Chit Funds and their implications

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Context: The Rajya Sabha passed the Chit Funds (Amendment) Bill, 2019 after it was passed by Lok Sabha.

Relevance:
Prelims: Current events of national and international importance.
Mains: GS III-

  • Indian Economy and issues relating to planning, mobilization of resources, growth, development, and employment. Inclusive growth and issues arising from it.

What is a Chit Fund?

  • Chit funds are a popular type of savings institutions in India. It is one of the main parts of the unorganized money market industry.
  • It refers to an agreement arrived at by a group of individuals to invest a certain amount through periodic installments over a specified period of time.
  • The chit fund provides access to savings and borrowings for people with limited access to banking facilities.
  • Chit funds in India are managed, conducted, and regulated according to the Chit Funds Act of 1982.
  • They are governed through central legislation while state governments are responsible for their administration.
  • Chit funds are the Indian versions of Rotating Savings and Credit Associations found across the globe.

Rotating Savings and Credit Associations

  • A Rotating Credit and Savings Association or ROSCA is an alternative financial vehicle in which a group of individuals fills the role of an informal financial institution.
  • In a ROSCA, members pool their money into a common fund, generally structured around monthly contributions.
  • Single members withdraw money from it as a lump sum at the beginning of each cycle.


Types of Chit Funds

There are three types of chit funds:

Chit funds run by state governments

  • These funds are managed and regulated by state governments.
  • Funds run by PSUs (public sector undertakings) also belong to this class.
  • These are safe and chances of loss are limited. Business processes are transparent and clean.

Private registered chit funds

  • These chit funds are registered as per the Chit Funds Act of 1982.
  • These are normally floated by prominent financial institutes or business houses.
  • Participating in these funds is not as safe as in-state governments or public sector undertakings.
  • However, as they are under the management of leading private sector companies or institutes the risk is calculated and bearable.

Unregistered chit funds

  • Unregistered chit funds are not legal and participation in these is up to the risk of members.
  • Such types of chit funds are common throughout India and are usually formed by a close group of associates.
  • Participation in these funds should be avoided as disputes are subject to members’ integrity and honesty.

Why Chit Funds?

  • Low rate of interest on small savings provided by commercial banks is usually not coherent with the market rate, resulting in the middle-income group moving towards unregulated deposit schemes.
  • Obtaining a formal loan still remains a huge task for a common man as banks, financial institutions are plagued by stringent procedures.
  • Less regulated regime at fairly competitive interest rates prevailing in the market makes these schemes easily accessible.
  • Chit funds come handy to meet exigencies like death or ill-health as well as joyous occasions like marriages and child-birth in the family.
  • These types of schemes promote savings culture as each member is supposed to contribute a fixed amount every month towards the fund.

Need for Stricter Regulations

  • Fraudulent companies: There have been rising instances of people in various parts of the country being defrauded by illicit deposit taking schemes such as Saradha Chit Fund Scam, Rose Valley Scam etc.

The Saradha Group financial scandal was a major financial scam and alleged political scandal caused by the collapse of a Ponzi scheme run by Saradha Group, a consortium of over 200 private companies that were believed to be running collective investment schemes popularly but incorrectly referred to as chit funds in Eastern India.

The Rose Valley group had allegedly floated a total of 27 companies for running the alleged chit fund operations of which only half a dozen were active. It is alleged that the company had made “cross investments” in its various sister firms to suppress its liabilities towards investors.

 

 

  • Financial Illiteracy: Lack of financial literacy results in people getting duped as they are promised huge returns on their investment which has no substantial basis to fulfill.
  • Despite the presence of staunch rules against scams by chit funds, a lot of these funds run Ponzi schemes and make away with a lot of people's money.
  • Ponzi Schemes: Ponzi schemes are investment operations that pay returns to old investors from the money garnered from new investors.
  • Non-Transparency: Chit funds, especially those catering to a large number of members, are opaque both in their operations and eliciting of bids.
  • Administrative Loopholes: Companies running such schemes exploit existing regulatory gaps and lack of strict administrative measures to dupe poor and gullible people of their hard-earned savings.
  • Lack of Accountability: There is no deposit insurance for investors. If a registered chit fund company files for bankruptcy neither the government nor the Reserve Bank of India can help the investors.

What are the names for a chit fund?

  • The Act specifies various names which may be used to refer to a chit fund. These include chit, chit fund, and Kuri.
  • The Bill additionally inserts ‘fraternity fund’ and ‘rotating savings and credit institution’ to this list.

What the terms that are substituted?

  • The Act defines certain terms in relation to chit funds. It defines:
  • ‘Chit amount’ as the sum of subscriptions payable by all the subscribers of a chit;
  • ‘Dividend’ as the share of the subscriber in the amount kept apart for running the chit; and
  • ‘Prize amount’ as the difference between chit amount and the amount kept apart for running the chit. 
  • The Bill changes the names of these terms to ‘Gross chit amount’, ‘Share of discount’ and ‘Net chit amount’, respectively.

How can the subscribers join the chit now?

  • The Act specifies that a chit will be drawn in the presence of at least two subscribers.
  • The Bill seeks to allow these subscribers to join via video-conferencing.

How much is the Foreman’s commission increased?

  • The Act specifies that the ‘foreman’ is responsible for managing the chit fund. He is entitled to a maximum commission of 5% of the chit amount. 
  • The Bill seeks to increase the commission to 7%.  Further, the Bill allows the foreman a right to lien against the credit balance from subscribers.

What is the aggregate amount of chits?

  • Under the Act, chits may be conducted by firms, associations or individuals.
  • The Act specifies the maximum amount of chit funds which may be collected.  These limits are:
    • Rs. 1 lakh for chits conducted by individuals, and for every individual in a firm or association with less than four partners, and
    • Rs. 6 lakh rupees for firms with four or more partners. 
    • The Bill increases these limits to Rs. 3 lakh and Rs. 18 lakh respectively.

What is the applicability of the act?

  • Currently, the Act does not apply to:
  • Any chit started before it was enacted, and
  • Any chit (or multiple chits being managed by the same foreman) where the amount is less than Rs 100.
  • The Bill removes the limit of Rs 100 and allows the state governments to specify the base amount over which the provisions of the Act will apply.



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