{“text”:"## What Is the Volcker Rule?
The Volcker Rule is a federal regulation that prohibits banks from engaging in certain investment activities using their own accounts and limits their involvement with hedge funds and private equity funds, also known as covered funds.
Key Takeaways
- The Volcker Rule restricts banks from short-term proprietary trading of securities, derivatives, commodity futures, and options on these instruments using their own accounts.
- As of June 25, 2020, the Federal Deposit Insurance Corp. (FDIC) announced plans to loosen the Volcker Rule restrictions, making it easier for banks to invest in venture capital and similar funds.
- The main criticism of the Volcker Rule is its potential to reduce liquidity due to decreased market-making activities by banks.
Understanding the Volcker Rule
The Volcker Rule aims to safeguard bank customers by preventing banks from making speculative investments that contributed to the 2007-2008 financial crisis. Specifically, it bars banks from short-term proprietary trading of securities, derivatives, commodity futures, and options on these instruments.
In August 2019, the U.S. Office of the Comptroller of the Currency (OCC) voted to amend the rule to clarify permissible securities trading activities. On June 25, 2020, FDIC officials announced further relaxation of the Volcker Rule, allowing banks to more easily invest in venture capital and similar funds.
Additionally, banks are no longer required to set aside as much capital for derivatives trades within the same firm, potentially freeing up billions of dollars for the industry.
Named after former Federal Reserve Chair Paul Volcker, the rule is part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. It aims to prevent banks, or insured depository institutions, from holding ownership stakes in hedge funds or private equity funds to decrease the risk associated with using their own funds for profit-driven investments.
Serial compliance with the rule started on April 1, 2014, with full compliance required by July 21, 2015. The Federal Reserve allows banks to request extended time for transitioning certain activities to full compliance.
The rule grants banks leeway in continuing market making, underwriting, hedging, trading government securities, and offering services related to hedge funds and private equity funds. However, banks can only engage in these transactions if they do not pose a material conflict of interest, high risk, or lead to financial instability within the institution or the U.S. financial system.
Compliance varies by the size of the institution; larger banks are subject to more rigorous reporting and independent testing requirements, while smaller banks face lesser requirements.
Additional History of the Volcker Rule
Paul Volcker proposed the rule in 2009 during the ongoing financial crisis to prevent banks from speculative trading in the markets\u2014a divide reemergence between commercial and investment banking that was partially repealed with the Glass-Steagall Act in 1999.
It became part of legislator\u2019s plans when approved in December 2013 by five federal agencies: the Federal Reserve, FDIC, OCC, Commodity Futures Trading Commission (CFTC), and Securities and Exchange Commission (SEC). A bank with less than $10 billion in assets, and with trading assets and liabilities comprising less than 5% of total assets, may be excluded from the Volcker Rule.
Criticism of the Volcker Rule
Critiques reveal that the rule has not been cost-benefit analyzed and that its implementation could decrease liquidity in financial markets due to a reduction in market-making activities. According to analyses by the International Monetary Fund (IMF) and the Fed\u2019s Finance and Economics Discussion Series (FEDS), the rule presents enforcement challenges and potential liquidity reductions. European Union (EU) abandoned a similar directive citing consensus difficulties.
Future of the Volcker Rule
In 2017, President Donald Trump directed then-Treasury Secretary Mnuchin to review financial regulations, leading to Treasury officials recommending easing the Volcker Rule. Treasury’s 2017 reports suggested significant changes without outright repealing it, advocating exemptions for small banks and refined definitions for proprietary trading and covered funds.
In June 2020, bank regulators scaled down provisions, allowing investments in venture capital and other assets. Under President Biden’s administration, indications are that some Trump-era deregulations may reverse.
The Goal of the Volcker Rule
The Volcker Rule originated to protect customers by preventing banks from making speculative investments contributing to the financial crisis. It aims to reinstate the divide between commercial and investment banking, partially repealed in 1999.
Main Criticisms of the Volcker Rule
Criticides argue that the rule faces implementation hurdles and unintended consequences like reduced market liquidity. The regulatory compliance burden opposed cost-benefit suitability assessed post-adjudication.
What Was the Glass-Steagall Act?
Introduced during the Great Depression, Glass-Steagall Act separated commercial and investment banking to mitigate conflicts of interest and protect account holders’ assets from overly speculative practices. The act held until its partial repeal in 1999.
The Bottom Line
The Volcker Rule aims to control speculative, high-risk activities by banks, like proprietary trading and investments in hedge funds and private equity funds while preserving services beneficial to customers, such as underwriting and market making, within federal financial regulatory agency frameworks.
Related Terms: Dodd-Frank Act, Glass-Steagall Act, Financial Crisis, Federal Reserve, FDIC.
References
- Federal Deposit Insurance Corp. “Statement by FDIC Chairman Jelena McWilliams on the Final Rule: Revisions to Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds”.
- U.S. Office of the Comptroller of the Currency. “Comptroller of the Currency Approves Volcker Rule Reforms”.
- Federal Deposit Insurance Corp. “Fact Sheet: Financial Regulators Issue Rule to Modify Volcker ‘Covered Fund’ Provisions and Support Capital Formation”.
- Federal Reserve History. “Paul A. Volcker”.
- U.S. Securities and Exchange Commission. “Responses to Frequently Asked Questions Regarding the Commission’s Rule Under Section 13 of the Bank Holding Company Act (the ‘Volcker Rule’)”.
- Federal Reserve System. “Volcker Rule”.
- U.S. Office of the Comptroller of the Currency. “Volcker Rule Implementation”.
- Federal Reserve System. “Board Votes 2018”.
- Federal Reserve System. “Opening Statement on the Volcker Rule Proposal by Chairman Jerome H. Powell”.
- U.S. Commodity Futures Trading Commission. “Final Rules to Implement the ‘Volcker Rule’”, Page 3.
- Bipartisan Policy Center, via U.S. Securities and Exchange Commission. “A Better Path Forward on the Volcker Rule and the Lincoln Amendment”, Pages 10–14.
- U.S. Chamber of Commerce. “Statement of the U.S. Chamber of Commerce”.
- Bloomberg | Quint. “IMF Calls Volcker Rule Hard to Enforce and Threat to Liquidity”.
- Federal Reserve System. “Finance and Economics Discussion Series, Divisions of Research & Statistics and Monetary Affairs: The Volcker Rule and Market-Making in Times of Stress”.
- Reuters. “EU Scraps Its Answer to U.S. Volcker Rule for Banks”.
- U.S. Department of the Treasury. “Treasury Releases Report on Nonbank Financials, Fintech, and Innovation”.
- U.S. Department of the Treasury. “A Financial System That Creates Economic Opportunities: Banks and Credit Unions”, Pages 21–22 (Pages 27–28 of PDF).
- Bloomberg. “A Wall Street Ally Leads the Charge to Roll Back the Volcker Rule”.
- Bloomberg | Quint. “IMF Calls Volcker Rule Hard to Enforce and Threat to Liquidity”.
- Federal Reserve Bank of St. Louis, FRASER. “Banking Act of 1933 (Glass-Steagall Act)”.
