3 Famous Indian Stock Market Crashes

A Brief Dive into India's Famous Stock Market Crashes

The stock market has always been susceptible to highs and lows, leading to both great fortunes and significant losses. India's stock market history is no exception, with several infamous crashes that have left a lasting impact on investors and the economy. This article delves into three significant stock market crashes that shook the nation, causing waves of panic and reshaping the financial landscape.

The Indian stock market has witnessed several major crashes that led to substantial losses for investors and impacted the economy. One such event was the Harshad Mehta scam of 1992 which involved manipulation of share prices leading to a market crash that erased nearly INR 5,000 crores of investor wealth. Using tactics like circular trading, price rigging and fictitious bank receipts, Harshad Mehta orchestrated one of the first major securities scams in India's financial history. This led to a 30% fall in the Bombay Stock Exchange Sensex over 3 months. Another crash occurred in 2008 when the global recession triggered large-scale selling in Indian markets, leading the Sensex to lose over 50% in a year. More recently, the spread of COVID-19 in 2020 resulted in a major market sell-off with the Sensex falling nearly 39% as India went into a national lockdown. Temporary halts in trading activity were imposed to curb heightened market volatility. While Indian stock markets have shown remarkable resilience in bouncing back after such crashes, these events highlight the market's vulnerability and the need for better risk management and regulations to build investor trust. Understanding the causes and impact of such crashes can provide useful insights for market participants.

1. The Harshad Mehta Scam (1992)

The Harshad Mehta scam, also known as the securities scam, refers to a financial fraud perpetrated by stockbroker Harshad Mehta in 1992. Often considered the biggest financial scam in India's history, it exposed major flaws in the Indian stock market and banking system at the time.

In the scam, Mehta exploited loopholes in the banking system to illegally raise funds from the banks which he then invested in stocks to inflate their prices artificially and make a quick profit. At its peak, the scam cost banks over ₹4,000 crores, though the exact figure remains disputed.

The scam shattered investor confidence, disrupted the economy, and highlighted the need for better regulation and oversight of the banking and financial sectors in India.

How the Scam Unfolded

Harshad Mehta was a prominent stockbroker in Mumbai during the early 1990s economic reforms when foreign investment and bull markets had led to a surge in stock trading volumes.

Taking advantage of weak internal auditing procedures in banks at that time, Mehta hatched an elaborate scheme to defraud the banks and stock market. The key mechanisms of the scam are outlined below:

Exploiting Bank Receipts (BRs)

• Mehta procured bank receipts (BRs) from smaller and little-known banks that were used to acknowledge interbank lending transactions
• He then used these fake BRs to obtain loans from large state-owned banks by creating the impression that the smaller banks had lent him money
• Mehta then invested this money in select stocks to inflate their prices

Circular Trading

• Mehta also took advantage of banks' 24-hour settlement cycle to engage in circular trading between his own accounts and client accounts
• This gave the impression of inflated trading volumes, thereby driving up stock prices
• The same funds were used to purchase more shares, amplifying the effect in a ripple effect

The Unraveling of the Scam

By 1992, Mehta had raised billions of dollars through these mechanisms which he invested across various shares that shot up dramatically seemingly overnight. This raised some suspicion among bankers and regulators who began scrutinizing his activities more closely.

A particular bank then accidentally discovered that the BRs provided by Mehta had not actually been issued by them. When they rejected his BRs, banks started demanding their money back from Mehta, leading to the eventual unraveling of the scam.

As Mehta defaulted on payments, investor confidence plunged, stock prices crashed, and the broader economy also faced disruptions. Eventually, Mehta was arrested and banned from stock trading while banks and regulatory bodies investigated the full scale of his fraudulent activities.

Key Impacts

The securities scam had some profound short and long term impacts on the Indian economy and financial system:

• Banks and financial institutions lost billions of dollars leading to a liquidity crisis
• Major stock indices like BSE Sensex crashed by over 40% after the scam broke out
• Retail investors suffered heavy losses undermining their trust in the stock market
• Economic growth slowed in subsequent years due to weakened investor sentiment
• Exposed flaws in RBI regulation such as short settlement periods for banks
• Led to establishment of SEBI as the markets regulator to improve oversight
• Stricter know your customer (KYC) norms introduced for bank accounts
• Improved computerization and internal auditing procedures in banks

Could a Scam of This Scale Recur?

Over 30 years later, the likelihood of a securities scam of the magnitude of Harshad Mehta recurring seems low though not impossible. This is because significant reforms and safeguards have been put in place since to improve transparency and regulation of India's capital markets and banking system. These include:

• Tighter settlement rules and electronic settlements to eliminate misuse of funds
• Increased vigilance by improved internal bank fraud controls
• Greater regulatory oversight powers of SEBI across capital markets
• Stricter KYC and auditing norms for all market intermediaries
• More extensive usage of surveillance tools like algorithmic trading alerts

However, newer and more technologically complex modes of financial fraud utilizing loopholes in Internet banking, forex trading etc. remain a concern. Scams still keep occurring though their scale and impact have greatly reduced after the lessons learnt from the securities scam of 1992.

Regular evaluation of existing safeguards alongwith appropriate regulations around new domains like fintech, high frequency trading etc. is crucial to protect market integrity and the interests of retail investors in India.

2. The Global Financial Crisis of 2008: Causes, Impact, and Lessons

The global financial crisis of 2008, also known as the Great Recession, was the worst economic disaster since the Great Depression of the 1930s. This economic meltdown originated in the United States but soon spread to Europe and the rest of the world, causing severe economic damage globally.

Causes of the Global Financial Crisis

The crisis had multiple complex causes, including:

• Excessive risk-taking and poor regulation of financial institutions, especially in the US housing and mortgage sector
• Proliferation of complex and risky financial products like collateralized debt obligations (CDOs)
• Loose monetary policy and low-interest rates in the early 2000s
• Global trade and financial imbalances
• Predatory lending practices and relaxation of credit standards
• Over-leveraging by investment banks, households, and financial speculators

The main trigger was the bursting of the United States housing bubble, as rising interest rates made housing unaffordable. As home prices declined, subprime mortgages began entering default in large numbers. With property values falling, banks wrote down billions in mortgage-related losses.

Impact of the Financial Crisis

The crisis had severe and wide-ranging consequences, including:

• Stock markets crashing - The Dow Jones fell 53% from its 2007 high
• Economic contraction and recessions in many countries
• Systemic banking failures like that of Lehman Brothers
• Government bailouts of distressed banks and financial institutions
• High and prolonged unemployment - Unemployment in the US peaked at 10%
• Declines in international trade and capital flows
• Sovereign debt crises in Europe

Millions lost their jobs, incomes, savings, and homes as a result of the crisis, while economic inequality rose. The crisis erased trillions in global economic growth and caused economic pain that took years to recover from.

India's stock markets were not immune to the global financial crisis which began in 2008 in the wake of subprime mortgage market collapse in the USA. The crisis triggered unprecedented waves of panic as major financial institutions collapsed across the Atlantic and USA government was forced to organize bailouts. Sentiment driven sell-off in global equities markets ensued as economic fears gripped investors worldwide. The contagion spread to impact Indian bourses leading to a sharp decline. The BSE Sensex lost over 50% within a year, falling from 21,000 points to under 10,000 points in the span of 10 months. Majority of stocks witnessed significant beating as market volatility spiked exponentially during this tumultuous period. Trading activity hit historic highs as India saw an economic slowdown coupled with high inflation. The crisis underlined the interconnectedness of markets due to globalization. While India's strong economic fundamentals helped markets gradually recover, this period reinforced the need for stringent risk monitoring policies for domestic investors and financial institutions. By optimizing risk management frameworks and following prudent market practices, India can fortify its stock markets against external shocks during times of global economic stress.

Lessons from the 2008 Financial Crisis

While the crisis caused tremendous damage, several crucial lessons were learned:

• Stricter regulation of banks and close monitoring of systemic risk
• Increased capital reserve requirements and limits on leverage
• More oversight on the creation/trading of complex financial products
• Better consumer protection laws and regulations against predatory lending
• Importance of coordinating monetary and fiscal policies globally during crises
• Need for rainy day funds to better withstand economic shocks
• Focus on responsible lending and borrowing practices by all parties

By learning from past mistakes, the hope is that the economic system will grow more resilient against similar disasters happening again. Tighter control of greed and speculation in finance should lead to sustainable long-term economic growth.

The 2008 crisis was an economic catastrophe but making the right policy choices to fix flaws in the system makes the economy safer. With prudent regulation and coordinated policy, the financial sector can power global growth rather than endanger it.

3. The COVID-19 Pandemic Stock Market Crash in India in 2020

The COVID-19 pandemic caused unprecedented economic damage globally, including triggering the worst stock market crash in India since the 2008 financial crisis. Implementation of necessary lockdowns, public health measures, and mobility restrictions led to severe disruptions in economic activity.

Causes of the Crash

The Indian stock market, represented by the benchmark indices Sensex and Nifty, crashed due to several pandemic-related factors:

• Sharp reduction in economic output and demand
• Disruptions to manufacturing and supply chains
• Flight of foreign institutional investors (FIIs)
• Declines in exports, trade, and tax collections
• Uncertainty about depth and duration of crisis
• Panic selling by investors

In March 2020, foreign portfolio investors sold nearly INR 1 lakh crore of Indian shares, sparking a market rout. As pandemic fears grew, the Sensex plunged from 41,000 points in January 2020 to a 3-year low of 25,638 points on March 24, 2020.

Impact on the Economy

The stock market carnage amplified India's economic woes during the pandemic:

• Wealth erosion for investors and households
• Tighter credit and financial conditions
• Loss of fiscal revenues from taxes on capital gains
• Currency weakness
• Reduced business confidence and investment
• Job losses and reduced incomes
• Plunge in economic growth to -7.3% in FY 2021

The rapid market declines and evaporating liquidity exacerbated the COVID-induced recession.

Lessons Learned

While the pandemic stock market crash was difficult to avert, lessons can be learned:

• Need for better pandemic risk assessment and preparedness
• Developing fiscal buffers for crisis situations
• Rethinking excessive reliance on foreign funds
• Reviewing circuit breaker mechanisms during routs
• Maintaining accommodative monetary policy
• Focusing economic relief on affected communities
• Staying calm and avoiding panic selling
• Having long-term investment horizons

With the right structural reforms and policy responses, the Indian economy and markets have good prospects for recovering from the pandemic. But better risk management is key to build resilience against such Black Swan events.

The COVID crash taught that investors and regulators must work hand-in-hand to strengthen the market's shock absorbers. With prudent regulation and continued economic liberalization, India can achieve sustainable high growth despite global crises.

You may also like to read - 5 Biggest Speculative Bubbles That Shook Global Financial Markets

Conclusion

These famous stock market crashes in India remind us of the inherent risks associated with investing in financial markets. They highlight the importance of a well-regulated financial system, investor awareness, and risk management strategies. Despite the turmoil caused by these crashes, the Indian stock market has shown resilience and the ability to rebound over time. However, the lessons learned from these crashes remain invaluable in shaping investor behavior and policy decisions to prevent such events from recurring in the future.