Stuart Rutherford in his famous book, The Poor and Their Money, narrates the story of Jyothi, a deposit collector in the slums of Vijayawada, as follows: Jyothi gives her clients, mostly poor women in the slums, a card divided in 220 boxes (20 columns and 11 rows). She visits her clients’ at their homes every day at a specified time. The client has the option to save a fixed amount every day. This saving is purely voluntary depending on the financial liquidity of the client on a particular day. Assuming that the client is able to save Rs5 every day, after 220 days she has saved Rs1,100. The question arises as to how much Jyothi should give back to her clients? A popular answer would be obviously not less than Rs1,100, or even higher, as the fund would surely attract some interest.
But surprisingly, as documented by Rutherford, Jyothi returns only Rs1,000 and keeps Rs100 as her fee for providing a safe place to save. As money is fungible unless the option for savings with Jyothi is available, the poor slum women would have spent Rs5 per day for some or the other purpose.
Now let us look at the operation of another savings mechanism called the Rotating Savings and Credit Association (Rosca), believed to be the root of the microfinance movement. Under Rosca, a few people, usually from same socioeconomic setting, come together to save a certain amount of money at regular intervals. Assume that 20 people agree to save Rs100 per week for 20 weeks and start a Rosca. In a simple Rosca scheme, a weekly collection of Rs2,000 is collected by one of the members on a mutually agreed basis. This is to develop a group corpus and for self-lending. But the most prominent form of Rosca is where members bid to get the fund. A member with an urgent need for the money would bid the highest. In this case, say in the first week two members bid, one for Rs200 and another for Rs300, the member who has quoted Rs300 will receive Rs1,700 and the remaining Rs300 will be distributed among the other members. The process continues for 19 more weeks till other 19 members receive their weekly collection. Rosca is very popular in western states in India, Bangladesh and in several African countries.
Both these savings mechanisms have been functioning well for times innumerable. The reasons may be as follows: In the first case, as Jyothi had not promised to pay any top-up amount over the principle, there was no need for her to invest the collected sum in any business venture. Keeping the money in a safe vault or regularly depositing the money in a savings account of a bank would be good enough for her to meet the obligation of the clients on time. The success of the second mechanism may be attributed to the governance structure of Rosca. Governance is ensured through self-selection of the members as well as by holding intimate knowledge of the activities of the other members.
The recent Saradha Group fiasco in West Bengal points to a failure on both fronts. First, Saradha Group’s promise to pay a high interest on deposit may have pushed the firm to invest in risky ventures but without it having the expertise to handle these. The second failure is of governance, as the depositors were kept in the dark and were clueless as to how Saradha Group would keep its promises.
The government as well as regulatory bodies such as the Reserve Bank of India that have a dominant role to play in preventing such market failure woke up to the crisis only after it shot up to its highest level.
The West Bengal government has proposed a fund of Rs500 crore to make up the losses of the duped depositors, safe-guarding their interest with taxpayers’ money. While this may bring some short-term relief to the depositors, the move is likely to have an adverse effect on the financial market in the long term as people will expect the government to bail them out for any of their irrational decisions. The state’s move, rather than forcing people to become cautious and making informed investment decisions, will only make investors more careless while investing in high-return deposit schemes.
While timely government intervention is essential to curb such market failure, the common man too should be careful while investing in deposit schemes as high returns can’t be without risk.
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