Credit & Counterparty Risk

• Credit default risk 
• Concentration risk 
• Country risk 

The risk of loss arising from a debtor being unlikely to pay its loan obligations in full or the debtor is more than 90 days past due on any material credit obligation.

Default risk may impact all credit-sensitive transactions, including loans, securities and derivatives.

The risk associated with any single exposure or group of exposures with the potential to produce large enough losses to threaten a bank's core operations.

• single name concentration
• industry concentration

The risk of loss arising from a sovereign state freezing foreign currency payments (transfer/conversion risk) or when it defaults on its obligations (sovereign risk).

• transfer/conversion risk
• sovereign risk 

country's macroeconomic performance and its political stability

• Risk-based pricing 
• Covenants 
• Credit insurance & credit derivatives 
• Tightening 
• Diversification 
• Deposit insurance 

Lenders generally charge a higher interest rate to borrowers who are more likely to default. Lenders consider factors relating to the loan such as loan purpose, credit rating, and loan-to-value ratio and estimates the effect on yield (credit spread).

Lenders may write stipulations on the borrower, into loan agreements

• ·Periodically report its financial condition
• ·Refrain from paying dividends, repurchasing shares, borrowing further, or other specific, voluntary actions that negatively affect the company's financial position
• ·Repay the loan in full, at the lender's request, in certain events such as changes in the borrower's debt-to-equity ratio or interest coverage ratio

Lenders and bond holders may hedge their credit risk by purchasing credit insurance or credit derivatives. These contracts transfer the risk from the lender to the seller (insurer) in exchange for payment. The most common credit derivative is the credit default swap

Lenders can reduce credit risk by reducing the amount of credit extended, either in total or to certain borrowers.

Lenders to a small number of borrowers (or kinds of borrower) face a high degree of unsystematic credit risk, called concentration risk. Lenders reduce this risk by diversifying the borrower pool.

Many governments establish deposit insurance to guarantee bank deposits in the event of insolvency and encourage consumers to hold their savings in the banking system instead of in cash.