Chit fund is an ancient system of banking that developed indigenously across geographies at least 1,000 years ago. Internationally known as ROSCA (Rotating Savings and Credit Association), this inventive mechanism of savings and credit has, for long, served as the safety net for communities left out of the mainstream financial system. 

It has provided systematic support to certain sections of people who do not even figure in the whole financial inclusion narrative; immigrants shunned by banks (even in advanced European countries), women living by the mandate of a kitchen budget, urban blue collar workers, slum dwellers, ragpickers, and socially ostracised communities such as transgenders and sex workers to name a few. 

Now some of you may ask why these communities even need credit or question their ability to put it to productive use.

Every individual is capable of building productive capacity. To take this idea further, let’s look at the waste management ecosystem for the time being. Did you know that India has one of the highest recycling rates for plastic PET bottles at 70% or that our surprisingly efficient waste management system manages to recover 56% of recyclable waste? Well, all thanks to ragpickers and kabadiwalas . What’s more, GST applies to scrap as well, which is indirectly paid by ragpickers by taking ~50% price slash. If you still question the ability of these communities (tax paying at that) to save and put credit to productive use, it would be sheer apathy. 

A system of savings and credit can do a lot for the welfare of these communities along with adding efficiencies to the sectors they operate in. And chit funds have been a rather efficient alternative system of finance, in providing assured access to cheap credit and curtailing defaults. Here are the stand-out features of chit funds that make it a go-to option for large sections of Indians. 

A net cast far and wide

ROSCAs dominate the developing world. They are particularly prolific in Africa, where they have exceptionally high membership rates — between 50% and 95% of the adult population in many countries. Estimates suggest that these associations mobilise more than 25% of national credit annually in countries of Africa, South Asia, and East Asia. 

Although ROSCAs are most common in underdeveloped parts of the world, there are places where they exist alongside more formal financial institutions, and where they are sometimes preferred. 

For instance, Kerala’s state-run chit fund KSFE is the preferred choice of celebrities and chai walas alike. Despite a high concentration of banks, the chit fund industry (both registered and unregistered) has been booming in Kerala. In fact, it attracts a considerable share of NRIs whose total investments in KSFE alone amounts to over Rs. 1,250 crores. 

The size of India’s registered chit fund industry alone is estimated at Rs. 35,000 crores per annum. However, this appears to be only an educated guess as there’s no centralised database; chit funds are regulated by respective state governments. As early as 2006, the number of unregistered funds in Delhi were 67 times the number of registered ones; in Tamil Nadu, unregistered funds accounted for triple the size of the regulated sector. And these two regions make just a fraction of India; extrapolate it to the whole of India, and you can imagine the size.

In late 2008, a consultancy called Centre of Gravity studied nearly 2,000 consumers in six Bangalore slums to check the financial pulse of 1,200 households. About 14% of the households belonged to the  Rs. 11,000-20,000 monthly income bracket, and 90% of those families had invested in unregistered chit funds. 

The bottom line is that the currently available numbers highly underestimate the size of the industry and underplay India’s willingness to participate in chit funds.

Flexible. Fair. Accommodative.

Chit funds offer a simple, hassle-free entry in comparison to complex, rigid ways of banks and other formal financial institutions. They are more accommodative of different types of collateral and the onboarding process is not mired in documentation. More importantly, they allow members to access cash whenever necessary. 

Above all, it’s a social and cultural institution as much as an economic institution. Cultural norms promoting fairness positively affect the organisational design of a ROSCA. Social sanctioning has played a major role in keeping default rate at a meagre 1-2%, as against, say, 12.7% in the personal loans segment for commercial banks. 

Inclusive yet problematic

The chit industry is not without its own share of problems. In fact, chit funds are often confused with ponzi schemes. The likes of Sarada scam and the Rose Valley Group scam are often mentioned in the same breath as chit funds — a bad rap the media earned for the chit industry through use of misnomers. However, one study pointed out how slum dwellers' choice of chits were unaffected by stories of operators running away with contributors’ money. This is because they had seen their neighbours benefit from it. However, the risk is real. 

News reports claim that between Rs 1.2 to 1.4 lakh crores of public money is lost to various chit fund schemes. Upwards of 350 scams, impacting 15 crore families, across 17 states were identified which targeted primarily low budget investors by several chit fund companies. Why?

Chit funds operate in an over-regulated industry, contrary to popular belief. This has led to increased costs of operations, pushing several registered chit companies ’underground’. Many companies have, in the recent past, either folded up or shifted their operations entirely to the informal arena becoming an ‘unregistered’ chit fund.

The FinTech breakthrough

Fintech has the potential to solve the problems of the industry on several fronts. One, bridge the gap in flow of information from chit fund companies to regulators. Two, provide credit check services of contributors, minimising default rate. Three, build credit identities of a large section of underserved populations and enable links to other financial services. 

Subscribers with a habit of consistent savings who may have lost out on a chit fund bid make for a ready borrower pool. The entry of fintechs is bound to fill information inefficiencies in the space and bridge the disconnect between India and Bharat.