Monitoring of Frauds in NBFC’s; RBI’s Master Direction 2016

Shailza Sharma

31 Dec, 2020

Reserve Bank of India by exercising its power conferred under section 45k, 45L and 45M of the RBI Act, 1934 issued a master direction to monitor the fraud ensue in NBFCs. The direction shall be called Monitoring of Frauds in NBFCs (Reserve Bank Direction, 2016).

Monitoring of frauds in NBFC; An overview

The financial sector in India has witnessed accelerated growth in the past few years. At the same time, the incidence of deception has also been on the rise.  In today’s economic environment, where the opportunity for growth is increasing day by day, the ratio of committing fraud has also been improved. For instance, cybercrime, money laundering, accounting frauds are generally known crimes that take place in the finance sector. Our regulatory authorities are continuously evolving, strict regulatory compliance and the regulators can be seen becoming more aggressive.

According to RBI, “the primary responsibility of preventing fraud lies with banks themselves.” Regulations governing financial institutions, institutions like Scheduled Commercial Banks (SCB), Insurance Companies, Non-Banking Financial Companies (NBFC), Regional Rural Banks (RRBs), are set to have a tremendous impact. Acknowledging, the risk factors applicable in NBFC, RBI has issued a master circular on reporting of these frauds. Master circular describes the responsibility of monitoring and preventing scams, subjecting NBFC to uncertain financial risks. The leaflets urge the NBFCs to place a reporting system to record the fraud without any delay.

Guidelines for Monitoring Frauds in NBFC

The direction provided in the master circular shall apply to all deposit-taking Non-Banking Financial Companies and systemically important non –banking financial companies’ (NBFC-ND-SI).

• There shall be a reporting system in all the NBFCs concerning record the fraud without any delay. NBFCs are required to fix the accountability of their staff in case of delay in reporting of fraud.
• The NBFC shall strictly adhere to the timeframe allotted in the master direction for reporting the fraud. If in case NBFC fails to report the fraud, they shall be liable for punishment as prescribed in chapter V of Reserve Bank of India act, 1934^[1].
• As per the direction, NBFC shall appoint an official either of the general manager rank or any other official of equivalent rank. The responsibility of the official is to submit all the returns to the bank and reporting as referred in this direction.
• There is no need for submitting any ‘NIL’ report to the fraud monitoring cell/Regional offices if no scams are detected.
• The amount of fraud shall be disclosed by the NBFCs in the balance sheet of the year.

Classification of Frauds

1. Frauds have been classified as under, mainly based on the provisions of the Indian Penal Code;

                                       Classification of frauds

  Cases of ‘negligence and cash shortages’ and irregularities in foreign exchange transactions are to be reported as fraud if the intention of cheat/defraud is suspected/proved.

• NBFCs, having offices/ branches outside India shall report all frauds to the banks as per the procedure described under chapter IV of the RBI act.

Reporting of Frauds

• Reporting of frauds involving INR 1 lakh and above
• A fraud reports should be submitted in all case where fraud amount is 1 lakh or above that committed through misrepresentation, breach of trust, manipulation of books, fraudulent encashment of FDRs, unauthorized handling of security charged to the applicable NBFC, misfeasance, embezzlement,   misappropriation of funds, conversion of property, cheating, shortage, irregularities, etc…
•  Fraud reports shall be submitted in cases where central investigating agencies have started the criminal investigation or where the bank has directed that they are reported as fraud.
• NBFCs are required to report the frauds committed in their joint ventures or subsidies.
• Where the fraud amount is INR 1 crore or above, they are bound to send the reports in the prescribed format within the three weeks from date of fraud is committed.  The address to where reports need to be marked-

Central Fraud Monitoring cell,
Department of Banking
Supervision,
Reserve Bank of India, 10/3/8
Nrupathunga Road,
P.B. No. 5467, Bengaluru –560001

The same report of fraud shall be sent to the Regional Office of the Department of Non-Banking Supervision of the Bank under whose jurisdiction the NBFC fall.

• In the case where the fraud amount is less than INR 1 crore, a report in the prescribed manner (FMR-1) shall be sent to Regional Office of the Department of Non-Banking Supervision of the Banks, within 21 days of detection of fraud.
• NBFCs are requested to submit case- wise quarterly progress reports on Frauds, involving INR 1 lakh  and above in the prescribed format given in FMR -3 only to the regional office of bank, department of Non- banking Supervision under whose jurisdiction the registered office of NBFC falls within 15 days of the end of the quarters to which it relates.
• The case of fraud shall be closed if only the actions are completed and regional offices have provided the approval to close the case. The actions which are required to be completed are as such –
  • the fraud cases pending with CBI/Police/Courts are finally disposed
  • the accountability of staff accountability has been achieved
  • the amount of fraud has been recovered or written off
  • an insurance claim has been settled
  • The appropriate authority i.e Board, Audit Committee of the board, has certified the NBFCs review system and procedures identified as the causative factors.

• NBFCs should proceed along with CBI for the final disposal of pending fraud cases.

NBFCs are advised to close the fraud cases where the fraud amount is up to 25 lakh, where,

• the investigation is on, or challan/charge sheet is not filled in the court for more than three years from the date of filing of FIR
• the trial court has not started any proceedings after filing the charge sheet.

Fraud Committed by Unscrupulous Borrower

• Frauds committed by unscrupulous borrower including companies, partnership firm/ proprietary concern or by their director/partners are
• Fraudulent discount  Instruments
• Fraudulent removal of pledge stocks/disposing of hypothecated stocks without NBFCs knowledge.
• Diversion of funds outside the borrowing units, lack of interest or criminal neglect on the part of borrowers, their partner, etc…
•  In case of fraud in areas accounts, NBFCs have to furnish their additional information as prescribed under Part of FMR-1.

Guidelines for reporting to Police

In case of reporting the fraud to police such as unauthorized credit facilities extended by NBFC for illegal gratification, negligence, and cash shortage, cheating, and forgery. The fraud shall be reported to state police authorities. In the following scenarios, the fraud cases should be referred to state police.

• Cases where fraud amount is INR 1 lakh and above, committed by outsider on their own or by any of the NBFC staff/officer.
• Cases of frauds committed by employees of NBFCs, where the amount is exceeding INR 10,000. 

Read our article:Loan Exposure of NBFC Increased: A Complete Analysis

Conclusion

NBFC sector has evolved in terms of its size, functions, technological development. With such developments, risk factor related to frauds also increases rapidly, as being a financial entity. In consideration of these frauds related to misfeasance, embezzlement,   misappropriation of funds, conversion of property, cheating, shortage, irregularities, etc… Reserve bank of India has issued a master circular for reporting frauds. Similar to the banking sector the master circular of RBI for reporting the frauds, stating a road map to fix the liability of averting the frauds on NBFCs, subjecting them to uncertain financial risks.