The Reserve Bank of India’s (RBI) latest revision of its Master Circular on Fraud Risk Management in banks and other regulated entities has not come a day too soon. Given the rising incidence of financial frauds, it is imperative that lenders adopt a fool-proof process that does not leave any scope for dishonest borrowers to escape on flimsy technical grounds.
At the same time, it is important that borrowers who have defaulted for genuine business reasons and without fraudulent intent are not penalized or made to suffer the opprobrium justifiably reserved for fraudsters.
According to RBI’s latest Annual Report, the number of frauds at banks rose 166% year-on-year in 2023-24, with frauds in loan portfolios accounting for an overwhelming share (84%) in terms of value. The regulator’s revised circular attempts to strike a balance between defaulting borrowers and banks.
It prescribes a much-needed uniform framework to be followed by all regulated entities before a loan account is classified as a ‘fraud’ account. Crucially, it mandates that banks must give defaulters enough time to respond before marking their accounts as fraudulent.
At a minimum, a “detailed Show Cause Notice” must be issued to “Persons, Entities and its Promoters/Whole-time and Executive Directors against whom [an] allegation of fraud is being examined.”
This must include complete details of transactions, actions or events on the basis of which the declaration and reporting of a fraud is under consideration. Further, a “reasonable time of not less than 21 days” shall be provided to the concerned party to respond to the charges.
This revision of instructions follows a recent Supreme Court ruling which said the principles of natural justice demand that the borrower be given a chance and time to respond to a charge of fraud.
In reality, as any practising banker knows, defaulters are given more than sufficient time to regularize their account or plead their case. This is hardly surprising. The principal objective of any bank is ensure that the money it lends a borrower is repaid. After all, banking is a business of intermediation—of taking money from depositors and on-lending it to borrowers.
If loan recipients do not repay, and in time, the bank will not be able to repay its depositors. So banks do their utmost to ensure the timely repayment of their loans.
Indeed, the criticism often levelled against banks, especially public sector lenders, is that they don’t do enough, are often much too slow to respond to warning signals, and tend to give their borrowers a long rope before classifying loans first as ‘special mention’ accounts and then as non-performing assets (NPA).
However, dodgy borrowers, looking to exploit legal loopholes to escape the long arm of the law, have often been quick to seek refuge in the claim of being denied fair treatment under the principles of natural justice.
The net result is that the tortuous process involved in formally declaring a loan account as defaulting and then fraudulent may have been overlooked by Indian courts—including the apex court—while ruling that the long-established principle of a fair hearing be made part and parcel of bank-fraud protocols.
Of course, there can be no quarrel with this and a clear formal framework will be of help. By making it part of ‘due process,’ RBI’s revised circular ensures that dishonest borrowers can no longer resort to specious arguments in an effort to dodge the law. And honest but defaulting borrowers are not wrongly penalized.