The New Auditing Engagement

In today's Finshots we talk about new guidelines on auditing commercial banks, NBFCs, and housing finance corporations.

The Story

India has seen its fair share of scams, frauds, and rackets in the financial sector. We have witnessed banks collapse, NBFCs capitulate and directors making a run for it. But the common denominator in almost all of these seemingly dubious engagements has to be auditor oversight. These are the people expected to tip off dodgy behavior. They’re the ones expected to stand up to the board and curb malfeasance. So when you see them underperform and routinely gloss over blatant violations, you have to look at the whole arrangement and ask — “What can we do to potentially alleviate some of these problems?”

Now, we are not saying all auditors are scammy.  Most auditors are good honest people trying to do their best in a high-stress environment. And we understand that tricky promoters could easily hoodwink even the most astute auditors. But sometimes boundaries have to be drawn and rules have to be rewritten. So the RBI decided to put out a new set of guidelines to govern the appointment of auditors for commercial banks, NBFCs, and housing finance companies. The guidelines are quite detailed with lots of nuances. So let’s get straight to them.

First up, you have tenure and appointment. Financial institutions can now appoint auditors for a period of three years, provided they satisfy all the eligibility norms. But after three years, they have to look for somebody else. They can’t hire the same people again. In fact, they can’t do it for another 6 years. It’s a cool-off period of sorts. The motive for introducing this rule should be obvious. Long-standing engagements with companies can morph into a symbiotic relationship. Auditors depend on companies for payment and when you grow alongside each other, maybe you’ll become a bit too dependent.

After all, are you going to betray a promoter who supports your very existence? Are you going to be diligent in reporting financial irregularities? These are tough questions and while you can’t eliminate these symbiotic relationships entirely, you can take steps to minimize their impact. If the auditor knows they’ll have to stop working with a company after three years, they probably won’t risk lying for them consistently. Also, if a promoter knows that a new auditor will walk in after three years, they’ll know the implications of pursuing a scam. The new auditor may no longer comply with your request and as a promoter, you’ll have to consider this possibility. Perhaps it’ll induce some fear.

Also, banks can no longer fire auditors during their tenure without prior approval from the RBI. Meaning, once you get an auditor on board, you’ll have to stick with them for three years. After all, if they no longer have to worry about being shown the door midway, they probably won’t be too afraid of flagging financial irregularities. It might just embolden them some more. All in all, the hope is that this will make the auditors more independent.

Finally, there are also new restrictions on the amount of audit work each company can take up. One audit firm can concurrently engage with a maximum of four commercial banks, eight urban cooperative banks, eight NBFCs, in any given year. The hope is that this new restriction will allow them to focus on quality above all else. Further, the number of auditors a company can hire will now be tied to the asset size of the firm. For example, a firm with ₹15,000 crores and above will need to conduct joint audits with two different auditing firms participating. Likewise, the number of required auditors goes up as the asset size of the institution increases. These auditors cannot have any common partners and they cannot be under the same network of audit firms.

And while many people believe that all these rules may increase the cost to companies, the general consensus is that it might improve accountability across the board. So yeah, that’s the story here. And if you’re an auditor or if you’re a stakeholder in the industry, please let us know what are your thoughts on the matter. Tweet at us here or maybe reply to the email. We appreciate everything you send our way :)

That’s it from us. We will see you tomorrow.

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