An Update on Emerging Issues in Banking 

Bank Auditing and Accounting Faces Scrutiny

March 11, 2002 

Regulators should consider strengthening the ground rules governing bank 

auditing and accounting, according to FDIC Chairman Don Powell. In a March 5, 

2002 speech, Powell noted that bank regulators have had the authority for some 

time to address auditing conflicts of interest, to mandate the retention of auditing 

documents, and to enhance sanctions imposed on auditors. 

Under Section 36 of the Federal Deposit Insurance Act, every FDIC-insured 

institution with assets of more than $500 million must be audited annually. Many 

smaller institutions choose to be audited as well. Bank regulators have the 

authority to set standards for auditor independence for institutions subject to 

Section 36. Powell said that regulators should consider banning accounting firms 

from providing internal auditing and other consulting services to the same 

financial institution they are auditing externally. 

Destruction of audit workpapers, in addition to being widely publicized in 

connection with the bankruptcy of Enron, has posed problems for the FDIC in 

connection with its resolution of failing banks. In resolving disputes with auditing 

firms in the early 1990s, the FDIC was able to obtain agreements from a number 

of firms regarding the retention of auditing working papers and other documents. 

Powell suggested that the SEC and other bank regulators may wish to consider a 

nationwide document retention requirement for the records and working papers 

used during the audit of any insured depository institution. 

Bank regulators can now discipline auditors for "knowing or reckless misconduct" 

under Section 8 of the Federal Deposit Insurance Act. For ten years, the 

regulators have had authority to craft regulations for the larger institutions subject 

to Section 36 that would cast a wider net with respect to auditor discipline, but 

they have thus far not exercised that authority. Powell said that this may be an 

appropriate time for bank regulators to implement such regulations. 

Powell also emphasized the importance of sound accounting for assets and 

liabilities arising from securitizations. After praising the new residual capital rule 

scheduled to take full effect at the end of 2002, Powell said that the current 

accounting literature may not be sufficient in other areas relating to 

securitizations. For example, how institutions account for accrued interest 

receivable arising from securitized assets needs to be considered. This issue 

directly affects only the small percentage of banks that are engaged in 

securitization activity, but for those institutions it is important to ensure that the 

capital reflected on their books is accurate. 

While accruing the interest owed by borrowers that has not yet been collected is 

a common practice, some credit card securitizers have subordinated their right to 

receive the collected interest payments to the bondholders in their securitizations. 

Such subordination provides a credit enhancement to those with a senior interest 

in the securitized assets. This is a form of recourse that requires the securitizing 

bank to hold capital commensurate with the amount of recourse. The FDIC and 

the other banking agencies currently are working together to ensure that the 

capital rules are properly applied in these situations.