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  • The Financial Encyclopedia
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Banking

  Banking   |   Terms
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  • October 26, 2023
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Default Risk

The probability that a borrower (an individual or institution) fails to make full and timely payments of a loan‘s principal and interest, as per the terms of the arrangement involved (loan, debt security, credit card payment, etc.)

Default risk may manifest itself in full or partial failure to make payments on the date(s) agreed and specified in the debt agreement. Default risk is a component of credit risk (the other component being loss severity).

For a bank or financial institution, default risk refers to the perceived likelihood that it will be unable to meet the payments/ repayments associated with its loans from other institutions. Given a strong degree of interconnectedness among institutions within the system, the default of a single bank or institution may ignite a cascading failure, which could potentially drive the entire system into a complete breakdown.

Default risk is also called default probability.


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