ROSCAs - The Advantages, Disadvantages and Everything in Between.

Following the previous blog about loans and savings this blog will focus on what financial options are available to those in rural areas where finance is in the hands of the villagers. The advantages, disadvantages and everything in between. 

Let's start with ROSCAs or Rotating Saving and Credit Associations.

Individuals meet at pre-defined intervals of perhaps a week or a month and contribute small amounts of money into a 'pot'. Notably, ROSCAs have been used by those with high incomes in the developed world and therefore income is exogenous to ROSCAs. They are simply common  in rural parts of the developing world, 50 to 95% of Adults engage in them in the Congo, Cameroon, Gambia, and villages of Liberia, Ivory Coast, Togo, and Nigeria (Bouman [1995] for references),due to the advantages discussed later. ROSCAs operate by either:

• Each interval giving the total to one individual. You can only receive the contents of the 'pot' once.
• Conducting a lottery, with those members who have already received their payouts being excluded from the lottery.
• Bidding, in which members who want the money most bid an additional sum to that which they have contributed. When the winner is known his or her contribution is then shared out equally. This is a relatively unknown in Africa.

The advantages of ROSCAs: 

• Social capital getting to know contacts or information within the ROSCAs.
• A range of different ROSCAs exist - religious, market, ethnic, office or neighborhood.
• Women tend to utilise them more then men the due to social and financial (normally lower income) reasons. For instance, in Kibera the probability that a woman is involved in a ROSCA is 40% compared to a man at 10.1%. Further, a study in Nairobi by Anderson and Baland (2002) showed that a women's bargaining position in the household is directly related to her contribution to household income.
• ROSCAs offer a personal source of income for women, particularly in Africa. Men in Africa are seen as 'deserving' personal spending money whereas a woman's income is collective. The work of Hoddinott and Haddad (1995) empirically verifies this claim for African households where, relative to women, men spend a greater portion of their income on goods such as alcohol and cigarettes,whereas women are more likely to purchase goods for children and for general household consumption.
• Transparency due to group regulation.
• Efficiency - money is put in the 'pot', the meeting occurs and the money distributed in the chosen way. 
• Can be tailored to the income of the group.
• The savings of many are transformed into a lump sum for one person. This is often used to improve household livelihoods, to invest in a new business or to pay school fees.
• Protect an individuals savings against immediate consumption - identified as particularly beneficial for women (Anderson and Baland, 2002)
• Offers a protection against theft as savings are not left within houses

The disadvantages of ROSCAs: 

• If the ROSCA distributes money by prior agreement or by lottery it is unlikely to be available at the time in a business cycle when it is most useful. These types of ROSCA are often then used in order to save up for household durables such as utensils or roofing sheets. They are an effective savings instrument, but relatively ineffective as a means of capitalising productive investment 
• The amount of money is fixed and may be inadequately matched to a person’s investment plans 
• There is no return on people’s investment in a ROSCA, except a marginal time-value of-money benefit of receiving a lump sum at no interest cost before reimbursement 

Further findings:

• ROSCAs are not a substitute for credit but rather complement it. But, are often the sole saving and credit institutions in many rural areas.
• While, ex ante, all individuals are better off by saving through a ROSCA, the member who receives the pot last is ex post worse off. Particularly if investment is set. For instance:

1. The purchasing power of a pound is slowly decreasing due to inflation. 
2. If ten individuals put ten pounds into a ROSCA then each week an individual at random is given one hundred pounds. 
3. At the beginning of the ROSCA one hundred pounds will have the equivalent purchasing power.
4. However, after ten weeks one hundred pounds may equate to less purchasing power, say ninety eights pounds, then at the beginning of the ROSCA.

Simply if a ROSCA 'pot' was ten pounds and could buy you ten apples at the beginning you may only be able to buy nine apples at the end of the ROSCA due to the price of apples inflating. Yet, orders of ROSCAs change every cycle? Not really... Anderson and Baland (2002) contend that ROSCA orders rarely change and often follow the first pattern which does not explain why the last recipient would stay and by backwards induction why the ROSCA does not break down.

Last in the ROSCA queue means less apples for you! Fair?

In conclusion, the rationale proposed by Besley, Coate, and Loury (1993) concerning the financial detriment the last member to receive the pot suffers is not debatable. However, ROSCA must benefit the members in many other ways, apart from financially, to explain the high usage in developing states. These benefits are listed in the advantages section and include social capital, self-sufficiency for women who argue that they 'should not rely on their husbands' and the ability to tailor the individual investment per pre-defined interval to the level of income of the members.

I'll cover other financial options available to those in rural areas in the next blog.

Resources used in article:

Allen, H. (2002) - CARE International’s Village Savings & Loan Programmes in Africa: Micro Finance for the Rural Poor that Works

Anderson, S. and Baland, J. (2002) - The Economics of ROSCAs and Intra Household Resource Allocation.

Besley, T. Coate, S. and Loury, G. (1993) - Rotating Savings and Credit Associations, Credit Markets and Efficiency
Varadharajan, S. (2004) - Explaining Participation in Rotating Savings and Credit Associations (RoSCAs): Evidence from Indonesia