1.

Scams and Frauds

1.1. Introduction
There are many reasons for the propagation of frauds and financial finagling. The major ones
are:
Business accountants use a set of agreed upon rules and conventions to account for the
value of most controversial items on balance sheets. One of these is the cost of capital
goods, which is valued at purchase price minus depreciation, which might not accurately
reflect its value. One controversial concept has been replacement cost, a concept which
says that capital goods should be valued at the cost of replacing them. Disagreements on
these conventions have caused confusions regarding actual net worth of companies
which has been exploited by some people.
Lax accounting and auditing rules which led many people to believe inflated balance
sheets and undervalued costs. In the 1990s, under pressure to produce rapidly growing
earnings, many companies manipulated their accounts to show glowing results or to
paper over losses.
A believing attitude of investors who seldom take care to investigate company
fundamentals and instead rely on market movements which can be rigged or misleading.
1.2. Enron: An illustrative example
The Enron scam is perhaps the most widely known accounting fraud of the last century. It
led to the downfall of not only the one of the largest energy firms in the world but also of
their auditors, Arthur Anderson, which was one of the worlds biggest accounting firms and
was stripped of its accounting license. (Its former consultancy wing is now known as
Accenture).
Enron started as a truly profitable and novel business idea of trading natural gas futures.
Along the way, however, its profits began to dwindle and it hid the decline from its
investors. The fact that such a large publicly traded firm could fool everyone for such a long
time has four main reasons which illuminate the major propagative factors of frauds:

When troubles began to rise, Enron exploited ambiguities in accounting principles.

For example, in Project Brave heart with Blockbuster Video, they projected
revenues over twenty years with a present value of $111 million, which Enron went
on to account for as current revenue even though this was based on highly dubious
assumptions.
The firm elected not to report the details of many financial transactions. For
example, it hid hundreds of partnerships from its investors.
The board of directors and outside auditors were passive and did not challenge or
even inquire into some of the details of Enrons accounts.

The investment community, which included large mutual funds, exercised little
deep independent analysis of Enrons numbers even though at the peak Enron
absorbed about $70 billion of investors funds.

1.3. An Indian Example: The 1992 Harshad Mehta Stock Market Scam
1.3.1. Introduction
In April 1992, press reports indicated that there was a shortfall in the Government
Securities held by the State Bank of India. In almost a month, investigations uncovered
the tip of an iceberg, later called the securities scam, involving misappropriation of
funds to the tune of over Rs. 3500 crores.
The scam engulfed top executives of large nationalized banks, foreign banks and
financial institutions, brokers, bureaucrats and politicians. The functioning of the
money market and the stock market was thrown in disarray. The tainted shares were
worthless as they could not be sold. This created a panic among investors and brokers
and led to a prolonged closure of the stock exchanges along with a precipitous drop in
the price of shares. In less than 2 months following the discovery of the scam, the stock
prices dropped by over 40%, wiping out market value to the tune of Rs. 100,000 crores.
The scam was in essence a diversion of funds from the banking system (in particular
the inter-bank market in government securities) to brokers for financing their
operations in the stock market.
The cost of finance in the informal money market which finances stock market
operations was about twice that of the formal market in which banks lend to each
other against government securities. The difference in the cost of finance in the two
markets could not be attributed to the difference in the level of risk. The phenomenon
of different interest rates was mainly due to artificial segmentation of the markets.
Therefore there were enormous profits to be had for anybody who could find a way of
breaching the artificial wall separating the two markets and arbitrage between them.
That in essence was what the scam was all about.
1.3.2. The Ready Forward Deal
The ready forward (RF) was in essence a secured short term (typically 15 day) loan
from one bank to another bank. The lending was done against government securities.
In form, however, the RF was not a loan at all but a repo or repurchase agreement. It
served two main purposes:
To provide liquidity to the government securities markets.
Statutory Liquidity Ratio (SLR) requirements. Banks in India were required to
maintain 38.5% of their demand and time liabilities (DTL) in government securities and
certain approved securities which are collectively known as SLR securities. RF helps in
managing this requirement in two ways:

 A bank which has a temporary surge in DTL may not want to buy SLR securities
outright and then sell them when the DTL comes back to normal. Instead it can do an
RF deal.
An RF deal is not legally a loan and hence not regarded as a part of the bank's
liabilities
1.3.3. Settlement Process
The normal settlement process in government securities was that the transacting
banks made payments and delivered the securities directly to each other. The broker's
only function was to bring the buyer and seller together. During the scam, however,
the banks or at least some banks adopted an alternative settlement process similar to
settlement of stock market transactions. The deliveries of securities and payments
were made through the broker. That is, the seller handed over the securities to the
broker who passed them on to the buyer, while the buyer gave the cheque to the
broker who then made the payment to the seller.
There were two important reasons why the broker intermediated settlement began to
be used in the government securities markets:
The brokers instead of merely bringing buyers and sellers together started taking
positions in the market. They in a sense imparted greater liquidity to the markets.
When a bank wanted to conceal the fact that it was doing an RF deal, the broker
came in handy. The broker provided contract notes for this purpose with fictitious
counterparties, but arranged for the actual settlement to take place with the correct
counterparty.
This allowed the broker to lay his hands on the cheque as it went from one bank to
another through him. The hurdle now was to find a way of crediting the cheque to his
account though it was drawn in favour of a bank and was crossed account payee.
It is purely a matter of banking custom that an account payee cheque is paid only to
the payee mentioned on the cheque. In fact, privileged (corporate) customers were
routinely allowed to credit account payee cheques in favour of a bank into their own
accounts to avoid clearing delays, thereby reducing the interest lost on the amount.
The brokers thus found a way of getting hold of the cheques as they went from one
bank to another and crediting the amounts to their accounts. This effectively
transformed an RF into a loan to a broker rather than to a bank.
But this, by itself, would not have led to the scam because the RF after all is a secured
loan, and a secured loan to a broker is still secured. What was necessary now was to
find a way of eliminating the security itself!
Three routes adopted for this purpose were:

 Some banks (or rather their officials) were persuaded to part with cheques without
actually receiving securities in return. A simple explanation of this is that the officials
concerned were bribed and/or negligent. Alternatively, as long as the scam lasted, the
banks benefited from such an arrangement. The management of banks might have
been sorely tempted to adopt this route to higher profitability.
The second route was to replace the actual securities by a worthless piece of paper
a fake Bank Receipt (BR). A BR like an IOU has only the borrower's assurance that the
borrower has the securities which can/will be delivered if/when the need arises.
The third method was simply to forge the securities themselves. In many cases, PSU
bonds were represented only by allotment letters rather than certificates on security
paper.
1.3.4. Aftermath
The scam was made possible by a complete breakdown of the control system both
within the commercial banks as well as the control system of the RBI itself.
The immediate impact of the scam was a sharp fall in the share prices. The index fell
from 4500 to 2500 representing a loss of Rs. 100,000 crores in market capitalization.
Purely technically speaking, the scam just resulted in withdrawal of about Rs. 3,500
crores from the market, which for a market of the size of Rs. 250,000 crores is a very
small amount, and therefore should have had little impact on the prices. There were,
however two major reasons for the fall, both related to the government's knee jerk
response to the scam. First was the phenomenon of tainted shares which created
panic in the market and second was the perceived slowdown of the reform process
which destroyed the very foundation on which the boom was based.
Most of the criminal cases against Harshad Mehta were closed after his death in 2002
of a heart attack. He was convicted in only one.

1.4. Notable International Financial Scams in recent years

1.4.1. The Lou Pearlman Scam (May 2008)
In an audacious two-decade scam, Lou Pearlman enticed individuals and banks to
invest millions of dollars in two companies which existed only on paper,
Transcontinental Airlines Travel Services Inc. and Transcontinental Airlines Inc.
He won investors' confidence wit h fake financial statements created by a fictitious
accounting firm.

Boy band mogul Lou Pearlman, who launched Backstreet Boys and 'N Sync, was
sentenced to 25 years in prison for swindling investors and major US banks out of more
than $300 million.

1.4.2. Enron (February 2002)

The Enron case was described above.
Former Enron Corp chief executive Jeff Skilling was sentenced to more than 24 years in
prison for leading a financial fraud that destroyed the company and came to symbolize a
dark era for corporate America.
US District Judge Sim Lake, in handing out the harshest sentenc e yet in the Enron
saga, said Skilling's crimes "have imposed on hundreds if not thousands of people a
lifetime of poverty."
Skilling also was ordered to pay $45 million in restitution to Enron investors, who lost
billions of dollars when the company collapsed. Thousands of employees lost their jobs
and retirement funds.

1.4.3. Allied Deals Inc. (June 2004)

Five metals traders for Allied Deals were found guilty of conspiracy related to bank,
mail and wire fraud and money laundering in a 2004 trial.
Anil Anand, the CFO of Allied Deals, pleaded guilty in 2002 and agreed to cooperate
with the government's investigation into the fraud.
The defrauded banks were located in the United States, Europe and Asia and included
JPMorgan Chase & Co; Fleet National Bank; PNC Bank NA; Dresdner Bank
Lateinamerika AG; China Trust Bank; and Hypo Vereins Bank.
The fraud involved inducing banks to issue hundreds of millions of dollars in loans.
The International Ponzi scheme led to more than $680 million in losses by some 20
banks.
Anand was ordered by the US federal court to pay restitution of $683.6 million.
1.4.4. Sir Allen Stanford ( February 2009)
Allen Stanford was a high-flying Texas billionaire with a Caribbean knighthood and a
penchant for publicity and cricket before the U.S. federal authorities charged the
financier and three of his companies with a "massive ongoing fraud."
The US Securities and Exchange Commission alleged Stanford and two fellow
executives fraudulently sold $8 billion in high-yield certificates of deposit. The SEC said
they and the bank reported "improbable" high returns and gave "false" assurances to

investors.
The SEC's revelation that Stanford's business empire -- stretching from the Caribbean
island of Antigua to Houston, Miami and Caracas, was exposed to losses from the
alleged Ponzi scheme run by financier Bernard Madoff completes the picture of a huge
financial fraud.
1.4.5. Brian Hunter (March/April 2006)
Hedge fund Amaranth Advisors LLC and former head trader Brian Hunter racked up
$6.4 billion in losses from natural gas contracts before the fund folded in 2006.
In July 2007, the Commodity Futures Trading Commission sued Amaranth and Hunter,
alleging they tried to manipulate natural gas futures prices.
1.4.6. Jerome Kerviel (January 2008)
French bank Societe Generale alleged that fraud by a single trader caused a $7.1 billion
loss. Jerome Kerviel, a junior trader, was jailed in connection with the case. He was
later released but still faces accusations that he caused SocGen billions of euros of
losses.
Richard Fuld, the chief of Wall Street firm Lehman Brothers, called the debacle
"everyone's worst nightmare."
1.4.7. John Rusnak (February 2002)
Ireland's largest bank, Allied Irish, revealed a rogue US trader, John Rusnak, had
defrauded its US subsidiary of up to $750 million.
Rusnak was sentenced in January 2003 to seven and a half years in prison.
He admitted devising a scheme that netted him $850,000 in salary and bonuses from
1997 to 2001.
1.4.8. Merill Lynch (September 2001)
Merrill Lynch fired two senior executives for their failure to supervise a currency dealer
who diverted profits on foreign exchange deals to favored clients, leaving the bank
facing a $10 million bill.
1.4.9. Reed Slatkin (September 2003)
Financier Reed Slatkin, who helped create Internet service provider Earthlink Inc, was
sentenced to 14 years in prison for bilking investors out of hundreds of millions of
dollars.

He had portrayed himself as a shrewd manager whose investments were

outperforming the markets, but prosecutors said he was in fact running a Ponzi
scheme. He was ordered to pay more than $240 million in restitution to clients.
He is serving time in the Lompoc, California penitentiary and is due for release in 2014,
according to the Federal Bureau of Prisons.
1.4.10. Yasuo Hamanaka (June 1996)
Japanese trading house Sumitomo Corp suffered a $2.6 billion loss over 10 years from
unauthorized copper trades, primarily by chief copper trader Yasuo Hamanaka.
Sumitomo fired Hamanaka, once dubbed "Mr Five Percent" because his trading team
was believed to control 5 percent of the world's copper trading. He was later jailed for
eight years.

1.5. Notable Financial Scams in India in recent years.

1.5.1. CRB Scam:
In 1996,Mr.Chain Kumar Bhansali,Chairman of CRB Capital markets Ltd was accused of
siphoning off Rs.12 billion in the CRB scam. CRB was accused of using its State Bank of
India's accounts to siphon off the bank funds by encashing interest warrants and
refund warrants.Millions of investors lost through fixed deposits and mutual funds. The
Unit Trust of India and Gujarat government also incurred heavy losses.
1.5.2. ITC-Chitalia FERA Violation Act:
The Foreign Exchange Regulation Act(FERA) violation was estimated around $80
million. In June 1996,Enforcement Directorate (ED)started FERA investigation of export
transaction between ITC and the Chitalia group of Companies (EST Fibers) for the
period of 1990-1995.The Chitalias and several directors of the company including ITC
Chairman Mr.K.K.Chaugh were arrested and later released on bail. Later,ITC filed a suit
on Chitalias for $15 million. Chitalias on the other hand, sued it for $ 55 million
claiming ITC owed them.
1.5.3. The 1998 Collapse:
In 1998, Harshad Mehta, Scamster of 1992,made a comeback by floating a website and
writing columns in several newspapers giving tips on stocks. The result was the
collapse of BPL, Videocon and Sterlite shares.

1.5.4. Ketan Parekh's Case:

Ketan Parekh ,a Mumbai based stock broker had large borrowings from Global Trust
Bank during its Merger with United Trust of India Bank. He got a loan of about Rs.250
Crores from Global Trust Bank's Chairman Mr.Ramesh Gelli who was asked to quit
later. This rigged the scrips of Global Trust Bank, Zee Telefilms, HFCL, Aftek Infosys,
Lipin Laboratories and Padmini polymers. The prices of the selective shares constantly
increased due to rigging .The investors who bought the share at higher prices thought
that the market prices were genuine. Soon after the discovery of the scam of 19992000, the price of the stocks came down to the fraction of value at which they were
purchased. The investors lost heavily. Even the banks faced a tremendous loss. Ketan
Parekh was arrested in the year 2002.
1.5.5. The Case of Home Trade:
This Company was launched in the year 2000 with Rs.24 crore of advertising campaign
roping celebrities like Hrithik Roshan, Sachin Tendulkar and Shahrukh Khan. Eight Cooperative banks like Valsad People Co-operative bank, Navasari Co-operative bank
from Guajrat lost around Rs.80 Crore due to bad investments by home trade. This was
linked to Rs.82 lakh forgery in a Central Government Undertaking EPF scheme.
Mr.Sunil Kedar, Chairman of Nagpur district Central Co-operative Bank was arrested
for bending the rules to invest in government securities and preparing false
documents. Mr.Sanjay Aggarwal, Chief Executive of Hometrade was initially missing
but later surrendered in Nagpur.
1.5.6. DSQ Software Scam:
Mr.Dinesh Dalmia, Managing Director of DSQ Software was accused of dubious
acquisitions and biased allotment in the year 2000 and 2001.The amount involved in
the Scam was Rs.595 Crores. Dalmia was arrested in the year 2006.
1.5.7. Sathyam Case:
Mr.Ramalinga Raju, the former Chairman and Chief Executive had admitted that he
had manipulated the balance sheet for several years to show huge inflated profits and
fictitious assets. The estimated fraud was Rs.700 Crore billion, one of the highest
committed frauds since 1996. Mr. Ramalinga Raju is in Jail for committing fraud,
cheating and forgery.

2. The Global Financial Crisis

2.1. Introduction

The global financial crisis, brewing for a while, really started to show its effects in
the middle of 2007 and into 2008. Around the world stock markets fell, large
financial institutions collapsed or had to be bought out, and governments in even
the wealthiest nations have had to come up with rescue packages to bail out their
financial systems.
In its 2008 report, the IMF had the following to say, The world economy is
decelerating quicklybuffeted by an extraordinary financial shock and by still-high
energy and commodity pricesand many advanced economies are close to or
moving into recession.
2.2. Causes and Precipitating Factors

2.2.1. The Subprime Crisis

The subprime crisis came about in large part because of financial instruments
such as securitization where banks would pool their various loans into sellable
assets, thus off-loading risky loans onto others. (For banks, millions can be
made in money-earning loans, but they are tied up for decades. So they were
turned into securities. The security buyer gets regular payments from all those
mortgages; the banker off loads the risk. Securitization was seen as perhaps the
greatest financial innovation in the 20th century.)

High street banks got into a form of investment banking, buying, selling and
trading risk. Investment banks, not content with buying, selling and trading risk,
got into home loans, mortgages, etc. without the right controls and
management. Many banks were taking on huge risks increasing their exposure
to problems. Perhaps it was ironic, as Evan Davies observed, that a financial
instrument to reduce risk and help lend more securitieswould backfire so
much.
When people did eventually start to see problems, confidence fell quickly.
Lending slowed, in some cases ceased for a while and even now, there is a crisis
of confidence. Some investment banks were sitting on the riskiest loans that
other investors did not want. Assets were plummeting in value so lenders

wanted to take their money back. But some investment banks had little in
deposits; no secure retail funding, so some collapsed quickly and dramatically.
Paul Krugman, the Nobel Prize winning economist who criticized the entire
thought process of finance in his noted article, How did economists get it so
wrong? has said that the housing bubble in the U.S.A. is an example of
ketchup economics (Proving that two bottles of ketchup cost twice as much
as one, and thus inferring that the price of one ketchup bottle must be right).
He states that the neo classical economists of the late 19 th century who came
up with financial innovations never equated them with real world fundamentals
like wages.
Refer to How did economists get it so wrong?-Paul Krugman, September
2009, New York Times and the popular reply by an eminent Chicago school of
Business professor John Cochrane, How did Paul Krugman get it so wrong?.
2.2.2. Financial Derivatives
Derivatives, financial futures, credit default swaps, and related instruments came out
of the turmoil from the 1970s. The oil shock, the double-digit inflation in the US and a
drop of 50% in the US stock market made businesses look harder for ways to manage
risk and insure themselves more effectively.
The finance industry flourished as more people started looking into how to insure
against the downsides when investing in something. To find out how to price this
insurance, economists came up with options, a derivative that gives you the right to
buy something in the future at a price agreed now. Mathematical and economic
geniuses believed they had come up with a formula of how to price an option,
the Black-Scholes model.
This was a hit; once options could be priced, it became easier to trade. A whole new
market in risk was born. Combined with the growth of telecoms and computing, the
derivatives market exploded making buying and selling of risk on the open market
possible in ways never seen before.
As people became successful quickly, they used derivatives not to reduce their risk, but
to take on more risk to make more money. Hedge funds, credit default swaps, can be
legitimate instruments when trying to insure against whether someone will default or
not, but the problem came about when the market became more speculative in
nature.
The market for credit default swaps market (a derivative on insurance on when a
business defaults), for example, was enormous, exceeding the entire world economic

output of $50 trillion by summer 2008. It was also poorly regulated. The worlds largest
insurance and financial services company, AIG alone had credit default swaps of
around $400 billion at that time. Furthermore, many of AIGs credit default swaps were
on mortgages, which of course went downhill, and so did AIG.
The trade in these swaps created a whole web of interlinked dependencies; a chain
only as strong as the weakest link. Any problem, such as risk or actual significant loss
could spread quickly. Hence, eventually AIG had to be bailed out by the US government
to prevent them from failing.
Derivatives didnt cause this financial meltdown but they did accelerate it once the
subprime mortgage collapsed, because of the interlinked investments. Derivatives
revolutionized the financial markets and will likely be here to stay because there is
such a demand for insurance and mitigating risk. The challenge now, is to reign in the
wilder excesses of derivatives to avoid those incredibly expensive disasters and
prevent more AIGs happening.

2.3. The scale of the Crisis

The extent of the problems has been so severe that some of the worlds largest financial
institutions have collapsed. Others have been bought out by their competition at low prices
and in other cases, the governments of the wealthiest nations in the world have resorted to
extensive bail-out and rescue packages for the remaining large banks and financial
institutions.
The total amounts that governments have spent on bailouts have skyrocketed. From a
world credit loss of $2.8 trillion in October 2009, US taxpayers alone spent some $9.7
trillion in bailout packages and plans, according to Bloomberg. $14.5 trillion, or 33%, of the
value of the worlds companies has been wiped out by this crisis. The UK and other
European countries have also spent some $2 trillion on rescues and bailout packages.
2.4. Impact of the Crisis on India
2.4.1. Why Has India Been Hit By the Crisis
There is, at least in some quarters, dismay that India has been hit by the crisis. This dismay
stems from two arguments.
The first argument goes as follows. The Indian banking system has had no direct exposure
to the sub-prime mortgage assets or to the failed institutions. It has very limited offbalance sheet activities or securitized assets. In fact, our banks continue to remain safe and
healthy. So, the enigma is how can India be caught up in a crisis when it has nothing much
to do with any of the maladies that are at the core of the crisis.

The second reason for dismay is that India's recent growth has been driven predominantly
by domestic consumption and domestic investment. External demand, as measured by
merchandize exports, accounts for less than 15 per cent of our GDP. The question then is,
even if there is a global downturn, why should India be affected when its dependence on
external demand is so limited?
The answer to both the above frequently-asked questions lies in globalization.
First, India's integration into the world economy over the last decade has been remarkably
rapid. Integration into the world implies more than just exports. Going by the common
measure of globalization, India's two-way trade (merchandize exports plus imports), as a
proportion of GDP, grew from 21.2 per cent in 1997-98, the year of the Asian crisis, to 34.7
per cent in 2007-08.
Second, India's financial integration with the world has been as deep as India's trade
globalization, if not deeper. If we take an expanded measure of globalization, that is the
ratio of total external transactions (gross current account flows plus gross capital flows) to
GDP, this ratio has more than doubled from 46.8 per cent in 1997-98 to 117.4 per cent in
2007-08.
Importantly, the Indian corporate sector's access to external funding has markedly
increased in the last five years. Some numbers will help illustrate the point. In the five-year
period 2003-08, the share of investment in India's GDP rose by 11 percentage points.
Corporate savings financed roughly half of this, but a significant portion of the balance
financing came from external sources. While funds were available domestically, they were
expensive relative to foreign funding. On the other hand, in a global market awash with
liquidity and on the promise of India's growth potential, foreign investors were willing to
take risks and provide funds at a lower cost. Last year (2007/08), for example, India
received capital inflows amounting to over 9 per cent of GDP as against a current account
deficit in the balance of payments of just 1.5 per cent of GDP. These capital flows, in excess
of the current account deficit, evidence the importance of external financing and the depth
of India's financial integration.
So, the reason India has been hit by the crisis, despite mitigating factors, is clearly India's
rapid and growing integration into the global economy.
2.4.2. How Has India Been Hit By the Crisis?
The contagion of the crisis has spread to India through all the channels the financial
channel, the real channel, and importantly, as happens in all financial crises, the confidence
channel.
Let us first look at the financial channel. India's financial markets - equity markets, money
markets, forex markets and credit markets - had all come under pressure from a number of
directions. First, as a consequence of the global liquidity squeeze, Indian banks and

corporates found their overseas financing drying up, forcing corporates to shift their credit
demand to the domestic banking sector. Also, in their frantic search for substitute
financing, corporates withdrew their investments from domestic money market mutual
funds putting redemption pressure on the mutual funds and down the line on non-banking
financial companies (NBFCs) where the MFs had invested a significant portion of their
funds. This substitution of overseas financing by domestic financing brought both money
markets and credit markets under pressure. Second, the forex market came under pressure
because of reversal of capital flows as part of the global deleveraging process.
Simultaneously, corporates were converting the funds raised locally into foreign currency to
meet their external obligations. Both these factors put downward pressure on the rupee.
Third, the Reserve Bank's intervention in the forex market to manage the volatility in the
rupee further added to liquidity tightening.
Second, the real channel. Here, the transmission of the global cues to the domestic
economy has been quite straight forward through the slump in demand for exports. The
United States, European Union and the Middle East, which account for three quarters of
India's goods and services trade, are in a synchronized down turn. Service export growth is
also likely to slow in the near term as the recession deepens and financial services firms
traditionally large users of outsourcing services are restructured. Remittances from
migrant workers too are likely to slow as the Middle East adjusts to lower crude prices and
advanced economies go into a recession.
Beyond the financial and real channels of transmission as described above, the crisis also
spread through the confidence channel. In sharp contrast to global financial markets, which
went into a seizure on account of a crisis of confidence, Indian financial markets continued
to function in an orderly manner. Nevertheless, the tightened global liquidity situation in
the period immediately following the Lehman failure in mid-September 2008, coming as it
did on top of a turn in the credit cycle, increased the risk aversion of the financial system
and made banks cautious about lending.
The purport of the above explanation is to show how, despite not being part of the financial
sector problem, India has been affected by the crisis through the pernicious feedback loops
between external shocks and domestic vulnerabilities by way of the financial, real and
confidence channels.
2.4.3. How has India Responded to the Challenge?
The failure of Lehman Brothers was followed in quick succession by several other large
financial institutions coming under severe stress. This made financial markets around the
world uncertain and unsettled. This contagion seemed to spread to emerging economies
and to India too. Both the government and the Reserve Bank of India responded to the
challenge in close coordination and consultation. The main plank of the government
response was fiscal stimulus while the Reserve Bank's action comprised monetary
accommodation and counter cyclical regulatory forbearance.

Monetary policy response

The Reserve Bank's policy response was aimed at containing the contagion from the outside
- to keep the domestic money and credit markets functioning normally and see that the
liquidity stress did not trigger solvency cascades. In particular, three objectives were
targeted:
to maintain a comfortable rupee liquidity position;
to augment foreign exchange liquidity;
to maintain a policy framework that would keep credit delivery on track so as to
arrest the moderation in growth.
This marked a reversal of Reserve Bank's policy stance from monetary tightening in response
to heightened inflationary pressures of the previous period to monetary easing in response
to easing inflationary pressures and moderation in growth in the current cycle.

Government's fiscal stimulus

Over the last five years, both the central and state governments in India have made a
serious effort to reverse the fiscal excesses of the past. At the heart of these efforts was
the Fiscal Responsibility and Budget Management (FRBM) Act which mandated a calibrated
road map to fiscal sustainability. However, recognizing the depth and extraordinary impact
of this crisis, the central government invoked the emergency provisions of the FRBM Act to
seek relaxation from the fiscal targets and launched two fiscal stimulus packages in
December 2008 and January 2009. These fiscal stimulus packages, together amounting to
about 3 per cent of GDP, included additional public spending, particularly capital
expenditure, government guaranteed funds for infrastructure spending, cuts in indirect
taxes, expanded guarantee cover for credit to micro and small enterprises, and additional
support to exporters. These stimulus packages came on top of an already announced
expanded safety-net for rural poor, a farm loan waiver package and salary increases for
government staff, all of which too should stimulate demand.
Impact of monetary measures
Taken together, the measures put in place since mid-September 2008 have ensured that
the Indian financial markets continue to function in an orderly manner. The cumulative
amount of primary liquidity potentially available to the financial system through these
measures is over US$ 75 billion or 7 per cent of GDP. This sizeable easing has ensured a
comfortable liquidity position starting mid-November 2008 as evidenced by a number of
indicators including the weighted-average call money rate, the overnight money market
rate and the yield on the 10-year benchmark government security. Taking the signal from
the policy rate cut, many of the big banks have reduced their benchmark prime lending
rates. Bank credit has expanded too, faster than it did last year. However, Reserve Banks
rough calculations show that the overall flow of resources to the commercial sector is less

than what it was last year. This is because, even though bank credit has expanded, it has
not fully offset the decline in non-bank flow of resources to the commercial sector.
Evaluating the response
In evaluating the response to the crisis, it is important to remember that although the
origins of the crisis are common around the world, the crisis has impacted different
economies differently. Importantly, in advanced economies where it originated, the crisis
spread from the financial sector to the real sector. In emerging economies, the transmission
of external shocks to domestic vulnerabilities has typically been from the real sector to the
financial sector. Countries have accordingly responded to the crisis depending on their
specific country circumstances. Thus, even as policy responses across countries are broadly
similar, their precise design, quantum, sequencing and timing have varied. In particular,
while policy responses in advanced economies have had to contend with both the unfolding
financial crisis and deepening recession, in India, our response has been predominantly
driven by the need to arrest moderation in economic growth.

References:
1.
2.
3.
4.
5.

www.iimcal.ac.in An anatomy of Securities Scam, 1992.

The Economic Times- Notable financial scams of recent years
The Financial Times - 12 years of major financial scams in India.
IMF survey Magazine- IMF Predicts Major Global Slowdown Amid Financial Crisis.
Impact of the Global Financial Crisis on India Collateral Damage and Response : Speech
delivered at the Symposium on "The Global Economic Crisis and Challenges for the
Asian Economy in a Changing World" organized by the Institute for International
Monetary Affairs, Tokyo on February 18, 2009 By Duvvuri Subbarao, Governor of RBI.
6. Paul Krugman, How did economists get it so wrong? New York Times op-ed.