The Chit Process – How it Works

How does a Chit Fund work?

Simply put, the chit fund begins on a specified date and continues for the number of months equal to the number of subscribers. Members contribute their monthly instalments to the pot, and a reverse auction is conducted each month allowing members to bid for the Prize Money.

The subscriber willing to take the lowest sum with the lowest bid is declared the winner and receives the Prize Money for that month. The balance amount is distributed as a dividend among all members after deducting the Foreman’s Commission (5%). The process is repeated each month, thus allowing each member to win the Prize Money.

A Chit fund offers you the unique advantage of allowing you to borrow from your future savings.

Example:

Assume a chit fund scheme with 50 members that will run for 50 months, with each paying a monthly instalment of ₹10,000/- to create a ₹5,00,000/- pot. When the auction is announced, the member who bids the highest discount wins the Bid. (40% is the maximum discount anyone can bid as per Law).

Number of members in the chit fund scheme – 50
Duration – 50 months
Monthly instalment payable by each member – Rs. 10000/-
Total pot value – Rs. 500000/- (50 members x 10000)

In this example, let us assume the winning Bid offered a 35% discount.

Discount offered by the winning Bid – 35%
Amount of discount – Rs. 175000/- (35% of 500000)
Amount received by the winner – Rs. 325000/- (500000 less 175000)

The balance amount is distributed equally among the members after deducting the Foreman’s commission.

Foreman’s commission – 5-7% = Rs. 25000/-
Total Dividend – Rs. 175000 less Rs. 25000 = Rs. 150000/-
Dividend credited to each member’s account – 150000/50 = Rs. 3000/-

So in the following month, the member will have to pay only ₹7,000(₹10,000-₹3,000) instead of ₹10,000.

Pictorial representation

Chit terminology (explained with the help of the above example)

Instalment = Monthly Subscription =₹10,000

Period = Number of months = 50

Gross Chit Amount = Total of Instalments by all members = ₹5 lac (₹10,000x50)

Bid offer Amount = Amount willing to be foregone by the subscriber to win the prize Money = ₹1,75,000 (if we consider Bid = 35%).

Min Bid Amount = 5% (Foreman Commission),

Max Bid Amount = 30% (for 30 & 40 months Chit Fund) and 35% (for 50 months Chit Fund)

Net Amount (Prize Money) = Chit Amount minus Bid-Offer Amount (₹5,00,000 - ₹1,75,000 = ₹3,25,000)

Foreman Commission (FC) = 5% of the Gross Chit Amount (₹25,000)

Total Dividend = Bid offer Amount minus Foreman Commission (₹1,75000 - ₹25,000 = ₹1,50,000).

Dividend per Customer (Share of Discount) = Total Dividend/No of Subscribers (₹1,50,000/50 = ₹3,000)

Next Month Instalment = Gross Instalment minus Dividend (₹10,000-₹3,000 = ₹7,000)

Example of a Chit Table(statement) for the entire period

If someone waits to win the Prize Money at the end of the period

Total Amount Invested = ₹4,19,500
Total Amount Received = ₹4,72,000 (₹5 lakhs – (FC + 12% of FC as GST)
Profit = ₹52,500

Note:- The above calculation is only an illustration; the actual return is determined by the auction discount decided by the Chit Fund subscribers.

SAVE > BORROW: INVEST> GROW

Key roles a Chit fund plays

The Winning Bidder: Receives the Prize Money (lump sum amount) based on his bid and in this case serves as a borrowing instrument.
The Members: Receive monthly dividends that reduce the amount they need to pay in the following month’s instalment, thus acting as a savings instrument.
The Organizer: Receives a commission (5%) for overseeing and organizing the Chit fund.

Procedure for the Foreman to create a Chit Group

Before setting up a chit fund, the Foreman (Muthoot Chits) obtains a Prior Sanction from the Registrar of Chits by making a security deposit equivalent to the Gross Chit Amount and the required forms/documents, including net worth statement as stipulated by the Chit Fund Act, 1982.
The terms and conditions of the chit must be accepted by The Registrar of Chits.
The Foreman can only start sourcing the Chit Fund after obtaining the sanction from The Registrar.,
All the members of the Chit Fund need to register with The Registrar too.

Activities after receiving Prior Sanction from The Registrar of Chits

Following receipt of the Prior Sanction, the Foreman can announce the launch of the Chit Fund and begin selling tickets.
After selling all of the tickets, the Foreman will register the agreement with the Registrar and obtain the Commencement Certificate to hold the first auction.
The contribution will be made in the form of a fixed monthly instalment (₹10,000 per month in the above example).
The collection in the first month would thus be ₹10,000 multiplied by the number of members (50), i.e. ₹5 lakh.
From the second month, onwards the members will be able to bid for the Prize Money from the collected funds through a reverse auction. The Highest Bidder/Prized Subscriber wins the Prize Money for that month.
40% is the maximum discount anyone can quote (as per Law).
As per the above example, the auction is confirmed at a 35% discount. (Discount amount is ₹1,75,000/-)
So, out of ₹5,00,000/- pooled, ₹3.25,000/- goes to the highest bidder (Prized Subscriber), 5% of ₹5,00,000/- (₹25000) goes to the Foreman (Muthoot Chits) and the balance ₹1,50,000/- will be equally distributed to all the 50 members.
Each member will get ₹3000 (₹1,50,000/50) as his income which is called Dividend (share of Dividend) & the same will be credited to his Chit account.
So next month, the subscriber needs to pay only ₹7000 (₹10,000-3,000) instead of ₹10k.

Participating in the Auction

A member can participate in the auction for the Prize Money from the second month onwards. The first month’s Gross Chit Amount goes to the company. To be eligible to make a bid the subscriber should have paid all the instalments and not have any pending ones.

Options to participate in the Auction

A subscriber can participate in the auction in the following ways.

1. Direct Participation

The member can either participate online or personally attend the auction in the Chit office on the date and time specified in the Chit Fund agreement.

2. Bid Offer Letter

The subscriber needs to fill in all the details in the letter before signing and sending it to the Chit’s office.

3. Bid Authorisation Letter

The customer can send a proxy to participate in the auction on their behalf. The proxy must carry the authorisation letter & valid ID proof to participate in the auction.