What are Chit Funds

Introduction

"Chit" is a Hindi word which basically means "Receipt" in the form of a small piece of paper. The formal English meaning closest to this is "a short letter or a note". A Chit fund is a kind of savings scheme practiced in India. For someone seeking a loan, it is a source of costly, but convenient, credit. For the small saver, it is an option that enforces monthly investment discipline. And for the un banked rural investor, it is a crucial step towards financial inclusion.

The Chit Fund Model
A chit fund is a traditional savings and borrowing mechanism. Members pool in a specified amount every month and one of them gets the entire sum that has been pooled. This process is repeated every month till all members get the booty. The winning member is chosen through an auction where the bidder accepts less than the pooled money. Organizer of the chit fund also gets a fixed amount.

Example
Bidders accept amounts less than the pooled money in order to get the kitty in a particular month. The lowest bidder for that month gets the pooled sum and the amount he forgoes is distributed among all the members. For instance, if 20 members pool in Rs 1,000 every month, they will have a kitty of Rs 20,000. If the lowest bid in the first month is Rs 16,200, the surplus of Rs 3,800 will be divided equally among the members. This will bring down the first month's net contribution of each member to Rs 810


Merits of Chit Funds
The chit fund participants see this as a win-win situation.
The bidder gets the money he desperately needs, and the other members get to pay a lower sum than the original amount agreed upon.
For the bidder, it means a quick loan that he will repay through monthly contributions till the end of the chit. For the other members, it means better returns on their investment in the chit.
The organizer (also known as foreman) of the chit fund also benefits. He gets to keep up to 5% of the gross amount every month as his commission. So, the foreman in our above example will pocket Rs 1,000 every month. This money will come out of the kitty amount, so the take-home lump sum for the bidder for that month will be lower than the amount that the winner of the auction had bid for.

Legal Acceptance
Chit funds are governed by the Chit Funds Act 1982. Though chit funds are governed by the central legislation, the administration of the Act is left to the state government. Section 89 of the Act also gives power to the state government to make rules to give effect to the provisions of the Act in consultation with the RBI.

Summary
The uncovering of the Saradha scam unleashed a media blitzkrieg against chit funds. However, the tainted company, Saradha Realty India, was not really a chit fund.
There is a lack of awareness about chit funds among the media and general public. Anything that fails is branded a chit fund, while the fact is that there are many well managed and long running chit funds which benefit small rural investors and play a crucial role in financial inclusion of the society. 

Cheers 

Manoj Arora

http://www.ratrace2freedom.com