Policy Documents

Volcker Rule May Make the Financial and Banking System Riskier

David John –
April 26, 2012

By now, it should be clear even to casual observers that the Volcker Rule, which was intended to limit the “risky” activities of banks by banning them from certain types of transactions, will be nearly impossible to implement without severe unintended damage to the U.S. financial system and many other types of businesses both here in the U.S. and overseas.

Even though the Federal Reserve now says that banks will not have to fully comply with it until July 2014, they will have to show “good faith planning efforts” to prepare for full compliance in the interim. Combined with the continuing confusion about what the Volcker Rule will actually prohibit, the rule will continue to cause serious uncertainty about the structure and services provided by banks for at least the next two years. Since neither the banks nor the regulators have any idea what the final regulations will say, they will have no idea what constitutes good faith efforts to comply. Because of the continuing confusion and its effects on the financial system, Congress should immediately begin a serious re-examination of the Volcker Rule’s likely effect both in this country and abroad and repeal it as quickly as possible.

While many were concerned about the negative effects of the Volcker Rule before the Dodd–Frank financial regulation bill passed, the realities of the situation became clear last October, when four financial regulators jointly issued a 298-page draft regulation that would implement it. The fact that the regulators were extremely unclear themselves about what the Volcker Rule intended them to do and how they were supposed to implement the rule was made clear by the 394 separate questions about various bank services and how they are used by their customers that were contained in the draft regulations.

The situation is so bad that so far, three high-ranking finance officials—including former House Financial Services chairman Barney Frank (D–MA)—have either called for the regulators to scrap the current draft regulations and start over or have urged them to release a greatly simplified version. However, as the comments on the draft regulations show, it would be impossible for the regulators to create workable regulations anywhere close to the July 21, 2012, deadline in Dodd–Frank. In the meantime, the financial institutions that would be most affected are living in limbo, unable to plan for the future with any confidence.

The draft received 383 detailed responses and a roughly 18,500 additional form letters generated by various groups. The detailed responses included submissions expressing concern about the effect of the proposal from a number of foreign governments—including Canada, Japan, the United Kingdom, and the European Union—all of whom are worried that the Volcker Rule would limit liquidity in the global financial system and make it harder for it to recover from the 2008 recession. This concern was echoed by a number of U.S. state and local governments as well as the Municipal Securities Rulemaking Board, which regulates the sale of state and municipal securities. Clearly, the Volcker Rule would have harmful effects on many more entities than its intended target and could result in making future financial crises even worse than they would be otherwise.