What does credit risk refer to?

Credit risk specifically refers to the potential for loss due to a borrower's inability to meet their financial obligations. This can happen when an individual or an entity defaults on a loan or a financial obligation, leading to a loss for the lender or investor. Assessing credit risk involves evaluating the creditworthiness of borrowers, which typically includes analyzing their credit history, financial statements, and overall ability to repay debt.

Understanding this risk is crucial for lenders and investors as it directly impacts their financial performance and stability. Effective credit risk management practices can help to minimize the potential losses by allowing institutions to make informed lending decisions, set appropriate interest rates, and create adequate reserves to cover potential defaults.

In relation to the other options, asset depreciation, external market changes, and liquidity risks pertain to different aspects of financial risk but do not directly address the concept of credit risk and its specific implications.