Forensic Audit for all Bad Loans

Cautioning that the rising trend of non-performing assets (NPAs) with banks has ‘the potential to damage the growth story’, the Finance Standing Committee of Parliament has called for immediate forensic audit of all restructured loans that had turned into bad debts. Forensic Auditing is different from Financial Auditing. The Financial Auditing may be deed as ‘a concentrated audit of all the transactions of the entity to the correctness of such transactions and to report whether or not any financial benefit has been attained by way of presenting an unreal picture’. Forensic auditing, on the other hand, aims at legal determination of whether fraud has actually occurred. In the process, it also aims at naming the person(s) involved (with a view to take legal action).

Forensic audit is also required for willful defaults and Reserve Bank of India (India) has been asked to prepare guidelines for the process. As on September 2015, net NPAs of public sector banks stood at ? 2,05,024 crore and may reach Rs. 4 lakh crore by the end of this fiscal, the panel said, adding that such a huge the ‘raises questions’ on the credibility of mechanisms to deal with NPAs. The report said willful defaulters owe public sector banks ? 64,335 crore, which constitutes about 21 per cent of total NPAs, and called for making public the names of the top 30 stressed accounts of each bank, in the category of willful defaulters.

Distinction Between Statutory Audit and Forensic Audit

S. No Particulars Statutory Audit Forensic Audit
1. Objective Express opinion as to ‘true & fair’ Determine correctness of the accounts
presentation. or whether any fraud has actually taken
2. Techniques ‘Substantive” and’ ‘compliance’ Analysis of past trend and substantive
procedures. or’ in depth checking of selected
3. Period Normally all transactions for the No such limitations. Accounts may be
particular accounting period. examined in detail from the beginning.
4. Verification of stock, estimation of Relies on the management certificate/ Independent verification of suspected/
realizable value of current assets, representation of management. selected items carried out.
provision/Liability estimation, etc.
5. Off balance-sheet items(like Used to vouch the arithmetic accuracy Regularity and propriety of these
contracts etc.) & compliance with procedures. transactions/contracts are examined.
6. Adverse dings, if any Negative opinion or qualified opinion Legal’ determination of fraud and
expressed, with/without quantification. naming persons behind such frauds.

Reserve Bank of India’s PCA Framework for commercial banks

The Reserve Bank has specified certain regulatory trigger points, as a part of prompt corrective action (PCA) Framework, in terms of three parameters, i.e. capital to risk weighted assets ratio (CRAR), net non-performing assets (NPA) and Return on Assets (RoA), for initiation of certain structured and discretionary actions in respect of banks hitting such trigger points. The PCA framework is applicable only to commercial banks and not extended to co-operative banks, non-banking financial companies (NBFCs) and FMIs.

The trigger points along with structured and discretionary actions that could be taken by the Reserve Bank are described below:


CRAR less than 9%, but equal or more than 6% – bank to submit capital restoration plan; restrictions on RWA expansion, entering into new lines of business, accessing/renewing costly deposits and CDs, and making dividend payments; order recapitalisation; restrictions on borrowing from inter-bank market, reduction of stake in subsidiaries, reducing its exposure to sensitive sectors like capital market, real estate or investment in non-SLR securities, etc.

CRAR less than 6%, but equal or more than 3% – in addition to actions in hitting the first trigger point, RBI could take steps to bring in new Management/ Board, appoint consultants for business/ organizational restructuring, take steps to change ownership, and also take steps to merge the bank if it fails to submit recapitalization plan.

CRAR less than 3% – in addition to actions in hitting the first and second trigger points, more close monitoring; steps to merge/amalgamate/liquidate the bank or impose moratorium on the bank if its CRAR does not improve beyond 3% within one year or within such extended period as agreed to.

Net NPAs

Net NPAs over 10% but less than 15% – special drive to reduce NPAs and contain generation of fresh NPAs; review loan policy and take steps to strengthen credit appraisal skills, follow-up of advances and suit-led/decreed debts, put in place proper credit-risk management policies; reduce loan concentration; restrictions in entering new lines of business, making dividend payments and increasing its stake in subsidiaries.

Net NPAs 15% and above ‘ In addition to actions on hitting the above trigger point, bank’s Board is called for discussion on corrective plan of action. ROA less than 0.25% – restrictions on accessing/renewing costly deposits and CDs, entering into new lines of business, bank’s borrowings from inter-bank market, making dividend payments and expanding its staff steps to increase fee-based income; contain administrative expenses; special drive to reduce NPAs and contain generation of fresh NPAs; and restrictions on incurring any capital expenditure other than for technological up-gradation and for some emergency situations.

Bad Debt Provisioning: NBFC to claim Tax Deduction

Accepting a long standing demand of industry, the Centre proposes to allow non-banking finance companies (NBFC) to avail tax deduction on the provisions they make towards bad debts. Union Budget 2016-17, presented on Monday, has allowed NBFCs to claim tax deduction on account of provision for bad and doubtful debts to the extent of 5 per cent of total income.

Economic and Social Development