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.