WHAT IS CHIT FUND?
- WHAT IS CHIT FUND?
What is Chit Fund?
A rotating savings and credit association system
known as a “Chit Fund” is used in India,
Bangladesh, Sri Lanka, Pakistan, and other
Asian nations. Chit fund schemes can be set up
by financial institutions or unofficially among
friends, family, and neighbours. Chit fund is an
unique financial instrument with both Savings
and Borrowing options. Micro finance
institutions function on the principles of chit
fund business.
It's History
According to legend, the chit fund is a tradition that dates back to ancient times. Chit funds were a common practice among friend groups in that area, according to William Logan, a former collector for the Malabar district of the Madras Presidency, who wrote about it in 1887. Chit fund lotteries were employed in South India in 1894, according to economic historian Edith Simcox, to earn money for special occasions like weddings. Several records from the 1930s indicate that chit funds were common in Kerala today. Between 1000 and 10,000 official funds operated in the state annually in the 1930s and 1940s.
In the 20th century, chit funds underwent overlapping formalisation phases. Merchants and salaried workers, in addition to farmers, started to join the fund as the organiser got more aggressive in raising money for it. Partnerships, limited liability companies, co-operatives, and joint-stock banks are examples of institutional organisers that entered the market. In Kerala, chit funds were being run by 166 banks in the 1930s. The Kerala government created Kerala State Financial Enterprises, the first state-run chit fund, in 1969. Its stated goal was to offer a competition to dishonest private-sector chit fund organisers. Despite only having 37.5% of the total number of chit funds in Kerala in 2000, it accounted for 77% of the capital volume. By 2012, it had expanded to provide service to 2.5 million subscribers and generate Rs 14,646 crore in yearly revenue.
Numerous fund organisers relocated to neighbouring states and began operating there as a result of the Kerala Chitties Act’s strict requirements, which were passed in 1975. As a result, Kerala saw a large fall in private chit funds. Several investment choices that resemble chit funds but aren’t officially chit funds were created in the 1990s.
In the 1990s, large chit funds for corporate requirements were also formed. In August 1995, the Hyderabad-based Model Chit Corporation launched its first Rs 1 crore chit fund.
How does it work?
A chit fund is made up of a number of subscribers. The group is brought together and its activities are managed by an organiser, which could be a business, a person, a close relative, or a neighbour. The organiser gets rewarded for their work either monthly or at withdrawal time. The fund begins on a specified day and runs for the same number of months as the subscribers. The subscribers contribute their monthly payments into the pot each month. The lowest amount a subscriber is willing to accept for that month is then determined through an open auction. For instance, if there are 50 participants and the monthly commitment is Rs1,000, the pot will start out with Rs50,000. After deducting expenses paid to the organiser, the surplus of Rs5,000 is given to the remaining 49 members if the winner of the auction is prepared to receive Rs45,000. The winning customer had access to Rs45,000 in the first month, and the other subscribers received their fair portion of the extra Rs5,000. Each month, one member receives the auction winnings through a repeated procedure. The remaining subscribers, including those who paid their instalments in a prior month but have not yet received their part, continue to do so.
As a result of subscribers’ ability to access substantial sums of money before making a full payment, the system functions as a borrowing scheme. Because each member makes a monthly contribution and has the potential to withdraw a sizable sum in the future while receiving their portion of the surpluses, it also serves as a savings system.
Variations of the technique delete the auction component in favour of selecting a winning chit from a box to determine the winner.
Risk
Because subscribers in chit funds could stop making their regular payments, both organisers and subscribers are subject to credit risk. 35% of subscribers have defaulted at least once while working for one of the companies, and 24% of them have defaulted after winning an auction for the pot, according to a study of data from two chit fund companies. Chit fund companies have the right to sue defaulters in court, but the process takes a long time and is unlikely to result in a quick resolution. The chit fund organisers are responsible for determining the subscribers’ creditworthiness. Some organisers additionally demand that subscribers who win auctions furnish sureties for their future obligations in order to lower the chance of default.
Chit fund systems are riskier than using bank savings accounts because they do not have government insurance.
Legal Framework
The Registrar of Firms, Societies, and Chits must receive an application from organised chit fund programmes. According to Section of the Chit Funds Act, 1982, a firm that manages, runs, or oversees a chit fund is referred to as a chit fund company. The Chit Funds Act of 1982’s Section 2(b) reads as follows:
“Chit means a transaction whether called chit, chit fund, chitty, kuree or by any other name by or under which a person enters into an agreement with a specified number of persons that every one of them shall subscribe a certain sum of money (or a certain quantity of grain instead) by way of periodical instalments over a definite period and that each such subscriber shall, in his turn, as determined by lot or by auction or by tender or in such other manner as may be specified in the chit agreement, be entitled to the prize amount”.
Chit funds are governed as Miscellaneous Non-Banking Companies even though the RBI Act does not require them to be registered (MNBCs). The Non-Banking Financial Companies and Miscellaneous Non-Banking Companies (Advertisement) Rules (1977), established by the Government of India pursuant to Section 58A of the Companies Act 1956, control their actions relating to deposit solicitation.
Conclusion
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