Chit Funds – a lot of us have heard about it, and read about it in the news, without always knowing the details about it. A lot of people are unaware that Chit Funds are unique to India. It is a kind of community-based financial pooling that is not practiced anywhere else in the world.
What is it exactly?
Chit Funds do have variations, but essentially they are groups or companies (with multiple chit groups) where a set number of members get together and pool in an agreed upon amount of money every month. This pool then can be bid upon by the members in need of immediate lump sum cash (or conversely, there could be an auction), with the lowest bid placed winning the monthly pool. The difference between the winning bid and the total amount is then re-distributed equally amongst all the members. For example, a 20-member chit fund group must agree to a 20-month period (equal to the total number of members) of contributions, which can be any specific amount. Let’s assume it is Rs. 1,000. So, every month, Rs. 20,000 is the pool on which the members can bid. Suppose in a month, the lowest bid is for Rs. 16,000. The member gets that amount, while the remaining Rs. 4,000 gets split equally amongst the 20 members, so each will receive Rs. 200 back, in effect making their contribution for that meeting Rs. 800. The winning member cannot bid again in the 20-month cycle.
In format, Chit Funds closely resemble the informal ‘kitty party’ trend that thousands of women in the country participate in.
The Organiser may Charge a Cut: The chit fund group, if it is convened and organised by a specific person who puts in the effort to get the group together and conduct the meetings, in some instances will charge a set commission for the effort. This commission can be 5% of the total pool, meaning s/he will be paid Rs. 1,000 per meeting. So, in the above example, after the bid has been placed and won, Rs. 1,000 will be paid to the organiser, and then the rest of the Rs. 3,000 will be re-distributed among the members.
Chit Funds are Regulated: The Central Chit Funds Act (1982) has the overall legal provisions attached to all chit fund activity in the country, but its implementation is controlled by individual state governments. A ‘commencement certificate’ is also to be sought from the Office of the Registrar by every Chit Fund. The Reserve Bank of India (RBI) is not present in this picture in any form.
There are State-owned Chit Funds: South India is a hugely popular market for Chit Funds, with private players as well as state governments actively participating in organising groups with total memberships running into lakhs! The Government of Karnataka, for example, backs the Mysore Sales International, regulated by the Chit Funds (Karnataka) Rules 1983. The Kerala Chitties Act (1975) lays down the rules for the ‘chitties’ or ‘kuri’ in the state, some of which are run by the popular Kerala State Financial Enterprises Limited, a government-owned entity.
Some states in northern India too have popular followings of Chit Funds, especially in Delhi and nearby sectors.
Who is it For?
Chit Funds are very popular among citizen/trade/occupational groups whose regular income streams are unable to support any sudden expense or any emergencies. A lot of small-scale workers, businessmen, artisans, and more like the idea of a Chit Fund because it gives them access to immediate liquidity without the formal hassle of a bank. Moreover, banks and financial institutions are more often than not unwilling to lend to such customers to finance occasions like weddings or payment of college fees. Chit Funds are a less complicated route to the emergency cash.
Are they Safe?
Now this question is up in the air! Chit Funds do have good stories attached to them, with thousands of winning bids having equipped people with much-needed money during a desperate crunch. But cases of cheating and fraud have also been many, with most of the news surrounding Chit Funds in fact focusing on this dubious aspect of the phenomena. The advice always is to explore this option when money is really tight and you cannot envisage any other avenue. Make sure to go to a trusted Chit Fund company, or to a group composed of friends and/or family. And, never consider a Chit Fund an ‘investment’. It never is!