Role and Structure of Capital Markets
The capital market is a key component of the financial system that deals in long‑term funds—both equity and debt—mobilised within the country and from abroad. It channels savings from households and institutions into productive investment by enabling the issuance and trading of securities over longer horizons than the money market.
This intermediation happens primarily through two routes. In the primary market, new securities are issued to raise capital for deficit sectors such as the government and corporate borrowers and to provide funding to financial intermediaries. These fresh issues convert the surplus cash of savers into long‑term productive finance. The secondary market complements this by allowing existing securities to be bought and sold, providing investors with liquidity and price discovery.
Liquidity in the secondary market is particularly important for long‑gestation projects. Many profitable investments require funds to be locked in for extended periods, and savers are hesitant to commit without a feasible exit option. A liquid market reduces the cost and risk of exiting an investment, thereby encouraging greater participation and facilitating the flow of long‑term capital.
For these reasons, the development of an efficient capital market is essential to create a favourable investment climate, mobilise savings effectively, and support sustained economic growth.
Core Functions of Capital Markets
An efficient capital market performs several interrelated functions that sustain economic growth and channel resources where they are most productive. At its core, a capital market mobilizes long‑term savings and transforms them into long‑term investments, supplying risk capital—by way of equity or quasi‑equity—to entrepreneurs and firms. By enabling people to own shares in productive enterprises, it broadens ownership of productive assets across the economy.
A well‑functioning market also provides liquidity, giving investors a mechanism to sell financial assets when needed, and enables rapid valuation of both equity and debt instruments. Through transparent, competitive pricing it lowers the costs of transactions and information and thereby improves the efficiency of capital allocation—so funds flow to projects offering the best risk‑adjusted returns.
Timely and widespread dissemination of information is another key function: market mechanisms and disclosure practices equip participants to form informed views about investing, disinvesting, reinvesting or holding particular instruments. Complementing information flows, markets offer tools to manage risk—derivative trading helps hedge market or price risk, while investor protection mechanisms address default risk.
Capital markets also expand participation by increasing market breadth: networking institutions and intermediaries encourage wider involvement by individuals and institutions. Operational efficiency is fostered through simplified transaction procedures, shorter settlement cycles, and lower transaction costs, all of which make market participation more attractive.
Finally, capital markets promote integration across the economy—linking the real and financial sectors, equity and debt instruments, long‑term and short‑term funds and interest rates, private and public sectors, and domestic and external sources of finance. By doing so they help direct the flow of funds into the most efficient channels through investment, disinvestment and reinvestment.
Structure and Functions of Capital Markets
The capital market comprises two interlinked segments. The primary market is where new securities are issued and funds flow directly to issuers—companies or governments—through mechanisms such as initial public offerings, rights issues and private placements. The secondary market, by contrast, is where already-issued securities are bought and sold among investors on stock exchanges or over-the-counter platforms; it provides liquidity, facilitates transferability and enables continual price discovery. Together, these markets channel long-term savings into productive investment and allow investors to trade and value financial claims.
The primary market channels long-term savings into productive uses by transferring funds from the surplus sector (households and other savers) to the government and corporate sectors through new issues of securities. Financial intermediaries—banks and non‑bank institutions—also play a role in mobilising and reallocating these funds, often participating in secondary market transactions. When corporates raise resources through primary issues, the proceeds are typically invested in capital formation: acquisition of fixed assets and additions to inventories. This investment expands productive capacity, improves efficiency, creates employment, and ultimately helps generate wealth.
Fund-raising in the market can be domestic or external. Domestically, equity is raised through primary issues by corporates and through transactions involving financial intermediaries; debt is issued by the government and corporates as primary issues, while financial intermediaries may also be active in secondary debt markets. On the external front, equity can be raised via Global Depository Receipts (GDRs) and American Depository Receipts (ADRs); debt can be sourced through External Commercial Borrowings (ECBs) and other external borrowings. Foreign direct investment (FDI) is another channel, available in both equity and debt forms, while foreign institutional investors (FIIs) provide portfolio flows. Non‑resident Indian (NRI) deposits—short‑ and medium‑term—also constitute an important external source of funds.
Within the primary market itself, companies raise capital through a few distinct routes: public issues made by prospectus to the general public, private placements to selected investors, rights issues offered to existing shareholders, and preferential allotments. Each route has different regulatory and disclosure implications but serves the same core purpose of converting savings into productive investment.
Foreign investment in India takes two broad forms: direct equity participation and portfolio flows. An investor is classified as making a foreign direct investment when they acquire more than 10 per cent of a company’s equity. Such investors—often multinational corporations—have long been active across key industries such as pharmaceuticals, consumer durables, FMCG, engineering and financial services, and more recently in telecom, banking and insurance. Multinationals typically enter India either by establishing a wholly owned subsidiary or by forming a joint venture with local partners. FDI is prized for helping bridge the savings–investment gap: it brings modern technology, access to export markets and generates both direct and indirect employment. Because it usually supports long‑term projects, FDI is relatively stable. At the same time, it can crowd out domestic firms, so authorities commonly impose conditions—minimum local content, export commitments, technology transfer obligations and compulsory listing on Indian stock exchanges—to protect domestic interests.
To raise long‑term capital, the government has set a target of attracting US$150 billion of FDI over the next ten years with a focus on infrastructure, financial services and agriculture. Achieving this depends on stable policies, predictable tax laws and incentives, minimal red tape and a corruption‑free environment. To identify and resolve investor difficulties, the government has created an investment commission. It has also liberalised entry in several sectors by raising FDI caps to 100 per cent in areas such as airports, power trading, petroleum marketing, distillation and brewing of potable alcohol, captive mining in coal and lignite, industrial explosives and hazardous chemicals; investments in these sectors no longer require approval from the Foreign Investment Promotion Board.
Portfolio flows, or foreign institutional investments, play a different role. FIIs invest in both primary and secondary capital markets and are useful for meeting short‑ to medium‑term financing needs. They support capital formation by subscribing to new issues in the primary market and by releasing existing risk capital through active trading in the secondary market. Regulatory limits have historically constrained FII holdings—for example, individual FII investment in a company has been capped at 24 per cent, with any additional foreign investment requiring the company’s board approval and not exceeding sectoral foreign‑investment ceilings. FIIs contribute to the development of capital markets and provide a channel for entrepreneurs to raise funds for new projects or expansion, but their flows can be volatile; sudden outflows may occur if market conditions deteriorate or investor sentiment turns negative.
The secondary market is the arena in which outstanding securities are bought and sold. Unlike the primary market, where new issues generate fresh capital, the secondary market does not create additional funds; it provides liquidity and marketability for existing equity and debt instruments. Equity instruments have no fixed maturity and can be traded continuously, whereas debt instruments trade in the secondary market until they reach their defined maturity. By enabling investors to sell existing holdings and reinvest elsewhere, the secondary market channels resources toward more efficient uses and thereby supports economic growth.
A key function of the secondary market is to provide continuous price information. Market prices react to company‑level and industry‑level developments and thus supply an almost instantaneous valuation for both equity and debt. These valuations help measure the cost of capital and expected rates of return at the microeconomic level, informing corporate and public-sector decision making. More broadly, the secondary market lowers the cost of capital by offering liquidity, facilitating price discovery, and allowing risk transfer. Liquidity means an asset can be bought or sold quickly, at low transaction cost and without materially affecting its price. Price discovery is the process by which buyers and sellers establish an equilibrium price, which is essential for planning investment, pricing, and other strategic choices. Derivatives markets, which form part of the broader secondary-market ecosystem, reveal market expectations about future prices of commodities, currencies, interest rates and securities; governments and firms use this information to time issues, set pricing commitments and plan capacity expansion.
The secondary market also creates a wealth effect. Rising share prices increase market capitalization, and this notional increase in financial wealth accrues—at least on paper—to governments, corporates, promoters, institutional investors and individuals. Regular dividend payments from companies or mutual funds reinforce this sense of greater wealth. When financial wealth increases, consumer spending tends to rise over time, which in turn can stimulate broader economic growth.
In India, the secondary market can be divided into two broad segments. The first covers trading in corporate securities and those of financial intermediaries. These trades take place on recognized stock exchanges, including the National Stock Exchange of India (NSE), the Over the Counter Exchange of India (OTCEI) and the Interconnected Stock Exchange of India (ISE). Market activity is conducted by registered brokers—both individual and institutional—who operate through networks of sub‑brokers and dealers and are linked by electronic trading and settlement systems.
The second segment comprises the secondary market for government securities and public sector undertaking (PSU) bonds. This market encompasses short‑term money‑market instruments such as Treasury Bills as well as longer‑dated government bonds with maturities typically ranging from five to twenty years. Major participants include primary dealers, commercial banks, financial institutions and mutual funds. Since September 1994, transactions in government securities have been carried out through the Subsidiary General Ledger (SGL), and both government and PSU bonds are traded in the Wholesale Debt Market (WDM) segments of the NSE, the Bombay Stock Exchange and the OTCEI.
Evolution of Indian Capital Markets
The Indian capital market has evolved over more than two centuries, beginning informally in the late eighteenth century when securities of the East India Company changed hands. For much of the nineteenth century trading remained unorganized and concentrated in the port cities of Bombay (now Mumbai) and Calcutta (now Kolkata), with Bombay emerging as the principal centre where bank shares predominated. A notable early boom occurred during the American Civil War (1860–61), when Bombay’s cotton trade flourished and share prices rose sharply; that boom collapsed on 1 July 1865 in a severe slump. Trading at the time was conducted by a small group of brokers who met under a banyan tree in front of Bombay’s Town Hall. These brokers formed an informal association in 1875—the Native Shares and Stock Brokers Association—which over time gave rise to formal stock exchanges in Bombay, Calcutta and Ahmedabad. The Bombay Stock Exchange received formal recognition in May 1927 under the Bombay Securities Contracts Control Act, 1925.
Under British rule the capital market remained underdeveloped because the colonial administration directed Indian capital largely toward London rather than nurturing domestic markets. After independence the market continued to be small. Early planning priorities—agrarian development and building public sector undertakings—meant that public enterprises absorbed much of the capital. Even when public sector companies had substantial paid-up capital, many of their shares were not listed. Further, the Controller of Capital Issues exercised strict control over new issues—monitoring timing, pricing, composition and allotment—which discouraged public offerings for several decades.
The 1950s brought both speculation and institutional development. A few scrips—Century Textiles, Tata Steel, Bombay Dyeing, National Rayon and Kohinoor Mills—became favourites of speculators, earning the market the nickname “satta bazaar.” Despite speculation, defaults were not widespread. To bring order to trading, the government enacted the Securities Contracts (Regulation) Act, 1956 and the Companies Act, 1956, while also building a network of financial institutions and state financial corporations to support capital formation. The 1960s, marked by wars and droughts, produced bearish markets and, in 1969, a ban on forward trading and the practice of badla (a mechanism for carrying forward positions and for borrowing funds), which further depressed sentiment. Institutional investors such as LIC and GIC and the creation of the Unit Trust of India in 1964 helped stabilise investor confidence.
The 1970s saw a partial revival when badla trading reappeared in a modified form, but the market was jolted again on 6 July 1974 by the Dividend Restriction Ordinance, which sharply limited dividend payouts and caused Bombay Stock Exchange market capitalisation to fall by about 20 per cent overnight, with trading halted for nearly a fortnight. A significant and more enduring stimulus to equity culture came from FERA-induced dilution of multinational holdings in the early 1970s. Forced divestments led to the offer of shares by over a hundred multinationals, bringing millions of new shareholders into the market and creating widespread retail interest in equity ownership. The late 1970s also marked the rise of new domestic entrepreneurial issuers—most notably Reliance Textiles in 1977—which became prominent market favourites.
The 1980s brought rapid expansion. Government liberalisation beginning in the mid-1980s, the popularity of convertible debentures, the introduction of public sector bonds, and landmark primary issues such as Reliance Petrochemicals and Larsen & Toubro revived the primary market and increased turnover in the secondary market. This decade saw growth in the number of exchanges, listed companies, paid-up capital and market capitalisation as millions of new investors entered equity markets.
The 1990s were transformational. As liberalisation and globalisation accelerated, the Capital Issues (Control) Act, 1947 was repealed in May 1992, ushering in free pricing and a much freer primary market. The decade witnessed a new industrial policy, the emergence of SEBI as the market regulator, entry of foreign institutional investors, euro-issues, new trading practices and market intermediaries—including private mutual funds and banks—and the establishment of new exchanges. However, the period was also marked by major scams that shook investor confidence, most famously the securities scam of March 1992, and later episodes such as the M S Shoes case in 1995. These crises exposed weaknesses in market regulation and prompted sweeping reforms.
Reform in the 1990s combined regulatory change with technological modernisation. New national institutions and market infrastructure—such as the Over the Counter Exchange (1992), the National Stock Exchange (1994), the National Securities Clearing Corporation (1995) and the National Securities Depository Limited (1996)—improved trading, clearing and settlement and enabled dematerialised trading. The Securities Contracts (Regulation) Act was amended in 1995–96 to permit options trading, and rolling settlement for the dematerialised segment began in January 1998. Wider automation and the spread of electronic trading facilities expanded participation across the country.
By the late 1990s the market’s composition changed as “new economy” stocks—information technology, telecommunications and media companies such as Infosys, Wipro and Satyam—dominated trading, reflecting a shift toward knowledge-intensive enterprises. Entering the twenty‑first century, the market endured further shocks, notably the Ketan Parekh episode, which led to the discontinuation of badla from July 2001 and the extension of rolling settlement to all scrips. Derivatives trading began in June 2000 and internet trading was permitted from February 2000. In July 2001 the Unit Trust of India suspended sales and repurchases under its flagship US‑64 scheme amid heavy redemptions, a sign of remaining fragility. Subsequent policy decisions—such as the privatisation and divestment of public sector undertakings, including the sale of VSNL in early 2002—helped deepen markets, and foreign institutional investors have since become major players. The National Stock Exchange has overtaken the Bombay Stock Exchange in trading volumes and in derivatives activity.
Today the Indian capital market is the product of a long journey from unorganised beginnings to a largely organised, integrated and technologically advanced system. Modern clearing, settlement and depository mechanisms, widespread automation and internet trading have reduced geographic barriers, broadened the investor base and integrated Indian markets more closely with global capital flows.
Evolution of Indian Equity Markets
A Brief History of the Rise of Equity Trading in India
The organized beginnings of equity trading in India date back to July 9, 1875, when native brokers in Bombay formed the Native Share and Stock Brokers’ Association. Membership was deliberately accessible—set at Re. 1—and the association soon numbered 318 members. Over the next decades the market gradually built physical and institutional infrastructure: by 1899 the Bombay Stock Exchange (BSE) had acquired its own premises, and in 1921 clearing houses were established to settle rising volumes of trades. In 1923 K. R. P. Shroff became the BSE’s honorary president, and in 1925 the Bombay Securities Contract Control Act (BSCCA) came into force, bringing regulatory structure to trading. The exchange building itself was formally acquired on December 1, 1939, and during World War II forward trading was banned (from 1943), permitting only ready delivery and hand-delivery contracts until 1946.
In the post‑war and early post‑Independence period the legal and institutional framework evolved further. The Securities Contract Regulation Act, modeled on the BSCCA, was enacted in 1956 to consolidate rules governing securities contracts. In 1957 the BSE became the first Indian exchange to receive permanent recognition. The Unit Trust of India (UTI) was established in 1964, and on April 1, 1966, K. R. P. Shroff retired, succeeded by Phiroze J. Jeejeebhoy. A policy shift arrived on June 29, 1969, when the government under Morarji Desai again banned forward trading. The 1970s saw the beginning of modern exchange infrastructure: construction of the P J Towers, named for Phiroze Jamshedji Jeejeebhoy, began in 1973.
The 1980s and 1990s were transformative as markets modernized and liberalized. On January 2, 1986, the BSE launched the Sensex—the first Indian stock market index, with 1978–79 as its base year. Mutual fund activity expanded: SBI Mutual Fund launched the Magnum Regular Income Scheme in November 1987. Regulatory oversight was strengthened with the setting up of the Securities and Exchange Board of India (SEBI) in April 1988; SEBI acquired statutory powers in January 1992. The early 1990s brought both crisis and reform. The Harshad Mehta securities scam broke in 1992, precipitating major changes including repeal of the Capital Issues Control Act, 1947, an opening to foreign institutional investors (FIIs), and the birth of new market institutions.
Modern trading architecture and new market segments emerged rapidly. On May 27, 1992, the Over the Counter Exchange of India was inaugurated, and within days private sector mutual funds—such as Kothari Pioneer—began operations. SEBI banned badla trading on the BSE in 1992. The National Stock Exchange (NSE) launched its wholesale debt market segment in November 1992 and put its capital markets segment on stream as a screen‑based trading platform shortly thereafter, marking the first time in India that trading was fully electronic. The BSE introduced its own on‑line system, BOLT, replacing open outcry, and the National Securities Clearing Corporation Limited—India’s first clearing corporation—was set up to bring transparency and settlement efficiency. As turnover shifted to electronic screens, the NSE overtook the BSE in trading volumes and the Nifty index was created. The National Securities Depository Limited (NSDL) was established to facilitate dematerialization of securities, and SEBI issued formal norms for takeovers and acquisitions.
Through the mid‑1990s exchanges continued to automate and expand services: the BSE introduced screen‑based trading; the NSE launched an automated lending and borrowing mechanism (ALBM); and SEBI recognized an Interconnected Stock Exchange formed by 15 regional exchanges (recognition in 1996, with the exchange beginning operations in February 1999). Depository and cross‑border links also advanced: Central Depository Services (India), promoted by the BSE, commenced operations, and several Indian companies achieved listings abroad—Infosys became the first Indian company to list on NASDAQ through ADRs, and ICICI was the first Indian company listed on the New York Stock Exchange.
The late 1990s and the turn of the century were marked by rising market capitalization, new products and historic highs. In 1999 the Sensex crossed the 5,000 mark for the first time, and in early 2000 it reached new peaks—on February 14 the BSE Sensex hit an all‑time high of 6,150, while on February 21 the NSE recorded a peak market capitalization of Rs 11,94,282 crore. Exchanges expanded product offerings: in 1999–2000 both the BSE and the NSE introduced index futures and later futures and options on individual stocks. The Sensex composition was revamped in April 2000 to reflect changing corporate prominence. By July 9, 2000, the BSE celebrated 125 years of operation. Internet‑based trading began to take hold, with the NSE commencing internet trading and the BSE moving toward broader electronic access.
In the years that followed, Indian equity markets continued to deepen and integrate with global capital markets. On October 19, 2000, Wipro listed on the NYSE. The BSE launched the Borrowing and Lending of Securities Scheme (BLESS) on January 22, 2001 to promote securities lending and borrowing. Market integrity was tested by episodes such as the Ketan Parekh scandal (2001), which led SEBI to suspend several broker‑directors and to tighten governance. The exchanges and the regulator took steps to increase transparency and reduce settlement risk: dematerialization was progressively mandated for various categories of scrips, index options and options on individual scrips began trading on the NSE, carry‑forward positions were banned, major securities moved to rolling settlement, and the commodity futures regulator (Forward Markets Commission) was eventually merged with SEBI—a structural change aimed at unified regulation of securities and derivatives. The BSE itself became an issuer of an initial public offering, which was listed on the NSE, reflecting how the exchange had evolved from a member‑driven body to a corporatized market participant.
Over more than a century, India’s equity markets have moved from informal native broker gatherings to a modern, electronic, and regulated market ecosystem—characterized by transparent electronic trading, central clearing and depositories, derivatives, mutual funds, foreign participation, and growing linkages with global capital markets.
Capital Market Scandals and Reforms
The post‑liberalization period in India’s capital markets was marked by a recurrent pattern of high‑profile scams, creating the impression that market opening and regulatory failure went hand in hand. The most notorious episode was the 1992 securities scam, orchestrated by Harshad Mehta and his network of bull operators with the collusion of some banks; its effects were so severe that the Bombay Stock Exchange (BSE) remained shut for a month. In the years that followed, unscrupulous promoters—especially of finance companies—exploited free pricing to raise funds through price rigging and other manipulative practices. Grey‑market activity became commonplace: securities were quoted at substantial premiums before formal listing, luring investors into speculative positions during subscription periods.
Several successive episodes underlined the systemic vulnerability. In March 1995 the M. S. Shoes affair, led by exporter Pavan Sachdeva, saw engineered price rises followed by a collapse that forced the market to close for three days. Later that year, a share‑switching controversy involving Reliance Industries, Fair Growth Financial Services and the exchange prompted the BSE to suspend trading in the Reliance script for three days. In May 1997 the collapse of C. R. Bhansali’s CRB Capital Markets exposed deep weaknesses in the regulatory framework: by manipulating his firm’s balance sheet and offering high‑rate deposits, Bhansali secured funds and the leverage needed to influence market prices, ultimately harming investors who had been enticed by attractive returns.
Price rigging continued to resurface as a recurring malady. In 1998 the technique was used again in scrips such as BPL, Videocon and Sterlite, precipitating a payment crisis; brokers who had built large positions were implicated, and some securities were debarred from trading for years. In the aftermath of these episodes, SEBI penalized several senior figures—including J. C. Parekh and other BSE board members—for price rigging and insider trading. A similar pattern reappeared in March 2001, when Anand Rathi, then president of the BSE, and six other broker‑directors were removed by SEBI for misconduct. Around the same time, Ketan Parekh emerged as a dominant market bull and took advantage of the same regulatory gaps, contributing to another damaging market episode.
Across these scandals the methods were strikingly consistent: price manipulation, insider trading, cartels and collusion, often involving bankers, brokers, politicians and promoters and usually timed around public issues or corporate restructurings. Regulatory responses were typically reactive, coming only after investors had suffered losses; limited investor awareness and the lure of quick gains made manipulation easier. Many post‑scam inquiries remain ongoing, reflecting the long tail of these failures and the continuing need for stronger market governance.
This chapter examines in detail two landmark episodes of the post‑liberalization era: the 1991–92 securities scam (the Harshad Mehta affair) and the 2001 Ketan Parekh scam.
The 1991–92 securities scandal, commonly known as the Harshad Mehta scam, grew out of India’s economic liberalization. As controls were removed and a market-oriented economy took shape, banks faced a new interest-rate environment and pressure to improve profitability. At the same time the Reserve Bank of India (RBI) enforced statutory liquidity ratio (SLR) requirements strictly to control money supply. These forces pushed public-sector banks into heavier trading in government securities, but rising yields on long-dated government bonds meant valuations of older holdings were falling. To mitigate capital losses, banks increasingly used a funding arrangement known as the ready forward or repo: selling securities on a spot basis and agreeing to repurchase them at a future date.
Repos are legitimate financial instruments, but in 1991–92 many inter‑bank deals were tainted by illegal insider information and procedural misuse. Banks wary of depreciation on held securities preferred to enter into ready forward contracts with counterparties that had surplus holdings, turning these deals over every fortnight to manage SLR computations. The RBI’s interim panel on securities noted instances of insider trading: for example, the State Bank of India purchased large quantities of government bonds on a ready forward basis one day before coupon rates were raised.
Beyond insider information, the market suffered extensive document misuse. Bank receipts (BRs), which should have functioned as acknowledgements for transfers of government securities, were forged and double-counted; SGL (Subsidiary General Ledger) forms were misused as well. This created the illusion of much larger securities holdings and helped inject an artificial expansion of money into the market. Small institutions issued BRs far beyond their resources—one regional bank with an equity base below Rs 1 crore issued BRs reportedly worth tens of thousands of crores, and major foreign banks accepted those receipts. A small number of brokers orchestrated an enormous volume of such transactions. RBI statistics cited in the interim report showed that of some 57,980 transactions totaling over Rs 9,00,000 crore in a 14‑month period beginning April 1991, only about 5.26 per cent were outright purchases; more than two‑thirds of transactions were concentrated in four foreign banks, over 60 per cent were routed through brokers, and nearly 95 per cent—roughly Rs 8,58,511 crore—were commitments to repurchase or resell securities. In more than 40 per cent of these cases, the commitments existed only as informal understandings and were undocumented.
Banks seeking higher returns also channelled client funds into equity markets through portfolio management arrangements offered by brokers. Harshad Mehta exploited these channels: by deploying funds—principally mobilised via inter‑bank ready forward deals and misused BRs—into select stocks, he helped engineer a rapid rise in prices. Mutual funds, newly encouraged by government policy and eager to offer attractive returns, further amplified the flow of funds into equities. Some corporate promoters engaged in insider trading to prop up share prices and fend off hostile takeovers. With large sums concentrated in a few brokers’ hands, the BSE Sensex surged dramatically—gaining about 1,500 points in 15 days at one stage.
The market boom that began in July 1991 peaked in April 1992 and then collapsed. Many stocks—Apollo Tyres, ACC, Castrol India, East India Hotels, GE Shipping, GNFC, Deepak Fertilisers and Chemicals, Tata Chemicals, among others—rose several-fold within a year. A wide range of institutions were implicated, including National Housing Bank, Bank of Karad, Metropolitan Co‑operative Bank, Standard Chartered Bank, Citibank, Bank of America, ANZ Grindlays, and several non‑bank financial companies. Between March 1991 and March 1992 the BSE sensitive index climbed from 1,168 to 4,285; at the peak the market capitalization was reported as an amount roughly half of GDP, compared with about one‑fifth the year before, and the market price‑to‑earnings ratio reached an unusually high level of about 55. The monetary extent of the securities fraud was later estimated at around Rs 73,542 crore. When the scandal surfaced, the Sensex fell sharply and the BSE was closed for a month.
The scam exposed serious weaknesses in India’s financial architecture: regulatory and procedural loopholes, misuse of instruments, and pervasive corruption. In response, the RBI banned inter‑bank repos and financial sector reform gathered renewed momentum. The government set up a special court by ordinance in June 1992 to expedite trial and to oversee identification, attachment and liquidation of assets; a court‑appointed custodian was tasked with auctioning assets and distributing proceeds. Reported bank exposure in the scandal ran into thousands of crores, with some banks—Standard Chartered and the State Bank of India among them—bearing significant losses. Banks lodged claims running into several thousand crores including interest; the custodian subsequently disbursed sums to banks (including a large payment to the SBI group) and transferred substantial recoveries to the Income Tax department as part of the settlement and recovery process.
In the late 1990s and early 2000s global investor enthusiasm for the new-economy sectors—Information Technology, Communications and Entertainment (the so‑called ICE stocks)—created fertile ground for price manipulation in India. Ketan Parekh exploited this trend by colluding with promoters and using a network of broking houses to pump up a set of favoured counter stocks, commonly referred to as the “K‑10” scrips. Stocks such as HFCL, Satyam and Global were driven to valuations comparable with international P/E levels, largely through coordinated buying and aggressive placement with institutional investors.
Parekh’s operations combined a complex distribution of orders through his own broking firms and dozens of satellite brokers, selective use of city-based brokers in Kolkata and Ahmedabad, and funding from non‑resident Indians and some private banks willing to accept shares as collateral. Institutional flows from mutual funds and foreign investors, who were heavily investing in technology and telecom names at the time, further buoyed these scrips. Parekh would bolster liquidity when demand rose and intervene forcefully to buy downfalls in his portfolio, while arranging the placement of shares with institutions at substantial premiums.
The speculative rally gathered momentum from May to November 1999, when Parekh’s concentrated trading in HFCL, Global, Satyam and Zee contributed to a sharp rise in the Sensex—from roughly 3,378 to over 4,400 points—and later to a peak near 6,100. The subsequent global correction in ICE stocks, however, precipitated a steep fall. As prices collapsed, margins on shares pledged as bank collateral eroded quickly. Banks began demanding fresh collateral or repayment; some, in turn, injected funds in an attempt to prop prices. The pressure exposed a wider liquidity squeeze among major bull operators and triggered disputes on the Kolkata Stock Exchange, where a large portion of trading was then conducted unofficially through cash badla arrangements. As badla rates spiked, many counterparties—including brokers in Kolkata—found themselves unable to meet obligations, producing a payment crisis in mid‑March 2001 and defaults by dozens of brokers.
A central weakness in Parekh’s funding chain was his relationship with the Ahmedabad‑based cooperative bank, the Madhavpura Mercantile Co‑operative Bank (MMCB). MMCB issued pay orders and extended large facilities without corresponding cash balances or acceptable collateral—practices that violated norms laid down by the Reserve Bank of India for cooperative banks. Several commercial banks, including the Bank of India, accepted and discounted these pay orders; when many of them bounced, the Bank of India pursued legal action. Parekh reportedly paid only a small fraction of the sums demanded, and criminal proceedings followed. The Crime Branch subsequently arrested him on charges of defrauding the bank.
The fallout was swift and severe. Market confidence collapsed: the BSE Sensex plunged from its peak near 6,100 to about 3,788 by 30 March 2001. In response to the systemic risks exposed by the episode, the market regulator, SEBI, took decisive action and banned deferral mechanisms—most notably badla—across all stock exchanges, aiming to curb roll‑over trading and strengthen market integrity. The Ketan Parekh episode remains a landmark case in Indian market history for the scale of manipulation, the vulnerability of financing channels, and the regulatory reforms it prompted.
The two episodes bear superficial resemblance: both involved deliberate price manipulation, used bank and mutual fund money, and exploited weaknesses in the financial system. Each relied on engineering market liquidity and confidence to drive up selected stocks and then benefited from the resulting price movements, exposing regulatory and operational loopholes at the time.
But the mechanics and implications were markedly different. The 1992 episode led by Harshad Mehta centred on older, established (“old‑economy”) stocks and on misuse of banking instruments such as bank receipts and entries in SGL ledger accounts; it mainly exploited public sector banks. By contrast, the Ketan Parekh episode targeted new‑economy stocks and involved misuse of pay orders and funds from private and cooperative banks. Where the Harshad case underscored that the capital market operated with inadequate checks and controls, the Parekh case showed that even after market reforms and tighter oversight, significant vulnerabilities persisted.
The proximate causes and market dynamics also diverged. In Ketan Parekh’s case a financial crunch produced by intense selling pressure — often described as bear hammering — triggered a sharp fall in prices and precipitated the crisis. In the Harshad Mehta episode the price collapse was largely an outcome of the scam rather than its initial cause. Similarly, the Harshad affair was widely perceived as primarily a banking scandal because banks and financial institutions incurred heavy losses; it became the catalyst for broad equity‑market reform. The Ketan Parekh scandal, however, occurred in a market that had already undergone significant transformation.
Regulatory responses reflected these differences. After the Harshad Mehta crisis the Reserve Bank of India moved to ban repurchase (repo) practices that had been abused; following the Ketan Parekh episode regulators clamped down on carry‑forward mechanisms such as badla and other deferral products. In short, Harshad exposed a market almost free of effective controls, while Parekh demonstrated that reforms reduced some risks but could not eliminate the potential for large, systemic manipulation.
The cycle of scams must be broken if the capital market is to develop in an orderly manner and contribute meaningfully to economic growth. Too often regulators have reacted only after a crisis unfolds, and that delay can worsen market turmoil. To prevent this, regulators need to adopt a proactive stance and build a robust market-intelligence capability that detects emerging risks and gives early warning signals before problems escalate.
Accountability must follow detection: those responsible for market abuse should face clear, deterrent penalties, and regulatory directives and legal provisions must be enforced consistently and without delay. Equally important is the relationship between the capital market and the banking system: neither can function effectively in isolation. For both sectors to survive and remain vibrant they must first cultivate greater self-discipline, supported by rigorous oversight and prompt corrective action when standards slip.
Capital Market Liberalisation and Regulation
The 1991–92 securities scam jolted policymakers into accelerating reforms across India’s capital market. Since then, a series of measures have been introduced to modernize both the primary market—where companies raise fresh capital through new issues—and the secondary market—where existing securities are bought and sold—aiming to strengthen transparency, improve market efficiency and enhance investor protection.
The primary capital market in India was reshaped beginning in the late 1980s and significantly deepened after the early 1990s. The Securities and Exchange Board of India (SEBI) began as a non‑statutory body in 1988 and was vested with statutory powers by the SEBI Act, 1992, with its twin mandates of investor protection and the orderly development of the securities market. In May 1992 the repeal of the Capital Issues (Control) Act, 1947 removed administrative controls that had required government consent for public issues and pricing. That liberalisation allowed issuers greater freedom to raise funds, while placing new emphasis on disclosure and investor protection under SEBI’s evolving guidelines.
Institutional and market infrastructure expanded rapidly. A network of merchant bankers, registrars, custodians and other intermediaries developed to support primary issues. Public sector banks, financial institutions and state‑owned enterprises increasingly tapped the market through both equity and debt issuances. The institutional supply side — notably mutual funds — grew sharply from the late 1980s, accelerating in the 1990s with many private sector funds; today several dozen mutual funds manage an aggregate asset base running into lakhs of crores.
Several market practices and instruments were liberalised to modernise issuance and improve market access. Restrictions on issuing shares at prescribed par values were removed and dematerialisation became a precondition for several flexibilities, including consolidation and splitting of existing shares. Disclosure requirements were strengthened: issuers must disclose all material facts and specific project risks in offer documents and justify pricing. SEBI introduced a code for advertising public issues to ensure truthful communication, and it introduced tools such as the green‑shoe option for post‑issue price stabilisation.
Procedure and cost structures were also simplified. Underwriting was made optional provided that issuers refunded subscriptions if an underwritten issue failed to reach a specified acceptance threshold. Private placement, book‑building and other issue procedures were rationalised to reduce transaction costs. The offer document itself is not formally vetted by SEBI, but strict disclosure and investor protection norms govern content and marketing.
Foreign investment and global capital access were important pillars of integration with international markets. Foreign institutional investors (FIIs) were progressively allowed into equity markets and later into debt securities; the overall FII ceiling was raised from 40% to 49% in 2000–01, subject to shareholder approval. Indian issuers were permitted to raise funds abroad via ADRs, GDRs, FCCBs and External Commercial Borrowings, and various measures introduced two‑way fungibility for ADRs/GDRs, subject to sectoral limits.
Special facilitation was provided for infrastructure financing. Several mandatory conditions for public issues (such as prescribed minimum public offers and minimum subscription conditions) were relaxed for infrastructure projects. Debt instruments of infrastructure companies and certain public bodies were allowed to be listed without prior equity listing, subject to conditions including investment‑grade ratings and minimum promoter equity contributions and lock‑in. Over time, similar conditional relaxations were extended more broadly to corporates to encourage project financing from the market.
Regulation of intermediaries and market conduct was tightened. Merchant bankers were restricted from undertaking fund‑based businesses outside capital market activities and category multiplicity was removed so that a single registration now covers merchant banking activity. SEBI’s regulatory ambit was extended to a wide range of intermediaries — mutual funds, portfolio managers, registrars, underwriters, debenture trustees, custodians, venture capital funds and others — to ensure consistent standards across the market.
Bank lending practices related to equity flows were also liberalised to support issuers. Banks were permitted, within prudential ceilings, to provide short‑term bridge finance against expected equity inflows and to extend certain loans to enable promoters to meet equity contributions. Margin requirements on advances against dematerialised shares were relaxed and limits on advances to individuals were revised to reflect the dematerialised environment.
Entry norms and eligibility for initial public offerings (IPOs) were both tightened and made more nuanced through successive amendments to the Disclosure and Investor Protection (DIP) Guidelines. Larger or less‑seasoned issuers have generally been channelled through the book‑building route with a significant allocation to qualified institutional buyers (QIBs), while certain sectors (notably IT, telecom, media and entertainment) were granted specific minimum offering thresholds to encourage market access. SEBI introduced a number of investor‑protection measures: lock‑in requirements for preferential allotments, obligations for venture capital and foreign venture capital investors in public issues, and mandatory credit ratings for certain debt issuances. IPO grading by rating agencies was allowed at issuers’ option to help retail investors, although SEBI did not endorse the grades.
Several procedural reforms improved market functioning and investor convenience. The dematerialised form was made mandatory for many public and rights offers; electronic clearing mechanisms were extended to refunds; the ASBA (Applications Supported by Blocked Amount) process was introduced in 2008 to streamline payment; and PAN was made mandatory for public and rights issues (with limited state exemptions). SEBI also revised definitions and allocation norms to protect retail investors — for example, redefining the retail investor threshold and increasing the allocation to retail investors in book‑built issues.
To improve market depth and liquidity, SEBI prescribed minimum public shareholding norms: listed companies were required to ensure a minimum public float (commonly set at 25%) to broaden share ownership and reduce price manipulation. Where public float fell below the prescribed level because of corporate actions, SEBI allowed a transition period for compliance and the government subsequently took steps to accelerate enhancement of public holdings in listed firms.
Across the 1990s and 2000s SEBI’s approach combined liberalisation of issuance channels and instruments with progressively stricter disclosure, prudential and investor‑protection norms. The cumulative effect has been a more diversified and internationally integrated primary market, greater participation by institutional and retail investors, and a regulatory framework aimed at balancing market development with the safeguarding of investors’ interests. Minimum public shareholding requirements were further reinforced, with a deadline set for compliance by August 22, 2017, reflecting the ongoing emphasis on transparency, liquidity and wider public participation in listed companies.
Reforms in India's Secondary Capital Market
The secondary capital market in India has undergone a profound transformation since the mid-1990s, moving from fragmented, floor-based trading to a unified, electronic, risk-managed marketplace. The traditional open outcry system, prevalent until 1995, gave way to on‑line, screen-based trading. Today multiple national and regional exchanges operate through thousands of trading terminals across the country, and three important national-level exchanges—OTCEI (1992), the National Stock Exchange (NSE, 1994) and the Interconnected Stock Exchange (1999)—were created in the 1990s to broaden market access and modernize trading infrastructure.
Settlement cycles and the mechanics of trade execution were substantially tightened to reduce counterparty risk. Uniform settlement periods were shortened from a 14-day account system to seven days in 1996, followed by the introduction of rolling settlement (initially T+5 in 1998). By the end of 2001 rolling settlement covered all scrips, and the cycle was further reduced to T+3 in April 2002 and later to T+2 in April 2003. To support these shorter cycles, exchanges and regulators introduced comprehensive risk containment measures—mark-to-market margins, intra-day trading limits, exposure limits, trade and settlement guarantee funds—and developed clearing corporations that act as central counterparties. For example, NSE established a separate clearing corporation to become the counterparty to capital market trades, and settlement guarantee funds can be used, under conditions, to meet shortfalls before members are declared defaulters.
A central pillar of market reform has been the dematerialization of securities and the shift to electronic book-entry transfers. To enable this, the National Securities Depository Limited (NSDL, 1996) and the Central Depository Services Limited (CDSL, 1999) were set up. Today actively traded securities are held, traded and settled in demat form, greatly simplifying transfers and reducing settlement risk.
Certain legacy trading practices were modified or discontinued. The carry-forward mechanism known as badla was reintroduced in 1996 with stricter safeguards but, following market abuses culminating in the 2001 scam, all deferral products including badla were discontinued from July 2001. At the same time, negotiated and private off‑market deals were banned in 1999 to improve transparency, and mandatory client codes, minimum free‑float standards and disclosure of block deals were prescribed to check price manipulation.
Investor protection and corporate accountability received sustained attention. Listed companies are required to make continuing disclosures under the listing agreement, including unaudited quarterly financial results and timely disclosure of material information. One of the most important governance initiatives was the SEBI-appointed committee chaired by Kumar Mangalam Birla, which framed a code of corporate governance and recommended its implementation through stock exchanges. Stock exchanges themselves were restructured to broaden their boards and reduce dominance by member interests; exchanges, brokers and sub‑brokers were brought under SEBI’s regulatory purview.
Regulatory reforms also covered takeover and insider trading rules. Insider trading was criminalized under SEBI regulations, and takeovers were made more transparent through successive amendments to the Takeover Code (including Bhagwati Committee recommendations in 2002). The revised code strengthened disclosure requirements at various shareholding thresholds, mandated open offers in more circumstances (including changes in management control), and permitted shareholders to withdraw tendered shares in an open offer and sell them in the market. Circuit breakers—index‑based market-wide pauses at 10%, 15% and 20%—and scrip-wise price bands (typically 20%) were introduced to curb speculative spikes.
Connectivity and access to the Indian market were expanded: trading terminals abroad were permitted from February 1999, internet trading was allowed from February 2000, and foreign institutional investors (FIIs) were progressively allowed broader participation in on‑exchange derivatives, sponsored ADR/GDR programmes, delisting offers and government disinvestment. To facilitate large trades without disturbing markets, exchanges opened separate windows for block deals (activated by BSE and NSE from November 14, 2005). ISINs for IPOs are now activated by depositories only on the date trading commences, preventing pre-market off‑exchange trades.
Derivatives and new instruments grew rapidly in the 2000s. Futures trading began in June 2000, options trading followed after legal amendments, and trading in index‑based and stock‑based options started in 2001; stock‑based futures began later that year. Interest rate futures and sectoral index futures and options were introduced in 2003. Over time SEBI permitted mutual funds, FIIs and NRIs to participate in exchange-traded derivatives, with appropriate restrictions (for example, naked short selling is prohibited and FIIs are barred from day trading). A formal securities lending and borrowing (SLB) framework was established, allowing clearing corporations or registered intermediaries to borrow securities to meet settlement shortfalls. Short selling frameworks were liberalized in 2008 under regulated SLB arrangements.
Market infrastructure and prudential norms were strengthened continuously. A 99% value‑at‑risk (VaR) based margining system for rolling settlement was introduced in July 2001. SEBI mandated unique identification numbers for intermediaries under the Central Data Base of Market Participants Regulations, 2003, and required listed companies to report investor complaints under an amended Clause 41 of the listing agreement. To enhance investor awareness, the Investor Education and Protection Fund (IEPF) was notified effective October 1, 2001. Disclosure and monitoring requirements for public issues were tightened in December 2007: any offer or rights issue exceeding Rs 500 crore must appoint a monitoring agency to oversee utilization of proceeds.
Mutual funds and institutional trading were also regulated more tightly. SEBI defined the roles and responsibilities of fund managers and CEOs, prescribed uniform NAV cut‑off times for subscriptions and redemptions, set a minimum number of investors for schemes, and limited any single investor to a maximum of 25% of a scheme’s corpus. Mutual funds were allowed to invest in derivatives and, within prescribed limits, in foreign securities. Institutional trades in the cash market have been subject to margining on a T+1 basis since April 2008, later moving to an upfront collection model.
Other market conveniences and protections were added: trading in rights entitlements was introduced in September 2008; Direct Market Access (DMA) facilities allow institutional clients to place orders electronically; brokers may use exchange infrastructure to distribute mutual funds; and rules restrict depositories or DPs from charging for internal transfer of a beneficial owner’s entire portfolio between branches or depositories when the BO accounts are the same.
Finally, the character of the Indian securities market changed markedly between 1992 and 2003. In 1992 the market lacked a dedicated regulator, operated largely through regional trading rings using open outcry and negotiated deals, relied on physical settlement, and carried significant counterparty risk. By 2003 a specialized regulator—SEBI—had been empowered to develop and regulate the market; intermediaries were registered and regulated; pricing and access became market-driven; ADRs/GDRs and ECBs facilitated international access; mutual funds expanded in the private sector; screen-based nationwide trading and consolidated order books replaced fragmented order flow; anonymity in trading increased; clearing corporations assumed central counterparty roles; settlement became electronic and rolling on a T+2 basis; and comprehensive risk‑management systems including capital adequacy, exposure limits and VaR-based margining were in place. These reforms have collectively modernized market design, improved transparency and reduced systemic risks while expanding participation.
Capital Markets: Structure and Evolution
The capital market is the segment of the financial system that channels long‑term funds, both equity and debt, within and across national borders. It brings together surplus units—households and institutions with excess savings—and deficit units—governments, corporations and financial intermediaries—so that long‑term investment needs can be financed.
The primary market is the mechanism through which fresh long‑term capital is raised. In this market surplus funds flow to the government and corporate sectors via new issues of shares and bonds; banks and non‑bank financial intermediaries also mobilize long‑term resources through primary offerings. These primary issues result in capital formation—the creation of net fixed assets and increases in inventories—thereby expanding the economy’s productive capacity.
The secondary market deals in outstanding securities and does not directly create new capital. Instead, it provides liquidity and marketability for existing equity and debt instruments, enabling investors to buy and sell claims quickly and at transparent prices. The Indian capital market has a long history—security trading dates back to the eighteenth century with East India Company securities—and has gradually become more organized, integrated, and modern. Today India’s equity markets are noted for advanced technology and greater global connectivity.