These are challenging times for chit fund operators. A scam involving the Saradha group allegedly conning customers under the guise of a chit fund, has raised serious questions for the industry. With a reported 10,000 chit funds in the country handling over Rs 30,000 crore annually, chit fund proponents maintain that these funds are an important financial tool. The scam has also sparked responses from both the centre and states: the Finance MinistryMinistry of Corporate Affairs and SEBI have all promised to act and the West Bengal Assembly has passed The West Bengal Protection of Interest of Depositors in Financial Establishments Bill, 2013, with Odisha and Haryana considering similar legislation. What is a chit fund? A chit fund is a type of saving scheme where a specified number of subscribers contribute payments in instalment over a defined period.  Each subscriber is entitled to a prize amount determined by lot, auction or tender depending on the nature of the chit fund.   Typically the prize amount is the entire pool of contribution minus a discount which is redistributed to subscribers as a dividend. For example, consider an auction-type chit fund with 50 subscribers contributing Rs 100 every month. The monthly pool is Rs 5,000 and this is auctioned out every month.  The winning bid, say Rs 1000, would be the discount and be distributed among the subscribers. The winning bidder would then receive Rs 4,000 (Rs 5,000 – 1,000) while the rest of subscribers would receive Rs 20 (1000/50).  Winners cannot enter the auction again and will be liable for the monthly subscription as the process is repeated for the duration of the scheme.  The company managing the chit fund (foreman) would retain a commission from the prize amount every month.  Collectively, the subscribers to a chit fund are referred to as a chit group and a chit fund company may run many such groups. What are the laws governing chit funds? Classifying them as contracts, the Supreme Court has read chit funds as being part of the Concurrent List of the Indian Constitution; hence both the centre and state can frame legislation regarding chit funds.  States like Tamil Nadu, Andhra Pradesh and Kerala had enacted legislation (e.g The Kerala Chitties Act, 1975 and The Tamil Nadu Chit Funds Act, 1961) for regulating chit funds. Chit Funds Act, 1982 In 1982, the Ministry of Finance enacted the Chit Funds Act to regulate the sector.  Under the Act, the central government can choose to notify the Act in different states on different dates; if the Act is notified in a state, then the state act would be repealed[i].  States are responsible for notifying rules and have the power to exempt certain chit funds from the provisions of the Act.  Last year the central government, notified the Act in Arunachal Pradesh, Gujarat, Haryana, Kerala and Nagaland. Under the Act, all chit funds require previous sanction from the state government.  The capital requirement for establishing chit funds is Rs 1 lakh and at least 10% of profits should be transferred to a reserve fund.  The amount of discount (i.e. the bid) is capped at 40% of the total chit fund value.    States may appoint a Registrar who would be responsible for regulation, inspection and dispute settlement in the sector. Any grievances over decisions made by the Registrar can be subject to appeals directed to the state government. Chit fund managers are required to deposit the entire value of the chit fund (can be done in 50% cash and 50% bank guarantee) with the Registrar for the duration of the chit cycle. Prize Chits and Money Circulation Schemes (Banning) Act, 1978 The Prize Chits and Money Circulation Schemes (Banning) Act, 1978 defines and prohibits any illegal chit fund schemes (e.g. schemes where auction winners are not liable to future payments).  Again, the responsibility for enforcing the provisions of this Act lies with the state government. Reports suggest that the government is discussing amendments to this Bill in the wake of the chit fund scam. West Bengal Protection of Interest of Depositors in Financial Establishments Bill, 2013 Last month the West Bengal Assembly passed the West Bengal Protection of Interest of Depositors in Financial Establishments Bill, 2013. This was a direct response to the chit fund scam in West Bengal. While not regulating chit funds directly, the Act regulates and restricts financial establishments to curb any unscrupulous activity with regards to deposits.  Chit funds are specifically included under the definition of deposits. The state government will appoint a competent authority to conduct investigations. What is the role of RBI and SEBI? The Reserve Bank of India (RBI) is the regulator for banks and other non banking financial companies (NBFCs) but does not regulate the chit fund business. While chit funds accept deposits, the term ‘deposit’ as defined under the Reserve Bank of India Act, 1934 does not include subscriptions to chits. However the RBI can provide guidance to state governments on regulatory aspects like creating rules or exempting certain chit funds. As the regulator of the securities market, SEBI regulates collective investment schemes.  But the SEBI Act, 1992 specifically excludes chit funds from their definition of collective investment schemes. In the recent case with Sarada Group, the SEBI investigation discovered that Sarada were, in effect, operating a collective investment scheme without SEBI’s approval.


[i] The central act repeals the Andhra Pradesh Chit Funds Act, 1971; the Kerala Chitties Act, 1975, the Maharashtra Chit Funds Act, 1974’, the Tamil Nadu Chit Funds Act, 1961 (applicable in Chandiragh and Delhi), the Uttar Pradesh Chit Funds Act, 1975,  Goa, Daman and Diu Chit Funds Act, 1973 and Pondicheery Funds Act, 1966.

The government is considering a number of measures to tackle corruption such as the formation of the office of the Lokpal or Ombudsman to investigate corruption cases, the Judicial Standards and Accountability Bill, 2010 that requires judges to declare their assets, lays down enforceable standards of conduct for judges, and establishes a process for removal of the Supreme Court and High Court judges (see PRS Analysis) and the Public Interest Disclosure and Protection of Persons Making the Disclosure Bill, 2010. In 2004, following the death of whistleblower Satyendra Dubey, the government issued a notification laying down certain guidelines for whistleblowing and protecting whistleblowers.  It introduced the Public Interest Disclosure and Protection of Persons Making the Disclosure Bill, 2010 in August 2010 to give statutory backing to the 2004 government resolution.  Commonly known as the Whistleblower’s Bill, it seeks to protect whistleblowers i.e. persons making a public interest disclosure related to an act of corruption, misuse of power or criminal offence by a public servant.  It designates the Central and State Vigilance Commissions to receive disclosures from whistleblowers and lays down safeguards for protection of whistleblowers (see PRS Analysis). The Bill was referred to the Departmentally related Standing Committee on Personnel, Public Grievances, Law and Justice.  The Committee presented its report on June 9, 2011. Key recommendations of the Standing Committee

  • § The Bill seeks to establish a mechanism to register complaints on any allegation of corruption or wilful misuse of power by a public servant.  The Committee broadly agreed with the provisions of the Bill but hoped that the government would consider the recommendations and adopt them wherever found appropriate.
  • § The Bill covers any complaint under the Prevention of Corruption Act, 1988; wilful misuse of power, and a criminal offence by a public servant.  The Committee suggested that the scope of the Bill may be widened to include offences such as maladministration and human rights violations.  Specifically, the Bill should cover accrual of wrongful gain to a third party.  Also, the definition of “public servant” in the Indian Penal Code and the Prevention of Corruption Act, 1988 could be adopted for this Bill.
  • § The Committee proposed that the defence forces and intelligence organisations should be included within the ambit of the Bill.  There could be reasonable exceptions based on operational needs of the forces.  Alternately, a separate authority could be set up for these exempted agencies.  It added that the Bill should cover members of the Council of Ministers, the judiciary (including higher judiciary) and regulatory authorities.
  • § The Bill states that a public interest disclosure can be made only to the Central or State Vigilance Commissions (VCs).  The Committee is of the opinion that this may restrict access especially to population in remote areas.  It recommended that the Rules should provide for a smooth and convenient system.  The Committee added that if there are multiple points at which complaints can be made, the identity of the complainant should be strictly protected.
  • § The Bill does not allow anonymous complaints.  The Committee however suggested that if the anonymous complaints have supporting documents that substantiates the claims, the VCs can investigate it.  It also advised that an alternative mechanism could be set up within or outside the Bill for inquiring into anonymous complaints.
  • § The Committee recommended that there should be a foolproof mechanism to ensure that the identity of the complainant is not compromised with at any cost.  This is especially important because without such a mechanism it would deter prospective complainants due to fear of harassment and victimisation.
  • § The Bill allows the VCs to reveal the identity of the complainant to the head of the organisation if it is necessary to do so.  The Committee recommended that the identity of the complainant should not be revealed to the head of the organisation without the written consent of the complainant.
  • § The Committee felt that undue burden should not be placed on the complainant to provide proof to substantiate his case.  As long as he is able to make out a prima facie case, the VCs should follow up on the case.
  • § The Committee is of the view that the VCs should inform the complainant about the outcome of the complaint.  Also, the VCs should give reasons if it decides to dismiss a complaint and the complainant should be given a reasonable hearing if he is not satisfied with the dismissal.
  • § The Committee proposed that there should be a time limit for conducting discreet inquiry by the VCs, for inquiry by the head of the organisation and for taking action on the recommendations of the VCs.  The authority would have to give reasons in writing if it wants the time limit to be extended.  There should also be some mechanism to ensure that the directions of the VC are not avoided to protect the wrongdoer.
  • § The Bill states that the VCs shall not entertain any complaints made five years after the action.  However, the Committee is not convinced that this restriction should be prescribed.  If at all there has to be a time limit, exceptions should be made in case of complaints which prima facie reveal offences of a grave nature.
  • § The Committee recommended that the term “victimisation” should be defined and the whistleblower should be provided with sufficient protection to protect him from violence.  Also, witnesses and other persons who support the whistleblower should be accorded the same protection.
  • § The Committee strongly recommended that there should be a mechanism to ensure that the orders of the VCs are complied with. Stringent action should be taken against any person who does not comply with the order.
  • § The Committee felt that the penalty for frivolous or malafide complaints was too high and should be substantially reduced.  Also, while deciding whether a disclosure is frivolous, the intention of the complainant should be examined rather than the outcome of the inquiry.  The complainant should also have the right to appeal to the High Court.