Craftsmen who want to strike irons into shapes that suit them know that the iron must be hot and their hammers must be ready. This is true for craftsmen of financial regulations as well. Five craftsmen of financial regulations in the US—Federal Reserve, CFTC, FDIC, OCC and SEC—yesterday issued final rules to craft the ‘Volcker rule’, a regulation named after former Federal Reserve chairman Paul Volcker. The Volcker rule prohibits insured depository institutions and companies affiliated with insured depository institutions, i.e. banking entities, from engaging in short-term proprietary trading of certain securities, derivatives, futures and options on these instruments, for their own proprietary account. The Volcker rule also imposes limits on banking entities' investments in, and other relationships with, hedge funds or private equity funds.
Regulatory irons were heated in the aftermath of the sub-prime crisis when major investment banks were in trouble. Some regulators and academics blame the 2008 financial crisis on Glass-Steagall’s repeal, at least in part. It was therefore an appropriate time for the regulatory craftsmen to reinstate the commercial banking—investment banking firewall by introducing the Volcker rule. The Volcker rule, in my view, is the regulator’s ‘fremium’ version of the Glass-Steagall Act—banks now don’t have to pay a regulatory cost for the basic banking services, but there are regulatory tabs attached for the more exotic financial services. Glass-Steagall prevented a certain type of institution, whereas the Volcker rule prevents a certain activity. For instance, a bank like JPMorgan Chase, which takes deposits and makes trades, would be prohibited under the Glass-Steagall Act, but under the Volcker rule, JPMorgan can still exist but it just wouldn’t be able to make certain types of trades, especially the proprietary ones.
Just because the regulators have stuck when the iron is hot doesn’t necessarily mean that they have stuck well. If the Volcker rule works the way it is intended, a bank’s profit in a few years would only be derived from the difference between interest earned on loans and interest paid on deposits—the way banking was done in the good old days. However, the transition seems unlikely to happen.
First of all,