What does Credit Risk refer to in the context of finance?

Credit risk specifically pertains to the potential that a borrower will fail to meet their financial obligations as outlined in a loan or credit agreement. This manifests as the possibility that the borrower may default on their payments, which can impact lenders and investors who have extended credit. Assessing this risk involves analyzing the borrower's creditworthiness, which includes their credit history, income, financial stability, and overall ability to repay debts.

In finance, understanding credit risk is crucial for lenders who want to minimize their losses and ensure profitability. Satisfactory credit risk assessment helps financial institutions determine interest rates and lending terms, as higher perceived risk typically results in higher interest rates to compensate for potential defaults. This nuanced understanding of how borrowers manage debt obligations is central to risk management in lending and investment strategies.