Hon’ble Supreme Court’s judgement in State Bank of India & Ors v. Rajesh & Ors
As per the Section 3 of the Reserve Bank of India, the Reserve Bank of India (“RBI”) is a statutory body. Furthermore, the Banking Regulation Act, 1949 deals with several aspects related to banking companies including but not limited to grant of license, issuance of directions and conduct inspections. Section 35-A of the BR Act authorizes RBI to publish directions that would be in the interest of public, banking policy and to secure proper management of banks. In light of the said powers RBI, initially issued Master Directions with respect to Frauds in 2016.
These directions were contested in various High Courts, mainly on the basis that borrowers were not being given a fair opportunity to be heard before their accounts were classified as fraudulent. Eventually, in the case of State Bank of India & Ors v. Rajesh & Ors, Civil Appeal No. 7300 of 2022, the Supreme Court concluded the discussions by affirming that, in accordance with fundamental rights and principles of natural justice, the right to be fairly heard is a crucial aspect when blacklisting an entity or person.
The court stressed that principles of natural justice can be inferred from a statute or notification even if it does not explicitly provide for a fair hearing for a party whose rights and interests might be affected by the orders issued, unless the statute explicitly states otherwise. Additionally, the Court observed that, according to Chapter 7 of the 2016 Directions, reporting a borrower's account not only results in a criminal complaint but also has penal consequences. This reporting also hinders the borrower’s ability to access institutional finance for current and future business purposes, thereby damaging their goodwill and reputation.
The court goes on to emphasize that it is not RBI’s competence to issue directions that is a contention but the simple fact that any and all directions must follow the due process of law along with securing the health of banks. While reiterating its decision in State of Orissa v. Binapani Dei 1967 AIR 1269, the Hon’ble Court in SBI v. Rajesh held that principle of Audi Alteram Partem cannot be impliedly excluded under the Master directions on Frauds 2016. The principles of natural justice must prevail and must serve a notice to the borrowers to explain the conclusions of forensic audits before being classified as fraudulent.
To implement the aforementioned observations, RBI released a revised Master Directions on July 15th , 2024 titled on “Master Directions on Fraud Risk Management in Commercial Banks (including Regional Rural Banks) and All India Financial Institutions”, RBI/DOS/2024-25/118 (“2024 Directions”). The new 2024 Directions will supersede the Master Directions on Fraud 2016. One of the major focuses of aforesaid 2024 Directions is to establish board approved policy regarding show cause notices to people against whom allegations are levied along with a 21 day period to respond. For said objective, in the 2024 Directions, there is to be a board committee in place along with senior management that looks at this implementation and passing a well reasoned order order conveying the details of events, circumstances relied upon and submissions made in response to the SCN, along with the reasons for the decision of the bank to declare fraudulence.
The 2024 Directions also establish a framework for Early Warning Signals (EWS) and Red Flagging of Accounts (RFA) as part of the overall fraud risk management policy. A Red Flagged Account is identified when one or more EWS indicators raise suspicions of fraudulent activity, prompting further investigation.
It is pertinent to highlight that the 2024 Directions not only focus on non-kyc compliant, money mule accounts, banking credit and non- credit transactions but also pays special focus on digital transactions and applications. Further, an MI unit and a Data Analytics team shall be set up to extensively monitor these. Along with digital, the 2024 Directions also focus on fraud cheques as provided under chapter 7. They work around the to conduct legal audits of large value loan accounts and encourage the banks to report cases of theft, burglary, dacoity, robbery to RBI, Law enforcement agencies.
The new directions pay attention to staff accountability implementing that banks need to examine staff accountability for all fraud cases within a set time frame. Public Sector Banks (PSBs) and AIFIs shall follow Central Vigilance Commission (CVC) guidelines for examining staff accountability. Penal measures for persons/entities classified as fraud further includes debarment from using facilities to raise funds or additional credit from RBI as well as all financial entities regulated by RBI for a period of Five Years from the date of full Repayment of the defrauded amount. But, the new 2024 directions also give a chance to de declassified as fraud and removal of the Penal Measures to the entity/person in question if IBC or RBI Resolution framework comes into effect which amounts to a change in the management or control of the business enterprise/entity.
The Proper procedure along with a guide is given under Chapter V for giving clarity to banks on what grade of fraud shall be reported to which Law Enforcement Agencies (LEAs). The guide has segregated Private/Foreign Banks with Public Sector/Regional Rural Banks to provide clarity. Similarly, in Chapter VI for reporting incidents of Fraud to RBI, all the relevant categories are mentioned which shall be present in the fraud category list on the online portal of Fraud Monitoring Returns under RBI. As per the 2024 Directions, Banks must ensure that information available in Central Fraud Registry is properly used for credit and fraud risk management. The modalities for reporting Incidents of Frauds are also laid down under Chapter VI along with criteria for closure of fraud cases reported to RBI using the ‘Closure Module’.
Therefore, the purpose of these new Directions can clearly be seen by the clarity provided in the formation of it. After addressing the issues underlined by the Hon’ble Supreme Court, the new norms streamline and provide proper structure for Fraud Risk Management. The stern yet fair norms give a chance to the defaulters to comply with the regulations or at least present their case as per the Principles of Natural Justice. They also lay down the punishment the entities/persons must endure if found guilty with full transparency for the decision removing the suspicion of foul play in the reporting and decision-making process.
The above article is authored by Yashodhara Burmon Roy (Senior Associate), and Darshita Sethia (Associate).
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