Chitfund

Chit Fund Scheme for Corporates Mooted	THE ECONOMIC TIMES
In Search of "Credibility"	THE ECONOMIC TIMES
"Chit Funds" or "Cheat Funds"	THE HINDUSTAN TIMES

SATURDAY 25 FEBRUARY 1995
CHIT FUND SCHEME FOR CORPORATES MOOTED

Subramaniam Sharma NEW DELHI 25 FEBRUARY 95

A Delhi-Based chit fund company, Chandra Lakshmi Chit Funds Ltd., is planning to launch a chit fund for corporates. This was revealed by the Director of the company Mr. Kamal Bhambhani. According to Mr. Bhambhani, the chit fund company plans to launch two schemes for corporates.
The first scheme, called Corporate Pool Finance, would be a chit fund that would be similar to the lines of an individual auction chit fund. Under this scheme various companies would come together to form a joint pool that would help them raise funds to meet their various business plans.
Says Mr. Bhambhani, "At present companies have the option of raising funds from banks, financial raising funds from banks, financial institutions, inter-corporate loans, debt instruments and the stock market. The corporate Pool Finance would allow them another option of raising funds at a later stage. A company might need funds fast at certain times for, say, a product launch, or building a marketing network or opening new offices etc and that's where the chit fund can step in."
He goes to say, "Basically the scheme would provide liquidity to corporates on a contingency basis. For instance, we could have a pool finance of Rs. 50 lacs for 20 months where 20 companies can participate with each company contributing Rs.. 2.5 lacs each month. Hence, at any given point of time a company can raise nearly Rs. 50 lakh within a month."
The second scheme, called Group Finance scheme, would be a chit fund that would meet the needs of the employees of a company. Under this scheme a chit fund would be started for a employees at the request of the company. Explains Mr. Bhambhani, "In what is turning out to be a highly competitive environment, companies need to attract and retain employees. But they might not always have the requisite funds to, say, extend car loans, or housing loans to their employees. And the company will stand as our guarantee against any defaults."
Mr.Bhambhani has already had discussions with various companies who have shown interest in the two schemes. He said, "We are waiting to get a credit rating from Crisil. Once we get that we would launch these two schemes."
Incidentally, Crisil has started credit rating of chit funds and plans to give ratings to a couple of chit funds by May this year. Chandra Lakshmi Chit Funds is one of the first few chit fund companies that has approached Crisil for a rating.
The idea of starting a chit fund for corporates was first mooted at a seminar organized by chit funds in Hyderabad last year. But it had not found many takers at that time because of the stigma that has dogged the chit funds business. The concept has now got a fillip with Crisil's rating of chit funds.

SUNDAY 26 FEBRUARY 1995
IN SEARCH OF CREDIBILITY

The total chit transactions in the country exceed Rs. 10,000, estimates the All India Federation of Chit Funds (AIFCF). The figure seems to indicate that chit funds could well become one of the favoured investment instruments after stock market and debt instruments.
Yet this informal financial sector is beset with problems, not the least the unscrupulous operators who take advantage of the rather loose regulations to defraud the public. Undoubtedly, there's no better way to gain respectability in the market these days than to get a credit rating done by a professional agency. So once the Credit Rating Information Services of India Ltd. (Crisil) starts rating chit funds, the confidence of the investors in chit funds could increase.
Crisil's G.V.Mani says, "Our rating for the chit fund operations of a company would indicate our opinion about the relative safety of timely payment of monies to the subscribers. The rating would also serve as an indication of Crisil's opinion on the relative degree of risks associated with subscribing to series floated by the chit fund."
The idea of rating chit funds was floated by the Delhi Chit Fund Association last year. In October, Crisil started to work out a process for rating a chit fund. Explains Mani, "there are basically two kind of risks that are involved in a chit fund. Firstly, delay on part of the subscriber to pay his installment. Second, delay on the part of the foreman, which is basically a question of willingness."
Apart from taking a close look at these two risk factors, Crisil's rating will look at the subscriber profile of the chit fund. "For instance," elaborates Mani, "if the subscriber is from the service class then he will be able to contribute his installment in time which may not be true in the case of a business class subscriber."
There will be two key factors that will be considered for rating. Business analysis would include track record of the chit fund operator, internal control systems in force, asset quality and management evaluation. Financial analysis would cover accounting quality, reported profitability, liquidity position and financial flexibility. The rating will also take into account the past track record of recoveries, the extent of exposure of the chit fund, the inherent strengths of the foreman, investments of the commission earned by the foreman, meeting capital adequacy norms etc.
But a only those chit funds which are incorporates as public/private limited companies will be rated. Says Mani, "These funds should also have an operating track record of at least 10 years and have a reported networth of Rs 5 lakh."
But why should a chit fund require a credit rating at all considering the fact that most chit funds are localized in their area of operation and as Kamal Bhambhani of Chandra Laxmi Chit Fund says "work on a social collateral"? Reasons Main, "Firstly, investors get an unbiased opinion about the credit worthiness of a chit fund. Secondly, the rating given by Crisil is applicable across the country hence it would help chit funds wanting to expand operations."
Thirdly, the rating scale for chit funds would parallel Crisil's fixed deposit scales. This means that if a fixed deposit scheme of a company and a chit fund both get an 'A' rating, then both are comparable from an investor's view point. Also, Crisil will classify the chit groups into investment grade and speculative grade.
Rating is one thing. But other lacunae exist. And though the introduction of rating would do a lot of good both for the chit fund operators and the subscribers, the lack of uniformity in accounting for transactions among the chit fund operators is likely to be the biggest stumbling block in the process of rating. The Institute of Chartered Accountants of India (ICAI) has only now thought of framing any accounting guidelines for chit fund companies.
The grey areas in accounting mainly relate to commission income and discount forfeited by the defaulting subscribers. Some chit fund companies account for commission income on an accrual basis whenever the auction is concluded. If income is accounted on an accrual basis, then there will be a revenue-expenditure mismatch.
The possibility of defaults from prized subscribers (the borrowers) increases towards the end of the chit duration, leading to increased collection charges, interest on working capital and bad debts. The income will, however, remain constant during the tenure of the chit group since the commission is a fixed percentage of the chit group.
Alternatively, the recognition of the commission income at the end of the chit will lead to huge income at the end of the chit group and huge losses till the conclusion of the chit group. This lack of uniformity in accounting will also have problems in providing for tax on income. The Central Board of Direct Taxes is not clear on the taxing of the chit discount in the hands of subscribers.
ICAI needs to bring out guidelines which will be beneficial both to the foremen and the chartered accountants who need to certify their final accounts. At least one chit fund company, the Bangalore based Shri ram Chits and Investments Ltd has taken an initiative to solve this problem. It has assigned Price Water house Associates the task of suggesting accounting methods
Chandra Lakshmi Chit Fund's Bhambhani points out two other areas which are hurting the business. "Firstly, we do not have an insurance cover. Secondly, the chit funds business is not recognized by the banks." In the first case, Bhambhani is demanding an insurance cover for the subscriber wherein if the chit fund is unable to pay back the subscriber then he is compensated by an insurance company. Also, the chit fund company gets an insurance cover if the subscriber defaults on his installment, which is basically a credit guarantee.
In the second case, banks do not give cash credit (CC) limit to borrowers who raise part of their funds from a chit. Explains Bhambhani, "If a person requires Rs 5 lakhs for expanding his business and he takes Rs 2 lakhs from a chit and approaches a bank for the remaining Rs 3 lakhs then a bank won't give him a loan. This is ridiculous."
Though chit funds act as financial intermediaries, they are not allowed to borrow from banks, too. They are not even eligible for temporary refinance. All of them are required by the Chit Funds Act, 1982, to keep security deposits individually which run into lakhs of rupees and collectively into crores of rupees. Unfortunately, say the operator, in times of adversity, these chit funds are not allowed access to these fixed deposits. Hence, they borrow at relatively high rates of interest mostly from directors, shareholders and partners and also from indigenous bankers.
Narendra Kumar, managing director of Klic Chits Ltd, says, "All forms of business activities have access to bank finance barring chit funds. The ratio of borrowings to net owned funds is not an appropriate parameter since the ratio of auction turnover to net owned funds is very high." He adds that financial investment is also necessary for office premises, furniture, staff and promotional activities.
As per the Chit Funds Act, "a company shall not commence or carry on chit business unless it has a paid up capital of not less than Rs 1 lakh". Further, " Every company carrying on chit business shall create and maintain a reserve fund and shall, out of the balance of profit of each year disclosed in its profit and loss account and before any dividend on its shares is declared, transfer to such reserve fund a sum equal to not less than 10 per cent of such profit."
M.J. Ramesh, managing director, Shubhashree Chits and Investments Ltd, says it is not feasible to bring in capital through equity since there is no exit route for equity capital. Klick Chit's Kumar says they should be given facilities to borrow from the banks, akin to cash to cash credit limit.
It is interesting to note that other financial intermediaries have the choice to fix the rate of interest at which they lend and also the people to whom they lend. The financial intermediaries benefit from the difference in interest rates on deposits and loans.
In contrast, chit funds merely act as passive middlemen without any right to fix the discount rate, select the prize winner or have control over their income. Through the process of auction, a member of chit fund fixes his discount rate and the time of borrowing. The role of the foreman is to simply collect his commission, receive the subscription and release the prize amount. Says A.S. Venkatraman, corporate vice-president, Shriram group, "The ceiling of five percent of the foreman's commission and the bid ceiling of 30 percent by the government is killing the chit industry.
The capital adequacy norms for the chit companies is 10 per cent of the monthly turnover. The chit fund companies, he says, have to walk the tightrope considering the net returns. The success of chit funds companies lies in the collection machinery of the company. That is the reason, Venkatraman says, that Shriram Chits opens new branches when the volume of business exceed a certain percentage.
The entire gamut of regulations are meant for small operators which acts as a disincentive for big industry houses to participate. He adds "In the Companies Act, there is a trust relied on the corporates. But in the Chit Fund Act, there is distrust for the operators. They are over concerned about protecting investors."
D. Ramachandra of the Chit Promoters Association points out, "In about 131 sections which govern the operations of chits in Karnataka, only three provisions are in favour of the foremen and the remaining 128 are to protect the investors."
The regulations provided in the Chit Fund Act prescribes the manner in which the daily books of accounts are to be maintained and the provisions are unlike any under other acts. For instance, the Banking Act and the Insurance Act prescribe only the format in which the balance sheet and the profit and loss account are to be maintained. Venkatraman says this hampers the computerization of the chit fund companies.
But more than anything else, it is the prejudice against chit funds that is keeping them from growing into a respectable industry. Says Delhi-based Chandra Laxmi Chit Fund's Bhambhani, "The Reserve Bank of India and the government take a very negative approach to chit funds because of certain happenings in history. This negative attitude is strangulating us."
The rating of chit fund companies would be an important step in changing the negative attitude that has marked this business and prompt the government to take a more favorable look at it.

SUNDAY May 14, 1995

CHIT FUNDS OR 'CHEAT' FUNDS' ?

Mr. Ram Prakash had been lured by a friend to invest in a 50,000 chit fund scheme with a company only a street away. It was a merry rustle of currency notes in a first few months till one fateful day, the 'foreman' (chit fund promoter) tragically announced the flight of two subscribers. Our friend threatened, cursed, went to the police and was later confined to bed for weeks. Dozens of gullible Ram Prakash cheated by fly-by-night chit owners find themselves at a dead end when one cog (subscriber) in the otherwise well-oiled wheel of tempting chits slips apart, leaving the group with a deep financial gash.
The Register of Chit Funds, Rashmi Krishnan, was candid enough on these unregulated unscrupulous chit fund owners. She said, 'The existing Madras Chit Funds Act of 1961' directs us to identify any unregistered chit fund operator but doesn't empowers us to take direct action against them. Even with the regular chit fund owners, investors security should be of prime concern. It should be strengthened by the Government, both for the investor as well as for the chit fund company.
Before delving deeper into the Chit Fund Act's anomalies, let the average reader first realize that chit funds, operated honestly, can be a great non-banking, financial instrument in the hands of the poor man.
"One of the oldest and simplest financial institutions in India" says Kamal Bhambhani of Delhi's leading Chandra Laxmi Chit Fund Company, chit funds emerge in the rural parts of Southern India more than a century ago. This was out of sheer necessity since banking was unheard of in the countryside. The chit fund was largely an arrangement for the safe keep of savings for the unlettered ruralities."
The word 'chit' has an interesting origin. 'Chit' literally means a piece of paper to write on. At first there were 'grain chits'. Farmers used to contribute specific amount of grain every six months from their produce. Those who'd had a bad time, would borrow grain and the amount would be penned on chits allotted to each farmer. Gradually, chits began to be used for money procured from selling that produce. The scheme consequently acquired the name of chit funds. In Malayalam , it was known as 'Kuri', which is derived from 'Kurippu', a synonym for chit.
Any chit fund scheme involves the following steps:
Pooling of the sums of money contributed by a group of individuals. A promoter acts as the governing body among a number of investing individuals called subscribers who would pay an agreed number of installments for a given period of time and receive the total collections minus the promoter's commission, which is at present fixed at a flat rate of 5 per cent. There is a direct correlation between the period of the chit and the number of subscribers. For instance, a scheme of one lakh for a period of 40 months will have 40 subscribers with 40 installments each of Rs.2,500.
For such a scheme, explains Bhambhani, who is also the Treasurer for the All India Federation of Chit Funds, the initial bidder has to pick the money at not more than Rs. 60,000. The differential of Rs. 40,000 is distributed evenly among the rest of the members. The members who opt to claim the scheme money towards the end usually benefit the most.
But what if one subscriber disappears with the money? This is a question to which most chit fund companies have no coherent answer. The stock reply is the concept of 'social collateral' on which the functioning of chit funds is based. The social collateral is the mutual trust of subscribers, the social embarrassment that a subscriber fears before deciding to disappear with the money. This is one deviant to the smooth functioning of this otherwise pragmatic financial instrument in the hands of people from different trades has discourages most investors to keep off chit funds. But a lot is happening around in the world of chit funds now.
Most importantly chit fund companies are seeking respectability of sorts through a credit rating done by professional agency. Once the Credit Rating Information Services of India Ltd (Crisil) starts rating chit funds, the confidence of the investors in chit funds would increase.
The primary objective of the rating exercise is to form an opinion as to the type of risks which affect the relative ability of chit fund companies to make timely payment to their subscribers. In business analysis, the key factors considered are: (a) Track record of the chit fund company, (b) Internal control systems in force, (c) Asset quality and financial flexibility.
But despite the above norms, the pitfalls of rating a chit fund are numerous.
Primarily cash transactions involved have little transparency. Secondly the need of the subscribers for money in the first few months may propel him to accept the lowest amount and win the bid. Lastly, the subscriber, especially the earlier bidder, may default in making timely payments in the subsequent months. These have been the prime reasons for chit fund companies defaulting in making timely payments.
Sudarshan Chit Fund, a popular company with an all-India business coverage, shocked its subscribers in 1976 when it went underground resulting in default to subscribers that ran into crores of rupees. The reason for this crisis was the 'foreman' (organizers) had siphoned off the funds of the chit funds to finance the allied business interests of the chit fund company- viz, shipping, hotel and transport.
On similar lines was the case of the Garuda Chit Fund where also the foreman concerned went on to use the subscribers' money to expand his other business interests.
"Thus the need for Crisil." says Bhambhani, whose company has an annual turnover of over 5 crore.
"In our entire career of over 20 years. We have had no such default since we function strictly on the basis of social collateral. New members are inducted mostly through the recommendation of the older members. At the time of induction of new members, we often scrutinize the financial position of our subscribers."
The Registrar of Chit Funds, Rashmi Krishnan, is not so happy with the existing Chit Funds Act.
"A good number of business-men, small salary households and even the middle class housewife have found chit funds a significant source of saving and borrowings. But the present law doesn't ensure maximum protection for the investor."
According to Krishnan, the investor must deal with only the registered, RBI- regulated chit fund companies. For registration, the chit fund owner must first approach the Registrar of Companies, who allot him a name. Then he has to fill in Form No.2 for issue of share capital. Subsequently, he goes to the Registrar of Chit Funds who assesses his financial position, does an inspection of the registered office prior to issuing a registered certificate for the commencement of business.
Importantly, the registered chit fund company has to deposit 50 percent of the chit fund value in the shape of FDR which remains pledged with the Registrar of Chit Funds. But is that security deposit enough for protecting investors in case the company defaults?
"No, this is not adequate, agrees Rashmi, "But still if an aggrieved investor has some claim, he can be given payment from the security deposit of the given chit fund company through the court. But that too is a tedious, long-drawn procedure."
A well-meaning Krishnan wants several changes in the existing Chit Funds Act of 1961. Her primary thrust is on making chit funds more protective towards the investor. Most chit fund companies are unanimous on this demand. First of all they want some sort of insurance cover for both 'credit guarantee' as well as 'deposit insurance'.
In many developed countries such insurance schemes for chit fund companies are already in force.
The other demand is of course credit rating to eliminate substandard services to the subscribers by getting a professional evaluator to certify the standing of a financial intermediary vis-a-vis the financial markets.
Since banks have been statutorily prohibited from transacting chit business, chit fund schemes at best complement the working of the banking and formal sector of the economy. Besides, at present, every corporate chit promoter is under an obligation to follow the guidelines framed by the State Government and at the same time fulfill its obligations towards the rules of the RBI. There are instance, where the statutes of the two regulatory agencies are conflicting.
Another legal anomaly that has hampered the healthy growth of chit funds- in Delhi the registered chit fund companies are around 2,500 but the functional are only 400- is that while Madras, Karnataka and some other States are being governed buy the new Chit Funds Act of 1982, Delhi is still being governed by the old law of 1961. The chit fund companies are unhappy even with the new , modified law since it too has done little to protect either the investor of the chit fund company itself in case of default.
"Now the Central authorities," said a chit fund owner in Karol Bagh, "want to impose the provision of the new Act on Delhi, which are quite stringent. There is a provision in the Act vide Section 13, limiting the aggregate chit amount. The limit is Rs.25,000 for individual chits and Rs. 1,00,000 for four partners or more. For incorporates limited companies, there must be a minimum paid up capital of Rs one lakh and the aggregate chit amount is limited to 10 times the net owned funds. Such a ceiling doesn't exist for any other business."
And now some suggestions for the layman before he decides to join any chit fund group.

First of all, he must make sure that the chit fund company is registered with the Registrar, Chit Funds, Delhi.
That he enters into written agreement with the company.
That he receives a copy of the signed agreement from the chit fund director.
That he gets a membership certificate from the owner.
That he makes sure that the company accepts payments only by cheque.
Gets a receipt for any payment made.

In case the subscriber doesn't receive payment even two months after the time of delivery, contact the Registrar, Chit Funds. Besides, if the subscriber has not received the payment even after the termination of the group, he may lose his claim if he doesn't register a complaint in the chit fund department within 60 days of the termination of the group.

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