Lessons from Saradha scam: India needs a chit fund regulator, now

The whole episode on the infamous multi-crore Saradha scam has taken a new turn with arrested ex-Trinamool Congress MP, Kunal Ghosh, accusing West Bengal Chief Minister Mamata Banerjee of being the biggest beneficiary of the scam.The Trinamool chief Mamata has so far defended her position on the subject and the blame game is on.

One thing is clear: the Saradha scam has much more linkages with politics than economics and more skeletons are waiting to tumble out of the closet in the days ahead.Saradha did exist for over a decade unnoticed by regulators and public scrutiny before it grew enormously in size and finally collapsed in 2013.

On the other hand, the Reserve Bank of India (RBI) is busy tightening its grip on the non-banking finance companies (NBFCs) to enhance the oversight on these institutions, which are often called shadow banks in the financial system.

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Indeed, the central bank’s efforts are well-intentioned since over 12,000 NBFCs operating in the country and they have emerged as powerful medium of financial intermediation over years, even competing withcommercial banks in certain areas.

These institutions were hitherto lightly regulated till the RBI came up with tough regulations similar tothat of commercial banks, with higher entry capital barriers, provisioning on bad loans and mandatory capital reserve requirements.

The idea is to weed out non-serious players from the financial system and ensure that NBFCs growing inter-connectedness with banks do not harm the financial system in the event a possible failure. Given the fact that banks’ exposure have significantly grown to NBFCs in recent years, RBI’s caution is warranted.
The total loans outstanding of banks to NBFCs, as on 19 September stood at Rs 2,93,600 crore, slightly lower than Rs 3,07,000 crore a year-ago, or 5 percent of the total bank loans.

Large NBFCs, being systemically connected and interlinked with the banking system, could indeed pose threat to the overall financial system in the event of a failure.

But the real pitfall for the regulator is to tackle the unregistered chit funds and financial schemes of similar nature that operate under multiple names and forms, unnoticed byregulators.There are several trillions of funds being mobilized by hundreds of chit funds operating across the country in different formats. Some of them have balance sheets that exceed NBFCs.

Till date, there are no uniform national regulations to control chit funds, except state-level supervision that often begins and ends on paper.According to a July 2014 report in Mint, there over 30,000 chit funds alone in India, which are registered with state registrars under the 1982 Chit Funds Act, but many states do not have a mechanism to effectively regulate such firms.

But several hundreds of unregistered funds thrive in the hinterlands. Are there more Saradhas in making?

Themulti-crore Saradha scam that broke out in April 2013 was not necessarily really involvinga chit fund but its operations were not very different from the operations of a typical chit fund.Saradha collected thousands of crores from poor investors, which later turned out to be part of operations of a nexus between criminals and local politicians.

Subsequent investigations and the questioning of Trinamool MP Ahmed Hassan Imran seem to have revealed that some parts of the funds thus collected from the poor were used to fund terrorist activities across border.Despite Saradha being an eye-opener to the nation, the critical fact is that there are still several chit funds still operating in the country who keep collecting deposits in small quantities from the poor who do not have access to formal banking services yet.

These funds, either operated by private individuals or institutions, may not be big in size, but such chit funds are certainly large in number. TheRBI has acknowledged the fact that India needs to do more to tackle companies or financial products that do not clearly fall under a regulator’s purview, including those taking deposits without having registered with the RBI.

But the RBI in the past has made it clear that it doesn’t have the infrastructure to regulate small lenders. This was evident in the regulation of micro-lending sector. The RBI regulates only NBFC microlenders, while non-NBFC MFIs are still not under any kind of regulation.

That leaves only the option of creation of a separate regulator to control the thriving illegal chit funds and bring them under much-needed regulation. Small, illegal financiers operating in large numbers are more difficult to tackle.

Hence, the initiative must come from the union government to create a new regulator, which hasthe machinery to operate on the ground and chase perpetrators, join hands with local governments and police force.Delay in regulating small illegal financiers and deposit-taking firms would mean more Saradhas in the making, which can some day, inflict pain upon several hundreds of poor savers.