RBI issues 3 Master Directions on Fraud Risk Management for Regulated Entities

On July 15, 2024, the Reserve Bank of India(RBI) issued 3 Master Directions(MD) on Fraud Risk Management for the Regulated Entities(RE) such as commercial banks including regional rural banks and All India Financial Institutions; urban, state and central cooperative banks; and non-banking finance firms and housing finance companies to replace the previous guidelines and consolidating 36 existing circulars.

• Aim: To provide a robust framework for the prevention, early detection, and timely reporting of frauds in REs.
• The directions mandate REs to comply with principles of natural justice in a time-bound manner before classifying persons/entities as fraud, taking into account the March 2023 Supreme Court(SC) Judgment on State Bank of India(SBI) versus Rajesh Agarwal.

The RBI released MD on Fraud Risk Management in

• Non-Banking Finance Companies(NBFCs) (including Housing Finance Companies(HFCs))
• Cooperative Banks (Urban Cooperative Banks(UCBs) / State Cooperative Banks(StCBs) / Central Cooperative Banks(CCBs))
• Commercial Banks(CBs)[including Regional Rural Banks(RRBs) and All India Financial Institutions (AIFIs)]

Note: All three MDs are together referred to as revised MD.

Non-Banking Finance Companies (including Housing Finance Companies)

i.MD: The Reserve Bank of India (Fraud Risk Management in NBFCs) Directions, 2024 have been issued in exercise of the powers conferred by Sections 45K, 45L and 45M of the Reserve Bank of India Act, 1934 (Act 2 of 1934), and Sections 30A, 32 and 33 of the National Housing Bank Act, 1987.

• This MD  will replace the MD– Monitoring of Frauds in NBFCs (Reserve Bank) Directions, 2016 dated September 29, 2016.

ii.Aim: To providing a framework to applicable NBFCs for prevention, early detection and timely reporting of incidents of fraud to Law Enforcement Agencies (LEAs),

iii.Applicability:These directions will be applied to –

• All Non-Banking Financial Companies (including Housing Finance Companies) in the Upper Layer, Middle Layer and in the Base Layer with asset size of Rs.500 crore and above.
• These NBFCs shall be further collectively be referred to as ‘Applicable NBFCs’ for the purpose of these Directions.

iv.Special committee: Applicable NBFCs have to form a Committee of the Board to be known as ‘Special Committee of the Board for Monitoring and Follow-up of cases of Frauds’ (SCBMF) with a minimum of three members of the Board, consisting of the Chief Executive Officer(CEO) and two Independent Directors(ID) and will be headed by one of the ID.

• Applicable NBFCs categorised as Middle Layer and Base Layer (NBFC-ML-BL) for regulatory purposes, will have the option of forming a Committee of the Executives (CoE) with a minimum of three members, at least one of whom shall be a Whole-time director or equivalent rank Official for the purpose of performing the roles and responsibilities of SCBMF as required under these Directions.
• The Senior Management shall be responsible for implementation of the fraud risk management policy.

v.The NBFCs shall also submit a quarterly Return, ‘Report on Bank Robbery, Theft, etc. (RBR)’ on theft, burglary, dacoity and robbery to RBI using online portal, within 15 days from the end of the quarter to which it relates.

Cooperative Banks(CBs) [Urban Cooperative Banks(UCBs) / State Cooperative Banks(StCBs) / Central Cooperative Banks(CCBs)]

i.The ‘Reserve Bank of India (Fraud Risk Management in UCBs / StCBs / CCBs) Directions, 2024’ issued in exercise of the powers conferred under Section 21 and Section 35A read with Section 56 of the Banking Regulation Act, 1949.

• This MD will replace the ‘Master Circular– ‘Classification and Reporting’ (DCBR.CO.BPD.MC.No.1/12.05.001/2015-16) dated July 1, 2015.

ii.Aim: To providing a framework to CBs for prevention, early detection and timely reporting of incidents of fraud to Law Enforcement Agencies (LEAs), RBI and  National Bank For Agriculture And Rural Development(NABARD) and dissemination of information by RBI and matters connected therewith or incidental thereto.

iii.Applicability: The provisions of these Directions will be applied to –

• All Primary UCBs and RRBs i.e.StCBs) and CCBs licensed or permitted to carry on banking business in India by the RBI.
• Such CBs will be collectively be referred to as ‘CBs’ for the purpose of these Directions.

iv. Special committee: Cooperative Banks have to form a Committee of the Board to be known as SCBMF with a minimum of three members of the Board. consisting of the Chief Executive Officer and two directors which will be headed by one of the directors.

• UCBs categorized as Tier 1 & 2 for regulatory purposes and StCBs / CCBs having deposits below Rs.1000 crore, will have an option of constituting a Committee of the Executives (CoE) with a minimum of three members, at least one of whom will be the Chief Executive Officer for the purpose of performing the roles and responsibilities of SCBMF as required under these Directions.

v. Framework for Early Warning Signals(EWS) for Detection of Frauds

• UCBs categorised as Tier 3 & 4 and StCBs / CCBs having deposits above Rs.1000 crore will have a framework for EWS under the overall Fraud Risk Management Policy approved by the Board.
• A Board Level Committee will monitor the effectiveness of the framework for EWS. The Senior Management shall be responsible for implementation of a robust Framework for EWS within the Applicable Cooperative Bank.

Commercial Banks(CBs)[including Regional Rural Banks(RRBs) and All India Financial Institutions (AIFIs)]

i.The ‘Reserve Bank of India (Fraud Risk Management in Commercial Banks (including Regional Rural Banks) and All India Financial Institutions) Directions, 2024’  have been issued in exercise of the powers conferred under Chapter III-A and Chapter III-B of the Reserve Bank of India Act, 1934, and Section 21 and Section 35-A of the Banking Regulation Act, 1949.

• This MD will replace the Reserve Bank of India (Frauds – Classification and Reporting by commercial banks and select FIs) Directions 2016 (Ref.DBS.CO.CFMC.BC.No.1/23.04.001/2016-17) dated July 01, 2016 (Updated as on July 03, 2017).

ii.Aim : To providing a framework to banks for prevention, early detection and timely reporting of incidents of fraud to LEAs, RBI and NABARD and dissemination of information by the RBI and matters connected therewith or incidental thereto.

iii.Applicability: The provisions of these Directions will be applied to –

• All commercial banks [including banks incorporated outside India licensed to operate in India (foreign banks), Local Area Banks (LABs), Small Finance Banks (SFBs), Payments Banks (PBs)], Corresponding New Banks, RRBs and SBI as defined under sub-sections (c), (da), (ja) and (nc) of Section 5 of the Banking Regulation Act, 1949 respectively.
• AIFIs including Export-Import Bank of India (Exim Bank), NABARD, National Bank for Financing Infrastructure and Development (NaBFID), National Housing Bank (NHB) and Small Industries Development Bank of India (SIDBI) as established by the Export-Import Bank of India Act, 1981; the National Bank for Agriculture and Rural Development Act, 1981; the National Bank for Financing Infrastructure and Development Act, 2021; National Housing Bank Act, 1987 and the Small Industries Development Bank of India Act, 1989.
• The Commercial Banks and AIFIs will collectively be referred to as ‘banks’ for the purpose of these Directions.

iv. Governance Structure : There shall be a Board approved Policy on fraud risk management describing the roles and responsibilities of Board / Board Committees and Senior Management of the bank and inclusive of the measures for ensuring compliance with principles of natural justice in a time-bound manner which at a minimum shall include:

• Issuance of a detailed Show Cause Notice (SCN) to the Persons, Entities and its Promoters / Whole-time and Executive Directors against whom allegation of fraud is being examined.
• At least 21 days should be provided to the Persons / Entities on whom the SCN was served to respond to the said SCN.
• The Fraud Risk Management Policy shall be reviewed by the Board at least once in three years, or more frequently, as may be prescribed by the Board.

v.Special committee: Banks shall constitute a Committee of the Board to be known as SCBMF with a minimum of three members of the Board, consisting of a whole-time director and a minimum of two IDs /NEDs. The Committee shall be headed by one of theIDs/NEDs. The Senior Management will be responsible for implementation of the fraud risk management policy approved by the Board of the bank.

•  Banks should adopt a transparent mechanism to ensure that Whistle Blower complaints on possible fraud cases / suspicious activities in account(s) are analyzed and concluded appropriately under their Whistle Blower Policy.

vi.Framework for EWS and Red Flagging of Accounts (RFA): Banks shall have a framework for EWS and RFA under the overall Fraud Risk Management Policy approved by the Board.

• A RFA is one where a suspicion of fraudulent activity is thrown up by the presence of one or more EWS.
• The Risk Management Committee of the Board (RMCB) shall oversee the effectiveness of the framework for EWS and RFA.