THE BANK SCAM AND LIBERALIZATION
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INTRODUCTION: What distinguishes 1992 from the rest of the period since Independence is that it witnessed a financial scandal unprecedented as much in magnitude as in the conduct of the Government, particularly the Union Finance Ministry, the Reserve Bank of India and the financial sector. DEVELOPMENT OF THOUGHT: The scam involved a problem exposure for commercial banks and other financial institutions of Rs 4000 crore. The scale of irregularities in securities transactions raised grave doubts about the efficiency of the RBI’s monitoring and the finance ministry’s own overseeing the working of the country’s financial system. While evidence of’ corruption has emerged as a result of CBI’s investigations and depositions before the Joint Parliamentary Committee, this does not explain all the problem exposure. Liberalization itself was in many ways responsible for the stock scam. CONCLUSION: The scam could not have taken place through dishonest individuals alone. It took place because the policy measures of the government were conducive and tolerant of it. Hence, there is a vital need for reform in the financial sector, if it is to function ably as well as responsibly. |
The financial market scam has brought out many oddities and deformities of our system to the fore. It is well known that a lot more remains to be known about the scam, its real magnitude and real culprits. Even the processes and forces associated with it have not yet been adequately documented.
What after all is the essential character of the murky deals discovered recently in our financial sector? Essentially the scam boils down to the deployment of a variety of dubious methods to divert the securities market and other short-term funds of the banks, surplus funds of public sector undertakings (PSUs) and other public financial institutions (PFIs), to the speculative.’ hot-house’ secondary share market.
This was possible through an unholy alliance between the banks, the share market brokers and the financial sector bureaucrats from a large number of development financial institutions and regulatory agencies under the half-open eyes and indulgent disposition of the RBI and the Finance Ministry. The banks and the financial institutions became enthusiastic and pliable instruments for making the public fund available to the unscrupulous brokers.
Spurred by the prospects of quick and huge gains and under the compulsion imposed by the Finance Ministry to improve their financial performance, wanting a 50 per cent increase in dividends in a single year, the public sector undertakings and private corporate entities parked their short-term surplus liquidity under various portfolio management services (PMS). These had been floated by the banks and their subsidiaries including, in a much bigger way, by the foreign banks to be made available to the stockbrokers. The PMS was operated largely as a substitute for short-run deposits in violation of the RBI directives and guidelines regarding returns, deployment, accounting, etc.
Frequent and large-scale transactions in the securities markets were affected, with the help of a number of brokers, who themselves are players in the securities and often stock-markets. While the banks employed brokers for their transactions, the brokers had their own transactions in securities mediated through the banks acting as brokers for their, broker-clients. This led to the development of a number of informal and close linkages between these institutions and the brokers.
Since the size and frequency of the dealings in securities preclude physical delivery and changes in the records of the Public Debt Office of the RBI take time, recourse was taken to Bank Receipts (BRs), which are to be discharged after appropriate adjustments in the accounts.
The scamsters indulged in massive abuse of the BRs to provide short-term liquidity to the stock market speculators by means of ready-forward and double-ready forward deals.
As these shenanigans were leading to a speculative boom in the share market, the authorities took it as an enthusiastic market response to the introduction of a liberalized policy regime and pro-growth, pro-rich, pro-foreign, capital budget. In any case, the financial dealings were increasing the income accruing to the institutions operating in the financial markets. The income contributed to the financial services sector was rising rapidly. This was helping the macro-economic managers to show improved performance of the economy. The foreign banks which have generally been treated on a rather preferential footing were adopting a number of `innovative’ devices to ‘earn disproportionate profits.
Given the nature of the scam and its magnitude, as recorded by the Janakiraman Interim Reports in excess of Rs. 12.25 lakh crore with nearly Rs 4000 crore coming under the shadow of bad debts, it is important to explore the roots of this scam. It is critical to unearthing the factors which permitted the scam. It is clear that factors like moral decay, inadequate controls and supervisions, political corruption and lack of computerisation etc., cannot go far in providing any credible explanation for the origin, timing and size of the scam.
These factors are constants with us for quite some time. They cannot, therefore, explain either the size or the timing or the ferocity or the extensive linkages and the indulgent attitude of the authorities towards it. It shows that nationalization, without social controls, social purpose and strict enforcement of accountability and periodic circulation of controllers, becomes the worst kind of action and bureaucratization, which in some cases, particularly in a mixed economy with inequities society and top-down democracy, can become the harbinger of serious and la long-term distortions.
 An examination of the essential elements of the scam brings out the crucial role played by some factors. There was a strong motivation for diverting the funds from the securities market to the stock market for brief spells of time. The system of banking regulation in the country created a large market for dealings in gilt-edged securities. This is a long-standing feature on account of the need to maintain the Statutory Liquidity Ratio (SLR). A system of trading in securities through the mediation of brokers has also been there for long. It was discovered in the course of time that contrary to the rules, the funds involved in the securities dealings and PMS can easily be lent or made available to the stockbrokers for a short period of time.
What could be the utility of the securities market funds briefly made available to the stockbrokers unless there emerged possibilities of their short-term highly profitable deployment? It seems the crucial factor in the process of diverting the money market funds to the capital market was the possibility of almost certain and sizable windfall gains in the latter. This was realised as the stock markets were dominated by bulls who, through their intensive trading in shares, pushed up the share price to dizzy heights.
 This behaviour can neither be explained in terms of the price to earnings (PE) ratio nor the basic strength of the companies whose share prices were booming. The share prices went up much beyond or even in the opposite direction of what was warranted by such basic, real factors. Their earning and dividends prospects, particularly in view of faltering production and sales, thanks to the recessionary conditions, slow-down and down-term in manufacturing output and growing number of sick units, were unlikely to support such high prices.
It is in this context that the stock market was booming quite unnaturally to unprecedented heights. This provided the rationale for the diversion of money markets funds to the capital market. The atmosphere of deregulation and self-regulation, corollaries of liberalization, made it possible for such diversions to go on merrily. Why did the stock market sky-rocket? Apparently, the demand for shares increased very rapidly. According to the estimates of Lehman Brothers demand for equity investment during 1992-93 was expected to increase by over Rs. 40.000 crores.
The supply or fresh issue of shares, despite, liberal industrial, trade and foreign capital policies, could not keep pace with such a massive spurt in demand. It became a case of too much money chasing too few shares. Without there be any appreciable increase in the rate of gross savings in the economy, which was practically stagnant around 22 per cent of GDP, and with net savings being in the vicinity of 13 percent of GDP, there was little reason to expect a shift in the demand of savers for equity, because lately interest rates have been revised upwards and a number of public sector units issued bonds on attractive terms.
Thus, in the normal course of development neither the absolute level of savings was increasing rapidly nor was the relative attractiveness of shares improving. Then, how does one explain the sharp and rapid increase in the demand for shares which made the diversion of short-term money market funds to capital market speculation so attractive and profitable?
 It seems highly probable that the whole economic outlook underwent a metamorphosis as a result of the policies of liberalization; marketisation and globalization introduced by the new government after it came to power in mid-1991. It is these policies which seem to have increased the demand for equity, particularly for the equity of existing companies in the secondary markets. The policies of industrial and trade liberalization, a number of fiscal bounties and enlargement of the scope for private sector investments improved the industrial prospects tremendously. Yet a concrete response of the market or of potential entrepreneurs in terms of fresh investment proposals and issue of equity was not comparable to the increase in the demand for equity.
Such an increase in demand for secondary market shares played a crucial role in the swindling of the banks and other financial institutions by the stock brokers. No factor other than the liberalization of policies regarding the industry, trade, fiscal, capital and ‘none); markets and opening up of the economy can probably explain this increase. The two budgets of the present government created virtual bonanza for the investors, industrialists, both Indian and foreign, by means of reduced income, wealth, corporate and capital gain taxes, time-bound promises of further tax cuts, free pricing of issues, exemption of shares and debentures from wealth tax, removal of capital issue control, impending liberalization and de-regulation of the financial sector, enhanced role of the private sector, dilution of FERA and MRTP Act, etc.
The fact that the writ of the IMF-World Bank duo was running over Indian policymaking gave a tremendous boost to private business, both Indian and foreign.
On top of all this was the discarding of all compromises from the growth of fundamentalism which continues to reign supreme in India. As a result, concern with equity, weak as it has been, was substantially watered down and financial sector growth and private capital were accorded key roles in the growth process. This led to relative overgrowth of the financial sector unrelated to the rural sector. As a result, though secondary sector, including its public component, accounted for about one-fourth of the GDP only, the capital market in Bomba alone saw daily over a lakh transactions, involving an annual turnover many times more than the fresh equity subscription every year.
 This support to ‘money making more money’ without in any way contributing to production reflected the reinvigorated policy stance which looked appreciatively at the speculative sharemarket boom, as many statements by the Finance Minister testify. The worst face of such factors as growth fundamentalism, overgrowth of the financial sphere and farewell to equity is shown by the total lack of concern over the receipt of a sum of nearly Rs 3800 crore by the securities brokers for mostly fraudulent deals. As a result of this perspective, an all-out quest for foreign exchange and attempts to send positive signals to the foreign investors made the government tolerate the illegal and highhanded activities of the foreign banks.
 The gospel of self-regulation with a good-bye to on-site inspections propounded by the Narasimham Report on financial sector reform emboldened the scamsters while weakening the resolve of the authorities to discipline and regulate the money-making games of all kinds played by various players in the financial markets.
 The Government gave in, in the face of a 20-day strike by the stockbrokers and thus the SEBI was rendered ineffective at its very inception. The disinvestment of PSUs shares at throw-away prices and in ‘a manner in which the PFIs can manipulate it to the advantage of a handful of brokers added to the size and dimensions of the scam. The amnesty schemes, initiated as a part of liberalization to bring into the open the black incomes and wealth hoarded at home and abroad was another means for facilitating the scam.
 It is clear from the above that the illegal and fraudulent practices prevalent for long in our financial markets involving banks, brokers and bureaucracy would not have assumed the dimensions they did without the big boost to the speculative spurt in share prices provided by the liberalization package. The relative overgrowth of the financial sector, total disregard of equity, nervousness vis-a-vis foreign banks on account of the imperative need for foreign borrowing, dismantling of controls over capital market without subjecting the share market to controls considered essential universally, etc were additional facets of liberalization which contributed to the scam. It is not dishonest individuals alone who could have caused it without a policy regime conducive to and tolerant of the scam.
