Friday, September 26, 2008

Some thoughts on the NBFCs Auditors Report Directions 2008 - I

Recently, as briefly referred to an earlier post here, the Reserve Bank of India has notified the NBFCs Auditors Report  (Reserve Bank) Directions 2008 (“2008 Directions”) (full text available here). These replace similar directions issued exactly a decade back, i.e., in 1998. Both these Directions require auditors of non-banking financial companies (“NBFCs”) to give specific comments regarding the compliance or otherwise of certain provisions applicable to NBFCs. These are to be given in a separate report to the Board of the NBFC. However, if there are any adverse remarks or there is any contravention of the laws applicable to them, as specified, then they have to report also directly to the Reserve Bank of India in what is called an exception report.

The 2008 Directions, however, are much more comprehensive than the 1998 Directions and particularly take into account many of the developments in law notified by Reserve Bank of India itself. It may be recollected that since the issue of the Directions relating to Public Deposits and relating to Prudential Norms in 1998, these provisions have undergone major changes. The objective of these 2008 Directions thus appear to update the reporting requirements of the Auditors in tune with these changes and also create certain fresh requirements apart from making some changes in light of experience.

The experience under the 1998 Directions has not been wholly satisfactory maybe due also to ambiguity in the Directions themselves or the provisions they covered.

The coverage of the 1998 Directions was very extensive they were to examine each and every of the provision relating to NBFCs under the RBI Act and the Directions issued thereunder and check whether these are complied with or not. This scheme continues even under the 2008 Directions. The provisions of law relating to NBFCs have many areas of ambiguity and controversies and the amendments over the years have not improved the situation. The Directions to Auditors nevertheless require the Auditors to take a call on each such requirement and consider whether these are complied with or not. If they are not complied with, they have to report to the Reserve Bank of India and that too directly. Obviously, though, as a good and fair practice, they would give an opportunity to the NBFC first to give their view.

The 2008 Directions, replacing the 1998 Directions, say that they come into immediate effect. However, clause 2 clarifies that the report required to be given under the Directions is only in respect of financial years ending on or after the commencement date. In other words, it will apply to the accounts for the year ended 31st March 2009 and NOT to the year ended 31st March 2008. For the year ended 31st March 2008, therefore, the 1998 Directions will continue to apply.

There are many strange aspects to the requirements in the Directions. Consider some of them.

The NBFC itself is not required to report to the Reserve Bank of India of the contraventions. It is the Auditors who have to report. Of course, the NBFC would be liable for the defaults but it makes sense on creating a requirement to report by the NBFC itself as an early indicator as also an opportunity to the NBFC to present the situation.

The negative report by the Auditors has to be given not to the shareholders, who would be affected by such contraventions, and not even to the depositors who would have serious concerns since non-compliance may be indicative of possible default or at least poor management. The report has to be given only and directly to the Reserve Bank of India. While on this, note also that the report to the Board is a separate report. There does not seem to be any legal requirement of enclosing this report alongwith the regular Auditors report to the shareholders. Of course, there is a possibility that some of the contraventions would be needed to be also reported in the regular report of the Auditors.

The adverse report of the Auditors is quite likely to reach even the Reserve Bank of India after a fairly long time after the contravention. Typically, the company has about 5 months after the yearend to finalise the accounts and audit. Further, even after this period, strangely, no time limit has been given to the Auditors to submit its exception report to the Reserve Bank of India.

(To be continued - second and concluding part in one or two days)

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