What does credit risk refer to?

Credit risk specifically pertains to the possibility of loss that a lender may face if a borrower defaults on their loan obligations. This risk is inherent in various lending activities, where a financial institution provides funds to an individual or business with the expectation that they will repay the loan according to the agreed terms. When a borrower fails to make scheduled payments or cannot fulfill their financial commitments, the lender may suffer a financial loss.

This definition aligns with the principles of credit assessment, which involve evaluating the borrower's creditworthiness and ability to repay. Financial institutions often use credit ratings, credit scores, and historical repayment behaviors to gauge the level of risk before issuing a loan. The higher the perceived risk, the more stringent the terms may be, potentially leading to higher interest rates to compensate for that risk.

In contrast, the other options encompass different types of risks unrelated to borrower default. Market fluctuations relate to changes in asset values, cybersecurity breaches involve the loss of data or financial resources from hacking or fraud, and regulatory penalties stem from non-compliance with laws and regulations. These are all significant considerations in the financial sector, but they do not fit the specific context of credit risk.