RBI’s Bank Audit Fantasy
If the staid profession of accountants hits the headlines, it can’t be for good reasons. The new audit guidelines of the Reserve Bank of India have caused an upheaval. The Big Four (Deloitte, EY, KPMG, and PwC) feel that the guidelines are a recipe for disaster. The Indian firms welcome them because some banks are within their reach.
The New Audit Norms
The guidelines apply this year onwards to commercial banks, urban cooperative banks , and non-banking finance companies.
The table below presents the major changes from the old guidelines, which did not cover UCBs.
Corporate Failures And Audit Firms
The sudden collapse of the IL&FS group and Dewan Housing Finance Corp. has triggered the RBI’s over-the-top reaction. The audit quality review reports issued by the National Financial Reporting Authority have brought out grave deficiencies in the audit of IL&FS Financial Services by Deloitte Haskins & Sells LLP (Deloitte network) and BSR & Associates LLP (KPMG network). NFRA has taken disciplinary action against partners of Deloitte Haskins & Sells and is investigating BSR & Associates. PwC has its cross to bear for the Satyam accounting fraud. The RBI banned S R Batliboi & Co. LLP (EY network) for one year from bank audits over audit lapses in a bank.
As a result, there are questions whether the Big Four still deserve their reputation and top dollar and investor confidence.
Audit Market Structure And The Politics Of The Accounting Industry
Since the 1990s, Indian firms have looked on helplessly as the Big Four not only dominate the top-tier corporate segment but have made inroads into the mid-tier segment. They don’t have many good options. For example, S.B. Billimoria & Co., S. R. Batliboi & Co., A. F. Ferguson & Co., and Fraser & Ross, once household names, are now in the Big Four fold. Some mid-sized firms, e.g. Walker Chandiok & Co. LLP, Desai Haribhakti & Co. LLP, MSKA & Associates, and Sridhar & Santhanam, have also joined global networks.
Other Indian firms — mostly family-owned — have been largely relegated to audits of public sector units, public sector banks, and mid-tier or small listed and unlisted companies.
They expected mandatory audit firm rotation introduced by the Companies Act, 2013 to bring new audit business. Contrarily, the Big Four have gained from rotation at the expense of Indian firms. Along with the ICAI, the industry association, Indian firms have been lobbying the regulators and the government. The election process ensures that they control the association. The new guidelines have a clear imprint of their lobbying.
Indian firms expect to be joint auditors as is the case in PSBs. Banks won’t appoint two Big Four joint auditors nor would two among the Big Four want to team up. Without rotation and joint audit Indian firms have little chance of getting private bank and bigger NBFC audits.
Life Upended For The Big Four?
Unsurprisingly, the Big Four oppose joint audits and ceiling on audits. They think their working, people, skills, and culture are so different from those of Indian firms that it would be hard to work with them. Billing rates are much higher for the Big Four because of their higher costs and better brand image. Participating in joint audits may also conflict with their network rules. They fear that association with lesser-known firms could also harm their reputation and expose them to greater liability.
Besides, the Big Four (possibly excluding PwC) have all been auditors of these banks/NBFCs in recent years. In many cases they are serving their cooling-off under company law. They aren't going be keen to return to shorter tenure rotation or joint-audits.
The table below presents information about the auditors of five large private banks (including two NYSE-listed) in 2020. A Big Four firm audited just one out of them, and the rest were members of smaller international networks.
Even so, the Big Four handle the high-paying and prestigious audits of financial statements filed with the NYSE.
Yet, since Big Four firms and Indian firms have been joint auditors for insurers, they must have found a modus vivendi for working together.
The new guidelines stand to benefit the Indian firms or smaller international networks more than they will the Big 4.
Will The New Norms Help Improve Audit Quality?
Too short audit durations will increase audit costs and audit risk. The Companies Act, 2013 has an audit term of 5 + 5 years. The three-year tenure is a straight lift from PSB audits, and may fulfil political mandates but not independence or quality ones.
While the new guidelines will redistribute the audit market, we should not expect audit quality to improve. Evidence on the benefits of rotation and joint audit is mixed. Audit quality is a wider problem.
As the audit committee chair of a large bank, I have seen how joint audit works. You cannot hold anyone responsible. After all, the board would want to hold someone accountable for the work. Things fall through the cracks. Also, clever managers set up one audit firm against another and sadly the audit firms are willing to play along.
The Big Four have come under intense scrutiny because they audit large companies. But, Indian firms too have a lot to answer for. They audit PSBs which have joint audits and three-year rotation. PSBs have the bulk of bad loans but don’t disclose them fully, so much so that they reported record losses after the RBI’s asset quality reviews. Again, the huge fraud in Punjab National Bank and the high incidence of fraud losses in PSBs are poor advertisements for the audit quality of these firms. Investors and depositors are the victims of bad audits. For their sake, the RBI should ask NFRA to review audit quality and punish aberrant auditors.
Micromanaging auditor choice is barking up the wrong tree.
R Narayanaswamy is Professor of Finance and Accounting, Indian Institute of Management, Bangalore; and Chair, Technical Advisory Committee, National Financial Reporting Authority. Views are personal.
The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.