Mumbai: The Reserve Bank of India (RBI) has expressed concerns over banks not adhering to the regulator’s income recognition and asset classification norms (IRAC) and reporting divergences in bad loan numbers.

According to the central bank, while there may be instances of information asymmetry between the supervisor and other stakeholders, bad loan divergence should not arise from lack of adherence to regulatory guidelines.

“Non-adherence to Income Recognition and Asset Classification (IRAC) norms by banks is a major concern. In this respect, audit function still needs to provide desired level of assurance to all stakeholders, including the Reserve Bank of India," it said in its FY18 annual report.

Scheduled commercial banks (SCBs) undertake various types of audit such as statutory audit, risk-based internal audit (RBIA), concurrent audit, information systems (IS) audit and special audits. RBI said that major fraud incidents reported by banks in the recent past have highlighted the need for improvement in the audit function and its governance. “In addition, an increase in divergence in asset classification and provisioning as assessed by the Reserve Bank vis-à-vis the audited financial statements of SCBs has been seen as a concern," it said.

The central bank said that the quality of internal audit was adversely affected due to inadequate human resources, lack of desired skill-sets (particularly for specialized branches), non-adherence to stipulated timelines for compliance with audit findings, non-inclusion of some critical areas. This, the report said, was an indication of inadequate attention to sustainable compliance with the findings of earlier reports.

“Many instances of repetitive and similar audit findings over the years were seen. Further, internal audit could not detect many frauds, which came to light after accounts turned non-performing. Fraud detection and reporting, as well as preventive steps, need to be more risk-focused so as to identify red flags at an incipient stage," it said.

RBI said it has been decided to put in place a graded enforcement action framework to enable appropriate action by the regulator for any lapses observed in conducting a bank’s statutory audit. “This would cover, inter-alia, instances of divergence identified in asset classification and provisioning during the Reserve Bank’s inspection vis-à-vis the audited financial statements of banks above the threshold specified by the Reserve Bank in the circular issued on April 18, 2017," the annual report added.

Owing to “large divergences" observed in asset classification and provisioning in by banks, the central bank has constituted an expert committee under the chairmanship of Y.H. Malegam, a former member of the central board of RBI. The committee will look into the reasons for high divergence observed in asset classification and provisioning by banks compared the RBI’s supervisory assessment, and the steps needed to prevent it; factors leading to an increasing incidence of frauds in banks and the measures (including IT interventions) needed to curb and prevent it, among others.