what is credit risk

Credit risk refers to the possibility of losing money when a borrower fails to repay a loan, resulting in a financial loss for the lender. Credit risk can arise from a borrowers inability to make required payments, which can lead to lost principal and interest, disruption to cash flows, and increased collection costs. Credit risk can be mitigated by analyzing factors about a borrowers creditworthiness, such as their current debt load and income. Lenders use proprietary risk rating tools to measure credit risk, which differ by firm or jurisdiction and are based on whether the debtor is a personal or a business borrower. Credit risk management is a multi-step process that involves assessing and managing credit risk to lessen the severity of a loss. Interest payments from the borrower or issuer of a debt obligation are a lenders or investors reward for assuming credit risk.