The truth involves us all...

Updated: Jan 28 2002, 05:30am hrs
All these are long overdue corrections," is the way Haribhakti & Co’s Shailesh Haribhakti sums up the Reserve Bank of India’s (RBI) and Securities and Exchange Board of India’s (Sebi) recent communications on the bank-audit front. And there have been a spate of them: the highest in any single accounting year so far.

The line-up includes consolidated balance-sheets, and half-yearly audited accounting from the central bank. From Sebi’s side, all listed companies -- including banks -- will have to adhere to AS-17 to AS-22. This will be mandatory from the accounting period commencing on or after April 1, 2001.

As per Sebi’s guidelines, these standards have to be incorporated in the financial results of the current fiscal ending March 30, 2002. Further, the RBI has also set up a high-level committee to remove discrepancies in accounting procedures between listed and unlisted banks.

"These measures will go a long way in making the system more transparent. From a rating agency’s point of view, it clearly means that there will be much more information on banks in the public domain. Window dressing and many of the ills that afflict banks will get rectified," points out Credit Rating and Information Services’ of India (Crisil) director for financial sector ratings S Venkataraman. He adds that spikes like in an year-end deposit surge or for that matter the true nature of a bank’s investments in its subsidiaries, and its effect on the parent’s balance-sheet will become clearer.

Others like HSBC’s area financial controller Anurag Adlakha sees it more as a move toward best business practices. "Simply put, AS-17 to AS-22 guidelines will tell your stakeholders -- equity and depositors -- as to where you are making money from. You anyway had to know it. Banks like ours, for instance, do so to our headquarters. We are already in line with international best practices."

For foreign banks, and to an extent, the new generation private banks, these measures may not be all that a big jump. But seen from the view of state-run banks, it is so -- plagued as they are by unreconciled entries, lack of management information systems (MIS), standardised documentation; and all this further compounded by a huge network of branches.

Points out former RBI deputy governor Dr S S Tarapore: "I would say that unreconciled entries are a big headache. There are even inter-state unreconciled entries. If the amounts are small, it is okay to an extent, but when you go into commercial banking, these entries may tend to camouflage frauds."

To flashback a bit. The big shift in bank accounting standards came in 1992 when the country adopted globalisation, and decided it will integrate with the world economy. "For two years after that, it was all going fine. Sometime after that, it lacked pace. I really do not know why that happened... but if you see the big picture, it took sometime for the coalition politics at the Centre and the Bharatiya Janata Party to settle in. What you are now seeing is a big push forward," explains Mr Haribhakti on the sudden momentum on the bank-audit front.

Even before the current guidelines, an earlier reports by the Rashid Jilani Committee (1996) had touched upon the issue of internal-audits, and interests therein. The impression gleaned from foreign bankers is that to a large extent, this may well be a superficial debate.

As Mr Adlakha points out: "In our bank, the compliance officer who does the internal-audit is assisted by an objective team. Some of them are ex-HSBC staffers. He has an administrative reporting line into the local country-CEO, but also has a strong functional line in to the regional compliance officer. And, there is nothing systemic that will force the officer to paper-over over shortcomings."

All this may sound far away for most local banks which are yet to come to terms with the new guidelines. Implementing some of them will be a tough task.

Take for instance, AS-17 on segment reporting. Banks will have to showcase asset-liabilities differently in every operating divisions. It has to recast financial statements in to both business segments and geographical segments: at least 75 per cent of total revenues is to be included in the reportable segments. Under AS-18, it is mandatory to define related-parties and establish disclosure requirements of related-party transactions. AS-19: statements should be made in respect of all assets leased during accounting periods commencing on or after April 1, 2001. AS-20 relates to earnings per share; and AS-22 is accounting for taxes on income. AS-21 is on consolidated balance-sheets, and banks have to follow this as per RBI’s regulation.

If one were to look at the broad sweep of audit measures that are now to be stressed, it becomes self-evident that tougher days are ahead.

External and internal audits will become stiffer. And sooner or later, like norms will also mean that urban-cooperative banks (UCBs), regional rural banks (RRBs) and sundry credit co-operative societies will also have a tough life.

Pertinent to note here also is that the Board for Financial Supervision has evolved an approach for consolidated supervision as appropriate in the Indian context.

Based on this, a set of measures was announced last year. The multi-disciplinary working group set up to look into the introduction of consolidated accounting and quantitative techniques for consolidated supervision asked banks to prepare consolidated balance-sheets from this fiscal onwards.

The stage is now set for an increasingly risk-based supervisory (RBS) architecture from a predominantly transaction-based one. The role external auditors is basically to aid central bank supervisors.

Said RBI in its discussion paper on RSB put out on August 13, 2001: "The supervisory process, instead of duplicating the efforts of external and internal auditors, should seek to leverage off the work by these agencies. Towards part of this, the long-form audit report (LFAR), which is currently under revision, will have to be put into use at the earliest.

RBI will look forward to make more use of external auditors as a supervisory tool by widening the range of tasks and activities which external auditors perform at present. RBI would enter into a dialogue with the Institute of Chartered Accountants of India (ICAI) and chalk out an action plan."

Noble, these intentions may well be, but it is not going to be a simple task. Mr Adlakha at HSBC narrates an incident at the Bankers Training College in Mumbai: "I made this presentation, and a few state-run bankers pointed out that while they would like to do all those things, their systems were just not in place."

In the case of AS-17, it will all depend as to what extent banks, state-run in particular, are wired up. MIS is, therefore, going to be the key. As Mr Haribhakti says: "You need top-of-the-line information systems. If you do not have it, then how are you going to adhere to AS-17" He feels that MIS is a very much neglected area, and that banks must go all out to get their act right on this front.

It will be necessary here to digress a bit. Take the Unit Trust of India (UTI) and the import of MIS in audit becomes clear.

Says the Tarapore-headed high-level committee set up to enquire into the activities of UTI in its report: "The committee has great concerns about the MIS within UTI. The credibility and availability of data reflect weakness which need to be rectified expeditiously. Vital information, which would be required for the use of the top management, is not readily available." The report adds that the UTI is not subject to management-audit.

The same applies to banks. "There is a lot of data that come in as banks report to the RBI, and within as well. But you got to datamine and make sense of it", explains Dr Tarapore.

Adherence to stricter audit norms will prove critical for banks. Capital raising is going to prove difficult.

Investors are getting finicky. And stakeholders in banks are just equity holders. Who knows One day raters will assign risk-based on audit compliance. Premiums paid for deposit insurance make over time get linked to ratings. Who knows But for now, it is getting increasingly appreciated by all concerned that audit is a question of faith really.