3 June 2020

Volcker 2.0 Comes At Good Time For Banks

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The new Volcker rule comes at an opportune time for banks, which are poised to ride a new wave of global market volatility.

The proposed changes unveiled by the Federal Reserve Wednesday would preserve the prohibition on proprietary trading by banks that enjoy government backstops. But it lightens and simplifies enforcement of the rule, giving bank managers more leeway to set limits on trader behavior.

For banks with big trading operations, the most immediate impact will be lower compliance costs. While welcome, this is unlikely to affect their share prices. The bigger question is will the rule change lift bank trading revenue.

Regulators and bankers all insist they support the principle behind the Volcker rule, so a big increase in trading activity is unlikely. What’s more, trading volumes have been held down for years by global factors, including bond-buying by central banks that has suppressed volatility. As a result, fixed-income trading revenue at major global banks has fallen in six of the past eight years, according to data from research firm Coalition.

But these trade-muffling forces are beginning to subside. With the Fed now raising rates and shrinking its balance sheet, and the sudden return of eurozone-crisis fears, volatility is back in the markets.

Speaking at a conference on Wednesday, Citigroup Chief Executive Michael Corbat said he expects this environment to create more market-making opportunities for big banks like his with global balance sheets. “As quantitative easing moves to quantitative tightening, the central-bank bid goes away, and the value of liquidity and intermediation goes up,” he argued.

Volcker 2.0 gives banks more flexibility to take advantage of the shifting landscape. The difference will be subtle but potentially significant. During episodes of volatility and other market displacements, bank managers may be just a bit more likely than before to clear an aggressive market-making trade.

In early 2016 for instance, a single Goldman Sachs trader famously netted more than $100 million in profits by scooping up billions of dollars of junk bonds during a global market panic, and then unloading them once conditions settled. Expect there to be more trades like this under the new regime, with less accompanying controversy.

This increased liquidity provision will make the overall market run smoother, though hopefully without banks taking on too much risk. It is now up to regulators, and banks, to show they can strike that balance.

Click here for the original article rom The Wall Street Journal.

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