I have decided to write on this topic because I currently work as an auditor. I have been up to this date in many firms where i conducted audits of the firm's financial statements and through various ways have "tested" the company's balance sheet's to determine any wrongdoing.
The thing that caught my eye was the fact when an auditor approaches a bank, the audit procedures in my opinion somehow breakdown. This is due to the fact that manufacturing firms have to sell a product and pay off suppliers to remain in business. A bank creates money from loaning out demand deposits and captures a spread.
The main difference when going about on audit of a mancufacturing company and a bank, is the perception of the person conducting the audit. The primary focus on a manufacturing firm is the ability to generate cash flow and the unbiaseness of the accrual process. When auditng a bank, most of the itme is focused on bank product of the bank - its' loans (for traditional markets this is the case).
If the loan receiver has a hard time paying of the loan, the auditor will quesiton the vaildity of the asset and request an impairment of th asset. The auditor however never questions the origins of the loan. By this I mean the systemic imbalance of borrowing short and lending ex nihilo long. The auditor is never concerned of any bank run due to the modern nature of the banking system.
I found this particularly odd. The only logical conclusion that I come by is the perception of the participant doing the audit, and the repetitiveness of the process. The participant views the fractional nature sound because a supranational (central bank) is stranding behind the Entity making sure that the diminishing reserves to cover the deposits is in line with "historical practices", or in line with industry and economic wide conditions.
This can be clearly seen at the examples in Cyprus a month ago, when the banks run ensued. I am sure that each bank that went under in Cyprus had an auditor. The auditor went through their books and determined no material misstatements of the banks' balance sheets. The other problem that would arise is the going concern basis: If the bank was unable to honor it's depositors for withdrawl on demand, then the bank would have been prepared for a banckruptcy filing. This hasn't occured as well. It is if the auditors were fooled or something; unable to see that the bank is always insolvent and can be brought to it's knees with a run.
The bottom line is this: An auditor can't see a bank run, because he is not interested in one, nor do most of them have any knowledge of economic theory underpinning their analysis. If they did have knowledge of economic cycles they would have made an adverse opinion of the statements during the boom faze, when the percentage of NPL's (non performing loans) is at a low in the cycle.
Unfortunatley, the common practice is to follow the mainstream approach and give a green light. Anyone that stands out will be attacked as reactionary and insance. Just as the rating agency Egan-Jones was called to b mad when they downgraded US debt and other debt for that matter.
There should be first of all an overhaul of the banking practices, and then an auditor will be able to make decent calls just as they do for manufacturing firms.
