Credit risk, also known as roll-over risk, is the possibility that a borrower’s credit worth, at the time of renewing a credit, is reclassified by the lender.
It is the risk that the promised CFs (Cash Flow) from the assets (loan of different types) & investments (investment made indifferent securities) held by the banks or FIs may not be realized in full is called credit risk..
- If the principle of all the financial assets are paid back in full and on maturity and interest payments are made on their promised date then, the FIs (Financial Institute) will face zero credit risk.
- If the borrower defaults both the principal loaned and the interest to be received are at risk. This is credit risk
Credit risk can be of:
- Firm Specific Credit Risk: The risk of default of the borrowing firm associated with the specific types of projects risk taken by that firm.
• Systematic Credit Risk: The risk of default associated with the general economic conditions of a country or macroeconomic dynamics that affects all borrowers. Portfolio of investment and loan diversification can reduce this risk as some level.
Credit risk is the probability that issuer of a loan or security will fail and default on any promised payments of interest or principal or both.
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