CHIT FUNDS OR CHEAT FUNDS ??

I really appreciate your effort in preparing a detailed mail criticizing my article related to ‘Chit Funds’.  But I really upset about one sentence

“ Don`t fool people by telling them about all will get very high returns educate them while parking their hard earned money”

With due respect, I would like to say that, I never tried to fool anyone of my readers, I always posted useful and informative articles and most of the readers like this, the way I receive the  positive response from them.    I have been receiving lot of queries every day related to savings, investments and taxes and used to provide prompt reply.    In this particular article also, I just explained the concept of Chit Fund like other investment options, I never recommend any one to subscribe to any chit fund.    

I would like to  clarify that, I am not a promoter of any chit fund or representative of any Kuri  or investment company.   I am a financial and investment professional having 18 years working experience with reputed financial institutions in India and aboard.  Presently I am working as Senior Investment Operations Manager in a reputed Invest Bank in Middle East.  

     Chitty Fund is a more than 1000 year old micro finance instrument available all over the world in different names.  But the basic concept and modus operandi is the same.  In our small state Kerala the concept of chit funds started way back in 1880 at the ruling time of Raja Rama Varma.   The approximate annual turnover from chit fund business is all most 30 lakhs cores in India.  Out of that 10-15% is Kerala’s contribution.     This itself evident that, still people are extensively using this micro finance instrument for meeting their various financial needs.    The question here is whether this chit funds are capable of meeting the financial requirements of needy people or not?  I can confidently say ‘YES’, because 90% of chit business is happening in the unorganized sector without proper registration or office.  The unregistered chit funds operating in Kerala may be 150-200% time than the registered ones.  Also it is important to note that, unregistered Chit Funds are normally serves the financial and investment needs of the low-income households, which have been excluded from the formal financial system.  In the unorganized sector, chit funds are formed by a small group of people, generally family members, neighbors, or friends. The idea is that the people forming the chit fund are generally known to each other and have the faith that the members of the fund will not default.  Most of the people in smaller places are attracted to chit funds, because of easy availability of credit and its simplicity of operations.  In rural areas banks are not much interested in lending to poor people and poor people see chit funds as perfect way of getting a loan, though at a high cost. So we can also look at them as microfinance tools.   In general low income group and small businessmen are the actual beneficiaries of chit funds.  They are not bothered about the return aspect, they may utilize this money for their children’s education, buying consumer durables, constructing house, paying off high cost debt which they might have taken from the local money lender.  These groups of people meeting their urgent financial commitment are very important than the returns.  How we can blaindly say that, all Chit Funds are giving minus returns.  The question of minus returns comes when you get back less than what you have invested or otherwise the actual return you received is less than the prevailing inflation rate (real return or Inflation adjusted return).    I can confidently say none of the guaranteed debt instruments (bank term deposits, Post Office deposits etc) presently available in the market is capable of providing a positive real return.

 

Eg.  Our average annual inflation rate for last one year is around 10%

a)     Bank Term Deposit interest for one year   around  8%   

Real Return is -2%   (8-10)

b)    Post Office MIS   annual interest  8.2% (subject to change)

Real Return is  - 1.80%

If you consider the tax aspect also, the net return will be much less.   Most of the chit business is presently happening in the unorganized sector, so they safely escaped from the tax net work.

In my article I never said Chit fund  investment is a lucrative investment option.  Two scenarios of chit fund investment is explained with the help of following table

Chit Amount   - Rs. 50,000.00

 Total Number of Months - 20

Contribution per month - Rs. 2,500.00

The following example shows subscriber avail loan in the second month

Month	Price amount/Loan	Contribution
1	-	(2,500.00)
2	37,500.00	(2,000.00)
3	-	(2,000.00)
4	-	(2,000.00)
5	-	(2,000.00)
6	-	(2,000.00)
7	-	(2,000.00)
8	-	(2,000.00)
9	-	(2,000.00)
10	-	(2,075.00)
11	-	(2,125.00)
12	-	(2,175.00)
13	-	(2,225.00)
14	-	(2,275.00)
15	-	(2,330.00)
16	-	(2,400.00)
17	-	(2,425.00)
18	-	(2,475.00)
19	-	(2,495.00)
20	-	(2,500.00)
	Total	44,000.00

 

 

  The following example shows subscriber avail loan in the 19^th month

Month	Price amount/Loan	Contribution
1	-	(2,500.00)
2	-	(2,000.00)
3	-	(2,000.00)
4	-	(2,000.00)
5	-	(2,000.00)
6	-	(2,000.00)
7	-	(2,000.00)
8	-	(2,000.00)
9	-	(2,000.00)
10	-	(2,075.00)
11	-	(2,125.00)
12	-	(2,175.00)
13	-	(2,225.00)
14	-	(2,275.00)
15	-	(2,330.00)
16	-	(2,400.00)
17	-	(2,425.00)
18	-	(2,475.00)
19	47,400.00	(2,495.00)
20	-	(2,500.00)
	Total	44,000.00

 

As per the above example, each subscriber contributed total Rs. 44,000.00.

In my article, I just explained how one can avail loan from chitty and utilize that amount to investment in other profitable option to enhance their total retunes.    That doesn’t mean that everybody is going to get the same % return.  Also, please read the last paragraph of my article, there I cautioned the prospective chitty subscribers also.

Also, I would like to comment on the point related to publishing chitty returns for last 1 year, 3 years and 5 years like Mutual Funds performance reporting.  We must understand one thing that, Chit Fund is entirely a different animal governed by the chit fund rules formulated by each state.   As far as Kerala is concerned Kerala Chitties Act, 1975 is the basic regulation governing chit funds.   Mutual Funds are regulated by SEBI and the concept and working of Mutual Funds are entirely different from Chit Funds.   But it is difficult to implement the same concept in the chitty business due to various technical factors.   The returns generated in a single chitty are different for different investors.  But the returns generated in a mutual fund scheme are same for all the unitholders provided they invested in the same day with same Net Asset Value.  In Mutual Funds they are publishing the total returns generated by the scheme as a whole, that doesn’t mean that, all the unit holders in that scheme will get the same return for their investments.   This is mainly depends on at what NAV they invested for plus the duration of their investment.

The following are the present interest rates applicable for small savings schemes.  This rate will change every year based on general interest rate movement.

a)      NSC   5 years                 8.40%

b)      NSC 10 Years                  8.70%

c)       Post Office Monthly Income Scheme    8.20%

d)      Post Office Recurring Deposit    8.00%

e)      Public Provident Fund     8.60%

 

Equity Mutual Funds last one year return on an average   - 40.00%

              Bank Deposit rates for individuals > 5 years   average      9.00%

I don’t want to discuss anything further related to this subject.

Best Regards

Prakash Nair

 

 

From: Krishnakumar B <bkkumar56@gmail.com>
To: Keralites@yahoogroups.com; ababudavis@yahoo.com; pnair1966@yahoo.com
Sent: Sunday, December 25, 2011 11:03 AM
Subject: Re: [www.keralites.net] All about Chit Funds

Dear Babu Davis.A,

Merry Cristhumas to you too.

First of all I agree totally with your observation regarding the "Cheat funds". How ever Mr P.R Nair has not insisted anybody to go for the Chit funds without any knowledge. All he wanted the readers to have better financial literacy . He has taken a financial instrument "CHITTY" to explain it, that's all. I really appreciate his efforts.

With regards and Happy New year to all
==========================================================

CHIT FUNDS OR CHEAT FUNDS ??

Res Sirs,

I had gone thru the details below and I appreciate you for the details, but I had some doubts.

Why a chit fund is not publishing theinvestor return in a chit(same type) completed when a new chit(y) is floated just like in mutual funds which is mandatory as per SEBI rules. Mutual funds should furnish the investor return given to a investor in the past yearly, 2years,3years may be from inception.

Chit funds can also declare that our last (justcompleted) chit of 100*1000(or any type) had given investors an average return of so and so,why they are not publishing? because if they publish that will bedeath-bellof CHIT(Y),because the fact is that chits gives nothing to investors (not for borrowers and everybody is not borrowers)most probably negative returns tomajority.

One of my friend had told me a story why chits and this money business in kerala isconcentrated in Trichur, I am not sure is it true it is upto you. On pathetic situation of Trichur town then Maharaja Sakthan Thampuran invited christiantradersfrom south to start business in Trichur for theprogress of town, the traders asked for financial help of Rs 100/-for starting the same and the king replied He have no huge funds to spare,subsequentlyfloated an idea .

He asked them toassemble on a particular dayand everybody should put one rupee and a lot will be taken and winning person will get the full amount " I DONT NEED ANY THING " everybody should attend till the end, all are happy and started the CHITTY ,I am not sure this is genuine or not.

Think today`s chits manifesto,COME TO ME(KSFE) PUT YOUR HARD EARNED MONEY EVERY MONTH I WILL TAKE A LUPSUM(commission anddocumentarycosts) AND BALANCE WILL BE given to you.This is happening in today`s chits.

In your example you had not told what a investor who is not willing to take back, and joined for long term investment .

In case of a KSFE or registered chits borrowers are very less and and deduction is very less, mostly after 5 lots there will no reduction that means everybody wants to remit the full amount.

Reduction is not assured ,you get reduction if there is persons to put a call,so it can not be expected ,and investments should not be done on assumptions.

Think a persons joins a chit as a investment of 100*1000=100,000

by the 100th month he had put 100000/- and what he will get, which is only the assured (all othres 1 to 99 is a chance not a choice) 100000-5% commission that is 95000/- is it a good investment? please think,

don`t compare with those lucky fellows who get the first few lots and many of the chits if you get the money back you are theluckiest fellow on Earth.(HIMALAYA,St MARY`S).

For bank deposits banks are giving 10.5%(current rate) for long term ,ie for a 100 lot chit your firstinstallmentis lying for 100/12= 8.33 years,that means a Rs 1000/- will fetch (1000*10.5/100) Rs 105 per year and for 8.33 years it will be 105*8.33=874

and just calculate for the full period I am not so good in such a calculation.

And if you put this 1000 in post office monthly recurring for 6 years (60 months)you will get 72000/-

after completion and this is the most secured and assured investment in INDIA ,if you put 100 000 in 6 years you will get 120,000/- which is better option and installment can be started with as little as Rs 10/- for 60 months you will get Rs 720/- on completion.

Don`t fool people by telling them about all will get very high returns educate them while parking their hard earned money.

Years back I had read in a malayalam magazine that the returns from various investments you can come to your ownconclusions.

1. Chits or Kuries NEGATIVE to 1%

2. Insurance policies 2 to 3%(one should haveat least 1or 2 policies not more)

3. S/B A/Cs 4 to 4.5% (years back)

4. Fixed Deposits 7 to 8.5%

5. Post office recurring (PoRD) 8.5%(compounding)

6.Post office MIS 8.5%(compounding)

7.PoRD with MIS income 12.5% (with 10% bonus at that time,now it is abolished)

8.Equity funds(mutual funds) 14% to 18% ,Be caution it is a risky investment, income is not assured and fluctuates according to SHARE MARKET and(now it is greatopportunity to start investing in mutual funds as share markets is at very low level,takenecessary precautions)

9 .Shares 20 to 25% not assured ,highest risk , and think twice study well, now very good opportunity for long term in good shares

If you don`t agree with me please forgive and simply avoid.

thanking you,

rgds,

=======================

All about Chit Funds
A Chit Fund (Chitty) is basically a contract between the foreman and the Subscribers. As per the contract, each subscriber agrees to remit a fixed amount of money every month for a number of months. Chit Fund is a unique scheme incorporating the aspects of a recurring deposit and loan (cash advance) In chit fund, the subscriber has an opportunity to bid and avail of cash in advance which amounts to a certain percentage of the total denomination of the chitty (sala), whereas in recurring deposit the advance can be availed only on the paid up amount. In case bidding is delayed due to draw of lots in the initial installments, one can resort to availing of chitty loan, which is a loan that "bridges" the gap between the need of the subscriber for money and the delay in the chitty getting prized.

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. 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. A Chit Fund can either be legally registered or unregistered. Registered Chit Funds, as the name suggests are being regulated under the various Chit Fund acts. While unregistered Chit Funds are unorganized and mostly run by the close friends, relatives or family members of the investor. Although it is very well known that unregistered Chit Fund industry is very popular in India, mainly in the rural and semi-urban area, where people have very little access to the banking services and where financial illiteracy is more.

The regulation of the Chit Fund industry was put in place by the Government of India to address the problem of misuse of informal Chit Funds by unscrupulous promoters and founders running away with the participant’s funds, leaving the members with little recourse to retrieve their money back. Chit funds in India are governed by various state or central laws. Organized chit fund schemes are required to register with the Registrar or Firms, Societies and Chits. Various Chit Fund Acts governing the industry in India are as under:

• Union Government – Chit Funds Act 1982 (Except the State of Jammu and Kashmir)
• Kerala – Kerala Chitties Act 1975
• Tamil Nadu – Tamil Nadu Chit Funds Act, 1961
• Karnataka: The Chit Funds (Karnataka) Rules, 1983
• Andhra Pradesh – The Andhra Pradesh Chit Funds Act, 1971
• New Delhi- The Chit Funds Act,1982 and Delhi Chit Funds Rules, 2007
• Maharashtra – Maharashtra Chit Fund Act 1975
• Uttar Pradesh: Uttar Pradesh Chit Funds Act, 1975
• Goa, Daman & Diu: The Goa, Daman and Diu Chit Funds Act, 1973
• Pudducherry: The Pondicherry Chit Funds Act, 1966

Who Conducts a Chitty?

A Chitty is conducted by a person or an institution and this entity is called the foreman

How many tickets can be enrolled in each chitty?
The number of tickets enrolling in a chitty will be equal to the number of months for which the remittance
have to be made or the duration of chitty in months.

What is Chitty “Prize Money”?

The total of the periodic subscription, called the chitty amount, will be given out as “prize money” to the person who bids by allowing for the maximum reduction in the prize money. The maximum reduction possible is 25% as per the prevailing Chitty Act and if there are more than one subscriber interested in bidding at 25% reduction, the numbers of the such bidders will be put to a draw. Thus each subscriber gets an opportunity to receive the prize money once during the tenure of the chitty. All the promoters have to contribute the periodic subscription till the end of the chitty. The first installment is normally for the promoter, and that is his seed capital. From the second month onwards the total sum will be auctioned among the members. Those who are in urgent requirement of money take part in the auction. The person who is willing to accept the least amount is given preference.

Suppose Total number of members is one hundred and the monthly installment is Rs. 200.00, the total amount comes to Rs. 20,000.00. Member X bids for Rs. 19,800.00 B for 19,500 rupees and C for just Rs.19,000.00, the amount goes to C, but he will get only Rs. 19,000.00. The balance amount for Rs. 1,000.00, on which all members have equal right. That will be given as discount in the payment of next installment. In this example a member has to remit only Rs. 190.00 instead of on Rs. 200.00 as his third installment. All members are benefited, the benefit of the member C, is that he gets the money in the next month itself. He can tide over the financial problem with ease. Other members get a credit of hundred rupees by remitting just ninety rupees.

Foreman’s Commission

The foreman is entitled to a certain percentage of the chitty amount (not more than 5% of the chitty amount) as his commission from each member

What are the Securities Acceptable for Payment of Prize Money?

The types of security acceptable for chitty prize money payment, belong to various categories like personal sureties (of employees of Government, aided schools, public undertakings, banks etc.), financial documents (like fixed deposits with banks and reputed organizations, Deposit-in-Trust, LIC policies, bank guarantees, National Savings Certificates etc.), landed property or Gold ornaments etc.

Bidding Thump Rule: -

No:1 - As a borrower
Bid the chitty at the maximum rate, since cost of chitty is always much less than the borrowing cost.
In case you want to take personal loan from the bank or financial institutions, you need to pay annual interest in the range of 15-20%. But in case of chit funds the cost of money borrowed is much less than the bank loans and more over it is easy and convenient.

No.2 -As an Investor

In the continuous bidding process, if the discount foregone/available on each month is less than or equal to the proportionate of the gross /maximum discount for the month, bid the ticket immediately and invest the proceeds in high interest paying deposits.

Tips :-

I. Per unit (in % terms) of discount foregone correspond to interest earned on the prize money should be arrived to maximize the return from chitty.

II. Discount forgone in auction should be suitably compensated with the interest/return earned by prize money receipt during the course of the chitty.

See the following example

Ex : Mr. X enrolled for a chitty for a total value (sala) of Rs. 1,00,000.00 for period of 50 months and Rs. 2,000.00 pm as installments.

i) If the chitty is auctioned at the 14th month \ installment at a total discount of 10%. prize money payable is 1,00,000-10,000= Rs 90,000.00

ii) Interest accrued on price money deposit for the balance period of (50-14) = 36 months @ 9.5%.
Therefore total interest for Rs 90,000 @ 9.5%(compounded Annually) for 36 months is = Rs 28,164.00

Total prize money received Rs 90,000.00

Total receipt/ inflow from chitty = 28,164.00+ 90,000.00 = Rs 1,18,164.00

iii) If the total dividend earned is Rs 6,000 during the entire chitty period,
The net outflow of the chitty payment is Rs1,00,000 – 6,000 = Rs 94,000.

IV) Net Surplus in chitty Rs 1, 18,164.00 – 94,000 = Rs. 24,164.00

Note : above calculation is without considering the Forman’s commission

A word of caution: Of late some crooked elements got involved in to this business and polluted it to the extreme. Some promoters disappeared with members’ money, and in other cases some members disappeared after accepting the money. You have to be very careful while selecting the chitty company. You can find chitty companies everywhere. When you deal with chitty companies, go for those companies promoted by reliable persons with sound track records. Don’t put your hard earned money based on some attractive TV advertisements of film stars or other celebrities offering valuable gifts like luxury cars, luxury villas or foreign trips etc.