CHAPTER ONE

INTRODUCTION

1.1       Background of the study

Banking is a financial intermediary service which is the link between two units of the economy, that is the surplus unit and deficit unit. The surplus unit supplies financial resources in the form of deposits to the bank which in turn channel these resources to the deficit unit in the form of loans, advances, investment, and leases.

There are different stages in banking operations. These stages involve – documentation, records of prime entry, double-entry records, summarization of entries, balancing of accounts and the preparation of financial statements (Kiabel & Akenbor, 2008). In order to minimize and prevent the occurrence of errors and irregularities in banks, previous studies have shown that internal control mechanism is a veritable measure (Nwaiwu & Peters, 2014). As a result of the branch networking of banks and the high volume of bank transactions, executive directors increasingly find it difficult to exercise personal first-hand supervision of operations; hence they have come to depend on accounting and statistical reports that summarize current happenings and conditions throughout the bank. The information carried by this stream of reports enables the executive directors to control and direct the operations of the bank group.

It was observed from investigation that some banks are engaged in the falsification of their status reports in order to enhance their share market value (Osisioma & Enahoro, 2006). With this scenario, one begins to ask why do banks do this. Osisioma & Enahoro (2006) posit that the job of the internal auditor is to investigate and appraise the system of internal control and the efficiency with which the various units and branches of the bank are carrying out their assigned functions.

Internal control system is defined as a set of methods, designed and controlled by senior management and board of directors to provide a limited assurance regarding reliability of financial reporting, effectiveness and efficiency of operations and their compliance with laws and regulations (Aksoy, 2007). The Auditing Practice Committee (APC) defines the Internal Control System as” the whole system of controls, financial and 3 otherwise, established by the management in order to carry on the business of the enterprise in an orderly and efficient manner, ensure adherence to management policies, safeguard the assets and ensure so far as possible the completeness and accuracy of the records”

Internal control is the plan of organization and all of the coordinated methods and procedures adopted within a business to safeguard its assets, check the accuracy and reliability of its accounting data, promote operational efficiency and encourage adherence to the prescribed managerial policies. We can say that internal control is a broad term with a wide coverage. Its scope extends beyond those matters which related directly to the functions of accounting and financial departments

The main objective of internal control system for banks is to continuously track the compatibility of all banking practices and operations with international auditing standards, banking laws, regulations and rules to solve problems that may arise where necessary. In addition to this, with an effective internal control system, erroneous, fraudulent transactions and irregularities are less likely to happen in banking (Ozten et al. 2012, p.133)

Previously internal check and control was taken as the same term but nowadays owners and managers are separate and different. So, it is taken as a separate term. Internal control incorporates inspection, internal audit and other factors of control. Nowadays, it is essential for the smooth operation of accounting, cash and other transactions of business.

Previous studies such as Kudinz (2009), have indicated some determinants of effective internal control system as presentation of early report, respect for authority, willingness to effect changes, lack of workers collusion, workers competence, independence of internal control staff, management observance of control, good remuneration of internal control staff, cost of instituting internal control measures, willingness to enforce controls, control measures for unusual transactions, and well-designed organizational structure. However, Profit is the primary objective of a business (Nimalathasan, 2009). In point of view of the heavy investment which is necessary for the success of most enterprises. Profit in the accounting sense tends to become a long- term objective which measures not only the success of the product, but also of the development of the market for it. It is determined by matching revenue against cost associated with it. Only those costs are placed against revenue, which have contribution in the generation of such revenue. An enterprise should earn profits to survive and grow over a long period of time. It provides evidence concerning the earnings potential of a company and how effectively a firm is being managed. If the enterprise fails to make profit, capital invested is eroded and if this situation prolongs the enterprise ultimately ceases to exist. In fact Profit and profitability are two different terms. Profit means as an absolute measure of earning capacity, while profitability is relative measure of earning capacity. Profit is defined by Iyer (1995) as “excess of return over outlay” (Nimalathasan, 2009) while profitability is defined as “the ability of given investment to earn a return from its use’. The words profitability is composed of two words profit and ability. The word profit has already been defined but the meaning of profit differs according to the use and purpose of the enterprise to earn the profits. Thus, the word profitability may be defined as the ability of given investment to earn a return from its use. Profitability ratios measure the firm’s ability to generate profits and central investment to security analysis, shareholders, and investors. Profitability is the primary measure of the overall success of enterprise.

The analysis of profitability ratios is important for the Shareholders, creditors, prospective investors, bankers and government alike.

 Bank profitability is an important ingredient of financial development, its relevance spans through banking firm performance to macroeconomic stability. At the firm level, a higher return to a large extent reduces bank fragility. At the macro level, increased profitability makes for a sustainable banking sector that can finance economic growth and development. However, due to the intermediation role of the banking system, higher returns may imply higher interest rates on loans. This informs a reason why monetary authorities are always poised to regulating the banking system. Increased regulations and counter deregulations have encouraged competition in the banking sector, and hence exposed banks to increased fragility. For example, between 1990 and 2004, bank regulators have increased the minimum share capital of banks operating in Nigeria five times (Aburime & Uche, 2008). These reforms were all aimed at improving the balance sheet, profitability and stability of banks in Nigeria, even though the outcomes sometime differ from expectations. Whilst some scholars have argued that bank profitability is enhanced by the improvements in the internal organization and managerial efficiency of the bank itself, others argue that industry wide factors are integral to the profitability of banks

It is upon this premise that this study is consummated to determine the impact of internal control system on deposit money banks in Nigeria (a case study of sterling bank plc.)  

1.2Statement of the problem

A notable feature of the industry is low ethical standard and transparency.  These are manifesting in the rising cases of unwholesome practices being recorded. A number of banks engage in some sharp practices to achieve compliance with some regulatory Requirements "on paper" Many banks 'returns provide inaccurate/misleading financial report thereby preventing timely detection of emerging problems by the supervisor. The managerial incompetence of the top management of some banks as evident in weak internal control system of the banks. Substantial losses incurred by many banks on their credit portfolio, frauds and forgeries and outright negligence have brought to the fore, the importance of sound internal control system. Appraisals of fraud-related losses by Bank Examiners Revealed that such losses could have been prevented had the affected banks maintained Effective internal control systems. The trending deficiencies in banks' earning assets especially loans and advances, arising from either poor loan administration or unethical lending (such as insiders ‘a buses).This is an Indication of managerial problems in this regard.

The importance of internal control system cannot be overemphasized where a variety of requirements, processes that are both manual and information communication technology based (ICT) are used. Organizations have recognized internal audit function as a tool for Ensuring effective workings of the internal control system. However, in Nigeria, the internal control function in the   banking sub-sector has not been fully tapped; consequently, cases of errors and intent to defraud and other fraud Cases exist in the banking industry. The distresses in the banking sector Reflected lack of effective control mechanism of the internal Control system in the banking industry.

Bank profitability is an important ingredient of financial development, its relevance spans through banking firm performance to macroeconomic stability. The various means employed by customer and staff or officials in defrauding the bank is a major problem confronting the deposit money banks and this affect the bank efficiency and profitability.

The Experiences of failed banks in Nigeria have therefore called for the reinforcement and the Strengthening of the controls system in the Nigerian banks.

1.3       Objective of the Study

The main objective of the study is to evaluate the impact of   internal control system on profitability of sterling bank in Nigeria. The specific objectives of the study are to:

1.                  Ascertain the impact of control on the banks profitability.

2.                  Identify the banks risk assessment process and profitability.

3.                  Evaluate the impact of information and communication system on the banks profitability.

1.4       Research Question

The following are a few of the questions, which were asked in the questionnaire in the carrying Out of this research work.

1.                  Does the banks control system affect its profitability?

2.                  Is adequate security a condition for granting loans and advances in your bank?

3.                  Does the control system limit operational activities within the bank?

4.                  Does the control system ensure the report of relevant financial information and communication?

1.5       Research Hypothesis

Ho: null hypothesis

Ho1: Control has no significant impact on the banks profitability.

Ho2: Risk Assessment Policy has no significant impact on the banks profitability.

Ho3: information and communication system has no significant impact on the banks profitability.

1.6       Significance of the Study

System of Internal control is very important factor affecting the effective and efficient working condition in the bank. A successful internal control system can reach its goals.

This study will identify the failures over the internal control system and it will help the    management to overcome the deficiencies.

It will also be of great importance to the banking staff especially the managers and officers whose interest are geared towards the enhancement of the chances of bank profitability; in serving as a guide in the performance of their duties.

Moreover, it will assess the effect of fraud, manipulations, errors, improper authorization, dishonesty, inadequate accounting records etc. on profitability in view of the existing of internal control system.

In fact, it will provide a comprehensive knowledge of system of internal control that will form a foundation on which the auditor’s report on “true and fair view” final account is based and as such, the study will be of immense values to the practicing Accountants, Auditors, Lawyers, shareholder and other interested parties for acceptance and reliance of financial statement.

Furthermore, it will include more research in the improvement of banking services in Nigeria for the interest of the shareholders, customers and government.

Finally, the study will provide the basis for recommendation to the management of the best approach to designing, installing and operating an improved system of internal control aimed at promoting operational efficiency and eliminating or at least minimizing.

1.7       Scope of the Study

The study will be carried out on financial data’s of sterling bank in Nigeria. We will look into their profitability and see how internal control system has an impact on the bank in the period of 2013-2017 (5 years). Other parts of the country were not covered, though empirically generalized view was made of them.

However, the study encountered a lot of constraints as regards sourcing of information. Effort (some) geared towards obtaining adequate information proved abortive due to the uncooperative attitude of some staff.

Besides, no bank likes the public to know the deficiencies in its internal control as the confidence reposed on it by the public might be lost. But, irrespective of these limitations, an in-depth study was still carried out.

1.8       Definition of Terms

The researcher at this point believes that some key words and terms that will be encountered while reading this research work should be defined.

1. Internal Control System: This is the whole system of controls, financial and other established by the management in order to carry on the business of the enterprises in orderly and efficient manner, ensure adherence to management policies, safeguard the assistance and secure as far as possible the complements and accuracy of the records.

2. Internal Accounting/Financial Control: Measures that relate to protection of assets and to the reliability of accounting information and financial statements.

3. Internal Administrative Control: A sub category of internal controls which Reply principally to operational efficiency and compliance with company policy and which do not bear directly on the dependability of financial statement.

4. Cheques: A cheque is a bill of exchange drawn on a banker, payable on demand” (Bill of exchange ordinance 1917 73).

5. Embezzlement: Theft by a person of assets entrusted to him or her

6. Internal Auditing: An activity carried on in some organization by a professional staff to investigate and evaluate the system of internal control on a year round basis. Also to evaluate the efficiency of individual department within the organization.

7. Documentation: This includes all the charts, firms, tapes, reports and other

Business papers that guide and describe the working of a company’s system of

Accounting and internal control,

8. Fraud: Dishonest acts intended to deceive, often involving the theft of assets and falsification of accounting records and financial statements.

9. Organization chart: A diagram showing organizational lines of authority and responsibility with emphasis on separation of function.

10. Irregularities: Acts by individuals in an organization aimed at perpetrating fraud or embezzlement.

11. Fidelity bond: A form of insurance contract is which a bonding company agrees to reimburse an employer for losses caused by theft by bonded employees.

12. Independent Auditor: Professional level accountants that examine the books and records of companies and express opinions the accounting records in the interest of third parties.

13. Effectiveness: Attainment of a predetermined goal.

14. Efficiency: Relationship between inputs and outputs

15. Collusion: Where two or more persons conspire to commit an illegal act such as fraud and embezzlement.

16 Illegal Acts: Actions that are not in conformity with prescribed company practices that are capable of leading to fraud.

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