Sharpening the Watchdog: Enhancing Internal Audits in Banks

By Enoch AKUFFU-DJOBI (PhD)

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Banks serve as the backbone of any economy, handling enormous amounts of capital, enabling the movement of finances from savers to borrowers, fostering investments, and propelling economic expansion.

However, in recent times, numerous scandals, instances of fraud, and bank failures within both the international and African banking sectors have unveiled an unsettling reality.

Internal audits frequently fall short of their intended effectiveness.

This brings up an essential query: Does the internal audit function within banks genuinely act as the independent, unbiased monitor it was intended to be, or has it devolved into just another routine compliance task?

The solution hinges on how earnestly financial institutions commit resources to, support, and implement their internal auditing mechanisms.

What is the problem?

Banks can collapse, similar to other businesses. However, when they falter, it can lead to wider consequences affecting clients, fellow financial institutions, local communities, and the overall economic market.

Customer funds might be held up, lending partnerships could fall apart, and business overdraft facilities used for payroll or supplier payments might not get extended. Furthermore, the collapse of a single bank has the potential to trigger further banking crises.

The internal audit serves as an internal check within financial institutions—to oversee activities, evaluate risks, and guarantee adherence to regulations.

Nevertheless, many prominent banking scandals worldwide have revealed considerable flaws in the efficacy and autonomy of internal audit departments.

The Wells Fargo fake account controversy in the United States alongside Wirecard’s financial deceit in Germany, Punjab National Bank’s SWIFT scam in India, and Danske Bank’s money laundering saga in Estonia highlight how internal auditors often overlooked evident red flags or were deprived of the necessary power and means to address these issues effectively.

These setbacks have resulted in billions of dollars in financial losses and eroded confidence in the worldwide banking sector.

Frequent problems consist of insufficient independence, audit personnel lacking qualifications, restricted scope, understaffed and underfunded audit teams, and an inability to address warning signs.

These examples illustrate that internal audits frequently function under limitations which can impede their capacity to stop or uncover fraudulent activities.

In order to rebuild confidence and minimize the chances of subsequent controversies, it is essential to reinforce the capabilities of internal audit departments, enhance their autonomy, and guarantee they possess the necessary resources and jurisdiction to adequately monitor intricate banking activities.

Why Internal Audit Matters

A well-functioning internal audit department acts as an early alert mechanism. It detects deficiencies in risk management, internal controls, and adherence to regulations before they escalate into major issues.

However, if the audit function is lacking in independence, resources, or enforcement, banks can become susceptible to fraud, regulatory violations, and harm to their reputation.

Case Study: Ghana — Cleaning Up the Banking Sector (2017–2019)

From 2017 to 2019, the Bank of Ghana rescinded the operating licenses of nine commercial banks along with numerous financial entities. One such institution was Capital Bank, which faced collapse as a result of poor management and inappropriate use of emergency funding. Inquiry findings indicated that internal auditing departments either overlooked or did not disclose irregularities in loan practices and unapproved investment activities, possibly because these issues were disregarded by senior leadership.

According to a 2020 report from the Bank of Ghana, internal auditors at numerous troubled banks often faced limitations in terms of independence, with their findings being modified or disregarded entirely by management.

Several audit committees within the board structures remained dormant, thereby diminishing oversight even more. This extensive failure in auditing processes resulted in a loss exceeding GHS 21 billion from taxpayers’ money allocated for recapitalization and recovery efforts.

Case Study: U.S. – Wells Fargo Fake Accounts Scandal

In the U.S., the Wells Fargo scandal from 2016 vividly illustrates the consequences of an ineffective internal audit system. More than 3.5 million fake accounts were created by staff aiming to achieve stringent sales goals.

Reportedly, internal auditors flagged concerns about these practices; however, senior management either dismissed or overlooked the alerts.

According to a report from the U.S. Office of the Comptroller of the Currency (OCC), Wells Fargo’s internal auditing department was lacking sufficient authority and impact to effectively counteract and deter misconduct within the company. This shortcoming resulted in significant financial penalties totaling billions of dollars, extensive job cuts, and severe damage to the bank’s reputation.

Frequent Flaws in InternalAudit Mechanisms

\xa0Lack of Independence:

At numerous banking institutions, internal auditors provide reports to senior management rather than directly to the board, which can result in potential conflicts of interest.

\xa0Under-Resourcing:

Frequently, audit teams do not have the necessary skilled staff or digital resources to identify complex fraudulent activities.

Ignored Recommendations:

Frequently, audit findings do not receive prompt action—or any action at all. In the absence of repercussions, audit reports become less influential.

\xa0Cultural and Ethical Challenges:

Fear of retaliation or pressure from top executives may silence auditors, especially in family-owned or politically connected banks.

What Should Change?

To avoid future failures, financial institutions should reinforce their internal audits through:

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  Ensuring independence:
  
  The auditors ought to present their findings to the board’s audit committee rather than directly to the CEO.
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  Investing in capacity:
  
  Expert auditors who have access to data analytics tools can identify problems at an early stage, earning competitive salaries.
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  Enforcing accountability:
  
  Members of the board and executives ought to be held accountable when they disregard warning signs from audits.
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  Adopting a risk-based approach:
  
  The emphasis should be on critical areas such as credit approval, cybersecurity, and procurement.
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  Regular external reviews:
  
  Regulators should mandate independent reviews of internal audit performance.

Conclusion: Empower the Watchdogs

Regardless of whether you’re in Ghana, the United States, or elsewhere, internal auditing serves as an essential defense against mismanagement and fraudulent activities. However, this function remains effective solely when auditors maintain their independence, authority, and respect within the organization. Financial institutions should cease perceiving internal audits merely as a routine requirement and instead recognize them as crucial instruments for ensuring sustainable growth over the long term.

Without a robust internal audit, another bank failure might simply be inevitable.
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Enoch holds credentials as a Chartered Accountant and Certified Banker and has a strong enthusiasm for fields such as accounting, banking, and corporate governance. With experience in teaching and professional practice, he demonstrates dedication to research and disseminating information. You may contact him at enakuffu@gmail.com.
Contact: +233244201383.

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