Fraud Classification of a Borrower Account under the RBI Directions

When a bank or NBFC classifies a loan account as fraud, the consequences go well beyond the loan. The lender reports the account to the Reserve Bank and to investigating agencies, the borrower and everyone associated with it are barred from fresh credit across the regulated financial system for at least five years, and the lender must report the matter to investigating agencies. Because the decision is taken by the lender itself, the RBI's directions surround it with a minimum procedure: a red-flag stage, a detailed show-cause notice, at least 21 days to reply, and a reasoned order.

This note sets out which instrument governs the process today, how an account moves from an early warning signal to a fraud classification, what the show-cause notice must contain, what follows classification, and how the process differs from a wilful defaulter declaration. It is written from the text of the RBI directions.

Key points

• The Master Directions on Fraud Risk Management of 15 July 2024 were repealed on 31 July 2026 and replaced by lender-specific Fraud Risk Management Directions, 2026, effective on issue.
• The fraud directions were not part of the RBI's 28 November 2025 consolidation; the wilful defaulter directions were.
• Before classification, the lender must serve a detailed show-cause notice and allow not less than 21 days to respond, then pass a reasoned order.
• Once an account is red-flagged, classification or removal of the red flag should ordinarily be completed within 180 days.
• A fraud return goes to the RBI within 14 days of classification, and the lender reports to the police, the SFIO or the CBI depending on the lender and the amount.
• The borrower and associated persons are debarred from raising funds or additional credit for five years from full repayment of the defrauded amount or settlement amount.

Which RBI directions govern fraud classification now?

The governing text has changed twice in ten years, and the date of the lender's action decides which version applies.

The 2016 directions on classification and reporting of frauds were superseded on 15 July 2024, when the Reserve Bank issued three Master Directions on Fraud Risk Management — one for commercial banks (including regional rural banks) and all-India financial institutions, one for co-operative banks, and one for NBFCs (including housing finance companies).

On 28 November 2025, the Reserve Bank consolidated a large body of regulatory instructions into entity-wise directions. The wilful defaulter framework, for example, became the Reserve Bank of India (Commercial Banks – Treatment of Wilful Defaulters and Large Defaulters) Directions, 2025, with parallel directions for other lenders. The fraud risk management directions were not renamed in that exercise.

On 31 July 2026, the Reserve Bank's Department of Supervision issued separate Fraud Risk Management Directions, 2026 for each category of lender. Each repealed the existing fraud risk management instructions for that category and came into effect immediately on issue.

The savings clause matters for accounts already in the pipeline. Any action taken or initiated under the repealed directions continues to be governed by them (paragraph 68 of the commercial bank Directions). A show-cause notice issued in June 2026 should therefore be tested against the 2024 text. The core safeguards — the detailed notice, the 21-day minimum, the reasoned order, the 180-day red-flag period and the five-year debarment — appear in both versions.

Paragraph references below are to the 2026 commercial bank Directions. The NBFC Directions follow the same scheme with different numbering; one difference is noted where it matters.

How does an account reach a fraud classification?

The Directions build a sequence. Each step leaves a record, and each record can be asked for.

Early warning signals and the red flag

Every bank must operate a board-approved framework for Early Warning Signals (EWS) and Red Flagging of Accounts (RFA) under its fraud risk management policy (paragraphs 5 and 12). A red flagged account is one where one or more EWS indicators throw up a suspicion of fraudulent activity, calling for deeper investigation from the fraud angle (paragraph 4(6)). The Risk Management Committee of the Board prescribes a turnaround time, preferably not more than 30 days, for examining EWS alerts (paragraph 14).

The decision to red-flag is taken by each bank individually, and the bank must report the status on the Reserve Bank's CRILC platform immediately and not later than seven days after red-flagging (paragraph 29). Accounts with an aggregate exposure of ₹3 crore and above are reported in the Red Flagged Account Return within seven days (paragraph 22). Where a law enforcement agency has itself begun investigating a borrower account, the bank must red-flag it immediately and run the classification process (paragraph 33).

Investigation and audit

For a red-flagged credit account, the bank uses an external audit, or an internal audit under its board policy, to investigate (paragraph 26). Loan agreements are to contain a clause permitting such an audit at the lender's instance. If the audit report is inconclusive, or is delayed because the borrower does not cooperate, the bank may conclude on the status of the account on the material on record and its own internal assessment — but only after strictly following the natural justice requirements (paragraph 28).

The 180-day period

Once an account is red-flagged, the whole process of classifying it as fraud or removing the red flag shall ordinarily be completed within 180 days from the date it was first reported as red-flagged on CRILC. Cases remaining red-flagged beyond 180 days must be reported to the board's Special Committee for Monitoring and Follow-up of Frauds with reasons, and are subject to supervisory review by the Reserve Bank (paragraph 31). The word "ordinarily" means the period is not an automatic expiry, but a long-pending red flag is a legitimate subject of correspondence with the lender.

Group companies

If any lender identifies an account as fraud, the borrowal accounts of other group companies with one or more common promoters or whole-time directors must also be examined from the fraud angle (paragraph 32). Examination is not classification: each group company is entitled to its own show-cause procedure.

What must the show-cause notice contain?

Paragraph 6 requires each lender's fraud risk management policy to ensure compliance with the principles of natural justice "in a time-bound manner", which at a minimum includes four things.

A detailed show-cause notice (paragraph 6(1)) to the persons, entities and their promoters, whole-time and executive directors against whom the allegation is being examined. The notice must provide complete details of the transactions, actions or events on the basis of which the lender contemplates declaring and reporting fraud. Third-party service providers and professionals — architects, valuers, chartered accountants, advocates and others — are also to be served where they are implicated.

Not less than 21 days to respond (paragraph 6(2)).

A well laid out system for issuing notices and examining the responses before any declaration (paragraph 6(3)).

A reasoned order (paragraph 6(4)) served on the persons and entities, conveying the decision on classification as fraud or otherwise. The order must contain the facts and circumstances relied upon, the submissions made in reply, and the reasons for the decision.

The Explanation to paragraph 6 states that these requirements apply to every person or entity, and its promoters and whole-time and executive directors, classified as fraud — in other words, to every fraud classification that may have civil consequences, such as penal measures or caution-listing. On non-whole-time directors, paragraph 6(1) notes that nominee and independent directors are normally not in charge of or responsible for the conduct of the company's business, and that the lender may take this into consideration before proceeding against them.

The date of classification, for reporting purposes, is the date on which the competent authority's approval is obtained and the reasoned order is passed (paragraph 4(3)). An order that has not been passed, or not served, is not yet a classification.

How should a borrower respond to a fraud show-cause notice?

The reply is usually the only opportunity to put the borrower's account before the decision is taken, and it is made to the lender, not to a court. A practical sequence:

• Diarise the 21-day period from the date of service, and record how and when the notice was served on each person named.
• Identify every transaction, action or event the notice relies on. If the notice refers to an audit report without disclosing which findings are relied on, ask in writing for the report and the specific findings, citing the requirement that the notice give complete details.
• If more time is genuinely needed because of the volume of transactions, ask for it in writing before the period expires, with reasons.
• Answer each transaction with primary documents: sanction terms, disbursement and end-use records, invoices and delivery records, bank statements, board approvals and lender consents.
• Distinguish commercial failure from fraud. A loss, a delay or a breach of covenant is not of itself one of the categories of fraud listed for reporting (paragraph 46).
• For each individual named, set out his or her actual role, designation and period of association. A non-whole-time director should rely expressly on paragraph 6(1).
• Ask for the reasoned order to be served on every person named, and keep the record of what was received and when.

What happens once an account is classified as fraud?

Reporting to investigating agencies

For private sector and foreign banks, frauds below ₹1 crore are reported to the State or Union Territory Police, and frauds of ₹1 crore and above to the police and also to the Serious Fraud Investigation Office. For public sector banks, frauds below ₹6 crore go to the State or Union Territory Police, and frauds of ₹6 crore and above to the Central Bureau of Investigation (paragraph 44). A footnote to that paragraph records that, under Section 33 of the BNSS, reporting is mandatory only for listed offences, and advises banks to report all frauds of ₹1 lakh or more. Under the NBFC Directions, frauds are reported to the State Police authorities.

Where the alleged fraud is also a scheduled offence under the money-laundering law, the reported FIR can lead to proceedings by the Enforcement Directorate, discussed in the notes on ED summons under Section 50 PMLA and bail under Section 45 PMLA. Investigating agencies sometimes seek travel restrictions at the same stage; see the note on look out circulars against bank borrowers.

The five-year debarment

Persons and entities classified and reported as fraud, and entities and persons associated with them, are debarred from raising funds and seeking additional credit from RBI-regulated entities for five years from the date of full repayment of the defrauded amount, or of the settlement amount in a compromise (paragraph 39). The period does not start running until the money is paid. After it ends, lending remains a matter of each lender's commercial discretion (paragraph 40).

Effect of an insolvency resolution

Where an entity classified as fraud goes through a resolution under the Insolvency and Bankruptcy Code, 2016, or under the RBI's resolution framework, and the resolution changes its management and control, the lender must examine whether the classification should continue after the plan is implemented (paragraph 41). The penal measures do not apply to the entity after implementation (paragraph 42) but continue against the erstwhile promoters, directors and persons in charge (paragraph 43), and criminal action against them is unaffected. The interplay with the insolvency process is covered in the guide to the Insolvency and Bankruptcy Code.

How is fraud classification different from wilful default?

The two are often run in parallel against the same borrower, and they are easily confused. They are separate processes under separate directions.

The wilful defaulter procedure, and the grounds on which those declarations are tested, are covered in detail in the note on wilful defaulter declarations. The NPA classification that usually precedes both is discussed in the note on challenging a wrongful NPA classification.

Can a fraud classification be challenged?

The Directions do not provide an appeal against a classification. They do contemplate that a court may direct the lender to withdraw a Fraud Monitoring Return or remove a name from it, and provide that the lender may then act immediately (paragraph 55). The remedy against a classification is ordinarily a writ petition under Article 226 of the Constitution before the High Court with territorial jurisdiction.

The record against which the classification is tested is the one the Directions require: whether a show-cause notice was served on each person classified; whether it gave complete details of the transactions relied upon; whether at least 21 days were allowed; whether the reply was considered; and whether a reasoned order, dealing with the reply, was served. Where an individual is named, the material against that individual, and the paragraph 6(1) note on non-whole-time directors, are part of the same examination. The borrower who has kept the notice, the reply, the covering letters and proof of service is in a position to show exactly where the procedure departed from the text.

For lenders, the same checklist is the defence of the order. Classification files that survive scrutiny show a transaction-specific notice, the material supplied, a genuine examination of the reply and an order that engages with it. Lender-side material is collected on the page for banks, NBFCs and ARCs.

Where this sits alongside recovery

A fraud classification does not recover anything. It runs alongside SARFAESI enforcement, recovery proceedings before the Debts Recovery Tribunal and any settlement discussion, and it changes the arithmetic of each: a settlement starts the five-year debarment clock, and a classification sitting on the record affects every later credit decision. Borrower-side matters are dealt with under banking disputes and NPA resolution.

This article is general information on the RBI directions and is not legal advice; the position in any account depends on its own record and on which version of the directions applies. Queries may be sent through the contact page.