Author: Tanishka Singh, 3rd Year, B.A. LL.B., Bharati Vidyapeeth, Deemed to be University New Law College, Pune
To The Point
The 2002 Supreme Court ruling in Central Bank of India v. Ravindra & Ors. cleared the half-century of uncertainty regarding how interest can be compounded by banks in India and whether penal interest can be charged interest on.
Prior to this case:
Banks were compounding interest based on contractual provisions and customary practices in the industry, at times half-yearly or even monthly.
Borrowers complained that these procedures were discriminatory, or at odds with Reserve Bank of India (RBI) guidelines.
Courts delivered contradictory judgments, some allowed capitalisation freely, while others forbade it unless specifically authorised.
The handling of penal interest (additional interest on defaults) was ambiguous: some judgments approved its capitalisation; others declared it illegal.
The Supreme Court in Ravindra settled the principles clearly:
1. Capitalisation of ordinary interest is legal if:
Authorised by contract;
In accordance with normal banking practice; and
In conformity with RBI instructions (including rest intervals).
2. Penal interest may be levied but never capitalized.
3. RBI instructions are statutorily binding and supersede conflicting contractual provisions.
4. Post-decree interest is controlled by Section 34 CPC, not the loan document, and is required to be reasonable.
This ruling is now the standard national norm in loan recovery suits, Debt Recovery Tribunal proceedings, and bank arbitrations.
Abstract
The judgment in Central Bank of India v. Ravindra & Ors. by the Supreme Court is a judicial milestone in Indian banking law clarifying the charging of interest specifically capitalised interest and penal interest by banks. Prior to this ruling, there was no consistent norm: High Courts issued contradictory decisions, banking practices were inconsistent, and borrowers regularly challenged compounding as usurious or against principles of fair lending.
The case covered two essential questions: whether interest which is not paid can be capitalized (so that interest on it is added in the future), and whether this can extend to penal interest charged for default. The Court confirmed the validity of capitalising regular interest where three criteria are fulfilled:
1. It must be expressly permitted in the agreement of the loan.
2. It must be consistent with prevailing banking practices.
3. It meets RBI guidelines, including recess periods.
At the same time, it forbade capitalizing penal interest, arguing that penalties are deterrents, not bases for further interest-generating revenue. The Court also reiterated that RBI guidelines have statutory effect under the Banking Regulation Act, 1949, and trump inconsistent contract terms.
The ruling made it clear that pre-decree interest is governed by contractual terms, whereas post-decree interest falls under Section 34 of the Code of Civil Procedure, 1908, which enables courts to determine reasonable rates after judgment. This safeguards borrowers from unlimited usage of exorbitant contractual rates after a decree is made.
By invalidating penal compounding but sustaining regulated interest capitalization, Ravindra struck a balance between commercial realities and borrower safeguard. It has since served as a talismanic precedent for courts, Debt Recovery Tribunals, and banks while formulating and enforcing loan agreements.
Use of Legal Jargon
The case involves quite a few technical terms:
Capitalisation of Interest – Including accrued interest in principal so that interest in the future is charged upon the enhanced amount.
Compound Interest – Interest on the original principal and also on interest already accrued.
Simple Interest – Interest calculated solely on the principal.
Penal Interest – Extra interest charged for non-payment or delay; a penalty for default.
Rest Period – The time period (quarterly, half-yearly, annually) at which interest is capitalised.
RBI Directives – Directions given under the Banking Regulation Act, 1949, binding on banks.
Usury – Charging exorbitant interest, in the past governed under the Usurious Loans Act, 1918.
Unconscionable Bargain – A contractual provision so uneven it is considered unfair and unenforceable.
Section 34 CPC – Provides courts with discretion to grant reasonable interest after a decree.
Statutory Override – Doctrine which statutory provisions take precedence over private contracts.
The Proof
1. Statutory Background
Banking Regulation Act, 1949 – Section 21 gives the RBI the power to issue directions to banks in terms of interest rates and credit policy.
Indian Contract Act, 1872 – Permits parties to negotiate terms of interest but subjects them to public policy and statutory restrictions.
Usurious Loans Act, 1918 – Empowers courts to reduce excessive or unconscionable interest rates.
Civil Procedure Code, 1908 – Section 34 – Prescribes interest from date of decree until payment.
2. RBI Directives on Capitalisation of Interest
RBI circulars have historically allowed quarterly or longer intervals for agricultural advances and quarterly intervals for commercial advances.
An important provision: Interest by way of penalty is not to be capitalised; it shall be computed separately and recovered accordingly.
RBI has also ordered banks to make lending rates transparent to avoid exploitation of borrowers.
3. Judicial Conflict Pre-Ravindra
Corporation Bank v. D.S. Gowda (1994) – Permitted capitalisation as per banking practice and RBI guidelines.
State Bank of India v. Yasangi Venkateswara Rao (1999) – Held RBI instructions prevail over contrary contract stipulations.
Other High Courts have differed and struck down clauses of compounding as being unfair unless specifically agreed.
4. Supreme Court’s Resolution
The Court brought the law into harmony by establishing a three-prong test for legitimate capitalisation:
1. Authorisation under the contract.
2. Conformity with normal banking practice.
3. Fulfilment of RBI directions.
And it absolutely forbade penal interest capitalisation.
Illustrative Example
Loan of ₹1,00,000 at 12% p.a., rests quarterly, no default:
End of Q1: Interest = ₹3,000 → New principal = ₹1,03,000.
End of Q2: Interest = ₹3,090 → New principal = ₹1,06,090.
This is legal if sanctioned and RBI-compliant.
Loan of ₹1,00,000 at 12% + penalty interest of 2% for delay, quarterly rests:
Penalty interest ₹500 charged extra → Cannot be added to principal for subsequent interest calculation.
Case Laws
The ruling in Central Bank of India v. Ravindra & Ors. was not one in vacuum. It borrowed from, harmonized, and in certain respects deviated from previous judicial dicta on the character, computation, and jurisprudence tolerability of interest in India.
1. Bengal Nagpur Railway Co. Ltd. v. Ruttanji Ramji & Ors. [(1938) 66 IA 66] – The Privy Council made it clear that interest is a compensatory one and, absent provision by agreement or statute, cannot be granted for the period before the filing of a suit. This rule formed the basis for the distinction between pre-suit, pendente lite, and post-decree interest — a distinction reiterated in Ravindra.
2. State Bank of India v. Yasangi Venkateswara Rao [(1999) 2 SCC 375] – The Supreme Court in this case recognized the binding force of RBI directives on scheduled banks. In Ravindra, this rule was extended to the effect that even contractual terms conflicting with RBI instructions are displaced in favour of such instructions.
3. Syndicate Bank v. West Bengal Cements Ltd. [(1989) 4 SCC 69] – This had allowed capitalisation of interest where sanctioned by contract and in accordance with banking practice. Ravindra built upon this but added a bright-line ban on capitalising penal interest, one that Syndicate Bank had not explicitly dealt with.
4. Corporation Bank v. D.S. Gowda & Anr. [(1994) 5 SCC 213] – The Court emphasized that penal interest is an independent charge meant to penalize default and cannot be extended as part of the principal. This argument was indeed extended in Ravindra to support prohibiting its capitalisation.
5. Punjab & Sind Bank v. Allied Beverage Co. (P) Ltd. [AIR 2010 SC 3371] – After Ravindra, the Court substituted its principles for striking down exorbitant claims of interest where the method of compounding went against RBI requirements. This indicates the sustained precedential strength of Ravindra.
6. Canara Bank v. P.R.N. Upadhyaya [(1998) 6 SCC 526] – Though prior to Ravindra, it reaffirmed that conditions relating to interest in loan deeds are open to judicial consideration for being oppressive or unconscionable under Section 23 of the Indian Contract Act. Ravindra’s systematic test for capitalisation included this fairness test.
7. M/s. N.M. Veerappa v. Canara Bank [(1998) 2 SCC 317] – Accepted that interest compounding is legal but needs to be transparent and in accordance with contractual and regulatory requirements. Ravindra borrowed from this to create its three-condition rule.
8. State Bank of Travancore v. Mathew K.C. [(2018) 3 SCC 85] – A recent ruling reaffirming Ravindra’s principles, upholding that RBI circulars govern calculation of interest and override against contractual provisions.
These judgments collectively weave a consistent judicial thread:
Interest is generally compensatory, not punitive.
Its calculation is contractually based but governed in the public interest.
RBI directives are an overriding benchmark of fairness and transparency.
By bringing these threads together, Central Bank of India v. Ravindra & Ors. constituted the settled law on capitalisation of interest, penal interest, and the interplay between contract and regulation in Indian banking.
Conclusion
The Supreme Court’s decision in Central Bank of India v. Ravindra & Ors. is not merely a case about the calculation of interest, it is a foundation stone in the jurisprudence of banking law in India. By establishing a clear, organised method of capitalisation of interest and specifically disallowing the capitalisation of penal interest, the Court was able to reconcile two conflicting interests:
The business need of banks to maintain the time value of money and discourage defaults.
The legal and ethical responsibility to ban exploitative behaviour that might enslave borrowers in continuous debt traps.
This decision has three enduring contributions:
1. Regulatory Supremacy – It established the position of the Reserve Bank of India as the paramount authority for determining acceptable banking practices, bringing uniformity and certainty of interest calculation.
2. Doctrinal Clarity – It removed the doubts surrounding the law on pre-decree and post-decree interest by succinctly marking a clear line at the moment of judgment for giving discretion under Section 34 CPC.
3. Borrower Protection – By not permitting the compounding of penal interest, it barred the conversion of fines into a vehicle of surreptitious profit-making.
Even after two decades, Ravindra remains widely quoted in commercial suits, debt recovery suits, and arbitration matters relating to loan defaults. It is also used as a reference for financial regulators, legal academicians, and commercial contract drafters in crafting interest clauses in loan contracts. The ruling is a pragmatic balance ,acknowledging that although credit is the lifeblood of business, it needs to circulate under the scrutiny of regulators and the judiciary to avoid systemic exploitation.
FAQs
1. What is the main legal principle established in Central Bank of India v. Ravindra & Ors.?
The Court ruled that ordinary interest can be capitalized (i.e., added to principal) if provided for under the contract expressively, in accordance with usual banking practice, and keeping RBI guidelines in mind. Penal interest, which is a charge of default deterrence, can never be capitalized.
2. What impact does the judgment have on loan agreements?
All interest terms in loan agreements now have to be worded with RBI instructions in view. Even if the borrower agreed to a contract providing for a practice prohibited by RBI, such terms will be not enforceable.
3. What is the difference between normal interest and penal interest?
Normal interest is paid to the lender for the use of funds over time. Penal interest is a fee charged for delay or default in payment. The former can be capitalized under circumstances; the latter cannot.
4. Will banks still be able to charge compound interest following this ruling?
Yes, compound interest (interest on interest) on ordinary interest is allowed to be charged by banks if the agreement allows it, banking practice allows it, and it is in line with RBI norms. But periodicity of compounding has to follow the rest periods as stipulated by RBI.
5. Is there any effect of this case on post-decree interest?
Yes. Once a money decree is passed by a court, post-decree interest is controlled under Section 34 CPC, under which the court may fix a reasonable rate regardless of the rate in the contract prior to judgment.
6. Why was penal interest capitalisation barred?
Because penal interest is meant purely as a punishment to discourage default — it is not a return on capital. Compounding it would transform a penalty into an income-generating device, which is both inequitable and contrary to public policy.
7. How is this ruling applied in the case of modern banking disputes?
Debt Recovery Tribunals (DRTs), commercial courts, and arbitration panels often refer to Ravindra when borrowers object to usurious interest charges, particularly where banks seek to add penal interest to principal or compound it.
8. Does the judgment extend to scheduled banks?
Primarily, yes — as it cites RBI directives binding scheduled banks under the Banking Regulation Act. But its rationale has been extended analogously to other lending intermediaries, such as some NBFCs, where fairness in the computation of interest is involved.
9. What can borrowers learn from this judgment?
Borrowers must note that even though contractual interest is enforceable, it needs to comply with RBI guidelines and should not comprise capitalised penalties. They have the right to challenge interest claims that violate these rules legally.
10. Has the principle in Ravindra ever been altered by subsequent cases?
The essential principles stand. Subsequent cases such as State Bank of Travancore v. Mathew K.C. and Punjab & Sind Bank v. Allied Beverage Co. have reaffirmed it, extending its rationale to strike down unjust or compliant interest claims.
