Illegal deposit takers: Time

for a crackdown?
July 8, 2014
Recent newspaper reports carried a story on one more fnancial pyramid
scheme, allegedly called Pandora Adertising! in "angalle, allegedly
modelled on another in "issamaharama, #uminous Adertising,! $oth in the
%am$antota &istrict'
A pyramid scheme is one $y which an unauthorised deposit ta(er o)ers
high interest rates to gulli$le depositors, paying o) early depositors, with
*unds deposited $y later depositors and at some point decamps with the
money'
+harles Pon,i, an -talian American is said to hae inented the scheme in
.ew /or( in 1020' 1ut author +harles &ic(ens, $oth in his 1844 noel 2artin
+hu,,elwit and 1834 noel #ittle &orrit, wrote a$out such schemes'
"he +15# it is reported defnes a pyramid scheme as where a participant is
re6uired to contri$ute or pay money, and the $enefts earned $y the
participant are largely dependent on the increase o* the num$er o*
participants in the scheme or the increase o* the contri$ution made $y
those participants!'
-n the past *ew years there hae $een a num$er o* such schemes such as
ones managed $y people named &anduwam 2udalali, &adi &anduwam
2udalali and 5a(ithi among others' "he fnancial regulator, places *ull
page adertisements in newspapers and uses other media to warn
depositors o* the dangers o* these schemes' -t is reported that an arrest has
$een made in the Panora case'
7hana
-n this conte8t it is good news that a crac(down is ta(ing
place on such illegal deposit ta(ers to protect the deposit
ma(ing pu$lic' 9or e8ample, in 7hana microfnance
companies operating without the re6uisite licenses are
$eing *orced to comply with the law or close down
operations'
"he 1an( o* 7hana, the regulator, has $een in the recent
past receiing *re6uent complaints a$out mushroom
microfnance frms whose o:cials either dupe or
mismanage *unds o* their depositors' "he depositors end
up $laming the $an( o* 7hana *or the lac( o* stringent
superision' last year the 1an( o* 7hana reised the
;perating Rules and 7uidelines *or 2icrofnance
institutions, increasing the minimum capital and li6uidity
re6uirements as part o* its e)orts to streamline their
operates and $ring order into the microfnance industry'
2inimum capital re6uirements hae $een prescri$ed *or
deposit ta(ing microfnance institutions and non deposit
ta(ing ones' "he regulator has licensed 4<3 such enterprises as o* may
2014' ;* these <80 $eing microfnance, 40 $eing money lenders and si8
registered as 9inancial .on 7oernment ;rganisations =9.7;s>' ;er 200
applications are still pending' 120 applications hae $een re?ected'
+omplaints $y the deposit ma(ing pu$lic in 7hana hae prompted these
actions $y the regulator, which could well $e emulated in other counties
*acing similar criticism o* inaction $y the regulator'
-ndia!s 5ahara
-n -ndia too, the Resere 1an(, has *ollowed suit, has fnally crac(ing down
an organisation that calls itsel* 5ahara Pariwar created and operated $y
5u$rata Roy' 9or decades 5ahara Pariwar has persuaded -ndia!s poor
underclass such as rural *armers, ur$an slum dwellers and low leel
goernment employees, such as peons, to trust it with their saings'
5ahara claims it has 80 million customers and a net worth o* @ 80 $illion'
5ahara was *ounded in 1048' -t claims to hae an army o* A00,000 agents
deployed in the feld who go to places where the well esta$lished players in
-ndia!s fnancial serices sector does not dare to go, rural illages and slums
which are there*ore yet untouched $y *ormal fnancial serices'
-t has da,,ling pu$lic relations with an emphasis on 1ollywood glamour and
nationalist patriotism, designed to persuade the poor o* its ininci$ility' -t
also has up to this point in time $een a$le to out*o8 the regulators, using
alternatiely, de*erence and defance'
5ahara!s 5u$rata Roy claims that its empire
ranges *rom the gangsterBridden lawless
$adlands o* -ndia!s ast, dirt poor, Cttar
Pradesh state, to the Pla,a %otel on .ew
/or(!s 9i*th Aenue, with its *amous
champagne $ar and stunning iew o* +entral
Par(' ;ne way $y which 5ahara has outwitted
the regulator is $y mesmerisingly switching
the products it o)ers to clients'
-t started o) in the 1040s $y o)ering
depositors lucratie pri,e schemes' #ater it
switched to housing fnance, $ut later
changed tac( to $ecome a mutual $eneft!
frm' -n 2008 the Resere 1an( crac(ed down
and ordered 5ahara to cease ta(ing deposits
and repay @ 4'3 $illion to depositors' 1y 2000
5ahara had once again switched to selling tric(y conerti$le $onds! to the
poor masses, which it argued did not *all within the regulatory regime o* the
Resere 1an( $ut *ell under a minor goernment ministry'
%oweer in 2011 the regulator made 5ahara re*und @ 3 $illion o* these
$onds to depositors' 5ahara was cleer in that the rules imposed on their
depositors had fne print, which loaded the dice distinctiely in 5ahara!s
*aour' 9or e8ample, customers were $ound to ma(e daily deposits, $ut
could *or*eit years o* accumulated interest i* a deposit date was missed'
&eposit gathering was out sourced to a legal entity which the Resere 1an(
did not hae authority to superise'
%oweer, fnally and ineita$ly, the law and the regulator caught up with
Roy and 5ahara' "he 5upreme +ourt o* -ndia on 4 2arch this year ?ailed Roy
*or contempt o* court, a*ter determining that 5ahara had *ailed to comply
with the order to repay the $onds, as directed'
"he +ourt o$sered that eery order was consistently and systematically
diso$eyed!' "he pleas su$mitted $y 5ahara were patently *alse!' 5ahara
has tried to su$?ect the +ourt to calculated psychological o)ensies and
mind games,! the +ourt o$sered' 1ut to date 5ahara!s fnances remain a
mystery' ;ne possi$le e8planation is that its claimed customer $ase is
partly fctitious, that the fctitious names are a *ront *or politicians! and
other $usiness tycoons! $lac( money'
-n 2012, the Resere 1an( as(ed 5ahara to proide the identities o* its
depositors' 5ahara responded $y dispatching a motorcade o* 124 ehicles
with <2,000 card$oard $o8es, hapha,ardly put together, which o:cials are
still trying to sort outD
Cse*ul lessons
"he 5ahara case has some use*ul lessons *or regulators worldwide'
"he frst is that gien time, political space and determination, regulatory
institutions can get their tas( properly done' "he Rule o* #aw preails, i*
allowed to' "he Resere 1an( o* -ndia, the 5ecurities Regulator o* -ndia and
the 5upreme +ourt, fnally got their man' 1ut as #ord Eellington *amously
said o* the 1attle o* EaterlooF -t was a damned close run thing!D ;ne
regulator, who wor(ed on the 5ahara case, says he got oer 100 telephone
calls *rom a irtual who!s who! o* -ndia as(ing him to go easy on the caseD
5econd, regulators need to moe away *rom the e8isting rulesB$ased, nitB
pic(ing system o* regulation, which can $e easily circumented and is
en*orcea$le only through a ?udicial process in which delays are endemic and
unaoida$le G to a regulatory system $ased on $road legal principles $ased
on $est practice,! which will gie o:cials more He8i$ility to deal with
croo(s who try to use the system and process, to outwit the regulators'
"he third lesson is that in -ndia and all other deeloping countries, where
the fnancial serices sector is a wor( in progress! and this includes 5ri
#an(a and een +hina where 5hadow 1an(ing, outside the *ormal sector is
a massie pro$lem G need to rapidly e8pand the outreach o* their *ormal
fnancial system' -n -ndia less than <3I o* adults hae $an( accounts, and
less than 1J< o* household saings ends up in the *ormal fnancial system'
Pawn $ro(ers and illage money lenders are
the pre*erred sources o* *unds $y -ndia!s poor'
"he Resere 1an( hopes to encourage the
creation o* a new generation o* simple $an(s
*ocused primarily on deposits and payments'
Regulators and the law hae to $e ery
nim$le, creatie and responsie to sa*eguard
the pu$lic'
7enerally, when pyramid fnancial schemes
collapse, there is a iolent reaction $y
depositors' Ee hae seen this in 5ri #an(a' -n
-ndia, when a chit *und! recently imploded in
Kol(ata, destroying the saings o* hundreds o*
thousands o* poor depositors, there were
around do,en suicides, one actually $y sel*B
immolation'
"he 5ahara customer $ase is so *ar 6uiet,
either they are satisfed $y the regulators
action or they don!t e8istD "he reputation o*
29, worldwide, has $een under attac(
recently, especially on the issue o* oerB
$orrowing and resultant oerBinde$tedness $y
29 clients' -n -ndia microfnance institution in Andhra Pradesh, was under
stress in the recent past, which resulted in much hardship to depositors and
politicians and regulators ta(ing a long hard loo( at the sector'
5ri #an(a
"here are concerns in 5ri #an(a on the prudential regulation o* deposit
ta(ing and other microfnance institutions =29-s> and some ethical issued
arising *rom their mode o* operation' Pro$a$ly arising *rom these concerns,
o* access to micro credit increasing inde$tedness and creating social stress,
the &istrict 5ecretary =&5> o* the 1atticaloa &istrict in the Lastern Proince
o* 5ri #an(a, summoned a meeting o* 2icro 9inance -nstitutions =29->
operating in the &istrict on 1 April' A representatie o* the +entral 1an( was
also present'
Representaties o* 29-s present at the meeting say that the &5 declared
that .on 7oernment ;rganisations which do not hae permission *rom the
+entral 1an( shall not implement 29 programs' "he &5 also is reported to
hae stated that a Registration +ertifcate o* a +ompany shall not $e
treated as license *or the proision 29 serices'
;n 4 April the &irector Planning, 1atticaloa &istrict 5ecretariat issued a
series o* guidelines under re*erence 1"J&P5J99PJ2icro 2014 $y which
among other things, the ma8imum rate o* interest *or micro credit actiity!
was f8ed at 12I per annum' 9urther the letter stated that 29- hae to wor(
with the 7A!s approal and with &iisional 5ecretaries =&i 5ec>
recommendation'
"he letter $anned wee(ly collection o* instalments' "he 29-!s were adised
to aoid duplication o* $enefciaries!' Lach and eery 29 loan should $e
recommended $y the &i 5ec' "he 29- should $e registered under +entral
1an(!s 7uidance!' -ndiidual house isits to collect loan instalments or to
ealuate loan application are not allowed' All .7;s in 29- actiities should
get special permission *or 29 actiities' 29 loans *or consumption were
prohi$ited' -t is nowhere stated under what legal authority the 7oernment
AgentJ&istrict 5ecretary has issued these orders'
"he #an(a 2icrofnance Practitioners Association =#29PA>, the ape8
organisation, too( this issue up with the authorities in the 2inistry *or
Lconomic &eelopment and it was suggested that a meeting $e held to
discuss the matter with the &istrict 5ecretary, 1atticaloa' .ewspapers
reported the crisis *aced $y $oth lenders and $orrowers in the 1atticaloa
&istrict $y the sudden imposition o* these draconian rules, most o* which
hae no legal $asis' 5u$se6uently it is reported that microfnance
institutions hae $een permitted to resume lending and collecting
instalments in 1atticaloa under certain conditions, a*ter the #29PA met the
&5' 1ut the legal $asis *or the &istrict 5ecretary to impose such regulations
is not (nown'
"his situation has come a$out currently in 5ri #an(a today due to the *act
29 seems a lucratie proft centre among fnancial serice proiders, there
$eing no comprehensie prudential regulatory mechanism in place' All
fnancial serice proiders ranging *rom licensed commercial $an(s, fnance
companies, non goernment organisations, cooperaties, money lenders,
pawn $ro(ers, cheetu schemes =Rotating 5aings and +redit Associations
MRo5+AN>, registered oluntary social serice organisations, etc' are
promoting themseles as proiders o* 29 to the poor and the marginalised'
#ong history o* microfnance
5ri #an(a has a ery long history o* microfnanceO the frst cooperatie rural
$an( too( in saings deposits and gae out its frst small loan, what is today
*ashiona$ly re*erred to as micro credit, in the early 1000 at 2eni(hinna, in
the Kandy &istrict' "he 7oernment has *rom time to time promoted
microfnance, *or e8ample through the +entral 1an(!s -suru Pro?ect, the
Janasaiya "rust 9und =J"9> and its successor the .ational &eelopment
"rust 9und =.&"9>' "he 5ri #an(a 5aings 1an( now has a special window
*or wholesale lending to microfnance institutions, using the .&"9 loan
repayment *unds, a*ter the latter was wound up'
"he current incarnation is &ii .eguma, the &ii .eguma Act defnes
2icrofnance asF A type o* $an(ing serice that is proided to employed or
low income indiiduals or groups, who would otherwise hae no other
means o* gaining fnancial serices!' "his is the only legal defnition
aaila$le in an enacted law' "he defnition is *ar *rom satis*actory' ;ne
recent estimate put the num$er o* 29-s at 1A,400' 2icrofnance has an
important role to play in gender empowerment in 5ri #an(a as it is
estimated that oer 40I o* depositors and $orrowers are women'
Ehile the +entral 1an( o* 5ri #an(a is the primary regulating authority *or
$an(ing and fnancial serices, the +ommissioner o* +ooperatie
&eelopment at the .ational leel and his Proincial counterparts, the
Registrar o* +ompanies, R;5+As =cheetu>, money lenders, pawn $ro(ers
and all other legally recognised proiders o* fnancial serices hae
designated regulators, under which the institutions under their puriew
hae $een set up'
"he ris( in 5ri #an(a is that this is one area which is irtually prudentially
unregulated, in comprehensie terms' 2icrofnance institutions which are
not caught $y the laws and regulations applying to fnancial serice
proiders such commercial $an(s, fnance companies, cooperaties, money
lenders, pawn $ro(ers, Ro5+As =cheetus>, &ii .eguma, etc' 5ome o* these
hae a prudential regulator, others hae in house! regulators G practically
how e)ectie, one may 6uestion' 1ut others G companies, oluntary social
serice organisations, trusts, .7;s, etc' are legal entities which are not
prudentially regulated in fnancial terms' 1ut they hae $een allowed to
continue fnancial operations, although technically in iolation o* the recent
9inance 1usiness Act, in terms o* a newspaper notice placed $y the
2onetary 1oardD
&ra*t 1ill .o' 0<
"he +entral 1an(, recently under the caption 2icrofnance -nstitutions, has
statedF "he +15# was inoled in preparing legislation *or the regulation o*
microfnance institutions' "here are seeral categories o* microfnance
institutions that are registered under arious laws, $ut are not regulated or
superised according to prudential criteria' %ence, to sa*eguard the interest
o* depositors and customers and also to strengthen the goernance and
serice deliery o* these entities, it was decided to $ring them under a
common regulatory um$rella'!
-n terms o* a 2icrofnance 1ill, hereina*ter re*erred to as G &ra*t 1ill .o' 0<!
G on microfnance announced recently as haing $een approed $y +a$inet,
the 2onetary 1oard o* the +15# is the regulator *or 29-s' "his is a welcome
step' -n 5ri #an(a although there is no legal defnition as to what specifcally
*alls with the defnition o* microfnance! =e8cept in the &ii .eguma Act>,
the &ra*t 1ill .o' 0< proides a defnition, di)ering *rom the &ii .eguma
defnition'
-n Part -- section 10=2> o* the dra*t law it is stated that microfnance
$usiness! is the acceptance o* deposits and proiding fnancial
accommodation any *orm and other fnancial serices mainly to low income
persons and micro enterprises!' "he discussion on the frst and second dra*t
$ills on 29-s in 5ri #an(a has resulted in the &ra*t 1ill .o' 0< $eing a great
improement on its predecessors' "he +15# itsel* has admitted that
seeral categories o* microfnance institutions that are registered under
arious laws, $ut are not regulated or superised according to prudential
criteria!'
.eed *or prudential regulation
Ehateer the controersies, at a glo$al intellectual or at operational leel,
in places li(e 1atticaloa and %am$antota &istricts, the *act remains that
microfnance is a fnancial instrument, which almost all fnancial serice
proiders in 5ri #an(a are presently utilising, in one way or another'
"he +entral 1an( itsel* has recognised the need *or prudential regulation'
7ie the rampant Pon,iJPyramid type scandals in the fnancial sector o*
lateO leaing the microfnance sector unregulated, in comprehensie terms,
is a high ris( strategy, which compounds the dangers, which micro saers
and micro $orrowers *ace'
As has $een pointed out, this sector is not a new deelopment in 5ri #an(a,
$ut has a long history, going $ac( to the 1000s' "he continued lac( o*
prudential regulation is a $etrayal o* the legal and moral o$ligation o* the
regulator o* which cognisance must $e ta(en at the highest leel, including
the %igher Judiciary which has to ensure the Rule o* #aw, as in -ndia' "he
fnancial serice regulators in 7hana and in -ndia, in the 5ahara case, hae
set an e8emplary e8ample o* responsi$le conduct which should $e
emulated'
="he writer is a lawyer, who has oer <0 years o* e8perience as a +L; in
$oth 5tate and priate sectors' %e retired *rom the o:ce o* 5ecretary,
2inistry o* 9inance and currently is the 2anaging &irector o* the 5ri #an(a
1usiness &eelopment +entre'>