As an investor, you work hard for your money and trust that the system is fair and regulated. Unfortunately, that is not always the case. In 1992, India was rocked by its biggest financial scandal to date. Harshad Mehta, a stockbroker, exploited several loopholes in the Indian banking system to swindle thousands of crores from the national banks. His shrewd manipulations and extravagant lifestyle were brought to light when investigative journalist Sucheta Dalal exposed his fraudulent methods. The scandal shattered the nation’s confidence in the stock market and banking system. Over 25 years later, the Harshad Mehta scam still stands as a sobering reminder of the damage that can be wrought by unchecked greed and corruption. This article examines how he orchestrated the fraud and its lasting impact on India’s financial regulations.
Who Was Harshad Mehta?
Harshad Mehta was an Indian stockbroker involved in a massive stock market fraud in the early 1990s. Known as the “Big Bull”, Mehta exploited several loopholes in the Indian banking system to siphon off thousands of crores from the banks.
Mehta’s Early Career
Mehta began his career in the late 1970s as a small-time broker on Dalal Street, the home of the Bombay Stock Exchange (BSE). He soon gained a reputation for being an astute trader with an ability to pick winning stocks. By the late 1980s, Mehta had become a prominent broker and financier. He cultivated close relationships with several top executives at large nationalized and private banks.
The Scam is Revealed
In April 1992, journalist Sucheta Dalal exposed irregularities in the functioning of the ANZ Grindlays Bank, including a large number of fictitious bank receipts issued by the bank in the names of several firms. This led to further investigations that revealed Mehta had fraudulently secured funds from inter-bank transactions and used them to ramp up the stock prices of certain shares. It emerged that Mehta had exploited “Ready Forward” deals where banks would lend him money against government securities, which he would then use to drive up stock prices before dumping the stocks for a profit.
The scale of the fraud was enormous, estimated at over ₹4,000 crores (US$2.2 billion), which made it the largest financial scam in India at the time. Mehta was arrested in November 1992 and banned from trading in the stock market. The scam also exposed serious weaknesses in the Indian banking system and resulted in reforms to prevent the misuse of bank funds in the stock market.
How the Harshad Mehta Scam Worked
To fully understand how Harshad Mehta was able to execute India’s biggest financial fraud, you must first understand how the Indian banking system worked at the time.
The Indian banking system in the early 1990s was not very sophisticated. Banks used a system where they didn’t maintain their balance sheets on a daily basis. Instead, they calculated balance sheets on Fridays when the week closed. This meant that for the rest of the week, a bank’s balance sheet would not reflect the day’s transactions. Mehta exploited this loophole.
How Mehta Exploited the Loophole
Mehta would borrow money from one bank on Monday, use the funds to buy securities, and sell the securities to another bank on Tuesday. Since the first bank’s books were not updated, it appeared he was holding cash instead of securities. He would then return the money to the first bank before the end of the week, so its books remained balanced. Meanwhile, he pocketed the profit from the security transactions.
- Mehta would borrow money (“take out a loan”) from a bank at a high interest rate.
- He would use that money to buy government securities with a lower interest rate.
- He would then sell those government securities to another bank at the higher interest rate and pocket the difference.
- Before the end of the week, he would repay the first bank by using the money from the securities sale to the second bank.
By exploiting this loophole, Mehta was able to siphon off thousands of crores from the Indian banking system, which eventually led to a major crisis when the scam came to light. The Harshad Mehta scam showed how vulnerabilities in the system could be manipulated, and led to major reforms in the Indian banking system.
The Scale of the Fraud
The scale of Mehta’s fraudulent activities was truly staggering. By 1992, the size of the scam was estimated to be around ₹4000 crore (equivalent to ₹26,000 crore or US$3.6 billion in 2020), more than the GDP of India at that time.
Mehta and his associates engaged in a massive stock market manipulation scheme to siphon off thousands of crores from the Indian banking system. They took advantage of loopholes in the Indian banking system to access funds from inter-bank transactions and used fake bank receipts to borrow large amounts of money from banks which they in turn used to drive up the stock prices of certain shares.
Mehta used the funds from various banks to artificially inflate stock prices through circular trading of shares amongst his own companies as well as controlled and manipulated deliveries of shares to counter parties. When the State Bank of India reported that they had issued fake BRs (Bank Receipts) for ₹2,000 crores, the scam unraveled. With the scam coming to light, stock market prices crashed and Mehta was banned from trading in the stock market.
The Harshad Mehta scam highlighted the inadequacies in the Indian banking system with respect to regulation, control and monitoring of funds in transit between banks, a loophole that Mehta fully exploited. The scam led to a major overhaul of the Indian financial system with the introduction of reforms improving transparency and control. However, the funds stolen by Mehta’s firms were not recovered and investors were not fully compensated for their losses.
Overall, the Harshad Mehta scam was a wake up call for the Indian financial sector, exposing issues with the system that needed urgent reform to prevent similar fraudulent activities from occurring again in the future. The unethical actions of Mehta caused substantial losses to the Indian economy and dented investor confidence in the stock market for years to come.
Aftermath of the Harshad Mehta Scam
The Harshad Mehta scam had a devastating impact on India’s economy and financial markets. Investor confidence was shattered, and the stock market crashed. The total losses were estimated to be over ₹4,000 crore (equivalent to ₹26,000 crore or US$3.6 billion in 2020).
Government Intervention
The government intervened to stabilize the stock market and protect investors. The State Bank of India absorbed the liabilities of the defaulting banks in the scam. The Reserve Bank of India tightened banking regulations and oversight to prevent similar frauds in the future. SEBI, India’s market regulator, was given statutory powers to regulate the stock market and prevent insider trading and manipulation.
Tightening of Laws
New laws were enacted to strengthen the banking system. The BR Act of 1949 was amended, giving more power to the RBI to regulate banks and access their books. The Securities Laws (Amendment) Act, 1995, gave SEBI more control over brokers and insider trading. The RBI also tightened norms for inter-bank transactions and banned banks from lending against shares and bonds.
Fall of the Bull Run
The Harshad Mehta scam ended India’s bull run of the early 1990s. The stock market had been booming, with the Sensex gaining over 600% between 1988 to 1992. But after the scam was exposed, the Sensex crashed nearly 60% from its peak by the end of 1992. It took over a decade for the Sensex to recover to pre-scam levels. Many retail investors lost their savings and stayed away from the stock market for years.
Lessons Learned
The Harshad Mehta scam highlighted weaknesses in the Indian financial system but also led to much-needed reforms. Stricter regulations, transparency standards, and enforcement mechanisms were put in place to strengthen the integrity of India’s capital markets. But constant vigilance and oversight are still required to protect investors and maintain public trust in the system. Overall, the scam served as an expensive lesson on the importance of good governance and ethical practices in finance.
Lessons Learned From the Harshad Mehta Scam
The Harshad Mehta scam highlighted several important lessons for India’s financial system and regulatory bodies.
Improved Regulation
The scam revealed major loopholes in India’s banking system that allowed Mehta to exploit weak regulations. In response, the Reserve Bank of India established new guidelines to improve auditing, limit bank exposure to brokers, and curb fraudulent transactions. Stricter enforcement of regulations and penalties for violations also aimed to deter future manipulations.
Addressing Systemic Issues
The scam underscored deeper problems in India’s banking system like disproportionate control and lack of transparency. Reforms focused on limiting bank reliance on a single broker, improving information sharing between banks, and centralizing transaction monitoring. These changes targeted the systemic failings that enabled Mehta’s fraud.
Importance of Ethics
The Harshad Mehta scandal demonstrated the necessity of ethical behavior and integrity in India’s financial institutions. His fraudulent actions undermined investor and public trust in the system. Promoting ethical practices and accountability at all levels of banking helped rebuild confidence.
Vigilance and Oversight
The enormity of Mehta’s scam revealed deficiencies in oversight and vigilance within regulatory bodies and banks. Failures to detect irregularities and act decisively allowed the fraud to spread. Enhanced monitoring systems, internal controls, and risk management practices strengthened oversight to identify manipulations early. Continuous vigilance and review remain essential to protect the system.
The Harshad Mehta scam served as an impetus for reform and continues to offer sobering lessons on regulation, ethics and oversight in India’s financial system. Bolstering these areas and remaining vigilant can help prevent future manipulations and rebuild trust in the market. Overall, the scandal highlighted the need for constant improvement and adaptation to close loopholes, promote integrity, and ensure a fair system.
Conclusion
As you’ve seen, the Harshad Mehta scam was a watershed moment that exposed the vulnerabilities in India’s financial system and shattered the nation’s confidence in its banking institutions. Mehta’s actions highlighted the need for stronger regulations and oversight to prevent such fraudulent activities from happening again. While the scam caused tremendous financial losses, it also prompted authorities to take action by passing new laws and safeguards. The scam serves as a sobering lesson in the importance of integrity, transparency and accountability in the financial sector. By learning from past mistakes and remaining vigilant, India has built a stronger, fairer system to power its growth as an economic powerhouse. Though the scam caused deep suffering, India emerged wiser and continues its march toward progress.