Internal Audit for MFI

Internal Audit for MFI -1- © Hong Ry, Senior Internal Auditor

INTERNAL AUDIT for MFIs

&'

Reorganized by Hong Ry, Senior AuditorPhnom Penh, Cambodia


OBJECTIVES: INTERNAL AUDIT

Understand the various risks faced by MFIsAppreciate the role of a robust control environment in mitigating risksDescribe various components of control environment and distinguish between themEvaluate internal checks within their organizations


OBJECTIVES: contd.

Understand the scope and role of internal auditsAssess the existing organizational policiesEvaluate the management information system of their organizationsFormulate internal audit plansConduct internal auditsControl fraud Report the findings in a systematic manner


RISK MANAGEMENT


Operational

Credit, Fraud, Inefficiency, Security etc.

Financial Management

Liquidity, Interest Rate etc.

External

Natural Calamities

Institutional

Mission Drift


Risk Management: A Systematic Approach

Identifying

Measuring

Mitigating

risks in an MFI


Risk Management

Internal Control

Internal Audit

External Audit


Risk Management Process Feedback Loop

1. Identify, assess and prioritize risks

2. Develop strategies to measure risk

3. Design policies and procedures to mitigate risks4. Implement

and assign responsibility

5. Test effectiveness and evaluate results

6. Revise policies and procedures


Assess and Prioritize the Risks

Quadrant 1-

High Frequency (Probability), Low Impact: Typical loan losses; Petty fraud

Quadrant 2-

High Frequency (Probability), High Impact: Losses from high risk business loans in one sector

Quadrant 3-

Low Frequency (Probability), High Impact: Fires, Natural disasters, wire transfer fraud, computer crime.

Quadrant 4-

Low Frequency (Probability), Low Impact: Refunds of service charges errors


Develop Strategies to Manage the Risk

• Avoid the risk

• Transfer the risk

• Accept the risk

• Control or mitigate the risk (in-house)


Assess and Prioritize the Risks


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


Risk Trade OffsRisk 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.



Internal Controls can be

•Preventive

•Detective

•Corrective


INTERNAL AUDIT


Risk Management

Internal Control

Internal Audit

External Audit


Internal Audit External Audit

Employee of MFI Independent Contractor

Serves the needs of the MFI Also serves third parties

Focuses on past and future events by evaluating controls to ensure achievement of goals

Focuses on whether statements reflect historical events clearly and accurately

Is directly concerned with preventing fraud

Incidentally concerned with fraud controls


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


The MFI

PEOPLE

Technology Systems and Procedures

Mission and Values

Organizational Structure


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 management’s 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

Branch Cashier

Branch Auditor Credit Officer Savings Officer

Branch Manager Branch Manager

Operations Manager

Internal Auditor

Cashiers Bookkeepers

Accountant

Finance Manager IS Manager

Human Resource Manager

General Manager


Approve MEDo MYSELFRecord I


Policies – indicate directionProcedures – tell how to implement and follow the policies

Effective Policies and Procedures are

WrittenSimple/Clear

AvailableUnderstood

Relevant andUP TO DATEImplemented

POLICIES AND PROCEDURES


Characteristics of good controls

• Timeliness• Economy• Accountability• Placement• Flexibility• Cause Identification• Appropriateness


Limitations of Internal Control

• Judgment• Breakdowns• Management Override• Collusion• Costs• People


INFORMATION SYSTEMS


INFORMATION

IS THE PILLAR

INSTITUTIONOF ANY MICROFINANCE


DataUnprocessed basic facts about the activities of a business that give no insight by themselves

InformationData 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 the Decision

Information Source(Who/How/Where)

Disbursing aLoan

Cash Flow PositionClient Profile Client Repayment RecordLoan Application FormLoan Officer Details andRecommendation

AccountingClient RecordsClient Records Loan ManagementrecordsLoan Officer Reports


Information System

The series of actions involved in: capturing raw data from various sources,processing the data into usable information,storing the information anddisseminating information in the form needed.”


Auditors

Tellers

Encoders

Bookkeepers

Managers

Clients

Loan Officers

Portfolio Management

System

Portfolio Management

System

Deposit Tracking System

Deposit Tracking System

Customer Information

System

Customer Information

System

Accounting System

Accounting System

Human Resource System

Human Resource System

Information System

Decisionor

Action

Processes or People Seeking

Information

Data Capture Processing Storage Information Reporting


IA5 – O6

Name of Branch : _______________ MonthName of Field Staff: _____________ Center No

Loan collection

Interest collection

Savings collected

Savings withdrawn

Loan collection

Interest collection

Savings collected

Savings withdrawn

Loan collection

Interest collection

Savings collected

Savings withdrawn

Loan collection

Interest collection

Savings collected

Savings withdrawn

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

Collection Sheet

Date__________ Date__________ Date__________ Date__________


Name of Branch : _______________ Week Ending IA5 – O7Name of Field Staff: _____________ Date: Center No ____________________

Loan ID Loan Amount Principal Outstanding Principal

Overdue Interest Overdue

Age of overdue

Principal Prepayments

Interest Prepayments

Current Principal Due

Current Interest Due

Principal Demand

Interest Demand Principal

collected Interest Collected

Fee collected

Principal Outstanding

Principal overdue

Interest overdue

Age of overdue

Principal Prepayments

Interest 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

Collection Sheet

Date of disbursement Opening Balances During the week Closing balance


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

CONFIDENTIALITY

INTEGRITY

AUTHENTICITY

NON-

REPUDIABILITY

AVAILABILITY


MANAGEMENTCONTROLS

ORGANISATIONAL CONTROLS

OPERATIONAL CONTROLS

APPLICATIONCONTROLS

KEY CONTROLS IN A COMPUTERISED ENVIRONMENT


AUDIT PROCESS


The Audit ProcessInspection of documents and recordsInspection of documents and records

Physical inspectionPhysical inspection

Observation/sObservation/s

InquiryInquiry

ConfirmationConfirmation

Computation & retracingComputation & retracing

Analytical proceduresAnalytical 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

How ?

• 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


Types of documentary evidence

External Documentsusually prepared outside the MFI most reliable documentExamples include purchase invoices, insurance policies, pay-in-slips

Internal Documents (validated)

validated by independent source/s fairly reliableExamples include signed vouchers for payment of loan (acknowledged receipt by clients)

Internal Documents (invalidated)

without independent validation limited reliance, that depends primarily upon the existence of ‘Internal Control’ systemExamples 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

Observation• Witness a performance of processes on site• Ascertain the compliance of procedures• Useful step, if observations are recorded in descriptive form

InquiryInformation seeking from knowledgeable internal & external source/sMay be oral OR writtenHelps obtain understanding of the system through which the economic information is generated


Key Analysis AreasAuthenticity(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


Computation and retracing

• Checking arithmetical accuracy of record/s

• Done via re-computation and retracing


Analytical procedures

• Analysis of significant ratios and trends,

and investigation of reasons therein

• Involve comparisons & study of

relationships

• Overall tests, rather than details


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)


Bank reconciliation statementPositive Negative

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


IA6-H9 Portfolio At Risk Collection Sheet of Micro Fund: Basic Information

Current week: 42

0-4 weeks 4-8

weeks 8-12

Weeks More than 12 weeks

1 5 10,000 200 7,200 36 37 41 1 200 2,800 2,800

2 10 6,000 120 3,840 32 32 42 - 2,160

3 11 8,000 160 4,160 26 31 37 5 800 3,840 3,840

4 14 12,000 240 4,560 19 28 33 9 2,160 7,440 7,440

5 18 10,000 200 5,000 25 24 42 - 5,000

6 22 12,000 240 4,800 20 20 42 - 7,200

7 26 4,000 80 1,280 16 16 42 - 2,720

8 30 8,000 160 1,920 12 12 42 - 6,080

9 34 10,000 200 1,600 10 8 42 - 8,400

10 40 6,000 120 120 1 2 41 1 20 5,880 5,880

Total 86,000 34,480 3280 51,520 8,680 3,840 7,440 -

Number of weeks in default

Principal outstanding

Amount past due

Principal at Risk

Loan cctt

Week of loan

disbursem ent

Amount of loan

disbursed Instalment

size Amount

paid

Number of instalments

paid

Number of Instalments

due

Week of last

payment


SAMPLING


Sampling Methods

Statistical Sampling Non-statistical Sampling

•Simple Random Sampling

•Systematic Sampling

•Stratified Sampling

•Cluster Sampling

•Judgement Sampling

•Convenience sampling


Simple Random SamplingEach item in the population has an equal chance of being included in the sample

1 2 3 4 5 6 7 8 9 10 11 12 13

1 1 1 1 1 1 2 2 2 2 2 2 2

2 2 2 3 3 3 3 3 3 3 3 3 3

4 4 4 4 4 4 4 4 4 4 5 5 5

5 5 5 5 5 5 5 6 6 6 6 6 6

Population

Sample4 6 3 1 1


Systematic SamplingElements are selected from the population at a uniform interval that is measured in time, order or spacePopulation1 2 3 4 5 6 7 8 9 1 1 1 1

1 1 1 1 1 1 2 2 2 2 2 2 2

2 2 2 3 3 3 3 3 3 3 3 3 3

4 4 4 4 4 4 4 4 4 4 5 5 5

5 5 5 5 5 5 5 6 6 6 6 6 6

Sample

2 1 2 3 4 5 6


Stratified SamplingWe first divide the population into relatively homogeneous groups called strata. Then we select items proportionately, from each stratum randomly

1 2 3 4 5 6 7 8 9 1 1 1 1

1 1 1 1 1 1 2 2 2 2 2 2 2

2 2 2 3 3 3 3 3 3 3 3 3 3

4 4 4 4 4 4 4 4 4 4 5 5 5

5 5 5 5 5 5 5 6 6 6 6 6 6

Sample4 2 3 4 5

Population

I

II

III

IV

V


Cluster SamplingWe 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

1

1

1

2

3

2

1

2

2

3

3

1

2

3

3

4

1

2

3

4

5

1

2

3

4

6

1

2

3

4

7

1

2

3

4

8

1

2

3

4

9

1

2

3

4

Sample

PopulationI II III IV V VI VII VIII IX

4 1 2 3 4


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


FRAUDS


WHAT IS FRAUD ?

“The risk of loss of earnings or capital as a result of intentional deception by an

employee or client.”


WHAT ARE THE MOST COMMON TYPES OF MFI FRAUD ?Fictitious loans

Kickbacks

Cash theft

Collusion in issuance of loans

Manipulation of financial data


FRAUD DETECTION SIGNALS

Increase in delinquency

Accounting irregularities

Employee tips


CORE

VALUES

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 objectivesfor implementation

4.Hire staff who share the core values

5.Train and Equip Staff

REDUCING THE LIKELIHOOD OF FRAUD


REDUCING THE LIKELIHOOD OF FRAUD

• Market Pricing

• Simplicity of operations

• Transparency


Preventing a fraud must be an element in several phases of the lending process !!!

LENDING PROCESS

Loan Monitoring

Supervision

SanctionsLoan Origination


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


Internal Audit REPORT WRITING

Internal Audit REPORT WRITINGGeneral Standards of Report Writing is 5C’s

1. Complete2. Clear3. Concrete4. Correct5. Concise


Condition/ Finding Criteria Rate Implication Recommandation

Interestcalculation forloan #101 wasshort $2/permonth.

Interest onthis loanshould be$10/permonth.

The MFI lost $2per month overthe past threemonths, for atotal loss of $6.

Remind loanofficers that interestrates are updated atthe beginning ofeach month.

Internal Audit REPORT Format


THANKS

Nothing is right unless it is proved right!


SOURCE DUCUMENT

INTERNAL AUDIT for MFIs26-29 MAY, 2008Phnom Penh, Cambodia