Bank Branch Statutory Audit
March, 2015
VERIFICATION OF ADVANCES INCL. NPAs
Paper Presented by :
CA Ismail B. Sonawalla
200, Ashoka Shopping Centre, 2nd floor, L. T. Marg
Next to G. T. Hospital, Mumbai 400 001. Tele: 022-2269 0070
Scope of the Topic
A.
B.
C.
D.
E.
Various Laws Applicable
Major Master Circulars issued by RBI
Audit of Advances
Classification of Advances
Verification of Non-Funded Advances
RBIs site – www.rbi.org.in - Check for various circulars
A. Various Laws Applicable or Whose Knowledge is Essential
2 sets of Laws
 Applicable to the Lender
 Applicable to the Borrower
1)
The Companies Act, 2013 or any other statute under which the Bank is registered. (applicable
to the Bank and the Borrower – registration of charge, resolutions, borrowing powers etc.)
2)
The Banking Regulation Act, 1949 (B. R. Act)
3)
The Reserve Bank of India Act, 1934
4)
The Foreign Exchange Management Act & FEDAI rules
5)
The Income Tax Act, 1961 and its rules (TDS, Tax audit, Income tax)
6)
Service Tax rules
7)
The Stamp Act applicable to the respective State
and / or
The Indian Stamp Act
8)
The Indian Contract Act, 1872
9)
Transfer of Property Act, 1882
10)
Sale of Goods Act, 1930
11)
Negotiable Instruments Act, 1881
12)
Limitation Act, 1963 (3 year’s limitation for documents)
13)
Memarts / Byelaws / Annual Closing Guidelines of the Bank
14)
Accounting Standards - Policies & Guidelines
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Certain features of these laws which need to be considered are follows:
Banking Regulation Act

Sec.5A of B.R. Act - The provisions of the Banking Regulation Act override the ones in any
other Act or the Rules or Byelaws including the Companies Act, 1956.

Sec. 14-A of B. R. Act - A Bank cannot create a floating charge on its assets.

Sec.20 of B.R. Act – Bank cannot give loan against its own shares.

Sec.20 of B.R. Act - Loans are not allowed to be given to directors (including members of
any committee) or firms or companies in which directors are directly or indirectly interested.
Further, under Sec 20A of B.R. Act – Remission of loans given to the above persons can be
done only with the prior approval of RBI. For further details, refer RBI’s Master Circular – Loans
& Advances – Statutory & Other Restrictions dated 1st July, 2014.

Sec.21 of B.R. Act – RBI has power to control advances being given by a banking company.

Sec.29 of B.R. Act - Banks have to prepare Balance Sheet and Profit & Loss Account in Form
‘A’ and Form ‘B’ respectively as given in Third Schedule to the B.R. Act.
Stamp Acts

For purpose of stamping of documents, Branch to follow law of the place where document is
executed and not where registered office of bank is situated. Eg., for stamping of documents
executed by a branch of Bank of India in Gujarat, The Gujarat Stamp Act to be followed and not
the Maharashtra Stamp Act, which is applicable to its registered office in Mumbai.

If certain provisions not available in State’s Stamp Act, provisions of the Indian Stamp Act, which
is a central act, to be followed. eg. provision for revenue stamp
Annual Closing Guidelines

Major policies and rules that the Bank follows are given in the Annual Closing Guidelines.
Hence, very essential that the same is read before the audit of Advances is commenced. If
some of these guidelines are not in line with the Accounting Standards or other statutory
guidelines prescribed, the guidelines, as given by the Bank should be followed and the fact
about its deviation from the statutory guidelines to be given in the report.
B. Major Master Circulars issued by RBI during the financial year 2014-15
During the year, RBI has issued a number of circulars concerning advances and other topics. On
certain topics, they have consolidated all the previous circulars and issued what is called “Master
Circular”. The auditor should acquaint himself with the contents of all such circulars, before
commencing the audit. More than 70 Master Circulars have been issued, details of some of
which is given in Annexure-1
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C. Audit of Advances
General
Before commencing, desirable to study accounting system followed by Branch, especially if it is
computerized, since a large number of details required by the Auditor for verification as well as
LFAR reporting, can be generated from the system itself – no need to prepare one manually.
Some of the statements that could be generated by the system as on 31st March are as follows:
 Facilitywise / partywise list of accounts outstanding, alongwith the outstanding balance. The
aggregate total of these lists should first be tallied with the figure of total advances in the Trial
Balance to ensure that none of such statements have been missed out.
 Sanctioning powers of the branch officials and the higher authorities
 List of accounts where the regular facility or the adhoc facility is due for renewal, but has not
been renewed
 List of accounts where stock / book debt statements are in arrears
 List of accounts where no insurance or inadequate insurance has been taken.
 List of accounts overdrawn beyond the sanction / DP limit.
 List of accounts where stock audit is due, but has not been done
 List of accounts where inspection has not been carried out in the last 3 / 6 months.
 For CC / OD accounts, monthwise details of debit and credit transactions
 NPA statements, as prepared by the Branch
Discussion with Credit Officer may reveal information about further such statements which are
generated from the computer.
Type of Facilities

Based on Funds – Funded – where actual money is given by the Bank and Non-Funded –
where only a guarantee or commitment or co-acceptance is given that a certain amount would
be paid on the occurrence of certain unknown events, or an accepted bill would be honoured on
presentation (Letter of Credit)

Based on Geography – Inland and Export (Packing/Pre-shipment credit, Post-shipment credit)

Based on Security – Secured and Unsecured
Secured - one granted against some security, while unsecured - one given against personal
surety only.
Secured can be further divided into hypothecation, pledge, mortgage, assignment etc. The
security could be tangible (goods) or intangible (bank / government guarantees).

Based on Sector – Priority sector (40% by RBI) and Non-Priority sector
Priority sector is one in which persons with small means are engaged or which needs to be
supported / encouraged by the government.
Type of Advances
 Demand / Term loan - such advance, though called “demand loan” generally repayable in predetermined instalments. If repayment period exceeds 36 months, called Term loan.

Cash Credit – this advance generally granted without any stipulation for repayment, but is
required to be renewed every year. Such advance, granted generally against security of stock
and book debts is called Cash Credit. When a borrower is allowed to draw beyond his
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sanctioned limit or drawing power limit, the said amount is called “Temporary Overlimit – TOL”.
TOL secured by existing securities against which the Cash Credit sanctioned.

Overdraft - advance similar to Cash Credit, except that either security is other than stock and
book debts – eg. FD receipts, NSC receipts, shares, LIC policies or no security is taken (termed
as “Unsecured Overdraft”) or, etc. When such secured or unsecured overdraft granted to
borrower to tide over temporary financial crisis, it is called “Temporary Overdraft – TOD”. Unlike
TOL, which is generally secured, TOD is generally unsecured.

Bills Purchased / Discounted – when advance against sale bill is granted to seller with the
condition that the same should be repaid before the physical possession of the goods passes
on to the buyer, it is called “Bills Purchased” facility; when an advance is granted against a sale
bill, wherein the buyer has received the goods and has agreed to pay the amount therein within
a stipulated period, such a facility is called “Bills Discounted”.
Extent of Verification

Based on existence and efficacy of internal control procedures (including concurrent audit)
Auditor to verify all large advances – constituting more than 5% of the outstanding advance or
Rs.2 crore, whichever is lower

If NPAs are high or extensive problem is identified, percentage of check to be increased.

Due to stressed business environment, banks have been extensively resorting to CDR
(Corporate Debt Restructuring). All such accounts, as well as all accounts which have heavy
NPAs should be selected for verification.
Reporting of Verification

Statutory Auditors have to report about discrepancies noted in the Advances in two separate
reports – one is the Statutory Audit Report for ‘Major / Critical Discrepancies’ and the other is a
detailed report in the Long Form Audit Report (LFAR) under para I-5 – Advances.

Before commencing verification of Advances, Auditor to devise query noting format, so that
requirements of above two reports are also complied with simultaneously.
Stages of Verification (COMMON SENSE IS THE MOST IMPORTANT INGREDIENT)
It is suggested that for verification of Advances especially the big ones, all the stages of verification
should be done by the same person to enable him to get a bird’s eye view of the account. A
suggested format for the same is enclosed herewith (Annexure-2).
RBI has issued a letter dt. August 7, 2004 outlining “Deficiency found in sanctioning of loans
and monitoring of borrowal accounts by banks / financial institutions” – (Annexure-3)
RBI has also issued a Master Circular – “LOANS & ADVANCES – STATUTORY & OTHER
RESTRICTIONS” dated 1st July, 2014. The same also needs to be read.
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(i)
March, 2015
Credit Appraisal & Sanction
 Documents required – documents required vary based on the profile of the borrower;
however, certain documents that need to be checked are: Statement of accounts,
debtors, creditors and stock, projected balance sheet and profit and loss account, visit
report by the branch, valuation report or proforma invoice for plant and machinery,
vehicle, etc., credit appraisal report of the bank, papers showing net worth of the
borrower and guarantors, CIBIL report showing the credit history of the borrower and
guarantors, confidential report from other banks, ratio analysis, etc., various licences as
required by that business, proforma invoice for purchase of machinery / equipments,
financial papers of guarantors, confidential report from previous bankers, if any; for
partnership firms – partnership deed; for companies - memarts, resolution, etc.

Sanction Letter – authority to sanction / terms of sanction – whether complied

Loans against security of shares, bonds, etc. to an individual not to exceed Rs.10/20
lacs, if the securities are held in physical / demat form respectively.
Uniform margin of 50 per cent to be applied on all advances / financing of IPOs /
issue of guarantees on behalf of stockbrokers and market markers. A minimum cash
margin of 25 per cent (within the margin of 50%) to be maintained in respect of
guarantees issued by banks for capital market operations

(ii)
(iii)
Previous adverse comments - Any adverse comments on the account in previous
statutory audit, internal inspection, concurrent audit etc.
Disbursement
 Documents by the Bank – A-DP Note, B-Hypothecation / Pledge / Mortgage documents,
C-Letter of Guarantee etc. – No tick marks on documents

Stamping (as per the law applicable)

Documents to be obtained – Charge Noting with ROC / RTA / Co-op. Housing Society,
Assignment of Policies, Transfer of shares, NSC, FDR, Insurance etc.

Insurance – all immovable and movable properties – assignment in favour of Bank

Special Conditions – Mode of disbursement (direct payment), clearing of dues,
processing charges etc.
Review of Operations – MOST IMPORTANT
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
RBI – Any transaction susceptible to fraudulent transaction to be
directly reported to RBI by the Auditors.

Intelligent scrutiny of the bank statement (debit / credit entries, cash / cheque,
transfer from / transfer to accounts, frequent return of cheques, excessive
withdrawals / deposit in cash, no / inadequate payments by cheque for
purchases, no / inadequate deposits by cheque for sale proceeds, turnover in
the account disproportionate to the sale / turnover of business, payment to
persons or for items not related to this business or transfer of funds to
personal accounts of owner or sister concerns etc. (diversion of funds)
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(iv)
March, 2015

Drawing power (DP) limits – based on the stock and book debts of the
borrower, monthly / quarterly drawing power limits are fixed, which are equal
to or less than the sanctioned limits; the auditor has to verify whether the
account is frequently / continuously overdrawn over the DP limits; at times,
DP limits are enhanced for temporary period by sanction of adhoc limits.
Incidentally, this verification is also necessary for NPA classification of the
borrower.

Verification of stock / book debt statements - compare movement of stock /
book debts from month to month with turnover in account and purchase and
sale declared by the borrower in the stock statements; the stock and book
debts declared in the statement for March of the previous year to be
compared with similar figures given in the audited or unaudited financial
statements of the concern; book debts statement to be certified by a
chartered accountant on a quarterly basis; for non-submission of these
statements, penalty is charged; necessary to verify whether the stock
includes unpaid stock (represented by Sundry Creditors), stock under L/C,
stock under Packing Credit, etc., since all these stocks being “unpaid stock”
have to be deducted from the total stock considered for DP limit. Specifically
verify the genuineness of stock-in-transit.

Account with other banks – is it permitted, purpose, details of transactions etc.

Audit and audit reports – compulsory for non-corporate entities, with
sanctioned limits above Rs.10 lacs, to get their accounts audited.

Recovery of instalments & its source / turnover in accounts – frequent
overdrawings.

Special conditions – in case of advance against exports, the same has to be
informed by the bank to Export Credit Guarantee Corporation (ECGC) to
cover the said advance under its insurance scheme. Further, concessional
rate of interest is charged to the borrower, provided certain conditions are
fulfilled and the advance is liquidated within a specified time limit out of the
export proceeds. If the same does not happen, the benefit of concessional
rate of interest is withdrawn.

Balancing of books (General ledger with Subsidiary ledgers) – Major frauds
take place
Renewal / Enhancement / Reschedulement / Balance Confirmation

Generally at the end of one year, unless it is an adhoc advance or it is otherwise
specified in the sanction letter; non-renewal can make the account a non-performing
asset (NPA).

For limits re-aligned or enhanced, necessary documents to be executed. Even if the
limit is sanctioned for a temporary period, proper stamping and execution of the
necessary documents is mandatory.
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(v)
March, 2015

Where a project gets delayed or temporary crisis arise in the business of the borrower,
the loan repayment amount and its time is rescheduled. Reschedulement is permitted,
but sanction for the same from the appropriate authority is necessary.

To avoid documents becoming time-barred, Letter of Acknowledgement of Debt (LAD)
to be obtained, preferably every year; applicability of Law of Limitation.
Physical Inspection of Securities (Visit to office / factory & verification of accounts)
(vi)

Stock / Machinery (obsolete stock, non-working machinery) – generally
Statutory Auditors do not go for inspection, but rely on report of stock /
concurrent / internal auditors – adverse comments to be looked into.
Stock audit mandatory above a certain limit of advance prescribed by
bank. Further, if account is NPA, mandatory for bank to obtain stock
audit report from an external agency every year in cases, with o/s
balance of Rs.5 crores and above. Auditor to examine these reports to
see if there are any adverse comments and its rectification. Special
attention to non-moving stock & obsolete machinery included in stock
statements on the basis of which DP limit is determined.

Demat or physical shares / TDR / Other Scrips with Branch

Valuation of securities – in case of loan against shares, bank to
prepare periodical statement of valuation of shares pledged to check
whether margin is still maintained. In case of NPA accounts, it is
mandatory for the bank to obtain valuation report for all immovable
properties / machinery mortgaged / hypothecated to the bank atleast
once in 3 years.
Verification of charges due on the advances
Following charges recoverable at rates prescribed. Auditor to test check recovery.
 Charges for processing of loan, stamping, insurance etc.
 Interest / charges on the advance, including “withdrawals against
effects” (WAE), temporary overlimit etc.
 Charges for late / non-submission of stock / QIS statements, nonrenewal of limits, inspection, valuation, etc.
Certain Indicators which could lead to identify Irregular Accounts / Frauds
While verifying loans and advances, the auditor has to take cognisance of certain indicators, which
may lead to irregular accounts / frauds.
 The branch has 1 or 2 major borrowers constituting more than 50% to 75% of the total
advances of the branch, to whom the branch goes out of its way to give continuous overlimits
or withdrawals against uncleared effects or does not pursue recovery of overdue bills or stock
statements are not received in time and yet drawing power limit is continued or account is not
renewed on due date or adhoc limits are not cleared and yet facility is continued, etc. etc.
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 While verifying CC a/c, OD a/c and bills a/c, the following observations are made
 account remains continuously overdrawn;
 a number of cheques are bounced due to insufficient funds;
 cheques deposited are not honoured and returned unpaid;
 the account has been granted continuous TOL by the branch – for 20 to 25 days every
month moreover, such TOLs have been granted by the Branch Manager, at times,
without having the power to do so;
 the 12 month’s turnover in the account does not commensurate with the sale and
purchase shown in 12 monthly stock statements or the statement of accounts submitted;
 the realisation of bills purchased / bills discounted is not received on the due date and
subsequently the same are cleared by debit to the borrower’s CC / OD a/c;
 as soon as the above bills are cleared, fresh bills are purchased / discounted;
 the facility has not been renewed on the due date and the reason given is that the
borrower has not submitted the necessary papers;
 all overdue CC limits, OD limits, unrealised bills, unrealised interest are bundled together
and the borrower is granted WCTL – Working Capital Term Loan to avoid the account
becoming NPA. Such bullet loan is an indicator that the account is having problems;
 for certain accounts, when papers are asked for, the branch is unduly slow in producing
the same or makes a plea that the same have been sent to some authority and hence is
unavailable at the branch;
 in case of certain accounts, the Branch Manager pleads not to put any adverse remark in
the report and that he shall get it rectified after the audit is over;
 in certain cases, the branch just does not produce the papers, pleading that the same are
not traceable;
 While verifying monthly / quarterly stock statements submitted, the following observations are
made
 generally stock statements are not submitted on time;
 the itemwise details of stock is not given and instead lumpsum figures are shown without
quantitative details;
 if itemwise details are given, a comparison of statements submitted over a period of time
shows that the same stock is repeated over and over again with the same quantity and
value;
 there is heavy “sundry creditors” indicating unpaid stock, but the said amount has not
been deducted from the stock value, before determining the DP – drawing power limit of
the borrower;
 the stock statement contains details of stock, which have actually financed by the branch
under LC limit or Packing Credit limit or some other limits;
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 there is a huge difference in closing stock shown in the stock statement of 31st March,
2014 and audited/unaudited accounts submitted subsequently or better still, the borrower
does not submit the stock statement of March or the same is untraceable in the branch;
 the stock statement reflects an unusually high amount of “stock in transit” every month,
which does not commensurate with the monthly purchases or the monthly turnover in the
accounts;
 though mandated, the Branch has not obtained the “stock audit report”;
 the stock audit report has adverse comments, but

the Branch has not taken any corrective steps; OR

the Branch Manager states that subsequently he has visited the unit and everything
is rectified and regularised;
 the stock inspection done by the branch is superfluous and does not record the details of
the stock verified – a few direct indepth questions to the branch staff, who went for the
concerned stock inspection would reveal the quality of the inspection done;
 While verifying monthly / quarterly book debts statements submitted, the following
observations are made
 book debts due for more than 90 days are not segregated, though the same is mandated
in the Sanction letter;
 a comparison of last 10-12 month’s statement reveals that there are a number of book
debts, which probably are being shown for more than 8-10 months and may be bad
debts or recovered, but not deducted from the statement;
 A comprehensive 10-12 month’s analysis of monthly sales, purchase and stock as shown in
the stock statements, the book debts, the turnover in the accounts and the audited financial
statements may reveal that the stock statements submitted every month are highly inflated.
 Verification of other records at the branch
 verification of immovable property documents under ultra violet rays can reveal whether
the document is genuine or a photo copy;
 in immovable property loans, the branch has not obtained “search report” of the property
from the Registrar’s office, or the adverse comments in such report have been ignored;
 the branch has not obtained NOC from the builder / society or such NOC has been
personally brought by the borrower to the branch instead of the same being directly
obtained by the branch from the builder / society;
 in case of loans to limited companies, details of previous charges have not been obtained
or if any adverse observations have been made, the same are ignored – for eg. the report
shows that the borrower has borrowed from other banks without the knowledge /
permission of the existing banker, old charges which were supposed to have been
cleared have not been done indicating that old loans are still outstanding;
 there is correspondence on record, which states that on the same immovable property,
the borrower has obtained loans from more than one bank;
 the branch has filed a suit against the borrower to recover the amount;
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D. Classification of Advances
Prudential Norms on Income Recognition & Asset Classification and Provisioning (IRAC
Norms) (also referred to as Non-Performing Assets – NPA – Norms)

Norms prescribed by RBI since 1992 for Income Recognition and Asset Classification
Master Circular dt. 1st July, 2014 by RBI updated upto 30th June, 2014.
The paragraph numbers mentioned hereinafter pertain this above Master Circular

Banks to classify all advances into standard, sub-standard, doubtful and loss assets, based on
age of principal amount and interest overdue and the value of securities available there against.
Non Performing Asset (NPA)
An asset, including a leased asset, becomes NPA when it ceases to generate income for Bank.
Specifically, various assets can be termed as NPA as follows: [Para 2.1.2]
Any amount due under any credit facility becomes “overdue”, if it is not paid on the “due date” fixed
by the bank [Para 2.3]

Term Loan – interest and / or instalment remains “overdue” for more than 90 days

Overdraft & Cash Credit – the account remains “out of order” i.e.


outstanding balance remains continuously in excess of the sanctioned limit / drawing
power;
OR
outstanding balance is less than the sanctioned limit / drawing power limit, but there have
been no credits continuously for 90 days / the credits are not enough to cover the interest
debited during the same period. [Para 2.2]

Bill Purchased / Discounted – the bill remains “overdue” (i.e. not paid on the due date) for more
than 90 days

Agricultural Advance (for details of components of Direct Agricultural Advance, refer
Annexure-2 on Pg.82 of Master Circular)
 Short Duration Crop Loan – principal or interest thereon remains “overdue” for 2 crop
seasons [Para 4.2.13]
 Long Duration Crop Loan – principal or interest thereon remains “overdue” for 1 crop
season. [Para 4.2.13]

Securitisation Transaction – amount of liquidity facility remains “overdue” for more than 90 days
[Para 5.9.11]

Derivative Transaction – overdue receivables representing +ve mark-to-market value remain
unpaid for a period of 90 days [Para 5.9.12]
Income Recognition [Para 3]

Policy of income recognition is based on the record of recovery. Thus,
 Account considered as NPA, if interest charged during any quarter is not serviced fully within
90 days;
 On account becoming NPA, all accrued interest, fees, commission, etc., which has been
credited to income account, but has not been realised, has to be reversed; and
 Thereafter, all interest, etc. to be accounted on receipt basis and not accrual basis[Para 3.2]
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
March, 2015
In case of leased assets, the finance charge component which had been credited to income
account, but has not been realised, has to be reversed [Para 3.2.3]

The above norms are also applicable to all government guaranteed accounts [3.1.1]

Fees and commission earned as a result of renegotiation / rescheduling of outstanding debts
can be taken on accrual basis during the period covered by the renegotiation / rescheduled
extension of credit [Para 3.1.3]

Interest on advances against Term deposit receipts, National Saving Certificates, Indira Vikas
Patra, Kisan Vikas Patra and Life Insurance policies may be taken to income account, provided
adequate margin is available. However, advances against gold ornaments, government and
other securities are not covered by this exemption [Para 3.1.2]

In case of advances, where moratorium has been granted for payment of interest, interest
becomes “due” only after the moratorium period is over.[4.2.12(i)]

Similarly, in case of housing or other loans granted to staff, where interest is payable after
recovery of principal, interest becomes “due” only on the predetermined “due date”.[4.2.12(ii)]
Classification of NPAs [Para 4.1]

Substandard Asset – an asset which has remained NPA for a period of less than or equal to 12
months.

Doubtful Asset – an asset which has remained sub-standard for more than 12 months

Loss Asset – an asset which has been identified as such, but has remained to be provided for /
written off.
Provisions to be made [Para 5]
Provision has to be made for all the assets, whether it is a standard asset or a NPA. The norms for
provisioning are as follows:

Standard Asset – based on the type of advance, provision ranging from 0.25% (for a direct
agricultural & SME loans) to 0.40% for all other loans to be made, except on Commercial Real
Estate loans @1%, on Commercial Real Estate-Residential Housing Sector @0.75% and Upto
5% - on Restructured NPAs, now classified at Standard accounts. Provision not to be netted
from the gross advances in the balance sheet, but to be shown separately as “Contingent
Provision against Standard Assets” under “Other Liabilities & Provisions Others” in Schedule 5
of the balance sheet. [Para 5.5]

Substandard Asset – a general provision of 15% for secured portion of the advances (without
considering any ECGC cover or securities available) (20% on Infrastructure loans) and a
provision of 25% for unsecured portion of the advances to be made. [Para 5.4]
From FY 2009-10, rights, licenses, authorisations, etc. taken as collateral security in respect of
projects (including infrastructure projects) not to be considered as tangible security and hence
the advance to be unsecured [Para 5.4(iii)(a)]

Doubtful Asset – a provision of 100% to be made for unsecured portion of advances, while a
provision of 25/40/100% to be made on secured portion, which has remained doubtful for upto
1 year / 1 – 3 years / more than 3 years respectively. [Para 5.3]

Loss Asset – a provision of 100% of outstanding amount has to be made.[Para 5.2]
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
March, 2015
Liquidity facility for Securitisation Transactions – the amount of such liquidity facility outstanding
for more than 90 days should be fully provided for.[Para 5.9.11]
Summarized Position of Asset Classification & Provision is as follows:
Asset Classification
Performing (Standard)
Asset
(Overdue upto 90 days)
Provision Required
a) 0.25% on direct advance to Agricultural & SME sectors
b) 0.75% on Commercial Real Estate (Residential Housing
Sector loans)
c) 1% on Commercial Real Estate Sector loans
d) 0.40-2% on Housing loan with teaser rates
e) Upto 5% - on Restructured NPAs, now classified at
Standard accounts.
f) 0.40% on those not covered above
Non-Performing Asset (NPA)
(Overdue > 90 days)
- Sub-Standard
(NPA upto 12 months wef. 31st March, 2005)
- Doubtful
(Sub-standard / NPA for > 12 months / erosion
in security > 50%)
- Loss
(No chance of recovery / value of security <
10% of the outstanding)
15% on secured outstanding
(20% on Infrastructure loans)
25% on unsecured outstanding
25 / 40 / 100% for secured doubtful O/s
upto 1 year/ 1-3 years / > 3 years resp.
100% for unsecured doubtful advances
100%
Floating Provision
Besides specific provisions, the bank can also make additional provision [Para 5.6]. It can be used
only for extraordinary contingencies (general, market and credit) with prior approval of RBI
Floating provision can be netted from gross NPAs or can be treated as part of Tier II capital, under
the overall ceiling of 1.25% of Risk Weighted Assets [Para 5.6.3]
Banks to make comprehensive disclosures on this in the “Notes to Accounts”.
Country Risk Provision
Besides above provision, if in any country, the net funded exposure is one percent or more of its
total assets, banks are also required to make provision for country risk w.e.f. 31st March, 2003 on
net funded country exposure ranging from 0.25% to 100% as per the risk category classification
provided by RBI. [Para 5.9.8]
Provisioning Coverage Ratio
A new concept - Specific + Floating provision should reach 70% of Gross NPAs by 30th September,
2010 [Para 5.10]
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Certain Exemptions from Provision

Advances against Term deposit receipts, National Saving Certificates, Indira Vikas Patra, Kisan
Vikas Patra & Life Insurance policies need not be treated as NPA, provided adequate margin is
available. However, advances against gold ornaments, government and other securities are
not covered by this exemption.[Paras 4.2.11 & 5.9.2]

Leased Asset – separate guidelines have been given for similar provisions to be made for
secured and unsecured portion of leased assets. [Para 5.8]

In respect of agricultural and other advances granted by banks to PACS / FSS under the onlending system, only the particular credit facility which is in default (and not all credited facilities
granted to the PACS / FSS) would be classified as NPA.[4.2.10]

Post-shipment Supplier’s Credit – to the extent payment is guaranteed under ECGC, the same
need not be treated as NPA. [Para 4.2.17]

Export Project Finance – where there is documentary evidence available to show that the
foreign importer has paid the dues to the bank abroad, but the bank is unable to remit due to
political or other reasons, the asset classification may be made after a period of one year from
the date of deposit of the amount by the importer.[4.2.18]

Advances covered by BIFR / ECGC / CGTSI Guarantees – separate guidelines have been
given for provision to be made in case of accounts covered under the above. [Paras 4.2.19,
5.9.1, 5.9.4, 5.9.5]
Other Important Aspects of NPAs

Income recognition and asset classification is based on record of recovery and hence
availability of security or net worth of borrower / guarantor is not considered for the
purpose of treating an account as NPA or otherwise. [Para 4.2.3]

The above norms are the minimum prescribed. Additional provision can be made by the bank.
This additional provision not to be considered as floating provision and hence can be
used to net off advances.[Para 5.7]

NPA accounts are considered borrowerwise and not facilitywise. [Para 4.2.7(i)]

While determining the total advances recoverable from a borrower, debits arising out of
devolvement of LCs or invoked guarantees and not cleared are also to be added [Para 4.2.7(ii)]

In consortium advance, the record of recovery at the bank being audited only has to be
considered. [Para 4.2.8]

In working capital borrowal account, drawing power calculated from stock statement older than
3 months has to be considered as “irregular” (overdue). If such “irregular” continues for 90 days,
account has to be classified as NPA, even though the account is otherwise operated
regularly. [Para 4.2.4(i)]

Similarly, accounts where regular / adhoc limits are not reviewed within 180 days from the due
date / date of adhoc sanction, have to be considered as NPA. [Para 4.2.4(ii)]

Accounts regularised with a few credits around the Balance Sheet date need to be carefully
looked into (source of the credit, genuine entries, additional facilities granted in some other
account etc.) [Para 4.2.6]
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
In case of accounts where there is erosion in value of security or fraud has been committed by
borrower, the same should straightaway be classified as doubtful or loss; specifically  where value of security has eroded by more than 50%, account should be classified as
‘doubtful’ and
 where realisable value of security is less than 10% of the outstanding amount, the existence
of security should be ignored and the account should be classified as ‘loss’ [Para 4.2.9 &
5.4(ii)]

If government guaranteed advance becomes NPA, then for the purpose of income recognition,
interest on such advance has not to be taken to income unless interest is realised. However, for
purpose of asset classification, credit facility backed by Central Govt. guarantee, though
overdue, can be treated as NPA only when the Govt. repudiates its guarantee, when invoked;
this exception is not applicable for State Govt. guaranteed advances, where advance is to be
considered NPA if it remains overdue for more than 90 days w.e.f. year ended 31st March,
2006. [Para 4.2.14]

RBI has given extensive guidelines for dealing with a) Projects under implementation, b)
Takeout Finance, c) Post-shipment Supplier’s Credit, d) Export Credit Finance, e) Advances in
BIFR cases, f) Transactions involving Direct Assignment of Cash Flows and g) Credit Card
Accounts [Paras 4.2.15 to 4.2.21].

For all accounts classified as ‘Doubtful’, necessary to determine a)- the existence of primary and
collateral securities properly charged to the Bank, b)– its present value through approved valuer
(once in 3 years) and c) - inspection (periodical). In case of NPAs with balance of Rs.5 crores
and above, stock audit at annual interval by external agency is mandatory. [Note in Para 5.3]

Suit filed accounts should generally be classified as doubtful, unless there is a strong
justification to show it is Sub-standard.
Special Guidelines for NPAs
In the IRAC circular, over the years, RBI has issued and modified Guidelines for Restructuring of
Advances, and its purchase / sale by various entities.

Specific guidelines formulated on sale of financial assets to Securitisation Company /
Reconstruction Company. [Para 6]

Specific guidelines have also been formulated on sale / purchase of NPAs [Para 7] and writing
off of NPAs [Para 8]

Under the NPA norms, separate prudential guidelines have been provided on ‘Restructuring of
Advances by Banks’ [Part B – paras 10 to 18]. It includes 4 sets of guidelines on restructuring
of advances extended to –
(i)
(ii)
(iii)
(iv)

Industrial units
Industrial units under Corporate Debt Restructuring mechanism (CDR)
Small & Medium enterprises (SME)
All other advances
Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair Recovery for
Lenders [Part C – paras 19 to 36]
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Upgradation of Accounts [Para 4.2.5]

Reschedulement of recovery cannot give the advance a better classification than the previous
one.

NPA accounts can be upgraded to Performing Accounts, provided all overdues are adjusted or
atleast reduced to a period of less than 90 days

However, restructured / rescheduled accounts under CDR or SME schemes cannot be
upgraded until 1 year of satisfactory performance of the account.

Upgradation within the NPA category is not permitted i.e. a Doubtful account cannot be made
Sub-standard even if the overdues are reduced to less than 15 months.
Memorandum of Change (MOC) & Interpretation of Circular
 Once statement of accounts prepared and submitted to the Controlling Office, Auditors to make
changes only through MOC. Many a times, changes suggested by Auditors not acceptable to
Branch Managers and hence they refuse to sign the MOC. In this context, it may be noted that
MOC is prepared by Auditors and not mandatory for Branch Manager to sign it. Branch
Manager’s signature only denotes his concurrence to what has been stated by Auditors.

Further, Branch Managers interpret NPA Circular differently than what is actually stated in the
circular, under the pretext that it is being done in a particular way for the last so many years –
for eg. 3 to 5 year old vehicles, against which loans have become doubtful, are reflected at their
purchase price 3/5 years old and not their depreciated value, or though stocks or book debts
have not been inspected for a long period of time, their one or two year old values available with
the Branch are taken for purpose of security. This is a very frequently used method by Branch
Managers to avoid classification of NPAs or reduce the provision amount. It is recommended
that Auditors should strictly go by what is stated in RBIs circular, which is quite unambiguous
and not by the Branch Manager’s interpretation of the same.
E. Verification of Non-Funded Advances
Generally, verification of funded and non-funded advances done simultaneously; certain
components of non-funded advances need to be looked into. Reserve Bank of India has issued a
Master Circular dated 1st July, 2014 under the heading “Guarantees and Co-acceptances”
Non-funded advances called “Off Balance Sheet” items, as their value not reflected in Balance
Sheet. They form “Contingent Liability”. However, for purpose of keeping a control over these
items, banks pass contra entries in its books of accounts at branch level & hence these items get
reflected on liability as well as asset side of Trial Balance. However, while preparing Balance Sheet
of the bank as a whole, value of these items reflected in “Notes to Accounts”.
RBI has mandated banks not to do non-fund business (guarantees, co-acceptances, LCs) with
persons, who do not enjoy credit facilities with the bank.
(i)

Guarantees
Two types – financial guarantee, wherein guarantor (bank) promises to pay stated amount
to beneficiary, if person for whom guarantee is given, fails to pay the same (invoking the
guarantee); performance guarantee, wherein guarantor promises to pay beneficiary a stated
sum, if the person for whom guarantee is given, fails to perform, as expected, in a given
period of time. Banks generally discouraged from issuing Performance guarantees.
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
Comprises of two independent, but related components – one guarantee issued by banker
(of buyer) to beneficiary (i.e. seller) and other is counter guarantee given by buyer to his
banker.

Since invoked Guarantees become funded advance, banks not to encourage borrowers to
over extend their commitments solely on the basis of guarantees.

Guarantees for specific transaction (specific guarantee) or for multiple transactions within a
specific time frame (continuing guarantees); should be for short durations – maximum
maturity period - 10 years.

Unsecured Guarantees to a particular borrower not to exceed 10% of total exposure

Banks not to concentrate its unsecured Guarantees to a particular borrower or a group.

Ghosh Committee recommended precautions to be taken by banks while issuing
Guarantees.

Guarantees issued by keeping margins, either as cash / term deposit or some other
security.

Guarantees issued on behalf of share and stock brokers - RBI has advised banks to obtain
minimum margin of 50% (with 25% being cash margin)

RBI restrictions on guarantees of inter-company deposits / loans and inter-institutional
guarantees.

RBI - extensive guidelines on issue of guarantees on behalf of exporters and importers.
(ii)
Letter of Credit (LC)

LC a promise by banker to honour payments to be made by its customer (buyer or importer)
to seller or exporter. Generally used in international trade.

At request of buyer, his banker opens an LC, which is sent to seller. Based on such LC,
seller despatches goods and sends bills through his banker to the buyer’s banker to make
payment of the bill. Buyer makes payment and routes it through his banker to seller’s
banker.

In case buyer fails to make payment (devolvement of LC), buyer’s banker, who has opened
the LC, liable to make payment to seller.

RBI has mandated banks not to discount bills drawn under LCs or otherwise for
beneficiaries, who are not their regular clients.
(iii)

Co-acceptance of bills
Seller despatches goods and raises bill on buyer. Buyer accepts the bill and then it is coaccepted by buyer’s banker. The seller’s banker then discounts this bill.

Facility often used by customers to float accommodation bills (i.e. bills which are not
supported by genuine sale and purchase of goods) and hence auditors should be
careful while examining such bills.
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Annexure-1
List of some Important Master Circulars issued by RBI
S.No.
Date
Advances
1
1/7/2014
2
1/7/2014
3
1/7/2014
4
1/7/2014
5
1/7/2014
6
1/7/2014
7
5/7/2014
8
1/7/2014
9
1/7/2014
10
1/7/2014
11
1/7/2014
12
1/7/2014
13
1/7/2014
14
1/7/2014
Deposits
1
1/7/2014
2
3
4
1/7/2014
Foreign Exchange
1
1/7/2014
2
1/7/2014
3
1/7/2014
4
1/7/2014
5
1/7/2014
6
1/7/2014
7
1/7/2014
8
1/7/2014
Special Programmes
1
1/7/2014
2
1/7/2014
Miscellaneous
1
1/7/2014
2
1/7/2014
3
1/7/2014
4
1/7/2014
5
1/7/2014
6
1/7/2014
7
1/7/2014
8
1/7/2014
9
1/7/2014
10
1/7/2014
11
1/7/2014
12
1/7/2014
13
1/7/2014
14
1/7/2014
15
1/7/2014
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Particulars
Master Circular – Export Credit Refinance Facility
Master Circular – Guarantees and Co-acceptances
Master Circular – Guidelines for Advances during Natural Calamity
Master Circular – Housing Finance
Master Circular – Interest rates on Advances
Master Circular – Lending to MSME Sector
Master Circular – Lending to Priority Sector
Master Circular – Prudential Norms on Income Recognition, Asset Classification and
Provisioning of Advances
Master Circular – IRAC Norms for Projects under Implementation
Master Circular – Exposure Norms
Master Circular – Rupee / Foreign Currency Export Credit
Master Circular – Wilful Defaulters
Master Circular – Loans and Advances – Statutory and Other Restrictions
Master Circular – Self-Help Groups – Bank linkages
Master Circular – FCNR (B) Deposits
Master Circular – NRO Deposits
Master Circular – Interest rates on all Deposits
Master Circular – KYC Norms & AML Standards
Master Circular – Export of Goods and Services
Master Circular – Foreign Investments in India
Master Circular – Import of Goods and Services
Master Circular – Remittance from India Facilities for Residents
Master Circular – Remittance Facilities for NRI / PIO / FN
Master Circular – FCRA Obligations
Master Circular – Acquisition & transfer of immovable property in India by NRI/PIO/FN
Master Circular – Vostro Accounts
Master Circular–Priority Sector - Credit Facilities to Minority Communities
Master Circular–Priority Sector - Credit Facilities to SC and ST
Master Circular – Branch Authorisation
Master Circular – Para-Banking Activities
Master Circular – Prudential Guidelines on Capital Adequacy (New CA Framework)
Master Circular – Prudential Guidelines on Capital Adequacy-Basel III
Master Circular – Frauds – Classification and Reporting
Master Circular – Prudential Norms on Investments
Master Circular – Customer Service in banks
Master Circular – Exemption from provisions of RBI Act
Master Circular – Credit Card / Debit Card Operations of Banks
Master Circular – Disclosure in Financial Statements - Notes to Accounts
Master Circular -- CRR and SLR
Master Circular – Disbursement of Pension
Master Circular – Govt. Business
Master Circular – Office by Foreign Entities
Master Circular - OLTAS
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Annexure - 2
_____________ BANK
Loan Verification
Name : ____________________________________________________________________
Facility Type
Limit (Rs. in lacs)
O/s
Sanctioning Authority
Documents Verified
Insurance
Other Sanction terms / Expiry date
Lien/Mortgage/ROC reg. etc.
Stock/Book Debt Statements
Stock Audit
Inspection/ Physical verification/Valuation
Operations/Overdrawings
Audited Statements
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Annexure-3
August 7, 2004
Deficiency found in sanctioning of loans and monitoring of
borrowal accounts by banks / financial institutions
I. Deficiencies at the stage of sanction
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
(ix)
(x)
(xi)
There were deficiencies in the appraisal of credit proposals. High projections of the borrowing company were
not critically analysed by the sanctioning authorities. With the result, the borrowers’ credit requirements were
not properly assessed. In some cases, the credit limits were sanctioned on the basis of appraisal made by
the Merchant Banking Division for the purpose of public issue. In such cases, the existence of a conflict of
interest was not always appreciated, as the arranging of finance was one of the services, which the
Merchant Banker was rendering to the borrower. The bank relied on such appraisal and no separate
assessment for credit risk was done. There were instances where term loans were sanctioned without
insisting on the project report, cost of project and means of finance.
At the time of mid-term review of the projects, additional loans were sanctioned without proper appreciation
of the market conditions and the factors which led to time and cost overruns in the projects by the
sanctioning authorities.
The sanctioning authorities had overlooked the irregularities pointed out by the lower level functionaries in
the borrowal accounts or in the accounts of the group companies based on stock verification reports, audit
reports, etc. and sanctioned the facilities. They had not taken into account the fact that the existing accounts
of the borrower were irregular, audit objections not cleared, estimates inordinately inflated and the vital
issues either not commented upon or wrongly commented in the inspection / audit report itself.
The sanctioning authorities were not given full facts about the borrowers and the projects by the officials in
controlling office / branch. This was mainly because the branch did not make proper scrutiny of the
borrowing company’s antecedents and verify the claims of achievements by them.
Contrary to the above, the sanctioning authorities had adequate facts about the unsatisfactory position of the
borrowal accounts and yet facilities were sanctioned overlooking the deficiencies.
There were instances where the sanction itself was not justified on the basis of projections made by the
borrowers and valuation of securities offered by them.
Sanctions were made deviating from the laid down policy on extending finance for capital expenditure / long
term working capital. In one case, facilities were sanctioned by the bank’s board in violation of its own
internal norms.
Sanctioning authorities overlooked the fact at the time of take over of accounts that the borrowing company
had irregular accounts with the previous bank/s.
Adhoc limits were sanctioned frequently even if the company had regular limits and its accounts were
running irregularly. At times, such limits were sanctioned by branch / Zonal Office / Central Office level
functionaries in excess of their delegated powers. Revival packages were also sanctioned by the Regional
authorities in respect of credit limits originally sanctioned by the bank’s Head Office Committee.
The terms and conditions prescribed at the time of sanction of loan facilities were subsequently relaxed by
the sanctioning authorities themselves while disbursing funds without any justification for such relaxation.
In some cases, it appears that the sanctioning authorities had acted on extraneous influences, rather than
deciding on the merits of the case. The borrowal account finally turned into a non-performing asset.
II. Deficiencies at the monitoring stage
(i)
(ii)
(iii)
(iv)
Loans / advances were released by the branch officials in blatant violation of the terms and conditions of the
sanction laid down by the Central Office.
No proper monitoring of the end-use of the funds by the borrowers was noticed in a few cases. Cases of
such diversion of funds in larger accounts were not reported to the bank’s Board for their information and
providing required direction in the matter.
Monitoring of the company’s financial standing especially with reference to the financial indicators was not
carried out effectively.
Undue reliance on the certificates given by the Chartered Accountants / Valuers without co-relating them
with other relevant procedures was noticed. For example, in the case of projects under implementation,
reliance was placed on the certificates without adequate monitoring of the progress of construction through
site visits. Similarly, in respect of certificates for verification of inventories, there was inadequate correlation of
the figures with audited financial statements and also inadequate follow-up on deficiencies reported. In one
case, it came to light subsequently that the borrower company had produced forged expenditure certificates
from the Chartered Accountants.
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(v)
(vi)
(vii)
(viii)
(ix)
(x)
(xi)
(xii)
March, 2015
There was also lack of proper monitoring even with regard to very important terms and conditions of the term
loan sanction such as, tie up of funds, stipulation of promoter’s contribution, etc leading to disproportionate
lending by the banks / FIs.
As regards working capital limits, failure to detect disappearance of stocks given as security had resulted in
misappropriation of funds / sale of stock and realization of receivables without the knowledge of banks/FIs.
Failure to ensure adequacy of the security offered by the borrowers, especially failure to verify whether the
same asset was mortgaged to another bank / FI was also noticed.
Periodical reviews of accounts were not undertaken after the funds were lent by the banks / FIs.
Proper assessment of the financial standing of the projects was not carried out when the bank / FI took over
an account from another bank.
Excess drawings permitted by the branch / Regional Office level functionaries, in the borrowal accounts were
ratified by the Head Office in a routine manner without examining the need for such permissions, at times,
frequently.
Limits sanctioned were allowed to be interchanged indiscriminately by the branch officials without proper
authority.
In cases pertaining to term loans for financing projects, important terms and conditions of the sanction
stipulated by the Board of Directors such as induction of technical directors, constitution of Audit Committees
and independent project monitoring committees are not taken seriously. Many a times, non-compliance even
at the stage of the release of the final instalment of the loan sanctioned is not taken seriously. This is a very
serious lacuna which cuts at the root of the principles of project management and project financing.
III. Suggestions to improve the system
The following suggestions are made with a view to improving the system.
(i)
In many cases diversion of funds is facilitated by opening of accounts with other banks wherein the sale
proceeds / proceeds of realized book debts are credited, without the knowledge of the lending bank. With a
view to prevent such malpractices, the lending bank should obtain a certificate from the borrowers on a
quarterly basis furnishing details of accounts opened with other banks.
(ii)
It is noticed that the banks rely on the certificates of valuation given by the external valuers which in some
cases were subsequently found to have shown grossly inflated values. It is, therefore, suggested that the
setting up of independent cells for valuation within banks themselves, which are manned by technical
personnel with the right expertise is considered seriously.
(iii)
Immediate action should be taken where the malafides / gross negligence on the part of dealing officials are
noticed. The Advisory Board finds that in the large majority of cases, administrative action is either not
initiated well in time or not initiated at all.
(iv)
Wherever there is a prima-facie case against the dealing officials, appropriate action in terms of CVC
guidelines for their inclusion in the list of officers with doubtful integrity should be initiated by banks / FIs in
consultation with the CBI.
(v)
While processing loan applications, there is no scientific application of mind by the bank officials in
observance of compliance with the stipulated terms and conditions by the borrowers and as a result, certain
serious defaults had occurred causing systemic failure of the financial sector. It is, therefore, suggested that
banks/FIs should evolve a process of check listing which would enable them to take note of any deficiencies
while releasing the funds to the borrowers or monitoring the end use of funds.
(vi)
There is a need for building up a cadre of officials with proper educational background and training to take
care of at least larger projects being financed by the banks / FIs.
(vii) Perhaps the single largest cause of financial loss to the lending institutions is the fact that in respect of
project finance, disbursements are not made by the lending institution in proportion to the funds disbursed by
the promoter / borrower. In several cases, the promoter / borrower is unable to bring in or raise the funds
which he is required to provide in terms of the sanction and consequently, in order to protect the investment
already made, the lending institution has to provide additional funds not envisaged in the original proposal.
The same situation persists when there are cost over-runs, whereby the exposure of the lending institution
gets increased.
This problem can be avoided if the promoter / borrower is required to bring in up-front his contribution (other
than funds to be provided through internal generation) and the lending institution commences its
disbursement only after the stipulated funds are brought in by the promoter / borrower.
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