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Report: Weakened Volcker Rule Will Be More Enforceable Than Current Regime

Looser banking regulations would better align with existing banking practices, while offering banks more flexibility in hedging and potentially improving liquidity, consultants say.

As the Federal Reserve seeks feedback on its proposed changes to the Volcker rule, it has become apparent that the biggest beneficiaries of the potential revisions would be overburdened banks, according to consulting firm Oliver Wyman.

The Fed’s proposed loosening of banking regulations would better align with existing banking practices, consultants Clinton Lively, Til Schuermann, and Christopher Spicer explained in a new report,  “Triumph of Risk Management Over Psychiatry: Revisions to the Volcker Rule.” The adjusted rule would also “significantly roll back the level of analysis required to demonstrate hedge effectiveness,” offering banks more flexibility and potentially improving liquidity.

These characteristics, the authors argued, are the makings of a regulatory regime that would be more enforceable than current regulations.

The Federal Reserve first published its proposed revisions to the Volcker rule, the banking regulation enacted in 2015 as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, on May 30.

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The proposal included 342 questions seeking public comment from institutions affected by the rule’s implementation. As it stands now, institutions have 45 days to respond to these questions with suggestions for the new regime.

“We therefore think that the door is open for banks and other financial services firms to engage in the revised rule making process in a significant and meaningful way,” the authors wrote.

The current Volcker rule was intended to eliminate proprietary trading and investments in hedge funds and private equity firms on the part of banks, while still allowing banks to engage in activities such as market making, hedging, underwriting, and transacting in U.S. government securities, according to the report. 

However, it resulted in regulations that were “complex” and “burdensome” to implement, the consultants argued. If the rules are changed, Lively, Schuermann, and Spicer said banks with limited and moderate trading operations would benefit the most.

These limited trading banks, which have very low trading volume, will have no obligation to show that they’re in compliance with the rules. Similarly, so-called moderate trading banks will no longer need to have specific Volcker compliance departments. According to the report, they can likely fold the remaining regulations into their current compliance program’s efforts. 

Banks with significant trading functions also stand to benefit: The amount of compliance requirements would be reduced, allowing banks to determine their risk appetite internally, the report said. 

At all levels of trading, the proposed changes would give banks more leeway in hedging activities. “This will allow firms to increase engagement in markets and potentially improve liquidity by removing an existing disincentive to assume risk they could be prevented from managing,” the authors concluded.

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