Rotating Savings and Credit Association (ROSCA): Definition

What Is a Rotating Savings and Credit Association (ROSCA)?

A rotating savings and credit association (ROSCA) is an informal financial institution consisting of a group of individuals who make set contributions and withdrawals to and from a common fund.

ROSCAs are most common in developing economies and among immigrant groups in the developed world. The participants are often women. They are also widely used in Muslim countries, where any interest paid or received on loans is considered impermissible based on Islamic finance rules. ROSCAs have appeared in South America, Africa, and Asia. An early example existed in China in about 200 B.C.

How a ROSCA Works

In a ROSCA, members pool their money into a common fund, generally structured around monthly contributions. A single member withdraws the money from it as a lump sum at the beginning of each cycle, which continues for as long as the group exists. 

ROSCAs are usually created in areas with limited access to formal financial institutions, such as banks. Members may share familial, ethnic, or geographical ties, and the structure of payments and withdrawals will vary according to the group's needs. Recipients of funds may be chosen based on financial need, social standing, monetary bids, or random assignment. The organizer of the ROSCA generally receives the first payout.

The successful operation of a ROSCA derives from the social capital of its members, who are usually personally acquainted and part of a community. To default on the obligation would reduce a person's standing in the group and lower their creditworthiness in the future. Group pressure helps ensure their commitment.

Advantages and Disadvantages of a ROSCA

ROSCAs have several advantages, but a few disadvantages also exist.

Advantages of a ROSCA

• ROSCAs encourage personal saving, particularly among people without a significant amount of disposable income.
• Provide a lump sum of funding to individuals who might not have access to a conventional banking system, including those who cannot build savings to invest in a business.
• ROSCAs have accountability. Knowing their fellow participants personally can make keeping their commitments easier, including how to use their withdrawals. Also, money cannot be freely withdrawn, helping participants who'd be inclined to spend it. 
• ROSCAs have social benefits. While the primary objective is usually to achieve the group's financial goals, ROSCA meetings can also provide opportunities for eating, drinking, and networking. In many places, meetings involve particular rituals. For example, in Cameroon, ROSCAs are called "djanggi," and participants exchange greetings and share kola nuts. Drinking occurs after the meeting has concluded.
• Diverse community. The nature of any given ROSCA is highly dependent on its members, the group's history, and the local culture; therefore, while ROSCAs share basic characteristics, they can vary considerably worldwide.

Disadvantages of a ROSCA

• ROSCAs don't pay interest on the money they collect, although some cultures prohibit the practice. At the same time, they don’t charge interest on the distributed funds.
• When members can receive a distribution is generally out of their personal control.
• The risk of members not paying into a ROSCA exists, meaning they don't meet their obligations.
  

Example of a ROSCA

An organizer might establish a ROSCA for the amount of $1,000. In this case, the ROSCA organizer could gather nine trustworthy individuals and require each of them to contribute $100 to the fund monthly.

At the end of the first monthly meeting, the organizer would take home a lump sum of $1,000. In the second monthly meeting, another member would take home the next $1,000. This process would continue until everyone has a turn with the proceeds. At the end of the 10 months, when everyone has received a distribution, the ROSCA would either disband or begin another round.

The Bottom Line

Rotating savings and credit associations (ROSCAs) provide people without access to a traditional banking system—or who do not wish to participate—a way to set money aside for the future. The money in a ROSCA is not insured by law, like conventional bank deposits in some countries, but instead relies on social bonds to make sure that members fulfill their obligations to contribute.