What is credit risk?

Credit risk refers to the potential for financial loss that arises when a borrower is unable or unwilling to meet their mortgage obligations or financial commitments, such as loan repayments. This risk is particularly relevant for lenders, including banks and financial institutions, as it directly affects their profitability and stability.

In this context, the risk encompasses situations where borrowers—whether they are individuals, companies, or governments—default on their loans, leading to defaults that can cause significant financial losses to lenders. Effective management of credit risk involves assessing the creditworthiness of borrowers, implementing robust underwriting standards, and continuously monitoring any changes in a borrower's ability to repay.

Other options represent different types of risks that are not directly related to credit. For example, market volatility refers to fluctuations in asset prices, while theft pertains to loss of physical assets rather than financial obligations. Opportunity cost involves evaluating alternatives in investment and is unrelated to the default on loans. Thus, recognizing credit risk as the consequence of borrower default provides essential insight into risk management practices within financial institutions.