What is credit risk?

Credit risk refers to the risk of loss that arises from a borrower's failure to repay a loan or meet contractual obligations. In the context of finance, it specifically pertains to the potential for a lender to suffer losses as a result of a borrower's inability to fulfill their repayment obligations. This risk is crucial for financial institutions and lenders because it directly impacts their profitability and financial health.

When assessing credit risk, lenders evaluate the borrower's creditworthiness, including their financial history, repayment capacity, and the likelihood of default. High credit risk may lead to higher interest rates to compensate for the anticipated potential losses, while low credit risk could result in more favorable loan terms.

Options referring to fluctuating interest rates, inflation impacts, and currency exchange losses focus on different financial risks that are important in their own right, but they do not encapsulate the essence of credit risk. These factors may influence a lender's considerations but are separate from the fundamental issue of whether a borrower will honor their debt obligations. Thus, the definition surrounding the risk of loss due to a borrower's default accurately captures the concept of credit risk.