Adapting Three Lines of Defense (LoD) to navigate through ever-changing Banking Regulations: A Perspective from Banking Compliance Transformation Expert Kinil Doshi - Finance Digest │ Financial Literacy │ Financial Planning (2024)

Introduction

Within a field known for constant fluctuation, managing risk and adhering to regulations are indispensable for any large banks.

Kinil Doshi, a Banking Compliance Transformation expert and Sr. VP at Citi Bank, sheds light on the pivotal role of the Three Lines of Defense structure which presents a strategic framework that furnishes a methodical way to handle the intricacies of banking rules and regulations continuous evolution.

Understanding the Three Lines of Defense (3 LoD)

The 3 LoD model establishes distinct accountabilities across three levels inside.

The first line of protection i.e. the business itself, handles risk on a daily basis. Operational groups formed within business units stand at the frontlines managing threats as they arise.

The second line of defense in risk management involves independent oversight of risk and compliance related activities. This level focuses on monitoring risk across the organization to ensure compliance with established risk appetites, policies and regulations. The second line of defense is often known as Independent Compliance and Risk Management.

Internal Audit functions as the third line of defense by objectively evaluating and enhancing the effectiveness of risk management, control, and governance processes as an unprejudiced assurance.

Enhancing the Three Lines of Defense

In order to successfully adjust to continuous evolving and dynamic world of rules and regulations, financial companies can execute planned improvements –

1. Operating Model Redesign: A reimagined framework necessitates maximizing talent potential, pinpointing capability shortfalls, and coordinating assets worldwide. This guarantees agility when reacting to evolving regulatory issues, cultivating pliability and toughness.
2. Framework Rationalization: By ensuring congruence between divisions, an organization can simplify adherence to rules across the board. Coordinating oversight duties for all departments means the company’s supervision matches what the law demands, better revealing potential issues, cutting out needless replication, and boosting how productively the business runs.
3. Technology Enablement: Effectively utilizing current technologies is imperative for changing how internal oversight duties are conducted. Digitization, computerization and use of AI tools allow risk identification to be anticipated and financially sensible. State-of-the-art methods strengthen risk administration, guaranteeing receptiveness to the progressively controlling authorized condition.

Roles of Each Line of Defense

1. First Line of Defense (1LOD): Those in the first line of defense, represent operational teams, maintain crucial duties involving thorough risk evaluations, executing safeguards, confirming adherence to rules and regulations, and nurturing an environment where risks are acknowledged. By actively finding and diminishing potential issues beforehand, the 1LOD lays the groundwork for strong risk administration.
2. Second Line of Defense (2LOD): Independent Compliance and Risk Management operating autonomously fulfill separate yet complementary roles within the firm’s risk governance structure. Specifically, the 2LOD designs risk frameworks, issues directives, performs risk evaluations, and confirms adherence to regulatory standards. Its function in anticipating risks proactively is paramount, feeding into the comprehensive efficacy of enterprise-wide risk procedures.
3. Third Line of Defense (3LOD): When assessing operations, Internal Audit aims to ensure compliance, independently oversee risks, and reinforce internal controls. Through contributions to managing regulatory changes, the third line helps to guarantee the organization’s ability to adapt to evolving standards.

Framework Rationalization for Harmonized Controls

A methodical assessment of established procedures is integral for effective risk administration. By systematizing safeguards and removing excess, monetary establishments accomplish an inclusive perspective of their hazard scenery. Aligning safeguards to particular dangers improves hazard inclusion, proficiency, and viability.

Technology Enablement for Digitalized Internal Control Functions

Kinil Doshi notes with technological progress, financial institutions place a major importance on digitizing internal oversight functions. Reconfiguring operating frameworks, harmonizing checks, and taking advantage of emerging technological solutions strengthen risk administration practices. Mechanization and innovative analytics give banks the ability to proactively discern hazards and optimize resource distribution. Most financial institutions reported that technology enablement has significantly improved their internal control functions. By adopting emerging technology solutions such as AI, machine learning, and RPA, these institutions have experienced a major increase in efficiency and a reduction in operational risks.

Adapting to Regulatory Change Management

Adapting to shifting regulatory requirements is key to effective risk management. Harmonizing oversight practices, digitizing internal auditing roles, and reengineering operational frameworks are vital actions. Kinil Doshi acknowledges that Financial institutions must maneuver the evolving compliance environment with strategic flexibility and technological nimbleness to guarantee adherence and preserve competitiveness.

Kinil Doshi’s Final Take

Financial institutions must adapt the Three Lines of Defense framework to successfully navigate the evolving regulatory environment for banks. Strategically updating operating models, streamlining frameworks, and leveraging technology allows these companies to actively address constantly changing compliance requirements. Such a strategy provides resilience by fostering a culture where compliance is a top priority, positioning these organizations for continued success as the banking sector undergoes transformation.