A very interesting point has been brought up.
City could in theory loan players to teams who aren't a direct threat to them that would improve such teams unless playing City (using City as an example due to having a squad of about 50 internationals!!).
For example, they could loan say Adam Johnson to a Sunderland type club. AJ playing for Sunderland would improve them and give them a greater chance of taking points off Arsenal, Chelsea, Spurs, United etc. Yet when City play them, AJ couldn't play making Sunderland slightly easier to beat for City.
You could say there is room here for the current system to be abused.
I personally don't believe you should be able to loan players to clubs in the same league as you (even though my club has done this also).