What is 'credit risk'?

Credit risk refers to the potential that a borrower will fail to meet their obligations in accordance with agreed-upon terms, leading to financial loss for the lender. This risk is particularly significant in lending and credit markets, where financial institutions evaluate the likelihood of a borrower defaulting on a loan. When assessing credit risk, factors such as the borrower's credit history, income stability, and overall financial health are taken into account.

The other options refer to different types of risks. Market price fluctuations are associated with market risk, where the value of investments may change due to variability in market conditions. Investment diversification relates to reducing investment risk by spreading assets across various investments, thus lowering the impact of any single asset's poor performance. Economic downturns are more closely tied to systematic risks that affect entire markets or economies, as opposed to the specific risk inherent in individual borrowers or credit transactions. Thus, the definition of credit risk aligns specifically with the consequences of borrower default, making it the correct interpretation.