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RSTV: THE BIG PICTURE- BANNING UNREGULATED DEPOSIT SCHEMES


RSTV: THE BIG PICTURE- BANNING UNREGULATED DEPOSIT SCHEMES


Introduction:

The Banning of Unregulated Deposit Schemes Bill 2019 was passed unanimously by both the houses of the parliament. This bill aims to protect the investors from Ponzi schemes and tackle the menace of illicit deposit taking activities which so far exploited regulatory gaps and lack of strict administrative measures to dupe poor and gullible people.

The bill provides for severe punishment ranging from 1 year to 10 years and fines ranging from 2 lakh to 50 crore rupees to act as a deterrent. It also has adequate provisions for disgorgenent or repayment of deposits in cases where deposits have been raised illegally. The bill also says that the first claim on the recovered money will be that of depositors.

 

The Banning of Unregulated Deposit Schemes Bill, 2019

The Banning of Unregulated Deposit Schemes Bill, 2019 was introduced in Lok Sabha by the Minister of Finance, Ms. Nirmala Sitharaman, on July 19, 2019. The Bill provides for a mechanism to ban unregulated deposit schemes and protect the interests of depositors. It also seeks to amend three laws, i.e., the Reserve Bank of India Act, 1934, the Securities and Exchange Board of India Act, 1992 and the Multi-State Co-operative Societies Act, 2002.

Deposit: The Bill defines a deposit as an amount of money received through an advance, a loan, or in any other form, with a promise to be returned with or without interest. Such deposit may be returned either in cash or as a service, and the time of return may or may not be specified. Further, the Bill defines certain amounts which shall not be included in the definition of deposits such as amounts received in the form of loans from relatives and contributions towards capital by partners in any partnership firm.

Currently, nine regulators oversee and regulate various deposit-taking schemes. These include: (i) the Reserve Bank of India (RBI), (ii) the Securities and Exchange Board of India (SEBI), (iii) the Ministry of Corporate Affairs, and (iv) state and union territory governments. For example, RBI regulates deposits accepted by non-banking financial companies, SEBI regulates mutual funds, state and union territory governments regulate chit funds, among others. All deposit-taking schemes are required to be registered with the relevant regulator.

Unregulated deposit scheme: The Bill bans unregulated deposit schemes. A deposit-taking scheme is defined as unregulated if it is taken for a business purpose and is not registered with the regulators listed in the Bill.

Deposit taker: The Bill defines deposit takers as an individual, a group of individuals, or a company who asks for (solicits), or receives deposits. Banks and entities incorporated under any other law are not included as deposit takers.

Competent Authority: The Bill provides for the appointment of one or more government officers, not below the rank of Secretary to the state or central government, as the Competent Authority. Police officers receiving information about offences committed under the Bill will report it to the Competent Authority. Further, police officers (not below the rank of an officer-in-charge of a police station) may enter, search and seize any property believed to be connected with an offence under the Bill, with or without a warrant. The Competent Authority may: (i) provisionally attach the property of the deposit taker, as well as all deposits received, (ii) summon and examine any person it considers necessary for the purpose of obtaining evidence, and (iii) order the production of records and evidence. The Competent Authority will have powers similar to those vested in a civil court.

Designated Courts: The Bill provides for the constitution of one or more Designated Courts in specified areas. This Court will be headed by a judge not below the rank of a district and sessions judge, or additional district and sessions judge.

After provisional attachment of the deposit taker’s assets, the Competent Authority will approach the Designated Court to: (i) make the provisional attachment absolute, and (ii) ask for permission to sell the assets. The Competent Authority will have to approach the Court within 30 days (extendable to 60 days). It will also open a bank account to realise and disburse money to depositors under the instructions of the Designated Court.

The Designated Court will have the power to: (i) make the provisional attachment absolute, (ii) vary or cancel the provisional attachment, (iii) finalise the list of depositors and their respective dues, and (iv) direct the Competent Authority to sell the property and equitably distribute the money realised among the depositors. The Court will seek to complete the process within 180 days of being approached by the Competent Authority.

Central database: The Bill provides for the central government to designate an authority to create an online central database for information on deposit takers. All deposit takers will be required to inform the database authority about their business. The Competent Authority will be required to share all information on unregulated deposits with the authority.

Offences and penalties: The Bill defines three types of offences, and penalties related to them. These offences are: (i) running (advertising, promoting, operating or accepting money for) unregulated deposit schemes, (ii) fraudulently defaulting on regulated deposit schemes, and (iii) wrongfully inducing depositors to invest in unregulated deposit schemes by willingly falsifying facts. For example, accepting unregulated deposits will be punishable with imprisonment between two and seven years, along with a fine ranging from three to 10 lakh rupees. Defaulting in repayment of unregulated deposits will be punishable with imprisonment between three and 10 years, and a fine ranging from five lakh rupees to twice the amount collected from depositors. Further, repeated offenders under the Bill will be punishable with imprisonment between five to 10 years, along with a fine ranging from Rs 10 lakh to five crore rupees.

 

Ponzi Scheme:

  • A Ponzi scheme is a form of fraud that lures investors and pays profits to earlier investors with funds from more recent investors.
  • The scheme leads victims to believe that profits are coming from product sales or other means, and they remain unaware that other investors are the source of funds.
  • A Ponzi scheme can maintain the illusion of a sustainable business as long as new investors contribute new funds, and as long as most of the investors do not demand full repayment and still believe in the non-existent assets they are purported to own.
  • The scheme is named after Charles Ponzi, who became notorious for using the technique in the 1920s

 

Rationale behind the bill:

  • To deal with the menace of illicit deposit taking schemes, as in the recent past, there have been rising instances of people in various parts of the country being defrauded by illicit deposit taking schemes.
  • The worst victims of these schemes are the poor and the financially illiterate, and the operations of such schemes are often spread over many States.
  • Increasing scams:
    • The CBI had lodged about 166 cases in the past four years related to chit funds and multi-crore scams, with the highest numbers in West Bengal and Odisha.
    • As per information provided by the Reserve Bank of India, between July 2014 and May 2018, 978 cases of unauthorised schemes were discussed in state-level coordination committee (SLCC) meetings in various states and union territories, and were forwarded to the respective regulators or law enforcement agencies in the states.

 

Impact of the bill:

  • Popular deposit schemes such as chit funds and gold schemes, which as part of the huge shadow banking system usually do not come under the purview of government regulators, have served as important instruments of saving for people in the unorganised sector.
  • The bill will immediately tackle the menace of illicit deposit-taking activities in the country launched by rapacious operators, which at present are exploiting regulatory gaps and lack of strict administrative measures to dupe poor and gullible people of their hard-earned savings.
  • It will altogether ban unregulated deposit taking schemes, and the law has adequate provisions for punishment and disgorgement or repayment of deposits in cases where such schemes nonetheless manage to raise deposits illegally
  • The Saradha chit fund scam in West Bengal is just one example of such a heinous financial crime against depositors.
  • The bill reflects a timely recognition of the need for greater legal protection to be offered for those depositors with inadequate financial literacy.

 

Limitations:

  • Unregulated Deposit Ordinance bans only Ponzi schemes not regulated deposits.
  • Reconciliation between the provisions of Insolvency and Bankruptcy code and Unregulated deposit scheme is difficult.
  • It does not stop any entity from seeking funds for its business or an individual raising a quick loan from relatives to tide over a crisis.
  • Unclear wrt to digital payments and online wallets.
  • Charitable institutions will find it difficult to fund students or those seeking medical assistance.

 

Way forward:

  • Policymakers will have to make sure that the bureaucrats responsible for the on-ground implementation of the bill are keen on protecting the savings of low-income households.
  • Database for the end use of deposits.
  • There must also be checks against persons in power misusing the new rules to derecognise genuine deposit schemes that offer useful financial services to customers in the unorganised sector.
  • In the past there have been several cases of politicians acting in cahoots with the operators of fraudulent deposit schemes to fleece depositors of their hard-earned money.

 

Conclusion:

While the intent of the bill, which is to protect small depositors, is indeed commendable, the benefits that depositors will eventually derive from the new legislation will depend largely on its proper implementation.

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