By – Dhuha Mir
Abstract
There has been an increasing digitisation of India’s financial ecosystem which has resulted in the access to banking from a commercial convenience into a requirement for meaningful economic participation. At the same time banks are required to adopt strict customer due diligence and risk management measures which result in growing practise of debanking. This article examines whether the legal framework in India can adequately balance financial integrity along with financial inclusion and whether Indian law should impose stronger procedural safeguards to govern decisions to deny or terminate banking services? This article argues that while banks should retain the ability to manage financial crime risks, their arbitrary exclusion from the financial system should be constrained by principles of transparency, proportionality and procedural fairness.
Introduction
India’s financial ecosystem has undergone a remarkable transformation over the past decade. There has been widespread adoption of digital payment systems, expansion of financial inclusion initiatives and increasing reliance on electronic banking which has made access to formal banking services essential for everyday economic participation. Something that was once viewed as a private contractual relationship between a customer and a bank has now evolved into an essential component of modern public infrastructure. Even after this transformation, banks still continue to have significant discretion to refuse or terminate the customer relationship through a practice which is commonly referred to as debanking. While such decisions are often based on grounds of regulatory compliance and financial integrity, they also raise concerns regarding transparency, fairness and financial exclusion. This article argues that even though banks must retain the discretion necessary to comply with anti-money laundering obligations and manage financial risks, such discretion shouldn’t become unrestricted in a digital economy where access to banking has become essential to social and economic participation. On examining India’s regulatory framework and the constitutional values, the article states that stronger procedural safeguards which are not an absolute right to banking are the ones that offer the most appropriate means of balancing financial integrity with financial inclusion.
Debanking and India’s Regulatory Framework
Debanking has a complex place within the banking law because it lies at the intersection of contractual freedom, regulatory compliance and financial inclusion. The bank has the authority to refuse or to terminate customer relationships. However this power is not exercised in a legal vacuum rather it is shaped by statutory obligations and regulatory directives which are designed to protect the integrity of the financial system.
Debanking is a result of various reasons such as KYC deficiencies, suspicious transaction patterns, PMLA compliance, anti-money laundering, counter-terrorism financing, fraud prevention, sanctions compliance and risk management.
The Prevention of Money Laundering Act, 2002 (PMLA), needs the banks to identify the customers, maintain transaction records, and report suspicious activities to the Financial Intelligence Unit-India (FIU-IND). These are done to prevent money laundering, terrorist financing, and other illicit activities. When a customer fails to provide documentation for identification, engages in suspicious transactions or poses a compliance risk then the bank may refuse to establish or continue the banking relationship. Debanking may therefore arise from statutory and regulatory compliance obligations, alongside banks’ internal risk-management policies. The RBI’s Master Direction – Know Your Customer (KYC) prescribes detailed procedures for customer onboarding, verification, and ongoing monitoring. It requires banks to carry out due diligence according to the level of risk presented by each customer rather than applying a uniform standard. However, RBI has also stated that these customer acceptance policies shouldn’t become so restrictive that it denies banking services to members of the general public, particularly those who are financially or socially disadvantaged. Thus while banks must safeguard the integrity of the financial system, regulatory compliance shouldn’t come at the cost of financial inclusion.
Although the RBI’s KYC Master Directions do contain certain safeguards, such as a risk-based approach to customer verification and grievance redressal mechanisms, they provide little guidance on how banks should fairly carry out account closures. While the existing framework recognises the importance of both financial integrity and financial inclusion, it does not offer much guidance regarding the procedural safeguards which should govern account closures or the circumstances in which debanking may become arbitrary or disproportionate. Banking has a central role in the economic life of people and due to this regulatory gap there are concerns regarding the adequacy of the existing legal protections for customers.
Financial Inclusion and Constitutional Values
The role of banking in society has changed and along with it the legal implications of debanking have also evolved. Traditionally, it was viewed as a contractual relationship between the bank and its customer. Now access to banking is an essential precondition to participate in the modern economy. This has led to the reconsideration of whether it is still appropriate to allow financial institutions to have broad contractual discretion in an increasingly digital financial system. Today, bank accounts are essential for receiving salaries, loans, insurance, carrying out UPI transactions, online shopping, and investments. Thus, exclusion from banking no longer just restricts financial transactions, it significantly hinders the individual’s ability to participate in economic and social life.
Even though banks have contractual discretion, the exercise of such discretion shouldn’t be arbitrary or discriminatory. Article 14 states that state action must be non-arbitrary, and even though private banks are generally not subject to constitutional scrutiny in the same way as public authorities, the principle of non-arbitrariness still plays an important role in shaping the regulation of banking practices. Similarly, Article 21 has been interpreted broadly to include conditions necessary for living with dignity. Since access to banking is determinant of an individual’s ability to receive wages, welfare benefits, and participate in economic life, their exclusion from the formal banking system raises concerns about the constitutional values of dignity and inclusive development. These constitutional values do not presently create an enforceable right to banking but they provide an important framework within which banking regulation should be interpreted.
Should India Recognise a Right to Banking?
The debate is not about choosing between financial inclusion and financial integrity. The real challenge is in determining whether the existing legal framework strikes an appropriate balance between empowering the banks to manage risk and at the same time protecting individuals from arbitrary exclusion. Banks must retain discretion because they have legal obligations under PMLA, RBI KYC Directions and FATF Recommendations. They must retain the authority to refuse or terminate relationships where customers present an unacceptable risk of money laundering, fraud, or terrorist financing. Limiting this discretion excessively could weaken the integrity of the financial system.
However, there are several issues with the current banking framework. The main concern with debanking is the lack of transparency surrounding the account closure decisions. In many cases, banks only communicate the termination of the relationship without disclosing the specific reasons for the decision. While confidentiality may be justified in certain cases, complete lack of transparency makes it difficult for customers to understand the basis of the action. Another concern that is there is the absence of adequate notice before banking services are terminated. When accounts are closed suddenly it may prevent individuals from accessing wages, paying essential expenses, or receiving government benefits. There is also limited opportunity afforded to customers to explain or correct alleged deficiencies. When there is an absence of opportunity to respond to the bank, account closures may occur without considering explanations or corrective measures that could have resolved the issue and preserved the banking relationship as well. The concern is therefore not the existence of the power to debank but rather the manner in which that power is exercised.
Thus there should be procedural safeguards such as written reasons for account closure, reasonable notice (except in urgent cases), an opportunity to rectify KYC deficiencies, internal review or appeal mechanism, enhanced RBI oversight over all a proportionality-based approach to account closures. Such measures would preserve banks‘ ability to combat financial crime while ensuring that exclusion from the financial system occurs only where justified, transparent, and proportionate.
Conclusion
India’s economy is becoming increasingly digital. Access to banking has become essential for economic and social participation. Banks must retain discretion to comply with the PMLA and RBI’s KYC framework. However, that discretion should be exercised transparently and fairly. India may not yet need an enforceable “right to banking,” but it should strengthen procedural safeguards such as reasoned decisions, adequate notice, opportunities to respond, and effective review mechanisms. In the digital age, the legitimacy of banking regulation will be measured by its capacity to ensure that exclusion from the financial system is justified, proportionate, and consistent with the objective of financial inclusion.
About the Author
Dhuha Mir is a third year B.A. LL.B student studying at OP Jindal Global University and she is interested in women’s rights, contract law, sports and international law.
Image Source : https://integratedcashlogistics.com/debanking/