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41. Clause 8.3 of the Master Circular prescribes early warning signals, and deals with Red Flag Accounts (RFA). Clause 8.3 and its Sub- clauses are as under:-

8.3 Early Warning Signals (EWS) and Red Flagged Accounts (RFA) 8.3.1 A Red Flagged Account (RFA) is one where a suspicion of fraudulent activity is thrown up by the presence of one or more Early Warning Signals (EWS). These signals in a loan account should immediately put the bank on alert regarding a weakness or wrong doing which may ultimately turn out to be fraudulent. A bank cannot afford to ignore such EWS but must instead use them as a trigger to launch a detailed investigation into a RFA.

8.3.7 A report on the RFA accounts shall be put up to the Special Committee of the Board for monitoring and follow-up of Frauds (SCBF) providing, inter alia, a synopsis of the remedial action taken together with their current status.

42. A bare perusal of Clause 8.3.1 clearly reveals that as soon as there is a suspicion of fraudulent activity, an early warning signal can be issued. These early warning signals would put the bank / financial institution on high alert, with regard to a weakness or wrongdoing by a person / entity, which may ultimately turn out to be fraudulent. According to Clause 8.3.6 of the Master Circular, the Fraud Monitoring Group ('FMG'), or any designated committee, can classify the account as RFA. Once the account is classified as RFA, the necessary information would be put up to the CMD / CEO every month. Moreover, according to Clause 8.3.7 of the Master Circular, the Report of the RFA accounts shall be placed before the Special Committee of the Board for monitoring and follow-up of frauds. Thus a complete warning system has been created to put up the concerned banks, other banks, and financial institutions on high alert.

8.12.5 Before reporting to IBA, banks have to satisfy themselves of the involvement of third parties concerned and also provide them with an opportunity of being heard. In this regard the banks should follow normal procedures and the processes followed should be suitably recorded. On the basis of such information, IBA would, in turn, prepare caution lists of such third parties for circulation among the banks.

51. A holistic analysis of the Master Circular clearly reveals that although it is important to report the discovery of a fraud to the RBI, although it is essential to initiate the criminal investigation within a short period, but nonetheless, a sufficient 'warning signal system' is built into the system, so as to alert not only the banks forming the Consortium, not only the RBI, but also the other banks. Therefore, the argument raised by Mr. B. S. Prasad, and Mr. B. Nalin Kumar that, unless urgency is shown in declaring a borrower as a fraudulent borrower, the entire banking organization may be exposed to further fraud by a borrower, is bereft of any merit. For, firstly, there is an inbuilt system for early detection and reporting of possible fraud. There is a system for checks / investigations during the different stages of loan life cycle - beginning with the pre-sanction, disbursement and annual review. Secondly, once a suspicion arises that there is some fraudulent activity, early warning signals can be triggered off putting the rest of the banks on high alert, while dealing with an alleged fraudulent borrower. Thirdly, an account can be declared as RFA by the Fraud Monitoring Group. Therefore, a complete safety system has been prescribed by the Master Circular. Hence, the contention that urgency demands that principles of natural justice should not be read into the Master Circular, is a fallacious contention.