Corporate governance is essential for the smooth operation of companies and the broader financial system. It involves the frameworks, policies, and practices that ensure companies operate with integrity and transparency. This is particularly vital in combating white-collar crimes such as fraud, embezzlement, and insider trading. Individuals in positions of trust often commit these crimes, which can significantly damage financial markets and institutions, leading to extensive economic fallout.
This article explores the relationship between corporate governance and white-collar crimes in India, focusing on recent regulatory updates like the Master Directions on Fraud issued by the Reserve Bank of India (RBI) in July 2024. These guidelines aim to bolster the framework for managing fraud and highlight the importance of strong corporate governance practices.
White-Collar Crimes and Corporate Governance
White-collar crimes are often sophisticated and difficult to detect, involving methods that obscure illegal activities. Such crimes can result in more than just financial loss; they also damage a company’s reputation and erode stakeholder trust. Effective corporate governance is crucial in addressing these risks through:
1. Implementing Strong Internal Controls: Effective internal controls and audit procedures are vital for detecting and preventing fraud. Regular audits and compliance with financial reporting standards are essential for spotting discrepancies and potential fraudulent activities.
2. Promoting an Ethical Culture: A culture grounded in strong ethical values, supported by clear policies, helps reduce the incidence of white-collar crimes. Organizations should foster an environment where ethical behavior is encouraged and unethical actions are penalized.
3. Enhancing Transparency: Transparency in operations and reporting helps ensure all financial transactions are properly documented and scrutinized. This openness can reveal unusual patterns or anomalies indicative of fraudulent behavior.
Key Aspects and Implications of the 2024 RBI Master Directions
1. Scope of Directives:
- Individuals and entities, including third-party service providers and professionals like architects, valuers, and chartered accountants, may be investigated for fraud.
- The guidelines clarify that non-whole-time directors, such as nominee and independent directors, are generally not accountable for business conduct. Banks must present substantial evidence before holding these directors responsible.
2. Treatment of Accounts Under Resolution:
- If an entity undergoing resolution changes its management or control, banks have the discretion to retain or remove the fraud classification.
- Penal measures will not apply post-resolution but will continue against former promoters or directors responsible for the entity’s management.
3. Penal Measures:
- Entities classified as fraudulent are barred from raising funds or accessing credit facilities for five years.
4. Governance Structure for Fraud Risk Management:
- Banks must adopt a Board-approved Fraud Risk Management Policy, reviewed at least every three years. This policy should detail the Board’s roles and responsibilities and adhere to natural justice principles.
- Show Cause Notices (SCNs) should provide detailed information on transactions and events leading to fraud consideration and offer a minimum of 21 days for responses.
- Banks need a systematic approach to issuing SCNs and evaluating responses before fraud determination, with a reasoned order documenting the decision.
5. Framework for Early Detection of Frauds:
- The new guidelines emphasize early fraud detection through a robust Early Warning Signals (EWS) framework and Red Flagging Accounts (RFA).
- Banks are required to integrate EWS with their Core Banking Solutions to monitor transactions and identify suspicious activities early.
6. Red-Flagged Accounts and Fraud Reporting:
- Both external and internal audits may be conducted on red-flagged accounts. Banks must report these accounts on the RBI’s Central Repository of Information on Large Credits (CRILC) platform within seven days.
- Decisions to classify red-flagged accounts as fraudulent must be made within 180 days, with adherence to natural justice principles and reporting to the Indian Banks’ Association.
7. Reporting Fraud Incidents:
- The Directives provide categories for reporting fraud to maintain uniformity such as misappropriation of funds and criminal breach of trust; fraudulent encashment through forged instruments amongst others as prescribed under Clause 6.1 of the Master Directives.
- Fraudulent electronic banking / digital payment related transactions committed on banks; and other type of fraudulent activity not covered under any of the above.
- Instances of payment system related disputes suspected or attempted fraudulent transactions are to be reported to Central Payments Fraud Information Registry (CPFIR).
- Banks shall adhere to the timeframe prescribed in these Master Directions for reporting of fraud cases to RBI such as individual fraud cases, fraud at overseas branches, amongst other as prescribed under Clause 6.3 of the Directives.
- In exceptional circumstances, the Bank upon such approval can withdraw the Fraud Monitoring Return.
- Banks are obligated to lodge complaint to law enforcement agency as under:
| Category of bank | Amount involved in the fraud | LEA to whom complaint should be lodged | Remarks |
|---|---|---|---|
| Private Sector / Foreign Banks | Below ₹1 crore | State / Union Territory (UT) Police | |
| ₹1 crore and above | In addition to State/UT Police, Serious Fraud Investigation Office (SFIO), Ministry of Corporate Affairs, Government of India | Details of fraud are to be reported to SFIO in Fraud Monitoring Return (FMR) format. | |
| Public Sector Banks / Regional Rural Banks | (a) Below ₹6 crore25 | State / UT Police | |
| (b) ₹6 crore and above | Central Bureau of Investigation (CBI) |
8. Reporting and Investigation:
- The updated guidelines provide detailed instructions on fraud reporting and establishing a governance structure for EWS and RFA frameworks. The Risk Management Committee of the Board (RMCB) will oversee these frameworks.
- Banks must create Data Analytics and Market Intelligence Units to enhance fraud detection across operations and extend EWS systems to monitor non-credit transactions.
9. Closure of Fraud Cases:
- Fraud cases should be closed once all necessary actions and legal proceedings are complete. Banks must maintain records of closed fraud cases for future audits.
10. Special Committee:
- Banks must form a ‘Special Committee of the Board for Monitoring and Follow-up of Cases of Frauds’ (SCBMF) with at least three members, including a whole-time director and two independent or non-executive directors.
- The SCBMF will monitor, review, and propose frameworks to reduce fraud cases, with senior management responsible for implementing the Board-approved fraud risk management policy and handling whistleblower complaints.
11. Staff Accountability:
- Banks have to examine the staff accountability of their senior management in fraud cases, as per their Internal Policy.
- Examination of staff accountability as per the guidelines issued by the Central Vigilance Commission is required by referring to the Advisory Board for Banking and Financial Frauds.
12. Additional Directives:
- Banks should create policies for using information from the Central Fraud Registry and report payment system disputes to CPFIR.
- Regular legal audits of title deeds for credit facilities above Rs. 5 crore are required, and due diligence must be conducted before transferring loan accounts to other lenders.
- Auditors must report any fraudulent transactions to senior management, and banks must notify the Fraud Monitoring Group of thefts, burglaries, and robberies within seven days, submitting quarterly reports.
The revised RBI Master Directions on Fraud Risk Management from July 2024 represent a significant advance in strengthening fraud prevention and control within India’s financial sector. By emphasizing natural justice and providing a comprehensive framework for reporting and compliance, these guidelines aim to enhance transparency and accountability, protecting the integrity of the financial system.