to non-corporate entities

with limits beyond Rs.20 lacs under the RBI guidelines with regard to
compulsory audit or under any other statute.
 Inspection or physical verification of securities charged to the Bank as

per the procedure laid down by the controlling authorities of the Bank.
 Deficiencies in value of securities and inspection thereof or any other

adverse features such as frequent/unauthorised overdrawing beyond


limits, inadequate insurance coverage, etc.
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LFAR
Review/Monitoring/Supervision


Recovery of credit card dues.

Identification and classification of advances into standard / sub-standard /


doubtful / loss assets in line with the norms prescribed by the Reserve Bank of
India.

Commenting on obtaining valuation reports from approved valuers for the fixed
assets charged to the bank, once in three years in case of NPA accounts.

Compliance with the Recovery Policy prescribed by the controlling authorities


of the bank with respect to compromise/settlement and write off cases.

List the major deficiencies in credit review, monitoring and supervision.

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LFAR
Guarantees and Letters of Credit
 Details of outstanding amounts of guarantees invoked and funded by
the Branch to be given in prescribed format.


Details of the outstanding amounts of LCs and co-acceptances funded


by the Branch at the end of the year may be reported in the prescribed
format.

Additional Reporting Requirement for branches dealing in very


large advances such as corporate banking branches and industrial
finance branches or branches with advances in excess of Rs.100
crores.
Additional Reporting Requirement for branches dealing in recovery
of Non Performing Assets such as Asset Recovery Branches.

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COMMONLY USED TERMS

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Commonly used terms


 Demand loan : An advance of fixed amount repayable on

demand
 Bills purchased and discounted: Bills Purchased refers

to the demand bills and cheques whereas bills discounted


refer to usance (time) bills.
 Funded and non funded credit facilities
 Funded Credit Facilities - actual fund transfers from the

bank to the borrower. Eg. Term loan, cash credit,


overdraft etc.
 Non Funded Credit Facilities - do not involve the transfer
of the fund. Eg. Bank Guarantee, Letter of Credit etc.
Manubhai & Co.

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Commonly used terms


 Primary and collateral securities:
 Primary security refers to the security acquired by the borrower

with bank finance. Principal security for an advance


 Collateral Security is an additional security which provides
cushion to the bank in case of need.

 Personal security of guarantor:


 The guarantee by the third party for the payment of the

outstanding in the event of the default made by the borrower.


No charge is created on guarantors movable and immovable
assets.

 Fixed and floating charge:


 Fixed Charge (Specific Charge) charge on some specific and

ascertained assets.
 Floating Charge is an equitable charge on the assets, present as
well as future. A floating charge attaches to assets whose
condition varies from time to time in the ordinary course of
business e.g. WIP.
Manubhai & Co.

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Commonly used terms


 Gilt edged securities:
 Securities issued or guarantees by the Central or State Govt.
 Margin:
 Banks do not provide full value of credit. A Suitable amount,
depending upon the risk perception of the bank, is deducted
from the value of the charged assets to take care of any
downward fluctuations in the market value of the assets is
called Margin.
 Insurance of banks deposits and loans:
 The bank may obtain insurance for its deposits and advances
from the Deposit Insurance Credit Guarantee Corporation
(DICGC)
 Export Credit Guarantee Corporation (ECGC) guarantees the
export credit
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System of base rate


 Banks to switch over from benchmark prime lending rate (BPLR)






system to the Base Rate with effect from July 01, 2010.
All categories of loans to be priced only with reference to the
Base Rate except (i) Differential Rate of Interest (DRI) Advance
(ii) loans to banks employee (iii) loans to banks depositors
against their own deposits.
Base rate is minimum rate for all loans, banks are not permitted
to resort to any lending below the base rate.
Banks are required to review the base rate at least once in a
quarter
Base rate system applicable for all new loans and for those old
loans that come up for renewal. In case existing borrowers want
to switch to the new system, before expiry of the existing
contracts, an option may be given to them on mutually agreed
terms.
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Prudential exposure limits


 RBI time to time prescribes limits or bank may also fix

internal limits on exposure to:

Single and group borrower


Sector limit
Lending to NBFCs
Lending under Consortium Arrangement
Bills purchased / discounted under Letter of credit
 Not under reserve exposure limit on bank
 Under reserve exposure limit on borrower
 Lending for real estate
 Lending for establishing SEZs
 Equipment leasing, Hire Purchase and Factoring services






 Exemptions from Exposure Norms








Rehabilitation of sick / weak industrial units


Food credit
Guarantee by government of India
Loans against own term deposits
Exposure on NABARD. Manubhai & Co.

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Nature of advance
 Cash credit:
 Facility provided for working capital requirement .
 Repayable on demand .
 Facility provided against security of stock of goods, standing crops, bills

/ book debts representing genuine sales.


 Most common form of collateral security are immovable properties,

movable fixed assets, deposits receipts etc.

 Overdrafts:
 Overdraft facility is granted to Current Account holders.
 No repayment schedule
 Secured or clean
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Nature of advance
 Loans:
 Loans with repayment periods beyond 36 months are

called term loans whereas repayment period of up to 36


months are called demand loans.
 Both loans are similar in many respects: such as

predetermined repayment schedule, disbursal by way of


limited number of debits.
 Basic difference between the two is that term loans are for

acquisitions of capital assets which then become the


security for the loan i.e. end use of funds is fixed. The
demand loans are granted against the existing securities
e.g. term deposits, gold and shares.
Manubhai & Co.

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Nature of advance
 Bills:
 Cash credit finance pre sales stage and finance against bills post

sales stage.
 The finance against bills can be in any of the below mentioned form:




Purchase of bills if payable on demand


Discounting of bills if usance or time bill
Advance against bills under collection from drawees

 A unique kind of facility advance against bills drawn on public sector

undertakings / government department which do not accept bills. In


such cases, pre-receipted challans are submitted by the borrower to
the bank as an evidence for availing finance. This facility known as
government bills facility.
 Purchase / discount bills may be under letter of credit.
 Bills may be documentary i.e. accompanies by the original documents
of title to the goods or clean i.e. without the original documents
 Documentary bills bank releases the documents of title to the
drawee only against payment if demand bill purchased or against
acceptance usance bills discounted
Manubhai & Co.

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Nature of advance
 Export credit
 Exporters granted facilities in form of cash credit and bills but termed as pre-

shipment credit and post shipment credit.


 Pre-shipment credit, advance required to finance the production cycle. The

advance is given either on the basis of individual order obtained or customer is


sanctioned an export packing credit limit.
 The exporter usually adjusts the account by drawing bills of exchange on the

foreign buyer, which are discounted by the bank under the letter of credit and
the proceeds collected from foreign bank.
 Pre-shipment credit has to be liquidated out of export proceeds only and can

not be adjusted out of rupee funds.


 Post shipment credit relates to financing of bills raised on overseas buyer upon

shipment of goods / services.


 The export proceeds to be received within 180 days from the date of shipment.

The period can be extended in genuine case.


 Pre-shipment credit granted in a foreign currency is called Packing Credit in

Foreign Currency
Manubhai & Co.

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Security : Mode of Creation of Security


 Mortgage:

English Mortgage: can be affected by a registered instrument


called Mortgage deed. It conveys the property to the mortgagee
as a security
 Equitable Mortgage: is effected by a mere delivery of title deeds
or other documents
 Pledge:
 Bailment or delivery of the goods by the borrower to the lending
bank with intention to create the charge thereon as security for the
advance.
 Hypothecation:
 The term refers to creation of an equitable charge which is created
in favour of the lending bank by execution of hypothecation
agreement in respect of movable securities belonging to the
borrower.


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Security : Mode of Creation of Security


 Assignment:
 Assignment represents a transfer of an existing or future debt, right

or property belonging to one person in favour of another


person.Only actionable claims such as book debts and life insurance
policies are accepted as security by way of assignment.
 Set off:
 The right of the set off enables the bank to combine two accounts
viz., a loan account and a deposit account, of the same person
provided both the accounts are of the same name and in the same
right.
 Stock exchange securities and other instruments
 Securities include shares, debentures, bonds, NSC, IVP, KVP.
 Securities usually in the possession of the bank.
 Banks are required to have them transferred in their own names

if the loan amount exceeds the ceiling prescribed by RBI.


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Security : Types of securities


 Goods
 May be hypothecated or pledged.
 In case of hypothecation of goods, banks obtain periodic statements
from the borrowers declaring quantity and value of goods on the
basis of which drawing power is fixed.
 Gold ornaments
 Life insurance policies
 To be assigned in favour of the bank.
 Such assignment has to be registered with the insurer.
 Surrender value of the policies is taken as the basis of valuation.
 Banks own deposits
 Immovable property
 Third party guarantee
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Security : Types of securities


 Banks general lien:
 A lien represents the right of retaining the goods / securities unless

a debt due by a debtor is paid to the creditor provided there is no


agreement, express or implied to the contrary. Example of
securities over which a banker has general lien are credit balance in
any other account, bonds and coupons deposited for collection etc.
 Negative lien:
 Negative Lien is commonly used to refer to an undertaking given by

the borrower to the bank that borrower will not create any charge
such as lien, pledge, hypothecation or mortgage over his immovable
and movable properties.

Manubhai & Co.

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Nature of borrowing arrangements


 Sole banking: Lending by Single Bank.
 Consortium Arrangement: Number of lending bank is more than

one
 Multiple Banking:
 No formal arrangement amongst the lending banks.
 Each of them has its set of loan documents, securities and mode of
lending, independent of other lending banks.
 Loan Syndication
 Inter bank participation certificates:
 Besides consortium lending, banks enter into arrangements with
other banks under inter - bank participation schemes.
 Two types (1) participation on risk sharing basis (2) participation
on non risk sharing basis
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OPERATIONAL ASPECTS

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Procedure : Sanction
 Receipt of request from the applicant supported by

documents
 Important documents such as:
 Financial statements
 Project report
 Particulars of associate concerns, promoters
 Particulars of proposed collateral security
 Resolutions etc.
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Procedure : Assessment of credit worthiness of borrower


 Evaluation in the context of RBI directions including prudential







exposure limits and banks own risk management guidelines


(including credit rating by bank and/or outside agency)
Appraisal to ensure technical feasible, economically viable and
commercially acceptable.
Preparation of detailed appraisal note and submission of the same
with supporting documents along with its recommendations to
appropriate sanctioning authority (Official,/ Committee)
Communication of sanction along with detailed terms and
conditions of the sanction to the branch.
Responsibility of branch to complete the formalities
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Procedure : Disbursement
 Obtains the consent from the applicant for the arrangement.
 Documents as prescribed in terms and conditions of sanctioned letter related to
execution of agreements, resolutions, creation and registration of charge, valuation
of security, guarantee etc. obtained
 Other pre-disbursement conditions compliance
 To achieve current ratio
 To introduce new capital

 Obtains legal report for documents executed


 Release of advance as per the sanction
 Term loans disbursed on the basis of quotations / proforma invoices obtained
by borrower for new assets and there may be instances where, borrower has
already purchased the assets and submits documentary evidence to the branch
and seeks reimbursement to the extent permissible.
 Cash credit advances released on the basis of stock statements and book debts
 Branch officials verify the statements and calculate the drawing power
 Packing credit disbursed on the basis of orders received for supply of goods
 Bills facility disbursed on the basis of invoice for goods supplied

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Procedure : Monitoring and supervision


 Report on inspection of borrowers assets and books
 Ensuring end use of disbursement and no diversion of fund

such as investment in associates concern, declaration of


dividend, acquisition of assets without knowledge of banks
etc.
 Cross checking figures declared in stock statement with

book maintained
 Periodic review of progress in implementation of project
 Obtaining and scrutiny of stock and book debt statement

for DP limit. Not to consider older stock and debts


 Comparison of data with projects, units performance
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Procedure : Renewal of advances


 Normally Working Capital Advances requires renewal if

the borrower wants its continuation.


 Loans repayable over a period of time are normally not

renewable.

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INCOME RECOGNITION, ASSET CLASSIFICATION,


PROVISIONING AND OTHER RELATED MATTERS

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Income Recognition, Asset Classification,


Provisioning and Other Related Matters:
Definitions
 Non performing Assets
 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 90days in respect of a term loan,
the account remains out of order in respect of an
Overdraft/Cash Credit (OD/CC),
the bill remains overdue for a period of more than 90 days in the
case of bills purchased and discounted,

 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.
Manubhai & Co.

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Income Recognition, Asset Classification,


Provisioning and Other Related Matters:
Definitions
 Out of Order status
 If the outstanding balance remains continuously in excess
of the sanctioned limit / drawing power.
 Outstanding balance 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 credits are
not enough to cover the interest debited during the same
period, these accounts should be treated as 'out of order'.

 Overdue
 Any amount due to the bank under any credit facility is

overdue if it is not paid on the due date fixed by the bank.


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Income recognition
 Income Recognition Policy:
 Interest income on performing assets on accrual basis.
 Income on NPA on actual realization basis.
 Interest on advance against term deposits, NSCs, IVPs,

KVPs and Life Policies may be taken to income on due


date, provided adequate margin is available in the
accounts.
 Government guaranteed advance become NPA, the

interest on such advances should not be taken to income


unless interest has been real.
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Income recognition
 Reversal of income:
 If any advance becomes NPA, the interest accrued and credited

to income account in the past periods, should be reversed if


the same is not realized. This will apply to Government
guaranteed accounts also.

 Appropriation of recovery in NPAs:


 In the absence of a clear agreement between the bank and the

borrower for the purpose of appropriation of recoveries in


NPAs (i.e. towards principal or interest due), banks should
adopt an accounting principle and exercise the right of
appropriation of recoveries in a uniform and consistent
manner.
Manubhai & Co.

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Asset classification
 Four broad categories:
 Standard assets

does not disclose any problem

 Substandard assets
 Doubtful assets

 Loss assets

and carries more than normal


business risk
remained NPA for a period less
than or equal to 12 months
remained in sub standard
category for a period of 12
months
is one where loss has been
identified by bank, internal /
external auditor or RBI
inspection

Manubhai & Co.

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Asset classification
 Upgradation of loan accounts classified as NPAs:
 If arrears of interest and principal paid by the borrower in NPA
loan accounts, the account may be classified as standard
accounts.
 Advances under consortium arrangements:
 Asset classification should be based on the record of recovery
of the individual member banks
 Accounts where there is erosion in the value of

security/frauds committed by borrowers:


 Accounts

should not classify as per various stages of


classification.
 Realizable value is less than 50%, NPA considered as doubtful
assets.
 Realizable value if less than 10%, NPA considered as loss assets.
Manubhai & Co.

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Provisioning for loans and advances


 In conformity with the prudential norms, provisions should

be made on the non performing assets on the basis of


classification of assets into prescribed categories.
 Loss assets
 Should be written off.
 If loss assets are permitted to remain in the books for any

reason, 100 percent of the outstanding should be


provided for.
Manubhai & Co.

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Provisioning for loans and advances


 Doubtful assets
 Unsecured Portion : 100 %
 DICGC / ECGC cover to be taken into account
 CGTSI guaranteed advance. No provision to that extent
 Secured portion: provision may be made on the following





basis:
Up to 1 year (D1)
More than 1 year and up to 3 years (D2 & D3)
More than 3 years (>D3)
Valuation of security



25%
40%
100%

NPA Rs. 5 crores and above stock audit at annual interval by


external agency
Collaterals once in every three years
Manubhai & Co.

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Provisioning for loans and advances


 Substandard assets
 A general provision of 15 percent on total outstanding should be

made without making any allowance for ECGC guarantee cover and
securities available.
 The unsecured exposures which are identified as substandard
would attract additional provision of 10 per cent, i.e., a total of 25 per
cent on the outstanding balance.
 Unsecured exposure: An exposure where the realizable value of the
security, as assessed by the bank/approved valuers / Reserve Banks
inspecting officers, is not more than 10 percent, ab-initio, of the
outstanding exposure.
 Exposure shall include all funded and non-funded exposures.
 Security will mean tangible security properly discharged to the
bank and will not include intangible securities like guarantees
(including State government guarantees), comfort letters etc.
 Standard assets
 Banks make general provision for standard assets at Head Office
Manubhai & Co.

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Guidelines for Provisions under Special Circumstances


 Advances classified as doubtful and guaranteed by

ECGC, provision should be made only for the balance in


excess of the amount guaranteed by the Corporation.
 While arrive at the provision, realizable value of the

securities first be deducted then amount guaranteed by


the Corporation and then provision should be made.

Manubhai & Co.

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Guidelines for Provisions under Special Circumstances


 Provision made as illustrated hereunder:
Outstanding Balance

Rs. 4 lakhs

ECGC Cover

50 percent

Period for which the advance has remained doubtful

More than 2 years

Value of security held

Rs. 1.50 lakhs

 Provision required to be made


Outstanding balance

Rs. 4.00 lakhs

Less: Value of security held

Rs. 1.50 lakhs

Unrealized balance

Rs. 2.50 lakhs

Less: ECGC Cover (50% of unrealizable balance)

Rs. 1.25 lakhs

Net unsecured balance

Rs. 1.25 lakhs

Provision for unsecured portion of Advance

Rs. 1.25 lakhs (@ 100 %)

Provision for secured portion of advance of Rs. 1.5 Lakhs

Rs.0.60 lakhs (@ 40 %)

Total provision to be made

Rs.1.85 lakhs
Manubhai & Co.

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Guidelines for Provisions under Special Circumstances


 Advance guaranteed by Credit Guarantee Fund

Trust for Small Industries:


 Such advance becomes nonperforming, no provision

need be made towards the guaranteed portion. The


amount outstanding in excess of the guaranteed
portion should be provided for as per the extant
guidelines

on

provisioning

for

nonperforming

advances.
Manubhai & Co.

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Guidelines for Provisions under Special Circumstances


 Illustrative example is given below:
Outstanding Balance

Rs. 10 lakhs

CGTISI Cover

75% of the amount outstanding or 75% of the


unsecured amount or Rs.37.50 lakh, whichever is the least
More than 2 years

Period for which the advance has


remained doubtful
Value of security held

Rs. 1.50 lakhs

Provision required to be made


Balance outstanding
Less: Value of security
Unsecured amount
Less: CGTSI cover (75%)

Rs.10.00 lakh
Rs. 1.50 lakh
Rs. 8.50 lakh
Rs. 6.38 lakh

Net unsecured and uncovered portion:


Provision for Secured portion @ 40% of Rs.1.50 lakh
Provision for unsecured & uncovered portion @ 100% of Rs.2.12 lakh
Total provision required

Rs. 2.12 lakh


Rs.0.60 lakh
Rs.2.12 lakh
Rs.2.72 lakh

Manubhai & Co.

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Other related matters


Temporary Deficiencies
 Bank should not classify an advance account as NPA merely due to the

existence of some deficiencies which are temporary in nature such as


 Non availability of adequate drawing power based on latest available
stock statement
 Balance outstanding exceeding the limit temporarily
 Non submission of stock statements and non renewal of limits on due
date
 For classification of accounts with such deficiencies guideline given as under:
 Drawing in working capital accounts covered by adequacy of current
assets. Drawing power to arrive at based on current stock statement.
Current assets comprising stock, drawing power to be computed by
reduction of sundry creditors comprising of unpaid stock before
application of margin. In case of book debt which are current and within
stipulated period would be reckoned. Stock statement should not be
older than 3 months.
Manubhai & Co.

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Other related matters


Temporary Deficiencies
 Outstanding in the account based on drawing power

calculated from stock statement older than 3 months is


deemed as irregular
 Working capital borrowing account will become NPA if

such irregular drawings are permitted in the account for a


continuous period of 90 days.
 Regular and ad-hoc credit limits need to be reviewed /

regularized not later than 3 months from due date / date


of ad-hoc sanction. An account where regular / ad-hoc
limits have not been reviewed / renewed within 180 days
from due date / date of ad hoc sanction will be treated as
NPA.
Manubhai & Co.

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Regularization near about balance sheet


 Assets classification of borrower accounts where a few

credits are recorded before the balance sheet should be


handled with care.
 Account indicates inherent weakness on the basis of data

available, the account should be deemed as NPA.

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Assets classification to be borrower wise and


not facility wise
 All the facilities granted to a borrower to be treated as NPA and not

particular facility
 Debits arising out of development of LC or invoked guarantees are
parked in a separate account, balance outstanding in that account
should be treated as a part of borrowers principal account for
income recognition and assets classification norms
 Bills discounted under LC favoring a borrower may not be classified
as a NPA when other facility granted to the borrower is classified as
NPA.
 However, documents under LC not accepted on presentation or
paid under LC on due date by LC issuing bank and borrower
does not make good the amount disbursed as a result of
discounting of concerned bills, outstanding bills discounted will
immediately be classified as NPA with effect from the date when
other facilities classified as NPA.
Manubhai & Co.

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Government guaranteed advance


 Credit facility backed by guarantees of central government
though overdue be treated as NPA only when the
government rejects its guarantee when invoked.
 The exemption is not income recognition
 In case of State Government guaranteed loans, this
exemption will not be available and such account will be
NPA if interest / principal / other dues remain overdue for
more than 90 days
Advance against term deposits, NSC, KVPs / IVP etc.
 Account need not be treated as NPAs provided adequate
margin is available in the accounts
Manubhai & Co.

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Prudential Guidelines on Restructuring of


Advances by Banks

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Prudential Guidelines on Restructuring of


Advances by Banks
 Eligibility criteria for restructuring of advances:
 Banks may restructure the accounts classified under 'standard',

'substandard' and 'doubtful' categories.

 Banks cannot reschedule / restructure / renegotiate borrowal

accounts with retrospective effect

 While a restructuring proposal is under consideration, the usual

asset classification norms would continue to apply. The process


of reclassification of an asset should not stop merely because
restructuring proposal is under consideration.

 The asset classification status as on the date of approval of the

restructured package by the competent authority would be


relevant to decide asset classification after restructuring /
rescheduling / renegotiation.

 If there is undue delay in sanctioning and in mean time assets

classification status of the account undergoes deterioration, it


would be a matter of supervisory concern.
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Manubhai & Co.

Prudential Guidelines on Restructuring of Advances


by Banks
 Asset classification norms:
 Restructuring of advances could take place in the following stages :


Before commencement of commercial production / operation;

After commencement of commercial production / operation but


before the asset has been classified as 'sub-standard';

After commencement of commercial production / operation and


the asset has been classified as 'sub-standard' or 'doubtful'.

 The accounts classified as 'standard assets' should be immediately

reclassified as 'sub-standard assets' upon restructuring.


 The NPAs, upon restructuring, would continue to have the same asset

classification as prior to restructuring and slip into further lower asset


classification categories as per extant asset classification norms with
reference to the pre-restructuring repayment schedule.
Manubhai & Co.

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Prudential Guidelines on Restructuring of Advances


by Banks
 Asset classification norms: (Continued . . . .)
 All restructured accounts which have been classified as NPA

upon restructuring, would be eligible for up-gradation to the


'standard' category after observation of 'satisfactory
performance' during the 'specified period (1Year)
 In case satisfactory performance after the specified period is
not evidenced, the asset classification of the restructured
account would be governed as per the applicable prudential
norms with reference to the pre-restructuring payment
schedule.
 Any additional finance may be treated as 'standard asset', up
to a period of one year after the first interest / principal
payment, whichever is earlier, falls due under the approved
restructuring package
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Prudential Guidelines on Restructuring of Advances


by Banks
 Income recognition norms:
 Interest income in respect of restructured accounts

classified as 'standard assets' will be recognized on


accrual basis and
 For the accounts classified as 'NPA' will be recognized on

cash basis.

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Prudential Guidelines on Restructuring of Advances


by Banks
Provisioning norms
 Normal provisions:
 Banks will hold provision against the restructured advances as per the existing

provisioning norms.

 Provision for diminution in the fair value of restructured advances:


 Reduction in the rate of interest and / or reschedulement of the repayment of

principal amount, as part of the restructuring, will result in diminution in the


fair value of the advance.
 Such provision should be held in addition to the provisions as per existing
provisioning norms and reflect the impairment due to deterioration in the
credit quality of the loan.
 For this purpose, the erosion in the fair value of the advance should be
computed as the difference between the fair value of the loan before and after
restructuring. Fair value is worked out based on present value of cash flows
from advance before and after restructuring. Termed as sacrifice loss.
 The total provisions required against an account (normal provisions plus
provisions in lieu of diminution in the fair value of the advance) are capped at
100% of the outstanding debt amount.
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Prudential Norms for Conversion of Unpaid Interest into


'Funded Interest Term Loan' (FITL)
 The FITL created by conversion of unpaid interest will be classified in the

same asset classification category in which the restructured advance has


been classified.

 Income recognition norms


 The unrealized income represented by FITL (interest on principal

facility) should have a corresponding credit in an account styled as


"Sundry Liabilities Account (Interest Capitalization)".
 The income, if any, generated by FITL (interest on FITL a/c) may be

recognized on accrual basis, if these instruments are classified as


'standard', and on cash basis in the cases where these have been
classified as a non-performing asset
 Only on repayment in case of FITL, the amount received will be

recognized in the P&L Account, while simultaneously reducing the


balance in the "Sundry Liabilities Account (Interest Capitalization)".
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Special Regulatory Treatment for Asset Classification


 Benefits available :
 An existing standard asset will not be downgraded to the

substandard category
 The asset classification of sub standard / doubtful

account will not deteriorate upon restructuring. If


satisfactory performance is demonstrated during the
specified period.

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Audit Approach and Procedures

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Audit Approach
 In Audit of advances, auditor is concerned with obtaining

evidence about
 Amounts included in Balance sheet in respect of advances
 Amounts due to the bank are appropriate supported by loan

documents
 There are no unrecorded advances
 Advances are disclosed, classified and described in
accordance with recognized accounting policies and practices
and relevant statutory and regulatory requirements
 Appropriate provisions have been made as per the RBI norms,
Accounting Standards and generally accepted accounting
practices
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Audit Methodology
 Audit Methodology to include obtaining sufficient

appropriate audit evidence relating to advances by ..


 examining validity of recorded amounts
 examining Loan documents
 examining existence, enforceability and valuation of

security
 checking compliance with RBI guidelines relating to
classification and provisioning
 Reviewing exceptional reports
 carrying out appropriate analytical procedures
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Audit Methodology
Illustrative list of exceptional reports
 Inactive/ Dormant accounts
 Zero Balance and Non-zero accrued Interest
 Debit Balance without Interest Rate
 Credit balances in Advance accounts
 Debit to Income Head account
 Unchecked Transactions
 Excess allowed over limits/ drawing power
 Time barred DP notes
 Temporary OD beyond sanctioned period
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Audit Approach and Procedures


Extent of verification
 All the large Advances i.e. advances outstanding amount of which is in
excess of 5% of advances of the branch or Rs.2 crore w.e. is less.
 Advances under Special Watch List.
 Advances which are adversely commented by/in:
 Previous Audit report
 Internal/ Concurrent auditors/ Banks Inspection Report
 Report on verification of security and RBI inspection report
 Managers charge handing over report
 Branches control returns to higher authorities concerning
overdrawing , adhoc sanctions etc
 Fresh advances granted during the year
 Accounts upgraded from NPA to standard
 Other advances on test check basis
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Audit Approach and Procedures


Some common irregularities observed during audit of advances;
 Appraisal/ Sanction on the basis of inadequate documents
 Disbursement without execution of all documents.
 Over drawings beyond sanctioned limit/drawing
 Non receipt of monthly/quarterly data/information.
 Inspection of unit/ security not done periodically as per terms of
sanction
 Insurance coverage over security not taken/ inadequate
 Copy of minutes of Consortium banks meeting not available
 Incorrect interest rate application
 Incorrect classification either in terms of security or in terms of
prudential guidelines
 Incorrect provisioning
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QUESTIONS???

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THANK YOU

Manubhai & Co.

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