Latha Varadarajan, a 44-year-old homemaker from Chennai, has been closely following the reports of the collapse of Saradha group's financial scheme in West Bengal in which thousands of investors have lost their money. Varadarajan and her friends from a village on the outskirts of Chennai have each been depositing Rs 2,000 into an informal chit fund in Tamil Nadu every month. The news of the Saradha scheme going bust doesn't worry Varadarajan. She says she has known the person who runs the chit fund for over three decades and trusts him with her money. She has no plans of pulling out.
Varadarajan isn't an exception. Several men and women from the city are confident that the chit fund industry will survive on trust and reputation. The cascading effect of the fiasco in West Bengal, if at all there is any, will only be momentary.
Chit funds should not be confused with what are called 'ponzi schemes' or other scams (such as the emu scheme in which investors lost hundreds of crores in the southern parts of Tamil Nadu) that offer unfeasible interest rates, cash prizes or gifts, says T S Sivaramakrishnan, the proprietor of Balussery Benefit Chit Fund and the secretary of All India Chit Fund Association.
"We are treated like prostitutes," he says when asked about the political outrage against chit funds. "In private, they (the political leaders) come to us for pleasure, but in public they disown us." His indignation is hard to miss because every time somebody decamps with public money, it is put down as the machinations of unscrupulous chit funds. "In all the frauds that have been reported, including the one in West Bengal, not even a single 'registered' chit fund was involved," says he. In the last few weeks, Sivaramakrishnan has shot off angry letters to editors of newspapers that have called for collaring chit funds.
In India, where banking penetration is still very low (40 per cent of the households still remain unbanked), chit funds have been one of the major means of multiplying money, especially in the rural parts of the country. The number of households participating in chit funds stands at 5-10 per cent of the total household population in each state (except in Delhi, the figures for which are not available). According to a study by the Institute for Financial Management and Research, Chennai, money circulated through chit funds is an average of around Rs 50,000 per household (except Kerala).
Registered chit funds in the country do a business of around Rs 30,000 crore in a year (the unregistered ones could be three times bigger), and the southern states account for almost two-thirds of it. There are over 10,000 registered chit funds in India. Of these, around 2,000 are in Tamil Nadu alone and they do business of aroundRs 4,000 crore a year.
Chit funds are different from debentures, bonds and securities in that money collected is taken by one of the members through bids. The deciding factor is the discount offered by the bidder - higher the discount, better the chance of getting the money. This discount pays the interest to the members and the commission to chit fund managers like Sivaramakrishnan.
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Chit funds were first started in India more than a thousand years ago. The first attempt to regulate the sector was made by the government of Travancore in 1914. This was followed by the Tamil Nadu Chit Funds Act of 1961, Andhra Pradesh Chit Funds Act of 1971, and Maharashtra Chit Funds Act of 1974. Parliament enacted the Chit Funds Act in 1982. Under this Act, chit funds have to deposit an amount equivalent to the "chit" money with the state government as security against default. This makes it a low-margin business.
R Chandrasekar, executive director of Shriram Chits Tamil Nadu, says it takes at least seven years for a new chit-fund company to break even. "It is not a cash cow." Besides, the Act is so stringent that it is difficult to start a business, he says. In a year, barely one or two new chit funds get registered.
Incidentally, the Shriram group started as a chit fund in 1974 and has now emerged as a financial conglomerate that manages funds worth over Rs 60,000 crore. In comparison, his Shriram Chit, he says, hardly makes Rs 40 crore. The commission of chit fund companies, he says, is around 5 per cent.
Despite all the negative news about the industry and words of caution from financial advisors, Shriram Chit gets 700-800 new applications every day from Tamil Nadu alone.
Sivaramakrishnan claims the industry in Tamil Nadu is growing at 25 to 30 per cent per annum, which shows that "customers aren't worried and they still trust chit-fund companies". Sivaramakrishnan's chit fund company, which has been in business for 65 years, caters to the fourth generation now. In a way, the southern states have paved the way for the Centre to come out with a regulation for the chit fund industry.
"States which properly implement the Chit Fund Act have not faced any issues," says Chandrasekar. "Take Tamil Nadu for instance. After the Act was implemented, not even one registered chit fund company closed down." Some of the other states which have such stringent rules include Andhra Pradesh, Karnataka, Delhi and Maharashtra.
Chandrasekar is confident that organised, or registered, chit funds cannot fail, "because an amount equivalent to that of the chit fund is kept as security with the state government."
Most of the dealings are in cash, hence awareness about the rules governing chit funds is a must. There have been cases where the people have approached the registrar in case of discrepancies in the chit fund, says Chandrasekar.
An official from the state registration department seconds this. All chit fund companies registered in the state are monitored by the district registrars. The Reserve Bank of India also gives periodical advice. Whenever there is a complaint, the officials act upon it according to rules.
The department also ensures that all the aspects of the Act are followed. Every three months, the chief inspector goes to the companies to check their records. Shriram Chit confirms that such exercises are carried out. These companies are also required to submit details of their auction, chit fund groups, minutes of their meetings as well as file tax returns and periodically submit receipts to the registrar.
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Agents of some chit fund companies, meanwhile, say scams such as the one being reported from West Bengal have had an impact on their business. New applicants, they say, have become wary.
A chit fund agent typically deals with two kinds of customers: one, who needs the money immediately to clear debts, credit card bills or for other emergencies; two, those who were willing to wait for 4-5 years and get a bulk amount with good return. Whenever such scams come to light, converting the second set of customers becomes a challenge.
"One has to understand that in this business, the company does not have liquid cash at any point of time," says an official of Shriram Chit. The money is collected on a daily basis and auctioned daily. What the company earns is just the 5 per cent commission, he adds.
Sivaramakrishnan adds that the All India Chit Fund Association is in the process of setting up a self-regulatory organisation for the industry which will be like the Bar Association or the Indian Medical Association. The need, he adds, is to create awareness and for the government to get more pro-active.