The idea that the interest charged to a loan should commensurate the risk of the loan, is rather new. It was just 20 years ago that governments around the world began repealing their usury laws, and allowing banks and creditors to charge more than 12 percent interest in their loans. Hence, the interest charged depends on the supply and demand for loans, and not on the ceiling of 12 percent. Hence, loan interests can go lower or higher than 12 percent, depending on the actual supply and demand for credit funds.
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The effect of modern bankruptcy laws under current legislation is to allow banks and other financial institutions to charge interest according to the risk of the loan and not merely according to the supply and demand of credit. The bankruptcy laws have in mind the protection of the rights of both the creditor and the borrower to facilitate the settlement of the loan. However, bankruptcy procedures gave banks and other financial institutions the opportunity to more accurately assess the risk of giving a company or individual loans. They also are able to charge the appropriate interest according to such risk.
Before the bank will approve any loan, the debtor has to submit a project and feasibility study. This will give the bank an idea on how the debtor proposes to pay the loan. While a good project and feasibility study should serve as an appropriate guide on how the debtor can obtain the funds to pay the loan, the actual bankruptcy procedures will give the bank a chance to assess what really went wrong with the submitted project and feasibility study and why the promised expectation of that study did not come through. The job of a bankruptcy attorney is to protect the rights of the debtor according to their rights as defined by the bankruptcy law. With the objective of settling the loan, the creditors could unduly harass a debtor in financial distress who has not hired a bankruptcy lawyer. But the purpose of bankruptcy law is not to give debtors rights at the expense of creditors, but to safeguard both parties' interests so that better relations can develop from their interaction.
As soon as the bankruptcy procedures are over and both parties come into a mutually beneficial agreement, the bank will give a credit rating to the business or individual. A low credit rating means that the business or individual is high risk, while a high credit rating means that the debtor is low risk. A low risk rating is not necessarily disadvantageous to a debtor. It means that banks are willing to extend them loans provided they will agree to a higher interest rate. The job of the bankruptcy attorney is to explain to the client why a low credit rating would be advantageous to him. Many clients prefer a high credit rating because it gives them prestige. But the credit rating of the bank has nothing to do with building prestige. The credit rating of a bank is their assessment of the credit risk of the debtor.
Debt default occurs because of the bad habits of the debtor, or because of the uncertain vagaries of the business situation. If the debtor is adventurous, he is likely to get into a novel venture that entails many risks. If the debtor has bad habits, the higher interest slapped on his loans will be an incentive for him to do something about those habits if he wants to get a lower interest. However, if he does not want to do anything about his bad habits, he can still obtain loans at a much higher interest rate. With a higher interest rate, the adventurous debtor can obtain the funds he needs to finance risky ventures. Hence, the higher interest rate is advantageous to a debtor with bad habits or with an adventurous spirit. It means that loans are available to him when he needs. The exorbitant interest charged by loan sharks is a result of high risk people seeking loans when they need them. By agreeing to the exorbitant interest rate charged by the loan shark, high risk debtors have a steady supply of loans when they need. Banks charge much lower interest rates than loan sharks. But by adopting sound principles of finance, reasonable loans are available to individuals who are in the high-risk category.
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