Why Are Banks and Creditors Willing to Take Less Money When Settling Debts?

Why Are Banks and Creditors Willing to Take Less Money When Settling?

When you work in an industry for a long enough time it really makes you consider why things function as they do instead of the alternative. At The Debt Relief Company, one of the questions we often get asked is why are creditors open to negotiations in the first place and why don’t they just say “no” to negotiations. They are technically owed the full amount of money? They don’t actually need to accept a lower amount? Well it’s a good a question. But the answer is a little more complicated than you might think.

It has a lot to do with the nature of the banking industry and how credit card companies write off losses. When consumers default on a loan, banks have a few options. They can either more aggressively pursue collections on the debt that is owed via litigation, they can either take a more passive route and write it off as a loss with the hopes that the consumers eventually pay it off or they can sell it to a collection company in hopes that they can collect the amount owed on their behalf. Sometimes they utilize all three approaches! Additionally, some collection companies buy the debt while some service it on behalf of the creditor and work under their guidelines. Likewise, some law firms buy the debt outright and others service it on behalf of the original creditor acting as a 3rd party liaison. The options at their disposal can get more complex than that and they can actually pursue a combination of all three of these options. Nothing technically prevents a creditor or debt collector from becoming very lax or very aggressive with regards to collection activity. At the end of the day, it’s up to whoever is the debt owner on how they want to collect.

In regards to legal action, some law firms tend to litigate aggressively while some debt collection companies use a more passive approach. They buy bulk accounts for cheap with the rationale that even if only a few accounts are paid and made whole, they’ll recuperate more than they their invested on the accounts and generate profit. For the most part these are the two industry associated norms. You can either create a partnership with a creditor where you service debt accounts on their behalf and don’t take on any of the risk associated with owning debt or you could directly buy and own accounts in the hopes that you can profit from buying wholesale debts for pennies on the dollar.

However, this still doesn’t answer our question. Why do banks allow debts to be settled in the first place? Well Banks and lenders make a lot of money on lent out deposit. They are in the business of giving out money to receive more money in return, it’s a pretty sweet gig to say the least. Banks profit enough that they expect to not be made whole on a set number of accounts with a negligible impact to their bottom line. It’s accounted for in advance, so they allow for many debts to go unpaid. One bad apple does not always ruin the bunch and Banks undergo numerous stress tests to prepare for a scenario in which many borrowers are not making good on their debts and other types of systemic failure. It’s just the nature of our current economic system and the fractional reserve banking system.

Under a fractional reserve banking system banks have a lot of leverage to lend out funds to consumers. Banks are only required to hold approximately 10 to 1 in reserves for all deposits they receive (the exact process is actually more complicated than this but we’ll generalize for simplification purposes). So, for every $100 you deposit into the bank, lenders can dish out $90 of that deposit with no need to hold more than $10 in reserves. Due to this, the impact of earning interest on all those deposits can truly be profound in generating profits.

Why else? Well one of the main reasons a bank will negotiate on a debt and settle is that when collection activities fail, they won’t have much other recourse to pursue the amount owed. Other than litigating on the account and taking the tax loss off on their books there aren’t many options available to them except to forego payment and take the loss. Creditors are unlikely to litigate on every account that goes unpaid since that just simply doesn’t make economic to do so. So, they opt to instead pick and choose what account to be more or less aggressive with. Any other accounts in between wind up either being unpaid or getting settled. Anytime an account that would have otherwise went unpaid gets settled the creditor is coming out on top. This is one of the main reasons choose to settle debts their owed.

It’s better to receive something instead of nothing…