Is using Informal Saving Mechanisms still viable?

I know we all start the year with the intention of putting some money in our piggy banks, but all too often we end up doing something else with it.

For young people, it can be used to pay various bills, daily expenses, and other unplanned expenses.

According to a report on financial inclusion published by the National Bank of Rwanda in 2020, both women and youth have less than the national formal savings rate of 54%.

When you consider that young people are among those who do not necessarily earn a lot of money, it becomes clear why saving is a problem.

With the rise of Formal Finance, it can be difficult to choose between formal and informal Savings Mechanisms (ISMs). Let’s dig deeper into the topic.

Why do people still use informal finance in this era of growing formal finance?

Informal Savings Mechanisms (ISMs) have long been an important part of many Rwandans’ day-to-day money management.

These mechanisms, which include Savings Groups, Rotating Savings and Credit Associations, and even leaving savings with someone outside the immediate family, are a variety of ways for individuals or groups of people to save money.

In Rwanda, 50% of youth save with formal financial service providers, while 55% save through informal mechanisms such as VSLA, tontine, or Ikimina savings associations. (BNR 2021, Access to Finance Rwanda, AFR,).

The majority of these informal savings are used to meet life goals such as purchasing a home/property/land, starting a business, or going to college.

ISMs provide a useful service that fits into people’s lives, and they frequently provide additional value in addition to financial services.

These community-based savings groups assist their members in saving money, starting with as little as Frw 5000.

They operate under simple rules that members agree on and enforce. They are adaptable across groups and over time, and they respond to local demand for savings and loans.

This can be advantageous for young people because ISMs provide regular (often weekly) savings, a strong social pressure to keep that saving going, the ability for savers to borrow short-term from the accumulating pool of savings, quite high rates of interest, and at the end of an agreed period, all savings plus accumulated interest is distributed to group members.

What would be the benefit of formal services?

Although ISMs can be useful, formal services can provide many financial services that ISMs cannot.

Benefits may include the security of surplus cash, the ability to save anonymously, the ability to save larger lump sums and/or over longer periods of time, larger and longer-term business loans at competitive interest rates, and micro-insurance.

Why not combine the two

Combining the two can be advantageous to young people. With the benefit of saving small amounts of money with ISMs, you can invest your earnings in a financial institution to reap the benefits.

Shifting your ISMs savings into formal services can be beneficial in the long run. However, formal services should also assist those with low income.

It is still important for young people to use mechanisms like ISMs because it is a viable option rather than abandoning the concept entirely.