nested transactions

Understanding Nested Transactions & Risk

A nested transaction in banking refers to a transaction that is initiated within the scope of another transaction. In other words, it’s a transaction that occurs within the context of a larger transaction. This concept is often encountered in the context of online banking or electronic fund transfers. In the realm of money transfers, “nested transactions” typically describe a situation where a money service business (MSB) or smaller financial institutions leverage the accounts of larger correspondent financial institutions to execute transactions for their own clientele.

For example, let’s say you’re transferring money from one account to another online. Within this larger transaction of transferring money, there could be smaller transactions, such as checking an account balance or verifying the recipient’s account details. These smaller transactions are nested within the larger transaction of transferring money.

Nested transactions can be useful for ensuring that all steps within a larger transaction are completed successfully before finalizing the entire transaction. They can also help in maintaining data integrity and consistency within the banking system. If any part of the nested transaction fails, the entire transaction can be rolled back to maintain data integrity.

Example of a Nested Transaction

Here’s an illustration of a nested transaction within the framework of a cross-border transfer:

  1. Customer A begins a funds transfer from their account at Bank A in Country X to their account at Bank B in Country Y.
  2. Bank A confirms that Customer A possesses adequate funds in their account for the transfer.
  3. If Customer A’s account holds sufficient funds, Bank A deducts the funds from Customer A’s account and commences the transfer to Bank B in Country Y.
  4. Bank B in Country Y receives the transfer and deposits the funds into Customer A’s account.

In this scenario, the funds transfer from Bank A in Country X to Bank B in Country Y constitutes a nested transaction, involving multiple sequential steps and contingent upon the preceding step’s outcome (verification of Customer A’s funds sufficiency).

Risks Presented by Nested Transactions

Numerous banks exercise caution when permitting nested transactions, and some may opt to avoid them entirely. To manage associated risks, banks permitting nested transactions typically demand thorough due diligence (AML, KYC, OFAC) on the MSBs or smaller financial institutions they serve, along with imposing stringent transaction monitoring and reporting obligations.

Specifically, the primary banking institution will evaluate the following risks of nested transactions:

  • AML (Anti-Money Laundering) and CTF (Counter-Terrorist Financing) Exposure: The opacity inherent in nested transactions heightens the risk of money laundering and terrorist financing. Malicious actors seeking to move funds illicitly can exploit nested services, potentially involving correspondent banks unknowingly and exposing them to regulatory penalties and reputational harm.
  • Regulatory Compliance Challenges: Banks face stringent regulatory obligations regarding transaction monitoring and reporting of suspicious activities. The dearth of information on the actual parties involved in nested transactions complicates compliance efforts, increasing regulatory risks for banks.
  • Transparency Deficiency: Correspondent banks may lack visibility into the genuine originators and beneficiaries of transactions because these transactions are nested within MSB accounts. This lack of transparency poses challenges for banks in effectively monitoring and identifying suspicious activities.
  • Legal Liability: Correspondent banks could be held accountable for facilitating illicit activities through nested transactions, even if unintentionally. This legal exposure may result in fines, sanctions, and damage to reputation.
  • Operational Complexity: Managing nested accounts necessitates additional controls and monitoring systems, adding complexity to bank operations. This increased burden introduces operational risks, such as internal process failures, human errors, or system malfunctions.

Why use Nested Transactions?

Despite the inherent compliance risk, nested transactions in money transfer offer several uses and advantages:

  • Transaction Efficiency: Nested transactions allow for the consolidation of multiple steps within a single transaction, streamlining the process and reducing the overall time required to complete a transaction.
  • Flexibility: Nested transactions offer flexibility in handling various types of transactions, including cross-border transfers, recurring payments, and batch transactions. This flexibility allows financial institutions to tailor their transaction processes to meet the specific needs of their customers.
  • Enhanced Security: By segregating different components of a transaction into nested transactions, security measures can be implemented at each step to safeguard sensitive information and prevent unauthorized access or manipulation.
  • Improved Transaction Monitoring: Nested transactions enable more granular monitoring of transaction activities, allowing financial institutions to detect and respond to suspicious or fraudulent behavior in a timely manner.
  • Reduced Operational Costs: Streamlining transaction processes through nested transactions can lead to cost savings by minimizing manual intervention, reducing errors, and improving overall operational efficiency.
  • Enhanced Customer Experience: The efficient processing of transactions facilitated by nested transactions can result in faster transaction processing times and improved customer satisfaction.

Overall, nested transactions offer financial institutions a robust framework for managing complex transaction processes efficiently while mitigating risks and enhancing security and customer experience.

The Players

Nested transactions are commonly utilized by Money Service Businesses (MSBs) and smaller financial institutions that may not have direct access to international banking networks or extensive correspondent banking relationships. These entities often rely on nested transactions to facilitate cross-border transfers or other complex financial transactions on behalf of their customers.

MSBs, such as remittance companies, currency exchange providers, and payment processors, frequently leverage nested transactions to access the global financial system through correspondent banks. By nesting transactions within the accounts of larger correspondent banks, MSBs can overcome limitations in their own banking infrastructure and provide their customers with access to international payment networks.

Additionally, smaller financial institutions, including community banks and credit unions, may also rely on nested transactions to expand their service offerings beyond their local markets. By partnering with larger financial institutions or utilizing nested transactions through correspondent banking relationships, these institutions can offer their customers access to a wider range of financial services, including cross-border payments and international remittances.

Overall, MSBs and smaller financial institutions that lack direct access to international banking networks or extensive correspondent banking relationships are most likely to rely upon nested transactions to facilitate cross-border transfers and other complex financial transactions for their customers.

Conclusion

Nested transactions are becoming increasingly more popular as more individuals and find themselves not relying on traditional banking institutions for money transfer and deposit. However, the challenge for the money service business becomes finding a correspondent banking partner willing to engage and help facilitate the manner of nested transaction that the MSB seeks to execute on behalf of its customer.

If you are a money service business or money transmitter seeking to identify suitable banking partners, be sure to reach out.

You can also book a free consultation here.

About Adam Tracy

Adam Tracy is a payments expert and entrepreneur who specializes in payment systems, blockchain technology, digital currencies, and other emerging technologies. He is the founder of Blockrunner, LLC that provides consulting services to clients in the blockchain, payments and cryptocurrency arenas.

Tracy has been involved in the payments industry as an attorney, consultant and entrepreneur since 2005, while he was become an expert in blockchain and cryptocurrency since its advent in 2013. Tracy has worked with a wide range of clients, including startups, established businesses, and investor – both in the United States and worldwide. He has advised clients on a wide range of compliance, legal and operational issues related to payment transfer systems, crypto token generation and architecture, cryptocurrency exchanges, regulatory licensing, smart contracts, and other blockchain applications.

In addition to his consulting work, Tracy has founded several companies in the payments, blockchain and cryptocurrency space, including a digital asset hedge fund, licensed electronic money institution and a blockchain-based tokenization platform. He is also a proponent of decentralized finance (DeFi) and has been involved in various DeFi projects.

Tracy is also a frequent speaker and writer on blockchain and cryptocurrency topics. He has been featured in a wide range of publications, including Forbes, Hollywood Reporters, CNBC, Reuters, CoinDesk, and Bitcoin.com.

Find Adam: https://linktr.ee/adamtracy

Blockrunner, LLC., is a financial services match-making marketplace and consulting company. We are not a bank, FI/NBFI, Payment Service Provider, deposit taking institution, trust, or money services business of any kind. We are not regulated by any financial regulator. Banking, Payment, Processing, and Licensing services are provided by our participating members. This website is for informational purposes only and does not constitute legal advice. If you need legal advice, please consult a licensed attorney in your jurisdiction.

Share