The Securities Scam 92 was a scandal that emerged in the year 1992. Stockbroker Harshad Mehta played a key role in the scandal that was brought to light by Sony LIV’s web series Scam 1992.. The scam’s size was estimated at Rs 4024 crore.
Stockbrokers sought bank loans during the Securities Scam 1992, which was prohibited by RBI regulations. Trade in government securities, collusion with banks, RBI circumvention, and stock market investment were their solutions. PSUs also sought strategies to use occasional surpluses. Under bank portfolio management services (PMS) schemes, PSUs took securities market positions, breaking restrictions. The BSE Sensex nearly quadrupled between April 1991 and May 1992 due to enormous market speculation.
Stockbrokers took proprietary stock positions or financed vyaj badla deals to finance their stock market trades. Big brokers were badla financiers and required capital to roll over their positions in uptrends. Brokers took advantage of a banking loophole to fund their stock market operations.
To meet RBI Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) requirements, banks traded securities to park a part of their deposits at zero interest. They also intended to increase their modest profits.
The relationship between securities trading and CRR and SLR compliance is complicated. Some banks ran out of cash or securities to meet SLR requirements when the RBI boosted CRR, causing buyers and sellers. To avoid this, banks created the “ready forward” mechanism to lend over the call money rate.
CRR and SLR rules required banks to deposit 63.5 percent of their deposits with RBI in cash or designated securities in the 1980s. This generated no interest or below market rates, leaving banks with little money for commercial lending. Bank deposits were less appealing to corporates with extra funds due to the interest rate cap.
Bank receipts were key to the scheme since the seller bank often delayed delivering the physical securities. The buyer would receive a ‘bank receipt’ (BR) from the seller bank until the securities were delivered. Once the buyer received the securities, the BR expired.
BRs were only allowed for PSU bonds or mutual fund units, not government securities. RBI’s Public Debt Office kept banks’ government securities in the Securities General Ledger. A bank sold government securities by giving the buyer an SGL transfer form. The PDO would credit the buyer’s account and debit the seller bank’s securities account after the buyer submitted the transfer paperwork.
Multiple infractions made BRs currency, traded as securities with few underlying securities changing hands. Despite RBI restrictions, banks issued BRs for government securities transactions. Banks buying assets would not require delivery within 90 days, making BRs valid indefinitely. Despite not having the securities, some banks issued BRs.
The RBI notified banks in July 1991 that they could only sell securities if they kept them in their investment account. The banks ignored the circular and violated BR regulations.
The Securities Scam in India involved a strong relationship between some banks and brokers, allowing brokers to access banks’ funds and execute unapproved transactions. Brokers benefited from banks lending funds to them in quick forward trades. Brokers used ‘routing’ banks.
In their own names, they traded or sold shares without disclosing they were representing brokers. When securities were scarce, they issued their own BRs. This allowed each securities bank to prefer brokers they were willing to bypass rules for.
Brokers helped banks meet regulations and profit from securities transactions. They also helped banks avoid losses when the RBI raised interest rates, which hurt profitability. Banks would temporarily store loss-making bonds with brokers to ease earnings losses. Brokers would take losses on some trades and get paid on others.
In 1989 and 1990, RBI special probes found major anomalies in foreign banks’ portfolio management services (PMS) operations and non-compliance with RBI circulars. Citibank, a foreign bank, violated RBI guidelines by short-selling government assets. Four international banks—Standard Chartered, ANZ Grindlays, Bank of America, and Citibank—accounted for 56% of bank securities transactions between April 1991 and May 1992.
As the government steadily removed budgetary support, PSUs raised enormous sums from the bond markets even without capital expenditure plans, which led to dubious securities market operations. PSUs sometimes had trouble selling large public issues, therefore they partnered with banks to subscribe to a large portion of the issues and lodge the funds in their PMS schemes.
PSUs invested Rs 36,000 crore in foreign bank and nationalized bank NBFC portfolio management services (PMS) schemes between April 1990 and December 1992. Government restrictions limited PSU investments to government securities, public sector bonds, and treasury bills, which were violated. After giving their money to banks, PSUs never checked where it was invested.
Bank irregularities affected the stock market. Banks traded about Rs 13 lakh crore in securities between April 1991 and May 1992, with only 5% of transactions including outright purchases or sells. This time saw the BSE Sensex rise from 1200 to a record 4467.
State Bank of India, National Housing Bank, UCO Bank, and ANZ Grindlays preferred stock market and money market broker Harshad Mehta. Mehta’s personal account received most of the funds, which he used to trade stocks and promote the replacement cost hypothesis, which drove stock prices upward.
The bear cartel and Harshad began fighting after a group of traders short-sold many shares, believing the stock market’s excitement was unfounded and the rally would not last. Harshad maintained his buy positions, driving prices higher and bleeding his rivals financially. They had to buy shares on the open market to close their short bets, fueling the rally and costing them extra.
Due to rampant securities trading infractions, banks’ investment portfolios have ‘holes’ supported by SGL transfer forms or BRs on hand or given by brokers. Few checked SGL transfer papers or BRs for securities backing. The books were illegally balanced by establishing new transactions with SGL transfer forms BRs without security.
RBI began checking bank books for securities transaction irregularities in January 1992. The RBI detected a Rs 649 crore investment portfolio deficiency at SBI in April. Harshad paid Rs 620 crore between April 13 and 24 under SBI pressure. However, the RBI discovered that Harshad had paid Rs 574 crore from his Grindlay’s Bank account. National Housing Bank cheques written to Grindlays Bank and credited to Harshad’s account funded Rs 489.75 crores.
SBI’s deficiency and NHB’s payments caused a securities market crisis. Other brokers failed to hide some banks’ investment portfolio ‘holes’ with replacement agreements. Karad Bank and Metropolitan Co-operative Bank collapsed from losses. The CBI froze Harshad Mehta’s bank accounts and assets by mid-May. CBI nabbed Harshad three weeks later.
After the hoax was revealed, stock prices fell as fund flow dried up. According to the Janakiraman Committee, the scam’s size was estimated to have been Rs 4024 crore.
