Chapter - Ii: Chit Funds - A Conceptual Overview
Chapter - Ii: Chit Funds - A Conceptual Overview
2.1 INTRODUCTION
undergone qualitative changes over the years through functional specialization. The role
of NBFCs as effective financial intermediaries has been well recognized as they have
inherent ability to take quicker decisions, assume greater risks, and customize their
services and charges more according to the needs of the clients. While these features, as
compared to the banks, have contributed to the proliferation of NBFCs, their flexible
structures allow them to unbundle services provided by banks and market the
components on a competitive basis1. The distinction between banks and non-banks has
been gradually getting blurred since both the segments of the financial system engage
themselves in many similar types of activities. At present, NBFCs in India have become
devising tailor-made products, NBFCs have also been able to build up a clientele base
among the depositors, mop up public savings and command large resources as reflected
in the growth of their deposits from public, shareholders, directors and other companies,
non-bank deposits in household sector savings in financial assets, increased from 3.1 per
cent in 1980-81 to 10.6 per cent in 1995-96. In 1998, the definition of public deposits
was for the first time contemplated as distinct from regulated deposits and as such, the
small borrowers at the local level in response to local requirements is well recognised.
The rising importance of this segment calls for increased regulatory attention and
protection.
In response to the perceived need for better regulation of the NBFC sector, the
Reserve Bank of India (RBI) Act, 1934 was amended in 1997, providing for a
comprehensive regulatory framework for NBFCs. The RBI (Amendment) Act, 1997
conferred powers on the RBI to issue directions to companies and its auditors, prohibit
deposit acceptance and alienation of assets by companies and initiate action for winding
up of companies. The Amendment Act provides for compulsory registration with the
RBI of all NBFCs, irrespective of their holding of public deposits, for commencing and
maintenance of a portion of deposits in liquid assets; and creation of reserve fund and
transfer of 20 per cent of profit after tax but before dividend annually to the fund3.
Accordingly, to monitor the financial health and prudential functioning of NBFCs, the
like capital adequacy, income recognition, asset classification, provisioning for bad and
doubtful assets, exposure norms and other measures. Directions were also issued to the
statutory auditors to report non-compliance with the RBI Act and regulations to the RBI,
2.2.1 Definition:
Company means
ii. A Non-Banking Institution which is a company and which has its principal
iii. Such other Non-Banking Institution or class of such institutions as the bank may
From the above definition, it is inferred that the principal business of Non-
Receiving Deposits
Companies. The primary difference is that the banks as well as the financial companies
are “PRODUCT DRIVERS” ie it is used to acquire a product such as car, house etc.,
whereas the NBFC‘s like chit fund companies are “PROCESS DRIVERS” ie it can be
used for an activity that a prudent subscriber considers relevant. Finally NBFCs cannot
S. Non-Banking Financial
Principal Business
No Entity
S. Non-Banking Financial
Principal Business
No Entity
Financial Intermediaries):
1. Chit Funds: These are indigenous rotating savings and credit organizations.
While chit funds are prevalent among households and small businesses all over
India, chit funds are also organized by Chit Fund Firms, especially in South
commercial banks, except for non-issuance of cheques and no provision for fund
transfer services.
3. Hire Purchase Firms: Such firms are generally active in vehicle and durable
4. Nidhis: These are single branch institutions similar to credit unions. They are
goods with trade credit. The volume of finance is large relative to the total size of
credit markets.
businesses, usually trade. They are grouped into various types (Multanis,
along community lines and operate in different parts of India. Among the major
main and sometimes only role is informational. They link up potential borrowers
10. Pawn Brokers: Found mainly in the South, they accept deposits and provide
pawn finance.
11. Money Lenders: While not as wide spread as in the rural areas, they rely on their
association with the formal credit markets. Along traditional lines, they are loan
brokers who undertake to obtain bank loans in their own names for a fee.
Chit funds, also known as Rosca (rotating savings and credit associations), are
India's oldest indigenous financial institution, catering to the credit gap in the country's
system. Internationally, such financial institutions have played a strong role in the
development of countries like Japan and South Korea. The chit fund industry in India is
estimated at Rs 20,000 crores (Ernst & Young), and accounts for 6% of country's savings
(Outlook Money, 2003). Despite the prevalence of banks, chit funds hold great
informal sector (Spectrum, 2005). At the same time, the public perception of chit fund
industry has been damaged by unscrupulous companies that have cheated on their
subscribers, usually salaried individuals and small traders. This has led the government
to regulate the industry with a heavy hand of bureaucracy. The Delhi Government runs
the chit fund department, administered by the Department of Finance, to control the
activities of chit fund companies in the state under the Madras Chit Funds Act, 1961 and
Delhi Chit Fund Rules, 1964. However, chit funds that started before 1961 are exempt
from the provisions of the Act. At the moment, there are 374 authorised chit fund
companies in Delhi, and those debarred are listed on the department's website.
incorporation from the Registrar of companies. Then, it has to apply for the registration
of its bylaws with the Registrar of the chit fund department. If bylaws do not contradict
the Act, or rules framed under it, the Registrar issues a certificate of registration. The
process does not end here. To actually launch the chit fund, the company needs to obtain
at least half the chit amount, and transferring the mortgage/deposited cash/securities in
the Registrar's favour. The chit fund department stipulates that the foreman (person
exceeding 5% of chit amount, and that minutes of all chit proceedings and agreements
should be filed with the Registrar. In case of complaints or grievances, involved parties
can either reach a mutual agreement through the chit fund panchayat or directly address
periodic intervals. Usually, the number of individuals and the number of periods will be
the same. At the end of each period, there will be an auction of the money. Members of
the chit fund will participate in this auction for the pooled money during that interval.
The money will be given to the highest bidder. The bid amount will be divided by
number of members, and thus determining per head contribution during that period.
Usually, the discount will continue to decrease over periods. The person getting money
in the last period will receive the full scheme amount. Such chit fund schemes are
relatives8.
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 Enterprises
(KSFE), 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 Ponzi scheme and absconding with their money. A Ponzi scheme is
a fraudulent investment operation that pays returns to its investors from their own money
or the money paid by subsequent investors, rather than from profit earned by the
individual or organization running the operation. The Ponzi scheme usually entices new
investors by offering higher returns than other investments, in the form of short-term
returns that are either abnormally high or unusually consistent. Perpetuation of the high
returns requires an ever-increasing flow of money from new investors to keep the
scheme going.
The chit fund schemes have a long history in the southern states of India. Rural
unorganized chit funds may still be spotted in many southern villages. However,
organized chit fund companies are now prevalent all over India. The word 'chit' is
derived from Hindi and refers to a small note or piece of something. The word passed
into the British colonial lexicon and is still used to refer to a small piece of paper, a child
or small girl9.
even pre-existent of our banking system, which has the ability to provide excellent
returns for savers and lower borrowing cost to the borrowers, at the same time. From the
Income Tax perspective; Chit, Chitty or kuri is a transaction for mutual benefit and it
shall carry the status of "association of persons". Chit funds are regulated under the
Central Chit Fund Act 1982, hence could be assumed to have sufficient protection to the
subscribers of the chit. There is a Chit Agreement executed between the foreman (Chit
operator/manager) of the chit and each subscriber. There are also provisions of
inspection of Chit fund books, records and documents and audit of chit fund accounts,
called as Panchajanya) has to file regular returns with the Joint Registrar of Chits
(J.R.C), which is a statutory authority notified by the concerned state government and
also with RBI on a regular basis. The Licensee also has to deposit Fixed Deposit Receipt
(FDR), usually in a Nationalized bank, favouring the JRC before he can commence any
group. This will be treated as a security and can be withdrawn by the licensee only at the
end of the group after he has satisfied the JRC that each member of the group has been
fully paid. A solvency certificate may be asked in some cases. The group can be started
and ―commencement certificate‖ procured from the JRC for each group separately, after
The JRC ensures that the security lodged by the licensed operator as a FDR is
used in case the licensed operator defaults on payment to the rightful subscriber. In case
directive, all the FDR's and immovable & movable properties belongs to the Chit fund
company are taken over by the JRC and distributed to the subscribers as enunciated in
the Chit Fund Act. Foreman is a person who is responsible for the conduct and
functioning of the Chit. Besides being an organizer of a Chit, he also happens to be one
of the subscribers of the particular chit group. He is entitled to obtain one chit amount
(generally first) without deduction. It is a good practice, if he ploughs back the entire chit
amount, to meet his future obligations, promptly. Subscribers are entitled to take part in
their sloppy accounting practices and poor record keeping. It is also a welcome measure
for those who generally borrow at exorbitantly higher rates around 3% p.m. Hence as a
matter of fact, Chit fund could be used as a financial tool in the hands of small or
medium enterprises/ companies and they can efficiently manage their working capital
needs with the help of Chits. It can nurture a business concern having seasonal nature, as
well. Small professionals or salaried employees could also use this investment option to
Functioning of Chit funds are better explained using an example. Take a typical
chit fund with 25 members contributing Rs.100 per week. This fund will run for 25
weeks. On the first week all members will contribute Rs.100. An auction meeting will be
conducted, and the foreman of the chit fund will preside over it. The total amount will be
Rs.2500. The auction will start with this amount. Bidders will start bidding by
discounting this amount (reverse bidding). Let us consider that the lowest bid is Rs.2150
(a discount of Rs.350). This amount (Rs.2150) is given to the winning bidder. Rest of the
amount (Rs. 350) is divided by 25, bringing the discount per person to Rs.14. This
discount amount is returned back to each member. Sometimes a part of this may be kept
Chit funds in India are governed by various state or central laws, like Travancore
Chit Act of 1945, Chit Funds Act, 1982 and Madras Chit Fund Act, 1961. Organized chit
fund schemes are required to register with the Registrar of Firms, Societies and Chits. 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 the concern incharge 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 (a fund made up of a portion of each pot in a poker game,
the pool of money, especially one to which a number of people have contributed for a
designated purpose) share but his name won‘t be there in the slips of box as he has
Some chit funds may be conducted as a savings scheme for a specific purpose.
An example is the Deepavali sweets fund, which has a specific end date - about a week
before Deepavali. The Hindus in India celebrate many festivals. The Diwali or Dipabali
is one such festival celebrated on the new moon day after the Dasahara. This is a festival
of lights. The Hindus decorate their houses with lights. The rich and the poor, both
celebrate it. The festival has a legendary background. The Diwali has a great significance
for the Hindus. The businessmen consider it as the beginning date of their business.
Their business is renewed from this day. This day marks the end of autumn and the
beginning of winter. Neighborhood ladies will get together to pool their savings 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
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 ‗pot‘. Chit
manager auctions out ―Pot‘ every month at a particular date. The highest bidder (also
known as the prized subscriber) wins the ‗pot‘ for that month. The bid amount is also
called the ‗discount‘ 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
members gather at the Chit Manager‘s office and put their bids. Actual auction lasts only
for five minutes. It is a convention that a bell is rung after closure of five minutes
indicating auction is closed. Highest bid at the bell shall be declared as ―Winning Bid‖. If
there is an equal bid then lottery method is applied to decide about the ―Wining Bid‖.
communicated to that extent. After the continuous period of 3 months default, he may be
removed from the Subscribers List. Notice of such removal and substitution, if any, of
the new subscriber, shall be intimated to the Registrar. There may be partial recovery,
depending upon the solvency of the defaulting member. Registrar may attach his salary,
personal property or collateral, if given, towards the recovery of unpaid dues. If such a
member is absconding, his guarantors or sureties may be asked to make the payment.
In all auctions commencing from the second instalment, subscribers can bid up to
a maximum of 30 per cent. If more than one subscriber offers an identical discount, the
prized subscriber (the subscriber who wins the prize) will be determined by lot. The
duration of the auction will be five minutes. Five per cent of the chit value will be
deducted from the bid amount towards the foreman‘s commission and the balance
distributed as dividend. Dividend rates are generally in the region of 10-15 per cent.
Chits can be seen in almost every society around the world, and have been in
existence for a considerable period of time. They are flexible and adapt themselves easily
The Chit Fund operation is illustrated in Table No. 2.2, explaining the concept
Chit Fund Calculations for Chit of Rs. 1,00,000 with EMI of Rs. 2,000/-
Monthly
Cumulative
Inst. Monthly Cumulative Returns
Dividend Dividend
No Investment Investment (%)
1 2000 2000 0 0 0
2 2000 4000 0 0 0
Monthly
Cumulative
Inst. Monthly Cumulative Returns
Dividend Dividend
No Investment Investment (%)
Monthly
Cumulative
Inst. Monthly Cumulative Returns
Dividend Dividend
No Investment Investment (%)
also the rate of borrowing is on the lower side as compared to other credit options. The
deposit, assignment of LIC policy as per the provisions of the Act, 1st Auction goes to
1) If the borrower subscriber could get success in 2nd auction, situation will be as
follows:
Period : 48 Months
2) If the borrower subscriber could get success in 10th auction, situation will be
as follows :
Period : 40 Months
share of dividend shall be taxed according to the (accrual or receipt basis) accounting
system he follows. Discount foregone can be claimed as a deduction from the income on
investments.
2) For businessman: The discount foregone at the time of prizing the chit is an
received.
3. Web-sites of chit funds, to get to know more about the company and
8. Admission fees
i. The basic advantage of the chit is that it offers an opportunity for members to
save, and at the same time keep such savings fairly liquid and maximizing return.
ii. It facilitates the availability of a lump sum of money, which allows for higher
iii. Most chit funds are organized along democratic lines, where operating
procedures and other details are decided/ agreed upon by its members.
iv. Profits (in the form of bid amounts, for example) and other returns on
v. Risk of default is shared by all members and therefore sets up peer pressure to
ii. Timing of the receipt of funds by a member may not necessarily coincide with his
iii. The cyclical timing also applies to savings, where a member cannot save when he
has surplus funds, but has to wait for the chit meetings.
2.3.5 Rotating Savings and Credit Associations (ROSCAs):
Rotating Savings and Credit Associations can be found all over the world and go
by different names in different regions and countries16. The following is a sample of such
names:
Africa
Gabon: Bandoi
Ivory Coast: Tonton, Tontine, Moni, Diaou Moni, War Moni, Djigi Moni,
Madagascar: Fokontany
Mali: Pari
Nigeria: Esusu, Osusu, Enusu, Ajo (Yoruba), Cha (Ibo), Oha, Oja, Adashi
(Haussa, Tiv), Bam (Tiv), Isusu (Ot), Utu (Ibo), Dashi (Nupe), Efe (Ibibios),
Umangelo
Swaziland: Stokfel
Tchad: Pare
Asia
Bangladesh: Samity
Cambodia: Tontine
China: Lun-hui, Yao-hui, Piao-hui, Hui, Ho-hui, Foei-Tsjing
India: Kameti, Kuri, Chitty, Chit funds, Vishi, Bishi, Nidhi, Committee
Sri Lanka: Chit Funds, Cheetu/Sheetu, Sittu Danawa, Situ Mudal, Sittu
Wendesiya
Taiwan: Hui
Vietnam: Hui, Hui Thao, Hui hue hong, Hui bac (ho), Yi hui
Yemen: Hacba
Bahamas: Esu
Barbados: Meetings
Panama: Pandero
Peru: Pandero
Surinam: Kasmonie
Tobago: Susu
-------------------------------------
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(1), 143-172.
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