The 3 Lines of Defence
Find out why banks and financial institutions that adopt the 3 lines of defence model are better equipped to manage credit risk and better positioned to achieve their strategic objectives.
Credit risk management is a crucial aspect of banking operations and the 3 lines of defence model has become an industry standard, providing a clear and transparent framework for managing credit risk across an organisation. The robust framework ensures the responsibility for managing credit risk is clearly defined and allocated. It also provides an effective system of checks and balances, which helps ensure that credit risk is effectively managed and controlled.
The first line of defence refers to the front-line staff who are responsible for originating and servicing loans. These staff members are typically loan officers, underwriters and other lending professionals. They’re responsible for identifying and managing credit risk at the transaction level. They’re also responsible for ensuring that the credit decisions are made in line with the bank’s credit policies and procedures.
The second line of defence refers to the credit risk management function, which is responsible for overseeing and managing credit risk across the organisation. This function includes risk managers, credit analysts and other risk professionals. The second line of defence is responsible for developing and maintaining the bank’s credit risk management policies, procedures and standards. They also provide guidance and oversight to the first line of defence and ensure that the credit risk management practices are consistent with the bank’s overall risk management framework.
The third line of defence refers to the internal audit function, which is responsible for providing independent and objective assurance on the effectiveness of the bank's credit risk management processes. The internal audit function is responsible for conducting periodic audits of the credit risk management processes and controls. They also provide feedback and recommendations to the management team on how to improve the bank's credit risk management practices.
So what benefit does the 3 lines of defence model provide banks and financial institutions? There are three key benefits. Firstly, it provides a clear and transparent framework for managing credit risk across the organisation. Secondly, it ensures that the responsibility for managing credit risk is clearly defined and allocated across the organisation. And finally, it provides a robust and effective system of checks and balances, which helps to ensure that credit risk is effectively managed and controlled.