A bank’s designation of a loan account as “fraudulent” can significantly restrict a borrower’s access to credit, invite criminal investigations, and affect future financial transactions. Recently, on April 7, the Supreme Court addressed a procedural disagreement between borrowers and banks regarding the necessity of a personal or oral hearing before labeling a loan account as fraudulent in accordance with Reserve Bank of India (RBI) regulations.
A panel comprising Justices JB Pardiwala and K V Viswanathan ruled that the tenets of natural justice do not mandate an oral hearing. They expressed concerns that requiring such hearings could disrupt banking operations. The court concluded that providing a written notice, allowing borrowers to submit a written response, and offering a reasoned decision are sufficient to uphold fairness in the process.
The classification of an account as fraudulent is critical since it can lead to exclusion from institutional financing.
Background of the Case
The case in question involves two distinct scenarios. The first pertains to Amit Iron Private Limited, which held an account with the State Bank of India (SBI). This account was designated as a Non-Performing Asset (NPA) in August 2019 due to missed repayments. In December 2023, the bank issued a show cause notice claiming “various acts of non-compliance with the agreed loan terms and irregularities suggesting fraudulent behavior.”
After the borrower provided a written response denying any misconduct, the bank classified the account as fraudulent in March 2024, claiming that a detailed order regarding this decision was communicated.
In a separate case involving Liliput Kidswear Limited, the borrower’s account at the Bank of India was classified as an NPA in March 2012. A show cause notice was served in August 2023 and January 2024. Following consideration of the borrower’s response, the classification of fraud was made in May 2025.
The Delhi High Court overturned this classification, asserting that a personal hearing was necessary, and that the audit documents should be fully disclosed.
In both instances, the banks adhered to a defined process: issuing a notice, allowing written replies, and delivering a reasoned decision. Borrowers contended that this procedure was inadequate given the serious repercussions of fraud allegations, which they likened to “civil death,” leading to blacklisting, reputational harm, and potential criminal implications.
Natural Justice and RBI Guidelines
The core issue revolves around the RBI’s Master Directions concerning the classification of fraud and their relationship with the principles of natural justice, particularly the concept of audi alteram partem, which means “listen to the other side.”
Section 35A of the Banking Regulation Act of 1949 gives the RBI the authority to direct banks in the public interest and to safeguard the interests of depositors and the banking sector. The guidelines for fraud classification stem from this authority.
However, the 2016 Master Directions did not specify procedural requirements, including the necessity for borrowers to be heard prior to the imposition of a fraud designation. In a 2023 ruling involving SBI and Rajesh Agarwal, the Supreme Court interpreted the need for natural justice within these directions, mandating that banks provide a notice, consider any responses, and issue a reasoned order before tagging any account as fraudulent.
In 2024, the RBI formalized this process by revising its Master Directions to require a show-cause notice, a minimum response period of 21 days, and a reasoned order.
However, the issue of whether “being heard” necessitated an oral hearing or personal meeting, as well as whether borrowers had the right to access the forensic audit report that informed the classification, remained unresolved.
The Supreme Court partially upheld the banks’ appeals and revised the procedures for fraud classification, nullifying the High Court’s requirement for personal or oral hearings prior to designating an account as fraudulent. The court found such a mandate to be “practically unfeasible” considering the volume of cases banks manage annually.
The court cited RBI statistics indicating 13,494 fraud cases in FY 2022-2023, 36,060 cases in FY 2023-2024, and 23,953 cases in FY 2024-2025, cautioning that requiring oral hearings could hinder timely decision-making and invite delays from “uncooperative borrowers.”
Furthermore, the court clarified its earlier ruling in SBI v Rajesh Agarwal, stating that it did not establish a right to a personal hearing, which could be adequately addressed through written representation.
On the issue of disclosure, however, the court affirmed that borrowers have the right to receive the forensic audit report prior to the fraud classification order being issued. The court emphasized that the content of the report is essential for borrowers to effectively challenge the conclusions drawn against them.
The court stated, “Simply providing findings and conclusions does not satisfy the principles of natural justice.” It noted that understanding the rationale behind the findings is crucial for borrowers to contest the outcomes. While allowing banks to redact portions of the report related to third-party privacy, the court warned against using redaction to conceal relevant information.
Ultimately, the court endorsed the RBI’s overarching fraud classification guidelines, asserting that the three-step process strikes an appropriate balance between expediency and fairness, aligning with the principles of natural justice to ensure equity for borrowers.
Describing the fraud classification process as a form of internal due diligence rather than a criminal trial, the court noted that the evidence involved is primarily documentary in nature, including financial records and transaction details, which are generally already known to the borrower.
