The Volcker Rule, a proposal approved by U.S. regulators on Tuesday that would restrict Wall Street's ability to trade for its own profit, could lower fixed income revenues significantly and affect the largest U.S. banks, one analyst said.
"It looks like based on the summaries that we're seen and what we've read in it that they're really trying to shut down flow trading [see definition below], which is really core to how fixed income operates," said Brad Hintz, a senior analyst at Sanford C. Bernstein.
"And unfortunately, that means a reduction in fixed-income revenues of somewhere around 20 to 25 percent, and a margin reduction."
Flow trading involves looking at pattern recognition of clients' demand for fixed income and then positioning investments to profit from that demand, Hintz said, adding that flow trading is how market-making works in fixed income.
Among the largest banks, Hintz said Goldman Sachs is most exposed to fixed income, followed by Morgan Stanley .
JPMorgan , Bank of America and Citigroup also deal in fixed income.
If the Volcker Rule results in less market-making in corporate bonds, liquidity could come out of the domestic fixed-income market — a move that would affect credit spreads. As a result, it could become cheaper to raise money in Europe or the euro-dollar market, Hintz said.
Hintz said he expects Goldman Sachs to lose money in the third quarter. Citigroup also recently released a forecast for a third-quarter loss for Goldman. Hintz added that Goldman has experienced a mark-to-market loss on merchant banking and their investment portfolio, and has had "very difficult fixed-income trading this quarter."
Regarding the contagion risk to U.S. banks from Europe, Hintz said he does not think they are at risk of failure.
"Their funding is adequate, strong," he said. "They have access to a lender of last resort. Their leverage ratios are half of what they were prior to the last crisis. Everyone has been battening down their hatches in anticipation of what would be a difficult period for the euro."
For more on the sector, watch: Looking for Strength in Financials
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Disclosures:
Brad Hintz owns stock in Morgan Stanley.