A Question Of Accountability

Recently, Delhi-based Punjab National Bank was in the news for an unusual reason. One of its six auditors offered a note of dissent on the banks method of asset classification. This is a rare development; bank auditors are expected to come to a consensus before signing the balance sheet.

In the best of times, bank auditing has been a tricky job. Deregulation has made matters more complex. Some banks in recent times have complained to the central bank that their auditors have often failed to assess banks non-performing assets.

Still others have charged their auditors with corruption. Among the accusations, banks say auditors have sometimes taken an undue interest in banks bill discounting business to help certain businessmen, halted allowance bills and even prepared false travel vouchers.

 

At the core of the deteriorating relationships between banks and their auditors are the RBIs guidelines on bank audit. If anything, the current debate only highlights the urgent need to radically rework the guidelines for bank audits to make them more effective in practice.

To get an idea of the problems consider the 19 top audit firms that were put on RBIs blacklist after the securities scam of 1992. None of the blacklisted firms can audit banks until the Institute of Chartered Accountants, the professions central regulatory authority, clears them.

This in itself is a problem because of the method the institute follows. The RBIs guidelines only add to the confusion.

The ICA follows a policy of trying individual members for irregularities, not the firm. There is a major contradiction here. The selecting authority (RBI or the Comptroller and Auditor General) considers the firm tainted, not the member.

The guidelines are also opaque on the question of conflict of interest. In theory, audit firms cannot be awarded banks with which their consultancy subsidiaries also do business. In practice this rule has been generalised to cover all such auditors that have consultancy subsidiaries that are doing business with banks irrespective of whether the case involves the same bank or not.

The selection enigma

The problem begins with the selection process (see box: How audit firms can fit the bill). The essential condition is that all firms need to be partnership firms to qualify as bank auditors.

The point is that this need not assure credibility. As a leading Mumbai-based chartered accountant points out, Many small proprietary firms, especially in places like Kanpur, Delhi, Punjab, Rajasthan, etc. come together and form a partnership firm only for the purpose of bank audits. So, in effect, the identity that they assume to get into the business is fictitious, says a leading Mumbai-based chartered accountant.

The scope for distortion is even greater because, strangely, the RBI puts all audit firms on par. There is no weightage given, for instance, to the joint ventures and foreign collaborations that some of the big firms have signed.

Then again, the tenure for which an auditor can audit a particular bank or branch is four years subject to reappointment every year. Most auditors feel that this tenure is extremely short. They reason that the process is subject to a learning curve in which the cost per audit decreases with the number of years, which means their return on investment increases.

What should I do?

The RBI sets out audit specifications to all auditors (see box: The job profile). This is over and above ICAs statutory audit requirements. Yet, most auditors say they are unclear about their role.

This is less a function of the RBIs guidelines per se. It is equally true that many auditors are unaware of critical banking operations like treasury management, credit appraisals and the like.

This fact gained prominence recently when Indian Bank and Vijaya Bank reported huge losses. Snap audits by RBI, which is allowed under section 30 I B of the Banking Regulation Act, have revealed irregularities like under provisioning bad debts in other cases as well.

On their part, auditors say relevant RBI circulars on the treasury and credit appraisal operations as well as provisioning norms are not made available, especially at the branch audit level.

Communication gaps between auditor and branch manager frequently compound the confusion.

This has resulted in the RBI dropping a host of audit firms even before they completed their tenure, as it did with the State Bank.

The atmosphere of hostility that has developed between banks and auditors is unlikely to benefit banks as they gear up for rapid deregulation. The solutions are obvious. RBI could help by reworking selection procedures. Audit firms could help by improving their knowledge of banking operations.

There have also been suggestions that the number of joint auditors have to be increased taking into consideration the fact that their tenures do not end simultaneously. This would help in a smoother transition to the next group of auditors. In the long run, greater professionalism on either side could bridge the gap between confusion and a healthy banking system.

How audit firms can fit the bill

The RBIs eligibility criteria for appointing bank auditors

The firm should have standing of ten years as a partnership firm.

The firm should have six chartered accountants, of which a minimum of four should be partners in the firm. Of these four partners, at least two should have been associated with the firm for a minimum of three years.

The firm should have audit experience of public sector undertakings for at least five years and branch audit of public sector banks for eight years.

It should have professional staff of not less than 15 excluding subordinate staff.

The job profile

The auditors, as a part of the statutory audit of banks, should verify compliance of statutory liquidity requirements (SLR) under Section 24 of the Banking Regulations Act, 1949. In the report or certificate to be submitted to the bank and to the RBI, auditors should indicate the dates for which compliance of SLR has been verified by them.

The auditors as a part of the statutory audit of the bank, should verify SLR and cash reserve ratio (CRR) returns submitted by the bank to RBI during the period under audit, and confirmation to this effect may be conveyed in the letter to be submitted to RBI.

The auditors should certify to the RBI that :

a) the treasury operations of the bank have been conducted in accordance with the instructions issued by the RBI from time to time

b) the income recognition, asset classification and provisioning has been made as per guidelines issued by the RBI from time to time.

As soon as the audit work is completed, the auditors must report to the top management and to the RBI (Department of Supervision) on serious irregularities noticed in the banks working which require immediate attention.

When auditors dont make the grade

Auditors who have been adversely commented upon in the Joint Parliamentary Committee (JPC) report ON WHAT? .

Audit firms who have been denied audit by the Comptroller and Auditor General (CAG) for audit of public sector undertakings

Audit firms against whom complaints have been received from banks.