Basel II and the internal auditing of agencies

Basel II means that it is medium-sized companies and of course agencies that in particular remain confronted with significant barriers due to the rule defining the capital adequacy requirements imposed on banks.

The aim behind the capital adequacy guidelines is a more discriminating, conservative credit risk assessment than has been the case to date. Loans will have to be differently underpinned with equity capital in accordance with the credit rating of the customers. Compared to companies with strong credit ratings, smaller agencies or those with a poor credit rating are therefore the less attractive loan customers.

Agencies frequently have economic problems, without actually realising it. These agencies could fare better if they were better informed and implemented counter-measures at an early stage. It is often the case that balance sheets or income statements are the sole sources of information and are supplied via the account after the fact.

In some cases this conflict between tougher access to loans and rudimentary "internal auditing" finds financial institutions becoming aware - through account management activities - of an existing imbalance with ensuing demands for swift action. By this time it is frequently too late.

But it need not reach such a stage if an effective agency internal auditing system is implemented. For only an appropriate management information system will tell the agency manager about the current status of the agency or the customer, if and to what extent the plan is not being fulfilled and what income and orders are in the pipeline.

Of course it is much easier to have the internal audit function implemented via the accountant , because this appears to be a manageable solution that is readily understandable. An effective agency internal auditing system has to be constructed carefully and also needs to be understood by the relevant people.

It is for this reason that many agencies shy away from taking the next step. But there is something forgotten when looking at the numbers produced by the accountant. These figures very often fail to reflect the true picture, because no account is taken of supplies and services not yet invoiced or of the semi-finished services or prepaid costs. If these values were known, the figures would frequently look quite different.

But just what does all of this have to do with the lending guidelines set out in Basel II?

Banks are obliged to critically examine borrowers' creditworthiness through ratings. Alongside "classic" factors such as annual financial statements and collateral, consideration is also taken of "soft" factors such as strategy as well as customer relations and customer evaluations. The extension of credit does not in any way entail the conclusion of this rating procedure, for it is often repeated on an annual basis.

Without an effective agency internal auditing system being in place, it will not be possible to supply additional information concerning customers, their turnover and contribution margins or a costs and budget forecast.