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Introduction
The Harshad Mehta Scam, also known as the Securities Scam of 1992, was one of the most significant financial scandals in India. It was orchestrated by Harshad Mehta, a well-known stockbroker at the time. The scam primarily involved the manipulation of the stock market through a technique known as “circular trading” and the misuse of banking funds.
Highlights of Harshad Mehta Scam
The key instruments used in the great scam were stamp papers, bank receipts, ready-forward deals, and higher interest rates. Sucheta Dalal exposed Mehta’s crimes and involvement in the columns of the Times of India in 1992 after taking keen interest in his overly luxurious lifestyle. As valued in 2019, the Harshad Mehta scam had swindled nearly Rs. 250 Billion from the banking system. The effects of the scam, while not persisting directly, still affect the conservative investors’ mindsets. Ketan Parekh, an associate working under Mehta, would later go on to reanimate a similar crime in the stock market in 2008 and be convicted for his involvement in market manipulation in 1992.
How did stockbrokers come into the picture?
Stockbrokers needed funds to finance their stock market trades. These brokers took up proprietary positions in stocks, or were financiers for vyaj badla trades.
Many of them were also brokers in the money market, where corporate bonds and government securities were traded.
What is vyaj badla?
Back in the 80s, stock market trades were settled once in two weeks. But buyers had the option to roll over their position to the next settlement cycle, if they could find somebody to finance it. The financier would charge an interest, which was higher than the rates in the bond markets, as well as the deposit rates offered by banks. Many big brokers were badla financiers as well.
Also, Read SCAM OF KETAN PAREKH
And when they were not financing other traders, the brokers would need funds to roll over their positions, if the market was in an uptrend.
So brokers found it profitable to access funds from the banking system and use it for their stock market operations. They found a loophole in the banking system that was there for everyone to see. They exploited it to the hilt. This was to do with banks’ trading in debt securities.
Why did banks trade in securities?
For two reasons. One is to meet the RBI regulations of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). CRR, as the term implies, requires banks to park a certain portion of their deposits with the RBI at zero interest. For SLR, banks had to park a certain portion of their deposits in government securities and other approved securities.
The second reason was to boost their profits, which were quite low at that time.
Here is a brief overview of the key elements of the Harshad Mehta Scam:
- Harshad Mehta was a Bombay-based stockbroker who gained fame and success in the late 1980s and early 1990s.
- He exploited loopholes in the banking system to manipulate the stock market and inflate the prices of certain stocks.
Mehta engaged in a practice known as “circular trading,” where he and his associates traded securities among themselves to artificially inflate the trading volumes and prices of those stocks.
Mehta used a financial instrument called “Ready Forward” (RF) to borrow funds from banks by using securities as collateral. He then invested these funds in the stock market to drive up prices.
- Mehta allegedly colluded with bank officials and manipulated the banking system to access large sums of money.
- He used bribes to ensure that the banks did not scrutinize the sources of funds too closely.
The scam came to light in 1992 when journalist Sucheta Dalal and her husband Debashis Basu published a series of articles in “The Times of India” exposing irregularities in the securities market.
- The revelation of the scam led to a significant stock market crash, causing losses for investors and financial institutions.
- Harshad Mehta and several others involved in the scam were arrested and faced legal consequences.
The Harshad Mehta Scam prompted regulatory and systemic reforms in the Indian financial sector, including changes in stock market regulations, banking practices, and the establishment of the Securities and Exchange Board of India (SEBI) to oversee and regulate the securities market.