Until recently, most European economies had witnessed relatively few bankruptcies, and their banks had enjoyed generous lending margins. This meant that the banks could succeed by avoiding truly bad loans: only minor benefit derived from being distinctively competent at risk rating, pricing, and monitoring. No longer is this the case. Throughout Europe, banks are now experiencing losses of unprecedented proportions. It is tempting to blame the current economic climate and hope that all will be better in a year or so, when the economy improves. But as a McKinsey study of credit risk management has found, both the underlying nature of the risk and its importance to a bank's profitability equation have fundamentally changed. So much so, in fact, that financial institutions need to develop a whole new technical and organizational approach to managing credit, which will radically alter the culture of traditional universal banks.

"Of course, financial ratios and local information are important. But one of my most reliable sources of judgment on credit risk is having my assistant observe the behavior of a client waiting for a credit negotiation meeting to begin." According to the senior credit officer of a major European bank, such "eye contact" methods...