The Chits That Need To Be Regulated

On 18 July 2018, the Banning of Unregulated Deposits Schemes Bill, 2018, was introduced in Parliament. If passed, this bill would have helped in preventing illicit deposit taking activities. The bill contained a substantive banning clause, which bans deposit takers from promoting, operating, issuing advertisements or accepting deposits in any unregulated deposit scheme.

In tackling unregulated deposit schemes, the bill proposed creating three different types of offences: running of unregulated deposit schemes, fraudulent default in regulated deposit schemes, and wrongful inducement in relation to unregulated deposit schemes.

A total of 166 cases have been lodged in the last four years relating to chit funds and multi-crore scams. Most of these scams have been lodged in West Bengal and Odisha. Besides having provisions for repayment of deposits, the bill also sought to attach properties and assets of people and companies responsible for scamming the depositors.

What Exactly Are Chit Funds?

A ‘chit fund’ is considered as a traditional financial machinery operated by different institutions that prevail in India. It is an indigenous mechanism which together combines savings as well as credit. This scheme is looked at as an innovative access to finance and growth of low-income household savings.

For a particular chit fund scheme there is a chit group which has a fixed number of investors. These investors have to contribute a fixed amount of money. The interval of paying the money is usually a month for the investors. The total duration of the scheme is reliant on the number of members of the chit group. The money thus collected from the members every month goes into a common fund. The money is then given to one member who is usually selected through a lucky draw.

Auction is another process to give away the money to one member based on the bid. The foreman is responsible for the collection of the installments and heading this auction. Every member is allowed to bid every month in the auction for the chit fund money collected that very month. The member offering the lowest bid is awarded the bid. The bid is based on the maximum percentage of discount the bidder is ready to offer on the collected money. The discount can go up to a maximum of 40 per cent.

The process of joining a chit fund is easy as very little paperwork is needed. Moreover, the entire system works on trust.

There are different types of chit funds that function in India. First, the chit fund groups/schemes controlled by the state governments or chit funds run by public sector undertakings (PSU). People can invest in this type of chit funds as they are the safest.

Second, the registered chit funds, which are run by big business houses and they are also considered to be safe.

Third, the chit funds, which are not registered and are unorganised and run among the families and friends.

In India, if the value of the chit run by a chit fund operator exceeds Rs 100 and it is not registered, it is considered to be an illegal chit fund. Every institutionalised and registered chit fund is safe and sound and offers support to its customers.

Although the number of registered schemes has reduced, the valued has increased as the registered companies are now offering larger schemes to their members. India has around 15,000 chit fund companies. Only 1 per cent of this number runs in registered form and remaining works in the unorganised setup.

As per an Institute for Financial Management and Research (IFMR) report, the total amount of capital lent per year through registered chit funds is between 10 per cent and 50 per cent of all priority-sector lending which is extended by regular banks in the states covered in the report.

A chit fund company named Kerala State Financial Enterprise, which operates under the Kerala state government, is the largest chit fund company in India. In Kerala, around 5,000 chit fund companies are functional with almost 3,000 located in Thrissur district. These operators offer employment to approximately 35,000 people directly and an equivalent number indirectly.

Chit funds are not only popular in the southern states of India like Kerala, Tamil Nadu, and Andhra Pradesh but also in Maharashtra and Delhi. Another Hyderabad-based company, which is a part of the Ramoji Rao Group named Margadarsi Chit fund is also a big chit fund company. There are other companies like Mysore Sales International Limited, Shriram Chits etc, which are run by big business houses and are registered.

When Chit Funds Go Wrong

The biggest chit fund scam ever heard in India was the Saradha Group Chit Fund Scam. This scam resulted in nearly 600 cases against Sudipta Sen, the chairman of the Saradha Group. Over 10 million people were duped by the investment schemes of Saradha Group, which was a consortium of over 200 private companies.

One more Rs 100 crore chit fund scam case was busted by the Punjab Police in March 2014. The company had claimed to double the money of its investors in one-and-a-half years. In this way they were able to lure and trap more than 10,000 people to invest their money. The company showed the depositors that their money was invested in the ongoing projects of real estate sector, forestry and paper mills.

Another company, which encouraged only women to invest in the schemes and join the chit fund group, was The Reddamma Dasara Chit Fund Company. It is alleged that housewives and small-time workers had put their hard-earned money in the company and the deposits had exceeded Rs 3 crore. In November 2013, when they went to withdraw money they were asked to return a couple of days later by which time the company organisers went missing.

The Saradha Group (SG) of financial services was incorporated in 2006. The initial appraisal of capital required by SG was by issuing secured debentures to investors and so this was their first method of raising funds. The company grew in strength and the numbers increased to 50 and any such group or company automatically falls under the jurisdiction of SEBI or Securities and Exchange Board of India.

SEBI investigated the Saradha Group for the first time in 2009 and persisted with its investigation through 2010 after which Saradha Group started running various collective investment schemes. The nature of the investments were kept away from the investors and instead they were fraudulently sold as chit funds. SEBI, no longer needing to remain a spectator, intervened and through the state government of West Bengal initiated a warning to Saradha to close down.

For the second time, SG ignored the warning and transformed its group into a small agency dealing in buying and selling of small and medium enterprises’ (SME) shares to other likely SMEs or public.

Apart from adapting to this method of raising funds, SG wanted to be liberated from all bindings of the government and SEBI and after only three months in this undertaking, realised that SEBI had a clear authorisation over shares being traded. The acquired capitals were invested largely in the Bengali film industry. Members of Parliament and a member of the legislative assembly were appointed as the brand ambassador of SG.

Further, SG, in order to increase its goodwill, undertook campaigning for, and fulfilling the financial necessities of the Kolkata Football Association. The Saradha Group also contributed motorcycles to Kolkata Police.

In the aftermath of the Saradha scam, the standing committee of finance in its report (21 September 2015) suggested the introduction of a comprehensive regulatory framework governing all entities engaged in activities involving acceptance of deposits from the public.

Thus, the Banning of Unregulated Schemes Ordinance was formulated. The purpose of the ordinance was to prohibit solicitation/acceptance of 'Deposits' outside the 'Regulated Deposits Scheme' and as the name suggests banning of 'Unregulated Deposit Schemes'.

Does this mean that scams of such type will stop occurring? No, the ordinance is here to provide legal framework for detecting and punishing the offenders. The real vigilance is to be shown by the public.

People now need to be more open, aware and conscious before choosing the right financial schemes for themselves. They have to become more alert instead of becoming the victim.

There is also a need of a more stringent law, and a more regularised, transparent and easy procedure for registration of chit funds.