Two weeks back reporters from The Sunday Times visited a coir industry project in the south where local communities spoke of a micro finance programme to fund some of their needs. This group of coastal women is recovering from the effects of the tsunami, which has adversely affected their business, and with the support of an international NGO is putting their lives back through self-employment ventures. One of the actions is a micro finance scheme where each member of a community building organisation (CBO) - as they are called – contributes Rs 40 per week and is able to take loans of upto Rs 3,000 at 5 % interest. The scheme is run by the women and is working perfectly.

But it is based on honesty and trust in those who manage these funds – not a common ingredient today. There is crisis of governance, transparency, trust and honesty in the thousands of schemes where the public deposits money and borrows.

The Sakvithi scam in which the owner has vanished with some colleagues along with depositor funds that could amount to millions of rupees once again raises the issue of risk-taking, regulatory processes and public awareness in investing in these insttutions.

The Sunday Times also today reports on the concerns of Cooperative Banks run by societies which don’t come under the control of the Central Bank (CB) but raise millions of rupees from deposits from members. These societies have been functioning for decades and have had no problems but the cracks are showing.

At least two institutions are having problems and depositors, worried about a Sakvithi-type scam are withdrawing their funds, resulting in a run on deposits. Separately the authorities responsible for Cooperative Banks are preparing legislation to deal more firmly with such institutions.

The ‘cheetu’ – collection between a group of friends and distributed – is a finance scheme that has survived the test of time and still popular. Again a scheme that relies on trust and honesty. The question of trust is not only affecting our smaller, deposit-collecting and lending institutions which spread from the villages to the towns. Bankers here say the global financial crisis was also triggered by international banks not trusting each other and thus being reluctant to lend.

The CB has been repeatedly issuing warning signals through the newspapers and advise on which institutions the public should deposit. Many dubious institutions have been named in the past and the public warned against investing in these institutions.

Nevertheless the public invests in places like Sakvithi at interest rates as high as 40% to 60% annually, against CB advice, and when something goes wrong the CB is blamed. The CB says it is acting under the rules governing these institutions and naming them to alert the public. The Okanda Finance company which has resisted, for many years, registering with the Central Bank on the grounds that it is not a finance company as specified in the law, has now collected registration forms and wants to join the formal, registered process. On an earlier occasion, when the Central Bank named Okanda as not legally allowed to collect deposits, the company went to court and won an injunction against the CB. That situation has changed since then and the CB hasn’t had any more problems when naming organisations that are not legally entitled to accept deposits.

In a way it’s not unusual in a Third World country for people to throw caution to the winds and become suckers to wildfire schemes where the returns are high and the risk greater. While it is unfortunate that the collapse of Sakvithi has left many depositors destitute, the despositors have themselves to blame for taking such a high risk.

The point here is that the higher the interest, the greater is the risk. Risks vary from place to place, instititution to institution. Risk-free investments are in registered commercial banks and CB securities like treasury bills or bonds. Registered finance companies are also a risk-free investment as all these instititutions are governed by the CB.

However this doesn’t mean CB monitoring and supervision helps in all cases. The collapse of Pramuka Bank is a case the CB would want to quickly forget for failing to read the warning signals from its regular checks at this bank. Depositors are still struggling to recover their money while the chief culprit, founder chairman Rohan Perera has fled abroad.

The moral in the Sakvithi scam, which is still reverberating through other scams coming to light and the crisis in governance and transparency, is that the public must be cautious and prepared to take the risk in high-yielding deposits which doesn’t come under any formal regulatory mechanism. The Central Bank on the other hand needs to continue its campaign of keeping the public informed of dubious organisations, and at the same time swiftly move in, in a crisis – and much faster than in the case of Pramuka Bank.