Are Savings Clubs a Good Alternative to Traditional Banking?

Informal savings clubs are a common form of thrift outside of traditional banking. Researchers report that in addition to being a way to provide insurance or purchase durable goods, they create a mechanism to deliver to their participants the self-discipline for saving.

Are informal savings clubs a good alternative to traditional banking? Unlike the latter, there aren’t rigorous legal protections for these clubs, which tend to be popular in areas without access to traditional banking structures, primarily in developing economies and among immigrant communities. Instead of legal protections, these clubs are based on reciprocity and trust in the social and familial bonds among those who are involved, and they leverage those ties to create the motivation for saving.

Savings Club vs. Formal Banking

Because they exist in many different cultures, these informal clubs go by many names. Brought over by immigrants, informal savings clubs have become increasingly common in the West, often carrying traditional names such as njangi, pandero, consorcios, or sousou. The more technical term is rotating savings and credit association (ROSCA), though it might be unidentifiable to those participating in the clubs.

In ROSCAs, people pool their money together at certain intervals, and the full sum is paid out to one member at a time on a rotating basis. They are considered universal phenomena because they have occurred all over the world. Take one example, as reported by NPR: In Kenya, they are called merry-go-rounds because of the cyclical nature of their payouts. A 63-year-old Kenyan woman named Mary Abagi, for instance, invested $10 per month into the pool along with 10 other people, using charitable aid from an American nonprofit to make the payments. Each month a different member would get a payout. When the rotation came to her, Abagi received $100, the total of her payment into the pool, which she used to purchase a goat.

Unlike traditional banking or savings clubs joined through traditional banks, ROSCAs are informal. They do not typically carry the legal protections of a bank, meaning that failure to live up to the terms of the agreement will typically not lead to a court date. It is therefore vital that those in the group trust each other to keep paying into the system. Otherwise, a member who got an early payout could theoretically stop paying into the pool, leaving other members without their funds. The importance of community trust carries over into providing a motivation to save, though the practice is not exclusively economic but one that also improves social cohesion. In fact, social capital replaces creditworthiness in determining who is allowed to join.

There are other notable differences that are relevant to the tool’s financial use:

• Liquidity—ROSCAs do not give easy access to the funds that are paid into them. When a person has invested in the pool, they must wait for their turn in the rotation to get their payout. This is notably less liquid than traditional banking.
• Interest—ROSCAs do not pay interest. Versions of these associations, known as accumulating savings and credit associations (ASCRAs), do, but these are less common. Most of the time, however, people will simply get back what they paid into the program. In traditional banking, depositors receive some interest on their deposits.

In the United States

Though normally associated with developing economies or low-income individuals, ROSCAs are actually joined by both people in higher socioeconomic groups and those in developed economies.

In the U.S., these systems extend the tradition of antebellum South mutual aid societies that put together insurance and benefits for Blacks in earlier centuries. They’ve become more prominent with the decline of immigrant access to the welfare state since the 1970s, as well as the restriction on loans and rising inequality since the Great Recession, according to scholarly accounts.

The contemporary uses of ROSCAs in America have been found to vary, including for major expenses such as weddings and funerals, with the relative success of West Indian and Asian immigrant small businesses in the country occasionally credited with the use of ROSCAs for startup capital in place of credit. There aren’t any solid statistics for how many such clubs exist in the U.S., but estimates have suggested that they are very common.

Scams

Scams masquerading as ROSCAs also occur. The U.S. Federal Trade Commission (FTC) warned of fake “sousou” clubs in the wake of the protests over the slaying of George Floyd. A “sousou” is an informal savings club originating from West Africa and the Caribbean. However, the scam “sousou” clubs were illegal pyramid schemes that promised investors that they would receive more money than they put in, cynically connecting the investments to social causes such as Black Lives Matter to encourage investment in the schemes. Legal savings clubs don’t promise profit, only savings, according to the FTC.

The Bottom Line

Most people who use ROSCAs are pursuing financial security. ROSCAs are more common among women than men in some societies, such as Kenya. They can be a way for married women to protect household savings from immediate consumption, in which case the inability to access the funds for some time and the recommitment to a particular expenditure become desirable features of the clubs.

ROSCAs can represent a good supplemental tool to traditional banking, one that leverages social bonds to help users save money and increase purchasing power, allowing expanded access to credit while avoiding the fees associated with traditional banking. They can also serve as a good informal structure for developing economies and places without reliable access to traditional banking structures, especially in countries where many people are unbanked. It’s also important to note that they improve socialization within a society and are not solely an economic tool.

However, the informal nature of these clubs brings possible disadvantages when considered as a primarily financial device in competition with traditional banking, some of which have been already mentioned. Notably, they don’t offer traditional banking’s legal protections or ease of access to savings, and they don’t pay interest on invested funds.

Some studies have suggested that blockchain technology could improve the performance of ROSCAs for the unbanked and underbanked portions of the American economy.