Regulators say will strike balance on Volcker rule

WASHINGTON Wed Jan 18, 2012 1:44pm EST

A picture illustration shows U.S. 100 dollar bank notes taken in Tokyo August 2, 2011.   REUTERS/Yuriko Nakao

A picture illustration shows U.S. 100 dollar bank notes taken in Tokyo August 2, 2011.

Credit: Reuters/Yuriko Nakao

WASHINGTON (Reuters) - Regulators said on Wednesday they believe their agencies could implement a ban on proprietary trading without crushing banks' ability to buy and sell securities on behalf of customers.

The 2010 Dodd-Frank financial oversight law's Volcker rule prevents banks that receive government backstops such as deposit insurance from making risky trades with their own funds.

Supporters of the crackdown say it will make the financial system safer and more stable.

Regulators, who released a proposed plan in October, have been under pressure from the banking industry since then, and last month extended the comment period into February to allow more time for additional commentary.

Banks have strenuously argued the trading restrictions will have unintended consequences, freeze up liquidity and harm the economy.

Regulators said at a House of Representatives hearing on the Volcker rule that while implementing the measure will be difficult, it can be done without greatly affecting so-called market-making activities.

A market maker is a broker-dealer firm that accepts the risk of holding a certain number of shares of a particular security in order to facilitate trading in that security.

Many dealers fear the Volcker rule will prevent them from performing market-making functions.

"I think can we can administer it in a very rational way," Securities and Exchange Commission Chairman Mary Schapiro told a House Financial Services Committee panel.

The implementation of the Volcker rule, named after former Federal Reserve Chairman Paul Volcker who championed the measure, has been one of the most heavily lobbied parts of Dodd-Frank.

Regulators released a proposal in October and are currently gathering feedback.

The trading restrictions will have the biggest impact on large banks including Goldman Sachs and Morgan Stanley.

The chief complaint in the industry is that the Volcker rule will greatly disrupt the ability of banks to make markets for customer trades because these activities will be difficult to differentiate from banned proprietary trades.

Proprietary trading is when a firm trades for direct gain instead of commission dollars.

Regulators on Wednesday acknowledged that making this distinction will be their biggest challenge, but they expressed confidence that it can be done.

"I think we can," said Federal Reserve Governor Daniel Tarullo.

Tarullo and other regulators say they understand banks' concerns and have been soliciting feedback to ensure market making activities are affected as little as possible.

Republicans at the hearing were skeptical, arguing the law requires regulators to determine the intent of trades when deciding if the law is being broken.

"When we have to interpret people's motives, we're on thin ice," said House Financial Services Committee Chairman Spencer Bachus.

Regulators said the trading restrictions would likely have some impact on liquidity in trading markets.

How much, they said, would depend on market response to a final rule and how much firms outside the banking industry fill whatever hole is left by the Volcker rule restrictions.

Republicans used the hearing to skewer the premise behind the Volcker rule arguing proprietary trading was not a cause of the 2007-2009 financial crisis and the ban will do little more than make lending more expensive for businesses.

"It is going to cost jobs, I think that is becoming obvious to all of us," Bachus said.

Rep. Barney Frank, the lead Democrat on the panel and an author of the law, conceded proprietary trading was not a cause of the crisis but said that did not make the Volcker rule a bad idea.

"The notion that in adopting regulation we should only deal with things that have proven to be problematic and not try to anticipate, not try to make other improvements, I think is a grave error," Frank said.

BETTER APPROACH?

Tarullo defended regulators' overall approach to implementing the crackdown, saying they attempted to take a "nuanced" approach in differentiating between permitted and banned activities.

He said drawing bright lines on what is allowed or, conversely, leaving it to banks to self-police would not be effective.

Tarullo added regulators are open to any idea that is better than what they laid out in their proposal for implementing the trading and investing crackdown.

"I haven't seen it yet," he said.

Under Volcker, banks also are greatly limited in how much of their own money can be invested in hedge and private equity funds.

The Volcker rule is set to go into effect in July.

Republicans pressed regulators on whether they would delay that deadline or at least issue another proposed rule to solicit more feedback since the October release contained hundreds of questions.

Regulators said that decision would have to be made after the comment period ends on their current proposal in February.

They also noted that there is a two-year phase-in period for Volcker and they can use that period to tweak any problems.

(Reporting By Dave Clarke, editing by Matthew Lewis. Editing by Gunna Dickson)

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