FAQs on chit funds and why they were seen as ponzi schemes

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Any reference to chit funds raises eyebrows. Most would refer to the Saradha, Rose Valley, I-Crore, MPS Greenery scams as a caution to stay away from chit funds. But the deposit mobilising ponzi schemes that acquired notoriety and had CBI and ED investigating them were different from chit funds.

Here are a set of FAQs on chit funds and the questions the topic throws up:

1. What are chit funds?

Ans: Chit funds are an indigenous financial instrument that works in groups of people who agree to observe certain commitment between themselves.

It is a kind of rotating savings instrument that thrives on agreement among different persons like friends, relatives, neighbours and associates to subscribe a certain sum of money for a specified period of time.

According to an agreement a fixed amount is deposited regularly by the participants and after a specified period of time the amount is returned to the subscribers with interest. Chit fund helps in collecting the small savings of the individuals which turns into a big amount.

In cases of emergency, one can borrow from the fund quickly.

2. What are the basic checks that one should do before putting one’s money in a chit fund?

Ans: One must put his money in a registered chit fund. If the chit fund is carrying out business without registration, it is an unrecognised entity where investors have no protection from any quarters in case of defaults. So one has to choose a registered fund and check its background.

3. How long have chit funds been in business?

Ans: Office bearers of the All India Association for Chit Funds claim that chit funds have been in business for hundreds of years, much before banking began.

There are thousands of chit funds that are registered with the All India Association of Chit Funds (AIACF) and the total money circulating in them are more than Rs 17,000 crore.

4. How safe is your money in chit funds?

Ans: Safety of your money which is in the possession and control of others usually depends on the integrity of the person who is in charge of your funds. The trust factor becomes very important here. Therefore, the track record of the business becomes an important differentiator.

AIACF claims that there are chit funds that have been in business for 25-30 years without any instance of default.

5. Are there legislations governing chit funds?

Ans: The Chit Funds Act 1982 was the original legislation that was enacted to frame rules for this huge informal sector of financing in the country. Then following the disaster in 2013-14 when dozens of deposit-mobilising companies went bust and sinking the billions of rupees of hard-earned money by poor and middle-class people mainly in states such as West Bengal, Assam, Jharkhand and Odisha, The Chit Funds (Amendment) Bill was introduced in Parliament that has subsequently been enacted. No chit fund can be created without permission of the state government.

The Act was later amended by the Chit Funds (Amendment) Act 2019.

This Act states “No person shall carry on chit business unless he uses as part of his name any of the words “chit”, “chit fund”, “chitty”, “kuri”, “fraternity fund” or “Rotating Savings and Credit Institution” and no person other than a person carrying on chit business shall use as part of his name any such word.”

This makes it relatively easier for the common man to identify which company is a chit fund and which is not.

6. Do Reserve Bank of India and Sebi regulate chit funds?

Ans: No, neither Reserve Bank of India nor the SEBI regulates, governs or monitors the operations of chit funds or deposit-mobilising companies. However, it needs to be mentioned that SEBI did get involved in multiple litigations with entities such Rose Valley and MPS Greenery. It also issued orders against MPS Greenery and Rose Valley in 2011-2012 for running collective investment schemes (CIS).

Deposits have been defined in a cumbersome way and legal experts have pointed out that cracking down on unauthorised money collection schemes wasn’t easy for the authorities, as these have operated in a regulatory grey zone.

Collective Investment Schemes fall within the jurisdiction of SEBI, but it first has to be established whether a scheme falls within its ambit. SEBI ordered a forensic audit of Saradha.

But SEBI did order winding up of such schemes and that money from the depositors be refunded.

7. Was Saradha, or the other entities against which CBI and ED are investigating, chit funds?

Ans: Though the term chit fund is popularly used to refer to deposit mobilising schemes such as Saradha, Rose Valley, I-Core, MPS Greenery strictly speaking they were not. They allegedly just began floating investment schemes through a vast network of agents and began promising unsustainable returns to the common man. A long the net inflow of money was positive, the schemes ran. But when the outflows began surpassing the inflows and the entity began to default on payments to depositors, the word spread quickly and panic gripped the depositors. This is how Saradha went bust in April 2013 and then panic spread through the depositors of all schemes resulting in the investigation by CBI, Enforcement Directorate and Serious Fraud Investigation Office.

Before Saradha went bust, SEBI asked the authorities of Rose Valley and MPS Greenery to wind up and return the money, but they did not comply.

8. What are the risks of putting money in a chit fund?

Ans: Be it a chit fund or deposit mobilisation entities by any other name, the principal risk of putting money in them is that the owners, or the key person, or groups of persons operating these funds, might run away with the money or squander it and the depositors have little chance of coming to know about it and preventing it.

Also if a company refuses to pay the money due to you, there is hardly any easy recourse and one has to go through the usual process of sending a legal notice followed by legal action.

9. Who would one turn to if one has complaints against a chit fund (mostly not getting dues of principal and interest)?

Ans: If you have a grievance that is not being addressed by the authorities of the company, you can send a legal notice through your advocate by claiming the sum you invested and the interest promised. Obviously, one must mention all the details in it.

If you don’t receive an answer to your satisfaction, you can take them to court. Criminal cases are usually applicable in these cases for cheating.

Some of the Sections are 406 (punishment for criminal breach of trust), 408 (employee of a company for criminal breach of trust), 409 (criminal breach of trust by public servant, or by banker, merchant or agent), 412 (dishonestly retaining stolen property), 416 (cheating by pretending to be someone else) to 420 (cheating and dishonestly inducing delivery of property) of Indian Penal Code.