By: Jeanette McKeever, CCBIA, Consultant & Internal Audit Operations Manager

There is risk in every aspect of the banking industry and the regulatory environment seems to continually change. As to the governance and control functions of the banking industry, it may be refreshing to the board of directors, audit committee, and executive management to have their internal audit function re-assessed and validated though a fresh set of eyes to assure that the controls in place are functioning as intended.

A strong internal control system, including an independent and effective internal audit function, is part of sound corporate governance. The board of directors, audit committee, senior management, and supervisors must be satisfied with the effectiveness of the bank’s internal audit function, that policies and practices are followed, and that management takes appropriate and timely corrective action in response to internal control weaknesses identified by internal auditors. An internal audit function provides vital assurance to a bank’s board of directors (which ultimately remains responsible for the internal audit function, whether in-house or outsourced) as to the quality of the bank’s internal control system. In doing so, the function helps reduce the risk of loss and reputational damage to the bank.

All internal auditors (whether in-house or outsourced) must have integrity and professional competence, including the knowledge and experience of each internal auditor and of team members collectively. This is essential to the effectiveness of the internal audit function.

We encourage bank internal auditors to comply with national professional standards, such as those issued by the Institute of Internal Auditors, and to promote due consideration of prudent issues in the development of internal audit standards and practices.

The scope of the internal audit function’s activities should ensure adequate coverage of matters of regulatory interest within the bank’s audit plan.  Regular communication by the audit committee, management, and affected personnel is crucial to identify the weaknesses and risk associated to assure that timely remedial actions are taken.

Young & Associates, Inc. can independently assess the effectiveness and efficiency of the bank’s internal controls and processes to provide value and assurance that the internal control structure in place operates according to sound principles and standards.

For more information on how we might provide internal audit services specific to your bank’s needs, whether it is outsourced or co-sourced, please contact me at 1.800.525.9775 or e-mail jmckeever@younginc.com.

By: Martina Dowidchuk, Senior Consultant

Does your liquidity management meet the standards of increased regulatory scrutiny?

What was once deemed acceptable is gradually coming under a more rigid review, and financial institutions need to be prepared to show that their liquidity risk oversight complies with both supervisory guidance and sound industry practices.

The liquidity risk may not be among the areas of community banks’ immediate concern given the abundance of liquidity in the banking industry today. However, the history shows that liquidity reserves can change quickly and the changes may occur outside of management’s control. A bank’s liquidity position may be adequate under certain operating environments, yet be insufficient under adverse environments. Adequate liquidity governance is considered as important as the bank’s liquidity position. While the sophistication of the liquidity measurement tools varies with the bank’s complexity and risk profiles, all institutions are expected to have a formal
liquidity policy and contingency funding plan that are supported by a liquidity cash flow forecast, projected liquidity position analysis, stress testing, and dynamic liquidity metrics customized to match the bank’s balance sheets.

Some of the common liquidity risk management pitfalls found during annual independent reviews include:

Cash Flow Plan

• Lack of projected cash flow analysis
• Inconsistencies between liquidity cash flow assumptions and strategic plan/budget
• Lack of documentation supporting liquidity plan assumptions
• Overdependence on outdated static liquidity ratios and lack of forward-looking metrics
• Lack of back-testing of the model

Stress Scenarios

• Stress testing of projected cash flows not performed
• Stress tests focusing on a single stress event rather than a combination of stress factors
• Stress tests lacking the assessment of a liquidity crisis impact on contingent funding sources
• Insufficient severity of stress tests

Contingency Funding Plan Document

• Contingency funding plan failing to address certain key components, such as the identification of early warning indicators, alternative funding sources, crisis management team, and action plan details
• Lack of metrics defined to assess the adequacy of primary and contingent funding sources in the baseline and stressed scenarios

Liquidity Policy

• Inadequate risk limits or lack of acceptable levels of funding concentrations defined in the liquidity policy
• Liquidity policy failing to address responsibilities for maintenance of the cash flow model, model documentation, periodic assumption review, and model validation

Management Oversight

• ALCO discussions related to liquidity management not containing sufficient detail and not reflected appropriately in the ALCO meeting minutes
• Lack of periodic testing of the stand-by funding lines
• Lack of liquidity model assumption review or documentation of such review
• Lack of periodic independent reviews of the liquidity risk management process

If you are interested in an independent review of your existing liquidity program and a model validation or are looking for assistance with developing a contingency funding plan, liquidity cash flow plan, and liquidity stress testing, please contact me at 1.800.525.9775 or mdowidchuk@younginc.com. Young & Associates, Inc. offers an array of liquidity products and services that can help you to ensure compliance with the latest regulatory expectations.