A case for relook by RBI for a pointed mechanism to address fraud

The auditors in their Audit Report under 'Auditors responsibly' declares 'We have taken into account the provisions of the Act, the accounting and auditing standards and matters which are required to be included in the audit report under the provisions of the Act and the Rules made there under' (vide APPENDIX IV of ICAI GN on Bank audit 2018 on Illustrative Format of Report of the Auditor on the Standalone Financial Statements of a Banking Company), though under 'Management Responsibly, it also speaks about provisions of Section 29 of the Banking Regulation Act, 1949 and circulars and guidelines issued by the Reserve Bank of India ('RBI') from time to time.

There appears a conflict of view of accounting/ auditing standards with certain RBI circulars and application. It is high time RBI address the issue.

As per AS 29, provision is a liability which can be measured only by using a substantial degree of estimation Further, a provision should be recognized when:

• an enterprise has a present obligation as a result of a past event;
• it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
• a reliable estimate can be made of the amount of the obligation.

If these conditions are not met, no provision should be recognized

RBI NORMS:

Loans and advances provided by banks are their main asset base. Depending on the performance of such loans and advances, they are classified as performing or non-performing asset (NPA) assets according to the norms prescribed by Reserve Bank of India. The classification is aimed to ensure transparency and consistency of a higher degree in the published accounts. The RBI is periodically varying the standard and sub-standard classification from time to time depending on the call and dictates of the time. What was a standard asset now can well become a sub-standard asset tomorrow on the position prevalent at that particular point of time, to be precise on the dictates and needs of the time.

Standard asset for a bank is an asset that is not classified as an NPA. The asset exhibits no problem in the normal course other than the usual business risk.

Sub-standard asset is an asset class drawn within the broader and much-known non-performance asset category of banks on the basis of term for which the asset class has not performed and extent of dues realization from collateral security with banks. In general, NPAs are the assets that have ceased to generate income for the banks. Further, on the basis of some other criterion stipulated for different kind of accounts, assets of the bank are classified as NPAs. More specifically, according to RBI circular, sub-standard asset is an asset that has continued to remain an NPA for a period less than or equal to 1 year. With well-specified credit weaknesses, the liquidation of the debt would be difficult and banks would necessarily have to sustain some losses if deficiencies with respect to interest and principal amount payment are not corrected. Another instance where a loan account or an asset class of the bank is categorized as a sub-standard asset is when the terms and conditions pertaining to the loan account are re-negotiated or revised. And depending on the satisfactory performance basis the revised terms, the account has to be classified within the sub-standard asset category for a minimum of 12 months. Thus, mere revision of terms of the account with no proper compliance does not result in the up-gradation of the asset quality. By changing norms of standard and sub-standard classification you cannot hope to improve the situation.

RBI has established PROVISIONING NORMS based on classification of assts. In nut shell (vide ICICI Guidance Note On Bank Audit) subject to further up gradation by RBI

PS:

• Realisable value of security includes principal security, collateral security, DIGCC/CGC claim Net worth of borrowers and guarantors, Deposits and value of attached assets as per court orders
• The country based risk provision ranging from 0.25 % to 100 % to be made.
• For all NPA accounts provisioning should be made on amounts outstanding less amount of interest/other charges debited not recovered by the year end.
• In respect of NPA balance of Rs.5 crores & above, bank needs to formulate policy for annual stock audit by external agencies & in respect of immovable properties, valuation to be carried once in 3 years by approved value.

A case for a relook of certain provisions/liabilities in the presentation/ disclosures in the Balance Sheet:

In this contest, it is highly proper to revisit certain areas to mull over the presentation / disclosures in the Balance Sheet as to certain provisions in Schedule IV-5 on Other Liabilities and Provisions to examine as to whether a relook is highly appropriate and demanding.

As stated earlier, Standard assets are not NPAs as on the date and exhibit no symptom of loss except normal risk. Whether it will qualify for provision to present as “Other liabilities and Provisions” under “Capital & liabilities”?

Or is it not more appropriate and justified if the presentation is suitably changed?

Further, the following items are specifically referred to on 5. 05 IV- 5 on others (Including Provisions) in the Guidance note – (Schedule 5 Other Liabilities and Provisions - item IV. Others (including provisions) APPENDIX II .The Third Schedule to the Banking Regulation Act, 1949 (See Section 29) FORM 'A'

Form of Balance Sheet

(b) Surplus in bad and doubtful debts provision account (such surplus is in the nature of a reserve).

(c) Surplus in provisions for depreciation in securities (such surplus is in the nature of a reserve).

(d) Contingency funds, which are actually in the nature of reserves but are not disclosed as such.

All the above three items are highly vocal and specific in declaring in the GN that they are more in the nature of reserve/contingent reserve. As pointed out earlier, 'Standard Assets' are not NPAs as on date and sprout no indication of loss except normal risk. If the above items are examined without any bias/ prejudice, RBI should rightly consider presenting them as 'Contingent Reserve' (of course net of tax) with appropriate clarificatory notes Besides, it will 'give true and fair' view that's kernel any presentation and disclosure

It is high time RBI, in this respect, should address the call sooner than later of this presentation.

A case for a pointed mechanism/ institution to address frauds:

The next point that is to be addressed is possible reasons for NPAS - one major cause for NPAs is due to ineffective management and the other is due to fraudulent approach. Frauds may be the offshoot from within the organisations (Borrowers) and the other in connivance with the concerned bank official at different levels.

Ineffective management:

• Internal factor - breakdown of business, incompetent management, inapt technology, product obsolescence
• External factor covering industrial recession, price escalation, power shortage, accidents etc., not taken care of at the time of loan

Fraudulent approach:

• Diversification of funds for expansion, investment in different areas and products, modernization, into taking up of new projects either with or without connivance of the bank officials. More often than not, this is the main culprit for deceitful use of bank money – a fraudulent approach.

Both the above factors are leading to

• Time / cost overrun during the project implementation stage leading to liquidity strain and turning NPA into
• Other factors in order or prominence are Government Policies like changes in Import / Excise duties etc.,
• Willful default, fraud / misappropriation, disputes etc.,

Positive role of NCTL under IBC:

Bad loans of especially of government banks are bulging and mounting by leaps and bounds running to lacks of Crores. Here, the role by Insolvency and Bankruptcy Code, 2016 is going to be astonishing. Big tickets NPAs are already under the National Company Law Tribunal (NCLT). Once referred to the NCLT, the resolution of the case in terms of either a sell-off of assets or revival or winding up will have to be completed within 180 days. As per reliable information floating in the news column, NPAs nearing to RS 1lac is nearing finalizations. RBI recently sends the second list.

NCTL is only to resolve already existing NPAs. Then, what about an institution that will monitor NPAs on day to day basis to nip the NPAs in the bud?

In today's environment, audit is completed within a month of closing of accounts. Auditors have not got the luxury of extended time that the judiciary is privileged to get in the form of adjournments. Auditors are to give opinion on 'true and fair view'. CARO (not applicable to banks) has a clause on fraud and that too when it is noticed. Section 143(12) requires an auditor to report on fraud if in the course of performance of his duties as an auditor, the auditor has reason to believe that an offence involving fraud is being or has been committed against the company by its officers or employees. Further, Section 143(2) requires the auditor to make out his report after taking into account, inter alia, the auditing standards. Accordingly, the term, “in the course of performance of his duties as an auditor” implies n the course of performing an audit as per the SAs. However, an auditor may not be able to detect acts that have intent to injure the interests of the company or cause wrongful gain or wrongful loss, unless the financial effects of such acts are reflected in the books of account/financial statements of the company

In view of the above, a dedicated and highly specialized department is to be instituted where specialists in criminal law including officials in the rank and cadre of IPS are to be the members apart from CAs/cost Accountants/ Company secretaries. All loan defaults beyond specified limits are to be referred for continuous monitoring for appropriate action. This will also inculcate a fear psychosis that will go in a long way to control if not arrest frauds

Though Guidance Note on Reporting on Fraud under Section 143(12) of the Companies Act, 2013 by The Institute of Chartered Accountants of India copiously deals with reporting on fraud, the institution that should be installed on the focused lines to cope up with the situation of fraud especially in banks my go in a long way to target and arrest fraud

As on date, there is no articulated Guidance nor any dependable check lists for reason that each assignment is unique and distinctive; and as a result, different routes to be used to go to the roots; - as seas can be used for navigation, roads for road traffic, planes by air- again different types of vehicles are used on the same routes depending of the size and level of passengers and quantum, size and quality of the materials. Therefore, most important in forensic audit is to decide the effective modus- operandi -technique, style procedure, approach, course of action and articulated methodology so as to successfully handle and deliver the correct result of the assignment so as to fix the fraud in all its manifestation.