MUMBAI/KOLKATA (Reuters) - Dalia Ghosh, a 28-year-old nurse in the eastern Indian city of Kolkata, invested her savings in an unlicensed fund run by media conglomerate Saradha Group last year, hoping to start her own clothes business.
But Saradha went bust in April, wiping out as much as $3.7 billion in deposits from mostly low-income Indians, miring West Bengal's state government in scandal, and illustrating the risks faced by the millions who live outside the banking system.
Saradha, which until April had at least two high-profile members of parliament on its payroll, lost money in bad investments, and on paying steep commissions to its agents, government officials said.
"We trusted them like fools because the return they assured was four times more than a nationalized bank," said Ghosh, who says she lost 100,000 rupees ($1,800) in the collapse of Saradha, believing it to be a government-approved fund.
Until it fell apart, Saradha was a powerful outfit in parts of India with holdings in real estate and media, including several newspapers and TV channels seen by many as the voice of Mamata Banerjee, the chief minister of West Bengal.
That media business has dissolved, and Banerjee is at war with what remains of Saradha.
Saradha ran one of the thousands of unlicensed financial schemes in India, many of which thrive below the regulatory radar with the protection of local politicians, economists say.
Lack of education and the absence of bank branches across huge swathes of the country puts more than half of India's population outside the formal banking sector.
Duvvuri Subbarao, head of the Reserve Bank of India (RBI), worries about the number of unregulated investment and savings schemes, but says the central bank alone cannot stamp them out.
"Curbing all this will need investigation, will need enforcement of law, but more importantly ... we must provide access to the formal financial system for a large segment of the population which do not have access now," he said.
The distinction between licensed and unlicensed financial services firms is lost on millions of Indians, many of whom have never stepped inside a bank branch.
"The basic problem is a lot of these para-banking models are based on Ponzi schemes," said Abheek Barua, chief economist at HDFC Bank Ltd, referring to a type of pyramid selling where returns are taken from money coming in from new joiners.
"Unless we have very aggressive bank penetration, these para-banking models will always have allure."
India has 10.6 bank branches for every 100,000 adults, compared with about 35 in the United States, according to the World Bank, while only 12 percent of adults said they had saved money at a formal financial institution in the past year.
Assets at non-bank finance companies in India have increased 20 percent annually for the past five years - faster than at banks - and stand at over $670 billion, a November report by the Switzerland-based Financial Stability Board said.
Saradha took its slice of this cash by operating under the guise of a credit association, according to India's market regulator the Securities and Exchange Board of India (SEBI). Such credit associations are known locally as a chit fund, legal in India if they are state-registered.
Conventionally, members of a chit fund pool money which is deposited in a regulated bank, and each month the winner of a big payout is selected at random.
Instead, Saradha used savers' money to buy into property and broadcasting businesses, government officials said.
SEBI began an investigation into the group in April 2010 after a government body brought Saradha's unregistered "collective investment scheme" to its attention.
Saradha denied it was running a fund, but in April this year SEBI ordered it to wind up the scheme as it was unlicensed, and refund investors' money within three months.
Saradha's chief Sudipta Sen is now under arrest and West Bengal police are trying to track down the missing money. Before police picked him up Sen wrote a letter - later seen by Reuters - saying he had been "blackmailed" by senior leaders of Banerjee's Trinamool Congress party into paying bribes to them.
Banerjee denies those allegations. Sen and his aide Debjani Mukherjee, a director of Saradha, could not be contacted as they are in police custody.
Banerjee, whose party pulled out of the national ruling coalition last year, promised to raise money to refund investors by increasing the state tax on cigarettes. "Smoke a little more to help the investors," she told local newspapers, though taxes have not changed.
Ghosh, who had been saving 6,000 rupees a month with Saradha, says she has no hope of getting her money back. "Some say I paid the price for my greed and for trusting a chit fund company," she said.
She may be part of a growing list of victims. Real estate company Rose Valley, endorsed by Bollywood icon Shah Rukh Khan, is being probed by SEBI and government agencies on suspicion of selling without having filed an application to do so.
Rose Valley says its operations are legal, but some in the industry worry that ineffective regulation raises the risk of losses.
"Banks are not present in all the areas. So, you give 15-18 percent interest rate and poor people will get attracted," said T.S Sivaramakrishnan, General Secretary of the All India Association of Chit Funds.
"If you ask me whether chit funds are foolproof, honestly I would say no. There are laws but who is there to implement them?" ($1 = 54.1275 Indian rupees)
(This story has been refiled to fix the spelling of the central bank governor's first name)
Editing by Daniel Magnowski