RBI asks lenders to hear out loan defaulters before tagging accounts as ‘fraud’; check revised norms

The Reserve Bank of India (RBI) on Monday, July 15, asked banks and other financial institutions to give defaulting borrowers adequate time before they are classified as “fraud accounts".

The banks now have to issue show-cause notices to fraudulent account holders which will have the full details of the fraud, said the RBI in a release. The central bank statement also said a reasonable time of “not less than 21 days” should be given to defaulters to respond to the show-cause notice.

The change in the current rule comes after the Supreme Court of India marked in a judgement in March 2023 that banks cannot independently declare a bank account as fraud without giving the chance to the account holder to present its case.

The principles of natural justice that are to be followed by the regulated entities demand that the borrowers must be presented with a notice which allows them to explain the conclusion of the audit report and they are to be allowed to represent themselves in front of the regulated entities. This should happen before an account is classified as a fraud account under the master directions of the RBI.

According to the RBI guidelines, the board of financial institutions must review their fraud risk management policy once every three years. The banks are also required to set up a special committee from the board that allows them to monitor and take follow-up action on fraud cases.

The new amendment of the master directions mandates the banks to have a framework for Early Warning Signals (EWS) and flag the fraud accounts which are under suspicion of the bank for one or more reasons in case of potential fraud. This will come under the overall risk management policy.

In addition to the said guidelines, the RBI has mandated banks to strengthen their EWS system by recognising suitable potential indicators of fraud.

These directions have now been made applicable to Regional Rural Banks, Rural Cooperative Banks and Housing Finance Companies as well, with the intent of promoting better fraud risk management systems and frameworks in such REs, according to the RBI statement.