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2015

Economy Updates – Mar-2015

Saradha Chit Fund Scam

  • Saradha group of companies were established in the year 2006 by Master Mind Sudipta Sen and spread in the states of West Bengal, Assam, Jharkhand, Orissa, Bihar   Chhattisgarh.
  • Estimated amount collected : Rs. 20,000 to 30,000 crore

Modus Operandi

  • Business started in the name of Sarada Devi, who is wife of Shri RamKrishna Paramhans, a highly respected spiritual guru born in West Bengal. Name of Sarita Devi also known as Mother Sarada used to gain trust of the people in the fund.
  • Money collected through agents by offering commission ranging from 15% to as high as 40%. Heavy returns were promised to the investors. Sometimes flat or land were offered in return.

How Chit Fund Works

  • Assume that there are 10 persons come together and decide to contribute Rs 5,000 every month. This means a total of Rs 50,000 will be collected every month. This amount is then auctioned among the 10 members after a minimum discount has been set.
  • Let’s say the minimum discount is set at Rs 4,000. This means the maximum amount any person can get from the total Rs 50,000 collected is Rs 46,000 (Rs 50,000 – Rs 4,000).
  • Now, bids are invited and all the persons bid. The one who bids a maximum discount gets the money.
  • For example a person has won the bid by offering a discount of Rs. 10,000. Now, he will get Rs 40,000 (Rs 50,000 – Rs 10,000). He will also have to bear the organizer charges of around 5 percent. Hence, person will get Rs. 37,500 (Rs. 40,000 – Rs. 2,500) after deducting the organizer charges.
  • The discount of Rs 10,000 is basically a profit of the group and it is distributed equally among the members, with each one of them getting Rs 1,000. This money that is distributed is referred to as a dividend.
  • This is how chit funds works and they are perfectly legal if they are registered under the Chit Funds Act 1982, a central statute or various state-specific acts.
  • A chit fund can not declare in advance the return an individual is likely to make, given the way its structured.

Role of the regulators is in question

  • As per SEBI regulations and the Companies Act, a company cannot raise capital from more than 50 people without issuing a proper prospectus and balance sheet. Saradha Group created an extremely complex tiered corporate structure of more than 200 companies to bamboozle SEBI. SEBI issued continuous notices from as early as 2010, reminding the State administration of a possible Ponzi Scheme.

How Ponzi Scheme works

  • The first rule, therefore, is that the company has to constantly keep on adding fresh investors. So even if the old depositors do not ask for refunds, the chain instantly treads into troubled waters if the company fails to get new depositors.

Impact on Economy

  • Rural Economy is heavily dependent on the small savings scheme of the Indian postal services. Due to low interest rates in postal saving scheme, major chunk got diverted to such chit funds.
  • West Bengal’s Small Savings Post Office Deposits Net Collection Data :
    Year 2006-07 2009-10 2010-11 2011-12
    Collection
    (Rs. In crore)
    6238.93 8985 8409 (-987.22)
  • Above table shows Net collection, i.e. excess of money collected after repayment. However, year 2011-12 shows negative outflow of Rs. 987 crores. This means in 2011-12, the whole amount of Rs.8409 crore plus Rs. 987.22 crore were diverted to some other financial schemes (likes of Saradha).
  • Such diversion took place because people were lured towards the higher returns offered by the Saradha group of companies.

Conclusion

  • India has a large low income rural population who have limited access to formal banking facility. Hence, a parallel informal banking system flourishes and gives space for such scams to happen.
  • The best way to give comprehensive financial inclusion is to increase the reach of masses to formal banking system. Recently launched Pradhan Mantri Jan Dhan Yojana by the Prime Minister of India under which more than 12.58 crore bank accounts have been opened is a welcome move towards the banking the unbanked.
Financial Management