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Unit 4: Capital Formation

Mutual funds like Alliance Capital, ICICI Prudential Fund and UTI also invested in K-10 Notes
stocks, and saw their net asset value soaring. By January 2000, K-10 stocks regularly
featured in the top five traded stocks in the exchanges. It is said that Ketan Parekh doesn’t
have the financial muscle to buy such large number of stocks. Financing methods of Ketan
Parekh were very simple. He bought shares when they were trading at low prices and
when the price was high; he pledged the shares with banks as collateral for funds. He also
borrowed from companies like HFCL. All this is not possible without the help of bank.

Ketan Parekh’s main ally in this was Ahmedabad-based Madhavapura Mercantile
Cooperative Bank (MMCB). Ketan Parekh and his associates started tapping the MMCB
for funds in early 2000. In December 2000, when Ketan Parekh faced liquidity problems in
settlements, he used MMCB in two different ways. First was the pay order route, wherein
Ketan Parekh issued cheques drawn on BoI to MMCB, against which MMCB issued pay
orders. The pay orders were discounted at BoI. It was alleged that MMCB issued funds to
Ketan Parekh without proper collateral security and even crossed its capital market
exposure limits. As per an RBI inspection report, MMCB’s loans to stock markets were
around ` 10 billion of which over ` 8 billion were lent to Ketan Parekh and his firms.

The second route was borrowing from an MMCB branch at Mandvi (Mumbai), where
different companies owned by Ketan Parekh and his associates had accounts. Ketan Parekh
used around 16 such accounts, either directly or through other broker firms, to obtain
funds. Apart from direct borrowings by Ketan Parekh-owned finance companies, a few
brokers were also believed to have taken loans on his behalf.
The MMCB pay order issue hit several public sector banks very hard. These included State
Bank of India, Bank of India and the Punjab National Bank, all of whom lost huge amounts
in the scam. Ketan Parekh’s modus operandi of raising funds is doing well when share
prices were high but as the value of K-10 stocks started declining, Banks asked Ketan
Parekh to pledge more share or return some amount. Mutual funds also reduced their
exposure in K-10 stocks. To his relief, in May 2000, K-10 stocks began picking up. HFCL
nearly doubled from ` 790 to ` 1,353 by July 2000, while Global shot up to ` 1,153. Aftek
Infosys was also trading at above ` 1000.
In December 2000, the NASDAQ crashed again and technology stocks took the hardest
beating ever in the US. In India too, people start questioning the future of technology
stocks. Mutual funds and other investors started reducing their investment in K-10 stocks.
Ketan Parekh began to have liquidity problems and lost a lot of money during that
period.

The payment crises at Calcutta Stock Exchange (CSE) gave the biggest setback to Ketan
Parekh. Brokers at CSE used to buy shares at Ketan Parekh’s behest. Though, officially the
scrips were in the brokers’ names, unofficially Ketan Parekh held them. Ketan Parekh
used to cover any losses that occurred due to price shortfall of the scrips and paid a 2.5%
weekly interest to the brokers. By February 2001, the scrips held by Ketan Parekh’s brokers
at CSE were reduced to an estimated ` 6-7 billion amount from their initial worth of ` 12
billion. The situation worsened as Ketan Parekh’s badla payments of ` 5-6 billion were
not honoured on time for the settlement and about 70 CSE brokers, including the top three
brokers of the CSE (Dinesh Singhania, Sanjay Khemani and Ashok Podar) defaulted on
their payments. The CSE brokers started pressurizing Ketan Parekh for payments. Ketan
Parekh again turned to MMCB to get loans.
By now, SEBI was implementing several measures to control the damage. An additional
10% deposit margin was imposed on outstanding net sales in the stock markets. Also, the
limit for application of the additional volatility margins was lowered from 80% to 60%.
To revive the markets, SEBI imposed restriction on short sales and ordered that the sale of
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