A review of the audits of 13 British banks and building societies by the UK’s Financial Reporting Council (FRC) has found ten of the audits examined to be either good or requiring limited improvements, while one required improvements and a further two were in need of significant improvements.
Published today, the review centred on the quality of the audit of the banks’ loan loss provisions and related IT controls. The results painted a picture of mixed progress in the much discussed area of bank audits, where qualitative improvement continues to coexist with areas still in need of improvement.
Announced in December 2013 and published today, the publication noted improvements in the quality of the audits, particularly noticeable within firms identified by the FRC as having had significant issues in recent years.
The thematic review was prompted by concerns around the lagging pace of improvement in the standards of bank and building society audits, particularly in the area of loan loss provisions and IT controls.
The concerns were aired following the FRC’s 2013 annual Audit Quality Inspection report, which pointed to the need for improvements in the quality of financial institutions audits as an area of "key concern".
In the majority of audits reviewed, the FRC questioned the consistency of the audit testing’s quality, including controls, substantive and IT testing. Although in most cases the effects of inconsistencies did not have a significant impact on the overall audit, according to the FRC the issues show auditors failing to consistently apply "a sufficient degree of challenge".
The review also showed improvements in these processes are not being identified by internal quality control procedures.
According to the FRC, however, one of the main takeaways of the report is that, given the necessary focus and resources, good quality audits can be achieved by most firms.
In particular, it found that firms with banking sector experience and updated specialist IT knowledge "are able to audit loan loss provisions to a good standard."
In light of the publication’s findings, FRC executive director Paul George said: "I am pleased to note the improvements achieved by many audit teams outlined in this report."
He added the review’s outcome: "reflects investment in sector specific procedures and focus by the firms in addressing concerns previously highlighted by the FRC."
However, he warned: "There is no room for complacency and we expect all audit firms to achieve consistently high quality."
Change yet to come
George’s comments were echoed by Institute of Chartered Accountants in England and Wales (ICAEW) head of financial services faculty Iain Coke.
Despite acknowledging "encouraging" overall improvements in the quality of auditing of loan loss provisions, he said: "However, the review highlights further improvements that can be made. Auditors and audit committee chairs have to remain on their toes, be proactive and challenge management robustly."
Looking to the future, he added: "The new financial instruments accounting standard – with more forward looking loan loss provisioning – will result in big changes to the way banks recognise and provision for loan losses. Auditor judgment and challenge will become even more important." As such, he said: "making sure everybody on the audit team has the right skills will be critical."
In the past, the ICAEW has pointed to other bank assessment indicators, such as risks-weighted assets and capital ratios. As such factors are not audited, the institute has argued there are concerns over their "reliability and comparability" as a measuring instrument.
Coke explained: "While auditors need to continually improve audit quality, investors may see the biggest increases in the value of audit from extending the scope of audit to include other key performance indicators, for example risk-weighted assets."
FRC audit inspection continue to expose reoccurring threats