Are chit funds still a good choice for quick money? Know their relevance, risks

For those unaware, chit funds – commonly known as chit, chitty or kuree – is a type of rotating savings scheme and credit association system is said to be have been a part of a largely Asian financial system for over a century. But how relevant are they in an age dominated by digital finance?

Resilient charm of chit funds

“Chit funds, a financial model with deep roots in South Asia, have been a key source of finance for many over the years. For generations, people have turned to chit funds when access to formal banking or loans was either unavailable or inadequate,” said Jose Paul, an Abu Dhabi-based banking analyst.

“The concept, at its core, is simple: a group of individuals contributes a fixed sum of money each month, and one member receives the pooled amount through a bidding process. This cycle continues for as many months as there are members in the group. Its simplicity alone appealed to the general masses.”

Parthiv Patnaik, a Dubai-based banker with nearly four decades, evaluates that the chit fund arrangement still serves as both a “savings tool and an emergency fund, making it especially useful for families facing urgent financial needs like medical emergencies, weddings, or house repairs.”

Still an urgent savings tool?

Historically, chits were considered a community-based solution in rural India, where formal banking was limited. People, often friends or neighbours, would contribute a fixed amount to a shared fund. The pooled money would then be lent to one in need, with the cycle continuing until all got their share.

Fast forward to today, and the landscape of chit funds has evolved. While the basic structure remains largely unchanged, technology has introduced new possibilities. Digital platforms have now entered the chit fund space.

Now, people can participate in chit schemes through online auctions by making electronic payments, and managing their subscriptions from the comfort of their homes. This transformation has made chit funds more accessible, bridging the gap between traditional systems and modern-day finance.

So how do chit funds work today?

Chit funds still operate in a similar fashion as they did decades ago, though with some modern adaptations. Typically, a chit fund comprises a fixed group of subscribers who commit to contributing a set amount every month.

The total monthly contribution is pooled together, and the funds are awarded to one subscriber through a bidding process, where participants bid the lowest amount they are willing to accept. The lowest bidder receives the pot, and the process continues until every participant has received their turn.

“In modern times, some chit fund organisers have moved online, and these systems often come with additional features like automated bidding and online payments,” added Patnaik. “While convenient, it also makes it difficult for users to track the credibility of platforms, making scams a significant risk.”

What’s the appeal of chit funds nowadays?

So, why do chit funds continue to attract individuals, especially in this age of digital finance and instant loans?

1. Interest-free borrowing

“Unlike loans from banks, which come with interest rates, chit funds still offer a way to access large sums of money without paying interest. This makes them attractive for those in immediate need of funds but who want to avoid the burden of high-interest loans,” added Paul.

2. Low documentation:

“In many cases, chit funds do not require extensive documentation or credit checks. For individuals who may not have a credit history or access to formal loans, chit funds offer a relatively easy way to borrow money.”

3. Community-driven trust

Chit funds often operate within tight-knit communities where trust plays a crucial role, noted Patnaik, while adding that this makes them “appealing to people who value personal relationships when it comes to dealing with money and communal financial solutions.”

Chit fund arrangement still serves as both a savings tool and an emergency fund, making it especially useful for families facing urgent financial needs like medical emergencies, weddings, or house repairs.

- Parthiv Patnaik, a Dubai-based banker

Above appeal not without its share of risks

“While chit funds can be a useful tool in certain circumstances, they are not without risks,” agreed Patnaik. Many financial advisors warn against relying solely on chit funds for long-term financial planning, especially as a primary investment vehicle. Some of the key risks Patnaik flag are:

1. Default risk

One of the biggest risks in chit funds is the possibility of default. If a member fails to make their monthly contribution, the fund’s stability is compromised. This is especially concerning in larger funds, where the amounts involved can be significant.

2. Lack of regulation

While traditional chit funds are regulated by local authorities, online chit funds are not as strictly monitored. This opens the door for fraudulent schemes that can leave investors vulnerable to scams. It is essential to thoroughly vet any chit fund scheme, especially those operating on digital platforms.

3. High organiser fees

Organisers of chit funds typically take a percentage of the pot as their fee. While this is understandable, the high fees charged by some organisers – especially in the case of informal chit funds – can reduce the amount received by participants, making it less of a good deal than it appears.

Some modern alternatives to chit funds?

While chit funds remain relevant in specific communities and contexts, there are more structured and regulated alternatives available today. Financial products like fixed deposits, personal loans, and microfinance options offer more predictable returns and lower risks.

“Insurance plans, health savings accounts, and emergency funds are other options that can provide a safety net in times of financial need, offering more security than informal schemes like chits,” Paul noted. “Also, digital lending platforms and peer-to-peer lending have emerged as modern day fixes.

“They offer quick access to funds without the need for traditional documentation. These platforms are often backed by stronger regulatory frameworks, providing more security and transparency than their informal counterparts.”