Policy Documents

Market Making Under the Proposed Volcker Rule

Darrell Duffie –
January 16, 2012

This submission discusses implications for the quality and safety of financial markets of proposed rules implementing the market-making provisions of section 13 of the Bank Holding Company Act, commonly known as the “Volcker Rule.” The proposed rules have been described by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Securities and Exchange Commission. The Agencies’ proposed implementation of the Volcker Rule would reduce the quality and capacity of market making services that banks provide to U.S. investors. Investors and issuers of securities would find it more costly to borrow, raise capital, invest, hedge risks, and obtain liquidity for their existing positions. Eventually, non-bank providers of market-making services would fill some or all of the lost market making capacity, but with an unpredictable and potentially adverse impact on the safety and soundness of the financial system. These near-term and longer-run impacts should be considered carefully in the Agencies’ cost-benefit analysis of their final proposed rule. Regulatory capital and liquidity requirements for market making are a more cost effective method of treating the associated systemic risks.