DOES INTERNAL CONTROL INFLUENCE FINANCIAL PERFORMANCE OF COMMERCIAL BANKS?

EVIDENCE FROM BANGLADESH

Does Internal Control Influence

Financial Performance of Commercial
Banks? Evidence from Bangladesh

Emon Kalyan Chowdhury*

This study intends to measure the impact of internal control on the financial performance of
commercial banks in Bangladesh. Primary data has been collected from senior bankers of
different commercial banks using a structured questionnaire and secondary data has been
collected from the annual reports. Factor analysis was applied to identify the major factors of
internal control variables such as environment, risk management, information and
communication, control activities and monitoring system as prescribed by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) framework and regression
analysis was used to measure the impact of internal control factors on the financial performance
namely return on assets of commercial banks. This study observes that the monitoring system
and the information and communication process have positive impact while the environment,
risk measurement and control activities have negative impact on the financial performance of
commercial banks. It has further been noticed that regulatory authority has less control over
the commercial banks in following the prevailing rules and regulations.
Key Words: Commercial banks, Components of control, COSO framework, Financial
performance, Internal control

INTRODUCTION
The economy of Bangladesh is flying high with more than 7% growth rate in the last
three consecutive years and envying 8.15% in 2019 (“Record GDP growth”, 2019).
This growth is expected to continue if there exists a sound and organized financial
system. Effective allocation of savings in more productive sectors is a prerequisite of
having a sound financial system. The financial sector in Bangladesh is significantly
dominated by banks. After independence in 1971, banking sector started to move
with 6 nationalized commercial banks, 2 state-owned specialized banks and only 3
foreign banks. At present, there are total 57 banks comprising 6 state-owned
* Associate Professor, CIU Business School, Chittagong Independent University (CIU), # 12 Jamal Khan
Road, Chattogram 4000, Bangladesh. E-mail: emonkalyanchy@[Link]

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commercial banks, 2 specialized banks, 40 private commercial banks, and 9 foreign

banks1. Banking sector is playing a vital role in improving the economy of Bangladesh.
The agricultural loan of Bangladesh Krishi Bank has increased from Bangladesh Taka
(BDT) 15.63 billion to BDT 82.15 billion during the last decade. The State-owned
commercial banks, Foreign commercial banks and specialized banks have disbursed
more than BDT 210 billion loan which exceeded the target amount of 175.5 billion
(Khuda, 2019). Banking sector is gradually expanding with increasing number of
financing institutions and different financial products. Although the size is expanding,
the increasing number of scams, malpractices and cyber heists put this promising sector
under unprecedented challenges.
International cyber hacker heisted a whopping BDT 6796 million from the treasury
account of Bangladesh Bank, the central bank of Bangladesh in 2016. An investigation
committee was formed headed by the former governor of Bangladesh Bank Dr.
Farashuddin (“No BB heist”, 2017). Farmers Bank embezzled BDT 5000 million with
the help of 11 different companies during 2013 to 2017. Bangladesh Bank instructed
the Farmers Bank to conduct a functional audit (Uddin, 2018). Janata Bank was
involved in a loan scam of BDT 12300 million during 2013-16. The corrupt company,
Thermax, requested Janata Bank to reschedule their loans and Janata Bank duly sent
the request to the Bangladesh Bank (“Another Janata Bank scam”, 2018). NRB
Commercial Bank did irregularities in sanctioning loan of BDT 7010 million during
2013-16. Bangladesh Bank appointed an observer to restore the discipline and corporate
governance in that bank (Islam, 2017). BASIC Bank Embezzled BDT 45000 million
through fictitious companies and dubious accounts during 2009-2013. Anti-Corruption
Commission sued 120 officials of that bank through 56 cases (Rahman, 2013). Bismillah
Group took loan of BDT 11,740 million from few banks namely Janata Bank, Prime
Bank, Jamuna Bank, Premier Bank and Shahjalal Islami Bank in 2011 in the name of
few fake sister concerns and laundered the money to foreign countries. ACC filed 12
cases against 54 people over this notorious scam (“Bismillah Group Chairman”, 2018).
Apart from these scams, there are many more corruptions that took place throughout
the decades and paralyzed the banking sector due to which people lost their confidence
in the banking system of Bangladesh (Islam, 2020).
To ensure stability and transparency in the banking sector, there have been made
few reforms in the last few years such as maximum number of family member on the
board of directors has been increased from two to four. The tenure of the board members
has been increased to nine years from six years by amending the Bank Companies Act
1991. To protect environment and reduce the social risk management for banks and
financial institutions in Bangladesh, a comprehensive guideline was introduced by
the Bangladesh Bank (Bangladesh Bank, 2017). Bangladesh Bank also released a set

1
[Link]

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 DOES INTERNAL CONTROL INFLUENCE FINANCIAL PERFORMANCE OF COMMERCIAL BANKS?
EVIDENCE FROM BANGLADESH

of code of conducts for both financial and non-financial institutions to contrivance

national integrity strategy in the financial sector of Bangladesh (Habib, 2018).
Bangladesh Bank (2015) introduced guideline on Information and Communication
Technology (ICT) security for banking and non-banking financial institutions to keep
financial environment free from the global macro-financial risks. Bangladesh Bank
enacted “Regulations on Electronic Fund Transfer” and “Guideline on Risk Based
Capital Adequacy for Banks” in 2014. Since, banking sector is one of the lifelines of
Bangladesh economy, the poor performance of this sector will certainly impede the
economic growth of this emerging nation (Chowdhury, 2020). Effective implementation
of internal control system prescribed by COSO will not only eradicate corruption and
frauds from this emerging sector but also ensure transparency of public information
through well-planned control and monitoring of operational and managerial activities.
OVERVIEW ON COSO INTERNAL CONTROL FRAMEWORK
An organization’s management, board of directors and other relevant parties influence
internal control to achieve operational, reporting and compliance centric objectives
(COSO, 2004). Internal control for banks was issued by the BASEL committee on
banking supervision to ensure sound banking operations and financial stability. The
committee instrumented thirteen principles which are broadly divided into five classes
namely Environment, Risk Recognition and Assessment, Control Activities,
Information Communication and Monitoring.
Environment of an organization is controlled by philosophy and operating cycle,
authority and responsibility, organization and development, intention and direction
governed by the top management along with their values and competencies (Hevesi,
2005).
Risk Assessment includes the relevant risk associated with the achievement of
organization’s goal and assessing the basis to reduce the risk level. It entails professional
advices to diminish the adverse situations that increase the risk level. The risk arises
from both internal and external sources. Since, risk is a common phenomenon, risk
assessment is considered as a perpetual activity (Coderre and Police, 2005).
Control includes basic rules, regulations, and policies to keep the managerial and
operational activities within the control level to reduce the risk in achieving the
organization’s goal. Control activities include authorizations, reconciliations,
verifications, approvals, performance review, segregation of duties and responsibilities
and security of assets (Bowling and Rieger, 2005).
Information and Communication include identification, processing and
communicating information to all the concerned persons both at upward and downward
levels of an organization. This system enables people at all levels to stay informed
about any changes at any levels. A sound information and communication system
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ensure that the information is authentic, reliable and disseminated in time to take
appropriate decisions as well as to report externally (Rubino and Vitolla, 2014).
Monitoring activities ensure outstanding performance of internal control. It confirms
that the legal compliances are met and provide reasonable assurance for operational
and reporting activities. It also includes external auditing department along with
internal auditing department (Agbejule and Jokipii, 2009).
Financial performance of an organization indicates the capacity to operate with
efficiency, expected growth rate, profitability and converting the environmental threats
to opportunities. To measure the financial performance, most often Return on Assets
(ROA), Return on Equity (ROE) and Net Interest Margin (NIM) are used. For this
study, ROA has been used to measure the performance of commercial banks in
Bangladesh. ROA is calculated dividing net income by total assets. Higher the value
of ROA, better the performance.
INTERNAL CONTROL AND FINANCIAL PERFORMANCE
There is a significant relation between internal control and financial performance in
achieving organization’s goals (Muraleetharan, 2011). Internal control enhances
efficiency, controls risk of business loss, and increases trustworthiness of financial
statements. Internal control ensures better compliances of laws and regulations
(Ricchiute, 2001). Organizations where internal control is not strong, earn poor return
or even encounter losses and provides a supportive environment for frauds and
corruptions (Doyle and McVay, 2007). In the current business world, agency problem
is a serious concern. Internal control of a bank not only reduces the agency costs, but
also alleviates controversies over financial reporting and scams. Agency problem
enormously shares earnings (Magara, 2013).

LITERATURE REVIEW
Organizations apply internal control to ensure effective operations and quality of
services. Setting clear objective is one of the important tasks of internal control which
in turn helps to achieve organization’s goals (Ejoh and Ejom, 2014). The Capital
adequacy, asset quality, management soundness, earnings and liquidity (CAMEL)
model for banks helps to translate the internal control into reality. The CAMEL ratios
calculate total banking system efficiency and evaluate a bank’s strengths and limitations
to ensure a bank’s stability and soundness (Dang, 2011). CAMEL ensures sound
financial performance of banks. Performance refers to the capacity to work effectively,
profitably, succeed, expand and adapt to opportunities and challenges to the
environment. Return on Equity, Return on Assets, and Net Interest Margin are
commonly used to proxy financial performance measures (Ssuuna, 2011). Several
researchers have conducted work to develop the correlation between internal control
and financial efficiency. Asiligwa and Rennox (2017) published an internal control
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 DOES INTERNAL CONTROL INFLUENCE FINANCIAL PERFORMANCE OF COMMERCIAL BANKS?
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analysis and its contributions to operational performance and effectiveness in Kenya.

They observed that the success of internal control depends on efficiency of internal
audit team. Ayagre, Appiah and Nartey (2014), found that financial efficiency depends
on the well-designed control and monitoring system. Hayali, Dinç, Sarılı, Dizman, and Gündoğdu
Dinç, Sarılı, Dizman, and Gündoğdu (2012) analyzed the value of the banking sector’s internal management
system in Turkey. They noticed that compliance of bank’s internal norms with
international norms result in long-term sustainability of banks. Internal control has
always been proved to be successful in creating a strong platform for efficient financial
performance. Ma and Ma (2011) applied Delphi expert scoring control system to know
the impact of COSO framework on government audit and found that internal control
improves the quality of employees and government reporting systems.
It is very alarming for Bangladesh to see that huge number of banks do not have
governance which ultimately results in irregularities, corruptions and financial scams
(“Banks need to strengthen internal”, 2019). Bangladesh Institute of Bank
Management (BIBM) reported that, in 2018, out of 57 banks, only 22 banks met the
requirements for internal control satisfactorily. State-owned commercial banks in
Bangladesh are still lagging behind to implement 100% automation. Only 72.30%
branches are covered by automation. The banks lack skilled people as well (Hasan,
2019). Apart from the few reports delivered by BIBM in different seminars, there are
no studies found on internal control in banking sector in Bangladesh. The outcome of
this study will help the policymakers, bankers and regulatory authority to know the
current scenario of internal control and its impact on the financial performance of
banks in Bangladesh. It is also expected that the contribution of this paper will enrich
the current literature to a significant extent.

PROBLEM STATEMENT
Although internal control is a blessing for banks, there are many banks, which are not
performing up to the mark. Corruptions, frauds, mis or poor management have always
put the banks under serious crisis time and again. This is a high time to know the
reasons behind the ill-performance of banks despite having established guidelines on
internal control. As there is dearth of sufficient research-based works in this vital
area, the recommendations of this study will greatly benefit the bankers, policymakers
and regulatory authority to utilize internal control system in improving the financial
performance of banks in Bangladesh.

OBJECTIVES OF THE STUDY

The objectives of this study are twofold. First, it will identify the factors that are
helpful to create a supportive environment for effective implementation of internal
control and second, it will measure the impact of COSO recommended internal control
factors on the financial performance of banks.

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DEVELOPMENT OF HYPOTHESES
This study aims to test the following hypotheses
First hypothesis
H01: The control environment and the financial performance do not have positive relation.
Second hypothesis
H02: The risk assessment and the financial performance do not have positive relation.
Third hypothesis
H03: The control activities and the financial performance do not have positive relation.
Fourth hypothesis
H04: The information and communication and the financial performance do not have
positive relation.
Fifth hypothesis
H05: The monitoring and the financial performance do not have positive relation.
Ha (1-5): Alternative hypothesis for each factor is that there is a positive relation.

RESEARCH METHODOLOGY
This is a descriptive cross-sectional research. The participants for this study have
been selected purposively. The reason for selecting this method is to ensure that the
best information is gathered. For this study, a senior banker was selected from a specific
bank who has knowledge and experience on internal control affairs of bank at least
for ten years. Responses of participants have been collected through a structured
questionnaire focusing on five dimensions of COSO prescribed internal control. The
respondents were asked to rank the position of their bank using a five-point Likert
scale. Total 26 responses have been collected. Since, the responses have been taken
only from the senior bankers, the sample size is very small. De Winter, Dodou and
Wieringa (2009) proved that exploratory factor analysis with small sample size gives
satisfactory results. The return on asset data of different banks have been collected
from the annual reports of respective banks. Data consistency and integrity has been
tested using Cronbach’s Alpha coefficient. Since this study uses both primary and
secondary data, it uses qualitative and quantitative methods for data analysis. Factor
analysis has been conducted to reduce the less important factors. Regression analysis
has been used to measure the impact of independent variables namely environment,
risk measurement, information and communication, control activities and monitoring
on the dependent variable known as return on assets by using the following equation:
ROA=  0+ 1 ENV+ 2 RISK+ 3 CONTROL+ 4 INFOCOM+ 5 MONITOR+e
ROA: Return on asset, a proxy for financial performance
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0 : Constant
ENV : Control Environment
RISK : Risk Assessment
CONTROL : Control Activities
INFOCOM : Information and Communication
MONITOR : Monitoring
e : Error Term
 1 to  5 : Measure of sensitivity of variables

FINDINGS AND DISCUSSION

Total 30 bankers were approached for the responses, out of them 26 responded, which
is 86.67%. This response rate is above the satisfactory rate (Babbie, 2002). The reliability
test (Table 1) of Cronbach’s Alpha value (94%) indicates that the data has consistency
and integrity.

Table 1: Reliability Test Result

Cronbach’s Alpha Number of Items
0.940 34

The descriptive data (Table 2) indicates that the mean responses for all the factors
are above 3.5 points.
The correlation matrix (Table 3) shows that the relations among all the variables
are positive except control environment and control activities. The negative correlation
is again very insignificant.
To know the reflection of factors on the internal control in commercial banks,
“Factor Analysis” has been applied. In this study, respondents were asked 34 questions,
all the questions are not of equal weights. Factor analysis helps to extract small number
of factors from multiple variables through a simplified variable structure technique.
Table 4 indicates that, the first eight principal components have eigenvalue greater
than 1.
The cumulative variance contribution rate of these components is 81.47%. The
component matrix (Table 5) shows ranking of factors that play important role to ensure
sound internal control in commercial banks.
The most important factor is the bank’s established risk management mechanism,
followed by separate process, check and evaluation system for controlling activities.
Respondents think, board members and committee members can take decision
independently. Since, most of the banks and their branches are operated through
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 Table 2: Descriptive Data
Descriptive Statistics
N Minimum Maximum Mean Std. Dev.
Monitoring implementation of internal control 26 1.00 5.00 3.9615 1.14824
Junior officers get feedback on operations of internal control 26 1.00 5.00 4.1538 1.00766
Instructions to guide behavior, activities and decision-making process 26 1.00 5.00 3.8846 1.10732
Existence of accounting and financial systems 26 1.00 5.00 4.1538 1.22286
Existence of independent and active audit committee 26 1.00 5.00 3.8077 1.05903
BoDs and committee members are independent 26 1.00 5.00 3.5769 1.06482
Ethical values are given priority in decision making process 26 1.00 5.00 4.0000 1.01980
Parties are committed to competence and integrity 26 1.00 5.00 3.8846 0.86380

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Atmosphere of mutual trust 26 1.00 5.00 3.6923 0.97033

66
Clear stated roles and responsibilities for employees 26 2.00 5.00 3.8462 0.96715

No. 1
Each department has separate objective 26 2.00 5.00 3.7692 0.65163
Spots risks that hampers achievement of objectives 26 2.00 5.00 3.8462 0.73170
Identifies most critical risks 26 2.00 5.00 3.8462 1.04661
Mechanism to neutralize ongoing risks 26 2.00 5.00 3.7308 0.82741
SOUTH ASIAN JOURNAL OF MANAGEMENT

Separate roles 26 2.00 5.00 3.8462 0.88056

Cross checking of works 26 1.00 5.00 3.9231 1.09263
Employees are trained on accounting and financial management systems 26 1.00 5.00 3.9615 1.11286
Corrective actions are taken to address the weaknesses 26 1.00 5.00 3.8846 1.10732
Chart of accounts are well-organized 26 1.00 5.00 4.0000 1.05830
No access to all information without permission 26 1.00 5.00 3.8846 1.10732
Controls to check on incurring expenditure in excess of allocated funds 26 1.00 5.00 4.1154 1.21085
 Table 2 (Cont.)
N Minimum Maximum Mean Std. Dev.
Practice of regular budget reviews and variance analysis 26 1.00 5.00 3.8077 1.02056
Strong securities for systems and assets 26 1.00 5.00 3.6154 1.06120
Financial statements are audited by external auditors regularly 26 1.00 5.00 4.0000 1.01980
Individual responsibilities for coordinating various activities 26 1.00 5.00 3.8462 0.88056
Employees understand the importance of internal control and division 26 1.00 5.00 3.7308 0.96157
of responsibilities
Guidelines and policies of banks are well-communicated 26 2.00 5.00 3.8846 0.99305
Organized reporting systems on bank’s structure and responsibilities 26 2.00 5.00 3.7692 0.65163
Necessary information is communicated in time 26 3.00 5.00 4.0000 0.69282
Timely audit review and resolution for non-compliances 26 2.00 5.00 3.9231 1.05539

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Regular check and evaluation of control activities 26 2.00 5.00 3.7308 0.87442

67
Monitoring improves the quality of performance 26 2.00 5.00 4.0000 0.93808
Regular review of internal control to enhance effectiveness 26 1.00 5.00 3.8462 1.00766

No. 1
Internal control is monitored by management 26 1.00 5.00 3.9231 1.05539
Valid N (listwise) 26
EVIDENCE FROM BANGLADESH

Table 3: Correlation Matrix

ENV RISK CONTROL INFOCOM MONITOR ROA
ENV 1.00
RISK 0.787** 1.00
CONTROL –0.020 0.230 1.00
INFOCOM 0.120 0.050 0.694** 1.00
*
MONITOR 0.439 0.330 0.417* 0.502** 1.00
* * **
ROA 0.415 0.310 0.404 0.497 0.994** 1.00
DOES INTERNAL CONTROL INFLUENCE FINANCIAL PERFORMANCE OF COMMERCIAL BANKS?

Note: Correlation is significant at the 1% (**) and 5% (*).

 Table 4: Total Variance Explained
Initial Eigenvalues Extraction Sums of Squared Loadings Rotation Sums of Squared Loadings
Component % of Cumulative % of Cumulative % of Cumulative
Total Total Total
Variance % Variance % Variance %
1 12.576 36.987 36.987 12.576 36.987 36.987 4.502 13.242 13.242
2 3.380 9.940 46.927 3.380 9.940 46.927 4.156 12.223 25.465
3 2.773 8.157 55.084 2.773 8.157 55.084 4.068 11.964 37.429
4 2.573 7.567 62.651 2.573 7.567 62.651 3.505 10.308 47.737
5 1.841 5.413 68.064 1.841 5.413 68.064 3.349 9.849 57.586
6 1.706 5.017 73.081 1.706 5.017 73.081 3.040 8.940 66.526

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7 1.574 4.630 77.711 1.574 4.630 77.711 2.858 8.406 74.932

68
8 1.280 3.765 81.475 1.280 3.765 81.475 2.225 6.544 81.475

No. 1
9 0.975 2.866 84.342
10 0.816 2.400 86.742
11 0.713 2.096 88.838
12 0.620 1.825 90.663
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13 0.589 1.733 92.396

14 0.554 1.630 94.027
15 0.399 1.173 95.199
16 0.369 1.084 96.284
17 0.306 0.901 97.185
18 0.287 0.845 98.030
19 0.196 0.577 98.607
 Table 4 (Cont.)

Initial Eigenvalues Extraction Sums of Squared Loadings Rotation Sums of Squared Loadings
Component
% of Cumulative % of Cumulative % of Cumulative
Total Total Total
Variance % Variance % Variance %

20 0.156 0.459 99.067

21 0.113 0.334 99.400
22 0.086 0.253 99.653
23 0.060 0.176 99.829
24 0.037 0.109 99.939

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25 0.021 0.061 100.000

69
26 0.000 0.000 100.000

No. 1
27 0.000 0.000 100.000
28 0.000 0.000 100.000
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29 0.000 0.000 100.000

30 0.000 0.000 100.000
31 0.000 0.000 100.000
32 0.000 0.000 100.000
33 0.000 0.000 100.000
34 0.000 0.000 100.000
DOES INTERNAL CONTROL INFLUENCE FINANCIAL PERFORMANCE OF COMMERCIAL BANKS?

Note: Extraction Method: Principal Component Analysis.

 Table 5: Component Matrix
Component
1 2 3 4 5 6 7 8
Mechanism to neutralize ongoing risks 0.799 0.108 0.209 –0.323 0.252
Regular check and evaluation of control activities 0.790 –0.124 –0.167 –0.253 0.190
BoDs and committee members are independent 0.780 –0.178 0.202 0.139
Strong securities for systems and assets 0.772 0.111 –0.253 –0.106 0.109
Atmosphere of mutual trust 0.752 0.496 –0.143
Employees understand the importance of internal control 0.749 0.146 0.386 –0.202
and division of responsibilities
Necessary information is communicated in time 0.738 –0.107 0.477 –0.186

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Cross checking of works 0.705 –0.434 0.134 0.166 0.117 0.199

70
Parties are committed to competence and integrity 0.699 0.187 0.488 –0.218

No. 1
Spots risks that hampers achievement of objectives 0.696 –0.370 –0.300 0.247 –0.215
Individual responsibilities for coordinating various activities 0.692 –0.126 0.551 0.115
Organized reporting systems on bank’s structure and responsibilities 0.646 –0.284 –0.409 –0.138 0.330 –0.216
Each department has separate objective 0.637 0.122 –0.465 0.366 –0.144 0.156
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Separate roles 0.633 –0.155 –0.172 –0.590 0.112 0.181 0.157

Timely audit review and resolution for non–compliances 0.630 –0.251 –0.470 0.195 0.146 0.246
Identifies most critical risks 0.621 0.180 0.278 –0.415 –0.253 0.246
Existence of independent and active audit committee 0.619 0.464 –0.292 –0.196 0.164 .149 –0.104
Practice of regular budget reviews and variance analysis 0.614 –0.567 –0.107 –0.213 0.153 0.330
Junior officers get feedback on operations of internal control 0.605 0.313 –0.275 0.247 –0.289 –0.385
Chart of accounts are well-organized 0.573 0.140 –0.222 0.419 –0.121 –0.426
 Table 5 (Cont.)
Component
1 2 3 4 5 6 7 8
Guidelines and policies of banks are well-communicated 0.568 –0.307 0.150 0.345 –0.231 –0.265 0.273
Clear stated roles and responsibilities for employees 0.560 0.336 –0.186 –0.409 0.347 –0.114
Ethical values are given priority in decision making process 0.558 0.258 –0.557 –0.474
Financial statements are audited by external auditors regularly 0.555 –0.534 0.233 0.204 –0.297 0.118 –0.206

Instructions to guide behavior, activities and 0.418 0.340 –0.377 –0.415 0.371 0.197 0.120
decision-making process

Existence of accounting and financial systems 0.441 0.647 –0.375 –0.139 0.276

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Controls to check on incurring expenditure in excess 0.426 –0.629 0.414 –0.136 0.213

71
of allocated funds

No. 1
Monitoring improves the quality of performance 0.337 0.564 0.170 0.123 0.463 0.385 0.141
No access to all information without permission 0.424 –0.524 –0.193 –0.334 0.415 0.263
EVIDENCE FROM BANGLADESH

Corrective actions are taken to address the weaknesses 0.462 0.474 0.242 –0.221 –0.341 –0.160 0.169
Monitoring implementation of internal control 0.445 –0.450 –0.253 0.178 0.295 –0.348 –0.212

Employees are trained on accounting and financial 0.511 0.203 0.135 0.245 –0.569 –0.157 –0.154
management systems
Internal control is monitored by management 0.380 0.114 0.475 0.423 0.144 0.137 0.537
Regular review of internal control to enhance effectiveness 0.334 0.312 0.437 0.427 0.219 0.442
Note: Extraction Method: Principal Component Analysis.
a. 8 components extracted.
DOES INTERNAL CONTROL INFLUENCE FINANCIAL PERFORMANCE OF COMMERCIAL BANKS?
 SOUTH ASIAN JOURNAL OF MANAGEMENT

online, strong security system for transactions and asset management of banks is another
vital factor. Bankers feel secured to work with colleagues in a very congenial
environment. Department heads discharge their responsibility with utmost trust and
reliability which is reflected in their transparent reporting systems. Bankers work in
their respective departments with specific known goals and objectives as they are
aware of their roles and responsibilities. Banks take necessary measures to ensure
compliances of different rules and regulations of law enforcing authorities. Most of
the banks have independent and active audit committee with clear objectives.
Although, senior members of internal control unit orally orient junior members regarding
their overall objectives, process and duties, unfortunately, there is a lack of necessary
training system for the junior bankers. Top management and board members do not
monitor the activities of internal control unit closely as a result, internal review of
implementation of the unit is very poor. Respondents believe, the financial statements
of banks are moderately verified by the external auditors. The information
communication culture of banks is not satisfactory, as a result, it creates scope for
financial scams and corruptions.
REGRESSION ANALYSIS
To measure the impact of control environment, risk measurement, information and
communication, control activities and monitoring on the financial performance of
commercial banks, multiple regression model has been applied.
Since, internal control is influenced by the five major factors and all the factors
have been incorporated in the questionnaire, the R-square value (99%) indicates
that independent variables can highly explain the influence on the financial
performance while very insignificant (1%) portion is explained by such variables which
have not been considered and it has been named as error term (Table 6).

Table 6: Model Summary

Model R R-Square Adjusted R-Square Std. Error of the Estimate
1 0.995 0.990 0.987 0.01802

The analysis of variance (Table 7) exhibits that the value of F is significant at 95%
level of confidence. The result indicates that financial performance is directly
influenced by independent variables.

Table 7: Analysis of Variance

Model Sum of Squares df Mean Square F Sig.
Regression 0.630 5 0.126 388.217 0.000
Residual 0.006 20 0.000
Total 0.637 25

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Table 8: Test for Coefficient

Standardized
Unstandardized Coefficients
Coefficients t Sig.
B Std. Error Beta
(Constant) –0.823 0.029 –28.562 0.000
ENV –0.016 0.027 –0.030 –0.601 0.555
RISK –0.001 0.031 –0.002 –0.046 0.964
CONTROL –0.014 0.025 –0.024 –0.558 0.583
INFOCOM 0.005 0.026 0.007 0.180 0.859
MONITOR 0.849 0.025 1.015 33.778 0.000

The test of coefficient (Table 8) depicts that control environment, risk measurement
and control activities have negative impact while information and communication
and monitoring have positive impact on the financial performance of the banks. Though
monitoring has significant impact, rest of the variables have insignificant impact. If
banks initiate any measures to control environment, reduce risk and ensure control
activities, it lowers the profitability while, actions to enhance information and
communication activities and monitoring measures increase the profitability. Therefore,
the first, second and third hypotheses are accepted and the fourth and fifth hypotheses
are rejected.
In light with the above findings, it is observed that commercial banks in Bangladesh,
are not interested to invest in internal control to strengthen their capacity. The moderate
influence of external audits indicates that banks are reluctant to improve their inefficient
audit system. Since majority of banks do not disclose their financial information with
utmost transparency, it increases the risk of operations and in turn, it negatively
influences the financial performance. This result is also similar to the findings of BIBM.
They found that the internal control and financial performance are positively correlated.
Twenty percent of banks confess that any negligence in internal control results in
reduction of profitability. It is found that an individual officer audits four departments
while, less than 800 people in central bank supervise more than 12,000 bank branches
in whole Bangladesh (“Banks need to strengthen internal control”, 2019).
Commercial banks are the lifeline of emerging economy in Bangladesh. The
sustainability of banks will ensure constant growth of economy. Sound internal control
plays vital role in ensuring the sustainability of banks. As mentioned earlier, people
lost their trust on banking system for absence of proper internal control, central bank
needs to revise the guidelines on internal control and compliance and to enforce
them strictly to get the lost confidence of public back. Moreover, central bank needs
to increase the man-power to ensure regular and strict monitoring on the scheduled
banks. Commercial banks should take prior approval from the central bank before
sanctioning any big amount loan and the central bank should conduct a comprehensive
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investigation to know whether the bank has strictly followed the due process or not
before giving such approval. Last but not least, to ensure a workable, ethical, disciplined
and inclusive internal control in the banks, both central bank and the commercial
banks need to work together with extreme harmony.

CONCLUSION
This study reveals that, internal control of commercial banks may be improved if both
central bank and commercial banks work together to address the identified factors.
Current status of internal control in banks is better than any time, but further
improvement is required to eradicate the prevailing anomalies, corruptions and frauds
in this emerging sector. For this study, primary data has been collected through a
structured questionnaire from 26 senior bankers using COSO prescribed mechanism.
The research outcomes truly reflect the current scenario of internal control in
commercial banks. Factor analysis has been conducted to find out more prominent
factors that are responsible for current state of banks’ internal control. Regression
analysis has been applied to measure the impact of control environment, risk, control
system, information and communication, and monitoring system on the financial
performance of commercial banks. Monitoring and information and communication
have positive impact on the financial performance while environment, risk and control
activities have negative impact. Although only monitoring has significant impact,
other variables have insignificant impact on the performance of banks. This research
considered only 26 banks to perform the financial performance of commercial banks.
In future, researchers may consider more banks for better representation.

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