Analysis of NIDHI and chit funds PDF

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Maharashtra National Law University Mumbai

Term Paper towards Fulfilment of The Assessment In the Subject of Economics-IV

FIRST DRAFT

CRITICAL ANALYSIS

OF

NIDHI

AND

Submitted To: Prof. Rohit Jadhav By: Devshree R. Patil (Course Instructor) 2018 012

CHIT FUNDS

Submitted Roll No.:

TABLE OF CONTENTS

1. INTRODUCTION………………………………………………………………… ..2 2. OVERVIEW OF CHIT FUNDS IN INDIA……………………………….....……3 3. OVERVIEW OF NIDHI COMPANIES IN INDIA……………………... ……….5 4. REPORT OF SABANAYAGAM COMMITTEE ON NIDHIS……………..……9 5. CONCLUSION.……………………………………………………………….. ……11

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1. INTRODUCTION Chit Fund Company is also known as the committee where fixed instalment is paid by the members over a definite period of time. Nidhi Company is an NBFC which can take a deposit and lend money to its members. Hence, Nidhi Company is very different from the Chit Fund Companies. Nidhi companies were regulated under Nidhi Rules 2014 and MCA is regulator, Chit companies were regulated under chit act, chit companies can be private or public, but Nidhi must always public. Nidhi companies cannot carry chit activities. Nidhi companies were defined under Section 406 of Companies Act 2013. A Nidhi Company is a form of business entity in India that belongs to a Non-Banking Indian Finance Sector. The purpose of this form of company is to receive deposits and lend loans. However, there is a caveat associated with this, for only the members of the Nidhi Company can partake in this type of business. It is the mail reason that this form of company has at-least 200 members at any given point in time.1 Chit funds are not business entities. But rather, they are finance schemes of a rotational nature. It is saving scheme whose goal is to bring savers and borrowers within the same platform. As for what it does mean, it can mean different thing to different people: A] For some, a chit fund is a 1 Bouman, F. J. A. 1995. "Rotating and Accumulating Savings and Credit Associations: A Development Perspective", World Development, Vol.23, No.3.

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scheme of loans. B] For some, a chit fund is a scheme for deposit and investment. Now, if you compare Nidhi company and chit funds, you might feel like they are the one and the same. However, the difference in their functioning is what separated them. 1. In a Nidhi company, the lending and borrowing can be done as a complete measure. What I mean by this is if someone wants to deposit 3 crores in a Nidhi Company, they can do so in one go. Similarly, if they want to 2. When it comes to chit funds, the whole sum of 3 Crores is not going to be deposited in one go, but rather, through instalments that it accepts for a fix period of time. The same goes for lending money. Chit funds allow only small portions of its deposits to be lent to the people, and that took over a fixed period of time.2 Chit Fund solely settle for instalments over a hard and fast amount of your time that is paid by its members, they neither do lend nor settle for the number as a full in contrast to the Nidhi Company. Chit Fund Company is additionally called the committee; it’s a kind of a saving theme in Asian nation wherever mounted instalment is paid by the members over a particular amount of your time. It’s one in all the special variety of corporations that need extra licenses to figure. 2. OVERVIEW OF CHIT FUNDS IN INDIA Non-banking financial companies are at all time high now days. Many such companies have started offering lucrative schemes by promising high interest rates and borrowing schemes to their investors. These schemes, generally termed as Chit Funds Schemes today have become the easiest choice of saving and borrowing technique. Investors are becoming the victims and taking high risks in name of such chit funds. 2 Besley, Timothy, Stephen Coate and Glenn Loury. 1993. "The Economics of Rotating Savings and Credit Associations", The American Economic Review, Vol. 83, No.4.

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People are not able to identify the difference between a registered chit fund company which are legal and safe and the unregistered unorganized chit fund companies. This case study makes an attempt to depicts the working principle of a recognized chit fund company/scheme, difference between registered and unregistered chit Fund Company thereby enhancing the awareness among people before making their choice and decision of choosing a chit fund scheme.

This paper is based on the

secondary data collected from government websites, interviews given by government officials and other published records.3 The Indian chit fund industry generates an estimated 3.39 per cent of household savings (or Rs 5.88 crore), compared to 4.92 per cent invested in shares and debentures. Over 95 per cent of chit fund companies are small and medium enterprises (SMEs) and they are important sources of finance for SMEs operating in other sectors. Large companies have managed to attract investors. The $1.3 billion (Rs 6,110 crore) Chennaibased Shriram Group, for example, which runs the largest chit fund business in the country, manages a corpus of Rs 3,200 crore annually.4 In India, if the value of the chit run by a chit fund operator exceeds Rs. 10 and is not registered, it is considered to be an illegal chit fund. Every institutionalized and registered chit fund is safe and sound and offer greatest support of its customers.

Before understanding the working

model of chit fund, let us know few terminologies which are specifically used in the working of such schemes 1. Chit Agreement - a legal contract with al detail of rules and regulations signed by foreman and investors 2. Chit Group – group of investors who are the part of registered chit fund group 3. Chit amount – the amount paid by the investors on specific period 4. Foreman – person/company who maintains records, responsible for collection of money and heads the auctions 5. Foreman’s Commission - 5% of the gross chit fund amount paid to the foreman 6. Prize money – Summation of al periodic collections minus maximum biding amount 3 Gochhait, Dr. Saikat. (2015). A Case Study of Chit Fund Scam in India. IRC's international Journal of Multidisciplinary research in social and management sciences. 3. 135-140. 4 The Hindu Business Line (Archives)

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(maximum biding amount is inclusive of foreman’s commission) For a particular chit fund scheme there is a chit group which has fixed number of investors. These investors have to contribute a fixed amount of money, presume Rs. 5,00 for at specific intervals for a period of time. The interval of paying the money is usually a month for the investors. The total duration of the scheme is equivalent to the number of members of the chit group. Suppose the group is of 10 members, then they have to pay for 10 months. The money thus collected from the members every month goes into a common fund. The money is then given to one member who is usually selected through a lucky draw. Auction is another process to give away the money to one member based on the bid. Foreman is responsible for the collection of the instalments and heading this auction. Every member is allowed to bid every month in the auction for the chit fund money collected that very month. The member offering the lowest bid is awarded the bid. The bid is on the maximum percentage of discount the bidder is ready to offer on the collected money. The discount can go up to maximum of 40%. In other words, the bidder who is ready to take the lowest sum of money wins the bid. The person wining the bid is called the ‘prized member’ who receives the ‘prize money’. The winning bidder receives the amount after deduction of the percentage of discount she has offered and also the percentage of commission to be paid to the foreman. The amount accrued by way of discount excluding foreman’s commission is then distributed among other members of the chit fund group as dividend. The prized member is not allowed to bid any more in the remaining months of the scheme.5 Recent years have seen a high rise in the number of fraudulent chit fund operations. They are making their way into the poor & middle-class people by luring them with offers of high interest rates and returns. People are falling prey to such companies and their schemes despite of the number of detected fake companies and schemes. For some victims, such risks are extended to physical threats or risks, los of their jewellery 5 Besley, Timothy, Stephen Coate and Glenn Loury. 1993. "The Economics of Rotating Savings and Credit Associations", The American Economic Review, Vol. 83, No.4.

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and homes, depression, and even suicide beyond their loss of personal savings or funds. Such frauds also have a considerable impact on economies and markets by dejecting consumer trust and confidence in legitimate businesses. Such companies are witty and quick to alter their modus operandi to reduce the risks of law enforcement detection and investigation and to respond to consumer and business awareness of their current methods. People need to be more aware and think before investing in such dubious companies. The biggest chit fund scam ever heard in India is the Saradha Group Chit Fund Scam. This recent scam is considered to create a world record by slapping nearly 60 cases against Mr. Sudipta Sen, chairman of Saradha Group. Over 10 million people have been duped by the investment schemes of Saradha Group which was a consortium of over 200 private companies. One more Rs. 10 Cr chit fund scam case has been busted by Patiala Police. The company claimed to double the money of its investors in one-and-a-half year. In this way they were able to lure and trap more than 10 thousand people to invest their money. The company showed the depositors that their money was invested on the ongoing projects of real estate sector, forestry and paper mills. Another company which encouraged only women to invest in the schemes and join the chit fund group was The Redamma Dasara Chit Fund Company promising them high returns. It is alleged that housewives and small-time workers had put their hard-earned money in the company and the deposits had exceeded Rs.3 crore.6 3. OVERVIEW OF NIDHI COMPANIES IN INDIA Nidhi Company is governed by Section 406 of the Companies Act, 2013 and Company Nidhi Rules, 2014 which has a sole objective of cultivating the habit of thrift and savings amongst its members. Nidhi companies are allowed to take deposit from its members and lend to its members only. Therefore, the funds contributed for a Nidhi company are only from its members (shareholders) and used only among the shareholders of the Nidhi Company. 6 Klonner, Stefan. 2002. "Understanding Chit Funds: Prize Determination and the Role of Auction Formats in Rotating Savings and Credit Associations", Yale university mimeo.

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Nidhi Company is a class of NBFCs and RBI is empowered to issue directions to them in matters relating to their deposit acceptance activities. However, in recognition of the fact that these Nidhis deal with their shareholder-members only, RBI has exempted the notified Nidhis from the core provisions of the RBI Act and other directions applicable to NBFCs. Therefore, Nidhi Company is an ideal entity to take deposit from and lend to a specific group of people.7 

Pre-Registration Requirements for Nidhi Company

1. Minimum 7 Members; 2. Minimum 3 Directors; 3. No Minimum Capital Requirement; 4. No Preference Shares allowed to issue; 5. The object of the company shall be receiving deposits from and lending to its members only for their mutual benefits. 

Post-Registration Requirements for Nidhi Company

Minimum 200 Members within 12 months of registration A Nidhi company must add at least 200 members to comply with this requirement of law. Further, it has to maintain this during the course of time. If the total members fall less than 200 at any time thereafter, it will leave the company at default. However, if you are not able to reach the limit of 200 members, then you must apply for time within 30 days of closure of financial year in Form NDH-2 with Regional Director, Ministry of Corporate Affairs. 1. Minimum Net Owned Fund (Paid Up Share Capital + Free Reserves) of 10 lakh or more 2. Unencumbered term deposits of not less than 10% of the outstanding deposits. 3. A Nidhi Company shall not admit a body corporate, trust or minor as a member.

7 Calomiris, Charles W. and Indira Rajaraman. 1998. "The Role of ROSCAs: Lumpy Durables or Event Insurance?" Journal of Development Economics, Vol.56.

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4. Net owned funds to Deposits should be 1:20e if you have net owned funds of 10 lakh, then your total deposit limit would be INR 2 Crore. 

Process of Registration of Nidhi Company

1. Name Approval in ‘RUN’ facility The Applicants are required to file name availability in RUN facility of MCA portal. Every Company proposed to be incorporated as a “Nidhi” shall have the last words ‘Nidhi Limited’ as part of its name. Now, one doesn’t require digital signature of applicant for name availability. 2. Obtaining Digital Signature Certificate (DSC) The proposed Directors who may also be the Promoters/Applicants of Nidhi Company have to obtain Class 2 DSC. 3. File form SPICe32 After the name approval, File form SPICe 32 with following attachments for incorporation of Nidhi Company. i.

Memorandum of Association

ii.

Articles of Association

iii.

PAN Card of subscribers

iv.

Id Proof of First Directors

v.

Address Proof of First Directors

vi.

Address Proof of Registered Office (Rent Agreement/Sale Deed)

vii.

Latest Utility Bill of Registered Office (Electricity/Telephone/Gas)

viii.

NOC of Owner of Registered Office

ix.

Consent and Declaration from first Director in form DIR-2

x.

Self-Declaration from First Directors and Subscribers in form INC-9 

Approval and Certificate of incorporation

It will take 15-20 days to get the incorporation certificate of Nidhi Company once all the documents have been filed and registration fee and

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stamp duty paid. Incorporation certification is a proof that all the formalities regarding the incorporation have been complied with. Documents Checklist for Incorporation of Nidhi Company Following Documents require from Members/Directors1. Copy of PAN Card 2. Passport size photograph 3. Copy of Aadhaar Card 4. Bank Statement/Electricity Bill/Telephone Bill Proof of Registered office 1. Copy of Rent agreement of office premises executed on the name of Company. (If rented property) 2. Copy of latest Electricity/Water/Gas/Telephone bill of registered office 3. NOC from Landlord that he has no objection for using his premises as the registered office of Company. Other Declarations and Affidavits from proposed 1st Directors of Nidhi Company in the prescribed Format. 

Transactions which Nidhi Companies Cannot enter

Nidhi Company can’t enter into following transactions: 1. Continuing business of chit fund, leasing finance, insurance, hire purchase or acquisition of securities issued by any corporate body; 2. Business other than borrowing and lending in its own name. Nidhi Company offers lockers on rent to its members subjected to rental income from such facilities not exceeding 20% of the gross income of the Nidhi at any time during the ongoing financial year; 3. Accept deposits from any other members, other than its own members; 4. Pledge any of assets lodged by its own members as security; 5. Lend or deposit money to any corporate body; 6. Enter into partnership in its activities of lending and borrowing; 9|Page

7. Pay any brokerage or incentives for mobilizing deposits from members; 

Annual Compliance for Nidhi Companies

a. NDH-1: Return of Statutory Compliances Nidhi shall file a return of statutory compliances in Form NDH–1 within 90 days from the closure of the financial year with the Registrar duly certified by a Company Secretary in practice or a Chartered Accountant in practice or a Cost Accountant in practice. b. NDH-2: Apply to the Regional Director for extension of time If the company is not complying with the minimum member criteria, it shall within 90 days from the close of the first financial year, apply to the Regional Director in Form NDH -2 for extension of time and the Regional Director may consider the application and pass orders within 30 days of the receipt of the application. c. NDH-3: Half yearly return with the Registrar Nidhi has to file form NDH-3 within 30 days from the conclusion of each half year, duly certified by a company secretary in practice or chartered accountant in practice or cost accountant in practice. 

Benefits of Nidhi Company

1. It’s easy for Nidhi Company to get funding or borrow capital from or lend money to group members. 2. No Minimum Share Capital Requirement 3. Easy to Manage 4. No External Involvement in Management 5. Relaxation in Compliances 6. Easy Transfer of Ownership 7. Low Rates of Interest 8. Secured Investments 9. Clear Objectives for easy donations and loans 10.

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Exemptions and Privileges under Companies Act, 2013

11.

Least intervention of R.B. I.8

4. REPORT OF SABANAYAGAM COMMITTEE ON NIDHIS The Central Government vide Notification No.5/7/2000-CL. V dated 23rd March 2000 constituted a Committee to examine the various aspects of the functioning of Nidhi Companies. The said Notification is reproduced below: “The Central Government hereby constitutes a Committee to examine various aspects of the functioning of Nidhi Companies and suggest an appropriate policy framework for overall improvement of the Nidhi Companies and to instil and restore the confidence of the investing public especially the small depositors and thereby facilitate the healthy functioning of the Nidhi Companies. Further, the Committee will examine alternative mechanism to regulate and facilitate Nidhi Companies to play key role in mobilising and gainfully investing small savings and examine in depth various aspects of the operation dynamics, existing deficiencies and suggest appropriate policy prescription for further improving their viability resilience and performance. To fulfil the task given to the Committee the Committee at its first meeting decided that all parties concerned with the functioning of Nidhis such as Association of Nidhis, Chambers of Commerce, Chartered Accountants, Company Secretaries, etc., should be given opportunity to make their representations. In order to focus their attention on issues rather than make general submissions a questionnaire (Appendix-I) was prepared and sent to all concerned. Meetings were held in Chennai, Delhi and Mumbai and intimations sent to all concerned (Appendix-II) to come and make their representations along with written statements. Frank discussions took place at these meetings so as to arrive at practical solutions.9 8 Srinivas, Alam and Rajeev Dubey. 1999. "The Nidhi Nightmare", Business Today.

9 Nidhi company registration – applicability, procedure ..., https://greenleafdsc.com/blog/nidhi-company-registration-applicability-procedurerequirements-restrictions/. (last visited March 20, 2020).

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All that needs to be emphasised is that for over a century Nidhis, with the objective of cultivating the habit of thrift, were promoted by public spirited

men

drawn

from

affluent

local

persons,

lawyers

and

professionals like auditors, educationists, etc., including retired persons. The area of operation was local – within municipalities and panchayat...