Forensic audit no solution to unearth the facts

Forensic Audit cannot reveal anything new or substantial. It is no better than any audits that remain essentially a post mortem exercise, pure and simple. It carries an enormous price tag only because of its fancy name



A lot is being written in the economic media on “Forensic audit” of big ticket bank loan default by Deccan Chronicle, Lanco Infra and Kingfisher. Many more skeletons are sure to emerge out of the closets once the corporate debt restructuring (CDR) cases presently not declared ‘sub-standard’ also start defaulting by faltering on compliances.



What presently stands designated as non-performing assets (NPAs) are mere tips of massive icebergs of stressed lending by banks across India? According to the Economic Times editorial on 21st April entitled - “Domain regulators must probe frauds”, bad loans, for the calendar year 2013, before making provisions stood at Rs2.43 lakh crore, up 35% on a year-on-year basis.



Earlier on 18th April, the newspaper has a detailed report -“Big Loan defaulters to face RBI audit” that inter alia said, “The Reserve Bank of India (RBI) has taken upon itself the task of investigating bank frauds after a series of inquiries by banks themselves in high profile cases involving Deccan Chronicle and Kingfisher Airlines yielded very little. The RBI’s Board for Financial Supervision, chaired by the Governor has, in fact, cleared a proposal that it will conduct an independent forensic audit of corporates declared fraudulent by banks…RBI will first get to the bottom of what went wrong with Deccan Chronicle. What is interesting is that the mandate has been given to PricewaterhouseCoopers (PwC), which was banned by the RBI for possible audit lapses of the Global Trust Bank… Senior bank officials with exposure to Deccan Chronicle told ET that they have received a letter from the RBI urging them to co-operate with PwC…Bank officials say this move reflects poorly on the banks and some promoters have developed cozy relationships [with politicians and MOF bureaucrats as well as Bank Boards] that has led to crores of bad loans.. A consortium of lenders led by Canara Bank had earlier appointed Ernst & Young to conduct a forensic audit on Deccan Chronicle, but it yielded very little. The report itself was inconclusive and the lenders did not act upon it.” (Italicized by me for greater emphasis.)



The extremely steep rise in bad loans certainly calls for strong measures to ensure that banks do not sweep them under the carpets as is presently being done by not classifying as ‘substandard’ and consequently NPAs the advances undergoing CDR consequently tantamount to virtual frauds because crores are sought to be written off without due process.



Deccan Chronicle promoters are reported to have borrowed over Rs4,000 crore from a consortium of 18 lenders who now allege that the company abused the banking system by borrowing from one set of lenders without keeping the others in the loop. The circumstances in the cases of Kingfisher Airlines and Lanco Infra are no worse.



The RBI mandates a failsafe warning mechanism to effectively monitor bad loans by putting in place appropriate flagging indicators. Already in place are a plethora of checks and balances from bottom to top for reporting on shortfalls in securities, exceeding drawing powers, day-to-day on-line reporting requirements, ratification requests, internal inspections, during the year concurrent, revenue, income and stock audits. Finally the annual statutory audits by independent firms of Chartered Accountants (CAs) who are also called upon to submit an additional “Long Form Audit Report-LAFR.” The demands of this report are so archaic that it is termed, in professional circles, as a “LAFDA Report”- a typical Bambiya lingo for anything and everything that’s not right!



All the present fraud cases (and more still to follow) essentially, follow very similar patterns:



• From day one when the unviable borrowing proposal is submitted to the lending banks,

• The proposals are subjected to extremely top-level tremendous pressures to disburse post haste.

• Overlooking due diligence,



• Go by to norms of viability, profitability, repayment capacity and



• Bypassing every known lending norm.



• Sometimes even defective documents that are unenforceable are signed, sealed and delivered, only later to be found to unenforceable when suits are to be filed, more particularly in cases of enforcing of third party guarantees.



• Immediately on sanction there are heavy large ticket withdrawals/ cheques for payments far beyond the projections for entirely different purposes or to closely related entities or patently dubious payees, large cash withdrawals and the like. Had each of these payments been duly flagged right away by the monitoring branch and reported promptly, the diversions and wrong end use could have been pre-empted before it snow balls into much larger outflows.



• Many bouncing of cheques issued beyond drawing powers go to indicate that there is total lack of financial discipline – faked sales not resulting in genuine receivables, no inventories, miss-match of purchases, consumption, sales and closing stocks.



• Inability to service interest when it falls due takes the final straw.



• A major a flaw at the monitoring level arises when the borrowings are not subjected to regular stock audit tally.



The fresh Re-audit calls for a patient and painstakingly diligent in-depth scrutiny of the accounts at the branch levels, covering each and every aspect listed above in respect of all (repeat all) of the borrowing accounts going back to the dates of their inception to identify and report on significant debits for each of the patently irregular withdrawals and all other related malfeasances. This can be carried out only by a senior bank auditor jointly with a high RBI and retired veteran, PSU General Manager-level officials.



After all, veteran domestic professional chartered accountants with adequate ground level exposure to bank branch audits are certainly much more qualified to assist the RBI’s internal team in big fraud case investigations over assigning it to the big ticket and not the more expensive firms whose reports do not inspire any confidence as is very apparent in the two reported cases.



To make a thorough success of the entire exercise and fix appropriate accountability the Re-audit teams have necessarily to be provided with an extremely no-holds-barred extremely wide cast-iron mandate with a virtual carte blanche to access and seek all information from any authority, however high and mighty it may be, even to go beyond the RBI, lending banks’ present and retired or past chairman managing directors (CMDs), members of the Board of Directors and to go all the way to the North Block at Delhi. Where hard documentary evidence of pushing a loan proposal or soft-peddling recovery proceedings is not available, it can record oral statements to that effect.



The accountability of other internal departments tasked with due diligence and also vetting defective documentations like unenforceable third party/ corporate guarantees also needs to be ascertained and reported.



The news report mentions appointments of PwC, and the report states, some were earlier black listed by RBI for audit lapses at Global Trust Bank -GTB [and just now two of its partners are delisted by the ICAI on grounds of professional misconduct in the Satyam scams. One of them was stated to be the Chairman of Ethics Committee of the Accounting Regulator the Institute of Chartered Accountant of India.] Another audit biggie, E&Y is charged with of being equally guilty of submitting an “inconclusive report that yielded little that the lenders did not act upon.” As of now, nothing is known nor any report made available in the public domain on what went wrong with the GTB and its audit, more particularly of the action, if any, taken on the gross irregularities. As of now the GTB’s then statutory auditors appear to have been let off the hook.



When the RBI insists on applying the “Fit & Proper Criteria” for all kinds of appointments, this practice should necessarily hold equally valid for its associating with the right experienced senior auditors with a good past record as a long standing auditors of banks possessing a great degree of proficiency to deal with such complex issues.



I’d rather term the exercise as “Re-audit” rather than the high sounding “Forensic Audit.” As a once RBI empanelled Statutory Auditor of banks for over quarter of a century, I, for one, strongly hold that “Forensic Audit” by any name, cannot reveal anything new or substantial - it is no better than any audits that remain essentially a post mortem exercises, pure and simple. It carries an enormous price tag only because of its fancy name – at best it is old wine in new bottle!



The entire bank audit approach, process and reporting regime calls for an immediate review.



(Nagesh Kini is a Mumbai-based Chartered Accountant turned activist.)