Fed’s Powell joins chorus of Volcker rule critics

Governor seeks to simplify rule banning prop trading

Federal Reserve governor Jerome Powell

Another senior US prudential regulator has condemned the Volcker rule as too punitive and overly complex.

“It’s just too complicated, it’s too burdensome, and we need to take another look at it,” Federal Reserve governor Jerome Powell said at an industry conference in Washington, DC earlier today (April 20). “Congress should take another look at the scope of the rule, and we as regulators should take a look at the way the rule has been implemented and try to do it in a simpler, more effective way.”

April has been a tough month for supporters of the Volcker rule as first departing Fed governor Daniel Tarullo and then New York Fed president William Dudley delivered withering critiques of the prop trading ban.

Tarullo was particularly scathing in his assessment of the rule, which he said fails to adequately distinguish proprietary trading from market-making. “We just need to recognise this fact and try something else,” he said. 

Powell also hinted at the difficulties of enforcing the rule in his comments. “The way we have interpreted the rule has forced us to distinguish between proprietary trading, hedging and market-making,” he said. “You need to effectively look into the heart and mind of every trader on every trade to see if there is proprietary intent.”

Former Fed chairman Paul Volcker stridently defended the eponymous rule in an interview with Risk.net earlier this week, in which he insisted the rule was “not futile” and that it had already achieved its primary goal of forcing banks to close their proprietary trading desks.

Powell’s comments will heap further pressure on the already beleaguered rule, however. The prop trading ban is one of several Dodd-Frank provisions earmarked for repeal in Jeb Hensarling’s Financial Choice Act. The House Financial Services Committee, which Hensarling chairs, is set to hold a hearing on the bill on April 26.

“I do think we are in a new phase. We are past the tsunami of new regulation phase and it really feels now with this new administration that we are in a new phase of assessment and how to change the regulations,” said John Dugan, a partner at law firm Covington & Burling, and the former US Comptroller of the Currency, who also spoke at the conference. “Reasonable minds will differ on how much things should be modified but we do seem to be in a phase where the focus is on recalibration, adjustments and perhaps elimination.”

Powell also backed a burgeoning effort to reverse the gold-plating of the leverage ratio for US banks. The Basel Committee on Banking Supervision recommends that banks hold capital equal to a minimum of 3% of their total assets, while the US supplementary leverage ratio (SLR) is set at 5% for bank holding companies and 6% for insured depository institutions.

“The leverage ratio is supposed to be a hard backstop because we have learnt that risk-based capital can be gamed,” Powell said. “In the normal state of affairs, you don’t want the leverage ratio to be the binding constraint on financial institutions, the main reason being it can impose excess costs on intermediation and low-risk assets. I always felt the US enhancement of the SLR on top of the leverage ratio ran the risk of doing exactly that.”

Powell pointed to the damaging impact the SLR is having on client clearing and the repo markets in calling for a review of the regulation.  

“I think we can look now and see that certain forms of low-risk intermediation, like repo, are being taxed too heavily by this,” he said. “Take central clearing for clients: this is something we want and we think makes the world a better place, but we apply the leverage ratio to the initial margin posted by clients which makes it more expensive. We see clients getting out of the client clearing business, so we are undermining the clearing mandate and the ability of smaller clients to get their products centrally cleared. I think we need to look again at the calibration of the leverage ratio in the US.”

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