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INTRODUCTION
Since the year 2006, Vidharbha has mocked the “socialist republic of India.” The suicide
of farmers, with rate as high as one suicide every 8 hours,1 the welfare state title seems
like an insult to IndiaAs a wit once remarked, it is tougher to borrow Rs 500 from a bank
than Rs 500 crore. Finance Minister P. Chidamabaram’s Rs 60,000-crore farm loan
package is more of a lifeline for banks than it is for farmers. Banks shy from lending to
the poor given the high risks and transaction costs, and the lack of information and
collateral. And moneylenders step in where institutional creditors fear to tread.
Unfortunately, farmers have no recourse even if banks — forget moneylenders — charge
higher interest rates, because there is no effective legislation for usury in India. The
Banking Regulation Act, 1949 made the Usurious Loans Act of 1918 inapplicable to
transactions between a bank and a borrower. The 1918 law, enacted by the British, had
not only capped the interest rate on loans charged by banks at the official rate, but also
allowed courts to reopen cases where farmers were charged excessive interest rates.
While states have their own usury laws, they rarely get enforced because farmers don’t
know about them.
In light of such a grim situation this project seeks to analyse Bank credit with special
reference to rural indebtedness. In the process of doing the same the legislative
competence of the states to enact the usury and debt relief acts, the role of the RBI in
light of Section 21 and the relief is any available to the farmers.
1
See, Jaideep Hardikar, One Suicide Every Eight Hours, Avaible at:
http://www.dnaindia.com/india/report_one-suicide-every-8-hours_1049554
Page |2
The Usurious Loans Act, 1930 was incorporated by the parliament to provide relief to the
debtors from the cascading menace of inflated interest rates imposed by the money
lenders. Till the year 1984, that is, prior to the amendment to the Banking Regulation Act
and insertion of Section 21A, the transactions entered into by the bank and the debtor
were susceptible to challenge under the Usurious Loans Act on the ground of the interest
being excessive and usurious. In determining whether interest is excessive under this
Section the Court took into account any amounts charged or paid whether in money or in
kind for expenses inquiries fines, bounces, premia, renewals or any other charges and if
compound interest is charged the periods at which it is calculated and the total advantage
which may reasonably be taken to have been expected from the transaction.
Predominantly, credit in India is advanced by banks and money-lenders. The legislative
competence of the Union and the States is divided subject wise between them in three
Lists contained in the Seventh Schedule of the Constitution. The Constitution lays down
that the power of the Union and the States shall be exclusive in the areas of their
respective Lists i.e. List I or Union List and List II or State List; and, that the Union’s
power will prevail in respect of any matters in List III or Concurrent List. By virtue of
Entry 30 of List II, money-lending is within the exclusive legislative competence of the
States.
The Supreme Court in Fatehchand Himmatlal v. Union of India2 while dealing with a
constitutional challenge to the Maharashtra Debt Relief Act, 1976 held that pernicious
practices, such as money-lending, are not constitutionally protected as a trade under the
Constitution. The Court ruled that:
“A meaningful, yet minimal, analysis of the Debt Act, read in the light of the
times and circumstances which compelled its enactment will bring out the
humane setting of the statute. The bulk of the beneficiaries are rural indigents and
the rest urban workers. These are the weaker sections for whom constitutional
concern is shown because institutional credit instrumentalities have ignored them.
2
(1977) 2 SCC 670
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Clearly, it is open for States to enact legislation to regulate money-lending. For a State to
claim competency to enact legislation about banking transactions3, it must show that the
“pith and substance” of the proposed legislation falls in the State’s List (List II, Schedule
VII) or the Concurrent List (List III, Schedule VII) but does not fall within the Union’s
List (List I, Schedule VII). The broad principles for determining legislative competency
are:
(a) The principle of ‘pith and substance to determine which Entry or Entries a legislation
falls under,
(b) The principles of exclusivity so that the Union and States do not encroach on each
others powers [Articles 245 and 246],
(c) The principle of repugnancy denying States the power to infringe Union legislation in
the Concurrent List [Article 254], and
(d) Invoking special principles for a situation of emergency or to fulfil international
obligations.
Therefore, it is not open for the States to enact legislation, the pith and substance of
which affects banking4. However, States may competently legislate on rural indebtedness
to the exception of banks to provide debtors suitable relief.
3
As banking falls within the purview of Union List. Entry 45 of List I
4
Associated Timber Industries v. Central Bank of India & Anr. (2000) 7 SCC 93, Bank of Baroda v.
Rednam Nagachaya Devi (1989) 4 SCC 470 and N. M. Veerappa (1998) 2 SCC 317.
Page |4
In the absence of relevant Union legislation and the inability of States to regulate loans
advanced by banks, recourse may be had to the regulatory powers of the Reserve Bank of
India (RBI). The RBI is vested with the power to regulate all banking in the country. In
exercising its regulatory powers, the RBI may issue circulars or directions to banks which
the latter are bound to comply with, under Section 21(3)5 and Section 35A(1) of the
Banking Regulation Act6. In the exercise of its regulatory powers, the RBI can even
specify maximum limits for interest rates and other aspects of agricultural loans7.
Banking, however, is subject to the exclusive legislative competence of the Union, since
it is listed in Entry 45 of List I. Courts used to have the power to reopen banking
transactions on grounds of excessive interest or substantial unfairness between the
parties. This power was traceable to Section 3(1) of the Usurious Loans Act, 1918.
However, in 1984, Parliament enacted an amendment to the Banking Regulation Act,
1949, to insert a new Section 21A to bar the jurisdiction of courts to examine banking
debt transactions on the grounds of excessive interest. Section 21A of the Banking
Regulation Act overrides Section 3 of the Usurious Loans and, therefore, courts can no
longer reopen usurious loan transactions8.
5
Section 21. Power of Reserve Bank to control advances by banking companies. (1) Where the Reserve
Bank is satisfied that it is necessary or expedient in the public interest 63[or in the interests of depositors or
banking policy] so to do, it may determine the policy in relation to advances to be followed by banking
companies generally or by any banking company in particular, and when the policy has been so
determined, all banking companies or the banking company concerned, as the case may be, shall be bound
to follow the policy as so determined. (2) Without prejudice to the generality of the power vested in the
Reserve Bank under sub-section (1) the Reserve Bank may give directions to banking companies, …….(3)
Every banking company shall be bound to comply with any directions given to it under this section.
6
Section 35A. Power of the Reserve Bank to give directions. (1) Where the Reserve Bank is satisfied that
(a) in the public interest; or (aa) in the interest of banking policy; or (b) to prevent the affairs of any
banking company being conducted in a manner detrimental to the interests of the depositors or in a manner
prejudicial to the interests of the banking company; or (c) to secure the proper management of any banking
company generally, it is necessary to issue directions to banking companies generally or to any banking
company in particular, it may, from time to time, issue such directions as it deems fit, and the banking
companies or the banking company, as the case may be, shall be bound to comply with such directions.
7
D. S. Gowda, (1994) 5 SCC 213, H. P. Krishna Reddy, AIR 1985 Kant 228 and Karnam Ranga Rao, AIR
1986 Kant 242.
8
Kamla Prasad Jadawal v. Punjab National Bank, New Delhi, AIR 1992 Madh Pra 45; Vijaya Bank v. Art.
Trend Exports, AIR 1992 Cal 12and Syndicate Bank v. Kailashchandra, (1993) 76 Com Cas 392 (Bom)
support their contention that Section 21-A overrides the provisions of Usurious Loans Act and the
prohibition contained in the said provision applies even to the suits pending before the Courts in respect of
Page |5
Section 21A of the Banking Regulation Act, 1949 provides for rates of interest charged
by banking companies not to be subject to scrutiny by courts. It states:
“Notwithstanding anything contained in the Usurious Loans Act, 1918 (10 of
1918), or any other law relating to indebtedness in force in any State, a transaction
between a banking company and its debtor shall not be re-opened by any court on
the ground that the rate of interest charged by the banking company in respect of
such transaction is excessive.”
The following observations with respect to Section 21A was made by the High Court of
Andhra Pradesh9
1) Section 21-A of the Banking Regulation Act, 1949 applies to all transactions entered
into between the banking company and its debtor whether the transaction was entered
into prior to its commencement or after.
2) Section 21-A of the Banking Regulation Act, 1949 applies to suits pending on the date
of coming into force of the said section.
3) Section 21-A applies to pending appeals irrespective of the fact whether a decree was
passed giving relief to the debtor or not.
4) Section 21-A makes no distinction between advances made for agricultural purpose or
for commercial purpose and it equally applies to both.
the transactions entered into prior to the coming into force of Section 21-A.
9
State Bank of Hyderabad v. Respondent: Advath Sakru AIR 1994 AP 170
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The limitation is that in exercise of these powers the Court shall not re-open any
agreement purporting to close previous dealings and to create a new obligation which has
been entered into by the parties or any persons from whom, they claim at a date more that
twelve year from the date of the transaction.
10
Explanation 2(c) to Section 3.
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the time of the loan so far as the same were known or must be taken to have been known
to the creditor11.
Proviso to clause (b) of sub-section (2) of Sec. 3 is to the effect that in the case of loans to
agriculturists if compound interest is charged, the Court shall presume that the interest is
excessive. If the interest is excessive, explanation (i) to Section 3 raises a presumption
that the transaction was substantially unfair. If the transaction between the parties thereto
is substantially unfair, the court shall reopen the transaction and relieve the debtor of all
liability in respect of any excessive interest or if the debtor paid more than the amount
required to be paid and then order the creditor to repay the sum which it considers to be
repayable in respect of the said transaction. However, there is an important aspect
referred to in explanation (i) to Section 3, viz., that though a presumption is raised that
the transaction is substantially unfair between the parties thereto, it is made a rebuttable
presumption. Therefore, the creditor can rebut the presumption that the transaction was
substantially unfair, by proof of special circumstances justifying the rate of interest.
(d) If compound interest was provided for the frequency of the period of calculation of
the interest and,
(e) The advantage which the debtor reasonably expected to derive from the transaction.
Page |9
Black's Law Dictionary defines interest inter alia as the compensation fixed by agreement
or allowed by law for the use or detention of money, or for the loss of money by one who
is entitled to its use; especially, the amount owed to a lender in return for the use of the
borrowed money13. According to Stroud's Judicial Dictionary of Words and Phrases
interest means, inter alia, compensation paid by the borrower to the lender for deprivation
of the use of his money14.
In Secretary, Irrigation Department, Government of Orissa & Ors. v. G.C. Roy15 the
Constitution Bench opined that a person deprived of the use of money to which he is
legitimately entitled has a right to be compensated for the deprivation, call it by any
name. It may be called interest, compensation or damages.
In Dr. Shamlal Narula v. C.I.T., Punjab16 this Court held that interest is paid for the
deprivation of the use of the money. The essence of interest in the opinion of Lord
Wright, in Riches v. Westminster Bank, Limited 17 is that it is a payment which becomes
due because the creditor has not had his money at the due date. It may be regarded either
as representing the profit he might have made if he had the use of the money, or,
conversely, the loss he suffered because he had not that use. The general idea is that he is
entitled to compensation for the deprivation; the money due to creditor was not paid, or,
in other words, was withheld from him by the debtor after the time when payment should
have been made, in breach of his legal rights, and interest was an compensation whether
the compensation was liquidated under an agreement or statute.
A Division Bench of the High Court of Punjab speaking through Tek Chand, J. in C.I.T.,
Punjab v. Dr. Sham Lal Narula18 thus articulated the concept of interest
13
7th Edition
14
5th edition
15
(1992) 2 SCC 508
16
MANU/SC/0109/1964
17
(1947) 1 All E R 469, 472,
18
MANU/PH/0119/1963
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With effect from 15.2.1984 Section 21A has been inserted in the Act which takes away
power of the Court to re-open a transaction between a banking company and its debtor on
the ground that the rate of interest charged is excessive. The provision has been given an
overriding effect over the Usury Loans Act, 1918 and any other provincial law in force
relating to indebtedness.
In K.C. Venkateswarlu v. Syndicate Bank, Udayagiri19, 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 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 Banking Company.
19
MANU/AP/0084/1986
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In the case of C. Narayana Reddy v. State Bank of India (Agricultural Development) 20 the
first respondent had filed a suit against the appellant and others, for recovery of a sum of
Rs.82,613.85 with interest thereon at 14 percent per annum. According to the first
respondent/ plaintiff, the first defendant on his behalf, and as the power of attorney for
other defendants, borrowed a sum of Rs.10,000/- on 27.11.1973 as crop loan, that they
have borrowed a further sum of Rs.50,000/-, for the purchase of a tractor and other farm
implements, as per the agreement dated 18.2.1975. It is the further case of the plaintiff
that the defendants though agreed to repay the loan amount on installment basis, failed to
pay the same, despite repeated request and demand. The first defendant as the power
agent, had acknowledged the liability, by executing the revival letters on 16.1.1978,
25.12.1980, 12.12.1983 and 20.10.1984 and in this view, according to the plaintiff, the
suit is in time. The effort of the bank, to realise the amount outside the Court failed
despite notice and therefore, a suit came to be filed, for recovery of the above said
amount. The first defendant opposed the claim of the plaintiff bank, admitting the
borrowing, that he did not agree to pay compound interest, then adding the interest to the
principal at regular intervals, that if at all, the plaintiff could claim only simple interest at
reasonable rate and in this view, the amount claimed in the plaint should be scaled down
substantially. The defendant challenged the inclusion of some sundry expenses such as,
inspection charges, insurance amount, etc. It is the further contention of the appellant/first
defendant, since he had not executed any revival letters, as alleged in the plaint, the suit is
barred by limitation. The further defence of the appellant is that, since the amounts were
advanced for agricultural purposes, as such, the plaintiff bank is not entitled to claim
interest, especially the subsequent interest at 14 %.
The respondent contended that the Court has no power, to reopen the settled account
which includes interest, in view of Section 21A of the Banking Regulation Act, 1949 (as
amended), that though the loan was advanced for agricultural purpose, the borrower had
the benefit of commercial activities, by utilizing the tractor and in this view, subsequent
interest also could be charged as per the contractual rate
20
[2005] 125 CompCas 67 (Mad)
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The Court heavily relied on the opinion by the Constitution Bench of the Apex Court in
Central Bank of India v. Ravindra.21 It was held:
As to capitalization of interest charged on periodical rests, it was observed that the banks
in India were not following a uniform practice and some banks charged interest with
monthly or quarterly rests while others charged with yearly or six monthly rests and
hence the Reserve Bank of India had to issue directives to bring about uniformity in that
behalf.
The question whether interest charged in excess of the minimum rate of interest
appointed by the Reserve Bank without fixing a ceiling and levying higher rate to be
charged at the discretion of each bank can be treated as excessive and unconscionable and
whether in such situation Section 21A would debar the Court from reducing the rate of
interest to a reasonable limit was left open and undecided as the same did not arise in the
case before the Court. However, it was made very clear that if the Reserve Bank has fixed
the maximum rate of interest under Section 21 and Section 35-A of the Act any
transaction charging interest within the limit so appointed would not be treated as
excessive.
21
AIR 2001 SC 3095
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Hence it can be seen it is seen that despite Section 21-A of the Banking Regulation
Act, 1949, if it is shown, that the interest charged is excessive and in contravention of
circulars/directions issued by the Reserve Bank of India, the bar enacted by Section
21-A of the Banking Regulation Act would not come to the aid of the bank. In that case,
the Court can go into the question and find out, whether any excessive amount has been
charged by way of interest, violating circulars/directions issued by the Reserve Bank of
India.
P a g e | 15
Should the States’ power to legislate in relief of rural indebtedness also extend to bank
debts? Further, the continued existence of Section 21-A of the Banking Regulation Act
prevents courts from examining banking transactions for usury, even where the debtor is
an impoverished farmer. With the States’ unable to legislate to protect farmers, the
Reserve Bank of India must exercise its supervisory power to place limits on the rates of
interest that may be charged on agricultural loans.
In Krishna Reddy v. Canara Bank22 it was observed that 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 purpose of giving relief to any party, this appears to be the intent of the Legislature in
enacting the Banking Laws (Amendment) Act. 1983. It was also observed that Section
21A has, however, no bearing on the jurisdiction of Courts 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.
In the matter of the In Re: State Bank of India, Eluru,23 a learned Single Judge of the said
High Court, however, held that Section 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 Parliament on the ground that it was 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
22
AIR 1985 Kant 228
23
AIR 1986 AP 291
P a g e | 16
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 usurious
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 of equity and equality, the learned
Judge refused to apply it in the fact of the case.
This judgement was overruled by the Karnataka High Court in the case of Bank of India
v. Karnam Ranga Rao and Ors.24 The Division Bench held that Banks were bound to
follow the directives or circulars issued by the 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 pointed out
that agricultural advances could not be equated with 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 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 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 dismissed25.
CONCLUSION
24
AIR (1986) Karnataka 242.
25
Refer: Corporation Bank v. D.S. Gowda and Anr. [1994] 81 CompCas 842 (SC)
P a g e | 17
BIBLIOGRAPHY
P a g e | 18
2. Sharad Joshi, Compounding troubles for farmers, The Hindu, Wednesday, Apr 05,
2006.
3. Gupta S.N. Banking Law in Theory and Practice in 3 Vols., Pioneer Book House,
4th Edition, 2005
5. Mark Hapgood, Paget's Law of Banking, Lexis Nexis Butterworths, 12th Edition
2004