A debt trap is a situation where a borrower can’t pay their debts due to high-interest rates. They may end up filing for bankruptcy, which means their creditors have no way of recouping their funds. From the perspective of a debt collection agency, debt traps are therefore bad for business.
Surprisingly, debt traps can just as easily arise from unnaturally low-interest rates. When the rates are low, more consumers are encouraged to borrow. They may assume that since the rates are so low, they will have no problem servicing their loans. This means a larger proportion of the population is left owing money.
This mass debt creates a spill-over effect as the economy adjusts itself. Debtors may continue with their normal lives, underestimating the scope of their debt. Since they don’t prioritise it, they find it easy to run out of cash before they pay the debt. If their monthly instalment were larger, they would pay it before anything else, but since it’s so small, it’s easily overlooked.
When this situation involves a corporate entity, it’s referred to as zombie company. Their earnings aren’t enough to cover both their expenses and their repayments, so they repayments get shelved. If this goes on long enough, their cumulative interest rates rise beyond what they can pay, and their company goes under.
Failing businesses and individual insolvency are terrible for everyone. Creditors lose their money and debtors have a hard time to make ends meet. So while low-interest rates seem like a good thing from a consumer perspective, they can be detrimental.
On a global level, interest rates are near zero, and it has led to a massive borrowing volumes. If too many of these debtors default, it can lead to a global financial crisis similar to what happened in the US in 2007/2008. That’s why some industry experts have been lobbying for a rise in interest rates to normalise the debt space.
Gertjan Vlieghe is a member of the Bank of England committee that sets interest rates. He is considered one of the most conservative members of the team and has consistently voted against raising interest rates. However, in mid-September 2017, he changed his stance and suggested increasing the rates to 0.25%.
This would be a big industry move, as global interest rates haven’t been adjusted since July 2007. The Bank for International Settlements (BIS) agrees with these sentiments. BIS often described as the Central Bank to Central Banks, and its department head for Monetary and Economic matters is Claudio Borio.
Mr Borio says global debt is rising because rates are lowering, and this creates a dangerous cycle. Since a majority of these debtors can’t keep up, there is the risk of another worldwide financial crisis. He feels raising interest rates is the best way to prevent this, and an increasing number of experts agree with him.
On an individual business level, your debtor may already be stuck in their own debt trap. This makes it harder for you to recover your funds. Boston Commercials have a team of trained professionals, so if you need to hire debt collectors in Sydney, we are the people to call.
- What is a “financial cycle” and how does it affect your business?
- Methods Of Recovering A Debt Part I
- Methods Of Recovering A Debt Part II
- Methods Of Recovering A Debt Part III
- Cash flow management: 5 tips to get your money back
- 5 ways you can avoid bad debt