HOW INFORMAL SAVINGS GROUPS OUTPERFORM THE FORMAL FINANCIAL SECTOR IN SOUTH AFRICA.

ROCHELLE JACOBS; NOVEMBER 2020

A lot of behavioural science has focused on financial behavior. Frequent questions include how we can increase savings or contribution to retirement funds, but the day-to-day behavior of making payments is often given less attention.

Every adult has payments to make: buying groceries and electricity, paying for children’s education, paying off debt, saving money. Money, of course, is finite, and, for a large portion of the worlds’ population, the payments we need to make outweigh the income we earn. 

This imbalance brings with it an inherent trade-off: which bills do people pay first? Because financial decisions are calculable and there are clear, measurable benefits and costs in what we prioritize, it’s easy to assume that people make rational decisions when making these decisions.

Of course, we know that they don’t.

In many African countries, community savings groups are a common mechanism for individuals to meet their financial goals or plan for big financial events. Usually called stokvels, these groups involve a set of individuals, paying an agreed-upon monthly contribution, where payouts are governed by rules that the group itself determined. These range from enabling emergency loans, to buying bulk food orders in December, to paying out a lump sum to all individuals at a given time of the year.

As part of our ongoing research, we’re investigating what payments individuals prioritize and the results have been surprising. South Africans prioritize stokvels. They make these payments before credit cards, store accounts, loans, and traditional savings. Many South Africans don’t consider stokvels as a way of saving – they say that they “don’t save anything” but that they do “contribute to a stokvel” and stokvels are almost always paid first.

Why? These other expenses – especially debts – are more costly, both in terms of financial losses in the form of interest paid, and in terms of important financial measures like credit ratings.

As an informal savings mechanism, participating in a stokvel doesn’t add to your credit rating at all, but missing credit card or store account payments certainly reduce it.

The answer seems to be a combination of social norms and immediate costs.  

Despite being informal, the rules for stokvels are very clear, usually quite harsh, and communally developed. Often, a single missed payment results in the person being kicked out of the stokvel entirely, losing the benefits that they’ve contributed towards for the entire year. Each of these components likely contributes to the success of stokvel contributions:

Clear rules stand in stark contrast to the terms and conditions specified in almost any formal financial product, which are typically filled with complex jargon.

Co-creation ensures that the rules are understood and deemed to be fair. In these early stages of development, each individual in the stokvel is designing and agreeing to rules, assuming that they will not be the one to default. Concern for themselves and a desire to protect their investment in the scheme results in stricter rules that all parties still believe to be fair.

Furthermore, the stokvel dynamic turns hyperbolic discounting on its head: where many financial services give instant rewards and on-the-spot agreement, stokvel rewards are only felt in the longer term. This reduces the emotional investment in the payout options, allowing for clearer and more objective consideration.

In contrast, the salient concern at the time of the design is that of other defaulting. These fears have emotional responses, giving rise to harsh and instant punishments. This is likely a further contributor to their success: punishment is harsh and immediately felt and, thus, strongly avoided.

Finally, the punishment itself is the loss of something the individual owned – leveraging endowment effects and loss aversion to create a powerful motivator for compliance.

Contrast these with store cards, where the reward is immediate, resulting in instant uptake with little regard for the rules of the game. If those rules do come into consideration, they’re likely complex and dictated by some vague corporate lawyer, taking little account of the individual agreeing to them.

If the person defaults, they’ll receive reminders – often inspiring feelings of guilt and shame – which will likely be ignored. Ignored for long enough, the debt is moved to a collections agency who will take their turn at reminding, cajoling, and persuading the person to make a payment long overdue with no immediate benefit.

Failing this, the person will take a hit to their credit rating, a punishment they’ll only ever feel the next time they need or want to take on new debt or make new financial commitments.

It would be overly optimistic to assume that the formal financial sector can take on the characteristics of stokvels in any meaningful way. It’s possible that these informal mechanisms, while well-liked by the population, would fail the consumer protection requirements expected of more formal institutions. Despite this, there are surely lessons to be learned as we continue to innovate in our provision of financial services.