Financial systems and development

Box 8.2 Rotating savings and credit associations
Rotating savings and credit associations (ROSCAs) are bids, a practice common in China, India, Thailand, and
a popular form of informal finance. They have various some parts of West Africa. The winner is the person
aliases: tanda in Mexico, pasanaku in Bolivia, san in the willing to accept the largest reduction in share payment
Dominican Republic, syndicate in Belize, gamaiyah in from other participants in return for receiving the next
Egypt, isusu in Nigeria, susu in Ghana, tontine in Niger fund. All participants in a commission ROSCA, except
(see Box 8.1), hagbad in Somalia, xitique in Mozam- the leader, pay for the right to participate and receive
bique, anisan in Indonesia, paluwagan in the Philip- back less than they contribute.
pines, chit fund in India and Sri Lanka, pia huey in Thai- Recent research in Bolivia showed that one-third to
land, hui in China, kye in Korea, and ko in Japan.
one-half of all adults living in urban areas often partici-
ROSCAs intermediate in the most basic way. A small pated in ROSCAs and that their ROSCA payments
number of individuals, typically six to forty, form a amounted, on average, to about one-sixth of their salagroup
and select a leader who periodically collects a ries. These associations were even found among emgiven
amount (a share) from each member. The money ployees of formal financial intermediaries. Despite hycollected
(the fund) is then given in rotation to each perinflation and poor loan recovery by formal lenders,
member of the group. In some countries, such as India Bolivians reported few problems in their ROSCAs.
and Cameroon, ROSCAs have evolved into formal Studies show that a relatively high proportion of those
banks. with steady incomes in Cameroon, India, and Sri
Three types of ROSCAs are found in many countries. Lanka often participate in ROSCAs. These associations
In common ROSCAs, the leader receives no special have also been reported among employees of the cenconsideration
(other than possibly getting the first tral banks of Belize, Bolivia, the Dominican Republic,
fund). Commission ROSCAs pay their leaders, who in and the Philippines.
return may assume liability for defaults. Promotional The popularity of ROSCAs among low- and middle-
ROSCAs are used by merchants to sell goods, espe- income groups shows that people like to save, even
cially consumer durables. under trying circumstances. The Bolivian research
Loans are interest free in most common and pro- showed that more than 90 percent of the people intermotional
ROSCAs; the amount received is equal to viewed joined ROSCAs primarily because they wanted
the total paid in by the member. More sophisticated to save more and felt that membership forced them to
ROSCAs may allocate funds on the basis of discount do so.
mm
loan losses and transaction costs reduce the real- credit may also borrow from moneylenders if forized
rate of return. To keep collection rates high mal lenders take too long to process an applicaand
transaction costs low and to minimize the cost tion. Two to three weeks is quick for many formal
of idle funds, the moneylender maintains relations intermediaries, and two to three months is not unwith
the same borrowers. Conversely, borrowers common. Often, loans from moneylenders are
are paying not only for that day's loan but also for used to make a transaction at short notice, and
continuing access to immediate credit.
funds from formal lenders are used to repay the
Loans from moneylenders are typically short- moneylenders.
term and are extended to clients of long standing; Borrowers who own marketable assets may turn
they are rarely tied to collateral. Most moneylend- to pawnbrokers for short-term credit. Pawnbroers
use their own funds for lending. Interest rates kers take possession of assets for a fixed term and
are high. Where entry is restricted and alternative lend against them at an agreed rate of interest.
financial services are lacking, high interest rates During the term of the loan the borrower is free to
may be partly a result of imbalances in economic repay and thereby to redeem his asset. Once the
and social power, but the cost and risk of small term expires, the pawnbroker can sell the asset
loans are also high. To meet the demand for timely and keep the proceeds. Because the loan has collatand
convenient loans, the moneylender must eral, the pawnbroker needs no further information
maintain adequate liquidity, some of which will be about risk. But the pawnbroker must know the
idle during slack periods. The opportunity cost of resale market well if he is to sell such assets
this reserve is part of the moneylender's costs. profitably-especially since the borrower has the
Many noncorporate agents with access to formal option of avoiding the pawnbroker altogether by
114