Chit Funds

Chit Funds

• A chit fund is a type of savings scheme where a specified number of subscribers contribute payments in installments over a defined period. Each subscriber is entitled to a prize amount determined by lot, auction or tender depending on the nature of the chit fund.
• Chit funds are primarily regulated under the Chit Funds Act, 1982, which provides a legal framework for the registration and operation of chit funds.

How Chit Funds Work?

The process begins by forming a group with a fixed number of members. Each member agrees to contribute a set amount every month. The total contribution becomes the chit value. Every month, the pooled amount is given to one member, who is usually chosen through a bidding process or auction.

Understanding Chit Fund Auctions

1. All members bid for the pooled amount
2. The member who offers the highest discount receives the fund, less their discount.
3. The dividend is calculated after deducting the foreman’s commission (capped at 7% according to the Chit Funds Act, 1982).
4. Every member receives the dividend equally.

Example: Suppose the total chit amount is ₹1 lakh and a member bids with a ₹10,000 discount. The member receives ₹90,000 as the prize amount. From the discount amount of ₹10,000, the foreman’s commission is deducted as per the chit agreement, subject to the statutory limit of 7% of the gross chit amount, and the remaining amount is distributed among the subscribers as their share of discount (dividend). Each member gets a chance to take the lump sum once during the cycle. Until then, they continue contributing monthly.

Regulation of Chit Funds in India

• Legislative Competence: The Supreme Court has held that chit fund transactions are essentially contracts and fall within Entry 7 of the Concurrent List (Contracts). Therefore, both Parliament and State Legislatures can legislate on chit funds.
• Chit Funds Act, 1982: The Act provides the principal legal framework governing chit funds in India. A chit cannot generally be commenced or conducted without obtaining the previous sanction of the State Government and complying with the registration requirements under the Act.
• State-level Administration: The regulation and oversight of chit funds are managed by appointed authorities under the Chit Fund Act of 1982. State governments appoint Registrars of Chits who are responsible for approvals and regulations concerning chit fund operations.

Features of Chit Funds

• Pooling of Resources: Members contribute a fixed amount periodically to create a common pool, which is distributed to one member in each installment.
• Bidding/Auction Mechanism: In auction-based chits, members bid for the pooled amount by offering a discount. The member offering the highest permissible discount generally becomes the prized subscriber.
• Dual Role of Saving and Borrowing: Chit funds combine features of savings and credit. Members requiring money early can bid for the prize, while others can continue contributing and receive it later.
• Flexible Use of Funds: The prize amount can generally be used according to the subscriber’s needs, such as personal expenses, emergencies or business requirements.
• Continued Contribution: A member who receives the prize must continue paying the prescribed installments until the completion of the chit cycle.
• Share of Discount: The discount offered by the prized subscriber benefits the subscribers through distribution according to the chit agreement, after applicable deductions.
• Defined Duration: A chit operates for a predetermined period with a specified number of installments.
• Default Risk: The arrangement may be affected if subscribers fail to make their required contributions.
• Regulated Financial Arrangement: Registered chit funds operate within the framework of the Chit Funds Act, 1982 and are administered primarily by State authorities.