Editing Credit risk (section)

== Mitigation ==
Lenders mitigate credit risk in a number of ways, including:

* '''Risk-based pricing''' – Lenders may charge a higher [[interest rate]] to borrowers who are more likely to default, a practice called '''[[risk-based pricing]]'''. Lenders consider factors relating to the loan such as [[loan purpose]], [[credit rating]], and [[loan-to-value ratio]] and estimates the effect on yield ([[credit spread (bond)|credit spread]]).
* '''Covenants''' – Lenders may write stipulations on the borrower, called '''[[loan covenant|covenants]]''', into loan agreements, such as:<ref>[http://moneyterms.co.uk/debt_covenants/ Debt covenants]</ref>
** Periodically report its financial condition,
** Refrain from paying [[dividend]]s, [[share repurchase|repurchasing shares]], borrowing further, or other specific, voluntary actions that negatively affect the company's financial position, and
** Repay the loan in full, at the lender's request, in certain events such as changes in the borrower's [[debt-to-equity ratio]] or [[times interest earned|interest coverage ratio]].
* '''Credit insurance''' and '''credit derivatives''' – Lenders and [[bond (finance)|bond]] holders may [[Hedge (finance)#Hedging credit risk|hedge]] their credit risk by purchasing '''credit insurance''' or '''[[credit derivatives]]'''. These contracts transfer the risk from the lender to the seller (insurer) in exchange for payment. The most common credit derivative is the '''[[credit default swap]]'''.
* '''Tightening''' – Lenders can reduce credit risk by reducing the amount of credit extended, either in total or to certain borrowers. For example, a [[Distribution (business)|distributor]] selling its products to a troubled [[retailer]] may attempt to lessen credit risk by reducing payment terms from ''net 30 '' to ''net 15''.
* '''Diversification''' – Lenders to a small number of borrowers (or kinds of borrower) face a high degree of [[systematic risk#Unsystematic risk|unsystematic]] credit risk, called '''[[concentration risk]]'''.<ref>[http://www.businessinsider.com/mba-mondays-diversification-2010-6 MBA Mondays:Risk Diversification]</ref> Lenders reduce this risk by [[Diversification (finance)|diversifying]] the borrower pool.
* '''Deposit insurance''' – Governments may establish '''[[deposit insurance]]''' to guarantee bank deposits in the event of insolvency and to encourage consumers to hold their savings in the banking system instead of in cash.