David Chaston calls for a shakeup in the way auditors are appointed to banks who are systemically important to our economy and our financial stability

By David Chaston

Banks are lenders. That's how they make their money.

Their loan books are the essential record of their business activity.

Management of those loan books is their core skill, the essential attribute investors are counting on.

Only management gets to see inside their loan book - with one exception, their auditor. Even regulators only get to be given sanitised 'views' of those loan books. But the auditor has access to the gritty detail.

So auditor oversight is an essential safeguard in the integrity of the banking system.

Auditor oversight is so essential that banks themselves have created internal audit and credit risk functions. But these are bank 'management' and not independent or external.

So the role of the external bank auditor is essential to the health of the banking system. Their review ensures that there is no creeping loss of standards or diminution of oversight.

But how independent are external auditors, really?

Over the past 10 years, there have been no changes of auditors at any major New Zealand retail bank.

Over the past 17 years (the limit of our review) there have only been two changes of any significance, each brought about by acquisition.

The table below gives the full picture:

Actually, things are even more concentrated than that. Of the five major retail banks, three of them are audited by one firm: PricewaterhouseCoopers.

Our bank's financial engines are being reviewed by essentially the same organisations, over and over and over and over. It is not a situation where the customer can have much confidence that fresh rigour is being used in these audits, or fresh eyes taken to any issues that maybe in these giant loan books - no matter how 'professional' these audit firms may be. If they 'win' an audit, it's theirs for keeps.

Customers and regulators rely on the investigation by auditors. But management (the board of directors) appoint them. And in New Zealand's case the ownership of four of the five major retail banks are subsidiaries with boards appointed essentially by Australian parent management. Essentially, the Australian board of directors appoints the New Zealand auditor, and having the same firm 'saves' a lot of potential for inconsistencies. But it might also hide genuine independent perspective within the materiality limits. Who knows?

The key point here is that the auditors are not working for or in the interest of customers or regulators. These stakeholders get what Aussie management decides.

And perhaps that is not good enough for institutions that are central to the economic life of the nation, and central to our financial stability.

In good times, there is no real pressure to change 'what is working'. The risk comes that such a long term cosy relationship may miss key inflection points as we build to the next stress point.

Perhaps it is time for the regulator to appoint or at least approve the auditor of the core large banks. And that the audit report be addressed to the depositing customers of the bank.

After all, depositing customers have $8 at risk for every $1 shareholders have at risk. The shareholders may reap the rewards but that alone should not mean they hold a lock on who the auditor is.

Or who the auditor reports to.

As an example, this is an extract from one audit report of who they do their work for;

This report is made solely to the shareholder as a body. Our work has been undertaken so that we might state to the shareholder those matters we are required to state to them in the Auditor’s Report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the shareholder as a body for our work, this report, or any of the opinions or conclusions we have formed.

Perhaps we are at the time where routine changeouts of auditors becomes the norm, say every five years. A fresh pair of eyes, a fresh look at the risks and exposures, a fresh look inside the loan books.

Even one of the most successful elite sporting teams in the world changes out its coaching staff regularly. Actually, bank shareholders change their senior management regularly too, recognising the benefits of fresh leadership at the top.

It should be ditto auditors.