Chit Funds – augmenting void generated by the traditional banking system in India

Do you remember the last time you wanted to go on that exotic holiday and found yourself short on funds? And then the pain and the frustration of being turned down by a bank for a personal loan because they the lender did not view as a credible borrower despite you earning a six-figure salary and have all the best intentions to repay.

If you have gone through the above situation, then you should know that you are not unique. Thousands – if not millions, of people who earn enough to fulfil their small dreams, often find themselves on the wrong side of the fence when they seek to borrow from the established lending institutions.

But is there a solution to this – you might ask.
In response let is suffice to say that in the recent decades, a significant portion of funding for small and medium sized firms in China is provided by what is called ’shadow banking’, which are depositors and lenders outside of the established banking system. According to a recent 2018 report by the Reserve Bank of Australia, the size of the non-banking financial institutions or the ‘shadow banking” system is similar to the size of small national economies measured in terms of their assets.

The report further states that about 25 per cent of the total non-financial sector debt in China is lent out by these firms. Interestingly, these firms also offer tools for small savings against which customers can ask for debt.

But what is the situation in India?
India too possesses a robust system of non-banking financial institutions that are outside of the established banking system. Have you ever wondered from where a person living in a small village manage to get debt to get his daughter married off? No, it is not always the ‘sahukar’ that they turn to in times of financial emergencies but to such small savings and lending firms who allow them to save in small amounts and borrow as well. One such saving and lending system is composed of the micro finance firms.

But coming back to the initial example of a young individual residing in an urban setting and earning enough and yet finding it difficult to get a debt when needed, what is the solution. Off course he/she might rue the fact that they did not engage in small monthly savings that could have helped them to get that loan which has become a coveted one because of the rejection by the established banking system in India.

The answer lies in chit funds.
Chit funds have been active and popular in India for many decades and according to rough estimate, there are more than 10,000 registered chit fund companies in the country. Financial advisers say that chit funds can be a very good investment tool if companies promoting such funds are prone to strictly follow the rules that have been laid down for them.

Chit funds are viewed to be a savings and borrowing instrument and are popular among housewives as well as with businessmen. Most engaging in chit fund view it not only as a savings tool but also a dependable tool for drawing a debt for small needs – virtually replacing the high interest tools such as personal loans.

But in the modern Indian society, chit funds are also considered apt for the salaried individuals and professionals as well because it offers a unique system of engaging in small monthly savings as well as acts as a convenient credit system which one would find difficult to avail from the established banking system.

It is as easy to borrow money from a chit fund as it is easy to store money in them, says Sridhar Alampalli, promoter of Shanthala Chits which was founded in 1996 and is strictly governed by the Chit Fund Act, 1982 of India.

Most chit funds are typically not very concerned with your credit scores – which are so loved by banks and other such financial organizations. Therefore, it is relatively easy to engage in small monthly savings and drawing debts from the fund for sudden family needs.

The functioning of a chit fund is also simple to understand. Typically, chit fund firms ask investors to pay an amount at specific intervals, usually a month, up to a fixed period. The money thus pooled in is transferred into a common fund. The amount collected is given to one person, usually selected in a lucky draw. Some other firms, such as Shanthala Chits also have an auction system for allotment of borrowing in which the person who gets the money is selected on the basis of the lowest bid.

But how safe are chit funds as an investment tool and why should the young, well salaried urban residing individual or a professional choose to chit funds over the established banking system.

Well for a start, chit funds are not touted to be alternatives for the banking system but rather an augmentation of the system for those who do not want to go through the hassles and bustles of traditional banking, the paper work and the need to be physically present often to get work done.

To know more about the safety of your money parked in a chit fund and further reasons why as a budding professional or a career-oriented individual you should invest in chit funds, look out for the next blog explain all the details.

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