Define: Volcker Rule

The Volcker Rule was established to reduce risk in banking institutions by prohibiting them from engaging in risky investments. It consists of two main parts: preventing banks from using their own funds for investments and restricting their investments in hedge funds or private equity funds. The rule was implemented in response to the Global Financial Crisis to prevent the blending of investment banking and commercial banking, which was a contributing factor to the crisis. While the rule has been criticized for limiting bank profits, the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 relaxed some of its restrictions. Banks are required to adhere to the rule by implementing an internal compliance program, with larger banks facing higher compliance requirements.

The Volcker Rule, established under the Dodd-Frank Act, aims to minimize risk in banking institutions by separating investment banking and commercial banking. It consists of two main components: a prohibition on proprietary trading, where banks use their own funds for high-risk investments, and a limitation on banks’ investments in hedge funds and private equity funds. The rule was implemented in response to the Global Financial Crisis, which was partly caused by risky investments made by banks. Prior to the crisis, investment banking and commercial banking were required to be separate, but this changed in the 1990s. The Volcker Rule seeks to reintroduce some separation between these two types of banking. For instance, it generally forbids banks from engaging in proprietary trades, meaning they cannot use their own funds for high-risk investments to generate profit. There are exceptions, such as for underwriting and market making activities, but these exceptions necessitate reporting and explanations. Additionally, the rule prohibits banks from owning or partnering with certain types of funds, like hedge funds and private equity funds. However, the Volcker Rule has faced criticism for constraining bank profits and limiting capital. In 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act relaxed some of the Volcker Rule’s restrictions, particularly for smaller banks. To comply with the Volcker Rule, banks must establish an internal compliance program that ensures adherence to limits, maintains documentation, and fulfils reporting requirements. Larger banks and those with significant investment operations must meet more stringent compliance, prudential, and monitoring standards.

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This glossary post was last updated: 17th April 2024.