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How do Chit Fund Scams work?
SEBI has over the years investigated over 350 companies involved in chit-fund scams. It is estimated that Indians have lost over Rs. 3 lakh crore just in chit funds.
To understand how chit fund scams work we need to understand a single-level chit fund concept which is indigenous to India and more specifically to Kerala where this goes back to the days when commodities were the currency.
*If we start with a chit fund scheme with 20 members, each paying a monthly instalment of INR 5,000, the first month’s corpus will be INR 1,00,000.
At the time of the auction, whichever member bids lowest get to take home the amount called prize money. So, if the maximum discount is INR 25,000, the prize money of INR 75,000 will be received by the winner. The discount amount, INR 20,000, is distributed equally amongst all the 20 members, after deducting the organizer’s fee which is typically 5% of the chit value, i.e., INR 5,000. For the winner, the chit fund acts as a borrowing scheme and for the remaining members, the fund provides returns on the amount that they have invested (INR 1,000 in this case).
This process is repeated for the next 19 months until each member has had a chance to take home the auction amount while other subscribers, including the previous winners, continue to contribute their monthly instalments. The borrowers continue to get the dividend as per the above scenario. Hence towards the end of the chit group life cycle, everyone pays the same money but what they get depends on when they take it.*
In a typical chit-fund scam this happens on an MLM model, and each level is only involved in a mix of the pyramid-Ponzi schemes.
How to spot a chit fund scam?
If the chit fund is registered under the State-Run Chit Funds scheme or registered with Registrar of Chits according to Chit Fund Act 1982, then such chit fund schemes can be deemed as legal.
Insist on getting a copy of the chit agreement registered with the state regulator. This is equivalent to a bond document you get when you invest in a LIC bond.
Try to know the promoters wherever possible and ensure that they are financially knowledgeable.
Ensure you get a proper passbook and receipt for every payment you make and keep a record of them. Attend auctions and follow up on payments if you win.
Lastly, if there's the mention of "quick and easy money to the subscriber" on enrolment then such schemes are banned in India and you should stay away from them.
