Banking News

Banks’ fraud account classification faces legal challenges: No personal hearings, potential court battles ahead


Mumbai: Banks will not give a personal hearing to the management of a company before tagging it as a ‘fraud’ account but will comprehensively re-examine the decision if the borrower legally challenges the classification on the grounds related to principles of natural justice.

The procedure, which some of the bankers as well as legal experts think may spark court-feuds in several cases, is at the core of the standard operating procedure laid down by the lenders, two senior bank officials told ET. Labelling a borrower as ‘fraud’ or ‘wilful defaulter’ is a sensitive and contentious matter in Indian banking as the stigma attached to such tags virtually banishes a borrower from the institutional credit market.

The procedure, aimed at formally codifying the mechanism and steps to classify companies with loans outstanding of ₹50 crore or more as a fraud account, follows the Supreme Court direction in March 2023 to provide a hearing to the borrower before such a step is taken.

Under the procedure, the show-cause notice, asking the borrower to respond in 15 days, shall be sent to the registered office of the borrower and the acknowledgement of the receipt will be kept on record.

“If it is not deliverable (due to the borrower not residing/operating from the registered address) or the borrower refuses to accept it, the same needs to be kept on record. This may serve to the cause of offering principles of natural justice through which an opportunity of hearing has been provided to the borrower,” said the model procedure, which has been approved by the managing committee of the lenders’ lobby Indian Banks’ Association and shared with CEOs of most banks.


Senior bankers and lawyers have differing opinions on the subject. “Principles of natural justice do not necessarily mean that the hearing has to be in person or an adversarial style hearing. Though this does not mean there will not be further rounds of challenges!,” said Jayesh H, co-founder of Juris Corp.However, according to Zulfiquar Memon, managing partner of MZM Legal, a firm which, among other things, specialises on disputes related to white-collar crimes, “I have not read the guidelines, but it seems somewhat arbitrary. The purpose is to grant a fair hearing before any prejudice is caused to the borrower due to it / him being declared a fraud. Firstly, there seems to be no provision for personal hearing. Secondly, accounts are classified as “red flagged” and shared on the CRILC data platform, even before due process is completed. The process for ‘wilful defaulter’ (compared to ‘fraud’) is more effectively laid down.”

(The CRILC – Central Repository of Information on Large Credits) platform stores credit data, which only lenders can access).

The steps leading to tagging an account as fraud would begin with banks making a note of the ‘early warning signals’ in a loan account. These could be tax or enforcement raids on the borrower, frequent changes in the scope of the project, several transactions with inter-connected entities, resignation of key personnel, delays in payments of dues etc. A compilation of such alerts forms the basis for classifying an account as a ‘red flagged account’. (RFA).

Once an account is red-flagged, a bank undertakes further investigation into the suspicious transactions, and may even hire the services of an external auditor or forensic expert. The findings of the investigation into an RFA are then placed before competent authorities which could typically comprise members of management committees and board of directors. Within six months, a bank has to either lift the RFA tag or classify the account as fraud.

Finally, the show-cause notice is issued at the direction of these committees. In case the borrower responds within the prescribed time, the case could be referred back to the competent authority. However, if the borrower contests the fraud classification on grounds of natural justice, such cases could be re-examined afresh.

“We understand this could lead to multiple litigations as most borrowers would move the court if they are categorised as a fraud account. But this is the best the industry could have done. It’s not easy dealing with such errant clients,” said a PSU bank official. According to another banker, who also requested anonymity, banks fear personal hearings could be used by dodgy borrowers to buy time and derail the process.


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