The Government Accountability Office (GAO) gave the following results in a report based on an examination of 39 failed banks: 9 The early warning system provided by bank call reports* is seriously l awed. The 39 failed banks’ call reports did not provide the regulators with advance warning of the true magnitude of the deterioration in the banks’ financial condition. As a result of the asset valuations FDIC prepared after these banks failed, loss reserves increased from $ 2.1 billion to $ 9.4 billion. A major portion of the $ 7.3 billion deterioration in asset values was not previously reported because deficiencies in GAAP allowed bank management to unduly delay the recognition of losses and mask the need for early regulatory intervention that could have minimized losses to the Bank Insurance Fund.
The key to successful bank regulation is knowing what banks are really worth. The 39 bank failures are expected to cost the fund $ 8.9 billion. Large banks present a major threat to the solvency of the Bank Insurance Fund and need closer scrutiny.
The corporate governance system upon which successful regulation depends is seriously l awed. Of the 39 banks, 33 had serious internal control problems that regulators cited as contributing significantly to their failure. Had these problems been corrected, the banks might not have failed or their failure could have been less expensive to the fund.
Many of the 39 failed banks did not obtain an independent audit in their last year prior to failure. Without an audit, a troubled institution’s management can more easily conceal its financial difficulties. Audits would enhance both the corporate governance and regulatory functions. In addition, the roles of both management and the auditors would be strengthened if they were required to assume responsibility for assessing and reporting on the condition of internal control, a significant cause of bank failures.
Describe in one or two concise, informative paragraphs how audits by external auditors could have prevented or limited the losses incurred by the Bank Insurance Fund.