CHAPTER ONE

INTRODUCTION

1.1 Background to the study

For commercial banks to be able to function effectively and contribute meaningfully to the development of a country, the bank must be stable, safe and sound. And for these conditions to be obtained, there must be a sound accounting system, which is occasioned by an effective control system.

Moreover, the quality of a company’s internal control affects not only reliability of financial data, but also the ability of the company to make good decisions and remain in business. Recent business failures can all be attributed to ineffective internal control system, which most often are circumvented by top management.

Current business trends have made it imperative for almost all Commercial banks to maintain effective internal control systems. Internal control has attracted intense debate and scholarly attention across industries in control industries in communication, accountancy and auditing literature over the past decades.

Internal control is a process effected by the entity’s board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievements of objectives in the categories; reliability of financial reporting, effectiveness and efficiency of operations, and compliance with applicable laws and regulations (Ray & Kurt, 2001). Internal control consists of five related components which are derived from the manner in which management runs its business. These components are; control environment, risk assessment, control activities, information and communication systems and monitoring. Commercial banks internal control systems could be less formal and unstructured but at the same time be very effective. According to Ledger Wood and White (2006), an internal control adopted by Micro finance Institutions need to be orderly, practical and   efficient enough to help them conduct business. Internal controls are most effective when they are directly incorporated in the process that support operations and enable quick response to changing economic conditions.

Commercial banks use internal control mechanisms to make sure the staffs respect its policies and procedures. Everyone in an organization has the responsibility to ensure internal control succeeds to some extent. Virtually all employees produce information used in the internal control system or take other actions needed to effect control. 

Commercial banks are organizations that carry out financial activities which occupy a center portion in the nation’s financial system and are essential agents in the development process of the economy. By intermediating between the surplus and deficit spending unit, institutions increase the quantity of national savings and investments and hence national output. According to the Consultative Group to Assist the Poor (CGAP,2006), Commercial banks are the provision of basic financial services to clients who otherwise lack access to financial institutions. Microfinance institutions help to reduce poverty by providing the poor with sustainable facilities to start small businesses. Three features distinguish microfinance from other formal financial institutions. The smallest of loans advances and or savings collected, the absence of asset-based collateral, and simplicity of operations. The goal of microfinance institutions as development organisations is also to service the financial needs of new markets as means of meeting development objectives. (Ledger wood, 1999).

Investigating internal control systems in a commercial bank is important because of the significant resources they leverage in regards to poverty alleviation. Internal control has been identified as a key tool to strengthen the financial performance of commercial banks and increase outreach of microfinance. Internal control will ensure that errors and irregularities are avoided or made apparent.  With internal control, commercial banks can look forward to increased efficiency and better client outreach. Commercial banks are an important contributor to the Cameroonian economy. The sector contributes to the nation’s objective of creating employment opportunities, training entrepreneurs, generating income and providing a source of livelihood for the majority of low-income households by financing the businesses that they run. The general perception is that enforcement of proper internal control systems always leads to improved financial performance. Nevertheless, available literature still points out that in spite of elaborate system of controls in organizations, financial performance has been elusive in most of these organizations (OAG, 2010). Commercial banks traditionally lend to medium and large enterprises which are judged to be creditworthy and tend to avoid doing business with the poor and the micro enterprises because the associated costs and risks are considered to be relatively high.

Commercial banks have therefore become the main source of funding for micro enterprises in Africa and in other developing regions. Internal control has five key components, for the sake of this study, it was limited to control environment as the major component. Control environment embraces all the other four components of internal control as it sets the tone for the organization and it also influences the consciousness of its employees (Committee of Sponsoring Organizations of the Tread way Commission (COSO).

Despite an extensive study on internal control in Cameroon institutions, there is still need for further emphasis on undertaking continuous studies on individual components of internal control and how it can lead to better financial performance which is the backbone objective of most business organizations and the need for research to be undertaken to evaluate internal controls and establish and establish its effect on organizational performance. Given that commercial banks would continue to go out of business if internal control is not adequately implemented to increase the performance of commercial banks. It is within this backdrop that there was seen a need to undertake this study.

Also, the regulatory and institutional framework of has improved significantly over the years yet still the commercial banks are faced with lots of challenges including extensive poor performance, alleged corruption and malpractices. It is against this background that this study was conducted to investigate the effectiveness of the internal control systems adopted microfinance institutions so as to establish the causes of persistent poor financial performance from the perspective of internal control.

1.2 Statement of The Problem

The absence of adequate internal control measures exposes the financial management of a commercial bank to  certain threats such as incorrect financial statement and loss of company’s  assets, stealing and mismanagement of organizational vital documents which may be done by an employee to take undue advantage, incorrect and unreliable financial records which may lead to loss of organizational  integrity, non-implementation of accounting policies in consistence with the applicable legislation appropriate in presentation of financial statement, faulty systems, bad loans, fraud, theft or poor financial management amongst other potential causes to name a few (COSO, 2011).

 Globalization and advancement in technology has become the hallmark for businesses today and microfinance institutions are not an exception. Commercial banks have been expanding their operations and activities beyond their domestic borders and as a result, businesses are also exposed to increased risks, fraud, alteration and other irregularities. This has made internal control an imperative system to be maintained by every business. The globalization of businesses, advancement in technology, increased risks of business failure, fraud and alterations that emerged in the business sector in Africa calls for proper maintenance of an effective internal control. 

Although the commercial banks have provided its worth as a weapon against poverty, it’s still going through a critical phase especial with regards to internal control practices within these organizations (Ladie, 2001). Most commercial banks face the challenge of achieving sustainability, but are also faced with the problem of internal control, in order to improve the performance of banks and make them a more effective weapon against poverty and hunger, it is important that we start by understanding the influence of internal control on the sector. 

Internal controls are put in place to safeguard commercial banks asset: to avoid misappropriation of its assets and to detect against probable frauds. However, despite all the above findings, commercial banks struggle with liquidity problems, operating and financial expenses are relatively high for micro finance institutions.

There are also cases of alleged corruption and financial malpractices. This is because of weak and inadequate control systems given that some internal control systems are costly and the cost might outweigh the benefits. In auditing standards, the concept of reasonable assurance recognizes that the cost of controls. However, there is no measure of how small internal control should be considered insignificant and if the tone set by management is not effective, internal control can be minimized to the extent that it can drastically pull-down performance. This research will there attempt to investigate the effect of internal control on financial performance of commercial banks which has hitherto been ignored.

1.3. Research Questions

The research questions of this study are;

1. To what extent does internal control affect return on equity? ii. To what extent does internal control affect return on assets

iii. To what extent does internal control affect net profit margin?

1.4. Objectives Of The Study

The main objective of the study is to examine the effect of internal control system on the financial performance of commercial banks in Cameroon.

The specific objectives are

1. To examine the effect of internal control on the return on assets
2. To examine the effect of internal control on return on equity

• To examine the effect of internal control on net profit margin

1.5. Research Hypothesis

The research hypothesis of this research stated in null form are; i. Internal control has no significant effect on return on assets

1. Internal control has no significant effect on rate of equity

• Internal control has no significant effect on net profit margin