Mumbai: A major challenge for the Narendra Modi-led National Democratic Alliance government will be to get a firm hold over the country’s informal finance market that has grown to several trillions of rupees, experts said.

The unregulated market for financial schemes is spread across multiple forms that include unregistered chit funds and Ponzi schemes operating under that tag. There is no official estimate of the size of this market.

Such schemes have partly acted as a source of liquidity in emergencies for low-income households without access to formal finance. But the lack of regulations, they pose significant risks on account of potential failures and frauds, besides acting as a carrier of black money in the financial system, experts said. There is no official estimate of unaccounted for money circulating in the country.

There have been several instances of financial fraud by unregistered chit funds or illegal financial schemes, the latest being the 2,000 crore Sarada scam in West Bengal. Many of these funds continue to elude regulation. Sarada was deposit-taking firm that paid investors money obtained from new investors rather than from profits.

In recent years, several states including Kerala, Maharashtra and Odisha have cracked down on unregistered funds, but the absence of national regulations weaken such attempts.

In Maharashtra, there are at least 500 cases registered against chit funds and Ponzi schemes, said an official at the Economic Offences Wing, who spoke on condition of anonymity.

“The challenge is to anticipate failure so that small depositors can be protected," said Shinjini Kumar, leader, banking and capital markets, PwC India, a consultancy. “Even though failures are occasional, the impact on the poor can be very big."

In March, the corporate affairs ministry released a list of 89 companies that include chit funds against which several complaints have been received. The names include Kolkata-based Rose Valley group, Saradha group and Prayag Group. Mint has a copy of the list.

“At present, there is no clear estimate with the government regarding the unregistered chit fund market," said D.K. Mittal, former financial services secretary. “The government should first take an estimate before it can frame regulations."

The informal chit funds operate under different names in different parts. They are known as “committees" or “kitty parties" in the north, where money is pooled in by a group of people for higher returns; in the south they operate under names such as “chitties" or changathikkuries.

“These schemes can be risky," said Abizer Diwanji, partner and national leader-financial services, EY India. “There are institutions operating without any registration which channels large amount of black money. In the absence of (registration) there is a risk of people from lower strata of society losing money."

To be sure, not all unregistered chit funds are badly-run or fraudulent schemes, but in the absence of regulation, this industry could pose a serious threat to small investors. “There is no way you can control such groups as most of them operate underground. There are instances when black money flows into such schemes," said the official at the Economic Offences Wing.

There are over 30,000 registered chit funds in India according to official estimates, which are regulated by state registrars under the 1982 Chit Funds Act, but many states do not have a mechanism to effectively regulate such firms, experts said.

In 2011, the finance ministry set up an expert panel to review chit fund regulations. The panel’s members included officials from the Reserve Bank of India (RBI), Indian Banks’ Association and representatives of state governments.

The panel recommended a slew of reforms, including tightening regulatory overview by creation of a common registrar for all states, making rating mandatory for chit fund firms, creation of a self-regulatory structure and ensuring insurance protection for customers, among others.

However, the recommendations are still on paper.

“The committee’s recommendations, if implemented, will be a maiden attempt to have a holistic view on the entire operations of chit fund industry," said T. Sivaramakrishnan, general secretary of the All India Association of Chit Funds.

Market regulator Securities and Exchange Board of India (Sebi) and RBI have so far stayed away from chit funds, saying they are constrained to regulate these companies due to issues related to jurisdiction. In 2013, though there were talks on amendments in the two-decade-old chit funds law to include higher penalties for offences and rein in unregistered funds, there was little progress on this.

At present, the maximum penalty for chit funds is as low as 5,000 in states such as Delhi, while in Haryana, there is no structure to regulate chit funds.

Such informal schemes are popular among the poor because they offer high returns and require no documentation, experts said. They become attractive in an environment where the poor don’t have enough saving avenues with formal financial institutions. Plus there is a lack of awareness about the high risks.

“Banks do not encourage small deposits, whereas the informal sources offer enormous convenience for them," said Samit Ghosh, who founded and runs Ujjivan Financial Services Pvt. Ltd, a microfinance institution based in Bangalore.

Khushboo Narayan contributed to this story.

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