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Credit risk is risk due to uncertainty in a counterparty's (also called an obligor's or credit's) ability to meet its obligations. Because there are many types of counterparties—from individuals to sovereign governments—and many different types of obligations—from auto loans to derivatives transactions—credit risk takes many forms. Institutions manage it in different ways.
In assessing credit risk from a single counterparty, an institution must consider three issues:
default probability: What is the likelihood that the counterparty will default on its obligation either over the life of the obligation or over some specified horizon, such as a year? Calculated for a one-year horizon, this may be called the expected default frequency.
credit exposure: In the event of a default, how large will the outstanding obligation be when the default occurs?
recovery rate: In the event of a default, what fraction of the exposure may be recovered through bankruptcy proceedings or some other form of settlement?
When we speak of the credit quality of an obligation, this refers generally to the counterparty's ability to perform on that obligation. This encompasses both the obligation's default probability and anticipated recovery rate.
To place credit exposure and credit quality in perspective, recall that every risk comprise two elements: exposure and uncertainty. For credit risk, credit exposure represents the former, and credit quality represents the latter.
Many forms of credit risk—especially those associated with larger institutional counterparties—are complicated, unique or are of such a nature that that it is worth assessing them in a less formulaic manner. The term credit analysis is used to describe any process for assessing the credit quality of a counterparty. While the term can encompass credit scoring, it is more commonly used to refer to processes that entail human judgment. One or more people, called credit analysts, will review information about the counterparty. This might include its balance sheet, income statement, recent trends in its industry, the current economic environment, etc. They may also assess the exact nature of an obligation. For example, senior debt generally has higher credit quality than does subordinated debt of the same issuer. Based upon this analysis, the credit analysts assign the counterparty (or the specific obligation) a credit rating, which can be used for making credit decisions.
Source: http://www.riskglossary.com/link/credit_risk.htm | 
