Volcker Rule may disadvantage small banks with unclear definitions

Donald Lamson

The controversial ban on proprietary trading known as the Volcker Rule could put smaller banks at a competitive disadvantage, even if regulatory agencies alter the rule, which is set to be finalized by year’s end.

Section 619 of Dodd-Frank does not specify which institutions will be subject to the ban, and regulators have yet to include an exemption for small banks, IFLR reports.

Smaller banks lack the resources and compliance staff that larger banks have and could be affected by an unclear net definition that could include hedging, small-bank market-making and asset liability management.

Donald Lamson, counsel at Shearman & Sterling, who assisted in drafting Dodd-Frank as a lawyer with the U.S. Treasury, expressed concern about the ability of smaller institutions to compete.

“Dodd-Frank compliance is deepening and widening the moat around large banks, making it harder for small banks to compete with large banks,” Lamson said, according to IFLR.

Lamson also said that U.S. regulators have less authority to make changes to the rule than other legislation.

“That’s one of the weaknesses in the drafting,” Lamson said, IFLR reports. “The ability to write a rule should be accompanied with the ability to make exceptions so unintended consequences can be minimized and mitigated.”

Spencer Bachus, the chairman of the House Financial Services Committee, requested comment on alternatives to the Volcker Rule last month in preparation for a possible hearing this fall.

The American Bankers Association responded to the call for comment and suggested a complete repeal of the legislation so regulators could focus on clarifying the rule’s definition of prohibited activities. Timothy Keehan, a vice president and senior counsel at the ABA, said that the rule was clearly intended to regulate larger financial institutions, hedge funds and private equity funds.

“Nowhere was it originally intended to have the Volcker Rule provide to every single bank,” Keehan said, according to IFLR. “I don’t think the regulators would have comfort putting together an asset-size exemption [because] there was nothing in the legislation talking about a particular type of institution or size of institution.”

Though regulators may be unable to carve out an exemption for small banks, they may be able to issue guidance on activities that could put them at risk of violating the Volcker Rule. Implementation and enforcement of the rule is under the authority of the Federal Reserve Board, Federal Deposit Insurance Corp., Securities and Exchange Commission, Commodity Futures Trading Commission and Office of the Comptroller of the Currency.

“It could possibly be a disordered, patchwork quilt of regulations and interpretations—that’s the fear,” Keehan said, IFLR reports.

The ABA further suggested that the Federal Reserve be named to spearhead efforts to interpret the Volcker Rule.

“That’s the way to have written this,” Keehan said, according to IFLR. “The Federal Reserve with consultation should have final interpretive authority.”

The Volcker Rule is on schedule to be finalized by year’s end. Banks would have until July 2014 to come into compliance.

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