US & World Economies US Economy Fiscal Policy The Volcker Rule and How It Protects You Banks Can No Longer Trade for Their Own Profit By Kimberly Amadeo Kimberly Amadeo Kimberly Amadeo is an expert on U.S. and world economies and investing, with over 20 years of experience in economic analysis and business strategy. She is the President of the economic website World Money Watch. As a writer for The Balance, Kimberly provides insight on the state of the present-day economy, as well as past events that have had a lasting impact. learn about our editorial policies Updated on March 4, 2021 Reviewed by Robert C. Kelly Reviewed by Robert C. Kelly Robert Kelly is managing director of XTS Energy LLC, and has more than three decades of experience as a business executive. He is a professor of economics and has raised more than $4.5 billion in investment capital. learn about our financial review board Share Tweet Pin Email In This Article View All In This Article What Is the Volcker Rule? How It Was Implemented Why It's Needed Impact on Banks Who Is Paul Volcker? Who the Volcker Rule Is Named After Photo: Photo by Mark Wilson/Getty Images The Volcker Rule prohibits banks from using customer deposits for their own profit. It also won't let them own, invest in, or sponsor hedge funds, private equity funds, or other trading operations for their own use. It protects depositors from the types of speculative investments that led to the 2008 financial crisis. The rule is section 619 of the Dodd-Frank Wall Street Reform Act of 2010. What Is the Volcker Rule? Under the Volcker Rule, banks can no longer trade securities, derivatives, commodities future, and options for their own account. This is called proprietary trading. It limits their investment in, and relationships with, hedge funds or private equity funds. Bank CEOs must annually attest in writing that their firm is complying with the rule. Note The Volcker Rule allows trading in two circumstances. Banks can trade when it's necessary to run their business. These include market-making, underwriting, hedging, and trading if it is to limit their own risk. For example, they can engage in currency trading to offset their foreign currency holdings. They may also hedge interest rate risk. Banks may also act as agent, broker, or custodian for their customers. It allows banks to trade on behalf of their customers with the client's approval. Sometimes, this means banks must have some of their own "skin in the game." Note Banks cannot engage in any trading activities that might create substantial risk. They cannot trade if doing so would create a conflict of interest. They can't expose the bank itself to high-risk trades. Most of all, they can't generate instability to the U.S. financial system. How the Volcker Rule Was Implemented Congress passed Dodd-Frank and the Volcker Rule in 2010. It gave the job of developing the law into specific regulations to a commission of five agencies. They continue to oversee the regulations today. They are: Federal Reserve Commodities Futures Trading Commission Federal Deposit and Insurance Corporation Office of the Comptroller of the Currency, a division of the Treasury Department Securities and Exchange Commission On December 10, 2013, the commission completed the regulations. On Jan. 31, 2014, it announced the regulations, giving the banks a year to prepare. As a result, the Volcker Rule has been in force since July 21, 2015. Current Status On May 30, 2018, the Fed voted to offer banks compliance relief. On June 25, 2020, the U.S. Securities and Exchange Commission released the final rule modifying the Volcker Rule. It addressed three areas: Clarified the prohibition against banks' use of hedge funds and private equity fundsLimited the impact of the Volcker rule on banks' foreign activitiesPermitted specific non-risky activities that had been banned by the Volcker Rule Purpose The Volcker Rule seeks to undo the damage done when Congress repealed the Glass-Steagall Act in 1999. It had separated investment banking from commercial banking. Under Glass-Steagall, investment banks were privately-run, small companies that helped corporations raise capital by going public on the stock market or issuing debt. They charged high fees, stayed small, and didn’t need to be regulated. Commercial banks were safe places for depositors to save their money and gain a little interest. They lent the funds at regulated interest rates. Commercial banks made money despite thin profit margins because they had access to lots and lots of capital in the depositors' funds. Congress repealed Glass-Steagall with the Gramm-Leach-Bliley Act in 1999. Banks wanted restrictions lifted so they could be internationally competitive. Retail banks, like Citi, started trading with derivatives like investment banks. Note The repeal of Glass-Steagall meant banks could now put the vast reserves of depositors' funds to work without much regulation to worry about. They could do so knowing that the federal government didn’t protect investment banks as much as commercial banks. The FDIC protected commercial bank deposits. Banks could borrow money at a cheaper rate than anyone else. That's called the LIBOR rate. It’s just a hair above the fed funds rate. This situation gave the banks with an investment banking arm an unfair competitive advantage over community banks and credit unions. As a result, big banks bought up smaller ones and became too big to fail. That’s when the failure of a bank would devastate the economy. A too-big-to-fail bank will likely need to be bailed out with taxpayer funds too big to fail. That added another benefit. The banks knew the federal government would bail them out if anything went wrong. Note Banks had the taxpayers as a safety net as both depositors and a source of bailout funds. That's called a moral hazard. If things went well, bank stockholders and managers won. If they didn’t, taxpayers lost. Five Ways It Affects You The Volcker Rule impacts you in the following five ways: Your deposits are safer because banks can't use them for high-risk investments. It's less likely that banks will require another $700 billion bailout. Big banks won't own risky hedge funds to improve their profit. Your local community bank now has a better chance to succeed and not get .bought out by a big bank. This will help small businesses. It's less likely that a company like Lehman Brothers will fail. Who the Volcker Rule Is Named After The Volcker Rule was proposed by former Federal Reserve Chairman Paul Volcker. At the time, he was the chair of President Barack Obama's 2009-2011 economic advisory panel. When Volcker was Fed Chairman, he courageously raised the fed funds rate to uncomfortable levels to starve double-digit inflation. Although this helped cause the 1980-1981 recession, it was successful. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Board of Governors of the Federal Reserve System. "Final Rules to Implement the 'Volcker Rule'." FDIC. "Annual CEO Attestation." CFA Institute. "Volcker Rule and Proprietary Trading." Office of the Comptroller of the Currency. "Volcker Rule Implementation." Board of Governors of the Federal Reserve System. "Federal Reserve Board Asks for Comment on Proposed Rule to Simplify and Tailor Compliance Requirements Relating to the 'Volcker Rule'." U.S. Securities and Exchange Commission. "Financial Regulators Modify Volcker Rule." Federal Reserve Bank of St. Louis. "Banking Act of 1933 (Glass-Steagall Act)." U.S. Congress. "S.900 - Gramm-Leach-Bliley Act."