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November 30, 2022

When a Bank Fails, People ‘Lose Faith’ in the Auditors

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Are bank failures bad PR for the firms that audit them? New research seems to show that depositors — a.k.a. bank customers — find it difficult to trust auditors when those auditors have been associated with a failed bank.

Via KU (Kentucky University) News:

The word “audit” has a different meaning depending on whether you’re an individual or a bank. But a perceived audit failure can have equally damaging consequences.

“We found that depositors — people who have money at banks — lose faith in an auditor when that auditor is associated with another bank that fails,” said Matthew Beck, assistant professor of business at the University of Kansas.

His new article, “The Role of Audit Firms in Spreading Depositor Contagion,” argues that depositors perceive bank failure as an audit failure, which reduces their assessment of auditor credibility. This leads to lower deposit growth at banks with the same auditor. It’s published in The Accounting Review.

Here’s the abstract:

Auditor credibility is important in the banking industry due to the opacity of bank assets and the use of financial statements by external parties to facilitate monitoring. Depositors monitor and discipline bank behavior, but they can also contribute to the spread of shocks from one bank to another. We argue that depositors perceive bank failure as an audit failure, which reduces their assessment of auditor credibility. We document that exposure to failure through the audit firm is associated with lower uninsured deposit growth following the failure, consistent with depositors perceiving failures as a negative signal of auditor credibility. We further document that this association is stronger when depositors perceive connection to failure to reflect a pervasive issue within the audit firm. Collectively, our results suggest that depositors consider accounting signals at other banks in assessing financial reporting credibility.

The authors wondered aloud if an auditor would get blamed when a bank fails. When an institution fails, customers might need “a scapegoat to point their fingers at,” Beck said.

His team took data sets from various banks, running multivariate regressions and using statistical analysis to find relationships between these two factors. This determined exposure to failure through the audit firm is associated with lower uninsured deposit growth, consistent with depositors perceiving this as a negative signal of auditor credibility. It also showed the results are stronger when awareness regarding the failure is greater, including when a larger bank is involved or when significant news coverage occurs.

For large accounting firms regularly writing checks for fines and failures, this is not good news.

The Role of Audit Firms in Spreading Depositor Contagion [SSRN]

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