Reputational risks for such issuers are too high for them to default and any default would typically impinge their ability severely to do further borrowings from the system.
However, the system by its very permissionless design allows anyone to be able to place a borrowing request. It does not, however, force the risk of any and every borrower on to all the lenders and lets them make their own choices. The lenders are always in control and can adjust their lending strategy based on their risk profile.
A mechanism has to be developed to allow for non-institutional parties to be able to borrow. For eg: It should allow someone sitting in El Salvador to make a borrowing request and get matched with a lender in Japan (if the lender is happy.) This is typically done in the real world by establishing credit scores.
However credit scores are a direct function of establishing the user's identity. In a non KYC DeFi world, traditional identities based on drivers licenses and passports are not available nor enforceable.
This forces us to go down to the basics and rework a new model for credit scores that can operate in this new environment.