Saradha Group scam: What is it all about?

Saradha Group scam: What is it all about?

The Saradha Group financial scam rocked the nation in April 2013, and one could hear the words of chit funds, Ponzi schemes, parallel banking sector, Multi-level marketing schemes, etc being thrown around. What are they? And what to they mean?

The Basis of the Saradha Group Financial Scam

Saradha Group scam was based on the principle of a Ponzi scheme and collective investment schemes (CIS), and it operated through the facade of a chit fund. The losses to investors are estimated to exceed Rs 30,000 crore.

What is a Ponzi scheme?

Ponzi schemes are named after Charles Ponzi, who conned a lot of unsuspecting investors before being exposed. He wasn't the first one to use this scheme, but he has the “honor” of having this scheme named after him.

In a Ponzi scheme, first, one gathers a group of initial investors who are lured in with the promise of astronomical returns. As more investors join in, the money of the latest investors is used to pay returns to the early investors, and so on, while the people executing the scheme make sure to keep a good slice for themselves in these transactions.

For this scheme to work there must be a perpetual flow of new investors, and because that isn't possible, the scheme is soon exposed, and many people lose their savings which they had invested in hopes of higher returns.

Chit funds and their popularity in India

Chit funds aren't really illegal, and there's a Chit Fund Act (1982) as well that defines and offers regulations. They are considered as micro-finance organizations. Some state governments, like Kerala, run them too. The need for such funds arose because, in India, there is a presence of a huge population of low-income unorganized sector that doesn't have access to formal banking facilities. Hence, the informal banking sector has thrived and flourished. This is the source of popularity of Chit funds in India.

There are an estimated 15,000 Chit funds running in India.

There are many variations of a chit fund.

The purpose of such funds is to make large sum of money available for people who may not have direct access to formal banking facilities. This lump sum money can then be used for buying a car, building a home, etc by the person.


Modus Operandi

True to its Ponzi roots, Saradha Group promised huge returns for comparatively smaller investments to its investors. It was advertised to be working under the scheme of chit funds but it wasn't a chit fund in principle.

Saradha group raised money through collective investment schemes (CIS) which meant raising money from the public using locally appointed agents who acted as recruiters, through an illegal variation of
Multi-level Marketing (MIM).

Saradha group is estimated to have raised funds from over 17 lakh depositors. The public were issued secured debentures and redeemable preferential bonds on commission basis. This was different than a chit fund in one fundamental aspect because in the Saradha scam the investors were promised rate of returns in advance.


Actions and Aftermath

Several people were alleged, arrested, and prosecuted who had direct connections with the scam. Securities and Exchange Board of India (SEBI) has promised strong action against the people responsible for the scam.

On the other hand many people found themselves robbed of their life savings. Some people committed suicide and thousands of people were left jobless. Saradha scam was so huge that it affected the state of West Bengal on a macroeconomic scale. Such scams only damage the confidence of investors in other legitimate non-banking financial companies, and low investor confidence further diminishes growth and development.

There was a boom in withdrawals and a lull in small-saving deposits, which only hurt the state government as it left them little to borrow from. According to some, the government suffered heavily because people were investing in riskier schemes that promised huge rate of returns and not going for the small-savings schemes.