Guidance Note On Audit of Banks

Guidance Note on
Audit of Banks (2021 Edition)
Attention
Members’ attention is invited to relevant directions/circulars issued by the

Reserve Bank of India up to February 05, 2021 available at ICAI website
for ease of use and reference. Members are advised to keep track of
legislative/regulatory developments, for example, circulars of the Reserve
Bank of India, issued subsequent to the aforementioned date and having
a bearing on the statutory audit of banks/bank branches for the year
ended March 31, 2021.
Members are also advised to read this Guidance Note in conjunction with
other two publications (Technical Guide on Audit of Internal Financial
Controls in Case of Public Sector Banks and Technical Guide on Revised
Formats of Long Form Audit Report) of AASB.
The Institute of Chartered Accountants of India

(Set up by an Act of Parliament)
New Delhi
 The Institute of Chartered Accountants of India
All rights reserved. No part of this publication may be reproduced, stored in a
retrieval system, or transmitted, in any form, or by any means, electronic,
mechanical, photocopying, recording, or otherwise, without prior permission, in
writing, from the publisher.
First Edition : November, 1994

Second Edition : March, 2001
Third Edition : March, 2005
Fourth Edition : March, 2006
Fifth Edition : February, 2008
Sixth Edition : February, 2009
Seventh Edition : March, 2011
Eighth Edition : March, 2013
Ninth Edition : February, 2014
Tenth Edition : February, 2015
Eleventh Edition : January, 2016
Twelfth Edition : February, 2017
Thirteenth Edition : March, 2018
Fourteenth Edition : February, 2019
Fifteenth Edition : March, 2020
Sixteenth Edition : March, 2021
Committee/
Department : Auditing and Assurance Standards Board
Website : www.icai.org
E-mail : aasb@icai.in
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ISBN : 978-81-8441-690-9
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March /2021/P2825(Revised)
Foreword
Banking Sector in India is rapidly changing due to technological innovation,

financial liberalization with entry of new private and foreign banks, introduction of
new products/services and geographical expansion. Banks function under the
supervisory and regulatory directions of the Reserve Bank of India to minimise
the internal and external risks that are faced by banks. Statutory Audit helps
banks to provide the stakeholders a comfort with regard to credibility of the
financial statements of banks.
In order to maintain quality of bank audits, it is essential that the statutory
auditors are well equipped in terms of their knowledge of the banking sector and
keep themselves abreast with the latest developments in banking sector. The
Guidance Note on Audit of Banks brought out by the Auditing and Assurance
Standards Board of ICAI every year is an important resource which provides
detailed guidance to the members on various aspects of bank audits.
I am happy to note that the Auditing and Assurance Standards Board of ICAI has
come out with revised 2021 edition of the “Guidance Note on Audit of Banks” for
the benefit of the members and stakeholders at large. The Guidance Note is
comprehensive and self-contained reference document. The Revised edition
incorporates the impact of the various circulars of the Reserve Bank of India as
well as certain important advisories, pronouncements of the ICAI which would be
relevant to bank audits for the financial year ending March 31, 2021.
I compliment CA. G. Sekar, Chairman, CA. Shriniwas Y. Joshi, Vice-Chairman,
and other members of the Auditing and Assurance Standards Board for bringing
out this revised Guidance Note to assist the members in maintaining quality in
bank audits. I also acknowledge the contribution of CA. (Dr.) Debashis Mitra,
Vice President, ICAI (Contributed as Co-Convenor of the study group) and CA.
Prasanna Kumar D, Convenor of the study group in revising this Guidance Note.
I am confident that the members and other stakeholders would find the Guidance
Note highly useful in their professional assignments.
New Delhi CA. Nihar N Jambusaria

March 19, 2021 President, ICAI
Preface
Banking in India has become service oriented, maturing from the days of ‘walking
in business’ to the present situation of 24*7 banking solutions to attract
customers. With such widespread and rapid growth of the banking industry and
their entry into a wide variety of services like insurance, mutual funds, etc., the
onus of the healthy sustenance and growth of the banking industry lies on the
back of reliable financial statements which can only be assured by quality audits.
The bank audit is thus an important step for all banks who seek a better
optimization of its overall management. It is essential that the members
undertaking statutory audit of banks, both at the branch as well as the central
level, keep themselves abreast with the latest developments in the banking
sector. The Auditing and Assurance Standards Board of ICAI has been helping
the members in maintaining quality in bank audits by bringing out its benchmark
publication “Guidance Note on Audit of Banks” to provide detailed guidance to
the members who undertake audits of banks and their branches. The Guidance
Note is updated every year to incorporate the recent updates, impact of
amendments and changes in banking environment which require attention of
statutory auditors, such as, master directions/circulars of RBI, relevant
advisories, pronouncements of ICAI having bearing on bank audits and
amendments/changes in applicable laws or regulations.
We are happy to place in your hands this revised 2021 edition of the Guidance
Note on Audit of Banks. The Guidance Note is broadly bifurcated into two
Sections i.e. Section A - Statutory Central Audit and Section B - Bank Branch
Audit. For benefit of the members, the Guidance Note also contains various
Appendices like illustrative formats of engagement letter, illustrative formats of
auditor’s report both in case of nationalized banks and banking companies,
management representation letter, the text of master directions, master circulars
and other relevant circulars issued by RBI.
RBI has made reporting on internal financial controls mandatory for statutory
auditors of public sector banks from the financial year 2020-21 onwards. Further,
RBI has issued revised formats of LFAR in September 2020 which will be
applicable for audits of banks for the financial year 2020-21 and onwards. To
provide specific guidance to the members on these aspects, two separate
publications i.e. “Technical Guide on Audit of Internal Financial Controls in case
of Public Sector Banks” and “Technical Guide on Revised Formats of Long Form
Audit Report” have been issued by Auditing and Assurance Standards Board.
Accordingly, we request the members to use this Guidance Note in conjunction
with the aforesaid publications.
At this juncture, we wish to place on record our sincere gratitude to CA.
Prasanna Kumar D, Central Council Member, ICAI and Convenor of the Study
Group and other study group members for revising the Guidance Note.
We express our sincere thanks to CA. Nihar N Jambusaria, Honourable

President, ICAI, CA. (Dr.) Debashis Mitra, Honourable Vice-President, ICAI and
CA. Atul Kumar Gupta, Honourable Immediate Past President, ICAI for their
guidance and support to the activities of the Board.
We are thankful to all the Board Members and Central Council Members for their
guidance and support in finalizing this Guidance Note. We appreciate the efforts
made by CA. Megha Saxena, Secretary, AASB, CA. Nitish Kumar, Executive
Officer, CA. Samriddhi Bhatt, Assistant Project Officer, Ms. Anitha P., and Mr.
Chirag Popli for their hard work in giving the Guidance Note its final shape.
We are sure that the members would find the Guidance Note useful while
conducting audits of banks and bank branches.
CA. Shriniwas Y. Joshi CA. G. Sekar

Vice Chairman Chairman
Auditing and Assurance Standards Board Auditing and Assurance Standards Board
Acknowledgement
The Board acknowledges the contribution made by the following members of the
Study Group constituted for the purpose of revising the Guidance Note on Audit
of Banks and we place on record our gratitude for their contribution in enrichment
of knowledge of the members:
CA. Pramod Jain, Central Council Member, ICAI, CA. Dhananjay J. Gokhale,
CA. M.M. Khanna, CA. Mangesh Pandurang Kinare, CA. Cotha S Srinivas, CA.
S. Ramesh, CA. Premnath Degala, CA. Gopalakrishnan A, CA. Chirag Bakshi,
CA. Rajan R G, CA. Anand P, CA. Vivek Newatia, CA. Venugopala Rao P, CA.
Rajendra Prasad Agarwal, CA. Ashutosh Pednekar, CA. Sanjay Khemani, CA.
Abhijit Sanzgiri, CA. Niranjan Joshi, CA. Sandeep D. Welling, CA. Parag
Hangekar, CA. Manish Sampat, CA. Lokesh Gupta, CA. Nilesh Joshi, CA.
Gautam V. Shah, CA. Vikas Kumar, CA. Abhay V. Kamat, CA. Kuntal P. Shah,
CA. Rahul Joglekar, CA. Nachiket Deo, and CA. (Dr.) Yogesh Satpute.
CA. Shriniwas Y. Joshi CA. G. Sekar

Vice Chairman Chairman
Auditing and Assurance Standards Board Auditing and Assurance Standards Board
Contents
Foreword
Preface
Section A – Statutory Central Audit ........................... 1-232
Chapter 1: Personal Banking and Operations Department ........................... 1-3

Chapter 2: Retail Banking and Marketing Department .................................... 4-9
Chapter 3: Wealth Management and Third Party Products ......................... 10-14
Chapter 4: International Banking Division ................................................... 15-16
Chapter 5: Treasury Operations .................................................................. 17-116
Chapter 6: Audit of Information Technology and Digital Banking
Division .....................................................................................117-143
Chapter 7: Human Resources Department ............................................ 144-147
Chapter 8: Large Corporate and Loan Syndication ...............................148-149
Chapter 9: Micro, Small and Medium Enterprises Department ............... 150-154
Chapter 10: Rural and Agricultural Business Department .........................155-157
Chapter 11: Law Department ..................................................................... 158-162
Chapter 12: Credit Recovery Department .................................................. 163-164
Chapter 13: Risk Management Department ............................................. 165-182
Chapter 14: Central Audit and Inspection Department ..............................183-186
Chapter 15: Credit Monitoring and Restructuring Department .................. 187-193
Chapter 16: Consolidation and Balance Sheet Preparation ......................194-216
Chapter 17: Government Business Department ........................................ 217-222
Chapter 18: Consolidation of LFARs for the Bank ..................................... 223-227
Chapter 19: Certification .............................................................................. 228-232
Section B – Bank Branch Audit .............................. 233-793
Chapter 1: Practical Guide for Statutory Branch Auditors performing
Bank Branch Audit for the First Time ......................................235-242
Chapter 2: Bank Branch Audit Planning ....................................................243-245
Chapter 3: Audit Documentation in Bank Branch Audit ............................246-247
Chapter 4: Overview of Standards on Auditing .........................................248-268
Chapter 5: Special Considerations in a CBS Environment.......................269-282
Chapter 6: Cash ..........................................................................................283-284
Chapter 7: Balances with Reserve Bank of India, State Bank of India and
Other Banks (For Branches with Treasury Operations) .........285-286
Chapter 8: Money at Call and Short Notice ..................................................... 287
Chapter 9: Investments (For Branches Outside India) .................................... 288
Chapter 10: Advances-Agriculture ...............................................................289-313
Chapter 11: Reporting for Advances ............................................................314-504
Chapter 12: Fixed Assets and Other Assets ...............................................505-518
Chapter 13: Borrowings and Deposits .........................................................519-552
Chapter 14: Other Liabilities .........................................................................553-557
Chapter 15: Contingent Liabilities and Bills for Collection ..........................558-575
Chapter 16: Profit and Loss Account ...........................................................576-599
Chapter 17: Audit Reports and Certificates .................................................600-641
Chapter 18: Gold/Bullion/ Security Items .....................................................642-643
Chapter 19: Books and Records ..................................................................644-646
Chapter 20: Inter Branch/ Office Accounts ..................................................647-653
Chapter 21: Fraud .........................................................................................654-663
Chapter 22: Miscellaneous ...........................................................................664-665
Chapter 23: Audit of Foreign Exchange Business ......................................666-690
Chapter 24: Clearing House Operations by Service Branches ..................691-695
Chapter 25: Recovery of Non-Performing Assets by
Asset Recovery Branches ........................................................696-706
Chapter 26: Bank Branch Audit and GST Compliance ...............................707-793
Contents available at ICAI website
A. Foreword and Preface of Past Years
B. Text of Guidance Note on Audit of Banks, 2021 Edition
C. Appendices of Guidance Note on Audit of Banks, 2021 Edition
 Appendices of Section A - Statutory Central Audit of Guidance Note on
Audit of Banks, 2021 Edition
 Appendix I : Illustrative Format of Report of the Auditor of a
Nationalised Bank
 Appendix II : Illustrative Format of Report of the Auditor on the
Standalone Financial Statements of Banking
Company
 Appendix III : Illustrative Format of Engagement Letter in case
of a Nationalised Bank
 Appendix IV : Illustrative Format of Engagement Letter in case
of a Nationalised Bank (Separate only for Audit of
Internal financial controls over financial reporting)
 Appendix V : Illustrative Format of Engagement Letter to be
sent to the Appointing Authority of the Banking
Company
 Appendix VI : Illustrative Format of Engagement Letter to be
Sent to the Appointing Authority of the Banking
Company (Separate only for Audit of Internal
Financial Controls over Financial Reporting under
section 143(3)(i) of Companies Act, 2013)
 Appendix VII : Illustrative Format of Management Representation
Letter to be obtained from Bank Management in
case of Statutory Central Audit
 Appendix VIII : Illustrative Format of Management Representation
Letter to be obtained from Bank Management in
connection with the Limited Review
 Appendices of Section B – Bank Branch Audit of Guidance Note on Audit
of Banks, 2021 Edition
 Appendix I : Text of Section 6 of the Banking Regulation Act,
1949
 Appendix II : The Third Schedule to the Banking Regulation
Act, 1949
 Appendix III : Illustrative Format of Report of the Branch Auditor
of a Nationalised Bank
 Appendix IV : Illustrative Format of Report of the Branch Auditor
of a Banking Company
 Appendix V : Illustrative Format of Engagement Letter to be
sent to the Appointing Authority of the
Nationalised Bank by Branch Auditor
 Appendix VI : Illustrative Format of Engagement Letter to be
sent to the Appointing Authority of the
Nationalised Bank by Branch Auditor (Separate
only for Audit of Internal financial controls over
financial reporting)
 Appendix VII : Illustrative Format of Written Representation
Letter to be obtained from the Branch
Management
 Appendix VIII : Suggested Abbreviations used in the Banking
Industry
 Appendix IX : Illustrative Bank Branch Audit Programme for the
Year ended March 31, 2021
 Appendix X : Typical reasons for the divergence observed in
asset classification (large accounts) by banks vis-
à-vis supervisory assessment made by RBI during
Supervisory Cycle 2019-20 (FY 2018-19)
 Appendix XI : Advisory for Statutory Bank Branch Auditors w.r.t.
Specific Considerations while conducting Distance
Audit / Remote Audit / Online Audit of Bank
Branch under current Covid-19 situation issued on
May 6, 2020
D. Text of Relevant Master Circulars Issued by RBI

E. Text of Relevant Master Directions issued by RBI
F. Text of Relevant Notifications, FAQs and General Circulars
Section A –
Statutory Central Audit
1
Personal Banking and
Operations Department
Introduction
1.01 The area of operation / function of the Personal Banking and Operations
Department is typically confined to the resource mobilization, i.e., source of funds
(for the bank) in the form of CASA Deposits, Term deposits and customer service
and operations. This department is responsible for monitoring the deposit portion
which is major contributor for the bank as resource of funds.
1.02 In today’s new age banking, there are various innovative products which
are launched by every bank which has its own unique characteristics and
customisation based on the need for funds and customer portfolio of the bank.
For example, the bank may have deposit products as well as products / services
linked with categorisation of customers based on predefined criteria offering
privileged banking services to certain section of customers. In the era of
liberalisation of rate of interest, every bank is expected to be proactive in terms of
decision making for rate of interest. Further, the banks do have specified polices
w.r.t. bulk deposits and the bank may offer need-based special rates on such
deposits.
Preparation / Planning
1.03 The Statutory Central Auditor (SCA) should obtain deposit policy of the
bank and rules and regulations related to deposits as framed by the bank.
Further, the auditor should get himself acquainted with the various deposit
products of the bank along with rules relating thereto. The bank may have
various methodologies adopted for interest payment wherein the deposits can be
non-cumulative or cumulative and in certain cases the bank may launch
schemes wherein there is a bullet payment of interest at the end of the tenure of
deposits without compounding of interest.
Conduct / Execution
1.04 The Auditor is required to carry out the following:
 Verify the application of rate of interest vis-à-vis interest table to every
product of deposits by taking sample accounts of each type of deposit
product including instances of premature withdrawal of deposits,
retrospective renewal of deposits.
Guidance Note on Audit of Banks (Revised 2021)
 Verify whether the TDS flag is correctly configured wherever Form 15G/15H
have been received by the Bank and that TDS as per the rates in force has
been deducted on interest payments made during the year.
 Verify whether the accounting effects of interest payable in the form of
interest accrued but not due and interest accrued and due are correctly
given and TDS compliances thereon.
 Verify the compliance of internal circulars of the bank in terms of
categorisation of customers and application of the said terms in the master
data of such deposit holders.
 Verify the compliance with the rules and regulations formulated by the bank
related with the deposit products based on sample check.
 Verify the complaints lodged w.r.t. the customer services and contingent
liability / liability arising thereon.
 Verify the special rate deposits (those deposits wherein rate of interest is
deviated as compared to the interest table) as regards the eligibility and
approval of the same as per the internal policy of the bank.
Reporting / Conclusion
1.05 Check whether the appropriate presentation of deposits is made in
financials of the bank with reference to the type of product, interest accrued
thereon and also verify the requirement for disclosure of contingent liability, if
any, arising out of consumer court and other cases, related to deposits. Based
on audit issue, appropriate reporting of adversities observed in the Deposit
section and customer services needs to be done.
1.06 Readers may note that for the reference and benefit of the members
various illustrative formats for Auditor’s Report, Engagement Letter, and
Management Representation Letter are given in the Appendices to Section A
(Available on ICAI website) of the Guidance Note on Audit of Banks (2021
Edition) as follows:
Appendix I – Illustrative Format of Report of the Auditor of a

Nationalised Bank
Appendix II – Illustrative Format of Report of the Auditor on the
Standalone Financial Statements of Banking Company
Appendix III – Illustrative Format of Engagement Letter in case of a
Nationalised Bank
2
Appendix IV – Illustrative Format of Engagement Letter in case of a

Nationalised Bank (Separate only for Audit of Internal
financial controls over financial reporting)
Appendix V – Illustrative Format of Engagement Letter to be sent to the
Appointing Authority of the Banking Company
Appendix VI – Illustrative Format of Engagement Letter to be sent to the
Appointing Authority of the Banking Company (Separate
only for Audit of Internal Financial Controls under section
143(3)(i) of Companies Act, 2013)
Appendix VII – Illustrative Format of Management Representation Letter
to be obtained from Bank Management in case of
Statutory Central Audit
Appendix VIII – Illustrative Format of Management Representation Letter
to be obtained from Bank Management in connection
with the Limited Review
3
2
Retail Banking and Marketing
Department
Introduction & Bank’s process

2.01 Banks generally provide various retail advances namely:
 Home loans and loans against property
 Vehicle/Automobile loans
 Education loans
 Personal loan
 Consumer durable loans
 Credit cards
 Micro finance loans
 Jewel loans or Gold Loan
2.02 Generally, loans are either sourced through direct selling agents or
through bank’s own branches. The bank has a credit policy which specifies the
process to be followed for sanction and disbursement of loan and the various
documents required. Sanction for retail loans and management of retail loans
cannot be outsourced.
2.03 The Reserve Bank of India (RBI) has prohibited banks from deploying
direct selling agents (DSAs) to sell retail loans and verifying borrowers'
documents. KYC procedures, involving verifying borrowers' original documents
should be performed by bank officials and cannot be outsourced.
2.04 Generally, the credit assessment process is different from corporate
loans. The bank generally collects following documents:
 Completely filled Loan Application Form with customers’ signature.
 Income proof like Salary slip, financial statements, Income tax returns,
Bank statement.
 Photograph.
 Business continuity proof (e.g. Form D of Maharashtra Shops and
Establishment Act/ Any other govt. certificate for doing business).
 Residence proof.
 Identification proof.
 Contact Point – Mobile No of applicants is mandatory.
 Age proof.
 PAN Card.
 Aadhaar Card.
Credit Due Diligence for Retail Financing
2.05 Credit due diligence for a retail financing is different from the
wholesale financing since the quantum of loan and the complexity of
transaction is different. Retail finance credit due diligence is parameterised /
score card driven wherein if the borrower fits into a pre-defined credit matrix /
parameters and gets a score which is above the threshold, loan is approved /
sanctioned. The scorecard parameter would be suitably deliberated and
considered based on historical experience and keeping in view the dynamic
environment like minimum income criteria, employment details, age, telephone
etc. Once the score is generated the bank would also run CIBIL score and if
CIBIL score is above the specific score then the bank considers further sanction.
The scorecard based approved portfolio is closely monitored at regular
frequency and the parameters are suitably modified based on portfolio’s
performance.
2.06 For example, for farm / tractor loan, parameters / factors like soil
fertility, area under cultivation, produce per acre, rainfall / reservoirs levels,
make model of the tractor, geography are pre-defined and weightages are
assigned to each parameter depending on the criticality which will throw up a
score for each borrower. These models/ score cards are embedded in the loan
management system of the banks which result into auto approval of the loan.
While the quantum of the loan is small, number of retail borrowers is
significantly large and therefore it is time consuming for banks to evaluate
credit for each borrower. Hence credit loan approval for retail financing is
primarily score card driven. Parameters could be qualitative and quantitative in
nature.
2.07 Banks generally have a system in which various information collected
are keyed into the system. Generally the system automatically runs a credit filter
report. The credit filter report is based on pre-defined criteria as per the credit
policy like minimum income criteria, employment details, age, telephone etc. and
the score are generated from the system.
2.08 As a part of sanction process of the loan, the bank also runs CIBIL
score and if CIBIL score is above the specific score then the bank considers for
further sanction.
5
2.09 The bank also conducts field investigations on the proposed customer
which generally involve residential and office visits. Few banks also have the
process of Fraud Containment Unit (FCU) screening of selected sample of file. At
the FCU, the FCU officer screens through the genuineness and authenticity of
the documents from the perspective of any traces of a fraud.
2.10 Post such verification by FCU, the bank also initiates the Positive de-
duplication check for positive database, wherein if the customer is an existing
customer of the bank, the system gets the popup of such links on his screen.
2.11 The credit officer initiates the negative de dupe check on the negative
database through system, Negative De dupe check against the RBI defaulter list,
terrorists list and declined applications. Such list is uploaded in the system by
Central team of the bank. If the customer is traced under such negative listing
then loan application is rejected by the credit officer in the system. Once, all the
processes are completed, based on the results, the bank sanctions the loan.
Post Disbursement Monitoring
2.12 Once the funds are disbursed, periodic reviews on the
portfolio/borrowers/assets are conducted by the relevant Business and Credit
Departments. Notwithstanding sound appraisal processes and risk
management, some portfolios / accounts may develop weakness on account of
changes in internal or external conditions. Mechanisms for monitoring and
identifying early warning signals (EWS) should be in place to review the
portfolio and identify such weak accounts before they turn NPA. These
monitoring mechanisms will help the bank to take remedial measures and limit
losses. Such monitoring can be undertaken through the following:
Retail Financing
Roll forward / roll back rates – (deterioration on days past due / improvement in
days past due).
Infant / Early delinquencies – non payment of first EMI / instalments.
Performance review across branch / scheme / program / Relationship
Manager etc., Scorecard parameter reviews.
Credit Risk Rating Process
Audit approach, procedures including regulatory considerations
A. Preliminary Check
2.13 An auditor should review product note or circular or policy related to
every loan product under the audit. Also, review that the product note/ policy/
circular is in line with RBI guidelines.
2.14 In retail advance, the volume of transactions are high; hence the
6
auditor needs to apply effective sampling to ensure proper coverage. While

selecting sample, the auditor may consider loan sanctioned/ disbursed near to
reporting date, high/low in interest rate sanctions as compared to average rate,
coverage of different branches and different type of loans.
2.15 An auditor should look at the following documents for checking the
bank process for selected sample accounts:
i. Prescribed Application form.
ii. CIBIL Check of borrower and guarantor.
iii. KYC Compliance.
iv. Income proof like salary slip, financial statement, Income tax returns, Bank
statement.
v. Property Valuation Report.
vi. Title clearance report in case where property like flat, plot, building is
mortgaged.
vii. Technical review in case of mortgage of machinery.
viii. In case of vehicle loans, copy of original invoices, copy of RC and
insurance policy of vehicle with bank clause should be obtained.
ix. In case of education loans, document for the studies in affiliated
universities/colleges, prospectus and fees details should be obtained.
x. Whether the Bank has complied with the particulars given in the
documentation manual.
xi. If the loan is taken over from another bank, satisfactory performance
report from that Bank needs to be collected.
xii. If any additional limit is granted, ensure the security and eligibility is being
considered.
xiii. Whether the Bank has obtained legal security report addition to valuation
report.
xiv. Whether all registers required by the Bank/Branch are kept updated.
xv. Confidential Report and NOC from the existing bankers.
xvi. Valuation report in case of Gold loan.
B. Disbursement
2.16 The auditor should check that the disbursement should happen only if
all the terms and conditions of the sanction letter have been fulfilled and an
acceptance letter for the same has been obtained.
Also check whether processing charges, inspection charges, mortgage charges
and documentation charges have been collected by the bank.
7
C. Post Disbursement Inspection

2.17 The bank should have a proper check on the active accounts. The
important elements that a statutory auditor can check are as follows:
i. There should be an acceptance letter duly acknowledged by the borrowers
& guarantors, if any for all the loan accounts.
ii. Execution of the loan documents should be as per the terms and conditions
of the sanction letter.
iii. All the original documents are held in the safe custody in fire resistance
safe.
iv. Valuation of Securities.
v. External and Internal Credit Rating.
vi. Due Diligence Certificate.
vii. Verify if the payment schedule as per the sanction letter is implemented. If
any, check the approval document for the same.
viii. Perform ledger scrutiny.
ix. Whether the interest and principal repayment are received in time in
accordance with the repayment schedule as mentioned in the loan
agreement/term sheet.
x. Whether the SMAs/EWS are reported to the management on regular
intervals and what course of action is taken to mitigate the same.
xi. Verify whether the group exposure and industry exposure are within the
prescribed limits.
xii. The auditor should set the expectation for the movement in yield based on
the discussion and inquiries made with the management; rate movement
observed in the industry, etc., and should obtain explanations for major
variances in the yield on monthly basis or quarterly basis.
xiii. The auditor should perform analytical procedures for computing the
processing fee percentage for different ticket size loans.
xiv. The Auditor should check the master data of the borrower in the CBS to
ensure correct feeding of data with regard to sectorial classification of
advances, e.g. priority sector and non-priority sector [in terms of RBI
circular No.FIDD.CO.Plan1/04.09.01/2016-17 dated July 7 2016 (as
updated from time to time)], amount of instalments with due dates of
payment etc.
2.18 The Auditor should check for any Non-Performing Asset (NPA). All
accounts which are overdue or stops generating income for the banks
continuously for 90 days, have to be treated as NPA and provision should be
made as per extant guidelines of RBI.
8
Other Aspects
2.19 RBI Master Direction DBR.Dir.No.85/13.03.00/2015-16 updated on 26th
February 2020 Master Direction - Reserve Bank of India (Interest Rate on
Advances) Directions, 2016. Vide this direction, it had been decided to link all
new floating rate personal or retail loans (housing, auto, etc.) and floating rate
loans to Micro and Small Enterprises extended by banks with effect from October
01, 2019 and floating rate loans from 1st April 2020 to external benchmarks.
(a) All new floating rate personal or retail loans (housing, auto, etc.) and
floating rate loans to Micro and Small Enterprises extended by banks from
October 01, 2019 shall be benchmarked to one of the following: -
 Reserve Bank of India policy repo rate;
 Government of India 3-Months Treasury Bill yield published by the
Financial Benchmarks India Private Ltd. (FBIL);
 Government of India 6-Months Treasury Bill yield published by the
FBIL;
 Any other benchmark market interest rate published by the FBIL.
(b) Banks are free to offer such external benchmark linked loans to other types
of borrowers as well.
(c) In order to ensure transparency, standardisation, and ease of
understanding of loan products by borrowers, a bank must adopt a uniform
external benchmark within a loan category; in other words, the adoption of
multiple benchmarks by the same bank is not allowed within a loan
category.
Direct Marketing Expenses
2.20 These are the expenses incurred mainly for sourcing of retails
loans/credit cards and collection of retail overdue loans. RBI circular
RBI/2006/167/DBOD.NO.BP.40/21.04.158/2006-07 dated 3rd November 2006
on “Guidelines on Managing Risks and Code of Conduct in Outsourcing of
Financial Services by banks” clearly states that activities of internal audit,
compliance function and decision making functions like compliance with KYC
norms for opening deposit accounts, according sanction for loans (including retail
loans) and management of investment portfolio cannot be outsourced.
9
3
Wealth Management and
Third Party Products
Introduction
Wealth management
3.01 Wealth management involves advice and execution of investments on
behalf of high net worth individuals/clients of Banks. Each bank will have its own
criteria for defining High Net Worth Individuals based on the relationship with the
bank and the amount of assets (under management) kept by the customers. The
focus is on the asset allocation of the client considering his financial goals, plans
and his risk appetite of such individuals/clients.
3.02 Banks have dedicated staff called Wealth Managers or Relationship
Mangers who look after the needs and requirements of their customers. They are
a single point of contact for dealing with and through the Bank. The staff have the
necessary training, qualifications and the expertise to handle these services.
3.03 Wealth Management is also synonymously used with Private Banking.
However, wealth management is a broader concept. Private Banking teams may
not render overall investment services or restrict themselves to the bank’s own
products. However, mostly the functions and roles overlap in many Banks.
3.04 These specifically designated staff help the customer with either a tailor
made portfolio or also suggest alternate investments across various asset class
either in Real-Estate, Debt, Mutual Funds, Equity, Art, Private Equity,
commodities, Structured Products etc. Banks also help with tax advice.
3.05 Optimal asset allocation after a prudent risk analysis is done for the
customer to design a tailor made, customized portfolio to balance the risk reward
ratio. This portfolio is continuously monitored to ensure that the Bank customer
earns a healthy return on his investments. A detailed customer risk appetite
study is done before designing the asset allocation. These services are generally
provided for a fee.
3.06 Some banks might have a separate subsidiary for wealth management
activity but some banks are carrying out such activity on their own. The
suggestive Audit Process would cover:
 The Auditors should check client service agreement with wealth
management clients and ensure that the bank is complying with all terms
contained in the agreement.
 The auditor should also check that the terms of such service agreements
are in compliance with the requirements/provisions of other market
regulators like SEBI etc.
 The Auditor should check fee income recognized by the Bank with charges
mentioned / agreed with the clients.
 The Auditor should ensure that these charges are recovered as per the
terms and old outstanding recoverable balances are dealt with accordingly
by the bank’s management.
 The Auditor should carry out cut-off procedures and ensure completeness
of fee income recognized for the year and accrue the earned
income/commission and defer income received in advance based on
services rendered.
Third party products
3.07 Banks not only have their own products in terms of Deposits, Loans,
Remittances, Lockers, Credit Cards etc. but also offer a variety of third-party
products. Third party products are those financial products that are sold by a
bank for some other Institutions. Banks only distribute or sell these products on
fee/commission/brokerage basis. These products are not created by the Bank.
Since such products do not form part of the Balance sheet of the Bank as
Deposit or Loans and Advances, banks do not have any requirement to allocate
Capital towards these products and hence these are not part of Bank’s CRAR
calculations. Bank can act as distributor/ Broker permitting them to sell such
products like insurance policies, mutual funds etc.
3.08 A third party (in this context) is an entity that is involved in a transaction
acting as an intermediary between two principal parties (like service provider &
recipient) but is not one of the principals. Third party activities are carried out to
provide overall financial service to customers for a fee.
3.09 Following the few Examples of Third Party Products:
 Insurance Products
 Mutual Funds
 Collection of utility bills and taxes
 Investment Advisory Services
 Mobile Recharge
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 Government Bonds/Securities
 Demat Accounts
 Portfolio Management Services
 Referral Services
 Equipment Leasing and Hire Purchase Business
 Sponsoring Infrastructure Debt
 Underwriting Activities
 Primary Dealership Business
 Pension Fund Management
3.10 Banks can undertake certain eligible financial services or para-banking
activities either departmentally or by setting up subsidiaries. Banks may form a
subsidiary company for undertaking the types of businesses which a banking
company is otherwise permitted to undertake, with prior approval of the Reserve
Bank of India. The instructions issued by Reserve Bank of India to banks for
undertaking various financial services are stated in RBI Master Direction
DBR.FSD.No.101/24.01.041/2015-16 May 26, 2016 (Updated as on September
25, 2017) on “Master Direction- Reserve Bank of India (Financial Services
provided by Banks) Directions, 2016”.
3.11 A bank can undertake business permitted under Section 6(1) of Banking
Regulation Act 1949 provided -
 There shall be a Board approved policy for the activity that shall
comprehensively cover the said activity including the various risks
associated with it and suitable risk mitigation measures.
 The instructions/ guidelines on KYC/AML/CFT applicable to Banks, issued
by RBI from time to time, shall be complied with.
 The general principles as enunciated in the Charter of Customer Rights
issued by RBI shall be adhered to.
 Specific conditions of IRDA, SEBI, PFRDA and Accounting Standards
issued by ICAI need to be complied.
 No Bank shall engage in a financial Activity without prior approval of RBI
other than approved activities.
 A Bank that is a trading/clearing member shall keep its and clients’ position
distinct from one another.
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 Professional Clearing Member of the commodity derivatives segment of

SEBI recognised exchanges need to satisfy the prudential criteria.
 Bank shall take exposure on its trading members as per the policy
approved by its board.
 Bank shall ensure strict compliance with various margin requirements as
may be prescribed by the Bank’s board or the Commodity Exchanges as
also the extant RBI guidelines regarding guarantees issued on behalf of
commodity brokers.
 Banks may invest in other equipment leasing/ hire purchase/factoring
companies within the limits specified in Section 19(2) of Banking Regulation
Act, 1949, with the Reserve Bank's prior approval but they shall not act as
promoters of such companies.
3.12 Banks earn revenue on sale of different products. Low-cost of
operations and NIL capital requirements make it viable for Banks to sell third
party products. Banks earn good commission income by cross selling multiple
products to existing customers.
3.13 The Auditor should note the following aspects while conducting audit of
third-party product operations:
1) Agreements are entered into with reputed third-party product providers.
Due diligence on the financial credentials and the reputation of the third
party is comprehensively done before the tie-up. Detailed diligence testing
and validation documents should be in place.
2) There is an approved policy in place detailing the products and the manner
in which they can be and are sold. The policy should be in conformity with
extant RBI and other regulatory guidelines. Adherence to the policy should
be strictly ensured.
3) Whether there is a policy in place for identifying vulnerable customers; if
any and the adequacy of governance and oversight process right from
product launch to ongoing monitoring.
4) Bank’s staff who are designated to sell these products have the necessary
prescribed qualifications and training. The sale should be done by the
designated employees only. The suitability and appropriateness of the
product to the customer to whom it is sold must be ensured.
5) Revenue earned on sale of these products is properly accounted and
received as per the contractual rates specified in the agreement entered
into between these parties. These rates could change from time to time.
Correct applicable rates should be accounted. The point of accounting of
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Income is critical and it should be consistently applied. The Auditor should

also verify compliances with GST & withholding tax provisions while
recognising revenue from distribution of third-party products.
6) The original agreements must be on record, properly filed and stored.
Compliance with the terms and conditions of the agreement from both
parties must be ensured. Timely renewal of these agreements should be
ensured.
7) Complaints, if any, on mis-selling of these products or deficiency in service
should be looked into for proper redressal and closure. These complaints
may pose both a regulatory and a reputational risk to the Bank. Necessary
disciplinary action against the concerned staff should be initiated as per
bank’s internal policy.
8) For any outstanding receivables from these third parties, balance
confirmations should be called for and be on record. Any old outstanding
should be verified for disputes, appropriate provisioning or write-off.
9) The auditor should verify the income recognized by cross checking data
received from principals (such as Mutual Funds/Insurance Companies) with
their internal systems. The Auditor should also insist on regular income
statements and balance confirmations from such parties.
10) General IT controls and controls over Management Information.
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4
International Banking Division
Functions of International Banking Division

4.01 The functions of International Banking Division include the following:
 Monitoring Overseas Branches
 Sanction of Loans of Overseas Branches
 Monitoring of advances accounts of Foreign branches
 Appointment of Statutory Auditors for these branches
 Obtaining Audit Reports of Overseas Branches
 Annual Budgeting of Overseas Branches
 Sanctioning of Expenses of Overseas Branches
 Review of policies for foreign branches such as ORM Policy, IBO Policy,
Premises Policy
 Compilation of Unhedged Foreign Currency Exposure
 Conversion of the Branch Balance Sheet for consolidation into Bank
Balance Sheet
 ECGC Claims
 Returns Filing
 Investments held by Foreign Branches - Monitoring the limits set by
Treasury
 GST compliances
 Cash management, fund and wire transfers
4.02 The auditor should understand the organization structure and the
functionalities of the specialized centralized division. If there is a manual of
operations in place, then he should obtain the latest updated version. The auditor
should also obtain copies of inspection or other internal audit reports of this
division which covers the efficiency of various functional operations. The auditor
should seek and peruse the inspection report by the local central bank or
regulatory or monitoring authority. The audit scope, frequency of audit and the
accuracy of MIS generated and communicated should be looked in to. Any open
issues should be followed up for closure and also the reasons why these issues
were not addressed till date should be understood.
4.03 Appointment of competent staff to handle overseas operations,
appointment of overseas statutory auditors, sanction of expenses, obtaining
timely audit reports in compliance with local laws, MIS, ensuring integration of
these accounts with local accounts are key functions and the Statutory Central
Auditor (SCA) who is allocated this responsibility should ensure that these are
conducted as per due process laid down in accordance with the regulations.
4.04 The auditor should understand the process of preparation of the Trial
Balance, Profit and Loss account, Balance Sheet and the internal financial
controls therein. Generally, this division would operate as a cost centre.
4.05 There may be cases where local branches would have given
Guarantees for overseas borrowers in foreign Branches which is a funded liability
in Foreign Books in which case, care needs to be taken to ensure that these are
netted off at the consolidation level and a funded / non-funded liability is not
shown for the same borrower in the consolidated accounts.
4.06 Where the borrower is an NPA in India but is either standard or credit
impaired overseas, the amount of provision held overseas should also be synced
to higher as per local laws.
4.07 Any significant or material amounts also having a bearing on
consolidated operations need to be disclosed separately or appropriately
disclosed as policies / notes on accounts at the consolidated level.
4.08 The auditor should satisfy that the translations of such overseas
operations are in accordance with the requirements of AS 11, ‘The Effects of
Changes in Foreign Exchange Rates (Revised 2018)’.
4.09 The auditors should note the methodology and approach to audit, the
extent of coverage and any good practices that can be benchmarked or adopted
locally should also be noted for incorporation.
4.10 Deviations or discrepancies noted should be appropriately reported in
the Long Form Audit Report.
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5
Treasury Operations
(A) Introduction and Bank’s Process

5.01 Treasury operations is one of the most important functions of a bank,
responsible for the processing of all financial market transactions and usually
much more, including a crucial role in managing risk. Treasury comprises of two
main components – Investments (comprising transactions related to domestic
investments and money market operations) and Forex & Derivatives. In a well-
functioning risk management system, banks broadly position their balance sheet
into Trading and Investment or Banking Books. While the assets in the trading
book are held primarily for generating profit on short-term differences in
prices/yields, the banking book comprises assets and liabilities, which are
contracted basically on account of relationship or for steady income and statutory
obligations and are generally held till maturity. Thus, while the price risk is the
prime concern of banks in trading book, the earnings or economic value changes
are the main focus of banking book.
Core functions of Treasury Operations in Bank
5.02 The core areas of treasury operations in a bank can be functionally
divided into the following broad compartments:
 Front Office Operations (Dealing room operations);
 Middle Office Operations (Market Risk Department / Product Control
Group); and
 Back Office Operations (Deal Confirmation, Settlement, Accounting and
Reconciliation).
5.03 Some of the main functions of Front Office, Mid-Office and Back-office
operations are detailed below:
Front Office (Dealing Room)
 Money and fixed income dealings
 Forex & Derivatives
 Treasury Sales
 Equities
 Primary Dealers
 Debt Sales
 Credit Default Swaps
Mid Office (Risk)
 Identification, measurement and monitoring of risk
 Monitoring counter party, product and dealer limits
Back Office
 Settlement and follow up
 Reconciliations
 Accounting
 Valuation
5.04 Increasing regulatory and compliance requirements and the need for
risk management have made ‘treasury front and back office efficiency’ as one of
the most critical factors in ensuring the well-being of any bank today. This is
certain to continue as the operations of treasury becomes more onerous while
financial products become increasingly complex, despite streamlining of
processing systems.
Front office Operations
5.05 The front office operations consist of dealing room operations wherein
the dealers transact deals with the various approved counterparties. Deals are
transacted by dealers on various anonymous order matching platforms such as
NDS-OM, CROMS, NDS-CALL, FX-CLEAR, FX-SWAP, E-Kuber and over
communication platform such as Reuters’, Bloomberg, telephonic conversation
with counter party or through empanelled brokers.
5.06 The dealers are primarily responsible to check for counterparty
exposure limits, eligibility, and other requirements of the Bank before initiating
any deal. Dealers must ensure that all risk/ credit limits are available before
transacting a deal. Also, the deal must not contravene the current regulations
regarding dealing in INR with overseas banks/ counterparties. All counterparties
are required to execute the International Swaps and Derivatives Association
(‘ISDA’) agreement as well as pass a board resolution allowing them to enter into
derivative contract. As soon as the deal is struck with counterparty, the deal
details are noted in a dealers’ deal pad and thereafter captured in front office
system of the Bank which gets queued in for authorization by back office.
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Middle office Operations

5.07 Middle office is responsible for online risk measurement, monitoring and
management reporting. The other functions of Mid-Office are:
 Limit setting and monitoring exposures in relation to limits.
 Assessing likely impact of market movements based on internal
assessments and external/ internal research.
 Evolving hedging strategies for assets and liabilities.
 Interacting with the bank’s Risk Management Department on liquidity and
market risk.
 Monitoring open currency positions.
 Calculating and reporting value at risk (VAR).
 Stress testing and back testing of investment and trading portfolios.
 Risk-return analysis.
 Marking open positions to market to assess unrealized gain and losses.
Back office Operations
5.08 The mainstream role of the back office is to provide direct support to the
dealing room or front office. Traditionally, this included the input of deal details in
the settlement system, checking of deal input details, verification by confirmation
from counterparty, settlement, verifying existence of a valid and enforceable
International Swap Dealers Association (‘ISDA’) agreement and reconciliation of
positions and NOSTRO accounts. However, with the advent of online front office
systems and, more importantly, online trading platforms, the input of deals has
progressively moved to the dealing room as mentioned above.
5.09 An important development in the back office has been the advent of
straight-through processing (STP), also called ‘hands-off’ processing. This has
been made possible through improved technology and real time online input in
the trading platform, which in turn has meant that the back office can authorise/
confirm deals pending for authorisation in the trading platform. In practice this is
done automatically by matching incoming data from counterparties thereby
focussing on investigating exceptions. With the introduction of online trading
systems, the deal is ‘confirmed’ as it is done, allowing the back office to
concentrate principally on handling exceptions, settlement and monitoring and
risk control. This is a completely different approach than the earlier system of
input and checking of written paper-based deals that represented only a dealer’s
version of what the deal was before external verification could even commence.
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5.10 One of the basic tenets for the treasury department in a bank is the
strict segregation and allocation of duties between the front, middle and back
office, the latter controlling confirmations, settlement and accounting of
transactions. These are even more important in an era of straight-through
processing where the checks are fewer and must essentially be independent.
However, while this is straight forward for the processing functions, the
independent monitoring and management of complex trading risks can be much
more problematic, requiring the ability and market knowledge to understand how
the trades and hedges in the dealer’s book are structured.
Functions of Back Office
Input and completion
5.11 The first core function of the back office is to extract details of the deal
either through the input system or by accessing the online platform and
authorise/ confirm the same after verifying the deal details with external evidence
i.e. incoming data from counterparty - Reuters’/ Bloomberg’s conversation,
broker notes. Deals input through front-end data capture or agreed on one of the
proprietary trading systems are subjected to numerous system checks to ensure
that the transaction details are technically correct. Some deals will require
settlement instructions to be added, but for straightforward foreign exchange and
derivative deals done with other banks and large corporates, standard settlement
instructions (SSIs) may have already been added as per the agreement. This
could also be true for derivatives transactions in the larger treasuries. However,
these types of transactions generally need more checking and manual
intervention because of the wide variety of their use. Bank normally releases its
own confirmation to the counterparty, particularly for over the counter (‘OTC’)
deals.
Counterparty confirmation
5.12 The second core function for the back office is to verify the deal from
the counterparty at the earliest after the transaction has been done. For bank-to-
bank trading, the verification can take the form of a confirmation of a deal done
through Reuters conversation or trading systems, or a broker’s confirmation if the
deal has been done through a broker. Telephone confirmations are also sought
for immediate authorisation. Further, the banks have entered into bilateral
agreement with counterparty banks who are members of CCIL whereby
exchange of confirmations for Forex Interbank deals (matched on CCIL) have
been discontinued.
20
5.13 Deals done with customers (non-banks) will normally be confirmed by e-

mail, with instructions swapped on the telephone, depending on the
arrangement. Increasingly, however, corporate customers are using automatic
confirmation-matching services. It is essential that the deal is confirmed
independently of the trader before any kind of value is given or payment is made.
F-TRAC (FIMMDA Trade Reporting and Confirmation) System
5.14 It is to be noted that all entities regulated by RBI, IRDA and PFRDA
have to mandatorily report secondary market Corporate Bond trades on F-TRAC.
Other entities regulated by SEBI or any other regulators have been mandated to
report OTC secondary market Corporate Bond on F-TRAC, or any other SEBI
authorised reporting platform. All entities have to report CP’s & CD’s only on F-
TRAC.
Settlement
5.15 The third core function in the processing chain is that of settlement. This
can take the form of a clean currency payment/receipt at the bank’s accounts or
through the medium of CCIL. The CCIL settlement process is a multilateral
netting system for Inter-bank transactions that will net the member’s payment
and receipts in a currency, even if they are due to or due from him from different
counterparties and settles the net position in both legs of the transaction.
Reconciliation
5.16 Operations areas are typically involved in a number of reconciliation
processes, including the reconciliation of dealers’ overnight positions, NOSTRO
accounts and brokerage payments. This can also mean reconciling positions for
margin calls in futures trading or reconciling custody accounts to the underlying
securities in securities trading. However, the basic reconciliation function is to
agree or reconcile the entries that have passed over an account with
correspondent bank against those that have been passed internally in the books
of the bank to a NOSTRO account. After reconciliation, the unmatched items in
both accounts then represent those that have not been responded to in either the
books of the bank or its correspondent and therefore requires to be investigated.
Important Terms
5.17 The following are some of the terms, which are commonly used in
relation to investments of banks.
Approved Securities
5.18 Section 5(a) of the Banking Regulation Act, 1949 defines ‘approved
securities’ to mean securities in which a trustee may invest money under
21
clauses (a) to (d) and (f) of section 20 of the Indian Trusts Act, 1882. Approved
securities comprise primarily the securities issued or guaranteed by the Central
or State Government, or any other security expressly authorised by the Central
Government by notification in the Official Gazette.
Subsidiary General Ledger (SGL)
5.19 This is a ledger maintained by the Public Debt Office (PDO) of RBI in
which accounts of different banks are maintained regarding their holding of
Government securities. The transactions through SGL Accounts should be in
compliance with Master Circular no. RBI/2015-16/97 DBR No BP.BC.6
/21.04.141/2015-16 on Prudential Norms for Classification, Valuation and
Operation of Investment Portfolio by Bank dated July 1, 2015.
Repo and Reverse Repo Transactions
5.20 Repo and Reverse Repo is one of the mechanisms of lending and
borrowing, wherein ‘Repo’ means borrowing of money (against placing of
Government security as collateral) and ‘Reverse Repo’ means lending of
money (against receipt of Government security as collateral) at a transaction
value equivalent to the market rate of the security as on the date on which the
transaction is made, at an agreed rate of interest and tenure. The underlying
security though transferred from one beneficiary to other counterparty, the
risk/rewards related to such underlying security remains with the lender of the
security.
5.21 The RBI has issued Repurchase Transactions (Repo) (Reserve Bank)
Directions, 2018 vide circular no. FMRD.DIRD.01/14.03.038/2018-19 dated
24th July 2018 and in supersession of all earlier instructions on this subject.
This circular has been further amended vide circular no.
FMRD.DIRD.21/14.03.038/2019-20 dated 28th November 2019. RBI has
decided to align the accounting norms to be followed by market participants for
repo/reverse repo transactions under Liquidity Adjustment Facility (LAF) and
Marginal Standing Facility (MSF) of RBI with the accounting guidelines
prescribed for market repo transactions. Accordingly, all repo/ reverse repo
transactions are required to be accounted for as lending and borrowing
transactions.
5.22 Banks shall classify the balances in Repo A/c under Schedule 4
(Borrowing). Similarly, the balances in Reverse Repo A/c shall be classified
under Schedule 7 (Balances with banks and money at call and short notice).
The balances in Repo interest expenditure A/c and Reverse Repo interest
income A/c shall be classified under Schedule 15 (Interest expended) and
under Schedule 13 (Interest earned) respectively.
22
5.23 Repo transactions are now allowed between the permitted entities,
namely, (a) SGL A/c holders; (b) SGL A/c holder and its own gilt account
holder (GAH); (c) SGL A/c holder and GAH under another custodian; (d) GAHs
under the same custodian; and (e) GAHs under two different custodians,
subject to the conditions as specified in the said notification.
Short Sale
5.24 Short sale is defined as sale of securities which one does not own,
i.e., selling of a security without possessing stock of such securities. A bank
can also undertake ‘notional short sale’ wherein it can sell a security short from
HFT even though the stock of the said security is held under HFT / AFS / HTM
category. Thus, short sales include actual as well as ‘notional’ short sale. A
short sale can be undertaken by the bank subject to certain conditions as
stipulated by RBI and within specified limits. Securities which are sold short are
invariably required to be delivered on the settlement. A bank may meet the
delivery obligation for a security sold short, by utilising the securities acquired
under ‘reverse repo’ mechanism (except under RBI’s Liquidity Adjustment
Facility). However, as announced in paragraph 13 of the Statement on
Developmental and Regulatory Policies, of the Fourth Bi-monthly Monetary
Policy Statement for 2017-18 dated October 04, 2017, it has been decided that
market participants undertaking ‘notional’ short sale need not compulsorily
borrow securities in the repo market. While the short selling entity may ordinarily
borrow securities from the repo market, in exceptional situations of market stress
(e.g. short squeeze), it may deliver securities from its own HTM/AFS/HFT
portfolios. If securities are delivered out of its own portfolio, it must be accounted
for appropriately and reflect the transactions as internal borrowing. All ‘notional’
short sales must be closed by an outright purchase in the market. It may be
ensured that the securities so borrowed are brought back to the same portfolio,
without any change in book value. The short selling entity must adhere to the
extant regulations and accounting norms governing sale or valuation of securities
in its portfolios. The bank may frame a Board approved policy for this purpose.
Even though reverse repos can be rolled over, short sale position needs to be
covered within a maximum period of three months including day of trade.
STRIPS
5.25 STRIPS stand for Separate Trading of Registered Interest and Principal
Securities. Stripping is a process of converting periodic coupon payments of an
existing Government Security into tradable zero-coupon securities, which will
usually trade in the market at a discount and are redeemed at face value. For
instance, stripping a five-year Government Security would yield 10 coupon
securities (representing the coupons), maturing on the respective coupon dates
23
and one principal security representing the principal amount, maturing on the
redemption date of the five-year security. Reconstitution is the reverse process of
stripping, where, the Coupon STRIPS and Principal STRIPS are reassembled
into the original Government Security. Detailed guidelines outlining the process
of stripping/ reconstitution and other operational procedures regarding
transactions in STRIPS are given in Master Circular no. RBI/2015-16/97 DBR No
BP.BC.6 /21.04.141/2015-16 on Prudential Norms for Classification, Valuation
and Operation of Investment Portfolio by Bank dated July 1, 2015.
“When Issued” Securities
5.26 ‘When, as and if issued’ (commonly known as ‘when-issued’ (WI))
security refers to a security that has been authorized for issuance but not yet
actually issued. ‘WI’ trading takes place between the time a new issue is
announced and the time it is actually issued. All 'when issued' transactions are
on an 'if' basis, to be settled if and when the actual security is issued. The
NDS-OM members have been permitted to transact on ‘When Issued’ basis in
Central Government dated securities, subject to the guidelines of RBI.
Certificate of Deposit (CD)
5.27 It is a negotiable money market instrument and issued in
dematerialized form or as a Usance Promissory Note against funds deposit at
a bank or eligible Financial Institution for a specified time period. CDs can be
issued by a bank with a maturity period which is not less than 7 days and not
more than one year, from the date of issue and should have a minimum
deposit size from a single subscriber not less than Rs. 1 lakh. CDs may be
issued at a discount to face value or at a fixed / floating coupon rate.
5.28 Banks have to maintain appropriate reserve requirements, i.e., CRR
and SLR, on the issue price of the CDs. There is no lock-in period for the CDs.
Though, NRIs may also subscribe to CDs (but only on non-repatriable basis),
such CDs cannot be endorsed to another NRI in the secondary market.
Banks/FIs may account the issue price under the Head "CDs issued" and show
it under deposits. Accounting entries towards discount will be made as in the
case of "Cash Certificates".
Commercial Paper (CP)
5.29 It is an unsecured money market instrument issued in the form of a
promissory note by Corporates, PDs, FIs subject to compliance with the
guidelines issued by RBI vide Master Direction no. RBI/FMRD/2016-
17/32FMRD.Master Direction No.2/2016-17 dated July 7, 2016 on Money
Market Instrument: Call/Notice Money Market, Commercial Paper, Certificate
of Deposit and Non Convertible Debentures (original maturity up to one year).
24
The tenure of CP should not be less than 7 days and not more than one year,
from the date of issue.
5.30 Options (Call/Put) are not permitted on CP. Also, underwriting or co-
acceptance to the issue of CP is not allowed. The minimum credit rating shall
be ‘A3’ as per rating symbol and definition prescribed by SEBI, which should
be ensured by the issuers.
Non-Convertible Debentures (NCDs)
5.31 It is a debt instrument issued by a corporate (including NBFCs) with
original or initial maturity up to one year and issued by way of private
placement, in denominations with a minimum of Rs. 5 lakhs (face value) and in
multiples of Rs. 1 lakh, subject to the eligibility criteria as specified by RBI.
5.32 An eligible corporate intending to issue NCDs shall obtain credit rating
for issuance of the NCDs from one of the rating agencies registered with SEBI
or other credit rating agencies as may be specified by RBI. NCDs shall not be
issued for maturities of less than 90 days from the date of issue and the
exercise date of option (put/call), if any, attached to the NCDs shall not fall
within the period of 90 days from the date of issue. The tenor of the NCDs shall
not exceed the validity period of the credit rating of the instrument i.e. minimum
‘A2’ as per rating symbol and definition prescribed by SEBI.
REITs & InvITs
5.33 Infrastructure Investment Trust (InvITs) and Real Estate Investment
Trusts (REITs) are like mutual funds, which enable investment by
individual/institutional investors in income earning assets to receive periodic
return consisting of return of principal as well as income.
5.34 The Reserve Bank of India vide Circular no. RBI/2016-17/280 DBR.
No. FSD. BC. 62/24.01.040/2016-17 April 18, 2017 on “Prudential Guidelines –
Banks’ investment in units of REITs and InvITs” and as further amended by
Master Direction/DBR.FSD.No.101/24.01.041/2015-16 dated May 26, 2016and
updated as on September 25, 2017 has allowed banks to participate in Real
Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs)
within the overall ceiling of 20 per cent of their net worth permitted for direct
investments in shares, convertible bonds/ debentures, units of equity-oriented
mutual funds and exposures to Venture Capital Funds (VCFs) [both registered
and unregistered]. Before making investments, Banks are required to put in place
a Board approved policy on exposures to REITs/ InvITs which should lay down
an internal limit on such investments within the overall exposure limits in respect
of the real estate sector and infrastructure sector. Banks are not permitted to
invest more than 10 per cent of the unit capital of a REIT/ InvIT. Banks need to
ensure adherence to the prudential guidelines issued by RBI from time to time on
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Equity investments by Banks, Classification and Valuation of Investment

Portfolio, Basel III Capital requirements for Commercial Real Estate Exposures
and Large Exposure Framework, as applicable.
State Development Loans
5.35 Paragraph 2 of the Statement on Developmental and Regulatory
Policies, issued as part of the second Bi-monthly Monetary Policy Statement
for 2018-19 dated June 06, 2018 states that with effect from September 30,
2018, Securities issued by each State Government, i.e., State Development
Loans (SDL’s), shall be valued in manner which would objectively reflect their
fair value based on observed prices/ yields made available by Financial
Benchmarks India Pvt Ltd (FBIL).
TREPS
5.36 In terms of the Repurchase Transactions (Repo) (Reserve Bank)
Directions, 2018 dated 24th July, 2018 "Tri-party repo" means a repo contract
where a third entity (apart from the borrower and lender), called a Tri-Party
Agent, acts as an intermediary between the two parties to the repo to facilitate
services like collateral selection, payment and settlement, custody and
management during the life of the transaction.
5.37 Triparty Repo i.e. TREPS facilitates borrowing and lending of funds, in
Triparty Repo arrangement. CCIL is the Central Counterparty to all trades from
Tri Party Repo Dealing System (TREPS) and also performs the role and
responsibilities of Triparty Repo Agent, in terms of Repurchase Transactions
(Repo) (Reserve Bank) Directions, 2018 as amended from time to time.
5.38 TREPS Dealing System is an anonymous order matching System
provided by Clearcorp Dealing Systems (India) Ltd (CCDS) to enable Members
to borrow and lend funds. It also disseminates online information regarding deals
concluded, volumes, rate etc., and such other notifications as relevant to
borrowing and lending under Triparty Repo by the members.
5.39 The eligible securities deposited by a member as collateral towards
borrowing limit as Triparty Repo Collateral are subjected to a valuation exercise
at the end of each business day. The valuation is carried out using CCIL’s mark-
to-mark price for such securities. The aggregate value of securities contributed
by a member, net of haircut, rounded downwards to the nearest rupee is set as
permissible borrowing limit for such member. Any security deposited during the
day as collateral towards borrowing limit is also revalued at last available MTM
price of the security and such a value, net of haircut, is made available as
Borrowing Limit. Value of any security withdrawn during the day is reduced from
the available borrowing limit. Apart from the end of the day valuation, CCIL
undertakes such valuation on multiple times during the day also.
26
5.40 RBI has made the reserve requirements for Triparty Repo borrowing
similar to borrowing in market repo and no CRR is required to be maintained for
Triparty Repo borrowings outstanding in the books of Member.
(B) Audit Approach, Procedures including regulatory
requirements/ restrictions & updates
5.41 The Auditor’s primary objective in audit of investments is to satisfy
himself as to their existence, ownership and valuation. Examination of
compliance with statutory and regulatory requirements is also an important
objective in audit of investments in as much as non-compliance may have a
direct and material impact on the financial statements.
5.42 The latter aspect assumes special significance in the case of banks
where investment transactions have to be carried out within the numerous
parameters laid down by the relevant legislation and directions of the RBI. The
auditors should keep this in view while designing their audit procedures
relating to investments.
Process Review, Walk through and Control Testing
5.43 For the purpose of identifying significant processes, the auditor may
identify significant accounts and processes linked to significant accounts. He
may carry out detailed understanding of process from inception of transaction
to its final accounting. Banks normally have documented standard operating
procedures (SOPs) and hence the auditor can peruse SOPs for understanding
and documenting significant processes. During the process understanding,
auditors may identify various control points in the process like reconciliation,
maker checker, segregation of duties, etc. The auditors may carry out walk
through of few transactions for validating process understanding and existence
of identified controls. Identified controls needs to be further segregated to
manual controls and IT controls for testing of those controls for sample
transactions. This sample needs to be selected randomly from total population
of transactions as per the methodology.
5.44 In today’s scenario, most of the treasury functions of banks are
performed in an automated environment (for example, trade booking,
settlement and accounting). In such a situation, it becomes imperative for the
auditors to test the general information technology controls and system
application controls around the functioning of the systems involved and also
the interfaces between various systems.
5.45 Some of the typical audit procedures include:
 Identification of specific application controls based on process
understanding and walkthroughs.
27
 Perusal of IT application controls and document whether controls are

effective and reliance can be placed on same.
 Perusal of IT system audit report, Internal Control Guidance report and
action taken thereon.
 Based on outcome of IT control testing, further audit strategy need to be
formulated.
In the Covid-19 scenario, an Auditor should also verify the controls put in place
to ensure appropriate functioning of the treasury operations from off premise
locations without compromising safety and security of the data. The auditor
should ensure that appropriate approvals have been taken from the respective
authorities before enabling and allowing dealing from off-premise locations.
RBI Circular no. FE.CO.FMD. No. 18380/02.03.137/2010-11 dated 3rd
February 2011 prescribes the requirements for off premise dealings.
Substantive Audit Procedures
5.46 Considering that the investments comprise a substantial portion of a
bank’s balance sheet, a combination of test of operating effectiveness of
controls and substantive audit procedures (including substantive analytical
procedures) would be necessarily carried out by the auditor to conclude
effectively on the completeness, recognition and measurement, accuracy and
existence of the banks’ investments, related income/ expenses and associated
balances.
Examination of Reconciliation
5.47 The Auditor should examine the reconciliation of the investment
balances as per the financial statements with that of the balances with the
custodians (PDO or a depository for investments held in dematerialised form),
account statements of mutual fund, physically verify the securities on hand,
obtain independent confirmations from custodians, counter-party banks for
BRs on hand, to examine the control and reconciliation of BRs issued by the
bank. In addition to examining the period end reconciliations, the auditor needs
to examine such reconciliations at other interim intervals, to ensure that the
process is followed throughout the audit period. Needless to add, the actual
control and reconciliations etc., are to be carried out by the bank’s
management; however, the auditor needs to examine the same.
5.48 Some typical audit procedures would include:
 Perusing the process, frequency of reconciliation and controls over same.
 Perusing the reconciliation (period end as well as interim) and examining
whether proper impact has been given for reconciling items.
 Obtaining direct balance confirmations.
28
Inspection of Documents
5.49 The Auditor should ascertain whether the investments made by the
bank are within its authority. In this regard, the Auditor should examine
whether the legal requirements governing the bank, relating to investments,
have been complied with and the investments made by the bank are not ultra
vires the relevant regulations. Apart from the above, the Auditor should also
ascertain that any other covenants or conditions which restrict, qualify or
abridge the right of ownership and/or disposal of investments, have been
complied with by the bank.
5.50 The Auditor should satisfy himself that the transactions for the
purchase/sale of investments are supported by approval of due authority and
documentation. The acquisition/disposal of investments should be verified with
reference to the broker’s contract note, bill of costs, receipts and other similar
evidence. The Auditor may also check whether brokers note is dated and time
stamped or not. The Auditor should also check the segregation of duties within
the bank staff in terms of executing trades, settlement and monitoring of such
trades, and accounting of the same (generally termed as front office, middle
office and back office functions’ segregation).
 checking compliance with all applicable legal requirements.
 checking approval and all supporting documents for purchase and sale of
investments.
 checking segregation of duties.
 ensure that the inherent risk of management overriding controls is
mitigated.
Examination of Existence of Investments
5.52 The auditor may advise the bank to list out investments held in
physical form separately from those held in dematerialised form with the PDO
or with a depository. Banks are permitted to make fresh investments and hold
bonds and debentures, privately placed or otherwise, and equity instruments only
in dematerialised form.
5.53 The Auditor should verify the investments held with PDO, custodians
and the depository, at the close of business on the date of the balance sheet
with the statement of holdings. The Auditor should circulate and maintain
control over independent investments' balance confirmation requests to the
custodian and other constituents (for example, RBI for SGL and CSGL
balances) in accordance with SA 505, “External Confirmations” issued by ICAI.
29
Furthermore, the Auditor should design sufficient alternative audit procedures

in situations where the independent confirmations are not received back (after
reasonable follow up procedures) before the Auditor signs off on the bank’s
financial statements. These alternative procedures should also be designed in
such a way that independent data points are used for corroborating investment
balances (E.g. the Auditor gets the bank personnel download the investment
statement in his own presence e.g. from E-Kuber for Government Securities,
DP’s website for Shares and Bonds etc.).
5.54 The Auditor should peruse bank’s process of periodic physical
verification of investments and satisfy himself with adequacy of process and
controls. Based on assessment of physical verification process of bank, the
auditor may verify the investment scrips physically at the close of business on
the date of the balance sheet. In exceptional cases, where physical verification
of investment scrips on the balance sheet date is not possible, the Auditor may
carry out the physical verification on a date as near to the balance sheet date
as possible. In such a case, they should take into consideration any
adjustments for subsequent transactions of purchase, sale, etc. In the current
environment, where the banks generally have their investment securities in
dematerialised form, the importance of independent audit confirmation
requests multiplies. Auditors may also check feasibility of converting physical
shares in dematerialised form. If feasible, auditors may suggest banks to
convert physical shares into dematerialised form.
5.55 Investments are normally dealt with at the head office and not at the
branches. However, sometimes, for realisation of interest etc., and other
similar purposes, some of the investment scrips may be held at branch offices.
In such cases, the auditor needs to examine the records maintained at the
head office to record details of scrips held at other locations and request the
respective Statutory Branch Auditors (SBAs) to physically verify such scrips as
a part of their audit. The auditor needs to obtain a written confirmation to this
effect from the SBAs. The SBAs should also be requested to report whether
adequate records are maintained by the branch for the securities held by it on
behalf of the head office.
5.56 The Auditor may specifically request the Statutory Branch Auditors to
examine and report any cases of non-receipt of income against investments for
a long period or of scrips being held without being redeemed long after the
redemption date, as these situations might be indicative of the scrips being
forged or otherwise unrealisable. In case the investment scrips are held at an
unaudited branch, the auditor should request the management to obtain the
scrips at the head office for his examination.
30
Cut-off Procedures
5.57 In terms of testing completeness of investments balances at the
reporting date, the Auditor should carefully devise cut-off procedures. This
should be designed after understanding the bank’s procedures for ensuring the
appropriate period of accounting for investments. Banks should follow
‘Settlement Date’ accounting for recording transactions in Government
securities. In respect of transactions other than in Government securities, the
bank should follow the accounting policy consistently either ‘Trade Date’ or
‘Settlement Date’ accounting.
 Obtaining list of transactions executed on period end date and examining
whether the same is correctly recorded and accounted.
 Checking first few sample transactions of subsequent period and
ascertaining whether the same pertains to current reporting period.
 Checking control over transaction numbering by the system and
ascertaining whether the transaction with last number for period end is
recorded in current period and next transaction is recorded in subsequent
period.
5.59 In respect of BRs issued by other banks and on hand with the bank at
the year-end, the Auditor should examine confirmations of counterparty banks
about such BRs. Where any BRs have been outstanding for an unduly long
period, the Auditor should obtain written explanation from the management for
the reasons thereof. This procedure may not, however, be necessary where
scrips are received from counterparty banks before the completion of the audit.
5.60 The Auditor should examine the reconciliation of BRs issued by the
bank. He should also examine whether the securities represented by BRs
issued by the bank and outstanding at the year-end have been excluded from
investments disclosed in the balance sheet.
Examination of Classification and Shifting
5.61 The auditor should examine whether the shifting of the investments
to/from HTM category is carried out only once during a financial year and at the
beginning of the financial year unless otherwise stipulated by RBI under
special dispensation. Such shifting is required to be duly approved by the
Board of Directors of the bank. As regards the shifting of investments from AFS
to HFT, the auditor should verify the same as having been duly approved by
the Board of Directors / ALCO / Investment Committee. In case of exigencies,
the shifting from AFS to HFT may be done with the approval of the Chief
31
Executive of the Bank/ Head of ALCO, but should be ratified by the Board of
Directors later. Shifting of investments from HFT to AFS is generally not
allowed. However, it will be permitted only under exceptional circumstances
like not being able to sell the security within 90 days due to tight liquidity
conditions, or extreme volatility, or market becoming unidirectional. Such
transfer is permitted only with the approval of the Board of Directors/ ALCO/
Investment Committee.
5.62 Transfer of scrips from AFS / HFT category to HTM category should
be made at the lower of book value or market value. In other words, in cases
where the market value is higher than the book value at the time of transfer,
the appreciation should be ignored and the security should be transferred at
the book value. In cases where the market value is less than the book value,
the provision against depreciation held against this security (including the
additional provision, if any, required based on valuation done on the date of
transfer) should be adjusted to reduce the book value to the market value and
the security should be transferred at the market value. The Auditor should
examine the memo (or internal note) on the periodic reviews of SLR / Non-SLR
investments carried out and reported to the Board, as specified in para 1.1.8
read with para 1.2 of the master circular on investments.
5.63 In the case of transfer of securities from HTM to AFS / HFT category the
following should be noted:
a. If the security was originally placed under the HTM category at a discount, it
may be transferred to AFS / HFT category at the acquisition price / book
value (It may be noted that as per existing instructions banks are not
allowed to accrue the discount on the securities held under HTM category
and, therefore, such securities would continue to be held at the acquisition
cost till maturity). After transfer, these securities should be immediately re-
valued and resultant depreciation, if any, may be provided.
b. If the security was originally placed in the HTM category at a premium, it
may be transferred to the AFS / HFT category at the amortised cost. After
transfer, these securities should be immediately re-valued and resultant
depreciation, if any, may be provided.
5.64 It is to be noted that in case if the bank is following ‘Weighted Average
Method’, the cost of acquisition of the security is not relevant and instead book
value (which would be weighted average value) needs to be considered for the
purpose of above mentioned both clauses.
5.65 If the value of sale or transfer (excluding one-time shifting and
additional shifting explicitly permitted by RBI), exceeds 5% of the book value of
32
HTM investments as at the beginning of the year, the bank should disclose
market value of the investments under HTM category along with disclosure of
excess of book value over market value for which provision is not made.
5.66 The audit procedures in this regard would include:
 obtaining list of shifting of investments during the reporting period.
 checking compliance with RBI guidelines and existence of proper approvals
for same.
 checking proper recording/ accounting of book value and depreciation on
date of shifting.
Examination of Accounting and Valuation
5.67 Investments in securities now-a-days constitute a substantial part of
total assets of many banks. Method of valuation of investments followed by a
bank may, therefore, have a significant effect on its balance sheet and profit
and loss account. The Auditor should examine whether the method of
accounting followed by the bank in respect of investments, including their year-
end valuation, is appropriate, consistent and in conformity with RBI guidelines.
5.68 The Auditor should examine the appropriateness of accounting
policies followed by the bank. In case any of the accounting policies are not
appropriate, the Auditor should consider the effect of adoption of such policy
on the financial statements and, consequently, on the audit report. In this
regard, it may be noted that Accounting Standard (AS) 13, “Accounting for
Investments”, does not apply to banks.
5.69 According to RBI guidelines, in respect of shares which are unquoted
or for which current quotations are not available, the market value has to be
determined on the basis of break-up value (excluding Revaluation Reserves, if
any) as per the latest balance sheet of the company (which should not be more
than one year prior to the date of valuation). In case the latest balance sheet is
not available the shares are to be valued at Re.1 per company. This might
create a problem in the case of new companies whose first annual reports are
not yet available. It appears that in such a situation, it would be appropriate to
value the shares at cost except where the evidence available indicates the
deterioration in the value.
5.70 RBI guidelines require that individual scrip in the available-for-sale
(‘AFS’) category should be marked to market at quarterly or more frequent
intervals. It is further required that net depreciation in respect of each of the
categories in which investments are presented in the balance sheet should be
provided for and net appreciation should be ignored. As regards the scrips in
33
Held for Trading (HFT) category, the same should be marked to market at
monthly or at more frequent intervals in similar manner, except in the following
cases:
i) Equity shares should be marked to market preferably on daily basis. If
not, at least on a weekly basis;
ii) Banks which undertake short sale transactions, the entire HFT portfolio
including the short position should be marked to market on daily basis.
The book value of the individual scrip would not undergo any change after
mark to market exercise is conducted at the balance sheet date.
5.71 It is pertinent to note that though intra-category netting off of
depreciation and appreciation is permitted, the same (netting off) is not
permitted inter-category. The provision for depreciation would be made on an
aggregate basis for HFT and AFS category separately without changing the
book value of individual scrips.
5.72 As regards the investments in HTM category, the same need not be
marked to market except in case wherein the diminution in the value is other
than temporary in nature or impairment of the investments due to specified
circumstances. As regards the other HTM securities, if the acquisition cost /
book value is more than face value, the premium should be amortised over the
period of residual maturity period using constant yield method or straight line
method.
5.73 In determining the market value of debt securities under HFT and AFS
categories, interest accrued up to the balance sheet date should be reduced
from the market price, if the market price includes the accrued interest, to avoid
its double counting of interest - first as accrued interest and secondly as a part of
market value.
5.74 The Auditor should examine the process of valuation followed by the
bank and perform checks to examine that the market rates taken by the bank for
valuation of investment securities are in accordance with the RBI guidelines. The
Auditor should also examine the accounting entries passed for marked to market
depreciation, to ascertain, whether RBI guidelines pertaining to inter-category
netting off are followed. Further, the Auditor should include investment from each
class of investment in his sampling technique in accordance with SA 530, “Audit
Sampling “so as to ensure that the valuation policy of all classes of investments
gets validated. Audit sampling can be applied using either statistical or non-
statistical sampling approach which is a matter of auditor’s judgment. Particular
focus should be on investments which involve management judgment or are not
simple rule based valuations (preference shares and pass through certificates).
While the Auditor checks the valuation of investment securities across products
34
in line with RBI prescribed methodology, he should also carefully focus on

assessing the appropriateness of inputs used in various valuation models/
formulae. This would include a check of:
 Use of appropriate cash flows (for instruments such as PTCs).
 Use of appropriate risk free rates (depending on maturity of instrument).
 Use of appropriate risk spreads.
 Use of appropriate ‘ratings’ for bonds.
 Receipt of dividend (for preference shares).
 Validity of various inputs like call/put option date, redemption premium,
staggered redemption, etc.
 Arithmetical accuracy of a valuation (using ‘re-performance’ technique).
5.75 In case of banks which have automated means of valuing the
investments, the Auditor should also check the system controls and if deemed
necessary, consider involving an expert to check the integrity of system logic (to
avoid, ‘garbage in garbage out’ kind of output).
5.76 In case the bank does not have automated means of valuation of
investments (for example, valuation is computed over excel spreadsheets), the
Auditor should check end user computing controls over such spreadsheet usage.
This would include a check of access controls over such files, change
management controls, etc. This would help Auditor to conclude that the files for
valuation of investments are not manipulated. This can also be classified as an
anti-fraud control.
5.77 The Auditor should examine whether the profit or loss on sale of
investments has been computed properly. The carrying amount of investments
disposed off should be determined consistently. In case of HTM investments,
Net Profit on sale of investments in this category should be first taken to the
Profit & Loss Account, and thereafter be appropriated to the ‘Capital Reserve
Account’ net of taxes and Net Loss will be recognised in the Profit & Loss
Account.
5.78 The classification of investments into “held-to-maturity”, “held-for-
trading” and “available-for-sale” categories is based on the intention with which
the respective investments have been acquired by the bank. The Auditor
should examine whether the investments have been properly classified in
either of the three categories at the time of acquisition based on such intention
as evidenced by dealers’ pad or equivalent, along with reference to the
35
decision of the competent authority such as Board of directors, ALCO or

Investment Committee.
5.79 Equity, debentures and other financial instruments acquired by way of
conversion of outstanding principal and / or interest should be classified in the
AFS category, and valued in accordance with the extant instructions on
valuation of banks' investment portfolio. Equity classified as standard asset
should be valued either at market value, if quoted, or at break-up value, if not
quoted (without considering the revaluation reserve, if any) which is to be
ascertained from the company's latest balance sheet. In case the latest
balance sheet is not available, the shares are to be valued at Re.1. Equity
instrument classified as NPA should be valued at market value, if quoted, and
where equity is not quoted, it should be valued at Re.1. Depreciation on the
instruments acquired by way of conversion, whether classified as standard or
NPA, should not be offset against the appreciation in any other securities held
under the AFS category.
5.80 As per RBI guidelines, investments classified under “held-for-trading”
category should be sold within 90 days of their acquisition, failing which they
should be shifted to the “available-for-sale” category. The Auditor should
accordingly ascertain that no investments purchased more than 89 days before
the balance sheet date have been classified under this category.
5.81 In respect of debt securities, interest accrued upto the balance sheet
date is usually recognised as income in the profit and loss account. One of the
essential conditions for accrual of income is that it should not be unreasonable
to expect ultimate collection thereof.
5.82 A change in the method of valuation of investments constitutes a
change in accounting policy and adequate disclosure regarding the fact of the
change along with its financial effect should be made in the balance sheet. If
the valuation of Investment is outsourced from an agency, certain audit
procedures would need to be applied at such processing agency also.
5.83 Some of the typical audit procedures would include:
 Obtaining list of investment as at reporting period from the bank and
ascertaining completeness of the same by reconciliation process as
highlighted above.
 Checking the carrying amount of investments and ensuring that the same
is calculated on a consistent basis. This is normally calculated by the
system and hence the Auditor needs to check IT controls and calculation
on sample basis for ensuring accuracy.
36
 In case quotes are available, checking the source of capturing market

price/ fair value as at reporting date.
 In case quotes are not available, checking calculation for fair value as at
the reporting date to ensure compliance with RBI guidelines.
 Checking calculation of Marked to Market Gain/ loss and accounting for
same in compliance with RBI guidelines.
5.84 The following Table gives the basis of Marked to Market procedure
based on the type of investments (unquoted)
Type of Investment Basis of Valuation
Unquoted Central Price / YTM rates put out by FBIL
Government Securities
Treasury Bills Carrying Cost (acquisition cost plus discount
accrued)
State Government Securities YTM method by marking it up by 25 basis
point above Central Government Securities’
Yield as put in by FBIL
Other Approved Securities YTM method by marking it up by 25 basis
point above Central Government Securities’
Yield as put in by FBIL
Debentures / Bonds Valued with appropriate mark-up (which
would be graded based on rating assigned to
the security, and subjected to minimum of 50
basis point) over Central Government
Securities’ Yield as put in by FBIL
Bonds issued by State Same as above except that the mark-up
Distribution Companies would be 50, 75 and 100 basis points, when
(DISCOM) under Financial the liability is with the respective State
Restructuring Plan Government, guaranteed by respective State
Government or not guaranteed by State
Government, respectively
Zero Coupon Bonds (ZCBs) Present Value (PV) to Face Value (FV) of
ZCBs to be calculated by using ‘Zero
Coupon Yield Curve (ZCYC)’ with
appropriate mark up as per zero coupon
spread put out by FBIL
Preference Shares Valued with appropriate mark-up (which
would be graded based on rating assigned to
37
Type of Investment Basis of Valuation

the security) over Central Government
Securities’ Yield as put in by FBIL, subjected
to an upper cap of redemption value of
preference shares
Equity Shares Valued at break-up value without considering
‘revaluation reserves’, if any
Units of Mutual Funds Latest re-purchase price or NAV and if NAV
is not available, at cost
Commercial Papers Carrying Cost (acquisition cost plus discount
accrued)
Investments in RRBs Carrying Cost (i.e., at book value)
Securities issued by Lower of redemption Value or Net Book
Securitisation Company (SC) Value (NBV)
/ Reconstruction Company
(RC)
Venture Capital Funds For first three years, VCFs may be classified
(VCFs) under HTM and subsequently under AFS
and valued for Units / Equity / Bonds as per
specified norms
Note: If the debentures/bonds/preference shares are quoted and are transacted

within 15 days prior to the valuation date, the valuation adopted as per above
mentioned method, should not be higher than the said transaction rate. For
further additional elaborate guidance, FIMMDA guidelines in this regard may be
referred to.
Spreading of MTM Losses and Creation of Investment Fluctuation
Reserve (IFR)
5.85 Banks had been given the option to spread provisioning for their mark to
market (MTM) losses on all investments held in AFS and HFT for the quarter
ended December 31, 2017 and March 31, 2018 equally over up to four quarters,
commencing with the quarter in which the loss is incurred. Banks that have
utilised the above option shall make suitable disclosures in their notes to
accounts/ quarterly results providing details of:
(a) the provisions made for depreciation of investment portfolio for the quarters
ended December, 2017 and March, 2018 made during the quarter/ year;
38
(b) the balance provisions required to be made in the remaining quarters; and
(c) creation of IFR.
5.86 The RBI vide circular no. DOR.BP.BC.No.42/21.04.141/2019-20 dated
March 17, 2020 has given certain additional guidance regarding considering IFR
forming part of General Provisions and Loss Reserves for capital purposes.
Non-Performing Investments (NPI)
5.87 In respect of securities included in any of the three categories where
interest/ principal is in arrears, banks should not reckon income on the securities
and should also make appropriate provisions for the depreciation in the value of
the investment. Banks should not set-off the depreciation requirement in respect
of these non-performing securities against the appreciation in respect of other
performing securities.
5.88 An NPI, similar to a non performing advance (NPA), is one where:
(i) Interest/ instalment (including maturity proceeds) is due and remains
unpaid for more than 90 days.
(ii) The above would apply mutatis-mutandis to preference shares where the
fixed dividend is not paid. If the dividend on preference shares (cumulative
or non-cumulative) is not declared/paid in any year it would be treated as
due/unpaid in arrears and the date of balance sheet of the issuer for that
particular year would be reckoned as due date for the purpose of asset
classification.
(iii) In the case of equity shares, in the event the investment in the shares of
any company is valued at Re.1 per company on account of the non
availability of the latest balance sheet in accordance with the instructions
contained in paragraph 3.5.5 of the RBI Master Circular no. RBI/2015-16/97
DBR No BP.BC.6 /21.04.141/2015-16 dated July 1, 2015 on Prudential
Norms for Classification, Valuation and Operation of Investment Portfolio by
Banks, those equity shares would also be reckoned as NPI.
(iv) If any credit facility availed by the issuer is NPA in the books of the bank,
investment in any of the securities, including preference shares issued by
the same issuer would also be treated as NPI and vice versa. However, if
only the preference shares are classified as NPI, the investment in any of
the other performing securities issued by the same issuer may not be
classified as NPI and any performing credit facilities granted to that
borrower need not be treated as NPA. The Auditor should review the
mechanism adopted by the Bank for classifying the investments as NPI
39
where the credit facility has been classified as NPA and vice versa and test
the effectiveness of the mechanism followed particularly the timeliness of
such classification.
(v) The investments in debentures / bonds, which are deemed to be in the
nature of advance would also be subjected to NPI norms as applicable to
investments.
(vi) In case of conversion of principal and / or interest into equity, debentures,
bonds, etc., such instruments should be treated as NPA ab initio in the
same asset classification category as the loan if the loan's classification is
substandard or doubtful on implementation of the restructuring package
and provision should be made as per the norms. Further movement in the
asset classification of these instruments would also be determined based
on the subsequent asset classification of the restructured advance.
(vii) When a Bank restructures credit facilities in accordance with RBI circular
no. DBR.No.BP.BC.45/21.04.048/2018-19 dated June 7, 2019 dealing with
Prudential Framework for Resolution of Stressed Assets, the investments
made by the Bank in the instruments of such borrowers will also be dealt
with in accordance with these guidelines.
Classification of State Government guaranteed investments as NPI
5.89 With effect from the year ending March 31, 2006, investment in State
Government guaranteed securities, including those in the nature of ‘deemed
advance’, attract prudential norms for identification of NPI and provisioning,
when interest/instalment of principal (including maturity proceeds) or any other
amount due to the bank remains unpaid for more than 90 days.
5.90 The prudential treatment for Central Government Guaranteed bonds
has to be identical to Central Government guaranteed advances. Hence,
bank’s investments in bonds guaranteed by Central Government need not be
classified as NPI until the Central Government has repudiated the guarantee
when invoked. However, this exemption from classification as NPI is not for the
purpose of recognition of income.
5.91 The audit procedures would include:
 Identifying Non-Performing Investments based on RBI guidelines as
defined above. In case advances given to a party is classified as NPA,
investment in securities issued by the same party also needs to be
classified as NPI and vice-versa except in case of preference shares,
wherein if a preference share is classified as NPI, the performing
securities and performing credit facilities granted to the said party need
not be treated as NPI / NPA.
40
 Ascertaining whether the bank has made appropriate provision for the
depreciation in the value of the NPI.
 Ensuring that the banks have not off-set the depreciation on NPI against
the appreciation in respect of other performing securities.
 Obtaining separate list of investments as a result of conversion of
interest/ principal. These investments need to be classified as NPI ab
initio, if the loan's classification is NPA on implementation of the
restructuring package.
Special Aspects
5.92 The auditor should pay special attention to ascertaining whether the
investments have been purchased or sold cum-dividend/ex-dividend, cum-
interest/ex-interest, cum-right/ex-right, or cum-bonus/ex-bonus. He should
check whether appropriate adjustments in this regard have been made in the
cost/sales value of securities purchased or sold.
5.93 In the case of a rights issue, the offer letter should be examined. The
Auditor should check control over recording, exercising, renouncing of rights
and also valuation of rights yet to be exercised. Where the rights have been
renounced or otherwise disposed off or not exercised, the auditor should
examine that the same have been duly accounted for. Similarly, the auditor
should examine the relevant documents in the case of detachable warrants. He
should also examine that these have been properly accounted for.
5.94 As regards bonus shares, the intimation to the bank regarding such
issue should be examined with a view to ascertaining the receipt and recording
of the requisite number of shares in the records maintained by the bank in this
regard.
Investment Fluctuation Reserve (IFR), Market Risk & Investment
Reserve Account (IRA)
5.95 The RBI had specified the following guidelines with respect to IFR and
IRA:
Investment Fluctuation Reserve
(i) Banks were advised to build reserves towards investment fluctuation, of a
minimum 5% of the investment portfolio within 5 years period.
(ii) To ensure smooth transition to Basel II norms, banks had been advised to
build adequate reserve towards capital charge for market risks in a
phased manner over a two year period as follows:
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(a) In respect of securities included in the HFT category, open gold

position limit, open foreign exchange position limit, trading positions
in derivatives and derivatives entered into for hedging trading book
exposures by March 31, 2005; and
(b) In respect of securities included in the AFS category by March 31,
2006.
(iii) As advised by RBI in October, 2005, Banks maintaining capital of at least
9 per cent of the risk weighted assets for both credit risk and market risks
for both HFT (of items - open gold position limit, open foreign exchange
position limit, trading positions in derivatives and derivatives entered into
for hedging trading book exposures) and AFS category as on March 31,
2006 were permitted to treat the entire balance of IFR as Tier I capital,
transfer the balance in the IFR ‘below the line’ in the Profit & Loss
Appropriation account to statutory reserve, general reserve or balance of
Profit and Loss Account.
Investment Reserve Account
(i) Provisions created for depreciation on investments in the AFS and HFT
categories if found excessive should be credited to the Profit & Loss
Account and equivalent amount (net of taxes, if any and net of transfer to
Statutory Reserve as applicable to such excess provision) should be
appropriated to an Investment Reserve Account in Schedule 2 –
“Reserves and Surplus” under the head “Revenue and Other Reserves”
and would be eligible for inclusion under Tier II capital within the overall
ceiling of 1.25% of total risk weighted assets prescribed for general
provisions/ Loss Reserves.
(ii) The Investment Reserve Account can be utilised in the prescribed
manner.
(iii) The amounts debited to the Profit & Loss Account for provision should be
debited under the head "Expenditure - Provisions & Contingencies". The
amount transferred from the Investment Reserve Account to the Profit &
Loss Account should be shown as "below the line" item in the Profit and
Loss Appropriation Account after determining the profit for the year.
Provision towards any erosion in the value of an asset is an item of
charge on the profit and loss account and hence should appear in that
account before arriving at the profit for the accounting period. Adoption of
the following would not only be adoption of a wrong accounting principle
but would, also result in a wrong statement of the profit for the accounting
period:
42
(a) the provision is allowed to be adjusted directly against an item of

reserve without being shown in the profit and loss account; or
(b) a bank is allowed to draw down from the Investment Reserve
Account before arriving at the profit for the accounting period (i.e.,
above the line); or
(c) a bank is allowed to make provisions for depreciation on investment
as a below the line item, after arriving at the profit for the period.
Hence none of the above options are permissible.
(iv) The withdrawal from the Investment Reserve Account cannot be used for
dividend declaration. Dividends should be payable only out of current
year's profit. However, the balance in the Investment Reserve Account
transferred ‘below the line’ in the Profit and Loss Appropriation Account to
Statutory Reserve, General Reserve or balance of Profit & Loss Account
would be eligible to be reckoned as Tier I capital.
5.96 The auditor should also examine whether the bank, as required by the
RBI, is maintaining separate accounts for the investments made by it on its own
Investment Account, on PMS clients’ account, and on behalf of other constituents
(including brokers). As per the RBI guidelines, banks are required to get their
investments under PMS separately audited by external auditors. The Auditor
should review the report of such external auditors, if available, and check
whether the discrepancies pointed out in the report have been adequately dealt
with. The Auditor should also verify that PMS transactions are carried out
through a separate SGL account, and that there is no switching between the
bank’s own investment account and PMS clients’ account except in accordance
with the guidelines laid down by the RBI in this regard.
5.97 Investments should not normally be held by any other person. If any
investments are so held, proper enquiry should be made to ensure that there is
some justification for it, e.g., shares may be held by brokers for the purpose of
transfer or splitting-up etc. Shares may also be lodged with the companies
concerned for transfer etc. When investments are held by any other person on
behalf of the bank, the Auditor should obtain a certificate from him. The
certificate should state the reason for holding the investment (e.g., in safe
custody or as security). The receipt originally issued by such person while
taking delivery of the investment is not adequate for audit purposes. In the
case of inscribed stock also, a certificate should be obtained which should
certify the holding of the bank as at the date of the balance sheet.
5.98 Where securities lodged for transfer have not been received back
within a reasonable period, or where share certificates, etc., have not been
43
received within a reasonable period of the lodging of the allotment advice, the
Auditor should examine whether adequate follow-up action has been taken. He
may, in appropriate cases, also enquire from the issuers, or their registrars,
about the reasons for the delay. In cases where the issuer/registrar has
refused to register the transfer of securities in the name of the bank, the
Auditor should examine the validity of the title of the bank over such securities.
5.99 If certain securities are held in the names of nominees, the Auditor
should examine whether there are proper transfer deeds signed by the holders
and also an undertaking from them that they hold the securities on behalf of the
bank. The Auditor may also check compliance with Section 89 of the Companies
Act, 2013 declaration in respect of beneficial interest in any share.
5.100 While examining the investment portfolio, the Auditor should pay special
attention to securities whose maturity dates have already expired. It is possible
that income on such investments may also not have been received. In case the
amount of such investments or the income accrued thereon is material, the
Auditor should seek an explanation from the management on this aspect. Auditor
should also consider whether the income accrued requires reversal as also
whether any provision for loss in respect of such investments is required.
Similarly, where income on any security is long overdue, the Auditor should
consider whether provision is required in respect of such income accrued earlier.
5.101 The Auditor should check whether the overdue amount in respect of
matured investment is disclosed as investment or other assets. Since the
investments had already matured, the overdue amount should be disclosed as
Other Assets and not Investments.
Income from investments
5.102 The Auditor should examine whether income from investments is
properly accounted for. This aspect assumes special importance in cases
where the bank has opted for receipt of income through the electronic/online
medium.
 Re-computation of amortisation of premium / discount on investment
securities.
 Re-performance of profit / loss on sale of investments keeping into
consideration the method of allocating cost to securities (FIFO or weighted
average).
 Assessing the dividend recognition policy of bank considering revenue
recognition principles of Accounting Standard 9, ‘Revenue Recognition’.
44
 Re-computation of interest income on investments and checking the

treatment of broken period interest, including ensuring proper cut-offs at
reporting period ends.
 Checking of proper recognition of investment valuation loss as at reporting
date.
 Checking of interest accrual in respect of interest-bearing investment
outstanding at reporting date.
5.104 Considering that banks have large investment portfolio, use of
substantive analytical procedures may be a useful audit technique for the
Auditor to conclude that income associated with investment balances is free
from material misstatement. One such techniques is to include ‘yield analysis’
for the disaggregated investment portfolio of the bank.
5.105 There may be cases where the certificates of tax deduction at source
(TDS) received along with the dividend/interest on investments are found
missing. This increases the incidence of tax on the bank. The Auditor should
see that there is a proper system for recording and maintenance of TDS
certificates received by the bank. The Auditor may also review Form 26AS
(Income-tax Rules,1962) to ensure that proper credit will be made available to
the bank.
5.106 Part of the outstanding principal amount can be converted into debt or
equity instruments by way of restructuring. In the case of restructured accounts
classified as 'standard', the income, if any, generated by these instruments may
be recognised on accrual basis. In the case of restructured accounts classified
as non-performing assets, the income, if any, generated by these instruments
may be recognised only on cash basis. The Auditor should verify that recognition
of assets on conversion / restructuring does not exceed the amount restructured.
Legal Requirements
5.107 For the purposes of section 24 of the Banking Regulation Act, 1949,
the valuation of securities is to be done with reference to the cost price, market
price, carrying cost or face value, or a combination of these methods, as may
be specified by the RBI from time to time.
5.108 Section 19 of the Act places restrictions on overall holding of
investments by banks in the shares of companies (except in the shares of
subsidiary company. As per Section 19(2) of the Act, no banking company
shall hold shares in any company, whether as pledgee, mortgagee or absolute
owner, of an amount exceeding thirty per cent of the paid-up share capital of
that company or thirty per cent of its own paid up share capital and reserves,
whichever is less.
45
5.109 It should be observed that the limit of thirty per cent, as specified in
section 19 of the Act, applies to all shares whether held as investments or as
pledgee or mortgagee. Securities pledged by borrowers against advances are,
therefore, to be taken into account. Securities held for safe custody are,
however, not to be taken into account.
5.110 Under section 15(2) of the Act, it is necessary that before distributing
dividends, a banking company provides for depreciation in the value of its
investments in shares, debentures or bonds (other than the investments in
approved securities) to the satisfaction of its Statutory Auditors. Investments in
approved securities are exempted from this requirement provided such
depreciation has not actually been capitalised or otherwise accounted for as a
loss. In this regard, it may be noted that the RBI guidelines require banks to
provide for depreciation in the value of certain approved securities also.
Depreciation in respect of such approved securities accounted for, as a loss by
the bank would not therefore be covered by the exemption granted under the
section.
5.111 In the case of banking companies, section 187 of the Companies Act,
2013 is also relevant. This section provides that all investments made by a
company on its own behalf shall be made and held by it in its own name,
except in the following cases:
(a) Shares in a subsidiary may be held in the name(s) of the company’s
nominee(s) to the extent necessary to ensure the minimum number of
members as required by law.
(b) Investments may be deposited with the bankers of the company for
collection of dividend or interest.
(c) Investments may be deposited with, or transferred to, or held in the name
of, the State Bank of India or a scheduled bank to facilitate transfer
thereof, subject to the conditions laid down in this behalf.
(d) Investments may be deposited with, or transferred to, any person by way
of security for repayment of a loan or performance of an obligation
undertaken by the company.
(e) Investments in the form of securities may be held in the name of a
depository.
5.112 In respect of investments not held in the company’s own name as per
the exceptions made under section 187 of the Companies Act, 2013, a register
has to be maintained by the company, as per format prescribed from time to
time. Section 186 of the Companies Act, 2013, which imposes certain
restrictions on the purchase of securities in other companies, does not apply to
a banking company.
46
5.113 The provisions of section 179 of the Companies Act, 2013, also need
to be noted. This section provides that normally, the power to invest the funds
of a company shall be exercised by its board of directors only by means of
resolutions passed at meetings of the Board. The section, however, permits
the Board, by means of a resolution passed at a meeting, to delegate this
function to a committee of directors, managing director, manager or any other
principal officer of the company or, in the case of a branch office, to a principal
officer of the branch office provided that such a resolution for delegation
specifies the amount up to which the investments may be made and the nature
of the investments.
Guidelines of the RBI regarding transactions in Securities
5.114 The Reserve Bank of India has issued Master Circular dated July 1,
2015 on “Prudential Norms for Classification, Valuation and Operation of
Investment Portfolio by Banks”, consolidating instructions/guidelines issued to
banks on matters regarding prudential norms for classification, valuation and
operation of Investment portfolio of banks. It may be noted that the Reserve
Bank of India has not issued consolidated master circular after issuing the
above said circular. The amendments are being issued through various
Notifications and Circulars and accordingly Auditors are advised to refer
various circulars and notifications related to treasury operations issued after 1 st
July, 2015.
Classification of Investments
5.115 Banks are required to classify their entire investments portfolio
(including SLR securities and non-SLR securities) into three categories: “held-
to-maturity”, “available-for-sale” and “held-for-trading”.
(i) Held-to-maturity (HTM)
This category would comprise securities acquired by the bank with the
intention to hold them up to maturity.
(ii) Held-for-trading (HFT)
The investments classified under HFT would be those from which the bank
expects to make a gain by the movement in interest rates/market rates. These
securities are to be sold within 90 days.
(iii) Available-for-sale (AFS)
This category will comprise securities, which do not qualify for being
categorised in either of the above categories, i.e., those that are acquired
neither for trading purpose nor for being held till maturity.
47
5.116 Banks should decide the category of the investment at the time of
acquisition and the decision should be recorded on the investment
proposal/deal slip. Investments under HTM category should not normally exceed
25% of the total investments of the bank, except as specified in the Master
Circular, wherein the limit of 25% can be exceeded. Banks may hold the
following securities under HTM:
(a) SLR Securities up to prescribed percentage of their DTL as on the last
Friday of the second preceding fortnight (updated vide RBI circular
no.DBR.No.Ret.BC.10/12.02.001/2018-19 dated December 05, 2018 on
“Section 24 and Section 56 of the Banking Regulation Act, 1949 –
Maintenance of SLR and holdings of SLR in HTM category).
(b) Non-SLR securities included under HTM as on September 02, 2004.
(c) Fresh re-capitalisation bonds received from the Government of India
towards their re-capitalisation requirement and held in Investment
portfolio, excluding re-capitalisation bonds of other bank acquired for
investment purpose.
(d) Fresh investment in the equity of subsidiaries and joint ventures.
(e) RIDF/SIDBI/RHDF deposits.
(f) Investment in long-term bonds (with a minimum residual maturity of seven
years at the time of investment) issued by companies engaged in
infrastructure activities.
5.117 The banks will have the freedom to decide on the extent of holdings
under HFT and AFS. This will be decided by them after considering various
aspects such as basis of intent, trading strategies, risk management
capabilities, tax planning, manpower skills, capital position. RBI vide its circular
no. DBR.BP.BC.No.31/21.04.018/2015-16 dated 16th July 2015 on “Deposits
placed with NABARD/SIDBI/NHB for meeting shortfall in Priority Sector
Lending by Banks-Reporting in Balance Sheet” decided that for accounting
periods commencing on or after April 1, 2015, deposits placed with NABARD/
SIDBI/ NHB on account of shortfall in priority sector targets should be included
under Schedule 11- ‘Other Assets’ under the subhead ‘Others’ of the Balance
Sheet instead of disclosing under Schedule 8 “Investments”.
5.118 Vide RBI circular no. DoR.No.BP.BC.9/21.04.141/2020-21 dated
September 1, 2020 Banks were allowed to hold under HTM category, SLR
securities acquired on or after September 1, 2020 up to an overall limit of 22
per cent of NDTL, up to March 31, 2021. This was further relaxed up to March
31, 2022 vide circular no. DoR.No.BP.BC.22/21.04.141/2020-21 dated October
48
12, 2020 w.r.t. the securities acquired between September 01, 2020 and March
31, 2021. Subsequently, it was further relaxed vide Circular no. RBI/2020-
21/94 DOR.No.MRG.BC.39/21.04.141/2020-21 dated February 5, 2021, to
extend the dispensation of enhanced HTM of 22 per cent to March 31, 2023 to
include SLR securities acquired between April 1, 2021 and March 31, 2022.
Thus, banks may exceed the limit specified w.r.t. total SLR securities held
under HTM category (as specified in paragraph 2(b) of the above circular) up
to 22 per cent of NDTL (instead of 19.5 per cent of NDTL) till March 31, 2023,
provided such excess is on account of SLR securities acquired between
September 1, 2020 and March 31, 2022. Thereafter it shall be progressively
reduced such that the total SLR securities held in the HTM category as a
percentage of the NDTL does not exceed
a. 21.00 per cent as on June 30, 2023.
b. 20.00 per cent as on September 30, 2023.
c. 19.50 per cent as on December 31, 2023.
Exposure Limits
5.119 The RBI, vide its Master Circular no. RBI /2015-16/70
DBR.No.Dir.BC.12 /13.03.00/2015-16 dated July 1, 2015 on “Exposure Norms”
provides requirements in respect of exposure limits for banks. Further, the
Reserve Bank of India vide Circular No. RBI/2018-19 /196 DBR.No.BP.
BC.43/21.01.003/2018-19 dated June 03, 2019 “Large Exposures Framework”
has issued guidelines on Large Exposure Framework (LEF). These guidelines
came into effect with effect from April 1, 2019. Further amendments to these
guidelines have also been made vide Circular no. DOR.No.BP.BC.70/
21.01.003/2019-20 dated May 23, 2020.
5.120 As per guidelines banks cannot participate in the equity of financial
services ventures including stock exchanges, depositories, etc., without
obtaining the prior specific approval of the Reserve Bank of India,
notwithstanding the fact that such investments may be within the ceiling
prescribed under Section 19(2) of the Banking Regulation Act. The RBI vide its
Circular no. DBR.No.FSD.BC.37/24.01.001/2015-16 dated September 16,
2015 on “Equity Investment by Banks – Review” has permitted banks which
have CRAR of 10 per cent or more and have also made net profit as of March
31 of the previous year that they need not approach RBI for prior approval for
equity investments in cases where after such investment, the holding of the
bank remains less than 10 per cent of the investee company’s paid up capital,
and the holding of the bank, along with its subsidiaries or joint ventures or
entities continues to remain less than 20 per cent of the investee company’s
49
paid up capital. Financial Services Companies have been defined in Annex I to

the Master Circular DBR.No.FSD.BC.19/ 24.01.001/2015-16 dated July 1,
2015. The investment will continue to be subject to prudential limits as
mentioned in Para 3.1 (a) and (c) of Master Circular DBR.No.FSD.BC.19/
24.01.001/2015-16 on ‘Para-banking Activities’ dated July 1, 2015.
The Auditor needs to check compliance with above mentioned circulars, while
auditing equity investments in financial services company by the bank.
(C) Certificate/ Reports (covering the requirements and
approach/ procedures)
Special-purpose Certificates Relating to Investments
5.121 It may be noted that pursuant to RBI’s circulars, issued from time to
time, banks require their Statutory Central Auditors to issue the following
certificates regarding investments of the bank (in addition to their main audit
report and the long form audit report):
(i) Certificate on reconciliation of securities by the bank (both on its own
Investment Account as well as PMS clients’ account). The reconciliation
is to be presented in a given format.
(ii) Certificate on compliance by the bank in key areas of prudential and other
guidelines relating to such transactions issued by the Reserve Bank of
India.
5.122 The Auditor may consider relying on the work done during the course
of audit for the purposes of such certificates. The certificate should reach the
Regional Office of the DBS, RBI, under whose jurisdiction the bank’s head
office is located within one month from the close of the accounting year, and
thus for banks whose accounts have not been audited by the stated period
may issue the certificate based on the unaudited books of account.
(D) Accounting Aspects
Disclosure Requirements
5.123 Investments of banks should be disclosed as per the following 6
classifications:
(i) Governments Securities
(ii) Other Approved Securities
(iii) Shares (both equity as well as preference)
(iv) Debentures and Bonds
50
(v) Subsidiaries/ Joint Ventures/ Associates

(vi) Other investments, such as, Commercial Papers, Certificate of Deposits,
Security Receipts (SR), Pass Through Certificates (PTC), Units of Mutual
Funds, Venture Capital Funds, Real Estate Funds, Real Estate
Investment Trust (REITs), Infrastructure Investment Trust (InvITs) etc.
However, banks are not permitted to make investments in immovable
properties for earning rentals, though it can gainfully deploy any business
premises, which is not being used for the business. Thus, banks will not have
immovable properties as part of their investment portfolio (Section 6 of Banking
Regulation Act, 1949).
Balance Sheet Presentation
5.124 The Third Schedule to the Banking Regulation Act, 1949, requires the
disclosure of investments in the balance sheet as follows:
I. Investments in India
(i) Government securities
(ii) Other Approved Securities
(iii) Shares
(iv) Debentures and Bonds
(v) Subsidiaries and/or Joint Ventures
(vi) Others (to be specified)
II. Investments outside India
(i) Government securities (including local authorities)
(ii) Subsidiaries and/or Joint Ventures Abroad
(iii) Other Investments (to be specified)
5.125 In addition to other disclosures regarding investments, the Notes and
Instructions for Compilation of Balance Sheet, also require the following
information to be disclosed in the balance sheet:
(a) gross value of investments in India and outside India;
(b) aggregate of provisions for depreciation, separately on investments in
India and outside India;
(c) net value of investments in India and outside India; and
(d) movement of provisions held towards depreciation on investments
51
including opening balance by adding provisions made during the year and
after deducting write-off/ write-back of excess provisions during the year.
5.126 The gross value of investments and provisions need not, however, be
shown against each of the categories specified in the Schedule. The break-up
of net value of investments in India and outside India (gross value of
investments less provision) under each of the specified category need only be
shown.
5.127 The Auditor should consider the following points in respect of
Investments held outside India –
a. Review the delegation of authority to confirm that in respect of branches
outside India holding investments, whether the foreign branches are
authorised to transact and hold investments in their books of accounts
and that the transactions have been duly executed as per the said
delegation matrix.
b. Physically verify these investments held by branches outside India. In
case it is not possible to verify these physically, undertake alternative
audit procedures to verify the existence and ownership of these
investments as at the reporting date.
c. Verify the valuation of these investments. The same should be in line with
RBI requirements. Similarly, local regulations in the country in which the
investments are made should also be referred to. The valuations should
be in line with the regulations that are more stringent.
(E) Internal Financial Controls Over Financial Reporting
including IT Controls
5.128 The Auditors should familiarise themselves with the instructions/
directions issued by the RBI regarding transactions in investment securities.
Banks should frame Internal Investment Policy Guidelines and obtain the Board’s
approval. The investment policy may be suitably framed / amended to include
Primary Dealer (PD) activities also. Further, the Reserve Bank of India has
issued Master Directions no. RBI/IDMD/2016-17/29 Master Direction
IDMD.PDRD.01/03.64.00/2016-17on Operational Guidelines for Primary Dealers
dated July 1, 2016 (updated November 22, 2018), which should be complied by
Banks. The Auditor should review the investment policy of the bank to
ascertain that the policy conforms, in all material respects, to the RBI’s
guidelines as well as to any statutory provisions applicable to the bank.
5.129 Banks' management should ensure that there are adequate internal
52
control and audit procedures for ensuring proper compliance in regard to the
conduct of the investment portfolio. The banks should institute a regular system
of monitoring compliance with the prudential and other guidelines issued by the
Reserve Bank of India. While examining the internal controls over investments
the Auditor should particularly examine whether the same are in consonance
with the guidelines of the RBI a gist of which has also been included in the
Master Circular no. RBI/2015-16/97 DBR No BP.BC.6 /21.04.141/2015-16 on
Prudential Norms for Classification, Valuation and Operation of Investment
Portfolio by Banks dated July 1, 2015. They should also judge their efficacy. By
efficacy, it is meant that not only the Auditor would check the operating
effectiveness of various internal controls but also in the first instance check
and evaluate the design of such internal controls.
5.130 Any deficiencies noted during the audit procedures should be reported
by the Auditor to the Management/ Those charged with Governance in
accordance with SA 265 “Communicating Deficiencies in Internal Control to
Those Charged with Governance and Management”.
 Perusing the investment policy and preparing brief note on key points of
compliances.
 examine whether the Investment policy has been periodically reviewed by
the Management and adequate corrective actions have been taken.
 verify whether investment policy lays down clear parameters for stop loss
limits or there exits any separate stop loss policy.
 perusing the minutes of board/board appointed committee for approval of
investment policy and obtain the list of modifications made in the policy
compared to earlier approved policy.
 examine whether the investments made by the bank are in accordance
with the laid down investment policy and are also in compliance with the
RBI guidelines w.r.t. exposure norms.
 verification of valuation of investments as per the method and frequency as
defined by RBI.
 perusing reports on concurrent audit of treasury transactions, system
audit report, if any and follow-up action taken by the management
thereon.
 perusing the half yearly review of portfolio by the Board of Directors of the
bank and also reviewing annual inspection report of the RBI carried out
under Section 35 of the Banking Regulation Act, 1949.
53
 Verification of voice recording mechanism and to ensure user ids of

dealers left / transferred/ on leave is deactivated / suspended on timely
basis.
Dealings in Securities on Behalf of Others
5.132 Apart from making investments on its account, a bank may also deal
in securities on behalf of its customers only with the prior approval from RBI.
These activities of banks are in the nature of trust or fiduciary activities. The
accounting implications of the trust activities of banks may be noted. Banks
commonly act as trustees and in other fiduciary capacities that result in holding
or placing of assets on behalf of individuals, trusts, retirement benefit plans
and other institutions. If the trustee or similar relationship is legally supported,
these assets are not assets of the bank and, therefore, are not included in its
balance sheet. If the bank is engaged in significant trust activities, disclosure of
that fact and indication of the extent of those activities is made in its financial
statements because of the potential liability if it fails in its fiduciary duties. For
this purpose, trust activities do not encompass safe custody functions.
5.133 The Auditor should examine whether bank’s income from such activities
have been recorded and is fairly stated in the bank’s financial statements. The
Auditor also needs to consider whether the bank has any material undisclosed
liability from a breach of its fiduciary duties, including the safekeeping of assets.
The Auditor also needs to give certificate for reconciliation of securities held by
the bank as custodian. An Illustrative Checklist for the verification of the aspects
of the Treasury/ Investments of the Bank in Statutory Audit is given as Annexure
to this Chapter.
(F) Compliance with CRR and SLR requirements
Introduction
5.134 Due to the nature of their operations, banks need to maintain
sufficient liquid assets in the normal course of their business. The failure of a
bank to meet its liabilities to depositors, as and when called upon to do so,
undermines the confidence of the depositors not in the particular bank alone
but in the entire banking system. While ensuring some liquid money against
deposits is the primary purpose of CRR, its secondary purpose is to allow the
RBI to control liquidity and interest rates in the economy. In the short term,
interest rates swing up or down depending on how much liquidity is available
for lending. Too much money leads to a collapse in rates, and too little, a
spike.
Regulatory Requirements
5.135 Recognising the need to safeguard the interests of depositors by
ensuring that banks do not over-extend their resources and to maintain the
54
confidence of the public in the banking system, Section 24(2A) of the Banking
Regulation Act, 1949 requires that a scheduled bank shall maintain in India, in
addition to the average daily balance which it is, or may be, required to
maintain under Section 42 of the RBI Act, 1934, and every other banking
company, in addition to the cash reserve which it is required to maintain under
section 18 of the Banking Regulation Act, 1949, assets the value of which shall
not be less than such percentage not exceeding forty per cent of the total of its
demand and time liabilities (DTL) in India as on the last Friday of the second
preceding fortnight in such form and manner as the RBI may by notification in
the official gazette, specify from time to time. This is referred to as ‘Statutory
Liquidity Ratio’ (SLR). The Friday with reference to which the amount of liquid
assets have to be maintained during a fortnight is determined is commonly,
referred to as the ‘reporting Friday’. The prescribed percentage of liquid assets
has to be maintained as at the close of business on every day. It may be noted
that the statutory liquidity ratio is to be maintained with reference to the bank
as a whole, and not for individual branches.
5.136 The RBI vide its Master circular No. RBI/2015-16/98 DBR.No.Ret.BC.
24/12.01.001/2015-16 on “Cash Reserve Ratio (CRR) and Statutory Liquidity
Ratio (SLR)” dated July 1, 2015, has specified that consequent upon
amendment to the Section 24 of the Banking Regulation Act, 1949 through the
Banking Regulation (Amendment) Act, 2007 replacing the Banking Regulation
(Amendment) Ordinance, 2007, effective January 23, 2007, the Reserve Bank
can prescribe the Statutory Liquidity Ratio (SLR) for Scheduled Commercial
Banks in specified assets. The value of such assets of a SCB shall not be less
than such percentage not exceeding 40 per cent of its total demand and time
liabilities in India as on the last Friday of the second preceding fortnight as the
Reserve Bank may, by notification in the Official Gazette, specify from time to
time.
5.137 Further, Reserve Bank has specified vide circular no. RBI/2016-17/83
DBR.No.Ret.BC.15/12.02.001/2016-17 dated October 13, 2016 on Section 24
and Section 56 of the Banking Regulation Act, 1949 - Maintenance of Statutory
Liquidity Ratio (SLR) that every Scheduled Commercial Bank shall continue to
maintain in India assets as detailed below, the value of which shall not, at the
close of business on any day, be less than a specified percentage of the total net
demand and time liabilities (NDTL) as on the last Friday of the second preceding
fortnight valued in accordance with the method of valuation specified by the
Reserve Bank of India from time to time:
(a) Cash; or
(b) Gold as defined in Section 5(g) of Banking Regulation Act, 1949 valued at a
price not exceeding the current market price; or
55
(c) Unencumbered investment in the following instruments which will be

referred to as "Statutory Liquidity Ratio (SLR) securities":
(i) Dated securities of the Government of India issued from time to time
under the market borrowing programme and the Market Stabilization
Scheme;
(ii) Treasury Bills of the Government of India; and
(iii) State Development Loans (SDLs) of the State Governments issued
from time to time under the market borrowing programme;
(d) the deposit and unencumbered approved securities required, under sub-
section (2) of section 11 of the Banking Regulation Act, 1949 (10 of 1949),
to be made with the Reserve Bank by a banking company incorporated
outside India; and
(e) any balance maintained by a scheduled bank with the Reserve Bank in
excess of the balance required to be maintained by it under section 42 of
the Reserve Bank of India Act,1934 (2 of 1934).
5.138 This has been amended by RBI circular no. DBR.No.Ret.BC.10
/12.02.001/2018-19 dated December 5, 2018 on Section 24 and Section 56 of
the Banking Regulation Act, 1949 - Maintenance of Statutory Liquidity Ratio
(SLR), which has reduced the SLR by 0.25% in a phased manner beginning from
5.1.2019 till it reaches 18% by 11.4.2020 as follows –
Effective date (from the fortnight SLR on net demand and time
beginning) liabilities (per cent)
October 14, 2017 19.50
05.01.20191 19.25
13.04.20191 19.00
06.07.20191 18.75
12.10.20191 18.50
04.01.20201 18.25
11.04.20201 18.00
1
Vide RBI notification no. RBI/2018-19/86/DBR.No.Ret.BC.10/12.02.001 dated 05.12.2018.
56
5.139 Provided that the instruments referred to in items (i) to (iii) above that
have been acquired under reverse repo with Reserve Bank of India, shall not be
included as SLR securities for the purpose of maintenance of SLR assets up to
October 2, 2016. From October 3, 2016 such securities acquired from Reserve
Bank shall be considered as eligible assets for SLR maintenance.
5.140 However, in terms of Master Circular RBI/2015-16/104 DBR.No.FID.
FIC.3/01.02.00/2015-16 on Prudential Norms for Classification, Valuation and
Operation of Investment Portfolio by Banks dated July 1, 2015, the regulatory
treatment of market repo transactions in Government securities will continue as
hitherto, i.e., the funds borrowed under repo will continue to be exempt from
CRR/SLR computation and the security acquired under reverse repo shall
continue to be eligible for SLR.
5.141 In respect of repo transactions in corporate debt securities, the amount
borrowed by a bank through repo shall be reckoned as part of its DTL and the
same shall attract CRR/SLR. Encumbered SLR securities are not to be included
for the purpose of computing the percentage specified herein above, to the
extent of outstanding liabilities against the same.
5.142 If a banking company fails to maintain the required SLR, it shall be
liable to pay to RBI in respect of that default, penal interest for that day at the
rate of three per cent per annum above the bank rate on the shortfall and if the
default continues on the next succeeding working day, the penal interest may
be increased to a rate of five per cent per annum above the bank rate for the
concerned days of default on the shortfall.
5.143 As section 24 of the Banking Regulation Act, 1949 is also applicable
to nationalised banks, State Bank of India and its subsidiaries, and regional
rural banks too have to comply with the above requirements. According to
Section 24(3) of the Banking Regulation Act, 1949, for the purpose of ensuring
compliance with this section, every banking company is required to furnish to
the RBI, in the prescribed form and manner, a monthly return showing
particulars of its assets maintained in accordance with this section and its
demand and time liabilities in India at the close of the business on each
alternate Friday during the month. If any such Friday happens to be a public
holiday, the computation of SLR is to be done at the close of business on the
preceding working day. The return in form VIII is to be furnished within 20 days
after the end of the month to which it relates. Banks should also submit a
statement as annexure to form VIII giving daily position of –
(a) value of securities held for the purpose of compliance with SLR; and
(b) the excess cash balances maintained by them with RBI in the
prescribed format.
57
5.144 As per Circular RBI/2016-17/302 Ref: DBR.CO.No.Ret.BC /66/

12.07.144/2016-17 dated May 11, 2017 on “Submission of Statutory returns
(SLR-Form VIII) in XBRL platform”, the reporting of SLR has been moved from
PCRPCD to XBRL (Extensible Business Reporting Language) platform from April
2017 onwards.
5.145 The RBI, vide its circulars DBOD No.761-A/08/07/003/93 dated
February 8, 1993 and 829/08.07.003/93 dated February 20, 1993, has asked
the banks to advise their Statutory Central Auditors to verify the compliance of
statutory liquidity ratio on twelve odd dates in different months not being
Fridays. The said compliance report by the Auditors is to be submitted
separately to the top management of the bank and to the RBI.
5.146 The Statutory Auditor should verify and certify that all items of outside
liabilities, as per the bank’s books had been duly compiled with the bank and
currently reflected under demand and time liabilities (DTL) and net demand
and time liabilities (NDTL) in the fortnightly/monthly statutory returns submitted
to the RBI for the financial year.
5.147 The Reserve Bank of India vide its Circulars no.:
DOR.No.Ret.BC.52/12.01.001/2019-20 dated March 27, 2020, DOR.RRB.
No.28/31.01.001/2020-21 dated December 4, 2020, RBI/2020-21/91 DOR.No.
Ret.BC.36/12.01.001/2020-21 February 05, 2021 and Press Release No.2020-
2021/401 dated September 28, 2020 on Marginal Standing Facility (MSF),
allowed banks to avail of funds under the MSF by dipping into the Statutory
Liquidity Ratio (SLR) up to an additional one per cent of their net demand and
time liabilities (NDTL), i.e., cumulatively up to three per cent of NDTL. The said
MSF relaxation has been extended upto September 30, 2021
Computation of CRR
5.148 The RBI introduced the system of lag of one fortnight in the
maintenance of stipulated CRR by banks w.e.f. November 06, 1999 to improve
cash management by banks. Further, the daily minimum CRR maintenance
requirement has been reduced to 90 percent effective from the fortnight
beginning from April 16, 2016.
5.149 RBI issued circular no. RBI/2020-21/92 DOR.No.Ret.BC.37
/12.01.001/2020-21 dated February 05, 2021 whereby Scheduled Commercial
Banks will be allowed to deduct the amount equivalent to credit disbursed to
‘New MSME borrowers’ from their Net Demand and Time Liabilities (NDTL) for
calculation of the Cash Reserve Ratio (CRR). For the purpose of this exemption,
‘New MSME borrowers’ shall be defined as those MSME borrowers who have
not availed any credit facilities from the banking system as on January 1, 2021.
58
This exemption will be available only up to Rs. 25 lakh per borrower disbursed up
to the fortnight ending October 1, 2021, for a period of one year from the date of
origination of the loan or the tenure of the loan, whichever is earlier.
5.150 The Reserve Bank of India reduced the CRR to 3% vide Circular
DOR.No.Ret.BC.49/12.01.001/2019-20 dated March 27, 2020 up to a period of
one year ending March 26, 2021. The said dispensation would be restored in two
phases - banks will be required to maintain the CRR at 3.50 per cent of their
NDTL effective from the reporting fortnight beginning March 27, 2021 and 4.00
per cent of their NDTL effective from fortnight beginning May 22, 2021.
Computation of SLR
5.151 Refer Master circular No. DBR.No.Ret.BC.24/12.01.001/2015-16 on
“Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)” dated July 1,
2015, for guidance on computation of SLR. Further, RBI notification RBI/2016-
17/83 DBR.No.Ret.BC.15/12.02.001/2016-17 dated October 13, 2016 on
“Section 24 and Section 56 of the Banking Regulation Act, 1949 - Maintenance
of Statutory Liquidity Ratio (SLR)”, as amended from time to time, has been
issued in this regard.
Audit Approach and Procedures
5.152 The certificate of the statutory Auditors in relation to compliance with
CRR and SLR requirements has to cover two aspects:
(a) Correctness of the compilation of DTL position; and
(b) Maintenance of liquid assets as specified in section 24 of the Act.
5.153 The Statutory Central Auditor should acquaint himself with the
circulars/ instructions of the RBI regarding composition of items of DTL. For
this purpose, he may request the management to provide him a copy of the
relevant circulars/instructions. He should keep these circulars/instructions in
mind while examining compliance with the SLR requirements.
5.154 The Statutory Central Auditor should carry out a process walk-through
of NDTL and CRR/ SLR calculation process to identify risk associated with
calculation and probability of error. The same should be noted in the working
papers of the Auditor.
5.155 To comply with the requirements relating to statutory liquidity ratio,
banks have evolved a system of consolidating trial balances of all branches
and head office to compile consolidated trial balance of bank as a whole at its
head office. Based on this consolidation, the DTL position is determined for
every reporting Friday. The Statutory Central Auditor should request the
Branch Auditors to verify the correctness of the trial balances relevant to the
59
dates selected by him. The Statutory Central Auditor should also request the
branch auditors to verify the cash balance at the branch on the dates selected
by him. It should be ensured that such request is communicated to the SBAs
well in advance of commencement of the audit so that they can draw up their
audit programme accordingly.
5.156 In many Banks, the consolidated trial balance (related to branches) for
selected dates can be generated through core banking system and hence,
verification by Statutory Branch Auditors may not be warranted.
5.157 Most of the liquid assets for the purpose of compliance with the SLR
requirements comprise of approved securities, which are usually dealt with at
the head office and a few large branches. The Auditors should test check the
relevant records maintained by the bank in respect of investments to verify the
amount of approved securities held by the bank on the dates selected by him.
The Auditor should ascertain the valuation basis applicable at the relevant time
and examine whether the valuation of securities done by the bank is in
accordance with the guidelines prescribed by the RBI.
5.158 The Auditor should examine the consolidations prepared by the bank
relevant to the dates selected by him. He should test check the figures in the
consolidations with the related returns received from the branches. He should
also test check the arithmetical accuracy of the consolidations.
5.159 While examining the computation of DTL, the Auditor may specifically
examine whether the following items have been excluded from liabilities:
a) Paid up capital, reserve, any credit balance in Profit and loss Account of
the bank, amount of any loan taken from the RBI and amount of refinance
taken from EXIM Bank, NHB, NABARD, SIDBI.
b) Bills discounting by a bank with eligible financial institutions as approved
by RBI.
c) Net Income tax provision.
d) Amount received from DICGC towards claims held by banks pending
adjustments thereof.
e) Amount received from ECGC by invoking the guarantee.
f) Amount received from insurance companies for adhoc settlement of
claims pending judgement of court.
g) Amount received from court receiver.
h) Net unrealized gain/loss arising from derivatives transactions under
trading portfolio.
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i) Income flows received in advance such as annual fees and other charges
which are not refundable.
j) Liabilities arising on account of utilisation of limit under bankers
acceptance facility (BAF).
k) Part amounts of recoveries from the borrowers in respect of debts
considered bad and doubtful of recovery.
l) Amounts received in Indian currency against import bills and held in
sundry deposits pending receipts of final rates.
m) Un-adjusted deposits/balances lying in link branches for agency business
like dividend warrants, interest warrants, refund of application money,
etc., in respect of shares/debentures to the extent of payment made by
other branches but not adjusted by the link branches.
n) Margins held and kept in sundry deposits for funded facilities.
5.160 Similarly, the Auditor may specifically examine whether the following
items have been included in liabilities:
(a) Net credit balance in Branch Adjustment Accounts. The credit entries in
branch adjustment account which are outstanding for more than 5 years
are required to be considered at gross.
(b) Interest accrued on deposits should be calculated on each reporting
fortnight (as per the interest calculation methods applicable to various
types of accounts), whether or not such interest is accounted for in books
of accounts, so that the bank’s liability in this regard is fairly reflected in
the total NDTL of the same fortnightly return.
Cash collaterals received under collateralized derivative transactions as
these are in the nature of ‘outside liabilities’.
(c) Borrowings from abroad by banks in India need to be considered as
‘liabilities to other’ and should be considered at gross level unlike
‘liabilities towards banking system in India’, which are permitted to be
netted off against ‘assets towards banking system in India’. Thus, the
adverse balances in Nostro Mirror Account should be considered as
‘Liabilities to other’.
(d) The reconciliation of Nostro accounts (with Nostro Mirror Accounts) needs
to be scrutinized carefully to analyze and ascertain if any inward
remittances are received on behalf of the customers / constituents of the
bank and have remained unaccounted and / or any other debit (inward)
entries have remained unaccounted and are pertaining to any liabilities
for the bank.
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5.161 While examining the computation of DTL, the Auditor may specifically
examine the details of exempted categories of the following items:
a) Minimum eligible credit (EC) and outstanding Long term bonds (LB) to
finance Infrastructure loans and affordable housing loan, as per RBI
circular no. DBOD.BP.BC.No.25/08.12.014/2014-15 dated July 15, 2014
on “Issue of Long Term Bonds by Banks – Financing of Infrastructure and
Affordable Housing” as amended by circular no. DOR.No.BP.
BC.41/08.12.014/2019-20 dated March 17, 2020.
b) The eligible amount of incremental FCNR(B) and NRE deposits of
maturities of three years and above.
5.162 The Auditor should also verify loans out of FCNR(B) deposits and
inter- bank Foreign Currency (IBFC) deposits for reporting in Form A return
should convert their foreign exchange assets/liabilities(including borrowings) in
USD, GBP, JPY and Euro into INR at RBI reference rate and for other currency
consider the New York rate to convert them into USD.
5.163 As per RBI circular RBI/2018-19/34/ DBR.Ret.BC. No.01/ 12.01.001
/2018-19 dated August 02, 2018, “Maintenance of CRR/SLR on Foreign
Currency Assets/Liabilities– Reference rate for INR/USD and exchange rate of
other major currencies”, for conversion of foreign Currency Assets/ Liabilities
reference rate from FBIL should be taken. If reference rate is not available
from FBIL, banks may continue to use New York closing rate for conversion of
such currency in USD.
5.164 The Auditor should also, particularly, examine whether the balances in
Branch Adjustment Accounts of foreign branches have been taken into account
in arriving at the net balance in Branch Adjustment Accounts.
5.165 The Auditor should examine whether the consolidations prepared by
the bank include the relevant information in respect of all the branches.
5.166 The Auditor should examine the correctness of data in Form A return
for CRR and Return in Form VIII for SLR purposes on sample basis.
5.167 As stated in the preceding paragraphs, a considerable part of the
information required by the Statutory Central Auditor for reporting on
compliance with the SLR requirements will flow from the branches. It is
suggested that the relevant information pertaining to the branches within a
region may be consolidated at the regional level. The Auditor of the region
concerned should verify the same in the manner described in the above
paragraphs and report on the same. The consolidated statement should also
be counter-signed by the regional manager. The Auditor at the central level
62
should apply the audit procedures listed in the above paragraphs to the overall
consolidation prepared for the bank as a whole. Where such a procedure is
followed, the SCA should adequately describe the same in his certificate.
5.168 While reporting on compliance with SLR requirements, the Auditor
should specify the number of unaudited branches and state that he has relied
on the returns received from the unaudited branches in forming his opinion.
Necessary audit procedures should be developed based on introduction of
Automated Data Flow (ADF) for CRR & SLR reporting.
Treasury Operations-Foreign Exchange and Derivative
Transactions
5.169 Banks transact in various treasury instruments with an objective of
hedging their risks and also to generate trading profits. Apart from regular
proprietary business, the treasury operations of a bank aim to continue to focus
on enhancing returns from customer relationships that have been built, and
successfully capitalise on this to rapidly increase income from foreign exchange
and derivative transactions from customers, as also to assist them in covering
and hedging their foreign currency and derivative positions.
5.170 The foreign exchange market encompasses transactions in which funds
of one currency are sold for funds in another currency. These transactions take
the form of contracts calling for the parties in the contract to deliver to each other
on a fixed date a specified sum in a given currency. The exchange, the delivery
of one currency on receipt of another, can take place at the time the contract is
negotiated or at some future date, as stated in the contract.
5.171 Foreign exchange transactions, to be distinguished from transactions in
foreign currencies, consist of contracts in which each party is committed to
deliver one currency while, at the same time, receive another. Until the time of
delivery, when settlement is to be made on the contract, the contract represents
a future commitment of the Bank's resources. Thus, the maturity of a contract
culminates in the realisation of the transaction envisaged in the contract, at which
time the counterparties are given value for the currencies the contract says they
are to receive.
5.172 In foreign exchange contracts, the value date is the date on which the
contract matures, that is the date on which settlement is to be made. For loans
and borrowings, including those in the money markets, on the other hand, the
value date is that date on which the borrower receives constructive use of the
funds loaned, while the maturity date is that future date on which it will repay the
funds it has borrowed.
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Derivatives
5.173 In India, different derivatives instruments are permitted and regulated by
various regulators, like Reserve Bank of India (RBI) and the Securities and
Exchange Board of India (SEBI). Broadly, RBI is empowered to regulate the
interest rate derivatives, foreign currency derivatives and credit derivatives. For
regulatory purposes, derivatives have been defined in the Reserve Bank of India
Act, vide circular No. DBOD. No. BP.BC. 86/21.04.157/2006-07 dated 20 April
2007 on “Comprehensive Guidelines on Derivatives” as amended from time to
time.
5.174 “Derivative” is a contract that changes in value in relation to the price
movements of related or underlying securities like change in interest rate, foreign
exchange rate, credit rating or credit index, price of securities or a combination of
more than one of them and includes interest rate swaps, forward rate
agreements, foreign currency swaps, foreign currency-rupee swaps, foreign
currency options, foreign currency-rupee options or such other instruments as
may be specified by the RBI from time to time.
5.175 A derivative is traded between two parties – who are referred to as the
counterparties. These counterparties are subject to a pre-agreed set of terms
and conditions that determine their rights and obligations.
Products offered in Forex and Derivative business
5.176 There are various types of foreign exchange and derivative contracts
offered in normal course of banking business including inter-alia Cash, Tom &
Spot, Foreign exchange forward, Swap, Currency Swap, Credit Default Swap,
Currency Option, Forward rate Agreement, Interest rate swap, Interest rate
futures, Interest rate cap & floor, Currency futures and Interest Rate Options. The
following circulars are relevant and give guidance on these products:
 IDMC.MSRD.4801/06.01.03 dated June 3, 2003 Exchange-Traded Interest
Rate Derivatives;
 IDMD.PDRD.No. 1056/03.64.00/2009-10 dated September 1, 2009
Guidelines on Exchange Traded Interest Rate Derivatives;
 RBI/2010-11/147 A.P. (DIR Series) Circular No. 05 dated July 30, 2010
“Guidelines on trading of Currency Options on Recognised Stock /New
Exchanges;
 DBOD.No.BP.BC.51 / 21.06.101 / 2010-11 dated October 28, 2010
Introduction of Exchange Traded Currency Options – Permitting Banks to
Participate in Currency Options on Recognized Stock / New Exchanges;
64
 DBOD.No.BP.BC. 44/21.04.157/2011-12 dated 2 November 2011

“Comprehensive Guidelines on Derivatives: Modifications” modifying the 20
April 2007 circular; and further amended vide circular no.
DBR.No.BP.BC.103/21.04.157/2017-18 dated April 6, 2018;
 DBOD.BP.BC.No. 61/21.06.203/2011-12 of 30th November 2011 “Prudential
Guidelines on Credit Default Swaps (CDS)" regarding credit default swaps;
 RBI/2016-17/199 FMRD.DIRD.12/14.01.011/2016-17, December 29, 2016
Introduction of Interest Rate Options in India, detailed directions of which are
given in Notification No. FMRD-DIRD.11/2016 dated December 28,2016 as
amended vide circular no. FMRD.DIRD.20/2019 dated June 26, 2019; and
 FMRD.DIRD.19/14.03.046/2018-19 dated June 26, 2019 Rupee Interest
Rate Derivatives (Reserve Bank) Directions, 2019.
Derivatives Markets
5.177 Derivatives can be traded on or off an exchange and are known as:
Exchange-Traded Contracts traded on a recognised exchange, with the

Derivatives (ETDs): counterparties being the holder and the exchange.
Over-the-Counter Bespoke contracts traded off-exchange with specific
Derivatives (OTCs): terms and conditions determined between two eligible
parties, with or without the use of an intermediary. As a
result OTC derivatives are more illiquid, eg forward
contracts and swaps.
RBI vide its circular RBI/2017-18/134 A. P. (DIR Series) Circular No. 18 dated
February 26, 2018 on “Risk Management and Inter-bank Dealings: Revised
guidelines relating to participation of a person resident in India and Foreign
Portfolio Investor (FPI) in the Exchange Traded Currency Derivatives (ETCD)
Market” permit persons resident in India and FPIs to take positions (long or
short), without having to establish existence of underlying exposure, upto a
single limit of USD 100 million equivalent across all currency pairs involving INR,
put together, and combined across all exchanges. This circular, alongwith other
requirements has been consolidated in FMRD Master Direction No. 1/2016-17
dated July 5, 2016 (updated as on June 01, 2020).
Participants
5.178 Participants of this market can broadly be classified into the following
two functional categories:
 User: A user participates in the derivatives market to manage an underlying
risk.
65
 Market-maker: A market-maker provides bid and offer prices to users and

other market-makers. A market-maker need not have an underlying risk.
At least one party to a derivative transaction is required to be a market-maker.
Purpose
5.179 Users can undertake derivative transactions to hedge an existing
identified risk on an ongoing basis during the life of the derivative transaction or
for transformation of risk exposure, as specifically permitted by RBI. Market-
makers can undertake derivative transactions to act as counterparties in
derivative transactions with users and also amongst themselves. Banks use
derivatives to hedge, to reduce the risks involved in the bank's operations. The
major objectives/purpose for undertaking derivative transactions has been
explained in the following Table.
Objectives/Purpose Reasons
 Use of derivatives by the Bank to manage its
balance sheet exposures.
Balance Sheet
Management  The Bank will use derivatives as a means for
managing the interest rate, liquidity and foreign
exchange risks arising from its banking operations.
 Offering derivative products to existing and new
clients as an additional product from the Bank.
Client servicing  The Bank will offer derivative products to enhance
product offerings to its existing clients as well as to
build new client relations.
 The Bank will undertake derivative transactions to
earn trading profits.
Proprietary Trading  The Bank’s treasury may take view-based
transactions as well as offer two-way quotes on
derivatives within the limits prescribed by this policy.
 Banks are exposed to interest-rate risk from their
on-balance-sheet activities when their assets do not
reprice at the same time as their liabilities. Hence
Hedging On-Balance
banks undertake derivatives transactions to hedge
sheet transactions
their Balance sheets transactions such as banks
may use swaps to hedge on-balance-sheet interest-
rate risk.
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Bank’s Process, Regulatory requirements/ restrictions & updates

5.180 The major requirements for undertaking any derivative transaction
include the following:
 In addition to generic derivative products, market-makers may also offer
structured derivative products to users as long as they do not contain any
derivative instrument as underlying and have been specifically permitted by
RBI in its Master Direction No. 1/2016-17 dated July 5, 2016 (updated
January 07, 2020) on ‘Risk Management and Inter-Bank Dealings’ and
RBI’s Circular DBOD.No.BP.BC.86/21.04.157/ 2006-07 dated 20 April 2007
on Comprehensive Guidelines on Derivatives and further amendments
issued vide circulars DBOD.No.BP.BC. 27 / 21.04.157/2011-12 dated 2
August 2011 and DBOD.BP.BC.44/ 21.04.157/2011-12 dated 2 November
2011 on Comprehensive Guidelines on derivatives.
a. The following derivative instruments used to hedge an existing
interest rate and forex exposure, on a standalone basis, may be
treated as generic derivative products:
o Forex Forward Contracts
o Forward Rate Agreements
o Interest rate caps and floors (plain vanilla only)
o Plain Vanilla Options (call option and put option)
o Interest Rate Swaps
o Currency Swaps including Cross-Currency Swaps
o Exchange traded Currency Futures
o Exchange traded currency options
o Interest Rate Options.
b. The following derivative products may be treated as “structured
derivative products”:
o Instruments which are combination of either cash instrument and
one or more generic derivative products.
o Instruments which are combination of two or more generic
derivative products.
5.181 Market-makers should be in a position to arrive at the fair value of all
derivative instruments, including structured products on the basis of the following
approach:
a. Marking the product to market, if a liquid market in the product exists.
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b. In the case of structured products, marking the constituent generic

instruments to market.
c. If (a) and (b) are not feasible, marking the product to model, provided:
 All the model inputs are observable market variables.
 Full particulars of the model, including the quantitative algorithm are
documented.
 It may be ensured that structured products do not contain any
derivative, which is not allowed on a standalone basis.
 All permitted derivative transactions, including roll over, restructuring
and novation can be contracted only at prevailing market rates.
 All risks arising from derivatives exposures should be analysed and
documented, both at transaction level and portfolio level.
 The management of derivatives activities should be an integral part of
the overall risk management policy and mechanism. It is desirable that
the board of directors and senior management understand the risks
inherent in the derivatives activities being undertaken.
 Market-makers should have a ‘Suitability and Appropriateness Policy’
vis-à-vis users in respect of the products offered, on the lines indicated
in the guidelines given in the Circular.
 Market-makers may, where they consider necessary, maintain cash
margin/liquid collateral in respect of derivative transactions undertaken
by users on mark-to-market basis.
Risk Management and Corporate Governance Aspects
5.182 The Comprehensive Guidelines on derivatives also sets out the basic
principles of a prudent system to control the risks in derivatives activities.
These include:
(a) Appropriate oversight by the board of directors and senior management.
(b) Adequate risk management process that integrates prudent risk limits,
sound measurement procedures and information systems, continuous risk
monitoring and frequent management reporting.
(c) Comprehensive internal controls and audit procedures.
Suitability and Appropriateness
5.183 While undertaking any derivative transactions with a user, a market-
maker should:
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(a) Document how the pricing has been done and how periodic valuations
will be done. In the case of structured products, this document should
contain a dissection of the product into its generic components to
demonstrate its permissibility, on the one hand, and to explain its price
and periodic valuation principles, on the other. The following information
may be shared with the user:
(i) Description of the transaction.
(ii) Building blocks of the transaction.
(iii) Rationale along with appropriate risk disclosures.
(iv) Sensitivity analysis identifying the various market parameters that
affect the product.
(v) Scenario Analysis encompassing both the possible upside as well
as the downsides.
(b) Analyse the expected impact of the proposed derivatives transaction on
the user.
(c) While selling structured products, the selling banks should make available
a calculator or at least access to a calculator (say on the market-maker's
website) which will enable the users to mark to market these structured
products on an ongoing basis.
5.184 Before offering any derivative product to a client the Auditor should
adopt the following measures:
(a) Obtain Board resolution from the corporate which contains the details
specified in the Comprehensive Guidelines on derivatives. Identify whether
the proposed transaction is consistent with the user’s policies and
procedures with respect to derivatives transactions, as they are known to
the market-maker.
(b) Ensure that the terms of the contract are clear and assess whether the
user is capable of understanding the terms of the contract and of fulfilling
its obligations under the contract.
(c) Inform the customer of its opinion, where the market-maker considers that
a proposed derivatives transaction is inappropriate for a customer. If the
customer nonetheless wishes to proceed, the market-maker should
document its analysis and its discussions with the customer in its files to
lessen the chances of litigation in case the transaction proves
unprofitable to the customer. The approval for such transactions should
be escalated to next higher level of authority at the market-maker as also
for the user.
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(d) Ensure the terms of the contract are properly documented, disclosing the
inherent risks in the proposed transaction to the customer in the form of a
Risk Disclosure Statement which should include a detailed scenario
analysis (both positive and negative) and pay outs in quantitative terms
under different combination of underlying market variables such as
interest rates and currency rates, etc., assumptions made for the scenario
analysis and obtaining a written acknowledgement from the counterparty
for having read and understood the Risk Disclosure Statement.
(e) Guard against the possibility of misunderstanding all significant
communications between the market-maker and user should be in
writing/email or recorded in meeting notes.
(f) Ensure to undertake transactions at prevailing market rates and to avoid
transactions that could result in acceleration/deferment of gains or losses.
(g) Should establish internal procedures for handling customer disputes and
complaints. They should be investigated thoroughly and handled fairly
and promptly. Senior management and the Compliance
Department/Officer should be informed of all customer disputes and
complaints at a regular interval.
(h) The market-makers should carry out proper due diligence regarding 'user
appropriateness' and 'suitability' of products before offering derivative
products to users. Each market-maker should adopt a Board-approved
'Customer Appropriateness & Suitability Policy' for derivatives business.
It may also be noted that the responsibility of ‘Customer Appropriateness and
Suitability’ review is on the market-maker.
5.185 As per Comprehensive Guidelines on Derivatives: Modifications dated
April 6, 2018 vide RBI/2017-18/151 DBR.No.BP.BC.103/21.04.157/2017-18 it
has now been decided that stand-alone plain vanilla forex options (without
attached structures) purchased by clients will be exempt from the ‘user suitability
and appropriateness’ norms, and the regulatory requirements will be at par with
forex forward contracts.
Documentation
5.186 This can range from simple customer mandates through to full legal
documentation with both banks and customers. The bank’s legal department is
responsible for legal agreements depending on what types of business is being
conducted and, crucially, whether the counterparties intend to net payments at
settlement. Organizationally, this area can be viewed in a similar way to the
accounting function. If documentation forms part of the back office then the
business will be more understood by management and better controlled as a
result.
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5.187 The Circular on the Comprehensive Guidelines on Derivatives require

the market participants to ensure that documentation requirements in respect
of derivative contracts are complete in all respects. The following instructions
in this regard may, therefore, be strictly adhered to:
(i) For the sake of uniformity and standardisation in respect of all derivative
products, participants may use ISDA documentation, with suitable
modifications. Counterparties are free to modify the ISDA Master
Agreement by inserting suitable clauses in the schedule to the ISDA Master
to reflect the terms that the counterparties may agree to, including the
manner of settlement of transactions and choice of governing law of the
Agreement.
(ii) It may be mentioned that besides the ISDA Master Agreement, participants
should obtain specific confirmation for each transaction which should detail
the terms of the contract such as gross amount, rate, value date, etc. duly
signed by the authorised signatories.
(iii) It is also preferable to make a mention of the Master Agreement in the
individual transaction confirmation.
(iv) Participants should further evaluate whether the counterparty has the legal
capacity, power and authority to enter into derivative transactions.
(v) Participants must ensure that ISDA Master Agreement is signed with the
counterparty prior to undertaking any derivatives business with them.
(vi) Participants shall obtain documentation regarding customer suitability,
appropriateness etc. as specified.
Identification and Management of Risk
5.188 Market-makers should identify the various types of risk to which they
are exposed in their derivatives activities. The main types of risk are:
 Credit risk
 Market risk
 Liquidity risk
 Interest risk
 Operational risk
 Legal risk
The RBI circular requires that all significant risks should be measured and
integrated into an entity-wide risk management system.
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Risk limits
5.189 Risk limits serve as a means to control exposures to the various risks
associated with derivative activities. Limits should be integrated across all
activities and measured against aggregate risks. Limits should be compatible
with the nature of the entity’s strategies, risk measurement systems, and the
board’s risk tolerance. To ensure consistency between limits and business
strategies, the board should annually approve limits as part of the overall
budget process.
Independent Risk control
5.190 There should be a mechanism within each entity for independently
monitoring and controlling the various risks in derivatives. The inter-
relationship between the different types of risks needs to be taken into
account.
5.191 Entities which are market-makers in derivatives should maintain a unit
which is responsible for monitoring and controlling the risks in derivatives. This
unit should report directly to the board or to senior management who are not
directly responsible for trading activities. Where the size of the entity or its
involvement in derivatives activities does not justify a separate unit dedicated to
derivative activities, the function may be carried out by support personnel in the
back office (or in a middle office) provided that such personnel have the
necessary independence, expertise, resources and support from senior
management to do the job effectively.
Operational Controls
5.192 Operational risk arises as a result of inadequate internal controls,
human error or management failure. This risk in derivatives activities is
particularly important, because of the complexity and rapidly evolving nature of
some of the products. The nature of the controls in place to manage operational
risk must be commensurate with the scale and complexity of the derivatives
activity being undertaken. The operational controls could, in addition to
segregation of duties, cover aspects such as:
 Trade entry and transaction documentation
 Confirmation of trades
 Settlement and disbursement
 Reconciliations
 Revaluation
 Exception reports
 Accounting treatment
 Audit trail
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Prudential Norms Relating to Derivatives

5.193 The prudential norms relating to derivatives – minimum capital
adequacy requirement, credit exposure norms, ALM etc. will be as prescribed
by the RBI from time to time. Attention of the readers may be drawn on RBI’s
Circular No. DBOD.No.BP.BC.48 / 21.06.001/2010-11 dated October 1, 2010
and DBOD.No.BP.BC.31/21.04.157/2008-09 dated August 8, 2008, DBOD.No.
BP.BC.57/21.04.157/2008–09 dated October, 13 2008, DBOD.No.BP.BC.
28/21.04.157/2011-12 dated August 11, 2011 and DBOD.No.BP.BC.31
/21.04.157/2012-13 dated July 23, 2012, RBI/2016-17/45DBR.No.BP.BC.7/
21.04.157/2016-17 dated August 25, 2016 on “Prudential Norms for Off-
Balance Sheet Exposures of Banks” and RBI’s Master Circular No.RBI/2015-
16/70/DBR.No.Dir.BC. 12/13.03.00/2015-16 dated July 1, 2015 on “Exposure
Norms”.
Asset Classification of Derivatives
5.194 RBI vide its Circular No. DBOD.No.BP.BC.57/ 21.04.157/2008-09 dated
October 13, 2008 on “Prudential Norms for Off-Balance Sheet Exposures of
Banks” and Circular No. RBI/2015-16/101DBR.No.BP.BC.2/21.04.048/2015-16
dated July 1, 2015 on “Prudential Norms on Income Recognition, Asset
Classification and Provisioning pertaining to Advances" advised the banks
including foreign branches of Indian banks as under:
i. The overdue receivables representing positive mark-to-market value of a
derivative contract will be treated as a non-performing asset, if these
remain unpaid for a period of 90 days from the specified due date for
payment.
ii. In case the overdues arising from forward contracts and plain vanilla
swaps and options become NPAs, all other funded facilities granted to the
client shall also be classified as non-performing asset following the
principle of borrower-wise classification as per the existing asset
classification norms.
iii. However, any amount, representing positive mark-to-market value of the
foreign exchange derivative contracts (other than forward contract and
plain vanilla swaps and options) that were entered into during the period
April 2007 to June 2008, which had already crystallised or might
crystallise in future and is / becomes receivable from the client, should be
parked in a separate account maintained in the name of the client
/counterparty. This amount, even if overdue for a period of 90 days or
more, will not make other funded facilities provided to the client, NPA on
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account of the principle of “borrower-wise asset classification”, though

such receivables overdue for 90 days or more shall itself be classified as
NPA, as per the extant IRAC norms. The classification of all other assets
of such clients will, however, continue to be governed by the extant IRAC
norms.
iv. If the client concerned is also a borrower of the bank enjoying a Cash
Credit or Overdraft facility from the bank, the receivables mentioned at
item (i) above may be debited to that account on due date and the impact
of its non-payment would be reflected in the cash credit/overdraft facility
account. The principle of “borrower-wise asset classification” would be
applicable here also, as per extant norms.
v. In cases where the contract provides for settlement of the current mark-to
market value of a derivative contract before its maturity, only the current
credit exposure (not the potential future exposure) will be classified as a
non-performing asset after an overdue period of 90 days.
vi. As the overdue receivables mentioned above would represent unrealised
income already booked by the bank on accrual basis, after 90 days of
overdue period, the amount already taken to Profit and Loss Account
should be reversed.
5.195 RBI vide its Circular No. DBOD.No.BP.BC.48 / 21.06.001/2010-11
dated October 1, 2010 on “Prudential Norms for Off-Balance Sheet Exposures
of Banks - Bilateral netting of counterparty credit exposures” has decided that
since the legal position regarding bilateral netting is not unambiguously clear,
bilateral netting of mark-to-market (MTM) values arising on account of such
derivative contracts cannot be permitted. Accordingly, banks should count their
gross positive MTM value of such contracts for the purposes of capital adequacy
as well as for exposure norms.
5.196 RBI vide its Circular No. RBI/2015-16/101DBR.No.BP.BC.2/21.04.048/
2015-16 dated July 1, 2015 on “Prudential Norms on Income Recognition, Asset
Classification and Provisioning pertaining to Advances" advised banks that credit
exposures computed as per the current marked to market value of the contract,
arising on account of the interest rate & foreign exchange derivative transactions,
credit default swaps, shall also attract provisioning requirement as applicable to
the loan assets in the 'standard' category, of the concerned counterparties. All
conditions applicable for treatment of the provisions for standard assets would
also apply to the aforesaid provisions for derivative exposures.
5.197 RBI vide its circular no. DBOD.BP.BC.28/21.04.157/2011-12 dated
August 11, 2011 has further clarified as under:
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 In cases where the derivative contracts provide for more settlements in

future, the MTM value will comprise of (a) crystallised receivables and (b)
positive or negative MTM in respect of future receivables.
 If the derivative contract is not terminated on the overdue receivable
remaining unpaid for 90 days, in addition to reversing the crystallised
receivable from Profit and Loss Account as stipulated in para 1 of
aforementioned circular, the positive MTM pertaining to future receivables
may also be reversed from Profit and Loss Account to another account
styled as ‘Suspense Account – Positive MTM’. The subsequent positive
changes in the MTM value may be credited to the ‘Suspense Account –
Positive MTM’ and not to Profit & Loss Account.
 The subsequent decline in MTM value may be adjusted against the balance
in ‘Suspense Account – Positive MTM’. If the balance in this account is not
sufficient, the remaining amount may be debited to the Profit & Loss
Account.
 On payment of the overdues in cash, the balance in the ‘Suspense
Account-Crystallised Receivables’ may be transferred to the ‘Profit and
Loss Account’, to the extent payment is received.
 If the bank has other derivative exposures on the borrower, it follows that
the MTMs of other derivative exposures should also be dealt with /
accounted for in the manner as described above, subsequent to the
crystallised/settlement amount in respect of a particular derivative
transaction being treated as NPA.
 Since the legal position regarding bilateral netting is not unambiguously
clear, receivables and payables from/to the same counterparty including
that relating to a single derivative contract should not be netted.
 Similarly, in case a fund-based credit facility extended to a borrower is
classified as NPA, the MTMs of all the derivative exposures should also be
classified as NPA.
 These guidelines are applicable to both outstanding derivatives contracts
and the derivatives transactions undertaken from the date of the circular.
5.198 Also RBI vide its circular no. RBI/2012-13/139DBOD.No.BP.BC.31/
21.04.157/2012-13 dated July 23, 2012 clarifies that there may be situations
where the clients of banks may like to reduce the notional exposure of the
hedging derivative contract. In such cases, banks may partially or fully terminate
the contract before maturity, at their discretion, thereby reducing the notional
exposure of the contract. This reduction in notional exposure would not be
treated as re-structuring of the derivative contract provided all other parameters
of the original contract remain unchanged.
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5.199 In such cases, if the MTM value of the derivative contract is not cash
settled, banks may permit payment in instalments of the crystallized MTM of
such derivative contracts (including Forex Forward Contracts), subject to the
following conditions:
i. Banks should have a Board approved policy in this regard.
ii. Banks should permit repayment in instalments only if there is a reasonable
certainty of repayment by the client.
iii. The repayment period should not extend beyond the maturity date of the
contract.
iv. The repayment instalments for the crystallized MTM should be uniformly
received over the remaining maturity of the contract and its periodicity
should be at least once in a quarter.
v. If the client is permitted to pay the crystallized MTM in instalments:
a. if the amount becomes overdue for 90 days from the date of partial /
full termination of the derivative contract, the receivable should be
classified as NPA.
b. if the amount becomes overdue for 90 days from the due date of
payment of subsequent instalments, the receivable should be
classified as NPA.
vi. Banks should reverse the entire MTM which has been taken to Profit and
Loss account on accrual basis in case of (v)(a) and (v) (b) above. For the
accounting of reversed MTM in these cases, banks should follow an
approach similar to the one stipulated in circulars DBOD.No.BP.BC.57/
21.04.157/2008-09 dated October 13, 2008 and DBOD.No.BP.BC.28/
21.04.157/2011-12 dated August 11, 2011 on ‘Prudential Norms for Off-
balance Sheet Exposures of Banks’. Accordingly, the crystallized MTM of
these derivative contracts should be reversed from Profit and Loss account
and credited to another suspense account styled as ‘Suspense Account -
Crystallised Receivables’.
5.200 If the client is not granted the facility of paying the crystallised MTM
value in instalments and the amount becomes overdue for 90 days from the date
of partial / full termination of the derivative contract, the entire receivable should
be classified as NPA and banks should follow the instructions stipulated in RBI
circulars dated October 13, 2008 and August 11, 2011, referred to above.
5.201 There may be cases, where the derivative contract has been
terminated, either partially or fully, and crystallized MTM has been permitted to
be repaid in instalments but the client subsequently decides to hedge the same
underlying exposure again by entering into new contract with same or other bank
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(provided such re-booking is permissible as per extant RBI guidelines). In such

cases, banks may offer derivative contracts to the client provided the client has
fully re-paid the entire outstanding instalments corresponding to the derivative
contract that was used to hedge the underlying exposure previously.
Re-structuring of derivative contracts
5.202 In cases where a derivative contract is restructured, the mark-to-
market value of the contract on the date of restructuring should be cash
settled. For this purpose, any change in any of the parameters of the original
contract would be treated as a restructuring. RBI vide Notification RBI/2016-
17/45 DBR.No.BP. BC.7/21.04.157/ 2016-17 dated August 25, 2016 has clarified
that cash settlement is required of the change in mark-to-market value of the
restructured derivative contract. Banks are permitted to restructure derivative
contract at prevalent market rates, and not on the basis of off-market rates.
Facilities for Hedging Trade Exposures, invoiced in Indian Rupees in
India
Purpose
5.203 To hedge the currency risk arising out of genuine trade transactions
involving exports from and imports to India, invoiced in Indian Rupees, with AD
Category I banks in India.
Products
5.204 Forward foreign exchange contracts with rupee as one of the
currencies, foreign currency-INR options.
Operational Guidelines, Terms and Conditions
5.205 The AD Category I banks can opt for either Model I or Model II as
mentioned in RBI circular vide RBI/2017-18/75 A.P. (DIR Series) Circular No. 08
dated October 12, 2017. The said circular has been consolidated in FMRD
Master Direction No. 1/2016-17 dated June 01, 2020.
Provisions in case of foreign branches and subsidiaries of the Indian
Banks
5.206 The RBI vide its circular No. DBOD.No.BP.BC.89 /21.04.141/2008-09
dated December 1, 2008 on “Operations of foreign branches and subsidiaries
of the Indian banks – Compliance with statutory/regulatory/administrative
prohibitions/ restrictions” provides that transactions by the foreign branches /
foreign subsidiaries, in financial products which are not available in the Indian
market and on which no specific prohibition has been currently placed by the
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RBI, no prior approval of the RBI would be required for the purpose provided
these are merely plain-vanilla financial products. Banks should, however,
ensure that their foreign branches / subsidiaries, dealing with such products in
foreign jurisdictions, have adequate knowledge, understanding, and risk
management capability for handling such products. Such products should also
be appropriately captured and reported in the extant off-site returns furnished
to the RBI. These products would also attract the prudential norms such as
capital adequacy, credit exposure, periodical valuation, and all other applicable
norms. In case the current RBI norms do not specify prudential treatment of
such financial products, it would be incumbent upon the banks to seek specific
RBI guidance in the matter. RBI vide Notification No./2013-14/588
DBOD.No.BP. BC.111/21.04.157/2013-14 May 12, 2014 permitted that if foreign
branches / subsidiaries of Indian banks propose to offer structured financial and
derivative products that are not specifically permitted by the Reserve Bank in the
domestic market, they may do so only at the established financial centers outside
India like New York, London, Singapore, Hong Kong, Frankfurt, Dubai, etc.
subject to compliance with the conditions stipulated therein.
Risk management
5.207 Banks are highly sensitive to treasury risk, as risk arrive out of high
leverage treasury business enjoys. The risks of losing capital are much more
than credit business.
5.208 This is a function that can sit well in the middle office provided it is
properly staffed by officers who understand fully the business and risks involved
– which usually means ex-market practitioners. It can range from agreeing
overnight cash positions for the trading room through to full-risk modeling
associated with derivatives trading and hedging. In between can come
monitoring of counterparty, country, dealer and market-related limits that have
been set and approved in other areas of the bank such as the credit department.
Banks shall comply with guidelines issued by RBI with regard to Internal Controls
vide circular FE.CO.FMD. No. 18380 /02.03.137/2010-11 February 3, 2011.
Risk Identification Process
Foreign Exchange Rate Movement Risk
5.209 Foreign exchange risk may be defined as the risk that bank may suffer
losses as a result of adverse exchange rate movements during a period in which
it has open position, either spot or forward or combination of two, in an individual
foreign currency. The banks are also exposed to interest rate risk which arises
due to maturity mismatching of foreign currency positions, default of counter
parties or settlement risk.
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5.210 Foreign exchange rate movement risk arises from net exchange
position in a currency. If the position is long or overbought and there is
depreciation in the currency, a loss occurs. On the other hand, if an appreciation
occurs while the dealer is holding a long net position, there will be a profit from
such change in exchange rates. The opposite will occur if the net positions were
short or oversold in that currency. Price risk of this kind also exists on execution
of a swap. This is also known as the 'tail', which arises because in a swap the
effects of two foreign currency amounts, inflow and outflow, are different on
account of present valuing all cash flows.
5.211 Three important issues that need to be addressed in this regard are:
a) Nature and magnitude of exchange risk.
b) Strategy to be adopted for hedging or managing exchange risk.
c) Tools of managing exchange risk.
US$ / INR FX Forwards Risk
5.212 Forward points (premia/discount) in the Indian markets are not entirely a
function of interest rate differentials but a function of demand and supply of
forward currency. As a result, normally banks treat traded forward points (up to
1-year) as a market factor, and use this to compute the implied INR rate (MIFOR)
up to the 1-year segment. Beyond 1-year, forward points are computed from the
INR currency swap/ MIFOR quotes and US$ swap curve.
Timing Risk
5.213 As per market practice, FX contracts with timing discretion (Option
Period Forwards or OPFs) versus INR are typically for a period of one week to a
maximum of one month. The customer has the discretion to pick up the contract
on any day of the window period. In case the customer is buying the foreign
currency (‘FCY’), the swap points/contract rate is fixed based on the last date of
the period in case the FCY is at a premium against the INR or the first date in
case the FCY is at a discount. Hence, unless the swap points change from
premium to discount or vice versa after entering into the contract, the
counterparty would not benefit by taking delivery before last date in case of
premium or after first date in case of discount. In the unlikely event of this
happening and if the bank has not hedged the contract similarly with another
contract with discretion period, an adverse impact on Profit and Loss Account
could arise. In such a case, the market counterparty could pick up the contract
early while the hedge contract would still be outstanding and the gap would have
to be covered again at incremental cost.
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Credit Risk
5.214 Credit risk is defined as the possibility of losses associated with
diminution in the credit quality of borrowers or counterparties. In a bank's
portfolio, losses stem from outright default due to inability or unwillingness of a
customer or counterparty to meet commitments in relation to lending, trading,
settlement and other financial transactions. Alternatively, losses result from
reduction in portfolio value arising from actual or perceived deterioration in credit
quality. Credit risk emanates from a bank's dealings with an individual, corporate,
bank, financial institution or a sovereign.
5.215 Credit risk is the risk that the counterparty to a financial transaction -
here a foreign exchange contract - may become unable to perform its obligation.
The extent of risk depends on whether the other party's inability to pay is
established before the value date or is on the same value date of the foreign
exchange contract.
Pre-Settlement Exposure
5.216 Trading (or pre-settlement) exposure occurs when a counterparty defaults
on its contractual obligation before the settlement date and the bank has to defend
the position in the market with another counterparty at the then prevailing rate. The
bank is exposed to possible adverse price fluctuations between the contract price
and the market price on the date of default or final liquidation.
Settlement Risk
5.217 This occurs when items of agreed upon original or equal value are not
simultaneously exchanged between counter parties; and/or when Bank’s funds
are released without knowledge that counter value items have been received by
the bank. Typically, the duration is overnight/over weekend, or in some cases
even longer i.e., until the bank receives the confirmation of receipt of funds. The
risk is that bank delivers but does not receive delivery. In this situation 100% of
the principal amount is at risk.
Market risk
5.218 Market risk is the risk of loss due to adverse changes in the market
value (the price) of an instrument or portfolio of instruments. Such exposure
occurs with respect to derivative instruments when changes occur in market
factors such as underlying interest rates, exchange rates, equity prices, and
commodity prices or in the volatility of these factors.
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Liquidity Risk
5.219 Liquidity risk refers to the ease with which a foreign exchange spots
position or gap can be liquidated. The approved spot DV01 limit factors in the
liquidity risk associated with the product. Tenor wise DV01 limits in the case of
US$INR gaps factor in the liquidity in the forward markets. Institutions involved in
derivatives activity face two types of liquidity risk: market liquidity risk and funding
liquidity risk.
Market Liquidity Risk
5.220 Market liquidity risk is the risk that an institution may not be able to exit
or offset positions quickly, and in sufficient quantities, at a reasonable price. This
inability may be due to inadequate market depth in certain products (e.g. exotic
derivatives, long-dated options), market disruption, or inability of the bank to
access the market (e.g. credit down-grading of the institution or of a major
counterparty).
Funding Liquidity Risk
5.221 Funding liquidity risk is the potential inability of the institution to meet
funding requirements, because of cash flow mismatches, at a reasonable cost.
Such funding requirements may arise from cash flow mismatches in swap books,
exercise of options, and the implementation of dynamic hedging strategies.
Sovereign Risk or Cross Border Risk
5.222 This is the risk that the Government of a particular country may interfere
with a payment due to the Bank from a client resident in that country and
preclude the client from converting and/or transferring the funds. In such cases,
bank’s oblige may be economically sound and capable of repaying its obligation,
but its country's Government may place an embargo on remittances for
political/economic reasons.
Operations Risk
5.223 Basel I defined operational risk as “the risk of direct or indirect loss
resulting from inadequate or failed internal processes, people and systems or
from external events”. Basel II, however, defined operational risk as, “the risk of
loss resulting from inadequate or failed internal processes, people and systems
or from external events”. As per RBI Guidelines on Basel III Capital Regulations,
Operational risk is defined as the risk of loss resulting from inadequate or failed
internal processes, people and systems or from external events. This definition
includes legal risk, but excludes strategic and reputational risk. Legal risk
includes, but is not limited to, exposure to fines, penalties, or punitive damages
resulting from supervisory actions, as well as private settlements. For emergence
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of such a risk four causes have been mentioned and they are people, process,
systems and external factors.
(a) People risk – Lack of key personnel, lack of adequate training/experience
of dealer (measured in terms of opportunity cost/employee turnover),
unauthorised access to the dealing room, tampering voice recorders, nexus
between the front and back offices, etc.
(b) Process risk - Wrong reporting of important market developments to the
management resulting in faulty decision making, errors in entry of data in
deal slips, non-monitoring of exposure in positions, loss of interest owing to
the liquidity beyond prescribed limits, non-revision of card rates in cases of
volatility, non-monitoring of closing and opening positions, wrong funding of
accounts (wrong currency, wrong way swap), lack of policies, particularly in
respect of new products.
(c) Systems - Losses due to systems failure, hardware and software failures,
telecommunication problems, and utility outages such as CCIL- not
maintaining secrecy of system passwords, failure of dealing platforms,
valuation engines, system issues with deal blotters interrupting deal flows to
back-office etc.
(d) Legal and regulatory risk - Treasury activities should comply with the
regulatory and statutory obligation. As per RBI Guidelines, Legal risk
includes, but is not limited to, exposure to fines, penalties, or punitive
damages resulting from supervisory actions, as well as private settlements.
Risk Management Limits and Monitoring
5.224 All bank managements should have a risk management policy, laying
down clear guidelines for concluding the transactions and institutionalise the
arrangements for a periodical review of operations and annual audit of
transactions to verify compliance with the regulations.
Overnight Net Exchange Position Limit/Factor Sensitivity Limits for
Spot FX
5.225 NOOPL may be fixed by the boards of the respective banks and
communicated to the Reserve Bank immediately. However, such limits should
not exceed 25 percent of the total capital (Tier I and Tier II capital) of a bank,
[Refer RBI Master Directions – Risk Management and Inter Bank Dealings dated
July 5, 2016 (updated as on June 01, 2020)]. This limits the maximum allowable
excess of assets plus exchange bought contracts over liabilities plus exchange
sold contracts ("overbought" position) and the reverse ("oversold" position) that
may be carried overnight in foreign currencies.
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Daylight Limit
5.226 As mentioned for NOOPL, daylight limit refers to the maximum net
positions that can be taken during the trading day in each currency. In case of
large intra-day flows and positions, it is expected that the desk will keep the risk
department informed about the same.
Value at Risk (VAR) limits
5.227 These limits are designed to restrict the amount of potential loss from
certain types of derivatives products or the whole trading book to levels (or
percentages of capital or earnings) approved by the board and senior
management. To monitor compliance with the limits, management calculates the
current market value of positions and then uses statistical modelling techniques
to assess the probable loss (within a certain level of confidence) given historical
changes in market factors.
5.228 The advantage of VAR limits is that they are related directly to the
amount of capital or earnings which are at risk. The level of VAR limits should
reflect the maximum exposures authorized by the board and senior
management, the quality and sophistication of the risk measurement systems
and the performance of the models used in assessing potential loss by
comparing projected and actual results. A drawback in the use of such models is
that they are only as good as the assumptions on which they are based (and the
quality of the data which has been used to calculate the various volatilities,
correlations and sensitivities).
Gap or Matured band limits
5.229 These limits are designed to control loss exposure by controlling the
volume or amount of the derivatives that mature or are repriced in a given time
period.
5.230 For example, the management can establish Gap limits for each
maturity band of 3 months, 6 months, 9 months, one year, etc. to avoid maturities
concentrating in certain maturity bands. Such limits can be used to reduce the
volatility of derivatives revenue by staggering the maturity and/or repricing and
thereby smoothening the effect of changes in market factors affecting price.
Maturity limits can also be useful for liquidity risk control and the repricing limits
can be used for interest rate management. Similar to notional and stop loss
limits, Gap limits can be useful to supplement other limits, but are not sufficient to
be used in isolation as they do not provide a reasonable proxy for the market risk
exposure which a particular derivatives position may present to the institution.
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5.231 Gap DV01 for USDINR FX forwards is monitored on MIFOR & LIBOR
curve. Gap DV01 is computed as the effect of 1 basis point change in the
MIFOR/ LIBOR for the tenor on the P&L. Gap VAR is computed using volatilities
for each tenor of the MIFOR/ LIBOR curve and the correlation between them.
Aggregate Contract Limit
5.232 This limits the gross outstanding spot and future exchange contracts,
both bought and sold. It is computed by adding the US$ equivalents of the sum
total of all outstanding contracts across all currencies. It restrains overall trading
volume and its monitoring provides an indication of any unusual activity.
Options Limit
5.233 These are specifically designed to control the risks of options. Options
limits should include Delta, Gamma, Vega, Theta and Rho limits.
• Delta is a measure of the amount an option’s price would be expected to
change for a unit change in the price of the underlying instrument.
• Gamma is a measure of the amount delta would be expected to change in
response to a unit change in the price of the underlying instrument.
• Vega is a measure of the amount an option's price would be expected to
change in response to a unit change in the price volatility of the underlying
instrument.
• Theta is a measure of the amount an option's price would be expected to
change in response to changes in the options time to expiration.
• Rho is a measure of the amount an option's price would be expected to
change in response to changes in interest rates.
• The Auditor should check the limit setting and its monitoring process along
with exception handling measures.
The Auditor is expected to make efforts and be aware of these concepts.
Stop Loss Limit
5.234 These limits are established to avoid unrealized loss in a position from
exceeding a specified level. When these limits are reached, the position will
either be liquidated or hedged. Typical stop loss limits includes those relating to
accumulated unrealized losses for a day, a week or a month.
5.235 Some institutions also establish management action trigger (MAT) limits
in addition to stop loss limits. These are for early warning purposes. For
example, the management may establish a MAT limit at 75 per cent of the stop
loss limit. When the unrealized loss reaches 75 per cent of the stop loss limit, the
management will be alerted of the position and may trigger certain management
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actions, such as close monitoring of the position, reducing or early closing out
the position before it reaches the stop loss limits. The above loss triggers
complement other limits, but they are generally not sufficient by themselves.
They are not anticipatory; they are based on unrealized losses to date and do not
measure the potential earnings at risk based on market characteristics. They will
not prevent losses larger than the stop loss limits if it becomes impossible to
close out positions, e.g., because of market illiquidity.
Limit Exceptions
5.236 A limit exception is a trade or position specific authorization to exceed a
limit for a defined period of time. All limit exceptions must be approved in
advance of establishing a position that would exceed a limit. Normally Market
Risk Management is responsible for maintaining all documentation of the excess
including the agreed upon corrective action and the resolution date and is
responsible for the ongoing monitoring of the excess to ensure the corrective
action is carried out. The Auditor should check whether all exceptions along with
the reasons are reported to senior management and approvals (Limit Breach
Ratifications) were taken for the same.
Regulatory Reporting Requirements
5.237 Derivatives are governed by the Foreign Exchange Management
(Foreign Exchange Derivative Contracts) Regulations, 2000. Derivatives are
allowed only under the provisions of these regulations and amendments, or with
the prior permission of the Reserve Bank of India. The reporting requirements
under RBI Master Direction No. RBI/FMRD/2016-17/31 FMRD master direction
no. 1/2016-17 dated July 5, 2016 (updated as on June 01, 2020) on ‘Risk
Management and Inter-Bank Dealings’ and RBI Circular No. DBOD. No.
BP.BC.86/21.04.157/2006-07 dated April 20, 2007 on “Comprehensive
Guidelines on Derivatives” should be adhered to.
5.238 Following are some of the reports to be submitted to RBI:
i) Daily statements of Foreign Exchange Turnover in Form FTD and Gaps,
Position and Cash Balances in Form GPB.
ii) Statement of Nostro / Vostro Account balances.
iii) Consolidated data on cross currency derivative transactions undertaken
by residents on half yearly basis.
iv) Details of exposures in foreign exchange as at the end of every quarter as
per those details of exposures of all corporate clients who meet the
prescribed criteria have to be included in the report. The AD banks should
submit this report based on bank's books and not based on corporate
returns.
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v) Details of option transactions (FCY-INR) undertaken on a weekly basis.

vi) Total outstanding foreign currency borrowings under all categories as on
the last Friday of every month.
vii) Monthly report (as on the last Friday of every month) on the limits granted
and utilized by their constituents under the facility of booking forward
contracts on past performance basis.
viii) Statement in Form BAL giving details of their holdings of all foreign
currencies on fortnightly basis through Online Returns Filing System
(ORFS).
ix) A monthly statement, in respect of cover taken by FIIs, indicating the
name of the FII / fund, the eligible amount of cover, the actual cover
taken, etc.
x) List (in triplicate) of all bank’s offices/branches, which are maintaining
Rupee accounts of non-resident banks as at the end of December every
year.
xi) Quarterly report on the forward contracts booked and cancelled by SMEs
and Resident Individuals.
xii) Consolidated data on the transactions undertaken by non-residents under
the scheme.
xiii) Doubtful transactions involving frequent cancellation of hedge
transactions and / or the underlying trade transactions by non-residents
under the scheme.
xiv) Report of Commodity Hedging in Overseas Market on Quarterly basis.
5.239 Another significant feature of the foreign exchange business of banks
in India is the requirement of reporting of transactions, at specified intervals, by
the branches to the Reserve Bank of India by means of ‘R’ returns, as
enumerated in the Exchange Control Manual. Those branches which handle
foreign exchange transactions and are under an obligation to report them
directly to Reserve Bank are called the ‘Authorised Dealers’ (AD–also called
‘position maintaining branches’). The ADs can be nominated only with the
approval of the Reserve Bank of India and each AD would have a unique Code
Number, which must be mentioned in all reports to the Reserve Bank. In
addition to these ADs, individual banks may also, subject to report to the
Reserve Bank, nominate some other branches to handle the specified type of
foreign exchange business but these branches will have to route their
transactions through an AD only (such branches are often called ‘reporting
branches’).
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5.240 Moreover, ADs have to provide Form A2 for all interbank cross-currency
deals done with overseas banks maturing during a fortnight to the RBI through
the R-Return which is submitted on a fortnightly basis. ADs also have to submit a
report (MAP/ SIR) in the format as prescribed by the RBI. This is required to be
prepared for 4 major currencies (i.e. US$, GBP, YEN and CHF). MAP will be
prepared for the last reporting Friday of each month.
5.241 As required by RBI circular FMD.MSRG.No.67/02.05.002/2011-12
dated March 9, 2012 on “Reporting Platform for OTC Foreign Exchange and
Interest Rate Derivatives”, all inter-bank OTC foreign exchange derivatives are
required to be reported on a platform to be developed by the Clearing
Corporation of India (CCIL). All/selective trades in OTC foreign exchange and
interest rate derivatives between the Category–I Authorised Dealer Banks/market
makers (banks/PDs) and their clients are required to be reported on the CCIL
platform subject to a mutually agreed upon confidentiality protocol. This circular
was further updated vide circular no. FMD.MSRG.No. 75/02.05.002/2012-13
March 13, 2013.
5.242 As per RBI circular FMD.MSRG.No.72/02.05.002/2012-13 dated
October 12, 2012 on “Reporting Platform for OTC Foreign Exchange and Interest
Rate Derivatives”, it was decided with effect from November 5, 2012 that the
following derivative products need to be reported to CCIL by the banks:
 FCY(excluding USD)-INR forwards.
 FCY(excluding USD)-INR FX swaps.
 FCY-FCY forwards.
 FCY-FCY FX Swaps.
 FCY-FCY options.
5.243 Further the RBI vide Circular No. RBI/2013-14/400 FMD.MSRG.No.94/
02.05.002/2013-14 dated December 4, 2013 on “Reporting Platform for OTC
Foreign Exchange and Interest Rate Derivatives” provides that the CCIL had now
completed development of the platform for reporting of the following transactions
in OTC derivatives (with effect from December 30 2013):
 Inter-bank and client transactions in Currency Swaps.
 Inter-bank and client transactions in FCY FRA/IRS.
 Client transactions in INR FRA/IRS.
Accounting
5.244 Accounting is generally handled by the back office which acts as an
intermediary between the treasury business unit and the finance department to
ensure that the accounting of treasury products is accurate and correct.
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5.245 Attention of the readers is invited to paragraphs 36 to 39 of Accounting

Standard 11, whereby a forward exchange contract or another financial
instrument that is in substance a forward exchange contract is entered into,
which is not intended for trading or speculation purposes, to establish the amount
of the reporting currency required or available at the settlement date of a
transaction, the premium or discount arising at the inception of such a forward
exchange contract should be amortized as expense or income over the life of the
contract. Exchange differences on such a contract should be recognized in the
statement of profit and loss in the reporting period in which the exchange rates
change.
5.246 Any profit or loss arising on cancellation or renewal of such a forward
exchange contract should be recognized as income or as expense for the period
in line with the RBI guidelines. Such contracts should not be marked to market.
5.247 It also enables treasury operations staff to understand the accounting
that is peculiar to treasury, such as the ‘trading account’ and ‘base currency’
concepts. This is vital as most of the accounting is ‘hidden’ by being
automatically systems generated as a result of deal input of various types.
Indeed, this problem is self-perpetuating as the more complex the deals become,
the more likely a bank will be to automate to prevent errors. Also accounting
framework for option contracts will be as per FEDAI Circular No.SPL-24/FC-
Rupee Options/2003 dated May 29, 2003.
Rate Reasonability
5.248 The bank’s risk department will perform the rate reasonability process
as per the Price Verification Policy of the bank and for any transaction that falls
outside the band specified, the same should be enquired into for reasons. This
process is also known as ‘Rate Scan’ or ‘Market Conformity Check’.
Position and P&L Reconciliation
5.249 This is one of the most important controls on deals position which is
carried out by the bank’s risk department / back office. The trader's net currency-
wise exchange position as per front office system should be matched on a daily
basis by risk department / back office with the back office systems position. The
position exceptions should be communicated to the front office and a resolution
is arrived at.
Valuation of foreign exchange forwards and derivative products
5.250 Valuation of derivatives, particularly long-tenor derivative products,
many of which could be proprietary products of banks, may be difficult, as they
may be illiquid instruments.
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5.251 As part of its normal day to day operations and for managing its interest
rate and foreign exchange risk, a bank or financial institution may deal with a
number of financial instruments. Depending on the type of financial instrument
and the purpose for which it was entered into, it is necessary to value the deals
periodically. Some of the financial instruments in which banks and financial
institutions transact are complex in nature.
5.252 The valuation models used for these financial instruments are
sophisticated and involve complex algorithms. Generally, inputs into these
models are sourced from market available data points. Given the enormous
“leverage” provided by various derivative financial instruments and the track
record of significant losses reported in the industry, the valuation of these
instruments will generally have a high inherent risk.
5.253 Valuation of derivatives should be based on marked to market (MTM)
and on net present value (NPV) basis.
Audit Approach
5.254 While innovative products and ways of trading create new possibilities
for earnings for the bank, they also introduce novel and sometimes unfamiliar
risks that must be identified and managed. Failure to do so can result in losses
entailing financial and reputational consequences that linger long after the loss
has been recognized in financial statements. Hence, the Auditor should assess
controls as part of audit work.
5.255 It is imperative that the Auditor obtains a complete overview of the
treasury operations of a bank before the commencement of the statutory audit.
After conducting appropriate risk assessment of the treasury processes, the audit
program needs to be designed in a manner that it dovetails into not just the
control assessments of the treasury process but there is an assurance that the
figures appearing in the financial statements as well as the disclosures are true
and reflect fairly the affairs of the bank’s treasury operations.
Audit Programming and Procedures
5.256 In framing the audit program, the Auditor needs to take into
consideration their findings of the adequacy of controls within the processes as
explained in this Guidance Note. The Reserve Bank of India prescribes
concurrent audit /internal audit for a 100% verification of treasury transactions.
Hence, the selection of samples can be influenced by the nature, extent and
timings of concurrent/internal audit function including the compliance mechanism
of the Bank. Further, RBI requires compliance reports on derivatives separately
to be prepared by the Bank as per RBI circular no. DBOD.No.BP.BC.44/
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21.04.157/ 2011-12 dated November 2, 2011 on “Comprehensive Guidelines on

Derivatives: Modifications” which the Auditor should take into consideration. This
circular was further updated vide circular no. DBR.No.BP.BC.103/21.04.157
/2017-18 dated April 06, 2018.
5.257 The following paragraphs illustrate the audit procedures/ approach that
may form part of the audit program.
Product Program and Policy
5.258 The Auditor should obtain the approved product policy and procedures
of the Bank relating to foreign exchange and derivative business and review
them for adequacy and coverage and check whether the policy is commensurate
with the nature of operations and adequately covers all the activities of the Bank.
5.259 Further, in accordance with the Comprehensive Guidelines on
derivatives, the Auditor should obtain and verify full particulars of the model used
for valuation and the documented algorithms used by the Bank through its
Valuation Policy and operating procedure manual for valuations.
Customer/User Suitability and Appropriateness Policy
5.260 The Auditor should obtain approved ‘Customer/User Suitability and
Appropriateness Policy’ and verify that such policy is in line with the
Comprehensive Guidelines on derivatives and is approved by the Board.
5.261 The Auditor should also verify the process followed by the bank for
classification of customers into different grades/classification and the customers
have been permitted to deal in the products applicable to their respective grades.
Credit limits
5.262 For the selected samples, the Auditor should check whether appropriate
credit limits are in place for foreign exchange and derivative transactions.
Additionally, the Auditor should:
 Check whether the name of the counterparty is in the approved
counterparty list for the purpose of treasury transactions.
 Check whether the credit limits (both pre settlement and settlement) are set
for different customers and they are adhered to in a consistent manner and
for any limit breaches, appropriate sanctions / ratifications are in place.
 Check whether the counterparty exposure limit reports for all brokers,
lenders, etc., are generated and monitored on a regular basis.
 Check whether the limits are properly entered in the bank’s system.
 Check dealer limits-Maximum amount a dealer can transact without seeking
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higher-level approval and sanctions/ratifications for any breaches. It

includes individual deal (deal ticket) size limit and open position limit for a
dealer as well.
 Check product limits- Maximum exposure the entity should have in a
particular instrument or product.
 Check sector limits – Maximum investment in a particular sector (for
example, exposures to companies incorporated with limited liability in
India).
 For the selected samples, confirm and review signed and authorized ISDA
agreement, signed and authorized collateral agreement, credit risk
assessment of the customer and confirm, whether credit positions are
within established limits for each customer.
 Check whether the above limits are entered into the software system being
used by the Branch for conducting the said transactions.
Deal Initiation and Recording
5.263 For deal initiation and recording, the Auditor should check the following:
 For the selected samples, the Auditor should check whether deals carried
out by the front office are appropriately recorded in the deal slips and
whether the same is correctly entered in the front office deal recording
system.
 For the selected samples check whether the deal ticket is complete and
accurate with respect to all transaction details like counterparty name,
contract rate, notional amount, transaction date / maturity date, value date /
settlement agent and buy / sell date.
 Check the flow of transaction from initiation of deal to the verification and
approval.
 Check whether deal tickets are generated automatically by front office
systems, or trader should use sequentially numbered deal tickets.
 Check whether the dealers use dedicated calling lines and all the telephone
lines are linked to a voice recording machine.
 Verify the adherence to the voice recording mechanism.
 Check whether the proper back-up of voice recordings is being maintained.
 Verify whether user IDs of dealers left / transferred/ on leave is deactivated
/ suspended on timely basis.
 Verify whether, the Use of Mobile Phones is restricted in the Dealing Room
and the mechanism for ensuring adherence thereto.
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 Verify the recordings for few of the selected samples to ascertain that the
recording machine is working in order.
 Check whether there is access of unauthorized persons in the dealing
room. If yes, whether proper approvals have been taken.
 Check whether dealers entering the deals have signed the code of conduct
for respective segment in which trades dealt in (e.g. FIMMDA, FEDAI, FX
Global etc).
Deal Authorisation
5.264 Following audit procedures may be followed by the Auditor while
checking the procedures for deal authorisation:
 Check the process flow of authorizations of deals in the system and check
areas of manual intervention in the system.
 Check whether proper authorization levels are set for treasury operations
and observe and verify whether the prescribed procedure is followed.
 For the selected samples, check whether deals entered in front office
system are authorised by the back office team after verifying the deal
details with external evidences like Reuters’ conversation, telephonic
conversation with customers’ back office, etc.
 Examine the selected deals from the front office and establish that they are
confirmed by the back office operations.
 Check that all sample deals are authorised at the proper levels of authority
against the deal slip.
 Check whether alterations and cancellations on deal slips are duly
authorised.
 Check whether bank is preparing trade amendments sheets and whether
the reasons for such amendments are mentioned in the sheet.
 Check whether any exceptional reports are being generated.
Segregation of Duties
5.265 For this aspect, the audit procedure may include:
 There will be complete segregation between Dealing room, Market risk
group and Back office.
 Checking and ascertaining that segregation of duties is in place. Under no
circumstances staff involved in initiating deals should be involved in
checking or receiving deal related documents.
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 Verify whether there is any overlapping of duties.

 Verify that there is clear segregation, functionally and physically, between
the front office, back office and middle office in respect of derivative
transactions.
 Check that there is segregation between functions of authorisation,
execution and recording of transactions.
 In cases where management override has taken place, ascertain that
satisfactory reasons for doing so were recorded and produced for audit
verification.
 Check whether treasury personnel have availed minimum leave during the
financial year.
 Check whether any duties have been outsourced from external parties.
Counterparty confirmations
5.266 For this aspect, the Auditor would inter alia:
 Understand the process of sending and tracking the confirmations including
follow – up procedures.
 Exchange of deal confirmations is mandatory. The counterparties should
exchange the rate fixing notices. However, in the case of an OTC Overnight
Index Swap (OIS) the trades are reported to CCIL. If the counterparties
have a bilateral agreement waiving the requirement to exchange of
confirmations, then exchanging of physical confirmations may not be
required for such IRS deals.
 Understand the process of MIS reporting to the senior management in
respect of the non-receipt of counterparty confirmations.
 Verify that confirmations from Bank to counterparty are sent within a
reasonable time and there exists a mechanism for follow-ups for pending
counterparty confirmations.
 Determine the status of any missing / pending confirmations (currently in
the Confirmation Tracking List) and assess whether there are any
provisioning concerns on the trades.
 Check whether the format of the counterparty confirmation is as approved
by the Local Legal Counsel of the Bank from time to time.
 Verify controls implemented by the bank to ensure completeness of all deal
confirmations.
 Check whether there is any persisting non-receipt of Counterparty
confirmation.
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 Inquire of any exception report or other mechanism of tracking missing

confirmations.
Customer Complaints
5.267 As per the Comprehensive Guidelines on Derivatives, while undertaking
derivative transactions with or selling structured derivative products to a user, a
market-maker should establish internal procedures for handling customer
disputes and complaints. They should be investigated thoroughly and handled
fairly and promptly. Senior management and the Compliance Department/Officer
should be informed of all customer disputes and complaints at a regular interval.
For this, the Auditor should verify controls over recording and handling of
customer disputes and complaints and ensure the Bank’s adherence to RBI
requirements.
Underlying document
5.268 The audit procedures for this aspect include:
 Understanding the process and policy of the Bank in respect of the
underlying documents.
 The Auditor should ensure that the bank should obtain the original
documents from the client and/or certified document by the person who is
authorised to do the derivative deal. The Auditor should check the details in
client master page by checking the board resolution.
 Understand the process of MIS reporting to the senior management in
respect of the non-receipt of underlying documents.
 The Auditor should ascertain whether the bank has a mechanism whereby,
if the documents are not submitted by the customer within 15 days, the
contract gets cancelled, and the exchange gain, if any, is not passed on to
the customer. The primary responsibility for ensuring this remains with the
Bank and the Auditor should verify controls around the same.
 The Auditor should ensure that the Bank has a mechanism to ensure that if
the underlying is not provided three times a year; then the client will have to
produce upfront underlying and the 15 days grace will not be allowed to the
client.
 For the selected samples, review and check the underlying documents duly
received by the bank.
 In cases, where the underlying documents with regard to the forex
transactions are maintained at branches, then, the Auditor may obtain
confirmation from such branches about existence of the underlying
documents and review sudden spurt in foreign exchange transactions of
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any branch in a particular month/period, if any, and test adherence to the

RBI guidelines relating to merchant transactions.
 The Auditor should check whether any transaction was undertaken without
execution of one time documents and approval for deferral of the same is
held on record and said documents were received before the expiry of such
deferral approval.
 Auditor should check whether the Bank has process of tracking deferrals.
Accounting of transactions in the general ledger
5.269 The audit procedures for this aspect include:
 Checking whether there is a direct hands-off between front end system and
the accounting system for passing accounting entries in the general ledger.
 Checking whether correct accounting entries are recorded in the general
ledger and the back office regularly reviews the accounting entries passed
in the general ledger.
 Checking whether the treasury department generates a daily P&L (desk-
wise) and the same has been reviewed and compared with the general
ledger to identify any mismatches.
 Understand the accounting scheme for the various products. Further,
inquire about the routine and non – routine accounting entries with the
bank.
 Check whether any exceptional reports are being generated by the system.
 For the selected samples, verify the accounting entries passed.
Position Reconciliation
5.270 The audit procedures include:
 Checking whether daily position reconciliations are performed between
front office deal positions and back office deal positions by the treasury
back office and position differences if any are appropriately enquired into.
 Checking whether the Bank maintains customer wise, currency wise and
deal wise positions on a daily basis in-order to monitor customer limit
breaches and sectoral limit breaches.
 Checking whether the inter branch reconciliations between the Treasury
Branch and the Authorised Branches are carried out on a periodic basis
and there are no old and long outstanding items uncleared.
Deal Settlements
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 Checking whether there exists effective mechanism for settlement of deals

on due date and whether deals due for settlement are generated on a daily
basis by back office.
 Examining whether customer intimations are sent across as soon as the
deal is settled and the respective customer accounts are debited / credited.
 Check whether separate responsibilities are in place between authorization
and release of settlement.
 Examining whether the Settlement desk ensures proper settlement of funds
through CCIL/RTGS/SWIFT networks. Any deal rejected by CCIL should be
examined and settlement through any other means should be taken up only
after thoroughly examining the deal/deal confirmation as in most of the
cases the rejection is on account of improper deal entry.
 Examining whether deal is settled / cancelled in case no confirmation is
received from customers till expiry dates.
 Check whether any settlements defaults were made.
Realised profit / loss on derivative transactions
 Recalculating the profit or loss for sample trades selected and tally with the
general ledger.
 Test the general and IT application controls for automated computation of
profit or loss.
 Vouch to cash settlement in the case of realized gains and losses.
 Verify if the bank is reckoning only the NOSTRO balances for adjustment of
the profit / loss revealed in mirror account or did it also consider the
outstanding forward transactions as at the date of valuation.
 The increase / decrease in profit is in line with increase / decrease in
volume of transactions.
 Check marking-to-market of risk exposures and reconciliation of risk
positions and profit/loss between the front and back offices.
 Verify preparation of management reports, including daily profit/loss results
and gross and net risk positions.
 Verify exceptional reports showing details of deals resulting in exceptional
profits and losses.
 In case of early termination/cancellation of contracts, check whether
amount of profit/loss is properly arrived at and paid to /recovered from
customer as per Bank’s policy.
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Valuation of FX contracts and Derivatives

5.273 The audit procedures for valuation of FX contracts and Derivatives
include:
 For ‘spot’ and ‘tom’ contracts checking whether correct FEDAI rates are
used by the Bank for marking them to market. In case of automatic feed of
FEDAI rates, verifying whether the rates are correctly uploaded into the
system. At the end of the reporting period, sight the process and verify the
process of downloading rates from external source and the process of
uploading of rates in the system by the middle/back office for all FX
contracts and derivatives.
 Process of computation of net present value of rates.
 Re-performing and checking on a sample basis the accuracy of the MTM
gain / loss booked by the bank on the outstanding forex contract.
5.274 In case of valuations of swaps, options and other derivative products
most of the banks have proprietary valuation models developed by them or
standard valuation software installed. In case of proprietary valuation models, a
model validation coupled with checking of input parameters would provide
reasonable comfort on valuations. In case of standard valuation models, the
Auditor can resort to checking of input parameters along with limited re-
performance of derivative valuations. In such cases, the Auditor should also
check system controls and if deemed necessary, consider involving an expert to
check the integrity of the system logic. Further, the Auditor can select certain
samples as per the methodology or depending upon the nature, timing and
extent for getting it revalued from the valuation expert. The Auditor should also
obtain the understanding of rate upload process and verify the timing of rates
upload in the system for valuation of derivative contracts. The Auditor should
carry out the valuation of the samples selected in a spreadsheet and compare
the end results with the valuation as provided by the software system.
Sometimes the software systems are not capable of valuing certain treasury
products such as partly redeemable perpetual bonds, Security Receipts etc., for
which the Bank has to value such products manually and the Auditor should gain
sufficient knowledge to understand and confirm their valuation.
Guidance for Arriving at Fair / Market Value
5.275 As a general rule, for an instrument that is actively traded on a
recognized public exchange, the price quoted by the exchange, where the
instrument is traded, is used as an appropriate valuation price to arrive at the fair
value of the instrument.
5.276 In case of instruments that are actively traded over the counter, the
quoted bid price for long positions and quoted offer price for short positions is
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used as an appropriate indicative valuation price. These may be obtained

through relevant market makers or brokers.
5.277 In case of infrequently traded instruments/non-traded OTC derivatives,
various techniques are used to determine the best estimate of market price. This
synthetic market price may be derived through the use of market data (such as
interest/ exchange rates) in appropriate models/systems designed for this
purpose.
5.278 In the case of the following instruments, fair value can be arrived at
using the market data as mentioned there against:
FX spot / Prices as published by Foreign Exchange Dealers

forwards Association of India (‘FEDAI’). With effect from 31
December 2014, these are further required to be adjusted
for arriving at the net present value.
Exchange traded Prices quoted on the relevant exchange.
interest rate
futures
Commodity Prices quoted on the relevant exchange.
futures
OTC derivatives:
Options Black Scholes Merton Method.
Swaps / Forward Discounted cash flows using the applicable Interest
Rate Agreements Curves (ROI can be taken from FIMMDA / NSE / Reuters’
site based on the nature and currency of the product).
5.279 Valuation of derivatives is based on exchange rate and the swap rate
prevailing on the valuation date. Various banks use different in-house/ vendor
developed model for valuation of their derivative products. However, the general
benchmarks used for valuation are OIS/MIBOR, MIFOR, MITOR, LIBOR and
INBMK as per the end of the day quotes appearing on the Bloomberg or Reuters
page.
5.280 In case of hedge swaps, the income/ expense is accounted for on an
accrual basis except the swap designated with an asset or liability that is marked
to market or lower of cost or market value in the financial statements. In that
case, the swap should be marked to market with the resulting gain or loss
recorded as an adjustment to the market value of designated asset or liability.
Whereas, the trading swaps are marked to market as per the instructions
contained in the RBI circular NO. Ref. No. MPD. BC. 187/07.01.279/1999-2000
dated July 7, 1999 on “Forward Rate Agreements/ Interest Rate Swaps”. Circular
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no. FMRD.DIRD.19/14.03.046/2018-19 dated June 26, 2019 has been issued in

supersession of the above circular and has consolidated the instructions issued
earlier.
5.281 The marked to market gain/ loss on forward financial derivatives
contract is derived from the difference between the agreed-upon contract price of
an underlying item and the current market price (or market price expected to
prevail) of that item, times the notional amount, approximately discounted. The
notional amounts, sometimes described as the nominal amount, is the amount
underlying a financial derivatives contract that is necessary for calculating
payments or receipts on the contract. This amount may or may not be
exchanged.
5.282 In the specific case of a swap contract, the market value is derived from
the difference between the expected gross receipts and gross payments,
appropriately discounted; that is, its net present value.
5.283 The market value for a forward contract can therefore be calculated
using available information – market and contract prices for the underlying item,
time to maturity of the contract, the notional value, and market interest rates.
From the viewpoint of the counter parties, the value of a forward contract may
become negative (liability) or positive (asset) and may change both in magnitude
and direction over time, depending on the movement in the market price for the
underlying item. Forward contract settled on a daily basis, such as those traded
on organized exchanges - and known as futures - have a market value, but
because of daily settlement it is likely to be zero value at each end-period.
5.284 The price of an option depends on the potential price volatility of the
price of the underlying item, the time to maturity, interest rates, and the
difference between the contract price and the market price of the underlying item.
5.285 For traded options, whether they are traded on an exchange or not, the
valuation should be based on the observable price. At inception the market value
of a non-traded option is the amount of the premium paid or received.
Subsequently, non-traded options can be valued with the use of mathematical
models, such as the Black-Scholes formulae, that take account of the factors
mentioned above that determine option prices. In the absence of a pricing model,
the price reported for accounting or regulatory purposes might be used. Unlike
forwards, options cannot switch from negative to positive value, or vice versa, but
they remain an asset for the owner and a liability for the writer of the option.
5.286 It may be mentioned that counter party wise netting is only allowed
where specific legally enforceable bilateral netting arrangement such as
International Swaps and Derivative Association (ISDA) master agreement, etc.,
exists.
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Examples for the Calculation of Market or Fair Values of Derivative

Contracts
5.287 The following examples indicate how to calculate the market or fair
value of various derivative contracts.
5.288 For a forward, a contract to purchase USD against EUR at a forward
rate of say, 1.00 when initiated has a positive market value if the EUR/ USD
forward rate at net present value at the time of reporting for the same settlement
date is lower than 1.00. It has a negative market value if the forward rate at net
present value at the time of reporting is higher than 1.00, and it has a zero
market value if the forward rate at the time of reporting is equal to 1.00.
5.289 For swaps, which involve multiple (and sometimes two-way) payments,
the market or fair value is the net present value of the payments to be exchanged
between the counter parties between the reporting date and the contracts
maturity, where the discount factor to be applied would normally reflect the
market interest rate for the period of the contract’s remaining maturity. Thus, a
fixed/floating swap which at the interest rates prevailing at the reporting date
involves net annual receipts by the reporter of say, 2% of the notional principal
amount for the next three years has a positive marked to market (or
replacement) value equal to the sum of three net payments (each 2% of the
notional amount), discounted by the market interest rate prevailing at the
reporting date. If the contract is not in the reporter’s favour (i.e., the reporter
would have to make net annual payments), the contract has a negative net
present value.
5.290 Unlike forwards or swaps, OTC options have a market or fair value at
initiation which is equal to the premium paid to the writer of the option.
5.291 Throughout their life, option contracts can only have a positive market
or fair value for the buyer and a negative market or fair value for the seller. If a
quoted market price is available for a contract, the market value to be reported
for that contract is the product of the number of trading units of the contract
multiplied by that market price. If a quoted market price is not available, the
market or fair value of an outstanding option contract at the time of reporting can
be determined on the basis of secondary market prices for options with the same
strike prices and remaining maturities as the options being valued, or by using
option pricing models.
5.292 In an option pricing model, current quotes of forward prices for the
underlying (spot prices for American options) and the implied volatility and
market interest rate relevant to the option’s maturity would normally be used to
calculate the market values. Options sold and purchased with the same counter
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party should not be netted against each other, nor should offsetting the bought
and sold options on the same underlying be resorted. RBI vide its Circular
DBOD. No.BP.BC.76/21.04.157/2013-14 dated December 09, 2013 has issued
operational Guidelines on “Novation of OTC Derivative Contracts”.
Rate Scan
5.293 The audit procedures for this would include:
 Checking whether for the selected deals, the rates taken are the prevailing
rates in the market at the time of striking the deal. In doing so the Auditor
needs to assess the process of advising card rates to customers, though its
branches or relevant operating departments.
 Checking whether in outright deals the back office checks the rate scans for
the veracity of the rate at which the dealer has struck the deal. Any
deviation should be enquired into for compliance with AS 11.
 Check whether any exceptional reports are being generated in this respect.
 In case of deviations, reasons should be obtained and check whether the
same have been reported to the senior management.
Margins held with exchanges / margins held under Credit Support
Annex (‘CSA’)
5.294 The forward contracts in banks are now a days increasingly being
collateralized using Customer Support Annex (CSA) margins which form part of
the ISDA agreement. The audit procedures for this would include:
 Sending independent third party confirmations to confirm the balances held
as at the reporting date.
 Agreeing the balances to underlying supporting such as margin statements.
Check whether margin statements are being sent to the clients and check the
correctness of the same.
Assessment of controls
5.295 The audit procedure may include verifying and assessing controls
including:
 Existence of comprehensive treasury policy and operating procedures
manual (SOP).
 Review of the policies and procedures document and assess
comprehensiveness of the same.
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 Determining whether the above document addresses, in granular detail, the

framework within which the treasury business and operations have to be
conducted.
 Inquiring on the procedures the bank has when there is a change over or
new appointment to a ‘review’ role within the treasury function.
 Check whether proper system of rotation of dealer is in place.
 Understanding the level of detail in which the process of handover of
responsibilities operates.
 Check whether mandatory leave policy is being compiled in the bank.
 Inquiring whether there has been any change in responsibilities in the
current period and in case there are changes, verifying whether there is an
appropriate training mechanism and whether signoffs have been
regularized after the new superior has taken over the responsibilities.
 On a test check basis, verifying whether the review process and controls
were working effectively during the transition period.
 Obtaining and reviewing on test check basis, the daily Profit and Loss
prepared for MIS purpose and assessing the granularity and
exhaustiveness of the same.
 Assessing whether such Profit and Loss is granular enough to provide desk
wise, product wise and various price component wise Profit and Loss.
 Assessing whether gross position reviews are undertaken and also whether
such Profit and Loss are prepared and reviewed at a gross trade level.
 Reviewing the Bank’s policy on valuation. On a test check basis, verifying
whether the material valuation adjustments are reviewed, authorized and
are appropriate.
 Verifying whether these valuation adjustments are disclosed / visible in the
reconciliation.
 Assessing whether there is an independent ‘Valuation Control’ team.
 Checking whether dealers have access to adjust or modify trade values.
 Checking whether the reconciliations are prepared on a timely basis and
the un-reconciled items are independently inquired by the back office.
 Reviewing the ageing and quantum of the un-reconciled items and inquire
for the high value and long outstanding reconciling items.
 Assessing whether the escalations are done in a timely manner for the
large / unusual / recurring reconciliation items.
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Market Risk System

 Reviewing the key market risk reports generated and verifying that these
reports are in sync with risk attributes of the products being traded and
convey the risk positions appropriately.
Cancelled / amended / late (C/A/L) booking of futures trades into the Front Office
risk system
 Reviewing the policy of the bank as regards the cancelled / amended / late
booked trades and whether there is a clear policy describing the Front
office supervisor’s responsibility in respect of reviewing and signing off on
these instances.
 Reviewing whether these instances are reported to the senior management
as per the policy and are ratified.
 Verifying whether the system is capable to capture the C/A/L and obtaining
a complete inventory of these instances.
 Reviewing the frequency of such instances during the period and verifying
on a test check basis whether there is a justification of such cancellations /
amendments / delays.
 Checking the process relating to late trades – how does these get captured
in risk reporting’s (if there is a time cut off when such reports are
generated).
 Check the approval and control process of the said transactions.
 Sample check of the same can be done by making dummy entries for
verification purpose.
Fictitious trades with deferred settlement dates and/or at off-market prices and
subsequent amendments
 Reviewing the controls over cancellation of trades before reaching
settlement dates and checking whether these are ratified by the authorized
personnel with appropriate justifications.
 Reviewing the “Rate scan” process performed by mid-office and whether
the exceptions noted in the rate scan are inquired and reasons are
obtained for the same.
 Reviewing the Day 1 Profit or Loss assessment process and verify whether
the Day-1 Profit or Loss is sufficiently assessed and explained.
 Verifying whether the change in pricing / other criterion is approved and
confirmed with the counterparty.
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Breaches of the Net Delta Limits

 Verifying whether the breaches of the delta limits set by the Bank are
monitored on a frequent basis and whether the breaches (if any) are ratified
by the authorized personnel and the reason is recorded for such breaches.
Failure to identify and escalate risk issues
 Verifying whether a process is in place to educate employees about
escalation mechanism to report any events that represent a risk to the
institution and is embedded in the code of conduct. This may include
directly reporting the incidences to the highest authorities on a no name
basis, hotline numbers etc.
Quality of supervision
 Assessing and determining the nature of comments and queries that are
posed by the reviewer on any reconciliation breaks, long unexplained
balances, exceptional trades, follow up on responses, etc.
 Determining and assessing whether the review function is not a mere sign
off and it is conducted with appropriate supervisory intent.
 Verification of training sessions conducted by the bank.
Temporary discontinuance of a process or control
 Verifying that the controls identified and tested have been operational
throughout the period and where there has been a temporary
discontinuance (for any reason) verify whether there were alternative
controls.
Rewards and recognition policy not in sync with ideal ‘risk and control’ culture
 Reviewing the remuneration policy and independently assessing how and
to what degree it addresses matters relating to risk and compliance with
control policies as part of the employee remuneration for treasury staff
members.
Outsourced/Hubbed process
 Reviewing the Service Level Agreements (SLAs) and agreements with such
agencies and verify the robustness of the controls that reside in house in
the bank to review and understand the work undertaken at outsourced /
hub locations.
 Reviewing and verifying the documentary evidence of the communication
the bank has with these agencies on a regular basis. The forward contracts
in banks are now a days increasingly being collateralized and using
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Customer Support Annex (CSA) margins, which form part of the ISDA
agreement. The Auditor should devise audit procedures required to be
performed for verification of these margin balances as per the underlying
agreements.
NOSTRO and VOSTRO Accounts
5.296 A fundamental feature of foreign exchange transactions is that the
useful possession of any currency can be had only in the country in which it is
a legal tender or countries in which it is circulated (e.g., US Dollar is widely
circulated in Russia, CIS countries). Therefore, in order to be able to put
through foreign exchange transactions, banks normally maintain stocks of
foreign currencies in the form of bank accounts (usually current accounts) with
their overseas branches/correspondents. Such a foreign currency account
maintained by a bank at an overseas centre is usually designated by it as
‘NOSTRO Account’ (i.e. “Our account with you”). Thus, banks in India may
maintain a pound-sterling account with its London office/correspondent; such
account would be called by it as NOSTRO Account. Conversely, if a foreign
bank is to deal in a local currency of another country, it would maintain a
‘VOSTRO Account’ (i.e. ‘your account with us’) with the local bank, e.g. a bank
in England may maintain a ‘VOSTRO Account’ in Indian Rupee with a
correspondent bank in India. A VOSTRO account is in substance no different
from any other account in the local currency.
NOSTRO / VOSTRO Reconciliation
5.297 In respect of old unreconciled entries in NOSTRO Accounts, the RBI
vide its Circular DBOD No.BP.BC.67/21.04.048/99 dated July 1, 1999 has
allowed, as onetime measure, a netting off procedure.
5.298 The Auditor may consider the following aspects in respect of
NOSTRO reconciliation:
 Whether a system of periodical reconciliation is in place and is up to date.
 Whether the reconciliation process followed ensures matching of each item
and not for overall matching of total amount.
 Whether logs are generated for any change made in entry and whether
maker checker is implemented for authorising changes made in entry, if
any, for reconciliation.
 Whether confirmations from the foreign banks are obtained on a periodic
basis. This may be through physical confirmations, swift messages, emails,
etc.
 Whether information to the controlling office is sent on a timely basis.
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 Whether long outstanding are taken up and cleared.

 Random check of the method of reconciliation.
 Debits outstanding in the NOSTRO accounts are to be verified and
recommended for provision wherever necessary.
 Set off the credit against debits only at the permission of the head office for
long outstanding entries.
 Whether payments are promptly advised and effected and receipts are
suitably recorded in the “Nostro” account.
 Whether large balance has been held in an inoperative account, for a long
period and if so, the reasons thereof.
 Whether bank has been submitting the BAL Statements periodically to RBI.
5.299 RBI’s circular no. DBOD.BP.BC.16/21.04.018/2001-02 dated August
24, 2001 on “Reconcilation of Nostro Accounts - Old Outstanding Credit
Entries” has also clarified that the balances carried in “Sundry Debtors/
Unclaimed Deposits Accounts” under NOSTRO Accounts, represent
unreconciled entries which may be large in a few cases and hence susceptible
to frauds. Accordingly, the banks should transfer the following balances in the
“Sundry Debtors/ Unclaimed Deposits Accounts” appearing in the books of the
bank as on September 30, 2001 to distinct “Blocked Accounts” and shown
under “Other Liabilities and Provisions” (item no. iv of Schedule 5) in the
balance sheet:
(i) the net credit balance arising out of the netting of entries pertaining to the
period prior to April, 1996; and
(ii) credit entries originated on or after April 1, 1996 and remaining
unreconciled in NOSTRO/ mirror accounts for more than three years.
5.300 Further, the balances in the Blocked Accounts will be reckoned for the
purposes of maintenance of CRR/ SLR.
5.301 Any adjustment from the Blocked Accounts should be permitted with
the authorisation of two officials, one of whom should be from outside the
branch concerned, preferably from the Controlling branch/ head office if the
amount exceeds Rs.1 lakh. Further, vide Circular no. DBOD.BP.BC.No.133/
21.04.018/2008-09 dated May 11, 2009, the RBI has advised accounting
treatment for old outstanding entries in NOSTRO Mirror accounts. It further
stated that Banks are advised to minimize the number of Nostro accounts to
have a better control over reconciliation and put in place a system of fast
reconciliation and close monitoring of pending items in Nostro accounts by top
management at short intervals. Banks are also advised to leverage technology
to avoid building up of such unreconciled balances.
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5.302 The audit considerations for this aspect include:

 Examining whether currency wise NOSTRO reconciliation is performed on
a day-to-day basis and check for long outstanding items.
 Checking whether there exists a policy of following up for outstanding
reconciliation items with the counterparties or with the respective banks.
 Outstanding debit items over 90 days attract provisioning under RBI
provisioning norms.
 Examining whether the statement of account is sent to the Vostro account
holder and periodic confirmation is obtained and discrepancies, if any, is
properly dealt in the books of accounts.
 To verify the bank submitted statement of Nostro / Vostro account balances
on monthly basis to RBI.
 Verify if reconciliation is done by separate department and not by treasury
department which operates Nostro accounts.
 Check for write off any un-reconciled item / number / amount and see if
details are sent to RBI for approval.
 Whether MIS of unreconciled entries of NOSTRO account is being sent to
senior management periodically and does the senior management review
the same.
Evaluation of Internal Audit/Concurrent Audit
 Examining whether treasury transactions are separately subjected to
concurrent audit by internal Auditors / external Auditors and monthly reports
containing their findings are submitted to the management for corrective
action.
 Obtaining the monthly concurrent audit reports of the treasury operations
and check whether deficiencies if any, mentioned in the report are rectified
or noted for corrective action by the management.
 In internal audit reports, examining whether major control weaknesses are
highlighted and a management action plan to remedy the weaknesses are
agreed with a timeframe.
 Check whether any persisting irregularities are being highlighted in the
audit reports.
The Management should periodically monitor newly implemented systems and
controls to ensure they are working appropriately. Failure of management to
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implement recommendations within an agreed timeframe should be reported to

the Audit Committee.
Risk Management
 Checking whether the bank has adequate risk management process, sound
risk measurement procedures, sound information systems, continuous risk
monitoring and frequent management reporting for treasury operations.
 Examining whether the mid-office monitors the exchange and gap positions
for cut loss limits, overnight limits, daylight limit, liquidity, counterparty
exposure limit and aggregate gap limit fixed in the banks trading policy/
guidelines.
 Reviewing the adequacy and effectiveness of the overall risk management

system, including compliance with policies, and procedures.
 Investigating unusual occurrences such as significant breaches of limits,

unauthorized trades and unreconciled valuation or accounting differences.
 Inquiring whether there is a ‘New Product Approval’ process prior to

undertaking transactions in new or structured derivative products and
verifying whether the ‘New Product Paper’ for all new derivative products is
approved and signed-off by the Chief Compliance Officer of the bank.
 Obtaining the ‘Risk Management Policy’ of the bank and verifying whether
risk management pertaining to derivative transactions is an integral part of
the policy.
 Verify whether the Policy is updated on a periodic basis in line with the
dynamic market and regulatory changes.
 The Board should have overall responsibility for management of risks and
should decide the risk management policy of the bank and set limits for
liquidity, interest rate, foreign exchange and equity price risks and verifying
that the policy inter alia covers the following aspects:
i. Defines the approved derivative products and the authorized
derivative activities.
ii. Details the requirements for the evaluation and approval of new
products or activities.
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iii. Ensures appropriate structure and staffing for the key risk control
functions, including internal audit.
iv. Establishes management responsibilities.
v. Identifies the various types of risks faced by the bank and establishes
a clear and comprehensive set of limits to control these.
vi. Establishes risk measurement methodologies which are consistent

with the nature and scale of the derivative activities.
vii. Requires stress testing of risk positions.

viii. Details the type and frequency of reports for monitoring risks which
are submitted to the Board (or committees of the Board).
ix. Typical risks and commonly used risk limits in respect of derivative
transactions.
x. It is essential that banks have interest rate risk measurement systems
that capture all material sources of interest rate risk and that assess
the effect of interest rate changes in ways that are consistent with the
scope of their activities. The assumptions underlying the system
should be clearly understood by risk managers and bank
management.
Information Technology (‘IT’) Controls

 Check controls over creation of all masters Like counterparty, broker, limit,
dealer, etc.
 Check the integration of various treasury application with Core Banking

Application.
 Check interface controls between various applications used in treasury

department (viz. SWIFT and CBS, Finacle Treasury and Finacle core, etc.).
 To verify the integration of CBS, including Trade Finance and/or aligned

software/modules, with SWIFT system and status of automation thereon.
 The Auditor should specifically verify whether any special privileges or

rights are given for operating SWIFT system allowing direct initiation of
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transactions through SWIFT without initiating the transactions through CBS.

And whether such transactions are reflected correctly in CBS.
 Obtain IT related information from the bank for treasury operations and
review, as appropriate, minutes of any committees responsible for
overseeing and coordinating IT resources and activities to determine user
involvement and organizational priorities.
 Check functional separation in the system.

 Verification of limit system and determination and reconciliation of positions
and results.
 Check whether there were any changes in EDP systems.
 Review organizational charts, job descriptions, and training programs to

ascertain that the bank has sufficient number of technology personnel and
that these personnel have the expertise the bank requires.
 Review MIS reports for significant IT systems and activities to ascertain that
risk identification, measurement, control, and monitoring are commensurate
with the complexity of the bank’s technology and operating environment.
 Evaluate the separation of duties and responsibilities in the operation and
data processing of treasury functions.
 Evaluate the adequacy of input/output controls and reconcilement
procedures for batch capture and image capture systems.
 Review controls and audit trails over master file change requests (such as
address changes, due dates, commission / interest rates, and service
charge indicator) and also consider individuals authorized to make changes
and potential conflicting job responsibilities and documentation/audit trail of
authorized changes and procedures used to verify the accuracy of master
file changes.
 Assess adequacy of controls over changes to systems, programs, data
files, and PC-based applications and consider procedures for implementing
program updates, releases, and changes.
 Check if controls are in place to restrict and monitor use of data-altering
utilities and adequate process management to select system and program
security settings (i.e., whether the settings were made based on using
sound technical advice or were simply default settings).
 Check whether controls are established to prevent unauthorized changes to
system and programs security settings.
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 Evaluate the effectiveness of password administration for employee and

customer passwords considering the complexity of the processing
environment and type of information accessed and consider confidentiality
of passwords - (whether only known to the employee/customer),
procedures to reset passwords to ensure confidentiality is maintained,
frequency of required changes in passwords, password design (number
and type of characters), security of passwords while stored in computer
files, during transmission, and on printed activity logs and reports.
 Check whether any system audit has been conducted by the bank.
 Determine whether the bank has removed/reset default profiles and
passwords from new systems and equipment and determine whether
access to system administrator level is adequately controlled.
 Check whether the “data hands off” process from one product processor to
another or to any other system is conducted under a secure environment
and without or with least but controlled manual intervention.
 Check whether proper backup of records is being maintained.
 Whether any dealer/employee has accessed the dealing room on holidays.
If yes, verify the reasons and approvals for the same.
 Check whether mandatory leave policy has been adhered to.
 Check BCP details of the bank in relation to Treasury activities.
 Check whether the voice recording systems are periodically tested by the
operations team and process to tag trades and corresponding unique voice
records. Concurrent Auditors are also required to verify this at periodic
intervals.
 Check compliance with Internal Control Guidelines issued by RBI vide
FE.CO.FMD. No. 18380 /02.03.137/2010-11 February 3, 2011.
Asset Liability Management (ALM)
5.306 The Management of banks has to base its business decisions on a
dynamic and integrated risk management system and process, driven by
corporate strategy. Banks are exposed to several major risks in the course of
their business - credit risk, interest rate risk, foreign exchange risk, equity /
commodity price risk, liquidity risk and operational risk. It is, therefore, important
that banks introduce effective risk management systems that address the issues
related to interest rate, currency and liquidity risks. Banks need to address these
risks in a structured manner by upgrading their risk management and adopting
more comprehensive Asset-Liability Management (ALM) practices than has been
done hitherto. ALM, among other functions, is also concerned with risk
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management and provides a comprehensive and dynamic framework for

measuring, monitoring and managing liquidity, interest rate, foreign exchange
and equity and commodity price risks of a bank that needs to be closely
integrated with the banks' business strategy. It involves assessment of various
types of risks and altering the asset-liability portfolio in a dynamic way in order to
manage risks.
5.307 Banks should give adequate attention to putting in place an effective
ALM System. Banks should set up an internal Asset-Liability Committee (ALCO),
headed by the CEO/CMD or the ED. The Management Committee or any
specific Committee of the Board should oversee the implementation of the
system and review its functioning periodically.
5.308 In order to capture the maturity structure of the cash inflows and
outflows, the Statement of Structural Liquidity should be prepared, Also, in order
to enable the banks to monitor their liquidity on a dynamic basis the statement of
Short-term Dynamic Liquidity should be prepared.
5.309 The ALM process rests on three pillars:
 ALM Information Systems
o Management Information Systems
o Information availability, accuracy, adequacy and expediency
 ALM Organisation
o Structure and responsibilities
o Level of top management involvement
 ALM Process
o Risk parameters
o Risk identification
o Risk measurement
o Risk management
o Risk policies and tolerance levels.
5.310 Banks are required to disclose the maturity pattern of Deposits,
Advances, Investments, Borrowings, Foreign Currency assets, Foreign Currency
liabilities as on balance sheet date. The maturity pattern needs to be disclosed in
several time buckets.
5.311 Measuring and managing liquidity needs are vital for effective operation
of commercial banks. By assuring a bank's ability to meet its liabilities as they
become due, liquidity management can reduce the probability of an adverse
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situation developing. The importance of liquidity transcends individual

institutions, as liquidity shortfall in one institution can have repercussions on the
entire system. Banks management should measure not only the liquidity
positions of banks on an ongoing basis but also examine how liquidity
requirements are likely to evolve under different assumptions. Experience shows
that assets commonly considered as liquid like Government securities and other
money market instruments could also become illiquid when the market and
players are unidirectional. Therefore liquidity has to be tracked through maturity
or cash flow mismatches. For measuring and managing net funding
requirements, the use of a maturity ladder and calculation of cumulative surplus
or deficit of funds at selected maturity dates is adopted as a standard tool.
Auditor’s Approach
5.312 The approach of the Auditors should be as under:
 Auditors should obtain the Board approved policies for Asset Liabilities
Management (ALM), Liquidity Risk Management and Liquidity Coverage
Ratio (LCR).
 Auditors should examine the process manuals across risk management
units and ALM/ALCO functionaries.
 Auditors should carry out complete process walkthrough.
Auditors should obtain and examine all the key ALM, ALCO and Risk
Management Committee meeting details and analyze the minutes of meetings.
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Annexure
Illustrative Checklist for the Verification of the Aspects of
the Treasury/Investments of the Bank in Statutory Audit
SN Area Description
1. Investment Policy Verify if the Bank has a Board Approved
Investment Policy in place and the same has
been reviewed on annual basis.
Verify if the Investment policy has been framed
in concurrence with RBI guidelines.
2. Prudential Limits Verify if the Bank has adhered to the prudential
limits relating to investments as prescribed by
RBI from time to time and Internal Policies.
3. Income Verify if the Income on various Investments has
Calculation & been correctly calculated and recorded in the
Accounting Books of Account taking into consideration RBI
guidelines issued from time to time and
Accounting Policies followed by Bank.
4 Verification of Verify the investments physically and/or with the
Investments available holding statements/confirmations.
5. Classification/ Refer RBI Master Circular No. RBI/2015-16/97
Valuation DBR No BP.BC.6/21.04.141/2015-16 dated July
01, 2015 on Prudential Norms for Classification,
Valuation and Operation of Investment Portfolio
by Banks
Classification:
Check if entire investment portfolio is classified
under three categories viz: AFS, HFT & HTM.
Sale/Transfer/Shifting:
Verify there are no securities held in the HFT for
more than 90 days.
Verify there has been no shifting of securities
to/from HTM Portfolio without the approval of the
Board beyond the allowed percentage as per the
RBI i.e. 5% of the HTM Portfolio is allowed only
in the beginning of the year.
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For Shifting in excess of 5% of the HTM

Portfolio, the Bank should disclose in the Notes
to Accounts the Market Value of Investments
held in HTM and also indicate the Book Value in
excess of Market Value to the extent not
provided for.
Profit & Loss from the HFT & AFS Category of
Investments is taken to P&L Account.
Valuation:
Check if the valuation of various securities have
been made in line with the RBI Master Circular –
Prudential Norms for Classification, Valuation &
Operation of Investment Portfolio of Banks.
 HTM Portfolio is carried at acquisition cost
unless it is more than the face value, in
which case the premium should be
amortised over the period remaining to.
 AFS has to be marked to market on
quarterly or frequent intervals. To arrive at
net appreciation or net depreciation in the
portfolio, The securities under same
classification can be aggregated to arrive at
the net appreciation or net depreciation No
set off can be done for the depreciation of
one classification against the other.
 Net depreciation to be provided for and net
appreciation to be ignored.
 HFT also has to be marked to market or
monthly or more frequent intervals.
6 Verification of Verify that the investments are classified as NPI
Non-Performing as per the extant guidelines issued by RBI from
Investments (NPI) time to time.
7. Regulatory Verify the accuracy of all the Regulatory Returns
Returns submitted to the RBI and also verify whether the
same have been submitted within the deadlines.
8. Computation of Verify the mechanism and accuracy of the
SLR & CRR computation of NDLT and SLR & CRR and
compliance thereof.
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9. Disclosure Verify the following disclosures required to be

Requirements made to the Notes to Accounts have been made
and made accurately.
1. Details regarding securities sold under Repo
and Purchased against Reverse Repo.
2. Details of the issuer composition of non-
SLR investments and the non-performing
non-SLR investments.
3. Details of Transfer of Securities from HTM
portfolio to AFS in excess of 5%, Banks
should disclose the market value of the
Investments and Book Value in excess of
Market value for which provision is not been
made.
4. Details of corporate debt securities lent or
acquired under repo or reverse repo
transactions.
5. In respect of the Non SLR Securities
portfolio, the issuer details in the format
prescribed vide RBI Master Circular on
Prudential Norms for Classification,
Valuation and Operation of Investment
Portfolio by Banks.
6. Penalty paid to Reserve Bank of India
during the financial year.
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6
Audit of Information Technology and
Digital Banking Division
Introduction
6.01 Over the past decade, the complexion of the financial services industry
has changed considerably, as constantly-evolving Information Technology (IT)
has had a huge impact on the industry, creating numerous new opportunities, but
also bringing in newer challenges. The technology driven changes coupled with
regulatory and demographic factors are cutting through the entire value chain of
the banking system resulting in a constant state of flux. Therefore, it is important
for banks to adapt to new technologies trending around the world.
6.02 Risks arising from the use of information technology can affect banks at
strategic, tactical and operational levels. Technology risk is pervasive and
continually changing. As we know, Information Systems (IS) increasingly
underpin a bank’s financial and operational progress. Under these
circumstances, effectively controlling IT/ IS risks has become very important for
sound financial and operational processes.
6.03 These risks are on account of threats and vulnerabilities ranging from
hacking, viruses, obsolescence, unpatched systems, unavailability of talent, loss
of key skills, inadequate testing of patches / software components, non
compatibility of the hard wares, inadequate control implementation, lack of
monitoring, natural disasters and frauds. The targeted cyber-attacks on banks
like SWIFT incidents, data theft/ loss, Distributed Denial of Service (DDoS), etc.
have led to greater regulatory focus and demand for robust cyber security
readiness.
6.04 Hence, banks must build capabilities to assess important Information
Technology risks, to mitigate these and demonstrate the same to all
stakeholders. The banks must keep abreast, and wherever possible anticipate,
fast-moving developments in Information Technology.
6.05 In the context of the above, IT audit needs to continually evolve to
effectively cover the relevant Information Technology risks. The IT audit also
requires professionals to have appropriate technical skills and experience to
meet the demands of a complex and constantly changing IT environment and
compliance with evolving legislation and regulations.
6.06 IT audit may, but not limited to, cover following aspects:
 Entity level IT Controls
o IT Governance and Organization
o IT Policies and Standards
o IT Procedures and Guidelines
o IT Strategy and Plan
 Business Process and Automated Controls
 Access Controls
 Change Management Controls
 IT Asset Management
 System Acquisitions/Development and/or Migration Controls
 IT Services Management Controls
o Incident Management
o IT Capacity and Performance Management
 Backup Management
 RBI Cyber Security Controls (including Physical, Network, Application and
Database Security)
 Payment Systems (including SWIFT) Controls
Other areas to be covered:
 Digital Banking - Key considerations
 Cryptography Key Management Controls
 Consumer Identity and Access Management
 Data Protection/ Privacy
 Outsourcing Risks
 RPA and AI
 Aadhaar Controls
 Blockchain
Scope
6.07 Range of the activities that are to be subjected to an IT audit are
discussed in the following paragraphs:
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Business process controls

6.08 Applications and systems such as ERP (Enterprise Resource Planning)
solutions, core banking applications, treasury systems, investment management,
core insurance, CRM (Customer Relationship Management) and other custom
systems shall be identified to audit processes with reference to the following:
Banking: Retail, Corporate and Investment Banking, Treasury
Insurance: New Business, Claims processing; Billing, Purchase to Pay, Order to
Cash, Record to Report
Customer Relationship: Lead, Relationship, service management
Finance and Accounts: General Ledger, Accounts Payable/Receivable, Fixed
Assets
HR Processes: Hire to Retire.
It shall also include the test of the adequacy of: system configuration controls,
process controls, maker checker controls, master data controls, reporting
controls, data upload/ interface controls, Information produced by the Entity (IPE)
controls, controls around end user computing sheets and information security
controls.
User Access Management
6.09 User access management controls are put in place to protect
organization’s internal and client confidential information by controlling who has
the rights to use or access information resources as per permissible
responsibilities’ / roles matrix. “Need to know, Need to do” principle should be
followed in user access management.
Policies and procedures for user access management
6.10 Robust policies and procedures shall be framed for the user access
management which will provide guidelines for the user access provisioning, user
access deprovisioning, user access review, generic user ids and authentication
controls.
User access creation including administrative and vendor IDs
6.11 Access to information resources are granted based on user privilege
and on a ‘need to know’ principle. Individuals should be granted access to
systems and/or data aligned to their job responsibilities.
Administrative accounts are accounts with access rights that may override
controls that exist at the assertion level, database level and at the application
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level (e.g., system administrators, security administrators, database

administrators).
Administrative access should be restricted to a small group of individuals and to
personnel/teams who require the administrative access as a part of their job
responsibilities.
Activities performed by users having administrative access should be monitored
and reviewed for appropriateness.
User access provisioning should be done based on the organization’s access
control policy.
User access modification including administrative and vendor
IDs
6.12 The transition of a user to a new role/department/location must be
agreed with the users existing reporting manager and with the new reporting
manager (if there are any changes) for the following points:
 A review of the existing permission should be performed to check what
access permissions are needed to be preserved during transition period
and when completed, these permissions must be removed (if applicable).
Ideally, no cross functioning access should be available with that user.
 New permissions required by the user as per his/her job responsibilities in
their new role.
User access revocation including administrative and vendor
IDs
6.13 When an individual/group of individuals leave the organization due to
termination, resignation, retirement, absconding etc., their system accounts
(including Active Directory access) should be disabled at the earliest to avoid
unauthorized access to the systems and data.
Review of role – right matrix
6.14 Access rights should be reviewed periodically to determine deviations
from role baselines and to validate rights in alignment to the job responsibilities.
Moreover, the system of review of validity of approval granted in exceptional
cases should be reviewed periodically.
Segregation of Duties/Conflicting Access
6.15 Segregation of duties (SOD) is the concept of having more than one
person required to complete a task end to end. In business, the separation by
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sharing of more than one individual in one single task is an internal control
intended to prevent fraud and error. SOD and critical access review shall be
performed on a periodic basis along with the assessment of the appropriateness
of access to critical transactions. Core application transactions shall be reviewed
along with the master data to determine instances of SOD violation and related
risk amounts.
Change Management
6.16 Change Management is the process of planning, documenting,
coordinating, approving, implementing and monitoring changes affecting the
Development, Quality Assurance, Staging and Production platform within the
organization environments.
The objectives of the Change Management processes are to:
 Ensure that changes are implemented with minimum disruption to the
services IT has committed to its users.
 Support the efficient and prompt handling of all changes.
 Provide accurate and timely information about all changes.
 Ensure all changes are consistent with business and technical plans and
strategies.
 Ensure that a consistent approach is used.
 Provide additional functionality and performance enhancements to systems
while maintaining an acceptable level of user services.
 Reduce the ratio of changes that need to be backed out of the system due
to inadequate preparation.
 Ensure that the required level of technical and management accountability
is maintained for every change.
 Monitor the number, reason, type, and associated risk of the changes.
6.17 Activities of the Change Management Process should include, but not
limited to the following:
 Receiving change requests from requesters.
 Assigning the change to resources within organization for solution.
 Identification, sizing and risk analysis.
 Accepting or rejecting the requested change.
 Assigning the change to solution development resources.
 Segregation between the production and test environment.
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 Reviewing the solution prior to implementation.

 Scheduling the change.
 Coordinating the change activities, including:
o Planning the change
o Documenting the change
o Developing back out plan
o Acquiring change approvals
o Change Implementation
o Post Implementation Testing
 Communicating change implementation date as required to all concerned
parties.
 Closing the change.
6.18 Change management policies and procedures shall be framed along
with the change requisition procedures where any change will involve
requirement analysis, change authorization and development, testing of changes
in User Acceptance Testing environment (UAT), segregation of the UAT and
production environment, change approval and migration controls, monitoring of
changes post implementation and segregation of duties for the changes. Sign off
from the user / user groups who has initiated the Change Requisition is very
essential. Procedures shall also be defined for emergency changes highlighting
implementation and approval mechanism which shall be followed for the same.
IT Service management
6.19 IT service management involves effective management of the following
areas where the organization should design, build, implement, operate and
manage these processes effectively.
Incident Management
6.20 Policies, procedures and guidelines for incident management shall be
defined and all the incidents should be classified, managed, monitored and
tracked to closure as per the defined guidelines.
System acquisition, development and maintenance
6.21 System requirements as part of the system acquisition / development,
System Requirement Study (SRS) and its maintenance shall be formulated as a
part of the Information Security policy. Due care should be taken during
executing change control procedure including correct processing techniques
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such as input data validation, control of internal processing, output data

validation and securing application services on public networks. Also, technical
review of application shall be conducted after operating platform changes.
Information security risk management
6.22 Risk management program shall be documented along with the
information security risk assessment policy and procedures. Information security
risk assessments should be performed on a periodic basis which would include
remediation of the identified gaps as well. Review of the business continuity
preparedness, business continuity policy and awareness and disaster recovery
testing shall also be performed as a part of the risk management program.
Capacity Management
6.23 Policy and procedures around capacity and performance monitoring
shall be framed along with the threshold metrics for capacity management.
Management shall define frequency to review the capacity management reports
and controls to address any deviation from the defined metrics.
Backup Management
6.24 Policy and procedures around backup management, backup failures,
offsite backup management and degaussing mechanism shall be framed along
with the implementation of technical controls around backup solution, secure
backup solution configuration, encryption and access restriction of the
management console.
Information asset management
6.25 A repository of all assets shall be maintained, and the process shall be
documented and followed for assigning an ownership to all assets, asset return,
denial of access in case of user termination, information classification/ labeling
and secure media disposal among other areas.
Information and Cyber security review
6.26 Security controls are safeguards or countermeasures to avoid, detect,
counteract, or minimize security risks to physical property, information, computer
systems, or other assets. There are various guidelines, circulars and mandates
released by RBI and other regulatory bodies for information technology, cyber
security and information security. It is advisable to check the latest RBI
guidelines on Information and Cyber Security aspect before conducting the
statutory audit. The RBI vide Circular No. RBI/2015-16/418
DBS.CO/CSITE/BC.11/ 33.01.001/ 2015-16 dated June 2, 2016 on Cyber
Security Framework in Banks has provided as follows:
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 Review of cyber security policy.

 Cyber crisis management plan (CCMP) - CCMP should address the
following four aspects: (i) Detection (ii) Response (iii) Recovery and (iv)
Containment. Banks need to take effective measures to prevent cyber-
attacks and to promptly detect any cyber-intrusions so as to respond /
recover / contain the fall out.
 Cyber security preparedness indicators - The adequacy of and adherence to
cyber resilience framework should be assessed and measured through
development of indicators to assess the level of risk/preparedness. These
indicators should be used for comprehensive testing through independent
compliance checks and audits carried out by qualified and competent
professionals.
 Vulnerability assessment.
 Information sharing initiatives - banks need to report all unusual cyber
security incidents (whether they were successful or were attempts which did
not fructify) to the Reserve Bank. Banks are also encouraged to actively
participate in the activities of their CISOs’ (Chief Information Security Officer)
Forum coordinated by IDRBT and promptly report the incidents to Indian
Banks – Center for Analysis of Risks and Threats (IB-CART) set up by
IDRBT (Institute for Development and Research in Banking Technology).
 Baseline Cyber Security and Resilience Requirements - An indicative but not
exhaustive list of requirements to be put in place by banks to achieve
baseline cyber-security/resilience is given. This may be evaluated
periodically to integrate risks that arise due to newer threats, products or
processes. To ensure adequate cyber-security preparedness among banks
on a continuous basis and to enhance the resilience of the banking system
following shall be followed but not limited to, putting in place an adaptive
incident response, management and recovery framework to deal with
adverse incidents/disruptions, preventing execution of unauthorized
software, environmental controls, network management and security,
application security life cycle, secure configuration, vendor risk
management, removable media, data leakage prevention strategy,
maintenance, monitoring, and analysis of audit logs, advanced real time
threat defense and management and user/employee/management
awareness.
 Organizational arrangements - Banks shall review the organizational
arrangements so that the security concerns are appreciated, receive
adequate attention and get escalated to appropriate levels in the hierarchy
to enable quick action.
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 Cyber-security awareness among stakeholders / Top Management / Board –

As management of the cyber risk requires the commitment of the entire
organization to create a cyber-safe environment, a high level of awareness
among staff at all levels shall be ensured. Top Management and Board shall
also have a fair degree of awareness of the fine nuances of the threats and
appropriate familiarization may be organized. Banks shall proactively
promote, among their customers, vendors, service providers and other
relevant stakeholders an understanding of the bank’s cyber resilience
objectives and ensure appropriate action to support their synchronized
implementation and testing. It is well recognized that stakeholders’ (including
customers, employees, partners and vendors) awareness about the
potential impact of cyber-attacks helps in cyber-security preparedness of
banks. Banks are required to take suitable steps in building this awareness.
RBI Cyber Security engagements for banks
6.27 Bank’s Statutory Central Auditors (SCA) were required to certify
whether the bank has attended to/not attended to/ or partially attended to (as
applicable) all the Circulars. It was advised that SCAs may assess the level of
compliance by banks in this regard through the following methodology:
 Discussion and process understanding with the bank.
 Review of notes/reports/documents submitted to various committees (Board,
Board level and Executive level) of the bank.
 Review of the audit reports – external as well as internal and their
compliance level as submitted to the Audit Committee (Board/Executive).
 Review of returns submitted by the bank to RBI (CSITE Cell, Department of
Banking Supervision (DBS)).
 List of circulars and advisories issued by RBI (CSITE Cell, DBS) to banks to
be referred for comments on the compliance including outstanding
observations and reviewing bank’s response/actions taken to the
advisories/alerts/circulars.
 Review of the organization structure for assuring the implementation of
controls or measures suggested as part of circulars/advisories/alerts.
 Reviewing third party assurance report.
 Reviewing the notes put up to Information Security Committee, ITSC
(Information Technology Sub Committee) on major issues – committee
minutes and actions.
 Review of the steps taken for assuring that controls gaps- identified, critical
or reoccurring gaps are reported to appropriate top committees and controls
are sustained.
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 Review whether bank has conducted audit of Third-party vendors

(outsourcing).
 Review the role of CISO.
 Check for the incidents reported by the bank to RBI (CSITE Cell) and its
status of closure at their end – reporting to customers, regulator, Root
Cause Analysis (RCA), Forensics etc.
 Review of the submissions made by the Bank to RBI through Risk Based
Supervision Tranche submission
Application Security
6.28 Application security mechanisms such as structural analysis, input
validation, application and user control, data transaction analysis along with
review of password policy controls, user access management, root/admin access
controls, SOD matrices, system administration and change management process
shall be taken into consideration for an application security review. It is expected
that the auditor will review the control framework as established by the bank as
part of general IT Control Testing.
Enterprise security
6.29 Policy and standards, strategy and governance framework shall be
framed as a part of enterprise security. Roles and responsibilities of the CISO,
board, head of functional departments, Technology/Operations/Admin/HR/
functional teams, business owners, senior Management, information users,
internal audit and functional technology teams along with the conduct of
information security training and awareness.
Physical and Environmental security
6.30 Secure physical access procedures shall be framed and implemented
which includes physical security, clear desk policy, cabling security, secure
disposal or re-use of equipment, security of equipment off-premises, physical
security, securing offices, room and facility, environmental controls such as mock
drills and security of the equipment off-premises.
Human resource security
6.31 Human resource security shall include defined activities, processes and
checks for the different phases - pre-employment, during employment and
termination of employment which would include background checks, terms and
conditions of employment to be agreed upon, defining the roles and
responsibilities of the personnel and management and return of assets and
removal of access rights post leaving the organization.
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Platform/ Infrastructure Security and Network Security

6.32 Secure configuration documents for operating system, web server,
application server, database server and network components shall be framed
and implemented along with a periodic review of these documents. Regular
scheduled assessments such as vulnerability scans, hardening checks and
secure configuration review shall be performed, and exception approval process
needs to be in place for exceptions in configuration.
Cryptography and Key Management
6.33 Policy on use of cryptographic controls shall be framed along with
implementation of processes around accountability for management of master
keys, security of master keys, key management process, key backup, retention
of keys and verification of digital certificates.
Aadhaar Guidelines review for banks based on AADHAAR
ACT 2016
6.34 Evaluate the applicability of the AADHAAR considering the Supreme
Court Judgment on usage of AADHAAR.
 Review of the IT Landscape based on the following applicable guidelines of
UIDAI (Unique Identification Authority of India) for AUA’s
 The Aadhaar (Targeted Delivery of Financial and Other Subsidies, Benefits
and Services) Act, 2016
 AADHAAR (Authentication) Regulations, 2016
 AADHAAR (Data Security) Regulations, 2016
 AADHAAR (Sharing of Information) Regulations, 2016
 Updated UIDAI Information Security Policy in respect of AUA (Authentication
User agency)/ KUA (KYC User Agency) for circulation
 Instruction for providing Authentication or eKYC Services by AUA KUA to
Sub-AUA
 Circular on AADHAAR Data Vault
 Procurement of Registered Devices for AADHAAR Authentication
 Registered Device Certification of Biometric Devices along with STQC
(Standardization Testing and Quality Certification) certificate
 Circular on Registered Devices (Implementation Timelines)
 Circular on AUA/KUA and ASA (Authentication Service Agency) Agreements
V 4.0
 Delta Certification process of Biometric Devices for Registered Devices
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 Implementation of HSM (Hardware-based security module) by

AUA/KUA/ASA
SWIFT review (vide RBI Press Release 2017-2018/2249)
6.35 RBI, as part of its ongoing efforts for strengthening of the supervisory
framework in the country, has been issuing necessary instructions to banks from
time to time on a variety of issues of prudential supervisory concern, including
the management of operational risks inherent in the functioning of banks. The
risks arising from the potential malicious use of the SWIFT infrastructure, created
by banks for their genuine business needs, has always been a component of
their operational risk profile. RBI had, therefore, confidentially cautioned and
alerted banks of such possible misuse, advising them to implement the
safeguards detailed in the RBI’s communications, for pre-empting such
occurrences.
6.36 In the wake of SWIFT-related fraud involving significant amount,
reported recently by Punjab National Bank, RBI has reiterated its confidential
instructions and mandated the banks to implement, within the stipulated
deadlines, the prescribed measures for strengthening the SWIFT operating
environment in banks.
SWIFT review primarily includes –
 SWIFT process-based reviews based on the RBI mandate
 Review of pre and post transmission of SWIFT messages
 Review of logging and session controls
 Review of network controls in place to support the application.
Audit Approach
6.37 This section provides description of the audit approach that will be
adopted to perform the IT audit for the applications having an impact on the
statutory financial statements of a bank and for the support applications (such as
change management tool, incident management tool, user access management
tool, ticketing tool) that aid to assist the IT processes for such financial
statements impacting applications or the overall bank security processes. During
audit planning and risk assessment stage, audit engagement teams are required
to determine the scope and extent of audit procedures for their IT audit based on
the following set of illustrative factors:
 Whether the IT application system is used in the financial statements
preparation or passing accounting entry- such as CBS, NPA (Non-
Performing Asset) module, Loan and Treasury systems etc.
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 The Auditor needs to ensure that each customer of the bank is tagged under
one single Customer ID / Unique Customer Identification Code (UCIC) in
respect of all its accounts, including those in which credit facilities are
granted, irrespective of their location, to enable the bank, (subject to the
relaxations/exceptions for the time being applicable to any account/facility),
to accord the same NPA classification status to the customer/borrower,
based on the most adverse classification determined for any of its account/
facility. The NPA classification of a group entity as such does not
automatically extend to other related / group entities, where the classification
would have to be judged based on independently, i.e., at the entity level and
not at a group level, unless there is a diversion of funds.
 Whether the IT application system directly or indirectly assists the processes
which are relevant in the preparation of financial statements or for ensuring
adequate control framework and governance over the financial statements
preparation and reporting process e.g. transaction processing systems,
Reconciliation systems etc. It is important to see to what level these
application systems are integrated / interfaced with each other.
 Whether IT application system is used for generation of reports or data
elements which will be used as audit evidence for the financial statements.
The may also include reports which are used by management for the
purpose of passing an accounting entry or for making a decision having
impact on financial statements e.g. applications systems used for
preparation of disclosures in the financial statements etc.
 IT systems not having direct impact on financial statements but necessary
for overall bank security posture of the Bank e.g. applications systems used
for compliance with RBI requirements around cyber security where auditor
also needs to provide a certificate etc.
 Any other IT application system or IT processes which the auditor believes is
relevant for the audit.
A summary of the activities that will follow are outlined in this section:
Strategic anchoring
6.38 Strategic anchoring requiring the following:
 Identify key stakeholders responsible and accountable for the Account and
preparation of financial statements / statutory audits.
 Perform interviews with process owner, stakeholders & various other
functional teams.
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 Understand the bank’s strategic goals, their competitors and identify what is
considered the major business risks within the bank.
 Walkthrough the internal and external service catalogue and map services to
strategic goals.
 Walkthrough of the operating model for different functions and validate with
leadership.
 Define capability characteristics and agree a desired target operating model.
 Understand if the current set-up is capable of achieving the desired state.
 Understand the requirements of Long Form Audit Report pertaining to IT
systems and control and take due consideration to the reporting
responsibilities
Functional review
6.39 Functional review would cover the following:
 Processes and procedures for the management and administration of the
security architecture, implementation of security solution controls in place to
protect data, network and systems against any kind of attack, the monitoring
and incident response efforts to ensure continuous compliance to security
requirements.
 Interviews will be followed by document review and sample-based testing.
 The security capability model will be used leveraging the technical security
domain to assess operating models while the detailed Control Security
methodology will be used to assess content and detailed operational
processes.
Report and Roadmap
6.40 This would require the following:
 Define findings to close the identified gaps by -
o Reviewing current capabilities and desired operating model
o Following factors need to be considered when assessing the risk of
failure:
 Nature and materiality of the misstatements which the control is
designed to prevent or detect;
 Inherent risk of error associated with relevant significant account
and assertions addressed by the control;
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 Competence of the personnel who perform the control or monitor

its performance and whether there have been changes in the
personnel;
 Nature of the control and frequency with which it operates;
 Whether the related significant account has a history of errors;
 Degree to which the control relies on the effectiveness of other
controls.
o Hold workshops with key stakeholders identified in the earlier phases
to:
 Walkthrough the findings ensuring input and insights from within
the bank;
 Validate results and incorporate insights.
 Basis of the risk of the identified gaps e.g.- low risk finding (control failed to
discover an error, the amount of the error is likely to be only a portion of the
total amount of the transaction being controlled) or a high risk finding
(control failed to detect or prevent an error, there is a greater likelihood that
the amount of the error could be the total transaction amount, or, in case of
the completeness assertion, greater than the transaction amount), adequate
impact analysis will be performed.
Reporting
Long Form Audit Report (LFAR)
6.41 Given below is the general flow and critical sections covered as a part
of the Long Form Audit Report as amended on September 5, 2020 under “Long
Form Audit Report (LFAR) – Review”
 Asset Quality: Special emphasis should be given on continuous monitoring
of classification of accounts into Standard, SMA, Sub-standard, Doubtful or
loss as per IRAC Norms by the system, preferably without manual
intervention, correct recognition of income, and adequacy of provision
thereof. Effectiveness of the system for compiling data relating to NPA and
their provision, data integrity, system of suspension of charging of interest
and adherence thereto, should be examined and commented upon.
Deviations observed, if any, should be provided along with requisite
examples.
 Management Information System: Review of Management Information
System for existence and adequacy, method of compilation and accuracy of
information, appropriateness of procedures for preparation of supervisory
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returns and its reliability under the Off Site Surveillance System of the RBI,
reliability of information flow for the internal risk management system.
Moreover, review of effective system of preparation and consolidation of
branch returns and financial statements.
 Robustness of IT Systems: Auditors should comment on the robustness of
IT systems covering all the software used by the bank along with functions
thereof, inter-linkage/interface between different IT Systems, ATM network
and its security, payment system products and services among others.
Further, it should be examined whether the software used by the bank were
subjected to Information System & Security Audit, Application function
testing and any other audit mandated by RBI. Adequacy of IS Audit,
migration audit (as and where applicable) and any other audit relating to IT
and cyber security system and bank’s compliance to the findings of those
audits should be commented upon.
 IT Security and IS Policy: The Auditors should comment whether the bank
has duly updated and approved IT Security and IS Policy and whether the
bank has complied with the RBI advisory/directives relating to IS
environment/cyber security, issued from time-to-time.
 Critical Systems / Processes: It should be examined whether there is an
effective system of inter-linkage including seamless flow of data under
Straight Through Process (STP) amongst various software / packages
deployed. Special emphasis should be placed on outsourced activities and
bank’s control over them, including bank’s own internal policy for outsourced
activities.
In addition to above, Point No. iii of Guiding Principles on objective, strategy,
scope and coverage of LFAR for branch auditors under LFAR to Management
and Statutory Central Auditors by Bank Branch auditors in case of bank
branches provides that “Verification of data integrity and data related control
systems and processes should be carried out and commented upon, with the
special thrust on those data inputs which are to be used for MIS at corporate
office level and for supervisory reporting purposes.”
Outsourcing
6.42 Technology Outsourcing framework of the bank should be documented
which must include IT related outsourcing process. This process should be
formulated after considering all the guidance and circulars issued by regulatory
authorities such as RBI. For instance Circular No. RBI/2010-11/494
DBS.CO.ITC.BC.No.6/31.02.008/2010-11 dated 29 April 2011 on “Working
Group on Information Security, Electronic Banking, Technology Risk
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Management and Cyber Frauds- Implementation of recommendations”. Key

areas to be covered as per the framework are (but not limited to):
 Broad category of IT activities outsourced by the Bank
 Governance structure for IT Outsourcing e.g. role of the Board and IT
Steering Committee
 Audit coverage and annual compliance certificate
 Assessment of outsourced IT activities i.e. materiality, risks & controls and
data sensitivity assessments
 Periodic review of service providers
 Business continuity and agreement covering legal obligations
 Verify the restrictions pertaining to outsourcing of activities as stipulated by
RBI from time to time.
Other aspects
Digital banking - Key considerations
6.43 The Auditor’s key considerations on digital banking are the following:
 Digital Banking has completely changed the way banks function in today’s
times. With Digital Banking, the customer can transact with higher speed,
ease and convenience. By definition, digital banking is banking done through
the digital platform, doing away with all the paperwork like cheques, pay-in
slips, Demand Drafts, and so on. It means availability of all banking activities
online. The first phase of the Digital Banking revolution was through the
internet. The second phase of Digital Banking involves mobile phone
platforms. After smartphones came into the market, Digital Banking has
taken off in a big way.
 Bank offers various services such as Internet banking, Mobile banking,
Credit Card/Debit Card, IMPS, RTGS, NEFT, ATM, Aadhaar based payment
and Prepaid Instruments. Digital banking involves high levels of process
automation, web-based services and may include APIs enabling cross
institutional services, use of payment gateway. Seamless flow of transaction
within fraction of second supported by integration of various applications is
possible only with the help of third-party service providers.
6.44 The Auditor should get an understanding of the following:
1. List of digital products offered by banks
2. Involvement of third-party service providers, NPCI, VISA, Master,
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aggregator, payment gateways, debit card/ credit card manufacturing

company
3. Flow of transactions of each product
4. Security of transaction flow, data confidentiality
5. Customer on-boarding process, authentication and OTP generation
6. Daily reports generated from bank’s own system and received from vendors
7. The Bank’s mechanism of monitoring vendors
8. RBI guidelines on digital products and for third party service providers.
6.45 The dependence of banks on third party service providers may expose
bank’s data in public domain and cyber risks. At the same time, data entered in
CBS for digital mode transactions are also generated from third party service
providers system. In this case Bank needs to have strong mechanism to verify
internal controls and cyber security controls at service providers.
6.46 Though the bank is providing services through digital mode that cannot
absolve it from regulatory compliance such as KYC, Anti Money Laundering
(AML) and Combating the financing of terrorism (CFT). The bank shall file
suspicious transactions report (STR) with Financial Intelligence unit (FIU-IND) for
mobile banking and internet banking transactions.
6.47 Customer Protection rights are also applicable to mobile and internet
banking services. Liability arising out of cyber events, insuring events from third
party should be considered while executing agreement between the payee and
payee’s bank, the participating banks and service provider.
(i) Role of NPCI in Digital Payment
6.48 NPCI provides National Financial Switch (NFS) platforms to route all
transactions. NFS is a shared ATM network that interconnects NFS members
and ATM switches. It also supports card plus PIN transactions on Micro ATMs.
NPCI provides services such as networking of ATMs, switching of ATM
transactions and settlement of transactions and charges. In return of such
services, card issuing banks pay transaction fees to NPCI and interchange fees
to card acquiring members.
(ii) Settlement process
6.49 NPCI maintains settlement account for all members participating in NFS
network. This account is the current account / RTGS settlement account
maintained by all members with RBI through which the inter-bank transactions
are routed in the day-to-day banking activity. NPCI carries out settlement
pertaining to NFS transactions and send daily reports to all member banks for
reconciliation and adjustments for discrepant transactions.
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In this context, the Auditor should examine control over:

 Settlement accounts, suspense or office accounts maintained for such
transactions,
 Daily reconciliation process, three-way matching of data from ATM switch
files, CBS files and NFS files,
 Chargeback, dispute resolution procedure.
(iii) Third party service provider
6.50 As already mentioned, Banks are heavily dependent upon third party
application service providers for shared services such as
 ATM switch applications,
 Credit/ debit card printing and issuance,
 ATM switch monitoring, Uptime monitoring,
 ATM daily reconciliation.
6.51 These service providers have exposure to the payment system
landscape and therefore, they become exposed to the associated cyber threats.
Hence, the agreement between banks and third-party application service
providers should cover necessary cyber security controls. In case of outsourcing
of digital payment transaction processing and reconciliation, then income and
expenses recordings are also based on the reports submitted by third party
vendors. In this situation, internal controls at service providers locations is
important. At the same time, Bank’s verification mechanism of vendor supplied
reports and control over suspense, sundry deposits accounts are critical.
6.52 The Auditor should consider:
 Bank’s mechanism of monitoring service providers
 Audit reports (Internal and External) to check compliance with relevant
controls
 Third party service provider’s compliance with relevant standards- PCI
DSS, ISO 27001, PA-DSS
 Confirmation on various RBI requirements
 Third Party assurance report
Consumer identity and access management
6.53 As organizations conduct more business online, they need to provide
customers with a personalized experience. This means recognizing, storing and
utilizing customer information. With consumer Identity & Access Management
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(IAM), people are associated with information, facilitating rich digital relationships
between providers and consumers.
6.54 Important aspects of Consumer IAM:
 Promoting access to products and services.
 'Know Your Customer', personalization, preferences and privacy (consent).
 Customer experience and ease of use.
 Access anywhere, anytime, on any device.
 Omni-channel relationships including real-world and digital services.
 Advanced authentication including multifactor, biometrics and behavioral.
6.55 Consumer IAM provides a platform that leverages identity information to
enhance a customers’ experience, while building loyalty, trust and business. This
platform must be agile and able to continuously adapt to changes in consumer
expectations – and risks – while supporting new capabilities such as adaptive
authentication.
6.56 By associating multi-sourced data about a customer with a digital
identity – often aided by data analytics – organizations can mirror the sort of
customer insight they enjoy in the physical world. In return, they can delight
customers with contextually relevant services, offers and personalization, and
even how an individual’s landing page is populated. Because the experience is
consistent across all channels, your systems can add value anywhere, anytime,
from any device.
6.57 Review of controls around, but not limited to privacy, customer
identification programs (CIP), information security and access management,
Know Your Customer (KYC), segregation of duties, role/attribute-based controls,
access governance, privileged access and data access governance shall be
conducted for evaluation of this area.
RPA (Robotics Process Automation) Assessment
6.58 RPA is the simplest form of digital labour. Its significance is that it
enables data to be collected, analyzed or calculated at a speed and scale far
greater than a human or team of humans could manage. RPA has enormous
implications for the audit and is already bringing huge benefits.
6.59 In the analogue world where accounting was done with manual tools
like physical ledgers, the auditor would validate processes and transactions
using statistically valid sampling or similar techniques. In today's digital world,
where data is proliferating across digital networks and systems, we are bringing
new capabilities to mine the mountain of data to identify audit risk, highlight
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anomalies and outliers, and perform further analysis. Already, new technology is
dramatically enhancing the analytical power of our audits. Using RPA, we can
analyze 100% of certain datasets through various audit lenses. This means that
we can quickly identify the outliers that need further examination. Areas such as
audit confirmations, reconciliations, generation of emails, automated emails, both
internally and with the organization's data, can all be facilitated with RPA.
6.60 A key use of RPA is to gather audit evidence by collecting information
where there is data in different organizations' systems that are not integrated.
This information can then be subjected to data analytics to inform the auditor to
enhance risk assessment procedures or provide audit evidence. RPA is not in
itself 'intelligent' but is a vital part of the process of gathering information that can
then be intelligently analyzed. RPA helps with collecting data, combining data
from different sources and applying a basic order to the data. The auditor may
consider SA 620, “Using the Work of an Auditor’s Expert” to arrive at necessary
comfort in this regard.
6.61 It is to be seen how RPA is having an impact on the transaction
capturing and processing level including its impact on accounting.
6.62 Review of following controls shall be covered to evaluate the
effectiveness of controls in this domain –
 Entity Level controls
o RPA program governance and assurance
o RPA policies and procedures
o RPA ownership and responsibilities
 Technology risk controls
o Bot access management
o Bot process changes management
o Bot logging and monitoring
 Bot logic and functionality
o Security by design
o Privacy by design
o Algorithm and logic review
o Secure code review
o Vulnerability assessment
o Bot process documentation and user stories
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Blockchain
6.63 In the current digital era, businesses across the world are running
transactions of humongous volumes. Blockchain technology is a step towards
modernization of digital infrastructure and allows the reorganization of data and
assets. Blockchain solutions across industries are helping to solve complex
problems with the use of its platform and technology qualities, yet it remains a
question whether we are ready to handle the risks that these solutions can bring
in. Traditional models of audit fail to take into consideration many of the risks
associated with block chain-enabled processes, and hence there is a need to
understand the specific set of risks and develop an evolved auditing approach for
blockchain based solutions.
6.64 Auditing block chain solutions have been developed keeping in mind
specific risks that block chain models entail. Following are the key areas which
can be covered as part of the audit:
 Interoperability and integration - Consistent communication between multiple
blockchain platforms and integration with organizations' enterprise and
legacy systems.
 Consensus mechanism - Blocks in the chain are validated by nodes to
maintain a single version of the truth to keep adversaries from derailing the
system and forking the chain.
 Heterogeneous regulatory compliance - Compliance with laws and
regulations across various country and state legislations that will govern
information and transactions processed.
 Key Ownership and management - Secure storage, maintenance, review
and governance of cryptographic private keys used for authentication and
validation by nodes.
 Network and nodes governance - Monitoring of network for information
compliance and node reputation checks to handle and resolve disputes.
 Infrastructure and application management - Secure software development
practices and testing of blockchain applications, platform, infrastructure and
communication interfaces.
 Access and permissions management - Permissions configured for defined
roles for access, validation and authorization of blockchain transactions by
internal and external participants.
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Information Technology related frauds in banks

6.65 Banking sector has grown by leaps and bounds during the last few
years, and this has also increased the need for more governance, accountability
and transparency. The pace of changes puts great challenges for banks to
grapple with multiple fraud related challenges, and to develop comprehensive
fraud risk management controls that will help in prevention as well as detection of
fraud as soon as they occur. E-banking, internet banking and internet fraud are
the top fraud risks that are currently posing highest concern for the banks.
Types of frauds possible in banks

6.66 Some of the possible frauds in banks are enumerated in the following
paragraphs:
 Frauds in banks – Cash lending during working hours, Missing notes in

bundles, use of same note bundles by two branches, Posting in wrong
accounts, Misuse of sensitive stationery, etc. These frauds are committed by
Bank’s Staff.
 Frauds on banks – Includes Technology related frauds, Deposit related
frauds, and Advances portfolio frauds.
6.67 Technology related frauds - The fraudsters employ hostile software
programs or malware attacks, phishing (mails), vishing (voice-mail), Smishing
(Text messages), whaling (Targeted phishing on high net worth individuals),
Card duplication Techniques apart from stealing confidential data to perpetrate
Frauds.
6.68 Deposit related frauds - Lack of compliance with KYC Guidelines,
misuse of inoperative accounts, Non-reconciliation of Suspense and Sundry
accounts and lack of control over transactions, in these accounts, result in
frauds.
6.69 Advances portfolio frauds - Majority of credit related frauds are on

account of deficient appraisal system, poor post- disbursement supervision and
inadequate follow-up. Most of the frauds relating to advances come to light only
during the recovery process initiated after the accounts have been classified as
NPA. Fabricated/fudged Financial Statements, inflated security valuation report,
defective search report for title deeds of mortgaged property are commonly
discovered.
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Fraud risks involving Digital Banking

6.70 Information Technology (IT) plays a significant role in the development
of Digital banking to make the banking operations fast, effective and efficient.
Use of IT in banking system made banking more customer oriented, quality
driven and easy to use by both bank and customer. Various initiatives have been
taken by the banks to converge themselves from their traditional banking to
Digital banking. The initiatives by the banks are as follows:
 Core Banking Systems (CBS)
 Digital Payment System
 Credit / Debit Cards
 ATMs/ POS Terminals/CDMs
 Internet Banking like NEFT/RTGS
 Mobile Banking
 Branchless Banking
 Digital Wallet
6.71 The following are the most common ways in which exploitation of IT is
being done on the most popular initiatives:
 Fraud Risk on CBS: When the letter of understanding (LOU) is issued,
message for the credit transfer is conveyed to the overseas banks through
SWIFT (Society for Worldwide Interbank Financial Telecommunication)
system by the sending bank and this message through SWIFT is termed as
sending bank’s consent and guarantee to the overseas bank. The sending
bank official must log into its CBS system to route the transaction on
SWIFT. fraud on CBS occurs when SWIFT is not integrated with CBS and a
perpetrator can easily send LOUs to overseas bank simply bypassing the
CBS.
 Fraud Risk on Digital Payment System: Digital payment system spread
across globe due to its scalability and acceptability by all class of users.
Handling of account by a user either through online or through mobile is
increasing day by day and hence they are the common target for the
perpetrator. The perpetrator may deploy different techniques to make fraud
happen.
Some techniques are explained as follows:
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Phishing: The Perpetrator sends emails to lure users, that he has won the
lottery, or some money needs to be deposited in his account and then
requesting user to provide the details of his bank account.
Device Compromise: Device through which the bank customer is
operating his account either through online or through mobile usually prone
to be compromised by the perpetrator for execution of the fraud.
Compromising the Operating system of the smart phone or any other status
change like firewall setting etc. may lead to fraud.
Man in the Middle Attack: The perpetrator, in this case by altering the
communication between the two legitimate parties executes the fraud. The
legitimate parties think that they are communicating with one another but in
real scenario their communication is received and altered by the
perpetrator.
Spoofing Attack: This attack is used to disguise the user by sending
fraudulent communication from the fraud site as legitimate site. For
example, instead of sbionline.com perpetrator may use sblonline.com for
the user and force the user to enter the credentials in the fraudulent site.
APT Attacks: Advance persistence threat used for the infiltration of

credentials of the customers of a bank. The perpetrator generally used
botnets (malicious software) to infect the computers in the bank network for
the infiltration of the credentials.
Location Manipulation: The perpetrator generally manipulates the actual

location of the device for the outstation account fraud.
 Credit / Debit Cards: There are two types of Credit / Debit Cards frauds as
detailed below:
Card physically Not Present Fraud: This type of Credit / Debit Cards
fraud prepared by the perpetrator by sending phishing emails to the card
holder and lure him to enter the card information in the email or disguised
portal directed by the link in the email. When all the information is available
related to the Credit / Debit Card the perpetrator uses the information to do
illegal transaction online without having the physical possession of the card.
Card physically present Fraud: This type of Credit / Debit Cards fraud is
executed by the perpetrator by using some device either at swiping
machine at sales counter or parallel reader in an ATM machine. Skimming
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money from the Credit / Debit card in the later stages would follow the
departure of the Credit / Debit Card holder from the said venue.
 Internet Banking Fraud: Internet banking used by the bank customer to do

the transaction to purchase from the E-Commerce websites, transfer the
money from his account to other accounts, to submit the EMI for loans to
the lending banks, instalments of PPF, RD etc. Bank customer logs into the
bank portal by providing the credentials to open his account page. The
perpetrator tries to crack the credentials of the users by different tricks
which are explained as follows:
Social Engineering: The perpetrator projects himself to be the person

which he is not, to get the credentials of the user. He exploits the emotions
and traits of the human like fear, greed, curiosity etc. as his tools to force
the user to disclose his credentials.
Shoulder Surfing: Shoulder surfing happens when a perpetrator tries to
look over other person in the hope to see his credentials at the time when
the said person is about to place his credentials in the bank portal. Once
the perpetrator is able to see the credentials, he will use the same to divert
the money from the user account.
Key Logger: Key logger is surveillance software installed by the
perpetrator in such a way that every keystroke by the user (including
credentials) in his computer is captured in an encrypted file. The perpetrator
using other means collects this file and figures out the credentials in the
long text.
Spoofing Attack: As discussed above this is used to obtain the credentials
of the user.
APT Attacks: As explained above, advance persistence threat is used for
the infiltration of the credentials of the customers of a bank.
6.72 These are the most common frauds that occur in Digital banking,
although banks are taking considerable and continuous efforts to arrest such
fraudulent activities by putting proper controls, customers trainings and sending
alerts but it is also the responsibility of the customer to follow the guidelines
issued by the bank from time to time. However an auditor is expected to review
the Fraud Reporting and Monitoring mechanism within the bank and adequacy of
provision / penalties / compensations.
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Key Take Aways

1. As technology is fast moving the Auditor needs to show resilience and adapt
the technology and its impact on the auditee.
2. Map the technology with any of the financial monitoring mechanisms of the
bank
3. Data integrity is a crux in any IT platform
4. When technology can be good, it creates numerous challenges for the
auditor in the risk assessment of the auditee. [The Auditor should do this risk
assessment basis the risk monitoring framework of the Bank, internal audit
coverage on the IT and Network security of the Bank, system auditors’
comments, Bank’s business needs and objectives]
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7
Human Resources Department
7.01 Human Resources (HR) Department is one of the most important
departments of a Bank. It plays vital roles including the drawing up HR policy for
the Bank and getting it vetted by the Management.
7.02 The HR policy would normally cover the following aspects:
1) Organizational and functional structure and chart including reporting
obligations.
2) Background checks – pre-employment medical checks – fixing turnaround
times for various activities related to recruitment.
3) Interviews, Selection and Recruitment processes.
4) Issuing Appointment Letters – fixing job roles, responsibilities and
designations.
5) Induction, awareness, sensitization and training.
6) Salary Fixation, structure and payment, TDS calculations, deductions and
payment, Issuance of Form 16, Salary slips, Profession tax payments,
fixing perks and privileges including insurance entitlements.
7) Provident Fund recoveries and contributions.
8) Grant of staff Loans and Advances, interest rates thereon and recovery
from salary.
9) Banking Holidays, Leave and attendance record management.
10) Performance appraisal process, transfers and promotions.
11) Skill set gap assessment and development.
12) Succession planning.
13) Disciplinary mechanism in case of any wrongdoings including issuance of
warnings and show cause notices.
14) Complaint Resolution.
15) Conflicts of interest and bribery.
16) Investigation mechanism for determining staff accountability in case of
frauds.
17) Handling employee retirements, resignations, retrenchments, terminations.

18) Full and Final settlements, Exit interviews.
19) Handling deviations from policy and ratifications, escalations thereof.
20) MIS – generation, circulation list and frequency.
7.03 HR department will also be responsible for the following for which there
might be specific policies:
a) Code of Conduct and Ethics
b) Dispute resolution mechanism
c) Whistle blower policy and hotlines
d) Prevention of Sexual Harassment Policy
7.04 Each Bank may have its own organization structure. While the policy
framing, sign off and periodical reviews would happen centrally, monitoring and
implementation could be decentralized at the Zonal, Regional or Cluster level as
the case may be, which will also depend on the size of the Bank in terms of
number of employees, branches and geographical spread.
7.05 HR department is generally headed by a Chief Human Resource Officer
who would also be designated separately. He could be assisted by functional
experts who would be individually and separately responsible for:
1) Recruitment
2) Training
3) Payment
4) Compliance
7.06 Each of these functional heads would have individual teams centrally
and at zonal, regional or cluster levels. This may vary from Bank to Bank. These
functional heads would be responsible for executing and enforcing various
activities as stated in the bank’s HR policy.
7.07 The Auditor will have to ensure that:
1) There is a comprehensive HR policy in place encompassing in detail all the
issues mentioned above. Such policy is periodically updated, reviewed and
signed-off.
2) The policy is not in violation of existing applicable laws especially labour
laws.
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3) The policy has been adhered to and this is monitored / validated

independently either internally by a distinct HR team or by internal audit or
internal audit conduct by external professionals.
4) Parameters are set to generate Exception reports to capture deviations.
These Exception Reports are generated, monitored and reviewed for
closure / resolution at defined intervals normally daily.
5) Any deviation or non-adherence to the policy should be appropriately
approved, addressed and closed. Ageing of open deviations is duly
monitored. Classification of deviations is done risk wise into ‘High’,
‘Medium’ and ‘Low’ categories as per pre-defined classification norms. High
risk deviations are stringently monitored for closure and open items duly
escalated.
6) Proper documentation is in place, stored and retained.
7) Tax calculations are done as per current tax laws, salary payments are in
adherence to labour laws and internal policy, issuance of appropriate tax
forms – Loan recoveries, interest charge, etc., are in order.
8) Process of Appointment – Induction – Performance and appraisal reviews,
Trainings, Complaints etc., are in order.
9) Impact on account of cash outflow is accrued / reflected in appropriate
heads.
10) Ensure strict adherence to the Code of Ethics, Whistle Blower Policy and
Prevention of Sexual Harassment Policy.
11) Actuarial valuation of Gratuity, Leave Encashment (generally obtained by
HR) has been duly obtained on record and the assumptions considered are
reasonable. The Auditor should also verify whether the salary and
employee data provided to the actuary are consistent with the data
maintained by the Bank.
12) Where payroll processing is done through a specialised software, whether
adequate IT controls are in place to ensure correctness of data input,
validations, processing, output and appropriate accounting thereof in the
accounting system of the Bank.
13) In case the HR aspect is subjected in internal or other audits, the Auditor
would have to peruse the reports of such audits to identify any audit issues
already flagged off.
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7.08 While most of the issues stated above will not have a direct quantitative
impact, indirectly they make a big impact on the employee motivation,
engagement, performance and productivity and hence, it is imperative that the
Auditor reviews the process end to end. Any issues noted therein should be
appropriately discussed for resolution and necessary reporting should be made
in the LFAR.
7.09 Profit per employee / Business per employee figures needs to be stated
in the Notes to Accounts by Banks. The Employee number and the methodology
for allotting this number will have to be certified by the HR department.
7.10 In September 2020, the Code on Social Security, 2020 was passed by
the Parliament. Though the effective date has not yet been notified, the Auditor
would want to comment in the LFAR on the adequacy of the process followed by
the Bank to quantify the impact of the said enactment on the overall employee
cost of the Bank.
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8
Large Corporate and Loan
Syndication
Introduction
8.01 All corporates require large of funds by way of debt and equity for timely
financial closure of their projects. Loan syndication most often occurs when a
borrower requires an amount too large for a single lender to provide or when the
loan is outside the scope of a lender's risk-exposure levels. Thus, multiple
lenders form a syndicate to provide the borrower with the requested capital. The
Bank which spearheads the process is called the “lead bank””. The lead Bank
carries out most of the due diligence. The Lead Bank in most of the cases is
responsible for the initial transaction, fees, documentation, compliance reports
and repayments throughout the duration of the loan, loan monitoring, and overall
reporting for all lending parties. Hence, the lead bank has more responsibility as
compared to other members of the syndication. Any laxity in any stage of the
loan i.e. Sanctioning, Documentation, Disbursement, Monitoring by lead bank
may increase the risk associated with the borrower for all syndicate members.
Normally in Loan Syndication one agreement is entered between all members of
the syndicate and the borrower. Though the lead banker is the single point for
correspondence, other Banks / lenders have the right in proportion to their share
in loan. The Lead Bank charges fees for the syndication arrangement which are
normally higher than the normal loan processing fees.
8.02 The Auditor of the lead bank in the case of Loan Syndication should
verify:
 Whether the bank has Board approved policy for business of Loan
syndication. Whether this policy has been updated & reviewed annually.
 Whether the Bank has processes in place for loan syndication business.
 Whether the bank has underwritten any loan which it has syndicated; if yes
whether the same has been considered as Contingent Liability.
 Whether the bank has collected fees in all cases of syndication.
 Whether Loan Syndication Department is adequately staffed having
different skill sets as required to carry out due diligence.
 Whether the bank has passed on the relevant information promptly to other
Banks.
 Whether meetings with all banks in the syndicate are held as per schedule
and the minutes of the meeting are timely and properly prepared and
circulated.
 Whether issues raised by member banks are replied in time and
satisfactorily.
 Whether the correspondences are duly filed in order.
8.03 The Auditor of other banks (Member banks) should verify the following:
 Whether the bank has a Board approved policy for participation in a
syndicate. Whether this policy has been updated and reviewed annually.
 Whether the bank has carried out its own due diligence on information
provided by the Lead Bank and raised queries, if any to the Lead Bank and
whether the same are resolved satisfactorily.
 Whether share of the bank is clearly mentioned in correspondence with
Lead bank and other syndicate members.
 Whether the bank has put in place for loan system for Delivery of Bank
Credit.
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9
Micro, Small and Medium
Enterprises Department
Introduction
9.01 Advances to the MSME Sector are categorised as Priority Sector
Advances as per existing guidelines issued by RBI. The target for the MSME
Sector advances is 7.5% of ANBC or credit equivalent amount of “Off Balance
Sheet exposure”, whichever is higher.
9.02 The categorisation of MSME was based on the limits of investment in
plant and machinery and equipment till 30th June, 2020, vide Notification
S.O.1642(E) dated September 9, 2006, as under:
Manufacturing Investment in Plant & Machinery
Sector Enterprises
Micro Enterprises Does not exceed twenty five lakh rupees
Small Enterprises More than twenty five lakh rupees but does not exceed
five crore rupees
Medium Enterprises More than five crore rupees but does not exceed ten
crore rupees
Service Sector Investment in Equipment
Enterprises
Micro Enterprises Does not exceed ten lakh rupees
Small Enterprises More than ten lakh rupees but does not exceed two crore
rupees
Medium Enterprises More than two crore rupees but does not exceed five
crore rupees
9.03 Considering that the Micro, Small and Medium Enterprises [MSME]
sector is a significant contributor towards building up of a strong and stable
national economy and considering that the present thresholds in MSME definition
has created an apprehension among MSMEs of graduating out of the benefits of
MSME and dampens the urge to grow, the Government of India vide notification
No: S.O. 2119(E) dated 26.06.2020 published in the Gazette of India,
Extraordinary, Part II, Section 3 Sub-Section (ii), has changed the definition
criteria of MSME as under:
Sector Definition
A Micro Enterprises Investment in Plant & Machinery or
Equipment does not exceed one crore
rupees and annual turnover does not
exceed five crores rupees.
B Small Enterprises Investment in Plant and Machinery or
Equipment does not exceed ten crore
exceed fifty crore rupees.
C Medium Enterprises Investment in Plant and Machinery or
Equipment does not exceed fifty crore
exceed two hundred and fifty crore rupees.
9.04 The revised definition as above is effective from 1st July, 2020. All
existing enterprises and new enterprises are required to register by filing a
memorandum known as “Udyam Registration” in the Udyam Registration Portal
based on self declaration. Composite criterion of investment and turnover shall
apply for classification of an enterprise as micro, small or medium. If an
enterprise crosses the ceiling limits specified for its present category in either of
the two criteria of investment or turnover, it will cease to exist in that category
and be placed in the next higher category but no enterprise shall be placed in the
lower category unless it goes below the ceiling limits specified for its present
category in both the criteria of investment as well as turnover.
9.05 All units with Goods and Services Tax Identification Number (GSTIN)
listed against the same Permanent Account Number (PAN) shall be collectively
treated as one enterprise and the turnover and investment figures for all of such
entities shall be seen together and only the aggregate values will be considered
for categorizing units into micro, small or medium enterprise.
9.06 The calculation of investment in plant and machinery or equipment and
turnover will be linked to the Income Tax Return (ITR) and GST Returns of the
previous years with certain conditions.
9.07 RBI has issued circular on MSME Sector – Restructuring of Advances –
vide RBI Circular No. RBI/2018-19/100 DBR.No.BP.BC.18/ 21.04.048/ 2018-19
dated January 1, 2019 on “Micro, Small and Medium Enterprises (MSME) sector
– Restructuring of Advances”. One time relaxation given for Restructuring of
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MSME Standard Accounts without downgrading, subject to compliance of the

1. Aggregate exposure (Fund Based/Non-Fund Based) of banks and NBFCs
should not exceed Rs. 25 Crores as on 01.01.2019.
2. Borrower account should be a Standard Asset as on 01.01.2019 and till the
date of implementation of the restructuring.
3. Borrower entity should be registered under GST on the date of
implementation of restructuring, unless exempted.
4. Restructuring of borrower accounts to be implemented on or before
31.03.2020 subject to fulfilment of certain conditions.
5. Additional provision of 5% to be made and retained till the end of specified
period or account demonstrating satisfactory performance.
6. Post restructuring, usual NPA norms to be applied.
7. Disclosure in Notes to Accounts required for MSME Restructured Accounts
specifying the number of accounts and the amount.
8. If restructured account is downgraded as NPA as per IRAC norms, the same
would be eligible for upgradation only if it demonstrates satisfactory
performance (Not overdue for more than 30 days) during the specified
period (1 year).
9.08 RBI has subsequently vide Notification dated February 11, 2020
extended the period for OTR relief to the MSME borrowers subject to the
a. Aggregate exposure (Fund based/Non Fund based) of all banks/ NBFC`s
should not have exceeded Rs. 25 Crs as on 01.01.2020.
b. The borrower account should have been Standard as on 01.01.2020 till the
date of restructuring.
c. The borrower should have been registered with GST. This condition is not
applicable to those entities which are exempt from registration under GST.
d. Restructuring should have been implemented on or before 31.12.2020.
Also those borrowers who have availed relief under the Notification dated
01.01.2019 are ineligible to claim relief under the Notification dated 11.02.2020.
9.09 Banks have to create 5% additional provision in respect of accounts
restructured in MSME OTR. Banks are required to put in place a Board approved
policy on restructuring of such advances including viability assessment. Many
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times it is observed that in their eagerness to restructure an account bank may

even restructure a non-viable unit. Hence special attention is to be paid to the
application of Board approved policy while restructuring of accounts.
9.10 The requirement of additional provision can be withdrawn only on
satisfactory performance during specified period, that is there should be no
payment which remains overdue for a period of more than 30 days or in case of
OCC/ OD account the outstanding in the account shall not be more than
sanctioned limit/ DP whichever is lower for more than 30 days for a period of 1
year from the commencement of the first payment of interest/ principal whichever
is later
9.11 It must be ensured that the borrower meets the definition of MSME
under MSMED Act 2006 (as amended w.e.f.1st July 2020) and may not be
required to obtain MSME Certificate to qualify for the scheme. In case of any
doubt the Auditor should insist of CA Certificate that the borrower meets the
definition of MSME under the Act. Additional disclosure is required to be made of
the number and value of restructured accounts under this scheme.
9.12 RBI has subsequently vide Notification dated August 06, 2020 extended
the period for OTR relief to the MSME borrowers subject to the following
conditions:
a. Aggregate exposure (Fund based/Non Fund based) of all banks/ NBFC`s
should not have exceeded Rs. 25 Crs as on 01.03.2020.
b. The borrower account should have been ‘Standard’ as on 01.03.2020 till
the date of restructuring.
c. Restructuring should have been implemented on or before 31.03.2021.
d. The borrower should have been registered with GST. This condition is not
applicable to those entities which are exempt from registration under GST.
e. Asset classification of borrowers classified as standard may be retained as
such, whereas the accounts which may have slipped into NPA category
between March 2, 2020 and date of implementation may be upgraded as
‘standard asset’, as on the date of implementation of the restructuring plan.
The asset classification benefit will be available only if the restructuring is
done in terms of the provisions of this circular.
f. Banks have to create 5% additional provision in respect of accounts
restructured in MSME OTR.
9.13 Also refer Circular No. 170/2020-21 dated June 24, 2020 issued by the
Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE)
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regarding “Distressed Assets Fund - Subordinate Debt for Stressed MSMEs”

scheme. As the credit facilities extended under the above scheme are backed by
a guarantee from CGTMSE, as a special dispensation, RBI vide its circular
RBI/2020-21/09 DoR.BP.BC.No.01/21.04.048/2020-21 dated July1, 2020 has
decided to permit the banks to reckon the funds infused by the promoters in their
MSME units through loans availed under the captioned scheme as equity/quasi
equity from the promoters for debt-equity computation.
9.14 Obtain the revised, updated MSME policy of the bank. Discuss the
process of collecting information from MSME customers and record the same in
Account Master of CBS. How is this process internally validated?
Conduct / Execution
9.15 Verify whether the process for identification of MSME account has been
followed at branches / Controlling offices / CBS:
 Check the internal controls for recognition of MSME accounts and eligible
MSME accounts for OTR.
 Check the controls for ensuring that once OTR is extended under 1st
January, 2019 Circular the same account is not eligible for OTR relief under
11th February, 2020 circular of RBI.
 Check 2% interest subvention to all GST registered MSME Accounts.
 Check for restructured MSME accounts additional 5% provision (over and
above provisions already held) is made at reporting date.
 Check for restructured MSME accounts disclosure required in financial
statements for the number of accounts restructured and the amount.
 What is the process for arriving at deviations and correction of the same, if
any.
9.16 Based on audit issue appropriate certificate, report on compliance for
MSME Advances in the Long Form Audit Report. Check whether appropriate
disclosures are being made in the notes to accounts in the financial statements.
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10
Rural and Agricultural Business
Department
Introduction
10.01 The Rural & Agricultural business department focuses on lending under
agriculture. The Department function revolves around Supervision, Policy &
Strategy formulation for lending under priority sector with a focus of agriculture
and other government schemes relating to farmers and weaker sections.
10.02 The Department is generally responsible for allocation, monitoring &
compliances relating to priority or agricultural business across various sectors/
subsectors.
10.03 This Department is also responsible to keep abreast with RBI
regulations with regard to Rural and Agricultural advances and to frame
guidelines within the frame work of RBI regulations and to issue internal circulars
to the branches, Regional/Zonal/Circle offices of the bank and also monitor
implementation of the same.
10.04 This Department also interacts and liaise with other agencies like
NABARD, SLBCs, and local government authorities in the implementation of the
schemes and reliefs.
10.05 This Department also maintains Day books for incurring administrative
expenses relating to the functions of the department.
Audit Approach
1 Comparative Statement I) Prepare a comparative chart of expenses as
per Profit & Loss Account of current year &
previous year and check in depth wherever
variance is much higher than last year.
Variance needs to be addressed.
II) Verify to see that all records are upto date.
2 Expenses & Provisions Verification of Expenses and Provisions made
Verification thereof.
3 Scrutiny of Office Verification of Office accounts - Scrutinizing
Accounts Long Outstanding entries in office accounts.
4 Closure of Previous Ensure adherence to the previous audit points,

Auditor's Report and MOC effects have been given.
5 Verification of Interest Verification of Interest Subvention process -
Subvention process Submission to RBI, Booking in Finacle,
Receipts from RBI and distribution to branches.
Verify and advice reversal of non- recoverable
amount.
6 Interest Subvention Verification of accuracy of Interest Subvention
Certificate Certificate.
7 Non-achievement of Scheduled Commercial Banks having any
priority sector targets shortfall in lending to priority sector shall be
allocated amounts for contribution to the Rural
Infrastructure Development Fund (RIDF)
established with NABARD and other Funds with
NABARD/NHB/SIDBI/ MUDRA Ltd. as decided
by the Reserve Bank from time to time. The
achievement will be arrived at the end of the
financial year based on the average of priority
sector target /sub-target achievement as at the
end of each quarter.
While computing priority sector target
achievement, shortfall / excess lending for each
quarter will be monitored separately. A simple
average of all quarters will be arrived at and
considered for computation of overall shortfall /
excess at the end of the year. The same
method will be followed for calculating the
achievement of priority sector sub-targets. An
Illustrative example is given in Annex of Master
Directions No. RBI/FIDD/2016-17/33
FIDD.CO.Plan.1/04.09.01/ 2016-17 dated July
07, 2016 (Updated as on December 05, 2019)
“Priority Sector lending – Target and
Classification”.
The interest rates on banks’ contribution to
RIDF or any other Fund, tenure of deposits, etc.
shall be fixed by RBI from time to time. The
misclassifications reported by the Reserve
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Bank’s Department of Banking Supervision

would be adjusted/ reduced from the
achievement of that year, to which the amount
of declassification/ misclassification pertains, for
allocation to various funds in subsequent years.
Non-achievement of priority sector targets and
sub-targets will be taken into account while
granting regulatory clearances/approvals for
various purposes.
8 Directions from To check various RBI and Government

Regulatory Authorities guidelines and actions taken by bank upon the
charged with same. Relevant board notes also to be
Governance checked.
9 Review Concurrent Review of Concurrent Audit Report.
Audit Report
10 Verification of various Various certificates issued by branch auditors to
certificates be verified and collated. Further some broad
checks to be employed to ensure correctness of
certificates.
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11
Law Department
11.01 One of the key risks faced by banks is the legal risk. The bank grants
various types of credit facilities to its customers with or without underlying
security, whether primary or collateral. The bank and the borrowers execute
various documents related to such credit facilities including loan agreements,
charge creation documents w.r.t. the securities which are hypothecated / pledged
to the bank. The law department ensures that such documents relating to credit
facilities are legally enforceable in court of law, are properly stamped & executed
and thus, the law department defines SOPs related to execution of such
documents including ensuring the enforceability of the documents.
11.02 The Bank obtains account opening forms duly executed from various
deposit and demat account holders. The bank obtains various documents to
legally validate (and protect its interest) a variety of transactions / activities
undertaken by the bank such as Locker arrangements, Lease agreements,
Borrowings, Remittances, Trade Finance transactions, Guarantees issued,
Forward Contracts, Interest rate or Currency Swaps. The Bank’s legal
department which is usually located centrally, ensures pre-vetting of all
documents used by the Bank in its borrowing, lending & investment/ treasury
operations and in discharge of its various income/expense bearing activities.
11.03 The key document w.r.t. Law Department is the legal policy of the bank.
It contains a detailed write-up on the roles, responsibilities and also the manner
of execution / implementation. It contains or refers to various documentation to
be obtained / executed for various funded and non-funded facilities sanctioned
by the bank and the custody, storage of the same as well as the stamping
requirements which could vary from State to State. Important documents are
scanned and movements of original loan papers need to be tracked.
11.04 The legal policy should be subject to periodic review. The legal
Department headed by the Chief Legal Officer is the original compiler and
custodian of this policy. The legal team is assisted by various staff centrally as
well as at decentralized zonal/Circle, regional or cluster levels. Banks have to
ensure that the legal team is adequately staffed and vacancies if any, are
promptly filled in by inducting competent resources.
11.05 One of the key functions of the legal team is to have a legal audit
conducted for advances over a particular threshold. The threshold varies from
Bank to Bank. This audit is done either pre-sanction or pre-disbursement of the
loan amount.
11.06 The risk policy of the bank talks of legal risks and the primary role of
protecting the bank from any legal risks rests with the legal department. The
legal team works in co-ordination with the risk department in this regard.
11.07 Various legal compliances like reporting to CIBIL / CRILC needs to be
done within the specified deadlines. These are centralised and also monitored
parallelly with the compliance team.
11.08 At times during the credit sanction process, various legal issues crop up
and the legal team is responsible for issuing opinions in that connection.
11.09 Banks have set processes wherein certain disbursements over a
threshold cannot be made unless there is a legal clearance certificate.
11.10 The legal department conducts the title search of the mortgaged
premises and ensures that the original title deeds are in order on record. The
work is also outsourced to panel advocates. The empanelment of advocates for
conducting outsourced work, the detailed due diligence to be done prior to
empanelment is all conducted by the legal team. The legal team is also
responsible for framing and monitoring the legal outsourcing policy.
11.11 Banks have cases of credit defaults and at various occasions, legal
action needs to be initiated against the borrowers for recovery. All legal cases of
the bank are handled and co-ordinated by the bank’s legal team either internally
or through support of the panel advocates.
11.12 Issuance of loan recall, recovery & securitization notices, newspaper
advertisements in this connection, obtaining symbolic- physical possession, filing
cases in Debt Recovery Tribunals or initiating insolvency proceedings in tribunal
is handled either by the bank’s recovery department, in case the bank has a
separate department, but in which case the recovery department closely liaisons
with and obtains guidance and support of the legal department wherever needed.
11.13 The legal team maintains a tracker of all legal cases court wise – date
wise which is constantly updated post each case hearing. These updates have to
be done timely. As best practice some Banks have an online legal tracker
updated close to real time. Timelines are also prescribed for updating the case
status post the case date.
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11.14 Bank should have a full-fledged legal department headed and manned
by an experienced, expert legal resource. The entire team has to comprise of
legal professionals who should be periodically trained and fully equipped to
handle all legal challenges.
11.15 While the tracker for time barred debts is monitored at individual
branches and also at cluster / regional / zonal/Circle level, in certain Banks, the
legal team also monitors this tracker parallelly.
11.16 The Auditor needs to liaison with the legal team to get an updated
status on all pending cases, filed by the bank or against the bank. This position
has to be obtained with the amount in litigation and also whether the cases have
been won or lost in earlier courts and appealed subsequently. Whether a lost
case needs to be appealed further and whether the appeal timelines are met is
also to be ensured by the legal team. The key discussion with the legal team is to
quantify the amount of contingent liability & arrive at the provisioning requirement
if any, thereon. The provisioning of the fees payable to advocates will also have
to be arrived at based on the agreements entered with the respective advocates
and discussions with the legal team.
11.17 The legal department also monitors non-credit related frauds committed
by employees or third parties. Whenever a fraud is unearthed or reported an
internal investigation is made by the bank through its legal department and also
subsequent procedures of filing FIR against the accused, filing criminal cases
and monitoring the same. The legal department also complies with provision
required to be made against loss due to such frauds.
11.18 Banks also have a panel of valuers for conducting valuation of
securities sanctioned / mortgaged to the Bank. The responsibility of appointment
of valuers, fixing their appointment terms and conditions is also co-ordinated by
the Bank’s legal team.
11.19 The legal team is responsible for conducting a performance review of
the efficiency and effectiveness of the empanelled advocates work. At times, the
services of empanelled advocates are discontinued due to work quality and in all
these decisions, the legal department is the key co-ordinator. The legal team is
also subject to an internal audit review for efficiency and effectiveness.
11.20 The auditor should ensure:
1) The Bank has an updated legal policy in place which is reviewed
periodically preferably annually.
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2) Due diligence for empanelment of panel advocates is done. This panel is

reviewed periodically with appropriate evaluation metrics framed. Further,
the bank may at its discretion take legal assistance of any other legal
counsel with due prior approval for the same for matters which may be
unusual and / or critical in nature.
3) Documentation requirements for each loan facility is established.
Documentation is reviewed and amended in view of changing regulations
and learnings from various ongoing litigations.
4) Tracker of legal cases is maintained court wise, amount wise, stage wise.
Delays, if any, are examined for root cause to ensure timely adherence in
future.
5) Arrival at the contingent liabilities for court cases, provisioning for legal
liability & Debits to profit and loss for legal fees is correctly done after due
evaluation of the case success probabilities.
6) Adverse issues noted in legal audit if any are properly addressed.
7) An internal team should review the entire legal process starting from
drafting of a plaint to the response / rejoinder there on. Compilation of best
strategy practices or what went right or wrongs impacting the eventual case
result could be learnings to be documented for future policy or tactical
change incorporation. The same should be a part of a structured process.
8) Deviations, if any, from the legal policy are appropriately recorded, duly
escalated, authorized and properly addressed.
9) Filing and custody of loan documents is in order.
10) Systematic track of legal opinions issued is maintained. Adverse court
judgments / order obtained against these opinions should be reviewed for
issuer competency or operational usage pursuant to disclaimers issued as
a part of the opinion.
11) Legal risks are identified and gaps therein, especially high risks, are noted
for remediation.
12) The Reserve Bank of India has directed the banks to undertake Legal Audit
of title documents in respect of large value loan accounts (i.e., exposures
above Rs. 5 crores) vide its circular 2012-13/524-DBS.FrMC.
BC.No.7/23.04.001/2012-13 dated June 07, 2013. Banks are required to
devise the methodology for compliance of the said guidelines.
161
13) Training should be an ongoing process to keep abreast with the latest
developments and upgrade legal skillsets.
14) If any opinion / consultation is sought from an advocate (either on the panel
of the bank or otherwise) the auditor should review / refer the same from
the perspective of financial implications and / or compliance related aspects
aligned thereto. The auditor may consider the legal opinions sought by the
management as one obtained from ‘Management’s Expert” as referred to in
‘SA 620 – Using work of an Auditor’s Expert’ and consider the same
appropriately as per the said SA. It would be pertinent to note that the legal
opinion / views as referred to by the auditor would not dilute the auditor’s
sole responsibility for the audit opinion expressed.
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12
Credit Recovery Department
Introduction
12.01 The area of operation / function of the Credit Recovery Department is
typically confined to the monitoring of ARBs (Asset Recovery Branches) with
major thrust on the areas related to recovery of credit portfolio of the bank. The
scope of the department may also include handling of recovery through various
other mechanisms like NBAs (Non-Banking Assets, Selling of Assets to Asset
Recovery Companies(ARCs) whereby upfront cash is realised or Security
Receipts (SRs) may be received, Cases under Insolvency and Bankruptcy Code
(IBC), One Time Settlement (OTS), upgradation of accounts, etc. The auditor
needs to be critical in income recognition policies of the bank as regards the
order of recovery and income recognition especially with respect to cases
wherein the recovery is made in the form of Non-Banking Assets and sale of
assets to ARCs.
12.02 The auditor should get acquainted himself with the Recovery Policy of
the bank and the guidelines of Reserve Bank of India as regards the accounting
and income recognition thereto. The auditor needs to take into consideration the
extent of automation of process related to accounting of recovery of credit
portfolio of the bank while audit planning.
Conduct / Execution
12.03 Following aspects need to be checked by the Auditor:
 Verify the returns / data from Asset Recovery Branches (ARBs) under
reporting of the departments.
 Verify the consistency in income recognition process as regards order of
recovery and whether the same is in sync with the internal policy of the bank
and is appropriately disclosed in notes on accounts.
 Verify whether income recognition is in compliance with extant RBI
guidelines related to income recognition.
 Verify whether the non-performing accounts upgraded during the period
under audit are upgraded in compliance with the extant RBI guidelines in
this regard.
 Verify whether the income is recognised against recovery especially through

NBAs and SRs only to the extent of cash realisation and not to the extent of
fair market value of NBAs / SRs as the same is yet to be realised.
 Review and verify as regards the possibility of the deterioration in the value
of NBAs and / or requirement of provision for diminishing in the value of
NBAs and the policy of the bank in this regard and the disclosure of the
same in notes on accounts.
 Verify the accounts upgraded (from NPA to PA) during the period under
audit with thrust on the source of funds and the compliance of upgradation
norms as per the extant RBI guidelines.
 Verify the compliance with Insolvency and Bankruptcy Code w.r.t. the
accounts under recovery under IBC mechanism.
12.04 Check whether the appropriate disclosure of policy related to recovery
especially in terms of order of recovery and NBAs / SRs is made in the ‘notes on
accounts’.
12.05 Based on adverse audit observations, appropriate reporting is to be
ensured in LFAR and / or Audit Report.
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13
Risk Management Department
13.01 Risk management is a key function in a Bank. Banks face various risks
in their conduct of business. The Basel framework on capital adequacy ratio
mandates banks to maintain minimum capital as per its risk weighted assets.
Risk calculation is a key Banking activity. Some risks which the Bank faces are:
1) Operational risk
2) Credit risk
3) Liquidity risk
4) Market risk
5) Investment risk
6) Interest rate risk
7) Legal risk
8) Regulatory risk
9) Reputational risk
10) Financial risk
11) Money laundering risk
12) Technology risk
13) Product risk
14) Concentration risk
15) Country Risk
13.02 Banks have a risk department which is responsible for framing a risk
policy. The risk policy contains detailed risk guidance on:
1) Risk identification – various risk scenarios, existing or emerging to which
the bank could be exposed on an end to end activity, sub-activity basis.
2) Risk assessment – classification of identified risks based on their probability
or likelihood and significance or impact into high, medium or low. The
methodology for risk classification has to be objectively quantified. Alternate
risks can also be classified into risk types.
3) Risk evaluation – mapping assessed risks based on current controls

designed and in place to mitigate / remediate the risks. Evaluation of risk
should also factor the impact on account of pandemic, floods and other
natural calamities and Policy changes.
Sector wise risk of the advances portfolio based on the last five years
average especially on the agriculture / priority / educational loan.
4) Risk monitoring – periodically reviewing the evaluated risks based on
operating effectiveness of the controls to actually identify the status of
residual risks or gaps. The Auditor is expected to ensure that controls are
automated and pro-active. Reactive and manual controls should be pointed
out for upgradation or stringent maker -checker.
5) Risk response – post risk evaluation, noting whether overall risks are within
the risk appetite and transaction wise within defined risk tolerances. If risks
are beyond the risk appetite, ensuring that they are appropriately
responded by strengthening controls to minimize impact to below risk
tolerance / appetite acceptable levels. Alternatively the bank could decide
whether to avoid such transactions or get them insured or budget losses
appropriately.
6) Risk communication – Banks have to ensure that activities have to be done
right from the start. Hence, they need to sensitize their employees and
make them risk aware and risk ready by proper training.
13.03 The risk policy of the Bank will have to be comprehensively compiled
and periodically updated. Banks have a risk department headed by a Chief Risk
Officer whose main responsibility is to ensure adherence to the risk policy in
terms of identification, assessment, evaluation, response and communication.
Banks have a risk review committee where key existing and emerging risks are
discussed brainstormed from control perspective.
13.04 The Risk department is generally centralized with various decentralized
support functionaries located zone, region or cluster wise as the case may be.
The key aspect is that risk is treated as close to the scene of origination
especially credit and money laundering risk.
13.05 The Auditor has to primarily ensure that the bank has a formal risk
structure in place with a formally approved comprehensive risk policy. The
Auditor should ensure that the Bank is in adherence to the policy. Deviations to
the policy should have been duly monitored and captured for action.
13.06 The RBI vide its circulars have mandated risk based audit in banks. The
Auditor should focus on high risk areas. Audit plan should be based on due risk
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classification and audit time spent should be commensurate with the risk
involved. The Auditor should ensure that there is a risk-based audit structure
formally in place.
13.07 Calculation of Capital to Risk-weighted Assets (CRAR) Ratio and
continuously monitoring the same to ensure that it is within the minimum
regulatory requirement, is also a vital function of Risk Management Department.
Important points in relation to CRAR that should be noted are:
1) Banks are required to maintain a minimum Capital to Risk-weighted Assets
Ratio (CRAR) of 9% on an on-going basis. In addition to this, outside the
period of stress, banks are also required to maintain Capital Conversion
Buffer (Comprised of Common Equity) at 2.50% of RWAs.
2) Credit Risk, Market Risk and Operational Risk together determine the
amount of minimum eligible capital to be maintained by the bank as per the
regulatory requirements.
Total Capital (CRAR) (%) = Eligible Total Capital
Credit Risk RWA + Market Risk RWA +

Operational Risk RWA
3) Minimum total capital (MTC) of 9% of total risk weighted assets (RWAs) is
further divided into different components.
Sr. Regulatory Capital As % to
No. RWAs
(i) Minimum Common Equity Tier 1 Ratio 5.50%
(ii) Capital Conservation Buffer 2.50%
(iii) Minimum Common Equity Tier 1 Ratio plus Capital 8.00%
Conservation Buffer [(i)+(ii)]
(iv) Additional Tier 1 Capital 1.50%
(v) Minimum Tier 1 Capital Ratio 7.00%
[(i) +(iv)]
(vi) Tier 2 Capital 2.00%
(vii) Minimum Total Capital Ratio (MTC) [(v)+(vi)] 9.00%
(viii) Minimum Total Capital Ratio plus Capital 11.50%
Conservation Buffer [(vii)+(ii)]
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4) The Auditor should ensure that calculation of RWAs for each type of risks
i.e. credit, market & operational has been done as per the detailed
methodologies contained in the RBI Master Circular No.
DBR.No.BP.BC.1/21.06.201/2015-16 dated 01st July, 2015 on Basel III
Capital Regulations.
5) Further, for the calculation of RWAs for credit risk, the auditor should
ensure that for all the entities with unhedged foreign currency exposures
and having ratio of likely loss/EBID(%) in excess of 75%, there is 25%
increase in the risk weight as a part of Incremental capital requirement.
6) For the calculation of RWAs for credit risk, the ratings assigned by the
eligible external credit rating agencies (wherever available) are largely used
while assigning risk weights for capital adequacy purposes. Accordingly,
the auditor has to ensure that the latest external credit rating has been
updated and used for this purpose.
7) For the calculation of Market Risk also external credit ratings are used to
determine the risk weight (%). Along with this, applicable RW (%) varies
based on the residual maturity of the investment. Thus, the auditor has to
ensure that for each investment correct external rating & residual maturity
has been taken.
8) Banks generally have investment in other bank’s capital instruments such
as bonds, equity shares etc. Risk weight (%) in these cases is based on the
level of common equity Tier 1 capital (CET1) including applicable capital
conservation buffer (CCB) (%) of the investee bank. In these cases, the
auditor shall ensure that the level of CET1 & CCB has been taken as per
reported in the latest quarterly results of the investee bank.
13.08 In addition to the above the Auditor has to verify that:
1) The bank has a formally defined risk appetite and risk tolerance levels are
fixed transaction wise.
2) Risk identification based on what can go wrong on an end to end activity
wise basis is conducted considering the organization structure, functions
and responsibilities. The bank should be maintaining a risk register for the
same.
3) Risk identification is an ongoing, periodic activity.
4) Risk assessment or classification of risks into risk types or high-medium-
low is comprehensively done.
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5) Existing controls are mapped to risks.

6) Trainings on risk awareness is conducted amongst employees.
7) Gaps which are beyond risk appetite / risk tolerance are addressed.
Timelines and the manner of addressal along with risk owner are identified.
Open risk items should be duly tracked. Proper escalation mechanisms
should be in place to highlight open items.
8) Risk policy is periodically updated and reviewed.
9) Minutes of Risk Committee Meetings are duly recorded on a timely manner.
10) Effectiveness of IT system/IT infrastructure including Management
Information Systems.
13.09 Any risk deviations noted are to be appropriately discussed with the
management or appropriate risk committee members and duly reported in the
Long Form Audit Report as the case may be.
Frauds
13.10 While the primary responsibility for preventing frauds lies with banks
themselves, the Reserve Bank of India (RBI) has been advising banks from time
to time about the major fraud prone areas and the safeguards necessary for
prevention of frauds. Banks are required to introduce necessary safeguards /
preventive measures by way of appropriate procedures and internal checks so
as to prevent/minimize occurrence of frauds and resultant financial loss to the
banks.
13.11 The CEOs of the banks are supposed to provide singular focus on the
"Fraud Prevention and Management Function" to enable, among others, effective
investigation in fraud cases and prompt as well as accurate reporting of fraud
cases to the appropriate regulatory and law enforcement authorities including
RBI. Banks are required to frame their internal policy for fraud risk management
and fraud investigation function with the approval of their respective Boards. The
Auditor should refer SA 240, “The Auditor’s Responsibilities relating to Fraud in
an Audit of Financial Statements” in this regard.
Classification
13.12 Frauds are classified, mainly on the basis of the provisions of Indian
Penal Code (IPC), as under:-
a) Misappropriation and criminal breach of trust.
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b) Fraudulent encashment through forged instruments, manipulation of books

of account or through fictitious accounts and conversion of property.
c) Unauthorized credit facilities extended for reward or for illegal gratification.
d) Cash shortages.
e) Cheating and forgery.
f) Fraudulent transactions involving foreign exchange
g) Any other type of fraud not coming under the specific heads as above.
13.13 As regards cases under (d) and (f) above cash shortages resulting from
negligence and fraudulent forex transactions involving irregularities / violation of
regulations have also to be reported as fraud if the intention to cheat/defraud is
suspected or proved.
13.14 Cases will be deemed to be fraud and reported in the following
circumstances:
a) Cases of cash shortage more than Rs. 10,000/-.
b) Cases of cash shortage more than Rs. 5,000/- if detected by management
/ auditor/ inspecting officer and not reported on the day of occurrence by
the persons handling cash.
Other points to be considered while reporting fraud are:
a) Frauds involving forged instruments have to be reported only by the paying
banker whereas collection of a genuine instrument fraudulently by a person
who is not the true owner, the collecting bank, which is defrauded, will have
to file fraud report with the RBI.
b) Collection of an instrument where the amount has been credited before
realization and subsequently the instrument is found to be fake/ forged and
returned by the paying bank, the collecting bank is required to report the
transaction as fraud with the RBI as they are at loss by parting the amount.
c) Collection of an altered/fake cheque involving two or more branches of the
same bank, the branch where the altered/fake cheque has been encashed
is required to report the fraud to its H.O. for further reporting to RBI by the
H.O.
d) An altered/fake cheque having been paid/ encashed involving two or more
branches of a bank under Core Banking Solution (CBS), the branch which
released the payment is required to report the fraud to its H.O. for further
reporting to RBI.
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e) Cases of theft, burglary, dacoity and robbery are not treated as fraud but
are required to be reported separately to the Reserve Bank of India.
f) Banks (other than foreign banks) having overseas branches/offices are
required to report all frauds perpetrated at such branches/offices to RBI.
Reporting
Reporting of Frauds to RBI (FMR)
13.15 All frauds irrespective of the amount
 Fraud including in the subsidiaries and affiliates/joint ventures of the Banks
perpetrated through those in misrepresentation, breach of trust,
manipulation of books of account, fraudulent encashment of instruments like
cheques, drafts and bills of exchange, unauthorised handling of securities
charged to the bank, misfeasance, embezzlement, misappropriation of
funds, conversion of property, cheating, shortages, irregularities, etc.
 Cases under criminal proceedings initiated by central investigating agencies
suo moto and/or where RBI has directed to treat the acts as frauds.
 In all frauds irrespective of the amount, banks are required to send soft copy
of the reports (FMR/B) to be reported through FMR application in XBRL
system supplied to them within three weeks from the date of detection of
fraud.
 A monthly certificate, in prescribed format to be submitted by bank to CFMC,
Bengaluru with a copy to the respective SSM of the bank within 7 days from
the end of the month.
 Banks are also required to furnish a Flash Report(FR) for frauds involving
amounts of Rs.50 million and above within a week of such fraud being
noticed.
 Any further developments in fraud cases are to be reported through FMR
update application in XBRL system.
a) Frauds committed by unscrupulous borrowers. Such frauds include:-
 Fraudulent discount of instruments or kite flying in clearing effects.
 Fraudulent removal of pledged stocks/disposing of hypothecated stocks
without the bank’s knowledge/inflating the value of stocks in the stock
statements and drawing excess bank finance.
 Diversion of funds outside the borrowing units, lack of interest or criminal
neglect on the part of borrowers, their partners, etc. leading to the unit
becoming sick as also due to laxity in effective monitoring / supervision over
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the operations in borrowal accounts on the part of the bank functionaries

rendering the advance difficult to recover.
 Banks are supposed to exercise due diligence while appraising the credit
needs of all borrowers, borrower companies, partnership/ proprietorship
concerns and their directors, partners and proprietors, etc. as also their
associates who have defrauded the banks. Banks should ensure appraisal
of credit proposal considering the genuine requirements of the working
capital based upon the turnover achieved / turnover projected Besides the
borrower fraudsters, other third parties such as builders, vehicle/tractor
dealers, warehouse/cold storage owners, etc. and professionals are also to
be held accountable if they have played a vital role in credit
sanction/disbursement or facilitated the perpetration of frauds. Banks are
required to report to Indian Banks Association (IBA) the details of such third
parties involved in frauds.
Most of the frauds in advances are perpetrated by the borrowers mainly due
to the slackness in monitoring and control of borrower accounts.
b) Frauds in borrowal accounts having multiple banking arrangements
(MBA)
 All banks under MBA arrangement are required to evolve a system of
exchanging information on fraud committed by the borrower so as to take
appropriate action including criminal action against the borrower.
 Banks are required to evolve an operating framework for tracking frauds and
dealing with them.
 It is not necessary that the fraud may take place in all the banks which are
the members of the consortium. However the information should be shared
with the members of the consortium when the fraud takes place in one bank.
 The time taken to report the fraud also needs to be monitored.
 CRILC reported accounts can be checked regularly for its classification with
other banks.
Provisioning Pertaining to Fraud Accounts
13.16 Banks are required to prescribe a uniform provisioning norm in respect
of all cases of fraud, as under:
(a) The entire amount due to the bank (irrespective of the quantum of security
held against such assets), or for which the bank is liable (including in case of
deposit accounts), is to be provided for 100% or over a period not exceeding
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four quarters commencing with the quarter in which the fraud has been
detected;
(b) However, where there has been delay, beyond the prescribed period, in
reporting the fraud to the Reserve Bank, the entire provisioning is required to
be made at once. In addition, the Reserve Bank of India may also initiate
appropriate supervisory action where there has been a delay by the bank in
reporting a fraud, or provisioning against therein.
Closure of fraud cases
13.17 Banks shall report to CFMC, RBI and the SSM (Senior Supervisory
Manager) of RBI, the details of fraud cases of ₹0.1 million and above closed
along with reasons for the closure after completing the process as given below.
13.18 Banks should close only such cases where the actions as stated below
are complete and prior approval is obtained from the SSM:
a) Case pending with CBI/Police/Court have been finally disposed off
b) Staff accountability has been examined/ completed
c) The amount involved in the fraud has been recovered or written off
d) Insurance claim wherever applicable has been settled
e) Bank has reviewed the systems and procedures and taken steps to avoid
recurrence
f) Banks should also pursue vigorously with CBI for final disposal of pending
fraud cases especially where the banks have completed staff side action,
etc.
Reports to the Board
Reporting of fraud
13.19 Banks need to ensure that all frauds of Rs. 1.00 lakh and above are
reported to their Boards promptly on their detection. Such reports should, among
others, contain the failure on the part of the concerned branch officials and
controlling authorities and consider initiation of appropriate action against the
officials responsible for the fraud.
Information relating to frauds for each quarter end are to be placed before the
Audit Committee of the Board of Directors. Further report on individual cases of
attempted fraud involving an amount of Rs. 10 million and above is to be placed
before the Audit Committee of its Board.
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Quarterly Review of Frauds

13.20 Information relating to frauds are to be placed before the Audit
Committee of the Board of Directors on quarterly basis ending March, June and
September with statistical analysis. The Auditor is supposed to read the minutes
of all such meetings and ensure the appropriate accounting and disclosure in the
financial statements.
13.21 Banks are required to constitute a Special Committee consisting of
CMD of public sector banks and MD in respect of SBI/its associates for
monitoring and follow up of cases of frauds involving amounts of Rs. 1.00 crore
and above exclusively. The main function of the committee would be to monitor
and review all the frauds of Rs. 1.00 crore and above and to put in place, among
others, measures as may be considered to prevent recurrence of frauds such as
strengthening of internal controls etc.
Annual Review of Frauds
13.22 Banks are required to conduct an annual review of the frauds and place
a note before the Board of Directors/Local Advisory Board for information. The
review would take into account, among others, whether the systems in the bank
are adequate to detect frauds once they have taken place within the shortest
possible time.
Early Warning Signals (EWS) and Red Flagged Accounts (RFA)
13.23 A “Red Flagged Account” (RFA) is one where a suspicion of fraudulent
activity is thrown up by the presence of one or more Early Warning Signals
(EWS).
The threshold for EWS and RFA is an exposure of Rs. 50 crores or more at the
level of a bank irrespective of the lending arrangement (whether solo banking,
multiple banking or consortium). All accounts beyond Rs. 50 crores classified as
RFA or ‘Frauds’ must also be reported on the CRILC data platform together with
the dates on which the accounts were classified as such.
The FMG or any such designated committee shall classify the account as RFA
and the details of RFA accounts shall be put up to the CMD/CEO every month.
In cases where the bank is the sole lender, the FMG will take a call on whether
an account in which EWS are observed should be classified as RFA or not. This
exercise should be completed as soon as possible and in any case within a
month of the EWS being noticed. Further within a period of 6 months, banks
should either lift the RFA status or classify the account as a fraud.
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In case of multiple banking/consortium the overall time allowed for the entire
exercise to be completed is six months from the date when the first member
bank reported the account as RFA or Fraud on the CRILC platform.
Guidelines for Reporting Frauds to Police/CBI
13.24 While reporting the frauds, banks are required to ensure that, besides
the necessity of recovering the amount expeditiously, the guilty persons do not
go unpunished.
Private Sector Banks/Foreign banks (operating in India)
13.25 All Cases are required to be referred to State Police including:
a) Cases of fraud involving an amount of Rs. 1.00 lakh and above committed
by outsiders on their own and/or with the connivance of bank staff/officers.
b) Cases of fraud involving amount exceeding Rs. 10,000/-committed by bank
employees.
c) Fraud cases involving amounts of Rs. 1.00 crore and above should also be
reported to the Serious Fraud Investigation Office (SFIO), GOI, in FMR-
format.
Public Sector Banks
13.26 Cases to be referred to CBI
a) Cases of fraud involving amount of Rs. 3.00 crore and above upto Rs. 25
crore:
 Where staff involvement is prima facie evident - CBI (Anti Corruption
Branch).
 Where staff involvement is prima facie not evident- CBI (Economic
Offences Wing).
b) All cases involving amount more than Rs. 25 crore but less than Rs. 50
crores - Banking Security and Fraud Cell (BSFC) of CBI.
c) All cases involving amount more than Rs. 50 crores-Joint Director(Policy)
CBI, HQ, New Delhi.
13.27 Cases to be referred to Local Police
Fraud involving Rs. 1.00 Lakh and Compliant to be filed with Regional
above but less than Rs. 3 Cores Head of the bank to State
CID/Economic Offences Wing of
State concerned
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Below Rs. 1.00 Lakh but above Rs. Local Police Station by the branch
10,000/- (if committed by staff)
Below Rs. 10,000/- involving bank Reported to Regional Head of the
officials bank to decide on further course of
action
Frauds involving forged instruments By paying banker to Local Police
Fraudulent encashment of Local Police concerned
DD/TTs/Pay orders/ Cheques/ DWs,
etc.
Collection of genuine instrument, but Collecting bank to Local Police
collected frequently by a person who is concerned
not the owner
Payment of uncleared instrument Collecting Bank to Local Police
which is found to be fake/forged and
returned by the paying bank
Collection/payment of altered/fake Branch where the cheque was
cheque involving 2 or more branches encashed to the Local Police
of the same bank
Reporting of Cases of Theft, Burglary, Dacoity and Bank Robberies

13.28 In respect of cases of theft, burglary, needs to be done: and bank
robberies the following:
 Occurrence of any bank robberies, dacoities, thefts and burglaries are
required to be reported immediately by Fax/e-mail to
a) CFMC, Bengaluru.
b) The SSM of the bank.
c) RO of DBS under whose jurisdiction the affected bank branch is located
to enable the Regional Office to take up the issues regarding security
arrangements in affected branch/es during the State Level Security
Meetings with the concerned authorities.
d) The Security Adviser, Central Security Cell, Reserve Bank of India,
Central Office Building, Mumbai - 400 001.
e) Ministry of Finance, Department of Financial Services Government of
India, Jeevan Deep, Parliament Street, New Delhi-110 001.
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 Banks are also required to submit a quarterly return to RBI electronically

using the XBRL system within 15 days of the end of the quarter it relates.
13.29 The Auditor has to check the above and confirm whether the bank has
complied with the above provisions.
Audit Methodology
13.30 The Auditor has to verify
1) That there is a fraud policy in place which is reviewed and updated at
periodic intervals. This Fraud policy has been circulated on the bank Intranet
and employees are sensitized of the fraud policy.
2) Periodic anti-fraud training and awareness sessions are in place.
3) Whistle Blower hotlines are in place.
4) Fraud risk scenarios are identified and current anti- fraud controls noted and
mapped to fraud risks. Measures are put in place to prevent significant gaps.
5) The bank’s zero tolerance policy for fraud or ethical violations are made
known to all employees.
6) Swift dismissal / termination of employees found guilty of fraud is in place.
7) There are automated systems / surveillance systems to detect fraud and
alerts.
8) Mechanisms of early detection and reporting of fraud incidents are in place.
9) Back ground screening checks for employee joining are in place.
10) There are periodic anti-fraud communications and care taken to prevent
frauds / money laundering.
11) Auditor to examine the robustness of anti-fraud controls and staff
accountability.
12) Reporting mechanisms to RBI are effectively in place.
13) Fraud is clearly identified. Policies for reporting on fund diversions,
siphoning of funds and wilful defaults are in place.
14) Auditors should examine Action Taken Report (ATR) in respect of all red
flagged accounts / fraud accounts.
If the Auditor notes adverse issues, the same have to be discussed at
appropriate levels of the management. Necessary reporting will have to be done
in the long form audit report or the main audit reports as the case may be.
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Risk weights on advances accounts for which Documentation & Sanction

has been completed but not opened in CBS
13.31 Risk weights on advances accounts not opened in CBS but for which
sanction and documentation had been completed also forms part of risk
weighted assets. Credit conversion factor of 50% is to be applied on term loans
while 20% is to be provided for others. Risk weights on this are to be applied
considering the rating of each borrower. These accounts do not form part of total
exposure for purpose of risk evaluation as these are not opened in CBS but have
the potential of adversely affecting the business as the documentation has been
completed and the exposure is exercisable at the option of the borrower.
13.32 As per RBI instructions vide DBR.No.BP.BC.17/21.06.001/2019-20
consumer credit, including personal loans and credit card receivables but
excluding educational loans, attracts a higher risk weight of 125 per cent or
higher, if warranted by the external rating of the counterparty. The risk weight for
consumer credit, including personal loans, excluding credit card receivables, is to
100%.
13.33 As per RBI instructions vide DoR.BP.BC.No.76/21.06.201/2019-20 in
respect of National Credit Guarantee Trustee Company (NCGTC) the captioned
scheme announced by the Government of India to extend guaranteed
emergency credit line to MSME borrowers the Member Lending Institutions
shall assign zero percent risk weight on the credit facilities extended under this
scheme to the extent of guarantee coverage.
Vigilance
13.34 The Chief Vigilance Officers in the banks have been authorised to
decide upon the existence of a vigilance angle in a particular case, at the time of
registration of the complaint. Once a complaint has been registered as a
vigilance case, it will have to be treated as such till its conclusion, irrespective of
the outcome of the investigation.
13.35 Key functions of the Vigilance Department include the following:
 Handling of complaints received from various quarters, examining the matter
from vigilance angle and advising competent authority to take suitable
disciplinary action.
 Determination/examining of existence of vigilance angle based on the
findings/lapses indicated in investigation reports, inspection reports, Special
Reports, fraud reports, accountability reports on advances which have
slipped to NPA, etc., and communicating the same to disciplinary authorities,
through HR Wing, for further action as per procedure.
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 Seeking advice of Central Vigilance Commission (CVC) as per the norms in

respect of vigilance cases involving officials who come under the jurisdiction
of CVC and communicating the advice to disciplinary authorities for further
action.
 Conducting intensive examination of works/purchase contracts as per norms
and ensuring implementation of CVC guidelines on tender procedures in the
Bank.
 Finalising agreed list with CBI and preparation of list of Officers of Doubtful
Integrity (ODI), and ensuring surveillance on such officials whose names
appear in agreed list/ODI. Co-ordinating with CBI on all matters of vigilance
investigations referred to them by the bank and providing assistance to CBI.
 Scrutiny of staff accountability reports in case of advances of large value.
 Ensuring implementation of guidelines of CVC, RBI and the Ministry in
matters relating to Vigilance.
 Submitting board notes/ review notes to the Board of Directors, Committee
of Directors, Audit Committee and Chairman and Managing Director in
respect of vigilance matters and also various returns to CVC, RBI, CBI and
Ministry.
13.36 Generally, vigilance angle could be perceptible in cases characterised
by:
(i) commission of criminal offences like demand and acceptance of illegal
gratification, possession of disproportionate assets, forgery, cheating,
abuse of official position with a view to obtaining pecuniary advantage for
self or for any other person; or
(ii) irregularities reflecting adversely on the integrity of the public servant; or
(iii) lapses involving any of the following:
(a) gross or wilful negligence;
(b) recklessness;
(c) failure to report to competent authorities, exercise of discretion without
or in excess of powers/jurisdiction;
(d) cause of undue loss or a concomitant gain to an individual or a set of
individuals/a party or parties; and
(e) flagrant violation of systems and procedures.
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13.37 In banking institutions risk-taking forms an integral part of business.

Once a vigilance angle is evident, it becomes necessary to determine through an
impartial investigation as to what went wrong and who is accountable for the
same.
13.38 Information about corruption, malpractices or misconduct on the part of
public servants may come to the CVO’s notice through various sources, such as:
(i) the complaints received from the public, or through the administrative
Ministry, CBI and the CVC;
(ii) departmental inspection reports and stock verification surveys;
(iii) scrutiny of property returns and the transactions reported by the concerned
employee under the Conduct Rules;
(iv) audit reports;
(v) press reports; and
(vi) reports of parliamentary committees etc. Information received verbally
should be reduced to writing and dealt with similarly.
13.39 The vigilance department acts upon all such kind of complaints and
conducts a detailed investigation. Periodic meetings are held with the respective
committees and cases are discussed with the top Management of the Bank. The
SCA is expected to read the minutes of the meetings and understand the
complaints and the actions taken upon them by the CVC/vigilance department.
The details of the individual cases should be ascertained and the same can be
discussed with the CVO and his department by the SCA. It is essential that the
SCA arrives at a proper judgement over the cases and concludes its proper
accounting/ disclosure in the financial statements.
Risk management limits and monitoring
13.40 Risk is a function of probability and impact. Risk management is an
important function in banks. Banks have a separate risk management
department and a committee. The department is responsible for identifying key
risks, assessing, evaluating, monitoring and responding to risks. The risk
committee ensures that the risk oversight is adequate and effective. Design of
automated Controls and its effective and efficient implementation and execution
to pro-actively remediate and mitigate the risks is monitored on an ongoing
manner.
13.41 One of the key aspects in risk monitoring is setting up limits and
ensuring that these are not breached. These are tolerance levels within which
the activities have to be conducted. Limits ensure control. Any breach in the
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limits needs to be escalated, ratified and approved at appropriate levels. The

limits are duly framed in respective policies and reviewed from time to time.
Some limits are framed by the RBI itself while some limits are set up by Banks
internally.
13.42 Limits are also in place for reporting purposes as transactions over a
particular threshold need to be reported to either RBI, FIU, Income Tax
authorities.
13.43 Banks have limits in place for various activities namely:
1) Advances – Single Borrower and Group Borrower exposure details –
Priority Sector lending – Unsecured Advances – Minimum Provisioning –
conduct of stock audits – obtaining end use and other certifications –
obtaining second valuations.
Recovery of NPA advances is a major area for concentration and action.
This requires constant follow up with legal and other support for expeditious
settlement. Auction of the properties offered as security is to be attempted
more vigorously.
2) Investments – Held to maturity securities / available for sale securities /
non SLR securities – creation of investment fluctuation / depreciation
reserve / investments made in government securities / venture capital fund.
3) Borrowing limits.
4) Transfers to statutory and other mandatory reserves.
5) Cash reserve ratio – Statutory liquidity ratio limits.
6) Overseas foreign currency borrowing limits including overdrafts in Nostro
accounts adjusted in 5 days.
7) Limits under various AP-DIR circulars - Reporting in XOS- BEF statements.
8) Treasury – Open limits, aggregate gap limits, individual gap limits,
counterparty limits, settlement limits, and currency limits.
9) Country risk only in respect of country where a bank net funded exposure is
1% or more of its total assets, the bank is required to formulate the CRM
policy for dealing with that country risk problem.
10) Obtaining PAN for cash transactions over a determined threshold.
11) Remittances under liberalized remittance scheme (LRS).
12) Legal audit and verification of title deeds for loans over Rs. 5 Crores –
conducting due diligence reporting.
13) RTGS transactions – Minimum amount should be over Rs. 2 lakhs.
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14) NEFT transactions have no limits. Earlier Banks had certain time
restrictions but now RBI has instructed that these facilities be available 24
hours.
15) Parameters are in place for automated transaction monitoring and breach
of these limits throws system alerts which are white washed or validated.
Exceptions are reported in the Suspicious Transactions Report. Banks also
have to report transactions in Cash transaction reports, Cross Border Wire
Transfer Report, Counterfeit Currency reports, Non-Profit organization
transaction reports.
16) Banks also have internal monitoring thresholds and any breach of these
parameters is reported as exceptional transactions in Exception Reports
which are generated and monitored daily.
17) Cash retention limits - Limits on amount of cash withdrawals at other than
home branch with / without charges – Cash deposits other than home
branches – ATM amount withdrawn per day.
18) Reporting under FATCA- CRS.
19) Limits for fraud reporting.
20) Annual information reporting.
21) Reporting to credit information companies.
22) Reporting to Central Repository of Information on Large Credits.
13.44 This list is not exhaustive and the auditor should look into various RBI –
FEMA - CBDT Circulars / bank’s internal policies for the list of limits to be
monitored and reported.
13.45 The Auditor should primarily obtain a listing of all limits which the Bank
is monitoring for internal control purposes or reporting purposes authority wise.
13.46 In the absence of such a list, the Auditor will have to primarily report the
non- existence of such a list as an issue.
13.47 The Auditor should examine the process for compilation of this list and
how these limits are monitored. An automated system should ideally be in place.
Where the monitoring is done manually, stringent maker checker process
controls should be in place which should operate effectively and efficiently at all
times.
13.48 Deviations or discrepancies noted should be reported appropriately in
the Long Form Audit Report or duly qualified in the accounts if necessary, as the
case may be.
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14
Central Audit and Inspection
Department
Introduction
14.01 Audit Department in Banks is a combination of centralized function with
some level of decentralization at the Cluster, Regional or Zonal level. The
structure may vary from Bank to Bank. Banks have an audit manual, Audit policy
or audit charter. The Audit department is usually headed by a Chief Audit
Executive. Designations would vary from Bank to Bank. The primary function is
to ensure that the audit function is handled smoothly, effectively & efficiently.
14.02 The functions are as under:
1) Scoping the audit – deciding who does what, how and when – maintaining
an audit calendar – ensuring that the audit calendar is maintained as
scheduled.
2) Ensuring that the statistical information and other inspection and audit
related agenda of Audit Committee are properly framed. Minutes of the
audit committee should record the proceeding details correctly.
3) Ensuring that the audit follows a risk based approach in accordance with
RBI guidelines. Audit issues need to be approached from the angle of lack
of control and supervision / fraud / potential weakness in the accounts /
sector / system.
4) Closure of open audit issues. Tracking audit issues for closure.
5) Placing audit reports before the Audit committee/ Management
Committees, as the case may be. Ensuring actions suggested by the audit
committee are duly followed and closed.
6) Identification of branches to be subjected to concurrent/ revenue audit.
7) Undertake Risk-Based Internal Audit (RBIA) as per the framework as
stipulated by Reserve Bank of India.
8) Appointment of concurrent auditors, deciding their scope, meeting the
concurrent auditors, discussing their issues, conducting trainings if needed,
and review of work of concurrent auditors. Ensuring that RBI guidelines on
concurrent audit are adhered.
9) Closely interacting with other departments like risk, compliance etc., to

ensure these functions are effectively performing their duties.
10) Following up closures of stock audit issues.
11) Conducting some audits internally – Branch audits, functional audits like
human resources, information technology, review of risks and compliance
functions for effectiveness and efficiency, MIS reviews etc.
12) Conducting application audit of new software applications (Developed in
house or vendor procured), updated versions of existing application
software, modules, patches, programs before its release/implementation by
using web-based Application Audit Package on the specific requests
received by the concerned functional groups and follow up for closure of
these audit reports.
13) Ensuring that the internal audit team is well equipped and trained and is
kept abreast of circulars and regulatory directions as issued by the
regulators from time to time.
14) Co-ordinating with RBI inspectors or statutory auditors whenever needed.
15) Ensuring that the audit function is automated and adopts the latest
techniques and procedures.
16) Re-risk rating of branches, whenever a fraud is reported in between two
RBIAs.
17) Co-ordinating with the department dealing with frauds for de-risking.
18) Laying down parameters for risk-based audit. Deciding risk classification in
co-ordination with Risk / Business department.
19) To attend to work relating to transfer, promotion, deputation and disciplinary
matters of Inspecting Officers.
20) Laying internal metrics for evaluating efficiency and effectiveness of audit
function and getting it validated externally – internally.
21) Close co-ordination with the Chairman of Audit Committee or similar
functionary for ensuring effective audit oversight.
22) Ensuring that other audits like revenue audits, legal audits, information
security audits, cyber security audits are duly conducted and the process
gaps noted therein are resolved.
23) Ensuring that the audit policy, audit manual or audit charter is duly reviewed
on an annual basis.
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14.03 Audit function, over the years, has moved from the traditional
transaction verification to the process driven risk-based audit. The focus is on
doing things right from start. The key is to ensure that there are no gaps and
gaps if any are closed within acceptable time frames. The Auditor should
examine the system of concurrent / internal audit along with follow-up /
compliance / remedial corrective action taken related thereto, with reference to
the bank’s internal policy related thereto.
Audit approach
14.04 The Statutory Central Auditor should ensure that the audit function is
effectively discharging its duties and functions enumerated above. He needs to
co-ordinate with the audit head and validate the audit process. The validation
could be done by a combination of transaction and system-process checks. It is
the statutory auditor who is validating the internal audit function for efficiency and
effectiveness. Any shortcomings or gaps noted have to be effectively escalated
to the audit committee and reported appropriately in the LFAR.
14.05 The Statutory Central Auditor may review the criteria set by the
department for selection of branches for the purpose of concurrent / internal /
audit. The Auditor shall ensure that selection of branches for the purpose of audit
is done objectively and no branch that ought to have been covered (owing to its
level of operation) under audit has been missed.
14.06 In addition to this, the Auditor shall ensure that special function
wings/units such as Forex Department, Treasury Department, Fixed Asset
Department etc. are also covered under the scope of Internal Audit with
adequate attention being given in terms of factoring in the eligibility and
qualification of the person carrying internal audit of these specialised branches.
14.07 The scope of Concurrent / internal audit reports is to be understood in
detail to check whether there is any area that needs the attention of the auditor
that has not been covered within the scope of the audit.
14.08 The statutory auditor will also go through the reports of Concurrent
Auditors of key branches/ functions. He will also have to scrutinize the system
audit reports, revenue audit reports, stock audit reports, internal inspection
reports. The scope, frequency and quality will have to be looked into in depth and
commented. The Auditor should review as to whether the short comings /
adverse remarks by the stock auditor have been duly and promptly attended to
and corrective measures have been taken.
14.09 The statutory auditor also goes through the RBI Inspection reports.
These are sensitive, confidential reports for internal consumption and the Auditor
should ensure these findings are noted for adherence. Such inspection reports
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provide various information on the control and management of the bank in

addition to divergence in provisions made by the bank vis-à-vis provision
required as per IRAC norms.
14.10 The focus is on systems, processes and a root cause analysis to find
out what went wrong and what could be done that the error does not recur again.
14.11 The statutory auditor could attend audit committee meetings to get real-
time grasp of how the meetings are held, issues discussed and resolved.
14.12 The SCA should review the scope of work assigned in the reporting
format for the concurrent audit of branches and other departments at HO and to
ensure that there is adequate coverage of the working of the branch / related
department, if not than may be reported in Long Form Audit Report of the bank
and may discuss with the respective department in the Head office and / or major
observation with the Audit Committee.
14.13 The SCA should also go through the minutes of the Board and
Management Committee meetings to understand and appreciate the policies of
the bank and other information including credit sanction.
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15
Credit Monitoring and
Restructuring Department
Introduction
15.01 Credit Monitoring & Restructuring department (CMRD), as the name
suggests is a credit monitoring hub of the entire bank. Like many other
departments at HO, CMRD too does not carry any financial activity. The
sanctioning and operations of credit takes place with the respective branches
and designated departments.
15.02 This department is expected to keep close watch over the health of the
credit portfolio and to ensure that funds lent are safe and bring returns and the
lending is done as per internal policy guidelines and RBI guidelines.
15.03 In every bank monitoring policy is framed to equip the field functionaries
with effective tools of monitoring so that various risks associated with the lending
are identified and remedial measures initiated well in time so as to maintain
quality asset.
15.04 The monitoring policy at the holistic level is an embodiment of the
Bank’s approach at making the systems and controls more effective so that
credit risks are managed in a systematic and effective manner.
15.05 The monitoring policy is reviewed every year keeping in view inputs
received from Branches/ROs/ZOs, experience gained and to update the
15.06 The CMRD also monitors the special mention accounts (SMA 1 & 2)
above a certain limit. The overdue statements generated by the bank are closely
monitored and necessarily followed up to the concerned department/ Branch or
officer is done through this department.
15.07 Further in some banks, this department may be responsible for
sanctioning of restructuring of advances. During the last few years in order to
give relief to MSMEs RBI has introduced restructuring schemes for stressed
MSMEs without a downgrade in asset classification and hence large number of
MSME accounts were given the benefit of these schemes and restructured.
Further, this department may also be responsible for calculation of the additional
provision required for the restructured portfolio and sacrifice calculations.
Audit Approach
15.08 It may be observed that all the activities of the department are in the
nature of controlling and compliance. This department is also responsible for
implementation of the bank’s policies w.r.t monitoring and restructuring. It is
necessary that the Auditor familiarises himself with the functions of the
department and draws up the audit plan accordingly.
Credit Monitoring
15.09 The CMRD is responsible to monitor the credit portfolio independently
and interact with the Zones/ Regions and Branches for the follow up. In
particular, this department performs the following functions:
 Closely monitoring the overall overdues statement generated by the bank,
particularly overdues above certain limits.
 Review of High risk rated accounts and providing periodic review notes to
MD&CEO in respect of accounts under monitoring.
 Review of “Quick Mortality Accounts” and placing review notes before the
Board of Directors/Audit Committee.
 Review of statement of expired credit limits and progress report on renewal
of credit limits periodically and placing a note before the higher authorities as
per extant guidelines.
 Ghosh Committee Recommendation – advances showing sticky tendencies
above a certain limit to be monitored.
 Stock Audit report review in respect of accounts under monitoring as a part
of monitoring exercise.
 Review of adhoc credit facility not regularized.
 To monitor effective implementation of Credit Audit System in the Bank.
15.10 While undertaking supervision, monitoring and control over the credit
portfolio, the auditor may be required to undertake certain tests with a different
perspective and keeping in mind the overall materiality. Keeping in view the
significance from the regulator’s perspective following transactions may be
selected for checking at the HO level:
1. Any account in the bank having exposure (funded and non-funded) which is
more than Rs. 2000 crores across banking sectors.
2. Accounts against whom NCLT proceedings are initiated either by the bank,
or any other financial creditors or the operational creditors.
3. List of SMA accounts having exposure of Rs. 50 crore and above.
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4. Red Flagged Accounts refer RBI circular no. DBS.CO.CFMC. BC.

No.007/23.04.001/2014-15 dated May 7, 2015 on “Framework for dealing
with loan frauds”.
5. Cases under vigilance or investigation for fraud. These are typically the ones
not reported as fraud and hence not available with Fraud monitoring
department.
6. List of upgraded accounts in the branch above Rs. 1 Crore.
7. Checking of Central Repository of Information on Large Credits (CRILC)
reported accounts for classification with other banks.
8. Restructured project loans, by way of revision of DCCO beyond the time
limits and retention of the ‘standard’ asset classification.
9. Large exposures on infrastructure and project funding, where there is
considerable time lag from the date of sanction / financial closures /
implementation to the date of commercial operation, effective / periodic
monitoring of such accounts with reference to the progress of work / project
implementation / government consents and approvals / capital required to be
brought in by the promoter, etc.
It is necessary to keep the following developments in mind while conducting
CMRD audit:
Market mechanism for Large Borrowers
15.11 Regarding the market mechanism for large borrowers the Auditor is
required to bestow his attention on the following:
 Guidelines issued on August 25, 2016, effective from April 1, 2017.
 Build-up of high concentration of credit risk at the systemic level in the
banking sector. While single and group exposure norms put a ceiling on the
amount an entity can borrow from a single bank, there is no ceiling on the
total bank borrowing by a corporate entity. This has resulted in banks
collectively having very large exposures to some of the large corporates in
India, particularly in power/ infrastructure, housing finance and steel
sectors/ industries. As observed from the analysis, many large corporates
are excessively leveraged and banking sector’s aggregate exposure
towards such companies is also excessively high. This poses a collective
concentration risk to the banking sector, even when the single and group
borrower exposures for each bank remain well within the prescribed
exposure limits.
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 Framework mitigates the risk posed to the banking system on account of

large aggregate lending by the banking system to a single corporate as the
single borrower exposure limit linked to a bank’s Tier 1 capital may not by
itself be sufficient to contain the risk the banking system is exposed to.
15.12 Key Aspects of this mechanism are discussed hereunder:
 Aggregate Sanctioned Credit Limit (ASCL) - The aggregate of the fund
based credit limits sanctioned or outstanding, whichever is higher, to a
borrower by the banking system. ASCL would also include unlisted privately
placed debt with the banking system.
 Specified Borrower: A borrower having an ASCL of more than
o Rs. 25,000 crore at any time during FY 2017-18.
o Rs. 15,000 crore at any time during FY 2018-19.
o Rs. 10,000 crore at any time from April 1, 2019 onwards.
 Reference Date: The date on which a borrower becomes a ‘specified
borrower’.
 Normally permitted lending limit (NPLL): 50 percent of the incremental
funds raised by the specified borrower over and above its ASCL as on the
reference date, in the financial years (FYs) succeeding the FY in which the
reference date falls. For this purpose, any funds raised by way of equity
shall be deemed to be part of the incremental funds raised by the specified
borrower (from outside the banking system) in the given year.
 Prudential Measures for NPLL: From 2017-18 onwards, incremental
exposure of the banking system to a specified borrower beyond NPLL shall
be deemed to carry higher risk which shall be recognised by way of
additional provisioning and higher risk weights as under:
o Additional provisions of 3 percentage points over and above the
applicable provision on the incremental exposure of the banking system
in excess of NPLL, which shall be distributed in proportion to each
bank’s funded exposure to the specified borrower.
o Additional Risk weight of 75 percentage points over and above the
applicable risk weight for the exposure to the specified borrower. The
resultant additional risk weighted exposure, in terms of risk weighted
assets (RWA), shall be distributed in proportion to each bank’s funded
exposure to the specified borrower.
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Mandatory Loan System for Delivery of Bank Credit

15.13 The Auditor should note the following:
 Draft Guidelines issued on June 11, 2018. Final Guidelines issued on
December 5, 2018.
 Guidelines made effective from April 1, 2019.
 Banks provide working capital finance by way of cash credit/overdraft,
working capital demand loan, purchase/discount of bills, bank guarantee,
letter of credit, factoring, etc. Cash credit (CC) is by far the most popular
mode of working capital financing.
 While CC has its benefits, it also poses several regulatory challenges such
as perpetual roll overs, transmission of liquidity management from the
borrowers to banks/RBI, hampering of smooth transmission of monetary
policy, etc.
Key Aspects of the Draft:
15.14 The salient aspects of the draft guidelines are as under:
 Minimum level of ‘loan component’ and Effective date: In respect of
borrowers having aggregate fund based working capital limit of Rs. 1500
million and above from the banking system, a minimum level of ‘loan
component’ of 40 percent shall be effective from April 1, 2019. Accordingly,
for such borrowers, the outstanding ‘loan component’ (Working Capital
Loan) must be equal to at least 40 percent of the sanctioned fund based
working capital limit, including ad hoc limits and TODs.
 Sharing of Working Capital Finance: All lenders in the consortium shall
be individually and jointly responsible to make sure that at the aggregate
level, the ‘loan component’ meets the above-mentioned requirements.
Under Multiple Banking Arrangements (MBAs), each bank shall ensure
adherence to these guidelines at individual bank level.
 Amount and tenor of the loan: The amount and tenor of the loan
component may be fixed by banks in consultation with the borrowers,
subject to the tenor being not less than seven days. Banks may decide to
split the loan component into WCLs with different maturity periods as per
the needs of the borrowers.
 Repayment/Renewal/Rollover of Loan Component: Banks/consortia/
syndicates will have the discretion to stipulate repayment of the WCLs in
instalments or by way of a "bullet" repayment, subject to IRAC norms.
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Banks may consider rollover of the WCLs at the request of the borrower,
subject to compliance with the extant IRAC norms.
 Risk weights for undrawn portion of cash credit limits: Effective from
April 1, 2019, the undrawn portion of cash credit/ overdraft limits sanctioned
to the aforesaid large borrowers, irrespective of whether unconditionally
cancellable or not, shall attract a credit conversion factor of 20 percent.
 Effective Date: The guidelines made effective from April 1, 2019 covering
both existing as well as new relationships. The 40 percent loan component
will be revised to 60 percent, with effect from July 1, 2019.
Restructuring of MSME Accounts
15.15 In order to give relief to stressed MSMEs the RBI has introduced one-
time restructuring of MSME Accounts subject to conditions as mentioned in
circular DBR.No.BP.BC.18/21.04.048/2018-19 dated 01st January, 2019. Validity
of this scheme was till 31st March 2020.
15.16 On 11th February, 2020 RBI vide circular No. DOR.No.BP.BC.34/
21.04.048/2019-20 the RBI decided to extend the validity of the above scheme
till 31st December, 2020.
15.17 RBI Circular dated 11th February, 2020 clearly mentioned that accounts
which have already been restructured in terms of the circular dated January 1,
2019 shall be ineligible for restructuring under circular dated 11th February, 2020.
15.18 Further, in view of the continued need to support the viable MSME
entities on account of the fallout of Covid19, RBI vide circular No.
DOR.No.BP.BC/4/ 21.04.048/2020-21 dated 6th August, 2020 the RBI has
extended the restructuring scheme notified vide circular dated 11th February,
2020 to 31st March, 2021. Further, vide circular no. DOR.No.BP.BC/13/
21.04.048/2020-21 dated 7 September 2020, RBI has also stipulated certain key
ratios while finalizing the resolution plans in respect of eligible borrowers.
15.19 The Auditor should ensure that the accounts restructured as per the
above-mentioned scheme satisfy all the conditions stipulated in the respective
circulars issued by RBI. In addition to that it should be verified that no MSME
account is restructured more than once under this Scheme.
Restructuring of Accounts
15.20 The following two calculations and working are integral parts of the
department audit:
 Sacrifice calculations at the end of the period.
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 Additional provisioning of the overall restructured portfolio.

These calculations are generally not being done by the CBS system of the Bank
at branches level.
Other Aspects
15.21 The Auditor should also obtain copies of inspection and other internal
audit reports and latest Long Form Audit Report of this Department which covers
the efficiency of various functional operations.
15.22 Any deviations or discrepancies noted should be appropriately reported
in the Long Form Audit Report and major observations need to be discussed with
the management / respective committees in the Bank.
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16
Consolidation and Balance Sheet
Preparation
16.01 The preparation of the financial statements in case of a bank is

significantly different as compared to the preparation of the financial statement of
the companies. The Third Schedule to the Banking Regulation Act, 1949 has
prescribed Form A (Format of Balance Sheet) and Form B (Format of Profit and
Loss Account). These formats for the Balance Sheet and Profit & Loss account
are prescribed as per Section 29 of the Banking Regulation Act, 1949.
16.02 The process of preparation of the financial statements is divided into
following phases:
A. Preparation of Standalone Financial Statements including consolidation of
the Branch Accounts, Role of SBA and SCA.
B. Preparation of Consolidated Financial Statements (including subsidiary,
associates, joint venture), Role of SCA.
A. Standalone Financial Statements including Branch Consolidation
16.03 The preparation of the Standalone Financials of the Bank is primarily
the consolidation of branch accounts and incorporation of various
verticals/departments at the bank. The consolidation of branch accounts (audited
and unaudited) is one of the important and sensitive aspect of the financial
statements of a bank. Preparation of the consolidated financial statements of the
bank (after consolidation of accounts of branches) is the responsibility of the
bank’s management. RBI vide its Circular No DBOD.No.BP.BC.72/
21.04.018/2001-02 dated February 25, 2003 has issued guidelines to banks on
consolidated accounting and other quantitative methods.
16.04 The following documents audited by the Statutory Branch Auditor are
consolidated at the Bank level:
 Balance Sheet
 Profit and Loss Account
 LFAR (Long Form Audit Report)
 Ghosh Committee compliance checklist

 Jilani Committee compliance checklist
 Tax Audit report
 Various other reports like assets classification, fixed assets, bills payable,
sundries, credit subventions, etc.
Process of consolidation
Branches
Regions
Zones
Verticals
Zones +
Verticals
Bank
16.05 The consolidation process starts from the Branch level and the
accounts of branches get consolidated at the respective regional office and those
of all regional offices get consolidated at respective Zonal office and all zonal
offices accounts get consolidated at Head Office. The procedures regarding
consolidation of accounts vary from bank to bank. In case of private Banks, the
consolidation process is centralized at the Head office since the systems and
processes of accounting are centralised and there is no concept of mandatory
branch audit by the Reserve bank of India.
16.06 All banks are on one or the other CBS application platform. However,
the CBS application is implemented largely as a transaction recording software.
As output, it can only give a Trial Balance. All financial Statements and reports
as required by SBI Act, BR Act, BCA Act, RBI, SEBI and Companies Act are
prepared with the help of another application where the data flows from various
sources. The data from the CBS will flow without manual intervention. but that
may not be true for the financial statements of Associates, Subsidiaries and Joint
Ventures.
16.07 Bank managements generally follow the below under-mentioned
process for the purpose of consolidation:
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Step 1
Data for the Financial Statements as on 31st March
16.08 At the year-end i.e., 31st March, the bank provides the financial data to
the statutory auditor in the form of various returns, Branch Balance Sheet, Profit
and Loss Account for the purpose of the audit.
Step 2
Audit Adjustments through Memorandum of Changes (MOC)
16.09 There are two types of financial statements, Pre-MOC, i.e., the original
data and Post-MOC, i.e., after giving the effect of accounting entries suggested
by the Statutory Central Auditor (which is known as MOC). The effect of these
MOCs are not fed in the live data but are recorded on a different software at
appropriate consolidation level and are considered for the purpose of giving the
financial impact in the closing financials.
16.10 Banks have varied mechanisms of posting the effects of the MOC’s in
the financial statements. e.g. in few banks all MOCs suggested at branches get
consolidated and recorded at Controlling Offices (Regional / Zonal / Circle
offices) and MOCs of Controlling Offices gets consolidated at the Head Office.
16.11 In this way, MOCs gets recorded in the parallel software e.g. ROSS,
ADF at all levels of the bank. For making changes in the financial statements
there must be a MOC approved by the SBA. Therefore, there will be a MOC for
the difference between Pre-MOC financial statements and Post-MOC financial
statements.
Accounting of MOC effect in live data
16.12 After the financial statements get approved and signed with all changes
the MOCs gets accounted in live data. For example, the financial statements for
the financial year 2019-20 gets approved and signed on 30th April, 2020, then on
that day or on any other day with value date of 30th April, 2020, all MOCs will be
accounted in the live data in CBS. Thus, if an account is marked as NPA by way
of MOC during the audit, the same would be effected as NPA in the system from
that day with date of NPA being the date as per the MOC suggested by the
Auditor.
Step 3
Consolidation at Controlling Office (CO)-Regional Office/Zonal Office
16.13 The process involves the following:
1. Branches can be either audited branches or unaudited branches depending
on the limits prescribed.
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2. The branch financial statements are generated by the Information

Technology department (ITD) or Central data Centre (CDC) and given to the
branches in the respective folders. These are used for audit by the SBA.
These statements once signed by the concerned bank official (with or
without MOC) are submitted to the regional(RO) or Zonal office(ZO) for
further processing. Where there are MOCs the financial statements will be
signed as given by the ITD but will carry the effect of MOC in parallel to be
consolidated at ZO.
3. Similarly, the RO/ZO standalone financial statement is prepared and
consolidated like a branch. All RO/ZO are cost centres and SCA will be
called upon to certify its financial statements.
4. These Controlling Office accounts get consolidated and adjustments, if any,
are made at regional level. The Controlling Office is a cost centre and the
auditor has to certify the financial statements of the Controlling Office in
addition to the consolidation of the Branches under the relevant Controlling
Office.
Audit Approach:
1. Statutory Central Auditor (SCA) for a CO must verify the completeness of
the data uploaded by the branches into the system. However, this
consolidation process is automated at most of the banks and the Auditor
should verify the various controls adopted by the controlling office
management to ensure the completeness.
2. SCA should obtain reasonable assurance and sufficient appropriate audit
evidence of the adjustments made if any at the Controlling office level for the
accounts which are audited by the Statutory Branch Auditor.
3. SCA should also reconcile and verify the effect of the Branch MOC’s which
are consolidated and effected at the CO office.
4. SCA may communicate to the SBAs, the requirements regarding process of
consolidation for the current year, about the significant observations from the
previous year’s audit, quarterly reviews and additional precautions,
modifications in Audit Program required considering the recent RBI
Circulars. This communication can be circulated along with the closing
instructions to SBAs.
5. SCA should ensure on sample basis if all the documents as required by the
respective banks have been taken at each level of consolidation i.e.
appropriate flow of data along with the required documents.
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6. SCAs are also required to verify the consolidation of various

certificates/returns which are audited by the SBAs; the SCA should clearly
bring out his/her responsibility while issuing the report at the CO level.
Consolidation Process at Head Office:
16.14 The consolidation process is as under:
At Head Office level all the Controlling office data is consolidated and further
adjustments if any is made, ensuring the accuracy of the data uploaded at each
stage of hierarchy. Further, the financial information from various other
departments are also consolidated and incorporated in the Financial Statements
like for e.g. Gratuity, Pension, Leave encashment, etc. are audited by the vertical
auditor and are consolidated while preparing the financial statements.
Also various provisions such as Provision on Standard Assets, Restructured
accounts, Stress sector provision are computed and provided at the Head office
level.
Audit Approach to be followed by the Consolidating Auditor:
16.15 The consolidating Auditor should do the following:
1. Understand the various process and systems used by the bank for
preparation and presentation of the financial statements.
2. Verify the various checks and controls placed by the bank to identify any
unusual entries or any other difference.
3. Ensure the completeness as well as accuracy of the data at the whole Bank
level. However, the responsibility of the consolidating auditor is to verify the
accuracy of the data consolidated from the various returns/financial
information which are audited by the auditor of various
departments/verticals.
4. Obtain reasonable assurance and sufficient appropriate audit evidence of
the adjustments made if any at the bank level.
16.16 The Consolidating Auditor should also examine the following key
additional aspects:
a. Check the effect of MOC from previous year is properly accounted.
b. Reversal of interest on inter-branch balances and other similar items.
c. Cancellation of transfers of assets among branches.
d. Review the observations made by the SBAs in audit report and LFAR;
however, such review is done by the respective auditors of controlling office.
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Where the SBA has made comment which should normally be reported
through a MOC, the SCA is well advised to insist on MOC rather than make
the changes based on the report. The MOC must come signed from the SBA
who reported the deviation.
e. Effect of Memorandum of Changes (MOC) if any made at Head office.
f. Provision on Standard Assets, Fraud Provision and Other Provisions.
g. Review of MOCs to ascertain whether there are systemic issues or
deficiencies which need to be addressed by the management.
IT Controls
16.17 There is a significant and voluminous data involved during this whole
process of consolidation. Consolidation being a system oriented process, the
Auditor must verify if the IT controls of the bank are effective. The Auditor should
also review the system audit report available with the Bank with respect to the
system used for the purpose of preparation of the financial statement.
16.18 The application that is used for consolidation is mainly departmental
and sometimes the ITD may not have full control over its daily functions. In many
banks this could be an end user application like MS Excel or some simple
addition software. It, therefore, requires higher level of vigilance on the part of
SCA to ensure that the possibility of material misstatements are removed by
testing vigorously.
Consolidation of Overseas Branches:
16.19 While consolidating the overseas branches the Auditor should examine
the following aspects:
a. Various reports of the overseas branches would be received in the local
currencies of the reporting countries which need to be converted into the
Indian currency.
b. The effect of reinstatement of assets and liability which is given in
Accounting standard 11, The Effects of Changes in Foreign Exchange
Rates. RBI has also issued a circular for compliance of AS 11.
DBOD.BP.BC.No.76/21.04.018/2005-06) dated April 5, 2006 and RBI/2016-
17/281 DBR.BP.BC.No.61/ 21.04.018/2016-17 on Guidelines on compliance
with Accounting Standard (AS) 11 [The Effects of Changes in Foreign
Exchange Rates] by banks – Clarification dated April 18, 2017.
c. As per AS 11 (revised 2003), the method used to translate the financial
statements of a foreign operation depends on the way in which it is financed
and operates in relation to the reporting enterprise. For this purpose, foreign
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operations are classified as either "integral foreign operations" or "non-

integral foreign operations".
d. In terms of its Circular no DBOD.BP.BC.76/ 21.04.018/2004-05 dated March
15, 2005, the RBI has prescribed that with the issuance of the said circular,
there should normally be no need for any Statutory Auditor for qualifying
financial statements of a bank for non-compliance with Accounting Standard
11 (Revised 2003). Whenever specific difference in opinion arises among
the Auditors, the Statutory Central Auditors would take a final view.
Continuing difference, if any, could be sorted out in prior consultation with
RBI, if necessary.
e. The Auditor may also review the compliance with the applicable local laws
and regulations of the concerned country by the overseas branches. The
Auditor should also review the report given by the overseas branch auditor
to identify the areas of concerns.
f. The Auditor should also verify the process of translation from the foreign
currency to the presentation currency and ensure that the consistent
process have been followed by the bank over a period.
g. The asset classification and provisioning on the loans are done as per the
local laws of those respective branches; however the Auditor should ensure
that the stricter norms have been followed by the bank at the time of
consolidation.
h. The Auditor should have issued audit instructions to the overseas branch
Auditor for various compliances/control at the respective branches. The
response needs to be considered and further information, if necessary
should be sought.
i. Many jurisdictions require the branches to report their financial statements
under IFRS. In such cases the SCA will require iGAAP financial statements
certified by the Auditor for the consolidation purposes.
Disclosure in Standalone Financial Statements:
16.20 The Consolidating Auditor is also required to verify various disclosures
made in the Financial Statements as required under Master Circular no.
RBI/2015-16/99 DBR.BP.BC No.23/21.04.018/2015-16 dated July 1, 2015
“Disclosure in Financial Statements - Notes to Accounts”. The circular requires
the bank to give various disclosures in Annual Accounts. Some of these
disclosures are audited and certified by the Auditor of various
department/verticals. However, generally there are certain disclosures which are
prepared and to be verified by the consolidating auditor e.g. Segment Reporting
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as per RBI Circular and Accounting Standard 17 and Earning Per Share as per
Accounting Standard 20. The consolidating auditor should carefully review these
disclosures and ensure their compliance as per the Master Circular or other
circulars/notification issued from time to time. Further, the Auditor should
carefully review the disclosure made for divergence in the asset classification
and provisioning as required by RBI Circular no. RBI/2016-17/283
DBR.BP.BC.No.63/21.04.018/2016-17 dated April 18, 2017. RBI/2019-20/220
DOR.No.BP.BC.63/21.04.048/2019-20 dated April 17, 2020 has added 4 more
disclosures which are required to be made in the “Notes to Accounts” for the year
2019-20 and 2020-21 relating to the COVID 19 Regulatory Package – Asset
Classification and Provisioning.
B. Consolidated Financial Statement (including Subsidiary, Associates and
Joint venture)
16.21 The PSB’s and Private Sector Banks in India are listed on recognised
stock exchange and are required to comply with the SEBI Regulations including
Listing Obligations and Disclosure Requirements (LODR) as issued and
amended on time to time basis.
16.22 As per Regulation 33 of SEBI LODR Regulations, the listed entities are
required to prepare the standalone financial results and consolidated financial
results shall be prepared as per Generally Accepted Accounting Principles in
India. Further, a new sub-regulation was inserted under Regulation 33 of the
SEBI LODR Regulations, which came into effect from April 01, 2019 requiring the
entities to prepare consolidated financial statements on quarterly basis.
16.23 Consolidated Financial Statements (CFS) are presented for a group of
entities under the control of a parent. A parent is an entity that has one or more
subsidiaries. It may be noted that if a parent does not have subsidiary but has
investment in associates and joint ventures, it will be required to prepare CFS.
However, for the purpose of quarterly reporting under SEBI guidelines, CFS will
not be necessary if the parent does not have subsidiary but has investments in
associates and joint ventures. For this guidance note a parent would mean a
Consolidating Bank.
Responsibility of a Bank
16.24 The responsibility for the preparation and presentation of CFS is that of
the Bank. This responsibility, inter alia, includes:
1. Identifying components including financial information.
2. Identifying reportable segments.
3. Identifying related party transactions.
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Responsibility of the Statutory Central Auditor

16.25 It is necessary for the Auditor to take into consideration the accounting
standards relevant for the purpose of CFS. They are AS 21: Consolidated
Financial Statements, AS 23: Accounting for Investments in Associates in
Consolidated Financial Statements and AS 27: Financial Reporting of Interests in
Joint Ventures. Further, careful consideration should be given by the Auditor of
CFS to Other Matters paragraph, Emphasis of Matter paragraph, Modified
Opinion in the report issued by the component auditors. The Auditor should also
refer Guidance Note on Audit of Consolidated Financial Statements (Revised
2016) issued by ICAI for the guidance while auditing the CFS.
16.26 When the parent bank’s auditor makes a reference to the auditor’s
report of the other auditors in the auditor’s report on CFS, the latter should
disclose clearly the magnitude of the portion of the financial statements audited
by the other auditor(s) in “Other Matter” paragraph. This may be done by stating
the rupee amounts or percentages of total assets and total revenue of
subsidiary(ies) included in CFS not audited by the parent’s auditor.
16.27 However, reference in the report of the auditor of CFS to the fact that
part of the audit of the group was made by other auditor(s) is not to be construed
as a modification of the opinion. With reference to the SEBI Circular no.
CIR/CFD/CMD1/44/ 2019 dated March 29, 2019 the Auditor should also consider
implications on reporting if some of the components are unaudited2.
16.28 Generally, while conducting audit of a bank, SCA has a practice of
issuing general instructions for the SBAs to facilitate easy consolidation of
branch accounts. It would be appropriate to have a similar approach with respect
to auditors of components, if the component auditors are different from the group
auditor. This is especially important in case of “the other financial information”
which is necessary for the purpose of consolidation and preparation of notes. It is
advisable to make sufficient arrangements for co-ordination and efforts at the
planning stage. In the present year the impact of COVID 19 related circulars and
regulations will have a major role to play. These have to be communicated to
SBA such that the SCA gets sufficient information to conclude.
Audit of Consolidated Financial Statements
16.29 The Auditor should carefully review the following while auditing the
consolidated Financial Statements:
2
Attention in this regard is drawn to the Announcement on “Manner of Disclosure in the Auditor’s
Report of the Fact of Inclusion of Unaudited Financial Statements/ Information of Component/s in
the Financial Statements Audited by the Principal Auditor(s)” issued by ICAI in February, 2014.
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 Accounting policy of the bank and its various components.

 Any subsidiaries, associates and joint ventures of the bank not
consolidated under CFS.
 Changes in the shareholding that might have taken place since the last
audit.
16.30 As far as possible the formats of the financial statements and cash
flows used for the purpose of bank’s individual financial reporting should be used
for the CFS. In case the subsidiaries/joint venture accounts are prepared as per
different regulation such as those issued by IRDA etc., the Auditor should be
careful while converting the same into format prescribed by Banking Regulation
Act. The Auditor, wherever possible, should obtain the “Fit-for-consolidation”
financial statements duly certified by the respective Statutory Auditors of
Subsidiaries/Joint Ventures.
16.31 The SCAs should examine that the CFS is prepared using uniform
accounting policies for matters like transactions and other events in similar
circumstances. If it is not practicable, that fact shall be disclosed together with
the proportions of the items in the CFS to which the different accounting policies
have been applied. For preparing the CFS using uniform accounting policies, the
banks shall rely on a Statement of Adjustments for non-uniform accounting
policies, furnished by the Statutory Auditors of the subsidiaries.
16.32 In cases where different entities in a group are governed by different
accounting norms laid down by the concerned regulator for different businesses,
the bank shall use for consolidation purposes the rules and regulatory
requirements applicable to the banks in respect of like transactions and other
events in similar circumstances. In situations where regulatory norms have not
been prescribed by RBI, the norms as applicable according to the accounting
standards may be followed.
16.33 The Standard on Auditing (SA) 580, “Written Representations” requires
the auditor to obtain written representations from management and where
appropriate those charged with governance. Such representations would include:
 Completeness of components included in the CFS.
 Identification of reportable segments for segment reporting.
 Identification of related parties and related party transactions for reporting.
Appropriateness and completeness of consolidation adjustments, including the
elimination of intra-group transactions.
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16.34 The valuation of investments in subsidiaries which are not consolidated

and associates which are excluded under AS 23, ‘Accounting for Investments in
Associates in Consolidated Financial Statements’, shall be as per the relevant
valuation norms issued by the Reserve Bank of India. The valuation of
investments in joint ventures shall be accounted for under the ‘proportionate
consolidation’ method as per AS 27, ‘Financial Reporting of Interests in Joint
Ventures’. The banks may consider the provisions of the accounting standards
relating to the exclusion of subsidiaries, associates or joint ventures from
consolidation under specific circumstances. This aspect shall be examined by
the Auditor.
Other Aspects
Head Office
16.35 Apart from examination of consolidation of branch returns, verification
of capital and reserves, and verification of investments and provisioning in
respect thereof, the Statutory Central Auditors also usually deal with the
following items:
 Review of Internal/ Office accounts.
 Depreciation on assets like, premises, etc. where the recording of the
relevant fixed assets is centralised at the head office.
 Employee benefits and provisions for certain employee costs, such as,
bonus/ex-gratia in lieu of bonus, gratuity, leave encashment, pension and
other retirement benefits.
 Provision for taxation.
 Provision for audit fee.
 Provisions to meet any other specific liabilities or contingencies the
amount of which is material, for example, provision for revision in pay-
scales of employees, provision for foreign exchange fluctuations, etc.
 Statutory Auditors of public sector banks (PSBs) shall also check that, the
conditions attached to capital infusion by the Government have been
complied with by the respective PSBs. In case of any non-compliance, the
same may be suitably highlighted by the Statutory Auditors of PSBs in
their Audit Report.
 Dividends.
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Review of Internal/ Office accounts

16.36 The Reserve Bank of India has time and again emphasised the need
for instituting proper control over the opening and operation of internal (office)
accounts, in general, and of the sundry I suspense accounts. To curb frauds,
malpractices, the opening of such internal accounts in the banks, as also their
periodic reconciliation, should receive utmost attention of their Top
Managements and be subjected to necessary checks in the form of concurrent
audit, coverage under Long Form Audit Report, as also monitoring and review
by the Audit Committee of the Board (ACB).
16.37 Post-migration to Core Banking Solutions(CBS), due to inherent
nature of IT systems, certain practices were open to susceptible operations in
opening and operating internal accounts that may prevent the system from
slipping into NPA. Wherever NPA was inaccurately captured by the system, in
almost all such cases, system-based identification of NPAs was bypassed in
this manner.
16.38 Sometimes cases have been found where these internal
accounts/branch GLs have been used for disbursing loan amount, parking
Govt. funds, disguising customer's cash transactions, booking expenses such
as telephone charges, ATM charges, service charge and interest reversals,
etc. Similarly, there are instances of advances to customers/staff members
have also been debited to such accounts.
16.39 Such transactions, though sometimes done inadvertently, amounts to
violation of the extant regulatory instructions, and tantamount to manipulation
of accounts.
16.40 Auditors need to ensure that internal accounts are not allowed to be
used unauthorised and proper checks are exercised before opening any such
account, including adherence to the delegated powers in this regard.
16.41 The Auditor is expected to check the CGL or BGL which relates to
Suspense, Sundry Debits, Sundry receivables, Inter-branch accounts, HO
accounts which are parking accounts. The normal clearance is T+1 day. The
SOP/Policy and rules of the bank will prescribe the permissible entries. That
would need evaluation and tracing if the entries are pending for more than 90
days. Any entry pending for more than 90 days requires 100% provision.
Provisioning for Non-performing Assets
16.42 The prudential norms issued by the RBI prescribe the percentage of
provision to be made in respect of advances classified under different
categories, viz., standard, sub-standard, doubtful and loss assets. In this
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context, the RBI has issued “Master Circular – Prudential Norms on Income
Recognition, Asset Classification and Provisioning pertaining to Advances”
(DBR.No.BP.BC.2/21.04.048/2015-16) dated July 1, 2015, read with updates
thereafter. The primary responsibility for making adequate provisions for any
diminution in the value of loan assets, investment or other assets is that of the
bank management and the statutory auditors. The assessment made by the
inspecting officer of the RBI is furnished to the bank to assist the bank
management and the statutory auditors in taking a decision in regard to making
adequate and necessary provisions in terms of prudential guidelines. It may be
emphasised that the percentages prescribed by the RBI reflect the minimum
proportion of an advance that a bank ought to provide for to comply with the
guidelines. A bank can, at its discretion, make a higher provision than that
required under the prudential guidelines. Further, the bank needs to ensure
that the bank complies with the PCR (Provision Coverage Ratio) as prescribed
by RBI.
Other Provisions at central office
1. Non-Performing Investments
Meaning of NPI
16.43 In respect of securities included in HTM/AFS/HFT Category where
interest/ principal is in arrears:
(i) Interest/ instalment (including maturity proceeds) is due and remains
unpaid for more than 90 days.
(ii) In case of preference shares where the fixed Dividend/ Maturity Proceeds is
not paid and remains outstanding for more than 90 days.
(iii) In the case of equity shares, in the event the investment in the shares of
any company is valued at Re.1 per company on account of the non-
availability of the latest balance sheet those equity shares would also be
reckoned as NPI.
(iv) If any credit facility availed by the issuer is NPA in the books of the bank,
investment in any of the securities issued by the same issuer would also be
treated as NPI and vice versa.
(v) The investments in debentures / bonds, which are deemed to be in the
nature of advance would also be subjected to NPI norms as applicable to
investments.
2. Convergence of Foreign Subsidiaries/Branches Balance Sheet
16.44 The Balance Sheets of the respective branches and subsidiaries are
drawn in the respective currencies hence for the purpose of the consolidation the
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same needs to be converted to the INR.

1. In compliance with AS 11 (Revised), The Balance sheet items are converted
to INR at the Closing Rates published by FEDAI.
2. The Profit and Loss account is converted on incremental basis for every
quarter based on the average rate of the quarter published by FEDAI.
For example, if the expense for the period of June 2019 is 100$, then the same
needs to be converted at average rate for the quarter ended June 2019.
If the same expense for the period of September 2019 is 300$, then the
incremental 200$ gets converted at average rate for the quarter ended
September 2019.
Recognition of Certain Expenses
16.45 Certain expenses, such as the following, are usually recognised at the
head office level (or at zonal or regional level):
(a) Directors' fees, allowances and expenses
(b) Insurance
(c) Auditors’ fees and expenses
(d) GST, etc.
Directors' Fees, Allowances and Expenses
16.46 This item includes sitting fees and all other items of expenditure
incurred in relation to directors. The daily allowance, hotel charges,
conveyance charges, etc., though in the nature of reimbursement of expenses
incurred, may be included under this head. Similar expenses of local
Committee members may also be included under this head. Under the
Companies Act, 2013 a director may receive remuneration by way of a fee for
each meeting of the Board or a Committee attended by him. Local Committees
are appointed by banks as advisory bodies in respect of the areas allotted to
them. Their members are also paid fees or allowances.
16.47 The Auditor may check the sitting fees and allowances with reference
to the articles of the banking company, agreements, minutes of the Board and
Local Committees, etc. It may be noted that in the case of nationalised banks,
the fees and the basis of reimbursement of travelling expenses are fixed by the
Central Government in consultation with the RBI. Copies of the relevant orders
may be examined in this behalf.
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Insurance
16.48 This item includes insurance charges on bank's property. It also
includes insurance premium paid to DICGC, etc., to the extent they are not
recovered from the parties concerned.
16.49 Banks submit a Return on Total Insurable Deposits to RBI on a
periodic basis. Insurance premium is payable on such deposits. The Auditor
should check the basis of computation of insurable deposits and the insurance
premium paid on same.
16.50 The DICGC guarantee fees payable by banks are based on the
outstanding amount of priority sector advances covered by DICGC as on 31st
March every year. The Auditor should check the basis of payment/provision for
such guarantee fees.
Auditors' Fees and Expenses
16.51 This item includes the fees paid to the statutory auditors and auditors
for professional services rendered and all expenses for performing their duties,
even though they may be in the nature of reimbursement of expenses. If
external auditors have been appointed by banks themselves for internal
inspections and audits and other services, the expenses incurred in that
context including fees incurred for such assignments may not be included
under this head but shown under 'Other Expenditure'.
Accounting for GST
16.52 As per the GST Law, banks are eligible for 50% of the GST paid on
the Purchase of input/capital goods and availment of services. Generally,
accounting for GST Receivable is centralised. Entire GST paid for expenses /
capital goods at the branch level is first debited to Profit & Loss Account. Then
at the HO Level while preparing the consolidated Balance sheet for the Bank
as a whole, 50% of eligible Input Tax Credit is recognised as asset (GST
Receivable). However, the treatment for accounting GST can differ from Bank
to Bank.
16.53 The Auditor needs to pay proper attention to the calculation done for
transferring eligible ITC from Expense head to GST Receivable Account. It is
also to be noted that GST paid on Inter-state supplies of goods or services (or
both) between two branches of the same 100% GST is eligible.
Provision for Depreciation
16.54 As mentioned earlier, practices differ amongst banks with regard to
accounting for fixed assets and provision for depreciation thereon. In case
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these accounting aspects in respect of all or certain categories of fixed assets

are centralised at the head office level, the Statutory Central Auditor should
examine the same. The procedures to be followed by the Auditor in this
respect would be similar to those discussed in Chapter 12, “Fixed Assets and
Other Assets” of Section B of this Guidance Note at the branch level, except
that the Statutory Central Auditor may request the respective branch auditors
to examine the evidence of physical existence of fixed assets that, as per the
records, are located at the branch or have been provided to employees for use
(such as residential premises).
Provisions for Certain Employee Costs
16.55 Provisions for certain employee costs such as bonus/ex-gratia in lieu
of bonus, and gratuity, leave encashment, pension and other retirement
benefits are usually made at the head office level.
16.56 The Auditor should examine whether the liability for bonus is provided
for in accordance with the Payment of Bonus Act, 1965 and/or agreement with
the employees or award of competent authority.
16.57 The Auditor should examine whether provisions in respect of
employee benefits are made in accordance with the requirements of
Accounting Standard (AS) 15, “Employee Benefits”. The Auditor should
particularly examine whether provision for leave encashment has been made
by the bank. As per AS 15, employee benefits include all forms of
consideration given by an enterprise in exchange for services rendered by
employees. It includes short-term employee benefits such as wages, salaries
and social security contributions and non-monetary benefits, post-employment
benefits, other long-term employee benefits and termination benefits. The
Auditor should examine the adequacy of the provisions made with reference to
such documentary evidence such as reports of actuaries or certificates from
the Life Insurance Companies, as appropriate under the facts and
circumstances of the case.
16.58 In the case of employee benefits, the Master Circular on “Disclosure in
Financial Statements – Notes to Accounts” (DBR.BP.BC No. 23/21.04.018/
2015-16) dated July 1, 2015 issued by the RBI with reference to Accounting
Standard 15, specifies that Banks may follow the disclosure requirements
prescribed under AS 15 (Revised), ‘Employees Benefits’ issued by the ICAI.
Provision for Taxation
16.59 Provision for taxation relates to income-tax, (including corporate
dividend tax). The Auditor must ensure compliance with AS 22, “Accounting for
Taxes on Income”.
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Income-tax
16.60 Some of the items which have an effect on the liability of a bank for
income-tax and therefore, need to be specifically considered by the Auditor are
discussed in the following paragraphs.
16.61 The Statutory Auditor should consider the impact of Income
Computation and Disclosure Standards (ICDS) issued by CBDT while
calculating provision of tax. The notification requires income computation and
disclosure standards to be followed by all assessees, following mercantile
system of accounting, for the purposes of computation of income chargeable to
income-tax under the head “Profit and gains of business or profession” or
“Income from other sources”.
Provision for Bad and Doubtful Debts
16.62 Section 36(1)(vii) of the Income-tax Act, 1961 deals with the
allowability of bad debts and section 36(1)(viia) deals with the allowability of
provision for bad and doubtful debts. According to section 36(1)(vii), bad debts
written off are admissible deduction subject to the conditions prescribed under
section 36(2), i.e.,–
(i) no such deduction shall be allowed unless such debt or part thereof has
been taken into account in computing the income of the assessee of the
previous year in which the amount of such debt or part thereof is written off
or of an earlier previous year, or represents money lent in the ordinary
course of the business of banking or money-lending which is carried on by
the assessee;
(ii) if the amount ultimately recovered on any such debt or part of debt is less
than the difference between the debt or part and the amount so deducted,
the deficiency shall be deductible in the previous year in which the ultimate
recovery is made;
(iii) any such debt or part of the debt may be deducted if it has already been
written off as irrecoverable in the accounts of an earlier previous year, but
the Assessing Officer had not allowed it to be deducted on the ground that
it had not been established to have become a bad debt in that year;
(iv) where any such debt or part of debt is written off as irrecoverable in the
accounts of the previous year and the Assessing Officer is satisfied that
such debt or part became a bad debt in any earlier previous year not falling
beyond a period of four previous years immediately preceding the previous
year in which such debt or part is written off, the provisions of sub-section
(6) of section 155 shall apply;
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(v) where such debt or part of debt relates to advances made by an assessee
to which clause (viia) of sub-section (1) applies, no such deduction shall be
allowed unless the assessee has debited the amount of such debt or part of
debt in that previous year to the provision for bad and doubtful debts
account made under that clause.
16.63 The said deduction is limited to the amount by which the bad debts
exceed the credit balance in the provision for bad and doubtful debts account
made under section 36(1)(viia). According to section 36(1)(viia), a specified
percentage of the total income and a specified percentage of the aggregate
average advances made by the rural branches of the bank, both computed in
the prescribed manner, is allowable as a deduction in respect of provision for
bad and doubtful debts made by banks other than foreign banks.
16.64 A scheduled /non-scheduled bank has the option to claim a further
deduction for an amount not exceeding the income derived from redemption of
securities in accordance with a scheme framed by the Central Government.
This is in addition to the deduction specified in paragraphs above with respect
to section 36(1)(viia). However, for the purpose of claiming this deduction, it is
necessary that such income should be disclosed in the return of income under
the head ‘Profit and gains of business or profession”.
16.65 Section 36(1)(vii) requires the amount of any bad debt or part thereof
to be written off as irrecoverable in the accounts of the assessee for the
previous year. It is sufficient compliance of the section if the write off is done at
Head Office level.
Special Reserve
16.66 Deduction in respect of a special reserve created and maintained by a
banking company:
(a) Section 36(1)(viii) provides for a deduction in respect of any special reserve
created and maintained by a specified entity, which includes a banking
company.
(b) The quantum of deduction, however, should not exceed 20% of the profits
derived from eligible business computed under the head “Profits and gains
of business or profession” (before making any deduction under this clause)
carried to such reserve account.
(c) The eligible business, in case of a banking company, means the business
of providing long-term finance for –
(i) Industrial or agricultural development or development of infrastructure
facility in India; or
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(ii) Development of housing in India.

(d) However, where the aggregate amount carried to such reserve account
exceeds twice the amount of paid up share capital and general reserve,
no deduction shall be allowed in respect of such excess.
(e) The Reserve Bank of India has issued circular No.: DBOD.
No.BP.BC.77/21.04.018/2013-14 dated December 20, 2013 for creation of
deferred tax liability on special reserves created under section 36(1)(viii)
and entire Special Reserves may be reckoned for the purpose computation
of Tier-I Capital.
Interest on Non-Performing Accounts (NPAs)
16.67 According to section 43D, read with Rule 6EA of the Income-tax
Rules, 1962, the income of a scheduled bank by way of interest in relation to
such categories of bad or doubtful debts as may be prescribed having regard
to the guidelines issued by the RBI in relation to such debts, shall be
chargeable to tax only in the previous year in which it is credited to the Profit
and Loss Account or in the year of actual receipt, whichever is earlier.
Transactions with Foreign Banks/Foreign branches of Indian banks
16.68 The applicability of any Double Taxation Avoidance Agreement(DTAA)
is to be taken into account for the purpose of computation of tax in respect of
transactions with foreign banks or foreign branches of Indian banks.
16.69 Similarly the applicability of Transfer Pricing Regulations is to be
taken into account for the purpose of computation of tax in respect of
international transactions with associated enterprises covered under section
92E of the Income-tax Act, 1961. Reference may also be made to the
“Guidance Note on Report on International Transactions under section 92E of
the Income-tax Act, 1961 (Transfer Pricing)” issued by ICAI.
16.70 In respect of any provision for bad and doubtful debts made by a
foreign bank, an amount not exceeding 5% of the total income (computed
before making any deduction under Chapter VI-A) is allowable as deduction.
Tax Refunds/Demands
16.71 Where an assessment order is received during the year, the Auditor
should examine the assessment order and if any interest is determined on the
amount of refund, the same should be considered as income. In case where
the assessment results in fresh demand, the Auditor should consider the need
for additional provisioning. Where an assessment order is received during the
course of audit, the Auditor should examine the same and consider its impact,
if any, on the accounts under audit.
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16.72 It is not prudent to recognise interest on possible refund which is not

determined by any order from tax authorities.
Pending Proceedings
16.73 The Auditor should review the appellate orders received during the
year and consider the need for any additional provision/reversal.
Method of Accounting
16.74 Many banks account for commission, exchange, brokerage, interest
on bills, locker rent and other fees as income upon realisation. Section 145 of
the Income-tax Act, 1961 provides, inter alia, that income chargeable under the
head "Profits and Gains of Business and Profession" shall be computed in
accordance with either cash or mercantile system of accounting regularly
employed by the assessee. Auditors of banks to which the Companies Act
applies are required to follow the accrual basis of accounting. Further, accrual
being a fundamental accounting assumption, the Auditor would need to
consider modification/ reference to/ in the Auditor’s Report wherever cash
basis of accounting is followed.
Reversal of Earlier Year’s Provision
16.75 It is possible that subsequent judicial pronouncements/ appellate
orders may make the provisions of earlier years excessive.
16.76 As per Accounting Standard (AS) 29, "Provisions, Contingent liabilities
and Contingent Assets", a provision should be recognised only when (a) an
enterprise has a present obligation as a result of a past event, (b) it is possible
that an outflow of resources embodying economic benefits will be required to
settle the obligation, and (c) a reliable estimate can be made of the amount of
the obligation. If these conditions are not met, no provision should be
recognised.
16.77 Only in rare cases like for example, a law suit, it may not be clear
whether an enterprise has a present obligation. In such a case, an enterprise
determines whether a present obligation exists at the balance sheet date by
taking into account all available evidence. On the basis of such evidence, if it is
more likely than not that a present obligation exists at the balance sheet date a
provision is recognised (if other recognition criteria are also met). However,
where it is more likely that no obligation exists at the balance sheet date, a
contingent liability is disclosed unless the possibility of an outflow of resources
embodying economic benefits is remote.
16.78 On the above considerations, if there is no requirement to retain a
provision, it can be reversed and the amount of liability is included in
contingent liability. A suitable note on the following lines is recommended:
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(a) Provision for Income Tax is arrived at after due consideration of

decisions of the Appellate authorities and advice of counsels; and
(b) No provision is made for the disputed demands of Income tax keeping in
view the judicial pronouncements and/or legal counsels’ opinion.
Items Requiring Special Consideration
Tax Implications of Valuation of Investments
16.79 The RBI has issued various circulars on valuation of investments,
according to which the difference between the market value/value as per yield
to maturity method (YTM) will have to be provided in the books of accounts for
certain types of investments. Various judicial decisions on the allowability of
depreciation in valuation of investments, including implication of ICDS VIII,
should be considered while provisioning.
Notional Gain/Loss on Foreign Exchange Translations
16.80 Banks are required to translate their foreign exchange balances /
obligations in foreign currency as per FEDAI Guidelines. While recognising
gains or loss for tax purposes the following decisions may be considered by
the Auditor along with FEDAI Guidelines:
 The Madras High Court in the case of Indian Overseas Bank Vs.
Commissioner of Income-tax (1990) 183 ITR 200 has held that notional
profits on conversion of foreign exchange forward contracts is not taxable.
 The Madras High Court in the case of Commissioner of Income-tax Vs.
Indian Overseas Bank (1985) 151 ITR 446 has held that notional loss on
conversion of foreign exchange contracts is not tax deductible.
Carry forward of unabsorbed business loss and depreciation on
amalgamation of a banking company with a banking institution
16.81 Section 72AA of the Income Tax Act, 1961 deals with Provisions
relating to carry forward and set-off of accumulated loss and unabsorbed
depreciation allowance in a Scheme of amalgamation of banking company in
certain cases.
FATCA /CRS
16.82 Foreign Account Tax Compliance Act (known in short as FATCA) is a
legislation to counter tax evasion in the United States of America (USA). FATCA
was introduced by US Dept of Treasury (Treasury) and US Internal Revenue
Service (IRS) to encourage better tax compliance by preventing US persons from
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using banks and other financial organisations to avoid US taxation on their

income and assets.
16.83 India and the USA have signed reciprocal version of model 1 IGA for
FATCA on 9th July 2015. India signed the OECD’s CRS (Common Reporting
Standards) on 3rd June 2015. The IGA has 2 models – India has signed Model 1
IGA wherein banks will have to report information to the prescribed authority who
in turn will submit information to the IRS.
16.84 In Model 1 IGA, the Foreign Financial Institutions (FFI) have to report all
FATCA related information to their governmental agencies, which would then
report the FATCA related information to the IRS. Some Model 1 IGAs are
reciprocal, requiring the US to provide certain information about residents of the
Model 1 country to the Model 1 country in exchange for the information that
country provides to the USA. An FFI covered by a Model 1 IGA need not sign an
FFI agreement but needs to register on the IRS’s FATCA Registration Portal or
file Form 8957.
16.85 Like FATCA, Common Reporting Standard (CRS) is a reciprocal
exchange of information on financial accounts on an automatic basis with other
countries/ non-sovereign territories so as to combat the menace of offshore tax
evasion and avoidance and stashing of unaccounted money abroad.
16.86 India would be obligated to get its financial institutions to share financial
account information of accountholders who are tax residents in any of these
countries. Likewise, India would also get similar information through financial
institutions of such treaty countries.
16.87 CBDT has notified Rule 114H for Due Diligence Requirement under
FATCA; major requirements for the Bank are as under:
All the concerned financial institutions should register on the related e-filling
portal of Income Tax Department as Reporting Financial Institution by submitting
the requisite details. Thereafter, the reports can be submitted online by using the
digital signature of the ‘Designated Director’ by either uploading the Form 61B or
‘NIL’ report.
16.88 As per RBI Circular RBI/2015-16/165 DBR.AML.BC.No.36/14.01.001
/2015-16, dated August 28, 2015, for the new accounts opened after September
1, 2015, the due diligence procedures specified in Rule 114H (4) and 114H (6)
would be applicable.
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16.89 All the FIs have to submit reports online using the digital signature of
the designated director by either uploading Form 61B or ‘Nil Report’ by
September 10, 2015. The first reporting will be with respect to calendar year
2014 if an account has been identified as US reportable account consequent to
completion of due- diligence procedures as laid down in Rule 114H. Therefore,
the reasons for the ‘Nil Report’ should be captured as under:
a. For pre-existing accounts
Option 1: Due diligence procedure not completed.
Option 2: Due diligence procedure completed but no reportable US account
identified.
b. For new accounts
Option 1: Alternative procedure invoked.
Option 2: Due diligence procedure as applicable to new accounts completed
but no reportable US account identified.
16.90 All the regulated entities should take appropriate action for the
implementation of due diligence and reporting requirements as laid down in the
Rules and ensure compliance in a manner that lends itself to credible auditability
including audit of the IT system which should be suitably upgraded to not only
maintain the information required under the Rules but also to record and store
the due diligence procedures. In due course, the detailed guidelines for carrying
out audit of IT system for ascertaining the degree and level of compliance with
due diligence procedures as laid down in the Rules will be issued.
16.91 The Statutory Auditor should verify whether the Bank has put a process
in place for complying with guidelines under FATCA/CRS and submitted reports
as required by FATCA.
16.92 The Supreme Court passed an interim order on September 03, 2020
w.r.t. the Writ Petition filed by Gajendra Sharma, stating that ‘the accounts which
were not declared NPA till 31.08.2020 shall not be declared NPA till further
orders.’ The SCA may refer to guidance given in para 11.370 of Chapter 11
“Reporting for Advances” of Section B of this Guidance Note in this regard. If a
bank has not classified any account as NPA subsequent to August 31, 2020,
which otherwise would have been classified as NPA, the SCA should review the
functional working of CBS in terms of compliance made by the bank in terms of
the said interim order of Supreme Court.
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17
Government Business Department
Introduction
17.01 The basic scope of work of Government business carried out by banks
is given in RBI Master Circular no. RBI/2020-21/03 DGBA.GBD.No.2/
31.12.010/2020-21 dated July 01, 2020 on “Conduct of Government Business by
Agency Banks – Payment of Agency Commission”.
Government transactions eligible for agency commission
17.02 Transactions relating to the following government business undertaken
by agency banks are eligible for agency commission:
a. Revenue receipts and payments on behalf of the Central/State Government;
b. Pension payments in respect of Central / State Governments;
c. Any other item of work specifically advised by Reserve Bank as eligible for
agency commission.
17.03 Short term/long term borrowings of State Governments raised directly
from financial institutions and banks are not eligible for agency commission as
these transactions are not considered to be in the nature of general banking
business. Reserve Bank pays the agency banks separate remuneration as
agreed upon for acting as agents for management of public debt. Transactions
arising out of Letters of Credit opened by banks on behalf of
Ministries/Departments etc. do not qualify for agency commission.
17.04 Whenever agency banks collect stamp duty through physical mode or
e-mode (challan based), they are eligible for payment of agency commission,
provided the agency banks do not collect any charges from the members of
public or receive remuneration from the State Government for doing this work.
17.05 If the agency bank is engaged by the State Government as Franking
Vendor and it collects stamp duty from the public for franking the documents, it
will not be eligible for agency commission since the State Government is paying
commission to it as Franking Vendor. However, the agency bank which-collects
the stamp duty paid by the Franking Vendor for credit to the Treasury through
challan in physical or e-mode for purchase of the franking bar, would be eligible
for agency commission since it is a regular payment of Stamp Duty as stated
above.
17.06 All agency banks while claiming Turnover Commission (ToC) should
certify that no claim of ToC is made on ineligible transactions.
17.07 Agency banks paying their own tax liabilities through their own branches
or through authorised branches of State Bank of India or offices of Reserve Bank
of India wherever they do not have their own authorised direct tax collection
branch should indicate the same separately in the scroll. Such transactions will
not be eligible for payment of agency commission. Banks should furnish a
certificate to the effect that own tax liabilities (TDS, Corporation Tax, etc.) paid by
them have been excluded while claiming agency commission.
Rates for agency commission
17.08 As per the agency bank agreement, RBI pays agency commission at
rates determined by it. The rates applicable with effect from July 1, 2019 are as
under:
Sr. No. Type of Transaction Unit Revised Rate
a. (i) Receipts - Physical mode Per transaction Rs. 40/-
(ii) Receipts - e-mode Per transaction Rs. 9/-
b. Pension Payments Per transaction Rs. 75/-
Per Rs. 100
c. Payments other than Pension 6.5 paise
turnover
In this context, the ‘Receipts-e-mode transactions’ indicated against Sr. No. a.(ii)
in the above table refer to those transactions involving remittance of funds from
the remitter’s bank account through internet banking as well as such transactions
which do not involve physical receipt of cash /instruments.
17.09 Agency banks would be eligible to claim agency commission for
pension transactions at the rate of Rs. 75/- per transaction only when the entire
work relating to disbursement of pension including pension calculation is
attended to by them. If the work relating to pension calculations, etc., is attended
to by the concerned Government Department / Treasury and the bank branches
are required only to credit the amount of pension to the pensioners' accounts
maintained with them by a single debit to Government Account, such transaction
is to be categorised under ‘other than pension payment’ and would be eligible for
payment of agency commission @ 6.5 paise per Rs.100/- turnover w.e.f. July 1,
2019.
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17.10 With reference to the implementation of Goods and Service Tax (GST)
regime, it is advised that a single Common Portal Identification Number (CPIN),
processed successfully leading to generation of a Challan Identification Number
(CIN), under GST payment process, may be treated as a single transaction, even
if multiple major head/sub major head/minor head of accounts are credited. This
means that CGST, SGST, IGST and Cess etc. paid through a single challan
would constitute a single transaction. Thus, all such records clubbed under a
single challan i.e., CPIN have to be treated as a single transaction for the
purpose of claiming agency commission effective July 1, 2017.
17.11 Similarly, in case of transactions not covered under GST, it is
emphasised that a single challan (electronic or physical) should be treated as
single transaction only and not multiple transactions, even if the challan contains
multiple major head/sub major head/minor head of accounts that will get
credited. Therefore, records clubbed under a single challan processed
successfully have to be treated as a single transaction for the purpose of
claiming agency commission.
17.12 Turnover commission is payable to an agency bank at the full rate
provided the transactions are handled by the bank at all stages. Where, however,
the work is shared between two banks, the turnover commission is shared
between the banks in the proportion of 75:25. Thus, broadly, the turnover
commission is payable to the agency banks as detailed below:
a. At the full rate, in cases where the transactions are handled by the bank at
all stages, i.e., up to the stage of dispatch of scrolls and challans / cheques
to the Pay and Accounts Offices, and treasuries/sub-treasuries.
b. At 75% of the applicable rate, where the dealing branch is required to
account for the transaction by passing on the scrolls and documents to the
local/nearest branch of Reserve Bank of India or any agency bank
conducting government business.
c. At 25% of the applicable rate, in the case of agency branch which received
the scrolls and documents from dealing branches of other banks and is
responsible for the account of these transactions and dispatching of the
scrolls and documents to the Pay and Accounts Offices, Treasuries, etc.
17.13 The number of transactions eligible for payment of agency commission
should not exceed 14 per pensioner per year. This includes one monthly credit
for payment of net pension and a maximum of two per year for payment of
arrears on account of increase in dearness relief, if applicable. Cases involving
payment of arrears on account of late start/restart of pension qualifies as a single
transaction for claiming of agency commission. In other words, any payment of
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arrears on account of late start/restart of pension should be treated as a single

credit transaction and not as separate monthly credits.
Claiming agency commission
17.14 Agency banks are required to submit their claims for agency
commission in the prescribed format to Central Accounts Section (CAS) Nagpur
in respect of Central government transactions and the respective Regional Office
of Reserve Bank of India for State Government transactions. The revised formats
for claiming agency commission claims for all agency banks and separate and
distinctive set of certificates to be signed by the branch officials and Chartered
Accountants or Cost Accountants are given in Annexure-2, 2-A and 2-B
respectively to the said RBI Master Circular dated July 01 2020. These
certificates would be in addition to the usual Certificate from ED / CGM (in
charge of government business) to the effect that there are no pension arrears to
be credited / delays in crediting regular pension / arrears thereof.
17.15 Where the External Auditor is also the Concurrent Auditor / Statutory
Auditor, claims can be certified by such Concurrent Auditor / Statutory Auditor.
The auditor’s certificate should, inter-alia, state that:
a. ‘receipt’ and ‘pension payment transactions’ as also the agency commission
claims for ‘payments other than pension payments’ indicated in the agency
commission claim application submitted to the RBI are tallied with the
records maintained at the concerned branch/es of the agency bank; and
b. the agency commission claims made in respect of volume (number) based
transactions viz. ‘receipt’ and ‘pension payment transactions’ have been
claimed only once and the same stands excluded while arriving at value
based transactions in respect of ‘payments other than pension payments’.
17.16 In addition to this, agency banks are required to ensure that the agency
bank’s internal inspectors / auditors verify the agency commission claims
submitted by their branches and confirm their accuracy during the course of their
inspection / audit.
17.17 Agency banks are required to ensure that agency commission claims
submitted to the Regional Offices of Reserve Bank of India / Central Accounts
Section, Nagpur in the prescribed format are accurate. Agency banks may also
alert their branches concerned to ensure that agency commission claims
submitted to our Regional Offices are accurate. Such erroneous claims, if
certified by the Internal / Concurrent Auditors, will defeat the very purpose of
making such requirement an essential condition for making quarterly claims.
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Deduction of TDS on Agency Commission

17.18 The Central Board of Direct Taxes (CBDT) has clarified that ‘tax would
not be required to be deducted by RBI on the turnover commission paid or
credited by it to agency banks for transacting general banking business of the
Central Government and State Governments’. However, agency commission
would be taxable in the hands of the banks concerned as it is part of the bank’s
income.
Penal interest for wrong claims
17.19 Agency banks will be liable to pay penal interest at Bank Rate as
notified by the Reserve Bank of India plus 2% for any wrong claims of agency
commission settled.
17.20 The Auditor has to do the following:
 Obtain Government Business Policy of the Bank
 Check Accounting policy whether it is on accrual or cash basis and
accordingly plan the work
17.21 Discuss the process of execution of Government Business through
authorised branches, recording of transactions in CBS system, reconciliation with
respective Government Departments for various schemes. Some examples listed
below:
Government Deposit E-Kisan Vikas Patra Scheme, 2014
Scheme Sovereign Gold Bonds
Public Provident Fund (PPF)
Senior Citizen Savings Scheme 2004
Sukanya Samriddhi Accounts 2014
RBI Bonds
Taxes Collection of Direct taxes (CBDT)
Goods and Services Tax
Collection of State Taxes
Pension Payments to Central/Civil
Government / Freedom Fighters Pension
Ministries /
Railway
Departments / others
Telecom & Postal
Defence
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Other Schemes Pension Payment to State Governments

National Pension System (NPS)
Treasury/Sub Treasury Business
e-Stamping
e-Biz
Services to Civil/Non-Civil Ministries
Atal Pension Yojana
EPFO Collection
ESIC Collection
PFMS-Public Fund Management System
NTRP (Non-Tax Receipt Portal)
Gold Monetization Scheme, 2015
Conduct / Execution
17.22 The Auditor is required to do the following:
 Verify whether Income from Government Business is accounted properly
This can be done by taking the data dump of the government transactions
and analysing them to confirm that the GL/BGL contains the GB
transactions, that the claim is arrived at automatically by the system – if not
then the transactions in claim amount and the transactions in the GL/BGL
match, that only those transactions which can be claimed have been
selected, that the bank has a system to verify the amount of receipt with the
amount of claim.
Any analytical tool will help in filtering the transactions on which agency
commission can be received. For all transactions there will be a tag or flag
which will determine whether there is any claim to be made.
 Check income reconciliation, follow up for recovery
 Check Tax Collection and Payment to Government Treasury in timely
manner
 Check the internal controls for receipt / payments
17.23 Based on audit, issue appropriate certificate, report on compliance for
Government Business. Check whether appropriate disclosures are being made
in financial statements.
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18
Consolidation of LFARs for the Bank
Introduction
18.01 The financial statements of the banks generally signed within 45 days of
the year end. However, RBI has given time up to June 30 for the submission of
LFAR. Hence usually, formal consolidation process starts after the Financial
statements of the Bank are signed and delivered.
18.02 The consolidation takes place based on Long Form Audit Reports
submitted by the Statutory Branch Auditors in respect of branches/offices and the
information / explanations and other data provided by the management, for
Audited/Un-audited branches and departments. Hence analyzing of the data is
required at the time of conducting the Financial audit at the zonal/ regional level
audit and not just during LFAR consolidation process. It is often noted that
branch LFAR may have given certain comments on the borrower account or
some process in the Branch that may need attention in the main audit report
issued by the auditors during financial audit. If analysis of branch LFAR is
deferred, there may be a probability of missing on such comments.
18.03 It is the responsibility of the consolidating auditor to highlight the
significant observations therein and summarise the issues after considering the
information provided by the Bank, wherever required. All statistical data needs to
be incorporated as provided by the Bank. Further the Auditor is expected to
consider the compliance report of the Bank on LFAR for the previous year.
18.04 The SCA should ensure that the intent of the comments specified by
SBAs in Branch LFAR is factored in while consolidating the Branch LFARs and
accordingly may consider to keep the same intact wherever need be. Further, the
SCA should review the major observations by SBAs including those which are
likely to have a systemic impact though have been reported at few branches. The
SCA may opt to conduct testing of such instances as reported by SBAs, to
identify impact of the same on the consolidated LFAR of the Bank.
18.05 At the start of the audit of the Financial Statements, the Statutory
Central Auditors need to communicate to Branch auditors and Departmental
Auditors specifically to provide the data in structured format for the purpose of
consolidation. The consolidated LFAR need not give the entire details reported
under the annexures. The Auditor may determine the materiality of the amounts
to be reported in LFAR. However, the said data is required to be compiled bank-
wide and submitted to the management.
Setting Reporting Materiality
18.06 The overall objective is to design and carry out our audit procedures in
order to obtain reasonable assurance about whether the financial statements are
free from material misstatement, whether due to fraud or error.
18.07 Materiality is set for the financial statements should represent the
maximum cumulative numerical misstatement in an account balance, class of
transactions or other disclosure that the auditor would regard as not influencing
the decisions of users of those financial statements. The materiality for reporting
may be categorised into the following two types:
(i) Specific Transaction Materiality
18.08 These transactions are selected for reporting irrespective of the
materiality due to their sensitive nature such as:
1. Any standard account in the branch having exposure (funded and non-
funded) which is more than 50 crore across bank.
2. Accounts against whom NCLT proceedings are initiated either by Bank, any
other financial creditors or the operational creditors.
3. SMA accounts above 5 crore.
4. Red Flagged Accounts.
The above list is indicative one.
(ii) The overall materiality limits
18.09 Having determined specific materiality it is necessary to determine a
level of overall materiality which will be used when assessing the risk of
reporting. The use of overall materiality is intended to reduce the risk of
inappropriate audit report.
18.10 Unlike financial statement materiality (which is dependent on the
perceptions of users) this materiality is affected by risk of misreporting.
18.11 Hence as a part of setting up of overall materiality limits, any un-
corrected observations affecting the financial statement above certain amount,
that may be decided by the Statutory Central Auditors (all observations put
together by individual auditor at unit level). The combined impact needs to be
assessed and reported in LFAR.
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The Reporting
18.12 The RBI has issued thoroughly revamped format of LFAR vide Circular
No. DOS.CO.PPG./SEC.01/11.01.005/2020-21 dated September 05, 2020.
Though the mandate and scope of the audit will be as per the revised format, if
the SCA feels the need of any material additions, etc., the SCA may have the
same effected by giving specific justification and with the prior intimation of the
bank’s Audit Committee of Board (ACB).
18.13 The compilation of the questions is done on the basis of information
provided by the Statutory Branch Auditors. However, as mentioned above, the
specific information or the annexures that may be required by the consolidating
auditor to ensure the adequacy of reporting, will have to be decided and called
for during communicating to the Statutory Branch Auditors as required by SA
600. The illustrative list of Annexures that may be required could be as under:
i. Instances of quick mortality cases.
ii. Instances of disagreement of Asset Classification with Bank, i.e.,
divergences observed at branch level.
iii. Instances of an account wherein auto-marking through CBS was not
effected.
iv. Instances of evergreening of Accounts.
v. Accounts where excess over sanctioned limits are allowed.
vi. Branches where limits were disbursed without complying with the terms
and conditions of sanction.
vii. Branches with deficiencies in documentation/inadequate insurance cover.
viii. Branches where periodic balance confirmation / acknowledgement of
debt not obtained.
ix. Branches having accounts where review / renewal is pending.
x. Branches where stock / book debt statements and other periodical
operational & financial statements not obtained.
xi. Branches where audited accounts not on record for advances to non-
corporate with limit over Rs. 10 lakh (or any other limit as decided by the
bank internally).
xii. Branches where stock audit report is not obtained at prescribed interval.
xiii. Short reviewed for period beyond six months.
225
xiv. Comments on major accounts (standard accounts having outstanding

exceeding Rs. 10 crore).
xv. Quarterly/half yearly statements not obtained.
xvi. Break up of outstanding entries in Nostro reconciliation as of 31.03.20YY.
xvii. Rate of interest charged less than prescribed rate decided by the bank.
xviii. Deficiencies noticed in appraisal, monitoring and supervision.
xix. Details of accounts where the relevant controlling authority of the bank
has authorised legal action for recovery of advances.
xx. List of overdue / matured term deposits.
xxi. Major / adverse comments / issues not addressed by the branch arising
out reports from previous auditors, concurrent auditors, stock or internal
auditors or special audit or inspection report of RBI.
xxii. Whether identification and classification of advances as standard/sub-
standard/doubtful/ loss assets is as per RBI circular and instructions as
per CO. If not, then details of accounts where there are deviations.
xxiii. Guarantees involved / expired but not adjusted / reversed.
xxiv. Outstanding amount of letter of credit / buyers credit.
xxv. Cash holding/ cash held exceeds retention limit.
xxvi. Details of cases where physical verification of securities not done as per
laid down procedure.
xxvii. Details of NPA accounts where valuation report is not obtained.
xxviii. Detail of items for more than three years in bills payable / sundry deposit
etc.
xxix. List of the accounts (with outstanding in excess of Rs. 10.00 crore), which
have been downgraded regarding their classification as non-performing
asset or standard asset during the year.
xxx. List of the accounts (with outstanding in excess of Rs. 10.00 crore), which
have been upgraded regarding their classification as non-performing
asset or standard asset during the year.
xxxi. List of recoveries and their appropriation against interest and principal
accounts settled/ written off/ closed during the year.
xxxii. List of new borrower accounts transferred to the branch during the year.
The above list is indicative one.
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18.14 There are separate formats (part of LFAR) for following specific
branches which need to be consolidated in respect of:
 Dealing in Foreign Exchange Transactions.

 Dealing in clearing house operations, normally referred to as service
Branches.
 Dealing in NPAs such as Asset Recovery Management Branches.
There is an Annexure III specified in the circular on Long Form Audit Report –
Review to be obtained by the Branch Auditors from branches dealing in large
advances / asset recovery branches.
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19
Certification
Introduction
19.01 The SCAs have to issue various Special Purpose Reports and
Certificates at Head Office level. The Appointment letter normally contains the
exhaustive list of all such Reports and Certificates which are required to be
certified by the SCA’s. These are to be verified and certified by the SCAs to
ensure their correctness and accuracy. RBI regularly updates the various lists of
certificates to be issued by SCAs. Many of these certificates are prepared by
consolidating the certificates issued by SBAs for the respective
branches/ROs/Zonal offices/Accounting units etc. and SCAs for the respective
head office departments allocated at the time of appointment.
19.02 The Reserve Bank of India vide its Master Direction No:
DBS.CO.CFMC.BC.No.1/23.04.001/2016-17 dated July 01, 2016 (updated July
03, 2017) on “Frauds- Classification and Reporting by commercial banks and
select FIs, issued guidelines for classification of frauds and reporting of frauds
to RBI, Central Office as well as the concerned regional office of the
Department of Banking Supervision / Financial Conglomerate Monitoring
Division (FCMD) at Central Office under whose jurisdiction the bank’s Head
Office/branch is situated. The reporting requirements for various categories of
frauds based on financial exposure are specified in the aforesaid Master
Directions.
19.03 While issuing a special purpose report or certificate, the auditors
should bear in mind the recommendations made in the Guidance Note on
Reports or Certificates for Special Purposes (Revised 2016) issued by the
Institute of Chartered Accountants of India (ICAI).
Audit Approach
19.04 At the time of accepting the Audit, issuing engagement letter,
preparing audit program, maintaining adequate working papers, the SCAs
should appropriately comply with the requirements of Guidance Note on
Institute of Chartered Accountants of India (ICAI). Readers may also refer
covering report for certificates as prescribed in Annexure A “Illustrative Format

of Covering Report for various Certificates issued by SCAs” of this Chapter.
19.05 Initially before commencement of the year end audit process, SCAs
should ask the bank’s management to prepare a complete list of all the
certificates to be issued as part of the audit based on RBI’s directions.
19.06 Based on the allocation of work/departments amongst joint auditors,
various SCA should be assigned the responsibility of verifying and certifying the
certificate to be submitted.
19.07 Depending on the centralization of operations at the bank, certificate to
be issued at central office should be separated from the certificates to be issued
based on consolidation process from various branches.
19.08 SCA should draft clear and adequate communication and instruction for
SBAs (which would form part of the annual closing instructions from bank’s
management to SBAs). Instructions should cover the requirements of the
certificate, areas and extent of verification, inclusions and exclusions if any and
in some cases draft of the format in which the certificates have to be issued. This
ensures compliance of SA 600, “Using the Work of Another Auditor”.
19.09 SCA should be more careful while issuing certificates based on
consolidation at branches/ROs/ZO/AU etc. The SCAs should understand and
verify the process for consolidation of certificates received from various
branches/ROs/ZO and head office departments with respect to the contents of
consolidated certificates to be issued at head office level. In some cases such a
consolidation may be happening manually and not through the bank’s CBS/IT
system. All the returns submitted by unaudited branches to various higher
authorities should be cross verified.
19.10 Wherever possible SCAs should reconcile or tally the closing balance of
the return/ certificate with the General Ledger Heads in the Trial Balance or other
relevant returns of the Bank as at the year end. This will be important for semi-
automatic or manual returns. For system generated returns without manual
intervention, it should still be ensured that they tally with the year-end figures,
though detailed verification may not be warranted.
Responsibility of the Management
19.11 The correctness in preparation of various certificates is the
responsibility of the management of the banks including designing,
implementing and maintaining internal control relevant to the preparation and
presentation of various certificates. Management is also responsible for
compliance with all the provisions of RBI and other regulatory guidelines. The
responsibility of the SCAs is to verify and report on the status of correctness of
the same through the necessary checks carried out during the audit. The
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results of the verification carried out by the SCAs on test check basis and their
comments thereon would be given in a separate report.
19.12 The format of certificates required to be issued by the SBAs and
SCAs are devised by the Bank, RBI and other authorities who are the users of
these certificates. The prescribed formats are required to be filled in by the
banks for reporting on compliance.
19.13 The SCA shall obtain a confirmation from the management whether it
has received the various reports / certificates from all the branches, regional/
zonal offices, etc. and also whether it has prepared the status report as
applicable to the Head Office level. The SCA shall obtain a list of the branches,
regional/ zonal offices which have not submitted the prescribed report. Such a
list would help the SCA to have a broad idea as to the extent of compliance.
19.14 The SCA should maintain proper documentation about the information
received, audit process carried out, extent of checking, observations and
findings.
19.15 The SCA should obtain and review a copy of these reports /
certificates so prepared / compiled and submitted to them by the bank. Such a
review would help the auditors identify areas which are susceptible to fraud/
malpractices. The results of such a review / checking may also require the
auditor to re-consider the nature, timing and extent of the procedures adopted
by him for carrying out the audit as well as his audit findings.
19.16 The SCA may also request the management to provide a list of
branches which had been subject to a concurrent audit/ inspection by the in-
house inspection department or the inspectors from the RBI. SCA may, if
considered necessary, select some such branches and review the comments
of the concurrent auditors/ inspectors on the status of implementation of the
recommendations. This would help to identify any common cause of concern
among the bank branches.
19.17 Some of the certificates to be issued by the SCAs are technical and
the Auditor may have to reply on the work done by other experts or
representation from the management. In such cases the SCA should be clear
in mentioning any scope limitations and necessary disclaimers in the
certificate. The Auditor may also consider modifying his opinion paragraph
(issue a negative assurance rather than a reasonable or absolute assurance
on the work done be him). SCA are also required to keep the requirements of
UDIN while issuing such certificates.
19.18 The certificates should clearly state the records checked, to what
extent they have been checked and what has been checked.
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Annexure A
Illustrative Format of Covering Report for various
Certificates issued by SCAs
Independent Auditor’s Certificate for various certificates issued during
the Statutory Audit of [Name of the Bank] for the Financial year 2020 –
2021.
1. This Certificate is issued in accordance with the terms of our
agreement dated [date of Engagement Letter].
2. The accompanying Statement contains various certificates issued by
us during the Statutory Audit of [Name of the Bank] for the Financial year 2020
– 2021, listed in Annexure [Name], which we have been initialled for
identification purposes only.
Managements’ Responsibility for the Statement
3. The preparation of the accompanying Statement is the responsibility
of the Management of the Bank. This responsibility includes designing,
implementing and maintaining internal control relevant to the preparation and
presentation of the Statement, and applying an appropriate basis of
preparation; and making estimates that are reasonable in the circumstances.
4. The Management is also responsible for ensuring that the Bank
complies with the requirements of the Equity Listing Agreement and for
providing all relevant information to the Securities and Exchange Board of
India.
Auditor’s Responsibility
5. Pursuant to the requirements of the various RBI guidelines, our
responsibility is to express reasonable assurance in the form of an opinion
based on our audit and examination of books and records on test check basis,
as to whether the [Name of the Bank] has undertaken only those activities that
have been specifically permitted by the RBI and has complied with the
specified terms and conditions.
6. We have audited the financial statements of [Name of the Bank] for
the Financial year 2020 – 2021, on which we issued an unmodified audit
opinion vide our reports dated [date of Audit Report]. Our audit of these
financial statements was conducted in accordance with the Standards on
Auditing and other applicable authoritative pronouncements issued by the
Institute of Chartered Accountants of India. Those Standards require that we
231
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement.
7. We conducted our examination of the Statements/Certificates given in
Annexure [Name], in accordance with the Guidance Note on Reports or
Certificates for Special Purposes issued by the Institute of Chartered
Accountants of India. The Guidance Note requires that we comply with the
ethical requirements of the Code of Ethics issued by the Institute of Chartered
Accountants of India.
8. We have complied with the relevant applicable requirements of the
Standard on Quality Control (SQC) 1, Quality Control for Firms that Perform
Audits and Reviews of Historical Financial Information, and Other Assurance
and Related Services Engagements.
Opinion
9. Based on our examination as above, and the information and
explanations given to us, we report that the Statement in Annexure [Name] is
in agreement with the books of account and other records of [Name of the
Bank] for the Financial year 2020 – 2021 as produced to us for our
examination, and the information thereof is prepared, in all material respects,
in accordance with the applicable criteria.
Restriction on Use
10. This certificate has been prepared at the request of the [Name of the
Bank] solely with reference to our appointment letter, for the purpose of onward
compilation of various certificates and disclosure requirements for [Name of the
Bank] as a whole. It should not be used by any other person or for any other
purpose. Accordingly, we do not accept or assume any liability or any duty of
care or for any other purpose or to any other party to whom it is shown or into
whose hands it may come without our prior consent in writing.
For
Chartered Accountants
Firm’s Registration Number:
Partner / Proprietor
Membership Number
UDIN
Place:
Date:
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Section B –
Bank Branch Audit
1
Practical Guide for Statutory Branch
Auditors performing Bank Branch
Audit for the First Time
1.01 The banking industry is the backbone of any economy as it is essential
for the sustainable socio-economic growth and financial stability in the economy.
There are different types of banking institutions operating in India. These are as
follows:
(a) Commercial Banks
(b) Regional Rural Banks
(c) Co-operative Banks
(d) Development Banks (more commonly known as ‘Term-Lending Institutions’)
(e) Foreign Banks
(f) Payment Banks
(g) Small Finance Banks
(h) EXIM Bank
1.02 All these banks have their unique features and perform various
functions / activities subject to complying with the RBI guidelines issued from
time to time. Section 6 of the Banking Regulation Act, 1949, lists down the forms
of business in which banking companies may engage. The text of Section 6 of
the Banking Regulation Act, 1949 has been reproduced in Appendix I of Section
B (Available on ICAI website) of the Guidance Note on Audit of Banks (2021
Edition). Of these banks, commercial banks are the most wide spread banking
institutions in India. Commercial banks offer a number of products and services
to the general public and other segments of the economy. Two of the main
functions of commercial banks are (1) accepting deposits and (2) granting
advances. In addition to their main banking activities, commercial banks also
undertake certain eligible Para Banking activities which are governed by the RBI
guidelines on Para Banking activities.
1.03 The functioning of banking industry in India is regulated by the Reserve
Bank of India (RBI) which is the Central Bank of our country. RBI is responsible
for the development and supervision of the constituents of the Indian financial
system (which comprises banks and non-banking financial institutions) as well as
for determining, in conjunction with the Central Government, the monetary and
credit policies keeping pace with the need of the hour. Important functions of RBI
are issuance of currency; regulation of currency issue; acting as banker to the
central and state governments; and acting as banker to commercial and other
types of banks including term-lending institutions. Besides, RBI has also been
entrusted with the responsibility of regulating the activities of commercial and
other banks. No bank can commence the business of banking or open new
branches without obtaining licence from RBI. The RBI also has the power to
inspect any bank.
1.04 The provisions regarding the financial statements of banks are
governed by the Banking Regulation Act, 1949. The Third Schedule to the
aforesaid Act, prescribes the forms of balance sheet and profit and loss account
in case of banks. Readers may refer Appendix II of Section B (Available on ICAI
website) of the Guidance Note on Audit of Banks (2021 Edition) for text of the
third schedule to the Banking Regulation Act, 1949. Further, in case of banking
companies, the requirements of the Companies Act, 2013, relating to the balance
sheet, profit and loss account and cash flow statement of a company, in so far as
they are not inconsistent with the Banking Regulation Act, 1949, also apply to the
financial statements, as the case may be, of a banking company. It may be noted
that this provision does not apply to Nationalised Banks, State Bank of India, its
Subsidiaries and Regional Rural Banks (RRBs). The provisions regarding audit
of Nationalised Banks are governed by the Banking Regulation Act, 1949 and the
RBI Guidelines. The provisions regarding audit of Banking Companies are
governed by the Banking Regulation Act, 1949, RBI Guidelines and the
provisions of the Companies Act, 2013.
Pre-commencement of Audit
Co-ordination with Branch Management
1.05 Now a days typically, Statutory Branch Auditors (SBAs), are given
limited time within which they have to undertake the audit of branches allotted to
them. Co-ordination between the auditor and the branch management is
essential for an effective audit and timely completion with the highest audit
quality. An NOC from the previous auditor should be obtained and kept on record
by the SBA. It is advisable that immediately after accepting the appointment, the
SBA should send a formal communication to the branch management/HO
accepting his appointment and other declarations and undertakings so required.
Further, the SBA should also specify the books, records, and other information
that he would require in the course of his audit. Such a communication would
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enable the branch management to keep the requisite documents, information,

etc., ready.
1.06 The SBA needs to plan the work properly prior to commencement of
audit. The SBA needs to issue the audit engagement letter in accordance with
Standard on Auditing (SA) 210, “Agreeing the Terms of Audit Engagements” and
the requirement letter which will contain the details or information needed to
conduct the audit. The SBA needs to obtain basic information about the size of
the branch and nature of the activities carried out at the branch, to find out
whether the branch is a normal branch or specialised branch such as forex or
service branch. If the branch is a normal branch, then based on size of the
branch, the SBA should organise his audit team and finalise the audit plan. If it is
specialised branch, composition of persons in the audit team should be
thoroughly acquainted with the rules and regulations governing such specialised
branch. The audit team needs to have a basic knowledge about the Reserve
Bank of India’s regulations and circulars governing the specialized branch and
when the appointment is made well before the year end, it is advisable to
complete the entire non-financial verification like documentation, sanctioning
terms, review of the supervision and monitoring terms, review of the
concurrent/internal audit and inspection reports before the year-end.
Engagement and Quality Control Standards
1.07 The auditor/audit firm should establish a system of quality control
designed to provide reasonable assurance that the auditor/firm and its personnel
comply with professional standards and regulatory and legal requirements, and
that reports issued by the firm or engagement partner(s) are appropriate in the
circumstances and will survive the test of any regulatory, legal or other action
that may arise in future. This system of quality control should consist of policies
designed to achieve its objectives and the procedures necessary to implement
and monitor compliance with those policies. The nature of the policies and
procedures developed by individual or firms to comply with SQC 1, “Quality
Control for Firms that Perform Audits and Reviews of Historical Financial
Information, and Other Assurance and Related Services Engagements” will
greatly depend on various factors such as the size, maturity, geographical
location, type of work handled and other operating characteristics.
1.08 The ICAI has issued various Engagement and Quality Control
Standards applicable to an audit of financial statements which are mandatorily to
be followed by all practitioners. Understanding of the concepts in these
Engagement Standards would help the SBA in discharging his duties in a diligent
way.
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1.09 In the present scenario of Statutory Bank Branch Audit, the most
important aspect is proper planning. Documentation of the Audit Plan is a must.
The SBA must have sound and complete knowledge of the business of the Bank.
1.10 The Auditor needs to study the following:
1. Appointment Letter – It is necessary to read the Appointment Letter
carefully and duly consider all the terms and conditions mentioned therein,
that are required to be followed during the process of the audit. The letter of
appointment sent by banks to Statutory Branch Auditors typically contains
the following:
 Appointment under the Banking Regulation Act, 1949, and the
underlying duties and responsibilities of the SBA.
 Particulars of branch(s) to be audited and of the region/zone to which
the branch reports.
 Particulars of Statutory Central Auditors (SCAs).
 Particulars of previous auditors.
 Guidelines for conducting audit of branches, completion of audit,
eligible audit fees and reimbursement of expenses etc.
 Procedural requirements to be complied with in accepting the
assignment, e.g., letter of acceptance, declaration of indebtedness,
declaration of fidelity and secrecy, other undertaking by the firm/SBA,
specimen signatures, etc.
 Scope of work - Besides the statutory audit under the provisions of the
Banking Regulation Act, 1949, the SBA is also required to verify
certain other areas and issue various reports and certificates like
LFAR, Tax Audit Report, certificates for cash verification on odd
dates, Ghosh & Jilani reports etc.
 The SBA needs to note compliance with relevant and applicable
Engagement and Quality Control Standards issued by the ICAI.
 The Appointment letter mentions a list of documents/working papers
which the RBI may require to be handed over. Such documents have
to be carefully maintained with all details as to be self-explanatory.
2. RBI Guidelines and Circulars – SBA must read and study RBI Circulars,
master directions, notification and the Banking Regulation Act, 1949.
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3. Bank’s Closing Circular – Along with the appointment letter, Banks also
issue closing guidelines. This Circular covers the process and policies
followed by Bank. Basic understanding of these circulars is necessary.
4. The SBA also needs to have a basic knowledge of allied applicable laws to
carry out an effective audit. For example: Indian Contract Act 1872,
Negotiable Instruments Act 1881, relevant Stamp Acts, etc.
Steps for audit of advances and NPA related matters
1.11 The SBA should document the criteria for test check which he has
chosen for verification of advances. SBA should prepare / suitably create check-
list to verify advances which are selected for verification. Based on RBI
guidelines the Auditor should see that Sanctioning, Disbursement, Review /
renewal and monitoring of advances is being done properly. If there are
deviations, the Auditor should report the same. The Auditor should select
appropriate sample from all categories of advances so that they truly represent
the entire population and carry out appropriate test checks.
1.12 The SBA should study the latest Income Recognition and Asset
classification (IRAC) guidelines of RBI. The Auditor should also check whether
the Bank has correctly classified the advances into performing and non-
performing categories. Appropriate test checks should be carried out regarding
classification of advances. The Auditor should appropriately deal with the
deviations in classification and accordingly, Memorandum of changes should be
issued if required. The SBA should report all deficiencies noted by him in the
Long Form Audit Report.
1.13 The RBI is now insisting on checking of Central repository of
Information on Large Credits (CRILC) for advances over Rs. 5 Crore, which
maintains history of the borrowers from inception. Banks have to update this
every time the borrower moves into or out of default. This history card will give a
snap shot of the borrower’s behaviour and is generally maintained with Zonal
authorities.
1.14 Similarly for advances less than Rs. 5 Crore, the RBI maintain Central
Fraud Registry (CFR) which holds all the data regarding frauds reported by
banks in India. This allows the bank to decide whether the borrower is eligible
before processing the sanction.
Steps for audit related to Cash and Housekeeping Matters
1.15 The SBA should check internal controls on custody of cash and see that
the cash management policy of the bank is strictly followed. The SBA should
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physically check cash at the branch and at the ATM attached to branch. The
SBA should examine rotation of duties of key management at branch for effective
operations. The SBA should examine the limit for cash holding and what cash
actually held by branch throughout the year.
Steps for audit related to Financial Statements
1.16 The SBA should apply basic audit principles and carry out checking of
the Financial Statements. The SBA may apply analytical procedures such as
ratio analysis, comparative analysis to find out material misstatements, if any in
the financial statements. Based on the audit process carried out by audit team
and after examination of the final financial statements, the auditor should frame
his audit opinion.
Steps for compiling the Main report & LFAR etc.
1.17 The SBA should also ensure that their audit report complies with the
requirements of SA 700 (Revised), “Forming an Opinion and Reporting on
Financial Statements”, SA 705 (Revised), “Modifications to the Opinion in the
Independent Auditor’s Report” and SA 706 (Revised), “Emphasis of Matter
Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report”.
Based on the audit process carried out the Auditor should report his findings in
the Audit Reports. The illustrative formats of auditor’s report are given in
Appendices III and IV of Section B (Available on ICAI website) of the Guidance
Note on Audit of Banks (2021 Edition) as follows:
Appendix III - Illustrative Format of Report of the Branch Auditor of a
Nationalised Bank
Appendix IV - Illustrative Format of Report of the Branch Auditor of a Banking
Company
1.18 Besides the main audit report, the terms of appointment of auditors of
public sector banks, private sector banks and foreign banks (as well as their
branches), require the auditors to also furnish a Long Form Audit Report (LFAR)
to the management. While planning the audit, the Auditor must cover all aspects
on which reporting is to be done in his main report and also in the LFAR. The
matters to be dealt with by auditors in LFAR have been specified by the RBI.
Latest revision to LFAR by RBI has been made in September 2020 and is to be
applied for audits of financial year 2020-21 and onwards. For matters which are
reported in the Main Report and LFAR, the Auditor should have necessary and
appropriate audit documentation to evidence the findings made. If the Auditor
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intends to issue modified opinion, reasons for such modified opinion need to be
mentioned. For the benefit of the members Illustrative Format of Engagement
Letter to be sent to the Appointing Authority of the Nationalised Bank by Branch
Auditor, Illustrative Format of Engagement Letter to be sent to the Appointing
Authority of the Nationalised Bank by Branch Auditor - Separate only for Audit of
Internal financial controls over financial reporting, Written Representation Letter,
Abbreviations used in the Banking Industry, Illustrative Bank Branch Audit
Programme for the Year ended March 31, 2021, Typical reasons for the
divergence observed in asset classification (large accounts) by banks vis-à-vis
supervisory assessment made by RBI during Supervisory Cycle 2019-20 (FY
2018-19), and Advisory for Statutory Bank Branch Auditors w.r.t. Specific
Considerations while conducting Distance Audit / Remote Audit / Online Audit of
Bank Branch under current Covid-19 situation issued on May 6, 2020 are given
in Appendices V to XI of Section B (Available on ICAI website) of the Guidance
Note on Audit of Banks (2021 Edition). These are as under:
Appendix V - Illustrative Format of Engagement Letter to be sent to the

Appointing Authority of the Nationalised Bank by Branch
Auditor.
Appendix VI - Illustrative Format of Engagement Letter to be sent to the
Appointing Authority of the Nationalised Bank by Branch
Auditor (Separate only for Audit of Internal financial controls
over financial reporting).
Appendix VII - Illustrative Format of Written Representation Letter to be
obtained from the Branch Management.
Appendix VIII - Suggested Abbreviations used in the Banking Industry.
Appendix IX - Illustrative Bank Branch Audit Programme for the Year
ended March 31, 2021.
Appendix X - Typical reasons for the divergence observed in asset
classification (large accounts) by banks vis-à-vis supervisory
assessment made by RBI during Supervisory Cycle 2019-20
(FY 2018-19)
Appendix XI - Advisory for Statutory Bank Branch Auditors w.r.t. Specific
Considerations while conducting Distance Audit / Remote
Audit / Online Audit of Bank Branch under current Covid-19
situation issued on May 6, 2020.
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Special Audit Considerations in Foreign Banks

1.19 Audit of foreign banks operating in India, poses unique challenges
compared to local banks in India. Foreign banks have different operating models
compared to local banks, and to a limited extent, they also operate in a different
regulatory environment.
1.20 Foreign banks generally operate in India through branches and do not
have a separate legal entity existence in India. Some are set up as Indian
subsidiaries of the foreign bank. However, the RBI regulates their functioning in
India, with regard to scale and nature of business they undertake in India.
1.21 Auditors of foreign bank will have to modify their audit procedures so as
to take care of the operational structure and operations of these banks. Some of
the important elements related to foreign banks which may have a bearing on the
audit plan and procedure are:
 Management structure.
 More centralised operational functions.
 Core banking software used globally.
 Requirement for compliance with foreign legal and regulatory requirements.
 Cross border flow and processing of data.
 Complex treasury operations and cross border forex deals.
 Operational processes.
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2
Bank Branch Audit Planning
Appointment of Auditors
2.01 The ICAI invites applications from CAs to be empanelled for carrying
out the Bank / Bank branch audit for nationalised banks. After due verification of
details submitted, approved list of CAs is submitted to the Reserve Bank of India
(RBI). The RBI circulates this list to banks for appointment of their auditors.
Banks Check with CA firms about their willingness and then confirm their
appointments. Once the appointment of statutory auditors is done, the final list is
submitted by all the nationalised banks for RBI’s approval.
Understanding the Business of Bank
2.02 The Auditor should understand the nature of activities carried out at the
bank branch. The Auditor should consider requirements of SA 315 “Identifying
and assessing the risks of Material Misstatement through understanding the
entity and its environment”. Besides the core business of banks of accepting
deposits and sanctioning advances, newer Banking products are being
periodically introduced by the banking industry. The Auditor should have
complete knowledge about the basics of the core business of banks and these
products offered at the branches. The Auditor should study the financial
implication of all the products offered at the branches. The types of facilities
provided to borrowers and the Standard Operating Procedures (SOP) should be
studied. Before commencing the audit, the Auditor should also have a basic
understanding of the core banking solution (CBS) used by the bank. Authority
levels should be understood. Based on the features of the products, the Auditor
should draw up a suitable audit plan to verify the transactions of the activities
being provided by the Bank. Risk Assessment is to be carried out based on clear
understanding of the business profile of the Bank.
2.03 The Auditor should find out the role and responsibilities of the branch
officials and the internal controls in operation. Most of the Banks have converted
their branches as Customer facing point of Contact and Sales and, almost all
processing / decision making is centralised. Depending on the functions being
carried out at the branch, the Auditor should design his audit plan and the extent
of verification.
2.04 The Auditor must also have a thorough understanding of the RBI
guidelines, prudential norms and master directions and be updated with the
various recent circulars and instructions issued by the RBI.
Audit Planning
2.05 The Auditor should plan the audit keeping in mind the requirements of
SA 300 “Planning an Audit of Financial Statements”. The Auditor should
document the audit plan and conduct a preliminary enquiry to know the nature,
size and category of bank branch to be audited. The Auditor should work out an
overall audit strategy for execution of the audit within the time limits.
2.06 The Auditor needs to assess the risk involved in branch being audited.
Depending on the nature of transactions executed at branch, the audit plan
should be designed. General branches will have one set of audit plan and
specialised branches will have different audit plans based on the nature of
transactions executed at branch, such as treasury branches, forex branches,
service / clearing branches. The category of the branch to be audited will also
determine the overall plan and the various checks to be applied for audit e.g.,
Large or mid Corporate, retail branch, rural or agricultural branch, etc.
2.07 The Auditor should assess the resource requirements for audit to be
completed within the stipulated timelines. Based on the volume and nature of
transactions executed at branch staff will be deployed. Audit team needs to be
updated with banking law and regulations and RBI Guidelines.
2.08 Detailed requirement letter seeking information regarding branch should
be sent by the Auditor to branch management so that necessary information is
received during the planning stage and accordingly proper audit plans can be
made. The Auditor should call for previous year’s inspection/ concurrent and
other important reports so that beforehand the Auditor may aware of the past key
issues. The Auditor should also look at the previous year/period’s reports of the
previous statutory auditor and its compliance status. A study of the previous
year’s LFAR will also help in gaining an understanding of the issues at the
branch.
2.09 All Public Sector Banks come out with closing instructions for bank’s
management and auditors at branches. The Auditor should design the audit plan
and audit procedures and the extent of checking keeping the bank’s closing
guideline/instructions. Many banks also have a practice of organising a meeting
of the Statutory Central Auditor and the branch auditors wherein insights are
244
shared and areas of importance are highlighted. The overall audit plan should
also consider the important aspect from this.
2.10 The Auditor should document in the Audit plan Direction, Supervision
and review strategies.
Audit procedures /understanding forms and content of financial
statements/reporting
2.11 Before carrying out the audit at the branches, the Auditor should
carefully make a list of all the annual returns/financial statements and certificates
to be verified and certified as part of the branch audit. Understanding the
underlying requirements of the annual statements to be certified would help the
Auditor in designing the plan and audit procedures to be carried out.
2.12 The Auditor should carry out analytical and substantive audit
procedures to verify true and fair view of the financial statements. Due to
stringent timelines set by the Bank, along with appropriate test checks carried
out, analytical procedures will be useful tools to find material misstatement, if
any, in the financial statements. The Auditor should set materiality level in
accordance with SA 320, “Materiality in Planning and Performing an Audit” and
carry out substantive audit procedures for all material transactions.
2.13 Various closing forms and certificates are to be certified by the statutory
auditors. Understanding the objective of such forms and certificates is very
essential. The Auditor should read relevant circulars and guidelines of the RBI
before verifying the forms and certificates and should understand the process
followed in making such forms / certificates.
2.14 Final audit report and Long form Audit Report are two documents that
are issued by the statutory auditor to the bank management. During the course
of audit, the Auditor should note down the observations, which he had come
across and which require attention of the management and various points need
to be reported in Long Form Audit Report. While carrying out audit of each area
simultaneously the Auditor should make replies for questions in Long Form Audit
Report.
2.15 It is also important that the branch auditor complies with all the pre-audit
formalities (like appointment letter, NOC from previous auditor, engagement
letter etc.) immediately on receipt of confirmation from the bank and before the
commencement of actual audit at the branch.
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3
Audit Documentation in Bank
Branch Audit
Audit Documentation in Bank Branch Audit
3.01 SA 230, “Audit Documentation” requires the auditor to duly prepare and
maintain audit documentation for an audit of financial statements. Bank Audit is
no exception and auditors need to collect all the documentary evidences while
carrying out an audit. The nature and purpose of audit documentation has been
explained in SA 230.
3.02 Various SAs also lay down the documentation that should be
maintained by an auditor which should be ensured. The Auditor should ensure
that the audit documentation meets the requirements of SA 230 and the specific
documentation requirements of other relevant SAs and other regulatory
requirements.
3.03 The Auditor should prepare the audit plans and make a note of the
checks that will be carried out by him during the audit process. He should note
the queries raised by him and how the same have been resolved, nature of
issues that have arisen and the documents obtained for the same and significant
matters which have come across. Audit documentation must ensure that it
provides sufficient evidence of the auditor’s basis for a conclusion about the true
and fair view of the financial statements of the branches, certificate issued, and
his observations mentioned in the LFAR. Further, audit documentation must also
ensure satisfactory evidence that the audit was planned and performed in
accordance with SAs and applicable legal and regulatory requirements.
3.04 The Auditor should prepare audit documentation on a real time basis
while conducting the audit. Audit documentation may be recorded on paper or on
electronic or other media which can be easily retrieved as and when required.
Audit documentation should be self-explanatory and should not require external
help for interpretation. Examples of audit documentation include: Audit plan and
programs (assigning responsibility of conduct, review and final authorization),
working papers and Analysis, Issue-Memorandum, Summaries of significant
matters, Letters of confirmations and representations, Checklists,
Correspondences (including e-mail) concerning significant matters.
3.05 An Illustrative list of documents to be maintained in the bank branch
audit file is given below-
 Appointment formalities, including appointment letter, NOC from previous
auditor, engagement letter etc.

 Latest RBI Master Directions / Circulars, other material for conducting the
audit.
 Closing Guidelines / Circular issued by the Bank.
 Summary of the relevant provisions of the RBI master directions, IRAC
norms, closing circular used at the branch.
 Details branch audit plan and program as per SA 230.
 Understanding of Powers and responsibilities at various levels in the
branch.
 Summary of the accounting policies, observations from previous audits,
inspection reports, concurrent audits etc. and how the Auditor has verified
their satisfactory compliances.
 Audit procedures adopted and determination of materiality levels.
Understanding of the internal controls, IT system Controls.
 Audit working papers and issue trackers. How the issues raised during
audit were concluded.
 Financial Statements of the previous year and current year.
 Management certified Trial Balance for the year.
 Various Audit reports such as internal inspection report, concurrent audit
reports, previous year statutory audit report.
 Statement of advances with classification along with various fields duly
filled such as security, sanction limits, date of sanction / renewal,
outstanding balance etc.
 Specific representation, notes and working papers received by the bank’s
management on sensitive or significant audit issues or accounts.
 List of latest and updated stock and security statements, valuation and
inspection reports.
 List of documents verified and minutes of meeting with the bank’s
management.
 Copies of supporting documents that are verified and confirmations
obtained during the audit.
 Outstanding items of assets / liabilities.
 Proof of various securities, cash and other assets physically verified during
the audit.
 Other Bank / RBI balance confirmation.
 Management Representation Letter.
 Various other Audit documents / evidence considered in audit process.
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4
Overview of Standards on Auditing
4.01 Effective implementation of Standards on Auditing (SAs) is essential to
ensure quality in bank branch audit as in the case of any other audit
engagement. While it is true that the degree of depth in application of SAs to
various sizes of the branch will vary materially, it is necessary that the Auditor
must have on its records evidence that he has carried the audit as per the
applicable SAs.
4.02 In order to facilitate compliance of these SAs, every audit file must
contain the list of these SAs and remarks of signatory against each whether the
standard is applied. This will inculcate necessary discipline among the staff
members and even the signatories of the audit statements.
4.03 Let us understand the overall structure of the standards on auditing.
The entire structure of SAs is divided as under:
SAs are applicable to all audit engagements. SAs are categorised as under:
1. General principles & Responsibilities SA 200 to SA 299
2. Risk assessment & Response to the assessed risks SA 300 to SA 499
3. Audit Evidence SA 500 to SA 599
4. Using the Work of Others SA 600 to SA 699
5. Audit conclusions & Reporting SA 700 to SA 799
6. Specialised Areas SA 800 to SA 899
4.04 It is necessary to keep a list of SAs in the audit documentation file to
ensure their compliance. The brief on each SAs is given below which can be
utilised as a reference checklist for each audit/ assignment undertaken.
SA - No. Name of SA Scope and Objective Remark
of
Auditor
SA-200 Overall This SA establishes the independent
Objectives of auditor’s overall responsibilities when
the conducting an audit of financial
Independent statements in accordance with SAs.
Auditor and the Specifically, it sets out the overall
objectives of the independent auditor,
Conduct of an and explains the nature and scope of an

Audit in audit designed to enable the
Accordance independent auditor to meet those
with Standards objectives. It also explains the scope,
on Auditing authority and structure of the SAs, and
includes requirements establishing the
general responsibilities of the
independent auditor applicable in all
audits, including the obligation to comply
with the SAs.
In conducting an audit of financial
statements, the overall objectives of the
auditor are:
(a) To obtain reasonable assurance
about whether the financial
statements as a whole are free
from material misstatement,
whether due to fraud or error,
thereby enabling the auditor to
express an opinion on whether the
financial statements are prepared,
in all material respects, in
accordance with an applicable
financial reporting framework; and
(b) To report on the financial
statements, and communicate as
required by the SAs, in accordance
with the auditor’s findings.
SA-210 Agreeing the This SA deals with the auditor’s
Terms of Audit responsibilities in agreeing the terms of
Engagements the audit engagement with management
and, where appropriate, those charged
with governance. This includes
establishing that certain preconditions
for an audit, responsibility for which rests
with management and, where
appropriate, those charged with
governance, are present.
The objective of the auditor is to accept
or continue an audit engagement only
when the basis upon which it is to be
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performed has been agreed, through:

(a) Establishing whether the
preconditions for an audit are
present; and
(b) Confirming that there is a common
understanding between the auditor
and management and, where
governance of the terms of the
audit engagement.
SA-220 Quality Control This SA deals with the specific
for an Audit of responsibilities of the auditor regarding
Financial quality control procedures for an audit of
Statements financial statements. It also addresses,
where applicable, the responsibilities of
the engagement quality control reviewer.
The objective of the auditor is to
implement quality control procedures at
the engagement level that provide the
auditor with reasonable assurance that:
(a) The audit complies with
professional standards and
regulatory and legal requirements;
and
(b) The auditor’s report issued is
appropriate in the circumstances.
SA-230 Audit This SA deals with the auditor’s
Documentation responsibility to prepare audit
documentation for an audit of financial
statements.
The objective of the auditor is to prepare
documentation that provides:
(a) A sufficient and appropriate record
of the basis for the auditor’s report;
and
(b) Evidence that the audit was
planned and performed in
accordance with SAs and
applicable legal and regulatory
requirements.
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SA-240 The Auditor's This SA deals with the auditor’s

Responsibilities responsibilities relating to fraud in an
Relating to audit of financial statements.
Fraud in an Specifically, it expands on how SA 315
Audit of and SA 330 are to be applied in relation
Financial to risks of material misstatement due to
Statements fraud.
The objectives of the auditor are:
(a) To identify and assess the risks of
material misstatement in the
financial statements due to fraud;
(b) To obtain sufficient appropriate
audit evidence about the assessed
risks of material misstatement due
to fraud, through designing and
implementing appropriate
responses; and
(c) To respond appropriately to
identified or suspected fraud.
SA-250 Consideration This SA deals with the auditor’s
of Laws and responsibility to consider laws and
Regulations in regulations when performing an audit of
an Audit of financial statements.
Financial The objectives of the auditor are:
Statements
(a) To obtain sufficient appropriate
audit evidence regarding
compliance with the provisions of
those laws and regulations
generally recognised to have a
direct effect on the determination
of material amounts and
disclosures in the financial
statements;
(b) To perform specified audit
procedures to help identify
instances of non-compliance with
other laws and regulations that
may have a material effect on the
financial statements; and
251
(c) To respond appropriately to non-

compliance or suspected non-
compliance with laws and
regulations identified during the
audit.
SA-260 Communication This SA deals with the auditor’s
(Revised) with Those responsibility to communicate with those
Charged with charged with governance in an audit of
Governance financial statements.
(a) To communicate clearly with those
charged with governance the
responsibilities of the auditor in
relation to the financial statement
audit, and an overview of the
planned scope and timing of the
audit;
(b) To obtain from those charged with
governance information relevant to
the audit;
(c) To provide those charged with
governance with timely
observations arising from the audit
that are significant and relevant to
their responsibility to oversee the
financial reporting process; and
(d) To promote effective two-way
communication between the
auditor and those charged with
governance.
SA-265 Communicating This SA deals with the auditor’s
Deficiencies in responsibility to communicate
Internal Control appropriately to those charged with
to Those governance and management
Charged with deficiencies in internal control that the
Governance auditor has identified in an audit of
and financial statements.
Management The objective of the auditor is to
communicate appropriately to those
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charged with governance and

management deficiencies in internal
control that the auditor has identified
during the audit and that, in the auditor’s
professional judgment, are of sufficient
importance to merit their respective
attentions.
SA-299 Joint Audit of This SA lays down the principles for
(Revised) Financial effective conduct of joint audit to achieve
Statements the overall objectives of the auditor as
laid down in SA 200. This SA deals with
the special considerations in carrying out
audit by joint auditors. Accordingly, in
addition to the requirements enunciated
in this Standard, the joint auditors also
need to comply with all the relevant
requirements of other applicable SAs.
The objectives of this Standard are:
(a) To lay down broad principles for
the joint auditors in conducting the
joint audit.
(b) To provide a uniform approach to
the process of joint audit.
(c) To identify the distinct areas of
work and coverage thereof by
each joint auditor.
(d) To identify individual responsibility
and joint responsibility of the joint
auditors in relation to audit.
SA-300 Planning an This SA deals with the auditor’s
Audit of responsibility to plan an audit of financial
Financial statements. This SA is framed in the
Statements context of recurring audits. Additional
considerations in initial audit
engagements are separately identified.
The objective of the auditor is to plan the
audit so that it will be performed in an
effective manner.
253
SA-315 Identifying and This SA deals with the auditor’s

Assessing the responsibility to identify and assess the
Risks of risks of material misstatement in the
Material financial statements, through
Misstatement understanding the entity and its
through environment, including the entity’s
Understanding internal control.
the Entity and The objective of the auditor is to identify
Its Environment and assess the risks of material
misstatement, whether due to fraud or
error, at the financial statement and
assertion levels, through understanding
the entity and its environment, including
the entity’s internal control, thereby
providing a basis for designing and
implementing responses to the
assessed risks of material misstatement.
This will help the auditor to reduce the
risk of material misstatement to an
acceptably low level.
SA-320 Materiality in This SA deals with the auditor’s
Planning and responsibility to apply the concept of
Performing an materiality in planning and performing an
Audit audit of financial statements.
The objective of the auditor is to apply
the concept of materiality appropriately
in planning and performing the audit.
Responses to responsibility to design and implement
Assessed responses to the risks of material
Risks misstatement identified and assessed by
the auditor in accordance with SA 315.
The objective of the auditor is to obtain
sufficient appropriate audit evidence
about the assessed risks of material
misstatement, through designing and
implementing appropriate responses to
those risks.
254
SA-402 Audit This SA deals with the user auditor’s

Considerations responsibility to obtain sufficient
Relating to an appropriate audit evidence when a user
Entity Using a entity uses the services of one or more
Service service organisations.
Organization The objectives of the user auditor, when
the user entity uses the services of a
service organisation, are:
 To obtain an understanding of the
nature and significance of the
services provided by the service
organisation and their effect on the
user entity’s internal control
relevant to the audit, sufficient to
identify and assess the risks of
material misstatement; and
 To design and perform audit
procedures responsive to those
risks.
SA-450 Evaluation of This SA deals with the auditor’s
Misstatements responsibility to evaluate the effect of
Identified identified misstatements on the audit
during the and of uncorrected misstatements, if
Audit any, on the financial statements.
The objective of the auditor is to
evaluate:
(a) The effect of identified
misstatements on the audit; and
(b) The effect of uncorrected
misstatements, if any, on the
SA-500 Audit Evidence This SA explains what constitutes audit
evidence in an audit of financial
statements, and deals with the auditor’s
responsibility to design and perform
audit procedures to obtain sufficient
appropriate audit evidence to be able to
draw reasonable conclusions on which
255
to base the auditor’s opinion.

The objective of the auditor is to design
and perform audit procedures in such a
way as to enable the auditor to obtain
sufficient appropriate audit evidence to
be able to draw reasonable conclusions
on which to base the auditor’s opinion.
SA-501 Audit Evidence- This SA deals with specific
Specific considerations by the auditor in
Considerations obtaining sufficient appropriate audit
for Selected evidence in accordance with SA 330, SA
Items 500 and other relevant SAs, w.r.t.
certain aspects of inventory, litigation
and claims involving the entity, and
segment information in an audit of
regarding the:
(a) Existence and condition of
inventory;
(b) Completeness of litigation and
claims involving the entity; and
(c) Presentation and disclosure of
segment information in accordance
with the applicable financial
reporting framework.
SA-505 External This SA deals with the auditor’s use of
Confirmations external confirmation procedures to
obtain audit evidence in accordance with
the requirements of SA 330 and SA 500.
The objective of the auditor, when using
external confirmation procedures, is to
design and perform such procedures to
obtain relevant and reliable audit
evidence.
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SA-510 Initial Audit This SA deals with the auditor’s

Engagements- responsibilities relating to opening
Opening balances when conducting an initial
Balances audit engagement.
In conducting an initial audit
engagement, the objective of the auditor
with respect to opening balances is to
obtain sufficient appropriate audit
evidence about whether:
(a) Opening balances contain
misstatements that materially
affect the current period’s financial
statements; and
(b) Appropriate accounting policies
reflected in the opening balances
have been consistently applied in
the current period’s financial
statements, or changes thereto are
properly accounted for and
adequately presented and
disclosed in accordance with the
applicable financial reporting
framework.
SA-520 Analytical This SA deals with the auditor’s use of
Procedures analytical procedures as substantive
procedures, and as procedures near the
end of the audit that assist the auditor
when forming an overall conclusion on
the financial statements.
(a) To obtain relevant and reliable
audit evidence when using
substantive analytical procedures;
and
(b) To design and perform analytical
procedures near the end of the
audit that assist the auditor when
forming an overall conclusion as to
whether the financial statements
are consistent with the auditor’s
understanding of the entity.
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SA-530 Audit Sampling This SA applies when the auditor has

decided to use audit sampling in
performing audit procedures. It deals
with the auditor’s use of statistical and
non-statistical sampling when designing
and selecting the audit sample,
performing tests of controls and tests of
details, and evaluating the results from
the sample.
The objective of the auditor when using
audit sampling is to provide a
reasonable basis for the auditor to draw
conclusions about the population from
which the sample is selected.
SA-540 Auditing This SA deals with the auditor’s
Accounting responsibilities regarding accounting
Estimates, estimates, including fair value
Including Fair accounting estimates, and related
Value disclosures in an audit of financial
Accounting statements. Specifically, it expands on
Estimates, and how SA 315, SA 330 and other relevant
Related SAs are to be applied in relation to
Disclosures accounting estimates.
whether in the context of the applicable
financial reporting framework:
(a) accounting estimates, including fair
value accounting estimates, in the
financial statements, whether
recognised or disclosed, are
reasonable; and
(b) related disclosures in the financial
statements are adequate.
SA-550 Related This SA deals with the auditor’s
Parties responsibilities regarding related party
relationships and transactions when
performing an audit of financial
statements. Specifically, it expands on
how SA 315, SA 330 and SA 240 are to
258
be applied in relation to risks of material

misstatement associated with related
party relationships and transactions.
(a) Irrespective of whether the
applicable financial reporting
framework establishes related
party requirements, to obtain an
understanding of related party
relationships and transactions
sufficient to be able:
(i) To recognise fraud risk
factors, if any, arising from
related party relationships
and transactions that are
relevant to the identification
and assessment of the risks
of material misstatement due
to fraud; and
(ii) To conclude whether the
financial statements, insofar
as they are affected by those
relationships and
transactions:
a. Achieve a true and fair
presentation (for fair
presentation
frameworks); or
b. Are not misleading (for
compliance frameworks);
and
(b) In addition, where the applicable
financial reporting framework
establishes related party
requirements, to obtain sufficient
appropriate audit evidence about
whether related party relationships
and transactions have been
appropriately identified, accounted
259
for and disclosed in the financial

statements in accordance with the
framework.
SA-560 Subsequent This SA deals with the auditor’s
Events responsibilities relating to subsequent
events in an audit of financial
statements.
The objectives of the auditor are to:
(a) Obtain sufficient appropriate audit
evidence about whether events
occurring between the date of the
financial statements and the date
of the auditor’s report that require
adjustment of, or disclosure in, the
financial statements are
appropriately reflected in those
financial statements; and
(b) Respond appropriately to facts that
become known to the auditor after
the date of the auditor’s report,
that, had they been known to the
auditor at that date, may have
caused the auditor to amend the
auditor’s report.
SA-570 Going Concern This SA deals with the auditor’s
(Revised) responsibilities in the audit of financial
statements relating to going concern and
the implications for the auditor’s report.
audit evidence regarding, and
conclude on, the appropriateness
of management’s use of the going
concern basis of accounting in the
preparation of the financial
statements;
(b) To conclude, based on the audit
evidence obtained, whether a
material uncertainty exists related
260
to events or conditions that may

cast significant doubt on the
entity’s ability to continue as a
going concern; and
(c) To report in accordance with this
SA.
SA-580 Written This SA deals with the auditor’s
Representa- responsibility to obtain written
tions representations from management and,
where appropriate, those charged with
governance.
(a) To obtain written representations
from management and, where
governance that they believe that
they have fulfilled their
responsibility for the preparation of
the financial statements and for the
completeness of the information
provided to the auditor;
(b) To support other audit evidence
relevant to the financial statements
or specific assertions in the
financial statements by means of
written representations, if
determined necessary by the
auditor or required by other SAs;
and
(c) To respond appropriately to written
representations provided by
management and, where
governance, or if management or,
where appropriate, those charged
with governance do not provide the
written representations requested
by the auditor.
261
SA-600 Using the Work This SA establishes standards to be

of Another applied in situations where the principal
Auditor auditor, reporting on the financial
information of an entity, uses the work of
other auditor w.r.t. financial information
of components included in the financial
information of the entity.
SA-610 Using the Work This SA deals with the external auditor’s
(Revised) of Internal responsibilities if using the work of
Auditors internal auditors. This includes (a) using
the work of the internal audit function in
obtaining audit evidence and (b) using
internal auditors to provide direct
assistance under the direction,
supervision and review of the external
auditor.
The objectives of the external auditor,
where the entity has an internal audit
function and the external auditor expects
to use the work of the function to modify
the nature or timing, or reduce the
extent, of audit procedures to be
performed directly by the external
auditor, or to use internal auditors to
provide direct assistance, are:
(a) To determine whether the work of
the internal audit function or direct
assistance from internal auditors
can be used, and if so, in which
areas and to what extent;
and having made that determination:
(b) If using the work of the internal
audit function, to determine
whether that work is adequate for
the purposes of the audit; and
(c) If using internal auditors to provide
direct assistance, to appropriately
direct, supervise and review their
work.
262
SA-620 Using the Work This SA deals with the auditor’s

of an Auditor's responsibilities regarding the use of an
Expert individual or organisation’s work in a
field of expertise other than accounting
or auditing, when that work is used to
assist the auditor in obtaining sufficient
appropriate audit evidence.
(a) To determine whether to use the
work of an auditor’s expert; and
(b)
If using the work of an auditor’s
expert, to determine whether that
work is adequate for the auditor’s
purposes.
SA-700 Forming an This SA deals with the auditor’s
(Revised) Opinion and responsibility to form an opinion on the
Reporting on financial statements. It also deals with
Financial the form and content of the auditor’s
Statements report issued as a result of an audit of
(a) To form an opinion on the financial
statements based on an evaluation
of the conclusions drawn from the
audit evidence obtained; and
(b) To express clearly that opinion
through a written report.
SA - 701 Communicating This SA deals with the auditor’s
Key Audit responsibility to communicate key audit
matters in the matters in the auditor’s report. It is
Independent intended to address both the auditor’s
Auditor's report judgment as to what to communicate in
the auditor’s report and the form and
content of such communication.
The objectives of the auditor are to
determine key audit matters and, having
formed an opinion on the financial
statements, communicate those matters
by describing them in the auditor’s
report.
263
SA-705 Modifications to This SA deals with the auditor’s

(Revised) the Opinion in responsibility to issue an appropriate
the report in circumstances when, in forming
Independent an opinion in accordance with SA
Auditor's 700(Revised), the auditor concludes that
Report a modification to the auditor’s opinion on
the financial statements is necessary.
This SA also deals with how the form
and content of the auditor’s report is
affected when the auditor expresses a
modified opinion.
The objective of the auditor is to express
clearly an appropriately modified opinion
on the financial statements that is
necessary when:
(a) The auditor concludes, based on
the audit evidence obtained, that
the financial statements as a whole
are not free from material
misstatement; or
(b) The auditor is unable to obtain
sufficient appropriate audit
evidence to conclude that the
financial statements as a whole
are free from material
misstatement.
SA-706 Emphasis of This SA deals with additional
(Revised) Matter communication in the auditor’s report
Paragraphs when the auditor considers it necessary
and Other to:
Matter (a) Draw users’ attention to a matter
Paragraphs in or matters presented or disclosed
the in the financial statements that are
Independent of such importance that they are
Auditor's fundamental to users’
Report understanding of the financial
statements; or
(b) Draw users’ attention to any matter
or matters other than those
presented or disclosed in the
264
financial statements that are

relevant to users’ understanding of
the audit, the auditor’s
responsibilities or the auditor’s
report.
The objective of the auditor, having
formed an opinion on the financial
statements, is to draw users’ attention,
when in the auditor’s judgment it is
necessary to do so, by way of clear
additional communication in the auditor’s
report, to:
(a) A matter, although appropriately
presented or disclosed in the
financial statements, that is of such
importance that it is fundamental to
users’ understanding of the
financial statements; or
(b) As appropriate, any other matter
that is relevant to users’
understanding of the audit, the
auditor’s responsibilities or the
auditor’s report.
SA-710 Comparative This SA deals with the auditor’s
Information- responsibilities regarding comparative
Corresponding information in an audit of financial
Figures and statements.
Comparative The objectives of the auditor are:
Financial
Statements
audit evidence about whether the
comparative information included
in the financial statements has
been presented, in all material
respects, in accordance with the
requirements for comparative
information in the applicable
financial reporting framework; and
(b) To report in accordance with the
auditor’s reporting responsibilities.
265

(Revised) Responsibilities responsibilities relating to other
Relating to information, whether financial or non-
Other financial information (other than financial
Information statements and the auditor’s report
thereon), included in an entity’s annual
report.
The objectives of the auditor, having
read the other information, are:
(a) To consider whether there is a
material inconsistency between the
other information and the financial
statements;
(b) To consider whether there is a
material inconsistency between the
other information and the auditor’s
knowledge obtained in the audit;
(c) To respond appropriately when the
auditor identifies that such material
inconsistencies appear to exist, or
when the auditor otherwise
becomes aware that other
information appears to be
materially misstated; and
(d) To report in accordance with this
SA.
SA-800 Special This SA deals with special
Considerations- considerations in the application of SAs
Audit of in the 100-700 series to an audit of
Financial financial statements prepared in
Statements accordance with a special purpose
Prepared in framework.
Accordance The objective of the auditor, when
with Special applying SAs in an audit of financial
Purpose statements prepared in accordance with
Frameworks a special purpose framework, is to
address appropriately the special
considerations that are relevant to:
(a) The acceptance of the
266
engagement;
(b) The planning and performance of
that engagement; and
(c) Forming an opinion and reporting
on the financial statements but not
for the purpose of expressing an
opinion on the effectiveness of the
entity’s internal control.
SA-805 Special This SA deals with special
Considerations- considerations in the application of SAs
Audit of Single in the 100-700 series to an audit of a
Financial single financial statement or of a specific
Statements and element, account or item of a financial
specific statement.
Elements, The objective of the auditor, when
Accounts or applying SAs in an audit of a single
Items of a financial statement or of a specific
Financial element, account or item of a financial
Statement statement, is to address appropriately
the special considerations that are
relevant to:
(a) The acceptance of the
engagement;
(b) The planning and performance of
that engagement; and
(c) Forming an opinion and reporting
on the single financial statement or
on the specific element, account or
item of a financial statement but
not for the purpose of expressing
an opinion on the effectiveness of
the entity’s internal control.
SA-810 Engagements This SA deals with the auditor’s
to report on responsibilities when undertaking an
Summary engagement to report on summary
Financial financial statements derived from
Statements financial statements audited in
accordance with SAs by that same
auditor.
267
The objectives of the auditor are to:

(a) Determine whether it is appropriate
to accept the engagement to report
on summary financial statements;
(b) Form an opinion on the summary
financial statements based on an
evaluation of the conclusions
drawn from the evidence obtained;
and
(c) Express clearly that opinion
through a written report that also
describes the basis for that
opinion.
Compliance with the SAs should be taken care of, while executing the audit as
well as reporting.
268
5
Special Considerations in a CBS
Environment
Introduction
5.01 The face of Banking Industry is changing rapidly. What banking is today
is quite different from what it was in the years gone by. Rapid strides in
technological advancements, different payment systems, integration of Aadhaar
for cardless transactions are changing the way of banking. However, in recent
times there have been few instances of manipulating the banking system for
unlawful gains and frauds.
Responsibilities of Branch Auditors
5.02 Generally, the branch auditors do not have access to the overall IT
policy, processes, controls and accounting procedures implemented by the
bank. Moreover, the branch auditors confront following practical issues at fully
computerised branches:
 Accounting manual, entries, calculations and framework is built in
computerised accounting systems.
 Critical IT and manual controls are centralised at HO level.
 Limited access to periodical MIS, exception reports, NPA related reports
generated by the system.
 Documentation of critical processes performed for accounting and book
keeping (IT and Manual).
 Access to primary records and entry level transactions.
 Difficulty in audit sampling due to huge population of data.
 Hard copies of transactions.
 Independent IT Audit at branches, etc.
 Staff ignorance about various aspects of the IT infrastructure at the
Branch.
5.03 Overall review of IT environment and of the computerised accounting
system has to be taken up at the central level. The management plays a more
proactive role to ensure that the computerised accounting systems are working
properly and effectively. It is for the Statutory Central Auditor to review whether
the management is performing this role effectively. The roles and

responsibilities of bank, and the branch auditors are enumerated in the
following paragraphs.
Role and responsibilities of the Bank
5.04 Considering the importance of IT systems in the preparation and
presentation of financial statement, it is imperative that the bank should share
detailed information about the following key aspects relating to IT environment
of the bank with the central/branch auditor at regular intervals:
 Overall IT Policy, structure and environment of the bank’s IT system and
changes/developments, if any, thereto. The Bank is also required to put
in place a cyber security framework as mandated by RBI vide Circular
no. DBS.CO/CSITE/BC.11/33.01.001/2015-16 dated June 2, 2016 and
any amendments thereto.
 Data processing and data interface under various systems.
 Data integrity and data security.
 Business Continuity Plans and Disaster Recovery Plans.
 Accounting manual and critical accounting entries (including month-end
and year-end) and the processes and involvement of IT systems.
 Controls over key aspects, such as, account codes and mapping thereof,
use of various account heads including other assets and other liabilities,
asset classification, income recognition, expense booking, overdue
identification, month-end and year-end procedures, valuation and re-
valuation of various items of the financial statements, KYC, AML, etc.
 Controls and recording of various e-banking and internet banking
products and channels.
 Manual processing of key transactions.
 MIS reports being generated and the periodicity thereof.
 Hard copies being generated and the periodicity thereof.
 Process of generating information related to various disclosures in the
financial statements and the involvement of the IT systems.
 Major exception reports and the process of generation thereof along with
logic embedded in generation of such reports.
 Major IT related issues (including frauds and failures) faced and
resolved/unresolved during the year, such as, data/system corruption,
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system break-down, etc., having a bearing on the preparation and

presentation of financial statements.
 Significant observations of internal auditors, concurrent auditors, system
auditors, RBI inspection, internal inspection, etc., related to
computerised accounting and overall IT systems.
 Customer complaints related to mistakes in transactions (interest
application, balances, etc.).
 In order to ensure that the technology deployed to operate the payment
system/s authorised is/are being operated in a safe, secure, sound and
efficient manner and as per the process flow submitted by the bank for
which authorisation has been issued; banks are required to get a System
audit done by a firm of Chartered Accountants. The auditor conducting
the System Audit should also be a Certified Information System Auditor
(CISA) and registered with the ISACA. The scope of the System audit
would include evaluation of the hardware structure, operating systems
and critical applications, security and controls in place, including access
controls on key applications, disaster recovery plans, training of
personnel managing systems and applications, documentation, etc. The
system auditor is also required to comment on the deviations, if any, in
the processes followed from the process flow submitted to RBI while
seeking authorisation.3
 Compliance documentation with RBI IT and Security directives and
guidelines.
Role and responsibilities of branch auditors
5.05 Based on the guidance and information received from the Statutory
Central Auditor / Bank, the branch auditors need to ensure that:
 Their roles and responsibilities are clearly understood and implemented.
 To the extent possible, data analysis tools are used for better and
effective audit.
 Test of controls and substantive checking of sample transactions are
carried out at the branch level and, where considered necessary, the
results are shared with the Statutory Central Auditors.
 Data review and analysis through CBS is carried out.
3Refer RBI circular No. DPSS.AD.No./ 1206/02.27.005/2009-2010 dated 7thDecember, 2009

on “System Audit of the Payment Systems operated under the PSS Act, 2007”.
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 Significant observations having bearing on the true and fair view are
reported to the Statutory Central Auditors.
 Any other limitations on audit which are required to be reported to the
Statutory Central Auditors are reported in a timely manner.
NPA Identification through System (RBI Guidelines)
5.06 The RBI had come out with the following Guidelines for NPA
identification.
 Various instances have been observed wherein Banks are still found to be
resorting to manual identification of NPA and also over-riding the system
generated asset classification by manual intervention. Several gaps have
been observed in automated processes for NPA identification, income
recognition, provisioning and generation of related returns.
 In order to ensure the completeness and integrity of the automated Asset
Classification (classification of advances/investments as NPA/NPI and their
upgradation), Provisioning calculation and Income Recognition processes,
RBI vide circular no. RBI/2020-21/37 Ref. No. DoS.CO.PPG./SEC.03/11.01.
005/2020-21, dated September 14, 2020, advised banks to put in place /
upgrade their systems to system based asset classification on an ongoing
exercise for both down gradation and up-gradation of accounts.
 As per this circular banks should ensure that the asset classification status is
updated as part of day end process. Banks should also be able to generate
classification status report at any given point of time with actual date of
classification of assets as NPAs/NPIs.
 Banks shall not resort to manual intervention / over-ride in the System based
asset classification process. In any exceptional circumstance where manual
intervention is required to override the System classification, it must have at
least two level authorisation.
 Day end process and manual interventions are generally at branch level
operations; branch auditor to ensure compliance of the said circular.
Auditors should note that the above Circular is applicable from June 2021.
Data Analytics on CBS MIS Reports
5.07 In terms of Chapter VIII of Master Directions no. RBI/DBS/2016-17/28
DBS.CO.CFMC.BC.No.1/23.04.001/2016-17, “Master Directions on Frauds –
Classification and Reporting by commercial banks and select FIs” dated July 1,
2016 (updated as on July 03, 2017), bank should track Early Warning Signals
(Annex-II of Master Directions) by integrating with the credit monitoring process
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in the bank so that it becomes a continuous activity and also acts as a trigger for
any possible credit impairment in the loan accounts, given the interplay between
credit risks and fraud risks.
5.08 Among the illustrative 42 EWS, the most prominent ones are,
suspicious related party transactions and financial and stock statement
manipulations are posed to high credit and fraud risks.
5.09 Further, the auditor should bring it to the notice of the top management
and if necessary to the Audit Committee of the Board (ACB) for appropriate
action such instances of EWS.
I. Related party transactions pose a big threat to credit risks and fraud risks. As
system preventive controls or manual maker and checker controls are weak in
banking with respect to controlling borrowers suspicious related party
transactions, auditors have carryout substantive analytical procedures using
tools like spreadsheet to rule out material misstatements due to fraud or error.
Data analytics can be used on the CBS MIS reports, borrowers financials and
stock statements for assessing credit and or fraud risks.
Spreadsheet can be used as an audit documentation tool in support of
compliance to various auditing standards viz. SA 230, SA 240, SA 315, SA 300,
SA 520, etc., spreadsheet functions like sort, filter, sumif, vlookup, pivot can be
used for audit documentation.
II. Financial Statement and Stock Statement manipulations for enhanced
loan eligibility
Following are control weaknesses in CBS
a. DP calculated on the basis of manual returns is entered in the CBS. Except
for maximum sanctioned limit/DP no other application control on quality of
returns.
b. There is a lack of independent application systems to assess the quality of
stock statements and periodical returns.
c. Validation controls are weak with respect to DP limits.
d. Controls around validation of borrowers’ financial statement are weak.
e. Audited Financial statements content is entered into spreadsheet template
as a part of CMA data for critical ratio analysis related to liquidity,
profitability, and other ratios. Application controls for analysis of financial
statements are weak.
III. Wrong IRAC classifications by banks are significant audit risks.
Following are control weaknesses in CBS:
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a. Basis of IRAC classification is dependent on fields such as Loan Sanction

Date, Period of Loan, Rate of interest, moratorium, nature of facility, priority
sector, terms of re-schedulement, etc., which are at times updated
manually at the branch and not through Centralised / automated process.
b. Periodic validation of IRAC classification, especially in case of Doubtful or
Loss Assets wherein at times it is observed that the same is not system
driven and updated manually at the branch.
Audit in a CIS environment
Assessment of Inherent and Control Risks
5.10 The nature of banking operations is such that the auditors may not be
able to reduce the audit risk to an acceptable low level by the performance of
substantive procedures alone. It may be so on account of following factors:
 The extensive use of IT and EFT systems, which mean that much of the
audit evidence is available only in electronic form and is produced by the
bank’s own IT systems.
 The high volume of transactions processed by banks, which makes
reliance on substantive procedures alone impracticable.
 The geographic spread of banks’ operations.
 Complex trading transactions (Highly inter connected and automated
systems such as card, mobile banking and payment systems).
 The susceptibility of the financial statements to frauds and auditor’s
responses as per SA 240.
5.11 In most situations, the auditors’ ability to reduce audit risk to an
acceptably low level would be affected by the internal control systems
established by the management that allow the auditors to be able to assess the
level of inherent and control risks as less than high. The auditors obtain sufficient
appropriate audit evidence to assess the level of inherent and control risks.
5.12 The auditor’s procedures would need to be adapted as circumstances
warrant and in respect of each account, different procedures may be necessary.
5.13 The principal objective of the auditor in undertaking an audit in a CIS
environment is to evaluate the effectiveness of controls. In simple words, controls
are those policies and procedures which the organisation implements to
minimise the events and circumstances whose occurrence could result in a loss /
misstatement. There are mainly four types of controls:
A. Deterrent controls - Deterrent controls are designed to deter people, internal
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as well as external, from doing undesirable activities. For example, written

policies including the punitive measures may deter people from doing
undesired activities.
B. Preventive Controls - Preventive controls prevent the cause of exposure
from occurring or at least minimise the probability of unlawful event taking
place. For example, security controls at various levels like hardware,
software, application software, database, network, etc.
C. Detective Controls - When a cause of exposure has occurred, detective
controls report its existence in an effort to arrest the damage further or
minimise the extent of the damage. Thus, detective controls limit the losses
if an unlawful event has occurred. Review processes in place at a Branch
are examples of detective controls.
D. Corrective Controls - Corrective controls are designed to recover from a loss
situation. For example, ‘business continuity planning’ is a corrective control.
Without corrective controls in place, the bank has risk of loss of business
and other losses due to its inability to recover essential IT based services,
information and other resources after the disaster has taken place.
5.14 The Auditor should obtain a preliminary understanding of the IT
environment and various controls put in place by the management, including
entity-level controls and then test and evaluate whether the controls are
operating effectively. The Auditor should discuss the methodology adopted by
the bank in implementing controls and their monitoring with the Head of the IT
department and the Head of the audit department. These discussions will
enable the auditor to get a view on the manner in which the bank has
implemented controls. Based on these discussions, the auditor could interact
with the various officials of the bank to determine whether they are sensitised
to the control expectations of the management considering the technology
deployed. If this sensitisation level is low, the auditor may need to perform
more extensive audit procedures.
Security Control Aspects
5.15 The key security control aspects that an auditor needs to address
when undertaking audit in a computerised bank include:
 Ensure that authorised, accurate and complete data is made available
for processing.
 Ensure that in case of interruption due to power, mechanical or
processing failures, the system restarts without distorting the completion
of the entries and records.
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 Verify whether “access controls” assigned to the staff-working match with

the responsibilities as per manual. It is important for the auditor to
ensure that access and authorisation rights given to employees are
appropriate.
 Verify that segregation of duties is ensured while granting system access
to users and that the user activities are monitored by performing an
activities log review.
 Verify that changes made in the parameters or user levels are
authenticated.
 Verify that charges calculated manually for accounts when function is not
regulated through parameters are properly accounted for and authorised.
 Verify that exceptional transaction reports are being authorised and
verified on daily basis by the concerned officials. It is important for the
auditor to understand the nature of exception and its impact on
financials.
 Verify that the account master and balance cannot be modified /
amended / altered except by the authorised personnel.
 Verify that all the general ledger accounts codes authorised by Head
Office are in existence in the system.
 Verify that balance in general ledger tallies with the balance in subsidiary
book.
Risks arising out of CBS environment
Credit Risk
5.16 Generally, the bank’s credit risk is not increased by the mere fact that
a loan is originated through an e-banking channel. However, the bank should
ensure that additional precautions are in place when originating and approving
loans electronically including assuring management information systems’
effectiveness by preparing a track of the performance of portfolios originated
through e-banking channels. The following aspects of on-line loan origination
and approval tend to make risk management of the lending process more
challenging:
 Verifying the customer’s ID for on-line credit applications and executing
an enforceable contract;
 Monitoring and controlling the growth, pricing, and on-going credit quality
of loans originated through e-banking channels;
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 Monitoring and oversight of third-parties operations doing business as

agents or on behalf of the banks;
 Valuing collateral and perfecting liens over a potentially wider
geographic area; and
 Collecting loans from individuals over a potentially wider geographic
area.
If not properly managed, these aspects can significantly increase the credit
risk.
Compliance/ Legal Risk
5.17 Compliance and legal issues arise out of the rapid growth in usage of e-
banking services and the differences between the electronic and paper-based
processes. E-banking is a new delivery channel where the laws and rules
governing the electronic delivery of certain financial products or services may be
ambiguous or still evolving. Specific regulatory and legal challenges include:
 Uncertainty over the legal jurisdictions applicable to the transaction
taking place through e-banking.
 Delivery of credit and deposit related disclosures/notices as required by
law or regulation.
 Retention of required compliance documentation for on-line advertising,
applications, statements, disclosures, notices.
 Establishment of legally binding electronic agreements.
5.18 Banks offering e-banking services, both informational and transactional,
assume a higher level of compliance risk because of the changing nature of the
technology, the speed at which errors can be replicated, and the frequency of
regulatory changes to address e-banking issues. The potential for violations is
further heightened by the need to ensure consistency between paper and
electronic advertisements, disclosures and notices.
Reputational Risk
5.19 The rise of the sophisticated cyber-crime has become one of the fastest
growing security and reputational risks to banks. The cyber-crime landscape
features malware exploits that can routinely evade traditional security controls.
The reactive attack and penetration approaches of the past may no longer be
sufficient to deal effectively with that level of ingenuity of cyber-attacks and are
being replaced with new forms of cyber intelligence capable of enhancing
traditional security programs. Adding a layer of complexity to the issue is the rise
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of social networking, online communications, and online financial transactions.

The bank has a significant role to play in identifying and addressing this risk
thereby safeguarding its reputation and instilling the confidence in its customers.
Audit through CBS
5.20 With the adoption of CBS by banks, realignment in the conventional
audit methodology has also become inevitable. Audit is required to be conducted
through the system. In various aspects, the automated controls in the CBS
system are also required to be reviewed and verified.
What is CBS?
5.21 The core banking system is the set of basic software components that
manage the services provided by a bank to its customers through its branches
(branch network). The bank's customers can make their transactions from any
branch, ATM, Service Outlets, Internet, Phone at their disposal. The CBS is
based on Service Oriented Architecture (SOA). It helps banks to reduce risk that
can result from manual data entry and out of date information. It also helps banks
to improve Service Delivery quality and time to its customer. The software is
accessed from different branches of bank via communication lines like
telephones, satellite, internet, etc.
5.22 Core Banking Solution [CBS] works on a concept of Centralized
Database and Processing. Transactions take place at various geographical
locations which get recorded and processed at a Centralized Server. Updating of
Database is on Real Time Basis. Due to the Centralization of Transaction
Processing, issue of Out of Date Information is eliminated. All the users
connected to CBS will be able to get up to date information. CBS also enhances
the quality of Reporting and strengthens Access Control.
5.23 Under CBS data is stored in centralized servers at Data Centre. This
effectively means that all operations at the connected branches, back offices are
carried out through servers at Data Centre including transactions through other
delivery channels like ATMs, Internet Banking, Phone Banking.
5.24 Under CBS, the branches, back offices are defined as SOL (i.e. Service
Outlets) where each SOL functions as a service window. The CBS is capable of
processing any transaction from any branch location connected to CBS. It can be
equated with single window operations at airline counters or railway reservation
counters wherein all the services can be obtained at one place. Hence, under
CBS customer is now a customer of the bank and not merely a customer of a
branch of the Bank. This has facilitated “Any-where, Anytime Banking”
convenience for the customer.
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5.25 From Bank’s perspective, control over the application and processes
has been entrusted at Data Center Level. In addition to it, CBS also makes
available effective MIS on real-time basis. It enables generation of all periodical
returns centrally.
5.26 There are various CBS developed by various software companies
available in the market. Few widely used CBS are (a) FINACLE, (b) BaNCS and
(c) FlexCube. An Illustrative List of Special Purpose / Exception Reports in CBS
is given as Annexure to this Chapter.
5.27 The Branch auditor should call for reports, if any, of the CBS
environment in use at the Branch. Further, the auditor should also consider
interaction of various other IT systems with the CBS and review whether the flow
of data between various systems is seamless and without any manual
intervention.
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Annexure
Illustrative List of Special Purpose / Exception Reports in
CBS
The following indicative list of reports will benefit SCAs and SBAs (if shared in
advance) while undertaking the audit in a fully computerised environment:
Advances
Sr. No. Report
i. Advances Snapshot covering all important parameters
ii. Accounts with overdue in excess of 90 Days and are classified as
Standard Assets
iii. List of LCs devolved during the period / year and current status of
account
iv. List of BGs invoked during the period / year and current status of
account
v. Standalone Non Fund Based Limits granted to customers
vi. List of SMA / Watch list / Probable NPA/Weak account accounts as
on the last date of Audit period
vii. Backdated updation of stock and book debt statements (Difference
between Date of updation in CBS and Date of Stock Statement
updated)
viii. List of accounts wherein the facility is not renewed / reviewed
ix. List of accounts slipped to NPA during the current period
x. List of accounts wherein there is an amendment in Date of NPA
xi. List of accounts written off during the period / year
xii. List of Accounts upgraded (along with date of upgrade and the
overdues on the date of upgrade)
xiii. Quick Mortality (NPA within 1 year of Advance)
xiv. List of NPA Accounts with Security Valuation not carried out within
the prescribed period
xv. List of accounts wherein re-phasement (Change in EMI, Tenor,
Moratorium period) is carried out in CBS (excluding re-phasement
due to change in the reference rate)
xvi. Loan / OD against FD with no linkage to FD (i.e. Security)
xvii. Loan to Minor (Excluding Non individual accounts and excluding
Education, Loan/OD against Deposit cases)
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Sr. No. Report

xviii. Loans below the benchmark rate (as applicable in each bank)
xix. Loans above the maximum lending rate (as applicable in each bank)
xx. Loans where disbursement is made in Cash (Threshold limit may be
prescribed)
xxi. Credit transactions in CC / OD / Loan Accounts with Value Date
(Back Date) without Value Date (Back Date) at Debit Leg
xxii. Advance accounts where effective interest rate is Zero
xxiii. CC Accounts with primary security is “Nil”
xxiv. Multiple TODs / Ad hoc Sanctions for a customer
xxv. Non delinking of Ad hoc facility sanctioned on expiry
xxvi Multiple Customer IDs having common PAN
xxvii Red Flagged Accounts since more than 6 months
Profit & Loss
Sr. Report
No.
i. Manual debit to Interest Income and Other Income Account
ii. Manual credits to Interest Income and Other Income Account
iii. Manual debit to Interest Expense Account
iv. Interest pegging marked as “Y” for loans sanctioned at variable rate i.e.
w.r.t. benchmark rates (pegging may freeze the interest rate at the
respective time)
Foreign Exchange, Internal Controls and Systems
Sr. Report
No.
i. Bills under LC devolved and not crystallized. / Bills under LC devolved
wherein the crystallization account is office account / not of customer
ii. Export Bills discounted / purchased and outstanding beyond due dates
iii. Packing Credits Accounts outstanding beyond due dates / Running
Packing Credit accounts with age of un-utilized orders is more than 365
days
iv. Resident Customers having Non Resident Account (under same or
multiple customer master)
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v. NRE Account Holder having Resident Savings Account (under same or

multiple customer master)
vi. FDs / RDs with aggregate balance at customer master level in excess of
Rs. 20,000 and closed one / all FDs / RDs in cash
vii. Cash Payments from Office Accounts in excess of Rs. 10,000
viii. Non Senior Citizen customers (based on DOB) with Senior Citizen
Interest Table code
ix. Preferential Interest Rate applicable to staff applied in non staff deposit
(Refer the policy of bank w.r.t. extending facility to ex-staff and relatives of
staff / ex-staff)
x. List of Outstanding Office Accounts entries (Pointing type accounts).
xi. Accounts with invalid PAN (No. of digits, structure, constitution code
mapping with 4th Digit)
xii. List of Foreign Exchange transactions with Exchange Rates beyond the
card rate / Maximum-Minimum Rate during the period
Capital Adequacy
Sr. Report
No.
i. Accounts above threshold limit wherein External Credit Rating is not
obtained / updated
ii. Bank Guarantees and LC Expired and not reversed
iii. Accounts with mismatch in Constitution code and BASEL Mapping
The above list of reports is indicative only. There are various other reports that
can be generated. However, the generation of reports requires in-depth review of
bank’s systems, processes and gaps. The reports can be made more effective
through continuation review and update mechanism.
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6
Cash
6.01 The primary check for cash is to carry out verification of the balance of
cash on hand. Wherever feasible, the Auditor should visit the branch at the
close of business on the last working day of the year or before the
commencement of business hours on the next day for carrying out physical
verification of cash. If, for any reason, the auditor is unable to do so, he should
carry out the physical verification of cash as close to the balance sheet date as
possible, at the time of audit and also reconcile with the cash register/balance
in CBS.
6.02 The physical verification should be evidenced through working paper
indicating the denominations and the number of currency notes. The auditor
should ensure that the physical verification of cash includes physical
verification of cash on hand, cash at ATM and cash at CDM (Cash Deposit
Machines) and the reconciliation of the same with the GL balances of the
respective GL heads. The counting sheet should be counter signed by the
Cashier and the Branch manager.
6.03 In some banks, the branch deposits a large portion of its cash balance
with the RBI or the State Bank of India or any other bank on the closing day
and in such cases, the auditor should request the branch to provide sufficient
appropriate evidence for the same and also ensure that the same is effected in
the books of accounts and is not appearing as a bank reconciliation item.
6.04 Besides the physical verification, if there are instructions or certifications
specific to the bank, the same needs to be complied with. Following specific
questions w.r.t. cash need to be addressed in LFAR.
(a) Does the system ensure that cash maintained is in effective joint custody of
two or more officials, as per the instructions of the controlling authorities of
the bank?
(b) Have the cash balances at the branch/ATMs been checked at periodic
intervals as per the procedure prescribed by the controlling authorities of
the bank?
(c) (i) Does the branch generally maintain / carry cash balances, which vary
significantly from the limits fixed by the controlling authorities of the bank?
(ii) Does the figure of the balance in the branch books in respect of cash
with its ATM(s) tally with the amounts of balances with the respective
ATMs, based on the year end scrolls generated by the ATMs? If there is
any difference, same should be reported.
(d) Whether the insurance cover available with the branch adequately meets
the requirement to cover the cash-in hand and cash-in transit?
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7
Balances with Reserve Bank of India,
State Bank of India and Other Banks (For
Branches with Treasury Operations)
7.01 In most of the branches, there will be no bank account. Hence this
section does not require any reporting. However, in case there is a bank account
balance, following steps need to be taken for the audit.
(i) Examine that no debit for charges or credit for interest is outstanding and
all the items which ought to have been taken to books of accounts for the
year have been considered. This should be particularly observed when
the bills collected, etc., are credited with net amount and entries for
commission, etc., are not made separately in the statement of account.
(ii) Examine that no cheque sent or received in clearing is outstanding. As
per the practice prevalent among banks, any cheque returned unpaid is
accounted for on the same day on which they were sent for clearing or on
the following day.
(iii) Examine that all bills or outstanding cheques sent for collection and
outstanding as on the closing date have been credited subsequently.
(iv) The auditor should also examine the large transactions in inter-bank
accounts, particularly towards the year-end, to ensure that no
transactions have been put through for window-dressing.
(v) In respect of balances in deposit accounts, original deposit receipts
should be examined in addition to confirmation certificates obtained from
banks in respect of outstanding deposits. The auditor should also ensure
that interest on such deposits has been recorded on time proportion basis
and interest has been recorded till the closing day.
(vi) The balances with banks outside India should also be verified in the
manner described above. These balances should be converted into
Indian currency at the exchange rates prevailing on the balance sheet
date.
(vii) Increasingly banks are automating the process of reconciliation with other
banks. In case of system process, the auditor should understand the
system, system controls and manual controls.
(viii) The auditor should review the bank reconciliation statement (whether
automated or manual) and undertake age-wise and entry-wise analysis of
the same and verify if any effect to un-responded entries is required to be
given and / or provision related thereto is required.
7.02 Besides the requisite audit checks as specified above, in respect of
branches where bank balances are maintained, following LFAR issues need to
be addressed:
a) Were balance confirmation certificates obtained in respect of outstanding
balances as at the year-end and whether the aforesaid balances have been
reconciled? The nature and extent of differences should be reported.
 Balance confirmation certificates to be obtained in respect of
outstanding balances as at the year end as well as at the end of the
month.
 Obtain the Bank Reconciliation Statement for the above referred
period.
 If the reconciliation is not carried out or carried out incorrectly the
same to be reported.
 If any difference is observed, then report the amount, nature of
difference and period since when the amount is lying in the
reconciliation statement.
b) Observations on the reconciliation statements may be reported in the
following manner:
(i) Cash transactions remaining un-responded (give details).
(ii) Revenue items requiring adjustments/write-off (give details).
(iii) Other credit and debit entries originated in the statements provided
by RBI/other banks, remaining un-responded for more than 15 days.
(iv) Where the branch maintains an account with the RBI, the following
additional matter may be reported:
Entries originated prior to, but communicated / recorded after, the
year end in relation to currency chest operations at the branch/other
link branches, involving deposits into / withdrawals from the currency
chest attached to such branches (Give details).
c) In case, any matter deserves special attention of the management, the
same may be reported.
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8
Money at Call and Short Notice
8.01 Generally, this activity is handled in the Treasury Department of the
bank. In view of the same, such types of transactions do not appear in the
Branch Books. However, the Auditor should confirm that no such transactions
are appearing in the Branch Trial Balance. The RBI statement provided to the
Treasury Branch mentions the branch code against each of the entries and in
turn the treasury department provides the same to the branch and asks the
branch to respond for passing the appropriate accounting entry in the books of
accounts. The auditor should check the communication between the branch and
the treasury branch and ascertain that any entry pertaining to the branch is
appropriately identified and passed in the books of accounts.
8.02 If there are such types of transactions, obtain the instructions/
guidelines laid down by the Controlling Authorities of the bank and examine the
compliance thereof.
8.03 The Auditor is required to report on following points for the said activity
in Long Form Audit Report:
a) Has the branch kept money-at-call and short notice during the year?
b) Has the year-end balance been duly confirmed and reconciled?
c) Has interest accrued up to the year-end been properly recorded?
d) Whether instructions/guidelines, if any, laid down by the controlling
authorities of the bank have been complied with?
9
Investments (For Branches Outside
India)
9.01 This area is looked after by Treasury Department of the bank. Hence,
such types of transactions do not appear in Branch Books. However, the auditor
should confirm that no Investments are appearing in the Branch Trial Balance.
However, in case of Branches outside India, the Investment activity is carried out
at branch level as well.
9.02 If investments are appearing in the branch trial balance, physical
verification and reconciliation with the books should be conducted and reported
accordingly. Also verify investment balance confirmation of counter party
(Investee) with balance appearing in Branch Books.
Reporting in Long Form Audit Report
9.03 For Branches outside India
a) In respect of purchase and sale of investments, has the branch acted within
its delegated authority, having regard to the instructions/ guidelines in this
behalf issued by the controlling authorities of the bank?
b) Have the investments held by the branch whether on its own account or on
behalf of the Head Office / other branches been made available for physical
verification? Where the investments are not in the possession of the
branch, whether evidences with regard to their physical verification have
been produced?
c) Is the mode of valuation of investments in accordance with the RBI
guidelines or the norms prescribed by the relevant regulatory authority of
the country in which the branch is located whichever are more stringent?
d) Whether there are any matured or overdue investments which have not
been encashed and / or has not been serviced? If so, give details?
9.04 The questions in LFAR are self-explanatory and no specific guidance is
provided here. However, the Auditor may refer to Chapter 5 “Treasury
Operations” given in the Section A of this Guidance Note.
10
Advances-Agriculture
Introduction
10.01 Agriculture has always been the backbone of the Indian economy
despite sustained progress in industrial and service(s) sector. It still contributes
around 14 per cent of the GVA (Gross Value Added) and provides employment
opportunities to around 42 per cent of the population (Source: National Council of
Applied Economic Research, Delhi). Indian agriculture has been the source of
raw materials to many of our leading industries like cotton, jute textile industries,
sugar, flour mills, vanaspati, oil mills etc. Besides, many industries like handloom
weaving, rice-dehusking etc. depend indirectly on agriculture.
10.02 Agricultural credit is considered as one of the most basic inputs for
conducting all agricultural development programmes. In India there is immense
need for proper agricultural credit as the economic condition of Indian farmers
generally is of subsistence.
10.03 With a view to ensure wider spread of agricultural credit, the
Government adopted the institutional credit approach through various agencies
like co-operatives, commercial banks, regional rural banks etc. to provide
adequate credit to farmers, at a cheaper rate of interest. The long term and short
term credit needs of these institutions are also being met by National Bank for
Agriculture and Rural Development (NABARD). It has the objective of promoting
the health and the strength of the credit institutions which are in the forefront of
the delivery system namely, cooperatives, commercial banks and regional rural
banks. It is, in brief, an institution for the purpose of refinance; with the
complementary work of directing, inspecting and supervising the credit- flows for
agricultural and rural development.
10.04 The evolution of institutional credit to agriculture could broadly be
classified into four distinct phases –
i. 1904-1969 (predominance of co-operatives and setting up of RBI)
ii. 1969-1975 [nationalization of commercial banks and setting up of Regional
Rural Banks (RRBs)]
iii. 1975 - 1990 (setting up of NABARD)
iv. 1991 onwards (Financial Sector Reforms): The genesis of institutional
involvement in the sphere of agricultural credit could be traced back to the
enactment of the Cooperative Societies Act in 1904. The establishment of

the RBI in 1935 reinforced the process of institutional development for
agricultural credit.
10.05 The Government has increasingly begun to tap institutional finance from
banks and other term lending institutions for financing various developmental
programmes in view of the need to supplement plan financing. Banks have also
played a pivotal role in this regard. However, credit should be utilized in a
prudent manner to maximize returns and spread the benefit over wider sections
of the population.
10.06 The State Level Bankers’ Committee (‘SLBC’), constituted by the
Reserve Bank of India under the Lead Bank Scheme periodically takes up the
review performance and monitors progress under special schemes. At the
District level the District Consultative Committee with the Chief Executive Officer
of Zilla Panchayat as chairperson and representatives of financial institutions and
Heads of Government departments at the district level as members’ monitors the
implementation of government sponsored schemes & Service Area Credit Plans.
At the block level, Block Level Bankers’ Committee chaired by Lead District
Manager with bank managers and departmental heads of government at block
level as members periodically reviews the implementation of government
sponsored schemes & Service Area Credit Plans and sorts out problems
encountered in the implementation of various programmes. In order to select and
prioritise the works for loan assistance from NABARD under Rural Infrastructure
Development Fund (RIDF) Scheme, launched in 1995-96, a Cabinet Sub-
Committee on RIDF has been constituted under the chairmanship of the Minister
for Public Works. There is also a High Power Committee chaired by the
Additional Chief Secretary and Development Commissioner for reviewing the
implementation of RIDF projects. These policy measures have resulted in an
increase in the share of institutional credit of the rural households.
Priority Sector Lending (PSL)
10.07 The RBI has classified lending to the agriculture and allied activities
under Priority Sector Lending. Commercial banks are guided by priority sector
lending policy of providing credit to various deserving sectors/sections including
agriculture and allied activities.
10.08 With a view to regulate and encourage the flow of agricultural credit by
all scheduled Commercial Banks, the RBI from time to time, issues a number of
guidelines /instructions/directives to banks on Priority Sector Lending.
10.09 Priority Sector Lending programme has been an integral part of the
banking policy in India. This scheme is intended to give loans to the important
290
sectors of the economy (agriculture, small scale industries etc.) in such a way to
ensure maximum credit flow to the last man in the last village of the country
through a strong banking network. Priority sector lending in its present form was
introduced in 1980, when it was also made applicable to private sector banks
and a sub-target was stipulated for lending to the “weaker” sections of the society
within the priority sector.
Meaning – Priority Sector & Priority sector advances
10.10 Priority sector refers to those sectors of the economy which may not get
timely and adequate credit in the absence of this special dispensation. Priority
sector advances are small value loans to farmers for agriculture and allied
activities, micro and small enterprises, poor people for housing, students for
education and other low income groups and weaker sections.
10.11 In terms of RBI Master Direction- RBI/FIDD/2020-21/72 Master
Directions FIDD.CO.Plan.BC.5/04.09.01/2020-21 dated September 04, 2020
“Master Direction-Priority Sector Lending Targets and Classification”, the
categories under priority sector are as follows:
(i) Agriculture
(ii) Micro, Small and Medium Enterprises
(iii) Export Credit
(iv) Education
(v) Housing
(vi) Social Infrastructure
(vii) Renewable Energy
(viii) Others
10.12 The targets and sub-targets for agriculture set under priority sector
lending for all scheduled commercial banks operating in India are furnished
below for domestic scheduled commercial banks and foreign banks with 20
branches and above:
Agriculture 18 per cent of Adjusted Net Bank Credit (ANBC) or Credit
Equivalent Amount of Off-Balance Sheet Exposure
(CEOBE), whichever is higher, out of which a target of 10%
is prescribed for Small and Marginal Farmers (SMFs).
Additionally, domestic banks are directed to ensure that the
overall lending to non-corporate farmers does not fall below
the system-wide average of the last three years
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achievement. The applicable target for lending to the non-

corporate farmers for FY 2020-21 will be 12.14% of ANBC or
CEOBE whichever is higher. All efforts should be made by
banks to reach the level of 13.5% of ANBC (erstwhile target
for direct lending to agriculture sector).
Guidelines issued by RBI for Priority Sector lending by Small
Finance Banks are different and these should be noted
separately.
Computation of Adjusted Net Bank Credit (ANBC)

10.13 The Table below presents the computation of adjusted net bank credit:
Bank Credit in India [As prescribed in item No.VI of Form ‘A’ I
under Section 42 (2) of the RBI Act, 1934].
Bills rediscounted with RBI and other approved Financial II
Institutions.
Net Bank Credit (NBC)*. III (I - II)
Outstanding deposits under RIDF and other eligible funds with IV
NABARD, NHB, SIDBI and MUDRA Ltd. on account of priority
sector shortfall + outstanding PSLCs.
Eligible amount for exemptions on issuance of long-term bonds V
for infrastructure and affordable housing as per circular
DBOD.BP.BC.No.25/08.12.014/2014-15 dated July 15, 2014.
Eligible advances extended in India against the incremental VI
FCNR (B)/NRE deposits, qualifying for exemption from CRR/SLR
requirements, as per guidelines.
Investments made by public sector banks in the Recapitalization VII
Bonds floated by Government of India.
Other investments eligible to be treated as priority sector (e.g. VIII
investments in securitised assets).
Face value of securities acquired and kept under HTM category IX
under the TLTRO 2.0 (Press Release 2019-2020/2237 dated April
17, 2020 read with Q.11 of FAQ and SLF-MF- Press Release
2019-2020/2276 dated April 27, 2020 and also Extended
Regulatory Benefits under SLFMF Scheme vide Press Release
2019-2020/2294 dated April 30, 2020.
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Bonds/debentures in Non-SLR categories under HTM category. X

ANBC III+IV-
(V+VI+VII)+
VIII-IX+X
* For the purpose of priority sector computation only. Banks should not deduct /
net any amount like provisions, accrued interest, etc. from NBC.
A. If a bank opts to subtract prudential write off at Corporate/Head Office level
while reporting Bank Credit as above, bank credit to priority sector and all
other sub-sectors so written off should also be subtracted category wise
from priority sector and sub-target achievement.
B. All types of investments or any other items which are treated as eligible for
classification under priority sector target/sub-target achievement should also
form part of Adjusted Net Bank Credit.
Agriculture Credit
10.14 Lending to agriculture sector has been defined to include:
(i) Farm Credit-Individual farmers (which will include short-term crop loans
and medium/long-term credit to farmers).
(ii) Farm credit-Corporate farmers, Farmer producer Organisations
(FPOs)/(FPC) Companies of Individual Farmers, Partnership firms and Co-
operatives of farmers engaged in Agriculture and Allied Activities.
(iii) Agriculture Infrastructure.
(iv) Ancillary Services.
(v) Small and Marginal Farmers (SMFs).
(vi) Lending by banks to NBFCs and MFIs for on-lending in agriculture.
10.15 A list of eligible activities under the above sub-categories is indicated
below:
(i) Farm Credit
Loans to individual farmers [including Self Help Groups (SHGs) or Joint Liability
Groups (JLGs), i.e. groups of individual farmers, provided banks maintain
disaggregated data of such loans] and proprietorship firms of farmers, directly
engaged in Agriculture and Allied Activities, viz., dairy, fishery, animal husbandry,
poultry, bee-keeping and sericulture. This will include:
293
a. Crop loans to farmers, which will include traditional/non-traditional

plantations and horticulture, and, loans for allied activities.
b. Medium and long-term loans to farmers for agriculture and allied activities
(e.g. purchase of agricultural implements and machinery, and
developmental loans for allied activities).
c. Loans for pre and post-harvest activities, viz., spraying, harvesting, grading
and transporting of their own farm produce.
d. Loans to distressed farmers indebted to non-institutional lenders.
e. Loans to farmers under the Kisan Credit Card Scheme.
f. Loans to small and marginal farmers for purchase of land for agricultural
purposes.
g. Loans against pledge/hypothecation of agricultural produce (including
warehouse receipt) for a period not exceeding 12 months subject to a limit
up to Rs. 50 lakh.
h. Loans to farmers for installation of stand-alone Solar Agriculture Pumps
and for solarisation of grid connected Agriculture Pumps.
i. Loans to farmers for installation of solar power plants on barren/fallow land
or in stilt fashion on agriculture land owned by farmer.
(ii) Loans to corporate farmers, farmers' producer organizations/companies of
individual farmers, partnership firms and co-operatives of farmers directly
engaged in Agriculture and Allied Activities, up to an aggregate limit of Rs. 2
crore per borrower entity for the following activities.
a. Crop loans to farmers which will include traditional/non-traditional
plantations and horticulture, and loans for allied activities.
b. Medium and long-term loans to farmers for agriculture and allied activities
(e.g. purchase of agricultural implements and machinery, and
developmental loans for allied activities).
c. Loans for pre and post-harvest activities, viz., spraying, harvesting, grading
and transporting of their own farm produce.
d. Loans up to Rs. 50 lakh against pledge/hypothecation of agricultural
produce (including warehouse receipts) for a period not exceeding 12
months.
e. Loans up to Rs. 5 crore per borrowing entity to FPOs/FPCs undertaking
farming with assured marketing of their produce at a pre-determined price.
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(iii) Agriculture Infrastructure

For the following loans, an aggregate sanctioned limit of Rs. 100 crore per
borrower from the banking system, will apply.
a. Loans for construction of storage facilities (warehouses, market yards,
godowns and silos) including cold storage units/ cold storage chains
designed to store agriculture produce/products, irrespective of their
location.
b. Soil conservation and watershed development.
c. Plant tissue culture and agri bio-technology, seed production, production of
bio-pesticides, bio-fertilizer, and vermi composting.
d. Loans for construction of oil extraction/ processing units for production of
bio-fuels, their storage and distribution infrastructure along with loans to
entrepreneurs for setting up Compressed Bio Gas (CBG) plants.
(iv) Ancillary Services
a. Loans up to Rs. 5 crore to co-operative societies of farmers for purchase of
the produce of members.
b. Loans for setting up of Agri-clinics and Agri-business centres.
c. Loans for Food and Agro-processing up to an aggregate sanctioned limit of
Rs. 100 crore per borrower from the banking system (Indicative list of
permissible activities is given in Annex-III to the Master direction).
d. Loans to Custom Service Units managed by individuals, institutions or
organizations which maintain a fleet of tractors, bulldozers, well-boring
equipment, threshers, combines, etc., and undertake farm work for farmers
on contract basis.
e. Bank loans to Primary Agricultural Credit Societies (PACS), Farmers’
Service Societies (FSS) and Large-sized Adivasi Multi-Purpose Societies
(LAMPS) for on-lending to agriculture.
f. Loans sanctioned by banks to MFIs for on-lending to agriculture sector as
per the conditions specified.
g. Loans sanctioned by banks to registered NBFCs (other than MFIs) as per
conditions specified.
h. Outstanding deposits under RIDF and other eligible funds with NABARD on
account of priority sector shortfall.
i. Loans up to Rs. 50 crore to Start-ups, as per definition of Ministry of
Commerce and Industry, Govt. of India that is engaged in agriculture and
allied services.
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(v) Small and Marginal Farmers (SMFs)

For the purpose of computation of achievement of the sub-target, Small &
Marginal Farmers will include the following:
a. Farmers with landholding of up to 1 hectare (Marginal Farmers).
b. Farmers with a landholding of more than 1 hectare and up to 2 hectares
(Small Farmers).
c. Landless agricultural labourers, tenant farmers, oral lessees and share-
croppers, whose share of landholding is within the limits prescribed for
small and marginal farmers.
d. Loans to Self Help Groups (SHGs) or Joint Liability Groups (JLGs), i.e.
groups of individuals Small and Marginal farmers directly engaged in
Agriculture and Allied Activities, provided banks maintain disaggregated
data of such loans.
e. Loans up to Rs. 2 lakh to individuals solely engaged in Allied activities
without any accompanying land holding criteria.
f. Loans to FPOs/FPC of individual farmers, and co-operatives of farmers
directly engaged in Agriculture and Allied Activities, where the land-holding
share of SMFs is not less than 75 percent, subject to loan limits prescribed
above.
(vi) Lending by banks to NBFCs and MFIs for on-lending in
agriculture
(a) Bank credit extended to registered NBFC-MFIs and other MFIs (Societies,
Trusts etc.) which are members of RBI recognised SRO for the sector, for
on-lending to individuals and also to members of SHGs/ JLGs will be
eligible for categorisation as priority sector advance under respective
categories of agriculture subject to conditions specified.
(b) Bank credit to registered NBFCs (other than MFIs) towards on-lending for
‘Term lending’ component under agriculture will be allowed up to Rs. 10
lakh per borrower subject to conditions specified.
Kisan Credit Card (KCC)
10.16 The salient features of the kisan credit card scheme areas under:
a. In terms of RBI Circular No. RPCD.FSD. BC.No. 77/05.05.09/2011-12 dated
11th May, 2012 on “Revised Kisan Credit Card (KCC) Scheme”, revised
scheme for issue of Kisan Credit card was introduced by RBI, which was
subsequently modified vide various circulars. The Latest circular issued by
RBI on the subject is Master Circular No. RBI/2018-19/10 FIDD.CO.FSD.
296
BC. No. 6/05.05.010/2018-19 dated July 04, 2018 “Kisan Credit Card
(KCC) Scheme” and KCC scheme for Animal Husbandry and Fisheries vide
RBI/2018-19/112 FIDD.Co.FSD.BC.12/05.05.010/2018-19 dated February
04, 2019.
b. The scheme aims at providing adequate and timely credit support under
single window to the farmers for their cultivation and other needs as
indicated below:
 Short term credit limits.
i. To meet the short-term credit requirement for cultivation of crops.
ii. Post-harvest expenses.
iii. Produce marketing loan.
iv. Consumption requirement of farmer household.
v. Working capital for maintenance of farm assets and activities allied
to agriculture.
 Long term Credit Limit:
Investment credit requirement for agriculture and allied activities.
c. It may be noted that KCC is not a type of loan, but is a channel for granting
either short term or long term agricultural finance to:
i. Farmers both individuals and joint borrowers who are owner cultivators;
ii. Tenant farmers, oral lessees and share croppers;
iii. Self Help Groups(SHGs) or Joint Liability Groups (JLGs) of farmers
including tenant farmers, share croppers etc.
d. Master Circular No. RBI/2018-19/10 FIDD.CO.FSD.BC.No. 6/ 05.05.010/
2018-19 dated July 04, 2018 “Kisan Credit Card (KCC) Scheme”, throws
more light on the following macro topics:
i. Eligibility for KCC.
ii. Fixation of credit limit / loan amount for:
 All farmers other than marginal farmers.
 For Marginal Farmers.
iii. How Disbursement takes place.
iv. Issue of Electronic Kisan Credit Cards.
v. Validity/Renewal.
vi. Rate of Interest (ROI).
vii. Repayment Period.
viii. Security and Margin.
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S.No. KCC limit Primary Collateral Margin

security security
1. Up to Rs.1.6 Lakh Hypothecation Nil Nil
of crops
2. Up to Rs.3 Lakhs with Hypothecation Nil Banks to
tie-up for recovery of crops decide
3. Above Rs.1.6 lakh in Hypothecation Collateral Banks to
case of non-tie up and of crops required decide
Rs.3 lakh in case of e.g. land.
tie-up advances
ix. Other features like simple documentation.

x. Classification of account as NPA.
The extant prudential norms on income recognition, asset-
classification and provisioning will apply for loans granted under the
KCC Scheme.
xi. Delivery Channels - Technical features:
 Issue of cards
 Type of card
 Delivery channels
 Mobile banking / Other channels
10.17 Interest Application
a. Unlike normal loans, the interest on agricultural advances is not charged at
monthly rests but is charged as per the instructions contained in circulars
RPCD.No.CPFS.BC. 60/PS.165-85 dated June 06, 1985 and RPCD.No.
PLFS.BC.129/05.02.27/97-98 dated June 29, 1998.
b. Interest on current dues i.e. crop loans and instalments not fallen due in
respect of term loans in respect of direct agricultural advances should not be
compounded.
c. The RBI vide its circular no. DBOD No. Dir. BC. 25/13.03.00/2002-03 dated
September 19, 2002 had advised the banks that instructions regarding
charging of interest on monthly rests shall not be applicable to agricultural
advances and banks shall continue to follow the existing practice of
charging/compounding of interest on agricultural advances linked to crop
seasons.
298
Examples of Interest application according to crop seasons and for other

activities:
Crop Season Kharif Rabi
Disbursement Period April 01 to September 30 October 01 to March 31
Interest Application Due date fixed for Due date fixed for
Date repayment repayment
Compounding from After due date After due date
date
Penal Interest From date the loan From date the loan
becomes overdue becomes overdue
Allied Activities
Dairy, Poultry Goat Rearing, Piggery
Repayment Quarterly Half Yearly / Yearly
Interest Application Quarterly Half Yearly / Yearly
Interest application date Quarter end Half Year end / Year end
Compounding Frequency Quarterly Half Yearly / Yearly
Compounding from date After Quarter end After Half Year end / Year end
Penal Interest If overdue, after If overdue after half year /year
Quarter end end.
Interest Subvention
10.18 Public / Private Sector Scheduled Commercial Banks (in respect of
loans given by the rural and semi urban branches) are eligible under the scheme.
On a loan given at 7 per cent interest, subvention of 2 per cent p.a. is allowed to
Banks on their own funds used for short term crop loans up to Rs.3.00 lakh per
farmer. Short term credit, thus made available at 7 per cent p.a. to farmers, is
considered for interest subvention. This is calculated on the crop loan amount
from the date of its disbursement/ drawl up to the date of actual repayment of the
crop loan by the farmer or up to the due date of the loan fixed by the banks,
whichever is earlier, subject to a maximum period of one year.
10.19 From 2011-12, additional interest subvention of 3% to those farmers,
who repay their short term crop loans promptly and on or before the due date.
Farmers, who promptly repay their crop loans as per the repayment schedule
fixed by the banks, are offered loans at an effective interest rate of 7% - 3% i.e.
4% p.a.
299
10.20 The RBI vide its circular no. RBI/2018-19/137 FIDD.CO.FSD.BC.No.15/

05.02.001/2018-19 dated March 07, 2019 has specified continuation of the
interest subvention scheme for 2018-19 and 2019-20 on the terms and
conditions approved in the guidelines. Aadhaar linkage was also made
mandatory for availing short-term crop loans in 2018-19 and 2019-20.
10.21 The RBI vide its circular no. RBI/2019-20/166 FIDD.CO.FSD. BC.
No.1785/05.02.001/2019-20 dated February 26, 2020 has stated that all Short
Term Crop Loans eligible for Interest Subvention (IS) and Prompt Repayment
Incentive (PRI) benefit are extended only through KCC w.e.f. April 1, 2020. The
existing Short Term Crop Loans which are not extended through KCC shall be
converted to KCC loans by March 31, 2020.
10.22 The RBI vide Circular No. RBI/2019-20/48 FIDD. CO. FSD. BC. No. 10/
05.02.001/ 2019-20 dated August 26, 2019 on “Interest Subvention Scheme for
Kisan Credit Card to Fisheries and Animal Husbandry Farmers (AHDF). During
the Years 2018-19 and 2019-20”, has decided to extend interest subvention for
KCC facility to Animal Husbandry farmers and Fisheries Subject to maximum
limit of Rs.2 Lakhs for KCC of AHDF within the overall limit of Rs.3 Lakh per
farmer with priority given to KCC of crop loans.
10.23 RBI vide Circular RBI/2019-20/250 FIDD.CO.FSD. BC.No.
25/05.02.001/2019-20 dated June 4, 2020 has provided 2% IS and 3% PRI to
farmers for the extended period of repayment up to August 31, 2020 or date of
repayment, whichever is earlier.
10.24 Additional subvention to short term crop loans also affected by
natural calamity. Further, as notified by the Government of India (Subject to
inclusion in the Interest Subvention Scheme on short term crop loans) from time
to time, to provide relief to farmers availing short term crop loans and affected by
a natural calamity, an interest subvention of 2 percent per annum shall be made
available to banks for the first year on the restructured loan amount. Such
restructured loans shall attract normal rate of interest from the second year
onwards.
10.25 However in case of severe natural calamities, ISS of 2% will be made
available to banks for the first three years/entire period (subject to a maximum of
5 years).
Interest subvention scheme to post harvest loans
10.26 Scheme extended to small and marginal farmers (having Kisan Credit
Card) for a further period up to six months, post-harvest, against negotiable
warehouse receipt for keeping their produce in warehouses. To discourage
distress sale by farmers and to encourage them to store their produce in
300
warehouses against warehouse receipts of warehouse accredited with

Warehousing Development Regulatory Authority (WDRA).
10.27 Auditors have to submit certificate of Interest Subvention along with
annual accounts of the branch audited by them.
10.28 Further, all short term crop loans processed in 2018-19 are required to
be brought on ISS portal / DBT platform. Banks are advised to capture and
submit category wise data of beneficiaries under the scheme and report the
same on ISS portal individual farmer wise once it is launched to settle the claims
arising from 2018-19 onwards.
10.29 Audit Procedure
1. For details of short term crop loans qualifying for subvention, obtain
information in Format I and Format II submitted by the Branch to HO or
submitted by Bank to RBI (Refer to Annexure 1 and Annexure 2).
2. The Auditor has to verify that the book credit entries are not passed for the
purpose of availing the interest subvention.
3. Obtain list of eligible borrowers with interest rate charged to the account.
4. Obtain the working sheet of interest subvention and verify the same.
5. Verify that the interest is first credited to the account and then a claim is
made for reimbursement for 3% prompt repayment subvention.
6. Verify the following for cases verified:
a) How the limit of 3 Lakh per borrower is verified for claim purposes.
b) Only cases where prompt repayment has been received are given the
benefit of interest subvention of 3%.
7. Inquire about any rejection made in earlier year’s claims and reasons thereof
and whether proper accounting done for the same in branch books.
10.30 As per RBI circular, the Auditor needs to certify the correctness of the
claim and hence substantive testing needs to be carried out for examinations.
10.31 As per the extant RBI guidelines, “long duration” crops would be crops
with crop season longer than one year and crops, which are not “long duration”
crops would be treated as “short duration” crops. The crop season for each crop,
which means the period up to harvesting of the crops raised, would be as
determined by the State Level Banker’s Committee in each State depending
upon the duration of crops raised by an agriculturist.
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State Level Banker’s Committee (SLBC)

10.32 Agriculture finance is supervised and monitored by State Level Banker’s
Committee (‘SLBC’) and its decisions are implemented by all banking sector
having branches in the state. Every state has its own SLBC and guidelines have
been issued to banks to develop agricultural finance.
10.33 The SLBC is an inter-institutional forum for co-ordination and joint
implementation of development programmes and policies by all the financial
institutions operating in a state. Although SLBC is envisaged as a bankers’
forum, Government officials are also included. The Lead Bank is designated as
'Convener Bank'. The State Level Banker's Committee meets once in a quarter.
10.34 The SLBC of the respective State decides the crop season for each
crop, which effectively means the period up to harvesting of the crop raised and
the banks of the respective State have to adhere with the crop season as
decided by the SLBC of that respective State. Hence, practically it may occur
that same crop may have different harvesting season in different States as
decided by the respective SLBC of those States. In these cases, the Auditor
needs to verify whether the banks have the requisite mechanism to map the crop
season(s) vis-à-vis the crop season(s) as defined by the SLBC of each State as
any discrepancies may have a direct impact on identification of NPAs. The
Auditors are advised to refer to the guidelines issued by SLBC of the State
wherein the branch under the audit is located.
RBI Clarification to the Maharashtra SLBC
10.35 Loan may be treated as NPA immediately on completion of two crop
seasons / one crop season (as the case may be, depending on the duration of
the crops) after the repayment due date. Two crop seasons after the due date
should refer to only those two consecutive crop seasons in which the farmer
usually undertakes crop production.
10.36 The crop season for each crop, means the period up to harvesting of
the crops raised. The asset classification norms assume that there is normal crop
yield during the season for which credit is extended. Hence, immediately after
consecutive two harvest seasons (as per the cultivation pattern followed by the
farmer borrower) from repayment due date, the account is to be identified as
NPA as per the revised guidelines. In case the yield is affected by natural
calamities as declared by the State Government, the loan accounts should be
restructured / rescheduled.
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Example of NPA identification

10.37 NPA in Agricultural advances
i. A loan granted for short duration crops will be treated as NPA, if the
instalment of principal or interest thereon remains overdue for two crop
seasons.
A loan granted for long duration crops will be treated as NPA, if the
instalment of principal or interest thereon remains overdue for one crop
season.
For the purpose of these guidelines, “long duration” crops would be crops
with crop season longer than one year and crops, which are not “long
duration” crops, would be treated as “short duration” crops.
The crop season for each crop, which means the period up to harvesting of
the crops raised, would be as determined by the State Level Bankers’
Committee in each State. Depending upon the duration of crops raised by
an agriculturist, the above NPA norms would also be made applicable to
agricultural term loans availed of by him.
The above norms should be made applicable only to Farm Credit extended
to agricultural activities as listed at Annex 2 of the Circular no.RBI/2015-
16/101 DBR.No.BP.BC2/21.04.048/2015-16 dated July 1, 2015. An extract
of the list of these items is furnished in the Annex - 2 of the circular. In
respect of agricultural loans, other than those specified in the Annex - 2 of
the circular and term loans given to non-agriculturists, identification of NPAs
would be done on the same basis as non-agricultural advances, which, at
present, is the 90 days delinquency norm.
ii. Where natural calamities impair the repaying capacity of agricultural
borrowers for the purposes specified in Annex - 2 of the circular, banks may
decide on their own as a relief measure conversion of the short-term
production loan into a term loan or re-scheduling of the repayment period;
and the sanctioning of fresh short-term loan, subject to guidelines as
detailed below.
iii. In such cases of conversion or re-scheduling, the term loan as well as fresh
short-term loan may be treated as current dues and need not be classified
as NPA. The asset classification of these loans would thereafter be
governed by the revised terms and conditions and would be treated as NPA
if interest and/or instalment of principal remains overdue for two crop
seasons for short duration crops and for one crop season for long duration
crops. For the purpose of these guidelines, "long duration" crops would be
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crops with crop season longer than one year and crops, which are not 'long
duration" would be treated as "short duration" crops.
iv. While fixing the repayment schedule in case of rural housing advances
granted to agriculturists under Indira Awas Yojana and Golden Jubilee
Rural Housing Finance Scheme, banks should ensure that the
interest/instalment payable on such advances are linked to crop cycles.
10.38 Example of NPA identification for various types of crop loans is given as
follows.
S.No. Particulars Short Term Crops Long Crops
Term
Kharif Rabi Sugarcane Banana
1 Sanction 1stApril 2018 1stOctober 1st 1st July, 2017
date to 30th 2018 to October,
September, 31st March, 2017
2018 2019
2 Harvesting September, March, December, September,
time 2018 2019 2018 2018
3 Repayment 31st 30th June, 31st March, 31st
due date December, 2019 2019 December,
2018 2018
4 Interest Available up to Available
subvention date of up to date
@ 3% repayment of
subject to repayment
maximum subject to
repayment maximum
due repayment
date.(subject due date.
to 1 year) (subject to
1 year)
5 Date of 31st 30th June, 31st March, 31st
irregularity
December, 2019 2019 December,
2018 2018
Multiple/ double cropping pattern
6 First crop 30th June, 31st NA NA
season end 2019 December,
date 2019
7 Second 31st 30th June, NA NA
crop season December, 2020
end date 2019
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8 Date of 31st 30th June, NA NA

NPA December, 2020
2019
Single/ mono cropping pattern
9 First crop 31st 30th June, 31st March 31st
season end December, 2020 2021 December
date 2019 2020
10 Second 31st December 30th June, NA NA
crop season 2020 2021
end date
11 Date of 31st December 30th June, 31st March 31st
NPA 2020 2021 2021 December
2020
The illustration given above is for guidance only and the facts may be verified
with reference to each case in hand.
Allied Activity (Instalment)
Type Dairy Goat Rearing Piggery Poultry
(equated (equated half (equated half (equated
quarterly yearly / yearly yearly / quarterly
instalment instalment yearly instalment
with considering instalment with
moratorium moratorium considering moratorium
period, first period of six moratorium period, first
instalment months first period of six instalment is
is due on instalment is months first due on Sept
Sept 30, due on June instalment is 30, 2018)
2018) 30, 2019) due on June
30, 2019)
Loan Disbursed 1-Jun-18 1-Jul-18 1-Jul-18 1-Jun-18
Due Date 30-Sep-18 30-Jun-19 30-Jun-19 30-Sep-18
Overdue Date 1-Oct-18 1-Jul-19 1-Jul-19 1-Oct-18
Compounding 1-Oct-18 1-Jul-19 1-Jul-19 1-Oct-18
NPA turning date 31-Dec-18 30-Sep-19 30-Sep-19 31-Dec-18
Remark After 90 After 90 days After 90 days After 90
days overdue overdue days
overdue overdue
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Investment Credit (Instalment)

Type Investment Credit - Minor Irrigation system to a
farmer cultivating cotton
Loan Disbursed 1-Jun-18
Due Date 31-Mar-19
Overdue Date 1-Apr-19
Compounding 1-Apr-19
NPA turning date 31-Mar-20
Remarks After two crop seasons. First crop season will end
at March 2019 and the other will end at March
2020
Key Points in Auditing Agriculture Advances

10.39 The audit approach for agriculture advances has to be on similar lines
as that of other advances. The following is a summary of Key aspects in the audit
of Agricultural Advances:
a. Sanctioned amount of agriculture loans should be as per scale of finance
applicable to the land under cultivation and the crop being cultivated.
Further, appropriate security should be obtained as per the guidelines
framed by the bank.
b. Auditors should verify that the agricultural credit is extended only after
obtaining ‘No dues/ No objection certificates’ from the existing credit
agencies in the area of finance.
c. Disbursement of agricultural finance is required to be carried out in various
‘stages’ based on the requirements of farming activity. This needs to be
ensured strictly. In some cases, the expenditure is incurred by the farmer
from his/her own sources or by raising loans from non-institutional lenders
and subsequently banks are requested to reimburse the same. In such
cases, the Auditors have to carefully verify the facts from the
documents/evidences available on record. Under all situations, Auditors
should verify that the bank holds documents evidencing the utilisation of
loans for agricultural activities.
d. For crop loans, primary security is normally the standing crops under
cultivation, as such pre and post sanction visits by the officers of bank, who
are experts in agriculture finance and adequate documentation of visit report
is a key control.
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e. While verifying the security offered for agricultural loans, it is to be confirmed

that the security is legally enforceable. Standing crops and agricultural
machinery and implements are secured by a hypothecation charge, while
the agricultural land is secured by a mortgage charge. Auditors have to
ensure that amongst others, the following have been duly taken on record by
the banks:
 Copy of the land revenue extracts, with bank charges recorded.
 Land Tax Assessment and payment receipt.
 Copy of record with sub registrar (wherever applicable).
 Original copies of the title deeds.
 Search of title deeds and Legal opinion from the advocate on the Bank’s
approved panel.
 Valuation of land from a valuer on the Bank’s approved panel.
f. Loans granted to farmers against the security of NSC, KVP or Fixed
Deposits of Banks, which have been utilised for agricultural purposes, is
allowed to be classified under the category of finance to agriculture under
priority sector in Schedule 9. However, Auditors should carefully verify the
loan documents and other supporting documents to ensure that non-
agricultural loans are not classified as Agricultural Finance.
g. Agricultural advances are required to be serviced through realisation of sale
proceeds of crop. Auditors should be sceptical about the nature and timing
of credits coming in to service the agricultural loans and ensure that they are
from genuine sources.
Agricultural Advances Affected by Natural Calamities
10.40 RBI Master Direction no. RBI/FIDD/2018-19/64 FIDD.CO.FSD.BC
No.9/05.10.001/2018-19 dated October 17, 2018 on “Reserve Bank of India
(Relief Measures by Banks in Areas Affected by Natural Calamities) Directions,
2018 deals elaborately with classification and income recognition issues due to
impairment caused by natural calamities. Banks may decide on their own relief
measures, viz., conversion of the short term production loan into a term loan or
re-scheduling of the repayment period and the sanctioning of fresh short-term
loan, subject to the guidelines contained in RBI Master Circular No. RBI/15-
16/101 DBR.No.BP.BC.2/ 21.04.048/2015-16 dated July 1, 2015 on “Prudential
Norms on Income Recognition, Asset Classification and Provisioning
Pertaining to Advances” and directions contained in RBI Master Direction no.
RBI/FIDD/2018-19/64 FIDD.CO.FSD.BC No.9/05.10.001/2018-19 dated October
17, 2018 on “Reserve Bank of India (Relief Measures by Banks in Areas
Affected by Natural Calamities) Directions, 2018”. In such cases the NPA
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classification would be governed by such rescheduled terms. Asset

classification of remaining amount (if any), not restructured, continue to be
governed by original terms and conditions.
10.41 Additional finance granted due to natural calamities treated as
standard assets, will be governed by the terms and conditions of its sanction.
Different dues from the borrower (e.g. current dues, dues which are not
restructured etc.) will be classified under different asset classification norms.
This is an accepted departure from the basic principle of IRAC norms, i.e. NPA
should be borrower-wise and not facility-wise.
10.42 In such cases of conversion or re-scheduling, the term loan as well as
fresh short-term loan may be treated as current dues and need not be
classified as NPA. The said benefit of restructuring of assets would not be
available for Short-term Crop Loans if the said loan was overdue at the time of
occurrence of natural calamity and for Long-term Credits if the borrower has
wilfully defaulted in repayment of loan in earlier years. The asset classification
of these loans would thereafter be governed by the revised terms and
conditions and would be treated as NPA if interest and/or instalment of
principal remain overdue for two crop seasons for short duration crops and for
one crop season for long duration crops. For the purpose of these guidelines,
"long duration" crops would be crops with crop season longer than one year
and crops, which are not 'long duration" would be treated as "short duration"
crops.
10.43 In case of receipt of claim of crop insurance, the insurance proceeds
shall ideally compensate the losses. Under the Prime Minister Fasal Bima
Yojana (PMFBY), all Seasonal Agricultural Operations (SAO) loans for notified
crops in notified areas are to be compulsorily provided insurance cover for all
stages of the crop cycle including post-harvest risks in specified instances. There
are further ancillary measures prescribed by RBI for providing relief in terms of
relaxation on KYC norms, providing access to banking services, etc.
Collateral Free Agricultural Loans
10.44 RBI vide notification No FIDD.CO.FSD.BC.No.13/05.05.010/2018-19
dated February 7, 2019 on “Credit Flow to Agriculture - Collateral free
Agricultural Loans”, has increased the collateral free limit for Agricultural Loans
from Rs.1 Lac to Rs.1.60 Lac. (Refer earlier circular RPCD.PLFS.BC.No
85/05.04.02/2009-10 dated June 18, 2010).
Agricultural Debt Relief / Waiver Schemes
10.45 There are various State and Central Government debt waiver / relief
schemes which are implemented for providing relief to the affected agriculture
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borrowers. An Auditor is advised to go through the schemes so declared and

implemented by State / Central Government for providing agricultural debt
relief / waiver as the case may be and consider the same in terms of eligible
loans under the scheme, amount of relief / waiver provided, asset classification
norms and accounting.
Audit Procedure
10.46 The audit procedure involve the following steps:
1. Obtain the copy of relevant schemes and bank’s circular in this regard.
2. Obtain list of eligible borrowers with outstanding balance.
3. Check the claim amount statement submitted to RO/ZO for claiming the
same.
4. Check the accounting entries passed for the credit of eligible amount in the
account of the borrower.
5. Verify the accounting of interest and other charges to be borne by the
lending institution as per the scheme.
6. Ensure reporting requirement as per closing instructions of the bank.
7. Obtain written representation from the management about the scheme and
its applicability including cutoff amount and period of loan disbursed.
10.47 Other Important points are as under:
i) Here Land holding being the deciding criterion for an Agricultural Loan to an
individual farmer, a company whose objects are farming etc., shall not
qualify for agriculture loans in that category, if it is not a farm producer
company and none of its directors hold land.
ii) Loans given for the purchase of vehicles like Balero, Maruti VAN, Bikes and
some other two wheelers and four wheelers shall come under commercial
vehicle Loan category. For purchase of Tractors loan can be given as
agriculture term loan.
iii) Loans to fishermen for purchase of trawlers/ boats etc. can be considered.
iv) SHG and JLGs where farmers are members of the Group, qualify to take
Agricultural Loans. Further loans are categorised according to the activities
carried out by the Groups and purpose for which the loans are taken.
v) If term deposits are given by farmers to the Primary Agricultural Societies
which are deposited in Banks, the Societies qualify for Loans against the
deposits. The primary Agricultural Society can back to back, give loans to
its member farmers.
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Annexure 1
Format I
Claim for 2% Interest Subvention on Short-term Crop Loans/ Post-harvest credit
against negotiable warehouse receipts/ Loans restructured due to NC/ Loans
restructured due to Severe NC, up to Rs. 3 lakh for the year 2018-19 / 2019-20.
Name of the Bank: _____________
Statement for the half year / year ended on

September 20/ March 20/ Additional Claim
*Total short term production Amount of total

credit at 7% p.a subvention claimed
(Rs. in actuals)
No. of accounts Amount Disbursed /
(in thousands) drawn (Rs. lakh)
Loans up to Rs.3 lakh
Category-wise claim for 2% Interest Subvention for 2018-19 /

2019-20 for All India except North East region
*Total short term production credit

at 7% p.a. for All India except
North East region
General SC ST
No. of Amount Amount of No. of Amount Amount No. of Amount Amount of

accounts Disbur- subvention accounts Disbur- of accounts Disbur- subvention
(in sed/ claimed (in sed/ subven- (in sed/ claimed
thousands) drawn (Rs. In thousands) drawn tion thousands) drawn (Rs. In
(Rs. actual) (Rs. claimed (Rs. actual)
lakh) lakh) (Rs. In lakh)
actual)
Loans
up to
Rs.3
lakh
310
Category-wise claim for 2% Interest Subvention for 2018-19 /

2019-20 for North East region
*Total short term
production credit
at 7% p.a. for
North East region
General SC ST
No. of Amount Amount of No. of Amount Amount of No. of Amount Amount
accounts Disburs subvention accounts Disburs subvention accounts Disburs of
(in ed/ claimed (in ed/ claimed (in ed/ subvent-
thousand) drawn (Rs. in thousand) drawn (Rs. In thousand) drawn ion
(Rs. actuals) (Rs. actuals) (Rs. claimed
lakh) lakh) lakh) (Rs. in
actuals)
Loans
up to
Rs.3
lakh
i) We certify having disbursed the above loans at 7% p.a. up to Rs. 3 lakh by

way of short-term production credit to the farmers during the year 2018-19 /
2019-20.
Sd/-
Authorised Signatory of the Bank
ii) (Statutory auditor certifying the correctness of the subvention claim)
Sd/
Seal and Signature of Auditor
Date:
(This claim format needs to be duly certified by the Statutory Auditors with the
Firm Registration Number and Membership Number of all Signatories)
* May be modified suitably for post-harvest credit against negotiable warehouse
receipts/ Loans restructured due to NC/ Loans restructured due to severe NC.
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Annexure 2
Format II
One - time Claim for Additional 3 per cent
Subvention for timely repayment of Short-term Crop
Loans / Loans restructured due to Severe NC, up to
Rs.3 lakh disbursed in 2018-19 / 2019-20
Name of the Bank:
*Total short term *Total short term Amount of
production credit at 7% production credit additional
p.a which were repaid in subvention
time claimed @
3% (Rs. in
No. of Amount No. of Amount
actuals)
accounts Disbursed/ accounts (in disbursed
(in drawn thousands) drawn (Rs.
thousands) (Rs. lakh) lakh)
Loans up
to Rs.3
lakh
Category-wise one-time claim for additional 3% Subvention for 2018-19 /

2019-20 for All India except North East region
*Total short term production credit which were repaid in time for All
India except North East region
Geneal SC ST
No. of Amount Amount No. of Amount Amount of No. of Amount Amount
accounts Disburs- of accounts Disburs- subvent- accounts Disburs- of
(in ed/ subven- (in ed/ ion (in thous- ed/ subvent-
thousands) drawn tion thous- drawn claimed ands) drawn ion
(Rs. claimed ands) (Rs. (Rs. In (Rs. lakh) claimed
lakh) (Rs. In lakh) actuals) (Rs. In
actuals) actuals)
Loans
up to
Rs.3
lakh
312
Category-wise one-time claim for additional 3% Subvention for 2018-19 / 2019-

20 for North East region
*Total short term production
credit which were repaid in time
for North East region
General SC ST
No. of Amount Amount No. of Amount Amount No. of Amount Amount
accounts Disburs- of accounts Disbur- of accounts Disburs- of
(in thous- ed/ subven- (in thous- sed/ subven- (in thous- ed/ subven-
ands) drawn tion ands) drawn tion ands) drawn tion
(Rs. claimed (Rs. claimed (Rs. claimed
lakh) (Rs. in lakh) (Rs. in lakh) (Rs. in
actuals) actuals) actuals)
Loans
up to
Rs.3
lakh
i) We certify that the above loans for which the claim is being made were
repaid in time and the benefit of additional 3 percent incentive subvention
has already been passed on to the account holders, thereby bringing down
the interest rate for such farmers to 4 per cent per annum for short term
production credit / Loans restructured due to Severe NC, up to Rs. 3 lakh
disbursed during 2018-19 / 2019-20 for these farmers.
Sd/-
Authorised Signatory of the Bank
ii) (Statutory Auditor certifying the correctness of the subvention claim)
Sd/-
Seal and Signature of Auditor
Date:
(This claim format needs to be duly certified by the Statutory Auditors with the
Firm Registration Number and Membership Number of all Signatories)
*May be modified suitably for Loans restructured due to severe NC.
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11
Reporting for Advances
Introduction
11.01 Lending constitutes a major activity of a bank besides the investment
function. The core business of banks is accepting deposits for onward lending.
Advances, generally, constitute the largest item on the assets side of the
balance sheet of a bank and are major source of its income.
11.02 Audit of advances is one of the most important areas covered by
auditors in bank audit. It is necessary that auditors have adequate knowledge
of the banking industry and its regulations. Auditors must be aware of various
functional areas of the bank/branches, its processes, procedures, systems and
prevailing internal controls with regard to advances.
11.03 Advances generally comprise of:
a) Money lent by bank to its customers including interest accrued and due
b) Debit balances in depositor accounts
c) Inter-Bank Participation Certificates.
11.04 Every bank has its credit policy approved by its board of directors
which is updated at regular intervals. The credit policy is in line with applicable
RBI guidelines, relevant laws and regulations. Auditors must acquaint
themselves with the credit policy of the bank and the advances portfolio
composition.
Type of Advances and Nature of Security
Types of Advances
Fund Based and Non-Fund Based Credit Facilities
11.05 In Fund based credit facilities, there is an actual outflow of funds from
the bank to the borrower, whereas non-fund based facilities, do not involve
outflow of bank’s funds. Typical fund based facilities are term loans, cash
credits and overdrafts while non-fund based facilities are letters of credit, bank
guarantees, letter of comfort/undertaking, etc. Non-fund based facility may turn
into a fund based facility on due date, if not paid by the borrower, for e.g.
devolvement of bills under LC, invocation of Bank Guarantee, etc.
Fund Based Facilities

Cash Credit
11.06 Cash credit facility is provided to entities (borrowers) engaged in
manufacturing and / or trading activities to enable them meet the gap in their
working capital requirements. This facility is repayable on demand. The cash
credit facility is generally granted against security of stocks of goods (net of trade
creditors), standing crops, bills / book debts representing genuine sales
(restricted to pre-defined age of such book debts).
11.07 A cheque book is issued to the borrower for withdrawal of money
against the limit sanctioned. The withdrawals are permitted to the extent, lower of
drawing power or sanctioned limit. This is a revolving facility and is, generally,
reviewed and renewed annually or on other intervals as per Bank policy. The
Bank performs a periodical review of the borrower based on his credit
assessment.
11.08 Cash credit advances are generally on ‘floating’ interest rate basis.
The rate is reset periodically, depending upon changes in the bank’s base rate
(MCLR – Marginal Cost of fund based Lending Rate) / spread in relation to the
borrower class and his risk perception.
Working Capital Demand Loan (WCDL)
11.09 WCDL is granted for a fixed period on expiry of which it has to be
liquidated, renewed or rolled over. WCDL is generally granted to meet the
working capital requirement gap and is considered as a part of working capital
facility. Depending on the sanction terms, repayment of WCDL can either be in
the form of instalments spread over the loan tenure or an end of tenure bullet
payment. It has to be ensured that there is actual repayment at the end of the
loan tenure by fund flows and not just a renewal by roll-over which could
tantamount to ever-greening.
11.10 As per RBI Circular dated December 05, 2018 Guidelines on Loan
System for Delivery of Bank Credit for FY 2020-21, In respect of borrowers
having aggregate fund based working capital limit (WCL) of Rs. 1500 million and
above from the banking system, a minimum level of ‘loan component’ of 60
percent is prescribed. Accordingly, for such borrowers, the outstanding ‘loan
component’ (Working Capital Loan) must be equal to at least 60 per cent of the
sanctioned fund based working capital limit, including ad hoc limits and TODs.
Hence, for such borrowers, drawings up to 60 per cent of the total fund based
working capital limits shall only be allowed from the ‘loan component’. Drawings
in excess of the minimum ‘loan component’ threshold may be allowed in the form
of cash credit facility.
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11.11 The amount and tenor of the loan component may be fixed by banks in
consultation with the borrowers, subject to the tenor being not less than seven
days. Banks may decide to split the loan component into WCLs with different
maturity periods as per the needs of the borrowers.
Guidelines on Loan System for Delivery of Bank Credit
11.12 The RBI issued circular RBI/2018-19/87 DBR.BP.BC.No.12/21.04.048/
2018-19 dated December 05, 2018, specified minimum level of loan component
as follows:
a. In respect of borrowers having aggregate fund based working capital limit of
₹1500 million and above from the banking system, a minimum level of ‘loan
component’ of 40 percent shall be effective from April 01, 2019.
Accordingly, for such borrowers, the outstanding ‘loan component’ (Working
Capital Loan) must be equal to at least 40 percent of the sanctioned fund
based working capital limit, including ad hoc limits and TODs.
b. All lenders in the consortium shall be individually and jointly responsible to
make sure that at the aggregate level, the ‘loan component’ meets the
above mentioned requirements. Under Multiple Banking Arrangements
(MBAs), each bank shall ensure adherence to these guidelines at individual
bank level.
c. The amount and tenor of the loan component may be fixed by banks in
consultation with the borrowers, subject to the tenor being not less than
seven days. Banks may decide to split the loan component into WCLs with
different maturity periods as per the needs of the borrowers.
d. Banks/consortia/syndicates will have the discretion to stipulate repayment
of the WCLs in instalments or by way of a "bullet" repayment, subject to
IRAC norms. Banks may consider rollover of the WCLs at the request of the
borrower, subject to compliance with the extant IRAC norms.
e. The guidelines will be effective from April 1, 2019 covering both existing as
well as new relationships. The 40 percent loan component will be revised to
60 percent, with effect from July 1, 2019.
Repayment/Renewal/Rollover of Loan Component
11.13 Banks/consortia/syndicates will have the discretion to stipulate
repayment of the WCLs in installments or by way of a "bullet" repayment, subject
to IRAC norms. Banks may consider rollover of the WCLs at the request of the
borrower, subject to compliance with the extant IRAC norms.
Risk weights for undrawn portion of cash credit limits
11.14 Effective from April 1, 2019, the undrawn portion of cash credit/
overdraft limits sanctioned to the aforesaid large borrowers, irrespective of
316
whether unconditionally cancellable or not, shall attract a credit conversion factor

of 20 per cent.
Term Loans
11.15 Term loans are generally extended for the following purposes:
 setting up of plants, acquisition of fixed assets like land and building,
plant and machinery, furniture, vehicles, implements, houses, consumer
durables, etc.
 meeting expenses on education/medical treatment of self/dependants.
 meeting other personal expenses.
 Travel – Vehicle - Housing purchase and renovation.
 meeting deficit in net working capital requirements as assessed by the
bank.
 Marketing / Launching / Branding etc.
11.16 Banks may give general purpose loans also i.e. without stipulating any
end-use of funds, on the strength of a suitable security, or even without
security based on the borrower’s credit worthiness. Bank’s policy provides
guidance and documentation to be obtained for end use of funds in such cases
which has to be ensured.
11.17 Term loans are repayable in instalments spread over a period of time
excluding the moratorium period, if granted. The moratorium period is
assessed by the lender based on future cash flows and borrower requirements.
If the borrower defaults in compliance with terms and conditions, the bank has
the right to demand repayment of the entire loan outstanding, before due date.
In few cases, there are terms for increase in interest rate as stipulated in
sanction terms and conditions. The amount, periodicity of repayment, last draw
down date and other terms and conditions are fixed at the time of sanction and
duly recorded in the loan documents. The amount and periodicity may be
uniform throughout the life of the loan, or either or both of them may differ from
instalment to instalment. Besides, repayment schedule may either be drawn
only for the principal amount in which case periodic interest has to be paid by
the borrower separately as and when due, or a schedule may be fixed with
‘equated monthly instalments’ which also includes amount of interest likely to
be applied to the account during its entire tenure at the rate of interest
applicable at the time of sanction/documentation/first disbursement. The
disbursal may happen in one tranche or more than one tranche as per the
borrower requirements.
317
11.18 The interest rate for loans may be on ‘fixed’ terms’ in which event, the
rate contracted originally holds good during the entire loan currency, or it may
be on ‘variable’ terms; where the rate may undergo changes at unspecified
periods on happening of certain events as outlined in the loan agreement. This
aspect is a subject matter of negotiation between the bank and the borrower.
Interest is charged on reducing balance method at monthly rests.
Foreign Currency Loans (FCL)
11.19 Banks are authorised to lend in foreign currency. These loans are
sanctioned as per the EXIM Policy and guidelines issued by RBI from time to
time. FCL may be in nature of Term loans or Working Capital loans. These
loans may be issued independently or through conversion of rupee
term/working capital loan to FCL for a stipulated period as per RBI guidelines.
Overdrafts
11.20 The overdraft facility may be either secured or clean (i.e., without
security) and does not generally carry a fixed repayment schedule. The most
common form of security for an overdraft arrangement is term deposit receipts.
Overdrafts may also be granted against other securities like immovable
properties, life insurance policies, shares, bonds, NSCs, Kisan Vikas Patra,
Indira Vikas Patra, etc. In case of term deposit receipts, care is taken to lien mark
the deposit in the system and also on physical fixed deposit receipt (not on fixed
deposit advice). Fixed deposits are generally for specific period and need to be
renewed on maturity. Care should be taken to ensure that interest rate spread
between overdraft and fixed deposit is maintained. The bank has to update lien
mark on the new fixed deposit. The bank has to ensure that proper margin i.e.
security value and loan amount is kept while sanctioning the overdraft and at all
times during the loan pendency.
Bills
11.21 Finance against bills is meant to finance the actual sale transactions
and can be in any of the under mentioned form:
 Purchase of bills if these are payable ‘on demand’.
 Discounting of bills if these are usance (or time) bills.
 Advance against bills under collection from the drawee, whether sent for
realisation through the bank or sent directly by the drawer to the drawees.
11.22 Bills may be either ‘documentary’, i.e., accompanied by original
documents of title to goods, or ‘clean’, i.e., without original documents of title to
goods. In case of documentary bills, the bank releases documents of title to the
drawee only against payment (in case of demand bills purchased) or against
318
acceptance (in case of usance bills discounted). On release of documents of

title after acceptance of usance bills, these assume the nature of clean bills.
The bills may be domestic (denominated in rupee for domestic trade) or foreign
(denominated in foreign currency for import/export).
11.23 A unique facility under this head is advances against bills drawn on
public sector undertakings / government departments which do not accept bills.
In such cases, pre-receipted challans are submitted by the borrower to the bank
as an evidence for availing finance thereagainst (a pre-receipted challan
establishes genuine movement of goods and ensures usage of bank funds for
sanctioned purposes only). This facility is commonly known in the banking sector
as ‘government bills facility’ or ‘supply bills facility’. The purchase / discounting of
bills may be either under or without a letter of credit. In case of dishonour of bills,
banks have the right to recover the amount from the drawer with penalty,
additional interest, etc.
11.24 RBI has issued guidelines for regulation of discounting and
rediscounting of bills (Ref. Master Circular No. DBR.No.Dir.BC.10/13.03.00/
2015-16, dated July 01, 2015, “Loans and Advances-Statutory and other
Restrictions”.
Exports
Export Credit
11.25 Exporters are granted facilities in the form of cash credit and bills only.
These facilities are in form of ‘pre-shipment credit’ and ‘post-shipment credit’. All
types of advances sanctioned to finance the production cycle – i.e. from
procurement of raw materials to bringing them to the port for despatch fall under
‘pre-shipment credit’ category. It also includes financing of working capital
expenses towards rendering of services. The advance is given based on
individual order obtained, or sanctioned as an Export Packing Credit (EPC) limit
and amounts disbursed on submission of individual orders; in the latter case,
EPC becomes a running account. The exporter usually adjusts the account by
drawing bills of exchange on the foreign buyer, which are discounted by the bank
under the letter of credit and the proceeds collected from the foreign bank. The
post-shipment credit relates to financing of bills raised on the overseas buyer
upon shipment of goods/ services. Export credit advance may be granted in
Indian Rupees or a designated foreign currency. In the latter case, the loan is
disbursed in a foreign currency. Export credit is granted at concessional rates of
interest. Pre-shipment credit has to be liquidated out of export proceeds only and
cannot be adjusted out of rupee funds (except where raw materials required for
processing exceed the FOB contract value, in which case the excess advance
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has to be repaid maximum within 30 days from the date of advance). Export
proceeds have normally to be received within 9 months from the shipment date.
This period can be extended in genuine cases, with the bank’s approval or RBI
approval, as permitted under FEMA Guidelines and operating instructions issued
by the RBI from time to time.
11.26 Pre-shipment credit granted in a foreign currency is called ‘Packing
Credit in Foreign Currency’ (PCFC) advance and has to be repaid out of export
bills discounted under the Export Bills Rediscounting (EBR) scheme or out of
export proceeds. Each bank designates a few select branches to handle PCFC
and EBR transactions. The Rupee Export credit is also allowed to be shared
between export order holders and manufacturer of the goods to be exported.
Similarly, banks may extend PCFC to the manufacturer on the basis of
disclaimer from the export order holder through his bank. PCFC granted to the
manufacturer can be repaid by transfer of foreign currency from the export order
holder by availing of PCFC or by discounting of bills. It should be ensured that no
double financing is involved in the transaction and the total period of packing
credit is limited to actual cycle of production of exported goods (Ref. Para 5.12 of
the Master Circular No. DBR No.DIR.BC.14/04.02.002/2015-16 dated July 1,
2015, “Rupee/Foreign Currency Export Credit and Customer Service to
Exporter”). PCFC may be made available to both the supplier of EOU/EPZ/SEZ
unit and the receiver of EOU / EPZ / SEZ unit and PCFC for supplier EOU / EPZ
/ SEZ unit will be for supply of raw material/components of goods which will be
further processed and finally exported by receiver EOU / EPZ / SEZ unit. The
PCFC extended to the supplier EOU/EPZ/SEZ unit will have to be liquidated by
receipt of foreign exchange from the receiver EOU/EPZ/SEZ unit, for which
purpose, the receiver EOU/EPZ/SEZ unit may avail of PCFC. The stipulation
regarding liquidation of PCFC by payment in foreign exchange will be met in
such cases not by negotiation of export documents but by transfer of foreign
exchange from the banker of the receiver EOU/EPZ/SEZ unit to the banker of
supplier EOU/EPZ/SEZ unit. Thus, there will not normally be any post-shipment
credit in the transaction from the supplier EOU/EPZ/ SEZ unit’s point of view. In
all such cases, it has to be ensured by banks that there is no double financing for
the same transaction. The PCFC to receiver EOU/EPZ/SEZ unit will be liquidated
by discounting of export bills or by receipt of export proceeds as per Master
Circular DBR No.DIR.BC.14/04.02.002/2015-16 dated July 01, 2015, on
“Rupee/Foreign Currency Export Credit and Customer Service to Exporter”. In
this context, attention is invited to RBI’s Circular No DIR.BC.14/04.02.002/2015-
16 dated July 01, 2015 on “Rupee/Foreign Currency Export Credit and Customer
Service to Exporter.
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Imports
Trade Credit – Buyer’s Credit
11.27 This facility is provided by Banks (foreign/overseas branches of Indian
banks), financial institutions, foreign equity holder(s) located outside India and
financial institutions in IFSCs located in India.to importers of capital goods and
raw material In India. The same is given against BG/SBLC issued by Indian
bank, on behalf of their Indian importer customers, to enable them to receive
such credit. The BG/SBLC issued by the Indian bank is duly recorded as a
“contingent liability” in its books.
Detailed guidelines for the same are provided in paragraph 23.13 in the Chapter
23 of ‘Audit of Foreign Exchange Business’ of Section B of this Guidance Note.’
Entries of inward and outward remittances are to be recorded in the books of
accounts (NOSTRO Mirror Account) of the Indian bank.
Nature of Security
11.28 Types of securities commonly accepted by banks for granting different
kinds of credit facilities are examined in greater details in this section. Security
can be in any form i.e. tangible or intangible, movable or immovable. Further, it
is classified into two types namely, primary and collateral securities.
Primary and Collateral Securities
11.29 ‘Primary Security’ refers to the security offered by the borrower for
bank finance or the one against which credit is extended by the bank. Primary
security is the principal security for an advance. A collateral security is an
additional security.
Mode of Creation of Security
11.30 Depending on the nature of the advance, creation of security may be
in the form of a mortgage, pledge, hypothecation, assignment, set-off, or lien.
Mortgage
11.31 Mortgage is defined under section 58 of the Transfer of Property Act,
1882, as “the transfer of an interest in specific immovable property for the
purpose of securing the payment of money advanced by way of loan, an
existing or future debt, or the performance of an engagement which may give
raise to a pecuniary liability”.
11.32 Mortgages are of several kinds but the most important ones are the
Registered Mortgage and the Equitable Mortgage. A Registered Mortgage is
effected by a registered instrument called the ‘Mortgage Deed’ signed by the
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mortgagor. It registers the property to the mortgagee as a security. Equitable

mortgage, is effected by a mere delivery of title deeds or other documents of
title with intent to create security thereof. The government mandates
registration of all types of mortgages with Central Registry of Securitisation
Asset Reconstruction and Security Interest of India (CERSAI) which should be
strictly followed by banks.
Pledge
11.33 A pledge is defined under section 172 of the Indian Contract Act,
1872, as “the bailment of goods as security for payment of a debt or
performance of a promise.” A pledge involves bailment or delivery of goods by
the borrower to the lending bank with the intention of creating a charge thereon
as security for the advance. The legal ownership of the goods remains with the
pledger while the lending banker gets certain defined interest in the goods. The
pledge of goods constitutes a specific (or fixed) charge. In a pledge, the bank
has all the liabilities and responsibilities of a bailee of goods. The bank may be
held responsible for not carrying out their obligations as bailee.
Hypothecation
11.34 The term ‘hypothecation’ in commercial parlance refers to the creation
of an equitable charge (i.e., a charge created not by an express enactment but
by equity and reason), in favour of the lending bank by execution of
hypothecation agreement in respect of the moveable securities belonging to
the borrower. Neither ownership nor possession is transferred to the bank.
However, the borrower holds the physical possession of the goods as an
agent/trustee of the bank. The borrower periodically submits statements
regarding quantity and value of hypothecated assets (stocks, debtors, etc.) to
the lending banker based on which the drawing power of the borrower is fixed.
Assignment
11.35 Assignment represents a transfer of an existing or future debt, right or
property belonging to a person in favour of another person. Only actionable
claims (i.e., claim to any debt other than a debt secured by a mortgage of
immovable property or by hypothecation or pledge of moveable property) such
as book debts and life insurance policies are accepted by banks as security by
way of assignment. An assignment gives the assignee absolute right over the
moneys/debts assigned to him. The transfer of debt, right or property is subject
to all the liabilities and equity to which the transferor was subject on the date of
transfer. In other words, the assignee cannot get a better title than that of the
assignor.
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Set-off
11.36 Set-off is a statutory right of a creditor to adjust, wholly or partly, the
debit balance in the debtor’s account against any credit balance lying in
another account of the debtor. A lending bank has the right of set-off in the
absence of an agreement, express or implied, to the contrary with the
borrower. The right of set-off enables a bank to combine two accounts (a
deposit account and a loan account) of the same person provided both the
accounts are in the same name and in the same right (i.e., the capacity of the
account holder in both the accounts should be the same). For the purposes of
set-off, all bank branches are treated as one single entity. The right of set-off
can also be exercised in respect of time-barred debts.
Lien
11.37 Lien is creation of a legal charge with the owner’s consent, which
gives the lender a legal right to seize and dispose / liquidate the asset under
lien.
Types of Securities
11.38 The characteristics of a good security from the view point of the
lending bank are marketability, easy ascertainability, stability of value, clean
title, realisability and transferability/transportability.
11.39 The most common types of securities accepted by banks are the
following.
Fixed and Floating Charges
11.40 A fixed charge (also called ‘specific charge’) is a charge on some
specific and ascertained assets. The creator of the charge (i.e., the borrower)
cannot deal with the asset without the specific consent of the holder of the
charge (i.e., the lender). A floating charge, is an equitable charge on the
assets, present and future. A floating charge attaches to assets whose
condition varies from time to time in the ordinary course of business (e.g.,
work-in-process). A floating charge crystallises (i.e., becomes a fixed charge)
when money becomes repayable and the holder of the charge (i.e., lender)
takes necessary steps for enforcement of the security.
Personal Security of Guarantor
11.41 The personal security of guarantor comprises a third party guarantee
for payment of loan outstanding, in the event of borrower’s default. No charge
is created on the guarantor’s movable or immovable assets.
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Margin
11.42 Margin on loans is upfront payment by the borrower towards the
purpose of sanctioned loan. Banks provide finance after keeping suitable
margin, depending on its risk perception. Margin is deducted from the asset
value to take care of any downward fluctuations in the asset’s market value.
Generally, margin is prescribed in every sanction letter in terms of percentage
of security value, as per bank’s credit policy. For certain loans such as
advances against gold ornaments and jewellery, RBI has defined the limits on
the loan to value.
Stock Exchange Securities and Other Instruments
11.43 Stock Exchange securities include shares, debentures and bonds
which are traded on stock exchanges. These securities are easily marketable;
the market value is readily ascertainable; it is easy to ascertain the title of the
depositor; and they are easy to pledge. Banks have policy for shares against
which they provide loans and periodically re-assess the eligible share as
security for lending. Banks also advance against instruments as gilt-edged
securities, National Savings Certificates, Kisan Vikas Patras, Indira Vikas
Patras, Gold Bonds, etc. Banks are not allowed to provide loans to companies
for buy back of shares / securities. Banks are also not allowed to provide loans
against security of its own shares.
11.44 These securities are usually in the possession of the bank. Wherever
the shares are held as security by a bank (as primary or collateral security),
banks are required to have them transferred in their own names if the loan
amount exceeds the RBI prescribed ceiling). The ceiling is different for shares
in dematerialised form and in physical form. In other cases, (i.e., where the
loan amount does not exceed the prescribed ceiling), banks accept the
aforesaid securities subject to following conditions:
(a) in the case of physical shares, they are accompanied by blank transfer
deeds duly signed by the person in whose name they are registered; in
case of shares held in dematerialised form, authorisation slips should be
obtained from the borrower and passed on to the relevant depository
participant who immediately marks those shares as pledged; or
(b) the bank holds a general power of attorney from the person in whose
name they are registered.
11.45 If the person in whose name the securities are registered is other than
the borrower, the bank has to particularly satisfy itself that the person has a
good title to the security. The bank also obtains a letter of renunciation from
the person in whose name the securities are registered.
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11.46 In the case of advances against bearer securities (Kisan Vikas Patras/
Indira Vikas Patras), banks obtain independent/direct confirmation of the
genuineness of the certificates from the issuing authorities. After obtaining
such confirmation, bank possession is sufficient.
11.47 In case of government paper and inscribed stock, banks should get
them registered in their own name while accepting them as security.
11.48 Before accepting shares as security, the lending bank has to ensure
that provisions of section 19 of the Banking Regulation Act, 1949 are not
contravened except otherwise specifically permitted by RBI regulations. This
section prohibits a banking company from holding shares in any company,
whether as pledge, mortgagee or absolute owner, of an amount exceeding
thirty per cent of the paid up share capital of that company or thirty per cent of
its own paid-up share capital and reserves, whichever is less.
Goods
11.49 Goods constitute a significant proportion of the securities taken by
banks. They are either stock-in-trade of its trading customers or finished
products of manufacturers. Raw materials, work-in-process, etc., are also
accepted as security. Banks should have a system in place to ensure that the
security in terms of stock offered by borrower is as per bank policy.
11.50 Goods may be either hypothecated to, or pledged with, the bank. As
mentioned earlier, in case of hypothecation of goods, banks obtain periodic
statements from the borrowers (monthly/quarterly), declaring quantity and
value of the goods basis which the borrowers drawing power is fixed. The
officers of the lending bank pay regular visits to borrower godowns or factories
to inspect and check the correctness of records maintained by the borrowers
basis which, the periodic statements are prepared by them. They also check
value of the goods in stock with reference to sale bills, market quotations, etc.
In the case of large advances, inventory is subject to inspection and
verification (stock audit) by external agency at stipulated intervals. The Auditor
may go through the same for determining the existence and adequacy of
security and also to determine irregularity in the account, if any.
11.51 Stock registers are maintained by godown keepers of the lending
bank in respect of goods pledged with the bank. Godowns are regularly
inspected by the inspectors and other bank officers. When goods are brought
into the godown, the godown keeper has to satisfy himself, by appropriate test
checks, regarding the quantity and quality of goods. Banks have to exercise
care to ensure that frauds are not perpetrated against them by pledging
packages not containing the specified goods and later on holding them
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responsible for the goods supposed to have been pledged as per the
documents.
11.52 The goods are insured against fire and other risks involved and the
insurance policies are either in the name of, or endorsed in favour of, the bank.
In case the borrower is a company, the bank has to ensure registration of
charge with the Registrar of Companies.
Documents of Title to Goods
11.53 A document of title to goods is a negotiable or quasi-negotiable
instrument. According to section 2(4) of the Sale of Goods Act, 1930, a
document of title is any document used in the ordinary course of business as
proof of the possession or control of goods, or authorising or purporting to
authorise, either by endorsement or by delivery, the possessor of the
document to transfer or receive the goods represented thereby.
11.54 Documents of title include:
 Bill of lading
 Railway receipt
 Transporter’s receipt
 Dock warrant
 Warehouse-keeper’s certificate
 Wharfinger’s receipt
 Warrant or order for delivery of goods
Before being pledged with the bank, these documents have to be appropriately
endorsed in bank’s favour.
Gold Ornaments and Bullion
11.55 Gold ornaments are accepted by banks as security on the basis of
assessor’s certificate regarding the content, purity, weight and value thereof.
Valuation, keeps on changing as a result of market fluctuations. Loans are
given only on the basis of gold content of ornaments, without considering gold
making charges. RBI, vide Master Circular No. DBR.No.Dir.BC.10/
13.03.00/2015-16 on Loans and Advances-Statutory and Other Restrictions
dated July 1, 2015, directed banks to give preference to hallmarked jewellery
for granting advances. RBI vide Circular No. DBOD.BP.BC.No.86/
21.01.023/2013-14 on “Lending against Gold Jewellery” dated January 20,
2014 read with Master Circular No. DBR.No.Dir.BC.10/ 13.03.00/2015-16 on
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Loans and Advances-Statutory and Other Restrictions dated July 1, 2015,

issued guidance in respect of “Advances against Gold Ornaments and
Jewellery for purpose of Medical Expenses and Meeting Unforeseen
Liabilities”. In this context, attention is invited to RBI’s Circular No.
DBOD.No.BP.79/21.04.048/2013-14 on “Non-Agriculture Loans against Gold
Ornaments and Jewellery” dated December 30, 2013 read with circular no.
RBI/2014-15/142 DBOD.No.BP.BC.27/21.04.048/ 2014-15 dated July 22, 2014
and Master Circular No. DBR.No.Dir.BC.10/ 13.03.00/2015-16 on Loans and
Advances-Statutory and Other Restrictions dated July 1, 2015 containing
guidelines on bullet repayment of loans extended against pledge of gold
ornaments and jewellery for other than agricultural purposes.
Life Insurance Policies
11.56 Life insurance policies have to be assigned in bank’s favour and such
assignment has to be registered with the insurer. The surrender value of the
policy is the basis of valuation.
Plantations
11.57 Advances are made to agriculturists such as tea gardeners to finance
their growing crops. When the produce is harvested, processed and sold, the
money is repaid to the bank.
11.58 The basis of calculating the amount of the advance is the estimated
crop of the season. This depends upon the area under cultivation, expected
yield, etc. Separate advances are made for each season’s crop.
11.59 The crop to be produced is hypothecated to the bank. Generally, fixed
assets of the plantation are also mortgaged with the bank as collateral security.
Finance is taken from the bank to incur expenditure on the crop. The amount of
the advance increases as the crop grows.
Immovable Property
11.60 Before advancing money on mortgage of immovable property, the
lending bank has to satisfy itself that the borrower has a clear and
unencumbered title to the property that is marketable and adequately insured.
Banks ascertain whether the property in question has already been mortgaged
to any other financial institution and if so, details of charges already created on
the property. In respect of advances to public companies against mortgage of a
block of assets, it is essential that provisions of section 180(1)(a) of the
Companies Act, 2013 are duly considered.
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Third Party Guarantees

11.61 Advances covered by third party personal guarantees (except banks
and government) in addition to borrower’s personal security are not classified
as ‘secured’ advances and are classified as ‘unsecured’ advances.
11.62 The guarantee bond executed by the guarantor in favour of the bank
may be in bank’s own prescribed form or otherwise. Such bonds are generally
executed by holding companies, overseas customers, overseas principals,
insurance companies, etc. A letter of continuity is also obtained from the
guarantor.
Banker’s General Lien
11.63 A lending bank also has a general lien under law. A lien represents
the right of retaining the goods/securities unless a debt due by a debtor is paid
to the creditor (retainer), provided there is no agreement, express or implied, to
the contrary. A lien is a statutory right, which does not require any separate
agreement. Under section 171 of the Indian Contract Act, 1872, a banker may,
in the absence of an agreement to the contrary, retain as security for a general
balance of account, any goods and securities bailed to him. This is called
banker’s general lien.
11.64 Two conditions necessary for creating such lien are:
(a) Securities must be placed in a banker’s hand by his customers; and
(b) Securities are not specifically appropriated.
11.65 Securities over which a banker has general lien are credit balance in any
other account, bonds and coupons deposited for collection, securities allowed to
remain in banker’s hands after repayment of a secured advance, etc.
11.66 Securities on which a banker does not have a general lien are securities
deposited for safe custody, money deposited or earmarked for a specific purpose,
documents executed for a special purpose, etc. Lien is applicable even in respect
of the borrower’s obligations as a surety. The banker’s right of general lien over the
security is not barred by the law of limitation and can be exercised in case of
unenforceable or time-barred debts also.
11.67 ‘Negative lien’ refers to an undertaking given by the borrower to the
bank that no charge such as lien, pledge, hypothecation, or mortgage, over his
immovable and moveable properties and assets including uncalled capital will
be created without bank’s prior permission. Negative lien relates to goods,
securities, etc., not in Bank’s possession. Negative lien does not require
registration with Registrar of Companies or similar authorities.
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Statutory Restrictions
Advances against Bank’s own Shares
11.68 In terms of Section 20(1) of the Banking Regulation Act 1949, a bank
cannot grant any loan or advance against the security of its own shares.
Advances to Bank's Directors
11.69 Section 20(1) of Banking Regulation Act, 1949 lays down restrictions on
loans and advances to directors and firms in which they hold substantial interest.
11.70 Banks are prohibited from entering into any commitment for granting
any loans or advances to or on behalf of any of its directors, or any firm in which
any of its directors is interested as partner, manager, employee or guarantor, or
any company (not being a subsidiary of the banking company or a company
registered under Section 8 of the Companies Act, 2013 or a Government
company) of which, or the subsidiary or the holding company of which any of the
directors of the bank is a director, managing agent, manager, employee or
guarantor or in which he holds substantial interest, or any individual in respect of
whom any of its directors is a partner or guarantor. Certain exemptions are given
in the aforesaid Master Circular in this regard.
11.71 For the above purpose, the term 'loans and advances' shall not include:
(a) Loans or advances against Government securities, life insurance policies or
fixed deposit.
(b) Loans or advances to Agricultural Finance Corporation Ltd.
(c) such loans or advances as can be made by a banking company to any of
its directors (who immediately prior to becoming a director, was an
employee of the banking company) in his capacity as an employee of that
banking company and on terms and conditions as would have been
applicable to him as an employee of that banking company, if he had not
become a director of the banking company. Banking company includes
every bank to which provisions of Section 20 of Banking Regulation Act,
1949 apply.
(d) such loans or advances granted by the banking company to its Chairman
and Chief Executive Officer, who was not an employee of the banking
company immediately prior to his appointment as Chairman/Managing
Director/CEO, for the purpose of purchasing a car, personal computer,
furniture or constructing/ acquiring a house for his personal use and festival
advance, with prior approval of RBI and on such stipulated terms and
conditions.
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(e) Such loans or advances granted by a banking company to its whole time
director for the purpose of purchasing furniture, car, personal computer or
constructing/acquiring house for personal use, festival advance with RBI
prior approval and on such stipulated terms and conditions.
(f) Call loans made by banking companies to one another.
(g) Facilities like bills purchased/discounted (whether documentary or clean
and sight or usance and whether on D/A basis or D/P basis), purchase of
cheques, other non-fund based facilities like acceptance/co-acceptance of
bills, opening of L/Cs and issue of guarantees, purchase of debentures
from third parties, etc.
(h) Line of credit/overdraft facility extended by settlement bankers to National
Securities Clearing Corporation Ltd.(NSCCL)/ Clearing Corporation of India
Ltd. (CCIL) to facilitate smooth settlement.
(i) Credit limit granted under credit card facility provided by a bank to its
directors to the extent the credit limit so granted is determined applying the
same criteria as applied by it in normal conduct of credit card business.
11.72 Purchase of or discount of bills from directors and their concerns, which
is in the nature of clean accommodation, is reckoned as ‘loans and advances’ for
purposes of Section 20 of the Banking Regulation Act, 1949.
Restrictions on Power to Remit Debts
11.73 Section 20A of the Banking Regulation Act, 1949 stipulates that
notwithstanding anything to the contrary contained in Section 180 of the
Companies Act, 2013, a banking company shall not, except with RBI’s prior
approval, remit, in whole or in part, any debt due to it by -
 any of its directors, or
 any firm or company in which any of its directors is interested as director,
partner, managing agent or guarantor, or
 any individual, if any of its directors is his partner or guarantor.
Any remission made in contravention of the above provisions shall be void and
shall have no effect.
Restriction on Holding Shares in Companies
11.74 As per Section 19(2) of Banking Regulation Act, 1949, banks should not
hold shares in any company except as provided in sub-section (1) whether as
pledgee, mortgagee or absolute owner, of an amount exceeding 30 per cent of
the paid-up share capital of that company or 30 per cent of its own paid-up share
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capital and reserves, whichever is less, except otherwise specifically permitted

by RBI regulations.
11.75 In terms of Section 19(3) of the Banking Regulation Act, 1949, banks
should not hold shares whether as pledgee, mortgagee or absolute owner, in any
company in the management of which any managing director or manager of the
bank is in any manner concerned or interested.
11.76 While granting loans and advances against shares, provisions of
Sections 19(2) and 19(3) should be strictly observed, except otherwise
specifically permitted by RBI regulations.
Restrictions on Credit to Companies for Buy-back of their Securities
11.77 As per Section 68 of the Companies Act, 2013, companies are
permitted to purchase their own shares or other specified securities out of
their:
 Free reserves.
 Securities premium account.
 Proceeds of any shares or other specified securities.
subject to compliance of various conditions specified in sub-section (2) of
section 68 of Companies Act, 2013. Therefore, banks should not provide loans
to companies for buy-back of shares/securities.
Regulatory Restrictions
Granting Loans and Advances to relatives of Directors
11.78 Without prior approval of the Board or its knowledge, no loans and
advances should be granted to relatives of bank's Chairman/Managing Director
or other Directors, Directors (including Chairman/Managing Director) of other
banks and their relatives, Directors of Scheduled Co-operative Banks and their
relatives, Directors of Subsidiaries/Trustees of Mutual Funds/Venture Capital
Funds set up by the financing banks or other banks. However, banks may
grant loan or advance to or on behalf of spouses of their Directors in cases
where the spouse has his/her own independent source of income arising out of
his/her employment or profession and the facility so granted is based on
standard procedures and norms for assessing the borrower creditworthiness.
Such facility should be extended on commercial terms. Accordingly, Banks
should not grant loans and advances without approval of the Board of
Directors/Management Committee aggregating Rupees twenty five lakhs and
above to –
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a. directors (including the Chairman/Managing Director) of other banks.

b. any firm in which any of the directors of other banks is interested as a
partner or guarantor.
c. any company in which any of the directors of other banks holds substantial
interest or is interested as a director or as a guarantor.
d. any relative other than spouse and minor/dependent children of their own
Chairmen/Managing Directors or other Directors.
e. any relative other than spouse and minor/dependent children of the
Chairman/Managing Director or other directors of other banks.
f. any firm in which any of the relatives other than spouse and minor/
dependent children as mentioned in (d) & (e) above is interested as a
partner or guarantor.
g. any company in which any of the relatives other than spouse and minor /
dependent children as mentioned in (d) & (e) above hold substantial
interest or is interested as a director or as a guarantor.
Restrictions on Grant of Loans and Advances to Officers and the Relatives
of Senior Officers of Banks
11.79 No officer or any Committee comprising, inter alia, an officer as
member, shall, while exercising powers of sanction of any credit facility, sanction
any credit facility to his/her relative. Such a facility shall ordinarily be sanctioned
only by the next higher sanctioning authority. Credit facilities sanctioned to senior
officers of the financing bank should be reported to the Board. Loans and
advances and award of contracts to relatives of senior officers of the bank or
proposals for credit facilities to the relatives of senior officers of the bank
sanctioned by the appropriate authority should be reported to the Board. Further,
when a credit facility is sanctioned by an authority, other than the Board, to:
 any firm in which any of the relatives of any senior officer of the financing
bank holds substantial interest, or is interested as a partner or guarantor;
or
 any company in which any of the relatives of any senior officer of the
financing bank holds substantial interest, or is interested as a director or
as a guarantor, such transaction should also be reported to the Board.
Credit facility will not include loans and advances such as housing loans, car
advances, consumption loans, etc., granted to an officer of the bank under any
scheme applicable generally to bank employees.
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Restriction on Advances against Sensitive Commodities under Selective

Credit Control (SCC)
11.80 To prevent speculative holding of essential commodities with the help of
bank credit and the resultant rise in their prices, in exercise of powers conferred
by Sections 21 & 35A of the Banking Regulation Act, 1949, RBI, issues, from
time to time, directives to all commercial banks, stipulating specific restrictions on
bank advances against specified sensitive commodities.
The Auditor should be updated as to which commodities are under selection
credit control during the audit period under review.
Restriction on payment of commission to staff members including
officers
11.81 Section 10(1)(b)(ii) of Banking Regulation Act, 1934, stipulates that a
banking company shall not employ or continue employment of any person
whose remuneration or part of whose remuneration takes the form of
commission or a share in the profits of the company. Clause (b) of Section
10(1)(b)(ii) permits payment of commission to any person who is employed
only otherwise than as a regular staff. Therefore, banks should not pay
commission to staff members and officers for recovery of loans.
Restrictions on offering incentives on any banking products
11.82 Banks are not permitted to offer any banking products, including online
remittance schemes etc., with prizes /lottery/free trips (in India and/or abroad),
etc. or any other incentives having an element of chance, except inexpensive
gifts costing less than Rs. 250/-, as such products involve non-transparency in
the pricing mechanism. Such products, if offered, by banks are considered as
violation of extant guidelines and banks concerned are liable for penal action.
Restrictions on Other Loans and Advances
Loans and Advances against Shares, Debentures and Bonds
11.83 Banks are required to strictly observe regulatory restrictions on grant
of loans and advances against shares, debentures and bonds as detailed in
Master Circular no. RBI /2015-16/95 DBR.No.Dir.BC. 10/13.03.00/2015-16
dated July 01, 2015 on “Loans and Advances – Statutory and Other
Restrictions”. The restrictions on loans and advances against shares and
debentures, are:
(a) No loans to be granted against partly paid shares.
(b) No loans to be granted to partnership/proprietorship concerns against
the primary security of shares and debentures.
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11.84 RBI’s Master Circular No. RBI/2015-16/95 DBR. No. Dir. BC.
10/13.03.00/2015-16 “Loans and Advances - Statutory and Other Restrictions”
contains guidelines for granting Loan and Advances against Shares, Debentures
and Bonds as follows:
Advances to individuals
11.85 Banks may grant advances against security of shares, debentures or
bonds to individuals subject to following conditions:
(i) Amount of advance: Loans against security of shares, debentures and
bonds should not exceed Rs. 10 lakhs per individual if the securities are
held in physical form and Rs. 20 lakhs per individual if securities are held in
dematerialised form. Auditors should note updated limits from time to time.
(ii) Margin: Banks should maintain a minimum margin of 50 per cent of the
market value of equity shares / convertible debentures held in physical
form. In case of shares / convertible debentures held in dematerialised
form, a minimum margin of 25 per cent should be maintained. These are
minimum margin stipulations and banks may stipulate higher margins for
shares whether held in physical or dematerialized form. Margin
requirements for advances against preference shares / nonconvertible
debentures and bonds may be determined by banks themselves.
(iii) Lending policy: Each bank should formulate with their Board of Directors,
approval, a Loan Policy for grant of advances to individuals against shares /
debentures / bonds keeping in view RBI guidelines. Banks should obtain a
declaration from the borrower indicating the extent of loans availed of by
him from other banks as input for credit evaluation. It would also be
necessary to ensure that such accommodation from different banks is not
obtained against shares of a single company or a group of companies. As a
prudential measure, each bank may also consider laying down appropriate
aggregate sub-limits of such advances.
Advances to Share and Stock Brokers/ Commodity Brokers
11.86 (i) Banks and their subsidiaries are not permitted to finance 'Badla'
transactions. Banks can grant advances only to SEBI registered share and
stock brokers complying with capital adequacy norms prescribed by SEBI /
Stock Exchanges. This would be towards need based overdraft facilities /
line of credit against shares and debentures held by them as stock in trade.
A careful assessment of need based requirements for such finance should
be made taking into account the borrower’s financial position, operations on
his own account and on behalf of clients, income earned, average turnover
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period of stocks and shares and the extent to which broker's funds are
required to be involved in business operations. Banks may also grant
working capital facilities to such stock brokers to meet cash flow gap
between delivery and payment for DVP transactions undertaken on behalf
of institutional clients viz. FIs, Flls, mutual funds and banks, duration of
such a facility will be short and based on an assessment of financing
requirements keeping in view cash flow gaps, the broker's funds required to
be deployed for the transaction and overall financial position of the broker.
Utilization has to be monitored based on individual transactions.
Banks may institute adequate safeguards and monitoring mechanisms. A
uniform margin of 50 per cent is required to be applied on all advances/
financing of IPOs/ issue of guarantees on behalf of share and stockbrokers.
A minimum cash margin of 25 per cent (within the 50% margin) shall be
maintained in respect of guarantees issued by banks for capital market
operations. The above minimum margin will also apply to guarantees
issued by banks on behalf of commodity brokers in favour of commodity
exchanges viz. National Commodity and Derivatives Exchange (NCDEX),
Multi Commodity Exchange of India Ltd. (MCX) and National Multi
Commodity Exchange of India Ltd. (NMCEIL), in lieu of margin
requirements as per commodity exchange regulations. These margin
requirements will also be applicable in respect of bank finance to stock
brokers by way of temporary overdrafts for DVP transactions. Banks may
issue guarantees on behalf of share and stock brokers/commodity brokers
in favour of stock exchanges in lieu of security deposit to the extent it is
acceptable in form of bank guarantee as laid down by stock exchanges.
Banks may also issue guarantees in lieu of margin requirements as per
stock exchange regulations.
(ii) The requirement relating to transfer of shares in bank's name in respect of
shares held in physical form mentioned at Sl. No. (ix) of Paragraph 2.3.1.14
of Master Circular on Loans and Advances would not apply in respect of
advances granted to share and stock brokers provided such shares are
held as security for a period not exceeding nine months. In case of
dematerialised shares, the depository system provides a facility for pledging
and banks may avail this facility. In such cases, there will not be a need to
transfer the shares in the bank’s name irrespective of the period of holding.
The share and stock brokers are free to substitute shares pledged by them
as and when necessary. In case of a default in the account, the bank
should exercise the option to get the shares transferred in its name.
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Bank finance for market makers

11.87 Necessary guidelines for the same as stated in the Master Circular to
be noted wherever applicable cases exist in the Branch.
Financing of Initial Public Offerings (IPOs)
11.88 Banks should ensure that no advances exceed Rs. 10 lakhs to any
individual against security of shares, convertible bonds, convertible debentures,
units of equity oriented mutual funds and PSU bonds for subscribing to IPOs.
Banks should not extend any credit or financing to Corporates for investment in
other companies’ IPOs and to NBFCs for further lending to individuals for IPOs.
Bank Finance to assist employees to buy shares of their own companies
11.89 (i) Banks may extend finance to employees for purchasing shares of their
own companies under Employees Stock Option Plan (ESOP)/ reserved by
way of employees’ quota under IPO to the extent of 90% of the purchase
price of the shares or Rs. 20 Lakhs, whichever is less. Banks are not
allowed to extend advances including advances to their employees/
Employees’ Trusts set up by them for purposes of purchasing their own
banks’ share under ESOPs/IPOs or from the secondary market irrespective
of whether the advances are secured or unsecured. Follow-on Public Offers
(FPOs) will also be included under IPO.
(ii) Banks should obtain declaration from the borrower indicating details of
loan/advances availed against shares and other securities specified above,
from any other bank/s to ensure compliance with the prescribed ceilings.
Advances to other borrowers against shares / debentures / bonds
11.90 (i) The question of granting advances against primary security of shares
and debenture including promoters’ shares to industrial, corporate or other
borrowers should not normally arise except for secured loans granted
towards working capital or for other productive purposes other than NBFCs.
In such cases, Banks should accept shares only in dematerialised form.
Banks may accept shares of promoters only in dematerialized form
wherever demat facility is available.
(ii) Banks may obtain collateral security of shares and debentures by way of
margin for a temporary period of one year from borrowers other than
NBFCs in the course of setting up of new projects or expansion of existing
business or for purposes of raising additional working capital. Banks have
to satisfy themselves regarding the capacity of the borrower to raise the
required funds and to repay the advance within the stipulated period.
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Bank Loans for Financing Promoters Contribution

11.91 The promoters’ contribution towards the equity capital of a company
should come from their own resources and bank’s should not normally grant
advances to take up shares of other companies. However, banks are permitted
to extend loans to corporate against security of shares (as far as possible in
dematerialised form) held by them to meet promoters’ contribution to equity of
new companies in anticipation of raising resources subject to terms and
conditions detailed in the loan policy of the bank, in addition to general guidelines
given in para 2.3.1.14 of the Master Circular no. RBI/2015-16 /95 DBR. No. Dir.
BC. 10/13.03.00/ 2015-16 dated July 1, 2015 on Loans and Advances –
Statutory and Other restrictions.
i) Margin and loan repayment period may be determined by the banks.
ii) Loans sanctioned to a corporate against security of shares (as far as
possible, demat shares) for meeting promoters' contribution to the equity of
new companies in anticipation of raising resources, should be treated as
bank’s investments in shares coming under the ceiling of 40 percent of the
bank's net worth as on March 31 of the previous year prescribed for the
bank’s total exposure including both fund and non-fund based exposure to
capital market in all forms. These loans will be subject to individual/group of
borrowers exposure norms and statutory limit on shareholding in
companies, detailed in Master Circular no. RBI/2015-16/70
DBR.No.Dir.BC.12/ 13.03.00/2015-16 dated July 1, 2015 on Exposure
Norms.
iii) Banks may extend financial assistance to Indian companies for acquisition
of equity in overseas joint ventures / wholly owned subsidiaries or in other
overseas companies, new or existing, as strategic investment, in terms of a
Board approved policy, duly incorporated in the bank’s loan policy. Such
policy should include overall limit on such financing, terms and conditions of
eligibility of borrowers, security, margin, etc. The finance would be subject
to compliance with the statutory requirements under Section 19(2) of the
Banking Regulation Act, 1949.
iv) Restriction on grant of bank advances for financing promoters' contribution
towards equity capital would also extend to bank finance to activities related
to acquisitions like payment of non-compete fee, etc. These restrictions
would also apply to bank finance to such activities by overseas branches /
subsidiaries of Indian banks.
v) With the approval of the Board of Directors, banks should formulate internal
guidelines with appropriate safeguards for this purpose.
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vi) Under refinance scheme of Export-Import Bank of India, banks may

sanction term loans on merits to eligible Indian promoters for acquisition of
equity in overseas joint ventures / wholly owned subsidiaries, provided the
term loans are approved by EXIM Bank for refinance.
Advances against Units of Mutual Funds
11.92 While granting advances against units of mutual funds, banks should
adhere to the following guidelines:
i) Units should be listed in Stock Exchanges or repurchase facility for the
Units of mutual fund should be available at the time of lending.
ii) Units should have completed the minimum lock-in-period stipulated in the
relevant scheme.
iii) Amount of advance should be linked to the Net Asset Value (NAV) /
repurchase price or market value, whichever is less and not to face value.
iv) Advance against units of mutual funds (except units of exclusively debt
oriented funds) would attract quantum and margin requirements as
applicable to advance against shares and debentures. However, the
quantum and margin requirement for loans/ advances to individuals against
units of exclusively debt-oriented mutual funds may be decided by
individual banks themselves in accordance with their loan policy.
v) Advances should be purpose oriented, taking into account the credit
requirement of the investor. Advances should not be granted for
subscribing to or boosting up the sales of another scheme of mutual funds
or for purchase of shares/ debentures/ bonds etc.
For exposure norms w.r.t. advances against units of Mutual Funds, refer to Para
4.6 of the Master Circular No. RBI/2015-16/70 DBR.No.Dir.BC.12/13.03.00/2015-
16 dated July 1, 2015 “Exposure Norms”.
Margin Trading
11.93 Banks may extend finance to stockbrokers for margin trading. The
Board of each bank should formulate detailed guidelines for lending for margin
trading, subject to the following parameters:
(a) Finance extended for margin trading should be within the overall ceiling of
40% of net worth prescribed for capital market exposure.
(b) Minimum margin of 50 per cent to be maintained on the funds lent for
margin trading.
(c) Shares purchased with margin trading to be in dematerialised mode under
pledge to the lending bank. Bank to put in place an appropriate system for
monitoring and maintaining the margin of 50% on an ongoing basis.
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(d) Bank's Board should prescribe necessary safeguards to ensure that no

"nexus" develops between inter-connected stock broking entities/
stockbrokers and the bank in respect of margin trading. Margin trading
should be spread out by the bank among a reasonable number of
stockbrokers and stock broking entities.
11.94 The Audit Committee of the Board should periodically monitor bank's
exposure by way of financing for margin trading and ensure that Board
guidelines, subject to the above parameters, are complied. Banks should
disclose the total finance extended for margin trading in "Notes on Account" to
their Balance Sheet.
Financing for Acquisition of Equity in Overseas Companies
11.95 Banks may extend financial assistance to Indian companies for
acquisition of equity in overseas joint ventures / wholly owned subsidiaries or in
other overseas companies, new or existing, as strategic investment, in terms of a
Board approved policy, duly incorporated in the bank’s loan policy. Such policy
should include overall limit on such financing, terms and conditions of eligibility of
borrowers, security, margin, etc. While the Board may frame its own guidelines
and safeguards for such lending, such acquisition(s) should be beneficial to the
company and the country. The finance would be subject to compliance with the
statutory requirements under Section 19(2) of the Banking Regulation Act, 1949.
Refinance Scheme of Export Import Bank of India
11.96 Under the refinance scheme of Export Import Bank of India (EXIM
Bank), banks may sanction term loans on merits to eligible Indian promoters for
acquisition of equity in overseas joint ventures / wholly owned subsidiaries,
provided that term loans are approved by the EXIM Bank for refinance.
Arbitrage Operations
11.97 Banks should not undertake arbitrage operations themselves or extend
credit facilities directly or indirectly to stockbrokers for arbitrage operations in
Stock Exchanges. While banks are permitted to acquire shares from the
secondary market, they should ensure that no sale transaction is undertaken
without holding the shares in their investment accounts.
General guidelines applicable to advances against shares / debentures / bonds
11.98 Statutory provisions regarding grant of advances against shares
contained in Sections 19(2) and (3) and 20(1) (a) of the Banking Regulation Act,
1949 should be strictly observed. Shares held in dematerialised form should also
be included for the purpose of determining limits under Section 19(2) and 19(3).
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11.99 While considering grant of advances against shares / debentures banks

must follow normal procedures for sanction, appraisal and post sanction follow-
up.
11.100 Advances against primary security of shares / debentures / bonds
should be kept distinct and separate and not combined with any other advance.
11.101 Banks should satisfy themselves about the marketability/ reliability of
the shares / debentures and the net worth and working of the company whose
shares / debentures / bonds are offered as security.
11.102 Shares/ debentures/ bonds should be valued at prevailing market prices
when they are lodged as security for advances.
11.103 Banks should exercise particular care when advances are sought
against large blocks of shares by a borrower or a group of borrowers. It should
be ensured that advances against shares are not used to enable the borrower to
acquire or retain a controlling interest in the company/ companies or to facilitate
or retain inter-corporate investments.
11.104 No advance shall be granted against partly paid shares.
11.105 No loans to be granted to partnership/ proprietorship concerns against
primary security of shares and debentures.
11.106 Whenever the limit/limits of advances granted to a borrower exceed
Rupees Ten lakhs, it should be ensured that the said shares / debentures /
bonds are transferred in the bank's name and that the bank has exclusive and
unconditional voting rights in respect of such shares. For this purpose the
aggregate of limits against shares / debentures / bonds granted by a bank at all
its offices to a single borrower should be taken into account.
11.107 Where securities are held in dematerialised form, the requirement
relating to transfer of shares in bank's name will not apply and banks may take
their own decision in this regard.
11.108 Banks should, however, avail of the facility provided in the depository
system for pledging securities held in dematerialised form under which the
securities pledged by the borrower get blocked in favour of the lending bank. In
case of default by the borrower and on the bank exercising the option of
invocation of pledge, the shares and debentures get transferred in the bank's
name immediately.
11.109 Banks may take their own decision in regard to exercise of voting rights
and may prescribe procedures for this purpose.
11.110 Banks should ensure that the scrip lodged with them as security are not
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stolen / duplicate / fake / benami. Any irregularities coming to their notice should
be reported immediately to the RBI.
11.111 Banks operating in India should not be a party to transactions such as
making advances or issuing back-up guarantees favouring other banks for
extending credit to clients of Indian nationality / origin by some of their overseas
branches, to enable borrowers to make investments in shares and debentures /
bonds of Indian companies.
11.112 A uniform 50 per cent margin shall apply on all advances against
shares/financing of IPOs/issue of Guarantees. A minimum 25 per cent cash
margin (within margin of 50 per cent) shall be maintained in respect of
guarantees issued by banks for capital market operations. These margin
requirements will also apply in respect of bank finance to stock brokers by way of
temporary overdrafts for DVP transactions.
Advances against Fixed Deposit Receipts issued by Other Banks
11.113 Instances have come to light where fake term deposit receipts,
purported to have been issued by some banks, were used for obtaining
advances from other banks. RBI has hence, advised banks to desist from
sanctioning advances against FDRs, or other term deposits of other banks.
Advances to Agents/Intermediaries Based on Consideration of Deposit
Mobilisation
11.114 Banks should desist being part to unethical practices of raising of
resources through agents/intermediaries to meet credit needs of
existing/prospective borrowers or from granting loans to intermediaries, based
on consideration of deposit mobilisation, who may not require funds for
genuine business requirements.
Loans Against Certificate of Deposits (CDs)
11.115 Banks cannot grant loans against CDs. Banks are also not permitted
to buy-back their own CDs before maturity. However, these restrictions on
lending and buy back in respect of CDs held by mutual funds have been
relaxed.
11.116 While granting such loans to mutual funds, banks should keep in view
provisions of Paragraph 44(2) of the SEBI (Mutual Funds) Regulations, 1996.
Further, such finance, if extended to equity-oriented mutual funds, will form
part of banks’ capital market exposure.
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Finance for and Loans/Advances against Indian Depository Receipts (IDRs)

11.117 Banks are not permitted to grant any loan / advance for subscription to
Indian Depository Receipts (IDRs). No loans/ advances can be granted against
security / collateral of IDRs issued in India.
Bank Finance to Non-Banking Financial Companies (NBFCs)
11.118 RBI, vide Master Circular No. DBR.BP.BC.No.5/21.04.172/ 2015-16
on Bank Finance to Non-Banking Financial Companies (NBFCs) dated July 1,
2015 states:
a) Ceiling on bank credit linked to Net Owned Fund (NOF) of NBFCs has
been withdrawn in respect of all NBFCs statutorily registered with RBI
and engaged in principal business of asset financing, loan, factoring and
investment activities. Accordingly, banks may extend need based working
capital facilities and term loans to all NBFCs registered with RBI and
engaged in infrastructure financing, equipment leasing, hire-purchase,
loan, factoring and investment activities.
b) Banks may finance NBFCs against second hand assets financed by
them.
c) Banks may formulate suitable loan policy with the approval of their
Boards of Directors within RBI prudential guidelines and exposure norms
to extend various kinds of credit facilities to NBFCs subject to the
condition that the activities as indicated in the Master Circular are not
financed by them.
11.119 In respect of NBFCs not required to be registered with RBI, viz.:
i) Insurance Companies registered under Section 3 of the Insurance Act,
1938;
ii) Nidhi Companies notified under Section 406 of the Companies Act, 2013;
iii) Chit Fund Companies carrying on Chit Fund business as their principal
business as per Explanation to Clause (vii) of Section 45-I(bb) of the
Reserve Bank of India Act, 1934;
iv) Stock Broking Companies / Merchant Banking Companies registered
under Section 12 of the Securities and Exchange Board of India Act, 1992;
and
v) Housing Finance Companies being regulated by the National Housing
Bank (NHB) which have been exempted from the requirement of
registration by RBI], banks may take their credit decisions based on usual
factors like purpose of credit, nature and quality of underlying assets,
repayment capacity of borrowers, risk perception, etc.
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11.120 Banks are prohibited from providing credit for the following NBFC
activities:
(i) Bills discounted/rediscounted by NBFCs, except for rediscounting of bills
discounted by NBFCs arising from sale of –
(a) commercial vehicles (including light commercial vehicles), and
(b) two-wheeler and three-wheeler vehicles, subject to following conditions:
 bills should have been drawn by the manufacturers on dealers only.
 bills should represent genuine sale transactions as may be
ascertained from the chassis/engine numbers.
 before rediscounting the bills, banks should satisfy themselves
about the bona fides and track record of the NBFCs discounting the
bills.
(ii) Investments of NBFCs both of current and long term nature, in any
company/entity by way of shares, debentures, etc. However, Stock Broking
Companies may be provided need-based credit against shares and
debentures held by them as stock-in-trade.
(iii) Unsecured loans/inter-corporate deposits by NBFCs to/in any company.
(iv) All types of loans/advances by NBFCs to their subsidiaries, group
companies/entities.
(v) Finance to NBFCs for further lending to individuals for subscribing to Initial
Public Offerings (IPOs) and for purchase of shares from secondary market.
Bank Finance to Residuary Non-Banking Companies (RNBCs)
11.121 Residuary Non-Banking Companies (RNBCs) are required to be
mandatorily registered with RBI. In respect of such companies, bank finance
would be restricted to their Net Owned Fund (NOF). The NOF computation will
be as per definition given in explanation to Section 45-IA of RBI Act, 1934.
Other Prohibition on Bank Finance to NBFCs
Bridge loans / interim finance to NBFCs
11.122 Banks should not grant bridge loans of any nature, or interim finance
against capital / debenture issues and / or in form of loans of a bridging nature
pending raising of long-term funds from the market by way of capital, deposits,
etc. to all categories of Non-Banking Financial Companies, i.e., equipment
leasing and hire-purchase finance companies, loan and investment companies
and also Residuary Non-Banking Companies (RNBCs).
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11.123 Banks should strictly follow these instructions and ensure that they
are not circumvented in any manner whatsoever by purport and / or intent by
sanction of credit under a different nomenclature like unsecured negotiable
notes, floating rate interest bonds, etc., as also short-term loans, repayment of
which is proposed / expected to be made out of funds to be or likely to be
mobilised from external / other sources and not out of surplus generated by
use of the asset(s).
Advances against collateral security of shares to NBFCs
11.124 Shares and debentures cannot be accepted as collateral securities for
secured loans granted to NBFCs borrowers for any purpose.
Restriction on Guarantees for placement of funds with NBFCs
11.125 Banks should not execute guarantees covering inter-company
deposits / loans thereby guaranteeing refund of deposits / loans accepted by
NBFCs / firms from other NBFCs / firms. The restriction would cover all types
of deposits / loans irrespective of their source, including deposits / loans
received by NBFCs from trusts and other institutions. Guarantees should not
be issued for purposes of indirectly enabling placement of deposits with
NBFCs.
Bank Finance to Equipment Leasing Companies
11.126 Banks should not enter into lease agreements departmentally with
equipment leasing companies as well as other Non-Banking Financial
Companies engaged in equipment leasing.
Bank Finance to Factoring Companies
11.127 Necessary guidelines given in the master circular should be noted in
applicable cases if any in branches.
Restrictions regarding investments made by banks in securities/ instruments
issued by NBFCs
11.128 Banks should not invest in Zero Coupon Bonds (ZCBs) issued by
NBFCs unless the issuer NBFC builds up sinking fund for all accrued interest
and keeps it invested in liquid investments / securities (Government bonds).
11.129 Banks are permitted to invest in Non-Convertible Debentures (NCDs)
with original or initial maturity up to one year issued by NBFCs. While investing in
such instruments banks should be guided by the extant prudential guidelines in
force, ensure that the issuer has disclosed the purpose for which the NCDs are
being issued in the disclosure document and such purposes are eligible for bank
finance.
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Advances Against NR(E) and FCNR(B) Deposits

11.130 Grant of advance against NR(E) and FCNR(B) deposits would be
subject to guidelines issued under Foreign Exchange Management Act, 1999.
Advances Against Bullion/Primary Gold
11.131 Banks are prohibited from granting any advance against bullion/
primary gold. However, specially minted gold coins sold by banks are not
treated as “bullion” or “primary gold” and hence are acceptable as security up
to 50 gms per customer. Such loans may be covered under the policy framed
by the bank’s Board, in terms of RBI circular DBOD.No. BC. 138/21.01.023/94
dated November 22, 1994. Where advances have been granted against gold
coins it should be ensured that end use of funds is for approved, non-
speculative purposes. Banks should desist from granting advances to silver
bullion dealers which are likely to be utilised for speculative purposes.
Loans for Acquisition of KVPs
11.132 Banks should ensure that no loans are sanctioned for acquisition
of/investing in Small Savings Instruments including Kisan Vikas Patras.
Advances against Gold Ornaments and Jewellery
11.133 RBI vide Master Circular No. RBI/2015-16/95 DBR.No.Dir.BC.10/
13.03.00/2015-16 dated July 1, 2015 on “Loans and Advances – Statutory
and Other Restrictions” states that hallmarking of gold jewellery ensures quality
of gold used in the jewellery as to carat fineness and purity. Hence, granting of
advances against security of such hallmarked jewellery is safer and easier.
Preferential treatment is given to loans against hallmarked jewellery as it is also
in the long-term interest of consumer, lenders and industry. Based on gold purity
and content, bank decides on margin and rates of interest.
Loan to Value Ratio for Loan against Gold Ornaments and Jewellery
11.134 RBI vide Master Circular No. RBI/2015-16/95 DBR.No.Dir.BC.
10/13.03.00/2015-16 dated July 1, 2015 on “Loans and Advances – Statutory
and Other Restrictions” provides that loans (including bullet repayment loans)
sanctioned by banks against pledge of gold ornaments and jewellery for non-
agricultural purposes should not exceed 75 per cent of the value of gold
ornaments and jewellery. The RBI issued circular DoR.No.BP.BC/6/
21.04.048/2020-21 dated August 06, 2020, wherein the permissible loan to value
ratio (LTV) for loans against pledge of gold ornaments and jewellery for non-
agricultural purposes was increased from 75% to 90%, to enable the borrowers
to tide over their temporary liquidity mismatches on account of COVID 19. The
said enhanced LTV is applicable up to March 31, 2021 and fresh loans which are
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sanctioned subsequently, i.e., from April 01, 2021 onwards shall attract LTV ratio
of 75%.
11.135 In order to standardize the valuation and make it more transparent to
the borrower, gold ornaments and jewellery accepted as security / collateral will
have to be valued at the average of the closing price of 22 carat gold for the
preceding 30 days as quoted by the India Bullion and Jewellers Association Ltd.
[Formerly known as the Bombay Bullion Association Ltd. (BBA)]. If the gold is of
purity less than 22 carats, bank should translate the collateral into 22 carat and
value the exact grams of the collateral.
11.136 Loans extended against pledge of gold ornaments and jewellery other
than for agricultural purposes, where both interest and principal are due for
payment at maturity of the loan will be subject to following conditions:
(i) Banks, as per their Board approved policy, may decide upon the ceiling
with regard to the quantum of loan that may be granted against pledge of
gold jewellery and ornaments for non-agricultural end uses.
(ii) Period of the loan shall not exceed 12 months from sanction date.
(iii) Interest will be charged at monthly rests and recognized on accrual basis if
the account is a ‘standard’ account. This will also apply to existing loans.
(iv) Such loans shall also be governed by other extant norms pertaining to
income recognition, asset classification and provisioning which shall be
applicable once the principal and interest become overdue.
Gold (Metal) Loans
11.137 Nominated banks can extend Gold (Metal) Loans to exporters of
jewellery who are customers of other scheduled commercial banks, by accepting
stand-by letter of credit or bank guarantee issued by their bankers in favour of
the nominated banks subject to authorised banks' own norms for lending and
other conditions stipulated by RBI. Banks may also extend the facility to domestic
jewellery manufacturers, subject to the conditions specified by RBI’s Master
Circular RBI/2015-16/95 DBR.No.Dir.BC.10/13.03.00/2015-16 dated July 1,
2015 on “Loans and Advances - Statutory and Other restrictions”.
11.138 Nominated banks may continue to extend Gold (Metal) Loans to
jewellery exporters subject to following conditions:
 Exposure assumed by the nominated bank extending the Gold (Metal)
Loan against stand-by LC / BG of another bank will be deemed as an
exposure on the guaranteeing bank and attract appropriate risk weight as
per extant guidelines.
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 The transaction should be on back-to-back basis i.e. nominated banks

should extend Gold (Metal) Loan directly to the customer of a non-
nominated bank, against the stand-by LC / BG issued by the latter.
 Gold (Metal) Loans should not involve any direct or indirect liability of the
borrowing entity towards foreign suppliers of gold.
 Banks may calculate their exposure and compliance with prudential norms
daily by converting into Rupee the gold quantity by crossing London AM
fixing for Gold / US Dollar rate with the rupee-dollar reference rate
announced by RBI.
11.139 Banks should recognise overall risks in extending Gold (Metal) Loans
and in extending SBLC / BG. Banks should lay down appropriate risk
management / lending policy in this regard and comply with Ghosh Committee
recommendations and other internal requirements relating to acceptance of
guarantees of other banks to obviate possibility of frauds.
11.140 Nominated banks are not permitted to enter into any tie up
arrangements for retailing of gold / gold coins with any other entity including non-
banking financial companies / co-operative banks / non-nominated banks.
Loans and advances to Micro and Small Enterprises (MSEs)
11.141 RBI has issued Master Directions on Lending to Micro, Small and
Medium Enterprises (MSME) sector vide Master Directions no. FIDD. MSME
and NFS.12/ 06.02.31/2017-18 dated July 24, 2017 (updated April 25, 2018), in
which definition of MSME and common guidelines/instructions for lending to
MSME section are given.
Working Capital Finance to Information Technology and Software Industry
11.142 Following the recommendations of the “National Taskforce on
Information Technology and Software Development“, the RBI has framed
guidelines for extending working capital to the said industry. Banks are free to
modify the guidelines based on their own experience without reference to the
RBI to achieve the purpose of the guidelines in letter and spirit.
11.143 Salient features of these guidelines are as under:
(i) Banks may consider sanction of working capital limits based on track
record of the promoter’s group affiliation, composition of the management
team, their work experience and infrastructure.
(ii) For borrowers with working capital limits of up to Rs 2 crore, assessment
may be made at 20 per cent of the projected turnover. In other cases,
banks may consider assessment of MPBF based on monthly cash budget
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system. For borrowers enjoying working capital limits of Rs 10 crore and

above from the banking system, guidelines regarding the loan system
would be applicable.
(iii) Banks may obtain collateral security wherever available. First/ second
charge on current assets, if available, may be obtained.
(iv) Rate of interest as prescribed for general category of borrowers may be
levied. Concessional rate of interest as applicable to pre-shipment/post-
shipment credit may be levied.
(v) Banks may evolve tailor-made follow up system for such advances. Banks
could obtain quarterly statements of cash flows to monitor operations. In
case the sanction was not made based on cash budgets, they can devise
a reporting system, deemed fit.
Guidelines for bank finance for PSU disinvestments of Government of India
11.144 In terms of RBI circular DBOD No. Dir.BC.90/13.07.05/98 dated August
28, 1998, the promoters’ contribution towards equity capital of a company should
come from their own resources and bank should not normally grant advances to
take up shares of other companies. Banks should ensure that advances against
shares are not used to enable the borrower to acquire or retain a controlling
interest in the company/companies or to facilitate or retain inter-corporate
investment.
11.145 The instructions of the 1998 circular would not apply in the case of bank
finance to the successful bidders under the PSU disinvestment program of the
Government, subject to the following:
 Banks’ proposals for financing the successful bidders in PSU disinvestment
programme should be approved by their Board of Directors.
 Bank finance should be for acquisition of shares of PSU under a
disinvestment programme approved by Government of India, including the
secondary stage mandatory open offer, wherever applicable and not for
subsequent acquisition of PSU shares. Bank finance should be made
available only for prospective disinvestments by Government of India.
 Companies, including promoters, to which bank finance is to be extended,
should have adequate net worth and an excellent track record of servicing
loans availed from the banking system.
 Amount of bank finance provided should be reasonable with reference to
the banks' size, its net worth, business and risk profile.
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11.146 In case the advances against PSU disinvestment is secured by shares

of the disinvested PSUs or any other shares, banks should follow RBI's extant
guidelines on capital market exposures on margin, ceiling on overall exposure to
the capital market, risk management and internal control systems, surveillance
and monitoring by the Audit Committee of the Board, valuation and disclosure,
etc. In this regard, banks may be guided by the Master Circular no. RBI /2015-
16/70 DBR.No.Dir.BC.12 /13.03.00/2015-16 dated July 1, 2015 on “Exposure
Norms”.
Stipulation of lock-in period for shares
11.147 Banks may extend finance to the successful bidders even though the
shares of the disinvested company acquired/ to be acquired by the successful
bidder are subjected to a lock-in period/ other such restrictions which affect their
liquidity, subject to fulfilment of following conditions:
(a) Documentation between Government of India and the successful bidder
should contain a specific provision permitting the pledgee to liquidate the
shares during lock-in period that may be prescribed in respect of such
disinvestments, in case of shortfall in margin requirements or default by the
borrower.
(b) If the documentation does not contain such a specific provision, the
borrower (successful bidder) should obtain waiver from the Government for
disposal of shares acquired under PSU disinvestment program during the
lock-in period.
11.148 As per the terms and conditions of PSU disinvestments by Government
of India, the pledgee bank will not be allowed to invoke the pledge during the first
year of lock-in period. During the second and third year of the lock-in period, in
case of inability of the borrower to restore the margin prescribed for the purpose
by way of additional security or non-performance of the payment obligations as
per the repayment schedule agreed upon between the bank and the borrower,
the bank would have the right to invoke the pledge. The pledgee bank’s right to
invoke the pledge during the second and third years of the lock-in period, would
be subject to documentation terms and conditions between Government and the
successful bidder, which cast certain responsibilities on the pledgee banks.
11.149 The RBI has clarified that the concerned bank must make a proper
appraisal and exercise due caution about creditworthiness of the borrower and
the financial viability of the proposal. The bank must satisfy itself that the
proposed documentation, relating to the disposal of shares pledged with the
bank, are fully acceptable and do not involve unacceptable risks.
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11.150 In terms of IECD Circular No. 10/ 08.12.01/ 2000- 2001 dated 8th
January 2001, banks are precluded from financing investments of NBFCs in
other companies and inter-corporate loans / deposits to/ in other companies.
11.151 Special Purpose Vehicles (SPVs) which comply with the following
conditions would not be treated as investment companies and hence not as
NBFCs:
a) They function as holding companies, special purpose vehicles, etc., with not
less than 90 per cent of their total assets as investment in securities held for
the purpose of holding ownership stake.
b) They do not trade in these securities except for block sale.
c) They do not undertake any other financial activities.
d) They do not hold/accept public deposits.
Financing Housing Projects
11.152 Master Circular No.DBR.No.DIR.BC.13/ 08.12.001/2015-16 dated July
1, 2015 on “Housing Finance” provides guidance in respect of housing finance
provided by banks. Banks could deploy funds under housing finance allocation
in any of the following three categories as per norms provided in the Master
Circular:
 Direct finance.
 Indirect finance.
 Investment in bonds of NHB/HUDCO, or combination thereof.
11.153 The Master Circular contains guidelines, including conditions wherein
a bank cannot extend credit for housing purposes. These conditions are as
follows:
(i) In case of lending to housing intermediary agencies, banks should ensure
compliance with National Housing Board (NHB) guidelines, in terms of
which, a housing finance company’s total borrowings, by way of deposits,
issue of debentures/ bonds, loans and advances from banks or from
financial institutions including any loans obtained from NHB, should not
exceed 16 times its net owned funds (i.e., paid up capital and free
reserves less accumulated balance of loss, deferred revenue expenditure
and intangible assets).
(ii) Banks are not permitted to extend fund and non-fund based facilities to
private builders for acquisition of land even as part of a housing project.
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(iii) Banks cannot grant finance for construction of buildings meant purely for
Government/Semi-Government offices, including Municipal and Panchayat
offices. However, banks may grant loans for activities refinanced by
institutions like NABARD.
(iv) Projects undertaken by public sector entities which are not corporate bodies
(i.e., public sector undertakings not registered under Companies Act or
which are not Corporations established under the relevant statute) cannot be
financed by banks.
(v) In terms of Delhi high court’s orders, banks cannot grant loans in respect of:
 Properties falling under unauthorised colonies unless and until they are
regularised and development and other charges paid.
 Properties meant for residential use but which the applicant intends to
use commercially and declares so while applying for the loan.
Loan to Value (LTV) ratio
11.154 To prevent excessive leveraging, LTV ratio and risk weight and
standard as set provisioning in respect of individual housing loans have been
prescribed. RBI Vide Circular No. RBI/2016-2017/317 DBR.BP.BC.No.72/
08.12.015/2016-17 dated June 7, 2017 “Individual Housing Loans:
Rationalisation of Risk –Weights and Loan to Value (LTV) Ratios” revised LTV
ratios is applicable for all loans sanctioned post June 7, 2017 are as under:
Category of loan LTV ratio (%) Risk Weight (%)
Up to Rs. 30 lakh ≤ 80 35
> 80 and ≤ 90 50
Above Rs. 30 lakh and up to Rs. ≤ 80 35
75 lakh
Above Rs. 75 lakh ≤ 75 50
11.155 Following LTV ratios, Risk Weights and Standard Asset Provision set
out in circular DBR.BP.BC.No.44/08.12.015/ 2015-16 dated October 8, 2015
“Individual Housing Loans: Rationalisation of Risk-Weights and LTV Ratios”,
shall continue to apply to loans sanctioned up to June 6, 2017.
Category of loan LTV ratio (%) Risk Weight (%)
Up to Rs. 30 lakh ≤ 80 35
> 80 and ≤ 90 50
Above Rs. 30 lakh and up to Rs. 75 ≤ 75 35
lakh > 75 and ≤ 80 50
Above Rs. 75 lakh ≤ 75 75
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11.156 The LTV ratio should not exceed the prescribed ceiling in all fresh
cases of sanction. In case the LTV ratio is currently above the ceiling
prescribed for any reason, efforts should be made to bring it within limits.
Waiver of EMI in case of regular payment of home loans
11.157 Some banks have introduced certain incentives to home loans to
borrowers who have been making regular payment of EMI/dues. As per this
feature, the borrower gets waiver of some EMI amount either at the end of the
loan or on some periodical basis. The Auditor needs to ensure that the bank
has made sufficient provision for future waiver of EMI in the books in the
books.
Innovative Housing Loan Products – Upfront Disbursal of Housing Loans
11.158 Some banks have introduced certain innovative Housing Loan Schemes
in association with developers / builders, e.g. upfront disbursal of sanctioned
individual housing loans to the builders without linking the disbursals to various
stages of construction of housing project, interest / EMI on the housing loan
availed of by the individual borrower being serviced by the builders during the
construction period / specified period, etc. This might include signing of tripartite
agreements between the bank, the builder and the buyer of the housing unit.
11.159 These loan products are popularly known by various names like 80:20,
75:25 Schemes. Such housing loan products are likely to expose the banks as
well as their home loan borrowers to additional risks e.g. in case of disputes
between individual borrowers and developers / builders, default / delayed
payment of interest / EMI by the developer / builder during the agreed period on
behalf of the borrower, non-completion of the project on time, etc. Further, any
delayed payments by developers / builders on behalf of individual borrowers to
banks may lead to lower credit rating / scoring of such borrowers by credit
information companies (CICs) as information about servicing of loans gets
passed on to the CICs on a regular basis. In cases where bank loans are also
disbursed upfront on behalf of their individual borrowers in a lump-sum to
builders / developers without any linkage to stages of construction, banks run
disproportionately higher exposures with concomitant risks of diversion of funds.
11.160 In view of the higher risks associated with such lump-sum disbursal of
sanctioned housing loans and customer suitability issues, banks are advised that
disbursal of housing loans sanctioned to individuals should be closely linked to
the stages of construction of the housing project / houses and upfront disbursal
should not be made in cases of incomplete / under-construction / green field
housing projects.
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11.161 Banks while introducing any kind of product should consider customer
suitability and appropriateness issues and also ensure that the borrowers /
customers are made fully aware of risks and liabilities under such products.
Retail loans
11.162 Banks generally provide various retail advances namely:
 Home loans and loans against property.
 Vehicle loans.
 Personal loans.
 Consumer durable loans.
 Credit cards.
11.163 Loans are either sourced through direct selling agents or bank’s own
branches. Banks have a credit policy which defines process to be followed for
sanction and disbursement of loan and various documents required.
11.164 The credit assessment process is not as detailed and followed in
corporate loans. Bank generally collects following documents:
 Completely filled loan application form with customers’ signature.
 Income proof like salary slip, financial statement, Income tax returns, Bank
statement.
 Photograph.
 Business continuity proof (e.g. Shops and Establishment Act, any other govt.
certificate for doing business).
 Residence proof.
 Identification proof.
 Contact Point – Mobile No. of applicants is mandatory.
 Age proof.
 PAN Card.
11.165 Banks generally have a system in which various information collected
are keyed into the system and the system automatically runs a credit filter report.
The credit Filter report is based on pre-defined criteria as per credit policy like
minimum income criteria, Aadhaar, employment details, age, telephone etc. and
the score is system generated.
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11.166 As a part of loan sanction process, bank runs CIBIL score and only if
CIBIL score is above a specific number, the bank considers further sanction.
11.167 Bank also conducts field investigations on the proposed customer which
generally involve residential and office visits. Few banks also have a process of
Fraud Containment Unit (FCU) screening of selected sample files. At the FCU,
an official screens through the genuineness and authenticity of the documents
for traces of fraud.
11.168 Post the above verification by FCU, the bank also initiates a Positive De
dupe check for positive database, wherein if the customer is an existing
customer of the bank, the system gets the popup of such links on his screen.
11.169 The credit officer initiates a negative de dupe check on the negative
database through system, Negative De dupe check is against RBI defaulters list,
Terrorist list and declined applications. Such list is uploaded in the system by the
bank’s central team. If the customer is traced under such negative listing then
loan application is rejected by the credit officer. Once, all the processes are
completed and based on favorable results, bank sanctions the loan.
Financing Infrastructure Projects
11.170 RBI has revised the definition of ‘infrastructure Lending’ vide Master
Circular no. “RBI/2015-16 /95 DBR.No.Dir.BC.10/13.03.00/2015-16 dated July
1, 2015 on Loans and Advances – Statutory and Other Restrictions read with
Circular No. RBI/2012 13/297/DBOD.BP.BC.No 58/08.12.014/ 2012-13 dated
November 20, 2012 on “Second Quarter Review of Monetary Policy 2012-13 -
Definition of ‘Infrastructure Lending”. The RBI has periodically added certain
sectors as infrastructure lending from time to time.
11.171 The revised definition of ‘infrastructure lending’ is effective from the
circular date. Exposure of banks to projects under sub-sectors included under
previous definition of infrastructure, but not included in the revised definition, will
continue to get benefits under ‘infrastructure lending’ for such exposures till
completion of the projects. However, any fresh lending to these sub-sectors from
the circular date will not qualify as ‘infrastructure lending’.
11.172 The definition of Infrastructure Lending includes credit facility extended
by Lenders (i.e., Banks and Selected AIFIs) to a borrower for exposure in various
infrastructure sub-sectors as per paragraph 2.3.7.2 of Master Circular no.
RBI/2015-16/95 DBR.No.Dir.BC.10/13.03.00/2015-16 dated July 1, 2015 on
Loans and Advances- Statutory and Other Restrictions, read with Circular No.
DBOD.BP.BC.No.66/08.12.2014/2013-14 on “Financing of Infrastructure –
Definition of ‘Infrastructure Lending’” dated November 25, 2013.
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11.173 Banks/FIs are free to finance technically feasible, financially viable and
bankable projects undertaken by public and private sector undertakings subject
to following conditions:
i. Amount sanctioned should be within overall ceiling of prudential exposure
norms prescribed by RBI for infrastructure financing.
ii. Banks/ FIs should have the requisite expertise for appraising technical
feasibility, financial viability and bankability of projects, with particular
reference to risk and sensitivity analysis.
iii. In respect of projects undertaken by public sector units, such term loans
should not be in lieu of or to substitute budgetary resources envisaged for
the project. The term loan could supplement budgetary resources if such
supplementing was contemplated in the project design. Banks/FIs are,
advised to follow the above instructions scrupulously, even while making
investment in bonds of sick State PSUs as part of rehabilitation effort.
iv. Banks may lend to SPVs in the private sector, registered under Companies
Act for directly undertaking infrastructure projects which are financially viable
and not for acting as mere financial intermediaries. Banks may ensure that
bankruptcy or financial difficulties of the parent/ sponsor should not affect
the financial health of the SPV.
v. In few cases where completion of the project gets delayed, RBI vide its
Master Circular No. RBI/2015-16/101 DBR.No.BP.BC. 2/21.04.048/2015-16
dated July 1, 2015 on “Prudential Norms on Income Recognition, Asset
Classification and Provisioning pertaining to Advances” provides detailed
guideline on classification and provision for project loans. RBI vide Circular
No. RBI/2016-17/122 DBR.No.BP.BC.34 /21.04.132/2016-17 dated
November 10, 2016 on “Schemes for Stressed Assets – Revisions” provides
guidelines for project companies where change of ownership happen/ are
happening after date of commencement of commercial operation (‘DCCO’).
vi. The Auditor should obtain a list of all outstanding project loans of the bank.
Details should also include information about original DCCO and revision of
DCCO, if any. The Auditor should verify that the revision of the project
DCCO is based on technical and financial study and is approved by
competent authority. The Auditor should also verify the revision in DCCO,
and check whether the same is permissible under extent RBI guidelines.
The Auditor should apply professional judgment and skepticism while
evaluating/ accessing and concluding on compliance of the said guidelines
for deferment of DCCO and retaining standard/standard restructured
classification. To verify compliance, the Auditor shall obtain documentary
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evidences like legal documents for Court cases, Lead engineers report/
Review note/ consortium meeting minutes specifying the event that is
beyond promoter’s control etc., as the case may be.
vii. The RBI has issued a mail box clarification on assessment and revision in
project cost. The clarification provides guidance on classification of loan in
case revision of project cost is above a certain percentage of original project
cost. The Auditor should ensure compliance with this clarification.
Types of Financing by Banks
11.174 (i) In order to meet financial requirements of infrastructure projects, banks
may extend credit facility by way of working capital finance, term loan,
project loan, subscription to bonds and debentures/ preference shares/
equity shares acquired as a part of the project finance package which is
treated as "deemed advance” and any other form of funded or non-funded
facility.
(ii) Take-out Financing - Banks may be guided by the instructions regarding
take-out finance as per Circular No.DBOD.BP.BC.144/21.04.048/2000
dated February 29, 2000.
(iii) Inter-institutional Guarantees: Banks are permitted to issue guarantees
favouring other lending institutions in respect of infrastructure projects,
provided the bank issuing the guarantee takes a funded share in the project
at least to the extent of 5 per cent of the project cost and undertakes
normal credit appraisal, monitoring and follow-up of the project.
(iv) Financing promoter's equity: In terms of Circular No.DBOD.Dir.BC.90/
13.07.05/98 dated August 28, 1998 - Banks are advised that promoters’
contribution towards equity capital of a company should come from their
own resources and Banks should not normally grant advances to take up
shares of other companies. However, under certain circumstances, an
exception may be made to this policy for financing acquisition of promoters’
shares in an existing company, engaged in implementing or operating an
infrastructure project in India.
11.175 Conditions, subject to which an exception may be made, are as follows:
 Bank finance would be only for acquisition of shares of existing companies
providing infrastructure facilities. Further, acquisition of such shares should
be in respect of companies where existing foreign promoters (and/ or
domestic joint promoters) voluntarily propose to disinvest majority shares in
compliance with SEBI guidelines, where applicable.
 Companies to which loans are extended should, inter alia, have a
satisfactory net worth.
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 Company financed and promoters/ directors of such companies should not

be a defaulter to banks/ FIs.
 Bank finance should be restricted to 50% of the finance required for
acquiring promoter's stake in the company being acquired.
 Finance extended should be against security of the assets of the borrowing
company or the assets of the company acquired and not against the shares
of that company or the company being acquired. Shares of the Borrower
Company / Company being acquired may be accepted as additional
security and not as primary security. Security charged to the banks should
be marketable.
 Banks should ensure maintenance of stipulated margins at all times.
 Tenor of the bank loans may not be longer than seven years. However, the
Boards of banks can make an exception in specific cases, where
necessary, for financial viability of the project.
 Financing to be subject to compliance with statutory requirements under
Section 19(2) of the Banking Regulation Act, 1949.
 Financing of acquisition of equity shares by promoters should be within the
regulatory ceiling of 40 per cent of their net worth as on March 31 of the
previous year for the aggregate exposure of the banks to the capital
markets in all forms (fund and non-fund based).
 Proposal for bank finance should have the approval of the Board.
System of Base Rate and Interest Rate/ Marginal Cost of Funds
based Lending Rate (MCLR)
11.176 The RBI vide DBR.Dir.No.85/13.03.00/ 2015-16 dated March 03, 2016
(Updated as on February 26, 2020) on “Reserve Bank of India (Interest Rate
on Advances) Directions, 2016” requires banks to freely determine lending
rates on the advances as per their Board approved policy subject to the
guidelines contained in the circular. The Base Rate system was operational
between July 1, 2010 and March 31, 2016 aimed at enhancing transparency in
lending rates of banks and enabling better assessment of transmission of
monetary policy.
 All rupee loans sanctioned and credit limits renewed w.e.f. April 1, 2016
will be priced with reference to Marginal Cost of Funds based Lending
Rate (MCLR) which will be the internal benchmark for such purposes.
The Auditor should verify whether new loans sanctioned and credit limits
renewed post April 1, 2016 are under the new MCLR regime.
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 MCLR will comprise of marginal cost of funds, negative carry on account

of CRR, Operating costs and Tenor premium.
 All new floating rate personal or retail loans and floating rate loans
extended by banks to Micro and Small Enterprises from October 01, 2019
and floating rate loans to Medium Enterprises from April 01, 2020 shall be
benchmarked to one of the following:
o RBI policy repo rate
o GOI 3months Treasury bill yields published by FBIL
o GOI 6 months Treasury bill yields published by the FBIL
o Any other benchmark market interest rate published by the FBIL.
 Banks may offer such external benchmarked loans to other types of
borrowers as well.
 Banks to adopt uniform external benchmark within a loan category.
Spread
11.177 (i) Banks should have a Board approved policy delineating components
of spread charged to a customer. Price differentiation should be
consistent with bank’s credit pricing policy.
(ii) Bank’s internal pricing policy must spell the rationale for, and range of,
the spread in case of a given category of borrower, as also, delegation of
powers in respect of loan pricing. Rationale of the policy should be
available for supervisory review.
(iii) The spread charged to an existing borrower should not be increased
except on account of deterioration in the credit risk profile of the customer
or change in the tenor premium. Any such decision regarding change in
spread on account of change in credit risk profile should be supported by
a full-fledged risk profile review of the customer. Change in tenor
premium should not be ‘borrower specific’ or ‘loan class specific’ and
should be uniform for all types of loans for a given residual tenor.
(iv) Guidelines contained in sub-paragraph (iii) above are not applicable to
loans under consortium/ multiple banking arrangements.
Accounting and Auditing Aspects
Balance Sheet Disclosure
11.178 The Third Schedule to the Banking Regulation Act, 1949 requires
classification of advances made by a bank from three different angles, viz.,
nature of advance, nature and extent of security, and place of making advance
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(i.e. whether in India or outside India). Accordingly, advances are classified in

Schedule 9 to the balance sheet as follows:
A. (i) Bills purchased and discounted
(ii) Cash Credits, Overdrafts and Loans repayable on demand
(iii) Term loans
B. (i) Secured by tangible assets
(ii) Covered by bank/government guarantees
(iii) Unsecured
C. I. Advances in India
(i) Priority sectors
(ii) Public sector
(iii) Banks
(iv) Others
II. Advances outside India
(i) Due from banks
(ii) Due from others
(iii) Bills purchased and discounted
(iv) Syndicated loans
(v) Others
Classification Based on Nature of Advance
11.179 Different classifications are as follows:
(a) In classification under section ‘A’, all outstandings – in India as well as
outside India – less provisions made, will be classified under three heads.
(b) Outstandings in credit card operations should be shown as part of
advances under the head ‘cash credits, overdrafts and loans repayable
on demand’.
(c) Term loans will be loans not repayable on demand and would include
overdue instalments.
(d) All interest bearing loans and advances granted by the bank to its
employees should be shown as part of advances.
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Classification Based on Nature and Extent of Security

11.180 Different classifications are as follows:
(a) All advances or part of advances, which are secured 4 by tangible assets,
whether in India or outside India, should be shown under the heading
‘Secured by tangible assets’. Advances against book debts may be
included under the head ‘Secured by Tangible Assets’, and presented in
Schedule 9 (Advances) as follows:
“B Secured by Tangible Assets” (includes advances against book debt).
(b) Advances in India and outside India to the extent they are covered by
guarantees of Indian and foreign governments and Indian and foreign
banks and DICGC and ECGC are to be included under the head
‘advances – covered by bank/government guarantees’.
(c) Unsecured advances will include advances not classified under (i) & (ii) of
section B.
Classification based on Place of Making Advances
11.181 a) Advances to sectors, classified as priority sectors according to the
instructions of the RBI, are to be classified under the head ‘priority
sectors’. Such advances should be excluded from, ‘Advances to Public
Sector’.
b) Advances to Central and State Governments and other government
undertakings including government companies and corporations which
are, according to the statutes, to be treated as public sector companies,
are to be included in the category ‘Public Sector’.
c) All advances to the banking sector including co-operative banks will come
under the head ‘Banks’.
d) All remaining advances will be included under the residual head ‘Others’;
typically this category will include non-priority advances to the private,
joint and co-operative sectors.
11.182 Advances generally constitute major part of the assets of the bank.
There are large number of borrowers to whom variety of advances are granted.
Audit of advances requires major attention from the auditors. In carrying out audit
4A ‘secured advance’, according to section 5(n) of the Banking Regulation Act, 1949 means an
advance made on the security of assets the market value of which is not at any time less than the
amount of such advance.
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of advances, the Auditor is primarily concerned with obtaining evidence about the
following:
a) Amounts included in balance sheet in respect of advances are outstanding
at the date of the balance sheet.
b) Advances represent amount due to the bank.
c) Amounts due to the bank are appropriately supported by Loan documents
and other documents as applicable to the nature of advances.
d) There are no unrecorded advances.
e) The stated basis of valuation of advances is appropriate and properly applied,
and that the recoverability of advances is recognised in their valuation.
f) Advances are disclosed, classified and described in accordance with
recognised accounting policies and practices and relevant statutory and
g) Appropriate provisions towards advances are made as per the RBI norms,
Accounting Standards and Generally Accepted Accounting Practices.
11.183 The auditor can obtain sufficient appropriate audit evidence about
advances by study and evaluation of internal controls relating to advances, and by:
 examining the validity of the recorded amounts;
 examining loan documentation and it’s vetting by the legal department;
 reviewing the operation of the accounts especially of accounts held and
operated with other banks;
 examining the existence, enforceability and valuation of the security from
time to time especially for loans given on a standalone basis;
 checking compliance with RBI norms including appropriate classification
and provisioning;
 carrying out appropriate analytical procedures; and
 procedure for loan balance confirmations.
11.184 In carrying out substantive procedures, the Auditor should examine all
large advances while other advances may be examined on sampling basis.
The accounts identified to be problem accounts need to be examined in detail
unless the amount involved is insignificant. The auditor should obtain list of
SMA 1 and SMA 2 borrowers from the bank and the same should also be
considered for selection of problematic accounts. The extent of sample
checking would depend on auditor’s assessment of efficacy of internal controls.
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What constitutes a ‘large advance’ needs to be determined in the context of

volume of operations of the branch. As a general rule, an advance may be
considered to be a large advance if the year-end balance is in excess of 10%
of outstanding aggregate balance of fund based and non-fund based advances
of the branch or Rs.10 crores, whichever is less. The said threshold has been
derived from the revised LFAR prescribed by RBI for the Branch audits from
the year 2020-2021.
11.185 Advances which are sanctioned during the year or which are
adversely commented by RBI inspection team, concurrent auditors, bank’s
internal inspection, etc., should, generally, be included in audit sample.
Besides this new advances sanctioned during the year should be included on
selective basis in the sample.
11.186 In nutshell, the Auditor at branch may keep following in mind to plan
comprehensive coverage of advances and for selection of sample.
1. Obtain top 10 exposure accounts: It may be advisable for a branch
auditor to visit the branch and ask the list of top 10 accounts/ exposures
along with all the details such as status and security etc. before starting of
the audit.
2. Obtain the list of stressed accounts: Stressed accounts include accounts
classified as SMA 1 or SMA 2 of projects where implementation is delayed.
The banks monitor stressed accounts on daily basis. Accounts that
generally have overdue beyond 60 days or likely to slip to NPA at the
quarter end are termed as stressed account (some banks may use different
terminology). It is advisable to obtain a list of stressed accounts at least 15
days ahead of the closing date i.e. say stressed account list as on 15th
March. This will provide the Auditor a ready list of such accounts. The
auditor then can scrutinize (based on materiality) whether the account has
slipped or if not whether has been kept standard by unusual transaction
that cannot be termed as business transaction. RBI through its circulars has
time and again emphasized that stray credits at the quarter end need not
qualify to keep account standard. We need to really assess whether the
account is inherently weak. If so the same may have to be downgraded. As
regards the partial recovery in overdue account (qualifying the criteria for
classification of an account as NPA), such account cannot be upgraded
unless overdue portion is recovered in entirety. As regards subsequent
credit (after the date of balance sheet), the same will not improvise the
classification of an advance.
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3. Obtain list of restructured accounts: Restructured account portfolio

requires separate additional provisioning. It is necessary to obtain the list of
such accounts and ensure that the restructure is as per RBI directives.
4. Obtain list of unsecured exposures above Rs. 1 Crore: Unsecured
exposure has significant impact on the bank, if it slips to NPA. Many times
such accounts are reviewed in the traditional manner. These require close
monitoring not only from the perspective of financial parameters of the
prudential guidelines but also non-financial parameters that give signals of
possible ill health. Banking industry (especially PSUs) has faced severe
damages on account non-identification of such non-financial parameters.
5. Early mortality cases: Any advance slippage to NPA within 12 months of
its sanction is called early mortality case. Early mortality cases invoke
penalty to the sanctioning authorities. This will have to be checked to
understand the reason for such happening to avoid such cases in future
and also to find out whether there are any cases classified as performing on
some untenable ground to push it beyond early mortality.
6. List of accounts upgraded during the year or previous years.
7. List of accounts rated adversely as per Bank’s internal ratings.
8. List of accounts where adverse issues have been noted in previous audits.
Evaluation of Internal Controls over Advances
11.187 The Auditor should examine the efficacy of various internal controls
over advances to determine the nature, timing and extent of his substantive
procedures. In general, the internal controls over advances should include, inter
alia, the following:
 Bank should make an advance only after satisfying itself as to the credit
worthiness of the borrower by doing KYC compliance, proper credit
appraisal etc. and after obtaining sanction from the appropriate authorities of
the bank. The sanction for an advance should specify, among other things,
the limit of borrowing, nature of security, margin to be kept, interest, terms of
repayment etc. It needs to be ensured that loans sanctioned are as per the
Loan Policy of the bank and adhere to regulatory (RBI) norms unless a
specific exemption is taken in this regard.
 All necessary documents (e.g., agreements, demand promissory notes,
letters of hypothecation, etc.) should be executed by the parties before
advances are made.
 Compliance with terms of sanction and end use of funds should be ensured.
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 Sufficient margin specified in the sanction letter should be kept against

securities taken to cover for any decline in the value thereof. Availability of
sufficient margin needs to be ensured at regular intervals.
 Controls over custody and storage of documents and their removal for
verification.
 If the securities taken are in the nature of shares, debentures, etc., the
ownership of the same should be transferred in the name of the bank and
effective control of such securities be retained as a part of documentation.
 All securities requiring registration should be registered in the name of the
bank or accompanied by documents sufficient to give clear title to the bank.
 In the case of goods in possession of the bank, contents of the packages
should be test checked at the time of receipt. The godown should be
frequently inspected by responsible officers of the branch concerned, in
addition to the inspectors of the bank.
 Surprise checks should be made in respect of hypothecated goods not in
physical possession of the bank.
 Drawing Power Register should be updated every month to record value of
securities hypothecated. These entries should be separately checked by an
independent officer.
 Accounts should be kept within the drawing power and the sanctioned limit.
 All accounts which exceed the sanctioned limit or drawing power or are
otherwise irregular should be brought to notice of the controlling authority
regularly.
 Operation of each advance account should be reviewed at least once a
year, and at more frequent intervals in case of large advances.
Consideration of Drawing Power/Limits in respect of stocks hypothecated
11.188 In respect of credit facilities against hypothecation of stocks
(inventories) being the primary security, Bank’s system of appraisal for
determining the maximum permissible finance to borrowers and fixing of limits,
inter alia, should take into consideration the level of sundry creditors. The
sanction is expected to be in tune with the appraisal so made. While sanctioning
such credit facility, the bank is expected to stipulate in the documents, that for
computing the Drawing Power, the value of declared stocks is to be considered
only net of the stipulated margin; and that declared stocks shall not cover the
borrower’s liability outstanding in form of sundry creditors for goods or covered
by LCs/ guarantees/ co-acceptances or Buyer’s Credit availed for procurement of
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material. The bank should also insist on such information from borrowers. In
case of consortium accounts, drawing power calculation and allocation made by
the Lead Bank is binding on all Member Banks.
11.189 The RBI has issued guidelines on treatment of unpaid stocks while
arriving at the drawing power available in borrower accounts. The thrust of the
guidelines is avoidance of double financing on unpaid stocks, if such stocks are
taken as eligible for computation of drawing power.
11.190 The matter having been re-examined by RBI vide directive No.
IECD.No.32/08.10.01/92-93 dated 28th April, 1993, banks were advised as
regards the treatment of unpaid stocks while arriving at the drawing power
available in the borrower accounts, wherein the thrust is avoidance of the double
finance on the unpaid stock, if such stocks are taken as eligible for computation
of drawing power. Thus, it would be unrealistic to assume that the composition of
the stock items, the level of stock held and the portion of unpaid stock
considered at the time of appraisal would be static and should be presumed to
be at the same level for subsequent period. For the said reason, the drawing
power needs to be recomputed based on variations, not only in composition and
level of stock but also in the unpaid portion of stocks before the stipulated margin
is applied as per the sanction terms of working capital finance.
11.191 The Auditor should review the bank policy for any inherent weakness in
the credit system, where the stringency in appraisal, is relaxed while sanctioning
the advances, having consequential effect on monitoring and supervision, and
may have effect on the classification status of the borrower, where the drawing
power falls short of the outstanding.
11.192 Banks usually consider credit facilities by way of hypothecation of
stocks and a charge on the sundry debtors. The Drawing Power is required to be
computed net of the stipulated margin, based on and applied to the total eligible
current assets comprising of:
 Net Value of Stock as stated above; and
 Net Value of Debtors (i.e., eligible Trade Debtors Less Bills Discounted with
Bank). The bank usually prescribes conditions as to what comprise of
“eligible trade debtors”, and stipulates the period for debts being considered
as current and good on which the margin is computed.
11.193 For purposes of classification of advances, computation of drawing
power based on realistic value of hypothecated stocks (net of unpaid for stocks,
whether covered by Buyer’s Credit, LCs/ Guarantees/ Co-acceptances or
otherwise) and margin as stipulated, is vital, particularly in cases of default, and
in border-line cases where health status of borrowers may be in question, to
gauge slippages.
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11.194 Due care is required to be exercised by the auditor in case of

 Documents retained in original at centralised offices where these are not
available at the branches that are advised of drawing power limits; and
 consortium advances, where bank, not being the leader, gets related
figures of drawing power from the leader bank, without related evidence of
computation or appropriateness of drawing power.
The Auditor needs to look into this aspect to verify that there is no slippage of the
account into NPA classification.
11.195 These days most of the banks have their ‘advances’ statements
generated through the system. The Auditor should ensure that the fields which
system copies from last year are the same and he should take extra care in
relation with the date of NPA and date of becoming doubtful asset as these facts
have great bearing on the provisioning. The auditor should obtain audit trail from
the bank to verify whether there are any changes or not.
Examination of Loan Documents
11.196 Documents relating to advances would be affected by the legal status of
the borrower and the nature of security. Thus, where the borrower is a company,
loan documents would include certificate of incorporation, memorandum and
articles of association, certificate of commencement of business (in the case of
public limited companies), resolution of board of directors, and special resolution
of shareholders [in cases covered by section 180 (1)(c) of the Companies Act,
2013, etc. Where the borrower is a partnership firm, loan documents would
include copy of partnership deed. Where the security is in the form of mortgage,
apart from mortgage deed (in the case of English Mortgage) or letter of intent to
create mortgage (in the case of Equitable Mortgage), the evidence of registration
of the charge with the Registrar of Companies would also form part of loan
documentation if the borrower is a company. Each bank has its own set of rules
regarding the documents to be obtained from various types of borrowers and in
respect of different kinds of securities. Formats of many of the documents are
also prescribed. The Auditor should evaluate the adequacy of loan documents in
the context of the rules framed by the bank in this regard.
Centralisation and location of original loan documents at Loan Processing
Centres
11.197 Of late, there is an increasing propensity in banks to process loans and
advances, including appraisal, sanction, documentation, initial disbursements,
etc., at Loan Processing Centres/Offices (by whatever name called) and to
execute and physically hold all the documents at such locations, that may not be
in very close proximity to the branch, where the borrower accounts are
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maintained/serviced. The Branch places reliance only on the sanction letters, on

the presumption that all required legal and documentation formalities are correct
and complete at the centralized location.
11.198 In the absence of the original documents (or even authenticated copies
thereof) on an updated basis, the Auditor would need to request the
management for the files identified for examination by him. The Statutory Branch
Auditor must be satisfied on the authenticity and terms of the sanction (in case
the sanction letters are only computer generated but not authenticated), the
completeness of the records, duly updated, for all accounts where the sanction
was so conveyed; and further whether the number of accounts and amounts
recorded at such centres tally with the corresponding data at the branch. It needs
to be confirmed whether there are any cheques held by such centres that remain
unbanked affecting the borrower account balance. Reference must also be made
to any adverse observations in the related monitoring/supervisory report on the
documentation aspects at the centralized location.
Review of Operation of Account
11.199 The Auditor should review the operation of the advance accounts. In
doing so, an intelligent scrutiny of the operation of the account should be carried
out to see that the limit is not exceeded; that the account is not becoming
stagnant; that the customer is not drawing against deposits which are not free
from lien; that the account is not window-dressed by running down overdrafts at
the year end and again drawing further advances in the new year, etc. The Audit
procedure should be able to highlight disbursals from pre/freshly sanctioned
limits made either to the same borrower or to group entities near the repayment
dates of critical dues.
11.200 The Auditor should also examine whether there is a healthy turnover in
the account. It should be seen that the frequency and the amounts of credits in
the account are commensurate with the sanctioned limit and the nature and
volume of business of the borrower. Any unusual items in the account should be
carefully examined by the auditor. If the auditor’s review indicates any unhealthy
trends, the account should be further examined. The auditor’s examination
should also cover transactions in the post-balance sheet date period. Large
transactions in major accounts particularly as at the year-end may be looked into,
to identify any irregularities in these accounts. A written note/explanation may be
obtained from the management as regards any major irregularities which may
have a bearing on his report.
11.201 The Auditor may also review the following to assess recoverability of
advances:
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(a) Periodic statements submitted by the borrowers indicating the extent of

compliance with terms and conditions.
(b) Latest financial statements of borrowers.
(c) Reports on inspection of security.
(d) Auditors’ reports in the case of borrowers enjoying aggregate credit limits
of Rs. 10 lakh (or as approved by Board of Directors of respective banks)
or above for working capital from the banking system.
11.202 The Auditor should verify that interest is being charged on all performing
accounts regularly and should compare the rate of interest with the agreement,
sanction letter and credit rating reports where rate of interest is linked to credit
rating. In case the interest rate is revised based on changes in PLR/BPLR/Base
Rate of the bank, it needs to be ensured that the rate of interest to be charged
form the borrower is suitably revised as and when there are changes in
PLR/BPLR/Base Rate. Calculation of interest should be test-checked. The
auditor should examine that interest not received on any account, which is a non-
performing asset as per RBI guidelines. It may be noted that interest accrued but
not due on advances does not form part of advances.
11.203 Penal interest on delayed submission of stock statements, non-creation
of security, overdrawn accounts etc., needs to be charged as per sanctioned
terms and norms of the bank. Compliance of the same should be checked in
detail by the auditors.
11.204 In case of advances covered by guarantees of DICGC/ECGC/CGTS, in
case of default the auditor should examine whether appropriate steps are taken
for lodging of claims for guarantees in accordance with applicable procedure.
The claims declined by DICGC/ECGC/CGTS should not be considered as
recoverable while calculating provisions against the respective advances.
11.205 In respect of consortium advances, the Auditor should examine:
(a) Compliance with limits stipulated by consortium in lending moneys to the
borrower;
(b) Bank’s monitoring of securities like stocks, etc., in its custody/charge; and
(c) Follow-up with lead bank on pending issues.
11.206 The auditor should examine whether the bank has correctly classified
the inter-bank participation certificates. In the case of participations on risk-
sharing basis, the auditor should examine whether any loss has devolved on the
bank as on the balance sheet date and, if so, whether adequate provision in
respect of such loss is made.
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Verification of Security against Advances

11.207 An advance is treated as secured to the extent of the value of the
security on the reporting date. If a part of the advance is covered by the value of
the security as at the date of the balance sheet, that part only should be
classified as secured; the remaining amount should be classified as unsecured.
11.208 Following points are relevant for classifying advances based on
security:
(a) Government guarantees include guarantees of Central/State Governments
and advances guaranteed by Central/State Government owned
corporations, financial institutions like IDBI, IFCI, ICICI, State Financial
Corporations, State Industrial Development Corporations, ECGC, DICGC,
CGTS, etc.
(b) Advances covered by bank guarantees include advances guaranteed
against any negotiable instrument, payment of which is guaranteed by a
bank.
(c) Advances covered by bank/government guarantees should be included in
unsecured advances to the extent the outstanding in these advances
exceed the amount of related guarantees.
(d) While classifying advances as secured, the primary security should be
applied first and for residual balance, if any, value of collateral security
should be taken into account. If the advance is still not fully covered, then,
to the extent of bank/government guarantees available, the advance should
be classified as ‘covered by bank/government guarantee’. Balance, if any,
remaining after the above classification, should be classified as
‘unsecured’.
(e) There may be situations where more than one facility is granted to a single
borrower and a facility is secured, apart from primary and collateral securities
relating specifically to that facility, by the residual value of primary security
relating to any other credit facility (or facilities) granted to the borrower. In
such a case, in the event of shortfall in the value of primary security in such a
credit facility, the residual value of primary security of the other facility (or
facilities, as the case may be) may be applied first to the shortfall and the
value of collateral securities should be applied next.
(f) In case of common collateral security for advances granted to more than
one borrower, if there is a shortfall in value of primary security in any one or
more of the borrower accounts, the value of collateral security may be
applied proportionately to the shortfall in each borrower account.
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(g) Advances covered by ECGC/DICGC, CGTS guarantees should be treated

as covered by guarantees to the extent of guarantee cover available. The
amount already received from DICGC/ECGC/CGTS and kept in sundry
creditors account pending adjustment should be deducted from advances.
(h) An account which is fully secured but the margin which is lower than that
stipulated by the bank should nevertheless be treated as fully secured for
purposes of balance sheet presentation.
(i) All documentary bills under delivery-against-payment terms (i.e., covered by
RR/Airway Bill/Bill of lading) for which the documents are with the bank as on
the balance sheet date should be classified as ‘secured’.
(j) Documentary bills under delivery-against-acceptance terms which remain
unaccepted at close of 31st March (i.e., for which documents of title are
with the bank on this date) should be classified as secured. All accepted
bills should be classified as ‘unsecured’ unless collaterally secured.
(k) Cheques purchased including self-cheques (i.e., where the drawer and
payee are one and the same) should be treated as unsecured.
(l) Advances against supply bills, unless collaterally secured, should be
classified as unsecured even if they have been accepted by the drawees.
(m) ‘Security’ means tangible security properly discharged to the bank and
will not include intangible securities like guarantees (including State
government guarantees), comfort letters, etc. Moreover, rights, licenses,
authorisations, etc., charged to banks as collateral in respect of projects
(including infrastructure projects) financed by them, should not be reckoned
as tangible security (Ref Master Circular No. RBI/2015-
16/99DBR.BP.BC.No.23/21.04.018/2015-16 dated July 1 2015 on
Disclosure in Financial Statements- Notes to Accounts).
11.209 In examining whether an advance is secured and, if so, to what extent,
the auditor is concerned with determining:
(a) whether security is legally enforceable, i.e., whether necessary legal
formalities regarding documentation, registration, etc., are complied with;
(b) whether security is in effective control of the bank; and
(c) to what extent the value of the security, assessed realistically, covers
amount outstanding in the advance.
11.210 The Auditor should examine the following aspects in respect of
advances classified as ‘secured’:
(a) Documents executed are complete and in force.
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(b) Where documents are not renewed, limitation period has not expired.
(c) Evidence is available to the market value of the security.
(d) Evidence is available that:
i. hypothecated/pledged goods are the property of the borrowers and are
not old/obsolete or otherwise unsaleable;
ii. advances against book debts of borrowers are related to their current
debts and not old/doubtful debts; and
iii. Stocks hypothecated/pledged are paid stocks owned by the borrower.
(e) In case of companies, charge is appropriately registered with the Registrar
of Companies and a certificate of registration of charge or other evidence of
registration is held.
(f) Borrowers are regular in furnishing requisite information regarding value of
security lodged with the bank.
(g) In respect of second charge being available in respect of certain assets, the
amount of the lender(s) enjoying the first charge on such asset be worked
out and only the residuary value, if any, available for second charge
holders, be considered.
Stock Exchange Securities and Other Securities
11.211 The Auditor should verify stock exchange securities and their market
value in the same manner as in the case of investments. The Auditor should
examine whether the securities have been registered or assigned in favour of the
bank, wherever required and verify the same with Demat Statement.
11.212 A quoted security may not have frequent transactions on the stock
exchange and the quotation included in the official quotations may be that of a
very old transaction. In such a case, the auditor should satisfy himself as to the
market value by scrutiny of balance sheet, etc., of the company concerned,
particularly, if the amount of advance made against such security is large.
11.213 Banks do not generally make advances against partly paid securities.
If, however, any such shares are accepted by the bank as security and these are
registered in the name of the bank, the auditor should examine whether the
issuing company has called up any amount on such securities and, if so, whether
the amount has been paid in time by the borrower/bank.
Goods
11.214 In respect of hypothecated goods, the auditor should check the quantity
and value of goods hypothecated with reference to the statement received from
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the borrower. He should also examine the reasonableness of valuation. Letter of

hypothecation should also be examined by the auditor. If the value of the goods
is higher than the amount mentioned in the letter of hypothecation, the bank’s
security is only to the extent of the latter. The Auditor should also verify that the
Bank has system of maintenance of proper register in this regard and a system
of scrutiny of stock/book debt statement furnished by the borrower.
11.215 The auditor should also check the nature of goods
hypothecated/pledged. If the goods are of perishable nature, it will not have a
market value. In case of goods/book debts, movable assets hypothecated,
auditor should also examine whether the Bank has system in place for periodical
inspection of such goods/debts/assets and records of borrowers by its own
officer or by external agencies like firm of Chartered Accountants. Whether
proper register is maintained in this regard and timely action is taken whenever
there is an adverse remark in the inspection report. The Auditor should also
check that there is adequate insurance cover in respect of goods /assets
hypothecated and there is a bankers' clause in the policy.
11.216 In respect of goods pledged with the bank, the auditor should check the
statement received from the borrower regarding the quantity and value of goods
pledged by him. He should test check the godown registers and valuation of
goods. If there is any outstanding delivery order against the goods as on the
balance sheet date, the same should be deducted from the total quantity in hand
in ascertaining the value of the goods constituting the security. The auditor may
also examine the key movement register to verify movement of goods inwards
and/or outwards.
11.217 Sometimes, goods are in possession of third parties, such as clearing
and forwarding agents, transporters, brokers, warehouse-keepers, etc. If these
parties have given an undertaking to the bank that they will hand over the goods
or sale proceeds thereof to the bank only, i.e., they have 'attorned' to the bank
the advances made against such goods should be considered as secured. In
such cases, certificates should be obtained by the bank from such third parties
regarding quantities on hand on balance sheet date. The valuation of such goods
should be checked by the auditor. In case the borrower is a company, the auditor
should examine the certificate of registration of charge on the goods
hypothecated with the Registrar of Companies. It may be mentioned that in case
of pledge of goods, registration of charge is not necessary.
Gold Ornaments and Bullion
11.218 The auditor may inspect and weigh (on a test basis) the ornaments on
the closing date. He should also see the assayer’s certificate regarding the net
gold content of the ornaments and their valuation. Valuation should also be
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checked with reference to the current market price of gold. In context to the
valuation, attention is also invited to the valuation norms as given in the RBI
circular no. DBOD.No.BP.BC.27/21.04.048/2014-15 on “Loans against Gold
Ornaments and Jewellery for Non-Agricultural End-uses” dated July 22, 2014.
Read with Master Circular no. RBI/2015-16/95 DBR.No.Dir.BC.10 /13.03.00
/2015-16 dated July 01, 2015 on Loan and Advances – Statutory and Other
Restrictions.
11.219 In respect of gold and silver bars, the auditor should inspect the bars on
a test basis and see that the mint seals are intact. The weights mentioned on the
bars may generally be accepted as correct.
Life Insurance Policies
11.220 The Auditor should inspect the policies and see whether they are
assigned to the bank and whether such assignment has been registered with the
insurer. The Auditor should also examine whether premium has been paid on the
policies and whether they are in force. Certificate regarding surrender value
obtained from the insurer should be examined. The auditor should particularly
see that if such surrender value is subject to payment of certain premia, the
amount of such premia has been deducted from the surrender value.
11.221 It should be verified whether policies are assignable in bank’s favour. In
certain types of policies where assignment to third party are restricted, due care
has to be taken while considering it as a security.
Bank’s Own Deposit Certificates
11.222 The Auditor should inspect such certificates and examine whether they
have been properly discharged and whether lien of the bank is noted on the face
of the certificates, in the relevant register of the bank and in CBS master data.
Hire-purchase Documents
11.223 These advances may be classified as secured against the
hypothecation of goods. Where there is no hypothecation, the advance will be
classified as unsecured.
Plantations
11.224 These advances are classified as secured against the crop and/or the
fixed assets (viz., mortgage of land) of the plantation. The auditor should
examine the agreement and the title deeds. Regarding the estimate of the crop,
he may examine the record of the garden for the last few years. He should also
ascertain whether the crop is properly insured against natural calamities and
other disasters such as hail, etc.
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11.225 The Auditor should keep in mind that where moratorium is available for
payment of interest in such plantation projects, the payment of interest becomes
due only after the moratorium or gestation period is over. In such a case the
account will become NPA in case interest is not recovered after the due date
after moratorium period, if specifically mentioned in the sanction letter.
Immovable Property
11.226 The Auditor should inspect title deeds, solicitor’s/advocate’s opinion
taken by the bank in respect thereof, and the mortgage deed. For valuation, he
may rely on the report of the architect or valuer (which should be taken at least
once in three years) after carrying out appropriate audit procedures to satisfy
himself about the adequacy of the work of the architect/valuer for this purpose5.
He should also examine the insurance policies.
11.227 In some cases, banks make advances against immovable properties
where the title deeds are not in the name of the borrower. For example, an
advance may be given against the security of a flat in a co-operative group
housing society, the title deeds of which may not be in the name of the borrower.
In such cases, the auditor should examine the evidence regarding the right or
interest of the borrower in the property mortgaged, e.g., power of attorney, share
certificate of co-operative group housing society, ‘no objection certificate’ from
the society/lessor (in the case of leasehold properties) for offering the property as
security, etc.
11.228 In case the bank has accepted third party property as a security, the
owner of the property should also execute guarantee bond in bank’s favour. The
mortgage value in bank’s favour should be equal/in excess of the loan amount
covered by such mortgage.
Reliance on / review of other reports
11.229 The auditor should take into account the adverse comments, if any, on
advances appearing in the following:
 Previous years audit reports.
 Latest internal inspection reports of bank officials.
 Reserve Bank’s latest inspection Report/Asset Quality Review/ Risk Based
Supervision report.
 Concurrent /internal audit report.
 Report on verification of security.
5 Reference may be made in this regard to SA 620, “Using the Work of an Auditor’s Expert”.
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 Any other internal reports specially related to particular accounts.

 Manager’s charge-handing-over report when incumbent is changed.
11.230 The above reports should be reviewed in detail. Statutory Central
Auditor’s(SCAs) must review the Annual Financial Inspection report of RBI
relating to the bank and should check whether variations in provisions, etc.,
reported by RBI have been properly considered by the bank management. SCAs
should consider the issues emerging from recent RBI inspections and obtain an
understanding of changes made by the banks pursuant to the inspection process
to enhance their identification of NPAs. Further audit procedures should be
suitably re-designed after considering such issues.
Third Party Guarantees
11.231 The Auditor should examine guarantee bonds and demand promissory
notes in order to verify the third party liability. The Auditor should satisfy that the
guarantee is in force as at the date of the balance sheet. In the absence of a
provision to the contrary, a guarantee terminates by revocation or upon death of
the surety. The surety is also discharged (unless there is a specific covenant to
the contrary) if the creditor arranges with the principal debtor for compromise, or
agrees to give time or agrees not to sue him, without consulting the surety. If any
variation is made in the terms of the contract between the principal debtor and
the creditor without the surety’s consent, it discharges the surety as to
transactions subsequent to the variation. The guarantee forms used by banks
normally seek to ensure the continuing obligation of the guarantor in spite of
these contingencies. If such clause is absent then the Auditor has to see if the
acknowledgement to debt from the borrower as well as guarantor is obtained by
the Bank.
Verification of Bills Purchased and Discounted
11.232 The Auditor should familiarise with the guidelines issued by RBI and the
policies framed by the bank regarding discounting and rediscounting of bills and
the Auditor should ascertain that the policy framed by the bank conforms to RBI
requirements.
11.233 Bills purchased and discounted have to be shown separately in the
balance sheet as part of ‘advances’. Further, under the head ‘advances outside
India’ in the balance sheet, bills purchased and discounted outside India have to
be shown separately. This category will include bills covering export of goods,
bills discounted by foreign branches of the bank and payable in their respective
countries, etc.
11.234 Banks purchase or discount bills of exchange drawn or endorsed by
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their customers. The bank credits the amount of the bill to its customer after
deducting the discount. The total amount of such bills is shown as an asset in the
balance sheet.
11.235 In certain eligible cases, the bills purchased or discounted by the bank
may be rediscounted by it with the RBI/IDBI/SIDBI. Such bills would not be
included under advance but would constitute a contingent liability.
11.236 Bills purchased and discounted by the bank are generally drawn on
outstation parties and are, therefore, sent by the bank to its branches or agents
for collection immediately after their receipt. They are generally not in the
possession of the bank on the closing date. The auditor therefore has to rely
upon the Register of Bills Purchased and Discounted and the party-wise Register
of Bills maintained by the bank. The auditor should examine these registers and
satisfy himself that:
(a) All outstanding bills have been taken in the balance sheet;
(b) All details, including nature of the bills and documents, are mentioned in the
register and that the bills have been correctly classified;
(c) Bills purchased or discounted from different parties are in accordance with
the agreements with them and total of outstanding bills of each party is not
in excess of the sanctioned limit; and
(d) Bills are not overdue. If there are any overdue bills, the Auditor should
ascertain the reasons for the delay and the action taken by the bank.
11.237 The Auditor should examine whether registers of bills purchased and
discounted are properly maintained and the transactions are recorded therein
correctly. He should examine whether bills and documents accompanying the
bills are properly endorsed and assigned in favour of the bank. In checking the
bills, it should be ensured that the bills are held along with the documents of title.
In case of documentary bills, it should be examined whether related RRs/TRs are
held along with the invoices/ hundies / bills and that these have not been parted
with. Wherever such RRs/TRs are not held on record, the fact should be duly
considered by the auditor and the Auditor should also examine the bills collected
subsequent to year-end to obtain assurance regarding completeness and validity
of recorded bill amounts.
Other Aspects
11.238 Sometimes, a customer is sanctioned a cash credit limit at one branch
but is authorised to utilise such overall limit at a number of other branches also,
for each of which a sub-limit is fixed. In such a case, the determination of status
of the account as NPA or otherwise should be determined at the limit-sanctioning
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branch with reference to the overall sanctioned limit/drawing power, and not by
each of the other branches where a sub-limit has been fixed. The Auditor of the
limit-sanctioning branch should examine whether it receives particulars of all
transactions in the account at sub-limit branches and whether status of the
account has been determined considering the total position of operation of the
account at all concerned branches. As far as sub-limit branches are concerned,
they should follow classification adopted by the limit-sanctioning branch.
11.239 The Auditor should examine that advances made by a banking
company otherwise than in the course of banking business, such as, prepaid
expenses, advance for purchase of assets, etc., are not included under
‘advances’ but is included under ‘other assets’.
11.240 The amount of advances in India and those outside India are to be
shown separately in the balance sheet. This classification will depend as to
where the advance was actually made and not where it has been utilised.
Generally speaking, figures of Indian branches will be shown as advances in
India and figures of foreign branches as advances outside India.
11.241 The Auditor should examine whether any loan has been granted in
violation of statutory limitations in section 20 of the Banking Regulations Act,
1949. If any such loan is granted the report will have to be drafted with suitable
qualifications, as the transaction is ultra vires.
11.242 It may also be examined whether the bank has a system of ensuring
end use of the funds granted compared with the purpose of sanction.
Drawing Power Consideration
11.243 Working capital borrower account, drawing power calculated from stock
statement older than 3 months has to be considered as “irregular” (overdue). If
such “irregular” account continues for 90 days, it has to be classified as NPA,
even though the account is otherwise operated regularly.
11.244 Stock statements, quarterly returns and other statements submitted by
the borrower to the bank should be scrutinized in detail.
11.245 The audited Annual Report submitted by the borrower should be
scrutinzed properly. Monthly stock statement of the month for which the audited
accounts are prepared and submitted should be compared and the reasons for
deviations, if any, should be ascertained.
11.246 It needs to be examined whether the drawing power is calculated as per
the extant guidelines formulated by the bank, which should also be in line with
RBI guidelines/directives. Special consideration should be given to proper
reporting of sundry creditors for purposes of calculating drawing power.
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11.247 Stock audit should be carried out by the bank for all accounts having
funded exposure over Rs.5 crores. The Auditors can also conduct or recommend
for conduct of stock audit in other cases if situation warrants the same. Branches
should obtain stock audit reports from lead bank or any other member, as
decided in consortium in cases where the Bank is not the leader of the
consortium of working capital. The report submitted by the stock auditors should
be reviewed during the course of the audit and special focus should be given to
the comments made by the stock auditors on valuation of security and
calculation of drawing power.
11.248 Drawing power needs to be verified carefully in case of working capital
advances to entities engaged in construction business. Valuation of work in
progress should be calculated properly and consistently. It should be examined
whether mobilization advance being received by the contractors is reduced while
calculating drawing power. In respect of certain businesses such as diamond
merchants and jewellers, the Auditor should exercise due caution while verifying
realisable value of precious metals, diamonds, jewellery etc. The Auditor may
also consider obtaining assistance of an expert in case circumstances so
warrant.
11.249 In case of consortium accounts, the drawing power calculation and
allocation is made by the Lead Bank and is binding on the Member Banks.
Lending under Consortium Arrangement / Multiple Banking Arrangements
11.250 In order to strengthen the information sharing system among banks in
respect of borrowers enjoying credit facilities from multiple banks, banks are
required to obtain regular certification by a professional, preferably a Company
Secretary, Chartered Accountant or Cost Accountant regarding compliance of
various statutory prescriptions that are in vogue, as per specimen given
in Annexure III (Part I and II), to RBI Circular No. DBOD.No. BP.BC.110/
08.12.001/ 2008-09 dated February 10, 2009 on “Lending under Consortium
Arrangement / Multiple Banking Arrangements” Read with Master Circular no.
RBI/2015-16/95 DBR.No.Dir.BC.10/13.03.00/2015-16 dated July 01, 2015 on
Loan and Advances – Statutory and Other Restrictions.
11.251 Accounts under consortium arrangements may, notwithstanding their
classification as Standard, due to servicing thereof, may nonetheless be
intrinsically weak or even be NPA in other participating bank(s), including on the
basis of the certificate/report as aforesaid. The Auditor should consider this
aspect and classify the account appropriately based on facts and circumstances,
particularly based on any serious adverse remarks/comments in the certificate
issued pursuant to the RBI circular.
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11.252 The Auditor should check compliance with RBI guidelines on unhedged
foreign currency exposure. Self-declaration from the client or Independent
auditors’ certificate of foreign currency exposure should be obtained by the Bank.
Such declaration/certificate can be cross checked with computation of standard
asset provisioning.
11.253 The bank should ensure that correct, sensitized and vetted data is duly
and timely captured so that analytics could be run intelligently through the
system to make data predictions to generate foresights on trends, patterns that
show incipient sickness. Pro-active monitoring of the Early Warning Signals
(EWS) as per Annex II of RBI Master Direction No. RBI/DBS/2016-17/28
DBS.CO.CFMC.BC.No.1/23.04.001/2016-17 dated July 01, 2016 (Updated as on
July 03, 2017) on Fraud – Classification and Reporting by commercial bank and
select FIs should be ensured. These (EWS) should be used as indicators for Red
Flagged accounts (RFA). The Auditors should comment on the prevalence of the
(EWS) - (RFA) system and its operational efficiency and effectiveness.
11.254 The Auditors should comment on the frequency and periodicity of
trainings given to Branch officials on knowledge and skill up-gradation especially
on usage of technology and other advanced developments on appraisal, risk,
controls and gap mitigation loan and cyber frauds.
Non fund based facilities
11.255 Non-fund based facilities are letters of credit, bank guarantees, letter
of comfort/undertaking, etc. Non-fund based facility may turn into a fund based
facility on due date, if not paid by the borrower, for e.g. devolvement of bills
under Letters of Credit, invocation of Bank Guarantee, etc. As on the date of a
sanction and original booking they do not involve an outflow of funds.
11.256 Letter of credit: A Letter of Credit (LC) is a promise by a banker to
honour the payments to be made by its customer (the buyer or importer) to the
seller or exporter. This type of payment facility is generally used in international
trade. In this type of facility, at the request of the buyer, his banker opens an LC,
which is sent to the seller. Based on such LC, the seller despatches the goods
and then sends the bills and other documents through his banker to the buyer’s
banker, which has opened the LC, to make payment of the bill. The buyer then
makes the payment and routes it through his banker to the seller’s banker. In
case, the buyer fails to make the payment (also known as devolvement of LC),
the buyer’s banker which has opened the LC is liable to make the payment to the
seller. RBI has mandated banks not to discount bills drawn under LCs or
otherwise for beneficiaries, who are not their regular clients.
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11.257 Bank Guarantee: A bank guarantee is a written contract given by a

bank on behalf of customer. By issuing this guarantee, a bank takes
responsibility for payment of a sum of money in case, it is not paid by the
customer on whose behalf the guarantee has been issued. In return, a bank
gets some commission for issuing the guarantee. Anyone can apply for a bank
guarantee, if his or her company has obligations towards a third party for which
funds needs to be blocked in order to guarantee that his or her company fulfils
its obligation (For example carrying out certain works, payment of debt, etc.) In
case of any changes or cancellation during the transaction process, bank
guarantee remains valid until the customer duly releases bank from its liability.
In the situations where customer fails to pay the money, bank must may the
amount within 3 working days. This payment can also be refused by bank if
claim is found unlawful. Guarantees are of two types—financial guarantee,
wherein the guarantor (the bank) promises to pay the stated amount to the
beneficiary, if the person for whom the guarantee is given, fails to pay the same
(also referred to as invoking the guarantee); performance guarantee, wherein the
guarantor promises to pay the beneficiary a stated sum of amount, if the person
for whom the guarantee is given, fails to perform, as expected, in a given period
of time. Banks are generally discouraged from issuing performance guarantees.
Guarantee transaction usually comprises two independent but related
components— one is the guarantee issued by the banker (of the buyer) to the
beneficiary (i.e., seller) and the other is a counter guarantee given by the buyer
to his banker, who has issued the guarantee.
11.258 Generally, guarantees should not be issued on behalf of customers,
who do not enjoy credit facilities with the bank. Since guarantees invoked could
get converted into funded advance to a borrower, banks should not encourage
borrowers to over extend their commitments solely on the basis of guarantees.
Guarantees could be for specific transaction (called specific guarantee) or it
could be for multiple transactions within a specific time frame (called continuing
guarantees). Guarantees should generally be for short durations; in any case, is
should not have a maturity period of more than 10 years. Unsecured Guarantees
to a particular borrower should generally not exceed 10% of the total exposure.
Banks should also not concentrate its unsecured guarantees to a particular
borrower or a group. The Ghosh Committee has recommended certain
precautions to be taken by banks while issuing guarantees. Guarantees are
generally issued by keeping margins, either in the form of cash/term deposit or
some other security. In case of guarantees issued on behalf of share and stock
brokers, the RBI has advised that banks should obtain a minimum margin of 50%
(with 25% being cash margin). RBI has laid restrictions on guarantees of inter-
company deposits/loans and inter institutional guarantees. In the above
mentioned circular, the RBI has also given extensive guidelines on issue of
guarantees on behalf of exporters and importers.
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11.259 Co-Acceptance of Bills: In this type of facility, the seller despatches the
goods and raises the bill on the buyer. The buyer accepts the bill and then it is
co-accepted by buyer’s banker. The seller’s banker then discounts this bill. This
type of facility is 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.
11.260 Non fund based facilities are recorded in the Books of accounts as a
contra item appearing on both sides of the Trial Balance. In the balance sheet
they appear under the prescribed schedule.
11.261 The Auditor should ensure that:
1) There is a proper procedure for sanctioning non fund based facilities and
these facilities are duly monitored and are within the sanctioned limits. Any
outstanding beyond sanctioned amount is a deviation and should be
promptly reported.
Banks do not issue these facilities especially Guarantees for walk-in
customers even with 100% cash margins. Necessary KYC checks and a
due sanction should be in place for issuance of these facilities.
2) There is a proper procedure for recording these amounts in the books of
accounts through serial numbers or other appropriate methods.
3) Necessary margins as prescribed in the sanction letter have been duly
collected. These margins are duly lien marked and not allowed to be
withdrawn during pendency of the facility.
4) They have been issued in the prescribed standard format. Care should be
taken to note the formats for issuance of Letters of Comfort / Undertaking.
5) They have been issued under proper authority. Banks have a schedule of
powers for sanction of various facilities and it should be noted that these
facilities are sanctioned under proper delegated authority levels.
6) They have been duly disclosed in the financials under appropriate
prescribed heads in the prescribed manner. Some Banks disclose these
facilities as Net of margins while some disclose this at Gross. The Auditor
should ensure that whatever practice is followed by banks is consistent as
per their policy and is duly disclosed in the financial statements.
7) The bank has proper policies, procedures, manuals which could also be a
part of their credit manual that describes in detail how these facilities are to
be sanctioned, disbursed, documented, monitored, accounted and
cancelled. The auditor should ensure due compliance with these policies,
procedures and manuals.
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8) If these facilities are devolved / invoked, then they would be funded

advances. Appropriate removal from “non fund based advances” should be
done to avoid duplicate disclosure as both funded and non funded
advances.
9) The underlying documents should be kept under proper control and
custody.
10) Where a number of guarantees / Letters of credit issued have been
invoked/ devolved, the auditor would have to consider the probability of
invocation / devolvement of the guarantees / letters of credit on their due
dates and consider making appropriate provisioning thereon as of current
date.
11) On expiry of their term and if no letter of invocation / devolvement has been
received and if the original Guarantee has been received back, there would
be no liability due on these Guarantees / Letters of credit, these would have
to be removed from the books of account.
Different banks have different practices in this regard especially for
Guarantees. In case of Guarantees some Banks wait for receipt of the
original guarantee back from the issuer before cancelling the liability from
the books .In such cases the auditor should also note whether there is a
timely system of sending letters to the issuers asking for return of the
original guarantees immediately post the expiry date.
11.262 For Guarantees issued to Governments, specific rules apply and the
Auditor should ensure that these are followed.
1) The Auditor should ensure proper classification of guarantees in to
performance or financial as they carry separate risk weights.
2) The Auditor should note that the RBI has issued Master Circular No.
RBI/2015-16/76 DBR.No.Dir.BC.11/ 13.03.00/2015-16 dated July 01, 2015
on Guaranteed and Co-acceptances. RBI also keeps on issuing guidelines/
circulars from time to time, which should be noted for compliance. RBI vide
circular no. RBI/2017-18/139 A. P. (DIR Series) circular no. 20 dated March
13, 2018 on “Discontinuance of Letters of Undertaking (LoUs) and Letters
of Comfort (LoCs) for Trade Credits” has also advised the AD Category-I
banks to discontinue the practice of issuance of LoUs / LoCs for Trade
Credits for imports into India with immediate effect.
3) Non fund based advances are prone to frauds as can be seen in recent
times and due care needs to be taken while verifying these facilities.
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4) These facilities are duly reviewed and renewed as per procedures

prescribed in the same manner and alongside funded advances.
5) Care should be taken to ensure that the bank does not issue letters on
behalf of their customers to 3rd parties which are in the form of a Comfort /
Undertaking and may need classification as a non fund based Liability.
Necessary procedures framed by the bank in this regard should be verified
including the awareness, training and sensitization thereof.
6) The internal controls designed and in operation over the process from start
to end from the sanction to the cancellation should be verified in depth on a
standalone basis. Any gaps noted in the control process should be
promptly reported.
Since these are specialized operational areas, Staff with necessary,
relevant experience with training are only posted to handle Guarantee /
Letters of Credit transactions. Controls over job rotations and mandatory
leaves to these staff should be verified and reported.
7) The LFAR contains specific questions needing reporting on non fund based
facilities. The auditor should note the requirements of the LFAR while
planning and conducting the audit.
8) Non fund based facilities should be duly considered for all reporting and
calculation purposes as prescribed in appropriate guidelines.
9) These facilities earn a fee based income for Banks. Banks have different
methods for booking fee based income especially in case of Guarantees.
Some do it up-front either monthly or quarterly. The Auditor should ensure
there is consistency in the methodology followed for booking of income in
accordance with prescribed policy at prescribed rates.
Banks should also ensure to collect processing fees on sanction, review
and renewal of these facilities at prescribed rates.
10) There may be cases where the main non funded limit may be sanctioned at
one branch and sub limits may be sanctioned at another branch. In such
cases, appropriate monitoring should be done in the same manner as is
done for sanctioned advances in similar situations.
For consortium accounts, monitoring and follow-up including obtaining of
relevant information would be the same as would be done in the case of a
funded facility.
11) In some Banks especially Foreign Banks, non fund based facilities
constitute a significant portion of their book size and at times even exceed
their funded facilities.
383
12) Forward Contracts, Swaps – Currency or Interest Rate are also non fund
based facilities which are also duly sanctioned, monitored, disclosed and
transacted as per policies and guidelines. Necessary details therein have
been disclosed in appropriate section of this Guidance Note.
Selection of accounts
11.263 The Auditor should obtain a list or breakup of all advance accounts as
at the yearend. This should be obtained facility wise – security wise – sanction
date and amount wise. In accordance with RBI guidelines contained in the LFAR,
the Auditor has to mandatorily comment on all advances in respect of which the
outstanding amount is in excess of 10% of outstanding aggregate balance of
fund based and non-fund based advances of the branch or Rs.10 crores,
whichever is less. Apart from these accounts mandatorily to be considered for
reporting, the auditor should also select advance accounts for each type – Each
of Unsecured, Educational. Housing, Vehicle, Personal, Loan against FD, Loan
against Shares, Loan against property, Loans granted against other securities.
Besides loans accounts cash credit accounts, overdraft against property, bills
discounting / purchase accounts should be selected for verification a mix of both
- new sanctions in the current year 2020-2021 and sanctions of previous years.
The sampling should be based on the Standards on Auditing (SA) 530, Audit
Sampling issued by the ICAI.
11.264 All the accounts falling within the threshold should be scrutinized in
depth end to end keeping in mind the reporting requirements of the LFAR.
Selection has to be done in a manner that each distinct and unique type of credit
facility is verified and reported. Adverse issues noted on verification to be
discussed with the Branch, Branch responses obtained and appropriate reporting
to be made in the LFAR.
11.265 The format of reporting for advances below Rs.10 Crores is not
specified. The auditor may report the same in the format he feels appropriate
ensuring that adverse issues noted are brought out for corrective action. It should
be noted that finding gaps in process is the key. The transactional errors noted is
the outcome of a weakness in the process and the process will need
strengthening to ensure that such transactional errors are minimized if not
zeroed.
11.266 The LFAR specifies the format (given below) in which the auditor has to
obtain data from the Branch for large advances. The compilation has to be done
by the Branch. The Auditor has to review on a test check basis whether the data
keyed into the system is correct.
384
11.267 While giving his observations, the Auditor has not only to go through all
the points filled in by the Branch but also through all the loan correspondence
files of the borrower. The process of appraisal, sanction, disbursement,
documentation, monitoring, review or renewal, follow-up, classification as SMA-
NPA will have to be independently verified for such accounts. Audit comments
should not be simply based on the data submitted by the Branch. Independent
verification and assessment is essential.
11.268 The Long Form Audit Report (LFAR) for Large / Irregular / Critical
Advance Accounts (To be obtained by the Branch Auditors from branches
dealing in large advances/asset recovery branches) is as under –
Sr. Items / Particulars Details
No.
1. Name of the Borrower
2. Address
3. Nature of business/activity
4. Total exposure of the branch to the
borrower
(a) Fund Based (Rs. in crore)
(b) Non-Fund Based (Rs. in crore)
5. Name of Proprietor / Partners / Directors
(As Applicable)
6. Name of the Chief Executive, if any
7. Asset Classification by the branch
(a) as on the date of current audit
(b) as on the date of previous Balance
Sheet
8. Asset Classification by the branch auditor
(a) as on the date of current audit
(b) as on the date of previous Balance
Sheet
9. Are there any adverse features pointed
out in relation to asset classification by
RBI inspection or any other audit
10. Date on which the asset was first
classified as NPA (where applicable)
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11. Facilities sanctioned

Date of Nature of Limit Prime Collateral Margin Balance
Sanction facilities (Rs. in Security Security % outstanding at the
crore) year-end
Current Previous
Year Year

No.
12. Whether the facility is a consortium facility or
a facility made on multiple bank basis
13. If Consortium-
(a) names of participating banks with their
respective shares
(b) name of the Lead Bank in Consortium
14. If on multiple banking basis, names of other
Banks
15. Has the branch classified the facility under
the Credit Rating norms in accordance with
the guidelines of the controlling authorities of
the bank
16. (a) Details of verification of primary
security and evidence thereof
(b) Details of valuation and evidence

thereof
Date of Nature of Security Value Valuation done by

Verification
Insured for Rs. (expiring on )

No.
17. (a) Details of verification of collateral security
and evidence thereof
386
(b) Details of valuation and evidence thereof

18. Give details of the Guarantee in respect of the
facility
(a) Central Government Guarantee
(b) State Government Guarantee
(c) Bank Guarantee or Financial Institution
Guarantee
(d) Corporate / Personal / Other Guarantee
Provide the date, validity and value of the

above Guarantees.
19. Compliance with the terms and conditions of
the sanction
Terms and Conditions Compliance

(i) Primary Security
a) Charge on primary security
b) Mortgage of fixed assets
c) Registration of charges with Registrar of
Companies
d) Insurance with date of validity of Policy
(ii) Collateral Security
a) Charge on collateral security
b) Mortgage of fixed assets
c) Registration of charges with Registrar of
Companies
d) Insurance with date of validity of Policy
(iii) Guarantees - Existence and execution of valid
Guarantees.
387
(iv) Asset coverage to the branch based upon the

arrangement (i.e., consortium or multiple-bank
basis)
(v) Others
(a) Submission of Stock Statements /
Quarterly Information Statements and
other Information Statements
(b) Last inspection of the unit by the branch
officials: Give the date and details of
errors/omissions noticed
(c) In case of consortium advances, whether
copies of documents executed by the
company favouring the consortium are
available
(d) Any other area of non-compliance with the
terms and conditions of sanction
20. Key financial indicators of the borrower for the last
two years and projections for the current year
Indicators Audited Audited Projections

Year ended Year ended for Current
31st March 31st March Year
Turnover
Increase in turnover % over
previous year
Profit before depreciation, interest
and tax
Less: Interest
Net Cash Profit before tax
Less: Depreciation
Less: Tax
Net Profit after Depreciation and
Tax
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Net Profit to Turnover Ratio

Capital (Paid-up)
Reserves
Net Worth
Turnover to Capital Employed Ratio
(The term capital employed means
the sum of Net Worth and Long
Term Liabilities)
Current Ratio
Stock Turnover Ratio
Total Outstanding Liabilities / total
Net Worth Ratio
In case of listed companies, market
value of Share?
(a) High
(b) Low
(c) Closing
Earnings Per Share
Whether the accounts were
audited? If yes, up to what date; and
are there any audit Qualifications
21. Observations on the operations in

the account
Particulars Excess over Excess over limit

drawing power
1. No of occasions on which
the balance exceeded the
drawing power/sanctioned
limit (give details)
Reasons for excess
drawings, if any
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Whether excess drawing

were reported to the
Controlling Authority and
approved
Debit Summation (Rs. Credit Summation
in crore) (Rs. in crore)
2. Total summation in the
account during the year
Less : Interest Balance

No.
22. Adverse observations in other audit reports /
Inspection Reports / Concurrent Auditor's
Report / Stock Audit Report / Special Audit
Report or RBI inspection with regard to :
(a) Documentation
(b) Operations
(c) Security/Guarantee
(d) Others
23. Branch Manager's overview of the account
and its operations
24. (a) In case the borrower has been identified /
classified as NPA during the year, whether any
unrealised income including income accrued in
the previous year has been accounted as
income, contrary to the income recognition
norms.
(b) Whether any action has been initiated
towards recovery in respect of accounts
identified / classified as NPA.
11. 269 An Illustrative list for Basis of Selection of Advance Accounts in case of
Bank Branch Audit is given as Annexure to this Chapter.
390
Bank Branch Audit

Procedure for Sanction, Documentation, Disbursement,
and Supervision
11.270 Each bank has its own procedures for sanctioning, disbursal,
documentation, supervision and renewal of advances. The procedures are
stated in the Credit policy which is generally updated at annual intervals. The
auditor should obtain the last updated credit policy and circulars issued post
the credit policy. The Auditor should ensure that the credit policy is in sync with
RBI Master Circulars especially the one on “Loan and Advances – Statutory
and Other Restrictions”.
Sanction
Loan Application
11.271 Initiation of process of sanction of advance is on receipt of a formal
request from the applicant. The request may be in the form of a standard
format (Loan Application Form) of the bank or in the form of a letter in which
case the Bank requests the intending borrower to furnish the standard format
duly filled in. All applications are entered in a “loan applications received
register” (the exact nomenclature may vary from bank to bank). The required
supporting documents are to be furnished along with the application. The Bank
should ensure that the documents are obtained from respective borrowers as
per the Loan policy of the Bank.
Credit Appraisal
11.272 The proposal is evaluated in the context of the directions of the RBI
including prudential exposure limits and the bank’s own credit policy and risk
management guidelines. The primary purpose is to ascertain the cash flows
and the repayment capacity of the borrower to repay the loan within the
stipulated timelines that would be prescribed. The proposal is mainly appraised
to find the Default Risk or the possibility of the borrower not repaying the loan
amount that would be sanctioned or disbursed, either in full or in part. This
process entails conducting a detailed SWOT – (Strengths – Weakness –
Opportunity Threat) analysis of the borrower. Besides, the proposal is
appraised on the following parameters to ensure technical feasibility, economic
viability and commercial acceptability (the degree of scrutiny depends largely
on the amount of the advance):
 Performance of the unit vis-a-vis other similar units.
 Conduct of its accounts with the lenders.
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 Experience, competence and profile of the management of the unit.

 Guarantees and collateral securities offered.
 Trend and ratio analysis to see that the unit’s growth is healthy, financials
are sound, liquidity is comfortable and the promoters have a reasonable
stake in the unit.
 Availability of inputs for production – right time and price.
 Market condition – fast changing tastes and preferences.
 Technology in use – factoring in obsolescence in technology.
 Unit’s capability to achieve the projected operating and performance levels
and to service the debt.
 Applicability of norms/benchmarks relating to scale of finance, e.g., Nayak
Committee recommendations for SSI units, scale of finance fixed by the
bank for agricultural finance to be extended in the local area, etc.
 CIBIL, RBI List of defaulter, Credit and confidential reports from other
banks. These are to be checked from respective websites.
 Various disclosure/notices issued by the government/government
authorities such as with regard to shell companies, defunct companies,
directors of these types of companies, etc.
 Latest Government Policy about particular industry / locational restriction,
etc.
 In the current complex scenario both internally and externally – VUCA
world as some describe it for an environment characterized by Volatility,
Uncertainty, Complexity and Ambiguity, assessment of cash flows over
longer term period is a challenge. The auditor should exercise greater
diligence while reviewing the appraisal process for such long tenor
advances.
 Diligence will be higher if the units are resorting to funding for the first time
ever or with the bank. In case of existing facilities for renewal – review,
there is a past performance or availability of data to base credit decisions.
For new units, validating the projections or estimated will need deeper
scrutiny.
 Banks generally have a Turn Around Time (TAT) for disposing off loan
applications – i.e. the time from receipt of Loan application to its rejection
or sanction. Causes for rejection also have to be noted in a Loan Rejection
Register or similarly named Register, The cases of appraisals have to be
within TAT. Deviations from TAT are monitored for process efficiency.
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Sanctioning Authority
11.273 If the official concerned finds the proposal acceptable, a detailed
appraisal note is submitted along with necessary supporting documents with
recommendations to the authority having powers to sanction it. Each official
who has been vested with powers to sanction advances has a monetary ceiling
up to which he/she can sanction advances to the specified kind of borrowers
(like individuals, partnerships, companies, etc.) and/or for the specified
activities (like agriculture, industry, professional education, business, etc.) and
/ or for the type of facility (term loan, overdraft, cash credit, etc.). Such powers
are properly documented and circulated by the bank to all its offices by way of
delegation of powers. The officials at the branch can sanction only those
advances, which fall within their delegated powers. For advances, which
require to be sanctioned by higher authorities, the branch has to carry out the
appraisal and send the proposal along with its recommendations to its
controlling office for necessary sanction. As and when the advance is
sanctioned by the competent authority (which could be an official, a committee
of officials or the Board of Directors of the bank, depending on the amount
involved), the fact of sanction along with detailed terms and conditions of the
sanction are communicated by the controlling office to the branch.
11.274 The auditor should ensure that all issues noted in the credit appraisal
process have been duly factored while preparing the Sanction Note and the
sanction letter and no significant issue is missed out. Clarifications on any
issues noted in the appraisal process should be duly documented. The Auditor
has to ensure that the sanctioning is done within the powers of the competent
authority. Any deviation noted will have to be reported appropriately.
11.275 Processing fees as applicable should be collected as per the bank’s
policy before the disbursement. Banks have a practice of debiting Cash Credit
accounts for processing fees. While this is in order for existing accounts, for
new facilities sanctioned, the same should be collected separately up-front
rather than being a part of disbursement.
Documentation and Disbursement
11.276 After the sanction of the advance, the branch communicates the terms
and conditions of the sanction to the applicant and obtains its consent for the
arrangement. Thereafter, the documents as prescribed by the bank are
obtained, charges created and, the bank’s charge over the unit’s assets noted
with the authorities concerned, e.g., Registrar of Companies, Road Transport
Authority, Insurance Company, Land Records Authority, CERSAI, etc. In the
case of an advance to a partnership firm, while the account is opened in the
trade name of the firm, the security documents are got executed from the
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partners in both their individual capacity (i.e., without mentioning the name of
the firm or affixing the stamp of the firm) and in their capacity as partners of the
firm. This is to ensure that the advance may be recovered from the assets of
the firm as well as from the individual assets of the partners. The bank
generally records the sanction details and stipulation in the system. In many
cases, the system is updated for pre-sanction, pre-disbursement documents
for each loan. The document discrepancy report then acts as a check for
documents received and pending for monitoring purposes.
11.277 After the above formalities have been completed, the advance is
released in the following manner:
 Term loans (granted generally for acquisition of fixed assets, etc.) are
disbursed on the basis of quotations/ proforma invoices obtained by the
borrower from the vendors and submitted to the bank either along with the
application or later. In case of large projects, the schedule and status of
completion of projects have also to be seen. Banks generally stipulate a
stated percentage of the cost to be met by the borrower from his own
funds. Once the borrower provides his contribution to the bank, the branch
debits the Term Loan account with the balance amount and pays the
amount to the vendor directly along with a letter stating the purpose of the
funds. The term loan may be released in one or more instalments. As and
when the asset is received by the borrower, the bank officials inspect it,
record the particulars in their books, and obtain copies of the final invoices
for their record from the borrower.
 There may be instances where, on business considerations, the borrower
has already acquired the asset. In such a case, he submits the
documentary evidence to the branch and seeks reimbursement to the
extent permissible. The branch officials inspect the asset and verify the
books of account of the borrower and, if satisfied, credit the eligible
amount to the borrower’s account (current / cash credit, as desired by the
borrower) by debiting his term loan account.
 Cash credit advances are released on the basis of drawing power
calculated as per the stock statements submitted by the borrower as per
the periodicity laid down in the terms of sanction. The branch officials
verify the stock statements and calculate the ‘drawing power’ based on the
security held by the borrower and the margin prescribed in the sanction. In
case of consortium accounts, the drawing power calculation and allocation
is made by the Lead Bank and is binding on the Member Banks (Circular
No. C&I/Circular/2014-15/689 dated 29 September 2014 issued by the
Indian Banks Association). This ‘drawing power’ is noted in the system in
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respect of Cash Credit accounts and is a guide to the official concerned

while authorising debits to the account.
 The procedures of many banks require the branch manager to periodically
submit a certificate to the controlling authority (i.e., regional or zonal office)
that all disbursements during the relevant period have been made only
after completion of the necessary formalities.
 Banks also require submission of End-Use certificates from Chartered
Accountants. Some banks have a format in which the same is to be
issued. It should be ensured that certificates are issued in the prescribed
format. In all other cases, it should be ensured that the certificate is as per
the requirements of the ICAI guidelines on special purpose certification.
 Central Registry of Securitisation Asset Reconstruction and Security
Interest of India (CERSAI) - The Auditor needs to keep abreast of the
mandatory requirements related to registration of mortgages and
compliance thereof by the lender bank, as applicable to the various forms
of securities offered as security for the advances.
 The Auditor has to ensure that all sanction terms and conditions have
been complied with. Pending sanction terms should be waived off by the
appropriate sanctioning authority or a time frame, post disbursal for their
obtention, be approved. In no case, the disbursal should take place
without a formally approved waiver.
 Banks should maintain an updated tracker of all sanction terms still not
complied with. If the due dates for their obtention are breached, causes for
the same should be noted for closure.
Monitoring and Supervision
11.278 The primary purpose of monitoring and supervision is to ensure that
there is no diversion or siphoning of funds. Any adverse features have to be pro-
actively tracked using technology to the fullest. Annex II of RBI Master Direction
No. RBI/DBS/2016-17/28 DBS.CO.CFMC.BC.No.1/23.04.001/2016-17 dated
July 01, 2016 (Updated as on July 03, 2017) on “Fraud – Classification and
Reporting by commercial bank and select FIs” gives indicators for Early Warning
Signals (EWS) which have to be followed up for possible Red Flagging.
11.279 Banks have to ensure that EWS are tacked through system, pro-actively
so that early signs of liquidity problems are known and followed up with the
borrower for possible re-structuring or rehabilitation to preserve the economic
value of the account and avoid it to slip into a NPA.
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11.280 The following are the procedures usually adopted by banks for
monitoring and supervision of advances after disbursement:
 Regular inspection of the borrower’s assets and books. The main
purposes of inspection are as follows:
o To ensure that the amounts disbursed have been utilised for purposes
for which the advance was sought.
o To check that the borrower has not acquired / disposed of any asset
without the consent / knowledge of the bank, depending upon the
terms of the advance. Acquisition of fixed assets from working capital
funds may amount to diversion of short-term funds which, from the
viewpoint of the bankers, is not a sign of financial prudence.
o To cross-check the figures declared in the stock statements with the
books maintained by the borrower (including excise and other
statutory records, as applicable) as well as to physically verify the
stock items, to the extent possible.
o To check that the unit has been working on projected levels
particularly in the areas of sales and production and the general
working of the unit is satisfactory.
o To ensure that the borrower has not availed of finance against stocks
for which it has itself not made the payment.
o To ensure that the borrower has not availed of unauthorised finance
from any other lender.
o To ensure that the borrower has not defaulted on payment of
Statutory Liabilities.
o To ensure that the borrower has not made any investment in, or
advances to, its associates without the bank’s approval, if such
approval is required as per the terms of the loan or otherwise diverted
the funds.
o To check that there is a regular turnover of stocks and the unit does
not carry any obsolete, unusable stocks. Generally, banks place a
limit on the age of stocks which are eligible for bank finance; the items
older than such limit are not financed. Similarly, in the case of book
debts, debts outstanding beyond a specified period are also not
eligible for bank finance. Also to check sundry creditors for goods.
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o To ensure that the borrower continues to be engaged in the activity for

which the loan has been granted.
 Periodic review of the progress in implementation of the project (to note
whether project timelines given at the time of processing loan are being
adhered to. If there are delays, it may hamper the project completion and
may affect servicing of loan). Generally, in large and complex projects,
banks appoint lead engineering agency to who provide the status of the
project periodically.
 Review of the conduct of the account.
 Obtaining and scrutinising stock statements.
 Obtaining other relevant financial data periodically and analysis of the
data. Banks obtain information at monthly / quarterly / half yearly / yearly
intervals about on the levels of sales, production, profit, cash accruals,
break up of assets and liabilities, cash flows etc. The analysis covers the
following points:
o Comparison of the data with the projections contained in the appraisal
note to find out the deviations, the reasons thereof, and the corrective
action to be taken, wherever necessary.
o Comparison of the unit’s performance, on an on-going basis, with
other similar units.
o Ratio analysis based on the provisional data submitted by the unit to
find out the liquidity and solvency position and any diversion of short-
term resources towards long term uses.
o Observing the credits to the account.
 Whenever the above analysis indicates weaknesses in operations, or the
need for additional documentation or security, a dialogue is held with the
borrower, with consequent follow-up.
11.281 RBI, vide its circular no. DBS.CO.PPD.BC.No. 5 /11.01.005/2010-11
dated January 14, 2011 on “End Use of Funds - Monitoring”, has advised banks
to evaluate and strengthen the efficacy of the existing machinery in the banks for
post-sanction inspection by the bank officers, supervision and follow-up of
advances. There needs to be a proper process of stock audit of the borrowers.
Effective monitoring of the end use of funds lent is of critical importance in
safeguarding a bank’s interest. Further, this would also act as a deterrent for
borrowers to misuse the credit facilities sanctioned, and in the process, help
build a healthy credit culture in the Indian banking system.
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Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair
recovery of lenders – Framework for revitalisation of distressed assets
11.282 The RBI has issued guidelines for classification of standard assets
into three sub-categories, viz., SMA-0, SMA-1 and SMA2 in order to recognise
the financial distress in any performing asset at an early stage, besides
regulatory compliances like forming of Joint Lender’s Forum, reporting to
CRILC, etc. for specified categories of Special Mention Accounts (SMA). In
case the bank does not follow the said regulatory compliances, such accounts
are subjected to accelerated provisions.
LFAR in respect of Advances for Bank Branches
11.283 Vide its circular no. DOS.CO.PPG./SEC.01/11.01.005/2020-21 dated 5th
September 2020, the RBI has come up with a revised LFAR applicable for audits
of F.Y. 2020-2021 and onwards. Various new clauses have been included for
reporting by the auditors. Annex II of the said circular deals with the LFAR for
bank branches. The auditor should refer to the Technical Guide on Revised
Formats of Long Form Audit Report for clause by clause analysis of the same.
RBI Guidelines on Income Recognition, Asset
Classification, Provisioning and Other Related Matters
11.284 In its report submitted in 1992, the Committee on Financial System set
up by the RBI under the Chairmanship of Mr. M. Narasimham made several
recommendations concerning accounts of banks. The Committee
recommended that a policy of income recognition should be objective and
based on record of recovery rather than on any subjective considerations.
Likewise, the classification of assets should be done on the basis of objective
criteria which would ensure a uniform and consistent application of norms. As
regards provisioning, the Committee recommended that provisions should be
made on the basis of classification of assets under different categories. Vide its
Circular No. BP.BC.129/21.04.043-92 dated April 27, 1992, the Reserve Bank
issued guidelines to be followed by all scheduled commercial banks (excluding
regional rural banks) for income recognition, asset classification, provisioning
and other related matters. These guidelines (commonly referred to as
‘prudential guidelines’ or ‘prudential norms’) have since been modified in
several respects through various circulars of the Reserve Bank. The latest
Master Circular No. RBI/2015-16/101DBR.No.BP.BC.2/21.04.048/2015-16 was
issued on July 1, 2015 on ‘Prudential Norms on Income Recognition, Asset
Classification and Provisioning Pertaining to Advances”. The salient points of
the guidelines as presently in force are discussed in the following paragraphs.
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Regulatory Guidelines vis-a-vis Audit Approach and

Reporting
A. Has the branch identified and classified advances into standard/
substandard/doubtful/loss assets through the computer system without
manual intervention (in line with the norms prescribed by the Reserve
Bank of India) (The auditor may refer to the relevant H.O. instructions for
identification of NPAs and Classification of Advances).
The auditor needs to review and comment as to whether such
identification & classification through the computer system, without
manual intervention?
Relevant Provision
11.285 The guidelines require banks to classify their advances into four broad
categories for the purpose of provisioning as follows:
(a) Standard assets:
A standard asset is one which is not a non-performing asset and does not carry
more than normal banking risk attached to the business.
As per RBI Circular RBI/2018-19/ 203 DBR.No.BP.BC.45/21.04.048/2018-19
dated June 7, 2019 on Prudential Framework for Resolution of Stressed
Assets, the banks shall recognise incipient stress in loan accounts,
immediately on default, by classifying such assets as special mention accounts
(SMA) as per the following categories:
SMA Basis of Classification
Sub-categories Principal or Interest payment or any other amount wholly
or partly overdue between
SMA-0 1-30 days
SMA-1 31-60 days
SMA-2 61-90 days
In the case of revolving credit facilities like cash credit, the SMA sub-categories
will be as follows:
Sub-categories Outstanding balance remains continuously in excess of
the sanctioned limit or drawing power, whichever is
lower, for a period of
SMA-1 31-60 days
SMA-2 61-90 days
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Lenders shall report credit information, including classification of an account as

SMA to Central Repository of Information on Large Credits (CRILC), on all
borrowers having aggregate exposure of Rs. 50 Millions (5 Crores) and above
with them on monthly basis. Further the lenders shall submit a weekly report
on instances of defaults of all borrowers having aggregate exposure of Rs. 50
Millions (5 Crores) and above on close of business on every Friday.
Such classification also serves to be useful for bank officers monitoring as well
as audit perspective to check the transactions and methods of keeping these
standard at the balance sheet date
(b) Sub-standard assets:
A sub-standard asset is one which has remained NPA for a period less than or
equal to 12 months. Such an asset will have well defined credit weaknesses that
jeopardize the liquidation of the debt and are characterized by the distinct
possibility that the banks will sustain some loss, if deficiencies are not corrected.
(c) Doubtful assets:
An asset is classified as doubtful if it has remained in the sub-standard category
for a period of 12 months. Such an asset has all the inherent weaknesses as in a
substandard asset and an added characteristic that the weaknesses make the
collection or liquidation in full highly improbable or questionable.
(d) Loss assets:
A loss asset is one which has been identified as wholly irrecoverable either by:
(a) the bank; or
(b) the internal or external auditors; or
(c) the RBI inspectors.
but the amount has not been written off wholly. In other words, such an asset is
considered uncollectible and of such little value that its continuance as a
bankable asset is not warranted although there may be some salvage or
recovery value.
Classification Norms relating to NPAs
Criteria for Classification of Various Types of Credit Facilities
11.286 A Cash Credit / Overdraft account should be treated as 'out of order' if
the outstanding balance remains continuously in excess of the sanctioned
limit/drawing power. In cases where the outstanding balance in the principal
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operating account is less than the sanctioned limit/drawing power, but there are
no credits continuously for 90 days as on the date of Balance Sheet or credits
are not enough to cover the interest debited during the same period, these
accounts should also be treated as 'out of order'. Further, any amount due to the
bank under any credit facility is ‘overdue’ if it is not paid on the due date fixed by
the bank.
11.287 The following criteria are to be applied for determining the status of
various types of credit facilities:
(a) Term Loans: A term loan is treated as a non-performing asset (NPA) if
interest and/or instalment of principal remain overdue for a period of more
than 90 days. Thus, in case of term loans wherein there is no amount
overdue (i.e., the ledger balance is less than ideal drawing power), such
accounts will not be marked as NPA as the criteria for marking a Term Loan
account as NPA is not based on the concept of servicing of interest but is
based on the overdue concept. However, as per Para 2.1.3 of Master
Circular No. RBI/2015-16/101DBR.No.BP.BC.2/ 21.04.048/2015-16 was
issued on July 1, 2015 on “Prudential Norms on Income Recognition, Asset
Classification and Provisioning Pertaining to Advances”, in case of term
loans, wherein only interest is due, the interest due and charged during any
quarter is not serviced in 90 days from the end of the quarter, such account
will be treated as NPA.
(b) Cash Credits and Overdrafts: A cash credit or overdraft account is treated
as NPA if it remains out of order as indicated above.
(c) Bills Purchased and Discounted: Bills purchased and discounted are
treated as NPA if they remain overdue and unpaid for a period of more than
90 days.
(d) Securitisation: The asset is to be treated as NPA if the amount of liquidity
facility remains outstanding for more than 90 days, in respect of a
securitisation transaction undertaken in terms of guidelines on securitisation
dated February 1, 2006.
(e) Agricultural Advances: A loan granted for short duration crops will be
treated as NPA, if the instalment of principal or interest thereon remains
overdue for two crop seasons and, a loan granted for long duration crops
will be treated as NPA, if the instalment of principal or interest thereon
remains overdue for one crop season.
(f) Credit Card Accounts: credit card account will be treated as non-performing
asset if the minimum amount due, as mentioned in the statement, is not
paid fully within 90 days from the payment due date mentioned in the
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statement as per Circular DBR.No.BP.BC.30/21.04.048/2015-16 dated July

16 2015 on “Prudential Norms on Income Recognition, Asset Classification
and Provisioning pertaining to Advances – Credit Card Accounts”. It is
further suggested by RBI that banks should follow this uniform method of
determining over-due status for credit card accounts while reporting to
credit information companies (CIC) and for the purpose of levying of penal
charges, viz., late payment charges, etc., if any.
11.288 As per the guidelines, “long duration” crops would be crops with crop
season longer than one year and crops, which are not “long duration” crops
would be treated as “short duration” crops. The crop season for each crop, which
means the period up to harvesting of the crops raised, would be as determined
by the State Level Bankers’ Committee in each State. Depending upon the
duration of crops raised by an agriculturist, the above NPA norms would also be
made applicable to agricultural term loans availed of by him.
11.289 The above norms should be made applicable to all direct agricultural
advances as listed in the Master Direction no. RBI/FIDD /2020-21/72 Master
Direction FIDD.CO.Plan. BC.5/04.09.01/2020-21 dated September 04, 2020 on
“Lending to Priority Sector-Target and Classification”. In respect of all other
agricultural loans, identification of NPAs would be done on the same basis as
non-agricultural advances, which, at present, is the 90 days delinquency norm.
Temporary Deficiencies
11.290 The classification of an asset as NPA should be based on the record of
recovery. Bank should not classify an advance account as NPA merely due to
the existence of some deficiencies which are temporary in nature such as non-
availability of adequate drawing power based on the latest available stock
statement, balance outstanding exceeding the limit temporarily, non-submission
of stock statements and non-renewal of the limits on the due date, etc. In the
matter of classification of accounts with temporary deficiencies, banks have to
follow the following guidelines:
(a) Banks should ensure that drawings in the working capital account are
covered by the adequacy of the current assets, since current assets are
first appropriated in times of distress. Drawing Power (DP) is required to
be arrived at based on current stock statement. Proper computation of
drawing power (as per Bank’s policy) is imperative as the advances are to
be checked with reference thereto. The Auditor should review the Bank’s
policy for treatment of creditor’s balances for computation of DP. The
auditor should factor in other considerations in the drawing power
calculations, such as (i) comparison of the level of stock and books debts
assumed at the time of assessment if the reduction of trade creditors is
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limited to the extent of excess over the level of trade creditors assumed at
the time of assessment; (ii) excess of other Sundry Creditors (i.e., other
than trade creditors) over the level assumed at the time of assessment (as
suggested in Annexure to IBA Circular No.: C&I/Circular/2014-15/689
dated September 29, 2014. Thus, if the bank is having a policy of
considering trade creditors to the extent of excess over the level of trade
creditors assumed at the time of assessment, the auditor will reciprocally
review and verify the level of stock and book debts assumed at the time of
assessment. Further, the Auditor will refer and review the methodology
adopted by the bank in the calculation of MPBF (as regards netting off of
trade creditors against stock and book debts) based on the level of stock,
book debts and trade creditors. Further, the term ‘paid stock’ denotes
value of stock as reduced by trade creditors at gross level. However,
considering the difficulties of large borrowers, stock statements relied
upon by the banks for determining drawing power should not be older
than three months. In case of consortium accounts, the drawing power
calculation and allocation is made by the Lead Bank and is binding on the
Member Banks (circular No. C&I/Circular/2014-15/689 dated 29
September 2014 issued by the Indian Banks Association).
(b) The outstanding in the account based on drawing power calculated from
stock statements older than three months is deemed as irregular.
(c) A working capital borrowing account will become NPA if such irregular
drawings are permitted in the account for a continuous period of 90 days
even though the unit may be working or the borrower's financial position is
satisfactory.
(d) Regular and ad hoc credit limits need to be reviewed/ regularised not later
than three months from the due date/date of ad hoc sanction. In case of
constraints such as non-availability of financial statements and other data
from the borrowers, the branch should furnish evidence to show that
renewal/ review of credit limits is underway and would be completed soon.
In any case, delay beyond six months is not considered desirable as a
general discipline. Hence, an account where the regular/ adhoc credit
limits have not been reviewed/ renewed within 180 days from the due
date/ date of adhoc sanction will be treated as NPA. It would be pertinent
to note that the counting of 180 days would be required to be done from
the date of original due date for renewal and not from the date of expiry of
short reviews / technical reviews. The RBI issued circular RBI/2020-21/27
DoS.CO.PPG.BC.1/11.01.005/2020-21 dated August 21, 2020 on Ad-
hoc/Short Review/Renewal of Credit Facilities, advising banks to follow
the instructions related thereto in letter and spirit.
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Regularisation Near About Balance Sheet date

11.291 The asset classification of borrower accounts where a solitary or a few
credits are recorded before the balance sheet date should be handled with care
and without scope for subjectivity. Where the account indicates inherent
weakness on the basis of the data available, the account should be deemed as a
NPA. In other genuine cases, the banks must furnish satisfactory evidence to the
satisfaction of the auditor about the manner of regularisation of the account to
eliminate doubts on their performing status.
Cheque bounce
11.292 In case the account is regularised by making payment through cheque,
the Auditor should review the actual realisation of cheques to assess the NPA
classification. In case, the cheque is bounced, same should not be considered as
credit in the Advance account for assessing the NPA classification.
Asset Classification to be Borrower-wise not Facility-wise
11.293 All facilities granted to a borrower and investment made in securities
issued by the borrower will have to be treated as NPA / Non-Performing
Investments (NPI), once any or a part of the facility / investment has become
irregular, except in case of preference shares wherein if the same are marked as
NPI, the rest of the exposures are not required to be considered as Non-
Performing.
11.294 In case debits arising out of devolvement of letters of credit or invoked
guarantees are parked in a separate account, the balance outstanding in that
account also should be treated as a part of the borrower’s principal operating
account for the purpose of application of prudential norms on income recognition,
asset classification and provisioning. The following provisions are given in the
master circular in this regard:
(i) The bills discounted under LC favouring a borrower may not be classified
as a non-performing advance (NPA), when any other facility granted to the
borrower is classified as NPA. However, in case documents under LC are
not accepted on presentation or the payment under the LC is not made on
the due date by the LC issuing bank for any reason and the borrower does
not immediately make good the amount disbursed as a result of discounting
of concerned bills, the outstanding bills discounted will immediately be
classified as NPA with effect from the date when the other facilities had
been classified as NPA. Further, in case of bill discounted under LC, if the
payment under the LC is not made on the due date by the LC issuing bank
for any reason, unless the amount is immediately made good by the
borrower, the Auditor needs to review the availability of security in the light
of the straight away classification norms specified.
404
(ii) The overdue receivables representing positive mark-to-market value of a

derivative contract will be treated as a non-performing asset, if these
remain unpaid for 90 days or more. In case the overdues arising from
forward contracts and plain vanilla swaps and options become NPAs, all
other funded facilities granted to the client shall also be classified as non-
performing asset following the principle of borrower-wise classification as
per the existing asset classification norms. Accordingly, any amount,
representing positive mark-to-market value of the foreign exchange
derivative contracts (other than forward contract and plain vanilla swaps
and options) that were entered into during the period April 2007 to June
2008, which has already crystallised or might crystallize in future and is /
becomes receivable from the client, should be parked in a separate account
maintained in the name of the client / counterparty. This amount, even if
overdue for a period of 90 days or more, will not make other funded
facilities provided to the client, NPA on account of the principle of borrower-
wise asset classification, though such receivable overdue for 90 days or
more shall itself be classified as NPA, as per the extant IRAC norms. The
classification of all other assets of such clients will, however, continue to be
governed by the extant IRAC norms.
(iii) If the client concerned is also a borrower of the bank enjoying a Cash
Credit or Overdraft facility from the bank, the receivables mentioned at item
(ii) above may be debited to that account on due date and the impact of its
non-payment would be reflected in the cash credit / overdraft facility
account. The principle of borrower-wise asset classification would be
applicable here also, as per extant norms.
(iv) In cases where the contract provides for settlement of the current mark-to-
market value of a derivative contract before its maturity, only the current
credit exposure (not the potential future exposure) will be classified as a
non-performing asset after an overdue period of 90 days.
(v) As the overdue receivables mentioned above would represent unrealised
income already booked by the bank on accrual basis, after 90 days of
overdue period, the amount already taken to 'Profit and Loss account’
should be reversed and held in a ‘Suspense Account-Crystallised
Receivables’ in the same manner as done in the case of overdue
advances.
(vi) Further, in cases where the derivative contracts provide for more
settlements in future, the MTM value will comprise of (a) crystallised
receivables and (b) positive or negative MTM in respect of future
receivables. If the derivative contract is not terminated on the overdue
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receivable remaining unpaid for 90 days, in addition to reversing the

crystallised receivable from Profit and Loss Account as stipulated above,
the positive MTM pertaining to future receivables may also be reversed
from Profit and Loss Account to another account styled as ‘Suspense
Account – Positive MTM’. The subsequent positive changes in the MTM
value may be credited to the ‘Suspense Account – Positive MTM’, not to
P&L Account. The subsequent decline in MTM value may be adjusted
against the balance in ‘Suspense Account – Positive MTM’. If the balance
in this account is not sufficient, the remaining amount may be debited to the
P&L Account. On payment of the overdues in cash, the balance in the
‘Suspense Account-Crystallised Receivables’ may be transferred to the
‘Profit and Loss Account’, to the extent payment is received.
(vii) If the bank has other derivative exposures on the borrower, it follows that
the MTMs of other derivative exposures should also be dealt with /
accounted for in the manner outlined, subsequent to the
crystallised/settlement amount in respect of a particular derivative
transaction being treated as NPA.
(viii) Since the legal position regarding bilateral netting is not unambiguously
clear, receivables and payables from/to the same counterparty including
that relating to a single derivative contract should not be netted.
(ix) Similarly, in case a fund-based credit facility extended to a borrower is
classified as NPA, the MTMs of all the derivative exposures should be
treated in the manner discussed above.
Non-Financial Parameters
11.295 Normally NPA assessment is done based on record of recovery of dues
in advances account. However, there are many other non-financial parameters
which also should be considered while assessing classification of NPA account
such as:
 Inherent weakness in account.
 Non-achievement of DCCO.
 Failure to comply with key restructuring conditions.
 Erosion in value of security.
Advances to Primary Agricultural Credit Society (PACS) Farmers Service
Society (FSS) ceded to Commercial Banks
11.296 In case of advances granted under the on-lending system, however,
only the particular credit facility granted to PACSs or FSSs, which is in default for
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a period of two crop seasons in case of short duration crops and one crop
season in case of long duration crops, as the case may be, after it has become
due will be classified as NPA and not all the credit facilities sanctioned subject to
such conditions as specified in the RBI’s Master Circular no. RBI/2015-16/101
DBR.No.BP.BC.2/21.04.048/2015-16 on “Prudential Norms on Income
Recognition, Asset Classification and provisioning pertaining to Advances” dated
July 1, 2015. The other direct loans and advances, if any, granted by the bank to
the member borrower of a PACS/ FSS outside the on-lending arrangement will
become NPA even if one of the credit facilities granted to the same borrower
becomes NPA.
Erosion in Value of Securities/ Frauds Committed by Borrowers
11.297 In respect of accounts where there are potential threats for recovery on
account of erosion in the value of security or non-availability of security and
existence of other factors such as frauds committed by borrowers, such accounts
need not go through the stages of asset classification. In such cases, the asset
should be straightaway classified as doubtful or loss asset, as appropriate.
Further consequences are:
(i) Erosion in the value of securities by more than 50% of the value assessed
by the bank or accepted by RBI inspection team at the time of last
inspection, as the case may be, would be considered as “significant”,
requiring the asset to be classified as doubtful straightaway and provided
for adequately.
(ii) In case of secured loan, if the realisable value of security as assessed by
bank/approved valuers/RBI is less than 10% of the outstanding in the
borrower accounts, the existence of the security should be ignored and the
asset should be classified as loss asset and accordingly fully provided for.
(iii) Provisioning norms in respect of all cases of fraud:
a. The entire amount due to the bank (irrespective of the quantum of
security held against such assets), or for which the bank is liable
(including in case of deposit accounts), is to be provided for over a
period not exceeding four quarters commencing with the quarter in
which the fraud has been detected.
b. However, where there has been delay, beyond the prescribed period, in
reporting the fraud to the Reserve Bank, the entire provisioning is
required to be made at once. In addition, the Reserve Bank of India may
also initiate appropriate supervisory action where there has been a
delay by the bank in reporting a fraud, or provisioning there against.
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c. Where the bank chooses to provide for the fraud over two to four
quarters and this results in the full provisioning being made in more than
one financial year, banks should debit 'other reserves' [i.e., reserves
other than the one created in terms of Section 17(2) of the Banking
Regulation Act 1949] by the amount remaining un-provided at the end
of the financial year by credit to provisions. However, banks should
proportionately reverse the debits to ‘other reserves’ and complete the
provisioning by debiting profit and loss account, in the subsequent
quarters of the next financial year.
Government Guaranteed Advances
11.298 The credit facilities backed by guarantees of Central Government
though overdue may be treated as NPA only when the government repudiates its
guarantee, when invoked. This exemption from classification of Central
Government guaranteed advances as NPA is not for the purpose of recognition
of income and thus, in such instances the income would be required to be
recognized on cash basis. In case of State Government guaranteed loans, this
exemption will not be available and such account will be NPA if interest /
principal / other dues remain overdue for more than 90 days.
Advances under Consortium
11.299 Consortium advances should be based on the record of recovery of the
respective individual member banks and other aspects having a bearing on the
recoverability of the advances. Where the remittances by the borrower under
consortium lending arrangements are pooled with one bank and/or where the
bank receiving remittances is not parting with the share of other member banks,
the account should be treated as not serviced in the books of the other member
banks and therefore, an NPA.
11.300 Banks participating in the consortium, therefore, need to arrange to get
their share of recovery transferred from the lead bank or to get an express
consent from the lead bank for the transfer of their share of recovery, to ensure
proper asset classification in their respective books.
Advances Against Term Deposits, NSCs, KVPs/ IVPs, etc.
11.301 Advances against Term Deposits, NSCs eligible for surrender, KVP/IVP
and life policies need not be treated as NPAs, provided adequate margin is
available in the accounts. Advance against gold ornaments, government
securities and all other securities are not covered by this exemption and should
be classified as NPA as per the extant IRAC norms. However, in respect of
Jewel Loans taken for Agricultural Purposes, the classification has to be
continued in accordance with Crop Seasons only.
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Agricultural Advances Affected by Natural Calamities

11.302 Master Direction FIDD.CO.FSD.BC No.9/05.10.001/2018-19 dated
October 17, 2018 on Master Direction – Reserve Bank of India (Relief
Measures by Banks in Areas affected by Natural Calamities) Directions 2018 –
SCBs” deals elaborately with the classification and income recognition issues
due to impairment caused by natural calamities. Banks may decide on their
own relief measures, viz., conversion of the short term production loan into a
term loan or rescheduling of the repayment period and the sanctioning of fresh
short-term loan, subject to the guidelines contained in RBI’s Master Circular. In
such cases the NPA classification would be governed by such rescheduled
terms. The Auditors are advised to obtain the latest decisions of State Level
Banking Committee (SLBC) and the minutes of the SLBC meeting will be
accessible in website.
11.303 In such cases of conversion or re-scheduling, the term loan as well as
fresh short-term loan may be treated as current dues and need not be
classified as NPA. The asset classification of these loans would thereafter be
governed by the revised terms and conditions and would be treated as NPA if
interest and/or instalment of principal remain overdue for two crop seasons for
short duration crops and for one crop season for long duration crops. For the
purpose of these guidelines, "long duration" crops would be crops with crop
season longer than one year and crops, which are not 'long duration" would be
treated as "short duration" crops.
11.304 While fixing the repayment schedule in case of rural housing
advances granted to agriculturist under Indira Awas Yojana and Golden
Jubilee Rural Housing Finance Scheme, banks should ensure that the interest/
instalment payable on such advances are linked to crop cycles.
Advances Granted Under Rehabilitation Packages Approved by BIFR/Term
Lending Institutions
11.305 In respect of advances under rehabilitation package approved by
BIFR/term lending institutions, the provision should continue to be made in
respect of dues to the bank on the existing credit facilities as per their
classification as sub-standard or doubtful asset. This classification cannot be
upgraded by the bank unless the package of renegotiated terms has worked
satisfactorily for a period of one year. As regards the additional facilities
sanctioned as per package finalised by BIFR and/or term lending institutions, the
income recognition, asset classification norms would apply after a period of one
year from the date of disbursement.
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Transactions Involving Transfer of Assets through Direct Assignment of

Cash Flows and the Underlying Securities
11.306 Originating Bank: The asset classification and provisioning rules in
respect of the exposure representing the Minimum Retention Requirement
(MRR) of the Originator of the asset would be as under:
a) The originating bank may maintain a consolidated account of the amount
representing MRR if the loans transferred are retail loans. In such a case,
the consolidated amount receivable in amortisation of the MRR and its
periodicity should be clearly established and the overdue status of the MRR
should be determined with reference to repayment of such amount.
Alternatively, the originating bank may continue to maintain borrower-wise
accounts for the proportionate amounts retained in respect of those
accounts. In such a case, the overdue status of the individual loan accounts
should be determined with reference to repayment received in each
account.
b) In the case of transfer of a pool of loans other than retail loans, the
originator should maintain borrower-wise accounts for the proportionate
amounts retained in respect of each loan. In such a case, the overdue
status of the individual loan accounts should be determined with reference
to repayment received in each account.
c) If the originating bank acts as a servicing agent of the assignee bank for the
loans transferred, it would know the overdue status of loans transferred
which should form the basis of classification of the entire MRR/individual
loans representing MRR as NPA in the books of the originating bank,
depending upon the method of accounting followed as explained in para (a)
and (b) above.
11.307 Purchasing Bank: In purchases of pools of both retail and non-retail
loans, income recognition, asset classification and provisioning norms for the
purchasing bank will be applicable based on individual obligors and not based on
portfolio. Banks should not apply the asset classification, income recognition and
provisioning norms at portfolio level, as such treatment is likely to weaken the
credit supervision due to its inability to detect and address weaknesses in
individual accounts in a timely manner. If the purchasing bank is not maintaining
the individual obligor-wise accounts for the portfolio of loans purchased, it should
have an alternative mechanism to ensure application of prudential norms on
individual obligor basis, especially the classification of the amounts
corresponding to the obligors which need to be treated as NPAs as per existing
prudential norms. One such mechanism could be to seek monthly statements
containing account-wise details from the servicing agent to facilitate classification
of the portfolio into different asset classification categories. Such details should
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be certified by the authorized officials of the servicing agent. Bank’s concurrent

auditors, internal auditors and statutory auditors should also conduct requisite
checks of these portfolios with reference to the basic records maintained by the
servicing agent. The servicing agreement should provide for such verifications by
the auditors of the purchasing bank. All relevant information and audit reports
should be available for verification by the Inspecting Officials of RBI during the
Annual Financial Inspections of the purchasing banks.
11.308 The above guidelines prescribed for Originating Bank and Purchasing
Bank do not apply to the following:
(a) Transfer of loan accounts of borrowers by a bank to other bank/FIs/NBFCs
and vice versa, at the request/instance of borrower.
(b) Inter-bank participations.
(c) Trading in bonds.
(d) Sale of entire portfolio of assets consequent upon a decision to exit the line
of business completely. Such a decision should have the approval of Board
of Directors of the bank.
(e) Consortium and syndication arrangements and arrangement under
Corporate Debt Restructuring mechanism.
(f) Any other arrangement/transactions, specifically exempted by the Reserve
Bank of India.
Post Shipment Supplier’s Credit
11.309 In respect of post-shipment credit extended by the banks covering
export of goods to countries for which the ECGC cover is available, EXIM Bank
has introduced a guarantee-cum-refinance programme whereby, in the event of
default, EXIM Bank will pay the guaranteed amount to the bank within a period of
30 days from the day the bank invokes the guarantee after the exporter has filed
claim with ECGC.
11.310 Accordingly, where the credit extended by banks are guaranteed by
EXIM Bank, the extent to which payment has been received from EXIM bank on
guarantee the advance may not be treated as NPA.
Takeout Finance
11.311 Takeout finance is the product emerging in the context of the funding of
long-term infrastructure projects. Under such an arrangement, the bank or
financial institution financing infrastructure projects will have an arrangement with
any financial institution for transferring to the latter the outstanding in respect of
such financing in their books on a predetermined basis. In view of the time-lag
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involved in taking-over, the possibility of a default in the meantime cannot be

ruled out. The norms of asset classification will have to be followed by the
concerned bank/financial institution in whose books the account stands as
balance sheet item as on the relevant date. If the lending institution observes that
the asset has turned NPA on the basis of the record of recovery, it should be
classified accordingly. The lending institution should not recognise income on
accrual basis and account for the same only when it is paid by the borrower/
taking over institution (if the arrangement so provides). The lending institution
should also make provisions against any asset turning into NPA pending its
takeover by the taking over institution. As and when the asset is taken over by
the taking over institution, the corresponding provisions could be reversed.
However, the taking over institution, on taking over such assets, should make
provisions treating the account as NPA from the actual date of it becoming NPA
even though the account was not in its books as on that date.
Export Project Finance
11.312 Where the actual importer has paid the dues to the bank abroad and the
proceeds have not been made good to the bank granting finance due to any
political reasons, such account need not be classified as NPA if the bank is able
to establish through documentary evidence that the importer has cleared the
dues in full by payment received to the credit of account of exporter maintained
in such country. The account will, however, have to be considered as NPA if at
the end of one year from the date the amount was deposited by the importer in
the bank abroad, the amount has not still been remitted to the bank.
Net Worth of Borrower/Guarantor or Availability of Security
11.313 Since income recognition is based on recoveries, net worth of
borrower/guarantor should not be taken into account for the purpose of treating
an advance as NPA or otherwise, except to the extent provided in Para 4.2.9 of
the Master Circular No. RBI/2015-16/101DBR.No.BP.BC.2/21.04.048/2015-16
was issued on July 1, 2015 on ‘Prudential Norms on Income Recognition, Asset
Classification and Provisioning Pertaining to Advances”. Likewise, the availability
of security and/or guarantee is not relevant for determining whether an account is
an NPA or not.
Project Finance Under Moratorium Period
11.314 In the case of bank finance given for industrial projects or for agricultural
plantations etc., where moratorium is available for payment of interest, payment
of interest becomes due after the moratorium or gestation period is over, and not
on the date of debit of interest. Therefore, such amounts of interest do not
become overdue and hence the accounts do not become NPA, with reference to
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the date of debit of interest. They become overdue after due date for payment of
interest as per the terms of sanction and consequently NPA norms would apply
to those advances from that due date.
Advances to Staff
11.315 Interest bearing staff advances as a banker should be included as part
of advances portfolio of the bank. In the case of housing loan or similar advances
granted to staff members where interest is payable after recovery of principal,
interest need not be considered as overdue from first due date onwards. Such
loans/advances should be classified as NPA only when there is a default in
repayment of instalment of principal or payment of interest on the respective due
dates. The staff advances by a bank as an employer and not as a banker are
required to be included under the sub-head ‘Others’ under the schedule of Other
Assets.
Partial Credit Enhancement to Corporate Bonds
11.316 In a waterfall mechanism, credit enhancement (CE) gets drawn only in a
contingent situation of cash flow shortfall for servicing a debt / bond etc., and not
in the normal course of business. Hence, such an event is indicative of financial
distress of the project. Keeping this aspect in view, a drawn tranche of the
contingent PCE facility will be required to be repaid within 30 days from the date
of its draw (due date). The facility will be treated as NPA if it remains outstanding
for 90 days or more from the due date and provided for as per the usual asset
classification and provisioning norms. In that event, the bank’s other facilities to
the borrower will also be classified as NPA as per extant guidelines.
NPA Management
11.317 The RBI has issued Master Circular dated July 1, 2015 on “Prudential
Norms on Income Recognition, Asset Classification and provisioning pertaining
to Advances”. The Circular stresses the importance of effective mechanism and
availability of granular data on NPA management in the banks and provides as
follows:
 Asset quality of banks is one of the most important indicators of their
financial health. However, it has been observed that existing MIS on the
early warning systems of asset quality, needed improvement. Banks are,
therefore, advised that they should review their existing IT and MIS
framework and put in place a robust MIS mechanism for early detection of
signs of distress at individual account level as well as at segment level
(asset class, industry, geographic, size, etc.). Such early warning signals
should be used for putting in place an effective preventive asset quality
management framework, including a transparent restructuring mechanism
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for viable accounts under distress within the prevailing regulatory

framework, for preserving the economic value of those entities in all
segments.
 The banks’ IT and MIS system should be robust and be able to generate
reliable and quality information with regard to their asset quality for
effective decision making. There should be no inconsistencies between
information furnished under regulatory/statutory reporting and the banks’
own MIS reporting. Banks are also advised to have system generated
segment-wise information on non-performing assets and restructured
assets which may include data on the opening balances, additions,
reductions, (upgradations, actual recoveries, write-offs etc.) closing
balances, provisions held, technical write-offs, etc.
 The RBI issued circular RBI/2020-21/37 DoS.CO.PPG./SEC.03/
11.01.005/2020-21 dated September 14, 2020 on ‘Automation of Income
Recognition, Asset Classification and Provisioning processes in banks’
with reference to earlier circular DBS.CO.PPD.No.1950/11.01.005/2011-
12 dated August 04, 2011 and have advised the banks to put in place /
upgrade their systems to ensure completeness and integrity of automated
asset classification, provisioning calculation and income recognition
process by June 30, 2021 in compliance with the extant guidelines issued
vide the circular.
Audit Procedures and Reporting
 The point requires the Auditor to verify and comment whether the
identification and classification of advances into standard/
substandard/doubtful/loss assets have been done in compliance with the
RBI Master Circular No. RBI/2015-16/101, DBR.No.BP.BC.2/21.04.048/
2015-16 dated July 01, 2015 “Prudential norms on Income Recognition,
Asset Classification and Provisioning pertaining to Advances” in
conjunction with H.O’s instructions for identification of NPAs and
Classification of Advances.
 The Auditor should verify as to whether the bank has a system of ongoing
identification and classification of advances through CBS without manual
intervention and its accuracy in crystallising date of NPA. In case of
accounts identified as NPA by the auditor, the auditor needs to review the
reasons of non-identification of such accounts through CBS as regards
the effectiveness of the existing auto-identification and marking system in
the CBS.
 The Auditor should verify the deposit account having debit balances due
to charging of service charges/interest time to time and pending for
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recovery since long. Verify whether, prudential norms on Income

Recognition, Asset Classification and Provisioning have been followed. If
there is any deviation to RBI circular and HO instructions same should be
commented and MOC should be given if required.
 The Auditor should also review the quality and correctness of master data
of loans accounts updated in Core Banking Software. Check parameters
viz. instalment amount, tenure of loan, moratorium period, interest rate,
interest flags, limits setup, due date of first instalment and instalment
amount. In case of errors in master data configuration, various advances
related reports, statement of overdue accounts will not be generated
correctly software. Such reports, if relied upon, lead to incorrect
identification of NPAs. In view of the same, the Auditor should take utmost
care while verifying the compliance of NPA norms.
 The Auditors should review and compare the date of NPA of loans
accounts mentioned in current year statements with that of previous year.
Normally there should not be change of date of NPA unless it is suggested
by previous auditor in MOC or by RBI Inspectors. Any change other than
these, should be reviewed closely and reasons for such change should be
ascertained.
 If an account is identified as NPA either by the bank or by the auditors, the
crystallisation of date of NPA needs to be carefully reviewed / verified,
which needs to be date of NPA after completion of requisite number days
of default (e.g. 91st day in case of continuously overdrawn CC/OD
Accounts). The said date of NPA need not be confined to the current
financial year but can be of earlier date too. However, in such
circumstances, the Auditor should also verify the reasons for such
accounts being not marked as NPA earlier through system.
 Whenever an incorrect master data related to interest or EMI or tenure of
advance, is rectified by the bank, the effects of the same should be given
as per the original terms of sanction and not prospectively as the
prospective effects of such rectifications in certain cases (wherein the
amounts due for repayment had been incorrectly considered on lower side
as compared to the terms of sanction) may amount to restructuring of an
advance. Further, the Auditor needs review and consider the instances of
non-charging of penal interest, bank charges, processing fees on the due
dates and its effects of NPA classification.
 In case of advances upgraded during the year, the Auditor needs to
review such upgradation in the light of criteria’s specified for upgradation
of NPA accounts, considering the possibility of incorrect upgradation of
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account on the basis of partial recoveries made in the account wherein

the overdue portion is not extinguished in entirety, recoveries made in the
account subsequent to the cut-off date, (i.e., date of financial statements)
and non-identification of NPAs on on-going basis resulting in an account
being considered as standard though overdue portion of such unidentified
NPAs is not recovered in entirety.
 The Auditor needs to ensure that each customer of the bank is tagged
under one single Customer ID / Unique Customer Identification Code
(UCIC) in respect of all its accounts, including those in which credit
facilities are granted, irrespective of their location, to enable the bank,
(subject to the relaxations/exceptions for the time being applicable to any
account/facility), to accord the same NPA classification status to the
customer/borrower, based on the most adverse classification determined
for any of its account/ facility. The NPA classification of a group entity as
such does not automatically extend to other related / group entities, where
the classification would have to be judged based on independently, i.e., at
the entity level and not at a group level, unless there is a diversion of
funds.
 The Auditor should also comment if the banks’ IT and MIS system are
robust and able to identify and generate reliable and quality information
with regard to their asset quality for effective decision making without any
manual intervention. There should be no inconsistencies between
information furnished under regulatory/statutory reporting and the banks’
own MIS reporting.
Other NPA related aspects
Income Recognition
On Advances Granted
11.318 Banks recognise income (such as interest, fees and commission) on
accrual basis, i.e., as it is earned. It is an essential condition for accrual of
income that it should not be unreasonable to expect its ultimate collection. In
view of the significant uncertainty regarding ultimate collection of income
arising in respect of non-performing assets, the guidelines require that banks
should not recognise income on non-performing assets until it is actually
realised.
11.319 If any advance including bills purchased and discounted, becomes
NPA, the entire interest accrued and credited to the income account in the past
periods should be reversed if the same is not realised. Interest for the current
year if recognised till the date of identification but not realised should also be
reversed. Further,
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i. Interest income on advances against term deposits, NSCs, IVPs, KVPs

and life policies may be taken to income account on the due date,
provided adequate margin is available in the accounts.
ii. Fees and commissions earned by the banks as a result of re-
negotiations or rescheduling of outstanding debts should be recognised
on an accrual basis over the period of time covered by the re-negotiated
or rescheduled extension of credit.
iii. If Government guaranteed advances become NPA (subject to what is
stated hereunder in respect of Central Govt. guaranteed accounts), the
interest on such advances should not be taken to income account
unless the interest has been realised.
Credit facilities backed by guarantee of the Central Government, though
overdue, may be treated as NPA only when the Government repudiates
its guarantee when invoked. Thus, where the guarantee is not
invoked/repudiated, the related account cannot be classified as NPA
and by implication, the advance is to be treated as “Standard” for the
purpose of provisioning. This exemption from classification of such
Central Government guaranteed advances as NPA is not for the
purpose of recognition of income; income is to be recognized only
based on realisations made.
Reversal of Income
11.320 If any advance, including bills purchased and discounted, becomes
NPA, the entire interest accrued and credited to income account in the past
periods, should be reversed or provided for if the same is not realised. This will
apply to Government guaranteed accounts also. In respect of NPAs, fees,
commission and similar income that have accrued should cease to accrue in
the current period and should be reversed or provided for with respect to past
periods, if uncollected. Further, in case of banks which have wrongly
recognised income in the past should reverse the interest if it was recognised
as income during the current year or make a provision for an equivalent
amount if it was recognised as income in the previous year(s).
On Leased Assets
11.321 The finance charge component of finance income (as defined in AS
19 – Leases) on the leased asset which has accrued and was credited to
income account before the asset became non-performing, and remaining
unrealised, should be reversed or provided for in the current accounting period.
On Take-out Finance
11.322 In the case of take-out finance, if based on record of recovery, the
account is classified by the lending bank as NPA, it should not recognise
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income unless realised from the borrower/taking-over institution (if the

arrangement so provides).
On Partial Recoveries in NPAs (Appropriation of recoveries in NPAs)
11.323 In the absence of a clear agreement between the bank and the
borrower for the purpose of appropriation of recoveries in NPAs (i.e., towards
principal or interest due), banks are required to adopt an accounting policy and
exercise the right of appropriation of recoveries in a uniform and consistent
manner. The appropriate policy to be followed is to recognise income as per
AS 9 when certainty attaches to realisation and accordingly amount
reversed/de-recognised or not recognised in the past should be accounted.
11.324 Interest partly/fully realised in NPAs can be taken to income.
However, it should be ensured that the credits towards interest in the relevant
accounts are not out of fresh/additional credit facilities sanctioned to the
borrowers concerned.
Memorandum Account
11.325 When an account turns NPA, banks should reverse the interest
already charged and not collected by debiting Profit and Loss account, and
stop further application of interest. However, banks may continue to record
such accrued interest in a memorandum account in their books for control
purposes. For the purpose of computing Gross Advances, interest recorded in
the memorandum account should not be taken into account.
Treatment of interest suspense account
11.326 Amounts held in “interest suspense Account should not be reckoned as
part of provisions. Amounts lying in this account should be deducted from the
relative advances and thereafter, provisioning as per the norms, should be made
on the balances after such deduction.
Guidelines on Restructuring of Advances by Banks
11.327 The RBI, vide its Master Circular No.DBR.No.BP.BC.2/21.04.048/
2015-16 dated July 1, 2015 issued guidelines on prudential norms on Income
Recognition, Assets Classification and Provisioning pertaining to Advances.
The Guidelines also contain the organisational framework for restructuring of
advances under consortium/ multiple banking/ syndication arrangements, i.e.,
the CDR mechanism.
11.328 In line with the recommendation of the Working Group under the
Chairmanship of Shri B. Mahapatra, to review the existing prudential guidelines
on restructuring of advances by banks/financial institutions, the extant incentive
for quick implementation of restructuring package and asset classification
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benefits (Paragraph 20.2.1 & 20.2.2 of Master Circular No. RBI/2015-16/101

DBR.No.BP.BC.2/21.04.048/2015-16 was issued on July 1, 2015 on ‘Prudential
Norms on Income Recognition, Asset Classification and Provisioning Pertaining
to Advances”) available on restructuring on fulfilling the conditions will however,
be withdrawn for all restructurings effective from April 1, 2015 with the exception
of provisions related to changes in DCCO in respect of infrastructure as well as
non-infrastructure project loans. It implies that with effect from April 1, 2015, a
standard account on restructuring (for reasons other than change in Date of
Commencement of Commercial Operations (DCCO)) would be immediately
classified as sub-standard on restructuring as also the non-performing assets,
upon restructuring, would continue to have the same asset classification as prior
to restructuring and slip into further lower asset classification categories as per
the extant asset classification norms with reference to the pre-restructuring
repayment schedule.
Key Concepts
11.329 Key concepts used in these Guidelines are defined in Annex – 5 to the
RBI’s Master Circular no. RBI/2015-16/101 DBR.No.BP.BC.2/21.04.048/2015-16
on “Prudential Norms on Income Recognition, Asset Classification and
Provisioning pertaining to Advances” dated July 1, 2015.
Eligibility criteria for restructuring of advances
11.330 Banks may restructure the accounts classified under 'standard', 'sub-
standard' and 'doubtful' categories. Banks cannot reschedule / restructure /
renegotiate borrowal accounts with retrospective effect. While a restructuring
proposal is under consideration, the usual asset classification norms would
continue to apply. The process of reclassification of an asset should not stop
merely because restructuring proposal is under consideration. The asset
classification status as on the date of approval of the restructured package by the
competent authority would be relevant to decide the asset classification status of
the account after restructuring/ rescheduling/ renegotiation. In case there is
undue delay in sanctioning a restructuring package and in the meantime the
asset classification status of the account undergoes deterioration, it would be a
matter of supervisory concern.
11.331 Normally, restructuring cannot take place unless alteration / changes in
the original loan agreement are made with the formal consent / application of the
debtor. However, the process of restructuring can be initiated by the bank in
deserving cases subject to customer agreeing to the terms and conditions.
11.332 No account will be taken up for restructuring by the banks unless the
financial viability is established and there is a reasonable certainty of repayment
from the borrower, as per the terms of restructuring package. Any restructuring
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done without looking into cash flows of the borrower and assessing the viability
of the projects / activity financed by banks would be treated as an attempt at ever
greening a weak credit facility and would invite supervisory concerns / action.
Banks should accelerate the recovery measures in respect of such accounts.
The viability should be determined by the banks based on the acceptable viability
benchmarks determined by them, which may be applied on a case-by-case
basis, depending on merits of each case. Illustratively, the parameters may
include the following:
 Return on Capital Employed
 Debt Service Coverage Ratio
 Gap between the Internal Rate of Return
 Cost of Funds
 Provision required in lieu of the diminution in the fair value of the
restructured advance.
11.333 The borrowers indulging in frauds and malfeasance will continue to
remain ineligible for restructuring. Banks may review the reasons for
classification of the borrowers as wilful defaulters, especially in old cases where
the manner of classification of a borrower as a wilful defaulter was not
transparent, and satisfy itself that the borrower is in a position to rectify the wilful
default.
11.334 Following are the erstwhile types of Restructuring mechanisms.
i. Joint Lenders Forum (JLF) and Corrective Action Plan (CAP).
ii. Strategic Debt Restructuring (SDR).
iii. Scheme for Sustainable structuring of Stressed Assets (S4A).
iv. Corporate Debt Restructuring (CDR) Mechanism.
11.335 With issuance of circular no. RBI/2018-19/203 DBR.
No.BP.BC.45/21.04.048/2018-19 on Prudential Framework for Resolution of
Stressed Assets dated June 07, 2019 and circular no. RBI/2017-18/131
DBR.No.BP.BC.101/21.04.048/2017-18 on Resolution of Stressed Assets –
Revised Framework dated February 12, 2018, the extant instructions on
resolution of stressed assets such as Framework for Revitalising Distressed
Assets, Corporate Debt Restructuring Scheme, Flexible Structuring of Existing
Long Term Project Loans, Strategic Debt Restructuring Scheme (SDR), Change
in Ownership outside SDR, and Scheme for Sustainable Structuring of Stressed
Assets (S4A) stand withdrawn with immediate effect. Accordingly, the Joint
Lenders’ Forum (JLF) as mandatory institutional mechanism for resolution of
stressed accounts was discontinued.
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Resolution of Stressed Assets – Revised Framework w.e.f. February 12,

2018
11.336 The RBI issued Circular no. RBI/2017-18/131 DBR.No.BP.BC.101/
21.04.048/2017-18 dated February 12, 2018 on ‘”Resolution of Stressed Assets
– Revised Framework”, wherein the existing provisions w.r.t. stress assets have
been revised in entirety with discontinuation of various enabling provisions for
retention of class of assets (under Corrective Action Plan (CAP), Strategic Debt
Restructuring (SDR), Scheme for Sustainable Structuring of Stressed Assets
(S4A). All accounts including the one where any of the schemes have been
invoked but not yet implemented, shall be governed by revised framework.
11.337 RBI had put a comma for restructuring by discontinuing special
regulatory treatment for asset classification from 31 March 2015. However, the
introduction / continuation of schemes like CAP, SDR, S4A, etc. allowed banks to
keep accounts standard after restructuring. With the new guidelines issued on
February 12, 2018, the RBI has overhauled the restructuring framework by
discontinuing prevalent restructuring schemes like CAP, SDR, S4A, etc. The new
framework goes one step ahead as it aims at resolution of stressed asset and
not just restructuring. With the enactment of Insolvency and Bankruptcy Code,
2016 (IBC), the process of resolution in case of failure of restructuring can be
expedited.
Prudential Framework for Resolution of Stressed Assets – Revised
Framework w.e.f. June 07, 2019
11.338 The earlier circular related to revised framework for Resolution of
Stressed Assets was replaced vide circular no. RBI/2018-19/203
DBR.No.BP.BC.45/21.04.048/2018-19 dated June 07, 2019 for ‘Prudential
Framework for Resolution for Stressed Assets’. The purpose of these
guidelines is to provide framework for early recognition, reporting and time
bound resolution of stressed assets.
11.339 These directions are issued without prejudice to issuance of specific
directions, from time to time, by the Reserve Bank to banks, in terms of the
provisions of Section 35AA of the Banking Regulation Act, 1949, for initiation of
insolvency proceedings against specific borrowers under the Insolvency and
Bankruptcy Code, 2016 (IBC). It has provided a framework for resolution of
stressed assets as follows:
I. Early Identification and reporting of stress
Lenders shall recognise incipient stress in loan accounts, immediately on
default by classifying such assets as per special mention accounts (SMA) as
per following categories.
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Sub-categories Principal or Interest payment or any other amount wholly
or partly overdue between
SMA-0 1-30 days
SMA-1 31-60 days
SMA-2 61-90 days
In the case of revolving credit facilities like cash credit, the SMA sub-categories
will be as follows:
Sub-categories Outstanding balance remains continuously in excess of
the sanctioned limit or drawing power, whichever is
lower, for a period of
SMA-1 31-60 days
SMA-2 61-90 days
II. Implementation of Resolution Plan

All lenders must put Board Approved Policy for resolution of stressed assets,
including timelines for resolution. It is expected that the lenders initiate the
process of implementing Resolution Plan even before a default. Once default is
reported, “Review Period” of 30 days starts, wherein lenders may decide on
resolution strategy and may choose to initiate legal proceedings for insolvency
or recovery. If RP is to be implemented, all lenders to sign Inter Creditor
Agreement (ICA) during the Review Period. Decision to be taken as agreed by
lenders representing 75% by value of total outstanding credit facilities
(FB+NFB) and 60% of lenders by number.
In case of accounts with aggregate exposure above a threshold with the
lenders, on or after the reference date, the resolution plan must be
implemented within 180 days from end of review period
Aggregate exposure of the borrower Reference Date
to lenders
Rs. 20 Billion (2000 Crores) and Date of these directions
Above
Rs. 15 Billion (1500 Crores) and January 1, 2020
above but less that Rs. 20 Billion
(2000 Crores)
Less than Rs. 15 Billion (1500 To be announced in due course
Crores)
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III. Implementation conditions of Resolution Plan

For 1 billion (100 Cr) and above exposure – Independent Credit Evaluation
(ICE) of the residual debt by Credit Rating Agencies (CRAs) specifically
authorised by RBI for this purpose.
For 5 billion (500 Cr) and above exposure – Two such Independent Credit
Evaluation (ICE) of the residual debt by Credit Rating Agencies (CRAs)
specifically authorised by RBI for this purpose.
RP is implemented if the following conditions are to be met:
i. RP Not involving Restructuring / Change in Ownership shall be deemed
to be implemented only if the borrower is not in default with any of the
lenders as on 180th day from the end of Review Period.
ii. RP involving Restructuring / Change in Ownership shall be deemed to be
implemented only if following conditions are met:
a. All related documentation, creation of security/charge / perfection of
security are completed by the lenders.
b. New Capital Structure and changes in terms of conditions of the
existing loans gets duly reflected in the books of the lenders and
borrower.
c. Borrower is not in default with any of the lenders.
IV. Delayed implementation of Resolution Plan
Additional provision required when viable RP is not implemented as follows:
Timeline for implementation of viable RP Additional Provision as
% of total outstanding
180 days from the end of review period 20%
365 days from the commencement of Review Period 15%
An additional provision is to be made over and above the higher of following
(max 100% of outstanding):
a. Provisions already held.
b. Provisions required to be made as per asset classification status of the
borrower account.
V. Prudential Norms
Restructuring is an act in which a lender, for economic or legal reasons relating
to the borrower's financial difficulty, grants concessions to the borrower.
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Restructuring may involve modification of terms of the advances / securities,

which would generally include, among others, alteration of payment period /
payable amount / the amount of instalments / rate of interest; roll over of credit
facilities; sanction of additional credit facility/ release of additional funds for an
account in default to aid curing of default / enhancement of existing credit
limits; compromise settlements where time for payment of settlement amount
exceeds three months.
11.340 A non exhaustive indicative list of “financial difficulty” (Based on Basel
Committee Guidelines) is as follows:
i. Borrower not in default, but is is probable that the borrower will default on
any of its exposures in foreseeable future without the concession.
ii. Borrowers outstanding securities have been delisted.
iii. Actual performance vs estimates, cash flows to be assessed insufficient
to service all of its loans or debt securities.
iv. Borrowers credit facilities are NPA.
v. Borrowers existing exposures are catagorised as exposures that have
already evidenced difficulty in borrowers’ ability to repay in accordance
with banks internal credit rating system.
Asset Classification
11.341 On restructuring the account will be downgraded from Standard to
Substandard. NPAs will remain in same category.
Upgradation
11.342 Only when all the outstanding loan / facilities in the account
demonstrate ‘satisfactory performance’ during the period from the date of
implementation of RP up to the date by which at least 10% of the sum of
outstanding principal debt as per RP and interest capitalisation sanctioned as a
part of the restructuring, if any is repaid (provided that account cannot be
upgraded before one year from the commencement of the first payment of
interest or principal, whichever is later, on the credit facility with longest period
of moratorium under the terms of RP).
11.343 In addition to the satisfactory performance, in case of aggregate
exposure of Rs. 1 Billion and above, external credit rating of investment grade
should be BBB - or better and in case of aggregate exposure of Rs. 5 Billion
and above, two such external credit ratings of investment grade should be
BBB- or better.
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11.344 On failure to demonstrate satisfactory performance during the

monitoring period, asset classification upgrade is subjected to fresh
restructuring / change of ownership framework as per IBC and additional
provision of 15% for such accounts should be made at the end of review
period.
Provisioning Norms
11.345 Accounts restructured under the revised framework shall attract
provisioning as per the asset classification category as laid out in the Master
Circular no. RBI/2015-16/101 DBR.No.BP.BC.2/21.04.048/2015-16 on
Prudential Norms on Income Recognition, Asset Classification and
Provisioning pertaining to Advances dated July 1, 2015. The circular further
provides guidelines for Supervisory Review and related to Disclosures.
11.346 Accounts restructured under earlier framework in which accounts are
continued to be classified as standard post restructuring, if satisfactory
performance after the specified period is not evidenced, the asset classification
of the restructured account would be governed as per the applicable prudential
norms with reference to pre-restructuring schedule.
Upgradation of Loan Accounts Classified as NPAs
11.347 (i) If arrears of interest and principal are paid by the borrower in the
case of loan accounts classified as NPAs, the account should no longer
be treated as non-performing and may be classified as ‘standard’
accounts. Upgradation is allowed only if the account reaches “no over
dues” status. This should not be misunderstood with “overdues brought
within 90 days”. Upgradation of a restructured/ rescheduled/CDR
accounts is governed by the restructuring / rescheduling /CDR norms.
Further, in case of borrowers wherein the bank has multiple exposures, it
would be pertinent to note that the ‘no overdue’ status needs to be
achieved w.r.t. all exposures of the bank as on the date of upgradation of
the account.
(ii) The Auditor has to verify that any upgrading of accounts classified as ‘Sub-
Standard’ or ‘Doubtful’ category wherein restructuring / rephasement of
principal or interest has taken place should be upgraded to the ‘Standard
Asset’ category only after a period of one year after the date when first
payment of interest or of principal, whichever is earlier, falls due under the
rescheduled terms, subject to satisfactory performance during the period.
The total amount becoming due during this period of one year should be
recovered and there should be no over dues to make it eligible for
upgradation. If the amount which has become due during this one year
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period is on a lower side vis a vis total amount outstanding, the other
aspects of the account, viz financial performance, availability of security,
operations in account, etc., should be reviewed in detail and only if found
satisfactory, the account should be upgraded.
(iii) Recovery in an advance which was rescheduled cannot give the advance a
better classification than the previous one. NPA accounts can be upgraded
to performing accounts, provided all overdues are adjusted.
(iv) Upgradation within the NPA category is not permitted i.e. a Doubtful
account cannot be made sub-standard even if the overdue are reduced to
less than 12 months.
Relief for MSME borrowers registered under GST
21.04.048/2017-18 dated February 07, 2018 on “Relief for MSME Borrowers
registered under Goods and Services Tax (GST)”, The Auditors need to be
vigilant as regards the applicability of the said circular and eligibility of the
borrower. This circular applies only to borrowers which are classified as micro,
small and medium enterprise under the MSMED Act, 2006. The exposure of
banks to such borrowers would be classified as standard assets subject to
conditions specified in the circular:
1. The borrower is registered under the GST regime as on January 31, 2018.
2. The aggregate exposure including non-fund-based facilities of banks and
NBFCs, to the borrower does not exceed Rs. 25 crores as on January 31,
2018.
Thus, the overall exposure of the borrower (including that of multiple
banking/ consortium banking) as on January 31, 2018 should not exceed
Rs. 25 crores, i.e. the overall exposure of the borrower to banks and NBFCs
combined should not exceed the cap of Rs. 25 crores. Further, it is to be
noted that as per RBI Master Circular no. RBI /2015-16/70
DBR.No.Dir.BC.12 /13.03.00/2015-16 on “Exposure Norms”, – ‘exposure’
shall include credit exposure (funded and non-funded credit limits) and
investment exposure (including underwriting and similar commitments). The
sanctioned limits or outstanding, whichever are higher, shall be reckoned for
arriving at the exposure limit. However, in the case of fully drawn term loans,
where there is no scope for re-drawl of any portion of the sanctioned limit,
banks may reckon the outstanding as the exposure.
426
3. The borrower’s account should be standard account as on August 31, 2017.

It would be pertinent to note that some banks may be following a system of
marking of accounts as NPA in the system as at quarter-end instead of
marking the accounts on on-going basis. However, the borrower account
needs to be tested for classification purpose as on August 31, 2017 and in
case such account is a NPA account as per the extant of IRAC norms
specified by RBI as on August 31, 2017, irrespective of the account being
marked or not by the bank, such accounts will not be eligible for relief
granted by this circular.
4. The amount from the borrower, overdue as on September 01, 2017 and
payments from the borrower due between September 01, 2017 and January
31, 2018 are paid not later than 180 days from their respective original due
date.
As per para 2.3 of Master Circular No. RBI/2015-16/101 DBR.No.BP.BC.2/
21.04.048/2015-16 was issued on July 1, 2015 on ‘Prudential Norms on
Income Recognition, Asset Classification and Provisioning Pertaining to
Advances” – ‘any amount due to the bank under any credit facility is
‘overdue’ if it is not paid on the due date fixed by the bank’. Thus, the
extension period of 180 days granted for the repayment of the overdue
amount as on September 01, 2017 as well as the amounts due between the
specified period is restricted to the extent of 180 days from the respective
‘due date’. Further, the email dated April 03, 2018 from DBR, Reserve Bank
of India, Central Office states thus: – “It is clarified that CC/OD limits are part
of the aggregate exposure to the borrower. OD/CC accounts which become
‘out of order’ as per para 2.2 of our Master Circular No. RBI/2015-
16/101DBR.No.BP.BC.2/21.04.048/2015-16 was issued on July 1, 2015 on
‘Prudential Norms on Income Recognition, Asset Classification and
Provisioning Pertaining to Advances”between September 01, 2017 and
January 31, 2018 may continue to be classified as standard provided the
irregularity in the account is removed within a period not exceeding 90 days
from the original date of the account becoming ‘out of order’.
5. A provision of 5% shall be made against such exposures which are not
classified as NPA (due to the relaxation as provided above), which otherwise
would have been classified as NPA as per usual IRAC norms (of accounts
overdue beyond 90 days period).
6. The additional time provided is for the purpose of asset classification only
and not for income recognition.
427
Thus, if an account is otherwise eligible to be classified as NPA as per usual

IRAC norms (of accounts overdue beyond 90 days period) but is classified as PA
based on the above-mentioned relaxation granted, the income is required to be
recognised on realisation basis and not on accrual basis.
11.349 Further RBI has issued Circular no. RBI/2017-18/186
DBR.No.BP.BC.108/ 21.04.048/ 2017-18 dated June 06, 2018 for Encouraging
Formalisation of MSME sector. This circular is in continuity with Circular no.
RBI/2017-18/129 DBR.No.BP.BC.100/21.0 4.048/2017-18 dated February 07,
2018 on MSME borrowers registered under the Goods and Services Tax (GST);
thus, the Auditor needs to be vigilant as regards the applicability of both these
circulars and eligibility of the borrowers. This circular applies only to borrowers
which are classified as micro, small and medium enterprise under the MSMED
Act, 2006. The exposure of banks to such borrowers would be classified as
standard assets subject to conditions specified in the circular as detailed below:
i. The aggregate exposure, including non-fund based facilities, of banks and
NBFCs to the borrower does not exceed ₹ 250 million as on May 31, 2018.
ii. The borrower’s account was ‘standard’ as on August 31, 2017.
iii. The payments due from the borrower as on September 1, 2017 and falling
due thereafter up to December 31, 2018 were/are paid not later than 180
days from their original due date.
iv. In respect of dues payable by GST-registered MSMEs from January 1,
2019 onwards, the 180 days past due criterion shall be aligned to the
extant IRAC norms in a phased manner, as given below. However, for
MSMEs that are not registered under GST as on December 31, 2018, the
asset classification in respect of dues payable from January 1, 2019
onwards shall immediately revert to the extant IRAC norms.
Period during which any payment falls due Time Permitted
September 01, 2017 – December 31, 2018 180 days
January 01, 2019 – February 28, 2019 150 days
March 01, 2019 – April 30, 2019 120 days
May 01, 2019 onwards 90 days
v. The other terms and conditions of the circular dated February 07, 2018
remain unchanged.
21.04.048/2018-19) dated January 01, 2019 on “Micro, Small and Medium
428
Enterprises (MSME) sector – Restructuring of Advances”, permitting one-time

restructuring of existing loans of MSMEs classified as ‘Standard’ without a
downgrade in asset classification subject to certain conditions. The said circular
is issued with reference to the earlier circulars related to MSME borrowers issued
on February 07, 2018 and June 06, 2018. The one-time restructuring as stated
above is subject to conditions specified in the circular as detailed below:
NBFCs to the borrower, does not exceed Rs. 25 crores as on January 01,
2019.
ii. The borrower’s account (can be in default but is standard as on January 01,
2019 and continues to be standard asset till the date of implementation of
the restructuring.
iii. The borrower is registered under GST as on the date of implementation of
restructuring. However, this condition will not apply to MSMEs which are
exempt from GST registration. The condition of exemption should be
determined on the basis of exemption limit obtaining as on January 01,
2019.
iv. The restructuring of the borrower account is implemented on or before
March 31, 2020. A restructuring would be treated as implemented if the
following conditions are met:
a. All related documentation including execution of necessary
agreements between lenders and borrowers / creation of security
charges / perfection of securities are completed by all lenders; and
b. The new capital structure and / or changes in the terms and
conditions of existing loans gets duly reflected in books of all lenders
and the borrower.
v. A provision of 5% in addition to the provision already held shall be made
w.r.t. the accounts restructured under these instructions. Such provision
can be reversed at the end of specified period subject to the account
demonstrating satisfactory performance during the specified period.
‘Specified Period’ means a period of one year from the commencement of
the first payment of interest or principal, whichever is later, on the credit
facility with longest period of moratorium under the terms of restructuring
package. ‘Satisfactory Performance’ means no payment (interest and/or
principal) shall remain overdue for a period of more than 30 days. In case of
cash credit / overdraft account, satisfactory performance means that the
outstanding in the account shall not be more than the sanctioned limit or
drawing power, whichever is lower, for a period of more than 30 days.
429
vi. Subsequent to the restructuring, NPA Classification of these accounts shall

be as per extant IRAC norms.
vii. Appropriate disclosure in the financial statements under ‘Notes on
Accounts’ related to MSME restructured accounts under these instructions
would be required specifying number of accounts restructured and amount.
viii. All other instructions applicable to restructuring of loans to MSME
borrowers shall continue to be applicable.
11.351 The RBI has further clarified that the accounts classified as NPA can be
restructured, however, the extant asset classification norms governing
restructuring of NPAs continues to apply. As a general rule, barring the above
one-time exception, any MSME account, which is restructured must be
downgraded to NPA upon restructuring and will slip into progressively lower
asset classification and higher provisioning requirements as per extant IRAC
norms. Such an account may be considered for upgradation to ‘standard’ only if it
demonstrates satisfactory performance during the specified period.
MSME Sector – Restructuring of Advances
Circular dated February 11, 2020
11.352 The RBI issued circular RBI/2019-20/160 DOR.No.BP.BC.34/21.04.048/
2019-20 dated February 11, 2020 in continuation of earlier circular RBI/2018 -
19/100 DBR.No.BP.BC.18/ 21.04.048/2018-19) dated January 01, 2019
extending the one-time restructuring of MSME advances classified as ‘standard’
without a downgrade in the asset classification with the following amended
conditions:
NBFCs to the borrower does not exceed ₹ 25 crores as on January 01,
2020.
ii. The borrower’s account can be in default but is standard as on January 01,
2020 and continues to be standard asset till the date of implementation of
the restructuring.
determined on the basis of exemption limit obtaining as on January 01,
2020.
December 31, 2020.
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Circular dated August 06, 2020

11.353 The RBI issued circular RBI/2020-21/17 DOR.No.BP.BC /4/
21.04.048/2020-21 dated August 06, 2020 in continuation of earlier circular
RBI/2019-20/160 DOR.No.BP.BC.34/21.04.048/2019-20 dated February 11,
2020 extending the one-time restructuring of MSME advances classified as
‘standard’ without a downgrade in the asset classification and aligning the
guidelines with the Resolution Framework for COVID19 – related Stress
announced for other advances, with following amended conditions:
NBFCs to the borrower does not exceed Rs. 25 crores as on March 01,
2020.
ii. The borrower’s account is standard as on March 01, 2020. In case the
account slips into NPA category between March 02, 2020 and date of
implementation of restructuring plan, the asset classification of borrowers
would be reinstated to standard provided restructuring is done as per
provisions of this circular.
determined on the basis of exemption limit obtaining as on March 01, 2020.
March 31, 2021.
v. For the accounts restructured under these guidelines, the banks shall
maintain additional provision of 5% over and above the provision already
held by them.
COVID19 Regulatory Package
COVID19 Regulatory Package dated March 27, 2020
11.354 The RBI issued COVID19 Regulatory package vide Circular RBI/2019-
20/186 DOR.No.BP.BC.47/21.04.048/2019-20 dated March 27, 2020 granting
relief to borrowers as follows:
i. Term Loans: In respect of all term loans (including agricultural term loans,
retail and crop loans), all commercial banks (including regional rural
banks, small finance banks and local area banks), co-operative banks,
all-India Financial Institutions, and NBFCs (including housing finance
companies), lending institutions are permitted to grant a moratorium of
three months on payment of all instalments falling due between March 1,
431
2020 and May 31, 2020. The repayment schedule for such loans as also
the residual tenor, will be shifted across the board by three months after
the moratorium period. Interest shall continue to accrue on the
outstanding portion of the term loans during the moratorium period. The
Instalments will include the following payments falling due from March 1,
2020 to May 31, 2020: (i) principal and/or interest components; (ii) bullet
repayments; (iii) Equated Monthly instalments; (iv) credit card dues. It
would be pertinent to note that the repayment schedule of the loans is
permitted to shift only to the extent of period equivalent to moratorium
period.
ii. Working Capital Facilities: In respect of working capital facilities
sanctioned in the form of cash credit/overdraft (CC/OD), lending
institutions are permitted to defer the recovery of interest applied in
respect of all such facilities during the period from March 1, 2020 up to
May 31, 2020 (deferment). The accumulated accrued interest shall be
recovered immediately after the completion of this period.
iii. Other facilities like LCBD, Bill Discounting, etc.: The captioned RBI
circular does not grant any relief to other facilities like LCBD and Bill
Discounting as both are neither in the form of Term Loan nor in the form
of Cash Credit / Overdraft facilities.
iv. Investments: The captioned RBI circular does not grant any relief to
Investment portfolio of the bank.
v. Easing of Working Capital Finance: In respect of working capital facilities
sanctioned in the form of CC/OD to borrowers facing stress on account of
the economic fallout of the pandemic, lending institutions may recalculate
the ‘drawing power’ by reducing the margins and/or by reassessing the
working capital cycle. This relief shall be available in respect of all such
changes effected up to May 31, 2020 and shall be contingent on the
lending institutions satisfying themselves that the same is necessitated on
account of the economic fallout from COVID 19. Further, accounts
provided relief under these instructions shall be subject to subsequent
supervisory review with regard to their justifiability on account of the
economic fallout from COVID-19.
The circular grants discretion to the lending institutions regarding
reduction in margin and reassessment of working capital cycle, during the
period up to May 31, 2020. The bank’s board approved policy will need to
prescribe the manner of implementing this requirement. The said relief
will have limited impact to the extent of change in method of calculation of
drawing power to the extent of reduction in margin and relaxation in
consideration of working capital cycle.
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vi. Classification as Special Mention Account (SMA) and Non-Performing

Asset (NPA): The relief granted by banks to the borrower as specified and
permitted under the said circular, will not be considered as concession or
change in terms and conditions of loan agreements due to financial
difficulty of the borrower under Paragraph 2 of the Annex to the Reserve
Bank of India (Prudential Framework for Resolution of Stressed Assets)
Directions, 2019 dated June 7, 2019 ('Prudential Framework‛).
Consequently, such a measure, by itself, shall not result in asset
classification downgrade. Thus, any relief granted over and above that
specified in the said circular may result in asset classification downgrade.
vii. The said circular did not distinguish between Standard Accounts and
Non-Performing Accounts and thus, the benefit of relaxation as provided
under this circular would be available across classifications of assets.
COVID 19 Regulatory Package – Asset Classification and
Provisioning dated April 17, 2020
11.355 The RBI circular RBI/2019-20/220 DOR.No.BP.BC.
63/21.04.048/2019-20 dated April 17, 2020 on COVID 19 Regulatory Package
on Asset Classification and Provisioning, granted relief as under:
i. Term Loans: In respect of Term Loan accounts classified as standard as
on February 29, 2020, even if overdue, the moratorium period, wherever
granted, shall be excluded by the lending institutions from the number of
days past-due for the purpose of asset classification under the IRAC
norms. The circular granted relief to the term loan accounts availing
moratorium benefit, to the extent of moratorium period granted, by
excluding the same while calculating the delinquency for asset
classification. Thus, in case if a term loan account has not opted for the
moratorium period, the benefit of the exclusion of the period between
March 01, 2020 to May 31, 2020 in calculation of delinquency for asset
classification would not be available.
ii. Working Capital Facilities: In respect of working capital facilities
sanctioned in the form of cash credit/overdraft (‘CC/OD‛), the Regulatory
Package permitted the recovery of interest applied during the period from
March 1, 2020 up to May 31, 2020 to be deferred (‘deferment period’).
Such deferment period, wherever granted in respect of all facilities
classified as standard, including SMA, as on February 29, 2020, shall be
excluded for the determination of out of order status. The circular granted
relief from testing a CC/OD account for determination of ‘out of order’
status during the intervening period of March 01, 2020 and May 31, 2020.
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Thus, an account which was standard as on February 29, 2020 (i.e., not
out of order status) would remain standard (or in other words in same
category as standard or SMA) till May 31, 2020.
iii. It would be pertinent to note that the circular does not prohibit
upgradation of accounts during the intervening period. Thus, in case a
NPA is regularised during the intervening period based on the revised
terms of repayment and / or interest due, the said account is eligible for
upgradation.
iv. Provisioning
a. Term Loans
In case of Term Loans, wherein the benefit of moratorium period has
been availed and such moratorium period has also been granted for
the purpose of calculating the delinquency related to asset
classification, on such accounts, a general provision of 10% would
be required to be made to the extent of total outstanding in the loan
accounts in phased-wise manner as follows:
(i) Quarter ended March 31, 2020 – not less than 5 per cent
(ii) Quarter ending June 30, 2020 – not less than 5 per cent
The said provision would be applicable only in cases wherein such
accounts would otherwise (i.e., without availing the benefit related to
asset classification) have been marked as NPA and the said
provisioning requirement will not apply to the accounts which
otherwise would have continued to be under standard category. The
following table includes illustrative examples to clarify further:
(Presumption: the account is standard account as at February 29,
2020 and has availed a moratorium period for payment of EMIs for a
period of 3 months (March 01, 2020 to May 31, 2020):
Instalment overdue since Provision Provision required for
required the quarter
December 15, 2019 Yes March, 2020 – 5%
June, 2020 – 5%
January 01, 2020 Yes March, 2020 – 5%
June, 2020 – 5%
January 15, 2020 Yes June, 2020 – 10%
February 29, 2020 Yes June, 2020 – 10%
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b. Working Capital Facilities

In case of working capital facilities wherein the benefit of exclusion
of period of March 01, 2020 to May 31, 2020 is availed, a general
provision of 10% would be required to be made to the extent of total
outstanding in the loan accounts in phased-wise manner as follows:
(i) Quarter ended March 31, 2020 – not less than 5 per cent
(ii) Quarter ending June 30, 2020 – not less than 5 per cent
The said provision would be applicable only in the cases wherein
such accounts would otherwise (i.e., without availing the benefit
related to ‘out of order’) have been marked as NPA and the said
provisioning requirement will not apply to the accounts which
otherwise would have continued to be under standard category.
c. The above provisions may be adjusted against the actual
provisioning requirements for slippages from the accounts reckoned
for such provisions. The residual provisions at the end of the
financial year can be written back or adjusted against the provisions
required for all other accounts.
d. The above provisions shall not be reckoned for arriving at net the
NPAs till they are adjusted against the actual provisioning
requirements as specified earlier. Further, till such adjustments,
these provisions shall not be netted from gross advances but shown
separately in the balance sheet as appropriate.
e. The said provision is required to be made to the extent of the
balance outstanding in the account wherein such benefit is availed
and thus is not required to be made borrower-wise.
v. As regards the accounts which have been marked as NPA as at February
29, 2020, the asset classification norms based on subsequent aging
would continue as per usual asset classification. Thus, the relaxation
specified in this circular is limited to the extent the borrower accounts
which were standard as at February 29, 2020 and not otherwise.
vi. It would be pertinent to note that the said circular specifies as regards
maintenance of status quo of account classification as at February 29,
2020 up to May 31, 2020 but that does not preclude upgradation of an
NPA account on account of extinction of delinquencies in the said
account due to which the account was classified as NPA (e.g.: In case of
term loan account, borrower has repaid the overdue amount to the fullest
extent).
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vii. The circular provides for the disclosure and reporting requirements
related to the assets which have availed the asset classification benefit as
per the extant relaxation under this circular.
11.356 The RBI issued circular RBI/2019-20/244 DOR.No.BP.BC.71/
21.04.048/2019-20 dated May 23, 2020 on COVID 19 Regulatory Package
thereby further extending the benefit provided vide earlier circular RBI/2019-
20/220 DOR.No.BP.BC. 63/21.04.048/2019-20 dated April 17, 2020 on COVID
19 Regulatory Package - Asset Classification and Provisioning, granting relief
w.r.t. Asset Classification and Provisioning as follows:
i. Term Loans: The specified lending institutions were permitted to extend
the moratorium by another three months, i.e., from June 01, 2020 to
August 31, 2020 on payment of all instalments in respect of term loans
(including agricultural term loans, retail and crop loans) and accordingly
residual tenor of repayment shifted across the board. Interest continued
to accrue on the outstanding portion of term loans during the moratorium
period.
ii. Working Capital Finance: The lending institutions were permitted
deferment of another three months, from June 01, 2020 to August 31,
2020 on recovery of interest applied. Further, the lending institutions were
permitted at their discretion, to convert accumulated interest for
deferment period up to August 31, 2020 into a funded interest term loan
(FITL), which shall be repayable not later than March 31, 2021.
iii. Easing of Working Capital Finance: The relief earlier granted to working
capital facilities sanctioned in the form of CC/OD to borrowers facing
stress on account of the economic fallout of the pandemic, lending
institutions was extended by permitting to recalculate the ‘drawing power’
by reducing the margins till August 31, 2020 and wherein temporary
enhancement of in drawing power is considered the margins to be
restored to original levels by March 31, 2021 and/or review of the working
capital sanctioned limits up to March 31, 2021, based on a reassessment
of working capital cycle.
iv. The conversion of accumulated interest into FITL as permitted under this
circular was not to be treated as concession granted due to financial
difficulty of the borrower and consequently will not result in asset
classification downgrade, thereby granting relief in the form of retention of
class of asset to such accounts.
v. Further relief was granted –as under:
a. In respect of accounts classified as standard as on February 29,
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2020, even if overdue, the moratorium period, wherever granted in

respect of term loans, shall be excluded by the lending institutions
from the number of days past-due for the purpose of asset
classification under the IRAC norms. The asset classification for
such accounts shall be determined on the basis of revised due dates
and the revised repayment schedule;
b. in respect of working capital facilities sanctioned in the form of cash
credit/overdraft (“CC/OD”), where the account is classified as
standard, including SMA, as on February 29, 2020, the deferment
period, wherever granted in terms of the circular shall be excluded
for the determination of out of order status.
COVID19 Regulatory Package – Review of Resolution Timelines
under the Prudential Framework on Resolution of Stressed Assets
11.357 The RBI issued circular RBI/2019-20/219
DOR.No.BP.BC.62/21.04.048/2019-20 dated April 17, 2020 on COVID 19
Regulatory Package - Review of Resolution Timelines under the Prudential
Framework on Resolution of Stressed Assets as follows:
The relief was granted in the form of extension of timelines under the
Prudential Framework on Resolution of Stressed Assets dated June 07, 2019 –
As per para 11 of the Prudential Framework, lenders are required to implement
a resolution plan in respect of entities in default within 180 days from the end
of Review Period of 30 days. The relaxation was given as follows:
a. In respect of accounts which were within the Review Period as on March
1, 2020, the period from March 1, 2020 to May 31, 2020 shall be
excluded from the calculation of the 30-day timeline for the Review
Period. In respect of all such accounts, the residual review period shall
resume from June 1, 2020, upon expiry of which the lenders shall have
the usual 180 days for resolution.
b. In respect of accounts where the review period was over, but the 180-day
resolution period had not expired as on March 1, 2020, the timeline for
resolution shall get extended by 90 days from the date on which the 180-
day period was originally set to expire.
11.358 Accordingly, the requirement of making additional provisions specified
in Paragraph 17 of the Prudential Framework shall be triggered as and when
the extended resolution period, as stated above, expires.
11.359 The lending institutions shall make relevant disclosures in respect of
accounts where the resolution period was extended in the ‘Notes to Accounts’
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while preparing their financial statements for the half year ending September 30,
2020 as well as the financial years FY 2020 and FY 2021.
11.360 The RBI issued Circular RBI/2019-20/245 DOR.No.BP.BC.72/21.04.
048/ 2019-20 dated May 23, 2020 on COVID 19 Regulatory Package - Review
of Resolution Timelines under the Prudential Framework on Resolution of
Stressed Assets, thereby further extending the benefit provided vide earlier
circular RBI/2019-20/219 DOR.No.BP.BC.62/21.04.048/2019-20 dated April
17, 2020 as follows:
a. In respect of accounts which were within the Review Period as on March
1, 2020, the period from March 1, 2020 to August 31, 2020 shall be
excluded from the calculation of the 30-day timeline for the Review
Period. In respect of all such accounts, the residual Review Period shall
resume from September 1, 2020, upon expiry of which the lenders shall
have the usual 180 days for resolution.
b. In respect of accounts where the Review Period was over, but the 180-
day resolution period had not expired as on March 1, 2020, the timeline
for resolution shall get extended by 180 days from the date on which the
180-day period was originally set to expire.
Resolution Framework for COVID19 related Stress
11.361 The RBI issued circular RBI/2020-21/16 DOR.No.BP.BC/3/
21.04.048/2020-21 dated August 06, 2020 providing window under Prudential
Framework to enable lenders to implement a resolution plan in respect of eligible
corporate exposures without change in ownership and personal loans, while
classifying such exposures as standard, subject to certain conditions. The
resolution under this facility was to be extended only to borrowers having stress
on account of Covid19 and the lending institutions requiring to assess the
viability of resolution plan subject to laid out prudential boundaries. Further, the
lending institutions are required to frame Board approved policies pertaining to
implementation of viable resolution plans for eligible borrowers under this
framework and also lay down the due diligence considerations to be followed to
establish the necessity of implementing a resolution plan w.r.t. the concerned
borrower. The reference date for outstanding amount of debt for resolution would
be March 01, 2020.
11.362 The following accounts are not eligible for resolution plan under this
framework:
i. MSME borrowers whose aggregate exposure to lending institutions
collectively, is Rs. 25 crore or less as on March 1, 2020;
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ii. Farm credit as listed in Paragraph 6.1 of Master Direction

FIDD.CO.Plan.1/04.09.01/2016-17 dated July 7, 2016 (as updated) or other
relevant instructions as applicable to specific category of lending
institutions;
iii. Loans to Primary Agricultural Credit Societies (PACS), Farmers' Service
Societies (FSS) and Large-sized Adivasi Multi- Purpose Societies (LAMPS)
for on-lending to agriculture;
iv. Exposures of lending institutions to financial service providers
v. Exposures of lending institutions to Central and State Governments; Local
Government bodies and body corporates established by an Act of
Parliament or State Legislature;
vi. Exposures of housing finance companies where the account has been
rescheduled in terms of para 2(1)(zc)(ii) of the Master Circular - The
Housing Finance Companies (NHB) Directions, 2010 after March 1, 2020,
unless a resolution plan under this framework has been invoked by other
lending institutions.
11.363 Resolution of Stress in Personal Loans
i. Eligibility:
a. The personal loans which are standard but not in default for more than
30 days as on March 01, 2020, i.e., accounts which are standard but
not under SMA1 or SMA2 category as on March 01, 2020.
b. The date of invocation is the date on which both borrower and lender
agree to proceed with a resolution plan under this framework. The
eligible accounts should be classified as ‘Standard’ till the date of
invocation of resolution under this framework.
ii. The resolution can be invoked up to December 31, 2020 and must be
implemented within 90 days from the date of invocation.
iii. The resolution plan may include:
a. Re-scheduling of payments
b. Conversion of any interest accrued or to be accrued into another credit
facility (FITL)
c. Granting of moratorium based on assessment of income streams of
borrower, subject to maximum of two years and accordingly overall
tenor modified commensurately. Moratorium if granted shall come into
force immediately upon implementation of the resolution plan.
439
iv. The resolution plan shall be deemed to be implemented if all the following
conditions are met:
a. all related documentation, including execution of necessary
agreements between lending institutions and borrower and collaterals
provided, if any, are completed by the lenders concerned in
consonance with the resolution plan being implemented;
b. the changes in the terms of conditions of the loans get duly reflected
in the books of the lending institutions; and
c. borrower is not in default with the lending institution as per the revised
terms.
v. Any resolution plan implemented in breach of these stipulated timeline shall
be governed by Prudential Framework, as if the resolution process was
never invoked under this Framework.
11.364 Resolution of Other Exposures
i. Eligibility:
a. All the eligible exposures which are not personal loan, and are
standard but not in default for more than 30 days as on March 01,
2020, i.e., accounts which are standard but not under SMA1 or SMA2
category as on March 01, 2020.
b. The date of invocation is the date on which both borrower and lender
agree to proceed with a resolution plan under this Framework. The
eligible accounts should be classified as ‘Standard’ till date of
invocation of resolution under this framework.
c. In case of multiple lending exposures to borrower, the resolution
process would be considered as invoked if
(1) lending institutions representing 75 per cent by value of the total
outstanding credit facilities (fund based as well non-fund based);
and
(2) not less than 60 per cent of lending institutions by number agree
to invoke the same.
failing to which, the invocation will be treated as lapsed.
ii. The resolution can be invoked up to December 31, 2020 and must be
implemented within 180 days from the date of invocation.
iii. In cases involving multiple lending institutions, where the resolution process
is invoked and consequently a resolution plan has to be implemented, ICA
shall be required to be signed by all lending institutions within 30 days from
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the date of invocation, failing to which, the invocation will be treated as

lapsed.
iv. Any resolution plan implemented in breach within the stipulated timeline
shall be fully governed by Prudential Framework, as if the resolution
process was never invoked under this Framework.
v. Expert Committee:
The RBI constituted an Expert Committee to recommend a list of financial
parameters which, in their opinion would be required to be factored into the
assumptions that go into each resolution plan, and the sector specific
benchmark ranges for such parameters. The parameters shall inter alia
cover aspects related to leverage, liquidity, debt serviceability etc.
The Expert Committee submitted list of financial parameters (vide report
dated September 04, 2020) and sector-specific desirable ranges for such
parameters to RBI which in turn notified the Financial Parameters vide
circular RBI/2020-21/34 DOR.No.BP.BC/13/21.04.048/2020-21 dated
September 07, 2020.
This Expert Committee has the responsibility of vetting the resolution plans
to be implemented under this window in respect of all accounts where the
aggregate exposure of the lending institutions at the time of invocation of
the resolution process is Rs. 1500 crore and above. The Committee would
check and verify that all the processes have been followed by the parties
concerned as desired without interfering with the commercial judgments
exercised by the lenders.
vi. Permitted features of Resolution Plan
a. Involving any action as provided in Paragraph 13 of the ‘Prudential
Framework’ permitted except compromise settlement.
b. Resolution Plan may include sanctioning of additional credit facilities.
c. Extension of residual tenor of loan allowed, with or without
moratorium, by a period not more than two years and moratorium if
granted to come in force with immediate effect upon implementation
of resolution plan.
d. The revised assumptions that go into the plan shall, at the minimum,
factor in the financial parameters decided by the Expert Committee
and the ranges for such parameters, as notified by RBI.
e. Conversion of a portion of debt into equity or other marketable, non-
convertible debt securities issued by borrower permitted subject to
fulfilment of conditions specified thereto.
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vii. If the aggregate exposure of the lending institutions at the time of

invocationof plan is Rs. 100 crores and above, and independent credit
evaluation (ICE) by any one credit rating agency (CRA) authorised by RBI
under Prudential Framework would be required.
11.365 Asset Classification and Provisioning
i. If a resolution plan is implemented in adherence to the provisions of this
facility, the asset classification of borrowers’ accounts classified as
Standard may be retained as such upon implementation, whereas the
borrowers’ accounts which may have slipped into NPA between invocation
and implementation may be upgraded as Standard, as on the date of
implementation of the plan.
ii. In respect of personal loans where a resolution plan is implemented under
this facility, the lending institutions shall keep provisions from the date of
implementation, which are higher of the provisions held as per the extant
IRAC norms immediately before implementation, or 10 percent of the
renegotiated debt exposure of the lending institution post implementation
(residual debt).
iii. In other cases where a resolution plan is implemented under this facility,
the lending institutions, which had signed the ICA within 30 days of
invocation, shall keep provisions from the date of implementation, which are
higher of the provisions held as per the extant IRAC norms immediately
before implementation, or 10 percent of the total debt, including the debt
securities issued in terms of clause 30, held by the ICA signatories post-
implementation of the plan (residual debt).
iv. If, lending institutions did not sign the ICA within 30 days of invocation, they
shall, immediately upon the expiry of 30 days, keep provision of 20 per cent
of the debt on their books as on this date (carrying debt), or the provision
required as per extant IRAC norms, whichever is higher. Even in cases
where the invocation lapses on account of the thresholds for ICA signing
not being met, such lending institutions which had earlier agreed for
invocation but did not sign the ICA shall also be required to hold 20 percent
provisions on their carrying debt.
v. Additional provision, if any, maintained by lending institutions in terms of
Circular DOR.No.BP.BC.63/21.04.048/2019-20 dated April 17, 2020 in
respect of such borrowers, to the extent not already reversed, may be
utilised for meeting the provision requirements in all cases under this
facility.
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vi. Any additional provision maintained in terms of Paragraph 17 of the

Prudential Framework, wherever applicable, may be reversed at the time of
invocation of the resolution plan under this facility. However, if the plan is
not implemented within 180 days from invocation, provision as per the
Prudential Framework shall be required to be maintained, as if a resolution
process was never invoked under this window.
11.366 Reversal of Provisions
i. In case of personal loans resolved under this facility, half of the above
provision may be written back upon the borrower paying at least 20 per
cent of the residual debt without slipping into NPA post implementation of
the plan, and the remaining half may be written back upon the borrower
paying another 10 per cent of the residual debt without slipping into NPA
subsequently.
ii. In case of resolution of other exposures, the provision maintained by the
ICA signatories may be reversed as prescribed in clause 44. However, in
respect of the non-ICA signatories while half of the provision may be
reversed upon repayment of 20 percent of the carrying debt, the other half
may be reversed upon repayment of another 10 per cent of the carrying
debt, subject to the required IRAC provisions being maintained.
11.367 Post-implementation Performance
i. For personal loans, after implementation of the resolution plan in terms of
this facility, the subsequent asset classification will be governed by the
criteria laid out in the Master Circular on Prudential norms on Income
Recognition, Asset Classification and Provisioning pertaining to Advances
dated July 1, 2015.
ii. In respect of exposures other than personal loans, any default by the
borrower with any of the signatories to the ICA during the monitoring period
shall trigger a Review Period of 30 days. ‘Monitoring period’, for this
purpose, is defined as the period starting from the date of implementation
of the resolution plan till the borrower pays 10 per cent of the residual debt,
subject to a minimum of one year from the commencement of the first
payment of interest or principal (whichever is later) on the credit facility with
longest period of moratorium.
iii. If the borrower is in default with any of the signatories to the ICA at the end
of the Review Period, the asset classification of the borrower with all
lending institutions, including those who did not sign the ICA, shall be
downgraded to NPA from the date of implementation of the resolution plan
or the date from which the borrower had been classified as NPA before
implementation of the plan, whichever is earlier.
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iv. In all cases, further upgradation shall be subject to implementation of a

fresh restructuring under the Prudential Framework.
v. Upon completion of the monitoring period without being classified as NPA,
the asset classification norms will revert to the criteria laid out in the Master
Circular onPrudential norms on Income Recognition, Asset Classification
and Provisioning pertaining to Advances dated July 1, 2015.
vi. The provision required to be maintained under this window, to the extent
not already reversed, shall be available for: (i) the provisioning
requirements when any of the accounts, where a resolution plan had been
implemented, is subsequently classified as NPA; as well as, (ii) the
additional provisioning requirements on account of Paragraph 17 of the
Prudential Framework, as and when the Prudential Framework becomes
applicable in respect of the particular account.
11.368 Disclosure and Credit Reporting
i. Lending institutions publishing quarterly statements shall, at the minimum,
make disclosures as per the format prescribed in Format-A to the circular in
their financial statements for the quarters ending March 31, 2021, June 30,
2021 and September 30, 2021. Such lending institutions shall also make
disclosures in the format prescribed in Format-B to the circular every half-
year, i.e., in the financial statements as on September 30 and March 31,
starting from the half-year ending September 30, 2021 till all exposures on
which resolution plan was implemented are either fully extinguished or
completely slips into NPA, whichever is earlier.
ii. Lending institutions required to publish only annual financial statements
shall make the required disclosures in their annual financial statements,
along with other prescribed disclosures.
iii. The credit reporting by the lending institutions in respect of borrowers
where the resolution plan is implemented under this facility shall reflect the
“restructured” status of the account if the resolution plan involves
renegotiations that would be classified as restructuring under the Prudential
Framework. The credit history of the borrowers shall consequently be
governed by the respective policies of the credit information companies as
applicable to accounts that are restructured.
11.369 The RBI published FAQs on Resolution Framework for Covid-19 on
October 13, 2020 related stress clarifying certain aspects related thereto.
i. The resolution plan may include:
a. Re-scheduling of payments
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b. Conversion of any interest accrued or to be accrued into another

credit facility (FITL)
c. Granting of moratorium based on assessment of income streams of
borrower, subject to maximum of two years and accordingly overall
tenor modified commensurately. The moratorium period if granted
shall come into force immediately upon implementation of the
resolution plan.
ii. The resolution plan shall be deemed to be implemented if all the specified
conditions herein below are met:
a. all related documentation, including execution of necessary
agreements between lending institutions and borrower and collaterals
provided, if any, are completed by the lenders concerned in
consonance with the resolution plan being implemented;
b. the changes in the terms of conditions of the loans get duly reflected
in the books of the lending institutions; and
c. borrower is not in default with the lending institution as per the revised
terms.
iii. Any resolution plan implemented in breach of these stipulated timeline shall
be governed by Prudential Framework.
Supreme Court Order dated September 03, 2020
11.370 The Supreme Court passed an interim order on September 03, 2020 in
the Writ Petition filed by Gajendra Sharma, stating that ‘the accounts which were
not declared NPA till 31.08.2020 shall not be declared NPA till further orders’. In
view of the said interim order if a bank has not classified any account as NPA
subsequent to August 31, 2020, which otherwise would have been classified as
NPA, the Auditor should ensure that
1. The Auditor shall make a suitable reference in the audit report as
prescribed in Standards on Auditing, to the disclosure made by the bank
along with reference to the said interim order of Supreme Court in financial
statements.
2. In the accounts which are not marked as NPA by a bank, (which otherwise
would have been required to be marked as NPA as per IRAC norms), the
income recognition and provisions norms would be continued to be applied
as if such accounts are marked as NPA, i.e. income on such account would
be recognised on cash basis and a provision would also be made, as would
have required to be made had this account been marked as NPA.
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Provisioning for Loans and Advances

11.371 The RBI’s Master Circular no. RBI/2015-16/101 DBR.No.BP.BC. 2/
21.04.048/2015-16 dated July 1, 2015 on Prudential Norms on Income
Recognition, Asset Classification and Provisioning pertaining to advances
contains the principles to be followed by the bank in calculating the provisions
required for the NPAs in conformity with the prudential norms. The circular also
requires the bank to take into consideration aspects such as time lag between
an account becoming an NPA, its recognition as such, realisation of security
and the erosion over time in the value of security charged to the bank, while
calculating the required amount of provision. The specific requirements of the
Master Circular in respect of provisioning are as follows:
(a) Loss assets
The entire amount should be written off. If the assets are permitted to remain in
the books for any reason, 100 per cent of the outstanding should be provided
for.
(b) Doubtful assets
11.372 The provisioning for doubtful assets under loans and advances is as
under:
(i) Full provision to the extent of the unsecured portion should be made. In
doing so, the realisable value of the security available, to which the bank
has a valid recourse, should be determined on a realistic basis. The
Auditor should verify whether that security is considered based on the
latest information available with the bank. Also check if DICGC/ECGC
cover is taken into account.
(ii) In regard to the secured portion, provision may be made on the following
basis, at the rates ranging from 25 to 100 per cent of secured portion
depending upon the period for which the asset has remained doubtful. In
case the advance covered by CGTSI guarantee becomes non-
performing, no provision need be made towards the guaranteed portion.
The amount outstanding in excess of the guaranteed portion should be
provided for as per the extant guidelines on provisioning for non-
performing advances.
Period for which the advance has % of provision
been considered as doubtful on secured
portion
Up to 1 year 25
More than 1 year and up to 3 years 40
More than three years 100
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Valuation of Security: With a view to bringing down divergence arising out of

difference in assessment of the value of security, in cases of NPAs with
balance of Rs. 5 crore and above, stock audit at annual intervals by external
agencies appointed as per the guidelines approved by the Board is mandatory
in order to enhance the reliability on stock valuation. Collaterals, such as
immovable properties charged in favour of the bank are required to be got
valued once in three years by valuers appointed as per the guidelines
approved by the Board of Directors.
(c) Sub-standard assets
11.373 A general provision of 15 per cent on total outstanding should be
made without making any allowance for DICGC/ECGC cover and securities
available. Unsecured exposures, which are identified, as sub-standard would
attract an additional provision of 10 per cent (i.e., total 25 per cent of total
outstanding). However, in view of certain safeguards such as escrow accounts
available in respect of infrastructure lending, infrastructure loan accounts which
are classified as sub-standard will attract a provisioning of 20 per cent instead
of the aforesaid prescription of 25 per cent. To avail of this benefit of lower
provisioning, the banks should have in place an appropriate mechanism to
escrow the cash flows and also have a clear and legal first claim on these cash
flows. Unsecured exposure' is defined as an exposure (including all funded and
non-funded exposures) where realisable value of the tangible security properly
charged to the bank, as assessed by bank/approved valuers/RBI inspectors, is
not more than 10 per cent, ab initio, of the outstanding exposure. ‘Security’
means tangible security properly discharged to the bank and will not include
intangible securities like guarantees (including State Government guarantees),
comfort letters, etc.
In order to enhance transparency and ensure correct reflection of the
unsecured advances in Schedule 9 of the banks' balance sheet, the following
RBI requirements are applicable from the financial year 2009-10 onwards:
a) For determining the amount of unsecured advances for reflecting in
schedule 9 of the published balance sheet, the rights, licenses,
authorisations, etc., charged to the banks as collateral in respect of
projects (including infrastructure projects) financed by them, should not be
reckoned as tangible security. Hence such advances shall be reckoned as
unsecured.
b) However, banks may treat annuities under Build-Operate-Transfer (BOT)
model in respect of road / highway projects and toll collection rights, where
there are provisions to compensate the project sponsor if a certain level of
traffic is not achieved, as tangible securities subject to the condition that
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banks' right to receive annuities and toll collection rights is legally

enforceable and irrevocable.
c) It is noticed that most of the infrastructure projects, especially
road/highway projects are user-charge based, for which the Planning
Commission has published Model Concession Agreements (MCAs). These
have been adopted by various Ministries and State Governments for their
respective Public-Private Partnership (PPP) projects and they provide
adequate comfort to the lenders regarding security of their debt. In view of
the above features, in case of PPP projects, the debts due to the lenders
may be considered as secured to the extent assured by the project
authority in terms of the Concession Agreement, subject to the following
conditions:
i) User charges / toll / tariff payments are kept in an escrow account
where senior lenders have priority over withdrawals by the
concessionaire;
ii) There is sufficient risk mitigation, such as pre-determined increase
in user charges or increase in concession period, in case project
revenues are lower than anticipated;
iii) The lenders have a right of substitution in case of concessionaire
default;
iv) The lenders have a right to trigger termination in case of default in
debt service; and
v) Upon termination, the Project Authority has an obligation of (i)
compulsory buy-out and (ii) repayment of debt due in a pre-
determined manner.
In all such cases, banks must satisfy themselves about the legal
enforceability of the provisions of the tripartite agreement and factor in
their past experience with such contracts.
d) Banks should also disclose the total amount of advances for which
intangible securities such as charge over the rights, licenses, authority,
etc., have been taken as also the estimated value of such intangible
collateral. The disclosure may be made under a separate head in "Notes
to Accounts". This would differentiate such loans from other entirely
unsecured loans.
As per the existing instructions of RBI, in the Balance Sheet of the banks, the
amounts comprising debtors (though not tangible assets), charged as security
are grouped as secured by tangible assets and disclosure is made with a
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remark in parenthesis in the Schedule 9, without any quantification of the

advances covered by security of debtors. The amounts comprising the
intangibles as per the RBI’s Master Circular no. RBI/2015-16/101 DBR. No.
BP.BC.2/21.04.048/2015-16 on Prudential Norms on Income Recognition,
Asset Classification and Provisioning pertaining to Advances will need to be
culled out of the secured exposures and quantified to be reflected as
unsecured advances; which would also require corresponding reclassification
of advances for the earlier year. More importantly, in case of NPAs, the
unsecured portion would attract a higher provision, when segregated from the
secured portion.
(d) Standard Assets
11.374 The bank is required to make a general provision for standard assets
at the following rates for the funded outstanding on global loan portfolio basis.
The general provision towards standard assets as per Master Circular is as
follows:
a) Farm Credit to Agricultural and Small and Micro Enterprises (SMEs)
sectors - 0.25%.
b) Advances to Commercial Real Estate (CRE) sector – 1.00%.
c) Advances to Commercial Real Estate – Residential Housing Sector (CRE -
RH) at 0.75 per cent.
For this purpose, CRE-RH would consist of loans to builders/developers
for residential housing projects (except for captive consumption) under
CRE segment. Such projects should ordinarily not include non-residential
commercial real estate. However, integrated housing projects comprising
of some commercial space (e.g. shopping complex, school, etc.) can also
be classified under CRE-RH, provided the commercial area in the
residential housing project does not exceed 10% of the total Floor Space
Index (FSI) of the project. In case the FSI of the commercial area in the
predominantly residential housing complex exceeds the ceiling of 10%,
the project loans should be classified as CRE and not CRE-RH.
d) Housing loans extended at teaser rates– 2.00%- The provisioning on
these assets would revert to 0.40 per cent after 1 year from the date on
which the rates are reset at higher rates if the accounts remain ‘standard’.
e) In terms of RBI Circular No. RBI/2016-17/317-DBR.BP.BC.No.
72/08.12.015/2016-17 dated June 07, 2017 on “Individual Housing Loans:
Rationalisation of Risk-Weights and Loan to Value (LTV) Ratios”, the bank
should make standard asset provision of 0.25% on individual housing loan
sanctioned on or after June 07, 2017. In respect of individual housing loan
sanctioned before that date provisions @ 0.40% is required to be made on
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standard assets in terms of Circular No. RBI/2015-16/200

DBR.BP.BC.No.44/ 08.12.015/ 2015-16 dated October 08, 2015 on
“Individual Housing Loans: Rationalisation of Risk-Weights and LTV
Ratios”.
f) Restructured accounts classified as standard advances will attract a higher
provision (as prescribed from time to time) in the first two years from the
date of restructuring. In cases of moratorium on payment of
interest/principal after restructuring, such advances will attract the
prescribed higher provision for the period covering moratorium and two
years thereafter.
Restructured accounts classified as non-performing advances, when
upgraded to standard category will attract a higher provision (as prescribed
from time to time) in the first year from the date of upgradation.
11.375 As per para 17.4.1 of Master Circular No. RBI/2015-16/101
DBR.No.BP.BC.2/21.04.048/2015-16 issued on July 1, 2015 on ‘Prudential
Norms on Income Recognition, Asset Classification and Provisioning pertaining
to Advances”, with effect from April 1, 2016 provision on new restructured
standard accounts would be made at 5 per cent.
All other loans and advances not included in (a), (b), (c), (d) and (e) above -
0.40%.
11.376 It is clarified that the Medium Enterprises will attract 0.40% standard
asset provisioning. The RBI issued circular RBI/2020-2021/10 FIDD.MSME &
NFS.BC.No.3/06.02.31/2020-21 dated July 02, 2020 specifying the criteria for
classification of enterprises into micro, small and medium enterprise with
reference to notification by Government of India through Gazette Notification
S.O. 2119 (E) dated June 26, 2020, as regards new criteria for classifying the
enterprises as Micro, Small and Medium enterprises w.e.f. July 01, 2020.
Further, the RBI has issued clarifications as regards new definition of the terms
Micro Enterprises, Small Enterprises, and Medium Enterprises vide circular
RBI/2020-2021/26 FIDD.MSME & NFS.BC.No.4/06.02.31/2020-21 dated August
21, 2020.
11.377 While the provisions on individual portfolios are required to be
calculated at the rates applicable to them, the excess or shortfall in the
provisioning, vis-a-vis the position as on any previous date, should be
determined on an aggregate basis. If the provisions required to be held on an
aggregate basis are less than the provisions held as on November 15, 2008,
the provisions rendered surplus should not be reversed to profit and loss
account but should continue to be maintained at the level, existed as on
November 15, 2008. In case of shortfall determined on aggregate basis, the
balance should be provided for by debit to profit and loss account.
450
11.378 The provisions on standard assets should not be reckoned for arriving
at net NPAs. The provisions towards Standard Assets need not be netted from
gross advances but included as 'Contingent Provisions against Standard
Assets' under 'Other Liabilities and Provisions - Others' in Schedule 5 of the
balance sheet.
11.379 Banks shall make additional provision of 2% (in addition to country
risk provision that is applicable to all overseas exposures) against standard
assets representing all exposures to the step-down subsidiaries of Indian
companies, to cover the additional risk arising from complexity in the structure,
location of different intermediary entities in different jurisdictions exposing the
Indian company, and hence the bank, to greater political and regulatory risk.
All the step-down subsidiaries, including the intermediate ones, must be wholly
owned subsidiaries of the immediate parent company or its entire shares shall
be jointly held by the immediate parent company and the Indian parent
company and / or its wholly owned subsidiary. The immediate parent should,
wholly or jointly with Indian parent company and / or its wholly owned
subsidiary, have control over the step-down subsidiary.
11.380 A high level of unhedged foreign currency exposures of the entities
can increase the probability of default in times of high currency volatility.
Hence, banks are required to estimate the risk of unhedged position of their
borrowers as per the instructions contained in RBI circular no. RBI/2013-
14/448 DBOD.No.BP.BC.85/21.06.200/2013-14 dated January 15, 2014 on
“Capital and Provisioning Requirements for Exposures to entities with
Unhedged Foreign Currency Exposure” and circular no. RBI/2013-14/620
DBOD.No.BP.BC.116/21.06.200/2013-14 dated June 3, 2014 on “Capital and
Provisioning Requirements for Exposures to entities with Unhedged Foreign
Currency Exposure-Clarifications” and make incremental provisions on their
exposures to such entities:
Likely Loss / EBID (%) Incremental Provisioning
Requirement on the total
credit exposures over and
above extant standard asset
provisioning
Up to 15 per cent 0
More than 15 per cent and up to 30 per 20 bps
cent
cent
cent
More than 75 per cent 80 bps
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Unhedged Foreign Currency Exposure of Corporates

11.381 To ensure that each bank has a policy that explicitly recognises and
takes account of risks arising out of foreign exchange exposure of their clients,
foreign currency loans above US$ 10 million, or such lower limits as may be
deemed appropriate vis-à-vis the banks’ portfolios of such exposures, should be
extended by banks only on the basis of a well laid out policy of their Boards with
regard to hedging of such foreign currency loans. Further, the policy for hedging,
to be framed by their Boards, may consider, as appropriate for convenience,
excluding the following:
 Where forex loans are extended to finance exports, banks may not insist
on hedging but assure themselves that such customers have uncovered
receivables to cover the loan amount.
 Where the forex loans are extended for meeting forex expenditure.
11.382 Banks may also consider stipulating a limit on unhedged position of
corporates on the basis of bank's Board approved policy. In this context,
attention of the readers is also invited to RBI’s Circular No.
DBOD.No.BP.BC.85/ 21.06.200/2013-14 on “Capital and Provisioning
Requirements for Exposures to entities with Unhedged Foreign Currency
Exposure” dated January 15, 2014 and clarification DBOD.No.BP.BC.116/
21.06.200/2013-14 dated June 3, 2014 on “Capital and Provisioning
Requirements for Exposures to entities with Unhedged Foreign Currency
Exposure-Clarifications” providing requirements for exposures to entities with
unhedged foreign currency exposure.
11.383 The Auditor while carrying out the audit of the Unhedged Foreign
Currency Exposure (UFCE) should ensure that the Bank has:-
 Obtained the UFCE information from all its branches (including foreign
branches) in respect of large borrowers.
 Obtained a certificate in respect of UFCE from entities on a quarterly
basis on self-certification basis, which has preferably been internally
audited by the entity concerned. However, at least on an annual basis,
UFCE information should be audited and certified by the statutory
auditors of the entity for its authenticity.
 Computed “Capital and Provisioning Requirements for Exposures to
entities with UFCE” at least on a quarterly basis, as per the applicable
RBI guidelines.
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Provisioning requirements for derivative exposures

11.384 Credit exposures computed as per the current marked to market value
of the contract, arising on account of the interest rate and foreign exchange
derivative transactions, and gold, shall also attract provisioning requirement as
applicable to the loan assets in the 'standard' category, of the concerned
counterparties. All conditions applicable for treatment of the provisions for
standard assets would also apply to the aforesaid provisions for derivative and
gold exposures.
Provisioning Norms for Leased Assets
11.385 i) Substandard assets
a) 15 per cent of the sum of the net investment in the lease and the
unrealised portion of finance income net of finance charge
component. The terms ‘net investment in the lease’, ‘finance income’
and ‘finance charge’ are as defined in ‘AS 19 Leases’ issued by the
ICAI.
b) Unsecured lease exposures which are identified as ‘substandard’
would attract additional provision of 10 per cent, i.e., a total of 25 per
cent.
ii) Doubtful assets
iii) Loss assets
Provisioning norms for aforesaid clause (ii) & (iii) are same as applicable to
Advances.
Accounting and Provisioning Norms for Equipment Leasing Activity
11.386 While the accounting and provisioning norms discussed above shall
also apply in respect of equipment leasing activities the bank should follow AS
19 on “Leases” issued by ICAI in accounting for lease transactions.
Advances Guaranteed by ECGC
11.387 In the case of advances guaranteed by ECGC, provision should be
made only for the balance in excess of the amount of such guarantee. Further,
while arriving at the provision required to be made for doubtful assets,
realisable value of the securities should first be deducted from the outstanding
balance in respect of the amount guaranteed by these Corporations and then
provision should be made (For examples on calculation of the provision, refer
the Master Circular no. RBI/2015-16/101 DBR.No.BP.BC.2/21.04.048/2015-
16 on “Prudential Norms on Income Recognition, Asset Classification and
Provisioning pertaining to Advances, dated July 1, 2015).
453
Advance covered by guarantees of Credit Guarantee Fund Trust for Micro

and Small Enterprises (CGTMSE) or Credit Risk Guarantee Fund Trust for
Low Income Housing (CRGFTLIH)
11.388 In case the advance covered by CGTMSE or CRGFTLIH guarantee
becomes non-performing, no provision need be made towards the guaranteed
portion. The amount outstanding in excess of the guaranteed portion should be
provided for as per the extant guidelines on provisioning for non- performing
advances. For illustrative examples of provisioning in case of advances
covered by CGTSI guarantee, refer Paragraph 5.9.5 of the Master Circular No.
on Prudential Norms on Income Recognition, Asset Classification and
Provisioning Pertaining to Advances, dated July 1, 2015.
Divergences reported by RBI
11.389 After statutory audit, RBI conducts annual financial inspection of banks.
Auditors may go through the divergence reported by RBI, if any, in terms of
classification as well as provisioning and whether the same divergence has been
appropriately addressed /clarified, by Banks. Accordingly, the Auditor would be
well advised to consider these aspects while take final view on classification
/provisioning of such accounts.
Reserve for Exchange Rate Fluctuations Account (RERFA)
11.390 When exchange rate movements of Indian rupee turn adverse, the
outstanding amount of foreign currency denominated loans (where actual
disbursement was made in Indian Rupee) which become overdue goes up
correspondingly, with its attendant implications of provisioning requirements.
Such assets should not normally be revalued. In case such assets need to be
revalued as per requirement of accounting practices or for any other
requirement, the following procedure may be adopted:
 The loss on revaluation of assets has to be booked in the bank's profit and
loss account.
 Besides the provisioning requirement as per Asset Classification, banks
should treat the full amount of the Revaluation Gain relating to the
corresponding assets, if any, on account of Foreign Exchange Fluctuation
as provision against the particular assets.
Provisioning For Country Risk
11.391 Banks are required to make provisions, with effect from the year
ending 31 March 2003, on the net funded country exposures on a graded scale
ranging from 0.25 to 100 per cent according to the risk categories mentioned
454
below. To begin with, banks are required to make provisions as per the
following schedule:
Risk Category ECGC Classification Provisioning
requirement
(per cent)
Insignificant A1 0.25
Low A2 0.25
Moderate B1 5
High B2 20
Very high C1 25
Restricted C2 100
Off-credit D 100
11.392 Banks are required to make provision for country risk in respect of a
country where its net funded exposure is one per cent or more of its total assets.
The provision for country risk shall be in addition to the provisions required to be
held according to the asset classification status of the asset. In the case of ‘loss
assets’ and ‘doubtful assets’, provision held, including provision held for country
risk, may not exceed 100% of the outstanding. Banks may not make any
provision for ‘home country’ exposures i.e. exposure to India. The exposures of
foreign branches of Indian banks to the host country should be included. Foreign
banks shall compute the country exposures of their Indian branches and shall
hold appropriate provisions in their Indian books. However, their exposures to
India will be excluded. Banks may make a lower level of provisioning (say 25% of
the requirement) in respect of short-term exposures (i.e., exposures with
contractual maturity of less than 180 days).
11.393 Provisioning norms for sale of financial assets to Securitisation
Company (SC) / Reconstruction company (RC) –
(i) When a bank / FI sells its financial assets to SC/ RC, on transfer the
same will be removed from its books.
(ii) If the sale of financial assets to SC/RC, is at a price below the net book
value (NBV) (i.e., book value less provisions held), the shortfall should be
debited to the profit and loss account of that year. Banks can also use
countercyclical / floating provisions for meeting any shortfall on sale of
NPAs i.e., when the sale is at a price below the net book value (NBV).
455
However, for assets sold on or after February 26, 2014 and up to March
31, 2015, as an incentive for early sale of NPAs, banks can spread over
any shortfall, if the sale value is lower than the NBV, over a period of two
years. This facility of spreading over the shortfall will be subject to
necessary disclosures in the Notes to Account in Annual Financial
Statements of the banks. The RBI vide Notification dated May 21, 2015
had decided to extend this dispensation for assets sold on or after March
31, 2015 and up to March 31, 2016.
Further RBI has vide notification RBI/2015-16/423 DBR.No.BP.BC.102
/21.04.048/2015-16 dated June 13, 2016 on “Prudential Norms on Income
Recognition, Asset Classification and Provisioning pertaining to Advances –
Spread Over of Shortfall on Sale of NPAs to SCs/RCs” has decided to
extend the dispensation of amortising the shortfall up to March 31, 2017.
However, for the assets sold from the period April 1, 2016 to March 31,
2017, banks will be allowed to amortise the shortfall over a period of only
four quarter from the quarter in which the sale took place.
Further, where a bank chooses to make the necessary provisions over
more than one quarter and this results in the full provisioning remaining to
be made as on the close of a financial year, banks should debit 'other
reserves' [i.e., reserves other than the one created in terms of Section 17(2)
of the Banking Regulation Act 1949] by the amount remaining un-provided
at the end of the financial year, by credit to specific provisions. However,
banks should proportionately reverse the debits to ‘other reserves’ and
complete the provisioning by debiting profit and loss account, in the
subsequent quarters of the next financial year.
Banks shall make suitable disclosures in the ‘Notes to Accounts’ with
regard to the quantum of provision made during the year to meet the
shortfall in sale of NPAs to SCs/RCs and the quantum of unamortised
provision debited to ‘other reserves’ as at the end of the year.
(iii) For assets sold on or after February 26, 2014, banks can reverse the
excess provision on sale of NPAs, if the sale value is for a value higher
than the NBV, to its profit and loss account in the year the amounts are
received. However, banks can reverse excess provision arising out of
sale of NPAs only when the cash received (by way of initial consideration
and / or redemption of SRs / PTCs) is higher than the net book value
(NBV) of the asset. Further, reversal of excess provision will be limited to
the extent to which cash received exceeds the NBV of the asset. With
regard to assets sold before February 26, 2014, excess provision, on
account of sale value being higher than NBV, should not be reversed but
456
should be utilized to meet the shortfall/ loss on account of sale of other

financial assets to SC/RC.
(iv) When banks/ FIs invest in the security receipts/ pass-through certificates
issued by SC/RC in respect of the financial assets sold by them to the
SC/RC, the sale shall be recognised in the books of the banks / FIs at the
lower of:
 the redemption value of the security receipts/ pass-through
certificates; and
 the NBV of the financial asset.
The above investment should be carried in the books of the bank / FI at
the price as determined above until its sale or realization, and on such
sale or realization, the loss or gain must be dealt with in the same manner
as at (ii) and (iii) above.
11.394 All instruments received by banks/FIs from SC/RC as sale
consideration for financial assets sold to them and also other instruments
issued by SC/ RC in which banks/ FIs invest will be in the nature of non SLR
securities. Accordingly, the valuation, classification and other norms applicable
to investment in non-SLR instruments prescribed by RBI from time to time
would be applicable to bank’s/ FI’s investment in debentures/ bonds/ security
receipts/PTCs issued by SC/ RC. However, if any of the above instruments
issued by SC/RC is limited to the actual realisation of the financial assets
assigned to the instruments in the concerned scheme the bank/ FI shall reckon
the Net Asset Value (NAV), obtained from SC/RC from time to time, for
valuation of such investments.
11.395 Investments of banks and FIs in debentures/ bonds/ security
receipts/PTCs issued by a SC/RC will constitute exposure on the SC/RC. As
only a few SC/RC are being set up now, banks’/ FIs’ exposure on SC/RC
through their investments in debentures/ bonds/security receipts/PTCs issued
by the SC/ RC may go beyond their prudential exposure ceiling. In view of the
extra ordinary nature of such event, banks/ FIs will be allowed, in the initial
years, to exceed prudential exposure ceiling on a case-to-case basis. Banks/
FIs, which sell their financial assets to a SC/ RC, shall be required to make the
disclosures in the Notes on Accounts in their Balance sheets. For guidelines on
the presentation of the disclosures, refer Para 6.6 of the Master Circular no.
RBI/2015-16/101 DBR.No.BP.BC.2/21.04.048/ 2015-16 on Prudential norms
on Income Recognition, Asset Classification and Provisioning pertaining to
Advances.
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Write-off of NPAs
11.396 Banks without forgoing the right of recovery, may prudentially write off
non-performing advances and claim tax benefits as applicable, by evolving
appropriate methodology in consultation with their auditors / tax consultants.
Subsequent recoveries in such accounts should be offered for tax as per the
rules. Banks may write-off advances at Head Office level, even though the
advances are still outstanding in the branch books. At the branch level,
provision requirement as per classification norms shall be made and in respect
of loss assets 100 per cent provision shall be made.
Readers may refer Chapter 25 “Recovery of Non-Performing Assets by Asset
Recovery Branches” of Section B of this Guidance Note for Guidelines on
Sale/Purchase of NPAs.
Audited Financial Statements in case of Bank Borrowers
11.397 The RBI vide Circular no. DBOD.No. CAS(COD)BC.146/27-77 dated
December 22, 1977 had prescribed that all borrowers having credit limit of
Rs.10 lakh and above from the banking system should get their annual
accounts audited by chartered accountants. Further the RBI vide circular
DBOD.No.BP.BC.33/21.04.018/2002-03 dated October 21, 2002 on
“Certification of Borrower's Account by Chartered Accountants” has authorised
the Board of Directors of banks to fix a suitable cut off limit with reference to
the borrowing entity's overall exposure on the banking system, over which
audit of accounts of borrower by chartered accountants would be mandatory.
Projects under Implementation
11.398 For all projects financed by the FIs/ banks after 28th May 2002, the date
of completion of the project should be clearly spelt out at the time of financial
closure of the project.
Project Loans
11.399 There are occasions when the completion of projects is delayed for
legal and other extraneous reasons like delays in Government approvals etc. All
these factors, which are beyond the control of the promoters, may lead to delay
in project implementation and involve restructuring/rescheduling of loans by
banks. Accordingly, the following asset classification norms would apply to the
project loans before commencement of commercial operations. These guidelines
will, however, not be applicable to restructuring of advances classified as
Commercial Real Estate exposures; Advances classified as Capital Market
exposure; and Consumer and Personal Advances which will continue to be dealt
with in terms of the extant provisions. For this purpose, all project loans have
been divided into the following two categories:
458
a. Project loans for infrastructure sector.

b. Project loans for non-infrastructure sector.
'Project loan' would mean any term loan which has been extended for the
purpose of setting up of an economic venture. Banks must fix a date of
Commencement of Commercial Operations (DCCO) for all project loans at the
time of sanction of the loan / financial closure (in the case of multiple banking or
consortium arrangements).
Project Loans for Infrastructure Sector
11.400 (i) A loan for an infrastructure project will be classified as NPA during any
time before commencement of commercial operations as per record of
recovery (90 days overdue), unless it is restructured and becomes eligible
for classification as 'standard asset' in terms of paras (iii) to (v) below.
(ii) A loan for an infrastructure project will be classified as NPA if it fails to
commence commercial operations within two years from the original
DCCO, even if it is regular as per record of recovery, unless it is
restructured and becomes eligible for classification as 'standard asset' in
terms of paras (iii) to (v) below.
(iii) If a project loan classified as 'standard asset' is restructured any time during
the period up to two years from the original date of commencement of
commercial operations (DCCO), in accordance with the provisions of Part B
of this Master Circular, it can be retained as a standard asset if the fresh
DCCO is fixed within the following limits, and further provided the account
continues to be serviced as per the restructured terms.
(a) Infrastructure Projects involving court cases
Up to another 2 years (beyond the existing extended period of 2 years
i.e. total extension of 4 years), in case the reason for extension of
date of commencement of production is arbitration proceedings or a
court case.
(b) Infrastructure Projects delayed for other reasons beyond the control of
promoters
Up to another 1 year (beyond the existing extended period of 2 years
i.e. total extension of 3 years), in other than court cases.
(iv) It is re-iterated that the dispensation is subject to adherence to the
provisions regarding restructuring of accounts as contained in the Master
Circular which would inter alia require that the application for restructuring
459
should be received before the expiry of period of two years from the original
DCCO and when the account is still standard as per record of recovery.
The other conditions applicable would be:
a. In cases where there is moratorium for payment of interest, banks
should not book income on accrual basis beyond two years from the
original DCCO, considering the high risk involved in such restructured
accounts.
b. Banks should maintain provisions on such accounts as long as these
are classified as standard assets as under:
Particulars Provisioning Requirement
If the revised DCCO is within 0.40 per cent

two years from the original
DCCO prescribed at the time of
financial closure
If the DCCO is extended beyond Project loans restructured with effect

two years and up to four years from June 1, 2013:
or three years from the original
5.00 per cent – From the date of such
DCCO, as the case may be,
restructuring till the revised DCCO or
depending upon the reasons for
2 years from the date of restructuring,
such delay
whichever is later.
(v) For the purpose of these guidelines, mere extension of DCCO would not be
considered as restructuring, if the revised DCCO falls within the period of
two years from the original DCCO. In such cases the consequential shift in
repayment period by equal or shorter duration (including the start date and
end date of revised repayment schedule) than the extension of DCCO
would also not be considered as restructuring provided all other terms and
conditions of the loan remain unchanged.
(vi) In case of infrastructure projects under implementation, where the
appointed date (as defined in the concession agreement) is shifted due to
the inability of the Concession Authority to comply with the requisite
conditions, change in date of commencement of commercial operations
(DCCO) need not be treated as ‘restructuring’, subject to following
conditions:
460
a. The project is an infrastructure project under public private partnership

model awarded by a public authority.
b. The loan disbursement is yet to begin.
c. The revised date of commencement of commercial operations is
documented by way of a supplementary agreement between the
borrower and lender.
d. Project viability has been reassessed and sanction from appropriate
authority has been obtained at the time of supplementary agreement.
Project Loans for Non-Infrastructure Sector
11.401 (i) A loan for a non-infrastructure project will be classified as NPA during
any time before commencement of commercial operations as per the
record of recovery (90 days overdue), unless it is restructured and becomes
eligible for classification as 'standard asset' in terms of paras (iii) to (iv)
below.
(ii) A loan for a non-infrastructure project will be classified as NPA if it fails to
commence commercial operations within one year from the original DCCO,
even if is regular as per record of recovery, unless it is restructured and
becomes eligible for classification as 'standard asset' in terms of paras (iii)
to (iv) below.
(iii) In case of non-infrastructure projects, if the delay in commencement of
commercial operations extends beyond the period of one year from the
date of completion as determined at the time of financial closure, banks can
prescribe a fresh DCCO, and retain the "standard" classification by
undertaking restructuring of accounts in accordance with the provisions
contained in this Master Circular, provided the fresh DCCO does not extend
beyond a period of two years from the original DCCO. This would among
others also imply that the restructuring application is received before the
expiry of one year from the original DCCO, and when the account is still
"standard" as per the record of recovery.
The other conditions applicable would be:
a. In cases where there is moratorium for payment of interest, banks
should not book income on accrual basis beyond one year from the
original DCCO, considering the high risk involved in such restructured
accounts.
b. Banks should maintain provisions on such accounts as long as these
are classified as standard assets as under:
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Particulars Provisioning Requirement

If the revised DCCO is within one 0.40 per cent
year from the original DCCO
prescribed at the time of financial
closure
If the DCCO is extended beyond one Project loans restructured with
year and up to two years from the effect from June 1, 2013:
original DCCO prescribed at the time 5.00 per cent – From the date of
of financial closure restructuring for 2 years.
(iv) For this purpose, mere extension of DCCO would not be considered as
restructuring, if the revised DCCO falls within the period of two years from
the original DCCO. In such cases the consequential shift in repayment
period by equal or shorter duration (including the start date and end date of
revised repayment schedule) than the extension of DCCO would also not
be considered as restructuring provided all other terms and conditions of
the loan remain unchanged.
Project Loans in Commercial Real Estate (CRE) Sector
11.402 The project loans to CRE sector should be identified on the basis of
instructions issued vide circulars DBOD.BP.BC.No.42/08.12.015/2009-10 dated
September 9, 2009 and DBOD.BP.BC. No.104/08.12.015/2012-13 dated June
21, 2013.
11.403 The RBI vide circular RBI/2019-20/158 DOR.No.BP.BC.33/ 21.04.048
/2019-20 dated February 07, 2020 harmonised the guidelines for deferment of
date of DCCO for projects in non-infrastructure and commercial real estate
(CRE) sectors. Accordingly, revised guidelines for deferment of DCCO for CRE
projects were issued as follows:
(i) Revisions of the date of DCCO and consequential shift in repayment
schedule for equal or shorter duration (including the start date and end date
of revised repayment schedule) will not be treated as restructuring provided
that:
a. The revised DCCO falls within the period of one year from the original
DCCO stipulated at the time of financial closure for CRE projects; and
b. All other terms and conditions of the loan remain unchanged.
(ii) In case of CRE projects delayed for reasons beyond the control of
promoter(s), banks may restructure them by way of revision of DCCO up to
another one year (beyond the one-year period quoted at paragraph i (a)
above) and retain the ‘standard’ asset classification if the account continues
462
to be serviced as per the revised terms and conditions under the

restructuring.
(iii) Banks while restructuring such CRE project loans under instructions at (ii)
above will have to ensure that the revised repayment schedule is extended
only by a period equal to or shorter than the extension in DCCO.
(iv) Banks may fund cost overruns that arise on account of extension of DCCO
(within the limits at (i) and (ii) above), subject to the instructions issued vide
circular DBOD.No.BP.BC.33/21.04.048/2014-15 dated August 14, 2014
and the mailbox clarification dated April 20, 2016.
(v) It is re-iterated that a loan for a project may be classified as NPA during any
time before commencement of commercial operations as per the record of
recovery (90 days overdue). It is further re-iterated that the dispensation at
(ii) above is subject to the condition that the application for restructuring
should be received before the expiry of period mentioned at paragraph (i)
(a) above and when the account is still standard as per record of recovery.
(vi) At the time of extending DCCO, Boards of banks should satisfy themselves
about the viability of the project and the restructuring plan.
(vii) All other aspects related to restructuring, income recognition, asset
classification, provisioning as applicable for projects under implementation
shall continue to apply.
(viii) Banks shall ensure that all provisions of the Real Estate (Regulation and
Development) Act, 2016 are complied with.
Change in Ownership
11.404 (i) In order to facilitate revival of the projects stalled primarily due to
inadequacies of the current promoters, if a change in ownership takes place
any time during the periods quoted in paragraphs 4.2.15.3 of the Master
Circular No. RBI/2015-16/101DBR.No.BP.BC.2/21.04.048/2015-16 was
issued on July 1, 2015 on ‘Prudential Norms on Income Recognition, Asset
Classification and Provisioning Pertaining to Advances” or before the
original DCCO, banks may permit extension of the DCCO of the project up
to two years in addition to the periods quoted at paragraph 4.2.15.3 of the
aforesaid circular as the case may be, without any change in asset
classification of the account subject to the conditions stipulated in the
following paragraphs. Banks may also consequentially shift/extend
repayment schedule, if required, by an equal or shorter duration.
(ii) In cases where change in ownership and extension of DCCO (as indicated
in paragraph 4.2.15.5 (i) of the aforesaid circular) takes place before the
463
original DCCO, and if the project fails to commence commercial operations

by the extended DCCO, the project will be eligible for further extension of
DCCO in terms of guidelines quoted at Paragraph 4.2.15.3 of the aforesaid
circular. Similarly, where change in ownership and extension of DCCO
takes place during the period quoted in Paragraph 4.2.15.3 (i) of the
aforesaid circular, the account may still be restructured by extension of
DCCO in terms of guidelines quoted at Paragraph 4.2.15.3 (ii) of the
aforesaid circular, without classifying the account as non-performing asset.
(iii) The provisions of Paragraphs 4.2.15.4 (i) and 4.2.15.4 (ii) of the aforesaid
circular are subject to the following conditions:
a. Banks should establish that implementation of the project is
stalled/affected primarily due to inadequacies of the current
promoters/management and with a change in ownership there is a very
high probability of commencement of commercial operations by the
project within the extended period.
b. The project in consideration should be taken-over/acquired by a new
promoter/promoter group with sufficient expertise in the field of
operation. If the acquisition is being carried out by a special purpose
vehicle (domestic or overseas), the bank should be able to clearly
demonstrate that the acquiring entity is part of a new promoter group
with sufficient expertise in the field of operation.
c. The new promoters should own at least 51 per cent of the paid up
equity capital of stake in the acquired project. If the new promoter is a
non-resident, and in sectors where the ceiling on foreign investment is
less than 51 per cent, the new promoter should own atleast 26 per cent
of the paid up equity capital or up to applicable foreign investment limit,
whichever is higher, provided banks are satisfied that with this equity
stake the new non-resident promoter controls the management of the
project.
d. Viability of the project should be established to the satisfaction of the
banks.
e. Intra-group business restructuring/mergers/acquisitions and/or
takeover/acquisition of the project by other entities/subsidiaries/
associates etc. (domestic as well as overseas), belonging to the existing
promoter/promoter group will not qualify for this facility. The banks
should clearly establish that the acquirer does not belong to the existing
promoter group.
f. Asset classification of the account as on the ‘reference date’ would
464
continue during the extended period. For this purpose, the ‘reference
date’ would be the date of execution of preliminary binding agreement
between the parties to the transaction, provided the acquisition/takeover
of ownership as per the provisions of law/regulations governing such
acquisition/takeover is completed within a period of 90 days from the
date of execution of preliminary binding agreement. During the
intervening period, the usual asset classification norms would continue
to apply. If the change in ownership is not completed within 90 days
from the preliminary binding agreement, the ‘reference date’ would be
the effective date of acquisition/takeover as per the provisions of
law/regulations governing such acquisition/ takeover.
g. The new owners/promoters are expected to demonstrate their
commitment by bringing in substantial portion of additional monies
required to complete the project within the extended time period. As
such, treatment of financing of cost overruns for the project shall be
subject to the guidelines prescribed in paragraph 13 of the circular.
Financing of cost overrun beyond the ceiling prescribed in paragraph 13
of the circular would be treated as an event of restructuring even if the
extension of DCCO is within the limits prescribed above.
h. While considering the extension of DCCO (up to an additional period of
2 years) for the benefits envisaged hereinabove, banks shall make sure
that the repayment schedule does not extend beyond 85 per cent of the
economic life/concession period of the project.
i. This facility would be available to a project only once and will not be
available during subsequent change in ownership, if any.
(iv) Loans covered under this guideline would attract provisioning as per the
extant provisioning norms depending upon their asset classification status.
Other Issues
11.405 (i) All other aspects of restructuring of project loans before
commencement of commercial operations would be governed by the
provisions of Part B of Master Circular no. RBI/2015-16/101
DBR.No.BP.BC.2/ 21.04.048/2015-16 on Prudential norms on Income
Recognition, Asset Classification and Provisioning Pertaining to Advances.
Restructuring of project loans after commencement of commercial
operations will also be governed by these instructions.
(ii) Any change in the repayment schedule of a project loan caused due to an
increase in the project outlay on account of increase in scope and size of
the project, would not be treated as restructuring if:
465
(a) The increase in scope and size of the project takes place before
commencement of commercial operations of the existing project;
(b) The rise in cost excluding any cost-overrun in respect of the original
project is 25 per cent or more of the original outlay;
(c) The bank re-assesses the viability of the project before approving the
enhancement of scope and fixing a fresh DCCO; and
(d) On re-rating, (if already rated) the new rating is not below the previous
rating by more than one notch.
(iii) Multiple revisions of the DCCO and consequential shift in repayment
schedule for equal or shorter duration (including the start date and end date
of revised repayment schedule) will be treated as a single event of
restructuring provided that the revised DCCO is fixed within the respective
time limits stipulated at Paragraphs 4.2.15.3 (iii) and 4.2.15.4 (iii) of the
Master Circular No. RBI/2015-16/101DBR.No.BP.BC.2/21.04.048/2015-16
on “Prudential norms on Income Recognition, Asset Classification and
Provisioning pertaining to Advances”, dated July 1, 2015 and all other terms
and conditions of the loan remained unchanged.
(iv) Banks, if deemed fit, may extend DCCO beyond the respective time limits
stipulated at Paragraphs 4.2.15.3 (iii) and 4.2.15.4 (iii) of the Master
Circular No. RBI/2015-16/101 DBR.No.BP.BC.2/21.04.048/2015-16 on
“Prudential norms on Income Recognition, Asset Classification and
Provisioning pertaining to Advances”, dated July 1, 2015; however, in that
case, banks will not be able to retain the ‘standard’ asset classification
status of such loan accounts.
(v) In all the above cases of restructuring where regulatory forbearance has
been extended, the Boards of banks should satisfy themselves about the
viability of the project and the restructuring plan.
(vi) The RBI vide Circular No. RBI/2014-15/182 DBOB. No.BP.BC.33/
21.04.048/2014-15 dated August 14, 2014 on “Prudential Norms on
Income Recognition, Assets Classification and Provisioning Pertaining to
Advances – Project under Implementation” (read with Master Circular no.
RBI/2015-16/101 DBR.No.BP.BC.2/21.04.048/2015-16 dated July 01, 2015
on Prudential norms on Income Recognition, Asset Classification and
Provisioning pertaining to Advances), mentions that banks have
represented to RBI that in respect of funding of cost overruns, which may
arise on account of extension of DCCO within the above (i.e.; two years
and one year for infrastructure and non-infrastructure projects respectively
from original DCCO date with other terms and conditions remain
466
unchanged), time limits may be allowed without treating the loans as

restructured.
(vii) In cases where banks have specifically sanctioned a ‘standby facility’ at the
time of initial financial closure to fund cost overruns, they may fund cost
overruns as per the agreed terms and conditions.
(viii) Where the initial financial closure does not envisage such financing of cost
overruns, based on the representations from banks, it has been decided to
allow banks to fund cost overruns, which may arise on account of extension
of DCCO within the time limits quoted at Paragraph (i) above, without
treating the loans as ‘restructured asset’ subject to the following conditions:
(a) Banks may fund additional ‘Interest during Construction’, which may
arise on account of delay in completion of a project.
(b) Other cost overruns (excluding Interest during Construction) up to a
maximum of 10 per cent of the original project cost.
(c) Debt equity ratio as agreed at the time of initial financial closure
should remain unchanged subsequent to funding cost overruns or
improve in favour of the lenders and the revised Debt Service
Coverage Ratio should be acceptable to the lenders.
(d) Disbursement of funds for cost overruns should start only after the
Sponsors/Promoters bring in their share of funding of the cost
overruns.
(e) All other terms and conditions of the loan should remain unchanged or
enhanced in favour of the lenders.
Flexible structuring of Long Term Project Loans to Infrastructure and
Core Industries
11.406 (i) In view of the challenges faced by Banks, the RBI has clarified in
Circular no. DBOD.No.BP.BC.24/21.04.132/2014-15 on Flexible Structuring
of Long Term Project Loans to Infrastructure and Core Industries dated July
15, 2014 (read with Master Circular no. RBI/2015-16/101
DBR.No.BP.BC.2/21.04.048/2015-16 dated July 01, 2015 on Prudential
norms on Income Recognition, Asset Classification and Provisioning
pertaining to Advances), that it has no objection to banks’ to fix longer
amortisation period for loans to projects in infrastructure and core industries
sectors, say 25 years, based on the economic life or concession period of
the project, with periodic refinancing, say every 5 years. For details refer to
the circular.
(ii) The RBI has further clarified in circular no. DBR.No.BP.BC.53/
21.04.132/2014-15 dated December 15, 2014 on “Flexible Structuring of
467
Existing Long Term Project Loans to Infrastructure and Core Industries”

that the flexible structuring of existing loans will be allowed in addition to
new loans as per the norms given in the circular.
(iii) For detailed guidelines on the Flexible structuring of Long Term Project
Loans, refer para 10 and 11 of the Master Circular DBR.No.BP.BC.2/
21.04.048/ 2015-16 on “Prudential norms on Income Recognition, Asset
Classification and Provisioning pertaining to Advances”.
Income recognition
11.407 (i) Banks may recognise income on accrual basis in respect of the
projects under implementation, which are classified as ‘standard’.
(ii) Banks should not recognise income on accrual basis in respect of the
projects under implementation which are classified as a ‘substandard’
asset. Banks may recognise income in such accounts only on realisation on
cash basis. Consequently, banks which have wrongly recognised income in
the past should reverse the interest if it was recognised as income during
the current year or make a provision for an equivalent amount if it was
recognised as income in the previous year(s). As regards the regulatory
treatment of ‘funded interest’ recognised as income and ‘conversion into
equity, debentures or any other instrument’ banks should adopt the
following:
a) Funded Interest: Income recognition in respect of the NPAs,
regardless of whether these are or are not subjected to restructuring/
rescheduling/ renegotiation of terms of the loan agreement, should be
done strictly on cash basis, only on realisation and not if the amount
of interest overdue has been funded. If, however, the amount of
funded interest is recognised as income, a provision for an equal
amount should also be made simultaneously. In other words, any
funding of interest in respect of NPAs, if recognised as income, should
be fully provided for.
b) Conversion into equity, debentures or any other instrument: The
amount outstanding converted into other instruments would normally
comprise principal and the interest components. If the amount of
interest dues is converted into equity or any other instrument, and
income is recognised in consequence, full provision should be made
for the amount of income so recognised to offset the effect of such
income recognition. Such provision would be in addition to the amount
of provision that may be necessary for the depreciation in the value of
the equity or other instruments, as per the investment valuation
468
norms. However, if the conversion of interest is into equity which is

quoted, interest income can be recognised at market value of equity,
as on the date of conversion, not exceeding the amount of interest
converted to equity. Such equity must thereafter be classified in the
“available for sale” category and valued at lower of cost or market
value. In case of conversion of principal and /or interest in respect of
NPAs into debentures, such debentures should be treated as NPA, ab
initio, in the same asset classification as was applicable to loan just
before conversion and provision made as per norms. This norm would
also apply to zero coupon bonds or other instruments which seek to
defer the liability of the issuer. On such debentures, income should be
recognised only on realization basis. The income in respect of
unrealised interest which is converted into debentures or any other
fixed maturity instrument should be recognized only on redemption of
such instrument. Subject to the above, the equity shares or other
instruments arising from conversion of the principal amount of loan
would also be subject to the usual prudential valuation norms as
applicable to such instruments.
Provisioning norms on restructured advances
Normal provisions
11.408 (i) Banks will hold provision against the restructured advances as per the
extant provisioning norms.
(ii) Restructured accounts classified as standard advances will attract a higher
provision (as prescribed from time to time) in the first two years from the
date of restructuring. In cases of moratorium on payment of interest/principal
after restructuring, such advances will attract the prescribed higher provision
for the period covering moratorium and two years thereafter.
(iii) Restructured accounts classified as non-performing advances, when
upgraded to standard category will attract a higher provision (as prescribed
from time to time) in the first year from the date of upgradation.
(iv) The above-mentioned higher provision on restructured standard advances
(2.75 per cent as prescribed vide circular dated November 26, 2012) would
increase to 5 per cent in respect of new restructured standard accounts
(flow) with effect from June 1, 2013 and increase to 5% by FY: 2015-16 in a
phased manner for the stock of restructured standard accounts as on May
31, 2013.
469
Provision for diminution in the fair value of restructured advances-

11.409 (i) Reduction in the rate of interest and/or rescheduling of the repayment
of principal amount, as part of the restructuring, will result in diminution in
the fair value of the advance. Such diminution in value is an economic loss
for the bank and will have impact on the bank's market value of equity. It is,
therefore, necessary for banks to measure such diminution in the fair value
of the advance and make provisions for it by debit to Profit and Loss
Account. Such provision should be held in addition to the provisions as per
existing provisioning norms and in an account distinct from that for normal
provisions.
For this purpose, the erosion in the fair value of the advance should be
computed as the difference between the fair value of the loan before and
after restructuring. Fair value of the loan before restructuring will be
computed as the present value of cash flows representing the interest at
the existing rate charged on the advance before restructuring and the
principal, discounted at a rate equal to the bank's BPLR or Base Rate6
(whichever is applicable to the borrower) as on the date of restructuring
plus the appropriate term premium and credit risk premium for the borrower
category on the date of restructuring. Fair value of the loan after
restructuring will be computed as the present value of cash flows
representing the interest at the rate charged on the advance on
restructuring and the principal, discounted at a rate equal to the bank's
BPLR or base rate (whichever is applicable to the borrower) as on the date
of restructuring plus the appropriate term premium and credit risk premium
for the borrower category on the date of restructuring.
The above formula moderates the swing in the diminution of present value
of loans with the interest rate cycle and will have to be followed consistently
by banks in future. Further, it is reiterated that the provisions required as
above arise due to the action of the banks resulting in change in contractual
terms of the loan upon restructuring which are in the nature of financial
concessions. These provisions are distinct from the provisions which are
linked to the asset classification of the account classified as NPA and
reflect the impairment due to deterioration in the credit quality of the loan.
Thus, the two types of the provisions are not substitute for each other.
ii) There could be divergences in the calculation of diminution of fair value of
accounts by banks. For example, divergences could occur if banks do not
6 This change has been introduced as a result of the introduction of Base Rate System w.e.f. July
1, 2010 vide circular DBOD.No.Dir.BC.88/13.03.00/2009-10 dated April 9, 2010 on ‘Guidelines on
the Base Rate’.
470
appropriately factor in the term premium on account of elongation of

repayment period on restructuring. In such a case the term premium used
while calculating the present value of cash flows after restructuring would
be higher than the term premium used while calculating the present value
of cash flows before restructuring.
Further, the amount of principal converted into debt/equity instruments on
restructuring would need to be held under AFS and valued as per usual
valuation norms. Since these instruments are getting marked to market, the
erosion in fair value gets captured on such valuation. Therefore, for the
purpose of arriving at the erosion in the fair value, the NPV calculation of
the portion of principal not converted into debt/equity has to be carried out
separately. However, the total sacrifice involved for the bank would be NPV
of the above portion plus valuation loss on account of conversion into
debt/equity instruments.
The Auditor should therefore verify that the bank has correctly captured
diminution in fair value of restructured accounts as it will have a bearing not
only on the provisioning required to be made by them but also on the
amount of sacrifice required from the promoters.
The Auditors should also verify that there is no any effort on the part of
banks to artificially reduce the net present value of cash flows by resorting
to any sort of financial engineering. The Auditor should also verify that there
is a proper mechanism in place of checks and balances to ensure accurate
calculation of erosion in the fair value of restructured accounts.
11.410 In the case of working capital facilities, the diminution in the fair value of
the cash credit / overdraft component may be computed as indicated in para
17.4.2 (i) of Master Circular No. RBI/2015-16/101DBR.No.BP.BC.2/
21.04.048/2015-16 issued on July 1, 2015 on “Prudential Norms on Income
Recognition, Asset Classification and Provisioning Pertaining to Advances”,
reckoning the higher of the outstanding amount or the limit sanctioned as the
principal amount and taking the tenor of the advance as one year. The term
premium in the discount factor would be as applicable for one year. The fair
value of the term loan components (Working Capital Term Loan and Funded
Interest Term Loan) would be computed as per actual cash flows and taking the
term premium in the discount factor as applicable for the maturity of the
respective term loan components.
11.411 If any security is taken in lieu of the diminution in the fair value of the
advance, it should be valued at Re.1/- till maturity of the security. This will ensure
that the effect of charging off the economic sacrifice to the Profit and Loss
account is not negated.
471
11.412 The diminution in the fair value may be re-computed on each balance
sheet date till satisfactory completion of all repayment obligations and full
repayment of the outstanding in the account, so as to capture the changes in the
fair value on account of changes in BPLR or base rate (whichever is applicable
to the borrower), term premium and the credit category of the borrower.
Consequently, banks may provide for the shortfall in the provision or reverse the
amount of excess provision held in the distinct account.
11.413 If due to lack of expertise / appropriate infrastructure, a bank finds it
difficult to ensure computation of diminution in the fair value of advances, as an
alternative to the methodology prescribed above for computing the amount of
diminution in the fair value, the bank has the option of notionally computing the
amount of diminution in the fair value and providing therefor, at five percent of
the total exposure, in respect of all restructured accounts where the total dues to
bank(s) are less than rupees one crore. The total provisions required against an
account (normal provisions plus provisions in lieu of diminution in the fair value of
the advance) are capped at 100 per cent of the outstanding debt amount.
Risk-Weights
11.414 The RBI circular also provides that:
a. Restructured housing loans should be risk weighted with an additional risk
weight of 25 percentage points.
b. With a view to reflecting a higher element of inherent risk which may be
latent in entities whose obligations have been subjected to restructuring /
rescheduling either by banks on their own or along with other bankers /
creditors, the unrated standard / performing claims on corporates should be
assigned a higher risk weight of 125 per cent until satisfactory performance
under the revised payment schedule has been established for one year from
the date when the first payment of interest / principal falls due under the
revised schedule.
c. For details on risk weights, Master Circular RBI/2015-16/58
DBR.No.BP.BC.1/21.06.201/ 2015-16 dated July 1, 2015 on ‘Basel III
Capital Regulations’ may be referred.
Prudential Norms for Conversion of Principal into Debt / Equity
Asset classification norms
11.415 A part of the outstanding, principal amount can be converted into debt
or equity instruments as part of restructuring. The debt / equity instruments so
created will be classified in the same asset classification category in which the
restructured advance has been classified. Further movement in the asset
classification of these instruments would also be determined based on the
subsequent asset classification of the restructured advance.
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Income recognition norms

Standard Accounts
11.416 In the case of restructured accounts classified as 'standard', the income,
if any, generated by these instruments may be recognised on accrual basis.
Non- Performing Accounts
11.417 In the case of restructured accounts classified as non-performing
assets, the income, if any, generated by these instruments may be recognised
only on cash basis.
Valuation and provisioning norms
11.418 These instruments should be held under AFS and valued as per usual
valuation norms. Equity classified as standard asset should be valued either at
market value, if quoted, or at break-up value, if not quoted (without considering
the revaluation reserve, if any) which is to be ascertained from the company's
latest balance sheet. In case the latest balance sheet is not available, the shares
are to be valued at Re. 1. Equity instrument classified as NPA should be valued
at market value, if quoted, and in case where equity is not quoted, it should be
valued at Re. 1. Depreciation on these instruments should not be offset against
the appreciation in any other securities held under the AFS category.
Prudential Norms for Conversion of Unpaid Interest into 'Funded Interest
Term Loan' (FITL), Debt or Equity Instruments
Asset classification norms
11.419 The FITL / debt or equity instrument created by conversion of unpaid
interest will be classified in the same asset classification category in which the
restructured advance has been classified. Further movement in the asset
classification of FITL / debt or equity instruments would also be determined
based on the subsequent asset classification of the restructured advance.
Income recognition norms
11.420 The income, if any, generated by these instruments may be recognised
on accrual basis, if these instruments are classified as 'standard', and on cash
basis in the cases where these have been classified as a non-performing asset.
11.421 The unrealised income represented by FITL / Debt or equity instrument
should have a corresponding credit in an account styled as "Sundry Liabilities
Account (Interest Capitalization)".
11.422 In the case of conversion of unrealised interest income into equity,
which is quoted, interest income can be recognized after the account is upgraded
473
to standard category at market value of equity, on the date of such upgradation,

not exceeding the amount of interest converted into equity.
11.423 Only on repayment in case of FITL or sale / redemption proceeds of the
debt / equity instruments, the amount received will be recognized in the P&L
Account, while simultaneously reducing the balance in the "Sundry Liabilities
Account (Interest Capitalisation)".
Valuation and Provisioning norms
11.424 Valuation and provisioning norms would be as referred above. The
depreciation, if any, on valuation may be charged to the Sundry Liabilities
(Interest Capitalisation) Account.
Introduction
B. Whether the branch is following the system of classification
the accounts into SMA-0, SMA-1, and SMA-2. Whether the auditor
disagrees with the branch classification of advances into standard
(Including SMA-0, SMA-1, SMA-2) /substandard/doubtful/ loss assets,
the details of such advances with reasons should be given. Also
indicate whether required changes have been incorporated/
suggested in the Memorandum of Changes.
11.425 (i) The auditor should obtain a listing of NPA classification obtained from
the system. If the same does not tally then a reconciliation should be
obtained.
(ii) If auditor does not agree with classification given by branch, he should give
necessary details along with reasons for the same.
(iii) This point also requires the Auditor to indicate whether suitable changes
have been incorporated in Memorandum of Changes as well.
C. Have you come across cases where the relevant Controlling
Authority of the bank has authorized legal action for recovery of
advances or recalling of advances but no such action was taken by
the branch? If so, give details of such cases.
Audit Procedures and Reporting:
11.426 The Auditor should ask for the list of cases from the management,
where approval for legal action for recovery of advances has been obtained from
controlling authority of bank. The Auditor should verify these cases and comment
where branch has not taken any legal action so far or taken with delay. Reasons
for delay should be ascertained.
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D. Whether the branch has reported accounts restructured or rephased

during the year to Controlling Authority of the bank?
11.427 The Auditor should verify reporting of the accounts restructured or
rephased during the year, to the controlling authority of the bank.
E. Have appropriate claims for credit guarantee (ECGC and Others), if any,
been duly lodged and settled? Give details of claims rejected? (As per the
given table)
Particulars Number Amount (Rs)
Claims as at the beginning of the year --------------- N.A. -----------------

(Give year-wise details)
Further claims lodged during the year --------------- N.A. -----------------
Total A
Amounts representing :
(a) claims accepted/settled ---------------- -----------------
(b) claims rejected
Total B
Balance as at the year-end (
A-B ---------------- N.A. -----------------
Whether the rejection is appropriately considered while determining the

provisioning requirements.
11.428 (i) The Auditor should verify that there is process of identifying the cases,
where claims are required to be lodged for credit guarantee (like ECGC and
others)
(ii) The Auditor should verify, whether in a required case, branch has taken
step for lodging the claims and same have been lodged.
(iii) The Auditor should obtain the numbers of accounts with outstanding
balance relating to credit guarantee claims (like ECGC and any other
claims). He should furnish year-wise breakup of number of account with
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amount in prescribed format for claims as at beginning of the year, claims

lodged, accepted /settled/ rejected during the year and balance at year end.
(iv) In cases where claims have been rejected, the Auditor should verify and
comment whether the rejection is appropriately considered while
determining the provisioning requirements.
F. In respect of non-performing assets, has the branch obtained valuation
reports from approved valuers for the immovables charged to the bank,
once in three years, unless the circumstances warrant a shorter duration?
Relevant Provision
11.429 Valuation reports should be obtained from empanelled valuers. The
bank should have a system of prior tracking of cases where the period of 3
years is expiring
11.430 According to the guidelines; the provisioning for doubtful assets under
loans and advances is as under:
(i) Full provision to the extent of the unsecured portion should be made. In
doing so, the realizable value of the security available, to which the bank
has a valid recourse, should be determined on a realistic basis. The
Auditor should verify whether the security is considered based on the
latest information available with the bank. Check if DICGC/ECGC cover is
also taken into account.
(ii) In regard to the secured portion, provision may be made on the following
basis, at the rates ranging from 25 to 100 per cent of secured portion
depending upon the period for which the asset has remained doubtful. In
case the advance covered by CGTMSE / CRGFTLIH / CGTSI guarantee
becomes non-performing, no provision need be made towards the
guaranteed portion. The amount outstanding in excess of the guaranteed
portion should be provided for as per the extant guidelines on provisioning
for non-performing advances.
Period for which the advance has % of provision on
been considered as doubtful secured
portion
Up to 1 year 25
More than 1 year and up to 3 years 40
More than three years 100
Note on valuation of Security: With a view to bringing down divergence arising
out of difference in assessment of the value of security, in cases of NPAs with
balance of Rs. 5 crore and above, stock audit at annual intervals by external
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agencies appointed as per the guidelines approved by the Board is mandatory in

order to enhance the reliability on stock valuation. Collaterals, such as
immovable properties charged in favour of the bank are required to be got valued
once in three years by valuers appointed as per the guidelines approved by the
Board of Directors.
11.431 (i) The Auditor should verify and comment whether, in case of NPA
accounts, branch has obtained approved valuer report for fixed assets
charged to bank once in three years or shorter duration as prescribed by
the bank. If there is any deviation same should be commented upon.
(ii) The Auditor should also verify and comment on compliance of Notes given
at the end of clause 5.3 of prudential norms master circular dated July 1,
2014 for stock audit and valuation of collaterals by external agencies in
case of NPAs with balance of Rs. 5 crore and above.
G. In the cases examined by you has the branch complied with the
Recovery Policy prescribed by the controlling authorities of the bank with
respect to compromise/settlement and write-off cases? Details of the cases
of compromise/settlement and write-off cases involving write-offs/ waivers
in excess of Rs.50.00 lakhs may be given.
11.432 (i) The Auditor should verify the cases of compromise/settlement and
write off during the year. The Auditor should verify that prescribed policy of
the bank for compromise/settlement and write off is followed by the branch.
Approval from designated authority has been obtained as per policy in all
cases.
(ii) The Auditor should obtain the details of all cases of compromise/ settlement
and write off cases involving write off/waiver in excess of Rs. 50 lacs and
submit along with report.
Renewal/ Enhancement/ Re-scheduling/ Balance Confirmation
Renewal
11.433 WCDL is granted for a fixed period on the expiry of which it has to be
liquidated, renewed or rolled over. Depending on the terms of sanction the
repayment of WCDL can either be in the form of instalments spread over the
tenure of the facility or bullet payment at the end of the tenure of the loan. WCDL
is generally granted to meet the gap in working capital requirement and
considered as a part of working capital facility at the time of renewal or roll over.
477
Each bank has its own procedures for sanctioning, disbursal, supervision and
renewal of advances. Following is the common process across banks w.r.t.
advances.
Renewal of Advances
11.434 Working capital advances are generally granted for one year at a time
and require renewal if the borrower wants to continue the facility beyond that
period at the same level, reduced level or increased level, depending upon the
borrower’s needs, its financial ratios, the bank’s perception of risk and so on.
Loans repayable over a period of time in instalments are not renewed. However,
some banks have a system of reviewing these loans from time to time primarily
with the objective of risk evaluation and interest rate resetting. The procedure
described above for sanction of advances is also followed, to the extent
applicable, for renewal of advances already granted to an applicant.
11.435 The RBI guidelines require banks to renew the advances within 6
months of the expiry of the limit. Hence no working capital limit can remain
without being reviewed for more than 18 months. It should be ensured that the
latest audited balance sheet, various compliance proofs should be on bank’s
record. Further the various monitoring reports such as inspections, stock audit
and operations in the account should be taken cognisance of during renewal.
Non-renewal sometimes may appear to be administrative delay but it may not be
so. Hence stricter compliances should be ensured.
Long Form Audit Report
11.436 The auditor has to comment on various specific issues as mentioned in
the Long Form Audit Report of the bank. While evaluating the efficacy of internal
controls over advances, the auditor should particularly examine those aspects on
which he is required to comment in his long form audit report. Thus, he should
examine, inter alia, whether the loan applications are complete and in prescribed
form; procedural instructions regarding grant/ renewal/enhancement of facilities
have been complied with; sanctions are within delegated authority and
disbursements are as per terms of the sanction; documentation is complete; and
supervision is timely, effective and as per prescribed guidelines. The auditor can
gather the requisite evidence by examining relevant documents (such as loan
application forms, supporting documentation, sanctions, security documents,
etc.) and by obtaining information and explanations from the branch
management in appropriate cases. The auditors must familiarise themselves with
those issues and guidance relating to the same and should cover the same
during the regular course of audit of advances.
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Enhancement
11.437 At the time of renewal of working capital facilities, the borrower may ask
for increase in the existing facilities, which is called enhancement. All the other
process is similar to that of renewal of working capital facilities, except the
exposure is higher than the earlier sanction.
Rescheduling / Restructuring
Retail Assets
11.438 The retail assets in various banks at present form a significant part of
their portfolio. As there are large numbers of accounts in these cases, the same
poses a challenge for the auditors. The classification and provisioning towards
the same should, however, be done as in case of other assets.
11.439 There may be a large number of accounts under retail assets, which
have been restructured/rescheduled during the respective years including
repetitive rephasements. The process of the bank to report / record all such
rescheduling / restructuring needs to be reviewed and adequacy of the same
should be checked. In case of restructuring of consumer and personal advances,
the same should immediately be treated as NPA. The accounts are treated as
restructured when the bank, for economic or legal reasons relating to borrower’s
financial difficulty, grants to the borrower concessions that the bank would
otherwise not consider. The HO of the bank should instruct properly to branches
in this regard.
Restructuring of cases
11.440 RBI has given guidelines for treatment of restructured accounts in part
B of the Master Circular no. RBI/2015-16/101 DBR. No. BP.BC.2/21.04.048/
2015-16 on Prudential Norms on Income Recognition, Assets Classification and
Provisioning Pertaining to Advances dated July 1, 2015.
11.441 RBI has given guidelines for early recognition of financial distress
whereby Joint Lenders Forum (JLF) will give a Corrective Action Plan (CAP) in
part C of the Master Circular no. RBI/2015-16/101 DBR.No.BP.BC.2/21.04.048/
2015-16 on Prudential Norms on Income Recognition, Assets Classification and
Provisioning Pertaining to Advances dated July 1, 2015.
11.442 RBI has given flexible restructuring scheme in Circular no.
DBOD.No.BP.BC.24/ 21.04.132/2014-15 dated July 15, 2014 on “Flexible
Structuring of Long Term Project Loans to Infrastructure and Core Industries”.
11.443 RBI has given SDR restructuring scheme in Circular no.
DBR.BP.BC.No.101/ 21.04.132/2014-15 dated June 8, 2015 on “Strategic Debt
Restructuring Scheme”.
479
11.444 RBI has given outside SDR restructuring scheme in Circular no.
DBR.BP.BC.No.41/ 21.04.048/2015-16 dated September 24, 2015 on “Prudential
Norms on Change in Ownership of Borrowing Entities (Outside Strategic Debt
Restructuring Scheme)”.
11.445 RBI has given S4A Scheme for sustainable structuring of stressed
assets in Circular no. DBR.No.BP.BC.103/21.04.132/2015-16 dated June 13,
2016 on “Scheme for Sustainable Structuring of Stressed Assets”.
11.446 RBI has issued circular no. DBR.No.BP.BC.101/21.04.048/2017-18
dated February 12, 2018 regarding Resolution of Stressed Assets – Revised
Framework, and subsequently issued circular no. DBR.No.BP.BC.45/
21.04.048/2018-19 dated June 7, 2019 regarding Prudential Framework for
Resolution of Stressed Assets, whereby the extant instructions on resolution of
stressed assets such as Framework for Revitalising Distressed Assets,
Corporate Debt Restructuring Scheme, Flexible Structuring of Existing Long
Term Project Loans, Strategic Debt Restructuring Scheme (SDR), Change in
Ownership outside SDR, and Scheme for Sustainable Structuring of Stressed
Assets (S4A) stand withdrawn with immediate effect. Accordingly, the Joint
Lenders’ Forum (JLF) as mandatory institutional mechanism for resolution of
stressed accounts also stands discontinued.
11.447 Once the bank receives an application/proposal in respect of an
account for restructuring, it implies that the account is intrinsically weak. Thereby
during the time the account remains pending for restructuring, the auditors need
to take a view whether provision needs to be made in respect of such accounts
pending approval for restructuring.
11.448 Existing loans to MSMEs classified as 'standard' may be restructured
without a downgrade in the asset classification, subject to the following
conditions:
NBFCs to the borrower does not exceed Rs. 25 crore as on March 1, 2020.
ii. The borrower’s account was a ‘standard asset’ as on March 1, 2020.
iii. The restructuring of the borrower account is implemented by March 31,
2021.
iv. The borrowing entity is GST-registered on the date of implementation of the
restructuring.
v. Asset classification of borrowers classified as standard may be retained as
such, whereas the accounts which may have slipped into NPA category
between March 2, 2020 and date of implementation of resolution plan may
be upgraded as ‘standard asset’, as on the date of implementation of the
restructuring plan.
480
vi. For accounts restructured under these guidelines, banks shall maintain
additional provision of 5% over and above the provision already held by
them.
[Reference: RBI notification DOR.No.BP .BC/4/21.04.048/2020-21 dated
August 6, 2020]
11.449 Vide Paragraphs 4 & 7 of RBI notification DOR.No.BP.BC.71/
21.04.048/2019-20 dated May 23, 2020, In respect of working capital facilities
sanctioned in the form of CC/OD to borrowers facing stress on account of the
economic fallout of the pandemic, banks may, as a one- time measure,
(i) recalculate the ‘drawing power’ by reducing the margins till August 31,
2020. However, in all such cases where such a temporary enhancement in
drawing power is considered, the margins shall be restored to the original
levels by March 31, 2021; and/or,
(ii) review the working capital sanctioned limits up to March 31, 2021, based on
a reassessment of the working capital cycle.
The above measures shall be contingent on the banks satisfying themselves that
the same is required on account of the economic fallout from COVID-19. Further,
accounts provided relief under these instructions shall be subject to subsequent
supervisory review with regard to their justifiability. Banks may, accordingly, put
in place a Board approved policy to implement the above measures.
Funding of Interest
11.450 In addition, the auditor should also consider the fact that during the
course of restructuring/rescheduling in any manner, the interest element, in
addition to the principal may also be rescheduled by the bank. This rescheduling
of interest may be with or without sacrifice. In some cases future interest may
also be funded apart from the principal. In such cases, the Auditor should
examine whether the RBI’s requirements with regard to provisioning for sacrifice
have been complied with by the bank. In case of interest sacrifice, the model
prescribed by RBI includes calculation and provisioning for sacrifice on future
interest as well. The Auditor should examine the terms of funding of interest and
if the same is in the nature of moratorium for payment of interest, then the
interest would become due only after the moratorium period is over. The funded
interest cannot be recognised as income if the account is treated as NPA.
11.451 In respect of working capital facilities sanctioned in the form of cash
credit/overdraft (“CC/OD”), banks are permitted to allow a deferment from March
1, 2020 to August 31, 2020, on recovery of interest applied in respect of all such
facilities. Banks are permitted, at their discretion, to convert the accumulated
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interest for the deferment period up to August 31, 2020, into a funded interest
term loan (FITL) which shall be repayable not later than March 31, 2021.The
conversion of accumulated interest into FITL are permitted to the borrowers to
specifically tide over economic fallout from COVID-19 and not be treated as
concessions granted due to financial difficulty of the borrower. [Reference:
Paragraphs 3 & 7 of RBI notification DOR.No.BP.BC.71/21.04.048/2019-20
dated May 23, 2020].
Sacrifice of interest
11.452 In respect of sacrifice of interest, the Auditor should examine the
following questions:
(a) Whether interest sacrifice involved in the amount of interest has been
provided for by debit to Profit and Loss account and held in a distinct
account.
(b) Whether sacrifice is recomputed on each balance sheet date till
satisfactory completion of all repayment obligations and full repayment of
the outstanding in the account, so as to capture the changes in the fair
value on account of changes in BPLR/ Base Rate, term premium and the
credit category of the borrower and the consequent shortfall in provision or
reversal of the amount of excess provision has been held in the distinct
account.
(c) Whether in the event any security taken against interest sacrifice, the
same has been valued at Re.1/- till maturity of the security. As per RBI
norms, the interest sacrifice in all the restructured cases needs to be
worked out including for Working Capital Loans. In the case of working
capital facilities, the diminution in the fair value of the cash credit
/overdraft component may be computed reckoning the higher of the
outstanding amount or the limit sanctioned as the principal amount and
taking the tenor of the advance as one year. The term premium in the
discount factor would be as applicable for one year. The fair value of the
term loan components (Working Capital Term Loan and Funded Interest
Term Loan) would be computed as per actual cash flows and taking the
term premium in the discount factor as applicable for the maturity of the
respective term loan components. The process of identifying such interest
sacrifice in case of working capital loans needs to be looked into in details.
In case the bank has agreed to convert existing/future exposure to the
borrower in to Funded Interest Term Loan, such interest should be parked
under sundry liabilities and should not be reckoned as income.
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Balance Confirmation
Examining the Validity of Recorded Amounts
11.453 The Auditor should ascertain the status of balancing of subsidiary
ledgers relating to advances. The total of balances in the subsidiary ledgers
should agree with the control accounts in the General Ledger. The Auditor
should also tally the total of the statement of advances with the balances as per
general ledger/ subsidiary ledgers. He should also cross-check the balances of
the advances selected for examination as listed in the statement of advances
with the balances in the relevant advance accounts in the subsidiary ledgers.
Banks often obtain balance confirmation statements from borrowers periodically.
Such statements have a dual advantage in preventing disputes by the customer
and extending the period of limitation by reference to the date of confirmation.
Wherever available, such confirmations may be seen.
Borrowing Arrangements
Nature of Borrowing Arrangements
11.454 The following paragraphs explain the different ways in which a banking
arrangement can be tied up by a borrower.
Sole Banking
11.455 In this arrangement, the borrower obtains credit from a single bank. This
is the simplest form of tie-up and is operationally convenient for both the lender
and the borrower. Most of the banking tie-ups in India are of this type because
the quantum of bank finance in an individual case is usually small. Depending on
the nature and extent of credit facility offered, the lending bank itself may
stipulate that the borrower will not avail of finance from another bank.
Consortium Arrangement
11.456 In this type of arrangement, the number of lending banks is more than
one. The lending banks form a formal consortium. Salient features of the
arrangement are:
● The consortium has a formal leader, called the ‘lead bank’ (normally though
not necessarily, the bank with the largest exposure).
● The consortium frames and adopts its rules within the RBI framework for
conducting its business with the borrower.
● There is a common set of loan documents, which is obtained by the lead
bank on behalf of other participating banks also.
● The lead bank is responsible for overall monitoring.
483
● The member banks of the consortium have rights over the security in an
agreed proportion.
● The borrower maintains direct business relationship with all member banks
of the consortium.
● Minutes of the consortium meetings are circulated amongst the members.
● Banks should exchange information about the conduct of the borrowers'
accounts with other banks at least at quarterly intervals.
Multiple Banking
11.457 In this type of arrangement, there is no formal arrangement amongst the
lending banks. Each of them has its set of loan documents, securities and mode
of lending, independent of other lending banks. The borrower has to deal with
each of the banks separately.
11.458 The RBI, vide its Circular No. DBOD No. BP. BC.46/ 08.12.001/2008-09
dated September 19, 2008 on “Lending under Consortium Arrangement/Multiple
Banking Arrangements”, encourages the banks to strengthen their information
back-up about the borrowers enjoying credit facilities from multiple banks as
under:
(i) At the time of granting fresh facilities, banks may obtain declaration from the
borrowers about the credit facilities already enjoyed by them from other
banks, as prescribed in the RBI Circular No. DBOD.No.BP.BC.94
/08.12.001/2008-09 dated December 08, 2008 on “Lending under
Consortium Arrangement/Multiple Banking Arrangements”. In the case of
existing lenders, all the banks may seek a declaration from their existing
borrowers availing sanctioned limits of Rs.5.00 crores and above or
wherever, it is in their knowledge that their borrowers are availing credit
facilities from other banks, and introduce a system of exchange of
information with other banks as indicated above.
(ii) Subsequently, banks should exchange information about the conduct of the
borrowers' accounts with other banks at least at quarterly intervals.
(iii) Obtain Diligence Report by a professional at regular intervals, regarding
compliance of various statutory prescriptions that are in vogue, as per
specimen given in the RBI Circular.
Prudential Exposure Norms
Prudential Exposure Limits
11.459 With a view to achieve a better risk management and avoidance of
concentration of credit risk, the RBI from time to time, prescribes, limits on
484
exposure of a bank to individual borrowers and groups of borrowers in India. The

Master Circular No. RBI/2015-16/70 DBR.No.Dir.BC.12/13.03.00/ 2015-16 dated
July 1, 2015 on “Exposure Norms”, lays down the ceiling on credit exposure to
individual/group borrowers in relation to bank’s capital fund as defined under
capital adequacy standards (Tier-I and Tier-II Capital). Further the RBI has
issued Circular no. DBR.No.BP.BC.43/21.01.003/2018-19 dated June 03, 2019
and Circular no. DOR.No.BP.BC.43 /21.01.003/2019-20 dated March 23, 2020
on “Large Exposures Framework (LEF)”.
Single and Group Borrower Limits
11.460 Large Exposure Limits- Single Counterparty: The sum of all the
exposure values of a bank to a single counterparty must not be higher than 20
per cent of the bank’s available eligible Tier I capital base at all times. In
exceptional cases, the Board of banks may allow an additional 5 per cent
exposure of the bank’s available eligible capital base. Banks shall lay down a
Board approved policy in this regard.
11.461 Groups of Connected Counterparties: The sum of all the exposure
values of a bank to a group of connected counterparties must not be higher than
25 per cent of the bank’s available eligible Tier I capital base at all times.
11.462 Exposures to NBFCs: Single NBFC: Banks’ exposures to a single
NBFC will be restricted to 15 per cent% of their eligible Tier I capital base.
11.463 Group of connected NBFCs or group of connected counterparties
having NBFCs in the group: banks’ exposure will be restricted to 25 per cent of
their Tier I Capital. Where the bank has exceeded the above referred prudential
exposure limit, the same should be appropriately disclosed in the “Notes to
Accounts” to the Balance Sheet.
11.464 With effect from June 03, 2019, In order to capture exposures and
concentration risk more accurately and to align the above instructions with
international norms, the following amendments have been incorporated in the
above mentioned instructions:
i) Exclusion of entities connected with the Sovereign from the definition of
group of connected counterparties.
ii) Introduction of economic interdependence criteria in definition of connected
counterparties.
iii) Mandatory application of look-through approach (LTA) in determination of
relevant counterparties in case of collective investment undertakings,
securitisation vehicles and other structures.
485
Disinvestment Programme of the Government of India

11.465 On account of banks’ financing of acquisition of PSU shares under the
Government of India disinvestment programmes, if any bank, is likely to exceed
the regulatory ceiling of single / group borrower limit, RBI will consider relaxation
on specific requests from banks in the single/group credit exposure norms on a
case by case basis, provided that the bank’s total exposure to the borrower, net
of its exposure due to acquisition of PSU shares under the Government of India
disinvestment programme, should be within the prudential single/group borrower
exposure ceiling prescribed by RBI.
Sector Specific Limit
11.466 Apart from limiting the exposures to an individual or a borrower group
as indicated above, banks may also consider fixing internal limits for aggregate
commitments to specific sectors, e.g. textiles, jute, tea, etc., so that the
exposures are evenly spread over various sectors. These limits could be fixed by
the banks having regard to the performance of different sectors and the risks
perceived. The limits so fixed may be reviewed periodically and revised, as
necessary.
Bills Purchased/Discounted under Letter of Credit(LC)
11.467 In cases where the bills discounting/purchasing/negotiating bank and
LC issuing bank are different entities, bills purchased/ discounted/ negotiated
under LC (where payment to the beneficiary is not “under reserve”) should be
treated as an exposure on LC issuing bank and not on borrower. In the case of
negotiations “under reserve”, the exposure will be treated as an exposure on the
borrower. However, in cases where the bills discounting/purchasing/ negotiating
bank and LC issuing bank are part of the same bank, i.e. where LC is issued by
the Head Office or branch of the same bank, then the exposure should be taken
on the third party/borrower and not on the LC issuing bank.
Lending for Real Estate
11.468 Banks are required to frame comprehensive prudential norms relating to
the ceiling on the total amount of real estate loans, single/group exposure limits
for such loans, margins, security, repayment schedule and availability of
supplementary finance and the policy should be approved by the banks' Boards.
The disbursements in case of these loans should be made only after the
borrower has obtained requisite clearances from the government authorities.
11.469 The RBI has also required that the banks' Boards may also consider
incorporation of aspects relating to adherence to National Building Code (NBC)
in their policies on exposure to real estate. The information regarding the NBC
can be accessed from the website of Bureau of Indian Standards
486
(www.bis.org.in). Banks should also adopt the National Disaster Management

Authority (NDMA) guidelines and suitably incorporate them as part of their loan
policies, procedures and documentation.
Financing of Joint Ventures
11.470 Banks are allowed to extend credit/non-credit facilities (viz. letters of
credit and guarantees) to Indian Joint Ventures/Wholly-owned Subsidiaries
abroad and step-down subsidiaries which are wholly owned by the overseas
subsidiaries of Indian corporates. Banks are also permitted to provide at their
discretion, buyer's credit/acceptance finance to overseas parties for facilitating
export of goods and services from India. The above exposure will, however, be
subject to a limit of 20 percent of banks’ unimpaired capital funds (Tier I and Tier
II capital) and would be subject to the conditions laid down in this regard in the
Master Circular no. RBI/2015-16 /95 DBR.No.Dir.BC.10/13.03.00/2015-16 on
‘Loans and Advances – Statutory and Other Restrictions’ dated July 1, 2015.
Limits on Banks’ Exposure to Capital Markets
Statutory limit on shareholding in companies
11.471 No banking company is permitted to hold shares in any company,
whether as pledgee, mortgagee or absolute owner, of an amount exceeding 30
per cent of the paid-up share capital of that company or 30 per cent of its own
paid-up share capital and reserves, whichever is less, except as provided in sub-
section (1) of Section 19 of the Banking Regulation Act, 1949. Shares held in
demat form should also be included for the purpose of determining the exposure
limit. This is an aggregate holding limit for each company.
Regulatory Limit
A. Solo Basis
11.472 The aggregate exposure of a bank to the capital markets in all forms
(both fund based and non-fund based) should not exceed 40 per cent of its net
worth as on March 31 of the previous year. Within this overall ceiling, the bank’s
direct investment in shares, convertible bonds / debentures, units of equity-
oriented mutual funds and all exposures to Venture Capital Funds (VCFs) [both
registered and unregistered] should not exceed 20 per cent of its net worth.
B. Consolidated Basis
11.473 The aggregate exposure of a consolidated bank to capital markets (both
fund based and non-fund based) should not exceed 40 per cent of its
consolidated net worth as on March 31 of the previous year. Within this overall
ceiling, the aggregate direct exposure by way of the consolidated bank’s
investment in shares, convertible bonds/debentures, units of equity-oriented
487
mutual funds and all exposures to VCFs [both registered and unregistered]
should not exceed 20 per cent of its consolidated net worth 7.
Sectoral Distribution
11.474 Advances are required to be classified, inter alia, into those in India and
those outside India, with further sub-classification under each category. One
such sub-classification that merits discussion from an Auditor’s perspective is
advances in India to priority sectors.
11.475 Priority sector advances include:
● Advances for agriculture and other allied activities – However, RBI, vide its
circular no. RPCD.CO.Plan.BC. 51 /04.09.01/2010-11 dated February 2,
2011 on “Classification of loans against gold jewellery” clarifies that loans
sanctioned to NBFCs for on-lending to individuals or other entities against
gold jewellery, are not eligible for classification under agriculture sector.
Similarly, investments made by banks in securitised assets originated by
NBFCs, where the underlying assets are loans against gold jewellery, and
purchase/assignment of gold loan portfolio from NBFCs are also not eligible
for classification under agriculture sector.
● RBI vide its master circular no RBI/2018-19/02 FIDD.FID.BC.No.02/
12.01.033/ 2020-21 dated July 01, 2020 has provided details on SHG-
Bank linkage Programme. In order to enable the banks to report their SHG
lending without difficulty, it was decided that the banks should report their
lending to SHGs and for on-lending to SHGs/members of SHGs under the
new segment, viz. 'Advances to SHGs' irrespective of the purposes for
which the loan have been disbursed members of SHGs. Lending to SHGs
should be included by the banks as part of their lending to the weaker
sections (under priority section).
● Advances to minority communities.
● Advances to micro/small/medium scale enterprises8.
● Advances to small road transport operators.
● Advances to retail traders and small business enterprises.
7
Attention of the readers is drawn to Master Circular of RBI, DBR.No.Dir.BC.12/13.03.00/2015-16
dated 1 July 2015 “Exposure Norms”, for components of capital exposure, exclusions, method of
computation of capital exposure for the purpose and Intra-day limits.
8
The RBI has issued a master Direction no. RBI/FIDD/2017-18/56 FIDD.MSME & NFS.
12/06.02.31/2017-18 on “Lending to Micro, Small and Medium Enterprises (MSME) Sector” dated
July 24, 2017 (updated as on April 25, 2018). Also refer circular no. RPCD.SME &
NFS.BC.No.79/06.02.31/2009-10 dated May 6, 2010 on “Working Group to Review the Credit
Guarantee Scheme for Micro and Small Enterprises (MSEs) – Collateral free loans to MSEs”.
488
● Advances to professionals and self-employed.

● Advances sanctioned to State sponsored organisations for scheduled
castes/scheduled tribes.
● Educational loans up to the prescribed limit – RBI, vide its circular no.
RPCD.SME & NFS.BC.No. 69/06.12.05 /2009-10 dated April 12, 2010 on
“Collateral Free Loans - Educational Loan Scheme”, clarified that banks
must not, mandatorily, obtain collateral security in the case of educational
loans up to Rs. 4 lakh.
● Housing loans up to prescribed limits9.
● Funds provided to RRBs.
● Micro credit10.
● Any other priority sector advances, such as SEPUP (Self-Employment
Programme for Urban Poor), PMRY (Prime Minister's Rozgar Yojana),
SEEUY (Self-Employment Scheme for Educated Unemployed Youth)
SGSY (Swarna jayanti Gram swaraj Swarojgar Yojana)11, SJSRY (Swarna
jayanti Sahakari Rozgar Yojana).
11.476 Priority sector advances generally carry an interest rate, which is lower
than the normal rate of interest on lending to other sectors. These advances are
also known as DRI advances, i.e., advances on which differential rate of interest
is applicable. Under the Reserve Bank of India’s guidelines, a specified
proportion of the total advances of banks are to be made to priority sectors
necessarily. Depending upon the nature and type of facilities extended, the bank
may get subsidy from the Government to fully or partly offset the shortfall in
interest rate and/or get indemnified for bad debts for the whole or a portion of
such advances.
11.477 RBI has issued guidelines for the targets and sub-targets set under
priority sector lending for all scheduled commercial banks operating in India. For
detailed information on the guidelines, refer RBI Direction no. RBI/FIDD/2016-
9
Attention is also invited to circular no. DBOD.No.BP.BC. 69 /08.12.001/2010-11 dated December
23, 2010 on “Housing Loans by Commercial Banks – LTV Ratio, Risk Weight and Provisioning”,
circular no. RPCD.MSME & NFS.BC.No. 30 /06.11.01/ 2012-13 dated September 18, 2012 on
“Scheme of 1% interest subvention on housing loans up to Rs. 15 lakh” and Master circular no.
DBR. No.DIR.BC.13/08.12.001/2015-16 dated July 1, 2015 on “Housing Finance”.
10
The RBI has issued a master circular no. RPCD.MFFI.BC.No. 05/12.01.001/2010-11 dated July
1, 2010 on “Micro Credit”.
11
Attention is the readers is drawn to master circular No. FIDD.CO.Plan.BC.04/04.09.01/2015-16
dated July 1, 2015 on “Priority Sector Lending - Special Programmes – Swarna jayanti Gram
Swarozgar Yojana (SGSY)” and Circular No. RPCD.GSSD.BC.No.30 /09.01.01/2010 -11 dated
December 15, 2010 on “Swarna jayanti Gram Swarozgar Yojana (SGSY) - Group Life Insurance
Scheme”.
489
17/33 Master Direction FIDD.CO.Plan.1/04.09.01/2016-17 dated July 07, 2016

(Updated as on December 05, 2019) on “Priority Sector Lending – Targets and
Classification”.
11.478 Government of India vide Notification dated February 04, 2016 has
specified “Dealing in Priority Sector Lending Certificates (PSLCs) in accordance
with the Guidelines issued by Reserve Bank of India” as a form of business
under Section 6 (1)(o) of the Banking Regulation Act, 1949. The purpose of
PSLCs is to enable banks to achieve the priority sector lending target and sub-
targets by purchase of these instruments in the event of shortfall and at the same
time incentivize the surplus banks; thereby enhancing lending to the categories
under priority sector. Refer RBI circular NO. FIDD.CO.Plan.BC.23/
04.09.01/2015-16 dated April 07, 2016 on “Priority Sector Lending Certificates” for
detailed guidelines on PSLCs.
Recovery mechanisms
11.479 This topic has been prepared with the sole intention of helping the
auditors who are doing the audit of Asset Reconstruction Management Branches
(ARMB) or any other branch which have one or more of the non-performing
assets (NPA) of a Bank or an Institution, understand the usual legal recovery
options available in a broad manner. This note is not intended to provide a
detailed insight to such options but only to provide a quick and an overall
perspective in a simple and brief manner. In this topic, the term “Bank” also
stands for Financial Institutions.
11.480 An account declared as NPA by a Bank warrants that the Bank take
steps for recovery of the outstanding dues. Such steps can involve steps like
rescheduling, re-phasing or restructuring of the outstanding loans. However, with
the spurt in the NPA levels across the banking sector, the Reserve Bank of India
– in departure to earlier guidelines – has issued revised guidelines from time to
time which usually makes it mandatory for Banks to declare an account as NPA
irrespective of the fact that the account could have been/ or is restructured.
11.481 This topic provides an insight to the following measures that a Bank
initiates once an account has been classified as NPA:
1. Recovery using the provisions of the SARFAESI Act, 2002.
2. Recovery using the provisions of the Recovery of Debt dues to Banks and
Financial Institutions Act, 1993.
3. Recovery using the Lok Adalats.
4. Recovery using the provisions of the Insolvency and Bankruptcy Code (IBC).
490
1. Recovery using the provisions of the SARFAESI Act, 2002

11.482 The Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002 (SARFAESI) empowers Banks /
Financial Institutions to recover their Non-Performing Assets (NPA) without the
intervention of the Court.
11.483 The provisions of this Act are applicable only for NPA loans in the
following circumstances:
 Contractual dues are above Rs. One Lakh (Rs. 1.00 lakh).
 The default must have occurred i.e. account should have become NPA as
per RBI norms.
 Securities are available in the loan account by way of hypothecation or
mortgage or assignment.
 The security charges to the Bank must be specific, clear and available to the
Bank. It must be duly and effectively charged to the bank and therefore,
enforceable if the borrower fails to pay in response to notice.
 The securities available are enforceable in nature – agricultural land,
aircrafts and vessels are not covered under the Act.
 Amount due is more than 20 per cent of the principal amount and interest
thereon.
 There is a single lender for an account or a secured asset or 60 per cent of
the lenders in consortium structured consent for action.
11.484 The Act provides three alternative methods for recovery of non-
performing assets, namely: -
a. Securitisation
b. Asset Reconstruction
c. Enforcement of Security without the intervention of the Court
a. Securitisation
It refers to the process of drawing and converting of loans and other financial
assets into marketable securities worth selling to the investors. In other words, it
involves repackaging of less liquid assets into saleable securities. The
securitization company takes over the mortgaged assets of the borrower and is
entitled to adopt the following steps:
 Getting hold of financial assets from bank.
491
 Creating funds from eligible institutional buyers by dint of issuing security

receipts to acquire the financial assets.
 Fund raising in any legal way.
 Financial asset acquisition along with taking over the mortgaged assets
(such as building, land etc.).
Asset Reconstruction Companies (ARC) – which can do the above – have been
created as a result of this Act.
b. Asset Reconstruction
It refers to conversion of non-performing assets into performing assets. There
are multiple steps to reconstruct asset. The point to be noted in this context is
that the reconstruction must be done in accordance with the SARFAESI Act and
RBI regulations.
c. Enforcement of Security without the intervention of the Court
The Act empowers the Bank/ ARC:
 To issue demand notice (Section 13 (2)) to the defaulting borrower and
guarantor, calling upon them to discharge their dues in full within 60 days
from the date of the notice.
 To give notice to any person who has acquired any of the secured assets
from the borrower to surrender the same to the Bank.
 To ask any debtor of the borrower to pay any sum due or becoming due to
the borrower.
11.485 If on receipt of demand notice, the borrower makes any representation
or raises any objection, the Authorised Officer shall consider such representation
or objection carefully and if he comes to the conclusion that such representation
or objection is not acceptable or tenable, he shall communicate the reasons for
non-acceptance within one week of receipt of such representation or objection.
11.486 A borrower / guarantor aggrieved by the action of the Bank can file an
appeal with DRT and then with DRAT, but not with any civil court. The borrower /
guarantor has to deposit 50 per cent of the dues before an appeal with DRAT.
11.487 If the borrower fails to comply with the notice, the Bank may take
recourse to one or more of the following measures:
 Take possession of the security
 Sale or lease or assign the right over the security
 Manage the same or appoint any person to manage the same.
492
Concluding remarks
11.488 Recovery action under this route is very popular as it does not entail a
Court administered mechanism and therefore is much faster and often cost
effective. Action under SARFAESI provisions must adhere to the provisions of
the Limitation Act though SARFAESI action itself is not considered to be an
action tenable under Limitation Act and hence a separate suit must be filed in the
Court to adhere to the provisions of the Limitation Act by the Bank.
2. Recovery through the Recovery of Debt dues to Banks
and Financial Institutions Act, 1993
11.489 This Act was enacted in 1993 to facilitate speedy recovery of loans due
to Banks and Institutions that were until then in the domain of Civil Courts. Debt
Recovery Tribunals (DRTs) were created as a result of this Act. The main
objective and role of DRT is the recovery of duties from borrowers payable to
banks and financial institutions. The Tribunals power is limited to settle cases
regarding the restoration of the unpaid amount from NPAs as declared by the
banks under the RBI guidelines. The Tribunal has all the powers vested with the
District Court. The Tribunal also has a Recovery officer who guides in executing
the recovery Certificates as passed by the Presiding Officers.
Applicability of the Act
11.490 The Act applies to the following cases:
 Where the amount of debt due is not less than Rs. 20,00,000/-.
 When the original application for recovery of debts is filed only by Banks and
Financial Institutions.
Composition of DRT
11.491 DRT is controlled over by a Presiding Officer, who is qualified to be a
District Judge and is appointed by notification by Central Government. The
Central Government may also authorise another presiding officer of a DRT other
than discharging the function of a presiding officer of a DRT.
Documents Required
11.492 Every application should be furnished by a paper book (called Original
application or OA in short), by the affected Bank containing details such as:
 A statement showing details of the debt due from a borrower and the
circumstances under which such debt has become due.
 Any documents relied upon by the Bank and those mentioned in the
application by the Bank.
493
 Details including crossed Bank Draft or Indian Postal Order representing the
application fee.
 Index of the documents produced.
DRT Application contents
11.493
 Particulars of debt.
 Particulars of security interest.
 Estimated value of security.
 If estimated value is less than the amount due then details of other assets
owned by debtor.
 Application to DRT seeking an order to disclose the other properties owned
by debtor.
 The application must be accompanied by true copies all documents relied
upon to substantiate the claim.
 Documents include statement of account or entry duly certified.
Procedure at Filing the Case in DRT
11.494 The following procedures are to be followed at the time of filing the case
in the debt recovery tribunal.
 The Recovery Application, in the prescribed format, should be submitted
with the DRT within the specified time (as applicable under the Limitation
Act).
 Recovery Application should contain the description of all relevant
documents and securities charged to the Bank.
 Interim reliefs such as the injunction against properties, attachment before
judgement, the appointment of Receiver, Recovery Certificate for admitted
dues should be appealed as a rule.
 Account Extracts to be provided and certified as per the provisions of
Bankers Books Evidence Act and be annexed to the Recovery Application.
Procedure after Filing the Case in DRT
11.495 The following procedures are to be followed after filing the case in debt
recovery tribunal.
 If the Recovery Application filed is satisfied in all respects, DRT will issue a
serial number and summons to borrowers or guarantors called defendants.
494
 Serving of warrant for quick disposal of the case and the Branch/Advocate
should get to see that summons are served within one month.
 If the summons is served on the defendants, proceedings commence with
evidence by way of affidavits filed by the bank followed by cross-
examination of Bank’s witnesses and vice versa followed by arguments
ending up in Recovery Certificates in respect of the Bank.
 Evidence by way of affidavits as preceding, clarifications or reports excepted
by the DRT should be filed.
Execution of Recovery Certificate
11.496 The Presiding Officer finally grants Recovery Certificate and sends it to
Recovery Officer (R.O.) for execution. On receipt of the Recovery certificate, the
RO can issue the notice to Certificate Debtors, giving 15 days for payment of the
amount stated in the Recovery Certificate.
11.497 If the defendant neglects to pay the amount, the RO will proceed to
recover the amount by any one or more of the methods, which are listed below:
 Attachment and sale of Movable or Immovable Property of the defendant.
 Arrest and Detention of the defaulter.
 Appointment of Receiver.
After full recovery of bank dues, the application is closed by the RO.
Appeal Against Recovery Officer
11.498 The appeal against an order of RO to DRT can be requested within 30
days from the date of order. The Tribunal has to resolve the claim within six
months. An appeal against the judgment of DRT can be made within 45 days to
DRAT (Debt Recovery Appellate Tribunal).
Concluding remarks
11.499 Banks resort to DRT as it is considered to be a legally tenable action
and therefore satisfies the condition of the Limitation Act. It is common for Banks
to simultaneously initiate action under SARFAESI and this Act. Having said that,
SARFAESI led resolution is usually faster than DRT led action. However, as
mentioned earlier, SARFAESI action applies for eligible securities clearly
charged to the Bank. In cases, where recovery from secured assets is not
enough to cover the dues of the Bank, the Bank needs to get additional assets
charged to recover its balance amount. Such attachment happens through the
DRT platform.
495
3. Recovery using the Lok Adalats

11.500 Lok Adalat is a process of administering justice in a cost free and
speedy manner without resorting to Courts. It is established under the Legal
Services Authority Act, 1987. Under the provisions of the Act, States have
constituted Legal Services Authorities at High Court, District and at Taluka level.
Under such Authorities, Courts are organising Lok Adalats in their respective
areas.
11.501 Lok Adalat settles the dispute through assuagement and compromise.
Lok Adalat acknowledges the cases pending in the civil courts within their
purview which could be settled by conciliation.
11.502 There are several advantages in utilising the forum of Lok Adalats:
 No court fees payable when cases are referred to it.
 It can take cognizance of existing suits and look into fresh disputes as well.
 If no settlement is arrived, parties can continue their legal proceedings in
civil courts.
 Every award by Lok Adalat shall be deemed to be a decree passed by Civil
Court and is binding on the parties and execution proceeding can be filed
accordingly.
 No appeal lies against the decree passed by Lok Adalats as the matter
settles through negotiation and mutual consent.
Types of Lok Adalat
11.503 Various kinds of Lok Adalats are as under:
 Continuous Lok Adalat
This type of Lok Adalat is organized for a number of days continuously.
 Daily Lok Adalat
As the name suggests, these are held every day.
 Mobile Lok Adalat
These are the utility vans which are set up in different areas to resolve petty
issues.
 Mega Lok Adalat
This is held on a single day at State level, in all the courts of the state.
496
 National level Lok Adalats

These are held at regular intervals throughout the country. The pending
cases are disposed of in huge numbers.
 Permanent Lok Adalats
The other type of Lok Adalat is the Permanent Lok Adalat, organized under
Section 22-B of The Legal Services Authorities Act, 1987. Permanent Lok
Adalats have been set up as permanent bodies with a Chairman and two
members for providing compulsory pre-litigation mechanism.
Applicability
11.504 If any of the party involved in a dispute, prior to approaching the court,
files a grievance to the legal service authority of the state, the case is taken by
the Lok Adalats. This is the pre-litigation stage.
Cases already pending before any court can also be referred to the Lok Adalats
if both the parties consent to it.
Process involved
11.505 Briefly stated, the procedure followed by the Lok Adalats is as under:
 After referring the case, the Lok Adalat tries to communicate with the parties.
They might invite the disputing parties for a meeting or communicate with
them in writing or orally. In this stage, the factual information is discussed
and if any one-party desires to keep the information confidential from
another party, it can be done.
 Suggestions are invited from both the parties to settle the case.
 When the Lok Adalat believes that there are elements of settlement of the
dispute and that the terms might be acceptable by the parties, it is informed
to the parties for observation and modifications and accordingly, the dispute
is resolved.
 If the case is referred by a court then the award granted by Lok Adalat
mentions a clause regarding refund of court fee to the parties.
 The members of Lok Adalat ensure that the issue is settled by mutual
consent and that there is no element of coercion or force.
Concluding remarks
11.506 Lok Adalats are low cost and speedy platform for recovery and Banks
do use this platform especially for settlement of cases where the amount
involved is low and protracted legal battle is uneconomical and not viable in
relation to the amount involved.
497
4. Recovery through the Insolvency and Bankruptcy Code

(IBC)
11.507 The Insolvency and Bankruptcy Code was first introduced in 2016 and
subsequently amended in 2019. The Code provides a time-bound process for
resolving insolvency in companies and among individuals. Insolvency is a
situation where individuals or companies are unable to repay their outstanding
debt.
Applicability
11.508 The Insolvency and Bankruptcy code at present can only be triggered if
there is a minimum default of Rs 1 lakh. This process can be triggered by way of
filing an application before the National Company Law Tribunal (NCLT). The
process can be initiated by two classes of creditors which would include financial
creditors and operational creditors. For the application to be admitted, the
creditor will have to show that a requisite default is ascertainable.
11.509 Another important aspect that has to be seen in respect of Insolvency
and Bankruptcy Code (IBC) is that at present only companies (both private and
public limited company) and Limited Liability Partnerships (LLP) can be
considered as defaulting corporate debtors. This code also contains provisions in
respect of individual insolvency, but these provisions have not been notified.
Therefore cases relating to unpaid debts against individuals and partnership
firms would fall outside the purview of this Code.
11.510 As soon as the matter is admitted by the NCLT, it proceeds with the
appointment of an Interim Resolution Professional (IRP) who takes over the
management of the defaulting debtor. The Resolution Professional may then be
continued or removed, contingent on the wishes of the Committee of Creditors
(COC). The role of the Resolution Professional primarily entails making on efforts
to ensure that the defaulting debtor should as far as possible continue to operate
as a going concern. All efforts will be made to ensure that maximum realization
of debts can take place as a consequence of the Corporate Insolvency
Resolution Process (CIRP) process.
Corporate Insolvency Resolution Process (CIRP)
11.511 The CIRP may include necessary steps to revive the company such as
raising fresh funds for operation, looking for new buyer to sell the company as
going concern. The outstanding debts may be satisfied by way of another person
498
submitting a Resolution plan to take over the company and pay off the remaining
debts. In the event a resolution plan is not submitted or not approved by the
COC, the CIRP process is deemed to have failed. In such a situation the
liquidation proceedings would then commence subject to the order of the
tribunal.
Timeline
11.512 The Code states that the insolvency resolution process must be
completed within 180 days, extendable by a period of up to 90 days. In the light
of the recent amendment to the code, for conducting the entire process a time
period of 330 days has been specified.
Facilitating Institutions
11.513 The Code creates various institutions to facilitate resolution of

insolvency. These are as follows:
 Insolvency Professionals: A specialised cadre of licensed professionals are

being created. These professionals will administer the resolution process,
manage the assets of the debtor, and provide information for creditors to
assist them in decision making.
 Insolvency Professional Agencies: The insolvency professionals will be

registered with insolvency professional agencies. The agencies conduct
examinations to certify the insolvency professionals and enforce a code of
conduct for their performance.
 Information Utilities: Creditors will report financial information of the debt
owed to them by the debtor. Such information will include records of debt,
liabilities and defaults.
 Adjudicating authorities: The proceedings of the resolution process will be

adjudicated by the National Company Law Tribunal (NCLT), for companies;
and the Debt Recovery Tribunal (DRT), for individuals. The duties of the
authorities will include approval to initiate the resolution process, appoint the
insolvency professional, and approve the final decision of creditors.
 Insolvency and Bankruptcy Board: The Board will regulate insolvency

professionals, insolvency professional agencies and information utilities set
up under the Code. The Board will consist of representatives of Reserve
Bank of India, and the Ministries of Finance, Corporate Affairs and Law.
499
Procedure to resolve insolvency
11.514 The Code contains the following steps to resolve insolvency:
 Initiation: When a default occurs, the resolution process may be initiated by

the debtor or creditor. The insolvency professional administers the process.
The insolvency professional provides financial information of the debtor from
the information utilities to the creditor and manage the debtor’s assets.
 Decision to resolve insolvency: A committee consisting of the financial

creditors who lent money to the debtor will be formed by the insolvency
professional. The creditors committee will take a decision regarding the
future of the outstanding debt owed to them. They may choose to revive the
debt owed to them by changing the repayment schedule, or sell (liquidate)
the assets of the debtor to repay the debts owed to them.
 Liquidation: If the debtor goes into liquidation, an insolvency professional

administers the liquidation process. Proceeds from the sale of the debtor’s
assets are distributed in the following order of precedence: i) insolvency
resolution costs, including the remuneration to the insolvency professional,
ii) secured creditors, whose loans are backed by collateral, dues to workers,
other employees, iii) unsecured creditors, iv) dues to government, v) priority
shareholders and vi) equity shareholders.
Corporate Insolvency Process
11.515 The following flowchart describes the insolvency process:
500
Concluding remarks
11.516 The IBC platform is relatively new but the processes are fast settling in
the Code has been challenged on various grounds and courts have clarifies
these issues and as a result the Code has been made more robust. In the days
to come, resolution through IBC mechanism is bound to pick up even more
widely especially for the bigger ticket exposures of Banks.
Role of Statutory Auditor
11.517 The role of the statutory auditor is as under:
 The Auditor should review the updated policies of the Bank framed for
handling recoveries through this mechanism.
 The rationale for transfer of cases to either of the aforesaid legal mediums
should be documented.
 Listing of cases pending in each of the forums and the updated status
should be obtained. Automated MIS trackers to be in place.to ensure
adherence to timelines is scrupulously maintained.
 Review of these processes by an internal audit team should be done. Issues
501
raised by audit, if any should be followed up for understanding the gaps and
initiating remedial action.
 Empanelment process for enrolment of Advocates or other professionals
should be examined.
 Key is to adhere to timelines stipulated in the policy. Delays, if any, in
adhering to the timelines needs to be reviewed and set right.
 During the pandemic, courts have not been functioning and cancellations /
extensions of court hearing procedures have happened delaying the judicial
process. Auditors should review the operational procedures to ensure that
necessary tracking and follow-up mechanism is in place and operating
effectively.
502
Annexure
Illustrative list for Basis of Selection of
Advance Accounts in case of
Bank Branch Audit
The list given for Bank Branch Auditors is only illustrative in nature. Members
are expected to exercise their professional judgment while using this list
depending upon facts and circumstances of each case.
Basis of selection of Advances accounts to be examined No. of

by Branch Auditor Accounts
1. All Large accounts (excess of 10% of outstanding
aggregate balance of fund based and non-fund based
advances of the branch or Rs.10 crores, whichever is
less).
2. Accounts wherein process under IBC is mandated but not
initiated by branch.
3. Borrowers wherein process of IBC initiated by any of the
creditors including bank.
4. NPA accounts upgraded to Standard during the year.
5. Advances where Restructuring Proposals/ requests are
pending approval/disposal at year end.
6. Accounts Restructured in the earlier years to determine
their year-end status, if in default or not classified as per
RBI norms.
7. Accounts Restructured during the year to determine their
year-end classification.
8. Restructured advances with moratorium of Interest where
interest is accrued contrary to RBI applicable norms.
9. FITL cases arising out of Restructuring where
corresponding provisions are held in “Sundry Liabilities
Account (Interest Capitalization)”.
10. Advances accounts where there is an initiation of
proceedings involving Investigation, vigilance, enquiry and
those where fraud is reported.
503
11. Staff Advances – where the persons have ceased to be

employees of the Bank; and accounts in default.
12. BIFR cases classified as Standard.
13. SSI/SME cases under rehabilitation as at the year end.
14. Standard advances in litigation.
15. Central Government guaranteed cases which are
Standard non-performing.
16. Standard accounts where there is Interest Suspense/
Unapplied Interest.
17. Advances in the list of wilful defaulters of the RBI.
18. Cases where one time settlement (OTS) has been sought;
and those in which OTS was accepted but there is default
in compliance.
19. Advances subject to re-financing.
20. Accounts which are not renewed regularly or adhoc not
regularised for more than 180 days.
21. Accounts which are classified as NPAs and also upgraded
during the year.
22. Accounts which are reported to CRILC during the year.
23. Fresh NPAs identified by the Branch.
24. NPA cases where the assessed realizable value of the
securities has a significant shortfall – 50% or more.
25. NPA cases where the realizable value of the security as
assessed by the Bank/approved valuers /RBI is less than
10% of the outstanding.
26. Standard Accounts with temporary deficiencies as per
Para 4.2.4 of Master Circular on Advances.
27. Quick Mortality Cases.
28. Advances comprising frauds detected (Para 4.2.9.(ii) of
the IRAC Master Circular dated 1.7.2015).
29. Other Accounts, not covered above, with adverse
comments in the existing/latest Reports (as per Para 1 of
Annexure I to the initial letter to Branch).
30. Comments on accounts as per latest RBI AFI Report.
504
12
Fixed Assets and Other Assets
Fixed Assets
Introduction
12.01 This Chapter deals with Fixed Assets and Other Assets. Fixed assets
include movable and immovable property. Fixed assets comprise premises and
other fixed assets such as furniture and fixtures, motor vehicles, office
equipment, computers, printers, UPS, generators, intangible assets such as
application software and other computer software, etc.
Purchase of Fixed Assets
12.02 In most banks, the fixed assets are generally purchased by the head
office or regional or zonal offices. Statutory Branch Auditor (SBA) has to
ascertain the procedure followed by the bank and plan the audit accordingly.
Also, the banks generally prefer to centralise the function of obtaining insurance
and obtain a comprehensive policy for assets at numerous locations (to avail the
benefit of rebate on bulk business). Fixed assets, particularly furniture and
fixture, consumer durables, etc. are provided by banks to the staff and the
account for the same is maintained at the office where the employee is posted.
12.03 The Auditor has to verify whether the original invoices (or copy of
original invoices) of the purchase including the purchases during the year are at
the Branch Office and also required approval are in place as per approval matrix.
The Auditor should make specific inquiries and also review open purchase
orders, to ensure completeness of purchases recorded for the year. It has been
observed that an asset is already delivered to the branch but in the absence of
invoice for same, accounting is not done. In case of sales /disposal of assets
done during the year, the relevant note and the process of the disposal including
the accounting entries are to be verified by the Auditor.
Maintenance of Records
12.04 In most of the banks the maintenance of records is centralised at HO. In
recent times, some of the banks have installed Fixed Asset Management
Software and the information relating to purchase, sale of fixed assets and
depreciation thereon (in some cases) is accounted for with the help of such
software. SBA has to ascertain the procedures followed and audit accordingly.
Physical Verification of Fixed Assets

12.05 The SBA has to physically verify the assets at the branch particularly
those acquired during the year and reconcile with the fixed asset management
system (manual or electronic). The SBA is to ensure that assets provided to
employees working in that branch are properly accounted.
Disclosure of Assets
12.06 The Third Schedule to the Banking Regulation Act, 1949 requires fixed
assets to be classified into two categories in the balance sheet, viz., Premises
and Other Fixed Assets. Though not specifically mentioned under the Banking
Regulation Act, 1949, the assets taken on lease and intangible assets should be
shown separately for proper classification and disclosure and also to comply with
the requirements of the Accounting Standards (ASs) issued by the Institute of
Chartered Accountants of India (ICAI).
12.07 As per the Notes and Instructions for compilation of balance sheet,
issued by the RBI, premises wholly or partly owned by the banking company for
the purpose of business including residential premises should be shown under
the head, ‘Premises’. Furniture and fixtures, motor vehicles, office equipment,
computers and all other fixed assets except premises should be shown under the
head ‘Other Fixed Assets’. An immovable property acquired by the bank in
satisfaction of debts due should be included under the head 'fixed assets' only, if
it is held by the bank for its own use.
Reduction or Revaluation of Fixed Assets
12.08 Generally reduction or revaluation of fixed assets (if any) will be dealt at
the Head Office level. The SBA has limited role to play. The Notes and
Instructions for Compilation of Balance Sheet, issued by the RBI, require that
where sums have been written-off on reduction of capital or revaluation of
assets, every balance sheet after the first balance sheet subsequent to the
reduction or revaluation should show the revised figures for a period of five years
with the date and amount of revision made. In case any assets are appearing in
the branch balance sheet, the SBA has to ensure that above instructions are
followed.
Depreciation on Fixed Assets
12.09 Rates of depreciation on fixed assets have not been prescribed by the
Banking Regulation Act, 1949. The provisions of the Schedule II to the
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Companies Act, 2013, should, therefore, be kept in mind in this respect

especially in so far as the banking companies are concerned. Depreciation on
Computers and Software forming an integral part of Computer Hardware, in and
outside India is provided on Straight Line Method at the rate of 33.33 per cent
p.a., as per the guidelines of RBI. The SBA has to examine and ensure that the
HO policy on depreciation is correctly followed. The auditor should be careful
regarding the date of recording the fixed asset in the books of accounts and
commencement of depreciation which should be from the date, the asset is put
to use.
Other Assets
Disclosure of Other assets
12.10 The following items broadly are to be disclosed under the head 'Other
Assets':
 Inter-office adjustments (net)  Stationery and stamps
 Interest accrued  Non-banking assets acquired in
satisfaction of claims
 Tax paid in advance/tax deducted
at source  Others
12.11 All loans and advances given to staff, which are non-interest bearing
should be included in item 'Others' under 'Other Assets' and should not be
reflected as ‘Advances’.
Fixed Assets
Audit of Fixed Assets
12.12 While carrying out the audit of fixed assets, the Auditor is concerned,
primarily, with obtaining evidence about their ownership, existence and
valuation. For this purpose, the Auditor should review the system of internal
controls relating to fixed assets, particularly the following:
 Control over expenditures incurred on fixed assets acquired or self-
constructed.
 Accountability and utilisation controls.
 Information controls for ensuring availability of reliable information about
fixed assets.
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Accounting of Fixed Assets

12.13 The SBA should ascertain whether the accounts in respect of fixed
assets are maintained at the branch or centrally. Similarly, the auditor should
ascertain the location of documents of title or other documents evidencing
ownership of various items of fixed assets. The procedures described in the
following paragraphs would be relevant only to the extent the accounts and
documents of title, etc., relating to fixed assets are maintained at the branch.
12.14 Where the acquisition, disposal, etc., of fixed assets take place at
branches / other offices, but accounting of fixed assets is done at the head
office, the SBA should examine whether acquisitions, disposals, etc. effected
at the branch during the year have been properly communicated to the head
office. The SBA should also bring this to the notice of Statutory Central Auditor
(SCA).
12.15 In cases where, for any reason acquisition of fixed asset is shown in
suspense account then the branch cannot classify the asset in the Balance
Sheet under this head unless the asset is put to use or ready for use, as the
case may be, and all internal formalities are completed. A long-standing
suspense entry of this type should be properly dealt with by the auditor and
may need to be escalated to the statutory central auditors if the amount
involved is material.
Premises
12.16 Verification of accounting for Premises: The Auditor should verify the
opening balance of premises with reference to schedule of fixed assets, ledger
or fixed assets register. Acquisition of new premises should be verified with
reference to authorisation, title deeds, record of payment, etc. Self-constructed
fixed assets should be verified with reference to authorisation from appropriate
authority and documents such as, contractors’ bills, work order records, record
of payments and completion certificate. The Auditor should also examine
whether the balances as per the fixed assets register reconcile with those as
per the ledger and the final statements.
12.17 As per the AS-10 (Revised), “Property, Plant & Equipment”, the banks
can adopt the policy to follow Cost Model or Revaluation Model for Premises or
any other class of Property, Plant & Equipment (PPE). The Auditor should
inquire about the policy followed by the bank and verify the accounting
treatment more specifically with reference to revaluation model. The Auditor
should also check the impairment, if any, by applying the principles laid down
in Accounting Standard (AS) 28, “Impairment of Assets”.
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12.18 Leasehold Premises: In the case of leasehold premises, capitalisation

and amortisation of lease premium, if any, should be examined. Any
improvements to leasehold premises should be amortised over their balance
residual life. It would be appropriate to segregate the cost/value of the land
from the building/superstructures to ensure that depreciation/amortisation is
appropriately considered in case of leasehold premises.
12.19 Capital Work-in-progress (CWIP): In case of property under
construction, it should be seen that they are shown under a separate heading,
e.g., ‘premises under construction’. Advances to contractors may be shown as
a separate item under the head ‘fixed assets’ or under the head ‘Other Assets’.
It should be verified that where the branch has obtained the licence to
commence business and is ready for use then the same is not shown as
“premises under construction”. In such cases even if all the bills/ documents
from the contractors/suppliers are not received, at the year end, an estimate of
the expenditure thereon should be made and capitalised on a provisional
basis. The Auditor should obtain ageing report of CWIP and inquire about old
balances outstanding as CWIP.
12.20 Holding of Immovable Property: The Auditor should specifically keep in
mind the provisions of section 9 of the Banking Regulation Act, 1949, which
prohibits a banking company from holding any immovable property, howsoever
acquired (i.e., whether acquired by way of satisfaction of claims or otherwise), for
a period exceeding seven years from the date of acquisition, except such as is
required for its own use.
12.21 The Auditor should specifically examine that no immovable properties
other than those required for the own use of the bank have been included in fixed
assets (own use would cover use by employees of the bank, e.g., residential
premises provided to employees). The SBA should also obtain a written
representation to the above effect from the branch management.
Other Fixed Assets
12.22 Other Fixed Assets: The procedures discussed above regarding
premises also apply, to the extent relevant, to verification of other fixed assets.
In respect of movable fixed assets, the Auditor should pay particular attention
to the system of recording the movements as well as other controls over such
fixed assets. The Policy regarding verification of fixed assets at premises, if
any, should be noted.
12.23 For assets used by the branch officials at their residences; the Auditor
should obtain confirmation from the respective staff member. In case of
discrepancies, the SBA should ensure that the same has been properly dealt in
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the books of account and adequate provision in respect of any damaged

assets has been made.
12.24 Operating Software: Banks incur substantial expenditure on computer
hardware and software. Computer hardware and operating software being an
integral part of the hardware, qualifies the definition of plant and equipment as
given in AS 10 (Revised), “Property, Plant and Equipment”. Expenditure
incurred on acquisition and installation of the hardware and operating software
should be capitalised in accordance with the principles laid down in AS 10
(Revised) and depreciated over the remaining useful life of the hardware.
Since these are susceptible to faster technical obsolescence; useful life of the
asset should not be for a period of more than three years.
12.25 Application Software: Application software is not an integral part of the
related hardware and is treated as an intangible asset. Accordingly, the same
should be accounted for as per Accounting Standard (AS 26), "Intangible
Assets". In estimating the useful life of application software, the rapid pace of
changes in software as also the need for periodic modification/ upgradation of
software to cater to changes in nature of transactions, information needs etc.
need special consideration. The software can be acquired from outside or
developed in-house. During the stage of development, the same needs to be
accounted in accordance with AS 26, while capitalising the same due
consideration be given to para 44 of the said standard. The software to be
capitalised on the date of asset put to use.
12.26 While conducting the audit of intangible assets, the Auditor should
also consider the guidelines issued by RBI by way of Circular
No.DBOD.No.BP.BC.82/21.04.018/2003-04, dated April 30, 2004 on
“Guidelines on compliance with Accounting Standards (AS) by banks”.
Transfer of assets between branches
12.27 Fixed assets like furniture, office equipment, etc., are transferred from
one branch to another. The Auditor should examine whether accumulated
depreciation in respect of such assets is also transferred. It may be noted that
the consolidated accounts of the bank would not be affected by such transfers.
In recent times, the fixed asset management software is in use. The Auditor
has to examine the reasonableness of the internal controls with respect to
recording such inter branch transfer of assets. The SBA may notice more of
such transactions during this year due to mergers of banks.
Classification of Fixed Assets
12.28 SBA should examine whether fixed assets have been properly
classified. Fixed assets of similar nature only should be grouped together. For
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example, items like safe deposit vaults should not be clubbed together with the
office equipment or the theft alarm system of the bank.
Sale / Disposal / Scrapping of Fixed Assets:
12.29 Usually, these decisions are taken at HO or Regional or Zonal offices,
branch will not have authority to make these type of decisions. In case of any
sale / disposal / scrapping of assets happen during the year, the SBA has to
examine whether there is adequate control system in place and also should
verify the records, receipts and value of the transactions. In case of heavy
values see whether proper authorisation is obtained from HO. Accounting for
original cost, accumulated depreciation, sale value and profit/loss on sale of
the asset to be verified. The SBA should ensure that proper taxes like GST are
collected wherever it is applicable on sale or disposal of assets. Due
consideration to be given to AS10 while accounting for the De-recognition of
the fixed asset.
Capitalisation of Expenditure
12.30 The auditor should examine whether any expenditure incurred on a
fixed asset after it has been brought to its working condition for its intended
use, has been dealt with properly. According to AS 10 (Revised), “Property,
Plant & Equipment”, such expenditure should be added to the book value of
the fixed asset concerned only if it increases the future benefits from the asset
beyond its previously assessed standard of performance.
Use of Depreciated Assets
12.31 At times, though depreciation has been fully provided on certain types
of assets, they still continue to be in use. In such cases the Auditor should
verify whether the bank’s policy in this regard has been followed.
Leased Assets
12.32 RBI/2015-16/30 DBR.No.FSD.BC.19/24.01.001/2015-16 dated July 01,
2015 on Para- banking activities consolidates all the instructions/guidelines
issued to banks till June 30, 2014 on para-banking activities. The aforesaid
circular also provides guidelines on Equipment Leasing in para no. 8 of the
circular dealing with methodology, exposure, accounting and prudential norms to
be followed by banks undertaking leasing activity. The auditor, in respect of
leased assets, should also have regard to the requirements of AS 19,
“Leases”. Assets given on Lease need to be separately shown in the same
manner as other assets.
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Impairment of Assets
12.33 These activities are done at HO level and branch has no role to play. In
case bank feels to do the exercise on impairment of assets, the same should be
done as per AS 28, “Impairment of Assets”. The standard prescribes the
procedure that an enterprise should apply to ensure that its assets are carried at
not more than their recoverable amount.
12.34 RBI’s circular on compliance with Accounting Standards, issued in April
2004 states as follows in respect of AS 28:
 The Standard would not apply to investments, inventories and financial
assets such as loans and advances and may generally be applicable to
banks in so far as it relates to fixed assets.
 Banks may also take into account the following specific factors while
complying with the Standard:
 Paragraphs 7 and 8 of the Standard have clearly listed the triggers
which may indicate impairment of the value of assets. Hence, banks
may be guided by these in determining the circumstances when the
Standard is applicable to banks and how frequently the assets
covered by the Standard need to be reviewed to measure impairment.
 In addition to the assets of banks which are specifically identified
above, viz., financial assets, inventories, investment, loans and
advances etc., to which the Standard does not apply, the Standard
would apply to financial lease assets and non-banking assets
acquired in settlement of claims only when the indications of
impairment of the entity are evident.
12.35 During the year if impairment of assets has taken place with respect to
any of the assets at the branch, the SBA has to verify that the procedures as
stated in AS 28 is duly followed by the branch. The Auditor should also inquire
about assets which are not in use for long period and whether any impairment
provision to be done on same considering recoverable value of those assets.
Other Assets
12.36 Other assets include Inter-office Adjustments, Interest Accrued, Tax
Payments, Stationery and Stamps among other items. SBA may carry out the
audit of various items appearing under the head ‘Other Assets’ in the following
manner.
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Inter-Office Adjustments
12.37 Inter Office Adjustments/Inter Branch Account is dealt separately in
Chapter 20, “Inter Branch/Office Accounts” of Section B of this Guidance Note. In
CBS environment these days in most of the banks interoffice adjustments/ inter
branch reconciliation are carried out by the system automatically on a real time
basis.
Interest Accrued
12.38 The main components of this item are interest accrued but not due on
investments and advances and, interest due but not collected on investments.
As banks normally debit the borrower’s account with interest due on the
borrower’s repayment cycle date, there would usually be an amount of interest
accrued but not due on advances on balance sheet date. On the other hand,
interest on government securities, debentures, bonds, etc., which accrues from
day to day should be calculated and brought into account, in so far as it has
accrued on the date of the balance sheet.
12.39 The auditor should examine whether the interest has been accrued on
the entire loans and advances portfolio of the bank. Special consideration should
be given to the overdue bills purchased/ discounted. Several times the interest
accrued on such advances is manually computed by the Branch and the auditors
should check the workings thoroughly so as to avoid any income leakages. As
far as possible, the detailed breakup of the loan portfolio and the interest accrual
should be obtained and the same should agree with the general ledger balance.
This would ensure completeness of the interest accrual of advances. The Auditor
should also examine the interest accrued on advances by re-computing it on a
test check basis by referring to the loan parameters like frequency of payment
of interest amount, rate of interest, period elapsed till the date of balance
sheet, etc., from the loan agreements. This would ensure the completeness of
the interest accrual on advances. In the current banking scenario, the interest
accrual setup is automated system driven for most banks and the auditor
should verify the in-built logic and controls of the system.
Tax Paid in Advance/Tax Deducted at Source
12.40 Generally, this item is dealt at the head office only and would,
therefore, not appear in the balance sheet of a branch, except that tax
deducted at source on fixed deposits and other products/services if handled at
the branch level. The procedures to be followed by the SBA for verification of
tax deducted at source by the branch would be similar to those in an audit of
other types of entities. The SBA needs to examine whether the certificates for
such tax deducted at source is collected by the branch and the original copy is
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sent to the Head Office along with the transfer of such Tax Deducted at Source
(TDS) amount to Head Office on periodic basis as defined.
Stationery and Stamps
12.41 Internal controls over stationery of security items (like term deposit
receipts, drafts, pay orders, cheque books, traveller’s cheques, gift cheques,
tokens, etc.) assume special significance in the case of banks as their loss or
misuse could eventually lead to misappropriation of the most valuable physical
asset of a bank, viz., cash. The SBA should study and evaluate the existence,
effectiveness and continuity of internal controls over these items in the normal
course of his audit.
12.42 Valuation of Stationery and Stamps: As per RBI instructions, the item
“Stationery and Stamps” should include only exceptional items of expenditure
on stationery like, bulk purchase of security paper, loose leaf or other ledgers,
etc., which are shown as quasi-asset to be written off over a period of time.
The valuation of such items is suggested to be at cost without any element of
escalation/appreciation. In other words, the normal expenditure on stationery
may be treated as an expense in the profit and loss account, while unusually
heavy expenditure may be treated as an asset to be written off based on
issue/consumption. At the branch level, the expenditure on latter category may
not appear since a considerable part of the stationery is supplied to branches
by the head office.
12.43 Physical Verification of Stationery and Stamps: The auditor should
physically verify the stationery and stamps on hand as at the year-end,
especially stationery of security items. Any shortage should be inquired into as
it could expose the bank to a potential loss from misuse. The auditor should
examine whether the cost of stationery and stamps consumed during the year
has been properly charged to the profit and loss account for the year in the
context of the accounting policy/instructions from the head office regarding
treatment of cost of stationery and stamps.
Non-Banking Assets Acquired in Satisfaction of Claims
12.44 This heading includes those immovable properties/tangible assets, which
the bank has acquired in satisfaction of debts due or its other claims and is being
held with the intention of being disposed of. As stated in para 12.20 above, the
banking company can’t hold any immovable property for any period exceeding
seven years. The RBI has the power to extend the aforesaid period in a particular
case up to another five years. During this period, the bank may deal or trade in
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any such property for the purpose of facilitating the disposal thereof. The above
provisions will not apply for those assets which the bank intends to use for its
own purpose.
12.45 Valuation and Verification: At the date of acquisition, the assets should
be recorded at the amount lower of the net book value of the advance or net
realisable value of asset acquired. At each balance sheet date, net realisable
value of such assets may be re-assessed and necessary adjustments may be
made.
12.46 The auditor should verify such assets with reference to the relevant
documentary evidence, e.g., terms of settlement with the party, order of the
Court or the award of arbitration, etc. The auditor should verify that the
ownership of the property is legally vested in the bank’s name by verifying the
Encumbrance Certificate (EC) of the property. If there is any dispute or other
claim about the property, the auditor should examine whether the recording of
the asset is appropriate or not. In case the dispute arises subsequently, the
auditor should examine whether a provision for liability or disclosure of a
contingent liability is appropriate, keeping in view the requirements of AS 29
"Provisions, Contingent Liabilities and Contingent Assets".
12.47 If an immovable property is obtained as satisfaction for a claim then a
Suitable display at the premises of the immovable property is to be made by the
bank stating that it is the property of the Bank with a view to avoid trespass and
illegal occupation of the premises by any other person/s.
12.48 Since, most of these activities are centralised at banks, branch will have
limited role of facilitating the process.
Others
12.49 This is the residual heading, which will include items not specifically
covered under other sub-heads, e.g., claims which have not been received,
debit items representing additions to assets or reductions in liabilities which
have not been adjusted for technical reasons or want of particulars, etc.,
receivables on account of government business, prepaid expenses, Accrued
income other than interest (e.g., dividend declared but not received) may also
be included under this head. The audit procedures relating to some of the
major items included under this head are discussed below.
12.50 Non-Interest Bearing Staff Advances: The auditor should examine
non-interest bearing staff advances with reference to the relevant
documentation and the bank’s policy in this regard. The availability,
enforceability and valuation of security, if any, should also be examined. It
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needs to be examined whether the same relates to employees on the roll of the
bank on the date of the preparation of financial statements.
12.51 Festival and Other Advances: Banks grant unsecured advances to
staff like festival/drought relief/housing advances etc. due to the employer-
employee relationship where normally lien is marked on the terminal benefits of
the employee; but advances against FDRs and other securities etc. are also
given. While a distinction needs to be made between advances given by the
bank as an "employer" and as "banker", the RBI's latest applicable circular
needs to be kept in view as regards disclosure requirement of advances in the
latter category i.e. as banker.
12.52 Security Deposits: Security deposits with various authorities (e.g., on
account of telephone, electricity, etc.,) and with others (e.g., deposits in
respect of premises taken on rent) should be examined with reference to
documents containing relevant terms and conditions, and receipts obtained
from the parties concerned. The auditor should verify that the deposits have
not become due as per the terms and conditions. If it is so, then the
recoverability of the same needs to be looked into in detail and appropriate
provision should be suggested against the amount where recovery is in doubt.
12.53 Suspense Account: 'Suspense' account is another item included
under 'other assets'. Ideally, where accounts are maintained properly and on a
timely basis, suspense account may not arise. However, in a practical
situation, suspense account is often used to temporarily record certain items
such as the following:
(i) amounts temporarily recorded under this head till determination of the
precise nature thereof or pending transfer thereof to the appropriate head
of account;
(ii) debit balances arising from payment of interest warrants/ dividend
warrants pending reconciliation of amounts deposited by the company
concerned with the bank and the payment made by various branches on
this account;
(iii) amounts representing losses on account of frauds awaiting adjustment.
12.54 Process of Creation of Suspense Accounts: The Auditor should study
the process of creation of suspense accounts, who is authorized to post and
reverse entries in these accounts especially, the necessity of posting these
entries, controls over monitoring of ageing and reversal of entries therein.
Auditors should also ensure that multiplicity of accounts and unnecessary
accounts are not opened as suspense accounts. RBI has also suggested a
quick audit of entries in Suspense Account and the status thereof to be
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reported in terms of RBI Circular No. DBOD.BP.BC.4/ 21.04.018/2003-04

dated 19 July, 2003 “Guidelines on netting off of old and small value entries -
Clearing Differences”.
12.55 Unusual items in Suspense Accounts: The Auditor should pay special
attention to any unusual items in suspense account since these are prone to
fraud risk. The Auditor should obtain the management policy for provision/write
off for old outstanding items. He should obtain from the management, details of
old outstanding entries/age-wise balances along with narrations in suspense
account. The Auditor should verify the process of the bank to ensure
expeditious clearance of items debited to suspense account and whether the
same is actually happening. Also, verify the reasons for delay in adjusting the
entries, if any. Where the outstanding balances comprised in suspense
account require a provision/write-off, the Auditor should examine whether the
necessary provision has been made/written off. All items of more than 90 days
in suspense accounts need special attention of the Auditor. The Auditor has to
certify all the suspense account entries through a separate certificate in the
annual closing sets. If there are any intangible items, the same should be
specifically reviewed for their recoverability. In case any of them are under
investigation, the same should be reviewed in detail, status taken and
accordingly be reported including if any provision needs to be made in this
regard.
12.56 The Auditor has also to verify whether any particular office account is
used for allowing debits to accommodate temporary overdrafts without
appropriate disclosures. This tantamount to a fraudulent practice and the bank
has to put in place suitable internal controls to avoid opening and operating of
such office account heads. Since, suspense account not monitored properly
may lead to frauds, the SBA has to make proper verification and also report the
same to the SCA.
12.57 The auditor should review the system at the Bank for clearance of items
debited to Suspense Account and the time taken for the same. Outstanding
entries in excess of 90 days needs to be scrutinized in detail and the reasons for
delay in adjusting the entries may be ascertained. Any old balances which are
not expected to be recovered should be provided for.
12.58 Prepaid Expenses: The Auditor should verify prepaid expenses in the
same manner as in the case of other entities and examine whether the basis of
allocation of expenditure to different periods is reasonable. The Auditor should
particularly examine whether the allocation of discounting and rediscounting
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charges paid by the bank to different accounting periods is in consonance with

the accounting policy followed for the bank as a whole. Timely apportionment
of entries from prepaid accounts as per Bank policy should be ensured.
12.59 Miscellaneous Debit Balances on Government Account:
Miscellaneous debit balances on government account in respect of pension,
public provident funds, compulsory deposit scheme payments, etc., for which
the branch obtains reimbursement from the government through a designated
branch, are also included under the head 'others'. In many cases, the
accounting for this is outside the core banking solution and needs the special
attention of the Auditor. The Auditor should review the ageing statements
pertaining to these items and should particularly examine the recoverability of
old outstanding items. The Auditor should also examine whether claims for
reimbursement have been lodged by the branch in accordance with the
relevant guidelines, terms and conditions. The net balances of the amount
recoverable at the Head Office level should also be taken along with age-wise
analysis of the same. Outstanding balances without any confirmation or proper
justification should be provided for /written off as the case may be in the
accounts.
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13
Borrowings and Deposits
Borrowings
13.01 Borrowings is usually handled as a centralised activity. In case of
exception borrowing happens at few designated branches authorised in this
behalf by the head office/ controlling authority either generally or specifically in
respect of a particular borrowing. Mostly, borrowings are handled by the
Treasury Branches and form part of the Balance Sheet of the Treasury Branch
and hence, does not figure in the balance sheets of most branches of the bank.
13.02 RBI, Export-Import Bank of India (EXIM Bank), National Bank for
Agriculture and Rural Development (NABARD) and Small Industries
Development Bank of India (SIDBI) are the major agencies providing refinance
to banks, generally for loans extended to specified sectors. Borrowings from
RBI include refinance obtained by the bank from the RBI. Similarly, borrowings
from other banks include refinance obtained by the bank from commercial
banks, co-operative banks, etc. Refinance obtained by the bank from EXIM
Bank, NABARD, SIDBI and other similar institutions and agencies are to be
included under ‘Borrowings from other institutions and agencies’. This head will
also include the bank’s liability against participation certificates on non-risk
sharing basis issued by it to participating banks.
Deposits and Types
13.03 Deposits represent the most important source of funds for banks.
Deposits are received from a large number of constituents, generally in small
amounts.
13.04 Deposits accepted by banks are primarily of two types – those
repayable on demand (demand deposits) and those repayable after a fixed
term (term deposits), though in this case also subject to certain conditions, the
deposits may be repaid prematurely at the request of the depositor.
Demand Deposits
13.05 Current account and Savings account are the most common form of
demand deposits.
Current Bank Deposits
13.06 Current accounts can be opened in the names of individuals,
associations of persons, corporate bodies, trusts, societies, etc., i.e., for all
kinds of customers. The operations in current accounts opened in joint names

may be joint, single, by either holder or by surviving holder, depending on the
mode of operation chosen by the account holders. The salient features of this
type of accounts are:
 There is no restriction on the withdrawal or deposit of money or number of
transactions by the account holder at any one time.
 Some guidelines are prescribed by the bank for maintaining a minimum
balance, which differ from bank to bank. Bank also charges a penalty for
non-maintenance of minimum balance, as per internal policy.
 No interest is generally payable on this deposit except where it may be
specifically permitted by the bank / RBI.
Savings Bank Deposits
13.07 Savings accounts are generally in the names of individuals– either
singly or jointly and HUF, and sometimes, in the names of institutions which
are specifically approved by the RBI for maintaining savings bank accounts
with banks (Trusts, Educational Institutes etc). In terms of RBI’s guidelines, no
bank can open a savings bank account for government departments, municipal
corporations, municipal committees, any political party, or any trade, business
or professional concern, whether such concern is a proprietary or a partnership
firm or a company or an association.
13.08 The salient features of this type of accounts are:
 Banks place restrictions on the maintenance of minimum balance
(separate for accounts with cheque book facility and those without cheque
book facility), amount of funds that can be withdrawn by the account
holder at any point of time. Beyond this cut-off level, banks require the
depositors to give notice of a specified period for withdrawal of the
amount.
 Banks also place restrictions on the number of withdrawals from the
account during a stated period of time, usually one year. For the number of
withdrawals beyond this number, banks have the right to levy service
charges. The intention behind putting this restriction is to ensure that the
savings bank accounts (on which the account holder is entitled to payment
of interest) are used to promote genuine savings and are not used as
substitutes for current accounts.
 Rate of interest has been largely deregulated and is on discretion of
individual banks subject to uniformity for balance up to Rs.1 Lakh and
differential rate for balance exceeding Rs. 1 Lakh. Banks pay interest at
520
quarterly or shorter intervals on daily outstanding balances. Depending on

the practice adopted by each bank provision for the balance period up to
the year-end may be made at branches/Head Office.
 With effect from April 1, 2015, while levying charges for non-maintenance
of minimum balance in savings bank accounts, banks shall adhere to the
following additional guidelines:
(i) In the event of a default in maintenance of minimum balance /
average minimum balance as agreed to between the bank and
customer, the bank should notify the customer clearly by SMS /
email / letter etc. that in the event of the minimum balance not being
restored in the account within a month from the date of notice, penal
charges will be applicable.
(ii) In case the minimum balance is not restored within a reasonable
period, which shall not be less than one month from the date of
notice of shortfall, penal charges may be recovered under intimation
to the account holder.
(iii) The policy on penal charges to be so levied may be decided with the
approval of Board of the bank.
(iv) The penal charges should be directly proportionate to the extent of
shortfall observed. In other words, the charges should be a fixed
percentage levied on the amount of difference between the actual
balance maintained and the minimum balance as agreed upon at the
time of opening of account. A suitable slab structure for recovery of
charges may be finalized.
(v) It should be ensured that the balance in the savings account does
not turn into negative balance solely on account of levy of charges
for non-maintenance of minimum balance.
13.09 In the case of both current and savings bank accounts, if there are no
operations on the account by the account holder during a prescribed period
(such period may vary from bank to bank), such accounts are identified as
‘dormant’ or ‘inoperative’ accounts and may be transferred to a separate GL
code. Further, transactions and even in some banks the viewing rights in these
accounts are allowed only with authority of the official designated by the bank
for this purpose.
Term Deposits
13.10 Term deposits (known by different nomenclature in different banks)
are repayable after a specified period of time. The minimum period of these
521
deposits, at present, is 7 days. The salient features of this kind of deposits are
given below:
 Interest is payable at periodic intervals to the depositors or as per their
instructions.
 In case a depositor so desires, the periodic interest can be reinvested in
fresh term deposits. Such schemes are generally called ‘reinvestment
plans’. In this case, the interest payable is compounded at the specified
intervals and the resultant maturity value is indicated on the deposit
receipt at the time of issuing the receipt. The head offices of banks issue
maturity value charts for the guidance of their branches from time to time.
13.11 Recurring deposit accounts are an important variant of term deposit.
In a recurring deposit, a specified sum is deposited at regular intervals,
generally once a month, for a pre-determined period. On the expiry of this
period, the maturity proceeds, which are known at the time of opening the
account, are repaid to the depositors or as per their instructions. No recurring
deposit is accepted under FCNR(B) Scheme. Some of the banks are offering
fixed / flexible recurring deposit accounts in recent times where the customer
chooses amount of deposit each time based on their convenience.
13.12 Cash Certificates and Certificates of Deposit (CD), in demat form or
otherwise, are two other variants of term deposits. Cash certificates are issued
at discounted value, e.g., a certificate with face value of Rs. 100 and term of 5
years may be issued at, say, Rs. 49. The certificates of deposit are short-term
negotiable money market instruments and are issued in only dematerialised
form or as a Usance Promissory Note. However, according to the Depositories
Act, 1996, investors have the option to seek certificate in physical form.
Further, issuance of CDs will attract stamp duty. In this regard, the RBI has
issued Master Direction No. RBI/FMRD/2016-17/32 FMRD. Master Direction No.
2/2016-17 dated July 07, 2016 on “Money Market Instruments: Call/Notice
Money Market, Commercial Paper, Certificates of Deposit and Non-Convertible
Debentures (original maturity up to one year)” (which include Certificate of
Deposit). CDs may be issued at a discount on face value. The rate of interest
thereon is negotiable with the depositor and may vary on a daily basis. The
maturity period of CDs issued by banks should not be less than 7 days and not
more than one year. Banks are allowed to issue CDs on floating rate basis
provided the methodology of compiling the floating rate is objective,
transparent and market-based. The issuing bank/FI is free to determine the
discount / coupon rate. The interest rate on floating rate CDs would have to be
reset periodically in accordance with a pre-determined formula that indicates
the spread over a transparent benchmark. CDs can be issued in Demat or in
physical form, and in the latter case must be issued on security paper
stationery, in denomination of Rs. 1 lakh (for a single subscriber) or in multiple
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of Rs 1 lakh and without the benefits of repatriation if issued to NRI. Other than
for NRIs, CDs are transferrable by endorsement and delivery.
13.13 There is no grace period for repayment of CDs. If maturity date
happens to be on holiday it should be paid on the immediately preceding
working day. Banks may, therefore, so fix the period of deposit that the
maturity date does not coincide with a holiday to avoid loss of discount /
interest rate. All OTC trades in CDs shall be reported within 15 minutes of the
trade on the FIMMDA reporting platform.
13.14 In respect of term deposits, banks issue Deposit Receipts. These
receipts are not negotiable, and therefore, deposits cannot be transferred
without the consent of the bank. Certificates of deposits are, however,
transferable. CDs held in physical form are transferable by endorsement and
delivery. CDs in dematerialised form can be transferred as per the procedure
applicable to other demat securities. There is no lock-in period for CDs. Banks
/ FIs cannot grant loans against CDs. Furthermore, premature buyback is not
permitted and no loans can be taken against CDs. However, the Reserve Bank
may relax these restrictions for temporary periods through a separate
notification.
13.15 Banks normally allow repayment of the deposits before the due date;
however, the rate of interest paid to the depositor in case of premature
repayment is as per the rate applicable to the period for which the deposit have
actually run which may be less than the rate contracted initially. Premature
penalty may also be levied by the bank as per its policy in this regard.
Issues to be considered by the Auditor
13.16 Following are the important issues in respect of different categories of
accounts which an Auditor must consider.
(a) FCNR (B) Accounts
Foreign Currency Non-Resident (FCNR) Accounts are the accounts, as
the name suggests opened by Non-Resident Indians in form of fixed
deposit only.
Further, RBI, vide its Master Direction-Reserve Bank of India (Interest
rate on Deposits) Direction, 2016 dated March 03, 2016 provides
guidance on the interest rates on deposits held in FCNR(B) accounts.
The Circular further prohibit banks to:
(i) accept or renew a deposit over five years;
(ii) discriminate in the matter of rate of interest paid on the deposits,
523
between one deposit and another accepted on the same date and for
the same maturity, Except for difference on account of tenor of
deposits and size of deposits.
Further, the interest rates on all deposits, with floating rate deposits
shall be within the ceiling of swap rates for the respective
currency/maturity and interest reset period shall be six months.
The interest rate ceiling on FCNR(B) deposits shall be as under:
Period of deposit Ceiling rate
1 year to less than 3 years LIBOR/ Swap plus 200 basis points
3 years and above up to and LIBOR/ Swap plus 300 basis points
including 5 years
The LIBOR / Swap rates quoted/displayed by Foreign Exchange

Dealers Association of India (FEDAI) shall be used as the reference
for arriving at the interest rates on FCNR(B) deposits.
Interest shall be calculated on the basis of 360 days to a year and
paid at intervals of 180 days each and thereafter for the remaining
actual number of days. Depositor may also receive interest on
maturity with compounding effect.
(b) Resident Foreign Currency (RFC) Accounts
The returning Indians can have their foreign currency accounts or NRE
accounts to be converted into RFC.
(c) Export Earners Foreign Currency (EEFC) accounts
 Exporters having good track record and a unit located in SEZ
entitled to open foreign currency account with banks with following
features.
 Non-interest bearing current account.
 No credit facilities against the security of the balances.
 Hundred per cent of export earnings can be credited to this account.
 Amount is credited in a calendar month is to be utilised for
authorised purposes by the end of next calendar month except the
amount set-aside for forward commitments. Any balance left
unutilised needs to be converted into Indian Rupees for credit to
rupee account of exporter.
524
(d) Diamond Dollar Accounts

This account may be opened with the permission from RBI to transact
business in USD.
Firms and companies dealing in purchase/sale of rough or cut
diamonds/precious metal jewellery with track record of at least 2 years
and average annual turnover of Rs.3 crores or above during preceding 3
licencing years.
(e) Non-resident (NRO and NRE) Bank Accounts
NRE account may be opened by Non-resident Indians (NRIs) and
persons of Indian Origin (PIOs), whereas NRO account may be opened
by all non-residents.
The accounts may be maintained in form of savings, current, recurring or
fixed deposit and are denominated in Indian Rupees.
The RBI, vide its Master Direction No. RBI/DBR/2015-16/19 Master
Direction DBR. Dir. No.84/13.03.00/2015-16 dated March 03, 2016
(updated as on February 22, 2019) on Reserve Bank of India (Interest
Rate on Deposits) Directions, 2016 provides guidance on the interest rates
on rupee deposits held in Domestic, Ordinary Non-Resident (NRO) and
Non-Resident (External) (NRE) Accounts.
(f) Special Non-Resident Rupee Account (SNRR)
Any non-resident having business interest in India may open SNRR
account for the purpose of putting through bona fide transactions in rupee
as specified under A.P.(DIR series) Circular no.09 dated Nov.22, 2019.
The account shall not carry any interest and the maximum period shall
not exceed seven years except in some specified cases.
Unclaimed Deposits/ Inoperative Accounts
13.17 As per RBI Circular no. DBOD No. Leg.BC.34/ 09.07.005/2008-09
dated August 22, 2008 on “Unclaimed Deposits/inoperative accounts in
Banks”, a bank is required to make an annual review of accounts in which
there are no operations (i.e. no credit or debit other than crediting of periodic
interest or debiting of service charges) for more than one year. A savings/
current account should be treated as inoperative/ dormant if there are no
transactions in the account for over a period of two years. In case any reply is
given by the account holder giving the reasons for not operating the account,
banks should continue classifying the same as an operative account for one
more year within which period the account holder may be requested to operate
525
the account. However, in case the account holder still does not operate the
same during the extended period, banks should classify the same as
inoperative account after the expiry of the extended period. If a Fixed Deposit
Receipt matures and proceeds are unpaid, the amount left unclaimed with the
bank will attract savings bank rate of interest. Further no penal charges are to
be levied for non-maintenance of minimum balances in any inoperative
account w.e.f. May 06, 2014(RBI/2013-14/580 DBOD.DIR.BC.No.109/ 13/03
/00/2013-14).
13.18 In terms of Foreign Exchange Management (Crystallization of
Inoperative Foreign Currency Deposits) Regulations, 2014 and vide Notification
No. FEMA 10A/2014-RB dated March 21, 2014; and as per Clause 2.7 of the
RBI Master Circular DBOD.No.Dir.BC.14/13.03.00/2014-15 dated July 01, 2014
“Master Circular of Instructions Relating to Deposits held in FCNR(B) Accounts”,
inoperative deposits having a fixed term and those with no fixed term maturity
after the expiry of a three month notice, upon completion of three years, will get
crystallized into Rupees.
Depositor Education and Awareness Fund (DEAF) Scheme 2014
13.19 The Reserve Bank of India vide its circular no. DBOD.No.DEAF Cell.
BC. 101/ 30.01.002/2013-14 dated March 21, 2014 issued “The Depositor
Education and Awareness Fund Scheme, 2014 - Section 26A of Banking
Regulation Act, 1949” laying down certain guidelines with respect to the said
fund. Under the provisions of Section 26A of the Banking Regulation Act, 1949
the amount to the credit of any account including savings, term, recurring, current
or any other deposit, cash credit account, loan accounts after due appropriation
by the bank, outstanding TT, DD, Sundry deposit accounts, clearing adjustments,
unreconciled credit balance in ATM, undrawn balance in prepaid card etc in India
with any bank which has not been operated upon for a period of ten years or any
deposit or any amount remaining unclaimed for more than ten years shall be
credited to the Fund, within a period of three months from the expiry of the said
period of ten years. . The depositor would, however, be entitled to claim from the
bank the deposit or any other unclaimed amount or operate the account after the
expiry of ten years, even after such amount has been transferred to the Fund.
The bank would be liable to pay the amount to the depositor/claimant and claim
refund of such amount from the Fund.
13.20 Normally the list of the dormant accounts is generated by the system
itself and the branch is required to follow up with the account holders. The
System identifies dormant accounts at the Branches and transfers the balances
ageing more than 10 years to the DEAF usually through the RBI current account
maintained at the Treasury Branch. The auditors should check all such balances
526
which have been dormant more than 10 years and not transferred to the DEAF
and make the necessary rectifications at the Branches. Various returns are
required to be submitted to RBI in this regard, which are also required to be
verified by the auditors.
13.21 As per RBI/2013-14/614 DBOD.No.DEAF Cell.BC.114/30.01.002/2013-
14 all such unclaimed liabilities (where amount due has been transferred to
DEAF) may be reflected as “Contingent Liability – Others-items for which the
bank is contingently liable” under Schedule 12 of the annual financial statements.
Banks are also required to disclose the amounts transferred to DEAF under the
notes to accounts.
Reserve Bank of India (Gold Monetization Scheme) Direction, 2015
13.22 The RBI issued Master Direction No.DBR.IBD.No.45/23.67.003/2015-16
dated October 22, 2015 (Updated as on August 16, 2019) on “Gold Monetisation
Scheme, 2015” to all Scheduled Commercial Banks that decide to implement the
Scheme(excluding Regional Rural Banks), requiring such banks that decide to
implement the Scheme (Designated Bank), to formulate a comprehensive policy
with approval of their respective boards.
13.23 The Gold Monetization Scheme, 2015 (GMS) which includes the
Revamped Gold Deposit Scheme (R-GDS) and Revamped Gold Metal Loan
Scheme (R-GML) was intended to mobilise gold held by households and
institutions to facilitate its use for productive purposes, and to reduce country’s
reliance on the import of gold.
13.24 Designated Banks are authorised to accept deposits, the principal and
interest of which, under the scheme, shall be denominated in gold and the
interest will start accruing from the date of conversion of gold deposited into
tradable gold bars after refinement or 30 days after receipt of gold, whichever is
earlier. Such deposits can be accepted from eligible persons, viz., Resident
Indians [Individuals, HUFs, Proprietorship & Partnership firms, Trusts including
Mutual Funds/Exchange Traded Funds registered under SEBI (Mutual Fund)
Regulations, Companies, charitable institutions, Central Government, State
Government or any other entity owned by Central Government or State
Government]. Joint deposits of two or more eligible depositors can be made on
the same basis as other joint deposit accounts and with nomination facility.
13.25 The minimum deposit at any one time shall be 30 grams of raw gold
with no maximum limit with two types of gold deposit scheme i.e. Short term
Bank deposit(STBD) and Medium and Long term Government Deposit (MLTGD).
The broad features of the Gold Monetisation Scheme are summarised and given
as at Annexure to this Chapter.
527
Know Your Customer Requirements (KYC)

13.26 The Reserve Bank of India vide its master direction dated February
25, 2016 and updated up to April 20, 2020 on “Master Direction-Know Your
Customer (KYC) Direction, 2016” has laid down certain guidelines to prevent
banks from being used, intentionally or unintentionally, by criminal elements for
money laundering or terrorist financing activities. The guidelines prescribed in
this circular, popularly known as KYC guidelines; also enable banks to
know/understand their customers and their financial dealings better which in
turn help them manage their risks prudently.
13.27 These guidelines contain detailed requirements for banks in respect of
customer acceptance policy, customer identification procedures, monitoring of
transactions and risk management. The auditor should also keep in mind the
reporting requirements under LFAR format while verifying the area.
Data Integrity and modifications
13.28 The Auditor need to verify the control processes to ensure that the
customer accounts opened in system are properly updated in the relevant
module in CBS and errors, if any are identified and rectified. Further any
subsequent changes in customer accounts, should be properly authorised and
control process should exist for their verification. Auditor may pick some cases
on sample basis to verify correctness of above data updated in CBS system
and any periodic changes in the same.
Borrowings
13.29 Borrowings from RBI, other banks/financial institutions, etc., should be
verified by the auditor with reference to confirmation certificates and other
supporting documents such as, application form, sanction letter, agreements,
interest rate, security, correspondence, etc. Audit evidence in the form of
external confirmations received directly by the Auditor from appropriate
confirming parties / lenders may assist the auditor in obtaining audit evidence
that the auditor requires to respond to significant risks of material
misstatement. The Auditor is required to comply with the requirements of
Standard on Auditing (SA) 505, “External Confirmations” which contains
guidance on designing and performing external confirmation procedures to
obtain relevant and reliable audit evidence.
13.30 The Auditor should also examine whether a clear distinction has been
made between ‘rediscount’ and ‘refinance’ for disclosure of the amount under
the above head since rediscount does not figure under this head.
528
13.31 The Auditor should examine whether borrowings of money at call and
short notice are properly authorised. The rate of interest paid/payable on, as
well as duration of such borrowings should also be examined by the auditor. In
case of borrowing through bonds and debentures, generally banks appoint the
registrar for maintenance of records of borrowing such as bond holders etc.
The Auditor can obtain the balance confirmation from registrar of the bonds
including other parameters of borrowing at each period end.
Deposits
13.32 In carrying out audit of deposits and liabilities, the Auditor is primarily
concerned with obtaining reasonable assurance that all known liabilities are
recorded and stated at appropriate amounts.
13.33 The Auditor may verify various types of deposits in the following
manner.
Current Accounts and Savings Bank Account
13.34 The Auditor should verify if any difference exist from legacy system of
control and subsidiary ledgers.
13.35 The Auditor should examine whether the debit balances in current
accounts are not netted out on the liabilities side but are appropriately included
under the head ‘Advances’.
13.36 Inoperative accounts are a high risk area of frauds in banks. While
examining current accounts, the Auditor should specifically cover in his sample
some of the inoperative accounts revived / closed during the year. The Auditor
should also ascertain whether inoperative accounts are ‘revived’ only with
proper authority. For this purpose, the Auditor should identify cases where
there has been a significant reduction in balances compared to the previous
year and examine the authorisation for withdrawals. Ratio analysis and
comparatives can be used to select / identify such variation.
13.37 As per RBI/2020-21/20 DOR.No.BP.BC/7/21.04.048/2020-21 dated
August 06, 2020 banks have been instructed not to open current accounts for
customer who have availed credit facilities in form CC/OD from the banking
system. In other cases of credit facilities current account may be opened for
facility less than Rs.5 crores and in other cases only lenders can open current
account and other banks may open collection accounts, as per specified
criteria.
13.38 The Auditor has to verify whether the savings accounts are opened for
only eligible entities for savings purposes and not for Business purposes.
529
Term Deposits
13.39 While evaluating the internal controls over term deposits, the Auditor
should specifically examine whether the deposit receipts and cash certificates
are issued serially and all of them are accounted for in the registers. The
auditor should also satisfy himself that there is a proper control over the
unused forms of deposit receipts and cash certificates to prevent their misuse.
13.40 As stated earlier, the rate of interest on Certificates of Deposits (CDs)
is negotiable with the depositor. This area is quite sensitive. The auditor should
bear this fact in mind while examining the efficacy of prescribed internal
controls with regard to rates of interest on CDs.
13.41 Term deposits from banks are usually (though not necessarily) in
round figures. Any odd balances in term deposits should therefore be selected
by the auditor for verification on a sample basis.
13.42 In case of Bulk Deposits (Rupees one crore and above for scheduled
commercial banks and Rs.15 lakhs for RRBs) the interest rate would be
obtained by the branch from the Treasury division. The Auditor to verify all
such cases to verify correctness of rates been offered.
13.43 In case of for closure of deposit test check to be made whether the
mandated foreclosure penalty has been deducted from the applicable Interest
rate payable.
Deposits Designated in Foreign Currencies
13.44 In the case of deposits designated in a foreign currency, e.g., foreign
currency non-resident deposits, the Auditor should examine whether they have
been converted into Indian rupees at the rate notified in this behalf by the head
office. The Auditor should also examine whether any resultant increase or
decrease has been taken to the profit and loss account. It may also be seen
that interest on deposits has been paid on the basis of 360 days in a year:
i) For deposits up to one year, at the applicable rate without any
compounding effect.
ii) In respect of deposits for more than 1 year, the interest on FCNR (B)
deposits should be calculated at intervals of 180 days each and thereafter
for remaining actual number of days, till normal maturity.
13.45 Further, in case of conversion of FCNR (B) deposits into NRE
deposits or vice versa before maturity has been subjected to the provisions
relating to premature withdrawal.
530
Other Non-resident Deposits

13.46 Only eligible credits are made to the NRE account and only legitimate
dues of the accountholder are credited to NRO accounts.
Debits to NRE and NRO accounts to be verified for any violation of applicable
guidelines.
In case of Premature of NRE deposit, before 1 year, no interest to be paid for
such deposits as per RBI guidelines.
It is also to be verified whether any customer is holding both non-resident and
resident account at the same point of time, which may not be permissible.
Summary of NRE, FCNR(B) and NRO Accounts
Non-Resident Foreign
(External) Currency (Non-
Non-Resident Ordinary
Rupee Resident)
Particulars Rupee Account Scheme
Account Account (Banks)
[NRO Account]
Scheme [NRE Scheme [FCNR
Account] (B) Account]
(1) (2) (3) (4)
Who can NRIs and PIOs Any person resident outside
open an India for putting through
Individual/entities of Pakistan and
account bonafide transactions in
Bangladesh shall requires prior
rupees.
approval of the Reserve Bank of
India Individuals/ entities of
Pakistan nationality/ origin
and entities of Bangladesh
origin require the prior
approval of the Reserve
Bank of India.
A Citizen of Bangladesh/
Pakistan belonging to
minority communities in
those countries i.e. Hindus,
Sikhs, Buddhists, Jains,
Parsis and Christians
residing in India and who
has been granted LTV or
whose application for LTV is
under consideration, can
531
open only one NRO account

with an AD bank subject to
the conditions mentioned
in Notification No. FEMA
5(R)/2016-RB dated April
01, 2016, as updated from
time to time.
Post Offices in India may
maintain savings bank
accounts in the names of
persons resident outside
India and allow operations
on these accounts subject to
the same terms and
conditions as are applicable
to NRO accounts maintained
with an authorised dealer/
authorised bank.
Joint May be held jointly in the names of May be held jointly in the
account two or more NRIs/ PIOs. names of two or more NRIs/
PIOs.
NRIs/ PIOs can hold jointly with a
resident relative on ‘former or May be held jointly with
survivor’ basis (relative as defined residents on ‘former or
in Companies Act, 2013). The survivor’ basis.
resident relative can operate the
account as a Power of Attorney
holder during the life time of the
NRI/ PIO account holder except
closure and remittance back of
funds to the depositor.
Currency Indian Rupees Any permitted Indian Rupees
currency i.e. a
foreign currency
which is freely
convertible
Type of Savings, Term Deposit Savings, Current, Recurring,
Account Current, only Fixed Deposit
Recurring,
Fixed Deposit
532
Period for From one to For terms not less As applicable to resident
fixed three years, than 1 year and accounts.
deposits However, not more than 5
banks are years
allowed to
accept NRE
deposits above
three years
from their
Asset-Liability
point of view
Permissible Credits permitted to this account Inward remittances from
Credits are inward remittance from outside outside India, legitimate
India, interest accruing on the dues in India and transfers
account, interest on investment, from other NRO accounts
transfer from other NRE/ FCNR(B) are permissible credits to
accounts, maturity proceeds of NRO account.
investments (if such investments
Rupee gift/ loan made by a
were made from this account or
resident to a NRI/ PIO
through inward remittance).
relative within the limits
Current income like rent, dividend, prescribed under the
pension, interest etc. will be Liberalised Remittance
construed as a permissible credit Scheme may be credited to
to the NRE account. the latter’s NRO account.
Care: Only those credits which
have not lost repatriable character
Permissible Permissible debits are local The account can be debited
Debits disbursements, remittance outside for the purpose of local
India, transfer to other NRE/ payments, transfers to other
FCNR(B) accounts and NRO accounts or remittance
investments in India. of current income abroad.
Apart from these, balances
in the NRO account cannot
be repatriated abroad except
by NRIs and PIOs up to
USD 1 million, subject to
conditions specified in
Foreign Exchange
Management (Remittance of
533
Assets) Regulations, 2016.

Funds can be transferred to
NRE account within this
USD 1 Million facility.
Repatriablity Repatriable Not repatriable except for all
current income.
Balances in an NRO
account of NRIs/ PIOs are
remittable up to USD 1 (one)
million per financial year
(April-March) along with their
other eligible assets subject
to payment of due tax
appropriately certified as per
law.
Taxability Income earned in the accounts is Taxable subject to
exempt from income tax and withholding tax.
balances exempt from wealth tax
Loans in AD can sanction loans in India to Loans against the deposits
India the account holder/ third parties can be granted in India to
without any limit, subject to usual the account holder or third
margin requirements. These loans party subject to usual norms
cannot be repatriated outside India and margin requirement.
and can be used in India only for The loan amount cannot be
the purposes specified in the used for relending, carrying
regulations. on agricultural/ plantation
activities or investment in
In case of loans sanctioned to a
real estate.
third party, there should be no
direct or indirect foreign exchange The term “loan” shall include
consideration for the non-resident all types of fund based/ non-
depositor agreeing to pledge his fund based facilities.
deposits to enable the resident
individual/ firm/ company to obtain
such facilities.
In case of the loan sanctioned to
the account holder, it can be repaid
either by adjusting the deposits or
through inward remittances from
534
outside India through banking

channels or out of balances held in
the NRO account of the account
holder. In case of a POA holder,
confirmation from the original
depositor must be obtained.
The facility for premature
withdrawal of deposits will not be
available where loans against such
deposits are availed of.
The term “loan” shall include all
types of fund based/ non-fund
based facilities.
Loans Authorised Dealers may allow their Not permitted
outside India branches/ correspondents outside
India to grant loans to or in favour
of non-resident depositor or to third
parties at the request of depositor
for bona fide purpose against the
security of funds held in the NRE/
FCNR (B) accounts in India,
subject to usual margin
requirements.
The term “loan” shall include all
types of fund based/ non-fund
based facilities
Rate of As per guidelines issued by the regulating Department
Interest
Operations Operations in the account in terms Operations in the account in
by Power of of Power of Attorney is restricted to terms of Power of Attorney
Attorney in withdrawals for permissible local is restricted to withdrawals
favour of a payments or remittance to the for permissible local
resident account holder himself through payments in rupees,
normal banking channels, but he remittance of current income
cannot close the account. to the account holder
outside India or remittance
to the account holder himself
through normal banking
535
channels. While making

remittances, the limits and
conditions of repatriability
will apply.
Change in NRE accounts On change in NRO accounts may be

residential should be residential status, designated as resident
status from designated as FCNR (B) accounts on the return of the
Non-resident resident deposits may be account holder to India for
to resident accounts or the allowed to any purpose indicating his
funds held in continue till intention to stay in India for
these accounts maturity at the an uncertain period.
may be contracted rate of
Likewise, when a resident
transferred to interest, if so
Indian becomes a person
the RFC desired by the
resident outside India, his
accounts, at the account holder.
existing resident account
option of the
Authorised should be designated as
account holder,
dealers should NRO account
immediately
convert the
upon the return
FCNR(B)
of the account
deposits on
holder to India
maturity into
for taking up
resident rupee
employment or
deposit accounts
on change in
or RFC account
the residential
(if the depositor is
status.
eligible to open
RFC account), at
the option of the
account holder.
Summary of EEFC, RFC(D) and RFC Accounts
Particulars Exchange Earners Resident Foreign Resident Foreign

Foreign Currency Currency Currency (RFC)
(EEFC) Account (Domestic) Account
[RFC(D)] Account
Who can Exchange Earners Individuals Individuals
open the
account
536

[RFC(D)] Account
Joint Jointly with eligible Jointly with any Same as EEFC
account persons; person eligible to
or open the account
With resident relative(s)
on former or survivor’
basis.
Relative as defined
under Companies Act,
2013 (viz. members of
HUF, spouse, parents,
step-parents, son, step-
son, daughter-in-law,
daughter, son-in-law,
brother/sister, step-
brother/ step-sister)
Relative joint account
holder cannot operate
the account during the
life time of the account
holder
Type of Current only Current only Current/ savings/
Account term deposits
Interest Non-interest earning Non-interest earning De-regulated (As
decided by the AD
bank)
Permitted 1) 100% of foreign 1) Foreign 1) Foreign
Credits exchange received exchange exchange
on account of export received as received by him
transactions. payment/ service/ as super-
2) advance remittance gift/ honorarium annuation/
received by an while on visit other monetary
exporter towards abroad or from a benefits from
export of goods or non-resident who overseas
services is on a visit to employer
537

[RFC(D)] Account
3) Repayment of loans India 2) Foreign
given to foreign 2) Unspent amount exchange
importers of foreign realised on
4) Disinvestment exchange conversion of
proceeds on acquired from AD the assets
conversion of ADR/ for travel abroad referred to in
GDR Section 6(4) of
3) Gift from close
FEMA 1999
5) professional relative
earnings like 3) Gift/ inheritance
4) Earning through
director’s/ received from a
export of goods/
consultancy/ lecture person referred
services, royalty
fees, honorarium to in Section
5) Disinvestment 6(4) of FEMA
and similar other
proceed on 1999
earnings received by
conversion of
a professional by 4) Foreign
shares into ADR/
rendering services in exchange
GDR
his individual acquired before
capacity 6) Foreign July 8, 1947 or
exchange any income
6) Interest earned on
received as arising on it
the funds held in the
earnings of LIC held outside
account
claims/ maturity/ India with RBI
7) Re-credit of surrendered permission
unutilised foreign value settled in
currency earlier 5) Foreign
forex from an
withdrawn from the exchange
Indian insurance
account received as
company
earnings of LIC
8) Payments received
claims/
in foreign exchange
maturity/
by an Indian startup
surrendered
arising out of sales/
value settled in
export made by the
forex from an
startup or its
Indian
overseas
insurance
subsidiaries
company
6) Balances in
NRE/ FCNR (B)
538

[RFC(D)] Account
accounts on
change in
residential
status
Permitted 1) Any permissible Can be used for any No restrictions on
Debits current or capital permissible current/ utilisation in/
account transaction capital account outside India.
2) Cost of goods transactions.
purchased
3) Customs duty
4) Trade related loans
and advances. The
amount received in
one calendar month
should be utilized
before end of next
calendar month
except what is
earmarked towards
future liability due for
payment in a near
future.
Difference between SNRR Account and NRO Account

Feature SNRR Account NRO Account
Who can open Any person resident outside Any person resident outside India
India, having a business for putting through bona fide
interest in India for putting transactions in rupees.
through bona fide
Individuals/ entities of Pakistan
transactions in rupees.
nationality/ origin and entities of
Opening of SNRR accounts Bangladesh origin require the prior
by Pakistan and approval of the Reserve Bank of
Bangladesh nationals and India.
entities incorporated in
However, a citizen of
539
Pakistan and Bangladesh Bangladesh/Pakistan belonging to

requires prior approval of minority communities in those
Reserve Bank. countries i.e. Hindus, Sikhs,
Buddhists, Jains, Parsis and
Christians residing in India and
who has been granted LTV or
whose application for LTV is under
consideration, can open one NRO
account with an AD bank subject
to the conditions mentioned in
Notification No. FEMA 5(R)/2016-
RB dated April 01, 2016, as
updated from time to time.
Type of Non-interest bearing Current, Savings, Recurring or
Account Fixed Deposit;
Rate of interest – as per guidelines
issued by Department of
Regulation.
Permissible Debits and credits specific/ Credits:
Transactions incidental to the business
Inward remittances, legitimate
proposed to be done by the
dues in India, transfers from other
account holder
NRO accounts and any amount
received in accordance with the
Rules/Regulations/Directions
under FEMA, 1999.
Debits:
Local payments, transfer to other
NRO accounts, remittance of
current income, settlement of
charges on International Credit
Cards.
Tenure Concurrent to the tenure of No such restrictions on tenure.
the contract / period of
operation / the business of
the account holder and in
no case should exceed
seven years, other than with
approval of the Reserve
540
Bank.
Restriction of seven years is
not applicable to SNRR
accounts opened for the
purposes stated at sub.
paragraphs (i) to (v) of
paragraph 1 of Schedule 4
of FEMA 5(R).
Repatriability Repatriable Not repatriable except for current
income; and remittances by NRIs/
PIOs up to USD 1 million per
financial year in accordance with
the provisions of FEMA 13(R).
Interest Accrued But Not Due

13.47 The auditor should examine that interest accrued but not due on
deposits is not included under the relevant deposits but is shown under the
head ‘other liabilities and provisions’.
Inoperative Accounts
13.48 Internal controls over inoperative accounts, is imperative. A response to
the letter addressed to the Branch will assist the auditor to take a view on the
system of dealing with inoperative Accounts. Attention needs to be sharply
focused on debits/withdrawals to ascertain whether these are unauthorised. In
testing the debits, attention should be specially paid to large and repetitive debits
out of otherwise dormant accounts.
Computer generated exception reports will also reveal the status of the
inoperative accounts.
The activation of the account to be made active only after the specific request
from the customer and there should be operation in the account on the day of
the activation.
The Auditor may verify the existence of Audit log for cheque returns due to
account dormancy and subsequent activation. The Auditor also to verify that
the system should not allow the withdrawal in inoperative accounts through
overrides.
The Auditor may verify whether there is a practice in the bank to intimate the
customers once the account has become dormant through letter/ SMS/ E-mails
and suitable advice.
541
Window-dressing
13.49 There are several ways in which the deposits of a bank may be
inflated for purposes of balance sheet presentation. For example, some of the
constituents may be allowed overdraft on or around the date of the balance
sheet, the overdrawn amounts may be placed as deposits with the bank, and
further advances may be given on the security of the deposit receipts, thus
inflating deposits as well as advances. The transactions may be reversed
immediately after the close of the year. Where the Auditor comes across
transactions, which indicate the possibility of window-dressing, he may report
the same in his long form audit report. In appropriate cases, the auditor should
consider making a suitable qualification in his main audit report also.
The Auditor has to verify whether the unavailed portion of the credit facilities
(Overdraft, cash credit) are used to boost the loans and deposit at the end
quarter/ Half year/Annual and reversed on the next day which might tantamount
to window dressing. If so the same to be suitable commented in the Audit report/
LFAR.
The Auditor has to verify whether cheques/ Bills are purchased/Discounted to
boost the loan and deposits at the end quarter/ Half year/Annual and reversed on
the next day which might tantamount to window dressing. If so the same to be
suitable commented in the Audit report/ LFAR.
The Auditor has to verify whether the debits are made in suspense account/
sundries receivable account with an offset credit in current account at the end of
the quarter and then reversed on the next day to validate the element of window
dressing.
LFAR Reporting
13.50 Reporting on deposits shall be as under:
a) Does the bank have a system of identification of dormant/ inoperative
accounts and internal controls with regard to operations in such accounts?
In the cases examined by you, have you come across instances where the
guidelines laid down in this regard have not been followed? If yes, give
details thereof.
 Refer to the process of the bank for identification of dormant/inoperative
accounts.
 Refer the process for control over inactive/dormant accounts by
restricting access and other control procedures.
542
 Check the process of identifying DEAF accounts and transfer the same
to RBI, as per process.
 Sample check the control process is working and identify discrepancies.
Properly report the same.
b) After the balance sheet date and till the date of audit, whether there have
been any unusual large movements (whether increase or decrease) in the
aggregate deposits held at the year-end? If so, obtain the clarifications from
the branch and give your comments thereon.
 Take the GL abstract on balance sheet date and date of audit and
check for variations in the figures of deposits and loans.
 Check the variations for any unusual movements, if any and identify the
specific accounts resulting in this movement.
 Obtain reasons and report accordingly after considering response of the
management.
c) Whether the scheme of automatic renewal of deposits applies to FCNR(B)
deposits? Where such deposits have been renewed, report whether the
branch has satisfied itself as to the 'non-resident status' of the depositor and
whether the renewal is made as per the applicable regulatory guidelines and
the original receipts / soft copy have been dispatched.
 Check for bank policy for renewal of FCNR(B) accounts and system
parameters for automatic renewal marked in FCNR(B) accounts.
 Check the process of obtaining documents at the time of renewal of
FCNR(B) accounts including verification of the process of continuation
of account holder in non-resident status.
 Check the bank’s policy of printing and dispatch of original receipts and
control over them. Test check sample cases to form an opinion about
the efficacy of the process.
d) Is the branch complying with the regulations on minimum balance
requirement and levy of charges on non-maintenance of minimum balance
in individual savings accounts?
 Check the bank policy for minimum balance maintenance and intimation
to customer for non-maintenance of the same.
 Check in sample cases levy of charges with intimation given by the
bank.
 Check for any charges levied in inoperative/dormant accounts by the
bank.
543
13.51 Implementation of KYCAML guidelines
 Whether the branch has adequate systems and processes, as required, to

ensure adherence to KYC/AML guidelines towards prevention of money
laundering and terrorist financing.
 Whether the branch followed the KYC/AML guidelines based on the test
check carried out by the branch auditors.
13.52 Management Information System
 Whether the branch has the proper systems and procedures to ensure data
integrity relating to all data inputs which are to be used for MIS at corporate
office level and for supervisory reporting purposes. Have you come across
any instances where data integrity was compromised?
544
Annexure
Features of the Gold Monetization Scheme
The Broad features of the Gold Monetization Scheme are summarised in the
following Table:
Acceptance 1. Deposits under the scheme are to be made at the

of Deposits
a. Collection and Purity Testing Centre (CPTC) -the
and Interest
collection and assaying centres certified by the Bureau of
accretion
Indian Standards (BIS) and notified by the Central
Government for the purpose of handling gold deposited
and redeemed under the Scheme, or
b. designated bank branches, where, at their discretion,
banks may accept the deposit of gold.
2. Minimum Deposits -With no maximum limit for deposit, the
minimum deposit at any one time shall be raw gold (bars,
coins, jewellery, excluding stones and other metals)
equivalent to 30 grams of gold (of 995 fineness only).
3. Assaying of Gold - All gold deposited under the scheme,
whether tendered at the CPTC or designated bank
branches, shall, (except standard good delivery gold
accepted at the designated branches), be assayed at CPTC
for fire assaying.
4. Interest on such deposits accrues from the date of
conversion of gold deposited into tradable gold bars after
refinement or 30 days after the receipt of gold at the CPTC
or the bank’s designated branch, as the case may be,
whichever is earlier.
5. Gold deposited to be treated as an item in safe custody -
Between the date of acceptance of the gold and till
commencement of the date of accretion of interest, the gold
deposited shall be treated as an item in safe custody held by
the designated bank.
545
Valuation On the day the gold deposited starts accruing interest, the
designated banks shall translate the gold liabilities and
assets into Indian Rupees*. The prevalent custom duty for
import of gold will be added to the above value to arrive at
the final value of gold. This methodology will also be
followed for valuation of gold at any subsequent valuation
date(s) and for the conversion of gold into Indian Rupees
under the Scheme.
(*by crossing the London AM fixing for Gold / USD rate with
the Rupee-US Dollar reference rate announced by RBI on
that day)
Reporting to The designated banks will be required to submit a monthly

RBI report on GMS to the RBI in the prescribed format.
However, as per RBI Circular No. DGBA GAD No

2294/15.04.001/2016-17 dated March 6, 2017, in order to
have uniformity in reporting, reconciliation and accounting,
agency banks may report the Gold Monetisation Scheme
transactions i.e., receipt, payment, penalty, interest,
commission for mobilisation, handing charges, etc., directly
through the government account maintained for the purpose
at Central Accounts Section, Reserve Bank of India, Nagpur,
on a daily basis.
Opening of Customer identification criteria as applicable to any other

Gold Deposit deposit accounts (KYC norms),shall apply and non-
Account customers can open a gold deposit account with zero
balance at any time prior to tendering gold at the CPTC.
(opened with a
The designated banks will credit/record the STBD or
designated
MLTGD, as the case may be (with the amount of 995
bank under the fineness gold as indicated in the advice received from
Scheme and CPTC), after 30 days of receipt of gold at the CPTC,
denominated regardless of whether the depositor submits the receipt for
in grams of issuance of the deposit certificate or not.
gold)
Tendering of gold to CPTC
Before tendering the raw gold to a CPTC, the depositor shall
indicate the name of the designated bank with whom he
546
would like to place the deposit.
After assaying the gold, the CPTC will issue a receipt signed
by authorised signatories of the centre showing the standard
gold of 995 fineness on behalf of the designated bank
indicated by the depositor. Simultaneously, the CPTC will
also send an advice to the designated bank regarding the
acceptance of deposit.
Fee to CPTC
If in agreement with result of the fire assay test, the

customer will exercise his option to deposit the gold with the
bank and the fee charged by the CPTC will be borne by the
bank. In case of any disagreement with the fire assay result,
the customer will have the option to take back the melted
gold after paying a nominal fee to the centre.
Documentation
Standard documentation (designed by IBA including

application form for tendering raw gold to the assaying
centers, the description of the physical appearance/
characteristics of gold, recording of the results of XRF by the
assaying centre, customer’s consent for melting the gold for
fire-assaying and for making the final deposit, the final
receipt to be issued to the depositor ), are to be made known
and available to the CPTCs and to the depositor upfront and
should include all the terms and conditions of the Scheme
including the schedule of charges.
----------------------------------------------------------------------------
(The 995 fineness equivalent amount of gold as determined
by the CPTC will be final and any difference in quantity or
quality found after issuance of the receipt by the CPTC
including at the level of the refinery due to refinement or any
other reason shall be settled among the three parties viz.,
the CPTC, the refiner and the designated bank in
accordance with the terms of the tripartite agreement to be
entered into.)
547
Types of 1. Short Term Bank Deposit (STBD).

deposits
2. Medium and Long Term Government Deposit
(MLTGD).
Short Term Duration - for a short term period of 1-3 years (with a roll
Bank Deposit over in multiples of one year), to be treated by banks as their
(STBD) on-balance sheet liability; the duration being subject to such
minimum lock-in period and penalties, if any, as may be
determined by the banks as per their laid down policy.
Interest-banks are free to fix the interest rates; and the
interest shall be credited in the deposit accounts on the
respective due dates and will be withdrawable periodically or
at maturity as per the terms of the deposit.
Redemption of principal and interest at maturity will, at the
option of the depositor be either in Indian Rupee equivalent
of the deposited gold and accrued interest based on the
price of gold prevailing at the time of redemption, or in gold.
The option in this regard shall be made in writing by the
depositor at the time of making the deposit and shall be
irrevocable:
Premature redemption, if any, shall be in Indian Rupee
equivalent or gold at the discretion of the designated bank.
Imports permitted by designated banks for redemption
The designated banks other than the nominated banks shall
be eligible to import gold only for redemption of the gold
deposits mobilised under the STBD.
(Nominated bank – A Scheduled Commercial Bank
authorized by RBI to import gold in terms of RBI circular
A.P.(DIR Series) Circular No.79 dated February 18, 2015)
CRR and SLR
CRR and SLR requirements apply (as per instructions of
RBI) from the date of credit of the amount to the deposit
account. However, the stock of gold held by banks in their
books will be an eligible asset for meeting the SLR
requirement in terms of RBI Master Circular - Cash Reserve
Ratio (CRR) and Statutory Liquidity Ratio (SLR) dated 1st
July 2015.
548
End use
In respect of gold mobilised under the STBD, the designated
banks may:
o sell the gold to MMTC for minting India Gold Coins (IGC),
to jewellers and to other designated banks participating
in GMS; or
o lend the gold under the GML scheme to MMTC for
minting India Gold Coins (IGC) and to jewellers.
Medium and Deposits shall be accepted by the designated banks on

Long Term behalf of the Central Government and shall constitute the
Government liability of Central Government; the receipts issued by the
Collection and Purity Testing Centre (CPTC) -the collection
Deposit
and assaying centres certified by the Bureau of Indian
(MLTGD)
Standards (BIS) and notified by the Central Government for
the purpose of handling gold deposited and redeemed under
the Scheme, and the deposit certificate issued by the
designated banks shall clearly state this.
Accordingly, such deposits shall not be reflected in the
balance sheet of the designated banks. Reserve Bank of
India will maintain the Gold Deposit Accounts denominated
in gold in the name of the designated banks that will in turn
hold sub-accounts of individual depositors.
Control over the gold deposited - The designated banks will
hold the gold deposited on behalf of Central Government
until it is transferred to such person as may be determined
by the Central Government.
The gold received under MLTGD will be auctioned by the
agencies notified by Government and the sale proceeds will
be credited to Government’s account held with RBI.
The details of auctioning and the accounting procedure will
be notified by Government of India.
Duration - the deposit can be made for a medium term
period of 5-7 years or a long term period of 12-15 years or
for such period as may be decided from time to time by the
Central Government (The designated banks may allow
whole or part premature withdrawal of the deposit subject to
such minimum lock-in period and penalties, if any, as
549
determined by the Central Government).

Redemption of the deposit including interest accrued -
Redemption will be only in Indian Rupee equivalent of the
value of the gold and accumulated interest as per the price
of gold prevailing at the time of redemption.
However, as per RBI Circular No.
DGBA.GBD.No.1007/15.04.001/2017-18 dated October 17,
2017.
- Reimbursement of payments made by banks, relating to
Medium and Long Term Government Deposit (MLTGD),
will be made by Central Account Section (CAS), Nagpur,
RBI.
- Accordingly, banks are advised to pay immediately the
interest amount already due to the depositors and to take
note that, in future, payment of interest to the depositors
is to be made on the due dates. After making payments,
the banks may raise a claim to Government through RBI
(CAS, Nagpur).
End Use:
Gold accepted under MLTGD will be auctioned by MMTC or
any other agency authorized by the Central Government and
the sale proceeds credited to the Central Government’s
account with RBI.
The entities participating in the auction may include RBI,
MMTC, banks and any other entities notified by the Central
Government in this regard.
Gold purchased by designated bank under the auction may
be utilized by them and they may :
o sell the gold to MMTC for minting India Gold Coins (IGC),
to jewellers and to other designated banks participating
in GMS; or
o lend the gold under the Gold Metal Loan (GML) Scheme
to MMTC for minting India Gold Coins (IGC) and to
jewellers.
550
Tripartite The designated bank shall enter into a legally binding

agreement tripartite agreement with the refiners and CPTCs with whom
between the they tie up under the Scheme; the refiners being refineries
designated accredited by the National Accreditation Board for Testing
banks, and Calibration Laboratories(NABL) and notified by the
Central Government for the purpose of handling gold
refiners and
deposited and redeemed under GMS.
CPTCs
The agreement shall cover the nature of services to be
provided, standards of service, arrangements regarding
movement of gold, payment of fees and rights and
obligations of the parties.
Transfer of The CPTCs will transfer the gold to the refiners as per the
gold to the terms and conditions set out in the tripartite agreement.
Refiners The refined gold may, at the option of the designated bank,
be kept in the vaults maintained by the refiners or at the
branch itself.
For the services provided by the refiners, the designated
banks will pay a fee as decided mutually.
The refiners shall not collect any charge from the depositor.
Oversight 1. The Central Government:

over the  in consultation with BIS, NABL, RBI and IBA, may put
CPTCs and in place appropriate supervisory mechanism over the
Refineries CPTCs and the refiners so as to ensure observance
of the standards set out for these centres by
Government (BIS and NABL).
 may take appropriate action including levy of
penalties against the non-compliant CPTCs and
refiners.
 may put in place appropriate grievance redress
mechanism regarding any depositor’s complaints
against the CPTCs.
2. Complaints against the designated banks regarding any
discrepancy in issuance of receipts and deposit
certificates, redemption of deposits, payment of interest
will be handled first by the bank’s grievance redress
process and then by the Banking Ombudsman of RBI.
551
Risk The designated banks should put in place suitable risk

management management mechanisms including appropriate limits to
manage the risk arising from gold price movements in
respect of their net exposure to gold.
The designated banks are allowed to access the
International Exchanges, London Bullion Market Association
or make use of Over-the-counter contracts to hedge
exposures to bullion prices subject to the guidelines issued
by RBI.
552
14
Other Liabilities
Bills Payable
14.01 Bills payable represent instruments issued by the branch against
moneys received from customers, which are to be paid to the customer or as
per his order (usually at a different branch). These include demand drafts,
telegraphic transfers, mail transfers, traveller’s cheques, pay-orders, banker's
cheques and similar instruments issued by the bank but not presented for
payment till the balance sheet date.
14.02 The important aspect to look for in ‘bills payable’ is; whether there are
material movements in the older balances. The reasonableness of such
transactions must be verified.
Inter-office Adjustments
14.03 The balance in inter-office adjustments account, if in credit, is to be
shown under this head.
14.04 Inter-office transactions mostly take place at branches. The balances
can be debit balance or credit balances in the balance sheet of the branches.
Branches have a number of transactions amounting to large sums with the other
branches and controlling office and hence it becomes very important to monitor
the same. It is the responsibility of the bank to reconcile their transactions on a
daily basis and keep a track on un-reconciled transactions.
14.05 The bank should first segregate the credit entries outstanding for more
than 5 years in the inter-office account and transfer them to a separate Blocked
Account which should be shown under ‘Other Liabilities & Provisions - Others’.
14.06 While arriving at the net amount of inter-office transactions for inclusion
here, the aggregate amount of Blocked Account should be excluded and only the
amount representing the remaining credit entries should be netted against debit
entries. Only net position of inter-office accounts, inland as well as foreign,
should be shown here. For arriving at the net balance of inter-office adjustments
all connected inter-office accounts should be aggregated and the net balance
only will be shown, representing mostly items in transit and unadjusted items.
14.07 Following are the major transactions which occur between branches
and Head office:
a. Issue of remittance instruments like drafts/TTs/MTs on other branches.

b. Payment of remittance instruments like drafts/TTs/MTs drawn by other
branches.
c. Payment to / receipts from other branches of the proceeds of instruments
received/sent for collection /realization/clearing.
d. Payments made under LCs of other branches.
e. Cash sent to/received from other branches.
f. Payment of instruments like gift cheques/ banker’s cheques/ interest
warrants/ dividend warrants/repurchase warrants/refund warrants /
traveller’s cheques, etc. which are paid by the branch on behalf of other
branches which have received the amount for payment of these
instruments from the customers concerned.
g. Head office interest receivable and payable by the branches.
h. Profit/loss transferred by the branch to head office.
i. Government receipts and payments handled by the branch either as the
nodal branch or as an agent of the nodal branch.
j. Operations by the authorised branches on the bank’s NOSTRO accounts.
k. Foreign exchange transactions entered into by the branch for which it has
to deal with the nodal forex department of the bank for exchange of rupees
with foreign currency.
l. Deposits into and withdrawal of money, by branches into currency chest
maintained by another branch.
m. Gold Banking Transactions at the branch on behalf of nodal branches.
n. Transactions through NEFT, RTGS, NACH, UPI, etc.
o. ATM transactions of the customer either at ATM linked with other branches
or with merchant establishments.
p. Internet based transactions other than inter-account transfers with the same
branch.
q. Credit card related transactions of the customers.
r. Control Accounts of Indian Branches maintained with Overseas Branches
of the bank.
s. Capital Funds with the Overseas Branches.
554
t. Head Office balances with the overseas branches including subordinated

debt lent to the overseas branches.
u. GST transactions advise to Nodal branches where GST remittance is made
where GST is remitted on behalf of other branches within their fold.
14.08 Following are the most common types of errors observed in inter branch
transactions.
 Wrong identification of the nature of transaction.
 Recording of particulars in incorrect fields.
 Wrong accounting of bank charges, commission, etc.
 Errors in writing the amounts.
 Incorrect branch code numbers.
 Incorrect schedule numbers.
 Recording the same transaction twice.
 Difference between the closing and opening balances in successive daily
statements.
 Squaring off the transaction by same amount without checking the
transactions.
 Forced matched transactions.
14.09 Banks generally have a separate department to deal with the process of
reconciliation of inter branch transactions. Hence reconciliation is not a
responsibility at the branch level. As all the Banks are on CBS and hence the
inter branch entries are reconciled and adjusted by the system on a regular
basis; but the Auditor has to scrutinise the old credit entries and check the nature
of such entries and confirm whether the same should remain in branch books or
should be transferred to Head Office as per the policy of the Bank. It is also
observed that sometimes there are system generated entries posted under this
head. The Auditor in such cases should ascertain the details of such entries and
find out if the necessary ticket has been raised by the branch with the IT
department for an appropriate resolution.
Interest Accrued
14.10 Interest due and payable and interest accrued but not due on deposits
and borrowings are to be shown under this head. The interest accrued in
accordance with the terms of the various types of deposits and borrowings are
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considered under this head. Such interest is not to be clubbed with the figures
of deposits and borrowings shown under the head ‘Deposits and Borrowings’.
Further it includes provisioning of interest on Matured Term Deposits.
Interest accruing on all deposits, whether payment is due or not, should be
treated as a liability.
Rebate on bills discounted
14.11 The bank collects interest in advance on usance bills discounted
normally ranging over a period of 90 to 180 days. Interest collected by the
branch is credited to ‘Rebate on bills Discounted’. The system calculates the
interest daily and debits the head. Sometimes the balance outstanding under
this head is not matching with the balance of loan outstanding under ‘Bills
Negotiated under LC’ or Bill purchased and discounting.
Where due to merger of the branches, the interest was not reversed on timely
basis or period of bills was not correctly entered in the system, the auditor
should review the outstanding balance of rebate on bills discounted account,
balance of loan under bills discounting and unexpired period of bills
outstanding. The branch can provide a report of outstanding interest on each
bill.
Others (Including Provisions)
14.12 At branch level, this includes only the expense provisions at the
branch.
14.13 Besides the above items, the following are other important items
usually included under this head:
(a) Collections in respect of suit-filed accounts. These are not adjusted
against advances till final settlement (However, for the purpose of
provisioning against non-performing advances, such credit balances are
taken into account for ascertaining net outstanding).
(b) Collection of income-tax on behalf of the Government.
(c) Collection from DICGC. These are carried till final realisation/write-off of
the concerned advance account.
(d) Provisions for frauds. These are ultimately adjusted by way of a write-off.
(e) Insurance claims received in respect of frauds. These are retained
separately till final write-off in respect of fraud.
(f) Provision for gratuity, pension and other staff benefits.
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(g) Provision for bank's share in the expenses of the Banking Services
Recruitment Board.
(h) Provision for audit fees.
(i) Unamortized interest income on the bills purchased/ discounted.
(j) Only pure deposits are to be disclosed under the head ‘deposits’ and hence
all surplus provisions for bad and doubtful debts contingency funds, secret
reserves, etc. which are not netted off against the relative assets should be
brought under the head ‘Others’ (including provisions).
It may be noted that many of the items to be disclosed under this head are
accounted for at the head office level and would not therefore form part of
balance sheet of a branch.
LFAR REPORTING
Bill Payable, Sundry Deposits, etc.
14.14 The number of items and the aggregate amount of outstanding items
pending for one year or more be obtained from the Branch and reported under
appropriate heads. Give details thereof
Year No. of items Amount (Rs.) Remarks
The Auditor should obtain the details of outstanding entries and match the same
with GL balances and report in the prescribed format.
14.15 Does your test check indicate any unusual items or material withdrawals
or debits in these accounts? If so, give details thereof.
As mentioned above, the balances under this head are susceptible to higher
risks if movement in the old balances in seen. The Auditor should check if the
transactions are genuine.
On sample basis auditor shall conduct scrutiny of such accounts to verify that
whether the transactions in accounts are of the purpose for which account is
opened. Any outlier/ unusual transaction should be inquired and reported. If MoC
is required, the same should be passed.
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15
Contingent Liabilities and
Bills for Collection
Introduction
15.01 The term ‘contingent liabilities’ can take two forms. On the one hand,
a contingent liability refers to possible obligations arising from past
transactions or other events or conditions, the existence of which will be
confirmed only by the occurrence or non-occurrence of one or more
uncertain future events not wholly within the control of the enterprise. On the
other hand, a contingent liability may also take the form of a present
obligation that arises from past events or transactions but is not recognised
due to the fact that either it is not probable that an outflow of resources
embodying economic benefits will be required to settle the obligation, or a
reliable estimate of the amount of the obligation cannot be made. Thus,
contingent liabilities may or may not crystallise into actual liabilities. If they
do become actual liabilities, they give rise to a loss or an expense. The
uncertainty as to whether there will be any obligation differentiates a
contingent liability from a liability that has crystallised. Contingent liabilities
should also be distinguished from those contingencies which are likely to
result in an obligation on the entity (i.e., the obligation is not merely possible
but probable) and which, therefore, requires creation of a provision in the
financial statements (Members may refer to Accounting Standard (AS) 29,
“Provisions, Contingent Liabilities and Contingent Assets”).
15.02 The Reserve Bank of India (RBI), has been issuing
directions/guidelines from time to time to cover the key aspects relating to
Contingent Liabilities in the banks; and reference may, in particular, be made
to the following circulars /Master Directions issued by the Reserve Bank of
India.
(i) RBI/2015-16/76 DBR .No. Dir. BC.11/13.03.00/2015-16 dated July 1, 2015
-issued to all commercial banks (excluding RRBs) - Master Circular -
Guarantees and Co-acceptances.
This is a statutory directive issued by the RBI in exercise of the powers
conferred by the Banking Regulation Act, 1949 and covers directions to the
commercial banks in the matter of conduct of guarantee business, including
prescriptions to be followed while issuing guarantees, restrictions placed on
certain types of guarantees, precautions to be taken to avoid the risk of

frauds etc.
(ii) RBI/FED/2018-19/67 FED Master Direction No.5/2018-19 dated March 26,
2019 - External Commercial Borrowings, Trade Credits and Structured
Obligations (updated as on August 08, 2019) – which covers certain
guidelines and restrictions on guarantees being issued on certain types of
borrowings, including ECBs and Trade Credits.
(iii) RBI/2017-18/139 A.P. (DIR Series) Circular No. 20 dated March13, 2018
on Discontinuation of Letter of Undertaking (LOUs) and Letter of Comfort
(LOCs) for Trade credit- issued to all Authorised Dealers Category-I Banks.
(iv) RBI/2013-14/614 DBOD.No.DEAF Cell.BC.114/30.01.002/2013-14 dated
May 27, 2014 - The Depositor Education and Awareness Fund Scheme,
2014 –Section 26A of Banking Regulation Act, 1949- Operational
Guidelines.
Letter of Credit, Bank Guarantees and Letters of Comfort, Letter of
Undertaking12
15.03 Letters of Credit, Bank Guarantees and Letters of Comfort, Letter of
Undertaking are contingent liabilities, which need to be disclosed as off Balance
Sheet items. The procedure for verification of these items is discussed under
Chapter 11, “Reporting for Advances” of Section B of this Guidance Note.
Letters of Credit:
15.04 Letters of credit (LCs) are documents under which the bank agrees to
meet the obligations of its customers (usually for purchases/imports).
15.05 Letters of credit are normally issued on certain terms, conditions and
stipulations, against guarantees of the customers and may be with/without
security/margin as permitted by the laid down policy of the bank. Generally the
Bank retains, as a percentage of the value of the LC, a cash margin or holds lien
marked Term Deposit Receipt(s) or marks a lien on the account of the
customers, to enable it to appropriate the same in the event of a default by the
customer in honouring its commitment to the bank. Upon honouring the
commitment and making payment to the other bank/party, the amount is debited
to the bank's customer and treated as an advance; and the related
margin/security is released/ adjusted depending upon the conditions of the LC.
12The Reserve Bank of India has issued circular no. RBI/2017-18/139 A. P. (DIR Series) circular
no. 20 dated March 13, 2018 on “Discontinuance of Letters of Undertaking (LoUs) and Letters of
Comfort (LoCs) for Trade Credits”, to discontinue the practice of issuance of LoUs/ LoCs for Trade
Credits for imports into India by AD Category –I banks with immediate effect.
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15.06 Such Letters of credit may be:

i. Clean;
ii. documentary - where bills drawn are accompanied by documents of title to
goods;
iii. revocable - entirely at the pleasure of the bank at any time prior to shipment
of goods;
iv. irrevocable or confirmed;
v. for single transaction or bill-covering purchases/ imports;
vi. "revolving" to cover a series of transactions within certain limits/value,
sometimes restrictions being placed on the limit of each bill.
Guarantees
15.07 Guarantees are issued on behalf of customers as part of the agency
functions of the bank, and for which the bank charges commission. There is no
outlay of the bank's funds till there is a default on the part of the bank's customer,
giving rise to a claim from any claimant/beneficiary in whose favour guarantee is
issued.
15.08 Guarantees issued may be specific to particular transactions or a series
of transactions involving assumption of obligations up to certain monetary limits.
Guarantees are issued for certain specified time limits and have a claim
obligation within the currency/ tenure/ validity period of the guarantee and a
specified time limit within which claims can be made by the claimant/beneficiary.
15.09 Such obligations are assumed by issuance of a guarantee document
which is expected to be issued only on security paper stationery, kept under dual
control, and normally signed on behalf of the bank, only by the authorised
signatories; and the bank normally obtains as security, either a cash margin,
generally based on a percentage of the obligation, or holds lien marked fixed
deposits and in some cases, the bank marks a lien on the account of the
customer, where the laid down policy so permits. It also obtains counter-
guarantee of a third party, to be invoked in case the obligation devolves.
15.10 Entries are imperative in the guarantee register/records for each
guarantee issued.
15.11 The entries are expected to be reversed upon expiry of the
guarantee/claim period and when effectively the obligations of the bank cease.
The management is duty bound to ensure that no contingent liability is carried in
the books/records of the bank where the obligations under the guarantee have
ceased, whether or not the original guarantee documents are formally returned to
the bank for cancellation.
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15.12 It is imperative for the Auditor that internal control for recording of
guarantees is looked into, to ensure that entries are made immediately upon
assumption of guarantee obligations.
Letter of Comfort (LoC) / Letter of Undertaking (LoU)
15.13 Banks agree to accept/ discharge the customers’ contracted liability on
due dates and assume obligations and give undertakings/assurance through
execution of documents in the form of Letters of Comfort or Letters of
Undertaking. The distinction between these needs to be understood.
15.14 Letter of Comfort (LoC) in banking parlance is referred to a document
which is provided by a person, typically an affiliate (such as the holding / parent
company) of the borrower (“LoC Provider”) assuring the financial soundness of
the borrower to repay its debt(s) and applies generally to obligations between
branches or subsidiaries of the bank. These require lower provisioning under the
Basel III Norms.
15.15 Letter of Undertaking (LoU), involves a contract to perform the stated
promise, or to discharge the liability, of a third person in case of his default and is
used in inter-bank obligations. Obligations comprising Letters of Undertaking
(LOUs), normally used for trade credits, are disclosed in the Notes in the manner
required (by RBI), in foreign currency and Rupee equivalent, that should be at
the year-end rates of exchange.
15.16 These attract higher provisioning under the Basel III Norms.
Liability on Partly Paid Investments
15.17 The Investments Portfolio is generally handled at the Head Office
and if the bank holds any partly paid Investments (shares, debentures, etc.),
the Auditor concerned to whom the related work is allocated, needs to
examine the related books and records to verify the amount comprising the
contingent liability by way of uncalled /unpaid amounts in respect of the
investments that are not fully paid up; and ensure that the Management has
made appropriate disclosure thereof as at the year end, in the Balance Sheet
of the Bank.
Liability on Account of Outstanding Forward Exchange Contracts
and Derivatives Contract
15.18 All branches which undertake foreign exchange business (i.e., those
which are authorised foreign exchange dealers) usually enter into forward
exchange contracts. The amount of forward exchange contracts, which are
outstanding on the balance sheet date, is to be shown under this head. The
treasury of the bank enters into Over The Counter (OTC) derivatives
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contracts like Interest Rate Swap, Cross currency Swaps, etc. Similarly, the
Bank may also be transacting in derivative contracts including forward
exchange contracts on exchanges, which are known as Exchange Traded
derivatives. The notional amount of these contracts should be disclosed
either separately or under this head as separate sub head. The Auditor
should verify that notional value of that leg of the contract where the bank is
under obligation to deliver is only considered as liability and therefore
receivable leg of the contract should not be included in the liability.
15.19 The general principles to be observed for forward foreign exchange
contracts are covered in detail in “Master Direction - Risk Management and Inter-
Bank Dealings” RBI/FMRD/2016-17/31 FMRD Master Direction No. 1/2016-17
dated July 5, 2016 (updated as on September 1, 2020).
Guarantees Given on Behalf of Constituents
15.20 The amount of all guarantees outstanding on the balance sheet is to
be shown under the above head after deducting therefrom any cash margin.
15.21 The guarantees may include those that have expired, where the
claim period has expired and where the obligations have ceased. Where the
bank's obligations have legally ceased, these cannot be included on the
ground that the related guarantee documents have not been formally
returned to the bank and that this verification needs to be done at the branch
level by the auditor. The Auditors need to be satisfied that appropriate
instructions have been issued by management to the branches to ensure due
care in compiling and disclosing this information.
Acceptances, Endorsements and Other Obligations
15.22 This item includes the following balances:
(a) Letters of credit opened by the bank on behalf of its customers.
(b) Letters of Comfort issued by the bank on behalf of its customers for
availing buyers’ credit facilities.
(c) Bills drawn by the bank's customers and accepted or endorsed by the
bank (to provide security to the payees) whether drawn under letters of
credit or letters of comfort.
15.23 The total of all outstanding letters of credit as reduced by the cash
margin and after deducting the payments made for the bills negotiated under
them should be included in the balance sheet. In case of revolving credit, the
maximum permissible limit of letters of credit that may remain outstanding at
any point of time as reduced by the cash margin should be shown. If the
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transactions against which the letter of credit was opened have been
completed and the liability has been marked off in the books of the bank, no
amount should be shown as contingent liability on this account.
Other Acceptances and Endorsements
15.24 Sometimes, a customer of the bank may issue a usance bill payable to
his creditor and drawn on the bank. The bank, on accepting such a bill, becomes
liable to pay it on maturity. In turn, it has to recover this amount from its
customer.
15.25 The Auditor should verify whether the management has disclosed as a
contingent liability, the total of all outstanding acceptances and endorsements at
the end of the year, as reduced by the cash margin.
Other Items for Which the Bank is Contingently Liable
15.26 As per the Notes and Instructions for compilation given by RBI vide its
circular DBOD.No.BP.BC.78/C.686/1991-92 dated February 6, 1992, under this
head are to be included such items as arrears of unpaid dividend on cumulative
preference shares, bills re-discounted, commitments under underwriting
contracts, estimated amounts of contracts remaining to be executed on capital
account, disputed tax liabilities, credit enhancement in respect of securitised
loans to which the assignee or the special purpose vehicle has recourse, etc.
15.27 Underwriting involves an agreement by the bank to subscribe to the
shares or debentures or issue of other similar securities which remain
unsubscribed in a public issue, in consideration of underwriting commission. It
also includes commitment made to participate in the venture capital fund or
private equity fund or AIF or similar funds, which has not been called up till the
Balance Sheet date.
15.28 Rediscounting is generally done with the RBI, or other financial
institutions or, in the case of foreign bills, with foreign banks. If the drawer
dishonours the bill, the re-discounting bank has a right to proceed against the
bank as an endorser of the bill. On the due date(s), the rediscounting entries are
reversed, including in respect of the dishonour of the bills.
15.29 Tax demands, which have been disputed are in the nature of
contingent liability should be disclosed, unless the same is considered as
“remote” as per Accounting Standard (AS) 29, “Provisions, Contingent
Liabilities and Contingent Assets”). Where an application for rectification of
mistake has been made by the entity, the amount should be regarded as
disputed. Where the demand notice/intimation for the payment of tax is for a
certain amount and the dispute relates to only a part and not the whole of the
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amount, only such part amount should be treated as disputed. A disputed tax
liability may require a provision or suitable disclosure as per provisions of
Accounting Standard (AS) 29, “Provisions, Contingent Liabilities and Contingent
Assets”.
15.30 The liability involved in cases lodged against the bank in various courts
including consumer dispute redressal forums, Banking Ombudsman as per
Reserve Bank of India and any other Authority are in the nature of contingent
liability and should be disclosed.
Depositor Education and Awareness Fund:
15.31 As per RBI Circular No. RBI/2013-14/ 614 DBOD.No.DEAF
Cell.BC.114/ 30.01.002/ 2013-14 dated May 27, 2014 on “The Depositor
Education and Awareness Fund Scheme, 2014 –Section 26A of Banking
Regulation Act, 1949- Operational Guidelines”, all such unclaimed liabilities
(where amount due has been transferred to DEAF) may be reflected as
“Contingent Liability – Others, items for which the bank is contingently liable”
under Schedule 12 of the annual financial statements.
15.32 Since the amounts could be claimed by the depositors together with
interest to be compensated by the DEAF, it is appropriate to include the same as
a contingent liability, by indicating that the claims, if any, are fully recoverable
from the said Fund.
15.33 Bills held by a bank for collection on behalf of its customers are to be
shown by way of a footnote to the balance sheet.
15.34 These bills are generally hundies or bills of exchange accompanied by
documents of title to goods. Frequently, no bills of exchange are actually drawn;
the bank is asked to present invoices and documents of title with instructions to
collect the amount thereof from the party in whose name the invoice has been
made. The documents of title enclosed with the bills for collection are usually not
assigned to the bank.
15.35 Bills for collection do not involve an outlay of the bank's funds and Bank
has no financial liability in respect of such bills, the proceeds of which are to be
credited to the customer's account if and when collected. The banks earn
commission for rendering service relating to collection of bills for their customers.
Bills not collected are normally returned to the customers, and only current
outstanding bills as at the year end are to be shown as ‘bills for collection’ in the
financial statements of the branches where such activity takes place. Thus, in the
normal course, such bills are expected to collect on behalf of customers in a time
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bound manner, and entries in respect thereof in the records cannot remain
outstanding for long periods of time, beyond their normal dates of collection.
Reasons for unwarranted retention of entries and their inclusion /disclosure in the
Notes, need to be enquired into, to ensure that the aggregate amount of such
bills is not overstated
15.36 A bank may get bills for collection from -
(a) its customers, drawn on outstation parties; or
(b) its other branches or other outstation banks or parties, drawn on local
parties.
15.37 On receipt of the bills drawn on outstation parties, the bank forwards
them to its branch or other correspondent at the place where they are to be
collected. Such bills are called Outward Bills for Collection.
15.38 Bills received by the bank from its outstation branches and agents, etc.
for collection are called Inward Bills for Collection.
15.39 It may be noted that if a bill is received by one branch of the bank from
a customer and sent by it to another branch of the bank for collection, the same
will be shown as an Outward Bill at the first branch and as an Inward Bill at the
other branch. In the consolidated balance sheet of the bank, however, all such
bills should be shown only once. Therefore, Inward Bills for Collection are
excluded from the balance sheet of each branch.
Co-acceptance of Bills
15.40 In its Master Circular No. RBI/2015-16/76 DBR. No. Dir. BC.11/
13.03.00/2015-16 dated July 1, 2015 on “Guarantees and Co-acceptances",
the RBI had reiterated the need for the banks to be cautious while co-
accepting bills of their customers and discounting the same so as to avoid
loss to banks arising on account of frauds perpetrated in the guise of bills.
The circular requires the banks, inter alia, not to extend their co-acceptances
to house bills/ accommodation bills drawn by group concerns on one another.
In the circular, the RBI had also listed a number of safeguards to be
undertaken by banks while co-accepting bills.
Contingent Liabilities
15.41 In respect of contingent liabilities, the Auditor is primarily concerned
with seeking reasonable assurance that all contingent liabilities are identified,
accounted and properly valued. To this end, the auditor should, generally
follow the audit procedures given below:
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(a) The Auditor should verify whether there exists a system whereby the non-
fund based facilities are extended only to their regular constituents, etc. in
line with the Bank's laid down policy.
(b) The Auditor should ascertain whether there are adequate internal controls
to ensure that transactions giving rise to contingent liabilities are
executed only by persons authorised to do so and in accordance with the
laid down procedures.
(c) The Auditor should also examine whether in case of LCs for import of
goods, as required by the abovementioned Master Circular on guarantees
and co-acceptances, the payment to the overseas suppliers is made on
the basis of shipping documents and after ensuring that the said
documents are in strict conformity with the terms of LCs.
(d) Ascertain whether the accounting system of the bank provides for
maintenance of adequate records in respect of such obligations and
whether the internal controls ensure that contingent liabilities are properly
identified and recorded.
(e) The Auditor should perform substantive audit tests to establish the
completeness of the recorded obligations. Such tests include confirmation
procedures as well as examination of relevant records in appropriate
cases.
(f) The Auditor should review the reasonableness of the year-end amount of
contingent liabilities in the light of previous experience and knowledge of
the current year's activities.
(g) The Auditor should review whether comfort letters issued by the bank
have been considered for disclosure of contingent liabilities.
(h) The Auditor should ascertain the process followed to restate the
contingent liabilities denominated in foreign currency into the reporting
currency as at the Balance Sheet date. It is preferable to have automation
in this regard to the extent possible.
(i) While testing the adequacy of internal control procedure, the Auditor
should test whether there exist a proper system of numbering of such
transactions for performing completeness test and whether there exists a
proper system over recording of such transactions in straight through
processing(STP). In case the straight through processing has not been
implemented or controls over straight through processing is not adequate,
the auditor should perform such additional procedure including the as
may be appropriate in the circumstances so that the risk of material
misstatement is adequately addressed.
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With banks using a variety of different programs for different needs,

ensuring all of the systems involved in the STP process work together
and transfer information accurately and smoothly without delay is often
the biggest challenge when implementing STP. Depending on the
information being relayed, many different programs may be required to
help transfer the data and information correctly. Gaps in integrating all of
those different programs to work together in one seamless structure can
result in Risk of Misstatement and Frauds.
In whichever branch SWIFT is installed, existence and adequacy of the
internal control system and procedures need to be kept in view. It needs to
be emphasised that for a fraud to be perpetrated in SWIFT
messages/transactions, one would have to play the role of all four—maker,
checker, verifier and the receiver of the transactional message from its
origination to conclusion, which would be in breach of internal control
system. Control systems would be robust where the outward messages,
expected to be in pre-serially numbered and sequentially arranged forms on
special stationery, are independently handled and authenticated at each
stage before being transmitted under the signatures of the authorised
officials. Similarly the laid down controls/procedure need to be strictly
followed for the inward SWIFT messages. It needs to be ensured that the
messages are linked to the CBS system; and at frequent short intervals, the
related transactions and their closure need to be checked, particularly
overdue entries outstanding in the accounts of the customers. The
verification of such transactions and balances should also be extensively
covered by Internal Inspection and concurrent audit.
SWIFT
Founded in 1973 as a member-owned cooperative society, initially with
239 banks in 15 countries, and called Society for Worldwide Inter-bank
Financial Telecommunications (SWIFT), it considerably expanded its
spread and operations, to provide services not only to banks, but
Brokerage Institutes and Trading Houses, Securities Dealers, Asset
Management Companies, Clearing Houses, Depositories, Exchanges,
Corporate Business Houses, Treasury Market Participants and Service
Providers, Foreign Exchange and Money Brokers.
Recognised for its core business as a vast messaging network SWIFT is
used by banks and other financial institutions, to quickly, accurately, and
securely send and receive information and instructions through a
standardized system of codes, and has attained, and holds, a dominant
position in the global processing of transactional messages for its
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members. In consideration of a one-time joining fee plus annual support

charges, which vary by member classes, and for usage of services,
SWIFT assigns to each such member, a unique code of 8, (going on to
11) characters (interchangeably called the Bank Identifier Code (BIC),
SWIFT code, SWIFT ID, or ISO 9362 code). The characters represent the
institution, country, location/city for the first 8 characters and the last
three are used by the banks/institutions at their option to identify their
branches etc.
(j) The Auditor should also examine whether the bank has given any
guarantees in respect of any trade credit (buyer’s credit or seller’s
credit) 13. The period of guarantees is co-terminus with the period of credit
reckoned from the date of shipment. The Auditor also needs to examine
as to whether contingent liability in respect of trade credits includes any
amounts actually arranged and received by the Bank from other banks in
its NOSTRO Account(s) overseas, to discharge the financial
commitment/obligation (of the Bank's customer in India), in favour of such
customer's overseas suppliers. The amounts so received are of the
nature of funded obligations and intrinsically not of the nature of
Contingent obligations. On behalf of the Bank’s customer in India,
guarantees provided to the customer’s overseas supplier for imports into
India, where no funds are transferred in discharge of the (customer’s)
liability, the same is of the nature of a contingent liability; and the
contingent liability would cease on actual payment on the due date.
(k) The Auditor should verify whether the bank has extended any non-fund
facility or additional/ad hoc credit facilities to persons other than its
regular customers. In such cases, the Auditor should examine the
existence of concurrence of existing bankers of such borrowers and
enquire regarding financial position of those customers. The auditor
should also verify whether the required margin as per the sanction letter
is invariably kept by the branch.
(l) If the bank is using separate application for communicating, transacting,
executing any co-acceptance / guarantees, the Auditor should verify the
interface controls in respect of these applications and CBS. If the system-
based interface is not available and manual intervention is involved then
the Auditor should verify the controls put in place by the bank for
confirming completeness and correctness of transactions.
13In terms of the Circular No. RBI/2004/34 A.P. (Dir. Series) Circular no. 60 dated January 31,
2004 “External Commercial Borrowings (ECB)”, any trade credit extended for a period of three
years and above comes under the category of external commercial borrowings.
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(m) The Auditor may also perform analytical procedure by analysing the
commission/fee earned from these transaction vis a vis aggregate
transactions during the period.
(n) The Auditor should obtain representation from the management that:
(i) all off-balance sheet transactions have been accounted in the books
of accounts as and when such transaction has taken place;
(ii) all off balance sheet transactions have been entered into after
following due procedure laid down;
(iii) all off balance sheet transactions are supported by the underlying
documents;
(iv) all year end contingent liabilities have been disclosed;
(v) the disclosed contingent liabilities do not include any crystallised
liabilities which are of the nature of loss/ expense and which,
therefore, require creation of a provision/adjustment in the financial
statements;
(vi) the estimated amounts of financial effect of the contingent liabilities
are based on the best estimates in terms of Accounting Standard
29, including consideration of the possibility of any reimbursement;
(vii) in case of guarantees issued on behalf of the bank’s directors, the
bank has taken appropriate steps to ensure that adequate and
effective arrangements have been made so that the commitments
would be met out of the party’s own resources and that the bank will
not be called upon to grant any loan or advances to meet the liability
consequent upon the invocation of the said guarantee(s) and that no
violation of section 20 of the Banking Regulation Act, 1949 has
arisen on account of such guarantee; and
(viii) such contingent liabilities which have not been disclosed on account
of the fact that the possibility of their outcome is remote include the
management’s justification for reaching such a decision in respect of
those contingent liabilities.
15.42 The specific procedures to be employed by the Auditor to verify
various items of contingent liabilities are discussed in the following paragraphs.
Claims Against the Bank Not Acknowledged as Debts
15.43 Information relating to claims against the Bank is recorded at each
Branch as also at the Head Office. Such information would include claims
made by staff (particularly those under suspension/dismissal), constituents
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(e.g. for dishonour of cheques, frauds in customers' accounts due to

negligence etc.), and any other matters in litigation which are contested by the
bank but not acknowledged as a liability. Such claims may arise from Govt.
bodies/authorities/others either under a statute or through litigation/arbitration
etc. At the Head Office, the Legal Department would have a record of such
claims, both originating at the Branches as well as at the Head Office.
15.44 The Auditor concerned should seek information from the management
as to the year end status of claims outstanding against the branch/ bank that
are not acknowledged as debts. To begin with, an enquiry needs to be made
as to the reasons for deletion during the year, of any such outstanding claims
which were disclosed as at the previous year end, to ensure that the deletion
thereof was justified based on facts and evidence. At the Head Office,
reference needs to be made to the minutes of the Board/Committees, the
records maintained by the Legal Department, relating to matters in
litigation/arbitration, particularly those relating to notices served on the Bank by
the Central/state Government and local authorities/bodies. A review of
subsequent events would also provide evidence about completeness and
valuation of claims. Based on the circumstances of each case and available
evidence, the auditor should verify whether the item is likely to remain a claim
against the bank not acknowledged as debt or it is likely to be a liability
requiring provisioning. The auditor may ask the Bank for an opinion from legal
experts in respect of crystallisation of claim against the Bank. The Auditor
should use professional judgement to determine as to as to whether a claim
needs to be provided or can be regarded as a contingent liability.
Liability on Account of Outstanding Forward Exchange Contracts and
Derivatives Contracts
15.45 Forward Exchange Contract: The Auditor may verify the outstanding
forward exchange contracts with the statement of outstanding forward
exchange contracts generated from the bank’s computerised accounting
system or manual register maintained by the branch. The auditor may
physically verify the underlying documents including confirmations from
merchants to test the existence of such outstanding contracts.
15.46 Derivatives Contract: The Auditor may verify outstanding derivatives
contracts (options, cross currency swaps, interest rate swaps, etc.) with report
generated from treasury application. The audit procedure mentioned may be
used for verification of derivative contracts:
 The Auditor may also verify the outstanding margin vis a vis the
outstanding forward foreign exchange contracts/derivative contracts with
reference to margin, if any, stipulated in terms of sanction.
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 The Auditor may also perform analytical procedure by analysing the

commission/fee earned from these transaction vis a vis aggregate
transactions during the period.
Guarantees Given on Behalf of Constituents
15.47 The Auditor should ascertain whether there are adequate internal
controls over issuance of guarantees, e.g., whether guarantees are issued
under proper sanctions, whether adherence to limits sanctioned for guarantees
is ensured, whether margins are taken from customers before issuance of
guarantees as per the prescribed procedures, etc.
15.48 The Auditor should ascertain whether there are adequate controls
over custody of unused guarantee forms, if the bank has process of issue of
guarantees in pre-printed forms, e.g., whether these are kept under the
custody of a responsible official, whether a proper record is kept of forms
issued, whether stock of forms is periodically verified and reconciled with the
book records, etc.
15.49 The Auditor should examine the guarantee register/statements
generated from the computerised system to seek evidence whether the
prescribed procedure of marking off the expired guarantees is being followed
or not.
15.50 The Auditor should check the relevant guarantee registers/statements
generated from the computerised system with the list of outstanding
guarantees to obtain assurance that all outstanding guarantees are included in
the amount disclosed in this behalf. The Auditor should also examine that
expired guarantees where claim period is also over are not included in this
head. He should verify guarantees with the copies of the letters of guarantee
issued by the bank and with the counter-guarantees received from the
customers. He should also verify the securities held as margin. The auditor
should examine as to whether adjustments/provision as required have been
made in respect of contingent obligations that have ceased.
15.51 The auditor should obtain a written confirmation from the management
that all obligations in respect of guarantees have been duly recorded and that
there are no guarantees issued up to the balance sheet date which are yet to
be recorded and that there are no obligations that have intrinsically ceased,
which are included as contingent liabilities as on the balance sheet date.
15.52 In case of counter guarantees issued in favour of foreign banks for
guaranteeing the obligation of bank’s constituents in India, generally these
guarantees are termed as “stand by letter of credit” or “letter of credit”. These
guarantees, standby letters of credit, letters of credit are transmitted through
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SWIFT messages, which has standard formats of different types of

transactions. The auditor may verify the SWIFT message to test such
transactions.
15.53 The Auditor should verify whether proper guidelines have been laid
down for classification of Guarantees as Performance or Financial and whether
such guidelines have been scrupulously followed, considering that commission
and margin and the risk weights are different for Performance and Financial
Guarantees.
Acceptances, Endorsements and Other Obligations
15.54 The Auditor should evaluate the adequacy of internal controls over
issuance of letters of credit and over custody of unused LC forms, if the bank
has process of issue of LCs in pre-printed forms, in the same manner as in the
case of guarantees.
15.55 The Auditor should verify the balance of letters of credit from the
register maintained by the bank. The register indicates the amount of the
letters of credits and the extinguishment of obligations based on utilisation by
the customer.
Other Acceptances and Endorsements
15.56 The Auditor should study the arrangements made by the bank with its
customers. He should verify the amounts of the bills with the register
maintained/statements generated from computerised system by the bank for
such bills. The Auditor should also examine whether such bills are marked off
in the register on payment at the time of maturity.
15.57 In respect of letters of comfort, the Auditor should examine whether
the bank has incurred a potential financial obligation under such a letter. If a
comfort letter does not cast any such obligation on the bank, no disclosure
under contingent liability is required on this account. The audit procedure
applicable for auditing bank guarantees as mentioned above, mutatis
mutandis, applies to the audit of the acceptances, endorsements and other
obligations.
Common Procedures
15.58 The Auditor should obtain a written confirmation from the
management that all obligations assumed by way of acceptances,
endorsements and letters of credit have been duly recorded and there are no
such obligations assumed up to the balance sheet date, which are yet to be
recorded.
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15.59 The Auditor should ascertain whether a contingent obligation

assumed by a bank either by way of acceptance, endorsement etc., has
resulted in an actual obligation owing to any act or default on the part of its
constituent. In such a case, the auditor should assess whether a provision is
required to be made in the accounts for the bank’s obligation, which should be
determined after taking into account the probable recovery from the customer.
15.60 Various tests need to be carried out to ensure that IT applications have
resulted in consisted and reliable system for inputting, processing and generation
of output of data as required under Jilani Committee Recommendations at the
branch level.
15.61 Verification is to be done for existence of the internal control as to
whether bank guarantees/LCs are issued in security forms serially numbered,
under two officers’ signatures of the bank -above certain cut off point in triplicate,
binding on beneficiary to seek confirmation of Controlling Office (incorporation of
suitable condition in the document) etc., and unused security stationery are to be
kept under joint custody as required under Ghosh Committee recommendations
(Relating to frauds and malpractices in banks to be implemented at the Branch
level).
15.62 Verification is to be done whether all bank guarantees
renewed/extended after the original due dates - including extension of due date
of Letter of credits are duly reflected in CBS ,as this is one fraud prone area;
possibility of heavy leakage of income exists in the absence of proper validation
in the system.
Other Items for Which the Bank is Contingently Liable
15.63 The Auditor should examine whether commitments under all
outstanding underwriting contracts have been disclosed as contingent
liabilities. Similarly, the Auditor should also examine whether commitment made
to participate in the venture capital fund or private equity fund or AIF or similar
funds, which has not been called up or unpaid till the Balance Sheet date have
been disclosed as contingent liabilities. For this purpose, the auditor should
examine the terms and conditions of the relevant contracts.
15.64 Rediscounting is generally done with the RBI or other financial
institutions or, in the case of foreign bills, with foreign banks. If the drawer
dishonours the bill, the rediscounting bank has a right to proceed against the
bank as an endorser of the bill. The Auditor may check this item from the
register of bills rediscounted maintained by the branch. He should satisfy
himself that all the bills are properly marked off on payment at the time of
maturity.
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15.65 The Auditor should check whether any liability is involved in cases
lodged against the bank.
15.66 The Auditor may verify other items under this head in the same
manner as in case of other entities.
15.67 The Auditor should examine whether the bills drawn on other
branches of the bank are not included in bills for collection.
15.68 Inward bills are generally available with the bank on the closing day
and the auditor may inspect them at that time. The bank dispatches outward
bills for collection soon after they are received. They are, therefore, not likely to
be in hand at the date of the balance sheet. The Auditor may verify them with
reference to the register maintained for outward bills for collection.
15.69 The Auditor should also examine collections made subsequent to the
date of the balance sheet to obtain further evidence about the existence and
completeness of bills for collection.
15.70 Regarding bills for collection, the Auditor should also examine the
procedure for crediting the party on whose behalf the bill has been collected.
The procedure is usually such that the customer's account is credited only after
the bill has actually been collected from the drawee either by the bank itself or
through its agents, etc. This procedure is in consonance with the nature of
obligations of the bank in respect of bills for collection.
15.71 The commission of the branch becomes due only when the bill has
been collected. The Auditor should, accordingly, examine that there exists
adequate internal control system that debits the customer’s account with the
amount of bank’s commission as soon as a bill collected is credited to the
customer’s account. The auditor should also examine that no income has been
accrued in the accounts in respect of bills outstanding on the balance sheet
date.
Co-acceptance of Bills
15.72 The Auditor should examine whether the bank has instituted an
adequate internal control system to comply with the safeguards as set out by
the RBI’s Master Circular No. RBI/2015-16/76 DBR. No. Dir. BC.11/
13.03.00/2015-16 dated July 1, 2015 on “Guarantees and Co-acceptances” to
ascertain whether such system, inter alia, captures all such items, appropriately
records the same and also determines all the material items forming contingent
liabilities, whether any item needs a provision in the books.
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Disclosures
15.73 The Third Schedule to the Banking Regulation Act, 1949, requires
the disclosure of the following as a footnote to the balance sheet.
(a) Contingent Liabilities
I. Claims against the bank not acknowledged as debts
II. Liability for partly paid investments
III. Liability on account of outstanding forward exchange contracts &
Derivatives Contracts
IV. Guarantees given on behalf of constituents
(a) In India
(b) Outside India
V. Acceptances, endorsements and other obligations
VI. Other items for which the bank is contingently liable *
(b) Bills for Collection
*This will include the amounts transferred to DEAF and remaining unclaimed.
15.74 The Auditor should report in the LFAR the list of major items of the
contingent liabilities (other than constituent’s liabilities such as guarantees, letter
of credit, acceptances, endorsements, etc.) not acknowledged by the branch.
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16
Profit and Loss Account
16.01 Sub–section (1) of section 29 of the Banking Regulation Act, 1949,
requires the preparation of Profit and Loss Account in Form B of the Third
Schedule to the Act or as near thereto as the circumstances admit. This sub–
section is applicable to Banking Companies, Nationalised Banks, State Bank of
India and its Subsidiaries, and Regional Rural Banks.
Disclosures
16.02 The Profit and Loss Account as set out in Form B has four broad heads:
 Income
 Expenditure
 Profit/ Loss
 Appropriations
The information to be provided under each of the above heads is also specified
in the Schedule. It would be pertinent to note that knowledge of the Bank’s
accounting policies is of utmost importance before verifying the items within the
profit and loss account. The Auditor must make enquiries with the management
to ascertain whether there have been any changes in the accounting policies and
also review the closing circulars issued by the controlling authorities of the Bank.
Applicability of AS 5 and Materiality
16.03 Accounting Standards are intended to apply only to items that are
material. Since materiality is not objectively defined, RBI, vide its Circular No.
DBOD. No.BP. BC. 89 /21.04.018/2002-03 dated March 29, 2003 on “Guidelines
on compliance with Accounting Standards (AS) by banks”, has advised that all
banks should ensure compliance with the provisions of accounting standards in
respect of any item of prior period income or expenditure, which exceeds one per
cent of total income/ total expenditure of the bank if the income or expenditure is
reckoned on gross basis or one per cent of the net profit before taxes or net
losses as the case may be if the income is reckoned on net of costs.
16.04 This guidance of the RBI needs to be applied to the Branch Audits by
suitable modification and assessing the impact of “Tolerable Errors & Unadjusted
Misstatements” keeping in view their nature and the materiality indicated by the
Central Statutory Auditors or closing circulars issued by the controlling authorities

of the bank.
16.05 Since the format of the profit and loss accounts of banks prescribed in
Form B under Third Schedule to the Banking Regulation Act, 1949 does not
specifically provide for disclosure of the impact of prior period items on the
current year’s profit and loss, such disclosures, wherever warranted, may be
made in the ‘notes on accounts’ to the balance sheet of banks. The relevant
extract of LFAR on income is as under:
Has the test checking of interest/discount/ commission/ fees etc. revealed
excess/short credit of a material amount? If so, give details thereof.
Background & Audit Approach
Interest Earned
16.06 The following items are included under this head:
(a) Interest/Discount on Advances/Bills: This includes interest and discount on
all types of loans and advances like cash credit, overdrafts, demand loans,
term loans, export loans, domestic and foreign bills purchased and
discounted (including those rediscounted), overdue and penal interest and
interest subsidy, if any, relating to such advances/bills. The amount to be
included under this head is net of the share of participating banks under
inter–bank participation schemes on risk–sharing basis. In modern day
banking, the entries for interest income on advances are automatically
generated through a batch process in the CBS system.
(b) Interest Income on Investments: This will be generally dealt by treasury at
the Head Office level so branch will not have any income under such head.
(c) Interest on Balances with RBI and Other Inter–bank Funds: This will be
generally dealt by treasury at the Head Office level so branch will not have
any income under such head.
(d) Others: This includes any other interest/discount income not included in the
above heads. Interest on advances given by the bank to staff member in its
capacity as employer rather than as banker should be included under this
head.
Income from Investments
16.07 Interest and dividend on investments are usually accounted for at the
Treasury Branch of the bank or at the Head Office. Thus, a branch will not have
any income under such head.
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Other Income
(i) Commission, Exchange and Brokerage: This item comprises of the
following:
(a) Commission on bills for collection.
(b) Commission/exchange on remittances and transfers, e.g. demand
drafts, NEFT, RTGS, etc.
(c) Commission on letters of credit and guarantees, letter of comforts.
(d) Loan processing, arranger and syndication fees.
(e) Mobile banking fees.
(f) Credit/Debit card fee income including annual fee income, merchant
acquiring income, interchange fees, etc.
(g) Rent from letting out of lockers.14
(h) Commission on Government business.
(i) Commission on other permitted agency business including
consultancy and other services.
(j) Brokerage on securities.
(k) Fee on insurance referral.
(l) Commission on referral of mutual fund clients.
(m) Service/transaction banking charges including charges levied for
transaction at other branches.
(n) Income from rendering other services like custodian, demat,
investment advisory, cash management and other fee based services.
(ii) Profit on sale of Land, Buildings and Other Assets: This item includes
profit (net of any loss) on sale of land, buildings, furniture, motor vehicles,
gold, silver, etc.
(iii) Profit on exchange transactions: This includes revaluation gains/losses on
forward exchange contracts and other derivative contracts, premium
income/expenses on options, etc.
14 As per the Notes and Instructions for compilation of the profit and loss account, issued by the
Reserve Bank, this item should come under this head. There is, however, a contrary view in some
quarters that locker rent should be included in miscellaneous income. The latter view seems more
plausible.
578
(iv) Income earned by way of dividends, etc., from subsidiaries and joint
ventures abroad/in India.
(v) Miscellaneous income
Profit/Loss on Revaluation of Property, Plant & Equipment (PPE)
16.09 According to the “Notes and Instructions” for compilation of profit and
loss account, issued by the RBI, the net profit/loss on revaluation of the
aforesaid assets may also be shown under this item. In this regard, the
requirements of AS 10 (Revised), Property, Plant & Equipment, relating to
revaluation of fixed assets assume significance. According to the AS 10
(Revised), when a PPE is revalued in financial statements, the entire class of
assets should be revalued, or the selection of assets for revaluation should be
made on a systematic basis. It is also provided that an increase in net book
value arising on revaluation of fixed assets should be credited directly to
owners' interests under the head of revaluation reserve. However, if such
increase is related to and not greater than a decrease arising on revaluation
which was previously recorded as a charge to the profit and loss account, it
may be credited to the profit and loss account. On the other hand, any
decrease in net book value arising on revaluation of fixed assets should be
charged directly to the profit and loss account except that to the extent that
such a decrease is related to an increase which was previously recorded as a
credit to revaluation reserve and which has not been subsequently reversed or
utilised, it may be charged directly to revaluation reserve account.
16.10 From the above, it can be seen that as per AS 10 (Revised), surplus
on revaluation of a fixed asset cannot be credited to the profit and loss account
except to the extent that such surplus represents a reversal of a related
previous revaluation decrease that was charged to the profit and loss account.
Profit on Exchange Transactions
16.11 This item includes profit (net of loss) on dealings in foreign exchange
and will be applicable at treasury or selected foreign designated branches.
Income Earned by Way of Dividends, etc. from Subsidiaries and Joint
Ventures abroad/in India
16.12 As investments are usually dealt with at the head office level, this item
may not appear in the profit and loss account of a branch.
Miscellaneous Income
16.13 This head generally includes the following items of income:
(a) Recovery in Written off Accounts.
(b) Rental income from bank's properties.
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(c) Security charges.

(d) Insurance charges recoverable from customers.
(e) Other income from carrying out other services like selling of gold coins
etc.
16.14 The “Notes and Instructions for compilation of profit and loss account”,
issued by the Reserve Bank, require that in case any item under this head
exceeds one per cent of the total income, particulars thereof may be given in the
notes.
Income
16.15 In carrying out an audit of income, the Auditor is primarily concerned
with obtaining reasonable assurance that the recorded income arose from
transactions, which took place during the relevant period and pertain to the bank,
that there is no unrecorded income, and that income is recorded in proper
amounts and is allocated to the proper period. In view of the mandatory
requirement of recognition of income, the recognition of revenue will have to be
subjected to examination vis-à-vis the guidelines. Vide circular DBOD.No.BP.
BC. 89 /21.04.018/2002-03 dated 29th March 2003 on “Guidelines on compliance
with Accounting Standards (AS) by banks, RBI has advised that in respect of any
income which exceeds one percent of the total income of the bank if the income
is reckoned on a gross basis or one percent of the net profit before taxes if the
income is reckoned net of costs, should be considered on accrual as per AS-9. If
any item of income is not considered to be material as per the above norms, it
may be recognised when received and the Auditors need not qualify the
statements in that situation. As per AS-9 Revenue Recognition, revenue arising
from the use by others of enterprise resources yielding interest, royalties and
dividends should only be recognised when no significant uncertainty as to
measurability or collectability exists. If revenue recognition is postponed, as per
AS 9, an enterprise should also disclose the circumstances in which the revenue
recognition has been postponed pending the resolution of significant
uncertainties.
16.16 Since the entire accounting in banks is done on the CBS, the Auditor
should plan the audit procedures based on controls testing. If he is not
satisfied with the controls in place for accounting and recording of items of
income and expenses correctly, he should resort to more of substantive
checking of documents and records.
16.17 In case the Auditor decides to adopt the control reliance strategy, the
Auditor should perform test of controls which mitigate the risk of what could go
wrong.
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16.18 As per Auditing Standards Revenue is always considered as Presumed

Risk of Material Mis-statements. The Auditor therefore should plan the audit and
test the controls considering mainly following assertions/attributes:
1. Occurrence – Whether recorded revenue is valid and accounting of revenue
is not as per the terms of contract.
2. Completeness – All revenue transactions are accounted for the period
covered under audit.
3. Accuracy – The Auditor needs to satisfy this assertion on the basis of
system controls and risk assessment and substantive audits of samples
derived.
4. Cut-off – Revenue is correctly accounted in case of period based contract.
5. Classification – Gross Revenue and Net revenue bifurcation is correctly
adhered.
6. Disclosures – Verify the various disclosures requirements as per BR act,
accounting standards and RBI directives.
Interest Income
16.19 As a measure of control and also to ensure that the legal remedies
against defaulting borrowers are not adversely affected, banks commonly
follow the procedure of recording interest on non-performing advances in a
separate account styled as 'Interest Suspense/ Interest Not Collected
Account (INCA)/ Unrealised interest of previous year (UIPY) ' or other similar
account. Amounts lying in Interest Suspense Account do not represent
income of the bank and have also to be deducted from the relevant
advances. The auditor should report the following in LFAR:
Has the branch compiled with the Income Recognition norms prescribed
by RBI (The Auditor may refer to the instructions of the controlling
authorities of the bank regarding charging of interest on non-performing
assets).
16.20 The Auditor should check whether, in terms of the income
recognition guidelines issued by the RBI, the bank has either reversed or
made provision in respect of interest accrued and credited to income
account, in respect of an advance (including bills purchased and discounted)
that becomes NPA during the year. Income in case of NPA account should
be recognised only on realisation on cash basis as per circular no. RBI/2015-
16/101DBR.No.BP.BC.2/21.04.048/ 2015-16 dated July 01, 2015 “Prudential
Norms on Income Recognition, Asset Classification and Provisioning pertaining
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to Advances”. These norms are also applicable to Government Guaranteed

Advances.
16.21 The said norms also require that the banks should not recognise
income from those projects under implementation which have been classified
as sub-standard and it should be recognised only on cash basis. The auditor
should also, accordingly, see whether any interest on such projects which
has been recognised as income in the past is either reversed or a provision
for an equivalent amount is made in the accounts.
16.22 The Auditor may assess the overall reasonableness of the figure of
interest earned by working out the ratio of interest earned on different types
of assets to the average quantum of the respective assets during the year.
The Auditor should obtain an in-depth understanding as to how the bank’s
management monitor their business, analyse its credit portfolio and the
interest income thereon.
16.23 For example, the auditor may obtain from the bank an analysis of
sector-wise and segment-wise deployment of credit, including the lending
rates of advances in various sectors and figures of advances outstanding at
the end of each month/quarter. From such information, the Auditor may work
out a weighted average lending rate. This analysis can be done for corporate
and retail loan portfolio separately. In case of retail loans, the portfolio can
be further bifurcated into home loans, auto loans, personal loans, jewel
loans, etc. Further, the Auditor should understand the process of
computation of the average balance and re-compute the average balance on
sample basis.
16.24 The Auditor should set the expectation for the movement in yield
based on the discussion and inquiries made with the management; rate
movement observed in the industry, etc., and should obtain explanations for
major variances in the yield on month basis or quarterly basis.
16.25 To ascertain completeness of interest income in the analysis, the
Auditor should obtain general ledger break-up for the interest income earned
during the respective months/quarter and examine whether the aggregation of
the same agrees with the interest income considered for the yield analysis. The
Auditor should analyze monthly/quarterly yields and document the reasons for
the variances as per the expectation set. The Auditor may compare the
average yield on advances with the corresponding figures for the previous
years and analyse any material differences. The Auditor may also compare
582
the reported market yield in percentage terms with market rates, RBI rates,
advertised rates and rates across various products of the bank. Interest
Income includes interest accrued but not due on investments.
16.26 The Auditor should, on a test check basis, verify the rates of interest
as per terms of sanction in the CBS as well as the calculation of interest
through product rate sheets generated by CBS to satisfy himself about the
following:
(a) Interest has been charged on all the performing accounts up to the date
of the balance sheet.
(b) Interest rates charged are in accordance with the bank’s internal
regulations, directives of the RBI and agreements with the respective
borrowers. The scrutiny of interest rates charged is particularly
important in the case of advances made on floating interest rate
basis.
The rate of interest is normally linked with MCLR/ base rate of bank.
But in case of consortium advances, the rate is normally linked with
the MCLR/ Base rate of lead bank or highest rate of member’s bank.
The rate of interest is reset from time to time. Normally the bank
disables the field of fixed rate and links with its own MCLR/ base
rate. Whenever there is change in the MCLR base rate of the bank,
the rate of interest is changed in such accounts also.
The Auditor should check the sanction letter and find whether the
rate of interest is reset as per sanction letter during the year. Special
care should be given when there is change in MCLR of the bank.
(c) Discount on bills outstanding on the date of the balance sheet has
been properly apportioned between the current year and the following
year.
(d) Any interest subsidy received (or receivable) from RBI in respect of
advances made at concessional rates of interest is correctly computed.
(e) The moratorium period entered also effects the date of application of
interest in the account and should therefore also be verified on samples
Basis.
16.27 The Auditor should also understand the process of accrual of interest
income on credit card portfolio. Credit card account will be treated as an NPA if
the minimum amount due as stated in statement is not fully paid within 90 days
from the date of next statement.
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16.28 The Auditor should understand the assumption taken for accrual of
interest income such as revolving portfolio, standard assets etc. and
independently assess the reasonableness of these assumptions.
16.29 Identification of NPA on CIF level should also to be applied in cases of
Credit Card NPA. The auditor should verify the same for the purpose of
revenue recognition as well.
16.30 The Auditor should also satisfy himself that interest on non–
performing assets has not been recognised unless realised.
16.31 As per AS 9, “Revenue Recognition”, dividends should be
recognised when the right to receive payment is established, i.e. dividend
has been declared by the corporate body at its Annual General Meeting and
the owner’s right to receive payment is established.
16.32 The Auditor should test certain samples of the dividend income booked
during the period by obtaining the counterfoils of dividend warrants and the
amount credited in the bank account.
16.33 In the case of bill discounting, interest income is received in advance
and hence the auditor should examine whether the interest income for the
period has been accounted for properly and the balance is treated as other
liabilities. In CBS, the interest on bill discounted is system driven and the
auditor should verify the in-built logic of the system. For the sample cases, the
auditor should verify the interest income on bill discounted by obtaining the
underlying documents like purchase order, letter of credit, etc. Also for the
overdue bills, the auditor should confirm whether the interest for the overdue
period has been accrued by the system or is calculated manually by the
Branch.
16.34 The Auditor should also understand the process of increase or
decrease in Marginal Cost of funds based Lending Rate (MCLR) and process
of updating in the system. The Auditor should ascertain compliance with RBI
guideline in respect of increase in tenor of retail loan due to increase in MCLR
and also verify on sample basis as to whether the increase/decrease in base
rate is effected in the system on the effective date.
16.35 Interest income includes interest accrued but not due on assets.
However, as banks normally debit the borrower’s account with interest due on
the month end, at balance sheet date there would not usually be any amount of
interest accrued but not due on advances on balance sheet date. Auditor
should verify the same.
584
16.36 The Auditor should examine the completeness of accrual of the interest
by obtaining a detailed break-up of the loan portfolio (scheme wise or segment
wise) and the interest accrual on the same. The aggregation of loan portfolio
should agree with to the general ledger.
16.37 The auditor should examine whether interest has accrued on the entire
investment and money market lending portfolio by obtaining the detailed break-
up of the investment and money market lending portfolio along with the interest
accrued thereon and agree the same with the general ledger. The Auditor
should re-compute the interest accrual on sample basis considering
parameters like frequency of payment of interest amount, rate of interest,
period elapsed till the date of balance sheet, etc., from the term sheet, deal
ticket, agreements, etc.
16.38 In determining the extent of sample checking, the Auditor should take into
account, inter alia, the results of the analytical procedures and the reports, if any,
on income and expenditure/ revenue audit as well as other internal and RBI
inspection reports and their compliance by the bank. The Auditor’s assessment of
the effectiveness of concurrent audit would also affect the extent of his detailed
checking of interest earned. In determining the extent of sample checking, the
auditor may place greater emphasis on examining interest on large advances.
Commission Income
16.39 The Auditor may check the items of commission, exchange and
brokerage on a test check basis. Such examination can be done for commission
earned on bills sent for collection, commission on letters of credit, guarantees
and letter of comfort. The auditor should examine whether the commission on
non–funded business (e.g., letters of credit, guarantees and bills for collection)
has been properly apportioned between the current year and the following year.
16.40 The Auditor should obtain details of loans sanctioned and disbursed
during the period as well as verify the policy of the bank for booking the
processing fee income on such loans. For corporate loans, the processing fee
income for the material loans sanctioned and disbursed should be re-computed
and verified on test check basis by obtaining the loan agreements, sanction
letter, etc. Further, for loans sanctioned but not disbursed wherein the processing
fee or non-utilisation fee income has been booked on accrual basis, the Auditor
should verify the subsequent receipt of the same and enquire for subsequent
reversals. For retail loans, the Auditor should perform analytical procedures for
computing the processing fee percentage for different ticket size loans.
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16.41 The Auditor should obtain an understanding of the various types of fee
income earned on credit cards and debit cards. Further, the Auditor should
obtain the rate matrix for various fees charged to the customer. On a sample
basis, the Auditor should verify whether the fees charged and accounted is as
per the rate matrix. Interchange fees is earned from service providers namely
Visa, Master card, Amex proportionate to the transactions entered by the
customer. On a sample basis, the Auditor should verify whether the interchange
fees have been received and accounted as per the agreement. Merchant
acquiring income is earned on the transactions entered by the customers of other
banks on the bank’s terminal. The Auditor should perform analytical procedures
for such income and obtain the explanation for the variances, if any.
16.42 The Auditor should understand how management monitors non-funded
business and use their analysis for analytical procedures. The Auditor should
understand the relation of fee income with the business. For example, checking
of month on month /quarter loan processing fees with sanction value to arrive at
average processing fees on monthly/quarterly basis. The Auditor should analyse
monthly/quarterly fee percentage and document the reasons for the variances as
per the expectation set. Similarly the Auditor can perform analysis of other fee
income by doing monthly/quarterly guarantee fees with average
monthly/quarterly guarantee amount, interchange credit card fees vis a vis inter
charge transactions etc.
16.43 The Auditor may also compare the average fee income with the
corresponding figures for the previous years and analyse any material
differences.
16.44 The Auditor should also check whether any fees or commission
earned by the banks as a result of renegotiations or rescheduling of
outstanding debts has, in terms of the income recognition guidelines issued
by the RBI, have been recognised on an accrual basis over the period of time
covered by the renegotiated or rescheduled extension of credit.
16.45 According to the guidelines for income recognition, asset
classification, etc., issued by the RBI, if interest income from assets in
respect of a borrower becomes subject to non-accrual, fees, commission and
similar income with respect to same borrower that have been accrued should
cease to accrue for the current period and should be reversed or provided for
with respect to past periods, if uncollected. The Auditor should examine
whether the bank has accordingly made suitable adjustments for de–
recognition/ reversal of uncollected commission, etc.
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16.46 Fee on insurance referral is fast emerging as a major source of

income for banks. In terms of the RBI Master Circular No. DBR.No.FSD.BC
19/24.01.001/2015-16 dated July 1, 2015 on “Para Banking Activities”, banks
are permitted to undertake insurance business as agents of insurance
companies on fee basis or referral arrangement without any risk participation
subject to the conditions prescribed under the Master Circular. The Auditor
should carefully examine the agreement entered into by the bank and the
concerned insurance company to see the basis for calculation of the said fee,
time when the referral fees becomes due to the bank. Normally, as an
industry practice, such agency arrangements also contain clauses known as
“claw back” of agency fee, whereby if the client referred to the insurance
company by the bank fails to pay the insurance premium for a stipulated
amount of time, the agency fees paid or due to the bank becomes
recoverable from the bank or is frozen. Such clauses have a direct impact on
the recognition of income from the agency fees in terms of Accounting
Standard 9, “Revenue Recognition” and may, therefore, require creation of a
corresponding provision in the accounts.
Income on account of Commitment Charges
16.47 Many times, it is noticed that the Loan Sanction letter contains a
clause to the effect that if the borrower is not availing the full sanctioned
limited in case of cash credit accounts, bank is supposed to levy commitment
charges on the unavailed portion of the loan which is usually recognised as
income of the period in which the same is realised by the bank. However, the
Auditor has to ensure that the same is accounted for on accrual basis so that
the income on this account is not understated.
Expenses
16.48 Expenditure is to be shown under three broad heads: interest
expended; operating expenses; and provisions and contingencies.
In the LFAR of the branch, the following question is to be answered by the
branch auditor:
Has the test check of interest on deposits revealed any excess/short debit
of material amount? If so, give details thereof.
Interest Expended
(a) Interest on Deposits: This includes interest paid/ payable on all types of
deposits including deposits from banks and other institutions. Usually,
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the rates of term deposits of banks are amended from time to time by the
ALCO or the Board.
(b) Interest on Reserve Bank of India/ Inter–Bank Borrowings: This includes
interest/ discount on all borrowings and refinance from the RBI and other
banks.
(c) Others: This includes discount/ interest on all borrowings/ refinance from
financial institutions. All other payments like interest on participation
certificates, penal interest paid, etc. may also be included here.
16.50 The RBI has issued Master Direction no. RBI/DBR/2015-16/19
DBR.Dir.No.84/13.03.00/2015-16 “Reserve Bank of India (Interest Rate on
Deposits) Directions, 2016 on March 03, 2016 (updated as on February 22,
2019) which contains the ‘Interest Rate Framework’. The RBI has deregulated
the savings bank deposit interest rate. In other words, the banks are free to
determine their savings bank deposit interest rate. The Auditor should verify
that prior approval of the Board/Asset Liability Management Committee (if
powers are delegated by the Board) has been obtained by the bank while fixing
interest rates on such deposits.
16.51 The Auditor should review the circulars or guidelines issued by the
controlling authorities of the Bank to identify the changes in the Interest Rates
during the year.
16.52 The RBI has also deregulated the interest rates on Non Resident
(External) Rupee Deposits and Ordinary Non-Resident (NRO) Accounts as
follows:
 Banks are free to determine their interest rates on both savings deposits
and term deposits of maturity of one year and above under Non-Resident
(External) Rupee (NRE) Deposit accounts and savings deposits under
Ordinary Non-Resident (NRO) Accounts. However, interest rates offered
by banks on NRE and NRO deposits cannot be higher than those offered
by them on comparable domestic rupee deposits.
 Prior approval of the Board/Asset Liability Management Committee (if
powers are delegated by the Board) needs to be obtained by a bank while
fixing interest rates on such deposits. At any point of time, individual banks
need to offer uniform rates at all their branches.
 The revised deposit rates apply only to fresh deposits and on renewal of
maturing deposits.
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 Banks also need to closely monitor their external liability arising on

account of such deregulation and ensure asset-liability compatibility from
systemic risk point of view.
16.53 The RBI has consolidated instructions pertaining to FCNR(B) deposits
by Banks. Specific consideration should be given to the ceiling on interest
rates, 360 days to a year basis for interest payment, rounding off of interest
etc. Recurring Deposits should not be accepted under the FCNR (B) Scheme.
The interest on FCNR (B) deposits should be calculated and paid at intervals of
180 days each and thereafter for the remaining actual number of days. However,
the depositor will have the option to receive the interest on maturity with
compounding effect.
Interest on Deposits
16.54 The Auditor may assess the overall reasonableness of the amount
of interest expense in accordance with Master Direction no. DBR.Dir.
No.84/13.03.00/2015-16 dated March 03, 2016 (Updated as on February 22,
2019) on “Reserve Bank of India (Interest Rate on Deposits) Directions,
2016” by analysing ratios of interest paid on different types of deposits and
borrowings to the average quantum of the respective liabilities during the
year. For example, the Auditor may obtain from the bank an analysis of
various types of deposits outstanding at the end of each quarter. From such
information, the auditor may work out a weighted average interest rate. The
Auditor may then compare this rate with the actual average rate of interest
paid on the relevant deposits as per the annual accounts and enquire into the
difference, if material. The Auditor may also compare the average rate of
interest paid on the relevant deposits with the corresponding figures for the
previous years and analyse any material differences. The Auditor should
obtain general ledger break-up for the interest expense incurred on deposits
(savings and term deposits) and borrowing each month/quarter. The Auditor
should analyse month on month (or quarter) cost analysis and document the
reasons for the variances as per the benchmark stated. He should examine
whether the interest expense considered in the cost analysis agrees with the
general ledger. The Auditor should understand the process of computation of
the average balance and re-compute the same on sample basis.
16.55 The Auditor should, on a test check basis, verify the calculation of
interest. He should satisfy himself that:
(a) Interest has been provided on all deposits and borrowings up to the date
of the balance sheet; and verify whether there is any excess or short
credit of material amount.
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(b) Interest rates are in accordance with the bank's internal regulations, the
RBI directives, and agreements with the respective depositors.
(c) In case of Fixed Deposits it should be examined whether the Interest
Rate (as applicable) in the accounting system are in accordance with the
Interest Rate mentioned in the Fixed Deposit Receipt/Certificate.
(d) Interest on Savings Accounts should be checked on a test check basis in
accordance with the rules framed by the bank in this behalf.
(e) Discount on bills outstanding on the date of the balance sheet has been
properly apportioned between the current year and the following year.
(f) Payment of brokerage is properly authorized.
(g) Interest on inter–branch balances has been provided at the rates
prescribed by the head office.
(h) Interest on overdue/ matured term deposits should be estimated and
provided for.
16.56 The Auditor should ascertain whether there are any changes in interest
rate on saving deposits and term deposits during the period. The auditor should
obtain the interest rate card for various types of term deposits and analyse the
interest cost for the period. The Auditor should examine the completeness that
there has been interest accrued on the entire borrowing portfolio by obtaining the
detailed breakup of the money market borrowing portfolio and the interest
accrued and the same should agree with the GL code wise break up. The Auditor
should re-compute the interest accrual on sample basis i.e., by referring to the
parameters like frequency of payment of interest amount, rate of interest,
period elapsed till the date of balance sheet, etc. from the term sheet, deal
ticket, agreements, etc.
Other question to be answered by the Auditor in LFAR is:
Does the bank have a system of estimating and providing interest accrued
on overdue/matured/ unpaid/ unclaimed term deposits including in respect
of deceased depositors?
16.57 In most of the banks, now a days, term deposits are auto renewed. If
the bank is not following the practice of auto renewal or customer has not given
consent for auto renewal, then the Bank should provide for interest on overdue
Term Deposit. The auditor should check whether Branch has the practice of
generating overdue Deposits report and making provision for interest as per the
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Bank’s policy. If the same is carried out centrally then the Auditor can check
whether all overdue deposits are considered by Central team by taking report
from them.
Another question in the context of LFAR is “Are there any divergent trends
in major items of income and expenditure, in comparison with
corresponding previous year, which are not satisfactorily explained by the
branch? If so, the same may be reported.”
16.58 As explained earlier the Auditor should carry out variance analysis of all
expenses head and seek clarification from the Branch for major variances, if any.
Also based on variances, the Auditor shall modify samples in respect of specific
expenses.
16.59 The other expenses head and audit procedure is as under:

(i) Payments to and Provisions for Employees: This item includes salaries and
wages of staff, allowances, bonus, other staff benefits like provident fund,
pension, gratuity, leave fare concession, staff welfare, medical allowance to
staff, etc. It may be noted that provision for terminal benefits like pension
and gratuity is usually made only at the head office level. Salaries and
allowances payable to the bank's staff and officers are usually governed by
agreement with the employee unions or awards of a Courts/Tribunals. The
payroll process is generally centralized in all banks. Auditors should
ascertain the control available at the branch level and test check sample
working.
(ii) Rent, Taxes and Lighting: This item includes rent paid by the bank on
buildings, municipal and other taxes, electricity charges and other similar
charges and levies. The Auditor should specifically review cases where
rental increases are in dispute and unpaid. Necessary provisions /
disclosures should be appropriately made. It may be noted that income-tax
and interest on tax are not to be included under this head. Similarly, house
rent allowance and other similar payments to staff would not appear under
this head.
(iii) Printing and Stationery: This item includes books and forms and stationery
used by the bank and other printing charges except those incurred by way
of publicity expenditure. While some stationery may have been purchased
by the branch, other stationery (security paper like draft forms, cheque
books) would have been received by the branch from the head office. The
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Auditor should specifically note the bank policy in this regard whether the
same is expensed out on purchase or on usage. In any case any
unusable or outdated stationery should be expensed out. If any stationery
is shown as an asset, necessary physical verification should be done.
(iv) Advertisement and Publicity: This item includes expenditure incurred by

the bank for advertisement and publicity, including printing charges of
publicity material. The Auditor should specifically review such agreements
to find out commitments made for such expenses in future periods.
(v) Depreciation on Bank's Property: This item includes depreciation on
bank's own property, motor cars and other vehicles, furniture, electrical
fittings, vaults, lifts, leasehold properties, non-banking assets, etc.
Depending on the procedure followed in the bank, provision for
depreciation may be either centralised at the head office level through
fixed asset management software or decentralized and manual at
branches and other offices. The Auditor should specifically review the
residual value and useful life at the year end and provide for additional
depreciation in case there is any downward revision in the useful life or
change in residual value. The Auditor should ensure that fixed assets are
accounted from the date the asset is put to use. Necessary accounting of
the asset to be done and depreciation calculated from this date.
Generally, banks account for fixed assets on date of final payment
irrespective of the asset being put to use much earlier.
The Auditor should note the process for verifying assets booked by branch
but allotted to employees and located at Bank residential premises allotted
to these employees. The Auditors should verify the calculation of
depreciation by exporting the relevant report from software.
The auditor should also ensure that the movement of asset on account of
transfer of employees are reconciled and confirmed by the Transferee
Branch to ensure appropriated depreciation charge on those assets.
(vi) Directors' Fees, Allowances and Expenses: Expenditure incurred in this
regard is recorded under this head. This item is dealt with at the head
office level and would not therefore be relevant at the branch level.
(vii) Auditors' Fees and Expenses: Remuneration payable to Statutory Auditors

and Branch Auditors and expenses in connection with audit like
reimbursements are recorded under this head. This item is usually dealt
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with at the head office level and would not therefore be relevant at the
branch level.
(viii) Law Charges: All legal expenses and reimbursement of expenses incurred
in connection with legal services are to be included here. The Auditor
should specifically review the Legal agreements to note future
commitments for payables. Expenses paid to advocates recovered from
Borrowers by direct debit to that account should be specifically noted for
consistency in accounting. The Auditor should also co-relate law charges
with the contingent liability appearing in financial statement or with the
specific annexure/report to be certified by the Branch Auditors’. Some
banks also have a separate vertical for handling legal issues and the
auditor may rely on confirmations / reconciliation of number of pending
cases to ensure adequacy of the data considered for accounting of law
charges.
(ix) Postage, Telegrams, Telephones, etc.: This item includes all postal
charges like stamps, telegrams, telephones, tele-printers, etc. Issuance of
telegrams has been discontinued since 15th July 2013 and this head is
now just for academic purposes.
(x) Repairs and Maintenance: This item includes repairs to bank’s property,
their maintenance charges, etc. Amortization of such expenses should be
specifically noted.
(xi) Insurance: This item is usually dealt with at the head office level and may
not therefore be relevant at the branch level. This includes premium paid
to DICGC, Insurance of Cash on Hand, in ATM & in transit and also
Insurance of Fixed Assets, Employee Fidelity Insurance, Fraud Covers,
Coverage for Cyber Risks. The Auditor should specifically ensure that all
risks are insured adequately. Decision not to insure specific risks / assets
should be approved at appropriate management level and the Auditor
should obtain the relevant documents for record.
(xii) Direct Marketing Expenses: These are the expenses incurred mainly for
sourcing of retails loans/credit cards and collection of retail overdue loans.
RBI circular RBI/2006/167/DBOD.NO. BP.40/21.04.158/2006-07 dated 3rd
November 2006 on Guidelines on Managing Risks and Code of Conduct
in Outsourcing of Financial Services by banks, clearly states that activities
of internal audit, compliance function and decision making functions like
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compliance with KYC norms for opening deposit accounts, according

sanction for loans (including retail loans) and management of cannot be
outsourced.
(xiii) Other Expenditure: This item includes all expenses other than those
included in any of the other heads, like, license fees, donations 15,
subscriptions to papers, periodicals, entertainment expenses, travel
expenses, etc. The Notes and Instructions for compilation of profit and
loss account, issued by the Reserve Bank, require that in case any
particular item under this head exceeds one per cent of the total income,
particulars thereof may be given in the notes. The Auditor should check
such large value items reported under this head and identify the nature of
items and if appropriate account head is available it should be classified in
that head.
16.60 Some banks follow the policy of providing for the promotional points
earned by the customers on the use of Debit/Credit cards on actuarial basis.
These provisions could be shown under this head.
16.61 Expenses should be accounted on accrual basis and not on cash basis.
The auditor may review payment vouchers of April month to ascertain the
correctness of provision made for expenses.
Operating Expenses
16.62 Generally the audit procedures followed by Auditors in any entity are
to be followed.
15 The Reserve Bank of India, from time to time, prescribes the limits up to which banks can make
donations. As per the Reserve Bank of India’s circular no. DBOD. No. Dir. BC. 50/ 13.01.01/ 2005–
06 dated December 21, 2005 on “Donations by banks”, the policy relating to donations given by
banks to various entities may be formulated by the Board of Directors of the banks. While
formulating any such policy, the circular requires the directors to take into account inter alia, the
following principles:
(i) profit making banks, during a financial year, may make donations up to one percent of the
published profits for the previous years. This limit of one percent would include contributions
made by the bank to any fund created for specific purposes such as encouraging research and
development in fields related to banking. However, donations/ subscriptions to the Prime
Minister’s National Relief Fund and to professional bodies related to banking industry, such as
the Indian Banks Association, Indian Institute of Banking etc., is excluded from such limit of
one percent.
(ii) loss making banks can make donations up to Rs. 5 lakhs in a financial year including
donations to the Prime Minister’s National Relief Fund and other professional organisations
listed in (i) above.
The circular has clarified that the unutilised portion of one percent cannot be carried forward to the
next year. The Circular also outlines the procedure for making contribution to the Prime Minister’s
National Relief Fund.
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Payments to and Provisions for Employees

16.63 The Auditor should ascertain the procedure followed by the bank in this
regard while verifying this item. The Auditor should obtain the human resource
policy and identify the benefits available to employees. The Auditor should
understand the compensation structure and process of payment of salary,
benefits like employee stock options, car assistance, leave encashment, asset
assistance, etc. to the various grades of employees. He should obtain the
standard compensation structure for each grade of employee. In case, where
payment is made on production of evidence or incurrence by employee, auditor
should ascertain whether provision for the same has been made in the books.
16.64 The Auditor should perform an overall analytical review for the
payments and provisions for employees by month on month grade-wise analysis
of the employees cost and number of employee in that grade to identify per
employee cost month on month and enquire about the variances, if any. The
auditor should examine whether all the benefits for all the employees have been
appropriately accounted for and should also check the calculation of salaries
and allowances, etc. on a test check basis with reference to appointment/
awards/ offer letters. He may also assess the reasonableness of expenditure
on salaries, allowances, etc. by working out their ratio to total operating
expenses and comparing it with the corresponding figures for previous years.
16.65 The Auditor should also obtain an understanding of the provision for
payment of bonus and other incentive and ascertain adequacy of the amount
recorded by the bank. Further, the Auditor should verify whether the bank has
made adequate provisions for employee benefits and has complied with the
recognition, measurement and disclosure requirements of AS 15, “Employee
Benefits”.
Rent, Taxes and Lighting
16.66 The Auditor may test check the following:
 Rent paid - verify whether adjustments have been made for the full year on
account of rent at the rates as applicable and as per agreement in force.
 Rent does not include House Rent Allowance to employees.
 Check whether municipal rates/ taxes are duly paid/ adjusted for the year
under audit.
 Enquire whether any disputed liability exists on this account up to the year-
end.
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 Further, the Auditor should obtain the listing of the premises which have
been obtained on lease. If the lease agreements have escalation clause,
lease equalization should be done in accordance with AS-19, “Leases”
unless the terms and conditions of the lease indicate otherwise.
 In addition, the Auditor should perform month on month rent analysis and
verify major variance in the average rent per month per branch. The Auditor
should also verify the provision made for the expired lease rent
agreements.
Printing and Stationery
16.67 The Auditor should verify this item with reference to documents
evidencing purchase/debit note received.
Advertisement and Publicity
16.68 Expenditure incurred by the bank for advertisement and publicity,
including printing charges of publicity material is verified with the documents.
Repair and Maintenance Expenses
16.69 The Auditor should verify the Annual Maintenance Contract (AMC) at
the Branch and should verify the provisioning and prepaid accounting of these
contracts.
Depreciation on Bank's Property
16.70 The Auditor should ascertain the procedure followed by the bank while
verifying this item. This item includes depreciation on bank's own property,
motor cars and other vehicles, furniture, electrical fittings, vaults, lifts, leasehold
properties, non–banking assets, etc. Depending on the procedure followed in the
bank, provision for depreciation may either be centralised at the head office level
or decentralised.
16.71 The Auditor should check head office instructions as regards
adjustments of depreciation on the fixed assets of the Branch. The auditor
should also check whether depreciation on fixed assets has been adjusted at
the rates and in the manner required by head office.
16.72 The auditor may also report unadjusted depreciation on assets
acquired but not capitalised. The Auditor should re-compute the depreciation
for the period, perform depreciation rationalisation and agree the amount with
the general ledger. The Auditor may also verify and obtain explanation for the
unadjusted depreciation on assets acquired but not capitalised.
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Provisions and Contingencies

16.73 This item represents the aggregate of the provisions made in respect of
the following:
(a) Non-performing assets.
(b) Taxation.
(c) Diminution in the value of investments.
(d) Provisions for contingencies.
16.74 Provisioning norms for NPA are given in Master Circular no. RBI/2015-
16/101 DBR.No.BP.BC.2/21.04.048/2015-16 dated 1st July 2015 on “Prudential
Norms on Income Recognition, Asset Classification and Provisioning
pertaining to Advances”. Interest reversal in case of advances which have
become NPA to be specifically checked. The most important item included in this
head is the provision in respect of non–performing assets. The other provisions
are usually made at the head office level.
Deferred Tax Liability on Special Reserve created under Section
36(1)(viii) of the Income Tax Act, 1961
16.75 RBI vide Circular No. DBOD.No.BP.BC.77/21.04.018/2013-14 on
“Deferred Tax Liability on Special Reserve created under Section 36(1)(viii) of
the Income Tax Act, 1961” dated December 20, 2013 has advised banks, that as
a matter of prudence, DTL should be created on Special Reserve.
16.76 For this purpose, banks may take the following course of action:
a) If the expenditure due to the creation of DTL on Special Reserve as at
March 31, 2013 has not been fully charged to the Profit and Loss account,
banks may adjust the same directly from Reserves. The amount so
adjusted may be appropriately disclosed in the ‘notes to accounts’ of the
financial statements for the financial year 2013-14.
b) DTL for amounts transferred to Special Reserve from the year ending
March 31, 2014 onwards should be charged to the Profit and Loss Account
of that year.
16.77 In view of the requirement to create DTL on Special Reserve, banks
may reckon the entire Special Reserve for the purpose of computing Tier-I
Capital. Reference in this regard is also drawn to the Announcement “Manner of
Reporting by the Auditors In Respect of RBI’s Circular on Deferred Tax Liability
on Special Reserve created under Section 36(1) (viii) of the Income Tax Act,
1961” dated April 30, 2014 issued by the Auditing and Assurance Standard
Board of the Institute of Chartered Accountants of India.
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Appropriations
16.78 Under this head, the net profit/ loss for the year as well as profit/ loss
brought forward have to be shown. The appropriations of the aggregate thereof
are to be shown under the following heads:
(a) Transfer to Statutory Reserves.
(b) Transfer to Capital Reserves.
(c) Transfer to Investment Fluctuation Reserve.
(d) Transfer to Debenture Redemption Reserve.
(e) Transfer to Other Reserves.
(f) Transfer to Government/ Proposed Dividend.
(g) Transfer to Tax on Dividend.
16.79 The appropriation of profits are decided at the head office level. This
item would not therefore appear in the profit and loss account at the branch level.
The Statutory Central Auditor should therefore verify compliance with the
statutory requirement regarding transfers to reserve accounts and the other
appropriation as applicable will have to be taken into consideration while
verifying these. According to RBI circular RBI/2006-07/132 DBOD.BP.BC No. 31
/ 21.04.018/ 2006-07 dated 20th September 2006 on “Section 17 (2) of Banking
Regulation Act, 1949 – Appropriation from Reserve Fund” all expenses including
provisions and write-offs recognized in a period, whether mandatory or
prudential, should be reflected in the profit and loss account for the period as an
‘above the line’ item (i.e. before arriving at the net profit).
Expenditure
Provisions and Contingencies
16.80 The Auditor should ascertain compliance with the various regulatory
requirements for provisioning as contained in the various circulars.
16.81 The Auditor should obtain an understanding as to how the Bank
computes the provision on standard assets and non-performing assets. It will
primarily include the basis of the classification of loans and receivables into
standard, sub-standard, doubtful, loss and non-performing assets. For
verification of provision on standard assets, the Auditor should verify the loan
classification on a sample basis. The Auditor should obtain the detailed break up
of standard loans, non-performing loans and agree the outstanding balance with
the general ledger. The Auditor should examine whether by performing re-
computation the provisions in respect of standard loans, NPA and NPI comply
with the regulatory requirements.
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16.82 The Auditor should obtain the tax provision computation from the bank’s
management and verify the nature of items debited and credited to profit and
loss account to ascertain that the same are appropriately considered in the tax
provision computation. The Auditor should re-compute the provision for tax by
applying the applicable tax rate after considering the allowances and
disallowances as per Income Tax Act, 1961 and as per Income Computation and
Disclosure Standards (ICDS). The other provisions for expenditure should be
examined vis a vis the circumstances warranting the provisioning and the
adequacy of the same by discussing and obtaining the explanations from the
bank’s management.
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17
Audit Reports and Certificates
BASEL Capital Adequacy Norms

17.01 Basel III Norms relate to the Capital Adequacy requirement compliance
which the Bank has to achieve as contained in the BASEL III accord. The
conclusive working or the calculation of capital adequacy is undertaken at the
Head Office of the Bank. The information related to capital is available at the
Head Office which is verified by the Statutory Central Auditors of the Bank along
with verification of working and calculation of capital adequacy for bank as a
whole. However, the calculation of risk weighted asset (RWA) values is
undertaken at the branch level w.r.t. the assets at the respective branches and
the same is required to be verified and certified by the SBAs. The calculation of
RWAs as certified by SBAs (as well as departmental auditors) is consolidated at
the head office.
Thus, a SBA needs to understand the fundamental concept of methodology of
calculation capital adequacy as per Basel III norms to ensure that the preliminary
level calculations of RWAs at branch level are duly verified.
Introduction
17.02 Basel capital adequacy norms are meant for the protection of depositors
and shareholders by prescriptive rules for measuring capital adequacy, thereby
evolving methods of determining regulatory capital and ensuring efficient use of
capital.
17.03 Basel III Accord strengthens the regulation, supervision and risk
management of the banking sector. It is global regulatory standard on capital
adequacy of banks, stress testing as well as market liquidity risk.
17.04 The Basel III Accord, aims at the following:
a. improving the banking sector's ability to absorb shocks arising from
financial and economic stress, irrespective of reasons thereof.
b. improving risk management and governance practices.
c. strengthening banks' transparency and disclosure standards.
17.05 Basel II was fully implemented in all commercial banks (except RRBs
and LABs) in India by March 31, 2009. In this regard, the RBI had issued a
Master Circular no. DBR.No.BP.BC.4/21.06.001/2015-16 dated July 1, 2015 on
“Prudential Guidelines on Capital Adequacy and Market Discipline - New Capital

Adequacy Framework (NCAF)”.
17.06 The major changes made in Basel III over Basel II are as under:
(a) Quality of Capital: One of the key elements of Basel III is the introduction
of much stricter definition of capital, which means the higher loss-
absorption capacity, which in turn would lead to banks becoming stronger
with enhanced capacity to withstand periods of stress.
(b) Capital Conservation Buffer: Beginning 31st March, 2016, Banks are
required to hold capital conservation buffer of 0.625 per cent, which would
be gradually increased to 2.5 per cent by 31st March, 2019. As per RBI
circular ref no. RBI/2020-21/93 DOR.CAP.BC.No.34/21.06.201/2020-21
dated February 05, 2021, in view of the continuing stress on account of
COVID-19, RBI has decided to defer the implementation of the last tranche
of 0.625 per cent of the Capital Conservation Buffer (CCB) to October 01,
2021. Accordingly, the minimum capital conservation ratios in para 15.2.2
of Part D ‘Capital Conservation Buffer Framework’ of Master Circular,
DBR.No.BP.BC.1/ 21.06.201/ 2015-16 dated July 1, 2015 on ‘Basel III
Capital Regulations’, shall continue to apply till the CCB attains the level of
2.5 per cent on October 01, 2021. This is to ensure that banks maintain a
cushion of capital that can be used to absorb losses during periods of
financial and economic stress, without affecting the core capital adequacy
of 9 per cent.
(c) Counter cyclical Buffer: The counter cyclical buffer is designed to achieve
broader macro-prudential goal of protecting banking sector from periods of
excess aggregate credit growth (wherein excessive credit growth results in
system-wide (national level) build-up of risk). The counter cyclical buffer is
implemented on need-based basis.
(d) Minimum Common Equity and Tier 1 Capital Requirement: The
minimum requirement for common equity, the highest form of loss-
absorbing capital, has been increased to 5.50 per cent of RWA. The
Minimum Tier 1 capital has been increased to 7 per cent, which means that
Additional Tier I (AT 1) capital can be a maximum of 1.50 per cent of RWA
and excess of Tier I capital can be used for Tier II capital. Though, the
minimum total capital (Tier I plus Tier II) requirement remains at 9 per cent,
which means that the Tier 2 capital can be admitted maximum of 2 per cent
of RWA. With the requirement of gradually maintaining 2.5 per cent of RWA
as Capital Conservation Buffer in the form of CET 1, the minimum overall
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capital requirement increases to 11.50 per cent of RWA by 31st March,

2020 (as per RBI circular dated January 10, 2019). [Refer to Press Release
for Domestic Systemically Important Banks (D-SIBs)].
(e) Leverage Ratio: Analysis of the 2008 financial crisis indicates that value of
assets went down much more than what was perceived based on their risk
rating, which led to stipulation of Leverage Ratio. Therefore, under Basel III,
a simple, transparent, non-risk based leverage ratio has been introduced. A
Leverage Ratio is the relative amount of capital to total assets (not risk-
weighted). It has been decided that the minimum Leverage Ratio shall be 4
per cent for Domestic Systemically Important Banks (DSIBs) and 3.5 per
cent for other banks. These guidelines shall be effective from the quarter
commencing October 1, 2019.
(f) Liquidity Ratios: Under Basel III, a framework for liquidity risk
management has been set up. Liquidity Coverage Ratio (LCR) has become
operational since 1st January, 2015.
17.07 Basel III capital regulation has been implemented from April 1, 2013 in
India in phases and it was planned to be fully implemented as on March 31, 2020
but because of the COVID-19 pandemic, it has now been postponed to October
01, 2021.
Guidelines on BASEL III Capital Regulations
17.08 The RBI had issued circular no. DBOD.No.BP.BC.98 /21.06.201/2011-
12 dated May 2, 2012 on the subject “Guidelines on Implementation of Basel III
Capital Regulations in India”. Through this circular, the RBI has prescribed the
final guidelines on Basel III capital regulations. RBI issued a Master Circular no.
RBI/2015-16/58 DBR.No.BP.BC.1/21.06.201/ 2015-16 dated July 1, 2015 on
Basel III Capital Regulations. Following are main features of these guidelines:
 These guidelines became effective from April 1, 2013 in a phased manner.
The Basel III capital ratios were planned to be fully implemented by March
31, 2019, but have since been postponed.
As per RBI circular ref no. RBI/2020-21/93 DOR.CAP.BC.No.34/ 21.06.201/
2020-21 dated February 05, 2021, in view of the continuing stress on
account of COVID-19, RBI has decided to defer the implementation of the
last tranche of 0.625 per cent of the Capital Conservation Buffer (CCB) to
October 01, 2021. Accordingly, the minimum capital conservation ratios in
para 15.2.2 of Part D ‘Capital Conservation Buffer Framework’ of Master
Circular, DBR.No.BP.BC.1/21.06.201/2015-16 dated July 1, 2015 on ‘Basel
III Capital Regulations’, shall continue to apply till the CCB attains the level
of 2.5 per cent on October 01, 2021. Further, the pre-specified trigger for
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loss absorption through conversion / write-down of Additional Tier 1

instruments (PNCPS and PDI) shall remain at 5.5 per cent of RWAs and
will rise to 6.125 per cent of RWAs from October 01, 2021.
 The RBI issued circular DoR.BP.BC.No.76/21.06.201/2019-20 dated June
21, 2020 w.r.t. 'Assignment of Risk Weights on Credit Facilities
(Guaranteed Emergency Credit Line) under the Emergency Credit Line
Guarantee Scheme' specifying that credit facilities extended under the
scheme guaranteed by NCGTC which are backed by an unconditional and
irrevocable guarantee provided by Government of India, Member Lending
Institutions shall assign zero percent risk weight on the credit facilities
extended under this scheme to the extent of guarantee coverage.
 The capital requirements for the implementation of Basel III guidelines may
be lower during the initial periods and higher during the later years. While
undertaking the capital planning exercise, banks should keep this in view.
 Banks are required to maintain LCR of 100 per cent with effect from
January 1, 2019.
 In order to accommodate the burden on banks’ cash flows on account of
the Covid19 pandemic, RBI vide its Circular No. RBI/2019-20/217
DOR.BP.BC.No.65/21.04.098/2019-20 dated 17th April, 2020 has permitted
the Banks to maintain LCR as under:
(i) From the date of circular to September 30, 2020 - 80 per cent
(ii) Oct 1, 2020 to March 31, 2021 - 90 per cent
(iii) April 1, 2021 onwards - 100 per cent
 Banks are required to prepare LCR restoration plans if there is a breach of
the aforesaid prescribed LCR requirement.
 Banks are also required to disclose capital ratios under Basel III from the
quarter ending June 30, 2013.
Components of Capital
17.09 Total regulatory capital will consist of the sum of the following
categories:
(i) Tier 1 Capital (going-concern capital)
(a) Common Equity Tier 1
(b) Additional Tier 1
(ii) Tier 2 Capital (gone-concern capital)
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Limits and Minima

Regulatory Capital As per
cent to
RWAs
(i) Minimum Common Equity Tier 1 Ratio 5.5
(ii) Capital Conservation Buffer (comprised of Common Equity) 2.5
(iii) Minimum Common Equity Tier 1 Ratio plus Capital 8.0
Conservation Buffer [(i)+(ii)]
(iv) Additional Tier 1 Capital 1.5
(v) Minimum Tier 1 Capital Ratio [(i) +(iv)] 7.0
(vi) Tier 2 Capital 2.0
(vii) Minimum Total Capital Ratio (MTC) [(v)+(vi)] 9.0
(viii) Minimum Total Capital Ratio plus Capital Conservation 11.5
Buffer [(vii)+(ii)]
Capital – What Constitutes Tier 1 and Tier 2 – a Representative Sample

17.10 Master Circular no. DBR.No.BP.BC.1/21.06.201/ 2015-16 dated July
1, 2015 on Basel III Capital Regulations discusses the capital funds in two
categories – capital funds for Indian banks and capital funds of foreign banks
operating in India. The following table shows the components of the capital
funds for Indian vis a vis foreign banks operating in India:
Indian Banks Foreign Banks operating in
India
Tier I Capital Paid up equity capital Interest free funds from Head
Common (ordinary shares)16 Office17
Equity Tier I Share premium on issue of
(CET 1) common shares
Statutory reserves Statutory reserves kept in
Indian books
Capital reserves Capital reserves representing
representing surplus surplus arising out of sale of
16 Refer Annexure 1 to Master Circular on Basel III Capital Regulations for criteria.
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arising out of sale assets in India held in a

proceeds of assets separate account and which is
not eligible for repatriation so
long as the bank functions in
India
Other disclosed free Remittable surplus retained in
reserves, if any Indian books which is not
repatriable so long as the bank
functions in India
Revaluation reserves with Revaluation reserves with
discount of 55 per cent discount of 55 per cent (till 29th
(with effect from 1st March February 2016), subject to
2015), subject to meeting meeting conditions prescribed
conditions prescribed in in RBI circular dated 1st March
RBI circular dated 1st 2016
March 2016
Foreign currency Foreign currency translation
translation reserve arising reserve arising due to
due to translation of translation of financial
financial statements of statements of their foreign
their foreign operations in operations in terms of
terms of Accounting Accounting Standard (AS) 11 at
Standard (AS) 11 at a a discount of 25 per cent,
discount of 25 per cent, subject to meeting conditions
subject to meeting prescribed in RBI circular dated
conditions prescribed in 1st March 2016
RBI circular dated 1st
March 2016
Balance in Profit and Loss
Account at the end of the
previous financial year
Profits of current financial
year on a quarterly basis
provided the incremental
provisions made for NPA
at the end of any of the
four quarters of the
previous financial year
have not deviated more
than 25 per cent from the
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average of the four

quarters with certain
adjustments given in the
Master Circular
Interest free funds remitted
from abroad for the purpose of
acquisition of property and
held in a separate account in
Indian books provided they
are non-repatriable and have
the ability to absorb losses
regardless of their source
Less: Regulatory Less: Regulatory adjustments
adjustments / deductions / deductions applied in the
applied in the calculation calculation of Common Equity
of Common Equity Tier 1 Tier 1 capital
capital
Additional Tier Perpetual non-cumulative Head office borrowings in
I (AT 1) preference shares18 foreign currency by foreign
banks operating in India as
per criteria19
Share premium on
instruments included in AT
1 capital
Debt Capital instruments
including Perpetual Debt
instruments20
Any other instrument Any other instrument notified
notified by RBI from time by RBI from time to time
to time
applied in the calculation calculation of Additional Tier 1
of Additional Tier 1 capital capital
Tier II Capital Revaluation reserves with Revaluation reserves with
discount of 55 per cent (till discount of 55 per cent (till 29th
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29th February 2016) February 2016)

General provisions against General provisions against
future but presently future but presently
unidentified losses and unidentified losses and loss
loss reserves reserves
Debt Capital instruments21 Head Office (HO) borrowings
in foreign currency received
as part of Tier 2 debt capital
Perpetual Cumulative Perpetual Cumulative
Preference Shares (PCPS) Preference Shares (PCPS) /
/ Redeemable Non- Redeemable Non- Cumulative
Cumulative Preference Preference Shares (RNCPS) /
Shares (RNCPS) / Redeemable cumulative
Redeemable cumulative preference shares (RCPS) 23
preference shares
(RCPS)22
Premium on instruments
included in Tier 2
applied in the calculation calculation of Tier 2 capital
of Tier 2 capital
17.11 In the case of foreign banks operating in India, RBI’s Master Circular on
Capital Adequacy also lays down certain additional provisions in respect of
capital to be followed by such banks.
17.12 Capital instruments which no longer qualify as AT 1 capital or Tier 2
capital (e.g. IPDI and Tier 2 debt instruments with step-ups) will be phased out
beginning January 1, 2013. Fixing the base at the nominal amount of such
instruments outstanding on January 1, 2013, their recognition will be capped at
90 per cent from January 1, 2013, with the cap reducing by 10 per cent in each
subsequent year. This cap will be applied to Additional Tier 1 and Tier 2 capital
instruments separately and refers to the total amount of instruments outstanding
which no longer meet the relevant entry criteria. The following chart graphically
depicts the provisions relating to such instruments:
607
TRANSITIONAL ARRANGEMENTS FOR NON-EQUITY REGULATORY

CAPITAL INSTRUMENTS
608
Deductions from CET I, AT I and Tier II

17.13 The deductions from CET I, AT I and Tier II are tabulated below:
Item Extent of Deduction
(in %)
CET I AT 1 Tier II
Intangible assets including goodwill 100 ---
Losses in the current period 100 ---
Losses brought forward from previous 100 ---
periods
Deferred tax asset associated with 100 ----
accumulated losses
Cash Flow hedge reserve 100 ---
Shortfall of provisions to expected losses 100 ---
Gains on sale related to securitisation 100 ---
transactions
Cumulative gains and losses due to changes 100 ---
in own credit risk on fair valued liabilities
Defined benefit pension fund liabilities and 100 -
un-amortised employees’ benefits
Investments in own shares (if not already 100 ---
netted off paid-up capital on reported
balance sheet) including indirect investments
DTAs which relate to timing differences Excess of ----
(other than those related to accumulated 10% of CET-
losses) 1
DTAs on timing difference along with limited Excess of
recognition of significant investments in the 15% of CET-
common shares of unconsolidated financial 1
(i.e. banking, financial and insurance) entities
taken together
Equity investments in insurance subsidiaries 100
Investments in equity instruments of other 100
subsidiaries and capital of other Banks,
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(in %)
CET I AT 1 Tier II
insurance companies etc. which is more than
10% of Bank’s CET1
Equity investments in non-financial 100
subsidiaries
Intra group transactions beyond permissible 100
limits
Reciprocal cross investments in capital of Full Full Full
other banks in the same component of
capital
Securitization exposure 50 50
Investment in financial subsidiaries and 50 50
associates which is above 30 per cent in the
paid-up equity of entity and not consolidated
for the capital adequacy purposes
Shortfall in the regulatory capital 50 50
requirements in the de-consolidated entity
Such amount of investment in the following 50 50
which is in excess of 10 per cent of investing
bank’s capital funds:
• Equity shares;
• Perpetual Non- Cumulative Preference
Shares;
• Innovative Perpetual Debt Instruments;
• Upper Tier II Bonds;
• Upper Tier II Preference Shares;
• Subordinated debt instruments; and
• Any other instrument approved as in the
nature of capital.
Investments made by a banking 50 50
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(in %)
CET I AT 1 Tier II
subsidiary/associate in the equity or non-
equity regulatory-capital instruments
issued by its parent bank
If net overseas placements with Head 100 ---

Office/other overseas branches/other
group entities exceed 10 per cent of the
bank’s minimum CRAR requirement, the
amount in excess of this limit would be
deducted from Tier I capital
Capital to Risk-weighted Assets Ratio (CRAR)

17.14 The RBI requires banks to maintain a minimum CRAR of 9 per cent on
an ongoing basis. The Master Circular on Capital Adequacy contains detailed
guidelines on calculation of risk weighted assets and off-balance sheet items and
CRAR.
17.15 The CRAR is computed as follows:
Eligible Total Capital funds × 100
----------------------------------------------------------------------------------------
Credit Risk RWA + Market Risk RWA + Operational Risk RWA
17.16 The minimum CRAR is required to be maintained at consolidated level

also as per Basel III Guidelines. The requirements mentioned above relates to
standalone Bank only. For the requirement for the consolidated capital, the
readers may refer Master Circular no. DBR.No.BP.BC.1/21.06.201/ 2015-16
dated July 1, 2015 on Basel III Capital Regulations number RBI/2015-16/58
DBR.No.BP.BC.1/21.06.201/2015-16 dated 1st July 2015.
Board Oversight
17.17 The board of directors and senior management of each
subsidiary/overseas branch should be responsible for conducting their own
assessment of the subsidiary’s/overseas branch’s operational risks and controls
and ensuring that the subsidiary/overseas branch is adequately capitalised in
respect of those risks.
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Disclosure (Pillar 3)
17.18 Pillar 3 aims primarily at disclosure of a bank's risk profile and capital
adequacy. It is recognised that the Pillar 3 disclosure framework does not conflict
with requirements under accounting standards, which are broader in scope. The
banks in India have to follow Pillar 3 disclosure over and above the RBI master
circular on “Disclosure in Financial Statements - Notes to Accounts”. Information
would be regarded as material if its omission or misstatement could change or
influence the assessment or decision of a user relying on that information. Pillar
3 disclosures will be required to be made by the individual banks on a standalone
basis when they are not the top consolidated entity in the bank.
Role of Statutory Branch Auditors (SBAs)
17.19 In case of credit risk management, the underlying computation for Basel
III is based on credit ratings, which may be driven centrally and passed on to
branches such that branches follow head office instructions in its entirety. This
way the bank SBAs check only the computation process and test check the
source rather than getting into the credit rating process. The SBAs can assess
any issues relating to completeness and correctness of the data, which is used to
compute the underlying risks emanating from credit market and operational risk.
It is a pyramid approach whereby data from branches get consolidated at head
office. The SCAs may choose to test check certain source data and also verify
the basis considered at the head office. The SBAs are advised to read the latest
RBI circulars dated October 12, 2020 and October 16, 2020.
17.20 It will not be practical to expect the branch to comprehensively
understand the Basel III requirements in its entirety. Thus, the SBAs should
assess the sufficiency of the instructions provided to the branch by the head
office and its adherence at the branch level. Any error at bank branch level can
have a cascading effect at the head office level, especially when a large number
of branches are involved.
17.21 At the Branch Level, the Auditors will have to verify whether proper
bucketing of assets has been done correctly or not. The risk weights are
allocated to each bucket and therefore it has to be ensured by the SBAs that
the respective advances have been reflected in the correct bucket so the risk
weights are correctly calculated for the advances held at the branch. While
verifying the bucketing of corporate and institutional advances the Auditors
should call for the latest credit ratings of the borrowers which should not be
more than one year old. The Auditors should further confirm whether separate
ratings are obtained for short term as well as long term advances. Although the
reports shall be generated from the system, it is important to verify whether the
612
figures match with the general ledger balances (or limits whichever is higher)
where ever required and the aggregate advances match with the return.
Auditors are also required to verify the bucketing for non-fund based advances
like Bank Guarantees and Letter of Credit which are also allotted risk weights.
17.22 Proper classification of all advances in SME sector, Commercial and
Institutional Sector (with appropriate External Credit Rating), Restructured
Advances, Non-Performing Assets, Unrated Institutional advances, etc. should
be ensured.
17.23 Appropriate classification of Guarantees into Performance and
Financial along with the cash margins held there against should also be
verified. An Illustrative Audit Checklist for Capital Adequacy is given as
Annexure A to this Chapter.
Special Purpose Reports and Certificates
Introduction
17.24 The SBAs have to issue various Special Purpose Reports and
certificates at branch level. SBAs should ensure the correctness of financial /
non-financial information given in these certificates.
17.25 The appointment letter normally contains the exhaustive list of all such
reports and certificates which are required to be certified by the SBA’s. These
are to be verified and certified by the SBAs to ensure their correctness and
accuracy. Since the SBAs have a direct access to the supporting branch
documents and the relevant information, various readers / users of these
certificates, such as Bank Management, CSA’s, State Government/Central
Government as well as RBI rely upon the Reports and Certificates issued by the
SBAs and actually use them to release the various grants and subvention
amounts to Banks.
17.26 The purpose of these Reports/Certificates may be for:
a) Disclosure requirements. SLR/CRR, Provisions of NPA’s, Movement of
NPA Provisions, Gross/Net NPA, Asset Liability Management related
returns, Exposure to Sensitive Sectors, Unhedged foreign currency
exposures, etc.
b) Related to Provisions to be made (other than advances) like Fraud,
Suspense Account, etc.
c) Certificates related to Compliance of Internal Control Systems and
Prevention of Frauds (Ghosh /Jilani Reports/Certificates).
d) Certification relating to various Subsidies, Interest subvention, loan waivers,
613
etc. to be issued to RBI who is acting as an agency on behalf of Central

and State Governments for administration of various Public welfare
schemes. Normally the advances to Priority sectors like Agriculture, SME
Sector, Educational Loans, Public Housing loans, etc. are covered under
this head.
e) Certification from SBAs relating to correctness of provisions and
compliance of IRAC norms in respect of advances.
f) Memorandum of Changes – MOCs for the changes recommended by the
SBAs to be considered by the Bank and SCAs in respect of
increase/decrease in assets/liabilities balances and/or increase/decrease in
profit/loss at the branch.
g) Certificates in respect of Physical custody of Branch in respect of
Investment scrips e.g. Local Municipal Bonds, Gold Coins, etc. held by the
Branch on behalf of Head Office.
h) Some additional certifications needed could be as under:
(i) Compliance with SLR requirements on 12 odd dates spread over the
entire year (not being Fridays) & the accuracy in the computation of
net DTL.
(ii) Verification of fortnightly CRR/SLR returns on a sample basis on at
least 12 occasions during the year, including the last fortnightly
returns, pertaining to every reporting quarter.
(iii) Adherence to income recognition, asset classification and provisions
(IRAC Norms).
(iv) Implementation of gold card scheme for exporters as per extant
instructions.
(v) Process and Policy adherence to MCLR.
(vi) Accuracy of computation of assessable deposits and premium
(DICGC) classified under Priority Sector.
(vii) Correctness of the interest subvention claims under Interest
Subvention Scheme for short term crop loans and Kisan credit card.
(viii) In cases of Frauds the, Process of Reporting to Central Fraud
Registry, Classification and monitoring of red flagged accounts.
(ix) Reporting of serious irregularities, if any.
(x) Compliance with exposure norms under Large Exposure Framework.
(xi) Compliance with instructions - Un-authorized operation of
Internal/Office Accounts.
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(xii) Automation of Income Recognition, Asset Classification and

Provisioning processes in banks.
(xiii) Implementation of COVID-19 –Regulatory Package.
17.27 The Reserve Bank of India vide Master Direction No:
DBS.CO.CFMC.BC.No.1/23.04.001/2016-17 Dated July 01, 2016 (updated
July 03, 2017) on “Frauds- Classification and Reporting and vide its Circular
no. RBI 2011-12/266/ DBS.FrMC.BC.No.4/23.04.001/2011-12 dated November
21, 2011 Frauds – Classification and Reporting by commercial banks and
select FIs”, issued guidelines for classification of frauds and reporting of frauds
to RBI, Central Office as well as the concerned regional office of the
Department of Banking Supervision / Financial Conglomerate Monitoring
Division (FCMD) at Central Office under whose jurisdiction the bank’s Head
Office/branch is situated. The reporting requirements for various categories of
frauds based on financial exposure are specified in the aforesaid Master
Directions.
While issuing a special purpose report or certificate, the Auditors should bear
in mind the recommendations made in the Guidance Note on Reports or
Certificates for Special Purposes (Revised 2016) issued by the Institute of
Chartered Accountants of India (ICAI).
Audit Approach
17.28 At the time of accepting the audit assignment, issuing engagement
letter, preparing audit program, maintaining adequate working papers, the
SBAs should appropriately comply with the requirements of Guidance Note on
ICAI. They may also refer covering report for certificates as prescribed in
Annexure B “Illustrative Format of Covering Report for various Certificates
issued by SBAs” of this Chapter.
17.29 The SBAs may verify the contents of certificates to be issued at branch
level. All the Returns submitted by branch to various higher authorities of the
respective bank and also to various authorities of the regulators as per the
Master Directions dated July 03, 2017 shall be verified. In case of frauds, Branch
Auditors should ensure the correctness of financial implication caused due to
such frauds and confirm that adequate provision for the same has been made.
17.30 Considering various types of Certificates and Reports to be issued by
the SBAs, it is very important for the Auditors to verify their correctness and
accuracy from the available branch records and documents, as the Bank, SCAs,
615
RBI and other Governmental agencies use this data for consolidation, disclosure
and also releasing various subsidies and waivers. Mostly the data certified by
SBAs is consolidated and further certified and endorsed by the SCAs at the head
office.
17.31 Where ever possible SBAs should reconcile or tally the closing balance
of the return with the General Ledger Heads in the Trial Balance of the Branch as
at the year end. This will be especially important for semi-automatic or manual
returns. For system generated returns without manual intervention, it should still
be ensured that they tally with the year-end figures, though detailed verification
may not be warranted.
17.32 UDIN needs to be generated for Reports and Certificates issued by
SBAs, as per the FAQs on UDIN issued by ICAI “Since UDIN has to be
generated per Assignment per Signatory on a given date, one UDIN will suffice
for the Bank Audit Report including LFAR and Certificates. However, separate
UDIN will be required for Tax Audit Report being separate assignment.” Further
while generating UDIN, the details of multiple reports and certificates can be
entered by “Add more” button.
Certificates and Reports
17.33 In addition to their audit reports, the SBAs and SCAs may also be
required by their terms of engagement or statutory or regulatory requirements
to issue other reports or certificates. For example, presently, the branch
auditors are required to issue reports/certificates on the following matters
besides their main audit report:
 Long Form Audit Report for Branch.
 Certificate as to whether the income recognition, asset classification and
provisioning have been made as per the guidelines issued by the RBI from
time to time.
 Report on the status of the compliance by the bank with regard to the
implementation of recommendations of the Ghosh Committee relating to
frauds and malpractices and of the recommendations of the Jilani
Committee on internal control and inspection/credit system.
 Certificate of cash and bank balances.
 Certificate relating to MOC entries of the previous year being accounted
for.
As the MOC’s are prepared and passed after the accounting year is over
during the course of the statutory audit itself, the actual accounting entries
in the records of the branch are passed during the next year. Therefore
616
SBA’s need to verify whether the previous year’s MOCs have been
effected at the Branch and accordingly they have to issue the necessary
certificate. Thus, for the current year audit of 2020-21, SBAs would verify
the MOCs accounting effects recommended by previous year’s SBAs i.e.
for the year 2019-20.
 Certificate relating to credit/ deposit ratio.
 Certification for advances to infrastructure project and income generated
thereon.
 Statement of accounts Re-structured/ Re-scheduled/ Re-negotiated
related to CDR and non-CDR accounts.
 Certificate of advances exceeding Rs.10 Crores.
 Certificate for IRAC Status of Credit Exposure in respect of Non-Performing
Investments.
 Certificates for IRAC Status of Credit Exposure in respect of borrowers
having exposure with foreign offices.
 Certificate for agricultural interest subvention claim @2% for residual period
of repayment of the loans disbursed during Financial Year.
 Certificate for agricultural interest subvention claim @2% for disbursements
made during Financial Year.
 Certificate for additional interest subvention (Incentive @3%) for prompt
repayment for short term production loans disbursed during Financial Year.
Certain other certificates as may be prescribed by the concerned bank in
their respective closing instructions or appointment letters.
 Certificate of interest subvention for certain housing loans.
 Certificate of interest subvention for certain education loans.
 Certificate on unhedged foreign currency exposure in case of borrowal
having exposure of 1 crore or more.
 Certificate on exposure to sensitive sectors, i.e. exposure to capital
market, infrastructure and real estate sector.
 Certificate in respect of ECGC claims filed at the branch and its status.
 Memorandum of changes –
In case of disagreement of the SBA with the Branch management on any
matter related to compliance of IRAC norms or in case of any mistake
observed by the SBA, it necessitates a change either in Asset/Liability
and/or Income/Expenditure at the Branch which would affect the financial
statements of the branch for the year under audit, then SBA can issue
MOC for such disagreement or the mistake observed. The SBA should
617
confirm that the amount is material enough warranting MOC and is above
the threshold limit prescribed in the bank circular. It should be further
ensured that MOC is prepared with correct account heads and codes and
also the correct amount, since these MOCs would be consolidated at the
HO level and these should not contain any discrepancy. A short reason or
remark leading to MOC also should be mentioned in the MOC to make it
self explanatory. Further MOCs effected at the branch should be
countersigned by the Branch Manager. Even if there is no entry to be
suggested in MOC, still it is advisable to issue a NIL MOC for the sake of
providing clarity to the SCA.
 Certain other additional certificates as may be prescribed by the
concerned bank in their respective closing instructions or appointment
letters.
Implementation of Ghosh & Jilani Committee
Recommendations
Introduction
17.34 The RBI had set up a High Level Committee on Frauds and
Malpractices in Banks under the Chairmanship of Shri A. Ghosh, the then
Deputy Governor, RBI to enquire into various aspects of frauds and
malpractices in banks with a view to make recommendations to reduce such
incidence. The Committee submitted its Report in June, 1992. The
recommendations contained in the report are related to frauds and
malpractices in banks.
17.35 The RBI had set up a “Working Group to Review the Internal Control
and Inspection and Audit System in Banks” under the Chairmanship of Mr.
Rashid Jilani. The Working Group was constituted in February, 1995 to review
the efficiency and adequacy of internal control and inspection and audit system
in banks with a view to strengthening the supervision system, both on-site and
off-site, and ensuring reliability of data.
Ghosh Committee Recommendations
17.36 The RBI in its efforts towards ensuring a strong, efficient and resilient
banking system in the country, vide its Circular No. DBS.Co.PPP.BC.No.39/
ND-01.005/99-2000 dated November 1, 1996, issued instructions relating to
frauds and malpractice in banks. The Circular was issued for the
implementation of the 44th report of the Committee on Government Assurances
– Ghosh and Jilani Committees’ Recommendations.
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17.37 The recommendations are divided into four groups as under:

(i) Group-A: Recommendations, which have to be implemented by the banks
immediately.
(ii) Group-B: Recommendations requiring RBI’s approval.
(iii) Group-C: Recommendations requiring approval of Government of India.
(iv) Group-D: Recommendations requiring further examination in consultation
with IBA.
17.38 The RBI has summarised each of these recommendations for the
purpose of reporting of their implementation by the banks, in a ‘yes’ or ‘no’
format. The RBI has also categorised these recommendations into:
(i) applicable to branches;
(ii) applicable to Controlling Offices like, Regional and Zonal Offices (some
banks may have some other name for controlling offices);
(iii) applicable to Head Office; and
(iv) applicable to Treasury Operations.
17.39 The report of the Ghosh Committee deals, mainly with the issues
related to day-to-day administrative functions that take place in a bank. The
main objective behind the recommendations contained in the Ghosh
Committee Report is to ensure that there exists a proper system in banks to
ensure the safety of assets, compliance with the laid down policies and
procedures, accuracy and completeness of the accounting and other records,
proper segregation of duties and responsibilities of the staff and also timely
prevention and detection of frauds and malpractices.
Jilani Committee Recommendations
17.40 The 44th Report of the Committee on Government Assurances
expressed concern that despite reporting of the compliance with
recommendations of the Jilani Committee, by the controlling office/branches,
the same might not have been implemented. Accordingly, RBI laid down the
following procedure to ensure the implementation of the recommendations:
 A format containing 25 questions was issued to indicate the answer as
either “Implemented” or “Not Implemented”.
 Information received from all branches and ROs/ZOs to be consolidated
at Head Office level and submission of consolidated statement to RBI.
 Implementation of recommendations to be verified during concurrent
audit/inspection of branches/controlling offices and comment on the same
to be included in their report.
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17.41 The report of the Jilani Committee contains twenty five

recommendations which can broadly be divided into three categories, (i)
dealing with the EDP environment in the banks, (ii) dealing with the
inspection/internal audit system in the bank and (iii) dealing with other
miscellaneous aspects of functioning of a bank. The RBI has summarised each
of these recommendations for the purpose of reporting of their implementation
by the banks, in a ‘Implemented’ or ‘not implemented’ format. Some of the
recommendations of Jilani Committee are to be implemented by the banks at
the branch office level, whereas some others are applicable to the
regional/zonal/head office level. However, some recommendations find
applicability at all levels.
Responsibility of the Management
17.42 The RBI, vide its subsequent Circular dated June 28, 2002, issued to
the banks has required the concurrent auditors and inspectors of the bank
branches/controlling offices to verify and comment in their reports as to the
status of implementation of the recommendations of the Ghosh and the Jilani
Committees in the banks.
17.43 In terms of the letters issued to the banks regarding appointment of
the Statutory Central Auditors by the RBI, the Auditors are also required to
verify and comment upon the compliance by the bank in regard to the status of
the implementation of the recommendations of the Ghosh and the Jilani
Committees.
17.44 From the above it is clear that the implementation of the
recommendations of the Ghosh and the Jilani Committees is the responsibility
of the management of the banks. The responsibility of the statutory auditors is
to verify and report on the status of implementation of these recommendations,
thus far and no further. The results of the verification carried out by the
statutory auditor and his/her comments thereon are to be given in a separate
report.
17.45 RBI through its Master Circular No. DBR. No. Dir. BC.11/13.03.00
/2015-16 dated July 01, 2015 on “Guarantees and Co-acceptances” has
required that Banks should implement the following recommendations made by
the Ghosh Committee:
(i) In order to prevent unaccounted issue of guarantees, as well as fake
guarantees, as suggested by IBA, bank guarantees should be issued in
serially numbered security forms.
(ii) While forwarding guarantees, banks should caution the beneficiaries that
they should, in their own interest, verify the genuineness of the guarantee
with the issuing bank.
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17.46 The RBI through Master Circular no. RBI/2015-16/95

DBR.No.Dir.BC.10/13.03.00/2015-16 dated July 1, 2015 on “Loans and
Advances – Statutory and Other Restrictions”. requires that banks should
ensure compliance with the recommendations of the Ghosh Committee and
other internal requirements relating to issue of guarantees to obviate the
possibility of frauds in the areas of issuance of Bank Guarantees in favour of
Financial Institutions, credit facilities extending to bank against the guarantees
issued by other banks/FIs and advancement of Gold (Metal) Loans.
17.47 In this regard, it may be noted that the RBI has also issued Master
Directions No. RBI/DBS/2016-17/28 DBS.CO.CFMC.BC.No.1/23.04.001/2016-
17 dated July 1, 2016 (updated July 03, 2017) on Frauds – Classification and
Reporting by commercial banks and select FIs. These directions deal with
Classification of Frauds, Reporting of Frauds to RBI, Quarterly Returns,
Reports to the Board, Fraud Monitoring Returns, etc. and the Auditor should
verify the compliance of the same.
17.48 The RBI has issued a Master Circular no. RBI/2015-16/100
DBR.No.CID.BC.22/20.16.003/2015-16 dated July 01, 2015 on “Wilful
Defaulters”, which also specifies the role of Auditors including
recommendations about action to be taken against negligent / deficient
Auditors wherein falsification of accounts on the part of borrower is observed.
Further, it specifies that to monitor end-use of funds, if the lenders desire a
specific certification from the borrowers’ Auditors regarding diversion /
siphoning of funds by the borrower, the lender should award a separate
mandate to the Auditors for the purpose. In addition to this, banks are advised
that with a view to ensuring proper end-use of funds and preventing
diversion/siphoning of funds by the borrowers, lenders could consider
engaging their own auditors for such specific certification purpose without
relying on certification given by borrower’s Auditors. However, this cannot
substitute bank’s basic minimum own diligence.
17.49 In order to ensure that directors are correctly identified and in no case,
persons whose names appear to be similar to the names of directors
appearing in the list of willful defaulters, are wrongfully denied credit facilities
on such grounds, banks/FIs have been advised to include the Director
Identification Number (DIN) as one of the fields in the data submitted by them
to RBI/CIC.
17.50 In terms of Para 2.9 of Master Circular on Wilful Defaulters as stated
above, Banks / FIs have already been advised to submit the list of suit-filed
accounts and non-suit filed accounts of wilful defaulters of Rs. 25 lakh and
above on a monthly or more frequent basis to all the four Credit Information
Companies. This would enable such information to be available to the banks /
FIs on a near real time basis.
621
17.51 Further, in terms of RBI Circular no. RBI / 2016-17 / 284 Ref.
DBS.CO.PPD.BC.No.9/11.01.005/2016-17 dated April 20, 2017 on Compliance
with Ghosh Committee Recommendations”, compliance to the Ghosh
Committee recommendation also need not be reported to Audit Committee of
the Board of Directors (ACB). However, banks are advised to ensure that:
i) the compliance to these recommendations is complete and sustained;
and
ii) these recommendations are appropriately factored in the internal
inspection/audit processes of banks and duly documented in their
manual/ instructions, etc.
17.52 The RBI has prescribed separate formats to be filled in by the banks
for reporting on compliance with/ implementation of the recommendations of
the Ghosh and Jilani Committees. The responsibility of the statutory auditors is
to certify the status of compliance with/ implementation of the
recommendations of the Ghosh and Jilani Committees. Accordingly, the
following procedures may be adopted by the statutory auditors of branches as
well as the Statutory Central Auditors for certifying the compliance/
implementation status of the Ghosh and Jilani Committees recommendations.
 In case of the branch, the SBA shall enquire from the management of the
branch whether it has prepared the prescribed report on the
implementation status of the recommendations of the Ghosh and Jilani
Committees. If yes, then whether the same has been forwarded to the
Head Office for necessary action. If no, then the Auditor should obtain
necessary representation from the management as to why the report has
not been prepared and/ or submitted and should appropriately qualify his
report.
 In case of the Head Office, the SCA shall obtain a confirmation from the
management whether it has received the report on the implementation
status of the recommendations of the Ghosh and Jilani Committees from
all the branches, regional/ zonal offices, etc. and also whether it has
prepared the status report as applicable to the Head Office level. The SCA
shall obtain a list of the branches, regional/ zonal offices which have not
submitted the prescribed report. Such a list would help the SCA to have a
broad idea as to the extent of implementation of the recommendations by
the bank as a whole.
 The SCA should obtain and review a copy of the implementation status
report(s) so prepared and submitted. Such a review would help the
Auditors identify areas which are susceptible to fraud/ malpractices. The
622
results of such a review may also require the Auditor to re-consider the
nature, timing and extent of the procedures adopted by him for carrying
out the audit as well as his audit findings.
 In case of Branch audit, where the concerned branch has been subjected
to a concurrent audit, then the report of the concurrent auditor on the
status of implementation of the recommendations of the Ghosh and Jilani
Committees should also be obtained. In case, the branch is not subject to
a concurrent audit, the SBA should enquire whether it had been subjected
to any inspection either by the in-house inspection department or by the
inspectors of the RBI. The Auditor should review the comments, if any, of
the concurrent auditor or such inspectors on the said implementation
status report.
 The SCA may also request the management to provide a list of branches
which had been subjected to a concurrent audit/ inspection by the in-
house inspection department or the inspectors from the RBI. SCA may, if
considered necessary, select some such branches and review the
comments of the concurrent auditors/ inspectors on the status of
implementation of the recommendations. This would help to identify any
common cause of concern among the bank branches.
 Where the status report, as prepared by the management indicates that
any of the recommendations have not been implemented, the SCA/SBA
should request the concerned management to give a written
representation as to why the particular recommendation(s) has/have not
been implemented.
 The SBA/SCA may also consider it necessary to carry out test checks to
ensure whether the recommendations which have been said to have been
implemented in the status report have indeed been implemented by the
management.
17.53 In case, SBA/SCA examination reveals that any of the
recommendations indicated as having been implemented, have in fact not
been implemented by the management, or where there is a failure to comply
with any of the recommendations of the two Committees, would not only
indicate a weakness in the internal control system in the bank but also raise
doubts as to the integrity of the management. The Auditor may, also need to
re-consider the nature, timing and extent of other audit procedures as also the
truth and accuracy of any other management re-presentations obtained by the
auditor.
Certificate / Report
17.54 Based on the work done, the auditor should assess whether any
623
information obtained during the verification indicates that any of the

recommendations of the Ghosh and Jilani Committees have not been
implemented, either in full or in part. The auditor may consider expressing
either disclaimer or appropriate comments in respect of certain clauses such
as Item Nos. 1.1 and 1.11 of Part II of Group A of Ghosh Committee.
17.55 The above-mentioned Certificate should describe the scope of the
verification undertaken to enable the readers to understand the nature of work
performed and make it clear that a full-fledged investigation had not been
undertaken. The certificate of the Auditor should also draw attention to the
following facts:
 That the responsibility for the implementation of the recommendations of
the Ghosh and the Jilani Committees is solely that of the management of
the bank.
 That the Auditor has also considered the reports of all or certain, as the
case may be, concurrent auditors/inspectors of the bank branches on the
status of implementation of the recommendations of the Ghosh and Jilani
Committees at the branch office and controlling offices.
 That the verification was limited primarily to enquiries and obtaining
confirmations from the management and other appropriate persons.
 That the auditor has carried out test checks to assess the status of
implementation of the recommendations of the Ghosh and Jilani
Committees.
17.56 Annexure C to this Chapter provides an illustrative format of the
auditor’s certificate w.r.t. compliance with/ implementation of the
recommendations of the Ghosh and Jilani Committees.
Tax audit
Introduction
17.57 Normally Tax Audit at the branch has a limited scope. Many times the
scope of work is defined by the Head office in its letter of appointment. As most
of the information is available at the Head office, the scope is limited to the
verification process limited to the Branch data and supporting documents
available there. Some of the Banks allot the work to SCAs or to External Audit
firms other than SCAs/SBAs.
17.58 In the following paragraphs, we shall cover only the important matters
relevant at the branch level. Although ,it is expected that the Branch makes full
and correct disclosures in Form 3CD, the branch auditors are expected to
exercise their professional skepticism to confirm whether the disclosures made
by the branch are correct and exhaustive and accordingly giver their report in
Form 3 CA for the branch under audit.
624
Fixed Assets and Depreciation – Clause No. 18 of Form 3CD

17.59 Branch Auditors should verify the Fixed Assets register maintained at
the branch and more specifically the new assets purchased during the year and
its tax invoices. The amount capitalized in the books of the branch, GST input
credit (if any) and proper asset classification in the Block of assets also needs to
be verified. From the last year’s audited return, the opening balances of current
year’s return should be verified block wise. The calculation of depreciation should
be verified in the light of the latest circular or as per closing instructions circular
issued by the Head Office.
General Scrutiny of Expenses/Charges – Clause No. 21 (a) of Form 3CD
17.60 General scrutiny of charges or the Profit and Loss expense heads
should be done to identify any nature of expenses which would be of personal
nature (not related to the business of the Bank and other than contractual
nature), capital or revenue nature. It should also be ensured that if the Branch
has paid any penalty or fine which requires disclosure under the relevant clause
of the Form 3CD, whether it has been done or not.
Non deduction/Non Payment of TDS and General compliance related to
TDS Provisions – Clause 21(b) of Form 3 CD
17.61 General scrutiny of expenses should also be made keeping in mind the
relevant TDS provisions covered under various sections and sub sections of 194
and 195 of the Income tax Act, 1961. Payments made to Non-residents
(including interest payments made to NRE Account holders) interest, contractors,
professionals, property owners, etc. should be verified keeping in mind the TDS
provisions. It should be confirmed whether appropriate tax has been deducted
and paid on various payments made to certain persons. Tax on fixed deposit
interest shall be deducted at source by the system automatically, which also
needs to be checked on a test check basis.
Likewise, compliance with the provisions of Tax collected at Source (TCS) is also
to be ensured by the SBA. Any case of non-compliance with both TDS and TCS
provisions should be reported under the appropriate sub-clause of Form 3CD.
Disallowance under Section 40A(3) read with Rule 6 DD – Clause No. 21(d)
of Form 3CD
17.62 General scrutiny of expenses or charges may also reveal any
disallowance under Section 40A(3) (read with Rule 6 DD) of the Income Tax Act,
1961 if payment of more than Rs. 10,000/- is made otherwise than by way of
account payee cheque or account payee draft. Auditors are expected to make an
appropriate disclosure about the non-availability of evidence under this clause,
apart from any specific case of non-compliance.
625
Payment of Interest to any MSME Supplier – Clause no. 22 of Form 3CD

17.63 Auditors should obtain an appropriate representation from the Branch
management whether it has paid any interest to any of its vendors or suppliers
registered under MSME for delayed payment. Under Section 23 of the Micro,
Small and Medium Enterprises Development Act, 2006. As such interest is
required to be disclosed under this clause and to be claimed disallowed in the
computation of income for the Bank.
GST Compliance with respect to ITC – Clause 27 (a)
17.64 Normally the Bank has got a global GST number and files one
consolidated return at the head office level. For the purpose of claiming the Input
tax credit, it obtains the monthly return about the Input tax credit along with other
details from all its branches and submits a consolidated claim in the return filed
at the head office. Then in such cases Branch Auditor can give a suitable
disclosure.
Prior Period Income/Expenses – Clause 27 (b)
17.65 Branch auditor while doing a general scrutiny of Charges should also
identify any prior period expenditure debited to Branch Profit and Loss account.
Repayment of loan or deposit exceeding the limit specified in Section 269T
– Clause 31 (c) and (d)
17.66 Considering the high volume of transactions at the branch, the Auditor
should obtain suitable management representation from the Branch
Management and make appropriate disclosure in the relevant clause of the tax
audit report.
TDS Compliance – Clause No. 34 (a) to (c).
17.67 This is the most important reporting clause in the Branch tax audit
report. This clause required the auditors to verify and report Section wise details
about the Total expenditure incurred at the branch covered under various
sections:
 194 A- Interest
 194 I – Rent
 194 J – Fees for Professional and Technical Services
 194 C – Payment made to contractors
17.68 The branch expenditure heads are required to be further classified into
the above sections, especially the payments made to contractors are spread in
various expenditure heads at the branch are required to be considered wherever
626
applicable. Similar is the case of fees for Professional and Technical services.
While reporting the amounts in column no. 3 these have to be matched with the
PL heads year-end figures wherever necessary.
17.69 Further, from the total amount from each head above the amount on
which TDS is not applicable due to various reasons are to be excluded to
determine the amount on which the TDS is required to be deducted. From the
balance amount in column 4 where the TDS is required to be deducted again
needs to be classified under following categories:
a) Amounts on which TDS at regular rates is to be made on the above.
b) Amounts on which TDS to be made at concessional rate (based on the
certificates obtained from Income Tax authority) and TDS on above.
c) Amounts on which tax is not deducted (to be matched with disclosure at
Clause No.21 (b) of Form 3CD.
d) Tax Deducted but not paid.
17.70 The accuracy in reporting under this clause is important because, this is
the most voluminous consolidation statement for reporting on the consolidated
tax audit report for the Bank as a whole and if there are any discrepancies in this
particular clause, then regional/zonal/HO consolidation is hampered and
delayed.
17.71 Clause No. 34 (b) and (c) are applicable if the Branch has obtained a
TAN and it is doing its compliance at the Branch level. In such a case the Branch
auditor is also required to verify the position, accuracy and timeliness of filing of
Quarterly ETDS returns filed by the branch and confirm the appropriate
disclosure about the dates of filing, Interest payment and delayed filing fees paid
by the branch. It is better to obtain CONSO files from TRACES and do the
independent consolidation of four quarters and verify the data furnished by the
branch to avoid the delay in verification of voluminous data.
17.72 As most of the points in Form 3CD are required to be verified only at the
head office level, the branch auditors should make appropriate disclosure about
the limitation of its scope Form 3CA submitted along with Form 3CD.
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Annexure A
Illustrative Audit Checklist for Capital Adequacy
The checklist is only illustrative in nature. Members are expected to exercise
their professional judgment while using the check list depending upon facts and
circumstances of each case.
Audit Procedures
CET 1, AT 1 and Tier II
1. Tally the balances in the various elements of

capital from the trial balance/ groupings/ draft
2. Check whether various instruments comply with the
guidelines as laid down in Master Circular by
referring to the Terms of Offer and whether the
same are approved by the Board or other
appropriate committee.
3. Check whether appropriate discounting has been
applied in the case of instruments issued.
4. In case of foreign banks, examine whether the
undertaking has been obtained that the bank would
not remit abroad the funds received and shown as
Capital Reserve or Remittable Surplus.
5. Examine whether various limits up to which
individual elements are to be included in CET1,
AT1 and Tier II capital as laid down in the Master
Circular are adhered to.
6. Verify various deductions with the balances in the
audited accounts and check the same for limits and
eligibility (e.g. securitisation exposure) as laid down
in the Master Circular.
7. Verify the correctness of progressive discount
based on the remaining maturity of instruments
eligible for AT1 and Tier II.
Capital Charge on Credit Risk
The capital charge for credit risk is the sum total of the
capital charge to be maintained in respect of the
628
following:
 On balance sheet items.
 Off balance sheet items.
 Failed transactions.
 NPAs.
 Securitisation transactions.
duly adjusted for haircuts based on the nature of the
collateral.
Risk Weights – On Balance Sheet Items
The risk weights for all on balance sheet items need to

be determined based on the credit ratings assigned by
the rating agencies chosen by the RBI.
1. Reconcile the balances of various advances and

other operating receivables where there is a credit
risk and which are considered for calculation with
the following schedules in the financial statements to
ensure completeness:
 Schedule 6 – Cash and balances with Reserve
Bank of India.
 Schedule 7- Balances with Banks and Money at
Call and Short Notice.
 Schedule 9- Advances.
 Schedule 11(vi) – Other Assets – Others.
2. Review and document the process of compilation
and mapping of the various items on balance sheet
based on the categories and their risk weights
together with the appropriate ratings and / or other
conditions, as applicable.
3. For a sample of transactions verify the ratings with

the letters issued by the rating agencies and
accordingly check the correctness of the risk
weights assigned.
4. In cases where the risk weights are dependent on

the fulfilment of certain conditions (other than
ratings) verify the compliance therewith based on
629
the appropriate documentary evidence (e.g. claims

on banks, regulatory retail portfolio, claims against
residential property etc.).
5. Verify the validity of guarantees issued by Central or
State Government. Verify whether the bank has
properly classified claims on State Government and
claims guaranteed by State Government due to
difference risk weight.
6. Verify the correctness of claims on CGTSI and
ECGC.
7. Verify the classification of loans – restructured loans/
NPAs/ NBFC/ CRE/ CRE-RH etc.
8. Verify LTV ratio on a test check basis in respect of
housing loans.
Risk Weights – Off Balance Sheet Items
The risk weight for all off balance sheet credit

exposures is generally calculated as a two step process
as under, separately for market and non-market related
exposures:
 The notional amount is converted into a credit
equivalent amount by multiplying the amount by the
specified credit conversion factor (for non market
transactions) or by applying the current exposure
method (for market related transactions).
 The resulting credit equivalent amount is multiplied
by the risk weight applicable to the counterparty or
the purpose for which finance is extended or the
type of asset, whichever is higher.
Where the exposure is secured by eligible collateral or
guarantee, the credit risk mitigation guidelines may be
applied.
1. Reconcile the balances of the various off balance

sheet exposures which are considered for
calculation with the financial statements, especially
the schedule of contingent liabilities.
630
2. Review and document the process of compilation

and mapping of the various off balance sheet item
based on the nature of the instruments.
3. For a sample of non-market transactions, check the
calculations of the credit equivalent amount with
specified credit conversion factor based on the
nature of the instrument. Check the necessary
documentation to confirm the nature of the
instrument.
4. For a sample of market related transactions, check
the necessary documentation to confirm the nature
of the contract and accordingly check the
calculations for the current credit exposure and the
potential future exposure.
5. Verify the classification of Financial and
Performance Guarantee by perusing the sample
guarantee issued by the branches.
6. Verify whether bills accepted under Letter of Credit
is assigned 100 per cent risk weight as CCF.
7. Verify whether the bank has proper control for
accounting Buyer’s credit/ Letter of Comfort.
8. Verify the correctness of undrawn exposures.
Capital Charge – Failed Transactions
1. Review and document the procedures for tracking

and monitoring the credit risk exposure arising from
unsettled transactions, both on Delivery Versus
Payment (DVP) and non DVP basis.
2. For a sample of DVP transactions, examine
whether the settlement has taken place on a timely
basis. In case of delays, check the calculation of
the capital charge by multiplying the positive
current exposure by the prescribed factor
depending upon the number of days delayed.
3. For a sample of non-DVP transactions, examine
whether the settlement has taken place as per the
contracted maturity. In case of delays, ascertain
whether any payment made is considered as a
631
loan and the appropriate risk weight is considered.

In case of settlement beyond five days ascertain
whether the full amount is deducted from the
capital.
Risk weights – NPAs
1. Review and document the procedures for

identifying the unsecured portion of NPAs
separately for qualifying residential mortgages and
others.
2. For a sample of residential mortgages which are
NPAs, examine whether they meet with the
qualifying criteria with regard to the LTV ratio and
other factors and accordingly check the assignment
of the risk weight for the unsecured portion
depending upon the level of provisioning.
3. For a sample of NPAs other than residential
mortgages check the assignment of the risk weight
based on the level of provisioning.
4. In respect of 3 above for identifying the secured
portion examine whether only eligible collateral are
considered and the same are properly documented
and the bank has a clear and marketable title to
realise the same.
5. Verify whether bucketing in difference risk weight in
respect of NPAs based on NPA provision is carried
out by the system and verify the correctness of
classification on a test check basis
Capital Charge – Securitisation transactions
Banks are required to hold regulatory capital after

adjusting the prescribed deductions eligible against all
securitisation exposures including those arising from
provision of credit mitigants, investment in asset
backed securities, retention of subordinated tranche
and extension of liquidity facility or credit
enhancement.
Examine whether the securitisation transactions fulfil
the requirements as prescribed in Master Circular on
632
“Prudential Guidelines on Capital Adequacy and Market

Discipline - New Capital Adequacy Framework” (extract
of the ‘Revision to the Guidelines on Securitisation
Transactions’, issued vide circular
DBOD.No.BP.BC.103/ 21.04.177/ 2011-12 dated May
07, 2012on 'Revision to the Guidelines on Securitisation
Transactions') to be eligible for deduction from capital.
1. Based on the above, for a sample of transactions /
deals examine whether the prescribed deduction
from both CET 1, AT I and Tier II capital has been
correctly done based on the rating and the level of
provisions. Review the necessary documentation in
support of the same.
2. Based on the above ascertain whether the
appropriate risk weights have been assigned.
Collateral Risk Management and Credit Risk
Mitigation
The objective of collateral risk management is to

ensure that only the eligible collateral are considered
for netting off which are adjusted for volatility
depending upon the nature of the capital and further
subjected to various types of haircuts for different
categories of mismatches like currency and tenor
mismatches.
1. Review and document the process for collateral
risk management as appropriate and relevant
including but not limited to:
 Ageing reports.
 Confirmation procedures.
 Control of documents.
 Compliance with covenants.
 Audit of collateral by independent agencies.
2. Examine whether the bank has complete legal
rights to enforce the security including specific lien
and is subject to haircuts for residual tenor
mismatch and currency mismatch. Check the
necessary documentation in respect thereof.
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Capital Charge for Market Risk
Capital charge for market risk involves computation of

the capital charge on interest rate related instruments
and equities in the trading book and foreign exchange
risk, including gold and other precious metals.
Accordingly, the following would be covered:
 Securities under the HFT and AFS category.
 Open gold and FX position limits.
 Trading position in derivatives.
 Derivatives entered into for hedging trading book
exposures.
Interest Rate – General Market Risk
The capital requirement for general market risk is the

sum of the following four components:
(i) Net short (only derivatives) or long position in the
trading book.
(ii) Small proportion of matched position for each time
band (vertical disallowance).
(iii) A larger proportion of the matched positions across
different time bands (horizontal disallowance).
(iv) Net change for positions in options where
applicable.
1. Reconcile the balances considered for calculation of
the general interest rate risks trading book positions
with the figures reported in the financial statements.
2. Review and document the process for computation
of the price sensitivity (modified duration) for each
instrument and test check the calculations for a
sample of instruments.
3. Review the process of capturing the above data
into different time bands based on the maturity and
accordingly apply the prescribed change in yield
and check the calculations for the resulting capital
charge and the consequential vertical and
horizontal disallowances.
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Interest Rate – Specific Risk
The specific interest rate capital charge for different

types of debt securities / issuers is prescribed
separately for the following categories:
 Central, State and Foreign government bonds

under HFT and AFS category.
 Banks bonds under HFT and AFS category.
 Corporate bonds and securitised debt under HFT
and AFS category.
1. Reconcile the balances of government securities
under AFS and HFT considered for computation of
specific interest rate capital charge with the financial
statements.
2. Review and document the process of compilation of
data in respect of various types of government
securities under AFS and HFT based on the type of
investment and the residual maturity.
3. For a sample of transactions in respect of the
above, verify the allocation percentage of the
specific risk capital based on the type of investment
and residual maturity based on the verification of the
relevant documentation.
4. Reconcile the balances of bonds issued by banks
under AFS and HFT considered for computation of
specific interest rate capital charge with the financial
statements.
data in respect of various types of bonds issued by
banks held as investments under AFS and HFT
based on the following parameters:
 Level of capital adequacy.
 Nature of the bank (scheduled or non-
scheduled).
 Residual maturity.
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specific risk capital based on the various parameters

based on the verification of the relevant
documentation.
7. Reconcile the balances of corporate bonds and
securitised debt under AFS and HFT considered for
computation of specific interest rate capital charge
with the financial statements.
data in respect of corporate bonds and securitised
debt instruments held as investments under AFS
and HFT based on the following parameters:
 Rating assigned.
 Nature of the investment.
 Residual maturity.
specific risk capital based on the various parameters
based on the verification of the relevant
documentation.
Equity – General and Specific Market Risk
A uniform percentage of 9 per cent is currently attracted

for the gross equity position for both specific and
general risks.
Foreign Exchange and Gold
These currently attract a risk weight of 100 per cent

which is in addition to the capital charge for credit risk
for on and off balance sheet items.
1. Check the computation of the net open position in

each currency as a summation of the following:
 Net spot position.
 Net forward position.
 Guarantees and similar instruments.
 Net future expenses / incomes not yet accrued
but fully hedged.
2. Based on the calculations of the market risk for each
of the above check the computation of the
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aggregate capital charge of market risks.

Interest rate risk
a) General market risk
 Net position
 Horizontal disallowance
 Vertical disallowance
b) Specific market risk
Specific and general market equity risk Foreign
Exchange and gold.
Capital Charge for Exposure to Entities with
Unhedged Foreign Exchange Exposures (UFCE)24
1. Ascertain the amount of the UFCE:

UFCE may exclude items which are effective hedge
against each other viz. financial hedge and natural
hedge (On sample basis, the UFCE considered by
the Bank can be verified with the certificates issued
by the statutory auditor of the borrower entities,
which is usually taken by the Bank from them on a
quarterly/ half yearly basis).
2. Estimate the extent of likely loss.

3. Estimate the riskiness of the unhedged position and
provide appropriately:
Likely Incremental Incremental
Loss/EBID (%) Provisioning Capital
Requirement on Requirement
the total credit
exposures over
and above extant
standard asset
provisioning
Up to15 per
0 0
cent
24 RBI/2013-14/448 DBOD.No.BP.BC. 85 /21.06.200/2013-14 dated January 15, 2014.
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More than 15
per cent and up 20bps 0
to 30 per cent
More than 30
to 50 per cent
More than 50
to 75 per cent
More than 75
80 bps
per cent
Banks should calculate the incremental provisioning

and capital requirements at least on a quarterly basis .
However, during the periods of high USD-INR volatility,
the calculations may be done on a monthly basis.
Capital Charge for Operational Risk
Currently banks are required to maintain capital charge

for operational risk at 15 per cent of the average gross
income for the last three financial years
1. Obtain the computation of the gross total income
and verify the same from the respective years
audited financial statements.
2. Examine whether the various deductions from the
net profit are appropriately considered.
 For computing the gross income for determining the capital to be held
against operational risk, there is a clarification that the same should be
considered based on the average of the last three financial years. However,
there is no clarity as to whether this includes the current financial year
though the better practice would be to consider the average of the
preceding three years.
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Annexure B
Illustrative Format of Covering Report for various
Certificates issued by SBAs
Independent Auditor’s Certificate for various certificates issued during
the Statutory Audit of [Name of the Branch] [Branch Code] of [Name of
the Bank] for the Financial year 2020 – 2021.
1. This Certificate is issued in accordance with the terms of our agreement
dated [date of Engagement Letter].
2. The accompanying Statement contains various certificates issued by us
during the Statutory Audit of [Name of the Branch] [Branch Code] of [Name of
the Bank] for the Financial year 2020 – 2021, listed in Annexure [Name], which
we have initialled for identification purposes only.
Managements’ Responsibility for the Statement
3. The preparation of the accompanying Statement is the responsibility of the
Management of the Bank. This responsibility includes designing, implementing
and maintaining internal control relevant to the preparation and presentation of
the Statement, and applying an appropriate basis of preparation; and making
estimates that are reasonable in the circumstances.
4. The Management is also responsible for ensuring that the (Name of the
Branch) (Branch Code of Bank) (Name of the Bank) complies with the
requirements of the Equity Listing Agreement and for providing all relevant
information to the Securities and Exchange Board of India.
Auditor’s Responsibility
5. Pursuant to the requirements of the various RBI guidelines, our
responsibility is to express reasonable assurance in the form of an opinion
based on our audit and examination of books and records on test check basis,
as to whether the [Name of the Branch] [Branch Code] of [Name of the Bank]
has undertaken only those activities that have been specifically permitted by
the RBI and has complied with the specified terms and conditions.
6. We audited the financial statements of [Name of the Branch] [Branch Code]
of [Name of the Bank] for the Financial year 2020 – 2021, on which we issued
an unmodified audit opinion vide our reports dated [date of Audit Report]. Our
audit of these financial statements was conducted in accordance with the
Standards on Auditing and other applicable authoritative pronouncements
issued by the Institute of Chartered Accountants of India. Those Standards
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement.
639
7. We conducted our examination of the Statements/Certificates given in

Annexure [Name], in accordance with the Guidance Note on Reports or
Certificates for Special Purposes issued by the Institute of Chartered
Accountants of India. The Guidance Note requires that we comply with the
ethical requirements of the Code of Ethics issued by the Institute of Chartered
Accountants of India.
8. We have complied with the relevant applicable requirements of the Standard
on Quality Control (SQC) 1, Quality Control for Firms that Perform Audits and
Reviews of Historical Financial Information, and Other Assurance and Related
Services Engagements.
Opinion
9. Based on our examination as above, and the information and explanations
given to us, we report that the Statement in Annexure [Name] is in agreement
with the books of account and other records of [Name of the Branch] [Branch
Code] of [Name of the Bank] for the Financial year 2020 – 2021 as produced to
us for our examination, and the information thereof is prepared, in all material
respects, in accordance with the applicable criteria.
Restriction on Use
10. This certificate has been prepared at the request of the [Name of the
Branch] [Branch Code] of [Name of the Bank] solely with reference to our
appointment letter, for the purpose of onward compilation of various certificates
and disclosure requirements for [Name of the Bank] as a whole. It should not
be used by any other person or for any other purpose. Accordingly, we do not
accept or assume any liability or any duty of care or for any other purpose or to
any other party to whom it is shown or into whose hands it may come without
our prior consent in writing.
For
Firm’s Registration Number:
Partner / Proprietor
Membership Number:
UDIN
Place:
Date:
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Annexure C
Illustrative Format of Certificate w.r.t. Compliance/
Implementation Status of the Recommendations of the
Ghosh and Jilani Committees
We have examined the attached Format of compliance/ implementation by
_____________ (name of bank/ bank branch/Department/Zonal Office) with
the recommendations of the Ghosh Committee relating to Frauds and
Malpractices in Banks and Format of Progress in Implementation of Jilani
Committee recommendations, as prepared by the management. The
responsibility for compliance with/ implementation of the recommendations of
the Ghosh and the Jilani Committees is that of the management of the
___________ (name of the bank/ bank branch/Department/Zonal Office). Our
responsibility is to examine the report on the status of compliance therewith as
contained in the attached Formats, as prepared by the management, thus far
and no further.
We have not carried out an investigation into the status of compliance by/
implementation of the management with the recommendations of the Ghosh
and Jilani Committees. Our examination is limited to inquiries and obtaining
confirmations from the management and other appropriate persons and test
checks of the attached status of recommendations.
Based on our above examination, subject to the matter highlighted below, we
certify that to the best of our knowledge and belief and according to the
information and explanation given to us and as shown by the records
examined by us, the attached Formats of compliance with the
recommendations of the Ghosh and Jilani Committees, as prepared by the
management is correct.
1. ………………………
2. ……………………….
Date: For and on behalf of
Place:
(Firm Registration No.)
………………………………..
(Name and Designation)
(Membership Number)
UDIN
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18
Gold / Bullion / Security Items
18.01 The Reserve Bank of India has discontinued the Gold/ Bullion sale at
bank branches. RBI designates certain Banks every year for the purpose of
importing Gold and selling it onward to customers. Besides some Banks sell
retail Gold coins of a specific purity in specific denominations to their customers.
18.02 In such cases, the Auditor should ensure that:
1) Gold coins are stored properly in fire proof safe custody.
2) Insurance cover is obtained.
3) Stock records are properly maintained showing receipts, sales and closing
stock.
4) Activity of verification and balancing of stocks is carried out on daily basis.
5) Sales / transfers within branches are made at prices determined by a
systematic central driven process.
6) Proper entries are made in the books.
7) Tax payments if any including billing of invoices is carried out properly.
18.03 The Auditor should duly verify the process and report discrepancies, if
any. Escalations could be made depending on the gravity of the issue.
Appropriate reporting could be made in the LFAR as follows:
a) Does the system ensure that gold/bullion are in the effective joint custody of
two or more officials, as per the instructions of the controlling authorities of
the bank?
The Auditor needs to take the details of the name and designation of the
people who have joint custody of the same. The same needs to be verified
as per the system laid down and the exceptions if any should be reported.
b) Does the branch maintain adequate records for receipt, issues and
balances of gold/bullion and updated these regularly? Does the periodic
verification reveal any excess/shortage of stocks as compared to book
records and the discrepancies observed have been promptly reported to
the controlling authorities of the bank?
The records maintained in this regard should be verified by the Auditors.
The details of discrepancies noticed and the reporting to the controlling
authorities should be taken and delays if any should be reported.
c) Does the system of the Bank ensure adequate internal control over issue
and custody of security items (Term Deposit Receipts, Drafts, Pay Orders,
cheque Books, Traveller's Cheques, Gift Cheques, etc.)? Whether the
system is being followed by the branch? Have you come across cases of
missing/lost items? For the purpose of review of compliance for this Audit
area the Auditor may consider the following points.
 The Head Office instructions should be reviewed for existence of
internal control.
 Carry out the physical verification of security items including stamps.
 Review whether lost security items have been promptly reported to the
Controlling Authority.
 Review the accounting treatment of Stationery items in financials.
Different banks follow different policies w.r.t. valuation and accounting
of Stationery and stamps.
 Comment on the usage of security items during the year and the stock
of such items vis a vis usage.
 Report lacunas observed in the system at the branch as this is a fraud
prone area.
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19
Books and Records
19.01 With respect to review and reporting of Books and Records, Branch
auditors are required to report on the following points in the Long Form Audit
Report.
a) Whether there are any software / systems (manual or otherwise) used at
the branch which are not integrated with the CBS? If yes, give details
thereof:
 At present, all the banks have implemented the core banking system.
The Auditor should report the system implemented at bank.
 The Auditor should also compile and review the details of other soft
wares deployed by the bank.
 The reporting requirement in LFAR expects Auditor to report the soft
wares which are not integrated with CBS. There can be numerous soft
wares implemented by the banks. However, the Auditor should review
the soft wares which have an impact on the financial transactions,
reporting or any core activity which have not been integrated and
report accordingly.
 For instance, whether the SWIFT System, Structured Financial
Messaging System (SMFS), System for Lockers etc. have been
integrated with CBS and if so, what is the degree / percentage of
integration of such system with CBS is required to be reviewed and
commented upon.
 The requirement of reporting of soft wares / systems not integrated
with CBS require in-depth review of all systems in place. Moreover, the
auditor should also review the activities carried out manually at branch
viz. compilation of details for various reporting, etc.
b) (i) In case the branch has been subjected to IS Audit whether there are any
adverse features reported and have a direct or indirect bearing on the
branch accounts and are pending compliance? If yes give details.
 The branch auditor should seek a confirmation from Branch
Management for IS Audit carried out at branch. If any IS Audit is
carried out at branch, the Branch Auditor should seek the copy of the
report.
 The issues reported by IS Auditor should be reviewed from two

important aspects viz. i) Impact of Issue identified on Branch Books
and ii) Compliance status of the issue. All the pending items with status
thereof should be reported.
 Necessary explanations (wherever required) should be obtained on
issues reported by IS Auditor.
(ii) Whether branch is generating, and verifying exception reports at the
periodicity as prescribed by the bank.
 Each bank has a system of generation of various exception reports at
the prescribed intervals. The Branch Auditor should obtain the list of
exception reports prescribed by bank along with its periodicity for
review.
 The auditor on sample basis should verify whether the branch has
followed the instructions issued by Bank w.r.t. generation and
verification of exception reports.
 The exception reports contain various types of transactions. Review of
such transaction on sample basis will help the Auditor in ascertaining
the nature of the transactions and risk involved.
iii) Whether the system of bank warrants expeditious compliance of daily
exception reports and whether there are any major observations pending
such compliance at the year end.
 The branch auditor should review whether exception reports which are
required to be generated, reviewed and commented upon on daily
basis have been complied with.
 Are there any issues which have not been complied / marked as
pending compliance? If so, the status of the same should be obtained.
All the critical items should be reported with status thereof.
iv) Whether the bank has laid down procedures for manual intervention to
system generated data and proper authentication of the related
transactions arising there from along with proper audit trail of manual
intervention has been obtained.
 The branch auditor should obtain instructions issued by the bank for
process to be followed when system generated data is manually
altered.
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 In case such instructions have not been issued, the same should be
commented upon.
 Moreover, the auditor should also review the cases wherein the system
data, report, reporting, etc. have been manually altered. However,
identification of such case is a complex process. The branch auditor
should identify the reporting requirement and should review the system
on sample basis to ascertain the authenticity of data.
 There have been instances of manual updation of Interest Rate /
refund of excess interest by debiting revenue / expenditure account.
Such transaction should also be reviewed from manual intervention
perspective.
v) Furnish your comments on data integrity (including data entry, checking
correctness / integrity of data, no back ended strategies etc.) which is used
for MIS at HO / CO level.
 Data integrity aspect is generally handled at Data Administration level
i.e. at Head Office / Corporate Office. Branches do not have any role to
play in this aspect. However, the data entry being done at branch level
which is used for MIS at HO / CO level needs to be reviewed at branch
level. The Auditor should carry out test check to verify that the data
being entered at branch level is done properly and there is proper
maker checker principle for verification of the same.
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20
Inter Branch/Office Accounts
A. Introduction and Bank Process

20.01 Office accounts are mostly used for internal business transactions of
banks or transactions to facilitate movement of funds in a flow of transaction.
Banks have large number of transactions involving substantial sums with the
other banks, branches and controlling office or other business establishments
and hence such transactions are carried out through office accounts. Therefore,
it becomes very important to monitor the same. It is the responsibility of the bank
to reconcile their transactions on a daily basis and keep a track on un-reconciled
transactions.
20.02 Following are the major transactions which occur between branches
and Head office through inter-office accounts:
a. Issue of remittance instruments like drafts/TTs/MTs on other branches.
b. Payment of remittance instruments like drafts/TTs/MTs drawn by other
branches.
c. Payment to / receipts from other branches of the proceeds of instruments
received/sent for collection /realization/clearing.
d. Cash sent to/received from other branches.
e. Payment of instruments like gift cheques/ banker’s cheques/ interest
warrants/ dividend warrants/repurchase warrants/refund warrants /
traveller’s cheques, etc.
f. Profit/loss transferred by the branch to head office.
g. Government receipts and payments handled by the banks.
h. Operations by the authorised branches on the bank’s NOSTRO accounts
through the Treasury/ International Banking Division.
i. Foreign exchange transactions entered into by the branch for which it has
to deal with the nodal forex department of the bank for exchange of rupees
with foreign currency.
j. Deposits into and withdrawal of money, by branches into currency chest
maintained by another branch.
k. Transactions through NEFT, RTGS, NACH, UPI, etc.

l. ATM transactions of the customer either at ATMs linked with other banks or
branches or with merchant establishments.
m. Internet based transactions.
n. Credit card related transactions of the customers.
o. Control Accounts of Indian Branches maintained with Overseas Branches
of the bank.
p. Capital Funds with the Overseas Branches.
q. Head Office balances with the overseas branches including subordinated
debt lent to the overseas branches.
r. GST transactions of Bank branches within a zone and Zonal or Head office.
s. TDS of the branches is deposited by the central office.
t. Parking of subsidies received from Government under various schemes.
u. Head Office, ‘Bad debts written off’ account.
20.03 In respect of CBS, office accounts are bifurcated between accounts
which mandatorily require the bank to enter a reference number while passing
entry (pointing) and accounts which do not have such mandate (non-pointing). In
respect of pointing accounts, reconciliation is easier as the entries can be
knocked off based on reference number and each outstanding entry constituting
outstanding balance at reporting date can be identified. In case of non-pointing,
reconciliation require manual intervention and tracking due to non-availability of
unique reference number.
20.04 The branch writes off the loan balance due to OTS or otherwise and
credit the balance of loan account and debit to Head Office bad debts written off
account. The same is transferred to head office after due approval of the
competent authority.
20.05 The Auditors should verify the balance in this head and should seek
explanation why the balance is not transferred to head office.
20.06 GST is normally centralised in banks but the entry of input is generated
by the branch. The auditor should verify the expense voucher to ensure that no
blocked credit is claimed by the branches and all eligible credit is claimed. The
entry of reverse charge may also be examined.
20.07 In CBS most of the above mentioned transactions are automatically
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executed by the system. Hence only where there is manual intervention these
are to be monitored.
20.08 Following are the most common types of errors observed in the office
accounts:
 Recording of particulars in incorrect fields.
 Posting of transactions in incorrect office accounts.
 Errors in writing the amounts.
 Recording the same transaction twice.
 Squaring off the transaction by same amount without checking the
transactions.
 Merging of branches two branches into one and data is migrated to another
branch but in absence of reference of original entry, the transaction is not
matched by the system.
Forced matched transactions
20.09 The RBI has issued a letter to all Banks regarding certain objectionable
practises observed by RBI in respect of office accounts. RBI has also instructed
the Banks to conduct a comprehensive audit of office accounts and place the
same before Audit Committee.
 Disguising cash transaction of customer to avoid AML reporting and
bypassing CTR/STR reporting of the same.
 Disbursal of loan or repayment of loan through office account General
Ledger resulting in misuse of funds and window dressing.
 No mandatory requirement of keying in reference number in case of
pointing accounts.
 Opening of saving and current account and funds movement thereon
misused and routed through office accounts.
 Crediting a dummy entry by debiting the office account to the credit of
borrowers account and then debiting so as to maintain the “standard” status
of borrower or to prevent from becoming NPA.
 Netting off liability related GLs with debit balances with credit balances in
other GLs resulting in disclosing net outstanding in Financials of the Bank.
 Many income accounts do not have debit freeze or reference id for
reversing charges.
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B. Audit Approach
20.10 Office accounts have been a very sensitive area and can prove to be
problematic or prone to errors and frauds. The Auditor should review the system
of operation for such sensitive accounts. Several times it has been observed that
there are old entries in such accounts due to migration issues. The auditor
should check thoroughly the details of such entries with their ageing and also the
improvement in settlement of the entries on a periodic basis by the bank
including its reporting to the appropriate higher authorities at regular intervals.
 Every bank has its own procedures and methodology for office accounts
transactions and hence it is very important for the Auditor to understand the
procedure followed by the bank for recording the same.
 Every office account is opened for specific purpose and hence the Auditor
on sample basis should review the transactions in office accounts to verify
whether the transactions in accounts are matching with the purpose of
account.
 Normally as part of MIS reporting, branches report only Ageing analysis of
the outstanding balances of office accounts; however the Auditor should
verify whether there are any entries near to reporting date where second
effect is to either office accounts or borrower account especially overdue
account. In former scenario, the Branch is avoiding long pending entry in
office account by transferring to other office account and in later, the branch
is trying to avoid classifying an account as NPA.
 The RBI has directed banks to carry out comprehensive audit to ensure that
internal accounts are not allowed to be used unauthorized and proper
checks are exercised before opening any such account, including
adherence to the delegated power.
 Banks have to make 100 per cent provision against the net debit balance
arising out of the un-reconciled entries outstanding for more than six
months in the inter-branch account, from the year ending March 31st, 2004
vide RBI circular no. DBOD No. BP.BC. 73 /21.04.018/2002-03 dated 26th
February, 2003 on “Inter-branch Accounts- Provisioning for net debit
balance”.
 In terms of the RBI Circular, from 1st April 1999, banks should maintain
category wise/Head wise accounts of various types of transactions under
inter branch accounts, if any and the netting off the transactions should be
done on category wise, hence the net debit in one category is not to be set-
off against net credit in another category.
650
 Banks have been advised by RBI to segregate the credit entries

outstanding for more than five years in inter-branch accounts and transfer
them to a separate blocked account which should be shown in the balance
sheet under the head ‘Other liabilities and provisions–Others’ (Schedule 5).
While arriving at the net amount of inter-branch transactions for inclusion in
the balance sheet, the aggregate amount of Blocked Account should be
excluded and only the amount representing the remaining credit entries
should be netted against debit entries. Banks have been advised that any
adjustment from the Blocked Account should be permitted only with the
authorisation of two officials, one of whom should be from outside the
branch concerned, preferably from the controlling/head office if the amount
exceeds Rs.1 lakh.
 There are some transactions like dividend warrant, interest warrant, refund
order etc. which required special attention because in the recent past
number of transactions have been reported by the banks in these groups.
In these transactions the funds are deposited at one branch and payments
take place at other branches. Hence to prevent the frauds outstanding
balances of these accounts should be checked with professional
skepticism.
 The Auditor should review all material transactions accounted in office
accounts just before the year end and where required, request the bank
management to rectify the same by accounting in the correct account head.
 The Auditor should cautiously review all material transactions outstanding
in office accounts even if it is outstanding for more than 6 months for which
100 per cent provision is made.
 The Auditor should check all adjustments in the office accounts and ensure
that the adjustments are done properly and supported by adequate
documentary evidence as to its validity. The Auditor should also verify that
the reversal entries are made under proper authority and after due
explanation and evidence.
 The Auditor should report on the year end status of office accounts
indicating the dates up to which all or any segments of accounts have been
reconciled. The Auditor should also indicate the number and amount of
outstanding entries in the inter branch accounts, giving the relevant
information separately for debit and credit entries. The Auditor can obtain
the relevant information primarily from branch audit reports.
 Nostro Accounts at branch - Branches should also prepare reconciliation
statement (REC) relating to those accounts for each of the Foreign Offices
or Foreign Correspondents, as the case may be for examination by SBAs.
651
 In respect to subsidy cases, the Auditor may verify that the credit to loan
account is not treated as recovery of interest and principal and NPA
accounts are not correctly identified. The banks may be advised in case of
back end subsidy accounts, instead of opening Subsidy term loan, teaser
rate of interest may be fixed in the term loan account of the borrower and
subsidy may be credited after the expiry of Lock in period.
 Also, the Auditor may review jottings/listing of Current / Savings Bank
account to check whether any account is opened with Generic Name/
Branch Address/ Bank Address/ Bank PAN, etc. If such account is identified
then the Auditor should verify the purpose of opening the account and
thoroughly review the transactions in the account. Also report about
existence of such account and transactions in the same in LFAR.
20.11 In CBS environment, in case of inter branch transactions the inter
branch account is automatically debited or credited by the system. An example of
the same is as under:
If person A having savings bank account in X branch withdraws cash from Y
branch. In such scenario, the following entries are passed:
In the Books of Branch Y In the Books of Branch X
Inter Sol/ Branch A/c (Branch Y)…. Dr ‘A’ savings bank A/c Dr
To Cash To Inter Sol/ Branch (Branch X) A/c
At day end the balance in Inter Sol / Branch A/c for Bank as a whole should be
Nil. The Statutory Central Auditor should verify the same.
C. Reporting
20.12 The Auditor needs to verify the following:
 Whether the bank has an effective system of office accounts w.r.t. each
type of entries?
 Whether the bank has requisite audit trail w.r.t. reconciled entries?
 Age-wise analysis of unreconciled entries for each type of entry covered
under office accounts, as on balance sheet date along with subsequent
clearance, thereof if any.
 Whether the bank has a defined procedure for auto and forced matching
of entries should be commented upon?
 Whether there are any unusual entries observed in the reconciliation
process?
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 Whether the bank has made adequate provision w.r.t. unreconciled entries
as per the RBI guidelines and to the satisfaction of the Auditor?
 Suggest for improvement in existing system related to inter-branch
reconciliation.
For LFAR purposes the Auditor needs to comment on Inter-Branch
Accounts
20.13 Does the branch expeditiously comply with/ respond to the
communications from the designated cell/ Head Office as regards unmatched
transactions? As at the year-end are there any unresponded/ uncomplied
queries or communications beyond 7 days? If so, give details?
 Now a day’s CBS is implemented and hence the question of reconciliation
of Inter – Branch Accounts does not arise at the Branch.
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21
Fraud
Introduction
Definitions of Fraud
21.01 The term ‘fraud’ has been defined in several statutes:
 Indian Contract Act, 1872: As per section 17, "Fraud" means and includes
any of the following acts committed by a party to a contract, or with his
connivance, or by his agents, with intent to deceive another party thereto or
his agent, or to induce him to enter into the contract:-
(1) the suggestion, as a fact, of that which is not true, by one who does
not believe it to be true;
(2) the active concealment of a fact by one having knowledge or belief of
the fact;
(3) a promise made without any intention of performing it;
(4) any other act fitted to deceive;
(5) any such act or omission as the law specially declares to be
fraudulent.
Explanation.—Mere silence as to facts likely to affect the willingness of a
person to enter into a contract is not fraud, unless the circumstances of the
case are such that, regard being had to them, it is the duty of the person
keeping silence to speak, or unless his silence is, in itself, equivalent to
speech.
 Companies Act, 2013: As per Section 447, “Fraud” in relation to the affairs
of a company or any body corporate, includes any act, omission,
concealment of any fact, or, abuse of position committed by any person or
any other person with the connivance in any manner, with intent to deceive,
to gain undue advantage from, or to injure the interests of, the company or
its shareholders or its Creditors or any other person, whether or not there is
any wrongful gain, or any wrongful loss.
 The Reserve Bank of India has defined the term “fraud” in its guidelines
on frauds as under.
“A deliberate act of omission or commission by any person, carried out in
the course of a banking transaction or in the books of accounts maintained

manually or under computer system in banks, resulting into wrongful gain to
any person for a temporary period or otherwise, with or without any
monetary loss to the bank”.
 Standard on Auditing 240 issued by ICAI defines Fraud thus: – “An
intentional act by one or more individuals among management, those
charged with governance, employees, or third parties, involving the use of
deception to obtain an unjust or illegal advantage.”
Classification of Frauds
21.02 In order to have uniformity in reporting, frauds have been classified as
under, based mainly on the provisions of the Indian Penal Code:
a. Misappropriation and criminal breach of trust.
b. Fraudulent encashment through forged instruments, manipulation of books
of account or through fictitious accounts and conversion of property.
c. Unauthorised credit facilities extended for reward or for illegal gratification.
d. Cash shortages.
e. Cheating and forgery.
f. Fraudulent transactions involving foreign exchange.
g. Any other type of fraud not coming under the specific heads as above.
As regards cases under (d) and (f) above cash shortages resulting from
negligence and fraudulent forex transactions involving irregularities / violation of
regulations have also to be reported as fraud if the intention to cheat/defraud is
suspected or proved. Notwithstanding the above, the following cases shall be
treated as fraud and reported accordingly:
a. on the day of occurrence by the persons handling cash cases of cash
shortage more than Rs. 10,000/-, (including at ATMs); and
b. cases of cash shortage more than Rs. 5,000/- if detected by management /
auditor/ inspecting officer and not reported.
Types of Fraud in Banking System
21.03 There are numerous ways in which banking frauds are committed. The
frauds committed in banking system can be classified under different types,
based on the historical data available. Some examples of banking frauds are as
under:
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 Account opening fraud: This involves an account being opened with

either fake or original KYC documents with an intent to depositing and
cashing of fraudulent cheques/ instruments.
 Cheque kiting: It is the method where by a depositor utilizes the time
required for cheques (which is issued from an account having insufficient
funds) to clear, to obtain an unauthorized loan with or without any interest
charge.
 Cheque fraud: It is the most common method where frauds are committed
through stolen cheques and forged signatures.
 Counterfeit securities: In this type of fraud, forged, duplicated or
tampered documents, securities, bonds and certificates are presented as
security for availing loan.
 Digital fraud: Under this type of fraud, the fraudster resorts to hacking,
tampering to gain unauthorised access to siphon off or misappropriate
funds.
 Loan fraud: This type of fraud is committed by lending funds to a non-
borrowing customer or allowing a borrowing customer to exceed his credit
limit, without adequate sanction / authority.
 Money laundering fraud: This type of fraud is committed by concealing
the existence, source or use of illegally obtained money, by converting the
cash into untraceable transactions in banks.
 Letters of Credit: This type of fraud is most common in international trade
but has been observed in domestic trade also. In respect of international
trade, these instruments used in cross borders transactions with underlying
trade documents which are forged, altered, adjusted and take longer to
identify ultimate destiny of merchandise. In respect of domestic trade these
instruments are used to convert non funded facility into cash in purported
trade transactions. Cash generated through such transactions is diverted or
misappropriated out of system.
 Advanced Fees Fraud: This is popularly also known as “419 scam‟.
Advanced fees fraud may involve agent with an offer of a lucrative business
proposition / promise to make substantial funds available against advance
fee or series of advance fees.
Early Warning Signals
21.04 Early Warning Signals (EWS) are those, which when noticed in any loan
account, should alert the bank officials about some wrong doings in the loan
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accounts which may turn out to be fraudulent. An illustrative list of some EWS as
per Master Directions on Frauds – Classification and Reporting by commercial
banks and select FIs (RBI/DBS/2016-17/28 DBS.CO.CFMC.BC.No.1/
23.04.001/2016-17) (updated as on July 3, 2017) are as follows:
1. a) Default in undisputed payment to the statutory bodies as declared in the
Annual report.
b) Bouncing of high value cheques.
2. Frequent change in the scope of the project to be undertaken by the
borrower.
3. Foreign bills remaining outstanding with the bank for a long time and
tendency for bills to remain overdue.
4. Delay observed in payment of outstanding dues.
5. Frequent invocation of BGs and devolvement of LCs.
6. Under insured or over insured inventory.
7. Invoices devoid of TAN and other details.
8. Dispute on title of collateral securities.
9. Funds coming from other banks to liquidate the outstanding loan amount
unless in normal course.
10. In merchanting trade, import leg not revealed to the bank.
11. Request received from the borrower to postpone the inspection of the
godown for flimsy reasons.
12. Funding of the interest by sanctioning additional facilities.
13. Exclusive collateral charged to a number of lenders without NOC of existing
charge holders.
14. Concealment of certain vital documents like master agreement, insurance
coverage.
15. Floating front / associate companies by investing borrowed money.
16. Critical issues highlighted in the stock audit report.
17. Liabilities appearing in ROC search report, not reported by the borrower in
its annual report.
18. Frequent request for general purpose loans.
19. Frequent ad hoc sanctions.
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20. Not routing of sales proceeds through consortium/ member bank/ lenders to
the company.
21. LCs issued for local trade/ related party transactions without underlying
trade transaction.
22. High value RTGS payment to unrelated parties.
23. Heavy cash withdrawal in loan accounts.
24. Non production of original bills for verification upon request.
25. Significant movements in inventory, disproportionately differing vis-a-vis
change in the turnover.
26. Significant movements in receivables, disproportionately differing vis-à-vis
change in the turnover and/or increase in ageing of the receivables.
27. Disproportionate change in other current assets.
28. Significant increase in working capital borrowing as percentage of turnover.
29. Increase in Fixed Assets, without corresponding increase in long term
sources (when project is implemented).
30. Increase in borrowings, despite huge cash and cash equivalents in the
borrower's balance sheet.
31. Frequent change in accounting period and/or accounting policies.
32. Costing of the project which is in wide variance with standard cost of
installation of the project.
33. Claims not acknowledged as debt high.
34. Substantial increase in unbilled revenue year after year.
35. Large number of transactions with inter-connected companies and large
outstanding from such companies.
36. Substantial related party transactions.
37. Material discrepancies in the annual report.
38. Significant inconsistencies within the annual report (between various
sections).
39. Poor disclosure of materially adverse information and no qualification by the
statutory auditors.
40. Raid by Income tax /sales tax/ central excise duty officials.
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41. Significant reduction in the stake of promoter /director or increase in the

encumbered shares of promoter/director.
42. Resignation of the key personnel and frequent changes in the
management.
Banks may choose to adopt or adapt the relevant signals from this list and also
include other alerts/signals based on their experience, client profile and business
models.
Expectations of Regulator
21.05 Central Fraud Monitoring Cell (CFMC) of RBI has analysed statistics of
reported frauds in the banking system during the period FYs 2014 to 2018.
Based on the said analysis some of the points worth noting are as under:
 There has been increasing trend in terms of number of frauds reported on
both counts volume and value.
 About 90 per cent of the frauds in terms of value involved have happened
in credit portfolio.
 Out of the frauds reported in FY 2018, frauds involving amount above Rs.
50 crores accounted for 80 per cent of total frauds reported.
21.06 The identified factors facilitating fraud are as under:
 Opening current account with banks outside consortium without the No
Objection Certificate from lenders.
 Deficient and fraudulent services/certificates by Third Party Entities (TPEs).
 Diversion of funds by the borrowers through various means including
through associated / shell / front-end companies.
 Lapses in credit underwriting standards.
 Failure to identify the Early Warning Signals (EWS) of incipient frauds.
21.07 It is expected that while conducting bank branch audit the Auditor
should plan and perform the audit to obtain reasonable assurance with respect to
existence and effectiveness of fraud identification and reporting framework laid
down as per Master Directions on Frauds – Classification and Reporting by
commercial banks and select FIs RBI/DBS/2016-17/28 DBS.CO.CFMC.BC.No.1/
23.04.001/ 2016-17 (Updated as on July 03, 2017) and Master Circular on Wilful
Defaulters RBI/2015-16/100 DBR.No.CID.BC.22/ 20.16.003/2015-16 issued on
July 1, 2015.
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Role and Responsibility of the Auditor

21.08 Branch Auditor’s primary objective is to opine on true and fair view of
branch financial statements. The audit process needs to confirm compliance with
standards on auditing issued by the Institute of Chartered Accountants of India
(ICAI). Specific to the area concerning fraud, as laid down in SA 240, the Auditor
has responsibility to plan and perform the audit to obtain reasonable assurance
as to whether the financial statements taken as a whole are free of material
misstatement, whether caused by error or fraud. SA 240 requires auditor to
perform procedures with an objective to:
 identify and assess the risks of material misstatement in the financial
statements due to fraud;
 obtain sufficient appropriate audit evidence about the assessed risks of
material misstatement due to fraud, through designing and implementing
appropriate responses; and
 respond appropriately to identified or suspected fraud.
21.09 While reporting on fraud in LFAR, the Statutory Branch Auditor has to
provide appropriate responses to identified or suspected fraud.
21.10 Further, RBI circular. DBS.FGV(F) No.BC.15/23.08.001/2002-2003 has
mandated that all Statutory, Internal and concurrent auditors appointed by the
bank have “to specifically report, simultaneously, to the Chief Executive Officer of
the bank and Central Office of the Department of Banking Supervision, RBI,
Mumbai, any matter susceptible to be fraud or fraudulent activity or any foul play
in any transactions.” Further instances of fraud or fraudulent activity where the
amount involved is Rs. 100 lakhs or above should be reported to the Reserve
Bank of India, Department of Banking Supervision, Central Office, Mumbai and
all other instances should be reported to Regional office of the Reserve Bank of
India, Department of Banking Supervision under whose jurisdiction the Head
Office of the bank falls.
21.11 Suggested audit approach and procedures to be performed are as
follows:
 Based on review of advances consider whether the branch is having an
effective credit monitoring for its advances portfolio.
 Obtain internal circulars of the bank pertaining to fraud identification and
reporting.
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 Examine whether the branch has an adequate system in place to identify

Early Warning Signals (EWS) of incipient sickness / fraudulent activities in
respect of loans within shortest possible time.
 Obtain and review reports of internal auditor, concurrent auditor, internal
inspector, revenue audit, system audit and vigilance functions and assess
existence of any of the early warning signals (EWS).
 If any of the aforesaid reports are pointing out existence of early warning
signals in any of the accounts, conduct further enquiries with the branch to
assess the branch has taken appropriate action and current status thereof.
 Enquire about any fraud reported to Controlling Authority/vigilance
department, Head Office during the financial year and current status
thereof.
 Whether frauds are examined from staff angle and, wherever necessary,
the cases are reported to the Vigilance Cell for further action.
 Whether preventive/punitive steps have been taken by the bank during the
year to reduce/minimise the incidence of frauds.
 Whether frauds have taken place because of laxity in following the systems
and procedures and, if so, whether effective action has been taken to
ensure that the systems and procedures are scrupulously followed by the
staff concerned.
 Whether frauds are reported to local Police or CBI, as the case may be, for
investigation, as per the guidelines issued in this regard to public sector
banks by Government of India.
 Review the analysis of frauds according to different categories detailed in
Paragraph 2.2.1 of Master Directions on frauds and also the different
business areas.
 Review and analyse modus operandi of major frauds reported during the
year along with their present position.
 Whether adequate provision for fraud has been done.
 Based on the audit procedures carried out, provide your suggestions.
Reporting
21.12 Though the objective of the statutory auditor is not to find out fraud /
fraudulent activity or its possibility, it would be advisable for the statutory auditor
to assess the existence and effectiveness of fraud risk mitigating and avoidance
framework and controls implemented by the auditee bank.
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Main report
21.13 Branch auditor needs to consider the impact of his observations made
in respect of fraud on overall presentation of financial statements of the bank
while opining on these financial statements.
LFAR
21.14 The branch auditor needs to report the particulars of frauds discovered
during the year under audit. The Auditor is also required to provide his
suggestions based on his audit to minimise the possibilities of their occurrence.
The Auditors has to furnish particulars of: :
(i) Frauds detected/classified but confirmation
of reporting to RBI not available on record at
branch.
(ii) Whether any suspected or likely fraud cases :
are reported by branch to higher office during
the year? If yes, provide the details thereof
related to status of investigation.
(iii) In respect of fraud, based on your overall :
observation, please provide your comments
on the potential risk areas which might lead
to perpetuation of fraud (e.g. falsification of
accounts/false representation by the
borrower; misappropriation of funds
especially through related party/ shell
company transactions; forgery and
fabrication of financial documents like
invoices, debtor lists, stock statements, trade
credit documents, shipping bills, work orders
and encumbrance certificates and avail
credit; Use of current accounts outside
consortium where Trust and Retention
Account (TRA) is maintained, to divert funds;
List of Debtors/ Creditors were being
fabricated and receivables were not followed
up/ write off of debt of related parties; Fake
export/shipping bill, etc.; Over statement of
invoice amount, stock statements, shipping
bills, turnover; fly by night operations -
including the cases where vendors, related/
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associate parties, manufacturing units etc.

aren’t available on the registered addresses;
Round Tripping of funds, etc.)
(iv) Whether the system of Early Warning

Framework is working effectively and, as
required, the early warning signals form the
basis for classifying an account as RFA.
Relevant circulars
1. RBI Master Circular No. RBI/2015-16/100 DBR.No.CID.BC.22/20.16.003/
2015-16 dated July 01, 2015 on “Wilful Defaulters”.
2. RBI Master Direction no. RBI/DBS 2016-17/28 DBS.CO.CFMC.
BC.No.1/23.04.001/2016-17 dated July 01, 2016 (Updated as on July 03,
2017) on Fraud – Classification and Reporting by commercial banks and
selected FIs.
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22
Miscellaneous
22.01 The Long Form Audit Report (LFAR) mentions a separate clause titled
“Miscellaneous” wherein the Auditors are required to provide their specific
comments on the relevant questions. The LFAR is a detailed questionnaire on
several of the key aspects which the Branch auditor has to reply for the perusal
of the Bank Management. Miscellaneous includes a residuary clause wherein the
branch auditor can specify his observations on any of the areas of the Branch,
which he feels necessary to be highlighted for the specific attention of the
Management and SCA. The relevant questions are detailed below:
(a) In framing your audit report/ LFAR, have you considered the major adverse
comments arising out of the latest reports such as:
i) Previous year’s Branch Audit Report / LFAR;
ii) Internal audit/ Snap Audit/ concurrent audit report(s);
iii) Credit Audit Report;
iv) Stock audit Report;
v) RBI Inspection Report, if such inspection took place;
vi) Income and Expenditure (Revenue) Audit;
vii) IS/IT/Computer/Systems Audit; and
viii) Any special inspection/ investigation report.
As part of Audit Planning, the Branch Auditor should review various audit
reports of audits carried out by internal audit department or other
departments of the Bank and any other external authorities. The adverse
comments in these reports should be considered while conducting branch
audit. Also, the Auditor should verify the status of the open observations in
these reports and report the same in LFAR in respective paras as open
observations from other audit reports. The Auditor shall comment how
he/she has considered observations / adverse comment while conducting
audit in this para.
(b) Are there any other matters, which you, as branch auditor, would like to
bring to the notice of the management or the Statutory Central Auditors?
The Auditor can put his observations under this clause which have not
been reported elsewhere in the report. The Auditor should use this clause
to highlight any matter which he feels is of importance for the attention of
the SCA and the Management. Some of the observations can be – the
software licences being used at the Branch are not genuine, pen drive can
be used on the desktop PCs at the Branch, placement of the branch server,
router etc., General housekeeping of the branch, overall monitoring of the
accounts etc.
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23
Audit of Foreign Exchange Business
23.01 Long Form Audit Report (LFAR) for Bank branches requires the
Auditors to review and comment on following aspects w.r.t. Branches Dealing in
Foreign Exchange Business.
1. Are there any material adverse features pointed out in the reports of
concurrent auditors, internal auditors and/ or the Reserve Bank of India’s
inspection report which continue to persist in relation to NRE/ NRO/ FCNR-
B/ EEFC/ RFC and other similar deposits accounts. If so, furnish the
particulars of such adverse features.
2. Whether the branch has followed the instructions and guidelines of the
controlling authorities of the bank with regard to the following in relation to
the foreign exchange and, if not, state the irregularities.
(a) deposits
(b) advances
(c) export bills
(d) bills for collection
(e) dealing room operations (where a branch has one)
(f) any other area
3. NOSTRO Accounts
Obtain from the branch management, a list of all NOSTRO Accounts
maintained/ operated by the branch.
(a) Whether the bank has a system of periodic confirmation/ reconciliation
of the balances in NOSTRO accounts maintained with each overseas
bank/ correspondent? Has such confirmation been received and
account reconciled at year end in each case. If not, give details.
(b) Whether the system of the bank ensures that all entries originated by
overseas banks/correspondents, have been duly responded promptly
in the respective NOSTRO accounts maintained by the bank?
(c) Are there any dormant/closed NOSTRO accounts in respect of which
balances continue to exist in the books of the branch, at year end?
(d) Have the NOSTRO balances been converted at year end at the rates
of exchange as prescribed by controlling authorities?
(e) In case, any matter deserves special attention of the management,
the same may be reported
4. Does the Branch follow the prescribed procedures in relation to
maintenance of Vostro Accounts?
23.02 This Chapter is divided into following parts.
Part – 1: Adherence to instructions and guidelines of controlling authorities in
relations to foreign exchange business carried out.
Part – 2: Nostro & Vostro Accounts related.
23.03 Further, the Auditor should refer to the master directions issued by RBI
in this respect which are stated as under:
1. Master Directions – Deposits and Accounts (RBI/FED/2015-16/9 FED
Master Direction No. 14/2015-16)
2. Master Direction – Remittance of Assets (RBI/FED/2015-16/8 FED Master
Direction No. 13/2015-16)
3. Master Direction – Miscellaneous (RBI/FED/2017-18/14 FED Master
4. Master Direction – Opening and Maintenance of Rupee/Foreign Currency
Vostro Accounts of Non-resident Exchange Houses (RBI/FED/2015-16/16
FED Master Direction No.2/2015-16)
Part 1: Adherence to instructions and guidelines of controlling authorities
in relation to Foreign Exchange business
23.04 The LFAR deals with review of adherence to instructions and guidelines
issued by RBI by branch w.r.t. Foreign Exchange Business in the field of:
a. Deposits
b. Advances
c. Export Bills
d. Bills for Collection
e. Dealing Room operations
f. Any other area
23.05 The Auditor should ensure compliances with internal policies of the
Bank and with various Master Directions as stated below:
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For the purpose of review of the said aspects the Auditor should refer to various
master directions issued by RBI in this respect. Few of the relevant master
directions are listed below:
1. External Commercial Borrowings, Trade Credits and Structured Obligations
(RBI/FED/2018-19/67 FED Master Direction No.5/2018-19) read with
Foreign Exchange Management (Mode of Payment and Reporting of Non-
Debt Instruments) Regulations, 2019 (Notification No.FEMA/395/2019-RB)
2. Establishment of Branch Office (BO)/ Liaison Office (LO)/ Project Office
(PO) or any other place of business in India by foreign entities
(RBI/FED/2015-16/6 FED Master Direction No.10/2015-16)
3. Direct Investment by Residents in Joint Venture (JV) / Wholly Owned
Subsidiary (WOS) Abroad (RBI/FED/2015-16/10 FED Master Direction No.
15/2015-16)
4. Borrowing and Lending transactions in Indian Rupee between Persons
Resident in India and Non-Resident Indians/ Persons of Indian Origin
(RBI/FED/2015-16/2 FED Master Direction No. 6/2015-16)
5. Liberalised Remittance Scheme (LRS) (RBI/FED/2017-18/3 FED Master
6. Other Remittance Facilities (RBI/FED/2015-16/4 FED Master Direction No.
8/2015-16)
7. Remittance of Assets (RBI/FED/2015-16/8 FED Master Direction No.
13/2015-16)
8. Deposits and Accounts (RBI/FED/2015-16/9 FED Master Direction No.
14/2015-16)
9. Import of Goods and Services (RBI/FED/2016-17/12 FED Master Direction
No. 17/2016-17)
10. Reporting under Foreign Exchange Management Act, 1999
(RBI/FED/2015-16/13 FED Master Direction No.18/2015-16)
11. Miscellaneous (RBI/FED/2017-18/14 FED Master Direction No. 19/2015-
16)
12. Opening and Maintenance of Rupee/Foreign Currency Vostro Accounts of
Non-resident Exchange Houses (RBI/FED/2015-16/16 FED Master
Direction No.2/2015-16)
13. Export of Goods and Services (RBI/FED/2015-16/11 FED Master Direction
No. 16/2015-16)
14. Money Transfer service Scheme (MTSS) (RBI/FED/2016-17/52 FED
Master Direction No.1/2016-17)
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15. Insurance (RBI/FED/2015-16/5 FED Master Direction No.9/2015-16)

16. Compounding of Contraventions under FEMA,1999 (RBI/FED/2015-16/1
FED Master Direction No.4/2015-16)
Part 1 (a) – Deposits
23.06 Detailed guidance for Deposit accounts is provided in Chapter 13,
“Borrowings and deposits” of Section B of this Guidance Note.
Part 1 (b) – Advances
23.07 Advances funded in foreign currency are handled in specialized
branches. The auditor should note the following:
Export Financing
A. Pre-Shipment/Packing Credit to Exporters
23.08 Important Points:
 Export packing credit can be in Indian Rupees and in Foreign Currency.
 To be issued basis letter of credit or a confirmed and irremovable order for
the export of goods/services, unless specifically waived.
 Period of packing credit will depend upon the circumstances of the individual
case subject to maximum period for of 360 days.
 EPC / PCFC is disbursed against specific orders, in one lumpsum tranche or
against the requirement as per export orders.
 To arrive at the eligible amount of drawl under EPC / PCFC facility, the
amount of contract is first aligned to FOB basis, prescribed margin is
deducted and thereafter the same is converted to rupees. The said eligible
amount can be drawn in INR under Rupee Credit Facility and in Foreign
currency in case of PCFC facility.
 Each original contract or LC is endorsed for PC granted.
 In packing credit running account facility PC is adjusted on FIFO basis and
not contact to contract.
 Monthly stock statement for PC facility should be furnished wherein DP is
available from paid goods only and book debts or unpaid goods are not
permitted.
 Stock, RM, WIP & FG should remain fully insured with policy endorsed in
bank’s favour.
 Rupee export packing credit can be shared between an Export Order Holder
(EOH) and sub-supplier of raw materials, components etc., of the exported
goods subject to:
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o Running account facility is not allowed.

o Bankers to an EOH will open an inland LC specifying the goods to be
supplied by the sub-supplier.
o The above scheme is an additional window beside the existing system
of sharing of packing credit. Further it has to be verified that the total
quantum of advance or period cannot be extended.
 Liquidation of EPC / PCFC will be by way of exports proceeds only.
Liquidation by any other means than by way of exports will attract –
commercial rate of interest as per Bank’s Policy. However, as per Master
Directions on Export of Goods and Services issued by RBI it is prescribed
that AD Category – I banks may permit exporters to repay packing credit
advances whether availed in Rupee or in foreign currency from balances in
their EEFC account and / or Rupee resources to the extent exports have
actually taken place.
Accounting aspects
 Banks open separate loan account in CBS for EPC / PCFC. It helps in
monitoring the utilization and liquidation.
 Bank at the request of the borrower must convert the amount of Pre-
Shipment credit into Post-Shipment credit by discounting / purchasing the
export bills. When PC is granted no export bill should be sent on collection
basis. If in case any problem is there in purchase of a bill say discrepant
documents, bill should be purchased and proceeds credited to PC account
and PC account should be earmarked till it is accepted or paid by the
foreign bank.
Compliance aspects
 End use of funds
Banks should keep a close watch on the end-use of the funds and ensure
that credit at concessional rates of interest is used for genuine
requirements of exports only. The cheques/withdrawal from the PC account
should be made to the suppliers of the raw materials purchased/ processed
or for manufacturing expenses of the goods to be exported. Banks should
also monitor the progress made by the exporters in timely fulfilment of
export orders.
Order Book Maintenance
 Banks maintain order book / register to track export orders vis-a-vis Export
Credit extended.
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 PC should be supported by valid export orders on hand. If any export order

or LC is expired the same should be extended or replaced.
Submission of Export Documents
 If pre-shipment advances are not liquidated from proceeds of bills on
purchase, discount, etc. on submission of export documents within 360 days
from the date of advance, or from balance in EEFC account and / or Rupee
resources to the extent exports have actually taken place, the advances will
not be treated as export credit ab initio.
 If exports do not materialise at all, banks should charge on relative packing
credit domestic lending rate plus penal rate of interest, if any, to be decided
by the banks on the basis of a transparent policy approved by their Board.
Auditing aspects
 Generate the list of EPC / PCFC accounts opened and maintained by the
branch.
 Verify whether all details are correctly filled in Masters.
 Whether the liquidation of EPC / PCFC is as per RBI guidelines? If not,
whether interest rate as per Bank’s Policy is charged or not.
 Documents evidencing end use of funds should be verified.
 Whether genuineness of Export LC is confirmed before sanctioning EPC /
PCFC?
 If remitting bank advises, bill is required to be presented to the alternate
drawee, then necessary approval and borrower consent should be
obtained.
 Similarly the advance should be covered under bank’s WTPCG cover if
stipulated. Premium should be recovered from the client if stipulated.
B. Post-Shipment Credit to Exporters
Export Bills Discounted / Purchased
23.09 Banks extend the following credits to exporters:
 Banks extend credits to Exporters by way of
o Export bills purchased / discounted / negotiated
o Advances against Bills on collection basis.
o Financing against duty drawback receivable from the Government.
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 Facility of discounting / purchase of bill is available in both Indian Rupee

and in Foreign Currency.
Revenue aspects
 Interest on Bill Discounting / Purchase is revenue for the bank. The Auditor
should review the accounting policy of the bank in this regards.
 Bank also charges fees for export bill lodgement and claims courier and
other charges for submission of Export Documents.
Accounting aspects
 In case of Discounting / Purchase in Foreign Currency:
o The rupee equivalent of the discounted value of the export bills will be
payable to the exporter and the same should be utilised to liquidate
the outstanding export packing credit.
o As the discounting of bills/extension of foreign exchange loans (DP
bills) will be in actual foreign exchange, banks may apply appropriate
spot rate for the transaction.
o The rupee equivalents of discounted amounts/foreign exchange loan
may be held in the bank’s books distinct from the existing post-
shipment credit accounts.
o In case of overdue bills, banks may charge overdue interest as per
the interest rate policy of bank from the due date to the date of
crystallization.
Compliance aspects
 In case of overdue bills, IRAC Norms for overdue bills will be applicable and
the advance will be subject to Asset Classification.
 Export Bills will be subject to maximum period of 365 days.
Auditing aspects
 Generate a report on Export Bills purchased/negotiated during the audit
period.
 Verify whether details are correctly filled in Masters especially amount and
discounting rate.
 Generate a report on outstanding / realized export bills during the audit
period.
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 In case of overdue bills check whether the interest has been charged as
per Bank’s Policy.
 Verify whether the period of sanction is within the period prescribed by RBI
i.e. 360 days.
 Verify credit report on buyer should be held from international agency.
 ECGC buyer wise cover should be obtained by the exporter client if
stipulated.
 Similarly the advance should be covered under bank’s WTPSG cover if
stipulated.
Import Financing
Trade Credits
23.10 Trade Credit (TC) is defined by RBI in Master Direction No.
RBI/FED/2018-19/67 FED Master Direction No.5/2018-19 dated March 26, 2019
(Updated as on August 08, 2019) - External Commercial Borrowings, Trade
Credits and Structured Obligations as follows.
‘Trade Credits (TC) refer to the credits extended by the overseas supplier, bank,
financial institution and other permitted recognised lenders for maturity, as
prescribed in this framework, for imports of capital/non-capital goods permissible
under the Foreign Trade Policy of the Government of India. Depending on the
source of finance, such TCs include suppliers’ credit and buyers’ credit from
recognised lenders.’
23.11 Framework prescribed for TCs: TC for imports into India can be raised
in any freely convertible foreign currency (FCY denominated TC) or Indian
Rupee (INR denominated TC), as per the framework given in the table below:
Sr. Parameters FCY denominated TC INR denominated TC
No.
i Forms of TC Buyers’ Credit and Suppliers’ Credit.
ii Eligible Person resident in India acting as an importer.
borrower
iii Amount Up to USD 150 million or equivalent per import transaction
under for oil/gas refining & marketing, airline and shipping
automatic companies. For others, up to USD 50 million or equivalent
route per import transaction.
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No.
iv Recognised 1. For suppliers’ credit: Supplier of goods located outside
lenders India.
2. For buyers’ credit: Banks, financial institutions, foreign
equity holder(s) located outside India and financial
institutions in IFSCs located in India.
Note: Participation of Indian banks and non-banking financial
companies (operating from IFSCs) as lenders will be subject
to the prudential guidelines issued by the concerned
regulatory departments of the Reserve Bank. Further, foreign
branches/subsidiaries of Indian banks are permitted as
recognised lenders only for FCY TC.
v Period of TC The period of TC, reckoned from the date of shipment, shall
be up to three years for import of capital goods. For non-
capital goods, this period shall be up to one year or the
operating cycle whichever is less. For shipyards /
shipbuilders, the period of TC for import of non-capital goods
can be up to three years.
vi All-in-cost Benchmark rate plus 250 bps spread.
ceiling per
annum
vii Exchange Change of currency of FCY For conversion to Rupee,
rate TC into INR TC can be at exchange rate shall be the rate
the exchange rate prevailing prevailing on the date of
on the date of the settlement.
agreement between the
parties concerned for such
change or at an exchange
rate, which is less than the
rate prevailing on the date of
agreement, if consented to
by the TC lender.
viii Hedging The entities raising TC are The overseas investors are
provision required to follow the eligible to hedge their
guidelines for hedging, if exposure in Rupee through
any, issued by the permitted derivative products
concerned sectoral or with AD Category I banks in
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No.
prudential regulator in India. The investors can also
respect of foreign currency access the domestic market
exposure. Such entities shall through branches /
have a board approved risk subsidiaries of Indian banks
management policy. abroad or branches of foreign
banks with Indian presence on
a back to back basis.
ix Change of Change of currency of TC Change of currency from INR
currency of from one freely convertible to any freely convertible
borrowing foreign currency to any other foreign currency is not
freely convertible foreign permitted.
currency as well as to INR is
freely permitted.
23.12 The typical flow of transaction of TC (with underlying import through LC

transaction) is as follows:
1) The borrower imports goods from foreign supplier against Foreign Letter of
Credit (FLC) drawn in favour of foreign supplier. [The Buyer’s Credit can
also be arranged for transactions of Import on Collection basis and Direct
Import cases.].
2) The borrower either through its Indian bank or on its own approaches
foreign bank (or overseas / foreign branches / offices of Indian banks),
financial institutions foreign equity holder for Buyer’s Credit and Supplier for
availing Suppliers’ Credit for payment to be made to the foreign supplier.
3) Issuance of Letter of Comfort by Indian bank to the foreign bank is not
permitted. However, Banks are permitted to issue Bank Guarantee in
favour of overseas TC lender (subject to compliance with provisions
contained in Master Circular No.DBR.No.Dir.BC.11/13.03.00/2015-16 dated
July 1, 2015 on “Guarantees and Co-acceptances”, as amended from time
to time). Banks are also permitted to create charge on assets for TC so
arranged.
4) The TC Lender remits funds to the NOSTRO Account of Indian bank which
is handling import transaction (under buyer’s credit) or agree to extend date
of payment under Supplier’s credit for buyer and securing payment through
bill discounting with all expenses on buyer.
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5) The Indian bank remits the funds to foreign supplier through its NOSTRO
Accounts in case of Buyer’s Credit.
6) The Indian bank subsequently retires and reverses the Letter of Credit in its
book and passes another entry for creation of a non-fund based
(contingent) liability of Bank Guarantee (if issued).
7) On the due date of TC, the Indian bank remits the funds (inclusive of
interest) to the overseas bank and recovers the similar amount from its
customer.
The entries of the inward and outward remittances (specified in steps 3 and
4) are to be recorded in the books of accounts (NOSTRO Mirror Account) of
the Indian bank.
8) For the purpose of raising TC, the importer may also offer security of
movable assets (including financial assets) / immovable assets (excluding
land in SEZs) / corporate or personal guarantee for raising TC. ADs may,
therefore, be allowed to permit creation of charge on security offered /
accept corporate or personal guarantee, duly ensuring that
(i) There exists a security clause in the loan agreement requiring the
importer to create charge, in favour of overseas lender / security
trustee on immovable assets / movable assets / financial securities /
issuance of corporate and / or personal guarantee;
(ii) No Objection Certificate, wherever necessary, from the existing
lenders in India has been obtained;
(iii) Such arrangement is co-terminus with underlying TC;
(iv) In case of invocation, the total payments towards guarantee should
not exceed the dues towards TC; and
(v) Creation/ enforcement / invocation of charge shall be as per the
provisions contained in Foreign Exchange Management (Acquisition
and Transfer of Immovable Property in India) Regulations, 2000 and
Foreign Exchange Management (Transfer or Issue of Security by a
Person Resident Outside India) Regulations, 2000 or any other
relative Regulations framed under the Foreign Exchange
Management Act, 1999 and should also comply with FDI/FII/SEZ
policy/ rules/ guidelines.
23.13 Following documents are required to be verified by the statutory
auditors during review of Buyers’ Credit and Suppliers’ Credit Transaction and its
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accounting treatment in the Indian Bank’s books.

1) (Loan) Agreement, if any, entered between the Indian importer (borrower),
overseas TC lender, the Indian bank (facilitator).
2) SWIFT messages originated by overseas bank specifying the terms of TC.
3) The calculation of contingent liability towards Bank Guarantee is inclusive
of interest accrued on the TC as on financial statement date.
4) Documentation / agreement between overseas TC lender and Indian Bank,
(if any) and, any further confirmatory documents exchanged between
overseas bank and Indian bank.
5) Review of documents specifying right of recovery against borrower, in case
if the borrower defaults in repayment of TC.
6) Balance confirmations obtained from the overseas TC lender.
7) Charge created in the records of RoC, if required, related to the security
offered for TC vis-à-vis disclosure of TC in the financials of borrowers as
secured / unsecured loan.
8) Acknowledgement of debt, if any, obtained from the borrower.
9) The period of finance for non-capital goods is lower of operating cycle or
one year (three years for shipyards / shipbuilders).
10) Form 15CA / Form 15CB(income tax) compliances made by the borrower.
Revenue aspects of TC transaction
23.14 Bank issuing BG for TC Transaction earns commission / charges.
Unusual increase in revenue by way of commission and charges should be
inquired into.
Accounting aspects of TC transaction
23.15 The following are the accounting aspects of TC transactions:
 Issuance of BG for TC is considered as Non-Funded facility by banks.
 The important aspect is to ensure that the fields in CBS match with details
reported in SWIFT message sent for BG. The BG is generally
communicated through MT760 which includes certain separately
identifiable details.
 The Auditor should also review the text of the guarantee to confirm
correctness of accounting treatment in books of accounts.
 The Auditor should also review any messages sent through MT799 (Free
Text Format) type SWIFT nessages. In this type of message the vital
details are included as a text and not as separately identifiable fields. In
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view of this even when an automated information reporting system (from

CBS to SWIFT) has been implemented, there is still a possibility of flowing
certain vital information through SWIFT message text which may not have
been recorded in CBS.
 The Auditor needs to verify the internal control process implemented by the
bank to ensure that all swift messages are properly accounted for and verify
that direct access to swift system is not granted, and the concerned officials
enter swift through the CBS system alone.
Compliance aspects of TC transactions
23.16 TC transactions involve the following compliances:
 TC transaction should be within the prescribed tenure.
 Interest rate and other costs for TC transaction must be within the
prescribed All-in-Cost ceiling.
 There are certain restrictions on availing TC for select commodities. Tenure
prescribed in Master Circular issued by RBI for the said TC transaction
must be adhered to. For instance, certain restrictions have been imposed
on TC for import of Gold, Diamonds, precious metals etc. The Auditor may
refer to Master Directions on Import of Goods and Services (Updated as on
October 28, 2020) RBI/FED/2016-17/12 FED Master Direction No. 17/2016-
17 issued on January 1, 2016 for the same.
Auditing aspects of TC transactions
23.17 Following are the auditing aspects in TC transactions:
 Underlying transaction for TC is Import Transactions. Hence, it is important
for the Auditors to verify the Evidence of Import. Exchange Control Copy of
Bill of Entry / Entry in IDPMS is the document / confirmation which can be
said to be Evidence of Import. In case of TC availed by SEZ units the
Auditor may review the compliance of provisions provided under Master
Directions for Trade Credit.
 The Auditor should check the Offer Letter issued by overseas lender and
conformity of TC transaction with FEMA guidelines.
 Are there any cases of devolvement by borrower in remitting TC amount in
past? In such cases bank which has issued LoU / LoC / BG has to remit the
funds on due date to Foreign Lender. Check whether there are any cases
of such nature during Audit Period? The reason for devolvement should be
verified and put on records.
 Whether the Fees / Charges for BG issuance / charges creation is collected
upfront?
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Part 1 (c) – Export Bills

23.18 There are different types of Export Bills in Foreign Exchange
transactions viz. Export Bills on Collection, Export Bills Discounted / Purchased,
Advance against Export Bills etc.
Important aspects of Export Bills discount/ purchase have been mentioned
above. For detailed guidelines the Auditor should refer Master Direction – Export
of Goods and Services (Updated as on March 23, 2016) RBI/FED/2015-16/11
FED Master Direction No. 16/2015-16 issued on January 1, 2016 and guidelines
provided in RBI/2019-20/206A.P.(DIR Series) Circular No.27 dated April 01,
2020.
Part 1 (d) – Bills for collection
23.19 Under Import bills for collection the Foreign Seller sends goods through
shipping channel and documents to its banker with an instruction to send the
same to the Importer’s Banker. The document so sent contains instructions on
handling of the said documents. The Importer’s Bank will follow the instruction
mentioned in the bill schedule and deliver the documents to the buyer.
In this type of transaction Importer’s Banker is dealing only as a mediator i.e. in
case the Importer does not pay the bill amount the Importer’s bank will notify the
Exporter’s Bank and will act as per Exporter’s Bank instruction.
Revenue aspects of Import Bills on Collection
23.20 Import bills on collection involve the following revenue aspects:
 Bank charges fees / commission for handling bills on collection.
 Generally, it is observed that in case of Forex Transactions handled
through CBS, the charges are collected by CBS. However, the Auditor
should carry out walkthrough process of collection of charges. Sanction for
waiver/concession in charges must be verified.
Accounting aspects of Import Bills on Collection
23.21 The accounting aspects on collection of import bills are the following:
 The bills are lodged in CBS / recorded in Import Bills on Collection register
 In case of CBS, the payment of Bill made through Bill module in CBS. CBS
will update the outstanding Bill Liability on realization event.
 Only contra transaction for Contingent Liability is created for Import Bills on
Collection.
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Compliance aspects of Import Bills on Collection

23.22 The compliance aspects on collection of import bills are the following:
 Import Bills under collection must form part of Contingent Liability.
 Lodgement, Realization and Closure of Bill should be carried out through
Bill module under CBS.
Auditing aspects of Import Bills on Collection
23.23 The auditing aspects on collection of import bills are the following:
 Generate bill balancing report for import bills on collection transaction. It is
preferable to have the said report generated for 31st March.
 Carry out physical verification of all outstanding bills appearing under Bill
Balancing Reports. Special attention should be given to bills under
“Lodgement” status for availability of Transport Documents (In normal
course, transport documents along with other documents are handed over
only after payment in case of Sight Bill or only after acceptance of bill of
exchange in case of usance bill).
 Verify whether total of outstanding import bills on collection as per bill
balancing report agrees with bills for collection under contingent liability?
 Whether the activity of collection of charges is system driven or manual?
Select appropriate sample based on the review of process.
 It is generally observed that the activity of collection of charges for
discrepancy memo is manual. If so, verify whether the charges have been
properly collected or not.
 Overdue bills report should be obtained and follow up done with the bank
may be verified.
 Compliance of GST on the Charges so collected and accounting thereof.
Part 1 (e) – Dealing Room operations
23.24 The core areas of treasury operations in a bank can be functionally
divided into the following broad compartments as mentioned below:
 Front Office Operations (Dealing room operations);
 Middle Office Operations (Market Risk Department / Product Control
Group); and
 Back Office Operations (Deal Confirmation and Settlement).
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23.25 Some of the main functions of Front Office, Mid-Office and Back-office
operations are detailed below:
Front Office (Dealing Room)
 Money and fixed income dealings
 Forex a derivatives
 Treasury sales
 Equities
 Primary dealers
 Debt sales
 Credit default swaps
Middle Office (Risk)
 Identification, measurement and monitoring of risk
 Monitoring counter party, product and dealer limits
Back Office
 Settlement and follow up
 Reconciliations
 Accounting
 Valuation
23.26 Increasing regulation and compliance requirements and the need for
risk management have made ‘treasury front and back office efficiency’ as one of
the most critical factors in ensuring the well-being of any bank today. This is
especially important as the operations of treasury become more onerous while
financial products become increasingly complex, despite streamlining of
processing systems. Staff of Front Office, Middle Office and Back Office should
be segregated and all the work should not be handled by one officer.
Front office Operations
23.27 The front office operations consist of dealing room operations wherein
the dealers transact deals with the various approved counterparties. Deals are
transacted by dealers on various anonymous order matching platforms such as
NDS-OM, CROMS, NDS-CALL, FX-CLEAR, FX-SWAP, E-Kuber and over
communication platform such as Reuters’, Bloomberg, telephonic conversation
with counter party or through empanelled brokers.
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23.28 The dealers are primarily responsible to check for counterparty

exposure limits, eligibility, and other requirements of the bank before initiating
any deal with the counter-party. Dealers must ensure that all risk/credit limits are
available before transacting a deal. Also, the deal must not contravene the
current regulations regarding dealing in INR with overseas banks/counterparties.
All counterparties are required to execute the International Swaps and
Derivatives Association (‘ISDA’) agreement as well as pass a board resolution
allowing it to enter into derivative contract. As soon as the deal is struck with
counterparty, the deal details are noted in a dealers’ deal pad and thereafter
captured in front office system of the Bank which gets queued in for authorization
by back office.
23.29 Quoting of rates to clients should be based on ongoing market and
specific policy should be framed for loading of margins based on size of the
transactions.
Middle office Operations
23.30 Middle office is responsible for online risk measurement, monitoring and
management reporting. The other functions of Middle Office are:
 Limit setting and monitoring exposures in relation to limits.
 Assessing likely impact of market movements based on internal
assessments and external /Internal research.
 Evolving hedging strategies for assets and liabilities.
 Interacting with the bank’s Risk Management Department on liquidity and
market risk.
 Monitoring open currency positions.
 Calculating and reporting VAR.
 Stress testing and back testing of investment and trading portfolios.
 Risk-return analysis.
 Marking open positions to market to assess unrealized gain and losses.
Back office Operations
23.31 The mainstream role of the back office is in direct support of the dealing
room or front office. Traditionally, this included the input of deal details in the
settlement system, checking of deal input details, verification by confirmation
from counterparty, settlement, checking existence of a valid and enforceable
International Swap Dealers Association (‘ISDA’) agreement and reconciliation of
positions and Nostro accounts. However, with the advent of online front office
systems and, more importantly, online trading platforms, the input of deals has
progressively moved to the dealing room as mentioned above.
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23.32 An important development in the back office has been the advent of
straight-through processing (STP), also called ‘hands-off’ processing. This has
been made possible through enhancement of computer system to real time
online input in the trading platform, which in turn has meant that the back office
can authorise/confirm deals pending for authorisation in the trading platform. In
practice this is done automatically by matching incoming data from
counterparties and thereby focusing on investigating exceptions. With the
introduction of online trading systems, the deal is ‘confirmed’ as it is done,
allowing the back office to concentrate principally on handling exceptions,
settlement and monitoring and risk control.
23.33 One of the basic tenets for a treasury area in a bank is the strict
segregation and allocation of duties between the front, middle and back office,
the latter controlling confirmations, settlement and accounting of transactions.
These are even more important in an era of straight-through processing where
the checks are fewer and must essentially be independent. However, while this is
straight forward for the processing functions, the independent monitoring and
management of complex trading risks can be much more problematical, requiring
the ability and market knowledge to understand how the trades and hedges in
the dealer’s book are structured.
Functions of Back Office
Input and completion
23.34 The first core function for the back office is to extract the details of the
deal either through the input system or by accessing the online platform and
authorise/confirm the same after verifying the deal details with the external
evidence i.e. incoming data from counterparty, Reuters’/ Bloomberg’s
conversation, broker notes. Deals input through front-end data capture or agreed
on one of the proprietary trading systems are subjected to numerous system
checks to ensure that the transaction details are technically correct. Some deals
will require settlement instructions to be added, but for straightforward foreign
exchange and derivative deals done with other banks and large corporates,
standard settlement instructions (SSIs) may have already been added as per the
agreement. This could also be true for derivatives transactions in the larger
treasuries. However, these types of transactions generally need more checking
and manual intervention because of the wide variety of their use. Bank normally
releases its own confirmation to the counterparty, particularly for over the counter
(‘OTC’) deals.
Counterparty confirmation
23.35 The second core function for the back office is to verify the deal from
the counterparty as soon as possible after the transaction has been done. For
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bank-to-bank trading, the verification can take the form of a confirmation of a

deal done through Reuters conversation or trading systems, or a broker’s
confirmation if the deal has been done through a broker. Telephone
confirmations are also sought for immediate authorisation. Further, the banks
have entered into bilateral agreement with counterparty banks who are members
of CCIL; whereby exchange of confirmations for Forex Interbank deals (matched
on CCIL) have been discontinued.
23.36 Deals done with customers (non-banks) will normally be confirmed by e-
mail, with instructions swapped on the telephone, depending on the
arrangements. Increasingly, however, corporate customers are using automatic
confirmation-matching services. It is essential that the deal is confirmed
independently of the trader before any kind of value is given or payment is made.
Settlement
23.37 The third core function in the processing chain is that of settlement. This
can take the form of a clean currency payment/receipt at the bank’s accounts or
through the medium of CCIL. The CCIL settlement process is a multilateral
netting system for Inter-bank transactions that will net the member’s payment
and receipts in a currency, even if they are due to or due from him from different
counter parties and settles the net position in both legs of the transaction.
Brokerage is paid on settlement basis in case of Forex Transactions.
Reconciliation
23.38 Operations areas are typically involved in a number of reconciliation
processes, including the reconciliation of dealers’ overnight positions, Nostro
accounts and brokerage payments. This can also mean reconciling positions for
margin calls in futures trading or reconciling custody accounts to the underlying
securities in securities trading. However, the basic reconciliation function is to
agree or reconcile the entries that have passed over an account with
correspondent bank against those that have been passed internally in the books
of the bank to a Nostro account. After reconciliation, the unmatched items in both
accounts represent those that have not been responded to in either the books of
the bank or its correspondent and should therefore requires to be investigated.
Others
23.39 Card rates should be decided in the beginning of the day and should be
prominently displayed uniformly in all exchange dealing branches.
Net Overnight Open Position Limit (NOOPL)
23.40 NOOPL may be fixed by the boards of the respective banks and
communicated to the Reserve Bank immediately. However, such limits should
not exceed 25 per cent of the total capital (Tier I and Tier II capital) of the bank.
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23.41 The Net Open position may be calculated as per the method given
below:
Calculation of the Net Open Position in a Single Currency
23.42 The open position must first be measured separately for each foreign
currency. The open position in a currency is the sum of (a) the net spot position,
(b) the net forward position and (c) the net options position.
a) Net Spot Position
The net spot position is the difference between foreign currency assets and the
liabilities in the balance sheet. This should include all accrued income/expenses.
b) Net Forward Position
This represents the net of all amounts to be received less all amounts to be paid
in the future as a result of foreign exchange transactions, which have been
concluded. These transactions, which are recorded as off-balance sheet items in
the bank's books, would include:
i. spot transactions which are not yet settled.
ii. forward transactions.
iii. Guarantees and similar commitments denominated in foreign currencies
which are certain to be called.
iv. Net future income/expenses not yet accrued but already fully hedged (at
the discretion of the reporting bank).
v. Net of amounts to be received/paid in respect of currency futures, and the
principal on currency futures/swaps.
c) Net Options Position
The net options position is the "delta-equivalent" spot currency position as
reflected in the authorized dealer's options risk management system, and
includes any delta hedges in place which have not already been included under
1(a) or 1(b) (i) and (ii) above.
23.43 Calculation of the overall net open position involves measurement of
risks inherent in a bank's mix of long and short position in different currencies. It
has been decided to adopt the "shorthand method" which is accepted
internationally for arriving at the overall net open position. Banks may, therefore,
calculate the overall net open position as follows:
i. Calculate the net open position in each currency.
ii. Calculate the net open position in gold.
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iii. Convert the net position in various currencies and gold into Rupees in
terms of existing RBI / FEDAI Guidelines. All derivative transactions
including forward exchange contracts should be reported on the basis of
Present Value (PV) adjustment.
iv. Arrive at the sum of all the net short positions.
v. Arrive at the sum of all the net long positions.
Overall net foreign exchange position is the higher of (iv) or (v). The overall net
foreign exchange position arrived at as above must be kept within the limit
approved by the bank’s Board.
23.44 Authorised Dealer banks should report all derivative transactions
including forward exchange contracts on the basis of PV adjustment for the
purpose of calculation of the net open position. Authorised Dealer banks may
select their own yield curve for the purpose of PV adjustments. Banks however
should have an internal policy approved by its ALCO regarding the yield curve/(s)
to be used and apply it on a consistent basis.
23.45 Examination of compliance with statutory and regulatory requirements
is also an important objective in audit of dealing rooms. The Auditors should
keep this in view while designing their audit procedures relating to dealing
rooms.
Process Review, Walk through and Control Testing
23.46 Banks normally have documented standard operating procedures
(SOPs), hence auditor can peruse SOPs for understanding and documenting
significant processes. During the process understanding, Auditors may identify
various control points in the process like reconciliation, maker checker,
segregation of duties, etc. The Auditors may carry out walk through of few
transactions for validating process understanding and existence of identified
controls. Identified controls needs to be further segregated to manual controls
and IT controls for testing of those controls for sample transactions. This
sample needs to be selected randomly from total population of transactions as
per the methodology.
23.47 In today’s scenario, most of the dealing room functions of banks are
performed in an automated environment (for example, trade booking,
settlement and accounting). In such a situation, it becomes imperative for the
Auditors to test the general information technology controls and system
application controls around the functioning of the systems involved and also
the interfaces between various systems.
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 perusing reports on concurrent audit of treasury transactions, system
audit report, if any and follow-up action taken by the management
thereon.
 perusing the half yearly review of portfolio by the Board of Directors of the
bank and also reviewing annual inspection report of the RBI carried out
under Section 35 of the Banking Regulation Act, 1949.
 Verification of voice recording mechanism and to ensure user ids of
dealers left / transferred/ on leave is deactivated / suspended on timely
basis.
Part 1 (f) –Other Area
23.49 Apart from the transactions referred to above in detailed, bank
Branches carry out various other transactions as well. The Auditor should review
the nature of transactions carried out by branch, the role of bank branch in
transaction in terms of FEMA guidelines and should review applicable Master
Directions / Circulars, Notifications.
23.50 The Auditors should also review linkages between CBS system and
SWIFT system.
23.51 The RBI has suggested banks to centralize / ensure effective control
over access and sending messages through SWIFT system by bank branches.
In case the SWIFT message system is centralized the Auditor should review
system / process of generation of SWIFT Messages. Auditors may, on test check
basis get the SWIFT messages generated from the said system and compare
the same with CBS information. Any deviation observed should be reported
under LFAR.
(i) Clean collection instruments.
(ii) Images of clean instruments should be sent to the correspondent banks for
collection.
(iii) As per arrangements the proceeds are immediately credited to the Nostro
account. However the same is released to the beneficiary after a reserve
period say 21 days during which they can debit our account for a returned
instrument.
(iv) In case of purchase of an instrument proper approval of the branch head or
proper authority should be obtained, recover interest for 15 days and credit
proceeds to the depositor’s account.
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23.52 Encashment of TC & CNs: Travellers cheques are encashed after

taking signature on the same before an Officer who witnesses the signing of
each and every TC. His passport particulars are noted, original PP is verified
regarding his identity and the cash is paid at the prevailing prescribed rates. The
list of Lost & Stolen TCs are verified before making payment. TCs are sent for
collection to the respective correspondent.
23.53 Auditors may also refer to the RBI/2012-13/383 A.P.(DIR series) circular
No.76 dated January 17, 2013 wherein various compliance are stated which the
bank as an authorised dealer is require to fulfil, any contravention of which may
invite penal consequences.
Part – 2: Nostro & VOSTRO Accounts related
23.54 As per the need of LFAR for NOSTRO & VOSTRO Accounts:
Obtain from the branch management, a list of all NOSTRO Accounts
maintained/ operated by the Branch
23.55 A nostro account refers to an account that a bank holds in a foreign
currency in another bank. As explained earlier in case of receipts in foreign
currency by the Bank from other countries, the counter party/ foreign bank will
remit funds in nostro account of the Bank. Then based on transaction types and
obtention of necessary documents, the bank will transfer amount in nostro
account to customer Rupee account post conversion or EEFC accounts.
23.56 The starting phase of this audit should be to obtain a list of all the
NOSTRO accounts maintained / operated by the branch. Also, the Branch will
have mirror account of each nostro account in its Trial Balance. The list shall
contain all the relevant details in this regard including the account number,
country, currency, etc. Ideally list of nostro accounts provided by the Branch
and details of mirror accounts should match.
a) Whether the bank has a system of periodic confirmation/ reconciliation of
the balances in Nostro accounts maintained with each overseas Bank/
correspondent? Has such confirmation been received and account
reconciled at year end in each case. If not, give details.
One of the important elements of the audit of NOSTRO accounts is to
check on the transactions entered through these accounts. It is important
that these accounts are duly confirmed and reconciled between the two
branches. The Auditor should check the confirmations received by the bank
branch from their overseas bank and also the reconciliation of the same.
The Auditor should not only verify the same relating to year end but also
688
verify if the branch had process of periodic reconciliation and confirmation

of the same. With respect to year end, the Auditor may also consider to
obtain independent confirmation from the overseas branch in case of
material balances / transactions. The reconciliation also needs to be tallied
with the subsequent transactions after year end.
b) Whether the system of the Bank ensures that all entries originated by
overseas banks/correspondents, have been duly responded promptly in the
respective NOSTRO accounts maintained by the Bank?
The overseas bank / correspondent intimates to the respective branch for
each transaction entered by them relating to them. It is imperative on the
part of the branch to respond to the same at the earliest. Timely response
results in proper entries and reconciliation of the same on timely basis.
The Auditor should study the process and system of the bank in this regard
and also whether the branch is acting as per the system defined. Delays in
the same if any should be properly highlighted and the impact of the same
at year end needs to be looked upon and wherever required, appropriate
entries should be passed or given in MOC.
c) Are there any dormant/closed Nostro accounts in respect of which balances
continue to exist in the books of the Branch, at year end?
The auditor needs to examine the transactions entered in the respective
Nostro accounts. There could be some of the accounts where there are no
transactions but still the balances are lying outstanding. The reasons for the
same needs to be taken and verified and reported accordingly.
d) Have the Nostro balances been converted at year end at the rates of
exchange as prescribed by controlling authorities?
The Nostro accounts are in foreign currency. For the purposes of the
accounting as per norms, these would need to be converted into Indian
Rupees at each period end. Accordingly, it is imperative that the rate of
conversion used for the same is proper. Generally, the rate of conversion is
put in the system of the bank and the same rate is used for conversion of
all the such balances at the whole bank. The Auditor needs to check that
the rates feeded in the system are the ones which are as prescribed by the
controlling authorities. It also needs to be verified that the rates prescribed
by the controlling authorities are appropriate.
As per RBI circular RBI/2018-19/34/ DBR.Ret.BC. No.01/ 12.01.001
/2018-19 dated August 02, 2018 on “Maintenance of CRR/SLR on
Foreign Currency Assets/Liabilities– Reference rate for INR/USD and
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exchange rate of other major currencies” for conversion of foreign

Currency Assets/ Liabilities reference rate from FBIL should be taken. If
reference rate is not available from FBIL, Banks may continue to use New
York closing pertaining to the day end of the reporting Friday for
conversion of such currency into USD.
e) In case, any matter deserves special attention of the management, the
same may be reported.
The Auditor needs to use his professional skepticism to check if there are
any unusual transactions or any unusual trend or significant transactions
reflected in the NOSTRO accounts. If any such transactions are noted, the
same needs to be further verified with respect to documents and purpose
and in case if the auditor is not satisfied, the same should be referred in
LFAR.
The reconciliation of Nostro accounts (with Nostro Mirror Accounts) needs
to be scrutinized carefully to analyze and ascertain if any inwards
remittances are received on behalf of the customers / constituents of the
bank and have remained unaccounted and / or any other debit (inward)
entries have remained unaccounted and are pertaining to any liabilities
for the bank. These need to be properly reported.
Borrowings from abroad by banks in India needs to be considered as
‘liabilities to other’ and thus, needs to be considered at gross level unlike
‘liabilities towards banking system in India’, which are permitted to be
netted off against ‘assets towards banking system in India’. Thus, the
adverse balances in Nostro Mirror Account needs to be considered as
‘Liabilities to other’
(f) Does the Branch follow the prescribed procedures in relation to
maintenance of Vostro Accounts?
The procedure and process reported for NOSTRO needs to be carried out
for VOSTRO accounts as well.
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24
Clearing House Operations by
Service Branches
Introduction/ Bank’s Process

24.01 The Service Branch/ Clearing House primarily acts as an intermediary
between branches and banks to ensure processing of negotiable instruments.
Considering functions of this branch, the primary objective of the Auditor is to
ensure that there are no long old outstanding open entries as well as
unreconciled entries.
24.02 The Service Branch ensures that the duly balanced outward clearing
batches are received from the various branches within the prescribed time
schedule. The outward clearing presentation for the bank as a whole, duly
balanced and with the necessary control documents, should be forwarded to the
Cheque Processing Centre as per the time schedule stipulated by it.
24.03 Under the Cheque Truncation System implemented by RBI, an
electronic image of the cheque is transmitted to the paying branch through the
clearing house, along with relevant information like data on the MICR band, date
of presentation, presenting bank, etc. This effectively eliminates the associated
cost of movement of the physical cheques, reduces the time required for their
collection. Under this approach the entire cheque volume in the country which
was earlier cleared through 66 MICR Cheque Processing locations is
consolidated into the three grids in New Delhi, Chennai and Mumbai. The
illustrative jurisdiction of the three grids are indicated below:
 New Delhi Grid: National Capital Region of New Delhi, Haryana, Punjab,
Uttar Pradesh, Uttarakhand, Bihar, Jharkhand, Rajasthan and the Union
Territory of Chandigarh.
 Mumbai Grid: Maharashtra, Goa, Gujarat, Madhya Pradesh and
Chattisgarh.
 Chennai Grid: Andhra Pradesh, Telangana, Karnataka, Kerala, Tamilnadu,
Odisha, West Bengal, Assam and the Union Territory of Puducherry.
24.04 Under grid-based Cheque Truncation System clearing, all cheques
drawn on bank branches falling within in the grid jurisdiction are treated and
cleared as local cheques.
24.05 In CTS, the presenting bank (or its branch) captures the data (on the
MICR band) and the images of a cheque using their Capture System (comprising
of a scanner, core banking or other application) which is internal to them, and
have to meet the specifications and standards prescribed for data and images.
24.06 To ensure security, safety and non-repudiation of data / images, end-to-
end Public Key Infrastructure (PKI) has been implemented in CTS. As part of the
requirement, the collecting bank (presenting bank) sends the data and captured
images duly signed digitally and encrypted to the central processing location
(Clearing House) for onward transmission to the paying bank (destination or
drawee bank). For the purpose of participation, the presenting and paying banks
are provided with an interface / gateway called the Clearing House Interface
(CHI) that enables them to connect and transmit data and images in a secure
and safe manner to the Clearing House (CH).
24.07 Only CTS 2010 compliant instruments can be presented for clearing
through CTS. The separate non-CTS clearing sessions in CTS grid centres has
been discontinued with effect from December 31, 2018. As on September 2020,
all ECCS centres have been migrated to CTS. Positive Pay system for Cheque
Truncation shall be implemented from January 1, 2021.
24.08 Cheques are scanned and retained at the presenting bank and do not
move physically move to the paying bank. To meet the legal requirements, the
presenting banks have to preserve the physical instruments in their custody
securely for a period of 10 years.
Income Recognition and verification by auditors
24.09 The Auditor should get the SOP for income accrual at these branches.
Basis of income booking should be understood, normally an amount accrues
based on number of instruments processed and charges / fees for processing is
booked in service / clearing branch and it is debited to the branch for which
instruments are processed / decoded. Income recognized needs to be checked
by the Auditor with respective instruments processed.
24.10 The Auditor should also examine the correspondence with RBI Clearing
house and ensure that branches directly dealing with RBI clearing house are
following applicable rules and regulations. The Auditor should check that RBI
account, if any, is reconciled as at year-end. The Auditor should also check that
Penalty / charges / late fees if any charged by RBI are accounted for by the
branch. RBI levies penalty for omissions and errors. Such penalties should be
accounted for only after obtaining approval from competent authority who is
vested with discretionary powers for such expenditure.
24.11 The Service branch is required to install devices/machines to detect the
frauds. The Auditor should verify whether such machines are being used
extensively and whether they are in working condition etc.
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24.12 Inward Clearing

• The Auditor is to check whether signature of the drawer of the cheque is
being verified by the staff religiously or not as else there will be liability of the
paying bank under all circumstances.
• If the encoded amount is more than the cheque amount and the cheque is
passed through oversight, it will create contingent liability for the bank. The
Auditor is required to verify if any claims for refund of the amount excess
debited are received from the customer, such claims to be verified and if
necessary provision for that to be made.
• As per RBI guidelines, the branch is required to either call the customer or
email him for any cheque received for the amount of Rs. 5 lakh and above.
The Auditor may verify the compliance on test check basis.
Outward Clearing
24.13 For outward clearing the following need to be done:
• Branch is required to verify if the cheque paper quality invariably.
• Branch is also required to verify if the signature of the drawer of the cheque
is chemically altered.
• If the encoded amount is more than the cheque amount and the cheque is
sent for collection and passed through oversight by the paying bank, it will
create contingent liability for the bank. The Auditor is to verify if any claims
for refund of the amount excess credited are received from the other banks,
such claims to be verified and if necessary provision for that to be made.
Fraud Monitoring
24.14 After centralising the clearing transactions work, both inward and
outward, at the service branch, perpetration of fraud in this area has increased.
The Service branch should initiate steps on ongoing basis to prevent frauds. All
the staff at service branch to be involved in awareness programmes and training
programmes to minimise frauds. They should be made aware about the frauds
taken place in recent past in other banks to ensure against its repetition in the
bank.
24.15 The Auditor should check that the cheque collection charges including
Speed Clearing Charges are not levied by banks if the collecting bank and the
paying bank are located within the jurisdiction of the same CTS grid even though
they are located in different cities.
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24.16 LFAR Reporting

1. Does the branch have a system of periodic review of the outstanding
entries in clearing adjustments accounts? In your view has the system
generally been complied with?
 To obtain note or to review existing SOP followed by the Branch /
Bank.
 To check the process to review outstanding entries. Whether nature of
entries examined and reason assessed. Check action taken to
reconcile the unreconciled entries.
 Any MIS/ exceptional report generated from System.
 System for reporting of long outstanding entries to Head Office.
 to ensure daily printout of inward and outward clearing scroll are
generated by the service branch and corrections if any are done by
the authorised official in the system itself.
 to verify that no high value transactions are routed through personal
accounts.
 to examine the report on failure to lodge clearing cheques.
 whether any amount lying in suspense for clearing difference for an
unusual long period- normally any entry should not remain
outstanding for more than 3 working days of lodgement.
 To examine whether any instrument stolen or fraudulently obtained by
a fraudster if red flagged in the system on the basis of communication
from the concerned bank.
 The Auditor should check all relevant documents maintained by the
branch and comments on level of compliance by the Branch. In case
branch has not followed the defined process/ system like non-
reporting of long outstanding entries etc., the Auditor should report
same.
2. Whether review of the clearing adjustments accounts (inwards/ outwards)
reveals any old/ large/ unusual outstanding entries, which remain
unexplained? Give year-wise break-up of outstanding in number and value:
 To obtain clearing adjustment account and review old entries.
 To obtain ageing of old entries along with nature of such entries.
 On sample basis, check old entries from the system, to ensure
correctness of ageing given by the Branch.
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 On sample basis, check origination of old outstanding entries.

 Check action taken to reconcile the unreconciled entries.
Year-wise break up should be given of outstanding clearing in number and value
in the following format:
Inward Clearing Number Value
Normal Clearing
High Value
Inter-Branch Clearings
National Clearings
Returned/ Dishonored Clearings
Outward Clearing Number Value

Normal Clearing
High Value
Inter-Branch Clearings
National Clearings
Returned/ Dishonored Clearings
3. Has the Branch strictly followed the guidelines of the controlling authority of
the bank with respect to operations related to clearing transactions?
Comment on the systems and procedures followed by the Branch in this
regard.
 Considering the unique nature of operations of the clearing branch,
the Controlling authority (Head Office) normally issues guidelines with
respect to operations of clearing transactions. The Auditor should
obtain those guidelines from the Branch / controlling office and ensure
that the Branch is complying with it.
 The auditor should carry out walk-through of some sample
transactions & check reporting done by the Branch to Head office to
understand the process followed by the Branch.
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25
Recovery of Non-Performing Assets
by Asset Recovery Branches
Introduction and Bank’s Process

25.01 Banks have designated branches/ department for recovery of Non-
Performing Assets(NPA). The accounts which are already marked as NPA are
transferred from other branches to this branch for centralized monitoring. The
responsibility of this branch is to ensure the best resolution/ recovery from these
NPA accounts either by recovery or restructuring or realization from liquidation of
security. The details of primary and collateral security available with Bank with
respect to these NPA accounts are also maintained at this branch.
Audit approach, procedures including regulatory considerations
25.02 Refer chapter 11 “Reporting for Advances” of Section B of this
Guidance Note for guidance on audit of NPA, Provisioning, Restructuring.
25.03 Other critical aspects to be considered by the Auditor in case of Asset
Recovery Branches are as follows:
 Asset Recovery Branches deal with only NPA accounts. Most of them are
old and with large outstanding amounts. The Auditor should obtain a list of
all NPA accounts at the start of the financial year, movement during the
year and closing NPA Accounts. To ensure that opening and closing
balances are matching with respective trial balance.
 The accounts get classified as NPA either due to record of recovery or non-
financial indicators like Inherent weakness in account, Non-Achievement of
DCCO, Failure to comply with key restructuring conditions, Erosion in value
of security etc. It is important to understand the reason of NPA for each
account.
 The Auditor for this purpose also needs to consider the policy of
transferring NPA accounts to these branches, especially with reference to
system aspect. Also it needs to see policy of transferring back to respective
branches when the account got upgraded.
 To analyse the reason for movement during the year. Key reasons for
movement will be as follows:
o Accounts transferred from other branches to Asset recovery branches

during the year or vice-versa.
o Accounts upgraded during the year – special attention is required for
audit of these accounts.
o Recovery effected during the year.
o Movement in provision due to change in classification of NPA or
change in value of security.
 To check that interest income on NPA is recognized only on actual receipt,
Interest accrued earlier and not received should be reversed.
 To verify adherence to policy related to expenses incurred by the Banks
after accounts become NPA.
 Recovery - The following aspects need to checked:
o In the absence of a clear agreement between the bank and the
borrower for the purpose of appropriation of recoveries in NPAs (i.e.,
towards principal or interest due), banks are required to adopt an
accounting policy and exercise the right of appropriation of recoveries
in a uniform and consistent manner. The appropriate policy to be
followed is to recognise income as per AS 9, “Revenue Recognition"
when certainty is attached to realisation and accordingly amount
reversed/derecognised or not recognised in the past should be
accounted. Interest partly/fully realised in NPAs can be taken to
income. However, it should be ensured that the credits towards
interest in the relevant accounts are not out of fresh/additional credit
facilities sanctioned to the borrowers concerned.
o In case of long-term loans, the valuation report of the security pledged
(the date of valuation and the values) to be seen. A valuation report
normally contains three values (Fair value, market value and distress
value). The policy adopted by the bank for consideration of value
needs to be seen. Banks generally consider Fair value to reduce the
burden of provision in absence of specific direction from RBI. The
matters need to be judged based on the facts of the cases and short
fall, if any, is to be provided as per RBI norms.
o Valuation reports should not be older than three years.
o In case of cash credit the values of the security as entered in the CBS
should be cross checked with the terms in the sanction letter.
o Consider any orders issued by any of the authorities like DRT,
SARFASEI etc.
697
o Verify the CGTMSE amount as recorded in the books for facilities

availed under MSME schemes since provision and classification are
made after deducting the claimed amount. In most of the cases the
amounts are recorded as per the claims lodged by the bank with the
Authorities. In case of some banks, the branches forward the
application to the respective regional offices that in turn upload the
details in the Government portal. Any subsequent change in the portal
are not incorporated in the individual borrower level, for e.g. any
rejection or modification of the claim lodged with the Authorities.
o In order to reflect the actual receivable amounts, proper classification
and provision, this exercise should be done periodically for the bank
as a whole which will include both NPA and standard accounts.
 To ensure compliance with the requirements of RBI circular on Prudential
Framework for Resolution of Stressed Assets dated June 07, 2019 and the
requirements of the Insolvency and Bankruptcy Code, 2016, in case where
the Borrower has been referred to IBC.
Guidelines on Sale/Purchase of NPAs
25.04 The Master Circular on Advances requires the Board of Directors of
banks to lay down policy in respect of the sale/ purchase of NPAs, including:
(a) non-performing financial assets that may be purchased/ sold;
(b) norms and procedure for purchase/ sale of such financial assets;
(c) valuation procedure to be followed to ensure that the economic value of
financial assets is reasonably estimated based on the estimated cash
flows arising out of repayments and recovery prospects;
(d) delegation of powers of various functionaries for taking decision on the
purchase/ sale of the financial assets etc.; and
(e) accounting policy.
25.05 The RBI also casts a responsibility on the Board to satisfy itself that the
bank has adequate skills to purchase non-performing financial assets and deal
with them in an efficient manner which will result in value addition to the bank.
25.06 Banks while selling NPAs should, work out the net present value of the
estimated cash flows associated with the realisable value of the available
securities net of the cost of realisation. The sale price should generally not be
lower than the net present value so arrived.
25.07 The estimated cash flows are normally expected to be realised within a
period of three years and at least 10 per cent of the estimated cash flows should
698
be realised in the first year and at least 5 per cent in each half year thereafter,
subject to full recovery within three years.
25.08 A bank may purchase/sell non-performing financial assets from/to other
banks only on ‘without recourse’ basis, i.e., the entire credit risk associated with
the non-performing financial assets should be transferred to the purchasing
bank. The selling bank shall ensure that the effect of the sale of the financial
assets should be such that the asset is taken off the books of the bank and after
the sale there should not be any known liability devolving on the selling bank.
25.09 Banks should ensure that subsequent to sale of the non-performing
financial assets to other banks, they do not have any involvement with reference
to assets sold and do not assume operational, legal or any other type of risks
relating to the financial assets sold. Consequently, the specific financial asset
should not enjoy the support of credit enhancements / liquidity facilities in any
form or manner.
25.10 Under no circumstances can a sale to other banks be made at a
contingent price whereby in the event of shortfall in the realisation by the
purchasing banks, the selling banks would have to bear a part of the shortfall.
Further, NPAs can be sold to other banks only on cash basis. The entire sale
consideration should be received upfront and the asset can be taken out of the
books of the selling bank only on receipt of the entire sale consideration.
25.11 A non-performing financial asset should be held by the purchasing bank
in its books at least for a period of 12 months before it is sold to other banks.
Banks should not sell such assets back to the bank, which had sold the NPA.
25.12 Banks are also permitted to sell/buy homogeneous pool within retail
non-performing financial assets, on a portfolio basis provided each of the non-
performing financial assets of the pool has remained as non-performing financial
asset for at least 2 years in the books of the selling bank. The pool of assets
would be treated as a single asset in the books of the purchasing bank.
25.13 The selling bank should pursue the staff accountability aspects as per
the existing instructions in respect of the non-performing assets sold to other
banks.
25.14 Prudential norms for banks for the purchase/sale transactions issued by
RBI, from time to time, should be adhered to.
25.15 As per the Master Circular no. RBI/2015-16/101 DBR.No.BP.BC.2/
21.04. 048/2015-16 dated July 01, 2015 on “Prudential Norms on Income
Recognition, Asset Classification and Provisioning pertaining to Advances”, if
the sale is in respect of Standard Asset and the sale consideration is higher than
699
the book value, the excess provisions may be credited to Profit and Loss
Account. Excess provisions which arise on sale of NPAs can be admitted as Tier
II capital subject to the overall ceiling of 1.25 per cent of total Risk Weighted
Assets. Accordingly, these excess provisions that arise on sale of NPAs would
be eligible for Tier II status.
Asset Classification Norms for sale/purchase of NPA
25.16 The asset classification norms for sale/purchase of NPAs are as
follows:
(i) Non-performing financial assets purchased, may be classified as ‘standard’
in the books of the purchasing bank for a period of 90 days from the date of
purchase. Thereafter, the asset classification status of the financial asset
purchased, shall be determined by the record of recovery in the books of
the purchasing bank with reference to cash flows estimated while
purchasing the asset which should be in compliance with requirements as
discussed in previous paragraphs.
(ii) The asset classification status of an existing exposure (other than
purchased financial asset) to the same obligor in the books of the
purchasing bank will continue to be governed by the record of recovery of
that exposure and hence may be different.
(iii) Where the purchase/sale does not satisfy any of the prudential
requirements prescribed in these guidelines the asset classification status
of the financial asset in the books of the purchasing bank at the time of
purchase shall be the same as in the books of the selling bank. Thereafter,
the asset classification status will continue to be determined with reference
to the date of NPA in the selling bank.
(iv) Any restructure/reschedule/rephrase of the repayment schedule or the
estimated cash flow of the non-performing financial asset by the purchasing
bank shall render the account as a non-performing asset.
Provisioning Norms
Books of Selling Bank
25.17 The provisioning norms for books of the selling bank are as under:
(i) When a bank sells its non-performing financial assets to other banks, the
same will be removed from its books on transfer.
(ii) If the sale is at a price below the net book value (NBV) (i.e., book value
less provisions held), the shortfall should be debited to the profit and loss
account of that year.
700
(iii) If the sale is for a value higher than the NBV, the excess provision shall
not be reversed but will be utilised to meet the shortfall/ loss on account of
sale of other non-performing financial assets.
Books of Purchasing Bank
25.18 The provisioning norms for books of purchasing bank are as under:
The asset shall attract provisioning requirement appropriate to its asset
classification status in the books of the purchasing bank.
Accounting of Recoveries
25.19 Any recovery in respect of a non-performing asset purchased from other
banks should first be adjusted against its acquisition cost. Recoveries in excess
of the acquisition cost can be recognised as profit.
Capital Adequacy
25.20 For the purpose of capital adequacy, banks should assign 100 per cent
risk weights to the non-performing financial assets purchased from other banks.
In case the non-performing asset purchased is an investment, then it would
attract capital charge for market risks also.
Exposure Norms
25.21 The purchasing bank will reckon exposure on the obligor of the specific
financial asset. Hence these banks should ensure compliance with the prudential
credit exposure ceilings (both single and group) after reckoning the exposures to
the obligors arising on account of the purchase.
Disclosure Requirements
25.22 Banks which purchase non-performing financial assets from other
banks shall be required to make the following disclosures in the Notes on
Accounts to their Balance sheets:
A. Details of non-performing financial assets purchased: (Amounts in Rupees
crore)
1. (a) No. of accounts purchased during the year.
(b) Aggregate outstanding.
2. (a) Of these, number of accounts restructured during the year.
(b) Aggregate outstanding.
B. Details of non-performing financial assets sold: (Amounts in Rupees crore)
1. No. of accounts sold.
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2. Aggregate outstanding.
3. Aggregate consideration received.
4. Additional consideration realized in respect of accounts transferred in
earlier years.
5. Aggregate gain / loss over net book value.
C. Details of Book Value of investments in Security receipts: (Amounts in
Rupees crore)
1. Book Value of investments in Security receipts - Backed by NPA’s sold
by bank as underlying.
2. Book Value of investments in Security receipts – Backed by NPA’s sold
by other banks / financial institutions/ non – banking financial
companies as underlying.
3. Totals of the above.
25.23 The purchasing bank shall furnish all relevant reports to RBI, Credit
Information Company which has obtained Certificate of Registration from RBI
and of which the bank is a member etc. in respect of the non-performing financial
assets purchased by it.
Sale/ Purchase of NPAs
25.24 In case of a sale/ purchase of NPAs by the bank, the Auditor should
examine the policy laid down by the Board of Directors in this regard relating to
procedures, valuation and delegation of powers.
25.25 The Auditor should also examine to find that:
(i) only such NPA has been sold which has remained NPA in the books of the
bank for at least 2 years;
(ii) the assets have been sold/ purchased “without recourse’ only;
(iii) subsequent to the sale of the NPA, the bank does not assume any legal,
operational or any other type of risk relating to the sold NPAs;
(iv) the NPA has been sold at cash basis only;
(v) the bank has not purchased an NPA which it had originally sold.
25.26 In case of sale of an NPA, the auditor should also examine that:
(i) on the sale of the NPA, the same has been removed from the books of the
account.
(ii) the short fall in the net book value (NBV) has been charged to the profit
and loss account.
702
(iii) where the sale is for a value higher than the NBV, no profit is recognised
and the excess provision has not been reversed but retained to meet the
shortfall/ loss on account of sale of other non-performing financial assets.
25.27 Similarly, in case of purchase of NPAs, the Auditor should verify that:
(i) the NPA purchased has been subjected to the provisioning requirements
appropriate to the classification status in the books of the selling bank.
(ii) any recovery in respect of an NPA purchased from other banks is first
adjusted against its acquisition cost and only the recovered amount in
excess of the acquisition cost has been recognised as profit.
(iii) for the purpose of capital adequacy, bank has assigned 100 per cent risk
weights to the NPAs purchased from other banks.
25.28 LFAR Reporting
1. In respect of borrowers with outstanding of Rs. 10.00 Crores and above
and other sample accounts selected by Auditor, the information should be
obtained from the Branch Management. Comments of the Branch Auditor
on advances with significant adverse features and which might need the
attention of the management / Statutory Central Auditors should be
appended to the Long Form Audit Report.
 To obtain list and information of borrowers having outstanding of
Rs.10.00 Crores and above.
 To review movement during the year in those accounts.
 The branch auditors should review each account and give comments
on adverse features, if any in accounts.
 The comments of branch auditors will be either account specific or
observations on system which may have impact on bank as whole.
Auditor should highlight nature of each comment for proper action to
be taken by the management / Statutory Central Auditors.
 The reporting in LFAR is not substitute for qualification or modification
in audit report. Hence if the observation of Auditors warrants
qualification in audit report, the auditor should make reporting of same
in main report.
 If the observation of the Auditor is having impact on financial numbers
like short provisioning, error in valuation of securities etc., the Auditor
should get the same rectified by suggesting appropriate MOC for the
same.
703
2. List the accounts with outstandings in excess of Rs. 10.00 Crores, which
have been upgraded from Non-Performing to Standard during the year and
the reasons thereof.
Sr. Name of the Outstanding IRAC Status as IRAC Status as Reasons
No. Unit / Account [Rs. In on 31st March on 31st March
Crore] [Last Year] [Current Year]
1
2
3
4
5
 To obtain a list of all upgrade accounts during the year. In some

cases, once the accounts are upgraded same are being transferred to
other branches hence may not appear in closing balances of this
branch.
 To analyse the reason of upgrade and link the same with reason for
classifying an account as NPA.
 To check entries for recovery in core banking system to ensure there
is full recovery of all dues before upgrade of account.
3. Whether the Branch has a system of updating periodically, the information
relating to the valuation of security charged to the Bank?
 To obtain details of security charged to the bank against all NPA
accounts.
 To understand and review process of updating value of security in the
system.
 The branch auditor should enquire as to the existence of the system,
if any, pertaining to the valuation of security charged to the bank. If
the system is in existence, the Auditor should examine whether the
system periodically updates the information pertaining to the value of
such security and takes necessary steps for increase/diminution in the
value of such security.
 If branch has not timely updated value of security in the books then
Auditor shall update it by issuing of MOC.
704
 The Branch Auditor shall check that the minimum realisable value of
securities from two or more different valuation report of securities for
advance above Rs 10.00___ Crore to be updated in the books and
that valuation report shall not be older than three years.
 The Branch Auditor should check and ensure that the value of other
securities like stock, Book Debt, Etc. Are realisable in nature and it is
not older than the specified time limit.
4. Age-wise analysis of the recovery suits filed and pending may be furnished,
for the last 3 years along with latest status thereof.
Year No. of Accounts Amount [Rs. In Crore]
Up to March 2018
2018-19
2019-20
2020-21
 To obtain the list of all recovery suits filed and pending as at reporting
date.
 To give details of age-wise details of recovery suits.
5. Is the Branch prompt in ensuring execution of decrees obtained for
recovery from the defaulting borrowers? Also list the time barred decrees, if
any, and reasons thereof. Give age-wise analysis of decrees obtained and
not executed.
 In case decrees have been obtained for recovery from the defaulting
borrowers, the Auditor should check whether the branch is prompt in
execution of decrees like, drawings from the account and payment
from these accounts have been stopped. If not, the same should be
reported. The list should be given in the case of time barred decrees
with the reasons therefor.
6. List the recoveries and their appropriation against the interest and the
principal and the accounts settled / written off / closed during the year as
per the bank’s policy. Give particulars of recoveries which are pending for
appropriation as on year-end with reasons thereof.
 A list will have to be annexed which will specify the non-performing
advances recovered and the amounts adjusted towards interest and
principal. A list of the accounts settled, written off or closed, if any, will
also have to be attached. The Auditor should satisfy himself whether
the recoveries appropriated against interest are in accordance with
the RBI guidelines and normal accounting principles.
705
7. List the new borrower accounts transferred to the Branch during the year.
Have all the relevant documents and records relating to these borrower
accounts been transferred to the Branch? Has the Branch obtained
confirmation that all the accounts of the borrower [including non-fund-based
exposures and deposits pending adjustment / margin deposits] been
transferred to the Branch?
 A list of new borrower accounts transferred to the branch from the
other branches during the year should be annexed. The Auditor
should verify whether the documents and records relating to the
transferred accounts have been obtained like, letter from the
transferor branch, detail of the accounts, etc. The branch should also
obtain a confirmation that all the accounts of the borrower (including
non-fund based exposures and deposits pending adjustment/ margin
deposits) have been transferred to the branch. In case any adverse
features have been observed in such transfer, the same should be
reported.
706
26
Bank Branch Audit and GST
Compliance
Background
26.01 GST, a paradigm shift from origin based to destination-based tax in
indirect tax regime was implemented in India from 1st July 2017.
Article 366(12A) of the Constitution of India provides that, Goods and Services
Tax means any tax on supply of goods, or services or both except taxes on the
supply of the alcoholic liquor for human consumption.
India adopted Dual GST model in view of the federal structure of the country.
Here, Centre and States simultaneously levy GST on taxable supply of goods or
services or both which, takes place within a State or Union Territory. The Centre
also has the power to tax intra-State sales and States are also empowered to tax
services.
Extent of GST
26.02 GST in India comprises of the following:
(A) Central Goods and Services Tax Act, 2017 (“the CGST Act”) which
extends to the whole of India.
In terms of Section 2(56) of CGST Act:
“India” means the territory of India as referred to in Article 1 of the
Constitution, its territorial waters, seabed and sub-soil underlying such
waters, continental shelf, exclusive economic zone or any other maritime
zone as referred to in the Territorial Waters, Continental Shelf, Exclusive
Economic Zone and other Maritime Zones Act, 1976, and the air space
above its territory and territorial waters.
Central Goods and Service Tax (CGST) is levied on all intra-State supplies
of taxable goods and/or services and collected by the Central Government.
(B) State Goods and Services Tax Act, 2017 (“the SGST Act”) is levied and
collected by the State Government/ Union Territory with State Legislatures.
The SGST Act of the respective State/Union Territory with State Legislature
[Delhi and Pondicherry]** extends to the whole of that respective
State/Union Territory.
**State: includes a Union territory with Legislature [Section 2(103) of CGST

Act].
(C) Union Territory Goods and Services Tax Act, 2017 (“the UTGST Act”)
extends to the Union territories of the Andaman and Nicobar Islands,
Lakshadweep, Dadra and Nagar Haveli, Daman and Diu, Chandigarh and
other territory, i.e. the Union Territories without State Legislature [Section 1
of the UTGST Act].UGST is levied and collected by Central Government
through appointed administrator.
(D) Integrated Goods and Services Tax Act, 2017 (“the IGST Act”) extends
to the whole of India. IGST is levied on all inter-State supplies of goods or
services or both (except alcoholic liquor for human consumption) at a rate
recommended by the GST Council (not exceeding 40 per cent). It is
collected by Central Government.
Apart from the above Acts there is one more Act under GST namely “The Goods
and Services (Compensation to States) Act 2017”. This Act was introduced to
provide for compensation to the States for the loss of VAT revenue, if any arising
on account of implementation of GST. This tax is levied on a few supplies at
present. It is provided that such levy will be collected for five years but this period
can be extended on recommendation of the GST Council.
NOTE: It is pertinent to mention here that, GST extends to whole of India
including the State of Jammu and Kashmir. Though, GST was implemented in
the State of Jammu and Kashmir from 8th July, 2017 vide the Central Goods and
Services Tax (Extension to Jammu and Kashmir) Ordinance, 2017 and the
Integrated Goods and Services Tax (Extension to Jammu and Kashmir)
Ordinance, 2017 extending the domain of Central GST Act and the Integrated
GST Act to the State of Jammu and Kashmir.
26.03 Now with the advent of Jammu and Kashmir Reorganisation Act, 2019,
from 31st October, 2019, State of Jammu and Kashmir has been re-constituted
into two union territories:
 Jammu and Kashmir (Union territory of Jammu and Kashmir with
Legislature); and
 Ladakh (Union territory of Ladakh without Legislature) vide Jammu and
Kashmir Reorganisation Act 2019.
26.04 In this regard, Ministry of Home Affairs (Department of Jammu and
Kashmir Affairs) issued Jammu and Kashmir Reorganisation (Removal of
Difficulties) Order, 2019 which inter alia stipulates that-
708
 The Jammu and Kashmir Goods and Services Tax Act, 2017 shall be
applicable to the Union Territory of J&K; and
 The Union Territory Goods and Services Tax Act, 2017 shall be applicable
to the Union Territory of Ladakh.
26.05 In this regard, CBIC vide Notification no. 62/2019 dated 26-11-2019 as
amended by Notification no. 03/2020-Central Tax dated 01st January 2020 has
notified transition plan with respect to J&K reorganization w.e.f. 31.10.2019 to be
followed till 31.12.2019. Persons whose principal place of business was in J&K
till 30-10-2019 and continues to be so in either of the Union Territories (UTs)
from 31-10-2019:
 The October 2019 tax period will be from 1st to 30th October 2019 and for
November 2019 tax period it will from 31st October till 30th November, 2019.
 The tax to be declared and paid through GSTR-3B shall be irrespective of
the tax amounts shown in the invoices raised between 31 -10- 2019 to 31-
12-2019. This implies that any adjustments can be allowed in GSTR-3B.
 Such taxpayers are allowed to transfer the input tax credit available under
GSTIN registered under the erstwhile State of J&K to the new GSTIN now
logged in either of two UTs, subject to following conditions:
o The taxpayers must inform of the transfer to the jurisdictional officers
of both the erstwhile State of J&K as well as newly formed UTs as
may be applicable.
o proportion of transfer must be based on the ratio of the turnover
earned in each of the UTs.
o the transfer must be indicated by filing in the GSTR-3B of any tax
period transition date, debiting ITC in the transferor’s electronic credit
ledger [Table 4 (B) (2)] and crediting the transferee’s electronic credit
ledger [Table 4 (B) (5)].
 The State taxes will be converted to Union territory taxes from 01st day of
January 2020. All such taxpayers are relieved from compulsory registration if
they make interstate supplies till 31-12-2019 i.e. transitional period.
26.06 However, there is ambiguity with regard to fresh registration for the
taxpayers who were registered in the state of Jammu & Kashmir before the
reorganization Act and having additional place of registration in the State of
Ladakh UT (Formed after reorganization). In respect of such taxpayers, no clarity
has been provided by the Government as the till date neither such taxpayers
have been automatically provided the fresh GSTN or nor any mechanism has
709
been provided for obtaining the fresh registration to the taxpayer who have
premises in the UT of Ladakh. For the existing taxpayers registered under J & K
State earlier with State code(01), having Principal Place of Business in
jurisdiction of Union territory of Ladakh then such taxpayer has been allotted the
New GSTN no with (with UT code “38”). In respect of such taxpayers,
instructions have been issued that they are requested to use new GSTINs while
generating the invoices and receiving of supplies etc. w.e.f. 1 st Jan 2020.
Levy
26.07 In terms of charging section 9(1) of the CGST Act/ Section 5(1) of the
IGST Act, the Central goods and services tax (CGST)/ Integrated goods and
services tax (IGST) shall be levied on all intra-State/ inter State supplies of goods
or services or both, except on the supply of alcoholic liquor for human
consumption, on the value determined under section 15 and at such rates, not
exceeding 20 per cent, as may be notified by the Government on the
recommendations of the Council and collected in such manner as may be
prescribed and shall be paid by the taxable person.
Supply
As inferred from the above, the taxable event under GST is a “Supply”.
26.08 The term Supply as per Section 7(1) of the CGST Act includes:
(a) all forms of supply of goods or services or both such as sale, transfer, barter,
exchange, licence, rental, lease or disposal made or agreed to be made for
a consideration by a person in the course or furtherance of business;
(b) import of services for a consideration whether or not in the course or
furtherance of business; and
(c) the activities specified in Schedule I, made or agreed to be made without a
consideration.
26.09 Further, Section7(1A) of the CGST Act stipulates that, certain activities
or transactions which constitute supply as per Section 7(1) are to be treated as
supply of goods or supply of services as referred to in Schedule II.
26.10 Section 7 (2) of the CGST Act, states that notwithstanding anything
contained in section 7(1):
(a) activities or transactions specified in Schedule III; or
(b) such activities or transactions undertaken by the Central Government, a
State Government or any local authority in which they are engaged as
public authorities, as may be notified by the Government on the
recommendations of the Council;
710
shall be treated neither as a supply of goods nor a supply of services.

26.11 Section 7(3) provides that the Government may, on the
recommendations of the Council, specify, by notification, the transactions that
are to be treated as:
(a) a supply of goods and not as a supply of services; or
(b) a supply of services and not as a supply of goods.
26.12 Hence, the following parameters, can be adopted to characterize a
transaction as supply:
1. There should be a supply. Supply of either goods or service or both other
than supply of goods or services excluded under GST.
2. Supply should be made for a consideration.
3. Supply should be made in the course or furtherance of business.
4. Supply should be made by a taxable person.
5. Supply should be a taxable supply.
26.13 While aforesaid parameters describe the concept of supply, there are a few
exceptions to the requirement of supply being made for a consideration and in the
course or furtherance of business. However, there are the following exceptions:
(i) As laid down in section 7(1) (c) activities specified in Schedule I, made or
agreed to be made without a consideration are deemed to be a supply even
without consideration.
(ii) Further as per section 7(1) (b) import of services for a consideration,
whether or not in the course or furtherance of business is treated as supply.
26.14 Supply may be composite supply or mixed supply. Composite
supply means a supply made by a taxable person to a recipient consisting of two
or more taxable supplies of goods or services or both, or any combination
thereof, which are naturally bundled and supplied in conjunction with each other
in the ordinary course of business, one of which is a principal supply. “Mixed
supply” means two or more individual supplies of goods or services, or any
combination thereof, made in conjunction with each other by a taxable person for
a single price where such supply does not constitute a composite supply. The
tax liability on a composite or a mixed supply shall be determined in the
following manner, namely:
a) a composite supply comprising two or more supplies, one of which is a
principal supply, shall be treated as a supply of such principal supply;
and
711
b) a mixed supply comprising two or more supplies shall be treated as a

supply of that particular supply which attracts the highest rate of tax.
Other Important Definitions
26.15 At this juncture, after understanding the term supply, it is of paramount
importance to know what goods or services under GST are:
Section 2(52) of the CGST Act defines goods as under:
“goods means every kind of movable property other than money and
securities but includes actionable claim, growing crops, grass and things
attached to or forming part of the land which are agreed to be severed
before supply or under a contract of supply”.
Section 2(102) of the CGST Act defines Services as under:
“services means anything other than goods, money and securities but
includes activities relating to the use of money or its conversion by cash or
by any other mode, from one form, currency or denomination, to another
form, currency or denomination for which a separate consideration is
charged”.
26.16 Now since money and securities both are excluded from definition of
goods and services, it is imperative to understand these terms under GST:
As per Section 2(75) of the CGST Act:
“money means the Indian legal tender or any foreign currency, cheque,
promissory note, bill of exchange, letter of credit, draft, pay order, traveller
cheque, money order, postal or electronic remittance or any other instrument
recognised by the Reserve Bank of India when used as a consideration to
settle an obligation or exchange with Indian legal tender of another
denomination but shall not include any currency that is held for its
numismatic value”.
Section 2(101) of the CGST Act defines ‘securities’ thus:
“securities shall have the same meaning as assigned to it in clause (h) of
section 2 of the Securities Contracts (Regulation) Act, 1956”.
Section 2 of the Securities Contracts (Regulation) Act, 1956 defines “securities”
to include—
(i) shares, scrips, stocks, bonds, debentures, debenture stock or other
marketable securities of a like nature in or of any incorporated company or
other body corporate;
(ia) derivative;
712
(ib) units or any other instrument issued by any collective investment scheme to
the investors in such schemes;
(ic) security receipt as defined in clause (zg) of section 2 of the Securitisation
and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002;
(id) units or any other such instrument issued to the investors under any mutual
fund scheme;
Explanation.—For the removal of doubts, it is hereby declared that
"securities" shall not include any unit linked insurance policy or scrips or
any such instrument or unit, by whatever name called, which provides a
combined benefit risk on the life of the persons and investment by such
persons and issued by an insurer referred to in clause (9) of section 2 of the
Insurance Act, 1938 (4 of 1938)
(ie) any certificate or instrument (by whatever name called), issued to an
investor by any issuer being a special purpose distinct entity which
possesses any debt or receivable, including mortgage debt, assigned to
such entity, and acknowledging beneficial interest of such investor in such
debt or receivable, including mortgage debt, as the case may be;
(ii) Government securities;
(iia) such other instruments as may be declared by the Central Government to
be securities; and
(iii) rights or interest in securities.
26.17 Further, from definition of securities, GST applicability on certain
transactions can be analyzed:
Sr. Nature Applicability of GST
No.
1 Shares, scrips, stocks, bonds, Specifically covered in definition of
debentures, debenture stock or other Security, hence no GST.
marketable securities of a like nature
in or of any incorporated company or
other body corporate;
2 units or any other instrument issued Specifically covered in definition of
by any collective investment scheme Security, hence no GST.
to the investors in such schemes;
713
3 Security receipt as defined in clause Specifically covered in definition of

(zg) of section 2 of the Securitisation Security, hence no GST.
and Reconstruction of Financial
Assets and Enforcement of Security
Interest Act, 2002;
4 Units or any other such instrument Specifically covered in the
issued to the investors under any definition of security and hence no
mutual fund scheme; GST.
5 Government securities; Specifically covered in definition of
Security, hence no GST.
6 Forward Contract in Currencies - It is not covered in the definition of
Actual delivery of underlying securities and hence would be
currency; treated as normal supply of goods
and liable to GST (Commission
portion).
7 Forward Contract in Currencies - These are derivative transactions
Where the settlement takes place by and covered in the definition of
way of net settlement of differential of securities, hence no GST
the forward rate over the prevailing
market rate on the settlement date;
8 Future Contract It is a financial derivative and falls
within the definition of securities
and hence not liable to GST.
Commission and documentation
charges will be liable for GST.
26.18 Therefore, no GST will be levied on activities and transactions covered

in the definition of “money and securities”.
Applicability to Banking Sector
26.19 As evident from the above, GST is applicable on Banking services as
far as it qualifies the taxable event i.e. Supply of Services. However, following
supplies made without consideration as specified in Schedule I of the CGST Act,
2017 are subject to GST:
 Permanent transfer or disposal of business assets where input tax
credit has been availed on such assets.
 Inter Unit Supply: Supply of goods/ services or both between related
714
persons or between distinct persons as specified in section 25, when

made in the course or furtherance of business.
 As per Section 22(1) of CGST Act, every supplier shall be liable to be
registered under this Act in the State or Union territory, other than special
category States, from where he makes a taxable supply of goods or
services or both, if his aggregate turnover in a financial year exceeds
twenty lakh rupees Registration under GST has to be taken.
 Further as per section 25(2) A person seeking registration under this Act
shall be granted a single registration in a State or Union territory.
Provided that a person having multiple places of business in a State or
Union territory may be granted a separate registration for each such place
of business, subject to such conditions as may be prescribed.
Hence have to take separate registrations for branches in each state or
voluntarily Banks can take separate registrations for each branch/office.
Such separate registrations shall be distinct persons under the Act.
Therefore, any supply of goods or services or both between
branches/offices/head Office of the Banks having separate registrations,
without consideration, shall be considered as supply under GST for
payment of tax.
 Any activity amounting to supply provided by the employer to the
employee without consideration will be taxable under GST, except
where the value such supply does not exceed Rs. 50,000 in a financial
year.
Although no consideration is involved here, payment of tax needs to done on
the value determined in terms of section 15 of the CGST Act read with Rule
28 of the CGST Rules.
Such transactions are generally not captured in the books of accounts, and
therefore the Auditor should apply substantive audit procedure to check
compliances.
Exemptions relating to Banking Sector
26.20 GST is applicable on all services provided by the banks except the
followings:
 Services by the Reserve Bank of India;
It needs to be noted that services provided by Bank to RBI are exigible
to GST Services provided by the banks to Reserve Bank of India/ United
Nations, etc. are taxable as these are not specifically exempt or
excluded from GST.
715
 Services by way of—

(i) extending deposits, loans or advances in so far as the consideration
is represented by way of interest or discount (other than interest
involved in credit card services);
(ii) inter se sale or purchase of foreign currency amongst banks or
authorised dealers of foreign exchange or amongst banks and such
dealers.
Where-
(zk) “interest” means interest payable in any manner in respect of any
moneys borrowed or debt incurred (including a deposit, claim or other
similar right or obligation) but does not include any service fee or other
charge in respect of the moneys borrowed or debt incurred or in respect
of any credit facility which has not been utilized;
 Services provided by a banking company to Basic Saving Bank Deposit
(BSBD) account holders under Pradhan Mantri Jan Dhan Yojana
(PMJDY). [inserted w.e.f. 01-01-2019 vide Notification No. 28/2018-
Central Tax (Rate), dated 31-12-2018 in CGST and vide Notification No.
29/2018-Integrated Tax (Rate), dated 31-12-2018 in IGST.]
 Services by an acquiring bank, to any person in relation to settlement of
an amounts up to Rs. 2,000 in a single transaction transacted through
credit card, debit card, charge card or other payment card service.
Explanation. — For the purposes of this entry, “acquiring bank” means
any banking company, financial institution including non-banking
financial company or any other person, who makes the payment to any
person who accepts such card.
 Services supplied by Central Government, State Government, Union
territory to their undertakings or Public Sector Undertakings (PSUs) by
way of guaranteeing the loans taken by such undertakings or PSUs from
the banking companies and financial institutions. [Initially this exemption
was inserted w.e.f. 27-07-2018 vide Notification No. 14/2018-Central Tax
(Rate), dated 26-07-2018 in CGST and vide Notification No. 15/2018-
Integrated Tax (Rate), dated 26-07-2018 in IGST. Later, the words
"banking companies and" were inserted w.e.f. 01-01-2019 vide
Notification No. 28/2018-Central Tax (Rate), dated 31-12-2018 in CGST
and vide Notification No. 29/2018-Integrated Tax (Rate), dt.31-12-2018.]
 Services by way of collection of contribution under the Atal Pension
Yojana.
716
 Services by way of collection of contribution under any pension scheme

of the State Governments.
 Services by the following persons in respective capacities:
(a) business facilitator or a business correspondent to a banking
company with respect to accounts in its rural area branch;
(b) any person as an intermediary to a business facilitator or a business
correspondent with respect to services mentioned in entry (a); or
(c) business facilitator or a business correspondent to an insurance
company in a rural area.
 Services by an intermediary of financial services located in a multi
services SEZ with International Financial Services Centre (IFSC) status
to a customer located outside India for international financial services in
currencies other than Indian rupees (INR).
Where-
The intermediary of financial services in IFSC is a person,-
(i) who is permitted or recognised as such by the Government of India
or any Regulator appointed for regulation of IFSC; or
(ii) who is treated as a person resident outside India under the Foreign
Exchange Management (International Financial Services Centre)
Regulations, 2015; or
(iii) who is registered under the Insurance Regulatory and Development
Authority of India (international Financial Service Centre) Guidelines.
2015 as IFSC Insurance Office; or
(iv) who is permitted as such by Securities and Exchange Board of India
(SEBI) under the Securities and Exchange Board of India
(International Financial Services Centres) Guidelines, 2015.
[inserted w.e.f. 25-01-2018 vide Notification No. 2/2018-Central Tax
(Rate), dated 25-01-2018 in CGST and vide Notification No. 2/2018-
Integrated Tax (Rate), dated 25-01-2018 in IGST]
 Services provided to the Central Government, State Government, Union
territory under any insurance scheme for which total premium is paid by
the Central Government, State Government and Union territory.
Intra/ inter-state supply of the above services has been specifically exempted
vide Notification No. 12/2017- Central Tax (Rate) dated 28th June,
2017[“Notification No. 12/2017”] and Notification No. 09/2017-Integrated Tax
717
(Rate) dated 28-6-2017 [“Notification No. 9/2017-ITR”] as amended from time

to time.
26.21 Additional exemptions under the IGST are:
 services received by RBI from outside India in relation to management of
foreign reserves. [Notification No. 9/2017-ITR]
 services imported by a unit or a developer in the Special Economic Zone
for authorised operations. [Notification No. 18/2017-Integrated Tax
(Rate) dated 5-7-2017]
26.22 Services provided by Asian Development Bank (ADB) and International
Finance Corporation (IFC) are exempt from GST as clarified by CBIC vide
Circular No. 83/02/2019-GST, dated 1-1-2019 read with C.B.I. & C. Circular
No. 211/1/2019-S.T., dated 15-1-2019.
26.23 The ADB Act, 1966 provides that notwithstanding anything to the
contrary contained in any other law, the Bank, its assets, properties, income
and its operations and transactions shall be exempt from all the taxation and
from all customs duties. The Bank shall also be exempt from any obligation
for payment, withholding or collection of any tax or duty [Section 5 (1) of the
ADB Act, 1966 read with Article 56 (1) of the schedule thereto refers]. Vide
letter No. 1/28/2002-ADB dated 22-01-2004 to ADB, it is conveyed that
services provided by ADB are exempted from service tax.
26.24 Similarly, IFC Act, 1958 also provides that notwithstanding anything to
the contrary contained in any other law, the Corporation, its assets,
properties, income and its operations and transactions authorised by the
Agreement, shall be immune from all taxation and from all customs duties.
The Corporation shall also be immune from liability for the collection or
payment of any tax or duty [Section 3 (1) of IFC Act, 1958 read with Article
VI, Section 9 (a) of the Schedule thereto refers].
26.25 CESTAT Mumbai vide final order dated 17-10-2016 in the case of M/s
Coastal Gujarat Power Ltd. has held that when the enactments that honour
international agreements specifically immunize the operations of the service
provider from taxability, a law contrary to that in the form of Section 66A of
Finance Act, 1994 will not prevail. With the provider being not only immune
from taxation but also absolved of any obligation to collect and deposit any
tax, there is no scope for subjecting the recipient to tax. There is no need for
a separate exemption and existing laws enacted by the sovereign legislature
of the Union suffice for the purpose of giving effect to agreements.
26.26 Accordingly, it is clarified that the services provided by IFC and ADB
are exempt from GST in terms of provisions of IFC Act, 1958 and ADB Act.
718
The exemption will be available only to the services provided by ADB and IFC
and not to any entity appointed by or working on behalf of ADB or IFC.
Taxability of the Income Earned by Banks
26.27 Albeit interest income forms the major part of the income of bank but
due to globalisation banking sector has involved themselves into numerous
activities resulting into variety of incomes. Let us analyze the applicability of
GST on various income so earned by banks:
1) Interest income - The income earned by way of grant of loans, deposits
etc., is a taxable supply. However, by virtue of entry 27(a) of Notification
No. 12/2017 and entry 28(a) of Notification No. 12/2017-ITR, no GST is
payable on income earned by way of interest except interest income
earned through credit card. The relevant extract of the said entry is as
under:
Sl Chapter, Description of services Rate Condition
No. Section, (%)
Heading, Group
or Service
Code (Tariff)
27 Heading 9971 (a) Services by way of— NIL NIL
(a) extending deposits,
loans or advances in so
far as the consideration is
represented by way of
interest or discount (other
than interest involved in
credit card services);
Para 2 clause (zk) of Notification No. 12/2017clarifies that interest does not
include any service fee or other charge in respect of the moneys borrowed
or debt incurred or in respect of any credit facility which has not been
utilised.
Therefore, audit from the perspective of GST may be restricted to the
fundamental question as to whether the income is rightly characterized
as ‘interest’ to enjoy the exemption under GST and especially the
income earned from credit card services as it is taxable under GST.
2) Commission income – Such income is classified as a supply of service
transaction and accordingly would be classified in terms of chapter
heading as specified in the relevant notifications issued under GST.
719
Commission earned (on accrual) is liable to GST. For e.g.: A Ltd. wants
to invest in fixed securities / bonds which can be only routed through
ICICI bank as they have exclusive rights for subscribing the same. ICICI
bank gets 2 per cent commission on the amounts so subscribed. For the
period 2020-21, the bank earns Rs. 250 crores of commission from such
subscription which is recorded as ‘Other Income’. The Auditor has to
check
o Whether GST is appropriately disbursed on the said amount.
o Whether payments are made by complying with the due date for
payment of GST.
If the tax is not discharge, then appropriate disclosure would be
required.
o Verify that the returns filed reveal the correct amount of liability.
Discrepancy in the returns filed (after any revision) and liability as
determined may be disclosed.
o Interest being mandatory may be suitably included in the disclosure.
o Suitable disclosure as to whether any contingency exists in respect
of applicable penalty may also be provided.
Further, review of agreements where commission is earned must be
carried out thoroughly and if any milestone incentives, performance
bonus, time bonus etc., is provided then appropriate tax treatment
should be suggested.
3) Brokerage income-This income is classified as a supply of service
transaction and accordingly would be classified in terms of chapter
heading as specified in the relevant notifications issued under GST.
4) Agency charges -Generally, such income is earned on account of being
appointed as an agency either by RBI, State Governments, Central
Governments or by some corporates. Under such arrangements, banks
act as a facilitator/collection centre and in lieu of provision of such
services such banks collect certain fees as “Agency charges”. Such
charges are liable for payment of GST. Very often, the underlying
arrangement will be of agency, but it may be described in a
contemporary terminology like ‘enablement charge’ or ‘facilitation fee’ or
simple ‘management fee’ which may appear misleading.
The Auditor needs to analyse the relevant agreements entered and has
to study the flow of consideration and its nature and thereafter decide
the taxability and the amount on which GST is applicable. The same has
to be communicated to the management if no GST is being paid till date.
720
5) Portfolio management service: Generally, the said services are being

provided by different entities within the banking sector. Due to stiff
competition and one-stop window for priority customer’s (i.e. customers
who are depositing amount beyond a certain limits) only one person
provides all such services and thereafter relevant commission is split
between entities or costs are shared. In fact, inter-branch sharing of
portfolio management services in lieu of the skill set available in selected
branches between different states is taxable and a fair value has to be
assigned to such transactions and applicable GST is payable on such
transactions. Further, appropriate classification has to be made for such
supply of services under relevant chapter heading as per the
notifications issued under GST.
6) Account maintenance charges: It is a common practice that in most of
the banks certain charges are recovered towards maintenance. The said
charges are nominal but the same is liable for payment of GST.
Accordingly, the concerned concurrent /internal /statutory auditor would
have to check on this aspect of taxability and ensure compliance.
Further, even locker charges are being recovered from the customers on
an annual basis which is liable for payment of GST. There can be
different modes of arrangement for availing such income, but such
income is taxable under GST.
7) Credit/Debit card charges- Income earned by way of issuing and
maintaining such transactions were liable for payment of GST.
Therefore, the Auditor should carefully examine such transactions and
appropriate disclosures be made in case of non-compliance with relevant
tax provisions. Following question in FAQs released is relevant in this
regard-
Q. Whether GST will be levied on interchange fees on card settlement
fees paid/shared by banks?
Ans. Fees charged for card settlement is a consideration which is part of a
separate transaction between the banks which are parties to this
transaction and shall be liable to GST. This is a B2B supply and credit
of this transaction is available.
8) Digital payment facilities- Banks charges some convenience fees from
persons who accept payment through debit card, credit card or through
some other card service. The charges earned by the bank are
chargeable under GST. No GST will be payable in respect of services
721
provided by bank, to any person in relation to settlement of an amount

up to Rs. 2000 in a single transaction transacted through credit card,
debit card or charge card or other payment card service.
9) Sale and purchase of foreign currency: Banking companies receiving
consideration for providing services by way of securities and foreign
exchange broking and purchase or sale of foreign currency, including
money changing is chargeable to GST on special value calculated as per
option availed in terms of Rule 32 of CGST Rules, 2017.
Hence at the time of conversion (purchase/sale) of foreign currency to

Indian currency or vice a versa, GST is applicable in two stages; once on
the charges separately levied by banks for such conversion and
secondly on value of sale/purchase as per Rule 32 of CGST Rules,
2017.
However, pursuant to entry no. 27(b) of Notification No. 12/2017 and

entry no.28(b) of Notification no 9/2017-ITR, inter-bank transactions of
sale or purchase of foreign currency or transactions with authorized
dealers of money changing are exempted under GST regime.
10) Other income-

o Income earned by banks by way of penalties, retention charges etc
are liable for payment of GST.
o Realisation of payment (NPA) by way of disposal of NPA to an asset
reconstruction company [ARC] or to any other buyer is a debatable
issue. There is a variant view to the aforesaid transaction and the
taxability will depend upon the structuring of the transaction. One
view is that this transaction may be considered as actionable claim
and GST will also not apply as definition of supply [Clause 6
Schedule III read with Section 7] under CGST Act exclude
actionable claim. Another view is that, this transaction may be an
outright sale. And when there is outright sale, the GST applicability
will depend on the nature of underlying asset sold and is to be paid
by borrower. e.g. IVY Bank sells one of its NPA as a going concern
to Company ABC then the instant transaction is taxable under GST
but the same is classified as a supply of service and accordingly the
rate of tax payable is NIL in terms of Entry 2 classified under
Chapter 99 as specified under Notification No. 12/2017.
722
26.28 The aforesaid discussion on the nature of services by bank and their
taxability is summarised as under:
Sl Nature of Service Remarks about Taxability

No.
1. Assignment or Sale of Debts Not Chargeable (Sale, transfer or
assignment of debts falls within the
purview of the actionable claims,
which are neither good nor service as
per Schedule III of the CGST Act. )
2. Bank Guarantee Commission Taxable
Charges
3. Bill Discounting Exempt to the extent of interest
component. However, commission,
fees, brokerage or documentation
charges will be taxable.
4. Charges on Cheque Bouncing Taxable
5. Interest and charges on delay/ Taxable
non-payment of credit card
bills
6. Charges for issuance of Taxable
Demand Draft
7. Loan or other Documentation Taxable
Charges
8. Forward Contract in Where the settlement takes place by
Currencies way of actual delivery of underlying
currency, then such forward contracts
would be treated as normal supply of
goods and liable to GST (Commission
portion).
Where the settlement takes place by
way of net settlement of differential of
the forward rate over the prevailing
market rate on the settlement date,
the same would be falling within the
purview of ‘securities’ as securities are
neither ‘goods’ nor ‘services’ as
defined in the CGST Act, 2017,
723
therefore future contracts are not

chargeable to GST.
9. Future Contracts Not Chargeable (Since it is financial
derivative and falls within the definition
of securities (which is neither goods
nor service in GST) and hence they
are not liable to GST. Commission and
documentation charges will be liable
for GST.
10. Income from Commercial Exempt, due to nature of interest.
Paper or Certificate of Deposit
11. Inspection Charges Taxable
12. Interest/ Discount on Loans / Exempt
Deposits or Advances
13. Issuance of Bank Statement Taxable, except for Basic Saving Bank
Charges Deposit (BSBD) account holders under
Pradhan Mantri Jan Dhan Yojana
(PMJDY).
14. Issuance of Letter of Credit Exempt, as it is included in the
definition of ‘Money’ u/s 2(75) of
CGST Act and hence outside the
definition of goods and services.
15. Ledger Folio Charges Taxable
16. Loan takeover transactions Taxable (GST will be charged on the
processing fees charged for the
takeover of the loan).
17. Processing Fees on Loans Taxable
18. Promissory Notes Not Chargeable [As it is covered in the
definition of “money” (which is neither
good nor service in GST) and hence
exempt. However, if any extra amount
is charged in the name of commission,
fees, brokerage etc. then it will be
chargeable].
19. Sale of Derivatives Not Chargeable (Since derivatives
falls within the definition of securities
(which is neither good nor service in
GST) and hence they are not liable to
724
GST. However, if any extra amount

charged in the name of commission,
fees, brokerage etc. than it will be
chargeable.
20. Security receipt as defined in Exempt, as covered under definition of
clause (zg) of section 2 of the "securities", which is excluded from
Securitisation and definition of "Goods" and “Services”.
Reconstruction of Financial
Assets and Enforcement of
Security Interest Act
21. Services provided to Reserve Interest charged on deposit kept with
Bank of India RBI is exempt. Other charges are
taxable, as not exempt specifically.
22. Standing Instruction Charges Taxable, except for Basic Saving Bank
Deposit (BSBD) account holders under
(PMJDY).
23. Stop Payment Charges Taxable, except for Basic Saving Bank
Deposit (BSBD) account holders under
(PMJDY).
24. Services supplied by a Taxable under RCM
recovery agent to a bank.
25. Services supplied by individual Taxable under RCM
Direct Selling Agents (DSAs)
other than a body corporate,
partnership or limited liability
partnership firm to bank.
26. Services provided by BF/BC to Exempt in Entry no. 39 [Heading no.
a banking company in 9971] of Notification 12/2017
compliance with RBI’s
CircularNo.DBOD.No.BL.BC.5
8/22.01.001/2005-2006dated
25.01.2006 and subsequent
instructions on the issue.
27. Services provided by a Exempt by NN 28/2018 dated 31 st
banking company to Basic December 2018.
Saving Bank Deposit (BSBD)
account holders under
725
Pradhan Mantri Jan Dhan

Yojana (PMJDY).
28. business facilitator or a Exempt by Notification 12/2017
business correspondent to a
banking company with respect
to accounts in its rural area
branch;
29. any person as an intermediary Exempt by Notification 12/2017
to a business facilitator or a
business correspondent with
respect to services mentioned
in Entry 28
30. Penal interest in case of delay Exempt with reference to Circular No.
payment of EMI 102/21/2019- GST dated 28th June
2019
31. Foreclosure charges for Under Service tax regime taxability of
foreclosure of loan to such income was under litigation and
compensate for the loss in recently CESTAT (LB) Madras in its
interest income decision in case of M/s Repco Home
Finance Ltd. Reported at 2020-TIOL-
1039-CESTAT-MAD-LB has held that
Service tax cannot be levied on the
foreclosure charges levied by the
banks and non-banking financial
companies on premature termination
of loans under "banking and other
financial services" as defined under
section 65 (12) of the Finance Act,
1994
One may take the base of the above
stated decision and argue that under
GST as well the said income is not
taxable.
However, the view of the department
may differ and it may cause litigation
in the future.
Hence all income sources of the banks, have to be thoroughly scrutinized

and thereafter the Auditor has to comment on its taxability, classification and
726
compliance with tax payment along with interest, applicable penalty and
transparency in disclosure in the returns filed.
Rate of Tax under GST
26.29 Broadly the rates of tax in GST are – Nil; 0.25; 3; 5; 12; 18 and 28 per
cent. Depending upon the classification of goods or types of services,
different rates are applicable on different goods or services. These rates are
uniform across India. In case IGST is levied, the rate is applied in
consolidation, say 18% IGST; and in case CGST and SGST are levied, the
rate is applied in two equal parts say 9 per cent CGST and 9 per cent SGST.
The charging section of CGST Act and IGST Act provides an upper cap of
rate as 20 per cent and 40 per cent respectively. However, currently the
actual maximum tax prescribed on any commodity or services is 28 per cent
plus cess, if applicable.
There is an increase in the tax rate from 15 per cent in service tax (erstwhile
indirect tax) to 18 per cent under GST on the transaction charges levied on
the financial services provided by the banks in relation to credit card, fund
transfer, ATM transactions, processing fees on loans etc.
Classification of Goods and Services
26.30 When we say that different rates have been prescribed for different
types of goods and services or when we say that tax is payable under
reverse charge for specific types of goods and services, we recognise these
different types of goods and services by their classification under the GST
Law. How the law has classified these goods and services is explained
below.
1. Classification of goods- Classification of goods in the GST Law is
based on HSN Codes. HSN system is a ‘Harmonised System of
Nomenclature’ to give a unique code to each commodity by which it is
recognized for the purpose of international trade. Each code is
accompanied with the corresponding description of goods which are
covered under that code.
In the GST Law, the HSN codes of the Customs Tariff Act have been
recognised. In the Customs Tariff Act, 1985, there are 98 Chapters
containing these codes. Each Chapter pertains to a broader class of
commodities and contains sub-codes for sub-classes of such commodity.
2. Classification of services - In GST, a list of different classes of
services has been given vide Annexure to Notification No. 11/2017-
Central Tax (Rate). This Annexure contains 4 to 6 digit numeral codes
727
for every description of services. One has to identify the service code
which matches with the description of service.
TIME OF SUPPLY under GST
26.31 Supply has been understood to hold the key to the incidence of GST,
but it is the ‘time of supply’ that determines the occasion when this incidence
will come to rest.
In order to calculate and discharge tax liability it is important to know the date
when the tax liability arises i.e. the date on which the charging event has
occurred. In GST law, it is known as Time of Supply. GST law has provided
separate provisions to determine the time of supply of goods and time of
supply of services. Sections 12, 13 & 14 of the CGST Act, 2017, deal with
time of supply and by virtue of section 20 of the IGST Act, 2017, these
provisions are also applicable to inter-State supplies chargeable to integrated
tax.
26.32 Therefore, it is essential to comprehend the time of supply of services
provided by the banks. Pursuant to section 13 of the CGST Act, time of
supply of services shall be the earliest of the following dates, namely: —
a) the date of issue of invoice by the supplier, if the invoice is issued within
the period prescribed under sub-section (2) of25 section 31 or the date of
receipt of payment, whichever is earlier; or
b) the date of provision of service, if the invoice is not issued within the
period prescribed under sub-section (2) of26 section 31 or the date of
receipt of payment, whichever is earlier; or
c) the date on which the recipient shows the receipt of services in his books
of account, in a case where the provisions of clause (a) or clause (b) do
not apply.
Explanation: -
 Date of receipt of payment: The date on which the payment is entered in
the books of account of the supplier or the date on which the payment is
credited to his bank account, whichever is earlier.
 Date of issue of invoice: If the supplier of services is an insurer or
banking company or financial institution including NBFC, invoice is to be
issued within 45 days from the date of supply of service.
25Omitted vide The Central Goods and Services Tax Amendment Act, 2018 w.ef. 01.02.2019.
26 Omitted vide The Central Goods and Services Tax Amendment Act, 2018 w.e.f.
01.02.2019.
728
26.33 It is pertinent to mention that, where the supplier of taxable service

receives an amount up to Rs. 1,000/- in excess of the amount indicated in
the tax invoice, the time of supply to the extent of such excess amount shall,
at the option of the said supplier, be the date of issue of invoice relating to
such excess amount.
Time of supply in case of reverse charge
26.34 In case of supplies in respect of which tax is paid or liable to be paid
on reverse charge basis, the time of supply shall be, earlier of the following
dates, namely: -
(a) the date of payment as entered in the books of account of the recipient
or the date on which the payment is debited in his bank account,
whichever is earlier; or
(b) the date immediately following sixty days from the date of issue of
invoice or any other document, by whatever name called, in lieu thereof
by the supplier;
Further, where it is not possible to determine the time of supply under
clause (a) or clause (b), the time of supply shall be the date of entry in
the books of account of the recipient of supply.
26.35 Moreover, in case of supply by associated enterprises, where the
supplier of service is located outside India, the time of supply shall be the
date of entry in the books of account of the recipient of supply or the date of
payment, whichever is earlier.
26.36 Time of supply of goods or services (Residual provisions): In case it
is not possible to determine the time of supply under aforesaid provisions,
the time of supply is:
 Due date of filing of return, in case where periodical return has to be
filed.
 Date of payment of tax in all other cases.
Invoice
26.37 As inferred from the above, GST is chargeable at the time of supply.
Invoice is an important indicator of the time of supply. Tax invoice is the
primary document evidencing the supply by the supplier and vital for availing
input tax credit by the recipient. Under the GST regime, an “invoice” or “tax
invoice” means the tax invoice referred to in section 31 of the CGST Act. This
section mandates issuance of invoice or a bill of supply for every supply of
goods or services or both.
729
26.38 The type of invoice to be issued depends upon the category of

registered person making the supply. For eg. if a registered person is making
supplies, then a tax invoice needs to be issued by such registered person.
However, if a registered person is dealing only in exempted supplies or is
availing composition scheme, then such registered person needs to issue a
bill of supply in lieu of tax invoice.Further, where a registered person is
supplying taxable as well as exempted goods or services or both to an
unregistered person, a single-invoice-cum-bill of supply may be issued for all
such supplies.
26.39 In terms of Rule 46 of the CGST Rules, 2017, subject to Rule 54
(Tax invoice in special cases), a tax invoice referred to in section 31, shall be
issued by the registered person containing the following:
(a) name, address and GSTIN of the supplier;
(b) a consecutive serial number, not exceeding sixteen characters, in one
or multiple series, containing alphabets or numerals or special
characters hyphen or dash and slash symbolised as “-” and “/”
respectively, and any combination thereof, unique for a financial year;
(c) date of its issue;
(d) name, address and GSTIN or UIN, if registered, of the recipient;
(e) name and address of the recipient and the address of delivery, along
with the name of State and its code, if such recipient is un-registered
and where the value of taxable supply is Rs. 50,000/- or more;
(f) name and address of the recipient and the address of delivery, along
with the name of the State and its code, if such recipient is un-
registered and where the value of the taxable supply is less than `
50,000/- and the recipient requests that such details be recorded in the
tax invoice;
(g) Harmonised System of Nomenclature code for goods or services;
[As regards the requirement to quote the HSN of the supplies, the
annual turnover of the registered person for the previous year shall be
referred. In case of suppliers having annual turnover in the previous
year:
i. Up to Rs.1.5 Crore – No HSN required
ii. Exceeding Rs. 1.5 Crore up to Rs. 5 Crore – HSN up to 2 digits
required
iii. Exceeding Rs.5 Crore – HSN up to 4 digits required.
730
8 Digit HSN Code needs to be quoted in case of Export Turnover

irrespective of the quantum of turnover.
The term ‘annual turnover’ has not been defined. Therefore, it may be
understood, to be the turnover in the State as defined in Section 2(112)
of the Act, computed for the preceding financial year.
It is also relevant to note that there has been no notification issued in
respect of services, separately. However, considering that the term
‘HSN’ has been used commonly in respect of both goods and services,
the aforesaid order can be applied even in respect of services, while
quoting the code from the scheme of Classification of Services, as
provided in Notification No. 11/2017-Central Tax (Rate) dated.28-06-
2017.]
(h) description of goods or services;
(i) quantity in case of goods and unit or Unique Quantity Code thereof;
(j) total value of supply of goods or services or both;
(k) taxable value of supply of goods or services or both considering
discount or abatement, if any;
(l) rate of tax (central tax, State tax, integrated tax, Union territory tax or
cess);
(m) amount of tax charged in respect of taxable goods or services (central
tax, State tax, integrated tax, Union territory tax or cess);
(n) place of supply along with the name of State, in case of a supply in the
course of inter-State trade or commerce;
(o) address of delivery where the same is different from the place of supply;
(p) whether the tax is payable on reverse charge basis; and
(q) signature or digital signature of the supplier or his authorized
representative.
However, such signatures or digital signature shall not be required in
the case of issuance of an electronic invoice in accordance with the
provisions of the Information Technology Act, 2000 (21 of 2000).
26.40 Further, the Government may, by notification, on the
recommendations of the Council, and subject to such conditions and
restrictions as mentioned therein, specify that the tax invoice shall have
Quick Response (QR) code. In this regard, w.e.f.01/10/2020, Government
731
has notified vide N/N- 72/2019 of CGST Act dated 13 th December 2019 that,
an invoice issued by a registered person, whose aggregate turnover in a
financial year exceeds Rs. 500 crore, to an unregistered person (hereinafter
referred to as B2C invoice), shall have Quick Response (QR) code. Where
such registered person makes a Dynamic QR code available to the recipient
through a digital display, such B2C invoice issued by such registered person
containing cross-reference of the payment using a Dynamic QR code, shall
be deemed to be having QR code.
26.41 Further, Notification No 68/2019-Central Tax dated 13th December
2019, inter alia inserted Rule 48(4) of CGST Rules, 2017, which stipulates
that the invoice shall be prepared by including particulars contained in Form
GST INV-01 after obtaining an Invoice Reference Number by uploading
information contained therein on the Common Goods and Services Tax
Electronic Portal in such manner and subject to such conditions and
restrictions as may be specified in the notification. In this regard, w.e.f.1 st
April 2020, vide Notification No. 70/2019 dated 13th December 2019, the
Government have notified registered person, whose aggregate turnover in a
financial year exceeds Rs. 100 crores, as a class of registered person who shall
prepare invoice in terms of Rule 48(4) in respect of supply of goods or services
or both to a registered person.
The Government has also notified the Common Goods and Services Tax
Electronic Portal for the purpose of preparation of the invoice as per Rule
48(4).
26.42 It is pertinent to mention that in case of export of goods or services,
the invoice shall carry an endorsement as follows:
1. Where the supply is effected on payment of IGST: “Supply meant for
export/supply to SEZ unit or SEZ developer for authorised operations
on payment of integrated tax” or
2. Where the supply is effected without payment of IGST: “Supply meant
for export/supply to SEZ unit or SEZ developer for authorised
operations under bond or letter of undertaking without payment of
integrated tax”. And details in lieu of those specified in Rule 46 (e) cited
supra, contain the following:
(i) name and address of the recipient;
(ii) address of delivery; and
(iii) name of the country of destination.
732
Time Limitation for Issuance of Invoice

26.43 Section 31(2) read Rule 47 provide that a registered person
supplying taxable services shall, before or after the provision of service but
within 30 days (or 45 days in case of suppliers of services being an insurer /
banking company / financial institution, including a NBFC) from the date of
supply of the service, issue a tax invoice, showing the description, value, tax
charged thereon and such other particulars as has been prescribed in the
Invoice Rules.
26.44 Further, an insurer or a banking company or a financial institution,
including a NBFC, or a telecom operator, or any other class of supplier of
services as may be notified by the Government on the recommendations of
the Council, making taxable supplies of services between distinct persons as
specified in section 25, may issue the invoice before or at the time such
supplier records the same in his books of account or before the expiry of the
quarter during which the supply was made.
26.45 Moreover, the Government may, on the recommendations of the
Council, by notification and subject to such conditions as may be mentioned
therein, specify the categories of services in respect of which:
(a) Any other document issued in relation to the supply shall be deemed to
be a tax invoice; or
(b) Tax invoice may not be issued.
26.46 Therefore, an insurer / banking company / financial institution,
including a NBFC may issue an invoice or any other document in lieu thereof.
26.47 Rule 54 of the CGST Rules which contain provisions relating tax
invoices in cases of special services, inter alia stipulates that, an insurer or a
banking company or a financial institution, including a non-banking financial
company, may issue a consolidated tax invoice or any other document in lieu
thereof, by whatever name called for the supply of services made during a
month at the end of the month, whether issued or made available, physically
or electronically whether or not serially numbered, and whether or not
containing the address of the recipient of taxable service but containing other
information as mentioned under rule 46.
26.48 The signature or digital signature of the supplier or his authorised
representative shall not be required in the case of issuance of a consolidated
tax invoice or any other document in lieu thereof as per the Information
Technology Act, 2000.
26.49 Further, Section 31 (1)(b) read with the proviso to rule 46 provides
that a registered person [other than the supplier engaged in making supply of
733
services by way of admission to exhibition of cinematograph films in multiplex

screens,] may not issue a tax invoice if the value of the goods or services or
both supplied is less than Rs. 200/- subject to the following conditions,
namely:
(1) the recipient is not a registered person; and
(2) the recipient does not require such invoice.
However, the supplier shall issue a consolidated tax invoice for such supplies
at the close of each day in respect of all such supplies.
Therefore, Banking companies have the option to issue a consolidated tax
invoice or any other document in lieu of tax invoice for the supply of services
made during a month, at the end of the month, either in physical form or
electronically.
Note
 A registered person on receipt of advance payment with respect to any
supply shall issue receipt voucher.
 Further, where at the time of receipt of advance:
o the rate of tax is not determinable the tax shall be paid at the rate of
18 per cent.
o the nature of supply is not determinable, the same shall be treated
as inter-State supply.
 Where, on receipt of advance payment with respect to any supply of
goods or services or both the registered person issues a receipt voucher,
but subsequently no supply is made and no tax invoice is issued in
pursuance thereof, the said registered person may issue to the person
who had made the payment, a refund voucher against such payment.
 A registered person who is liable to pay tax under section 9(3) or 9(4)
shall issue an invoice in respect of goods or services or both received by
him from the supplier who is not registered on the date of receipt of
goods or services or both. Here, a registered person may issue a
consolidated invoice at the end of a month for supplies covered under
section 9(4), the aggregate value of such supplies exceeds Rs. 5,000/- in
a day from any or all the suppliers.
 A registered person who is liable to pay tax u/s 9(3) or (4) shall issue a
payment voucher at the time of making payment to the supplier.
 GST Law specifies the particulars to be contained in documents
evidencing supply:
734
CGST Rule Document substantiating supply

Rule 46 Invoice
Rule 49 Bill of supply
Rule 50 Receipt voucher
Rule 51 Refund voucher
Rule 52 Payment voucher
Rule 53 Revised tax invoice and credit or debit notes
 In cases where tax invoice has been issued for supply of any goods or
services or both and subsequently it is found that the value or tax
charged in that invoice is more than what is actually payable/ chargeable
or where the recipient has returned the goods, the supplier can issue a
credit note to the recipient.
In cases where tax invoice has been issued for supply of any goods or
services or both, and subsequently it is found that the value or tax
charged in that invoice is less than what is actually payable/chargeable,
the supplier can issue a debit note to the recipient.
The adjustment of GST already paid is allowed only by way of issuance
of credit/debit note in terms of Section 34 of the CGST Act, 2017. The
proviso to section 34(2) of the CGST Act, 2017 provides that no reduction
in liability would be allowed if the incidence of tax has been passed on to
another person. If bad debts are on account of deficiency in supply of
services, or tax charged being greater than actual tax liability, or goods
returned, GST paid on the same is refundable subject to fulfilment of the
prescribed conditions. Therefore, GST already paid on bad debts, as
used in the trade parlance, cannot be adjusted.
 The tax invoice must be prepared in triplicate for goods, and in duplicate
for services. Each copy of the tax invoice in case of service, is required
to be marked as follows:
Goods Services
1. ORIGINAL FOR RECIPIENT 1. ORIGINAL FOR RECIPIENT
2. DUPLICATE FOR TRNSPORTER 2. DUPLICATE FOR SUPPLIER
3. TRIPLICATE FOR SUPPLIER –
735
Value of Taxable Supply Under GST

26.50 Once it is determined that an activity or transaction is supply under
GST, ascertaining the value of the same becomes significant.
26.51 Under Section 15(1) The value of a supply of goods or services or
both shall be the transaction value, which is the price actually paid or
payable for the said supply of goods or services or both where the supplier
and the recipient of the supply are not related, and the price is the sole
consideration for the supply.
26.52 Explanation to Section 15 of the CGST Act deems the following
persons to be “related persons”:
 Officers / Directors of one another’s business.
 Partners in business.
 Employer – employee.
 A person directly / indirectly owns / controls / holds 25 per cent more of
the outstanding voting stock or shares of both the persons.
 One directly / indirectly controls the other.
 Both are directly / indirectly controlled by a third person.
 Together, they directly / indirectly control a third person.
 Members of the same family.
 Sole agent / distributor / concessionaire of the other.
S-15(2) Transaction Value Transaction Value EXCLUDES
INCLUDES: discount
(i) Amounts charged by the supplier (i) Before / at the time of supply
to recipient in respect of any
Single condition: Such discount
taxes, duties, cesses, fees and
is duly recorded in the invoice
charges levied under any statute,
other than taxes paid under GST  After the supply: Cumulative
regime; conditions:
(ii) Amount incurred by recipient Agreement establishing discount
which is liable to be paid by the entered into before / at the time
supplier and not included in price of supply
actually paid or payable; Discount specifically linked to
(iii) Charges by Supplier to Recipient relevant invoices
being: ITC reversed by the recipient to
Incidental expenses (e.g.: the extent attributable to the
736
packing, commission) discount

(iv) Charges for anything done by the
supplier at the time or before the
supply, in respect thereof
Interest/ late fee/ penalty for
delayed payment of consideration
(v) Subsidies directly linked to price
– for supplier receiving the
subsidy (excluding Central and
State Govt. subsidies; i.e.,
Government subsidies will not be
included in transaction value)
26.53 To determine value of certain specific transactions, specific rules

have been incorporated in CGST Rules, 2017 (Rule 27-35). Rules pertaining
to banking Sector are:
Banking sector provides services of purchase and sale of foreign currency to

its customers, the value of which can be ascertained in terms of Rule 32(2) of
the CGST Rules as:
OPTION –I [Section 32(2)(a)] OPTION -II [Section -32(2)(b)]
When exchanged from or/ to INR: Where

Amount of
(i) Difference of Buying rate /
currency
Selling rate and RBI reference
exchanged
rate X Total units of currency
(If RBI reference rate is not Up to Rs. 1 1 per cent of the
available, value shall be 1 per lakh gross amount of
cent of gross amount of INR currency exchanged
received or provided) or Rs. 250/-,
(ii) If neither of the two currencies whichever is higher
exchanged in INR,
Rs. 1 lakh Rs. 1,000/- plus 0.5
(iii) the value shall be equal to 1 and up to per cent of the gross
per cent of the lesser of the two Rs. 10 amount of currency
amounts lakhs exchanged above Rs.
(iv) the person changing the money
737
would have received by 100,000/-

converting any of the two
currencies into INR exceeding Rs. 5,500/- plus 0.10
Rs. 10 per cent of the gross
(v) on that day at the reference
lakhs amount of currency
rate provided by RBI.
exchanged above Rs.
10 lakhs or Rs.
60,000/-, whichever
is lower
Note - A person supplying the services may exercise the option to ascertain
the value in terms of clause(b) for a financial year and such option shall not
be withdrawn during the remaining part of that financial year.
26.54 Further, it is pertinent to mention here that Rule 34 of the CGST Rules
provides the rate of exchange of currency, other than Indian rupees, for
determination of Value as under:
Transactions undertaken in foreign currency must be translated into Indian
Rupees. The rate of exchange for the determination of the value of taxable
goods shall be the applicable rate of exchange as notified by the Board
under section 14 of the Customs Act, 1962 and for the determination of the
value of taxable services it shall be the applicable rate of exchange
determined as per the generally accepted accounting principles for the date
of supply in respect of such supply in terms of section 12 or, as the case may
be, section 13 of the Act.
Valuation of services between the distinct and related persons
(excluding agents)
26.55 Generally, banks would have lots of common/ shared services being
supported from Head Office such as call center, security software etc.
Further, many times one branch would internally provide service to other
branches for example: resolving issue of a customer having PAN India
accounts, providing local information etc. to other branches etc. The value
will be determined in terms of Rule 28 of the CGST Rules, 2017 as under:
738
Value of supply based on cost i.e. cost of supply plus 10 per cent mark-up
(Rule 30 of the CGST Rules 2017).
Value of supply determined by using reasonable means should be consistent
with the principles and general provisions of GST law (Rule 31 of the CGST
Rules 2017).
Value of supply in case of Re-possessed Assets from defaulting
borrowers
26.56 Rule 32(5) provides that where a taxable supply is provided by a
person dealing in buying and selling of second hand goods i.e., used goods
as such or after such minor processing which does not change the nature of
the goods and where no input tax credit has been availed on the purchase of
such goods, the value of supply shall be the difference between the selling
price and the purchase price and where the value of such supply is negative,
it shall be ignored.
Provided that the purchase value of goods repossessed from a defaulting
borrower, who is not registered, for the purpose of recovery of a loan or debt
shall be deemed to be the purchase price of such goods by the defaulting
borrower reduced by 5 per cent points for every quarter or part thereof,
between the date of purchase and the date of disposal by the person making
such repossession.
Rate of exchange of currency, other than Indian rupees, for
determination of value
26.57 The rate of exchange for determination of value of taxable goods or
services or both shall be the applicable RBI reference rate for that currency
739
on the date of supply as determined in terms of section 12 or section 13 of

the CGST Act.
Value of supply inclusive of integrated tax, central tax, State tax,
Union territory tax
26.58 Where the value of supply is inclusive of GST, the tax amount shall
be determined in the following manner, Tax amount= (Value inclusive of
taxes X GST tax rate in %)/( 100+ sum of GST tax rates in %).
For example - If the value inclusive of tax is Rs. 100/- and applicable GST
tax rate is 18 per cent then Tax amount = (100x18)/ (100+18) =
1800/118=Rs. 15.25.
Nature of Supply and Place of Supply
26.59 The term ‘Place of Supply’ is of vital importance role in the GST. To
know the nature of supply whether the supply is inter-State supply or intra-
State supply, one should know the place of supply to determine the nature of
supply.
Inter-State Supplies
Supply of goods/ services when location of the supplier

Inter-State Supplies
and the place of supply are in two different States / UTs
Supply of goods/ services imported into the territory of

India
Supplier located in India and the place of supply is

outside India
Supply to/by an SEZ developer or SEZ unit; or
Supply in the taxable territory, not being an intra-State

supply & not specified anywhere
26.60 Section 7 of the IGST Act, provides as to when the supplies of goods
and/or services shall be treated as supply in the course of inter-State
trade/commerce.
Sections 7(1) and 7(2) of IGST Act, primarily cover two kinds of supplies –
740
Supply of goods within India and supply of goods imported into India
respectively and Sections 7(3) and 7(4) of IGST Act, cover two kinds of
supplies – supply of services within India and import of services into India
respectively. Certain supplies of goods or services are treated as supplies in
the course of inter-State trade or commerce as defined in Section 7(5) of the
IGST Act.
26.61 Inter-State Supplies: Section 8(1) of IGST Act, deals with supply of
goods and Section 8(2) of IGST Act with Supply of Services treated as
supplies in the course of intra-State trade or commerce.
Section 8(2) of IGST Act reads thus:
“Subject to the provisions of section 12, supply of services where the
location of the supplier and the place of supply of services are in the
same State or same Union territory shall be treated as intra-State
supply:
Provided that the intra-State supply of services shall not include supply
of services to or by a Special Economic Zone developer or a Special
Economic Zone unit.
Explanation 1 ––For the purposes of this Act, where a person has, ––
(i) an establishment in India and any other establishment outside
India;
(ii) an establishment in a State or Union territory and any other
establishment outside that State or Union territory; or
(iii) an establishment in a State or Union territory and any other
establishment being a business vertical27 registered within that
State or Union territory;
then such establishments shall be treated as establishments of distinct
persons.
Explanation 2 ––A person carrying on a business through a branch or an
agency or a representational office in any territory shall be treated as having
an establishment in that territory.”
With regard to supply of service, if the twin factors of “location of supplier of
services’ and ‘place of supply of services’ are in the same State or UT, then
such supply will be treated as intra-State supply. Location of the supplier of
services has been defined in the Act to mean ‘place of business from where
27 Omitted vide The Integrated Goods And Services Tax (Amendment) Act, 2018 w.e.f
01.02.2019
741
supply is made and duly registered for the purpose’. It also includes other
places and reference may be had to the discussion in respect of inter-State
supply of services for the implications of this definition.
For e.g. Consider audit services being provided by a Chartered Accountant
located in Delhi to a company in Delhi. For the purpose of the audit, the
Chartered Accountant visits the company’s factory located in Noida. Here,
although the Chartered Accountant is physically moving to Noida, he is not
supplying the audit services from Noida. The transaction will be an intra-
State supply from Delhi to Delhi.
Therefore, it is relevant to understand the terms “location of supplier of
services’ and “place of supply of services’ to determine the nature of supply.
26.62 Section 2 (15) of IGST Act states that, location of supplier of
services means –
(a) where a supply is made from a place of business for which the
registration has been obtained, the location of such place of business;
(b) where a supply is made from a place other than the place of business for
which registration has been obtained (a fixed establishment elsewhere),
the location of such fixed establishment;
(c) where a supply is made from more than one establishment, whether the
place of business or fixed establishment, the location of the
establishment most directly concerned with the provision of the supply;
and
(d) in the absence of such places, the location of the usual place of
residence of the supplier.
26.63 Where, Section 2(85) provides inclusive definition of place of business
and Section 2(50) provides exclusive definition of fixed establishment thus:
 place of business includes:
(a) a place from where the business is ordinarily carried on, and
includes a warehouse, a godown or any other place where a
taxable person stores his goods, supplies or receives goods or
services or both; or
(b) a place where a taxable person maintains his books of account; or
(c) a place where a taxable person is engaged in business through an
agent, by whatever name called.
 fixed establishment means;
o a place (other than the registered place of business)
o which is characterised by –
742
 a sufficient degree of permanence; and

 suitable structure in terms of human and technical resources
to supply services, or to receive and use services for its own
needs.
It can be inferred from the above that, in case of services provided by bank
to a customer from multiple locations, the location of supplier will be the
home branch/ account branch. The other branches providing services to such
customer actually provide services to the home branch/ account branch.
Place of Supply
26.64 Provisions relating to place of supply are contained in sections 10 to
14 of IGST Act. For understanding the concept of place of supply in case of
services, it is imperative to know the phrase “Location of the recipient” as
provided in the following 4 sub-clauses of Section 2(14) of IGST Act:
(a) Services received at a place of business where registration is obtained
– Location of such place of business.
(b) Services received at a fixed establishment (i.e., a place of business
not registered, but having a sufficient degree of permanence involving
human and technical resources) – Location of such fixed
establishment.
(c) Services received at more than one establishment – Location of the
establishment most directly concerned with the receipt of the supply.
(d) Services received at a place other than above – Location of the usual
place of residence of the recipient (address where the person is legally
registered/ constituted in case of recipients other than individuals).
PLACE OF SUPPLY
Place of supply of goods Place of supply of Services
Section 10 Section 11 Section 12 Section 13
Other than supply where location of

Where location of
of goods imported Imported into,or supplier or location
supplier and
into, or exported exported from India of recipient is
recipient is in India
from India outside India
743
Default Rule for services other than the 12 specified services

Description
S.No. Place of Supply
of Supply
1. B2B Location of such Registered Person
(i) Location of the recipient where the address on
2. B2C record exists, and
(ii) Location of the supplier of services in other cases
Default Rule for cross-border supply of services other than 9 specified
services
Description Place of Supply: Location of the recipient of service;
of Supply: If not available in the ordinary course of business, the location
ANY of the supplier of service
Place of supply for Banking Sector

26.65 In the case of banks and financial institutions the place of supply will
have to be determined as under:
 In case, where the location of the banks or location of the recipient of
service is in India, section 12(12) of the IGST Act, 2017, provides for
the place of supply of services -
The place of supply of banking and other financial services, including
stock broking services to any person shall be the location of the
recipient of services on the records of the supplier of services.
Provided that, if the location of recipient of services is not on the
records of the supplier, the place of supply shall be the location of the
supplier of services.
Hence, the place of supply of banking and other financial services, to
any person shall be the location of the recipient of services on the
records of the supplier of services. The address available on the
records of the Bank or Financial Institution, which is ordinarily used for
communication with the customer, may be considered as the Place of
Supply. In case where the address location of recipient of services is
not on the records of the supplier, the place of supply shall be the
location of the supplier of services.
 In cases, where the location of the banks or location of the recipient of
service is outside India, section 13(8) of the IGST Act, 2017, provides
744
as under:
The place of supply of the following services shall be the location of the
supplier of services, namely: ––
(a) services supplied by a banking company, or a financial institution, or
a non-banking financial company, to account holders;
(b) intermediary services;
(c) services consisting of hiring of means of transport, including yachts
but excluding aircrafts and vessels, up to a period of one month
Explanation - For the purposes of this sub-section, the expression, ––
(a) “account” means an account bearing interest to the depositor, and
includes a non-resident external account and a non-resident
ordinary account;
(b) “banking company” shall have the same meaning as assigned to it 2
of 1934. under clause (a) of section 45A of the Reserve Bank of
India Act, 1934;
(c) ‘financial institution” shall have the same meaning as assigned to it
2 of 1934. in clause (c) of section 45-I of the Reserve Bank of India
Act, 1934;
(d) “non-banking financial company” means, ––
(i) a financial institution which is a company;
(ii) a non-banking institution which is a company, and which has as
its principal business the receiving of deposits, under any
scheme or arrangement or in any other manner, or lending in
any manner; or
(iii) such other non-banking institution or class of such institutions,
as the Reserve Bank of India may, with the previous approval of
the Central Government and by notification in the Official
Gazette, specify.
In terms of section 13(8) of the IGST Act, 2017 service provided by the bank
to its account holder shall be deemed to be service provided at the place
where such bank is located. “Account” here means an account bearing
interest to the depositor, and includes a non-resident external account and a
non-resident ordinary account.
26.66 Further, in terms of section 13 of the IGST Act, 2017, where
Location of Supplier or Location of Recipient is outside India, place of supply
745
will be the location of the recipient of the services. Where the location of the
recipient of services is not available in the ordinary course of business, the
place of supply shall be the location of the supplier of services. Therefore,
the service provided by the bank to person other than an account holder
located outside India, shall be the location of the supplier of services.
Accordingly place of supply of service provided by the bank to its customer
located outside India shall be the location of bank and Central tax and State
tax or Union territory tax, as the case may be, will be payable.
26.67 Further Section 2(13) of IGST Act defines the term ‘intermediary’
“intermediary” means a broker, an agent or any other person, by
whatever name called, who arranges or facilitates the supply of goods or
services or both, or securities, between two or more persons, but does
not include a person who supplies such goods or services or both or
securities on his own account;
As inferred from section 13(8)(b) of IGST Act, the place of supply in the case
intermediary services provided by a banking company, or a financial
institution, or a non-banking financial company, to account holders shall be
the location of the supplier.
Registration
26.68 One of the criteria to exemplify a transaction to be a supply under GST
is that the supply should be made by a taxable person. Section 2 (107) of the
CGST provides that taxable person means a person who is registered or
liable to be registered under section 22 or section 24. Therefore,
understanding provisions pertaining to registration under GST is indispensable.
26.69 During the pre-GST regime, the services provided by the banks were
liable to service tax, which was a central tax only. Therefore, in spite of
banks having their branches spread in multiple states, they had an option to
have a centralised registration, payment and compliance. Accordingly, most
of the banks opted for centralised registration and its compliance activities
were managed at this centralised registration centre.
26.70 Unlike the concept of centralized registration available under erstwhile
service tax, under GST every supplier effecting taxable supplies, subject to a
threshold limit is liable for registration and hence the concept of Centralized
registration does not exist here.
26.71 In terms of section 22 of the CGST Act, every supplier shall be liable
to be registered under this Act in the State or Union territory, other than
special category States [as specified in sub-clause (g) of clause (4) of Article
746
279A of the Constitution], from where he makes a taxable supply of goods or

services or both, if his aggregate turnover in a financial year exceeds Rs. 20
lakh and in case of special category state wherein the registration limit is Rs.
10 lakhs. It is important to note that registration is required ‘in’ the State ‘from
which’ taxable supplies are made. Registration is not required ‘in’ the State
‘to’ which taxable supplies are made, even though this is a destination-based
tax.
26.72 Explanation to Section 22 defines ‘Special Category States‘ as the
States specified in sub-clause (g) of clause (4) of Article 279A of the
Constitution except Jammu& Kashmir.28 Following are the list of States
provided in Article 279A(4)(g) of the Constitution:
“Arunachal Pradesh, Assam, Jammu & Kashmir, Manipur, Meghalaya,
Mizoram, Nagaland, Sikkim, Tripura, Himachal Pradesh, Uttarakhand”.
Further, w.e.f.1-02-2019 vide CGST, (Amendment) Act, 2018 read with
Notification No.2/2019 dated 29.01.2019, the States of Arunachal Pradesh,
Assam, Meghalaya, Sikkim, Himachal Pradesh, and Uttarakhand have been
excluded from the definition of Special category States for the purpose of
Section 22 of GST Act, 2017.
Therefore, now for all States excepting the States of Manipur, Mizoram,
Nagaland and Tripura, threshold limit for registration is Rs.20 lakhs.
Moreover, w.e.f. 1-02-2019 vide the CGST, (Amendment) Act, 2018, the
Second Proviso to Section 22(1) has been inserted to provide that
Government may, at the request of a special category State and on the
recommendations of the Council, enhance the aggregate turnover referred to
in the first proviso from ` 10 lakhs to such amount, not exceeding ` 20 lakhs
and subject to such conditions and limitations, as may be so notified.
26.73 It needs to be noted that the proviso to section 22(1) appearing in
the CGST Act also appears in the SGST Act(s). As a result, for a taxable
person in a non-Special Category State, who has a branch in Special
Category State, the threshold becomes Rs. 10 lacs and not Rs. 20 lacs.
26.74 Besides the above, with effect from 1 st April 2019, the Central
Government vide Notification No. 10/2019-Central Tax dated 7th March 2019
has granted exemption to persons engaged exclusively in the supply of
goods and whose aggregate turnover in the financial year does not exceed
Rs 40 lakh from obtaining registration except persons making intrastate
supplies in the States of Arunachal Pradesh, Manipur, Meghalaya, Mizoram,
Nagaland, Puducherry, Sikkim, Telangana, Tripura and Uttarakhand.
28 Inserted vide CGST (Extension to Jammu and Kashmir) Act, 2017 w.e.f.8-07-2017.
747
26.75 From above it is important to understand the term aggregate

turnover which means the aggregate value of all taxable supplies, exempt
supplies, export of goods or services or both and inter-State supplies of
persons having the same PAN, to be computed on all India basis and
excludes CGST/SGST, IGST, UTGST and cess.
26.76 Aggregate turnover does not include the value of inward supplies on
which tax is payable on reverse charge basis.
26.77 For calculating the threshold limit, as per Explanation to section 22
of the CGST Act, the turnover shall include all supplies made by the taxable
person, whether on his own account or made on behalf of all his principals.
Further, supply of goods by a registered job worker, after completion of job
work, shall be treated as the supply of goods by the “principal” referred to in
section 143 (i.e. Job work procedure) of this Act. The value of such goods
shall not be included in the aggregate turnover of the registered job worker.
26.78 Now, it is important to mention that section 23 provides relaxation
from the requirement of obtaining registration to the following two categories
of persons -
 Agriculturist.
 Persons engaged exclusively in the supply of exempted goods or
services or both.
The Government on the recommendation of the council, by notification may
specify the category of persons who may be exempted from obtaining
registration under this Act.
26.79 The term exclusive indicates engaging in only those supplies which
are exempt. Therefore, if a supplier is supplying both exempt and non-
exempt goods and/or services, then this provision is not applicable, and he is
required to obtain registration under section 22 and aggregate turnover will
include both taxable as well as well exempted supplies.
26.80 A person whose ‘entire’ supply consists of ‘exempt supplies’, is
excluded from obtaining registration in terms of section 23 of the CGST Act.
Compulsory Registration Under GST
26.81 Notwithstanding anything contained under section 22 (1) , Section
24 of the CGST Act provides the categories of persons who shall be required
to be registered under this Act irrespective of the threshold. The following
categories of persons are required to obtain registration compulsorily under
this Act:
(i) Persons making any inter-State taxable supply.
748
Exception: vide Notification 10/ 2017–Integrated Tax, dated 13.10.2017,

persons making inter State supply of services and having turnover not
exceeding Rs. 20 lakhs have been exempt u/s. 23 from obtaining
registration. Accordingly, only persons who make inter-State supply of
goods have to compulsorily obtain registration and not eligible to claim
the benefit of notification no. 10/2017-Integrated Tax dated 13.10.2017.
However, the aggregate value of supply of services should not exceed
Rs. 10 lakhs in respect of Special Category States except the States of
Jammu and Kashmir, Arunachal Pradesh, Assam, Himachal Pradesh,
Meghalaya, Sikkim and Uttarakhand.
(ii) casual taxable persons making taxable supply.
(iii) persons who are required to pay tax under reverse charge.
(iv) person who are required to pay tax under section 9(5).
(v) non-resident taxable persons making taxable supply.
(vi) persons who are required to deduct tax under section 51.
(vii) persons who make taxable supply goods or services or both on behalf
of other taxable persons whether as an agent or otherwise.
(viii) input service distributor.
(ix) persons who supply goods or services or both, other than supplies
specified under section 9(5), through such electronic commerce
operator who is required to collect tax at source under section 52.
(x) every electronic commerce operator who is required to collect tax at
source under section 52.
(xi) every person supplying online information and database access or
retrieval services from a place outside India to a person in India, other
than a registered person.
(xii) such other person or class of persons as may be notified by the
Government on the recommendations of the Council.
Note: Out of the twelve categories of person who need to take registration
compulsorily, two categories of person are most relevant to the banking
sector i.e person who is required to pay tax under reverse charge [listed at
(iii) above] and Input service distributers[listed at (vii) above].
Effective date of Registration
26.82 Where the application for registration has been submitted within
749
thirty days from the date on which the person becomes liable to registration,
the effective date of registration shall be date on which he become liable for
registration.
26.83 Where an application for registration has been submitted by the
applicant after thirty days from the date of his becoming liable to registration,
the effective date of registration shall be the date of grant of registration.
26.84 In case of registration pursuant to any survey, enquiry, inspection,
search or any other proceedings, the effective date shall be the date of order
of registration.
26.85 Section 25 read with Rules 8 to 26 of the CGST Rules, 2017 related
to registration provides a detailed road map on the procedural aspects of the
registration. The time limit for application is 30 days (for persons other than
casual taxable person or a non-resident taxable person) and casual taxable
person or a non-resident taxable person shall have to obtain the registration
at least 5 days prior to the commencement.
GST applicability on receipt of services under RCM
26.86 Generally, the obligation to discharge GST lies on the supplier. But
there exist certain cases in which reverse charge is applicable and hence the
duty to discharge tax is cast on the recipient of supply. Even various
expenses incurred by the banks are exigible to tax under on Reverse Charge
Mechanism (“RCM”). No partial reverse charge will be applicable under GST.
100 per cent tax will be paid by the recipient if reverse charge mechanism
applies.
26.87 All taxpayers required to pay tax under reverse charge have to
mandatorily obtain registration and the threshold exemption is not applicable
on them. Payment of taxes under Reverse Charge cannot be made with
utilisation of Input Tax Credit and has to be made in cash.
26.88 Section 9(3) of CGST/ Section 5(3) of the IGST Act specify the
categories of supply of goods or services or both as notified by Government
on recommendations of the Council on which RCM is applicable. In this
regard, the Govt. vide Notification No. 13/2017- Central Tax (Rate) dated
28.06.2017 (“Notification 13/2017”) / Notification No. 10/2017- Integrated Tax
(Rate) dated 28.06.2017 (“Notification 10/2017-ITR”) as amended from time
to time specify the category of services on which RCM is applicable
26.89 The list of such services mentioned in Notification 13/2017 are as
under:
750
Sl. Category of Supply of Supplier of Recipient of

No. Services service Service
(1) (2) (3) (4)
1 Supply of services by a Goods (a) Any factory
goods transport agency Transport registered under or
(GTA), [who has not paid Agency (GTA) governed by the
central tax at the rate of Factories Act, 1948
6%,]29 in respect of (63 of 1948); or
transportation of goods by (b) any society
road to- registered under the
(a) any factory registered Societies
under or governed by the Registration Act,
Factories Act, 1948(63 of 1860 (21 of 1860)
1948);or or under any other
(b) any society registered law for the time
under the Societies being in force in any
Registration Act, 1860 (21 part of India; or
of 1860) or under any other (c) any co-operative
law for the time being in society established
force in any part of India; or by or under any law;
(c) any co-operative society or
established by or under any (d) any person
law; or registered under the
(d) any person registered CGST Act or the
under the CGST Act or the IGST Act or the
IGST Act or the SGST Act SGST Act or the
or the UTGST Act; or UTGST Act; or
(e) any body corporate (e) any body

established, by or under corporate
any law; or established, by or
under any law; or
(f) any partnership firm
whether registered or not (f) any partnership
under any law including firm whether
association of persons; or registered or not
under any law
(g) any casual taxable including
person. association of
29 Inserted vide Notification No. 22/2017 – Central Tax (Rate) dt. 22.08.2017
751
[Provided that nothing persons; or

contained in this entry shall (g) any casual
apply to services provided taxable person;
by a goods transport located in the
agency, by way of transport taxable territory.
of goods in a goods
carriage by road, to, -
(a) a Department or
establishment of the
Central Government or
State Government or Union
territory; or
(b) local authority; or
(c) Governmental agencies,
which has taken registration
under the CGST Act, 2017
(12 of 2017) only for the
purpose of deducting tax
under section 51 and not for
making a taxable supply of
goods or services.]30
2 [Services provided by an An individual Any business entity
individual advocate advocate located in the
including a senior advocate including a taxable territory.
or firm of advocates by way senior advocate
of legal services, directly or firm
indirectly.
Explanation.- “legal service”
means any service provided
in relation to advice,
consultancy or assistance
in any branch of law, in any
manner and includes
representational services
30 Inserted vide Notification No. 29/2018 – Central Tax (Rate) dt. 31.12.2018.
752
before any court, tribunal or

authority.]31
3 Services supplied by an An arbitral Any business entity
arbitral tribunal to a tribunal. located in the
business entity. taxable territory.
4 Services provided by way of Any person Any body corporate
sponsorship to any body or partnership firm
corporate or partnership located in the
firm. taxable territory.
5 Services supplied by the Central Any business entity
Central Government, StateGovernment, located in the
Government, Union territory
State taxable territory.
or local authority to a Government,
business entity excluding, -
Union territory
or local
(1) renting of immovable
authority
property, and
(2) services specified
below-
(i) services by the
Department of Posts by
way of speed post,
express parcel post,
life insurance, and
agency services
provided to a person
other than Central
Government, State
Government or Union
territory or local
authority;
(ii) services in relation to
an aircraft or a vessel,
31 Substituted vide corrigendum to Notification No. 13/2017-Central Tax (Rate), dt.

25.09.2017. Prior to substitution it read: “Services supplied by an individual advocate
including a senior advocate by way of representational services before any court, tribunal or
authority, directly or indirectly, to any business entity located in the taxable territory, including
where contract for provision of such service has been entered through another advocate or a
firm of advocates, or by a firm of advocates, by way of legal services, to a business entity.”
753
inside or outside the

precincts of a port or
an airport;
(iii) transport of goods or
passengers.
5A Services supplied by the Central Any person
Central Government, State Government, registered under the
Government, Union territory State Central Goods and
or local authority by way of Government, Services Tax Act,
renting of immovable Union territory 2017.32
property to a person or local
registered under the authority
Central Goods and
Services Tax Act, 2017 (12
of 2017).
5B Services supplied by any Any person Promoter33
person by way of transfer of
development rights or Floor
Space Index (FSI)
(including additional FSI)
for construction of a project
by a promoter.
5C Long term lease of land (30 Any person Promoter34
years or more) by any
person against
consideration in the form of
upfront amount (called as
premium, salami, cost,
price, development charges
or by any other name)
and/or periodic rent for
construction of a project by
a promoter.
6 Services supplied by a A director of a The company or a
director of a company or a company or a body corporate
32 Inserted vide Notification No. 3/2018 – Central Tax (Rate) dt. 25.01.2018
754
body corporate to the said body corporate located in the

company or the body taxable territory.
corporate.
7 Services supplied by an An insurance Any person carrying
insurance agent to any agent on insurance
person carrying on business, located in
insurance business. the taxable territory.
8 Services supplied by a A recovery A banking company
recovery agent to a banking agent or a financial
company or a financial institution or a non-
institution or a non-banking banking financial
financial company. company, located in
the taxable territory.
35(9 Supply of services by a Music Music company,
music composer, composer, producer or the like,
photographer, artist or the photographer, located in the
like by way of transfer or artist, or the taxable territory.
permitting the use or like
enjoyment of a copyright
covered under clause (a) of
sub-section (1) of section
13 of the Copyright Act,
1957 relating to original
dramatic, musical or artistic
works to a music company,
producer or the like.
9 Supply of services by an Author or music Publisher, music
author, music composer, composer, company, producer
photographer, artist or the photographer, or the like, located
like by way of transfer or artist, or the in the taxable
permitting the use or like territory.)
enjoyment of a copyright
covered under clause (a) of
sub-section (1) of section
literary, dramatic, musical
35 Substituted vide Notification No. 22/2019-Central Tax (Rate) dated 30.09.2019 effective
from 1.10.2019.
755
or artistic works to a
publisher, music company,
producer or the like.
36[9A Supply of services by an Author Publisher located in
author by way of transfer or the taxable territory:
permitting the use or Provided that
enjoyment of a copyright nothing contained in
covered under clause (a) of this entry shall
sub-section (1) of section apply where,-
(i) the author has
taken registration
literary works to a
under the Central
publisher.
Goods and Services
Tax Act, 2017 (12 of
2017), and filed a
declaration, in the
form at Annexure I,
within the time limit
prescribed therein,
with the
jurisdictional CGST
or SGST
Commissioner, as
the case may be,
that he exercises
the option to pay
central tax on the
service specified in
column (2), under
forward charge in
accordance with
Section 9 (1) of the
Central Goods and
Service Tax Act,
2017 under forward
charge, and to
comply with all the
provisions of
36Inserted vide Notification No. 22/2019- Central Tax (Rate) dated 30.09.2019 effective from
1.10.2019.
756
Central Goods and

Service Tax Act,
2017 (12 of 2017)
as they apply to a
person liable for
paying the tax in
relation to the
supply of any goods
or services or both
and that he shall
not withdraw the
said option within a
period of 1 year
from the date of
exercising such
option;
(ii) the author
makes a
declaration, as
prescribed in
Annexure II on the
invoice issued by
him in Form GST
Inv-I to the
publisher.]
10 Supply of services by the Members of Reserve Bank of
members of Overseeing Overseeing India.]37
Committee to Reserve Bank Committee
of India constituted by
the Reserve
Bank of India
11 Services supplied by Individual A banking company
individual Direct Selling Direct Selling or a non- banking
Agents (DSAs) other than a Agents (DSAs) financial company,
body corporate, partnership other than a located in the
or limited liability body corporate, taxable territory.38
partnership firm to bank or partnership or
37 Inserted vide Notification No. 33/2017 – Central Tax (Rate) dt 13.10.2017

38 Inserted vide Notification No. 15/2018 – Central Tax (Rate) dt 26.07.2018.
757
non-banking financial limited liability

company (NBFCs). partnership
firm.
12 Services provided by Business A banking
business facilitator (BF) to a facilitator (BF) company, located in
banking company the taxable
territory.39
13 Services provided by an An agent of A business
agent of business business correspondent,
correspondent (BC) to correspondent located in the
business correspondent (BC) taxable territory.40
(BC).
14 Security services (services Any person A registered person,
provided by way of supply other than a located in the
of security personnel) body corporate taxable territory.41
provided to a registered
person:
Provided that nothing
contained in this entry shall
apply to, -
(i)(a) a Department or
Establishment of the
Central Government or
State Government or Union
territory; or
(c) Governmental agencies;
which has taken registration
under the Central Goods
and Services Tax Act, 2017
(12 of 2017) only for the
purpose of deducting tax
under section 51 of the said
Act and not for making a
39 Inserted vide notification No. 29/2018 – Central Tax (Rate) dt 31.12.2018.

758
taxable supply of goods or

services; or
(ii) a registered person
paying tax under section 10
of the said Act.
4215 Services provided by way of Any person, Any body corporate
renting of any motor vehicle other than a located in the
designed to carry body corporate taxable territory.
passengers where the cost who supplies
of fuel is included in the the service to a
consideration charged from body corporate
the service recipient, and does not
provided to a body issue an
corporate invoice
charging
central tax at
the rate of 6
per cent to the
service
recipient
4316 Services of lending of Lender i.e. a Borrower i.e. a
securities under Securities person who person who borrows
Lending Scheme, 1997 deposits the the securities under
("Scheme") of Securities securities the Scheme through
and Exchange Board of registered in his an approved
India ("SEBI"), as amended. name or in the intermediary of
name of any SEBI.
other person
duly authorised
on his behalf
42Substituted vide Notification No. 29/2019- Central Tax (Rate) dt. 31.12.2019. Prior to this
substitution it was read as below which was inserted vide Notification No. 22/2019- Central
Tax (Rate) dated 30.09.2019 effective from 1.10.2019.
15. Services provided by Any person other than a body corporate, Any body
way of renting of a paying central tax at the rate of 2.5% on corporate
motor vehicle renting of motor vehicles with input tax located in the
provided to a body credit only of input service in the same line taxable territory
corporate of business
43 Inserted vide Notification No. 22/2019- Central Tax (Rate) dt. 30.09.2019 effective from
1.10.2019.
759
with an
approved inter-
mediary for the
purpose of
lending under
the Scheme of
SEBI
In addition to the above list given under Central Tax- Rate, following
additional category of supply of services is listed under Notification
10/2017-ITR on which GST shall be paid by the recipient on reverse charge
basis:
Sl. Category of Supply of Supplier Recipient of Service
Services
No. of service
(1) (2) (3) (4)
1 Any service supplied by Any Any person located in the
any person who is located person taxable territory other than
in a non-taxable territory to located in non-taxable online
any person other than non- a non- recipient.
taxable online recipient taxable
territory
2 Services supplied by a A person Importer, as defined in
person located in non- located in clause (26) of section 2 of
taxable territory by way of non- the Customs Act, 1962(52
transportation of goods by a taxable of 1962), located in the
vessel from a place outside territory taxable territory.
India up to the customs
station of clearance in India
RCM as per section 9(4) of the CGST Act or section 5(4) of the IGST Act
26.90 Pursuant to section 9(4) of the CGST Act or section 5(4) of the IGST
Act, supply of taxable goods or services or both by an unregistered supplier
to a registered person was exigible to CGST/ IGST under RCM.
26.91 Thereafter, vide Notification No.8/2017-Central Tax (Rate) dated
28.06.2017, intra-State supply of taxable goods or services or both by an
unregistered supplier to a registered person were exempt from CGST provided
the aggregate value of such supplies of goods and/or services received by a
registered person from any or all the unregistered suppliers did not exceed Rs.
5,000 in a day. However, no such parallel notification was issued under IGST for
inter State supplies.
760
26.92 Subsequently, the aforesaid limit was withdrawn vide Notification no.
38/2017- Central Tax (Rate) dated 13.10.2017 and hence, intra-State supply
of taxable goods or services or both by an unregistered supplier to a registered
person was exempted till 31.03.2018.
26.93 Moreover, vide Notification No. 32/2017 – Integrated Tax (Rate)
dated 13.10.2017, the Central Government exempted inter-State supply of
goods or services or both received by a registered person from any unregistered
supplier, from IGST leviable under section 5(4) of IGST Act till 31.03.2018.
26.94 Later, this provision of reverse charge was deferred till 30.09.2019.
Then, in view of bringing into effect the amendments (regarding RCM on
supplies by unregistered persons) in the GST Acts, reverse charge
exemption Notification No. 8/2017-Central Tax (Rate) dated 28.06.2017 and
Notification No. 32/2017 – Integrated Tax (Rate) dated 13.10.2017 have
been rescinded with effect from 1.02.2019 vide Notification No 01/2019-
Central/ Integrated Tax (Rate), dated 29-01-2019.
26.95 Further, with effect from 1st February 2019, the Central/Integrated
Goods and Services Tax (Amendment) Act, 2018 has substituted section 9(4)
of the CGST Act/ 5(4) of the IGST Act, as under:
“(4) The Government may, on the recommendations of the Council, by
notification, specify a class of registered persons who shall, in respect of
supply of specified categories of goods or services or both received from
an unregistered supplier, pay the tax on reverse charge basis as the
recipient of such supply of goods or services or both, and all the
provisions of this Act shall apply to such recipient as if he is the person
liable for paying the tax in relation to such supply of goods or services or
both.”
Hence, reverse charge on inward supply of goods and / or services effected
by a registered person from an unregistered supplier is applicable only in
respect of (a) notified ‘class of registered persons’ and (b) notified
‘categories of goods or services’.
26.96 Some of the services which are relevant with respect to the banking
sector are explained in details in the following paragraphs:
 Services provided by recovery agent -Generally, loans are the areas
wherein the banks earn major portion of their income. It is the most
organized form of extending credit to customers and interest is earned
as an income in respect of such credits extended. Majority of banks
spend great time and effort in recovering credits so granted.
761
Further, many banks sell their loans to third parties or hire third party
agents to initiate recovery on their behalf.
Loans sold to factoring agents are not liable for payment of GST. The
Auditor should examine to ensure that these transactions would be
‘exempt supply’ depending on whether these are with or without
recourse.
Another type of transaction is where third parties are hired to initiate
recovery on behalf of the banks which is purely a service transaction
and liable to payment of GST. Further, RCM is applicable on such
transactions and therefore the banks which hire such third-party agents
are liable for payment of GST on the fees so paid to these recovery
agents/third party agents. Banks also provide infrastructure, phone
facilities and such other benefits to these third-party agents in order to
perform their services. Even such value is required to be taken into
consideration while determining the value of supply for the purpose of
payment of GST.
An auditor should check the agreements between the bank and the
recovery agent. Under GST regime, the bank should raise a self-invoice
and thereafter appropriate GST @18 per cent should be paid on the
same. The income so earned should be disclosed in the relevant
chapter heading as classified under the GST regime.
 Services provided by insurance agent- If the banks are also engaged
in business of insurance, then the services provided by such insurance
agent who sell insurance products of the banks is liable for payment of
GST. Further, the amount on which tax is payable is commission so
paid to the insurance agent. Such commission also includes
reimbursement by any mode.
The insurance division of the banks so receiving the services from those
insurance agents are liable for payment of GST under RCM.
An Auditor should check the agreements between the bank and the
insurance agent. Under GST regime, the bank should raise a self-
invoice and thereafter appropriate GST @ 18 per cent should be paid
on the same. The income so earned should be disclosed in the relevant
chapter heading as classified under the GST regime.
 Services provided by goods transport agency service - W.e.f. July
1,2017 vide Entry No.1 of Notification 13, if any services in respect of
transportation of goods by road are provided by goods transport agency
(GTA) to the following recipients located in the taxable territory, then the
recipient of service is liable to pay tax under reverse charge:
762
(a) Any factory registered under or governed by the Factories Act,

1948 (63 of 1948); or
(b) any society registered under the Societies Registration Act, 1860
(21 of 1860) or under any other law for the time being in force in
any part of India; or
(c) any co-operative society established by or under any law; or
(d) any person registered under the CGST Act or the IGST Act or the
SGST Act or the UTGST Act; or
(e) any body corporate established, by or under any law; or
(f) any partnership firm whether registered or not under any law
including association of persons; or
(g) any casual taxable person.
However, w.e.f. from 22 nd August 22,2017 vide Notification No. 22/2017
dated 22.08.2017 which amended Notification 13/2017, the GTA was
given an option to pay to GST @ 5 per cent (2.5 CGST+2.5 SGST/ 5
per cent IGST) if no input tax credit is availed subject to RCM. Further,
if GTA has been availed ITC/ GST is to be paid by the GTA @12 per
cent.
Further, w.e.f. 1 st January,2019 vide Notification No. 29/2018-Central
Tax (Rate), dated 31-12-2018, nothing contained in this entry shall
apply to services provided by a GTA, by way of transport of goods in a
goods carriage by road, to, -
(a) a Department or establishment of the Central Government or State
Government or Union territory; or
(c) Governmental agencies;
which has taken registration under the CGST, 2017 (only for the
purpose of deducting tax under section 51 and not for making a taxable
supply of goods or services.
Therefore, the Auditor has to check that correct ITC is taken, and
appropriate person has discharged the tax. Carriage of Goods by Road
Act, 2007 mandates that no motor vehicle undertakes transport of
goods by road except with a proper registration of such motor vehicle.
Every consignment must be accompanied by a forward note or
receiving note. Merely because goods are not of substantial value or not
involving supply or involving inter-branch movement, it is not
appropriate to avoid issuing such a ‘note’. When such ‘note’ is issued,
763
the transporter will be a GTA. Under the GST notification, GTA is one
who issues a consignment note ‘by whatever name called’.
 Services provided by advocates: W.e.f. 1st July , 2017 In terms of
entry no. 2 of Notification 13/2017, RCM was applicable on services
supplied by an individual advocate including a senior advocate by way
of representational services before any court, tribunal or authority,
directly or indirectly, to any business entity located in the taxable
territory, including where contract for provision of such service has been
entered through another advocate or a firm of advocates, or by a firm of
advocates, by way of legal services, to a business entity.
Thereafter a Corrigendum to Notification No. 13/2017 was issued [M.F.
(D.R.) Corrigendum F. No. 336/20/2017-TRU, dated 25-9-2017], and
RCM was made applicable on services provided by an individual
advocate including a senior advocate or firm of advocates by way of
legal services, directly or indirectly.
“Legal service” means any service provided in relation to advice,
consultancy or assistance in any branch of law, in any manner and
includes representational services before any court, tribunal or
authority.
Very often, legal services are availed by banks ‘on account of’ their
customers. Here, Auditors should ensure that banks do not withhold
themselves from payment of RCM on legal fee paid on the premise that
these services are availed ‘on account of’ their customers, especially
when the legal fee is debited to customer’s account. It is more
appropriate that banks discharge RCM as fee from advocate will be
issued to bank. Very often, it is observed that where expenses are
incurred but debited to customer’s account, RCM liability thereon, is
somehow omitted. Customer’s being unaware of the various
components of costs that are embedded in the amounts debited to the
account, RCM liability cannot possibly be discharged by them. Hence,
banks may be advised to suitably ensure RCM is complied with.
 Service provided by way of import of services: Many banks do
spend a lot of funds on procuring services from abroad. Where the
supply of goods or services or both are taxable in nature, GST is
payable by the recipient bank. Some important areas are summarized
as under:
1. Bond floating expenditure: Generally, bond floating expenditure
is an expenditure which though appropriately recorded in the
764
books of accounts, skips the attention and the applicable taxes are
not discharged often in respect of the same. Therefore, the
concerned Auditor should thoroughly inspect the books of
accounts and identify all payments in foreign currency for
compliance with these provisions.
For e.g.: IVY Bank wants to issue bonds in NYSE and for the said
purpose has appointed WYE bank a leading bank of America for
floating the said bonds and acting as a lead merchant banker. The
fee for the same is generally a fixed per centage of the ticket size
which is recorded appropriately in the books of accounts. The
instant transaction is taxable in terms of Section 13 (2) of the IGST
Act, 2017.
Under the GST regime, the same requires a thorough analysis of
the transaction, these are generally taxable as per Section 13 of
the IGST Act, 2017. However, the answer may vary depending
upon the structuring of the transaction.
2. Underwriting charges: If underwriting charges are paid in foreign
currency to an underwriter who is located outside India, then GST
is payable on such transactions. Appropriate ledgers, contracts
etc., should be scrutinised in great detail and thereafter relevant
disclosures should be made regarding taxability on the same.
3. I.T infrastructure cost: It is a common cost which the banks bear
on all-India basis and execute one common contract for the same
if the vendor is based outside India or the technicians are outside
India and payment is being disbursed in foreign currency. Though,
such cost requires careful apportionment in terms of appropriate
provisions including rules and depending upon the nature of the
transaction appropriate GST (generally @ 18 per cent) is payable.
Further, credit for GST so paid is available.
NOTE-It is pertinent to mention here that, certain services exigible to service
tax under RCM have been discontinued under GST like rent-a-cab,
Manpower Supply, Security services, works contract service etc.
Input Tax Credit
26.97 Under the GST regime, a banking company or a financial institution
including a non-banking financial company engaged in supplying services by
way of accepting deposits, extending loans or advances shall have the
following two options to avail Input tax credit in terms of Section 17(4) of the
765
CGST Act 2017. And the option once exercised shall not be withdrawn during
the remaining part of the financial year.
Option I
Reverse the credit pertaining to exempted services as per the method stated
in Section 17(2) of the CGST Act, 2017 read with the relevant State Act and
Rules thereof.
Option II
Avail 50 per cent of the eligible input tax credit on inputs, capital goods and
input services in that month and the rest shall lapse. Accordingly the
following procedure be adopted in accordance with Rule 38 of the CGST
Rules, 2017:
1. Such banking company or financial institution shall not avail credit of:
 the tax paid on inputs and input services that are used for non-
business purposes; and
 the credit attributable to the supplies specified in Section 17(5), in
FORM GSTR-2.
2. Further, the condition of 50 per cent restriction would not be applicable
in case of the tax paid on supplies made by one registered person to
another registered person having the same PAN. Hence, a banking
company or financial institution shall avail the credit of tax paid on inputs
and input services in case of supplies made to its own branches i.e. inter
branch i.e., by one registered person to another registered person
having different GSTIN.
Avail full credit on inter-branch supply of services between distinct
persons of the banking or NBFC company. In other words, if HO has
restricted the credit to 50 per cent and those goods or services are
involved in inter-branch taxable supplies, the receiving branch is NOT
required to further apply the 50 per cent restriction. This relief is provided
in second proviso to section 17(4).
3. 50 per cent of the remaining amount of input tax shall be admissible and
shall be furnished in FORM GSTR-2.
4. The amount referred to in point 2. and 3 above shall subject to the
provisions of Sections 41, 42 and 43, be credited to the electronic credit
ledger of the said banking company or financial institution.
NOTE- The non-applicability of 50 per cent reversal is only to the extent of inter-
branch services between registered branches having the same PAN in India.
766
Thus, tax paid on services received from a related person / distinct person
located outside India would be liable to 50 per cent reversal.
Apportionment of credit
26.98 Section 17 (2) of the CGST Act stipulates that, where the goods or
services or both are used by the registered person partly for effecting taxable
supplies including zero-rated supplies under this Act or under the IGST Act
and partly for effecting exempt supplies under the said Acts, the amount of
credit shall be restricted to so much of the input tax as is attributable to the
said taxable supplies including zero-rated supplies.
26.99 Credit attributable to exempt supplies is not available to a registered
person. Exempt for this purpose means all supplies other than taxable and
zero-rated supplies and specifically include the following:
 Supplies liable to tax under reverse charge mechanism
 Transactions in securities
 Sale of land
 Subject to Para 5(b) of Schedule II, sale of building.
26.100 Moreover, vide CGST Amendment Act,2018 w.e.f 1-02-2019, the
“value of exempt supply’’ shall not include the value of activities or
transactions specified in Schedule III, except those specified in paragraph 5
of the said Schedule i.e., Sale of Land (S-III) / building (S-II).
26.101 Rule 42 of the CGST Rules, 2017: Manner of determination of ITC in
respect of inputs or input services and reversal thereof via illustration:
Sl. Particulars Reference CGST SGST/ IGST
No UTGST
1 Total input tax on T 1,00,000 1,00,000 50,000
inputs and input
services for the tax
period May 2018
Out of the total input
tax (T):
2 Input tax used T1 10,000 10,000 5,000
exclusively for non-
business purposes
(Note 1)
3 Input tax used T2 10,000 10,000 5,000
exclusively for
767
effecting exempt
supplies (Note 1)
4 Input tax ineligible T3 5,000 5,000 2,500
under Section 17(5)
(Note 1)
Total 25,000 25,000 12,500
ITC credited to C1 = T 75,000 75,000 37,500
Electronic Credit -(T1 +
Ledger (Note 1) T2
+T3)
Input tax credit used T4 50,000 50,000 25,000
exclusively for
taxable supplies
(including zero-rated
supplies) [Note 4]
Common credit C2 = 25,000 25,000 12,500
C1 - T4
Aggregate value of E 25,00,000 25,00,000 25,00,000
exempt supplies for
the tax period May
2018 (Note 2 & 3)
Total Turnover of the F 1,00,00,000 1,00,00,000 1,00,00,000
registered person for
the tax period May
2018 (Note 2)
Credit attributable to D1 = 6,250 6,250 3,125
exempt supplies (E/F) *
(Note 5) C2
Credit attributable to D2 = C2 * 1,250 1,250 625
non-business 5%
purposes
Net eligible common C3 = C2 - 17,500 17,500 8,750
credit [Note 6] (D1 + D2)
Total credit eligible G = T4 67,500 67,500 33,750
(Exclusive + + C3
Common)
768
Note 1: T1, T2, T3 and T4 shall be DETERMINED AS ABOVE and declared

in Form GSTR-2 and at summary level in FORM GSTR-3B.
Note 2: If the registered person does not have any turnover for May 2018,
then the value of E and F shall be considered for the last tax period for which
such details are available.
Note 3: Aggregate value of exempt supplies and the total turnover shall
exclude the amount of any duty or tax levied under entry 84 and entry 92A of
List I of the Seventh Schedule to the Constitution and entry 51 and 54 of List
II of the said Schedule.
Remarks: Please note in case of supply of services covered by clause (b) of
paragraph 5 of Schedule II of the Act (in case of apartment construction
project-promoter), the calculation of Note 4 and 5 will done differently. For
detail Refer Rule 42 of the CGST Rules.
Note 6: Amount of ‘C3‘, ‘D1’ and ‘D2’ shall be computed separately for ITC of
CGST, SGST, UTGST and IGST declared in FORM GSTR-3B or through
FORM GST DRC-03.
And the amount equal to aggregate of ‘D1’ and ‘D2’ shall be reversed by
registered person in FORM GSTR-3B or through FORM GST DRC-03.
Note 7: The registered person is expected to make such computation for
each tax period and reverse the same in the periodic returns being filed by
such registered person. However, on completion of the financial year, input
tax credit shall be determined accurately based on actuals, in the same
manner as provided in Rule 42. A reconciliation is required to be done on an
annual basis (between the amounts reversed for each tax period during the
year and the amount determined at the end of the financial year) and any
excess credit availed needs to be reversed with interest while short credit, if
any, needs to be re-availed within 6 months from end of the financial year.
26.102 It is to be noted that the registered person would be required to
remit excess ITC claimed (as determined in Note 7 above) with interest
calculated at for the period starting from the first day of April of the
succeeding financial year till the date of payment. However, no interest can
be claimed if, at the end of the financial year, it is found that short credit was
availed.
26.103 Therefore, an Auditor can check whether the concerned branch is
reversing ITC in compliance to the above Rule. If ITC is not reversed in
compliance to the above Rules, it shall be treated as ITC wrongly taken and
the same will be recovered along with the interest under Section 50 of the
CGST Act, 2017.
769
26.104 Note the following pre-requisites for availing credit by registered

person pursuant to section 16(2) of the CGST Act:
(a) He (Registered Person) is in possession of tax invoice or any other
specified tax paying document.
(b) He has received the goods or services. “Bill to ship to” scenarios also
included.
(c) Tax is actually paid by the supplier.
(d) He has furnished the return.
(e) If the inputs are received in lots, he will be eligible to avail the credit only
when the last lot of the inputs is received.
(f) He should pay the supplier the value of the goods or services along with the
tax within 180 days from the date of issue of invoice, failing which the
amount of credit availed by the recipient would be added to his output tax
liability, with interest [rule 37(1) & (2) of CGST Rules, 2017]. However, once
the amount is paid, the recipient will be entitled to avail the credit again. In
case part payment has been made, proportionate credit would be allowed.
26.105 Beside the above, the value of supplies in respect of the following shall
be deemed to have been paid and ITC shall not be reversed in such cases:
 Value of supplies made without consideration as per Schedule-I.
 Value of supplies on account of any amount added in accordance with
section 15(2) (b), i.e. any amount that the supplier is liable to pay in relation
to such supply but which has been incurred by the recipient of the supply
and not included in the price actually paid or payable for the goods or
services or both (Notification No. 26/2018-Central Tax, dated 13.06.2018).
 Value representing discount for which financial credit notes have been
issued by the supplier.
 Note- Provisions of section 18(6) of the CGST Act, 2017 for reversal of input
tax credit availed on capital goods would be applicable to banks only to the
extent of the input tax credit availed by it.
Documents required for availing credit (Sec 36 of the CGST Act)
(a) Invoice issued by a (b) Invoice issued as (c) A debit note issued
supplier of goods or per Section 31(2)(f) by supplier under
services or both as by recipient along Section 34
per Section 31 with proof of
payment of tax
770
(d) Bill of entry or (e) Revised invoice (f) Document issued by

similar document Input Service
prescribed under Distributor
Customs Act, 1962
Restriction/ No ITC allowed to be availed
 Beyond September of the following FY to which invoice pertains or date

of filing of annual return, whichever is earlier. However, due date of
taking ITC for FY 17-18 was extended till 31 st March, 2019.
 In terms of Section 36(4), ITC to be availed by a registered person in
respect of invoices or debit notes, the details of which have not been
uploaded by the suppliers under section 37(1), shall not exceed 10 per
cent44 of the eligible credit available in respect of invoices or debit notes
the details of which have been uploaded by the suppliers under section
37(1) of the CGST Act.
No ITC can be availed in terms of Section 17(5) of CGST Act, 2017

No ITC shall be available in respect of the following namely:
(a) motor vehicles for transportation of persons having approved seating
capacity of not more than 13 persons (including the driver), except when they
are used for making the following taxable supplies, namely: —
(A) further supply of (B) transportation (C) imparting training on
such motor vehicles; of passengers; driving such motor
or or vehicles;
(aa) vessels and aircraft except when they are used––
(i) for making the following taxable supplies, (ii) for transportation of
namely goods
A. further B. transportation C. imparting D. imparting

supply of of training on training on
such vessels passengers; navigating such flying such
or aircraft; or or vessels; or aircraft;
44 Substituted vide Notification No. 75/2019 - Central Tax dated 26-12-2019 w.e.f.1-01-2020. Prior
to such substitution it was 20 % vide Notification No. 495/2019 - Central Tax dated dt. 09.10.2019
via which Section 36(4) was inserted.
771
(ab) services of general insurance, servicing, repair and maintenance in

so far as they relate to motor vehicles, vessels or aircraft referred to in
clause (a) or clause (aa):
However, ITC is available respect of such services
(i) where the motor (ii) where received by a taxable person
vehicles, vessels or engaged –
aircraft referred to in (I) in the manufacture of such motor
clause (a) or clause (aa) vehicles, vessels or aircraft; or
are used for the (II) in the supply of general insurance
purposes specified services in respect of such motor
therein; vehicles, vessels or aircraft insured
by him;
(b) the following supply of goods or services or both—
(i) food and beverages, outdoor (ii) membership of (iii) travel benefits
catering, beauty treatment, a club, health extended to
health services, cosmetic and and fitness employees on
plastic surgery, leasing, renting centre; and vacation such
or hiring of motor vehicles, as leave or
vessels or aircraft referred to in home travel
clause (a) or clause (aa) except concession
when used for the purposes
specified therein, life insurance
and health insurance ###
### Provided that the ITC shall be available where an inward supply of such
goods or services or both is used by a registered person for making an
outward taxable supply of the same category of goods or services or both or
as an element of a taxable composite or mixed supply;
Note- The provisions have been amended so as to allow ITC in respect of

goods or services or both specified above if it is made obligatory for an
employer to provide such services under any law for the time being in force.
In all the above cases [section17(5)(b)], the credit will be available if the
goods or services are required to be provided by the employer through any
obligation imposed under any law.
(c) works contract services when supplied for construction of immovable
property, (other than plant and machinery), except where it is an input
service for further supply of works contract service;
(d) goods or services or both received by a taxable person for
construction of an immovable property (other than plant and machinery) on
772
his own account, including when such goods or services or both are used in
the course or furtherance of business;
Explanation. - For the purpose of clause (c) and (d), the expression
“construction” includes re-construction, renovation, additions or alterations or
repairs, to the extent of capitalization, to the said immovable property.
(e) goods or services or both on which tax has been paid under section 10;
(f) goods or services or both received by a non-resident taxable person
except on goods imported by him;
(g) goods or services or both used for personal consumption;
(h) goods lost, stolen, destroyed, written off or disposed of by way of gift
or free samples; and
(i) any tax paid in accordance with the provisions of sections 74, 129
and 130. i.e., any tax paid due to short payment on account of fraud,
suppression, mis-declaration, seizure, detention.
Credit utilization
26.106 In terms of section 49 of the CGST Act, the amount of ITC available
in the electronic credit ledger of the registered person on account of:
 IGST shall first be utilised towards payment of IGST and the amount
remaining, if any, may be utilised towards the payment of CGST and
SGST/UTGST, in that order.
 CGST shall first be utilised towards payment of CGST and the amount
remaining, if any, may be utilised towards the payment of IGST.
 SGST/UTGST shall first be utilised towards payment of SGST/UTGST
and amount remaining, if any, may be utilised towards payment of IGST.
However, w.e.f. 1-02-2019 vide the CGST (Amendment) Act, 2018, ITC
on account of SGST/UTGST shall be utilised towards payment of IGST
only where the balance of ITC on account of CGST is not available for
payment of IGST.
 CGST shall not be utilised towards payment of SGST/ UTGST and vice
versa respectively [section 49(5)(e) and (f)].
26.107 Subsequently, w.e.f. 1-02-2019, Sections 49A and 49B have been
inserted vide the CGST Amendment Act 2018. Section 49A stipulates that
notwithstanding anything contained in section 49, ITC on account of CGST,
SGST/UTGST shall be utilised towards payment of IGST, CGST, SGST or
UTGST as the case may be, only after the ITC available on account of IGST
has first been utilised fully towards such payment.
773
26.108 Further, Section 49B of the CGST Act, 2017 provides that
notwithstanding anything contained in ITC Chapter V of the CGST Act and
subject to section 49(5)(e) and (f) of the CGST, the Government may, on the
recommendations of the Council, prescribe the order and manner of utilisation of
the ITC on account of IGST, CGST, SGST or UTGST, as the case may be,
towards payment of any such tax.
26.109 In this regard, w.e.f. 29-03-2019 vide Notification No. 16/2019 –
Central Tax dated 29.03.2019, Rule 88A of the CGST Rules has been
inserted which provides the order of utilization of ITC as under:
“Input tax credit on account of integrated tax shall first be utilised towards
payment of integrated tax, and the amount remaining, if any, may be
utilised towards the payment of central tax and State tax or Union territory
tax, as the case may be, in any order:
Provided that the input tax credit on account of central tax, State tax or
Union territory tax shall be utilised towards payment of integrated tax,
central tax, State tax or Union territory tax, as the case may be, only after
the input tax credit available on account of integrated tax has first been
utilised fully.”
Return Under GST – Banking Sector
26.110 To avoid Interest and penalties, timely filling GST Return is of
paramount importance. Every registered banking and/or financial institution
including non-banking financial company is liable to file GSTR-3B, GSTR-1,
GSTR-6, GSTR 9 and GSTR-9C.
FORM PARTICULARS DUE DATE APPLICABLE
TO
GSTR- Monthly th
summary 20 of the next month All registered
3B return persons (other
than Input
Service
Distributor (ISD),
person liable to
deduct TDS and
personally liable
to collect tax at
source).
GSTR-1 th
Outward Supplies > 11 of the next month Normal / Regular
1.5 Crore Last date of month Taxpayer
Outward Supplies < subsequent to the
1.5 Crore quarter
774
GSTR-6 Monthly return by 13th of the next month Input Service

input service Distributor
distributors
GSTR-9 Annual return 31st December of the Normal tax payer
next Financial Year Voluntary Filing
For FY 18-19 last of GSTR – 9 in
date was 31st Dec, case of Turnover
2020 and for FY 19- not exceeds 2 Cr
20 last date has been in Previous FY)
extended up to 28th
February 2021.
GSTR- Annual return along 31st December of the Normal tax payer
9C with the copy of next Financial Year having aggregate
audited annual For FY 18-19 last turnover of more
accounts and a date was 31st Dec, than Rs. 2 crores
reconciliation 2020 and for FY 19- (Now Limit is -
statement 20 last date has been Exceeding 5 Cr)
extended up to 28th
February 2021.
Obligation to furnish information return

26.111 Any person, being a banking company within the meaning of section
45A(a) of the Reserve Bank of India Act, 1934, who is responsible for
maintaining record of registration or statement of accounts or any periodic return
or document containing details of payment of tax and other details of transaction
of goods or services or both or transactions related to a bank account or
consumption of electricity or transaction of purchase, sale or exchange of goods
or property or right or interest in a property under any law for the time being in
force, shall furnish an information return of the same in respect of such periods,
within such time, in such form and manner and to such authority or agency as
may be prescribed.[Section150(1)(e) of the CGST Act]
26.112 Furthermore, if the Commissioner, or an officer authorised by him in
this behalf, considers that the information furnished in the information return
is defective, he may intimate the defect to the person who has furnished such
information return and give him an opportunity of rectifying the defect within
30 days from the date of such communication of information or within such
further period. If the defect in the return is not rectified within the time prescribed,
the information return should be treated as not submitted and penalty of Rs.100/-
per day for each day during which the failure continues, would be payable
subject to a maximum of Rs. 5,000 in terms of section 123 of the CGST Act.
775
26.113 Moreover, if no information return is filed, within the stipulated period,

authority may serve a notice requiring him to furnish of such return within a
period not exceeding 90 days from the date of service of the notice and such
person shall furnish the information return.
Note:
Department in terms of Circular no.129/48/2019-GST dated 24th December 2019
follow Standard operating procedure in case return is not filed on time as:
Timeline Action by Department
3 Days prior to Due A system generated message would be sent to all
Date i.e. on 17th of the registered persons to remind them about filing of
any month the return for the tax period by the due date.
After due date i.e. A system generated mail / message would be sent to
any day after 20th of all the defaulters immediately after the due date to
any month the effect that the said registered person has not
furnished his return for the said tax period; the said
mail/message is to be sent to the authorized
signatory as well as the proprietor/ partner/director/
karta, etc.
Five days after due A notice in FORM GSTR-3A (under section 46 of the
date i.e. 25th of any CGST Act read with rule 68 of the CGST Rules) shall
month be issued electronically to such registered person
who fails to furnish return under section 39, requiring
him to furnish such return within fifteen days.
15 days from 25th of 1. In case the said return is still not filed by the
any month defaulter within 15 days of the said notice, the
proper officer may proceed to assess the tax
liability of the said person (under section 62) of
the CGST Act, to the best of his judgement
taking into account all the relevant material
which is available or which he has gathered and
would issue order (under rule 100) of the CGST
Rules in FORM GST ASMT-13.
2. The proper officer would then be required to
upload the summary thereof in FORM GST
DRC- 07.
3. For the purpose of assessment of tax liability
under section 62 of the CGST Act, the proper
officer may take into account the details of
776
outward supplies available in the statement

furnished (under section 37 (FORM GSTR-1)),
details of supplies auto-populated in FORM
GSTR-2A, information available from e-way
bills, or any other information available from
any other source, including from inspection
(under section 71).
4. In deserving cases [Not specified] , based on
the facts of the case, the Commissioner may
resort to provisional attachment to protect
revenue (under section 83 of the CGST Act)
before issuance of FORM GST ASMT-13.
30 days after service In case the defaulter furnishes a valid return within
of assessment order 30 days of the service of assessment order in
FORM GST ASMT13, the said assessment order
shall be deemed to have been withdrawn (in terms of
section 62(2) of the CGST Act).
However, if the said return remains unfurnished
within the statutory period of 30 days from issuance
of order in FORM ASMT-13, then proper officer may
initiate recovery proceedings (under section 78) and
recovery of Tax (under section 79) of the CGST Act
Any time after above The proper officer would initiate action for
30 days cancellation of registration(under section 29(2) of the
CGST Act) in cases where the return has not been
furnished for the period specified in section 29
Input Service Distributor

26.114 Input Service Distributor (ISD) is an office of the supplier of goods or
services or both where a document (like invoice) of services attributable to other
locations are received (since they might be registered separately). Since the
services relate to other locations the corresponding credit should be transferred
to such locations (having separate registrations) as services are supplied from
there. Please note ISD cannot be an office that does any supply of its own but
must be one that merely collects invoice for services and issues prescribed
document for its distribution.
26.115 ISD cannot normally be used in a situation where there is a liability to
pay GST. It can only receive input tax credits on invoices related to input
services and distribute such credits in the manner discussed below. An ISD
777
cannot discharge tax liability under reverse charge. This would require obtaining
another registration as a regular registered person and discharge RCM liability.
26.116 Section 20 read with Rule 39 of the CGST Act deals with the manner
and procedure of distribution of credit by ISD. ISD shall distribute the credit of
CGST as CGST or IGST and IGST as IGST or CGST, by way of issue of a
document containing, the amount of ITC credit being distributed in such manner
as may be prescribed and subject to certain conditions. ISD may distribute the
credit available for distribution in the same month in which it is availed. As per
Rule 39(1)(e) and (f) of the said rules, ISD shall distribute:
 ITC on account of CGST and SGST or UTGST
o in respect of recipient located in the same state shall be distributed as
CGST and SGST or UTGST respectively.
o in respect of a recipient located in a State or Union territory other than
that of the ISD, be distributed as IGST.
 the amount to be so distributed shall be equal to the aggregate of the
amount of ITC of CGST and SGST or UTGST that qualifies for distribution
to such recipient in accordance with Rule 39(1)(d).
 ITC on account of IGST shall be distributed as IGST.
26.117 The conditions to be adhered as prescribed in section 20 are:
 the credit can be distributed to recipients against a document containing
such details as may be prescribed.
Where ISD is an office of a banking company or a financial institution,
including a nonbanking financial company, a tax invoice shall include any
document in lieu thereof, by whatever name called, whether or not serially
numbered but containing the prescribed information.
Each type of tax must be distributed through a separate ISD invoice.
However, there is no requirement to issue ISD invoices at an invoice-level
(received from the supplier of the service). However, there is no
requirement to issue ISD invoices at an invoice-level (received from the
supplier of the service).
 the amount of ITC distributed shall not exceed the amount of credit
available for distribution.
 the credit of tax paid on input services attributable to recipient of credit shall
be distributed only to that recipient.
 the credit of tax paid on input services attributable to more than one
recipient of credit shall be distributed amongst such recipient(s) to whom
778
the input service is attributable and such distribution shall be pro rata on the
basis of the turnover in a State or turnover in a Union Territory of such
recipient, during the relevant period, to the aggregate of the turnover of all
such recipients to whom such input service is attributable and which are
operational in the current year, during the said relevant period.
 the credit of tax paid on input services attributable to all recipients of credit
shall be distributed amongst such recipients and such distribution shall be
pro rata on the basis of the turnover in a State or turnover in a Union
Territory of such recipient, during the relevant period, to the aggregate of
the turnover of all recipients and which are operational in the current year,
during the said relevant period.
Payment dates
26.118 GST should be disbursed by following the due dates mentioned
below: — 20th of the next month. FORM GST PMT-6 Challan for deposit of
GST — valid for 15 days from the date of generation of challan.
26.119 Further, interest under Section 50, to be paid in case of failure to
pay tax or part thereof to the Government within period prescribed is 18 per
cent from the due date of payment to the actual date of payment of tax And
24 per cent in case Excess claim of Input Tax Credit or excess reduction in
output tax liability.
Accounts and Records
26.120 Section 35-36 of the CGST Act and Rule 56 to 58 of CGST Rules
deals with provisions pertaining to accounts and records. Rule 56 of the
CGST Rules provide for the documents with maintenance of accounts by
registered persons. Rule 56(7) stipulates that every registered person shall
keep the books of account at the principal place of business and books of
account relating to additional place of business mentioned in his certificate of
registration and such books of account shall include any electronic form of
data stored on any electronic device.
26.121 Section 36 inter alia prescribes that, every assessee shall retain the
books of accounts and other records until the expiry of 72 months (6 years)
from the due date for filing of Annual Return for the year pertaining to such
accounts and records. If the Annual Returns for the FY 2017-18 are filed on
say 31.12.2018, even then, the books of account and other records are to be
maintained till 31.12.2024. Even if the annual return is filed earlier, the start
date for considering 72 months runs from the end of due date to file the
annual return.
779
26.122 In case an appeal or revision or any other proceeding is pending

before any Appellate Authority or Provisional Authority or Appellate Tribunal
or Court, or in case the assessee is under investigation for an offence under
Chapter XIX, the assessee shall retain the books of account and other
records pertaining to the subject matter of such appeal or revision or
proceeding or investigation for a period of one year after final disposal of
such appeal or revision or proceeding, or for the period specified records u/s
35(1), whichever is later.
26.123 Based on the above discussions, an exemplary Questionnaire for
GST Audit of Banks is prepared as under:
Name of the Branch:
GSTIN:
Particulars/information for the year
PART A: Basic Details of Assessee
1. Name of the Supplier/ Recipient of Supply
2. Full address of (Note- In GST, there is no Concept of Centralised
Registration. State wise registration prevails and each unit in the
respective states should be added in the registration certificate
classifying as a principal place of business in the State and others
as additional place of business).
Address of the Branch under audit and address of the branches in
the State:
3. List of GST registration numbers in the State with date of
registration and nature of registration as Supplier/ Recipient of
Supply.
4. Validity Period of Registration (in case of casual person and NRI)
5. PAN of the assessee
6. List the principal activities (Note- In order to understand the
taxability of various supplies provided by the concerned
branch/head office, it is important to identify the various supplies
provided by such branch or head office. For this purpose, the
auditors may analyse the various income heads (Operating and
Non-Operating).Hence in GST various Lists of principal supplies
need to be provided by the unit registered (assesse) i.e., branch)
780
7. Is there any change in the activities stated above during the year as
compared to immediately preceding year? Whether the same is
included in registration (Note- Check whether any new service is
provided by the concerned branch or head office. If yes, being an
auditor, we can check whether the same is updated in the GST
Registration Certificate or not? However, GST portal allows addition
of Top 5 supplies only. It becomes important because taxability of
any activity depends upon its nature and any exemption or relief will
be available accordingly).
8. Whether taxpayer has maintained accounts and records in terms of
Section 35 -36 of the CGST Act, 2017 read with Rule 56 to 58 of the
CGST Rules, 2017.
PART B: EXEMPTION AVAILABLE UNDER CGST/SGST/IGST
9. Broad description of nature of income
10. Erstwhile service tax law was not applicable in case of J&K but GST
is applicable, so check no transaction is left.
(b) Are services provided outside India? If Yes, please specify
nature of Service and amount involved
11. Broad description of exempted services provided, if any, along with
Notification No. and amount Involved
12. Whether GST is leviable on Transaction in Money under GST?
13. Whether securities/ derivatives are exigible tor GST?
14. Whether any service charges or administrative charges or entry
charges are recovered in addition to interest on a loan, advance or a
deposit such as locker rent, folio charges, loan processing fee, late
payment fee, lease management fee, rent, management fee etc. are
exigible to GST?
15. Whether the Bank is trading in Commercial paper /Certificates of
deposits?
If yes, whether any separate charges are collected, and GST being
paid on the same and provide details thereon.
16. Whether GST is levied on late fee charges collected from credit card
holders?
If yes, then whether GST is being paid on the same and give details
thereof.
781
PART C: COMPLIANCES UNDER GST ACTs AND RULES, 2017

11 (a) Is Section 9(3) of the CGST Act read with Notification No.13/2017
as amended followed by the bank?
11 (b) If the answer to (a) is No, specify the head of expenditure and
corresponding details
11 (c)  Whether GST has been paid on RCM on services procured from
supplier in terms of Section 9(3) of the CGST Act?
 Whether GST has been paid on advances paid by the banks u/s
9(3) of the CGST Act?
 Whether all inward supplies (whether creditable or not) flow into
the books of the bank through the GSTR-1 of any registered
supplier? If not, have such supplies been reported in GSTR-2/ 3B
under section 9(3) of CGST Act / 5(4) of IGST Act, even if no tax
is payable from 13th October, 2017?
 Whether in respect of each inward supply where no tax has been
paid, is there a clear disclosure made to the Auditors as to the
reasons for the tax position taken in each case? The Auditor may
examine, if the tax position taken requires to be reported in the
audit report or other communication?
 Whether the credit taken in respect of services covered under
RCM is taken only after making payment of GST under RCM?
17. (a) Whether payment and other ledger entries are made in terms of
the CGST Act and payment rules given in CGST Rules, 2017?
[Refer Annexure B (for discharge of liability)]
(b) If tax is paid belatedly, specify interest paid on delayed payment
under Section 50 of the CGST Act, 2017?
(c) Whether RCM tax liability is not discharged by utilizing the
accumulated ITC?
18. The banking sector provides services of purchase and sale of
foreign currency to its customers, the value of which can be
ascertained in terms of Rule 32(2) of the CGST Rules, hence liable
to GST. However, (i) inter se sale or purchase of foreign currency
amongst banks or authorised dealers of foreign exchange or
amongst banks and such dealers is exempt vide Notification
No.12/2017.[Note- Auditor has to check, the value of supply of
services in relation to the purchase or sale of foreign currency,
782
including money changing is determined in terms of Rule 32(2)] and

also check the parties involved in the supply.
PART D: COMPLIANCE OF ITC PROVISIONS GIVEN UNDER CGST ACT
AND CGST RULES, 2017
19. (a) Whether ITC taken/ utilized is matching with books of accounts
and GST returns (Annexure A)
(b) If the answer of (a) above is negative, Report differences thereof.
20. Whether ITC credit taken, utilized and reversed on input services /
inputs and Capital goods (Annexure C) is as per the CGST Act read
with CGST Rules?
21.  Whether the head office has not availed depreciation under
section 32 of the Income Tax Act, 1961 on the amount of GST on
the capital goods on which input tax credit has been availed?
 Whether the bank has taken the Input Tax Credit in respect of
input and capital goods / services on the basis of proper duty
paying documents, containing all particulars as prescribed by
CGST Rules read with section 31 of the CGST Act, 2017?
22. Where the taxpayer is registered as an ISD the Auditor should
check the following points:
(a) Ensure that every person being an ISD shall make a separate
application for registration as such Input Service Distributor?
(b) Whether an ISD invoice is issued to each recipient of credit on
every distribution in terms of CGST Act read with CGST Rules?
(c) Ensure, Credit distributed does not exceed the credit available
for distribution?
(d) Whether ISD is distributed to those taxable persons whose PAN
no is same as that of ISD (Under GST)?
(e) Whether credit attributable to a specific unit is distributed to that
unit only?
(f) Whether, Section 20 of the CGST Act is adhered in reference to
the manner of distribution of credit by ISD?
(g) Whether, procedure for distribution of ITC by ISD is adhered?
(h) Whether tax paid on input services used by a particular location
(registered as supplier), is to be distributed only to that
location?
783
(i) Whether, credit of tax paid on input service used by more than
one location who are operational is to be distributed to all of
them based on the pro rata basis of turnover of each location in
a State to aggregate turnover of all such locations who have
used such services?
(j) Ensure that, each type of tax must be distributed through a
separate ISD invoice?
(k) Whether the credit of IGST is distributed as IGST, irrespective
of the location of the ISD?
(l) Whether the aggregate of CGST and SGST and UTGST), as
IGST, where the ISD is located in a State other than that of the
recipient of credit?
(m) Whether the CGST and SGST (or UTGST) is distributed as the
CGST and SGST (or UTGST), respectively, where the ISD is
located in the same State as that of the recipient?
(n) Whether turnover for the distribution has been determined in
accordance with the CGST Rules?
(o) Ensure every ISD shall, for every calendar month or part
thereof, furnish a return in FORM GSTR-6 within 13 days after
the end of such month?)
23. List of major Input services /inputs on which the company takes ITC:
whether it comply with CGST Act read with CGST Rules.
24. Whether credit has been reversed for every month for an amount
equal to 50 per cent of the Input Tax Credit availed on inputs, input
services and capital goods or input tax credit has been reversed in
respect of exempted supplies on actual basis?
Note- such reversal is not required in case of cross charge made to
other branches (refer Rule 42 )
25. Whether ITC distributed is in compliance with Section 20 of the
CGST Act 2017,
If the answer to the above is in negative, provide the discrepancy in
the distribution and reasons thereof.
26. Amount of ITC received from ISD, if any together with address of the
unit from which it is received.
784
27. Whether any input tax credit has been claimed on invoice/ debit
notes after the due date of furnishing of the return under section 39
for the month of September of the subsequent financial year or
furnishing of the relevant annual return?
PART E: COMPLAINCES OF GST ACTS AND CGST RULES, 2017
28. (i) Value of service provided to persons other than account holders
where tax not charged on the ground that the place of supply is
outside the taxable territory.
(ii) Value of services exported.
 With payment of IGST and claimed refund.
 Without payment of IGST under the cover LUT or Bond and
claimed refund.
29. Whether conditions for export of supply of service satisfied to avail
benefit of export supply without payment of tax, as such benefit is
subject to furnishing of LUT/Bond?
30. Is the payment for services exported received by the service
provider in convertible foreign currency within the time limit
prescribed by RBI? If not, give details.
PART F- OTHERS
31.  Whether GST have been properly charged by the head office,
regional offices, zonal offices in case of inter unit / branch
transactions?
 Whether the registered person have filed the applicable returns on
timely basis as notified by the Government?
 Whether IGST has been paid on ‘import of services’?
 Whether ITC has been reversed with Interest, if recipient fails to
pay the amount to the supplier within 180 days(Rule 37)?
 Whether Tax wrongfully collected and paid to Central or State
Government (interstate supply considered as intra state supply or
vice versa)?
 If Yes, state the details of transaction (quantum)
 GST audit report for earlier year should be examined for comments by
GST auditor. Also the concurrent audit reports need to be reviewed for
any comment on GST.
785
NOTE: Also refer Frequently Asked Questions (FAQ) issued by CBIC on

Banking, Insurance and Stock Brokers Sector updated as on 27.12.2018
which is relevant for GST Audits as given at below cited link:
http://cbic.gov.in/resources//htdocs-cbec/gst/27122018-
UPDATED_FAQs%20ON%20BANKING,%20INSURANCE%20AND%20STOC
K%20BROKERS.pdf;jsessionid=26FC0CC2AE1BD05BAEB2B153C4EEE8E8
786
NAME OF THE ASSESSEE

ANNEXURE A
RECONCILIATION OF TURNOVER FOR THE YEAR……….
GSTR 1:
RECON
WITH
BOOKS
Total Credits in statement of profit and loss XXX
Less: Not Goods / Not Services - e.g. dividend income (XXX)
Less: Sch III Items which is not a Supply e.g.: Land & (XXX)
Building etc
Less: April - June Supplies (only for FY 2017-18) (XXX)
Less: Receipts not in the course of business (XXX)
Add: Sch I Supplies like Branch Transfer not in books, XXX
but supply as per GST Law
Add: Receipts capitalised but taxable to GST XXX
Less: Profit on Sale of capital goods (XXX)
Add: Taxable Value of Supply of capital goods XXX
Add: Advance received during the current period XXX
Less: Advance of earlier period adjusted during the (XXX)
current period
Less: Closing unbilled revenue recognised - but time of (XXX)
supply did not arise
Add: Opening unbilled revenue (Billed during the XXX
period/Time of supply falls in the month)
Total Value in GSTR 1 XXX
Less: Exempted Supply (XXX)
Less: Non-Taxable Supplies: Supplies Like HSD, Motor (XXX)
Spirit Etc including Liquor
Less: NIL Rated Supply (XXX)
Taxable Value in GSTR 1 XXX
787
B
A
al
Month Month
Jul
Tot
Oct
Feb
Jan
Apr
Jun
Apr
Mar
Sep
Dec
Nov
Aug
May
Liability
Liability for
Credit utilised
Liability
CGST
CGST
Cash utilised
Delay
Ratio
Date of
Liability
Interest
Credit utilised
Liability
SGST
SGST
Cash utilised
Delay
788
Ratio
Date of off-
Liability
ANNEXURE B
Interest
Credit utilised
Liability
NAME OF THE ASSESSEE
IGST
IGST
Cash utilised
Delay
Details of Discharge of Liabilities
Ratio
Date of off-
Liability
Interest
Credit utilised
Liability
Cess
Cess
Cash utilised
Delay
Ratio
Date
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan
Feb
Mar
Tot
al
789
ANNEXURE C
Details of Input Tax Credit
A Goods / services on Goods / services on Total Out of (B),
which ITC is eligible which ITC is ineligible inwar Value of
(A) (B) d capital
suppl goods on
-ies which
credit is
Month
not
availed on
account
of Sec.
16(3) of
Value of Input services
Value of Capital goods

Value of Capital goods
Value of Input services
the CGST
Value of Inputs
Value of Inputs
Total ineligible
To match with
Total eligible
Act, 2017
Annex 4
(Depreciati
on claimed
on Capital
Goods on
GST
componen
t under the
IT Act,
1961)
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan
790
Feb
Mar
Total
B. Out of total of (A), eligible credits on supplies received from related

persons and distinct persons
GSTIN of Nature of Value of supply Tax
supplier relationship
Goods Services CGST SGST IGST
ITC reversal
A Details of amount of tax credit paid as output tax liability u/s 16 r/w Rule
37, which was reclaimed during the year
Amount of credit reclaimed upon payment of
consideration
Month in Amount of ITC
which the paid as output
credit was tax liability u/s
May
Aug
Nov
Dec
Sep
Mar
Jun
Feb
Apr
Jan
Oct
Jul
paid as 16(2) read with

output Rule 37
liability
PY -3
PY -2
PY -1
Apr -
May - -
791
Jun - - -
Jul - - - -
Aug - - - - -
Sep - - - - - -
Oct - - - - - - -
Nov - - - - - - - -
Dec - - - - - - - - -
Jan - - - - - - - - - -
Feb - - - - - - - - - - -
Mar - - - - - - - - - - - -
Total
B Details of amount of tax credit paid as output tax liability u/s 16 r/w
Rule 37, which was reclaimed during the year
Month in which the amount of credit
should have been paid as output liability
u/s 16(2) r/w rule 37
Month in Amount of ITC
which paid as output
the tax liability u/s
credit 16(2) r/w Rule 37
May
Aug
Nov
Dec
Sep
Mar
Jun
Feb
Apr
Jan
Oct
Jul
was paid
as
output
liability
Apr
May
Jun
Jul
Aug
792
Sep
Oct
Nov
Dec
Jan
Feb
Mar
Total
793
Readers may refer the following link on ICAI
website for Foreword and Preface of Past Years,
Appendices of the Guidance Note, Text of Relevant
Master Circulars, Master Directions issued by RBI,
Text of Relevant Notifications, FAQs and General
Circulars:
https://www.icai.org/post/guidance-note-on-audit-of-banks-
2021-edition

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Guidance Note on

Audit of Banks (2021 Edition)

Members’ attention is invited to relevant directions/circulars issued by the

The Institute of Chartered Accountants of India

First Edition : November, 1994

Price : Rs. 700/-

Banking Sector in India is rapidly changing due to technological innovation,

New Delhi CA. Nihar N Jambusaria

We express our sincere thanks to CA. Nihar N Jambusaria, Honourable

CA. Shriniwas Y. Joshi CA. G. Sekar

CA. Shriniwas Y. Joshi CA. G. Sekar

Section A – Statutory Central Audit ........................... 1-232

Chapter 1: Personal Banking and Operations Department ........................... 1-3

D. Text of Relevant Master Circulars Issued by RBI

Appendix I – Illustrative Format of Report of the Auditor of a

Appendix IV – Illustrative Format of Engagement Letter in case of a

Introduction & Bank’s process

auditor needs to apply effective sampling to ensure proper coverage. While

C. Post Disbursement Inspection

 Professional Clearing Member of the commodity derivatives segment of

Income is critical and it should be consistently applied. The Auditor should

Functions of International Banking Division

(A) Introduction and Bank’s Process

Middle office Operations

5.13 Deals done with customers (non-banks) will normally be confirmed by e-

Equity investments by Banks, Classification and Valuation of Investment

 Perusal of IT application controls and document whether controls are

Furthermore, the Auditor should design sufficient alternative audit procedures

in line with RBI prescribed methodology, he should also carefully focus on

decision of the competent authority such as Board of directors, ALCO or

 In case quotes are available, checking the source of capturing market

Type of Investment Basis of Valuation

Note: If the debentures/bonds/preference shares are quoted and are transacted

(a) In respect of securities included in the HFT category, open gold

(a) the provision is allowed to be adjusted directly against an item of

 Re-computation of interest income on investments and checking the

paid up capital. Financial Services Companies have been defined in Annex I to

(v) Subsidiaries/ Joint Ventures/ Associates

 Verification of voice recording mechanism and to ensure user ids of

(c) Unencumbered investment in the following instruments which will be

5.144 As per Circular RBI/2016-17/302 Ref: DBR.CO.No.Ret.BC /66/

 DBOD.No.BP.BC. 44/21.04.157/2011-12 dated 2 November 2011

Exchange-Traded Contracts traded on a recognised exchange, with the

 Market-maker: A market-maker provides bid and offer prices to users and

Bank’s Process, Regulatory requirements/ restrictions & updates

b. In the case of structured products, marking the constituent generic

5.187 The Circular on the Comprehensive Guidelines on Derivatives require

Prudential Norms Relating to Derivatives

account of the principle of “borrower-wise asset classification”, though

 In cases where the derivative contracts provide for more settlements in

(provided such re-booking is permissible as per extant RBI guidelines). In such

v) Details of option transactions (FCY-INR) undertaken on a weekly basis.

5.245 Attention of the readers is invited to paragraphs 36 to 39 of Accounting

21.04.157/ 2011-12 dated November 2, 2011 on “Comprehensive Guidelines on

higher-level approval and sanctions/ratifications for any breaches. It

 Verify whether there is any overlapping of duties.

 Inquire of any exception report or other mechanism of tracking missing

any branch in a particular month/period, if any, and test adherence to the

 Checking whether there exists effective mechanism for settlement of deals