A unique discussion came up with a fellow customer while buying my weekly groceries. It caught my attention for the uniqueness, simplicity and yet the potential dangers in it. It’s a way which is used(quite frequently to my surprise) by local people belonging to lower middle class societies to fulfill their debt needs and investment aspirations. It’s something they call the Committee System.

Now the traditional means of getting debt at a local level involves either dealing with a bank (which grants loans based on lots of financial criteria) or borrowing from a friend (lot of trust involved if you ask for a big amount) or the local money lenders (which charge huge interest). These are all difficult avenues for lower middle income class and lower income class people. Similarly investment options are very limited to PPF and Post Office Savings. It is probably these reasons which led to the development of this unique methodology of investment and debt raising. How legal is it I am unable to comment but I thought it would be interesting to share and get views.

The Committee System involves a group of people (can range from 5-20) coming together to form a “Committee” where each person contributes certain amount of money towards a corpus of funds. Typically the person initiating the committee is the cashier and is responsible for each transaction and servicing of everything that goes for that particular committee.  So for example lets assume that Mr. X is the cashier of a committee floated by him having 10 members and each member contributes Rs. 10,000 towards the corpus which amounts to Rs. 1,00,000. Now the committee holds an auction among the 10 members for granting this corpus as a debt. The auction amount is basically the interest portion on the corpus. So in our committee of Mr. X with a corpus of Rs. 1,00,000 the auction starts at lets say Rs. 5000. What is means is that the person bidding Rs. 5000 will, if he wins the auction at that bid, take the Rs. 1,00,000 corpus for a cost of Rs. 5000 so effectively he will get Rs. 95,000. The start amount is declared by the cashier because in case their is no higher bid he has to take on the debt. So each member is given a chance to bid. Let’s assume that Mr. Z is the winner of the auction at Rs. 10,000. So Mr. Z will get and Rs. 90,000 (Corpus of Rs. 1,00,000 at a loss of Rs. 10,000). The Rs. 10,000 bid amount is divided among the 10 people forming the committee. So at a investment of Rs. 10,000 each member get profit of Rs. 1,000 upfront. The principal amount has to be paid by Mr. Z in a time-frame (lets assume 12 months) on 15th of each month.

For Investor

Upfront investment = 10,000

Upfront interest = 1,000

Principal per month for 12 months = 833

(Effective Rate of Return) IRR = 20.2% per annum

Similary,

For Borrower

Loan Taken = 1,00,000

Upfront interest paid = 10,000

Principal Installments for 12 months = 8330

Effective interest Rate (IRR) = 20.2% per annum

Innovative and effective ! And most importantly useful for those who can’t get debt from banks. Now obviously there are risks here. The biggest is the credit risk that the person does not pays the principal payments. In that case the burden falls on the cashier to pay the members of committee. For the same reason committee are often formed between close members of society where trust level is high. As I said before, I cannot comment on the legality of this system although my fellow buddy did tell me that they do paperwork (enforceability of which is again doubtful to me).

Have you heard or know such a system in place ? Are there other such unique models out there among the local masses. Let me know 🙂 !