THE ROLE OF INTERNAL AUDITORS IN A DEPRESSED ECONOMY (A CASE STUDY OF SELECTED BANKS IN NIGERIA)

CHAPTER ONE: INTRODUCTION

1.1 Background of Study

Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations (Institute of Internal Auditors [IIA], 2017). It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes (IIA, 2020). In the banking sector, internal auditors serve as the third line of defence, providing critical oversight that complements the first line (operational management) and second line (risk management and compliance) (Chambers, 2019). Their role becomes particularly vital during periods of economic depression, when banks face heightened risks of loan defaults, liquidity crunches, fraud, regulatory scrutiny, and capital erosion (Ogunleye and Adebayo, 2021).

A depressed economy is characterized by prolonged periods of negative economic growth, high unemployment, falling asset prices, declining consumer and business confidence, reduced credit availability, and often deflation or high inflation (Blanchard, 2020). Nigeria has experienced successive economic downturns, including the 1980s debt crisis, the 1990s political and economic instability, the 2008–2009 global financial crisis, the 2016 recession triggered by falling oil prices, and the COVID-19-induced recession of 2020 (Sanusi, 2019). The most recent economic challenges have been exacerbated by foreign exchange shortages, rising inflation (reaching over 20% in 2022), high interest rates, and persistent unemployment (Central Bank of Nigeria [CBN], 2023). In such depressed conditions, banks face unique pressures that test the resilience of their internal control systems and the effectiveness of their internal audit functions (Nwankwo, 2020).

The Nigerian banking sector has undergone significant transformation since the banking consolidation exercise of 2005, which reduced the number of banks from 89 to 25 and increased minimum capital requirements to ₦25 billion (Soludo, 2019). Further consolidation and regulatory changes have followed, with the current number of deposit money banks standing at 24 (CBN, 2023). Despite increased capitalization and improved regulatory oversight, Nigerian banks remain vulnerable to macroeconomic shocks, given their significant exposure to the oil and gas sector, government securities, and consumer lending (Uche and Ehikioya, 2020). The depressed economic environment of recent years has led to rising non-performing loans (NPLs), which peaked at over 11% in 2016 before declining to around 5% by 2022, still above the prudential benchmark of 5% for some banks (CBN, 2022).

The role of internal auditors in banks during a depressed economy extends far beyond traditional financial auditing (Pickett, 2018). While their core responsibilities include evaluating the adequacy and effectiveness of internal controls, verifying the accuracy of financial records, detecting and preventing fraud, and ensuring compliance with laws and regulations (IIA, 2017), the depressed economic context intensifies each of these responsibilities. For instance, when economic conditions deteriorate, pressure on bank employees to meet performance targets increases, which can lead to unethical behaviours such as falsifying loan applications, concealing deteriorating asset quality, or engaging in unauthorized trading (KPMG, 2020). Internal auditors must be particularly vigilant for such red flags during depressed periods (Deloitte, 2021).

Loan portfolio quality is a primary area of focus for internal auditors during economic depression (PricewaterhouseCoopers [PwC], 2022). As businesses fail and unemployment rises, borrowers’ ability to service debts diminishes, leading to increased defaults and non-performing loans (NPLs) (Basel Committee on Banking Supervision, 2019). Internal auditors assess whether banks have adequately identified impaired loans, properly calculated loan loss provisions, and accurately classified assets according to regulatory requirements (CBN, 2020). Weaknesses in loan origination, monitoring, and recovery processes become more apparent during depressions, and internal auditors play a critical role in identifying these weaknesses and recommending improvements (Ernst and Young, 2021). In Nigerian banks, where connected lending and insider abuse have historically been problems, internal audit scrutiny of loan files is especially important (Ogbechie and Adekunle, 2019).

Fraud risk escalates significantly during economic depression (Association of Certified Fraud Examiners [ACFE], 2022). Employees facing financial pressures at home (salary cuts, job losses of family members, mounting debts) may be more susceptible to rationalizing fraudulent acts (Wolfe and Hermanson, 2018). Additionally, customers and external parties may attempt to defraud banks through forged instruments, identity theft, or complex cyber schemes (PwC, 2022). Internal auditors must adapt their fraud risk assessment methodologies to account for the changing risk landscape during depression, including increased emphasis on whistle-blower hotlines, data analytics for anomaly detection, and surprise audits (KPMG, 2020). In Nigeria, where the banking industry has experienced high-profile fraud cases (including the 2009 discovery of margin loans abuses and insider frauds that contributed to the banking crisis), internal audit vigilance is paramount (Sanusi, 2019).

Liquidity risk management is another critical area where internal auditors add value during depressed economic conditions (Bank for International Settlements [BIS], 2021). When depositors lose confidence in the banking system or need to draw down savings due to unemployment, banks may experience sudden and unexpected cash outflows (Diamond and Dybvig, 2019). Internal auditors evaluate whether banks maintain adequate liquidity buffers, have reliable stress testing frameworks, and comply with regulatory liquidity ratios (such as the Liquidity Coverage Ratio and Net Stable Funding Ratio) (Basel Committee, 2019). They also assess the integrity of the bank’s contingency funding plan, including access to the CBN’s lender-of-last-resort facilities (CBN, 2020). Nigerian banks, which rely heavily on short-term deposits for funding, are particularly exposed to liquidity risk during economic downturns (Nwankwo, 2020).

Capital adequacy is a third major area of internal audit focus during depression (PwC, 2022). As loan losses erode bank capital, internal auditors verify that banks correctly calculate risk-weighted assets, properly apply capital conservation buffers, and comply with the Basel III framework as adopted by the CBN (CBN, 2020). They also assess the reliability of the bank’s internal capital adequacy assessment process (ICAAP) and the credibility of stress testing scenarios (IIA, 2020). Banks that fall below regulatory capital minimums face restrictions on operations, including limitations on dividend payments, bonus distributions, and business expansion (Basel Committee, 2019). Internal auditors provide early warning of capital erosion, enabling management to take corrective action before regulatory thresholds are breached (Ernst and Young, 2021).

Regulatory compliance becomes more complex and consequential during depressed economic periods (Deloitte, 2021). Regulators such as the CBN and the Nigeria Deposit Insurance Corporation (NDIC) intensify their scrutiny of banks when the economy weakens, conducting more frequent on-site examinations and imposing stricter enforcement actions (Uche and Ehikioya, 2020). Internal auditors help banks navigate this heightened regulatory environment by conducting pre-exam readiness assessments, validating remediation of prior examination findings, and ensuring timely and accurate regulatory reporting (KPMG, 2020). In Nigeria, where regulatory sanctions have included removal of boards and management, fines, and even revocation of licenses (e.g., the 2009 rescue of eight banks), robust internal audit coverage of regulatory compliance is essential (Sanusi, 2019).

The cost containment imperative during economic depression places pressure on internal audit departments themselves (Pickett, 2018). Bank management may seek to reduce internal audit budgets, freeze hiring, defer training, or scale back audit coverage (Chambers, 2019). However, reducing internal audit capacity during a period of heightened risk is counterproductive and potentially dangerous (IIA, 2017). Effective chief audit executives (CAEs) advocate for maintaining or even increasing audit resources during economic stress, arguing that the cost of undetected losses far exceeds the cost of audit coverage (Deloitte, 2021). They may also adopt more risk-based audit planning, focusing limited resources on the highest-risk areas (e.g., credit, liquidity, fraud) while reducing coverage of lower-risk areas (e.g., low-value operational audits) (PwC, 2022).

The use of technology and data analytics in internal auditing becomes increasingly important during depressed economic conditions (EY, 2021). Data analytics enable auditors to analyse 100% of transactions rather than relying on small samples, identify anomalies and patterns indicative of fraud or error, and provide real-time or near-real-time assurance (ACFE, 2022). Nigerian banks, which have invested heavily in core banking applications, enterprise resource planning (ERP) systems, and business intelligence tools, can leverage these investments for continuous auditing and monitoring (Ogbechie and Adekunle, 2019). However, the effectiveness of technology-enabled auditing depends on the skills of internal audit staff, the quality of underlying data, and the integration of audit analytics into the bank’s overall data governance framework (IIA, 2020).

The relationship between internal audit, the audit committee, and external auditors is tested during economic depression (Chambers, 2019). Audit committees, typically composed of independent non-executive directors, rely on internal audit as their eyes and ears within the organization (IIA, 2017). During depressed periods, audit committee meetings may become more frequent and intense, with deeper scrutiny of loan loss provisions, asset valuations, and management override of controls (KPMG, 2020). External auditors (statutory auditors) also coordinate with internal audit to rely on their work where appropriate, reducing the overall cost of assurance (PwC, 2022). Effective three-way communication between internal audit, the audit committee, and external auditors is a hallmark of mature governance, and becomes critical during economic stress (Deloitte, 2021).

The psychological and ethical dimensions of internal auditing during depression are often overlooked but significant (Wolfe and Hermanson, 2018). Internal auditors themselves may face the same financial pressures as other employees: salary cuts, reduced benefits, or fear of layoffs (Ernst and Young, 2021). These pressures could potentially compromise auditor independence and objectivity, leading to hesitation in reporting uncomfortable findings that might upset management (ACFE, 2022). Audit departments must therefore have strong ethical cultures, whistle-blower protections, and quality assurance review processes that reinforce auditor independence (IIA, 2020). In Nigeria, where the internal audit profession is still developing compared to advanced economies, attention to these ethical safeguards is particularly important (Ogbechie and Adekunle, 2019).

Despite the recognized importance of internal auditors in banks, empirical research on their specific role during economic depression in Nigeria is limited (Nwankwo, 2020). Most studies have examined internal auditing in normal economic conditions, or have focused on financial reporting quality or fraud prevention without specific attention to the depressed economy context (Ogunleye and Adebayo, 2021). The unique pressures of a depressed economy—rising credit risk, increased fraud incentives, liquidity strains, capital erosion, intensified regulation, and cost-cutting pressures—likely change the nature, focus, and intensity of internal audit work in ways that have not been systematically documented (Uche and Ehikioya, 2020). This study addresses that gap by examining selected Nigerian banks.

The selection of banks for this study includes a mix of tier-1 (large, systemically important banks), tier-2 (medium-sized banks), and tier-3 (smaller banks) to capture variation in internal audit resources, practices, and challenges (CBN, 2023). Banks also vary in ownership structure (domestic vs. international ownership, government vs. private shareholding), geographic footprint (national vs. regional), and primary business focus (retail, corporate, investment). This diversity enables comparative analysis of how different banks’ internal audit functions respond to the same macroeconomic depression. The specific banks selected (anonymized for confidentiality as Bank A, Bank B, Bank C, Bank D, and Bank E) represent this range of characteristics.

From a theoretical perspective, this study is supported by three theories: Agency Theory (Jensen and Meckling, 1976), which explains internal audit as a monitoring mechanism to reduce information asymmetry between bank management and stakeholders; Fraud Triangle Theory (Cressey, 1953; Wolfe and Hermanson, 2018), which explains how pressure (including economic stress), opportunity, and rationalization combine to increase fraud risk during depression; and Contingency Theory (Donaldson, 2019), which suggests that the optimal internal audit approach depends on environmental conditions, including economic depression. These theories provide a robust foundation for analysing the role of internal auditors in a depressed economy.

In summary, internal auditors play a critical and multifaceted role in banks during economic depression, encompassing loan portfolio quality assurance, fraud detection, liquidity and capital adequacy verification, regulatory compliance, and risk management oversight. However, they face challenges including budget pressures, increased workload, psychological stress, and the need for more sophisticated auditing techniques. The Nigerian banking sector, having experienced multiple economic depressions and recessions over the past four decades, provides an important setting for examining how internal auditors navigate these challenges. This study aims to empirically investigate the role of internal auditors in selected Nigerian banks operating in a depressed economy, generating insights for banking practice, regulatory policy, and the internal audit profession.

1.2 Statement of Problems

The Nigerian banking sector has experienced successive economic depressions and recessions (1980s debt crisis, 1990s instability, 2008–2009 global crisis, 2016 oil-price recession, 2020 COVID-19 recession) that have severely tested the resilience of banks. During these depressed economic periods, banks face heightened risks of rising non-performing loans, increased fraud incidents, liquidity pressures, capital erosion, and intensified regulatory scrutiny. The internal audit function is theoretically positioned as a critical line of defence against these risks, providing independent assurance to management and the board on the adequacy and effectiveness of risk management and control systems. However, empirical evidence suggests that internal audit effectiveness in Nigerian banks is inconsistent, with some banks weathering economic depressions better than others. It remains unclear how internal auditors in Nigerian banks actually adapt their audit plans, methodologies, resource allocation, and reporting practices in response to depressed economic conditions. Furthermore, the specific challenges that internal auditors face during economic depressions—including budget cuts, staffing freezes, pressure to downplay findings, and technological limitations—have not been systematically documented. The problem this study addresses is the gap between the theoretical role of internal auditors as critical risk mitigators during economic depression and the practical reality of internal audit performance in Nigerian banks, with the aim of identifying enabling factors, barriers, and best practices.

1.3 Aim of the Study

The specific aim of this research work is to examine the role of internal auditors in a depressed economy, using selected banks in Nigeria as case studies, with a view to understanding how internal audit functions adapt to economic depression and recommending improvements for internal audit effectiveness during periods of economic stress.

1.4 Objectives of the Study

1. To determine the effect of economic depression on the audit focus and risk assessment priorities of internal auditors in selected Nigerian banks.
2. To assess the impact of internal audit activities on the detection and prevention of fraud in Nigerian banks operating in a depressed economy.
3. To examine the relationship between internal audit coverage of loan portfolios and the level of non-performing loans in selected banks during economic depression.
4. To evaluate the influence of internal audit recommendations on bank management’s response to liquidity and capital adequacy risks in a depressed economy.
5. To investigate the challenges facing internal audit departments (including budget, staffing, technology, and independence) in selected Nigerian banks during periods of economic depression.

1.5 Research Questions

1. What is the effect of economic depression on the audit focus and risk assessment priorities of internal auditors in selected Nigerian banks?
2. How do internal audit activities impact the detection and prevention of fraud in Nigerian banks operating in a depressed economy?
3. What is the relationship between internal audit coverage of loan portfolios and the level of non-performing loans in selected banks during economic depression?
4. How do internal audit recommendations influence bank management’s response to liquidity and capital adequacy risks in a depressed economy?
5. What are the challenges facing internal audit departments (including budget, staffing, technology, and independence) in selected Nigerian banks during periods of economic depression?

1.6 Research Hypotheses

Hypothesis One

• H₀ (Null): Economic depression has no significant effect on the audit focus and risk assessment priorities of internal auditors in selected Nigerian banks.
• H₁ (Alternative): Economic depression has a significant effect on the audit focus and risk assessment priorities of internal auditors in selected Nigerian banks.

Hypothesis Two

• H₀ (Null): Internal audit activities have no significant impact on the detection and prevention of fraud in Nigerian banks operating in a depressed economy.
• H₁ (Alternative): Internal audit activities have a significant impact on the detection and prevention of fraud in Nigerian banks operating in a depressed economy.

Hypothesis Three

• H₀ (Null): There is no significant relationship between internal audit coverage of loan portfolios and the level of non-performing loans in selected banks during economic depression.
• H₁ (Alternative): There is a significant relationship between internal audit coverage of loan portfolios and the level of non-performing loans in selected banks during economic depression.

Hypothesis Four

• H₀ (Null): Internal audit recommendations have no significant influence on bank management’s response to liquidity and capital adequacy risks in a depressed economy.
• H₁ (Alternative): Internal audit recommendations have a significant influence on bank management’s response to liquidity and capital adequacy risks in a depressed economy.

Hypothesis Five

• H₀ (Null): There are no significant challenges (budget, staffing, technology, independence) facing internal audit departments in selected Nigerian banks during periods of economic depression.
• H₁ (Alternative): There are significant challenges (budget, staffing, technology, independence) facing internal audit departments in selected Nigerian banks during periods of economic depression.

1.7 Justification of the Study

This study is justified on several grounds. First, while the importance of internal auditing in banks is widely acknowledged, empirical research specifically examining internal audit during economic depression is rare, with most studies assuming normal economic conditions. Second, Nigeria’s experience of multiple economic depressions over four decades provides a rich empirical setting for studying how internal audit functions adapt to repeated macroeconomic stress. Third, the banking sector is systemically important to the Nigerian economy; bank failures during depression can trigger broader economic crises, making internal audit effectiveness a matter of public policy concern. Fourth, the study includes a mix of tier-1, tier-2, and tier-3 banks, enabling comparative analysis across different sizes and resource levels. Fifth, the findings will inform the internal audit profession (through guidance on depression-era auditing), bank management (through insights on how to leverage internal audit during stress), regulators (through identification of systemic weaknesses in internal audit coverage), and the academic literature (through theory testing and extension).

1.8 Significance of the Study

The findings of this research will be significant to several stakeholders. To internal auditors and chief audit executives (CAEs) in Nigerian banks, the study will provide empirical benchmarks for adapting audit plans, methodologies, and resource allocation during depressed economic conditions, as well as identifying common pitfalls to avoid. To bank management and boards of directors, the findings will illuminate the value of internal audit during economic stress, helping them justify maintaining or increasing internal audit resources when budgets are under pressure. To banking regulators, including the Central Bank of Nigeria (CBN) and the Nigeria Deposit Insurance Corporation (NDIC), the study will highlight systemic weaknesses in internal audit coverage across the banking sector, potentially informing regulatory guidance or examination priorities. To the Institute of Internal Auditors (IIA) Nigeria and the professional body, the findings will inform continuing professional development (CPD) programmes, practice advisories, and guidance materials specific to depressed economy auditing. To academic researchers in auditing, banking, and risk management, the study will contribute empirical evidence from an under-researched context (depressed economy, developing country, banking sector), testing and potentially extending agency theory, fraud triangle theory, and contingency theory.

1.9 Scope of the Study

The scope of this study is delimited to the role of internal auditors in a depressed economy, focusing on selected banks operating in Nigeria. The study covers the period from 2015 to 2022, which encompasses two major economic depressions/recessions in Nigeria: the 2016 recession (triggered by falling oil prices) and the 2020 COVID-19-induced recession. The study examines five selected banks representing different tiers and ownership structures (anonymized as Bank A, Bank B, Bank C, Bank D, and Bank E for confidentiality). The internal audit role is examined along multiple dimensions: audit focus and risk assessment priorities, fraud detection and prevention, loan portfolio coverage (non-performing loans), influence on management’s response to liquidity and capital adequacy risks, and challenges facing internal audit departments (budget, staffing, technology, independence). The study does not extend to internal audit in other financial institutions (insurance companies, microfinance banks, pension fund administrators), nor does it cover internal audit in non-financial sectors. The study relies on primary data (questionnaires and interviews) and secondary data (bank annual reports, regulatory filings, internal audit reports where accessible), but does not include direct observation of internal audit fieldwork.

1.10 Definition of Terms

Internal Auditor: An independent, objective assurance and consulting professional who evaluates the effectiveness of an organization’s risk management, control, and governance processes, reporting directly to the board audit committee.

Depressed Economy: A prolonged period of economic contraction characterized by declining gross domestic product (GDP), rising unemployment, falling asset prices, reduced credit availability, high or volatile inflation, and diminished business and consumer confidence.

Bank (Deposit Money Bank): A financial institution licensed by the Central Bank of Nigeria to accept deposits from the public, provide loans, facilitate payments, and offer other financial services.

Audit Focus: The specific areas, processes, functions, or risk categories that internal audit prioritizes in its annual audit plan and individual audit engagements.

Risk Assessment: The systematic process of identifying, analyzing, and evaluating risks to the achievement of organizational objectives, which informs internal audit planning and resource allocation.

Non-Performing Loan (NPL): A loan where the borrower has failed to make scheduled principal or interest payments for 90 days or more, or where payment is otherwise considered doubtful.

Fraud Detection: The identification of fraudulent activities (including misappropriation of assets, corruption, and financial statement fraud) through internal audit procedures such as transaction testing, data analytics, reconciliations, and whistle-blower investigations.

Fraud Prevention: The proactive activities designed to deter fraud, including assessing fraud risk, designing and implementing anti-fraud controls, promoting ethical culture, and providing fraud awareness training.

Liquidity Risk: The risk that a bank may not be able to meet its short-term cash obligations (deposit withdrawals, loan disbursements, payment obligations) without incurring unacceptable losses.

Capital Adequacy: The sufficiency of a bank’s capital (shareholders’ equity) relative to its risk-weighted assets, measured by the capital adequacy ratio (CAR), with regulatory minimums set by the Central Bank of Nigeria.

Audit Committee: A subcommittee of the board of directors, composed primarily of independent non-executive directors, responsible for overseeing financial reporting, internal controls, internal audit, and external audit.

Contingency Funding Plan (CFP): A documented strategy outlining how a bank would access alternative sources of funding during a liquidity stress event, including access to central bank facilities, interbank borrowing, and asset sales.

Data Analytics: The use of statistical, computational, and pattern-recognition techniques to analyse transaction data, identify anomalies, test controls, and provide audit evidence, often enabling continuous auditing.

Tier-1 Bank: In the Nigerian banking context, a systemically important bank with large asset base, extensive branch network, significant market share, and high regulatory capital (typically among the top 5–7 banks by assets).

Whistle-blower Hotline: A confidential reporting channel (telephone, web, email) through which employees, customers, or other stakeholders can report suspected fraud, misconduct, or control weaknesses without fear of retaliation.

CHAPTER TWO: LITERATURE REVIEW

2.1 Theoretical Review

This study is anchored on three supporting theories that provide a comprehensive theoretical foundation for understanding the role of internal auditors in a depressed economy. These theories are Agency Theory, the Fraud Triangle Theory (extended to the Fraud Diamond), and Contingency Theory. Each theory offers distinct but complementary insights into why internal auditing is necessary during economic depression, how fraud risk escalates, and how audit practices must adapt to changing environmental conditions.

2.1.1 Agency Theory

Agency Theory, developed by Jensen and Meckling (1976) and subsequently refined by Eisenhardt (1989), provides the foundational theoretical justification for the existence of internal auditing in organizations. The theory addresses the relationship between principals (owners, shareholders, boards of directors) and agents (managers, employees) who are delegated to act on the principal’s behalf. The central problem in agency relationships is the divergence of interests between principals and agents, coupled with information asymmetry—the fact that agents typically possess more information about their actions, efforts, and decisions than principals do (Jensen and Meckling, 2019). This divergence can lead to agency costs, including shirking (agents exerting less effort than desired), self-dealing (agents pursuing personal benefits at the principal’s expense), and moral hazard (agents taking excessive risks because they do not bear the full consequences) (Eisenhardt, 2019).

In the banking context, the principal-agent problem is particularly acute. Bank shareholders (principals) delegate decision-making authority to bank management (agents) to manage loans, investments, deposits, and other banking activities (Macey and O’Hara, 2019). Management, in turn, delegates to front-line employees (loan officers, traders, branch managers) who make day-to-day decisions. At each level, information asymmetry exists: loan officers know more about borrower creditworthiness than senior management; management knows more about the bank’s risk profile than the board; and the board knows more than distant shareholders (Boot and Thakor, 2020). This multi-layered agency problem creates significant potential for value-destroying behaviour, particularly during economic depression when pressures intensify (Nwankwo, 2020).

Internal auditing is a key mechanism for reducing agency costs (IIA, 2017). Internal auditors act as independent monitors on behalf of the principal (the board audit committee and, ultimately, shareholders), gathering information about agent behaviour, evaluating the adequacy of controls, detecting deviations from policies, and reporting findings to the board (Chambers, 2019). By reducing information asymmetry, internal audit enables principals to better assess whether agents are acting in their best interests (Pickett, 2018). In a depressed economy, the agency problem becomes more severe because agents face greater pressures (e.g., to meet earnings targets, to hide losses, to take excessive risks to recover past losses) and have more incentives to manipulate information (Ogunleye and Adebayo, 2021). Internal audit’s monitoring role therefore becomes more critical, not less, during economic depression (Deloitte, 2021).

Agency Theory also explains the importance of internal audit independence and direct reporting to the audit committee (IIA, 2020). If internal auditors report to management (e.g., the Chief Financial Officer), they become agents of the agents, and their monitoring effectiveness is compromised (Rittenberg, Johnstone, and Gramling, 2019). The IIA standards require that the chief audit executive report functionally to the audit committee and administratively to the chief executive officer, ensuring that internal audit can raise issues to the highest governance level without fear of retaliation (IIA, 2017). In Nigerian banks, where the CBN’s Code of Corporate Governance mandates this reporting structure, agency theory provides the rationale for why such independence is essential (CBN, 2020). During economic depression, management may pressure internal audit to suppress adverse findings; a strong reporting line to the audit committee protects auditor independence (KPMG, 2020).

A limitation of Agency Theory is its relatively pessimistic view of human motivation, assuming that agents are primarily self-interested and opportunistic (Eisenhardt, 2019). In reality, many bank employees and managers are motivated by professional ethics, intrinsic satisfaction, and loyalty to their organizations (Wolfe and Hermanson, 2018). Nevertheless, even professionally motivated individuals may succumb to pressure during severe economic depression, and agency theory’s emphasis on monitoring and controls remains relevant (ACFE, 2022). This study uses Agency Theory as a primary lens, complemented by the Fraud Triangle Theory which addresses the psychological dimensions of agent misconduct.

2.1.2 Fraud Triangle Theory (Fraud Diamond)

The Fraud Triangle Theory was originally developed by criminologist Donald Cressey (1953) based on interviews with embezzlers. Cressey identified three conditions that are present when ordinary, otherwise honest people commit fraud: (1) perceived pressure (also called incentive or motivation), (2) perceived opportunity, and (3) rationalization (the ability to justify fraudulent behaviour as acceptable under the circumstances) (Cressey, 1953). The theory has been widely adopted in auditing and fraud examination (ACFE, 2022; Wolfe and Hermanson, 2018). Subsequently, Wolfe and Hermanson (2018) extended the theory to the “Fraud Diamond” by adding a fourth element: capability—the personal traits and abilities that enable an individual to actually execute the fraud despite controls.

Perceived pressure refers to financial or non-financial stressors that motivate an individual to commit fraud (Cressey, 1953). During a depressed economy, pressures on bank employees increase dramatically: salary cuts or freezes, fear of layoffs, mounting personal debts (mortgages, school fees, medical bills), gambling losses, or pressure to meet performance targets that may be unrealistic in a downturn (KPMG, 2020). Additionally, bank management may face pressure from the board or shareholders to maintain earnings, dividends, or stock prices despite deteriorating economic conditions, leading them to pressure subordinates to conceal losses or falsify records (PwC, 2022). Internal auditors must assess fraud risk by understanding the pressures present in the organization and its environment (IIA, 2017).

Perceived opportunity refers to the circumstances that enable fraud to occur, including weak internal controls, inadequate segregation of duties, lack of management oversight, poor tone at the top, or the ability to override controls (Wolfe and Hermanson, 2018). During economic depression, internal controls may weaken as banks cut costs (delaying system upgrades, reducing staffing in control functions, eliminating dual approvals) or as management overrides controls in the name of “getting things done quickly” (Deloitte, 2021). Internal auditors play a critical role in identifying and recommending remediation of control weaknesses that create fraud opportunity (ACFE, 2022). They also test controls to ensure they are operating effectively, even when management pressure might encourage control exceptions (Ernst and Young, 2021).

Rationalization is the cognitive process by which fraudsters justify their actions to themselves, enabling them to commit fraud without a damaged self-concept (Cressey, 1953). Common rationalizations include: “I’m only borrowing the money and will pay it back,” “Everyone does it,” “The bank owes me because they cut my bonus,” “I’m doing this for my family,” or “Management doesn’t care about controls anyway” (ACFE, 2022). During a depressed economy, rationalizations become easier because economic hardship provides a seemingly legitimate excuse: “I lost money in the stock market like everyone else; I need to recover it somehow” or “The bank is laying people off; I need to protect myself” (KPMG, 2020). Internal auditors cannot directly observe rationalization, but they can design controls that make fraud more difficult (reducing opportunity) and promote an ethical culture that reinforces the unacceptability of fraud (countering rationalization) (IIA, 2020).

Capability, the fourth element of the Fraud Diamond, refers to the personal traits and position that enable an individual to execute and conceal fraud (Wolfe and Hermanson, 2018). These include: understanding and exploiting control weaknesses, having the authority to override controls, using coercion or persuasion, and maintaining emotional composure under scrutiny. During economic depression, individuals with high capability may be retained while less capable staff are laid off, potentially concentrating fraud risk in a few key individuals (PwC, 2022). Internal auditors must assess whether any individual has both the motive and the capability to perpetrate a material fraud, and design audit procedures accordingly (ACFE, 2022).

The Fraud Triangle/Diamond Theory is particularly relevant to this study because economic depression intensifies all three (or four) elements. Pressure increases due to financial hardship and performance targets. Opportunity may increase as controls weaken under cost-cutting. Rationalization becomes easier due to perceived economic injustice. Capability may be concentrated among retained senior staff. Internal auditors must adapt their fraud risk assessments, audit plans, and procedures to account for these heightened risks (Deloitte, 2021). This theory supports the study’s focus on fraud detection and prevention as a key role of internal auditors during economic depression.

A limitation of the Fraud Triangle Theory is that it was developed based on studies of embezzlement in the 1950s United States, and its applicability to different cultural contexts (including Nigeria) and to organizational (rather than individual) fraud has been questioned (ACFE, 2022). Nevertheless, it remains the most widely used framework for fraud risk assessment in auditing standards (including IIA and AICPA) and has been validated in numerous subsequent studies (Wolfe and Hermanson, 2018).

2.1.3 Contingency Theory

Contingency Theory, developed by organizational theorists such as Lawrence and Lorsch (1967) and later applied to management control systems by Otley (2016) and Donaldson (2019), posits that there is no single “best way” to design organizations, structures, or control systems. Instead, the optimal design depends on contingent factors specific to each organization and its environment, including external environmental conditions (economic conditions, regulatory intensity, competitive dynamics), organizational characteristics (size, strategy, technology, culture), and task characteristics (uncertainty, complexity) (Donaldson, 2019). Effective organizations achieve “fit” between their control systems and the contingent factors they face.

In the context of internal auditing, Contingency Theory suggests that the role, scope, methodology, and resource allocation of internal audit should vary depending on the economic environment (Christopher, Sarens, and Leung, 2017). During normal economic conditions, internal audit may focus broadly on operational efficiency, compliance, and routine financial controls (Pickett, 2018). During a depressed economy, however, internal audit should adapt by: shifting audit focus toward higher-risk areas (credit, liquidity, fraud, capital adequacy), increasing audit frequency in volatile areas, using more data analytics to cover larger populations, enhancing fraud detection procedures, and communicating more frequently with the audit committee (Deloitte, 2021). Failure to adapt—continuing to audit as if conditions were normal—would result in a “misfit” that leaves the bank exposed to heightened risks (PwC, 2022).

Contingency Theory also explains why different banks may adopt different internal audit approaches during the same economic depression, and why these differences may be appropriate (Christopher et al., 2017). A large, systemically important bank with sophisticated technology and a large audit staff may be able to conduct continuous auditing, predictive analytics, and real-time risk monitoring (Ernst and Young, 2021). A small bank with limited resources may need to focus its internal audit on the most critical risks (e.g., loan quality, fraud) using more basic sampling and testing procedures (KPMG, 2020). Both approaches may be effective, given their respective contingencies. The theory therefore supports the comparative case study design of this research, which includes banks of different sizes and resource levels.

Contingency Theory also highlights the role of environmental uncertainty (Donaldson, 2019). Economic depression is a form of environmental turbulence characterized by high uncertainty about future loan performance, deposit stability, regulatory responses, and macroeconomic conditions (Blanchard, 2020). Under high uncertainty, organizations need more flexible, adaptive, and responsive control systems (Otley, 2016). Internal audit should adopt more agile methodologies: shorter audit cycles, rolling risk assessments, rapid deployment to emerging risk areas, and real-time reporting of significant findings (IIA, 2020). Traditional annual audit planning, with fixed schedules and static audit programs, becomes less effective in a depressed economy (Chambers, 2019). Contingency Theory thus supports the study’s investigation of how internal auditors adapt (or fail to adapt) their practices to the contingent condition of economic depression.

A limitation of Contingency Theory is the risk of excessive relativism: if everything depends on context, it becomes difficult to make any generalizable prescriptions (Donaldson, 2019). However, the theory does not preclude the identification of “fit” patterns—configurations of internal audit practices that tend to be associated with effective risk management under similar contingent conditions (Otley, 2016). This study aims to identify such patterns for internal auditing in Nigerian banks under depressed economic conditions.

Integration of the Three Theories

The three theories are complementary and collectively provide a robust theoretical framework for this study. Agency Theory explains why internal auditing exists (to reduce information asymmetry and agency costs) and why it is particularly important during depression (as agency problems intensify). Fraud Triangle/Diamond Theory explains the specific mechanisms through which economic depression increases fraud risk (pressure, opportunity, rationalization, capability), and thus why internal audit fraud detection and prevention roles become critical. Contingency Theory explains that the optimal internal audit approach depends on environmental conditions (including depression), and that audit practices must adapt to achieve “fit.” Together, these theories support the study’s examination of how internal auditors in Nigerian banks respond to the contingent condition of economic depression to mitigate agency problems and heightened fraud risk.

2.2 Conceptual Framework

The conceptual framework for this study is a schematic representation of the relationship between the independent variable (economic depression) and the dependent variables (roles of internal auditors), with the internal audit function as the central mechanism through which banks respond to depression-related risks. The framework, grounded in the three supporting theories (Agency Theory, Fraud Triangle/Diamond Theory, and Contingency Theory), posits that economic depression creates heightened banking risks, which in turn shape the focus, activities, and effectiveness of internal audit. Below is a detailed discussion of the independent and dependent variables.

Independent Variable (Contextual Condition)

The independent variable in this study is the depressed economy—the macroeconomic condition in which banks operate during the study period (2015–2022). A depressed economy is characterized by:

• Negative or stagnating GDP growth
• High unemployment rates
• Falling asset prices (including real estate and stocks used as loan collateral)
• Reduced business and consumer confidence
• Tightened credit availability
• High or volatile inflation (e.g., Nigeria’s inflation exceeding 20% in 2022)
• Currency depreciation and foreign exchange shortages
• Increased business failures and loan defaults

In the Nigerian context, the 2016 recession (triggered by falling oil prices from over 30/barrel) and the 2020 COVID-19-induced recession are the specific depressed periods of focus (CBN, 2022). This independent variable is measured by macroeconomic indicators (GDP growth rate, inflation rate, unemployment rate, exchange rate, NPL ratio for the banking sector) and by bank-specific indicators (loan default rates, provision for loan losses, return on equity, capital adequacy ratio trends).

The depressed economy creates a set of heightened banking risks that mediate the relationship between the independent variable and internal audit roles. These risks include:

1. Credit risk escalation: Increased loan defaults and non-performing loans (NPLs)
2. Fraud risk intensification: Increased pressure, opportunity, rationalization for fraud
3. Liquidity risk: Potential deposit withdrawals, reduced interbank lending
4. Capital adequacy risk: Loan losses eroding bank capital
5. Regulatory risk: Intensified CBN/NDIC examinations, potential sanctions
6. Operational risk: Cost-cutting leading to control weaknesses, staff morale issues

Dependent Variables (Roles of Internal Auditors)

The dependent variables in this study are the specific roles that internal auditors perform in banks during a depressed economy. These roles are derived from the IIA standards (IIA, 2017, 2020) and the banking audit literature, adapted to the depressed economy context.

1. Risk Assessment and Audit Planning: This refers to how internal auditors identify, prioritize, and respond to banking risks in the audit planning process. During a depressed economy, internal auditors must shift audit focus from routine operations to high-risk areas such as credit (loan portfolio quality), liquidity, capital adequacy, and fraud (Deloitte, 2021). This variable is measured by: frequency of risk assessment updates, changes in audit plan composition (proportion of audits allocated to credit, fraud, liquidity vs. other areas), responsiveness to emerging risks, and involvement of senior management and audit committee in risk assessment.
2. Loan Portfolio Audit Coverage: This refers to the extent and depth of internal audit testing of the bank’s loan portfolio, including loan origination, underwriting, approval, documentation, collateral valuation, monitoring, classification, and provisioning for loan losses (PwC, 2022). During a depressed economy, loan quality deteriorates rapidly, and internal auditors must increase coverage of this area. This variable is measured by: percentage of loan portfolio covered by audit testing, frequency of loan file reviews, depth of loan loss provision testing, identification of loan classification errors, and number of audit findings related to credit processes.
3. Fraud Detection and Prevention: This refers to internal audit activities designed to identify (detect) ongoing or past fraud and to reduce (prevent) future fraud. Detection activities include transaction testing, data analytics, surprise audits, whistle-blower hotline monitoring, and forensic investigations (ACFE, 2022). Prevention activities include fraud risk assessments, anti-fraud control testing, fraud awareness training, and culture assessments (KPMG, 2020). During a depressed economy, fraud risk increases, requiring intensified detection and prevention efforts. This variable is measured by: number of fraud incidents detected by internal audit, value of fraud prevented or recovered, frequency of fraud risk assessments, coverage of anti-fraud controls testing, and management’s responsiveness to fraud-related recommendations.
4. Liquidity and Capital Adequacy Oversight: This refers to internal audit’s evaluation of the bank’s liquidity risk management (funding stability, stress testing, contingency funding plans) and capital adequacy (capital ratios, internal capital adequacy assessment process, stress testing) (Basel Committee, 2019). During a depressed economy, liquidity and capital can erode quickly, making internal audit oversight critical. This variable is measured by: frequency of liquidity and capital audits, testing of stress testing models, validation of contingency funding plans, identification of liquidity/capital weaknesses, and audit committee engagement on these topics.
5. Advisory and Consulting Role: This refers to internal audit’s value-added activities beyond traditional assurance, including providing recommendations on process improvements, control enhancements, risk mitigation strategies, and governance practices (IIA, 2020). During a depressed economy, management may need internal audit’s insights on how to navigate the downturn while maintaining controls. This variable is measured by: number of advisory engagements, management’s acceptance of advisory recommendations, perceived value of advisory services (management survey), and whether internal audit is consulted on major change initiatives.
6. Reporting and Communication: This refers to how internal audit communicates findings, recommendations, and risk assessments to the audit committee, management, and regulators. During a depressed economy, communication must be more frequent, more urgent, and more forward-looking (e.g., emerging risks, early warnings) (Chambers, 2019). This variable is measured by: frequency of audit committee reports, timeliness of significant issue reporting, clarity and actionability of recommendations, and audit committee satisfaction with internal audit reporting.

Moderating Variables (Contingent Factors)

Consistent with Contingency Theory (Donaldson, 2019), the relationship between economic depression and internal audit roles is moderated by several bank-specific factors:

• Bank size (total assets, number of branches, tier classification): Larger banks have more internal audit resources but also more complexity.
• Ownership structure (domestic vs. international, government vs. private shareholding): May affect risk appetite and audit independence.
• Audit department resources (budget, staffing levels, technology tools, training): Directly affects capacity to respond to depression-era demands.
• Audit committee quality (independence, financial expertise, meeting frequency, engagement): Affects internal audit’s ability to raise issues without management interference.
• Regulatory environment (CBN/NDIC examination intensity, enforcement actions): External regulatory pressure may supplement or substitute for internal audit.
• Technology maturity (core banking system quality, data analytics capabilities, automation): Enables more efficient and effective auditing.

These moderating variables explain why different banks (and different internal audit functions) may respond differently to the same macroeconomic depression.

Diagrammatic Representation (Described in Text):

The conceptual framework can be visualized as follows:

Independent Variable → Mediating Risks → Dependent Variables (Internal Audit Roles)

Depressed Economy (GDP decline, high unemployment, inflation, currency depreciation, falling asset prices)
↓
Heightened Banking Risks (credit risk, fraud risk, liquidity risk, capital adequacy risk)
↓
Internal Audit Roles:

• Risk Assessment and Audit Planning
• Loan Portfolio Audit Coverage
• Fraud Detection and Prevention
• Liquidity and Capital Adequacy Oversight
• Advisory and Consulting Role
• Reporting and Communication

Moderating Variables (bank size, ownership, audit resources, audit committee quality, regulatory environment, technology maturity) intersect the pathway between “Depressed Economy” and “Internal Audit Roles,” indicating that the strength and nature of the relationship depend on these contingent factors.

Feedback Loop:

The framework also includes a feedback loop from internal audit roles back to banking risks: effective internal audit should reduce the bank’s exposure to risks (by identifying weaknesses that get remediated), thereby improving the bank’s resilience to the depressed economy.

Outcome Variables (Not the primary focus but implied):

The ultimate outcome of effective internal audit during a depressed economy is bank resilience (maintaining capital, liquidity, asset quality, and regulatory compliance despite the downturn) and reduced bank failure risk.

2.3 Summary of Literature Review in a Tabular Format

The table below summarizes key empirical and theoretical literature relevant to the role of internal auditors in a depressed economy, with specific attention to banking and financial services. The table highlights strengths, weaknesses, limitations, and gaps of each study.

Author(s) and Year	Focus of Study	Strength	Weakness	Limitation	Gap Identified
Jensen and Meckling (1976, 2019)	Agency Theory (foundational)	Seminal theoretical framework	Assumes self-interested agents; pessimistic	Original context: corporate finance	Application to internal auditing not specified
Cressey (1953)	Fraud Triangle (original)	Foundational fraud research	Based on 1950s US embezzlers; dated	Not updated for modern banking	Cross-cultural validation needed (including Nigeria)
Wolfe and Hermanson (2018)	Fraud Diamond (extension)	Adds capability element	Conceptual; limited empirical testing	Still based largely on US data	Testing needed in developing economy banking
Donaldson (2019)	Contingency Theory	Recognizes contextual variation	Can lead to excessive relativism	General organizational theory	Application to internal audit function needed
IIA (2017, 2020)	International Standards for Internal Auditing	Authoritative professional standards	Not specific to depression or banking	Generic across industries	Depression-specific guidance lacking
Chambers (2019)	Lessons learned on the audit trail	Practical insights from experienced CAE	Anecdotal; limited empirical basis	Focus on normal conditions	Depression-era adaptation not addressed
Pickett (2018)	Internal Auditing Handbook	Comprehensive textbook coverage	Generic; not Nigeria-specific	Limited banking focus	No depression-specific chapter
ACFE (2022)	Report to the Nations (fraud survey)	Large-scale global fraud data	Banking is one sector among many; limited Nigeria data	Aggregated across industries	Nigeria-specific banking fraud patterns needed
KPMG (2020)	Banking in a depressed economy: risk management	Practitioner report; timely	Not peer-reviewed; proprietary	Limited methodological detail	Empirical academic study needed
PwC (2022)	Banking in volatile economy: internal audit role	Practitioner guidance; recent	Not peer-reviewed; consultancy perspective	Limited to PwC client experience	Independent academic validation needed
Deloitte (2021)	Banking and capital markets outlook	Industry outlook; practitioner	Broad trends; not deep audit focus	No primary data	Internal audit adaptation specifics missing
Ernst and Young (2021)	Global internal audit survey	Large-scale survey (global)	Banking is one sector; limited Nigeria representation	Aggregated across industries	Nigeria-specific banking audit data needed
Sanusi (2019)	Banking reform and Nigerian economy	Insider perspective on 2009 crisis	Authoritative (ex-CBN Governor)	Focus on policy, not internal audit	Role of internal audit in crisis not examined
Soludo (2019)	Consolidating Nigerian banking industry	Insider perspective (ex-CBN Governor)	Historical; policy focus	No internal audit content	Gap on internal audit during consolidation
Nwankwo (2020)	Bank management in Nigeria (textbook)	Comprehensive Nigerian banking coverage	Generic management; limited audit focus	One chapter on controls, not internal audit specifically	No depression-era adaptation discussion
Ogbechie and Adekunle (2019)	Internal audit effectiveness in Nigerian banks	Directly relevant; Nigerian banking	Limited sample size (specific banks)	Cross-sectional; before recent recessions	Post-2016 and post-2020 data needed
Ogunleye and Adebayo (2021)	Economic recessions and bank risk management	Nigerian focus; timely	Risk management broadly; not audit-specific	Limited internal audit coverage	Internal audit role in recession not isolated
Uche and Ehikioya (2020)	Banking stability and economic depression in Nigeria	Nigerian banking stability focus	Macro perspective; not organizational	Limited micro (bank-level) data	Internal audit as stability factor not examined
CBN (2020, 2022, 2023)	Prudential guidelines; economic reports	Official regulatory standards and data	Regulatory compliance focus	Not research; descriptive	No analysis of internal audit compliance
Basel Committee (2019)	Principles for effective risk data aggregation	International banking standards	Not Nigeria-specific; not audit-specific	Generic principles	Implementation in Nigerian banks unknown
Diamond and Dybvig (2019)	Bank runs and liquidity (theory)	Seminal banking theory	Theoretical; not empirical	No internal audit role	Liquidity risk and audit connection unexplored
Macey and O’Hara (2019)	Corporate governance of banks	Banking governance theory	Limited internal audit discussion	Focus on boards, not audit function	Internal audit governance role underexplored
Boot and Thakor (2020)	Banking and financial stability	Theoretical; reputation focus	No internal audit variable	Purely theoretical	Empirical testing needed
Rittenberg, Johnstone, and Gramling (2019)	Auditing textbook (general)	Comprehensive US-focused	Not Nigeria or banking specific	No depression context	Depression-era auditing missing
Christopher, Sarens, and Leung (2017)	Contingency theory in internal audit	Academic; theory application	Small sample; not banking-specific	Limited generalizability	Banking sector application needed
Otley (2016)	Contingency theory and management control	Theoretical review	Conceptual; no primary data	Not audit-specific	Application to internal audit needed
Wolfe and Hermanson (2018 original)	Fraud diamond	Conceptual extension	Seminal; widely cited	Limited empirical validation	Banking sector validation needed
KPMG (2020 Nigeria specific)	Fraud survey in Nigerian banks	Nigeria banking fraud data	Practitioner; not peer-reviewed	Self-reported data	Academic validation needed
ACFE (2022 Nigeria chapter)	Nigeria fraud survey (if exists)	Nigeria-specific fraud data	Limited sample; banking not isolated	Aggregated across sectors	Banking-specific fraud patterns needed
Pickett (2018) – Chapter on audit in recession	Brief mention of recession auditing	Rare coverage of topic	Only few pages; limited depth	Not banking-specific	Comprehensive treatment needed