What is a default and what does it threaten?

The word default causes panic in every investor and ordinary citizen who remembers how the previous crises in the CIS countries affected the realities of life. What is there to be afraid of? Let's try to understand the terminology and understand what a default is.

Default is the inability to fulfill debt obligations to an individual and a legal entity or the state on promissory notes, bonds, mortgages, loans and checks, interest and commissions, within the period established by the agreement. The result of a default is the recognition of one of the parties to the agreement as bankrupt.

Default is often confused with bankruptcy, making a gross mistake. Bankruptcy is one of the consequences of default.

Preconditions for default

Default is rarely considered without reference to devaluation and denomination, since 1998 and subsequent crises in the CIS countries included a whole bunch of economic and financial problems. What factors are related to default and precede it:

• carrying out destructive steps in financial policy;
• external factors (collapse of the stock market, sanctions, bankruptcy of key market players, etc.);
• a protracted crisis in the economy and politics;
• large contributions to the social sphere to maintain loyalty to existing policies;
• investment in selected areas and industries;
• devaluation of the national currency;
• rising inflation;
• the distribution of the budget is irregular or unbalanced;
• decrease in income;
• collateral instruments of low credit quality;
• a sharp increase in costs;
• inflated expectations of potential returns, etc.

If we talk about special cases, the prerequisites for the default of the enterprise are:

• regular delay in salaries;
• poor organization of management processes;
• ill-conceived redistribution of the company's capital and rising costs;
• risky business transactions.

What default threatens the state, citizens, companies

The default of the state leads to a rapid increase in unemployment and non-payment of wages to state employees, an even greater depreciation of the national currency and inflation. In addition to economic problems, the state suffers reputational long-term losses:

• confidence on the part of international investment companies and financial structures is falling;
• the rating of the state in the stock and credit markets is falling.

For companies, default threatens with bankruptcy, wage arrears, recognition of the insolvency of the enterprise and the complete cessation of activities. As a result, there is a full or partial sale of tangible assets to cover debts to creditors.

For an individual, default threatens to be denied a loan or loan of funds. Issues related to debts are decided by law, taking into account the interests of two parties: the borrower and the lender. If real estate or any other property acts as a loan collateral, then the result of the trial will be confiscation to pay off the debt. Lack of funds to pay the debt makes an individual officially bankrupt and insolvent.

If an individual knows about possible problems in the future with payments, you should not wait for a magical resolution of the situation and a miracle, you need to contact the lender and discuss the option of providing a loan holiday or deferment.

Technical default

A technical default occurs when a borrower of funds admits that they cannot make payments right now and undertakes to repay the debt and interest in the future.

From the point of view of the lending agreement between the parties, we are talking about a violation of one clause and default in this case is not a reason for bankruptcy or insolvency.

For a better understanding of the situation, it is worth remembering 1998, in Russia during this period there was a technical default, devaluation and denomination were the result of a series of economic and political miscalculations. The country was unable to pay interest on government short-term bonds (now similar to OFZ). The crises of 2008, 2014 and 2020 are associated with the devaluation or depreciation of the national currency. Most likely, 2022 will soon appear on this list.

Summing up

A default is an economically devastating event for a company and a country, which can lead to a severe crisis or give impetus to development and a total reboot of the system.

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Paul Roberts

Paul Roberts 51 years old Born in Edinburgh. Married. Studied at University of Oxford, Department of Public Policy and Social Work. Graduated in 1997. Works at Standard Life Aberdeen plc.

• finance

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