Concept Of Bank Audit And Inspection. By: Adeeba Faheem
Concept Of Bank Audit And Inspection.
Authored By: Adeeba Faheem
(Advocate)
ABSTRACT
Financial institutions are the
backbone of any financial system because of their role in spurring economic
growth through maturity transformation and supporting payment systems.
There is little question that the
financial system plays a strategic role in an economy, and even countries where
banks credit roles have declined relative to other sectors of the financial
sector, the banking industry remains at the core.
TABLE OF CONTENT
CHAPTER NO.1
Introduction.
-Audit of banking company
- Inspection of banking company
CHAPTER NO.2
- Government
role
- Scrutiny
CHAPTER NO.3
-Supervisory function in India
-Functions and powers
CHAPTER NO.4
-Core principles of banking
supervision
-Preconditions for effective banking
supervision
- Supervisory powers,
responsibilities and functions.
CHAPTER NO.5
Conclusion
BIBLOGRAPHY
CHAPTER-1
INTRODUCTION
Banks occupy the pride of place in
any financial system by virtue of the significant role they play in spurring
economic growth by undertaking maturity transformation and supporting the
critical payment systems. The balance sheet and the profit and loss account of
a banking company have to be audited as stipulated under Section 30 of the
Banking Regulation Act, 1949. Special responsibility is cast on the bank
auditor in certifying the bank’s balance sheet and profit and loss account,
since that reflects the sound financial position of the banking company.
The specificity of banks, the
volatility of financial markets, increased competition and diversification,
however, expose banks to risks and challenges. The protection of depositors’
interests and ensuring financial stability are two of the major drivers for
putting in place an effective system of supervision of banks.[1]
Credibility of an institution,
particularly that of financial institution depends on its internal control and
supervision mechanism that can promptly detect irregularities, if any, and take
corrective measures and ensure non-recurrence of irregularities. Business of
banking is susceptible to frauds. It is therefore necessary to have an internal
control and supervision mechanism for ensuring that no one person is in a
position to violate procedures, rules, regulations, guidelines, do an
unauthorized act detrimental to the organization which remains undetected for
an indefinite period or long time. Therefore, inspection and audit plays
crucial role in success of banking operations.[2]
AUDIT OF BANKING COMPANY
The balance sheet and the profit and
loss account of a banking company have to be audited as stipulated under
Section 30 of the Banking Regulation Act, 1949. Every banking company’s account
needs to be verified and certified by the Statutory Auditors as per the
provisions of legal framework. The powers, functions and duties of the auditors
and other terms and conditions as applicable to auditors under the provisions
of the Companies Act are applicable to auditors of the banking companies as
well. The audit of banking companies’ books of accounts calls for additional
details and certificates to be provided by the auditors.[3]
They include:
Whether or not;
information and explanation, required
by the auditor were found to be satisfactory;
The transactions of the company, as
observed by the auditor were within the powers of the company;
Profit and loss account shows a true
picture of the profit or loss for the period for which the books have been
audited and any other observations to be brought to the notice of the
shareholders;
Special responsibility is cast on the
bank auditor in certifying the bank’s balance sheet and profit and loss
account, since that reflects the sound financial position of the banking
company. Apart from the balance sheet audit, Reserve Bank of India is empowered
by the provisions of the Banking Regulation Act, 1949 to conduct/order a
special audit of the accounts of any banking company. The special audit may be
conducted or ordered to be conducted, in the opinion of the Reserve Bank of
India that the special audit is necessary;
In the public interest and/or
in the interest of the banking
company and/or
In the interest of the depositors.[4]
The Reserve Bank of India’s
directions can order the bank to appoint the same auditor or another auditor to
conduct the special audit. The special audit report should be submitted to the
Reserve Bank of India with a copy to the banking company. The cost of the audit
is to be borne by the banking company.[5]
INSPECTION OF BANKING COMPANY
As per Sec 35 of the Banking
Regulation Act, the Reserve Bank of India is empowered to conduct an inspection
of any banking company. After conducting the inspection of the books, accounts
and records of the banking company a copy of the inspection report to be
furnished to the banking company. The banking company, its directors and
officials are required to produce the books, accounts and records as required
by the RBI inspectors, also the required statements and/or information within
the stipulated time as specified by the inspectors. [6]
CHAPTER-2
GOVERNMENT’S ROLE
The Central Government may direct the
Reserve Bank to conduct inspection of any banking company. In such cases, a
copy of the report of inspection needs to be forwarded to the Central
Government. On review of the inspection report, the Central Government can take
appropriate action. In the opinion of the Central Government if the affairs of
the banking company are not being carried out in the interests of the banking
company, public and or depositors, the Central Government may
Prohibit the banking company to
accept fresh deposits
Direct the Reserve Bank to apply for
winding up of the banking company under the provisions of the Banking
Regulation Act.
Before taking action, the Government
has to give an opportunity to the banking company to explain their stand. Based
on the response, the Government can initiate appropriate action as required.[7]
SCRUTINY
Apart from inspecting the books and
accounts of the company, the Reserve Bank can conduct scrutiny of the affairs
and the books of accounts of any banking company. Like in the case of
inspection, the Reserve Bank can handle the scrutiny as required.
CHAPTER-3
SUPERVISORY FUNCTION IN INDIA
The legal and institutional framework
for bank supervision in India is provided under the Banking Regulation Act,
1949. Until 1994, different departments in Reserve Bank of India were
exercising supervision over banks, non-banking financial companies and
financial institutions. To keep a close watch on financial markets and avoid
recurrence of crisis in the financial system, the Board for Financial
Supervision was set up under the aegis Reserve Bank under Reserve Bank of India
(Board for Financial Supervision) Regulations, 1994 with the objective of
paying undivided attention to the supervision of the institutions in the
financial sector.
To have better supervision and control, a
separate board was constituted namely “The Board for Financial Supervision” as
per the provisions of the RBI. The Board has the jurisdiction over the banking
companies, nationalized banks, State Bank of India and its subsidiaries. The
members of the Board are: Governor of the Reserve Bank of India as the
chairperson, Deputy Governors of the Reserve Bank of India, and one of the
deputy governors should be nominated by the Governor as the full time vice
chairman, four directors from the Central Board of the Reserve Bank nominated
by the Governor as members.
FUNCTIONS AND POWERS
The Board performs the functions and
exercises the powers of supervision and inspection under the RBI Act, with
respect to different banking companies. The department of supervision assists
the Board. The Board has to report to the Central Board on half yearly basis.
The Board meets on a monthly basis, with at least one meeting in a month. The
vice chairman of the Board is the ex-officio chairman of the committee.
Apart from the above, the Governor
may constitute an advisory committee to offer advice from time to time to the
Board. The council will have at least five members who have special knowledge
in different areas like accountancy, law, banking, economics, finance and
management. The Governor presides over the meetings and the other members of
the council are the vice chairman and other members.[8]
CHAPTER-4
CORE PRINCIPLES OF BANKING
SUPERVISION
The Core Principles for Effective
Banking Supervision are the de facto minimum standard for sound prudential
regulation and supervision of banks and banking systems. Originally issued by
the Basel Committee on Banking Supervision in 1997, they are used by countries
as a benchmark for assessing the quality of their supervisory systems and for
identifying future work to achieve a baseline level of sound supervisory
practices.
The RBI has continued with the
post-liberalization strategy of setting prudential norms based on international
best practices within which banks are left free to operate. The compliance of
the Bank with the Basel Committee’s Core Principles on Banking Supervision was
gone into in great detail and the gaps in supervision were addressed by setting
up seven in-house groups to make necessary recommendations.
The reports of these groups were
discussed by the BFS in a specially convened session and the agenda set for
action to be taken to bridge the gaps. Since then, the compliance is being
monitored on a regular basis. The BFS also authorized the release in the public
domain of the assessment of compliance, and this document is being shared with
overseas supervisory agencies and international financial institutions. The IMF
also completed an assessment using the revised methodology of the Core
Principles which was in line with the Bank’s own assessment.[9]
RBI’s efforts in this area have been
well recognized in international forums and in August 1999, it was made a
Member of the Core Principles Liaison Group (CPLG) of the Basel Committee for
Banking Supervision, which has been set up to promote the implementation of the
Core Principles worldwide. RBI has also examined the proposed New Capital
Adequacy Framework currently under discussion by the BCBS, and has communicated
its response to the Basel Committee. RBI is also represented on the Working
Group of Capital of the Core Principles Liaison Group, which has been
constituted to obtain the inputs of the non G-10 countries in the international
standard setting exercise.
PRECONDITIONS FOR EFFECTIVE BANKING
SUPERVISION
Sound and sustainable macroeconomic
policies;
A well-established framework for
financial stability policy formulation;
A well-developed public
infrastructure;
A clear framework for crisis
management, recovery and resolution;
An appropriate level of systemic
protection (or public safety net); and
Effective market discipline
SUPERVISORY POWERS, RESPONSIBILITIES
AND FUNCTIONS
There are twenty-nine Core Principles
in all out of which we enlist a few:
Responsibilities, objectives and
powers: An effective system of banking supervision has clear responsibilities
and objectives for each authority involved in the supervision of banks and
banking groups.
Cooperation and collaboration: Laws,
regulations or other arrangements provide a framework for cooperation and
collaboration with relevant domestic authorities and foreign supervisors.
Supervisory approach: An effective
system of banking supervision requires the supervisor to develop and maintain a
forward-looking assessment of the risk profile of individual banks and banking
groups, proportionate to their systemic importance; identify, assess and
address risks emanating from banks and the banking system as a whole; have a
framework in place for early intervention.
Supervisory techniques and tools: The
supervisor uses an appropriate range of techniques and tools to implement the
supervisory approach and deploys supervisory resources on a proportionate
basis, taking into account the risk profile and systemic importance of banks.
Supervisory reporting: The supervisor
collects reviews and analyses prudential reports and statistical returns from
banks on both a solo and a consolidated basis, and independently verifies these
reports through either on-site examinations or use of external experts.
Corrective and sanctioning powers of
supervisors: The supervisor acts at an early stage to address unsafe and
unsound practices or activities that could pose risks to banks or to the
banking system. The supervisor has at its disposal an adequate range of
supervisory tools to bring about timely corrective actions. This includes the
ability to revoke the banking license or to recommend its revocation.
Internal control and audit: The
supervisor determines that banks have adequate internal control frameworks to
establish and maintain a properly controlled operating environment for the
conduct of their business taking into
Financial reporting and external
audit: The supervisor determines that banks and banking groups maintain
adequate and reliable records, prepare financial statements in accordance with
accounting policies and practices that are widely accepted internationally and
annually publish information that fairly reflects their financial condition and
performance and bears an independent external auditor’s opinion
Disclosure and transparency: The
supervisor determines that banks and banking groups regularly publish
information on a consolidated and, where appropriate, solo basis that is easily
accessible and fairly reflects their financial condition, performance, risk
exposures, risk management strategies and corporate governance policies and
processes.
Abuse of financial services: The
supervisor determines that banks have adequate policies and processes,
including strict customer due diligence rules to promote high ethical and professional
standards in the financial sector and prevent the bank from being used,
intentionally or unintentionally, for criminal activities.[10]
CHAPTER-5
CONCLUSION
The importance of the financial
system in an economy can hardly be overstated, and the banking industry remains
at the core of the financial system, even in countries where its credit role
has diminished relative to other financial sectors. Recent changes in the
nature of banking, and the frequency in the past couple of decades of costly
banking crises around the world, have only heightened the interest of policy
makers and industry participants in the effective regulation and supervision of
banks.
Therefore, few recommended action
plan for greater compliance with the Basel Core Principles are:
Provide greater certainty regarding
the independence of RBI by removing impeding provisions from related acts.
Provide greater clarity regarding the
role of the nominee director in the public banks, which can blur the
distinction between the legal powers of RBI as a banking supervisor and an
active role of RBI appointed staff in the management or compliance function of
a bank. .
Reconsider the strict rotation
policies, so as to ensure staff can build up expertise in banking supervision
and regulation.
Developing mechanisms for written
material (including inspection reports) to be regularly shared on a timely
basis;
Broadening and strengthening
escalation protocols to promptly alert other relevant supervisors about
concerns that a supervisor is developing; and
Regularly holding the semi-annual
meetings on major banking companies, but also allowing the opportunity for a
regulators-only discussion of issues regarding that banking company.
Only a stable financial system can
fulfill its macro-economic function – the cost-effective transformation and
provision of financial resources. A properly functioning banking system is
indispensable for the performance potential of a country’s economy and an
efficient banking supervision system is therefore essential for the whole
economy. The accounting process produces financial and operational information
for management's use and it also contributes to the bank's internal control.
Thus, understanding of the accounting process is necessary to identify and
assess the risks of material misstatement whether due to fraud or not, and to
design and perform further audit procedures. In obtaining an understanding of
the accounting process, the auditor may seek to identify the significant flow
of the transactions and significant application systems that are relevant to
the accounting process. When obtaining an understanding of the accounting
process, the auditors, ordinarily, focus only on such processes that relate to
the effectiveness and efficiency of operations and compliance with laws and
regulations and impact the financial statements or their audit procedures.
While obtaining the understanding of the significant flow of the transactions,
the auditor should also obtain an understanding of the process of recording and
processing of journal entries, and should also make inquiries about
inappropriate or unusual activity relating to the processing of journal entries
and other adjustments, Transactions flow automated across CBS, digital banking,
payments and settlement systems, card operations etc. and their integration
with external systems such as NPCI, international payment gateways, SWIFT and
INFINET etc. (SWIFT INSIGHT :IN 1973 global finance saw a back-room revolution
when a group of banks formed a co-operative to offer those moving money across
borders a slick alternative to the clunky old telex. Today the electronic
financial-messaging system of the Society for Worldwide Interbank Financial
Telecommunication (SWIFT) transmits more than 5 billion bank-to-bank messages
each year. In 2013 it oiled the transfer of trillions of dollars globally by
the 10,500 banks, asset managers and firms that are its members. SWIFT does not
initiate transfers, hold customers' money, or clear or settle payments. Rather,
it provides a template that helps international transfers flow smoothly and be
tracked. Electronic Payments effected through alternate products/channels are
becoming popular among the customers with more and more banks providing such
facilities to their customers. One such initiative by RBI is mandating
additional factor of authentication for all Card Not Present (CNP)
transactions. Banks have also to put in place mechanisms and validation checks
for facilitating on-line funds transfer, such as: (if) enrolling customer for
internet/mobile banking; (ii) addition of beneficiary by the customer; (iii)
velocity checks on transactions. The dependence of banks on mobile banking
service providers may place knowledge of bank systems and customers in a public
domain. Mobile banking system may also make the banks dependent on small firms
(i.e., mobile banking service providers) with high employee turnover. It is
therefore imperative that sensitive customer data, and security and integrity of
transactions are protected. It is necessary that the mobile banking servers at
the bank's end or at the mobile banking service provider's end, if any, should
be certified by an accredited external agency. In addition, banks should
conduct regular information security audits on the mobile banking systems to
ensure complete security. Banks without end-to-end encryption can facilitate
transactions up to Rs. 5000/-. The banks through adequate security measures may
address the risk aspects involved in such transactions. (Circular
DPSS.CO.No.2502/02.23.02/ 2010-11 dated May 4, 2011) RBI Circular dated 4th
December 2014 on Mobile Banking Transactions in India - Operative Guidelines
for Banks has felt the need for greater degree of standardization in procedures
relating to on-boarding of customers for mobile banking (new customers,
existing account holders whose mobile numbers are available with the bank but
not registered for mobile banking, and existing account holders where mobile
number is not available with the bank), as also the subsequent processes for
authentication, including accessible options for generation of MPIN by
customers. Where banks are providing E-Wallet facility, auditor should evaluate
proper controls and checking of transactions through E-Wallets and presentation
of the balances of E-Wallet in the financial statements based on underlying
arrangement for providing such facility.
Based on the recommendations of a
High Level Steering Committee (HLSC) for Review of Supervisory Processes of
Commercial Banks, the Reserve Bank of India had in September 2012, introduced a
Supervisory Program for Assessment of Risk and Capital (SPARC) for commercial
banks. This Risk Based Supervision (RBS) approach helps the regulator in
focusing on evaluating both present and future risks, identifying incipient
issues and facilitating prompt intervention/ early corrective action - as
against the earlier compliance-based and transaction testing approach (CAMELS)
which was more in the nature of a 'point in time' assessment. The RBS approach
also benefits the regulator by optimizing its use of supervisory resources and
assisting the regulated entities in improving their risk management systems,
oversight and controls. RBI is empowered under section 21 of the Banking Regulation
Act, 1949, to control advances by banks in general or by any bank in
particular. Among the measures that the RBI can adopt for this purpose are to
prescribe purposes and extent of advances, margin requirements, maximum
exposure to a single Banking in India borrower, rate of interest and other
terms and conditions, etc. Besides these measures (which are usually called
'selective credit control' measures), RBI also controls the total volume of
bank credit by varying bank rate through open market operations or by varying
cash reserve and similar requirements. Bank rate refers to the rate of interest
at which the RBI re-discounts the first class bills of exchange or other
eligible instruments from banks. Variations in bank rate affect the interest
rates charged by banks - generally, interest rates of banks move up or down in
tandem with movements in bank rate. Under Base Rate system that came into
effect from July 1, 2010, all categories of domestic rupee loans of banks are
priced only with reference to the Base Rate, subject to certain conditions. For
monetary transmission to occur, lending rates have to be sensitive to the
policy rate. At present, banks follow different methodologies for computing
their Base Rate like average cost of funds method, marginal cost of funds,
blended cost of funds (liabilities) etc. Open market operations involve sale or
purchase of government securities in the open market. When RBI buys government
securities from banks in the open market, the funds in the hands of selling
banks increase, enabling them to expand credit, and vice versa. Banks are
required to maintain at least a prescribed minimum percentage of their demand
and time liabilities in India in the form of cash and/or current account
balances with the RBI (called 'cash reserve ratio'). Additionally, they are
required to maintain a further percentage in the form of cash and/or other
liquid assets (called 'statutory liquidity ratio'). Varying the cash reserve
ratio and/or statutory liquidity ratio enables the RBI to increase or decrease
(as the case may be) the funds available to banks for lending and other similar
purposes. A major development that has implications for banks throughout the
world is the 'International Convergence of Capital Measurement and Capital
Standards' generally known as the Basel Accord. Basel III ensures better
quality of capital and robust liquidity risk management. The smooth functioning
of the payment and settlement systems is a prerequisite for stability of the
financial system. In order to have focused attention on payment and settlement
systems, a Board for Regulation and Supervision of Payment Systems (BPSS) was
set up in March, 2005. The launch of the Real Time Gross Settlement System
(RTGS) and NEFT (National Electronic Funds Transfer) has led to a reduction of
settlement risk in large-value payments in the country. Similarly, IMPS (Inter
bank Mobile Payment Service/Immediate Payment Service) is a mobile-based
payment mechanism introduced by the National Payments Corporation of India to
allow customers to transfer money instantly, facilitating instant remittance
across multiple platforms. The setting up of NSDL Guidance Note on Audit of
Banks (Revised 2018) and CDSL for the capital market settlements and CCIL for
G-sec, forex and money market settlements have improved efficiency in market
transactions and settlement processes. A series of legal reforms to enhance the
stability of the payment systems have been carried out. With the introduction
of the Payments and Settlement Act in 2008, the Reserve Bank has the
legislative authority to regulate and supervise payment and settlement systems
in the country.
BIBLIOGRAPHY
-Power, Michael. 1999. The Audit Society: Rituals of
Verification. Oxford: Oxford University Press.
- Loeb,
Stephen E.; Shamoo, Adil E. (1989-09-01). "Data audit: Its place in
auditing".
-Assurance, Auditing and.
Chapter 1, Volume 1: Institute of Chartered Accountants of India. p. 1.
-Derek Matthews, History of
Auditing (2006-09-27. Routledge-Taylor & Francis Group.
- A., Moyer (January 1951).
"Early Developments in American Auditing". Accounting Review.
[1] Report of High Level Steering Committee for
Review of Supervisory Processes for Commercial Banks dated 19th June, 2012
[2] Ibid
[3] Audits Of Banks: Lessons From
Crisis/
[4] Supra Note 1
[5] Supra Note 2
[6] Marshall C. Cons, Bark Auditing
–Cambridge, Mass.: Bankers Publishing Company, 1955
[8] Supra Note 6
[9] Supra Note 12
[10] Financial Sector Assessment
Program—Detailed Assessments Report on Basel Core Principles for Effective
Banking Supervision, IMF, 2013