A Chit Fund is an all in one financial instrument. Chit funds are savings cum borrowing schemes, where member or subscriber agrees to contribute a fixed amount every month for a fixed period. The total amount contributed by subscribers shall be auctioned and given as prize money to one of the needy subscribers every month.

The company registers each group with the authority (Registrar of Chits, Govt. of Karnataka), obtains prior sanction order, invites the subscribers to join a group, and enters a chit agreement with the company. We to submit a 100% amount of chit as a security amount before the start of chit.
Suppose one chit fund starts with 50 members with a monthly contribution of Rs.10,000 per month.
50 people x Rs 20,000 = 10 Lakh
The amount collected from all members in a group called the pot.
Once this amount is collected it is placed for auction among subscribers. The subscriber who agrees to take the lowest amount will get the prize money. Suppose for the first month one subscriber bid lowest say 70% of pot amount. This means 7 Lakh (70% of pot amount) will be given to this subscriber as a prize.
10 Lakh – 7 Lakh = 3 Lakh (Remaining amount)
Foreman is a person/company who started a chit fund. Foreman will charge up to 5% of the chit value as a commission for providing services, prompt payment of prize money, and guaranteeing all the subscribers for other subscribers.
Suppose 5% commission is charged by Foreman.
5% of 10 Lakh (i.e Total Pot amount) = Rs 50,000/-
The remaining amount will be 2.5 Lakh. This amount will be distributed among all subscribers. All remaining subscribers get Rs.5000/- each. So, the effective contribution for the current month would be Rs.15,000 for every subscriber. In next month’s auction, only non-prize subscribers can participate as a bidder. The process of the auction will continue every month till all subscribers get the prize money. The Foreman will appropriate all the subscription money collected in the first month towards the security deposit provided to the registrar of chits.

Chit fund has been in existence and has played a key role even before the advent of organized banking systems especially to all unorganized classes of people and businesses. The financial option has multiple benefits and they are the reasons why people prefer the option.

• Easy access to fund
• User-Friendly
• TDS free dividend
•  Flexible payment modes

• Chit funds can be used for any purpose without questions, unlike financing institutions that need a reason such as Medical/Education expenses, Marriage, Home, Mortgage, etc.
• The money borrowed is against your future contribution.
• Prized subscribers have the freedom to decide the interest rate that varies from auction to auction.
• Chit fund is both a borrowing and investment (similar to Recurring Deposit) option.

Chit fund comparison with other instruments

A Fixed Deposit (FD) is accepted for a pre-determined time period by Banks. Interest paid ranges between 7.5-9.5% and is dependent on government regulation. The interest earned from fixed deposits can either be taken out periodically (monthly/quarterly/half-yearly/yearly) or an investor can earn cumulative interest which is paid at the end of the term period.
The principal amount cannot be used by the investor if he has to incur any unforeseen expenditure. If the investor opts for a cumulative interest group, the entire amount is returned only on the maturity of the fixed deposit. A chit on the other hand can help an investor by paying him an interest rate between 12-16%. The interest is paid in the form of a dividend. If an investor has a lump sum amount, he can invest the same in a vacant chit. By investing in a vacant chit, the waiting period is shorter; the investor can participate in an auction and use those funds for any planned or unplanned expenditure or wait until the end of the chit and enjoy higher dividends.

Recurring Deposit scheme is offered by almost all banks in one form or the other. Recurring Deposit is very popular among the salaried class, especially those who can afford to save only a few hundred or say a few thousand rupees per month. This scheme is a boon for people who do not have a large amount of savings and thus cannot use the Fixed Deposit scheme of the banks.
Under this scheme, the customer deposits a minimum amount (normally fixed) every month and the bank pays the interest at the pre-determined rates (which is usually lower than that for fixed deposits). At the end of the period i.e. on the maturity date, the customer is paid the maturity value i.e. principle deposited and the interest payable. The current rate offered by banks is around 8.5%. This is subject to government regulation. The same money can be invested in chits and the investor can earn 12-16%. He can also borrow against the chit which is not possible with a recurring deposit.

The tremendous growth in the banking sector has seen an explosion of personal loans given to young salaried employees in the information technology, BPO, and other sectors. This segment has higher disposable income and is willing to spend on cars, motorbikes, and the like. Banks/financial institutions charge an interest rate anywhere between 12-24% on personal loans. There is also no guarantee that the loan application will be accepted. The Equated Monthly Installments (EMIs) are higher due to higher interest costs. If an employee is smart, he can plan his purchase of a car using a chit. The interest cost and sureties required are much lesser in comparison with a personal loan.