Willful default

From CEOpedia | Management online

Willful default - takes place when a party to a contract or a court case intensionally fails to do something what was required under obligation. The word willful means that the person failed on purpose and the word default means transgression. Willful default is described as a major reason for rising overdues (M. J. Nelson 2011, p. 22).

Willful default: trusts and loans

This term is used in a trust instrument and means intensional transgression. For example: one party does not repay the loan by designing a failure on purpose. The borrower might have the available funds in some other form of assest but is not making a payment.

The Reserve Bank of India defines willful default as not meeting the payment commitment if any of following conditions apply:

  • the party had ability to meet the required obligations,
  • the borrower did not use the finances for the purpose lent but has switched to some other purposes,
  • the party has pump off the funds - neither utilized for the agreed purpose nor are funds available in the form of other assets,
  • it had disposed of or cleared away the movable fixed assets or immovable property given by it for the reason of securing a term loan (L. Karthik 2018, p. 18).

Unfortunately in most cases of debt contracts we are facing a problem with asymmetric information between the borrower and the lender which might be the main reason to the continual issue of loan default. In this context the problem might grow for two reasons. First, it might grow because the borrowers taking out loans from the lender usually have better knowledge than the lender about potential risk and return from investment that the borrower is going to undertake. The lenders are facing lack of information regarding the activity of the borrower, it is difficult to monitor what has been done with the loan. Second, if the information about the cash flow which was generated from the investment is private and known only by borrower, then default might rise as well (S. Bardhan 2013, p. 101).

Developing vs. developed countries

The trouble with nonperforming loans is much more serious in the developing countries than in developed ones. Since the banks are depending less on the juridical system than the financial markets, it is disputed that they do better when the legal system is weak. A stable regulation of banks might be a solution for the problems of banking system of the developing countries. It is not possible to verify and check the data of the actual cash flow in developing country as the auditing is very expensive so accordingly irregular and punishment fall behind because of inefficient legal system.

Compering to developed countries, developing ones possess poor credit culture of banks and much less information about credit worthiness of the borrowers what brings to inefficient credit allocation and underreporting of nonperforming Loans. Sharing information on willful defaulters between the banks is also at a very beginning stage in most of the developing countries what is mainly caused by their technological backwardness. A stronger regulation of banks might be a solution for banking system of the developing countries. Countries with the strongest regulatory environment in the banking system are United Kingdom, The United States of America, Switzerland, Canada, Australia, Hong Kong, China and Singapor and the weakest ones are Indonesia, Pakistan, India, Sri Lanka and Russia (S. Bardhan 2013, p. 107-108).


Willful default — recommended articles
Foreign national mortgage — Friendly loan — Mudaraba — Credit Facility — Cross Default — Liquidity risk — Direct paper — Sovereign guarantee — Cleared funds

References

Author: Sylwia Kotysz

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