Internal Audit For Mfis: Reorganized by Hong Ry, Senior Auditor

INTERNAL AUDIT for MFIs
&'
Reorganized by Hong Ry, Senior Auditor
Phnom Penh, Cambodia
Internal Audit for MFI
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Hong Ry, Senior Internal Auditor
OBJECTIVES: INTERNAL AUDIT

Understand the various risks faced by MFIs Appreciate the role of a robust control environment in mitigating risks Describe various components of control environment and distinguish between them Evaluate internal checks within their organizations
Internal Audit for MFI -2 Hong Ry, Senior Internal Auditor
OBJECTIVES: contd.
Understand the scope and role of internal audits Assess the existing organizational policies Evaluate the management information system of their organizations Formulate internal audit plans Conduct internal audits Control fraud Report the findings in a systematic manner
RISK MANAGEMENT
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Operational Credit, Fraud, Inefficiency, Security etc. Financial Management Liquidity, Interest Rate etc. External Natural Calamities
Institutional Mission Drift
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Risk Management: A Systematic Approach

Identifying Measuring Mitigating
risks in an MFI
Risk Management
Internal Control
Internal Audit
External Audit
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Risk Management Process Feedback Loop

1. Identify, assess and prioritize risks
6. Revise policies and procedures
2. Develop strategies to measure risk 5. Test effectiveness and evaluate results 4. Implement and assign responsibility
Internal Audit for MFI -8-
3. Design policies and procedures to mitigate risks
Assess and Prioritize the Risks
Quadrant 3Low Frequency (Probability), High Impact: Fires, Natural disasters, wire transfer fraud, computer crime. Quadrant 4Low Frequency (Probability), Low Impact: Refunds of service charges errors
Quadrant 2High Frequency (Probability), High Impact: Losses from high risk business loans in one sector Quadrant 1High Frequency (Probability), Low Impact: Typical loan losses; Petty fraud
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Develop Strategies to Manage the Risk

Avoid the risk Transfer the risk Accept the risk Control or mitigate the risk (in-house)
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Assess and Prioritize the Risks
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RISK MANAGEMENT AND THE NEED FOR BALANCE Risk and return are opposite sides of the same coin The greater the risk, the greater the potential for gain and loss The lower the risk, the lower the potential for gain and loss
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Risk Trade Offs

Risk trade-offs occur when one type of risk is substituted for another, Examples of trade-offs: By outsourcing transfers to Western Union, MFI shifts from operational risk to counterparty and reputation risk and reduces operational risks By linking its clients to an insurance company, MFI shifts the actuarial and operational risks and in turn accepts counterparty and reputation risk By deciding to take security for its credit exposures, MFI converts credit risk into operational as well as market risk Trying to eliminate human error by computerization is replacing one form of operational risk with another.
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Internal Controls can be
Preventive Detective Corrective

INTERNAL AUDIT
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Risk Management
Internal Control
Internal Audit
External Audit
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Internal Audit Employee of MFI Serves the needs of the MFI Focuses on past and future events by evaluating controls to ensure achievement of goals Is directly concerned with preventing fraud
External Audit Independent Contractor Also serves third parties Focuses on whether statements reflect historical events clearly and accurately Incidentally concerned with fraud controls
-18 Hong Ry, Senior Internal Auditor
INTERNAL AUDIT
is a systematic, objective appraisal of the diverse operations and controls within an organization to determine whether: Financial and operating information is accurate and reliable Risks to the enterprise are identified and minimized External regulations and acceptable internal policies are followed Satisfactory operating criteria are met Resources are used efficiently and economically and The organizations objectives are effectively achieved All for the purpose of assisting members of the organization in the effective discharge of their responsibilities.
Internal Audit function

Acts independently Reviews transactions in the field, compares actual procedures with those documented, frequently reports to the board through written reports and presentations. reports on open items from previous audits
INTERNAL CONTROL
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The MFI
Mission and Values Organizational Structure
PEOPLE
Technology Systems and Procedures
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INTERNAL CONTROLS
The system of internal control is the plan of organization and all the methods and procedures adopted by the management of an entity to assist in achieving managements objective of ensuring, as far as practicable, the orderly and efficient conduct of its business. It constitutes of:
Organisation Structure Segregation of Duties Management Authorisation and Approval Arithmetical and Accounting Physical Security Personnel Policies and Procedures
MY MFI
Board of Directors General Manager
Human Resource Manager
Operations Manager
Finance Manager Internal Auditor
IS Manager
Branch Manager
Branch Manager
Branch Auditor
Credit Officer
Savings Officer
Accountant
Branch Cashier
Internal Audit for MFI -24-
Cashiers
Bookkeepers
Approve Do Record
ME MYSELF I
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POLICIES AND PROCEDURES

Policies indicate direction Procedures tell how to implement and follow the policies
Effective Policies and Procedures are
Written Simple/Clear Available Understood Relevant and UP TO DATE Implemented

Characteristics of good controls

Timeliness Economy Accountability Placement Flexibility Cause Identification Appropriateness
Limitations of Internal Control

Judgment Breakdowns Management Override Collusion Costs People
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INFORMATION SYSTEMS
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INFORMATION
IS THE PILLAR
OF ANY MICROFINANCE INSTITUTION

Data
Unprocessed basic facts about the activities of a business that give no insight by themselves
Information
Data transformed into a meaningful form that helps someone to make sound, quality decisions or to gain insight.
Information and Decision Making

Decision Information Needed to Make Information Source the Decision (Who/How/Where) Accounting Client Records Client Records Loan Management records Loan Officer Reports
Disbursing a Cash Flow Position Loan Client Profile Client Repayment Record Loan Application Form Loan Officer Details and Recommendation
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Information System
The series of actions involved in: capturing raw data from various sources, processing the data into usable information, storing the information and disseminating information in the form needed.
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Information System
Loan Officers Accounting Accounting System System Tellers Portfolio Portfolio Management Management System System
Encoders
Processes or People Seeking Information
Bookkeepers
Deposit Tracking Deposit Tracking System System
Decision or Action
Managers Customer Customer Information Information System System
Clients
Auditors
Human Resource Human Resource System System
Data Capture
Processing
Storage
Information Reporting
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IA5 O6
Collection Sheet
Name of Branch : _______________ Name of Field Staff: _____________ Center No Date__________ Date__________ Date__________ M onth
Date__________
Loan Interest collection collection Group 1 Laxmi M ahalakshmi Parameswari M eenakshi Rajammal
Savings collected
Savings withdrawn
Loan Interest Savings Savings Loan Interest Savings Savings Loan Interest Savings Savings collection collection collected withdrawn collection collection collected withdrawn collection collection collected withdrawn
Group Total Group 2

Pushpavalli Gandhimathi Amsavalli Shanthi M ariammal
Group Total Group 3

Rajeswari Venkateswari Velmani Pushpavalli Rajalakshmi
Group Total Center Total
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Collection Sheet
Name of Branch : _______________ Name of Field Staff: _____________ Center No ____________________ Loan ID Loan Amount Date of disbursement Opening Balances Principal Interest Age of Principal Overdue Overdue overdue Prepayments During the week Interest Current Current Principal Interest Principal Prepayments Principal Interest Demand Demand collected Due Due Week Ending Date: IA5 O7
Principal Outstanding
Interest Collected
Fee collected
Principal Outstanding
Principal overdue
Closing balance Interest Age of Principal Interest overdue overdue Prepayments Prepayments
Group 1 Laxmi Mahalakshmi Parameswari Meenakshi Rajammal Group Total Group 2 Pushpavalli Gandhimathi Amsavalli Shanthi Mariammal Group Total Group 3 Rajeswari Venkateswari Velmani Pushpavalli Rajalakshmi Group Total Center Total
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Key aspects of good recording

Should capture all relevant information Should not duplicate recorded data Should take the minimum possible time Should be easy to fill up and understand
Issues in report design

Focus of contents Frequency of reporting Importance of timely information Importance of accurate and reliable information Levels of reporting appropriate level of aggregation for user Identification of reports Usability Regularity of design improvements
Features of a Good MIS

Reliability Timeliness User-friendliness Up-gradability Physical security Data back-up User-access rights
FEATURES OF A GOOD COMPUTERISED INFORMATION SYSTEMS
AVAILABILITY
CONFIDENTIALITY
NONREPUDIABILITY INTEGRITY
AUTHENTICITY
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KEY CONTROLS IN A COMPUTERISED ENVIRONMENT
MANAGEMENT CONTROLS
APPLICATION CONTROLS
ORGANISATIONAL CONTROLS
OPERATIONAL CONTROLS
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AUDIT PROCESS
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The Audit Process

Inspection of documents and records Inspection of documents and records Physical inspection Physical inspection
Observation/s Observation/s Inquiry Inquiry Confirmation Confirmation
Computation & retracing Computation & retracing Analytical procedures Analytical procedures
Inspection of documents and records

What is inspection? It is the examination of appropriate documents/vouchers to support each transaction Why is it important? Auditing technique for performing both compliance and substantive procedures Test the compliance of laid down procedures for processing/sanction of all documents, and its attestation by the concerned authority Cross-checks if all committed documents are transparent and are available to/for access by the client
How ?
Types of documentary evidence

usually prepared outside the MFI most reliable External Documents document Examples include purchase invoices, insurance policies, pay-in-slips
Internal Documents Examples include signed vouchers for payment (validated) of loan (acknowledged receipt by clients) Internal Documents (invalidated)
validated by independent source/s fairly reliable
without independent validation limited reliance, that depends primarily upon the existence of Internal Control system Examples include payment for misc. expenses at branch level, re-imbursement of personnel expenses
Physical inspection
Physical verification of cash & fixed assets Cash reconciliation of cash book & bank statement and corresponding cash amount Assets verify their usage surprise element eliminates the scope of manipulation Witness a performance of processes on site Ascertain the compliance of procedures Useful step, if observations are recorded in descriptive form
Observation
Inquiry
Information seeking from knowledgeable internal & external source/s May be oral OR written Helps obtain understanding of the system through which the economic information is generated
Key Analysis Areas

Authenticity (genuineness of document) Appropriateness (legitimacy of the transaction record) Authorisation (necessary approvals present) Classification (properly classified in records)
Remember to cross check for dates, client name, signatures, cutting & overwriting of amounts & identification and serial numbers
Confirmation
Corroboration of records by obtaining client information --- feedback system Reliable evidence Helps the auditor understand efficiency of controls and whether systems and policies are being properly implemented
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Computation and retracing

Checking arithmetical accuracy of record/s Done via re-computation and retracing
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Analytical procedures
Analysis of significant ratios and trends, and investigation of reasons therein Involve comparisons & study of relationships Overall tests, rather than details
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Comparisons
Involves comparing financial information with Corresponding information for a prior period Anticipated results such as budgets and forecasts Similar information for other MFIs/the mF sector
Study of relationships
Auditor studies relationships Among elements of financial information (such as PAR trends, fluctuations in OER, OSS) Between financial information and relevant non-financial information (PAR & growth rate)
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Bank reconciliation statement

Positive Balance as per the Ledger balance Bank charges levied 3 but not yet recorded Bank interest given 5 but not yet recorded Cheques issued 2,000 but not yet presented for clearance Cheques deposited in the bank 3,123 but not yet realised Cheques deposited 2,030 wrongly entered in the ledger as 3,020 Subtotals Balance as per the Bank statement
Negative
IA 6-H9
Portfolio A Risk Collection Sheet of Micro Fund: B Inform t asic ation Current week: 42
W of eek loan A ount of m Loan disbursem loan Instalm ent A ount m paid cctt ent disbursed size
Principal at Risk Num of ber instalm ents paid Num of ber Instalm ents due W of Num eek ber last of weeks paym ent in default A ount m past due Principal outstanding 0-4 weeks 4-8 weeks 8-12 More than W eeks 12 weeks
1 2 3 4 5 6 7 8 9 10 Total
5 10 11 14 18 22 26 30 34 40
10,000 6,000 8,000 12,000 10,000 12,000 4,000 8,000 10,000 6,000 86,000
200 120 160 240 200 240
7,200 3,840 4,160 4,560 5,000 4,800
36 32 26 19 25 20 16 12 10 1
37 32 31 28 24 20 16 12 8 2
41 42 37 33 42 42 42 42 42 41
1 5 9 1
200
2,800 2,160
2,800
800 2,160
3,840 7,440 5,000 7,200 2,720 6,080 8,400
3,840 7,440
80 1,280 160 1,920 200 1,600 120 120 34,480
20 3280
5,880 51,520
5,880 8,680 3,840 7,440 -
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SAMPLING
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Sampling Methods
Statistical Sampling
Non-statistical Sampling
Simple Random Sampling Systematic Sampling Stratified Sampling Cluster Sampling Internal Audit for MFI -56-
Judgement Sampling Convenience sampling
Simple Random Sampling

Each item in the population has an equal chance of being included in the sample Population
1 1 2 4 5 2 1 2 4 5 3 1 2 4 5 4 1 3 4 5 5 1 3 4 5 6 1 3 4 5 7 2 3 4 5 8 2 3 4 6 9 2 3 4 6 10 2 3 4 6 11 2 3 5 6 12 2 3 5 6 13 2 3 5 6
Sample
4 6 3 1 1
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Systematic Sampling
Elements are selected from the population at a uniform interval that is measured in time, order or space Population
1 1 2 4 5 2 1 2 4 5 3 1 2 4 5 4 1 3 4 5 5 1 3 4 5 6 1 3 4 5 7 2 3 4 5 8 2 3 4 6 9 2 3 4 6 1 2 3 4 6 1 2 3 5 6 1 2 3 5 6 1 2 3 5 6
Sample
2 1 2 3 4 5 6
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Stratified Sampling
We first divide the population into relatively homogeneous groups called strata. Then we select items proportionately, from each stratum randomly Population
I II III IV V
Sample
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Cluster Sampling
We divide the population into groups, or clusters, and then select a random sample of these clusters. We assume that these individual clusters are representative of population as a whole
Population
I
1 1 1 2 3 2 1 2 2 3
II
3 1 2 3 3
III
IV
4 1 2 3 4 5 1 2 3 4
VI
6 1 2 3 4
VII
7 1 2 3 4
VIII
8 1 2 3 4
IX
9 1 2 3 4
Sample
4 1 2 3 4
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Judgemental Sampling
This requires professional judgement about the composition of the sample. Particularly useful for small samples
Convenience Sampling
Selection of units from the population is based on easy availability and accessibility. Useful when it is expensive or impractical to use statistical sampling methods
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FRAUDS
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WHAT IS FRAUD ?
The risk of loss of earnings or capital as a result of intentional deception by an employee or client.
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WHAT ARE THE MOST COMMON TYPES OF MFI FRAUD ?

Fictitious loans Kickbacks Cash theft Collusion in issuance of loans Manipulation of financial data
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FRAUD DETECTION SIGNALS

Increase in delinquency Accounting irregularities Employee tips
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REDUCING THE LIKELIHOOD OF FRAUD

1. Begin with stating the Core Values of the Institution: Justice/Fairness, Integrity, Quality, Commitment, Respect, etc 2.Set policies and procedures consistent with the values 3.Set strategies and objectives for implementation
CORE
4.Hire staff who share the core values
VALUES
5.Train and Equip Staff

REDUCING THE LIKELIHOOD OF FRAUD
Market Pricing Simplicity of operations Transparency
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Preventing a fraud must be an element in several phases of the lending process !!!
Loan Monitoring
Loan Origination
LENDING PROCESS
Sanctions
Supervision
WHEN ARE MFIs MOST VULNERABLE TO FRAUD?

Weak information and accounting systems Changing systems Late completion of reports Weak internal control system High employee turnover Non standardization of products & operations Loan officer handle cash Experiencing high growth
What are the Key Challenges?

Maintaining effective control of fraud without excessive cost or burdensome procedures as the program grows Maintaining high staff morale and culture of ethics in a large, growing program Maintaining awareness of new and more complex types of fraud as the MFI develops new products and becomes more sophisticated
INTERNAL AUDIT REPORT
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Internal Audit REPORT WRITING

Internal Audit REPORT WRITING General Standards of Report Writing is 5Cs 1. Complete 2. Clear 3. Concrete 4. Correct 5. Concise
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Internal Audit REPORT Format

Condition/ Finding Interest calculation for loan #101 was short $2/per month. Criteria Interest on this loan should be $10/per month. Rate Implication The MFI lost $2 per month over the past three months, for a total loss of $6. Recommandation Remind loan officers that interest rates are updated at the beginning of each month.
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Nothing is right unless it is proved right!

THANKS
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SOURCE DUCUMENT INTERNAL AUDIT for MFIs

26-29 MAY, 2008
Phnom Penh, Cambodia
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Internal Audit For Mfis: Reorganized by Hong Ry, Senior Auditor

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INTERNAL AUDIT for MFIs

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

OBJECTIVES: INTERNAL AUDIT

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

Institutional Mission Drift

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

Risk Management: A Systematic Approach

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

Risk Management Process Feedback Loop

6. Revise policies and procedures

3. Design policies and procedures to mitigate risks

Hong Ry, Senior Internal Auditor

Assess and Prioritize the Risks

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

Develop Strategies to Manage the Risk

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

Assess and Prioritize the Risks

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

Risk Trade Offs

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

Internal Controls can be

Preventive Detective Corrective

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

Internal Audit function

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

Internal Audit for MFI

Finance Manager Internal Auditor

Hong Ry, Senior Internal Auditor

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

POLICIES AND PROCEDURES

Effective Policies and Procedures are

Written Simple/Clear Available Understood Relevant and UP TO DATE Implemented

Characteristics of good controls

Internal Audit for MFI

Limitations of Internal Control

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

OF ANY MICROFINANCE INSTITUTION

Information and Decision Making

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

Internal Audit for MFI

Hong Ry, Senior Internal Auditor

Processes or People Seeking Information