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1. INTRODUCTION
Chit funds have been a popular savings scheme in several parts of India for
generations together now. It has paved its way as a convenient finance option amongst
businessmen, small scale industrialists, and other small time investors. Though very
often shrouded by news of fraudulence, they have still managed to retain their
popularity. So what exactly are chit funds and how efficient a financial tool is it? Read
on to find out more.
A Chit fund is a kind of savings scheme practiced in India. A Chit fund
company means a company managing, conducting or supervising, as foremen, agent
or in any other capacity, chits as defined in Section 2 of the Chit Funds Act, 1982.
According to Section 2(b) of the Chit Fund Act, 1982, "Chit means a transaction
whether called chit, chit fund, chitty, kuri or by any other name by or under which a
person enters into an agreement with a specified number of persons that every one of
them shall subscribe a certain sum of money (or a certain quantity of grain instead)
by way of periodical installments over a definite period and that each such subscriber
shall, in his turn, as determined by lot or by auction or by tender or in such other
manner as may be specified in the chit agreement, be entitled to the prize amount.
Such chit fund schemes may be conducted by organized financial institutions
or may be unorganized schemes conducted between friends or relatives. 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 Enterprise, 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.

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With the advent of the Chit Funds Act, initially in the year 1961 (Madras Act)
and amended subsequently in the year 1982 (Central Act), chit funds have been highly
regulated and governed by stringent rules. The purpose of the said Act and its
proposed benefit to the chit funds industry is, however, questionable.

Chit funds are also, more importantly, a means of easy and profitable access to
finance for the Small and Medium Enterprises (SMEs). The limited access to funds of
SMEs from banks and the formal financial domain had begun to strangle the growth
prospects of these enterprises. Thus, the advent of chit funds is really a boon to these
businesses. To understand more about the workings of chit funds and the difficulties
that they face in their business, we interviewed a number of chit fund managers in
Mumbai, Chennai (India). These in-depth interviews gave us an idea about the
possible research questions that may be addressed in this area. The questionnaire used
for the purpose is annexed at the end of the document. The following sections relate
the findings from these interviews.

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2. EVOLUTION OF CHIT FUND
Chit funds evolved years ago, when the present system of banking did not
exist. Few families in a village would get together to form a chit or a group, to save
money and to avail of loans amongst the group formed. A sensible person is chosen to
manage the group. This informal system of saving prevailed only on trust. Gradually,
as groups became larger and the money involved became huge, many companies
started chit fund schemes with attractive offers. To thus provide for the regulation of
chit funds and for matters connected therewith, the government introduced the Chit
Funds Act in 1982.
The concept of chit funds originated more than 1000 years ago. Initially it was
in the form of an informal association of traders and households within communities,
wherein the members contributed some money in return for an accumulated sum at the
end of the tenure. Participation in chit funds were mainly for the purpose of
purchasing some property or, in other words, for consumption purposes. However,
in recent times, there has been tremendous alteration in the constitution and
functioning of chit funds. With the advent of the Chit Funds Act, initially in the year
1961 (Madras Act) and amended subsequently in the year 1982 (Central Act), chit
funds have been highly regulated and governed by stringent rules. The purpose of the
said Act and its proposed benefit to the chit funds industry is, however, questionable.
Chit funds are also, more importantly, a means of easy and profitable access to
finance for the Small and Medium Enterprises (SMEs). The limited access to funds of
SMEs from banks and the formal financial domain had begun to strangle the growth
prospects of these enterprises. Thus, the advent of chit funds is really a boon to these
businesses (India). These in-depth interviews gave us an idea about the possible
research questions that may be addressed in this area the end of the document.

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B. STUDY OBJECTIVE:-
Chit fund model is an easy and innovative method of access to finance for the
low income households. It caters to the needs of different sections of the society,
mainly in the income generating households. Chit schemes have traditionally been
generic, differentiating only in value and duration. The need for customization of
products, to address varied requirements of chit members, is evident. In this regard, I
took an Initiative to study the nature and extent of the Chit fund industry, need for
financial education and customization of chit schemes, and eventually design and test
new financial products that will further enhance the value of financial services
provided via chit funds.

The research objective is to:-

1. Determine the size of the chit fund industry (registered and unregistered) and
document Recent trends.

2. Understand the financial needs of poor households and also determine to what
extent their financial needs are met by registered chit funds.

3. Estimate interest rates in registered chit funds.

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3. WHAT IS CHIT FUND?

Chit funds are the Indian equivalent of the Rotating Savings and Credit
Associations (ROSCA) that are famous throughout the world. ROSCAs are a means to
save and borrow at the same time. It is considered one of the best instruments to
cater to the needs of the poor.
A chit fund is a savings cum borrowing scheme, in which a group of people
enter into an agreement to contribute fixed amounts periodically, for a specified
period of time. The amount so collected (or the chit value) is distributed among each
of the persons in turns, which is determined by way of lots or an auction. Chit funds
provide an opportunity to save excess cash on a daily, weekly or monthly basis, and
give an easy access to it in case of emergency.
Participation in Chit funds was mainly for the purpose of purchasing some
property or, in other words, for CONSUMPTION purposes. However, in recent
times, there have been tremendous alterations in the constitution and functioning of
Chit funds. While in most places ROSCAs are user-owned and organized informally,
in India, chit funds have been formally institutionalized as well. Legally recognized
firms provide a variety of chit schemes. Under the Chit Fund Act, this industry has
been highly regulated and is governed by stringent rules. This institutionalization of
the chit funds (a) makes it easier for poor or illiterate people to know exactly what
different chit schemes the chit companies offer, (b) provides an option to people to
participate in schemes where members need not know each other; hence there is a
larger diversification of the idiosyncratic risks.

This makes it easier to provide chit schemes in urban settings where social
linkage among members might be weak, (c) to some extent ensures transparency in
the operations, (d) given that the law determines the size of the bidding and the
commission the company can charge, it encourages competition among chit fund
firms to improve services to clients, and (e) legal recognition also helps the chit fund
operators to scale their operations.

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It allows the chit fund operator to use the legal means to handle defaults and
more importantly it infuses faith in the clients that there are sufficient checks and
balances which will prevent opportunistic behavior. In return the chit fund companies
take a fee from the clients to cover their expenses, in the form of a commission. The
chit fund company provides a variety of mechanisms by which the savings of the
members can be transformed into lump sums.


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4. HOW DOES CHIT WORKS?

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. The pot is then auctioned out every month. 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 required contribution is brought down by the amount of dividend.

To illustrate the above, let us take the example of a chit scheme with the
following characteristics. Chit Value = Rs.500000, Duration = 50 months and
Members = 50. The contribution in this case would be initially Rs.10000 per month
per member. In the first month, the collection would, therefore, be Rs.10000
multiplied by the number of members i.e. Rs.500000. This amount is called the pot
which is auctioned out at the end of the month. Now let us assume that the highest bid
in the first month auction is Rs.100000. This is called the discount. The highest
bidder now gets the amount equal to the chit value, Rs.500000, less the discount,
Rs.100000, i.e. Rs.400000. The discount amount of Rs.100000 is then divided among
the other 49 members equally (the dividend for the 49 members work out to roughly
Rs.2040 each). For the subsequent month, therefore, the contribution of these
members reduces by the amount of dividend (i.e. the contribution in the second month
for the 49 members would be Rs.10000 less Rs.2040 which is equal to Rs.7960).

This process gets repeated for all months till the end of the scheme. There are
many variations to the above mentioned process depending on the scheme, preference
of the members, capability of the company and so on. Generally, the chit manager or
the company is also a member in each scheme.

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This is because the chit manager has to deposit an amount equal to the chit
value of the scheme with the Registrar of Chits for the particular jurisdiction. We will
discuss this in detail in the Regulations section.


Chlt Vulue Members Months
Monthly
Collectlon
Dully
Collectlon
5,00,000 20 20 25000 850
3,00,000 20 20 15000 450
1,00,000 20 20 5000 160
50,000 20 20 2500 80
25,000 20 20 1250 40
10,000 20 20 500 15
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5. GENERAL CHARACTERISTIC OF CHIT FUND
INTERVIEWED

The chit owners we approached were in the business for the past 2 to 6 years.
In most cases, the owner or manager was already involved in a similar line of business
(like income tax consultant, chartered accountant, and jeweler or kirana shop owner)
and expanded or diversified into the chit business. All the chit companies interviewed
were running unregistered funds. The number of schemes open at a particular time
ranged from 1 to as many as 8. The chit values ranged from Rs.10000 to Rs.1000000
and the duration from 12 to 50 months. The majority of members of the chit funds
were small traders and businesses. Households (mainly housewives) and salaried
employees also Participated extensively in these schemes.

The funds generally allow multiple-membership in each scheme, which means
that a member can contribute double or more number of times the amount and
participate in that many auctions during the tenure of the scheme. For instance, in a 20
month scheme where the contribution is Rs.1000 per month per member, a member
who pays a contribution of Rs.3000 per month can participate in 3 out of the 20
auctions. However, the members can bid again only after 50% of the duration is
completed (for instance, in case of a 20 month scheme, the member who has won the
pot in the first 10 months can bid again only after the completion of 10 months).
Usually only members with high credit worthiness will be allowed such a privilege.

The chit companies do not require much documentation, which is their
advantage over banks and other financial institutions. Some of the companies,
however, ask for income proof and address proof from new members. Most of the
companies require the members to have a bank account, as 100% of the transactions
are done through check payments. No business or address verification is undertaken
by the chit funds unless it is deemed absolutely necessary.

Most chit companies admit only members who are either connected to other
existing chit members or known to the chit manager personally. Some chit funds
employ agents to acquire new members. However, in case the members are not
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personally known to the managers, rigorous verifications are made to ensure the
credibility of the member. In some cases, the new members are not allowed to
participate in the auction for the first few months of the scheme and will only
contribute to the pot during that period. Generally, the members who want to bid in
the auction are asked to produce a guarantor or surety who is trusted by the chit
manager. In some cases, collaterals are also demanded from members prior to their
participation in the auction. However, if the members are well known, only a
promissory note is collected from them for admission to membership.
$%(1(),76 O) CH,7 )81D ,1V(67M(17

A chit fund investment has its share of benefits too.
y It inculcates the habit of compulsory regular saving.
y It earns dividends every month. So the net effective rate of return proves to
be pretty attractive.
y For any unexpected financial requirement, bidding for the lump sum
amount, could prove to be a better option than going through the hassles of
a loan.
y Chit fund investments are not affected by any market fluctuations.
y Finance option through chit funds are easier to re-pay through the
remaining monthly installments.

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%DR$:%$CK6 O) CH,7 )81D ,1V(67M(17 : -
Chit-funds do not offer any pre-determined or fixed returns. Higher returns are
earned when there are more number of members in the group or if the duration of the
scheme is longer. One would earn more, when more members need emergency funds.
Thus returns cannot be calculated and decided when one joins the scheme.
Among the limitations of Chit Funds, as only one person every auction can win
the pot, participants cannot be sure that they get loans whenever needed. If there are
multiple bidders, the pot will go to the highest bidder or be allocated through a
lottery if the bids are the same in a given auction. This could potentially be
detrimental to people who cannot delay their consumption or investment, as they are
in desperate need of funds. They might have to resort to money lenders or other
informal sources offering very high interest rates.

There could also be a scenario where, a member in desperate need of the
money is actually successful in winning the pot, but ends up with an extremely high
interest rate. This also highlights another limitation of the Chit Fund. In order to
function optimally, there is a need to ensure that the need for funds from the members
in a given scheme is idiosyncratic. Thus the selection of members in a given scheme
requires a balancing act between savers and borrowers, as Chit Funds have less
liquidity than banks that have thousands of savers and borrowers.

The Chit Fund organizer plays a very important role in ensuring that the groups
are well balanced between savers and borrowers.

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6. WHY SHOULD ONE GO FOR CHIT FUND?

In many parts of India, Chit Funds address gaps left by the traditional banking
sector. They mobilize huge amounts of small savings, and in return allow members to
have access in the form of loans to lump sum amount of money that they would often
not be able to get from traditional banks. Easy accessibility and flexibility are
important aspects of this form of financing. Compared to banks, Chit Funds require
less documentation, are more flexible about collateral, and allows to determine own
interest rate (within the constraints of a given chit scheme).

Furthermore, there is no need to determine upfront whether funds are used for
saving or borrowing. This is a salient feature of chit funds as it not only puts in place a
disciplined saving mechanism, but it also allows to access cash when needed. In
addition, as Chit Funds use the funds of the participants there is much less capital
requirements for the institution (unlike banks).

Our survey results also show that Chit Funds are mainly used as a tool for saving
and as a source of loan for consumption, business and emergency purposes.

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6.1 Comparison With other source of Available Funds
The most popular outside options to Chit Fund members, besides family and
friends are moneylenders, banks, and unregistered Chit Funds. These options vary in
the terms and conditions offered. The table below highlights the most salient features
of each option.
Table: Outside Options - Interest Rates for Loans


Parameter
Registered
Chit Fund
Money
Lenders
Bank/Formal
Institution
Unregistered
Chit Fund
Collateral
Requirements

Depends on the chit
fund manager and
credit history of the
member

They usually accept
personal guarantees

Other types of
collaterals accepted
are
post dated checks,
insurance policy,
house/land property
Papers etc.


Depends upon the
type of
moneylender.

Loans with or
without
Collateral are
available.

Variety of items
considered as
collateral

Legal ownership
transferred /not
transferred
depending
Borrower closeness.

Depends upon the
type of loan asked
for.

Most of the banks
do ask for some
kind of collateral
Insurance policy,
House/property
papers etc.

Interest rate
applicable varies
with the amount
and quality of the
collateral provided

Usually no
collateral required
since member and
chit fund manager
know each other
Personally.

Chit fund owner
sometimes asks for
bond paper worth
the value of one chit
Installment which
will be returned to
the member after he
wins the bid.
Interest Rates

Interest rates vary
According to the
chit value and
duration. They also
vary according to
the month of
auction.

Rates range from
0.5% to 3.5% per
month
Rates ranging from
as low as 1% per
month to as high as
20% per month are
observed.

There are minor
variations based on
the type of loan and
collateral provided
and profile of the
Borrower.

PLR: 12.75%-
13.25% per yr
The average interest
rate varies from 1%
to 2% per month.
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7. REGISTERED v/s UNREGISTERED

A Chit Fund can be either registered or unregistered. Registered Chit funds
are organized by Chit Fund firms/companies and regulated by the Chit Fund Act.
They are in essence impersonal contracts that depend on market forces. Unregistered
Chit Funds are unorganized and run by friends, relatives or personal groups. They are
personal contracts that do not depend on market forces but more on personal ties.
Unregistered Chit Funds which exceed Rs. 100 ($2) in chit value are illegal in India,
although it is widely known that the unregistered Chit Funds industry is still very
popular in rural areas and among the poor population in urban and semi-urban areas.

8. RULES AND REGULATION

The regulation of the Chit Fund industry was put in place by the Government
of India to address the problem of misuse of informal Chit Funds by unscrupulous
promoters and founders running away with the participants funds, leaving the
members with little recourse to retrieve their money back.

A.VARIOUS CHIT FUND ACT:-

The first enactment of chits was made by Government of Travancore (Kerala)
in the year 1914. Subsequently many states in India formulated and enacted chit acts.
With the collapse of big chit companies in the early seventies, the Government of
India constituted a special committee to undertake the study of chits, its implications
and benefits or problems to the Indian economy.
On the recommendation of this committee a special chit act was formulated
under the name of 'The Chit Funds Act 1982' by the Parliament of Union Government.
In Karnataka this Central Chit Funds Act was promulgated in 1984 along with the
Chit Fund (Karnataka) Rules 1983.

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The other Chit Fund Acts that are in force are as follows:-

The Andhra Pradesh Chit Funds Act, 1971, the Kerala Chitties Act, 1975, the
Maharashtra Chit Funds Act, 1974, the Tamil Nadu Chit Funds Act, 1961 as in force
in the state of Tamil Nadu and in the Union territories of Chandigarh and Delhi, the
Uttar Pradesh Chit Funds Act, 1975, the Goa, Daman and Diu Chit Funds Act, 1973,
and the Pondicherry Chit Funds Act, 1966.

Important points from The (Central) Chit Funds Act (1982):-
1. The State Government may exempt any Chit fund from all or any of the provisions
of the Central Act.
2. According to this Act, no bank can commence or carry on chit business after the
commencement of this Act.
3. This Act does not apply to any Chit fund the amount of which does not exceed one
hundred rupees.
4. This Act extends to the whole of India except the State of Jammu and Kashmir.
5. According to this Act, the chit manager needs to deposit 100% of the chit value
with the Registrar of Chits prior to the commencement of the chit scheme. This
deposit will be refunded to the chit manager on the successful completion of the
chit cycle.
6. A Chit fund registered under this Act needs to have its accounts audited by a
qualified Chartered Accountant. The fixed deposit made at the beginning of the
scheme will be refunded only on the submission of the audited Balance Sheet and
Statement of Accounts.
7. The Act also requires all registered Chit funds to impose a 40% cap on the bidding
amount. This 40% is calculated on the chit value of the scheme. This bid-cap is
administered to ensure that the bid does not rise uncontrollably leading to
subsequent default by the bidder. The minimum bid is restricted to 5% of the chit
value which is the foremans (or chit managers) commission.

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Points of difference between Acts prevailing in different states of India:-

Most of the provisions of the Central Act apply to the Chit funds run in
different parts of India. However, the State Acts may override certain provisions as
deemed necessary. For instance, the Andhra Pradesh Chit Funds Act 1971 had
previously required the chit managers in that state to deposit only 50% of the chit
value with the Registrar of Chits prior to the commencement of the chit scheme. This
provision has been amended recently with the adoption of the provision from the
Central Act that requires 100% deposit from chit managers.

Similarly, the Kerala Chitties Act was amended recently to include a provision
which stipulates that companies can float chit schemes only amounting to 50% of the
foremans asset, whereas in other states that adopt the Central Act, companies are
allowed to float chit schemes up to ten times the foremans assets. The Kerala Act also
imposes other stringent rules that have resulted in many companies registering
themselves outside the state (primarily in Jammu and Kashmir where the Central Act
does not apply). One should also note that in states which do not enact a State Chit
Fund Act, the Central Act will automatically prevail.

B. COST OF REGULATION:-

Registration of a chit scheme entails numerous fee payments and other
formalities, such as filing of returns, maintaining minutes of the meeting, auditing of
accounts and so on, that need to be satisfied by the chit manager. The Registrar of
Chits of a particular jurisdiction is responsible for registering the chit funds in that
jurisdiction. As a first step in the formation of a group or scheme, prior sanction needs
to be obtained from the Registrar. The prior sanction is granted at the filing of an
application and at the payment of fees of Rs.50 ($1). Subsequently the company needs
to file a chit agreement with every member in that particular group. The fee for the
purpose is around Rs.20 ($0.4) per member. Once the chit agreement is filed and
approved, the certificate for commencement of the scheme is issued.

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The registration process generally takes around two months to complete. There
is no subsequent requirement for renewal of the registration. Once the scheme
commences, the chit manager has to file the minutes of each auction with the
Registrar every month along with a fee of around Rs.4 ($0.08). Other costs of
registration include fees payable on transfer of membership and on any other filing
requirement that may arise during the course of the scheme.

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9. DEFAULT HOW THEY ARE HANDLED?

The default rates in the chit industry however around a meager 1-2%. This is
because the chit members are, in most cases, personally known to the chit managers.
However, even the default by a single member can shake the foundation of the chit
scheme as it is totally dependent on the dedicated participation of all the members.
Hence, it becomes essential for the chit managers to screen the members before
admission. When members fail to make their contribution for any particular month,
they are initially requested by oral correspondence to pay the dues. If this fails, a
reminder is sent by mail and finally a legal notice is issued and the person is taken to
Court.

There is an arbitrary provision under the Chit Fund Act that provides for
immediate redressed. The Registrar may admit or dismiss the case depending on the
strength of the argument on both sides. In some cases, there may also be partial
recovery depending on the financial solvency of the member. The Court attaches the
salary, collateral and sometimes even the personal property of the member to the
unpaid dues. In case the member is not traceable, then the guarantor or surety is asked
to make the payment and, in their absence, the company is obliged to do the same.

In case of delay in payment of dues, interest is charged on the delayed payment
and sometimes even the dividends are forfeited if the delay is for too long. In case the
reason for delay is genuine then the interest is waived. To minimize delays, discounts
are given for prompt payments

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10. CHARACTERISTIC AND NEED OF CHIT PARTICIPANT

Understanding the behavior and financial needs of the chit members is an
important step in studying how to facilitate financial access for the poor through Chit
Funds. It will allow us to identify current gaps in financial services, as well as
determine if the financial needs of the lower income households can indeed be met by
Chit Funds.

Timely available finance to the right amount is need of every person, whether
he is above poverty line or below poverty line. People above poverty line can manage
funds and way to pay off their debt but those people below poverty line can hardly
manage to pay even the interest charged on them. With this study I have found that
people doing directly or indirectly associated to chit fund are mostly household wife,
salary earners, small scale business man like shop keeper, or other small scale
operators. Various type of Chit fund serve as a source of fund for many occasion, like.
Organized chit funds
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 concern in charge 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 persons name slip is torn and there after he comes for
meetings regularly and gives his kitty's share but his name won't be there in the
slips of box as he has already collected his share.
Special purpose funds
Some chit funds may be conducted as a savings scheme for specific purpose.
An example is the Deepavali sweets fund, which has a specific end date - about a
week before Deepavali. Neighborhood ladies will get together to pool their savings
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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 shops, etc. to promote their products.

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11. AUCTIONS IN CASE OF LOAN

The chit manager auctions out the pot every month on a particular date. The
members who wish to participate in the auction assemble at a particular place
(generally the chit managers office) and call out their bids. The auction essentially
lasts for five minutes preceded by five minutes of preliminaries and succeeded by five
minutes of closing procedure.

At the end of the fifth minute of the auction, a bell will ring to indicate the
closure. The highest bid at the time of the bell will be recorded as the winning bid. If a
member, interested in participating in an auction, is unable to be physically present,
then he/she may send a sealed bid to the chit manager/foreman 24 hours prior to the
auction.

In case there is an equal bid, the decision of who is entitled to the loan is made
by means of a lottery. When none of the members require the loan, a lottery is
conducted among the non-prized subscribers and the member selected is given the
loan amount at the minimum bid of 5%. Where two members are equally in urgent
need of the loan in any particular month, the chit manager may allow them to make
compromises among themselves wherein they may divide the pot equally between
them.

However, in such cases, one of them will be held liable directly to the group for
the entire amount and the other would be liable to the former for his/her share of the
loan.

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12. SOURCE OF INCOME TO CHIT MANAGER

The chit manager gets a high return on the chit business which is justified by
the high risk involved in such a business. His/her major source of income is the
foremans commission of 5% of the chit value for every scheme. This provides a
regular monthly income of around Rs.10000 on an average for every scheme that is in
vogue. This steady income flow is sufficient to cover the operating cost and other
statutory costs of running the scheme. The interest lost on the deposit that needs to be
made ab initio, and the monthly contributions as part of every scheme that has to be
borne by the manager, require such an income source to keep him/her afloat.

Apart from this formal and transparent source of income, chit managers also
make money in other less evident ways. For instance, it is a common phenomenon for
the loan to be disbursed a month after the auction date. This means that the chit
manager will earn interest on the loan amount for a whole month. When this repeats
for every scheme in force, a large quantity of money accumulates.

To illustrate this, let us consider a chit scheme that has an auction on the 7th of
January. The contributions will be collected on the 1st of January. Now, the prized
subscriber at the auction will be provided with the loan amount or the pot only after
a month, i.e. on the 7th of February. The chit manager will earn the interest on the
collected amount essentially from the 1st of January to the 7th of February. Hence, the
chit managers have a very rich source of income. However, with the increase in costs
of registration and other costs prescribed by the Government, and the increased risk
faced by the managers, little can be said regarding the profits they make.
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13. USE OF CHIT MONEY

Chit managers do not require the members to specify the purpose to which they
deploy the funds. Generally, chit loans or money are used by households for
consumption purposes like marriages, buying property (land, vehicle etc.) and
education.

It is primarily considered a means to saving free cash by the women of the
household in order to provide for any contingencies that may arise in the future.
Sometimes, the chit fund or loans may also be used to settle outstanding loans with the
money lenders. The chit member may use the pot to pay off the money lender loan
which is at a much higher rate and thus save money. Such members, who have several
loans from varied sources, may run the risk of defaulting in some cases, as they may
be caught in the vicious circle of debt or the debt trap.

Literature shows that the primary uses of Chit Funds are the following:-

To address consumption needs such as marriage, education, property purchase and
so on.

To pay off costlier loans from outside sources like loan from money lenders.

To address working capital, business expansion or start-up capital needs of small
businesses.

For emergency needs or simply as savings for future needs.


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14. CHIT FUND AND SMALL BUSINESS

Small traders and businessmen participate extensively in chit funds. Chit funds
provide an opportunity for them to save their excess cash on a daily or monthly basis
and, at the same time, to have access to easy finance in case of emergency or other
requirement.

Generally, the funds are used as either working capital, for expansion of
business or as emergency funds. Small enterprises have been historically wedged
between the money lenders, with their exorbitant cost of loans, and banks, with their
stringent procedures. Chit funds are a welcome measure for such enterprises to
overcome their financial constraints. This is evident from the enthusiastic participation
of small businessmen in the chit funds we came across. Small businesses usually have
free cash which they can profitably invest in chit funds to earn returns. Some chit
funds allow small traders to make daily contributions, instead of monthly, to
coordinate with their income cycle (small traders in the cash and carry business
generally have daily cash flows from their business).

As and when the need arises, they bid in the auction and receive the loan out of
their own funds. Once they receive the loan, they continue to pay the monthly
contributions, and this accounts for the payment towards both the interest and the
principal which makes the repayment easier and less arduous. Also, in chit funds,
small traders can decide their own interest rates depending on the need (chit fund
interest rates are in effect the market determined interest rates).

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15. SCOPE FOR FUTURE RESEARCH AND PRELIMINARY
FINDINGS

In view of the importance of this source of finance and the obvious advantages
it presents to the small enterprises it is only prudent to study the industry in more
detail. There are many blindsides to the chit fund industry that need to be more
thoroughly explored. More importantly, it is necessary to bring the positive aspects of
chit funds to light, so that the stringent regulations that strangulate the industry may be
lightened.

Therefore, the research questions that need to be addressed are as
follows:
1. How are the chit fund loans being used?
2. Are chit funds used as a source of capital? If so, what? - a) Working Capital, b)
Emergency Capital, c) Rotation funds
3. What are the other sources of finance the chit members have and what is the cost of
such sources? (Benefits vis--vis outside options)
4. Why do chit members not wait till the end to take the loan when the interest rates
come down?
5. Do the uses of chit funds vary according to the nature of the business like age, size,
etc.?
6. What is the impact of participation in chit funds on the growth of the business of
chit members?
7. Are the low default-rates in the chit industry due to cautious member selection or
does the structure of the chit fund compel the members to borrow from other sources
to repay?
8. Why do chit members participate in more than one chit scheme?
9. Do chit funds provide the bulk of financing for its participants?

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In order to answer the questions enumerated above, we propose to undertake a
two pronged approach to the research - (a) collect bidding data from various chit
companies, and calculate the loan and savings interest rates that are available to the
members and (b) conduct a comprehensive survey of the chit members (mainly small
traders) to understand why they use chit funds and how it affects their business.

From the bidding data collected so far, we see that the loan interest rate varies
between 1-2% per month on the reducing balance. This works out to around 12% per
annum which is much lower when compared to the interest rate charged by the money
lenders (that work out to as much as 72% per annum in most cases). Though quoted
loan interest rates by banks are similar, and sometimes much lower, to the chit fund
interest rates, in reality, the transaction costs for small business loans cause the
effective interest rates to be much higher.

The loan interest rates generally follow a near bell shaped curve which means
that the interest rates tend to increase mid-way of the scheme and decrease towards the
end. This is because there are generally no takers for the loan towards the end of the
scheme. The following example from a chit company in Chennai called Thiripura
Chits illustrates the above:

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Table 1: Loan interest rates for different chit schemes run by
Thiripura Chits with the same duration but different
chit values


Month
CV
10000
CV
25000
CV
50000
CV
100000
CV
300000
1 00139 00132 00139 00139 00139
2 00153 00146 00153 00153 00153
3 00169 00161 00169 00169 00169
4 00187 00179 00187 00187 00187
5 00209 00199 00209 00209 00209
6 00235 00224 00235 00235 00235
7 00265 00252 00265 00265 00265
8 00300 00287 00300 00300 00300
9 00344 00328 00344 00344 00344
10 00290 00239 00290 00290 00290
11 00260 00231 00260 00260 00260
12 00218 00185 00218 00218 00218
13 00160 00122 00160 00160 00160
14 00032 00101 00083 00083 00083
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Such a recurring pattern indicates that the members do not apriority calculate
the interest rates that they pay. This is an interesting aspect that can be explored
further. The hypothesis that more experienced chit members pay a lower loan interest
rate because they calculate apriority the required rate of return and bid accordingly
needs to be tested.

The preliminary research has put forward various new ideas and has increased
the scope of the actual research.

And as on 31 March 2010, Assets under management o registered chit funds is
Rs.18, 000 cr. And are growing with an Annual Growth of 12-15%.

7otul Money Clrculuted vlu Chlt )und per Household (SM)
6tutes 2003 2004 2005 2006 Chunge %
$ndhru Prudesh 825 850 905 1,003 215
Delhl 1,576 1,505 1,469 1,555 -133
7umll 1udu 788 794 819 917 263
Kerulu 36 38 41 45 25

7otul Money Clrculuted vlu Reglstered Chlt )und (SM)
6tutes 2003 2004 2005 2006 Chunge %
$ndhru Prudesh 392 334 428 412 51
Delhl 18 21 23 226 228
7umll 1udu 25 26 282 278 112


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16. CONCLUSION

Chit funds are a very good tool for financing the activities of small businesses.
In recent years, there have been some unscrupulous activities in the industry that have
instigated the Government to take serious measures. The occasional failure of chit
funds is generally attributed to expansion beyond capacity. A chit fund is not a
scalable model unless the chit manager or company has sufficient personal resources
as a backup for financial contingencies. However, in recent times, big companies like
Shriram Chits and Margadarshi Chits have given a new meaning to the concept of chit
funds with their national outreach and presence.

The regulatory hurdles that the chit companies face due to the stringent rules
proposed by the Government progressively, have been a setback to the growth of the
industry.

The effect of the increased costs of operations for the registered chit companies
has been to push these companies underground. Many companies have, in the recent
past, either folded up or shifted their operations entirely to the informal arena
becoming an unregistered chit fund. The unorganized chit fund market is huge and
growing (6000 unregistered chit funds in Hyderabad out of the total 7300). This
causes serious problems not only for the industry and its participants, but also for the
Government, which loses its revenue.

Therefore, in order to promote this concept, which is generally beneficial to all
the parties concerned, it is imperative that more rigorous research be done on the
issues that they face. A strong lobby should also be developed in their favor. The day
when the Government and the industry participants alike understand the importance of
chit funds to the economy would mark the beginning of a new era.



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Safety of Chit Funds
With the plethora of chit fund companies around, the safety of a chit fund lies
in choosing the right one. In a registered chit fund company, under legal binding, the
activities are regulated and institutionalized by the Chit Fund Act. And hence could be
considered safe. However, other unregistered companies operating informally do
exist. One needs to exercise caution while choosing where he desires to invest.
Chit funds definitely are an attractive option for regular saving. It inculcates a
disciplined approach to financial planning. It has the added advantage of bringing a
combination of savings as well as hassle free borrowing. This dual purpose investment
tool could be a friend in need at times of unexpected financial emergencies.

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17. CASE STUDIES
Mr. Chandran
Unlike most of the other respondents, Mr. Chandran considers unregistered
Chit Funds as a formal way of doing business. He has been running schemes since
1989 and at present he owns six schemes of different value and duration. The smallest
scheme is only Rs. 10,000 ($200) with duration of 10 months while the largest scheme
has chit value of Rs. 200,000 ($4000) and duration of 30 months. From every scheme,
Mr. Chandran claims the second prize money as commission. In order to keep late
payments at a minimum level, members get fined Rs. 50 ($1) or Rs. 25 ($0.5) per day
according to the size of the scheme. For the larger schemes (>Rs. 50,000 or $1000),
Mr. Chandran also requires securities from his Members. According to him, only by
applying such rules, chit schemes can continue to work.

When asked why he does not want to get his Chit Fund registered, Mr.
Chandran says it makes no difference with registered Chit Funds; if needed I could
file a case at court, e.g. in case of default payments. Luckily, this has never
happened.

Mr. Bharat Bhayana

Bharat Bhayana, a second hand car dealer from Vikas pur, New Delhi, dreaded
going to banks for business loans. The thought of being interrogated by snappy bank
officers and the complex paper work that followed gave him cold feet. The whole drill
made little sense to him as many a time bank denied Full Amount Disbursals. And
when they did it was at the rates that could put Shy-lock to shame.

High Interest Rates coupled with cumbersome loan Procedures and rigid
payment schedules are prompting small time borrowers like Bharat Bhayana to join
chit fund. Much like other Small and Medium Enterprise (SME) owners and Traders,
40-old Bhayana required Rs.5-10 Lakh on regular basis to buy cars, repair or modify
them, before finding a new Buyer.
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Bank do not Give loans for Shorter Period. Also rates are higher for
unsecured loans. I borrowed from chit fund at much Lower cost. Repayment is also
easy as it can be made in easy installments, said Bhayana, owner of Car point who
has invested in several ongoing chit schemes

Mr. Ratnaswamy
Mr. Ratnaswamy who is less positive about unregistered Chit Funds after
experiencing a loss of Rs. 150,000 ($3000) to a relative who was in charge of the
scheme. Ever since, Mr. Ratnaswamy is no longer interested in participating in any
Chit Fund. If he is in need of money he prefers getting a loan from the bank instead

Mr. Thirumurthy:

Mr. Thirumurthy is one of the few unregistered Chit Fund owners in rural
Erode who is not a farmer. He started operating chit schemes in 2002 to be able to
save money for his Marriage. Members were easily found among friends and
relatives; 80% of whom were business people as well. Four of his members also
started their own Chit Fund but Mr. Thirumurthy did not participate in any of these
although he did participate in his own schemes.

The first scheme had a chit value of Rs. 50,000 ($1000) and duration of 20
months; the second and third scheme had a chit value of Rs. 30,000 ($600) each and
duration of 12 months. After completion Mr. Thirumurthy re-started all the three
schemes and operates them till date. He charges 4% commission from his members as
a source of income from the scheme. Meanwhile Mr. Thirumurthy has saved enough
money to get married and now uses the Chit Fund money for business investments.

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Mrs. Shivling
Mrs. Shivling, who owns 12 acres of Farmland in her hometown, has
participated in no less than 100 Chit schemes from 1980 till date. When in 1991
sudden and necessary investment had to be made in maintaining farmland, Mrs.
Shivling decided to start her own Unregistered Chit Fund. She selected ten friends and
relative who agreed to put in Rs.500 (10$) each. Auctions were held only once in a
year so that the total duration of the scheme lasted ten years. When the first scheme
came to an end in 2000, she restarted the scheme in 2001 of equal duration with the
only difference that there was not one but two scheme simultaneously and the
contribution had increased to Rs.1000 (20$) and Rs.2000 (40$) per member.
These two schemes lasted till 2010 and in 2011 she started her fourth and final
scheme with the chit value of 400,000 (8000$). Instead of yearly auction two auctions
were held per year so that the total duration of the scheme was not ten years but five
years. From these saving she purchased another 5 acres of land which she leased out
as farm land. An Interesting detail is that the total of 40 members who participated in
Mrs. Shivlings four Schemes also started their own scheme in all of which she has
participated.

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17. BIBLIOGRAPHY

a) BOOKS:-

i. Eeckhout, Jan and Kaivan Munshi. 2005. "Mitigating
Regulatory Inefficiency: The Nonmarket Response to
Financial Regulation in India".
ii. Confederation of Indian Industry. 2006. "Credit Delivery
to SMEs".

b) NEWS PAPER:-

i. Economic times, dated 5
th
Oct 2011 Wednesday.

c) MAGAZINE:-

i. Srinivas, Alam and Rajeev Dubey. 1999. "The Nidhi
Nightmare", Business Today

d) WEBSITES :-

l ZZZ*ooglecoln
ll ZZZZlklpedlucom


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18. APPENDIX
Questionnaire for the Chit Managers:-
1. How long have you been running a chit fund?
2. Did you start the chit fund? If yes please tell us about it was started,
at the start how did you get members for the chit fund, if you got it
registered How long does it take?
3. How Many different schemes are you running presently? For each
scheme answer Question 4 to 7 Separately:
4. Is this Scheme Registered or Unregistered?
5. Please describe the functioning of the scheme? (Amount, Duration,
Number of Member, etc)
6. Please describe in detail a typical profile of member? (For E.g.
Occupation, Age, Income, Education, Purpose of joining a chit fund
etc.)
7. What is key Difference between a registered and un-registered Chit
fund?
8. In case of default by a member:
a. What Steps were taken by you?
b. Who pays the future Fees?
c. Do you allow new member mid way of the scheme? If yes
then how are they chosen?
9. What steps do you take to minimize defaults?
10. If you are able to determine that a member has defaulted for a
genuine reason (for example, sickness, death or some other
emergencies) do you take different actions than otherwise? If yes
please describe?
11. Are there any new members (first timers) in this scheme? If yes how
many new members are there? What procedures were followed to
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induct new members? Are there any restrictions on the new members
- if yes please describe in detail?
12. In case of delayed payment by a member:
a. What steps are taken by you?
b. Who pays for the delayed amounts?
13. What steps do you take to minimize delayed payments?
14. If delay is due to some genuine reason (for example, sickness, death
or some other emergencies) do you take different actions than
otherwise? If yes please describe?
15. Are the members who delay payments, the ones who generally
default?
16. In your opinion what are the advantages vis--vis other financial
intermediaries (like banks, money lenders, pawn brokers, etc) to a
member in participating in this scheme? (Please compare the
advantages (or disadvantages) with respect to different financial
intermediation)
17. Do you allow multiple memberships in a scheme? Is there a
restriction on the number of memberships?
18. Are there any restrictions on the bid? If yes, please describe the
restrictions and why are the restrictions imposed?
19. If two or more members have equal bids then how is it resolved?
20. If none of the members have bid for the amount then what happens to
the funds?
21. When members apply to the scheme, do you match them into
different schemes according to the type of member?
22. What is the duration of each auction? Please describe the auction in
detail.
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23. What is the procedure in case a member is not able to be present in an
auction? Can the member send a proxy to take part in the auction or
can he mail his bid to the chit manager?
24. In your opinion who are the main competitors to the chit fund
industry?
25. What are the documents that you would ask for before admitting a
member to a scheme? Is it necessary for the member to have a bank
account? If so, why?
26. What are the verifications that you would undertake before admitting
a member?
27. Do you require your chit fund members to use the chit fund money
for a specific purpose? If so, how do you ensure that the money is
being used for the specified purpose?
28. What, in your opinion, are the uses for which the members allocate
the chit fund money?
29. Is your chit fund used as a savings tool or as a loan product by the
members?
30. Do you also undertake any other business apart from chit funds? If
so, please specify and explain about the other operations.
31. Have you heard of any frauds in the chit fund business? If yes, have
these frauds affected the confidence of the customers? Explain.

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19. GLOSSARY
1. $uctlon: - Auction is a procedure for identification of the non-
prized subscriber who wants to take a chit amount at the highest
permissible discount. All non-prized subscribers who have paid their
installments up to date are allowed to participate in the auction for
bidding the highest auction discount, within a period of five minutes,
allowed for each auction.

2. Contribution: - The amount payable by each member of the chit
fund every month is called the contribution.

3. Discount: - The difference between chit value and the amount at
which a successful bidder takes a chit in an auction is known as
auction discount.

4. Dividend: - Auction discount minus company commission (5% of
chit value) is the total group dividend. Total group dividend is
distributed equally amongst all the subscribers. This dividend so
distributed is deducted from the next installment payable by the
subscriber.

5. Kirana: - Small shops selling food items like groceries, cereals and
so on.