That’s not what this change is intended to do. Rather than relaxing the prohibition on proprietary trading, the proposed revision of the Volcker Rule is an attempt to enforce the prohibition “without undue burden” by replacing “overly complex and inefficient” compliance requirements with a “more streamlined set of requirements,” as the Fed chairman, Jerome Powell, describes it. The Federal Reserve and the other agencies that enforce the Volcker Rule are the ones who drafted the revision. Many advocates of the Volcker Rule support the change, including Lael Brainard, who was appointed to the Federal Reserve Board of Governors by President Obama.
Banks are not the only ones who will gain from the rule change. Anyone who might want to buy or sell debt securities or foreign exchange will benefit. Global banks are uniquely positioned to make markets in debts and foreign exchange, given their global reach and their knowledge of clients’ holdings and preferences, which allows efficient matching of buyers and sellers. The fall in inventories of securities held by banks in recent years, which the Volcker Rule may have contributed to, makes it harder to maintain price stability.
The reforms are well crafted, but they don’t do enough to promote efficiency in financial markets.
Regulations other than the Volcker Rule, such as limits on simple leverage and liquidity requirements, are probably more binding constraints on banks’ market-making inventories in debt markets. Those regulations act as a disincentive to holding low-risk debt instruments in trading books. A carve-out from those rules would encourage banks to hold low-risk debt inventories and would improve debt market liquidity.
To be sure, there are risks to proprietary trading. But there are alternatives to prohibiting it, as the Volcker Rule does. Those risks could be dealt with by capping the amount of proprietary trading and requiring banks to maintain generous loss-absorbing equity buffers.
It is important to mitigate the risks of proprietary trading, but just as important to understand its value.
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