He triggered a rise in the Bombay Stock Exchange in the year 1992 by trading in shares at a premium across many segments. Taking advantages of the loopholes in the banking system, Harshad and his associates triggered a securities scam diverting funds to the tune of Rs 4000 crore (Rs 40 billion) from the banks to stockbrokers between April 1991 to May 1992. Mehta soon mastered the tricks of the trade and set out on dangerous game plan. Mehta has siphoned off huge sums of money from several banks and millions of investors were conned in the proces
The crucial mechanism through which the scam was effected was the ready forward (RF) deal. The RF is in essence a secured short-term (typically 15-day) loan from one bank to another. Crudely put, the bank lends against government securities just as a pawnbroker lends against jewellery….The borrowing bank actually sells the securities to the lending bank and buys them back at the end of the period of the loan, typically at a slightly higher price.”It was this ready forward deal that Harshad Mehta and his cronies used with great success to channel money from the banking system.A typical ready forward deal involved two banks brought together by a broker in lieu of a commission. The broker handles neither the cash nor the securities, though that wasn’t the case in the lead-up to the scam.“In this settlement process, deliveries of securities and payments were made through the broker. That is, the seller handed over the securities to the broker, who passed them to the buyer, while the buyer gave the cheque to the broker, who then made the payment to the seller.In this settlement process, the buyer and the seller might not even know whom they had traded with, either being know only to the broker.”This the brokers could manage primarily because by now they had become market makers and had started trading on their account. To keep up a semblance of legality, they pretended to be undertaking the transactions on behalf of a bank. The banks needs to maintain certain amount of money(SLR) in the form of government securities and certain approved securities. The RF was a secured short term loan between banks. Typically it was for 15 day period. It was kind of agreement between two banks in which borrowing bank actually sells the securities to the lending bank with a promise to buy it back at the end of the period at a slightly higher price. It helps both the banks in a way that the bank who is in temporary surge of government securities gets them and at the same time the other bank earns some income and securities remains with them. RF is legally not a loan so it does not constitute a part of its liability. In the beginning the banks use to deal directly with each other but it use show which banks needs the money and which use to increase the cost of borrowing. So brokers came into the deal. Now, the banks were not aware which bank is lending and which bank is borrowing, the broker use to earn the commission for this transaction. The broker use to take securities from one bank and cheque from other bank. It use to give the both the things after interchanging
Another instrument used in a big way was the bank receipt (BR). In a ready forward deal, securities were not moved back and forth in actuality. Instead, the borrower, i.e. the seller of securities, gave the buyer of the securities a BR.As the authors write, a BR “confirms the sale of securities. It acts as a receipt for the money received by the selling bank. Hence the name - bank receipt. It promises to deliver the securities to the buyer. It also states that in the mean time, the seller holds the securities in trust of the buyer.”Having figured this out, Metha needed banks, which could issue fake BRs, or BRs not backed by any government securities. “Two small and little known banks - the Bank of Karad (BOK) and the Metorpolitan Co-operative Bank (MCB) - came in handy for this purpose. These banks were willing to issue BRs as and when required, for a fee,” the authors point out.Once these fake BRs were issued, they were passed on to other banks and the banks in turn gave money to Mehta, obviously assuming that they were lending against government securities when this was not really the case. This money was used to drive up the prices of stocks in the stock market. When time came to return the money, the shares were sold for a profit and the BR was retired. The money due to the bank was returned.The game went on as long as the stock prices kept going up, and no one had a clue about Mehta’s modus operandi. Once the scam was exposed, though, a lot of banks were left holding BRs which did not have any value - the banking system had been swindled of a whopping Rs 4,000 crore. For this purpose he used 2 small and little known banks - Bank of Karad(BOK) and Metropolitan Bank(MCB). These banks were willing to issue BR&apos;s for a fee. These fake BR&apos;s were used to get money from other banks. The collected money was then invested in sock market and was used to drive up the prices of selected stocks. When time period use to end, the stocks were sold and money returned to the bank after making a profit. The game kept on going till the time stock prices were going up. But when the market fell, the game came in front. Because the banks who have lended the money have got fake bank receipts which was just worth scrap.
The day scam was revealed and leading player Harshad Mehta arrested that the Sensex fell by 570 points i.e. 12.77 per cent in a single day, on April 28, 1992. That was a Black Tuesday too. There is a pervading sense of despair and frustration among investors with the drastic erosion of shareholder wealth, running into several thousands of crores of rupees.
The Harshad Mehta induced security scam, as the media sometimes termed it, adversely affected at least 10 major commercial banks of India, a number of foreign banks operating in India, and the National Housing Bank, a subsidiary of the Reserve Bank of India, which is the central bank of India.As an aftermath of the shockwaves which engulfed the Indian financial sector, a number of people holding key positions in the India&apos;s financial sector were adversely affected, few of them include the arrest of K. M. Margabandhu, then CMD of the UCO Bank; removal from office of V. Mahadevan, one of the Managing Directors of India’s largest bank, the State Bank of India.
He was arrested on June 5, 1992 for his role in the scam. When the end came, he had a score of cases filed under different stages of trial and one conviction by the Special Court in the Maruti Udyog case. But the last decade had certainly taken its toll. The sunny optimism and good cheer, was replaced by a more pensive and tired visage.
Details of the Scam
The Ready Forward Deal
A short term secured loan
Typically for 15 days
By one bank to another
Against government securities.
Details of the scam
The Bank Receipt
• Something like IOU (I Owe You Securities)
• Confirms the sale of securities
• Acts as a receipt for money received by
the selling bank
• Promise to deliver the securities to the
Impact of the Scam
• Sensex fell from 4500 to 2500 loosing
100,000 crore in market capitalization
• The liberalization policies were put on
hold by the government.
• Inability of Indian companies to raise
capital in world markets
• Adversely affected major banks of
• Arrest of people holding key positions
• Special court set up for the trail
• Special ordinance passed- creation of
• Banning of RF deals.
• Various committees were set up
• Harshad Mehta arrested
• Charged with 72 criminal offences
• Prosecuted for 2 cases
Use of Maruti Udyog Ltd funds to the tune
of Rs 300 million
Misappropriating shares worth Rs 2.50
billion of 90 blue chip companies.
• Government, RBI & Banks as much
responsible as brokers.
• Some more followers of the “Big Bull”
Ketan Parekh, C.R. Bhansali
• A counterparty limit is required
• Money market operations should be
transparent and open.
• More fair methods for recovery of