In the early 1990s, every bank in India was supposed to maintain Statutory Liquidity Ratio, i.e. a particular amount of their deposits
were to be in the form of government bonds. They were also to submit a balance sheet with full details by the end of the day showing the capital that has been invested in government bonds. However, now the banks only have to show their balance sheet on Fridays. Along with this change, a clause was added according to which through the daily percentage was not mandatory to be above SLR, however, the average percentage over the week was necessary to be above SLR. This new clause allowed the banks to sell bonds in the beginning of the week and then purchase them back toward the end.
Who was Harshad Mehta and what his role was
It is when the banks wish to buy back stocks that the brokers come into the scenario. The broker works as a middleman between the bank that has more bonds (‘plus’) and the bank that has less (‘short’). One such broker in the Indian stock market was Harshad Mehta whose name has emerged in a scam. Harshad Mehta has been working with a lot of banks for long. Through his work he was able to gain the trust of the senior managements of those banks. What he did was that he told a ‘short’ bank to write a cheque in his name because he was not sure whom we may end sealing the deal with as he works with multiple banks together. Writing the cheque in favor of the broker was forbidden by law. But since he was a trusted person, banks obliged to his request. After acquiring the money, Harshad Mehta used to go to a ‘plus’ bank and would say that he needs the bonds for A right away however he will pay the money the next day. To make the offer of one day extension tempting for the ‘plus’ bank, he offered a 15% return to them. Eyeing the good return, ‘plus’ banks used to agree to this deal.
The Scam and Implications on Stock market
As Harshad Mehta was playing this game with all the banks he was dealing with, he was able to maintain a working capital in his account at all times. During those times, the banks were not permitted to make investments in equity markets. Through his clever skills, Mehta was able to snatch some funds from the banking system which he then used to invest in the stock market via which he managed to make a lot of money and stoke a huge boom. He was responsible for taking the ACC price from 200 to whooping 9000, i.e. an increase of 4400%. The entire market was on the rise. In the end, as he was to book profits, he sold the stocks on the day the market crashed. Aware of the fact that he would be heavily blamed for writing the cheque in the name of Mehta, chairman of Vijaya Bank (one of the banks being handled by Harshad Mehta) committed suicide.
A lesser known fact about the Indian stock market scam by Harshad Mehta is the involvement of Nimesh Shah who managed to keep a very low profile. Shah was similarly involved, however, he kept himself well out of the hands of the law. Harshad Mehta is now dead but Shah still deals in stock market and is considered as a heavy player. Thought the Harshad Mehta scam has not been the only scam in the stock market, but its scale shook many players. It also came across as a lesson for banks to not write the cheque in name of the broker no matter how trusted they were.