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How Volcker Rule will hit your bank

By Claes Bell · Bankrate.com
Thursday, October 13, 2011
Posted: 2 pm ET

In the furor over new checking account fees that's been dominating banking news, a fairly significant development in the implementation of the Dodd-Frank financial reform law has been drowned out.

This week we got details about how a key provision in Dodd-Frank, known as the Volcker Rule, will actually work in practice. The rule is intended to keep banks from engaging in "proprietary trading," the practice of making bets in the financial markets to try and boost profits, financed in part with retail banking customers' FDIC-insured deposits.

Those bets went badly wrong for many banks in 2008, pushing the U.S. financial system to the brink of crisis and leading to a massive and unpopular bailout.

This week the FDIC released an official draft of the rule. Here are the main points:

  • The rule defines proprietary trading so regulators will know what to look for when enforcing the new restrictions. That definition includes most types of investing activities, including buying and selling of "securities, derivatives, commodity futures, and options on such instruments," for the benefit of the bank itself.
  • There are some exemptions for allowable trading activities, including trading that helps banks manage risk, or trading that's a necessary part of providing services to financial exchanges or clients engaging in trading.
  • The rule prohibits banks from having a stake of more than 3 percent in a hedge fund or private equity fund.

If you're wondering what this means for you, most of the impact of this rule will be felt by bank employees and stockholders. That impact will mostly be negative, as the new rule will undoubtedly make some banks less profitable by curtailing what has been a major source of revenue for them since the practice was legalized in 1999. That could, in turn, lead to some layoffs and depressed stock prices.

For bank customers, the rule may reduce the risk their accounts will end up being shuffled back and forth due to bank failures during the next economic downturn. But it could also result in higher fees for bank customers, as banks have historically dug into customers' pockets to cover profit shortfalls created by new regulations. It remains to be seen how much farther banks can push customers on fees, but I think it's a possibility.

Keep in mind, too, that this is just a draft, and we could see it softened as large banks lobby fiercely to protect a key source of revenue.

What do you think? Will banks try to pass on the cost of the Volcker Rule to customers? Will it help prevent future bailouts?

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