Sunday, September 16, 2007

Audit and Inspection



Why Inspection?

Banking is predominated human resources service industry. Its efficient functioning largely depends upon its human resources. Though competitive environment has compelled banks to computerize their operations for meeting customer expectations and to provide efficient services, human factor continues to dominate and play important role in the industry.
Credibility of an institution, particularly that of financial institution depends on its internal control and supervision mechanism which 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 organisation which remains undetected for an indefinite period or long time “. Therefore, system of Inspection and Audit is necessary for taking care of this aspect.
Inspection and Audit plays crucial role in success of banking operations. It helps in toning up the operations and at the same time helps in plugging leakage in income.

Objectives of Internal Audit/Inspection:

The overall objective of internal audit/inspection is to help bank management in achieving efficiency and effectiveness in all operations. It enables bank management in finding out that the branch/office of the bank is functioning soundly from financial and organizational point of view. It provides management an in sight into the seismic activities going on in a branch/office/department, which may adversely affect bank’s interest.

What is auditing?

Auditing involves gathering and assessment of factual information from various sources. Auditing, in general, is described as:
"The independent examination of records and other information in order to form an opinion on the integrity of a system of controls and recommend control improvements to limit risks".
Auditing is essentially a review of financial records by an independent person, whether the financial statements exhibit true and fair picture in accordance with the accepted principles of accounting and as per the applicable legal requirement.
Purpose of Audit :-
The purpose of audit is to ensure that
1. All assets and liabilities of a bank are properly recorded.
2. All income to which the bank is entitled is received and recorded in the proper income account.
3. All expenses are properly accounted for.
4. To enquire into the various aspects relating to frauds and malpractices in banks.
5. Internal control system is properly implemented and is in force at the branches.
6. Periodical control returns are submitted to the controlling offices.
The function of auditing is to make sure that controls are maintained and that proofs are accurate. A well - conceived and carefully executed control and audit programme will "protect weak people from temptation, strong people from opportunity, and innocent people from suspicion:"(Marshall C. Cons, Bark Auditing –Cambridge, Mass.: Bankers Publishing Company, 1955).

Purpose of Inspection: -

Inspection is a crucial element of direct control mechanism over branches by bank management. It is generally done once in every 12 months. The main purpose of internal inspection is to scrutinise working of the branch and various departments of the bank with objective to help the bank in keeping a watch on safe and useful deployment of funds.
It ensures that the operating units scrupulously follow the laid down systems and procedures and if found otherwise, to initiate prompt corrective steps.
Inspection is not a faultfinding mechanism but is a developmental tool. It is an early warning signal system for undesirable trends in operations. It is a whistle blowing mechanism.
Inspection and operations go hand in hand and do not function parallel. The ultimate objective of inspection is to ensure that functioning of branches are sound both at financial and organizational level. Inspection serves as ears and eyes of management and at the same time acts as a friend, philosopher and guide to the operating staff.

Inspecting officers are the watchdogs and not the bloodhounds. Reporting of irregularities, inadequacies and deviations are their main objectives, but playing a supportive role to ensure realization of corporate goals is equally important. Inspection report is the most comprehensive document under Management Information System, which provides essential feed back to the management.

Difference between Audit and Inspection: -

The expression “ Audit and Inspection ” are many times synonymously and interchangeably used.
Audit - It is quantitative analysis of the operations of an organization. It is essentially a review of financial records by an independent person. It is an activity, which ensures that correct accounting principles, systems and procedures have been followed. Proper and due provisions have been made and that the books of accounts represent correct, true and fair picture of the affairs of the organisation. Its basic purpose is to assess the integrity of books of accounts and records.
Audit is a statutory requirement. Bank’s financial results cannot be treated as correct unless certified by auditors’ i.e. Chartered Accountants. The board adopts financial results only when they are certified and signed by auditors
.
Audit is done by outside qualified auditors, whereas inspection is done by bank’s internal team having experience in bank’s operations .In exceptional / special cases inspection is also assigned to professionals outside the bank .In some banks audit nomenclature is also used for special inspection activities carried out by internal team.
Inspection: - It is one of the important tools for controlling the affairs of bank and also judging the efficiency of management. It is a multi purpose function, which gives feed back to the upper tier of management about the affairs of bank. It is the physical verification of transactions. It includes all the elements of audit. It is a qualitative review of the entire affairs of a branch. It is a mechanism, which helps, in overall improvement in the working and efficiency of the branch.

Extent and Scope of Inspection:

The system of internal control is not restricted only to the functions of the accounting and financial aspects but extend beyond these matters. It provides assurance to the management as to the adequacy of its audited procedures and the extent to which they are being effectively carried out. It is a qualitative review of entire operations both at operational level, managerial and supervisory level. If the operations deviate from the prescribed procedures, rules and regulations, the internal control puts the management in psychic quarantine.
A good internal control system ensures that no one person is in a position to make significant errors or perpetrate significant irregularities eluding timely detection.
Inspection helps in identifying seismic activities undergoing in a branch, which lead to catastrophe in other operational areas.
The overall objective of Inspection is to have flawless operations as per the directives and guidelines. However, some of the major objectives are mentioned below .It is not a comprehensive list.
· To assess whether the performance of the branch is in consonance with the policy guidelines, budget, as per market trends.
· To ascertain whether laid down systems and procedures are scrupulously followed.
· To examine the books of accounts, registers and records with a view to ensure that they are maintained in accordance with the systems as prescribed.
· To provide management information to controlling authorities for taking corrective measures and for deciding policies.
· To physically check cash, securities and other tangible valuables and ascertain that they are in order and in agreement with other books of accounts, records and registers.
· To ascertain whether the advances sanctioned are within the discretionary lending powers and if not whether due sanction was obtained. Whether all the terms and conditions have been complied with and due diligence taken.
· Whether documentation is proper and as per the term of sanction.
· To find out whether health of advances portfolio is improving or deteriorating. Whether Non performing assets are increasing or reducing, Whether slippages are under control, Whether recovery is up to date, whether compromises have been done as per bank’s guidelines. Whether one time settlement is as per bank’s guidelines or not.
· Whether guidelines issued by Reserve Bank of India and other statutory authorities are being followed.
· To ascertain whether periodical returns both internal and statutory are correctly submitted at the stipulated intervals.
· To examine whether expenses incurred are as per authority. Whether discretionary authority is judiciously utilized. In case authority is exceeded whether action is got confirmed and approved from the competent authority.
· To ascertain whether income is properly booked. Is there any leakage of revenue? Whether charges are levied as per banks directives.
· To assess productivity and profitability of the branch.
· To see whether there is inefficiency or dereliction of duties at various operational levels.
· To evaluate the quality of service, staff relations, at the branch.
· To examine lay out, ambience, ergonomics and location of branch from business prospects and suitability.

Submission of Reports: -

After the inspection is over, inspecting officer submits a detailed descriptive report to the branch on its functioning. The inspection report specifically comments, on the irregularities observed during the course of inspection. The inspection/audit officials have to critically analyse and make in-depth study of the corruption/fraud prone areas such as appraisal of credit proposals, balancing of books, reconciliation of inter-branch accounts, settlement of clearing transactions, suspense accounts, premises and stationery accounts during the course of inspections leaving no scope for any malpractices/irregularities remaining undetected.
A copy of the report is also submitted to the controlling authorities of the branch. In case irregularities of serious nature are observed, needing prompt and immediate attention of the branch as well as of controlling authorities whose rectification can not wait finalization and submission of report, special communication is sent both to the concerned branch and its controlling authorities for taking action on war footing.
In some banks in addition to preparation and submission of descriptive reports,
numerical rating on various functional areas and aspects is also given .The rating is done on a predetermined and prescribed scale. On the basis of which branches are rated on performance quotient/ assessment factor.

Rectification of Irregularities: -

All the irregularities pointed out in the report are to be rectified within a specified time schedule. Branches have to submit confirmation to this effect to their controlling authorities in the form of a clean rectification certificate. In those cases, where rectification of an irregularity may take longer period, claused rectification certificate is submitted with details of the irregularities yet to be rectified and action initiated towards the rectification. Branches have also to submit detailed comments on the various observations of inspecting officer mentioned in the report.

Types of Inspections and Audit in banks: –

Audit and Inspection are the most commonly used components for achieving the objectives and for ensuring cohesiveness of actions. It is a tool for ascertaining commonality of purpose at all levels of the organization. Banks are presently subject to following kinds of inspection and audit.

1. Inspection of operating units. -

Inspection department of bank carries out regular inspection of both General and Specialised branches. The emphasis is on adherence to procedures, execution of documents and control of expenditure and realisation of revenue. Generally inspection of a branch is done once in 12 months. However, in special circumstances, inspection of a branch is done even within a period less than 12 months.

2.Special inspections carried out internally

Credit Audit
Snap audit
Quick audit
Revenue inspection / audit
Short Inspection
Human Resource Audit
Technical Inspection
Investment portfolio Audit

1.Credit Audit: -

The Narang Committee constituted by Reserve Bank of India suggested for “ Credit Audit “ in banks. Thereafter, Reserve Bank advised that banks should ensure review mechanism for larger advances (loan). Accordingly. Credit portfolio audit was implemented in banks. The audit focuses both on new accounts and accounts transferred.
The audit focuses on larger advances and group exposures. It also scrutinizes high value accounts shifted to the bank along with executives/officials and the accounts transferred from other branches along with the officials.
This audit is done soon after the sanction of advances. The purpose of the credit audit is to facilitate better credit administration
Credit Audit helps in
· Improving in the quality of credit portfolio
· Reviewing sanction process and compliance status of large advances.
· Obtaining Feed back on regulatory compliance.
· Independent review of credit risk assessment.
· Picking up early warning signals and in suggesting remedial measures
· Taking corrective actions for improving credit quality, credit administration and credit skills of staff.

2.Human Resource Audit: -

It helps in enforcing discipline and punctuality at branch/office level. It is a mechanism to review the compliance of various service rules /regulations governing human resources. It also maintains compliance of statutory labour requirements. It helps in reducing risk of liabilities arising from non-compliance of labour requirements and misinterpretation of rules and regulations. It plays a vital role in instilling a sense of confidence in management of Human Resources related issues in the bank.

3.Revenue Audit:

Generally the Revenue audit is conducted in large branches. It is done unearth leakage of income and to find out the reasons. Banks do in-depth examination and take corrective measures. Action is also taken against the officials responsible for the lapses.

4.Short Inspections:

Banks conduct surprise short inspections at irregular intervals, particularly of large branches, not only to look into the general working of the branches but also to ensure that no malafide practices are being indulged in to by the branch officials. In addition wherever so warranted, spot/special inspections or scrutiny are also carried out on receiving signals to that effect.

5.Investment Portfolio Audit:

In view of the possibility of abuse, purchase and sale of government securities etc., the internal audit department periodically checks the reconciliation of the balances of SGL transfer forms as per bank’s books.

The internal auditors (Chartered Accountants/Statutory Auditors in the absence of Internal Auditors) who audit the treasury operations also scrutinises that::
· Aggregate upper contract limit for each of the approved brokers is within the limit of total transactions (both purchase and sales) entered into by the bank during a year.
Disproportionate part of the business is not transacted through only one or a few brokers and that aggregate contract limits for each of the approved brokers are not exceeded.

Inspection by Reserve Bank :

The basic objective of inspections by the Reserve Bank of India is to protect the interests of banks and their depositors through maintenance of sound banking system and to ensure that banks function as per the laid down guidelines, policies and instructions issued from time to time.
As per the provisions of Banking regulations Act 1949 and the Reserve Bank of India Act 1934, extensive powers of Supervision, regulation and control over commercial banks vested with Reserve bank of India with a view mainly to
· Ensuring solvency of the banking system, quality of assets, adequate liquidity and profitability.
· Watching adherence to statutory and regulatory requirements.
· Enforcing implementation of socio-economic policies and developmental objectives of the Government/ Reserve Bank.

Inspection of Banks is the most significant supervisory function exercised by the Reserve Bank of India. The basic objectives of inspection of banks are to safe guard the interest of depositors and to build up and maintain a sound banking system in conformity with the banking laws and regulations as well as the country’s socio-economic objectives. Accordingly, inspections serve as a tool for overall appraisal of the financial and managerial systems and procedures of the banks, toning up of their procedures and methods of operations and prevention of serious irregularities.

Reserve Bank conducts inspection of banks to

1. Assess the quality of management including the Board of Directors and the Chief Executive Officer.
2. Determine the adequacy or otherwise of the organisational structures so as to meet the emerging needs of the institution.
3. Find out the adequacy and effectiveness of internal control machinery so as to focus attention on weaknesses that require remedial actions.
4. Identify areas, practices, procedures, policies and methods of operation, which require corrective action with a view to improving the quality of performance.
5. Assess the performance in the matter of achieving the declared social objectives.
6. Make an overall assessment of the bank’s financial position & solvency.
7. Appraise its assets including advances with a view to ascertaining whether the criteria of safety and liquidity are maintained properly.
8. Whether the instructions of the Reserve Bank and the provisions of law including Foreign Exchange Regulations are being followed?
9. Whether FEMA stipulations are adherence to?
Difference between RBI inspection and Internal & External Audit
The inspection by the Reserve Bank of India differs from Internal & External Audit.
· Inspection/ audit is one of the important measures employed by the management to supervise and control the working of the branches.
· The Internal & External Audit is primarily concerned with ensuring that the policies, practices and procedures followed by the branches are in conformity with those prescribed by the management from time to time.
· The external auditors are independent of the bank and its management. They are appointed as per the provisions of law to express an opinion on the annual accounts.
· The job and responsibility of external auditor is essentially to certify the accuracy of the accounts and to ensure that the balance sheet gives a true and fair view of the state of affairs and that the profit and loss accounts exhibits a true and fair view of the profit and loss. In the process, the auditor has to verify and satisfy himself that the advances made by the bank are good and recoverable and, if not, whether in his opinion, the provisions made for bad and doubtful debts are adequate.
· During the course of an inspection conducted by the Reserve Bank, an evaluation of advances is made and the extent to which debts have become bad or doubtful and whether as per the judgment of Reserve Bank have been correctly arrived at .It is a part of the exercise for arriving at the real value of the banks’ paid up capital and reserves.
· RBI Inspection appraises the competence, adequacy and effectiveness of the internal inspection/audit machinery and assesses the quality of management.

· Activity specific inspection -Audit carried out by the Accountant Generals Office to determine whether transactions undertaken on behalf of the Government are in accordance with rules and regulations. The audit focuses on pension payments and remittances to Government accounts (i.e. collection of custom, excise duties etc.)

· Management Assessment Related
Management Audit
· Statutory obligation specific
· Statutory Audit-
· Concurrent Audit

Statutory Audit-

Banks have to close their books of accounts every year as at March 31st and prepare a Balance Sheet and Profit and Loss account as prescribed in the III rd schedule to the Banking Regulations Act.
As the name suggests this audit is compulsory by law. The law also laid down the periodicity of audit, the qualification of person who can carry such audit, and to whom the audit report is to be addressed. The rights and duties of a statutory auditor are governed by the statute by which such audit is made compulsory. It cannot be changed by company or its shareholders or by any other person. Only a practicing Chartered Accountant who is a member of Institute of Chartered Accountants of India (ICAI) can carry out statutory audit. For companies incorporated under Companies Act, 1956 duties of auditors are prescribed under Section 224 to 233. This audit is undertaken by a practicing Chartered Accountant, annually of the financial statements, in accordance with the provisions in the Banking Regulations Act, 1949. The report of statutory auditor is required to be placed before “General Meeting “ of the company’s shareholders. The Statutory auditor presents its report to the Board of the bank, which is adopted and signed by auditors and Chief Executives of the bank. The report is addressed to the President of India.
All these forms of audits are related to the operational aspects of bank functioning. These are carried out to ensure that bank function properly and that specific guidelines issued for carrying out transactions are adhered to.

Concurrent Audit: –

In March 1992 a committee under the Chairmanship of Shri A.Ghosh the then
Dy. Governor was set up by Reserve Bank of India to enquire into the various aspects of frauds and malpractice’s in banks. As per the recommendations of the committee, Reserve Bank of India advised all Schedule Commercial Banks (Except Regional Rural Banks) in October 1993 to introduce the system of concurrent audit at large and exceptionally large branches, system of Concurrent Audit.

Objects of Concurrent Audit: -

Concurrent audit system is part of bank’s early warning system to ensure timely detection of irregularities and lapses. It is essentially a management process towards the establishment of sound internal functions and effective control to minimize the time lag between occurrence /incidence of serious errors or fraudulent manipulations and their timely detection.

It is a systematic examination of all financial transactions on a continuous basis for ensuring accuracy, authenticity and due compliance with internal system, procedures and guidelines of the bank as issued from time to time, and guidelines issued by Reserve Bank of India and other supervisory authorities on various parameters. It helps in detecting and preventing fraudulent transactions at branches. The object is that the branches take timely action for rectification of the irregularities /errors/discrepancy observed [B1] and ensure that these do not recur again.

Concurrent audit provides an additional administrative support to the branches, helps them in adherence to the prescribed systems and procedures and prevention and detection of lapses/irregularities at the branches. It shortens the interval between a transaction and its examination.
It is a tool in the hands of management for on the spot examination of the financial transactions at the branches by an independent agency and to know that the branches are performing within the delegated authority and that the delegated authority is exercised diligently. The person conducting this audit cannot become a part of the decision making process for any transaction/activity which is not accordance with the laid down procedure for conduct of the business.
It also encompasses physical verification of assets charged to the Bank including go down inspection at regular periodic intervals.
Concurrent Auditor to look into: -

1. Treasury functions bill rediscounting, dealing room activities, investment portfolio, foreign exchange business etc.
2. Branches whose total credit and other risk exposures aggregate to not less than 50% of the total credit and other risk exposure of the bank and branches whose aggregate deposit cover not less than 50% of aggregate deposits of the bank.
3. All special branches handling foreign exchange, dealing room operations, large problem branches and any other branch/department at the discretion of bank.
4. The major business covered by Concurrent Auditor is cash, investment, deposits, advances, foreign exchange, house keeping etc.
5. Since cent percent checking is not possible, Reserve Bank of India indicated the extent of the same ,i.e.,
· 100% checking in respect of off-balance sheet items, investments portfolio, foreign exchange transaction, fraud prone areas, advances of outstanding balance of Rs. 50 lac or more.
· 10-25%of checking of income/expenditure items, inter bank transactions, clearing transactions etc. and
· Intensive checking in areas requiring close monitoring and high value transactions.
Concurrent Auditor to report minor irregularities to Branch Manager on the spot for rectification; If these are rectified within a week, then, these are to be reported to controlling office. If serious irregularities are observed, these are to be reported to controlling office immediately.
Banks without delay should effectively follow up the points made by the Reserve Bank of India at the time of discussion of findings of inspection with the top management of banks and compliance report should be put up to the Board periodically.
Banks should examine the need for introducing a separate section of internal inspection machinery to scrutinise credit portfolio only. It will be necessary to staff this Section with competent and experienced personnel who will make an in-depth examination of the credit portfolio. It should be the responsibility of this Section to particularly scrutinise larger accounts and group exposures. To be effective, apart from competent officials to man the Section, the Section should be under the charge of a senior personnel reporting directly to the Chief Executive Officer of the bank. The summary of important findings should also be put up to the Audit Committee of the Board.

Management Audit: -

Management Audit is the complete health check of an organisation for ascertaining that all its systems, faculties are functioning properly. It is a systematic fact finding approach that examines the effectiveness of objectives, policies, standards, structure, procedures and control functions of an organisation. The objective of management audit is to point out weakness or irregularities at whichever level of management. It deals with Management Performance in qualitative terms. It probes into managerial practices and examines effectiveness of existing systems. The approach of this audit is constructive and futuristic. The purpose is to take corrective measures lest efficiency and effectiveness of organisation does not suffer and the organisation performs at optimum level with high standards of productivity.
Management audit is different from financial audit. While financial audit is based on historical data and examines the financial and accounting practices. Management audit probes into management practices, ensures compliance of statutory directives, regulations and identifies vulnerable areas of management functioning.
Management audit seeks to ascertain
· Whether managerial policies and actions are commensurate with resources available?
· Whether available resources are put to maximum advantage in terms of achieving the organisational goals?
· What kind of linkage /relationship exists between authority and responsibility of various functionaries?
· How efficiently the management has been able to anticipate changes that are taking place in the market?
· What is the level and quality of decisions taken by exercising authority vested and or delegated?
· What are the shortcomings of management processes and functioning?
It is the audit of overall quality of management. It is an independent and systematic appraisal of management functions, processes, policies, procedures, systems, objective, standards and utilization of available resources. It helps in measuring organisational effectiveness and also helps the organisation in chalking out strategies to foresee, manipulate and control environment. It is an ongoing surveillance system to ascertain whether sensory electrical nerves of the institution are judiciously functioning or not and that the person in command are judiciously making use of the power and authority. It is the analysis of the past and present on which depends the future. The object is to attain optimize efficiency and effectiveness in every field and also to aid /assist management in accomplishment of its goal. It helps in identifying weakness or irregularities at all levels of management.
As the name implies, Management Audit is concerned with the audit of all components of management processes like planning, organising, staffing, directing and controlling.
Difference between Management Audit and Inspection: -

1 Inspection:

It is the total audit system encompassing the entire gamut of management functions including the internal audit and inspection machinery
Management audit
It helps in ensuring compliance of directives, regulations, and procedures that is based on historical data
2_Inspection
It is an ongoing process and is concerned with all components of management processes like planning, organising, staffing, directing, controlling, leading, decision-making, motivating, delegating etc. All these functions are interwoven.
Management Audit
It basically evaluates accounting and procedures and covers microscopically, physical verification of transactions.

3Inspection
It evaluates functioning of those systems which are different from financial verification

Management audit

It is essentially an audit of the overall quality of management, in relation to the organisation’s objectives and policies

Computer Auditing:-

Information technology is playing an important role in the banking industry across the globe and banking industry in India is not an exception. Banks in India are rapidly switching over from manual operations to technologically embedded operations. This has resulted into overhauling of systems, procedures, processes, record keeping, and data management and control mechanism. Embracing technology has made banks vulnerable to intrusion and frauds. Computer crimes are on rise. Therefore computer auditing has become necessary.
Computer auditing is a branch of general auditing concerned with control of information and communications technologies (computers). Computer auditors work with technical controls built-in to the computer systems, also procedural controls (operations procedures etc.), legal controls (software licenses etc.),

A Computer auditor primarily studies computer systems and networks from the point of view of examining the effectiveness of their technical and procedural controls to minimize risks. Computer auditors often use data analysis tools to examine computer records.

Responsibility of a Computer auditor involves looking into

· Whether there are automated controls to check that all data input to the systems are within the bounds defined by the Bank? All data entered into a computer system are accurate, complete and authorized.
· That the application provides an adequate degree of control over the data being processed.
· Whether critical or sensitive data are subjected to the most stringent controls.
· That information stored by the computer is not accidentally (or deliberately) changed by some unauthorized process?
· This introduces the concept of control totaling and balancing, which is effectively the accounting concept of double-entry bookkeeping.
· Whether the process actually commits the organization to incur a liability (e.g., issues a payment), how do we know the liability is valid? How do we know it is properly approved?



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