Well done, Mr. Mehta!

I have been taking GD\PI with an IIMA pass out named Malay Ray. Now that dude has set out on the unenviable task of making us ignorant engineers appear as if we are aware of what is happening in the world. So he has been teaching us about everything from the power sector to telecom to banking to stock markets!

Now, just a couple of days ago, he was talking about the Harshad Mehta scam. After hearing what really happened I was truly amazed at the intelligence of the man. Sad really that he decided to use it the wrong way.

The Harshad Mehta scam:

Well, I just learnt it a couple of days ago, I am assuming that most of the junta is as ignorant as me and will be just as unaware. So here goes the most interesting scam ever!

In the early 1990s, the banks in India had to maintain a particular amount of their deposits in government bonds. This ratio was called SLR(Statutory Liquidity Ratio).Each bank had to submit a detailed sheet of its balance at the end of the day and also show that there was a sufficient amount invested in government bonds.

Now, the government decided that the banks need not show their details on each day, they need to do it only on Fridays. Also, there was an extra clause that said that the average %age of bond holdings over the week needs to be above the SLR but the daily %age need not be so. That meant that banks would sell bonds in the earlier part of the week and then buy bonds back at the end of the week. The capital freed in the starting of the week could then be invested.

Now, at the end of the week many banks would be desperate to buy bonds back. This is where the broker comes in. The broker knew which bank had more bonds (called ‘plus’) and which has less than the required amount (called ‘short’). He then acts as the middleman between the two banks.

Harshad Mehta was one such broker.

He worked as a middle man between many banks for a long time and gained the trust of the banks’ senior management.

Lets say that there are two banks A(short) and B(plus).Now what Harshad Mehta did was that he told the banker at A that he was dealing with many banks and hence did not know who would he deal in the end with. So he said that the bank should write the cheque in his name rather than the other bank (which was forbidden by law), so that he could make the payment to whichever bank was required. Since he was a trusted broker, the banks agreed.

Then, going back to the example of bank A and B, he took the money from A and went to B and said that he would pay the money on the next day to B but he needed the bonds right now (for A).But he offered a 15 % return for bank B for the one day extension. Bank B readily agreed with this since it was getting such a nice return.

Now since Harshad Mehta was dealing with many banks at the same time he could then keep some capital with him at all times. For eg. He takes money from A on Monday, and tells B that he’ll pay on Tuesday, then he takes money from C on Tuesday and tells D that he’ll pay on Wednesday and the money he gets from C is paid to B and as a result he has some working capital with him at all times if this goes on with other banks throughout the week.

The banks at that time were not allowed to invest in the equity markets. Harshad Mehta had very cleverly squeezed some capital out of the banking system. This capital he invested in the stock market and managed to stoke a massive boom. He took the price of ACC from 200 to 9000.Thats an increase of 4400%!!!The market went up like crazy and the bulls were on a mad run.

Since he had to book profits in the end, the day he sold was the day when the market crashed. The same day Vijaya Bank chairman committed suicide by jumping from the top of the banks’ office. The chairman knew that when it would become public that he had written cheques in the name of Mehta, he would be dead meat.

One rather unknown fact about this scam is that there was a very important player in this scam who managed to keep a very low profile. That man was Nimesh Shah.He was just as involved as Harshad Mehta but he knew how keep out of the hands of the law. Nimesh Shah still deals in the stock market and is known to be a heavy player.

Harshad Mehta is now dead. It is rumored that when he died, he still had 10% of ACC shares with him.