A type of risk that may arise when an issuer of debt security or a debtor defaults or experiences a decline in its creditworthiness. As a result, the price of the securities the or value of the underlying debt would drop, impacting the debtor-creditor relationship particularly in terms of the losses that would be incurred by the creditor.

It reflects the possibility that a borrower may fail to make required payments and repayment of the principal amount of debt. A lender would experience, in addition to losses in the principal and interest, disruption to cash flows, and increased collection cost, among others.

For mitigation of this type of risk, credit risk management involves assessing borrowers’ credit risk – including payment behavior and affordability (ability to repay).

Broadly speaking, credit risk constitutes the possibility of a loss arising due to a borrower’s failure to repay a loan or to meet contractual obligations.