ISFB Insight
Financial Risks: Understanding the Mechanisms to Ask the Right Questions
July 8, 2026
Julien Pelegry, an ISFB lecturer for the Certificate in Governance and Risk Management for Board Members, points out that financial risks can no longer be left solely to in-house specialists. Liquidity, credit, interest rates, market risks, regulatory ratios, and stress tests require board members to have a sufficient understanding of banking mechanisms to make decisions, challenge assumptions, and fully assume their responsibilities.
Julien Pelegry, you discuss financial risks in the ISFB Certificate. What are the risks that a bank director can no longer afford to leave solely to specialists?
To conduct business—regardless of the type of bank (commercial, wealth management, or retail)—the bank uses its balance sheet to engage in maturity transformation: this means it mobilizes clients’ short-term liquidity to make investments and extend medium- and long-term loans. The gap between assets and liabilities primarily creates liquidity risks. Advisory services are therefore central to the management of this risk, and advisors must have a thorough understanding of their liquidity contingency plan, as well as the triggers and recovery measures.
Furthermore, investments and loans extended to customers give rise to credit and interest rate risks. As part of sound governance, risk limits for investments and credit, as well as the most significant transactions, must be approved by the members of the Board. Indeed, while there is a focus on the Credit Suisse case, we must not forget past events such as the SVB crisis or instances of significant loan losses. Since the end of the subprime crisis, the difficulties faced by certain banks have no longer been linked to positions taken on complex instruments, but rather to a poor understanding of the financial risks associated with “traditional” instruments or loans.
Finally, FINMA has significantly strengthened its requirements regarding financial risks as well as the pressure it can exert on board members. Beyond setting risk tolerance levels, the regulator now requires active involvement in risk management processes. This includes, in particular, validating the assumptions used in certain calculations (e.g., IRRBB), approving liquidity contingency plans, and participating in capital planning. It is therefore necessary for a board member to have a basic understanding of liquidity, credit, and interest rate risks in order to effectively challenge internal specialists.
Your career path has taken you from investment banking to asset management, and then to financial risk management in private banking. What has this experience taught you about how market, credit, interest rate, and liquidity risks interact?
All financial institutions and business activities require a solid understanding of traditional financial instruments. Investment banking taught me how to use them. Beyond that, while most institutions use the same instruments, they do so in different ways to generate revenue. In fact, it is the way these instruments are combined that determines the level of risk taken. For example, a structured product is a combination of several traditional instruments packaged together into a single product.
Thus, a thorough understanding of financial risks requires a grasp of the mechanisms governing financial instruments, as well as an analysis of the residual risk assumed by each institution. There is sometimes little difference in risk-taking between the trading desks of an investment bank and alternative asset management: only the “bearer” of that risk changes. On the other hand, the risk appetite between an investment bank and a private bank—excluding factors of volume and complexity—is quite different, which is reflected in the residual risks taken.
It is therefore necessary to adjust one’s approach to align with a private bank’s risk appetite. Subsequently, over the years, pressure on margins as well as regulatory pressure have led to a consolidation of tasks within centers of expertise and a significant strengthening of risk management frameworks. As a result, regulators have imposed new frameworks (e.g., Basel IV, updates to the liquidity circular, IRRBB), involving ratios and calculations that are sometimes complex. This has prompted banks to heavily involve their risk departments, which possess the necessary expertise in financial instruments to perform and interpret these calculations. Consequently, there has been a rapid shift from “market risk”—which primarily covered the trading portfolio—to “financial risk,” which encompasses the entire balance sheet across a broader range of risks.
On a board of directors, financial risks often take the form of metrics, limits, ratios, or stress tests. How can a board member know if they truly have a sufficient understanding to make decisions, challenge management, and fulfill their responsibilities?
There are two types of metrics reported to the board of directors. First, there are the regulatory metrics mandated by FINMA. The purpose of this course is to explain the key ratios, how they are calculated, and what they mean. In fact, the regulator sometimes allows some flexibility regarding how they are calculated. It is therefore important to have both a basic understanding of the key components that make up a ratio and to grasp the risks the regulator seeks to limit. The regulator’s approach falls under Pillar I, namely the minimum capital requirements to cover risk. This means that the regulator will penalize or discourage the bank from taking certain types of risks or adopting certain practices.
However, the regulatory perspective remains insufficient, which is why “economic” indicators are also reported to the boards of directors. These indicators, as well as how they are calculated, depend heavily on the institution’s business model. The course I am teaching will cover two aspects: the first is a review of balance sheet mechanisms. To identify the right indicators, it is essential to understand how the bank generates its revenue and what risks it takes to do so. The second aspect covered in this course is to provide a clear understanding of how to calculate the key indicators and what they mean.
Risk management is based first and foremost on common sense, which is why this course focuses on mechanisms rather than mathematical formulas. It explains the key indicators that are reported, as well as how they are presented to board members. There is often confusion between accounting, regulatory, and risk perspectives. It is therefore important for a director to consider the level of detail in the information that is reported. The course addresses these various aspects.
Stress tests have become central to banking management. How can a board member distinguish a useful stress test from one that is too theoretical or too reassuring?
A stress test is based primarily on assumptions, and an increasing number of the assumptions used in these tests require validation by the Board and a third party. Indeed, FINMA is paying increasing attention to an often-overlooked risk: model risk. It is therefore very important for a director to first ensure that there is strict governance over the models underlying the stress tests. Indeed, if changes to assumptions are not properly managed and reported to the Board, the results presented from one period to the next may have very different implications.
However, governance alone is not enough: it is up to the Board to challenge the assumptions used in key stress tests and, above all, to ensure that they are aligned with the business model. Furthermore, every model has biases, and assumptions cannot be based solely on “storytelling.” They must also be supported by internal statistics and real-world events that have occurred at other institutions. It is therefore vital that board members be able to connect the assumptions to the reality of the business model.
The course will help directors identify the mechanisms at work when a bank uses its balance sheet to generate revenue. This greater understanding will enable directors to assess whether an assumption is appropriate or overly lenient.
What do you want participants to take away from your presentation: a better understanding of financial indicators, the ability to ask the right questions, or a risk culture that is more fully integrated into decision-making?
FINMA is asking board members to become increasingly involved in areas that were previously reserved for in-house specialists. As a result, for a growing number of risks—such as liquidity risk, for example—the board must be at the center of the risk management framework. It must approve an increasing number of technical elements, such as the assumptions used in stress tests. These heightened requirements mean that directors must acquire greater expertise and understanding of liquidity, credit, interest rate, and market risks.
By the end of the course, participants will not have earned a degree in mathematics, but they will have mastered the essential mechanisms for asking the right questions when assessing situations involving financial risk. The objective of this module is to provide an understanding of the mechanisms of financial instruments commonly used within a bank, to explain how a bank generates risks through its balance sheet, and to describe how to measure those risks.
Participants will also gain an understanding of how the key ratios—both regulatory and economic—that are regularly reported work. The course will explain the methodology used to calculate stress tests, as well as the key assumptions that influence these calculations. Participants will thus be better equipped to understand the summary reports presented to them and may be able to request new reports or more detailed analyses on certain aspects of the risks associated with the business model of the bank they manage.
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