EPW, Vol - XLVIII No. 18, May 04, 2013 | Subhanil Chowdhury
The Saradha group's collapse has possibly bankrupted lakhs of small investors robbing them of their life savings, and has rendered thousands of its agents jobless. The scam highlights the failure of the government and its regulatory agencies to reign in the mushrooming chit fund companies in West Bengal. It also brings under the scanner the Trinamool Congress' proximity with the tainted group. In the wake of the scandal, the article attempts to understand why the dubious Ponzi schemes have thrived and flourished in state.
Subhanil Chowdhury (firstname.lastname@example.org) teaches at the Institute of Development Studies, Kolkata
Sudipto Sen, the chairman of the Saradha group of companies, was arrested in Kashmir on April 23, 2013, for allegedly defrauding lakhs of depositors who had invested in various schemes floated by his companies. After the Saradha group went bust, Mamta Banerjee, the chief minister of West Bengal callously told the duped investors, “let go whatever has gone”. However after two days, she announced a Rs 500 crore relief package for the hapless investors. In light of the unfolding events, this article attempts to analyse the political economy of the dubious shadow finance organisations in West Bengal.
The Modus Operandi
Let us take a look at the modus operandi of the Saradha Group of companies. The group collected money from the investors, through agents, promising them either land or a flat, or an option for a refund with a rate of return ranging between 12-24 per cent approximately, as per the Securities Exchange Board of India (SEBI) notice.1 The agents in turn were assured of a commission ranging from 15 to 20 per cent on the funds mobilised by them, according to local media reports. In some schemes, the group promised that on a deposit of Rs 1 lakh an investor will get Rs 10 lakhs after 14 years. If the same amount of money was kept in a fixed deposit in a bank for the same period, the amount accrued would be Rs 4 lakh. In other words, the rate of return promised by the group was more than double of that promised by commercial banks. According to some media estimates, the number of agents employed by Saradha group may run into thousands or even in lakhs, while the total amount of money mobilised by the group can run into thousands of crores. The huge collection of money from the agents was deposited with the main company which loated 160 companies (according to the letter submitted by Sudipto Sen to the CBI), including a large number of newspapers in various languages and TV channels in Bengali.
The entire money mobilisation exercise of the group was, however, deeply problematic for a number of reasons. Firstly, in none of the documents given to the Registrar of Companies did the group mention anything about mobilising such huge amount of money from the public, and hence kept itself out of the purview of either the Reserve bank of India (RBI) or SEBI.2 The SEBI report also categorically mentions that the group never sought any permission from it to run such a scheme. The promise of providing a plot of land, or a flat after the maturity of the scheme was also a hoax. The SEBI found that the land/flat allotted to the investors was not pre-determined, and the investors had no control over the scheme, or the property. Moreover even after repeated prodding by the SEBI, the group did not furnish the required information, and tried to mislead it by providing voluminous data, which was basically irrelevant. When at last they furnished the information, it was found that it contained details of only 5 projects while the group stated to have acquired land in 31 locations. The details of allocation, booking, cancellation etc, were not provided, thereby prompting the SEBI to conclude that “it is highly unlikely that the projects are actually in progress”.3 There are also reports in the media that a motorcycle factory run by the group did not carry out any manufacturing. The workers were told to act as if they were producing the bikes when the group brought in investors to showcase the factory as an important asset of the group.4 In short, the group’s functioning was blatantly illegal and fraudulent.The working of the group in such blatant violation of all regulations and laws shows a mammoth failure of the regulatory authority of the government, both at the centre as well as the state level.
In April 2010, the Left Front government sent a letter to the SEBI to investigate the group's activities. Prior to this, the Left Front government had passed a bill first in 2003, and then in 2009, to protect the interest of depositors and reign in such fraudulent companies. The bill has sections under which the property of such companies could be confiscated and auctioned to repay investors and charge them with criminal culpability. But even after four years, the bill still awaits Presidential assent. It can be argued that the Left Front government should have done more in terms of devising some mechanism to either control the functioning of the group, or at least alert the public. However, the matters came to a head under the Trinamool Congress (TMC) government.
The Unholy Nexus: TMC and Saradha Group
There are deep links between the Trinamool Congress party and the Saradha group. The CEO of the group's media wing Mr. Kunal Ghosh, and Mr. Srinjoy Bose, owner of the Pratidin newspaper, which has extensive business deals with Saradha, are both TMC MPs. Newspapers such as Pratidin, Sakalbela (owned by the Saradha group), etc, and TV channels such as Channel 10 are practically mouthpieces of the TMC. The brazen manner in which they support the chief minister Mamata Banerjee and the TMC makes a mockery of journalism.
The TMC has been equally complicit in patronising Saradha's media network. The TMC government had ordered all public libraries to subscribe to newspapers owned by the Saradha group, including a Bengali daily Kolom, which Mamta Bannerjee had inaugurated recently. Video footage of her distributing ambulances, motorcycles and bicycles donated by the Saradha Group in Jangalmahal in 2011, has also been circulating. It is also reported that Sudipto Sen bought a painting of Banerjee for Rs 1.86 crore. The TMC transport minister, Mr. Madan Mitra, was appointed the president of the employees' union of the group, and at a programme organised by Saradha he proclaimed that its owner Sudipto Sen was the pride of Bengal. Moreover till April 15, the Chief minister feigned ignorance about Saradha being a chit fund company. Infact in March 2013, Sachin Pilot the Union Minister of Company Affairs placed in Loksabha, a list naming 73 companies from West Bengal who were running Ponzi schemes. The list included the Saradha group. No action was ever initiated by the TMC government against Saradha in the last two years. Rather the growing proximity between the ruling party and the group only helped in increasing the latter's credibility. After his arrest, the group's chairman in a letter to the CBI claimed that TMC MPs like Kunal Ghosh and Srinjoy Bose promised to protect him from the law if he acceded to their demands.
Reasons for Small Investors Flocking to Saradha
As has been already noted, the Saradha group promised a very high rate of return to the investors. It is true that the investors did not know that the scheme was a big fraud. However, it was evident that the abnormally high returns promised by the group was either not feasible, or involved too much risk, which could lead to investors loosing all their money. Currently, the rate of growth in India has slowed to 5.5 per cent, and the rate of interest prevailing in the market is between 8 and 9 per cent. In such a scenario to promise a rate of return above 20 per cent was blatantly absurd. So why did the people give their hard earned money to such complete fraudsters? There are number of reasons for this phenomenon.
Slide in small saving deposits- If we look at the savings portfolio of the household sector in India, we find that between 2000-2005 the financial assets consisted of 12.8 per cent of GDP, while the physical assets accounted for 12.9 per cent. However between 2005-2010, the financial assets increased to 15.6 per cent of GDP, while physical assets declined to 11.8 per cent. In other words there was a greater degree of financialisation of savings in the second half of the last decade. If we further analyse the financial savings data we find that bank deposits account for the largest share-- increasing from 37.8 per cent in 2000-2005 to 51.6 per cent in 2005-10. The share of life insurance fund and that of stocks and debentures also witnessed a significant increase. However, there was a drastic fall in the share of claims on government -- mainly the small savings schemes -- which declined from 19.5 per cent in 2000-05 to 2.6 per cent in 2005-10.5 This drop in small savings holding is because of two reasons: (a) a decline in the interest rates of the schemes on offer (b) the availability of other financial instruments in the market made possible by economic liberalisation.
West Bengal has been particularly hit hard by the fall in small savings deposits. The net collection from small savings was Rs 6,238.93 crore in 2006-07. This increased to Rs 8,985 crore in 2009-10,marginally declined to Rs 8409 crore in 2010-11 and then and subsequently declined to (-)987.22 crore in 2011-12.6 Therefore within two years, approximately Rs 9,000 crore did not go to small savings schemes. The question is where did this money go? This money, which was earlier mobilised by the small savings scheme, must have been invested in financial instruments which promised a higher rate of return than that provided by the small savings schemes. Therefore, the shadow financial organisations like Saradha became an obvious choice for the small investor.
Lowering of the rate of interest on small savings - The issue of lowering of the rate of interest on small savings is a direct result of central government policies. With the opening up of the financial sector and the concomitant liberalisation of financial institutions, the ruling establishment has let markets determine financial investments. As a result, various committees of the central government which looked into the issue of small savings suggested that the interest rate should be market-determined, or it should be aligned with the interest rate obtainable on government securities of the same maturity. With lower rates of interest on small savings, and lower financial inclusion, fraudulent companies like Saradha group become the obvious choice of the people to deposit their savings.
Low Financial Inclusion -The state of West Bengal has one of the lowest ranks in financial inclusion in the country, as stated in a working paper published by the RBI.7 Excluding Kolkata, all other districts of West Bengal have very low financial inclusion. The Index of Financial Inclusion (IFI) constructed by this RBI paper has a maximum value of 1. Most of the districts in the state have a value of IFI less than 0.1, with some like South 24 Parganas having a value of 0.01.8Given such abysmally low levels of financial inclusion, most of the people in the state are outside the net of organised financial institutions. Therefore, the people park their savings in shadow finance institutions like the Saradha who promise a rate of return much higher than that offered by the commercial banks.
Several reasons can be cited for this low rate of financial inclusion in West Bengal. The RBI Working Paper, mentioned above, states that the main reason why the people do not keep their money in banks is that their income level is not sufficient to open and operate bank accounts. There is a lack of awareness about banking facilities and the benefits that banks offer. Since most of the people do not have a collateral against which they can take loans, they borrow from the rural money lenders and carry on their banking transactions in the informal sector. While all these factors are important in understanding why financial inclusion has lagged behind in West Bengal, the change in banking policies with the introduction of liberalisation should not be underestimated. With the advent of economic reforms in the early nineties, there has been a decline in the bank offices opened in the rural areas (from 35,360 in 1993 to 31,667 in 2009), while the number of offices in the urban areas have increased significantly. Moreover, there is a huge concentration of both credit and deposit in the urban and metropolitan areas, which account for 77 per cent of the deposits and 80.4 per cent of the total credit provided by the scheduled commercial banks in 2009.9 With the banking sector's focus on earning more profits, the social aspects of banking has been adversely affected. The norms of opening branches in the rural sector and providing banking services to the poor have not been adhered to by the private banks. The public sector banks have to compete with the private banks and are reluctant to open more branches in the rural areas, or areas where financial inclusion is low. The net result has been that in a state like West Bengal, which is a predominantly agricultural state, majority of the people living in rural areas have not been included in the organised financial sector.
Lured by Saradha
However, two sets of questions can be raised at this point. (a) Any financial venture has to be based upon the trust factor. Why did the people even believe what the Saradha group promised? (b) Why did thousands of people enroll as agents of this kind of a dubious group? I have tried to answer these questions.
a) Information asymmetry - With respect to the issue of trust, the first point that needs to be made is that there was an acute information asymmetry between the Saradha group and its customers. The Saradha group chairman was fully aware that he was running a fraud company, and that his promise of a higher rate of return was false. But the customers had faith in that promise and believed that they will reap high dividends.
In any financial transaction such information asymmetry can be present. This is normally dealt with by a regulatory mechanism as it exists in case of Banks and other financial companies. The regulator along with the government’s statutory authority maintains faith in the working of financial instruments. But in case of Saradha, no such mechanism in terms of a regulatory framework existed. What existed was the active patronage of the company by the TMC.
The information asymmetry got exacerbated because of the group's connection with the political party. Primarily, money was invested in Saradha by the people on the belief that both the TMC and the state government were behind the company. There were also some media reports that the Saradha group chairman had asked its agents to actively campaign for the TMC in the 2011 assembly elections. In other words, the trust was earned by Saradha because of the patronage provided by the TMC. People put their bet on Saradha looking at TMC as the guarantor. This kind of political underwriting of a dubious financial organisation by the ruling party is unique in the history of West Bengal. However at the same time it must be highlighted that the people did not use their judgment to invest prudently. Though most people were misled by Saradha and its association with the TMC, given their weak educational and class background, it cannot be denied that they got lured by high profits offered by the Ponzi schemes.
b) Seeking employment with Saradha - The employment situation in the state is under severe stress with a huge informalisation of the labour force. While it is true that this informalisation is an all-India phenomenon, the proportion of informal workers is higher in West Bengal than in rest of the country. In India around 75 per cent of the rural workers and 69 per cent of the urban workers worked in informal sector, while for West Bengal the numbers were 86 per cent and 71 per cent respectively. 10 The manufacturing as well as the agricultural sector in the state has also witnessed a slowdown, particularly in the last two years of the TMC rule. The share of manufacturing in GSDP in West Bengal has has been steadily declining. Therefore, with a fall in the share of manufacturing, income of the informal workers was adversely affected. Moreover even after the implementation of NREGA, there has been only a minimal increase in real wages of unskilled workers in rural areas as compared to the rest of the country.11 The huge informalised workforce, in search of a better livelihood, was lured by companies like Saradha with the promise of a huge commission. In the meantime, the central government also cut the commission of the agents of LIC and other small savings instruments. These agents therefore decided to seek employment with Saradha and other similar companies.
There was yet another reason why people gravitated towards Saradha. The growth in West Bengal has been mainly led by the services sector, and more specifically the real estate and construction sector. These are two sectors whose share in GSDP has increased significantly in the recent period. Therefore, the common perception of the people was that this is a booming sector, and hence nobody will suffer a loss if money was invested here. Since Saradha’s main investments were supposedly in real estate, this attracted both agents as well as investors to the company.
Not Borrowing from Banks
Another important aspect of these shadow finance institutions has to be highlighted. Saradha and other companies of the same ilk raised money from customers at a higher rate compared to what the banks would have charged them if they had borrowed from them. The credit-deposit ratio in West Bengal fell from 64.8 per cent in March 2010, to 62.9 per cent in March 2012. These figures indicate that the credit market in West Bengal was definitely not supply constrained. Therefore if somebody wanted to start a business, s/he could easily borrow from banks at a reasonable interest rate. Given this situation why were companies like Saradha collecting money from public with a commitment to pay a higher rate of return, than borrow from banks? Firstly, if these companies had borrowed from the banks then they would have had to observe certain norms of financial prudence. These norms ensured that excessive risk was not taken by the borrowers, and that in case of default the money could be rescued by auctioning the collateral. The basic motive of companies like Saradha was to either dupe people, or speculate in excessively risky assets. This could not have been done by borrowing money from the commercial banks. Therefore, they took the route of borrowing money from the public, bypassing all rules and regulations. They were unconcerned with the fact that the inevitable bursting of the bubble would lead to a loss of livelihoods and lives.
Need for a Regulatory Framework
The only way to deal with such problem is to organise a clamp down on such companies, and at the same time ensure financial inclusion of the people. What is clear from the Saradha case is that there has been a breakdown of the regulatory framework. This has been facilitated by an absence of suitable laws at the state level, and a lack of vigilance on the part of both the government as well as regulators like the SEBI. What is required, therefore, is to have a sound regulatory framework to deal with companies like Saradha. The experience of Tripura can be of help here. The state had formulated an act protecting the interests of depositors in 2000, and then amended it in 2011. As a result of this act, the menace of such companies has been greatly reduced in Tripura.12 At the same time a central law must also be passed to deal with such fraudulent financial enterprises.
However on an immediate basis, the people who have lost their money should be protected. The setting up of a Rs 500 crore relief fund by the chief minister for the affected investors is fraught with many bureaucratic hurdles. Without a proper regulatory framework in place, this kind of announcement might embolden other such companies to become even more reckless knowing well that the government will refund the defrauded investors. Therefore instead of announcing token relief for the people, which in any case is too little and too late, the government should concentrate upon bringing to book all those who are involved with this scam irrespective of their political colour. They should confiscate and auction the property of Saradha to pay back the investors in the least possible time, and develop a proper regulatory framework to deal with all such companies. Unless these measures are taken, tragedies like the busting of Saradha will recur in West Bengal.
1. The Stock Exchange Board of India (SEBI) in its notice dated April 23, 2013 (No. WTM/RKA/ERO-CIS/19/2013) has given some details regarding the schemes floated by the group.
2. Chit Wriggles past Watchdogs, The Telegraph, 20 April, 2013.
3. All details from the SEBI notice dated April 23, 2013.
4. Bengali daily ‘Ei Samay’, 24 April.
5. All data quoted from Report of the Sub-Group on Household Sector Saving during the Twelfth Five-Year Plan (2012-13 to 2016-17) Planning Commission.
6. Statistical Appendix, Economic Review, 2012-13, Government of West Bengal.
7. Financial Inclusion in India: A case-study of West Bengal, Sadhan Kumar Chattopadhyay, RBI Working Paper Series, August 2011.
8. Financial Inclusion in India: A case-study of West Bengal, Sadhan Kumar Chattopadhyay, RBI Working Paper Series, August 2011.
9. Basic Statistical Returns of Scheduled Commercial Banks in India, various issues, RBI.
10. Calculated from NSS Report on Employment and Unemployment in India.
11. Database of Indian Economy, RBI.
12. Anandabazar Patrika, 24 April 2013.