What Are the Causes of Financial Risk?

The financial market in the United States continually tackles several types of risk on a daily basis. All these types of risk have a root cause in the timely payment of credit accounts, be they the smaller credit accounts of consumers or the larger debts of corporations. An inability of either to meet financial obligations can spell trouble for the financial market and the economy as a whole.

Financial markets must constantly guard against credit risk, according to the International Financial Risk Institute. This type of market risk is caused by debtors who cannot meet obligations to pay back loans or make payments on credit accounts, and therefore default or are forced to declare bankruptcy. When a debtor declares bankruptcy, the lender may be able to recover only a portion of the original loan amount. Financial markets attempt to combat credit risk by maintaining stringent requirements for extending credit, such as examining each applicant's credit report for evidence of past financial irresponsibility and maintaining credit score requirements.

Financial markets also face the problem of liquidity, or difficulty in being able to turn assets into cash. This form of financial risk is caused by one or more financial market participants not having enough cash to meet all financial obligations by the due dates of the accounts. The fear with this type of risk is that failure of one financial market participant, such as a corporation, to meet its financial obligations may expose larger financial problems in the market.

A settlement risk is the chance a creditor takes of a debtor filing for bankruptcy or settling his credit account for less than the full amount owed. This type of financial risk can be caused by a number of factors, from a debtor's own financial circumstances to the terms of a credit account or loan he agreed to repay. A creditor has the right to appeal to the court to not allow a debtor to enter into bankruptcy protection. A creditor may also attempt to secure a judgment against a debtor in an attempt to force the debtor to repay his account.

Systemic risk represents the larger financial problems caused by the inability of financial market participants to meet repayment obligations on extensions of credit. The problem is systemic because the inability of one participant to pay may lead to an inability of other participants to meet credit obligations. This domino effect played out in the market during the mortgage crisis of 2009. The rash of foreclosures caused by a lack of payments on mortgage loans led to mortgage companies being unable to meet financial obligations. This spread throughout the market, causing a lockup in liquidity where banks refused to lend money for fear of insurmountable financial risk.