Counterparty risk

The risk that the party on the other side of an arrangement fails to pay what it owes you.

Example

A bank deposit, a money market fund and a treasury bill answer the question "who owes me this money?" with a bank, a portfolio of issuers, and the state.

Important

It is a question about the institution, never about the label on the product. A balance above a deposit guarantee limit carries real counterparty risk however reassuring the word savings sounds.

Related terms

• Bank deposit — Money handed to a bank in exchange for a claim on it. The bank owns the money and lends most of it out; what you hold is a debt that institution owes you, repayable on the terms of the account.
• Deposit insurance — A government-backed guarantee that repays depositors when an institution fails, up to a stated limit, per depositor, per institution.
• Credit risk — The risk that an issuer fails to make a contracted payment. It is the risk most associated with bonds and, for high-quality issuers, rarely the one that moves the price.
• Default — The failure of an issuer to meet a contracted obligation - a missed coupon, a missed principal repayment, or the breach of a term that permits creditors to demand repayment.

Lessons that explain it

• A deposit is a loan you made to a bank — Money in a savings account is not money you are holding. It is a debt the bank owes you, and what makes it safe is a government guarantee with a limit - not a property of money itself. (9 min)
• The nominal safety that loses money anyway — The balance cannot fall, and that is exactly why the real risk in this class is invisible. Inflation reduces what the money buys, and the tax is levied on the nominal interest rather than on what you actually gained. (13 min)
• A physical good, and three very different ways to own it — Metal in a vault, a listed product that holds metal, and a dated contract on metal are not three versions of one investment. They differ in minimum size, cost, storage and who owes you what. (9 min)
• A secret number, and one line in a shared record — What you own is not a coin and not a claim on anybody. It is the ability to authorise a change to one entry on a ledger - and who holds that ability is the whole of the risk. (10 min)
• Total loss is an outcome here, not a tail — Four separate routes lead to zero, none of them exotic. Then the volatility arithmetic, the costs nobody totals, and a tax treatment that can leave a bill in currency against a position that has already fallen. (13 min)
• A contract about a price, not a piece of anything — An option or future is an agreement whose value depends on another asset. You own a right or an obligation with an expiry date, not a share of a business. (10 min)

All 578 terms in the Investing glossary