The definition of default can differ depending on the asset classes, the rules set by the supervisory authority, and the borrower and the borrowing contract terms. Delaying a payment obligation for a few days or filing for bankruptcy may be a breach of one of the terms of the loan contract that leads to a cross-default. In bank loans, for example, bank supervisors typically include loans with payback terms of more than 90 days in the definition of default. Furthermore, the time period in which the default assessment is made is critical as well. Using the one-year probability of default means assessing the default that may occur in the next 12 months. When the cumulative or multi-year likelihood of default is employed, it means that the risk of default in the coming years is considered.
In accordance with Basel standards, the default and probability of default, which banks would consider as risk components when calculating their capital requirements, are defined in the JCR ER methodological infrastructure. Accordingly, the occurrence of at least one of the following situations of a note payable or debt securities acquired for trading is defined as a default in the JCR ER methodological framework;
- JCR ER's conclusion that there isn’t any possibility of the debtors to repay the loan they have taken or the debt instruments they have issued without converting the collateral (if any) into cash,
- Limit excesses are not resolved within 90 days (or within minimum periods to be determined by local audit authorities) from the date the limit is exceeded (not from due date),
- The loan is not paid within 90 (or within periods to be determined by audit authorities) days even though it is overdue,
- The interest for the period has not been paid until the dates agreed by the parties at the latest (For bond/sukuk issuances).
In order to be satisfied that there is no possibility of payment, the following factors will be considered;
- Monitoring of an existing loan debt as a non-performing loan by the creditor,
- Significant decline in credit quality,
- Selling or transferring the loan with significant loss by the creditor,
- The application for foreclosure and loan restructuring, which considers the risk of a financial loss due to the waiver or postponement of some of the principal interest and other add-ons,
- The bank has applied to legal authorities to declare the debtor bankrupt,
- Applying to legal authorities to declare bankruptcy by the debtor himself.
any of these conditions must occur.
In the JCR ER systematic, distinction is not made between credit and debtors. Therefore, retail loans are also included in this definition. The importance of this distinction is based on: If the debtor is unable/cannot pay a certain debt, the definition of default does not require the application of a default on other loans of the debtor in the loans downgraded to the credit level. However, if the definition of default is narrowed to the debtor criterion, all of the borrower's debts are included in the scope of default if a loan is not paid. In the default definition of JCR ER, no such distinction is made.
The probability of default is the probability that the debtor will be unable to pay within a time period. The probability of default in the JCR ER methodology is based on the fact that the debtor's default is triggered when the asset value falls below a certain limit. The probability of default is a directly proportional function of the cash flow arising from the operations of the enterprises and the principal and interest payments included in their financial liabilities. In order to accurately estimate the probability of default, a certain assumption must be made about the loss at the time of default. For each asset category, the process of separating these two risk components is different. For example, in a stock-like asset, if the issuing company defaults, its share value will fall to zero, so it can be said that the default risk arises only from the probability of default, and no recovery is expected at the time of default. Decomposition of the default risk for assets in the form of corporate bonds, on the other hand, is quite simple. In this context, companies that can generate higher cash flows from their operations compared to their financial liabilities have a lower probability of default than companies that have lower cash flows. As a result, corporations with assets that can generate a high degree of cash flow have a lower default risk than those that cannot. More stable cash flow leads to lower probability of default and lower default risk premium. Companies operating in sectors that are more stable and meet expectations have a lower default risk premium than companies operating in a volatile sector.
As a result; the probability of default is JCR ER's numerical and percentage judgment of whether the borrowers will pay the principal and interest amounts of the loans they have received or plan to take, as well as the debt instruments they have issued or plan to issue, within the specified maturities.