Default: what it is and how it impacts creditors and debtors
Default in the financial market is the breach of legal obligations and conditions of a loan, and impacts both creditors and debtors.
Financing in banks, financial loans and operations with debt securities are common activities in the financial market, but those who establish these types of agreements must bear the obligation to pay the installments periodically, right?
However, many people end up not being able to fulfill their financial obligations and become defaulters or we can say that Default occurred.
Understand the impacts of default on the relationship between creditors and debtors. Good reading!
What is Default?
The term Default is most used in the financial market when countries are unable to pay their debts, whether external or internal.
However, when an investor acquires government bonds, private bonds or other types of investments , he will have some default risk involved in the debt.
What can be done when a Default occurs?
When a bad debt is issued, it usually means that the lender no longer sees the borrower as a customer, but sees the borrower as a debtor.
When the person fails to settle the payment or fulfill his obligation, it can be said that a Default has occurred.
That is, default means non-compliance with the legal obligations and conditions of a loan.
Imagine that a company does not honor its obligation to pay a fixed income investment such as debentures, for example, this means that the debtor has entered into default .
It is worth considering that, despite the occurrence of default, this does not mean that the country, company or person involved in the debt will no longer pay what it owes.
A financial default usually has devastating consequences for the citizens and companies of the country in question and, in addition to a “crisis of confidence”, can lead to lasting reputational damage.
If countries default on bond payments, this is characterized as a sovereign default – also called a moratorium.
What can be done when a default occurs is that the debt will exist and the payment can be made with interest. But it is also possible that there will be a kind of debt renegotiation – something that can be requested by the debtor party.
However, in the credit market, when a person fails to pay off his financing debt, the financial institution can take the financed asset depending on the clauses of the contract and the defaulted installments.
That is, in case of default of a person who took a loan, the financial institution still has means of recovering the money.
What if a default occurs with a bank?
Suppose a client makes an investment in a financial institution and chooses a CDB, but the bank goes bankrupt, what happens to that investor?
Well, he should know that all financial institutions authorized by the Central Bank to operate in Pak, which issue the Guaranteed Financial Instruments, are obligatorily associated with the Credit Guarantee Fund (FGC) , which guarantees that the client remains protected by the guarantee during the term of your application. This means more security for people and companies to deposit their money in these institutions.
The security of the FCG fund is that it guarantees that it will refund the bank’s customers, in cases of Default, a total amount of up to $250,000.00.
Consequences of Default
When borrowers default, their loans continue to accrue interest. A default will inevitably result in damage to the defaulting debtor’s reputation and may affect its ability to engage in other future business.
The consequences of default can not only affect your ability to borrow, but can also affect your finances.
Debtor
For the debtor there are some consequences of default, such as:
the loss of credibility in the credit market;
the downgrade in your rating (degree of risk);
the increase in interest;
worsening of payment terms offered, both in present and future loans.
Finally, there is the possibility of executing the debt through a judicial process, with attachment of assets, blockade of assets, etc.
Creditor
On the other hand, the effects of default for the creditor are:
total or partial loss by not receiving the capital back;
accrued interest;
negative impact on capital flow;
accounting losses;
loss of credibility with investors and shareholders, in the case of investment funds, etc.
Conclusion
Knowing now what default is, you will be able to make more assertive decisions when choosing a company to invest in, taking into account financial institutions and different market scenarios.
Consider the default risk of a bond issuer before investing your capital. This way you avoid future problems.
It should be noted that no single factor can predict default. As with other investment risks , there may be no way to accurately predict default . But with accurate research and analysis, the risk of default can be managed effectively.
