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What is the Volcker Rule that five regulators just approved?

All five financial regulatory agencies have approved a ban on big banks’ proprietary trading, named for its chief proponent, former Federal Reserve chair Paul Volcker, center. Photo Ralph Alswang for Flickr user Third Way.

In 2008, in the wake of the financial crisis, the now 86-year-old Paul Volcker, who served as Fed chairman in the 1970s and 1980s, proposed a ban on big banks making risky bets for their own benefit. As a top adviser to President Barack Obama, he was eager to prevent the kind of instability that had necessitated a taxpayer-funded bailout of financial institutions that benefited from federal deposit insurance.
There’s a reason this sounds familiar. The Volcker Rule was codified in the 2010 Dodd-Frank financial reform law that Sens. Carl Levin, D-Mich., and Jeff Merkley, D-Ore., pushed through Congress. (Two-thirds of the regulations in Dodd-Frank are not fully drafted yet.) Since then, America’s financial regulators have been haggling over the actual writing of the Volcker Rule — with a lot of lobbying from the financial industry.

The Federal Reserve, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, the Commodity Futures Trading Commission and the Office of the Comptroller of the Currency approved the rule Tuesday. Banks will have until July 2015 to comply.

Proponents of the rule hope that it will make banks’ money safer because they won’t be able to engage in proprietary trading, which is when they make bets on stocks and bonds (with money people have deposited in the bank) to make more money for themselves, as opposed to buying and selling securities on behalf of clients. The rule also restricts some other kinds of risky hedge fund investing. But banks can still hedge — that is, trade assets to protect their other holdings.

In short, the complex rule establishes which are legitimate trades banks can make and which aren’t. But making that distinction troubled regulators, who in some cases, won’t know whether a trade was intended to increase the bank’s profits or protect their other holdings against loss in the market.

Some of the rule’s critics are afraid the rule will over-regulate and clamp down on market-making that they say stimulates the economy. The banking industry lobbied regulators intensely for the past three years to try to whittle down the list of what’s not allowed.

Despite that pressure, regulators seemed to have toughened some aspects of the rule released Tuesday, compared to earlier draft versions. In its current form, the rule mandates that bank CEOs annually attest to taking steps to comply with the rule, which banks had objected to. JPMorgan’s $6.2 billion loss from placing bets in the “London Whale” trading scandal encouraged regulators to tighten up on some of the exemptions banks had been fighting for.

Other critics, however, don’t think the rule — what former Sen. Ted Kaufman, D-Del., calls Glass Steagall lite — goes far enough to crack down on banks that they fear are ready to exploit its loopholes and ambiguities. (Glass Steagall, until the 1990s, separated commercial banks and securities firms.)

Many banks have already closed down their proprietary trading desks, so it will be up to the five regulatory agencies charged with implementing and enforcing the rule to decide which trades are now truly proprietary.

This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions

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