Before there were microloans or online crowdfunding, there were money pools, a centuries-old system of informal lending circles through which friends and family help each other save for short-term goals.
Such money pools, also called rotating savings and credit associations (ROSCAs), exist predominantly in developing countries, where access to credit is poor. But they remain a way of life — and an example of people helping people on a fundamental level — in many immigrant communities across the United States.
Money pools most often involve a group of family members, coworkers, or close friends who agree to pool their money equally through monthly (or regular) contributions to a fund. The amount agreed upon might be small, say $50 per month, or large, like $200 every two weeks, for a fixed period of time.
The fund manager then distributes the pot, or lump sum, to a different member of the ROSCA every month until the pool is depleted. If 12 people put $1,000 in, 12 people get $1,000 back, with zero interest paid or earned.
For those who receive their lump sum early in the distribution cycle, it’s an interest-free loan. For those who get their share toward the end, it’s a form of forced savings.
ROSCAs can provide an immediate source of cash for an unexpected medical bill, a tuition payment for college, or money for new tires on your car. The person who manages the account determines the order of lump-sum distributions, often based on financial need. And they do not require collateral, as most lenders do.
Participants who know they have a bill coming due can time their money pool participation accordingly.
In Latin circles, ROSCAs are known by many names: "tandas," in south and central Mexico, "cundinas," between northern Mexico and Washington state, "susus" in the Caribbean, and "pandeiros" in Brazil. (Related: Hispanics face greater retirement risks)
“I recently asked the students in one of my graduate school courses how many people had heard of a ROSCA and of the six Hispanic students in my class, four were participants,” said Carlos Vélez-Ibáñez, an anthropology professor at Arizona State University’s School of Transborder Studies, and author of "An Impossible Living in a Transborder World," in an interview.
Default rates are nil
In the United States, Vélez-Ibáñez said many Anglo-Americans struggle to grasp why those who choose to participate in a ROSCA don’t simply save on their own. After all, ROSCAs involve risk without a clear incentive. If any one members do not keep up with contributions after they get their share of the pot, those who haven’t yet collected would face financial loss.
The reason is simple: positive peer pressure. By making a financial commitment to a network of their peers, participants are more motivated to adhere to a savings discipline.
“What you would lose if you flake out on your obligation, or attempt to commit fraud, is social collateral,” said Vélez-Ibáñez, noting members who can’t make their monthly payment go to exhaustive lengths to ensure that they don’t let their friends and family down. “The downside of being cut off from your parents or sister or neighbors is much greater than the economic loss you would face by failing to pay a traditional lender.”
As to the question of risk? Defaults apparently just…don’t occur.
In his study of more than 130 operating ROSCAs in the U.S. and abroad, which involved between 3,000 and 5,000 participants, Vélez-Ibáñez said the nonpayment rate was 0.005 percent.
Money pools abroad
Money pools are not unique to Latin cultures, however, and are commonly deployed in rural communities across the globe. They are called "hui" in Asia, "arisan" in Indonesia, and "ayuuto" in Somalia.
“You can find some sort of short-term savings club in most low-income communities around the world,” said Daryl Collins, managing director of Bankable Frontier Associates, a financial services consulting firm in Boston, Massachusetts that works primarily with low-income clients. “They are a very persistent financial instrument, and they come in many different shapes and sizes.”
While tandas, or traditional ROSCAs, are most common in North America, a slightly different short-term savings tool known as an accumulating savings and credit association (ASCA) is more common in South and East Africa.
Participants in an ASCA put money into a pot every month, but get no lump-sum distribution until the end of the year. With the group’s consent, the money may be loaned to the community to earn interest income.
“In South Africa, the monthly interest rate charged by these loans is typically 30 percent,” said Collins, who co-authored "Portfolios of the Poor: How the World’s Poor Live on $2 a Day." “When it works well, this can really be a very good little money maker for the members of the group. But when you start loaning money, you do run a risk that borrowers won’t pay you back. That happens more often than participants would like.”
In U.S.-based immigrant neighborhoods, such as Chinatown and Koreatown in Los Angeles and New York, private loan clubs have been a critical source of capital for restaurateurs, grocers, and mom-and-pop shops that might otherwise struggle to survive during economic downturns.
A money pool derivative known as “auction ROSCAs” or “bidding ROSCAs” are most common in Southeast Asia, in which members who need their distribution early on will pay the group a small percentage or fee to claim the pot.
“This type of short-term financial instrument is very widely used in rural India,” said Collins.
While savings and credit circles differ slightly depending on locale, fundamentally, they all have one thing in common: They distribute a lump sum to participants.
“It’s all about getting that lump sum, which is very hard to accumulate on your own,” said Collins.
Of ROSCAs and microloans
Many credit ROSCAs as the mother of modern-day crowdfunding and microloans, though their target and modus operandi are much different.
While money pools are designed to help individuals reach their financial goals, crowdfunding involves fundraising for entrepreneurs through the combined efforts of friends, family, and individual investors. Typically, crowdfunding is organized online via social media, giving upstart business owners an opportunity to reach a wider pool of accredited investors.
Microloans, by contrast, are more formalized small-business loans available to low-income entrepreneurs through a lending network called a micro financial institution (MFI), and more recently through the federal government’s Small Business Administration. Typically, business owners with need can secure up to $35,000, but some MFIs will lend $100,000 or more.
Alternative financing models -- be they ROSCAs, microloans, or Internet crowdfunding platforms, like Kickstarter and GoFundMe -- meeting a growing need for safe and affordable sources of money in minority populations, said Ashley Wessier, vice president of development and communications for Accion East, a U.S. non-profit that offers small-business loans ranging from $500 to $250,000 to mostly minority entrepreneurs, who demonstrate financial need.
Indeed, access to capital can change lives, helping parents to finance a college degree for their child, putting homeownership within reach for more Americans, and giving cash-strapped entrepreneurs a chance to convert their vision into a steady paycheck.
“There is just as much demand for alternative financing here in the U.S. as there is abroad,” said Wessier. “Minorities, in particular, are struggling to access affordable capital, so it’s important to be in this space to help certain populations save and grow.”
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