investment and treasury

8/11/2019 Investment and Treasury

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BANK AUDIT

INVESTMENT AND TREASURY

Presented byCA C. V. SAJAN


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How to approach the audit Regulatory perspective takes in to account most of the

aspects as RBI has given detailed guidance on accounting ,

internal control , risk management and accountabilityissues. Therefore compliance of RBI circular is the prime

objective

Work allocation can be broadly in to (a)Asset

classification(b) valuation Verification of front office and

back office operation including account examination and

reconciliation (d) Examination of files , reports, board notes.

Getting acquainted with the system and software is the key

LFAR shall comprehensively cover observations on every

point RBI has prescribed as compliance including from

proprietary angle


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Regulatory concerns this year

Tendency to stack up investment in HTM on one side and

at the same time conducting sales from that portfolio in

violation of RBI circular spirit.

Exposure to capital marketdirect and indirect

correctness of data and system of data capturing

Exposure to NBFCs and using NBFC route for sensitivesector like Real estate

Compliance of guidelines in investing PTC and SCs issued

by SC /RC

Private placement of Debt in the name of Infra structurewithout adhering to rating, listing requirements and other

exposure to unlisted securities

Correctness of Valuation in view of rising yields and NPI

in unlisted categories


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Valuation

Valuation could be a laborious exercise

Master circular dt 1-7-09 , Paragraph 3.5 to 3.10.3 givedetailed yard sticks for measurement

Market value in the case of unlisted securities could be a

challenge.

Correctness of market quotes /YTM rate applied in

government securities need thorough examination

Zero coupon Bonds , deep discount Bonds etc need

special care Investment in SR/PTC issued by SC/ RCs need care as

lower of NBV of assets or redemption value is the norm


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Profit and loss aspects

No capitalization of broken period interest paid

/received. As such they are to the P/L account Income recognition on accrual basis only where there are

no arrears

Dividend recognition only after AGM approval by

investee companies , ie after establishing right to receive

Income on NPI not accrued as in advances


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Verification of settlement

The settlement of all outright secondary market

transactions in Government Securities will be doneon a standardized T+1 basis

Select appropriate samples and ensure that settlements

are done on T+1 basis


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Same day accounting for SLR purpose

All the transactions put through by a bank, either on

outright basis or ready forward basis and whetherthrough the mechanism of Subsidiary General Ledger

(SGL) Account or Bank Receipt (BR), should be

reflected on the same day in its investment account

and, accordingly, for SLR purpose whereverapplicable.

Based on sample testing, this aspect needs to be

verified


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Authenticity of BRs ( Bankers Receipt )

BR s are less prevalent now a days. Yet in case of

allotment in pipeline BRs are used For issue of BRs, the banks should adopt the format

prescribed by the Indian Banks' Association (IBA) andstrictly follow the guidelines prescribed by them in

this regard. The banks, subject to the above, could issue BRs

covering their own sale transactions only and shouldnot issue BRs on behalf of their constituents,

including brokers. Undertaking whether transactions through BRs were

there or not , to be collected and in case of any,verification on sample basis needed


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Instances of SGL form return by RBI

There are remote possibilities of SGL form returning by

RBI , for want of balance in sellers account This is a fraud prone area

Immediate information to RBI is necessary in such cases.

Ask for records that capture such instances and conclude

on instances, if any, during reporting period


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LFAR to carry comment on investments in shares/

debentures The observation to include whether the bank has

(i) Built up adequate expertise in equity research byestablishing a dedicated equity research department, aswarranted by their scale of operations;

(ii) Formulated a transparent policy and procedure forinvestment in shares, etc., with the approval of the

Board; and (iii) The decision in regard to direct investment in

shares, convertible bonds and debentures were takenby the Investment Committee set up by the bank'sBoard.

Opinions shall be formed from proprietary anglewhether the Investment Committee should be heldaccountable for the investments made by the bank.


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Ready forward transactions Repo transactions , and reverse repo transactions , are

liquidity management tools

Securities are not transferred, but only lien is marked. Banks shall show these transactions as sale and purchase

First leg of transaction is contracted at market rate Plusinterest accrued. On completion of second leg, net

difference between contracted prices and settlement ofinterest accrued becomes the interest expenses ( inrepo) . Security is accounted at original carrying value oncompletion of second leg.

Outstanding RF transactions on reporting date to reflectthe mark to market impact in buyers books.

Seller shall reverse the profit booked on repo and put inother liabilities. Similarly loss booked on repo if any bereversed to reflect in other assets.


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RBI Norms on ready forward transactions

Repo transactions may not be done with the custodian of

SGL and Both the constituents shall not have SGL account with

the same custodian

Central government securities ( including T Bills ) and

dated State government securities are only allowed Permitted for securities only in excess of SLR

All ready forward contracts shall be settled throughthe SGL Account / CSGL Account maintained with the

RBI, Mumbai, with the Clearing Corporation of IndiaLtd. (CCIL) acting as the central counter party for allsuch ready forward transactions.


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Reconciliation of SGL balance

SGL account with RBI has to be reconciled with

investment portfolio of the bank Instances of bouncing from SGL account of insufficient

balance of security in SGL account in case of sale of

securities be enquired in to for reporting purposes.

Similarly instances of bouncing from current accountwith RBI on account of purchase of securities also be

enquired into .


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Short sale of government securities

Banks may sell a government security already contracted for

purchase, provided:

1. The purchase contract is confirmed prior to the sale,

2. The purchase contract is guaranteed by CCIL or the security is

contracted for purchase from the Reserve Bank and,

3. The sale transaction will settle either in the same settlement cycle

as the preceding purchase contract, or in a subsequent settlement

cycle so that the delivery obligation under the sale contract is met

by the securities acquired under the purchase contract

For purchase of securities from RBI through Open Market

Operations (OMO), no sale transactions should be contracted priorto receiving the confirmation of the deal/advice of allotment from

the RBI.


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Investment in shares

Audit committee is required to monitor and keep

surveillance of investment in shares Monthly review of exposure to capital market be done ,

both for fund and non fund exposures . Board note may

be examined to ensure compliance of this.

The review shall cover adequacy of internal control andrisk management systems


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Engagement of Brokers

Inter bank security transactions are not allowed through

brokers Brokers are permitted for other deals , only for the

limited purpose of introducing the two parties.

Of the total transactions , individual broker can not

transact for more than 5% volume.

Records to explicitly carry details on broker engagement

and top management be informed (brokerwise) , about

the transactions , brokerage etc..

Auditor to examine on the overall involvement of brokers

and make an audit note appropriately for inclusion in

LFAR if required.


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Half yearly review reports

Make sure that half yearly review reports sent by the

Bank to RBI are examined Study the concurrent audit reports and reconcile with

reports to Board /RBI.

Make note of the points about system flaws or non

compliance of norms for inclusion in LFAR

Treasury concurrent audit reports are required to be

presented to CMD on monthly basis. Examine the report

and take cues there from.


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NON SLR INVESTMENTS

Include shares, Corporate debts, Units of MFs,Investment in VCF, Mortgaged backed securities, Asset

Backed securities, Bonds issued by SCs and RCs Investment grade credit rating and listing required for

corporate bonds .(Exception for infrastructure Bonds)

Ceiling for unlisted Non SLR investments up to 10% of

total Non SLR Investments plus additional 10% forspecified SC/ RC Bonds

All the procedures in credit appraisal and sanction , needto be followed in investment in Non SLR.

Private placement of debts with investment departmentis an area of Concern for RBI.

Auditors need to thoroughly examine all the exposures inthis category from the risk , reward and compliance

points, more particularly of borrower clients.


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Exposure to capital market

Verify the data capturing system for this purpose and

include observation in LFAR. Aggregate exposure limit in all forms (both FB and

NFB) is 40 per cent of its net worth as on March 31

of the previous year.

Within this overall ceiling, the banks direct

investment in shares, convertible bonds /

debentures, units of equity-oriented mutual funds

and all exposures to Venture Capital Funds (VCFs)[both registered and unregistered] should not exceed

20 per cent of its net worth.

Board can fix lower ceiling limits too. Check it out.


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Issues related to classification

Categorization in to HTM , AFS , HFT is required at the

time of transaction. Ensure compliance Further classification in to following six heads for

the purpose of presentation

a) Government securities,

b) Other approved securities,

c) Shares,

d) Debentures & Bonds,

e) Subsidiaries/ joint ventures and

f) Others (CP, Mutual Fund Units, etc.).


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HTM to include only the following

(a) SLR Securities upto 25 percent of their DTL as on

the last Friday of the second preceding fortnight. (b) Non-SLR securities included under HTM as on

September 2, 2004.

(c) Fresh re-capitalisation bonds received from the

Government of India towards their re-capitalisation

requirement and held in Investment portfolio.

(d) Fresh investment in the equity of subsidiaries and

joint ventures (e) RIDF/SIDBI deposits.


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Treatment of profit on HTM sale

Profit on sale is first credited to P/L, however, equal

amount is appropriated to capital reserve.

Ensure correctness of HTM profits to comment on the

appropriation

Loss on HTM sale is charged to P/L


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Can debentures/ Bonds be under HTM

Those issued prior to Sep 2, 2004 were allowed to be

included under HTM, provided they were part ofadvances granted to a company

Non SLR investments issued after Sep 2, 2004,are not

allowed to be included in HTM. Accordingly Debentures/Bonds are out of scope of HTM .

Consequently they are subject to mark to market

valuation and provisioning norms .


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Complication with HFT and AFS

While HFT is meant for short term trading , AFS becomes

the residual category Profit or loss on sale in both cases go to P/L

HFT must be liquidated in 90 days

Shifting HFT to AFS is permitted only in exceptional

situations (, like failure to sell in 90 days due to tight

liquidity in market), and that too subject to top

management approval .

Not selling with in 90 days for fear of loss requires

commenting.

Auditors to take a view on the HFT trade practices, efficacy

of buy-sell strategies and about the shifting of HFT to AFS

during the year


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Valuation HTM

No marking to market

Measure at cost. In case cost is more than redemptionvalue , excess is amortised over the residual life period.

In such cases the cost less amortization is the value.

Such a charge is allowed as reduction from interest

income from Investments

Where there are investments in JVs/ Subsidiaries ,

dimunition in value other than temporary be providedfor , investment wise


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Valuation AFS and HFT

Every item is Marked to market , taking all the items in a

classification together. In the case of foreign investments, marking to market under

five classifications is done, scrip wise

Further, the investment in a particular classification, both in

domestic and foreign securities, may be aggregated for thepurpose of arriving at net depreciation/appreciation of

investments under that category.

Net depreciation, if any, shall be provided for. Net

appreciation, if any, should be ignored

No offsetting of depreciation in one classification with

appreciation in another.

Book values of individual securities undergo, no change.


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Valuation Challenges

AFS/ HFT are valued at market rates for quoted items

For unquoted , different norms are prescribed rangingfrom cost basis for T bills , periodical YTM( announced

PDAI )basis for central govt securities to bench marked

YTM basis for others like State Govt securities, Other

approved securities etc.. Zero coupon Bonds and other Deep discount bounds

require special attention as Interest accrued shall be

reckoned as part of carrying value

Unquoted preference shares are based at YTM. Howeverthose issued as rehabilitation etc require special bench

marking . Care needed in testing valuation basis


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Unquoted Preference shares

a) The YTM not to be lower than that for a GOI loan

B) The mark-up for the unrated preference sharesshould appropriately reflect the credit risk borne by

the bank.

c) Investments in preference shares as part of the

project finance may be valued at par for a period of

two years after commencement of production or

five years after subscription whichever is earlier.

d) Where investment in preference shares is as partof rehabilitation, the YTM rate should not be lower

than 1.5% above the coupon rate/ YTM for GOI loan

of equivalent maturity.


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Preference shares - contd..

e) Where preference dividends are in arrears, no credit

should be taken for accrued dividends and the value

determined on YTM should be discounted by at least 15% ifarrears are for one year, and more if arrears are for more

than one year. The depreciation/provision requirement

arrived at in the above manner in respect of non-performing

shares where dividends are in arrears shall not be allowed tobe set-off against appreciation on other performing

preference shares.

f) The preference share should not be valued above its

redemption value. g) When a preference share has been traded on stock

exchange within 15 days prior to the valuation date, the

value should not be higher than the price at which the share

was traded.


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Derivatives

Verification of derivative transactions

Examine whether they are own account or clientaccount and correctness of disclosure

Issues of client complaints on sale of any derivative

products or any claims / litigation

correctness of marking to market

Completeness of disclosure on derivatives in Notes on

accounts

LFAR Note on derivative activities, loss /gain , nature ofexposures, hedging strategies, effectiveness , outstanding

etc..


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Other treasury operations

Verification of liquidity management,

Call money operations Interest calculation and

issue of CRR compliance certificates

Issue of other certificates including verification of SLR

etc..


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Thanks

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