Bank risk, financial deregulation and prudential regulation: an expectation-variance analysis.

Summary The objective of this paper is to analyze banking risk in the regulatory environment of the 1980s. The two-parameter portfolio model (expectation and variance) is applied to the banking firm and prudential rules are introduced. It is shown both from a theoretical and an empirical point of view that prudential rules, even the most sophisticated ones (radio cooke), are unable by themselves to control the risk of bank failure. It is suggested that individualized control of banks by the authorities is also necessary as long as the problems of imperfect information and moral hazard are not resolved.