What Is A Chit Fund & How Do Chit Funds Work?

A chit fund is a rotating saving scheme that has been a part of India’s financial system for more than a century now. It is also known as chit, chitty or kuree. Chit fund is an excellent financial instrument for both – saving and borrowing. As a savings instrument, it gives a good return on investment, and as a borrowing scheme, it can be a reliable source of funds in emergencies and otherwise.

Table of Contents

How Do Chit Funds Work?

In a chit fund scheme, a group of people contribute periodically towards the chit value for a duration equal to the number of investors (members or subscribers). The amount collected is given to the person, who is either selected through a lucky draw (lottery system) or an auction.
In the auction allotment system, the person who bids the lowest bid (agrees to claim the lowest amount) gets the money. This type of auction system is known as a reverse auction. The amount forgone by the winning bidder is then distributed among the other members equally after deducting the foreman’s commission and other charges. The amount received by each member is called a dividend. Even after claiming the amount, the winning bidder has to continue investing.
The chit fund begins at the pre-decided date for the number of months equal to the number of investors. The subscribers contribute their monthly instalments into the pot. An open auction is then conducted, allowing the members to bid for the chit fund value. The subscriber who is willing to take the lowest sum is announced the winner and gets to take the chit fund for that month.

Video: How Does Chit Fund work?

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The Math Behind Chit Fund Reverse Auction Scheme

Lets check out how chit fund works with the help of an example:

Let’s assume that a chit fund scheme has 50 members, each paying a monthly instalment of ₹1000 to have a first-month pot of ₹50,000. When the auction is announced, the member who bids to take home the least amount of the chit fund wins the bid.
Let’s assume the winning bidder agrees to accept ₹45,000 of the total chit fund value for that month, the rest of the amount – ₹5,000 – is distributed equally amongst the other 49 members, after subtracting the organizer’s fees.

Quick highlights of the above example:

The winning bidder gets access to a lump sum of ₹45,000 in the first month.

(Chit fund acts as a borrowing scheme here)

The other 49 members earn good returns on the amount they invested.

(Chit fund acts as a saving instrument here)

The organizer gets the commission.

(Chit fund allows the organizer to be compensated for putting in efforts to organize the event)

So, it’s a win-win for all.

The process repeats with each member getting the opportunity to take the auction amount each month while all the other subscribers, including the previous month’s winning bidder, continue to contribute their monthly instalments.

What Can You Use Chit Funds For?

Chit funds address the following needs:

  • Consumption
  • Emergency
  • Investment
  • Business
  • Saving

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Features of Chit Funds

Here are 6 features of chit funds you must know before investing

  • They are a credit and savings schemes rolled into one.
  • They act as a microfinance institution.
  • They have predetermined value and duration.
  • They allow you to borrow at an interest rate lower than moneylenders.
  • They are best for meeting the financial requirements of people belonging to lower-income households.
  • The deposits made by all the subscribers are turned into a lump sum.

Types of Chit Funds

There are five different types of chit funds that you can invest in and be a part of.
  • Registered Chit Funds
  • Unregistered Chit Funds
  • Online Digital Chit Funds
  • Organized Chit Funds
  • Special Purpose Chit Funds
 
  • Registered Chit Funds: Registered chit funds are the ones that are registered with the Registrar of Firms Societies and Chits. The RBI regulates these types of chit funds with Chit Funds Act, 1982 that is enforced across states in India.
  • Unregistered Chit Funds: Investment instruments: Unregistered chit funds are saving schemes that are operated among friends, family or colleagues. This type of chit funds is considered riskier than registered chit funds.
  • Online Digital Chit Funds: With digitalization, chit funds have evolved and are organized online. These types of chit funds have online auctions. The subscribers can make their monthly contributions online and also receive their prize money through online modes. In this type, each subscriber has to create an online account through which he/she can manage and circulate chit funds.
  • Organized Chit Funds: More common in North India, this type of chit fund requires all the members to come together on a monthly or weekly basis. The names of all the members are written on small paper slips and collected in a box. The person in charge of the group picks up a paper slip in front of all the group members. The name picked up gets the whole collection of funds. That name is then removed from the box. For the next meeting, even though the member’s name will not be selected again, he/she has to be present and contribute their share of the money.
  • Special Purpose Chit : Funds: Special purpose chit funds are organized to save for a particular purpose. For example, a group of neighbourhood women could group together to organize a saving scheme for Diwali sweets. This Diwali sweets fund would have an end date, which is usually one week before Diwali. The fund collected is used to buy and prepare sweets in bulk. The prepared sweets are then distributed among all the members during Diwali. Special purpose chit funds reduce the cost and also the effort.
  • Top 9 Benefits of Chit funds

    The Benefits of Chit funds are

    • Saving and investment tool: Chit funds offer you the advantage of saving as well as borrowing.
    • Quick access to money: It’s easy to join a chit fund scheme, and you have the opportunity to borrow the lump sum (the pot) by just paying the first instalment.
    • No or less paperwork: It’s a great product to meet the financial needs of people without providing documents such as IT returns, PAN card etc.
    • No collateral: Unlike banks and other financial institutions which ask for tangible security, the chit fund is given on personal sureties.
    • No questions asked: You don’t need to reveal the purpose of using the borrowed money (the pot) .
    • Emergency cash:You can easily access the money to meet an unexpected expense or a financial emergency.
    • High dividend:The subscribers get a dividend which is comparatively higher than the interest accrued on the money saved in various deposit schemes.
    • Low interest:The subscribers mutually determine the interest rate, and it varies from auction to auction. Additionally, the interest rate of borrowing from the chit fund is comparatively lower than other forms of borrowing.
    • Flexibility in its usage: You can draw upon your chit fund for any purpose you wish – marriages, shopping, travel, medical expenses, religious ceremonies, festivals, children’s education, etc.
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    List of 12 Best Chit Fund Companies & Platforms in India

    12 Best Chit Fund Companies & Platforms in India are

    • 01

      The Money Club

      The Money Club is a fast-growing digital chit fund platform that ensures zero risk, zero paperwork and lowest commission as compared to the traditional chit fund platforms.It is a transparent, safe and secure platform that allows like-minded people from all over India to save, invest or borrow efficiently through their smartphones.

    • 02

      Government of Kerala Backed Chitty

      The government of Kerala supports the Kerala State Financial Enterprises (KSFE). To a great extent, it is limited to the people of Kerala. It’s a risk-free financial product that blends the advantages of both borrowing and investment.

    • 03

      Shriram Chits

      Shriram Chits is the biggest chit fund company in India. It is safe and protected and serves various states like Maharashtra, Andhra Pradesh, Tamil Nadu and Karnataka. It has about 6,000 chit representatives.

    • 04

      Mysore Sales International

      Mysore sales international limited began chit funds business in 2005, and it belongs to the Government of Karnataka foundation. Popularly known as MSIL, this company gives access to quick money in emergencies.

    • 05

      Purasawalkam Santhatha Sanga Nidhi Limited

      Purasawakam Santhatha Sanga Nidhi Limited, established in 1879, is a public limited company and it is classified as a Non-government Company. It is registered at Registrar of Companies, Chennai. The company’s authorized share capital is ₹20,000,000, and its paid-up capital is nearly ₹7,350,000.

    • 06

      Margadarsi Chit Funds

      Margadarshi Chit Fund Private Limited was founded by Ramoji Rao of Eenadu groups in 1962. It has three branches in three different states – Tamil Nadu, Andhra Pradesh and Karnataka.

    • 07

      Guru Nanak Chit Fund

      Guru Nanak Chit Fund Pvt Ltd, established on 29 June 1964 is a private limited company, classified as a State Government company. This company is registered under the Registrar of Companies at Kanpur. The company’s authorized share capital is ₹20,000.

    • 08

      Gielle Investments Ltd

      Gielle Investments Ltd is a public organization, delegated as a non-government company. It is registered with the Registrar of Companies, Kolkata. It has an authorized share capital of ₹10 Lakh and its paid-up capital is ₹6 Lakh.

    • 09

      Kapil Chit funds

      Kapil Chits is a private limited company, established on 29 August 2008. This is a non-government company, registered at Registrar of Companies, Hyderabad. It has an authorized capital of ₹50 Lakh.

    • 10

      Amruthadhara Chits and Finance Private Limited

      Amruthadhara Chits and Finance Private Limited, established on 31 December 1900, is a non-government organization. This unlisted private organization is named ‘organization restricted by shares’. This company’s approved capital is ₹2.5 Lakh, and its paid-up capital is at 18.4% (₹40,000).

    • 11

      Louis Chit Funds Private Limited.

      Louis Chit Funds Private Limited is a private unlisted, non-government organization, named under ‘organization restricted by shares’. Its authorized share capital is ₹50,000, and its paid-up capital is ₹48 Lakh (96%).

    • 12

      Gokulam Chits

      Sree Gokulam Chit & Finance Co. Pvt. Ltd. (SGCF) is the flagship company of the Gokulam Group of Companies. This Chit and Finance business started at Mylapore, Chennai on 23rd July 1968 and has branches in Tamil Nadu, Kerala, New Delhi, Andhra Pradesh, Maharasthra, Karnataka, Telangana, Puducherry (Pondicherry), and Haryana..

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    Top 6 things to Consider Before Investing in Chit Funds

    Chit fund can be a risky investment. Hence you should take the following precautions before investing money in it:

    • Make sure that your chit fund is a registered company. Check the certificate of incorporation from the registrar of the companies.
    • Find out who the promoters of the chit fund company are. Ensure that they all are financially sound.
    • Check the registration number and certificate issued by the registrar of chit funds of the state in which the chit fund company operates.
    • Find out how much commission the foreman takes. Choose the chit fund company with the lowest commission.
    • Find out from the office of the registrar of chit funds whether there are any complaints or pending court cases against the chit fund company.
    • Ensure that you are financially prepared to contribute throughout the chit fund cycle.

    FAQs

    Q. Are chit funds legal?

    Ans. In India, chit fund companies come under the Chit Fund Act, 1982 and hence are legal, registered, and safe. They are different from unregulated deposits and Ponzi schemes. Unregistered chit funds are not legally bound to pay the amount deposited to its members. Hence, they pose a maximum risk of fraud.

    Q. Who regulates chit funds?
    Ans. The Chit Fund Act, 1982 regulates the chit fund companies in India. Under this law, the chit fund business registration can be done only by its respective state governments. The government appoints the Chit Registrar under section 61 of the Chit Fund Act, 1982.
    Q. Are chit funds safe?
    Ans. The registered chit funds are safe as the Chit Fund Act, 1982 regulates them. Under this law, the chit fund business can only be registered by its respective state governments. During the registration, the owner has to pay a security deposit with the registrar of chits, which is 100% of the chit value. The security deposit can only be taken out when the chit fund group closes, and every member is paid what’s due to them. Thus, this regulation protects the money invested by the subscribers. If fraud occurs, the Registrar of chit fund and the concerned State Government can take regulatory action against the chit fund company’s owner. Unregistered chit funds don’t have any legal binding to pay the deposited amount to its subscribers, hence are not safe.
    Q. Is chit fund a good investment?

    Ans. Chit funds have a bad reputation because scamsters have misused them in the past. However, registered and government-run chit funds are one of the best investment instruments as they pay good dividends. Many people, especially from small towns, have benefitted from such schemes.

    Q. Is GST applicable for chit funds? Who pays the GST?
    Ans. GST is applied to the services provided by the foreman of the chit fund. The GST on chit fund was fixed by the GST council during the introduction of GST in July 2017 and is at 12% with ITC of input services.
    Q. How do you save yourselves from chit fund scams/frauds?
    Ans. When you decide to invest in a chit fund company, check the chit fund companies’ list in the chit registrar of the respective state. If the chit company’s name is mentioned in the list, you can invest your money in the company. If the name doesn’t appear in the list of approved chit companies, don’t invest your hard-earned money.Another point to consider here is that whenever anyone approaches you to invest in a scheme where you need to add some members to earn higher commissions, take it as a red flag and stay away from it as it is most likely to be a Ponzi scheme.