Home/ Industry / Banking/  Ruling on fraud accounts opens Pandora’s box

The Supreme Court order for banks to hear out borrowers before declaring a ‘fraud’ will lead to further complications and delays in reporting them. It’s helpful to borrowers wishing to challenge past cases, but leaves bankers with quite a task at hand. Mint explains:

What is the case that led to this order?

At the heart of this is a 2016 guideline from the Reserve Bank of India (RBI) on classification and reporting of bank loans as fraudulent. A clutch of borrowers who were affected by this circular approached various high courts. In one case, the Telangana high court in 2020 agreed with an appellant that banks need to give a personal hearing to borrowers before classifying their account as fraud. The cases eventually reached the Supreme Court and on Monday, the apex court upheld the Telangana high court order, saying the principles of natural justice required borrowers to be given a hearing.

How will this impact lenders?

Bankers are worried. First, they believe it would take longer to classify and report a borrower as fraud, owing to the additional layer of personal hearing. Second, they think some borrowers who have already been categorized as frauds could contest those decisions, opening up room for more litigation. However, banks are confident that borrowers can only delay the process of reporting, not identification. Unless RBI decides to introduce amended norms, banks will have to formalize a process that would allow them to issue a show-cause notice, consider borrowers’ replies, and then decide the outcome.

Graphic: Mint
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Graphic: Mint

Where do fraud loans originate?

As per RBI’s analysis, public sector banks led the way in terms of the fraud amount. Private sector lenders, on the other hand, reported the highest number of frauds. The frauds reported during 2020-21 and 2021-22 showed a significant lag between the date of occurrence and its detection, the central bank said in its latest annual report.

What can be done to follow the order?

While the fraud classification guidelines of the RBI do not mention personal hearings, its circular on classifying wilful defaulters has a clause on this. It says an “opportunity should be given to the borrower and the promoter or whole-time director for a personal hearing if the committee feels such an opportunity is necessary". The ‘committee’ is to be headed by an executive director or equivalent of the concerned bank. To sync with SC, RBI may want to add a similar clause to its fraud account circular.

What is the fraud classification process?

In loan accounts involving several banks, once a bank classifies an account as ‘red-flagged’ or fraudulent, it has to be reported to the RBI’s Central Repository of Information on Large Credits. If the bank decides to tag an account as fraud at this stage, it has to report it to the RBI and enforcement agencies. Then, the consortium of lenders must meet and if at least 60% of lenders by share of loans approve, the account is red flagged by all the banks and a forensic audit is conducted.

Shayan Ghosh
Shayan Ghosh is a national writer at Mint reporting on traditional banks and shadow banks. He has over a decade of experience in financial journalism. Based in Mint’s Mumbai bureau since 2018, he tracks interest rate movements and its impact on companies and the broader economy. His interests also include the distressed debt market, especially as India’s bankruptcy law attempts recoveries of billions worth of toxic assets.
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Updated: 30 Mar 2023, 01:01 AM IST
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