By Lisa Lambert

WASHINGTON (Reuters) - The U.S. watchdog for consumer finances unveiled on Thursday a proposal to toughen regulation of the multibillion-dollar debt collection industry, with a focus on keeping agencies from pushing people to pay debts they do not owe, informing borrowers of their rights and cutting down on calls to debtors.

Both the industry and consumer advocates expressed disappointment with the proposal. The business side worried about the costs of complying with the suggested requirements, which they warned could be passed on to borrowers or force some of the thousands of small collection firms to shutter. Those pushing for consumer rights said the proposal left major holes in borrower protections and did not go far enough.

"Today we are considering proposals that would drastically overhaul the debt collection market," said Consumer Financial Protection Bureau Director Richard Cordray in a statement. "This is about bringing better accuracy and accountability to a market that desperately needs it."

The proposal covers third-party collectors and debt-buyers. The CFPB will address first-party collectors and creditors, such as banks with their own collection departments, in the future.

According to a summary, the proposal would ensure collectors "substantiate the debt before contacting consumers," by confirming their identities and the amount owed, as well as checking for any payments made after a default. Consumers frequently file complaints at the agency about receiving calls for debts that do not exist.

In an attempt to "limit excessive contact," the proposal would cap agencies' calls to debtors to six attempts each week. It would also create a 30-day waiting period after a person dies for contacting survivors.

Agencies would have to communicate specific information to consumers, such as when outstanding debt is too old for a lawsuit. They would also have to make it easier to dispute or pay a debt through tear-off coupons on the bottoms of collection notices.

A federal law, the Fair Debt Collection Practices Act, already prohibits collectors from using abusive, unfair or deceptive practices to recoup money.

The industry has awaited the overhaul proposal since 2013 and CFPB had penalized a number of large debt collectors in recent years. The CFPB receives thousands of complaints each month about debt collection, more than any other area.

"If you look at their analysis, they are stating that everything has either a low or moderate cost to market participants. They’ve done this in the past and I suspect the costs to market participants are going to be significant," said John Redding, partner at BuckleySandler, a firm specializing in financial services law.

He added that new requirements on collecting and sharing information would lead to, at minimum, expensive modifications to the technology firms use to track debts.

The proposal could encourage consumers to dispute all debts, even those rightly owed, said Walter Zalenski, also a partner at BuckleySandler. That could lead to more borrowers manufacturing disputes that have no legitimate basis, he said.

Roughly 13 percent of consumers have a debt in third-party collection, with an average amount of $1,300, data from the Federal Reserve Bank of New York shows.

Ira Rheingold, executive director of the National Association of Consumer Advocates, disputed the notion that the proposal will encourage borrowers to game the system.

"I wish consumers were that sophisticated. The problem we have today is they don’t dispute," he said. "People wind up getting default judgments against them all the time."

"Lots of people are being harassed and paying back debts they do not owe or are not responsible for any more legally," he added.

For Rheingold, the proposal should ban collectors outright from going after debts that have passed the statute of limitations and impose stricter limits on the number of calls each week. He said the CFPB could also have reformulated the penalties for violating the Fair Debt Collection Practices law to impose steeper costs for bad behavior.

In a survey released alongside its proposal, the CFPB found more than three-quarters of the country's 3,994 debt collection firms are small, with fewer than 100 employees. Larger firms pull in about two-thirds of the industry's $12.18 billion total revenue.

The agency also found credit card, student loan and automobile debts in collection typically have balances of $2,000 or more.

The proposal now goes to a panel of small business owners for review.

(Reporting by Lisa Lambert; Editing by G Crosse and Meredith Mazzilli)