The financial compliance landscape is complex and requires a perfect balance between regulatory requirements, reporting, risk management protocols, and efficient transaction tracking systems to combat financial crimes. Circular trading in bill discounting is a common tactic used by fraudsters or criminals to hide or mask the source of their illicit funds.
Therefore, it is crucial for financial institutions to go above and beyond to detect the early signs of potential fraud in biII discounting and tackle them efficiently to minimise bad debt and maintain regulatory compliance.
This article explores the warning signs that financial institutions must look out for to combat fraud committed by circular trading in bill discounting.
What is Circular Trading?
Circular trading, not to be mistaken for trade-based money laundering (TBML), is a common domestic tax evasion or financial fraud technique used by criminals or a group of companies by issuing invoices or trading goods among themselves.
This is primarily done to secure loans (i.e., invoice financing), inflate the company’s turnover, and claim tax rebates illegally.
How Does Circular Trading Work?
Let’s understand how circular trading works with an example.
Suppose, there are three companies, Company A, Company B, and Company C.
Circular trading follows this pattern:
On paper, Company A shows that it is selling goods to Company B, Company B shows it is selling to Company C, and Company C shows it is selling to Company A.
In short, the invoice issued by Company A circles back to it, which results in increased sales on paper, but in reality, the sales never happened.
All the involved business entities use these invoices to secure credit, apply for credit, and evade taxes, committing financial fraud.
Circular Trading in Bill Discounting: Red Flags
This section explores the red flags financial institutions should watch out for in circular trading in biII discounting.
1. Unusual or Suspicious Transaction Patterns
If the same group of companies or individuals share and accept invoices among themselves, as seen in the above example, it is a huge red flag.
You must inspect how quickly you discount bills or invoices. If you discount them immediately, you can flag these transactions.
2. No Legitimate Proof of Supplied Goods or Services
Imagine this. Apart from the invoices or bills, a company does not have any proof or evidence that justifies the supply of goods or services provided, such as formal communication emails, logistics-related documents, and delivery notes.
Typically, such businesses have low-value assets but a high turnover, indicating potential fraud.
3. Erratic Financial Behaviour
Typically, businesses involved in circular trading in bill discounting attempt to secure credit by showing high accounts receivable.
However, the receivables are expected from the same group of colluding businesses, highlighting the potential of fraud and credit-related risk.
4. Know Your Customer (KYC) Irregularities
All the parties involved in bill discounting fraud often share similar boards of directors, owners, and addresses. Further, upon investigation, there is a strong chance their KYC details, including phone numbers, PAN numbers, and tax IDs, are either interconnected or overlapping.
This is one of the most obvious signs of collusion and an attempt to defraud financial institutions.
Ways to Prevent Circular Trading in Bill Discounting
Fraudsters and criminals are keeping up with the technological advances and evolving regulatory landscape by resorting to complex and hard-to-detect techniques, along with targeting digital loopholes.
Here are a few ways financial institutions can prevent circular trading in biII discounting:
1. Leverage Technology
Forward-thinking financial institutions are harnessing Artificial Intelligence (AI) and machine learning-powered tools to spot red flags and discrepancies in bill discounting, highlighting suspicious activities well in advance before they can escalate.
Such technological advancements have paved the way for accurate monitoring tools, thus preventing businesses from engaging in circular trading in bill discounting.
2. Better Compliance
Criminals are likely to target stubborn and complacent financial institutions that are unwilling to adapt and tighten their compliance practices.
Thus, perform strict background checks, verify KYC documents, note ownership structure, and monitor for overlapping elements.
3. Work With Trade Credit Registries
One of the most effective ways to tackle fraud and irregularities in bill discounting is by collaborating with platforms, including Receivables Exchange of India Limited (RXIL), to keep tabs on the involved parties.
Parting Notes
Circular trading in bill discounting is common and goes undetected unless financial institutions use technology to address it.
The need of the hour is to leverage AI-driven tools that can aid financial institutions in detecting the early warning signs and tackle financial fraud in bill discounting before it hurts their integrity.
From bank statement analysers and credit bureau data analysis to document identification, Finezza provides end-to-end solutions to tackle circular trading.
These solutions use cutting-edge technology to detect anomalies and suspicious financial activities, empowering financial institutions to intervene promptly.
Book your free demo today to learn more about Finezza’s solutions.
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