A COMPARISON BETWEEN FORMAL AND INFORMAL MUTUAL-CREDIT ARRANGEMENTS Francesco REITO 1 * and Salvatore SPAGANO 2 1 Department of Economics and Business, University of Catania, Catania, Italy, and 2 IUSS Pavia (Institute for Advanced Study of Pavia), Pavia, Italy First version received February 2013; final version accepted March 2014 We analyze under what conditions a group of potential entrepreneurs prefer to form a Rotating Savings and Credit Association (ROSCA), or a mutual-guarantee association, which we interpret in a rotating scheme and call Rotating Savings and Collateral Association (ROSCoA). We argue that: (1) ROSCAs (ROSCoAs) are likely to be more developed in countries with high (low) bank concentration; (2) the individual flow of savings required to participate in a ROSCoA is generally lower than that needed in a ROSCA; (3) under the assumption that members share their project income at the end of each period, ROSCAs and ROsCoAs are sustainable even without the use of sanc- tioning mechanisms. Keywords: Collateral; Moral hazard; ROSCA; Mutual-guarantee association JEL classification: D81, D82, O16 I. INTRODUCTION T his paper analyzes the behavior of a group of potential entrepreneurs who, owing to insufficient resources, decide to join a mutual-credit arrangement to undertake their projects. We consider that agents can choose between a Rotating Savings and Credit Association (ROSCA), or a mutual-guarantee asso- ciation that, to ease the comparison, we consider in a rotating scheme and call Rotating Savings and Collateral Association (ROSCoA). In the model presented in this paper, there is a group of potential entrepreneurs, with similar projects, who can decide to form either a ROSCA or a ROSCoA. The two main results are: a) if the contributions to the pot in each period are not sufficient for the project start up, entrepreneurs can only form a ROSCoA, and ask for loans; b) if the contributions to the pot are high enough, i) risk-neutral * Corresponding author: Francesco Reito, University of Catania, Department of Economics and Business, Corso Italia 55, 95100 Catania, Italy. Tel: +39-3-288242694; Fax: +39-0-957537710; Email: reito@unict.it This paper has benefited from the constructive and detailed comments made by two anonymous referees. The Developing Economies 52, no. 2 (June 2014): 179–201 doi: 10.1111/deve.12043 © 2014 Institute of Developing Economies