In the context of money transfers, the term “nested transactions” generally refers to a scenario in which a money service business (MSB) or smaller financial institutions use the accounts of larger, correspondent financial institutions to process transactions on behalf of their own customers.
Nested transactions can create several issues from a risk management perspective for banks:
- Lack of Transparency: The correspondent banks may not have visibility into the true originators and beneficiaries of transactions. This is because the transactions are “nested” inside the MSB’s account. This opacity can make it difficult for banks to monitor and identify suspicious activity effectively.
- AML (Anti-Money Laundering) and CTF (Counter-Terrorist Financing) Risk: The lack of transparency can exacerbate money laundering and terrorist financing risks, as individuals or entities looking to move funds illicitly may take advantage of nested services. The correspondent bank might unknowingly facilitate such transactions, exposing themselves to regulatory penalties and reputational damage.
- Regulatory Compliance Risk: Banks are subject to strict regulatory requirements when it comes to monitoring transactions and reporting suspicious activities. The lack of information on the true parties involved in nested transactions can make it more difficult for banks to comply with these regulations.
- Legal Risk: If nested transactions involve illicit activities, the correspondent banks could be held partly responsible for facilitating these activities, even if inadvertently. This can lead to legal ramifications including fines, sanctions, and reputational damage.
- Operational Risk: Managing nested accounts often requires additional controls and monitoring systems, which can add complexity to a bank’s operations. This additional burden may lead to operational risks, including failures in internal processes, human errors, or system breakdowns.
- Reputational Risk: If a correspondent bank is involved in a scandal or regulatory action related to money laundering or terrorist financing through nested transactions, it could suffer reputational damage. This may cause a loss of customer trust and potential business.
Because of these risks, many banks are cautious about allowing nested transactions, and some may avoid them altogether. To mitigate risks, banks that do allow nested transactions will generally require extensive due diligence on the MSBs or smaller financial institutions they service and impose strict transaction monitoring and reporting requirements.
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This page was last updated on June 30, 2023.
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