The Effect of Corporate Governance on Occurrence of Fraud In Commercial Banks In Kenya

Abstract

The purpose of the study was to examine the effect of corporate governance on occurrence of fraud in commercial banks in Kenya. The study assessed four research questions; To what extent does top leadership’s tone at the top affect occurrence of fraud in commercial banks in Kenya? To what extent do the prudential control systems set by commercial banks’ regulator impact on occurrence of fraud? To what extent does the alignment of top leadership’s compensation structures to fraud risk affect occurrence of fraud? To what extent do the fraud response strategies by commercial banks in Kenya affect occurrence of fraud? Occurrence of fraud was measured by magnitude of fraud loss, frequency of fraud and amounts of fraud loss’ recovery rates. The study adopted Culture, Leadership, Alignment, Systems, and Structure (CLASS) model of corporate governance. The study adopted positivism research philosophy and descriptive correlational research design. The population of the study consisted of 13,411 management staff of 43 commercial banks regulated by Central Bank of Kenya. A sample size of 169 top management staff stationed in Nairobi City were drawn using stratified random sampling method. Primary data was collected using structured questionnaires. Data was analysed using descriptive statistics of frequency, mean, standard deviation and coefficient of variation. Additionally, data was analysed using inferential statistics of Pearson’s Correlational Analysis, Analysis of Variance and stepwise regression analysis. Statistical tool of SPSS was used for analysis and results presented in figures and tables. In relation to the effect of top leadership’s tone at the top on occurrence of fraud, the study found significant correlations between top leadership’s tone at the top and amount of fraud loss (r= -0.47, p<0.01) and frequency of fraud (r=0.38, p<0.01) and increases fraud loss recovery rates (r=0.41, p<0.01). In regard to effect of prudential control systems set by CBK on occurrence of fraud, the study showed that effective prudential control systems set by CBK lowers the amount of fraud loss (r= -0.58, p<0.01) and enhances the fraud loss recovery rates (r= 0.34, p<0.01). In relation to effect of alignment of top leadership’s compensation structure on occurrence of fraud, the grouped correlations showed significance relationship with amount of fraud loss (r=-0.40, p<0.01) and increase in fraud loss recovery rate (r=0.24, p<0.01). In regard to effect of fraud response strategies on occurrence of fraud, the grouped correlational results of the study showed that the robust vi fraud response strategies by the banks, lower amount of fraud loss (r= -0.28, p<0.01) and increases fraud loss recovery rates (r= 0.27, p<0.01). Using stepwise regression analysis to test the null hypotheses, the study found existence of proper reward systems to staff members significantly predicted unofficial borrowings by the tellers from the teller tills (β = -3.51, p<.05). The study found that “Banking Fraud Investigations Department Officers are effective in carrying out their duties” significantly predicted occurrence of fraud (β = -5.51, p<.001), as did “change of reporting structure of Banking Fraud Investigation Department to be answerable to the CBK Governor instead of the current structure where they are answerable to Directorate of Criminal Investigations under National Police Service” (β = -4.49, p<.01). With regard to alignment of top leadership’s compensation structure, the study found “Increase in monthly salary” significantly predicted occurrence of management fraud (β = -3.76, p<.001), as did “equity based compensation” affected top management participation in computer-aided fraud (β = -2.71, p<.01). Finally, using stepwise regression analysis, the study found that “Established procedures of reporting incidences of fraud” significantly predicted occurrence of fraud through falsification of documents by staff (β = -3.702, p<.01). The study concluded that the more the positive tone at the top the lower the likelihood of occurrence of fraud, the more stringent the prudential control systems set by the regulator the lower the likelihood of occurrence of fraud, the more commensurate the top leadership’s compensation structure, the less likelihood of occurrence of fraud, and finally, the more the effective fraud response strategies the lower the amount of fraud loss and frequency and the higher the fraud loss recovery rates. The study recommended extension of fit and proper assessment for all commercial banks’ staff in fraud prone departments, designing of dynamic organizational-wide anti-fraud strategies, improvement of banking supervisions by creation of fraud specific prudential reports, legislative amendments to create fraud specific courts with judicial support systems and structural review of BFID reporting line. In relations to further research, the study suggested inclusion of all fraud typologies and getting the perception of board of directors and operational level staff, replication of the same study to all Central Bank of Kenya’s regulated financial institutions and also assessing the impact of fraud awareness initiatives by all the stakeholders on occurrence of fraud.