Broadly, agricultural credit in India is advanced by banks and money-lenders. A brief overview of the legal regimes that govern each of these activities is necessary.

The legislative competence of the Union and the States is divided subjectwise 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 (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 (‘Concurrent List’). By virtue of Entry 30 of List II, money-lending is within the exclusive legislative competence of the States.

That pernicious practices, such as money-lending, are not constitutionally protected as a trade under the Constitution, was laid down by the Supreme Court in Fatehchand Himmatlal (1977) 2 SCC 670, while dealing with a constitutional challenge to the Maharashtra Debt Relief Act, 1976. 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. Money lending may be ancillary to commercial activity and benignant in its effect, but money lending may also be ghastly when it facilitates no flow of trade, no movement of commerce, no promotion of intercourse, no servicing of business, but merely stagnates rural economy, strangulates the borrowing community and turns malignant in its repercussions. The former may surely be trade but the latter – the law may well say – is not trade. In this view, we are more inclined to the view that this narrow, deleterious pattern of money lending cannot be classed as ‘trade’. No other question then arises, since the petitioners and appellants cannot summon Article 301 to their service.”

Clearly, it is open for States to enact legislation to regulate money-lending.

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 transactions¹

For a State to claim competency to enact legislation about banking transactions, 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 banking.² However, States may competently legislate on rural indebtedness to the exception of banks to provide debtors suitable relief.

In the absence 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 sections 21(3) and 35A(1) of the Banking Regulation Act. In the exercise of its regulatory powers, the RBI can even specify maximum limits for interest rates and other aspects of agricultural loans. ³

From the above discussion, it is clear that in order to fulfil the objects of the scheme of constitutional protection, the States’ power to legislate in relief of rural indebtedness must 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.