Working Paper: NBER ID: w21683
Authors: Hanming Fang; Rongzhu Ke; Lian Zhou
Abstract: 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: Rotating Savings and Credit Associations; Formal Credit Markets; Social Welfare; Risk Management
JEL Codes: D44; G21; O16; O17
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| perfect credit market (D41) | roscas (crowded out) (O54) |
| imperfect credit market (G21) | roscas (complementary interaction) (D74) |
| roscas (complementary interaction) (D74) | social welfare (I38) |
| imperfect credit market (G21) | social welfare (I38) |
| credit market imperfections (E44) | social welfare (I38) |