ALL INDIA ASSOCIATION OF CHIT FUNDS (Regd.)
Regn. No. S-35943
‘Bansi House’ 1/24, Asaf Ali Road, New Delhi – 110002
Ph. 011 – 23234035/2335
P.J. Krishna Murthy B. Shivalingappa A. Chitrarasu
President Vice President – AIACF Organizing Secretary
+91 9141841809 President – KCA +91 93800 44454
Understanding Chit Fund Model
Chit fund model is prevalent even before the evolution of banking in India providing access to finance for the low income households. It caters to the needs of different sections of the society, mainly in the income-generating households. Chit schemes have traditionally been generic, differentiating only in value and duration. There are more than 30,000 registered chit operators having an annual turnover exceeding Rs.40000 Crores.
Chit funds are the Indian equivalent of the Rotating Savings and Credit Associations (ROSCA) that are famous throughout the world. ROSCAs are a means to “save and borrow‟ simultaneously. It is considered one of the best instruments to cater to the needs of the poor. It enables poor people to convert their small savings into lump sums. The concept of chit funds originated more than 1000 years ago. Initially it was in the form of an informal association of traders and households within communities, wherein the members contributed some money in return for an accumulated sum at the end of the tenure. Participation in Chit funds was mainly for the purpose of purchasing some property or, in other words, for “consumption‟ purposes. However, in recent times, there have been tremendous alterations in the constitution and functioning of Chit funds.
While in most places ROSCAs are user-owned and organized informally, in India, chit funds have been formally institutionalized as well. Legally recognized firms provide a variety of chit schemes. Under the Chit Fund Act, this industry is overregulated but under-governed. This institutionalization of the chit funds (a) makes it easier for poor or illiterate people to know exactly what different chit schemes the chit companies offer, (b) provides an option to people to participate in schemes where members need not know each other; hence there is a larger diversification of the idiosyncratic risks. This makes it easier to provide chit schemes in urban settings where social linkage among members might be weak, (c) ensures transparency in the operations, (d) given that the law determines the size of the bidding and the commission the company can charge, it encourages competition among chit fund firms to improve services to clients, and (e) legal recognition also helps the chit fund operators to scale their operations. It allows the chit fund operator to use the legal means to handle defaults and more importantly it infuses faith in the clients that there are sufficient checks and balances which will prevent opportunistic behavior. In return the chit fund companies take a fee from the clients to cover their expenses, in the form of a commission. The chit fund company provides a variety of mechanisms by which the savings of the members can be transformed into lump sums. The main mechanisms are; savings deposit which allow a lump sum to be enjoyed in future in exchange for a series of savings made at present, loans which allow a lump sum to be enjoyed at present in exchange for a series of savings to be made in the future and, insurance which allows a lump sum to be enjoyed at some unspecified future time (for example, daughter’s marriage) in exchange for a series of savings made both at present and in the future.
The maiden survey conducted on the working of chit funds by Small Enterprise Finance Centre of Institute of Financial Management and Research, Chennai and the report prepared by the Research Associates of IFMR under the guidance of a Professor of ISB, Hyderabad and a Professor of MIT Sloan School of Management, USA under the aegis of the Gates Foundation is an eye opener unraveling the inherent potential of this industry and suggesting ways and means to enhance its services to the deserving lot, in the context of the current economic goals of the Government of India. The potential of this Industry to cater to the lower and middle income households is unlimited.
A chit scheme generally has a predetermined value and duration. Each scheme admits a particular number of members (generally equal to the duration of the scheme), who contribute a certain sum of money every month (or everyday) to the ‘pot’. The pot‟ is then auctioned out every month. The highest bidder (also known as the prized subscriber) wins the “pot‟ for that month. The bid amount is also called the “discount‟ and the prized subscriber wins the sum of money equal to the chit value less the discount. The discount money less fixed commission to foreman is then distributed among the members as “dividend‟ and in the subsequent month, the required contribution is brought down by the amount of dividend.
Chit Funds address gaps left by the traditional banking sector. They mobilize huge amounts of small savings, and in return allow members to have access in the form of loans to lump sum amount of money that they would often not be able to get from the formal banking. Easy accessibility and flexibility are important aspects of this form of financing. Compared to banks, Chit Funds require less documentation, are more flexible about collateral, and allows to determine own interest rate (within the constraints of a given chit scheme). Furthermore, there is no need to determine upfront whether funds are used for saving or borrowing. This is a salient feature of chit funds as it not only puts in place a disciplined saving mechanism, but it also allows to access cash when needed. In addition, as Chit Funds use the funds of the participants there is much less capital requirements for the institution (unlike banks).
But the recent trends in the industry have led to a concerning evolution which has limited the reach of the Chit Funds to poorer households.
- Chit Fund regulation have significantly increased the transaction costs for chits, and since most of the costs have to be incurred for each additional member, the regulations could push funds away from serving the poor. As funds can only justify the transaction costs per capita if the individual ticket size is relatively large, this possibility cannot be ruled out.
- Shift of Chit Funds from registered to unregistered or maturation of industry: The financial exclusion of low-income households from the registered industry will push them into the unregistered chit industry where their investments are less secure.
- Also, The Chit Fund Act, 1982 is obsolete and needs amendment to several provisions that are inconsistent to the present times and practically not possible to adhere to.
All the above stated explanations point to a disturbing trend within the Chit Fund industry, as it is being compelled to exclude the poor from their target group mainly because they are perceived to be unprofitable to serve. The following have also added to the woe of this industry.
Service Tax / GST
The imposition of Service Tax (Now GST), on this unique saving instrument, crushed the remaining life out of this traditional financial intermediary.
- Has rendered the chit model cost inefficient as neither the subscribers nor the chit promoters can afford to burden
- Depicts the step-motherly treatment meted out to the chit fund industry that has been singled out for taxing while other NBFCs enjoy 90 to 100% abatement
- Even globally financial services have been exempt from the Service Tax/GST net for obvious reasons that got exemption/abatement for other NBFCs in India as well.
While the Chit industry had been pleading to increase the abatement from 30 to 90 or 100%, to make it at par with other NBFCs, the implementation of GST has further dented our prospects as we have now ended up paying more than the Service Tax levy. To explain, we were being charged at an effective rate of 10.5% (15% less abatement of 30%) in the service tax regime but in the GST it has been increased to 12%. The functionality of the chit funds is akin to banks and NBFCs who mobilize savings from account holders and lend them to borrowers. The spread between the interest rate on the deposits and lending is the earning of banks/NBFCs which is used for administration of the activities. The foreman commission, capped at 5%, is similar to the above referred spread.
Sec 269ST of the Income Tax Act
A new Section 269ST was introduced in the Income Tax Act, 1961 (‘IT Act’) with a corresponding penal provision introduced in Section 271DA. With the introduction of Section 269ST, cash receipts exceeding Rs.2 lacs are not permitted and non-compliance of the same would trigger penal provisions and penalty equivalent to the amount of cash receipt can be levied.
Government, Banking Companies, post office savings bank and cooperative banks have been exempted from the provisions of Section 269ST with power accorded to the Central Government to exempt further persons or class of persons or receipts. This exemptions has now been rightly extended to NBFCs & HFCs as well as it would have adversely affected their collections thus increasing their NPA
While we welcome this amendment which would discourage transactions in black money as it seeks to penalize the receiver, such a penal provision would be harsh on an industry such as ours which in fact has been playing a greater role in mobilizing small cash pockets into the larger financial system by bringing them into the banking channels which is exactly what is sought to be achieved by Section 269 ST.
Rationale for granting relief to Chit Funds:
- Chit Fund industry; predominantly channelize the savings of lower and middle income groups. A sizeable proportion of this income group receives their incomes in cash and is still new to the Banking system.
- Chit Funds play the role of financial intermediary in bringing the cash available with the low and medium income households into umbrella of the banking system and thus are akin to banking companies and post offices who have been conferred relief from complying with Section 269 ST.
- The main reason for introducing Section 269 ST is that the unaccounted wealth is stored and used in cash. The organized chit fund industry, catering to the needs of the lower income groups in providing attractive means of investment and hassle free availability of finance for personal and entrepreneurial needs are in fact doing the role of ensuring that wealth does not remain stored and used in cash and are ploughed to the mainstream economy. To reiterate, proceeds to prized subscribers are always paid through account payee cheques and never in cash
- All vital information including name, address, proof of identity etc. are collected and maintained in the database of all registered chit fund entities. This information is also submitted to the Registrar of Chits in respective States.
Though we have submitted several representations to the concerned departments, this Press Meet is another attempt to highlight our plight and seek redress.
- Bring in Amendment to the Chit Fund Act, 1982
The process of amendment started about five years ago with the setting up of a Key Advisory Group (KAG) on Chit Funds by the Department of Financial Services (DFS), Government of India with participation from all stakeholders, RBI, State Governments, Industry Confederations, relevant departments and reputed consultancy firms. The report of the KAG with recommendation of sweeping reforms and amendment to several provisions of the outdated Act was submitted more than 4 years back. The Parliamentary Standing Committee on Finance, in agreement with the recommendations of the KAG had pulled up the DFS for not implementing the report. However, till date, the process of amendment has not been initiated!
- Grant exemption/Lower slab in GST
Representations, on merit, have been made to the concerned departments. This levy is just not feasible on the chit model and if for any reason exemption is not possible, we should at least be taxed in a manner so to make the effective rate of levy similar to other NBFCs.
- Grant exemption from the harsh implications of Section 269ST, on an equal footing with that of banking companies, NBFCs, HFCs, as it would adversely affect our collections and thus increase the NPA
- Tool for Financial Inclusion
Chit Funds, unlike other formal sources of finance, are “bottom-up” institutions – schemes typically begin only when a group is ready to participate and scheme values reflect the needs of the members in the scheme. Given the importance and magnitude of the efforts needed to achieve the objectives of financial inclusion, there is an urgent need to recognise and support the role of this uniquely democratic and potentially serious contributor.As the gap between the banking and the informal Banking sector is quite huge and as the financial inclusion are mostly on papers and seminars, with the grass root connection the chit promoters maintain it will be a win-win situation for our economic agenda.
Apart from regulatory challenges faced by this indigenous industry, most damaging is a common misunderstanding of what constitutes a registered Chit Fund – there is a frequent misidentification of Chit Funds in unrelated financial scams in the media that threatens to undermine the legitimacy of the registered Chit Funds industry. In reality, the rate of default in the industry is less than 2%. Our sincere appeal to the media is to verify the facts before labelling any financial scam as “Chit Fund Scam”.
All is not gloomy! Some recent happenings that has brightened the prospects of this industry are
- The industry in the recent years has been digitalizing the operations for greater transparency and consumer delight. This has greatly helped the industry in the post demonetization era!
- Demonetization is a blessing for the Registered Chit Industry. Recent trends indicate that the demand for the registered chits will shoot up as the un-registered operators and the subscribers are facing heat. Time is ripe for the Government to reap benefits of this shift and it should act quickly to promote the registered industry, wholeheartedly.
- Recently, many fin-tech startups like CredRight, ChitMonks, KyePot, etc. have entered the chit fund domain and they see huge potential in catering to this sector.