Banks must compensate digital arrest victims if due diligence fails: Supreme Court

The Supreme Court said banks and other financial institutions must compensate victims when a fraud is found to have resulted from inadequate due diligence. This makes financial institutions potentially accountable not only for reporting fraud after it happens, but also for failing to detect warning signs beforehand. The court stressed that compensation should be included in the framework being considered by the Reserve Bank of India.

For example, an unusual transfer that sharply differs from a customer’s normal transaction pattern might signal a digital arrest scam. The court asked why such a payment could not be temporarily withheld while the transaction’s genuineness is checked. Banks may also need to alert nearby police stations when customers appear to be victims.

The court will examine the RBI’s proposed KYC Amendment Directions, 2026. It has asked for details of covered institutions and possible compensation measures before issuing further directions. The article does not state a final compensation formula.

A digital arrest scam is a fraud in which criminals pose as police, crime branch officers, or other authorities. They tell victims that they are linked to a crime and are under arrest or investigation. The threat is delivered through mobile, WhatsApp, voice, or video calls. There is no genuine arrest, but the victim is pressured to transfer money.

In Kozhikode, fraudsters allegedly posed as Mumbai Crime Branch officers and threatened a 57-year-old woman with criminal cases. They instructed her to transfer ₹1.35 crore to the Reserve Bank of India for verification. In another case, a farmer was allegedly accused of sending money to a suspect in the Pahalgam terror attack.

The amicus curiae said fear of arrest drives victims to comply, with some psychologists describing the effect as hypnosis. The CJI questioned how anyone could believe an arrest happens on a mobile phone. Despite campaigns and media coverage, such scams continue across India.

The scale remains severe even though the Attorney General told the Supreme Court that reported digital arrest cases had declined by around 50% compared with the previous year. The Chief Justice responded that losses from such offences had still reached nearly ₹800 crore this year. A separate report cited 21,900 digital arrest complaints registered until September.

Recent cases show how quickly losses can become large. A Delhi resident was targeted in an alleged ₹2.10-crore scam. A woman in Kozhikode allegedly lost ₹1.35 crore, while a farmer in Dakshina Kannada allegedly lost ₹1.31 crore. In Hyderabad, a retired employee and his daughter allegedly lost ₹29.17 lakh.

These figures show why the Court is focusing on prevention, not only investigations after money disappears. It wants banks to detect unusual transactions and potentially pause them. The proposed RBI directions may establish wider safeguards and possible compensation, but the article gives no final rules.

The Supreme Court wants financial institutions to intervene before suspicious money transfers are completed. It questioned why a transaction could not be withheld the moment it arrives for processing. The aim is to prevent victims’ money from reaching fraudsters, rather than documenting the loss after it has happened.

The proposed safeguards include temporarily suspending transactions that depart from a customer’s established pattern. Banks should automatically report suspicious activity and use physical verification to establish whether a transaction is genuine. The Court also said banks should alert neighbouring police stations when unusual transactions involve customers who may be digital arrest victims.

These measures would add a preventive layer to existing fraud responses. The Attorney General reported that cases had declined by around 50%, but losses still reached nearly ₹800 crore this year. The Court has asked the RBI for a list of authorised financial institutions and will examine its proposed KYC Amendment Directions, 2026, before issuing further directions.

KYC, or Know Your Customer, refers to procedures financial institutions use to verify a customer’s identity and understand the account’s expected activity. It matters because banks need a reliable baseline for deciding whether a payment looks ordinary or suspicious. The article links these duties to the RBI’s proposed KYC Amendment Directions, 2026.

For instance, a large or unusual transfer that sharply differs from an account holder’s established pattern could trigger further checks. The Court suggested temporarily withholding such a transaction, using automated suspicious-activity reporting, and physically verifying whether it is genuine. Banks could also alert nearby police stations if the customer appears to be under a digital arrest scam.

The proposed framework may clarify how institutions should meet these obligations and compensate victims when they fail. The Court asked which institutions would be covered and what measures could compensate losses. The article does not provide the final KYC amendments or a detailed compliance procedure.

The Court has not announced a final compensation formula. Its position is that the framework should provide suitable compensation when a financial institution fails its due diligence obligations and that failure is linked to the victim’s loss. In practice, compensation could depend on evidence about the warning signs, the bank’s checks, and the transaction’s handling.

A possible case would involve a transfer that sharply departed from the customer’s established pattern. If the bank failed to pause it, verify it, or report it despite required safeguards, the victim could argue that the omission contributed to the loss. The article does not state whether compensation would be full or partial.

Proof may be difficult because the victim must connect the fraud, the unusual payment, and the institution’s specific failure. Records of alerts, verification, and transaction reviews would matter. The RBI is expected to notify proposed directions by November 30 and operationalise them by December 31, subject to the Court’s examination.

The Supreme Court is examining the RBI’s proposed KYC Amendment Directions, 2026, and may issue directions covering authorised financial institutions. It is pressing for prevention, accountability, and possible compensation. The RBI is responsible for proposing the KYC framework, listing covered institutions, and setting measures that banks may need to operationalise.

Banks and other financial institutions must conduct due diligence, identify unusual transactions, potentially suspend them, report suspicious activity, and verify transactions physically. They may also alert neighbouring police stations when customers appear to be digital arrest victims. Police investigate the scams, trace mule accounts, arrest suspects, and register cases.

The article gives examples of these responses. Delhi police arrested two men linked to a mule account in an alleged ₹2.10-crore scam. Hyderabad cybercrime police arrested two alleged suspects, while another remained absconding. The Court wants these roles connected earlier, so suspicious transfers are prevented rather than addressed only after losses occur.