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Chit Funds Amendment Act

  Jul 25, 2020

Chit Funds Amendment Act

What is a chit fund?

Chit fund is defined as per the Section 2(b) of the Chit Fund Act, 1982. According to this act; A chit fund is a type of rotating savings and agreement among different persons i.e. friends, relatives, neighbors and family members to subscribe a certain sum of money for a specified period of time. Chit funds are often microfinance organizations. Chit Funds are also known as the Chitty, Kuree, chit.

In simple terms, a chit fund is an arrangement that a group of people arrive at to contribute money in a defined manner at periodic intervals into a pool or a kitty. During the process of collection, any member can draw a lump sum through various ways like a lucky draw, an auction or a bid.

Working of Chit fund Illustrated in a diagram

What is importance of chit funds in India?

Chit funds are alternative source of finance and saving for the poor. The need to protect investor interest highlights the crucial role chit funds play in India’s rural economy, providing people with access to funds and investment opportunities, especially in regions where banks and financial institutions do not have a presence. Chits are based on local informal networks and hold trust of people, which is under threat due to multi-level marketing schemes that are illegally run as chit funds to dupe gullible poor people.

What are the laws governing chit funds?

Classifying them as contracts, the Supreme Court has read chit funds as being part of the Concurrent List of the Indian Constitution; hence both the Centre and state can frame legislation regarding chit funds.  States like Tamil Nadu, Andhra Pradesh and Kerala had enacted for regulating chit funds. 

Chit Funds Act, 1982 In 1982, the Ministry of Finance enacted the Chit Funds Act to regulate the sector. Under the Act, the central government can choose to notify the Act in different states on different dates; if the Act is notified in a state, then the state act would be repealed. States are responsible for notifying rules and have the power to exempt certain chit funds from the provisions of the Act. Under the Act, all chit funds require previous sanction from the state government. States may appoint a Registrar who would be responsible for regulation, inspection and dispute settlement in the sector. Any grievances over decisions made by the Registrar can be subject to appeals directed to the state government. 

What is the role of RBI and SEBI? 

The Reserve Bank of India (RBI) is the regulator for banks and other non-banking financial companies (NBFCs) but does not regulate the chit fund business. While chit funds accept deposits, the term ‘deposit’ as defined under the Reserve Bank of India Act, 1934 does not include subscriptions to chits. 

However, the RBI can provide guidance to state governments on regulatory aspects like creating rules or exempting certain chit funds. 

As the regulator of the securities market, SEBI regulates collective investment schemes.  But the SEBI Act, 1992 specifically excludes chit funds from their definition of collective investment schemes. 

In the recent case with Sarada Group, the SEBI investigation discovered that Sarada were, in effect, operating a collective investment scheme without SEBI’s approval.

Why in news?

Parliament passed chit funds amendment bill in November 2019, to streamline operations of collective investment schemes or chit funds, with the aim to protect investors that primarily comprises economically weaker sections of the society.

What are amendments?

  1. It has introduced words such as ‘fraternity fund’, ‘rotating savings’ and ‘credit institution’ to help these funds get an image makeover, and build a brand for them.
  2. raising the maximum commission of the manager the fund from 5% to 7% of the chit amount. 
  3. The foreman will also have the ‘right to lien’, a legal right, against the credit balance from subscribers. 
  4. According to the current Act, chit fund schemes operated by individuals can raise a maximum of ₹3 lakh, up from the existing ₹1 lakh. 
  5. For firms, with four or more partners, the Centre raised the amount from ₹6 lakh to ₹18 lakh.
  6. Among other amendments, chits are supposed to be drawn in the presence of at least two subscribers, and also allow subscribers to join through video conferencing.