- 1. Part IV: Non Depository Institutions Topic 13 Finance
Companies
2. What is a Finance Company?
- The Federal Reserve definition : a firm whose primary assets
are loans to individuals and businesses.
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- Non-banking financial institutions
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- Non-depository credit intermediaries
- A finance company is similar to a bank in that loans are
underwritten to finance the activities of certain lenders
- The balance sheet of a finance company looks similar to a bank,
but with one MAJOR exception.
3. Finance Company Balance Sheet
- A finance company does not have any depositor
liabilities!!
- While finance companies offer mortgages, commercial loans and
consumer loans just as a bank do, the finance these activities with
non-depositor liabilities, mainly:
4. Types of Finance Companies
- Sales Finance Institutions :
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- GMAC General Motors Acceptance Corp
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- Sears Roebuck Acceptance Corp
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- Specialize in making loans tocustomers(captive finance
companies), providing on the spot financing
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- Can process loans quicker and more conveniently than depository
institutions
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- Adverse selection process might be compromised
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- A bank may refuse a car buyer due to bad credit
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- GMAC may be willing to take on a borrower with bad credit due
to pressure from GM, if sales incentives are high
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- Lower rates (e.g. 0% financing) may be required to attract
customers to GM cars, hence GMAC may be subsidizing GM.
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- Finance company loans are not regulated in the same way that
bank loans are, so more risk can be absorbed in the lending
decision.
5. Types of Finance Companies
- Personal credit institutions : Make installment and other loans
to customers
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- Some specialize in low income (sub prime) lending with bad/no
credit history, providing higher margins (through higher charged
interest rates) if adverse selection is adequately addressed.
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- Subject to state-imposed usury ceilings.
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- Credit Card companies (Capital One) fall into this category of
finance companies
6. Types of Finance Companies
- Business credit institutions : Provide financing to
corporations
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- Equipment leasing (e.g. aircrafts to airlines)
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- Finance companies buy the receivables from corporations at a
discount
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- Take responsibility for collection with no assurances from the
corporation
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- Allows the corporation to free up assets (loans), converting
them to cash so that they may pursue investments related to their
core competency
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- The Moral Hazard problem may surface is finance companies have
no recourse with the corporation (ie corporation lowers quality of
A/R).
7. Finance Company Asset Funding & Receivables Annual
changes in level of funding source: Board of Governors of the
Federal Reserve System ;Flow of funds Accounts of the United
States. 8. Finance Company Receivables
- Similar to a bank, loans are assets and are referred to as
accounts receivables
- The three major categories of Financing activity are:
- Consumer loans and leases
- Commercial loans and leases
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- Property, plant & equipment
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- Securitized 1-4 family homes
source: Board of Governors of the Federal Reserve System ;Flow
of funds Accounts of the United States. 9. Finance Company
Receivables source: Board of Governors of the Federal Reserve
System ;Flow of funds Accounts of the United States. 10. Finance
Company Oversight
- Since finance companies do not accept demand deposits, they are
not subject to the same Federal Regulation of Depository
Institutions
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- Finance companies are not Chartered by the State or OCC
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- Finance companies are not examined by the OCC, State
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- There is no need for FDIC insurance
- The cost to no federal regulation: there is not regulatory
safety net to protect investors
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- Finance companies generally have lower leverage ratios than
banks to signal solvency
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- Shareholders (equity owners) invest in finance companies
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- But shareholders of depository institutions do not receive
federal assurance for their ownership either
11. Industry and Competition
- Finance companies compete head-to-head with banks in certain
markets
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- Relaxed regulation affords certain competitive advantages
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- Finance companies do not have to meet capital adequacy
requirements
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- Finance companies have managed receivables greater than
$1Trillion, about the same size as the Thrift industry, twice as
large as credit union industry
Source: reprinted from financialservicesfacts.org Some finance
companies are actually subsidiaries of commercial banking units
(e.g. Citigourp credit card division) 12. Industry and
Competition
- Concentration of finance company assets:
- The top 20 largest finance companies = 65% of total assets
- The 8 largest finance companies =51% of total assets
- The 4 largest finance companies account for 41% of total
assets
Source: reprinted from financialservicesfacts.org 13. Industry
Consolidation The total number of finance companies dropped from
1,200 in 1996 to 1,000 last year 14. Fringe Banking
- Service offered by non banking financial institutions could be
considered loan sharking, but have grown in recent years.
15. Money Transactions by Non Bank Financial Institutions
- Coopers and Lybrand 1997 Study for the Financial Crimes
Enforcement Network (FinCEN) on Non-bank financial institutions,
based on size of market. The following diagrams break down the $200
Billion dollar sector measured by dollar transactions.
Type of Transaction Revenue Generated ($200 Billion) 16. Money
Transactions by Non Bank Financial Institutions
- Revenue from money transmissions reflect an average fee of 10%,
so while they constitute only 5% of all money transactions, they
account for 30% of all money transaction revenue by non-bank
financial institutions. Check Cashing fees are roughly 2%.
- Over 158,000 business locations in the U.S. Offer these
services, including:
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- U.S. Postal service locations (25% of transactions)
17. Money Transactions by Non Bank Financial Institutions
- 97% of the market is concentrated in two companies, and much of
the market is focused on money remittances, foreigners sending
money back to their home country. Mexico is the largest country by
aggregate size of remittances.
U.S. Money Transmission Market Share U.S. Market Share of
Travelers checks 18. Money Transactions by Non Bank Financial
Institutions U.S. Money Order Market Share U.S. Market Share of
Travelers checks cashed