Third Line of Defense Crucial in Financial Crime Risk Management
A robust third line of defense is essential for financial institutions to effectively manage risk and comply with anti-money laundering (AML) and combating the financing of terrorism (CFT) regulations.
Importance of Third Line of Defense
According to a recent report by the Committee of Sponsoring Organizations (COSO), the third line of defense is vital in evaluating the effectiveness of compliance with policies and procedures related to financial crime. This function typically provides guidance to management on developing and designing control frameworks, as well as training staff on AML/CFTR regulations.
External Auditors’ Role
External auditors play a significant role in evaluating the internal controls and procedures of financial institutions during their financial audits. They confirm that these institutions are compliant with AML/CFT regulations and supervisory expectations.
- It is essential for licensees to ensure that the scope of the audit is adequate to address their risks, and that the assigned auditors have the requisite expertise and experience in AML/CFTR regulations.
Board Oversight
The Board should regularly review and monitor the financial crime risk management regime of the institution to ensure it is commensurate with regulatory and industry standards. Key areas for review include:
- Legislative and regulatory changes
- Relationship and customer acceptance
- Ongoing relationship and transaction monitoring
- Correspondent banking
- Exception reporting
- Cash transactions
- Suspicious transactions reporting
- Ethical employee behavior
- Guidelines for business conduct
Business Acceptance
Part II of the Financial Transactions Reporting Act (FTRA) emphasizes the legal obligation of licensees to verify client identities. The Securities Industry (AML and CFT) Rules and new customer due diligence (CDD) and account opening guidelines annexed to the Central Bank of The Bahamas (CBOB) AML/CFT Guidelines highlight the requirement to use independent source documents, in addition to customer attestations, to fulfill these legal mandates.
Ongoing Monitoring
The majority of customers are not financial criminals, and a risk-based approach should be adopted to ensure that risk management systems do not pose a significant inconvenience to law-abiding customers. The principle of proportionality to the risk assessment of the client/product/jurisdiction will yield varying levels of compliance requirements.
- Once a relationship has been risk-rated according to the institution’s established framework, due diligence must be applied commensurate with the level of risk associated with the relationship.
- For lower-risk relationships, simplified measures are appropriate, while enhanced measures should be taken for higher-risk clients or relationships to mitigate and manage those risks.
Conclusion
A robust third line of defense is essential in ensuring that financial institutions effectively manage risk and comply with AML/CFT regulations. External auditors play a critical role in evaluating internal controls and procedures, while the Board must regularly review and monitor the institution’s financial crime risk management regime. Business acceptance and ongoing monitoring are also crucial components of a comprehensive financial crime risk management strategy.