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Federal regulators today approved a tough new set of restrictions on the kinds of trading that banks can do. The so-called Volcker rule largely prohibits FDIC-protected banks from trading securities for their own financial gain. It's part of the Dodd-Frank overhaul passed three years ago.
The name comes from the man who proposed it, former Federal Reserve chairman Paul Volcker. In 2009, he warned that risky investments by banks posed a big danger to the financial system. NPR's Jim Zarroli begins our coverage.
JIM ZARROLI, BYLINE: The final version of the rule was unveiled this morning and then quickly approved by five different federal regulatory bodies, including the Securities and Exchange Commission and the Fed. It aims to reduce the odds of another financial crisis by reining in the risks taken by big banks. And it does this in a number of ways. Dennis Kelleher, president of the reform group Better Markets, says it's tougher on banks than he'd expected.
DENNIS KELLEHER: The rule strongly limits the banks' market making and hedging activities to ensure that they're in fact for customers and not a swing-for-the-fences gamble for their own bonuses.
ZARROLI: The Volcker rule places sharp limits on what the former Fed chairman called proprietary trading by big banks. That's commonly thought to mean trading that's done for the banks' own portfolio and not for its customers. But former Fed governor Randall Kroszner says it's not always so easy to define where one kind of trading ends and another begins.
RANDALL KROSZNER: One of the reasons that the rule has taken more than two years to finalize and has a nearly thousand-page explanatory preamble is because it's so difficult to define this.
ZARROLI: For instance, Wall Street banks typically buy large amounts of stock on behalf of their customers and sit on it for a while, and in the process, they may earn a profit. The Volcker rule goes to great pains to try to spell out whether activities like that constitute proprietary trading. And Kroszner predicts that complying with the rule is going to be a huge legal headache for banks.
KROSZNER: And I worry that this is going to distract the supervisors' and examiners' attention from the fundamental risks towards compliance. And, boy, is this going to be a big compliance enterprise.
ZARROLI: But Bank of America CEO Brian Moynihan said today that the rule probably wouldn't affect his bank much. He said Bank of America has already curtailed proprietary trading in anticipation of the Volcker rule. For bank officials, the rule hits home in some other ways. It requires CEOs to personally attest that they have effective policies in place to comply with the rule. And it bars banks from tying their employees' compensation to trading profits. Josh Rosner is managing director of Graham Fisher.
JOSH ROSNER: Really, what they're trying to do is break the alignment of incentives between the traders and the banks, so that the trader really doesn't feel that his income is going to be driven by how much money he makes the bank on a specific trade.
ZARROLI: Ultimately, the success of the Volcker rule will depend on how aggressively regulators embrace it. Dennis Kelleher of Better Markets says there's bound to be a lot of pushback from the financial sector.
KELLEHER: A banker told me not long ago that the big banks on Wall Street really aren't in the banking business. They are in the loophole creation and exploitation business. And there's no reason to believe that Wall Street's loophole-seeking lawyers won't be working overtime and getting rich in trying to evade and bend this rule.
ZARROLI: The man who gave his name to the rule, Paul Volcker himself, addressed some of those concerns in a statement today. The 86-year-old former Fed chairman said he hopes that respect for the intent and spirit of the law would become second nature for banks and their supervisors. Jim Zarroli, NPR News, New York. Transcript provided by NPR, Copyright NPR.