Letter to Secretary, Economic Affairs Dated 26-Sep-2012

September 26, 2012

Dr. Arvind Mayaram,
Secretary, Economic Affairs,
Ministry of Finance
North Block,
New Delhi.
Respected Sir,
Memorandum from Chit Fund Industry

To introduce us, All India Association of Chit Funds is the sole body representing more than 30, 000 registered chit operators across India through their respective State and District Associations. The major challenge that our Association confronts is unfortunately from within our own industry, which is the unregistered sector, their estimate being almost 100 times that of registered ones. And their emergence and unprecedented growth is mainly on account of over-regulation.
The only subsidy the Chit Industry has received from the Government perhaps is the Legislative sanction. Though the concept of Chit fund is prevalent in South Asian countries, West Africa, Cambodia, Korea, Indonesia known as ROSCAS and other names, India is the only country where this activity is regulated by an enactment. The precise problem is, The Chit Funds Act 1982, a Central legislation in force is obsolete, since it is almost a replication Cochin Kuries Act, 1932. i.e. outdated by more than 80 years! The legislation not being in tune with the ongoing liberalization policy has driven many a chit operators under ground.

Utility of Chit Fund
In many parts of India, Chit Funds address gaps left by the traditional banking sector. They mobilize huge amounts of small savings, and in return allow members to have access to lump sum amount of money that they would often not be able to get from traditional banks. Easy accessibility and flexibility are important aspects of this form of financing. Compared to banks, Chit Funds require less documentation, are more flexible about collateral, and allows to determine own interest rate (within the constraints of a given chit scheme). Furthermore, there is no need to determine upfront whether funds are used for saving or borrowing. This is a salient feature of chit funds as it not only puts in place a disciplined saving mechanism, but it also allows access to cash when needed. In addition, as Chit Funds use the funds of the participants there is much less capital requirements for the institution (unlike banks). Though the banking sector has come up with No-Frill account, Mobile Banking, Banking Correspondent Model etc, these do not help the un-served population to get funds for their income generation activity. As regards MFIs, multiple lending, high cost of borrowing etc has affected their agenda; mainly because they are focused on redistribution of wealth while what is required is inclusion in the Creation of wealth. All said and done, debt distribution to the poor as done by MFIs by itself does not grow economies! Chit Funds on the contrary, as against air dropping the finance, make sure that the entire cycle from distribution to collection is complete effectively, that too with out any Government subsidy, thereby playing the crucial role in Financial Inclusion.

The tie –up with Bill and Melinda Gates Foundation
While the “Financial Inclusion Program” is of recent origin, Chit Funds and other informal Financial Institutions are already implementing this, for the last several decades, catering to those cross sections, which are beyond the reach of Banking and other Financial Intermediaries.  The Bill and Melinda Gates Foundation knowing the standing of this Industry has tied up with the All India Association of Chit Funds, to reach the economically weaker section of the society through Chit Fund companies; under their ‘Poverty Alleviation Program’. The maiden survey conducted on the working of Chit Funds by the Institute of Financial Management and Research, Chennai under the Aegis of the Gates Foundation is an eye opener unraveling the inherent potential of this industry and suggesting ways and means to enhance its services to the deserving lot, in context of the current economic policies. The potential of this Industry to cater to the Lower and Middle Income Households is quite substantial, which can be optimized only with the legislative and Administrative support. The complete research material can be submitted as and when required.
The issues we are up against are as follows.
The Chit Funds Act, 1982
As it is not the mere formulation of an Act, but its effective implementation that matters, the Chit Fund Act need to be amended immediately. The amendment exercise which was being carried out for more than 4 years finally picked momentum, thanks to the formation of a  Key Advisory Group on Chit Fund / Nidhi Companies with a view to Review the existing legal/regulatory / institutional framework for Chit Fund/Nidhi Companies and its efficacy; to decide the Action plan including policy initiatives for orderly growth of the Sector; and to recommend the legal / institutional / regulatory initiatives related measures required for orderly growth of the Sector. The recommendations of the KAG, in principle, have been accepted by the DFS, but are yet to be introduced in the parliament.
Apart from the Amendment to “The Chit Funds Act, 1982”, elucidation to the following issues will allow us to position this Industry at par with other financial intermediaries.
Insurance coverage
The Act rightly provides Penal provisions for various defaults on the part of the foreman but the subscribers’ main concern is safety and security of their money in the hands of the foreman and not the punitive provisions of the Act as such. So, extending Insurance coverage to the Subscribers money in the hands of the Forman may be a prudent initiative. Extending insurance coverage, apart from safe-guarding the hard earned money of the subscribing public, will make good business sense for the Insurance companies.
Securitization facility
RBI rightly has prohibited Chit companies from accepting any deposit from the public but at the same time there should be some options for arranging liquidity, in order to enable the foreman to honor their commitments to the chit subscribers. Securitization can be a right step in this direction. Chit companies may also be permitted to raise funds within the framework of its functioning.  We are aware that this may bring to the fore the bigger policy issues such as if the ARC can securitize good loans of miscellaneous non-banking financial companies at all but a beginning may have to be made at some point of time!
Value addition to the Chit Industry
Allowing Chit companies to undertake fee based activity like selling insurance policies and other financial products like educational, housing loans etc should be considered favorably. The availability of Credit history is essential in the context of selling these products from the banks and other deposit taking institutions. The data bank that we have on this information qualifies us to undertake procurement, processing and disbursement of such products very effectively in view of our skill on intrinsic evaluation, cost effectiveness, market intelligence and the quality of ownership. This will also benefit those cross sections that are beyond the reach of banking and other financial intermediaries.
Grievance redressal cell
Chit Fund Association/Promoters should take the primary responsibility of addressing the subscribers’ grievances. The grievance redressal cell, which can consist of a representative of the Registrar of Chit Funds, a representative of the Chit Funds Association and representative of the subscribing public/or experts in the field so that complaints, as and when occur, can be resolved in the elementary stages. Such a cell has yielded result in States where it had been voluntarily set up.
Rating of chit fund companies
Chit funds traditionally operate on a small scale; foreman-participant as well as intra-participant relations is based upon mutual trust and personal information. The smaller Chit Funds have higher overheads and less capital cushioning but often provide more customized services and personalized attention to their clients. The larger Chit Funds are regarded as financially more reliable. To be successful and acceptable at an increased size and scale, chit funds need transparent processes, risk identification and management strategies, a pool of useful products, professional management, proper documentation, increased use of technology and financial strength to bear the risks.  Brand recognition comes with this type of professional management.  Though some process certifications, (such as ISO) exist, a holistic assessment of the quality of governance and strategies, strength of risk management and operating systems, legal compliance and financial performance can be delivered only by undergoing a detailed performance rating process. Hence it must be made mandatory to obtain ‘Rating’ from agencies like  M-CRIL/CRISIL etc which will be beneficial both to the subscribing public and also motivate the chit promoters to excel. Necessary enactment may kindly be initiated in this regard.
Formation of SRO
It’s high time that Chit Funds constitute an SRO, which we understand has also been suggested many times by RBI, as in the case of Bar Association of India, Institute of Chartered Accountants, and Medical Council for Doctors etc. The said SRO will further increase the transparency & ethical practices. This body can keep a tab on the chit promoters and can act as a deterrent for the erring companies thereby reducing the burden on the administrators.  This forum may further help in

• Advocacy of best practices
• Corporate Governance
• Best financial practices
• Ethical behavior
• Educational & awareness activities

As we are unable to form this body on our own, a hand holding approach on the part of the Government will enable us in achieving this objective.
Requirement of a common Registrar
One major drawback we find is that activities of any company in one State are not made known to the Registrar of another State. Creation of the post of a ‘Common Registrar’ for all the States will enable the working status of companies in different States and look into the complaints, if any, for the overall benefit of the subscribing public. The respective State Registrar can keep posting computerized financial and other relevant reports on a periodical basis.
Easy availability of the computerized information to the public from the office of the Common Registrar, based on a few points, and not the entire balance sheet, and some awareness program to the extent that they should deal only with companies who are in the approved list will be enough to maintain effective control.  If any individual chooses to deal with an unregistered company just for the sake of better returns, he should be doing at his own risk.  Risk taking behavior is inherent in human nature and undue concern to protect the public who knowingly lend themselves in the hands of unscrupulous elements is unwarranted.  Over regulation can only promote unhealthy practices and is also against the ongoing liberalization program. In fact the activities of all the non-banking financial institutions can be monitored by this common Registrar who can maintain the efficiency index based on one common index/Permanent Account number.
Inclusion Chit Funds in the ‘Negative List’ for Service Tax.
Imposing Service Tax on Chit Funds is akin to levying Service Tax on Micro Credit, Self Help Groups, and Co-operative Societies etc. While the Government and R.B.I. are rightly thinking in terms of using the Money Lender Channel for reaching the poor agriculturalists, artisans etc in granting credits at low rates, encouraging our industry will only be just and apt. Though Financial Inclusion has become buzzword only recently, Chit Funds have been addressing the very objective since time immemorial.  Service tax on Chit Funds will act as a disincentive. The Chit Fund companies do not manage any fund or cash as no money is left in their hand to manage, neither they undertake any activity to maximize the return of its subscribers. The companies do not do anything to “effectively cause movement of
such cash to keep it working”.  More over, as the Service Tax collected may not even cover the cost of such collection, the Government even on the merit of this may consider excluding Chit Funds from Service tax as the exercise will be cost inefficient. While we were hopeful of getting relief at least on this front, this recent levy has further aggravated the situation and will force more operators to enter the unregistered arena, which not only will harm us but also give a boost to the unregistered sector as the subscriber will also be enticed to join them.
TDS on Chit Dividend
This is another classic case not seeing in the right perspective. Even though the Law is very clear, there seems to be some ambiguity causing us unnecessary anxiety, which needs to be cleared.
Role of Chit Funds in the economy and National Financial Inclusion Program
Chit funds operate on the unique principle of intrinsic evaluation. It is a faith on the subscriber’s ability to repay and not the collaterals or its value, thus easing the credit flow to lower/middle income group, small entrepreneurs etc which are often wedged between the exorbitant cost of the moneylenders and the stringent procedures of the bank. The chit is not seen as an investment but a plan to get lump-sum finance for meeting the expenses such as marriage, education, and housing etc. at a future date. Our industry accounts for a lion’s share of credit to the rural masses and provides direct and indirect employment to millions giving impetus to GDP growth. Dr. Babatosh Dutta Committee, Dr. A.C. Shah committee have lauded chit funds for the role in our economy. In the findings of James Raj Committee based on whose report the 1982 Act was enacted, Chapter 6 Para 13 “…. The rationale of chit funds is that they bring the borrowing class directly in contact with the lending class…” in other words, in the case of chit funds, the savers as well as the borrowers are put together and they are allowed to save or borrow for a pre determined term, the rates of interest being fixed on the principle of demand and supply of funds in the same group. The Chit Funds are of a self-liquidating nature and par-take the character of mutual benefit schemes.” That is to say,  institutions like Chit Funds absolves the Government of their responsibility in reducing the interest rates, stabilizing the fiscal balance, reduction in the GDP etc in its own way.  
Prayer: 
In view of the significant contribution of our industry to the society and the pivotal role visualized therefore and to enable the chit operators to enhance their participation in prestigious projects like ‘National Financial Inclusion Program’ etc., we appeal to your good self to

1. Help push the Amendment of the Chit Fund Act 1982.
2. Relieve the chit industry from sword of ‘Service Tax’
3. Clear the ambiguity on TDS, once for all.
4. Give us a lead in the formation of (i) Advisory Committee (ii) Introduce

An Efficiency Index (iii) Appoint a Common Registrar (iv) Allow Securitization Facility, (v) Allow us the benefit of Insurance Coverage (vi) formation of SRO and Other benefits you deem fit in the light of the above.
Total support from the government alone will facilitate our participation in the Micro economic reforms initiated by the present regime. Encouraging chit funds, which has been a “Financial Inclusion” activist since its inception will be in tune with the present Government policies, which we are sure you will agree.
In the light of above, we request you to make use of your good office and help bail out our industry.

Thanking you,
Sincerely,
For All India Association of Chit Funds (Regd.)

T.S. Sivaramakrishnan
General Secretary
Mobile # +91 98100 24853