Audit of Banking Companies

          AUDIT of BANKING COMPANIES

The audit of Banks is a specialized task. It is made compulsory under the enactments governing the banks.  It requires the thorough knowledge of various enactments affecting banks, understanding the operations of banks, their accounting system, and above all appreciation of audit aims of Bank audit.

Ø Salient Features of Enactments Affecting Banks :

The audit of the Banks should be well-acquainted with the provision of the special enactment that govern different types of Banks, particularly those which affect the various items of financial implications of the business carried on by Banks and the types of the transaction that arise in the day-to-day operations.

There are some salient features of enactments that affect the banking operations in Bangladesh-

        I.            Restrictions on Business :

According to the Bank Company Act, 1991 a banking company is one which carries on the business of banking in Bangladesh and includes foreign company carrying on banking business in Bangladesh.

It is necessary that an auditor of banks must be aware of the restrictions on the powers of Banks. A banking company in Bangladesh is allowed to carry on only some business activities which are:

§  Borrowing and lending money

§  Dealing in negotiable/quasi negotiable instruments

§  Issuing letters of credit/travelers cheques/circular notes

§  Buying and selling of billions, foreign exchange

§  Underwriting, dealing in shares etc acting as managers to public issue of shares etc.

§  Providing safe deposit vaults

§  Carrying on agency, guarantee and indemnity business

§  Managing, selling or dealing with property acquired in full or part settlement of its claims( non-banking assets)

§  Acting as trustees, executors

§  Any other business notified by Govt. in this behalf

      II.            Capital Requirements :

The Act contains minimum capital in terms of TK to be maintained, raised and kept by banks. It also lays down that the subscribed capital of the banks should be not less than 50% of authorized capital, and also paid capital should not be less than 50% of the subscribed capital.

In addition to this, Bangladesh Bank has issued circular requiring banks to meet capital adequacy ratio that is nothing but expression of total capital of the bank as multiple of funded and non-funded assets and off-balance sheet items. For this purpose, total capital includes share capital, reserves and subordinated debts. Assets and off-Balance sheet items (like contingent obligations) are taken at values after adjusting them with prescribed factors applicable to each asset/item depending on its risk element.

At present the ratio of capital adequacy ratio should be minimum of 8.

    III.            Reserve Fund :

According to the Bank Company Act, 1991, every banking company must transfer at least 20% of its net profits to fund called reserve fund.

It is a statutory reserve that must be shown separately in the Balance Sheet. The banks must continue transferring 20% of net profit every year till the balance in the reserve fund cross the aggregate of paid up capital and share premium amount. It is a kind of additional security available to depositors that must be kept enact.

   IV.            Cash Reserve and Statutory Liquidity Reserve :

According to the Act, the scheduled banks in Bangladesh must maintain cash reserve with Bangladesh Bank Ltd. for a sum not less than 3% of its time and demand liabilities. Bangladesh Bank can increase the percentage up to 15% in this regard. In addition to this, every bank must maintain with Bangladesh Bank statutory liquidity reserve for a sum prescribed by Bangladesh Bank Ltd. The SLR is to be maintained in the form of cash, gold or unencumbered approved securities. The SLR should not be less than 25% of total demand and time liabilities.

     V.            Restrictions on Investments, loans and Advances :

A banking company cannot hold shares whether as pledgee, mortgagee or absolute owner of other companies exceeding 30% of its own paid up capital and reserves or 30% of capital of other companies whichever is less.

A banking company also cannot advance loans on the security of its own shares. It cannot give any unsecured loan or advance to any of its director or firm or private company in which such director is interested.

Again, permission from the Bangladesh Bank Ltd. is to be obtained for remitting the whole or part of debt due by director to it. The Act empowers Bangladesh Bank to give directions to banking companies in regard to advances granted to directors. Bangladesh Bank may require banks to obtain still more security or refuse further loans or recall the loans already granted to them. Monthly returns in the prescribed format regarding loans and advances to directors are to be submitted to Bangladesh Bank Ltd.

   VI.            Dividend :

Banks cannot pay dividend unless all capitalized expenses are fully wiped off.

 VII.            Audit :

The act also deals with audit of accounts. The accounts of the Bangladeshi banking companies shall be audited by Chartered Accountants. The appointments, powers, duties, removal and liabilities of banking auditors are as same as company auditors. However, the Bangladesh Bank Ltd.’s approval is to be obtained for appointment, re-appointment and removal.

In case of audit of nationalized banks, the statutory auditor shall send his audit report to central govt. with copies to Bangladesh Bank. Then the audit report shall state –

§  Whether in his opinion, the balance sheet is a full and fair balance sheet containing all necessary particulars and is properly drawn up so as to exhibit true and fair view of state of affairs of the bank or not.

§  Whether he has obtained satisfactory information and explanation or not.

§  Whether the transactions which have come to his notice are within powers of bank or not.

§  Whether the returns received from branches are found to be adequate or not.

§  Whether profit or loss account give true and fair view of profit or loss of the bank for the period.

§  Any other matter which auditor wants to bring to the notice of central govt.

Ø Internal Control System in A Bank :

Good internal check is a pre-requisite in operating system of a bank for matters of convenience and control. Main internal controls operating in a bank are –

§  Division of Work: No individual clerk has control over a transaction from origin to end.

§  Slip System of Posting: Original vouchers evidencing transactions are used for making records in ledgers.

§  Periodic Job Rotation: Job rotation among staff periodically.

§  Sectional Balancing System: Existence of sectional balancing systems ensures accuracy of data at any point of time.

§  Joint Custody: Prescription of joint custody for dealing with vulnerable assets like cash, jewels, pledged etc.

§  Authorization Levels: Existence of clear-cut authority level for incurring monetary commitments either by way of loans, investments or incurring of expenditure (capital or revenue).

§  Monitoring: The transaction affected by an officer is put to well-laid monitoring system. Generally, self-monitoring and superior-monitoring occur in a bank.

§  Review: Independent review of operations by inspectors, internal auditors and statutory auditors periodically or at surprise intervals or effective control to the system.

§  Reporting: Periodical control statements on various operational areas are often submitted to the controlling authorities by banks.

Ø  Bank Audit – Its Approach :

The statutory auditor of a bank cannot carry out post and vouch audit. It is sometimes, described as a balance sheet audit, a system audit and mostly an audit of advances. As there are special features in accounting of banks, so too are audit approaches –

§  Bank audit is time-framed program.

§  The aim of statutory audit is to express opinion on truth and fairness of balance sheet items and profit/loss of bank.

§  The transactions of a bank are voluminous, repetitive. An auditor cannot check all these. The auditor cannot be familiar with signatures of all deposit holders. No useful purpose is to be served in wasting time on checking routines.

§  There exist well laid procedures to effect internal checks. What matters for an auditor is to apply checks and tests to ensure that the system actually functions effectively.

§  As auditor gives opinion on items of balance sheet, his attention will be more drawn on item ‘advance’. Because the item ‘advance’ constitutes major items of assets in the balance sheet. Hence the statutory audit of a bank can be described as an audit of balance sheet, system and advances.

Ø Steps in Bank Audit :

Like any other audit, the auditor has to plan and proceed in bank audit. In particular, he may identify the following areas as important in his programming –

§  Evaluation of internal control system

§  Checking of advances

§  Checking of other items of assets

§  Checking of liabilities

§  Scrutiny of P&L items

§  Making audit report

To evaluate internal control system, the auditor can make auditing in depth in respect of certain transactions. He may study the reports of internal auditor and inspectors to identify areas of fraud or malfunctioning.

Ø Checking Major Items of Assets :

§  Cash Balance - The auditor should physically check the cash balance as on the date of his audit. He should get all records and scrutinize them. He should see that cashier’s scroll, officer’s scroll, balance in cash book and general ledger balance for cash-all tally with each other in respect of receipts, payments and balance’ he should obtain certificate of balance from manager of the bank for his records.

§  Balances with Other Banks - Balances with other banks, money at call and short notice are checked by verifying confirmation of balances obtained from other banks/borrowers. If balance shown by them differs from that shown by books of the bank the auditor should obtain reconciliation statement. He should scrutinize the causes of difference and satisfy himself that nothing is unusual.

§  Investments - Auditor should check that efficient internal control operates with various aspect of investment, like- issuing order for purchase, decision to sell, custody, making entries in records etc. he should physically check all investments with bank to ensure ownership of bank and encumbrance if any. Where investments are with other party, say, brokers or safe deposit agency, he must ensure that there is nothing unusual in their having bank’s investments. He must obtain written confirmation from them.

According to Gosh Committee (1982) recommendations, the investments are to be classified into two categories ­- permanent and current investment depending on the intention of bank.

The permanent investment can be shown at cost or market value on a consistent basis. But the current investments must always be shown at cost or market value whichever is lower. And the auditor should ensure that bank complies with this valuation policy.

§  Fixed Assets & Other Assets - Fixed assets and other assets are to be checked bearing in mind principles enumerated in valuation of assets. The auditor should check that proper depreciation is provided for fixed assets on a consistent basis.

Ø  Checking of Liabilities :

§  Capital – In checking capital, the auditor should ensure that legal requirements as regards to capital are met by the bank.

§  Reserves – In checking reserves, the auditor should see that reserve fund is created as per the Banking Company Act. He must see that no appropriations are made out of it without Bangladesh Bank approval.

§  Deposits – Auditor must scrutinize various types of deposits and study the trend in their growth. He must satisfy himself that the deposit figure is not ‘bloated’ by adopting any window dressing methods.

§  Borrowings – While checking borrowings, auditor must satisfy himself about the power of the bank to borrow, the terms and conditions attached to borrowings.

§  Other liabilities – The auditor should ensure that adequate provision is made in respect of interest accrued on deposits but not paid to deposit holders. Similarly, it is to be ensured that all outstanding expenses, provision for bonus, gratuity etc. are correctly included in liability.

Ø  Scrutiny of P & L Items :

In income side, interest earned on advances constitutes major revenue. Income from investments, discount on bills purchased etc. also constitute important sources of revenue. The auditor should ensure the income is properly recognized as per the Bangladesh Bank guidelines. In respect of discount on bills, he must check rebate on unexpired discount had been created.

In expenditure side, interest on deposits constitutes major expense. He must check few cases to ensure the accuracy. Unpaid interest should be adequately provided for. The auditor should test-check other items of expenditure like salary, depreciation, loss on sale of investments, miscellaneous expenses.

Ø Audit of Advances :

Checking of advances is a major area of bank audit. In checking advances, an auditor is guided by the following aims in mind –

§  To check that there exists an effective internal control in various areas of credit management

§  To check that the advance is shown in the balance sheet fairly in its realizable value

§  To check that the income generated by the advance is properly recognized and measured

§  To check various information required to be disclosed in financial statements are properly disclosed

Ø Classification of Advances :

Advances in a bank can be classified into –

o   Facility Wise,

§  Cash credit, overdraft, demand loans, bills purchased and discounted

§  Term loan

§  Cash credit, overdrafts are drywall accounts with limit attached. And discounted are facility granted to drawer or holder of bills.

§  Term loans mean loans repayable by installments exceeding 36 months.   

o   Security Wise,

§  Secured loans

§  Unsecured loans

§  Loans guaranteed by Bank/Govt.

o   Sector Wise,

§  Advances to priority sector like agricultural advances, advances to SSIs, or other priority industry, service or business.

§  Advances to public sector

§  Advances to other sector