The money market is the backbone of a country’s economy and therefore whatever laws and regulations are imposed on it should be made keeping the broader aspect in mind. This will ensure that the economy of the country is not affected adversely or the creditors and the consumers.
Not only the government buy you as a responsible citizen must play your part to make sure that the country’s economy moves on the right track in the right direction. For this, you will need to know and abide by the debt laws as formulated by the government especially if you are into loaning and lending business. Consumer debt collection and its regulation have a significant effect on the country’s finance which is why you will need to understand the economics of it.
Role of the CFPB
CFPB plays a significant role in the regulation of the debt market. It deliberates on whether or not it should add any new debt collection regulation or simply modify the existing regulations. No matter what it does, it is essential that it does so by considering the role of debt collection as well as its operation of the entire consumer credit system.
- This is important because the desired result will only be achieved when the potential of the consumer credit contracts and the debt collection function are understood.
- This will also help the CFPB to improve the current scenario as well as the operation of the entire system.
Following the rules of economics, a creditor must make a loan to make a profit. This is possible only when the risk the loss is priced accurately. This means, if such a risk of loss is higher, then the lender will automatically have to charge a higher price so that the heightened risk of loss is effectively and adequately compensated.
On the other hand, if the lender is not able to price the risk factors of the loan accurately especially due to the imposed regulatory limits, then the lender will have no other alternative but to reduce its risk exposure in other ways. These ways include:
- Lending to fewer borrowers
- Limiting credit offered to the higher risk borrowers or
- Lending less by reducing loan size or credit lines to the same borrowers.
The most significant element of the risk of loss is the ability of the creditor to collect the dues from a debtor in case of defaults. If the power of the creditor to collect is weaker, then the loss rate will once again be higher. There are two significant reasons for this such as:
- First, if the creditor has more limitation to collect then naturally it will recover much less than the actual amount owed by the defaulted debtor making the entire collection efforts more costly in the end and
- Second, if the costs of default are less severe, the borrowers will be more likely to default.
This means that in both the situations it is the creditor who is likely to face the loss more in comparison to the debtors simply due to the greater restraints on collection on the creditors. As a result, the lenders will respond to such increased risk of loss either by increasing the prices of the loans to compensate for the risk or by reducing risk exposure.
It is for this reason that most creditors often deny debt settlement as they lose more in the process. If you go through the debt settlement and debt consolidation reviews you will come to know more about these aspects of debt management.
A priori matter
Considering the a priori matter, therefore, it can be said at this moment is it not very clear as to whether the consumers or the creditors as a whole will be benefitted with such changes in the debt laws or it will make the matters even worse due to the stricter regulation of collections. As of now, those consumers who are already in default are usually benefitted from such greater restraints on collections.
- However, this benefit of a handful of such consumers comes at the expense of other consumers because they will now have to pay more on obtaining a loan due to the limited access to credit.
- This will also reduce the borrowing power of the debtors currently in default in case they want to take on a new credit in the future.
This is because the lender will not be able to predict accurately which particular borrower will eventually default and therefore will be extra cautious at the time of making a loan. This means that they will generalize all borrowers and therefore all potential borrowers will now be compelled to pay higher costs if they want to take on a new loan.
Conversely, if the creditor remedies are weakened by the debt laws, it will increase the risk of loss for the creditors as well and once again result in a higher cost of debt. Typically, such a modification will lead to a reduced supply of loans at a much higher price with all other things remaining the same as before.
- At this juncture, it seems that strengthening the restrictions on the creditor remedies will concurrently shift the supply curve inward as this will increase the rate of loss and thereby the cost of lending.
- On the other hand, the demand curve will move outward due to the increase in consumer demand due to the minor adverse consequences from default.
If you consider both, the overall effect of the increase in demand and simultaneous reduction in supply due to the regulatory or contractual restrictions on debt is hugely ambiguous in terms of the quantity of credit overall.
It is therefore required that all potential borrowers who are within the desired credit score range know about the risk and pay the premium as well. In such a given condition it is likely that lending occurs on the basis of the extralegal fetters on default that includes repeat dealing, morality, reputation, conscience, economic hostage taking, collateral, and lending between family members.