oversight

Progress Made Toward Independent and Comprehensive Audits of the Inter-American Development Bank

Published by the Government Accountability Office on 1971-07-20.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

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                                    B-161.470
                                                   Y
                                        d
Department of the Treasury
                            COMPTROLLER       GENERAL      OF   THE      UNITED    STATES
                                            WASHINGTON.     D.C.      20548




             B-l   61470




             To the    President       of the Senate    and the
        Li   Speaker     of the     House   of Representatives


*\e#f                This is our report      on the progress       made toward          inde-
             pendent    and comprehensive        audits    of the Inter-American
             Development      Bank,   an intergovernmental         financial     institution
             in which    the United   States   holds membership.

                       Our review      was made           pursuant   to section 14(c)                 of the
             Inter-American          Development            Bank Act, as amended
              (81 Stat. 226).

                      Copies   of this      report    are being   sent to the Director,
             Office    of Management           and   Budget,   and to the Secretary     of the
             Treasury.




                                                                   Comptroller              General
                                                                   of the Unit_ed           States




                                     5OTH    ANNIVERSARY                 1921-    1971
                                                                                               d
                           Contents
                                                             Page

DIGEST                                                         1

CHAPTER

       1   INTRODUCTION                                        5

   2       PROGRESSTOWARDACHIEVEMENTOF AN EFFECTIVE
           PROGRAMOF AUDIT                                     9
              Comments on the Group's staff capacity           9
              Comments on the Group's first  report--
                Study of Sources and Uses of Funds            12
              Comments on the Group's second report--
                Report on Loans to Venezuela                  16
              Conclusions,  recommendations, and agency
                actions                                       19

APPENDIX

       I   Letter dated A$ril 26, 1971, from the Assis-
             tant Secretary    of the Treasury for Inter-
             national  Affairs                                23

  II       Officials primarily responsible   for adminis-
             tration of U.S. participation   in the Inter-
             American Development Bank                        25
 ,I
  I
,/
  I
  I          COMPTROLLER
                       GENERAL'S                        PROGRESSMADE TOWARDINDEPENDENTAND
  I          REPORT
                  TO THECONGRESS                        COMPREHENSIVEAUDITS OF THE INTER-
  I                                                   / AMERICAN DEVELOPMENTBANK R. 8&
  I
         I                                           2 Department of the Treasury B-161470 38
         I
         I
         I
         I   DIGEST
             ------
         I
         I
  I
  I
  I
             h?Hl?
                 THEREVIEWWASMADE
  I
  I                  The Inter-American  Development Bank makes loans and provides technical
  I
  I                  assistance for the economic development of its Latin -- American   member
                                                                              __-_-~-c.-"_
  I                  countries.   Its operat-ibns arZ'filiXnced principally by contributions
-1
  /                  from members and borrowings on the open bond market.
  !
  I
  I                  The Bank has 23 member countries, one of which,        the United States,    has
  1                  contributed 76 percent of all members' financial        support.
  I
  I
  I                  U.S. membership in the Bank was authorized by the Inter-American  De-
     I‘              velopment Bank Act, approved August 7, 1959. The Bank was established
-I                   by international  agreement that same year.
     1
     I
                     The act was amended in 1967. Among other things, it directed the
     I               Secretary of the Treasury (the U.S. representative to the governing
     I
     I
                     body of the Bank) to work toward independent and comprehensive audits
     I               of the Bank.
     I
     I
                     It directed the Comptroller General to prepare a scope of audit and
' J-.I               auditing and reporting standards for use in formulating   th-ms     of
 .I\-L -.                                                                                               I
  I..                reference for ?X?%diYsti~%?review    periodically audit reports issued,
       I             and to report to the Secretary of the Treasury and to the Congress on
   : .               his review of the reports.                                                         \

                     This is the first     report   by the General Accounting   Office   (GAO) since
                     the 1967 legislation.


             FINDINGSAND CONCLUSIONS
                     In January 1968 the Comptroller General transmitted   to the Secretary of
                     the Treasury the required statement on the scope of audit and the
                     auditing and reporting standards.   This was the basis for a statement
                     of basic guidance and standards on the establishment    and operation of
                     the audit program approved by the Bank's Board of Executive Directors
                     in March 1968.




             Tear Sheet
                                                                                                   I
                                                                                        I
Implementation of the program was begun in October 1968 with the' crea'-
tion of a staff called the Group of Controllers    of the Review and*Eval-            ' I
uation System.   The Group  is independent of the   Bank's management; it               I
is responsible  to and derives its working instructions    from the Bankss              I
Board of Executive Directors.
To date,     the Group has issued three          reports.

        Study of Sources and Uses of Funds, dated August 1969 (forwarded
        to GAO in April 1970).

        Report on Loans to Venezuela,           dated July 1970 (forwarded   to GAO
        in December 1970).
                                                                                               I
        Evaluation Report on Bank Operations in Paraguay, dated November                       1
        1970 (forwarded to GAO in February 1971).                                              I
        NOTE: The Treasury Department has advised GAO that there will be                       i
              a normal delay of a few months in making the Group's reports                     I
                                                                                               I
              available    to GAO; the reports will be made available only                     I
              after the Bank's Board of Executive Directors has accepted                       I
              the report, at which point it becomes formally available     for                 I
                                                                                               I
              distribution    to member governments.                                           I
The Group's third report was not included in GAO's current review-be-                      I
cause it was forwarded after GAO had completed its review of the first                     I
two reports and had sent a draft report thereon to the Department of the                   I
Treasury for comment. .                                                                    I


GAO believes that the issuance of the reports by the Group represents a
positive    step toward implementation of a program of independent and
comprehensive audit of the Bank. To date, however, the Group's pro-
ductivity     has been limited,     in part, because of its small staff.   GAO
believes that the staff,        which consists entirely   of economists, should
be expanded. GAO believes also that, to complement the Group's ex-
pertise,    it would be desirable to recruit      persons from varied academic
disciplines     and professional     backgrounds.  (See pp. g to 11.)
The first  two reports issued by the Group have deficiencies       in either               I
                                                                                           I
substance or format, which severely limit the reports'       usefulness as                 I
management tools.     Treasury Department and Bank officials    were aware             I
                                                                                           I

of these deficiencies    and indicated that they expected considerable                 I
improvement in future reports.                                                         I
                                                                                       I
Stud2   of   Sources   and   Uses of   FLRUL~

This study is basically   an accumulation of statistics  and data from
the Bank's annual financial     reports. The study appears to be best                  I
                                                                                       I
suited for use as an internal working document and as such was prob-
ably a necessary initial    step by the Group members in orienting  them-              I
selves and assembling basic data which presumably will be useful to                    I
                                                                                       I
their later work.                                                                      I




                                        2
I

              The study may have been a necessary exercise9 but it falls considerably
              short of being the concise, accurate, analytical   examination required
              by the basic guidance and standards which were adopted by the Bank's
              Board of Executive Directors,   The study suffers from two basic de-
              ficiencies--inadequate  scope and unsupported conclusions.    (See p. 12.)

              Report on Loans to VeneaueZa

              This report is a comprehensive, detailed study of all the Bank's loans
              to Venezuela3 with description    and analysis of their impact on the
              country's economy. The report represents an analytical       examination,
              as required by the basic guidance and standards, but loses most of its
              potential  usefulness because of its lack of organization     and sheer
              size--l90  pages of text and 91 pages of statistical    appendixes.      It
              consists principally   of a narrative on the various activities     that
              were examined.

              This report contains many good points.         They are not, however, sum-
              marized, highlighted,     or even identified    except as can be gleaned
              from the detailed text of the report.         A statement of the scope of
              work is lacking and the support for statements made in the report is
              not always evident.      Thus it is difficult    for a reader to judge the
              veracity and reliability     of statements made.

              GAO believes that     the report would have better met the basic guidance
              and standards and     would have been more useful to the busy managers
              and executives for     whom it was intended if it had been organized and
              concisely written     in terms of its findings and recommendations for
              corrective  action.      (See pp. 16 to 19.)

              Evahation   Report on Bank Opero,tions in Pamgua~

              This report will be analyzed by GAO in the future.    The report was ac-
              companied by a brief which appeared to be an excellent    summary of the
              findings and recommendations for corrective  action.   Also the brief
              will need to be analyzed by GAO in the light of the report itself,
              but, on cursory review2 it appears to be a useful tool for the Bank's
              management and Board of Executive Directors.    (See pa 19.)



              Although the Bank's program of audit has experienced problems, in-
              cluding getting off to a slow start,  it is hoped that, with the re-
              cent appointment of a new U.S. member to the Group and close attention
              by the Department of the Treasury9 the Group will develop into an ef-
              fective evaluative mechanism.




        Tear Sheet
    I
RECOiWENDATIONS
             ORSUGGESTIONS
    The Secretary   of the Treasury       should:

       --Urge the Bank's Board of Executive Directors to expand the Group
          with additional   senior staff having professional experience in
          management auditing or consulting and varied academic backgrounds.

       --Impress upon the Group the continued need for clear and concise
          presentation   of its findings and reconrnendations for corrective
          action.    (See pa 20.)


AGENCY
     ACTIONSAND UNRESOLVED
                        ISSUES
    The Department of the Treasury said that it agreed with the overall
    thrust of GAO's report and that it was in the process of implementing
    GAO's recommendations.

    The Department added that, although the size and skills     of the senior
    staff of the Group were now being expanded, the Bank's internal     audit
    staff was planning to step up its review activity    and that the degree
    to which this work should be duplicated or replaced by the Group needed
    further study.   GAO believes that all internal   audits and reviews should
    be taken into account by the Group when setting the scope of its own
    work.   (See p. 11.)

                                                                                    .
MATTERS
      FORCONSIDERdTION
                     BY THECONGRESS
    Observations on the experiences and reports of the Inter-American         De-
    velopment Bank review group discussed in this report should be useful
    in any considerations   concerning the establishment  of similar review
    bodies for other major international    organizations and institutions,b\ll>
    as was recorunended in a GAOreport to the Committee on Foreign Affairs,
CcHouse   of Representatives.     (B-161470, December 4, 1970.)




                                                                                         I
                                                                                        I
                                                                                        I
                                                                                        I
                                                                                        I
                                                                                        I
                                                                                        I
                                                                                        I
                                                                                        I
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                                                                                        I

                                      4
COMPTROLLER
          GENERAL'S                    PROGRESSMADE TOWARDINDEPENDENTAND
REPORT
     TO THECONGRESS                    COMPREHENSIVE AUDITSOF THE INTER-
                                       AMERICAN  DEVELOPMENTBANK
                                       Department of the Treasury B-161470


DIGEST
_-----

WHYTHEREVIEWWASMADE
    The Inter-American Development Bank makes loans and provides    technical
    assistance for the economic development of its Latin American member
    countries.  Its operations are financed principally  by contributions
    from members and borrowings on the open bond market.

    The Bank has 23 member countries, one of which,         the United States,   has
    contributed 76 percent of all members' financial         support.

    U.S. membership in the Bank was authorized by the Inter-American De-
    velopment Bank Act, approved August 7, 1959. The Bank was established
    by international  agreement that same year.

    The act was amendedin 1967. Among other things, it directed the
    Secretary of the Treasury (the U.S. representative to the governing
    body of the Bank) to work toward independent and comprehensive audits
    of the Bank.

    It directed the Comptroller General to prepare a scope of audit and
    auditing and reporting standards for use in formulating  the terms of
    reference for the audits, to review periodically  audit reports issued,
    and to report to the Secretary       of the Treasury   and to the Congress on
    his review of the reports.

    This is the first     report   by the General Accounting   Office   (GAO) since
    the 1967 legislation.


FINDINGSAND CONCLUSIONS
    In January 1968 the Comptroller General transmitted to the Secretary of
    the Treasury the required statement on the scope of audit and the
    auditing and reporting standards.   This was the basis for a statement
    of basic guidance and standards on the establishment  and operation of
    the audit program approved by the Bank’s Board of Executive Directors
    in March 1968.
Implementation  of the program was begun in October 1968 with the crea-            '
tion of a staff called the Group of Controllers   of the Review and,Eval-      '
uation System. The Group is independent of the Bank's management; it
is responsible to and derives its working instructions   from the Bank's
Board of Executive Directors.
To date,   the Group has issued three    reports.

     Study of Sources and Uses of Funds, dated August 1969 (forwarded
     to GAO in April 1970).

      Report on Loans to Venezuela,     dated July 1970 {forwarded   to GAO
      in December 1970).

     Evaluation Report on Bank Operations in Paraguay, dated November
     1970 {forwarded to GAO in February 1971).
     NOTE: The Treasury Department has advised GAO that there will be
           a normal delay of a few months in making the Group's reports
           available to GAO; the reports will be made available only
           after the Bank's Board of Executive Directors has accepted
           the report, at which point it becomes formally available  for
           distribution  to member governments.

The Group's third report was not included in GAO's current review be-
cause it was forwarded after GAO had completed its review of the first
two reports and had sent a draft report thereon to the Department of the
Treasury for comment.

GAO believes that the issuance of the reports by the Group represents a
positive    step toward implementation of a program of independent and
comprehensive audit of the Bank. To date, however, the Group's pro-
ductivity     has been limited,  in part, because of its small staff.   GAO
believes that the staff, which consists entirely       of economists, should
be expanded. GAO believes also that, to complement the Group's ex-
pertise,    it would be desirable to recruit    persons from varied academic
disciplines     and professional   backgrounds.  (See pp. g to 11.)
The first  two reports issued by the Group have deficiencies       in either
substance or format, which severely limit the reports'       usefulness as
management tools.     Treasury Department and Bank officials    were aware
of these deficiencies    and indicated that they expected considerable
improvement in future reports.

Study of Sources and Uses of Funds
This study is basically   an accumulation of statistics  and data from
the Bank's annual financial     reports. The study appears to be best
suited for use as an internal working document and as such was prob-
ably a necessary initial    step by the Group members in orienting  them-
selves and assembling basic data which presumably will be useful to
their later work.



                                 2
The study may have been a necessary exercise, but it falls considerably
short of being the concise, accurate, analytical   examination required
by the basic guidance and standards which were adopted by the Bank's
Board of Executive Directors.   The study suffers from two basic de-
ficiencies--inadequate  scope and unsupported conclusions.    (See p. 72.)

Report on Loans -to VenezueZa
This report is a comprehensive, detailed study of all the Bank's loans
to Venezuela, with description   and analysis of their impact on the
country's economy. The report represents an analytical      examination,
as required by the basic guidance and standards, but loses most of its
potential  usefulness because of its lack of organization    and sheer
size--190 pages of text and 91 pages of statistical    appendixes.      It
consists principally  of a narrative on the various activities     that
were examined.

This report contains many good points.         They are not, however, sum-
marized, highlighted,     or even identified    except as can be gleaned
from the detailed text of the report.         A statement of the scope of
work is lacking and the support for statements made in the report is
not always evident.      Thus it is difficult    for a reader to judge the
veracity and reliability     of statements made.

GAO believes that     the report would have better met the basic guidance
and standards and     would have been more useful to the busy managers
and executives for     whom it was intended if it had been organized and
concisely written     in terms of its findings and recommendations for
corrective  action.      (See pp. 16 to 19.)

Evaihation Report on Bank Operations in Paraguay_
This report will be analyzed by GAO in the future.    The report was ac-
companied by a brief which appeared to be an excellent    summary of the
findings and recommendations for corrective  action.   Also the brief
will need to be analyzed by GAO in the light of the report itself,
but, on cursory review2 it appears to be a useful tool for the Bank's
management and Board of Executive Directors.    (See p. 19.)



Although the Bank's program of audit has experienced problems, in-
cluding getting off to a slow start,  it is hoped that, with the re-
cent appointment of a new U.S. member to the Group and close attention
by the Department of the Treasury, the Group will develop into an ef-
fective evaluative mechanism.




                                     3
RECOMx'ENDATIONS
             OR SVGGE,STIC?iS
    The Secretary   of the Treasury   should:

      --Urge the Bank's Board of Executive Directors to expand the Group
         with additional   senior staff having professional  experience in
         management auditing or consulting    and varied academic backgrounds.

      --Impress upon the Group the continued need for clear and concise
         presentation   of its findings and recornnendations for corrective
         action.    (See p. 20.)


AGENCY
     ACTIONSAND UNRESOLVED
                        ISSUES
    The Department of the Treasury said that it agreed with the overall
    thrust of GAO's report and that it was in the process of implementing
    GAO's recommendations.

    The Department added that, although the size and skills     of the senior
    staff of the Group were now being expanded, the Bank's internal     audit
    staff was planning to step up its review activity    and that the degree
    to which this work should be duplicated or replaced by the Group needed
    further study.   GAO believes that all internal   audits and reviews should
    be taken into account by the Group when setting the scope of its own
    work.   (See p. 11.)


Id4TTERS
       FORCONSIDERATION
                     BY THE CONGRESS
    Observations on the experiences and reports of the Inter-American         De-
    velopment Bank review group discussed in this report should be useful
    in any considerations   concerning the establishment   of similar    review
    bodies for other major international     organizations and institutions,
    as was recommended in a GAO report to the Committee on Foreign Affairs,
    House of Representatives.     (B-161470, December 4, 1970.)
                             CHAPTER1

                           INTRODUCTION

       The Inter-American      Development Bank, which was estab-
lished by international        agreement in 1959, is an intergovern-
mental institution      having 23 members consisting     of the United
States and 22 Latin American countries.           It makes loans and
provides technical      assistance    for economic development of
its Latin American member countries.

       The Bank's operations    are managed by its President      and
a professional    and administrative     staff.   Proposals for
loans and technical    assistance    to member countries    and rou-
tine policy considerations      are subject to approval by the
Board of Executive Directors       which represents   member govern-
ments.    Major policy matters are considered and approved by
the Board of Governors which also represents         member govern-
ments.

      U.S. membership in.the     Bank was authorized    by the Inter-
American Development Bank Act (Pub. L. 86-1471, approved
August 7, 1959. The United States signed the international
agreement establishing      the Bank on October 14, 1959. The
Secretary of the Treasury has the primary responsibility           for
managing U.S. participation      in the Bank. Also,he serves as
the U.S. Governor on the Bank's Board of Governors.            The
Secretary   is assisted   in carrying'out  his responsibilities
by the National Advisory Council on International         Monetary
and Financial   Policies   which evaluates proposed Bank loans
and other actions and recommends decisions        to the Secretary.
This Council consists     of the Secretary   of the Treasury as
Chairman, the Secretaries      of State and Commerce, the Presi-
dent of the Export-Import      Bank of the United States, and the
Chairman of the Board of Governors of the Federal Reserve
system.

       From inception of the Bank through November 30, 1970,
it had approved loans totaling    $3.9 billion.     The operations
of the Bank are financed principally     by financial   contribu-
tions from members and borrowings     on the open bond market,
The United States has contributed     76 percent of all members'
financial   support of the Bank, as shown in the following
table.

                                   5
                                                                        .



             Financial    Support as of December 31, 1970
             (in millions    of U.S. dollar equivalents)

                                                      All
                         United      States     other members       Total
    Bank fund           Amount       Percent   Amount Percent      amount

Ordinary capital        $     150         39    $238      61       $        388
Fund for Special
  Operations                1,800         77     528      23           2,328
Social Progress
  Trust Fund                  525a     100        -       -                 525

     Total              $2,475            76    $766      24      $3,241

aIncludes     $18.8 million     not yet paid to the Bank,

      The above amounts do not include members' callable    (by
the Bank) subscriptions   to the ordinary  capital of the Bank,
which amounts to $2.4 billion   (U.S. share is $1 billion).
Callable   subscriptions act as a guarantee for the Bank's
borrowings   on the open bond market.

        In 1967 the Inter-American       Development Bank Act was
amended by Public Law 90-88.          This amendment, among other
things,    directed    the Secretary of the Treasury to instruct
the U.S. Executive Director         of the Bank to propose the es-
tablishment      by the Bank's Board of Executive Directors        of a
program of selective       but continuing    independent and compre-
hensive audit of the Bank, in accordance with such terms of
reference     as the Board of Executive Directors       may prescribe.

       The amendment directed       also the Comptroller        General to
prepare for the Secretary of the Treasury a scope of audit
and auditing    and reporting      standards for use by the U.S. Ex-
ecutive Director    in assisting       in the formulation       of the
terms of reference.       It  further     directed   the  Comptroller
General to review periodically          the reports     of audit and
findings   issued and to report to the Secretary             of the Trea-
sury and to the Congress suggestions             for improving the
scope of audit or auditing         and reporting     standards.

      On January 24, 1968, the Comptroller  General            transmit-
ted to the Secretary  of the Treasury the required             statement


                                      6
on the scope of audit and the auditing   and reporting    stan-
dards.   This was the basis for a statement of basic guidance
and standards on the establishment   and operation   of the au-
dit program approved by the Bank's Board of Executive Direc-
tors on March 28, 1968.

      The basic guidance provided that the work be carried
out by a group having three principal   members--one from the
United States and two from the other member countries.      The
Group, called the Group of Controllers    of the Review and
Evaluation   System, was installed on October 3, 1968.

       In August 1969 the Group submitted its first   report, en-
titled   "Study of Sources and Uses of F'unds," to the Bank's
Board of Executive Directors.    The Department of the Treasury
forwarded the study to the Comptroller    General in April of
1970.

     The Group submitted     its second report,   entitled     "Report
on Loans to Venezuela,"    to the Board of Executive Directors
in December 1969. The Board returned the report to the
Group with instructions    to improve its format,        In July 1970
the Group resubmitted   the second report.      The Department of
the Treasury forwarded the report to the Comptroller          General
in December 1970.1

        In December 1970 we made a review of these two reports.
Our review was directed    toward determining   whether the re-
ports were responsive    to the basic guidance and directives
of the Bank's Board of Executive Directors      and to the in-
terests    of the U.S. Congress upon whose initiative    the pro-
gram of audit was established.      In our review we referred
to the Bank's annual reports     and to certain   other documents


1In commenting on a draft of our report,     the Department of
 the Treasury advised us that there would be a normal delay
 of a few months in making the Group's reports     available    to
 us due to the procedures for review and approval of the re-
 ports by the Bank's Board of Executive Directors.        The re-
 ports will be made available    to us only after the Board
 has accepted the report,    at which point it becomes formally
 available  for distribution   to member governments,
and had discussions with members of the Group and officials
of the Department of the Treasury. We did not verify the
accuracy of the data and the statements made in the reports.
      At the time of our review, the Group had completed a
review of the Bank's operations in Paraguay. After we had
completed our review and made a draft of our report avail-
able for comment by the Department of the Treasury, the De-
partment forwarded the Group's report on the Bank's opera-
tions in Paraguay to us. Although the Paraguay report was
not included in the scope of this review, it appears, on
the surface, to be significantly    improved in format over
the Group's first two reports.     We intend to analyze this
report at a future time in connection with our continuing
evaluation of the Group's activities.




                             8
                              CHAPTER 2

               PROGRESSTOWARDACHIEVEMENTOF AN
                  EFFECTIVE PROGRAMOF AUDIT

      Progress has been made toward implementation       of a pro-
gram of audit of the Inter-American       Development Bank, as ev-
idenced by the establishment      of the Group and the issuance
of the Group's initial   reports..     To date, however, the
Group's productivity   has been limited,      in part, because of
its small staff.

        The Group's first    report undoubtedly       had value as an
internal    working document for the Group, and its second re-
port contained a great deal of useful information.               Both re-
ports, however, have deficiencies           in either   substance or
format, which severely       limit   the reports'     usefulness  as ef-
fective    management tools.       Treasury Department and Bank of-
ficials    are aware of these deficiencies         and have indicated
that they expect considerable          improvement in future reports.

COMMENTSON THE GROUP'S'STAFF CAPACITY

        The amendment to the Inter-American     Development Bank
Act, which directed      the Secretary of the Treasury to in-
struct    the U.S. Executive Director    of the Bank to propose
the establishment      of the program of audit, was approved on
September 22, 1967, and the Comptroller        General's   statement
on audit scope and standards was transmitted         to the Secre-
tary of the Treasury on January 24, 1968. The Group was in-
stalled     on October 3, 1968, after formulation      and acceptance
of the terms of reference      for the program of audit and the
recruitment     and selection  of the members of the Group.

       At the time of our review, the Group consisted        of its
three principal    members (Controllers)--one      each from the
United States, Argentina,    and Ecuador--and      four professional
assistants.     Each of the Controllers      and assistants  were
economists.

     Through the end of 1970, two reports prepared by the
Group had been released to the Department of the Treasury
and, in turn, to us.   The Group*s third report, which was
not included in the scope of our review, was forwarded to

                                     9
us in February 1971.        (See p. 8.)    As discussed in the fol-
lowing section,    the Group's first      report,   issued 10 months
after the Group was installed,        was not really     an audit re-
port but essentially      was an internal     working document for
use of the Group itself.         The Group's second report--its
first  substantive    report--was    issued in July 1970.

      Some of the time spent in the earlier     period was un-'
doubtedly  used in basic orientation    and organization.     Also,
the work of the Group was somewhat hampered by the subse-
quent ill health and resignation     of its original    U.S. member
in September 1969. His successor was not appointed until
July 1970.

         We understand  that, at the time of our review, the
Group was engaged in a single assignment,      a functional  re-
view of loans made by the Bank in the education sector.         We
were informed by the Group that it had been able to work on
essentially      only one review at a time because of the size
of the staff.

       We were informed also that the Group had relied and
intended to rely,    in the future,     on the staff    of the Bank's
management for the development of data used in the Group's
reviews.    In view of the need to maintain       independence in
the performance of the reviews,       there should be extreme cau-
tion in the extensive use of this practice.           Independently
derived data is an essential      element of the review process,
to provide a basis for the Group's judgments and conclu-
sions.

       The above factors,    we believe,     indicate   a need for
greater   staff capacity    to enable the Group to direct        a num-
ber of simultaneous     reviews and thus achieve greater utili-
zation of each Controller's      own experience       and skills  during
the 3-year period that each will         serve as a member of the
Group.

       Moreover,  to complement the Group's expertise          (at the
time of our review all of the Controllers           and assistants
were economists),     it would be desirable      to recruit    persons
from other academic disciplines         and professional    backgrounds.
This would provide      insight   into   the Bank's operations       from
various perspectives.        The desirability    of a variety     of

                                    10
training  was recognized and encouraged by the Board of Ex-
ecutive Directors   in approving the regulations     governing the
operation  of the audit program.    These regulations     state,
in part, that:

     "the auditors  shall be persons of recognized com-
     petence and wide experience    in evaluating economic
     and financial  matters.   Their experience should
     include a minimum of ten years in auditing    or in
     the discipline  of law, economics or engineering
     with a background of auditing    and/or the evalua-
     tion of economic development projects."

     We believe that the U.S. Executive Director      should urge
the Bank to expand the Group with additional     senior staff
members having professional  experience   in management auditing
or consulting  and varied appropriate   academic backgrounds,

      In commenting on a draft of our report,    the Department
of the Treasury said that the size and skills      of the senior
staff   of the Group were now being expanded.   It added, how-
ever, that the Bank's internal    audit staff was planning to
step up its reviews to cover all activities    in each country
every 3 years and that the degree to which this work should
be duplicated   or replaced by the Group needed further    study.
We believe that all internal   audits and reviews should be
taken into account by the Group when setting     the scope of
its work.




                                 11
COMMENTSON THE GROUP'S FIRST REPORT--
STUDY OF SOURCESAND USES OF FUNDS

        The study does not represent     an audit in the strict
sense of the word.       It is basically   an accumulation    of sta-
tistics    and data from the Bank's annual financial       reports.
There appears to have been little        or no independent evalu-
ation of the data presented in the report.          The report ap-
pears to be primarily        an internal working document,     The
study was probably a necessary initial         step by the Group
members in orienting       themselves and assembling basic work-
ing data which presumably would be useful to their          later
work.     We were informed that the study was useful in iden-
tifying    potential  areas for future management reviews.

      We would have no reason to comment on the use of the
report as an internal   working document, for which it appears
to be best suited.    As an external  product of the Group,
however, it fails   in several ways to satisfy  the require-
ments of the basic guidance and the auditing    and reporting
standards adopted by the Bank's Board of Executive Directors.

Inadequate     scope

       The basic guidance governing the work of the Group
states9 with respect to the scope of audit:

      "The audits are intended *** to be analytical          ex-
      aminations  of all important   operations,   activities
      and procedures of the Bank with special consider-
      ation to the implementation    and administration       of
      the Bank's loans and technical    assistance    opera-
      tions."

        The study is not an analytical          examination       of opera-
tions,     activities,      and procedures of the Bank. The report
shows the flow of funds through the Bank without                    in-depth
interpretation         of the data reflected.        The little      analysis
included in the report is very superficial,                  It is more a
narrative      of financial     events than an analysis.           The study's
shallow scope undoubtedly           was a contributing       factor     to the
report's     failure     to meet the required      reporting      standards--
i.e.,    reporting      unsupported   conclusions--as      noted in the
following      section.

                                      12
Unsupported   conclusions

       The basic guidance   and standards approved      by the Board
of Executive Directors,     in regard to standards      of reporting,
states:

     "Matters    included in the auditors'   reports    should
     be significant,      and they should be clearly    writ-
     ten, accurate,      and fully supported by facts."

      The report includes a number of statements under the
heading "Summary and Comments" that do not appear to have
been supported or substantiated    by the work performed by the
Group.   We  believe that it  is appropriate, therefore, for us
to comment on some of these statements.

       For example, the report concluded that,     on the basis of
the Group's study, the Bank was in a sound financial       posi-
tion and that, on the strength     of its own resources and its
prestige   as an international  institution,    the Bank had been
able to raise funds by floating      bond issues,

       We believe that the report does not contain sufficient
evidence to support its conclusion          concerning the financial
condition   of the Bank. In commenting on a draft of our re-
port 9 the Department of the Treasury agreed that the state-
ments made in the Group's report on the institution's            finan-
cial condition    were not supported,by        the study itself.    The
Department of the Treasury added that the Bank had an inde-
pendent financial     audit made each year by a leading U.S. ac-
counting firm and that the firm had made a comprehensive
audit of the financial      situation     of the Bank. The Depart-
ment of the Treasury asserted that there was no question
about the absolute financial         solvency of the Bank.

       That the Bank is or is not in sound financial     condition
is, of course, not at issue,       As recognized by the Treasury
Department,     the study simply does not support the report's
conclusion    that the Bank is in sound financial   condition    and
therefore   does not satisfy    the basic guidance and standards
approved by the Board of Executive Directors,

      There is no question that the Bank has enlarged            its
own resources.   We believe,  however, that the Bank's           large

                                  13
proportion   of callable  capital    stock subscriptions,  rather
than its prestige    as an international    institution,  probably
has been the primary reason for its success in selling         bond
issues.    Each of the Bank's recent annual reports has stated
that the Bank has been able to sell bonds because its call-
able capital   serves as a guarantee that the bondholders will
be paid.

       On a somewhat related matter,    the report concluded that,
except for one case, the Bank had no past due loans and thus
permitted   the multiple   use of its funds.

      Although we are not suggesting     that past due loans have
been a significant    problem, by way of comment, we refer to
note I of the Notes to the Financial       Statements for Ordinary
Capital   Resources in the Bank's 1968 annual report,        which
stated that,    in 1966, two borrowers,    one in Brazil and one
in Argentina,    had defaulted on interest     and principal   pay-
ments on two loans each,

       The Bank started    foreclosure     proceedings on the bor-
rowers, both private     enterprises,      and obtained and sold the
collateral   of the Argentine      borrower,     The Bank realized
$954,122, which was applied against the amount owed, and the
balance of $1,845,149 was charged against the General Re-
serve for Ordinary Capital.         Brazilian    courts have upheld
the Bank's rights     to foreclose     on the Brazilian   borrower,
and steps are being taken to sell the property           seized, ac-
cording to the annual report.

       Thus, according to the note to the 1968 financial     state-
ments,   the Bank  has had not one but four  past due  loans  to
two separate borrowers.     The charge of $1,845,149 against
the General Reserve for Ordinary Capital     in 1968 is shown
as a Special Charge in a supporting    schedule to the Group's
report on the study.

       The Department of the Treasury advised us that all of
these defaults    were known by the Group but that the Group's
analysis   had proceeded on the basis of the current      position
on open defaults    and had focused on the identity   of the bor-
rower rather than on the number of loans to the borrower.
It should be noted, however, that the Group's stated reason
for using the flow-of-funds     analysis was that traditional

                                14
financial   statements enabled analyses of only a static          sit-
uation,   whereas the purpose of its study was to disclose
financial   changes over a period of time.     We believe,      there-
fore, that it would have been more relevant       to reveal the
number and amount of loans defaulted     and written     off, as
well as those not yet written    off, rather than to disclose
only the number of borrowers currently      in a default     status.




                                   15
~CM.ME2..TS
          ON THE GROUP'S SECONDREPORT--
REPORT ON LOANS TO VENEZUF.J.&

        This report is a comprehensive,        detailed     study of all
the Bank's loans to Venezuela, with description                and analysis
of their    impact on the country's       economy.      The report repre-
sents an analytical     examination      and contains     several excel-
lent points but loses most of its potential              usefulness   be-
cause of its lack of organization          and sheer size--190       pages
of text and 91 pages of statistical          appendixes.        It does
not meet the criteria     of the basic guidance and standards
approved by the Board of Executive Directors              that "Audit
findings    and related  conclusions      and recommendations       should
be presented in an objective,        concise,    complete, and con-
structive    manner" and that "All reports         should clearly     state
the scope of the auditors'       inquiry    and nature and extent of
their work."

Need for   improved    format

       The first    section,   entitled   "Remarks, Conclusions and
Recommendations,"       is 56 pages long and consists       chiefly    of
descriptive      remarks.    Few conclusions   are identified       as
such, and few recommendations are made.

      The report appears to be organized and written      in terms
of activities   examined by the Group.  We believe that the
report would have been more useful to the Bank's management
and Board of Executive Directors   for whom it was intended
if it had been organized and concisely   written  in terms of
its findings   and recommendations for corrective   action.

        No central   theme or conclusion    is presented.    Issues,
problems, and accomplishments       are not highlighted     or even
identified     except as can be gleaned from the text of the
report.     A statement of the scope of work done is lacking,
although such statement is required by the basic guidance
and standards,      and the support for statements made in the
report is not always evident.        Thus it is difficult     for a
reader to judge the veracity       and reliability    of statements
made.

       In short the reader can form conclusions    on the effec-
tiveness of Bank loans only after carefully     studying  the

                                    16
report several times.     The value of this type of report to
busy managers and executives     is limited because of the time
required to extract   its message..

Significant       points     made in the report

        Notwithstanding    the deficiencies     in format and organi-
zation,    the report does contain a number of good points and
obviously      is the product of a rather exhaustive      analysis.
Some of the more significant         points are presented herein
for the purpose of illustrating          the kinds of information    the
Group is in a position        to make available    for consideration
and action by the Bank's management and Board of Executive
Directors.

      Undisbursed          loan balances

     The Bank's 1969 annual report reveals that over 36 per-
cent of the Bank's current    loans to Venezuela is undisbursed.
The Venezuela report concluded that the disbursement     lag
was due to inadequate project     studies which caused delays
in project  execution. ‘It recommended that:
      1. Additional   documentation  be required       in the loan
         documents, i.e.,   an assessment of the economic and
         social viability   of the project,      including   an esti-
         mate showing the cost-benefit      ratio.

      2. The impact of the project              on employment,    wages, and
         project-related  activities             be determined.

      3. The Bank exercise          permanent     control   measures during
         project execution.

      4. A policy be established     for the Bank to govern sub-
         loans by the borrower to protect      the Bank's invest-
         ment by forestalling    defaults   and ensuring effective
         utilization  of the Bank's funds.

      Agrarian      reform system
      not fully       successful

     The Bank has made two loans to Venezuela for a total
of $12.7 million to finance farm settlements  in its

                                           17
agrarian   reform program.         The report indicates    that this
program has not been completely           successful   in achieving   its
major objective        of creating   a genuine class of small farm-
ers in Venezuela, although in terms of land settled,               homes
and schools built,        and people moved, it could cite impres-
sive statistical        accomplishments.     The report attributes
the program's lack of success to the fact that             all of the
settlers'    living     needs are provided by the government and
most of their       farming work is done for them by government
agencies.

      Need for   improved     proiect        reporting,

      The report indicated    that, of the 14 Bank loans to
Venezuela that were completely      disbursed,   four still lacked
a final   report from the borrower to the Bank and three had
incomplete     final reports.   The report indicated   also that
quarterly    reports were inadequate.

       Furthermore   the report noted that, although the Bank
carefully    reviewed progress reports because they involved
pending disbursements,      final reports were not being reviewed
carefully    because no further   processing was required  after
the project    was terminated.

       The report stated that, in the case of three loans
lacking final    reports,   the borrowers were awaiting   a method-
ology and appropriate     instructions   from the Bank for prepar-
ing them.
      Subloan defaults

       The report indicated     that all payments of principal
and interest     to the Bank had been made on time by Venezuelan
borrowers,    there being no loans in default       or even in ar-
rears.     On the other hand several of the borrower agencies
were experiencing      defaults   and delinquencies   by industrial
subborrowers.

      Problems   in housing     sector        loans

      According to the report,    problems were encountered in
the construction    of low-income housing projects  under the
supervision    of an intermediate  credit  agency. The report

                                        18
noted that (1) much of the completed housing lacked basic
services-- such as water, electricity,          and other community
facilities    --which resulted      in nonoccupancy,    (2) early con-
struction     was on the edge of the highways, in two long rows
of houses, which resulted         in higher costs of water supply
and in a lack of community development,           (3) repayments were
very much in arrears,       and (4) the intermediate       credit
agency 3   from   an organizational     point  of view,   had  some seri-
ous flaws.

     The report emphasized that the loans had been granted
some years  ago when the Bank still     had not fully  consoli-
dated its technical-administrative      organization  and indi-
cated that lessons learned from these early adverse experi-
ences had been reflected      in recent loans.

CONCLUSIONS, RECOI%ENDATIONS, AND AGESKYACTIONS

      Although the Bank's program of audit has experienced
problems, including    getting off to a slow start,    it is
hoped that, with the recent appointment     of a new U.S. mem-
ber to the Group and close attention    by the Department of
the Treasury,the    Group will develop into an effective     eval-
uative mechanism.

       After we completed our review of the Group's first             two
reports     and made a draft of our report available        for re-
view by the Department of the Treasury,the           Department for-
warded to us the Group's third report which related             to a
review of the Bank's operations         in Paraguay.    We intend to
analyze the report in connection         with our continuing      evalua-
tion of the Group's activities.          Also, the Group published
a brief     of the report,     which appeared to be an excellent
summary of the Group's findings         and recommendations     for
corrective     action.     Also, we will need to analyze this
brief    in the light   of the report itself,     but, on cursory
review, it appears to be a useful tool for the Bank's man-
agement and Board of Executive Directors.

       On the basis of our review of the Group's first   two
reports,    we recommend that the Secretary of the Treasury:

      --Urge the Bank's Board of Executive Directors            to ex-
         pand the Group with additional  senior staff          having

                                    19
        professional     experience in management auditing   or
        consulting     and varied academic backgrounds.

     --Impress   upon the Group the continued need for clear
        and concise presentation   of its findings and recom
        mendations for correction   action.

      The Department       of the Treasury said that it agreed with
the overall   thrust     of our report and that it was in the pro-
cess of implementing         our recommendations.    The Department
said, however, that        the report on Paraguay had a much im-
proved format.      We   agree that the brief     accompanying the
report on Paraguay       is a step in the right direction.




                                   20
        APPENDIXES




,   .



          21
   .                                                                                                   APPENDIX I



                               THE DEPARTMENT                   OF THE TREASURY
                                              WASHINGTON,          D.C.   20220


ASSISTANTSECRETARY
                                                                                         April      26,    1971


          Dear       Mr.   Stovall:

                Thank you for        the opportunity     to comment       on the draft
          GAO report,       entitled     "Progress   Toward    Implementation        of a
          Program     Audit    of the Inter-American        Development       Bank."

                  I agree    with   the overall         thrust        of your     report.       In
          particular,        I believe      the conclusion              section     is a fair      ap-
          praisal      of the current         status      of the development              of this
          innovative        and constructive          audit       procedure,        and we are in
          the process         of implementing         your     recommendations.             In our
          opinion,       your report      provides        further        enc.ouragement       to the
          Bank to move forward            energetically             in their      present     direction.

                 There       are three         parts       of the report            itself,         on which       I
          would     like       to provide          comments         and clarification.                  First,
          there     will       be a normal          delay        of a few months               in making       audit
          reports        formally        available           to the GAO, due to the internal
          procedures           for   appioval.             Completed         reports         are submitted           to
          the Bank's           Board     of Executive              Directors        for      examination        and
          review.          In these        initial         reports,         ample      lead      time   was neces-
          sary for         them to study             the document            before        it was finally
          reviewed         in the Board.               It is only           once the Board            has ex-
          amined      and accepts            the audit           report      that      it becomes         formally
          available          for   distribution              to Governors.               At that      stage,       the
          u. S. Governor             formally          transmits          it to the GAO.              This     ex-
          plains      what might           otherwise           seem fo be an unnecessarily                       long
          delay     between        completion            of the unapproved                 report      and sub-
          sequently          Treasury's          making        it available            to you.

                  Secondly,         your    report     accurately         states             that   the first
          study      on sources         and uses of funds           was for              internal      use and
          orientation.            It was not designed             to be an               analytical       audit
          or financial          report.        From that       viewpoint,                it is true       that
          several         of the statements           made in the Bank                   report     on the
          institution's           financial        condition      were not               supported      by the
          study       itself.
                                                     [See GAOnote, p. 24.1
                                           As you are aware,               the Bank has an inde-
          pendent,         outside    financial         audit        each year,     carried     out by
          a leading          U. S. accounting           firm,       which    makes a comprehensive
          audit    of      the financial        situation            of the Bank.         There  is no
          question         about   the absolute            financial       solvency      of the insti-
          tution.




                                                              23
APPENDIXI




                                       [See GAO note.]



         Your report    has correctly        identified        shortcomings     in
   the format     of the second      report.         The third      report  on Paraguay,
   which    is now in your   possession,          has a much improved         format,    ,
   so that     it is now a useful       management       tool.

           Lastly,         your       report       recommends           an expansion            of the size
   and skills            of the senior               staff      on the group.                This     is now tak-
   ing place           within         limits;        however,         we would          like    to point         out
   that     we believe              there       are real        limits        to the rate           of expansion.
   For example,               the group           must apply          a unifo'rm          approach       and
   criteria          to each audit.                  As you are aware,                  the Bank has its
   own internal               audit       staff.         In addition,             the Bank staff              conducts
   ex-post         project          evaluations            of a general             economic        nature.          A
   principal           difference             between        these      staff       activities          and those
   of the new group                   is that        the former           are reported            directly         to
   management,              rather        than     to the Board.                The internal            audit      group
   is now planning                  to step-up           its    reviews         in order        to cover         all
   activities            in each country                 every      three       years.         The degree          to
   which      this       work should              be duplicated             or replaced           by the compre-
   hensive         audit        group       is an open question,                    which      we will        be
   discussing            with       you as the system                 evolves.

                                                                 Very      truly       yours,




                                                                 John      R.      Petty




   The Honorable
   Oye V. Stovall
   Director,      International         Division
   United    States      General     Accounting                   Office
   Washington,        D. C.      20548

   Attachment



    GAO note:           Comment refers to material     in the draft                                 report       but
                        excluded from the final    report.



                                                          24
                .
.                                                       APPENDIX II


                       OFFICIALS PRIMARILYRESPONSIBLE
                                                    FOR
                                   ADMINISTRATION
                                                OF
                           U.S. PARTICIPATIONIN THE
                        INTER-AMERICANDEVELOPMENT
                                              BANK
                                                      - Appointed   or
                                                       Commissioned
    SECRETARYOFTHE TREASURY:
       John B. Connally                                   Feb.   1971
       David M. Kennedy                                 Jan.     1969
       Henry H. Fowler                                  Apr.     1965
 ASSISTANTSECRETARYOF THE
 TREASURYFOR INTERNATIONALAFFAIRS:
        John R. Petty                                 - %Y       1968
        Winthrop Knowlton                               Aug.     1966
    U.S. REPRESENTATIVE TO ?HE BANK'S
    BOARDOF EXECUTIVEDIRECTORS:
        Henry J, Costanzo                               Nov.     1969
        Edward Clark                                    MY       1968
        W. True Davis,       Jr.                          Sept. 1966




US. GAO. Wash.. D.C.
                                         25