The concept of Chit Fund originated in India long way back. Basically, amounts are pooled in and distributed amongst the subscribers by the administrators. Though there is no authentic history, it is believed that this concept started in a very small way and spread in a big into what we call today as Chit Fund.
The concept started within a community of known people. The person who started this came to be known as the organizer and the contributing members known as subscribers. Each subscriber must pay a certain amount and the collected amount would be given to one member, after deductions, by way of drawing a chit from the pot. Hence this came to be known as Chit or Chitti or Chit Fund as it is known today.
As the popularity these chits raised, a bidding system came into vogue. The subscriber who wanted money in that particular month would bid offering discount. The highest bidder would get the pooled amount and the discounts distributed amongst the remaining subscribers. Over a period of time these types of schemes became popular and also the number of deceitful players. Most of the Southern States have enacted Chit Regulation Act and there is a Central Chit Act from the Govt. of India as well. With the advent of these laws, the industry has been regulated bringing in security to the subscribers.
A chit fund comprises a group of members, called subscribers. An organizer, a company or a trusted relative or neighbor, brings the group together and administers the activities of the group. For their efforts, the organizer is either compensated each month or at withdrawal time. (The fee may be omitted in informal situations.)
The fund starts at an announced date and continues for the number of months equal to the number of subscribers. Each month, the subscribers put in their monthly installments into the pot. Then, an open auction is conducted to determine the lowest sum a subscriber is willing to take that month. For example, if the monthly installment is ₹1000 and there are 50 members, the pot in the first month will contain ₹50,000. If the auction determines a winner who is willing to accept ₹45,000 for that month, the surplus ₹5,000 is distributed to the other 49 members, after subtracting fees paid to the organizer. The subscriber who won the auction was able to access ₹45,000 in the first month and the others benefited in their share of the ₹5,000 surplus. The process repeats, distributing the auction amount to one member each month. All of the other subscribers, including the ones who took their share in a previous month, continue paying the monthly installments.
The system acts as a borrowing scheme, because subscribers are able to access large sums of money before they've paid the full amount. It also acts as a savings system, because each subscriber contributes every month and may retrieve a large sum in the future while receiving their share of the surpluses.
Variations of the system omit the auction part, instead drawing a winner by picking a chit out of a box. (The term chit fund comes from such an arrangement.)
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