The Harshad Mehta scam also known as Indian Stock Market Scam took place in 1992. It was carried out by Harshad Mehta with other bank officials and Politicians on the Bombay Stock Exchange. The Scam caused a significant shock to the Stock Market Of India.
Harshad Mehta used fake cheques, misused market loopholes, and manipulated the market to inflate the prices 40 times higher than their original prices.
Stock traders colluding with Mr Mehta were able to make good returns by fraudulently obtaining unsecured loans from the banks. When the Scam was discovered in April 1992, it led to the collapse of the Indian Stock Market.
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What was the scam
Harshad Mehta and stock brokers drained funds from interbank transactions by the use of ready-forward deals, fake bank receipts and fake checks etc.
A ready-forward deal is a 15-day loan from one bank to another. The lending is done against government securities. The transacting banks make payments to each other and deliver securities. The delivery of securities and payments, in this case, were made through brokers and only the broker would know both parties. The brokers perfected the method and started trading on their own accounts. They pretended to transact on behalf of a bank but actually were transacting personally.
The brokers also used bank receipts in place of securities that were traded. So in reality securities were not exchanged, only the bank receipts were.
How Bank Receipts were used
In the whole process of ready-forward deals, the actual securities were not used, instead, the seller of the securities gave the buyer a Bank Receipt in lieu of those securities. These bank receipts were a promise that the buyer will receive the securities at the end of the 15-day deal.
So Mr. Mehta used this loophole and colluded with the banks which provided him with fake receipts. These fake receipts were then used in transactions with other unsuspecting banks. Mr Mehta gained huge amounts of money by way of these transactions, which were further invested in the stock market. he gained huge profits by selling shares, with further shook the share market.
How Ready Forward deals were used
The ready-forward deal is two banks exchanging securities through a middleman, who is a broker. So Mr Mehta acted as a broker between banks and got cheques issued in his name, and not the banks and when the banks wanted the money for the securities, he would approach another unsuspecting bank and repeat the same process. The money from both banks was credited into the broker’s account thus he had a constant flow of money, which was used in the stock market.
Impact on Share Market
Harshad Mehta gained unending capital by defrauding the banks and investing in the stock market. He promised the banks higher rates of interest in exchange for securities while crediting the money into his personal account. He used this money temporarily in his account to buy shares and inflate the demand for certain shares such as that of ACC, Sterile, Videocon etc. He sold the shares at inflated rates, paid off the banks and kept the remainder for himself. This also led to the rise of the Bombay Stock Exchange SENSEX
Trial and Conviction
Harshd Mehta was charged with 72 criminal offences relating to bribery, cheating, forgery, criminal conspiracy and falsification of accounts, and there were more than 600 civil action suits.
He was arrested by the CBI on 9 November 1992 and blacklisted from the stock market for misappropriating more than 2.8 million shares of about 90 companies. The total value of the shares misappropriation was around Rs250 Crores.
Harshd Mehta led to a fall in share prices and market index. It disrupted the functions of the commercial banks and RBI, thus causing the share market to collapse.
The government thus realised that the fundamental problem lay with the financial structure. It was the lack of digitised systems which impacted the whole stock market.
The bank officers who colluded with Harshad Mehta were investigated and implicated in fraudulent charges. Financial Fairgrowth Services Limited and Andhra Bank Financial Services Ltd were also involved.
The lack of digitisation of the system which was blamed to be the main cause of the Harshad Mehta scam is not the only factor causing harm to the banking system and economy of India. Even after digitisation, the government is still unsuccessful in curbing the issue of scams in India. The recent Nirav Modi scam has left the Indian economy in a sensitive situation. The lack of regulatory oversight alongside bad governance is the biggest loophole in the Indian banking system. In the absence of good banking governance and regulatory checks, the situation is likely to change for the worse.
Written By- Shweta Mehra,
Pursuing LL.M. at Lovely Professional University