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CHAPTER ONE

INTRODUCTION

1.1   Background to the Study

There is currently considerable interest in the topic of internal control systems and its contribution to exact management of any business economic resources (Kantzos & Chondraki, 2016; Rittenberg, 2016). This developing role of the internal controls is also reflected in its current definition as posited by Cahill (2016) which states that “internal control is the system of internal administrative and financial checks and balances designed by management, and supported by corrective actions, to ensure that the goals and responsibilities of the organization are achieved”. The growth in international financial markets, the emergence of the universal banking policy amongst others has given banks the opportunity to design new products and to provide a wide range of services which has come with increases in associated risks (Palfi & Muresan, 2015). Consequently, there is growing management recognition of the importance of implementing a good internal control system as the activities of internal controls are now seen as critical elements in the assurance process.

With particular emphasis on banks, strong internal contract systems have long been seen as particularly relevant to banks because of their vulnerability to fraud and the links between information systems and money (Cahill, 2016). A system of effective internal controls is a critical component of bank management and a foundation for the sate and sound operation of banking organizations. A system of strong internal controls can help to ensure that the goals and objectives of a banking organization will be met, that the bank will achieve long-term profitability targets, and maintain reliable financial and managerial reporting. Such a system can also help to ensure that the bank will comply with laws and regulations as well as policies, plans, internal rules and procedures, and decrease the risk of unexpected losses or damage to the bank’s reputation.

According to the Basle Committee on Banking Supervision (1998), this heightened interest in internal controls is, in part, a result of significant losses incurred by several banking organizations. An analysis of the problems related to these losses indicates that they could probably have been avoided had the banks maintained effective internal control systems. Such systems would have prevented or enabled earlier detection of the problems that led to the losses, thereby limiting damage to the banking organization. The committee report highlighted further that the internal control systems must be designed to provide reasonable assurance of realizing the underlying objectives, as there should be necessary assurance that all bank’s revenues accrue to its benefit, all expenditure is duly authorized and properly disbursed, all assets are adequately safeguarded, all liabilities are recorded, all statutory requirements relating to the provision of accounts are complied with and all prudential reporting conditions are strictly adhered to in such a manner for providing management information.

In the Nigerian banking industry, there is the perception by stakeholders that the quality of internal control appears to be inadequate. The persistence of financial fraud and fragility in the system resulting to several bails out attempts by the apex bank (i.e. Central Bank of Nigeria) strengthens the suspicion of a deep-rooted internal control challenge. Though studies in this regards have been largely anecdotal, the Basle Committee on Banking Supervision (1998), report provides a comprehensive framework that provides insight into what could determine the internal control weakness such as; Lack of adequate management oversight and accountability, and failure to develop a strong control culture within the bank, insufficient guidance and oversight by boards of directors and senior management, inadequate recognition and assessment of the risk of certain banking activities, the absence or failure of key control structures and activities. The focus of the study therefore is to examine and provide empirical findings of the factors influencing the quality of internal controls in the Nigerian banking industry.

1.2   Statement of Problem

This heightened interest in internal controls is, in part, a result of continue losses incurred by several banking organizations. An analysis has been put before the banks to maintain effective internal control systems. Such systems would have prevented or enabled earlier detection of the problems that led to the losses, thereby limiting damage to the banking organizations. The trend analysis of fraud in the banking sector as indicated in the NDIC (2009) report reveals that in 2003, the total number of attempted fraud was 850, in 2004 it increased to 1175, in 2005 it further increased to 1229. The total number of attempted frauds declined to 1193 in 2006 and increased again to 1553 in 2007. The experience in 2008 -2013 showed above 30% increase in the number of fraudulent attempts. The total expected losses to the banking sector from 2003 – 2005 were 857.46million, 2610.00 million, 5602.05 million respectively. In 2006, it stood at 2768.67 million while in 2007, it stood at 2970.85 million. The amounts seem to have increased progressively from 2007 – 2013 with an average increment rate of above 25% (NDIC, 2009). Research into the factors that could be responsible for internal control weakness is a largely undeveloped research area in the Nigerian environment and specifically for the Nigerian banking industry. Against this bank drop, the study intends to examine the main causes and how best these problems can be eradicated or minimize to its barest minimum. 

1.3   Research Questions

In the light of the issues in framework provided in the Basel 1999 report, the following research questions have been identified and will form the direction for the study;

1. Is there a significant relationship between bank internal control environment and internal control weakness?

2. Is there a significant relationship between the quality of bank’s risk assessment activities and the internal control weakness?

3. Is there a significant relationship between Banks internal monitoring activities and the internal control weakness?

4. Is there a significant relationship between Banks internal control activities and the internal control weakness?

1.4   Objective of the Study

The following are the objectives of the study;

1. To examine if there exist a significant relationship between bank internal control environment and internal control weakness.

2. To identify if there exist a significant relationship between the quality of bank’s risk assessment activities and the internal control weakness

3. To determine if there exist a significant relationship between banks internal monitoring activities and the internal control weakness.

4. To examine if there exist a significant relationship between banks internal control activities and the internal control weakness.

1.5   Research Hypotheses

The following hypotheses have been specified to guide the direction of the study;

Hypothesis One

HO: There is no significant relationship between bank internal control environment and internal control weakness.

HI: There is a significant relationship between bank internal control environment and internal control weakness.

Hypothesis Two

HO: There is no significant relationship between the quality of Bank’s Risk assessment activities and the internal control weakness.

HI: There is a significant relationship between the quality of Bank’s Risk assessment activities and the internal control weakness.

Hypothesis Three

HO: There is no significant relationship between Banks internal monitoring activities and the internal control weakness.

HI: There is a significant relationship between Banks internal monitoring activities and the internal control weakness.

Hypothesis Four

HO: There is a significant relationship between Banks internal control activities and the internal control weakness.

HI: There is a significant relationship between Banks internal control activities and the internal control weakness.

1.6   Significance of the Study

Astudy of this nature holds numerous benefits across an eclectic range of stakeholders in the Nigerian banking industry.

1. The study will be useful to management in evaluating the like determinants of internal control quality in the banking sector. The research objectives clearly delineate critical factors that may be perceived as basis for the tendencies for weakness of internal control system and findings about these factors will be useful.

2. The study will contributes to the literature especially as it provides evidence from a developing economy like Nigeria.

3. The study will be of immense benefits to policy institutions like the CBN and the NDIC as well as could provide the necessary theoretical framework needed for effective policy formulation, simulation andimplementation.

1.7   Scope of the Study

This study is to examine the determinants of bank persistence of internal control weakness in Nigeria. The study focused on the determinants of the persistence of internal control weakness in Nigerian banks. A respondent’s size of 120 from thirteen publicly quoted commercial banks was selected as the study sampling size from a population of twenty two commercial banks operating in Nigeria. The study covers financial years between 2007 and 2013, the study is restricted to only staff in Benin City branches.   

1.8   Limitations of the Study

The study identifies the following limitations; firstly, there is the challenge of inappropriate measurement of variables especially when qualitative issues such as those addressed in this study are examined. Thus in dealing with such issues the potential for subjectivity is often inevitable. In addition, the smallness of the sample size is also considered a limitation. Furthermore, there is the challenge of low response rate especially with regards to questionnaires. There is the potential for intended respondents to display apathy towards filling of the research questionnaires. This is an often cited challenge associated with primary research. Also, the eventual analysis of the research findings is always subject to the assumption that the respondents have provided a true opinion to the questions and often times this cannot beascertained by the researcher.

1.9   Definition of Terms

Internal Control: It has been defined by the Auditing Planning Committee (APC) in UK as “the whole system of control financial and otherwise established by management in order to carry out the business of the enterprise in an orderly and efficient manner to safeguard the assets and secure as far as possible, the competence and accuracy of records, the prevention and detection of errors and fraud in accordance with the final preparation of financial statement.”

Control: Is an exercise performed in the present to achieve a plan drawn up for the future.

Management: It is defined as the process of planning, organizing co-ordinating and controlling the activities of an organization. It is seen as a group of people who monitor and control the organization activities towards the achievement of the organization objectives.

Internal Audit: Internal audit can be defined as audit carried out by employees of an enterprise who are specially assigned by management to conduct a review of the accounting and internal control systems and to make recommendations to management on how to improve the system (Institute of Internal Auditors, 1998).

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