Sucheta Dalal :Whose money drives the reckless spiral?
Sucheta Dalal

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Whose money drives the reckless spiral?  

Sep 19, 2005

Banks, directly and through brokerage firms, are fuelling the feverish stock run


In 1992, when the late Harshad Mehta was pushing share prices to stratospheric levels, many of us were perplexed at his access to limitless funding. The market grapevine whispered about two possible sources: underworld money or funds of political parties. The market was unfazed: it showed Harshad Mehta had access to real money and that satisfied his legion of followers. Only in April 1992 did I learn the funds were being siphoned out of India’s largest bank, State Bank of India, numerous other public sector undertakings (Maruti, Air-India, Coal India, to name a few) and nationalised banks.


Now, cut to year 2000. Another bull, Ketan Parekh, and a similar scenario. Parekh’s personal wealth was counted in thousands of crores and he was seen on the society pages flanked by industrialists, media barons and deep-pocket foreign investors. When the crash happened, it became clear he was not playing with the profits he had encashed by spotting IT stocks very early. His money came from Global Trust Bank (which funded a variety of scamsters and Ketan’s industrialist friends), from Bank of India, and from the pockets of lakhs of small depositors whose savings were in Madhavpura Mercantile Cooperative Bank.


At the end of five years, the banks have collapsed, but Parekh is not doing badly at all.


Now 2005, and another big bull run. This time, no identifiable ‘Big Bull.’ Instead, an amorphous mass of foreign institutional investors (FIIs) who are apparently pumping $100 million every day into Indian stocks, even after the Sensex has crossed 8,000. At the same time, we have a bunch of experts telling us that price-earnings multiples (P/E) of leading indices are so safely at 14 and 15, that current market practices pose no risk to the market.


Are FIIs alone driving the Sensex up by an unsustainable 100 points every day? No. Domestic mutual funds have suddenly turned aggressive net buyers after the Sensex approached 8,000. More important, will the safe P/Es in the top 500 stocks cushion the impact of a crash or deep correction when it happens? Or, are we again missing the main source of mischief, because we have identified some big sources of funds?


• The market knows many FIIs are fronts for shady Indian investors

• Banks and brokers are fuelling retail investors in an unsustainable spiral


I believe this is true. First, many FIIs are fronts for shady Indian investors. The link between these FIIs and Indian scamsters/industrialists is an open secret in the stock market—only the regulators cannot seem to establish it. A second problem is that retail action is concentrated in ‘penny stocks.’ This imprecise definition covers several thousand small and medium cap listed companies, whose share prices are up anywhere between 100-3,000%. These retail investors/punters/speculators are flush with funds to invest in such stocks. They are all hugely leveraged and basking in their paper profits, as their tipsters have given them perfect advice till now. A financial consultant who forwards SMS messages of penny stock tips marvels at their accuracy. The tip is usually accompanied with a prediction of how much the stock will rise in a given period — usually a week or 10 days. He says most of the predictions have been bang-on. But then, everybody is a pundit in the middle of a furious bull market. What we need to worry about is the source of retail financing and what could go wrong when a correction finally happens and margin calls begin to come in. The question, then: who is funding the retail speculator?


The answer is banks and their stockbrokers. Every foreign bank has been offering personal finance at anywhere between 15-16.5%, with no questions asked. Most of this has gone into penny stocks and makes great business, so long as stock prices rise at 30% and more.


A second source of the funds luring retail punters to over-speculate are brokerage firms. Banks fund most brokerage firms, with very few queries. Competition between banks is so intense, they no longer fund specific projects or activities; they fund the balance sheet. According to market reports, a leading private bank has a Rs 200 crore unsecured exposure to a brokerage firm whose soaring share price is making global headlines. The brokers, in turn, are funding retail investors and encouraging them to punt on penny stocks.


The music is going to stop some day. Chances are that the government will figure what fuelled the penny-stock mania only when recovery officers start driving some investors to suicide.


-- Sucheta Dalal