Abstract

Almost all microfinance institutions must now maintain efficient internal control systems due to current business developments. Over the last few decades, internal control has sparked heated discussion and scholarly interest across sectors in the control environment and activities, information and communication, accounting, and auditing literature. This study had as prime objective to assess ‘the impact of internal control systems on the performance of microfinance institutions in Fako.

The study specifically examines the impact of control environment, risk assessment, control activities, information and communication and monitoring in the performance of microfinance institutions. The research was conducted using a quantitative approach, using survey, regression analysis and descriptive survey as research designs. Data was collected using questionnaires administered to 45 personnel of microfinance institutions in Fakoselected using a convenience random sample technique.

Data was analyzed using the descriptive and inferential tools where conclusions were drawn from tables and figures. The study findings revealed that components of internal controls such as risk assessment, control activities, information and communication and monitoring, only the control environment had a significant effect on the performance of microfinance institutions in Fako.

The study concluded that internal controls have positive effects on the performance of microfinance institutions in Cameroon and especially in the South West Region of Fako-Division. It was recommended that adequate organizational controls remolded and strengthened, adequate training of workers in the accounting section, clear organizational targets and budgets.

CHAPTER ONE

INTRODUCTION

1.1 Background of the study

The growth and expansion of Microfinance Institutions (MFIs) in terms of the services and products they offer has necessitated the adoption of an effective risk management framework. Nevertheless, the internal risk management systems of MFIs are often a step or two behind the scale and scope of their activities (Microfinance Network, 2000). Strong internal capacities to identify and anticipate potential risks to avoid unexpected losses and surprises have been necessitated by the growth experienced by most MFIs.

The spurring growth of MFIs in our economy and the world over is evidence of their increasing importance, and the demand for their products and services. This increasing demand for the services of MFIs is backed by the large mass of poor and low-income people who need and want a range of financial products and services to build income and wealth, smooth expenditure patterns, and reduce risk (African Development Bank [ABD] & African Development Fund [ADF], 2006).

These MFIs are spread across the country offering diverse products and services to the average Cameroonian including deposits, loans, payment services, leasing, money and remittance transfers, pensions, and insurance. They are constantly penetrating the financial markets especially in the rural areas offering less stringent loan policies and conditions; a move which is believed will facilitate the attainment of Millennium Development Goals (MDGs) as access to financial services for all people underpins the attainment of the MDGs (ADB & ADF, 2006).

However, the operations of a microfinance institution just like any other organization continuously expose it to a wide range risks. This includes liquidity risk, credit risk, transaction risk, fraud risk, market risk, legal and compliance risk and governance risks. More so, the changing nature of the environment in which microfinance institutions operate exposes them to new risks thus making it necessary for them to adopt more sophisticated risk management tools. (Microfinance Network, 2000).

Furthermore, the findings of the Tread way Commission Report of 1987 in the United States (USA) confirmed that the absence of internal controls or the presence of weak internal controls is the primary cause of many cases of fraudulent company financial reporting. The widespread global corporate accounting scandals in recent years inform this study.

Internationally, the collapse of Barings Bank and Yamaichi Securities further focused the financial sector’s attention on risk management and internal control (Bishop, 1991). The Basle Committee analyzed the problems related to these losses and concluded that they probably could have been avoided if the banks had maintained effective internal control systems (Basoln, 2002). In addition, 38 active British businesses went into liquidation in the third quarter of 1992 and in 1991 a total of 21,827 businesses failed compared to 15,051 in 1990, majorly because of weak Internal control systems (Galloway, 1994). Furthermore, in Uganda, about 90% of Ugandan SMEs collapse within 3 years (Katuntu, 2005) due to lack of internal control. Lack of or weak internal control is therefore an indicator of poor financial performance. In Nigeria, the managing director and chief financial officer of Cadbury Nigeria were dismissed in 2006 for inflating the profits of the company for some years before the company’s foreign partner acquired controlling interest. These scandals emphasize the need to evaluate, scrutinize, and formulate systems of checks and balances to guide corporate executives in decision-making

Therefore, the establishment of the internal control function in MFIs should be effective to the extent of contributing to the achievement of the overall organizational goal. Internal control should not only serve basic functions of monitoring financial control systems and making recommendations to management as its primary and initial focus but should be effective to contribute to the achievement of organizational profitability. Sawyer (1995) stated that internal controller’s job is not done until defects are corrected and remain corrected. Despite the regulatory framework put in place by the Cameroon government over the years to regulate the activities of the microfinance industry, the industry could be characterized by a lot of challenges like poor internal controls. In the light of this, it has become very imperative for firms in the microfinance industry especially savings and loans establishments to establish proper internal control systems. For the past decade, many savings and loans companies have come to appreciate the importance of establishing internal control functions.

Internal control has become an instrument and means of risk control that helps the enterprise to achieve its goals and to perform its tasks. Only an effective internal control in the enterprise can help objectively assess the potential development and tendencies of the enterprise performance and thus detect and eliminate the threats and risk in due time as well as to maintain a particular fixed level of risk and provide for its reasonable security.

The system of control in an economy greatly determines the development and growth of that economy to ensure optimization in money, material, machine, time, resources, and management of men. Controls are essential. These controls are installed by many organizations including microfinance institutions to check how effective and efficient they maximise their resources. Internal control started to become significant to authors in the united states early in the 20th century (Staub, 1904p,p.98; Vincent, 1952, p.3; Brown, 1962, p.699; Myres, 1985, p.69)

MFIs are an important contributor to the economy of Cameroon. The sector contributes to the national 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 business that they run. The general perception is that the enforcement of proper internal control systems always leads to improved financial performance. Nevertheless, available literature still points out that despite the elaborate system of controls, organizations performance has been elusive in most of these organizations.

Financial performance is measured in terms of liquidity, return on asset, return on equity, profitability, etc. Stoner (2003), financial performance is the ability to operate efficiently, profitably, survives, grow and react to environmental opportunities and threats. Most MFIs have not attained financial stability as a result of not putting in place sound financial cost control portfolios and are relying on subsidies as their source of funds. A small number of MFIs are taking deposits to cushion risks associated with non-repayment of loans. It was within this backdrop that there was seen a need to undertake this study.

The need for the internal control systems in microfinance institutions cannot be undermined, due to fact that the financial sector which has a crucial role to play in the economic development of a nation is now being characterized by macro economic activities, corruption and the risk of fraud.

Fraud which is the major reason for setting up an internal control system, has become a great pain in the neck of many Cameroons Micro finance managers. Fraud is really eating deep in to the Cameroon financial system and that any MFI with a weak internal control system, is dangerously exposed to fraud.

In the nutshell, the damage which this menace, called fraud has done to the financial institutions is innumerable and needs urgent attention. Therefore, the attempt to put an end to this economic degradation, gave rise to the topic of this research study which is the impact of internal control  on the of MFI in Fako Division of Cameroon.

The study at hand is important because of the role played by MFIs in ensuring that the population is living a better health life thanks to saving and lending services provided to them. Most MFIs overriding mission is to contribute to the economic growth of the country by strengthening entrepreneurship spirit among the population, and improve the health of the world’s poorest and most vulnerable people by closing the gap resulting from the lack of the funds.

One of the objectives to achieve the above mission is through establishment of sound financial management systems for accountability, measurement of the financial performance and provision of timely information and to provide sound governance and oversight of the MFIs activities. The above objective therefore implies that the institutions should set up proper books of account and financial management and measurement systems including the setting up of an internal control system to ensure proper financial performance.

Southworth and Mritunjay (1995) revealed that for the financial institution to perform financially, they should see to it that financial responsibilities and authority are defined in employee job descriptions; written procedures are maintained regarding financial and accounting practices. They further found out that written policies on travel, personnel and procurement practices; safeguards and policies should be in place to guard against conflict of interest. Cash and expenses are segregated, and if applicable financial records are subject to internal or external audit routinely, at least once per year. More importantly, cash receipts are deposited promptly; payments are executed only with the appropriate approval and upon submission of the required documentation: detailed invoices, copies of purchase orders and shipping documents, etc.

Microfinance financial performance is measured in terms of customer satisfaction, through reduced customer complaints (Rezaee, 1995), number of clients, through liquidity, efficiency effectiveness of operations, accuracy and reliability of accounting information, and thus profitability. This study sets out to investigate if the sound internal control within MFIs could enable them to be profitable, efficient, effective, in short, goals attainment.

1.2 Statement of Problem

The absence of adequate internal control measures exposes the financial management of a MFI to certain threats such as incorrect financial statement and /loss of the 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 consistent 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 but only a few (Coso, 2011).

The African microfinance sector is a dynamic and growing market place. In general, since 2005 there has been a spurt of overall growth in microfinance activity in sub-Saharan Africa. The region’s aggregate loan portfolio increased by 69 percent from 2006 to 2007 and savings increased by 60 percent in the same period of time (Africa Microfinance Action Forum [AMAF], 2009). In 2007, sub-Saharan Africa experienced economic growth of 6.7 percent and continued to accelerate progress in human development, improve the huge lack of infrastructure, and strengthen governance. Microfinance has been able to capitalize on these positive developments, experiencing strong growth in recent years. This tremendous growth in MFIs across Africa has been attributed to the fact that they use savings mobilization as a main funding source (International association of Microfinance investors, 2010).

However, with over a decade of existence, even fewer microfinance institutions operating in Cameroon have reached the level of self-sufficiency. The majority of MFIs in Cameroon are not-for-profit organizations registered as financial cooperatives and credit unions. As such, their main source of loan able capital comes from the savings of their members (Lairap, 2004). Mismanagement of the savings of members and customers is becoming rampant. Thus, many are not able to survive resulting in a decrease in the number of microfinance institutions over the last few years. The number of MFIs decreased from 652 in 2000, to 481 in 2008 (COBAC Annual Report, 2000, 2008). In addition, the development of the microfinance sector is hampered by a loose regulatory network and supervisory framework for MFIs. There is also clear absence of governance in the management of most MFIs. In fact, almost all the microfinance institutions have at least one strong shareholder who tends to influence the smooth functioning of the institution especially when it comes to giving out loans. Likewise the president of ANEMCAM highlighted among other poor governance, loan delinquency and incompetent staff as a major hurdles faced by MFIs in Cameroon (Cameroon today, 2011). Majority of the MFIs in Cameroon, similar to most in Africa, struggle with sound leadership which is believed to be the primary condition for success as a successful MFIs on the continent have a strong board of directors. Therefore, their internal control environment is seemingly lagging behind. The control environment is weakened by absence of a policy guideline regarding the protection of savings clients among the COBAC regulations (Ndiaye, 2005). With a majority of the MFIs relying on savings mobilized from their members and customers, as funding for capital for their operations, the protection of the savings and its efficient utilization become paramount. Moreover, transparency and accountability are increasingly being required from all financial institutions including MFIs. Currently, as investors are more and more demanding regarding financial accountability and transparency, a strong internal system has acquired the utmost importance.

On the other hand, fraud has continued to be an issue of concern owing to its nature and the large losses reported from several cases. According to the fraud survey released in 2003, 75% of the respondents reported losses due to fraud as against 62% in 1998 (singleton et al., 2006). Furthermore, of the frauds reported, 36% incurred $ 1 million or more in cost, up from 21% in 1998. The Association of Certified Fraud Examiners (ACFE) reported an estimated $660 billion in losses due to fraud in 2004. Disturbing as the figures may be, the occurrence of fraud is a major problem for corporate organizations and institutions. Thus, prompting the search for techniques and risk management frameworks which effectively mitigate fraud. However, most MFIs have not been able to come to terms with the benefits of effective internal audit due to their inability to analyze the impact of effective internal audit and how much they could actually save financially. In this light, management of most MFIs simply ignore the need to put in place simple yet efficient internal control systems to safeguard assets, ensure reliable financial reporting and compliance with laws and regulations especially as the regulating of these institutions has not been comprehensibly developed.

Despite all the above findings, MFIs struggle with liquidity problems, operating and financial expenses are relatively high for MFIs and on average, and revenues from MFIs remain lower than in other global regions. There are also cases of alleged corruption and financial malpractices. Effectively in terms of cost per borrower is also low to provide for the potential loss from defaulted loans.

More so, a system of internal control cannot, however, provide protection with certainty against a company failing to meet its business objectives or all material errors, losses, fraud, or breaches of laws or regulations. Therefore, it becomes imperative to examine the impact of internal control on financial performance of MFIs. This research is therefore structured to provide answers to the following questions:

1.3. Research Questions

1.3.1 Main Specific Question

What is the impact of Internal Control on Financial Performance of MFI in Fako?

1.3.2 Specific Questions

Specifically, the study sought to;

1. What is the effect of the Control Environment on the financial performance of MFIs in Fako?
2. What is the effect of Risk Assessment on the financial performance of MFIs in Fako?
3. What are the effects of Control Activity on the financial performance of MFIs in Fako?
4. What is the effect of Information and Communication on the financial performance of MFIs in Fako?
5. What is the effect of Monitoring the financial performance of MFIs in Fako?

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