Revisiting regulations

Rules should not bypass the principles of natural justice

One of the reasons why India is said to be better placed to deal with the global economic slowdown is that the balance sheets of banks have improved significantly over the last few years. This has been possible through comparatively strong regulatory oversight and efforts on the part of the banks in terms of cleaning up their balance sheets and raising capital. However, while the process has worked well for banks, it appears that some borrowers may not have been treated fairly during the course. This was reflected in an important judgment delivered by a Supreme Court Bench of Chief Justice of India D Y Chandrachud and Justice Hima Kohli this week. The court held that borrowers must be heard before an account was classified as fraud by lenders. The court was hearing an appeal by State Bank of India and others.
 

“The Master Directions on Frauds — Classification and Reporting by Commercial Banks and select FIs of the Reserve Bank of India (RBI)”, issued in 2016, expect banks to submit details of fraud in a time-bound manner. The circular was challenged before various high courts on the grounds that the borrowers were not given a chance to present their positions before their accounts were classified as fraud. The Telangana High Court in this context held that the principle of natural justice must be read into the provisions of the RBI circular, and the verdict has now been upheld by the Supreme Court. It held that the principle of audi alteram partem cannot be excluded under the directions issued by the RBI for classifying fraud accounts. It further noted that the principle of natural justice demands that borrowers must be served a notice and given an opportunity to explain. Interestingly, lawyers appearing for banks argued that lenders have a structure in place to identify and investigate fraud. They file a complaint with law-enforcement agencies, which then conduct the investigation. The ultimate decision on fraud is pronounced by a competent court. The principles of natural justice thus are not applicable at the stage of initiating the process of criminal law. The Supreme Court, however, took the view that Master Directions led to serious consequences for borrowers. They are treated as untrustworthy by banks, along with other ramifications.
 

The judgment gave much-needed relief to borrowers and reduced the somewhat uneven balance of power between lenders and borrowers. As the non-performing assets (NPAs) began to rise in the last decade with wider macroeconomic and political consequences, there was pressure to clean up the banking system as early as possible. The RBI brought several regulations to improve NPA detection and resolution before the Insolvency and Bankruptcy Code was implemented. While there is no dispute that banks have every right to recover loans, they should also give borrowers a fair chance before taking punitive action with wider consequences. It is possible that banks may not change their decisions in many cases, but affected borrowers will at least now have a chance to explain their position. The best way, however, for banks to avoid dealing with bad accounts is to improve lending standards. They should not repeat the mistake of lending to a large number of unviable companies and projects with unrealistic expectations.