Chit Funds

The simplest form of chit fund arises among a group of people who know each other, such as family members, neighbors or co-workers. Participants contribute a certain sum at regular intervals – typically once a month – and take turns withdrawing the total pool. The order in which participants receive the fund is usually determined by random drawing. By providing individuals with lump sums of money, chit funds allow them to fund major purchases, pay for unforeseen expenses or make investments they normally couldn’t afford on their own.

Other chit funds involve the payment of a commission to an organizer, or foreman, who oversees the collection and disbursement of funds. At each interval, subscribers “bid” on the pool, with the lowest bid receiving the money. The difference between the bid and the total fund – known as the discount, or interest – is then distributed equally among the other subscribers, minus the organizer’s commission (usually 5%). Once a subscriber has placed a winning bid, they are no longer eligible to bid on future pools, although they are still required to make their regular contributions for the duration of the fund.

Commission-based chit funds offer various advantages to subscribers. For individuals facing immediate financial needs, the bidding process offers an opportunity to pay a premium to receive the cash right away. For subscribers more interested in saving money over the long term, the structure of the chit fund allows them to withhold their bids until the end of the cycle, when a lack of competition gives them a chance to offer a lower discount for the pool. In this way, commission-based chit funds provide participants with a certain amount of financial flexibility depending on their needs.

A rise in chit funds scams in India during the 20th century led to the passage of the Chit Fund Act in 1982. Chit funds became subject to strict regulation, which gave consumers certain protections against fraud. Since that time, registered chit funds have played an increasingly active role in India’s financial sector.

Even with increased government oversight, however, unregulated chit funds continue to thrive in India, particularly in rural areas. Despite their inherent risks, these informal financing associations provide a vital financial service to people unable to obtain credit from conventional banks. A cornerstone of Indian economic activity for centuries, chit funds demonstrate the power of the collective to help individuals achieve fiscal freedom and autonomy.

Contributor: Stephen Meyer