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• GS 3 || Economy || Structure of the Indian Economy || Parallel Economy

Why in the news?

Bernard Madoff, who was convicted for running the largest known Ponzi scheme in history, died recently in prison where he was serving a 150-year sentence

What is a ‘Ponzi’ scheme?

• Ponzi schemes are investment schemes that are intended to cheat people.
• These schemes promise people a tremendously high rate of return on their investments. Ponzi schemes provide returns for those investors that invested in the initial days of launching the scheme by acquiring new investors.
• The origin of the Ponzi scheme dates way back to the year 1919. The Ponzi scheme is named after Charles Ponzi.
• He was known for his deception to convince people to invest their money. Charles Ponzi is recorded to have run the first-ever Ponzi scheme.

Adverse Impacts of Ponzi schemes:

• Exploitation of poor and vulnerable: Many people get duped and they lose their hard earned money by investing in such schemes. The CBI had lodged about 166 cases in the past four years related to chit funds and multi-crore scams, with the highest numbers in West Bengal and Odisha.
• Decline of trust in the financial systems: If such schemes spread to very large people it may impact the financial system and therefore trust of people in the financial system may decline.
• Moral degradation: Moral degradation in society since people gets inspired for huge gains with little risks and thus may cause negative behaviour development and that will not be good for the larger society in the long term.
• A good governance challenge: According to the Reserve Bank of India, between July 2014 and May 2018, 978 cases of unauthorised schemes were discussed in state-level coordination committee (SLCC) meetings in various states and union territories, and were forwarded to the respective regulators or law enforcement agencies in the states.

Ponzi schemes in India: regulatory framework

• Ponzi schemes are banned under the Prize Chit and Money Circulation (Banning) Act, 1978. It is a Central Act but the respective State governments are the enforcement agency of this law
• These schemes are also dealt by the Enforcement Directorate (ED) under Prevention of Money Laundering Act, 2002.
• The Banning of unregulated Deposit Schemes Act 2019 has been enacted to prevent the fraudulent schemes.

Banning of unregulated Deposit Schemes Act 2019: Salient features

• The Parliament had passed the Banning of Unregulated Deposit Schemes Act, 2019. The Act aims to protect investors from fraudulent investment schemes, such as Ponzi schemes.

The salient features are:

• Definition of ‘deposit’: The Act defines a deposit as an amount of money received through an advance, a loan, or in any other form, with a promise to be returned with or without interest. Such deposit may be returned either in cash or as a service, and the time of return may or may not be specified. Also, All deposit-taking schemes are required to be registered with the relevant regulator.
• Unregulated deposit scheme: The Act bans unregulated deposit schemes. A deposit-taking scheme is defined as unregulated if it is taken for a business purpose and is not registered with the regulators listed in the Act
• Deposit taker: The Act defines deposit takers as an individual, a group of individuals, or a company who asks for (solicits), or receives deposits. Banks and entities incorporated under any other law are not included as deposit takers.
• Competent Authority: The Act provides for the appointment of one or more government officers, not below the rank of Secretary to the state or central government, as the Competent Authority. Police officers receiving information about offences committed under the Bill will report it to the Competent Authority.
• Designated Courts: The Bill Act for the constitution of one or more Designated Courts in specified areas. This Court will be headed by a judge not below the rank of a district and sessions judge, or additional district and sessions judge.
• Central database: The Act also provides for the central government to designate an authority to create an online central database for information on deposit takers. All deposit takers will be required to inform the database authority about their business. The Competent Authority will be required to share all information on unregulated deposits with the authority.
• Offences and penalties: The Act defines primarily three types of offences, and penalties related to them. These offences are: (i) running (advertising, promoting, operating or accepting money for) unregulated deposit schemes, (ii) fraudulently defaulting on regulated deposit schemes, and (iii) wrongfully inducing depositors to invest in unregulated deposit schemes by willingly falsifying facts.

Challenges:

• Even though the unregulated Deposit Schemes Act 2019 is comprehensive, it bans only Ponzi schemes not regulated deposits.
• The reconciliation of the Act with the provisions of Deposit Schemes Act 2019 with other Acts such as insolvency and bankruptcy code, etc.
• It does not stop any entity from seeking funds for its business or an individual raising a quick loan from relatives to tide over a crisis.
• The Act does not include digital payments and online wallets.
• Charitable institutions may face difficulty to fund students or those seeking medical assistance.

Way forward:

The Banning of Unregulated Deposit Schemes Act, 2019 needs to be implemented on grounds in letter and its spirit alike.

The provisions of the database needs to be used extensively for the probe into the Ponzi schemes. The dedicated courts need to be equipped with adequate manpower to function them effectively. There must also be checks against persons in power misusing the new rules to de-recognise genuine deposit schemes that offer useful financial services to customers in the unorganised sector.

Model Mains Question:

1. What do you understand about the ‘Ponzi scheme’? Examine the existing regulatory framework for the unregulated deposits in India.