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Volcker Rule rollback is not the kind of reg relief small banks need

The idea that the trading ban burdens community banks and prevents them from investing in fintech opportunities is misleading


August 24, 2017

By Thomas M. Hoenig

I have long been advocating for regulatory relief for traditional banks that take deposits and make loans within their community. They should be able to make decisions and invest in assets to best serve their customers and community. In this regard, I am disappointed that the Volcker Rule continues to be characterized as a burden to community banks and allegedly is prohibiting them from taking part in fintech investment opportunities. This argument appears misleading and for the purpose of implementing broader rollbacks of the Volcker Rule. I regularly meet with hundreds of community bankers from around the country, and while they voice major concerns about regulatory burden, the Volcker Rule is not one they highlight.

The Volcker Rule neither favors nor disfavors community banks. It prohibits all FDIC-insured banks and their affiliates from investing in hedge funds. It was adopted because during the last financial crisis banks of all sizes experienced significant losses from investments in complex, unregistered on- and off-balance sheet funds. It is common knowledge that these losses seriously impacted the Deposit Insurance Fund. If the fund were used to protect deposits that underwrite such activities and their unique risk, it would require a significant increase in insurance premiums to account for such risk. Since all banks would share such a premium adjustment — thereby shouldering the risk of the few institutions making these types of investments — this seems unwise.

Community banks play an essential role in the American financial system and provide the majority of small business and farm loans, among other lending and general banking services. This is their core competency. While regulators are not opposed to community banks investing in new technologies, it should be for the purpose of better serving their customer and community and not a wager on whatever the hot technology stock is at the time.

At the same time, the industry is well aware that there already is an effort underway by regulators to determine whether the Volcker Rule can be made less burdensome. However, a blanket exemption from the Volcker Rule for banks under a certain asset size — just so community banks can place bets on new technologies funded by venture capital — seems imprudent and certainly unwarranted. In fact, doing so would only reinstate the use of insured deposits to be freely invested in opaque hedge fund-type vehicles subject to extreme volatility in their promise of ever-higher yields, while doing little to further the mission of a community bank.

Importantly, whether it is fintech-based or otherwise, a fund can be structured to comply with the Volcker Rule, or to fall outside its scope, in a manner that would allow any bank to invest as long as it meets its board-approved investment policy. Indeed, many types of funds have been able to conform to the rule over the last several years without undermining their performance or limiting their market.

And contrary to recent criticism that the Volcker Rule allegedly hinders community bank investment in fintech, the fact is that any bank can lend or invest directly in such a company, similar to recently publicized actions taken by larger U.S. banks. While it is true that smaller banks, because of their size, might have fewer options to invest, the Volcker Rule is certainly not the cause of the competitive disparities between large and small banks.

I would suggest that if smaller banks are concerned about inequity then they should focus on the differences in their much higher cost of capital compared with their too-big-to-fail GSIB counterparts in the United States. That is the playing field they should work to level if they are truly interested in their long-term prospects. Compromising the Volcker Rule to allow community banks to own hedge funds will only place them, depositors and the insurance fund at greater risk.

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