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How investment climate has changed after Harshad Mehta scam broke in 1992

Confidence in the Indian ecosystem has grown by leaps and bounds and we now have the Investor Protection Fund to meet the legitimate investment claims.

October 10, 2020 / 11:12 AM IST

Pritam Deuskar

Harshad Mehta was acting as a broker in Ready Forward Deals (RFD) and managed to get money from banks and used it for stock market purchases. He is said to have artificially manipulated stock prices using bank money. Certain shares skyrocketed in a short time. There were also effects of liberalisation, which had just taken off.

On 29 February 1992, the Sensex surged past 3,000. On 30 March, it crossed the 4,000-level to close at 4,091 and in May, it made another peak. But by January 1993, it had crashed to 2,200.

The RBI Janakiraman Investigation Committee put the scam size at a staggering Rs 4,025 crore. Mehta was charged with 72 criminal offences and many action suits. The impact on the market was much bigger.

There was a market capitalisation loss of Rs 1 lakh crore. Mehta took advantage of a loophole and also used bank receipts, which were not backed by enough government securities, with two banks involved. Some bankers were convicted and the chairman of a bank died by suicide.

Close

As per the RBI mandate at that time, the minimum threshold of government securities/bonds holdings that banks needed to keep was about 38 percent (what we call today as SLR statutory liquidity ratio).

At that time banks were not permitted to trade in the stock market. So if some banks were falling short of government securities, then RFDs were allowed. Using RFDs, a bank could take short-term loans from another bank with government bonds as collateral. So instead of transferring actual bonds, bank receipts were created for such transactions.

The tenure was 15 days and the difference in prices would make up the interest charge. Brokers played intermediaries in these transactions and Harshad Mehta was one such broker.

Brokers ensured that the banks would not know other dealing parties until an agreement was made and availability of liquidity ensured. Money was transferred to him and Mehta utilised this temporary money to buy stocks. Some well-known stocks skyrocketed in a short period, eg ACC price went from Rs 200 to Rs 9,000.

Also, through forgery bank receipts were created without the collateral of government bonds. This was a scam inside a scam. On April 23, 1992, journalist Sucheta Dalal exposed the scam in a column in Times of India. The market started tanking with a huge fall in share prices. Many brokers and shareholders were hit.

A new film, The Big Bull, starring Abhishek Bacchan and produced by Ajay Devgan is also being talked about and is said to be loosely based on this storyline. SonyLiv has already released the series Scam 1992 The Harshad Mehta Story, which has been directed by national award-winning filmmaker Hansal Mehta.

Every such event acts as a catalyst to reforms, policy changes and strengthening of rules and regulations. India's financial markets were quite unorganised in those times. We have come a long way today, with computerisation, clusters and financial instruments.

Confidences in the Indian ecosystem from FII and investors have grown by leaps and bounds. Public interest is put first in such regulations. We have now the Investor Protection Fund to meet the legitimate investment claims.

Orders and transactions happen with transparency and efficiency. We have evolved for much better. Since 1992, India has changed drastically but for the good. Income tax above 1 lakh was 40 percent at that time. The corporate tax rate in 1994 was 40 percent, which is 25 percent today and is moving well towards the global rate.

This makes India a highly competitive investment destination, where tax rates are similar to other countries with the largest English-speaking talented young population in a highly internet-connected world with democratic governance.

Listing of agreements, Securities Laws (Amendments) Act 1995, regulatory guidelines on venture funds, FII and company disclosures are way better placed today to maintain transparency and efficiency.

Warren Buffett says it takes years to build a reputation but a minute to destroy it. One should always focus on building trust and not on short cuts. Systems should always be preventive than corrective. Whenever there are some asset bubbles and markets swing to irrational exuberance without any reason, it is time to pause and reflect.

I recall a quote by Alan Greenspan. “Capitalism is based on self-interest and self-esteem; it holds integrity and trustworthiness as cardinal virtues and makes them pay off in the marketplace.”

Also, we learn from history that whenever complex financial instruments arise and detrimental risk effects on the system are not measured and analysed at the very start, such risks will keep visiting.

(The author is Founder of Wealthyvia.com)

Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Pritam Deuskar
first published: Oct 10, 2020 11:12 am

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