Page 43 - Azerbaijan State University of Economics

S.A.Najafov: Debt rigidity crisis

debts and debt services in future, and selling assets lowers the equity of a unit that

decreases their future incomes.

Note that the cyclicity of economy are due to the law of diminishing returns

that is a fundamental principle of economics, according to which as total investment

increases, the total return on investment as a proportion of the total investment (the

average product or return) decrease.

Thus, debt crises are due to the cyclical nature of economic development and

are caused by downward debt rigidity: though business incomes are cyclical and

decreases in the phase of the economic downturn, debts of companies on the

downward phase of the economy doesn‘t decline, and even increase because of the

interest rates that restricts the ability of debtors to fulfill debt obligations.

Debt crisis may be triggered by asset prices collapse too. In case individual's

assets (capital or financial assets) are financed through debt, debtors‘ ability to fulfill

debt depends not only on debtors‘ income, but on asset price too. So in case asset

prices collapse value of assets is not sufficient to fulfill debt and debtors face loan

default. Thus, debt crisis is triggered not only by decrease in debtors‘ income (as

Minsky said) but by asset price collapse too.

To make real sector resistant to shocks, companies‘ liabilities similarly to

income and assets price also should be flexible. Liability flexibility may be provided

by profit/loss sharing financing. As a result of flexibility of liabilities, companies and

real sector in whole will be more flexible and respond to economic shocks better.

Profit participating financing will strengthen stability of banks too as money attracted

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