Effect of Internal Control Sytems on Fraud Detection in Banking Industry in Kenya

Abstract

Effective internal control systems play a pivotal role in fraud detection within the dynamic and complex landscape of the banking industry in Kenya. As financial institutions continually face evolving risks and sophisticated fraudulent schemes, the need for robust internal controls becomes increasingly paramount. These controls serve as a proactive defence mechanism, safeguarding the integrity of financial transactions, customer data, and the overall stability of the banking sector. Drawing from agency theory, fraud triangle theory, and control theory, this study employed a descriptive research design with primary data collected through questionnaires which were distributed to 39 licenced commercial banks. Key variables investigated included control environment, risk assessment, control activities, information and communication, and monitoring. The dataset attained a commendable 88.46% response rate, and a combination of descriptive and inferential statistics was utilized to uncover meaningful insights into the association between internal control systems and fraud detection in the banking industry in Kenya. The study revealed several significant correlations between key variables and fraud detection. A strong positive correlation was identified between control environment and fraud detection. Additionally, there was a moderate positive correlation between thorough risk assessment practices and fraud detection. Control activities exhibited a strong positive correlation with fraud detection, indicating that effective control measures significantly influence the detection of fraudulent activities. Similarly, a strong positive correlation was found between information and communication practices and fraud detection, underscoring the substantial role of quality information exchange and communication within an organization. Lastly, monitoring activities showed a strong positive correlation with fraud detection, emphasizing the crucial role of frequent and diligent monitoring practices in identifying fraudulent activities. The study's comprehensive analysis of internal control system on fraud detection in the banking sector offers key recommendations for optimizing fraud detection. Strengthening the control environment is crucial, emphasizing an ethical culture, regular training, and accountability mechanisms. Prioritizing risk assessment practices and continuous monitoring is essential. Optimization of control activities, effective information and communication, and diligent monitoring practices are recommended for enhancing fraud detection capabilities in the dynamic banking landscape