Judgment

AHMADI, J.- These appeals brought by the aforementioned Banks by special leave raise certain important questions of law touching the business 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 yearly rest, or compound interest in any other manner, from a borrower who has obtained a loan or an advance for agricultural/commercial purposes, 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 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 21-A in the Banking Regulation Act, 1949 by Banking Loans (Amendment) Act, 1983 (Act No. 1 of 1984), courts are precluded from subjecting transactions entered into between the 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? 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 I 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.

2. In Bank of India v. Rao Saheb Krishna Rao Desai{(1980) 2 Kar LJ 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 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 heard by a Division Bench of the Karnataka High Court. The Division Bench referred to Pagets Law of Banking, 8th Edn. (1972), Chapter V, wherein under the caption interest it was stated :

"There is no common law right to charge even simple interest on an overdraft 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 changed 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 compound interest. The effect of the practice of bankers in debiting interest to an overdrawn current account periodically and thereby increasing the capital sum was considered in Yourell v. Hibernian 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 customer.