Tough audit rules

RBI must consider the concerns of financial services players

About a month ago, the Reserve Bank of India (RBI) issued a circular that substantially altered the ground rules under which financial services companies of significant size are audited. These changes have set off concern that has been gathering momentum in recent weeks. While the RBI’s intentions are sensible, and the reasons for the changes are clear and comprehensible, the central criticism is that these new rules will be difficult, costly, and complex to implement. The regulator will have to do more work, together with audit firms and large financial services companies, to figure out how the principles underlying the new rules can successfully be applied.

The RBI circular, dated April 27, mandated that the auditors required by statute to examine the books of financial services (finserv) companies with assets greater than Rs 1,000 crore should be changed every three years, and there should be a six-year cooling-off period before they are attached to the same institution again. Larger finserv companies, with assets greater than Rs 15,000 crore, would need joint audits, in which two or more firms would share the task, so as to ensure more eyes on the same books. There were also restrictions on audit firms’ other activities; the non-audit services they could provide their audit clients or associated companies were restricted by the guidelines, and auditors themselves had a cap placed on the number of financial services companies they could audit. These changes were to go into force in 2021-22. Naturally, the largest audit firms — the so-called “Big Four” — will see a significant diminution of their business opportunities, and some might place far greater emphasis on their non-audit consulting activities. But it is not just the auditors who are worried. The Finance Industry Development Council, which represents India’s non-banking financial companies, has asked for the deadline to be pushed back to 2022-23. The Confederation of Indian Industry (CII) has also argued that “retrospective” application to the ongoing financial year is unjust. The CII also makes the point that, for larger firms and particularly corporate groups, the new regulations would require an enormous increase in the number of auditors over time. But there is simply not enough capacity in the system for this to happen. The CII also highlighted problems of coordination between the different auditors of different group companies.

These criticisms are well-meant and must be taken on board by the RBI. Certainly, the transition period could be extended fairly easily. But the larger point must also be considered. If the RBI has actually modelled the capacity increase at the top of the auditing profession required by the new regulations, then it should share its assumptions and conclusions in order to satisfy these concerns. If it has not, then this policy change itself needs re-examination. The expansion of the audit space and reducing its dependence on non-audit fees and the largest firms are a worthy end. But it cannot be accomplished by fiat overnight. A clear transition plan is needed, which takes into account the supply constraints on top of the line human capital for the audit business, and the returns to investment for small and medium audit firms wishing to transition to the big leagues. The RBI can and must do the additional work, or the guidelines themselves will eventually fail in their ends.