The objectives of this report are to (1) identify U.S. supervisors’ expectations for adequate internal controls and audits in U.S. branches and agencies of FBOs (FBO branches), (2) determine the extent of serious weaknesses in FBO branches’ internal controls and audit reported by U.S. supervisors, and (3) describe U.S. supervisors’ efforts to address these weaknesses. U.S. U.S. Bank Supervisors Expect Internal Controls That Enable Timely Detection of Any Significant Errors or Irregularities

According to the examination manual, supervisory agencies in the United States expect each U.S. FBO branch to have internal controls consistent with the size and complexity of its operations as well as an independent internal audit function and/or adequate audit coverage by the head officeor external auditors. In assessing an FBO branch’s internal controls, supervisors are to consider (1) the adequacy of these controls and the level of adherence to them; (2) the frequency, scope, and adequacy of the branch’s internal and external audit function; (3) the number and severity of internal control and audit exceptions; (4) whether internal control and audit exceptions are effectively tracked and resolved in a timely manner; (5) the adequacy and accuracy of management information reports; and (6) whether the system of controls is regularly reviewed to keep pace with changes in the FBO branch’s business plan and laws and regulations. In general, good internal control exists when no one is in a position to make significant errors or perpetrate significant irregularities without timely detection, according to the examination manual. A Significant Number of FBO Branches Rated Fair or Lower Had Serious Internal Control and Audit Weaknesses

The results of our analysis of examination reports of the 254 FBO branches rated fair, marginal, and unsatisfactory (i.e., 3, 4, or 5) from January 1993 to June 1996 indicate that a significant number of these FBO branches were reported to have serious weaknesses in internal controls, and that a majority of the FBO branches had at least 1 serious audit weakness. Forty-one Percent of the FBO Branches Were Reported to Have Inadequate Frequency of Audits

We found that 41 percent (103) of the FBO branches rated fair or lower were found by supervisors to have audits of inadequate frequency. Supervisory staff we interviewed agreed that inadequate response to audit criticisms is among the most serious of audit weaknesses and could be indicative of poor management. U.S. The objectives of these efforts include helping to ensure (1) the detection of losses that have occurred as the result of a branch’s weaknesses in internal controls and audits, (2) the timely correction by branches of serious weaknesses in internal controls and audits, (3) an increased understanding among multinational banks of the importance of adequate internal controls and audits, and (4) the preparedness of supervisors to conduct effective assessments of internal controls. U.S. U.S. U.S. Supervisors’ Measures Do Not Capture Linkages Between Initiatives and Results

U.S. supervisors have not yet developed a strategy for evaluating the results of their initiatives to improve internal controls and audits at FBO branches.
Why GAO Did This Study

Pursuant to a congressional request, GAO: (1) identified U.S. supervisors' expectations for adequate internal controls and audits in foreign banking organization (FBO) branches; (2) determined the extent of serious weaknesses in FBO branches' internal controls and audits reported by U.S. supervisors during examinations; and (3) described U.S. supervisors' efforts to address these weaknesses.

What GAO Found

GAO noted that: (1) U.S. supervisors expect each U.S. FBO branch to have: (a) a system of internal controls that is consistent with the size and complexity of its operation; and (b) an internal audit function of adequate scope and frequency or an adequate system of head office or external audits; (2) although few FBO branches' deposits are insured by the Federal Deposit Insurance Corporation (FDIC), U.S. supervisors have an interest in the activities of FBO branches because the supervisors wish to preserve standards that help ensure the efficiency of and confidence in U.S. markets; (3) a guiding principle for U.S. supervisors in assessing internal controls is that good internal control exists when employees are not in a position to make significant errors or perpetrate significant irregularities without timely detection; (4) in evaluating a FBO branch's overall system of internal control, U.S. supervisors are to consider the adequacy of controls and the level of adherence to them; (5) a significant number of the 254 FBO branches U.S. supervisors rated fair or lower had one or more of the weaknesses in internal control that U.S. supervisors identified as being among the most serious, and a majority of the FBO branches had one or more of the weaknesses in audit function identified as being among the most serious; (6) 67 percent of the 254 FBO branches whose examination reports GAO reviewed were reported to have had audits of inadequate scope; 41 percent were reported to have had audits of inadequate frequency; and 28 percent were reported to have had inadequate management response to audit criticisms; (7) according to U.S. supervisors, these audit weaknesses represent serious problems in management's oversight of internal controls and could slow or limit improvement of internal controls at some FBO branches; (8) GAO found that U.S. supervisors are undertaking numerous efforts intended to address internal control and audit weaknesses at FBO branches; (9) the objectives of these efforts include helping to ensure: (a) detection of losses that have occurred as the result of an FBO branch's internal control and audit weaknesses; (b) timely correction by FBO branches of serious weaknesses in control procedures and audit functions; (c) increased understanding among multinational banks of the importance of adequate internal controls and audits; and (d) preparedness of supervisors to conduct effective assessments of internal controls; and (10) prompt attention to the development of a strategy for evaluating the results of these initiatives is now needed to determine whether progress is being made in improving the condition of internal controls at FBO branches.