The Volcker Rule, which prohibits trading for direct gain, is expected to reduce pretax profits by an estimated $10 billion at the nation’s largest eight banks through lower revenue and higher compliance costs, according to Standard & Poor’s. It will go into effect on April 1, 2014, and banks have until July 21, 2015 (with the opportunity for two one-year extensions) to comply; there are also multi-tiered compliance deadlines based on the banks’ level of trading assets and liabilities, with the lowest tier starting at $10 billion in trading assets and liabilities.
Regulators say the rule will not be applied to community banks engaging in proprietary trading, which is probably more of a letter-of-the-law issue than something with real impact. Since the debut of Dodd-Frank, community banks have vigorously argued that regulatory measures to address big-bank activity impose unfair regulatory burdens on them. However, the number of community banks that engage in the level of proprietary trading addressed in Volcker might well be low.
Five financial regulatory agencies had a hand in the final version of the law — the FDIC, which gets to make depositors whole after a bank failure; the Federal Reserve; the Office of the Comptroller of the Currency, which shuts down and reopens failing banks; the Commodity Futures Trading Commission, the primary agency for 110 banks registered as swaps dealers, and the Securities and Exchange Commission.
The regulation still allows banks to trade on behalf of clients, and to invest their own assets in government bonds, but they – particularly their CEOs — will be held responsible to prove that trading activities don’t cross the line into proprietary. They can’t hold large stakes in hedge or private equity funds. Trading desks can’t hold securities in excess of anticipated customer demands. They can speculate or can have a governmental safety net, but not both. A somewhat gallows humor observation is that the Volcker rule creates a good opportunity to buy good assets from banks that will have to sell.
It’s a bit of redux, back to the days of the Depression-era Glass Steagall Act. That act’s repeal in 1999, after a decade of a robust stock market in the U.S., was heralded as bringing banking law current with the new reality. No longer did the financial community have to keep the regulatory equivalent of a kosher household in terms of who could accept deposits and who could make trades. No more ‘two sets of dishes’! The market was essentially romanticized as being highly efficient and quick.
Well, let’s hear it from the man himself. Paul Volcker, quoted in The Wall Street Journal on Dec. 11, said: “Before the crisis we had lots of trading, lots of liquidity… what happened? We had a big balloon.” The market quickly proved to be just as efficient in wiping out gains when it was overloaded with dot-com speculation, and, less than a decade later, securitized mortgages.
So the Volcker Rule is bound to be bitter medicine for the biggest players, but it will result in a re-infusion of reality into the banking system, by concentrating banks’ risk-taking into entities which have a face – their borrowers.
