Posted: May 25th, 2022

The disbursement of loan funds discussion

Accounting Information System

Greater Providence Deposit and Trust needs more effective control and audit procedures over the disbursement of loan funds, with greater oversight and validation of approved customers getting the loan amounts by check, not by cash. A fundamental flaw in the processes Providence relied on was to allow a person with audit control over the financial statements to allow have loan origination and decision-making authority eventually up to $25.000. A fundamental design criterion for ensuring auditor employees do not gain access to loans and embezzle is to both rotate auditors through an organization while also never allowing anyone with audit clearances to also have loan approval authority (Van Wijk, Holmes, 2007). Clearly Providence Deposit and Trust broke this fundamental rule of sound risk management. Creating an effective division of labor across auditing, accounting, and loan management can avert millions of dollars in embezzlement over time, ensuring auditing procedures track transactions by originator and requiring identification before dispersements are made (Wells, 1998).

Another strategy Providence Deposit and Trust could concentrate on reducing fraud risk is to rotate loan clerks and the auditors assigned to each type of loan over time. The continual rotation of loan clerks and auditors will eventually disrupt patterns of fraud and embezzlement, making them easier to discover and prosecute (Wells, 1998). The spot-check based auditing of loans and the use of random sampling of transactions throughout any given loan clerk’s tenure is also an excellent idea. Going as far as to call customers to see if the loan transaction met their expectations or not would not only provide insights into customer satisfaction, it would also ensure that loans were actually being originated by real customers. Another area the bank could significantly improve the loan review procedure would be to audit the deposit of each loan dispersements or check down to the individual account number of patrons. In fact the bank could put into place an innovate marketing and customer service strategy of free lifetime checking if the loaned funds are kept at the bank in a checking account. This would immediately flag the loans going outside their own bank and also provide greater insights into how customers were using funds over time. Another approach is to incent auditors to find fraud and embezzlement and make it widely known in the bank that anyone finding illegal practices would receive a reward up to 20% of the error found. Auditors, who are traditionally not paid that much, would work overtime looking for fraud, hoping to earn 20% of the fraud found, thereby drastically reducing the threat. While this may appear expensive, without this strategy a bank could go for years, losing millions of dollars, if no action was taken.

In the case study, it is apparent that Greater Providence Deposit and Trust auditors were not organized or incented in their job design and rewards to actively seek out embezzlement and fraud. This is a major limitation in the design and operation of many auditing departments in financial services (Van Wijk, Holmes, 2007). A large part of why the auditors would not have found the fraud can be traced to the lack of control environment and complete disconnect between Section 404 of the Sarbanes-Oxley Act (SOX) of 2002 and the processes, procedures and controls in place. Unfortunately for many financial institutions, this is commonplace, with the disconnects between SOX reporting requirements and actual operations being completely different (Holtfreter, Beaver, Reisig, Pratt, 2010). For the Greater Providence Deposit and Trust, the only alternative was to delist themselves, go private, get their auditing and reporting processes and procedures more robust, and then attempt to stay in business by re-earning trust.

References

Kristy Holtfreter, Kevin M. Beaver, Michael D. Reisig, & Travis C. Pratt. (2010). Low self-control and fraud offending. Journal of Financial Crime, 17(3), 295-307.

Eelco R. Van Wijk, & Timothy R. Holmes. (2007). Fraud in the Audit Department. The Internal Auditor, 64(2), 83-85,8.

Joseph T. Wells. (1998). An unholy trinity. The Internal Auditor, 55(2), 28-33.

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