Chit Fund Final Part- 2

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1. INTRODUCTION

Chit funds have been a popular savings scheme in several parts of India for

generations together now. It has paved its 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.

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 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 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 organized financial institutions

or may be unorganized 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. In Kerala, there exists a

company under the State Government, called Kerala State Financial Enterprise, the

main business activity of it being the chitty business.

Chit Funds are also misused by its promoters and there are many instances of

the founders running what is basically a ³Ponzi scheme´ and absconding with their

money.



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With the advent of the Chit Funds Act, initially in the year 1961 (Madras Act)

and amended subsequently in the year 1982 (Central Act), chit funds have been highly

regulated and governed by stringent rules. The purpose of the said Act and its

proposed benefit to the chit funds industry is, however, questionable.

Chit funds are also, more importantly, a means of easy and profitable access to

finance for the Small and Medium Enterprises (SMEs). The limited access to funds of

SMEs from banks and the formal financial domain had begun to strangle the growth

prospects of these enterprises. Thus, the advent of chit funds is really a boon to these

businesses. To understand more about the workings of chit funds and the difficulties

that they face in their business, we interviewed a number of chit fund managers in

Mumbai, Chennai (India). These in-depth interviews gave us an idea about the

possible research questions that may be addressed in this area. The questionnaire used

for the purpose is annexed at the end of the document. The following sections relate

the findings from these interviews.



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2. EVOLUTION OF CHIT FUND

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.

The concept of chit funds originated more than 1000 years ago. Initially it was

in the form of an informal association of traders and households within communities,

wherein the members contributed some money in return for an accumulated sum at theend of the tenure. Participation in chit funds were mainly for the purpose of

purchasing some property or, in other words, for ¶consumption¶ purposes. However,

in recent times, there has been tremendous alteration in the constitution and

functioning of chit funds. With the advent of the Chit Funds Act, initially in the year

1961 (Madras Act) and amended subsequently in the year 1982 (Central Act), chit

funds have been highly regulated and governed by stringent rules. The purpose of the

said Act and its proposed benefit to the chit funds industry is, however, questionable.

Chit funds are also, more importantly, a means of easy and profitable access to

finance for the Small and Medium Enterprises (SMEs). The limited access to funds of

SMEs from banks and the formal financial domain had begun to strangle the growth

prospects of these enterprises. Thus, the advent of chit funds is really a boon to these

businesses (India). These in-depth interviews gave us an idea about the possible

research questions that may be addressed in this area the end of the document.



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B. STUDY OBJECTIVE:-

Chit fund model is an easy and innovative method of access to finance for the

low income households. It caters to the needs of different sections of the society,

mainly in the income generating households. Chit schemes have traditionally been

generic, differentiating only in value and duration. The need for customization of

products, to address varied requirements of chit members, is evident. In this regard, I

took an Initiative to study the nature and extent of the Chit fund industry, need for

financial education and customization of chit schemes, and eventually design and test

new financial products that will further enhance the value of financial services

provided via chit funds.

The research objective is to:-

1. Determine the size of the chit fund industry (registered and unregistered) and

document Recent trends.

2. Understand the financial needs of poor households and also determine to what

extent their financial needs are met by registered chit funds.

3. Estimate interest rates in registered chit funds.



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3. WHAT IS CHIT FUND?

Chit funds are the Indian equivalent of the Rotating Savings and Credit

Associations (ROSCA) that are famous throughout the world. ROSCAs are a means to

¶save and borrow¶ at the same time. It is considered one of the best instruments to

cater to the needs of the poor.

A chit fund is a savings cum 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.

Participation in Chit funds was mainly for the purpose of purchasing some

property or, in other words, for ³CONSUMPTION´ purposes. However, in recent

times, there have been tremendous alterations in the constitution and functioning of

Chit funds. While in most places ROSCAs are user-owned and organized informally,

in India, chit funds have been formally institutionalized as well. Legally recognized

firms provide a variety of chit schemes. Under the Chit Fund Act, this industry has

been highly regulated and is governed by stringent rules. This institutionalization of the chit funds (a) makes it easier for poor or illiterate people to know exactly what

different chit schemes the chit companies offer, (b) provides an option to people to

participate in schemes where members need not know each other; hence there is a

larger diversification of the idiosyncratic risks.

This makes it easier to provide chit schemes in urban settings where social

linkage among members might be weak, (c) to some extent ensures transparency in

the operations, (d) given that the law determines the size of the bidding and the

commission the company can charge, it encourages competition among chit fund

firms to improve services to clients, and (e) legal recognition also helps the chit fund

operators to scale their operations.



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It allows the chit fund operator to use the legal means to handle defaults and

more importantly it infuses faith in the clients that there are sufficient checks and

balances which will prevent opportunistic behavior. In return the chit fund companies

take a fee from the clients to cover their expenses, in the form of a commission. The

chit fund company provides a variety of mechanisms by which the savings of the

members can be transformed into lump sums.



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4. HOW DOES CHIT WORKS?

A chit scheme generally has a predetermined value and duration. Each scheme

admits a particular number of members (generally equal to the duration of the

scheme), who contribute a certain sum of money every month (or everyday) to the

³pot´. The ³pot´ is then auctioned out every month. The highest bidder (also known as

the prized subscriber) wins the ³pot´ for that month. The bid amount is also called the

³discount´ and the prized subscriber wins the sum of money equal to the chit value

less the discount. The discount money is then distributed among the rest of the

members (or the non-prized subscribers) as ¶dividend¶ and in the subsequent month,

the required contribution is brought down by the amount of dividend.

To illustrate the above, let us take the example of a chit scheme with thefollowing characteristics. Chit Value = Rs.500000, Duration = 50 months and

Members = 50. The contribution in this case would be initially Rs.10000 per month

per member. In the first month, the collection would, therefore, be Rs.10000

multiplied by the number of members i.e. Rs.500000. This amount is called the ¶pot¶

which is auctioned out at the end of the month. Now let us assume that the highest bid

in the first month auction is Rs.100000. This is called the ¶discount¶. The highest

bidder now gets the amount equal to the chit value, Rs.500000, less the discount,

Rs.100000, i.e. Rs.400000. The discount amount of Rs.100000 is then divided among

the other 49 members equally (the dividend for the 49 members work out to roughly

Rs.2040 each). For the subsequent month, therefore, the contribution of these

members reduces by the amount of dividend (i.e. the contribution in the second month

for the 49 members would be Rs.10000 less Rs.2040 which is equal to Rs.7960).

This process gets repeated for all months till the end of the scheme. There are

many variations to the above mentioned process depending on the scheme, preference

of the members, capability of the company and so on. Generally, the chit manager or

the company is also a member in each scheme.



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This is because the chit manager has to deposit an amount equal to the chit

value of the scheme with the Registrar of Chits for the particular jurisdiction. We will

discuss this in detail in the Regulations section.

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5. GENERAL CHARACTERISTIC OF CHIT FUND

INTERVIEWED

The chit owners we approached were in the business for the past 2 to 6 years.

In most cases, the owner or manager was already involved in a similar line of business

(like income tax consultant, chartered accountant, and jeweler or kirana shop owner)and expanded or diversified into the chit business. All the chit companies interviewed

were running unregistered funds. The number of schemes open at a particular time

ranged from 1 to as many as 8. The chit values ranged from Rs.10000 to Rs.1000000

and the duration from 12 to 50 months. The majority of members of the chit funds

were small traders and businesses. Households (mainly housewives) and salaried

employees also Participated extensively in these schemes.

The funds generally allow multiple-membership in each scheme, which means

that a member can contribute double or more number of times the amount and

participate in that many auctions during the tenure of the scheme. For instance, in a 20

month scheme where the contribution is Rs.1000 per month per member, a member

who pays a contribution of Rs.3000 per month can participate in 3 out of the 20

auctions. However, the members can bid again only after 50% of the duration is

completed (for instance, in case of a 20 month scheme, the member who has won the

pot in the first 10 months can bid again only after the completion of 10 months).

Usually only members with high credit worthiness will be allowed such a privilege.

The chit companies do not require much documentation, which is their

advantage over banks and other financial institutions. Some of the companies,

however, ask for income proof and address proof from new members. Most of the

companies require the members to have a bank account, as 100% of the transactions

are done through check payments. No business or address verification is undertaken

by the chit funds unless it is deemed absolutely necessary.

Most chit companies admit only members who are either connected to other

existing chit members or known to the chit manager personally. Some chit funds

employ agents to acquire new members. However, in case the members are not



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personally known to the managers, rigorous verifications are made to ensure the

credibility of the member. In some cases, the new members are not allowed to

participate in the auction for the first few months of the scheme and will only

contribute to the pot during that period. Generally, the members who want to bid in

the auction are asked to produce a guarantor or surety who is trusted by the chit

manager. In some cases, collaterals are also demanded from members prior to their

participation in the auction. However, if the members are well known, only a

promissory note is collected from them for admission to membership.

$%(1(),762)&+,7)81',19(670(17

A chit fund investment has its share of benefits too.

y

It inculcates the habit of compulsory regular saving.

y It earns dividends every month. So the net effective rate of return proves to

be pretty attractive.

y For any unexpected financial requirement, bidding for the lump sum

amount, could prove to be a better option than going through the hassles of

a loan.

y Chit fund investments are not affected by any market fluctuations.

y

Finance option through chit funds are easier to re-pay through the

remaining monthly installments.



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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.

Among the limitations of Chit Funds, as only one person every auction can win

the ³pot´, participants cannot be surethat they getloans whenever needed. If there are

multiple bidders, the ³pot´ will go to the highest bidder or be allocated through a

lottery if the bids are the same in a given auction. This could potentially be

detrimental to people who cannot delay their consumption or investment, as they are

in desperate need of funds. They might have to resort to money lenders or other

informal sources offering very high interest rates.

There could also be a scenario where, a member in desperate need of the

money is actually successful in winning the ³pot´, but ends up with an extremely high

interest rate. This also highlights another limitation of the Chit Fund. In order to

function optimally, there is a need to ensure that the need for funds from the members

in a given scheme is idiosyncratic. Thus the selection of members in a given scheme

requires a balancing act between savers and borrowers, as Chit Funds have less

liquidity than banks that have thousands of savers and borrowers.

The Chit Fund organizer plays a very important role in ensuring that the groups

are well balanced between savers and borrowers.



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6. WHY SHOULD ONE GO FOR CHIT FUND?

In many parts of India, Chit Funds address gaps left by the traditional banking

sector. They mobilize huge amounts of small savings, and in return allow members to

have access in the form of loans to lump sum amount of money that they would often

not be able to get from traditional banks. Easy accessibility and flexibility are

important aspects of this form of financing. Compared to banks, Chit Funds require

less documentation, are more flexible about collateral, and allows to determine own

interest rate (within the constraints of a given chit scheme).

Furthermore, there is no need to determine upfront whether funds are used for

saving or borrowing. This is a salient feature of chit funds as it not only puts in place a

disciplined saving mechanism, but it also allows to access cash when needed. Inaddition, as Chit Funds use the funds of the participants there is much less capital

requirements for the institution (unlike banks).

Our survey results also show that Chit Funds are mainly used as a tool for saving

and as a source of loan for consumption, business and emergency purposes.



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6.1 Comparison With other source of Available Funds

The most popular outside options to Chit Fund members, besides family and

friends are moneylenders, banks, and unregistered Chit Funds. These options vary in

the terms and conditions offered. The table below highlights the most salient featuresof each option.

Table: Outside Options - Interest Rates for Loans

ParameterRegistered

Chit Fund

Money

LendersBank/Formal

Institution

Unregistered

Chit Fund

Collateral

Requirements

Depends on the chitfund manager andcredit history of themember

They usually accept personal guarantees

Other types of collaterals acceptedare ± post dated checks,insurance policy,house/land propertyPapers etc.

Depends upon thetype of moneylender.

Loans with or withoutCollateral areavailable.

Variety of itemsconsidered ascollateral

Legal ownershiptransferred /nottransferreddependingBorrower closeness.

Depends upon thetype of loan askedfor.

Most of the banksdo ask for somekind of collateral ± Insurance policy,House/property papers etc.

Interest rateapplicable varieswith the amountand quality of thecollateral provided

Usually nocollateral requiredsince member andchit fund manager

know each other Personally.

Chit fund owner sometimes asks for bond paper worththe value of one chitInstallment whichwill be returned tothe member after hewins the bid.

Interest Rates

Interest rates varyAccording to thechit value andduration. They alsovary according tothe month of

auction.

Rates range from0.5% to 3.5% per month

Rates ranging fromas low as 1% per month to as high as20% per month areobserved.

There are minor variations based onthe type of loan andcollateral providedand profile of theBorrower.

PLR: 12.75%-

13.25% per yr

The average interestrate varies from 1%to 2% per month.



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7. REGISTERED v/s UNREGISTERED

A Chit Fund can be either ³registered´ or ³unregistered´. Registered Chit funds

are organized by Chit Fund firms/companies and regulated by the Chit Fund Act.

They are in essence impersonal contracts that depend on market forces. Unregistered

Chit Funds are unorganized and run by friends, relatives or personal groups. They are

personal contracts that do not depend on market forces but more on personal ties.

Unregistered Chit Funds which exceed Rs. 100 ($2) in chit value are illegal in India,

although it is widely known that the unregistered Chit Funds industry is still very

popular in rural areas and among the poor population in urban and semi-urban areas.

8. RULES AND REGULATION

The regulation of the Chit Fund industry was put in place by the Government

of India to address the problem of misuse of informal Chit Funds by unscrupulous

promoters and founders running away with the participants¶ funds, leaving the

members with little recourse to retrieve their money back.

A.VARIOUS CHIT FUND ACT:-

The first enactment of chits was made by Government of Travancore (Kerala)

in the year 1914. Subsequently many states in India formulated and enacted chit acts.

With the collapse of big chit companies in the early seventies, the Government of

India constituted a special committee to undertake the study of chits, its implications

and benefits or problems to the Indian economy.

On the recommendation of this committee a special chit act was formulated

under the name of 'The Chit Funds Act 1982' by the Parliament of Union Government.In Karnataka this Central Chit Funds Act was promulgated in 1984 along with the

Chit Fund (Karnataka) Rules 1983.



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The other Chit Fund Acts that are in force are as follows:-

The Andhra Pradesh Chit Funds Act, 1971, the Kerala Chitties Act, 1975, the

Maharashtra Chit Funds Act, 1974, 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, theUttar Pradesh Chit Funds Act, 1975, the Goa, Daman and Diu Chit Funds Act, 1973,

and the Pondicherry Chit Funds Act, 1966.

Important points from The (Central) Chit Funds Act (1982):-

1. The State Government may exempt any Chit fund from all or any of the provisions

of the Central Act.

2. According to this Act, no bank can commence or carry on chit business after the

commencement of this Act.

3. This Act does not apply to any Chit fund the amount of which does not exceed one

hundred rupees.

4. This Act extends to the whole of India except the State of Jammu and Kashmir.

5. According to this Act, the chit manager 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 chit manager on the successful completion of the

chit cycle.

6. A Chit fund registered under this Act needs to have its accounts audited by a

qualified Chartered Accountant. The fixed deposit made at the beginning of the

scheme will be refunded only on the submission of the audited Balance Sheet and

Statement of Accounts.

7. The Act also requires all registered Chit funds to 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. The minimum bid is restricted to 5% of the chit

value which is the foreman¶s (or chit manager¶s)commission.



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Points of difference between Acts prevailing in different states of India:-

Most of the provisions of the Central Act apply to the Chit funds run in

different parts of India. However, the State Acts may override certain provisions as

deemed necessary. For instance, the Andhra Pradesh Chit Funds Act 1971 had

previously required the chit managers in that state to deposit only 50% of the chit

value with the Registrar of Chits prior to the commencement of the chit scheme. This

provision has been amended recently with the adoption of the provision from the

Central Act that requires 100% deposit from chit managers.

Similarly, the Kerala Chitties Act was amended recently to include a provision

which stipulates that companies can float chit schemes only amounting to 50% of the

foreman¶s asset, whereas in other states that adopt the Central Act, companies areallowed to float chit schemes up to ten times the foreman¶s assets. The Kerala Act also

imposes other stringent rules that have resulted in many companies registering

themselves outside the state (primarily in Jammu and Kashmir where the Central Act

does not apply). One should also note that in states which do not enact a State Chit

Fund Act, the Central Act will automatically prevail.

B. COST OF REGULATION:-

Registration of a chit scheme entails numerous fee payments and other

formalities, such as filing of returns, maintaining minutes of the meeting, auditing of

accounts and so on, that need to be satisfied by the chit manager. The Registrar of

Chits of a particular jurisdiction is responsible for registering the chit funds in that

jurisdiction. As a first step in the formation of a group or scheme, prior sanction needs

to be obtained from the Registrar. The prior sanction is granted at the filing of anapplication and at the payment of fees of Rs.50 ($1). Subsequently the company needs

to file a chit agreement with every member in that particular group. The fee for the

purpose is around Rs.20 ($0.4) per member. Once the chit agreement is filed and

approved, the certificate for commencement of the scheme isissued.



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The registration process generally takes around two months to complete. There

is no subsequent requirement for renewal of the registration. Once the scheme

commences, the chit manager has to file the minutes of each auction with the

Registrar every month along with a fee of around Rs.4 ($0.08). Other costs of

registration include fees payable on transfer of membership and on any other filing

requirement that may arise during the course of the scheme.



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9. DEFAULT HOW THEY ARE HANDLED?

The default rates in the chit industry however around a meager 1-2%. This is

because the chit members are, in most cases, personally known to the chit managers.

However, even the default by a single member can shake the foundation of the chit

scheme as it is totally dependent on the dedicated participation of all the members.

Hence, it becomes essential for the chit managers to screen the members before

admission. When members fail to make their contribution for any particular month,

they are initially requested by oral correspondence to pay the dues. If this fails, a

reminder is sent by mail and finally a legal notice is issued and the person is taken to

Court.

There is an arbitrary provision under the Chit Fund Act that provides for immediate redressed. The Registrar may admit or dismiss the case depending on the

strength of the argument on both sides. In some cases, there may also be partial

recovery depending on the financial solvency of the member. The Court attaches the

salary, collateral and sometimes even the personal property of the member to the

unpaid dues. In case the member is not traceable, then the guarantor or surety is asked

to make the payment and, in their absence, the company is obliged to do the same.

In case of delay in payment of dues, interest is charged on the delayed payment

and sometimes even the dividends are forfeited if the delay is for too long. In case the

reason for delay is genuine then the interest is waived. To minimize delays, discounts

are given for prompt payments



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10. CHARACTERISTIC AND NEED OF CHIT PARTICIPANT

Understanding the behavior and financial needs of the chit members is an

important step in studying how to facilitate financial access for the poor through Chit

Funds. It will allow us to identify current gaps in financial services, as well as

determine if the financial needs of the lower income households can indeed be met byChit Funds.

Timely available finance to the right amount is need of every person, whether

he is above poverty line or below poverty line. People above poverty line can manage

funds and way to pay off their debt but those people below poverty line can hardly

manage to pay even the interest charged on them. With this study I have found that

people doing directly or indirectly associated to chit fund are mostly household wife,

salary earners, small scale business man like shop keeper, or other small scale

operators. Various type of Chit fund serve as a source of fund for many occasion, like.

Organized chit funds

In north India common type of chit fund is where small slips with each

members name are written and gathered in a box. When all members gather for a

monthly or weekly meeting then concern in charge in front of all members will pick up one slip from the box and who so ever's name comes that person will be

entitled to get the collection of that day.

Afterwards that person¶s name slip is torn and there after he comes for

meetings regularly and gives his kitty's share but his name won't be there in the

slips of box as he has already collected his share.

Special purpose funds

Some chit funds may be conducted as a savings scheme for specific purpose.

An example is the Deepavali sweets fund, which has a specific end date - about a

week before Deepavali. Neighborhood ladies will get together to pool their savings



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each week. This fund will be used to prepare sweets in bulk just before the Deepavali

festival, and the sweets will be distributed to all members.

Preparation of Deepavali sweets may be a time consuming and costly activity

for individuals. Such a chit will reduce the cost, and relieve the members from excess

work from an already tense festival season. Nowadays, such special purpose chits are

conducted by jewellery shops, kitchenware shops, etc. to promote their products.



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11. AUCTIONS IN CASE OF LOAN

The chit manager auctions out the ¶pot¶ every month on a particular date. The

members who wish to participate in the auction assemble at a particular place

(generally the chit manager¶s office) and call out their bids. The auction essentially

lasts for five minutes preceded by five minutes of preliminaries and succeeded by five

minutes of closing procedure.

At the end of the fifth minute of the auction, a bell will ring to indicate the

closure. The highest bid at the time of the bell will be recorded as the winning bid. If a

member, interested in participating in an auction, is unable to be physically present,

then he/she may send a sealed bid to the chit manager/foreman 24 hours prior to the

auction.

In case there is an equal bid, the decision of who is entitled to the loan is made

by means of a lottery. When none of the members require the loan, a lottery is

conducted among the non-prized subscribers and the member selected is given the

loan amount at the minimum bid of 5%. Where two members are equally in urgent

need of the loan in any particular month, the chit manager may allow them to make

compromises among themselves wherein they may divide the ¶pot¶ equally between

them.

However, in such cases, one of them will be held liable directly to the group for

the entire amount and the other would be liable to the former for his/her share of the

loan.



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12. SOURCE OF INCOME TO CHIT MANAGER

The chit manager gets a high return on the chit business which is justified by

the high risk involved in such a business. His/her major source of income is the

foreman¶s commission of 5% of the chit value for every scheme. This provides a

regular monthly income of around Rs.10000 on an average for every scheme that is in

vogue. This steady income flow is sufficient to cover the operating cost and other

statutory costs of running the scheme. The interest lost on the deposit that needs to be

made ab initio, and the monthly contributions as part of every scheme that has to be

borne by the manager, require such an income source to keep him/her afloat.

Apart from this formal and transparent source of income, chit managers also

make money in other less evident ways. For instance, it is a common phenomenon for the loan to be disbursed a month after the auction date. This means that the chit

manager will earn interest on the loan amount for a whole month. When this repeats

for every scheme in force, a large quantity of money accumulates.

To illustrate this, let us consider a chit scheme that has an auction on the 7th of

January. The contributions will be collected on the 1st of January. Now, the prized

subscriber at the auction will be provided with the loan amount or the ¶pot¶ only after

a month, i.e. on the 7th of February. The chit manager will earn the interest on the

collected amount essentially from the 1st of January to the 7th of February. Hence, the

chit managers have a very rich source of income. However, with the increase in costs

of registration and other costs prescribed by the Government, and the increased risk

faced by the managers, little can be said regarding the profits they make.



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13. USE OF CHIT MONEY

Chit managers do not require the members to specify the purpose to which they

deploy the funds. Generally, chit loans or money are used by households for

consumption purposes like marriages, buying property (land, vehicle etc.) and

education.

It is primarily considered a means to saving free cash by the women of the

household in order to provide for any contingencies that may arise in the future.

Sometimes, the chit fund or loans may also be used to settle outstanding loans with the

money lenders. The chit member may use the ¶pot¶ to pay off the money lender loan

which is at a much higher rate and thus save money. Such members, who have several

loans from varied sources, may run the risk of defaulting in some cases, as they may

be caught in the ³vicious circle of debt´ or the ³debt trap´.

Literature shows that the primary uses of Chit Funds are the following:-

To address consumption needs such as marriage, education, property purchase and

so on.

To pay off costlier loans from outside sources like loan from money lenders.

To address working capital, business expansion or start-up capital needs of small

businesses.

For emergency needs or simply as savings for future needs.



24 | P a g e

14. CHIT FUND AND SMALL BUSINESS

Small traders and businessmen participate extensively in chit funds. Chit funds

provide an opportunity for them to save their excess cash on a daily or monthly basis

and, at the same time, to have access to easy finance in case of emergency or other

requirement.

Generally, the funds are used as either working capital, for expansion of

business or as emergency funds. Small enterprises have been historically wedged

between the money lenders, with their exorbitant cost of loans, and banks, with their

stringent procedures. Chit funds are a welcome measure for such enterprises to

overcome their financial constraints. This is evident from the enthusiastic participation

of small businessmen in the chit funds we came across. Small businesses usually havefree cash which they can profitably invest in chit funds to earn returns. Some chit

funds allow small traders to make daily contributions, instead of monthly, to

coordinate with their income cycle (small traders in the cash and carry business

generally have daily cash flows from their business).

As and when the need arises, they bid in the auction and receive the loan out of

their own funds. Once they receive the loan, they continue to pay the monthly

contributions, and this accounts for the payment towards both the interest and the

principal which makes the repayment easier and less arduous. Also, in chit funds,

small traders can decide their own interest rates depending on the need (chit fund

interest rates are in effect the market determined interest rates).



25 | P a g e

15. SCOPE FOR FUTURE RESEARCH AND PRELIMINARY

FINDINGSIn view of the importance of this source of finance and the obvious advantages

it presents to the small enterprises it is only prudent to study the industry in more

detail. There are many blindsides to the chit fund industry that need to be more

thoroughly explored. More importantly, it is necessary to bring the positive aspects of

chit funds to light, so that the stringent regulations that strangulate the industry may be

lightened.

Therefore, the research questions that need to be addressed are as

follows:

1. How are the chit fund loans being used?

2. Are chit funds used as a source of capital? If so, what? - a) Working Capital, b)

Emergency Capital, c) Rotation funds

3. What are the other sources of finance the chit members have and what is the cost of

such sources? (Benefits vis-à-vis outside options)

4. Why do chit members not wait till the end to take the loan when the interest rates

come down?

5. Do the uses of chit funds vary according to the nature of the business like age, size,

etc.?

6. What is the impact of participation in chit funds on the growth of the business of

chit members?

7. Are the low default-rates in the chit industry due to cautious member selection or

does the structure of the chit fund compel the members to borrow from other sources

to repay?

8. Why do chit members participate in more than one chit scheme?

9. Do chit funds provide the bulk of financing for its participants?



26 | P a g e

In order to answer the questions enumerated above, we propose to undertake a

two pronged approach to the research - (a) collect bidding data from various chit

companies, and calculate the loan and savings interest rates that are available to the

members and (b) conduct a comprehensive survey of the chit members (mainly small

traders) to understand why they use chit funds and how it affects their business.

From the bidding data collected so far, we see that the loan interest rate varies

between 1-2% per month on the reducing balance. This works out to around 12% per

annum which is much lower when compared to the interest rate charged by the money

lenders (that work out to as much as 72% per annum in most cases). Though quoted

loan interest rates by banks are similar, and sometimes much lower, to the chit fund

interest rates, in reality, the transaction costs for small business loans cause the

effective interest rates to be much higher.

The loan interest rates generally follow a near bell shaped curve which means

that the interest rates tend to increase mid-way of the scheme and decrease towards the

end. This is because there are generally no takers for the loan towards the end of the

scheme. The following example from a chit company in Chennai called Thiripura

Chits illustrates the above:



27 | P a g e

Table 1: Loan interest rates for different chit schemes run by

Thiripura Chits with the same duration but different

chit values

MonthCV

10000

CV

25000

CV

50000

CV

100000

CV

300000

1 2 3 4

5 6 7 8 9

10

11 12 13 14



28 | P a g e

Such a recurring pattern indicates that the members do not apriority calculate

the interest rates that they pay. This is an interesting aspect that can be explored

further. The hypothesis that ¶more experienced chit members pay a lower loan interest

rate because they calculate apriority the required rate of return and bid accordingly¶

needs to be tested.

The preliminary research has put forward various new ideas and has increased

the scope of the actual research.

And as on 31 March 2010, Assets under management o registered chit funds is

Rs.18, 000 cr. And are growing with an Annual Growth of 12-15%.

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29 | P a g e

16. CONCLUSION

Chit funds are a very good tool for financing the activities of small businesses.

In recent years, there have been some unscrupulous activities in the industry that have

instigated the Government to take serious measures. The occasional failure of chit

funds is generally attributed to expansion beyond capacity. A chit fund is not a

scalable model unless the chit manager or company has sufficient personal resources

as a backup for financial contingencies. However, in recent times, big companies like

Shriram Chits and Margadarshi Chits have given a new meaning to the concept of chit

funds with their national outreach and presence.

The regulatory hurdles that the chit companies face due to the stringent rules

proposed by the Government progressively, have been a setback to the growth of theindustry.

The effect of the increased costs of operations for the registered chit companies

has been to push these companies ¶underground¶. Many companies have, in the recent

past, either folded up or shifted their operations entirely to the informal arena

becoming an ¶unregistered¶ chit fund. The unorganized chit fund market is huge and

growing (6000 unregistered chit funds in Hyderabad out of the total 7300). This

causes serious problems not only for the industry and its participants, but also for the

Government, which loses its revenue.

Therefore, in order to promote this concept, which is generally beneficial to all

the parties concerned, it is imperative that more rigorous research be done on the

issues that they face. A strong lobby should also be developed in their favor. The day

when the Government and the industry participants alike understand the importance of

chit funds to the economy would mark the beginning of a new era.



30 | P a g e

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.



31 | P a g e

17. CASE STUDIES

Mr. Chandran

Unlike most of the other respondents, Mr. Chandran considers unregistered

Chit Funds as a formal way of doing business. He has been running schemes since

1989 and at present he owns six schemes of different value and duration. The smallest

scheme is only Rs. 10,000 ($200) with duration of 10 months while the largest scheme

has chit value of Rs. 200,000 ($4000) and duration of 30 months. From every scheme,

Mr. Chandran claims the second prize money as µcommission¶. In order to keep late

payments at a minimum level, members get fined Rs. 50 ($1) or Rs. 25 ($0.5) per day

according to the size of the scheme. For the larger schemes (>Rs. 50,000 or $1000),

Mr. Chandran also requires securities from his Members. According to him, only by

applying such rules, chit schemes can continue to work.

When asked why he does not want to get his Chit Fund registered, Mr.

Chandran says ³it makes no difference with registered Chit Funds; if needed I could

file a case at court, e.g. in case of default payments.´ Luckily, this has never

happened.

Mr. Bharat Bhayana

Bharat Bhayana, a second hand car dealer from Vikas pur, New Delhi, dreaded

going to banks for business loans. The thought of being interrogated by snappy bank

officers and the complex paper work that followed gave him cold feet. The whole drill

made little sense to him as many a time bank denied ³Full Amount´ Disbursals. And

when they did it was at the rates that could put Shy-lock to shame.

High Interest Rates coupled with cumbersome loan Procedures and rigid

payment schedules are prompting small time borrowers like Bharat Bhayana to join

chit fund. Much like other Small and Medium Enterprise (SME) owners and Traders,

40-old Bhayana required Rs.5-10 Lakh on regular basis to buy cars, repair or modify

them, before finding a new Buyer.



32 | P a g e

³Bank do not Give loans for Shorter Period«. Also rates are higher for

unsecured loans. I borrowed from chit fund at much Lower cost. Repayment is also

easy as it can be made in easy installments,´ said Bhayana, owner of Car point who

has invested in several ongoing chit schemes

Mr. Ratnaswamy

Mr. Ratnaswamy who is less positive about unregistered Chit Funds after

experiencing a loss of Rs. 150,000 ($3000) to a relative who was in charge of the

scheme. Ever since, Mr. Ratnaswamy is no longer interested in participating in any

Chit Fund. If he is in need of money he prefers getting a loan from the bank instead

Mr. Thirumurthy:

Mr. Thirumurthy is one of the few unregistered Chit Fund owners in rural

Erode who is not a farmer. He started operating chit schemes in 2002 to be able to

save money for his Marriage. Members were easily found among friends and

relatives; 80% of whom were business people as well. Four of his members also

started their own Chit Fund but Mr. Thirumurthy did not participate in any of these

although he did participate in his own schemes.

The first scheme had a chit value of Rs. 50,000 ($1000) and duration of 20

months; the second and third scheme had a chit value of Rs. 30,000 ($600) each and

duration of 12 months. After completion Mr. Thirumurthy re-started all the three

schemes and operates them till date. He charges 4% commission from his members as

a source of income from the scheme. Meanwhile Mr. Thirumurthy has saved enough

money to get married and now uses the Chit Fund money for business investments.



33 | P a g e

Mrs. Shivling

Mrs. Shivling, who owns 12 acres of Farmland in her hometown, has

participated in no less than 100 Chit schemes from 1980 till date. When in 1991

sudden and necessary investment had to be made in maintaining farmland, Mrs.

Shivling decided to start her own Unregistered Chit Fund. She selected ten friends andrelative who agreed to put in Rs.500 (10$) each. Auctions were held only once in a

year so that the total duration of the scheme lasted ten years. When the first scheme

came to an end in 2000, she restarted the scheme in 2001 of equal duration with the

only difference that there was not one but two scheme simultaneously and the

contribution had increased to Rs.1000 (20$) and Rs.2000 (40$) per member.

These two schemes lasted till 2010 and in 2011 she started her fourth and final

scheme with the chit value of 400,000 (8000$). Instead of yearly auction two auctions

were held per year so that the total duration of the scheme was not ten years but five

years. From these saving she purchased another 5 acres of land which she leased out

as farm land. An Interesting detail is that the total of 40 members who participated in

Mrs. Shivling¶s four Schemes also started their own scheme in all of which she has

participated.



34 | P a g e

17. BIBLIOGRAPHY

a) BOOKS:-

i. Eeckhout, Jan and Kaivan Munshi. 2005. "Mitigating

Regulatory Inefficiency: The Nonmarket Response to Financial Regulation in India".

ii. Confederation of Indian Industry. 2006. "Credit Delivery

to SMEs".

b) NEWS PAPER:-

i. Economic times, dated 5th

Oct 2011 Wednesday.

c) MAGAZINE:-

i. Srinivas, Alam and Rajeev Dubey. 1999. "The Nidhi

Nightmare", Business Today

G WEBSITES :-L ZZZ*RRJOHFRLQ

LL ZZZZLNLSHGLDFRP



35 | P a g e

18. APPENDIX

Questionnaire for the Chit Managers:-

1. How long have you been running a chit fund?

2. Did you start the chit fund? If yes please tell us about it was started,

at the start how did you get members for the chit fund, if you got it

registered ± How long does it take?

3. How Many different schemes are you running presently? For each

scheme answer Question 4 to 7 Separately:

4. Is this Scheme Registered or Unregistered?

5. Please describe the functioning of the scheme? (Amount, Duration,

Number of Member, etc)6. Please describe in detail a typical profile of member? (For E.g.

Occupation, Age, Income, Education, Purpose of joining a chit fund

etc.)

7. What is key Difference between a registered and un-registered Chit

fund?

8. In case of default by a member:

a. What Steps were taken by you?

b. Who pays the future Fees?

c. Do you allow new member mid way of the scheme? If yes

then how are they chosen?

9. What steps do you take to minimize defaults?

10. If you are able to determine that a member has defaulted for a

genuine reason (for example, sickness, death or some other

emergencies) do you take different actions than otherwise? If yes

please describe?

11. Are there any new members (first timers) in this scheme? If yes how

many new members are there? What procedures were followed to



36 | P a g e

induct new members? Are there any restrictions on the new members

- if yes please describe in detail?

12. In case of delayed payment by a member:

a. What steps are taken by you?

b.

Who pays for the delayed amounts?

13. What steps do you take to minimize delayed payments?

14. If delay is due to some genuine reason (for example, sickness, death

or some other emergencies) do you take different actions than

otherwise? If yes please describe?

15. Are the members who delay payments, the ones who generally

default?16. In your opinion what are the advantages vis-à-vis other financial

intermediaries (like banks, money lenders, pawn brokers, etc) to a

member in participating in this scheme? (Please compare the

advantages (or disadvantages) with respect to different financial

intermediation)

17. Do you allow multiple memberships in a scheme? Is there a

restriction on the number of memberships?

18. Are there any restrictions on the bid? If yes, please describe the

restrictions and why are the restrictions imposed?

19. If two or more members have equal bids then how is it resolved?

20. If none of the members have bid for the amount then what happens to

the funds?

21.

When members apply to the scheme, do you match them into

different schemes according to the type of member?

22. What is the duration of each auction? Please describe the auction in

detail.



37 | P a g e

23. What is the procedure in case a member is not able to be present in an

auction? Can the member send a proxy to take part in the auction or

can he mail his bid to the chit manager?

24. In your opinion who are the main competitors to the chit fund

industry?

25. What are the documents that you would ask for before admitting a

member to a scheme? Is it necessary for the member to have a bank

account? If so, why?

26. What are the verifications that you would undertake before admitting

a member?

27.

Do you require your chit fund members to use the chit fund moneyfor a specific purpose? If so, how do you ensure that the money is

being used for the specified purpose?

28. What, in your opinion, are the uses for which the members allocate

the chit fund money?

29. Is your chit fund used as a savings tool or as a loan product by the

members?

30. Do you also undertake any other business apart from chit funds? If

so, please specify and explain about the other operations.

31. Have you heard of any frauds in the chit fund business? If yes, have

these frauds affected the confidence of the customers? Explain.



38 | P a g e

19. GLOSSARY

1. $XFWLRQ Auction is a procedure for identification of the non-

prized subscriber who wants to take a chit amount at the highest

permissible discount. All non-prized subscribers who have paid their

installments up to date are allowed to participate in the auction for

bidding the highest auction discount, within a period of five minutes,

allowed for each auction.

2. Contribution: -The amount payable by each member of the chit

fund every month is called the contribution.

3. Discount: The difference between chit value and the amount at

which a successful bidder takes a chit in an auction is known as

auction discount.

4. Dividend: -Auction discount minus company commission (5% of

chit value) is the total group dividend. Total group dividend is

distributed equally amongst all the subscribers. This dividend so

distributed is deducted from the next installment payable by the

subscriber.

5. Kirana:Small shops selling food items like groceries, cereals and

so on.

Chit Fund Final Part- 2

Documents

Transcript of Chit Fund Final Part- 2