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Chit Fund

  • 22 Feb 2019
  • 8 min read

Last Updated: October 2022

For Prelims: Chit Funds

For Mains: Chit Funds: Different Types, Reasons to use Chit Funds, Regulations, Need of Stricter Regulations, Steps that can be taken.

Why in News?

In 2019, Parliament passed the Chit Funds (Amendment) Bill, 2019. It streamlined operations of collective investment schemes or chit funds, with the aim to protect investors that primarily comprise economically weaker sections of society.

What is Chit Fund?

  • Chit funds are a popular type of savings institutions in India. It is one of the main parts of the unorganised 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 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.

What are 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.

What are the Different 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 the chances of loss are limited. Business processes are transparent and clean.
    • Private Registered Chit Funds:
      • These chit funds are registered as per 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?

  • The low rate of interest on small saving provided by commercial banks are 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 institution is plagued by stringent procedures.
  • A 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 childbirth 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.

What are the Existing Regulations?

  • At present chit funds are governed by Chit Funds Act of 1962, Reserve Bank of India (RBI) Act of 1934, and Securities & Exchange Bond of India (SEBI) Act of 1992 etc.
  • Under the Chit Fund Act of 1962, businesses can be registered and regulated only by the respective State Governments.
  • Regulator of chit funds is the Registrar of Chits appointed by respective state governments under Section 61 of Chit Funds Act.
  • Functionally, Chit funds are included in the definition of Non-Banking Financial Companies (NBFCs) by RBI under the sub-head Miscellaneous Non-Banking Company (MNBC).
  • RBI, however, has not laid out any separate regulatory framework for them.

Why is there a 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 the Saradha Chit Fund Scam, Rose Valley Scam, etc.
  • Financial Illiteracy: Lack of financial literacy results in people getting duped as they are promised a huge return on their investment which has no substantial basis to fulfil.
  • 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 off 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 RBI can help the investors.

What can be the Way Forward?

  • The proposed amendment will prohibit unregulated deposit-taking and provide for deterrent punishment for promoting or operating such schemes, besides introducing other changes.
  • The focus needs to be on implementing the rules without political interference and strengthening the judicial mechanism without which any amendment to the law will be of little help to the citizens.
  • Amendment in the proposed legislation will only safeguard the depositor interests, without addressing the structural problems of lack of financial inclusion, skewed bank ratio in rural areas etc.
  • Better and accessible banking alternatives will not only check undue exploitation of poor people but will also correct leakages in the economy.
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