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What’s the Volcker Rule and why should I care about it?

by: (Associate Director, Research and Development) on

The Volcker rule has been in the news a bit at the moment. But what is it and why should we care? Let’s take a look and see if we can answer that question. First port of call, Investopedia.

According to Investopedia

[The Volcker Rule is]… a federal regulation that prohibits banks from conducting certain investment activities with their own accounts, and limits their ownership of and relationship with hedge funds and private equity funds, also called covered funds. The Volcker rule’s purpose is to prevent banks from making certain types of speculative investments that contributed to the 2008 financial crisis.


OK so, so far we’ve got that this is a piece of US regulation designed to, boiling it down a bit, reduce risk and prevent another credit crisis situation occurring.


What’s this bit about funds?


Well essentially it’s centred round who will benefit from banks making these investments. It was observed that some banks were effectively using funds (including therefore the assets of their customers) to partake in short term speculative trading. This was designed to boost the banks own profit, not to create a return for investors, as such, and involved complex financial products such as derivatives and commodities futures. You know, that stuff that most people don’t really understand. But if it comes off you’re laughing.


The trouble is though, if it doesn’t come off (maybe the price of Orange Juice rises unexpectedly based on a poor crop) then the opposite happens. If you’d like to know more about this and fancy a somewhat less intense take on it, I’d recommend watching Trading Places


But I digress.


How did it come about?


Let’s go back to Investopedia for the historical take: 

Five federal agencies—the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Commodity Futures Trading Commission and the Securities and Exchange Commission—approved the final regulations that make up the Volcker Rule in December 2013. The rules, formally known as section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, went into effect April 1, 2014, with banks' full compliance required by July 21, 2015.


But it seems it wasn’t that straightforward. Banks could still undertake the activity I’ve outlined above on behalf of customers, but had to pay particular attention to (1) conflicts of interest and (2) exposing themselves, or the overall system, to high risk assets and therefore more systemic instability.


Think it’s starting to sound complicated? You’re not alone. Throw into the mix that different regulatory approaches are applicable to different sizes of firms, and you soon find that different compliance standards (and costs) become apparent. Reporting of trading activity is required, but this again depends on activity and size of institution. OK. Deep breath…


Was it all worth it then?


Arguably not. Which kind of brings us up to where we are today.


The Volcker Rule has been widely criticised. A top IMF official described it as “a rule that’s very difficult to enforce, because it’s very difficult to distinguish between what are proprietary trades and what are client trades. So it’s not clear how effective it is”.


Not a glowing endorsement then.  


The banks affected also highlighted the disparities, particularly focusing on the cost of compliance and how that balances against the actual benefits provide by the Rule. There have also been a lot of grumbles about what is actually covered, and a lack of liquidity in markets that actually having an adverse impact on customers.


This is why the Volcker Rule is back in the news at the moment. You may not be surprised to know that President Trump fancies making some changes to it, on the basis it hampers the growth of banks.


Volcker Rule


So why should I care?


So why should we care about the Volcker Rule? Because it’s there to protect us, the consumer. Some will argue that there is too much regulation, others that there’s not enough. That’s healthy debate. Like with many things, it’s about finding that balance. The Financial Times summed it up nicely:


All that said, the Volcker rule has plenty of proponents — from ordinary Americans (it may be the only piece of well-known financial regulation) right up to some senior bankers. The odd bank boss has even been known to thank Mr Volcker personally for helping change a flawed culture at their institution. At the very least it has helped restrain the worst excesses in trading.


If we don’t take an interest, we might end up looking back and wishing we had.


It’s been 10 years since the Credit Crunch. Just sayin’.


If you're keen to know more, take a look at the ICA International Diploma in Governance, Risk and Compliance > /qualifications/diploma-in-grc/

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Dawn said...
Excellent reference to 'Trading Places'...the complex world of commodities trading explained via pork bellies and oranges..
August 18, 2017 09:32


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