The Risk Revolution

Risk Practice

McKINSEY WORKING PAPERS ON RISK

The Risk Revolution

Number 1 Kevin Buehler, September 2008 Andrew Freeman and Ron Hulme

Confidential Working Paper. No part may be circulated, quoted, or reproduced for distribution without prior written approval from McKinsey & Company.

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Contents

Introduction Acknowledgements The emergence of modern risk management Table: Important theories and their applications Risk in the financial sector Goldman Sachs and the culture of risk Risk for nonfinancial companies Case study: TXU Corporation A practical corporate risk-management process Table: Examples of risk across industries Selected sources 2 3 3 5 8 15 18 21 24 33 37

McKinsey Working Papers on Risk is a new series presenting McKinsey's best current thinking on risk and risk management. The papers represent a broad range of views, both sector-specific and cross-cutting, and are intended to encourage discussion internally and externally. Working papers may be republished through other internal or external channels. Please address correspondence to the managing editor, Andrew Freeman, andrew_freeman@mckinsey.com

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Introduction

In the past 18 months, we have witnessed a major credit and liquidity crisis in the banking system as losses from subprime mortgages, structured investment vehicles, and “covenantlite” leveraged loans generated significant knock-on effects worldwide. Major financial institutions have taken more than $500 billion in write-offs, and central banks around the globe have initiated emergency measures to restore liquidity. CEOs have been replaced at such venerable institutions as Citigroup, Merrill Lynch, and UBS. Bear Stearns, a firm once viewed as having a conservative approach to risk management, has been the target of a Federal Reserve-driven (and to some extent, sponsored) rescue by JPMorgan. Lehman Brothers has filed for bankruptcy. Goldman Sachs and Morgan Stanley have changed status to become bank...