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Why in the news?
The Central Bureau of Investigation (CBI) arrested ministers Firhad Hakim and Subrata Mukherjee, TMC MLA Madan Mitra, and former Kolkata Mayor Sovan Chattopadhyay in the Narada bribery case
About chit funds and Ponzi schemes:
- Chit Funds: Chit Funds or Chitty is a kind of a savings deposits which is done by a group of people. The concept is very similar to Kitty Parties which are organised by women to save some money for a particular community project. These chit funds can be managed by registered companies or it can also be organised by a group of people like family and friends.
- Ponzi Schemes: Ponzi Schemes are basically structured in such a way that the money channeled from the investors go around and around in circles. This basically means that, the money collected from the investors are used to pay off the old investors. The Ponzi Schemes basically function till the amount of money coming in from new investments is more than the money going out to pay the old investors.
- Ponzi Schemes try to attract investors by offering very rate of returns, while Chit Funds don’t offer anything similar to this. It’s basically a group of people contributing some amount of money each month and getting a lump sum amount in only one particular month.
Types of Chit Funds:
- Chit funds run by state governments: These funds are managed and controlled by state governments. Funds run by PSUs (public sector undertakings) conjointly belong to the present category. These are safe and probabilities of loss are restricted. Business processes are clear and clean.
- Private registered chit funds: These invoice funds are registered as per chit Funds Act of 1982. These are commonly floated by distinguished money institutes or business homes. Collaborating in these funds isn’t as safe as in state governments or public sector undertakings. However, as they’re underneath the management of leading non-public sector firms or institutes the danger is calculated and tolerable.
- Unregistered chit funds: Unregistered invoice funds aren’t legal and participation in these is up to the danger of members. Such kinds of invoice funds are common throughout Bharat and are sometimes shaped by an in depth cluster of associates. Participation in these funds ought to be avoided as disputes are subject to members’ integrity and honesty.
Why chit fund and Ponzi schemes prevalent rife in India?
- Less interest rate: Low rate of interest on little savings provided by business banks are sometimes not coherent with the market rate, leading to middle financial gain clusters moving towards unregulated deposit schemes.
- Easy to get loan: Obtaining formal loan still remains a large task for a typical man as banks, financial organizations are tormented by rigorous procedures.
- Less regulated regime: at fairly competitive interest rates prevailing within the market makes these schemes simply accessible.
- Money can be withdrawn anytime: Chit funds return handy to satisfy exigencies like death or ill-health additionally as joyous occasions like marriages and child-birth within the family.
- Promote savings culture: These kinds of themes promote savings culture as every member is meant to contribute a hard and fast quantity each month towards the fund.
- At present chit funds are ruled by Chit Funds Act of 1962, run Act of 1934, and SEBI Act of 1992 etc.
- Under the chit Fund Act of 1962, businesses may be registered and controlled solely by the several State Governments.
- The Registrar of Chits, who is appointed by several state governments under Section 61 of the Chit Funds Act, is the regulator of chit funds.
- Functionally, invoice funds are enclosed within the definition of Non-Banking money firms (NBFCs) (LINK) by run underneath the sub-head Miscellaneous Non-Banking Company (MNBC).
- RBI but has not arranged out any separate restrictive framework for them.
- The Chit Funds (Amendment) Bill, 2019, has been approved by Parliament. It would simplify the operations of collective investment schemes, or chit funds, with the aim of protecting investors who are mostly from economically disadvantaged groups.
Reason for failure of chit funds:
- Fraudulent companies: There are rising instances of individuals in varied components of the country being defrauded by illicit deposit taking schemes like Saradha chit Fund Scam, Rose natural depression Scam etc.
- Financial Illiteracy: People who lack financial literacy are duped because they are offered a large return on their investment that does not have a solid foundation.
- Despite the presence of staunch rules against scams by chit funds, plenty of those funds run Ponzi schemes and create away with plenty of people’s cash.
- Ponzi Schemes: Ponzi schemes are investment operations that pay returns to previous investors from the money garnered from new investors.
- Non-Transparency: Chit funds, particularly those occupation to an oversized range of members, are opaque each in their operations and eliciting of bids.
- Administrative Loopholes: firms running such schemes exploit existing restrictive gaps and lack of strict body measures to dupe poor and gullible folks of their hard-earned savings.
- Lack of Accountability: there’s no deposit insurance for investors. If a registered invoice fund company files for bankruptcy neither the govt nor the Federal Reserve Bank of Bharat will facilitate the investors.
What investor should do to forestall chit fund scam?
- Check for the credibleness and trustiness of the corporate and its promoters.
- Warn folks regarding fallacious firms & Report them to involved authorities.
- Opt for state-run invoice firms and escort corporations with an extended record and financially sound promoters.
- Understand the distinction between organized chit fund schemes that are needed to register with the Registrar or corporations, Societies and Chits and cash circulation schemes.
- Invest in a very theme with no incentives for subscribers to herald a lot of folks to the theme
- Implementation of easy-to-use web-based Chit Fund Management system (CFMS).
- The planned change can require unregulated deposit-taking and supply for deterrent penalization for promoting or operative such schemes, besides introducing different changes.
- The focus got to air implementing the foundations while not political interference and strengthening the judicial mechanism while not that any change to the law are of very little facilitate to the voters.
- Amendment within the planned legislation can solely safeguard the investor interests, while not addressing the structural issues of lack of monetary inclusion, skew bank magnitude relation in rural areas etc.
- Better and accessible banking alternatives won’t solely check undue exploitation of poor folks however also will correct leakages within the economy.
- Saradha chit fund scam:
- Sudipto Sen was the Chairman of the aradha Group, a conglomerate of over 200 private companies. It was thought to be running chit funds, which is an incorrect term for collective investment schemes. As we all know, a chit fund can’t predict how much money an individual will make in the future. Returns were promised in the Saradha chit fund, however.
- Fixed deposits, revolving deposits, and monthly income schemes were available. The promised profits were substantial. Foreign trips were also offered to high-value depositors.
- The Saradha group was raising money and offering land or flats in exchange for the money; those assets should still exist. Saradha was attempting to give the impression that it was doing anything. But it wasn’t really accomplishing anything.
- They were paying off the older investors whose investments had to be redeemed with capital brought in by younger investors. At the same time, they were building the appearance of a company that did not exist.
- In the first year, they were prompt with payments. Agents were later instructed to pay maturities with fresh collections or change against renewals.
- To keep bringing in new customers, they even pay high commissions to agents. These schemes will continue to operate as long as the money brought in by later investors exceeds the money that must be paid to earlier investors.
- These so-called chit funds will go bankrupt the day this equation changes. The same thing happened with the Saradha chit fund. Until collapsing in April 2013, the company had raised between $200 and $300 billion from over 1.7 million depositors.
Mains oriented question:
Why chit funds and Ponzi scheme are more chosen over any loan or bank procedure by financial safety? What are the issues associated with it? (250 words)