If a bank extends too many non- performing loans, the quality of its balance sheet can be seriously impaired. This can create systemic effects that could jeopardise the financial stability of other banks. Payment risk is the risk that a transaction between two parties fails, leaving the payee without the promised funds. Banks are generally careful about credit risk, but the risk cannot be eliminated. Inevitably some loans will not be repaid, and during economic downturns the number of unpaid loans usually increases.
Commodity currencies have no credit risk because they are solid assets.
The value of a commodity currency is not based on an extension of credit, as are all fiat currencies. Thus, when an institution or individual accepts fiat currency, that institution or individual is accepting a promise to pay. Settlement risk exists because payments in certain transaction systems are not always made. Although non-payment can happen for many reasons, it primarily occurs when the paying bank does not have sufficient funds to pay as it had promised. Therefore, most settlement risk is caused by a liquidity crisis within the banking system brought on by credit repayment problems.