The Reserve Bank of India (RBI) has been constituted for the purpose of taking over the management of currency from the Central Government, regulating the issue of bank notes, keeping of reserves with a view to securing monetary stability, and operating the currency and credit system of India.

Incidence of frauds with the banks / financial institution is a matter of great concern and the primary responsibility of preventing such frauds lies with the Institutions itself. RBI has advised the Banks from time to time about the major fraud prone areas and the safeguards necessary for prevention of frauds. RBI has also been circulating to banks, the details of frauds and unscrupulous borrowers and related parties who have perpetrated frauds on other banks so that banks could introduce necessary safeguards / preventive measures by way of appropriate procedures and internal checks and also exercise caution while dealing with them. To facilitate this ongoing process, it is essential that banks report to RBI, complete information about frauds and the followup action taken thereon.

Reserve Bank of India (Frauds Classification and Reporting by Commercial Banks and Select FIs) Directions, 2016 was brought into force and the same apply to the scheduled commercial banks and select Fis

operating in India. These directions are issued with a view to provide a framework to banks thereby enabling them to detect and report frauds early and taking timely consequent actions like reporting to the Investigative agencies so that fraudsters are brought to book early, examining staff accountability and do effective fraud risk management. These directions also aim to enable faster dissemination of information by Reserve Bank of India to Banks on the details of frauds, unscrupulous borrowers and related parties, based on Banks’ reporting so that necessary safeguards / preventive measures by way of appropriate procedures and internal checks may be introduced and caution exercised while dealing with such parties by banks

The present case is a challenge to the Reserve Bank of India (Frauds Classification and Reporting by Commercial Banks and Select FIs) Directions, 2016. These directions issued by the Reserve Bank of India, were challenged before different High Courts primarily on the ground that no opportunity of being heard is envisaged to borrowers before classifying their accounts as fraudulent.

The major question that arose before the Hon’ble Apex Court in the matter State Bank of India & Ors. Vs. Rajesh Agarwal & Ors.1 was whether the principles of natural justice particularly Audi Alteram Partem2 has to be necessarily read into the Master Directions on Frauds to save it from the vice of arbitrariness.

It was noted by the Hon’ble Supreme Court that Chapter VIII of the Master Directions on Fraud issued by RBI provides for the procedure to be followed by the banks/lenders before forming an opinion to proceed with criminal complaint against the borrower after classifying their account as fraudulent. The forming of an informed opinion is administrative in nature and it is a settled position of law that in administrative law it is mandatory to provide an opportunity of being heard when an administrative action results in civil consequences. This position has been reaffirmed and reiterated in a plethora of judgments passed by Hon’ble Supreme Court including landmark case of Maneka Gandhi v. Union of India3 .

Further, civil consequences entail infractions not merely of property or personal rights, but also of civil liberties, material deprivations, and non-pecuniary damages. Every order or proceeding which involves civil consequences or adversely affects a citizen should be in accordance with the principles of natural justice.

The Hon’ble Apex Court very keenly observed that the procedure laid down in the Master Circular on Frauds providing the procedure to be followed for classifying a borrower’s account as fraudulent entails significant civil consequences to the borrower. Since it does not expressly provide for an opportunity of being heard before classifying the borrower’s account as fraud the rule of Audi Alteram Partem has to be read into the provisions of the said directions to save them from the vice of arbitrariness.

The Hon’ble Court further held that the Rule of Audi Alteram Partem ought to be read into Clause 8.9.4 and 8.9.5 of the Master Direction on Frauds stating that 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. It was also held that a reasoned order has to be issued on the objections addressed by the borrower.