What defines credit risk?

Credit risk is defined specifically as the chance of a debtor failing to make payments as agreed. This notion encapsulates the financial assessment of an individual or organization that has borrowed money or agreed to pay for goods and services over time. When lenders or investors extend credit, they take on the risk that the borrower may default, which means failing to meet their contractual obligations to repay the principal amount or make interest payments.

Understanding credit risk is crucial for financial institutions and investors as it influences the interest rates they set, the amount of credit they extend, and the management of their portfolios. The evaluation of a borrower's creditworthiness, often through credit scoring and analysis of financial history, helps mitigate this risk and informs lending decisions. As such, proper assessment and management of credit risk are fundamental in maintaining financial stability and profitability for lenders.