Training Workshop on

Audit of Banks
December 31, 2012

1
Major Areas of Branch Audit

 Advances

 Deposits

 General Banking

2
 PRUDENTIAL REGULATIONS

Prudential
Regulations

CORPORATE / Consumer Agriculture Small Medium Micro Finance

COMMERCIALL Financing Financing Enterprises Banks

3
Small Medium Enterprises: means a company (ideally not a public limited
company), which fulfills following three conditions.

No. of Assets Excluding Net

Employees Land & Building Sales

 Manufacturing/service concern Upto 250 Upto R.100 M Upto

Rs.300M

 Trading concern Upto 50 Upto R.50 M

UptoRs.300M

Note:

An individual , if he or she meets the above criteria can also 4 be categorized as

SME.
Consumer Financing: is allowed to individuals for meeting their personal, family
or household needs.

Categories of facilities under consumer financing are as follows:

• Credit cards: mean cards which allow a customer to make payments on

credit (corporate cards does not fall in this category)

• Auto loans: means loan provided for the purchase of vehicles

• Housing Finance: loan availed for the purchase or improvement of

residential house /apartment / land

• Personal loans: means loans to individuals for payment of goods, services

and expenses

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Procedure of sanction and disbursement of advances

 Proposal / application from customer for the specific loan.

 Introductory meeting with the customer regarding nature of business, purpose of
loan and securities offered by the customer.
 Preliminary investigation / assessment of the customer at branch level by credit
department.
 Bank’s prescribed form i.e. BBFC to be filled and signed by the customer.
 BOD resolution of the company stating matter of obtaining finance facility.
 The audited financial statement of the latest year end and of the running period
to assess the financial performance of the company.
 Memorandum & Articles of Association, Certificate of incorporation and CIB report
are required to be submitted by the company / customer.
 The securities can be offered that was demanded by the bank depending upon the
nature and amount of loan. Some of those securities are as follows
 Pledge / hypothecation of good.
 Mortgage of immovable properties.
 Lien & personal guarantee ,etc.
 For sanctioning of loan, concerned branch sends proposal and related documents
for approval from zonal head or regional head or Credit and monitoring division
(CMD) at H.O depending on the limit of approval.
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 After inspection and internal audit clearance the loan is disbursed.
Types of Advances

 Running Finance
 Cash Finance
 Term Finance
 Payment against documents (PAD)
 Finance against imported merchandise (FIM)
 Finance against Trust Receipts (FATR)
 Bills purchased / negotiated under LC i.e. IBP or IBD
 SBP export refinance i.e. Finance Against Foreign Export Bills (FAFEB)
 Finance against packing credit
 Consortium / Syndicated financing

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Assertions and key risks in
loans and advances

The assertions which are addressed through our procedures at branch:

• Occurrence
• Rights & obligations
• Cut off
• Existence

Following are the key risks that pertain to advances:

• Regulatory Risk- Non compliance of regulations of SBP while sanctioning

the loans

• Valuation- Improper classification of advances which leads to under

provisioning against impaired loan 8
Approach to audit of advances

 Verify 80% of regular portfolio of branch on subjective & objective basis

and its compliance with Prudential Regulations.

 Verify 100% classified advances through Statement of Classified

Advances (SCA).

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Purpose of Credit Review Sheet

 It is the document which gives the complete detail of the selected parties.

 To check the credit compliance (guidelines issued by SBP).

 It is a tool which gives the reviewer a complete picture of the party.

 It requires the branch manager to comment on the classification proposed

by us.

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XYZ Bank Prepared by :
Branch Name__________________ Date :
Audit for the year ended December 31, 2011 Reviewed by :
Extent of Income on advances
Rs. in '000

Cash Demand Total Income

Running Finance ERF FIM
S.No. Borrowers Ref. Finance Finance Verified

------------------------------- Rupees in '000 -------------------------------

1 ABC Company 5540.1 40,000 200 10 40,210

Total Income on Advances - Verified

40,000 200 10 - - 40,210

Total Income on Advances- As Per Branch 400,000 3,000 200 403,200

Extent Verified 10% 7% 5% 10%

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ABC Bank Limited Prepared by:
Branch Name Reviewed by:
YEAR ENDED: DECEMBER 31, 2012

BORROWER'S NAME / GROUP NAME

LEGAL STATUS:
BUSINESS:

FUND BASED EXPOSURE Rupees in millions

CLASSIFICATION
As per OUTSTANDING AS AT DECEMBER 31,
NATURE OF As per
Bank 2012
FACILITY MYASCo
Return
PRINCIPAL MARK-UP TOTAL

Total Funded Exposure - - -

NON - FUND BASED EXPOSURE Rupees in millions

CLASSIFICATION
As per OUTSTANDING AS AT DECEMBER 31,
NATURE OF As per
Bank 2012
FACILITY MYASCo
Return
PRINCIPAL MARK-UP TOTAL

Total Non - Funded Exposure - - -

Grand Total - - -

For Single Party Exposure

- 20% of the equity of the bank as disclosed in latest audited financial statements
- 30% of the equity of the bank as disclosed in latest audited financial statements
- Excess over 20% of the equity of the bank as disclosed in latest audited financial statements -
Funded Exposure
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- Excess over 30% of the equity of the bank as disclosed in latest audited financial statements -
Total Funded and Non-funded exposure

For Group Exposure

 CIB Report

(vi) Nature of Security Date ___________

Regular Loan Rs._______________
Overdue Loan Rs._____ period ___ with Bank ____
Approved By Group default Loan ____ period ___ with Bank ___

SPECIFIC PROVISION FOR

Outs tandingB alance CLASSIFICATION
PRINCIPAL

Value of
Principal Less
Securities
Markup/ Markup/ value of Security
Recommend (A)
interest interest As Per Bank As Per Bank As Per Short /
Principal Total ed by
(receivable (Suspense Return Return MYASCO (Excess)
MYASCo.
Account) Account)

1 2 3 4=1+2+3 5 6 7 8=1-7 9 10 11

Dec
31,
2009

Branch Manager's Comments

Provision of
Instalment Principal less
Category of Classification
Overdue By value of
securities

Substandard 90 days 25% Job Incharge Conclusion

Doubtful 180 days 50%

Loss 1 year 100%

Trade Bills 180 days 100%

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ABC Bank Limited
BRANCH NAME:________________
SECURITIES VERIFICATION SHEET Prepared by:_________________
YEAR ENDED: DECEMBER 31, 2012 Reviewed by : ________________

TOTAL VALUE OF SECURITIES SECURITIES DOCUMENTS CHECKLIST

Rupees in millions
A. Liquid Securities Yes/No Date Remarks

- Bank deposits A. PRIMARY SECURITIES

- Deposit certificates Original Deposit certificates
- Government securities Share certificates / Government Securities
- Shares of listed companies Letter of pledge / Lien (IB-26)
- NIT units Stock Report (in case of pledge)
- Mutual fund certificates
- Inventories pledged to the B. SECONDRY SECURITIES
bank with perfected lien Primary Documents
- Bank Guarantees from Legal Opinion
Bank Sale/Conveyance/Gift Deed
Lease Deed
Search Certificate / NEC
Total liquid securities - Mortgage Deed
Permission to Mortgage
B. Collateral Securities - Power of Attorney
Valuation Report By An Approved Valuer
C. Other Securities In case of Equitable Mortgage
Pledge Memorandum of Deposit of Title Deed (IB-24)
Hypothecation In case of Registered Mortgage
Others Registered Mortgaged Deed (IB-22)
Total - In case of Charge on Fixed Assets of Companies
Total ( A + B + C ) - Charge Registration Certificate

Secondary documents
b-i. Collateral Securities Articles of Asociation / Memorandum of Association
CA Date Hypothecation Agreement
Description of Fixed assets Mutation Letter (Trasfer)
1 Approved Construction Plan
2 Property tax challan
3 Stock Report (in case of hypo stock)
- Insurance Cover - Hypothecation
Insurance Cover - Pledge

Charge Forms
Demand Promissory Note (IB-12)
Markup Agreement (IB-6)
Personal Gurantee (IB-29)

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TO BE FILLED FROM BORROWER'S FINANCIAL STATEMENT Initial Date

Completed by:

Reviewed by:

Name: Name of Party

Year: December 31, 2012

Auditor: XYZ & Co

RUPEES IN ‘000’
CURRENT PRIOR QUARTER
QUARTER
TURNOVER/REVENUES (a)
G.P. (b)
N.P. AFTER TAX (c)

SHAREHOLDERS EQUITY (excluding revaluation reserves) (d)

ACCUMULATED PROFIT/ (LOSSES) (e)
REVALUATION RESERVES (f) (for first three years only) *
SUBORDINATE LOAN (Loans from directors/ associates) (g)
TOTAL EQUITY OF BORROWER ( h = d + e + f + g)

TOTAL LONG TERM DEBT (i)

ADD:CURRENT MATURITIES OF LONG TERM LIABILITIES (j)
LONG TERM DEBT ( k = i +j )
SHORT TERM BORROWINGS (l)
TOTAL FUND BASED EXPOSURE (m = k + l)

DEBT TO EQUITY RATIO ( n = k / k + h)

CURRENT ASSETS (o)
CURRENT LIABILITIES (p)
CURRENT RATIO ( q = o / p )
CURRENT ASSETS LESS STOCK IN TRADE , SPARES &
PREPAYMENTS ('r)
QUICK/ LIQUID RATIO ( s = r / p )

EBITDA (t)
FINANCIAL CHARGES (u)
INTEREST COVER (v)

CASH FLOW FROM OPERATING ACTIVITIES

BORROWINGS FROM BANKS/ FINANCIAL INSTITUTIONS

- FUND BASED EXPOSURE (w = m)
- NON FUND BASED (commitments) (x)
TOTAL BORROWINGS (y = w + x )
TEN TIMES OF EQUITY ( z = h x 10 )
CUSHION / (EXCESS) ( z – y )
FOUR TIMES OF EQUITY (aa = h x 4 )
CUSHION / (EXCESS) ( aa – w )

CONTINGENCIES:
Equity of bank

Means tier-I capital or core capital and includes:

 paid-up capital,
 general reserves * ,
 balance in share premium account,
 reserve for issue of bonus shares,
 retained earnings / accumulated losses as disclosed in latest annual audited
financial statements.

* ‘ In case of corporate financing reserve shall include revaluation reserve on

account of fixed assets to the extent of 50% of their value’

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Equity of borrower

includes

 paid-up capital,
 general reserves,
 balance in share premium account,
 reserve for issue of bonus shares and retained earnings / accumulated losses,
 revaluation reserves on account of fixed assets *,
 subordinated loans and
 Preference shares.

* ‘Revaluation reserves will be part of equity for first three years only from the
date of revaluation’

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Liquid assets

 assets which are which are readily convertible into cash without recourse to
a court of law;

 encashment/realizable value of;

 government securities,
 bank deposits,
 certificates of deposit,
 shares of listed companies actively traded on the stock exchange,
 NIT Units,
 certificates of mutual funds,

 Guarantees issued by domestic banks / DFIs when received as collateral by

banks / DFIs will be treated at par with liquid assets.
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Important Regulation on PR
In cae of Corporate finance

Regulation-1 Limit on exposure to single person

 Total (funded and non-funded) exposure of up to 30% of the bank’s equity,

 Fund based exposure of up to maximum of 20% of the bank’s equity.

Regulation-1 Limit on exposure to group

 Total (funded and non-funded) exposure of up to 40% of the bank’s equity

to the group,

 Fund based exposure of up to maximum of 35% of the bank’s equity to the

group.
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Important Regulation on PR
In case of Agricultural finance

Regulation-5 Limit on exposure to single person

 Total (funded and non-funded) exposure of up to 30% of the bank’s equity,

 Fund based exposure of up to maximum of 20% of the bank’s equity.

Regulation-5 Limit on exposure to group

 Total (funded and non-funded) exposure of up to 50% of the bank’s equity to

the group,

 Fund based exposure of up to maximum of 35% of the bank’s equity to the

group.

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Important Regulation on PR
In case of SME

Regulation-6 Limit on exposure to single person

• The maximum exposure of a bank/DFI on a single SME shall not exceed Rs

75 million.
• The total facilities (including leased assets) availed by a single SME from
• the financial institutions should not exceed Rs 150 million
• However, the facilities excluding leased assets shall not exceed Rs 100
million.

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Requirements as to obtain/file Financial Statements

 “Banks / DFIs shall, as a matter of rule, obtain a copy of financial

statements duly audited by a practicing Chartered Accountant, relating to
the business of every borrower which is a limited company or where the
exposure of a bank / DFI exceeds Rs 10 million, for analysis and record. The
banks / DFIs may also accept a copy of financial statements duly
audited/certified by a practicing Cost and Management Accountant in case
of a borrower other than a public company or a private company which is a
subsidiary of a public company.
 However, if the borrower is a public limited company and exposure exceeds
Rs. 500 million, banks/DFIs should obtain the financial statements duly
audited by a firm of Chartered Accountants which has received satisfactory
rating under the Quality Control Review (QCR) Program of the Institute of
Chartered Accountants of Pakistan.
 Banks / DFIs may waive the requirement of obtaining copy of financial
statements when the exposure net of liquid assets does not exceed the limit
of Rs 10 million. Further, financial statements signed by the borrower will
suffice where the exposure is fully secured by liquid assets.”
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Regulation-5 Linkage Between Financial
Indicators of the Borrower and total exposure
from Financial Institutions

Limit on exposure of the borrower:

Where the equity of the borrower is positive:

 Total exposure 10 times of borrower’s equity

 Fund based exposure 4 times of the borrower’s equity.

Where the equity of the borrower is negative and he has injected fresh equity
during current year:

 Not exceeding 3 times of the fresh injected equity.

 Provided the borrower shall plough back (not to distribute to the
members) at least 80% of the net profit each year.

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Current Ratio of Borrower:

At the time of allowing fresh exposure/enhancement/renewal, the banks/DFIs

should ensure that the current assets to current liabilities ratio of the
borrower is not lower than such ratio as may be required under the Credit
Policy of the bank/DFI. .

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Regulation-8. Classification and
provisioning for assets loans / advances
Classification of asset portfolio and provisioning there
against – Time Based Criteria
Classification Determinant Treatment Provision to be
of Income made on
principal net
off liquid
securities and
prescribed %*
of FSV
1.Sub – Mark up/interest or Principal amount overdue by 90 As above Provision of
standard days or more from the due date. 25%
2. Doubtful Mark up/interest or Principal amount overdue by 180 As above Provision of
days or more from the due date. 50%
3. Loss a. Where mark-up/ interest or Principal is overdue As above Provision of
beyond one year or more from the due date. 100%
b. Where Trade Bills (Import/ Export or Inland Bills)
are not paid/ adjusted within 180 days of the due
date.

Exemptions from classification of assets portfolio and provisioning their against

Classified loans / advances that have been guaranteed by the Government, however, markup / interest on
25

such accounts shall be taken to suspense account instead of income account

Prescribed % of FSV
Category of Asset Forced Sale Value Benefit allowed from
the date of classification
a. For Corporate, commercial and SME Financing.
•75% for first year
Mortgaged residential, commercial and industrial • 60% for second year
properties (land & building only) • 45% for third year
• 30% for fourth year, and
• 20% for fifth year
• 30% for first year
Plant & Machinery under charge • 20% for second year, and
• 10% for third year
• 40% for first, second, and third year
Pledged stock
b. For Consumer Financing.
• 75% for first year
• 50% for second year
Mortgaged Residential Property.
• 30% for third year

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Subjective Basis Classification:

In this case classification is made after considering the following factors:

 Creditworthiness of the borrower is not sound (For e.g. CIB report shows
overdue).

 Borrower has cash flow problems.

 Security is not adequate.

 Documentation of security is incomplete / defective.

 Low current ratio

 Personal Guarantee of directors duly approved by their BOD of private limited

company has not obtained.

 Facility provided Excess or over the limit. 27

 The borrower has Going Concern issue.

The rescheduling / restructuring of
non-performing loans

Restructuring:

When an advance is restructured, the following concessions / remissions are

considered:
Reduction in rate of mark up;

Capitalization of accrued mark-up/ liquidated damages; and Part of the loan

Principal may be written-off as a very special case only where circumstances
warrant.

Rescheduling

Refers to the extension in the date(s) of payment of the installment(s) due to

various reasons including late commencement of commercial production or
teething problems faced by the project during trial run.

When an advance is rescheduled almost all general conditions28 remain unchanged

except their repayment period which is extended for a certain period.
The rescheduling / restructuring of
non-performing loans (Contd…)

Change in the status

Status of the Principal Amount

Rescheduling/Restructuring shall not change the status of classification of a loan

/ advance etc. unless; the terms and conditions of rescheduling/restructuring
are fully met for a period of at least one year (excluding grace period, if any)
from the date of such rescheduling/restructuring and at least 10% of the
outstanding amount is recovered in cash.

Change in the status of the Unrealized mark up

The unrealized mark-up on such loans (declassified after rescheduling /

restructuring) shall not be taken to income account unless at least 50% of the
amount is realized in cash.
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Deposits

Deposits of money from customers may be accepted by a bank in any of

the modes permitted by law which includes deposits on profit / loss
sharing (PLS) basis, interest free deposits.

Different types of deposits

 Current deposit

 PLS deposit

 Call deposit

 Term deposit

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Deposits – Key risk

 Tendency of branch management to override policies, procedures and local

regulations to attract deposit holders who prefer to keep their identities
undisclosed or involve in transactions having money laundering implications or
wrongful activities.

 Attempt to deliberately manipulate the rate of return in fractions or effective

days to avoid the interest cost on deposits.

 Identification and disclosure of Dormant and inoperative Accounts.

 Overstatement of deposit balances particularly at year-end.

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ANTI-MONEY LAUNDERING AND KNOW YOUR
CUSTOMER (KYC)
Transparency in the banking sector is an ever-increasing concern of the
regulators so as to insulate the banking system from being abused or
used as a conduct for illicit activities and white collar crime. Towards
this end, the SBP has issued due diligence requirements for KYC purposes
and anti-money laundering in line with international best practices.

The salient features of this regime include:

(a) Banks are to ensure the true identity of the account holders and seek
appropriate introduction on the integrity, respectability and nature of
business etc. of the prospective customer.

(b) Banks are to be aware of money laundering crimes and should develop
policies and procedure manuals to minimize this risk. High ethical
standards should be adopted by banks and adequate training shall be given
to all staff on these lines who should be made aware of their
responsibilities.
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ANTI-MONEY LAUNDERING AND KNOW YOUR CUSTOMER (KYC)
(Contd..)

(c) Banks should have clearly defined and comprehensive KYC policy for their
borrowers and depositors duly approved by their BOD. Branches of foreign
banks shall have such policy duly approved by their head office.

(d) There shall be in each bank a KYC compliance unit with a full time head,
and a system of monitoring and MIS and a proper record of customer
identification.

(e) Banks should be skeptical of cross-border transactions which appear to be

out of character or apparently inconsistent with past history, trends and
other characteristics.

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ACCOUNT OPENING DOCUMENTATION

For Individuals:

 Attested photocopy of Computerized National Identity Card* (CNIC)

or passport of the individual by a gazette officer or an officer of the
bank / DFI.
 Banks / DFIs shall ensure that the CNIC and the photograph are of
the same person whose account is being opened with them.
 Particulars / CNIC of such persons must be confirmed from NADRA
in writing or through its “VeriSys” system by the bank/ DFI.
 Bank should obtain a attested copy of his service card, or any other
acceptable evidence of service, in case of salaried person.
 In case of illiterate person, a passport size photograph of the new
account holder besides taking his right and left thumb impression on
the specimen signature card. 34
For Partnerships:

 Attested photocopy of identity card of all partners.

 Attested copy of ‘Partnership Deed’ duly signed by all partners of the firm.
 Attested copy of Registration Certificate with Registrar of Firms. In case the
partnership is unregistered, this fact should be clearly mentioned on the Account
Opening Form.
 Authority letter, in original, in favor of the person authorized to operate on the
account of the firm.

For Limited Companies:

Bank should obtain the certified copies of:

 Resolution of Board of Directors for opening of account specifying the person(s)
authorized to operate the company account.
 Memorandum and Articles of Association.
 Certificate of Incorporation.
 Certificate of Commencement of Business.
 Attested photocopies of identity cards of all the directors.
 List of Directors on Form 29 issued by the Registrar.
 Financial Statement should be obtained at the time of opening35of account.
For Clubs, societies and associations:

 Certified copies of
 (a) Certificate of Registration.
 (b) By-laws/Rules & Regulations.
 Resolution of the Governing Body/Executive Committee for opening of
account authorizing the person(s) to operate the account and attested copy of
the identity card of the authorized person(s).
 An undertaking signed by all the authorized persons on behalf of the
institution mentioning that when any change takes place in the persons
authorized to operate on the account, the banker will be informed
immediately.

36
For Trust Accounts:

 Attested copy of Certificate of Registration.

 Attested photocopy of identity cards of all the trustees.
 Certified copy of ‘Instrument of Trust’.

37
General Banking

General banking mainly comprises of the following items

 Bills payable

 Contra items (LC/LG)

 Head office a/c

38
Bills payables

An Outward / Inward Remittance is a fund transfer either in local or foreign

currency which can be affected by way of:

Inter Branch Credit Advice (IBCAs)

These include the transfer of funds from one branch to another of the Bank
under special arrangements of the payments to the beneficiary through fax is
called Inter Branch Credit Advice (IBCA).

Demand Draft

Demand draft is a written order, drawn by one branch of a bank upon another
branch of the same bank, or upon other bank (in both the cases the drawee
branch should not be in the same city) under special arrangements to pay a
certain sum of money to or to the order of a specified person.

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Contra Account

Letter of Credit

Written undertaking by a bank (issuing bank) given at the request and in accordance
with the instructions of the buyer (the applicant) to the seller (the beneficiary) to
effect payment up to a stated sum with in prescribed time limit, against stipulated
documents and provided that the terms and conditions are complied with.

L/Cs can be categorized as:

Sight L/Cs (SLC)
Usance L/Cs (ULC)

Sight L/Cs

Sight L/Cs are Letters of Credit where the Bank engages to honour the beneficiary's
sight draft upon presentation of documents

Usance Letters of Credit (ULC)

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ULC are similar to sight L/Cs but call for a time or Usance draft payable after a
specified period of time.
Contra Account (Contd…)

Letter of Guarantees

These facilities cover a number of specific types of guarantees that the Bank
may issue for its customers.

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Head office A/c

 Obtain reconciliation statement

 Ensure that outstanding entries are not outstanding more than 30 days.

 Make sure no entries of profit and loss are routed through this account.

 Ensure that suspense account was not misused by making payments without
any consideration detrimental to the interest of the bank and also make sure
that reconciliation and clearance is properly done in shortest possible time.

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Documents To Be Used For The Audit Of Branches

 Instructions

 Audit programs

 Std - Internal Control Memorandum (ICM)

 P.R. review checklist

 Deposit and advances control templates

 Analytical Sheets

43