Housing Finance Companies

RBI extends the Risk Based Internal Audit Rules to HFCs

The Reserve Bank of India released a notification regarding extension of Risk based Internal Audit rules to all deposit-taking and non-deposit taking Housing Finance Companies with assets more than 5000 crore rupees with effect from 30^th June 2022. In this article, we shall have a look at this RBI notification.

Background: Risk Based Internal Audit Rules

On Feb 3, the Reserve Bank had made these rules applicable to other entities. The share price of Housing Finance Companies took a beating after the RBI released the circular regarding extending internal audit rules to HFCs. The share price of the LIC Housing Finance fell to a low of 519 rupees per piece, down 1.5% from the previous close.

While announcing the rules on risk based internal audit for NBFCs and Urban Co-operative Banks on Feb 3, the RBI stated that the circular is applicable to the NBFCs with asset size of 5000 crore rupees and above and all primary urban co-operative banks with an asset size of 500 crore rupees and above.

 Further, the RBI said that the circular intends to provide essential requirements for a robust internal audit function which includes sufficient authority, stature, independence, resources and professional competence in order to align such requirements in larger NBFCs/UCBs with those that are stipulated for scheduled commercial banks.

The RBI expects that the adoption of Risk based internal audit by such entities can enhance the quality & effectiveness of their internal audit systems.

In the Statement on Developmental and Regulatory Policies issued as part of the Monetary Policy Statement dated December 4, 2020, RBI pointed out that suitable guidelines will be given to large Urban Co-operative Banks and NBFCs for the adoption of RIBA to strengthen the internal audit function, which acts as a third line of defence.

What is Risk based Internal Audit Rules?

The Housing Finance Companies should put in place a RBIA framework by 30^th June 2022. So what is RBIA? An effective RBIA is an audit methodology which links an organizations’ overall risk management framework and provides an assurance to the directors and senior management on quality and effectiveness of an organizations’ internal control, risk management and governance related systems as well as processes.

What do the new rules say?

The new guidelines of RBI^[1] are crucial in the context of rising cases of financial regularities and governance issues in banks as well as NBFCs in previous years. In order to make sure a smooth transition from the extant system of internal audit to RBIA, the NBFCs & UCBs concerned will have to form a committee of senior executives with the task of formulating a suitable action plan.

The RBI said that the committee may address transitional and change the management issues and must report progress periodically to the board & senior management.

As per the new rules, the NBFC ad UCBs boards are primarily responsible for overseeing their internal audit functions.

The RBI said that the RBIA policy will be formulated with the boards’ approval and disseminated widely within the organization. The policy should properly document the purpose, authority and responsibility of the internal audit activity with a clear demarcation of the role & expectations from risk management function & risk based internal audit function.  

Moreover, the RBI said that the senior management of these firms is responsible for ensuring adherence to the internal audit policy guidelines approved by the board and development of an effective internal control function which identifies, measures, monitors and reports all risk faced.

It further stated that it would ensure that appropriate action is taken on the internal audit findings within the given timelines and status on the closure of audit reports is placed before the ACB/Board.

Also, the senior management should establish a comprehensive and independent internal audit function that should promote accountability and transparency.

The RBI has explicitly said that the internal audit function should assess and make appropriate recommendations to improve the governance process on business decision making, risk management & control, promote appropriate ethics & values within the organization & ensure effective performance management & staff accountability etc.

The RBI, in order to ensure effectiveness, said that the internal audit function should have enough authority, stature, independence and resources, thus enabling internal auditors to perform their assignments properly.

Conclusion

The RBI said that all deposit-taking Housing Finance Companies, regardless of their size and non-deposit taking HFCs with an asset size of 5000 crore rupees and above, will come under the Risk Based Internal Audit rules.

Read our Article:Framework for Housing Finance Companies as per RBI