The Volcker Rule

What Is the Volcker Rule?

The Volcker Rule is a federal regulation that generally prohibits banks from directing certain investment activities with their own accounts and limits their dealings with hedge funds and private equity funds, likewise called covered funds.

Understanding the Volcker Rule

The Volcker Rule aims to shield bank customers by keeping banks from making certain types of speculative investments that contributed to the 2007-2008 financial crisis. Essentially, it prohibits banks from involving their own accounts for short-term proprietary trading of securities, derivatives, and commodity futures, as well as options on any of these instruments.

In August 2019, the U.S. Office of the Comptroller of the Currency (OCC) casted a ballot to revise the Volcker Rule trying to explain what securities trading endlessly was not permitted by banks. On June 25, 2020, Federal Deposit Insurance Corp. (FDIC) officials said the agency will loosen the limitations of the Volcker Rule, permitting banks to all the more effectively make large investments into venture capital and comparable funds.

The Volcker Rule aims to shield bank customers by keeping banks from making certain types of speculative investments that contributed to the 2007-2008 financial crisis.

Also, banks won't need to set to the side as much cash for derivatives trades among various units of a similar firm. That requirement had been put in place in the original rule to guarantee that banks wouldn't get cleared out assuming speculative derivative wagers turned out badly. Loosening those requirements could free up billions of dollars in capital for the industry.

The Volcker Rule is named after economist and former Federal Reserve (Fed) Chair Paul Volcker, who kicked the bucket on Dec. 8, 2019, at age 92. The Volcker Rule alludes to section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which sets forward rules for executing section 13 of the Bank Holding Company Act of 1956.

The Volcker Rule likewise bars banks, or insured depository institutions, from getting or holding ownership interests in hedge funds or private equity funds, subject to certain exemptions. As such, the rule aims to discourage banks from taking too much risk by banishing them from utilizing their own funds to make these types of investments to increase profits. The Volcker Rule depends on the reason that these speculative trading activities don't benefit banks' customers.

The rule came full circle on April 1, 2014, with banks' full compliance required by July 21, 2015 — albeit the Fed has since set procedures for banks to request extended opportunity to change into full compliance for certain activities and investments. On May 30, 2018, Fed board individuals, drove by Chair Jerome "Jay" Powell, casted a ballot consistently to push forward a proposal to loosen the limitations around the Volcker Rule and reduce the costs for banks that need to follow it. The goal, as per Powell, was "...to replace excessively complex and inefficient requirements with a more streamlined set of requirements."

The rule, as it exists, permits banks to proceed market making, underwriting, hedging, trading government securities, taking part in insurance company activities, offering hedge funds and private equity funds, and acting as agents, brokers, or custodians. Banks might keep on offering these services to their customers to produce profits. Notwithstanding, banks can't engage in these activities in the event that doing so would make a material conflict of interest, open the institution to high-risk assets or trading strategies, or create flimsiness inside either the bank or the overall U.S. financial system.

Contingent upon their size, banks must meet differing levels of reporting requirements to uncover subtleties of their covered trading activities to the government. Larger institutions must carry out a program to guarantee compliance with the new rules, and their programs are subject to independent testing and analysis. More modest institutions are subject to lesser compliance and reporting requirements.

Extra History of the Volcker Rule

The rule's beginnings date back to 2009, when Volcker proposed a piece of regulation in response to the continuous financial crisis (and after the country's largest banks accumulated large losses from their proprietary trading arms) that aimed to deny banks from hypothesizing in the markets. Volcker eventually wanted to restore the split between commercial banking and investment banking — a division that once existed however was legally disintegrated by a partial nullification of the Glass-Steagall Act in 1999.

Albeit not a part of then-President Barack Obama's original proposal for financial upgrade, the Volcker Rule was embraced by Obama and added to the proposal by Congress in January 2010.

In December 2013, five federal agencies — the Board of Governors of the Fed; the FDIC; the OCC; the Commodity Futures Trading Commission (CFTC); and the Securities and Exchange Commission (SEC) — endorsed the last regulations that make up the Volcker Rule.

A bank might be excluded from the Volcker Rule on the off chance that it doesn't have more than $10 billion altogether consolidated assets and doesn't have total trading assets and liabilities of 5% or a greater amount of total consolidated assets.

Analysis of the Volcker Rule

The Volcker Rule has been widely censured from different angles. The U.S. Chamber of Commerce claimed in 2017 that a cost-benefit analysis was never finished and that the costs associated with the Volcker Rule offset its benefits. That very year, the top risk official of the International Monetary Fund (IMF) said that regulations to forestall speculative wagers are difficult to implement and that the Volcker Rule could unexpectedly lessen liquidity in the bond market.

The Fed's Finance and Economics Discussion Series (FEDS) put forward a comparative viewpoint, saying that the Volcker Rule will reduce liquidity due to a reduction in banks' market-production activities. Moreover, in October 2017, a Reuters report revealed that the European Union (EU) had rejected a drafted law that many characterized as Europe's solution to the Volcker Rule, refering to not a single foreseeable agreement to be found. In the mean time, several reports expectedly affect the incomes of big banks soon after the rule's enactment — albeit progressing improvements in the rule's implementation could influence future operations.

Fate of the Volcker Rule

In February 2017, then, at that point President Donald Trump marked an executive order coordinating then-Treasury Secretary Steven Mnuchin to survey existing financial system regulations. Since the executive order, Treasury officials have delivered various reports proposing changes to Dodd-Frank, including a prescribed proposal to permit banks greater exemptions under the Volcker Rule.

In one of the reports, delivered in June 2017, the Treasury said it prescribes massive changes to the Volcker Rule while adding that it doesn't support its nullification and "supports on a basic level" the rule's limitations on proprietary trading. The report remarkably suggests absolving from the Volcker Rule banks with under $10 billion in assets. The Treasury additionally refered to regulatory compliance loads made by the rule and suggested rearranging and refining the meanings of proprietary trading and covered funds on top of relaxing the regulation to permit banks to all the more effectively hedge their risks.

Since the June 2017 assessment, Bloomberg reported in January 2018 that the OCC has driven efforts to change the Volcker Rule as per a portion of the Treasury's proposals. A course of events for any proposed updates to produce results stays indistinct, however it would certainly require months or years. In June 2020, bank regulators loosened one of the Volcker Rule provisions to permit lenders to invest in venture capital funds and different assets.

After the election of President Joseph Biden in 2020, the new administration flagged its support to reverse the Trump period decreases to the financial system regulations.

The Bottom Line

The Volcker Rule is expected to confine high-risk, speculative trading activity by banks, for example, proprietary trading or investing in or supporting hedge funds or private equity funds. It keeps up with banks' capacities to offer important customer-situated financial services, for example, underwriting, market making, and asset management services.
The regulations have been developed by five federal financial regulatory agencies, all portrayed over: the Federal Reserve Board; the CFTC; the FDIC; the OCC; and the SEC.

Features

• On June 25, 2020, Federal Deposit Insurance Corp. (FDIC) officials said the agency will loosen the limitations of the Volcker Rule, permitting banks to all the more effectively make large investments into venture capital and comparable funds.
• The primary analysis of the Volcker Rule is that it will reduce liquidity due to a reduction in banks' market-production activities.
• The Volcker Rule prohibits banks from involving their own accounts for short-term proprietary trading of securities, derivatives, and commodity futures, as well as options on any of these instruments.

FAQ

What are the primary reactions of the Volcker Rule?

The Volcker Rule has been widely reprimanded from different angles. The U.S. Chamber of Commerce claimed in 2017 that a cost-benefit analysis was never finished and that the costs associated with the Volcker Rule offset its benefits. The Fed's Finance and Economics Discussion Series (FEDS) contended that the Volcker Rule will reduce liquidity due to a reduction in banks' market-production activities. Moreover, International Monetary Fund (IMF) analysts have contended that regulations to forestall speculative wagers are difficult to authorize.

What was the Glass-Steagall Act?

Prodded by the disappointment of very nearly 5,000 banks during the Great Depression, the Glass-Steagall Act was passed by the U.S. Congress as part of the Banking Act of 1933. Sponsored by Sen. Carter Glass, a former Treasury secretary, and Rep. Henry Steagall, chair of the House Banking and Currency Committee, it denied commercial banks from participating in the investment banking business and vice versa. The reasoning was the conflict of interest that emerged when banks invested in securities with their own assets, which of course were actually their account holders' assets. Basically, the bill's defenders contended that banks had a fiduciary duty to safeguard these assets and not to engage in unnecessarily speculative activity.

What was the goal of the Volcker Rule?

The Volcker Rule's starting points date back to 2009, when economist and former Federal Reserve (Fed) Chair Paul Volcker proposed a piece of regulation in response to the continuous financial crisis (and after the country's largest banks accumulated large losses from their proprietary trading arms). The aim was to safeguard bank customers by keeping banks from making certain types of speculative investments that contributed to the crisis.Essentially, it prohibits banks from utilizing their own accounts (customer funds) for short-term proprietary trading of securities, derivatives, and commodity futures, as well as options on any of these instruments. Volcker at last wanted to restore the split between commercial banking and investment banking — a division that once existed however was legally broken down by a partial nullification of the Glass-Steagall Act in 1999.