[Answered] What are Chit Funds? Discuss the significance of Chit funds and concerns associated with them.

It is an alternative source of credit, which is the earliest form of peer-to-peer lending. In this, a piece of paper is used for writing a bid amount, known as a chit. Therefore, it is known as a ‘chit fund’.

It doesn’t fall under the jurisdiction of the Reserve Bank of India. These are the legal entities, registered with and regulated by, the state governments under the Chit Funds Act of 1982.

Chit fund schemes may be organized by financial institutions and unorganized money market industries or informally among friends, relatives, or neighbours. It is mostly popular in the areas where people have limited access to banking facilities therefore they prefer to invest their money in a Chit fund.

Significance of Chit funds:

• In the case of a chit fund, any investor can bidto borrow from others against the promise of future contributions, while the credit risk devolves to the chit fund’s promoter.
• A chit fund is a unique hybrid instrumentthat makes an individual a saver/lender instead of a borrower.
• One can bid early in the cycle if one needs money for any planned purchase, working capital for business, or for a personal emergency. Alternatively, one can wait and take the lump sum in a later part of the cycle.
• Professional chit funds have served a segment of the Indian population that do not have stable income streams, proof of regular income, or the collateral that banks need to sanction personal as well as small business loans.
• Borrowers in chit funds pay interest lower than most other sources of credit. For savers, the interest earned is a maximum of 4-6%or often even lower.

Concerns:

• Chit funds have known to be vulnerable to scams. E.g. Saradha Chit Fund Scam, Rose Valley Chit Fund Scam.
• The biggest risk involving a chit fund is the misuse of the pooled funds by the foreman.
• Sometimes members stop paying the dues and have already taken the first bid.
• Lack of financial literacy results in people getting duped as they are promised huge returns on their investment which has no substantial basis to fulfill.
• Despite the presence of staunch rules against scams by chit funds, a lot of these funds run Ponzi schemes and make away with a lot of people’s money.

Better and accessible banking alternatives will not only check undue exploitation of poor people but will also correct leakages in the economy.