Absolute right of banks to recover loans

The best way for banks to avoid fraudulent accounts is to improve credit standards

One of the reasons for India's chances of better handling the global economic downturn is that our banks' balance sheets have improved significantly over the past few years. This was possible because regulatory oversight remained relatively tight and banks also worked hard to keep their balance sheets clean and raised new capital. However, while this process has proven effective for banks, it seems that some borrowers may not have been treated fairly during the process. Recently, this matter has come to the fore in an important decision of the Supreme Court bench. The court said that banks should give full opportunity of hearing to the borrower before declaring the account fraudulent. The court was hearing an appeal filed by State Bank of India and others.

The key guidelines on fraud-classification and reporting issued by the Reserve Bank of India for commercial banks and selected financial institutions in 2016, expect banks to report fraud in a timely manner. The circular was challenged in various High Courts on the ground that the borrowers were not given an opportunity to explain their position before the accounts were classified as fraudulent accounts.

In this context, the Telangana High Court observed that the principles of natural justice should be read into the provisions of the RBI circular. Now the Supreme Court has also maintained it. The principle of natural justice which says that no person can be convicted without trial should also be applied in cases of accounts classified as fraudulent accounts by the Reserve Bank. The principle of natural justice demands that the borrower should be given notice and given an opportunity to present his views.

The final decision on fraud is pronounced by the competent court. In such a situation, the principles of natural justice do not apply while initiating criminal law proceedings. However, the Supreme Court believes that the key directives can have very serious consequences for borrowers. Banks do not consider them trustworthy. Apart from this there are many other effects. This decision has provided much needed relief to the borrowers and balanced the relationship of borrowers and lenders to an extent. In the last decade, as bad loans began to rise and have wider macroeconomic and political consequences, pressure began to mount to fix the banking system as quickly as possible.

The Reserve Bank has formulated several rules for timely checking of bad loans. This was done before the advent of bankruptcy and insolvency codes. While there is no dispute that banks have every right to recover loans, they should give borrowers one more chance before resorting to punitive measures with far-reaching consequences. It is possible that the bank may not change its decision in many cases but the affected borrowers will get an opportunity to explain their position. The best way for banks to avoid fraudulent accounts is to improve credit standards. They should avoid lending to a large number of unviable companies with projects that are far from reality.