How Does It Work? The Fi­nan­cial Logic

Consumer Voice - - Bfsi -

A chit fund is a sav­ings-cum-bor­row­ing scheme wherein a few peo­ple (known as mem­bers or sub­scribers) come to­gether and in­vest a fixed amount ev­ery month for a fixed pe­riod. Some say that it’s a per­sonal loan, a re­cur­ring de­posit and a kitty party rolled into one.

The num­ber of months for which the in­vest­ment is made is the same as the num­ber of sub­scribers in the scheme. Ev­ery sub­scriber gets a turn to take the to­tal amount col­lected in a month; this means in ev­ery month one sub­scriber will get the col­lected amount. The sub­scriber to get the money will be de­cided based on ei­ther a lucky draw or a bid­ding sys­tem, the lat­ter be­ing the pop­u­lar op­tion. Once a sub­scriber gets his turn, he is not al­lowed to par­tic­i­pate in the bid­ding again. Gen­er­ally, those who are in need of money in a par­tic­u­lar month par­tic­i­pate in the bid­ding, and the sub­scriber with the low­est bid is al­lowed to take the amount. The chit fund scheme is man­aged by one of the mem­bers, known as the fore­man. He is re­spon­si­ble for col­lect­ing the sub­scrip­tion amount from sub­scribers, record­ing de­tails of mem­bers and con­duct­ing the auc­tions. For these du­ties he is paid a fee, which is gen­er­ally five per cent of the amount col­lected. The fore­man’s fee is re­duced from the amount paid to the sub­scriber who wins the bid. Any ex­tra amount from the monthly col­lec­tions is dis­trib­uted equally among all the sub­scribers. The chit-fund com­pa­nies are ba­si­cally the fore­man.

Il­lus­tra­tive ex­am­ple

As­sume there is a chit fund with 10 mem­bers/sub­scribers con­tribut­ing Rs 3,000 each per month for 10 months. The to­tal monthly col­lec­tion in this chit fund is Rs 30,000. Sup­pose in the first month there are two mem­bers who need funds and par­tic­i­pate in the bid­ding. One mem­ber bids for Rs 27,000 while the other mem­ber bids for Rs 26,000. The sec­ond mem­ber be­comes el­i­gi­ble to draw the money for the month as his bid is lower than the first mem­ber’s bid. (If there is more than one mem­ber bid­ding for the same low­est amount, a lot­tery is drawn to de­ter­mine which of the mem­bers will be el­i­gi­ble for with­draw­ing the amount.) In this il­lus­tra­tion, the sec­ond mem­ber can with­draw Rs 24,500 (sub­tract­ing fore­man’s fee of Rs 1,500, which is five per cent of Rs 30,000). The re­main­ing Rs 4,000 (Rs 30,000 – Rs 26,000) is dis­trib­uted equally among all the mem­bers – so each mem­ber gets Rs 400 each. So in ef­fect, dur­ing the first month each mem­ber con­trib­utes only Rs 2,600.

In the sec­ond month, another mem­ber is given a chance to with­draw the bulk amount. Sup­pose this mem­ber bids for Rs 28,000; so the re­main­ing Rs 2,000 is di­vided among the mem­bers – that is, Rs 200 per mem­ber. This process is re­peated ev­ery month for a to­tal of 10 months. On the com­ple­tion of 10 months’ pe­riod, each sub­scriber will have with­drawn a bulk amount once, in ad­di­tion to get­ting the monthly nom­i­nal amount. This monthly amount works like a div­i­dend for the money in­vested and is com­par­a­tively higher than the bank in­ter­est (FD rate) that gets ac­crued in re­cur­ring de­posit schemes of com­mer­cial banks.

Rules for de­ter­min­ing which mem­ber takes the bulk amount ev­ery month and also the with­drawal amount vary from one chit fund to another in dif­fer­ent states. How­ever, they all have to abide by the Chit Funds Act 1981.

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