The Reserve Bank of India (RBI), while revising its master directions on fraud risk management in the regulated entities (REs), directed lenders, including commercial banks, all India financial institutions, cooperative banks and non-banking finance companies (NBFCs), including housing finance companies (HFCs), to hear borrowers before classifying the borrower or borrowing entities as fraud. With the issuance of three master directions, RBI says the existing 36 circulars on fraud risk management in REs are withdrawn. This is done with the intent of rationalising the existing instructions and reducing the compliance burden on the REs, it added.
RBI says, "The master directions now expressly require that the REs shall ensure compliance with the principles of natural justice in a time-bound manner before classifying persons or entities as fraud, duly taking into account the Supreme Court judgment dated 27 March 2023 in the matter of State Bank of India Vs Rajesh Agarwal. Framework on early warning signals (EWS) and red flagging of accounts (RFA) has been strengthened further for early detection and prevention of frauds in the REs and timely reporting to law enforcement agencies (LEAs) and supervisors. Further, requirements for data analytics and market intelligence unit for strengthening risk management systems have been mandated."
"These directions have now been made applicable to regional rural banks, rural cooperative banks and HFCs as well, with the intent of promoting better fraud risk management systems and framework in such REs," it added.
According to RBI, these master directions are prepared based on a comprehensive review of the earlier master directions, circulars and emerging issues. "These master directions are principle-based and strengthen the role of the board in overall governance and oversight of fraud risk management in the REs. These directions also emphasise the need for instituting robust internal audit and control framework in the REs."
While tweaking a 2016 master circular on frauds issued by RBI, the Supreme Court in March last year ruled that a hearing must be allowed for borrowers before classifying their accounts as fraud. Since classifying an account as fraud entails serious civil consequences for the borrower, RBI's directions must be construed reasonably by reading the requirement of observing the principles of natural justice, the apex court says.
A bench headed by chief justice DY Chandrachud affirmed an order passed by the Telangana High Court (HC) and set aside the contrary view of the Gujarat HC.
In its order, the bench says, “Consistent with the principles of natural justice, the lender banks should provide an opportunity to a borrower by furnishing a copy of the audit reports and allow the borrower a reasonable opportunity to submit a representation before classifying the account as fraud. A reasoned order has to be issued on the objections addressed by the borrower. On perusal of the facts, it is indubitable that the lender banks did not provide an opportunity to hear to the borrowers before classifying their accounts as fraud. Therefore, the impugned decision to classify the borrower account as fraud is vitiated by the failure to observe the rule of audi alteram partem.” (
Read: Borrowers Must Be Heard before an Account Is Classified as Fraud: SC)
