Demonetisation hits private chit fund operators hard, subscribers and operators left in the lurch

A good part of the huge parallel economy is made up of the chit funds business. Ask any government official or even their kith and kin - most of them would have invested their monies in chit funds run by locals with financial muscle.

This month, chit fund operators were at the receiving end of a huge blow, as all the money they held were in the form of Rs 1,000 and Rs 500 notes, which have now been demonetised. “Now, I cannot pay anyone or call the chit this month,” says Bhagya Lakshmi, famous as a chit fund operator and hand loan giver in Bengaluru’s busy K.R. Market area.

Now, why would anyone want to expose themselves to such great risk by investing outside the legal system? The answer is simple: the money invested in these funds comes from cash payments received for favours. To put it bluntly, corruption contributes to the chit fund business in a big way.

When Prime Minister Narendra Modi spoke of black money, it was not only with reference to the money stashed away abroad or in high-value currency bundles within the country. The demonetisation of Rs 1,000 and Rs 500 currency notes was also an attempt to curb the cancer of corruption plaguing the common man dealing with representatives of the government.

The sector’s appeal

There are many ways to convert black money into white, and chit funds are one of them. A large number of Indians have been investing in chit funds, and sometimes even lose money when an operator goes bust.

Venkatarama Reddy, a staffer in a Karnataka state public sector unit, admits that chit funds are risky, but insists that they are one way to buy assets that are out of reach on a state government employee’s salary, be it white goods, fancy phones, two-wheelers, pre-owned cars, paying for their children’s education or even real estate and gold as investments.

“We rotate everything we earn as we are outside the banking system. With my kind of salary, I am not eligible for a credit card or a personal loan. So, if I need to buy anything, I have to pay through cash, which is accepted by all,” says Reddy.

Chit funds are a short term investment made within small, trusted groups of people, say a maximum of 20-25 members. “I have subscribed to five separate chit funds ranging from Rs 2,000 to Rs 25,000 per month. Most are for a set duration of 12, 18, 24 or 30 months. Of course, when you total the amount invested per month, it is more than my salary,” he says, grinning.

How does it work?

If one subscribes to a Rs 120,000 chit fund for 12 months, then, assuming there are 20 members in the group, one needs to pay Rs 6,000 per month. The advantage lies in being able to get the money before the set date, in around the 10^th or 11^th month, depending on the demand, and in receiving the whole amount despite having paid only Rs 108,000, or thereabouts.

Chit funds are a huge business, and they are run in the organised sector too. Margadarshi Chit Funds, run by a Hyderabad-based media baron, is very popular. Even Mysore Sales International Limited, a Karnataka government undertaking, got into the business after paper lotteries sold by MSIL were discontinued.

The chit fund business is regulated under the Chit Funds Act, 1982, but the rules are framed by state governments. Functionally, they are included in the definition of Non-Banking Financial Companies by the RBI under the category of miscellaneous NBFCs.

But the concept’s popularity in the unorganised sector is very hard to match. It is mostly government officials who invest here. The illegitimate nature of the business means that there are chances that the fund operator sometimes may not be able to pay all of the subscribers, at which point he/she just disappears.

According to Bengaluru City Police, while statistics on chit fund cases are not maintained separately, they are listed under financial crimes and registered under IPC sections that deal with cheating. A police officer, on condition of anonymity, said that they constitute as much as 30 percent of the total financial fraud cases. “The amounts vary. It could be from Rs 5 lakh to sometimes a few crores. Many chit fund operators come from the same set of subscribers, but at some point, their ambition overtakes them and they become victims of greed. It is difficult to take action as very few complainants want to openly come out, given that it involves black money. So, we help them arrive at some sort of compromise,” he says.

He also says that some operators are women who come from discredited backgrounds, and those who invest with them take a huge risk.

Why is it attractive?

Those operating the funds have the right to take the first or second chit, and also take up to two percent of the amount left over after every month’s bidding. They also get to keep the balance cash as it is only accounted and not paid to the other subscribers, which makes them very rich, oozing with cash and confidence.

“We trust them as they are also among the subscribers in the chit group. Also, we get more than bank interest and can be withdrawn earlier too,” said Reddy.

But, things changed…

A few days ago, after demonetisation the business came crashing down. “When I previously walked around the market, people always kept a distance and respected me. They looked upon me as a benefactor. But in the last two days, they have been looking upon me with suspicion, and many have come to my residence demanding a meeting even at midnight. I have no way of paying anyone as I cannot deposit this currency in any bank, nor can I get it exchanged. I have told subscribers to leave it this month, dividing the losses equally, and continue with the fund from next month onwards. But not many are sure they want to continue and they want a refund. I am not in a position to repay such large sums,” Lakshmi says.

The operator allegedly runs several funds, rolling close to Rs 2 crore every month. A majority of her subscribers are housewives whose husbands are all well-placed lower-rung officials, from policemen and bus conductors to utility officials and second division clerks working in lucrative government departments.

While the demonetisation has temporarily put a halt to chit fund businesses, it remains to be seen whether corruption will actually come down and reduce the ability of government officials to participate in such funds.