United States Small Business Administration
Office of Advocacy
RS 160
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Purpose
Finance companies encompass a broad range of lenders, extending
from companies such as General Motors Acceptance Corporation (GMAC)
to those owned by individuals. The industry has evolved as a
significant participant in the financial capital market over the
past couple of decades. Redirecting their portfolios toward business
and real estate credit and away from the traditional source of
customers, consumer loans, finance companies increased their total
business lending from just under $86 billion in 1980 to nearly
$300 billion in 1992. Although little information is available
about finance companies' lending to small business in the United
States, there does exist a popular notion that finance companies
are the "pawn shops of the financial services industry"
-- insignificant and isolated participants in the financial services
market, attracting primarily high risk borrowers and charging
these borrowers relatively high loan prices. This study explores
the "pawn shop" notion, profiling finance company borrowers,
examining their demands for financial services and assessing whether
they pay higher loan prices than borrowers of bank loans.
Scope and Methodology
In this study, finance companies are separated into two groups,
captive and non-captive. Captive finance companies, such as GMAC,
use the financial strength of their parent company to raise low
cost capital and their product knowledge to efficiently resell
assets acquired in loan defaults, hence decreasing their total
cost of capital. Non-captive finance companies supply finance
products marketed by other companies, and typically have no comparative
advantage in raising capital or disposing of products acquired
in a loan default. Non-captive finance firms depend on offering
other financial services (such as consulting, sales financing,
and accounts receivable factoring) to survive.
The data source for this study is the 1988 National Survey of
Small Business Finances (NSSBF). The NSSBF provides for the first
time information on small business borrowing from different types
of lenders, such as banks and finance companies. The NSSBF sampled
the population of non-financial, non-agricultural businesses with
fewer than 500 employees. The information requested was for the
year 1987. A probability sample was designed to select a sample
from the Dun's Market Identifier file. Of 5,190 eligible firms,
3,404 businesses completed the survey instrument, yielding a 65.6
percent response rate. Because interest rate information was to
be used to assess the loan prices, only firms with loans since
1978 were retained in the sample for the pricing analysis (1,786
firms). In addition, a study verification survey was conducted
to discuss and verify the results of the statistical analysis
with knowledgeable individuals who either own or work for a finance
company.
The study employed a conceptual model depicting loan pricing behavior
for two lenders (commercial banks and finance companies) who evaluate
borrowers based on their credit riskiness and relationship with
the lender. Based on the conceptual model, hypotheses tested included:
(1) borrowers with close lender relationships will have a higher
probability of being attracted to commercial banks than finance
companies (and conversely, borrowers without close lender relationships
will have a higher probability of being attracted to finance companies
than commercial banks); (2) high risk borrowers will pay higher
loan prices than low risk borrowers; and (3) finance company borrowers
will pay lower loan prices (that is, face lower interest rates
and lower collateral requirements) than other borrowers.
Highlights
Ordering Information
The complete report is available from:
National Technical Information Service
5285 Port Royal Road
Springfield, Virginia 22161
(703) 487-4650
(703) 487-4639 (TDD)
Order Number: PB96 146485
Cost: A06/$27.00; A02/$12.50 Microf.
*Last Modified 6-11-01