The Impact of Internal Control Measures on Detection and Prevention of Fraud in Banks
Employees Understanding and Knowledge of Fraud
Effective Internal Control Measures Utilized in the Detection of Fraud in the Banking Sector
Effective Internal Control Measures Utilized in the Prevention of Fraud in the Banking Sector
Evaluation of Fraud and its Impact on the Banks
The Role of Internal Auditors and Management in Fraud Detection and Prevention
Effects of Internal Control Systems on Detection and Prevention of Fraud
The paper comprises of comprehensive research analysis on the impacts of internal control measures on the detection and prevention of fraud in the banking section. The internal control measures serve an integral purpose in the detection and prevention of fraud in the banking industry such as operations of Citibank Nigeria Limited and Citigroup Inc. in the U.S. Fraud is a significant problem in the banking sector which must be mitigated vehemently (Rivera 2019). Fraud in the banking sector can be classified as a major impendent to the performance, competitiveness, and business continuity of the banks (Figure 1). The acts of fraud in the banking sector include aspects of embezzlement, acceptance of bribery, actions of personal enrichment, influence peddling, among others (Offiong et al. 2016; Salleh & Suryanto 2019). This presents a clear conflict of interest between the employees and the bank as the former acts contrary to the values and norms of organizational culture and code of ethics (Said et al. 2017). Thus, fraud is a significant challenge in the banking sector that must be continuously addressed and mitigated to ensure smooth operations and functionality of all activities of the bank (Lederman 2019; Roden et al. 2016; Schuchter & Levi 2016).
Figure 2: The Fraud Diamond Theory
Source: Mansor, 2015; Sujana, Yasa & Wahyuni, 2019
The research utilizes scholarly, journal, and peer-reviewed articles to attain empirical information vital to the analysis of the impacts of internal control measures on enhancing detection and prevention of fraud capacity in the banking sector (Figure 2). The approach to strengthening the internal control measures coupled with audit activities are integral to long-term capabilities of fraud detection and prevention (Olatunji & Adekola 2017; van Driel 2019; Yakubu et al. 2017). The paper delves into the banking sector of the United States and Nigeria as the two contrasting countries of study. With increased social ethos and reduced corruption in the United States, it is interesting to examine how this differs from the Nigerian case amid rampant corruption and erosion of the social fabric (Rahman et al. 2019). The comparison of the two countries offers a wide breadth of knowledge to the detection and prevention of fraud in the financial and banking institutions in the two countries. Thus, the paper will identify distinctions in practice and application of internal controls as a measure of fraud detection and prevention.
The paper aims to explain four key issues essential to the application and functionality of internal controls as a measure of fraud detection and prevention in the U.S. and Nigeria. The following objectives are fundamental to guide the paper’s research and analysis.
Fraud is a profound problem in the banking sector in any country. Contemporary practices dictate the use of internal control measures as vital tools to enhance fraud detection and prevention in the banks (Dal Magro & Da Cunha 2017; Haladu 2018). The prevalence of fraud impedes the competitive and increased performance of the banking sector as it is marred with challenges and unethical practices. Fraud erodes the code of conduct of the employees and exists as a vice that threatens the future of the banks. Fraud in itself is an enormous risk threatening its existence and operability capacity (Hussaini et al. 2018). The internal control measures outline a framework that enables the bank to stay on course and properly vet potential all the loopholes that may negatively affect its operations. Therefore, the statement of the problem connotes the value and significance of delving into internal control measures as a way to provide fundamental insights essential to enhance competitiveness. As well, the utilization of effective internal control measures strengthens the capacity of the bank to detect and prevent fraud in the banking sector (Kabue & Aduda 2017). Thus, guarantee business continuity and progress in the future through assured quality services and compliance with legal and ethical standards of practice.
The research on the impacts of the internal control measures on fraud detection and prevention creates an opportunity to create a clear understanding of fraud, its main causes, and its prevalence in the banking sector. Examining the U.S. banking sector as compared to the Nigerian banking – the two countries shows diverse practices and demands to eliminate fraud in the financing and banking industry. While in the United States is not marred with fraud causes as compared to the Nigerian case, fraud remains to be a significant problem threatening the banking operations (Offiong et al. 2016). Thus, a clear understanding of the mitigation, capacity building, and building of organizational culture free from fraud is fundamental to increased competitiveness and promise of the future in the banking sector in both countries.
The examination of the employees’ understanding of fraud as part of the research is significant to inform the banking sector on the measures to utilize in building capacity and efficiency in fraud detection and prevention. The investigation of internal control measures and how they are utilized in the United States and Nigerian is essential to draw the best practices vital to the transformation of the banking sector. The paper creates an insightful opportunity to emphasize the importance of internal controls and audit function as a way to detect, identify, and offer solutions to prevailing problems in the banks (Figure 2; Hazami-Ammar 2019). The internal control measures are fundamental in detecting potential risks that threaten the future of the banks. Thus, the paper is extensively important to add to the body of knowledge stipulating how internal control measures can be reinforced to improve transparency, ethical values, and strong organizational culture that detest fraudulent activities in the bank operations.
The study on the effects of internal control measures on fraud detection and prevention in the banking sector is highly valued. The study provides critical insights into the practices and factors that influence the occurrence of fraud, undermining the banks’ “operational efficiency, profitability, and liquidity capacity” (Yakubu et al. 2017). According to Yakubu et al. (2017), strengthening of the internal control measures is integral to enhancing the capacity in which fraud is detected and prevented in Citigroup Inc. and Citibank Nigeria Limited. The capacity to eliminate fraud in the banking sector is vital to increased competitiveness, profitability, and operational capacity. In turn, culminate in the efficacy of the banks to eliminate threats and risks associated with fraud occurrence in its operations (Haladu 2018).
Haladu (2018) states that “control systems in any organization establish the pillar for an efficient accounting system.” The achievement accountability and transparency indicate the strength of an organization to maintain supreme internal control systems over the financial power that may reign in an organization. Rivera (2019) asserts that “internal control systems enable the organization to enhance the audit function and compliance intervention measures.” These are critical measures that enable an organization to detect and prevent fraud from becoming a part of the organization. The existence of a robust internal control system is essential for timely and reliable information, improves the capacity to correct a deficiency in the organization, and outlines the framework in which the compliance with legal, technical and administrative order is maintained in an organization (Rivera 2019). Thus, build capacity to ascertain strong organizational culture, values, and code of conduct that facilitate the employees to stay clear of fraudulent activities.
The internal control systems providing a clear framework for the management of financial resources, as well as, assets of an organization eliminate potential risks of fraud in the system. Kabue and Aduda (2017) note that “financial governance control measures such as risk management committee, finance, and investment committee, and reporting and budgetary control measures are some of the most essential internal control measures utilized in detecting and preventing fraud.” The rationale behind the strengthening of internal control measures as part of fraud detection and prevention is emphasized by Haladu (2018) who asserts that they are critical to the realization of organizational goals and performance – in an optimum capacity. Strong internal control measures are fundamental to an organization as they prevent loss of resources, ascertain the organizations’ compliance with the laws and regulations, and improve the production of reliable reports and statements (Haladu 2018; Kabue & Adadu 2017; and Rivera 2019).
According to Rahman et al. (2019), “building strong internal control systems enables an organization to reasonably reduce business risks and prevent the occurrence of fraud.” The establishment of strong internal control systems provides a framework with which certain limits are maintained to mitigate the occurrence of fraud in an organization. Haladu (2018) echoes these sentiments as he argues that internal controls, such as the application of the audit function role act as crucial features in the detection and prevention of fraud. That is through continuous evaluation of internal controls that impact the prevention of risk, facilitate the protection of assets and resources in an organization, mitigate possible fraud instances, and promote effectiveness, efficiency, transparency, and expansion of the economy (Rivera 2018; and Kabue & Adadu 2017).
In any organization, including the banking sector, fraud exists in the form of embezzlement of company resources and assets, person enrichment plot, bribery, partaking in corruption actions, and influence peddling. In its form, fraud prevails as a way of compromising personal interests against the organizational interests impacting to conflict of interests. According to Yakubu et al. (2017), the study conducted in his research identifies the following as the main causes of fraud in the banking sector. These comprise of “prevalence of poor internal control systems that increase loopholes for fraudulent activities, presence of unqualified staff with no capacity to detect and prevent fraud, inadequate staffing, poor record-keeping practices that reduce accountability and transparency, and inadequate training and re-training of the staff to build capacity essential for fraud detection and prevention.” Banks that fail to meet the above standards are prone to the risk of fraud while those that advance their control systems through capacity building thwart any potential of fraud risks (Haladu 2018).
Hazami-Ammar (2019) evaluates the role of internal auditors in advancing the functions of pursuing accountability and transparency in an organization as integral to fraud detection and prevention. The capacity to investigate fraud is enhanced by the internal auditors who remain focused and objective in meeting the objectives of the organization. Olatunji and Adekola (2017) emphasize the value of auditors in fraud detection and prevention in the banking sector. Taking the case study of the Nigerian banking sector, auditors are core to the evaluation of the banks’ financial records and statements enabling them to detect and prevent fraud occurrence in any form. Kabue and Adadu (2017) compliment the argument with the assertion that auditors establish levels of fraud detection and prevention which act as buffers in the elimination of the risk to the banking operations. Thus, auditors are treasured assets in the strengthening of internal control systems that culminate in the protection, detection, and prevention of fraud.
Moreover, Salleh and Suryanto (2018) assert that fraud detection is a fundamental aspect of the banking sector. The detection of fraud enables the improvement of the operability of the banking sector leading to competitiveness and better service delivery. The capacity to access quality banking and financial services is a fundamental aspect of the sector. Kolapo and Olaniyan (2018) add to the argument offering the connotation of “the impact of fraud on the performance of deposit money banks.” The banks must ascertain high professionalism and code of conduct liable to the legal framework. Thus, compliance with International Financial Reporting Standards (IFRS) stipulates the guidelines of significant strides in the development of internal control systems impacting on the efficiency of detecting and preventing fraud (Haladu 2018).
Furthermore, Rivera (2019) asserts that fraud monitoring through internal control systems can be attained by strengthening several key components. The control environment, which stipulates the ethical values and integrity principles that the company is governed, enable fraud detection and prevention as advanced by the Fraud Diamond Theory (Mansor, 2015). The continuous “risk evaluation outline the definition of risks, risk identification and evaluation, the probability of occurrence of fraud, risk management, and potential events that upset the internal control systems” (Rivera 2019). The component which provides the framework of control activities including policies and procedures utilized in risk reduction. Also, the flow of information within the organization impacts the efficiency of the internal control systems (Simeon, 2018). Finally, supervision activities that monitor the activities of the bank such as internal audit evaluation processes. Thus, collectively work together to enhance the internal controls used in the detection and prevention of fraud as a risk to the bank’s performance and operability efficacy.
The employees are a core part of the internal control system that is tasked with fraud detection and prevention in the banking sector. The level of employees’ understanding and knowledge of fraud detection and prevention mechanisms is integral to the capacity of the banking sector to reduce the risk. According to Haladu (2018), “employees who are actively trained in risk management are better able to identify threats to the organization due to weak or non-existent internal controls.” This asserts the significance of staff training as a fundamental element towards raising the bank’s capacity to resolve arising risks associated with the fraud. Dal Magro and Da Cunha (2017) connotes the value and significance of employee training as a key element to enhance the banks’ capacity to detect and avert fraud. In the evaluation of red flags as an internal control measure applied in detecting credit cooperative fraud, Dal Magro and Da Cunha (2017) state that “continuous employee training impacts to knowledge advancement and understanding of fraud in the bank sector.” Thus, it builds capacity and responsive measures of the employees in dealing with fraud.
Haladu (2018) asserts the significance of banks’ communication of fraud mitigation policies, their approaches, and perceptions in how they regard fraudulent activities. In the U.S., enhancing employee capacity to deal with fraud is a fundamental element of the internal control measures (van Driel 2018). The banking sector emphasizes the value of employees as part of fraud elimination and avoiding the temptation of falling victim. Said et al. (2017) states that employee fraud in countries like the United States and Malaysia attracts heavy penalties and punishment from the government. The strict need to adhere to the rules and regulations of money handling is essential to deter the occurrence of fraud. In the aspect, employee fraud becomes a part of the organizational vices – severe legal measures are bound to befall the employees (Luo, 2017).
Similarly, in Nigeria, fraud in the banking sector is viewed as a negative catalyst that undermines the potential and operational capacity of the banking sector (Said et al. 2017). Haladu (2018) emphasize that fraud in the Nigerian government sector poses the threat of public management integrity and weakens the internal controls of the financial running in the country. This applies similarly to the United States which views the fraud in the banking or public sector as a major impediment to the functionality and competitiveness of their operations (van Driel 2018). Thus, in both countries, continuous staff training is encouraged to build the capacity and potential of the employees to avoid fraud, as well as expand knowledge and understanding of fraud as a threat to the organizations.
According to Hussaini et al. (2018), “the bank performance is highly influenced by the effectiveness of the internal controls to function fully in a capacity to maintain smooth operations.” The internal control systems present a continuous approach in which the banking sectors in the United States and Nigeria assess the inner operations of the banks. That includes the evaluation of financial operations, reports, and statements to determine the accountability of the actions of the employees. Yakubu et al. (2019) recommend the maintenance of “continuous practice of the internal control system to ensure that fraud of any form is reduced to the barest minimum.” Thus, resulting in increased competitiveness and performance of the banks through effective detecting potential fraud or risk that may risk the operational capacity of the banking sector (Onyuka & Otinga, 2019).
Kabue and Aduda (2017) emphasize the significance of the existence of strong internal control systems in banking as a key part of fraud detection in the banking sector. The articles identify internal controls such as finance governance control measures such as risk management committee, reporting, and budgetary control measures, finance and investment committee, as well as reconciliation controls as integral to enhancing the level of fraud detection in the banking sector (Almajir & Usaini, 2020; Wangombe & Kiragu, 2019). Rivera (2019) upholds the role of the internal audit function role as a crucial element of fraud detection. The internal audit function provides a mechanism in which continuous evaluation of internal controls is maintained to detect and eliminate risk to the banks. Thus, both in the U.S. and Nigerian banking sectors – the value of the internal controls in detecting fraud remains to be profoundly important and crucial to effective measures being applied (Agung, 2015).
Haladu (2018) states that “adequate training of staff ensures compliance with policies and standards, authorization and approval of transactions, effective recording and processing of transactions, and positively adapt regular checks are vital components of fraud detection.” To transform the unqualified personnel into strategic assets of fraud prevention – extensive training measures must be aggressively applied in the banking sector. Yakubu (2017) identifies the approach as efficient to build the capacity of the employees to prevent any potential threat and risk to the banking sector. The realization of efficient personnel and vast capabilities in fraud detection – enhanced performance and competitiveness is guaranteed.
Rahman et al. (2019) place a high value on internal controls that enhance continuity in the regulation of effectiveness assessing business risks for the prevention of fraud as a fundamental feature. The culmination of the actions is strengthening the internal controls such as the auditing capacity, authenticity, and integrity – guaranteeing effective fraud prevention approaches. The cooperation of the banking staff in threat mitigation enables the banking sector in Nigeria and the U.S. to build better approaches to fraud prevention. The approaches culminate efficiency and operational ability of the bank (Rivera 2019).
According to Said et al. (2017), “employees lacking in ethical values will tend to conduct bribery and corruption transactions.” The U.S., compared to Nigeria, shows a difference in employees’ ethical values and moral foundation. The employees in Nigeria are susceptible to corruption activities encumbering the potential of internal controls in fraud prevention. The building of organizational culture and ethical values is paramount to the conduct and practices of the employees in the banking sector (Rivera 2019). This impacts the potential of employees willingly taking action against fraud occurrence in the banks. The ability to prevent fraud highly revolves on the employees’ ethical values and fabric to respect the law and void conflicting tendencies in their actions.
The evaluation of fraud impacts the banks’ potential and operability positively inducing growth and increased competitiveness. The prevalence of strong internal control systems enables the banks to operate in a progressive manner that detects and prevents any risk from affecting the bank. Consequently, banks raise their reputation in their integrity and values as a trusted financial institution (Hussaini et al. 2018). This impacts the improvement of the bank’s competitiveness by allowing the realization of strategic performance and positioning of the bank in the sector. As a result, high performance, value addition, and expansion of the bank are guaranteed in the long-term.
The elimination of fraud as a problem in the banking and financial institutions – both in the United States and Nigeria result in improved customer service delivery (Adenike, 2017). The detection and prevention of fraud in the banking sector have a positive relationship with customer service delivery. This is as a result of removing unprecedented hitches and problems associated with the occurrence of fraud (Rahman et al. 2019). Better service delivery is guaranteed in high quality, whereby employees are committed to serving the clients in the best way possible. The consequence comprises of increased competitiveness and resolute measures being taken to address any arising issue.
According to Hussaini et al. (2018), the existence of strong internal controls and operational capacity result in the reduction of bottom-line financial expenditures. The protection of organizational assets and resources implies that they can be utilized in other aspects that improve the productivity of the banks (Ozigbo, 2015). The banks have the mandate to ensure that they are free from the fraudulent activities which impede the functionality of the financial institutions. The resolution of prevailing loopholes and risk points enables the banks to compete fairly and in a robust manner. This is fundamental to the perception of the bank and its future operations (Yakubu et al. 2017).
Auditors and management play a vivacious role in the prevention and detection of fraud. They serve as the epicenter of the bank’s mechanism to prevent and detect fraud (Le et al., 2018). The functions of the auditors and management provide an assessment of the approaches to ensure the banks maintain the highest code of conduct. The auditors and managers are a crucial part of the internal control systems that establish a framework of operation and creation of policies in which the banks follow (Ahmad, 2019). The auditors exist as independent entities that exist to oversee the operations and functionality of the banks. This increases the chances of fraud prevention and detection through aggressive measures used to ensure the integrity and ethical values are adhered to in the organization (Kravet et al., 2018).
According to Olatunji and Adekola (2017), auditors are tasked with the “examination of records and financial statements of an organization.” Based on the information examined, auditors have the power to form an opinion that depicts the accuracy and correctness of the compiled financial statements. In turn, determine the level of risk and threat extent to which fraud causes on an organization. Olatunji and Adekola (2017), “auditors are tasked with planning and performing appraisal procedures to identify underlying factors which posit a threat to the institution.” The auditors have the capacity to assess, consider, and determine the level of the risk of the evaluated materials misstatements found in the financial statements (Petkovic & Cvetkovic, 2018). This includes the fraud error identified by the auditors in the financial materials misstatements.
The primary role of the auditors in an organization is designed to provide a framework to expose frauds, errors, and weaknesses that exist in the banking system (Olatunji & Adekola 2017). This culminates into three key functions of the auditors that include prevention, risk assessment, and detection of fraud, financial misstatements, and errors that impede successful performance and competitive banking system (Efiong et al., 2018). The conduct of forensic fraud investigation is essential in the combat of fraud in the banking sector in Nigeria. This calls for concerted efforts to strengthen the audit function and their execution of mandates in the banking sector.
In a study conducted by Kolapo and Olaniyan (2018), fraud prevalence in the banks exists in the form of “reported fraud cases, amount lost to fraud, and some staff involved in fraud cases.” This undermines the operational capabilities if the bank resources and assets are lost to fraud (Adelana & Toba, 2018). The existence of strong internal control systems exists to prevent the occurrence of fraud that induce adverse effects on the operability capacity of the organization (van Driel 2018). The presence of strong internal controls enables the banks to improve their performance the commitment of their resources and assets towards competitiveness (Offiong et al. 2016). Thus, posit the value of internal control systems towards the realization of the strategic objectives of the bank.
Offiong et al. (2016) note that “the existing regulatory guidelines on deterrence and prevention of banking sector frauds in Nigeria are currently inadequately addressing detection and mitigation activities.” The building of the capacity of internal control systems depicts the commitment of the banking institutions to achieve high standards of operations and compliance with regulations and laws of financial reporting. Rivera (2019) emphasizes on the significance of effective internal control systems towards enabling information reliability and timeliness and provide a framework of measures essential to correct control deficiencies (Fahriani & Tobing, 2019). Hence, the existence of effective internal control systems on the banking sector that efficiently detect and prevent fraud occurrences promotes transparency, the performance of the bank, growth of the economy, protect assets and resources of the organization, and mitigate possible fraud (Rivera 2010; Yakubu et al. 2017). Thus, it comprises of elimination of risks that threaten the competitiveness and performance of the financial institutions.
The study finds limited material on the application of internal control systems in the United States and their impact on the prevention and detection of fraud. This presents room for more research and analysis of how the banking sector in the United States has utilized internal controls systems in the prevention and detection of fraud. The measures utilized in the U.S. following the successes in the banking sector provides fundamental lessons to the banking institutions in Nigeria. Despite the progress and attempts made in the Nigerian banking sector, it has not been as successful as it is in the United States. Therefore, further research and analysis are essential to inform the disparities between the United States and Nigerian banking sectors in their application of the internal control systems and other factors that influence their application.
Also, as part of the internal control system – employee training culminates in the knowledge and understanding of the personnel on fraud, its dynamics, and implication on the bank. A strong, vibrant, and knowledgeable workforce is critical for prevention and detection. The research on fraud awareness among the workforce in the banking sector in the two countries is minimal. This limits the scope and application of knowledge, understanding, and awareness of fraud in the banking sector. Further research is necessary to outline how employees understand and perceive fraud. This impacts profoundly on the prevention and detection of fraud as a significant risk that threatens the operability and performance of the bank. Thus, more studies are integral in the future to illustrate the employees’ support to other internal controls increasing the banks’ capability to prevent and detect fraud.
In conclusion, fraud is analyzed as a grave problem to the operations and performance of the banking and financial institutions. In the United States, as well as, Nigeria – efforts towards building the capacity of the internal control systems are seen as significant elements towards the detection and prevention of fraud. The research identifies the audit function as the epicenter of ascertain effective measures and sealing of potential loopholes in the banking sector. Audit among other internal control systems such as the reconciliation controls, financial governance controls, and reporting and budgetary controls enhance the level off fraud detection and prevention in the banking sector. This culminates in the intervention using robust internal control systems that lead to compliance with the legal, administrative, and technical systems.
As well, research indicates that the efficiency of internal control systems impacts the banks’ capacity to provide timely and reliable information, provide measures to correct control deficiencies, and continuous evaluation of internal control systems. In turn, prevent any potential risk that may impede the effective functioning and performance of the banks. The efficacy of the internal control systems impacts the promotion of efficiency, transparency, the efficiency of banking operations, and the growth of the economy. The protection of bank assets and resources is paramount to its operations. Thus, resulting in the mitigation of possible fraud that may affect the banking operations.
Additionally, the aspect of employee awareness, knowledge, and understanding of fraud prevention and detection in the banking sector is integral to the internal controls in both the United States and Nigeria. Research indicates that some of the core causes of fraud in the banking and financial industry consists of the existence of poor internal control systems (mostly found to affect Nigeria more that it is experienced in the United States), the presence of unqualified personnel, poor record-keeping practices, inadequate staffing of the banks, and lack of sufficient training and re-training of the staff.
Therefore, to ascertain the efficiency of internal controls in the prevention and detection of fraud in the banking sector in both the United States and Nigeria, the following recommendations are crucial to the overall improvement of performance. First, the building of capacity of the employees through proper training and re-training on the fraud prevention and detection measures. The continuous employee training results in more awareness, knowledge, and understanding of fraud and its implications in the banking sector. Second, the incorporation and strengthening of audit functions are critical for regular assessment of internal control measures allowing detection and prevention of any risk to the banking sector. Third, the banking sector in Nigeria can attain key practices on ethical values and organizational culture from the U.S. counterparts to improve the environment in which the internal control systems are implemented resulting in effective fraud prevention and detection measures. Finally, overall reform and restructuring are fundamental to enhance the framework on fraud prevention and detection in the banking sector – both in Nigeria and the United States.