Corporate and Economic Laws · Investment and Loans

Section 186: Interest Rate, Board Approval and Loan Conditions

Updated 11 October 2026 · Fact-checked

Under Section 186, a company cannot give a loan at an interest rate below the prevailing yield of the one, three, five or ten year Government Security closest to the loan tenor. The Board must sanction the loan at a meeting with consent of all directors present. Prior approval of a public financial institution is needed where a term loan subsists, unless the exception applies.

Understand Rate of Interest, Board Approval and Conditions for Loans

Section 186 controls how a company lends and invests. Besides the monetary limits, it sets conditions on how each loan is made. This topic covers three of them: the minimum interest rate, the Board's approval, and the lender's approval.

Minimum interest rate (sub-section 7). No loan under this section can be given at a rate lower than the prevailing yield of the one year, three year, five year or ten year Government Security closest to the tenor of the loan. So you first find the tenor of the loan. Then you pick the Government Security yield for the nearest tenor. That yield is your floor. The text says "loan" only. It does not set a rate floor for guarantees, security or investments.

Board approval (sub-section 5). No investment, loan, guarantee or security can be given unless the resolution sanctioning it is passed at a meeting of the Board with the consent of all the directors present at the meeting. The word is "present". You do not need every director on the Board. You need every director who attends to consent. One dissent from a director present means the resolution fails. The section requires a meeting, so a resolution by circulation does not satisfy it.

Prior approval of public financial institution (sub-section 5 proviso). Where a term loan from a public financial institution is subsisting, its prior approval is needed. That approval is not required if two things hold together. First, the aggregate of loans, investments, guarantees and security (existing plus proposed) does not exceed the limit in sub-section (2). Second, there is no default in repayment of loan instalments or payment of interest to that institution.

Related conditions. A company in default in repayment of deposits, or interest on them, cannot give any loan, guarantee or security or make an acquisition while the default continues (sub-section 8). The sub-section (2) limit is 60% of paid-up share capital, free reserves and securities premium, or 100% of free reserves and securities premium, whichever is more. If the limit is crossed, a special resolution in a general meeting is needed (sub-section 3). That requirement does not apply to a loan, guarantee or security given to a wholly owned subsidiary or joint venture company, or to an acquisition of securities of a wholly owned subsidiary by its holding company. Note that this exemption is from the special resolution requirement only. The text does not exempt such a loan from the interest rate floor in sub-section (7) or from the Board consent rule in sub-section (5). Treat those as still applicable.

Key rules to remember

Minimum interest rate (S.186(7)): Rate of interest ≥ prevailing yield of the 1, 3, 5 or 10 year Government Security closest to the tenor of the loan; Applies to loans. Choose the Government Security whose tenor is closest to the loan's tenor.
Board approval (S.186(5)): Board meeting + consent of ALL directors present; Unanimity of those present, not of the whole Board. Passed at a meeting.
Prior approval of public financial institution: Needed if a term loan subsists, unless (aggregate loans, investments, guarantees and security including proposed ≤ S.186(2) limit) AND (no default in instalments or interest); Both exception conditions must be met together.
S.186(2) limit: Higher of: 60% × (paid-up share capital + free reserves + securities premium) OR 100% × (free reserves + securities premium); Above this limit, a special resolution in a general meeting is needed under S.186(3).
Default bar (S.186(8)): Default in repayment of deposits or interest thereon → no loan, guarantee, security or acquisition while default subsists; Applies until the default is cured.

How to solve Rate of Interest, Board Approval and Conditions for Loans questions

Use the same checklist for any question on conditions for a loan under Section 186. Go through the conditions in order and state the result of each.

1Identify what is being done: a loan, guarantee, security or investment. The interest rate floor applies to loans only.
2Check the default bar: is the company in default in repayment of deposits or interest on them? If yes, it cannot lend or give guarantee or security until the default ends.
3Compute the S.186(2) limit using the higher of the two tests. Add existing loans, investments, guarantees and security to the proposed amount and compare.
4If the aggregate exceeds the limit, a special resolution in a general meeting is needed. Check whether the recipient is a wholly owned subsidiary or joint venture company, which removes only this requirement.
5Check the rate of interest against the Government Security yield closest to the loan tenor. If the rate is lower, the loan is not permitted.
6Check the Board resolution: passed at a meeting, with consent of all directors present. Test for any dissent.
7Check for a subsisting term loan from a public financial institution. If it exists, prior approval is needed unless the limit is not exceeded and there is no default.
8Conclude clearly: permitted, or not permitted and which condition fails. Add the penalty only if asked.

Quickest way: Four-gate check for a loan

When to use it: Use this for MCQs and short case scenarios where you must decide quickly whether a loan is valid.

Gate 1, rate: is the interest at or above the nearest Government Security yield?
Gate 2, Board: did all directors present consent at a meeting?
Gate 3, lender: is there a subsisting term loan from a public financial institution? If yes, was prior approval taken, or do both exception conditions hold?
Gate 4, limit and default: is the aggregate within the S.186(2) limit (or is a special resolution passed), and is there no deposit default?
If any gate fails, the loan is not valid as given. Name the failed gate in your answer.

Common mistakes in Rate of Interest, Board Approval and Conditions for Loans

Saying the Board resolution needs consent of all directors of the company.
Students read "all directors" and forget the words "present at the meeting".
Fix: Write "all the directors present at the meeting". Absent directors do not affect the resolution.
Applying the Government Security yield test to investments and guarantees.
Students treat the whole section as one rule for all four kinds of transactions.
Fix: Sub-section (7) speaks of loans only. Apply the floor only when the question involves a loan.
Believing a loan to a wholly owned subsidiary is exempt from every condition.
The proviso to sub-section (3) is remembered as a general exemption.
Fix: It removes only the special resolution requirement of sub-section (3). Do not assume exemption from the rate floor or Board consent unless a provision in the question says so.
Saying prior approval of the public financial institution is always required.
Students skip the proviso to sub-section (5).
Fix: State the exception: no approval where the aggregate is within the sub-section (2) limit and there is no default in instalments or interest. Both conditions must be met.
Using a circular resolution to approve a loan.
Circulation is a common way to pass Board decisions, so students assume it works here.
Fix: The section requires a resolution passed at a meeting of the Board. Mention this when the facts show circulation.
Picking the lowest Government Security yield instead of the closest tenor.
Students look for the cheapest benchmark.
Fix: Match the loan tenor to the nearest of the one, three, five or ten year securities and use that yield.

Worked examples

Example 1

Mehta Textiles Ltd proposes a 5 year loan of ₹40,00,000 to Sharma Traders Pvt Ltd at 6.5% per annum. The prevailing yield of the 5 year Government Security is 7.1%. All directors present at the Board meeting consented. Can the loan be given?

Show the solution

The transaction is a loan, so the sub-section (7) rate floor applies.
The loan tenor is 5 years. The closest Government Security is the 5 year one, with a yield of 7.1%.
The proposed rate is 6.5%, which is lower than 7.1%.
Board consent is satisfactory, because all directors present consented at a meeting. But this does not cure the rate defect.

Answer: The loan cannot be given at 6.5%. The rate must be at least 7.1%, the yield of the 5 year Government Security. Board consent alone is not enough.

Example 2

Kapoor Industries Ltd has a term loan subsisting from a public financial institution and is not in default of any instalment or interest. Its paid-up share capital is ₹50,00,000 and free reserves plus securities premium are ₹30,00,000. It has no earlier loans, guarantees, security or investments. It proposes a loan of ₹45,00,000 to an unrelated company at an adequate interest rate. Of 7 directors, 5 attended the Board meeting and all 5 consented. What approvals are needed?

Show the solution

Compute the limit. 60% of (50,00,000 + 30,00,000) = 60% of 80,00,000 = ₹48,00,000.
100% of free reserves and securities premium = ₹30,00,000.
The higher is ₹48,00,000, so the sub-section (2) limit is ₹48,00,000.
Aggregate including the proposed loan is ₹45,00,000, which is within ₹48,00,000. So no special resolution is required.
Board approval: all 5 directors present consented at a meeting, so sub-section (5) is satisfied. The absence of 2 directors does not matter.
Public financial institution: a term loan subsists, but the aggregate is within the limit and there is no default. So prior approval is not required.

Answer: The loan is within the limit of ₹48,00,000. It needs only the Board resolution passed at a meeting with consent of all directors present. No special resolution and no prior approval of the public financial institution are needed.

Exam tips

In case scenarios, the facts are often planted: a dissenting director, a circular resolution, a rate below yield, or a deposit default. Scan for each.
Always show the limit computation with both tests and pick the higher. Marks are given for the working.
Use the exact phrases "all the directors present at the meeting" and "closest to the tenor of the loan".
For the lender approval rule, always state both exception conditions. Missing one costs marks.
If a question involves a wholly owned subsidiary, say the exemption removes the special resolution requirement only, and then deal with the other conditions.

Practice questions from Investment and Loans

Rate of Interest, Board Approval and Conditions for Loans: frequently asked questions

What is the minimum interest rate on a loan under Section 186?

Sub-section (7) says no loan can be given at a rate lower than the prevailing yield of the one, three, five or ten year Government Security closest to the tenor of the loan. Find the tenor, match the nearest security, and use its yield as the floor.

Do all directors of the company have to approve a loan?

No. The resolution must be passed at a Board meeting with the consent of all the directors present at that meeting. Directors who are absent are not counted. If any director present dissents, the resolution cannot be passed.

Is a loan to a wholly owned subsidiary exempt from Section 186?

Only partly. The proviso to sub-section (3) says the special resolution requirement does not apply to a loan, guarantee or security given to a wholly owned subsidiary or joint venture company. The disclosure in the financial statement is still required. Do not claim a wider exemption without a provision that says so.

When is prior approval of a public financial institution needed?

It is needed where a term loan from the institution is subsisting. It is not needed if the aggregate of loans, investments, guarantees and security, including the proposed one, is within the sub-section (2) limit and there is no default in instalments or interest.