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Volcker Rule muzzled — for now

Interim rule issued Jan. 14 offers reprieve

Washington’s rancorous debate about the power of government to regulate the financial services industry is now focused on legislation known as the Volcker Rule, a part of the mammoth Dodd-Frank legislation.

According to, the Volcker Rule “separates investment banking, private equity and proprietary trading (hedge fund) sections of financial institutions from their consumer lending arms. Banks are not allowed to simultaneously enter into an advisory and creditor role with clients, such as with private equity firms. The Volcker rule aims to minimize conflicts of interest between banks and their clients through separating the various types of business practices financial institutions engage in.”

Although many people applaud the spirit of the rule, the American Bankers Association estimates that it will take 6.6 million hours of work to implement the law and an additional 1.8 million hours per year for enforcement. Additionally, banks would have to hire more than 3,000 employees just to remain in compliance with the Volcker Rule. Another study found that the Volcker Rule could cost banks and investors $350 million. The result may be higher fees for consumers or a rise in the cost of trading stocks.

At press time, the American Bankers Association (ABA) and three community banks had pending litigation concerning the Volcker Rule. An interim final regulation federal regulators issued on Jan. 14 was designed to fix a problem with the Volcker Rule that would have caused hundreds of banks to take write-downs on certain assets. According to American Banker, although the rule “ostensibly helps just smaller institutions, it is worded in such a way that many large banks will also benefit. It was not immediately clear if regulators’ move would cause the ABA to drop the lawsuit.”

In a statement, the Independent Community Bankers of America (ICBA) said legislation introduced by subcommittee chair, U.S. Rep. Shelley Moore Capito (R-W.Va.) and committee chairman, U.S. Rep. Jeb Hensarling (R-Texas) was essential in “pressuring the federal banking regulators to release an interim final rule to rectify the Volcker Rule provision.”

“The final Volcker Rule, as issued on Dec. 10, would have a harsh and immediate impact on some 300 community banks that hold collateralized debt obligations (CDOs) backed by trust preferred securities (TruPS),” ICBA said . “The Dec. 10 rule would cause an irreversible impact on the earnings and capital of these banks. We know of several community banks that would literally be put out of business if this rule stands.”

Capito and Hensarling’s Fairness for Community Job Creators Act (H.R.3819) would allow banks to retain their holdings of TruPS CDOs issued before Dec. 10, 2013. Prior to Jan. 14’s interim final rule, the Volcker Rule would have required, in certain instances, that banks divest their holdings of these securities and write down these investments under “other than temporary impairment” accounting rules. For some banks, writing down these securities could result in a permanent loss of capital, an unanticipated requirement that was not included in the proposed Volcker Rule.



Escalating battle



Daniel Santaniello president and CEO of Fidelity Bank, explains that the Volcker rule will not, in all likelihood, impact community banks in northeastern Pennsylvania. Yet he confirms that the fight over Volcker is part of an escalating battle for increasing government regulation of the financial community.

To understand the Dood-Frank battlefield, Santaniello says it is necessary to review the events of 2008 when the American financial markets crashed. Many of the nation’s largest banks became distressed after extensive participation with questionable mortgage activities and sub-prime lending.

“When this house of cards fell, it brought on the Great Recession,” says Santaniello. “Washington vowed it would never happen again, and the Senate and House took action.”

Sections of the subsequent Dodd–Frank legislation require banks to qualify mortgages in a ore traditional manner than had become the norm during the housing bubble. Moreover, today borrowers must prove their ability to pay back the loan through income verification and other measures abandoned in the days leading up to the crash.

Another huge new change is The Consumer Financial Protection Bureau (CFPB), an independent federal super-agency that holds primary responsibility for regulating consumer protection as it relates to financial products and services. “Washington also added many enforcement attorneys, giving the enforcement end of the regulatory process real teeth,” says Santaniello. “This includes expansion at the levels of the FDIC and the Office of the Comptroller of the Currency.”



Pendulum swings



According to Santaniello, agreement is universal in the banking community that the regulatory pendulum has now swung much too far towards excessive control. This is causing many banks — including small community banks — to pay for the sins of the few, even though most community banks never took part in predatory lending.

In addition, a strict regulation process increases costs of operations, and bankers agree that regulatory legislation without balance doesn’t benefit the shareholders in the financial system. Trickle-down effects of regulation are also inhibiting bank process efficiency, particularly when a lack of continuity with regulations is the norm.

“Dodd Frank has had more than 400 changes since the bill was enacted,” says Santaniello, adding that the Volcker Rule will create unintended financial consequences. “More than 300 banks sit on trust preferred securities,’ says Santaniello. “If they are sold at a loss it will be painful.”

As he looks into the future, Santaniello expects Washington’s regulatory pendulum to continue its unpredictable swings. However, he doesn’t expect over-regulation to subside any time soon.

“The financial costs of dealing with massive amounts of regulations will be proportional to the size of the bank,” he says.