Supreme Court of India
CORPORATION BANKversusD.S. GOWDA AND ANR.
- Citation
- 1994 INSC 222
- Decided
- 20 June 1994
- Disposal
- Disposed off
- Bench
- A M AHMADI
Holding
Interest rates and rests prescribed by RBI circulars within the statutory ceiling are not excessive, and courts may intervene only when a bank charges interest beyond that ceiling, notwithstanding Section 21A.
Summary
Corporation Bank advanced an overdraft facility to D.S. Gowda for construction of flats, later securing the debt by an equitable mortgage and charging interest at 16.5% per annum with quarterly rests. The borrower contested the rate as excessive and argued that the RBI circulars and the Mysore Usurious Loans Act barred such interest. The Supreme Court examined the statutory powers of the Reserve Bank of India under Sections 21 and 35 of the Banking Regulation Act, the effect of the later‑added Section 21A, and the applicability of the Mysore Usurious Loans Act. It held that RBI circulars have statutory force, that interest rates fixed within the RBI‑prescribed ceiling are not excessive, and that Section 21A does not preclude courts from striking down interest that exceeds the RBI ceiling. Consequently, the Court restored the High Court’s decree but reduced post‑decree interest to 12.5% per annum, allowed the appeal in Civil Appeal No. 4214 / 1982, and dismissed the appeal in Civil Appeal No. 544 / 1986.
Issues considered
- Whether a bank may charge interest with periodical rests or compound interest on commercial and agricultural loans.
- Whether banks are bound to follow RBI circulars issued under Section 21 of the Banking Regulation Act and to what extent.
- Whether Section 21A of the Banking Regulation Act bars judicial scrutiny of bank‑borrower transactions under the Usurious Loans Act or similar State laws.
- Whether RBI circulars constitute a ‘special circumstance’ under Explanation 1 to Section 3 of the Mysore Usurious Loans Act and its effect.
Legislation cited
- Banking Regulation Act, 1949s. 21, s. 21-A, s. 35
- Code of Civil Procedure, 1908s. 34
- Mysore Usurious Loans Act, 1923s. 3(1)
- Reserve Bank of India Act, 1934
Subjects
interest with periodical restsRBI circularsSection 21AUsurious Loans Actagricultural loanscompound interestbanking regulationjudicial review
Judgment
A CORPORATION BANK
v.
D.S. GOWDA AND ANR.
JUNE 20, 1994
B (AM. AHMADI AND S.C. AGRAWAL, JJ.)
Banking Regulation Act 1949-Sections 21, 21-A and 35- A-Reserve
Bank of lndia's Circulars and directives issued thereundei--lnterest with pe-
riodical rest chargeable by banks-For commercial loans, interest with
C quarterly rests held permissibl~or agricultural loans interest can only be
fixed with annual rests coinciding with the time when th~ farmers can
repay-Compound interest chargeable only when entire loan becomes over-
due-Held : Circulars and directives of Reserve Bank are based on rational
policy, have statutory force and binding on banks-Where rate of interest with
D periodical rests is f1Xed by Bank in disgard of RBI circulars, held, Court can
reopen transaction and grant suitable relief.
Mysore Usurious Loans Act 192J-Section 3(1) Explanations I & II
(a) and (d}-Commercial loan-Bank charging interest at 16.5% per annum
with quarterly rests-In accordance with maximum prescribed by cir-
E culars/directions of RBI under Sections 21 and 35 of Banking Regulation,
Act 1949-Substantial unfaimess--Rebuttal of-Special circumstances'-No
evidence led by boiTower to rebut-Held : Interest charged not excessive.
Banker and customer-Bank loan-interest with periodical rest;-
F Governed by terms of agreement between bank and bo1rower-ln the absence
of agreement the practice is to debit accrued interest to bo"ower's account at
regular periodic intervals.
In these appeals by Corporation Bank against the Judgment of the
Karnataka High Court, the following qnestions arose for consideration:
G
1. Whether the Bank is entitled to claim interest with periodical
rests, e.g., a monthly rest, a quarterly rest, a six monthly rest, or a yearly
rest, or compound interest in any other manner, from a borrower who
has obtained a loan or an advnace for agricultural/commercial purposes,
H as the case may be?
170
CORPN. BANK v. D.S. GOWDA 171
2. Whether the Banks are bound to follow the directives/circulars A
issued by the Resen'e Bank of India in exercise of power conferred by
Section 21 or the Banking Regulation Act, 1949 prescribing the structure
of interest to be charged on loans/advances made from time to time, and
if yes, to what rxtent?
3. Whether in view or the insertion or Section 21A in the Banking
B
Regulation Act, 1949 by Banking Loans (Amendment) Act, 1983, Courts
are precluded from subjecting transactions entered into between the Banks
and borrowers from scrutiny under the provisions or the Usurious Loans
Act, 1918 or any other similar State law, with a view to giving relief
thereunder, and, if yes, whether relier under such laws is wholly impermis· C
sible? and
(4) Whether the directives/circulars issued by the Reserve Bank of
India under Section 21 of the Banking Regulation Act, 1949 can be
termed as a 'Special circumstance' within the meaning of Explanation 1 D
to Section 3 of the Mysore Usurious Loans Act, 1923? If yes, what is its
effect?
Disposing of the appeals, this Court
HELD : 1.1. Although there is no common law right to charge E
interest on an overdraft by universal custom of bankers a reasonable rate
of interest on overdraft~ is permissible. So also charging or interest with
periodical rests or compounding or interest would be allowed if there is
evidence of the customer having acquiesed therein, provided the relation-
ship of banker and customer is subsisting. However, if the relationship F
under goes a change into that or mortgagee and mortgagor by the taking
of a mortgage, the charging of interest would be governed in accordance
wit~ the terms of the mortgage. The taking or a mortgage to secure the
fluctuating balance of an overdrawn account, being not inconsistent with
the relationship or banker and customer, would n.ot displace an earlier G
right to charge compound interest. Thus the practice of bankers to debit
the accrued interest to the borrower's current account at regular periodic
intervals is a recognised practice. The circulars issued by the Reserve Bank
are not inconsistent "ith this recognised practice. [190·A·B·C·D]
1.2. As under the common law there is no right to charge even simple H
I
I
172 SUPREME COURT REPORTS (i994] SUPP. 1 S.C.R.
A Interest oli overdrafts, the claim of interest has to be supported on the
ground of universal custom of bankers or on the basis of implied agree·
ment. This would be so in a case where there is no agreement between the
bankers and customer in regard to the payment of interest but where the
loan or advance is made on certain terms reduced to writing, the parties
B would be governed by those terms and there could be no question of falling
back on practice or custom. The normal practice of banks in India was to
charge interest with yearly or half-yearly rests but shorter rests also
prevaiied. Sections 21 and 3S·A of the Banking Regulation Act enable the
Reserve Bank lo issue directives in public interest to regulate the charging
of interest on loans or advances made from time to time. It is in exercise
c of this power that it issued the various circulars fixing the rates of Interest
to be charged from borrowers. A Bank could ignore the directive on pain
of being penalised. The Reserve bank not only desired to bring about
uniformity but also controlled the rate of interest. It cannot, therefore, be
D said that no rational policy could be discerned from the directives of the
Reserve Bank. It cannot also be said that the Reserve Bank did not pay
"adequate attention" to the question of rests or compounding of interest
when lt was tlie precise question of bringing uniformity in that behalf to
which the Reserve Bank addressed itself. (176-E-F, 193·A·B·C·D·EJ
•E 1.3. The interest rate of 16.5% per annum with quarterly rest on
a. secured loan is not so excessive as to render the transaction snbstan·
tially unfair within the meaning of the Mysore Usurious Loans Act 1923.
If the Reserve Bank, keeping In view the economic scenario of the country
and the impact that interest rates would have on the economy, fixes the
F minimum and maximum interest rates banks can charge excessive and
would in any case amount to a "special circumstance" within the meaning
of the Explanation to Section 3(1) of the Mysore Act. The guidelines
issued by the Reserve Bank permitted a maximum interest rate of 16.5%
per annum with quarterly rests. The borrower neither contended in bis
G written statement that the interest charged was excessive nor did he lead
evidence to show that the prevailing market rate was lower than the
interest charged by the Bank. Nor was It shown that any other Bank
would have charged less. Admittedly be has not paid a farthing towar\ls
the loan or interest till the date of the execution of the mortgage. This
H shows he was a bad pay master. The property was still under construe·
CORPN. BANK v. D.S. GOWDA 173
lion and did not yield any income on the date of the mortgage and so A
it could not be said that the security was sound. Though he came out
with a statement that the property was ·.~orth Rs. 20.25 lakhs it is the
value of the property at the date of the mortgage which is relevant, for
which there is no evidence. The benefit of the rise in value will enure to
the borrower but that subsequent fact cannot help in evaluating the risk B
factor at the date of the mortgage. Admittedly at no point of time, not
even at the time of confirmation of balance, did he protest that the
interest charged was excessive. He was totally indifferent. He did not
make any mention of deposit rates etc., in his written statement or oral
testimony on which the High Court has based its opinion. C
[195-C-H & 196-A-C-D]
1.4. However, if in any case, it is shown that the Bank was
claiming interest in excess of that permitted by the circular/direction of
the Reserve Bank, the Court could give relief to the aggrieved party
notwithstanding Section 21-A to the extent of interest charged in excess of D
the rate prescribed by the Reserve Bank. A distinction must be drawn
between the Court's interference on the premise that the interest charged
is excessive and Court's interference on the premise that the interest
charged is in contravention of the circulars/directions issued by the
Reserve Bank. But if the Reserve Bank has fixed the maximum rate of E
interest in exercise of the powers conferred by Sections 21/35-A of the
Banking Regulation Act, Section 21-A would be attracted and the transac-
tion would not be liable to be reopened on the ground that the rate of
interest fixed is excessive even though not exceeding the ceiling determined
by the Reserve Bank. (199-G-H, 200-H, 201-A]
F
2.1. However, agricultural loans stand on a different footing. The
circular issued by the Reserve Bank from time to time in exercise of power
conferred by Sections 21/35-A of the Banking Regulation Act provide that
agricultural advances should not be treated on par with commercial loans
in so far as the rate of interest thereon is concerned because the farmers G
do not have any regular source of income except sale proceeds of their
•
crops which income they get once a year. The question of _recovery of
interest with quarterly or six-monthly rests from farmers is therefore n~t
feasible. The fact that farmers are Ouid at a given point of time every year
has to be kept in mind in determining the point of time when they should H
174 SUPREME COURT REPORTS [1994] SUPP. 1 S.C.R.
A be expected to repay the loan or pay the instalment/interest on advance.
Therefore, to allow the banks to charge interest on quarterly or half-yearly
rests from farmers would tantamount to virtually compelling them to pay
compound interest, since they would not be able to pay the interest except
once in a year i.e. when they receive the income from sale proceeds of their
B crops. According to the circulars/directions of the Reserve Bank so far as
the loans for agricultural purposes are concerned, at best interest may be
charged with yearly rests and may be compounded if the loan/instalment
·becomes overdue. [198-C-H]
2.2. In the instant case, since interest was charged with six-monthly
C rests that was clearly In contravention of the Reserve Bank circulars/direc·
!ions. Compounding of interest on current dues on agricultural advances
having been discouraged, the Bank was not entitled to charge interest with
shorter periodical rests and compound the same. The Bank could add
Interest outstanding to the principal and compound the interest when the
D crop loan or term loan becomes overdue, having regard to the tenor of the
circular date 14-3-1972. [199·A·B]
D.S. Gowda v. Corporation Bank, AIR (1983) Kant. 143 = (1982) 2
Kant LJ 40, reversed
E Bank of India v. Kamam Ranga Rao, AIR (1986) Kant. 242, affirmed.
H.P. Krishna Reddy v. Canara Bank, AIR (1985) Kant 228, approved.
Bank of India v. Rao Saheb Krishna Rao Desai, (1980) 2 Kar LJ 495;
F K.C. Venkateswarlu v. Syndicate Bank, AIR (1986) AP 290 and State Bank
of India, v. Eluru, AIR (1986) AP 291, referred to.
Yourell v. Hibernian Bank, (1918) AC 372; Holder v. !RC, [1932] All
ER 265 : 1932 AC 624 and Reddie v. Williamson, [1863] 1 Macph (Ct. of
G Sess) 228, reffered to.
Paget's Law of Banking 8th Edn. (1972) Chapter V Halsbry's Laws
of England (4th Edn.) Vol.3, Page 118 para 160, referred to.
CIVIL APPELLATE JURISDICTION : Civil Appeal No. 4214 of
H 1982.
CORPN. BANK v. D.S. GOWDA [AHMADI, J.] 175
From the Judgment and Order dated 22.10.82 of the Karnataka High A
Court in Regular First Appeal No. 107 of 1981.
With
Civil Appeal No. 544 of 1986.
B
With
SLP (C) No. 16444/92.
K.N. Bhat, S.S. Javali, S.N. Bhat, Ranjit Kumar, H.S. Parihar, Kul-
deep S. Parihar, Vineet Kumar, Ms Niha Gupta, Nand Kumar, UA. Rana C
and Rajiv Tyagi for M/s Gagrat and Co .. for the appearing parties.
The Judgment of the Court was delivered by
AHMADI, J. These appeals brought by the aforementioned Banks by
special leave raise certain important questions of law touching the business D
activities of the Banks in the matter of grant of loans/advances and recovery
thereof which may be formulated as under : -
1. Whether the Bank is entitled to claim interest with periodical
rests, e.g., a monthly rest, a quarterly rest, a six monthly rest, or a E
yearly rest, or compound interest in any other manner, from a
borrower who had obtained a loan or an advance for agricul-
turaVcommercial purpose, as the case may be?
2. Whether the Banks are bound to follow the directives/circulars
issued by the Reserve Bank of India in exercise of power conferred F
by Section 21 of the Banking Regulation Act, 1949 prescribing the
structure of interest to be charged on loans/advances made from
time to time, and if yes, to what extent?
3. Whether in view of the insertion of Section 21A in the Banking G
Regulation Act, 1949 by Banking Loans (Amendment) Act, 1983
(Act No. 1 of 1984), Courts are precluded from the subjecting
transactions entered into between Banks and borrowers from
scrutiny under the provisions of the Usurious Loans Act, 1918 or
any other similar State law, with a view to giving·relief thereunder,
and, if yes, whether relief under such laws is wholly impermissible? H
176 SUPREME COURT REPORTS (1994] SUPP. 1 S.C.R.
A and
4. Whether the directives/circulars issued by the Reserve Bank of
India under Section 21 of the Banking Regulation Act, 1949 can
, be termed as a 'special circumstance within the meaning of Ex-
planation 1 to Section 3 of the Mysore Usurious .Loans Act, 1923
B , (Mysore Act No. IX of 1923)? If yes, what is its effect?
These questions which have a bearing on the day to day transactions of
loan/advance entered into by the Banks arise in the following background.
C In.Bank of India v._Rao Saheb Krishna Rao Desai, (1980) 2 Karnataka
Law Journal 495, the Bank had advanced a loan for purchasing a tractor
to improve the agricultural land. The borrower executed a promissory note
as also a hypothecation deed whereby he agreed to repay the said sum on
demand with interest at 4.5% per annum over the Reserve Bank rate,
minimum being 9.5.% per annum 'with quarterly rests'. The original rate
D fixed was 10.5% per. annum, On the failure of the borrower to adhere to
the terms of the loan, the Bank instituted a suit for recovery of the loan •
wherein it claimed compound interest on· the strength of the term 'with
quarterly rests'. The suit was decreed by the trial court with future interest
at 10.5% per annum. The claim for compound interest was rejected.
Feeling aggrieved, the Bank preferred the aforesaid appeal which was
E heard by a division Bench of the Karnataka High Court. The Division
Bench referred to Paget's law of Banking, 8th Edition (1972), Chapter V,
.wherein under the caption 'interest' it was stated :
, "There is no common law right to charge even simple interest on
F ·an over-draft, but the claim could be supported on the ground of
universal custom of bankers or on the basis of implied agreement.
:Where the customer has acquiesced in the system under which the
interest is charged, that also would justify the claim. Such acquies-
cence will justify the charging compound interest or interest with
periodical ·rests, so long as the relation of banker and customer
G exists, and the relationship is not change into that of mortgagee
and mortgagor. The taking of a mortgage or a charge by way of
' legal mortgage to secure the fluctuating balance of an account is
not however, inconsistent with the relation of Banker and customer
so as to preclude comllo~nd interest. The effect of the practice of
H bankers in debitingc'~rest to an _over-drawn current account
(
CORPN. BANK v. D.S. GOWDA [AHMADI, J,] 177
periodically and thereby increasing the capital sum was considered A
in Yourell v. Hibemin Bank, [1918] AC 372, in which Lord Atkin-
son said :
· "The Bank, by taking the account with these half yearly rests,
secured for itself the benefit of compound interest. This is a usual
and perfectly legitimate mode of dealing between banker and B
customer. 11
In Holder v. Inland Revenue Commissioners, [1932] AC 624 = 1932 All
E.R. 265, the Court of Appeal approved the statement of Lord Cowan in
Reddie v. Williamson, [1863] 1 Macph (Ct. of Sess.) 228 : c
"That the periodical interest at the end of each year is a debt to
be then paid, and which must be held to have been paid when
placed to the debit of the account as an additional advance by the
bank for the convenience of the obligations."
D
Relying on the above passage, the Division B_ench observed that the custom
of charging compound interest by Banks would be normally applicable in
the matter of over-draft facilities only and that too, when there exists
relationship of banker and customer, which relationship has not been
transformed into that of mortgagee and mortgagor. Sabhahit, J ., speaking E
for the bench, observed :
"Compound interest or the practice of quarterly or half-yearly rest
is something strange to agricultural financing where the loans are
either short-terms, middle-term or long-term. Short-term financing
is done for growing the annual crops. They are termed as 'crop F
loans'. Middle term financing is done for improvements in the
lands and the period would be about three years to five years.
Long-term financing is given for clearing off old debts and for the
Jong-term investment. That being so, in agricultural financing, the
question of the normal commercial banking conditions as in over- G
drafts would not come into play and the Bank 'custom' and habits
which are usual in the case of commercial banking .cannot be
smuggled into agricultural financing."
On facts, the court found that the parties understood, if at all,
'quarterly rest' to mean that inter.est is to be paid every quarter and nothing H
178 SUPREME COURT REPORTS [1994] SUPP. 1 S.C.R.
A more. It was also noticed that the loan advanced was in fact a mortgage
transaction and therefore the usual practice and custom prevailing in the
case of over-drafts would have no application. The Court, therefore, held
that the clause 'quarterly rests' used in the printed form was never intended
to burden the borrower with the obligation to pay compound interest.
Hence thi; Division Bench held that the clause which was noted by the
B parties at its inception and execution to permit the Bank to recover
compound interest must be deemed to be void in the eye of law and cannot
be allowed to be enforced by the Bank. We have referred to this decision
even before we refer to the decisions impugned in these appeals as it has
a direct bearing on the subsequent decisions.
c The decision of the Division Bench of the Karnataka High Court
impugned in Civil Appeal No. 4214 of 1982 is reported as D.S. Gowda v.
Mis. Coporation Bank, AIR (1983) Karnataka 143. D.S. Gowda who was
allotted a building site by the Banglore Development Authority, had ap-
proached the Bank for financial help to construct residential flats on the
D said site. The Bank acceded to his request and granted over-draft facility
upto Rs. 2,50,000. The borrower accepted the facility and commenced
construction at the site. However, it was soon realised that the sanctioned
facility was insufficient and so he .approached the Bank for additional
finance. Since he had failed to pay interest/instalments his financial indeb-
E tedness had risen. On November 26, 1973, he executed in irrevocable
Power of Attorney authorising the Bank Manager to supervise and/or to
put up construction according to the sanctioned plan to induct tenants and
recover rents from them in repayment of the loan and interest due to the
Bank. Unfortunately for him, the building could not be completed and by
1975 the outstanding loan and interest had swollen to over Rs. 4 lacs. The
F Bank then felt the need for adequate security whereupon on October 10,
1975, the borrower executed a deed of equitable mortgage by deposit of
title deeds for Rs. 5 lacs. The Bank gave him further accommodation on
. the execution of the said document. Under the terms of the mortgage, the
borrower covenanted to repay the mortgage loan of Rs. 5 lacs with interest
at 16.5% per annum subject to such rate of interest as may be prescribed
G within a period of two years. It was further agreed by the mortgagor that
he will pay interest on the mortgage amount at the end of each calendar
month without default and in the event of default over due interest may be
charged. On November 7, 1975, he at the instance of the Bank executed a
promissory note by way of collateral security !lndertaking to pay Rs. 5 lacs
H with interest at 16.5% per annum 'with quarterly rests'. By March 1, 1978,
CORPN. BANK v. D.S. GOWDA[AHMADl,J.] 179
the amount payable with penal interest, service charges, etc., stood at Rs. A
7,56,934.17 paise. The Bank instituted a suit for recovering the said amount
with future interest and costs by the sale of mortgaged property under
Order XXXIV of the Code of Civil Procedure. The borrower admitted the
execution of the equitable mortgage deed and the promissory note, but
contended that the promissory note was executed as a collateral security
and the provision of quarterly rest provided therein was not one of the B
conditions of the loan granted to him. He further contended that the
amount actually borrowed under the mortgage was Rs. 4 lacs but the Bank
got the mortgage deed executed for Rs.5 lacs by including the interest due
on Rs. 4 lacs. He, therefore, contended that he was not liable to pay
compound interest or penal interest since such a liability did not arise C
under the loan transaction. In any event he contended that the interest
charged was exorbitant, the transaction was substantially unfair and, there-
fore, he was entitled to relief under the provisions of the Mysore Act.
It was urged on behalf of the borrower that there was no banking
practice to charge interest with monthly or quarterly rests and in the D
absence of statutory sanction from the Reserve Bank of India, the Bank
could not collect compound interest. Counsel for the Bank however sub-
mitted that there was a banking practice to charge compound interest by
providing for monthly or quarterly rests as also to charge penal and service
charges from the defaulter. The minimum lending rate of 12.5% prescribed
by the Reserve Bank of India did not preclude the Bank from charging E
interest at 16.5% with quarterly rests. He, therefore, submitted that there
was nothing substantially unfair in the transaction to attract the provisions
of the Mysore Act. The trial court decreed the suit holding that the
borrower was initially given Rs. 4,22,000 as loan and Rs. 78,000 were added
thereto by way of accrued interest making a total of Rs. 5 lacs for which
he executed the equitable mortgage. The trial court further held that the F
borrower had not proved that he was not liable to pay interest with
quarterly rests and hence the Bank was justified in charging interest as
claimed in the suit. Lastly, the trial court stated that the borrower had not
established that the loan transaction was substantially unfair or that the
interest charged was excessive to entitle him to relief under the Mysore G
Act. The trial court, therefore, directed that a preliminary decree be drawn
up for the suit claim along with costs and future interest at 16.5% per
anoum to be realised by sale of the mortgaged property if not paid within
six month. Feeling aggrieved the borrower appealed to the High Court. ·
The Divisions Bench of the High Court formulated two principal questions
H
180 SUPREME COURT REPORTS [1994] SUPP. 1 S.C.R.
A for consideration, namely, (1) whether the terms of the mortgage deed
providing for payment of interest at 16.5% with monthly rests are valid
under statutory directives of the Reserve Bank of India or could be
supported by banking practice, and (2) whether the interest charged by the
bank including penal interest and service charges was excessive and
whether the Court could call into aid the provisions of the Mysore Act to
B mitigate the rigour of the loan transaction, and if so, what relief defendant
is entitled to? The Division Bench thereafter examined the provisions of
the Reserve Bank of India Act, 1934, the Banking Regulation Act, 1949
and the Banking Companies (Acquisition and Transfer of undertakingsO
Act, 1970 as amended from time to time and noticed the various direc-
C lives/circulars issued by the Reserve Bank in exercise of power conferred
by Section 21 of the Banking Regulation Act, 1949 and concluded as
under:-
"It is thus clear that the ordinary practice or custom of Banks was
only to charge interest with yearly or half-yearly rests and that too
D only on over-draft amounts and unsecured loans. The.monthly and
quarterly rests, therefore, does not appear to be the recognised
banking practice."
The Division Bench next examined whether the Reserve Bank of India
E while prescribing quarterly rests under its directive of March 13, 1976 had
recognised any such banking practice. Taking note of the background
'material in this behalf, the Division Bench concluded as under : -
"From the above narration, one thing becomes very clear that the
·Reserve Bank did not pay adequate attention to the question of
F "rests" or the compound interest to be charged by Banks on loans,
advances and other facilities save those connected with agricul-
r ture."
Relyin~ on Section 3(1) of the Mysore Act the Cour~ held that the direc-
tives of the Reserve Bank .of India cannot by themselves constitute a
G 'special circumstance' under the explanation to section 3(1) and therefore
since the Bank had charged compound interest as well as penal interest,
there can be no doubt that a presumption arose that the transaction was
substantially unfair and the burden of rebutting the presumption that-the
interest charged was not excessive squarely lay on the Bank which it had
H to discharge. The Division Bench, therefore, held that the borrower was
CORPN.BANK v. D.S.GOWDA[AHMADI,J.] 181
entitled to relief and sliced down the interest rate to 12.5% per annum with A
annual rest. As to the levy of penal interest, the Division Bench pointed
out that there was no stipulation in the agreement to support it. In regard
to the service charges, it noticed that the Reserve Bank by circular dated
November 15, 1976 had directed that Banks in their discretion could charge
at a flat rate from January 1978 at 1/20th of 1% upto a maximum of Rs. B
25.000 on a once for all basis as processing fees. The Division Bench,
therefore, allowed the Bank to recover Rs. 25,000 by way of processing
fees. In the above view, the appeal was allowed and the matter was remitted
to the trial court for working qut the dues in the light of the above decision.
It is this decision which is assailed in Civil Appeal No. 4214 of 1982.
c
Next is the case of H.P. Krishna Reddy v. Canara Bank, Bangalore,
AIR ( 1985) Karnataka 228. The facts of the case show that the suit filed
by the Bank for recovery of money due under an equitable mortgage and
promissory note was contested mainly on the ground that the Bank's claim
to interest at the rate of 13% per annum with quarterly rests was unsus- D
tainable. That claim was laid on the rules of business, trade, usage and
custom. This claim was based on a Circular of the Reserve Bank dated
August 17, 1978 which in turn referred to an earlier Circular of October
5, 1974. By the time this decision was rendered Section 21-A was intro-
duced in the Banking Regulation Act, 1949 which reads as follows :
E
"21A: Rates of interest charged by Banking Companies not to be
subject to scrutiny by Court. - Notwithstanding anything contained
in the Usurious Loans Act, 1918, or any other law related to
indebtedness in force in any State, a transaction between a Banking ·
Company and its debtor shall not be re-open:ed by any court on p
the ground that the rate of interest charged by the banking com-
pany in respect of such transaction is excessive."
The Division Bench came to the conclusion that the loan in question was
for agricultural purposes and, therefore, under the Reserve Bank's Cir-
culars the Bank was precluded from recovering interest with quarterly G
rests. On the question whether the contractual rate of 13% was excessive,
the Division Bench ruled against the borrower. However, on the question
of applicability of section 21A it observed that the said pro'1sions had no
bearing on the question of court's jurisdiction to give relief to an aggrieved
partly if the bank in any particular case has charged interest in excess of H
,.
'
182 SUPREME COURT REPORTS (1994] SUPP. 1 S.C.R.
A the limits prescribed by the Reserve Bank, since that would render the
bank liable to penalty under the Banking Regulation Act. Therefore, it was
observed that if in any case it is shown that the bank had charged interest
in disobedience of the Reserve Bank directive, the court would be justified
in granting relief to the borrower, notwithstanding section 21A extracted
B earlier. As regards the grant of interest pendente lite, the rate of interest at
6% per annum was justified in view of the constraints of explanations 1
and 2 to proviso to section 34 of the Civil Procedure Code since the loan
was admittedly for agricultural purposes. We have referred to this decision
at this stage to indicate the trend of the said High Court.
c Th~ judgment impugned in Civil Appeal No. 544 of 1986 has been
reported as Bank of India v. Kamam Ranga Rao and others, AIR (1986)
Karnataka 242. The said matter arises out of the suit instituted by the Bank
for recovery of Rs. 30,564, (principal sum being Rs. 10,000) borrowed for
raising sugarcane crop. Under the documents executed by and between the
D parties the borrowers were liable to pay interest at the rate of 4% above
the rate prescribed by the Reserve Bank subject to a minimum of 13% per
annum with quarterly rests. The Bank, however, had charged only half
.yearly rests and had claimed at the same rate in the suit. The borrowers
while admitting the fact of having taken the loan denied their liability to
pay interest with quarterly rests on the ground that the loan was for
E agricultural purposes and it was settled practice that the Bank should not
charge interest with periodical rests i.e. compound interest. The Trial
Court held that it was well settled that for agricultural loans in India
charging of compound interest was not permissible. The Bank was, there-
fore, directed to submit a revised statement which it did determining the
F dues at Rs. 19,851.66. The Trial Court decreed the suit for the said amount
with future interest at 6% per annum. Feeling aggrieved by the said
decreed the Bank approached the High Court in appeal. Since the question
raised in appeal related to the Bank's right to charge compound interest
on agricultural advances and since in a number of matters pending before
the court the same question was involved, the court thought it advisable to
G issue notice under Order I Rule 8 of the Code Civil Procedure as also to
the Reserve Bank of India with a direction to inspect the accounts and
submit a report. Accordingly the report came to be submitted on June 7,
1985. That report disclosed that the Bank had debited interest to the crop
loan account thrice with half yearly rest before the due date of payment of
H the loan and had also compounded the interest. The Division Bench
CORPN. BANK v. D.S. GOWDA [AHMADI, J.] 183
observed as under : A
"The Bank, however, could not add interest outstanding to the
principal and compound the interest when the crop loan becomes
overdue keeping in view what has been stated in the Circular dated
March 14,1972. As such the Bank's compounding of interest at half . B
yearly intervals after the loan amount has become overdue cannot.
be questioned."
Reference was made to as many as six circulars issued by the Reserve Bank
between March 14, 1972 and September 15, 1984. The Division Bench held
that Banks were bound to follow the directives or circulars issued by the C
Reserve Bank prescribing the structure of interest to be charged on loans
and any interest charged in excess of the prescribed limit would be illegal
and void. Following its earlier decisions it was further held that Banks
could not charge interest with quarterly rests on agricultural advances. It
was poirlted out that agricultural advances could not be equated with D
commercial loans in the matter of compounding of interest. In the case of
agricultural loans it was pointed out that since farmers did not have by
regular source of income other than the sale proceeds of their crops, they
received income once in a year and were, therefore, not in a position to
pay interest at fixed rests and hence in such transaction the parties could
never be taken to have intended that the interest should be compounded E
quarterly or half yearly. On the question of applicability of section 21A of
the Banking Regulation Act it was said that unless it is proved that the
interest charged by the Banks is not in conformity with the rates prescribed
by the Reserve Bank, the Court would be precluded form re-opening the
transaction. However, if the rate charged is in violation of the Reserve F
Bank's circular, the excess rate of interest can be chopped off as illegal and
void. On this line of reasoning the Bank's appeal was dismissed.
At this stage it would be convenient to notice two decisions of the
Andhra Pradesh High Court which have a bearing on some of the points
under consideration. In KC. Venkateswarlu v. Syndicate Bank, Udayagiri, G
AIR (1986) A.P. 290, the Division bench held that the newly added Section
21A of the Banking Regulation Act made the provisions of the Usurious
Loans Act, 1918, inapplicable to a transaction of loan between a bank and
a borrower. The Division Bench recorded its conclusion in paragraph 5 of
the judgment thus : H
184 SUPREME COURT REPORTS (1994] SUPP. 1 S.C.R.
A "It is clear that the said provision makes the provisions of Usurious
Loans Act inapplicable to any transaction between a banking
company and its debtor. The Courts' power to reopen the trans-
action, under the provisions of the Usurious Loans Act on the
ground that the rate of interest charged is excessive is no longer
available. It is not disputed that it affects the pending proceedings·
B also though the Act came into force on 15.2.1984. Thus it is clear
that the Usurious Loans Act is no longer applicable to any debt
due to a Banking Company''.
It is important to note that it was not disputed before the Court that
C restriction imposed on the Court's power by Section 21A extended to
pending proceedings as well.
In the matter of the State Bank of India, Eluru AIR (1986) A.P. 291, ·
a learned Single Judge of the said High Court, however, held that Section
D 21A cannot have overriding effect over the Usurious Loans Act, 1918, as
amended by the Madras Amendment Act No. VIII of 1937, in its applica-
tion to agriculturists. According to the learned Judge, the use of the generic
word 'debtor' in Section 21A was not intended to refer to agriculturists.
The learned Judge also held Section 21A ultra vires the power of Parlia-
ment on the ground that it ~as not a law relating to Banking but was
E intended to deny relief to agriculturists from indebtedness which was
beyond the legislative competence of Parliament. He. felt that the said
provision could not be saved by the application of even the pith and
substance doctrine. Further, the learned Judge found Section 21A ultra
vires Article 14 on the plea that a law which requires or compels courts to
F implement harsh, unequal and unconscionable transactions providing for
payment of compound interest or usurisous rates of interest by depriving
the debtors of their right to claim relief under the provisions of the
Usurious Loans Act or similar State laws would offend Article 14 inasmuch
as it permits discrimination against hapless debtors. Holding that the
provisions of Section 21A was arbitrary, partisan and offensive to our sense
G of equity an equality, the learned Judge refused to apply it in the fact of
the case. It may, however, be mentioned that the attention of the learned
Single Judge was not invited to the Division Bench decision in the case of
Venkateswar/u (supra) which was rendered only a few days before, How-
ever, in the appeals before us neither the Parliament's competence to enact
H section 21A nor its constitutional validity based on Article 14 has been
CORPN. BANK v. D.S. GOWDA [AHMADJ, J.] 185
challenged. We are, therefore, not required to go into these questions. A
Before we notice the circulars/directives issued by the Reserve Bank
of India, it would be advantageous to briefly capitulate the functions of this
Country's Central Bank. It was estaJilished under the Reserve Bank of
India Act with effect from 1st April, 1935 and was nationalised immediately B
after independence in 1948. Amongst others, its functions are to act as a
banker to the Government, regulate the issue of currency in India, act as
a banker to other commercial b~, exercise control over the volume of
credit of commercial banks to maintain price stability, to control advances
granted by commercial banks and to prescribed the rates of interest on C
which advances may be granted. One of the ways it employs to control the
volume of bank credit is through the fluctuations in the bank rate i.e., the
rate of interest at which it discounts bills or exchange from .commercial
banks. By the increase or decrease of the bank rate it reduces or increases
the volume of credit with the commercial banks. Section 21 of the Banking
Regulation Act enables the Reserve Bank to give directions to all other D
banks in regard to loan policies with a view to control credit facilities and
curb speculative activities. This is clearly a matter of public interest. This
provisions authorises the Reserve Bank to give directions to other banks
inter alia in regard to the rate of interest to be charged on advances/finan-
cial accommodation. The newly added section 21A restricts the Court from E
reopening a transaction between a banking company and its debtors on the
ground that the rate of interest charged is excessive, the Usurious Loans
Act or any other similar State Act, notwithstanding. If any of the directions
given by the Reserve Bank are violated, apart from the punishment that
can be imposed on the officers, section 47A empowers the Reserve Bank
to penalise the banking company also. These, in brief, are the powers and F
functions of the Reserve Bank.
We may now notice the directives/circulars issued by the Reserve
Bank relating to charging of interest on advances. The first circular, by far
the most important, is dated March 14, 1972. It takes note of the fact that G
agricultural finance stands on a different footing for the reason that agricul-
turists do not have any regular source of income other than the sale
proceeds of their crops. They would, therefore, be in a position to pay
interest only when they receive the sale proceeds of their crops. Taking
note of the said position, the circular proceeds to state as under : H
186 SUPREME COURT REPORTS [1994) SUPP. 1 S.C.R.
A "Having regard to the special characteristics of agricultural finance,
banks are advised to bear in mind the following principles in the
matter of application of interest on such advances.
(i) Repayment period of agricultural advances, whether
short-term or medium-term, should be so fixed as to coincide
B with the period when the farmer is fluid i.e., after harvesting
and marketing of his crops. Payment of interest should also
be insisted upon only at the time of repayment of loan/instal-
ment so fJXed.
c (ii) Interest on current dues should not be compounded.
(iii) When crop loans or instalments under medium-term
loans become overdue, banks can add interest outstanding to
the principal amount and compound the interest keeping in
view what has been stated in paragraph 1 above."
D l
The circular further says that banks may adopt suitable accounting proce-
dures in the matter of charging interest on agricultural loans. Jn paragraph
1 of the circular it is stated that there is at present no uniformity in the
matter of charging interest on various types of agricultural advances and
E although interest is compounded at monthly, quarterly or half yearly rests
on advances, such a system of compounding in the case of agricultural .
advances may not ·be suitable. Thus the aforesaid circular recognises the
fact that agriculturists have to be treated differently from other loanees for
the reason that they do not have any regular source of income other than
the sale proceeds of thier crops. That is why it advised the banks to fix the
F repayment period of agricultural advances, short-term or medium-terms,
in such a manner as to coincide with the period when the farmer is fluid,
meaning thereby, when the farmer gets money on the sale of his corps. It
is at that point of time that payment of interest should be insisted upon.
The second circular is dated October 5, 1974. By this circular the Reserve
G Bank reiterates that interest on current dues in respect of agricultural
advances should not be compounded. It has, therefore, advised all banking
institutions to advise their branches to follow the first mentioned circular.
The third circular dated March 13, 1976 is general in nature and prescribes
that the rate of the interest should not more than 16.5% per annum with
quarterly rests. It, however, permits recovery of penal interest in addition
H to normal interest even if both put together exceed the prescribed ceiling.
CORPN. BAN.K v. D.S. GOWDA [AHMADI.J.J 187
The fourth circular dated August 17, 1976 addressed to all Scheduled A
Commercial Banks in regard to the method of charging interest on agricul-
tural advances states :
"Please refer to our directive ..... dated 13th March, 1976 stipulating
the maximum rate of interest that could be charged on loans, B
advances, etc., by scheduled commercial banks. It has been stated
therein that interest shall be charged with quarterly rests. It is
clarified that this aspect of the directive will not apply to agricul-
tural advances in respect of which the instructions issued in our
letters ... dated the 14th March, 1972 and ..... dated the 5th October,
1974 will continue to prevail. In other words, payment of interest C
on agricultural advances should be insisted upon only at the time
of repayment of principaliinstalment of principal and interest on
current dues should not be compounded."
D
The circular makes it clear that the circular dated March 13, 1976 would
not apply to agricultural advances which would continue to be governed by
the first two circulars dated 14th March, 1972 and 5th October, 1974. The
fifth circular dated February 28, 1978 was issued in supersession of the
third circular dated March 13, 1976. By this circular the maximum rate of
interest prescribed under the third circular was reduced from 16.5% to E
15%. In regard to compounding of interest it is directed that interest. shall
be charged with quarterly or longer rests. The sixth circular dated Septem-
ber 15, 1984 restates the general guidelines laid down in the previous
circulars in regard to the procedure for charging interest on loan accounts
and adds that banks can charge interest on loan accounts at quarterly or F
longer rests. In respect of agricultural advances it says that banks should
not compound the interest in the case of current dues, i.e., crop loans and
instalments not fallen due in respect of term loans, as the agriculturists do
not have any regular source of income other than the sale proceeds of their
crops. Therefore, when crop loans or instalments under term loans become G
overdue, banks can add interest outstanding to the principal. It further
adds that where the default is due to genuine reasons banks should extend
the period of loan or reschedule the instalments under term loan. Once
such a relief is extended the overdoes become current dues and banks
should not compound interest. This reveals the concern of the Reserve
Bank towards agriculturist- loanees. H
188 SUPREME COURT REPORTS [1994] SUPP. l S.C.R.
A From the above circulars issued by the Reserve Bank from time to
time it is evident that the procedure for charging interest on loans ad-
vanced to agriculturists, be they short term or middle term loans, was
different from loans advanced to other borrowers. The first and the second
circulars in terms refer to charging of interest on agricultural advances.
There is nothing equivocal or ambiguous about it. The third circular is
B general in nature and prescribes the ceiling for the recovery of interest with
the qualification that if there is an agreement permitting charging of penal
interest it will be permissible to charge the same for the default period in
addition to the interest rate regardless of the fact that normal interest and
penal interest may cross the ceiling. As the third circular was likely to raise
c doubts in regard to the applicability of the first and second circulars, it was
clarified by the fourth circular that it (third circular) shall have no applica·
tion to agricultural advances. The fifth circular superseded ceiling to 15%
with effect from 1st March, 1978, with qnarterly or longer rests. The
proviso further reduces the ceiling in case of term loans with a maturity of
D not less then three years. This circular is once again a general circular. The
sixth circular while providing that Banks can charge interest on loan I
accounts at quarterly or longer rests stipulates that in respect of agricul-
tural advances Bank should not compound the interest in case of current
j
dues unless term loans have become overdne. Thus this circular draws a
distinction between loanees other than agriculturists and advances made to
E agriculturists in the matter of charging interest. It is, therefore, quite clear
tfiat agricultural loans stand on a different footing from other loans includ-
ing a loan or advance secured for construction of flats, as in the case of ~ ,
D.S. Gowda. So far as agricultural loans are concerned, having regard to
its special characteristics and the time factor relating to the farmer's
F capacity to meet his financial obligations, it was realised that farmers would
not be in ·a position to pay interest at short periodical rests and if their
inability to do so is visited with compouncling of interest it would be too
harsh and unjust on the farmers. The Reserve Bank, conscious of this
difficulty of the farmers, directed the banks that repayment period should
be so fixed as to coincide with the period wh!'n the farmer is fluid and
G payment of interest should also be insisted upon only at the time of
repayment of the loan or instalment. Further it directed that interest on
current dues should not be compounded but if and when the crop loans or
medium-term loans become overdue, interest outstanding to the principal
amount may be added and compounded. The procedure in regard to
H
CORPN. BANK v. D.S. GOWDA [AHMADI, J.] 189
charging of interest on short-term and medium-term agricultural loans is, A
therefore, clearly spelt out in the first circular of March 14, 1972. There is
no ambiguity about it. In regard to loans belonging to the non-agricultural
category, the circular dated March 13, 1976, February 28, 1978 and Sep-
tember 15, 1984, clearly state that the Banks may charge interest with
quarterly on longer rests. Therefore, loans advanced for construction of B
flats would fall in the latter category against which interest can be charged
with periodical rests. The case of respondent Karnam Ranga Rao falls in
the former category since it was a loan taken for raising sugarcane crops
whereas the case of the respondent D.S. Gowda falls in the latter category
of non-agricultural loan as it was secured for construction of flats. This
position emerges on a plain reading of the relevant Reserve Bank circulars. C
In Halsbury's Laws of England (Fourth Edn), Volume 3 at page 118,
para 160 read thus :
"160. Interest. By the universal custom of bankers, a hanker has
the right to charge simple interest at a reasonable rate on all D
overdrafts. An unusual rate of interest, interest with periodical
rests, or compound interest can only be justified, in the absence
of express agreement, where the customer is shown. or must be
taken to have acquieseed in the account being kept on that basis.
Whether such acquiescence can be assumed from his failure to E
protest at an interest e.ntry in his statement of account is doubtful.
Acquiescence in such charges only justifies them so long as the
relation of banker and customer exists with respect to the advance.
If the relation is altered into that of mortgagee and mortgagor by
the taking of a mortgage, interest must be calculated according to F
the terms of the mortgage, or according to the new relation.
The taking of a mortgage tu secure a fluctuating balance of an
overdrawn account, is not, however, inconsistent with the relation
of a banker and customer, so as to displace a previously accrued G
right to charge compound interest.
•
' ... 'Wis lhe practice of bankers to debit the accrued interest to the
borrower's current account at regular period (usually half-yearly);
where the current account is overdrawn or becomes overdrawn
as the result of the debit the effect is to add the- interest to the H ·
190 SUPREME COURT REPORTS [1994] SUPP.1 S.C.R.
A principal, in which case it loses its quality of interest and becomes
capital."
From the above note, which by and large corresponds to Pagels' opinion
extracted earlier, it is evident that although there may be no common law
right to charge interest on an overdraft, by universal custom or bankers a
B reasonable rate of interest on overdrafts is permissible. So also charging of
interest with periodical rests or compounding of interest would be allowed
if there is evidence of the customer having acquiesced therein, provided
the relation of banker and customer is subsisting. However, if the relation-
ship undergoes a change into that of mortgagee and mortgagor by the
C taking of a mortgage, the charging of interest would be governed in
accordance with the terms of the mortgage. The taking of a mortgage to
secure the fluctuating balance of an overdrawn account, being not incon-
sistent with the relationship of banker and customer, would displace earlier
right to charge comp.ound interest. Thus, the practice of bankers to debit
D the accrued interest to the borrower's current account at regular periods
is a recognised practice. The circulars issued by the Reserve Bank referred
to earlier are not inconsistent with this recognised practice.
We may now deal with D.S. Gowda's case. He had secured overdraft
facilities upto Rs. 2,50,000 from the Bank to construct flats on the plot
E allotted to him by the Bangalore Development Authority. However, the
borrower failed to repay the loan and interest thereon. By 1975 the dues
had risen to over Rs. 4,00,000. To secure the debt the Bank obtained an
equitable mortgage on 10th October, 1975 for Rupees five lacs. Under the
said mortgage deed the borrower covenanted to reply the loan with
F interest at 16.5% per annum. The borrower further agreed that he would
pay the interest at the end of each calendar month and in case of default
he would pay overdue interest. This was followed by the execution of a
promissory note on 7th November, 1975 for Rupees five lacs repayable on
demand with 16.5% interest per annum, with quarterly rest. The borrower
G did not dispute the execution of the aforesaid documents but contended
that the amount actually borrowed under the mortgage was only Rs.
4,00,000 but the bank had added Rs. 1,00,000 as interest due•from him
under the earlier advance which included compound interest and penal
interest. He stated that the promissory note was executed as a collateral
security. Lastly, he contended that the interest charged was excessive and
H hence he was entitled to the protection of the Mysore Act. In his oral
CORPN. BANK v. D.S. GOWDA [AHMADI, J.) 191
evidence he deposed that in 1975 further loan was sanctioned and a A
mortgage deed for Rs. 5,00,000, (comprising Rs. 4,22,000 actual loan plus
Rs. 78,000 interest) was obtained from him. He deposed that Rs. 78,000
was added to the principal amount even though there was no agreement
to that effect. This shows a deviation from his version in the written
statement in the suit. The trial court, therefore, was disinclined to place B
reliance on his version. On the question of interest on the loan advanced
it was noticed that under the promissory note Exh. P-1 dated 26th Novem-
ber, 1973 he had agreed to pay interest at 12% per annum with quarterly
rests and thereafter under the mortgage deed of 10th October, 1975 he
undertook by clause 3 to pay interest at the end of each calendar month
failing which he agreed to pay overdue interest. However, under the C
promissory note dated 7~ November, 1975 he agreed to pay interest al
16.5% with quarterly rest. The trial Court also held that since he had
admittedly not paid any interest on the overdraft as agreed under terms of
the promissory noted dated 26th November, 1973 till ·the date of the·
execution of the mortgage deed, the Bank was perfectly justified in adding D
the outstanding interest of Rs. 78,000 to the actual Joan amount to con-
stitute the principal or mortgage money. The calculation of interest due on
the overdraft facility at the specified rate with quarterly rest perfectly
justified as the relationship of banker and customer subsisted till the date
of the execution of the mortgage deed. After the relationship changed to
mortgagee and mortgagor on the execution of the mortgage deed, interest E
had to be charged as agreed under the terms of the mortgage which was
16.5% per annum to be paid monthly failing which the Bank was permitted
'overdue interest'. The learned trial judge rightly notes that ·if interest is
charged with monthly rest under the mortgage instead of quarterly rest as
claimed the same would prove disadvantageous to the borrower. On the F
question of the transaction being 'uni'air' or the interest being 'excessive'
the learned trial judge points out that the borrower who is a graduate, an
ex-MLA and a man ofrepute (as claimed by him), would have objected to
the same if it were so and would not have acquiesced in it till the suit was
commenced against him. The trial judge thus brushed aside the defence
version and ordered a preliminary decree to be drawn up. Future interest G
was allowed under Section 34 of the Civil Procedure Code at 16.5% on the
sum decreed, i.e., Rs. 7,56,934.17.
On appeal the Division Bench, in the light of the submissions made
at Bar, formulated two questions extracted earlier for determination and, H
192 SUPREME COURT REPORTS (1994) SUPP. 1 S.C.R.
A after considering the relevant statutory provisions governing banks, the
structure of the Reserve Banlc of India with its power of superintendence
and control over all banking institutions including the directive and cir-
culars issued by it, concluded that the ordinary practice or custom of banlcs
was only to charge interest with yearly or half yearly rests and that too only
B on overdrafts and unsecured loans. The High Court, however, inferred that
the monthly or quarterly rests do not appear to be the recognised banlcing
practice. It, however, noted that some banks might have charged interest
with quarterly rests or monthly rests on some transactions but it could not
be said that there existed a generally accepted or universally followed
banking practice to charge interest accordingly. On the circulars/directives ·
C of the Reserve Banlc the High Court o.bserved that the Reserve Bank had
not paid 'adequate attention' to the question of "rests" or the compound
interest to be· charged by banks on loans, advances and other facilities
except to those connected with agriculture. It is obvious from the above
that the High Court fell into two errors. Firstly, it failed to recognize that
D as under common-law there was no right to charge even simple interest on·
overdrafts the claim for interest had to be supported on the ground of
universaL custom' of banlcers or on the basis of implied agreement. This
would be .so··in case where there is no agreement between the banlcer and
the cust6hlet in regard to the payment of interest· but' where the loan or
advance·is inade on certain terms reduced to writing, the parties would be
E 1 governed by.thos\)•terms and there would be no question of falling back on
practice·""' austjlm. Besides, we have already pointed out earlier that
Paget's ·opinion and the statement of law in para 160 of Halsbury clearly
· show that it 'has: ib1'en the practice of bankers to debit accrued interest to
borrower,s'.aoo011n'ilat regular periods usually half yearly. The High Court
F 1 notites<.iha~banks<irr India were not following a uniform practice and some
banks,chavged•intldest with monthly or quarterly rests while others charged
with yeatl.y or six•monthly rests and hence the Reserve Banlc had to issued
directives' to bring about uniformity in that behalf. What is important is to
realise that:'the;normal practice was yearly or half yearly rests but shorter
rests also p/eva'iled. Secondly, the High Court was wrong in going behind
G ' the diciilatS'Pidil:eetives of the Reserve Bank on the plea that the Reserve
Balikrtfofnbtlpay ~itdequate.attenlilit{ to the qtlestion of rests or compound
interest to be charged from borrowers other than agriculturists. As pointed
out earlier, under the Banlcing Regulation Act wide powers are conferred
on the Reserve lilank to enable it to exerCise effective control over all
H '~fJ
CORPN. BANK v. D.S. GOWDA [AHMADI, J.] 193
banks. Sections 21 and 35A enable it to issue directives in public interest A
to regulation the charging of interest on loans or advances made from time
to time. It is in exercise of this power that it issued the circulars referred
to earlier fixing the rates of interest to be charged from borrowers. The
Corporation Bank was nationalised with effect 11th July, 1980. Since the
suit in question was filed in 1978 it was governed by the said guidelines B
which prescribed a minimum rate of 12.5% per annum. Any bank which
committed a breach of the directives was liable to be penalised under
section 47A. A bank could ignore the ditective on pain of being penalised.
Therefore, before issuing guidelines er directives the Reserve Bank must
be taken to have given serious thought to the nature of directives to be
issued. The Reserve Bank Governor's letter dated March 12, 1976, shows C
that it was to bring about uniformity that the banks were advised to charge
interest with quarterly rests because some banks charged interest with half
yearly or yearly rests, some others charged the same on monthly .or quarter-
ly basis. It is also evident from the circulars or March 13, 1976, February
28, and September 15, 1984 that the Reserve Bank not only provided that D
interest may be charged with quarterly or longer rests but also provided
the maximum rate of interest that could be charged. The Reserve Bank,
therefore, not only desired to bring about uniformity but also controlled
the rate of interest. It is, therefore, difficult to appreciate how it can be
said that no rational policy could be discerned from the aforesaid directives
of the Reserve Bank. E
The High Court has next observed that the Reserve Bank did not
pay 'adequate attention' to the question of rests or compounding of inter-
est. In the view of the High Court even though the banking policy had been
completely reoriented after nationalisation yet the evil practice of quarterly F
rests had resisted all reform. It hoped that the Reserve Bank would fall in
line with the universal banking practice of charging half yearly or yearly
rests. True it is that while the universal banking practice is usually to charge
interest with half yearly rest, there is nothing to prevent the practices from
agreeing to quarterly rest and such an agreement would be perfectly valid G
unless it is shown to be opposed to pnblic policy. The reasons why it
became necessary to enact the Usurious Loans Act, 1918, and similar State
legislations was to relieve the debtor from exploitation by empowering the
courts to grant relief if the interest charged is excessive rendering the
transaction substantially unfair. Such laws would not have been necessary
if an agreement providing for excessive rate of interest was per se violative H
194 SUPREME COURT REPORTS (1994) SUPP. 1 S.C.R.
A of section 23 of the Contract Act. Besides it is difficult to say that the
Reserve Bank did not pay adequate attention to the question of 'rests"
when it is evident from the directives referred to earlier that it was the
precise question of bringing about uniformity in that behalf to which the
, Reserve Bank addressed itself. The High Court has not put down the policy
B but has merely condemned it. Unless the directives lying down the said
policy are declared illegal and unenforceable Banks would be bound to
follow them for otherwise they would be penalised. We, however, find it
difficult to agree that adequate attention to the question of 'rests' wa8 not
paid by the Reserve Bank.
C The real question, therefore, is whether the charging of interest at
16.5% per annum with quarterly rests is so obnoxious as would attract the
provisions of the Usurious Loans Act, in this case the Mysore Act. Section
3(1) indicates that if in any suit the court has reason to believe that the
transaction in question was substantially unfair the court may reopen the
transaction provided that if shall not reopen any agreement purporting to
D close previous dealings and to create a new obligation entered into by the
parties. Explanation I says that if the interest is 'excessive' the court shall
presume that the transaction was 'substantially unfair' but the said
presumption could be rebutted by proof of 'special circumstances' justify-
ing the rate of interest. Clause (a) of Explanation II says that the term
E 'excessive' means in excess of what the court deems to be reasonable having
regard to the risk incurred by the creditor while advancing the loan. Clause
(d) of that Explanation further provides that in considering whether the
transaction was 'substantially unfair' regard shall be had to the various
factors set out therein. Therefore, before the Court can direct reopening
of the transaction it must have reason to believe that the transaction is
F substantially unfair as the interest charged is excessive. If compound inter-
est is charged from agriculturist a presumption of the transaction being
unfair can arise which can be rebutted. If it is shown that the transaction
in question is substantially unfair and the court must reopen the same, the
question may arise whether the newly added Section 21A to the Bank
G Regulation Act bars such an enquiry. It may be mentioned that this
provision was inserted after the High Court's judgment and, therefore, the
view of the High Court on this point is not available. It may also have to
be considered if Section 21A would apply to pending proceedings like the
present one.
H
CORPN. BANK v. D.S. GOWDA[AHMADl,J.] 195
Now on the question of unfairness of the transaction, the High Court A
rejected the Bank's contention that the obligation to follow the Reserve
Bank guidelines/directives constituted a 'special circumstances' within the
meaning of Explanation I. So also the High Court rejected the contention
that the provisions of the Mysore Act cannot apply where the creditor is a
bank supervised and controlled by the Reserve Bank. The High Court then
B
held that there was no warrant for charging interest with monthly as well
as quarterly rests. The High Court examined the interest rates on deposits
as well as the Bank Rates and concluded that the reasonable rate would
be 12.5% per annum with annual rests. Penal interest was refused on the
ground that the mortgage-deed did not provide for it.
c
The point boils down to whether interest rate of 16.5% per annum
with quarterly rest on a secured loan can be said to be so excessive as to
render the transaction substantially unfair? Now, as we have pointed out
earlier, the said rate of interest with the duration of the rest was prescribed
and claimed consistently with the Reserve Bank directions. Having regard D
to the powers and functions of the Reserve Bank to which we have drawn
attention, can it be said that interest rates prescribed by the Reserve Bank
with the minima and maxima fixed, are unfair particularly when they have
been fixed in public interest? Can the Court have reason to so believe? Do
the facts of the case warrant a conclusion of the interest rate being
excessive? The term 'excessive' is a relative terms; what may be excessive E
in one case may not be so in another. Much will depend on the circumstan-
ces obtaining at the material date. In our view if the Reserve Bank, keeping
in view the economic scenario of the country and the impact that interest
rates would have on the economy, fixes the minimum and the maximum
interest rates that banks can charge on loan/advances, the same cannot be F
termed to be unreasonable or excessive and would, in any case, amount to
a 'special circumstances' within the meaning of the Explanation to section
3(1) of the Mysore Act. In the present case the borrower did not specifi-
cally contend in his written statement that the interest charged was exces-
sive but merely contended that the Bank was not entitled to quarterly rest G
and hence the claim made in the plaint on that basis was not admitted.
Secondly he had shifted ground on what was the principal sum an interest
which went to make the total of Rs. 5,00,000. Admittedly he had not paid
a farthing towards the loan interest till the date of execution of the
mortgage. This shoW. he was a bad. pay master. The property was still
under construction and did not yield any income at the date of the H
196 SUPREME COURT REPORTS (1994) SUPP. 1 S.C.R.
A mortgage and so it could not be said that the security was sound. True it
is that is re-examination he came out with a statement that the property
was worth Rs. 20-25 lacs. But the value of the property at the date of the
mortgage is relevant for which there is no evidence. The benefit of the rise
in value will ensure to the borrower but thai subsequent fact cannot help
in evaluating the risk factor at the date of the mortgage. Admittedly at no
B point of time, not even at the time of confirmation of balance, did he
protest that the interest charged was excessive. He went to the length of
saying 'even now I cannot say what is excessive interest'. That is because
he never bothered to repay any part of the loan nor did he attempt to pay
interest. He was totally indifferent. He led no evidence to show that the
C prevailing market rate was lower than the interest charged by the Bank.
Nor is it shown that any other bank would have charged less. There is no
mention of deposit rates, etc., in his written statement or oral testimony on
which the High Court has based its opinion. The learned counsel for the
bank was justified in contending that the decision of the High Court is
D based on no evidence since the borrower did not lead any evidence and if
he had done so the Bank would have led evidence to rebut th~ same.
The track record of the borrower was poor. Till 1975, admittedly, he
had not paid a single paisa by way of instalment or interest. Presumably
because he was an influential person, the bank granted hi.ID further indul-
E gence on his agreeing to execute a mortgage. Till that date the building
was not complete and did not yield any income. In the circumstances the
Bank was justified in being cautions. The guidelines issued by the Reserve
Bank permitted a maximum interest rate of 16.5% per annum with quarter-
ly rests. The fluctuations in the rates of interest between 1973 and 1975 on
F borrowing in the mercantile community is not on record. There is. also no
evidence on record as to the rate at which loans could be had in 1975 on
the security of immoveable property in the open market. The High Court
has concluded that the rate of interest charged_ was excessive solely on the
basis of rates of interest allowed by Banks on deposits and the interest
G charged by the Reserve Bank .on borrowings by banking institutions. The
High Court concludes as under :
"It is thus seen that as on today banks get advances from the
Reserve Bank at 10% and pay the interest on deposits not more
H than 10% for deposits of three years and above."
CORPN. BANK v. D.S. GOWDA[AHMADI,J.) 197
On this finding the High Court thought that 12.5% interest with A
annual rest from the date of equitable mortgage would meet the ends of
justice. The learned counsel for the Bank pointed out that since no
evidence was led in this behalf the Bank could not draw the attention of
the High Court to the fact that out of every hundred rupees mobilised as
deposit by Banks, 7% has to be deposited with the Reserve Bank of India B
free of interest, 35% has to be invested in the form of cash and Government
securities (Government securities yield a low rate of simple interest), 10%
has to be compulsorily lent to the Food Corporation of India carrying
interest at 12.5% per annum and the remaining 48% becomes available to
the Banks for lending purposes out of which 40% goes to priority sectors C
which yield interest at 10.5% to 11.55 per annum, 1% has to be compul-
sorily lent to members of the weaker sections at simple interest of 4% per
annum under the DIR Scheme and the balance has to be utilised in other
sectors. Thus the cost of acquisition to funds by Banks average at 12% per
annum and if the High Court judgment is upheld the Bank will earn 0.5%
only. The learned counsel pointed that if the Bank had an opportunity to D
place these facts before the; High Court, the High Court would not have
sliced down the rate of interest to 12.5% as it did by the impugned
judgment. It was further contended that the rate of interest prescribed by
the Reserve Bank take into consideration the true financial and economic
policy of the country and operate as bench-makers against which private E
lending parties are supposed to adjust and compare,. their own rates of
interest and, therefore, the court should ordinarily show reluctance to
interfere in such matters as it may have the effect of disturbing the
economic policy meticulously framed and implemented in the cou~try. We
find considerable substance in this line of reasoning, particularly where the F
minima and the maxima are prescribed by the Reserve Bank.
The second limb of the argument was that the provisions of Usurious
Loans Act would have no application as fixation of rates interest is
governed by the special law, namely, Banking Regulation Act which must G
prevail over the former. To put the matter beyond the pale of doubt section
' 21A came to be introduced in the Banking Regulation Act to _clarify that
the provisions of the Usurious Loans Act would have no application to
transactions between a Banking Company and its debtor on the plea that
the rate of interest charged is excessive. It is not necessary for us to go into H
198 SUPREME COURT REPORTS (1994] SUPP. 1 S.C.R.
A the question whether the provisions of the Banking Regulation Act would,
prevail or whether the newly added section 21A would apply to pending
cases as ·on the facts stated hereinbefore we are satisfied that the High
·Court fell into an error in holding that the rate of interest on the mortgage
is question was excessive.
B Insofar as Civil Appeal No. 544 of 1986 is concerned it relates to the
bank's right to charge compound interest i.e. interest with periodical rests
on agricultural advances. We have already referred to the various circulars
issued by the Reserve Bank from time to time in exercise of power
conferred by section 21/35A of the Banking Regulation Act. We have
C pointed out that the said circulars/directives provide that agricultural ad-
vances should not be treated on par with commercial loans insofar as the
rate of interest thereon the concerned because the farmers do not have any
regular source of income except sale proceeds of their crops which income
they get once a year. The question of recovery of interest with quarterly or
·D six monthly rests from farmers is, therefore, not feasible. The fact that the
farmers are fluid at a given point of time every year has to be kept in mind
in determining the point of time when they should be expected to repay
the loan or pay the instalment/interest on advances. Therefore, to allow the
banks to charge interest on quarterly or half yearly rests from farmers
E would tantamount to virtually compelling them to pay compound interest,
since they would not be able to pay the interest except once in a year i.e.
when tli.ey receive the income from sale proceeds of their crops. The
Reserve Bank has shown concern for the farmers by directing all banking
institutions to so regulate the recovery of interest as to coincide with the
point of time when the farmers are fluid. It has, therefore, been emphasised
F by the Reserve Bank that interest should be charged once a year to
coincide with point of time when the farmer is fluid and interest on current
dues should not be compounded although it may be done when the
advance/instalment becomes overdue. Thus according to the cir-
culars/directives, so far as loans for agricultural purposes are concerned,
G at best interest may be charged with yearly rests and may be compounded
if the loan/instalment becomes overdue. In the present case, since interest
was charged with six monthly rests that was clearly in contravention of the
Reserve Bank ccircularsidirectives. Compounding of interest on current
dues on .agricultural advances having been discouraged, the Bank was not
'
H
CORPN.BANK v. D.S.GOWDA[AHMADJ,J.] 199
entitled to charge interest with shorter periodical rests and compound the A
same. The Bank could add interest outstanding to the principal and com-
pound the interest when the crop loan or terms loan becomes overdue
having regard to the tenor of the circular dated March 14, 1972. The High
Court was, therefore, fully justified in coming to the conclusion that the
Bank was not entitled to charge interest with half yearly rest. B
The learning counsel for the Bank, however, invoked section 21A of
the Banking Regulation Act introduced by Act No. 1 of 1984. We have
already extracted the said provision in the earlier part of this judgment.
Under the said provision a transaction between a Banking Company and
its debtor is not liable to be reopened by any court on the ground that the C
rate of interest charged by the Banking Company in respect of such
transaction is excessive, the provisions of the Usurious loans Act, 1918 and
similar State laws notwithstanding. In Krishna Reddy v. Canara Bank, AIR
(1985) Karnataka 228 it was observed as under :
D
'The mandate of this section is that Court cannot re-open the
account relating to a transaction between a Banking Company and
its customers on the ground that the rate of interest charged, in
the opinion of the Courts, is excessive or unreasonable. The Courts,
in other words, cannot exercise jurisdiction under the Usurious
Loans Act or any other law relating to indebtedness for the E
purpose of giving relief to any party, This appears to be the intent
of the Legislature in enacting the Banking Laws (Amendment)
Act. 1983.'
Section 21A has, however, no bearing on the jurisdiction of Courts F
to give relief to an aggrieved party when it is established that the
Bank in a particular case has charged interest in excess of the limit
prescribed by the Reserve Bank of India."
Therefore, according to the High Court if, in any case, it is shown that the
Bank was claiming interest in excess of that permitted by the circular/direc- G
lion of the Reserve Bank, the Court could give relief to the aggrieved party
noiwithstanding section 2lA to the extent of interest charged in excess of
the rate prescribed by the Reserve Bank. A distinction must be drawn
between court's interference on the premise that the interest charged is
excessive and court's interference on the premise that the interest charged H
200 SUPREME COURT REPORTS (1994] SUPP. 1 S.C.R.
A is in contravention of the circulars/directions issued by the Reserve Bank.
These circulars/directions having been issued under section 21/35A of the
Banking Regulation Act would have statutory flavour. In the judgment
impugned' in this case the Division Bench of the High Court summed up
thus:
B
"The Courts cannot re-open any account maintained by Banks
relating to transaction with its customers on the ground that the
rate of interest charged, in the opinion of the Courts, is excessive
or unreasonable. Section 21A of the Banking Regulation Act is a
restraint on such power of Courts, However, in any case, if it is
c proved that the interest charged by Banks on loans advanced is
not in conformity with the rate prescribed by the Reserve Bank
then the Court could disallowed such excess interest and gi~e relief
to the party notwithstanding the provisions of Section 21A. Banks
are bound to follow the directives or circulars issued by the
Reserve Bank prescribing the structure of interest to be charged
D
on loans and any interest charged by Banks in excess of the
prescribed limit would be illegal and void. Banks cannot charge
compound interest with quarterly rests on agricultural advances."
We are in respectful agreement with the above interpretation place
.E
on section 21A of the Banking Regulation Act. We must, however, clarify
that we should not be understood to be expressing any opinion whatsoever
·on the question whether section 21A would debar the courts from inter-
fering if the circulars/directives issued by the Reserve Bank do not fJX the
maxima and leave to the discretion of the Banks to determine the rate of
F interest above the minimum flXed. To put it differently if under the Reserve
Bank circulars/directives the minimum rate of interest is flXed, say 12.5%
without a ceiling, leaving it to the discretion of each Bank to flX a higher
rate of interest at its sweetwill above 12.5%, a question may arise whether
the interest fJXed by the Bank is excessive and unconscionable and whether
G in such situation section 21A would debar the court from reducing the rate
of interest to a reasonable limit. We do nor express any opinion on this
question as the same does not arise in the present case. But if the Reserve
Bank has flXed the maximum rate of interest in exercise of the powers
conferred by section 21/35A of the Banking Regulation Act, section 21A
H would be attracted and the transaction would not be liable to be reopened
CORPN. BANK v. D.S. GOWDA [AHMADI, J.] 201
on the ground that the rate of interest fixed is excessive even though not A
exceeding the ceiling determined by the Reserve Banlc. In the case of
agrictiltural loans/advances the position has been made amply clearly by
the circ1ilars referred to earlier which do not permit Banlcs to Charge
compound interest with quarterly rests, In such cases as observed earlier
the interest can be fixed with annual rests coinciding with the time when
B
the farmer is fluid and if thereafter the farmer fails to pay the interest it
wowd be open to compound the interest· on the crop loan or instalments
upon the term becoming overdue. In 'liew of the above we do not see any
flaw in the reasoning of the High Court so far as this appeal is concerned.
We, therefore, must dismissed the appeal.
c
In the reslilt Civil Appeal No. 4214 of 1982 is allowed and the
decision of the High Court is restored, with this modification that the
post-decree interest shall be calculated at 12.5% per annum. In the facts
and circumstances of the case we make no order as to costs, Civil Appeal
No. 544 of 1986 is, however dismissed with cost. D
SLP (C) No. 16444192
The grievance of the respondent-association in the High Court re
lated to charging of compound interest on loans given to its members for
the purchase of tractors. E
The Division Bench of the High Court of Orissa presided over by
the then learned Chief Justice held that the agreement entered into by the
Banlc with the borrower did not stiplilate the payment of compound
interest and hence it was unnecessary to examine if there existed such a F
stipulation, the same wowd have been enforceable . by the Bank. See
paragraph 13 of the judgment. It is true that in the body of the judgment
reference has been made to the case of Bank of India v. Kamam Ranga
Rao, AIR (1986) Karnataka 242 and it is observed that since farmers do
not have regular source of income other than sale proceeds of their crops,
G
and receive. the sale proceeds annually, they cannot be expected to have
agreed to pay interest with periodical rests. In paragraph 8 of the judgment
the High Court has observed :
'The present, therefore, is a case which would make the finding of
the Karnataka High Court relevant insofar as tile policy circulars H
202 SUPREME COURT REPORTS (1994] Sl!PP. l S.C.R.
A of the Reserve Bank of India are concerned."
But the High Court ultimately decided in favour of 1he borrower
·because in its view the agreement did not provide for periodical rests nor
did it stipulate for payment of compound interest, making the above quoted
observations obiter dicta. In that view of the matter, we see no reason to.
B interfere as the decision does not ultimately rest on.the aforequoted view
based on the Karnataka High Court decisions. We may incidentally say that
we have today by a separate j~dgment dismissed the Bank's appeal against
the said decision. We dismiss this petition on the short ground that the
agreement on which the Bank's claim is founded does not provide for
C payment of qimpound interest or interest with periodical rests.
R.R. CA. Nos. 4214/82 allowed.
CA. No. 544/86 and SLP (C) No. 16444/92 dismissed.
1:'
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