The biggest Wall Street banks are finally getting some relief from the Trump administration on the heavily protested Volcker Rule, but smaller banks are really the big winners.
Federal regulators approved the rewrite of a cluster of Obama-era reforms meant to prevent a repeat of the 2008 financial panic, but they’re largely leaving intact the most controversial provision that bans big banks from making risky trades with federally-insured deposits.
The new changes appear to offer the biggest benefits to smaller banks by creating a tiered regulatory framework that exempts them from the most stringent requirements of Volcker Rule, named after the former chairman of the Federal Reserve who lent his name to the cause of reform.
The Federal Deposit Insurance Corporation and the Comptroller of the Currency earlier this week approved the changes. The remaining three regulators, including the Fed and the Securities and Exchange Commission, are expected to follow suit in the next few weeks.
The new changes “simplify the rule in a common sense way that preserves the safety and soundness of the federal banking system and eliminates unintended negative consequences of the prior rule,” said Joseph Otting, the Comptroller of the Currency.
The vote on the FDIC board was 3 to 1, with all three Trump nominees approving the changes. Obama nominee Martin Gruenberg, chairman of the board until one year ago, was the lone dissenter.
Gruenberg accused the board of opening a backdoor banks could use to get around the ban on proprietary trades. Proprietary trading involves the sale or purchase of stocks, bonds or other assets to profit banks themselves instead of their clients.
Gruenberg particularly objected to exceptions in the final Volcker Rule for certain kinds of financial instruments, such as equities held at fair value and derivatives not held for trading. He said they could allow banks to define them in such a way that they fall outside the regulatory definition of proprietary trading.
These changes could enable banks to engage in “hundreds of billions of dollars” of speculative trades funded in part by individual deposits insured by taxpayers, Gruenberg asserted.
Outside analysts were less alarmed.
“The Trump administration’s regulatory agenda has delivered more benefits for mid-size and smaller banks while there have been fewer regulatory changes for the largest banks,” Brian Gardner of Keefe Bruyette & Woods wrote in a note to clients.
Read:Biggest banks prefer full Volcker Rule repeal, but a rewrite would do
The Volcker rule has been a focal point of Wall Street
opposition since its initial passage as part of the 2010 Dodd-Frank Act. The rule took three years for regulators to write and has been subject to unending criticism.
After President Trump replaced a slew of Obama appointees, the five regulatory agencies responsible for enforcing the Volcker rule agreed in July 2018 to tweak some of its more controversial provisions.
The most fiercely contested part of the Volcker Rule effectively barred banks from making speculative investments in hedge funds and private-equity funds to reduce the potential cost of a government bailout if another financial crisis erupted. That ban was mostly left intact.
The revised rules do offer some regulatory relief, however, especially for smaller banks.
Banks with “significant” trading assets, for example, are still subject to the toughest Volcker Rule requirements, but the threshold for what is considered significant will be raised to $20 billion from $10 billion.
The CEOs of smaller banks will no longer have to sign that they are in full compliance with the Volcker Rule.
“Small banks are big winners here,” Dan Ryan, a PricewaterhouseCoopers partner and its Banking and Capital Markets leader, told MarketWatch. “Foreign banks are also getting a break.”
That’s because the trading assets of foreign-owned banks will be calculated solely on their U.S. operations instead of their worldwide assets as was previously the case, Ryan noted.
In another notable change, banks will no longer have to count securities issued or guaranteed by a government sponsored enterprise such as Fannie Mae or Freddie Mac as trading assets.
Banks of all sizes, meanwhile, might benefit from a lighter and less costly regulatory burden.
The original Volcker Rule required banks to collect hoards of information tied to their investment and trading strategies to make sure they weren’t skirting the rules. The FDIC contends the volume of data supplied by banks could fall by a whopping 94%.
“Easing compliance burdens doesn’t mean there will be a big change in how banks do business,” Ryan said. “Big banks were forced to collect data that wasn’t used for anything other than Volcker rule compliance.”
Another hotly contested decision related to a proposal to replace part of a test that determines which assets are covered by the Volcker Rule. The proposal to replace the “short-term intent prong” with an “accounting prong” was rejected and the original rule retained.
The original Volcker rule, PwC’s Ryan told MarketWatch, tried to apply legal and accounting definitions to trading activities. But “the accounting definition doesn’t always fit with the marketplace definition of trading,” he said.
Rob Nichols, President of the American Bankers Association, applauded regulators for dropping the proposed accounting prong that he called “overly broad and unworkable.”
One of the bigger wins for Wall Street was a shift in the burden of proof on what’s considered a short-term investment from banks to regulators.
The “rebuttable presumption” in the original Volcker rule requires banks still subject to the intent-prong test to prove financial assets held for less than 60 days are not trading assets. In the future bank inspectors will have to prove that short-term investments are trading assets.
Industry critics were less than pleased.
Non-profit bank watchdog Better Markets said the changes deliver Wall Street its biggest victory against reforms since the 2008 financial crisis. Proprietary trading used to be a source of outsized bank profits and big executive bonuses.
“Regardless of the stated reasons, that’s why Wall Street has lobbied relentlessly for more than nine years to kill or weaken the Volcker Rule ban on proprietary trading,” Better Markets said in a statement on its website.
Ian Katz of the independent research firm Capital Alpha Partners LLC anticipated that objection.
“The typical narrative when a regulator revises a proposal after getting criticized by banks is, ‘Wall Street got its way again.’ That happens sometimes, but it doesn’t tell the whole story this time,” Katz wrote.
“We presume that the new proposal will be an improvement, easier for use in the real world. But we also believe that the regulators will be periodically tweaking and revising Volcker for years, if not decades,” he added.