Wednesday, February 3, 2010


Volcker Rules: Proposed Bank Reforms

• The White House, with support from congressional Democrats, has
proposed sweeping new regulations on banks. High levels of
uncertainty about future financial regulatory policy have been
unsettling to Wall Street and hit stock markets.

• At this stage these are only a number of different proposals. While
some form of financial-sector regulatory reform is likely, it is unlikely
to look like the White House’s current broad proposals.

•Overall we think any major reduction in banks’ leverage and risk
taking is likely to limit bank lending and could put US banks at a
disadvantage. However, there are no clear proposals to analyze, so it
is impossible to anticipate their potential impact with much

The proposal from the White House to segregate investment and commercial banks is not new – it was addressed in both the Volcker G30 proposals[1] in January 2009 and the White House White Paper on Financial Sector Regulatory Reform released in September 2009. Additionally, many different proposals on the Hill include proposals in a similar vein. However, the timing of the White House announcement hit markets by surprise. The proposal came with very few details, making it difficult for analysts and markets to assess the potential implications. Additionally, the idea of limiting banks’ size could have widespread implications, but for that very reason is unlikely to take an extreme form.

We believe the White House has a less than 50% chance of getting through legislation along the lines of what they broadly outlined on 21 January. First, with the loss of the Democrats' supermajority in the Senate, any bill will require bipartisan support. Second, there is resistance
on the Hill, including among Democrats, to reinstating Glass-Steagall (the separation of investment banking and commercial banking after the Great Depression), given such a move's unknown and potentially widespread consequences, and the White House proposal does suggest moving in this direction. Third, the timing is poor as momentum around financial sector regulatory reforms has already been dwindling. And, finally, the White House would be able to accomplish a great deal, especially on the proprietary trading side, through changes in regulations that would not need Congressional approval.

There are many other proposals to reshape financial-sector regulation, including some that have already passed the House or have been considered in Committee in the House or Senate. These include a Tobin-tax, or turnover tax on financial transactions, a one-time fee on large banks, a consumer financial protection agency, an increase in capital requirements (Basel III), various proposals to limit the size of individual banks (“too big to fail” policies), limits to the Federal Reserve’s power and independence, liquidity buffers, guidelines and limits on bankers’ compensation, and a full return to Glass-Steagall, among others. Clearly, not all of these proposals will pass as they go in different directions and curtail the current banking system to different degrees. However, the magnitude and diversity of options has raised the policy risk
and heightened investors’ worries about the health of banks, the stock market, and the economic recovery as a whole.



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