The standard practice of a bank grading a loan for risk at the time of origination may obstruct the equally routine banking practice of imposing higher rates of interest following a loan default, following a ruling by the District Court of New South Wales on Friday.In a decision bound to reverberate, Judge Phillip Mahony resolved that Arab Bank Australia Ltd must refund around A$250,000 in additional interest charges imposed following the default (in the sense of late periodic payments) on a $7 million commercial loan to a concreting contractor in south-west Sydney. The borrower used the loan in part to fund a multi-unit development in Liverpool.At the time it was made in the mid 2000s this was a considerable business loan for Arab Bank, representing one eighth of its entire commercial loan book."At the time the facility was entered into, the imposition of the default interest rate on the whole amount of the principal outstanding was not a genuine pre-estimate of the cost to the defendant, emanating from the breach," Mahony wrote in his judgment.He ruled that this "led to an extravagant return to ABAL by comparison to the greatest loss from that breach, and therefore constitutes a penalty."Sayde Developments Pty Ltd first took out the contested loan with Arab Bank in 2006, refinancing the facility in 2011.A tussle of the evidence of experts helped decide the case, with the District Court judge finding the analysis of John Fairley for the plaintiffs the most persuasive. Fairley is executive chair of finance broker CrediFlex Finance. He gained his industry experience at ANZ and Esanda.Judge Mahony explained in his judgment that the experts agreed that "in the event of a major default, such as the failure to make a payment due more than 90 days after the due date, the uplift in interest payable of two percentage points would not constitute a penalty."?He wrote that "where the experts differed in their opinions was in relation to what was referred to as 'a minor breach', such as a non-payment between one day and 90 days past the due date."Fairley reasoned that because the costs of managing the loan was built into the interest rate, determined by ABAL at the time of inception of the loan, having regard to its own risk assessment grading, it was not a pre-estimate of the cost to ABAL of the breach by the borrower, and therefore was a penalty."The judge continued that "the evidence established that the bank, before offering the facility, assessed the risk involved in making the loan and graded that risk according to its own assessment. "That impacted directly on the interest rate offered on the facility. "What was clear, was that whilst not a large bank, the defendant employed a recoveries manager and had other resources to manage loans without incurring significant additional costs, where only minor default occurred. "As the experts agreed, significant other costs were incurred once a major default event occurred, which was not the case here."The judge also pointed out