Archives for category: informal finance

The state of Lagos in Nigeria decided to embrace de Soto’s “Legalist” idea of development and to start a process of mass formalization of the informal sector. I don’t know if Hernando de Soto will go there in person, but his Peru-based think tank – the Institute of Liberty and Democracy- is involved in the project. From an article in This Day Live:

The Lagos State Government has begun a comprehensive reform process, which it designed to formalise about 90 per cent assets currently locked in the state’s informal sector.

the state government had trained more than 100 enumerators in collaboration with the Institute for Liberty and Democracy (ILD), Peru to assist in data collation and information gathering under the state’s informal sector reform initiative.

.. Raji [Ministry of Commerce and Industry] said the state government was interested in having comprehensive information about the sector, and know why most people choose to operate informally, and, then work out modalities that will help in formulation policies that will encourage their migration to the formal sector.

Giving more recognition to informal operators is undoubtedly a good thing, but I wonder how far this can go. The Legalist school argues that formalizing property rights in the informal sector would trigger a virtuous cycle: business formalization turns “dead capital” (i.e. capital without property rights) into real collateral. Real collateral allows access to formal finance and new markets. Increased access to formal finance encourages business investments. Increased investments … I bet you can guess the rest of the story.

I used to like de Soto’s ideas, and to some extent I still do: as simple as they are, they point to the right direction – informal economies have a large development potential. But I turned more critical when I realized that his simple arguments have transformed into an over-simplification of reality. The equation “business registration=formalization” neglects that most activities in the informal economy are sustained by an infrastructure of (non-formal) regulatory, financial and welfare institutions beyond the reach of official governance. The central question raised in Lagos, “to know why most people choose to operate informally, and, then … encourage their migration to the formal sector” misses the point. The question should be reversed: we should try to understand how informal firms and their institutions work in practice, and to determine how formal institutions can “scale-down” and become appropriate for their needs – definitely not the other way around.


Let me point out two errors in the title of this post. First, the plural of chama in Swahili is ‘vyama’, not ‘chamas’ like English speakers say. Second, the term self-help group is a “development-friendly” way of describing a chama, but in fact chama means ‘association’, ‘club’ or ‘party’ which can be involved in all kinds of activities. In the past I enjoyed using exotic terms like ‘indigenous’ (or ‘endogenous’) institutions in my papers but I realized that, whether I like it or not, they tend to indicate some sort of backwardness.  So, I started calling them “social networks”, like sociologists do, but I’m still not convinced.

Vyama are widespread all over Kenya and deeply embedded in the local culture, probably because they allow members to face problems and opportunities as part of a group rather than individually. This is quite a difference from the individualistic environments where I grew up (hint, it’s in Europe), where I may count on my immediate family members and friends in some occasions, but in general people rely on markets and formal institutions for almost everything. Vyama instead seem to work for the exact opposite reason: because they are flexible and informal and because they are built on social ties instead of formal structures. I should point out that vyama do get some sort of government recognition, as they usually register as Community-based Organizations (CBOs) at the Ministry of Gender, Children and Social Development but this doesn’t make them a legal entity. In very rare occasions, vyama are registered at the Attorney General’s office as private enterprises, partnerships or societies, but this happens only if the chama makes profit or large-scale investments.

What do vyama do?

Because of their flexible and informal nature, vyama are extremely difficult to categorize in simple groupings. Though, since this is a blog and I can over-simplify things, I would divide them in four main categories: (i) financial, (ii) investment (iii) welfare (iv) regulation.

Financial vyama are by far the most common. You’ll find them in the literature under the name of ROSCA, ASCA, merry-go-round or saving club. Members meet regularly and put money in a common “pot”. The sum is then given to one of the members on a rotating basis (a la ROSCA) or is given as a loan with interest (a la ASCA). A growing type of chama are the so-called “investment clubs”, which are vehicles for investments usually in land, the stock market, or in new businesses ventures. Welfare clubs are also extremely common in Kenya; they usually operate as informal safety nets and help members in case of emergencies, funerals or other type of financial shocks.  Finally the “regulatory vyama” are associations that operate in specific locations (i.e. a neighborhood, a market, etc.) and set a number of internal rules.

Now, the readings:

Probably one of the most comprehensive accounts of chama groups written in Kenya is the recent book by Mary Njeri Kinyanjui called “Vyama: Institutions of Hope” (disclosure: I work with Mary at the University of Nairobi). The book looks at the role of vyama in learning and education, investment, redistribution, social protection and socio-economic development. She also wrote a paper in 2010 (freely available here) which I strongly recommend.

If you are interested specifically in the financial role of chama groups at the household level, then you should read the papers by Susan Johnson (from 2004 and 2012, both PDFs), which show the complex landscape of formal and informal financial providers in Kenya. The organization called FSD-Kenya has collected a wealth of data on this issue as well. For more info check out the nationally-representative Finaccess surveys conducted in 2006 and 2009. The 2012 survey should come out over the next months (disclosure 2: I am also collaborating with FSD, but on a different project).

Finally, if you want more info on investment chama groups, there is an interesting manual written by the “Kenyan Association of Investment Groups – The Chama People” (KAIG) which gives suggestions about registration of chamas, internal regulations, type of investments and lots of other things. I noticed just now that KAIG recently changed policy and you need to register in order to download the “Chama handbook”. That’s quite annoying, but if you are a University student you can register for free here.

My supervisor calls them “institutions of hope” but most academics use fancier acronyms like ROSCAs and ASCAs, or terms like merry-go-round, saving clubs, business associations or insurance networks. Kenyans just use the word “chama” to define “groups” or “associations” that people voluntarily create to pull resources, help each other or find common “rules of the game” in areas where there is little legal enforcement.

Yesterday, during one of the awesome Kariobangi lunchtime conversations (that’s when the best observations always come out!), my table companions and I realized that it would be impossible to understand the dynamics of local markets without considering chamas. They are an “infrastructure” of regulation and financial support that shapes the way businesses function. Though, there are huge differences within the local market in Kariobangi/Korogocho: my impression is that the more businesses operate informally, the more they depend on chamas, the more business are formalized, the lower is their reliance on these social networks–we’ll see what the data says.

The best statements that came out during lunch:

  1. The informal economy would not exist without chamas.
  2. If the government effectively outlawed chamas, the informal economy would disappear (let’s hope that no politician is listening to us!).
  3. Chamas are more relevant today than they used to be for our parents.
  4. Everybody uses chamas, also the rich people.

Saving up’, or setting money aside until it grows into a usefully large sum, is hard to do. An alternative is to ‘save down’ – to set money aside to repay a loan rather than build a pot of savings. A loan is, essentially, an advance against future savings, and for a number of reasons saving down (borrowing) can help ensure that those savings really are made.

Somehow I missed this excellent blog post by Stuart Rutherford from a few months back.  He argues that “saving down” (i.e. borrowing and repaying a loan) has a variety of advantages in low-income contexts, although many people prefer to save rather than be indebted with a MFI.

First, borrowing provides you outside help with the discipline you need to make the savings, since the lender has a strong interest in getting you to (re)pay and will take steps to make sure you do. Second, with a loan you get the lump sum up-front, so borrowing provides you with certainty that the lump sum that you will build through saving is indeed created, and not lost, stolen or blocked. Third, borrowing is timely: you get the lump sum now, when you need it, not after a laborious and uncertain saving effort.

He takes the example of SafeSave, his project in a slum in Bangladesh

SafeSave clients borrow-and-repay much more than they save-and-withdraw. Why?

Many clients tell SafeSave researchers that they’d like to save more and borrow less: it’s less stressful, cheaper, provides a greater sense of security, and lump sums formed that way don’t need to be repaid. But they constantly fall into a liquidity trap. They save, but when the next urgent spending need arrives their accumulated savings aren’t enough to satisfy it, so they borrow. Now, with the need to make repayments added to the constant pressure of regular expenditure, their capacity to save is constrained even further, and so the cycle deepens and repeats

After last week’s post on microfinance vs credit cooperatives we want to talk more about the “socio-financial landscape” in urban economies in Kenya. The fieldwork we are doing in Kariobangi is telling us some interesting stories.

First, we are realizing that the term “unbanked” depicts a completely wrong image of what’s happening in local economies: most entrepreneurs in Kariobangi, both informal and semi-formal, have one or more bank accounts. This might be the particular case of Kenya where the financial sector has deepened in the low-income population. Furthermore, banks must find their market segments in complex preexisting financial structures: in addition to bank accounts, entrepreneurs use a variety of other (mostly unconventional) financial instruments. In a certain way, the term “hyper-banked” seems more appropriate than “unbanked”.

So what are the “financial portfolios” of MSEs?

Starting from the informal side of the spectrum, the most common socio-financial instruments are the so-called ROSCAs (Rotating saving and credit associations) and ASCAs (Accumulating Savings and Credit Associations). ROSCAs are also known as “mery-go-round”: members of the groups meet regularly and contribute a certain amount. Then the entire “pot” (or lump-sum) of money collected goes to one member at each meeting on a rotating basis. ASCAs work on a similar way, but the money collected is given as a loan, not a lump-sum, to the members who apply for it, who have to pay it back to the group with interest over an agreed period. At the end of the year, all the money collected by the group plus interests on loans is divided among the group members.

Other common group types are the so-called saving clubs, where members simply keep their savings for future use; the investment clubs, where the money is used for investment in business, property or stock markets. Then there are the welfare associations, which operate as informal insurance companies. Moneys collected by groups are used only for emergencies, such as hospitalizations or funerals.

On the more formal side of the spectrum, there are the institutions that everybody knows: banks, microfinance institutions (MFIs) and credit cooperatives (SACCOs). We are noticing a growing hostility towards MFIs because of the high interest rates and the “harassment” of debtors when they are late with the repayments. Though, many businesses said that MFIs were very important for the growth of their business, but they can’t afford to borrow repeatedly over time. Some businesses also secured loans from banks such as Equity Bank and Co-operative Bank. Though, it is only a minority of businesses.