Speech by Bank of Russia Governor Elvira Nabiullina at the International Conference ‘Modern Auditing: Problems and Prospects’ (verbatim record)

Good afternoon, dear colleagues. Let me start with giving a substantive answer to a rather comprehensive question. The modern financial market is a complex entity, whose efficiency largely depends on the quality of operation of a great number of institutions involved in investment decision-making generating capital flows between countries, industries, and economic agents.

The performance of institutions in each single country determines the competitiveness of the local financial market and, consequently, an access to global financial market for national economic agents.

The auditing quality is currently in the focus of attention, since the majority of shareholders, financial services consumers, and even regulators do not have a possibility of checking the reliability and integrity of information being disclosed and assessing the quality of corporate governance and risk management.

It is precisely internal and external auditors who are called upon to perform this function in the financial market, the function which ensures trust in the information based on which investors and regulators make their decisions.

As a financial market regulator the Bank of Russia is extremely interested in developing the auditing industry, improving the quality of auditing and precluding malpractices. We would like to be sure that if a financial institution has got an auditor’s report, we can rely on it and we must be sure that its statements are trustworthy.

That is why this year we have decided for the first time to initiate holding a conference for professional participants to comprehensively discuss these problems. I am glad to see here such a wide audience, as I have already mentioned: representatives of major banks and financial institutions, internal auditing divisions, and, what is very important, our Russian and international auditing firms.

I also hope that we will be able to constructively discuss the state, trends and ways of development, problems facing the auditing industry, including problems of cooperation between external and internal auditors in the financial sector.

I want to thank Anton Siluanov (the Ministry of Finance, which regulates this industry facing many innovations) and Tatyana Golikova (the Audit Chamber, undoubtedly, sets the quality standards for external auditing), and our international experts – Robert Hodgkinson (external audit problems) and Mark Karavan (internal audit issues) for their consent to take part in our conference.

We believe that through the dialogue with participants in the auditing services market the regulators will be able to develop optimal approaches to both regulation and supervision and lay the basis for sustainable development of auditing institutions in Russia.

It is of paramount importance for us to ensure a high quality of work and transparency of both external and internal auditors.

I would like to start with internal audit issues at financial institutions. Credit institutions as a whole have already been competent in organising operation of internal audit and internal control services. Internal audit of credit institutions has been a success in solving such tasks as investigation of abuses, support of inspections by external auditors and external supervisors, independent assessment of risk management, check-up of the efficiency of the methodology for assessing banking risks.

The activity of internal audit and internal controls at many institutions complies with the requirements of the Russian regulator and is in demand with both owners and management of credit institutions. They base their work on the best international practices adapting their activities to economic environment, business realities, and business models of credit institutions proper.

As of the beginning of 2016, internal audit and internal controls of credit institutions accounted for 12,500 employees, roughly 1.5% of the total number of banking employees. Therefore, we see that a great number of people are employed in this sphere.

However, the situation is not so harmless. There are a number of problems which prevent us from assuring you that internal audit operates on a full scale.

Internal audit faces the following major problems:

  • Interaction between internal auditors and bank management is often quite formal;
  • Low quality control. The majority of divisions do not have internal documents regulating the assessment of their work quality. Less than a third of internal audit divisions undergo external assessment;
  • Inadequate qualification of internal audit personnel at credit institutions.

The Bank of Russia will continue to improve and develop the system of internal controls and auditing.

Our priorities in this sphere in order to respond to these problems are as follows:

  • We believe it is necessary to work out common approaches to the internal control procedures, including risk-based planning and stress testing;
  • We need general approaches to develop the internal control procedures regulating risk management process;
  • We also need general approaches to the procedures and requirements for compiling recommendations based on the results of inspections held by internal controls and audit;
  • Common approaches should be worked out to exercise control over the elimination of violations revealed by internal audit;
  • The quality of interaction between internal audit and owners and management of financial institutions should be improved;
  • The competence of auditors and certification of internal audit personnel should also be improved.

The Bank of Russia intends to establish a unified system of national internal audit standards for the financial sector, credit institutions, and also non-bank financial institutions which would be based on the best international practices.

Now, let me proceed to say a few words on external audit in the financial market.

Unfortunately, it is not uncommon for auditing firms to come up in their reports with unconditionally positive conclusions as to the reliability of some credit institutions’ statements; afterwards, however, the Bank of Russia is forced to revoke such institutions’ licences on grounds which include substantially false statements.

This long-standing problem is not a truly Russian phenomenon. The stories of Arthur Andersen’s and Enron’s auditors are a reminder here. Following the Enron crash, it turned out that the auditor suggested to the company that they apply a sort of creative approach towards the compilation of financial statements. The Enron case raised doubts about reporting submitted by thousands of US businesses, including public companies, banks, insurers and financial institutions, which were borrowing, to a varying degree, funds in the financial market. The event subsequently brought about the emergence of the Sarbanes-Oxley Act, which set strict requirements for auditors, thereby restoring the credibility which then helped the US capital market to retain its global lead, and to this day. Strict auditor requirements are essential to confidence in the capital market. At the time, naysayers were lambasting this act-caused rise in corporate costs to comply with all requirements for quality and completeness of reporting; these were estimated to be as high as would cause the debt market to flee the US to other financial centres where requirements are softer. However, the subsequent events proved otherwise: the other financial centres followed suit and toughened their requirements for disclosure of statements and their auditing procedure.

The Russian financial market is no exception here and is faced up with the same need for high-quality audit services.

Let me tell you several figures that can illustrate how unreliable the financial sector’s statements can be. Since 2013 to date, as many as 291 lenders have had their licences revoked, with the majority of them showing cases of false statements, to a varying degree. As many as 205 credit institutions declared bankrupt between 2013 and 2016 have operated with assets worth of only 40% of their reported value.

The auditor could make a difference when it comes to addressing the issue of reporting reliability. I regret to state, however, that it is often the case that auditors fail to meet the expectations of both the financial market and the regulator. It is not uncommon that an auditor would really conclude unconditionally in favour of reliability of a lender’s reporting in its auditor’s report. Of the above-mentioned 205 bankrupt credit institutions, as many as 182, that is about 90%, were reported to have received unmodified auditors’ reports. In 2016, 77 credit institutions had their licences revoked, of which 58 were recognised bankrupt, and of which 52, that is, almost 90%, were in possession of auditors’ reports affirming reliability of annual statements.

A similar situation finds its way in the auditing segment of non-bank financial institutions. For example, in 2016 as many 17 non-governmental pension funds had their licences terminated, of which 8 had unmodified auditors’ reports confirming reliability of their annual reporting.

In a situation like this, the auditor opinion can hardly be viewed as a tool supporting market discipline and enabling market players to enjoy confidence over reliability of financial organisations’ reporting.

I realise this is not that only auditors are to blame – considering that they look into the statements as submitted, as they say. The facts of misreporting may be hard to find. Yet, the capability to expose such misstatements is a matter of the auditor’s competence, which unfortunately may be insufficient. And, we believe this problem to be systemic.

As we see it, heightened requirements should cover not only the auditing of financial institutions but also the quality of auditing services provided to public companies and corporations with listed securities. The operations of public companies affect the interest of a broad range of investors and, ultimately, have implications for the investment climate.

As regards public companies, alongside the need for a broader scope of auditing as regards compliance with required ratios, assessment of internal control / risk management systems, compliance with approved strategies, etc., they should have a broader coverage of auditing.

In this way, independent auditing of accounts in Russia has yet to become the powerful tool to build effective and advanced market relations, as it is viewed in advanced economies.

Worryingly, the matters are getting worse as the auditing services market is shrinking, the prestige of the auditing profession is in decline, as well as the number of auditing companies and certified auditors. In just five years, the number of corporate and private auditors has dropped by more than 15%; an almost fifth part of certified auditors have left the occupation – which is also a concern.

Unfortunately, the current market conditions are such that individual companies are monopolising the segment. The revenue gap creates competitive advantages for larger auditing organisations, failing to provide the level playing field for competing market players.

We have yet to begin to apply the legal framework of the Law ‘On Auditing’ that sets forth a judicial procedure for invalidating auditor’s reports as deliberately false.

The operation of multiple self-regulatory organisations in the market has resulted in some competition between them. Supposedly, we should welcome this competition. Yet we see that these self-regulatory organisations now resort to the worst strategy of applying minimal requirements to their deliverables, with lots and lots unscrupulous and even unprofessional auditors entering the market.

This is why the competitive mechanisms of auditors will sometimes fail. The negative practices of late include that of tendering external auditing out by executive bodies, not by board of directors, as well as the failure to involve boards or audit committees. The outcome is conflict of interest in the course of auditing.

We have been working jointly with the Ministry of Finance to enhance the regulation of auditing. Back in 2014, additional requirements were set for the independence of auditing companies, and last year the scope of an auditor’s report was extended to include, for credit institutions, the conclusion concerning compliance with required ratios. Nevertheless, we believe, we have a long way to go. We should see what can be meaningful action to take the auditing industry to a new level and enhance the quality of its regulation. This is also confirmed by international experts.

I regret to mention that the FSAP team that was recently studying the current regulation and supervision in the financial market, looking into the overall problems of auditing standards, independence and certification of auditors, failed to recognise Russia as fully compliant with the Core Principles for Effective Banking Supervision as established by the Basel Committee on Banking Supervision.

What steps are needed to make the difference?

First, we need to strengthen control over external auditors of financial institutions.

Second, we need to provide for specialisation in the activities of auditing organisations which operate across financial market segments. We believe the Bank of Russia should have the authority to maintain the register for these and control the quality of auditing services provided by authorised entities. That is, only auditors which qualify should gain access to these professional activities.

Third, we face the need to upgrade requirements for auditors’ qualifications and the professional training system, together with the introduction of auditors’ specialisation through further and in-service training.

We need to look into financial market infrastructures, such as securities market operators and credit bureaus. For information exchange between the Bank of Russia and the Government, there should be an effective interaction mechanism to enable effective delivery of our plans. And, we believe the current auditing legislation needs to change. These problems should remain in our focus as we need to upgrade requirements, encouraging bona fide auditing firms to engage in competition.

My hope is that today’s conference will present the opportunity to have substantive discussion on the steps which are needed to enhance regulation so we can come up at the earliest with proposals to go before the legislators. We are aware that this is a charged and sensitive matter not only to consumers of auditing information but to auditors themselves.

We understand that the auditor can be a hostage of circumstance when, on the one hand, an objective opinion should be issued to meet the strict requirements as per standards and, on the other hand, some prudence may be necessary in a shrinking market environment with tight competition that is sometimes unfair. So that ultimately all – investors, auditing information consumers and the regulator – could rely on an auditor opinion and view it as an independent professional judgement.

Thank you very much.

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