What is the 'Volcker Rule'
A federal regulation that prohibits banks from conducting certain investment activities with their own accounts, and limits their ownership of and relationship with hedge funds and private equity funds, also called covered funds. The Volcker rule’s purpose is to prevent banks from making certain types of speculative investments that contributed to the 2008 financial crisis.
BREAKING DOWN 'Volcker Rule'
Named after former Federal Reserve Chairman Paul Volcker, the Volcker rule disallows short-term proprietary trading of securities, derivatives, commodity futures and options on these instruments for banks’ own accounts under the premise that these activities do not benefit banks’ customers. In other words, banks cannot use their own funds to make these types of investments to increase their profits. The purpose is to discourage banks from taking too much risk.
Five federal agencies—the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Commodity Futures Trading Commission and the Securities and Exchange Commission—approved the final regulations that make up the Volcker Rule in December 2013. The rules, formally known as section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, went into effect April 1, 2014, with banks' full compliance required by July 21, 2015.
The rule allows banks to continue market making, underwriting, hedging, trading of government securities, insurance company activities, offering hedge funds and private equity funds, and acting as agents, brokers or custodians. Banks may continue to offer these services to their customers and generate profits from providing these services. However, banks cannot engage in these activities if doing so would create a material conflict of interest, expose the institution to high-risk assets or trading strategies, or generate instability within the bank or within the overall U.S. financial system.
Depending on their size, banks must meet varying levels of reporting requirements to disclose details of their covered trading activities to the government. Larger institutions must implement a program to ensure compliance with the new rules, and their programs will be subject to independent testing and analysis. Smaller institutions are subject to lesser compliance and reporting requirements.
The Volcker rule has been widely criticized from a variety of angles. The U.S. Chamber of Commerce claimed in 2014 that a cost-benefit analysis was never done, and that the costs outweighs benefits. In 2017, the International Monetary Fund's top risk official said that regulation to prevent speculative bets are hard to enforce and an unintended consequence is diminished liquidity in the bond market. The Federal Reserve's Finance and Economics Discussion Series (FEDS) made a similar argument, saying that the Volcker rule will reduce liquidity due to a reduction in bank's market making activities.
For more on the Volcker rule, read How The Volcker Rule Affects You.