How do chit funds work?

Chit funds, a savings avenue that is as popular with housewives as it is with businessmen, if chosen wisely, give people the hassle free option to both save and borrow. But the scores of scams (like Saradha Chit Fund) in the name of chit funds, have given them a reputation that is undeserved, hence people fear to put their money in them thinking them as ponzi schemes.

India has nearly 10,000 registered chit fund companies, the largest one being run by the Kerala government which has been in existence since 1969. According to a report of Asian Development Bank, the turn over of some 1066 chit fund companies, as far back as 1986 was, an astounding Rs.81.6 billions. The estimated turnover of Registered Chit companies all over India as of now is exceeding Rs 35,000 crores per annum. Financial advisers also say that chit funds can be a good investment, provided the promoters follow the strict rules that have been laid down for them.

HOW CHIT FUNDS WORK

The investor pays an amount at specific intervals, usually a month, up to a fixed period. The money goes into a common fund. The amount collected is given to one person, usually selected in a lucky draw.

There is also the auction system for allotment in which the person who gets the money is selected on the basis of the lowest bid (he agrees to claim the least amount among the bidders). The difference between that and the full amount due is distributed among the other members. However, even after this, the winner has to continue investing.

Chit fund is a good savings instrument and it can be a reliable source of funds in an emergency.

One can also claim the amount without a draw through reverse auctioning. In this, the person who submits the highest bid (interest for picking the collected amount) is given the total collected money and his bid amount is distributed among the remaining people in his chit fund. This system is used in The Money Club mobile app which is a platform where people can form their own chit fund within their own trusted network (friends, family or office colleagues). The trusted network ensures a minimum credit risk here.

FUND MATHS

In chit funds, the number of installments (months) is equal to the number of members.

Following the reverse auction as in The Money Club app, let’s assume that 10 people decide to invest Rs 2,000 for 10 months. So, every month, the collection is Rs 20,000 (Rs 2000 x 10 members). Now, let’s say two members are willing to bid for getting this amount in a given month. Mr A bids for Rs 1,700 while Mr B bids for Rs 1,800. This means Mr A is willing to pay Rs 1,700 as interest while Mr B is agreeing to pay Rs 1,800 as interest (in order to get Rs. 20,000 pool amount). So here, Mr. B will win the pool amount and net-net he will get Rs. 18,200 ( Rs. 20,000 — Rs. 1,800).

Mr. B’s interest of Rs. 1,800 is distributed among the remaining 9 of his group members, so each one will get Rs. 200 as returns on their investment. The winner (Mr. B) cannot bid the next time.

ADVANTAGE OF CHITS OVER OTHER FINANCIAL INTERMEDIARIES

1. It is a borrowing cum savings instrument.
2. The rate of borrowing is determined by the participants themselves and not by an external agency. Usually is low.
3. The intermediation cost is the lowest when compared to other instruments.
4. The process of intrinsic evaluation based on factors like Social Collateral etc. give a lead this Institution, over the formal Banking sector, as an Financial Inclusion Activist etc.

DISADVANTAGE OF CHITS

1. Chit-funds do not offer any pre-determined or fixed returns.
2. Chance for default by the person who borrowed money.
3. The Foreman who runs the chit scheme charges huge amount as commission expenses (sometimes in the range of 5–10% pa).

But The Money Club is continually trying to mitigate the cons of a chit fund. It is a platform that removes the foreman from the chit fund and the huge profits which are consumed by the foreman in traditional chit funds are equally split among all the members. So here, the members earn more than the other chit funds. Secondly, since The Money Club allows only a trusted group of people to form a chit fund, the chances of default are a lot minimized. Finally the best thing is that the money is not pooled up here and stored with the company. Instead the money of the members remain in their pockets and whenever a members wins the bid, all the other members transfer him the funds directly from their bank account to his bank account. The Money Club keeps a track of all the transactions done in the group. It very transparent, secure and a safe platform.

Benefits — Through this app, you can

1. Save money regularly
2. Borrow money whenever you need it the most
3. Earn 3–4 times higher returns than bank fixed deposits.
4. Buy things on EMIs. You don’t need to wait for saving money in order to but something.
5. Search for ‘The Money Club’ on Google Play and download the app (app icon has blue background with white ‘M’ in the center).
6. Discuss with your friends about Money Club.
7. You will be required to form a Whatsapp Group with all your group members and a representative of the Money club. This group serves as a common ground to answer all the queries that any members might have
8. The Money Club representative will form the pilot club on the Money Club App and send out invitations to all the respective club members.
9. Details of the Pilot Club will be the following:

• Contribution per member: Rs 200 per day
• Frequency: daily
• Pooled Amount: Rs 2000 (max)
• Minimum Bid : 1 % of pooled amount i.e. Rs20
• The members will bid in the form of an interest rate for the pooled amount.
• Money club Commission: 10% of the winner’s bid (where bid amount is the interest paid by the winner to pick the pool amount).
• Bidding duration :15 minutes

6. As per the RBI Guidelines, it is mandatory for all users to complete their KYC on the Money Club Platform. We will verify address and PAN number of every member while the pilot is progressing

7. Once the Pilot Club is completed successfully, form the club button gets activated on the Money club App . Users can click the button and form their own club.

Watch the video given below to know the concept behind The Money Club: