The Three Lines of Defense Model

The Basel Committee on Banking Supervision (BCBS) which establishes international banking standards, has emphasized the importance of the three lines of defense in its guidance on “Sound management of risks related to money laundering and financing of terrorism”

The "Three Lines of Defense" model that has been developed and widely adopted in the field of risk management and governance, particularly within the financial services industry.

This model is applied as a risk management and control model designed to enhance the effectiveness of risk management practices within organizations. This model helps ensure a clear delineation of responsibilities and accountabilities for managing and mitigating risks. The three lines of defense framework are typically applied in the context of financial institutions, but they can be adapted for use in various industries.

 First Line of Defense (Front Office / operations / customer facing staff Responsibilities) ensures that the bank operates in compliance with regulations, clear written policies and procedures are in place for all employees. These documents must outline the obligations and provide guidance on staying within legal boundaries, the internal procedures to identify and report any suspicious transactions.

Committing to high standards, the bank must have robust policies for screening both new and existing staff. This will help maintain ethical and professional conduct within the organization.

An ongoing training program must ensure that all staff members understand and implement Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT) policies. The timing and content of training must adapt based on job roles, responsibilities, and the bank's risk profile.

All new employees must undergo training soon after joining to familiarize themselves with the bank’s policies. Bank also must provide a refresher course to remind staff of their responsibilities and keep their knowledge up-to-date. The frequency and content of these refresher courses must be tailored to the specific risks associated with each employee's role in the bank.

Second Line of Defense (Compliance officers (CO) Role):

The CO is responsible for regularly checking if the bank is following all AML/CFT duties. This involves testing a sample of activities for compliance and reviewing exception reports. If there are concerns about how management is handling AML/CFT procedures. The CO will be reporting to senior management or the board of directors.

The CO will be the main contact for all AML/CFT matters with internal and external authorities, including supervisory authorities and financial intelligence units (FIUs).

To avoid conflicts of interest, the CO's responsibilities should not clash with the bank's business interests. They should not have roles in business lines, data protection, or internal audit. Procedures are in place to ensure that if conflicts arise, AML/CFT concerns are considered objectively at the highest level.

The CO is also responsible for reporting suspicious transactions. They have enough resources to carry out their duties effectively and actively contribute to the bank's AML/CFT efforts. To do this, they must fully understand the bank's AML/CFT requirements, legal rules, and the risks related to money laundering and financing of terrorism in the bank's activities.

Sometimes if needed the CO must also take on the roles of Chief Risk Officer or Chief Compliance Officer. They report directly to senior management or the board. If duties are separated, clear definitions are in place.

 Internal audit, as the third line of defense, plays a crucial role in independently assessing a bank's risk management and controls. It fulfills this responsibility by regularly evaluating compliance with AML/CFT policies and procedures, reporting to the audit committee of the board of directors or a similar oversight body.

Banks should establish clear policies for audits, covering the adequacy of AML/CFT policies in addressing identified risks, the effectiveness of staff in implementing these policies, the efficiency of compliance oversight, and quality control, including criteria for automatic alerts.

Senior management must ensure that audit functions are staffed with knowledgeable and appropriately skilled individuals. The scope and methodology of audits should align with the bank's risk profile, and audit frequency should be risk-based. Internal auditors should periodically conduct AML/CFT audits on a bank-wide basis. Internal auditors should have a process to actively follow up on their findings and recommendations. The auditing processes should generally align with the broader audit mandate of the internal audit, while adhering to any specific AML/CFT auditing requirements.

The three lines of defense model promotes a collaborative and integrated approach to risk management. Each line has distinct roles and responsibilities, and they work together to ensure a robust risk management framework within the organization.

This model helps organizations achieve a balance between operational flexibility and effective risk management, providing assurance to stakeholders that risks are being appropriately identified, assessed, and managed.