Compliance function framework in banks

In collaboration with Dina Al Majzoub, CAMS

Introduction

In today’s evolving financial landscape, the Compliance function in banks plays a pivotal role in safeguarding not only regulatory adherence but also the bank’s reputation and operational integrity. With increasing scrutiny from regulators, heightened public awareness, and the potential for severe financial penalties, a robust Compliance framework is regarded as essential.

This article provides a summary examination of the Compliance function framework in banks, covering its main components and key responsibilities.

I. Main components

1) Compliance leadership

Effective Compliance leadership begins with an unwavering commitment to integrity and transparency at the top of the hierarchy. Board members and senior management must lead by example, fostering a culture where Compliance is seen as a foundational principle rather than an obligation. This proactive approach instills a culture of accountability and risk awareness, embedding Compliance as a core element of all bank operations, not just a function limited to specialized teams.

2) Compliance culture

True Compliance effectiveness is achieved by embedding it within the bank’s broader culture. This cultural integration promotes adherence not only to the letter but also to the spirit of the law, encouraging high ethical standards and proactive risk management across all operations. A strong Compliance culture starts with leadership but must extend to every employee in the bank, as engagement at all levels is crucial. When employees feel personally invested in Compliance, they are more likely to raise concerns and adhere to policies, making Compliance a shared value rather than a set of rules. While a centralized Compliance function can offer a systematic approach to managing Compliance, it’s essential to clearly set responsibilities when Compliance is managed across multiple departments. This clarity minimizes overlaps or ambiguities, reinforcing a cohesive, enterprise-wide Compliance strategy.

3) Compliance risk

In a banking context, Compliance risk encompasses potential exposure to legal or regulatory penalties, financial losses, reputational harm or economic sanctions from failure to meet evolving legal standards, regulatory guidelines, or codes of conduct. Compliance risk is not confined to legal breaches; even actions that technically comply with regulations but negatively affect shareholders, clients, employees, or the broader market can lead to significant reputational damage, highlighting the need for a holistic view of Compliance risk. One of the primary challenges in compliance management is keeping pace with rapid regulatory changes. Banks operating across multiple jurisdictions must navigate different regulatory frameworks, making consistent compliance a complex task. Additionally, limited resources can strain compliance teams, particularly in smaller institutions, requiring a strategic focus on the adoption of a risk based approach in the Compliance function.

4) Organizational design

Depending on the bank’s size and complexity, the Compliance function may adopt a centralized model, where a single team manages all compliance activities, or a decentralized model, where compliance responsibilities are embedded within each business unit. Each model has its strengths; a centralized approach ensures consistency, while a decentralized model allows for more tailored compliance strategies. The Compliance function must also operate in close collaboration with legal and risk management departments to form a comprehensive risk mitigation framework. The legal team’s role in interpreting and advising on laws complements the Compliance team’s mandate to monitor and enforce adherence to internal policies and external standards, while the risk management team can support the Compliance team in identifying and assessing risks associated with the bank’s other operational functions. To optimize interdepartmental synergy, structured channels of communication and regular information-sharing protocols are essential, fostering alignment in Compliance goals.

5) Head of Compliance

The Head of Compliance is instrumental in shaping and executing the bank’s Compliance strategy. This role goes beyond oversight, involving strategic collaboration with senior management to align Compliance with overall business objectives while mitigating risk. Clear, consistent communication channels between departments and higher management enable the Head of Compliance to address issues proactively, facilitating a cohesive and transparent Compliance environment that champions integrity and accountability across the organization. This ensures the bank not only meets regulatory standards but also strengthens its reputation as a responsible, ethically driven institution.

II. Key responsibilities

1) Identifying, measuring & assessing Compliance risk

The Compliance function should, on a pro-active basis, identify the Compliance risks associated with the bank’s business activities, including the development of new products and business practices, the proposed establishment of new types of business or customer relationships, or material changes in such relationships.

The Compliance function should select specific parameters to measure Compliance risk (e.g. by using performance indicators) and use such measurements to enhance Compliance risk assessment. Technology should be used as a tool in developing performance indicators by aggregating or filtering data that may be indicative of potential Compliance issues (e.g. alerts when there is an increasing number of customer complaints, irregular trading or payments activity, etc.).

The Compliance function should assess the appropriateness of the bank’s Compliance procedures and guidelines, promptly follow-up any identified deficiencies, and formulate proposals for amendments.

2) Monitoring, testing & reporting Compliance matters

The Compliance function should monitor and test Compliance by performing sufficient and representative Compliance testing on the bank’s operations, transactions and business practices to ensure adherence to laws, regulations, and internal policies or to detect potential Compliance risks. The outcomes of these tests help refine compliance strategies and enhance risk mitigation efforts.

The Head of Compliance should report regularly to senior management on Compliance matters. The reports should refer to the Compliance risk assessment that has taken place during the reporting period, including any changes in the Compliance risk profile based on relevant measurements such as performance indicators, and a summary of identified breaches and/or deficiencies and the corrective measures recommended to address them, and report on corrective measures already taken. The reporting format should align with the bank’s Compliance risk profile and activities to provide clear insights for decision-making.

3) Managing the Compliance program

The responsibilities of the Compliance function should be carried out under a Compliance program that sets out its planned activities, such as the implementation and review of specific policies and procedures, Compliance risk assessment, and Compliance testing, and training staff on Compliance matters.

The Compliance program should be risk-based and subject to oversight by the Head of Compliance to ensure appropriate coverage across businesses and coordination among risk management functions.

4) Providing Compliance advice & opinions

The Compliance function should advise senior management on Compliance with laws, rules, and standards, including keeping them informed of developments in the area. It should also provide senior management and operational departments with opinions on the Compliance of specific transactions and operations.

5) Assisting in Compliance guidance & training

The Compliance function should assist senior management in:

• Establishing written guidance to staff on the appropriate implementation of Compliance with laws, rules and standards through policies and procedures and other documents such as Compliance manuals, internal codes of conduct and practice guidelines.

• Training staff on Compliance issues.

• Acting as a contact point within the bank for Compliance queries from staff.

6) Executing statutory responsibilities & liaison

The Compliance function may have specific statutory responsibilities (e.g. fulfilling the role of anti-money laundering officer). It may also liaise with relevant external bodies, including regulators, standard setters and external experts. This involves maintaining open channels of communication to stay informed of regulatory changes, responding to inquiries, and managing audits or inspections. This helps in proactively addressing any potential concerns, thereby safeguarding the bank’s standing and reputation.

Conclusion

The Compliance function is essential for maintaining the integrity and stability of banking operations, ensuring adherence to laws, regulations, and ethical standards. As the regulatory landscape continues to evolve, banks must adapt their Compliance strategies to address emerging risks, especially with the rise of digital banking and FinTech innovations that present new risks and opportunities, requiring a dynamic and forward-thinking approach to Compliance. Ultimately, a well-structured and proactive Compliance function will not only safeguard the bank’s operations but also serve as a key driver in maintaining trust and integrity in the financial sector.

Source: ACAMS; BIS; BCBS