Summary: This blog traces the regulatory and judicial evolution of fraud classification by banks. It provides an overview of the 2016 Fraud Directions, the Supreme Court’s ruling in Rajesh Agarwal, reading natural justice into the 2016 Directions, and summarises the key changes introduced by the 2024 Directions. It also analyses the Supreme Court’s ruling in Amit Iron, which clarifies Rajesh Agarwal and settles the procedure banks must follow in classifying an account as fraud, including that banks need not necessarily grant an opportunity of oral hearing to borrowers, but must ordinarily furnish the complete forensic audit report, giving borrowers an opportunity to be heard before the serious consequences of a fraud classification take effect.

INTRODUCTION:

The classification of a Borrower/ Persons[1] and its Promoters/ Whole-time Directors and Executive Directors as ‘Fraud’ entails serious consequences. The Supreme Court has in a catena of judgments[2] held that such classification is akin to blacklisting and effectively constitutes civil death for the affected Borrower/ Persons. The classification inter alia results in mandatory reporting to Law Enforcement Agencies (“LEAs”) and debarment from institutional finance for a period of five years from the date of full repayment of the defrauded/ settlement amount.

This article traces the development of regulatory and judicial evolution of fraud classification by banks. It covers the development of the Master Directions on Frauds, dated July 1, 2016 (as amended) (“2016 Directions”), followed by the ruling in State Bank of India and Ors. v. Rajesh Agarwal and Ors.[3] (“Rajesh Agarwal”), which read natural justice into the 2016 Directions. It then examines the Master Directions on Fraud dated July 15, 2024 (“2024 Directions”), which superseded the 2016 Directions. It also deals with the Supreme Court’s recent ruling in State Bank of India v. Amit Iron Pvt. Ltd.[4] (“Amit Iron”),which clarified Rajesh Agarwal and settled the procedure banks must follow for fraud classification.

2016 FRAUD DIRECTIONS

The 2016 Directions replaced and consolidated various circulars into a single framework for early detection and reporting of fraud, timely reporting to LEAs, fraud risk management, and faster dissemination of information across the banking system. In doing so, it marked a shift from fragmented, post-facto reporting to a structured, time-bound classification regime that enabled banks to classify accounts as fraud based on early indicators and red flags, without awaiting conclusive criminal findings from courts.

A fundamental lacuna in the 2016 Directions was the absence of any procedural safeguard prior to fraud classification. Banks were not required to issue a show-cause notice, leaving borrowers with no opportunity to contest the allegations. This procedural vacuum rendered the framework constitutionally vulnerable and triggered a wave of litigation.

THE RAJESH AGARWAL CASE

Telangana High Court

The proceedings originated from a Writ Petition filed before the Telangana High Court[5]. The Petitioner argued that a fraud classification attracted grave civil and criminal consequences without any prior hearing, violating Articles 14 and 19(1)(g) of the Constitution. The lender, on the other hand, argued that fraud classification was undertaken solely to report to LEAs and a prior show-cause notice could forewarn borrowers and hamper investigation and recovery. 

The Telangana High Court, relying on inter alia the Supreme Court’s decision in State Bank of India v. Jah Developers (P) Ltd.[6], held that considering the drastic consequences of fraud classification, a borrower must be afforded a hearing prior to classification of its accounts as fraud.

Supreme Court

The Supreme Court had to determine whether the principles of natural justice, specifically audi alteram partem[7], were required to be read into the 2016 Directions. The Court drew a distinction between reporting a criminal offence or registering an FIR and held that fraud classification not only results in reporting crime to investigating agencies but also has other penal and civil consequences against borrowers, including debarment from institutional finance akin to blacklisting. Accordingly, it held that audi alteram partem must be read into Clauses 8.9.4 and 8.9.5 of the 2016 Directions. It further held that (i) borrowers must be served a notice, (ii) given an opportunity to explain the conclusions of the forensic audit report (“FAR”) on which the bank’s decision is based, (iii) be allowed to represent before fraud classification, and (iv) fraud classification by banks must be by way of a reasoned order.

OVERVIEW OF THE 2024 DIRECTIONS

Following the Rajesh Agarwal judgment, the RBI issued the 2024 Directions on July 15, 2024, superseding the 2016 Directions.

Clause 2.1.1 of the 2024 Directions specifically requires banks to issue a detailed Show Cause Notice (“SCN”) to the Persons/ Borrowers and its promoter/ directors with complete details of transactions/ events in the SCN underlying the proposed classification and allows a reasonable period of not less than 21 days for the Persons/ Borrowers to respond to the SCN. It further requires banks to have a well laid out system for issuance of SCN, examination of responses and passing reasoned orders, which must be duly served on the affected Persons/ Borrower and its promoters/directors.

Other notable changes of the 2024 Directions include: (i) expanded applicability to all banking companies and All India Financial Institutions, (ii) a mandatory Board-approved fraud risk management policy incorporating natural justice safeguards, (iii) constitution of a Special Committee of the Board for Monitoring and Follow-up of cases of Frauds for all fraud cases, (iv) a shortened 14-day Fraud Monitoring Return filing timeline, (v) an expanded list of fraud classification categories, (vi) a mandatory Early Warning Signals and Red Flagging of Accounts framework, (vii) removal of fraud classification for entities successfully resolved under IBC or RBI frameworks with a change in management, while preserving criminal liability against erstwhile management, and (viii) a new obligation on auditors to escalate suspected fraud to top management and the Audit Committee.

AMIT IRON JUDGMENT: SETTLING RESIDUAL QUESTIONS

Following the landmark judgment in Rajesh Agarwal, two specific questions remained unresolved: (i) whether affording opportunity of a personal or oral hearing to a borrower is mandatory; and (ii) whether banks are required to furnish the complete FAR relied upon in the SCN or may supply only its conclusions. The Calcutta High Court[8] and Delhi High Court[9], interpreting Rajesh Agarwal, held that borrowers have a right to a personal hearing and that banks must furnish the complete forensic audit report. The Division Benches of both High Courts affirmed these rulings, which banks subsequently challenged before the Supreme Court. The key issues before the Supreme Court were:

• Does the decision in Rajesh Agarwal recognise the right to a mandatory personal/ oral hearing to the borrower prior to fraud classification?
• Whether banks are obligated to furnish the entire FAR to borrowers prior to declaring their accounts as fraud, or whether furnishing only the conclusions of the FAR suffice?

RULING IN AMIT IRON CASE

• No mandatory right to a personal hearing: The Supreme Court held that Rajesh Agarwal did not recognise any right in the borrower to a personal hearing before classifying their account as fraud. The procedure of issuing a show-cause notice, furnishing evidentiary material, eliciting a written reply, and passing a reasoned order would meet the requirements of fairness. It held that mandating personal hearing in fraud classification proceedings would convert an administrative process intended to be swift into a protracted one, defeating the very purpose of the exercise, and would provide an opportunity to recalcitrant borrowers to dissipate assets, destroy evidence, or abscond, causing enormous prejudice to public interest. The Court further distinguished fraud proceedings from wilful defaulter proceedings, noting that fraud carries an element of criminality. Accordingly, no discrimination arises merely because the wilful defaulter framework provides for personal hearing.
• Full forensic audit report must be furnished: Relying on the Supreme Court’s ruling in T. Takano v. Securities and Exchange Board of India and Anr. and other judgments[10], the Court held that supply of forensic audit report is the rule, and that furnishing findings and conclusions alone would not satisfy the principles of natural justice, as the reasoning appears in the body of the report and a complete understanding requires reading it in full. The right to disclosure is, however, not absolute. Where disclosure of any part of the report would affect third-party interests, the bank may withhold those portions after recording reasons and give the borrower an opportunity to demonstrate if the said information is necessary for an effective defense.

Accordingly, both appeals were allowed. The directions requiring personal hearings were set aside and those mandating furnishing of forensic audit reports were upheld. The banks were directed to furnish the reports, call for written representations, and pass fresh orders under the 2024 Directions.

Concluding Thoughts

The regulatory and judicial evolution traced in this article reflects India’s increasingly sophisticated approach to balancing banking regulation with individual rights. Rajesh Agarwal filled a genuine procedural vacuum by reading principles of natural justice into fraud classification, and the 2024 Directions have codified that safeguard through a show-cause notice, written representation, and reasoned order. Amit Iron now settles the residual questions: banks need not necessarily grant an oral hearing, but must ordinarily furnish the complete forensic audit report, giving borrowers an opportunity to be heard before the serious consequences of a fraud classification take effect.

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[1] Including Third Party Service Providers and Professionals such as architects, valuers, chartered accountants, advocates, etc.

[2] (2014) 9 SCC 105; (1975) 1 SCC 70; (1989) 1 SCC 229

[3] (2023) 6 SCC 1

[4] Civil Appeal Nos. 4243-4244 of 2026

[5] W.P. No. 19102 of 2019 (Telangana HC, decided on December 10, 2020).

[6] (2019) 6 SCC 787

[7] Latin for ‘listen to the other side’ or ‘let the other side be heard as well’

[8] Civil Appeal arising out of SLP (C) Nos. 20618-20619 of 2025, decided by the Calcutta High Court (Single Judge) on August 7, 2024 and by the Division Bench on March 12, 2025.

[9] Civil Appeal arising out of SLP (C) No. 38805 of 2025, decided by the Delhi High Court on June 6, 2025 and by the Division Bench on July 29, 2025.

[10] (2022 8 SCC 162); (2010) 13 SCC 255; (2023) 13 SCC 632