Capital Markets

Bank Internal Auditors Warned About Lending Risks

As a variety of headwinds continue to buffet financial institutions, internal auditors need to sharpen their monitoring skills, say experts at Pric...
Kathy HoffelderSeptember 27, 2013

Internal auditors have to be more diligent in their oversight of banks because financial institutions continue to face geopolitical and macroeconomic headwinds, said Richard Reynolds, national banking and capital markets internal audit leader at PricewaterhouseCoopers, on a webcast Tuesday.

“For 2012 and continuing this year,  bank profitability is the highest since 2006, so there’s an appearance that the banking industry has recovered” since the financial crisis, Reynolds said. But that positive news needs to be tempered somewhat. Some of that profitability was accomplished by lowering expenses as opposed to outright growth, he said.

Although bank loan portfolios are growing on the back of slight increases in retail borrowing, including mortgages, said Walter Smiechewicz, a managing director in risk assurance at PricewaterhouseCoopers, it’s important for internal auditors not to be overly complacent.

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For example, auditors need to be aware when a loan growth begins to slow, since this can often be followed by a slippage in bank underwriting standards. That can lead to less profitable loans being brought onto the balance sheet, Smiechewicz said.

Addressing internal auditors on the call, Kenneth Peyer, a managing director in the financial services risk and regulatory practice at PwC, added, “You need to be able to raise your hand at the appropriate time if you see the lending function beginning to take on more risk.” Internal auditors, he noted, also need to provide an independent opinion on such matters to the board of directors.

What are the best ways to keep an eye on banks? Smiechewicz recommended that the chief audit executive (CAE) conduct an internal audit of a bank’s loan pricing systems and perform an internal audit of the bank’s loan review department “with a focus on covenant protection and monitoring.”

Additionally, Smiechewicz said that conducting an internal audit of new product risks and approval processes is also helpful. Banks, he said, often pursue new lending products or services that present unfamiliar risks, especially when margins are under pressure.

CAEs also need to sharpen their monitoring capacity to comply with regulators and trade groups that have upped their focus on revamping internal audit functions.

Revised internal audit standards that went into effect at the start of the year by the Institute of Internal Auditors (IIA), for example, give more weight to CAEs and help to bring the internal audit function closer to boards of directors.

Similarly, in May the Committee of Sponsoring Organizations of the Treadway Commission (COSO), an organization comprised of accounting associations, developed a more thorough look at internal controls for corporations. COSO is recommending that companies start using its revised framework as soon as feasible.