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New Normal, Digital Transformation, Industry 4.0

Trust | Transparency | Traceability

Blockchain and Chit Fund

11 September 2020

Chit Funds is the country’s oldest form of banking. It is essentially a savings and credit association organized by financial institutions or informally by friends, relatives, and community members. It is therefore a precursor of community micro finance and p2p lending. This mechanism is further due to get a digital transformation with the help of emerging technology like Blockchain. The fundamental attributes of blockchain, i.e. consensus, trust, immutability, provenance and smart contracts, can foresee a huge opportunity for different domain use cases in maintenance of records, reduction of frauds, rigging and non-payment to investors. Ergo, it can be leveraged to address many of the other challenges, which would reduce the information, interaction and innovation frictions between the parties involved. Chit funds on a blockchain system helps in eliminating chit fund fraud and creating a parallel, decentralized banking system which has the potential to bank the unbanked and eliminate bank fraud at the same time.

Chit Funds are key instruments of financial inclusion in India, especially for those with little access to formal institutions. In India, chit funds come in three variants i.e. those offered by the state governments, those started by registered companies, and those that are unregistered. The last variant is an informal chit fund that can be started between friends, families, and acquaintances, whereas the first two are comparatively safer avenues for customers or subscribers to engage in.

The size of the organised chit fund industry is close to Rs 60,000 crore, with 45,000 registered chit fund entities working in the country. However, the size of the untapped chit fund sector is more than 30 to 40 times of the regulated one.

Opportunity for Technology Collaboration: – To improve the vigil mechanism on Fraudulent Companies, Financial Illiteracy (improve dissemination of correct information), Non-Transparency, Administrative loopholes, Lack of Accountability and prevention of Ponzi Schemes.

Main Parties: -Subscribers, Regulators and Foreman

Existing Process: – Existing Process Chit funds are run across the country through a range of mechanisms. Traditional chit funds have been run in hyperlocal markets where the group is formed by a foreman within his trusted circle where the trust is mutual and the risk is always social inhibitions. The foremen manage these lending fee or commission.

(As Chit fund is an age-old funding system practiced in India therefore it has huge scope for better and accessible banking alternatives which would not only check undue exploitation of poor people but will also correct leakages in the economy)

Latest Administrative Act

The new Chit Funds Amendment Bill 2019 aims to protect the rights of the investors. The bill provides that the chit fund operator has to have a secured deposit to the size of the scheme, which is a sufficient safeguard for people subscribing the scheme. The bill clarifies that the chit funds are legal and it is different from an unregulated deposit scheme or Ponzi schemes.

Use Cases

Main Solution

Chit fund as a financial instrument has many strengths and weaknesses, especially in operations. Foundational technologies like blockchain have a lot of scope to percolate and address many key challenges as in the case of high fees, cash movements, reporting, auditing and potential fraud from the parties including foreman and subscribers.

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