Disorganised chit funds will remain working capital lifeline for micro SMBs
Prime Minister Narendra Modi has turned his focusto bringing down the disorganised chit fund industry. He kickstarted a debate to this effect in the Assam poll campaign last week in the light of the Saradha Financial scam that rocked the eastern part of the country a couple of years ago. The government has every reason to go after this industry because it wants lending to be provided by the formal banking system than these chit fund lenders. The strong case against chit funds is that the scheme organisers disappear with the money invested as savings by ordinary folks.
The Saradha Financial Group scam and the emu scam in Tamil Nadu are just a few scams that ran into crores if not thousands of crores. However, there are small businesses that use this system efficiently and would lose out on a lot if it was banned completely. These chit funds provide 10-day and 15-day credit, which is not provided by the formal banking industry. Here is why it will remain the lifeline of micro-entrepreneurs.
Look at small towns
The government is going after an industry where people themselves are staunch supporters of the disorganised system. One has to visit industrial towns of Erode, Tirupur, Salem, Chittoor, Vijayawada and Solapur to understand how intricate the chit fund system is in funding entrepreneurs. According to Crisil, there are 45 million micro and medium-sized industries that use this form of a lending and savings platform. Around 400 million Indians are estimated to be using such disorganised services.
These entrepreneurs—borrowing from and operating in a chit fund—work on a system of mutual trust and confidence while operating a chit fund. Even large cities have families using chit funds for savings and investments. So the government is going after a debt and savings platform that is as old as Indian commerce and ethnicity.
"In small towns this system is sometimes more popular than banking and part of the savings and lending strategy. But it is unregulated and works on trust," says Pawan Gupta, founder of Connect2India, a consulting firm that works with SMBs.
Today, there are over 10,000 registered and approved chit funds. The industry is a Rs 35,000-crore business. But the disorganised chit fund business is practically the defacto banking industry in the country and is estimated to be more than Rs 2 lakh crore.
Organise it, not shut it down
Modi wants to tackle this persistent issue with the Jan Dan Yojana by opening zero bank accounts to the unbanked population so that they can access credit from banks. But the problem is the reach of the Indian banking system to businesses and individuals who want short-term money.
This disorganised industry is also the lifeline of at least eight million kirana retailers. The International Monetary Fund says that there are only 11 bank branches per 1,00,000 people in India as compared to 24 in China.
"There is a need to make this part of the formal economy and some registered companies are very large," says V Balakrishnan, founder of Exfinity Ventures.
The government should formalise the industry rather than going after such platforms. There are towns where women thrive in this business. This system has also served as a vehicle for their emancipation by way of helping set up small business units. Nevertheless, Ponzi schemes exist and they are not going to die. Credit is fundamental to commerce and chit funds can be used more effectively than being treated as the taboo of society.