Framework of Risk Based Internal Audit will be Applicable on NBFCs and UCBs

The Reserve Bank of India (RBI) on 03.02.2021, by way of Notification No DoS. CO. PPG. / SEC. 05/ 11.01.005/ 2020-21 has increased the applicability of Risk Based Internal Audit. That means the framework of Risk Based Internal Audit will be applicable to NBFCs and UCBs as well.

Further, the concept of RBIA was firstly implemented for all the Scheduled Commercial Banks (except the Regional Rural Banks) vide RBI Circular DBS.CO.PP.BC.10/ 11.01.005/ 2002, issued on 27.12.2002. The same was further supplemented by way of circular DoS. CO. PPG/ SEC.04/ 11.01.005/2020-21, issued on 07.01.2021.

Concept of Risk Based Internal Audit

The term RBIA is an audit methodology that links an entity’s overall risk management framework and offers an assurance to the BOD (Board of Directors) and the Top Level/ Senior Management on the quality and efficiency of the organisation’s risk management, internal controls, and governance concerning systems and processes. The same is done by using a systematic and disciplined approach.

Further, it shall be noted that the same is an essential part of sound corporate governance and is termed as the third line of defence.

Need for Increasing the Ambit of Risk Based Internal Audit Framework

An independent and effective “internal audit function” in a financial entity offers vital assurance to the Board of Directors^[1] and its senior or top level management concerning the quality and efficiency of the organisation’s internal control, governance, and risk management framework.

Further, the essential requirements for a strong and robust internal audit function comprise of the following:

1. Sufficient Authority;
2. Proper Stature;
3. Independence;
4. Adequate Resources, and;
5. Professional Competence;

Further, the range and commonality of the risks faced by SEs (Supervised Entities) would warrant harmonized and effective systems and processes for the “internal audit function” across the SEs. The same will be based on some common guiding principles.

Which are all NBFCs and UCBs Eligible for Risk Based Internal Audit?

The NBFCs (Non banking Financial Companies) and UCBs (Urban Cooperative Banks) eligible for the risk based internal audit are as follows:

1. All the deposit taking NBFCs, regardless of their size;
2. All the Non-deposit taking NBFCs (comprising of Core Investment Companies) with an asset size of Rs 5000 crores and above;
3. All the UCBs that have an asset size of Rs 500 crore and above;

Directions for the Eligible NBFCs and UCBs

All Supervised Entities, as specified in Paragraph 3, will implement the framework of RBIA by 31.03.2022. The same must be done in accordance with the Guidelines issued on the Risk Based Internal Audit by the apex bank.

Further, the guidelines issued intend to enhance and improve the efficacy of the internal audit mechanisms and procedures followed by the NBFCs and UCBs.

Also, in order to confirm a smooth transition from the prevailing system of internal audit to the Risk Based Internal Audit, the concerned NBFCs and UCBs will require to constitute a committee comprising of senior executives with the duty of formulating an appropriate action plan.

Furthermore, the said committee may address the transitional and change management issues as well and need to report the progress periodically to the Board of Directors and Senior management.

Conclusion

In a nutshell, to improve the efficacy of the internal audit mechanism followed by NBFCs and UCBs, the apex bank has decided that the framework of Risk Based Internal Audit will be applicable on these entities as well. The same was notified by way of Notification Notification No DoS. CO. PPG. / SEC. 05/ 11.01.005/ 2020-21, issued on 03.03.2021.

Read our article:What are the Major Challenges and Remedies by NBFCs? – An Overview

Official RBI Notification on the Applicability of Risk Based Internal Audit Framework