Wrong-way risk

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED 2026-11-06

// THE SHORT ANSWER

Wrong-way risk is the risk that a bank's exposure to a counterparty grows at the same time as that counterparty becomes more likely to default. A lender meets it in hedging: a business that has fixed its rate with a swap owes more on the swap as rates fall, and rates often fall in a downturn that is also weakening its trade. The same pattern shows in support: a guarantee or share pledge from a company in the same group or market tends to lose value just when it is called on. Banks look for it when they set derivative limits and count related-party support as security.

BASIS  Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.