Public Sector Bank Branch: A Government Guarantee, an Out-of-Order Cash Credit and an LFAR

Classification is driven by the record of recovery, not by the comfort the branch feels about a guarantee or a borrower's circumstances.

Account 1 - ₹18 crore textile term loan. Overdue by 130 days, i.e. beyond 90 days: it is a non-performing asset, sub-standard, from the date it crossed 90 days. The state government guarantee does not suspend classification; the branch's reasoning is incorrect and should be an audit objection. The guarantee affects provisioning only, and only if it is a valid guarantee that has been invoked and the claim admitted - the auditor must inspect the scheme document, the invocation and the admission before accepting any reduction in provision. Absent that, treat it as a secured sub-standard advance and provide 15% of the outstanding (₹2.70 crore) as a starting point, checking the valuation of the hypothecated stock and whether the realisable value actually covers the exposure. Income must be recognised only on realisation; interest already debited and not collected must be reversed.

Account 2 - ₹6.5 crore cash credit with a ₹40 lakh temporary overdraft. The overdraft has been outstanding 110 days, interest has not been serviced since December 2025 and stock statements for two quarters are missing. The account is out of order: the outstanding has continuously exceeded the drawing power, which itself must be recomputed with no DP for stock older than the permitted age. Classify it as sub-standard and treat the overdue TOD as part of the same account, not as a separate facility. Reverse uncollected interest and stop accruing income. Provision 15% on the secured portion and 25% on the unsecured portion, where the shortfall between realisable security value and the outstanding is unsecured.

Account 3 - ₹75 lakh housing loan, borrower deceased. Death is not itself an NPA trigger. Examine whether EMIs continued through legal heirs, a joint borrower or guarantor, or whether credit-linked insurance has settled the loan. If the account is overdue beyond 90 days or no recovery exists, classify accordingly; also verify the mortgage documentation and possession before relying on the security.

The LFAR supplies the qualitative information the central statutory auditors need and the statutory report cannot carry. It goes to the central auditors, not to branch management. Relevant areas, given the facts:

• Cash: whether cash was physically verified by the branch manager and by the auditor, at what intervals, whether differences were reported, and whether the cash retention limit was observed. Cash of ₹22 lakh against insurance of ₹10 lakh is a shortfall in cover that must be reported, along with the reasons and whether the excess arose systematically.
• Deposits: KYC compliance for high-value and new accounts, interest rates applied against card rates, deposits from other banks, unclaimed and inoperative accounts, and any manipulation of maturity dates.
• Advances: a sample of large accounts tested for documentation, sanction terms, charge creation and registration with ROC/CERSAI, insurance of securities, periodic review and renewal, drawing power and stock statements, and whether the account is being ever-greened with fresh lending. Report specifically on NPA identification and provisioning, restructured accounts, advances to directors and connected persons, and any instance of the branch deviating from sanction conditions.
• The three accounts above: the incorrect classification of the guaranteed term loan, the out-of-order cash credit and the treatment of the deceased borrower's housing loan.
• Other areas: other assets and suspense accounts, stationery and security items, reconciliation of inter-branch and nostro accounts, profit and provisions reported by the branch, compliance with RBI directions and the bank's internal circulars.

Each comment should state the fact, the amount and the effect, so the central auditors can decide whether the bank-level financial statements need adjustment.

Reporting line. The branch auditor is appointed by the bank (with the approval of the central statutory auditors/RBI framework) and reports to the central statutory auditors, not to the branch manager. The deliverable is the branch audit report in the prescribed format plus the LFAR. The branch auditor does not form an opinion on the bank as a whole; the central auditors consolidate branch returns, may revisit any classification, and are responsible for the bank-level opinion. If the central auditors differ from the branch classification, the difference and its effect should be documented and, where material, reflected in the bank's financial statements.

Immediate escalation. Matters that cannot wait for the report write-up:

• any fraud or suspected fraud, including misappropriation of cash or fictitious advances, which must be communicated without delay to the central statutory auditors and to the bank's management; the statutory reporting under section 143(12) and SA 240 is handled at the bank level by the central auditors, and delay by the branch auditor can itself be a breach;
• irreconcilable differences in cash or suspense balances;
• deliberate misclassification of NPAs identified during the audit, since provisioning feeds the bank's results;
• any indication that the branch is suppressing transactions or manipulating records for the audit.

Independence and documentation. Do not accept internal audit, concurrent audit or any management function at the same branch, and do not take instructions from the branch manager on scope. Retain the working papers (SA 230) evidencing the classification testing, the security valuations and the cash verification, and make them available to the central auditors and to inspection.