A chit fund is a type of savings scheme typically found in India. It essentially involves a group consisting of subscribers. Each of these subscribers pays a fixed sum periodically over a predetermined term. Each of these subscribers is entitled to prize money that is determined through lottery or draw of lots. Chit funds in India are regulated by Chit Fund Act of 1982.
How chit funds work
The most important criterion of a chit find is that the number of subscribers or members to a fund must be equal to the duration of a fund, which usually is in term of months. For 50 subscribers the duration of chit cannot be more than 50 months and for 100 members 100 months. The working of a chit is best illustrated by an example.
The process begins with determination of a chit amount, say Rs. 10,00,000 (rupees ten lakhs). Let it be assumed that the duration of this chit amount is 100 months. This period of 100 months is known as term period. Once the term period gets fixed at 100 months it is mandatory that there must be 100 members or subscribers in the chit group. The person conducting this chitty is termed foreman.
Responsibilities of foreman:
- The foreman is the key person in a chit group;
- Foreman is responsible for gathering subscribers/ members and collects money from them;
- Foreman further bears the responsibility of registering concerned chit with Registrar of Chits;
- He/she has to pay 100 percent of the entire chit amount as security. This security money cannot be withdrawn till every member is paid corresponding dues and the chit group closes.
The last point protects the interest of subscribers to a significant extent.
In this example, chit amount of Rs.10,00,000 is to be shared by 100 members equally, i.e. Rs.10,000/- per member per month. The monthly subscription or subscription is the maximum that a member might contribute every month. After this money is collected it is placed among members for auction. According to custom, the member who bids lowest gets the prize money. Let us assume that the lowest bid is 60 percent of pot amount of Rs.10,00,000, i.e. Rs.6,00,000.
For every auction, foreman is paid 5% of pot amount. In our example it works out to Rs.50,000 (5 percent of Rs.10,00,000).
The proceeds of an auction go like this:
Pot amount of Rs.10,00,000 – 6,00,000 (lowest bid amount) = Rs.4,00,000 remaining;
Rs.4,00,000 – Rs.50,000 (foreman’s 5% commission) = Rs.3,50,000.
This amount of Rs.3,50,000 is distributed equally among 100 members, so each member receives Rs.3,500. The net contribution for every member comes to Rs.6,500 for the first month.
In this way, the auction is carried every month. A member can be a bidder during the entire time period of a chit fund. In this way all hundred members get a chance of bidding during the term period of 10 years.