WASHINGTON — Former Federal Reserve chief Paul Volcker said a proposed US ban on banks trading on their own accounts would serve the public interest without hurting the same financial institutions.
Defending the reform named after himself, Volcker said high-risk proprietary trading was inconsistent with the public mission of banks and the government support they get, in the form of cheap Fed credit and deposit insurance.
But he did not comment directly on the worries of foreign governments such as Japan, Britain and Canada that the "Volcker Rule" would effectively dry up liquidity in the markets for their sovereign bonds and also place excessive restrictions on foreign banks with US operations.
"Proprietary trading of financial instruments -- essentially speculative in nature ... does not justify the taxpayer subsidy implicit in routine access to Federal Reserve credit, deposit insurance or emergency support," Volcker said in an open letter to financial sector regulators.
Proprietary trading occurs when a bank trades financial instruments with the firm's own money, as opposed to their customers' funds, to make a profit for itself.
The Volcker Rule is a component of the broader Dodd-Frank reforms to the financial services industry that arose after the 2007-2008 implosion of the risk-heavy financial services sector.
Numerous banks and financial institutions collapsed in the crash, while the government intervened and kept some of the largest afloat at huge cost to taxpayers.
The Federal Reserve, Treasury, Securities and Exchange Commission and other regulators are heading into a final decision on whether to implement the Volcker Rule, which identifies proprietary trading as a particular weakness of the industry.
Banks have argued that it is a necessary part of their business and that ending the "prop trade" will remove liquidity in key financial markets.
They also say foreign banks allowed to stay in the business will have an advantage over them.
Officials from Canada, Britain, Japan and other countries have said their own banks with US operations will be hampered because they will be unable to make markets in their own country's bonds.
The rule says banks can actively trade US debt for their own account, but not the bonds of other countries.
Last month the Bank of Japan asked for an exception for Japanese sovereign bonds. Without that, US banks could end up pulling out of Japan and Japanese banks from the United States, it said.
Luxembourg Finance Minister Luc Frieden said in Washington Monday that the new rule could create tough new problems between Europe and the United States.
The Volcker Rule "will make it very difficult for European companies, for European financial institutions to continue to work with the United States," he said at a conference.
"And I think this cannot be in the long term interest of the United States. It's certainly not in the interest of Europe.
"In a strong partnership, we have to discuss these things on a bilateral, or multilateral level before such laws are being implemented."
Volcker, however, said the rule was aimed at banks' speculative trading and that regulators would be able to come up with frameworks which would allow more normal needs, including market making for customers and adjusting their own asset portfolios.
He said the proprietary trade mainly benefited stockholders and "limited groups of highly paid employees" while detracting from a bank's main public mission.
"The result is to undermine the financial services industry as a service industry."
He added that non-banks, without the government support, engage in proprietary trading and those who want to be in the business should simply give up their banking license.
"Today, thousands of hedge funds operating with relatively little leverage and dependent on the equity capital of partners, represent much more limited risk to the financial system in the event of failure," he said.
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