Author: VAISHNAVI TRIPATHI, ARYA KANYA DEGREE COLLEGE, UNIVERSITY OF ALLAHABAD, PRAYAGRAJ
To the Point
The case of Central Bank of India v. Ravindra stands out as a landmark judgment by the Hon’ble Supreme Court of India. In this case, the Court took a close look at the practice of capitalising interest in simpler terms, charging interest on unpaid interest and laid down clear rules about its legality and limitations. The case settled ambiguities regarding how and when banks can apply compound interest, especially during loan defaults and moratorium periods. It balances the financial interest of banking institutions with the principles of fairness and borrower protection.
Use of Legal Jargon
Capitalisation of Interest: Means adding the unpaid interest to the main loan amount, so that future interest is charged on this increased total.
Penal Interest: An additional charge imposed on delayed repayments.
Compound Interest: Compound interest is when interest is calculated not just on the original loan amount (principal), but also on the interest that has already built up over time.
Rest Period: The frequency with which interest is calculated and added.
Doctrine of Fairness: The legal principle that regulatory mechanisms must not be arbitrary or unjust.
Accrual: The accumulation of interest over time.
Loan Default: It happens when a borrower fails to repay the loan as per the agreed terms and conditions.
Equitable Principles: Norms based on fairness, justice, and conscience, not necessarily strict law.
The Proof
The Court’s reasoning was anchored in:
Section 34, Code of Civil Procedure (CPC): Empowers courts to award reasonable interest and disallows penalisation through compounding beyond what is fair.
RBI Guidelines: Periodic circulars on interest calculation and compound interest limits. They regulate the frequency of rests and prohibit usurious interest rates.
Indian Contract Act, 1872: Especially Sections 23 (unlawful considerations) and 28 (agreements in restraint of legal proceedings) concerning legality and enforceability of contractual terms involving capitalised interest.
Doctrine of Natural Justice: Arbitrary charging of penal interest or lack of transparency in calculation violates the fairness expected under public policy.
The Court emphasised that in any banking relationship, especially during distress periods or litigation, there must be a balance between contractual enforcement and equitable consideration. A clause in a loan agreement permitting the capitalisation of penal interest may be contractually valid but still subject to judicial scrutiny for fairness.
Abstract
This article examines the Supreme Court’s authoritative ruling in Central Bank of India v. Ravindra and its implications on India’s banking jurisprudence. The judgment clarifies how and when banks can apply compound interest, and prohibits charging penal interest on accrued interest, reinforcing the principles of reasonableness, transparency, and good faith in contractual enforcement. The decision brought clarity to banking practices at a time when borrowers were being unduly penalised by unregulated compounding of debts.
The judgment continues to guide both courts and financial institutions in structuring repayment schedules, particularly in default and moratorium situations. Importantly, the court laid down the test that even if capitalisation is permitted under the agreement, it must not lead to a situation where the borrower is trapped in a cycle of unpayable interest liability.
Case Laws
Central Bank of India v. Ravindra & Ors.
(2002) 1 SCC 367
Facts: The Central Bank had granted loan facilities to several borrowers. Upon default, it charged compound interest, calculated quarterly, including penal interest. Borrowers challenged this on the ground that such capitalisation was unjust and excessive.
Issue: Whether a bank is legally permitted to charge interest on interest during the pendency of loan repayment or after default.
Held:The Supreme Court held that capitalisation of interest is permissible, but penal interest cannot be capitalised.
The practice of compound interest is valid if agreed upon contractually, subject to RBI norms.
However, courts have the discretion to reopen accounts, strike down unconscionable terms, and reduce unfair charges under certain conditions.
Ratio Decidendi: “Penal interest cannot be capitalised.
i.e., charged upon interest already accrued. To do so would be to enforce an unconscionable term against the borrower.”
The Court further observed that although capitalisation of simple interest is acceptable during the currency of a loan, it cannot be applied retrospectively or post-default unless specifically agreed upon and permitted by regulatory instructions.
State Bank of India v. Yasangi Venkateswara Rao
(1999) 2 SCC 375
Reinforced that penal interest must be distinguished from normal interest, and any deviation from RBI norms is non-binding on the borrower.
Syndicate Bank v. R. Veeranna
(2003) 2 SCC 15
Confirmed that contractual clauses regarding interest must align with public policy and fairness. The Court reiterated that even freely agreed contracts are not immune from scrutiny when terms appear harsh or unjust.
United Bank of India v. Dhruba Kumar Sur
(1976) 4 SCC 252
This case recognised the discretionary power of courts in moulding relief in banking disputes where statutory and equitable considerations demand a deviation from contractually agreed terms.
Conclusion
The Supreme Court in Central Bank of India v. Ravindra harmonized the interests of financial institutions with consumer protection principles. It upheld the legitimacy of compound interest when contractually stipulated but struck down the capitalisation of penal interest as unjust. This judgment remains a cornerstone in understanding the application of interest norms in Indian banking law.
By reiterating the regulatory supremacy of RBI norms and embedding judicial review into banking practices, the Court established a benchmark that curbs arbitrary compounding practices. The judgment provides litigants with a legal framework to challenge unfair interest charges and protects borrowers from being entrapped by unauthorised accrual mechanisms. It emphasizes that no clause in a loan document can override public interest and constitutional fairness.
FAQs
Q1: Can banks charge compound interest on defaulted loans?
Answer: Yes, but only if it is contractually agreed and compliant with RBI norms. However, penal interest cannot be compounded. This ensures borrowers are not doubly punished for the same default.
Q2: What is the difference between penal interest and normal interest?
Answer: Normal interest compensates for the time value of money, whereas penal interest is a deterrent for delayed payments. The latter, being punitive, cannot be added to principal or further compounded.
Q3: What legal remedies are available if a bank overcharged interest?
Answer: The borrower can approach civil courts, Debt Recovery Tribunals (DRTs), or consumer forums to reopen accounts and seek refund or adjustment based on Ravindra judgment. Courts have held that equity demands reviewing excessive compounding.
Q4: Does the judgment apply retrospectively?
Answer: Yes, the Supreme Court allowed retrospective applicability but left it to the discretion of the courts based on facts of each case. Courts have reopened cases where unfair compound interest led to disproportionate liabilities.
Q5: How has RBI responded post-Ravindra ruling?
Answer: The RBI issued several guidelines reaffirming the prohibition on compounding penal interest and introduced Fair Practices Code for lenders. This mandates clarity in loan terms, periodic statements, and limits on interest loading during defaults.
