Keep reading to learn how these alternative financial vehicles work, as well as some pros and cons.
Definition and Example of a Rotating Savings and Credit Association
A rotating savings and credit association is a group of individuals who act as an alternative financial institution. Each person contributes money toward a common fund, and the funds rotate through members at regular intervals. The member who borrows funds will eventually repay the debt back into the association so the next member can withdraw their funds, but the methods of borrowing and repaying may vary between associations.
Acronym: ROSCA
For example, let’s say a group of 10 individuals come together to contribute to a ROSCA. Each member contributes $100 per month, and at the end of each month, one member is selected to withdraw the entire $1,000.
How a ROSCA Works
A ROSCA is an informal financial institution where a group of people comes together to contribute money to a common fund. These groups are often made up of family members, friends, or members of the same community. Each member contributes an equal amount, and over time, all of the members get an opportunity to withdraw money from the fund. In this way, each member acts as both a lender and a borrower. ROSCAs have appeared across the globe, including parts of South America, Africa, and Asia. They are particularly prevalent in developing economies and low-income societies. The people participating in ROSCAs may not have access to formal financial institutions like banks, or the members don’t have the economic resources to take advantage of these types of institutions.
Types of ROSCAs
Simple ROSCA
In a simple ROSCA, each member contributes a predetermined amount to the fund. At each meeting, a different member will receive access to the pooled savings. For instance, the group organizer may access the funds first, and from there, the funds are distributed at random assignment. By the end, each member has received a one-time lump sum of their total monthly contributions.
Bidding ROSCA
In a bidding ROSCA, members make equal monthly contributions just as they would in a simple ROSCA. The difference is that in this arrangement, members bid to determine who receives access to the group funds. At the beginning of each meeting, members who haven’t received access to the money will make bids. Whoever has the highest bid receives access to the funds, but the winning bid results in a discount for the other members.
Pros and Cons of a ROSCA
Pros Explained
Alternative to banks: ROSCAs are common in developing economies. It’s a good alternative to traditional banking and lending institutions. No interest payments: Members won’t have to make interest payments on the money they withdraw from the common fund. Minimal consequences for failure to pay: Unlike borrowing money from a bank, there are no financial or legal consequences for failing to make payments to the group fund. Social benefits: A ROSCA is usually made up of members of the same community, so there are social benefits to participating in one. Members will often spend time eating, drinking, and networking together during the meetings.
Cons Explained
Some members may not pay: A ROSCA only works if everyone contributes to the fund—there is always the chance that certain members will decide not to pay. And there’s always the chance the funds could be mismanaged. No interest earned: Members won’t earn any interest on the money saved in the group fund. Could result in a loss of social standing: If you fail to pay the agreed-upon amount, you could lose access to the ROSCA and experience a loss of social standing.
