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Financial Market Regulation-Security Scams In India with historical evidence and the role of corporate governance

Narayanan, Supreena (2004): Financial Market Regulation-Security Scams In India with historical evidence and the role of corporate governance.

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Abstract

The financial system consists of specialized and non specialized financial institutions, of organized and unorganized financial markets, of financial instruments and services, which facilitate transfer of funds. Procedures and practices adopted in the markets, and financial interrelationships are also parts of this system. In product or other service markets, purchasers part with their money in exchange for something now. In finance, money “now” is exchanged for a “promise to pay in the future”. However, in product or service markets, if the object sold – from a car to a haircut – is defective, the buyers often find out relatively soon. On the other hand, loan quality is not readily observable for quite some time and can be hidden for extensive periods. Moreover, banks and non-bank financial intermediaries can also alter the risk composition of their assets more quickly than most non-financial industries, and banks can readily hide problems by extending loans to clients that cannot service previous debt obligations. Theoretically, the financial market facilitates allocation of resources efficiently, which involves quick dissemination of information and reaction to it. The financial markets are susceptible to manipulation as some participants have information that others do not that is information asymmetry is ubiquitous in financial markets. To overcome this problem corporate governance is required to ensure that suppliers of finance to corporations are assured that they get their return on their investment . Despite the existence of institutional and legal framework numerous financial scams continue to be perpetuated both in developed and developing countries.The objectives of this study are : a) To examine some of the major misdemeanors which perpetuated in the financial system in 1991 and 2001 in India . b) Understand the financial regulatory measures which have been adopted after the 1991 share scam in India and why despite such measures adopted a security scam has recurred in 2001. c) Examine the theoretical structure of corporate governance for analyzing security scams that have occurred in the 1990s and the new millennium. The second section contains a summary of the events that occurred leading to the share scams and financial frauds in India and abroad during the recent decade that shook the financial markets. The third section surveys the rationale for regulation of securities markets and the functional procedures adopted in India in the aftermath of the scams. The fourth section looks at the theoretical underpinnings of corporate governance which, is followed by a discussion of the shortcomings of the regulatory set up in India which fails to prevent the recurrence of financial misdemeanors. Financial Liberalization is a phenomenon that is almost all pervasive in the world today. While liberalization has led to substantial benefits in terms of increased transparency, it has ushered in opportunities of corporate misgovernance. This implies that the mechanism by which legal institutions ensure that suppliers of funds receive the return on investment is not sufficient or appropriate. Recent trends through the 1990s in India and abroad reveal how corporate governance has not been effective permitting unscrupulous and opportunistic individuals to manipulate the market in their favor. The process of financial market regulation ensures that important guidelines are issued regarding how primary dealers (brokers) should operate with regards to mode of operation, conduct, litigation, amount of business to be handled, management of risk, internal control etc. These security scams and financial scandals discussed here involved the manipulation of huge amounts of money. The perpetrators of these gross transgression had such a comprehensive knowledge of how the system worked that they manipulated it to their advantage operating in an opportunistic manner . The essence of the argument in is that the occurrence and reoccurrence of such security scams and financial scandals can be attributed to a failure of corporate governance in finance despite the existence of an functioning regulatory authority empowered with the legal sanctions.

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