Captive Finance Company: What It Is, How It Operates

What Is a Captive Finance Company?

A captive finance company is a wholly-owned subsidiary that finances retail purchases from the parent firm. They range from mid-sized entities to giant firms depending on the size of the parent company.

The basic services of a captive finance company include basic card services like a store credit card and full-scale banking. This can offer the parent company a significant source of profit and limit the amount of risk exposure.

One aspect of captive finance companies that may give investors pause: the companies will often offer shorter loan periods than other types of lenders, meaning monthly payments will be higher.

Understanding Captive Finance Company

A captive finance company is usually wholly owned by the parent organization. The best-known examples of captive finance companies are found in the automobile industry and the retail sector. When it comes to the auto sector, captive finance companies offer car loans to buyers in of need financing. Some examples include General Motors Acceptance Corporation, Toyota Financial Services, Ford Motor Credit Company, and American Honda Finance.

Notably, after the bankruptcy of General Motors in 2009, GMAC underwent a name change to Ally Bank and rebranded as Ally Financial in 2010. Each company represents the financing and credit divisions of the larger brand name automobile manufacturer.

In contrast, retailers use captive finance companies to support store card operations. Store credit cards offer customers various benefits for shopping at specific stores, including free shipping, additional discounts, and amplified rewards with every purchase.

It also helps the parent company reduce risk exposure. The captive company ends up incurring losses rather than the larger corporation when a customer defaults on a store card or fails to make a payment. This enables the parent company to increase sales and avoid the struggle of outsourcing funds from outside lenders. Furthermore, the larger corporation also receives interest from store cards issued by captive companies.

Key Takeaways

  • A captive finance company is a wholly-owned subsidiary of an automaker or retailer that provides loans and other financial services to the customers of those companies.
  • Captive finance companies provide store credit cards for retailers and full-scale banking, including multi-year auto loans.
  • Their purpose is to provide the parent company with a substantial source of profit and also limit the company's risk exposure. 

Advantages of a Captive Finance Company

A captive finance company can be a significant driver of sales and profit growth for larger corporations. Customers with store credit cards often have an incentive to spend more at the specific store and benefit from the convenience of owning the card. As for the bottom line, the larger company receives interest payments from past due accounts. This helps fuel earnings growth and profitability.

Loans from a captive finance company can be mutually beneficial for customers as well. Obtaining loans from a captive finance company involves minimal guesswork as rates and payment schedules are often predetermined. Sometimes captive finance companies offer lower loan rates than other types of loan companies. In the auto industry, they can also extend loans to buyers with below-average credit, as they control both the loan and purchase in one sitting.