# CORPORATION BANK v. D.S. GOWDA AND ANR

- **Citation:** [1994] Supp. 1 S.C.R. 170
- **Court:** Supreme Court of India
- **Decided:** 1994-06-20
- **Case number:** Civil Appeal No. 544 of 1986
- **Bench:** Am. Ahmadi, S.C. Agrawal
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/corporation-bank-v-d-s-gowda-and-anr-12385
- **Pages:** 33

## Headnote

Banking Regulation Act 1949-Sections 21, 21-A and 35- A-Reserve
Bank of lndia's Circulars and directives issued thereundei--lnterest with periodical 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 overdue-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 cirE 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.
G
In these appeals by Corporation Bank against the Judgment of the
Karnataka High Court, the following qnestions arose for consideration:
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
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
B
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 relationship 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]

## Text

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A
B
CORPORATION BANK
v.
D.S. GOWDA AND ANR.
JUNE 20, 1994
(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 periodical 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 overdue-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 cirE 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.
G
In these appeals by Corporation Bank against the Judgment of the
Karnataka High Court, the following qnestions arose for consideration:
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
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
B
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 relationship 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
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
c of interest on loans or advances made from time to time. It is in exercise
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·
I
I
•
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 transaction 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]
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
F
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]
E
D.S. Gowda v. Corporation Bank, AIR (1983) Kant. 143 = (1982) 2
Kant LJ 40, reversed
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, Kuldeep 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 agriculturaVcommercial 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
A
B
176
SUPREME COURT REPORTS (1994] SUPP. 1 S.C.R.
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 to Section 3 of the Mysore Usurious .Loans Act, 1923
, (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 :
F
G
H
, "There is no common law right to charge even simple interest on
·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 acquiescence will justify the charging compound interest or interest with
periodical ·rests, so long as the relation of banker and customer
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
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 Atkinson 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 :
"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."
Relying on the above passage, the Division B_ench observed that the custom
of charging compound interest by Banks would be normally applicable in
c
D
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 overG
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.
B
c
Hence thi; Division Bench held that the clause which was noted by the
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.
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 approached 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 indebE
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, therefore, 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 submitted 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 F
he executed the equitable mortgage. The trial court further held that the
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
B
whether the Court could call into aid the provisions of the Mysore Act to
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 direcC
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 agriculr ture."
Relyin~ on Section 3(1) of the Mysore Act the Cour~ held that the directives 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.
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
c
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 introduced in the Banking Regulation Act, 1949 which reads as follows :
"21A: Rates of interest charged by Banking Companies not to be
subject to scrutiny by Court. - Notwithstanding anything contained
E
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 company 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 Circulars 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
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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, thereF
fore, directed to submit a revised statement which it did determining the
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,
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 :
G
H
184
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B
SUPREME COURT REPORTS (1994] SUPP. 1 S.C.R.
"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 transaction, 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·
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 application 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 ParliaE
F
ment on the ground that it ~as not a law relating to Banking but was
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
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, However, 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/financial 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 agriculturists 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
A
B
c
D
186
SUPREME COURT REPORTS [1994) SUPP. 1 S.C.R.
"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.
l
(i) Repayment period of agricultural advances, whether
short-term or medium-term, should be so fixed as to coincide
with the period when the farmer is fluid i.e., after harvesting
and marketing of his crops.