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Nearly 17 million American adults don't have bank accounts. Here's one way they can build credit.

Not everyone has experienced the joy of standing in line at the bank.
Not everyone has experienced the joy of standing in line at the bank.
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Let's say your bank disappeared tomorrow, and with it all of your credit cards and accounts. How would you save money or get a loan? There's the proverbial practice of stowing your money under your mattress. Or you could beg a parent or sibling for a loan so you could make your next rent payment.

But many Americans have other, more organized ways outside the financial system to build up savings and credit. One of those is the rotating savings group. These go by different names — rotating savings and credit associations (RoSCA) is one way experts refer to it — but they are often informally called savings circles.

How does it work?

The concept is simple: you get together with a group of your most trusted family members or friends, and you all agree to pay $50 a week into the pot. If there are 8 of you, you will pay $50 in for 7 weeks, then get the full pot ($350, not counting your $50) one of those 8 weeks. It puts behavioral economics to work for users — you don't want to let your relatives down and cause them to miss out on their lump sum this week.

Savings circle

A diagram of how a savings circle works. (Source: US Financial Diaries)

Eight percent of American households are unbanked, according to the FDIC — that means that around 1 in 12 households doesn't have a checking or a savings account. And according to new research, the savings circle is one key way many Americans make ends meet.

The US Financial Diaries Project, in which researchers from NYU and the Center for Financial Services Innovation (a New York-based nonprofit) closely followed the financial lives of 200 US families with low to moderate incomes, found that 9 percent of those households use circles. The households aren't a representative sample, but the findings do suggest that significant numbers of certain populations, like immigrants, make particularly heavy use of the circles.

What's the use of savings circles?

They solve one big problem lower-income Americans have: The researchers (and other studies) have found that these households often have troubles building up lump sums of savings, whether for short- or long-term use.

The strategy isn't just for the unbanked, of course. One savings circle user, Argelia Diaz, says she uses the structure in addition to her bank accounts. Diaz lives and works near Bakersfield, California, and has participated in circles with her family members for five or six years, she says. Circles are a tradition in her Mexican-American family, and she talks about it using language that evokes both loans and savings accounts.

"It's just an easier and quicker way to save up money on the side without having to accumulate interest at the end or paying it off," she says. "It's a quicker way to establish money on the side — something you need within weeks or so. For me it's short-term."

Diaz uses circles for short-term saving, but many of her family members have other reasons, she says. Many aren't well educated on how to use banking services she says, and some people she knows are undocumented and don't have the paperwork necessary to establish a bank account.

But she adds that it also comes easily in a tight-knit family where she, her mother, and her siblings see each other every week or even every day.

What are the drawbacks?

People who regularly "borrow" money in these structures miss out on big benefits of formal finance — particularly, credit score benefits. But there is a push to change that. The San Francisco-based Mission Asset Fund has been working to make circles more of a formally recognized structure by reporting to credit agencies.

Step one has been stopping calling them "savings circles," he says. The concept of circles isn't new, says John Quinonez, CEO at MAF. It has been around for centuries, and in many cultures — Businessweek earlier this year wrote about Pakistanis using the circles.

But for the purposes of emphasizing the credit-building and money-lending aspect of them, he has been applying other labels to the practice.

"Every time we talk about our work, about lending circles, that is just our way of articulating or sort of translating that activity that is invisible to the financial mainstream in a way that it can be understood here," he says. "If we formalize it and define everything as a social loan … then we can report [payments on that loan] to a credit bureau."

But he also adds that he wants to change cultural perceptions. The fact that savings circles are informal structures built upon family trust and often used by people from non-white-American cultures, says Quinonez, means anthropologists and other writers often talk about them in a quaint light, making them sound "cute." The point, he says, is to both legitimize the practice but also link it to the formal financial system.

"What was critical for us was to see beyond the nomenclature of savings circles and see the activity in the circles in a different light," he says. "We went beyond celebrating the fact that people save informally together to formalize that activity in a way that they could build their credit history."

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