RBI mandates banks to set up committees for inspection of fraud cases after the SC ruling

Following the Supreme Court judgment of March 27, 2023, the Reserve Bank of India (RBI) on Monday came up with the revised norms that lenders must follow before classifying loan accounts as fraud.

The apex bank issued its revised Master Directions on Fraud Risk Management for Regulated Entities (REs). 

As per the revised directions, the lenders have to issue a detailed show-cause notice (SCN) to the persons or entities against whom the fraud allegations are labelled.

"Issuance of a detailed Show Cause Notice (SCN) to the Persons, Entities, and its Promoters/WWhole-time and Executive Directors against whom allegation of fraud is being examined7. The SCN shall provide complete details of transactions, actions, and events on which declaration and reporting of fraud is being contemplated under these Directions," the RBI's Master Directions document read.

It provides for a reasonable time of not less than 21 days for the persons or entities against whom the SCN is served to respond. 

"Banks shall have a well-laid-out system for issuance of SCN and examination of the responses made by the persons or entities prior to declaring such persons or entities as fraudulent," the document added.

The RBI mandates the banks to constitute a Committee of the Board known as the 'Special Committee of the Board for Monitoring and Follow-up of Cases of Frauds' (SCBMF) with a minimum of three members of the Board, consisting of a whole-time director and a minimum of two independent directors or non-executive directors.

The RBI further added that banks have to set up an appropriate organizational structure for the institutionalization of fraud risk management within their overall risk management functions or departments.

 A senior official in the rank of at least a general manager or equivalent shall be responsible for monitoring and reporting fraud.

These revised directions will be applicable to commercial banks, upper-middle- and base-level non-banking finance companies, all India financial institutions, and cooperative banks.

The banking regulator said, "The policy shall also incorporate measures for ensuring compliance with principles of natural justice in a time-bound manner."

The latest directions follow the SC comment in March last year that the borrowers be heard before they are classified as fraud. 

"We hold that the principles of natural justice, particularly the rule of audi alteram partem, have to be necessarily read into the Master Directions on Frauds to save them from the vice of arbitrariness. 

Since the classification of an account as fraud entails serious civil consequences for the borrower, the directions must be construed reasonably by reading into them the requirement of observing the principles of natural justice, the SC said.

The RBI said that directions now mandate adherence to principles of natural justice in a timely manner when classifying individuals or entities as frauds, aligning with a recent Supreme Court judgment.