Lenders fear delay in recovery as SC offers loan defaulters a legal window

The latest Supreme Court (SC) ruling that banks must give borrowers an opportunity to be heard before classifying their loan account as fraud will lead to delay in the loan recovery process since legal cases are prone to get dragged on, according to banking industry experts.

Borrowers have the right to be heard before banks classify their accounts as fraud, the Supreme Court ruled on March 27.

Earlier in the day, the SC said that borrowers have the right to be heard before banks classify their accounts as fraud and that principles of natural justice must be followed and read into the Reserve Bank of India's (RBI) 2016 master circular on fraud.

The court held that when an account is classified as fraud, it results in civil and criminal consequences for the borrower. It amounts to "blacklisting" a borrower from availing any credit. Hence, a hearing must be granted under the Master Directions on Fraud, the country's top court said.

In 2016, the RBI issued a circular allowing banks to unilaterally classify accounts of wilful defaulters as fraudulent, a move that was challenged in several high courts.

The Supreme Court, however, said the borrower need not be given an opportunity of being heard before registering of an FIR. The judgment also notes that the banks must pass a reasoned order on their decision to classify an account as fraudulent, to avoid arbitrariness.

Experts caution

Industry experts, however, said the SC order will primarily result in major delays for banks to hear the cases of borrowers.

Rajnish Kumar, former chairman of State Bank of India (SBI) said that the order will result in more processes for the banks to follow.

From private sector lenders, Murali Ramakrishnan, managing director and chief executive officer (MD&CEO), South Indian Bank said that order may impact the timely classification as well as reporting of fraud.

"It will also delay initiation of action against the unscrupulous borrowers impacting the recoverability aspects to a great degree and also increases the loss arising out of the fraud," Ramakrishnan said.

Other than bankers, industry experts also highlighted the issues with the order for banks.

“As the cases lie in proceedings for long, there are chances that banks will have to bear more financial costs,” said Naresh Malhotra, a banking expert and former banker with the State Bank of India (SBI).

Mukesh Chand, Senior Counsel, Economic Law Practice, a law firm, too said the apex court’s order will mean more legal and litigation costs for banks.

"Now banks will follow a long legal process. Hence, this will increase the number of legal proceedings, resulting in more legal and litigation costs for banks,” Chand said.

What did the RBI say?

The apex bank had in 2016, issued a master circular, allowing banks to unilaterally classify accounts of wilful defaulters as fraudulent. In the March 27 order, the Supreme Court said that principles of natural justice must be followed and read into the RBI’s master circular.

The latest order by the apex court came in the backdrop of several appeals by the State Bank of India (SBI) and RBI against a Telangana High Court order in 2020, which directed the RBI to ensure that principles of natural justice be read into the clauses in the master circular issued for detecting frauds in the banking sector.

Karan Gupta, banking analyst, India Ratings and Research, Fitch Group, said that the latest SC ruling is an additional procedure for banks.

“For banks, if the borrower case was actually a wilful default, they would already have evidence to prove the same in the courts. This is just a new procedural step,” Gupta said.

But Chand highlighted that this new process could lead to further allocation of litigation resources for banks.

“There is a possibility that the order will result in more litigation, which would mean that banks will have to allot more resources,” Chand said.

Whereas Ramakrishnan highlighted that the delay in frauds reporting could also delay the alerting of other banks about the modus operandi through caution advice or central fraud registry (CFR) by RBI that may result in similar frauds being perpetrated elsewhere.

What is status of bad loans and willful defaulters? 

The gross non-performing asset (GNPA) of scheduled commercial banks (SCBs) fell to a seven-year low of 5 percent in September 2022, RBI’s Financial Stability Report (FSR) showed.

The net non-performing assets (NNPA) dropped to a 10-year low of 1.3 percent in September 2022, the FSR report said.

Also read: Wilful defaulters owe major banks Rs 88,435 crore, up from Rs 75,294 crore in a year

India’s top 50 wilful defaulters owed Rs 92,570 crore to Indian banks as of March 31, 2022, data from the RBI showed. Earlier, Moneycontrol had reported that defaults with major private and public sector banks were at Rs 88,435 crore in 2023, up from Rs 75,294 crore in 2022.

Wilful defaulters are those who have the means to pay but are unwilling to pay.