Senior Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce
August 15, 2019
For years, the business community has raised concerns that prohibitions on proprietary trading embodied in the Volcker Rule would raise the cost of and reduce the ability of businesses to raise capital.
Now, the U.S. Office of Financial Research (OFR) has released a report with new evidence that confirms this concern. The report finds that the Volcker Rule does not reduce risk, but instead imposes unnecessary costs on fixed income markets that make it more difficult for companies to raise capital.
The Volcker Rule sounds simple in principle: prohibit federally insured depository institutions from trading on their own account, also known as proprietary trading. However, this was not a cause of the financial crisis.
Trading by banking entities, especially in the form of market-making, promotes liquidity by ensuring there is enough inventory to meet the needs of buyers and sellers of securities in our capital markets.
The U.S. Chamber of Commerce has continued to be a leader on this issue, and has raised concerns since the ban on proprietary trading was originally proposed in 2011. In 2012, the U.S. Chamber released a study finding the Volcker Rule would:
- Have a negative effect on market making and liquidity provision for many securities.
- Reduce the network benefits of market making for financial institutions and businesses.
- Lead to higher costs of capital for businesses and potentially lower capital investments by these borrowers.
- Make bank risk management less efficient.
The most recent survey of corporate treasurers conducted by the U.S. Chamber found that 42% of U.S. businesses believe financial regulation has negatively affected their ability to access capital. The Volcker Rule is an obvious and pressing example of the repercussions of such regulation.
It may come as a shock that financial regulators never conducted the statutorily required cost-benefit analysis of the Volcker Rule when originally promulgated. Now their successors are stuck cleaning up the mess. The good news is that financial regulators are moving to alleviate costs imposed on U.S. businesses. As the U.S. Chamber pleaded a year ago, the sooner the better.
The OFR’s findings are stunning, but maybe not shocking: “The Volcker rule appears to have increased the cost of the liquidity provided by covered firms and has not decreased the liquidity risk exposure of covered firms.” In short, it is now more expensive for bank dealers to help businesses access the capital markets, but the promised benefits of reducing the riskiness of these activities has not manifested.
Additionally, OFR notes that the exemptions in the rule intended to make it easier for businesses to access fixed income markets are not working: “We find evidence that the rule has increased the markups Volcker-covered dealers charge their clients even on trades that we would anticipate would qualify for the rule’s market making exemption . . . these findings are highly significant, both statistically and economically.”
Finally, OFR concludes that the effects “do not appear to be transitional,” which undercuts observations of some policymakers that the costs would subside as banks found less burdensome compliance solutions.
Previous studies from the public sector have reached similar conclusions to those of OFR.
In 2016, staff at the Federal Reserve Board published a paper finding, “Dealers regulated by the Rule have decreased their market-making activities while non-Volcker-affected dealers have stepped in to provide some additional liquidity . . . Since Volcker-affected dealers have been the main liquidity providers, the net effect is that bonds are less liquid during times of stress due to the Volcker Rule.”
Now that the Volcker Rule has been in effect for five years, there is plenty of evidence that Congress should repeal it or, at a minimum, make it simpler. Short of changes to the law, there are many things financial regulators can do to make the Volcker Rule more workable.
Financial regulators should move expeditiously to make changes to the Volcker Rule that will reduce costs imposed on dealers so they can help businesses access the capital markets. Our members depend on vibrant corporate debt markets to secure funding that will allow them to hire new employees, make capital investments, and enter new markets. Financial regulators need to take all steps to make this growth easier.
While the U.S. Chamber has not always agreed with the research and findings of the Office of Financial Research, we can confirm that U.S. businesses share their views about the Volcker Rule.