Identifying the problem with traditional co-operative loan schemes
What is the definition of 'Turn' in the context of Takaturn
Using game play as an example, games with multiple players, each player takes his or her 'turn' in playing out their strategy towards a desired outcome. In these types of games, every player has a turn according to a predetermined formula, either decided by the collective or through a chance selection.
How does this relate to Takaturn in real world terms?
The concept of cooperative loans is being practiced today in many countries globally. It is known as “Gamaeyah” in Egypt, “Chit Fund” in India, “Tontines” in Cameroon, "Kiwiinah" in Uganda, “Ballot Committee” in Pakistan, “Paluwagan” in Philippines, “Money Circles”, “Rotating Savings & Credit Associations” (ROSCA) and other names by practitioners.
Let’s take an example of a group of 10 people. Each person agrees to pay $100 for 10 months into a collective fund. In month 1, person 1 gets the full amount paid that month equal to $1,000. In month 2, person 2 gets the full $1,000 paid that month; this goes on until everyone gets $1,000 once in the 10-month period and everyone has paid a total of $1,000.
The same can be done with 6 people for 6 months, or 20 people for 20 weeks; and the amounts can vary according to the needs of the participants. Who gets the money in which order is either determined by the group or randomly determined by lottery.
What are the challenges faced by participants in traditional co-operative loan schemes?
Generally speaking, entering into a loan cooperative requires a high level of trust within the group, as there is a risk that anyone in the group may default on the loan. Most often, participants enter into cooperative loans with family, friends and people they trust.
This has the impact of limiting the co-operative loans' capacity to small circles thus limiting community support for the purchase of big (or bigger) ticket items such as cars, homes, income-generating assets, potential private equity funding of trade and other business ventures.
The current system of cooperative loans has two primary problems. First, without a centralized authority to administer the program, it requires a high-level of trust among participants. However, the presence of a centralized authority eliminates some of the key benefits of the cooperative system that make it attractive in the first place; it would be like going to the bank for a loan, requiring an application and approval process and introducing new costs and fees into the program.
The second problem of the cooperative loan relates to the mundane task of fund management, collecting and distributing the funds, ensuring each participant is the beneficiary only once and making sure funds are not pilfered or lost. This requires at least one trusted person to take an active management role which again limits the scalability of the program.
What is the purpose of these co-operative loans?
People participate in this mode of cooperative loans due to a lack of access to traditional financial services through banks or otherwise. There are also many benefits to the cooperative loan over bank financing.
There is no (or very little) paperwork or approval process to get started
These loans are no or low cost as there is no outside party (such as a bank) to take a cut
There is a positive social impact as participants are helping one another
It helps participants develop a regular savings habit
For Muslims, these loans are shariah-compliant and don’t involve interest
The benefit for the participant that receives the full loan amount in the early months of the loan term is clear. Going back to our 10-person example, the first beneficiary of the $1,000 is able to access this money by only putting in $100. To get this same amount on his own, he would have to save $100 for 10 months.
While there is diminishing utility for each subsequent beneficiary, it is still useful for accessing a larger amount of money sooner than the time it will take one to save that amount. This is true for all participants except the last beneficiary. So why does the last beneficiary participate? This is actually a non issue since the intangible benefits of the structure, namely, interest free, forced savings, guaranteed receipt of turn in 10 months, the somewhat certain nature of the proceeds allows for better budgeting and planning on the part of the 10th recipient, far outweigh the diminishing utility aspect of time value of money.
If the order of beneficiaries is random, then we can argue that no one is expecting to be the last beneficiary when he first engages in the cooperative loan. In case the order is already known, then it appears that the cooperative loan is really being used as a savings program. By committing an amount to the cooperative loan each month, not only does it help others, it also acts as a savings program that you cannot procrastinate. After all, if you even skip one month of contribution, your friends in the co-op will be very upset.
Typically, people engage in cooperative loans to finance smaller purchases such as electronics or furniture. However, it’s not uncommon for people to use these for bigger purchases like weddings, automobiles and even homes.
Shariah Compliance and Co-operative loans
It is commonly accepted that cooperative loans are shariah compliant as they do not involve riba (interest), gharar (uncertainty), nor maysir (gambling). The peer to peer nature of these loans means that the costs associated with setting up the loans scheme are kept to an absolute minimum as well.
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