Rosca Meets Formal Credit Market
45 Pages Posted: 30 Oct 2015
Date Written: October 23, 2015
Rotating Savings and Credit Association (Rosca) is an important informal ﬁnancial institution in many parts of the world used by participants to share income risks. What is the role of Rosca when formal credit market is introduced? We develop a model in which risk-averse participants attempt to hedge against their private income shocks with access to both Rosca and the formal credit and investigate their interactions. Using the gap of the borrowing and saving interest rates as a measure of the imperfectness of the credit market, we compare three cases: (i) Rosca without credit market; (ii) Rosca with a perfect credit market; (iii) Rosca with an imperfect credit market. We show that a perfect credit market completely crowds out the role of Rosca. However, when credit market is present but imperfect, we show that Rosca and the formal credit market can complement each other in improving social welfare. Interestingly, we ﬁnd that the social welfare in an environment with both Rosca and formal credit market does not necessarily increase monotonically as the imperfectness of the credit market converges to zero.
Keywords: Roscas, Informal Credit Institutions, Insurance, Private Information
JEL Classification: D44; G21; O16; O17
Suggested Citation: Suggested Citation