Reasons for Credit Risk & Default

Why does a company stop paying its debts? It is rarely a sudden event. It is usually a process driven by specific factors.

1. Insolvency (Asset-Liability Mismatch)

This is the fundamental reason.

• Condition: Assets < Liabilities.
• The company owes more than it owns. Even if it sells everything, it cannot pay back creditors.

2. Illiquidity (Cash Flow Mismatch)

A company might be Solvent (Assets > Liabilities) but still default because it has no Cash.

• Condition: Current Liabilities > Current Assets.
• Example: A Real Estate developer owns land worth 100 Crores but has 0 cash to pay a 1 Crore interest payment due today.

3. Macroeconomic Factors

• Recession: Sales drop, profits vanish.
• Interest Rates: If rates rise, floating-rate debt becomes more expensive to service.
• Exchange Rates: If a company borrows in Dollars but earns in Rupees, a falling Rupee increases their debt burden.

4. Industry-Specific Factors

• Technological Disruption: Kodak filed for bankruptcy because digital cameras destroyed their film business.
• Regulatory Changes: A ban on diesel engines could bankrupt a diesel engine manufacturer.

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