SEC's Gallagher sounds alarm on Volcker rule

WASHINGTON (Reuters) - A securities regulator said policymakers may need to overhaul the Volcker rule proposal that curbs banks' proprietary trading, saying a hasty approach could cause market disruptions and harm U.S. competitiveness.

Dan Gallagher, a Republican commissioner at the U.S. Securities and Exchange Commission, said on Monday that a quick review of the thousands of comment letters revealed widespread fears about the rule's potential impact.

"These comments provide powerful evidence that the benefits the proposed rule was designed to provide may come at an unacceptably high cost," Gallagher said in prepared remarks for a speech at the Institute of International Bankers conference in Washington.

He said regulators must be willing to re-examine their initial efforts and "if necessary" go back to the drawing board on the proposal.

This marks the second time that a U.S. financial market regulator has publicly called for potentially scrapping the complicated Volcker proposal that was released in October, in hopes of crafting a more workable draft.

Last month, Gallagher's Republican colleague at the SEC, Commissioner Troy Paredes, made similar statements during a speech in Washington.

The Volcker rule, which has become one of the most controversial parts of the 2010 Dodd-Frank financial oversight law, seeks to add distance between the world of speculative trading and commercial banking.

The proposal bans banks from proprietary trading, or trades solely for their own profit, and limits their investments in hedge funds.

Banks have complained that a poorly crafted rule could hurt their risk hedges and their ability to make markets for their customers, while foreign regulators have said the crackdown could affect the liquidity of sovereign debt markets.

In a sign of how regulators are struggling to address critics' concerns, Federal Reserve Chairman Ben Bernanke said last week that a final rule will not likely be ready by a July deadline.

Bernanke has not said whether the regulators may decide they need to scrap the current proposal and come up with a new draft.

Earlier on Monday, Kiyohiko Nishimura, the Bank of Japan's deputy governor, told the banking conference that liquidity could be hit if the Volcker rule does not exempt foreign debt from banks' trading restrictions.

Dodd-Frank specifically exempts U.S. debt from the Volcker rule, but regulators can only extend the exemption to other countries' debt if they determine that doing so would protect the financial stability of the United States and the safety and soundness of banks.

Also at the conference, U.S. Treasury Assistant Secretary for Financial Markets Mary Miller was asked if regulators have the flexibility under the law to expand the exemption beyond U.S. debt or whether Congress would need to change the law for this to happen.

Miller said she believes the law gives regulators the flexibility they need if they decide to expand the exemption.

SEC's Gallagher said in his remarks that policymakers owe it the markets to not move forward on the Volcker rule until they understands if it will cause damage.

"We must avoid regulatory hubris and should not regulate - particularly where the changes are so novel or comprehensive - with the belief that we completely understand the consequences of the regulations we may impose," he said.

(Reporting By Sarah N. Lynch; Additional reporting by Dave Clarke; Editing by Tim Dobbyn)