On May 30, 2018, the Federal Reserve proposed rules to simplify compliance requirements relating to the "Volcker rule," which was established after the global financial crisis of 2008, and prevented taxpayer-insured banks from engaging in risky proprietary trading, and from owning or controlling hedge funds or private equity funds. The Fed’s proposed changes do not go against the rule’s core principles of prohibiting banking entities from making risky financial bets, but aim to ease the nightmarish burden of compliance. While these changes appear to only benefit big banks, they will provide much needed relief to small banks and credit unions, especially those not engaged in significant securities trading activity.Volcker Rule Created Regulatory Nightmare
Since the Volcker rule was finalized in December 2013, its complexity created compliance uncertainty and excessive burden of proof for firms subject to the rule. As Fed Chairman Jerome Powell noted:
"Our goal is to replace overly complex and inefficient requirements with a more streamlined set of requirements . . . in ways that will allow firms to conduct appropriate activities without undue burden, and without sacrificing safety and soundness."
Proposed Changes (aka Volcker 2.0)
The Fed plans to focus on firms with the highest levels of trading activity, clarify and simplify compliance rules, and promote safety and soundness while reducing unnecessary burdens. Proposed changes to the Volcker rule, dubbed Volcker 2.0, would:
- Continue to ban proprietary trading, whereby the bank uses its own capital to make speculative bets
- Simplify the process for determining which types of trading are permitted (such as market-making and hedging) and which aren’t (such as proprietary trading)
- Selectively allow banks to hold stakes in hedge funds
- Tailor compliance requirements based on the size of a firm's trading assets and liabilities, with the most stringent requirements applied to firms with the most trading activity
- Simplify the “trading activity information” that banking entities are required to disclose
Reaction to Volcker 2.0
Financial institutions welcomed the proposed changes but insisted they did not go far enough.
Consumer advocates, however, are concerned that an easing of restrictions would let banks revert to their old ways of speculative risk-taking in their quest for higher profits, and precipitate another banking crisis down the road.
And here’s what Paul Volcker, the rule’s original architect had to say on the Fed’s proposed changes:
“I welcome the effort to simplify compliance with the Volcker Rule. What is critical is that simplification not undermine the core principle at stake - that taxpayer-supported banking groups, of any size, not participate in proprietary trading at odds with the basic public and customers’ interests. I trust the final rule will strongly maintain that position by, as intended, facilitating its practical application.”
Our Take: Volcker 2.0 will Benefit Small Banks and Credit Unions
The Fed’s proposed changes will not go into effect until after a 60-day comment period and approval by four other banking regulators - the Commodity Futures Trading Commission (CFTC), the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), and the Securities and Exchange Commission (SEC). So the final version of Volcker 2.0 could yet see some changes.
But what’s clear is that the Fed’s proposed changes to the Volcker rule, a related recent bipartisan measure to exempt small banks and credit unions from the Dodd-Frank Wall Street reform law, and the Fed’s earlier proposal to ease stress testing go a long way in reducing systemic regulatory cholesterol and should boost the fortunes of smaller financial institutions.