President Obama proposed two new restrictions designed to limit the size and scope of financial institutions. One restriction would limit the scope of a financial institution’s activities by barring any insured depository institution, or any financial firm which owns an insured depository institution, from owning, investing in or sponsoring a hedge fund or private equity fund and from engaging in proprietary trading operations unrelated to serving the institution’s customers. The proposal did not provide a definition of proprietary trading, which some commentators have asserted may be difficult to distinguish from trading that relates to business conducted for customers.
The other restriction would limit the size of a financial institution through a cap on an institution’s nondeposit liabilities. Depository institutions are currently prevented from acquiring another depository institution if such transaction would result in the resulting institution holding more than 10 percent of aggregate U.S.-insured deposits. Financial institutions are allowed to exceed the 10 percent limitation through organic growth. The proposed restriction would supplement the deposit cap and would include such liabilities as non-insured deposits and wholesale funding. The level of the proposed cap has not yet been determined. This restriction is designed to limit the future growth of the largest U.S. financial institutions.
The President’s proposal was heavily influenced by former FRB Chairman Paul Volcker, so much so that the President referred to the restriction on proprietary trading as the “Volcker Rule.” Many of the details of the proposal remain unclear, and some have asserted that it may prove to be unworkable. The President asked Congress to incorporate these restrictions into its financial regulatory reform legislation. In December 2009, the House of Representatives passed a comprehensive regulatory reform bill which contained broad authority to limit the size and scope of firms that pose a grave threat to the U.S. economy and financial stability. For more on the House bill, please see the December 15, 2009 Alert. The Senate Banking Committee is currently working on its version of financial regulatory reform legislation. House Financial Services Chairman Barney Frank stated that “What we’re hoping is that [Senate Banking Committee Chairman] Senator Dodd will incorporate them into his bill and we’ll push them in conference.” Senator Dodd was noncommittal to the President’s proposal, stating that he agrees that companies that take risks should not have taxpayer help and that he would study the proposal and give it careful consideration.
It is unclear if these restrictions would apply to the U.S. subsidiaries of foreign institutions, or to the foreign operations of U.S. institutions. Many in the financial services industry fear that these restrictions would create a severe competitive disadvantage for U.S. financial institutions. The Obama administration has also indicated that it may propose further restrictions on bank holding companies that engage in other risk-prone activities.
The Alert will continue its coverage of these and other issues concerning financial regulatory reform in future issues.