Asks auditors to check related party transactions: RBI Governor flags ‘camouflaged’ transactions, fund diversions

With several instances of fund diversion and transfer of profits to “connected parties” surfacing, Reserve Bank of India (RBI) Governor Shaktikanta Das on Monday asked auditors to identify and thoroughly scrutinise related or connected party transactions to ensure that there is no undue transfer of income or assets.

“Of late, several instances of related party transactions without following ‘arms-length’ principle and established transfer pricing mechanism have been observed,” he said.

“There have been instances of diversion of funds and/or transfer of profits to connected parties through various means – intra-group loans on favourable terms, over or under invoicing of transactions, asset transfers without fair valuation, etc,” Das said while addressing the National Academy of Audit and Accounts, Shimla.

“Auditors need to identify and thoroughly scrutinise related or connected party transactions to ensure that there is no undue transfer of income or assets,” he said. Three major financial entities – IL&FS, DHFL and Srei firms – had come under supervisory action in the last three years due to fund diversion and mismanagement.

“We have also seen cases of manipulation and misstatement of true nature of financial statements by employing opaque technological means (IT black boxes),” Das said. Real transactions are camouflaged beneath various layers of IT solutions by a few entities. As such, auditors need to be technologically savvy and be able to ‘see-through’ the layers of information technology to detect the real nature of hidden transactions, the Governor said.

“Such undesirable practices and structures should draw the attention of the auditors. Since RBI, as the supervisor of the financial system, relies and leverages on the work done by auditors, the audit professionals are being sensitised through various fora to improve the quality of their reporting,”

Das said. “We are constantly engaged with individual auditors, audit firms and the Institute of Chartered Accountants of India (ICAI) to improve the quality and depth of audit. A lot of work has been done in this area, but lot more needs to be done,” he said.

He said inaccurate information may lead to sub-optimal decisions or excess resource allocation, which would be neither in public interest where a public authority is involved nor in the interest of individual stakeholders.

He said statutory auditors play a vital role in maintaining market confidence on audited financial statements. “In banking industry, this public role is particularly relevant for financial stability, given that banks hold public deposits.”