Regulatory grey areas allow investment scams to function

These work under regulatory cracks.

Several investors lost money recently in the Kolkata investment scam. Monika Halan, editor, Mint Money, and Vivek Law, editor, Bloomberg TV India, in their weekly personal finance show Smart Money, discuss why and how such schemes operate. Edited excerpts:

Vivek: Monika what’s happened? While it has come into focus in view of what happened in Bengal, but this is not new. How would you explain it—greed or bad regulation?

Monika: I would say a bit of both, so let’s take the regulation first. I think to be able to catch somebody, we need to understand who the regulator is and what he should be doing. The first problem in this space is that nobody knows what to call these companies. So the entire media has been calling them chit funds. But these are not chit funds. Chit funds are actually legitimate financial products, which work for people who are unbanked in villages and smaller towns. Chit funds are regulated by the Chit Funds Act, 1982.

These work under regulatory cracks. So there is a set of people who found out where the grey area is between all the different regulators and designed these schemes around a product. The product could be anything, an emu, a goat, or something which is not even physical like an online magazine. So it’s really these regulatory grey areas which have allowed these people to function for so long.

Vivek: What amazes me is that it is so obvious that there is something wrong and yet thousands of people go and put their money there. Why is that?

Monika: There are two parts to it. One is what we have seen with Saradha scam, where the schemes operate in parts of India which are unbanked. I put it very strongly as a failure of our banks that have not been able to provide banking facilities at the bottom of the pyramid. So here are people who want these services so badly that they are willing to take some risk and work with anybody who comes and gives them this service. I don’t see how much of it is greed and how much of it is really the desire to get these financial services. The second lot is educated people who have invested in emus and have fallen for companies such ad Speak Asia, Home Trade and so on. In this case, I think it’s about greed, fear and also about competitiveness. Emotions like “do you know what that person has got", “do you know how much he has made", “you are the only person left out", “this is the deal and it’s happening now so get it now". So they are pressing all the buttons and that’s how it works.

Vivek: A lot of these people who are actually putting money, as you rightly said, are educated. While we talk of financial inclusion, how much more ground do you think we need to cover till such time that legitimate and regulated products are made available even in small towns and villages?

Monika: I think we have to take the FSLRC (Financial Sector Legislative Reforms Commission) report, which has drafted the Indian financial code so beautifully and very seriously. It looks at the whole financial landscape with consumer protection at its heart. Which other law does that? And it also removes all these dark areas of regulatory arbitrage. So I think there has to be a lot of debate on it and we should have the political and regulatory will to actually go through it. So it’s a long haul, it’s not as if this will end in the next five years. But were we to start the process then I think we are much closer to a safer financial system than what we have today. Today we are sitting on a minefield.

Vivek: Vinayagam joins us from Chennai. He wants to know whether he would be able to achieve his goals with the financial options he has. Monika his portfolio seems a little all over the place to me.

Monika: I see five insurance policies. We have real estate which is making up more than 80% of your portfolio, we have gold and I see a chit fund. So do you think you have got a good chit fund?

Vinayagam: No I am not happy with it and I am going to close it by the year-end.

Monika: There are mutual funds, but only 1% of your entire portfolio. Now let’s look at what you don’t have. You have a medical cover from your company. But you must get your own cover because if you were to change your job you would need your own cover. Your emergency fund I feel is less funded. You have 1 lakh, but given your income level we need three-six months of expenses because you have got four dependants on you. And there is no Public Provident Fund, or PPF.

I will streamline your insurance first. You have already identified two plans that you want to stop funding. You are spending 54,000 a year on the two money-back plans and what you are getting back is not more than 3-5% per annum. You build in the tax breaks still you have better products out there like the PPF. I think it’s worth taking that hit and getting rid of the two plans. You have another policy that is maturing in three years and it’s worth keeping that. Your fourth product will give you 5,500 a month when you turn 49, when you won’t really need it. By the time we hit 40, typically the high-income period begins. You need income when you hit 60-65. So get rid of this too; we can use the money better elsewhere. Your fifth plan is a good product as it is a term cover for 75 lakh. As you approach 40, you can look at increasing this cover to about 2 crore depending upon your income.

Your second question was what to do with 10 lakh of inheritance. You can put 4 lakh in your emergency fund; you have 2 lakh for your PPF. We still have 4 lakh left. With 3 lakh, you start mutual fund systematic investment plans and with the remaining 1 lakh you could go for a good gold or diamond gift for your wife!

Write to mintmoney@livemint.com OR sms at 9773270010. Type SM, give a space, and write your query.

Catch the show on Friday: 08:30pm, Saturday: 06:00pm, 08:30pm, Sunday: 10:00am, 12:30pm and 05:30pm on Bloomberg TV India.

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