What is a default?
Default is...
Default (default) is a borrower's failure to make payments to the lender, including the inability to make deposits to repay the debt, the stipulated interest, and to meet other loan terms. Simply put, this is a situation where there is no money to repay the debt or the borrower is bankrupt.
What is the essence of the default?
In the global financial practice and in almost every state there is the concept of lending. A needy country, company, person is provided with financial assistance in the form of a loan from, respectively, other states, international organizations, commercial banks, etc.
Naturally, the loan is not given for free, it must be repaid. That is, the borrower assumes an obligation to the lender to return a certain amount of money within a clearly defined time frame. The borrower's refusal or inability to fulfill these financial obligations is commonly referred to as a default.
The concept of default can be used as a synonym for the term "bankruptcy," referring to the inability to pay debts.
Default can be declared within the state, when the state cannot return money borrowed from citizens and at the international level, when the state cannot return within a specified period of time previously granted loans.
What are the causes of default?
The main causes of default are:
- Wrong economic strategies;
- Illiterate financial management;
- Radical reforms and changes adopted by state authorities;
- The rejection of previous debt obligations by the state's new authorities;
- Unbalanced budget of the company or the state;
- An economic or political crisis;
- Unforeseen circumstances.
What kinds of defaults are there?
It is customary to distinguish two types of default:
- Simple default;
- Technical default.
What is a simple default?
Simple default or bankruptcy is the officially recognized inability of a borrower to meet financial obligations to a lender due to lack of money.
If a company or commercial bank declares simple default (bankruptcy), a temporary administration (crisis management) is introduced, which takes over the function of making further decisions on the company's bankruptcy procedure, such as establishing the procedure for selling the available assets.
If the default is declared by the state, the problem is solved at the international level with the involvement of other states and financial institutions (IMF etc.).
In turn, a simple default can be sovereign and cross-default.
Sovereign default
- Sovereign default is the state's inability to fulfill both foreign and domestic debt obligations.
Cross-default
- Cross-default implies the spreading of the default on one obligation to other financial obligations.
What is a technical default?
A technical default, also called a temporary default, refers to any breach of loan agreement clauses when it is physically possible for the lender to comply with them to a certain extent.
What's wrong with default?
- Reputational losses
When a default is declared, it inevitably decreases credit rating state (company). Reputational losses make it much more difficult to obtain further financial assistance. The loan will not be denied to the state, but it will be given on much tougher conditions, as the creditors will take into account the high risks of lending to the country that has defaulted.
- Devaluation of national currency
The inevitable consequence of a default is devaluation - The decline in the exchange rate of the national currency, which is accompanied by a sharp increase in inflation. The purchasing power of the population and the standard of living decline sharply. The fall in the real income of citizens is directly proportional to the state's dependence on imports.
- Growth of foreign and domestic debt
The default of the national economy leads to an increase in external debt - the state needs money to cover expenses, and internal debt - the state does not have enough money for social and other expenses (delays in wages, social payments, etc.).
- Partial or complete shutdown of production
A default entails a complete or partial stoppage of production. The fall of the national currency makes domestic production unprofitable, since most production facilities depend on imported supplies of technology, equipment, raw materials and energy. In turn, the stoppage of production leads to an increase in unemployment.
- Violation of the stability of the banking system
Due to the default, foreign companies leave the domestic market, withdrawing their capital from the country. Commercial banks lose the ability to obtain financing in foreign markets, deposits in the national currency depreciate, and the volume of deposits and withdrawals grows sharply, leading to the withdrawal of banking services and the freezing of accounts of individuals and companies. Money turnover drops to a critical minimum.
- Deterioration of the external and internal political situation
The defaulted state's relations with foreign partners are deteriorating. The lack of necessary financial resources seriously reduces the country's influence on the global political arena.
Within the state, the discontent of the population is growing. A crisis of power can lead to protests and a violent seizure of power or civil war.
What good is a default?
- Redirecting finances to solve internal problems
By foregoing external payments, the state redirects financial flows to solve domestic problems.
- Growing competitiveness and domestic production
Due to the devaluation of the national currency and the rising cost of imports, enterprises are forced to seek resources inside the country. Previously unclaimed production capacities are being restored, and domestic goods occupy market shares that were previously occupied by imported goods. Under the conditions of fierce domestic competition, only the most sought-after enterprises and companies remain in the domestic market.
- Reforming the state economy
By reducing imports, the authorities are able to carry out economic reforms designed to stabilize the national economy by attracting domestic resources.
- Assignments of creditors
Sometimes, when a state officially declares default, creditors go for a reduction in interest, partial or complete cancellation of debts.