After Supreme Court's fraud tag verdict, responsibility now on banks

The Supreme Court’s (SC’s) verdict on Monday that a borrower must be heard before an account is classified as fraud has come as a big relief for India Inc. The decision places responsibility on banks before they proceed on this line. 

Borrowers — small and large — can now seek a relook at their cases. Senior bankers pointed out that “natural justice” to an aggrieved borrower was the casualty to a large extent because of the short interval available to them to offer relief under the Reserve Bank of India’s Master Directions (Frauds-Classification and Reporting by commercial banks and select Financial Institutions of July 1, 2016 — and updated as on July 3, 2017).

The Master Directions said banks need to furnish Fraud Monitoring Return (FMR) in individual fraud cases, irrespective of the amount involved, to RBI electronically within three weeks from the date of detection. In addition to the FMR, banks are required to furnish a Flash Report for frauds involving amounts of Rs 50 million and above within a week of such frauds coming to the notice of the bank’s head office. It held that delay in reporting frauds and the consequent delay in alerting other banks about modus operandi and dissemination of information against unscrupulous borrowers could result in similar frauds being perpetrated elsewhere.

“Banks should therefore, strictly adhere to the timeframe fixed in this circular for reporting of fraud cases to RBI failing which they would be liable for penal action prescribed under Section 47(A) of the Banking Regu­lation Act (1949).”  It puts the spotlight on the “wilful default” aspect, which came into effect on April 1, 1999.

It may be recalled that on December 19, 2022, Minister of State for Finance Bhagwat Karad told Parliament in a written response that the country's top 50 “wilful defaulters” owed Rs 92,570 crore to banks at the end of FY22. “Wilful default” kicks in when a borrower evades financial obligations despite having the capacity to honour them; diverts funds for purposes other than what it was sanctioned for; siphons funds; and evades financial obligations and sells the same granted for procuring a loan devoid of the banks’ knowledge.

This is because Section 8.12.1 of the RBI’s Master Directions also notes that in general, “the penal provisions as applicable to wilful defaulters would apply to the fraudulent borrower, including the promoter director(s) and other whole-time directors of the company insofar as the raising of funds from the banking system or from the capital markets by companies with which they are associated is concerned, etc.”

The SC was of the view that this leads to serious civil consequences for the borrower, and is akin to blacklisting them for both being untrustworthy and unworthy of credit. That said, the ruling puts the spotlight on the delays in identifying fraud, in general.

The Annual Report for FY21 noted that the average time lag between the date of occurrence of fraud and its detection stood at 23 months; for large frauds (Rs 100 crore and above), this was at 57 months. A two-decadal analysis by the Financial Stability Report of June 2019 found that frauds between FY01 and FY18 constituted 90.6 per cent of what was reported in FY19 by value.

In 2019, RBI Deputy Governor M K Jain observed that “some of the weaknesses and irregularities observed have been recurring in spite of the averments made by bank managements (about) having carried out remediation.” And that “it will not be an exaggeration to say that some of the big losses suffered by banks on account of frauds could have been avoided if a good compliance culture was ingrained in the banks”.