WASHINGTON — Banks would be barred from trading for their own profit instead of their clients under a rule federal regulators proposed Tuesday.
The Federal Deposit Insurance Corp. backed the draft rule on a 3-0 vote. The ban on so-called proprietary trading was required under the financial overhaul law.
For years, banks had bet on risky investments with their own money. But when those bets go bad and banks fail, taxpayers could be forced to bail them out. That’s what happened during the 2008 financial crisis.
The Federal Reserve has also approved a draft of the so-called Volcker Rule, named after former Fed Chairman Paul Volcker.
The Securities and Exchange Commission must still vote on it, and then the public has until Jan. 13 to comment. The rule is expected to take effect next year after a final vote by all three regulators.
A ban on proprietary trading could help President Barack Obama in next year’s election by showing he has adopted tough rules to rein in risky trading on Wall Street.
A harder line with bankers might also help Obama win over protesters on Wall Street. Many believe Obama was too lenient on the banks because he continued the bailouts that had begun under President George W. Bush.
Congress and Obama had hoped the Volcker Rule would blunt such criticism. But they left most of the details for regulators to sort out. It’s unclear how strictly the ban will be enforced.
Under the draft, banks must hold investments for more than 60 days. Regulators determined that was enough time to limit speculative trading.
Senior and mid-level managers would be required to make sure bank employees comply with the restrictions. But the rule doesn’t say what happens if they don’t.
Traders should not be paid in a manner that encourages risk-taking, but the rule doesn’t outline what that entails.
Critics contend that the rule as written is too vague and its effect on risk-taking will be limited. Banks have a history of working around rules and exploiting loopholes. In this case, banks can make most trades simply by arguing that the trade offsets another risk that the bank bet on.
The draft rule “draws too few bright lines to make clear what banks can and cannot do,” said Bartlett Naylor, financial policy advocate at the liberal group Public Citizen. “The regulators are proposing that they will detect the difference between various trades by fishing through complex data provided by the banks after the fact. This is an invitation for evasion.”
The rule was proposed by the Fed. Some critics argue the Fed often capitulates when bankers complain that regulations make it harder for them to do business.
Wall Street banks say the ban on proprietary trading could prevent them from buying and selling investments that their customers might want.
The banking industry said Tuesday the rule is too complex to work and will put U.S. financial firms at a competitive disadvantage to those in other countries.
“How can banks comply with a rule that complicated, and how can regulators effectively administer it in a way that doesn’t make it harder for banks to serve their customers and further weaken the broader economy?” Frank Keating, head of the American Bankers Association, said in a statement.
At the same time, several big U.S. banks have already shut down their proprietary trading operations in response to the financial overhaul. Critics say they have merely spread those traders across other desks without ending their risky practices.
The rule also would limit banks’ investments in hedge funds and private equity funds, which are lightly regulated investment pools. Banks wouldn’t be allowed to own more than 3 percent of such a fund. In addition, a bank’s investments in such a fund couldn’t exceed 3 percent of its capital.
Before Congress passed the financial regulatory overhaul, banks had no limit on how much of those funds they could own. Still, typically on Wall Street, such investments already fall below the 3 percent threshold.
Banks could still put their clients’ money into those funds. They will still be able to manage such funds, and collect fees and a percentage of trading profits.