The FSA’s monitoring of financial institutions’ internal audit functions
The FSA has been working to promote the advancement of internal audit functions in financial institutions since 2019. In 2019, the FSA published a report titled “Current Status and Challenges of Internal Audit Advancement in Financial Institutions” and has continued to promote the advancement of internal audit functions through monitoring efforts. The FSA has now compiled the results of these monitoring efforts, together with the FSA’s awareness of issues and expectations, into the “Monitoring Report for the Advancement of Internal Audits at Financial Institutions,” which was published on September 10, 2024.
Findings
The FSA’s 2024 monitoring efforts show that many financial institutions have made significant progress in advancing their internal audit functions since 2019, but there are still differences between institutions. More mature internal audit functions are characterized by a stronger commitment to risk-based auditing, improved communication and collaboration with senior management, and a stronger focus on audit quality. Less mature internal audit functions are characterized by a more traditional focus on compliance and transaction testing, less effective communication with senior management, and a weaker commitment to audit quality.
Key Findings
The report highlights several key findings.
Commitment to the Advancement of Internal Audit Functions
The report found that financial institutions have made significant progress in advancing their internal audit functions. However, the report also found that there are still differences in the level of commitment to internal audit advancement. Some financial institutions have made significant progress in advancing their internal audit functions while others are still in the early stages of development.
Support from Senior Management
The report found that the level of support from senior management is a key factor in the success of internal audit functions. In institutions with strong internal audit functions, senior management is actively involved in supporting and promoting internal audit. Senior management actively engages with internal audit departments, participates in governance bodies and actively provides feedback on the audit process. Conversely, in institutions with less mature internal audit functions, senior management has a weaker commitment to internal audit. In these institutions, internal audit is not often actively involved in decision making or is considered a compliance-focused function.
Internal Audit Department Focus
Financial institutions with strong internal audit functions are more focused on improving their audit capabilities to contribute to the institution’s risk and business strategy. This is in contrast to less mature internal audit functions where the focus is generally on compliance and transaction testing with limited focus on risks beyond internal control and operational effectiveness.
Communication with Audit Clients
The report found that strong internal audit functions are characterized by effective communication with audit clients. This is also in contrast to less mature internal audit functions, which may have limited communication with audit clients. In these institutions, senior management is less likely to engage with internal audit departments and there may not be as much focus on communication and collaboration.
Commitment to Audit Quality
The report found that financial institutions with strong internal audit functions are committed to improving the quality of their audits. This includes a strong focus on developing and implementing quality assurance programs, providing training to internal auditors, and actively participating in professional development activities. In contrast, less mature internal audit functions may have less of a focus on audit quality. They may not have a formal quality assurance program or may provide less training to internal auditors.
Recommendations
The report makes a number of recommendations for financial institutions and regulators.
Financial Institutions
Financial institutions should continue to advance their internal audit functions.
Developing a Strong Commitment to Internal Audit
Financial institutions should demonstrate a strong commitment to internal audit by actively supporting and promoting internal audit. This includes providing sufficient resources for internal audit, creating a culture of transparency and accountability, and actively engaging internal audit in governance bodies.
Developing a Strong Focus on Risk-Based Auditing
Financial institutions should move away from a traditional focus on compliance and transaction testing and shift towards a more risk-based approach to auditing. This includes developing a comprehensive understanding of the institution’s risks, identifying key risk areas, and tailoring audit procedures to address these risks.
Improving Communication and Collaboration
Financial institutions should improve communication and collaboration between internal audit and senior management. This includes establishing regular communication channels, providing timely feedback on audit findings, and involving internal audit in decision-making processes.
Improving Audit Quality
Financial institutions should focus on improving the quality of their internal audit functions. This includes developing and implementing a comprehensive quality assurance program, providing training to internal auditors, and actively participating in professional development activities.
Regulators
The report recommends that regulators continue to provide guidance and support to financial institutions as they advance their internal audit functions. Regulators should continue to monitor the progress of financial institutions in advancing their internal audit functions and should develop new guidance and regulations as needed.
Challenges for Financial Institutions
The report also highlights some challenges for financial institutions.
Funding Internal Audit Functions
One challenge is funding internal audit functions. Internal audit is often viewed as a cost center, and financial institutions may be hesitant to invest in resources for internal audit. Financial institutions should recognize that internal audit is an important function that can help to protect the institution’s reputation and financial stability and needs to be adequately funded.
Attracting and Retaining Talent
Another challenge is attracting and retaining talented internal auditors. Internal audit can be a demanding career, and many talented professionals may choose to pursue other careers. Financial institutions need to make internal audit an attractive career path by offering competitive compensation and benefits, providing opportunities for professional development, and creating a positive work environment.
Keeping Up with Change
Another challenge is keeping up with the rapidly changing regulatory environment. The financial services industry is constantly evolving, and internal audit functions need to adapt to these changes. This includes staying up-to-date on new regulations, developing new audit techniques, and using technology to enhance audit effectiveness.
Conclusion
The report concludes by stating that internal audit is an essential function for financial institutions and that the FSA will continue to monitor the progress of financial institutions in advancing their internal audit functions. The FSA will also continue to provide guidance and support to financial institutions as they develop their internal audit functions.
The report provides a valuable overview of the current status of internal audit functions in Japan. It also highlights a number of important challenges for financial institutions and regulators. As the financial services industry continues to evolve, internal audit will continue to play a critical role in helping institutions to manage risk and protect their reputation. Financial institutions should continue to invest in resources for internal audit, attract and retain talented professionals, and keep up with the rapidly changing regulatory environment.
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