Bloomberg News

Volcker Rule Costs Banks $1 Billion, U.S. Government Says

October 28, 2011

(Updates with Stanley comment in 11th paragraph and Lamson comment in 18th paragraph.)

Oct. 28 (Bloomberg) -- The Dodd-Frank Act’s ban on proprietary trading and limits on hedge-fund investments will cost U.S. national banks about $1 billion for compliance and capital, according to a government estimate.

The Volcker rule, proposed by the Federal Reserve, Federal Deposit Insurance Corp. and two other regulators this month, would result in $917 million in capital costs for the banks, according to the Sept. 7 impact analysis conducted by the Office of the Comptroller of the Currency.

Dodd-Frank, the financial regulation overhaul enacted in July 2010, bans banks from having more than 3 percent of their Tier 1 capital invested in private-equity and hedge funds. The law requires banks to deduct aggregate investments in the funds from their Tier 1 capital.

Under Dodd-Frank, 152 national banks may have a combined maximum investment in funds of $18.3 billion, according to the 14-page OCC analysis. The OCC estimated the cost of capital would be 5 percent, or a maximum overall cost of $917 million.

The OCC analysis also said that 2,096 national banks would have annual legal and compliance costs of about $50 million. Most of those costs would fall on national banks with at least $1 billion in trading accounts or investments in private-equity or hedge funds.

A national bank is a commercial bank with a charter from the OCC. The institutions are part of the Federal Reserve System and belong to the FDIC.

Impact on Companies

The analysis was produced under a 1995 law requiring some agencies, including the OCC, to produce an impact statement before publishing a rule if it may result in at least $100 million in annual expenditures by the private sector. The OCC estimate said that, for purposes of the 1995 law, the Volcker rule’s impact is $50 million. The capital costs are required by the Dodd-Frank law and are considered separate from the cost of the regulation implementing it, according to the analysis.

Dean DeBuck, an OCC spokesman, declined to comment about the impact analysis.

The proposed rule, named for former Fed Chairman Paul Volcker, was included in Dodd-Frank to limit the kind of risky trading that helped fuel the 2008 credit crisis.

‘Credit Negative’

Regulators are seeking public comment on the 298-page proposal and may make changes before its scheduled effective date of July 21, 2012. The Securities and Exchange Commission, Commodity Futures Trading Commission and OCC are also required to draft and oversee the restrictions. The CFTC has yet to propose its version.

“Only $50 million of these costs are these kinds of costs of government regulation,” said Marcus Stanley, policy director for Americans for Financial Reform, a coalition of 250 groups including the AFL-CIO labor group and AARP. The cost “is very small compared to potentially making trillions of dollars in assets safer,” he said in a telephone interview.

Moody’s Investors Services said Oct. 10 that the rule would be “credit negative” for bondholders of Bank of America Corp., Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley, “which have substantial market-making operations.”

Revenue Fall

Banks’ fixed-income desks could see revenue fall as much as 25 percent under measures included in a draft of the proposal, Brad Hintz, a Sanford C. Bernstein & Co. brokerage analyst said in an Oct. 10 note.

The Volcker rule will affect banks’ standalone proprietary trading desks and trading for their own accounts conducted elsewhere in the companies.

Standalone proprietary-trading groups at six bank holding companies -- Bank of America, JPMorgan Chase, Citigroup, Wells Fargo & Co., Goldman Sachs and Morgan Stanley -- had a net loss of about $221 million from June 2006 through the end of 2010, according to a July 13 Government Accountability Office report.

“Compared to these firms’ overall revenues, their standalone proprietary trading generally produced small revenues in most quarters and some larger losses during the financial crisis,” the GAO said.

The OCC analysis doesn’t include estimates for the rule’s impact on overall bank revenue or how it will change the level of competition in markets, which can determine the price difference for buyers and sellers.

‘Understate the Costs’

“There are a number of costs associated with this and I think the rulemaking and official government assessments understate the costs,” Donald N. Lamson, a former OCC assistant director who’s now a Washington-based counsel at Shearman & Sterling LLP, said today in a telephone interview.

The OCC wasn’t able to identify the number of banks with an ownership interest in a private-equity or hedge fund. “Thus, we use banks’ reporting of investments for fiduciary clients as a proxy to estimate the number of banks that may have an ownership interest,” the OCC said in the analysis.

In the proposal, regulators asked if the dollar-for-dollar capital deduction is appropriate, or if the impact on Tier 1 capital should be related to the leverage of a private-equity or hedge fund.

The capital deduction provision would affect 34 national banks with at least $5 billion in trading accounts or covered funds and would cost them $770 million, according to the analysis. Those banks would have a maximum $15.4 billion in combined investment in funds.

The Volcker proposal requires compliance programs at banks that may include quantitative measurements of trading activities. The rule will have an impact on 2,096 U.S. national banks, of which 1,831 will have minimal compliance requirements, according to the analysis.

--With assistance from Phil Mattingly and Cheyenne Hopkins in Washington and Michael J. Moore in New York. Editors: Maura Reynolds, Dan Reichl

To contact the reporter on this story: Silla Brush in Washington at sbrush@bloomberg.net.

To contact the editor responsible for this story: Lawrence Roberts at lroberts13@bloomberg.net


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