The securities scandal of 1992, with Harshad Mehta as its main player, is back in collective consciousness nearly three decades after it was perpetrated, thanks to Sony LIV’s popular web series Scam 1992.
While the series has been praised for its largely accurate portrayal of the events that transpired — down to a fleeting mention of the fiscal deficit in the Budget 1986 speech, as is shown when a character is watching it on TV — there are only so many details that it can capture given the scope of the medium.
Here’s a detailed FAQ that takes an in-depth look at the Securities Scam 1992.
At its core, what was the Securities Scam 1992 about?
Stockbrokers wanted to borrow funds to deploy in the market. Stringent RBI regulations restricted them from borrowing from banks, the cheapest source of funds. Brokers found a workaround built on trading in government securities, colluding with banks, circumventing RBI rules, getting their hands on bank funds and diverting it to the stock market.
Brokers and banks got help from public sector undertakings (PSUs), which were looking for avenues to deploy their temporary surpluses. In violation of rules, PSUs started taking positions in the securities market through the portfolio management services (PMS) schemes run by banks.
This wall of money fuelled massive speculation in stocks between April 1991 and May 1992, and caused a near fourfold jump in the BSE Sensex.
What is vyaj badla?
Back in the 80s, stock market trades were settled once in two weeks. But buyers had the option to roll over their position to the next settlement cycle, if they could find somebody to finance it. The financier would charge an interest, which was higher than the rates in the bond markets, as well as the deposit rates offered by banks. Many big brokers were badla financiers as well.
And when they were not financing other traders, the brokers would need funds to roll over their positions, if the market was in an uptrend.
So brokers found it profitable to access funds from the banking system and use it for their stock market operations. They found a loophole in the banking system that was there for everyone to see. They exploited it to the hilt. This was to do with banks’ trading in debt securities.
Why did banks trade in securities?
For two reasons. One, to meet the RBI regulations of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). CRR, as the term implies, required banks to park a certain portion of their deposits with the RBI at zero interest. For SLR, banks had to park a certain portion of their deposits in government securities and other approved securities.
The second reason was to boost their profits, which were quite low at that time.
What is the link between securities trades and compliance with CRR and SLR requirements?
When the RBI raised CRR, some banks would find themselves short of cash. Similarly, some banks would find themselves short of securities to meet SLR requirements. This meant there both a buyer and a seller, a prerequisite for any market.
But banks in need of cash could have directly borrowed from the call money market where banks lend to each other?
Till 1988, the interest rate in the money market was capped at 10 percent by the Indian Banks Association. So banks with surplus cash were not keen to lend in the call market. To circumvent the IBA rule, banks devised the ‘ready forward’ mechanism, and so could lend at a rate higher than the call money rate.
What is a ‘ready forward’ deal?
Bank A, which temporarily required cash to meet the CRR rule, would sell securities to Bank B. After a few days, Bank A would buy the securities back from Bank B at a slightly higher rate. The difference in the purchase and sale price of securities was the interest paid for borrowing the funds. This would be higher than the call money rate. Note, the coupon rate or yield on the securities had no connection to the trade, which was a pure financing deal.
What was the reason for banks’ profits being low?
In the 80s, banks had to park 63.5 percent of their deposits with RBI, in cash or specified securities to comply with the CRR and SLR requirements. This earned either no interest or interest way below market rates. Around 40 percent of the remaining deposits was earmarked for priority sector lending. That left banks—both public sector and private sector–with little funds for commercial lending.
Also, there was a cap on the interest rate that banks could offer its depositors. So bank deposits were not the first choice for corporates with surplus funds.
Source: CNBC
