India has a long history of various savings schemes. Among all the schemes, Chit Funds are one of the most popular and widespread savings schemes. The concept of chit funds originated in 1800. Then, the Cochin ruler of Kerala state, Raja Ravi Varma, gave a loan to a Syrian Christian merchant, keeping a certain portion of the loan for himself, and later claimed this money as a principle of justice. According to Section 2(b) of the Investment Funds Act, 1982, an Investment Fund Company is a company that manages, supervises, and controls funds. It is a scheme that allows the user to borrow and also save some money. This article briefly describes the Swoop on Chit Fund Companies, & Regulations imposed by RBI on Chit Fund Business.
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What is the meaning of Chit Fund?
Chit basically means transaction. It has various other names like “chit fund,” “chitty, “kuree etc. The mechanism of chit funds is that a person makes an agreement with a certain number of people so that they all subscribe for a certain amount of money or kind of profit. When it’s a person’s turn, whether they claim it themselves, through a lottery mechanism, or through some kind of auction, they draw the amount of money they need. Through regular installments over a period of time, he has to repay the money earned.
How Chit Fund Works?
We will see an example in the case of chit funds. Let’s say 10 people get together and start a chit fund. Each of them pays Rs 1000 every month for 10 months (number of months = number of people in the fund). In this group, there will be one organizer who will take care of all the meetings, auctions, etc. He will collect some fees from the organizer.
Now, in the first month, all 10 people come together and deposit Rs. 1000 each. A total of Rs. 10,000 is now available. Let’s say three people bid for this money. Person A offers Rs. 9000, Person B bids for Rs. 7000, and Person C bids for Rs. 8000. The person who bids the lowest price gets the amount, so person B gets an amount of Rs. 7,000. He will also be charged a 5% organizer fee, which is around Rs. 500. In total, he gets back Rs. 6,500. The remaining $3,000, which is the profit, is divided equally among all 10 people. Each person gets Rs. 300 back. Each month, a different person bids, and the process continues for up to 10 months.
Types of Chit Funds
The following are the types of Chit Funds:
- Registered Chit Funds: Registered chit funds are those registered with the Registrar of Firms, Societies, and Chits.
- Unregistered Chit Funds: Unregistered mutual funds are savings schemes that are run between friends, family, or colleagues.
- Online Digital Chit Funds: With digitization, chit funds have evolved and are organized online. These types of chit funds have online auctions. Subscribers can deposit their monthly contributions online and also earn rewards through online transactions.
- Organized chit funds: More common in northern India, this type of umbrella fund requires all members to meet on a monthly or weekly basis. The names of all members are written on small pieces of paper and collected in a box. The group leader collects the slip in front of all the group members.
- Special Purpose Chit Funds: Special purpose funds are organized to save for a specific purpose.
Features of Chit Fund
Chit funds have the following features:
- They have a predetermined value and duration.
- They function as microfinance institutions.
- They combine both, loans and savings in one system.
- They will take care of the financial needs of low-income households.
- They allow contributors’ deposits to be converted into a lump sum.
This happens through three mechanisms.
- Safe Deposits: A person can deposit money in the present and avail the lump sum in the future.
- Loans: A person can take a loan in the area code and continue repayment in the future.
- Insurance: Allows the depositor to use a lump sum in case of emergency.
- They offer a loan at a lower interest rate than loan sharks.
Red flags to be aware of Chit Funds
The following are the Red Flags to Chit Funds:
- The promise of High Returns: The returns from the chip fund scheme can only be achieved after the end of the chip cycle and cannot be estimated in advance.
- Mobilization of Deposits: Chit funds are not allowed to collect deposits, so any such scheme should be avoided even if the return offered is reasonable.
- Not registered in your State: Chit funds can only operate in the state where they are registered.
- Recruiting Incentive: Promising additional revenue based on recruiting new members is a feature of the money chain and should be avoided.
- Bending the Rules: Some chit funds offer to exempt valued members from future installments. This is illegal.
- Online Chits: Some investment funds offer the ability to invest and transact online. However, it is difficult to verify the details of these companies.
Advantages and Disadvantages of Chit Funds
The following are the Advantages and Disadvantages of Chit Funds in India:
Advantages
The following are the Advantages:
- Chit funds are easy to join.
- They promise high returns.
- The interest rate on chit fund loans is low.
- People from households with lower incomes can also participate.
- It helps micro enterprises develop.
Disadvantages
The following are the Disadvantages:
- High transaction costs.
- Chit funds are known to be prone to fraud.
- Associated with a number of risks They are:
- The biggest risk regarding the stipend fund is the misuse of the pooled funds by the master.
- Sometimes members stop paying dues and have already accepted the first offer.
- In some chit funds, the discount rate is rigged, and the desperate member ends up paying a higher discount.
Swoop on Chit Fund Companies
In recent years, many chit fund companies in India have come under the scanner for fraudulent activities. In 2013, a massive scam involving the Saradha Group, a chit fund company based in West Bengal, was uncovered. The company had collected over Rs 2,500 crore from investors across several states in India and had failed to repay the investors. The scam had led to widespread protests and had caused a huge uproar in the country.
Following the Saradha scam, the Indian government had set up a special investigation team (SIT) to investigate similar cases of chit fund fraud. The SIT had identified several chit fund companies that were involved in fraudulent activities and had recommended action against them.
In March 2021, the Indian government had ordered a swoop on chit fund companies across the country. The swoop was conducted by the Central Bureau of Investigation (CBI) and the Enforcement Directorate (ED), two premier investigation agencies in India. The agencies had conducted raids on the offices and residences of several chit fund companies and their promoters across several states in India.
The agencies had seized several documents, including bank statements, property papers, and other incriminating evidence during the raids. The swoop had resulted in the arrest of several promoters of chit fund companies, including the owner of the popular Kolkata-based Rose Valley Group, Gautam Kundu.
Regulations imposed by RBI on Chit Fund Business
To prevent such fraudulent activities, the Reserve Bank of India (RBI), the country’s central banking institution, has imposed a series of regulations on the chit fund business in India. These regulations aim to protect investors and ensure that chit funds operate transparently and fairly.
- Registration and Licensing: The RBI has made it mandatory for all chit fund companies to register and obtain a license from the Registrar of Chits. The license is granted only after a thorough scrutiny of the company’s background, management, and financial status. This ensures that only legitimate companies are allowed to operate chit funds.
- Capital Requirements: To operate a chit fund, companies must maintain a minimum capital requirement as specified by the RBI. This ensures that the company has sufficient funds to operate the chit fund and pay out the pooled amount to members.
- Restrictions on Collection of Subscriptions: Chit fund companies are only allowed to collect subscriptions from members in the form of cheques, demand drafts, or online transfers. Cash payments are not allowed to prevent money laundering and other illegal activities.
- Transparency in Operations: Chit fund companies are required to disclose all the terms and conditions of the chit fund to members before they join. The company must also disclose the date, time, and place of each chit fund auction to all members. This ensures transparency in the operations of the chit fund and prevents any fraudulent activities.
- Maintenance of Accounts: Chit fund companies must maintain proper accounts and records of all transactions related to the chit fund. The accounts must be audited by a chartered accountant and submitted to the Registrar of Chits on a regular basis. This ensures that the company operates in a transparent and accountable manner.
- Restrictions on Borrowing and Lending: Chit fund companies are not allowed to borrow or lend money to any person or entity other than the members of the chit fund. This prevents chit fund companies from engaging in illegal activities and ensures that they operate within their designated scope of business.
Some other RBI Regulations are:
- Chit fund trading can only be done by a registered company. The operation of the Chit business by family and partnership firms is restricted.
- The maximum discount that could be obtained in the offer was limited to 30% of the total amount of chips. However, in 2001, the same was increased to 40% (in the case of a Rs. 1 lakh chit, the bid amount cannot be more than Rs. 40,000).
- Details of each and every note must be provided to the Reserve Bank of India along with the personal details of the subscribers.
- It is mandatory to keep the monthly chip amount of all subscribers and members with the Reserve Bank of India till the end of the particular chip.
Conclusion
The swoop on chit fund companies in India is a welcome move by the Indian government to protect the interests of investors and curb fraudulent activities. The lack of proper regulation and transparency in the functioning of chit fund companies has made them a hotbed for fraudulent activities. The recent raids and arrests of chit fund company promoters send a strong message to the perpetrators of such frauds that the law will catch up with them sooner or later. The Indian government must continue its efforts to regulate and monitor chit fund companies to prevent such scams in the future.
