chit funds
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This article is written by Pearl Narang, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.com. Here she discusses “All You Need to Know about Chit Funds”.

Introduction 

When a person has money, all he wants is a good investment scheme. But, how does he identify a good investment scheme? A scheme which generates high returns and also allows the investor to withdraw money whenever he needs, would qualify as a good investment scheme. Chit fund is one such scheme that allows even people of lower income bracket to invest and earn interest on their deposits.

Understanding Chit Funds

Chit Funds is a kind of investment scheme where people agree to deposit a certain sum of money from time to time in a fund. One of the subscribers of the fund is chosen by drawing a lot. The subscriber who wins the lot will receive the price amount from the fund.

Let’s take an example: 

There are 20 members in a particular chit fund. They agree to deposit Rs. 1000 per month. Members will pay 1000 Rupees each. The total value of the fund is 20,000 Rupees. Every month a chit would be drawn and the person who wins the chit will get the 20,000 Rupees.

Section 2(b) of the Chit Funds Act, 1982 gives the definition of chit funds. It states that a chit fund is an agreement in which one person agrees with other contributors to deposit a certain sum of money for a certain duration of time and each contributor shall be entitled to the prize money by way of tender or auction as agreed in the agreement. 

Other Names for Chit Funds

Chit funds are known by a number of names. 

  1. Internationally, chit funds are known as Rotating Savings and Credit Associations (ROSCA), this is because they provide a facility of saving and borrowing simultaneously.
  2. In India, they are called, 
  1. chit, or
  2. chitty, or 
  3. Kuree. 

After the amendment of the Chit Funds Act in 2019, the following names have also been added. These are, 

  1. Fraternity Fund, or 
  2. Rotating Savings, or 
  3. Credit Institutions.

Features of Chit Funds

Chit funds have the following features:

  1. They have a predetermined value and duration. 
  2. They work like microfinance institutions.
  3. They combine both, credits and savings in a single scheme.
  4. They cater to the financial needs of low income households.
  5. They allow the deposits made by the contributors to be turned into a lump sum. This is done by three mechanisms.
  1. Safe Deposits: A person can deposit the money in the present and enjoy the lump sum in future.
  2. Loans: A person can take a loan in the preset and continue to make payments in the future.
  3. Insurance: Allows the depositor to enjoy the lump sum in case of an emergency.

    6. They offer loan at a lower interest rate than moneylenders.

What are Chit Funds Used For?

Chit funds are used for the following reasons:

  1. They address consumption needs.
  2. They help in case of an emergency such as a daughter’s marriage.
  3. They help a person to pay for education of their children, purchase property etc.
  4. They help pay for costlier loans from moneylenders.
  5. They address capital needs of small businesses.

How does a Chit Fund Work

Let’s understand how a chit fund works through an illustration. 

Illustration: Rohan and Abhishek were friends. 

Rohan was well educated and had a good job. Additionally, Rohan was also planning to start a business to sell fresh food to corporates online. For his business venture, Rohan needed capital. But banks and financial institutions charged too high rate of interest on a loan and required Rohan to fulfil a number of formalities. Rohan needed a capital of 8,00,000 rupees immediately. He couldn’t afford to wait to start his venture. He was stuck between Private money lenders and banks. These options require asset as collateral. They also accrue hefty amount interest. 

Abhishek had a PhD. and was in a well paying job. He had no intention to start a venture but he was looking to save his earnings in a medium, where he can earn good interest and can withdraw money whenever he wants to. Abhishek was also finding it difficult to get an investment scheme that would allow him to deposit cash and withdraw money without any losses. No options were apt. Bank Accounts and Fixed Deposits had their own limitations. And investing in mutual funds and shares involved a lot of risks. 

Chit Funds are a unique combination of saving cum loan investment. Investors can invest money in them and withdraw it anytime the need arises. Moreover, there is no interest charged on borrowings. The person can borrow anytime and for any purpose. A group of people pool in a fixed sum of money every month. Every month through competitive bidding, a contributor gets to win the pool. A contributor can win the pool only once. 

Rohan and Abhsehk decided to invest in a government funded chit funds scheme. The scheme included 20 members who contributed 40,000 each month for 20 months. The jackpot being 8 lakhs every month which would go to one member via competitive bidding till all members get to take the pot home once. Rohan and Abhsihek contributed 40,000 each in the first month. Since Rohan needed 8,00,000 for his capital he decided to participate in the bidding process in the first month itself. Rohan decided to forgo the maximum limit permitted which was 2,00,000 rupees or 25% of the total amount. Thereby taking back 6,00,000 rupees. The remaining 2,00,000 rupees was with the foreman. The foreman kept his fixed monthly commission that is 40,000 or 5% of the chit fund value, and distributed the remaining 1.6 lakh among all the 20 members. 

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Rohan opened his restaurant he couldn’t bid for the remaining months but he continue to deposit 40,000 every month. Abhishek, on the other hand, waited entire 40 months and got to take back the entire pot minus the foreman’s commision of 40,000 rupees. This way Abhishek earned extra amount since he didn’t have to forgo any amount and also earned the monthly dividends from the amount forgone by other bidders. 

Cash Flow For Abhishek 

 

Cash Flow For Rohan 

Thus, chits funds helps people in a number of ways. 

  1. They give freedom to the person use the funds however he wants. 
  2. It provides a lump sum in case of emergency. 
  3. It gives handsome returns in terms of dividends.
  4. It helps by inculcating the habit of saving money. 

Types of Chit Funds

Chit funds are of different kinds. These are:

Organized Chit Funds: In northern India, a common type of chit fund is where small paper chits with each member’s names are gathered in a box. When all the members come together for a monthly gathering, the person who is in charge in front of all the present members picks a chit from the box. The member so selected gets to take home the day’s collection. Afterwards, that person’s chit is removed from the box. The person who was previously selected comes to the meetings and pays his/her share, but his/her name will not be selected again.

Special Purpose Funds: Some chit funds are organized for a specific purpose. For example, Christmas gifts fund which has a very specific end date which is about a week before Christmas. Such a fund can reduce the cost and relieves the members from extra work in the busy festival season. Nowadays, such special purpose chit funds are conducted by, ladies wear shops, jewellers etc. to promote their goods.

Online Chit Funds: With the popularity of e-commerce, Chit funds are being organized online as well. Online chit funds are conducted online, and contributors can make their monthly contributions and receive the prize through online transactions including electronic funds transfer system. Each member gets his or her own online account to manage and circulate chit funds.

Registered Chit Funds: Registered chit funds are those funds which are registered with the state government under the Chit Funds Act,1982. There are over 10,000 registered chit funds in India.

Unregistered Chit Funds: Unregistered funds are those which are not registered with any state government. They are not regulated under any law. 

Relevant Statute Governing Chit Funds

The Supreme Court has classified chit funds as contracts and also held that chit funds are a part of the Concurrent List of the Indian Constitution; hence both the centre and state can frame legislation regarding chit funds. 

There are a number of legislations that regulate chit funds. They are:

  1. Chit Funds Act, 1982, is the Act of Central Government which provides a uniform law for governing chit funds.
  2. In addition to this, some states and union territories in India have passed their own chit funds legislation as well. These are: 
  1. The Kerala Chitties Act, 1975;
  2. The Maharashtra Chit Funds Act, 1974;
  3. The Tamil Nadu Chit Funds Act, 1961 as in force in the state of Tamil Nadu and in the Union territories of Chandigarh and Delhi;
  4. The Uttar Pradesh Chit Funds Act, 1975;
  5. The Goa, Daman and Diu Chit Funds Act, 1973 and
  6. The Pondicherry Chit Funds Act, 1966.
  1. Since SEBI is the regulator and controller of the securities market, it regulates and manages collective investment schemes.  But the SEBI Act, 1992 specifically excludes chit funds from their definition of collective investment schemes.
  2. Prevention of Money Laundering (Amendment) Act, 2012 has recognized Chit Funds in Section 2(l).
  3. Under the Prize Chits and Money Circulation Scheme (Banning) Act, 1978 ‘Conventional Chit, ‘i.e., the chit has been defined in Section 2(a). In the Act, another kind of chit has also been defined under Section 2(e). These are known as ‘Prize Chit’ they are banned in India. Prize chit is different from conventional chit as prize chit involves the sale of certificates, units, and other financial instruments and also includes an admission fee.

Chit Funds Act, 1982

Important definitions in the Act

Chit Funds Act defines a number of important terms. They are:

  1. Chit Agreement: It is defined as a document which contains the articles of agreement between the foreman and the subscribers of the chit.
  2. Chit Amount: It is the sum-total of all the subscriptions payable by all the subscribers for any instalment of a chit without any deduction of discount.
  3. Discount: It is the sum of money which a prized subscriber is, under the terms of the chit agreement, required to forego and which is set apart under the said agreement to meet the expenses of running the chit or for distribution among the subscribers or for both.
  4. Foreman: The person who under the chit agreement is responsible for the conduct of the chit and includes any person discharging the functions of the foreman under section 39 of the Act.

Features of the Act

  1. The Act states that all registered chit funds should contain either of the words “chit fund”, “chitty”, or “Kuri” as part of their name. These names can only be used by chit funds, no other person or entity has the right to use these names.
  2. Registered chit funds are not allowed to conduct any business other than chit businesses. 
  3. The foreman is allowed to start or run several chits simultaneously. However, prior approval of the state government is required before starting each chitty.
  4. It prohibits every kind of fund that does not have prior permission of the respective state government.
  5. The foreman needs to deposit 100% of the chit value with the Registrar of Chits prior to the commencement of the chit scheme. This deposit will be refunded to the foreman on the successful completion of the chit cycle.
  6. All Chit funds registered under this Act needs to have its accounts audited by a qualified Chartered Accountant. 
  7. The Act requires that all registered chit funds impose a 40% cap on the bidding amount. This 40% is calculated on the chit value of the scheme. This bid-cap is administered to ensure that the bid does not rise uncontrollably leading to subsequent default by the bidder. 

Chit Funds Amendment Bill, 2019

  • Application of the Act

Before 

The Act did not apply to:-

(i) any chit started before the enactment of the Act, and

(ii) any chit (or multiple chits being managed by the same foreman) where the amount is less than Rs 100. 

After 

The Bill removes the limit of Rs 100, and also allows the state governments to specify the base amount over which the provisions of the Act will apply. 

  • Addition of names for chit funds

Before

The Act specified various names which may be used to refer to a chit fund. These include chit, chit fund, and Kuri. 

After

The Bill additionally inserts three more names, Fraternity Fund, Rotating Savings, Credit Institutions.

  • Video-Conferencing

Before

The Act specifies that a chit will be drawn in the presence of at least two subscribers. 

After

The bill has a provision which allows subscribers to join through video conferencing.

  • Foreman’s Commission 

Before

Under the Act, the foreman is entitled to a maximum commission of 5% of the chit amount. 

After

The Bill seeks to increase the commission to 7%. The Bill also allows the foreman a right to a lien against the credit balance from subscribers.

  • Total Amount of Chit Funds

Before

The Act, chits may be conducted by firms, associations or individuals. The Act states the maximum amount of chit funds which may be collected.  These limits are: 

(i) one lakh rupees for chits conducted by individuals, and for every individual in a firm or association with less than four partners, and 

(ii) six lakh rupees for firms with four or more partners. 

After

The limit of chit fund has been increased to three lakh rupees and 18 lakh rupees.

  • Substitution of Terms

Before

The Act defines certain terms in relation to chit funds. It defines: (a) ‘chit amount’, ‘dividend’, ‘prize amount’.

After

The Bill changes the names of these terms to ‘gross chit amount’, ‘share of discount’ and ‘net chit amount’, respectively.

Advantages and Disadvantages of Chit Funds

Advantages

  1. Chit funds are easy to join.
  2. They promise high returns.
  3. The rate of interest of borrowing from chit funds is low.
  4. People of lower income households can also participate.
  5. Helps micro-enterprises to develop.

Disadvantages

  1. High transaction cost.
  2. Chit funds have known to be vulnerable to scams. 
  • Saradha Chit Fund Scam: The scam was run by Saradha Group. The group collected 200 to 300 billion rupees before it collapsed in 2013.
  • Rose Valley Chit Fund Scam: The Rose Valley scam was a bigger financial fraud than the Saradha scam, more than Rs 15,000 crore was reportedly collected from depositors all across India.

    3. Associated with a number of risks. They are:

  1. The biggest risk involving a chit fund is the misuse of the pooled funds by the foreman. 
  2. Sometimes members stop paying the dues and have already taken the first bid.
  3. In certain chit funds, discount rate is rigged, and a desperate member ends up paying a higher discount.

Things to Keep in Mind while Investing in Chit Funds

When a person invests in chit fund, they should keep the following things in mind:

  1. Make sure the chit fund is registered: Before investing in a chit fund, a person should make sure that the chit fund is registered. This can be done by checking the certificate of registration from the Registrar of Companies.
  2. Check if the certificate is genuine: The certificate and registration number issued by the Registrar should also be checked.
  3. Check if the chit is approved: Every new chitty started by the chit fund should have prior approval.
  4. Know the promoters: Go through the list of the director of the Company to check whether the fund is financially sound.
  5. Complaints against the Fund: Complaints about the fund can be verified from the Office of the Registrar. 

Rights available to a Subscriber of the Chit Fund

The subscriber has a right to:

  1. Get a proper receipt and copy of chit agreement for the payment of subscription.
  2. Get the amount when the chit is prized in his favour.
  3. Attend auction and bid during an auction.

Conclusion 

Therefore, even though chit fund is a great investment avenue, one has to be cautious before participating in it.


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