Banking Frauds: Classification and Reporting under RBI Fraud Directions

A bank lends other people's money. When that money is taken by deceit the loss falls first on the bank's balance sheet and then, through the price of credit, on every honest borrower. The law therefore does not leave fraud to the criminal courts alone. It builds a parallel regulatory machinery that detects fraud early, records it centrally, shuts the defrauder out of the credit system, and fixes accountability inside the bank. The present shape of that machinery was set by three Master Directions issued by the Reserve Bank of India on 15 July 2024, which replaced the earlier framework and, for the first time, wrote the borrower's right to be heard into the process. On 31 July 2026 those Directions were carried, substantially unchanged, into entity specific Fraud Risk Management Directions, 2026.

1. Why fraud is regulated and not merely prosecuted

A prosecution punishes an offender. It does nothing for the bank's money, and it does nothing to stop the same person borrowing again from the bank across the road. The regulatory response to fraud is built to do three things that a prosecution cannot do.

• Detect early. A fraud that surfaces when the account turns non-performing has already consumed the money. The framework therefore works on signals rather than on confessions.
• Record centrally. A fraud known only to the defrauded bank is an invitation to the next bank. The Central Fraud Registry turns one bank's loss into every bank's warning.
• Exclude. The five year debarment from credit is the sharpest tool in the framework, and it bites long before any court reaches a verdict.

The framework sits alongside, and not instead of, the criminal law. A classification of fraud is a regulatory and administrative finding. It is not a conviction, it does not require proof beyond reasonable doubt, and it does not displace the obligation to report the matter to the police.

2. What the Fraud Directions are and whom they bind

On 15 July 2024 the Reserve Bank issued three Master Directions on fraud risk management, one for each family of regulated entities. They superseded the earlier sets of directions and withdrew thirty six circulars, so that the whole subject sat in one place for each category of lender.

1. Commercial banks, including Regional Rural Banks, and All India Financial Institutions.
2. Cooperative banks, that is urban cooperative banks and State and central cooperative banks.
3. Non-banking financial companies, including housing finance companies.

The three sets follow the same architecture. Each requires a board approved fraud risk management policy, a governance structure to own it, an Early Warning Signals framework, a procedure that satisfies natural justice before a person or an entity is classified as fraud, a reporting discipline towards the Reserve Bank and the law enforcement agencies, and a staff accountability examination.

On 31 July 2026 the Reserve Bank consolidated these instruments into entity specific directions, among them the Reserve Bank of India (Commercial Banks, Fraud Risk Management) Directions, 2026, which took effect at once. The consolidation was substantially an exercise of restatement. The notable change is that the Board itself now fixes the threshold above which fraud cases are placed before its Special Committee, having regard to the scale and complexity of the bank. The account of the framework below therefore holds good under the 2026 text.

Figure 1: How a fraud is classified for reporting

3. Governance: who inside the bank owns fraud risk

The Directions push fraud risk upwards. The Board must approve the policy, and the Board must see the cases.

• A Special Committee of the Board for Monitoring and Follow-up of cases of Frauds, of at least three directors including a whole time director and at least two independent or non-executive directors, and headed by one of the latter, oversees the effectiveness of fraud risk management, reviews the cases and examines their root causes.
• The fraud risk management policy is approved by the Board and reviewed at least once in three years.
• A periodic review of incidents of fraud is placed before the Board or its Audit Committee.
• A Data Analytics and Market Intelligence Unit must be set up to strengthen the Early Warning Signals framework and to watch non-credit transactions, especially digital ones, for unusual patterns.

4. Early Warning Signals and the Red Flagged Account

An Early Warning Signal is an indicator, drawn from the bank's own data, that an account may be heading towards fraud. The framework must be integrated with the core banking solution so that signals fire in something close to real time rather than at the next review.

An account in which one or more signals have fired is tagged as a Red Flagged Account. The tag is internal. It triggers a closer examination, and where the policy provides for it an audit by external or internal auditors, for which the loan documentation must reserve the lender's right. The borrower is not told of the tag, because the purpose of the tag is to look before the money moves.

The signals in use include defaults in statutory dues, dishonour of high value cheques, unexplained transactions with related parties, movements of funds through real time gross settlement that do not fit the business, inventory and receivable figures that do not reconcile, inconsistencies between the annual report and the returns filed with the lender, and changes in the promoter's shareholding.

5. The right to be heard before classification

The most important change made by the 2024 Directions was not written by the Reserve Bank. It was written by the Supreme Court.

The 2024 Directions give effect to that judgment. Each regulated entity must have a board approved policy that provides for the following sequence.

1. A show cause notice to the person or entity proposed to be classified as fraud, and to its promoters and whole time and executive directors, setting out the transactions and events on which the proposed classification rests.
2. A period of at least twenty one days to reply.
3. Consideration of the reply, and a reasoned order that records the events relied on, the submissions made and the reasons for the conclusion.
4. Communication of the order to the person or entity concerned.

Figure 2: From the first signal to the closure of the case

6. Reporting to the Reserve Bank, the police and the registry

To the Reserve Bank

Reporting is through the Fraud Monitoring Return on the Reserve Bank's reporting platform.

• A return for every fraud, whatever the amount, filed at once and in any event within fourteen days of the date of classification, which is the date on which the competent authority approves the reasoned order.
• A red flagged account with an aggregate exposure of three crore rupees and above is reported to the Reserve Bank's credit information system within seven days of being red flagged, before any classification.
• Theft, burglary, dacoity and robbery, including attempts, are reported to the Reserve Bank immediately and not later than seven days from their occurrence, with a quarterly return within fifteen days of the end of the quarter. These are reported separately and are not classified as frauds.
• A closure module through which a case is formally closed.

To the law enforcement agencies

Reporting to the police is immediate and does not depend on the amount. Which agency receives it depends on the ownership of the bank and on the size of the fraud. The reporting is a continuing obligation rather than a single act, so a first information report must be lodged promptly and the bank must thereafter coordinate with the investigating agency, supplying documents and witnesses as the investigation requires. The Directions do not permit a bank to wait for the completion of its own enquiry before approaching the police.

To the registry

Every classified fraud is recorded in the Central Fraud Registry, and the Directions require regulated entities to consult the registry in their credit appraisal and fraud risk decisions. A third party service provider found to have been involved in a fraud is reported to the Indian Banks' Association so that other lenders may act on the information.

7. Staff accountability and the penal consequences

A fraud on a bank is very rarely committed from outside alone. The Directions therefore require the examination of staff accountability to be completed within the time frame fixed by the policy, and a case may be closed only after both the cases pending with the law enforcement agencies or the courts are disposed of and the accountability examination is complete. For public sector banks and All India Financial Institutions, cases of three crore rupees and above go to the Advisory Board for Banking and Financial Frauds, constituted by the Central Vigilance Commission, to examine the role of the officials involved.

The consequence for the defrauder is exclusion.

• No credit facility from any entity regulated by the Reserve Bank for a period of five years, counted from the date of full repayment or settlement of the defrauded amount.
• The bar attaches not only to the borrowing entity but also to the entities and persons associated with it, including its promoters and its whole time and executive directors, following the Supreme Court's reasoning on who suffers the civil consequence.
• A compromise settlement of the dues does not erase the classification or the penal measure. The five years then run from payment of the agreed settlement amount.
• Where a resolution under the Insolvency and Bankruptcy Code, or under the Reserve Bank's prudential framework, results in a change in the management or control of the borrower, the penal measures cease to apply to the resolved entity once the plan is implemented, and the lender examines whether the classification itself should continue. The measures continue against the erstwhile promoters and directors.

8. Fraud and wilful default compared

The two frameworks are often confused because both end in exclusion from credit. They answer different questions. Wilful default asks whether a borrower who could pay has chosen not to. Fraud asks whether the money was obtained or used by deceit. A borrower may be both, may be either, and may be classified as a fraud while the account is still standard and the instalments are being paid, because the deceit lies in how the facility was obtained or how the money was applied.

9. Quick Revision

1. Frauds are reported under eleven categories that run from misappropriation, criminal breach of trust and cash shortages through forged instruments, manipulated books and falsification to credit extended for gratification, foreign exchange frauds and digital payment frauds, with a residual head.
2. Theft, burglary, dacoity and robbery are not frauds. They are reported separately, within seven days and then quarterly.
3. The Early Warning Signals framework must be integrated with the core banking solution, and a Data Analytics and Market Intelligence Unit must support it.
4. A Red Flagged Account is an internal tag that triggers investigation. The borrower is not told of it.
5. Before classification the borrower gets a show cause notice, at least twenty one days, and a reasoned order.
6. Reporting to the police is immediate and irrespective of amount.
7. The Central Fraud Registry must be consulted, not merely fed.
8. A case closes only after the cases before the law enforcement agencies or the courts are disposed of and the staff accountability examination is complete.
9. The penal measure survives a compromise settlement but ceases for the resolved entity on a change in management or control through a resolution process.

10. Frequently Asked Questions

Can an account be declared a fraud without hearing the borrower?

No. That was the position before State Bank of India v. Rajesh Agarwal, (2023) 6 SCC 1, and it is no longer the position. The borrower must receive a show cause notice with the material relied on, including the forensic audit report, must be given at least twenty one days to reply, and must receive a reasoned order. A classification made without that process is liable to be set aside, and the borrower is ordinarily restored to the position before classification while a fresh and lawful process is undertaken.

Does a fraud classification require the borrower to be in default?

No. This is the sharpest difference between fraud and wilful default. Fraud goes to the honesty of the representation or of the use of the money. An account may be regular, the instalments may be arriving on time, and the account may still be classified as a fraud if, for example, the facility was obtained on forged title deeds or the money was diverted to a purpose other than the one sanctioned.

Is the five year debarment a punishment?

It is a civil consequence and not a criminal sentence, which is precisely why the Supreme Court insisted on a hearing. It is nonetheless severe. It runs for five years from full repayment or settlement of the defrauded amount, it extends to the promoters and the persons in charge, and it applies across every entity regulated by the Reserve Bank and not merely the bank that was defrauded. A borrower who neither repays nor goes through a resolution that changes management remains excluded without any clock running at all.

Does a fraud classification survive an insolvency resolution of the company?

Where a resolution plan is implemented under the Insolvency and Bankruptcy Code, or a resolution takes place under the Reserve Bank's prudential framework, and the result is a change in the management or control of the borrower, the penal measures cease to apply to the resolved entity, and the lender examines whether the classification itself may be removed. The logic is that the penal measure is aimed at the persons who practised the deceit, and those persons no longer run the company. The measures continue to apply to the erstwhile promoters and directors in their own right, and any criminal action against them continues.

Who decides whether a bank officer was complicit?

The bank does, through the staff accountability examination mandated by the policy and within the time frame it fixes. For public sector banks and All India Financial Institutions there is an additional layer. Cases of three crore rupees and above are referred to the Advisory Board for Banking and Financial Frauds, constituted by the Central Vigilance Commission, which examines the role of the officials concerned, including whole time directors, before proceedings are initiated. A fraud case cannot be closed on the Reserve Bank's platform while the accountability examination is still open.

Does a fraud classification reach a guarantor?

Not merely because he guaranteed the facility. The show cause notice and the penal measures reach the borrower and, following the Supreme Court's reasoning on who suffers the civil consequence, its promoters and its whole time and executive directors. A guarantor who is also a promoter or such a director of the borrowing entity is therefore caught in that capacity. A guarantor who is a stranger to the management, for instance a relative or a collateral provider, is not classified as a fraud simply by reason of the guarantee, though the bank's recovery remedies against him under the contract of guarantee are untouched. Any classification that does reach him requires the same show cause notice, the same twenty one days and the same reasoned order.

Why must a borrower be heard before the account is classified as fraud?

Because the classification carries civil consequences that follow the borrower for years: reporting to the Reserve Bank and the credit registry, criminal complaints, and the bar on fresh finance for five years. In State Bank of India v. Rajesh Agarwal the Supreme Court held that the principles of natural justice must be read into the fraud classification framework, so the bank must serve the forensic audit material, issue a show cause notice and consider the reply, and record a reasoned order, though no personal hearing is required. A classification made without that process is liable to be set aside, which is why the Directions now build the show cause and reasoned order into the procedure itself.

11. Related Topics and Provisions

• Resolution of stressed assets and the treatment of wilful defaulters
• Criminal liability in banking and the Prevention of Corruption Act, 1988
• The Prevention of Money-Laundering Act, 2002 and the obligations of banks
• Inspection, supervision and penalties under the Banking Regulation Act, 1949
• Non-performing assets: classification, provisioning and the prudential framework
• Electronic banking and customer liability for unauthorised transactions