On July 15, the Reserve Bank of India issued a master circular on fraud risk management for all banks, Housing Finance Companies and Non-Banking Financial Companies (NBFCs). These master directions incorporated the Supreme Court judgment’s recommendations that ask banks to hear a borrower before an account is classified as fraud.
The circular read, “The Master Directions now expressly require that the REs 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 Hon’ble Supreme Court Judgment dated March 27, 2023 (Civil Appeal No. 7300 of 2022 in the matter of State Bank of India & Ors. Vs. Rajesh Agarwal & Ors.)” According to the revised notice, 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 served notice.
In the SBI versus Rajesh Agarwal case, an SC bench led by CJI DY Chandrachud was vocal about the rights of the borrower. As per the bench, the borrower is to be heard before an account is classified as fraud.
As per the RBI, the framework on early warning signals (EWS) and red flagging of accounts (RFA), has also been solidified further for early detection. These measures will also help prevent fraud in the REs and timely reporting to law enforcement agencies and supervisors. Early warning signals (EWS) are indicators that help banks find potential liquidity problems in businesses.
EWS identifies these problems they become critical. According to RBI, a red-flagged account is one where suspicion of fraudulent activity is shown by the presence of one or more indicators of early warning signals. This leads to a deeper investigation from the point of view of potential fraud.
The RBI further mentioned that it has also mandated data analytics and market intelligence units for strengthening the risk management systems as part of the review. According to the Central Bank, The directions also emphasise the need for instituting a robust internal audit and control framework in the Regulated Entities. The REs include Scheduled Commercial Banks (excluding Regional Rural Banks) and Small Finance Banks. These also include payment banks; large urban cooperative banks and large non-banking finance companies (including housing finance companies). They also comprise the Credit Information Companies and All India Financial Institutions.
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