Auditing bank auditors

Auditing bank auditors

Bank Indonesia's recent regulations on procedures for
financial reporting by commercial banks put both external and
internal auditors under tougher supervision. The rulings require
banks to hire only from among the independent public accountants
(external auditors) who have been registered at the central bank.
The regulations also empower the central bank to reject the
external auditors hired by a bank.

Tougher still is the obligation imposed on external auditors
requiring them not only to examine the financial statements of a
bank, but also to review the structure of the bank's internal
audit system. Hence, we think, the audit requirements imposed on
banks are now the most stringent among those for the business
entities throughout the country.

The rationale of the rulings is quite obvious -- the fiduciary
responsibility of banks and the crucial role played by these
financial intermediaries in mobilizing private savings and
allocating financial resources to the various sectors.

For sure, the primary objective of the rulings is to ensure
the independence and integrity of the external auditors in giving
their opinions on the condition and performance of the banks they
audit. Past experiences show that some companies put pressure on
their external auditors to agree with their improper accounting
treatment, and the auditors often failed to be strong enough to
resist such pressure at the risk of losing big clients.

However, the central bank does realize that external auditors
do not examine every document related to financial statements.
Therefore, even public accountants remain vulnerable to being
misled by a company management which colludes with its internal
auditors to produce false records and books. The dilemma here is
that external auditors cannot be held responsible for the
incorrectness of audited financial statements, if they follow the
accepted accounting and auditing principles and procedures in
their professional activities and are unknowingly misled by
falsified documents and records. Herein, we think, lies the
importance of obligating external auditors to review the
structure and performance of the internal auditors of banks.

The review will hopefully provide valuable input to the
central bank, which is now formulating better standards on the
function of internal auditors of banks in cooperation with the
Indonesian chapter of the Institute of Internal Auditors.

It is too much to expect external auditors to detect fraud at
the companies they audit because requiring such foolproof work
would make the auditing process prohibitively expensive. But the
new rulings, we think, will achieve two objectives: First, they
will prevent too cozy a relationship between external auditors
and their bosses (bank management). That is important because
although in theory external auditors are appointed by
shareholders, in practice, in so far as the companies are not
publicly listed, they are hired and fired by the management.

Second, internal auditors, who are often at the mercy of the
management of their employer, will be encouraged to profess a
high degree of independence and integrity. A fairly independent
internal control system will, therefore, be the first preventive
step against misleading financial statements.

All those rulings on financial reporting, which is one element
within the full disclosure requirement, will hopefully minimize
collusion between either the management and internal auditors of
a bank, or between the management of a bank and external
auditors. But those rulings will be effective only if they are
fully enforced by a central bank, which is not vulnerable to
lobbying, nor pressure, by politically well-connected bankers,
and by bank inspectors with a high degree of honesty and
integrity.