The 1992 Indian stock market scam was a market manipulation carried out by Harshad Shantilal Mehta with other bankers and politicians on the Bombay Stock Exchange. The scam caused significant disruption to the stock market of India, defrauding investors of over ten million USD.
Techniques used by Mehta involved having corrupt officials signing fake cheques, misusing market loopholes, and fabrication to drive the prices of stocks up to 40 times their original price. Stock traders making good returns as a result of the scam were able to fraudulently obtain unsecured loans from banks. When the scam was discovered in April 1992, the Indian stock market collapsed, and the same banks suddenly found themselves holding millions of Indian rupees (INR) in now useless debt.
1992 Scandal
Overview
The scam was the biggest money market scam ever committed in India, amounting to approximately 5,000 crores. The main perpetrator of the scam was a stock and money market broker Harshad Mehta. It was a systematic stock scam using fake bank receipts and stamp paper that caused the Indian stock market to crash. The scam exposed the inherent loopholes of the Indian financial systems and resulted in a completely reformed system of stock transactions, including an introduction of online security systems.
Security frauds refer to the idea of diversion of funds from the banking system to various stockholders or brokers. The 1992 scam was a systematic fraud committed by Mehta in the Indian stock market which led to the complete collapse of security systems. He committed a scam of over 1 billion from the banking system to buy stocks on the Bombay Stock Exchange. This impacted the entire exchange system as the security system collapsed and investors lost hundreds of thousands of rupees in the exchange system. The scope of the scam was so large that the net value of the stocks was higher than the combined health and education budget of India. The scam was orchestrated in such a way that Mehta secured securities from the State Bank of India against forged cheques signed by corrupt officials and failed to deliver the securities. Mehta made the prices of the stocks soar high through fictitious practices and sold the stocks that he owned in these companies. The impact of the scam had many consequences, which included the losses incurred by lakhs of families and the immediate crash of the stock market. The index fell from 4500 to 2500 representing a loss of 1000 billion in market capitalization. The 1992 scam raised many questions involving bank officials responsible for being in collusion with Mehta. An interview with Montek Singh Ahluwalia (Secretary, economic affairs at the Ministry of Finance) revealed that many top bank officials were involved.
Bank funds scam
In the early 70's, banks in India were not allowed to invest in the equity markets. However, they were expected to post profits and to retain a certain ratio (threshold) of their assets in government fixed interest bonds. Mehta squeezed capital out of the banking system to address this requirement of banks and pumped this money into the share market. He promised the banks higher rates of interest, while asking them to transfer the money into his personal account, under the guise of buying securities for them from other banks. At that time, a bank had to go through a broker to buy securities and forward bonds from other banks. Mehta used this money temporarily in his account to buy shares, hike up demand of certain shares (such as that of ACC, Sterlite Industries, and Videocon) dramatically, sell them off, pass on a part of the proceeds to the bank and keep the rest for himself. This resulted in stocks like ACC, which was trading in 1991 for ₹200/share, catapult to nearly ₹9,000 in just 3 months.
Bank receipt scam
Another major instrument 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. The BR serves as a receipt from the selling bank, and also promises that the buyer will receive the securities they have paid for at the end of the term. Having figured this out, Mehta needed banks, which could issue fake BRs, or BRs not backed by any government securities.
Once these fake BRs were issued, they were passed on to other banks and the banks in turn gave money to Mehta, plainly assuming that they were lending against government securities when this was not really the case. He took the price of ACC from ₹200 to ₹9,000. That was an increase of 4,400%. Since he had to book profits in the end, the day he sold was the day when the markets crashed.