What is credit risk?

Credit risk specifically refers to the possibility that a borrower will be unable to meet their financial obligations, particularly in repaying loans or making timely interest payments. This type of risk is crucial for lenders, investors, and financial institutions as it directly affects their potential returns. When a borrower defaults, the lender may incur losses, which underscores the importance of assessing creditworthiness before extending credit.

While market fluctuations, legislative changes, and general investment losses pertain to various financial risks, they do not encompass the specific nature of credit risk, which is rooted in the borrower's capacity and willingness to fulfill their debts. Understanding credit risk is vital for managing a portfolio, ensuring that investments are made in borrowers who have a reasonable likelihood of repaying their obligations.