A Case Study on Saradha Group scam: the bad drives out the good the Ponzi way?

Ananda Das Gupta

I

In connection with Saradha scam in West Bengal recently, a number of people have commented that a root cause is the lack of availability of proper financial services. If financial inclusion had been achieved then people would not have to turn to deposit outfits like Saradha. Some articles explicitly claimed that the Reserve Bank of India (RBI) was directly responsible for such scams because it hadn’t allowed the expansion of banks. While it may be true that India has fewer banks than it needs but the idea of this being a root cause of Saradha-type scams is pure bunkum.

Historically, it has often been said that bad money drives out the good. In a somewhat similar way, bad financial services drive out the good. Could it be that all those people who put money into Saradha wouldn’t have done so if they had a bank in their neighbourhood? Very unlikely. A lot of the deposits seem to have come from towns where there would have been banks. Moreover, almost every ponzi scheme that has come to light in the last few years has actually flourished in towns and cities. The investors who fell for StockGuru or the Emu farms or other schemes all had access to legitimate alternatives.

Fraudulent schemes will always drive out the legitimate ones because they have many advantages that the legitimate ones can’t match. They will promise much higher returns since the returns are fictional anyway. They spend much more on sales commissions, on offices, keeping politicians happy and getting media coverage because they can just dip into the deposited money for all these expenses. Therefore, even if legitimate financial services are available passively, they won’t be able to compete. 

For example, the post office offers excellent schemes with a huge reach in rural and semi-urban areas but can it compete on sales and marketing? In fact, when the government eliminated commissions on PPF and other deposits in post offices in 2011, it effectively eliminated whatever little sales muscle there was. It’s clear that the mere presence of legitimate services cannot compete with fraudulent ones — the latter have to be stamped out proactively.

Among the many bizarre stories circulating about  Sudipto Sen is that he was forced to get his face reconstructed by plastic surgery after being mauled by attack dogs. Sen was born Shankaraditya Sen and got involved with the Naxalbari movement in the 1970s and was even jailed in 1971-72. In the late 1990s, he resurfaced as Sudipta Sen. With a new identity, Sen started as a real estate broker in the late 1990s in Kolkata. The money-circulating schemes began in the mid-2000s. This eventually morphed into nearly 100 companies, including his flagship Saradha Realty India, launched in 2008. Some of his other businesses were Saradha Properties, Saradha Biogas Production, Saradha Multipurpose Himghar, Saradha Livestock Breeding and Saradha Ad Agency.

II

Suicides, thousands of duped investors, hundreds of laid-off journalists, bickering politicians, protests slack regulation, one suspected mastermind arrested: it’s Ponzi scheme time in West Bengal, and it looks likely that little will change after the drama ends. The latest fleecing of poor and middle-class investors brought in an estimated $730 million, according to media reports, though public interest litigation filed in the Calcutta High Court by one lawyer says the amount is as high as Rs. 300 billion. ($5.5 billion) The head of the Saradha Group and accused mastermind of the scheme, Sudipta Sen, was arrested in Kashmir on April 23,2013 after two weeks as a fugitive. He has maintained his innocence, and reportedly threatened suicide, saying he might not be able to repay investors.

Sen started out as a small-time property dealer in the late 1990′s in Kolkata. His Saradha Group in the past decade had interests in real estate, tours groups and newspapers and television stations and eventually owned nearly 100 companies. Data from India’s Ministry of Corporate Affairs reveals interesting details. Many were incorporated in a one-week period in January 2011. They shared an address: 455 Diamond Harbour Road, Behala, Kolkata. They each listed working capital of Rs. 5 lakh each ($9,196). Their email addresses were the same. India’s market regulator, the Securities and Exchange Board of India, began investigating the Saradha Group in 2010.Three years after its investigation began, SEBI on April 23 ordered the company to pay back investors in three months. It has threatened to start a criminal case if investors don’t get their money back, according to NDTV. West Bengal sought Sen’s arrest, and the Congress Party has asked for a federal law enforcement investigation.

Here is how Saradha allegedly presented the scheme, according to NDTV: glossy brochures, abnormally high returns of 15 percent to 50 percent, an estimated 250,000 to 350,000 people investing their money and bringing others on board for 15-percent to 40-percent commissions. Starting amount for investment: as little as 100 rupees ($1.83). Also: promises of land and holiday packages. The scheme collapsed, NDTV said, as some policies matured and the group couldn’t pay up.

The responsibility for stopping such schemes lies with the state government, not the regulator. See this excerpt from an article in The Hindu Business Line. While SEBI investigates “Collective Investment Schemes,” the paper reported, state governments regulate the “chit funds,” or group savings funds that the Saradha Group used in this case. And the investigation has taken plenty of time to get anywhere.

West Bengal politicians have taken less action, and are accusing each other of ignoring the problem instead. The Left Front blames the Trinamool Congress for helping this group to flourish, while the government of Chief Minister and Trinamool leader Mamata Banerjee castigates the Left Front for allowing “cheat funds” to exist. Trinamool has proposed a 10 percent tax on cigarettes to raise money for a Rs. 500 crore ( – actually $92 million. Editor’s error.) investor relief fund.

“All political parties are involved, at least parts of it — that is, individuals. … They are of course to blame,” said economist Avirup Sarkar of the Indian Statistical Institute. “In West Bengal, lots of people have gained from such schemes and they have made fortunes. Their names will come out eventually. Now we see the usual blame game between political parties. That is not going to change the situation. Poor people have lost money and that is not going to come back.”

Nor are their jobs. At least 10 Saradha Group-owned newspapers and television channels in West Bengal and the neighboring state of Assam have shut down in the past month. Did the journalists know that they were financed by a Ponzi scheme?“Yes, we knew,” said one newspaper journalist who lost his job when the papers closed. He declined to be identified to avoid souring his future job prospects. “But they were paying good money, and we never thought that they would wind up the media organizations so soon.”

Others – poor people – reportedly killed themselves after losing most of their money in the scheme. What drew them to it in the first place? Sarkar said that the typical reason is financial illiteracy. And a journalist who works in the Burdwan district of West Bengal, where two people killed themselves because of the scheme’s failure, said that the temptation is too great to resist.

“Poor villagers find it much easier to invest in these schemes as they do not require too much documentation work, unlike opening a bank account or an account with the local post office,” said the journalist, who declined to be identified. “Also, the high interest returns are a lure.”

While the Saradha story has made plenty of headlines, it is far from the only Ponzi scheme that has surfaced recently. In March, India’s corporate affairs minister Sachin Pilot told Parliament that there have been complaints against 87 companies across India over Ponzi schemes. As many as 73 of those were from West Bengal. Ten were Saradha Group accusations, leaving another 67 to tackle. With the time it took to figure out that anything was wrong, it seems like defrauding investors may remain a safe bet for a while.

III

The success of Ponzi schemes targeting low-income individuals is seen by analysts as indicative of broader failures in India’s banking sector.Banking penetration in India is estimated to be 52 percent among middle- and high-income groups, but only 5 percent among low-income people, according to numbers cited by banking industry officials.It is estimated that only 57 percent of India’s population has access to bank accounts, 13 percent have debit cards and 2 percent use credit cards, Dun and Bradsreet, a research firm, reported in 2011. 

“This is a huge problem," said Ramnath Pradeep, former Chairman of Corporation Bank, one of India’s largest public-sector lenders. “The rural poor have very few options available to invest and often end up falling prey to dubious investment schemes. India urgently needs more banks especially in the rural sector,” Pradeep said. Regulators have been closing down companies considered unfit to run investment schemes, but experts believe that desired results will take more time.India is home to more than 12,000 registered financial services companies and monitoring the activity of each of them remains difficult. “But there have been improvements and India’s banking regulations have been changed several times to encourage financial inclusion,” Pradeep said.Between 2011 and 2012 deposits in India’s commercial banks grew at 18.3 percent, and lending has gone up by 22.9 percent, Dun and Bradstreet reported. Average population per branch has also improved from 14,000 in 2010 to 13,466 in 2011. Under India’s revised banking policy, banks have been asked to open at least 25 percent of their new branches in rural areas.

While, market regulator Sebi is probing the Kolkata-based Saradha group, it is time to ponder at what RBI can do to deter recurrence of such Ponzi schemes or misuse of funds raised by street-corner chit fund companies in the country.In a country of 1.2 billion population, every second person requires money and sometimes more than others can imagine. The chit-fund business has grown since the 1970s as a major corner-house meeting where one can raise funds for daily business needs. Every shop owner in India knows how to make use of money from chits than visiting banks and getting loans. Thanks to strict RBI stipulations, money flow from the banks to the needy corner-shop owners is still a herculean task making it easy for microfinance banks to reach them.Not for long and thanks to Vikram Akula, the founder and former chairperson of SKS Microfinance, who misinterpreted Bangladeshi economist and Nobel Laureate Muhammad Yunus's Grameen model of microfinance in his rush for numbers that the model went bust, and consequently brought forth a near-restriction on the business process of microfinance in India. 

IV

Despite some movement on reform, critics believe the combination of endemic corruption, the greed of investors demanding high returns and a weak banking sector in rural areas mean the problem could get worse.“These scams happen because smaller investors fall for the high returns,” said Ashis Biswas, a senior journalist. Even with access to bank accounts, India’s poor may have little to cheer about. For more than five years, inflation has been close to 6 percent in India, while average annual returns on bank deposits have been between 8-9 percent, reducing real income significantly. The worst affected are India’s poor, who often live on less than $2 a day.

At a time when it looked difficult to defraud the public in a modern, well-connected society, the Kolkata-based chit fund group proved otherwise. The Saradha group of companies were running openly under political patronage and the current exposure obviously attracted a knee-jerk reaction from the Trinamool Congress leader to set up a fund to give instant relief, ironically with the additional tax money collected from the smokers.

 The case is ironic but not rational. The society or tax-payer at large cannot always foot the bill of fraudulent players in society. Though chits come under the state list, the Centre and the RBI cannot wait for such scams to dent our strong unitary financial supervision practised since 1935. When microfinance players can be curbed with an iron hand, why not the chit fund organisers? The question should be how soon than when?

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