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What is a Chit Fund?

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 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 instalments 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 organised financial institutions or may be

unorganised schemes conducted between friends or relatives. There are also variations of chits

where the savings are done for a specific purpose.

A collection of members called a chit group makes their contribution in the form of money to

collect a chit amount and they bid in an auction to be awarded with the prized money which is

equal to the chit amount the discount and the foreman's commission.

The chit is registered with the Deputy Registrar of Chits and a registered number is obtained.

The Foreman promotes and conducts the Chits as per the regulations of the Chit Funds Act and

Rules.
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How Chit Fund Works?

Different chit funds operate in different ways; and there are also many fraudulent tactics

practiced by many private firms. The basic necessity of conducting a 'Chitty' is a group of

needy people called subscribers. The foreman - the company or person conducting the chitty

- brings these people together and conducts the chitty. Foreman is also the person responsible

for collecting the money from subscribers, presiding the auctions and keeping records of

subscribers. He is compensated a fixed amount (generally 5% of gross chitty amount) monthly

for his efforts; other than that the foreman does not have any specific privileges, he is just a

subscriber of the chitty.

The general pattern of the chitty can be readily noticed by a simple formula:

Monthly Premium Duration in Months = Gross Amount

E.g.: 1000 * 50 = 50,000/-. Where 1000 is the maximum monthly contribution needed from a

subscriber, 50 is the duration of the chitty in months and 50,000 is the maximum sum assured.

The duration also equals the number of subscribers, as there must be (not more or less) one

subscriber to receive the price money every month.

The chitty starts on an announced date, every subscriber come together for the auction/lot. As

per Kerala chit act, the minimum prize money of an auction is limited to 70% of the gross sum

assured that is 35,000 in the above example. When there are more than one person willing to

take this minimum sum, lot are conducted and the 'Lucky subscriber' get the prize money for

the month. If there is no person is willing to take the minimum sum, then a reverse auction is

conducted where subscribers open-bid for lower amounts; that is from 50,000 >> 49,000 >>

48,000, and so on. The person bidding lowest sum get bid amount.
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In both the cases the auction discount, that is the difference between the gross sum and auction

amount, is equally distributed among subscribers or is deducted from their monthly premium.

For example if the auction is settled on a sum of 40,000, then the auction discount of 10,000

(50,000 - 40,000) is divided by 50 (the total number of subscribers) and everyone gets a

discount of 200. The same practice is repeated every month and every subscriber gets a chance

of receiving some money.

Reason to invest in Chit funds

India has a large low-income rural population. According to the World Bank reviewed and

proposed revisions in May 2014, to its poverty calculation methodology and purchasing power

parity basis including India, the world has 872.3million people below the new poverty line, of

which 179.6 million people live in India (Economic Times 10th May). These poor people do

not have access to the formal banking facilities. Capital market is far behind of their

knowledge due to their educational as well as financial literacy. A trap of parallel informal

banking gets out of bed to fill the emptiness. Few corrupt people known as financial operators

run Ponzi schemes in various disguises.

Impact on economy
The rural economy of our country is mostly relied on small savings schemes of Indian postal

services. The low rate of interest in post offices encouraged the rise of various Ponzi schemes

in 1980s, 1990s and later in 2008 like Sanchayita Investments, Overland Investment

Company, Verona Credit and Commercial Investment Company and recently the Saradha chit

fund. Naturally a major chunk of earnings of ordinary investors go to the speculative

businessmen instead of being channelized either to the Bank, Post-office or to the Capital

market. Thus the rural economy becomes a void since at the end of the day the investors are

the losers. When the Saradha group was collapsed in

April 2013 it is found that it eradicated an estimated

amount of INR 200-300 billion (US $4-6 billion) and

it collected money from 1.7 million depositors.

Fall in small savings

West Bengals small savings post office deposits. In the year 2006-07, the net collection from

small savings was Rs. 6,238.93 crore (Business Standard, 2nd March, 2013) and this increased

to Rs. 8,985 crore in 2009-10. But in 2010-11 it marginally declined to Rs. 8,409 crore and

afterwards in 2011-12 the amount of small savings had gone down to Rs.(-) 987.22 crore. This

means in 2011-12, the whole amount of Rs.8409 crore plus Rs. 987.22 crore i.e. total

Rs.9396.22 crore were eaten away by other financial instruments. The obvious question raises

that where the money had gone? This money had certainly been invested in such financial
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instruments where the rate of interest was higher than the small savings rate of interest. The

investors observably had a choice of investing money in Saradha like organization.

Impact on capital market

Rs.910, 603,234,300,000 which is equal to USD 20.23 trillion (Summary of all scams in India

since 1947, Kundu, Paresh Ratan). The Indian capital market entered the trillion dollar club

first time in June, 2007 but moved out in September 2008, during the worldwide economic

recession. It again joined the elite league in May 2009 and had persisted there for a long time

except for some phases, including once in 2012. On 5th august 2013, the total valuation (free-

float market capitalization) of all listed stock in India stood at Rs. 61,55,448.63 crore ($ 1.011

trillion), upgrading India to the elite global league of markets having a trillion-dollar valuation

(business today- 6th august 2013). Across the world the economy of few countries like UK,

Japan, China, Canada, Hong Kong, Germany, France, Switzerland, Australia, South Korea,

Nordic region and Brazil are presently enjoy a trillion dollar status, led by the US (an estimates

USD 20 trillion). This corroborates that if the total amount of the scam would have been

channelized in to the capital market, our country, India would have been the permanent

member of trillion dollar club long before and would have been the leader in the world capital

market.

Role of SEBI
As per the Chit Fund Act of 1982 the chit funds are regulated by the state governments rather

than the SEBI. Recently, the chairman of SEBI Mr. U.K.Sinha has stated that the State
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Governments have immense powers, if utilized well, to bring to book such entities (The

Statesman, 15th September, 2014).

From the Desk of SEBIs Chairman

Illicit money-pooling schemes sprout across nooks and corners of the country;

State governments should provide the first line of defense against such activities and

provide early warning systems for cases requiring action by the SEBI;

There will be full support of SEBI in fighting this menace where fraudsters have

collected thousands of crore of rupees through various Ponzi and other illegal

schemes.

The chairman has urged all state governments to pass the State Deposit Protection Act,

which would allow the state governments to take stern action against illegal deposit

taking activities within their jurisdictions. Many states have already passed this Act.

The governor of RBI and the chairman of SEBI have already requested the chief

secretaries of states to take action against those running illegal money-pooling

schemes under the State Deposit Protection Act.

Under a new law, SEBI has been authorized to take action against all unregulated

money-pooling schemes with a corpus of Rs.100 crore or more.

Conclusions
As per the Securities regulations and the companys Act, 1956 (Section 67) no company can

raise capital from more than 50 people without issuing prospectus. Also their accounts must

be audited and Balance sheet of the company must be available to the public. Further, for

raising capital any company should have explicit permission from SEBI. But in case of

Saradha no legal formalities were followed. The state government was also apathetic although

the market regulator SEBI informed the state government for a number of times. SEBI first

defied Saradha Group in 2009. SEBI continued its investigation through 2010. SEBI warned

the state government of West Bengal about Saradha Groups deceptive chit fund activities in

2011 again. SEBI later in the year 2012 came to the conclusion that the groups activities were

merely a Collective Investment Scheme (CIS), not chit fund, and claimed that it should

instantaneously stop its operations. But Saradha Group ignored SEBI, and continued to

operate in the similar modus till it collapsed in April 2013. It is observed that these companies

are not chit funds. They are formed under The Companies Act, 1956, and are registered with

the Ministry of Corporate Affairs.

The sorry state of affair is that many influential persons of high profile were involved in this

illegal money mobilizing activities. Likewise in west Bengal, in Assam also one top level

police officer was involved who committed suicide recently (The Statesman,18th September,

2014) after his name got linked to the scam with other list of names by CBI. Many names

from political and social arena are coming out which is very shocking not only to the state

government but also to the younger generation of India. What world we are giving present to

them. In 2013, Ministry of Corporate Affairs, Government of India, released the list of fake

chit fund companies operating in India. As per the governments notification, all those
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companies were deceiving people in the name of investment. Out of them 5 are from Tamil

Nadu and 5 from Delhi, 2 from Rajasthan, 1 from each Karnataka and Uttar Pradesh whereas

72 from West Bengal. Truly West Bengal has got the disgusting title of Ponzi capital of

India.

The following line of actions can be taken at least to give a jerk to the dreadful problem being

faced by India:

1. The state government should play the role of a whistle blower.

2. The central as well as state government should try to make our people financially literate.

3. If the state government does not take action, SEBI without making any further delay should

take immediate action so that the problem does not aggravate.

4. At the cost of common mens money the SEBI, RBI and the State government should stop

blame game to each other.

5. State government should stop any kind of gimmick like imposing tax on cigarettes to collect

money for distribution among the cheated people, rather should try to nip it in the bud so that

it does not become ingrained.

6. Political patronage should be stopped.

7. Above all the Election Commissioner of India should see the political parties should not

use any kind of illegal money for contesting elections.