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NEWS RELEASE FEDERAL DEPOSIT INSURANCE CORPORATION WASHINGTON, D. C. 20429 FOR RELEASE AT 1 0 :0 0 A* M. THURSDAY, JUNE 17, 1969? AUDIT AS A MANAGEMENT TOOL An Address By K. A. RANDALL, CHAIRMAN FEDERAL DEPOSIT INSURANCE CORPORATION Washington, D. C. b efore the ANNUAL CONVENTION o f the VIRGINIA BANKERS ASSOCIATION at The Homestead Hot Springs, V irg in ia 1 0 :0 0 A. M. Thursday, June 17, 19^5 I Telephone: 393-8400 Br. 221 AUDIT AS A MANAGEMENT TOOL Banks today are operating in an in te n siv e ly com petitive environment. An environment o f dynamic growth and change. Banking techniques and banking se rv ice s are changing and adapting to new con d ition s. The demands upon the banking industry have been in creasin g as never b efore in h is to ry . Every bank can meet these demands, i f management is w illin g . One major element is the n e c e s sity o f proper co n tro l o f bank op eration s. The advantages o f audit procedures are many, yet i t is a l l too tru e th a t many bank s t i l l do not u t i l i z e them. Important work is being done to fo s te r development o f au d it, e s p e c ia lly by NABAC, The A ssociation fo r Bank Audit, C ontrol, and Operation, but the supervisory a u th o r itie s , s ta te and n a tio n a l, are a lso concerned with the need to broaden audit programs. In our time today, I would lik e to o u tlin e fo r you some reasons fo r t h is push fo r au dit. The use o f audit is a management, and an ownership r e s p o n s ib ility . The demand fo r c r e d it , the pressure fo r continued economic growth, has sparked the emergence o f new banking tech n iqu es. The use o f amortized loans in a l l f ie ld s o f lend ing, development o f leaseback s e r v ic e s , broader a g ric u ltu ra l lending s e r v ic e s , going fa r beyond the t r a d itio n a l cash crop lo an , broadened consumer c re d it tech n iqu es, flo o r planning fo r more and more goods, have required new methods o f op eration , which even sm all banks must to a degree master i f they are to se rv ice the needs o f th e ir communities and remain com petitive. 2 The c o s t-p ric e squeeze a ffe c tin g the banking industry has emphasized new approaches. Non-loan s e r v ic e s , which do not requ ire the use o f c o s tly d e p o sits, are being developed. Travel se r v ic e , bookkeeping arrangements, and other se rv ice s are becoming commonplace. More so p h istica te d banking methods are being u tiliz e d . Automation i t s e l f is opening up a host o f new s e r v ic e s , and new techniqu es. Competition has sharpened tremendously, not only w ithin the banking indu stry, but from other fin a n c ia l in s t it u tio n s . A ll fin a n c ia l in s titu tio n s are broadening t h e ir own b a s is o f se rv ice and b lu rrin g the lin e s o f separation between them. There is a great in te ra c tio n o f other economic f a c t o r s , a ffe c tin g the a c t i v i t i e s o f a l l banks. They have become more and more im portant. Balance o f payments problems, f i s c a l and monetary p o lic ie s , and the n a tio n 's larg e commitment in space, a ssista n ce to other n a tio n s, and the m ilita r y budget, a l l play an important ro le in the d ecision s which a ff e c t bank a c tio n s. None o f th ese fa c to r s can be ignored. A. bank ch arter c a r r ie s with i t broad r e s p o n s ib ility . The bank must serve i t s community, and must conduct i t s a f f a i r s to develop the community's c r e d it resources to the community's b e st advantage. Unimaginative management, which f a i l s to appreciate the world in which i t op erates, can weaken the community's growth. Conversely, bank management which u t i l i z e s i t s resources in t e llig e n t ly , and a s s i s t s i t s community to keep pace with changing con d itio n s, i s f u l f i l l i n g i t s b a s ic ch arter r e s p o n s ib ilit ie s . These r e s p o n s ib ilit ie s emphasize the need fo r every bank manager not only to meet rou tine requirem ents, but to assure through proper co n tro ls - 3 the sa fe ty and s t a b i l i t y o f h is bank, and i t s continued a b i l i t y to fu n ctio n . A d d ition ally , fo r su rv iv al and continued serv ice to a community, the bank manager should be in a p o sitio n to u t i l i z e new techniques and new s e r v ic e s . This req u ires a degree o f knowledge o f the c a p a b ilitie s o f the bank. The g o a l, o f safe operation perm itting a f u l l range o f s e rv ic e , can b e st be accomplished where the bank uses a program o f day-by-day in te rn a l c o n tro l, concurrent with proper accounting tech n iqu es, backed and supervised by an audit program, including v e r if ic a tio n procedures. Some banks, e s p e c ia lly sm aller ones, seem to f e e l th a t supervisory examinations can take the place o f audit programs. This is not tru e I An examination does u t i l i z e some audit tech n iqu es, but i t is not an au d it. The examiner approaches h is ta sk from a d iffe r e n t viewpoint than the au d itor. This is rig h t and necessary, and i t is e s s e n tia l th a t the bank manager understand the d iffe re n ce in approach. An understanding o f t h is d iffe re n ce w ill serve to help the manager make the proper use o f examination re p o rts. Broadly speaking, the examination i s p rim arily a q u a lita tiv e p rocess, developing the value o f a bank’ s holdings, t h e ir soundness, the le g a lit y of the bank's a c tio n s , the soundness o f c a p it a l, and the q u a lity o f management. The au d it, on the other hand, is a q u a n tita tiv e p rocess, analysing a bank's a sse ts and l i a b i l i t i e s , i t s income and expenses, determining what does and what does not belong on the books, and whether or not th ese tra n sa ctio n s are a ccu rately r e f le c te d . An audit does not analyse a bank’ s management, except in d ir e c tly by showing, through fig u r e s , what the r e s u lts a re. It w ill determine whether or not s t a f f is adhering to management p o lic ie s . - k - No supervisor wants to undertake an audit r o le , except as an in c id e n ta l p art o f the examination p rocess. I f e e l most stron gly th a t audit is an ownership and a management r e s p o n s ib ility . No supervisor wants to or properly can e x e rcise the fu n ction s o f management. The supervisor can only urge management to do what i t should do, and in the examination process evaluate the a b i l i t y o f management to discharge i t s r e s p o n s ib ilit ie s . There are c e rta in th in gs any supervisor looks fo r in an audit and co n tro l program. The supervisor looks fo r a program o f in te rn a l c o n tro ls , stru ctu red permanently in to the bank’ s operating procedures, on a rou tin e and constant b a s is . Among these co n tro ls a re : --S tru c tu rin g operations so th a t no one person co n tro ls a tra n sa c tio n from o rig in to p o stin g . --Mandatory v acation s fo r a l l personnel, including senior management, to assure th a t every employee has a minimum o f two weeks away from the bank, on consecutive business days, and without en try to the bank during th a t period. --D ual co n tro ls in se n s itiv e a rea s, such as s e c u r it ie s . --R o ta tio n o f assignments, e s p e c ia lly among those employees handling records or a sse ts vulnerable to a lte r a tio n or m isappropriation. --P e rio d ic su rp rise checks, e s p e c ia lly in the same areas where assignments should be ro ta te d . For example, p erio d ic checks o f the cash l e t t e r s as they come in , by an au d ito r, or by senior management, and a comparison o f the items in the cash l e t t e r s again st ledger sh e ets. The supervisor looks fo r a proper audit program. In our view, and in te rn a l au d ito r, as fre e as p o ssib le from other assignments, i s e s s e n tia l to any com pletely s a tis f a c to r y audit program. However, the use of audit committees - 5 by the board o f d ire c to rs is a larg e step in the rig h t d ir e c tio n , and the p erio d ic use on a su rp rise b a sis o f outside independent au ditors a lso h elp s, although i t does not give the day by day sa fe ty o f a f u l l in te rn a l program. Among the assignments the supervisor considers necessary fo r a proper audit program - - and t h is presupposes an in te r n a l auditor — a re : --In su rin g th a t a proper accounting system is in e f f e c t and is fu nctioning as intended, on a continuing b a s is . --E sta b lis h in g and p e rio d ic a lly reviewing the bank’ s system o f in te rn a l c o n tro ls. --A uditing accounts sy ste m a tica lly with a view toward p ro tectin g and safeguarding the bank’ s a s s e ts , and determining i t s l i a b i l i t i e s . --Determ ining th a t a l l members o f the bank’ s s t a f f are adhering to management p o lic ie s . --A ssuring th a t the bank complies with ap p licab le laws and re g u la tio n s. --Preparing and subm itting to management, p eriod ic re p o r ts , assuring management o f an accurate and substantive p ictu re o f the bank’ s s ta tu s . To the examiner and the w e ll-tra in e d au d ito r, the process o f d ir e c t v e r ific a tio n remains the sin g le stron gest to o l to prevent or d isclo se i r r e g u la r it ie s . The frequency o f v e r if ic a t io n , and i t s scope, are important elements in i t s su cce ssfu l u se. We f e e l stron gly th a t even in banks which do not have a fu ll-tim e au d ito r, d ir e c t v e r if ic a tio n through an outside auditor or through a board o f d ire c to rs committee is e s s e n tia l as a co n tro l. V e r ific a tio n should be d ire cted to deposit accounts, including dormant accounts, and to lo a n s, e s p e c ia lly including purchased paper such as d ealer lo an s. The supervisory agencies have always checked c a r e fu lly every bank’ s co n tro ls and audit program as a major part o f t h e ir examination. Our examiners at the Federal Deposit Insurance Corporation are in stru cted to give c a re fu l con sid eration to one-man banks, to c a r e le s s ly run in s t it u tio n s , to banks without mandatory v acation p o lic ie s or with seriou s d e fic ie n c ie s in in te rn a l c o n tro ls , and to banks without audit procedures. We at FDIC f e e l most stron gly the need fo r fu rth er a c t iv it y in t h is area. A ccordingly, we are undertaking a three-pronged approach. F ir s t: We have in stru cted a l l our examiners to check c a r e fu lly fo r use o f d ir e c t v e r if ic a t io n , and, where v e r if ic a tio n i s not being used, to urge managements to embark on such a program. We are paying e s p e c ia l care to the area o f v e r if ic a tio n o f purchased paper. Second: We have placed ourselves on record as favoring an approach to more uniform accounting techniqu es. The reg u la tio n s we issued to implement the S e c u r itie s Act Amendments o f 196U req u ire more uniform accounting techniqu es. While these reg u latio n s a f f e c t only la rg e r banks at p resen t, we f e e l th a t as they are accepted by the public and by th e indu stry, they w ill help to develop more uniform techniques fo r a l l banks. I t i s hoped th a t t h is uniform ity w ill lower auditing c o s ts . T hird: We are considering a new program at FDIC. This is the p o s s ib ilit y o f developing an advisory se rv ice fo r banks th a t la c k audit programs. It would be a voluntary program, designed to a s s i s t banks in developing techniqu es. As we p re sen tly see i t , t h is would lead to a program where f i e l d auditors tra in e d in bank auditing techniques and in teaching methods, would a t the - 7 bank’ s request be able to a s s is t banks. The degree o f a ssista n ce would depend upon th e bank's needs and i t s s k i l l s at the time they sought a s s is ta n c e . While we are not committed form ally to t h is program, i t is under c a re fu l study, and a p ilo t group i s being tra in e d . This group cu rre n tly i s being used to in te n s ify and extend the audit phase o f our exam inations, but they may become th e b a s is fo r t h is new program. There are some su b s ta n tia l b e n e fit s , in our opinion, which ju s t i f y the co sts o f good au d itin g. Proper use o f audit programs, including v e r if ic a t io n , assures as fa r as p o ssib le s t a f f honesty. I t provides a b e tte r working clim ate through the proper use o f ro ta tio n tech n iqu es, which develop s t a f f s k i l l s and personnel development. D irect v e r if ic a tio n can be used e f f e c t iv e ly as a means o f developing b e tte r pu blic r e la t io n s . unfounded. Fears th a t i t w ill d istu rb a ban k's customers are What customer is going to be disturbed by the thought th a t h is bank is try in g to p ro tect him and keep h is records in accurate balance? In stead , the use o f v e r if ic a tio n programs can be made to pay p o sitiv e dividends in crea tin g an impression o f a bank which cares fo r and p ro te c ts i t s customers. This can be used as a s e llin g t o o l. Such audit programs, lim itin g sharply exposure to frau d, can lower blanket bond and f i d e l i t y bond c o s ts . F in a lly , au diting provides an e x c e lle n t to o l fo r co st accounting, co st c o n tro ls , and development o f a r e a l i s t i c p rice s tru c tu re , r e la te d to a ctu a l c o sts. F a ilu re o f a banker to u t i l i z e to the f u l l e s t the c r e d it resources o f h is community, as represented by h is own in s t it u tio n , i s a f a ilu r e o f a tr u s t - 8 - imposed as an e s s e n tia l part o f the hank ch arter under which he op erates. F a ilu re to do what the bank can do and should do harms the community. F ailu re to e x e rc ise co n tro ls to assure s a fe ty o f h is in s titu tio n i s an even g reater f a ilu r e o f h is t r u s t ; i t i s inexcusable and can be d isastro u s to the community. I t is the r e s p o n s ib ility o f bank ownership, the board o f d ir e c to r s and senior management, to u t i l i z e a l1 p o ssib le techniques to preserve the sa fe ty and to enhance the a b i l i t y o f the bank. Accounting and audit togeth er c o n stitu te a major means o f f u l f i l l i n g t h is r e s p o n s ib ility . We f e e l most stron gly th a t the b e n e fits to be derived from such a program are so larg e th a t no bank can properly ignore them. moving world. This i s a f a s t The bank which is equipped to safeguard i t s e l f , and to understand i t s e l f through sound accounting and auditing tech n iqu es, is the bank which w ill master new tech n iqu es, serve i t s community, and ju s t i f y i t s continued e x iste n c e . This i s a challenge to a l l o f u s. F o rtu n ately , the h is to r y o f t h is n a tio n 's banking system i s a continued h is tc r v o f response to ch allen g es, and a continuing development o f b e tte r banks and b e tte r techniqu es. With a continued w illin g n ess to meet such ch a llen g es, the banking industry can look to the fu tu re w ith confidence. # # # #
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