They used to be India's oldest finance companies. Now, the nidhis are proving to be India's boldest financial fraudsters. And investors have become the victims of yet another mega-money scam.

By Alam Srinivas & Rajeev Dubey

Will our money never be safe? Those among us who survived the Great Indian Securities Scam of 1992 and the Non Banking Finance Companies Megabust of 1997 may have imagined that we were, finally, protected from fraud. But, suddenly, the Nidhi Nightmare of 1999 is upon us. Like the other debacles in India's troubled financial services sector, this one too is set to claim millions of depositors, billions of rupees, and hundreds-if not thousands-of companies as its victims.

"The biggest anomaly plaguing the nidhis business id dual regulation by both the RBI and the DCA. That should end." Mahesh Thakkar Executive Director, Association of Leasing & Finance Companies

The self-styled mutual-or, ironically, permanent-benefit companies, intended to be confused with the mutual funds, which are popularly known as nidhis, are at the centre of the third major financial scam-and-bankruptcy scandal to hit the country since liberalisation. With the first wave of defaults washing over the nidhis-which started life more than 150 years ago in Tamil Nadu-the stage is set for spectacular failure. The warning signs are evident: last month, the Reserve Bank of India (RBI) barred the Rs 560-crore Kuber Group's Kuber Mutual Benefits (deposits: Rs 230.38 crore, members: 5 lakh) from either raising fresh deposits or selling off its assets. The result: a run on the nidhi.

Just before that, on December 11, 1998, the RBI slapped similar restrictions on the Lucknow-based Lions Mutual Benefits (deposits: Rs 60 crore, members: 1 lakh), which quickly shut shop, leaving its depositors high and dry. Moreover, the RBI as well as the Department of Company Affairs (DCA) in the Industry Ministry are closely scrutinising the operations of 3 more nidhis, including the Sahara India Mutual Benefit Co. (deposits: Rs 750 crore, members: 12 lakh) and the Singh Mutual Benefit Fund (deposits: Rs 15 crore, members: 30,000). While these investigations represent the regulator's eye-view, at the ground level, many nidhis have already started their disappearing acts.

What the regulators are actually worrying about-as should investors-is the dimension of the problem. Although their exact number is unknown-since less than 200 are registered-there are over 500 nidhis in the country, which account for deposits of more than Rs 3,500 crore, garnered from 50 lakh depositors. With new regulations challenging their modus operandi-attracting deposits by promising extremely high returns, and servicing them by lending at even higher rates to borrowers whom the banks won't entertain-the nidhis are in trouble. So, naturally, is the depositor's money-a fact that investors are grimly waking up to.

In Hyderabad, the 3,700 investors who had poured Rs 5 crore into GNS Nidhi (deposits: Rs 100 crore, base: 2 lakh), between May, 1995, and June, 1996, are reconciling themselves to their fate even as the State CID continues its investigation. Says a sad G.R. Mohan, 38, a professor at the Homeopathic Medical College, Hyderabad: ''I have lost all hope of recovering my money.''

As their fear spreads across the country, depositors are queuing up outside the offices of the nidhis to withdraw their money. The Lucknow-based Al-Falah Mutual Benefits (deposits: Rs 2.50 crore, members: 11,000) was besieged by investors soon after the RBI slapped restrictions on Kuber Mutual Benefits. And its Managing Director, Sayeed Rasheed Ahmed, a well-known figure in the city, suffered a heart attack when his nidhi defaulted on a Rs 30-lakh repayment. Since then, he has closed down 5 of its 13 branches. Asks Ejazul Hai, 28, the owner of a small Chikan shop in Lucknow's Nazibabad area, to whom Al Falah owes Rs 35,902: ''Has the company gone bust? I will not let them run away like this.'' Retorts Al-Falah's Chief Manager Shaban Khan, 33: ''Earlier, we had an untarnished reputation. But now, depositors have lost faith in the nidhis.''

The scene is being replicated everywhere. In Delhi, irate investors are thronging the offices of Kuber Mutual Benefits, brandishing bounced cheques and demanding that their money be returned. In Chennai, hapless depositors trickle past the closed offices of GNS Nidhi, whose promoters cannot be located. At the registered office of Lions Mutual Benefits in Aliganj, Lucknow, frustrated depositors are welcomed by empty rooms.

Since February, 1999, the legal notices sent by Lucknow's Deputy Commissioner of Income Tax, P.K. Bajaj, to the registered-office of Trikone Mutual Benefit Fund (deposits: Rs 60 crore, members: 1 lakh) at B-143, Sector C, Mahanagar, Lucknow, have been coming back unopened. In towns like Haldwani, Nainital, and Meerut in Uttar Pradesh, nothing remains of the nidhis called Shikhar Mutual Benefit Co., Galaxy Mutual Benefit, and Trywell Finance Mutual Benefit-except thousands and thousands of angry, frustrated, cheated depositors.

"We can only examine cases of failure based on company received by us, the Department of Company Affair, and the Reserve Bank of India." T.S. Krishnamurthy Secretary, Department of Company Affairs

Coming as it does on the heels of the scams in the non-banking finance business, (See The Non Banking Fraud Company, BT, August 7, 1997), the plantation business (See Trick Or Teak?, BT, August 22, 1998), and, before that, financial services groups like CRB (See CRB: The Inside Story, BT, June 7, 1997), the nidhi fiasco could deal a body-blow to retail investment in this country. A scrutiny of the past, present, and future of the nidhis reveals how the nebulous nidhis are shaking up the financial markets.

How Do the Nidhis Deceive Depositors?

Outside the RBI's regional office at Hazratganj (Lucknow), hundreds of angry investors are clamouring for the return of the money they have deposited with Kuber Mutual Benefits. Says a frustrated Ajit Pratap Singh Bhadauria, 24, a copper-chain trader, who had invested Rs 2 lakh in the nidhi: ''My cheques have bounced three times. I have sent thousands of faxes to them, but they only kept asking me to re-deposit the cheques.''

As with the NBFCs, the nidhis were born of the marriage between the high demand for and the low supply of savings, and loan-opportunities. Squeezed between the inaccessibility of far-flung banks and the greed of the local moneylender, people started patronising the informal banks happily. This trend branched off into similar, but divergent directions. North India saw the proliferation of para-banking organisations, working on lines similar to those of the banks. In East and South East India, chit funds spread their wings.

In this sophisticated business, a company forms a group of, say, 25 members, each of whom buys a chit for, say, Rs 4,000, adding up to a corpus of Rs 1 lakh every month. Each member is empowered to borrow from this corpus through a Dutch Auction, with the loan being extended to the one who bids the highest rate of interest. The earnings from the interest are then shared by the remaining members and the company. In South India were born the blade companies-primarily in Kerala-offering absurdly high rates of interest of upto 50 per cent, which they serviced by drawing more and more deposits. And, of course, the nidhis, which used to be concentrated in Tamil Nadu and Andhra Pradesh.

Despite the similarities, where the nidhis stand out is in their unique charter of doing business with only their members. Anyone who wants to either lend to or borrow from a nidhi must buy a single share at the nominal rate of Rs 10, raised from Re 1 by the RBI in December, 1995. This provides a fig-leaf: strictly speaking, the nidhis conduct business not with the general public, but only with their members. Of course, depositors are offered rates of interest going up to 26 per cent, to service which liability the nidhis lend at rates of as high as 33 per cent, thus maintaining their 7 per cent spreads.

Since only high-risk borrowers would agree to paying such rates, just how do the nidhis manage to stay afloat? The answer lies in their innate conservatism, never quite at odds with their lending business. Sure, the nidhis lend money mainly to those whom the banks wouldn't entertain, but that is because of the seeming unviability of the projects that such borrowers seek to finance. However, the nidhis lend only against undepreciable collateral; typically, real estate, gold, or, of course, nidhi deposits.

Moreover, no nidhi will allow exposures to someone whom at least one of its managers doesn't know personally. Confirms B. Hari Krishna, 55, the Managing Director of the Hyderabad-based Sree Teja Benefit Fund (deposits: Rs 5 crore; members: 5,000): ''We extend loans to the extent of 75 per cent of the value of the collateral against deposits, 65 per cent in the case of gold jewellery, and 50 per cent when it is real estate.'' Likewise, the 113-year-old Nungambakkam Saswatha Dhana Rakshaka Nidhi (NSDMN; deposits base: Rs 100 crore, members: 30,000), lends Rs 230 against every gram of gold (current market price: Rs 430) pledged by a member.

This is the strategy that the most active nidhis have used to grow to gargantuan proportions. For instance, the Chennai-based RBF has a deposit-base of Rs 410 crore with a membership of 3 lakh while the Alwarpet Benefit Fund boasts of 86,000 members and deposits of more than Rs 110 crore. And the enormous amounts mobilised by Kuber Mutual Benefits and Sahara India Mutual Benefit Company only show how successful these schemes have been in collecting money from people, playing on their credulity. Operating as they do all along the continuum between holes-in-the-wall and full-fledged corporate entities, the nidhis conduct business on scales both large and small.

At one extreme are outfits like GNS Nidhi-acquired by Devi Gold House, a Chennai-based jewellery-shop, in 1995-which opened 40 new branches in a span of 18 months between April, 1995, and September, 1996, before going bust in 1997. Or rbf-whose plush offices in Chennai's Royapettah are no different from any corporate headquarters, with flashy, expensive decor-which has invested more than Rs 8 crore in computerising its 13 branches to improve its customer-service. At the other are single-room operations like those of Monarch Benefit Fund, whose staff consist of 3 clerks and 1 peon.

The gullibility of depositors, compounded by the lack of regulatory control, has enticed ever-larger numbers of entrepreneurs into the business. In the first half of the 1990s, when start-ups needed cash and the regulators were swept off their feet by the explosive growth in financial services, it was easy for the nidhis to mushroom. Recalls S. Muralidhar, 33, Chartered Accountant, Ranga Rao & Co.: ''Back in 1993, I used to get an average of 3 requests a day to help register a nidhi.'' By 1995, every locality in Chennai could boast of a neighbourhood nidhi.

Across the country, cities, like Delhi and Lucknow, as well as smaller towns, like Haldwani (Uttar Pradesh) and Ananthapur (Andhra Pradesh), proved fertile ground for the species. Worse, neither credentials nor financial track-records were required to set up a nidhi. In 1993, Hari Krishan, a mechanical engineer, floated Sree Teja Mutual Benefit in Hyderabad. K. Naganna and D.V. Narayana, former employees of the State Bank of India, started the city's Monarch Benefit Fund in 1996. And, back in 1962, the Pal family, which runs the Rs 35-crore Pal Group-which is in construction, transportation, and stone-crushing-floated 2 finance companies, including a nidhi.

Crucially, the numbers that swelled the records of the Registrar of Companies were only the tip of the iceberg. Officially, there were 192 nidhis registered in 1995 under Section 620 (A) of the Companies Act, 1956-up from a mere 11 in 1988. Points out Nandan Maluste, 48, Senior Vice-President, Kotak Mahindra Finance: ''There has been unchecked growth in this business. The criminals who thrive on grabbing middle-class money would have stayed out if the punishment were quick and severe.'' Perhaps. But then, retribution has never been quick or severe enough for India's scamsters.

How did The New Regulations Unearth The nidhis Scam?

At the dingy, dilapidated karyalaya (office) of the Kotwali in Haldwani-which has 3 broken chairs, a long 12 X 4-foot desk, which appears to be a legacy from the British Raj, and huge registers strewn across the room-about 20 complaints have been filed by investors and depositors under Section 420/467/ 468/ 406 of the Indian Penal Code. The cases, which pertain to the period 1998-99, are all against finance companies and nidhis whose promoters have disappeared without repaying their investors. Of the 86 finance companies which operated in the early 1990s in Haldwani, only 16 still exist.

India's Great Nidhi Scam has surfaced precisely because the new rules have put an end to the chicanery that they were instruments of. Until 1995, the virtual lack of regulation had turned the nidhis into dual instruments of fraud. First, they were being used to lure money from unsuspecting investors who would, sooner rather than later, find that their trusted nidhi had disappeared. And, second, they were being used as vehicles for laundering black money. For, it was easy to use them as fronts to bring in such money in the guise of deposits, and to siphon it off as loans to other front companies owned by the promoters.

Says a retired colonel, K.N. Mishra, 64, who runs the Financial Companies' Investors Association: ''These companies were promoted with the primary objective of rotating black money. So long as the deposits were larger than the amounts they were paying back, everything was fine. The moment the inflows stopped, they fled because they never had any intention of paying the investor back.''

A parallel stream of cash flowed into and out of the nidhis even as regular depositors were wooed with high rates of interest, with the specific intention of short-changing them afterwards. That such a framework would lead to hundreds of nidhis disappearing with the investor's money is hardly surprising. Explains Dipankar Chatterjee, 50, a partner in the audit firm, L.B. Jha & Co.: ''In most cases, the nidhis went bust because the promoters intended to cheat their depositors.''

Many finance companies used the laxity of the law to become hydra-headed, operating as NBFCs, nidhis, and chit funds-depending on the clientele. And some of them used the nidhi format only to attract money. The Sahara India Mutual Benefit Company stands accused of following just such a practice. Denies O.P. Srivastava, 45, Director, Sahara India Mutual Benefit Company: ''We have not received any notices from either the DCA or the RBI.''

However, a notice issued to the Sahara Group in December, 1994, by the Department of Income Tax alleges that its nidhi is just a front for the deposits being collected by Sahara India, the group's flagship, through its 1,086 branches. Tellingly, the nidhi has extended loans of Rs 28 crore to the promoters of the Sahara Group over the past few years-and has not been able to either raise fresh deposits or renew existing ones after the allegations surfaced in 1996. Muses Anupam Prakash, 36, Company Secretary, Sahara India Mutual Benefit Company: ''The kind of restrictions that the government has imposed on us makes it impossible to conduct the mutual benefits business. We have told the DCA in writing that we are no longer interested in promoting this business.''

It wasn't until 1995 that the nidhis faced their first roadblock. Only in that year did the Union Finance Ministry and the RBI finally wake up to the enormous potential for fraud that the nidhis possessed. In an amendment, dated April 28, 1995, to the Companies Act, the nidhis were banned from entering the chit funds business, from investing in shares, and even from opening new branches without seeking prior permission.

Seven months later, on December 12, 1995, came the second restriction: a nidhi would be allowed to operate only in the district where its registered-office was located, and could conduct business with only its members. Then, on October 20, 1997, both the DCA and the RBI banned the nidhis from lending to corporates, capped the permissible loan to each depositor at 1 per cent of the deposit-base-subject to a maximum of Rs 7.50 lakh-and imposed a ceiling of 16 per cent on the rate of interest that they could offer. They also specified the minimum net owned funds, Rs 10 lakh-raised later to Rs 25 lakh-and the minimum number of members, 2,000, that a nidhi must have.

If this wasn't enough to put the nidhis out of business, the RBI squeezed them out by announcing, on January 2, 1998, that only 192 would be allowed to function as notified nidhis. The rest would enjoy the status of loan companies, governed by a different set of rules, and, unlike the nidhis, they:

• Could not raise deposits without a credit-rating.

• Needed to maintain a capital adequacy ratio of 10 per cent.

• Would have to submit half-yearly prudential returns certified by auditors, to the RBI.

• Had to maintain liquid assets (cash and bank balances) of 15 per cent.

Sure, in an April 13, 1999, notification, the RBI relented somewhat, ruling that un-notified nidhis registered with the RBI before January 9, 1997, could still operate as nidhis so long as they adhered to the new regulations by April, 2002. That only extended the universe to another 103 players. Deprived by these new regulations of the power to offer sky-high interest rates, the nidhis found funds drying up, robbing them of their facade. And the lid was blown off their practices.

Of course, both the honest nidhis as well as trusting depositors suffer from the fact that that both the RBI and the DCA regulate their business. This offered smart operators the opportunity to use the inevitable loopholes arising from dual authority. Reasons Mahesh Thakkar, 40, Executive Director, Association of Leasing & Finance Companies: ''The biggest anomaly is dual regulation, which should end.'' Admits a senior manager at the RBI, who is involved in regulating the nidhis: ''We are only one of the regulators. We cannot monitor their working on a daily basis.'' And the DCA shrugs off responsibility too. Says T.S. Krishnamurthy, 59, Secretary, DCA: ''We can only examine cases of failures against the complaints received by us and the RBI. And we can only tighten the provisions of the law to ensure minimal failures.'' Surveillance, in other words, is not a priority with either regulator

More

Issue Contents  Write to us   Subscriptions   Syndication