Challenges of implementing the three lines of defence model in financial services

In our new article series, Understanding Three Lines of Defence in Financial Services, we explore the three lines of defence (3LoD) model and how financial institutions can implement it effectively to manage risk and strengthen their resilience.

The first article of our series, The Fundamentals, explores what 3LoD is and why it’s important to consider implementing the model. The following article provides an overview of the challenges of implementing 3LoD.

Challenges of implementing 3LoD

Within the financial services sector, effective risk management is critical in safeguarding the financial system's safety and stability, while protecting the interests of customers. The 3LoD model has gained popularity within the industry as a structured approach to manage risk across an organisation, by dividing responsibilities among the three lines of defence.

However, organisations may face a number of challenges when implementing the model, including:

  • Communication and coordination: Implementing the 3LoD model demands that each line of defence must have a clear understanding of its roles and responsibilities. Reliable communication channels is essential to ensure effective collaboration and coordination across the three lines.
  • Role ambiguity: When the roles and responsibilities of each line of defence are unclear, it can lead to confusion and inefficiencies. For example, risk takers in the first line of defence may prioritise generating revenue and profits over implementing necessary controls. To address this, there must be alignment in remuneration and commissions to ensure risk management objectives are prioritised.
  • Resource allocation: Implementing the 3LoD model requires organisations to assign resources to each line of defence. This can be difficult for smaller organisations with limited risk management resources.
  • Independence and objectivity: To provide effective oversight, the second line of defence - which includes risk management, compliance, and other control functions - must be independent of the first line. However, achieving the necessary organisational independence can be difficult. As a result of hierarchal and structural constraints in the organisation, the second line may not always have the authority to challenge the first line.
    Furthermore, the subjective risk assessment of internal audits can jeopardise their objectivity in providing independent assessments of the institution's risk management and control processes. Internal audits must maintain a high level of independence and objectivity to provide effective oversight.
  • Change management: Implementing the 3LoD model often requires significant cultural shifts within the organisation, particularly in risk management. This can be difficult, especially if the organisation has a history of reacting to risks rather than managing them proactively. Change management is a vital component of ensuring the success of the 3LoD implementation internally.
  • Compliance requirements: The 3LoD model may require compliance with specific regulations and standards, such as the Sarbanes-Oxley Act or ISO 31000. This can be challenging, particularly for organisations operating in multiple jurisdictions with varying compliance requirements.

How we can help

The 3LoD model is not just about compliance - it's also a powerful tool for enhancing business performance. By empowering the first line of defence to take ownership of risk management, fostering collaboration and communication across all lines, and leveraging data analytics to drive insights, financial institutions can achieve greater agility and resilience in a fast-changing environment.

For help in implementing the 3LoD model in your financial services business, get in touch with a member of our specialised team.