Borrowers must be heard before fraud tag, says SC

While Monday’s apex court’s judgment is aimed at protecting the interests of borrowers, bankers are still assessing the fine print before deciding their next course of action.

Bank, Supreme Court, Borrowers, Bank fraud, Chief Justice, DY Chandrachud, Banking, Finance
The ruling was challenged in the Supreme Court.

The Supreme Court on Monday said banks must hear borrowers before classifying an account as ‘fraud’. Declaring an account as fraud has serious consequences for the borrower such as the inability to borrow in future, a bench comprising Chief Justice DY Chandrachud and Justice Hima Kohli observed, upholding a Telangana High Court order.

The Telangana HC had in a December 2020 verdict said that the principles of “audi alteram partem” or “hear the other side” must be applied before declaring a borrower as “fraudulent”. This is because declaration of fraud entails civil and legal consequences, which results in blacklisting borrowers from accessing institutional finance, it had said. The ruling was challenged in the Supreme Court.

While Monday’s apex court’s judgment is aimed at protecting the interests of borrowers, bankers are still assessing the fine print before deciding their next course of action. However, there is a general consensus that the process of tracking defaulters and giving them time for hearing would delay the process of classifying them as wilful defaulters.

Currently, a borrower account is declared as fraud based on the findings of a forensic report where the loan has become a non-performing asset (where interest or principal payment is overdue for 90 days).

Broadly, bankers acknowledge that the apex court’s decision will have an impact on how they conduct operations, even though the extent of this impact is yet to be ascertained.

“The Supreme Court order will definitely have a ramification. There could be a situation in consortium banking where any bank which has information on suspicious activity will raise an issue and others will get to know. The process we follow is red-flag the account and depending on what is decided in the consortium, we will probably get in an independent party to submit a report on the basis of discussions with promoters and parties involved. Based on the outcome of the report, we can decide on whether it qualifies as fraud,” Murali Ramakrishnan, managing director and chief executive officer, South Indian Bank, said.

“The apex court judgment will definitely delay the process of tagging somebody as fraud. As per the Reserve Bank of India (RBI) definition, the tagging of frauds cannot be done frivolously. We can only tag an account as fraud on the basis of evidence,” he added.

Among various other activities, RBI classifies misappropriation and criminal breach of trust as fraud. A 2016 circular by the central bank allowed banks to classify wilful defaulters as ‘fraud’.

“In most of the cases of fraud, it is impossible to reach out to a customer. It is unlikely that customers will admit to fraud. In cases of an unsecured loan, the party would be untraceable. There is a question over how the apex court’s order will be implemented. I will try and send a registered post to a potentially customer, asking them to respond within seven days. If the customer does not respond, then a fraud will be implied. Nothing more can be done,” a senior official at a leading private bank said.

Veena Sivaramakrishnan, partner, Shardul Amarchand Mangaldas and Co, said: “Usually, in other classifications whether it is wilful defaulter, non-cooperative borrower, the RBI circular lays down a process and from that process, if the borrower is not participating, one can go ahead and classify an account as fraud. So, I do not see that as a problem by itself. From a timing perspective and a process perspective, I think the fraud classification process may become slightly elongated. But I do not think it will be significant.”

While India has seen a handful of noteworthy bank frauds in recent years, the quantum of such frauds fell 46% year-on-year to `19,485 crore in April-September 2022.

“The judgment comes as a big relief to the borrowers and is a step in the right direction. By requiring the financial institutions to pass reasoned orders and giving the borrowers an opportunity of making a representation before their account(s) are classified as fraud under the RBI guidelines, the decision would bring about more transparency and would inspire higher levels of confidence in the entire decision-making process,” said Abhimanyu Kampani, partner at Luthra and Luthra Law Offices India.

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First published on: 28-03-2023 at 05:30 IST