Completing the internal control in Vietnamese commercial banks

stem and the financial performance at the Graduate Training Institute in Uganda; Muraleetharan, P. (2011) studied that Risk Assessment, Control Activities and Monitoring have a positive effect on corporate 4 financial performance in Sri Lanka; Olumbe, C.O.O. (2012) demonstrated that good corporate governance of Kenyan Commercial Banks relates to strong Internal Control system; Leng, J. & Zhao, P., (2013) studied the quality of the Internal Control system positively related to the efficiency of business activities of enterprises in China; Magara, C.N. (2013) explored the impact of the Internal Control system on financial performance in credit companies (SACCOs) in Kenya; Musya, F.A. (2014) studied the relationship between components of the Internal Control system with the revenue of County Commission in Kenya. 3. Research objectives General goal of research The study “Completing the Internal Control system in Vietnamese Commercial Banks” has a general objective to assess the current state of the Internal Control system of Commercial Banks and proposes recommendations to complete the Internal Control system in Vietnamese Commercial Banks. Detail goal of research From the overall research objective to improve the Internal Control system in Vietnamese Commercial Banks, the specific research objectives and tasks include: (1) Assessing the status of the Internal Control system in Commercial Banks in Vietnam. (2) Analyzing the components of the Internal Control system in Vietnamese Commercial Banks. (3) Proposing recommendations to improve the Internal Control system in Vietnamese Commercial Banks. 5 4. Research questions The study raised four main research questions as follows: Question (1): What is the actual situation of the Internal Control system in Commercial Banks in Vietnam? Question (2): What does the role of the components of the Internal Control system effect on the Control objectives in Vietnamese Commercial Banks? Question (3): Which components of the Internal Control system in Vietnamese Commercial Banks need to be completed? Question (4): What recommendations is proposed to improve the Internal Control system in Vietnamese Commercial Banks? 5. Research subjects and scope of research The research object of the thesis is the theory and practice of the Internal Control system of Commercial Banks in Vietnam. The research scope of the thesis focus on the Internal Control system in order to propose recommendations for improving the Internal Control systems of Vietnamese Commercial Banks. The scope of space, focusing on domestic group of Commercial Banks, including State-owned Commercial Banks and Joint Stock Commercial Banks. The scope of time, survey questionnaires are made in State- owned and Joint Stock Commercial Banks in 2016. 6. Research methodology Theoretical basis Research is based on agency theory and contingency theory approach, based on the concept of the Internal Control, components of the Internal Control, Control Objectives under the framework of COSO and Basel. 6 Research methods Qualitative research methods including: literature review method, expert methodology, questionnaire survey methodology, descriptive statistical methodology, analytic and evaluation methodology, comparison methodology. Quantitative research methods including: Cronbach Alpha analysis, Exploratory Factor Analysis (EFA), T-test and ANOVA analysis, Confirmatory Factor Analysis (CFA), Structural Equation Model (SEM). Data research Research used primary data which has collected through the sampling survey. Using the interview method through the questionnaire. Duration of the survey is from June 2016 to September 2016. As a result, 293 valid questionnaires for the study. Data processing methods The thesis used SPSS software for Cronbach Alpha analysis, Exploratory Factor Analysis, descriptive statistics the Internal Control systems of Commercial Banks in Vietnam, T-test and ANOVA analysis to test the differences in the Internal Control systems among Commercial Banks Groups. The thesis used AMOS software for Confirmatory Factor Analysis, Structural Equation Model to test the theoretical model analysing the 5 components of the Internal Control and the influencing of the Control Environment on the other components of the Internal Control system. 7. The contribution of the thesis Theoretically, the thesis has the following contributions: Firstly, the research has contributed to the systematization of theoretical basis and the development of theories on the Internal Control system of corporation in generally and the Internal Control system of bank in particularly. 7 Secondly, the study identified the Internal Control system components and Control objectives in Commercial Banks based on components and principles of the Internal Control under the COSO and Basel framework. Thirdly, the study used descriptive statistics method, T-test and ANOVA analysis, Structural Equation Model (SEM) to evaluate and analysis the actual situation of the Internal Control system; using expert methods to identify the components of the Internal Control system that need to improve in Vietnamese Commercial Banks. In practice, the thesis has the following contributions: Firstly, the study evaluated the components and control objectives of the Internal Control system in Vietnamese Commercial Banks, analyzing the difference of the Internal Control system in Commercial Banks groups by ownership and by region. Secondly, the research has analyzed 5 components of the Internal Control system to be completed; moreover, the study verified the role of the Control Environment that influence on the Risk Assessment, the Control Activities, the Information and Communication; as a basis for proposing recommendations to complete the Internal Control system. Thirdly, the practical meaning of the study has been shown in the recommendations of improving the Internal Control system in Vietnamese Commercial Banks. This is a valuable reference to adjust and supplement the design of the Internal Control system of Commercial Banks, to meet the requirements of the Internal Control system in Vietnamese Commercial Banks. Fourthly, the study has built a survey questionnaire on the Internal Control system in Commercial Banks, as a basis for 8 designing the evaluation questionnaire of the checking the Internal Control system in Commercial Banks, as well as recording on the Internal Control system and reporting to the State Bank of Vietnam. 8. New points of the thesis Firstly, the research has approached the contingency theory explaining the Internal Control systems under the framework of COSO and Basel. Secondly, the research has made the reliable survey questionnaire about the Internal Control system of Commercial Banks. It can be used evaluating the Internal Control system which bases on COSO and Basel framework. Thirdly, the research has collected the database of 293 questionnaires from bank staff with a high level of knowledge about the Internal Control system, covering all 3 regions of Vietnam. Fourthly, the study assessed the status of the Internal Control system, explored the differences in the Internal Control system in Vietnamese Commercial Banks groups by ownership and by region. Fifthly, the study has used the SEM to analyze the components of the Internal Control system, as a basis for recommendations to complete the Internal Control system in Vietnamese Commercial Banks. The method allows the study to analyze the effect of exogenous variables on endogenous variables, at the same time analyze the effects of exogenous and endogenous variables. Sixthly, the research has found the influence of the Control Environment on the Risk Assessment, the Control Activities, the Information and Communication. This is a new point of the thesis in studying the recommendations to complete the Internal Control system in Vietnamese Commercial Banks. 9 Seventhly, the research combined quantitative and qualitative methods proposing recommendations to complete the Internal Control system in Vietnamese Commercial Banks under the framework of COSO 2013 and Basel 1998 framework. 9. The thesis structure In addition to the introduction and conclusion, the thesis is organized into 4 chapters: Chapter 1: Theoretical approach and Literature review of the Internal Control system Chapter 2: Commercial Banks and Research Design Chapter 3: Assessing the Internal Control system in Vietnamese Commercial Banks Chapter 4: Recommending to complete the Internal Control system in Vietnamese Commercial Banks CHAPTER 1: THEORETICAL BASIS AND LITERATURE REVIEW OF THE INTERNAL CONTROL SYSTEM 1.1. Theoretical approach 1.1.1. The Agency theory approach Agency theory approach assumes that there is the agency problem in the coperation “separating between ownership and control leads to conflict of interest and risk sharing”. Corporate governance helps satisfy ownership and controls the coperation to make the company's operations more efficient. The Internal Control system is one of the internal governance mechanisms of the company. Research on the Internal Control system approaching agency theory explains the necessity of the Internal Control system of coperation. 10 1.1.2. The Contingency theory approach Contingency theory approach assumes the Internal Control system can be changed. Contingency theory approach provides research on the Internal Control system that is a process of implementing control procedures in accordance with characteristics, size, structure and change of the coperation. This is the theory to study the Internal Control in context of diverse types of companies, diverse industries and much change of the coperation. 1.2. Overview of the Internal Control system 1.2.2. Internal Control concept The internal control system is the process of implementing control procedures and mechanisms to achieve business goals, including: effectiveness and efficiency operation; reliability of financial statements; complying with laws and regulations. 1.2.1. Nature of Internal Control The Internal Control system is one of the internal corporate governance mechanism, contributing to the achievement of objectives in operation. 1.3. Literature review 1.3.1. Internal Control framework 1.3.1.1. Internal Control under the COSO framework Under COSO's Internal Control framework, the Internal Control system consists of 5 components, developed into 17 principles. 1.3.1.2. Internal Control in banks under Basel framework The Basel framework sets out 13 principles for designing and evaluating the Internal Control system of banks; basically, these principles are similar to the 5 components of the Internal Control system in the framework of COSO. 11 1.3.2. Empirical literature review This section reviews the international and domestic study on the Internal Control systems. Including: research on the COSO and Basel framework of the Internal Control; research on the Internal Control components, the effectiveness and efficiency of the Internal Control system; researching and assessing the status of the Internal Control systems of companies and commercial banks; studying the impact of the Internal Control system on control objectives. From there, study gived policy implications based on research results. 1.4. Research gap Through the literature review of the research situation, the thesis identified 5 gaps in theorical gap as well as practicing gap for the research on the Internal Control system in Vietnam: (1) The study mainly bases on the COSO framework, (2) The study has not combined the COSO and Basel framework, (3) Little study approachs agency theory and contingency theory for analysing the Internal Control system in Vietnam, (4) Research is mainly based on qualitative, (5) Mainly case study for only one bank. CHAPTER 2: COMMERCIAL BANKS AND RESEARCH DESIGN 2.1. Overview of commercial banks 2.1.1. Concept of Commercial Bank A Commercial Bank is a financial institution that accepts deposits from the public and creates credit by monetary and banking services. 2.1.2. Classify Commercial Banks by ownership State-owned Commercial Banks: The State owns more than 50% of capital. Non-state Commercial Banks include: joint-stock Commercial 12 Banks, joint-venture Banks, foreign Bank branches, 100% foreign- owned Commercial Banks. 2.1.3. Operation of Commercial Banks Deposits, Credit, Financial investment, Foreign exchange, Payment services, Valuable property preservation, Government activities funding, Stakeholder, some other services ... 2.2. Developing research hypothesis Hypothesis H1: There is a positive impact of the Control Environment (CE) to Internal Control Objectives (ICO) of Commercial Banks in Vietnam Hypothesis H2: There is a positive impact of Risk Assessment (RA) to Internal Control Objectives (ICO) of Commercial Banks in Vietnam Hypothesis H3: There is a positive impact of Control Activities (CA) to Internal Control Objectives (ICO) of Commercial Banks in Vietnam Hypothesis H4: There is a positive impact of Information and Communication and (IC) to Internal Control Objectives (ICO) of Commercial Banks in Vietnam Hypothesis H5: There is a positive impact of Monitoring Activities (MA) to Internal Control Objectives (ICO) of Commercial Banks in Vietnam Hypothesis H6: There is a positive impact of Control Environment (CE) on Risk Assessment (RA) of Commercial Banks in Vietnam Hypothesis H7: There is a positive impact of Control Environment (CE) on Control Activities (CA) of Commercial Banks in Vietnam Hypothesis H8: There is a positive impact of Control Environment (CE) on Information and Communication (IC) of Commercial Banks in Vietnam Hypothesis H9: There is a positive impact of Control Environment (CE) on Monitoring Activities (MA) of Commercial Banks in Vietnam 13 2.3. Modeling the components of the Internal Control system in Vietnamese Commercial Banks 2.3. Scale measurement components of the Internal Control system and the Control Objectives 2.4. Scale measurement components of the Internal Control system and the Control Objectives 2.4.1. Scale measurement of the Control Environment (CE): measured by 7 observed variables from CE1 to CE7. 2.4.2. Scale measurement of Risk Assessment (RA): measured by 5 observed variables from RA1 to RA5. 2.4.3. Scale measurement of Control Activities (CA): Measured by 5 observed variables from CA1 to CA5. 2.4.4. Scale measurement of Information and Communication (IC): H1 H2 H3 H9 H8 H7 H6 CE H4 H5 RA CA IC MA Internal Control Objectives 14 measured by 5 observed variables from IC1 to IC5. 2.4.5. Scale measurement of Monitoring Activities (MA): measured by 5 observed variables from MA1 to MA5. 2.4.6. Scale measurement of Control Objectives (ICO): measured by 6 observed variables from ICO1 to ICO6. 2.5. Scale of research components: using the 5-point Likert scale. 2.6. Developing the survey questionnaire: the questions in the questionnaire are accordant to the scale of the Internal Control components and Control Objectives. 2.7. Research methods: qualitative research methods and quantitative research methods. 2.8. The research framework of the Internal Control system in Vietnamese Commercial Banks 2.9. The research process of the Internal Control system in Vietnamese Commercial Banks CHAPTER 3: ASSESSING THE INTERNAL CONTROL SYSTEM IN VIETNAMESE COMMERCIAL BANKS 3.1. Describe the research sample Commercial Banks by ownership Commercial Banks region Classify Amount % Classify Amount % State-owned Commercial Banks 110 37,54% North 18 6,15% Central 181 61,77% Joint stock Commercial Banks 183 62,45% South 94 32,08% Total: 293 100% Total: 293 100% 15 3.2. Evaluating the reliability of the scale - Cronbach Alpha method Variables after performing Cronbach alpha analysis: CE (CE2, CE3, CE4, CE5, CE6, CE7), RA (RA1, RA2, RA3, RA5), CA (CA1, CA2, CA3, CA4, CA5), IC (IC1, IC2, IC3, IC4, IC5), MA (MA1, MA3, MA4, MA5), ICO (ICO1, ICO2, ICO3, ICO4, ICO5, ICO6) are included in the Exploratory Factor Analysis ( EFA). 3.3. Evaluation of scale value of Internal Control components and Control Objective - Exploratory Factor Analysis (EFA) After extracting variables, the result of EFA is: CE (CE2, CE3, CE6, CE7), RA (RA2, RA3, RA5), CA (CA1, CA2, CA5), IC (IC1, IC3, IC4) MA (MA1, MA4), ICO (ICO1, ICO2, ICO3, ICO5, ICO6). 3.4. Statistics Internal Control components, the Internal Control system and Control Objectives in Vietnamese Commercial Banks Analysis data shows that the scale of measuring 5 components of the Internal Control, general assessment of the Internal Control system and the Control Objectives of Vietnamese Commercial Banks are rated above average and at a quite good level. 3.5. Analyzing the difference in the Internal Control system in Vietnamese Commercial Banks There is no difference in evaluating 5 components of the Internal Control, general assessment of the Internal Control system and assessing Control Objectives between Vietnamese Commercial Banks groups by ownership and by region. The Risk Assessment (RA) has the difference between Commercial Banks by ownership and by region, but this gap is not large. 16 3.6. Analysing the 5 components of the Internal control system and Control Objectives - Confirmatory Factor Analysis (CFA) - Critical measurement model 17 3.7. Analysing the 5 components of the Internal control system in Vietnamese Commercial Banks - Structural Equation Model (SEM) SEM (standardized) results of theory model SEM (standardized) results of adjustment model 18 The SEM (standardized) results of the adjustment model based on the MI coefficient 19 The regression coefficient of the adjustment model; R2: Internal Control Objectives = 72,8%; R2: Risk Assessment = 10,5%; R2: Control Actitivites = 48,7%; R2: Information&Communication = 48,6% Correlate Non- standardized Estimate Standardized Estimate S.E. C.R. P CE → RA 0,242 0,324 0,067 3,591 0,0000 CE → CA 0,684 0,698 0,106 6,470 0,0000 CE → IC 0,777 0,697 0,111 6,973 0,0000 CE → ICO 0,257 0,286 0,145 1,767 0,077 RA → ICO 0,192 0,160 0,088 2,184 0,029 CA → ICO 0,186 0,203 0,112 1,655 0,098 IC → ICO 0,308 0,383 0,096 3,229 0,001 MA → ICO 0,284 0,228 0,100 2,829 0,005 CHAPTER 4: RECOMMENDING TO COMPLETE THE INTERNAL CONTROL SYSTEM IN VIETNAMESE COMMERCIAL BANKS 4.1. Recommended to complete the internal control components of Vietnamese Commercial Banks 4.1.1. Control Environment (CE): the best assessment (3,819), affecting the other Internal Control components, affecting the Control Objective at a high level (0.286). Focus on developing CE to create the core values of the Internal Control system of Commercial Banks, to support the other Internal Control components, to achieving the Control Objectives of Vietnamese Commercial Banks. CE2 (COSO 02): the best assessment (3.87), strongly affects CE (0.62). Need to determine the control objectives, determine supervision responsibilities of the Board of Directors; the Board of Directors must 20 be independent; need to consider the duties of the Board of Directors and the objectives of Commercial Banks; expect Management Board to be honest, respect moral values, be capable of leadership; Board of Inspectors perform the supervising role of the Board of Directors. CE6 (COSO 04): the lowest assessment (3.76). Human resource policy needs to retain qualified staff; Managers determine the requirements for staff capacity, specifically by requirements of knowledge and skills; Managers identify and evaluate important positions and functions that help achieve operational goals. CE7 (COSO 05): fairly high average (3.83), strongly affecting CE (0.62). The Board of Directors is responsible for managing Commercial Banks activities; Managers is supervised by the Board of Directors on this responsibility; establish and implement responsibility of Managers; measuring performance include quantitative and qualitative standards; encourage managers and employees to complete their tasks. 4.1.2. Risk Assessment (RA): under the average of the Internal Control system (3,746), the lowest impact on the Control Objectives (0.160). Focusing on RA could improve the Internal Control system in Vietnamese Commercial Banks. RA2 (COSO 07, Basel 04): fairly average assessment (3.74), the strongest influence on RA (0.76), it is necessary to carry out Risk Assessment, assessing risks at all level of Commercial Banks activities, analysing risk assessment; dealing with risk. 4.1.3. Control activity (CA): under the average level of the Internal Control system (3,747); low affect to Control Objective (0.203). Completing CA to improve the Internal Control system in Vietnamese Commercial Banks. 21 CA1 (COSO 10, Basel 05): lowest assessment (3.70). Control Activities should be consistent with Risk Assessment, need to be professional control for Commercial Banks activities, need to be effective to coordinate Control Activities, Control Activities to achieve the full, accurate, real and compliance objectives in practicially, control is required at all level of Commercial Banks. CA5 (COSO 12): assessed fairly (3.73), the strongest influence on CA (0.62). Evaluating policies and procedures periodically, applying necessary solution to correct control policies and control procedures, policies and procedures in control activities are implemented carefully and promptly. 4.1.4. Information and Communication (IC): lowest assessment (3,696); strongest influence on Control Objectives (0.382). Focus on IC to improve the Internal Control system and contribute to achieving Control Objectives in Vietnamese Commercial Banks. IC1 (COSO 13): lowest assessment (3,68). Identifying information requirements for each level of management, selecting sources that provide relevant and useful information, issuing information management policies, stating responsibilities for information quality. IC4 (Basel 08): the best assessment (3.72), the strongest influence on IC (0.69). Establishing and maintaining information systems to fully manage the activities of Commercial Banks, focusing on electronic information technology system. 4.1.5. Monitoring Activities (MA): under the average level of the Internal Control system (3,744), affecting the Control Objectivies at a high level (0.228). Completing MA to improve the Internal Control system and helping to achieve Control Objectives in Vietnamese Commercial Banks. 22 MA1 (Basel 10): the best assessment (3.77), the strongest influence on MA (0.77). Continuously monitoring and evaluating the Internal Control systems in the context of changes internal and exterior Commercial Banks, Monitoring Activities are carried out by the Supervisory Board and Internal Audit department; need regular and periodic Monitoring Activities. MA4 (Basel 11): the lowest assessment (3.71). The functions of the Supervisory Board and internal audit should be independent of the daily operational functions of commercial banks, Board of Inspectors and Internal Auditors provide information about the Internal Control systems and activities of Commercial Banks, Board of Inspectors and Internal Auditor report on the Internal Control system and the operation of Commercial Banks directly to the Board of Directors and Managers. 4.2. Recommendations for law on the Internal Control in Vietnamese Commercial Banks State Bank of Vietnam need to promulgate more specific guidelines for components of the Internal Control system. It is possible to use and refer to the 2013 COSO framework and the 1998 Basel framework. Specific guidelines on components of the Internal Control system will help Vietnamese Commercial Banks to report more fully on the Internal Control system to the State Bank of Vietnam. 10. Conclusions The doctoral dissertation “Completing the Internal Control in Vietnamese Commercial Banks” was done based on agency theory and contingency theory for research on the Internal Control. Based on the COSO 1992 framework, update 2013 and the Basel 1998 23 framework; established the principles and components of the Internal Control system