Volcker Rule
Quick Definition
A provision of the Dodd-Frank Act that restricts banks from engaging in proprietary trading and limits their investments in hedge funds and private equity.
Key Takeaways
- Prohibits banks from proprietary trading — trading for their own profit
- Limits bank ownership in hedge funds and private equity to 3%
- Named after former Fed Chairman Paul Volcker
- Part of the Dodd-Frank Act (Section 619), effective April 2014
- Exempts market-making, underwriting, hedging, and government securities trading
What Is Volcker Rule?
The Volcker Rule, named after former Federal Reserve Chairman Paul Volcker and codified as Section 619 of the Dodd-Frank Act, prohibits banking entities that benefit from federal deposit insurance or Federal Reserve lending facilities from engaging in proprietary trading (trading for the firm's own profit rather than on behalf of clients). The rule also restricts these institutions from owning, sponsoring, or having certain relationships with hedge funds and private equity funds, generally limiting ownership to 3% of a fund's total ownership interest and 3% of the bank's Tier 1 capital. Certain activities are exempt, including market-making, underwriting, hedging, trading in government securities, and insurance company investments. The rule took effect in April 2014 and was simplified in 2020 to provide greater clarity on permitted activities.
Volcker Rule Example
- 1After the Volcker Rule took effect, Goldman Sachs shut down its proprietary trading desk and redeployed traders to client-facing market-making roles.
- 2A bank reduced its private equity fund investments to comply with the Volcker Rule's 3% ownership cap, divesting over $2 billion in fund stakes.
Related Terms
Dodd-Frank Act
Comprehensive financial reform legislation enacted in 2010 to reduce systemic risk and protect consumers after the 2008 financial crisis.
Glass-Steagall Act
A 1933 law that separated commercial banking from investment banking to reduce conflicts of interest and protect depositors.
FDIC
Independent federal agency that insures bank deposits up to $250,000 per depositor, per institution, and supervises financial institutions for safety and soundness.
SEC (Securities and Exchange Commission)
The primary U.S. federal agency responsible for regulating securities markets, protecting investors, and enforcing federal securities laws.
Compliance Officer
A professional responsible for ensuring a financial institution adheres to all applicable laws, regulations, and internal policies.
Insider Trading
The illegal practice of trading securities based on material, non-public information obtained through a position of trust or confidence.
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