Default Management
Last updated
Last updated
The definition of defaulted debt within the context of mutual credit, and specifically within the context of the ReSource Stable Credit protocol, differs considerably from how this term is normally defined in traditional lending scenarios.
In traditional finance, the extension of credit entails the allocation of preexisting capital to a borrower who is obligated to return it, in addition to interest, within a given timeframe. "Default" is defined as a failure to meet this obligation.
Within the context of mutual credit however, "credit" is the ability to participate in reciprocal trade with a privilege granted to receive goods and services against a promise to provide equally valued goods and services in the future. While technically still "credit", liquidity provided this way is not sourced from a creditor's investment that needs to be returned at a given point in time in addition to an ROI that would justify such an investment.
As a result, the term "default" in mutual credit refers to a situation in which a member, over time, fails to participate in mutual exchange in a fashion that provides comparable value to both the member and the network at large. In other words, a defaulting member is one whose activity within the network is extractive, rather than additive.
Following this definition, members are not obligated to return a "loan" at a given point in time in order to be in good standing. Rather, they are obligated to demonstrate that, on average, their income is in healthy proportion to their expenditures, meaning that their offerings are demanded by their peers.
As long as a member can demonstrate that they're willing and able to accept Stable Credits as a means of payment for goods and services, they are considered to be in good standing, even if they spend most of their time with a negative balance.
To determine whether or not a member is in good standing, the ReSource Stable Credit protocol relies on the following rules:
The Equilibrium Rule The equilibrium rule requires members to rebalance their account to 0 (or above), once in every credit period (normally 90 days). Within a given credit period, members may utilize their credit line as they see fit, and spend as much time with a negative balance as they require. There is no obligation to "hit zero" at a specific moment in time, or for a specific period. As long as a member's account has been rebalanced at least once during this period, they are considered to be in good standing.
The Income to Debt Ratio (ITD) Rule Members who have not complied with the equilibrium rule may still be in good standing, as long as the average credits received in proportion to their balance at the end of a given credit period is deemed "healthy". " While still in good standing, members who have complied with the ITD rule without having complied with the Equilibrium rule, may see their credit limit contract to proportions that better fit their demonstrated capacity to participate in reciprocal trade.
Members in non-compliance with both rules will be flagged by the system as candidates for default. If after an additional grace period (defined by the network operator) they were unable or unwilling to move their trade balance into acceptable margins, their account will be closed and written off to the Network Debt Account.
Conversely, members who finish a given credit period with a positive closing balance may see their credit limit expand if they demonstrated a full utilization of their credit line during the period.
This design automatically adjust credit lines over time to provide the maximum amount of liquidity to the network, while reducing possible defaults to an absolute minimum. The chart below details the logic driving this mechanism.
