Credit risk is the risk that a borrower will not repay their debt. It is the single biggest risk that banks face. When a bank lends $1 million, there is always a chance the borrower defaults — and the bank loses some or all of that money.
Banks manage credit risk through multiple layers: credit scoring (FICO, CIBIL), collateral requirements, loan covenants, diversification (not lending too much to one borrower or industry), and setting aside provisions (loan loss reserves) for expected defaults.
The 2008 financial crisis was essentially a massive credit risk failure. Banks lent to millions of borrowers who could not repay (subprime mortgages), bundled these risky loans into securities, and when defaults surged, the entire financial system nearly collapsed. Total losses exceeded $2 trillion globally.