Auditing Credit Department of a Bank Branch – step-by-step procedure

Auditing Credit Portfolio – PART 1

In this article, I have briefed you about the system and procedure for conducting an audit of the Credit Department of a Bank Branch.  This shall exhaustively cover the auditing step-by-step and would make it easy for an Auditor/Inspecting Officer to do his job.

Step-by-Step Procedure

ASK for the concerned Loan/Advance account file and go through the same thoroughly.

The Inspecting Officer should make a cursory glance over the previous records, in case of long-standing loanees.

Verify:

• Whether there is a prescribed application duly bearing the signature of the borrower?
• Whether the application is properly filled in all respects, i.e. applicable columns and rows?
• Whether relevant documents are obtained along with the application and the same have been verified by the Branch Officials to confirm correctness?
• Whether KYC norms fulfilled?
• Whether Upfront service charges are collected wherever applicable?
• Whether the Branch has given proper acknowledgment to the applicant about the receipt of the Loan application?
• Whether the Branch is maintaining a proper Register for recording receipt of Loan applications and the entries up-to-date?

Pre-sanction Process and Appraisal: Verify:

• Whether the Branch has conducted proper Due Diligence on the applicant?
• Whether the Branch has confirmed the actual availability of the business in case of Business Loans?
• Whether the proposal was not declined by Higher Offices for any reason?
• Whether the requested quantum of Loan falls within the powers of the Branch Head?
• In case of Takeover of loans/advances from other financial institutions, whether No Objection Certificate is obtained by the Branch?
• In case of Takeover of loans/advances from other financial institutions, whether Credit Opinion/Credit Report has been obtained from the existing Bank/financial institution and scrutinized?
• Whether Takeover norms are complied?
• Whether outstanding amount of loan/advances with the existing Bank/financial institution is obtained?
• Whether the account is in Standard Category?
• Whether the borrower has fulfilled the repayment obligations as per the sanction terms?
• Whether the applicant has cleared all the Statutory dues/including contingent liabilities outstanding?
• Whether CIBIL verification is done and CIBIL Scores are at satisfactory level?
• Whether Balance Sheet analysis has been done by the Branch?
• Whether the Branch has ascertained the repaying capacity of the applicant?
• In case of a new Project, whether the Branch has obtained the Project Report and analyzed the same?
• Whether feasibility check was done by the Branch?
• Whether satisfactory Technical Officer’s Report (wherever required) has been obtained and held on record?
• Wherever required, whether necessary Government approval has been obtained and confirm the same is in order?
• Whether Pollution Control Board Certificate is obtained, in case of loans for establishing a factory/ manufacturing unit?
• Whether Mining approval has been obtained and is in current status, in case of Mining Units like Granite industries etc.
• Whether Explosive Certificate is obtained and the same is in Current status, in the case of Mining Units and Crackers manufacturing/trading units?
• Whether Internal Rating/External Rating has been done, as per extant guidelines?
• Whether Pre-sanction inspection has been conducted and reports are held on record?
• Whether verification of existing mortgages/charges has been done?
• Whether Search has been conducted in respect of properties taken as mortgage – both Primary and Collateral, wherever required and reports are held on record?
• Whether the Branch has conducted Search with Registrar of Companies and Search Report is held on record, in case of loans/advances to Private Limited Companies?
• Whether the Branch has obtained Board Resolution detailing the intention to borrower from the concerned Bank/Branch, Authorised Signatory(ies) in case of loans/advances to Private Limited Companies?
• In case of Jewel Loans, whether the jewels pledged to the Bank are duly appraised by the Appraiser as per extant norms?
• Whether Valuation Certificate given by a Panel Valuer of the Bank is obtained and the value has been by independent verification by Branch Officials?
• Whether proper assessment on requirement of loan is done and is in accordance with the Higher Office regulations?
• Whether the shortcomings in the financial parameters have been discussed in the Process Note and the explanations given therein are satisfactory?
• Whether Stock/Bookdebt Statements are obtained and verified by carrying out pre-sanction inspections by the Branch Officials?

Sanction:

• Whether the loan is sanctioned as per extant norms with regard to time norms?
• Whether proper Rate of Interest is stipulated as per the guidelines of Higher Offices?
• Whether the loan is recommended by concerned Officer and is sanctioned by the Competent Authority?
• Whether proper sanction has been conveyed to the applicant through Sanction Advice/Sanction Letter?
• Whether the Sanction communication is duly bearing the signatures of the Branch Head/Authorised Officer of the Bank/Branch?
• Whether copies of documents and sanction etc. have been conveyed to the Member Banks in the event of Consortium Advances?
• Whether the applicant has accepted the Terms of Sanction and duly acknowledged without any conditions from their end?
• Whether the Branch has recovered all Service Charges?
• Whether the Branch has completed all documentation process and the same duly stamped (wherever required)?
• Whether all the documents are signed by all the parties, including the Guarantor (wherever required)?
• Whether the Common Seal has been affixed in the documents (in case of Private Limited Copany)?
• Whether the borrower has brought in the required margin into the system?
• Whether the Loan is disbursed strictly as per the sanction terms?
• Whether the Branch has obtained necessary Bills/receipts etc. for the amount/installment disbursed and verified the same for ascertaining proper end use of funds?
• Whether the loan amount is disbursed strictly based on the progress of the Project implementation and necessary site visits are made whenever required?
• Whether necessary securities/charges have been created to safeguard the interest of the Bank?
• Whether Mortgage Register is updated with necessary entries?
• If the loan is for purchase of movable assets like Car, Motorbike, Scooter, etc, whether Bank’s charges have been registered with the concerned RTO?
• Whether the Branch has reported the sanction to Higher Offices in their Weekly/Fortnightly/Monthly Returns?
• Whether the Controlling Office has made any remark about the sanction and if so, the Branch has submitted their satisfactory reply?
• In case of Takeover of loans/advances from other Bank/financial institutions, whether the Branch has directly disbursed the loan to the extent of outstanding with them and local closure letter is obtained and held on record?  Also, whether No Due Certificate has since been obtained from the existing Bank / financial institution and held on record?
• During inspection of Units by the Inspecting Official, ensure that Bank”s Name Board is displayed at a prominent place.  Also, verify whether the Unit name is displayed at the entrance.  Ensure that adequate stocks are available to cover the Bank’s exposure to the borrower.  Unit inspection should be carried out with an authorized Official of the Bank, Unit.

I will author another elaborate write-up on STOCK INSPECTION/STOCK AUDIT.

Auditing Credit Portfolio-Part 2

In this Part, I shall provide the Checklist that the Inspecting Officer should consider when conducting an audit of the Credit portfolio.

Release and End use of funds:

After completing the file’s perusal, the Inspecting Officer should ensure that the Branch has completed all the pre-release formalities. In some cases sanctioned by the Higher Office, they would have stipulated additional documentation formalities like obtaining Undertakings, Declarations, etc. Ensure that they have since been obtained and held on record.

In some loans sanctioned by higher offices, the requirement of a Credit Process Audit, Legal Audit, Pre-release audit, etc., would have been stipulated. The Audit Official should ensure that these Audits are completed and that their observations vis-a-vis rectification, if any, are required.

After completing the above exercise, the Audit Officer should review the transactions that have taken place in the account. The loan should have been disbursed strictly as per the terms spelled out in the Sanction Letter. Ensure that the borrower brings in adequate margin to the system.

In the case of Consortium advances (where the Auditee Bank is not the leader), a copy of the compliance certificate should be obtained from the Leader of the Consortium along with a copy of the Sanction Letter.  If any non-compliance is noticed, the matter should be brought in the Audit Report.

Any Sanction of Limit/facilities is subject to availment by the applicant within a stipulated period.  If the borrower has not availed the facilities within that stipulated time limit, the applicant should submit a request letter to the concerned Sanctioning Authority whether it is the Branch or Higher Office(s) and get the sanction re-validated.  The reasons for the non-availment of the facilities within the stipulated period should be explained and the same should be convincing.  The Sanctioning Authority may re-validate the sanction for a further period of availment.

The Inspecting Officer should peruse the account opened in the system, go through the Account Master, and ensure that the Repayment period, installment amount, Rate of Interest, and repayment schedule are entered correctly.

The Inspecting Officer should also ensure that necessary Service Charges like Processing Charges, Documentation Charges, other incidental charges like Valuation charges, SRO Registration charges, and Legal service charges are recovered from the borrower.  If not, the same should be computed and reported in the Leakage of Income statement in his Audit Report.  He should also ensure that the service charges are recovered during the audit itself.

It should be ensured by the Auditor that the funds sanctioned by the Bank are utilized for the purpose for which the facilities are sanctioned.  There should be supporting vouchers, invoices, and bills held on Branch records, duly verified by the Branch officials ascertaining the end use of funds.

If the loan is sanctioned for the purchase of some articles/machinery, the amount should be directly released to the supplier or the vendor.  This amount should be exclusive of the margin amount to be brought in by the borrower.  It is always better to ensure that the borrower pools in the margin amount into their account with the Branch wherefrom the same can be debited for combining with the loan amount while issuing Demand Draft / RTGS / NEFT payments to the suppliers.

The Inspecting Officer should ensure that the Branch has made Stage-wise inspections wherever required and are applicable and proper verification has been made by the Branch officials so that the end use of funds is confirmed.

The Branch should have made CERSAI registration with regard to the properties mortgaged to the Bank.  This should be ensured by the Auditing Official.

Credit Monitoring:

Monitoring of Credit plays a major role in the banking industry.  If there is a lapse in the monitoring of credit, it will ultimately lead to derailment of the Bank.  Therefore, it is considered to be a vital aspect of a Branch or Higher Office.  In the event of improper monitoring, it will be very difficult to recover from the losses.

The Inspecting Officer should see whether the Branch is submitting Monitoring Reports in all cases in time to this Controlling Office and whether the Controlling Office has made any adverse comments.  If so, the action taken by the Branch and submission of reply to Higher Office should be analyzed.

The Branch, after confirming the end use of funds, should ascertain that the Project is completed as per schedule or Project Report submitted, and the borrower has commenced Commercial Production.  This can be achieved by conducting inspections to the Unit of the borrower.  Depending on the operations in the account, the Inspecting Official can make an Unit visit.

The Branch is supposed to conduct Unit visits and submit reports to the Controlling Office at periodical intervals as stipulated by the Central Management.  The Auditor should peruse the Unit inspection reports submitted by the Branch to see whether any adverse remarks are made therein about the availability of stocks and other securities.

If the advance is sanctioned under Consortium arrangement, the Inspecting Officer should see  whether joint inspections are being carried out and reports are held on record.  In case of any adverse points made therein, the Auditor can seek clarifications from the Branch and incorporate the same in his report.

The Branch should conduct valuation of Primary/Collateral securities at stipulated periodicity recordings should be made.  The Auditing Official should peruse the reports and get himself satisfied that there are no adverse remarks nor there is any depletion in the value.  If there is any deviation, the same should be brought out in his Audit Report.

Insurance Policy for the Primary/Collateral securities, wherever application, should be in Current status and the Sum assured should be adequate to cover the exposure to the borrower.

As per policies in vogue, the acceptable age of Book Debts/Sundry Debtors is 90 days old.  The Inspecting Official should go through the statements at random and confirm the guidelines and adequate Drawing Power is available for the exposure to the borrower.

In some Banks, the Debtors’ statements are required to be duly certified by a Chartered Accountant at a stipulated period to ensure that the declaration made by the borrower is in order.  This should be seen by the Inspecting Officer.

The borrower is required to submit the financial statements in time to the Bank every year and the same should be certified by a Chartered Accountant.  If the audit is taking place prior to the completion of the deadline, at least a Provisional Balance Sheet certified by a Chartered Accountant should be in place.  The Inspecting Official should ensure that this point is complied with.

On going through the operations in the account, the Inspecting Officer should ensure that the borrower is routing all business transactions and the Credit Summation for the annual year is at least 4 or 5 times of the credit limit sanctioned. If any other transactions are noticed or there is inadequacy in the credits or irrelevant debits are made, the same should be brought out in the Audit Report.  This would go a long way to ensure that the interest of the Bank is safeguarded.

On going through the Balance Sheets vis-a-vis operations in the account, the Inspecting Officer may be in a position to ascertain whether the credit operations are in line with the Projections.  If not, the same should be brought on record by the Auditor.

The account should be subject to Internal/External Crediting, wherever application.  Auditing Official should ensure that the same has been done or not.  If there is a depletion in the rating, the Inspecting Officer should recommend for charging of appropriate Rate of Interest in the account.

In case of Consortium advances, the Auditor should ensure that Consortium Meetings are conducted and Minutes are recorded.  If any adverse comments are made in the Minutes, the same should be got clarified with the Branch and the same should be brought in the Audit Report.

It should be ensured by the Auditing Official that adequate follow ups are being made by the Branch in the case of overdues in the accounts and the same are recovered in time to avoid the accounts slipping into NPA Category.

The Branch is supposed to obtain Debit Balance Confirmation from the borrower at periodical intervals as stipulated by the Central Management.  The Inspecting Officer should check whether such DBCs are held on record or not.

Renewal of Credit facilities:

All loans/advance accounts are to be subject to review/renewal at periodical intervals.  This exercise should be completed in time.  If the borrower has not submitted the required papers for this exercise, the Branch may conduct a Short Renewal (mostly valid for only Three months) of the account based on the operations in the account, by preparing Short Renewal Note explaining in detail all the factors.  It should be noted that operations in expired limits are either not allowed or allowed with some penalty depending upon the conduct of the account or the credit worthiness of the borrower.  In the latter case, the Inspecting Officer should ensure that necessary penalty is being charged and recovered from the borrower.

If the borrower is enjoying Bank Guarantee facility sanctioned by the competent authority, the Inspecting Officer should ensure that the Guarantees are issued strictly as peer the Sanction terms and necessary Guarantee Commission is recovered from the borrower.  It should also ascertained by the Inspecting Officer that the Guarantees so issued by the Branch do not contain any Onerous Clauses, which may be detrimental to the Bank.  The Guarantees should be issued only with Limitation Clause.

If the guarantees are invoked, the Inspecting Officer should ensure that the Branch has made payments promptly and the same has been reported to Higher Offices.

The Branch should call back the Original Guarantee if it has expired and the same should be cancelled.  The Inspecting Officer should take a list of expired guarantees and advise the Branch to conduct this exercise during the course of audit itself.