After Supreme Court order on banking fraud, RBI to issue new guidelines

After Supreme Court order on banking fraud, RBI to issue new guidelines

The bench cleared that not providing the opportunity of hearing to a person was an infraction of his rights under the Constitution of India

The Supreme Court has made a judgment stating that natural justice must be provided to a borrower before declaring him a fraud. Thus, the Reserve Bank of India (RBI) will shortly be revising its guidelines on fraudulent account classification.

Mukesh Jain, the Deputy Governor in charge of Banking Supervision stated, "Subsequently, hearing a review petition filed by SBI, the apex court clarified that there was no need to give a personal hearing.”

In the 27 March order, the Apex Court said banks should provide a reasonable opportunity of hearing to borrowers before declaring an account as fraud.

Thereafter, the State Bank of India (SBI) moved the court with a review petition, seeking to know whether the 27 March order only applied prospectively and would not affect the past decisions.

While a bench led by Chief Justice DY Chandrachud refused to review the order, it clarified that a personal hearing meant only that a defaulter should be given adequate notice and an opportunity to make a representation. Also, the order would apply only prospectively.

Thus, Jain said, "The RBI is reviewing the entire guidelines on the fraud classification in consultation with various stakeholders and will shortly come out with our guidelines…Nevertheless, the SC judgment is applicable to all the regulated entities irrespective of RBI's guidelines.”

Upholding a 2020 order of the Telangana High Court, a bench of Chief Justice DY Chandrachud and Justice Hima Kohli had said the classification of an account as a fraud not only resulted in reporting the crime to investigative agencies but also had other penal and civil consequences for the borrowers. The principles of natural justice demand that the borrowers must be served a notice and given an opportunity to explain the conclusions of the forensic audit report.

The bench ruled, "Consistent with the principles of natural justice, the lender banks should provide an opportunity to a borrower by furnishing a copy of the audit reports and allow the borrower a reasonable opportunity to submit a representation before classifying the account as fraud. A reasoned order has to be issued on the objections addressed by the borrower."

The court delivered the judgment on pleas relating to the Reserve Bank (Frauds Classification and Reporting by Commercial Banks and Select FIs Directions, 2016. These were challenged before different high courts on the ground that no opportunity of being heard was envisaged to borrowers before classifying their accounts as fraudulent.

Elaborating on the consequences when a borrower's account was declared fraud, the apex court stated that it led to a credit freeze for the borrower, who was debarred from raising finance from financial markets and capital markets.

It added that it meant an infraction of their rights under Article 19(1)(g) of the Constitution of India. "Since debarring disentitles a person or entity from exercising their rights and/or privileges, it is elementary that the principles of natural justice should be made applicable and the person against whom an action of debarment is sought, should be given an opportunity of being heard. Indeed, debarment is akin to blacklisting a borrower from availing credit.”

Explaining that it meant the borrower was untrustworthy and unworthy of credit by the banks, it prevented the borrower from accessing institutional finance for the purpose of business.

The bench stated, “The action of classifying an account as a fraud not only affects the business and goodwill of the borrower but also the right to reputation.”