Credit Risk
The probability that a borrower or counterparty will fail to meet its financial obligations.
What is Credit Risk?
Credit risk is the risk of financial loss arising from a borrower's or counterparty's failure to repay a loan or meet contractual obligations. It is the oldest and most fundamental risk in banking and lending. Credit risk encompasses default risk (the borrower will not repay), credit migration risk (the borrower's creditworthiness deteriorates), and recovery risk (the amount recovered after default is less than expected). Lenders manage credit risk through credit analysis, diversification of loan portfolios, loan covenants, collateral requirements, and credit derivatives such as credit default swaps. Credit rating agencies (Moody's, S&P, Fitch) assess and communicate credit risk for bonds and other instruments.
Example
Silicon Valley Bank (SVB) failed in March 2023 partly due to concentration risk — the bank held a large portfolio of long-duration government bonds that fell in value as interest rates rose. Combined with a concentrated depositor base in the tech sector, this interest rate and liquidity risk triggered a bank run and regulatory seizure. SVB's failure illustrates how credit and liquidity risks interact in practice.