Blog Competition on Suitable Finance for Agricultural Households
By Preethi Rao
After the successful completion of the first phase of our Chit Fund Research, Small Enterprise Finance Centre (SEFC) is entering into the second phase that involves 3 year long, rigorous, on-the-ground experiments. Our findings from the study titled “Chit Funds as an innovative access to finance for low income households” point to the fact that though Chit Funds are an important source of finance for small businesses and low-income households in India, there has been a general exodus of low value chit schemes from the registered Chit Fund market. This is mainly because registered Chit Funds find it less lucrative to serve the poor due to the increased cost of operating such schemes imposed by the regulators.
We find that the Chit Fund industry addresses the savings needs of people, is considered very safe and also offers loans at lower interest rates than moneylenders. In order that these benefits reach the poor, we propose to test different schemes for the poor in collaboration with Chit Fund companies across India and understand how Chit Funds can be developed as an innovative access to finance for low-income households. In particular we propose to test the following:-
1. Impact of setting up registered Chit Funds in rural areas – Majority of the poor people in India live in the rural areas. Under this pilot project, we propose to collaborate with volunteering chit companies to start a registered chit scheme in one village in each of the four states – Tamil Nadu, Andhra Pradesh, Karnataka and Delhi. We will document the costs of registration and implementation of the schemes as well as the defaults and repayment behavior of the rural chit members. We will compare the costs and member behavior to that of an urban scheme with similar characteristics to understand what are the costs and benefits to chit companies to do business in rural areas and thus serve the poor in these areas.
2. Impact of altering collateral/guarantee requirements – Most of the poor people in India are unable to provide collateral or guarantee for the loans they require as they do not have access to any property of significant value nor are they able to provide guarantees from trusted people (like government employees). Under this pilot project, we propose to work with volunteering chit companies to start low value chit schemes where the members are asked to provide nil or lower collateral or guarantee than in a usual scheme. We will study the defaults and repayment behavior in the schemes to understand the impact of lowering collateral and guarantee requirements.
3. Developing a credit scoring model for Chit Funds – Given the long history of chit funds in India, the information that each chit company will have on its members will be humongous. Under this pilot project, we propose to look at the data available with the chit companies, put the data in an analyzable format and finally build prediction models using the data that would help Chit Funds to foresee the repayment behavior of the members.
In order to explain the nuances of the research projects and to gain cooperation from the participants we have conducted in-depth meetings and discussions with chit fund companies in Tamil Nadu and Karnataka and we propose to conduct similar meetings in the other two states i.e. Andhra Pradesh and Delhi. So far, the participating chit fund companies have expressed interest in the proposed projects and are very enthusiastic to take it forward.
To learn more about how chit fund is an innovative access to finance for low-income households, write to preethi.rao [at] ifmr.ac.in or sharon.buteau [at] ifmr.ac.in or leave a comment below. We would love to hear what you have to say.
Preethi Rao is a senior research associate with the Small Enterprise Finance Centre at IFMR Research.
This is great work Preethi. I wonder if there is material somewhere that compares and contrasts traditional banks with Chit Funds. I am curious to see how the traditional Basle like principles that govern banks play out within a Chit Fund.
This is seems really cool. Chit funds are really popular in cities , and provide access to liquidity as and when needed at the lowest rates of interest. But there is an inherent trust among the chit fund members, the panchayat of the village will have to be involved in this .
But this could turn out to be on the best options for savings in rural India.Kudos to you !!
Thanks Nachiket. In our report, we have compared the scheduled bank deposits and credit to the money circulated in chit funds as of 2006. The Act that governs chit funds, stipulates an aggregate chit value to Net Owned Funds ratio of 1:10. Though this is somewhat similar to the VaR stipulations of Basel, they are not as robust and a comparison would surely throw light on how the Act can be further improved.
Thanks for the valuable suggestion Rahul. We indeed intend to involve the village Panchayat in the process. As you rightly point out, the chit fund model is trust-based and this is the right way to ensure that the rural people trust the company and its intentions.
Hi Preethi,
This is fascinating work that you and Sharon propose to do, one of the important things that you may want to look at is the tenure of the group. My feeling is that the rural people would be looking at lower tenures then the 50 month ones that is being offered in urban areas. Also it is good for the lender to have a lower term. the only hitch is that the transaction cost of the chit fund company will more or less remain same. So the challenge would be to have a lower term, lesser cost (documentation, collection etc.) but still be able to offer good/ higher returns and still be able to lend at lower cost.
Also, would be interesting to note what you define "Poor" as!
Thanks Jagan. These are indeed very good points. As you have rightly pointed out, tenure is an important factor to be considered when we introduce chit schemes in the rural areas. From the ground work we have done till now, we also learned that the schemes should be of lower tenure. So we propose to introduce schemes of 10 or 20 months duration.
As for the definition of the poor, we are currently using the <1.25$ USD a day definition of the world bank. However, we will finalize the definition only after thoroughly studying the income and consumption levels of people in the rural areas and from the lower stratum in the urban areas.
The interesting flip side to lower tenure is that you will be able to have only that many people included in to the group so if you run with 10 month then you will limit it to 10 people. which by itself throws up different other challenges like the success of a chit fund is to balance the savers and borrowers so u wud have to micromanage this. Then the other part is you would like to have financial inclusion for the bottom end of the pyramid so the organisation would hav to run with a phenomenal number of groups for this and there in comes in the cost of managing this. When you run with a person who is going to earn about Rs 60/ day which is like Rs 1,800 a month. If the savings is 10% which is quite high considering the low income, you will run with a ticket size of Rs.3,600 for a 20 month period and Rs.1,800 for 10 months ( herein the point of cost becomes pertinent). With this amount being bid what a person lands would be ~3,000 or so which will not make a significant impact. So i think you are having a big challenge to balance all this. When you do at 10 to 20 months, I wonder whether the chit funds and the Self Help Group mode of operation may look similar (except for the difference in the source of funds). All in all a interesting work to watch out for.
The schemes we plan to run will be closely monitored and micromanaged as you have pointed out. We have a lot of work to do to ensure that the experiments are academically sound and the results are quantifiable. The pilots as such are mere experiments and it is up to the chit fund companies to scale it up in later years. We are very excited to start the pilots as well and will be sure to share interesting information and results in this space as and when we have them.
this is very good plan for new ganrestion.
MAM ITS VERY VERY FANTASTIC WORK FOR THE RURAL PEOPLE ESPECIALLY FOR THE POOR WHO FALL PREY UNDER THE MONEY LENDER. I’M A RESIDENT OF GUWAHATI (ASSAM) AND WOULD LIKE TO START A CHIT FUND COMPANY, PLZ HELP FOR THE PROCEDURE FOR THE SAME.IN ASSAM THERE IS NO CHIT FUND ACT THEN WHO WILL GIVE REGISTRATION?
MAM ITS VERY VERY FANTASTIC WORK FOR THE RURAL PEOPLE ESPECIALLY FOR THE POOR WHO FALL PREY UNDER THE MONEY LENDER. I’M A RESIDENT OF GUWAHATI (ASSAM) AND WOULD LIKE TO START A CHIT FUND COMPANY, PLZ HELP FOR THE PROCEDURE FOR THE SAME.IN ASSAM THERE IS NO CHIT FUND ACT THEN WHO WILL GIVE REGISTRATION?