The Scam

1. The 1992 Indian Securities Scam: A Perfect Storm of Greed and Regulatory Failure

"The scam was not limited to individuals. Everybody was in it, like vultures nibbling at a rotten corpse."

A system ripe for exploitation. The 1992 Indian securities scam was a result of multiple factors converging to create a perfect storm in the financial markets. At its core, the scam exploited the inefficiencies and loopholes in the banking system, particularly in the government securities market.

Key elements that contributed to the scam:

• Over-regulation on paper, but lack of control in practice
• A creaking financial infrastructure
• Misguided policies of the Reserve Bank of India (RBI)
• Absence of a proper market for securities worth Rs 200,000 crore
• Lack of transparency in bond trading

The scale of the fraud. The scam involved various financial instruments, including government securities, public sector bonds, and units of mutual funds. It was estimated to be worth around Rs 4,000 crore (about $1.3 billion at the time), making it the largest financial scandal in Indian history up to that point.

2. Harshad Mehta: The Rise and Fall of India's First Stock Market Superstar

"I thought I'd be like a pied piper. I thought I can start selling dreams because somebody needed to come and sell dreams, that asset creation is not a crime...."

The Big Bull's journey. Harshad Mehta's rise from a small-time stockbroker to the "Big Bull" of the Indian stock market was meteoric. His aggressive trading strategies and market manipulation techniques helped him amass enormous wealth and influence in a short period.

Mehta's key strategies:

• Exploiting the ready forward deal (RFD) system in the banking sector
• Using bank funds to inflate stock prices
• Promoting his "replacement cost theory" to justify high stock valuations
• Creating a cult of personality around himself as a market guru

The inevitable crash. Mehta's empire came crashing down when the scam was exposed in April 1992. His illegal methods of routing money from banks to the stock market through a complex web of transactions were revealed, leading to his arrest and eventual downfall.

3. The Role of Banks and Financial Institutions in Fueling the Scam

"Banks were acting in concert with the brokers to fund each other and cover each other's losses."

A systemic failure. The scam exposed the deep-rooted problems in the Indian banking system. Both public and private sector banks were found to be complicit in various degrees, either through active participation or negligence.

Key players and their roles:

• State Bank of India (SBI): Largest exposure to Harshad Mehta's fraudulent transactions
• Bank of Karad and Metropolitan Cooperative Bank: Issued fake Bank Receipts (BRs)
• Canbank Financial Services (Canfina) and Canbank Mutual Fund: Heavily involved in dubious transactions
• Foreign banks like Citibank and Standard Chartered: Exploited regulatory loopholes for profit

The ready forward deal (RFD) system. This was the primary mechanism used to divert funds from the banking system to the stock market. The lack of proper checks and balances in the RFD system allowed brokers like Mehta to manipulate it for personal gain.

4. Portfolio Management Schemes: The Heart of the Scandal

"PMS was, after all, clients' money held by the banks in a fiduciary capacity and the bank was not obliged to turn over the profits made in excess of the 'guaranteed' return."

A loophole exploited. Portfolio Management Schemes (PMS) were intended to allow banks to manage funds for clients. However, they became a key tool in the scam, used to bypass regulatory requirements and divert funds.

How PMS were misused:

• Banks accepted short-term deposits under PMS, violating the minimum one-year rule
• Guaranteed returns were offered, which was against regulations
• Funds were used for speculative trading rather than prudent investment
• Profits were often not passed on to clients

The scale of PMS abuse. Major banks and financial institutions, including foreign banks, were found to be heavily involved in PMS-related irregularities. The total amount of funds misused through PMS was estimated to be in thousands of crores of rupees.

5. Foreign Banks: Buccaneers in India's Financial Wild West

"Citi's basic strategy was bend the rules for a fast buck. If charged deny it. If caught say sorry and try to do it again."

Exploiting regulatory gaps. Foreign banks, particularly Citibank and Bank of America, were major players in the scam. They used their sophisticated systems and well-connected employees to exploit weaknesses in the Indian financial system.

Foreign banks' strategies:

• Aggressively using PMS to bypass reserve requirements
• Developing close relationships with select brokers
• Employing relatives of influential government officials
• Denying wrongdoing when caught and transferring key employees

The case of Citibank. Citibank was particularly notorious for its involvement. It was found to have violated numerous regulations, including issuing BRs without proper backing, conducting deals at artificial rates, and misusing client funds in PMS accounts.

6. Regulatory Failures: RBI's One-Eyed God Syndrome

"RBI acted like a one-eyed god; its other eye was often closed and when opened occasionally, it merely winked."

Systemic blindness. The Reserve Bank of India (RBI), as the primary regulator of the banking system, failed spectacularly in preventing and detecting the scam. Its approach was characterized by a lack of market understanding and poor enforcement of existing regulations.

RBI's key failures:

• Ignoring repeated warnings from its own inspectors about malpractices
• Failing to understand the complexities of the evolving financial markets
• Not taking action against banks violating PMS guidelines
• Inadequate supervision of foreign banks

Too little, too late. When the scam finally broke, RBI's actions were often reactive and inconsistent. It struggled to coordinate with other investigating agencies and failed to provide clear guidance to the banking sector in the aftermath of the scam.

7. The Aftermath: Witch-hunts, Escapes, and Lessons Unlearned

"It was bad enough that a gigantic scam took place. It is as incredible how ham-handed the scam investigation has been."

Chaotic investigations. The aftermath of the scam was characterized by multiple, often uncoordinated, investigations by various agencies including the CBI, Income Tax Department, and a Joint Parliamentary Committee (JPC).

Key issues in the aftermath:

• Focus on individual brokers rather than systemic issues
• Lack of coordination between investigating agencies
• Selective prosecution, with many big players escaping scrutiny
• Failure to recover a significant portion of the lost funds

Lessons not learned. Despite the scale of the scam and its impact on the financial system, many of the underlying issues remained unaddressed. The Indian financial markets continued to be vulnerable to manipulation and fraud, as evidenced by subsequent scams in the following years.

Long-term impacts:

• Increased scrutiny of the banking sector, but limited structural reforms
• Introduction of new regulations, but weak enforcement
• Temporary loss of public confidence in the stock market
• Continued influence of powerful players in the financial sector

The 1992 securities scam exposed deep-rooted problems in India's financial system, but the opportunity for comprehensive reform was largely missed, leaving the door open for future financial irregularities.

Last updated: April 19, 2025