Regulation: The Fed means business on the Volcker rule
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Regulation: The Fed means business on the Volcker rule

The central bank found a way to enforce the rule just before lawmakers attempt to dismantle it.


Fining a European bank for violation of a uniquely US rule is a little ironic, especially as it’s the first time the rule has been enforced. But if any bank was going to fall foul of the Volcker rule without actually actively falling foul of it, it was Deutsche Bank. 

Volcker rule. Volcker rule. Volcker rule. 

If you say it enough times, like Beetlejuice or the Candyman, the most controversial of Dodd-Frank regulations will apparently cross over from its regulatory netherworld to inhabit our plane of existence. Late April was the first time the rule was enforced since its implementation in July 2015. 

Ever since president Donald Trump took office, it has been the subject of speculation about whether or not it would disappear again, along with other parts of the Dodd-Frank Act.

The Volcker rule has probably had more public discussion in the last few months than since it was first proposed. In late March, Congress had its first hearing on the rule and it will almost definitely come under review for potential amendment or, less likely, repeal. The rule has continued to be in the headlines as various ex-regulators, like Daniel Tarullo, criticize it or, like Paul Volcker himself, defend it.

And then, right at the end of April, the Fed announced the first enforcement of the rule in the form of a $19.7 million fine for Deutsche Bank.

There are many who thought the rule would never be enforced. After all, it applies to the subjective intent of traders, not any action that can be objectively assessed. While it is ironic that the first to be fined under the Volcker rule should be a German bank – Europe doesn’t have a Volcker rule equivalent – it is also comically obvious. Of course it should be Deutsche! Though the bank seems to have been fined for more of a philosophical paradox rather than a rule. We’re talking about a bank that represents pretty much all the troubles banks are facing in the post-crisis era. 

Not the spirit

It has already beenfound wanting for internal controls and IT failures. In fact it was Deutsche’s own admission of failings that led to the fine and was probably one of the reasons why it was just $19.7 million; that and the fact that it had not actually violated the rule’s main component, engaging in proprietary trading. Rather, it was fined for not having the correct procedures and infrastructure in place to assess whether or not its traders were following the spirit of the rule.

The Volcker rule was always meant to be a simple regulation, albeit one that tried to define a discrepancy many still think cannot be made. It became, as these things do in politics, a highly complex rule that nonetheless retained the vague fulcrum it balances on: proprietary trading is bad, market making is good. 

That the Fed fined Deutsche for not having the systems in place to comply with the Volcker rule is interesting for two reasons. First, it is likely the regulator wanted to get one enforcement action done before the US Congress has a chance to revisit Dodd-Frank and potentially repeal or water down the rule. This is the regulator proclaiming it intends to take Volcker seriously. Congress has already begun debating the rule, which, as probably the most controversial of items under Dodd-Frank, is seen as among the most vulnerable to an attack by Trump’s anti-Dodd-Frank initiative. 

Second, while one can imagine that a bank could be fined retroactively for violation of the rule, it hasn’t happened yet because it is so difficult to objectively prove infringement. But the Fed got round that problem ingeniously. Regulators are often criticized for only getting to the bottom of a problem after the damage has already been done. In the Volcker rule, the Fed has a regulation that is quite difficult to assess violations of after the fact. Instead, it has gone for the processes and infrastructure that are supposed to help keep the bank from violating the rule in the first place.

But, given the Fed’s implied statement of intent here, that could well change. Indeed, it is easy to imagine banks subject to Volcker enforcement in the future looking back on this fine enviously. Those banks that do have sufficient controls and documentation procedures in place will be even more vulnerable if there is anything like another ‘London Whale’ incident, simply because, by the Fed’s reasoning, they should have caught it themselves. 

Easy enforcement

Retrospective enforcement will be particularly easy for regulators, since egregious losses, regardless of what the subjective intent of a given trader is, are easily painted as the effect of negligence, greed and irresponsible risk-taking. Since the key component of the Volcker rule – the ban on proprietary trading – is essentially a rule against subjective intent, it is probably pretty easy to enforce if there is enough political will to do so. 

Lawmakers rolled out legislation to kill the Volcker rule in April.

But even if only amendments to the rule get passed – which is still not certain – banks can be sure that the Fed intends to do what it can to make sure Volcker’s regulatory legacy remains intact.

For a while it seemed like the Volcker rule wasn’t really going to be a big problem. But don’t let the size of the Fed’s fine on Deutsche Bank fool you. This is the regulator telling banks they mean business. And if there is one sector in which business has been good in recent years, it is regulatory enforcement.

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