Chit funds explained: how the auction works, the law, and the risks

What makes a chit fund different from a plain savings circle

Our global guide to savings circles explains the basic rotation: everyone pays the same amount each round and one member takes the pot. A chit fund adds two things.

An auction. Instead of a fixed order or a draw, members who want the money now bid for it. The bid is the amount they agree to give up. The Act also allows the winner to be chosen "by lot or by auction or by tender", but auction chits are the common commercial form.

A licensed organiser. The person or company running the chit is called the foreman. The foreman collects contributions, conducts the draw, pays the winner, and earns a commission out of the discount. In a traditional circle, the organiser is usually just a trusted member.

The Act's definition covers a transaction "whether called chit, chit fund, chitty, kuri or by any other name". The 2019 amendment added two more names, "fraternity fund" and "Rotating Savings and Credit Institution". It also renamed the key terms: the pot is now the gross chit amount, what the winner takes home is the net chit amount, and the old "dividend" is now the share of discount.

A worked auction, rupee by rupee

Take a small chit: 10 members, each paying ₹10,000 a month for 10 months. The gross chit amount each month is 10 × ₹10,000 = ₹1,00,000. The foreman's commission is set at 5% of that, ₹5,000 a month, within the legal ceiling.

Each month the auction works in four steps:

1. The winning bidder offers the largest discount, meaning the amount they are willing to give up.
2. The foreman takes the commission out of the discount.
3. What remains is split equally among all 10 members as the share of discount, which reduces what each person pays that month.
4. The winner receives the gross amount minus the discount: the net chit amount.

Here is a plausible year, with bids that fall as fewer members are left competing. These are illustrative figures, not quotes from a real chit.

Two details matter. The bid can never fall below the commission, because the commission is paid out of it: in month 10 the last member has no rival, bids the minimum ₹5,000, and takes home ₹95,000. And every member, winners included, receives the share of discount every month, so each person pays the same total over the cycle: ₹8,000 + ₹8,400 + … + ₹10,000 = ₹92,300.

Over the 10 months the foreman earns 10 × ₹5,000 = ₹50,000. Check: members pay in 10 × ₹92,300 = ₹9,23,000; winners receive ₹8,73,000; the difference is the ₹50,000 commission.

Who gains and who pays: early versus late winners

Since everyone pays ₹92,300, the only difference between members is when they win and how much they take home.

The month-1 winner gets ₹75,000 immediately (₹67,000 net of that month's ₹8,000 payment) and then repays ₹84,300 over the next nine months. Solving for the rate that balances those cash flows gives about 4.7% a month, roughly 74% a year compounded. That is the price of getting a lump sum without a bank loan, and it is high because the chit is short and the early bid is steep.

The month-10 winner is a saver: they pay ₹92,300 across ten months and receive ₹95,000 at the end, an effective return of about 0.67% a month, or 8.3% a year. Members in the middle land close to break-even. (For them, the "interest rate" is not well defined, because money flows in both directions; the net rupee result is the useful figure.)

Researchers see the same pattern in real data. Jan Eeckhout and Kaivan Munshi studied every winning bid in the groups run by Shriram Chits in Chennai that started between October 1992 and September 1994: about 78,000 participants in 2,000 groups. They found that bids fall over the life of each group and bottom out near the company's commission, and that the chits paid savers an implicit interest rate of about 19%, when bank deposits paid around 9%. After the 30% cap on bids was enforced in September 1993, the implicit rate fell to about 14%.

Why would anyone bid 25% for money? Stefan Klonner, in the International Economic Review (2003), modelled bidding circles among risk-averse members whose incomes swing unpredictably. His conclusion: the auction works as a form of insurance, because whoever is hit by a shock that month can outbid the others and get cash when they need it most. For someone facing an emergency with no access to bank credit, the realistic alternative may be an informal moneylender.

The law in practice

The Chit Funds Act, 1982 sets out how a registered chit must run. The main rules, with the 2019 changes:

• Sanction and registration. No chit can start without prior sanction from the state government and registration with the state's Registrar of Chits (sections 4 and 7). The foreman may only begin auctions after the registrar issues a certificate of commencement, once every ticket is subscribed (section 9).
• Security from the foreman. Before applying, the foreman must lodge security in the registrar's name: a bank deposit equal to the chit amount, or government or trustee securities worth at least one and a half times it (section 20). It stays locked until every subscriber has been paid.
• The draw. Each draw happens at the date and place in the agreement, with at least two subscribers present. Since 2019 they can attend by video conference. Minutes are signed and a copy filed with the registrar within 21 days (sections 16 to 18).
• Commission and the first pot. Up to 7% of the chit amount since 2019. Unless the agreement says otherwise, a foreman who holds a ticket may take the first instalment's pot without any discount (section 21).
• Size limits. An individual foreman may not run chits with an aggregate value above ₹3 lakh; a firm with four or more partners, ₹18 lakh. Companies are limited to ten times their net owned funds (section 13).
• Bid cap. The Act caps the discount a chit agreement may allow; the 1982 text sets it at 30% of the chit amount, and an amending act passed in 2001 provides for 40% once notified. Your chit agreement states the maximum that applies to you.
• Duration. Normally no longer than five years (section 6).
• The name. Anyone carrying on chit business must use a word such as "chit", "chitty", "kuri" or "fraternity fund" in its name, and nobody else may (section 11).

The RBI's role. The Reserve Bank's own FAQ says chit fund companies "would be registered and regulated by the State Government" under the Act. Chit subscriptions are excluded from the legal definition of a deposit, and the RBI has prohibited chit fund companies from accepting deposits from the public since 2009. So if a "chit" company offers you a fixed deposit or a guaranteed return, it is stepping outside what a chit fund may do.

Saradha and other "chit fund scams"

Indian headlines often use "chit fund scam" for any collapsed savings scheme. Many were not chit funds. The Saradha Group in West Bengal, which collapsed in 2013, raised money through collective investment schemes: on 23 April 2013, SEBI ordered Saradha Realty India Ltd to wind up those schemes and refund investors within three months. On 9 May 2014, the Supreme Court handed the investigation to the CBI (Subrata Chattoraj v. Union of India).

The difference is structural. In a real chit, nobody can promise you a fixed return in advance, because your result depends on future auctions. Schemes like Saradha's promised returns and paid early investors with later investors' money. The RBI notes that collective investment schemes fall under SEBI, and that money-circulation schemes are banned outright by the Prize Chits and Money Circulation Schemes (Banning) Act, 1978.

How to check a chit before you join

If you live abroad, some registered foremen take non-resident members. Kerala's state-owned chit company KSFE, founded by the Government of Kerala in 1969, runs Pravasi Chitty for Keralites outside the state, with an online auction room.

Tracking your chits

Many families hold tickets in several chits at once, and it is easy to lose track of which instalment is due and what each auction paid. Binome360's savings-circle module keeps the record of an informal circle: members in payout order, contributions ticked, the pot and who receives this round and next. It does not run auctions or calculate bids, so for a chit the practical use is the ledger and reminders, with bids noted by hand.

Frequently asked questions

Is a chit fund a good investment?

For a late winner, a chit can return more than a savings account, as the Chennai data shows, but the return is not guaranteed and depends on how others bid. For an early winner, it is an expensive loan. Treat it as a mix of saving and borrowing, and take personal advice from a qualified professional if a large sum is involved.

Is a chit fund legal in India?

Yes, when it is sanctioned and registered with the state government under the Chit Funds Act, 1982. Running an unregistered chit is not allowed, and neither is a "chit" that promises guaranteed returns or takes deposits.

Who regulates chit funds?

The state governments, through their Registrar of Chits. The RBI does not register chit fund companies, but it prohibits them from accepting public deposits.

What happens if I win and stop paying?

You still owe the remaining instalments. The Act lets the foreman demand security from a prized subscriber before paying out the net chit amount, and the agreement sets penalties for default.

In short

A chit fund is a savings circle with an auction and a registered organiser: early winners borrow at a price, late winners earn it, and the foreman takes up to 7%. The law protects you only if the chit is registered. First action: before you pay anything, ask for the registration number and certificate of commencement, and read the maximum discount in the agreement.

Sources

• The Chit Funds Act, 1982 (Act 40 of 1982), text as published by the Government of India (sections 2, 4, 6, 7, 9, 11, 13, 16–18, 20, 21).
• The Chit Funds (Amendment) Act, 2019 (Act 41 of 2019), Gazette of India, 5 December 2019.
• PRS Legislative Research, "The Chit Funds (Amendment) Bill, 2019": prsindia.org.
• Reserve Bank of India, "FAQs on All you wanted to know about NBFCs", questions 27, 36 and 37, updated September 2026: rbi.org.in.
• Jan Eeckhout and Kaivan Munshi, "Matching in Informal Financial Institutions", Journal of the European Economic Association, 8(5), 2010, pp. 947–988.
• Stefan Klonner, "Rotating Savings and Credit Associations When Participants Are Risk Averse", International Economic Review, 44, 2003, pp. 979–1005.
• SEBI, order in the matter of Saradha Realty India Ltd, 23 April 2013: sebi.gov.in.
• Supreme Court of India, Subrata Chattoraj v. Union of India, (2014) 8 SCC 795, order of 9 May 2014.
• KSFE, About us and Pravasi Chitty: ksfe.com, pravasi.ksfe.com.

Also available in Français.