The Federal Reserve wants to relax investment rules for banks

Photo (c) Nuthawut Somsuk - Getty Images

One trade group says more work must be done to ensure that big banks don’t create instability by making bad investments

The Federal Reserve Board made a move on towards relaxing investment rules for banks on Thursday. In essence, the move aims to give banking entities permission to invest in or even sponsor hedge funds and private equity funds, aka "covered funds.”

The proposal would overhaul the Volcker Rule, which, as part of the 2010 Dodd-Frank law, restricted United States banks from making certain kinds of speculative investments that hold no upside for their customers. If approved, banks can gamble on chancy investments using customer deposits.

The Fed believes the Volcker rule has created compliance uncertainty and saddled banks with limits on certain services and activities that the rule was not designed to control.

“It is inescapable that compliance and enforcement have been difficult and can be simplified for both banking entities and regulators,” said Randal K. Quarles, Vice Chair for Supervision at the Federal Reserve.

Getting it right this time around

The Fed tried its best to turn that around in 2019 by simplifying requirements on trading restrictions. Thursday’s proposal would modify the restrictions further by allowing banks to take an ownership interest in venture capital funds, or pools of investment that might focus on a small business or start-up. The changes would also address the treatment of certain foreign funds.

“As I have said before, the intent behind the Volcker rule is the right one -- banks should not use deposits that are insured by taxpayers to make risky proprietary trades or investments in hedge funds and private equity funds,” said Board Chair Jerome H. Powell in his opening remarks to the board. 

“We now have considerable supervisory experience putting that common sense prohibition into practice, and we have learned that a simpler, clearer approach to implementing the rule makes it easier for both banks and regulators to carry out the intent of the rule. … This should (also) reduce complexity and reduce compliance burdens for banks and their investors.”

The potential downside

Are the proposed changes a good thing or a bad thing for banks? One banking trade group says further inspection on the impact on all sizes of banks is needed.

Chris Cole, counsel for the Independent Community Bankers of America, a trade group that represents thousands of "community banks,” remarked that the proposal merits some added scrutiny regarding whether relaxing restrictions on big banks’ venture capital investments went too far.

“The group’s biggest concern is that if big banks’ venture capital investments went belly up and destabilized the banks themselves, the Federal Deposit Insurance Corporation would end up having to bail them out using money collected for the deposit insurance fund,” Cole told the New York Times. “After that, the premiums on the deposit insurance that all banks are required to pay would go up.”

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