Unveiling the Most Intelligent Finance Scam: A Deeper Look into Harshad Mehta Scam
Finance fraud has been a recurring theme in history, with one of the most audacious and complex schemes taking place in the mid-1990s. This article delves into the details of the Harshad Mehta securities scam, exposing how this intricate financial manipulation nearly brought down India's market and the subsequent measures taken by the government to prevent such loopholes in the future.
Understanding Finance Frauds: The Role of Banking
Finance frauds are often facilitated by flaws within the banking and financial systems. One key flaw is the fractional reserve banking system, where banks can create money by making loans without having the full amount of real property backing. This system, while not inherently fraudulent, can be exploited by those with the right knowledge and resources.
The Harshad Mehta Securities Scam: A Comprehensive Overview
Harshad Mehta, a stock market broker, found several loopholes in the inter-bank lending system in India during 1992. By exploiting these loopholes, Mehta orchestrated a significant financial scam, which is estimated to have cost banks almost 4000 crores (approximately 4 billion Indian Rupees).
Background and Context
In 1991, India underwent significant economic reforms, with the introduction of Liberalization, Privatization, and Globalization (LPG). This led to intense competition among commercial banks to maintain profitability, often by increasing Portfolio Management Scheme (PMS) investments.
Under existing regulations, banks were required to maintain a Statutory Liquidity Ratio (SLR), which meant they had to invest a certain percentage of their deposits in cash, government securities, or gold. These investments earned interest, allowing banks to fund their operations and generate income. However, the government relaxed the daily reporting requirements for SLR compliance, easing the liquidity constraints on banks.
The Operation of the Scam
With this new loophole, banks could manipulate their SLR ratios by selling government securities at the beginning of the week and buying them back at the end, thus freeing up capital for other investments. This practice was widespread, creating a dependency on intermediaries like Harshad Mehta.
Mehta identified the demand and supply gaps in the market and became an intermediary between banks. He would arrange for the purchase of government securities on behalf of banks, creating a facade of compliance with the SLR rules. By doing so, he could accumulate large sums of money and invest them in the stock market, leading to artificial inflations in stock prices.
The Unraveling of the Scam
The scam continued for almost a year, until Mehta's fraudulent activities were detected. This not only tarnished the reputation of the affected banks but also caused significant turmoil in the Indian stock market. The infamous incident known as the "Harshad Mehta Scam" shook the financial ecosystem of India, leading to drastic reforms and improvements.
Lessons Learned and Reforms
The incident served as a catalyst for restructuring and reformation of the Indian financial market. The government took several steps to plug the loopholes and strengthen the regulatory framework:
Introduction of stringent regulations and oversight measures by the Securities and Exchange Board of India (SEBI).
Improved transparency and accountability within the banking sector to prevent similar future incidents.
Delete or modify existing rules that could be exploited for such fraudulent activities.
The Harshad Mehta scam is a stark reminder of the need for vigilance and robust regulatory frameworks to prevent financial frauds. In the aftermath of this scam, the Indian financial market became more resilient and transparent, thanks to the stringent measures implemented by the government.