What does credit risk refer to?

Credit risk refers specifically to the likelihood that a borrower will default on a loan or fail to meet their contractual obligations. This risk is a critical concern for lenders and financial institutions because it directly affects their ability to recover funds that were lent out. An understanding of credit risk allows these institutions to evaluate the creditworthiness of borrowers, set appropriate interest rates, and establish lending policies that mitigate potential losses.

In the context of the other options, market fluctuations refer to the volatility in asset prices and do not pertain to individual borrower behavior. Identity theft involves unauthorized access to personal information, which is a security issue but is not related to the borrower's ability to repay a loan. Lastly, while transaction fraud involves deceitful practices to gain financial advantages, it again does not pertain to individual creditworthiness or the risk associated with a borrower's repayment capability. Thus, the focus on the likelihood of defaulting on a loan clearly aligns with the definition of credit risk.