Banking laws and willful defaulters: Striking a fair balance

Last Month, Parliament passed the Banking Laws (Amendment) Bill, 2024, a progressive step allowing bank account holders to nominate up to four individuals. Finance Minister Nirmala Sitharaman deserves high praise for championing this reform, which empowers bank account holders to nominate up to four individuals, enhancing flexibility and security for countless families. During the Rajya Sabha debate, Sitharaman also highlighted her unwavering commitment to tackling financial misconduct. She pointed to 912 cases tied to bank frauds, including willful defaulters, filed as of 2025, with 239 prosecution complaints before special courts and nine individuals declared fugitive economic offenders by December 31, 2024. Her determination to pursue genuine culprits is laudable, reflecting a strong resolve to cleanse the banking sector and hold true offenders accountable.

However, this vigour must be tempered with caution. Labeling someone a willful defaulter is a potent measure with severe consequences, often rendering individuals financial outcasts, unable to secure loans or sustain businesses or even lead normal lives. They end up becoming societal outcasts.

Not all defaulters are willful—many face genuine financial distress due to business failures, adverse economic conditions, or global factors, rather than deliberate intent. Distinguishing between these requires careful investigation, an assessment of a company’s repayment capacity and intent, and dialogue with the affected party. Sitharaman’s proactive stance is a strength, but pairing it with diligence ensures the innocent aren’t unfairly penalized.

This challenge connects to longstanding critiques of the Reserve Bank of India’s (RBI) framework on fraud and willful default. The Supreme Court’s March 27, 2023, ruling in the Rajesh Agarwal case exposed its flaws, mandating banks to follow a fair process before classifying accounts as fraudulent. Responding to this, the RBI revised its master directions on fraud risk management last year, incorporating principles of natural justice and requiring compliance in a time-bound manner before tagging individuals or entities as fraud. The central bank emphasized strengthening board oversight and aligning with the court’s directive, a step toward fairness.

Yet, the system still tilts heavily toward banks, which, as parties to borrower-lender commercial contracts, hold significant authority to label defaulters—often deflecting accountability for their own missteps. This conflict of interest fuels a bias that protects institutional interests over equity. The Bombay High Court underscored this in April 2024, striking down a government clause empowering public sector bank leaders to seek Look Out Circulars (LOCs) against defaulters or guarantors. The court deemed it arbitrary and a violation of fundamental rights, a view echoed by former Financial Services Secretary D.K. Mittal, who argued last year that such actions lack thorough investigation, unlike those by agencies like the CBI. He noted that defaults often stem from external pressures, not willful intent, with only a minority of borrowers aiming to evade repayment.

Default by a borrower can take place due to various reasons, including business failure, economic condition turning adverse, global factors, etc., he had said, adding that there are only a few willful borrowers whose intension is not to pay.

Additionally, he said, banks often hastily label borrowers as willful defaulters without thorough investigation, severely impacting their future business prospects.

The stakes are high. Beyond commercial setbacks, being branded a fraud or willful defaulter delivers a blow to civil liberties, damaging livelihoods and reputations. Entrusting such power to banks undermines the equity of commercial transactions, where no single party should dominate under law or regulation. A clear solution emerges: transfer this authority to an independent body under the RBI’s purview. A dedicated, impartial committee could evaluate allegations, requiring banks to refer cases rather than unilaterally deciding outcomes. This aligns with judicial calls for due process and ensures balanced decisions.

India’s economic future should not hang in the balance. A flawed system deters entrepreneurship and innovation, discouraging new investments—already scarce beyond large conglomerates—when borrowers fear hasty retribution. Sitharaman’s success in nabbing true defaulters is a foundation to build on, but it must be matched with a transparent, equitable mechanism that protects the innocent and fosters growth. The Banking Laws (Amendment) Bill, 2024, signals progress; coupling it with a reformed approach to willful defaulters ensures accountability and fairness coexist, safeguarding both justice and the nation’s entrepreneurial spirit.