The chit fund scheme is classified under the non-financial banking scheme, where the small group of members deposits some amount and later through bid or auction the amounted invested is given as return with a high-interest rate. The concept of chit fund is very old and existed even before the formal banking system came into the picture. A Chit is a mutually beneficial scheme wherein a group of people contributes monthly money towards the chit value and one member from the group is given the prize amount and the dividends are shared with all other members. There are different acts governing the chit funds in India.
Chit fund is a financial saving instrument widespread from even before the formal banking system came into play. Such an arrangement is carried out based on coordination and trust between operators and members investing the amount. Chit funds companies are classified as non-banking financial companies where the company offers many lucrative schemes by promising high-interest rates and borrowing schemes to the investors, which is generally termed as Chit Fund Schemes.[i]A chit fund is basically a financial arrangement among a specified number of people. Under this arrangement, each person shall contribute a certain sum of money by way of periodical instalments for a definite period, and such amount collected shall be given to one of the members by auction after deducting discount[ii]. The person who run the chit fund scheme is known as foreman, around whom other members of the group are depended and confident. The chit fund is regulated under different acts in India like the Central Act called Chit Fund Act, 1982.
Concept of Chit Fund
Chit fund in India is equivalent of the Rotating Saving and Credit Associations (ROSCA) that are famous through the world. ROSCA are informal financial institutions which are found all over the world. The Indian ROSCA is commonly known as chit fund or chitty.
The concept of the chit fund can be explained as ‘a voluntary grouping of individuals who agree to contribute financially at each of a set of uniformly spaced dates towards the creation of the fund, which will then be allotted in accordance with some pre-arranged principle to each member of the group in turn’. The term ‘chit’ means a written piece of paper, which directly points to one important allotment mechanism, where the draw of lot decides the winner of the chit and shall be entitled to the prize amount prescribed.
Chit fund is considered as traditional financial machinery regulated by various financial companies in India It is an initial mechanism which together combines savings as well as credit. This scheme is very well popular amongst the low-income household as the innovative access to finance may help in saving and investing both. The act of chit fund is well recognized in the country and the groups operating a chit fund scheme have to be registered under Chit Fund Act 1982.
The different legislations governing the chit funds in India are:
- Union Government- Chit Fund Act 1982
- New Delhi- Delhi Chit Funds Rules, 2007
- Maharashtra- Maharashtra Chit Fund Act 1975
- Tamil Nadu- Tamil Nadu Chit Funds Act 1961
- Kerala- Kerala Chitties Act 1975
- Andhra Pradesh- The Andhra Pradesh Chit Funds Act 1971
- Karnataka- The Chit Funds (Karnataka) Rules 1983
- Uttar Pradesh- The Uttar Pradesh Chit Fund Act 1975
- Puducherry- The Puducherry Chit Funds Act 1966
Types of Chit Funds[iii]
There are three kinds of chit funds
1. Simple Chit- This is also known as chit by lots. In this type of chit, the entire amount collected called the chit amount and shall by distributed among the members without any deduction of discount.
2. Business Chit- It is also known as Auction chit. The groups running a chit fund scheme are generally registered companies and are based on auction type of chits. Where the duration and value of chit are predetermined. Each chit admits a particular number of members, equal to the duration of the scheme
3. Prize Chits- It is also known as the lottery chit. The foreman enrols more members than the number of instalments at a regular interval, and through a draw of lots, the member whose name appeared is eligible for the chit amount.
Chit Fund Management System
The organization of the chit fund is based on some transactional terms specified by the central act. The value of chit is run by a chit fund operator exceeds Rs. 100 and if not registered it is considered as illegal chit fund. Every non-financial company who operates a chit fund scheme is obliged to register the chit fund scheme as proposed.
To have sound and safe welfare and attract more investors the companies are bound to registered the chit amount. The working of chit fund is simple and easy process.
- For a particular chit fund scheme, there is a chit group which has a fixed number of investors
- These investors have to contribute some fixed amount of money for a specified period of time. The total duration of the scheme is similar to the number of members of the chit group[iv]. (example, if 5 members are there, then they have to pay for 5months).The interval of paying the money is usually a month for the investors
- Later, the money thus collected from the members goes into the common fund. The money is given to one member who is selected through a draw of lots or by way of auction or lottery.
- Foreman is held responsible for heading the auction and collection of the instalments.
- Every member is obliged to bid the amount and the bid is awarded who is offering the maximum amount of discount on the collected money. (The person who is ready to intake the lowest sum of money wins the bid)
- The person who wins the bid is known as ‘prized member’ who receives the ‘prize money’ after the deduction of commission for foreman and the discount amount he has offered.
- The money received by way of discount is then distributed among other members of the chit fund group as a dividend.
- Further, the prized member is barred to bid more in the remaining months of the scheme.[v]
Moreover, the process for joining a chit fund scheme is very easy as the entire system works on the foundation of trust. There are various types of chit funds operated in India like the scheme run by the state or central government, by the financial companies or by the family members or friends.
For Example- if we consider a chit value is Rs 1,00,000 with 20 members for a duration of 20 months, then in the group each member has to contribute Rs.5000 whereby (20*5000) Rs.100000 is collected. The auction is conducted in which members participate and the person who discounts the maximum is declared as the prized subscriber. If there is more than one participant for a maximum discount the successful bidder will be decided by way of lottery. 45% is the maximum bid allowed, which means a person forgoes Rs.45000 and the balance Rs.55000 is paid to the subscriber. Out of 45% discount, 5% goes to the company towards company’s commission for conducting the chit and the balance is distributed among the other members in form of dividend which is the return on investments for the monthly deposit made to their accounts[vi].
Operators of Chit Funds in India
There are many chit fund companies operating across the country like Kerala State Financial Enterprise works under the Kerala State Government, Bengaluru Chit Fund Companies under the Karnataka Chit fund Act, and another is Haryana based company named Margadarsi Chit Fund Company and many more.
Chit Fund Scams
The biggest chit fund scam is the Saradha Group Chit Fund scam[vii] in 2008 and it had collected nearly Rs. 30000 crore from lakhs of people spreading its area from west Bengal to Assam, Orissa, Bihar, Jharkhand and Chhattisgarh. During the economic slowdown, the owner of the group started to trap the money of people and have foster gain.
Another company which encouraged women to invest in the schemes and join the chit fund group was the Reddamma Dasara Chit Fund Company promising high rate interest and returns. The money invested was nearly Rs. 3 crore and was taken away by the company[viii].
2G scam in 2008, coal scam in 2012, Saradha Chit Fund scam in 2013 are few major scams observed in the country.
The effect of chit fund may hinder a person life if the company is involved in any such malpractices and have the plan to attract the public money for ill-gotten gain or personal benefit.
Chit fund is a well-recognized concept in India. The theme of the chit fund exists in India even before the existence of the formal banking system. Every chit fund company is registered under the applicable act and they are not only governed by the Central Chit Fund Act or Section 45(1) of the Reserve Bank Act but also administered by the individual state governments. Even the chit fund scams are prevailing more in number, but they need to have proper check and awareness and information of the scheme is very important. The members investing in the scheme must have all information about the amount invested, its regulation and the duration period specified by the company. The chit fund concept is very indigenous and accepted scheme as it offers both saving and investing theme.
Frequently asked Questions (FAQs)
1. What is chit Fund?
Chit is a mutually beneficial scheme where in a group of people contributes monthly money towards the chit value and one member from the group is given the prize amount and the dividends are shared with all other members.
2. Who can become the member of a Chit Funs?
Anyone who has a regular source of income and the capacity to repay can apply for the membership.
3. Why is it better to procure funds from Chit when compared to other intermediaries?
Service is more personalized, and formalities are simpler, when compared to Banks and other financial institutions. There is less paper work involved, and the saving rate is higher and borrowing cost is much lower.
4. Can one become a subscriber to a Chit jointly with someone in the family?
Yes, one can have a chit in joint name with any family member or a friend. The prize amount is given in the ratio of subscription.[ix]
5. How soon can one get the Chit after the auction?
The prize amount is payable latest before the next auction date, provided some security is given by the bidder for proper repayment of the future installments.
[i]Prof. Silpy Gupta, CHIT FUNDS AS AN INDIAN SAVING SCHEME: A CONCEPTUAL STUDY, JJ University (Jul 23rd, 2020, 3PM).
[ii] Vidyanathan R. and K. Sriram, 2000, The Non-Banking Financial Sector, Indian Institute of management, Bangalore.
[iii]Narendra Singh Rana, A critical study of chit fund business in India (Jul 24,2020, 5PM), www.jmsjournals.in
[iv] CHIT FUNDS AS AN INDIAN SAVING SCHEME: A CONCEPTUAL STUDY (Jul 23, 2020, 7PM), https://docplayer.net/46268550-Chit-funds-as-an-indian-saving-scheme-a-conceptual-study-key-words-nbfc-non-banking-financial-companies-chit-fund-companies-chit-fund-schemes.html
[v] What is Chit Fund and how does it work?, Jagranjosh (Jul 23, 2020, 9PM), https://www.jagranjosh.com/general-knowledge/meaning-of-chit-fund-1549543314-1
[viii] Police close to cracking chit fund cheating case, The Hindu (Jul 23, 2020, 8PM) https://www.thehindu.com/news/cities/Vijayawada/police-close-to-cracking-chit-fund-cheating-case/article5367439.ece