Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

Does Volcker Rule Conflict With Basel?

Government Regulation

We may have dueling regulations.

The Volcker rule approved today by Securities and Exchange Commission and yesterday by the Federal Reserve may conflict with one of the central reforms global regulators agreed to put in place as part of the Basel III regulations.

And it will all turn on what regulators mean by the phrase "near-term."

The proposed Volcker rule, which is intended to curb proprietary trading by banks, creates a narrow exception for trading made for the purposes of “bona fide liquidity management.” Which is to say, banks can trade for their own account in order to make sure they have adequate liquidity.

Regulators are concerned, of course, that banks will abuse any exemption and engage in proprietary trading under another name. So in order to prevent traders from using liquidity trading to seek proprietary trading profits, the Volcker rule imposes a number of restrictions on what counts as liquidity trading.

One provision requires that the trades made for liquidity management purposes be limited to an amount “consistent with the banking entity’s near-term funding needs.”

It’s the phrase “near-term” that may create a conflict with Basel III rules. The Volcker Rule and the accompanying explanatory material don’t explain what is meant by “near-term.” If the “near-term” is limited to the next few days or even weeks, this could create problems.

Basel III would put in place a new Liquidity Coverage Ratio that would require banks to hold a stock of high quality assets so that they could cover cash outflows in a stress situation for 30 days.

To put it differently, Basel III requires banks to accumulate positions sufficient for 30 days of liquidity. If Volcker’s near-term requirement is shorter than 30 days, banks would find themselves barred from meeting the Basel liquidity requirements.

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