The Reserve Bank of India (RBI) has directed banks and other financial institutions to give defaulting borrowers at least 21 days to respond before classifying them as fraud accounts.

The lenders will also have to communicate to the borrower their reasons for tagging the account as fraud.

Show-cause notices will have to be issued to fraudulent account holders having complete details of the fraud, the RBI said on Monday. A reasonable time of “not less than 21 days” should be given to defaulters to respond to the show-cause notice, the central bank said in a circular.

The RBI’s need to revise the master directive on fraud management follows a Supreme Court judgment on March 27, 2023, which says that banks must adhere to the principles of natural justice and cannot unilaterally declare an account as fraud without providing defaulters with the right to be heard.

In its revised circular, the RBI said banks must have a board-approved policy on fraud risk management which should be reviewed once every three years. The board of each bank will also have to set up a special committee to monitor and take follow-up action on fraudulent cases.

The RBI said the revised guidelines will also apply to regional rural banks, rural cooperative banks and housing finance companies. The intent is to promote better fraud risk management systems and frameworks in such regulated entities.

As per the revised guidelines, banks will need to have a framework for Early Warning Signals (EWS) and reg-flagging of accounts. 

The RBI has also mandated the requirement for data analytics and market intelligence unit for strengthening risk management systems.