Designing The Internal Audit Function At MFIs: Some Critical Issues…

Ramesh S Arunachalam

Rural Finance Practitioner  

Internal auditors play a very critical role in any organization and the same applies to micro-finance.

Role of Internal Auditors: The primary role of internal auditors is to independently and objectively review and evaluate an MFIs activities to maintain or improve the efficiency and effectiveness of risk management, internal controls, and corporate governance. They do this by:

·         Evaluating the reliability, adequacy, and effectiveness of accounting, operating, and administrative controls.

·         Ensuring that MFI internal controls result in prompt and accurate recording of transactions and proper safeguarding of assets.

·         Determining whether an MFI complies with laws and regulations and adheres to established policies.

·         Determining whether management is taking appropriate steps to address current and prior control deficiencies and audit report recommendations.

Internal auditors must understand an MFIs strategic direction, objectives, products, services, processes as well as clients to conduct these activities and make a judgement on the above. The auditors then communicate findings to the board of directors or its audit committee, who then will brief and discuss with senior management.

In addition, internal auditors often have a role in transformation activities. This role may include such duties as helping the board and management evaluate safeguards and controls, including appropriate documentation and audit trails, during the transformation process at the MFI – this is a very critical issue as many MFIs transform to become for profits from non-profits

Oversight and Structure: MFIs should conduct their internal audit activities according to existing professional standards and guidance. But how the internal audit function is accomplished depends on the MFI’s size, complexity, scope of activities, and risk profile, as well as the responsibilities assigned to the internal auditor by the board of directors.

In larger MFIs, a chief auditor and a full-time internal audit staff may accomplish the internal audit function. In other MFIs, the internal audit function may be accomplished by one or two employees or a holding company or even by an outside vendor. In many small MFIs, the officer or employee designated as a part-time auditor may also have operational responsibilities. In any case, to maintain independence, the person responsible for accomplishing the internal audit function should be independent of whatever area is being audited and should report findings directly to the board or its audit committee.

The audit committee should position the internal audit function in the institution’s organizational structure such that the function will perform its duties with impartiality and not be unduly influenced by managers of day-to-day operations. The ideal organizational arrangement is having the internal audit function report directly and solely to the audit committee regarding both internal audit issues and administrative matters, e.g., resources, budget, and compensation.

Some MFIs place the manager of internal audit under a dual reporting arrangement: functionally accountable to the audit committee for matters such as the design of audit plans and the review of audit scope and audit findings, while reporting to a senior executive on administrative matters. Such an arrangement potentially limits the internal audit manager’s independence and objectivity when auditing the senior executive’s lines of business. Thus, chief financial officer, controller, or other similar positions should generally be excluded from overseeing the internal audit activities even in a dual role. In structuring the reporting hierarchy, the audit committee should weigh this risk of diminished independence against the benefit of reduced administrative burden in adopting a dual reporting organizational structure. Under a dual reporting arrangement, the internal audit function’s objectivity and organizational stature is best served when the internal audit manager reports administratively to the chief executive officer.

That said, the best option of course is to ensure that the internal audit departmental head reports directly to the board or audit committee of the MFI, to ensure that all potential and real conflicts of interests are negated…

Have A Nice Day!