When we talk about the informal economy, we are not just talking about the unorganized wage and labour set-up, but another purely cash-driven business model – the Chit Funds business. Come to think of Demonetization of the ₹500 and ₹1000 currency notes, which is a super – duper move to discipline parallel and black economies; this is one sector that has taken a bleeding blow. The Chit fund business is part of both the organized and unorganized sector. It falls under the so called grey area of the financial system.
While there are legally run chit fund businesses like the Margadarsi Chit Fund, MSIL and Indira Nagar Chit fund, there also a large number of chit funds that are home – run and completely localized. In truth, the localized ones are the most popular for reasons like knowing the organizer by face or in-person; the organizer is a friend, colleague, neighbour or well-known to a friend or relative. Another important reason chit funds in the unorganized sector are popular is because of liquidity, zero-tax and the all-in-cash’ characteristics of the business. And it goes without saying, that profits from the business too go unaccounted. This is typically why the demonetization drive has become an unfavorable move for the informal sector. So here we go…
Gajendar Bellad, works for the Karnataka Food and Civil Supplies Corporation. He is of the strong belief that goods like a fancy mobile phone, a two wheeler, other consumer durables or pre-owned cars, gold etc., cannot be afforded in a government employee’s salary. The localized chit fund allows him to buy the things his family fancies. Apart from the EPF, a Life Insurance and some gold, he has no other investments or savings he can fall back upon. He pays the monthly chit contribution and bids on it when he has an emergency or when he needs to make a purchase. He looks at Demonetization as a punishment for the undeserved.
Many people like Gajendar rotate everything they earn. Individuals who make anything below ₹25,000 and those who cannot avail a personal loan or a credit card, use the Chit Fund like a short term investment.
How do Chit Funds work?
Important for us to understand why this sector looks at demonetization and ‘going cashless’ as a blow below the belt. For example: If 20 members are part of a ₹1, 00,000 chit fund each member would have to contribute ₹5000 every month. The group will have one organizer or primarily the chit owner who would take the pains of organizing, calling for a meeting, collecting the chit money from the members every month etc., the organizer will be paid 5% of the bid amount every month.
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Every month the member who places the lowest bid takes away the chit. For eg: If three people bid ₹95000, ₹90,000 and ₹89000 the member who bid ₹89000 (lowest bid) will be given the chit for the month. The lowest bid is mostly from a member who is in urgent need of the cash. Of this ₹89000 , 5% of ₹1, 00,000 – the organizer’s fee which is ₹5000 is deducted, and the member receives ₹84,000 The balance of ₹11000 which is the profit (₹1, 00,000 – ₹89,000) is shared by all the chit members. This cycle continues for the next month too. The member who wins the bid for the month will not be allowed to participate in bids of the subsequent months, but will continue to pay the monthly chit value.
Why the Chit Fund is not an Investment?
Returns: Assessing returns in a chit fund is not a logical, data driven or rational process. It depends on how low the bids can go each month.
Risk: A big YES! There is substantial evidence and news about chit fund companies that have gone bust. The Chit Funds are regulated by the Chit Fund Act of 1982, which applies to every state in India except Jammu and Kashmir. The localized and unrecognized chit funds are the ones that can run away with your money at any time. No guarantees whatsoever. For that matter, even registered Chit Funds have gone bust.
Mythili is a smart housewife who resides at Madivala, Bengaluru. Her chit fund came crashing down after the Demonetization announcement. Running several chits at a time and rotating close to a crore, she has urged her subscribers (mostly housewives, shopkeepers, and other second-class government and quasi government employees) to book losses or divide them equally on the existing fund and move on. Her subscribers have been frequenting her house, sometimes even late in the night demanding a refund.
Legality: Every unregistered Chit Fund is illegal. It is so rampant in India and has every kind authority in its loop making it secretly and hideously popular among income groups which look at the Chit Fund as their emergency fund or short term investment. Above all, the Chit fund is structured in a way to exploit financial weakness. It cannot become an investment option. A subscriber’s profit is dependent on another subscriber’s emergency or need of cash. If a friend or a colleague is inviting you to join a chit, think twice.
Know about Investments that are legal, rewarding and ones that balance risk and enable you achieve your financial goals by offering you information about your choices.
This article has been contributed by Right Horizons