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| Chapters: 1-5
| Pages: 76
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
The Nigerian Banking Sector has become a soft target for fraudsters (internal and external) who have been getting away with colossal amounts of cash daily, weekly, monthly, quarterly and annually. Most corporate financial institutions in Nigeria are subject to fraud risks. Large frauds have led to the downfall of most financial institutions, massive investment losses, significant legal costs, incarceration of key individuals, and erosion of confidence in capital markets. Publicized fraudulent behaviour by key executives has negatively impacted the reputations, brands, and images of many organizations around the globe. According to PKF Report (2015), The Financial Cost of Fraud, the real financial cost of fraud and error average losses were 5.47% of expenditure. Also according to the Association of Certified Fraud Examiners (ACFE) (2014), annual fraud survey report, typical organization loses 5 % of its revenue to fraud each year. The Banking and Financial Services sector had the highest number of fraud cases analyzed at 17.8%. Fraud results in financial losses to the Banks and their customers. Shareholders’ funds are eroded and this depletes the capital base of the bank. The end result is bankruptcy and the loss of confidence in the banking sector as a whole (Okaro, 2014). Fraud risk management refers to activities aimed a risks arising from the actual and potential cases of corporate fraud. It includes prevention, detection and response. Fraud detection includes those activities designed to pick up potential rising of a red flag or a subsequent review such as the use of data analytic technique (KPMG, 2010).
Schmalleger (1991) says, “More money has been stolen at the point of a pen - than at the point of a gun”1 which directly shows the seriousness of corporate fraud. Fraud has become a challenge to the business organisations in today’s dynamic environment. Globalisation has induced intense competition among the business houses that are fighting for profits and market share. Stock prices are considered as benchmark of the corporate performance which drive the managers to panic and resort to unwanted intentional acts leading to fraud. Standard on Auditing (SA 240)2 defines fraud as, “an intentional act by one or more individual among management, those charged with governance, employees and third parties, involving the use of deception to obtain an unjust and illegal advantage.” Fraud is a willful act to obtain money, property or any other advantages that recipient otherwise is not lawfully authorised to own.
Corporate fraud is committed for or against business firm by fraudsters (Singleton & Singleton, 2010). Generally, fraud and error are mistaken as similar terms and used interchangeably. However, both the words have different connotation. Fraud is a deliberate act while an error occurs unintentionally. Golden et al. (2006) stated four elements necessary for a fraudulent act:
False statement of material nature. Knowledge to fraudster of the false statement. Victims belief on false statement. Results in financial damage Association of Certified Fraud Examiners (ACFE, 2014) classified fraud as asset misappropriation, corruption and financial misstatement. Conversely, Statement of Auditing Standard3 (SAS) and Standard on Auditing used two corporate fraud categories namely asset misappropriation and financial statement fraud4 . Assets misappropriation (also called employee fraud) relates with theft or misuse of company’s assets and takes place against organisation while financial statement fraud (management fraud) is intentional material misstatement through revenue manipulation, concealed liabilities and improper disclosure which is ultimately committed for the benefit of the organisation. Razaee (2005) acronym financial statement fraud with CRIME i.e. C for Cooks, R for Recipes, I for Incentives, M for monitoring, E for End result. Direct control of management over financial statements makes financial statement fraud difficult to detect.
Fraud has turned out to be a serious threat to the sustainability of organizations globally (ACFE, 2016). This is because fraud negatively affects the profitability, economic growth and social welfare of the firms (Simbolon, Ahmed & Elviani, 2018). For instance the 2007 to 2009 global financial crisis was caused by a wide range of fraud activities in the mortgage industry through conspiration between mortgage originators, the securities issuers and underwriters (Fligstein & Roehrkasse, 2016). The conspirators were identified, prosecuted and ended up paying multibillion-dollar penalties (Fligstein & Roehrkasse, 2016). Fraud refers to the deliberate misrepresentation of the truth with an aim of deceiving a particular entity or person for unfair wrongful gain at their own expense (Kingsley, 2015). According to ACFE (2018) based on 2690 fraud cases that have been experienced by numerous organizations in 125 countries, a total sum of $7 billion has been lost. It was revealde that asset misappropriation was actually a conventional type of fraud scheme that is perpetuated all over the world (ACFE, 2018). This type of fraud consitutes 89% of the fraud cases, though it was established that it is not very costly when compared to other forms of fraud since every fraud case accounts for $114,000 (ACFE, 2018). On the other hand, the most costly type of fraud scheme was estabilished to be the financial statement fraud accounting for $800,000 per fraud case, though rarely perpetuated (10% of the fraud cases) when compared to other forms of fraud (ACFE, 2018). On the other hand, based on survey conducted by PwC (2020) it was noted that the most common fraud scheme perpetrated were bribery & corruption, procurement fraud, asset miasppropriation and customer fraud. In Kenya, the fraud menace has led to the collapse of big firms listed at the NSE such as Imperial Bank, Uchumi supermarket, National Bank, Kenya Airways and Mumias Sugar (Mpiana, 2017). One of the key factors leading to fraud to thrive is lack of sufficient or weak anti-fraud control systems (ACFE, 2018; Deloitte, 2018). This is besides other factors such as perceived pressure, rationalization and capacity to commit fraud (Cressy, 1953; Wolfe & Hermanson, 2004). Girgenti and Hedley (2011) contended that fraud could only be effectively managed by preventive, detective and corrective measures. When fraud is effectively controlled by the preventive and detective measures, it can consequently boost the firm’s financial performance especially in the context of Kenyan commercial banks. When fraud is effectively controlled by the preventive and detective controls then the financial performance of a particular organization will be boosted especially in the context of Kenyan commercial banks (Ohando, 2015). However, the study will examine a corporate fraud risk: an insight from the Nigerian Financial Institution (A study of some selected micro-finance banks in Nigeria)
1.2 Statement of the Problem
Fraud is a universal problem as no nation is free from it; though developing countries and their various states suffer it more. The corrupt and fraudulent events witnessed daily across the nation have continued to betray every good intention and selfless effort made by true patriotic Nigerians toward restoring economic glory of Nigeria as was in the 80’s when the United States Dollar had unreserved respect for the Naira in the international market (Okoye, 2016). The incidences and magnitude of fraud are increasing (Okoye & Gbegi, 2013). The above view was collaborated by Modugu and Anyaduba (2013), Gbegi and Adebisi (2014), and Okoye and Akamobi (2009). Imoniana, Antunes and Formigoni (2013) did not only acknowledge the endemic and escalating nature of fraud but re-echoed the description by KPMG (2009) that described fraud as an industry not just for fraudsters; academics study it, Investigators investigate it, lawyers litigate on it, and conference goers debate on it. However, the industry is built on managing the consequences of fraud rather than on preventing fraud. What a shabby and shallow foundation!
Owolabi (2010) disclosed that Dictionary of Economics and Commerce revealed that 200 banks failed in England between 1815 and 1850; a period of 35 years. Among the reasons attributable to that was fraud. Nwankwo in Uchenna and Agbo (2013) traced the history of bank failure in Nigeria to 1930s which brought about crisis of confidence in Nigerian banking industry when all indigenous banks collapsed except one- the National Bank. Similar incidence repeated during the banking ‘boom and crash’ of the late 40’s when all but four indigenous banks were liquidated. Furthermore, between 1952 and 1954 16 out of 21 indigenous banks failed. Also, in late 1990s, 26 failed banks were liquidated while others were restructured, acquired or sold outright. In all these periods, Nwankwo (2005) asserted that fraud played a prominent role.
These bank failures led to significant financial loss to depositors, loss of confidence by the banking public, and cast doubt on the ability of Nigerians in managing banking business as the primary objective of banking-safe keeping of money seemed threatened. Government in reaction to these developments set up the Paton Commission of Inquiry in 1948 with the outcome leading to first banking regulation in 1952 and establishment of CBN in 1958. The bank reform of 1986 (Structural Adjustment Programme, SAP) lead to proliferation of banks and boom till late 1990’s (Olukotun, et al, 2013). In 2005, there was another reform in Nigerian banking sector to avert imminent collapse. The 2005 reform was characterized largely by mergers and acquisitions of many banks to the extent that only 25 banks emerged out of 89 after the exercise.
Notwithstanding the above measures, the threat of fraud has continued. For instance, according to Nigerian Deposit Insurance Corporation (NDIC) annual report, (2010), 1,532 cases of fraud were reported involving 21.29 billion naira with expected actual loss of 11.69 billion naira. Also, in 2011, 2,352 cases of fraud were reported involving 28.4 billion naira with expected actual loss of 4.071 billion naira. This represents a 53.5 percent increase. In 2014, there were 10,612 reported cases of fraud as against 3,786 in 2013 with involvement of 25.61 billion naira and 21.80 billion naira respectively. This represents about 17.5 percent increase in amount involved. The expected actual loss for 2014 was 6.19 billion naira as against 5.76 billion naira in 2013, representing an increase of about 7.5 percent. In 2009, Central Bank of Nigeria while employing the services of Forensic Accountants in five commercial banks, uncovered fraud. As a result, the Chief Executive Officer of Oceanic Bank was prosecuted by Economic and Financial Crimes Commission (EFCC) and was sentenced by the court on conviction to 18 months in prison (Dada, Owolabi & Okwu, 2013). It has been observed that reported cases of bank fraud have been on the increase, but its impact on the Nigerian banking sector is of great concern (NDIC report, 2015).
There has been studies on the impact of fraud on Nigerian banks by scholars like Kanu and Okoroafor (2013), Aruomoaghe and Ikyume (2013), Owolabi (2010), Uche and Agbo (2013), Ikpefan (2006) and Odi (2013). While most of them looked at it from the number and classes of staff involved, others were looked at the relationship of the fraud with dividend, credit mobilization and so on. With respect to credit mobilization, Kanu and Okoroafor (2013) and Ikpefan (2006) discovered significant relationship between bank deposit and fraud while Uche and Agbo (2013) found that the percentage of mobilized fund lost to fraud was high between 2001-2006 but reduced between 2006-2011. Odi (2013) and Ademoye (2012) on their study of the impact of fraud on bank performance found devastating impact of fraud on bank performance with Inaya and Isito (2016) have gone ahead to find that fraud have negative social impact on fraud. On bank staff involvement on fraud, Owolabi (2010) discovered that bank executives were involved in over 70 percent of the frauds in bank while the study by Idolor’s (2010) revealed that bank staff do not see un-official borrowing and foreign exchange malpractices as a form of bank fraud. In view of the above studies, we want to look at the impact of fraud on bank profit, its assets and liabilities
Hence, this study is conducted to investigate the corporate fraud risk: an insight from the Nigerian Financial Institution (A study of some selected micro finance banks in Nigeria)
INTRODUCTION
1.1 Background of the Study
The Nigerian Banking Sector has become a soft target for fraudsters (internal and external) who have been getting away with colossal amounts of cash daily, weekly, monthly, quarterly and annually. Most corporate financial institutions in Nigeria are subject to fraud risks. Large frauds have led to the downfall of most financial institutions, massive investment losses, significant legal costs, incarceration of key individuals, and erosion of confidence in capital markets. Publicized fraudulent behaviour by key executives has negatively impacted the reputations, brands, and images of many organizations around the globe. According to PKF Report (2015), The Financial Cost of Fraud, the real financial cost of fraud and error average losses were 5.47% of expenditure. Also according to the Association of Certified Fraud Examiners (ACFE) (2014), annual fraud survey report, typical organization loses 5 % of its revenue to fraud each year. The Banking and Financial Services sector had the highest number of fraud cases analyzed at 17.8%. Fraud results in financial losses to the Banks and their customers. Shareholders’ funds are eroded and this depletes the capital base of the bank. The end result is bankruptcy and the loss of confidence in the banking sector as a whole (Okaro, 2014). Fraud risk management refers to activities aimed a risks arising from the actual and potential cases of corporate fraud. It includes prevention, detection and response. Fraud detection includes those activities designed to pick up potential rising of a red flag or a subsequent review such as the use of data analytic technique (KPMG, 2010).
Schmalleger (1991) says, “More money has been stolen at the point of a pen - than at the point of a gun”1 which directly shows the seriousness of corporate fraud. Fraud has become a challenge to the business organisations in today’s dynamic environment. Globalisation has induced intense competition among the business houses that are fighting for profits and market share. Stock prices are considered as benchmark of the corporate performance which drive the managers to panic and resort to unwanted intentional acts leading to fraud. Standard on Auditing (SA 240)2 defines fraud as, “an intentional act by one or more individual among management, those charged with governance, employees and third parties, involving the use of deception to obtain an unjust and illegal advantage.” Fraud is a willful act to obtain money, property or any other advantages that recipient otherwise is not lawfully authorised to own.
Corporate fraud is committed for or against business firm by fraudsters (Singleton & Singleton, 2010). Generally, fraud and error are mistaken as similar terms and used interchangeably. However, both the words have different connotation. Fraud is a deliberate act while an error occurs unintentionally. Golden et al. (2006) stated four elements necessary for a fraudulent act:
False statement of material nature. Knowledge to fraudster of the false statement. Victims belief on false statement. Results in financial damage Association of Certified Fraud Examiners (ACFE, 2014) classified fraud as asset misappropriation, corruption and financial misstatement. Conversely, Statement of Auditing Standard3 (SAS) and Standard on Auditing used two corporate fraud categories namely asset misappropriation and financial statement fraud4 . Assets misappropriation (also called employee fraud) relates with theft or misuse of company’s assets and takes place against organisation while financial statement fraud (management fraud) is intentional material misstatement through revenue manipulation, concealed liabilities and improper disclosure which is ultimately committed for the benefit of the organisation. Razaee (2005) acronym financial statement fraud with CRIME i.e. C for Cooks, R for Recipes, I for Incentives, M for monitoring, E for End result. Direct control of management over financial statements makes financial statement fraud difficult to detect.
Fraud has turned out to be a serious threat to the sustainability of organizations globally (ACFE, 2016). This is because fraud negatively affects the profitability, economic growth and social welfare of the firms (Simbolon, Ahmed & Elviani, 2018). For instance the 2007 to 2009 global financial crisis was caused by a wide range of fraud activities in the mortgage industry through conspiration between mortgage originators, the securities issuers and underwriters (Fligstein & Roehrkasse, 2016). The conspirators were identified, prosecuted and ended up paying multibillion-dollar penalties (Fligstein & Roehrkasse, 2016). Fraud refers to the deliberate misrepresentation of the truth with an aim of deceiving a particular entity or person for unfair wrongful gain at their own expense (Kingsley, 2015). According to ACFE (2018) based on 2690 fraud cases that have been experienced by numerous organizations in 125 countries, a total sum of $7 billion has been lost. It was revealde that asset misappropriation was actually a conventional type of fraud scheme that is perpetuated all over the world (ACFE, 2018). This type of fraud consitutes 89% of the fraud cases, though it was established that it is not very costly when compared to other forms of fraud since every fraud case accounts for $114,000 (ACFE, 2018). On the other hand, the most costly type of fraud scheme was estabilished to be the financial statement fraud accounting for $800,000 per fraud case, though rarely perpetuated (10% of the fraud cases) when compared to other forms of fraud (ACFE, 2018). On the other hand, based on survey conducted by PwC (2020) it was noted that the most common fraud scheme perpetrated were bribery & corruption, procurement fraud, asset miasppropriation and customer fraud. In Kenya, the fraud menace has led to the collapse of big firms listed at the NSE such as Imperial Bank, Uchumi supermarket, National Bank, Kenya Airways and Mumias Sugar (Mpiana, 2017). One of the key factors leading to fraud to thrive is lack of sufficient or weak anti-fraud control systems (ACFE, 2018; Deloitte, 2018). This is besides other factors such as perceived pressure, rationalization and capacity to commit fraud (Cressy, 1953; Wolfe & Hermanson, 2004). Girgenti and Hedley (2011) contended that fraud could only be effectively managed by preventive, detective and corrective measures. When fraud is effectively controlled by the preventive and detective measures, it can consequently boost the firm’s financial performance especially in the context of Kenyan commercial banks. When fraud is effectively controlled by the preventive and detective controls then the financial performance of a particular organization will be boosted especially in the context of Kenyan commercial banks (Ohando, 2015). However, the study will examine a corporate fraud risk: an insight from the Nigerian Financial Institution (A study of some selected micro-finance banks in Nigeria)
1.2 Statement of the Problem
Fraud is a universal problem as no nation is free from it; though developing countries and their various states suffer it more. The corrupt and fraudulent events witnessed daily across the nation have continued to betray every good intention and selfless effort made by true patriotic Nigerians toward restoring economic glory of Nigeria as was in the 80’s when the United States Dollar had unreserved respect for the Naira in the international market (Okoye, 2016). The incidences and magnitude of fraud are increasing (Okoye & Gbegi, 2013). The above view was collaborated by Modugu and Anyaduba (2013), Gbegi and Adebisi (2014), and Okoye and Akamobi (2009). Imoniana, Antunes and Formigoni (2013) did not only acknowledge the endemic and escalating nature of fraud but re-echoed the description by KPMG (2009) that described fraud as an industry not just for fraudsters; academics study it, Investigators investigate it, lawyers litigate on it, and conference goers debate on it. However, the industry is built on managing the consequences of fraud rather than on preventing fraud. What a shabby and shallow foundation!
Owolabi (2010) disclosed that Dictionary of Economics and Commerce revealed that 200 banks failed in England between 1815 and 1850; a period of 35 years. Among the reasons attributable to that was fraud. Nwankwo in Uchenna and Agbo (2013) traced the history of bank failure in Nigeria to 1930s which brought about crisis of confidence in Nigerian banking industry when all indigenous banks collapsed except one- the National Bank. Similar incidence repeated during the banking ‘boom and crash’ of the late 40’s when all but four indigenous banks were liquidated. Furthermore, between 1952 and 1954 16 out of 21 indigenous banks failed. Also, in late 1990s, 26 failed banks were liquidated while others were restructured, acquired or sold outright. In all these periods, Nwankwo (2005) asserted that fraud played a prominent role.
These bank failures led to significant financial loss to depositors, loss of confidence by the banking public, and cast doubt on the ability of Nigerians in managing banking business as the primary objective of banking-safe keeping of money seemed threatened. Government in reaction to these developments set up the Paton Commission of Inquiry in 1948 with the outcome leading to first banking regulation in 1952 and establishment of CBN in 1958. The bank reform of 1986 (Structural Adjustment Programme, SAP) lead to proliferation of banks and boom till late 1990’s (Olukotun, et al, 2013). In 2005, there was another reform in Nigerian banking sector to avert imminent collapse. The 2005 reform was characterized largely by mergers and acquisitions of many banks to the extent that only 25 banks emerged out of 89 after the exercise.
Notwithstanding the above measures, the threat of fraud has continued. For instance, according to Nigerian Deposit Insurance Corporation (NDIC) annual report, (2010), 1,532 cases of fraud were reported involving 21.29 billion naira with expected actual loss of 11.69 billion naira. Also, in 2011, 2,352 cases of fraud were reported involving 28.4 billion naira with expected actual loss of 4.071 billion naira. This represents a 53.5 percent increase. In 2014, there were 10,612 reported cases of fraud as against 3,786 in 2013 with involvement of 25.61 billion naira and 21.80 billion naira respectively. This represents about 17.5 percent increase in amount involved. The expected actual loss for 2014 was 6.19 billion naira as against 5.76 billion naira in 2013, representing an increase of about 7.5 percent. In 2009, Central Bank of Nigeria while employing the services of Forensic Accountants in five commercial banks, uncovered fraud. As a result, the Chief Executive Officer of Oceanic Bank was prosecuted by Economic and Financial Crimes Commission (EFCC) and was sentenced by the court on conviction to 18 months in prison (Dada, Owolabi & Okwu, 2013). It has been observed that reported cases of bank fraud have been on the increase, but its impact on the Nigerian banking sector is of great concern (NDIC report, 2015).
There has been studies on the impact of fraud on Nigerian banks by scholars like Kanu and Okoroafor (2013), Aruomoaghe and Ikyume (2013), Owolabi (2010), Uche and Agbo (2013), Ikpefan (2006) and Odi (2013). While most of them looked at it from the number and classes of staff involved, others were looked at the relationship of the fraud with dividend, credit mobilization and so on. With respect to credit mobilization, Kanu and Okoroafor (2013) and Ikpefan (2006) discovered significant relationship between bank deposit and fraud while Uche and Agbo (2013) found that the percentage of mobilized fund lost to fraud was high between 2001-2006 but reduced between 2006-2011. Odi (2013) and Ademoye (2012) on their study of the impact of fraud on bank performance found devastating impact of fraud on bank performance with Inaya and Isito (2016) have gone ahead to find that fraud have negative social impact on fraud. On bank staff involvement on fraud, Owolabi (2010) discovered that bank executives were involved in over 70 percent of the frauds in bank while the study by Idolor’s (2010) revealed that bank staff do not see un-official borrowing and foreign exchange malpractices as a form of bank fraud. In view of the above studies, we want to look at the impact of fraud on bank profit, its assets and liabilities
Hence, this study is conducted to investigate the corporate fraud risk: an insight from the Nigerian Financial Institution (A study of some selected micro finance banks in Nigeria)
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