Deregulation danger: the U.S. federal regulators rolled back the Volcker Rule

26 Jun, 2020 11:18
source: Singularity Financial

Singularity Financial Hong Kong June 26, 2020 – Bank stocks surged as much as 3% on Thursday after federal regulators rolled back the Volcker Rule, a financial crisis-era rule that restricted banks from operating proprietary trading units and from acquiring or retaining ownership stakes in hedge funds or private equity funds.

It marked a continued relaxation of restriction under U.S. President Donald Trump. Last year, the Fed, Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corp. (FDIC) eased Volcker restrictions to allow lenders to engage in proprietary trading. That allows institutions to make market bets for themselves instead of on behalf of clients.

The new rule modifies “the Volcker rule’s prohibition on banking entities investing in or sponsoring hedge funds or private equity funds, known as covered funds,” the Fed said in a statement. “The final rule is broadly similar to the proposed rule from January.”

In a statement on the rule change, Rob Nichols, president and CEO of the American Bankers Association said, “We welcome the measured steps taken today by the FDIC, which will allow banks to further support the economy at this challenging time for the nation.”

The Volcker Rule

The Volcker Rule, part of the broader Dodd-Frank bill enacted in 2010 following the meltdown of big banks in 2008, sought to crack down on risky behavior by Wall Street firms. It was named after former Federal Reserve chair Paul Volcker, who passed away in December.

 The Volcker Rule was designed to prevent banks from acting like hedge funds. The general principle is that they are allowed to facilitate trades for clients, but not allowed to strap on risk for big proprietary bets.

The eventual collapse of the subprime mortgage market — loans to borrowers with poor credit histories — created a ripple effect that led to the collapse of Bear Stearns, Lehman Brothers, Washington Mutual and countless other firms.

The rule also barred banks from making potentially speculative investments using customers’ FDIC-insured deposits. That included venture capital funds, although lawmakers have said the VC industry may have been unfairly grouped with hedge funds and private equity.

Deregulation danger

The rule rollback, which was opposed by Democratic appointees at both the Fed and the FDIC, represents one of the biggest victories for the Trump administration’s deregulation drive.

While the banking industry has acknowledged the benefits of being required to hold more capital to cushion losses, lobbying groups and individuals including JPMorgan CEO Jamie Dimon have criticized parts of the post-financial crisis regulatory regime as being overly restrictive or redundant.

The looser restrictions approved on Thursday will allow banks to more easily make investments in various areas of venture capital.

The rule change will also allow banks to avoid having to set aside cash when making derivatives trades between different affiliates of the same firm. That change is expected to free up billions of dollars that banks will now have available for other investments.

Former Federal Deposit Insurance Corporation Chair Sheila Bair said the bank regulators’ moves were “ill-advised”:

“I think they’re significantly in the direction of deregulation. That’s kind of been the glide path we’ve been on for several years now, which I think directionally is the wrong way, and we’re paying for it now in terms of what we could have: larger capacity for banks to deal with the current pandemic. These two specific proposals I think are ill-advised, especially as a former chair of the FDIC. It won’t surprise you to hear me say that that $40 billion that will no longer be in banks to protect them against derivatives exposures that their affiliates are imposing on them is no longer there. I think that imperils, increases risk to the deposit insurance funds. So, I do think that’s ill-advised. And the Volcker Rule, they’ve been loosening that for years now. It’s been under constant assault. This, as I understand it, the rule change basically defers to banks to decide what’s proprietary or not. We went down that road with risk-based capital, in case you remember. We were basically letting banks decide how much capital they should have prior to the great financial crisis. So, been there, done that in a different context. It’s not a good idea. So, I think very disappointing, but it is what it is. I’m getting used to it with the current — I respect all of them, but I think they are directionally so going the wrong way on all of this.”