Funding liquidity risk, also known as balance sheet risk, arises when a borrower's credit position is deteriorating or is perceived by market participants to be deteriorating. In the case of Elipsa Bank, the credit quality of its borrowers has significantly declined, which has negatively impacted its loan portfolio and overall balance sheet position. This situation makes it difficult for the bank to negotiate new credit terms for its own funding needs. Potential lenders and investors may be hesitant to lend to the bank under the same terms as before due to the increased risk. As a result, any new funding for the bank may come with stricter credit terms, such as higher interest rates. This scenario exemplifies funding liquidity risk, as the bank’s ability to meet its funding needs is compromised due to the deteriorating credit quality of its borrowers.

Choice A is incorrect. Systemic risk refers to the potential for a major disruption in the function of an entire market or financial system due to the failure of a single entity or group of entities. While Elipsa Bank’s situation is concerning, it does not necessarily imply a systemic risk unless the bank’s failure could cause significant disruption to the broader financial system.

Choice C is incorrect. Reputation risk involves damage to an organization's reputation which can lead to loss of revenue or legal, regulatory, or financial costs. In this scenario, there is no mention of any reputational damage suffered by Elipsa Bank due to its declining loan portfolio and balance sheet position.

Choice D is incorrect. Strategic risk arises from poor business decisions, improper implementation of decisions, inadequate resource allocation, or failure to respond well to changes in the business environment. The scenario does not provide any information suggesting that Elipsa Bank has made poor strategic decisions leading up to its current predicament.

Things to Remember

• Systemic risk is the risk of a major disruption in the function of an entire market or financial system due to the failure of a single entity or group of entities.
• Reputation risk involves damage to an organization's reputation which can lead to loss of revenue or legal, regulatory, or financial costs.
• Strategic risk arises from poor business decisions, improper implementation of decisions, inadequate resource allocation, or failure to respond well to changes in the business environment.