S Murlidharan

How large chit funds cheat

S. MURLIDHARAN | Updated on March 12, 2018

The Saradha episode highlights the fact that rural areas are underbanked   -  Business Line

Chit funds are fine as a kind of self-help group for those with modest means. Once they grow, like Saradha, they become dubious.

Chit funds are a classic example of a self-help groups, if one were to go by their origin. The group typically included those in the neighbourhood, known to each other or those glued by some other common bond like workplace, kinship or vocation.

Let us say, five members join hands, and agree to subscribe Rs 1,000 each every month for five months with the understanding that each month the amount pooled of Rs 5,000 would be bid for, and the one offering the maximum discount would win the prize.


In the first month, let us say the first member bids Rs 4,500 and the fifth Rs 4,800 for Rs 5,000. The first in view of the offer of higher discount of Rs 500 vis-à-vis the discount offered of Rs 200 by the fifth, wins the prize.

The prize-winner now is debarred from bidding in the ensuing four remaining bids but remains committed to pay the remaining four instalments of Rs 1,000 each. This is how the game goes, with there being no explicit repayment of loan or explicit interest thereon.

The implicit interest is built into the discount which is variable, fluctuating each time depending on the aggressiveness of the bids. For the non-prize winners, the dividend received from out of discount received from the highest bidder is the reward.

The most passive of them gets the last tranche of chit amount sans offer of any discount and thus might be perceived as getting the maximum reward.

But that would be naïve because the one bidding aggressively is doing so with an eye on putting the money in a lucrative business deal.

Well, this in nutshell is how chit funds came to be described as saving-cum-borrowing schemes that came handy to meet exigencies like death or ill-health as well as joyous occasions like marriages and child-birth in the family.


In course of time, chit funds came to be eyed by businessmen with covetous eyes. For them, the discount offered proved to be much less than the interest charged by commercial banks. The prize also was won without much ado, sans the stifling conditions normally put by banks.

Chits suit those businessmen who enjoy humungous profits and for whom the discount offered proved to be a piffling amount.

With profits beckoning, money lenders and non-banking financial institutions entered the chit fund business.

Weak regulation

The Centre stepped in and enacted the Chit Funds Act, 1982 that extends to the whole of India save Jammu and Kashmir.

Small wonder, the West Bengal Government has been heard saying that chit funds are the Centre’s baby in the context of l’affaire Saradha chit funds. Be that as it may.

The law itself is no great shakes, though.

It should have laid down the maximum number of tickets per scheme. In its absence there can be thousands of subscribers, each holding as many tickets — subscription units — as they want.

Gullible investors hardly realise their money is not secure. The law permits conducting of bids with a laughably low quorum of just two.

It also normally permits schemes to run for five years, which can be extended to ten years with the special permission of the State government. Chit fund companies are allowed to collect aggregate subscriptions not exceeding ten times their net worth.

With such slack and liberal regulations, chit fund companies are having a field day. Business is conducted in closed rooms sans meaningful subscriber participation, because only those interested in bidding attend.

The vast majority views the schemes as essentially savings-oriented, little realising that the security offered by the ‘foreman’ as well as the prize winners is often woefully inadequate.

When the prize winners decamp after winning the bids, precious little therefore can be done and the gullible non-prize winning subscribers have to bear the cross.

It is common knowledge that the prize winners are those belonging to the charmed circle of the foreman, read the chit fund company.

Shut doors on businesses

The Centre should clamp down heavily on chit fund companies.

Initially, chit funds catered to small people with modest means, as a self-help group with minimal fuss and paperwork. Once the group is no longer small, the mutual trust is lost.

Businessmen should be made to seek the more transparent and better regulated bank finance or the costlier microfinance, if they want financiers at their doorsteps.

Chit funds, especially those catering to a large number of members, are opaque both in their operations and eliciting of bids.

Unlike in bank borrowings, the interest rates are not explicitly set out but have to be deduced from the discount offered and the number of instalments yet to be paid after winning the prize.

Chit funds thus should be allowed to operate only as household enterprises and not on a large scale. Schemes with more than 50 members should be declared illegal.

The size of each ticket should not be allowed to exceed, say, Rs 20,000. And the duration of a scheme should not be allowed to spill over beyond the third year.

That chit funds are essentially meant for small householders is reinforced by the Chit Fund Act itself — periodic contributions can be made in rupees or grain!

Incidentally, l’affaire Saradha has brought to fore once again the grim fact that the Indian rural landscape is thoroughly under-banked.

Rural folks gravitate towards chits and other unconventional banking or para-banking services.

(The author is a New Delhi-based chartered accountant.)

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Published on April 24, 2013
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