Internal Audit For MFI

INTERNAL AUDIT for MFIs
&'
Reorganized by Hong Ry, Senior
Auditor
Phnom Penh, Cambodia
Internal Audit for MFI -1- © Hong Ry, Senior Internal Auditor
OBJECTIVES:
INTERNAL AUDIT
9 Understand the various risks faced by
MFIs
9 Appreciate the role of a robust control
environment in mitigating risks
9 Describe various components of control
environment and distinguish between
them
9 Evaluate internal checks within their
organizations
OBJECTIVES: contd.
9 Understand the scope and role of internal
audits
9 Assess the existing organizational policies
9 Evaluate the management information
system of their organizations
9 Formulate internal audit plans
9 Conduct internal audits
9 Control fraud
9 Report the findings in a systematic manner
RISK MANAGEMENT
Operational
Credit, Fraud,
Inefficiency,
Security etc.
Financial
Institutional Management
Mission Drift Liquidity, Interest

Rate etc.
External
Natural
Calamities
Risk Management:
A Systematic Approach
Identifying
Measuring
Mitigating
risks in an MFI
Risk Management
Internal Control
Internal Audit
External Audit
Risk Management Process Feedback Loop
1. Identify, assess
and prioritize risks
6. Revise
policies and
procedures
2. Develop
strategies to
measure risk
5. Test
effectiveness
and evaluate 3. Design
results policies and
procedures to
4. Implement mitigate risks
and assign responsibility
Assess and Prioritize the Risks
Quadrant 3- Quadrant 2-
Low Frequency High Frequency
(Probability), High (Probability), High
Impact: Fires, Natural Impact: Losses from
disasters, wire high risk business
transfer fraud, loans in one sector
computer crime.
Quadrant 4- Quadrant 1-
Low Frequency High Frequency
(Probability), Low (Probability), Low
Impact: Refunds of Impact: Typical
service charges loan losses; Petty
errors fraud
Develop Strategies to Manage the Risk
• Avoid the risk
• Transfer the risk
• Accept the risk
• Control or mitigate the risk (in-house)
Assess and Prioritize the Risks
RISK MANAGEMENT AND THE NEED FOR BALANCE
• Risk and return are opposite sides of the same coin

• The greater the risk, the greater the potential for
gain and loss
• The lower the risk, the lower the potential for gain
and loss
Risk Trade Offs
Risk trade-offs occur when one type of risk is
substituted for another,
Examples of trade-offs:
• By outsourcing transfers to Western Union, MFI shifts
from operational risk to counterparty and reputation
risk and reduces operational risks
• By linking its clients to an insurance company, MFI
shifts the actuarial and operational risks and in turn
accepts counterparty and reputation risk
• By deciding to take security for its credit exposures,
MFI converts credit risk into operational as well as
market risk
• Trying to eliminate human error by computerization is
replacing one form of operational risk with another.
Internal Controls can be
•Preventive
•Detective
•Corrective
INTERNAL AUDIT
Risk Management
Internal Control
Internal Audit
External Audit
Internal Audit External Audit
Employee of MFI Independent Contractor
Serves the needs of the

Also serves third parties
MFI
Focuses on past and
Focuses on whether
future events by
statements reflect
evaluating controls to
historical events clearly
ensure achievement of
and accurately
goals
Is directly concerned Incidentally concerned

with preventing fraud with fraud controls
INTERNAL AUDIT
is a systematic, objective appraisal of the diverse
operations and controls within an organization to
determine whether:
• Financial and operating information is accurate and
reliable
• Risks to the enterprise are identified and minimized
• External regulations and acceptable internal
policies
are followed
• Satisfactory operating criteria are met
• Resources are used efficiently and economically and
• The organizations objectives are effectively achieved
All for the purpose of assisting members of the organization
in the effective discharge of their responsibilities.
Internal Audit function
• Acts independently
• Reviews transactions in the field,
• compares actual procedures with
those documented,
• frequently reports to the board
through written reports and
presentations.
• reports on open items from previous
audits
INTERNAL CONTROL
The MFI
Organizational
Mission and
Structure
Values
PEOPLE
Technology Systems and

Procedures
INTERNAL CONTROLS
“The system of internal control is the plan of
organization and all the methods and procedures
adopted by the management of an entity to assist in
achieving management’s objective of ensuring, as far
as practicable, the orderly and efficient conduct of its
business”.
It constitutes of:
• Organisation Structure
• Segregation of Duties
• Management
• Authorisation and Approval
• Arithmetical and Accounting
• Physical Security
• Personnel
• Policies and Procedures
MY MFI
Board of Directors
General Manager
Human Resource Manager
Operations Manager Finance Manager IS Manager
Internal Auditor
Branch Manager Branch Manager
Accountant
Branch Auditor Credit Officer Savings Officer
Cashiers Bookkeepers
Branch Cashier
Approve ME
Do MYSELF
Record I
POLICIES AND PROCEDURES
Policies – indicate direction
Procedures – tell how to implement and
follow the policies
Effective Policies and Procedures are

Written
Simple/Clear
Available
Understood
Relevant and
UP TO DATE
Implemented
Characteristics of good controls
• Timeliness
• Economy
• Accountability
• Placement
• Flexibility
• Cause Identification
• Appropriateness
Limitations of Internal Control
• Judgment
• Breakdowns
• Management Override
• Collusion
• Costs
• People
INFORMATION SYSTEMS
INFORMATION
IS THE PILLAR
OF ANY MICROFINANCE
INSTITUTION
Unprocessed basic facts about the
Data activities of a business that give no
insight by themselves
Data transformed into a

Information meaningful form that helps
someone to make sound, quality
decisions or to gain insight.
Information and Decision Making
Information Needed to Make Information Source
Decision
the Decision (Who/How/Where)
Disbursing a Cash Flow Position Accounting

Loan Client Profile Client Records
Client Repayment Record Client Records
Loan Application Form Loan Management
Loan Officer Details and records
Recommendation Loan Officer Reports
Information System
The series of actions involved in:
capturing raw data from various sources,
processing the data into usable information,
storing the information and
disseminating information in the form
needed.”
Information System
Loan Officers
Accounting
Accounting
System
System
Tellers
Portfolio
Portfolio
Encoders Management
Management
System
System
Processes or
People Seeking Bookkeepers Deposit
Deposit Tracking
Tracking Decision
Information System
System or
Action
Managers
Customer
Customer
Information
Information
System
System
Clients
Human
Human Resource
Resource
Auditors System
System
Data Capture Processing Storage Information Reporting
IA5 – O6
Collection Sheet
Name of Branch : _______________ Month
Name of Field Staff: _____________
Center No
Date__________ Date__________ Date__________ Date__________
Loan Interest Savings Savings Loan Interest Savings Savings Loan Interest Savings Savings Loan Interest Savings Savings
collection collection collected withdrawn collection collection collected withdrawn collection collection collected withdrawn collection collection collected withdrawn
Group 1
Laxmi
Mahalakshmi
Parameswari
Meenakshi
Rajammal
Group Total
Group 2
Pushpavalli
Gandhimathi
Amsavalli
Shanthi
Mariammal
Group Total
Group 3
Rajeswari
Venkateswari
Velmani
Pushpavalli
Rajalakshmi
Group Total
Center Total
Collection Sheet
Name of Branch : _______________ Week Ending IA5 – O7
Name of Field Staff: _____________ Date:
Center No ____________________
Loan ID Loan Amount Date of Opening Balances During the week Closing balance
disbursement Principal Principal Interest Age of Principal Interest Current Current Principal Interest Principal Interest Fee Principal Principal Interest Age of Principal Interest
Outstanding Overdue Overdue overdue Prepayments Prepayments Principal Interest Demand Demand collected Collected collected Outstanding overdue overdue overdue Prepayments Prepayments
Due Due
Group 1 -
Laxmi
Mahalakshmi
Parameswari
Meenakshi
Rajammal
Group Total
Group 2
Pushpavalli
Gandhimathi
Amsavalli
Shanthi
Mariammal
Group Total
Group 3
Rajeswari
Venkateswari
Velmani
Pushpavalli
Rajalakshmi
Group Total
Center Total
Key aspects of good recording
• Should capture all relevant information
• Should not duplicate recorded data
• Should take the minimum possible time
• Should be easy to fill up and

understand
Issues in report design
• Focus of contents
• Frequency of reporting
• Importance of timely information
• Importance of accurate and reliable
information
• Levels of reporting – appropriate level
of aggregation for user
• Identification of reports
• Usability
• Regularity of design improvements
Features of a Good MIS
• Reliability
• Timeliness
• User-friendliness
• Up-gradability
• Physical security
• Data back-up
• User-access rights
FEATURES OF A GOOD COMPUTERISED
INFORMATION SYSTEMS
AVAILABILITY
CONFIDENTIALITY
NON-
REPUDIABILITY INTEGRITY
AUTHENTICITY
KEY CONTROLS IN A COMPUTERISED ENVIRONMENT
MANAGEMENT
CONTROLS
APPLICATION
CONTROLS ORGANISATIONAL
CONTROLS
OPERATIONAL
CONTROLS
AUDIT PROCESS
The Audit Process
Inspectionof
Inspection ofdocuments
documentsand
andrecords
records
Physicalinspection
Physical inspection
Observation/s
Observation/s
Inquiry
Inquiry
Confirmation
Confirmation
Computation&&retracing
Computation retracing
Analyticalprocedures
Analytical procedures
Inspection of documents and records
What is inspection? It is the examination of appropriate

documents/vouchers to support each
transaction
Why is it important? Auditing technique for performing

both compliance and substantive
procedures
• Test the compliance of laid down

procedures for processing/sanction
How ? of all documents, and its attestation
by the concerned authority
• Cross-checks if all committed
documents are transparent and are
available to/for access by the client
Types of documentary evidence
usually prepared outside the MFI most reliable
External Documents document
Examples include purchase invoices, insurance
policies, pay-in-slips
validated by independent source/s fairly reliable

Internal Documents Examples include signed vouchers for payment
(validated) of loan (acknowledged receipt by clients)
without independent validation limited reliance,

Internal Documents that depends primarily upon the existence of
(invalidated) ‘Internal Control’ system
Examples include payment for misc. expenses at
branch level, re-imbursement of personnel
expenses
Physical inspection
• Physical verification of cash & fixed assets
– Cash – reconciliation of cash book & bank statement
and corresponding cash amount
– Assets – verify their usage
• surprise element
• eliminates the scope of manipulation
Observation
• Witness a performance of processes on site
• Ascertain the compliance of procedures
• Useful step, if observations are recorded in descriptive
form
Inquiry
Information seeking from knowledgeable internal & external
source/s
May be oral OR written
Helps obtain understanding of the system through which the
economic information is generated
Key Analysis Areas
Authenticity
(genuineness of document)
Appropriateness
(legitimacy of the transaction record)
Authorisation
(necessary approvals present)
Classification
(properly classified in records)
Remember to cross check for dates, client name, signatures, cutting
& overwriting of amounts & identification and serial numbers
Confirmation
• Corroboration of records by obtaining client
information --- feedback system
• Reliable evidence
• Helps the auditor understand efficiency of

controls and whether systems and policies
are being properly implemented
Computation and retracing
• Checking arithmetical accuracy of record/s
• Done via re-computation and retracing
Analytical procedures
• Analysis of significant ratios and trends,
and investigation of reasons therein
• Involve comparisons & study of

relationships
• Overall tests, rather than details
Comparisons
Involves comparing financial
information with -
• Corresponding information for a prior
period
• Anticipated results such as budgets
and forecasts
• Similar information for other
MFIs/the mF sector
Study of relationships
Auditor studies relationships -
• Among elements of financial
information (such as PAR trends,
fluctuations in OER, OSS)
• Between financial information and
relevant non-financial information
(PAR & growth rate)
Bank reconciliation statement
Positive Negative
Balance as per the Ledger balance
Bank charges levied 3 but not yet recorded
Bank interest given 5 but not yet recorded
Cheques issued 2,000 but not yet presented for

clearance
Cheques deposited in the bank 3,123 but not yet
realised
Cheques deposited 2,030 wrongly entered in the
ledger as 3,020
Subtotals
Balance as per the Bank statement
IA6-H9
Portfolio At Risk Collection Sheet of Micro Fund: Basic Information
Current week: 42
Week of Principal at Risk

loan Amount of Number of Number of Week of Number
Loan disbursem loan Instalment Amount instalments Instalments last of weeks Amount Principal 4-8 8-12 More than
cctt ent disbursed size paid paid due payment in default past due outstanding 0-4 weeks weeks Weeks 12 weeks
1 5 10,000 200 7,200 36 37 41 1 200 2,800 2,800
2 10 6,000 120 3,840 32 32 42 - 2,160
3 11 8,000 160 4,160 26 31 37 5 800 3,840 3,840
4 14 12,000 240 4,560 19 28 33 9 2,160 7,440 7,440
5 18 10,000 200 5,000 25 24 42 - 5,000
6 22 12,000 240 4,800 20 20 42 - 7,200
7 26 4,000 80 1,280 16 16 42 - 2,720
8 30 8,000 160 1,920 12 12 42 - 6,080
9 34 10,000 200 1,600 10 8 42 - 8,400
10 40 6,000 120 120 1 2 41 1 20 5,880 5,880
Total 86,000 34,480 3280 51,520 8,680 3,840 7,440 -
SAMPLING
Sampling Methods
Statistical Sampling Non-statistical Sampling
•Simple Random •Judgement Sampling

Sampling
•Convenience
•Systematic sampling
Sampling
•Stratified
Sampling
•Cluster Sampling
Simple Random Sampling
Each item in the population has an equal chance of
being included in the sample
Population
1 2 3 4 5 6 7 8 9 10 11 12 13
1 1 1 1 1 1 2 2 2 2 2 2 2
2 2 2 3 3 3 3 3 3 3 3 3 3
4 4 4 4 4 4 4 4 4 4 5 5 5
5 5 5 5 5 5 5 6 6 6 6 6 6
Sample
4 6 3 1 1
Systematic Sampling
Elements are selected from the population at a
uniform interval that is measured in time, order or
space
Population
1 2 3 4 5 6 7 8 9 1 1 1 1
1 1 1 1 1 1 2 2 2 2 2 2 2
2 2 2 3 3 3 3 3 3 3 3 3 3
4 4 4 4 4 4 4 4 4 4 5 5 5
5 5 5 5 5 5 5 6 6 6 6 6 6
Sample
2 1 2 3 4 5 6
Stratified Sampling
We first divide the population into relatively
homogeneous groups called strata. Then we select
items proportionately, from each stratum randomly
Population
I
1 2 3 4 5 6 7 8 9 1 1 1 1
1 1 1 1 1 1 2 2 2 2 2 2 2
II
2 2 2 3 3 3 3 3 3 3 3 3 3
III
IV
4 4 4 4 4 4 4 4 4 4 5 5 5
V 5 5 5 5 5 5 5 6 6 6 6 6 6
Sample
4 2 3 4 5
Cluster Sampling
We divide the population into groups, or clusters, and then select a
random sample of these clusters. We assume that these
individual clusters are representative of population as a whole
Population
I II III IV V VI VII VIII IX
1 2 3 4 5 6 7 8 9
1 1 1 1 1 1 1 1 1
1 2 2 2 2 2 2 2 2
2 2 3 3 3 3 3 3 3
3 3 3 4 4 4 4 4 4
Sample
4 1 2 3 4
Judgemental Sampling
• This requires professional judgement about

the composition of the sample.
• Particularly useful for small samples
Convenience Sampling
• Selection of units from the population is based
on easy availability and accessibility.
• Useful when it is expensive or impractical to use
statistical sampling methods
FRAUDS
WHAT IS FRAUD ?
“The risk of loss of earnings or capital as
a result of intentional deception by an
employee or client.”
WHAT ARE THE MOST COMMON
TYPES OF MFI FRAUD ?
w Fictitious loans
w Kickbacks
w Cash theft
w Collusion in issuance of loans
w Manipulation of financial data
FRAUD DETECTION SIGNALS
Ö Increase in delinquency
Ö Accounting irregularities
Ö Employee tips
REDUCING THE LIKELIHOOD OF FRAUD
1. Begin with stating the Core

Values of the Institution:
Justice/Fairness, Integrity, Quality,
Commitment, Respect, etc
2.Set policies and procedures

consistent with the values
3.Set strategies and objectives

for implementation
CORE
4.Hire staff who share
VALUES
the core values
5.Train and Equip Staff
REDUCING THE LIKELIHOOD OF FRAUD
• Market Pricing
• Simplicity of operations
• Transparency
Preventing a fraud must be an element in
several phases of the lending process !!!
Loan Monitoring
Loan LENDING Sanctions

Origination PROCESS
Supervision
WHEN ARE MFIs MOST
VULNERABLE TO FRAUD?
• Weak information and accounting systems

• Changing systems
• Late completion of reports
• Weak internal control system
• High employee turnover
• Non standardization of products & operations
• Loan officer handle cash
• Experiencing high growth
What are the Key Challenges?
• Maintaining effective control of fraud

without excessive cost or burdensome
procedures as the program grows
• Maintaining high staff morale and culture
of ethics in a large, growing program
• Maintaining awareness of new and more
complex types of fraud as the MFI
develops new products and becomes more
sophisticated
INTERNAL AUDIT REPORT
Internal Audit REPORT
WRITING
Internal Audit REPORT WRITING
General Standards of Report Writing is
5C’s
1. Complete
2. Clear
3. Concrete
4. Correct
5. Concise
Internal Audit REPORT
Format
Condition/ Finding Criteria Rate Implication Recommandation
Interest Interest on The MFI lost $2 Remind loan

calculation for this loan per month over officers that interest
loan #101 was should be the past three rates are updated at
short $2/per $10/per months, for a the beginning of
month. month. total loss of $6. each month.
Nothing is right unless it
is proved right!
THANKS
SOURCE DUCUMENT
INTERNAL AUDIT for MFIs

26-29 MAY, 2008
Phnom Penh, Cambodia

Internal Audit For MFI

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INTERNAL AUDIT for MFIs

Mission Drift Liquidity, Interest

• Avoid the risk

• Transfer the risk

• Accept the risk

• Control or mitigate the risk (in-house)

• Risk and return are opposite sides of the same coin

Employee of MFI Independent Contractor

Serves the needs of the

Is directly concerned Incidentally concerned

Technology Systems and

Human Resource Manager

Operations Manager Finance Manager IS Manager

Effective Policies and Procedures are

Data transformed into a

Disbursing a Cash Flow Position Accounting

Data Capture Processing Storage Information Reporting

Date__________ Date__________ Date__________ Date__________

• Should capture all relevant information

• Should not duplicate recorded data

• Should take the minimum possible time

• Should be easy to fill up and

What is inspection? It is the examination of appropriate

Why is it important? Auditing technique for performing

• Test the compliance of laid down

validated by independent source/s fairly reliable

without independent validation limited reliance,

• Helps the auditor understand efficiency of

• Checking arithmetical accuracy of record/s

• Done via re-computation and retracing

• Involve comparisons & study of

• Overall tests, rather than details

Balance as per the Ledger balance

Bank charges levied 3 but not yet recorded

Bank interest given 5 but not yet recorded

Cheques issued 2,000 but not yet presented for

Balance as per the Bank statement

Week of Principal at Risk

1 5 10,000 200 7,200 36 37 41 1 200 2,800 2,800

2 10 6,000 120 3,840 32 32 42 - 2,160

3 11 8,000 160 4,160 26 31 37 5 800 3,840 3,840

4 14 12,000 240 4,560 19 28 33 9 2,160 7,440 7,440

5 18 10,000 200 5,000 25 24 42 - 5,000

6 22 12,000 240 4,800 20 20 42 - 7,200

7 26 4,000 80 1,280 16 16 42 - 2,720

8 30 8,000 160 1,920 12 12 42 - 6,080

9 34 10,000 200 1,600 10 8 42 - 8,400

10 40 6,000 120 120 1 2 41 1 20 5,880 5,880

Total 86,000 34,480 3280 51,520 8,680 3,840 7,440 -

Statistical Sampling Non-statistical Sampling

•Simple Random •Judgement Sampling

• This requires professional judgement about

w Collusion in issuance of loans

w Manipulation of financial data

1. Begin with stating the Core

2.Set policies and procedures

3.Set strategies and objectives

5.Train and Equip Staff

Loan LENDING Sanctions

• Weak information and accounting systems

• Maintaining effective control of fraud

Interest Interest on The MFI lost $2 Remind loan

Date Date Date Date

w Collusion in issuance of loans

w Manipulation of financial data