Power in Financial Reform

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Wall Street is entering an uncertain new era as the Volcker Rule — the regulation at the heart of Washington’s efforts to rein in financial risk-taking — takes hold. The rule, a copy of which was reviewed by The New York Times, imposes some requirements that are tougher than the banks had wanted. Five federal agencies are expected to vote to approve it on Tuesday — though some might do so in private because of inclement weather in the Washington area.

Named after former Federal Reserve Chairman Paul Volcker, The Volcker rule separates investment banking, private equity and proprietary trading (hedge fund) sections of financial institutions from their consumer lending arms. Banks are not allowed to simultaneously enter into an advisory and creditor role with clients, such as with private equity firms. The Volcker rule aims to minimize conflicts of interest between banks and their clients through separating the various types of business practices financial institutions engage in. The rule was introduced following the recession of 2008, to control the risk associated with the financial sector. Wall Street banks were accused of accumulating an excessive amount of risk and unfair business practices due to the inability of regulators to properly monitor their complex instruments and activities. The Volcker rule aims to protect individuals by creating a more transparent financial framework which can be regulated with greater ease.

  

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The rule also allows banks to do proprietary trades in bonds issued by governments. United States banks can make bets with Treasuries and even municipal bonds. In a significant concession, the Volcker Rule allows the foreign affiliates of United States banks to trade in bonds issued by foreign governments.

The Wall Street Journal reports that five U.S. financial regulatory agencies are expected to approve the rule, which bans banks from making bets with their own money and limits their ability to invest in certain trading vehicles, such as hedge funds and private-equity vehicles.

The rule, which hasn’t been publicly released, will require banks to provide “demonstrable analysis of historical customer demand” for financial assets they buy and sell on behalf of clients.

Dealbook New York Times states that at its core, the rule bans banks from trading for their own gain. The practice, known as proprietary trading, is one of Wall Street’s most lucrative — and riskiest — activities.

Image Credit: New York Times