How Three Lines Of Defense Model Work For AML/CFT Compliance?

“Within the framework of AML/CFT [Anti-Money Laundering / Combating the Financing of Terrorism], the business units… are responsible for identifying, evaluating, and managing the risks associated with their operations… The chief officer in charge of AML/CFT, the compliance department, as well as technology or human resources, make up the second line of defense. The internal audit role ensures the third line of defense.”

–  Basel Committee on Banking Supervision, Guidelines on Sound Management of Risks Related to Money Laundering and Financing of Terrorism 2020

The “Three Lines of Defense” approach has been created and extensively used in the internal control and risk management domains, especially in the financial services sector.

Risk management is an essential component of an organization’s successful business strategy to prevent the money laundering and financing of terrorist activities.

Oftentimes, it gets challenging for MLROs to manage diverse and complicated money laundering activities. To ensure compliance with the latest AML/CFT rules, businesses must shape their policies per the three lines of defense.

According to IIA, short for Institute of Internal Audits, “The three lines of defense model helps organizations identify processes and structures that best assist the achievement of the company’s objectives.

In 2022, 35% of businesses reported organizational threats associated with compliance and AML regulatory risks.

These instances highlight the need for a comprehensive line of defense approach to support strong monitoring and integrate AML-compliant risk management policies by delineating specific roles across each line.

So, what exactly are the three lines of defense (3LOD), and what are some real-life cases of facing penalties due to poor implementation of the three lines of defense?

How do they optimize the organization’s compliance with the anti-money laundering regulations? Here’s the comprehensive guide showing the significance of the three lines of defense:

What are the Three Lines of Defense?

The three lines of defense are a comprehensive defense framework that is developed to optimize the company’s risk management strategy.

This model is of great importance in the context of the AML and counter-terrorism financing compliance framework.

Formulated in 2013 by the Institute of Internal Audits (IIA), the 3LOD model actively seeks to clarify risk management functions and responsibilities among three lines. Its purpose is to minimize money laundering risks in real-time.

The purpose and responsibilities of each of the three lines are briefly examined below:

First Line of Defense: Operational Management

The first line of defense is associated with the company’s front-line operations. It is primarily implemented by the business units performing daily operations to achieve the company’s goals of mitigating money laundering risks.

During this phase, the managers identify the scope of the risks that could undermine the company’s goal-oriented measures. The frontline managers maintain controls to stay in continuous compliance with the regulatory policies and legal AML boundaries.

These staff members are in charge of carrying out AML/CTF regulations via Know Your Customer (KYC) procedures, continuous transaction monitoring, and compliance with legal regulations.

The core responsibilities defined in the first line of defense fall on the business managers, which are discussed below:

• Employees are required to identify the potential threats through risk-based AML protocols, including PEP monitoring and sanction list screening.
• Employees are encouraged to acquire ongoing training sessions to thoroughly understand the counter-terrorism and anti-money laundering policies.
• Business units must implement corrective measures and ensure that their internal controls remain aligned with the company’s risk appetite.

Case Study: Starling Bank Penalties

In 2024, the Financial Conduct Authority (FCA) imposed a £29 million fine on Starling Bank for failing to implement adequate anti-money laundering (AML) and sanctions screening procedures.

Failure

Inadequate customer screening by frontline employees during onboarding and transaction monitoring resulted in the opening of over 54,000 accounts for 49,000 high-risk clients and facilitated transactions.

Impact

In violation of a 2021 agreement, Starling Bank was fined close to £29 million by the FCA for failing to comply with AML standards and for continuing to establish accounts for high-risk clients.

Second Line of Defense: Risk and Compliance Functions

The second line of defense revolves around the introduction of compliance functions that support and oversight the first line operations.

In this phase, the AML compliance officers are responsible for developing risk-based policies, and they are mandated to report directly to the board of directors.

Here, the risk management functions are focused on ensuring that the first-line operations are properly designed and align seamlessly with the AML regulatory environment.

Compliance Officers’ responsibilities include creating thorough AML/CFT rules, evaluating risks, and educating employees on compliance issues.

The breakdown of the second line of defense responsibilities is briefly discussed below:

• The compliance officers and quality controllers must prioritize the understanding of the bank’s legal rules and AML efforts.
• An extensive investigation of the current and emerging business-specific risks is promoted in the second line of defense.
• Senior management is required to examine whether or not first-line operations are compliant with the company’s internal policies.

Case Study: TD Bank Scandal

In 2024, TD Bank consented to pay more than $3 billion in fines to close investigations into money laundering and Bank Secrecy Act (BSA) breaches.

Failure

The compliance department did not put in place efficient AML safeguards, and due to these lacks bank’s systems processed illegal activity, including drug trafficking.

Impact

The compliance department’s crucial role in upholding strong AML procedures was highlighted by the harsh regulatory proceedings TD Bank faced, which included an asset cap and a four-year monitoring period.

Third Line of Defense: Internal Audits

In the last line of defense, internal auditing is promoted. This often involves the services of auditors not directly involved in the company’s AML risk management operations.

The lines of defense model’s main benefit is that it separates and avoids conflicts of interest between those who establish and enforce standards.

To promote impartial advice to management and permit fair decisions, the Basel Committee, for instance, advises that the top AML/CFT officer should not have business line duties.

Separation and autonomy are provided so that the first and second lines can work together in mutually complementary ways.

In the third line of defense, the auditors are directly accountable to the company’s board of directors.

Some of the crucial responsibilities in this tier are:

• Independent auditors make up the third line of defense, assessing how well the first and second lines handle AML/CTF concerns. With the help of the other two lines, this function runs independently.
• The organization’s compliance system is objectively evaluated by internal audits, which also reveal any shortcomings that must be fixed.
• Through unbiased evaluations of the company’s compliance structure, internal audits can spot any flaws or gaps that require attention.

Case Study: Entain Group Violation

AUSTRAC, Australia’s financial crime authority sued Entain Group, the parent company of Ladbrokes, in December 2024 for violating anti-money laundering (AML) and counter-terrorism funding (CTF) regulations.

Failure

When it came to high-risk clients in particular, the internal audit function was unable to spot and fix flaws in the AML framework, such as insufficient supervision and the use of pseudonyms to hide identities.

Impact

Entain Group could have been fined up to $22.2 million for each infringement, highlighting the value of the internal audit function in evaluating and improving AML procedures on its own.

3 Lines of Defense – Why it is Important in Banks?

In several industries, the three lines of defense model serves as a progressive approach that manages the observed risk through internal controls.

As per the Basel 3 regulatory framework, banking institutions are subjected to higher AML risk management practices to stimulate transparency in order to comply with global regulatory policies.

During the new account opening procedure, the 3 lines of defense in banking actively identify the customer’s risk profile.

The 95/46/EC directive formulated by the European Parliament states that to ensure transparent processing, the controllers should implement appropriate AML preventative measures to tackle the discrepancies and data inaccuracies in real time.

The formulation of a successful risk assessment forum enhances the bank’s risk awareness checks and promotes a secure organizational culture.

The 3 lines of defense model guide banks with strong customer monitoring to manage the concerned risk levels. This approach safeguards the institution from long-run financial and reputational risks.

What are the Core Responsibilities of the Compliance Officers in the 3LOD Model?

The three lines of defense model provides a structured risk management approach that promotes transparency and accountability.

Under Directive 2015/849 of EBA guidelines, there are several requirements and responsibilities associated with the compliance officers during the implementation of three lines of defense.

This approach is extensively used in various industries due to its fraud prevention framework. These are:

• To formulate a streamlined 3LOD model, the management body is responsible for actively overseeing the AML strategy, internal monitoring, and risk mitigation frameworks to ensure compliance with anti-money laundering laws.
• The compliance officers should have sufficient industry and regulatory knowledge regarding the potential money laundering risks. They are mandated to ensure regular reporting to the board of directors on AML/CFT activities.
• They must prioritize the identification of specific tasks related to the company’s policy development and customer due diligence checks, especially for high-risk entities.

What the Future Holds for Three Lines of Defense in the AML Framework?

To keep pace with the changing AML/CFT framework, the three lines of defense model must keep up with the regulatory trends.

As far as the first line is concerned, the integration of enhanced risk ownership checks in the business operations is ensured to address the ML threats in real time.

With time, automation in the company’s risk compliance objective is necessary to stimulate AML practices in order to significantly rectify the money laundering practices.

Simultaneously, technological advancement in the 3 LOD model also plays a crucial role in shaping the effectiveness of the AML framework, which includes:

• The data-driven risk detection process boosts the effectiveness of the model as it promotes accurate and comprehensive identification of compliance risks.
• Businesses must prioritize the integration of real-time risk monitoring tools to protect businesses from external money laundering risks.
• The integration of data-driven tools may optimize the functionality of the three lines by formulating an additional layer of security and in-depth scrutinization to counter money laundering.

Institutions are adopting innovative and advanced technology to strengthen their AML/CFT compliance through these lines of defense.

One such technology is AML Watcher, which provides thorough screening to strengthen the three lines of defense against money laundering.

How?

Find here:

How Does AML Watcher’s Screening Solution Support the Three Lines of Defense in AML/CFT Compliance?

AML Watcher’s all-inclusive AML risk screening solution improves the efficacy of all three lines of defense, which gives operational teams real-time risk detection capabilities, compliance teams comprehensive insights for well-informed decision-making, and auditors access to transparent, verifiable data for independent reviews.

AML Watcher assists:

At First Line of Defense

Real-Time Risk Screening

AML Watcher allows operational teams to instantly screen customers and transactions against extensive local and international sanction lists, politically exposed individuals (PEPs), and negative media sources.

With this, frontline employees are better able to spot suspicious activity at the point of entry and stop illegal transactions before they happen.

Customized Alerts

Every time a match takes place, frontline teams are automatically notified so that possible risks may be addressed right away.

This improves the organization’s operational risk management capabilities for compliance.

At Second Line of Defense

Comprehensive Risk Assessment

The comprehensive screening conducted by AML Watcher across many databases, including over 3500 watchlists and real-time adverse media scanning from 50k+ media sources, gives the compliance team comprehensive risk assessments.

Global comprehensive screening assists compliance officers in identifying high-risk customers and transactions, so the institution can make sure it complies with national and international regulations.

Risk Scoring and Classification

Compliance teams may classify customers according to their risk levels (e.g., high-risk PEPs, high-risk nations) and take the necessary steps, including enhanced due diligence (EDD), with the help of automated risk classification and customizable risk scoring.

This makes it possible to allocate resources more precisely and handle risks proactively.

Unified Case Management

Through efficient case management, AML Watcher helps in redefining the organizational policies that could streamline the risk management process.

Its ability to centralize diverse customer information on a single platform helps address the major compliance challenges.

At Third Line of Defense

Audit Trail and Reporting

Internal auditors may easily monitor compliance efforts with AML Watcher’s comprehensive audit record of all screening actions.

During audits or regulatory inspections, these thorough records may be utilized to confirm adherence to FATF and other local rules and offer insight into how well the institution’s AML compliance systems are working.

Independent Review

The real-time monitoring features of the platform enable auditors to independently examine actions that have been identified and evaluate the effectiveness of risk management strategies.

In addition to making sure all legal requirements are fulfilled, they may guarantee that the first and second lines of protection are operating effectively.