Audit of Bank Advances

Prepared by CA Mahesh K
Madkholkar
 Index
Introduction
Advances – Funded and Non Funded
Classification of Advances
Evaluation of Internal Controls
Provisioning Norms
Audit Procedures
Loan Documents
Reviewing Operation of accounts
Verification of Securities against Advances
Restructuring and Upgradation of Assets
Resources

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 Introduction

The third schedule to the Banking Regulation Act,

1949 requires classification of advances made by Bank
from three different angels :

Nature of Advances
Nature and extent of security
Place of Making the advances ( In India or Outside)

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 Advances –
Funded and Non Funded
 Funded Facilities
Term Loans
Cash Credit
Bill Purchase/ Discounting
Pre-shipment and post-shipment finance

 Non Funded Facilities

Letter of Credit
Guarantees
Underwritings
Other Commitments

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 Classification of Advances
 An asset, including a leased asset, becomes non performing
when it ceases to generate income for the bank.

 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 90 days in respect of a term loan
 the account remains ‘out of order’ in respect of an
Overdraft/Cash Credit (OD/CC) 

 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.
 Out of Order Accounts

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 Classification of Advances

Standard Sub Doubtful

Asset Standard Asset
Asset
Remained Remained
NPA for 12 sub-standard
months or for 12
less months or
less

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 Evaluation of Internal Controls
Creditworthiness of the borrowers
Execution of Loan Documents
Margin Sufficiency
Cut- off point for high value accounts
Joint Custody of Security
Title over the Securities
Inspection after regular Intervals
Surprise Checks
Modifications to DP Book
Regularization of Accounts

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 Guidelines for Classification
Take into account the degree of well-defined credit
weaknesses and the extent of dependence on
collateral security for realization of dues

Establish appropriate internal systems to eliminate

the tendency to delay or postpone the identification of
NPAs, especially in respect of high value accounts.

Responsibility and validation levels for ensuring

proper asset classification may be fixed by the banks.

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 Asset Classification to be borrower-
wise and not facility-wise

It is difficult to envisage a situation when only one

facility to a borrower/one investment in any of the
securities issued by the borrower becomes a
problem credit/investment and not others.

All the facilities granted by a bank to a borrower

and investment in all the securities issued by the
borrower will have to be treated as NPA and not
the particular facility/investment or part thereof
which has become irregular
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 Accounts not to be considered as
NPAs

Accounts regularized near about the Balance Sheet Date

Temporary Deficiencies
Non availability of adequate DP
Non submission of Stock Statement
Non renewal of Limits on due date

Irregular Accounts

Upgraded or restructured accounts

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 Provisioning Norms
Classification of Asset Type Provision (%)
Standard Asset Agricultural & SME 0.25 %
Commercial Real Estate 1.00%
Other Standard Asset 0.40%
Sub Standard Asset Secured 10.0%
Unsecured 20.0%
Infrastructure Loan 15.0%
Accounts
Doubtful Asset Unsecured 100%
Secured- upto 1 year 20.0%
Secured- 1 to 3 years 30.0%
Secured- 3 years & 100%
above
Loss Asset ---- 100%

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 Audit Procedures
 Evidence is to be obtained for

Amounts included in the balance sheet in respect of advances

are outstanding at the date of the balance sheet.

Advances represent amount due to the Bank

There are no unrecorded advances

The stated basis of valuation of advances is appropriate and

properly applied and that the recoverability of advances is
recognized in their valuation.

The advances are disclosed, classified and described in

accordance with recognized accounting policies and practices
& relevant statutory and regulatory requirements.

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 Loan Documents

Documents depend upon

Legal status of the Borrower
Nature of Security

Documents include
Certificate of Incorporation
MoA and AoA/ Partnership Deed
Resolution of Board of Directors
Resolution of Shareholders
Mortgage Deeds ( Equitable/ English Mortgage), etc

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 Review of Operation of Account
Whether limit is generally exceeded?

Whether the customer is not drawing against deposits

which are not free from lien?

Whether account is not window-dressed?

Whether there is healthy turnover?

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 Review of Operation of Account
Review the following to assess the recoverability of
advances

Periodic Statements submitted by borrowers indicating

extent of compliance
Latest Financial Statements of Borrowers
Reports of Inspection of Security
Auditors’ reports
Claims Lodged for guarantees under DICGC/ ECGC
covers

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 Verification of Security
against advances

Legal enforceability of the security

Effective control of the Bank

Amount of Outstanding Loan Covered

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 Types of Securities provided
 Stock Exchange Securities
 Goods ( Pledge)
 Documents of Title to Goods (Hypothecation)
 Gold Ornaments/ Bullion
 LIC policies
 Bank’s own Deposit Certificates
 Hire- Purchase Documents
 Plantations
 Immovable Property
 ECGC Covers

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 Restructuring of Loans

The stages at which the restructuring / rescheduling /

renegotiation of the terms of loan agreement could take
place, can be identified as under:

Before commencement of commercial production

After commencement of commercial production but

before the asset has been classified as sub standard,

After commencement of commercial production and

after the asset has been classified as sub standard

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 Treatment of Restructured
Standard Accounts
At any of the foregoing first two stages
A rescheduling of the installments of principal alone
would not cause a standard asset to be classified in
the sub standard category provided the loan/credit
facility is fully secured
A rescheduling of interest element would not cause
an asset to be downgraded to sub standard category
subject to the condition that the amount of sacrifice,
if any, in the element of interest, measured in
present value terms, is either written off or provision
is made to the extent of the sacrifice involved

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 Treatment of restructured
Sub-standard accounts
A rescheduling of the installments of principal alone,
would render a sub-standard asset eligible to be
continued in the sub-standard category for the specified
period, provided the loan/credit facility is fully secured

A rescheduling of interest element would render a sub-

standard asset eligible to be continued to be classified
in sub standard category for the specified period
subject to the condition that the amount of sacrifice, if
any, in the element of interest, measured in present
value terms, is either written off or provision is made
to the extent of the sacrifice involved

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 Upgradation of restructured accounts
One Year after the date on which first payment falls
due
Sub Standard Standard
Asset Asset

Provision can also be reversed after one

year

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 Resources
 DBOD.No.BP.BC.21 /21.04.048/2010-11
“ Master Circular -Prudential Norms on Income
Recognition,
Asset Classification and Provisioning pertaining to
Advances”
notified by RBI

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 Thank You!!!

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