Federal Reserve Proposes Banking Rule Reform

Published July 12, 2018

The Federal Reserve and Trump administration agencies will solicit public comments on a proposed change to the Volcker Rule, a provision of the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010, commonly referred to as “Dodd-Frank.”

Under the proposed rule, banks with less than $10 billion in assets or engaging in trades held for 60 days or less would no longer have to provide regulators with documentation of compliance with the rule when engaging in financial activity.

The current provision, named after former Federal Reserve Chairman Paul Volcker, prohibits commercial banks from owning investment firms or investing their own money instead of using depositors’ money.

Banks are currently required to provide evidence that all investments are compliant with the Rule, regardless of the bank’s size or the specific nature of the activity.

The rule change will be an interagency proposal issued by the Federal Deposit Insurance Corporation, U.S. Treasury’s Office of the Comptroller of the Currency, the Commodity Futures Trading Commission, and the Securities and Exchange Commission (SEC).

Once the cooperating agencies have agreed on a proposed rule, public comments will be accepted for 60 days after publication in the Federal Register.

Markets for Main Street

Daniel Press, a policy analyst at the Competitive Enterprise Institute, says the Volcker Rule makes borrowing more expensive for everyday people.

“‘Main Street consumers’ very strongly rely on well-functioning capital markets,” Press said. “Things like credit card debt, student loans, and mortgages are all packaged up into securities that are sold and traded into capital markets. You need to act as market-makers for these kinds of assets to actually keep liquidity flowing through the system and be able to hold down prices for consumers.”

Thomas Jacobs, a visiting assistant professor of finance at Northern Illinois University, says the Volcker Rule is an attempt to reduce taxpayer risk created by government guarantees of people’s bank deposits.

“The Volcker Rule was implemented as part of Dodd-Frank Act and limits the activity in which banks can engage,” Jacobs said. “They are prohibited from having direct activities in hedge funds and doing any proprietary trading. Essentially, any kind of risky activities that might expose the taxpayers, who are providing the deposit insurance, are supposed to be stricken, as of the Volcker Rule.”

Restoring Liquidity

Jacobs says the proposed change would restore the presumption of innocence in some financial transactions.

“Financial institutions with less than $10 billion in assets will be exempt from having to show regulators they are not doing proprietary trading,” Jacobs said. “The biggest issue regarding this change is the fact that it is very hard to tell the difference between a bank that is doing proprietary trading and a bank that is making markets for its customers.”

Press says the Volcker Rule artificially restricts the availability of investment capital, increasing the cost of loans for everybody.

“When there is more liquidity in the market for these things, there isn’t as much risk and as much price attached,” Press said. “Having well-functioning capital markets, which proprietary trading or trading these kinds of assets provides, allows for cheaper credit card debt, student loan debt, mortgages, and things along these lines. The Volcker rule, by trying to prohibit proprietary trading, makes legitimate trading by banks harder and therefore raises the price of things like securitized credit card debt, student loan debt, and mortgages.”

‘Conceptually Flawed’ Rule

Press says the Volcker Rule is a presumed solution to a problem that never existed.

“They issued the Volcker Rule because Paul Volcker’s thesis was that proprietary trading contributed to the 2008 financial crisis, which I and many other people find very debatable,” Press said. “The Volcker Rule that came out of this idea is conceptually flawed from the start. If you look at the kinds of institutions that actually failed during the crisis, the investment banks like Bear Sterns or Lehman Brothers had no commercial banking arm, which means they had no federally insured deposits to actually make speculative bets or do proprietary trading.

“On the other hand, the commercial banks that failed didn’t do so because of proprietary trading,” Press said. “They failed because of the subprime mortgage lending.”

Press says the crisis Dodd-Frank was intended to stop from happening again was caused by bad bank loans, not investment trades.

“The crisis really wasn’t actually about risky trading,” Press said. “It was more about poor lending practices. This whole idea that somehow banks’ trading activity is more risky than general commercial lending activities, the core concept of the Volcker Rule, is flawed.”