"Some of these fears are unfounded in the current
environment because the system has enough checks and balances to support a
wider bond market," said a veteran broker. The bond market is like a
world-class airport with very little air traffic.
It was a world where money was scarce, smart brokers struck deals with MNC banks to make money, stock transactions were not disclosed, and government bond deals were reported with a lag in single entry records in RBI ledgers. Harshad wanted to play the game that was confined to a handful of smart brokers and banks. He used the government bond market to fund his stock purchase. As a broker for deals where one bank borrowed against security from another bank, Harshad credited the cheque to his account instead of the borrowing bank's, and used the money to buy stocks.
Simply put, he was going short on bonds and long on stocks. In a tight money market with bond prices falling, he bought back bonds at a lower rate to cover the short. With the country's largest lender, State Bank of India, acting as financier, he not only took on the older players in the bond street but simultaneously pushed up stocks to levels unheard of. Stocks surged, traders followed him, and legitimate transactions gave way to illegal ones. Banks that borrowed often issued bank receipts, or BRs, instead of bonds as printing of securities took time.
The intention - and there was nothing fraudulent about it - was to allow institutions sell bonds purchased in a primary issue against letter of allotment. Frauds happened when banks, under the spell of Harshad and his followers, started issuing BRs with no proper security to back up. SBI, according to bankers of that era, discovered a Rs 500-crore hole in its bond book when tax officials trying to cross-check whether brokers have paid tax approached the bank.
As Harshad bought stocks, there was a parallel set of players who misused the bond market in a reverse way. They were the lenders in badla trades (done to roll over positions). Like Harshad, they too used the bond market and banks for finance. But unlike Harshad, they did not buy stocks, but lent the money to those who wanted to roll over their positions. In a way they shorted bonds as well as stocks.
TIME TO CHANGE
It was only natural that after the scam, doors to the bond market were shut for brokers. What had shocked the world then was not the nature of the deals, but the magnitude of the scam and the number of players involved. Today there are some signs that the doors may be opened up in the near future.
Perhaps, banks as well as regulators are beginning to understand the importance of a corporate bond market (which will remain shallow as long as government bonds stay the way they are). When banks, with their new and stifling capital rules, find it difficult to give loans endlessly, large borrowers like infrastructure companies and blue-chip corporates as well as mid-sized firms will turn to the bond market for funds. At that point, they should not run out of resources.
Retail investors in stocks, who were the biggest losers in the '92 scam (as in all scams), had returned to the market after some years. Regulators, however, take a long time to change their minds. If they fail to quickly bury the past, the price of an illiquid bond market can turn out to be far more than any scam.
It was a world where money was scarce, smart brokers struck deals with MNC banks to make money, stock transactions were not disclosed, and government bond deals were reported with a lag in single entry records in RBI ledgers. Harshad wanted to play the game that was confined to a handful of smart brokers and banks. He used the government bond market to fund his stock purchase. As a broker for deals where one bank borrowed against security from another bank, Harshad credited the cheque to his account instead of the borrowing bank's, and used the money to buy stocks.
Simply put, he was going short on bonds and long on stocks. In a tight money market with bond prices falling, he bought back bonds at a lower rate to cover the short. With the country's largest lender, State Bank of India, acting as financier, he not only took on the older players in the bond street but simultaneously pushed up stocks to levels unheard of. Stocks surged, traders followed him, and legitimate transactions gave way to illegal ones. Banks that borrowed often issued bank receipts, or BRs, instead of bonds as printing of securities took time.
The intention - and there was nothing fraudulent about it - was to allow institutions sell bonds purchased in a primary issue against letter of allotment. Frauds happened when banks, under the spell of Harshad and his followers, started issuing BRs with no proper security to back up. SBI, according to bankers of that era, discovered a Rs 500-crore hole in its bond book when tax officials trying to cross-check whether brokers have paid tax approached the bank.
As Harshad bought stocks, there was a parallel set of players who misused the bond market in a reverse way. They were the lenders in badla trades (done to roll over positions). Like Harshad, they too used the bond market and banks for finance. But unlike Harshad, they did not buy stocks, but lent the money to those who wanted to roll over their positions. In a way they shorted bonds as well as stocks.
TIME TO CHANGE
It was only natural that after the scam, doors to the bond market were shut for brokers. What had shocked the world then was not the nature of the deals, but the magnitude of the scam and the number of players involved. Today there are some signs that the doors may be opened up in the near future.
Perhaps, banks as well as regulators are beginning to understand the importance of a corporate bond market (which will remain shallow as long as government bonds stay the way they are). When banks, with their new and stifling capital rules, find it difficult to give loans endlessly, large borrowers like infrastructure companies and blue-chip corporates as well as mid-sized firms will turn to the bond market for funds. At that point, they should not run out of resources.
Retail investors in stocks, who were the biggest losers in the '92 scam (as in all scams), had returned to the market after some years. Regulators, however, take a long time to change their minds. If they fail to quickly bury the past, the price of an illiquid bond market can turn out to be far more than any scam.
http://timesofindia.indiatimes.com/business/india-business/Time-to-bury-the-ghosts-of-Harshad-Mehta-scam-and-revive-the-bond-market/articleshow/12906433.cms
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