Bank Regulation/Supervision and Bank Auditing

Abstract

We investigate how the overlapping activities of bank regulators/supervisors and bank auditors influence banks’ internal control quality, the effort expended by bank auditors, and banks’ financial statement reliability. Using material weaknesses in internal controls as the proxy for internal control quality, we find that banks exhibit fewer internal control problems than do comparable nonbank financial firms. Using audit fees and earnings announcement lags as proxies for audit effort, we find that auditors expend less effort in audits of banks than in audits of nonbanks. Using restatements of financial statements as the proxy for financial statement reliability, we find that banks’ financial reports are more reliable than those of nonbanks. Collectively, our findings suggest that, despite lower auditor effort, the aggregate efforts of bank regulators/supervisors and bank auditors yield enhanced internal control and more reliable financial reporting by banks than by nonbanks.

Keywords: Banks, auditing, audit effort, regulation, supervision, internal controls, material misstatements, accounting

JEL Classification: G21, G23, G28, M41, M42