But still, lots of lenders go bust. Lots of loans end up non-performing. Interest isn't a free money loophole, it's profit in exchange for risk.

Presently, the safety of bank deposits are in most countries guaranteed by the government, but before this they weren't risk free either. That's why bank runs happened. People panicked to get their capital out before it was gone.

In the private market: yes the interest is a compensation for the risk taken by the lender.

However certain institutions like banks have access to so called "risk free" lending. They can (must) deposit capital at the central bank and get paid interest. In the US this would be the "interest on reserve balances" or through reverse repo transactions, where the FED pays the interest. From the point of view of the bank (inside a financial system) this is risk free profit.