#Scam1992TheHarshadMehtaStory: Did the things "really" change?

From 1992 to 2020, it has been nearly three decades since the infamous securities scam has been unearthed. The scam involved the high-profile broker, so called ‘The Big Bull’ or ‘Amitabh Bachchan of the stock market’, Harshad Shantilal Mehta, who revealed the loopholes in India’s banking sector – a problem that still leads to countless bank frauds in the country.

The Securities Scam : A Brief Introduction

The money market in India back then in 1992 was operated in a shady manner. There was a cartel of foreign banks and top notch brokers who dictated the norms of market to their own benefit.

Harshad Mehta entered the money market to fill in his pockets. He took the advantage of existing loopholes and diverted the money from money markets to stock market. He acted as a broker for many banks who wanted to deal in government securities. He would become a mediator between banks who wanted to sell or buy securities and ultimately used it to his own advantage.

At the time, bank receipts were given by borrower banks to lender banks that were willing to buy securities. This actually meant that real securities did not exchange hands and only BRs were issued. It was simply an exchange of trust. (read: loophole)

Although RBI guidelines mandated banks to directly deal with other banks in case of security dealings, they chose to rely on brokers as it was easier and less time-consuming. A process called Ready-forward deals (RFD) was used by many banks to increase the value of their government bond holdings. RFDs were secured short-term 15-day loans from one bank to another.

The lending was done against government securities. Therefore, the borrower bank had to sell securities to the lending bank and buy them back at the end of the tenure at a slightly higher price.

For instance, if one bank wanted to sell securities and another wanted to buy them, Harshad would approach both the banks as a broker. Harshad had colluded with officials at the Bank of Karad and Metropolitan Cooperative Bank to get fake bank receipts. Mehta used these fake bank receipts to take money from banks - the same money was then diverted to the stock market. The cycle expanded as Mehta expanded his dealing with many banks using fake bank receipts.

Mehta siphoned off thousands of crores from the banking system to buy stocks on the Bombay Stock Exchange. As he pumped in money, the markets continued to achieve new highs. Retail investors followed what Mehta was buying. All of Harshad’s stocks, namely ACC, Mazda Industries, Apollo Tyres, etc. soared high, turning into a frenzy.

In the period between April 1991 and April 1992, the Sensex went into a frenzy and quadrupled, moving from 1,194 points to 4,467. That is the highest annual return for the index in India’s history ever.

The scam came to light when the SBI reported a shortfall in government securities. That led to an investigation that later showed that Mehta had manipulated around Rs 5000 crore in the system. On August 6, 1992, after the scam was exposed, the markets crashed by 72 percent leading to one of the biggest falls in the history of Sensex ever.

The scam exposed the involvement of many public sector banks and even NHB, the subsidiary of RBI. The chairman of Vijaya Bank committed suicide after the scam was out. The scam also revealed involvement of many high-profile politicians and bribing of then Prime Minister P.V. Narasimha Rao. For, the first time in India’s history ever, a PM was alleged of taking a bribe personally-very sensational!. But as usual, the biggies escape and someone is made a scapegoat. 

Mehta was sentenced to imprisonment and he died of heart attack in 2001 while serving imprisonment, at the age of 47.

The After Effects of the scam

The Securities Scam brought a list of reforms in India’s Financial System and Securities Market. Previously, everything was manual, mechanical, information was slow and uncertain and the main way of making money seemed to be to manipulate information flows and exploit information gaps. 

One interesting aspect is that insider trading was not illegal. In fact, not only was it not illegal, it just wasn't defined in India. In the law and regulations, there was no such thing as insider trading. It was implicit that what we call insider trading now was the way to make money on the markets then. Today, insider trading is an offense and can even lead to ban from stock markets.

Today, we live in an investing environment where it is understood that fundamental financial facts about a company are of the utmost importance. Till the 80s, things were not like that. For the most part, the stock exchanges were a world unto themselves and what happened to the shares of a company was mostly decided in trading battles between rival cabals of powerful brokers rather than by the actual business of the company whose shares were being traded.

After the scam, many sweeping reforms were brought which changed the Indian Financial System. Zerodha founder, Nithin Kamath explains the 8 things that changed after #Scam1992:

1.  Settlement cycle: Back in 1992, the settlement cycle - the time within which brokers have to pay full money and take delivery of stocks or deliver stocks if sold - was 14 days. Now, it is two days, and SEBI is also hinting at a 1-day cycle soon.
2. Minimum balance: In 1992, there was no rule over maintenance of minimum balance that a customer needs to ensure to buy stocks. But now, a customer can’t buy stocks without the minimum money in the account or sell without stocks in Demat account. The new rule helps reduce the systemic risk from aggressive brokers who were previously compromising risk for the business.
3. Electronic transactions: Back in 1992, the settlement of trades was done through paper and counter-party risk was evident. Now, all the settlement of trades happens through clearing corporations (CC), and all transactions are electronic.
4. Broker's approval: Today since the risk from the customer is way lesser due to margin requirements & CC, you don’t need approval from a broker to open an account like in 1992. You can open a trading account online in under 15 minutes with any broker now.
5. Brokerage firms' role: In 1992, brokerage firms dealt as advisory, but now they focus on execution and not advisory.
6. Trading process: Back in 1992, all the trades were placed through dealers and hence they carried a huge execution risk. These days, most of the trades are executed by customers on their own.
7. Brokerage fee: In 1992, customers were mostly unaware and paid at least 1 percent as brokerage for equity delivery trades, while no charges have to be paid now. 
8. Price difference: Lastly, in 1992, dealers used pocket a cut by telling different price to customer than actual trade price. However, these days the process is 100 percent transparent.

But, did the things “really” change?

After death of Harshad Mehta in 2001, his close aide Ketan Parekh diverted the money from a cooperative bank for manipulating stocks. Soon after Parekh's arrest, share markets crashed again and investors lost more than Rs 2,000 crore. Again a regulatory failure.

In Kingfisher Airlines case, Vijay Mallya duped the public sector banks of 9000 crores.

In 2018, PNB fraud was unearthed which involved diamantaire Nirav Modi and Mehul Choksi. This fraud was also due to regulatory oversight where the duo used fake Letter of Undertakings – similar to Harshad Mehta’s fake BRs.

 Also, there is an infamous story about how Yes Bank and PMC Bank had suffered due to bad loans lent by them to personally benefit few top executives of bank and borrowers. The systems put in place couldn’t detect the irregularities at an early stage. 

The loopholes are a matter of concern because it is ultimately the money of public which is wiped off. These scandals have even brought out many nexus of fraudsters with top politicians, but power and influence downplayed the system.

The scams at these banks and many others that have occurred over the years are evidence of gaping loopholes in India's vast banking system. It brings us to a line quoted in the SonyLiv web series, Scam 1992, The Harshad Mehta Story: "Bohot kuch badla, lekin phir bhi, kuch nahi badla” (Many things changed, yet nothing has changed).