Volcker Rule

A federal law that restricts banks' ownership in and interactions with hedge funds and private equity firms.

The Volcker Rule is a federal law restricting banks' ownership and interactions with hedge funds and private equity firms. It prevents them from engaging in specific investment activities with their accounts, like directly trading in volatile securities with funds deposited by the customers. 

The Volcker Rule aims to stop banks from engaging in certain speculative investment practices that fueled the 2008 financial crisis.

The rule prohibits short-term proprietary trading of securities, derivatives, commodities futures, and options on these instruments for banks' accounts because these actions do not benefit banks' clients. 

In simple words, the aim here is to make banks stick to their core activities rather than risky investments that are of no potential use to bank customers. It is named after former Federal Reserve Chairman Paul Volcker. 

Banks are not permitted to make these kinds of investments with the money to boost their earnings. The intention is to deter banks from taking on excessive risk.

Although the Dodd-Frank law contains various exceptions, the regulation is frequently referred to as a prohibition on proprietary trading by commercial banks, in which deposits are used to trade on the bank's accounts.

The Regulation

Five federal agencies approved the Volcker Rule's final regulations: 

The Volcker Rule was enacted on April 1, 2014, and banks were required to comply fully by July 21, 2015.

The regulation permits banks to keep doing the following services: issuing hedge funds and private equity funds; underwriting, trading, and hedging government securities; operating as agents, brokers, or custodians; and engaging in insurance company operations. 

Banks' provision of these services to their clients may continue, and they may make money.

Banks are prohibited from engaging in these activities. However, doing so will put the institution in danger, expose it to high-risk investments or trading techniques, or cause instability inside or throughout the U.S. financial system.


Did you know that several big banks asked for a 5-year extension to exit illiquid investments on August 11, 2016?

The UK has likewise struggled with limitations on banks' ability to engage in proprietary trading

In the Vickers Report, the Independent Commission on Banking (ICB) recommended "ringfencing" domestic retail depository institutions from international wholesale/investment banking operations. 

The ringfenced institutions would have their boards of directors and up to 20% of the parent company's capital.

The Dodd-Frank Act's provisions for the rule were supposed to go into effect on July 21, 2010; however, that date was postponed. The appropriate agencies adopted the rule's implementing regulations on December 10, 2013, and were due to take effect on April 1, 2014.

Following a lawsuit filed by community banks regarding restrictions on specialty securities, amended final regulations were established on January 14, 2014.

The Federal Reserve proposed repealing several rule's requirements on January 30, 2020, particularly those restricting bank investment in venture capital and securitized loans. On June 25, 2020, these alterations were approved.

The Friction in implementation

Republicans in Congress have also voiced concern about the Volcker Rule, stating that its limitations would harm American banks' capacity to compete globally and that they may try to decrease funding to the government agencies in charge of implementing it.

That is, they believed that if the regulation was enforced, government money would be jeopardized. Goldman Sachs, Bank of America, and JPMorgan Chase & Co. were among the financial companies that filed comments opposing the bill.

It was unsurprising to see the then-Chairman of the House Financial Services Committee, Representative Mr. Spencer Bachus (R-Alabama), declares his intention to minimize the impact of the Volcker Rule due to its harsh limitations on banks and financial institutions. Nevertheless, he considered that the rule greatly affected financial organizations.

The public had until February 13, 2012, to comment on the proposed regulations, and over 17000 comments were received.

Ben S. Bernanke, then-chairman of the Federal Reserve, forecasted that the central bank and other authorities would likely miss that deadline in his report to Congress on February 29, 2012.

Each of the five main financial regulatory agencies passed the guidelines on December 10, 2013. As a result, the implementation date of April 1, 2014, was met. However, the final regulation required more time to comply and had fewer metrics than previous ideas.

Furthermore, the final regulation required CEO certification of the compliance program's effectiveness and placed the burden of proof on banks to demonstrate that their trading operations are by the rule. 

It was a critical obligation under the law to ensure that the banks provided written proof of compliance.

The Impact

Top proprietary traders from large banks began leaving after the Volcker Rule proposal to start their hedge funds or join existing ones. 

These individuals included:

The rule's detractors pointed to the ensuing exodus of top talent. Still, the lost expertise in trading would only be relevant to the activity that the new framework intended to curtail.

It would only be a loss to the banks and not the economy as a whole and could be seen as precisely the kind of cultural change that the rule was meant to bring about within taxpayer-supported banks.

The Volcker Rule will negatively impact market-making and liquidity availability for many securities. 

The Volcker Rule would encourage banks to reduce their market-making activities in smaller, riskier assets where significant supply-demand shocks are more likely. Unfortunately, this will reduce market-making in the very securities where it is most valuable. 

Both investors and securities issuers will see the consequences.


There is a possibility that The Volcker Rule will reduce the effectiveness of bank risk management and harm the structure of financial institutions more generally, making it more difficult for firms to acquire money.

There will be further negative effects on bank clients. Less liquidity will be available for the securities that banks issue, the value of the financial services they provide will be reduced, and the values of bank securities will be more skewed than before.

Higher capital expenses are projected to result from the Volcker Rule for businesses, as well as possible decreased capital expenditures by these borrowers and a potential increased emphasis on riskier or more transient investments. 

Since there is less liquidity and more perceived regulation, borrowers would face greater capital expenses due to uncertainty. 

This will probably reduce total investment while increasing riskier ventures' allure. Moreover, Faster-paying initiatives will be more appealing to businesses as investment opportunities. 

The decline in a considerable reduction in employment may result from overall capital investment.


The main objective of the Volcker Rule is to stop financial institutions from engaging in proprietary trading or funding hedge funds and private equity firms using government-insured deposits and the capital of depository banking institutions.

As long as they do not have access to the capital or insured deposits of the depository institution, affiliates within a bank holding structure should be allowed to invest in private equity funds.

Broker/dealer affiliates of a bank holding company should be allowed to trade for market-making and hedging purposes, provided that the affiliate does not have access to either the capital or insured deposits of the depository institution.

Investors have expressed concern that limitations on market-making could harm markets for illiquid instruments like fixed-income securities. Accordingly, they have urged regulators to closely monitor implementation to swiftly make changes if it appears that the new rules have a significant and unfavorable impact on liquidity in these markets.

One of the papers, published in June 2017, stated that the Treasury "supports in principle" the Volcker Regulation's restrictions on proprietary trading while recommending major revisions to the rule. 

The research suggests exempting banks with less than $10 billion in assets from the Volcker Rule. The Treasury also emphasized the rule's constraints on regulatory compliance. It proposed that the definitions of covered funds and proprietary trading be clarified and simplified in addition to loosening the rules to make it easier for banks to manage their risk.

Lastly, The regulation supports banks' continued ability to provide crucial client-focused financial services, including underwriting, market making, and asset management services.

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Researched and authored by Tirath Shah | LinkedIn

Reviewed and edited by Parul Gupta LinkedIn

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