MUMBAI: Following the March 2023 Supreme Court judgment on classifying an account/borrower as fraud, the Reserve Bank has incorporated certain changes to ensure “natural justice to the borrower” and has issued a new master circular detailing the essential measures to that all lenders--commercial banks, non-banks, housing financiers and all cooperative banks --have to adhere to before classifying fraud accounts.
In an order on March 27, 2023, the Supreme Court upheld the petition that sought natural justice and directed the banks to give time and offer detailed explanation the borrower and also asked the Reserve Bank to issue new directions towards the same.
In a clarificatory order on May 12, 2023 (after SBI sought some changes on the March order), the court led by the chief justice D Y Chandrachud had said, "the March 27 order did not ask a lender to accord personal hearing to the defaulter borrower. Rather we had said that they should be given adequate notice and an opportunity to make a representation."
The central bank said the latest master circular has been prepared after a comprehensive review of earlier master directions which had laid down the essential measures that a lender’s board must adhere to, before classifying persons/entities as fraud.
The monetary authority said the new master circulars on fraud risk management are aimed at strengthening the internal audit and controls of the boards, and also seeks the use of data analytics in fraud detection.
The new master circulars now mandate a board-approved policy to lay down roles and responsibilities of the board and senior management, when it comes to fraud risk management.
"The master directions now expressly require that all the regulated entities shall ensure compliance with the principles of natural justice in a time-bound manner before classifying persons/entities as fraud, duly taking into account the March 2023 Supreme Court judgment in the matter of State Bank of India & others vs Rajesh Agarwal & others," the circular said.
All regulated entities will now have to issue a detailed show cause notice to the persons, entities and its promoters/whole-time and executive directors against whom allegation of fraud is being examined, as per the revised rules. The show cause notice would have to provide complete details of transactions/actions/events on the basis of which declaration and reporting of a fraud is being contemplated.
"A reasonable time of not less than 21 days shall be provided to the persons/entities on whom the show cause notice was served to respond to the said show cause notice," RBI said.
As part of the revised master directions on fraud risk management, the Reserve Bank said the framework on early warning signals and red flagging of accounts has also been strengthened further for early detection and prevention of frauds in the regulated entities and timely reporting to law enforcement agencies and supervisors.
“These provisions shall apply to all commercial banks, housing finance companies, non-banking finance companies, primary (urban) cooperative banks and rural cooperative banks (state booperative banks) and central cooperative banks, housing finance companies,” it said.
The new direction asks banks to independently confirm from a third-party service providers including professionals that a particular account is fraudulent.
The move is a setback for lenders in making borrowers responsible for the public money they borrow from lenders will impact the credit culture at a time banks have been successful in bringing down bad loans which were in mid-teens a few years back to 2.8 per cent (gross NPAs) in FY24 and the net NPAs down to just about 0.6 per cent.
"These directions are issued to provide a framework to lenders for prevention, early detection and timely reporting of incidents of fraud to law enforcement agencies, RBI and Nabard and dissemination of information by RBI and matters connected therewith or incidental thereto.
There shall be a board-approved policy on fraud risk management delineating roles and responsibilities of the board/board committees and senior management of lenders. The said policy shall also incorporate measures for ensuring the management report the incidents of fraud to all authorires concerned," it said.
Such policy shall contain measures towards prevention, early detection, investigation, staff accountability, monitoring, recovery and reporting of frauds. At the same time, ensure that the policy is in compliance with principles of natural justice in a time-bound manner which at a minimum shall include issuance of a detailed show cause notice to the persons/entities and its promoters/ whole-time and executive directors against whom allegation of fraud is being examined.