Have you ever wondered about chit funds and how they operate?
In India, chit funds have been around for ages, helping people save and borrow money in a simple yet effective manner.
Let’s talk about chit funds—what they mean, how they function, and a real-life example to give you clarity.
What is a Chit Fund?
A chit fund is a savings and borrowing scheme popular across India, especially in communities where formal banking services are not easily accessible.
It’s a financial arrangement among a group of people who agree to contribute a fixed amount periodically into a pool.
This pooled money is given to one member of the group every month (or a set time) through a bidding or lottery system. For operators, products like Suvit can streamline the process by automating contribution tracking and generating reports for transparency.
Sounds simple, right? Well, there’s a bit more to it. Let’s nail it down.
How Does a Chit Fund Work?
To understand how chit funds function, picture a small group of 20 people who agree to save together. Here’s how it plays out step by step:
1. Formation of the Group
A chit fund begins when a group of individuals (called members or subscribers) comes together under a chit fund operator. The operator could be an institution or an individual managing the fund.
2. Agreement on Terms
The group decides on:
- The amount each member will contribute monthly.
- The duration of the chit fund.
- The maximum pool amount (total of all contributions for the month).
For instance, if each member contributes ₹5,000 and there are 20 members, the pool amount would be ₹1,00,000.
3. Auction or Lottery
Each month, an auction or lottery is conducted:
- Auction Method: Members bid on how much they are willing to forego from the pool as a discount or commission to the fund. The highest bidder takes the money.
- Lottery Method: A member is randomly chosen to receive the pooled money.
The operator keeps some of the money as a commission or as a reserve fund.
4. Monthly Payout
The winning member takes the pool money, but they continue to pay their monthly contributions for the rest of the chit cycle.
5. Repeat Till Completion
This cycle continues until every member has had a chance to receive the pooled money.
Benefits of Joining a Chit Fund
Chit funds aren’t just about pooling money; they bring multiple advantages:
1. Dual Purpose
Members can use chit funds to save money regularly and borrow a lump sum when needed.
2. Flexibility in Usage
The funds can be used for various purposes—paying off debts, funding education, weddings, or even investing in a small business.
3. Easy Access
Unlike banks, chit funds don’t require extensive documentation or a credit score for participation.
4. Community Trust
Many chit funds are operated within close-knit communities where trust is a strong factor.
Also Read: Non-Performing Assets (NPAs): The Silent Killer of Loan Success - Don't Let It Haunt You!
Example of a Chit Fund
Let’s take an example to make this even clearer.
Scenario:
- A chit fund has 10 members.
- Each member contributes ₹2,000 per month.
- The total pool is ₹20,000.
- The chit runs for 10 months.
Month 1: The group conducts an auction. Member A bids to forego ₹3,000, so they take ₹17,000 (₹20,000 - ₹3,000). The ₹3,000 is distributed as a dividend among the remaining members.
Month 2: Another auction is held, and Member B bids ₹2,000. They take ₹18,000 (₹20,000 - ₹2,000).
This continues until all members have received the pool money once. Each member’s total contribution remains the same, but the timing of receiving the lump sum varies.
Is It Safe to Join a Chit Fund?
Chit funds can be a practical tool, but safety depends on the operator and regulatory adherence. Here are some tips:
1. Check Registration
Ensure the chit fund is registered under the Chit Funds Act, 1982. This law governs chit funds and ensures they operate fairly.
2. Research the Operator
Join only if the operator or institution has a good reputation and history of running chit funds without disputes.
3. Understand the Rules
Go through the terms carefully, including the commission charged by the operator and penalties for late payments.
4. Avoid Unregistered Funds
Many informal or unregistered chit funds operate without oversight, increasing the risk of fraud.
Chit Funds vs. Other Savings Options
Chit funds stand out because of their unique structure, but how do they compare to other options?
| Feature | Chit Funds | Fixed Deposits (FD) | Recurring Deposits (RD) |
|---|---|---|---|
| Accessibility | Easy to join locally | Through banks | Through banks |
| Returns/Dividends | Varies, can be high | Fixed interest | Fixed interest |
| Risk | Depends on operator | Very low | Very low |
| Liquidity | Depends on bid timing | Low | Low |
Real-Life Use of Chit Funds
Chit funds have been particularly useful for small business owners and traders. They use them to finance stock purchases, expand operations, or meet emergency expenses.
With Suvit, operators can easily maintain financial transparency and generate accurate reports, ensuring smooth fund operations for such critical needs.
Farmers also use chit funds during sowing seasons when quick capital is required.
Challenges and Drawbacks
While chit funds have benefits, they also come with challenges: Risk of Fraud, High Penalties, and No Fixed Returns. Addressing these issues requires careful management and transparency, often supported by tools that streamline operations.
1. Risk of Fraud
Unregulated or informal chit funds can lead to scams, leaving members at a loss.
2. High Penalties
Missing contributions can attract hefty penalties.
3. No Fixed Returns
Unlike FDs or mutual funds, returns from chit funds depend on bidding and may not always be predictable.
Also Read: Using Collateral for Loans: A Smart Move or a Risky Bet?
Shall I consider Chit Funds as A Saving Option?
Chit funds are an interesting combination of borrowing and saving.
They’ve stood the test of time, providing financial flexibility to people across various income groups.
Whether you’re considering joining one or managing one, understanding them is vital to making the most out of it, be it saving or earning!
For chit fund operators and members, managing finances and tracking contributions can get overwhelming. That’s where products like Suvit (Get a free trial) come in.
