Examination of CFIs Introduction

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(No Transcript)
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Systemic Risk in Credit Union Networks and Tools
for Controlling It

• Presented by
• Normunds Mizis
• Project Director/Uzbekistan
• World Council of Credit Unions, Inc.
• May 29, 2005

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Definition

• Systemic Risk is a danger of decrease of trust
  in the system by members and potential members of
  credit unions due to operational deficiencies or
  failures by the credit unions.
• Control of the systemic risk is in the best
  interest of credit union boards and management.

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Tools for Controlling Risks

• Policies and Procedures
• Financial Performance Standards
• Plans and Budgets
• Internal Audit
• External Audit
• Supervision and Examination

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Internal Audit

• Implemented to provide General Membership with
  the assessment on the compliance of operations
  with statutes and regulations and provide quality
  control.
• Quality safeguarded having Audit Committee
  independent from the Board of Directors and
  management and elected directly by membership.

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External Audit

• Implemented to provide membership and general
  public and relevant government institutions with
  an independent assessment of the compliance with
  laws and regulations and certification of
  financial statements regarding their accuracy and
  reliability.
• Quality safeguarded thru professional
  associations and licensing of auditors.

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External Supervision

• Instituted to issue safety regulations in
  addition to legislation and statutes and enforce
  compliance on those regulations upon credit
  unions.
• Quality maintained thru creating professional
  supervisory authority legally responsible for
  controlling systemic risk and maintenance of
  safety of deposits. Authority given to replace
  management and boards as well as institute other
  regulatory actions, such as cutting access to
  loans and suspending savings mobilization.

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Internal Control

• Definition
• Internal Control is a coordination between
  accounting activities, employees duties and
  management procedures.

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Internal Control Key Components

• Key principles of operations
• adequate hiring of staff and appropriate training
• efficient communication and monitoring of
  performance
• defining responsibilities and rotating staff
• separation of recording transactions and managing
  funds

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Internal Control Purpose (1)

• Confirm compliance with
• Laws
• Regulations
• Bylaws
• Policies and Procedures
• Financial Performance Standards
• Plans and Budgets

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Internal Control Purpose (2)

• Prevention of fraud and detection of errors
• forgery and embezzlement
• omission of transactions
• false transactions
• inadequate accounting practices

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Internal Control Purpose (3)

• Prevention of fraud and detection of errors
  (contd)
• arithmetical and recording errors
• omission or incorrect data entry
• inadequate use of accounting procedures

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Internal Control - Assets

• Financial internal controls
• 1) asset control
• cash handling
• bank transactions and account reconciliation

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Internal Control - Assets

• Financial Internal Control (contd)
• 2) investment control
• confirm physical existence of securities
• verify terms and conditions of the investment
• determine quality of the portfolio

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Internal Control - Assets

• Financial Internal Control (contd)
• 3) Loan portfolio
• check for preferential treatment
• identify loan concentration and adequacy of
  collateral/guarantee
• check physical existence of loans granted
• assess efficiency of delinquent loan collection

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Internal Control - Assets

• Financial Internal Controls
• 4) accounts receivable and payable
• check records of CUs liabilities to third
  parties
• analyze accounts to see if adequate provisions
  have been created
• verify that CUs external loans are repaid
  according to the schedule or in advance in case
  of excess liquidity
• analyze the age of obligations and collections

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Internal Control - Assets

• Financial Internal Control
• 5) Fixed assets
• ensure that disbursements were budgeted for and
  do not exceed the authorized levels
• maintain inventory list and perform physical
  check
• write off unusable property
• liquidate unutilized fixed assets
• check if contracts for purchase, delivery and
  services have been fulfilled

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Internal Control - Assets

• Internal Financial Controls
• 6) Other assets
• establish control over accounts not covered
  elsewhere
• check all questionable accounts
• prevent embezzlement because of the lack of
  control

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Internal Control - Liabilities

• Internal Financial Controls
• Liabilities Control
• 7) savings
• analyze compliance with interest rate policies
• perform follow-up on member transactions from
  teller to accounting records
• check safety of files

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Internal Control - Liabilities

• Internal Financial Controls
• Liabilities Control
• 8) external borrowings
• confirm justification for external borrowing
• check efficiency of savings mobilization programs
• compare demand for loans, levels of external
  borrowings and growth of savings over the past
  periods
• evaluate expected loan demand for the future and
  compare it with the CUs loan financing strategy

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Internal Control - Liabilities

• Financial Internal Controls
• 9) Other Liabilities
• establish control procedures for accounts not
  covered in other sections
• identify transactions that are not usual for CUs
  operations

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Internal Control - Liabilities

• Financial Internal Control
• 10) Equity control
• analyze if capital ratio conforms to legal
  requirements and internal prudential standards
• check if surpluses are capitalized according to
  bylaws, capitalization strategies and decisions
  of policy makers
• check conformity of use of reserves according to
  legal provisions and goals of the CU

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Internal Control - Income

• Internal Financial Controls
• 11) Income control
• Compare effective return with the nominal return
  and delinquency level
• Check adequacy of fee income
• Assess adequacy of proceeds from fixed asset
  liquidation

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Internal Control - Expenses

• Internal Financial Control
• 12) expense control
• payments to suppliers to be made by non-cash
  transaction when possible
• check authorization of unusual expenses
• monitor expense trends in comparison to average
  assets

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Internal Control - Liquidity

• Internal Financial Control
• 13) liquidity control
• Track cash disbursements vs. cash collections
• compare average number of days for collecting
  receivables with number of days for settling
  payables

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Internal Control - Other

• Other procedures
• records and reconciliation
• electronic data processing
• document files
• safety
• quality of information

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External Audit

• Check compliance with Laws and Regulations
• Assess accounting process and verify accuracy of
  accounting information
• Certify financial statements

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Supervision

• Perform licensing
• Issue safety standards
• Implement on-site and off-site control
• Require compliance
• Take administrative actions, when necessary

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Examination Mechanism for Obtaining Accurate
Information

• Verification of CUs compliance with the
  existing legislation, regulations, performance
  standards and operational policies and procedures
  and assessment of the risks CU poses to its
  savers, creditors and to the CU network.

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Examination Objectives

• Evaluate CUs financial soundness (ratios)
• Apprise the quality of services, operations and
  management
• Evaluate source and use of funds, pricing
  strategies and protection against inflation,
  matching of earnings and costs and expenses
• Assess risk posed to the members/system
• Develop action plans, when necessary

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Pre-Examination Review

• Evaluate most recent financial statements and
  ratios and their trends
• Check critical documents in advance to get
  familiarized with the recent developments
• Set the time, discuss duration and present a
  scope of the examination

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Items Needed List for Examination

• Most Recent Balance Sheets
• Most Recent Income Statements
• Most Recent Management Reports and Financial
  Ratios
• Most Recent Delinquency Report
• CUs Operating Policies and Procedures or Most
  Recent Amendments to those Documents
• Most Recent Minutes by elected bodies

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Variable Scope Examination

• Examination is variable in scope
• Scope can be extended and adjusted during the
  examination

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Minimum Examination Scope

• General Ledger
• Loan Portfolio
• Investment Portfolio
• Savings Portfolio
• Capital Adequacy
• Interest Rates and Profitability
• Business and Strategic Planning
• Utilization of Plans for Management

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Initial Steps of the Examination

• Review Internal Auditors Reports
• Determine detail of General Ledgers Review
• Review CUs budget, Assumptions and Variance
  Analysis
• Assess Loan Portfolio Quality and Investments
• Determine Adequacy of Loan Loss Provisions
• Determine Adequacy of Capital Position
• Review Financial Ratios and Trends

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Initial Steps of the Examination (2)

• Review CU Polices and Procedures
• Review Elected Bodies Minutes with Particular
  Emphasis on Recent Changes
• Meet with Management and Policy Makers to Discuss
  Operations and their Roles and Responsibilities
• Plan for the Exit Meeting with the Officials and
  Managers to discuss Results and Plans

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Examination Procedures

• Analyze specific operational areas to determine
  compliance with regulations and performance
  standards
• Develop reasonable plans to address weaknesses
  and set timelines
• Agree with the officials and management on
  implementation of the plans
• Provide follow-up on the implementation of those
  plans

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Examination Procedures of the General Ledger

• Assess compliance with the accounting standards
  and methodology
• Verify balances of the subsidiary ledgers and GL
• Verify Financial Statement balances with GL
• Review adequacy of Loan Loss Provisions and
  procedure of creating provisions
• Determine accuracy of material income and expense
  accounts
• Assess appropriateness of depreciation

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Examination procedures of record keeping system

• Review the system for security and data
  protection
• Assess the ability of the system to generate
  reports with the required detail of the
  information

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Procedures for Examination of Cash Handling

• Review policy and procedures for cash handling
• Assess safety of cash
• Assess adequacy of procedures for staff in case
  of burglary or robbery

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Procedures for Assessment of Capital Adequacy

• Determine Capital Adequacy Ratio
• Review compliance with Capitalization Policy and
  Procedures
• Audit reserve and allowance accounts and
  frequency of transactions on those accounts
• Check compliance with capital maintenance plan
• Assess promptness of correcting deficiencies in
  capital adequacy

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Ratios for Capital Adequacy Assessment

• S8, S9 and S11
• E8
• E9
• A1
• P1 and P2
• Total delinquent loans to capital

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Equity Accounts

• Institutional Capital Accounts
• Temporary Capital Accounts

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Institutional Capital Accounts

• Retained Earnings
• Donations
• Year to Date Net Income to be Capitalized

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Temporary Capital Accounts

• Accrued Dividend
• Donated supplies/subsidy

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Allowance for Loan Losses

• Assess portfolio risk assessment procedures used
  by the management
• Determine understanding of the management of the
  purpose and use of the account
• Confirm that balance of the account accurately
  reflects the risk

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Adequacy of the ALL

• 35 of balances of loans delinquent between 1-12
  months
• 100 of balances of loans delinquent over 12
  months

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Procedures for Examination of Adequacy of
Profitability

• Income and expense trends
• Adequacy of policies and practices for managing
  income and expense trends
• Compare financial results with projections
• Assess adequacy of Gross Income to pay for funds
  and cover operating expenses and risks
• Determine adequacy of profitability to build or
  maintain capital adequacy

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Procedures for Assessment of Profitability

• PEARLS Report
• or
• Profitability Assessment Worksheet

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Analysis of Profitability

• R1
• R5
• R6
• R9
• R12
• Compare results versus targets

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Procedures for Examining Quality of Financial
Management

• Strategic Plan
• Business Plan and Budget for the Year
• Written operating polices
• Matching of sources and uses of funds
• Managing liquidity to offer loan products that
  best satisfy loan demand

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Procedures for Assessment of Management and
Governance

• Assessment must reveal
• Understanding of management and officials of
  their responsibilities
• Compliance with regulations and standards
• Carrying out of responsibilities
• Quality of financial targets for operations
• Conflicts of Interest and Self-dealing
• Soundness of management decisions

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Areas for Discussion During Management Interview

• Key personnel changes since last Examination
• Future plans for personnel, officials changes
• New products and plans
• CU policy on interest rates and methodology
• Investments in non-earning assets
• Membership growth
• Changes in loan portfolio

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Areas for Discussion During Management Interview
(2)

• Plans for diversifying sources of funds
• Record-keeping issues
• Written policies and procedures
• Capital accumulation strategy
• Business plan
• Strategic plan
• Systemic review of policies and procedures

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Meeting Minutes of Policy Making Body (1)

• Financial Performance/Financial statement review
• Loan Policy changes
• Agreements on collection of problem loans
• Record-keeping problems
• Interest rate changes
• Investment activities
• Capital accumulation and maintenance policy

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Meeting Minutes of Policy Making Body (2)

• Approval of loan charge-off
• Material fixed asset purchases
• Loans to officials
• Progress in meeting goals

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Procedures for Examining Loan Portfolio

• If examination of all loans is not required or is
  not practical, random sample of loans must be
  selected
• All officials loans for delinquency and
  preferential treatment
• 10 largest loans outstanding
• Loans charged off over past 12 months
• Loan refinancing/extension

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Examination Report

• Provide report with key factual findings
• Highlight weaknesses
• Recommend solutions
• Insert agreements achieved on resolving
  shortcomings
• Provide agreed upon timetable for required
  changes in operations

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Exit Meeting

• Present findings
• Give recommendations
• Agree on Action Plan
• Set framework for follow-up