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. 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 banks interest.
What is auditing - "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".
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.
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.
1.To assess whether the performance of the branch is in consonance with the policy guidelines,
budget, as per market trends.
2. To ascertain whether laid down systems and procedures are scrupulously followed.
3. 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.
4. To provide management information to controlling authorities for taking corrective measures

and for deciding policies.

5. 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.
6. 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.
7. Whether documentation is proper and as per the term of sanction.
8. 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 banks guidelines. Whether one time
settlement is as per banks guidelines or not.
9. Whether guidelines issued by Reserve Bank of India and other statutory authorities are being
followed.
10. To ascertain whether periodical returns both internal and statutory are correctly submitted at the
stipulated intervals.
11. 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.
12. 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 banks
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
countrys 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 banks 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
companys 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
malpractices 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 banks 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 organisations 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?