Credit risk is more simply defined as the potential of a bank borrower or counterparty to fail to meet its obligations in accordance with the agreed terms. For most banks, loans are the largest and most obvious source of credit risk. It is the most significant risk, more so in the Indian scenario where the NPA level of the banking system is significantly high.
Counter party Risk and Country Risk are two variants of Credit Risk:
Counter party Risk: This is a variant of Credit risk and is related to non-performance of the trading partners due to counter party’s refusal and or inability to perform.
Pre–settlement risk: Pre-settlement risk arises when the counterparty goes bankrupt (or some other event which impairs the ability of counter party honouring its obligatory payment) prior to settlement. In such a case, is the risk to the organisation 100% of the principal amount of the deal or just the replacement value of the original financial agreement?
Settlement risk: Settlement risk arises with respect to the settlement of a transaction. Example: one party buying USD against EUR. In a bi-lateral settlement, each party is obligated to honour their part of the transaction (their leg of the transaction). In settlement risk, the exposure is the entire value of the counterparty’s obligation.
Country Risk: This is also a type of credit risk where non-performance of a borrower or counterparty arises due to constraints or restrictions imposed by a country.
Strategic Risk
Strategic Risk is the risk arising from adverse business decisions, improper implementation of decisions or lack of responsiveness to industry changes.
Reputation Risk
Reputation Risk is the risk arising from negative public opinion. This risk may expose the institution to litigation, financial loss or decline in customer base.