The existence of formal and informal markets for credit is a common phenomenon in developing countries.
Being originally from Egypt which is considered as a developing country, I decided to talk about RoSCAs where I grew up being surrounded with this kind of informal associations everywhere in the society.
But wait!! What are RoSCAs?
RoSCAs stands for Rotating Savings and Credit Associations, which is commonly defined in literature as “locally organized groups that meet at regular intervals; at each meeting members contribute funds that are given in turn to one or more of the members. Once every participant has received funds, the RoSCA can disband or begin another round. In joining a RoSCA, an individual agrees to a schedule of periodic payments in return for which she receives a lump-sum payment at a future date”.
Usually RoSCAs bear no interest rate, in addition to the little or even no control of the participants over when they receive the funds. In this kind of social association, participants choose to bear the risk that other participants may not fulfill their obligations, so to overcome this risk, those kinds of associations are mostly formed in cooperation with trusted family, friends, and/or co-workers.
RoSCA can be considered as one of the oldest savings institutions found in the world, in which those kinds of informal associations play an important role in the mobilization of savings in many developing countries till date.
Since RoSCAs in general can be risky and to some extent not flexible, why would anyone join a RoSCA instead of saving on his own?!, especially with the availability of other saving options and technologies?
To be able to answer this question we have to look at some of the literatures that have tackled the rationality behind formation of RoSCAs, where Besley, Coate, and Loury (1993) suggested that “individuals join RoSCAs to finance the purchase of an indivisible durable good, taking advantage of the gains from intertemporal trade between individuals so that individuals expect to enjoy the benefits of savings sooner than if they had saved on their own”. While Klonner (2003) argued that “RoSCAs with funds allocated by bidding allow participants to insure themselves against idiosyncratic risks”. Moreover, Anderson and Baland (2002) show that “women’s RoSCA membership in urban RoSCAs in Kenya as developing country is a forced-savings mechanism that is the result of asymmetric preferences for indivisible household goods between husbands and wives”.
ROSCAs vary but most have a similar structure. Someone who does not need a certain amount of money at a given point in time decides to put it in a communal pot, but this pot is not for only one participant, RoSCAs can only be successful if more than person decided to participate. This big chunk of money is then to be distributed in rounds according to the needs of the participants. Where the main condition is that every person who received the big bulk of money has to pay the same equal amount in return in the following rounds to other participants, so that at the end no one loses money. RoSCAs are supposed to help people save money, or buy something needed or even invest the amount received from the RoSCA into something valuable.
How does it work in the Middle East, specially in Egypt?!
RoSCAs are commonly known in Egypt with the Arabic term “Gamieya” which simply means an institution, however as mentioned above, RoSCAs are mostly formed in the informal economy so there are no records of it. Simply lower income households specially women long time ago started this system to help them save or buy something or even use the money to throw a wedding for their daughters.
Afterwards, RoSCAs became so popular that almost every Egyptian has either participated or even has a family member or know someone who participated in the so called Gamieya. Even me, I have participated in several Gamieyas, sometimes I needed the money to spend it on something, sometimes my friends needed the money so we decided to start the Gamieya to help those friends in need where in that matter we just consider it as a win-win situation where we help our friends and also tend to save a lump-sum of money instead of spending this money anyways.
Nowadays, Gamieya system in Egypt is everywhere, it is not just for the poor, people now tend to form Gamieya just to assist them save, overcome inflation, or even invest the money they receive into buying real estate, gold, or even buying a new car. The formation of such association is usually based on social capital and the trust level between the network of participants, that is why it is commonly done among groups of family, friends, and co-workers in order to guarantee the reliability of the receiving participants.
The amount of money invested depends on the standard of living of the members of the Gamieya, so for example if the person can afford paying every month 1000 Egyptian pounds and he agreed with 10 people to form the Gamieya for 10 rounds, then he will pay every month 1000 EGP for 10 months, where in one of those rounds (usually agreed upon from the beginning) he is sure that he will receive 9,000 EGP from the other members of the RoSCA plus the 1000 EGP that he will pay as well this round. The amount agreed upon at the initiation of the Gamieya depends on how much the participants can simply afford paying every month as extra payment from their income, so it is also common to see Gamieyas formed between rich people who just want to get a lump-sum of money without going through the formal credit sector to borrow a loan from the bank to buy a new Villa or pay the initial payment of new BMW car for example.
- Anderson, S., and Baland, J.M., (2002), ” The Economics of Roscas and Intrahousehold Resource Allocation”, The Quarterly Journal of Economics, Vol.117, No.3, pp.963-995.
- Besley, T., et al, (1993), “The Economics of Rotating Savings and Credit Associations”, The American Economic Review, Vol. 83, No.4, pp.792-810.
- Gugerty,M. K., (2007), ” You Can’t Save Alone: Commitment in Rotating Savings and Credit Associations in Kenya”, Economic Development and Cultural Change, Vol. 55, No. 2, pp.251-282.
- Klonner, S., (2003), ” Rotating Savings and Credit Associations When Participants are Risk Averse”, International Economic Review, Vol.44, No.3, pp. 979-1005.
- Mohieldin, M., Wright, P., (1994), ” Formal and Informal Credit Markets in Egypt”, Economic Development and Cultural Change, Vol. 48, No. 3, pp.657-670.