The 1992 Indian stock market scam was a stock market scam orchestrated by Harshad Mehta. The scam took place in Mumbai and was the biggest market scam of India.
Background
The 1992 scam was the biggest stock market scam ever committed in the Indian Stock Market. The main perpetrator of the scam was a well known stock broker Harshad Mehta. The 1992 scam was a systematic stock fraud using bank receipts and stamp paper which caused the Indian Stock market to crash. The scam lead to a complete structural change of the security system of India and introduced a completely new system of stock transactions. The 1992 scam exposed the Indian financial systems through the inherent loopholes of the system. This scam led to the reform of the security system of India and introduced online security systems. Securities scam refers to the idea of diversion of funds from the banking system to various stockholders or brokers. The 1992 scam in the security system of India was a systematic fraud committed by Harshad Mehta in the Indian stock market which made the entire securities system collapse. Mehta allegedly committed a fraud of over 1000 crores from the banking system of India to buy stocks on the Bombay Stock Exchange. The scam impacted the entire exchange system as the securities system collapsed and investors lost thousands of rupees in the exchange system. The scope of the scam was so large that the net value of the stocks was higher than the health budget and education budget of India. The scam was orchestrated in such a way that Mehta secured securities from the State Bank of India against forged cheques signed by corrupt officials and failed to deliver the securities. Mehta made the prices of the stocks soar high through fictitious practices and would go on to sell the stocks that he owned in these companies. The impact of the scam had many consequences which included the loss of money to lakhs of families but more importantly the immediate impact of the scam was a sharp fall in the share prices. The index fell from 4500 to 2500 representing a loss of Rs. 100,000 crores in market capitalization. This rapid fall was the largest the stock market had ever seen. The 1992 scam raises many questions which involved many bank officials responsible for collusion with Mehta. In an interview with Montek Singh Ahluwalia, he said that there was involvement of many top bank officials. The scam caused the entire stock market of India to collapse. This table illustrates the extent of money certain banks lost.
During the 1990-1992 period, India was not involved in the equity markets. Mehta looked at the equity markets and interest rates as a loophole to finance his share market holdings. Mehta promised banks higher interest rates and used the money from the banks to put into his stock shares. After carefully squeezing capital out of the banking system, Mehta used the same approach with several different banks where he invested in bubble stocks that lost value by over 95 percent. The scam came to light in 2001 as odd numbers in the equity market were discovered. Ketan Parekh was ordering uncontrolled overtrading in the equity market when these numbers were discovered. The case of Ketan Parekh led to the discovery of the illicit equity market approach used by Mehta.
Ready forward deal scam
The Ready Forward Deal scam is a way in which there exists a broker between two banks. When one bank wants to sell securities, it approaches a broker. This broker goes to another bank and tries to sell the securities and vice versa for buying. Since Mehta was a very renowned broker, he got cheques issued in his name instead of the bank. When the bank that wanted the money for the securities, he approached another bank and repeated the same process while using Bank Money in the stock market. Mehta used the ready forward deal and applied it to the Bank Receipts system of the Indian financial systems. This system was the most flawed system as the Janakiraman Committee restructured the entire Bank Receipts system after the 1992 scam.
Bank receipt scam
The bank receipt scam is a ready forward deal of securities. The Bank Receipt confirms the sale of securities. The receipt acts as a receipt for the money received by the selling bank. Through the bank receipt, the bank promises securities. The seller holds the securities in trust for the buyer according to principal. Mehta perfected the art of using fake BRs to obtain unsecured loans from the banking system. He persuaded some small and little known banks - the Bank of Karad and the Metropolitan Cooperative Bank - to issue BRs as and when required. Since these banks were small, Mehta held on to the receipts as long as he wanted. The cheques in favour of both the banks were credited into the brokers' accounts which was the account of Mehta. As a result, banks made heavy investments into BOK and MCB as they showed positive signs of growth. Using the BR scam, Mehta took the price of ACC from Rs 200 to Rs 9000 in a short span of time. This 4400% percent increase was seen in several other stocks and as he sold the stocks, the market crashed.
The Impact of the 1992 scam
The immediate impact of the scam was a fall in share prices and the biggest plunge in the index the market had ever seen. The scam cause the breakdown of the control system both within the commercial banks as well as the fundamental system of the RBI. The scam opened the inherent issues within the security system of India. The scam just resulted in withdrawal of about Rs. 3,500 crore from the market, which for a market of the size of Rs. 250,000 crore which seems to be a small amount in terms of the market price, however, the scam resulted in a majority collapse of many stock market shares. This was due to the fact that the BSE resorted to tampering within the records in the trading system. The majority Indian stock market is based on emotions rather than quantitative analysis and as the scam came to light, many investors withdrew their capital from the market. This caused a demand and supply collapse of the prices and quantity which caused the entire system to be affected due to the 1992 scam. As the scam came to light, many banks were impacted as the news of the scam spread through the financial markets around the world. Several foreign banks like Standard Chartered and ANZ Grindlays, were implicated in the scam. Standard chartered was accused of the bank receipt scam as they issued receipts to Mehta while ANZ Grindlays was accused of pumping money into Mehta's personal account. Therefore, the private sector was the main participant in the market for the Bank Receipts Scam. The government realized that the fundamental problem with the financial structure of the stock markets was the lack of computerized systems which impacted the whole stock market.
Impact on the criminal system
The 1992 scam caused an investigation through which many officials were implicated in fraudulent charges. The five main accused officials were related to the Financial Fairgrowth Services Limited and Andhra Bank Financial Services Ltd. The chairman of Vijaya Bank committed suicide following the outbreak of news about the bank receipt scam. The scam also led to the resignation of P. Chidambaram who was accused of owning shell companies related to Mehta. Mehta was convicted by the Bombay High Court and the Supreme Court of India for his part in this financial scandal valued at Rs. 49.99 billion. There were many arrests that were made which exposed several bank officials and led to complete breakdown on many banking systems
Reform in the security system of India after the 1992 scam
The security system of India took a rapid reform in its fundamental structure post the 1992 scam. The first major structural change was the formation of the National Stock Exchange of India. The first major reform in the financial sector of India was the formation of CII Code for Desirable Corporate Governance developed by Rahul Bajaj. The formation of this code paved way for two major committees headed by Kumar Mangalam Birla and N. R. Narayana Murthy which was overlooked by the Securities and Exchange Board of India. These committees were formed to look after corporate governance as the 1992 scam was based on the principles of corporate governance. Post 1992, a new regulatory board known as the Securities and Exchange Board of India was formed to monitor the National Stock Exchange and the National Securities Depository. There were structural changes in the equity market. The government introduced ten acts of parliament and one constitutional amendment based upon the principles of economic reform and legislative change for the equity market. The NSE introduced online trading in 1994 which changed the dynamics of stock buying and selling. The capital market now opened up nationally as opposed to being confined in Mumbai. The exchange system started functioning based on satellite communications that abolished geographical barriers.
Changes in the financial structure of India
The 1992 scam saw the Indian Market collapse completely as the stock prices dropped by almost 40% wiping out market value by Rs 1,00,000 Crores. The Indian Financial system saw a complete restructuring of the fundamental systems. The first structural change that was enforced was the payments for purchase of investments for which Subsidiary General Ledgers and Bank Receipts were recorded so as to prevent any defaulted paperwork. A new committee was formed within the financial systems to overlook the Securities and Exchange Board of India through the decision of the Janakiraman Committee. The committee ordered that the long standing practice of banks entering in to ”ready forward” and “double ready forward” deals with other banks be restricted under the guidelines of the Reserve Bank of India to only government securities. The committee made changes to the idea of custodian banks by making all banks custodians rather than principals in transactions. The banks were ordered to have a separate audit system for portfolio management of the banks whose adequacy was monitored by the RBI. The RBI was given more power and their scope in the financial markets increased. The entire stock system restructured to prevent any other scams.
