Audit of Banking and Insurance Companies
1. Audit of Banking Companies: Regulatory Framework
Commercial banks operate under strict statutory oversight governed by the Banking Regulation Act 1949, the Reserve Bank of India Act 1934, the Companies Act 2013, and regular Master Circulars issued by the Reserve Bank of India (RBI).
Peculiar Characteristics of Bank Auditing:
- Massive volume of daily financial transactions processed through computerized Core Banking Solutions (CBS).
- Dispersed geographic operations through thousands of retail branches.
- Fiduciary custody of public depositors’ savings, requiring extreme internal check standards.
- Complex portfolio of loans, foreign exchange dealings, and statutory reserve maintenance: Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).
2. Multi-Tier Audit Structure in Banking
To maintain rigorous control, commercial banks operate under three distinct layers of audit:
The Three Pillars of Bank Auditing
1. Concurrent Audit
A real-time, ongoing daily audit conducted at large branches to verify high-value cash transactions, loan disbursements, and forex dealings as they occur, ensuring instant rectification of irregularities.
2. Statutory Branch Audit
Conducted at the close of the financial year (March 31) by independent practicing Chartered Accountants appointed under RBI guidelines to audit branch trial balances and certify loan advances.
3. Statutory Central Audit
Conducted by senior CA firms at the bank's corporate headquarters to consolidate thousands of branch audit returns, audit head office investments, and sign the consolidated balance sheet.
3. Verification of Advances & Classification of NPAs (IRAC Norms)
The single most critical area in bank auditing is the verification of Advances (loans, cash credits, overdrafts, and bills discounted). Under the RBI’s Prudential Norms on Income Recognition, Asset Classification and Provisioning (IRAC Norms):
Definition of a Non-Performing Asset (NPA):
An asset (loan or advance) becomes a Non-Performing Asset (NPA) when it ceases to generate income for the bank:
- In term loans: Interest or installment of principal remains overdue for more than 90 days.
- In overdraft / cash credit (OD/CC): The account remains “out of order” (outstanding balance exceeds sanctioned limit or no credits for 90 days).
- In agricultural loans: Overdue for 2 crop seasons (short duration crops) or 1 crop season (long duration crops).
Asset Classification and Provisioning Requirements under RBI Norms
Standard Asset
Performing Loan (No Default):
Regular repayments; general provisioning required ranges from 0.25% to 1.00% depending on sector (0.40% for general commercial advances).
Sub-Standard Asset
NPA for ≤ 12 Months:
Remained an NPA for a period less than or equal to 12 months. Mandatory general provision of 15% for secured loans and 25% for unsecured loans.
Doubtful Asset
NPA for > 12 Months:
Exceeded sub-standard category for over 12 months. Provision on secured portion: D1 (up to 1 yr): 25%, D2 (1-3 yrs): 40%, D3 (> 3 yrs): 100%. Unsecured portion: 100% provision!
Loss Asset
Identified as Uncollectible:
Identified by bank inspectors, statutory auditors, or RBI inspection as completely uncollectible. Mandatory provision: 100% of the entire outstanding amount.
4. Audit of Insurance Companies (Life & General Insurance)
Auditing insurance corporations is governed by the Insurance Act 1938, the Insurance Regulatory and Development Authority of India (IRDAI) Act 1999, and IRDAI (Preparation of Financial Statements) Regulations 2002.
A. Vouching of Premium Income
Premium is the primary operating revenue of an insurance company:
- Premium Register: Compare policyholder applications with premium registers and computerized policy master logs.
- Grace Period & Lapsed Policies: Ensure premiums received within the statutory grace period (usually 30 days) are credited to income; check treatment of lapsed policies.
- No Coverage Without Advance Premium (Section 64VB): Under Section 64VB of the Insurance Act, an insurer cannot assume any insurance risk until the premium has been received in advance or guaranteed by bank deposit. The auditor must verify strict adherence to this fundamental statutory provision!
B. Vouching of Claims Paid and Outstanding
Claims represent the largest expense and liability of an insurance firm:
- Life Insurance Claims:
- Maturity Claims: Verify policy documents, age admission proof, discharge vouchers signed by policyholders, and calculate accrued bonuses.
- Death Claims: Inspect death certificates, claim forms, post-mortem / police reports (in accident cases), legal heirship certificates, and check for early death claims within 3 years of policy inception (requires investigation for fraud).
- General Insurance Claims (Fire, Marine, Motor):
- Inspect independent Surveyor’s Reports for damage assessment.
- Verify salvage value deductions, average clause applications, and reinsurance recoveries from reinsurers (e.g., GIC Re).
- Verify adequate provisions for Claims Incurred But Not Reported (IBNR) and Claims Incurred But Not Enough Reported (IBNER) based on certified actuarial valuations.
C. Vouching of Commission Payments to Agents
- Check whether commission calculations comply with rates approved by IRDAI under Section 40 of the Insurance Act 1938.
- Ensure commission is paid only to licensed insurance agents whose licenses were active on the date the premium was collected.
- Verify deductions for Income Tax (TDS under Section 194D) from agent commission payouts.
5. Key Exam Review Questions
- Explain the classification of advances into Standard, Sub-standard, Doubtful, and Loss Assets under the RBI’s IRAC Norms, along with provisioning percentages.
- What is a Concurrent Audit in commercial banks? Why is it considered vital for risk management?
- What is the significance of Section 64VB of the Insurance Act 1938 regarding premium collection? How does the auditor verify compliance?
- Outline the audit steps for verifying Claims Paid in a General Insurance Company.