Why Banking is Not Treated as Usury and How RBI Can (in Legal Sense) Ensure that Micro-Finance is Also Not Treated As Usury in India?

Ramesh S Arunachalam

Rural Finance Practitioner

Recently, a good friend of mine, who is also a senior and respected colleague in the Indian micro-finance sector, asked me, how can we ensure that micro-finance is not treated as usury? Something he further said made me very curious – when banking does not attract this usury argument, why should micro-finance, which also uses predominantly bank funds (under PSL), be treated as usury?

I was determined to understand why and here is what I found in my research trail…as compiled from various sources and court judgments...

Banking is subject to the exclusive legislative competence of the Union. Entry 45, List I reads thus,

 “45. Banking”

a)      In earlier times, 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, which read as follows,

“3. Re-opening of transaction. –

(1)   Notwithstanding anything in the Usury Laws Repeal Act, 1855 (28 of 1855), where, in any suit to which this Act applies, whether heard ex parte or otherwise, the Court has reason to believe,

(a)   that the interest is excessive; and

(b)   that the transaction was, as between the parties thereto substantially unfair,

the Court may exercise all or any of the following powers, namely may,-

                                                               i.      re-open the transaction, take an account between the parties and relieve the debtor of all liability in respect of any excessive interest;

                                                             ii.      notwithstanding any agreement, purporting to close previous dealings and to create a new obligation, re-open any account already taken between them and relieve the debtor of all liability in respect of any – excessive interest, and if anything has been paid or allowed in account or in respect of such liability, order the creditor to repay any sum which it considers to be repayable in respect thereof;

                                                            iii.      set aside either wholly or in part or revise or alter any security given or agreement made in respect of any loan, and if the creditor has parted with the security, order him to indemnify the debtor in such manner and to such extent as it may deem just:

Provided that, in the exercise of these powers, the Court shall not

a.      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 than twelve years from the date of the transaction;

b.      do anything which affects any decree of a Court.

Explanation: In the case of a suit brought on a series of transactions the expression "the transaction" means, for the purposes of proviso (i), the first of such transactions.

b)      There are a number of cases where the Usurious Loans Act has been used by courts to examine loans that were unfair or excessive and relieve the debtor of liability [See, for example, Dayawati AIR 1966 SC 1423, Srinivasa Vardachariar AIR 1967 SC 412 and C. T. George AIR 1975 Ker 169].

c)      However, in 1984, The Indian 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 reads as follows,

“21-A. Rates of interest charged by banking companies not to be subject to scrutiny by courts. – 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 reopened by any Court on the ground that the rate of interest charged by the banking company in respect of such transaction is excessive.”

d)      Section 21A of the Banking Regulation Act overrides Section 3 of the Usurious Loans and, therefore, courts can no longer reopen usurious loan transactions [See, Section 3 of the Usurious Loans Act; and, Yasangi Venkateshwara Rao (1999) 2 SCC 375, N. M. Veerappa (1998) 2 SCC 317, Koramsetty Venkateswarlu AIR 1986 AP 290 and Advath Sakru AIR 1994 AP 170].

Now what can be done with regard to Micro-finance?

I am no legal expert and therefore, I would caution you in using the following information…Nonetheless, to the best of my knowledge, it seems that, in the absence of any directive by the Government of India, here is what could be done by The RBI to ensure that the aspect of usury does not affect micro-finance transactions...in their day to day operations…Read On…

e)      In the absence relevant Union directive, 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. That is clear for all of us…

f)        In exercising its regulatory powers, the RBI may issue circulars or directions to banks which the latter are bound to comply with [See, Sections 21(3) and 35A(1) of the Banking Regulation Act; and, Canara Bank (1998) 6 SCC 526 and Central Bank of India (2002) 1 SCC 367].

g)      The circulars of the RBI under sections 21 and 35A of the Banking Regulation Act are of statutory effect [See, Canara Bank (1998) 6 SCC 526 and Central Bank of India (2002) 1 SCC 367].

h)      In the exercise of its regulatory/statutory powers, the RBI can thus specify that all loans provided to low income people (through various direct and intermediate channels and using PSL funds) are indeed ‘Banking’ transactions. This will prevent usury laws from being used against loans to low income people. Thus, all loans to Low Income People, irrespective of intermediary will become equivalent of ‘Banking Transactions’ and therefore, not attract same treatment under the usury laws…

I hope the relevant authorities examine this matter and take suitable action to help safeguard micro-finance from the usury laws…as they are and should be in the realm of banking…without questions, that is where micro-finance belongs...