Financial Institution Management

1.            What is the primary function of finance companies? How do finance companies differ from commercial banks?

The primary function of finance companies is to make loans to individuals and corporations. Finance companies do not accept deposits, but borrow short- and long-term debt, such as commercial paper and bonds, to finance the loans. The heavy reliance on borrowed money has caused finance companies to generally hold more equity than commercial banks for the purpose of signaling solvency to potential creditors. Finally, finance companies are less regulated than commercial banks, in part because they do not rely on deposits as a source of funds.

2.      What are the three major types of finance companies? To which market segments do these companies provide service? 

The three types of finance companies are (1) sales finance institutions, (2) personal credit institutions, and (3) business credit institutions. Sales finance companies specialize in making loans to customers of a particular retailer or manufacturer. An example is General Motors Acceptance Corporation. Personal credit institutions specialize in making installment loans to consumers. Business credit institutions provide specialty financing, such as equipment leasing and factoring, to corporations. Factoring involves the purchasing of accounts receivable at a discount from corporate customers and assuming the responsibility of collection.

3.      What have been the major changes in the accounts receivable balances of finance companies over the 29-year period from 1977 to 2006?

The amount of consumer and business loans has decreased from 95 percent of assets to 52.8 percent of assets. Real estate loans and other assets have replaced some of the consumer and business loans and are now 27.9 percent of assets.

4.      What are the major types of consumer loans? Why are the rates charged by consumer finance companies typically higher than those charged by commercial banks?

Consumer loans involve motor vehicle loans and leases, other consumer loans, and securitized loans, with loans involving motor vehicles involving the largest share. Other consumer loans include loans for mobile homes, appliances, furniture, etc. The rates charged by finance companies typically are higher than the rates charged by banks because the customers are considered to be riskier. 

5.      Why have home equity loans become popular? What are securitized mortgage assets? 

Since the enactment of the Tax Reform Act of 1986 only loans secured by an individual’s home offer tax-deductible interest for the borrower. Thus, these loans are more popular than loans without a tax deduction, and finance companies as well as banks, credit unions, and savings institutions have been attracted to this loan market.