Why small banks need Volcker rule amendments

Author: | Published: 18 Sep 2012
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The Volcker rule is expected to result in a greater competitive disadvantage for small banks, even if regulators make improvements to the rule set to be finalised by the end of the year.

This is because section 619 of Dodd-Frank makes no mention of the size of institutions subjected to prohibitions on proprietary trading, and regulators are not thought to have the jurisdiction or the will to provide a small bank exemption not considered in the legislation.

Small banks do not have the compliance staff or resources of larger banks and could be captured by a largely unclear definition of proprietary trading that might include small-bank market-making, asset liability management and hedging activities.

"Dodd-Frank compliance is deepening and widening the moat around large banks, making it harder for small banks to compete with large banks," said Donald Lamson, a counsel at Shearman & Sterling who helped draft Dodd-Frank as an attorney with the Treasury Department.

Lamson said regulators have less authority to create exceptions in the Volcker rule than in other legislation.

"That’s one of the weaknesses in the drafting," Lamson added. "The ability to write a rule should be accompanied with the ability to make exceptions so unintended consequences can be minimised and mitigated."

An exemption for small banks will probably have to come in the form of a legislative fix. House Financial Services Committee chairman Spencer Bachus requested comment on Volcker rule alternatives last month in preparation for a hearing on possible legislation yet to be scheduled but expected this autumn.

The American Bankers Association (ABA) responded on the September 7 deadline. Among the ABA’s recommendations – first and foremost being total repeal of the Volcker rule – was a request that legislators sharpen the rule’s focus on what constitutes prohibited activities so small and mid-sized banks could manage their activities accordingly.

Timothy Keehan, vice president and senior counsel at the American Bankers Association, said the Volcker rule was clearly intended to regulate large banks, hedge funds and private equity funds based on how the administration introduced the rule and how Congress described it.

"Nowhere was it originally intended to have the Volcker rule provide to every single bank," Keehan said. "I don’t think the regulators would have comfort putting together an asset-size exemption [because] there was nothing in the legislation talking about a particular type of institution or size of institution."

Administrative turf

Regulators, while hampered in their ability to provide an exemption for small banks, might be able to provide some guidance on the activities that expose them to Volcker rule violations. This is not an area of much optimism, though.

Dodd-Frank delegates Volcker Rule implementation and enforcement authority to the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Securities & Exchange Commission, the Office of the Comptroller of the Currency and the Commodity Futures Trading Commission (CFTC). Regulators issued a proposal last October, with the CFTC releasing its companion proposal months later.

It might be difficult for five different regulators to agree on some focused definitions of the activities qualifying as proprietary trading. Bankers’ attorneys are concerned the final rule could result in fragmented regulation.

"It could possibly be a disordered, patchwork quilt of regulations and interpretations – that’s the fear," said Keehan.

The ABA, in its comment letter to chairman Bachus, suggested legislation to name the Federal Reserve as the lead agency for interpretation of the Volcker rule.

"That’s the way to have written this," Keehan said. "The Federal Reserve with consultation should have final interpretive authority."

FDIC chairman Martin Gruenberg said on Friday the Volcker rule is on pace to be finalised by the end of the year. Banks would be required to comply by July 2014 if the rule is finalised without legislative changes – unexpected in absence of a Republican majority of 60% needed to prevent a filibuster in the Senate.