THE EFFECT OF INTERNAL CONTROL SYSTEM ON

NIGERIAN BANKS

Akinyomi Oladele John

Department of Financial Studies,

Redeemer’s University, P. O Box 861 RCCG Redemption City, Ogun State, Nigeria

GSM: 08038673767. E-mail: delejohn21@yahoo.com

Abstract

A system of effective internal control has been described as critical component of an organization’s

management (banks inclusive) and a foundation for its safe and sound operations. This study examined the

effect of internal control system on Nigerian banks. Three banks were randomly selected for the study, while

three hundred and sixty (360) questionnaires were distributed to respondents, but only three hundred and forty-

two (342) were retrieved.

The study revealed that the lack of a good internal control system is a major cause of fraud in banks. It was also

discovered that banks with effective internal control system can prevent and stand against the menace of fraud.

One of the major recommendations is that adequate internal control system should be put in place at all level of

banks’ operation. Also, it is recommended that an effective internal audit department should be established

possibly with qualified Chartered Accountants as the head.

Key Words: Banks, Internal Control System and Fraud Prevention.

THE EFFECT OF INTERNAL CONTROL SYSTEM ON NIGERIAN BANKS

INTRODUCTION

A system of effective internal control is a critical component of an organization’s management (banks

inclusive) and a foundation for its safe and sound operations. A system of strong internal controls can help to

ensure that the goals and objectives of bank will be met, that it will achieve long-term targets and maintain

reliable financial and managerial reporting. Such a system can also help to ensure that the banks will comply

with laws and regulations as well as policies, plans, internal rules and procedures, and reduce the risk of

unexpected losses and damage to the organization’s reputation.

Fraud, which is one of the major reasons for setting up internal control system, has become a great pain in the

neck of many Nigerian bank managers and a concern to all stakeholders. It has become obvious that banks with

a weak internal control system, is dangerously exposed to bank fraud. The damage which fraud has caused the

banking sector is enormous. There is the need to ascertain whether or not an effective and efficient internal

control system is the best control measure for fraud detection and prevention in banks.

The objective of this study is to determine the effect of internal control, on the management of banks in Nigeria.

We will also examine the relevance of internal control system in fraud detection and prevention.

Hypothesis tested: Two hypotheses are formulated and tested in this study.

HOi: The lack of a good internal control is not a major cause of fraud in banks

H1i: The lack of a good internal control is a major cause of fraud in banks

HOii: Banks with internal control systems cannot prevent the menace of fraud

H1ii: Banks with internal control systems can prevent the menace of fraud

METHODOLOGY

The data, from which the information constitutes the findings, were collected from three banks in Nigeria.

These include Oceanic Bank Plc, Union Bank and Bank PHB. Data were obtained from both the primary and

secondary sources, which includes; interview, structured questionnaire, journal publications, textbooks,

newspapers, internet facilities. Secondary data are used to complement the primary data as the primary data.

Data captured for this study were analyzed through descriptive and inferential statistical methods. The

descriptive analysis involves the use of percentages, tabulation and graphical presentation, while the inferential

statistical method involved the use of chi square.

REVIEW OF RELATED STUDY

Definition of internal controls

Internal controls are policies, procedures, practices and organizational structures implemented to provide

reasonable assurance that an organization’s business objectives will be prevented or detected and corrected,

based on either compliance or management initiated concerns (Awe, 2005)

Mayo and BPP (1988) defined it as the measures taken by an organization for the purpose of protecting its

resources against wastes, fraud, inefficiency; ensuring accuracy and reliability in an accounting and operating

data; securing compliance with organization policies and evaluating the level of performances in all divisions of

the organizations. As regards bank's internal control, according to banking literature (Nitu, 2002; Dedu, 2003;

Nagy, 2005), it consists of an collection of measures at management's disposal intended to ensure bank's proper

functioning, a correct management of bank's assets and liabilities, and a true recording in accounting evidences.

This definition expresses the striking feature of internal control and the participants to this process.

From these definitions; it can be deduced that internal control comprises the plan of an organization and all of

the coordinated methods and measures adopted within it, to safeguard its assets, check the accuracy and

reliability of its accounting data, promote operational efficiency and adherence to prescribed managerial

policies.

ICAN (2006) categorized controls into three major classifications as follows:

Preventive controls: These are controls that predict potential problems before they occur and make adjustments.

They also prevent an error, omission or malicious act from occurring. Examples of preventive controls includes:

using well- designed documents to prevent errors.

Detective Control: These controls are designed to detect and report the occurrence of an omission, an error or a

malicious act. An example of detective controls includes; duplicate checking of calculations.

Corrective Control: these control helps to minimize the impact of threat, identify the cause of a problem,

correct errors arising from the problem. They also correct problems discovered by detective controls and modify

the problem. Examples of corrective controls are: contingency planning back up procedures rerun procedures.

The Concept of Fraud

Hornby (1998) defines fraud as an action or an instance of checking somebody in order to make money or

obtain goods illegally. Archibong (1992) describes fraud as a predetermined and well planned tricky process or

device usually undertaken by a person or group of persons, with the sole aim of checking another person or

organization, to gain ill- gotten advantages, be it monetary or otherwise, which would not have accrued in the

absence of such deceitful procedure.

Classification of Fraud

Basically, two broad schemes of frauds have been identified, they include: i) Management fraud and ii)

Employees fraud. According to Fakunle (2006), management fraud often involves the manipulation of the

records and the account, typically by the enterprise’s senior officers with a view to benefitting in some way. An

example is obtaining finance under false pretences, or concealing a material item, i.e. window dressing.

Robertson (1996) defines management fraud as a deliberate fraud, committed by management that injures

investors and creditors, through materially misleading financial statements. Management fraud is sometimes

called fraudulent financial reporting. It is usually perpetrated by the management staff of an organization, which

includes directors, general managers and managing directors. The classes of victims of management frauds are

investors and creditors and the instrument of perpetration is financial statement. The essence of management

fraud most times is to attract more shareholders to come and invest in the organization.

Employee fraud: These are frauds that are perpetrated by the employees of the organization. Robertson (1996)

defines it as the use of fraudulent means to take money or other property from an employer. It usually involves

falsification of some kind, like false documents, lying, exceeding authority, or violating an employer’s policy,

embezzlement of company’s funds. Employee fraud is more likely to be encountered where internal controls are

weak.

Type of Bank’s Common Fraudulent Practices

Ovuakporia (1994) gave account of thirty three types of bank frauds in the banking sector. These includes theft,

embezzlement, defalcations, forgeries, substitution, suppressions, payment against unclear effects, unauthorized

lending, lending to ghost borrowers, kite flying and cross firing, unofficial borrowing, foreign exchange

malpractice, impersonation, over involving, manipulation of vouchers, fictitious accounts, over and under

valuation of properties, false declaration of cash shortages, falsification of status reports, duplication of cheque

books, mail transfer, interception of clearing cheques, computer frauds, fake payments, teeming and lading,

robbers and others.

The above numerous types of fraudulent practices in banks, serve as threats to the success of many banks. If

adequate preventive and detective measures are not put into action, it could lead to the complete failure of

financial institutions especially banks in Nigeria.

Causes of Bank Frauds

There are many identified causes of fraud in banks. They vary from institutional to economical, social,

psychological, legal, and even infrastructural causes. The immediate causes of frauds in general as provided by

Ogbunka (2002) include the following: i) Availability of opportunities to perpetuate frauds and forgeries; ii)

Human greed, avarice, instability; iii) Poverty and the widening gap between the rich and the poor; iv)

Prevailing misplaced social values, moral and spiritual decadence; v) Increasing incidence of unemployment;

vi) Increasing financial burden on individuals; vii) Misapplied intelligence – say for adventure; viii) Job

insecurity; ix) Social misconception that banks money is nobody’s money property and therefore can be

defrauded; x) Societal expectation; xi) Inadequate training of personnel; xii) Unhealthy comparison and

competition; xiii) Revenge; xiv) Peer group pressure; xv) Non adherence to ethical standards; xvi) Leadership

by bad example; xvii) Poor/weak recruitment policies; xviii) Over ambition/frustration of staff; ixx) Increasing

and changing sophisticated in technological equipment; xx) Inadequate training of manpower; xxi) Societal

indiscipline, especially with money; xxii) Risk on fraudsters may be low or none; xxiii) Possibility of

identifying or stopping a fraud may be very little; xxiv) Lack of effective machinery that guarantee severe

punishment for fraudsters and forgers; xxv) Poor/weak management control, monitoring and supervision and

xxvi) Weak internal control system of the bank.

Of a truth, there are many causes of bank frauds, but weak internal control system stands as a major cause of

frauds in banks. It is therefore, expedient that adequate, efficient and effective internal control system be

installed in every bank in order to reduce this disaster called FRAUD.

Fraud Management

In devising the general preventive measures, the bank should appreciate the main feature of fraud, one of which

is that fraud is rapidly increasing and it is a highly profitable industry. According to Ekeiqwe (2000), computer

technology facilities and accentuates the growth. Other features are that frauds involve misappropriation of

assets and manipulation or distortion of data and most frauds result from basic failure and inadequacies of

internal controls. This was rightly confirmed in a report by the NDIC 1999 annual reports and statement of

accounts, where it said that most frauds are committed by insider usually in collusion with outside third parties,

and mostly are discovered by accident or tip offs rather than internal and external auditors.

It was suggested by Nwankwo (1991) that on the discussion of the anatomy of frauds, management should

evolve positive attitudes towards safeguarding the banks’ assets and ensuring that staff does not exploit the

weakness in internal control. He further said that the policies should stress the cardinal principles of separation

of duties to ensure that one person does not originate and complete an assignment or entry. The policy should

also emphasize dual control of sensitive areas such as strong rooms and locks to security documents and

account, the need for daily balancing of account and the various precautions which include necessary references

for opening of accounts. Ekechi (1990) was of the opinion that, in order to attain the objective of fraud

management, there is need for full compliance with established policies, rules and procedures. Also employees

should be made aware of the risks of attempting to defraud the bank and the action expected if caught.

Finally the policy should incorporate and emphasize investigation and possible prosecution of suspected frauds.

In controlling fraud in the banks, the boards of directors play a major role because the leadership responsibilities

must be clearly spelt out and formally explained to them. This responsibility should include the directing of the

overall policy and management of the bank, fiduciary duty to act honestly and with utmost good faith, and

exercise of skill and care in discharging the statutory obligations of the bank. In particular, the board has the

collective responsibility of the members to ensure that suitable security systems exist, there are adequate

accounting records and internal control measures and there are adequate precautions to prevent falsification of

accounting records and facilitate the discovery of any falsification (Asukwo, 1991 and Oyeyiola, 1996).

The CBN plays its own role in helping banks manage fraud through its monetary policy and guidelines. CBN

demands that banks should make provisions for loss through frauds from its gross profit. This policy was

enacted to safeguard the depositor’s money since it is obvious that depositor’s money will be lost when there is

an incidence of fraud.

Effects of Fraud on Nigerian Banks

Fraud is perhaps the most fatal of all the risks confronting banks. The enormity of bank frauds in

Nigeria can be inferred from its value, volume and actual loss. A good number of banks’ frauds never get

reported to the appropriate authorities, rather they are suppressed partly because of the personalities involved or

because of concern over the negative image effect that disclosure may cause if information is leaked to the

banking public The banks’ customers may lose confidence in the bank and this could cause a setback in the

growth of the bank in particular.

Fraud leads to loss of money, which belong to either the bank or customers. Such losses may be absorbed by the

profits for the affected trading period and this consequently reduces the amount of profit, which would have

been available for distribution to shareholders. Losses from fraud which are absorbed to equity capital of the

bank impairs the bank’s financial health and constraints its ability to extend loans and advances for profitable

operations. In extreme cases rampant and large incidents of fraud could lead to a bank’s failure.

Fraud can increase the operating cost of a bank because of the added cost of installing the necessary machinery

for its prevention, detection and protection of assets. Moreover, devoting valuable time to safeguarding its asset

from fraudulent men distracts management. Overall, this unproductive diversion of resources always reduces

outputs and low profits which in turn could retard the growth of the bank.

It also leads to a diminishing effect on the asset quality of banks. The problem is more dangerous when

compounded by insider loan abuses. Indeed, the first generation of liquidated banks by NDIC was largely a

consequence of frauds perpetrated through insider loan abuses. If this problem is not adequately handled, it

could lead to distress and bank failures.

Management’s responsibilities towards fraud prevention and detection: According to Ola (2001), primary

responsibility for the invention and detection of errors and irregularities rest with management. This

responsibility arises out of a contractual duty of care by directors and managers and also because directors and

other managers act in stewardship capacity with regard to the property entrusted to them by the shareholders or

others owners. Izedonmi (2000) also said that the responsibility for the prevention and detection of fraud and

errors, within an enterprise, rest with the management. This responsibility is discharged by management,

through the establishment of an adequate system of internal controls, including internal check and internal audit.

It is therefore, pronounced that the management of any banking organization is totally responsible for the

prevention and detection of fraud, majority by the establishment of an adequate, efficient and effective internal

control system.

DATA ANALYSIS

The analysis will be descriptive in nature that is, it would include tabulation, frequency counts and percentages.

Chi-square will be used for all relevant hypotheses.

Preliminary analysis of questionnaires: Three hundred and sixty (360) questionnaires were distributed to

respondents, but only three hundred and forty-two (342) were retrieved.

Table 1: Analysis of the distribution of the Questionnaire to the selected Banks

Area/respondent TQD R NR R (%) NR (%)

Oceanic Bank 120 110 10 92 8

Union Bank 120 114 6 95 5

Bank PHB 120 118 2 98 2

Total 360 342 18 95 5

TQD: Total Questionnaires Distributed; R: Retrieved; NR: Not Retrieved; R (%): Percentage Retrieved; NR (%): Percentage Not

Retrieved.

Table 2: Categories of the staff

Position at work No of respondents %

Management staff 92 26.9

Senior staff 189 55.26

Junior staff 61 17.84

Total 342 100.0

Table 3: Professional qualifications of staff

In Table 2, it shows that the senior staffs are the highest respondent that is to mean that 50% of the respondents

are senior staff that has wealth of experience on the subject matter.

Table 3: Representation of Professional Qualification obtained by the respondents

Professional qualification obtained No of respondents %

ACA 167 48.83

ACIB 120 35.09

CIMA 50 14.62

Others 5 1.46

Total 342 100.0

In Table 3, the respondents with the ACA qualification are the highest. That is to mean that they know more

about the subject under study/review. Hence, 58% of the professionals that has a wide knowledge of internal

control system.

Table 4: Representation of the perpetrators of fraud in the Bank

Perpetrators of bank frauds No o f respondents %

Board of directors 25 7.31

Accountants 33 9.65

Cashier 155 45.32

Account clerks 18 5.26

Managers 111 32.46

Total 342 100.0

In Table 4, it suggests that cashiers are the most fraudulent set of fraud perpetrators in the bank. Almost 43.6%

of the perpetrators are from cashiers. Hence, the managers 38.7% and cashiers are the perpetrators.

Table 5: Representation of the type of frauds mostly committed

Forms of fraud mostly committed No of respondents %

Theft of assets others than cash 50 14.62

Theft of cash 223 65.20

Others-forging of bank draft 42 12.29

Falsification of receipts e.t.c 27 7.89

Total 342 100.0

Table 5, reveals that direct theft of cash alone accounts for 64.52% of total kinds of frauds committed. This is

not surprising, given the monetized nature of the economy. Overall, my findings reveal that cash is the most

vulnerable form of assess to fraud.

Table 6: Representation of the nature of fraud

Nature of frauds No of respondents %

A 112 32.75

B 230 67.25

C - -

Total 342 100.0

A: collusion-Management and Management personnel; B: Single-Management alone, senior and junior staff alone; C: None of the above.

From the Table 6, it is clear that the fraud committed by management staff alone, senior or junior staff alone is

the highest. According to the Table 5, it can be seen that management staff do not collide to defraud the bank,

instead it is singularly done, either by a management staff senior or junior staff. This stretches the responsibility

of the management in the installation of a good internal control system to prevent fraud in banks.

Table 7: Representation of the measure to prevent fraud

Measures to prevent fraud No of respondents %

A 277 80.99

B - -

C - -

D 65 19.01

Total 342 100.0

A: Efficient and adequate internal control system; B: Attractive pay package; C: Keeping of proper records; D: Monitoring of staff in the payroll department.

From Table 7, it is obvious that effective and adequate internal control system is necessary in order to detect

and prevent frauds, since it accounted for 80.99% of the total response.

Result of the analysis/decision taken

HOi: X² calculated = 15.75, while X² tabulated at a level of significance of 0.05 is 5.991. That is, X² cal > X²

tab: 15.75 > 5.991.

Since X² cal is greater than X² tab, HOi is rejected and HIi is accepted, thus concluding that the lack of a good

internal control system is a major cause of fraud in banks.

H2: X² calculated = 131.42, while X² tabulated at a level of significance of 0.05 is 5.991. That is, X² cal > X²

tab: 131.42 > 5.991.

Since X² cal is greater than X² tab, HOii is rejected and HIii is accepted, thus concluding that banks with

effective internal control system can prevent and stand against the menace of fraud.

CONCLUSION

Fraud in the Banking sector is no becoming a global phenomenon. It generally inflicts hardship on banks

owners, customers and their family members, as most bank failures are associated with large scale frauds. The

prevention and detection of frauds are basically the responsibility of the management, through the establishment

of an effective and efficient internal control system.

Finally, the importance of the internal control unit of any organization, especially banks cannot be undermined.

Since the lack of an effective internal control system, according to the findings, is the major cause of bank

fraud. Management of every bank should create and establish a standard internal control system. This will

promote and enhance the liquidity, solvency and going concern concept of the banks.

RECOMMENDATION

The following recommendations are made with respect to the detection and prevention of bank fraud:

First, adequate internal control system should be put in place at all level of banks’ operation. This will help to

prevent the occurrence of fraud. Also, an effective internal audit department should be established possibly with

qualified Chartered Accountants as the head. Furthermore, it is recommended that proper cash monitoring

should be carried out on regular basis. Since cash remained the most vulnerable asset to theft, as our findings

revealed; banks should also arrange for cash-in-transit insurance cover in order to prevent the risk of loss of any

cash in transit. Finally, good management that comply with the laid down rules, policies, procedures and

regulation in the performance of any banking function will go a long way in fraud prevention in banks..

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