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Keynote Speech at the Audit Seminar for SAIs in South Pacific Region
2014-10-30日   Soure : :

An Outlook on the Development of SAI’s Financial Sector Auditing at the Post-financial Crisis Era

——Address at the China-US Audit Seminar

by Liu Jiayi, Auditor General of China

27th October 2014

Distinguished Guests, Ladies and Gentlemen, Dear Colleagues and Friends:

Good morning! It is a pleasure to meet you all in the beautiful city of Nanjing in the golden days of October. First, please allow me, on behalf of the National Audit Office of China, and in my own name, to extend my warmest welcome to all friends and colleagues coming from afar for this China-US Audit Seminar.

Last October, the XXI INCOSAI approved the Beijing Declaration, which states that “While promoting good governance at home, Supreme Audit Institutions (SAIs) must remain dedicated to improving governance globally through international and regional cooperation.” That was why Mr. Gene Dodaro and I decided to established a mechanism of meeting and seminars between the SAIs of China and the US. Today, with the opening of the Audit Seminar, this mechanism is officially in operation.

Ladies and Gentlemen:

Finance is economy in miniature, which lies at the core of modern market economy. The sound operation of the financial industry is the basis of a healthy economy and society. Strengthening financial regulation is crucial to the stability and security of the financial system. By auditing the promulgation and execution of financial regulatory policies, SAIs have played a significant role in ensuring the effective and appropriate regulatory policies, maintaining national financial security and enhancing performance of the financial sector. Therefore, we have taken “Audit and Evaluation of the Implementation of Financial Regulatory Policies” as the theme of the first China-US Audit Seminar, to share experiences in financial system audit, conduct in-depth discussions, improve on audit methodologies, build audit capacities, giving better play to the role of audit in maintaining economic and financial security in the world. Now, I am pleased to share with you my views on the development of SAI’s financial sector auditing at the post-financial crisis era.

Since the emergence of finance, financial crises have followed closely on its heels like shadows. Crises hit the economy repeatedly almost every ten years, like ocean waves to the shore. From as early as the “Tulip mania” and “South Sea Bubble” in Europe, to the banking sector crisis in 1907 and the Great Depression in 1929 in the US, to the economic and financial crisis triggered by the Oil Shock in 1973, to the debt crisis in Latin America in 1980s, to the Asian financial crisis in 1997, and to the financial crisis in 2007. The nature of financial capital in pursuing profits, correlation between fluctuations of financial markets and economic cycles, inherent fragility of banks as credit products operators, as well as the complexity and diversification of economy and society, are all underlying reasons for the repeated outbreaks of crises. Charles Kindleberger, a leading architect of the Marshall Plan, had pointed out that financial crises recur, and will never perish.

As seen from the history of finance and its management, the outbreak of each major financial crisis has posed not only challenges to financial institutions in various countries, but also comprehensive tests to the financial regulatory regime and regulatory institutional system. Since 1970s, with the wave of financial liberalization, deregulations have become a common phenomenon around the world, and countries have reduced or lifted controls on financial activities, relaxed restrictions on business scope of different financial institutions. Such deregulation has lead to the expansion impetus of financial institutions, especially the growth spurts of off-balance sheet businesses and financial derivatives, which has brought about excessive credit creation in deviation of the development of real economy, increased overall leverage ratio, and thus sowed the seeds of the financial crisis. The over-exuberance of financial derivatives, which are meant to circumvent regulation, disperse and transfer individual risks, have become the concentration and accumulation of systemic risks of the financial system. With the increasing complexity of financial innovations and financial businesses, it is getting obvious that financial regulation lags far behind financial development. The regulatory bodies for banking, securities and insurance sector assess only the risk management of individual financial institutions, but not a single regulator is mandated to conduct cross-sector supervision and to identify the overall systemic financial risks. Actually, the global financial crisis in 2008 showed that the regulatory bodies of various countries focused merely on the supervision of individual financial institutions, but ignored the prevention of systemic financial risks.

We should also realize that, with economic globalization and the progress of financial innovations, the high correlation among financial institutions has become a striking feature of modern financial system. Such high correlation, as well as the virtualization of financial products, has lead to the direct transmission of risks through cross holding of financial assets, which accelerated the spread of risks, increased the force of impact, and brought about magnified systemic risks globally, like the “butterfly effect” and “domino effect”. That is why the 2008 financial crisis imposed broader, deeper and longer impacts than crises in the early 20th century, despite much more intensified financial regulatory capacity and enhanced institutions and system.

Ladies and Gentlemen:

After the global financial crisis, the National Audit Office of China (CNAO) has set goals to maintain security, accelerate reform and promote development. Through audits of the financial regulators and institutions, CNAO has stepped up the exposure of major violations of regulation and law in financial operation, attached more importance to the identification of major risk areas and systemic financial risks, conducted in-depth research on problems in financial systems and mechanisms and put forward substantial policy recommendations, giving better play to the role of financial system audit in risk identification, financial security and thus facilitation of good national governance.

First, CNAO has carried out real time audit of the implementation of macro economic and financial policies. With an eye to supervise the performance of public funds, state-owned assets and resources, CNAO has conducted real time audit of the implementation of macro economic policies and macro regulation measures, which is also performance audit. Since 2009, CNAO has organized real time audits of the new loans in major commercial banks, which focused tightly on the decisions made about national economy and financial system and measures and requirements of macro regulation, revealing outstanding problems and policy risks in implementing national monetary and credit policies, as well as macro regulation measures including regional development, supporting agriculture, energy saving and emission reduction and supporting small- and medium- sized enterprises, on the part of financial institutions. Those audits have urged financial institutions to comply voluntarily with national macro regulation policies and ensure the actual implementation of policy measures. Against the background of China’s deepened reforms in all aspects, conducting real time audit of policy implementation is a long-term, continuous task, which also signifies that national audit in China has entered a new era.

Second, CNAO has strengthened the accountability audits of leaders in financial regulatory bodies and financial institutions. Since 2008, CNAO has conducted accountability audits of the leaders of financial regulators including People's Bank of China (PBOC) and the budget execution of China Banking Regulatory Commission (CBRC), China Securities Regulatory Commission (CSRC) and China Insurance Regulatory Commission (CIRC) as well as legal persons of large state-owned financial institutions, with an attempt to enhance the constraint and supervision of financial regulation and the power to allocate financial resources. During auditing, objective assessment of the leaders’ performance was made with the verification of budget execution of the financial regulators as well as the truthfulness, compliance and performance of balance sheets and income statements of financial institutions as the basis, with the examination of the implementation of macro economic policy measures as well as the power to allocate financial resources as the common thread, so as to urge relative leaders, departments and institutions to better perform their duties.

Third, CNAO has place priority on the fight against corruption and crimes. Given the severe damage, huge amounts and wide coverage of financial crimes, CNAO has always put the identification of major violations of law and leads to major cases as key subject matter, and detected all kinds of cases such as loan frauds, embezzlement and misappropriation, illegal fund raising, illegal private banks, tunneling and commercial bribery. By doing so, CNAO has successfully cracked down on irregularities and crimes in the financial sector, helped enforce financial and economic laws and regulations, and maintained the safety of financial assets.

Fourth, CNAO has devised and refined a new audit organizational model where auditors make overall analysis to identify leads and then verify them separately before studying on specific subject matter. To cope with the data concentration of commercial banks, since 2008, CNAO has set up digital audit platforms in eight major commercial banks. Centered on data analysis, through regular audits, CNAO has heightened the supervision of cross-market, cross-industry and transregional financial transactions of large amounts and flow of funds, identified systemic risks, operational risks and major violations of law and regulation and issued early warnings accordingly, in order to safeguard national economy and facilitate good national governance.

Ladies and Gentlemen:

Today, with the rapid progress of globalization featured as integrated international economy and finance, and free trade and investment, and fueled by the development of information technology, the world’s financial sector is becoming increasingly complex, convergent and disintermediate. Consequently, systemic risks in the financial sector have assumed a series of new characteristics: 1) financial innovation and mixed operation have increased the homogeneity of financial markets, and “firewalls” have been crossed, which may trigger chain reactions; 2) the pro-cycle institutional arrangements in the financial system, like risk assessment and credit rating, may cause intensified economic and financial market turbulence; and, 3) more and more financial institutions raised leverage ratio and return on investment through off-balance-sheet activities, which may cause liquidity risks and trigger systemic crisis.

Financial innovations and development have posed higher requirements to financial system audit. Nevertheless, judging from the early warning, identification and resistance of financial crisis by various SAIs, there are still inadequacies in auditing. For example, SAIs usually focus on financial audits of financial regulators, but lack in mature experience in auditing the execution and outcome of financial policies. Especially due to the absence of supervision of the overall operation of financial policies and macro economy, SAIs fails to detect risks in the economic and financial systems, or reveal defects in financial regulatory structure and regime, or provide early warning against financial crisis. After the outbreak of financial crisis, some SAIs conducted crisis-related audits; however, no systemic countermeasures were put in place to resist the financial crisis. At the post crisis era, new challenges facing SAIs are as follows: how to adjust the development strategy of financial sector auditing, how to expand its scope, enrich its contents and innovate its methodologies, and how to serve for the stability and efficiency of financial system in a better way. CNAO will work with other SAIs in the research on financial innovations, risks and regulatory efficiency, update ideas, organizational model and techniques of financial system audit, centering on the maintenance of national financial security, to reveal and reflect hidden risks and outstanding problems that affect the sound operation of economy and society, and facilitate the prevention and mitigation of systemic, regional and global financial risks.

1. SAIs should accelerate the improvement of financial regulation with a focus on preventing systemic financial risks. Judging by the trends of financial regulatory reforms worldwide, the systemic risks, caused by financial innovation and mixed operation, could not be effectively prevented solely through micro-supervision of individual financial institutions. Hence, after the financial crisis, governments of various countries have gradually strengthened macro prudential regulation, so as to better monitor and address potential causes of financial instability in financial systems. That is why financial system audit should pay attention to the whole picture of financial development, to reflect systemic risks and deep-rooted problems, rather than restrict audits merely to the punishment of single cases or the revealing of the appearance of risks. On the one hand, audit institutions should strive to reveal systemic risks to the entire financial sector and the national economy on the macro level based on the detection of each financial risk area on the micro level. Audit institutions should not only pay close attention to tendencies and symptoms and disclose financial hidden risks and put forward a list of financial risk areas, but also contribute to the improvement and reform of the financial system, in order to prevent and mitigate those risks and maintain national economic and financial security. On the other hand, SAIs should review and evaluate the appropriateness of regulation on financial markets, identify flaws in the regulatory system, assess the effectiveness of financial regulators' supervision of complex innovations of financial derivatives, Internet finance, financial holding companies that are becoming increasingly globalized and synthetic, follow closely on the weaknesses and potential risks in social and economic operation, reveal systemic defects in regulatory policies and regulations, market entry and consistent regulation, regulatory information sharing and so on. Aud it recommendations should be made on improving macro prudential regulation and refining financial regulatory system.

2. SAIs should encourage the financial sector to better serve the real economy with standardizing the development of financial innovations as a priority. The real economy not only reflects national productivity, comprehensive strength and resistance against risks, but is also the origin of people's wellbeing and the cornerstone of financial development. Finance is economy in miniature, and finance and real economy rise and fall as an entirety. If the real economy does not develop properly, huge risks must be posed to the financial sector; whereas if financial innovations are developed in isolation of the real economy and fall into self cycling, the financial sector will not only weaken the real economy but also jeopardize its won sustainable development. The major trigger of this financial crisis is the excessive expansion of real estate, subprime mortgage and its derivatives, which on the one hand led to accumulation of internal risks and on the other hand deviated further and further away from the real market, and lost control on financial innovations. Hence, SAIs should take the essential connections between financial sector and real economy as a baseline, pay attention to the proper design of financial products and their risk control measures, prevent “innovations” aiming to circumvent regulation and in negligence of the needs of economic development, and help the financial system better serve the real economy, so that the financial system can truly rely on as well as boost the growth of real economy.

3. SAIs should protect financial customers with the maintenance of a fair financial system as the mission. Given the complexity and high risks of financial products, as well as information asymmetry, customers are in a weak position in terms of financial strength, professionalism and risk identification. Therefore, it is necessary to put in place effective financial customer protection mechanisms in order to ensure fair transactions in financial markets. In fact, among the numerous problems exposed by the international financial crisis this time, there was the public distrust in the financial system due to financial frauds and infringement on the rights of financial customers. The financial crisis has highlighted inadequate financial customer protection in the former regulatory system, and thus various countries have made customer protection one of the major contents in their regulatory reforms. SAIs should review and evaluate whether the existing regulatory policies are able to ensure sufficient information disclosure to strengthen transparency of transactions, evaluate the performance of regulatory bodies in the supervision and fulfillment of customer protection, and maintain a fair financial system in good order.

4. SAIs should push forward the innovation of audit methodologies by relying on big data analysis. Big data is a new way of looking at the world and explore the connections among massive data through digitalized thinking and advanced processing techniques, which imposes profound impact on the social and economic development. Big data will affect the future IT application in SAIs tremendously, and bring great changes to national audit. SAIs should innovate constantly and develop new audit methodologies to cope with new circumstances, so as to adapt to the requirements of audit development. In the big data environment, on the one hand, research should be carried out in data integration of the financial sector, and realize the multi-dimensional data mining, multi-angle correlations, multi-level fitting, multi-area evaluation and multi-directional predictions towards data of commercial banks, trust, insurance, securities and funds. On the other hand, correlation analysis should be strengthened among data of public finance, finance, enterprises and social security, in order to identify risks in economic operation, safeguard the economy and improve governance through data mining and integration of different industries.

5. SAIs should enhance cooperation with the promotion of global governance as the common understanding. With the process of financial globalization, financial institutions worldwide have become increasingly interrelated through an ever growing financial market system, in which the convergence of financial products, business model of financial institutions and financial market operations have intensified the homogeneity of global financial markets and amplified the multiplier effect of risks. Moreover, globalization has given rise to numerous transnational financial institutions, whose own mistakes may lead to major risks in the global economy. Besides, with the rapid flow of international financial capital, crimes like financial frauds and money laundering have also been globalized, seriously endangering national security and stability of global economy and society. Therefore, it has become a common understanding among various SAIs that they should broaden the horizon of financial system audit and strengthen international cooperation. Given the globalization of financial regulation, SAIs should increase multilateral cooperation and information exchange concerning financial system audit, and facilitate the construction of a global network of financial security, so as to improve global economic governance.

Ladies and gentlemen:

The participating SAIs are all well experienced in financial system audit, and thus we believe that the convening of the Audit Seminar will initiate communication of good practices and experiences in the audit and evaluation of the implementation of financial regulatory policies among us, and increase INTOSAI’s knowledge reserve in this important topic.

This Seminar will not only include exchanges of expertise and experience in financial system audit but also future-oriented theoretical discussions. Hence, I suggest that we form a China-US consensus on the audit and evaluation of the implementation of financial regulatory policies on the basis of the papers submitted and the two-day seminar. The consensus will be disseminated and utilized by the INTOSAI Working Group on Financial Modernization and Regulatory Reform, for the benefit of all SAIs. As the organizer of the first seminar, we will strive to encourage experience sharing and consensus building among participating SAIs. We look forward to contributions by all experts here, and to the continuance of such audit seminars, which will contribute to the advance and win-win cooperation of INTOSAI and various SAIs.

Last but not the least, I wish the Audit Seminar a huge success. I also hope you enjoy your stay in Nanjing.

Thank you.