Chit fund

A Chit fund is a kind of savings scheme practiced in India.

A Chit fund company means a company managing, conducting or supervising, as foremen, agent or in any other capacity, chits as defined in Section 2 of the Chit Funds Act, 1982. 

According to Section 2(b) of the Chit Fund Act, 1982, "Chit means a transaction whether called chit, chit fund, chitty, kuri or by any other name by or under which a person enters into an agreement with a specified 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 installments 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".

Such chit fund schemes may be conducted by organised financial institutions or may be unorganised schemes conducted between friends or relatives.

There are also variations of chits where the savings are done for a specific purpose. Chit funds also played an important role in the financial development of people of south Indian state of Kerala, by providing easier access to credit.

In Kerala, chitty (chit fund) is a common phenomenon practiced by all sections of the society. A company named Kerala State Financial Enterprise exists under the Kerala State Government, whose main business activity is the chitty.

Chit Funds are also misused by its promoters and there are many instances of the founders running what is basically a Ponzi scheme and absconding with their money.

Chit funds have been a popular savings scheme in several parts of India for generations together now.

It has paved it’s way as a convenient finance option amongst businessmen, small scale industrialists, and other small time investors. Though very often shrouded by news of fraudulence, they have still managed to retain their popularity.

So what exactly are chit funds and how efficient a financial tool is it? Read on to find out more.

The Beginning of Chit Funds

Chit funds evolved years ago, when the present system of banking did not exist. Few families in a village would get together to form a chit or a group, to save money and to avail of loans amongst the group formed.

A sensible person is chosen to manage the group. This informal system of saving prevailed only on trust. Gradually, as groups became larger and the money involved became huge, many companies started chit fund schemes with attractive offers. 

To thus provide for the regulation of chit funds and for matters connected therewith, the government introduced the Chit Funds Act in 1982.

What is a Chit Fund?

A chit fund is a kind of savings borrowing scheme, in which a group of people enter into an agreement to contribute fixed amounts periodically, for a specified period of time. 

The amount so collected (or the chit value) is distributed among each of the persons in turns, which is determined by way of lots or an auction. Chit funds provide an opportunity to save excess cash on a daily, weekly or monthly basis, and give an easy access to it in case of emergency.

How Does a Chit Fund Work?

Different chit funds operate in different ways; and there are also many fraudulent tactics practiced by many private firms. The basic necessity of conducting a 'Chitty' is a group of needy people called subscribers.

The foreman - the company or person conducting the chitty - brings these people together and conducts the chitty. Foreman is also the person responsible for collecting the money from subscribers, presiding the auctions and keeping records of subscribers.

He is compensated a fixed amount (generally 5% of gross chitty amount) monthly for his efforts; other than that the foreman does not have any specific privileges; he is just a subscriber of the chitty.

The general pattern of the chitty can be readily noticed by a simple formula:

Monthly Premium × Duration in Months = Gross Amount

E.g.: 1000 * 50 = 50,000/-. Where 1000 is the maximum monthly contribution needed from a subscriber, 50 is the duration of the chitty in months and 50,000 is the maximum sum assured. 

The duration also equals the number of subscribers, as there must be (not more or less) one subscriber to receive the price money every month.

The chitty starts on an announced date, every subscriber come together for the auction/lot. As per Kerala chit act, the minimum prize money of an auction is limited to 70% of the gross sum assured that is 35,000 in the above example.

When there is more than one person willing to take this minimum sum, lots are conducted and the 'Lucky subscriber' gets the prize money for the month. 

If there is no person is willing to take the minimum sum, then a reverse auction is conducted where subscribers open-bid for lower amounts; that is from 50,000 >> 49,000 >> 48,000, and so on. The person bidding lowest sum get bid amount.

In both the cases the auction discount, that is the difference between the gross sum and auction amount, is equally distributed among subscribers or is deducted from their monthly premium.

For example if the auction is settled on a sum of 40,000, then the auction discount of 10,000 (50,000 - 40,000) is divided by 50 (the total number of subscribers) and everyone gets a discount of 200. The same practice is repeated every month and every subscriber gets a chance of receiving some money.

Drawbacks

Chit-funds do not offer any pre-determined or fixed returns. Higher returns are earned when there are more number of members in the group or if the duration of the scheme is longer.

One would earn more, when more members need emergency funds. Thus returns cannot be calculated and decided when one joins the scheme.

Safety of Chit Funds

With the plethora of chit fund companies around, the safety of a chit fund lies in choosing the right one. In a registered chit fund company, under legal binding, the activities are regulated and institutionalized by the Chit Fund Act. 

And hence could be considered safe. However, other unregistered companies operating informally do exist. One needs to exercise caution while choosing where he desires to invest.

 

Chit funds definitely are an attractive option for regular saving. It inculcates a disciplined approach to financial planning. 

It has the added advantage of bringing a combination of savings as well as hassle free borrowing. This dual purpose investment tool could be a friend in need at times of unexpected financial emergencies.

Should you invest?

A big “no”

These chit funds are not at all proper and reliable investment vehicles where you park your hard earned money.

So, please avoid them unless you want to exactly take that kind of risk.