Problems of Internal Control Audits Within Microfinance

Microfinance involves supplying loans and other banking services to small firms with little to no credit or collateral. Since the 1970s, microfinance institutions have made loans to small businesses in countries that have been underserved by traditional lenders. Although these lenders have demonstrated their capabilities in providing capital to businesses with limited resources, their expanded use has led to closer scrutiny of their financial management and reporting practices. Many microfinance institutions use internal control audits to assess how they employ these practices.

A major issue that internal auditors face when dealing with a microfinance institution involves the potential for fraudulent misconduct. Fraud can stem either from borrowers falsifying documentation, lenders seeking to take advantage of the system or collusion between both parties. For instance, the lender may set up phantom loans for a borrower, and the lender receives a portion of the proceeds as a bribe in exchange for relaxing or ignoring the repayment schedule.

In many of of the poorer regions of the world that rely on microfinance, the infrastructure for communications, transportation and banking services is often well below the standards typical in the Western business world. Without this support structure, many microfinance lenders resort to cash transactions and handshake agreements, rather than wire transfers and rigorous loan documentation. This lack of infrastructure can lead to delays in communication, poor record keeping and inconsistent lending practices. Internal auditors must be aware of these challenges and align their assessments according to the conditions on the ground.

Another barrier for internal auditors of microfinance institutions stems from the lack of experience among many of the managers of microfinance programs. According to the United States Agency for International Development, most of the managers of these programs have much more experience in social work and social welfare projects than in financial management. Because these managers lack the experience in finance and accounting, they also frequently lack a basic understanding of financial reporting, record-keeping procedures and establishing internal controls.

While most microfinance lenders often lack the resources to maintain an internal auditor position, those that do may find that the auditor's independence is compromised. The lack of independence may stem from a personal relationship with the loan manager, a lack of experience or other job duties. For instance, the loan manager may ask the lending institution's accounting staff to audit the institution's own records. The internal auditor must remain independent of the financial and political pressures within the organization while delivering an accurate and actionable report.