The Volcker Rule and the Dodd Frank Act have been hanging over the head of bank stocks for so long now that when the Volcker Rule was finally approved Tuesday, financial shares barely shrugged.
But make no mistake: Going forward, banks are going to be much less profitable.
That’s especially the case at bank stocks such as Goldman Sachs (GS), a firm which practically prints money with its own proprietary trading operations. Those prop trading desks are officially goners.
Not that there were many left, anyway.
Big bank stocks knew proprietary trading would be banned under the Volcker Rule years ago, so they’ve been shutting down desks and cutting traders loose for a while.
What they didn’t know was just how hard the Volcker Rule would come down on prop trading. Heck, no one did. The Dodd Frank Act — of which the Volcker Rule is a central part — has been under construction for so long that even if you asked regulators “What is Dodd Frank, exactly?” they couldn’t really answer.
But now things have become much more clear. The adoption of the Volcker Rule pretty much completes the Dodd Frank Act’s regulatory overhaul of the banking sector — an enormous enterprise meant to keep banks from blowing themselves up.
Highlights of the Volcker Rule
We’ll explore what all this means, but first, here are some key passages from the Volcker Rule:
- A banking entity may not engage in proprietary trading.
- A banking entity may not, as principal, directly or indirectly, acquire or retain any ownership interest in or sponsor a covered fund (for example, a hedge fund or private equity fund).
- Each banking entity shall develop and provide for the continued administration of a compliance program reasonably designed to ensure and monitor compliance with the prohibitions and restrictions on proprietary trading and covered fund activities and investments.
- Each banking entity must adopt a written compliance program approved by the board of directors, an appropriate committee of the board, or equivalent governance body, and senior management.
- Based on a review by the CEO of the banking entity, the CEO of the banking entity must, annually, attest in writing that the banking entity has in place processes to establish, maintain, enforce, review, test and modify the compliance program.
Volcker Rule: Saving Banks From Themselves?
The Volcker Rule — named for former Federal Reserve Chairman Paul Volcker — will help make banking boring again. Taking in deposits and making loans is hardly a road to crazy profit and share-price growth … but it’s safe.
On the other hand, proprietary trading, owning hedge funds and private equity funds, and engaging in other kinds of high-stakes Wall Street wheeling and dealing can be amazingly profitable.
But they’re also risky enough to bring down the entire financial system if not kept in check.