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There has been growing momentum throughout the year to alter or repeal the Volcker Rule.
Earlier this month, the U.S. Office of the Comptroller of the Currency sent out a formal notice soliciting comment on whether certain parts of the rule should be revised.
The U.S. Treasury Department in a report from June recommended exempting banks with less than $10 billion in assets from the rule. And the U.S. House of Representatives in June passed the Financial Choice Act, which would repeal the Volcker Rule, although the bill may have a hard time getting through the Senate.
“The vast majority of community banks do not engage in the activities that were intended to be prohibited by Volcker, nor do community banks present the kind of systemic risk the statute sought to limit,” Bryan Hubbard, deputy comptroller for public affairs at the OCC, said in an email. “For those reasons, the OCC has supported exempting small community banks from the Volcker Rule.”
Named after former Federal Reserve Chairman Paul Volcker, the rule was put into place as part of the Dodd-Frank Act, which intends to ensure the U.S. never again enters a financial crisis such as the one that occurred in 2008.
The Volcker Rule – which didn’t go into effect until 2015 after much scrutiny by the banking industry – prohibits banks from conducting certain investment activities, such as short-term proprietary trading of securities, derivatives, commodity futures and options on these instruments for banks’ own accounts.
The rule means to limit banks’ relationships with hedge funds and private equity, also known as covered funds, and to prevent banks from the speculative investments that many believe contributed to the financial crisis.
Although altering or repealing the Volcker Rule is not likely to have a dramatic impact on community banks, it would ease regulatory burdens as well as possibly provide greater flexibility on certain investment activities.
Compliance Relief
Despite the fact many community banks do not engage in investment activities prohibited under the Volcker Rule, they still need to prove it to regulators.
“Even if a bank isn’t doing anything that is considered a trade, they need to have policies in place saying ‘We don’t violate the Volcker Rule,’” said Jon Skarin, senior vice president at the Massachusetts Bankers Association, who deals with regulatory issues. “Most community banks are not doing hedge fund investments. For the most part it’s saying, ‘We don’t do these things.’”
The Volcker Rule is over 950 pages, which requires additional work to not only make sure a bank complies with the rule, but to also make sure banks are not investing in anything that might be prohibited under the rule, said Skarin.
Determining what is and is not prohibited has been a challenge for banks and regulators.
Daniel Tarullo, a member of the Federal Reserve Board of Governors, said in his departing remarks earlier this year that “the Volcker Rule is too complicated.”
He specifically called out the fact that five federal agencies are involved in regulation. This, he said, makes it difficult agree on what distinguishes market making from proprietary trading.
“Achieving compliance under the current approach would consume too many supervisory, as well as bank, resources relative to the implementation and oversight of other prudential standards,” he said in his remarks. “And although the evidence is still more anecdotal than systematic, it may be having a deleterious effect on market making, particularly for some less liquid issues.”
Investment Options
No, for the most part banks are not involved in the type of investing or trading the Volcker Rule seeks to prohibit. But that doesn’t mean that some of their investing activities don’t fall under the rule’s jurisdiction.
According to Kevin Handly, a Boston-based banking lawyer who also teaches at Boston University Law School’s graduate program in banking and financial law, community banks before the Volcker Rule used to invest in collective investment funds. But the rule classified these as private equity, except for funds dedicated to low-income housing that banks could receive tax credits for investing in.
The rule also did not stop banks from making direct public welfare investments in projects eligible for new market tax credit funds, historical rehabilitation tax credits and renewable energy tax credit, provided they are permissible under banking laws, such as a qualified CRA investment.
“The perverse effect of the Volcker Rule is to force banks to invest on an individual basis, rather than on a collective basis through a diversified fund,” said Handly. “The Volcker Rule prohibits banks from investing in a fund, even if the fund invests solely in projects that bank can invest in directly.”
LIHTC and NMTC projects generally always qualify as public welfare investments, Michael Novogradac, CPA and managing partner at Novogradac & Co., said in an email, whereas renewable energy is case by case.
“A relaxing of the Volcker Rule could increase bank investor interest in many renewable energy tax credit investments,” he said.
The rule also has an impact on community banks that make equity investments in other banks.
Skarin said in Massachusetts there are about 30 or 40 banks – mostly savings banks and other smaller banks – that previously made these investments, mostly in blue chip stocks.
These investments have been grandfathered in so those banks that had them did not have to divest under the Volcker Rule. Relaxing the rule could allow these banks more flexibility when managing their portfolios, he said.
