Personal Finance

Chit Funds: The good and the bad

Satya Sontanam | Updated on November 13, 2019

If you plan to join a chit fund, keep off the unregistered ones

“I invest a small amount in a chit fund every month and at the end of the term, I use the lumpsum to buy gold as an investment,” says Kalpana, 26, working in an IT company in Chennai. Like Kalpana, there are many in the country who prefer investing in chit funds over other financial instruments. To them, the benefits from chit funds seem obvious — higher returns (reportedly sometimes as high as 18-20 per cent per annum), option of getting a quick loan, and the ease of operation.

But not all is hunky-dory with chit funds. Many chit funds have been in the news, often for the wrong reasons. There have been several instances of chit fund frauds or the organiser disappearing with the contributors’ funds. Some recent high profile cases of investors losing money in chit funds include the AgriGold scam.

Unlike the Reserve Bank of India and the Securities and Exchange Board of India that regulate bank deposits and stock market investments, respectively, there is no regulatory body for chit funds that can provide timely legal remedy in case of an adverse event. Thus, investments in chit funds are only for those whose risk appetite is high.

Even if your risk-taking ability is high, stick only with registered chit funds. These are governed by the Chit Funds Act, 1982 and administered by State governments. Registered chit funds must keep security deposits equal to the chit value, with the Registrar of Chits appointed by the respective State governments.

Unregistered chit funds are those operated informally among relatives, friends or colleagues; these are considered illegal and far riskier than registered chit funds. It’s best to keep away from unregistered chit funds; in a bad situation, you may end up running from pillar to post without much remedy.

Here are a few things that investors in registered chit funds need to to be aware of and cautious about.

How it works

In a chit scheme, a group of people contribute towards the chit value periodically for a duration that equals the number of investors.

For instance, let us take a scheme where a group of 10 people contribute ₹1,000 every month for 10 months – this makes the chit value ₹10,000.

Every month, an auction is conducted wherein the members bid for the chit amount. The person who bids for the lowest amount — by offering the highest discount — is awarded the bid.

The discount can range from a minimum of the foreman (fund administrator) commission (up to 5 per cent) to a maximum of 40 per cent.

The discount is distributed among all the members equally after deducting the foreman’s commission and other charges.

In the above example, say, the winning bidder offers the lowest bid, of ₹7,000, that is, discount of ₹3,000. After deducting the foreman’s commission of, say, 5 per cent (₹500, the balance discount of ₹2,500 will be distributed as dividend among all the 10 members, that is ₹250 each This can be paid to the members or adjusted against their contribution due next month.

The bid-winner has to continue contributing to the chit fund but cannot bid again.

Also, the winner has to offer enough security for the due payment of all future subscriptions unless he/she offers to deduct the amount of all future subscriptions from the bid amount.

Don’t miss the payment

Before committing to invest in chit funds, be sure about your financial ability to stay the course, else the penalty, interest charge, and security encashment could burn a hole in your pocket.

If you default in paying the subscription due as per the chit agreement, you will be termed a ‘defaulting subscriber’ and may have your name removed from the list of subscribers.

Unless you pay the defaulted instalment with interest (at a specified rate), your name will not be re-entered in the list of subscribers.

If you fail to pay, the amount contributed by you until then will be returned only at the termination of the chit.

Meanwhile, if there is another subscriber willing to take your place by paying all the instalments until the date of substitution, the foreman will pay back your contribution immediately. But, even here, you will not be paid interest on the amount that you have invested until then.

What if you default in making payments after having won a bid? In this case, the foreman might send you a written notice to make the consolidated payment of all the future instalments forthwith; this could be a huge financial burden. The foreman encashing the security deposited by you on winning the prize amount, could also cost you dear.

Know your rights

Understanding the terms and conditions such as the number of instalments, the amount payable for each instalment, and the interest or penalty, if any, on payment default is crucial before participating in the chit. The organiser should provide you the copy of the chit agreement before the first draw. Make sure to get your copy.

During the course of the chit, you have a right to inspect the chit documents in the Registrar’s office. You may also obtain a certified copy or an extract of documents or records.

You can also apply for winding up of the chit fund company in certain circumstances including when the foreman is not able to pay the amounts due to subscribers, or when you can prove that there has been a fraud or collusion in the matter of taking securities from any prized subscriber.

The Chit Fund Act states that any amount due to the subscriber from a foreman in relation to the chit business shall be a first charge on the chit assets.

Be aware

If you have an appetite for high-risk and choose to invest in a chit fund, opt for registered entities with a long track record and financially sound promoters. The list of registered chit fund companies is available on the MCA website.

Do not fall prey to chit funds that claim that the amount will double or triple in a certain time. Returns from chit funds are not assured and depend on the bidding interest.

Published on November 12, 2019

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