Credit Risk Management Practice Exam

What is the largest risk incurred by a lender in retail banking?

1. Liquidity risk

2. Operational risk

3. Market risk

4. Credit risk

The correct answer is: Credit risk

In retail banking, the largest risk incurred by a lender is credit risk. This type of risk arises from the possibility that borrowers may fail to meet their financial obligations as per the agreed terms. In retail banking, lenders predominantly extend credit products such as mortgages, personal loans, car loans, and credit cards to individuals. The assessment of a borrower's ability to repay these loans is critical, as it directly influences the lender's profitability and financial stability. Credit risk encompasses various aspects, including the creditworthiness of borrowers, the economic environment, and changes in borrower behavior. Retail banks must therefore implement rigorous credit risk management practices to mitigate potential losses from defaults. This is often achieved through careful underwriting processes, credit scoring models, and monitoring of borrower performance over time. Other types of risks, while significant, do not overshadow credit risk in the context of retail lending. Liquidity risk pertains to the institution's ability to fulfill financial obligations, operational risk relates to system failures or fraud, and market risk involves losses due to fluctuations in market prices. However, credit risk remains the primary concern as the direct impact on a lender's assets and earnings can be profound when borrowers default on their loans.