The discovery of the multi-crore Saradha Group scam has put the spotlight right back on the operations of millions of companies involved in chit fund operations and experts point out that lack of enforcement infrastructure and unavailability of a mechanism to track down finances of such entities, coupled with lack of political will allows them to operate freely right under the nose of RBI and Sebi, which cite various technicalities for their inability to govern operations of such groups.
Scam-ridden Saradha Group boss Sudipta Sen, arrested for being the alleged kingpin of the multi-billion rupee chit fund scam, was grilled by Assam Police in the cases of fraud and forgery lodged against him.
A team of police officers from Assam quizzed Sen about the four cases filed against his group companies in the northeastern State. Two of the cases were registered in Dispur and one each in Geetanagar and Paltan Bazar.
Corporate and legal experts say that chit fund companies function quite like non banking financial companies (NBFCs) and those which have net owned funds (NOFs which means the extent of funds or contributions generated by such firms) above Rs 2 crore should ideally be registered with RBI. Once chit funds companies are registered with the central bank, they get the certificate to function as NBFCs.
Chit fund schemes are very small in size and operate among a small and fixed group of investors for a fixed tenure. In such schemes, generally a small number of people come together to pool in their money every month and one of those persons is given the entire pool of money through lottery. The money is later returned in installments.
Industry watchers point out that normally companies in such cases deal in hard cash and even the receipts given to investors are not 'pucca', meaning that through such a piece of paper, the antecedents of the company cannot be properly verified as only its name is mentioned on it.
Chit fund companies spawned mainly due to common man's inaccessibility to banks in remote parts of the country, and experts added that the reason they thrived and continue to do so is the lure of high interest rates and easy process.
“Banks offer around 4 per cent interest whereas in chit fund companies the rate of return could go as high as up to 50 per cent. Also there is no complicated paper work involved and transactions are simple. These are the two major reasons which lure people into this business.
There is no limit on enrolment and therefore investors keep coming and due to the spiralling effect, the chain continues as members normally know each other and recommend their acquaintances into it with the attraction of handsome returns,” said a legal expert with experience of dealing with such entities.
Ideally it is for the RBI to track finances of chit funds companies which have crossed the threshold limit of Rs 2 crore in terms of NOF. Ironically though, RBI does not have the mechanism or the synchronised data to monitor whether such companies have crossed the said limit, an industry watcher on condition of anonymity said.
This allows such entities to get away by not registering themselves with RBI and thus explains the mushrooming of millions of chit fund companies across the country, with quite a few of them not surprisingly, turning out to be fly by night operators. As per information on the website of the Ministry of Corporate Affairs (MCA), more than 2,400 chit fund companies are registered with it.
Also once the threshold limit is crossed, apart from getting themselves registered, chit funds companies also need to create a reserve fund where 20 per cent of their profits need to be parked, industry sources informed.
However this too is mostly not done by such companies in several cases since no registration has happened in the first place, with these entities being fully aware of the RBI's handicap.
“Also it is easy to show that the NOF limit has not been crossed by diverting funds into other channels,” a source closely involved with several key initiatives of the Government, said. This, the source added, is normally done by chit fund companies by diversifying into other sectors, like it happened in Saradha's case, which had several entities dealing with sectors like realty, travel and tourism among others.
Ideally if a company is diversifying, then it needs to intimate about the change in its main objective to the Registrar of Companies (RoC), as 50 per cent of the company's revenue is generated through its main objective. However with several chit funds companies not having registered themselves with RBI, their diversification into other businesses too goes unnoticed.
On his part though, RBI Governor D Subbarao has said that the central bank does not regulate chit fund firms and therefore it is up to the state governments to be more vigilant in terms of taking action against multi-level marketing by chit funds which mobilise public money.
Industry watchers say that this only indicates towards “passing the buck” attitude of the Government, as even Sebi says that it governs only those entities which are involved in collective investment schemes (CIS) and that too which are listed. Sebi does not count chit fund companies under CIS category.
“This clearly shows that though mechanisms are there to regulate entities like chit funds companies, due to lack of enforcement infrastructure and most importantly due to lack of political will (to ensure enforcement), has led to regular eruption of such scams,” a source said.
As far as states being asked to govern activities of chit fund companies is concerned, official sources said that all states have their respective Money lenders Act, under which companies indulging in giving loans and earning interests on such amounts, need to be registered.