Financial audit of banking companies

INTRODUCTION

Banks occupy the pride of place in any financial system by virtue of the significant role they play
in spurring economic growth by undertaking maturity transformation and supporting the critical
payment systems. The specificity of banks, the volatility of financial markets, increased
competition and diversification, however, expose banks to risks and challenges. The protection of
depositors’ interests and ensuring financial stability are two of the major drivers for putting in
place an effective system of supervision of banks.

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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 organization which remains undetected for an indefinite period
or long time. Therefore, inspection and audit plays crucial role in success of banking operations.

AUDIT OF A BANKING COMPANY

The balance sheet and the profit and loss account of a banking company have to be audited as
stipulated under Section 30 of the Banking Regulation Act, 1949. Every banking company’s
account needs to be verified and certified by the Statutory Auditors as per the provisions of legal
frame work. The powers, functions and duties of the auditors and other terms and conditions as
applicable to auditors under the provisions of the Companies Act are applicable to auditors of the

banking companies as well. The audit of banking companies books of accounts calls for additional
details and certificates to be provided by the auditors.
They include:

Whether or not;

• information and explanation, required by the auditor were found to be satisfactory;
• the transaction of the company, as observed by the auditor were within the powers
of the company;
• profit and loss account shows a true picture of the profit or loss for the period for
which the books have been audited and any other observations to be brought to the
notice of the shareholders;

Special responsibility is cast on the bank auditor in certifying the bank’s balance sheet and profit
and loss account, since that reflects the sound financial position of the banking company. Apart
from the balance sheet audit, Reserve Bank of India is empowered by the provisions of the Banking
Regulation Act, 1949 to conduct/order a special audit of the accounts of any banking company.
The special audit may be conducted or ordered to be conducted, in the opinion of the Reserve Bank
of India that the special audit is necessary;

• in the public interest and/or
• in the interest of the banking company and/or
• in the interest of the depositors.

The Reserve Bank of India’s directions can order the bank to appoint the same auditor or another
auditor to conduct the special audit. The special audit report should be submitted to the Reserve
Bank of India with a copy to the banking company. The cost of the audit is to be borne by the
banking company.

INSPECTION OF A BANKING COMPANY

As per Sec 35 of the Banking Regulation Act, the Reserve Bank of India1

is empowered to
conduct an inspection of any banking company. After conducting the inspection of the books,

accounts and records of the banking company a copy of the inspection report to be furnished to
the banking company. The banking company, its directors and officials are required to produce
the books, accounts and records as required by the RBI inspectors, also the required statements
and/or information within the stipulated time as specified by the inspectors.

• prohibit the banking company to accept fresh deposits
• direct the Reserve Bank to apply for winding up of the banking company
under the provisions of the Banking Regulation Act.

Before taking action, the Government has to give an opportunity to the banking company to explain
their stand. Based on the response, the Government can initiate appropriate action as required.

SUPERVISORY FUNCTION IN INDIA

The legal and institutional framework for bank supervision in India is provided under the Banking
Regulation Act, 1949. Until 1994, different departments in Reserve Bank of India were exercising
supervision over banks, non-banking financial companies and financial institutions. To keep a
close watch on financial markets and avoid recurrence of crisis in the financial system, the Board
for Financial Supervision was set up under the aegis Reserve Bank under Reserve Bank of India
(Board for Financial Supervision) Regulations, 1994 with the objective of paying undivided
attention to the supervision of the institutions in the financial secto

To have better supervision and control, a separate board was constituted namely “The Board for
Financial Supervision” as per the provisions of the RBI. The Board has the jurisdiction over the
banking companies, nationalized banks, State Bank of India and its subsidiaries. The members of
the Board are: Governor of the Reserve Bank of India as the chairperson, Deputy Governors of the
Reserve Bank of India, and one of the deputy governors should be nominated by the Governor as
the full time vice chairman, four directors from the Central Board of the Reserve Bank nominated
by the Governor as members.

CORE PRINCIPLES OF BANKING SUPERVISION

The Core Principles for Effective Banking Supervision are the de facto minimum standard for
sound prudential regulation and supervision of banks and banking systems. Originally issued by
the Basel Committee on Banking Supervision in 1997, they are used by countries as a benchmark
for assessing the quality of their supervisory systems and for identifying future work to achieve a
baseline level of sound supervisory practices. The RBI has continued with the post-liberalization
strategy of setting prudential norms based on international best practices within which banks are
left free to operate. The compliance of the Bank with the Basel Committee’s Core Principles on
Banking Supervision was gone into in great detail and the gaps in supervision were addressed by
setting up seven in-house groups to make necessary recommendations.

The reports of these groups were discussed by the BFS in a specially convened session and the
agenda set for action to be taken to bridge the gaps. Since then, the compliance is being monitored
on a regular basis. The BFS also authorized the release in the public domain of the assessment of
compliance, and this document is being shared with overseas supervisory agencies and
international financial institutions. The IMF also completed an assessment using the revised
methodology of the Core Principles which was in line with the Bank’s own assessment.

RBI’s efforts in this area have been well recognized in international forums and in August 1999, it
was made a Member of the Core Principles Liaison Group (CPLG) of the Basel Committee for
Banking Supervision, which has been set up to promote the implementation of the Core Principles
world-wide. RBI has also examined the proposed New Capital Adequacy Framework currently
under discussion by the BCBS, and has communicated its response to the Basel Committee. RBI
is also represented on the Working Group of Capital of the Core Principles Liaison Group, which
has been constituted to obtain the inputs of the non G-10 countries in the international standard
setting exercise.

CONCLUSION

The importance of the financial system in an economy can hardly be overstated, and the banking
industry remains at the core of the financial system, even in countries where its credit role has
diminished relative to other financial sectors. Recent changes in the nature of banking, and the
frequency in the past couple of decades of costly banking crises around the world, have only
heightened the interest of policy makers and industry participants in the effective regulation and
supervision of banks.”

Author: Somil Shrivastava, NMIMS, Mumbai, in case of any queries please contact/write back to us at support@ipandlegalfilings.com or   IP & Legal Filing.