What exactly is debt restructuring? It’s commonly defined as a process by which the terms of a financial commitment -usually the maturities and interest rates- are modified. We’ll take a closer look at the terms.

1. B Y S U Z Z A N N E U H L A N D
WHAT IS DEBT RESTRUCTURING
AND WHY IS IT IMPORTANT?

2. WHAT IS DEBT RESTRUCTURING AND
WHY IS IT IMPORTANT?
What exactly is debt restructuring? It’s commonly defined as a process by
which the terms of a financial commitment -usually the maturities and interest
rates- are modified. We’ll take a closer look at the terms later on.
When a person, company or country has difficulties or is unable to meet the
commitments as agreed, they can try to restructure their debt. The debt can be
restructured by mutual agreement between the debtor and the creditor. In
this case, the debt restructuring is a renegotiation. In case of financial difficulties
of the debtor, the creditor has an interest in agreeing on a debt restructuring to
avoid default or bankruptcy of the debtor.
In other cases, for example, if interest rates decrease, the debtor can get a
new loan -at a lower rate- to cancel the original debt -at a higher rate-, thus the
debtor benefits from the low interest rates. The new debt may be owed to the
original lender or a new lender. You can also change the deadline by extending it.

3. WHAT HAPPENS WITH COUNTRIES?
Some countries with large dollar debts changed their debts in order for
them to be in their local currency, transferring the currency risk to
creditors. To place local currency debt, government entities had to
accept interest rates that were higher than the equivalent in foreign
currency.
It has also happened that in cases of default or large possibilities of
default, creditors agree to a debt reduction of capital or a substantial
reduction in the agreed interest rate. It is usual that countries conduct a
public offering, with reductions of capital or a lower interest rate. As the
creditors are many, some may accept the offer, while others may not
conform to it. Those who do not accept the initial offer can expect a new
offer, using national or international courts, or sell their debt to funds that
are responsible for buying the debt in default and try to get a return on it.
These funds are usually called vulture funds. The international financial
system doesn’t have a solid, stable legal framework over time for
restructuring sovereign debt, so the procedures are not really established
and they may vary for each individual case.

4. WHAT HAPPENS WITH COUNTRIES?
Financial institutions such as the International Monetary Fund were
instrumental in restructuring the debt of many Latin American
countries, especially in the second half of the 1990s and early 2000s.
These entities, which had acted as lenders of last resort in large
international crises (Mexico, Russia, Brazil) became creditors, imposing
conditions on debtor countries.
The conditions generally related
to limits on fiscal deficits and
printing money. When it came to
sovereign debt refinancing, the
IMF imposed new conditions.
Image courtesy of Simon Cunningham at
Flickr.com

5. THE CASE OF BUSINESSES
Regarding companies, in many cases, for creditors, debt
restructuring is a less expensive alternative than bankruptcy.
In addition to the cases mentioned above -modification of
terms, interest rates, and so on- companies can offer shares
in exchange for part of the debt. Companies may have
acquired debts with financial institutions, with the
government and with suppliers.

6. REGARDING INDIVIDUALS
In addition to companies and states, in some cases, people can also
restructure their debts. In some cases, financial institutions prefer to
restructure the debt of a creditor rather than face a situation of default of
payments and then have to auction the collateral properties.
In other situations, such as
an economic crisis, banks
face a situation of high
proportion of bad debt in
their portfolios.
Image courtesy of Chris Potter at
Flickr.com

7. RESTRUCTURING CREDIT CARD DEBTS
A widely used instrument for personal financing are credit cards. There are cases in
which the banks that issued credit cards offer plans in which they refinance the debt
with longer maturities. In special cases, you can cancel the penalty interest for non-
payment.
Terms of a debt
The most important terms of a debt are:
• Total amount due
• Interest rate: in addition to the value itself, it can be a fixed or variable rate. If it’s
variable, it can be adjusted by an inflation index, or by other interest rates.
• Depreciation method -the French, the German, and so on-
• Frequency of payments -monthly, semi-annual, annual, and so on-
• Base currency: a debt may be expressed in local currency, dollars, euros, and
others.
• Other clauses: these usually define what happens in the case of defaults, life
insurance, which courts would intervene in case of legal disputes, and so on.

8. OTHER IMPORTANT CONCEPTS TO KEEP
IN MIND
Financial institutions are not required to agree to renegotiate a debt and if
this is not achieved, this will cause call and collect of interests, and other
fees that have been suspended will be charged.
As with default interests, collection costs are incurred when you fail to
comply with the obligation acquired with a financial institution. They are
generated when the bank hires a collection firm to remind you of the
commitment you have with the financial institution.