Proprietary Trading: Of Scourges, Scapegoats, and Scofflaws

Abstract

The Volcker Rule was designed to strike a compromise between reestablishing the firewall between investment and commercial banking activities under the Glass-Steagall Act and retaining the synergistic benefits of bundling such services championed by the Gramm-Leach-Bliley Act. This paper will approach the topic from the perspective of regulators who must grapple with the Rule’s implementation. On the one hand, the financial community can be expected squarely to resist any aggressive implementation of the Rule; on the other, failure to adopt a set of rules and an associated supervisory program would almost surely result in regulators taking significant heat if the Rule does not at least have some impact on the configuration of Wall Street’s activities. Moreover, such efforts must be implemented in a manner that complements other initiatives mandated by Dodd-Frank.

The regulators have staked out a three-pronged approach in their proposed rulemaking: (i) formalizing the classification of trading activities, (ii) adopting quantitative measures, and (iii) mandating a system of internal controls that provides a roadmap for regulatory compliance, supervision, and enforcement. This paper considers the arguments made for and against the Rule’s restrictions on proprietary trading, analyzes the public debate over the proposed implementation of the Rule, and offers some remarks on how regulators might advance the Rule’s moral imperative.

Keywords: Volcker Rule, proprietary trading, bank regulation

JEL Classification: K22