The basis of measurement in auto finance market is primarily on the finance rate concept. Most of the commercial banks involved in auto finance in both forms such as direct and indirect financing, cater to the needs of the car purchasers, both individuals as well as businesses.
- They basically extend such loans directly to the customers and usually advertise the rates they charge for such loans relying basically on the communications media.
- When it comes to the large commercial banks they also compete with the smaller ones as well as the alternative sources of auto finance actively.
All these efforts are made with an intention to get more dealer patronage especially for the indirect financing. They provide several different inducements to those specific car dealers who they consider to be most competitive with the sales finance companies.
The bulk of the financing for new cars to the consumers is provided by the sales finance companies as well as the commercial banks. However, there are minor shares that accrue to other arms of the finance machinery such as:
- The credit unions
- The personal loan companies and
- The auto dealers who sell and service customer’s obligations of their own.
Research and analysis reveals that there is a distinct predominance of the indirect lenders when it comes to auto financing whether it is Liberty Lending or any other for that matter. It proves and supports that fact that the hierarchy of auto financing has not changed since 1939 though a significant decline in the market share was witnessed in 1956.
It is mainly due to the competition given by the paper originated by auto dealers and the car sales finance companies. It was found that this year and years after they have been able to successfully retain the major share of the auto finance market.
- However, the commercial banks pulled up their socks and they made most important inroads since 1939.
- It is also found that the commercial banks have made noteworthy gains in the direct auto financing segment of the market since 1939.
If you combine both these segments of the auto finance market you will see that it is clear that the commercial banks have held the biggest share of the by the auto credit outstanding by the end of 1958. This is spread across many different types of credit agency in this specific segment of the finance market.
Dominance of commercial banks
The dominance of the commercial banks increased in the years that followed. If you consider the recent years you will see that there has been a significant growth in the activity of the credit union in auto financing has increased remarkably if you if you further break down and analyze the ‘other’ component.
This ‘other’ component data includes lots of different things that are obtained after subtracting the outstanding amount of debt held by different segments of the auto finance industry such as:
- The consumer finance companies
- The auto dealers and
- The affiliates.
When you consider the data obtained from different researches and studies that signifies the growth in market shares of the credit unions and other categories you will see that:
- It was 4.6% in 1955
- It rose to 9.9% in 1961
- It experienced a slight drop to 9.7% in 1962
All these figures and data are supported by the Federal Reserve Bulletin and the figures found in the Federal Reserve Board release match with what the other researchers have found. Moreover, the factors considered by the Federal Reserve Board appear to be the same as the other study elements and includes:
- The consumer finance companies
- The auto dealers
- All credit unions
- The industrial loan companies
- The mutual savings banks
- The savings and loan associations and more.
It is also seen that the method of operation of all of them are more or less the same and is primarily based on the measure and principles that are based on the finance rate concept.
The finance rate concept
The finance rate is actually the annual rate that is effective on loan that the buyers’ take out. It characterizes the decreasing unpaid credit balance of the loan account spread through the period of indebtedness that is scheduled. The basic elements of all credit transactions are found to include the following:
- The amount of the loan
- The time plan for repayment and
- The finance charges.
In addition to that most of the auto loan contracts also require a periodic amortization of the outstanding balances of the loan which is usually represented in monthly installments. This monthly installment has two parts included in it such as:
- A portion of it is implied for the finance charges and
- The rest of amount repaid each month goes to the deduction of the principal amount.
During every payment date the ratio of the fees and finance charges to the principal unpaid till that tome period represents the rate of interest and charges for that particular period. Typically, the auto finance market works out their finance charges, rate of interests and other fees taking a year as their basic unit of time to express these.
The constant ratio formula
The auto financers use a constant ratio formula as they have to deal with a large number of individual loan contracts to calculate the finance rates on each of the loan accounts.
The formula is i = D/ [(n + 1)/rn] ± P12 = 2rnD/P (n + 1). Here:
- i is the finance rate
- D is the finance charge in dollars and cents and
- n is the number of payments
- rn is the number of payments in a year
- P is the principal of the note.
This helps them to determine the monthly installments each borrower has to pay along with the actuarial computation of interest.