Technical default - is it the end or just a stimulus to change the economic course?

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:55

In finance, default is the inability of an entity to meet its obligations. Since it is bad both for the borrower and for the lender, they try to prevent it in every possible way. A technical default is what, for example, happened in the summer in Greece. Its main difference from the usual one is the hope for a happy outcome in the future. If we say what a technical default is, in simple terms, then it is a situation where the borrower, although he cannot respond to his obligations in a timely manner, but intends to do so in some future. But there are many nuances, which will be discussed in this article.

General information

Default is the inability to repay borrowed money to the lender on time or continue to pay interest regularly. For example, a person took a house on a mortgage, and it turned out to be an unbearable burden. Suppose he declares a technical default. What is it in simple words? When this person, realizing the unbearability of his burden at this particular point in time, asks for a deferment from the bank that provided the loan for the house. A similar situation can occur with any commercial organization or government. Default means they can no longer meet their obligations. For example, they cannot pay for bonds issued at one time to increase capital. A technical default is a temporary situation that only threatens to turn into a catastrophe. It often comes against the will of the borrower. But both sides are still hoping for a favorable resolution.

Default types

The most notorious recent bankruptcy is that of Lehman Brothers. This company's private default was due to its inability to repay US$600 billion to its creditors. Another famous case occurred in Greece. The sovereign default in this country occurred in March 2012. The amount of debt at that time was 138 billion US dollars. In the summer of 2015, a technical default was declared. This means that Greece was not able to cope with the economic situation in the country and demanded that the IMF write off part of its financial obligations.

Distinctions of insolvency

Before moving on to the story of what a technicaldefault, in simple terms, you need to understand the terminology. It is important to understand the difference between the two states - insolvency and bankruptcy. Default essentially means a situation where the borrower has not repaid the loan when it should have done so. It has two main types: technical and normal. We will talk about a number of forms that it can take next. Insolvency and bankruptcy are legal terms. The first means that the borrower is in a situation where he will not be able to meet his obligations.

Peculiarities of bankruptcy

Insolvency precedes default. The situation is already being recognized, but the negative outcome has not yet arrived. A technical default is a more joyful option, when the possibility of paying off the debt is still being considered, but postponed to the future. In this case, the borrower and the lender have some prerequisites to believe that the economic condition of the former has good chances to improve. And finally, bankruptcy. It's also a legal term. It means that there are legal grounds for establishing judicial supervision over the financial affairs of an insolvent entity.

Technical default: what is it in simple words?

We've got the basic terminology out of the way, now it's time for the real subject of our article. There are two types of default: debt service and technical. The first, as we have already found out, comes at the moment when the borrower cannot make the planned payment due to his own financialproblems. A technical default means that a clause of the agreement has been violated. Affirmative commitments require a firm to maintain a certain level of capital or financial performance. The most common are violations of the terms of the share of retained earnings, short-term liquidity and debt service. Negative liabilities are terms in contracts that restrict or prohibit a firm from doing certain things (for example, selling an asset, paying dividends). Most agreements include a clause that default on any other debt automatically leads to default on all others.

Consequences of a technical default

As we have already found out, insolvency and bankruptcy are links in the same chain. But what threatens a technical default? After all, it seems that the country has a real chance to get out of the current economic situation. But rumors about a possible real default are starting to harm the whole indicator. First of all, the investment climate is deteriorating. And this leads to a decrease in all kinds of ratings, which entrepreneurs with free financial resources pay attention to. This is followed by a collapse in the financial and currency markets. And who can trust a state that is almost bankrupt? Therefore, so often a technical default develops into an ordinary sovereign one. But unlike the latter, there are still hopes for the recovery of the economy. If external creditors agree to write off part of the debt, restructure and defer the remaining part of the debt, then thiscan help the whole world to start trusting the state again. But a happy future still depends on the competent economic policy of the national government.