Chit Funds

A chit fund is a type of rotating savings and credit scheme or mutual financial arrangement in which a group of individuals contribute a fixed amount of money periodically into a common pool, and the collected amount is distributed to one member of the group in each cycle, usually through a lottery or auction system.
Chit funds serve as both savings and borrowing instruments, offering financial support to participants who may not have access to formal banking systems. They are a traditional form of community finance in India and continue to play an important role in informal financial inclusion, especially in rural and semi-urban areas.

Definition

According to the Chit Funds Act, 1982 (Government of India):

“A chit means a transaction whether called chit, chitty, kuri 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 value of it) by periodical installments for a definite period, and each such subscriber shall, in his turn, be entitled to a prize amount.”

Thus, a chit fund is essentially a voluntary savings and loan scheme organised among a group of members for mutual financial benefit.

Nature and Working of a Chit Fund

A chit fund operates on mutual trust and reciprocal benefit among participants. The process typically involves:

1. Formation of a Group:
   • A fixed number of members (usually 20–50) agree to contribute a specified sum at regular intervals (monthly, fortnightly, etc.).
2. Collection of the Fund:
   • Each member pays the subscription amount to the foreman (organiser of the chit fund) who manages the operations.
3. Auction or Draw:
   • The total collected amount is offered to members through either:
     • Lottery (draw system): A random member is selected to receive the lump sum (prize amount).
     • Auction system: Members bid for the lowest discount; the bidder accepting the least amount receives the chit.
4. Distribution of Dividend:
   • The discount amount (difference between the total fund and bid amount) is distributed equally among other members as a dividend.
5. Repetition:
   • The process continues until every member has received the prize amount once.
6. Completion:
   • At the end of the scheme, all members have contributed and received benefits in equal proportion.

Example of a Chit Fund

Suppose 20 members agree to contribute ₹5,000 per month for 20 months.

• Monthly Pool: ₹5,000 × 20 = ₹1,00,000
• Each month, an auction is held among members to decide who takes the pool.
• If a member bids to take ₹90,000 (discount of ₹10,000), that member gets ₹90,000 that month.
• The ₹10,000 discount is distributed equally among all members (₹500 each).
• The process repeats monthly until every member receives the pooled amount once.

Components of a Chit Fund

1. Foreman:
   • The organiser or manager who conducts the chit operations.
   • Responsible for collecting contributions, conducting auctions, and disbursing payments.
   • Entitled to a commission (usually 5%) for managing the scheme.
2. Subscribers (Members):
   • Individuals who participate by contributing a fixed amount periodically.
3. Prize Amount:
   • The total pool collected minus foreman’s commission and dividend distribution.
4. Discount or Dividend:
   • The difference between the pooled amount and the amount received by the winning bidder, distributed among other members.

Types of Chit Funds

1. Registered (Organised) Chit Funds:
   • Operate under the Chit Funds Act, 1982, and are registered with the Registrar of Chits in each state.
   • Legally recognised and regulated by the State Government.
2. Unregistered (Informal) Chit Funds:
   • Operate on trust within small communities or among friends and relatives.
   • Common in rural areas but often unregulated, posing risks of fraud.
3. Online/Digital Chit Funds:
   • Technology-enabled platforms managing chit groups digitally, improving transparency and convenience.

Regulatory Framework in India

The chit fund business in India is regulated by:

1. The Chit Funds Act, 1982:
   • Provides for registration, regulation, and control of chit fund companies.
   • Administered by the State Governments.
2. Reserve Bank of India (RBI):
   • Supervises Non-Banking Financial Companies (NBFCs) engaged in similar activities but does not directly regulate registered chit funds.
3. Ministry of Corporate Affairs (MCA):
   • Regulates incorporated chit fund companies under the Companies Act, 2013.
4. State Chit Fund Rules:
   • Each state has its own rules under the 1982 Act (e.g., Tamil Nadu Chit Funds Act, Kerala Chitties Act).

Advantages of Chit Funds

1. Dual Benefit:
   • Acts as both a savings and borrowing instrument.
2. Financial Inclusion:
   • Provides access to credit for low-income and unbanked individuals.
3. Flexibility:
   • No restriction on usage of the prize amount (can be used for business, marriage, education, etc.).
4. Low Documentation:
   • Simple procedures compared to banks and formal financial institutions.
5. Community-Based Trust:
   • Encourages mutual help and solidarity among members.

Disadvantages and Risks

1. Fraud and Mismanagement:
   • Unregistered chit funds can lead to scams and loss of money for participants.
2. Lack of Transparency:
   • Foremen may manipulate auctions or misappropriate funds.
3. No Guaranteed Returns:
   • Returns depend on auction results and timing of participation.
4. Default Risk:
   • Members or foremen may default on payments.
5. Limited Legal Recourse:
   • Recovery of lost money is difficult in informal schemes.

Prominent Chit Fund Scandals in India

• Saradha Group Scam (West Bengal, 2013): A massive Ponzi-type fraud disguised as a chit fund, causing losses to thousands of investors.
• Rose Valley Scam (2015): Another large chit fund scam affecting investors across eastern India.
• These incidents prompted stricter regulation and greater public awareness about legitimate, registered chit funds.

Government Reforms and Safeguards

• Chit Funds (Amendment) Act, 2019:
  • Enhanced transparency and reduced fraud.
  • Increased the maximum foreman’s commission from 5% to 7%.
  • Allowed video-conferencing for conducting chit draws.
  • Permitted the use of the terms fraternity fund and rotating savings fund to replace chit fund, improving public perception.
• Public Awareness Campaigns:
  • The government and RBI issue regular advisories to caution citizens against unregistered chit funds and Ponzi schemes.

Economic and Social Role

In the context of rural and informal economies, chit funds:

• Serve as an important microfinance mechanism, particularly where access to banks is limited.
• Provide working capital to small entrepreneurs and traders.
• Encourage savings discipline among low-income households.
• Promote community trust networks, forming the base for cooperative finance.