| Definition |
The risk that a borrower or counterparty will default on their financial obligations. |
The risk of losses due to changes in market prices such as interest rates, stock prices, or currency values. |
| Nature |
Specific to individual borrowers or issuers. |
Systematic and affects the overall market or asset class. |
| Example |
A company defaults on a corporate bond or a borrower fails to repay a loan. |
Losses due to a stock market crash, interest rate hike, or currency fluctuation. |
| Causes |
Poor financial health of borrower, default history, or adverse credit conditions. |
Economic changes, geopolitical events, changes in supply-demand, or investor sentiment. |
| Measurement Tools |
Credit ratings, credit scoring models, probability of default (PD), loss given default (LGD). |
Value-at-Risk (VaR), beta coefficient, stress testing, duration analysis. |
| Impact Area |
Affects lending institutions, bond investors, and credit markets. |
Affects equity, bond, commodity, and derivative investors. |
| Key Instruments Affected |
Loans, bonds, credit derivatives, receivables. |
Stocks, currencies, commodities, interest rate products. |
| Risk Mitigation |
Credit insurance, collateral, diversification, strong underwriting. |
Hedging with options, futures, diversification, asset allocation. |
| Frequency |
Event-driven, less frequent but high impact when it occurs. |
Can occur daily due to market volatility. |
| Volatility Impact |
Not directly affected by volatility; depends on counterparty risk. |
Highly sensitive to market volatility and fluctuations. |
| Regulatory Framework |
Basel III norms for credit risk capital adequacy. |
Regulations under market risk capital requirements (e.g., FRTB – Fundamental Review of the Trading Book). |
| Control Measures |
Credit limits, credit approvals, risk-adjusted pricing. |
Stop-loss orders, position limits, portfolio rebalancing. |
| Type of Risk |
Idiosyncratic (specific to borrower). |
Systematic (affects all participants). |
| Time Sensitivity |
More related to long-term contracts or debt tenure. |
Impacts both short-term and long-term holdings. |
| Risk Transfer |
Credit derivatives (e.g., Credit Default Swaps). |
Market hedging instruments (futures, options, swaps). |
| Investor Focus |
Important for fixed income and lending institutions. |
Important for active traders, equity investors, and portfolio managers. |
| Monitoring Frequency |
Monitored periodically (e.g., monthly or quarterly). |
Requires daily or real-time monitoring. |
| Result of |
Borrower’s inability or unwillingness to pay. |
External market dynamics and volatility. |
| Can Be Reduced By |
Strong credit analysis and financial covenants. |
Diversification across asset classes and regions. |
| Impact on Portfolio |
Potential default loss or recovery delays. |
Immediate mark-to-market losses on valuation. |
Credit Risk vs Market Risk