Question13 Which of the following best explains why banks are exposed to credit risk? Customers may forget their internet banking passwords and are unable to withdraw money to spend Bank managers spill coffee on important loan documents that void its validity The central bank may lower the official cash rate unexpectedly surprising financial markets Borrowers may fail to meet their contractual repayment obligations on their interest payments and/or principal amount Customers get busy with their daily lives and forget to deposit their savings with their bank ResetMaximum marks: 1 Flag question undefined

Question

BlackTom AI · Accepted Answer

Credit risk arises when a borrower fails to meet contractual repayment obligations, causing potential loss to the lender.

1) Relevant knowledge points and concepts
- Credit risk (default risk): the possibility that a borrower will not pay interest and/or principal as promised, producing a loss for the lender. Key components: probability of default, exposure at default, and loss given default.
- Distinguish from other bank risks: operational risk (processes/people/systems failures), market/interest-rate risk (changes in market prices or rates), and liquidity/funding risk (inability to meet short-term obligations).

2) Step-by-step reasoning
- Identify the scenario that matches the definition of credit risk: a borrower failing to meet contractual repayment obligations is the textbook example of credit risk because it directly creates potential loss on loans and credit exposures.
- Evaluate each option relative to the credit-risk definition:
  - If a borrower defaults, the bank’s asset (loan) loses value and expected cash flows are reduced — this is credit risk.

3) Calculations/intermediate steps
- No numeric calculation is required here. The logical step is matching each option to the correct risk category.

4) Why the correct answer is correct
- "Borrowers may fail to meet their contractual repayment obligations on their interest payments and/or principal amount" precisely describes default: the risk that promised cash flows from borrowers stop or are impaired. This directly causes expected losses on loan portfolios, which is the essence of credit risk.

5) Why the other options are incorrect
- Forgetting internet banking passwords: an operational/customer-service inconvenience, not a credit loss by borrowers.
- Bank managers spilling coffee on loan documents: an operational or legal/documentation risk, not borrower default.
- Central bank lowering the official cash rate unexpectedly: this is interest-rate/market risk or monetary policy risk affecting rates and markets, not direct credit default.
- Customers forgetting to deposit savings: a behavioral or funding-liquidity issue for the bank, not credit risk from borrower default.

6) Conclusion
The correct choice is "Borrowers may fail to meet their contractual repayment obligations on their interest payments and/or principal amount," which matches the provided answer.

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