Publication: The Economic Time
Date Of Publication: JUN 20, 2017
Article Written By: SHAILESH MENON
In the narrow bylanes of Chandni Chowk, Salem and Thrissur, where banks fear to open branches or install ATMs, there exist scores of ‘chit fund’ companies to help low wage earners build their little nest eggs.
Fallen from grace a long time ago, but still clinging on to vestiges of their glorious past, these companies are braving the perils of stringent regulations, “unfair” taxation, policy-level lacunae and rapid modernisation. The Rs 35,000-crore chit fund industry – which runs mostly on cash — is living in constant fear of coming under the income tax scanner. That apart, the ignominy of being unreasonably linked to the Sarada, Sahara and Rose Valley scams has dented their credibility, so much so that new generation investors avoid this indigenous savings-cum-investment product.
“Any financial product goes bust, the blame would finally be attributed to chit funds. Sarada and Rose Valley were not chit funds; they were indulging NBFC operations. But when they went belly up, everyone blamed chit funds,” laments A Chitrarasu, MD of Kurinji Chit funds, a Chennai-based registered entity.
“We’re being targeted for no reason… People who blame us don’t even know what chit funds are.” A chit fund is both a savings and credit product. Chits bear pre-determined value and are of a fixed duration, mostly two to three years. Each scheme admits a specific number of members (whose monthly contributions would add up to the total value of the chit fund at term-end).
The monthly collection from all subscribers is called the ‘pot’ and is auctioned every month. The subscriber bidding the lowest (from the whole monthly pot) gets the money. The subscriber who has bid from the pot in a particular month continues his contribution till termed. There are over 12,000 registered chit funds in India. (See ‘How It Works’). “Chit funds are over-regulated… Of the 140-odd sections and sub-sections in the Central Chit Fund Act, only four to five are supportive of the industry. Most is for subscriber safety… Now one should note, there has not been any big chit fund failure over the last 35 years,” affirms PJ Krishnamurthy, MD of Girivajra Chits. TS Sivaramakrishnan, the Secretary of All India Association of Chit Funds, says the funds have been in existence for over 100 years.
Some of the earliest were launched decades before India became independent. “These funds have lasted so long only because they conducted business honestly and repaid people on time,” he argues. Over the years, with several finance companies going bust, the government tightened laws for indigenous players, limiting scope of doing business. Chit funds bore the brunt of these regulations as most finance companies that went belly up were inadvertently labelled chit funds.
We are going through difficult times because officials have not understood what we do… They’re not aware of our processes. They even forget that we serve the real grassroots — poor people who do not have the confidence to open bank accounts,” Sivaramakrishnan says. “For effective conduct of financial activity, you need smart, proactive regulations — not tough laws.”
Over-regulation has clearly backfired in the case of chits funds. As a result of it, several “chitsters” (people who run chit funds) have gone underground, “de-registering” from official records and running their own scheme in an unregulated manner. According to AIACF members, illegal chit companies (the unregistered ones) run portfolios 10 times larger than the registered ones. These operate in small towns and villages, do not pay taxes or abide by any laws. Subscribers in illegal chit funds are at grave risk as there is limited legal recourse in the event of fund managers swindling people.
A taxing problem
The latest misfortune to hit the industry is insertion of Section 269ST in the Income Tax Act, which prevents any entity from receiving Rs 2 lakh or more in cash. Chit funds, by virtue of their clientele, have 40- 50% of collections in cash. Though small chits may not be directly affected by this law, the larger ones are finding it difficult to coerce their subscribers to pay using cheques.
“Vegetable vendors, small business owners, cobblers, daily wage earners form a large chunk of our clients. These people do not have the means to give us a cheque,” reasons Sivaramakrishnan. “We are not accepting larger amounts anymore… If we do that, we’ll be required to pay a huge penalty to the government.” Sivaramakrishnan manages the sevendecades-old Balussery Benefit Chit Fund. According to chit fund managers, there is adequate know-your-customer (KYC) procedure at the time of admitting new subscribers into a scheme.
PAN cards, Aadhaar details, photographs, a reference letter from older subscribers and bank statements (if available) are mandatory in registered chit funds. Every chit scheme launched has to be registered with the state-appointed registrar. Details of all subscribers and an amount equal to total value of the fund has to be deposited with the registrar prior to starting the fund. This deposit is only released after all subscribers in the chit scheme have been been paid off at tenure.
“The deposit with the registrar makes chit funds completely safe… also, minutes of our auction are given to the registrar every month. If authorities want to track down black money, they simply need to check the pre-scheme filings and auction minutes,” explains Chitrarasu. The association members have given representations to the government for some relaxation in the bulk deposit banning Act (Section 269ST). Their plea is to at least allow smaller chit funds to operate in cash mode.
These would range at Rs 1-5 lakh; the larger ones could be running into crores, with average monthly pay-ins being in the range of Rs 50,000 to a few lakh. Larger funds such as Balussery Benefit have started accepting payments via bank transfers and other digital modes. They are now trying to link up payment gateways on their mobile apps for direct pay-ins.
The problem here is, most banks are not agreeing to transact through the governmentowned, free-to-use UPI-BHIM interface. “They’re asking us to link their own gateways on our app… Otherwise they will charge us for every transaction,” said the IT head of a leading chit fund house.
For the money they manage, chit foremen (a foreman is one who runs a chit scheme; the fund manager) charge 5% as commission. The upcoming GST regime would put chit funds under the 12% tax bracket. “With a 5% remuneration cap, 12% GST would not be very viable for us… If we pass this to our subscribers, their returns will drop quite significantly. People will not join chit schemes after that,” says Sivaramakrishnan.
Chit funds operate on high collection costs. They also cannot broaden revenue schemes as chit companies are not allowed to sell third-party investment products to their customers. Broadly speaking, chit fund companies have only two revenue streams — the 5% commission received from subscribers and minor interest earned on bank deposits. “The government has waived GST on ‘interest income’ pocketed by BFSI companies… Just because our fees is called ‘commission,’ we’re brought under GST ambit. It’s just a confusion over nomenclature,” says Chitrarasu.
The cost dynamics have prompted several funds to shut shop in the past few years. That said, the illegal, unregistered chit fund network — which does not pay taxes or keep payout margins — has burgeoned in north and south India over the past few years.
Demonetisation & black money
The government’s decision to withdraw old Rs 500 and Rs 1,000 notes was a blessing in disguise for several chit funds. Several subscribers had then made bulk payments to get rid of their old currency notes. “A lot of defaulters paid their dues in bulk cash. Our collections had risen 10-15% in the first three weeks of November. Some subscribers even asked us to accept their entire pay-ins in one shot,” says a Gurgaon-based chit foreman on conditions of anonymity.
Since then, the IT department has called for records of chit funds which have posted a spike in their November and December collections. The chit fund association has asked all its members to cooperate with the IT Department and share details of subscribers who remitted bulk cash. Seven months into the government’s demonetisation drive, fund operators in Kerala are still finding it difficult to get subscriber pay-ins, for want of cash in bank.
Chitsters of Kerala are worried about widening shortfall in their monthly collections. “Repayments and monthly pay-ins have dropped to a trickle post demonetisation,” says KP Geevarghese Babu, general secretary of the All Kerala Association of Chit Funds and owner of St George Chitties.
“When we go for collections, people tell us they have not been able to get money from their banks or state treasury. We’re staring at a long list of defaults now,” Babu adds. Rising number of defaults is not restricted to Kerala alone. According to AIACF numbers, the industry is currently dealing with a pay-in shortfall of `700 crore. A good part of this is on account of chit fund managers asking their patrons to pay-in using cash or through bank transfers. “This happens more in case of subscribers who have already borrowed from the pot… When we refuse to accept cash from them, they’ll simply go away not paying anymore of their dues,” clarifies Sivaramakrishnan.
Chit fund managers have been crying foul over the usage of the words ‘chit fund’ while referring to failure of Sahara, Sarada Group and Rose Valley public deposit schemes. “Sarada and Rose Valley were raising deposits from people and investing the money in real estate. They were functioning like NBFCs… They were even selling third party products,” says Chitrarasu. “Chit funds do not engage in such activities. The money people give us is always put in a bank account and it is never reinvested or used for any other purpose.”
According to fund managers, poor industry reputation is keeping new investors from chit funds, which in turn hurts their performance. Over the years, chit companies have been relying too much on their existing subscriber base to run their fund. This has scuttled the ‘borrower-saver’ ratios of most funds, foremen opine. Most people (among existing subscribers) join chit funds to “bid and borrow” from the pot in the first four months of the scheme. Higher number of borrowers results in monthly pots getting bid at deep discounts.
“Many a time members have to wait fourfive months to successfully bid and borrow from the pot. They’re forced to bid at deep discounts to win the pot,” says Neeraj Bansal, CEO of CredRight, a financial institution which arranges loans on back of (future) chit fund receivables. Newer batches of investors would tip the ‘borrower-saver’ ratio to an even keel.
It may also bring down desperate (deep-discount) bids by members in urgent need of money. But new investors may not park their money in chit funds anytime soon. For them, chit funds are scam-tainted and unreliable — much deserving of the name, ‘cheat funds.’
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