1

Training Workshop on

Audit of Banks

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Roadmap for Audit of Banks

Training for BOP Strategy and Operations

Audit Of A Bank– Basic Concepts

An audit of a bank is different from a conventional audit mainly for the following two reasons: - The Nature of business is altogether different from any other sector.

Money is the raw material and money is the finished good.

It is a highly regulated sector of the economy. The Central Bank of our country i.e. the State Bank of Pakistan established policies and procedures in the form of regulatory and operational requirements and

require strict compliance to these.The assets and liabilities of a bank are arranged on the face

of balance sheet in descending order of their liquidity.

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Major Areas of Branch Audit

1. Advances / Loans / Credits / Risk Assets Facilities.

2. Deposits

3. Operations / General / Retail / Miscellaneous Banking

Loans / Credits / Advances / Risk Assets / Facilities

• Bank lending i.e. loans and advances, usually represent the largest class of asset in a bank balance sheet. It is also a bank's greatest source of exposure to loss, and this necessitates a high degree of internal control.

• Loans are granted by a bank’s branch to its clients and these are

generally funded by borrowing money at KIBOR (Karachi Inter-Bank Offered Rate). The branch then charges its client markup at a rate higher than KIBOR to generate a profit on the interest rate differential (called SPREAD). Therefore, nowadays almost all loans are priced with KIBOR as their base.

Throughout this booklet the term KIBOR is used. All countries have their own inter-bank base rate at which all banks are willing to accept deposits from each other. For the purposes of this booklet all funds are considered to be borrowed and lent at KIBOR but in practice it could be at any rate.

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Classification of Loans / Credits / Advances / Facilities

Loans/Facilities can be broadly divided in two categories

a. Funded Facilities• A funded facility is one in which actual funds are credited/disbursed to the borrower’s

account and default risk is born by the bank.• Examples:

• Running Finance• Term Finance• Bridge Finance

a. Non-Funded FacilitiesIn case of a non-funded facility the bank only assumes a financial obligation on behalf of the

customer towards a third party in the event of default by the customer.

• Examples:• Letter of Credit

• Letter of Guarantee

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Types of Advances

• Overdrafts / Running Finance

• Cash Finance

• Term Credit Facilities– Term Finance

– Syndicated Loans

– Bridge Finance

– Demand Finance

• Payment against documents (PAD)

• Finance against imported merchandise (FIM)

• Finance against Trust Receipts (FATR)

• Bills purchased / negotiated under LC

• SBP export refinance

• Pre Shipment Export Finance (FAPC-I, FAPC-II, FAPC-G)

• Consortium / Syndicated financing

Running Finance

• Also called roll over facility or revolving credit.• It is the form of lending, where customer is allowed to borrow money from a

banker up to a certain limit either at once or as and when it is required. If it is availed and withdrawn at different intervals and paid back on various occasions, then the mark up levied thereon is worked out on daily product basis. The formula to work out mark up on "daily product basis", in respect of Running Finance, according to recognized Banking practice is:

• 'Balance Outstanding X Number of days X Rate 365 days in a calendar year“.

• The mark up in running finance facility, is a revolving credit. It renews until exhaustion of amount of credit, the customer has the facility to draw it again when limit is reached. Credit is automatically reinstated after each drawing, within the limit. The limit is renewable credit, until it's full utilization.

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Cash Finance

This facility is generally provided against pledge of goods. Under this type of financial accommodation the facility amount is disbursed in specially opened account for the purpose. The pledged goods are released to the borrower against cash payment only. In case the goods pledged are seasonal in nature, the customer would be required to adjust the facility before the season ends. Rollover shall not be allowed.

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Audit Procedure on RF & CF

• Obtain the 303014 report (complete facility ledger report) and check the date of Sanctioning of Loan that should not be more than 1 yr old. Then in 303014 check the Limit Sanctioned and the Drawing power and compare it with the Outstanding amount. Conduct Loan evaluation of selected parties of the branch.

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Term Finance

These are made for a fixed period of time and can be repayable either in installments or in full at the maturity date. A short term loan is generally regarded as being a loan which is repayable within one year from when it is granted. A medium term loan is generally regarded as being repayable after at least one year but before the expiry of five years. A long term loan is generally regarded as one that is not finally repayable until at least five years after it was granted. The interest rate is normally predetermined for short term loans and is likely to be of a floating nature for medium to long term loans

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Term Credit Facilities - Policy All Credit Facilities approved for periods over one year with a fixed

repayment schedule are defined as term credit facilities.

a) Tenor Tenor should not exceed seven years, including grace period, from the date of commitment to the date of final maturity. Exception to it may be allowed where facility is being extended under any special scheme approved by the Government.

b) Amortization Principle must be amortized through regular installments, preferably quarterly, but not less frequently than semi-annually, starting from the date of final takedown. A grace period of up to two years may be allowed before beginning repayment, but in all cases this grace period must be justified by the circumstances of the particular financing.

c) Mark-up Frequency Mark-up should preferably be paid monthly, but not greater than quarterly, starting from the date of initial takedown. The relevant approving authority may, allow exception where sound business and credit grounds exist.

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Audit Procedures – Term Credit Facilities

• Take 303014 report and compare expiry date with the year end date. If the expiry date is after the year end date then the party is regular as far as the principle is concerned.

• But if the expiry date of the principle of the facility is before the year end then check the facility for the classification.

• Prepare a predictive test on mark-up for the quarter by multiplying the outstanding principal amount with the mark-up rate. Compare it with the mark-up outstanding in 303014 report. If this markup calculated is approximately half of the outstanding markup then check that party for the classification.

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Syndicated Loans / Consortium Financing A syndicated loan is one that is provided jointly by a number of

banks or financial institutions (consortium of banks / financial institutions) who would be individually either unwilling or unable to provide funds in view of the size and nature of the funding.. These banks or financial institutions are usually brought together by one or possibly more managing banks which have organized and negotiated the whole package. The managing (or sometime it's called lead) bank handles the negotiations with the borrower, perhaps the documentation, collects the funds from participants and then disburses the full amount to the borrower. Subsequently the managing bank is responsible for collecting all sums due from the borrower (both principal and interest) and for passing their share of these sums to the participants. Apart from the managing bank, the syndicate participants do not have any direct dealing with the borrower as all their information needs and any required action (e.g. in case of default) is dealt with solely by the managing bank.

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Bridge Financing

Bridge financing is a way for companies, just before their IPO, to obtain the cash they need to maintain operations throughout the process. Usually the funds are supplied by the investment bank who will, in turn, receive shares of the company at a discount from the declared issue price. This discount will typically offset the total amount of the bridge loan .

The financing is basically a forward payment for the future sale of the stock by the investment banker.

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SBP Export Finance Scheme(EFS)

• In order to support export business in the economy SBP has provided a facility to the exporters that they can packaging credit on a significantly low rates, that finance is called FAPC (Finance Against Packaging Credit).

• SBP has recently changed the rate on these loans, in fact they have increased the rates from 6.5% to 8% which is the base rate.

• Actually commercial banks give such loans to the exporters and then gets the reimbursement/refinance from SBP. They add a spread up to 1% for the services they charged so the rate charged from the exporters becomes Base Rate+1%.

• There are actually two types of EFS, Part-I & Part-II

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EFS Part -I

• Financing under Part I of the Scheme is a transaction-based facility. The finance is granted by the bank to the exporter on the basis of a Firm Export Order / Export Letter of Credit, for a maximum period of 180 days. The financing facility can be availed at pre-shipment stage for procuring inputs and manufacturing the goods to be exported. Financing at Post Shipment stage is also granted against goods already shipped to the importer abroad, for the period up-to realization of export proceeds or 180 days, whichever is earlier.

• After making a shipment the exporter prepare all relevant shipping documents and evidence of shipment. The exporter contacts his bank to lodge the financing scheme by providing following documents:

– Demand Promissory Note or DP Note on prescribed format– Undertaking on Non-Judicial Stamp paper or Form B– LC documentation– Party request letter– Form D– Commercial Invoice

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EFS Part -II• Under Part-II of the Scheme, a revolving finance limit is sanctioned to the exporter

equivalent to 50% of his export performance during the previous year on July - June basis. Exporters can avail this financing facility for a period of 180 days. Facility once availed needs to be repaid in totality. Exporters having availed Part-II facilities have to export / ship eligible goods and realize export proceeds and submit the evidence of performance on the prescribed statement within two months from close of each financial year.

• Annual revolving limit based on half of the previous year export performance in respect of eligible commodities.

• Available to Direct Exporters but not to Indirect Exporters.• Monitoring of performance through EF-1 Statement.

– Duplicate of EE-I– DP Note– Undertaking

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Finance Against Packing Credit.(FAPC)• Definition

– It is also called Pre-shipment Credit or Packing Credit.

– It is working capital finance provided by commercial banks to the exporter prior to shipment of goods. The finance required to meet various expenses before shipment of goods is called pre-shipment finance or packing credit.

– It is a type of bank’s own source finance provided to clients engaged in export trade. As the term packing indicates that the credit line is granted to an exporter for the purpose of packing merchandise for shipment to an importer abroad.

– An exporter should give documentary proof to the bank consist of L/C in favor of exporter indicating the description of the merchandise, the purchase price, date of delivery along with other terms.

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Importance of FAPC

• To purchase raw material, and other inputs to manufacture goods.

• To assemble the goods in the case of merchant exporters.

• To store the goods in suitable warehouses till the goods are shipped.

• To pay for packing, marking and labeling of goods.

• To pay for pre-shipment inspection charges.

• To import or purchase from the domestic market heavy machinery and other capital goods to produce export goods.

• To pay for consultancy services.

• To pay for export documentation expenses.

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FORMS OR METHODS OF PRE-SHIPMENT FINANCE• Cash Packing Credit Loan

In this type of credit, the bank normally grants packing credit advantage initially on unsecured basis. Subsequently, the bank may ask for security.

• Advance Against Hypothecation Packing credit is given to process the goods for export. The advance is given against security and the

security remains in the possession of the exporter. The exporter is required to execute the hypothecation deed in favor of the bank.

• Advance Against Pledge The bank provides packing credit against security. The security remains in the possession of the bank. On

collection of export proceeds, the bank makes necessary entries in the packing credit account of the exporter.

• Advance Against Red L/C The Red L/C received from the importer authorizes the local bank to grant advances to exporter to meet

working capital requirements relating to processing of goods for exports. The issuing bank stands as a guarantor for packing credit.

• Advance Against Back-To-Back L/C The merchant exporter who is in possession of the original L/C may request his bankers to issue Back-To-

Back L/C against the security of original L/C in favor of the sub-supplier. The sub-supplier thus gets the Back-To-Bank L/C on the basis of which he can obtain packing credit.

• Advance Against Exports Through Export Houses Manufacturer, who exports through export houses or other agencies can obtain packing credit, provided

such manufacturer submits an undertaking from the export houses that they have not or will not avail of packing credit against the same transaction.

• Advance Against Duty Draw Back (DBK) DBK means refund of customs duties paid on the import of raw materials, components, parts and packing

materials used in the export production. It also includes a refund of central excise duties paid on indigenous materials. Banks offer pre-shipment as well as post-shipment advance against claims for DBK. 22

Finance Against Foreign Bills (FAFB)

• It is a Post-Shipment facility, generally known as Finance Against Foreign Bills (FAFB), allowed to the exporters against their export bills drawn under usance LC and/or Export Sales Contracts. The facility so allowed remains on customer risk till realisation of proceeds of that particular Bill of Exchange.

• This advances is against foreign bill covering bills of exchange, bills of lading, airway, bills of exchange etc

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Audit Procedure on FAPC & FAFB

• Take report of FAPC and FAFB and compare the expiry date with year end date. If the expiry date is before the year end date then classify the facility and report in the management letter both customer name and facility number along with the amount classified for provisioning. This facility is classified within 180 days of its lodgment.

• Also verify the total ledger balance with the Statement of Affair. If the balance does not match report in the management letter and inquire from the management.

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Finance Against Trust Receipt (FATR)

This facility is mostly extended to Selective Corporate customers against goods imported under a letter of credit. The consignment is cleared by the importers from customs, and stored under their controls in Trust for a period as approved by the Bank. Financing against Trust Receipt (FATR) by nature amounts to a “Hypothecation”, allowing customers to retain the goods in trust and sell or utilize the same and deposit corresponding value with the Bank simultaneously to settle their outstanding.

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Payment Against Documents (PAD)

Import documents received under Sight LCs are lodged in PAD, which are released on payment from the party. If the party fails to pay within 180 days of lodgment, the facility will be classified as loss.

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Finances Against Imported Merchandise (FIM)

Business organizations import variety of finished goods for own manufacturing. Consumption of some items might be slow , which hampers the importer’s liquidity quite often. To meet such eventualities and to cover their Liquidity gaps, the businessmen negotiate a financing facility with the Banks against pledge of the imported merchandise known as “FIM”. Banks are required to determine “Credit Cycle” for the facility, realistically assessing the period when the customer shall be able to dispose off the consignment and generate adequate Cash to settle outstanding under FIM. Facility under FIM is provided on “Pledge” basis. The Bank holds control over goods, through a middle person called “ Muccaddum”.

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Audit Procedures on PAD, FATR, FIM

Take the complete report of facility as at year end, and compare the maturity date with the year end date. If the maturity date falls before the year end date, then that facility needs to be classified to loss category as per the prescribed criteria of SBP. Facilities are to be settled within 180 days of their lodgment date. All outstanding facilities more than 180 days of their lodgment are classified in the loss category.

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TRADE LOANS UNDER FE 25 OF 1998

FE-25 is the Trade Loan facility for exporters and importers

Banks have been allowed to use/invest their deposits mobilized under FE 25 for financing of Import/Exports. Necessary guidelines by SBP on the subject are as under:-

1. Exports (For financing pre-shipment, discounting/purchase of documents)

a. Trade loan facility under FE 25 scheme is entirely on self-liquidating basis from export proceeds.

b. At the time of allowing the facility, the foreign exchange component of such facilities should be surrendered to an Authorized Dealer at the buying rate.

2. Imports (Financing against Import Bills)

a. The facility for imports can be allowed only from the date of actual execution of import payments in foreign currency by creating a foreign currency loan against the importer. The maximum period of such loans should not exceed six(6) months from the date of disbursement.

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Non-funded Facilities

Letter of Credit Letter of Guarantee Bank Guarantee

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Letter of CreditA Letter of Credit (LC) is one of the most widely used modes of settling

international trade debts. It is also convenient and common method of obtaining short term finances from the banks.

LCs are broadly classified as follows:

i) Sight Letters of Credit (DP) In case of Sight LC, the draft is drawn at sight and the relevant documents are held by the importing bank until retired (released) by the customers.

ii) Usance Letters of Credit (DA) In the case of Usance LCs, the draft is drawn for a certain period

(number of days) clearly mentioning in the LC, payable by the customer on due date.

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Bank Guarantee (BG)

A Bank Guarantee is a guarantee issued by a bank whereby the bank undertakes to pay the beneficiary the agreed sum, if the bank’s customer fails or defaults in fulfilling its obligations under the terms and conditions of the contract with the beneficiary. All Bank Guarantees must state the amount, purpose for which the guarantee is issued, specific expiry date and a specific claim period.

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Audit Procedure – LCs, LGs

• Inquire all LC’s and acceptances outstanding for more than one year.

• Ask management for the basis to keep these as contingencies and commitments.

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PRUDENTIAL REGULATIONS

Prudential Regulations

CORPORATE / COMMERCIAL

CONSUMER FINANCE

SMALL & MEDIUM

ENTERPRISES

AGRICULTURE FINANCE

Commercial loans in BOP

• CNG filling stations• Auto lease financing scheme.• Car Dealers• Karobar barhao scheme.• Fertilizer dealer financing scheme.• Ali akbar group franchise financing scheme.• Motorcycle dealer financing scheme.• Financing scheme for the purchase of shop/office.• Running Finance• Demand Finance• Cash finance• Women's Entrepreneur Finance Scheme.

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Corporate Loans• Working Capital Finance,• Long Term/Demand Finance.• Project Finance.• Letter of Credit, Contracts and Export collection services.• FE Loans, Pre and Post Shipment Export Financing etc.• Import Financing.• Bills Discounting.• Letter of Guarantees.• Cash Management Services• Syndications and Consortium Financing.

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Consumer / Retail Finance

• Asaish Loan

• Quick cash

• Car Lease

• House Loan

• Smart Cash Personal Loan

• Motorcycle Lease Scheme

• Caravan Fleet Financing

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Consumer Financing: is allowed to individuals for meeting their personal, family or household needs.

Categories of facilities under consumer financing are as follows:

– Credit cards: mean cards which allow a customer to make payments on credit (corporate cards does not fall in this category)

– Auto loans: means loan provided for the purchase of vehicles

– Housing Finance: loan availed for the purchase or improvement of residential house /apartment / land

– Personal loans: means loans to individuals for payment of goods, services and expenses

SMEsSmall Medium Enterprises: means a company (ideally not a public limited company), which fulfills following three conditions.

No. of Assets Excluding Net Employees Land & Building Sales

•Manufacturing/service concern Up to 250 Upton R.100 M Rs.300M

•Trading concern Upton 50 Upton R.50 M Rs.300M

Note:

An individual , if he or she meets the above criteria can also be categorized as SME.

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Potential errors and key risks inloans and advances

The assertions / potential errors which are addressed through our procedures at branch:

• Valuation• Completeness• Validity • Recording• Cut off

Following are the key risks that pertain to advances:

• Regulatory Risk- Non compliance of regulations of SBP while sanctioning the loans

• Valuation- Improper classification of advances which leads to under provisioning against impaired loan

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• Control Assurance Strategy – Maximum control assurance

– Internal control questionnaire

• Substantive Procedures

– Audit program– Legal Compliance checklist– Working paper templates (Confirmation control

summary and test of details)

Review of work papers and methodology for Lending cycle

Starting point for Advances

• In each branch, the first step is to obtain the credit portfolio (list of creditors) party wise and facility wise as at the balance sheet date from management.

• The portfolio is to be matched with the statement of affairs of each branch (branch trial balance)

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• In branches, we have to thoroughly study the financing agreement and account statement of each selected borrower to check that the following items are in accordance with the agreement:-

– Total amount disbursed is within the sanctioned limit.– Principal and interest is paid as per the agreed schedule.– The required documentation is complete and properly authenticated.

• We have to check existence and genuineness of the following documents:

– Facility offer letter (FOL) indicating all types of facilities provided to borrower and their sanction limit and agreed terms and conditions.

– Credit Information Bureau (CIB) report of the borrower, that might depict any default on account of the borrower or any of its group company(s). CIB report is available from the Credit Information Bureau of State Bank of Pakistan.

– For corporate borrowers only, the board resolution relating to the concerned loan.– Borrower’s Basic Fact Sheet (signed and stamped by the borrower) indicating

borrower’s particulars and borrower’s current status of funded and non funded facilities.

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Approach to audit of advances

• Verify 80% of regular portfolio of branch on subjective & objective basis and its compliance with Prudential Regulations.

• Verify 100% classified advances.

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Purpose of Credit Review Sheet

• It is the document which gives the complete detail for the selected

parties.

• To check the credit compliance (guidelines issued by SBP).

• It is a tool which gives the reviewer a complete picture of the party.

• It requires the branch manager to comment on the classification

proposed by us.

Extent of Verification

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The Bank of PunjabBranch Name__________________Audit for the year ended December 31, 2012Extent of verification of advances

- - - - - - - - - - - - -

Regular Portfolio - Verified- - - - - - - -

Regular Portfolio - As per Branch

Regular Portfolio - Extent Verified 0% 0% 0% 0% 0% 0% 0% 0.00%

Classified Portfolio - Verified

Classified Portfolio - As per Branch

Classified Portfolio - Extent Verified 0% 0% 0% 0% 0% 0% 0% 0%

Total Portfolio - Verified - - - - - - - -

Total Porfolio - As per Branch - - - - - - - -

Total Porfolio - Extent Verified 0% 0% 0% 0% 0% 0% 0% 0%

Running Finance/Cash

FinanceDemand Finance Export refinance FIM

Payment Against Documents

Own Acceptance

Payment

S.No. Borrowers Ref.

---------------------------------------------------------- OUTSTANDING BALANCES AS AT December, 2012 -----------------------------------------------------------Funded Facilities

--------------------------------------------------------------------------------------- Rupees in 000 ---------------------------------------------------------------------------------------

TOD Total Funded

CLASSIFIED PORTFOLIO

TOTAL PORTFOLIO

REGULAR PORTFOLIO

General Considerations

• If one party is select for one advance or facility, then all the facilities should be verified availed by the party.

• Each and every field is required to be filled, or write sufficient explanation for fields not completely filled.

• All sheets are to be signed-off by the respective branch seniors.

• Cross refer the sheets where marked.• Attach the working of markup calculation and trace few

receipts in bank statements along with receipts of principal.

• For each exception, refer to ICM

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CHECK LIST FOR DOCUMENTS TO BE REVIEWED

DOCUMENTS Compliance Y/NValue

(if applicable)Date of CA

Date of documents (Should be date prior to CA in most cases)

Authorization

Common Documentation for All FacilitiesCredit Approval (Latest)Facility Offer Letter (latest)Disbursement Authorization CertificateFinancing Agreement (F-65)Demand Promissory Note (F-49)Letter of Arrangements (F-48)Letter of AuthoritySBP UndertakingLegal Opinion on Documentation (Mention name)Personal Guarantees (F-68): (Mention Guarantor’s name)Running FinanceLetter of Hypothecation (F-54)Memorandum of Deposit of Title DeedsLetter of Continuity (F-53)Letter of Lien (F-57 & 58) Agreement for Sale & Buy back of Marketable SecuritiesEvidence of noting mutation of Bank’s Mortgage charge in concerned Revenue RecordUndertaking signed by the borrower that Dividend warrant, bonus shares or other benefits shall be passed over to the BankCash FinanceLetter of Pledge (F-56)Letter of Continuity (F-53)Demand FinanceLetter of Installments (F-55)Evidence of noting mutation of Bank’s Mortgage charge in concerned Revenue RecordRegistered Mortgage Deed.

In case of Equitable Mortgage:Title Deed of PropertyNon-Encumbrance CertificateIrrevocable General Power of AttorneyMemorandum of Deposit of Title DeedsNOC issued to other banks (if any)

Documentation for Commercial LeaseAsset Lease Agreement Signed By:

§ Borrower § Authorized Representative of Bank

§ Two other 3 rd party witnessesApplication for the Creation of Charge Signed and stamped by:

Branch Manager Certificate of Creation of Charge

Signed and stamped by:§ Branch Manager

Others (Specify)

In case of Companies: Board ResolutionSearch ReportCertificate of Registration Of Mortgages and chargesCopy of ID card of authorized signatories and specimen signaturesMemorandum & Articles of Association(Especially for borrowing powers, power to charge its assets, issuance of guarantee etc)

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THE BANK OF PUNJABMAIN BRANCHAUDIT FOR THE YEAR ENDED DECEMBER 31, 2012BORROWER'S NAME / GROUP NAMELEGAL STATUS: BUSINESS:

BREIF DESCRIPTION

FUND BASED EXPOSURE Rupees in '000

As per Bank

Return

As per MYASCo

PRINCIPAL MARK-UP TOTAL

Total Funded Exposure - - -

NON - FUND BASED EXPOSURE Rupees in '000

As per Bank

Return

As per MYASCo

Total Non - Funded Exposure - - -

Grand Total - - -

Compliance of Exposure Limits (PR-1)

% Amount (Rs. ‘000)

Single Borrower

Total (Funded and

Non Funded)

30 % of Bank’s equity

1,653,586

Funded 20 % of

Bank’s equity1.102,391

Group

Total (Funded and

Non Funded)

30 % of Bank’s equity

2,480,379

Funded25 % of

Bank’s equity1,929,184

Equity of the bank as per audited accounts as at 31 December 2008 is Rs. 5,511,953 (‘000’)If the exposure is above than the prescribed limits as mentioned above, check the exposure as per annexure I of the PR for corporate and commercial banking.

BorrowerNature of Exposure

Maximum Limit as per PR-1Compliance Excess

NATURE OF FACILITY

CLASSIFICATION

OUTSTANDING AS AT DECEMBER 31, 2012

NATURE OF FACILITY

CLASSIFICATION OUTSTANDING AS AT

DECEMBER 31, 2012

COMMISSION INCOME

TOTAL

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*THE BANK OF PUNJABBRANCH NAME:VERIFICATION SHEET OF LOAN / ADVANCEFOR EACH CLASS OF LOAN OF EACH BORROWERYEAR ENDED: DECEMBER 31, 2012

Borrower Date of Disbursement

Nature of Finance Term of Repayment

Approval WP Ref:

(i) Number Grace Period

(ii) Date Rate of Markup/Interest

(iii) Limit

Last Payment Principal Markup Principal

(iv) Expiry date (i) Due on

(ii) Received on date

(v) Reschedule (iii) Amount

(iv) Overdue days

(vi) Nature of Security

Date Amount Rs. Amount Rs. Period Bank Amount Rs. Period

Approved By

(Checked as per Limits)

1 2 3 4=1+2+3 5 6 7 8=1-7 9 10 11

Job Incharge Conclusion (on the basis of evaluation tick whichever is applicable)

SatisfactoryDoubtful of

recoverySecurity Shortfall Excess over limit

Defective Documentation

Defaults in CIBIrregular

RepaymentsNegative Financial

Indications

Substandard 90 days 25%

Doubtful 180 days 50% If not satisfactory:

Loss 1 year 100% Branch Manager's Comments:

Trade Bills 180 days 100%

Dec 31,

2012

* NOTE: Banks have to determine the margin over KIBOR at transaction date; however, once the margin is agreed with the customer, bank should not increase it, during the tenor of the loan. For additional consideration please see attached annexure-Note 1.

Category of ClassificationInstalment

Overdue By

Provision of Principal less

value of securities

Short / (Excess)

OUTSTANDING BALANCE CLASSIFICATION

Value of Securities

(A)

Principal Less value of Security

SPECIFIC PROVISION FOR PRINCIPAL

Principal

Markup/ interest

(receivable Account)

Markup/ interest

(Suspense Account)

TotalAs Per Bank

ReturnRecommended by DTTL

As Per Bank Return

As Per DTTL

Regular Loan Rs. Overdue Loan Group default Loan

As per Original Sanction As per Rescheduling Approval

------- 30-Sept-2012 ------- ------- 31-Dec-2012 ------

CIB Report

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The Bank of PunjabBranch Name:Annual Audit or the Year ended December 31, 2012 Prepared by:Test of Details on Letter of Credit Reviewed by:

Rupees in '000

S. No. Type of L/C L/C No. L/C AmountNature of Letter of

Credit

Date of opening

Checked Approval of L/C

Checked entry in LC

register

Amount of margin withheld

Amount of Commission

Commission is as per Schedule

of Charges

1

IMPO

RT L/C

s

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The Bank of PunjabBranch Name: Annual audit for the year ended December 31, 2012 Prepared by:Test of Detail on Letter of Guarantee Reviewed by:

Rupees in '000

S. No.Type of

L/GL/G No.

Amount of LG

Date of Opening

Checked Approval of

L/G

Checked entry in LG

Register

Checked Guarantees are within customer

approved credit limits (as per sanction

advice)

Amount of Margin

Withheld Commission

Ensure that margin is released on

expiry /cancellation of

Guarantees

1

2 Inlan

d L/G

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Name:

Year:

WP Reference #

30-June-2012(Audited)

30-June-2011(Audited)

Revenue (a) - G.P. (b) -

Profit / (Loss) after Tax (c)

Shareholders equity (excluding revaluation reserves) (d)Retained Earnings / (losses) (e)Revaluation Reserves (for last three years only) * (f) - - Sub-ordinated Loans (Loans from directors/ associates) (g) - Total Equity of Borrowers (h = d + e + f + g) - -

Long-term Debt & Finance Lease liability (i)Add: Current maturities - Total long term liabilities (k = i + j) - - Short-term borrowings (l)Total fund based exposure (m = k + l) - -

Debt to equity ratio (n = k / k + h) #DIV/0! #DIV/0!Current Assets (o)Current Liabilities (p)Current Ratio (q = o / p) #DIV/0! #DIV/0!Current Assets less inventories, spares and prepayments (r)Quick ratio (s = r / p) #DIV/0! #DIV/0!

EBITDA (t) 2,685 3,304 Finance Costs (u)Interest Cover (v) #DIV/0! #DIV/0!

Cash Flows: (not in PRs needed to be checked whether it is included in bank’s credit policy)Cash Flow from Operating Activities:Cash Flow from Investing Activities:Cash Flow from financing Activities: Net Cash Inflow / Outflow:

CONTINGENCIES:

Borrowings from Banks / Financial Institutions - Fund Based exposure (w = m) - - - Non-fund based (commitments) (x) Total Borrowings (y = w + x) - - Ten Times of Equity (z = h x 10) - - Cushion / (Excess) ( z – y ) - - Four times of equity (aa = h x 4) - - Cushion / (Excess) (aa – w) - -

i. Name of Auditors:ii.Auditor’s Opinion: Clean / Modified / Going Concern inappropriate?iii.Brief Description of Modification, if any:

COMMENTS:

RUPEES IN ‘000’

Ideal interest cover is 3 times. One or lower cover is not a healthy sign, it should be discussed with Credit Manger and reported to management letter if not justified.

If cash flow from operating / investing activities is negative, discuss the matter with credit manger and report the same in ML if satisfactory explanation is not provided.

54

The Bank of PunjabMain BranchSecurity Review ChecklistAudit for the year ended December 31, 2012

Pledge of Shares / Securities:

1. Amount of securities as per Credit Approval : Rs. ………………………………………………Gurantee???

2. Value as at December 31, 2012:

Y/N Y/N

Total (A)Less: Margin (R-6)30 % of the value calculated above in case of shares10% if TFCs are rated A or above20% if TFCs are rated A- and BBB Drawing Power

Yes No

Only shares in CDC are considered as security.

3. Value during the period:

A B C D E=(C-D)Example: Monthly 31-Jan-12 1M 1.5 M (0.5M) Y

4. Physical Verification:

Any difference as per records CDC statement: __________________

Are the CDC statements showing “pledge” status of these shares? Y/N

REGISTERED / EQUITABLE MORTGAGE/PARI-PASSSU CHARGE:

Description & Location of Property (Only Residential, Industrial and Commercial Property, will not include Agricultural Land and Property)

Property Location1234

(Rs.)

The bank has to monitor margin on at least weekly basis and will take appropriate action for top-up or sell-out on the basis of their board of directors approved credit policy and pre written authorization from the borrower

Compliance

Frequency of receipt of shareholding reports (Usually

monthly reports)

Date of Report (Usually each month end Fill the column for

whole year )

Market Value of Shares

Outstanding Principal at the

date of report of shareholding

(Shortfall)/ExcessShortfall

reported to ML

Description

Shares kept in CDC

Shares / Securities Issued by Listed Quantity Closing Rate Market Value

55

Rupees in '000A. Liquid Securities WP Reference Yes / No Date

- Bank deposits - A. PRIMARY SECURITIES

- Deposit certificates - Original Deposit certificates- Government securities - Share certificates / Government Securities- Shares of listed companies - Letter of pledge / Lien (IB-26)- NIT units - Stock Report (in case of pledge)- Mutual fund certificates - - Inventories pledged to the B. SECONDRY SECURITIES

bank with perfected lien - Primary Documents

- Bank Guarantees from Legal Opinion Bank - Sale/Conveyance/Gift Deed

Less: Margin (R-6) in case of pledge of shares Lease Deed30 % of the value calculated above in case of shares Search Certificate / NEC10 % if TFCs are rated A or above Mortgage Deed20 % if TFCs are rated A- and BBB Permission to MortgageDrawing power Power of Attorney

Total liquid securities Valuation Report By An Approved ValuerIn case of Equitable Mortgage

Memorandum of Deposit of Title Deed (IB-24)In case of Registered Mortgage

B. Primary Securities Registered Mortgaged Deed (IB-22)Pledge In case of Charge on Fixed Assets of Companies

Hypothecation Charge Registration CertificateOthers ________________ - Total Primary securities -

C. Collateral Securities

__________________ - __________________ - Total Collateral Securities -

Total ( A + B + C ) -

Secondary documentsPropotionate Share in Syndicate Security Articles of Asociation / Memorandum of Association

Hypothecation AgreementTotal syndicate loan amount Mutation Letter (Transfer)Loan share of BOP Approved Construction Plan

Property tax challanTotal value of charge 0 Stock Report (in case of hypo stock)

Insurance Cover - PledgeShare of BOP in security #DIV/0! Insurance Cover - Hypothecation

Charge Forms

Demand Promissory Note (IB-12)Markup Agreement (IB-6)Personal Guarantee (IB-29)

TOTAL VALUE OF SECURITIES SECURITIES DOCUMENTS CHECKLIST

Remarks

56

Yes/ No/ N/A Remarks

A PRUDENTIAL REGULATIONS REGARDING EXPOSURE

R4Exception – Export finance scheme shall be exempt from per party limit.

R1

R1

Check that where the equity of a borrower is negative and the borrower has injected fresh equity during its current accounting year, it will be eligible to obtain finance up to 3 times of the fresh injected equity provided the borrower shall plough back at least 80% of the net profit each year until such time that it is able to borrow without this relaxation.

R5

5. Ensure that total exposure (both funded and non-funded) does not exceeds with 10 times of total equity of borrower subject to fund based exposure not exceeding 4 times of borrower's equity as disclosed in financial statements.

R5

6.

a). Practicing Chartered Accountant, relating to the business of every borrower who is a limited company or where the exposure of a bank exceeds Rs 10 million, for analysis and record.

R3

b). Accept a copy of financial statements duly audited by a practicing Cost and Management Accountant in case of a borrower other than a public company or a private company which is a subsidiary of a public company.

R3

c). Financial statements signed by the borrower will suffice where the exposure is fully secured by liquid assets.

R3

d). If the borrower is a public limited company and exposure exceeds Rs. 500 million, banks/DFIs should obtain the financial statements duly audited by a firm of Chartered Accountants which has received satisfactory rating under the Quality Control Review (QCR) Program of the Institute of Chartered Accountants of Pakistan.

R3

R3

R3

B. SPECIFIC PROVISION OF PRINCIPAL

1.

C. INTEREST / MARKUP

1. Ensure that rates of interest / markup are in accordance with the loan agreements.

Ensure that only those liquid assets are deducted from the outstanding balance of principal for calculation of specific provision which are readily convertible into cash without recourse to the court of law under perfected lien with bank duly supported with flawless documents.

8 Check that CIB report obtained while considering proposals for taking any exposure exceeding Rs.500,000 after netting off the liquid assets held by bank as security.

4.

Check that the Bank may obtain a copy of financial statements from borrower as under:-

7. Banks shall not approve and / or provide any exposure (including renewal, enhancement and rescheduling / restructuring) until and unless the Loan Application Form (LAF) prescribed by the banks is accompanied by a ‘Borrower’s Basic Fact Sheet’ under the seal and signature of the borrower.

2. Check that total outstanding fund and non fund based exposure to single person shall not exceed 30% of bank equity provided maximum outstanding fund based exposure does not exceed 20% of bank equity subject to conditions.

3. Check that total outstanding fund and non fund based exposure to group shall not exceed 30% of bank equity provided maximum outstanding fund based exposure does not exceed 25% of bank equity subject to conditions.

THE BANK OF PUNJABANNUAL AUDIT FOR THE YEAR ENDED DECEMBER 31, 2012

BRANCH……………………PRUDENTIAL REGULATIONS REVIEW CHECLKLIST

1. Check that Bank does not provide unsecured advance above Rs.500,000/- to any single borrower.

Documents to be Reviewed

57

Approval Limits per party for all facilities (Funded & None Funded)

Approval Limits

(million)

1 Country Credit Committee

Committee will comprise of following ExecutivesChairman:

President of the Bank shall be the Chairman of the Committee.

Members:a. Deputy Chief Executive Officerb. Chief Risk Officer (CRMD)c. Country Corporate Head (C&IBG)

Term of Reference:

Approval/restructuring/reschedule all types of finances over and above. 350

2 Corporate Banking Credit Committee

Committee will comprise of followingExecutivesChairman:

Deputy Chief Executive OfficerMembers:

a. Chief Risk Officer (CRMD)b. Country Corporate Head (C&IBG)

Term of Reference:

Approval/restructuring/reschedule all types of finances from 150 to 350

3 Corporate Banking Credit Committee-Regional

Committee will comprise of following ExecutivesChairman:

Deputy Chief Executive OfficerMembers:

a. Regional Corporate Headb. Representative of the Credit Risk Management

Term of Reference:Approval/restructuring/reschedule all types of finances up to 150

Approval Limits Complied Yes----------------------

No-----------------------

STRUCTURE

The following Committees will invariably consider every aspect of lending business within jurisdiction/amount defined including but not restricted to approvals, restructuring, waivers and approval for suit filing.

58

Important definition of PR-CorporateExposures

means financing facilities whether fund based and / or non fund based and include:

• Any form of financing facility extended or bills purchased/ discounted except ones drawn against the L/Cs of banks rated at least ‘A’ by credit rating agency on the approved panel of State Bank of Pakistan and duly accepted by such L/C issuing banks;

• Any financing facility extended or bills purchased/ discounted on the guarantee of the person;

• Subscription to or investment in – shares, – Participation Term Certificates, – Term Finance Certificates or – any other Commercial Paper by whatever name called (at book value) issued or

guaranteed by the persons;• Credit facilities extended through corporate cards;• Any financing obligation undertaken on behalf of the person under a letter

of credit;• Loan repayment financial guarantees;• Any obligations undertaken on behalf of the person under any other

guarantees including underwriting commitments;• Acceptance/endorsements made on account;• Any other liability assumed on behalf of the client to advance funds

pursuant to a contractual commitment.

59

Equity of bank

Means tier-I capital or core capital and includes

• paid-up capital,• general reserves * ,• balance in share premium account,• reserve for issue of bonus shares,• retained earnings / accumulated losses as disclosed in

latest annual audited financial statements.

* Reserve shall include revaluation reserve on account of fixed assets to the extent of 50% of their value.

60

Equity of borrowerincludes

• paid-up capital,

• general reserves,

• balance in share premium account,

• reserve for issue of bonus shares and retained earnings / accumulated losses,

• revaluation reserves on account of fixed assets *,

• subordinated loans and

• Preference shares.

* ‘Revaluation reserves will be part of equity for first three years only from the date of revaluation’

61

Liquid assets

• assets which are which are readily convertible into cash without recourse to a court of law

• mean encashment / realizable value of government securities, bank deposits, certificates of deposit, shares of listed companies which are actively traded on the stock exchange, NIT Units, certificates of mutual funds, Certificates of Investment (COIs) issued by DFIs / NBFCs rated at least ‘A’ by a credit rating agency on the approved panel of State Bank of Pakistan

• Listed TFCs rated at least ‘A’ by a credit rating agency on the approved panel of State Bank of Pakistan; and

• Certificates of asset management companies for which there is a book maker quoting daily offer and bid rates and there is active secondary market trading.

• These assets with appropriate margins should be in possession of the banks / DFIs with perfected lien.

• Guarantees issued by domestic banks / DFIs when received as collateral by banks / DFIs will be treated at par with liquid assets

• The inter-branch indemnity / guarantee issued by the bank’s overseas branch in favor of its sister branch in Pakistan, would also be treated at par with liquid assets

62

Important Regulation on PR

Regulation-1 Limit on exposure to single person

• Total (funded and non-funded) exposure of up to 30% of the bank’s equity,

• Fund based exposure of up to maximum of 20% of the bank’s equity.

Regulation-1 Limit on exposure to group

• Total (funded and non-funded) exposure of up to 45% of the bank’s equity to the group,

• Fund based exposure of up to maximum of 35% of the bank’s equity to the group.

63

Effective date

Exposure limit as a % of bank’s/ DFI’s equity (as disclosed in thelatest audited financial statements)

For single person For group

Total outstanding (fund and non-

fund based) exposure limit

Fund based outstanding limit

Total outstanding (fund and non-

fund based) exposure limit

Fund based outstanding limit

31-12-2009 30 20 45 35

31-12-2010 30 20 40 35

31-12-2011 30 20 35 30

31-12-2012 30 20 30 25

31-12-2013 25 25 25 25

REGULATION R-1LIMIT ON EXPOSURE TO A SINGLE PERSON/GROUP

64

For the purpose of calculating exposure limit banks/DFI’s are required to follow these guidelines.

A) 100% of the deposits placed with lending bank / DFI, under perfected lien and in the same currency, as that of the loan, shall be excluded.

B) 90% of the following shall be deducted; (i) deposits placed with the lending bank/DFI, under perfected lien, in a currency other than that of the loan; (ii) deposits with another bank / DFI under perfected lien; (iii) encashment value of FIBs, PIBs, Treasury Bills and National Saving Scheme

securities, lodged by the borrower as collateral; and (iv) Pak. Rupee equivalent of face value of Special US Dollar Bonds converted at inter-bank rate, lodged by the borrower as collateral.

C) 85% of the unconditional financial guarantees accepted as collateral and payable on demand by banks / DFIs, rated at least ‘A’ or equivalent by a credit rating agency on the approved panel of SBP.

D) 50% of listed TFCs held as security with duly marked lien shall be deducted. The TFCs to qualify for this purpose should have been rated at least ‘A’ or equivalent by a credit rating agency on the approved panel of SBP.

E) Weight age of 50% shall be given to; (i) documentary credits (except Standby Letter of Credits where 100% exposure would be counted) opened by banks / DFIs; (ii) guarantees / bonds other than financial guarantees; (iii) underwriting commitments.

65

For the purpose of calculating exposure limit, following should not be included:

• Loans and advances (including bills purchased and discounted) given to the Federal Government.

• Obligations under LCs and LGs to the extent of cash margin held by the bank / DFI.

• LCs opened on behalf of Federal Government where payment is guaranteed by SBP / Federal Government.

• Facilities provided to commercial banks / DFIs through REPO transactions with underlying Statutory Liquidity Requirements (SLR) eligible securities.

• Pre-shipment / post-shipment credit provided to finance exports of goods covered by LCs / firm contracts including financing provided from the bank’s / DFI’s own resources.

• Letters of credit established for the import of plant and machinery.

66

Regulation-3 Minimum conditions for taking exposure

For taking exposure against regular parties

Obtain Credit Information Bureau (CIB) report while considering proposals for taking any exposure exceeding Rs.500,000 after netting off the liquid assets held by bank as security

For taking exposure against defaulters

Banks may take exposure on defaulters keeping in view their;

Risk management policies and Criteria.

The bank should properly record reasons and justifications in the approval form.

67

Regulation-4 Limit on exposure againstunsecured financing facilities

Per party limit for clean financing

• Clean facilitiesAll facilities without any securities and against personal guarantees.

• LimitClean facilities provided to any one person shall not exceed Rs.500,000.

• Condition for granting clean facilitiesAt the time of granting a clean facility, banks shall obtain a written declaration

68

Following shall be excluded / exempted from the per party limit of Rs.500,000 on clean facilities:

• Facilities provided to finance the export of commodities eligible under Export Finance Scheme.

• Financing covered by the guarantee of Pakistan Export Finance Guarantee Agency.

• Loans / advances given to the employees of the banks / DFIs in accordance with their entitlement / staff loan policy.

• Investment in COIs / inter bank placements with NBFCs, provided the investee NBFC is rated ‘A+’, ‘A’ or ‘A-’ for long-term rating and at least ‘A2’ for short-term rating or equivalent by a credit rating agency on the approved panel of the State Bank of Pakistan

69

Requirements as to obtain/file Financial Statements

The bank should obtain a copy of Financial Statements duly audited by:

• a practicing Chartered Accountant in the following cases

• A limited Company and / or • Where the exposure of the bank exceeds Rs.10m.

• a practicing Cost and Management Accountant in case of:

• a borrower other than a public company or • a private company which is a subsidiary of a public company

• This condition may be waive where exposure net off liquid assets does not exceed Rs.10 million.

• Financial statement signed by the borrower will suffice where exposure is fully secured by liquid assets.

70

Regulation-5 Linkage Between Financial Indicators of the Borrower and total exposurefrom Financial Institutions

Limit on exposure of the borrower

• Where the equity of the borrower is positive

• Total exposure 10 times of borrower’s equity• Fund based exposure 4 times of the borrower’s equity.

• Where the equity of the borrower is negative and he has injected fresh equity during current year;

• Not exceeding 3 times of the fresh injected equity.Provided the borrower shall plough back (not to distribute to the members) at least 80% of the net profit each year.

71

Exceptions

Banks may allow seasonal financing to borrowers, for a maximum period of six months;

• Fund based exposure does not exceed 8 times• Total exposure does not exceed 12 times of borrower’s equity

NBFC

• Fund based exposure does not exceed 4 times• Total exposure does not exceed 10 times of borrower’s equity.

Current Ratio of Borrower

Fresh exposure or enhancement in the running exposure or renewal of the existing exposure, current ratio of the borrower shall not be lower than 1:1.

Relaxation in the current ratio of Borrower

Banks may relax this ratio upto 0.75:1

72

Regulation-8. Classification and provisioning for assets loans / advancesClassification of asset portfolio and provisioning thereagainst – Time Based CriteriaClassification Determinant Treatment of

Income Provision to be

made on principal net off

liquid securities and *

40% of FSV

1.Sub –standard

Mark up/interest or Principal amount overdue by 90 days or more from the due date.

As above. Provision of 25%.

2. Doubtful Mark up/interest or Principal amount overdue by 180 days or more from the due date.

As above. Provision of 50%.

3. Loss a. Where mark-up/ interest or Principal is overdue beyond one year or more from the due date.b. Where Trade Bills (Import/ Export or Inland Bills) are not paid/ adjusted within 180 days of the due date.

As above. Provision of 100%.

Exemptions from classification of assets portfolio and provisioning their againstClassified loans / advances that have been guaranteed by the Government, however, markup / interest on such accounts shall be taken to suspense account instead of income account

73

* Forced Sales Value (FSV)• FSV means value which can currently be obtained by selling the

mortgaged / pledged assets in a forced / distressed sale conditions.

• Banks are allowed to take the benefit of 40% of FSV of pledged stocks, mortgaged commercial and residential properties and industrial land and buildings held as collateral against all NPLs for three years from the date of classification for calculating provisioning requirement.

• The FSV benefit shall be available only on liquid assets, pledged stock, residential & commercial property and industrial land and buildings having registered or equitable mortgage and/or having pari-passu charge shall be considered on proportionate basis of outstanding amount.

• Exceptions: Hypothecated assets, plant and machinery or assets with second charge shall not be available for benefit.

74

Subjective Basis

In this case classification is made after considering the following factors:

• Creditworthiness of the borrower is not sound (For e.g. CIB report shows overdue)

• Borrower has cash flow problems.• Very nominal movement in account especially in respect of cash deposit.• Security is not adequate.• Documentation of security is incomplete / defective.• Borrowers current ratio is less than 1:1 (in exceptional cases banks may

accept the current ratio 0.75:1)• Personal Guarantee of directors duly approved by their BOD of private

limited company has not obtained.• Facility provided Excess or over the limit.

Note Post mortgage legal opinion: Post mortgage legal opinion is the opinion after creation of effective

mortgage.

Pre mortgage legal opinion: Pre mortgage legal opinion is the opinion that effective mortgage can be

created. Ensure that legal documentation mentioned by advocate has been obtained by branch.

Banks generally maintain a margin (cushion) between the sale value of securities and the amount disbursed against these. For example, if a bank has the policy of keeping 40% margin against fixed properties, then for a property with value of Rs 100 million, the maximum allowable funding would be Rs 60 million (100 million – 40% of 100 million). This is called the Drawing Power margin.

Banks may accept any types of assets belonging to a borrower as a security for funding. It depends upon factors such as liquidity, perish ability, nature and amount of funding, banks own policy etc. Common types of assets accepted as security are: -

– Highly liquid assets such as Defense Saving Certificates, National Saving Certificates, Fixed Deposit Receipts, Stock exchange shares and securities etc.

– Movable personal and family assets of the borrowers e.g. jewellery, ornaments etc.

– WIP stocks, finished goods, raw material stocks etc.– Residential, commercial or industrial land and/or buildings, houses, shops,

factories etc. etc.Assets offered as security for bank funding are mostly mutated by bank officials so as to avoid any subsequent fraudulent activity by the borrowers. Appropriate charges are created on these assets and where relevant, these charges are registered with the registrar of joint stock companies as per the guidelines given in the Companies’ Ordinance, 1984.

75

Types of Secutities

Various types of securities are: - Hypothecation

A charge created on movable assets without transfer of physical possession. Generally created on current assets, including but not limited to stocks and receivables.

Pledge A charge created on movable assets involving transfer of physical

possession from the borrower to the lender. Also created mostly on current assets, including stocks.

MortgageEquitable mortgage – Two steps are involved:-The borrower deposits the title deeds of property with the bank.A document called “Memorandum of Deposit of Title Deeds” is

executed.Registered mortgageA proper mortgage deed is executed. The property is mortgaged in

the name of the bank in government records. Personal Guarantees of Promoters/Directors/Corporate Guarantee Financial Guarantee (A guarantee for performance by another bank) Cash Margin (Up to a certain percentage of total funding e.g. 10% - 25%)

76

• The charges may be created on any of the following basis: -– First exclusive charge (In the event of liquidation of borrower, if the total

assets fall short of total liabilities, the bank will have First right over assets without any sharing with any other lender).

– Joint pari-passu charge (In the event of liquidation of borrower, if the total assets fall short of total liabilities, the bank will have Equal right over assets without any sharing with any other lender).

– Second Charge (As the name implies, in the event of liquidation of borrower, if the total assets fall short of total liabilities, the bank will have a Secondary right over assets after the lenders with first charges are paid).

77

78

Exercise 1

Classification of loans on objective basis

• Period end: December 31, 2012• Nature of facility: Demand finance• Principal outstanding: 25,000,000• Accrued markup: 250,000• Markup due on: September 9, 2012• Markup is still outstanding at December 31, 2012• Value of liquid assets 10,000,000• Value of mortgaged asset 30,000,000

Required

Does this party need to be classified as per the requirement ofPR and if yes then calculate the amount of provision?

79

Solution

Markup is overdue by 90 days, so as per Annexure IV of Prudential Regulation Corporate/ Commercial Banking it should be classified as “Sub-standard”.

Provision to bookedPrincipal 25,000,000Value of liquid asset <10,000,000>FSV of mortgaged asset <12,000,000>

3,000,000

Provision requirement 25%Provision 750,000

Note:Markup accrued will be taken into suspense a/c.

80

Exercise 2

Classification of loans on objective basis

• Period end: December 31, 2012• Nature of facility: Running finance• Principal outstanding: 15,000,000• Accrued markup: 1,200,000• Sanction expired June 30, 2012• Not renewed by Head office• Value of liquid assets 8,000,000• Value of mortgaged asset 17,000,000

Required

Does this party need to be classified as per the requirement of PR?

81

Solution

• Markup is overdue by 180 days, so as per Annexure IV of Prudential Regulation Corporate/ Commercial Banking it should be classified as “Doubtful”.

• Provision to booked• Principal 15,000,000• Value of liquid asset <8,000,000>• FSV of mortgaged asset <6,800,000> 200,000

• Provision requirement 50%• Provision 100,000

Note:

• Markup accrued will be taken into suspense a/c.

82

Exercise 3

Classification of loans on Subjective basis

• Period end: December 31, 2012• Nature of facility: Running finance• Principal outstanding: 10,000,000• Current ratio 0.5:1• Auditor’s opinion: Going Concern issue• Accumulated losses 21,500,000 • Operating cash flow Negative• CIB report Overdue balance 6 months

Note: Payment of markup and Principal is due on March 30, 2013

Required

Does this party needs to be classified as per the requirementof PR?

83

Solution

The repayment of markup & Principal is due in march 2013, so there is no overdue balance, therefore the party cannot be classified on objective basis.

However, considering the CIB report, there is also going concern issue and weak financial position as indicated in the borrower’s financial statement, therefore we should propose classification on “Subjective basis” at least “sub standard”.

84

Exercise 4

Classification of loans on Subjective basis• Period end: December 31, 2012• Nature of facility: Cash finance & Running finance• Principal outstanding: CF - 500,000,000

RF - 100,000,000• Current ratio: 0.5:1• Auditor’s opinion: Going Concern issue• Security: 700,000,000 • Loan disbursement date: November 15, 2012• Loan sanction: Loan was declined by BOD

subsequent to the approval of President.

Note1: The loan was disbursed on the approval of President of the

bank as the limit of finance was within the sanctioning power of the President.

2: Branch has made no further disbursements once the sanction of facility was declined by BOD.

RequiredDoes this party need to be classified as per the requirement of PR?

85

Solution

On the basis of subjective criteria in PR, we should classify all the facilities of this borrower as at least “Sub-standard”.

86

The rescheduling / restructuring ofnon-performing loans

Restructuring:

When an advance is restructured, the following concessions / remissions are considered:Reduction in rate of mark up;

Capitalization of accrued mark-up/ liquidated damages; and Part of the loan Principal may be written-off as a very special case only where circumstances warrant.

Rescheduling

Refers to the extension in the date(s) of payment of the installment(s) due to various reasons including late commencement of commercial production or teething problems faced by the project during trial run.

When an advance is rescheduled almost all general conditions remain unchanged except their repayment period which is extended for a certain period.

87

The rescheduling / restructuring of non-performing loans (Contd..)

Change in the status

Status of the Principal Amount

shall not change the status of classification of a loan / advance etc. unless; the terms and conditions of rescheduling/restructuring are fully met for a period of at least one year (excluding grace period, if any) from the date of such rescheduling/restructuring and at least 10% of the outstanding amount is recovered in cash.

Change in the status of the Unrealized mark up

The unrealized mark-up on such loans (declassified after rescheduling / restructuring) shall not be taken to income account unless at least 50% of the amount is realized in cash.

88

Exercise 5

If a bank has rescheduled / restructured a loan given to Company “A” having outstanding balance of Rs.1,000,000 which has the following revised repayment schedule.

Principal Rs.25,000 in every quarterInterest 10% of the outstanding balance

payable quarterly.

89

Status of the party

If a company has paid to the bank according to the given repayment schedule and followed other terms and conditions then the status of a loan will change after 1 year.

90

Exercise 6

If the repayment schedule in the above case is

Principal Rs.25,000 Semi annuallyInterest 10% of the outstanding

balance payable quarterly

91

Status of the party

Then the status of classification will change after 2 years because 10% of the outstanding will be collected in 2 years.

92

Reversal of Provision

In case of cash recovery, other than rescheduling / restructuring, banks may reverse specific provision held against classified assets;

Classified category Reversal of provision

In case of Loss account Reversal may be made to the extent that the remaining outstanding amount of the classified asset is covered by minimum 100% provision.

In case of Doubtful account reversal may be made to the extent that the remaining outstanding amount of the classified asset is covered byminimum 50% provision.

In case of Substandard account Reversal may be made to the extent that the remaining outstanding amount of the classified asset is covered by minimum 25% provision.

93

ExampleReversal of provision on cash recoveryPrincipal amount outstanding Rs.100 millionSecurity- liquid assets Rs. 10 millionParty classification DoubtfulMark-up in suspense account 5 millionNature of finance Demand financeProvision against the party 45 million

The party has repaid Rs. 10 million (5 million against the principal amount and 5 million against the mark-up amount.)

Reversal to be madeThe adjusted principal after cash recovery Rs. 95 millionProvision at the rate of 50% Rs. 42.5 millionImpact on the provision Provision is decreased

by Rs. 2.5 million that is50% of cash recoveryagainst principal

94

Exercise 7

Principal amount outstanding Rs. 300 millionNature of finance Demand FinanceSecurity-Liquid assets 100 millionSecurity-FSV of collateral 100 millionClassification LossMark-up in suspense Rs. 50 millionProvision Rs.100 million

Repayment by the borrower Rs.80 million (50 million against the mark-up and rest against the principal)

Calculate the reversal in provision amount ?

95

Solution on above exercise

Principal amount after recovery Rs.270 million

Less: Amount of liquid security Rs.100 millionLess: FSV benefit of collateral security Rs.100 million

Principal less liquid security & FSV Rs.70 million

Provision Rs. 70 million

Provision is decreased by Rs. 30 million (Full amount of principal recovery)

96

Exercise on filling the verification sheet on advances

Introduction

You have been sent to audit the branch of XYZ Bank where you have selected ABC party which is incorporated as Company with the SECP to do leasing business. While performing the credit review, you came to know that the branch has disbursed demand finance to a party amounting to Rs. 500 million on August 22, 2008. The sanction advice # ROI/CAD/2899 dated August 13, 2008 is approved by CAD. The terms and conditions mentioned in the sanction advice are as follows:

Nature of finance Demand financeLimit of principal Rs.500 millionGuarantee amount Rs.200 millionExpiry date 3 yearsNature of security 1st parri passu charge

on fixed assets of Rs.666.67 millionTerms of repayments 5 equal semi annual installmentsGrace period 6 monthsRate of mark-up *6 month’s KIBOR + 1%

97

Exercise on filling the verification sheet on advances (Contd..)

Other information

The last installment was received as per terms mentioned in the sanction advice on August 08, 2009. The branch classifies this party as regular because the party is paying as per terms agreed. Equity of the bank as per latest financial statements is Rs. 18 billion

– The six month’s KIBOR will be set on the date of first disbursement and subsequently on the first working day at the beginning of each semi annual period for the mark-up due at the end of the period. KIBOR rates are given as follows:

Date KIBOR rateAugust 22, 2008 11%February 22,2009 11.5%August 22, 2009 11.3%

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[CLIENT NAME] XYZ Bank Preparer :AABRANCH _____Write the name of branch______________________ Reviewer: MFSPERIOD ENDED: December 31, 2012

BORROWER'S NAME / GROUP NAME ABCLEGAL STATUS: CompanyBUSINESS: Leasing

FUND BASED EXPOSURE Rupees in thousands

As per Bank Return

As per Deloitte

No. of daysPRINCIPAL MARK-UP TOTAL PRINCIPAL MARK-UP August 10

Sep. 30Demand Finance Regular Regular 500,000 - 500,000 500,000 - October 31

November 30101

December 31132

Mark up rate 11.3%1.0%

Total Funded Exposure 500,000 0 500,000 500,000 - 12.3%

NON - FUND BASED EXPOSURE Rupees in thousands

Markup CalculationRupees in '000As per Bank Return

As per Deloitte

Loan OustandingAmount TOTAL Amount Markup

No. of days outstandingGuarantee Regular Regular 100,000 100,000 100,000

Markup Calculation

Total Non - Funded Exposure 100,000

Grand Total 600,000

For Single Party Exposure- 20% of the equity of the bank as disclosed in latest audited financial statements 3,600,000 - 30% of the equity of the bank as disclosed in latest audited financial statements 5,400,000

OUTSTANDING AS AT December 31, 2009

CLASSIFICATIONOUTSTANDING AS AT December 31,

2007NATURE OF

FACILITY

OUTSTANDING AS AT December 31, 2009

NATURE OF FACILITY

CLASSIFICATIONOUTSTANDING AS AT December 31,

2007

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Deposits

Deposits of money from customers may be accepted by a bank in any of the modes permitted by law which includes deposits on profit / loss sharing (PLS) basis, interest free deposits.

Different types of deposits

• Current deposit

• PLS deposit

• Call deposit

• Term deposit

• Notice deposit

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Certain provisions regulating customer operations include:

(a) All terms and conditions of operating an account should be conveyed to the account holder at the time of opening an account.

(b) Banks are free to determine their charges for various

services, but charges relating to exports are determined by the SBP.

(c) Banks are allowed to charge fee on PLS deposits.

(d) Banks are to get their own automated teller machines or get connected to a switch, operating in Pakistan.

(e) Banks shall not undertake any business of cash payments except at authorised places of business.

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Deposits – Key risk

• Tendency of branch management to override policies, procedures and local regulations to attract deposit holders who prefer to keep their identities undisclosed or involve in transactions having money laundering implications or wrongful activities.

• Attempt to deliberately manipulate the rate of return in fractions or effective days to avoid the interest cost on deposits.

• Identification and disclosure of Dormant and inoperative Accounts.

• Overstatement of deposit balances particularly at year-end.

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Review of work papers and methodology for deposit cycle

Control Assurance Strategy – Maximum control assurance

– Internal control questionnaire– Use of Control Matrix and Business cycle database

Substantive Procedures

– Audit program– Legal Compliance checklist– Working paper templates (Confirmation control summary

and test of details)

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Transparency in the banking sector is an ever-increasing concern of the regulators so as to insulate the banking system from being abused or used as a conduct for illicit activities and white collar crime. Towards this end, the SBP has issued due diligence requirements for KYC purposes and anti-money laundering in line with international best practices.

The salient features of this regime include:

(a) Banks are to ensure the true identity of the account holders and seek appropriate introduction on the integrity, respectability and nature of business etc. of the prospective customer.

(b) Banks are to be aware of money laundering crimes and should develop policies and procedure manuals to minimize this risk. High ethical standards should be adopted by banks and adequate training shall be given to all staff on these lines who should be made aware of their responsibilities.

ANTI-MONEY LAUNDERING AND KNOW YOUR CUSTOMER (KYC)

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(c) Banks should have clearly defined and comprehensive KYC policy for their borrowers and depositors duly approved by their BOD. Branches of foreign banks shall have such policy duly approved by their head office.

(d) There shall be in each bank a KYC compliance unit with a full time head, and a system of monitoring and MIS and a proper record of customer identification.

(e) Banks should be skeptical of cross-border transactions which appear to be out of character or apparently inconsistent with past history, trends and other characteristics.

ANTI-MONEY LAUNDERING AND KNOW YOUR CUSTOMER (KYC) (Contd..)

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ACCOUNT OPENING DOCUMENTATION

For Individuals:

• Attested photocopy of Computerized National Identity Card* (CNIC) or passport of the individual by a gazetted officer or an officer of the bank / DFI.

• Banks / DFIs shall ensure that the CNIC and the photograph are of the same person whose account is being opened with them.

• Particulars / CNIC of such persons must be confirmed from NADRA in writing or through its “VeriSys” system by the bank/ DFI.

• Bank should obtain a attested copy of his service card, or any other acceptable evidence of service, in case of salaried person.

• In case of illiterate person, a passport size photograph of the new account holder besides taking his right and left thumb impression on the specimen signature card.

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For Partnerships:

• Attested photocopy of identity card of all partners.• Attested copy of ‘Partnership Deed’ duly signed by all partners of the firm.• Attested copy of Registration Certificate with Registrar of Firms. In case

the partnership is unregistered, this fact should be clearly mentioned on the Account Opening Form.

• Authority letter, in original, in favor of the person authorized to operate on the account of the firm.

For Limited Companies:

Bank should obtain the certified copies of:• Resolution of Board of Directors for opening of account specifying the

person(s) authorized to operate the company account.• Memorandum and Articles of Association.• Certificate of Incorporation.• Certificate of Commencement of Business.• Attested photocopies of identity cards of all the directors.• List of Directors on Form 29 issued by the Registrar.• Financial Statement should be obtained at the time of opening of account.

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For Clubs, societies and associations:

• Certified copies of

(a) Certificate of Registration.

(b) By-laws/Rules & Regulations.• Resolution of the Governing Body/Executive Committee for opening of

account authorizing the person(s) to operate the account and attested copy of the identity card of the authorized person(s).

• An undertaking signed by all the authorized persons on behalf of the institution mentioning that when any change takes place in the persons authorized to operate on the account, the banker will be informed immediately.

For Agent Accounts:

• Certified copy of ‘Power of Attorney’.

• Attested photocopy of identity card of the agent.

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For Trust Accounts:

• Attested copy of Certificate of Registration.• Attested photocopy of identity cards of all the trustees.• Certified copy of ‘Instrument of Trust’.

For Executors and Administrator Accounts:

• Attested photocopy of identity cards of the Executor/Administrator.• Certified copy of Letter of Administration or Probate.

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General banking mainly comprises of the following items

• Bills payable

• Contra items (LC/LG)

• Head office a/c

General Banking

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Bills payables

An Outward / Inward Remittance is a fund transfer either in local or foreign currency which can be affected by way of:

Telegraphic Transfers

Transfer of funds from one branch to another branch of the same bank or other bank under special arrangements of the payment to the beneficiary through telex / swift / fax is called a telegraphic transfer.

Inter Branch Credit Advice (IBCAs)

These include the transfer of funds from one branch to another of the Bank under special arrangements of the payments to the beneficiary through fax is called Inter Branch Credit Advice (IBCA).

Demand Draft

Demand draft is a written order, drawn by one branch of a bank upon another branch of the same bank, or upon other bank (in both the cases the drawee branch should not be in the same city) under special arrangements to pay a certain sum of money to or to the order of a specified person.

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Contra Account

Letter of Credit

Written undertaking by a bank (issuing bank) given at the request and in accordance with the instructions of the buyer (the applicant) to the seller (the beneficiary) to effect payment up to a stated sum with in prescribed time limit, against stipulated documents and provider that the terms and conditions are complied with.

L/Cs can be categorized as: Sight L/Cs (SLC) Usance L/Cs (ULC)

Sight L/Cs

Sight L/Cs are Letters of Credit where the Bank engages to honour the beneficiary's sight draft upon presentation of documents

Usance Letters of Credit (ULC)

ULC are similar to sight L/Cs but call for a time or Usance draft payable after a specified period of time.

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Letter of Guarantees

These facilities cover a number of specific types of guarantees that the Bank may issue for its customers but in all cases the common factors are:

• The Bank substitutes its own credit standing for that of its customer,

• No actual movement of funds takes place at the time of issuing the guarantee although there is a clear commitment by the Bank to effect payment when called upon to do so under the terms of the particular guarantee. Thus it is necessary to record these commitments as contingent liabilities.

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Head office A/c

• Obtain reconciliation statement

• Ensure that outstanding entries are not outstanding more than 30 days.

• Make sure no entries of profit and loss are routed through this account.

• Ensure that suspense account was not misused by making payments without any consideration detrimental to the interest of the bank and also make sure that reconciliation and clearance is properly done in shortest possible time.

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Documents To Be Used For The Audit Of Branches

• Instructions

• Audit programs

• Std - Internal Control Memorandum (ICM)

• P.R. review checklist

• Deposit and advances control templates

• Analytical Sheets

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