Three Questions: Prof. Andrew Metrick on Revising the Volcker Rule

U.S. regulators have proposed revising the Volcker rule, which restricts the ability of banks to make risky trades with money from depositors. The proposed change would streamline the compliance process and reduce restrictions on smaller banks. We asked Yale SOM’s Andrew Metrick, the director of the Yale Program on Financial Stability, about the potential consequences of the change. 

The Fed says that the proposed changes to the Volcker rule would simplify it and make it easier to enforce. Other observers say this is a loosening of restrictions that will lead to riskier trading by banks. Would this change increase the risk of another financial crisis?
The Volcker rule is not designed to prevent financial crises. It is just “good regulatory discipline.” The underlying logic is that institutions that have access to the government safety net should not be able to exploit that access to make risky bets that have nothing to do with their insured deposit-taking business. The fundamental role of the Volcker rule is not likely to be altered by the proposed changes.

Bank profits are almost as high as they were before the crisis. Is there a problem that needs to be solved here? 

I don’t think that the level of bank profits should have anything to do with this decision. The question should be about the cost-benefit tradeoff of the rule in various forms. I do think there is some good evidence that the implementation of the rule can be improved. The proposals for this improvement are reasonable, but the devil will be in the details. The industry can be very good at getting these rules written in ways that leave big gaps. Regulators will need to be vigilant.

Is this proposed change part of a broader effort to roll back financial regulations? How significant would it be relative to other changes? 
There is certainly pressure to roll back regulations, and in some places (most notably on the consumer side), this pressure has been effective. But from what I have seen so far, the Federal Reserve has been striking a good balance, responding to the strong political pressure for rollback while holding the line on the most important things. I see the Volcker changes as consistent with this strategy. If they are implemented as I expect, then I think these changes could be a net positive.

Janet L. Yellen Professor of Finance and Management