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U.S. Volcker rule may have less impact on bank revenues than expected

David Henry
Wednesday, 18 Dec 2013 | 6:39 PM ET

NEW YORK, Dec 18 (Reuters) - The 900-plus page Volcker rule regulators released last week will not impact big bank trading revenues as much as banks had feared, said industry executives and consultants who have finally plowed through the rule.

While the U.S. rule bans banks from making blatant bets on securities or other assets, it gives them leeway to make judgments, such as how many assets they should buy in anticipation of customer demand. Banks had worried they would have much less leeway that what is being allowedfu.

The final rule, required by the 2010 Dodd-Frank financial reform law, also allows banks to protect themselves by hedging against price changes in groups of securities, loans, or other assets, instead of having to hedge individual securities as some bankers had feared.

"It is fairly manageable for the banks," said David Sapin, a PricewaterhouseCoopers consultant to big banks. A few days before the rule came out, some clients were "just nervous about what was going to happen," he said.

An executive at a major bank, who was not authorized to speak to the media, said, "There were fears it was going to get a lot worse...There is some relief."

Bank profits have been hurt by low interest rates and lower trading volume since the financial crisis, so any benefit that banks get from the Volcker rule is welcomed by the industry.

Analysts at credit rating service Standard & Poor's last year said that if the rule were as strict as possible, pre-tax profits for the eight biggest trading banks could drop by as much as 15 to 30 percent, vaporizing some $10 billion of total annual profits. On Friday, S&P said the final rule will not be that bad.

Bankers were bracing for the worst after JPMorgan Chase & Co last year lost $6.2 billion on derivatives trades that were originally meant to reduce, or hedge, the bank's risk. Many on Wall Street feared that regulators would make the Volcker rule as strict as possible to prevent such big losses from happening again.

To be sure, regulators have broad discretion in determining when banks are breaking the rules, which in turn could have a big impact on how much the Volcker rule costs banks.

"Ultimately, the impact will depend on how regulators enforce the rule," said David Fanger, a bank credit analyst at Moody's Investors Service.

And, unusual items on some bank balance sheets could be hit surprisingly hard, as has happened already with certain instruments that small and mid-sized banks bought up before the financial crisis, known as "collateralized debt obligations."

Zions Bancorp said on Monday that it expects to take a charge of up to $387 million to update the value of its CDOs because the rule will require that they be sold. The American Bankers Association on Tuesday called on regulators to give "prompt attention to the serious and unintended consequences" of the rule on trust preferred securities that have been bundled into CDOs. 1/8ID: nL2N0JX1NO 3/8

Another negative with the rule is that banks will have to file reports to regulators justifying their trading decisions, which could boost their costs. The rule "is going to be very difficult and expensive to administer," said Rodgin Cohen, a lawyer for big banks and senior chairman at Sullivan & Cromwell.

The Federal Reserve and four other U.S. agencies released the final rule more than two years after they requested comments on a draft measure. Banks, trade groups, investors, and other parties sent some 18,000 comment letters.

The rule is intended to fix a problem with too-big-to-fail banks: their profits are enjoyed by shareholders, while their losses, if big enough, are borne by taxpayers. That asymmetry could encourage bank employees to take big, speculative bets.

GREATER INVENTORIES

Banks had feared that their "market making" activities, where they buy and sell securities, derivatives, and other instruments to investors, would be hurt by the rule. When a bank buys an asset, it is not always clear to outsiders if it is doing so because it expects customers to buy the asset in the future, or to make a bet on the price of that asset.

Under the final version of the Volcker rule, banks can judge, subject to review by regulators, how much inventory of assets they need to meet demand. The original proposal suggested regulators might put caps on inventories.

The flexibility that the final rule allows for banks to hold inventory should yield more revenue, Moody's analyst Fanger said.

The final rule also allows the banks to make trades that they judge to be hedges against multiple securities or instruments. News reports before the rule came out said that there would be strict prohibitions against hedging portfolios, which could have forced banks to avoid trading certain instruments because they would not have been able to reduce their risk, said Bob Maxant, a bank consultant and partner at Deloitte & Touche.

"Greater judgment may allow for greater inventory and that might allow greater revenue," Maxant said.