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, and a single member withdraws the money from it as a lump sum at the beginning of each cycle. This continues for as long as the group exists. 

ROSCAs are usually created in areas where access to formal financial institutions, such as banks, is limited. Members may share familial, ethnic, or geographical ties, and the structure of payments and withdrawals will vary according to the needs of the group. 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 both 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

The principal advantages of ROSCAs are two-fold. First, they encourage personal savings, particularly among people without a lot of disposable income. Second, they provide a significant lump sum of money to individuals who might not be able to accumulate one otherwise. That individual might, for example, use the lump sum to invest in a business.

Beyond providing funding to individuals who might not have access to a conventional banking system, ROSCAs have the added benefit of accountability. Knowing their fellow participants personally can make keeping their commitments easier. This includes making a commitment on how to use their withdrawals. As well, money cannot be freely withdrawn, which can be a positive aspect for participants who'd be inclined to spend it. 

ROSCAs have social benefits, as well. 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. The nature of any given ROSCA is highly dependent on its members, the group's history together, and the local culture; therefore, while ROSCAs share some basic characteristics, they can vary considerably across the world.

ROSCAs also go by a variety of names in different places. In parts of Mexico, for example, they are known as "tanda," while in India they are called "chits."

On the downside, ROSCAs pay no interest on the money they collect (although some cultures prohibit that to begin with). At the same time, they don’t charge interest on the money they distribute. When members can receive a distribution is generally out of their personal control, as well. The major risk in a ROSCA is that other members won't meet their obligations to continue paying in.

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 would continue until everyone has a turn with the proceeds. At the end of the 10 months, when everyone has had a distribution, the ROSCA would either disband or begin another round.

The Bottom Line

ROSCAs provide people without access to a traditional banking system—or who do not wish to participate in one—with 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.