Banks Can Only Tag Accounts As Fraudulent After Seeking Borrower's Response: RBI

The Reserve Bank of India (RBI) on July 15, 2024, issued three revised master directions on fraud risk management for banks that requires them to give borrowers at least three weeks to respond before tagging them as fraud accounts.

These directions are applicable to commercial banks, non-banking finance companies, housing finance companies, and cooperative banks.  RBI mandated these changes taking into account compliance with principles of natural justice before classifying persons or entities as fraud, taking into account the March 2023 Supreme Court judgment on State Bank of India versus Rajesh Agarwal.

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Key Changes In Master Directions

The revised directions state that banks are required to issue detailed Show Cause Notices to individuals, entities, and their Promoters or Whole-time and Executive Directors against whom allegations of fraud are being examined.  Further, they must be given a minimum of 21 days to respond to the Show Cause Notice. "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.

The circular states that banks must have a formal system in place for issuing show-cause notices and examining responses from individuals or entities before declaring them as fraudulent. It also emphasises the need to strengthen internal audits, controls, and use of data analytics for fraud detection.

Additionally, banks must have a framework for Early Warning Signals (EWS) and Red Flagging of Accounts (RFA) as part of the Fraud Risk Management Policy that the Board must approve. Red-flagged accounts warrant deeper investigation and may require external or internal audits.

A red-flagged account is one where there is suspicion of fraudulent activity due to the presence of one or more early warning signals. This triggers a deeper investigation from the perspective of potential fraud. When a credit facility or loan account is classified as a red-flagged account, banks must conduct further investigation using either external or internal audits. The Fraud Risk Management Policy should be reviewed by the Board at least once every three years, the circular said.