A bank tagging a loan account as “fraud” can cut off a borrower’s access to credit, trigger criminal scrutiny and follow her across future transactions. Earlier this week (April 7), the Supreme Court settled a procedural dispute between borrowers and banks on whether a borrower must be given a personal or oral hearing before a loan account is classified as fraudulent under RBI norms.A bench of Justices JB Pardiwala and K V Viswanathan held that the principles of natural justice do not require an oral hearing, and doing so would “throw the banking operations into disarray,” the court said. A notice, an opportunity for the borrower to respond via a written reply, and a reasoned decision meet the requirements of fairness, it held.The “fraud” classification matters because it can lead to blacklisting from institutional finance.How the matter reached courtThe current case arises from two sets of facts.Borrower Amit Iron Private Limited had an account with the State Bank of India (SBI), which was declared a Non-Performing Asset (NPA) in August 2019 due to repayment defaults. By December 2023, the bank issued a show cause notice alleging “various acts of non-compliance with the agreed terms of the loan documents, commission of irregularities in financial conduct suggesting fraudulent activity.”After the borrower submitted a written reply denying wrongdoing, the bank, in March 2024, classified the account as fraudulent, stating that “a speaking order passed in this regard was communicated”.The Calcutta High Court then held that the borrower should have been granted a “personal hearing” and access to the full forensic audit report before such a classification.Experts Explain | Jan Vishwas Bill 2026: Scale, scope and impact of India’s major decriminalisation exerciseIn the case of Liliput Kidswear Limited, the borrower’s account at the Bank of India had turned into an NPA in March 2012. A show cause notice was served upon in August 2023 and January 2024. After considering the borrower’s reply, the account was classified as fraudulent in May 2025.Story continues below this adThe Delhi HC set aside that classification, saying that a personal hearing was required and the audit material needed full disclosure.Across both these cases, the banks followed a set process: notice, a written reply, and a reasoned decision. Borrowers argued that the procedure was insufficient, as the consequences were severe. They described the fraud allegations as akin to “civil death”, leading to blacklisting, reputational damage and possible criminal consequences.Natural justice and RBI directionsAt the centre of the case are the RBI’s Master Directions on fraud classification and how they interact with principles of natural justice, particularly audi alteram partem (“listen to the other side”).Section 35A of the Banking Regulation Act, 1949, empowered the RBI to direct banks in public interest, in the interest of banking policy, or to prevent conduct “detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company.” The classification guidelines for the “fraud” tag flow from that authority.Story continues below this adBut the 2016 Master Directions are silent on procedure and giving borrowers a hearing before the tag is applied. In 2023, the SC in SBI vs Rajesh Agarwal read natural justice into these directions and required banks to issue a notice, consider a reply and pass a reasoned order before classifying any account as fraudulent.Also Read | How Karnataka’s new law against honour killing affirms absolute right of adults to choose their partnersBy 2024, the RBI had formalised this process by updating its Master Directions to include a show-cause notice, a minimum 21-day response window, and a reasoned order.What remained unresolved was whether “being heard” required something more — a personal or an oral hearing — and whether borrowers had a right to see the forensic audit report that formed the basis of the classification.What the court saidThe SC has partly allowed the banks’ appeals and reset the procedure for the fraud classification. It set aside HC directions requiring banks to grant a personal or oral hearing before declaring an account as fraudulent. The court held that such a requirement would be “practically inexpedient” given the number of cases handled by banks each year.Story continues below this adThe court noted RBI data showing 13,494 fraud cases in FY 2022-2023, 36,060 fraud cases in FY 2023–24, and 23,953 in FY 2024-25, warning that mandating oral hearings would paralyse decision-making and enable delay tactics by “recalcitrant borrowers”.It also clarified the ruling in SBI v Rajesh Agarwal, stating it did not recognise any right to a personal hearing and that this can be done by written representation.On disclosure, however, the court upheld the borrower’s entitlement. It said that banks have an obligation to furnish the forensic audit report to the borrower before passing an order classifying the account as fraudulent. The reasoning turned on what a report actually contains and why it matters.“The furnishing of findings and conclusion alone would not tantamount to compliance with the principles of natural justice,” the court held. The reasons for those findings sit inside the body of the report. Without those reasons, a borrower cannot challenge the conclusions. “A complete sense of the findings and conclusions can be made only after reading to the contents of the report,” it said.Story continues below this adAlso Read | Explained: Right to be considered for promotion as a fundamental right, and how it works in practiceIt allowed banks to redact portions of the report, but only where they relate to third-party or privacy, and cautioned against using redaction to withhold relevant material.The court upheld the RBI’s broader fraud classification directions and said the three-step process “strikes a fair balance between promptitude and fairness and duly comports with the principles of natural justice ensuring fairness to the borrower.”It also described fraud classification as, in part, “in the broad sense a housekeeping due diligence, internally carried out by the bank,” and not a criminal trial. The evidence is predominantly documentary, including financial statements and transaction records, and that evidence is already within the borrower’s knowledge.The court further addressed the comparison borrowers had drawn to wilful defaulter proceedings, where oral hearings are routinely provided. It held that fraud and wilful default are “of a qualitatively different order.” A wilful defaulter has the means to pay and chooses not to, while fraud “involves an element of criminality,” misappropriation, forgery, and cheating. The RBI is entitled to design different procedures for them, and courts should not “second guess the regulator” in such matters, it said.