Navigating the Hidden Risks in Nested Transactions

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In today’s interconnected financial system, master and sub-merchant structures have become essential for businesses looking to enter new markets, enabling (non-) regulated entities to offer financial services to downstream clients. However, these multi-layered setups bring hidden risks that can compromise transparency and elevate compliance risk.?

For banks, Payment Service Providers (PSPs), and Banking-as-a-Service (BaaS) providers, the stakes are high. A lack of visibility across downstream networks creates vulnerabilities, making institutions susceptible to financial crime and regulatory breaches. To navigate these structures effectively, institutions need integrated solutions that provide the transparency, control, and actionable insights required to safeguard against risks inherent in nested relationships and transactions.

Concealed Risk in Master/Sub-Merchant Models

In a master/sub-merchant arrangement, a central "master" account oversees numerous sub-entities, each conducting separate transaction activities. While this structure enables financial inclusion and innovation, it also brings complexities that clash with compliance. Nested transactions—funds routed through multiple entities within a multi-tiered framework—can hide crucial details about the funds' origin, purpose, or destination.

Each additional layer compounds the difficulty of conducting accurate due diligence, limiting visibility and making it difficult to meet anti-money laundering (AML) compliance and other regulatory standards. Tracing participants and funds across these tiers is essential to monitor fraud or money laundering activities, as each layer can harbor concealed risks, heightening exposure to regulatory penalties.

The Risks Inherent in Nested Transaction Structures

Risks from Limited Transaction Visibility

In multi-layered structures, tracking the true origin and end-point of funds becomes challenging. Each intermediary within nested transactions complicates visibility, increasing the risk that suspicious activities go undetected. This obscured view of transaction flows means that financial institutions are more vulnerable to potential money laundering and fraudulent activities.?

Identity and Documentation Risks

In nested structures, multiple entities are involved. This setup creates gaps in verifying the identities of all individuals or businesses, especially for downstream entities that aren’t directly connected to the financial institution. The absence of identity verification providing insight upstream across the layers heightens the risk that unauthorized or high-risk individuals gain access without adequate scrutiny. Document verification becomes similarly difficult; missing or incomplete documentation in any layer of nested structures can result in compliance blind spots, increasing exposure to regulatory fines and penalties.

Challenges with Real-Time Monitoring of Multi-Layered Transactions

Nested transactions make real-time monitoring exceedingly difficult. With funds passing through multiple intermediaries, detecting unusual transaction patterns is challenging, as each intermediary could obscure details that would otherwise raise red flags. The inability to monitor transactions in “real-time” can lead to delays in identifying suspicious activities, providing more opportunities for money laundering and fraud. This lack of immediate oversight is especially problematic in fast-moving digital environments where fraudulent schemes can evolve quickly.

Reporting and Accountability Gaps in Nested Structures

Nested structures also introduce issues that hinder clear reporting and accountability. When financial institutions cannot trace each transaction directly to its origin, it becomes harder to create an accurate audit trail. This limitation can leave institutions vulnerable to regulatory scrutiny and fines due to incomplete or inaccurate reporting. Additionally, without clear accountability across layers, financial institutions may find themselves liable for compliance breaches occurring at downstream entities, even if those breaches were not directly within their control.

Nested Transactions Challenges Across Institutions

The challenges associated with nested transactions vary across financial institution types, each facing distinct operational and regulatory risks:

Correspondent Banking Relationships

Direct Correspondent Relationships expose banks to significant risks even with transparent fund flows between partnered institutions. Banks must continuously scrutinize transaction activities to ensure AML compliance, as they become vulnerable to their partner's financial practices and clientele. Poor partner oversight can lead to regulatory violations and reputational damage.

Nested Correspondent Relationships create additional complexity when Bank A accesses Bank C's services through Bank B's account. This multi-layered structure muddies fund origins and destinations, significantly increasing money laundering and terrorist financing risks. Transaction monitoring becomes particularly challenging as funds pass through multiple intermediaries, making it difficult to identify suspicious patterns or maintain clear accountability.

Banking-as-a-Service (BaaS)?

BaaS providers enable non-bank entities to offer banking services, creating intricate risk landscapes where each fintech client typically manages numerous sub-accounts. Partner stability concerns become more critical as financial stress at any level can cascade through the entire structure. Technology integration vulnerabilities multiply as each connection point represents a potential security risk. Regulatory compliance gaps can emerge as different jurisdictions and requirements intersect.?

Third-Party Payment Processors (TPPPs)

TPPPs face notable challenges when processing payments through multiple layers, particularly when one payment processor serves another. This nested arrangement complicates transaction flow visibility and beneficiary identification. The extended chain between originator and beneficiary creates additional points where fraud can occur, while making illicit activity detection more difficult. These blind spots in transaction monitoring create vulnerabilities that sophisticated financial criminals can exploit.

Money Services Businesses (MSBs)

MSBs introduce distinct risks when providing services through multiple layers, especially in currency exchange and remittance services. When one MSB operates through another, each additional layer complicates transaction monitoring and the ultimate origin of funds. These nested structures make traditional due diligence procedures less effective and create challenges for compliance teams attempting to maintain clear audit trails across multiple service layers.

Ahrvo Comply: Bringing Clarity to Complex Nested Transactions

Ahrvo’s Partner Program enables financial institutions to resell our identity, document, and transaction solution to manage downstream clients - turning compliance from a cost center to a revenue generator. More importantly, Ahrvo Comply helps institutions manage compliance and enhance transparency, addressing the core vulnerabilities inherent in multi-layered financial arrangements.

Enhanced Visibility Across Layers: Ahrvo Comply consolidates data from each layer within a nested structure, offering compliance teams a unified, real-time view of transaction origins, intermediaries, and endpoints. This visibility helps institutions track transactions comprehensively, revealing potential risks that might otherwise remain hidden within layered, multi-entity networks

End-to-End Identity Verification: With Ahrvo Comply’s identity verification capabilities, institutions can ensure that all individuals and entities within a nested structure undergo thorough Know Your Customer (KYC) checks. This feature reduces the risk of unidentified high-risk participants within multi-layered transactions, reinforcing due diligence across the entire network.

Comprehensive Document Reconciliation: Ahrvo Comply’s automated document verification allows institutions to maintain accurate and up-to-date records for each entity within a nested structure. This ensures that all layers meet regulatory documentation standards, creating a reliable audit trail that supports compliance teams during regulatory reviews or audits.

Tailored Monitoring for Early Risk Detection: Through its customizable monitoring,? capabilities, Ahrvo Comply allows institutions to detect anomalies within nested transactions as they occur. This enables proactive identification of suspicious patterns or unusual activity, mitigating risks related to fraud and money laundering before they escalate.

Real-World Challenges and Regulatory Oversight

Several real-world cases underscore the need for robust compliance systems to manage nested transaction risks effectively. For example, Green Dot Bank's strategic pivot in 2022 away from certain BaaS relationships emphasized the delicate balance between innovation and compliance risk management. Wells Fargo’s cautious approach to BaaS partnerships, influenced by regulatory scrutiny, further highlights the compliance burden nested transactions place on traditional banking institutions. Leading payment processors, including PayPal, Stripe, and Adyen, have also enhanced their compliance frameworks to address nested transaction challenges, implementing integrated solutions to reduce downstream fraud risk.

In recent years, oversight efforts have increasingly focused on transparency, risk management, and consumer protection. For example, in June 2024, the Federal Reserve mandated Evolve Bancorp Inc. to improve its risk management programs related to fintech partnerships following findings of inadequate policies. In September 2024, the Federal Deposit Insurance Corporation (FDIC) proposed a rule aimed at enhancing recordkeeping for custodial deposit accounts with transactional features. This proposal seeks to address risks associated with third-party arrangements, particularly those involving non-bank companies that accept deposits on behalf of consumers and businesses. The FDIC's initiative underscores the importance of accurate recordkeeping to ensure prompt payment of deposit insurance to depositors in the event of a bank failure.?

Conclusion

As financial institutions continue to expand their service offerings through master-sub-merchant structures, managing the risks of nested transactions becomes crucial for long-term viability. Implementing integrated identity, document, and transaction management systems provides a comprehensive solution to mitigate downstream risks, ensure regulatory compliance, and safeguard financial integrity. By adopting integrated solutions, institutions can better navigate the complexities of nested transactions, fostering trust and stability across the broader financial ecosystem.

About the Author

Appo Agbamu, CFA is the Founder and CEO @ Ahrvo Labs Inc. Ahrvo develops, markets, and sells compliance, payment, and banking solutions. Appo earned a B.Acc. in Accounting and a BBA in Economics, w/a minor in Financial Markets from the University of Minnesota. In addition, Agbamu is a Chartered Financial Analyst (CFA) charterholder.

About Ahrvo Labs

Modernize your payment, banking, and compliance infrastructure with Ahrvo Network's enterprise platforms. Ahrvo Comply integrates 20+ production-ready modules for identity, document, and transaction management, while our Portable Identity Gateway streamlines financial service access—unifying multi-provider onboarding into one reusable process across 800+ institutions. Learn more @ https://ahrvo.com.