The Reserve Bank of India has recently said that lenders should give defaulting borrowers enough time to respond before they are classified as “fraud accounts”. The necessary action has been taken to ensure adherence to the principles of natural justice, a fundamental aspect of which is affording both parties involved in a dispute the opportunity to be heard. This decision was made in response to the ruling by the Supreme Court on March 27, 2023, which mandates that borrowers are entitled to a fair hearing before their accounts can be labeled as fraudulent.
The RBI has updated its master direction on “Fraud Risk Management”, in which it has been mandated that lenders have to issue a detailed show-cause notice (SCN) to persons, entities, and promoters/whole-time and executive directors against whom there are allegations of fraud.
“The SCN shall provide complete details of transactions/actions/events basis which declaration and reporting of a fraud is being contemplated,” the master direction said.
The central bank has said banks will have to issue a show-cause notice to fraudulent entities, with complete details of the fraud. A “reasonable” time of “not less than 21 days” should be provided to such persons or entities to respond to the show-cause notice, it added.
The master direction is applicable to commercial banks; upper-, middle-, and base-layer non-banking financial companies; all India financial institutions; and cooperative banks.
The RBI has announced that a board-approved policy focusing on fraud-risk management is a prerequisite for all banks. This policy is mandated to clearly outline the roles and responsibilities of the board and its committees, as well as those of the senior management within a bank. Referred to as the “Fraud Risk Management Policy,” it is required to undergo a thorough review by the board at intervals of not more than once every three years.
Reacting to RBI’s direction, “In accordance with the judgement of the Hon’ble Supreme Court in Civil Appeal No. 7300 of 2022 in the matter of State Bank of India & Ors. Vs. Rajesh Agarwal & Ors, dated 27.03.2023, the Reserve Bank of India (RBI) issued the revised Master Directions on Fraud Risk Management for Regulated Entities for commercial banks, cooperative banks, and NBFCs,” said Rishi Agrawal, CEO and Co-Founder of Teamlease Regtech.
The master directions now expressly require that the REs issue a show cause notice to the person/ entity against whom there is an allegation of fraud. As such, retail borrowers can respond to the show cause notice within 21 days.
The RE must consider the relevant information as well as the submission made by the borrower before deciding whether the account is involved in fraudulent
activity.
These 2024 Master Directions lay down the broad categories of activities/ transactions/ incidents that will be categorised as fraudulent activities. These are:
> Misappropriation of funds and criminal breach of trust
> Fraudulent encashment through forged instruments
> Manipulation of books of accounts or through fictitious accounts and conversion of property
> Cheating by concealment of facts with the intention to deceive any person and cheating by impersonation
> Forgery with the intention to commit fraud by making any false documents/electronic records
> Wilful falsification, destruction, alteration, or mutilation of any book, electronic record, paper, writing, valuable security or account with intent to defraud
> Fraudulent credit facilities extended for illegal gratification
> Cash shortages on account of fraud
> Fraudulent transactions involving foreign exchange
> Fraudulent electronic banking/ digital payment-related transactions committed on NBFCs
> Other types of fraudulent activity not covered under any of the above categories
“Retail borrowers must be aware of these items and ensure that their transactions/ banking activities are not fraudulent. Borrowers must ensure compliance with the terms and conditions of the loan sanction documents as well as the wider law of the land and avoid fraudulent transactions,” said Agrawal.
Mayank Khera, Co-Founder & COO, Credgenics, said: “We commend the Reserve Bank of India for its initiative to enforce rigorous norms before classifying loan accounts as fraud. This move reinforces the principles of natural justice, ensuring that all parties involved are given a fair opportunity to present their case. Borrowers are entitled to equitable treatment under the law, which serves as a safeguard against lenders resorting to unjust or misleading tactics when recovering defaulted loans. This ensures that borrowers are protected from any form of exploitation or abuse throughout the debt recovery process, fostering a climate of trust and integrity in financial transactions.”
He added: “By mandating a more transparent and just process, the RBI is not only protecting borrowers’ rights but also enhancing the integrity and accountability within the financial system. We believe this development will foster greater trust and cooperation between lenders and borrowers, ultimately contributing to a more robust financial ecosystem. Moreover, the move by the central bank to mandate data analytics and market intelligence units for strengthening risk management systems as part of the review, is a supportive step.”
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