Even a twice-revised Volcker Rule is apparently not bank-friendly enough for the rule’s critics.

A coalition of self-described free-market groups is among those urging regulators to reconsider their efforts to revise the rule. The coalition’s letter, signed by 13 groups and made public this week, asks that recently proposed revisions be further reconsidered to exclude banks with $10 billion or less in total consolidated asset and banks of all sizes that engage in limited asset trading.

“The Volcker Rule was a flawed and unnecessary response to the financial crisis. It has imposed substantial burdens on industry, predicted to be as high as $4 billion in regulatory costs, while damaging financial market liquidity, raising the cost of credit for businesses and consumers,” the letter says.

Signatories included: Competitive Enterprise Institute, American Commitment, Americans for Limited Government, Americans for Tax Reform, Campaign for Liberty, Center for Individual Freedom, Citizens Against Government Waste, The Committee for Justice, Consumer Action for a Strong Economy, FreedomWorks, Less Government, National Black Chamber of Commerce, and Taxpayers Protection Alliance.

The Volcker Rule, named for former Federal Reserve Chairman Paul Volcker, is a ban on proprietary trading by federally insured banks that would otherwise be standard depository institutions. It was a centerpiece of post-financial crisis legislative reforms bundled as the Dodd-Frank Act. Multiple agencies—the Office of the Comptroller of the Currency, Federal Reserve, Federal Deposit Insurance Corporation, Securities and Exchange Commission, and Commodity Futures Trading Commission—jointly oversee the rule and its enforcement.

“Compliance with the rule has been challenging, to say the least, with many requirements that are extremely complex and overly subjective. While we may not all agree on the ultimate destination, there seems to be broad consensus that changes and adjustments to the rule are needed.”

Jelena McWilliams, Chairman, Federal Deposit Insurance Corporation

Proponents say the rule is a necessary remedy for keeping banks simple and risk-averse. Critics, however, see the rule as a massive compliance burden for all banks, especially community banks that are, effectively, punished for the risky moves of their larger brethren. Another common complaint is that the rule impedes the role of banks buying and selling securities on behalf of their customers, a practice known as “market making.” The argument is that as corporations issue debt to pay for capital investments, research, development, and payroll, banks, by acting as intermediaries between buyers and sellers, hold prices down.

For nearly two years, efforts have been afoot to minimize burdens inherent in the rule. As related legislation came, stalled, and disappeared, reform efforts gained steam among the rule’s designated regulators. Last year, those agencies issued a notice of proposed rulemaking that became known as Volcker 2.0. It would:

  • tailor the rule’s compliance requirements based on the size of a firm’s trading assets and liabilities, with the most stringent requirements applied to firms with the most trading activity;
  • provide more clarity by revising the definition of “trading account” in the rule, in part by relying on commonly used accounting definitions;
  • clarify that firms that trade within appropriately developed internal risk limits are engaged in permissible market making or underwriting activity;
  • streamline the criteria that apply when a banking entity seeks to rely on the hedging exemption from the proprietary trading prohibition;
  • limit the impact of the Volcker Rule on the foreign activity of foreign banks; and
  • simplify the trading activity information that banking entities are required to provide to the agencies.

Round 2 came on Feb. 8 of this year, with a separate notice of proposed rulemaking intended to harmonize the existing Volcker Rule with the regulatory-relief-focused Economic Growth, Regulatory Relief, and Consumer Protection Act. To do so, a “regulated insured depository institution” would be defined as one that has more than $10 billion in total assets and more than 5 percent total trading assets and trading liabilities.

“Instead of following the clear text of the law, regulators are attempting to implement much less regulatory relief than what Congress intended,” the recent letter by free-market groups says. “While the legislation provides exemptions to the Volcker Rule for banks under $10 billion in assets or banks that engage in limited asset trading, the proposed rule would instead exclude only those banks that are under $10 billion in assets and engage in limited asset trading. … The effect of changing the ‘or’ to an ‘and’ is substantial: it would mean that the Volcker Rule would continue to burden not just Wall Street behemoths, but many traditional banks serving their communities. This would constrain these banks’ ability to reward savers and lend to consumers and small businesses.”

The Competitive Enterprise Institute, in its own letter to regulators, echoed the coalition’s criticisms. “We can analogize the situation to a hypothetical involving ice cream,” it wrote. “Imagine that ice cream products, in general, have been an extensively regulated category, but then a new statute narrows that category to consist of only mint chocolate ice cream. Clearly, to fall into that new category, an ice cream must be both mint and chocolate.  If an ice cream is not mint, or if it is not chocolate, then it is excluded from regulation under the statute’s new, narrower definition.”

“In short, the statute creates two alternative criteria for excluding certain types of ice cream from regulation: all ice cream that isn’t mint is excluded, and all ice cream that isn’t chocolate is excluded,” CEI added. “But under the agencies’ proposal, there is only one exclusion criterion—ice cream that is neither mint nor chocolate. This is clearly contrary to the statute—the latter excludes both plain mint and plain chocolate from regulation, while the proposal includes them.”

Jelena McWilliams, chairman of the FDIC, shared a regulatory point of view on the Volcker Rule at the Institute of International Bankers Annual Washington Conference on March 11.

“Compliance with the rule has been challenging, to say the least, with many requirements that are extremely complex and overly subjective,” she said. “While we may not all agree on the ultimate destination, there seems to be broad consensus that changes and adjustments to the rule are needed.”

McWilliams said she has “witnessed first-hand the challenges of implementing the Volcker Rule.” As general counsel of a regional U.S. bank, “it became clear that navigating the potential for unintended consequences would be akin to walking through a mine field.”

“I encountered that mine field when the bank was looking to invest in clean energy credits,” she said. “A team of two dozen employees from various departments within the bank and an outside counsel invested hours in making sure that investment would be structured in compliance with the Volcker Rule. I suspect that the drafters of the provision were not thinking about clean energy credits when they wrote the rule.”

Now, with her “regulatory hat on,” McWilliams is asking: “How can we structure the Volcker Rule in a way that satisfies its intended statutory requirements while sparing another general counsel from the labyrinth I had to navigate?”

The multi-agency notice of proposed rulemaking that became known as Volcker 2.0 is no magic bullet in her view. “After considering the proposal, reviewing the comment letters, and hearing from stakeholders, it is clear that with respect to certain elements of the rule and the proposal, the agencies still have work to do. I believe we can get this right and do so promptly,” McWilliams said. “As we revise the rule … we have to provide more certainty to regulated entities and improve how we define what types of trading are prohibited and what types of funds are within the scope of the rule so that both bankers and supervisors have clear rules of the road.”

The rule, she said, “needs to be appropriately tailored so that the requirements are commensurate with the size and scope of an institution’s activities covered by the rule” and the regulatory regime “should reflect the fact that the overwhelming majority of activity covered by the rule is conducted by relatively few banks.”

Regulators also need to be mindful of the effects the Volcker Rule can have on banks engaged in international activity, including activities conducted overseas by foreign banks that have a U.S. presence, McWilliams said. “The agencies tried in the existing rule to limit the Volcker Rule’s extraterritorial reach, but the result was overly complex and has not worked as intended. We need to right size the rule’s extraterritorial scope while also minimizing competitive inequities between U.S. banking entities and their foreign counterparts.”

For various types of foreign funds, the current rule “is overly complex and, frankly, impractical to implement,” she added.

“While the agencies have a heavy workload, we are prioritizing getting the Volcker Rule right … or at least as close to right as we can get within the statutory framework given to us,” McWilliams said.