08.05.2011
By Terry Flanagan

Volcker Rule Tough To Enforce

When the Dodd-Frank Wall Street Reform and Consumer Protection Act went into effect this year, many wondered aloud about the implications at banks and other large institutions.

The Volcker Rule provision, which was targeted at preventing banks from participating in proprietary trading and large hedge fund investments, forced many banks to shutter proprietary trading desks and opening up a flood of talent to institutions that don’t accept customer deposits.

But questions remain for banks and other institutions that still engage in two-sided market making and other internal trading activities. One problem with existing regulation is that proprietary trading isn’t clearly defined. A recent GAO report also notes that there isn’t enough concise data offered from trading divisions of banks to make a firm decision.

Another problem for regulators is that proprietary trading makes up an extremely small portion of revenue at banks compared to other services. Thus, the risk involved with proprietary trading is low and non-systemic.

“Compared to these firms’ overall revenues, their stand-alone proprietary trading generally produced small revenues in most quarters and some larger losses during the financial crisis,” said the report. “In 13 quarters during this period, stand-alone proprietary trading produced revenues of $15.6 billion–3.1 percent or less of the firms’ combined quarterly revenues from all activities.”

“These firms’ hedge and private equity fund investments also experienced small revenues in most quarters but somewhat larger losses during the crisis compared to total firm revenues,” the report also noted. “Losses from these firms’ other activities, which include lending activities and other activities that could potentially be defined as proprietary trading, affected their overall net incomes more during this period than stand-alone proprietary trading and fund investments.”

Regulators have a tough time ahead of them due to a lack of available data and an argument that falls short.

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