4 questions on Chit Funds answered

By Morningstar |  16-03-21 | 

Rotating savings and credit associations, or ROSCAs, are informal financial “institutions” that are locally organized.

Members contribute funds that are given in turn to one or more of the members. In joining one, an individual agrees to a schedule of periodic payments in return for which she receives a lump-sum payment at a future date. The risk is that participants may have little or no control over when they receive the funds, and also bear the risk that other participants may not fulfill their obligations. You can read more on the economics of it.

While that is in the U.S., countries have their own improvised version of it. In India, it is the chit fund.

Chit fund schemes may be organized by financial institutions or informally among friends, relatives, or a group of people. It’s popular where individuals have limited access to banking facilities.

Simply put, a specific number of investors invest their money with a promise that their investment will be multiplied within a span of time with a guaranteed return. These subscribers make payments over a defined period of time.

Aatish Khanna of Money Club,  a digital chit fund platform, says that a chit fund is India’s oldest forms of banking. Here he explains the basics.

  1. How do Digital Chit Funds work?

In an online chit fund, a group of people contribute a certain amount for a period of time equivalent to the number of members in the group. A member of the group gets the chit fund amount through an auction.

The fund value is given to the person who bids the lowest – claims the lowest chit fund amount. The amount the bid winner forgoes is then equally distributed among the other members after deducting the organiser’s commission or fee. The amount that each member receives is called the dividend. The winning member has to continue contributing even after he has claimed the chit fund amount.

Let’s say a chit fund scheme has 20 members, each investing an amount of ₹1,000 every month. For the first month, the pot is ₹20,000.

During the auction, a member who bids to take the lowest amount of the pot value home is declared the winner. Let’s assume the winning bidder agreed to take home ₹15,000. The remaining ₹5,000 of the pot is then divided equally among the rest 19 members after subtracting the organiser’s fee.

  1. How does a Digital Chit Fund differ from a traditional or offline one?

Technology and legislative changes have given this age-old form of finance a cleaner, streamlined look. Due to its ease of operation, high liquidity, low risk, decent returns and minimal paperwork, online chit fund schemes are gaining in popularity.

Registered online chit funds have a high level of transparency, are technology driven, fast and efficient. Thus, lowering the probability of a fraud. It is also more convenient as consumers can join, auction, and transfer money online and don’t have to meet physically to auction and distribute the proceeds.

  1. Must you invest in one?

Chit funds are often associated with scams due to its unregulated mode of functioning. However, it does have a purpose as a saving and borrowing mechanism specifically for people who are excluded from India’s formal banking system.

There are registered and unregistered chit funds. Under the Chit Funds Act, chit fund businesses are registered by the Registrar of Chits, appointed by respective state governments under Section 61 of Chit Funds Act.

Make sure that you choose registered online chit fund schemes because they are:

  • More secure
  • Easy to transact
  • Easy to get quick cash in case of emergencies
  • Offer a higher dividend as compared to the traditional or offline chit fund model
  1. Who regulates it?

Chit funds in India are not regulated by the Reserve Bank of India (RBI), nor the Securities and Exchange Board of India (SEBI).

The term ‘deposit’ as defined by the Reserve Bank of India Act, 1934 does not comprise the subscription to chits. The SEBI Act, 1992 specifically precludes chit funds from their definition of collective investment schemes.

The Prevention of Money Laundering (Amendment) Act, 2012 has recognized Chit Funds in Section 2(l).

According to the Chit Funds Act, 1982, the chit funds are registered and regulated only by the respective state governments. The latter appoint the Registrar of Chits, under Section 61 of the Chit Funds Act.

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