Addressing the Phenomenon of Default: How Banks can Protect Against Default on Credit under Conventional Banking and Islamic Principles

The problem of bad debts leading to default is widespread and not limited to a single country. Failure of a business to repay its creditors may produce a chain reaction of large-scale defaults that can ultimately affect an entire country’s banking system. This, in turn, has the potential to spill over to other countries causing a global economic crisis. In order to develop better mechanisms that counter default on credit, there is a need to develop a common understanding of what generally leads to such default. However, there are significant complexities attached to the phenomenon of default due to different manifestations of default and its relationship with other related concepts as well as in terms of the possible classifications of default. These complexities create uncertainties regarding the process of measuring creditworthiness of clients as well as the legal bases to classify default, which consequently affect the performance of banks. Placing the existing banking guidelines in the context of conventional and Islamic principles, this article analyses different ways to establish an integrated mechanism to understand, detect, and prevent default in all its possible forms. The creation of various processes and systems proposed in this article offer the possibility for detection of credit default before it occurs and possible counter-measures during various stages of default to ensure financial safety and solvency of both banks and their clients.