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The Bad Drives Out The Good

The mere presence of legitimate financial services will not stop the Saradhas of the world...

In connection with Saradha scam in West Bengal, a number of people have commented that a root cause is the lack of availability of proper financial services. If financial inclusion had been achieved then people would not have to turn to deposit outfits like Saradha. Some articles explicitly claimed that the RBI was directly responsible for such scams because it hadn't allowed the expansion of banks. While it may be true that India has fewer banks than it needs but the idea of this being a root cause of Saradha-type scams is pure bunkum.

Historically, it has often been said that bad money drives out the good. In a somewhat similar way, bad financial services drive out the good. Could it be that all those people who put money into Saradha wouldn't have done so if they had a bank in their neighbourhood? Very unlikely. A lot of the deposits seem to have come from towns where there would have been banks. Moreover, almost every ponzi scheme that has come to light in the last few years has actually flourished in towns and cities. The investors who fell for StockGuru or the Emu farms or other schemes all had access to legitimate alternatives.

Fraudulent schemes will always drive out the legitimate ones because they have many advantages that the legitimate ones can't match. They will promise much higher returns since the returns are fictional anyway. They spend much more on sales commissions, on offices, keeping politicians happy and getting media coverage because they can just dip into the deposited money for all these expenses. Therefore, even if legitimate financial services are available passively, they won't be able to compete.

For example, the post office offers excellent schemes with a huge reach in rural and semi-urban areas but can it compete on sales and marketing? In fact, when the government eliminated commissions on PPF and other deposits in post offices in 2011, it effectively eliminated whatever little sales muscle there was. It's clear that the mere presence of legitimate services cannot compete with fraudulent ones--the latter have to be stamped out proactively.

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