The Hindu Business Line : `Chit funds stunted by stiff regulations'

The major inhibiting regulations are those that relate to cap on the foreman's commission, cap on the discount that can be offered by the bidders and the enormous, time-consuming filing requirements, the study says.

The Chennai-based Shriram Chits Pvt Ltd mandated the study.

Chit funds are among the oldest financial institutions in the country. They specialise in micro credit.

A chit fund operates like this: A group of, say, 20 people agree to contribute a fixed amount, say Rs 500, every month, so that the group pools in Rs 10,000 each month — the `prize' money.

Every month an auction is held. The member who offers the highest discount is given the prize money. For example, a person, in an urgent need of money, may take the prize at a discount of Rs 3,000.

The person or company that conducts the chit— called `foreman' — will pay him Rs 7,000 after deducting a fee. The `prize-winner' will, however, continue to pay Rs 500 every month. The amount `discounted' (Rs 3,000 minus the foreman's fee) is the profit for the group, which will be distributed among all the 20.

Now, the Chit Funds Act 1982, caps the discount that can be offered at 40 per cent. This legislation was brought in to protect borrowers from having to pay high rates of interest.

However, the borrower is not going to pay a rate higher than what he can get from the market. The rates are arrived at by a bidding process which is a market-determined rate. So, why mandate a ceiling? asks Ernst & Young.

"The auction procedure makes the chit a financial product based on market mechanics in such a pure form as to be unparalleled by any other single financial product available in the country," comments E&Y.

Second, the foreman's commission is capped at 5 per cent. "This ceiling was determined on the basis of studies conducted on small chit operators, functioning from their residences," notes E&Y.

However, the ceiling does not make any provisions for either the risks assumed by the foreman or inflation.

Further, chit companies are prohibited from transacting any other business.

However, the aggregate chit amount is restricted to 10 times their net owned funds. "If chit companies are permitted to carry on other activities up to some limit, they would be able to support the chit business by marketing other products using their network strength," says E&Y.

And, the chit companies have to file enormous amounts of returns. For example, Shriram Chits files some 4.5 lakh pieces of paper every year. Who reads these papers?

The study says that the size of the chit funds industry is about Rs 20,000 crore. The industry is mostly unorganised. The leading companies in this business are the Chennai-based Shriram Chits and Margadarshi Chit of Hyderabad. Shriram has some 17 lakh customers, while Margadarshi has about 2.7 lakh.