RBI Introduces Revised Norms to Safeguard Borrowers from Swift Account Tagging as ‘Fraud’

In a recent development aimed at enhancing transparency and fairness in banking practices, the Reserve Bank of India (RBI) has issued revised guidelines instructing financial institutions to provide defaulting borrowers with sufficient opportunity before classifying their accounts as fraudulent.

As per the updated directives effective from July 15[1], banks and other financial entities are now required to issue show-cause notices to account holders suspected of fraudulent activities. These notices must comprehensively outline the allegations, ensuring clarity on the basis of the fraud classification. Importantly, defaulters must be afforded a reasonable period of “not less than 21 days” to respond to these notices, thus allowing them ample time to present their case.

This regulatory amendment follows a landmark Supreme Court ruling in March 2023[2], which emphasized that banks cannot unilaterally declare an account as fraudulent without granting the account holder an opportunity to present their side. Upholding principles of natural justice, the RBI’s directive underscores the necessity for due process wherein borrowers are duly informed and given the chance to refute any adverse findings arising from audits or investigations before any punitive action is taken.

Under the updated master directions issued by the RBI, financial institutions are mandated to review their fraud risk management policies at least once every three years. Furthermore, they are required to establish a dedicated committee within their boards to oversee and undertake necessary follow-up actions in cases of suspected fraud. This framework aims to strengthen the overall risk management capabilities of banks and ensure proactive measures are in place to mitigate potentially fraudulent activities.

A pivotal component of the revised norms includes the establishment of Early Warning Signals (EWS) frameworks within banks. These frameworks are designed to identify and flag accounts showing suspicious activities or behaviors that may indicate potential fraud risks. By integrating robust EWS systems into their operations, banks can enhance their ability to detect and respond to emerging threats promptly.

In a move aimed at promoting uniformity in fraud risk management practices across different types of financial entities, the RBI has extended these guidelines to include Regional Rural Banks, Rural Cooperative Banks, and Housing Finance Companies. This expansion underscores the RBI’s commitment to fostering a standardized approach to fraud prevention and management, thereby safeguarding the interests of all stakeholders within the financial ecosystem.

In conclusion, the RBI’s proactive measures reflect its ongoing efforts to uphold fairness and transparency in banking operations. By instituting stricter guidelines for the classification of fraudulent accounts and enhancing oversight through regular policy reviews and structured committees, the RBI aims to bolster trust and confidence in the banking system while ensuring robust safeguards against financial malfeasance.

[1] https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12702&Mode=0 (Master Directions on Fraud Risk Management in Commercial Banks (including Regional Rural Banks) and All India Financial Institutions)

[2] Please refer to the judgment of the Hon’ble Supreme Court dated March 27, 2023 on Civil Appeal No.7300 of 2022 in the matter of State Bank of India & Ors vs. Rajesh Agarwal & Ors., and connected matters, read with the Order dated May 12, 2023 passed by the Hon’ble Supreme Court in Misc. Application. No.810 of 2023. The orders of the Hon’ble High Court of Bombay dated August 7, 2023 in Writ Petition (L) No. 20751 of 2023 and the Hon’ble High Court of Gujarat dated August 31, 2023 in Special Civil Application No. 12000 of 2021 and connected matters shall be referred to.