DAMODARAM SANJIVAYYA NATIONAL LAW

UNIVERSITY
VISAKHAPATNAM, A.P., INDIA

TOPIC: AUDIT AND INSPECTION OF BANKS

BANKING LAW

MR. POOSARLA BAYOLA KIRAN SIR

Name of the Candidate

Roll No. & Semester

Kalyan Ginka

19LLB070 & Sem-6.

1
 ACKNOWLEDGEMENT

I would sincerely like to put forward my heartfelt appreciation to our respected BANKING LAW
professor- Mr. Poosarla Bayola Kiran Sir for giving me a golden opportunity to take up this
project. I have tried my best to collect information about the project in various possible ways to
depict clear picture about the given project topic.

Kalyan Ginka

19LLB070

2
 CONTENTS

Topic Page
Acknowledgement 2
Abstract 4
Introduction 7
Audit & it’s Objectives 7
Types of audits 8
Auditors 9
Accounts and auditing in Ancient India 10
Concept of compulsory audits 10
Bank auditing and limitations 10, 11
Inspection and objectives 11
Difference b/w audit and inspection 11
Regulatory framework 12
Banking regulation Act, RBI Act 12
Applicability 12
Banking Company’s audit 13, 14
Inspection of Bank 14
Role of Government 14
Scrutiny 15
Supervisory Function and Board 15, 16
Banking Supervision Core Principles 16, 17
Effective Banking Supervision- Core Principles 17
Accounts and balance Sheet 17, 18
Auditors and Consumer Protection Act 19
Legal Audits- Boon/Bane? 19 to 21
Conclusion 22
Bibliography 23, 24

3
 ABSTRACT

Banks occupy a unique position in either financial system due to the essential part they play in
promoting development of economy through "maturity transformation", that also includes the
upkeep of critical payment networks. Banks occupy a unique position in every financial system
due to the critical role they play in driving economic development through maturity
transformation & the upkeep of critical payment systems. The fundamental motivations for
building an effective bank supervisory system are the protection of depositors' interests and the
preservation of financial stability.

An institution's credibility, especially a financial institution's, is based on its internal control &
oversight structure's ability to swiftly detect anomalies, take corrective action, and ensure that
anomalies do not recur. Deception is common in the banking industry. As a consequence,
possessing an internal control as well as supervision mechanism in place is necessary to assure
that neither single person will be in a position to break procedures, rules, regulations, or
guidelines, or even to commit a non - authorized act harmful towards the organisation that goes
unnoticed for an indefinite/long period time. As a result, inspection & audit play a critical role in
ensuring that banking operations run smoothly.

Section 30, Banking Regulation Act(1949) mandates that a banking company's balance sheet
and profit and loss account be audited. The bank auditor is responsible for verifying the bank's
balance sheet and profit and loss account, which show the company's financial soundness. The
Banking Regulation Act, Section 35, deals with bank inspections.

4
Objective of the study:

To completely understand the concepts of bank audits, auditors, inspection of banks in India and
the regulatory framework of the inspection & audits in India, role of government and boards and
the effectiveness of legal audits.

Scope of the Study

The scope is limited to only the concepts of bank audits, auditors, inspection of banks in India
and the regulatory framework of the inspection & audits in India, role of government and boards
and the effectiveness of legal audits.

Significance of the study

This project will highlight the concepts of bank audits, auditors, inspection of banks in India and
the regulatory framework of the inspection & audits in India, role of government and boards and
the effectiveness of legal audits.

Literature review

 IMF-World Bank: India – Basel Core Principles for Effective Banking Supervision

http://www.taxmann.com/topstories/222330000000001423/imf-world-bank-india-basel-core-
principles-for-effective-banking-supervision.aspx/

This article in taxmann says about basel core principles for effective banking supervision in
detail. So, I used this article to include those concepts of supervision, principles.

 Balbir S. Sihag, KAUTILYA ON THE SCOPE AND METHODOLOGY OF

ACCOUNTING, ORGANIZATIONAL DESIGN AND THE ROLE OF ETHICS IN
ANCIENT INDIA, The Accounting Historians Journal, Vol. 31, No. 2 (December
2004), pp. 125-148.

5
This journal says about the history of audits and accounts in India. So, I used this journal to
include all the topics of audits in Mauryan empire, Mughal empire, Gupta empire etc.

 Report of High Level Steering Committee for Review of Supervisory Processes for
Commercial Banks (19th June, 2012).

Available at: http://www.rbi.org.in/scripts/PublicationReportDetails.aspx?ID=663/

This RBI article says about the supervision and inspection of banks in India. So, I used this
journal to include all those topics in my project.

Research methodology

The study is based on doctrinal method of research, and it is descriptive and explanatory study.

Primary sources- The primary sources include case laws, judgments delivered by various
judges in some renowned cases.

Secondary sources- The researcher has taken information from secondary sources like web
sources, online articles and journals.

Research Question

1. Whether the audit and inspection of banks is effective?

2. Whether any statutes are applicable for regulation of audits and inspection in India?

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 INTRODUCTION

AUDIT

DEFINITION AND MEANING

The word audit comes from the Latin audire, which means "to hear."

According to L.R.Dicksee-

“Auditing is an examination of accounting records undertaken with a view to establishment.

whether they correctly and completely reflect the transactions to which they purport to relate.”

A bank audit is a routine evaluation of the organization's records and services to ensure that
they are in conformity with industry laws and regulations. Banks must undergo a variety of
audits, including statutory audits, revenue audits, concurrent audits, and so on.1

OBJECTIVES

Primary Objectives

1. Examining the internal control system.

2. Verifying posting, casting, balancing, and other arithmetical correctness of books of
accounts.
3. Verifying transaction legitimacy and validity.
4. Ensure that the capital and income aspects of transactions are properly distinguished.
5. Confirming the existence of assets and obligations, as well as their value.
6. To make an enquiry about frauds.

Subsidiary Objectives

1
Definition of various authors on Audit; Avaiable at https://www.coursehero.com/file/p7721ttb/Different-
authorities-have-defined-Auditing-as-follows-1-R-K-Mautz-Auditing-is/

7
Detention & Prevention of errors and frauds.2

TYPES OF AUDITS

The bank audit can be divided into 3 types:

1. Concurrent Audit

Concurrent auditing entails auditing the ongoing transaction or current transaction as it occurs. It
is a monthly audit that is carried out on a continuing basis. Banks get a large number of day-to-
day transactions whereby a record must be kept, hence the bank engages in concurrent auditing.
It protects banks against inconsistencies, job overload, including transaction overlap, and it is
especially useful as each year comes to a close.

2. Statutory Audit

Each bank is required to have its accounts audited. Each bank performs statutory audits in
accordance with the Act's rights & duties. It is held at the end of the fiscal year (1st April to 31st
March). The RBI appoints statutory auditors in collaboration with ICAI. Statutory audit
compliance includes the PSL requirements, CRR, SLR, as well as other RBI circulars.

The statutory auditor is obliged to provide the bank's management and the RBI with a report
called as the Long Form Audit Report.

3. Information System Audit (Internal)

Instead of concurrent auditing, several banks opt on internal audits. Internal auditing is the
process by which an organisation or bank forms an audit team within its own organisation to
meet its auditing needs.

“Internal auditing is done by internal auditors' teams that go over each branch one by one”. An
information audit is a new type that has emerged in recent years, mostly as a result of the
computerization of the bank's operations. With the fast advancement of technology in the

2
The Institute of Chartered Accountants of India (2014), Guidance note on Audit of Banks, published by Sahitya
Bhawan Publications, 2014.

8
banking sector, such as ATMs, online banking, mobile banking, and so on, it is vital to conduct
periodic reviews of how such systems are operating.3

AUDITORS

 “An auditor of a banking firm, a nationalized bank, or a regional rural bank must be
legally competent to be an auditor of companies. As a consequence, the company auditor,
as defined under section 226, Companies Act 1956, and who is not subject to any of the
disqualifications set out therein.”
 RBI appoints the state bank of India's auditors after consulting with the central
government. The state bank of India appoints the auditors for the state bank of India's
subsidiaries. It is worth noting that the State Bank of India Act of 1955 specifically
allows for the appointment of “two or more auditors.”
 The appointment of an auditor for a co-operative bank is controlled by the appropriate
Co-operative Societies Act.

Powers-

 Right of access: Every company's auditor has the ability to see the company's books of
accounts & vouchers at any time. The Auditor does have the ability to demand from
business leaders whatever information and explanations he believes important for the
discharge of his obligations. There is a thorough list of issues wherein the auditor must
acquire information and also explanation. 
 “The auditor of the company shall sign the auditor's report or sign or certify any other
document of the company, and any financial transactions or matters mentioned in the
auditor's report that have any adverse effect on the company's functioning shall be read
before the company in general meeting and shall be open to inspection by any member of
the company.”
 Auditors of banking firms are subject to the rights, responsibilities, and obligations of
auditors, as well as the liabilities and fines imposed under Section 227 of the Companies

3
CA. M. M. Chitale, Bank Audit — Opportunities and Concerns.
Available at: https://www.bcasonline.org/ContentType/3.%20MChitale.pdf.

9
 Act. In addition to the foregoing, a banking company's auditor is required to include
some extra information in his audit report.4

ACCOUNTS &AUDITING IN ANCIENT INDIA

Accounting & auditing are mentioned in the Vedas, Ramayana, & Mahabharata. Kautilya's
Arthashasastra has precise regulations for accounting and auditing governmental finances. To
oversee governmental finances, the Mauryas, Guptas, and Mughals devised an accounting and
auditing system. Akshapataladhyaksha is the accountant-general in the Mauryan Empire.
Therefore, accounting and auditing sprang from the necessity for the government to manage the
state's and army's revenue & expenditure. The primary goal of auditing was to discover and
prevent mistakes & frauds.5

CONCEPT OF COMPULSORY AUDITS

As the number of corporations rose, the laws of some countries started to impose required audits
of corporate accounts. Thus, auditing the accounts of limited companies became necessary in the
United Kingdom in 1900. In India, the Companies Act of 1913 required company auditing.  Even
as number of corporations increased, companies' acts in several nations began to require
mandatory audits of company finances. Similarly, in the United Kingdom, auditing the accounts
of limited corporations became mandatory in 1900. In India, the Companies Act of 1913 made
auditing of corporate accounts essential. As companies expanded in size, the purpose of auditing
shifted to assessing if the accounts were "true and fair" rather than "true and accurate."6

BANK AUDITING- LIMITATIONS

 An auditor can't verify each and every transaction; instead, he must check only a subset
of the regions and transactions.

4
https://www.taxmann.com/post/blog/an-overview-of-bank-statutory-audit/?amps
5
Balbir S. Sihag, KAUTILYA ON THE SCOPE AND METHODOLOGY OF ACCOUNTING,
ORGANIZATIONAL DESIGN AND THE ROLE OF ETHICS IN ANCIENT INDIA, The Accounting Historians
Journal, Vol. 31, No. 2 (December 2004), pp. 125-148.
6
CA. M. M. Chitale, Bank Audit — Opportunities and Concerns.
Available at: https://www.bcasonline.org/ContentType/3.%20MChitale.pdf.

10
  Because audit evidence isn't really conclusive, confirmation from a debtor is not
conclusive evidence that money will be recovered. Evidence is stated to be non-
conclusive in nature.

 Deeply rooted frauds are difficult to detect because they include concealment activities
such as forgery, willful failure to register transactions, and false explanations.
 An auditor must rely on experts in relevant fields such as attorneys, engineers, valuers,
and so on for assessing contingent liabilities, valuing fixed assets, and so on.7

INSPECTION

Bank inspection is the process of watching banks in order to ensure that they are functioning
safely and in accordance with existing laws, rules, and regulations. It is a means of assessing a
company's financial status and ensuring that all rules and regulations are obeyed at all times.

OBJECTIVES

Banking inspection aims at contributing to the safe and healthy development of credit institution
and financial system; to protect depositors' and credit institutions' clients' legal rights and
interests; to maintain and expand public confidence in the credit institution system; to ensure
compliance with monetary & banking laws & policies; as well as to contribute to improving the
efficiency and effectiveness of state management.8

DIFFERENCE BETWEEN AUDIT AND INSPECTION

“A site is usually obliged to conduct an inspection as part of a compliance duty. An audit is a

procedure for ensuring that compliance duties have indeed been satisfied, along with the
completion of needed inspections.”
7
Basel Committee on Banking Supervision (2001), Internal Audit in Banks and the Supervisor’s Relationship with
Auditors, Bank for International Settlements, August 2001.
8
D. N. Ghosh, 'Fit and Proper' Banks: Importance of Regulatory Surveillance, Economic and Political Weekly
Vol. 39, No. 42 (Oct. 16-22, 2004), pp. 4599-4601

11
 REGULATORY FRAME WORK

There are various laws applicable to the audit and inspection of various banks in India.

Some of those acts are-

1. Co-operative Societies Act 1912

2. Banking regulation Act, 1955
3. Reserve Bank of India Act, 1934
4. State Bank of India Act, 1955
5. Regional rural banks Act, 1976
6. Companies Act, 20139

BANKING REGULATION ACT, 1955 & RESERVE BANK OF INDIA ACT,

1934

Applicability-

“Co-operative banks are governed by the Co-operative Societies Act of 1912, as well as Part-
V of the Banking Regulation Act of 1949 and the Co-operative Societies Act of the state in
which they operate. Several portions of the Banking Regulation Act have been amended, while
others have been excluded from distribution to cooperative banks. The Banking Regulation Act
regulates nationalized banks, state banks, and their subsidiaries. Regional rural banks are
governed by the Regional Rural Banks Act of 1976. The provisions of the State Bank of India
Act 1955 and the State Bank of India (Subsidiary Banks) Act 1959 submit an application for

9
CA. M. M. Chitale, Bank Audit — Opportunities and Concerns.
Available at: https://www.bcasonline.org/ContentType/3.%20MChitale.pdf.

12
the State Bank of India as well as its subsidiaries. Regional rural banks, & the State Bank of
India and its subsidiaries, are subject to certain parts of the Banking Regulation Act, 1949.”10

BANKING COMPANY’S AUDIT

Section 30, Banking Regulation Act, 1949 mandates that a banking company's balance sheet
and profit and loss account be audited. Every financial company's account must be audited and
authorized by Statutory Auditors, according to the legislative framework. Auditors of banking
businesses are subject to the same rights, responsibilities, and obligations as apply to auditors
under the Companies Act, as well as additional terms and restrictions.11

The bank auditor's work is unique in that he or she verifies the bank's balance sheet & profit &
loss account, which both indicate the bank's good financial situation. Apart from balance sheet
audit, the RBI has the authority underneath the BRA, 1949 to perform a special audit of every
banking company's accounts. In the public interest, the banking company's interest, the
depositors' interest, the RBI may execute or order a special audit if it deems it is warranted.12

The Reserve Bank of India has the authority to direct the bank to select the same or a different
auditor to undertake the special audit. The Reserve Bank of India should receive the special audit
report, along with a copy to the financial business. The banking business is responsible for the
audit costs.13

INSPECTION OF BANK

The RBI has the authority to inspect any banking institution under Section 35, BR Act. A copy
of the inspection report must be sent to the banking company just after inspection of banking
company's books, accounts, and records. The banking company, its directors, and officers must
10
Kaveri V S (1997), Evaluation of concurrent audit in banks. State Bank of India Montlily Review, Marcli 1997, pp
140-149.

11
http://www.bis.org/publ/bcbs06a.pdf/
12
Audits Of Banks: Lessons From Crisis
Available at: https://www.icaew.com/~/media/Files/Technical/Audit-and-assurance/audit-quality/audit-quality-
forum/meeting-notes-2010/audit-of-banks-lessons-from-the-crisis-5-jul-2010.pdf/
13
Report of High Level Steering Committee for Review of Supervisory Processes for Commercial Banks (19th June,
2012).
Available at: http://www.rbi.org.in/scripts/PublicationReportDetails.aspx?ID=663/

13
present the relevant books, accounts, & records, as well as the necessary statements and/or
information, in within timeframe given by the RBI inspectors.14

ROLE OF GOVERNMENT

The Reserve Bank may be ordered by the Central Government to inspect any banking firm. In
such circumstances, a copy of the inspection report must be sent to the federal government. The
Central Government can take suitable measures after reviewing the inspection report. If the
Central Government believes the banking company's affairs are not being conducted in the
banking company's, public, or depositors' best interests, the Central Government may intervene:

 prohibit the banking company from receiving new deposits, and direct the Reserve Bank
to file a petition for the banking firm's winding up under the Banking Regulation Act's
Section 38 provisions.

Prior taking action, the government must provide the financial business a chance to clarify their
position. The government can then take necessary measures based on the response.15

SCRUTINY

Banking Regulation Act’s Section 35 (1A)

The Reserve Bank may conduct a review of any banking company's affairs and books of
accounts, in addition to verifying the company's books & accounts. Such as the inspection, the
Reserve Bank may control the scrutiny as required.16

SUPERVISORY FUNCTION

14
Marshall C. Cons, Bark Auditing –Cambridge, Mass.: Bankers Publishing Company, 1955
15
Supervision of the Indian Financial System (2nd march, 2002)
Available at: http://www.rbi.org.in/scripts/PublicationsView.aspx?id=2545/
16
Sanjana Sahu and Sangitesh Shivam, Regulatory Framework of Bank Audit and Inspection- A Critical Study,
February 5, 2015.
Available at: https://www.lawctopus.com/academike/regulatory-framework-bank-audit-inspection-critical-study/

14
Banking Regulation Act of 1949 establishes the administrative & legal basis for supervision of
banks in India. Until 1994, “the Reserve Bank of India had separate divisions that supervised
banks, non-banking financial firms, and financial organisations.”

 Board for Financial supervision

The Board for Financial Supervision was established under the aegis of the "RBI Act (Board for
Financial Supervision) Regulations, 1994" with the goal of “giving undivided attention to
supervision of financial institutions in order to keep a close eye on financial markets and avoid
recurrence of financial system crises. Regulation 4 of the Above Act deals with the construction
of such board.”17

Applicability-

The Board is in charge of the Banking Companies, Nationalized Banks, State Bank, as well as its
subsidiaries.

Powers & Functions- Under the RBI Act, the Board performs duties and exerts powers of
supervision and inspection with respect to different banking organisations. The Department of
Supervision assists the Board. The Board is required to report to the Central Board every six
months. Underneath the RBI Act as well as the BR Act, the board performs duties and exercises
powers of supervision & inspection in numerous sectors of financial system, including banking
businesses. The board will also carry out any additional duties as directed by the Reserve Bank's
central board. Aside from the foregoing, the Governor may appoint an advisory group to provide
the Board with recommendations from time to time. At least five members of the council will
have specialised knowledge in fields such as accounting, law, banking, economics, finance, &
management.18

BANKING SUPERVISION – CORE PRINCIPLES

17
Sanjana Sahu and Sangitesh Shivam, Regulatory Framework of Bank Audit and Inspection- A Critical Study,
February 5, 2015.
Available at: https://www.lawctopus.com/academike/regulatory-framework-bank-audit-inspection-critical-study/
18
IMF-World Bank: India – Basel Core Principles for Effective Banking Supervision
Available at: http://www.taxmann.com/topstories/222330000000001423/imf-world-bank-india-basel-core-
principles-for-effective-banking-supervision.aspx/

15
The "Core Principles for Effective Banking Supervision" are the de facto minimum standard for
prudential regulation & supervision of banks and banking systems. Countries use them as a
benchmark for assessing the quality of domestic supervisory systems and planning future efforts
to achieve a minimum level of sound supervision. The "Basel Committee on Banking
Supervision" originally published them in 1997.19

The RBI has stuck to its post-liberalization stance of establishing prudential standards based on
worldwide best practises while allowing banks to operate freely. The Bank's compliance with the
Basel Committee's Core Principles on Banking Supervision was examined in depth, and
oversight weaknesses got addressed by forming seven in-house committees to provide
suggestions.20

The BFS considered the reports of these groups in a specially called session, as well as an agenda
was formed for action to be done to close the gaps. Compliance has been reviewed on a regular
basis ever since. The BFS also approved the public publication of the evaluation of compliance,
which is being shared with international financial institutions including abroad regulatory
organisations. The IMF also undertook an evaluation that use the updated Core Principles
approach, which was consistent with the Bank's own findings.

The RBI's efforts in this area have indeed been acknowledged in international forums, but was
appointed a member of the Core Principles Liaison Group (CPLG) of the Basel Committee for
Banking Supervision in August 1999, which was founded to promote the adoption of the Core
Principles internationally. The RBI also has examined the proposed New Capital Adequacy
Framework, which is now being considered by the BCBS, and has reported its conclusions to the
Basel Committee. RBI is also a member of the Working Group of Capital of the Core Principles
Liaison Group, which was formed to gather input from non-G-10 countries in the international
standard-setting process.21

19
India: Financial Sector Assessment Program—Detailed Assessments Report on Basel Core Principles for
Effective Banking Supervision, IMF, 2013
Available at: http://www.imf.org/external/pubs/ft/scr/2013/cr13267.pdf/
20
IMF-World Bank: India – Basel Core Principles for Effective Banking Supervision
Available at: http://www.taxmann.com/topstories/222330000000001423/imf-world-bank-india-basel-core-
principles-for-effective-banking-supervision.aspx/
21
IMF-World Bank: India – Basel Core Principles for Effective Banking Supervision
Available at: http://www.taxmann.com/topstories/222330000000001423/imf-world-bank-india-basel-core-
principles-for-effective-banking-supervision.aspx/

16
 EFFECTIVE BANKING SUPERVISION- PRECONDITIONS

 solid and long-term macroeconomic strategies; 

 a well-defined framework for formulating financial stability measures; 
 solid and long-term macroeconomic strategies; a well-defined framework for formulating
financial stability measures; 
 a precise structure for managing, recovering from, and resolving crises;
 systemic protection (or a public safety net) at an adequate level; and
 effective market discipline22

ACCOUNTS AND BALANCE SHEET

Section 29, Banking Regulation Act- Accounts & Balance Sheet

As per Banking Regulation Act, banking businesses must prepare their balance sheet as well as
accounts once a year. According to the Act, the accounts must be audited by suitably competent
auditors. The audited balance sheet and accounts must be filed with the Reserve Bank as returns,
while copies must be filed with the Registrar of Companies.

Noncompliance with the Reserve Bank of India Act, the Banking Regulation Act, as well as the
orders, rules, regulations, or instructions made below these statutes is punished.

All banks with stock exchange listings are required to report their unaudited quarterly results in
accordance with the SEBI's proforma. According to Section 29, Banking Regulation Act, every
banking firm must create a balance sheet & profit and loss statement.

Banking companies established in India must cover their whole operation for this purpose, and
international banks operating in India must cover all of their branches in India for this reason.
The banking corporation must follow the Reserve Bank's regulations & instructions in regard of
income recognition, asset categorization, provisioning, and other matters while producing the
accounts.

22
India: Financial Sector Assessment Program—Detailed Assessments Report on Basel Core Principles for
Effective Banking Supervision, IMF, 2013
Available at: http://www.imf.org/external/pubs/ft/scr/2013/cr13267.pdf/

17
Companies must provide copies of their accounts and balance sheets, as well as the auditor's
report, to the Registrar of Companies under Section 220, Companies Act. In the case of banking
companies, even so, Section 32, Banking Regulation Act requires the registrar to provide 3
copies of the accounts, balance sheet, and auditor's report submission to the Reserve Bank as
per Section 31 of the Act, which will be treated as if they were submitted as per Section 220,
Companies Act throughout all respects.

When a corporation provides supplementary balance sheet & profit & loss account information
towards the Reserve Bank pursuant Section 27(2), Banking Regulation Act, a copy of
information must also be sent to the Registrar.23

AUDITORS AND CONSUMER PROTECTION ACT

Despite the fact that the legislation does not specify a specific code of behaviour for auditors.
The Consumer Protection Act makes no clear provision for holding Auditors liable for failure in
service. Deficiency in Professional Service has came to also be understood in a broad sense.24

LEGAL AUDITS- BOON/ BANE?

According to the most recent estimates, public sector banks' non-performing assets have risen to
4.1 percent of their gross advances. These debtors frequently fail to fulfil their loan, compounded
by the difficulties of enforcing the security offered. Recent incidents of fraud &
misrepresentation have surfaced in which borrowers lacked jurisdiction over the assets they
supplied as security, resulting in multiple banks & financial institutions vying for security for the
same property.

There have been cases of top bank executives circumventing loan approval processes and
collaborating with borrowers to provide favourable loan terms. This was essentially a bank
robbery.

Recently, the Reserve Bank of India (RBI) ordered audits of several big public sector banks to
determine the causes of the increase in bad loans in such institutions and to look for anomalies in
23
Editor Shuchi Ojha (2000) TP’s comprehensive Bank Audits Practice Manual, The Tax Publishers, 2000, pp 7-10.
24
Akshay Ramesh and Gokul L., Present Status Of Consumer Protection In Indian Banking Sector, (19 November
2019)
Available at: https://www.mondaq.com/india/dodd-frank-consumer-protection-act/865580/present-status-of-
consumer-protection-in-indian-banking-sector

18
loan approval. Such instances have also been investigated by the Ministry of Finance as well as
the Central Bureau of Investigation. In view of the above, the RBI had asked banks to perform
legal audits in addition to other procedures it has taken.

The usual practise is insufficient

Once granting a loan /monitoring the terms of previously sanctioned loans, banks typically
perform financial or commercial due diligence and, in some cases, technological due diligence.
As a consequence of banks failing to do significant legal due diligence here on borrower,
situations like borrower incapacity, lack of permission to issue security due to the absence of
proper corporate actions, and inadequate establishment and perfection of security arise.

As a result, the requirement for banks to perform a legal audit has emerged. The RBI previously
found that the borrower's submission of forged documents accounted for a substantial proportion
of frauds.

Issued Directions

With above said concerns in mind, the RBI issued a circular on June 30, 2011, basically telling
banks to implement a concurrent audit system that would include: (a) a system for verifying title
documents; (b) a process for requesting title search reports from local revenue authorities; and
(c) a process for banks to independently verify certificates submitted by borrowers.

After the above-mentioned circular, the RBI issued a new one on June 7, 2013, requiring banks
to conduct a periodic legal audit of all documents relating to credit exposures of $50 million
(US$814,000) or more. While the loan was outstanding, banks were also advised to perform a
quarterly re-verification of the borrower's title papers with the appropriate authorities as part of a
standard audit exercise.

The 2013 circular also suggested that banks give periodic review notes to their boards of
directors or audit committees on the legal audits they complete. The review notes could include
data including such: (a) the number of loan accounts covered or due for legal audit; (b)
deficiencies noted by the auditors as well as steps taken to correct the deficiencies; (c) the
number of accounts that cannot be rectified; and (d) the course of action taken to protect the
bank's interests in such cases.

19
Worthy cause

According to the preceding, the RBI's objective is to ensure that banks have sufficient systems in
place to ensure that they execute legal audits on a regular basis and prevent fraud by not relying
simply on the borrower's statements or third-party certification. The regulator has clearly taken
an important step in ensuring that banks have adequate checks and balances in place for their
lending operations. Legal audits also would help banks mitigate the impact of non-performing
assets by removing the possibility of fraud due to a lack of due diligence.

However, it is crucial to emphasise that regulatory action in this area, as well as a growth in the
number of problematic accounts, may raise the burden on banks. Recent legislative changes have
done nothing to improve the situation. For example, Section 30A of the Maharashtra Stamp Act,
1958 requires banks and financial institutions to guarantee that all documents (including those
prepared before to the date of change) is legally stamped and charges a punishment for
noncompliance. This modification requires banks to verify that papers previously supplied by
them are accurately stamped after the legal audit is completed.

Though the regulator's measures may look cumbersome at the moment, they are in fact helpful
and therefore will benefit banks and the general public in the long run.25

25
Jeet Sen Gupta, Legal audits by banks: A boon or a bane? (2 October 2014)
Available at: https://law.asia/legal-audits-rbi-banks-india/

20
 CONCLUSION

The importance of the financial system in such an economy can't be emphasised, as well as the
banking industry continues at its heart, even in nations where its credit position has waned in
comparison to other financial sectors. Recent developments in the banking system, as well as the
recurrence of expensive financial crises throughout the world in recent decades, have piqued
policymakers' & industry players' interest in effective banking supervision.

As a result, the following are a few suggested action plans for enhanced compliance with Basel
Core Principles:

 Provide more assurance about the RBI's independence by eliminating impediments from
related statutes.
 Increase clarity upon that role of the nominated director in public banks, which could
cross the boundaries b/w the RBI's legal obligations as a banking supervisor as well as
RBI-assigned staff' active engagement in a bank's management.
 Rethink the stringent rotation procedures in order to guarantee that workers may gain
knowledge in banking supervision and regulation.
 Creating systems to ensure that written content (especially inspection reports) is
disseminated on a regular and timely manner;
 extending and improving escalation mechanisms to warn other relevant supervisors as
soon as a supervisor has concerns; and
 Frequent semi-annual conferences on significant banking operations, as well as a
regulators- issues' discussion pertaining to a specific banking business.

Just a stable financial system can achieve its macroeconomic goal of efficient financial resource
transformation and provision. A properly-functioning banking system, as well as an effective
financial oversight system, are essential for a country's economic performance potential.

21
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