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Mountain of NPAs? Blame it on inter-corporate loans

Along with restricting inter-corporate loans, the government should also put an end to the practice of omnibus objects clauses

October 31, 2019 / 02:34 PM IST

S Murlidharan  

The struggle of Indian banks with bad loans is well documented. But scratch the surface. You will realise that it’s the liberal inter-corporate loan regime that could be the real culprit – though unwittingly.

According to the Section 186 of the Companies Act, 2013, a company cannot provide loans, guarantee or security to any other body corporate exceeding 60 per cent of its paid-up share capital, free reserves and security premium account, or 100 per cent of its free reserves and security premium account, whichever is more.

This unbelievably liberal regime tantalizes crooked promoters to siphon off funds through a complex network of shell companies often holed up in tax havens such as the Cayman Islands and Panama.

Dewan Housing Finance Ltd, for instance, is alleged to have diverted at least Rs 20,000 crore through such ‘box companies’, as this Moneylife article said. DHFL has denied such allegations as mischievous.


To be sure, Parliament had noble motives in mind while putting in place a liberal regime which allowed companies to start stand-alone subsidiaries or associates which will not blotch the balance sheet of the parent. This, of course, happened in a milieu when consolidated accounts was not mandated. Companies are well aware that creation of subsidiaries is the quickest way to get off the ground. A long gestation, inevitable for many industries and manufacturing, can have an adverse impact on the parent company’s balance sheet.

Still, mandatory consolidation of accounts has to a degree robbed companies of this advantage. The plain truth is the good intentions of Parliament and the generous limits for inter-corporate loans have come to be abused by the unscrupulous promoters.

More often than not, corporate frauds or failures owe their origin to a subsidiary storyline and the abuse of the inter-corporate loan regime. The grounded Kingfisher Airlines and Jet Airways illustrate the point in ample measure.

In fact, many a time, one is left wondering whether a manufacturing company is actually a manufacturer or an investment firm as its balance sheet shows less of fixed assets and more of inter-corporate loans and advances. Of course, the government has taken a small step in arresting the tendency to create labyrinthine maze of subsidiaries. Under the Companies Act, 2013, companies can have only two layers of subsidiaries. But it is a prospective measure so much so that the subsidiaries created in the era prior to this clampdown thrive and cause serious damage to our economy, particularly banks who are often the victims of diversion of funds through inter-corporate loans. Furthermore, crooked promoters grant loans to closely-held companies that are not their companies’ subsidiaries.  It is this gumption too that needs to be challenged and stopped.

Apart from the liberal inter-corporate loan regime, allowing companies to have an omnibus objects clause in their memoranda of association is also responsible for the diversion of funds.  Using this clause, companies arm themselves to do virtually all businesses under the sun. This becomes a plausible alibi for granting liberal loans to subsidiaries and associates. Therefore, along with restricting inter-corporate loans, the government should also put an end to the practice of omnibus objects clauses.

Common shareholders and retail investors are invariably the victims of such acts by the promoters. If a company has excess funds or profits, these are better returned to shareholders as dividends. Banks too are victims of illegal funds diversion by promoters. The sick-companies-rich-promoter syndrome is not an exaggeration in the Indian context.

Yes, the standard clause in loan agreements put in place by financial institutions and banks requiring their consent before any inter-corporate loans are advanced. But that has not really helped matters. In fact, almost all cases of diversion of bank loans have happened despite this seemingly solemn standard clause in the loan agreement.

(S Murlidharan is a chartered accountant and columnist. Views are personal.)
first published: Oct 31, 2019 02:27 pm

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