RBI Issues Revised Guidelines for Fraud Risk Management in Loans

The Reserve Bank of India (RBI) has issued a revised master directive on fraud risk management, aimed at ensuring that banks follow the principles of natural justice while dealing with borrowers. This move comes after a recent Supreme Court judgement emphasized the importance of providing defaulters with the right to be heard before declaring an account as fraud.

According to the new guidelines, banks must now give borrowers at least three weeks to respond before tagging their accounts as fraud. This means that banks will need to issue a show cause notice (SCN) with complete details of the fraudulent transactions, and borrowers will have a reasonable time of not less than 21 days to respond. The SCN must contain the relevant facts and circumstances relied upon, the submission made against the notice, and the reasons for classification as fraud or otherwise.

The RBI has also emphasized the importance of having a well-planned system for issuing SCNs and examining responses by persons or entities before declaring an account as fraud. Banks must have a board-approved policy on fraud risk management, which should be reviewed once every three years. Each bank must also constitute a special committee to monitor fraudulent cases, comprising at least three members, including an independent or non-executive director, a whole-time director, and two independent directors.

The committee will analyze the root cause of fraud and suggest measures to strengthen internal controls and risk management frameworks to minimize the incidence of fraud. In cases where an account is red-flagged, banks must appoint an external or internal auditor for further investigation. The loan agreement with the borrower should contain clauses for the conduct of such an audit by lenders.

The revised guidelines also include a framework on Early Warning Signals (EWS) and Red-Flagging of Accounts (RFA), which aims to strengthen early detection and prevention of fraud by regulated entities and timely reporting to law enforcement agencies and supervisors.

In cases where the audit report remains inconclusive or is delayed due to non-cooperation by the borrower, banks shall conclude on the status of the account as a fraud or otherwise based on their own internal investigation. The RBI has stated that the revised guidelines will apply to all banks, including regional rural banks, rural cooperative banks, and housing finance companies.

These revised guidelines are a significant step towards ensuring that banks follow a fair and transparent process while dealing with borrowers. By providing borrowers with a reasonable time to respond and a clear explanation of the reasons for classification as fraud, the RBI is promoting a culture of accountability and transparency in the banking sector.

Historical Context:

The Reserve Bank of India (RBI) has been actively working to strengthen the banking sector’s fraud risk management framework in recent years. In 2019, the RBI issued a circular on fraud risk management, which emphasized the importance of banks having a robust system for detecting and preventing fraud. The circular also emphasized the need for banks to have a board-approved policy on fraud risk management and to constitute a special committee to monitor fraudulent cases.

In 2020, the Supreme Court of India delivered a landmark judgement in the case of State Bank of India vs. V. Ramakrishnan, which emphasized the importance of providing defaulters with the right to be heard before declaring an account as fraud. The judgement stated that the principle of natural justice requires that a person or entity should be given an opportunity to respond before a decision is taken against them.

In light of this judgement, the RBI has revised its guidelines on fraud risk management to ensure that banks follow the principles of natural justice while dealing with borrowers.

Summary in Bullet Points:

• The RBI has issued revised guidelines on fraud risk management, aimed at ensuring that banks follow the principles of natural justice while dealing with borrowers. • Banks must give borrowers at least three weeks to respond before tagging their accounts as fraud, and must issue a show cause notice (SCN) with complete details of the fraudulent transactions. • The SCN must contain the relevant facts and circumstances relied upon, the submission made against the notice, and the reasons for classification as fraud or otherwise. • Banks must have a well-planned system for issuing SCNs and examining responses by persons or entities before declaring an account as fraud. • Each bank must constitute a special committee to monitor fraudulent cases, comprising at least three members, including an independent or non-executive director, a whole-time director, and two independent directors. • The committee will analyze the root cause of fraud and suggest measures to strengthen internal controls and risk management frameworks to minimize the incidence of fraud. • In cases where an account is red-flagged, banks must appoint an external or internal auditor for further investigation. • The loan agreement with the borrower should contain clauses for the conduct of such an audit by lenders. • The revised guidelines include a framework on Early Warning Signals (EWS) and Red-Flagging of Accounts (RFA), which aims to strengthen early detection and prevention of fraud by regulated entities and timely reporting to law enforcement agencies and supervisors. • In cases where the audit report remains inconclusive or is delayed due to non-cooperation by the borrower, banks shall conclude on the status of the account as a fraud or otherwise based on their own internal investigation. • The revised guidelines will apply to all banks, including regional rural banks, rural cooperative banks, and housing finance companies.