It has come to the notice of Professional Development (PD) Committee of Institute of  Chartered Accountants of India (ICAI) that one of the public sector banks (PSBs) has  requested that Indian Banks’ Association (IBA) to consider the representation on  exemption from statutory bank branch audit, for the year ended March 31, 2020, in view of the delay in starting the bank audits on account of lockdown due to Covid-19 pandemic. It is understood that IBA has requested all PSBs to consider the proposal and inform the pros and cons of the same so that the representation can be made to Reserve Bank of India (RBI) on the subject. Accordingly, the PSBs have approached the Statutory Central Auditors (SCA) about their opinion on challenges in completion of central statutory bank audits of PSBs without the statutory branch audit.

The PD Committee considered the issue. In the opinion of PD Committee, it is too early to start this discussion considering guidance from RBI read with guidance from  SEBI, that the date of completion of audit by banks stands extended by one month up to 30th June and completion of LFAR by 31st July as the condition of continuation lock down is still not known. Even if lockdown is relaxed in a phased manner, it will be easily possible to complete the work of branch audit in time.The Committee was further of the opinion that there will be several serious problems in dispensing with the statutory bank branch audit for the year ended March 31, 2020, and it would not be in the interest of the banks, auditors and stakeholders of the PSBs not to have bank branch audit. The various impact that such a hasty decision would have on the audit of PSBs is enumerated below:

1. Management Challenges

a. Is PSB bank management really geared up to undertake centralized audit on it’s own? Unfortunately, the answer will have to be negative at this juncture. The CBS provides information to the top management. However,   the   functions   are   completely   decentralized.   Right   from  opening of deposit accounts to liability provisions and opening of loan accounts, sanction, disbursement and its monitoring (operations and  the authority both) are heavily decentralized. It is necessary to note that mere making information available is not sufficient for audit, the documentation  and  the  explanation  thereof  would  be  needed.  The higher management of PSBs first need to gear up to this challenge.

b. The current functioning is not conducive to centralized audit. It is often observed   that   since   the   decision-making process of  PSBs  is decentralized, answer to the queries raised by the central auditors is  not easily possible. The concerned officer needs to explain the same and  substantiate  with  documents  which  are kept at the respective branches. Even during the normal course of audit, officers travel from  one place to another to provide documentary evidence. Locating audit at  the center   would   pose  serious  problem  to  the  management personnel  in  satisfying  the  audit  queries.  The  actions  of  branch managers cannot be explained or defended by the officers located centrally. The very structure of PSB is bottoms up. All this again will take much longer time as compared to getting the local branch audit done.

c. In respect of Banks where amalgamation is taking place effective April 1, 2020 the challenge would be the branches and the business that will be  merged will  be unaudited. It is often  observed that in case of amalgamations, the granular level aspects matter the most. It would be a challenge to the managements accepting the substantial portion of the transactions merging without audit.

2. Audit Quality Impact

a. Audit Planning Impact

Audits are conducted as per the Standards of Auditing issued by ICAI. Audit planning is integral and critical part in the audit process. The PSBs have been following a certain audit pattern whereby the large pool of professionals doing audit at Central and Branch level contribute to the audit risk mitigation process.

Central statutory Auditor’s (CSAs) audit planning considers this entire chain  of  audit  while  planning  their  audit.  Change  of  this  process abruptly  will  create  major  audit  planning  deficiency.  In  order  to overcome this deficiency, CSAs will have to redraw their audit plan, which is not possible at this juncture. SCAs have not planned to cover zones,  regions  in  their  audit  plan.  Many specialized branches like MSME, housing loan, staff loan etc. would go unchecked.

This will involve providing of substantial data by the management. All this will take much longer time as compared with audit by Branch auditors which is a matter of maximum of 2 weeks. As such the dates for regulatory submissions have been extended to take care of the period lost due to the current pandemic.

b. Coverage Impact

Regulatory  requirement  of  Percentage  of  advances  that  should be covered in audit is 75% of each category of Advance. It will not be possible to do so as advances of some of the categories such as MSME, agriculture and personal loans etc. which are in the branches would not be covered at all.

Expecting CSAs to cover this as last-minute adjustment is unfair for them  as  well  as  towards  the  spirit  of  the  audit.  Indian  banking operations are large in number and it will not be possible to cover these in such short span only through CSAs. It will be much effective and speedy with branch audits.

Moreover, as the number of central auditors has been reduced over the period by PSBs under RBI guidelines, this will make it even more difficult  for  central  auditors  to  cover  the  entire  work  in  the  given timeline.

Further sudden increase of scope of CSA and coping with it will take much longer time than 2 weeks that branch auditors would accomplish due to the efforts taken by ICAI by constantly training them. Huge pool of trained staff available across India in anticipation of doing branch audit will make this possible faster. Instead creating a trained staff suddenly by CSA firms in short time to ensure this is not feasible.

The statutory bank branch auditors are generally appointed considering the availability in the area where branches are situated, with minimum travel  requirement.  If  central  auditors  need  to  travel  to  audit such branches, it would involve enormous amounts of costs and time. In the current situation under Covid-19, having a local auditor would be an immense advantage rather than requiring a central auditor to risk its staff travelling extensively.

Several frauds are found by branch auditors especially where audit is done once in five years. A number of branches which are not covered in concurrent/internal audit are covered in statutory bank branch audit.

Documentation of PSBs is not centralized. Scanning is not intelligent so  as  to  enable  navigation  through  it.  Several ocumentations for various types of loans such as agriculture, Mudra, gold, NSC, LIC, vehicle loan, housing loan etc. is maintained only at the branch. The documentation on non-fund advances, the most fraud-prone area, is available only at the branch. By dispensing with statutory bank branch audit the whole of this documentation will go unchecked.

Specialised branches like foreign exchange branches need extensive checking. Several branches are allowed to deal in foreign exchange, where statutory bank branch audit is a must, considering that in several cases the public sector banks are using the services of their own retired staff to do the work of concurrent audit.

Fraud-prone accounts such as parking accounts, sundry and suspense need to be checked in detail at branch level. Clearing of entries in such accounts and substantial amounts transacted through these accounts need to be reported in LFAR. Unusual items also need to be reported. This cannot be done without the branch auditors.

Checking  of  depreciation,  verification  of  assets,  stock  verification, insurance and stock statements based on which drawing power is calculated are all checked by branch auditors. The window dressing in accounts cannot be found at central level as it is done through the account   operations   at   branch   level.   Major   issues   identified   in concurrent audit need solutions at branch level itself, which can be checked by statutory branch auditors only.

Income generation activities need checking with physical documents available  with  the  branch.  There  is  no  control  centrally for correct booking of income. Tax audit data need to be checked at branch level. Contingent liabilities are required to be listed appropriately, which is checked by branch auditors.

Substantial authority is available at branch/zone for passing expense vouchers which need checking at appropriate levels only. As per RBI guidelines,  early  warning  signals (EWS) and Know Your Customer (KYC) is required to be checked at branch level only.

Indian  banking  even  today  is  socio-commercial,  wherein  material  amount of transactions and control thereof is with the branches. PSBs  though  work on CBS, the decision-making process and the action thereon is completely decentralized. Not visiting these places for audit would pose serious challenge on the audit coverage. In fact, even though private sector banks have tried to centralize the process, recent events clearly shows the control lapses. In our opinion whether these private banks too require to undertake PSB audit model which has proved to be robust should be discussed. Given this fact, applying top down audit approach instead of bottoms up approach in the current environment will be more effective in the functioning of PSBs. It would be  hasty and premature to take such a step  of discontinuation of branch audit citing incidental issues.

c. Regulatory Compliance Impact

RBI inspections heavily depend on offsite surveillance these days. It also  depends  on  various  reports  &  certificates  submitted  by the auditors at large during the course of audit. Several control deficiencies are pointed out by auditors and recommendations are given in their long   form   audit   report (LFAR).   Producing   such   comprehensive document   without   branch   audit   is   not   possible.   It   would   be unacceptable to regulators too.

Several  certifications  are  required  to  be given by statutory branch auditors. This is taken as a base by central auditors while giving their certificates to bank for sending them to RBI. The examples are Ghosh Jilani, BASEL-III, advance classification, interest subsidy, government subsidies,   priority   sector   classification   etc.   Providing   sufficient coverage of data to issue these certificates is not possible due to the current functioning pattern in PSBs.

The NPA statement is required to be system-driven. But in several cases it has been found in the past that manual intervention is either required or has been inadvertently done. Several Memorandums of Changes (MOCs) are given by branch auditors requiring substantial reclassification  of  advances and provision for NPAs. The accounts regularized  near  balance  sheet  date and  inherent  weaknesses  in accounts can be noticed at branch level. Central auditors would not be able to perform extensive scrutiny of individual accounts, as normally done  by  statutory  branch  auditors.  Several  small  loan accounts of agriculture, Mudra loans, MSME etc. would escape NPA due to this.

Resorting to centralized checking mechanism at the year-end would lead  to  restricting  the  audit  scope  thereby seriously impacting the conclusion as far as these certificates are concerned.

Further, the regulator has put the restrictions of 20 large branches to CSAs. Based on the experiences of the audit, these large branches many times carry advances which are individually material but are not sufficient as a coverage. Also, these branches have lesser number of accounts. The transactional complications and the control along with the huge number of accounts are operated through next 50 to 400 branches. Not extending the audit cover to these would lead to opening of huge “audit limitation” risk.

d. Opinion Impact

Considering the aspects mentioned above, two significant items of the financial  statements  viz.  Advances  &  Income  would  largely  remain under  coverage  leading  to  deficiency  of  audit  evidence.  This  will necessarily lead to disclaimer on Financial position by the Auditor in his report. In such as case saying that the audit is complete and the financial statements give true and fair view would be misleading.

Further it will have serious impact on all the certificates relating to critical   regulatory   parameters   such   as   CRAR (on account   of classification of advances into various buckets), Asset Classification  (on account of interventions possible in the masters such as Reviews, DP calculations etc.), Provisioning (on account of security value), Red Flagging (since transactions need to be scrutinized to arrive at the conclusion)

Due to serious limitations in scope for audit coverage, all the auditors of PSBs would have to qualify their reports. They will not be able to express any opinion on the accounts of the banks. In such a case, audits done at central level would be infructuous as almost all deposits and a substantial percentage of advances would not be covered in audit.

The last-minute changes in audit pattern will thus lead to serious audit opinion issues rendering the exercise meaningless even at the central level.

3. Authority and the legal implications

On a technical side auditors are appointed by the stakeholders based on the appointment policy as devised by the audit committee. The question arises as to whether auditee can determine the audit requirement. The auditee cannot decide  how audit  should  be  done.  The  auditee  cannot  dilute  the  audit procedures required to be carried out as per the auditing standards applicable in India. It is not the banks but the stakeholders who need to decide whether branch audits   are required,   as   public   money   is   involved   with   heavy government stakes in PSBs.

Further not conducting the branch audit on account of management difficulty of getting the branch audits conducted cannot be the excuse to limit the audit scope.

Keeping all these issues in mind, the current practice of appointing the branch auditors is the only efficient way to accomplish the objective of effective and timely audit. As such extensions given by the regulators would easily enable the auditors to complete their task, if the practices are not changed.

In view of the above, it is imperative that it is not in the interest of the country to discontinue statutory bank branch audit in PSBs.

Source- ICAI –

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June 2021