Chit fund is a traditional micro-saving cum borrowing product. It involves participants pooling their money into a common fund on a monthly basis. Withdrawals are made in lump-sum by a single member selected through a bidding process every month. Every member of the group is entitled to the pooled money only once during the cycle of the scheme, post which the group is dissolved. The earliest form of chit fund can be dated back to 19th century when the then ruler of the princely state of Cochin, Raja Ravi Varma, gave loan to traders after keeping a part of the loan for his administrative expenses. Despite the growth in financial savings products, chit funds continue to attract a lot of investors across all socio-economic classes. The main reason why chit funds continue to remain popular is because participants have access to their future savings today. In other words, a chit fund investor can access his to-be-saved funds in the present, when in dire need. This in turn encourages disciplined saving among chit investors. At present, there are around 30,000 registered businesses in India, generating a yearly turnover of R35,000 crore. There are also non-registered chit fund businesses, estimated to be 100 times the size of registered businesses.
Even though common perception is that chit fund is an unregulated product, in truth, it is an over-regulated industry. It is guided by the Central Chit Fund Act, 1982 and Section 45 (1) of the Reserve Bank of India Act, 1934, while the administration of chit fund falls under the ambit of the state government where the business is located. Section 89 of the Central Act also empowers the state governments to make rules in consultation with RBI, to give effect to the provisions of the Act. For states without a chit fund legislation, chit businesses are by default governed by the Central Chit Fund Act. So, the obvious question that arises is that despite the existence of so many regulations, why do chit funds scams continue to occur?
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The truth is that most of the commonly cited scams are in fact not chit funds at all. The Saradha scam unleashed itself on the common public, turning out to be the biggest ponzi scheme to have happened in the annals of this country. The media and the common public took no time to paint chit fund companies with the same brush as that of Saradha, completely ignoring the fact that the Saradha group was not even a chit fund business. While chit funds are classified as NBFC (miscellaneous) and are banned from accepting deposits from public by RBI; Saradha Group was a Residuary Non-Banking Finance Company (RNBFC) that accepted deposits from people on the pretext of awarding them with residential flats on maturity. To an average individual, it was not even known that Saradha was not a chit fund company. The Rose Valley Group Scam, another ponzi scheme reported to be seven times the size of Saradha, was no different. Another common misconception has been associating registered chit funds with prize chits. Prize chits were banned under The Prize Chits and Money Circulation Schemes (Banning) Act way back in 1978. Under the prize chit scheme the promoter used to collect deposits, in whole or in instalments, by way of subscription or membership fee. The collected money was further utilised to award a randomly selected person from the scheme with prize in cash or kind. In such schemes, the prize winner was not mandatorily under a liability to make further payments after he/she won a prize.
Finance ministry did in fact set up the Key Advisory Group (KAG) on Chit Fund in 2011. The evaluation by the KAG brought forth a whole set of recommendations. First, the KAG suggested immediate revision of the 1982 Act, including tightening of prudential norms. The Chit Fund Act of 1982 is loosely based on the Cochin Kuries Act of 1932 making it almost a century-old law. Second, the creation of a self-regulatory organisation was recommended, much like the Institute of Chartered Accountants of India (ICAI) and the Association of Mutual Funds in India (AMFI). This would increase transparency, advocate best practices, generate investor awareness and improve investor protection measures. Third, the group suggested the need for an independent advisory committee to coordinate between the multiple policymakers. Fourth, the committee also emphasised the need for a common central registrar to coordinate with state registrars for public information and grievance redressal. Fifth, in the interest of investors’ protection, the committee also recommended insurance coverage for subscriber’s money, credit rating of chit fund houses and development of a grievance redressal mechanism. Sixth, the committee also suggested securitisation as a way of allowing chit fund businesses for meeting liquidity requirements and to undertake fee based activities such as cross-selling of financial products. However, these recommendations have remained on paper and no headway has been made despite repeated assurances by the ministry of finance to implement them.
Chit fund is an excellent tool to promote financial inclusion, if channelised in the right format. And unless the government takes some proactive initiatives, an age old, tried and tested mechanism of micro-saving and micro-borrowing will be erased. Yet, policymakers seem to view chit funds with a certain degree of repugnance. Archaic legislations have made it impossible for the chit fund industry to adopt technology and move to a system of e-auctions and e-payments because of the insistence of “physical presence” required as per Sections 16 of the Central Chit Fund Act.
It is high time that policymakers review their apathy for the chit fund industry to redesign and modernise the legislation that regulates this widely spread financial practice. Otherwise, the day is not far when another Saradha or Rose Valley will erupt only to be unfairly branded as a chit fund scam!
The author, Arindam Goswami is associate fellow, Pahle India Foundation.Views are personal