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The Volcker Diet for Mega-Banks

by Michael W. Stocker
Eyes On Wall Street |

The Obama administration has renewed a push to toughen regulations on banks that are "too big to fail." The proposal, dubbed the "Volcker Rule" after the former Federal Reserve Chairman Paul Volcker, would limit the scope and size of banks and other financial institutions by ensuring that no bank will engage in "proprietary trading" -- that is, trading operations unrelated to serving customers.

Proprietary trading places bank capital at risk through speculation. Although such trading is engaged in by only a handful-probably four or five-of American mega-sized commercial banks, the commercial banking sector could take a dangerous hit if these bets go wrong.

Proponents of the Volcker Rule argue that such a prohibition is essential to ensure the stability of the commercial banking sector and to protect banking customers from undue risk undertaken by corporate management. It would also discourage banks from engaging in insider trading using inside information and data gleaned from their customer relationships.

The proposed Volcker Rule has been met with strong resistance in Congress. Critics argue that the objective of the proposal could be achieved under a provision in the House bill adopted last year which let regulators ban speculative trading by banks if it is deemed too risky. They also contend that it will be hard for regulators to differentiate between transactions that a bank makes for its clients from those made in its own account.

One thing that is clear is that if "too big to fail" banks expect an implicit guarantee of taxpayer support, they should be prepared for much greater regulatory review of the risks they undertake.