By Long Le
Recently, there has been a call for the City of Philadelphia to utilize Rotating Savings and Credit Association (ROSCA) programs to target at small business owners least able to access loans from banks or Community Development Financial Institutions (CDFIs).
Policy experts from Woodrow Wilson School of Public and International Affairs and economists from the Federal Reserve Bank of Philadelphia have cited the use of informal ROSCAs – often utilized by immigrant business owners to pool money for and distribute from rotating loans – of which could play a vital role for small business owners to access other sources of capital. In the case of Philadelphia, a formal structure of CDFI-sponsored ROSCAs that funds for technical assistance staff and guarantees loans might help particular small business owners to remain in their commercial corridors who are confronted with gentrification pressures. Such CDFI-sponsored ROSCA lending circles have been created in which a group of 15 low-income business owners would receive a $1,400 loan and must pay back $100 per week during a 15-week period. Therefore, participants would not only gain credit history but also develop networks and relationships with lenders.
Although formalizing and legalizing ROSCAs in order for them to be viable in new communities, some argue that “harmonizing” the informal with the legal financial system may adversely affect the dynamic of the ROSCA and may have implication of the continual ‘discovery’ for a more ‘social’ finance.
The Tradition and Diversity of ‘Banking on Each Other’
According to Shirley Ardener, ROSCA is a collective action of core members who make regular contributions to a fund to which distributes their savings to each member in rotation without requiring formal collateral. In addition, rotation can be quickly adjusted to help a member in need and most do not charge interest. On the one hand, there is considerable institutional and pragmatic variation in ROSCAs, such as whether associations are formed only for a period of time or exist for specific expenses; whether they are organized for primarily poor women to bargain their position in the household or utilized by groups who already have some degree of financial stability and responsibility; and whether sums from the rotation are paid out by bidding or by drawing lots.
On the other hand, the remarkable geographic and historical distribution of ROSCAs around the globe could be the fact that they normally offer interest-free credit, as well as providing solidarity function whose process is usually transparent that can minimize administrative muddle and reduce risks. ROSCAs have been utilized by immigrant and ethnic groups in the United States – Trinidadian immigrants call such mechanisms a sou-sou, tanda for Mexicans, the esusu for West Africans, the tanomoshi for Japanese, the hui for Chinese, the gae for Koreans, the Hulagan for Filipinos, and the bui for Vietnamese – but they seem to operate parallel to (rather than seeking some form of “joint venture” with) the conventional credit markets; for example, transferring funds between them and borrowing from banks to pay their contribution to a ROSCA, of which resemble complementary interactions. In other words, when credit market is present but imperfect, Rosca and the formal credit market can complement each other in improving social welfare.
Notwithstanding, in recent years community economic development efforts by non-profit organizations, receiving public and private subsidies, have started to formalize and connect ROSCAs to formal financial institutions. In general, these formalized ROSCAs are designed to assist small business owners in accessing greater amounts of capital and tracking repayment to build a formal credit history. By some accounts, the benefits of formalized ROSCAs include minimizing the risk of default among group members as well as the exploitative tactics used by the group to ensure that members repay.
In fact, some pilot programs on formalized ROSCAs have reported that repayment rates are “near perfect.” In addition, formalized ROSCAs have the potential to transform the “bonding social capital” of such associations (i.e., solidarity among people with similar backgrounds) to “bridging social capital” (i.e., social trust between people from different backgrounds) across small business owners and financial lenders. That “bridging social capital” could help underserved entrepreneurs to improve their business processes and maintain broader socio-economic networks that could help with on-going investment in their businesses.
However, formalized ROSCAs by CDFIs can altered some of the before mentioned core dynamics, including loans that are no longer collateral free (now requiring asset-based collateral though guarantees for loans can be accepted) or interest free (now consisting of interest rate though at relatively lower rate). In addition, the more align interests of borrowers and lenders (because individuals play both roles) are now being shifted to the interests of the CDFIs and financial lenders. Moreover, required training and meetings as precondition of receiving financing by formal ROSCAs are usually more substantial that of the informal ROSCAs.
Here, the transaction costs can dissuade lower-income small business owners from participating in such programs and who, therefore, may prefer to transact with fringe financial institutions or the new cyber-financing networks that do not impose higher transaction costs. For CDFIs, it is also noted that it is extremely costly for them to develop and manage due diligence and financial education related to the implementation of formalized ROSCAs. This does not include the fact that formalized ROSCAs cannot guarantee repeat transactions for the small business borrowers.
Overall, due to the significant social investments needed to administer – from individuals, corporations, foundations, and governments – formalized ROSCAs cannot be easily scaled up.
Retaining the Core Dynamics of ROSCAs in Context of Microcredit Industry in the US?
By some accounts, there have been wide array of organizations dubbed ROSCAs that move back and forth in people’s hands with signs of value that are here “economic,” there “prestige-oriented” or “solidarity” or something else. That is, ROSCA systems are in constant motion despite, or perhaps because of, efforts to fix it both informally and formally. What seems to be lacking, at least in terms of formalizing ROSCAs in the US, are efforts to retain the core dynamics of informal ROSCAs – not utilizing unknown intermediaries, not involving large numbers of borrowers and lenders, and not demanding collateral or interest rate. If there is an interest to maintain the above core dynamics, it appears that ROSCA model would need to be replicated by community-based organizations who have existing client communities already equipped with the prerequisite social or cultural attributes.
For instance, Catholic Social Services (CSS) of the Archdiocese of Philadelphia could identify existing groups of trustworthy at-risk youth, struggling families and single parents who they work with on a regular basis. In terms of staff and training for participation in its ROSCA program, CSS could partner with Catholic Relief Services who have successfully implemented ROSCA models internationally. The cost to explore whether the above ROSCA program could work effectively can be aided by the development of a pilot-tested ROSCA board game. In fact, this ROSCA board game — developed by the Institute for Money, Technology, & Financial Inclusion at University of California-Irvine for a potential ROSCA program targeted women workers in a Cambodian factory — is being digitalized. That through an app members are taught how to participate in a ROSCA program, and that the staff can have the information on how members behave in order to assess whether such program is viable.
Relative to microfinance institutions in developing countries, the mission-driven and non-profit CDFIs in the U.S. simply cannot fill the gap in providing financial services to underserved entrepreneurs — mostly due to vast economic, social and regulatory differences. More recently, the growth of peer-to-peer lending — connecting many individuals at once, across class, race, ethnicity, nationality, space, and time – have clearly stumbled. Some of the problems include lenders that are mainly hedge funds and other sophisticated parties; that peer-to-peer is really about about business-to-people; and whether loans from companies such as Lending Club have violated U.S. usury laws which are usually capped at 15 percent (but some states like Utah and South Dakota have no caps).
Although the role of CDFIs and peer-to-peer lending could be regulated to promote economic justice or democratic banking, it would seem to require a considerable paradigm shift of U.S. policymakers and regulators. That is, in order to provide lending to higher-risk, lower-income individuals would probably require an interest rates and fees to levels of between 18% and 36% per annum for peer lending platforms to be profitable. However, a recent federal court decision appears to make it possible that such high interest loans might be illegal or considered void.
On balance, the recent efforts to formalize ROSCAs in the U.S. offer an important opportunity to understand the challenges and opportunities of replicating the situational logic (i.e., collective understanding in regards to reciprocity and reputational collateral) of informal ROSCAs. And such understanding can be further explored to evaluate whether the recent growth of peer-to-peer lending can “fix” ROSCAs to something more “democratic” in a fast-moving digital environment.