PAPS 1004: Bank Auditors & Banking Supervisors

Philippine Auditing Practice Statement (PAPS) 1004 Overview

• Prepared by the Auditing Standards and Practices Council (ASPC).
• Supplements Philippine Standards on Auditing (PSAs) to aid auditors or encourage best practices without holding the same authority as PSAs.
• Based on International Auditing Practices Statement (IAPS) 1004.
• IAPS 1004 was a collaboration with the Basel Committee on Banking Supervision and based on ISAs extant at October 1, 2001.
• Aims to enhance understanding and communication between banking supervisors and external auditors due to the increasing complexity of banking.

Purpose of the Statement

• Provides guidance on strengthening the relationship between bank auditors and supervisors for mutual benefit.
• Considers the Basel Committee's Core Principles for Effective Banking Supervision.
• Offers useful guidance on the roles of the Bangko Sentral ng Pilipinas (BSP) and banks' external auditors.

Contents of the Statement

• Describes the responsibilities of a bank's board of directors and management.
• Explores the role of the bank's external auditor.
• Examines the role of the Bangko Sentral ng Pilipinas (BSP).
• Reviews the relationship between the BSP and the bank's external auditor.
• Suggests ways external auditors can contribute to supervision.
• Addresses the need for dialogue between the BSP and accounting profession.

Introduction to Banking and Auditing

• Banks ensure the payment of goods and services and promote development of business.
• Banks' stability is a public interest matter because of the banks' vital role.
• Banks face prudential supervision by the BSP, unlike other commercial enterprises.
• External audits enforce standards of independence, objectivity, competence, due care, planning, and supervision.
• Auditors' opinions enhance financial statement credibility and reinforce confidence in the banking system.
• Increased banking complexity requires more demanding tasks of auditors and the BSP, leading to roles perceived as complementary.
• The BSP benefits from results of the auditors' audits.
• Auditors require bank information to discharge responsibilities efficiently.
• Mutual understanding between the BSP and auditors can improve audit and supervision effectiveness.

Roles and Responsibilities

• Roles and responsibilities for bank's board, management, auditors, and BSP come from the law, custom, and professional standards.
• The statement aims to remove misconceptions, enhance cooperative effectiveness.

Basel Core Principles

• The Basel Committee published "Core Principles for Effective Banking Supervision" in September 1997.
• The Core Principles serves as a benchmark for an effective international supervisory system.
• The PAPS was prepared with the Core Principles in mind.

The Bank’s Board of Directors and Management

• The bank's board and management have primary responsibility for the conduct of the bank's business.
• The board establishes strategic objectives, policies, and procedures.
• The board monitors and oversees management actions.
• Responsibilities include appointing qualified officers; establishing business strategies; prescribing corporate values; preventing illegal activities; establishing written policies; defining responsibilities; establishing checks and balances; monitoring management; adopting risk management policies; and forming an audit committee.

Management Responsibilities

• Managements prepares financial statements according to the Philippine GAAP.
• Managements ensure that sufficient supporting documentation, so that financial statements can remain in good standing.
• Ensures auditors have complete access to the information that’s necessary for an audit.
• The setup of audit committees addresses directors' practical challenges for internal control.
• Audit committees reinforce both the internal control system and internal audit functions.
• Internal and external auditors should be allowed to attend audit committee meetings.
• An internal audit function monitors internal control and risk management but must be operated independently.
• Regular reporting to board and management can address potential procedure improvements, and implementations.

The Banks Board of Directors

• The board of directors' and managements’ responsibilities do not diminish with the supervision of the BSP.
• An audit completed by an external bank auditor does not diminish responsibility either.

Objective of an Auditor

• The objective of the external auditor is an objective audit that is not misleading.
• Concluded by the accounting principles in the Philippines.
• Stated in the PSA 700 (Auditor's Report on Financial Statements).
• The auditor presents reports to involved parties.
• Auditors do not report on the efficiency of the management’s processes.

Audit Overview

• Auditors lower any risks of opinionated audits opinions.
• Auditors look for material misstatements.
• Auditors assess entities' risks for internal controls.
• After assessing risks, auditors perform procedures to lower audit risk.
• Procedures search for potential fraudulent activity, including misappropriation.

External Auditor Characteristics

• Banks have large sums of funds and instruments meaning they are subject to misappropriation and fraud.
• Banks must have well-defined procedures for rigorous controls.
• Banks conduct transactions cross-jurisdictionally.
• Banks have high leverage, increasing vulnerability to risk of failure.
• Banks' assets are quickly devalued and are often hard to determine.
• Loss of confidence may lead to depositors withdrawing and therefore a liquidity crisis.
• The Fiduciary Duties of the banks in the assets, such as procedure and internal control.
• Banks have high volume and value transactions and usually use IT.
• Banks operate in distributed departments.
• Transactions are digitally initiated by customers.

Additional Considerations

• Bank assume funds with no initial transfer.
• Governmental authorities regulate those banks, but they are often non-compliant.
• Firms may have customer relationships that impact their independence.
• Exclusive access to clearing and settlement systems may pose systemic risk.
• Banks may deal in complex financial instruments and need good valuation procedures.
• External auditors test internal controls and processes.
• Auditors must have an understanding of the valuation of loans and liabilities.
• It is in the best interest for an external auditor to assess risks.

External Audits

• External auditors decide on the nature/timing of audit procedures.

PSA 610

• PSA 610 dictates external auditors to check the work of internal auditors.
• Auditors must note things such as their technical competence and their organizational status.

PSA Judgement

• Judgement is important for auditors.
• Areas to consider are fraud, inherent risk, and control risk.
• Consideration for procedure effectiveness.
• Consider management assessments.
• The auditor must have reasonable assurance.
• Auditor's consideration will be based on the bank's decisions.
• Both the financial statement level and account balance levels are considered.

Overall Opinion

• Overall, auditors obtain reasonable assurance that financial statements are prepared with GAAP.
• Testing can be incomplete, and auditor judgements may be inconclusive.
• Fraud risks exist above risks of financial misrepresentation.
• External auditors must detect problems or failures.

Communications

• Auditors communicate certain supplemental information and audit findings.
• Required information to report to the BSP include: Findings involving dishonesty that reduce the capital funds by 1%
• Adjustments/potential losses accumulating to 1% bank capital
• Total bank assets are inadequate to cover liabilities

The Role of the BSP

• Objective of banking supervision is to maintain stability/confidence
• Regulation verifies compliance to laws that govern banking activities
• Licensing is a tool to identify/control entry to a banking system
• License requirements for BSP systems include suitable shareholders/board members, management that is honest/trustworthy, and consistent organizations/internal control.

BSP Systems

• BSP (continued) must have sufficient fluidity, capital, structure, and legality.
• Minimum numerical ratios determine capital/liquidity adequacy
• Regulation helps bank conduct business and overcome circumstances
• The BSP rejects proposals to transfer significant ownership
• The ongoing supervision of the BSP offers legal powers that can bring correction
• Legal power can also revolve a bank’s license

Capital Adequacy

• One of the foundations of all supervision is capital adequacy
• The Basel Committee proposes a three pillar framework of minimum capital, a review process, and market discipline
• The first pillar defines minimum requirements based on the risk (credit, market, operational)
• The second pillar relies on the fact that banks should have solvency and the ability to hold capital
• Banks must assess their current capital and profile
• The third pillar is market discipline.

Market Discipline Considerations

• Banks are subject to a variety of risks such as currency, market, risk, legal, liquidity, and credit.
• The BSP monitors/limits banking risk
• Systems of measurement will capture exposure to specific risks
• The systems are used for limits/controls

Other Bank Objectives

• The overall most significant is how obligations will be settled with customers.
• The BSP must manage credit risks
• Assess loan quality within their regulations
• Banks manage possible losses via policies and procedures.

Importance of valuations

• Assessing the quality of bank loans is difficult overall.
• However, an accurate valuation can determine accurate financial condition.
• Valuations often require judgements
• Proper valuations also fall on parts where the BSA performs.

Bank policies

• Banks need adequate controls, of which are internal, to assist.
• The management protects against all fraudulent activity.
• Bank should have proper security, accounting practices, and overall compliance.

E-commerce

• Real time computer systems have improved control capabilities.
• These systems can create additional risks of failure or fraud.
• E-Commerce introduces new controls/risks

Further Expectations

• The BSP is worried about overall business quality.
• Examiners look opportunity for management deficiencies.
• The BSP interviews management to understand operations/strategies.
• Contacts help the BSP assess information about competency.
• Effective supervision needs to collect information about supervised banks and review/analyze reports.

Validation

• The BSP validates their received information using external auditors/internal inspections.
• Inspections are structured to provide independent and verifiable data.
• Compliance with standards must meet criteria.

Committees

• The BSP authorities will periodically meet with banking’s audit board or committee.
• Board discusses effectiveness with the bank
• Supervisors ensure auditors are properly licensed, experienced, subject to quality control, and are objective.

Relationships

• The BSA has clear interest in banking/high standards.
• Contact is maintained with the ASPC.

Key Interests of Auditors and the BSP

• Both external auditors and the BSP need to consider main complementary concerns.
• The BSP looks to maintain the system/soundness to individual banks to protect users' financial statements to assess their condition.
• However, the auditor considers the appropriateness of those statements.
• The auditor also inquires about management knowledge cast.
• The BSP looks to maintaining standards of internal control as the basis, and this relates to external.
• BSP may want to check adequacies with consistent practices.

Further Considerations

• The BSP watches for audited financial statements used in the procedures.
• Supervisory needs are not a factor on why prepared
• An audit, done with a PSA, is designed to be free from material misstatement.
• Need appropriate accounting for GAAP
• Statements will contain judgement
• Financials are affected by events
• Auditors/banks may need control to prepare correct.

Dialogue

• Both BSP work can be useful, and communication helps this.
• Valuable insight goes into the banks overall operations.
• Insights can be beneficial from auditors (insights in management)
• Interview occurs, and findings are drawn.
• Reports need to be in writing for that records can be accessed.

Confidentiality

• Confidentiality by both parties is normal.
• It is recommended that both auditors/BSA take measures so neither parties can be liable.
• However, is this is not possible where management is included fraudulent conduct.
• The auditor must follow the law.

PSA 260

• PSA dictates those charged with governance must communicate to others.
• Many of the governance interest is likely of interest to the BSA.
• If no agreements, the auditor communication must be timely.

Overall considerations

• Actions on the auditor’s part can require urgent action by the BSP.
• Also relevant are:
  • Failures to fulfil bank licenses
  • Conflicts on key functions
  • Data on the auditors resignations
  • Changes can create risk.
• The auditor needs to ensure licensing, systems, organization, regulations, and applicable policies.

Cooperation

• The BSO/Internal auditors are encouraged to make supervisory processes efficient.
• The cooperation is based on periodic meetings.

Supervisory Processes

• If the BSP asks for an external auditor, there needs to be a context of well-defined framework found in an agreement.
• Supply accurate information to banks

Safeguarding

• Relationships can be safeguarded.
• Information between both parties are communicated on their own except for instances.
• BSP needs to request bank to acquire information that needed.
• Before the process, conflicts need to be resolved and approved before BSP.

Requirements

• The requirements must be specific/clear with what is needed.
• The measurement helps the auditor's report if standards have been achieved.
• If standards are required, the BSP needs to give standards for loans and classifications.
• Tasks that the BSA asks must be both practical/technical.
• The auditors can perform more economically with their specialized skillset.

Environments

• The way role can be extended depends on the environment.
• However, without careful guidance the auditor won't be able to judge if something is excessive.
• The auditors should avoid duplication overall with their analysis.

Dialogue

• The BSP should discuss current concerns on a continuous basis as a process.
• Discussions can be on areas of mutual concern
• This can help in judgements for BSP’s attitude/skill.
• Standard of auditors can also work or have a view on accounting policies.
• Discussions should include what policies exist.

Other discussions

• Talks should be about accounting issues and topical topics.
• These discussions assist most policies.
• The parties should have high interest in banks following uniform applications.

Effective Date

• As of December 31, 2003.

Acknowledgement

• This PAPS is formed under standards of banks external auditors.
• Changes were given based on banking systems.